The government of Malaysia has set its sights firmly on growth in the coming years, intent on transforming the country from middle- to high-income status by 2020. Intent on doubling Malaysia’s GDP per capita to $15,000 and tripling its gross national income to $17,700 by 2020, Malaysia's government has been keen to emphasise that FDI will play a key role in its economic aspirations. Accordingly, the launch of the Malaysian Investment Development Authority’s (MIDA) new headquarters in July sent a clear message to foreign investors of the country's continuing support of their presence.

A major component of the government’s economic agenda is outward facing, as foreign investments have historically played a pivotal role in powering Malaysia’s growth. Malaysia’s open economy is a legacy of a country shaped by foreigners. Geographically split into two parts by the South China Sea, Malaysia is a product of successive waves of immigration from across Asia over the centuries. The country’s cosmopolitan capital, Kuala Lumpur, is a microcosm of Malaysia’s unique demography that mainly comprises Malay, Chinese and Indian cultures.

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Keen to capitalise on this, prime minister Dato' Sri Abdul Tun Najib Razak has presented Malaysia to investors as the gateway to Asia, in a bid to attract foreign companies. “Diversity is our strength,” says Raja Nong Chik Zainal Abidin, Malaysia’s minister of federal territories and urban wellbeing. “Historically, Malaysia has always been a trading nation and it is good location-wise. The people of Malaysia come from three of the major markets in Asia. [Within one] company, you could find someone who is from Malaysia, someone from China and someone from India. Plus, we have strong English skills to cover the English-speaking countries, as well as the Muslim countries.”

Investment initiatives

Located at the centre of the Association of South-east Asian Nations trading bloc, bordering a broad economic region of more than 1.5 billion people, the Malaysian government has presented the country to investors as a strategic point of access to the south-east Asian market. “Malaysia will leverage on its ethnic and cultural diversity to network strategically across the borders,” says Lee Heng Guie, regional head of economics at CIMB Investment Bank. “Asia is the centre of growth, and Malaysia is strategically located in Asia,” adds Zainal Amanshah, CEO of investment promotion agency Invest KL. “We have rich historical links with China, India and the Middle East, as well as strong relationships with the West.”

In its bid to fast-track Malaysia to the level of a developed country by 2020, the country's government has enacted a series of economic initiatives. The Economic Transformation Programme (ETP), launched in 2010, is its most comprehensive plan to date. With the goal of attracting investments into specific high-value-added sectors such as business services and information and communications technology (ICT), the ETP has been estimated by research and consultancy firm Oxford Business Group to require $448bn-worth of investments, 92% of which is expected to be private-sector funded.

“The ETP has identified 12 national key economic areas, from the oil and gas industry, to agriculture, financial services and transport,” says Mr Lee. “The quality of FDI matters rather than the quantity. Given the government’s push for economic transformation for Malaysia to move to a high-income growth economy, the investment policy will likely focus on the high-value-added creative and knowledge-based industries, such as high-tech, capital-intensive technologies.”

Satisfied customers

The announcement this year by business research and consulting firm Frost & Sullivan to set up a global innovation centre in Malaysia shows that foreign investors are responding well to the government’s initiatives. “Our main rationale for investing in Malaysia is to support the growth of Frost & Sullivan’s business in the Asia-Pacific region,” says Gary Jeffery, partner and director for Frost & Sullivan’s UK operations.

“We originated in North America and then grew into Europe and more latterly we have grown our business in Asia. Our Asia-Pacific business is our newest location with the highest potential [as] it is experiencing the fastest growth. A large element of what we are doing in Malaysia is offering frontline solutions to clients in the region. Frost & Sullivan is looking for consultants so we have a higher degree value addition in the roles we are looking for. Our strategy is to continue our growth in Malaysia, [and] to set up some global service centres.”

Frost & Sullivan’s new centre will employ 830 people by 2020 to develop the company’s thought leadership, as well as its intellectual property programmes. “We had a number of countries to choose from when we were making our decision, yet Malaysia was very high up our list,” says Mr Jeffery.

“We have had an operation in Kuala Lumpur for 12 years, [and] during our time we developed very strong links with government bodies in Malaysia, such as the Malaysian Development Council. There is a really thriving business culture in Malaysia. There is great economic potential, a very supportive government set-up and the government offers companies who are looking to invest in Malaysia good incentives.

"Also you have the cost competitiveness. For a consulting business such as Frost & Sullivan, our number one expense is payroll, and Malaysia offers significant savings in [comparison to] payroll costs in western Europe and North America. It is not the lowest cost, as there are places in the region [that are even cheaper]. However, Frost & Sullivan is looking for consultants, so for higher order roles, Malaysia offers significant benefits to the more mature Western economies.”

Offshoring aim

In line with its economic agenda to move into high-value-added production, the Malaysian government has worked towards establishing itself in the shared services and outsourcing industries through modernising its infrastructure and developing its talent pool, as well as improving its ICT resources. It appears its strategy is paying off, as an AT Kearney report, which ranked Malaysia as the world’s third most popular global services location, highlighted a growing trend of multinational companies offshoring business functions locating in Malaysia.

“We have witnessed some commendable progress in enhancing Malaysia’s competitiveness in the eyes of investors,” says Mr Lee. “In the areas of doing business, the government has streamlined cumbersome rules to make it easy for investors to start a business in Malaysia. There have been quite a number of improvements in our rankings in terms of competitiveness, cost of doing business and FDI confidence. For example, Malaysia moved up five places to number 18 in the World Bank’s ‘Ease of Doing Business’ report.”

Mr Amanshah says: “Renewed investor confidence in Malaysia has been seen in the increase in foreign investments. Between 2010 and 2011, Malaysia's FDI inflows increased by 12.3%. The key factors to the increasingly positive investor sentiment were the government’s transformation programmes.”

Middle-income trap

Yet for all its strengths, there are concerns that the government’s economic plans may not be sufficient to move Malaysia out of its ‘middle-income trap’. According to the Oxford Business Group, Malaysia is not moving quickly enough along the path of economic development. With a population of 28 million, Malaysia has in recent years received less attention from investors than neighbouring countries such as Indonesia, which has a population of 280 million. Additionally, the rise of China and India has undercut Malaysia’s competitiveness, and AT Kearney’s report reveals that the two Asian giants ranked first and second, respectively, ahead of Malaysia, as the world’s most popular global services locations.

Moreover, figures from greenfield investment monitor fDi Markets show that FDI inflows to Malaysia have not recovered to the levels seen during their peak in 2008. Instead, greenfield FDI projects have been steadily declining. Despite witnessing reasonable growth rates, the highly open economy of Malaysia was not spared the effects of the global financial crisis. Between 2003 and 2012, fDi Markets recorded 1565 projects worth a combined $105.6bn in Malaysia. Just over 14% of these projects were recorded in 2008, estimated to be worth $26.1bn. Contrary to official estimates, fDi's figures suggest Malaysia witnessed a steady decline in greenfield FDI, as the value of capital investments decreased from $15.5m-worth of investments recorded in 2010 to $13.6m in 2011.

“Being a highly open economy, Malaysia is not spared from the external environment, and looking at the recent data, it suggests that growth has started to ease,” says Mr Lee. “Last year, the Malaysian economy grew by 5.1% lower than 7.1% in 2010, largely dragged down by weak external demand. When looking at expected growth for this year, CIMB’s in-house estimates expect Malaysia to grow by 3.8%. Yet there is scope for further improvement to that number, given the recent signs of improvement in the US economy and some signs of stabilisation in the eurozone.”

Although credit rating agency Standard & Poor’s rates Malaysia’s foreign and local currency as stable, the country’s foreign currency received an A- rating. In its analysis, S&P maintains that Malaysia's export-oriented economy remains vulnerable to global economic conditions. Although the country’s GDP growth rebounded from a low of 1.6% in 2009 to 7.2% in 2010, S&P says the growth moderated to 4.8% in 2011.

“Since total sizeable trade, including the exports and imports, is 167% of the country’s GDP, Malaysia is one of those open and small economies that is vulnerable to the external environment, and it will definitely be affected by another global economic slowdown,” says Takahira Ogawa, primary credit analyst at S&P. “Though the first quarter [of this year] is already out [at] 4.7% growth, given the uncertain global economic condition, I think the pace of this growth might be a little slower at about 4.1% in 2012.”

Domestic growth

While Malaysia's government remains keen to court foreign investment, it has become increasingly aware of the need to seek other sources of growth, in order to reduce its dependence on FDI. Speaking at the opening of MIDA's new headquarters in July, the country's prime minister made public the government’s Domestic Strategic Fund, worth RM$1bn ($316m). Keen to generate growth internally through supporting Malaysian firms, the fund will function as an assistance package to enhance local firms’ technological capabilities.

Commentators have noted that the government’s move to promote internal growth is helping offset the slow decline in FDI through a growth in domestic consumption. “Domestic drivers will augur well for Malaysia because what we now see is a very resilient level of domestic demand, and this is providing the Malaysian economy with an economic insulator,” says Mr Lee. “Consumer spending remains resilient. It rose by 7.1% last year, and in the near term it will likely remain close to the 6% to 7% range. That represents about 51% of total GDP, and it could become an important catalyst that may drive the Malaysian economy over the medium term, underpinned by the re-energised private investment growth.”

The US and the UK have been the top two source countries that accounted for a majority of greenfield investment projects in Malaysia, according to fDi Markets. Thus, although the protracted economic slowdown in these countries has had a significant knock-on effect on Malaysia’s growth, Mr Amanshah at Invest KL maintains that the government’s progressive domestic policies will go some way in helping moderate these effects in the short-term.

“Though our exports will be affected by the slowing demand in the US, Europe and other parts of the world, domestic demand has been the main driver of growth for the past two to three years,” he says.

“Ten years ago, such a global economic development would have slowed our growth down to 2%. Yet we have focused on developing our domestic demand and economy, therefore we are more resilient today. The inflation rate, as measured by the annual change in the consumer price index, declined to 3.2% in the fourth quarter of last year. Going forward, the government has well-crafted domestic strategies embedded as part of the ETP plan, and this will create multiplier effects in the economy. Barring any other unforeseen circumstances, I am confident that we can expect full-year growth in 2012 coming in at 5%.”

The road to achieving developed-economy status is strewn with obstacles for Malaysia. Although it remains to be seen if the government will rise to the challenge, it appears that its sense of economic pragmatism may bode well for the country’s short-term growth prospects.