New Malaysia PM inches forward on economic reform

Malaysian Prime Minister Najib Razak's plan to allow foreigners 100 percent ownership of some service companies was greeted with a yawn by markets on Thursday, but it may not be the end of the road for the country's controversial race-based economic policies.

The Malaysian ringgit barely moved and the main Kuala Lumpur stock index was just 0.78 percent higher a day after Najib, in office since just April 3, announced the end of quotas for ethnic Malays in some areas of the economy.

Race-based quotas are the cornerstone of Malaysia's economic, and social policies, spelling which political party you join, which business you can own and which university you can attend.

In his announcement, Najib avoided using the word Malay or referring to the so-called "bumiputra" policy -- which means "sons of the soil" -- that says the Malay and indigenous populations must own 30 percent of business equity for fear that he would antagonise his voter base.

He faces a similar balancing act next week when he is due to announce a liberalisation of the financial sector and risks incurring the wrath of Malays, the core of his United Malays National Organisation party, or pitch less ambitious reform.

Najib's predecessor, Abdullah Ahmad Badawi, backed off reform under pressure from the party and influential ex-premier Mahathir Mohamad.

"On one hand, he has to grapple with the dire implications of the impending economic recession. On the other hand, he has to keep the party happy," said Terence Gomez, a professor at the University of Malaya economics and administration facility.

"The party is concerned about any relaxation of affirmative action in all segments of society, not just the economy."

Ideas on financial reform range from opening up the ATM network to foreign banks to allowing foreign insurance companies greater market access.

The fact that Najib has to push reform at all is a sign of how tough things have become economically.

"The last time a liberalisation of this magnitude was announced was during the Asian financial crisis, when the 30 percent bumiputra ownership was scrapped for manufacturing," said Citigroup economist Kit Wei Zheng.

The government that has ruled Malaysia for 51 years has kept a lid on tensions between races in this Southeast Asian country of 27 million people by promising a bigger slice of the economic cake for all.

When the economy has grown strongly, quotas have allowed Malays to catch up with the richer ethnic Chinese population while at the same time ensuring they too grew wealthier.

But the cake is not growing as quickly as promised and the country that is Asia's third largest exporter after Hong Kong and Singapore has been hit hard by the global downturn, with exports dropping 15.9 percent from a year ago.

During the 10 years of the second Malaysia industrial plan to 2005, economic growth averaged 4.6 percent a year compared with a target of 7.9 percent a year as the country was buffeted by the 1998 Asian financial crisis, its last major recession.

The third industrial plan, under which Malaysians have been promised their country will become as wealthy as rich western nations by 2020, envisioned average annual growth of 6.3 percent.

That growth target has been hit just once and if the economy contracts by one percent this year -- the bottom end of government forecasts -- annual average growth from 2006 will be 4.14 percent.

As Malaysia's budget deficits have risen and political uncertainty has grown, portfolio investors have fled, withdrawing 33.2 billion Malaysian ringgit ($9.15 billion) in the third quarter after 56.2 billion in the second.

Its markets are perceived as more risky than Thailand where there are street protests and investors demand a yield of 3.524 percent to hold the country's five year bonds versus 2.28 percent for its neighbour.

BRAVER THAN PREDECESSOR

Even though Najib's announcement to free up investment in 27 areas in health, tourism, transport, business services, social and computer-related businesses did not affect a huge chunk of Malaysia's economy, it was significant.

Former premier Abdullah backed down on plans to open up services after he was accused of selling the country to Singapore when he allowed unlimited foreign investment in some areas of the multi-billion dollar Iskandar development zone.

Iskandar is located in the Malaysian state of Johor, next to the island state.

Zainal Aznam Yusof, an economist who is a member of the government's National Economic Council, believes Najib plans to go far beyond these few sectors if services are to account for 60 percent of the economy by 2020, up from 55 percent now.

"We need to bring in expertise, competitiveness, technology and therefore I would not be too concerned about the adverse impacts, if you can call them that, on bumiputra ownership," he said.

He noted that while the government was unlikely to end ownership quotas in the retail sector, where foreign hypermarkets such as Britain's Tesco and France's Carrefour have designs, there were other liberalising measures such as on opening hours and in distribution.

Given Najib's low popularity rating, which stands at just 41 percent in the most recent poll, he may have little room for manoeuvre in a political party that fears its hegemony could end in elections due by 2013 at the latest.

Whatever the promises, the reality may be business as usual with companies forced to employ ethnic Malays in any case.

"How will it be manifested when its played out on the ground?" asked Gomez from the University of Malaya. "Will it draw in investments, and will the government ensure that there is no covert from of enforcement of the bumiputra participation in all these ventures?"

($1=3.630 Malaysian Ringgit)

By Razak Ahmad and David Chance

KUALA LUMPUR, Apr 23 (Reuters) -