chapter 4

Business Environment

BMI VIEW
Malaysia has one of the most open, investmentfriendly economies in South East Asia. Corruption is improving and there are few regulations for new businesses, although the number of foreign contracts available may be falling.

BMI Core Scenario

Malaysia will remain one of the easiest places in Asia in which to do business. It has a reasonable record on transparency, the rule of law will remain strong, and starting a business will continue to be simple and quick, with few restrictions except for those on the recruitment of labour. However, the opportunities available for investors are not certain. Foreign ownership in several sectors remains restricted and the government is also trying to cut back on large state-funded projects.

SWOT Analysis Strengths

Standards of corporate governance have improved much in Malaysia since the Asian financial crisis at the end of the 1990s more so, in fact, than in many neighbouring countries. Foreign companies, or at least foreign manufacturing companies, looking to do business in Malaysia, will continue to be welcomed with open arms with the government offering lavish tax breaks and concessions.

Weaknesses
State subsidisation of prices will remain a peripheral but persistent part of daily economic life in Malaysia. Doing business in Malaysia will always, to some extent, mean dealing with the politically wellconnected. Big construction projects and big contracts for foreign construction firms are unlikely to be as much of a priority for Malaysias government as they were under the previous administration of former prime minister Mahathir Mohamad.

Opportunities
The opportunity to invest in Malaysian state assets could improve. The government, if it sticks to its word, will conduct its biggest ever divestment of state shareholdings. Malaysia is eager to compete globally in banking and although it currently lacks a domestic champion, with ten main institutions in the market, bank consolidation is a strong possibility.

Threats
The waterways and shipping lanes that surround Malaysia will continue to pose the threat of piracy and terrorism. Malaysia is at risk, conceivably, of losing out to China in the race for foreign investment. Penang, once the pillar of Malaysias electronics industry, has seen an exodus of foreign firms, with Seagate, Motorola and Solectron all shifting production elsewhere in Asia.

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BMI Business Environment Risk Ratings

Following a meeting with foreign and local fund managers, at which the bureaucratic delays involved in the issue of licences and permits was criticised, the Finance Ministry has established a cabinet to fast-track approval of important projects. The committee will meet weekly, if required, and should greatly reduce the red tape that has been frustrating would be investors.
Business Environment Singapore Hong Kong New Zealand Australia Japan Taiwan South Korea Malaysia Thailand China Philippines Vietnam Sri Lanka India Indonesia Cambodia Laos Bangladesh Pakistan North Korea Myanmar Regional Average: 52.5 82.8 81.3 79.8 78.4 75.4 69.5 68.4 63.9 56.1 51.6 47.3 43.6 42.7 40.6 40.6 35.3 35.1 33.8 31.2 24.7 19.9 Emerging Market Average: 45.0 Rank Trend 1 = 3 = 4 = 5 = 8 15 = 18 = 28 = 40 = 55 = 67 = 77 = 80 = 88 = 88 = 104 = 105 = 110 = 116 = 129 = 131 = Global Market Average: 48.7

Risk Interaction Diagram

BMIs Risk Interaction Diagrams give a more informative picture than the composite rating of the information conveyed jointly by the political and economic ratings. One problem with the composite, which is an unweighted geoChina South Korea 100 metric mean of the short-term 90 Thailand Singapore political and short-term eco80 Hong Kong nomic ratings, is that a misleadIndia 70 Malaysia Indonesia ing picture can be presented if Vietnam Pakistan 60 Philippines Sri Lanka the two components are widely 50 Cambodia Bangladesh different. In the Risk Interac40 30 tion Diagram, the short-term poLaos 20 litical rating is plotted along the 10 horizontal axis, the short-term 0 economic rating along the ver0 10 20 30 40 50 60 70 80 90 100 Short-term political rating tical axis. The averages for all countries rated by BMI are in- Axes cross at emerging markets average dicated by horizontal and vertical broken lines. Countries in the top right quadrant, therefore, have above-average ratings. The more equally balanced countries appear along the diagonal of the quadrant.
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MALAYSIA Q1 2007

Legal Framework
Overview
Malaysian law is founded on English common law. The country has a single-structured court system consisting of superior courts and subordinate courts. The subordinate courts are the Magistrate Courts and the Sessions Courts; superior courts comprise the two High Courts one for Peninsular Malaysia and the other for the States of Sabah and Sarawak the Court of Appeal and the Federal Court. The Federal Court, which has ultimate jurisdiction in constitutional matters, reviews decisions referred from the Court of Appeal.

Independence Of The Judiciary

The constitution nominally affords the judiciary full independence, but in practice the court system has been subject to political influence. The judiciarys independence was undermined during the 1980s, under Mohammed Mahathirs premiership. After a dispute over a court ruling on a political leadership race, Mahathir proposed amendments to the constitution which withdrew the power of judicial review from the High Courts and ended the separation of executive and judicial power. The acquittal in 2004 of former finance minister Anwar Ibrahim is a pointer to growing judicial confidence, in the post-Mahathir era.

Effectiveness Of System
Transparency levels are relatively strong and the legal system is seen as relatively supportive, furnishing investors with sufficient powers of redress to feel comfortable. Cases of disputes involving foreign investors are rare and the legal system has tended to handle claims amenably. If the local judicial system fails to resolve a dispute, it is referred to the UNs International Centre for Settlement of Investment Disputes. The Kuala Lumpur Regional Center for Arbitration also offers international arbitration for trade disputes.

Property Rights
Malaysian law ensures adequate protection of private property. Since 1998 all foreigners and foreign businesses can purchase all types of property in Malaysia, costing more than MRM250,000. The purchase of any property by foreigners/foreign owned companies requires the prior approval of the Foreign Investment Committee.

Intellectual Property Rights

Malaysia is in the process of bolstering its IPR protection, with new laws and improved enforcement. A special government task force has led a crackdown on piracy, with a further 700 enforcement officers added in 2006 in addition to the 1400 existing staff. In early 2005 the Ministry of Domestic Trade and Consumer Affairs warned 65,000 corporations to validate their software before end-May 2005 or risk enforcement raids. The International Intellectual Property Association estimates that piracy caused industry losses in Malaysia of US$188mn in 2004. The association estimated 2004 piracy rates at 63% for business

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software. In 2003 Malaysia amended its laws to allow it to join the Patent Cooperation Treaty. It is also party to the WTOs Trade Related Intellectual Property (TRIPS) agreement.

Corruption/Red Tape
Corruption is a key concern, despite substantial efforts from the government to crack down on bribery. Foreign businessmen are asked to report any individuals who ask for payment in return for government services, and bribes are not tax deductible. However, there are concerns that the governments anti-corruption drive is running out of steam. For example, the government has yet do deliver on recommendations from an April 2005 royal commission on police reform. Bureaucratic red tape is a concern, with one of the biggest bugbears being the difficulty foreign companies have in securing work visas for expatriates. However, Malaysia is in some ways better placed than other countries in the region. World Bank data shows that it takes just 30 days to start a business in Malaysia, against an average of 61 days in East Asia.

Labour Force
Size
Malaysias labour force numbers 10.67mn, a participation rate below 50%. Unemployment is low at 3.6%.

Structure
Most Malaysians are employed in the services and industry sectors, with agriculture accounting for 15% of jobs. The rapidly growing economy has led to increased demand for skilled labour. The shortage of skilled workers is expected to remain a long-term problem, especially given the shift in production to higher-value-added products and more sophisticated processes. The manufacturing and construction industries have traditionally relied on imported unskilled labour from Indonesia and other Southeast Asian countries. TABLE: DEMOGRAPHIC INDICATORS (2005)
2000 Dependent population, % of total Dependent population, total Active population, % of total Active population, total Youth population, % of total Youth population, total Pensionable popn, % of total Pensionable popn, total
Source: World Bank

2005 36.99 9,473 63.00 16,132 32.38 8,291 4.62 1,182

2010 34.39 9,526 65.61 18,175 29.37 8,135 5.02 1,391

2030 33.07 11,511 66.93 23,294 22.90 7,969 10.18 3,542

38.10 8,866 61.90 14,404 34.00 7,911 4.10 955

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Periodically, Malaysias government introduces measures to protect the local Malay work force, for example by implementing freezes on hiring foreign workers. In 2005, the government forcibly repatriated all illegal workers in Malaysia, with up to 400,000 people removed. It still seems to have had little effect by the end of May 2005, total registered foreign workers numbered 1.62mn, which represents a 10.2% increase over 2004.

Regulation
The Malaysian labour force is comparatively lightly regulated judging by the World Banks Employment Laws index. There are no nationwide or industry-wide standards for fixing wage rates, and there is no legal minimum rate. Affirmative-action policies oblige firms to employ bumiputras (Malays and other indigenous peoples) at all levels in proportions reflecting the local ethnic composition. The government also rigorously monitors hiring practices to ensure that all foreign employers strive to meet guidelines designed to ensure a racial balance in employment. All foreign-invested firms are also required to set up training programmes for their Malaysian staff.

Industrial Unrest/Strikes
Malaysia enjoys stable industrial relations, with a tradition of consensus between management and labour. Trade union rights are heavily circumscribed. Strikes are actively discouraged and many disputes are arbitrated through an industrial court (though many cases can remain stuck in the court process for years). Once a case is referred to the industrial court, workers are forbidden to engage in industrial action. As a result, strikes are very rare in Malaysia. National trade unions are proscribed, although there are a number of national confederations of trade unions and in-house unions at individual companies. There are no unions representing workers in the electronics sector. Furthermore, high-ranking union leaders and their organisations are forbidden from engaging in political activity. TABLE: EMPLOYMENT INDICATORS
1998 Economically active pop, 000 - % change y-o-y - % of total population Employment, 000 - % change y-o-y - male - female female, % of total Tot employt, % of labour force Unemployment, 000 - male - female - Unemployment rate 8,884 3.67 40.45 8,600 0.35 5,719 2,881 33.50 96.80 284 185 99 3.20 1999 9,152 3.02 40.70 8,838 2.77 5,851 2,987 33.79 96.57 314 212 101 3.40 2000 9,616 5.08 41.81 9,322 5.48 6,086 3,236 34.71 96.94 287 183 104 3.00 2001 n/a n/a n/a 9,357 0.38 6,056 3,301 35.28 n/a 342 212 130 3.50 2002 n/a n/a n/a 9,543 1.98 6,142 3,401 35.64 n/a 344 211 133 3.50 2003 n/a n/a n/a 9,870 3.43 6,324 3,546 35.93 n/a 370 236 134 3.60

n/a = data not available. Source: ILO

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Foreign Investment Policy

Overview
Following the economic slump of the late 1990s, the encouragement of FDI is now a major plank of government policy. The manufacturing sector is particularly open to investment. However, foreign ownership in several sectors is restricted and the government maintains the right to approve individual investments. High import tariffs are applied to protect some industries, notably vehicle manufacture. The countrys privatisation programme has slowed and has even been reversed in some cases national air carrier MAS was renationalised, for example. The government promotes the use of the bumiputra principle, which encourages partnerships with local partners to better reflect the countrys ethnic composition. FDI inflows are on an upward trajectory, with US$4.2bn committed in 2005, a rise of US$700mn over the previous year.

FDI Regime
Malaysia is open to FDI, especially in manufacturing for export and in hi-tech industries. The Malaysian Industrial Development Authority (MIDA) vets all proposals for manufacturing projects. Investment in other sectors is handled by relevant agencies. TABLE: ASIA, ANNUAL FDI INFLOWS
2003 US$bn Australia China Hong Kong India Indonesia Malaysia Pakistan Philippines Singapore South Korea Sri Lanka Taiwan Thailand Vietnam
Source: UNCTAD, BMI.

2004 Per capita 352.5 41.2 2,003.5 4.0 -2.7 101.2 3.6 4.3 2,211.1 79.8 11.9 20.0 30.9 17.7 US$bn 42.59 60.63 34.03 5.34 1.02 4.62 0.95 0.47 16.06 7.69 0.23 1.90 1.06 1.61 Per capita 2,137.2 46.4 4,932.6 5.0 4.6 185.8 6.4 5.7 3,761.1 161.3 11.9 82.9 16.7 19.4

6.96 53.51 13.62 4.27 -0.60 2.47 0.53 0.35 9.33 3.79 0.23 0.45 1.95 1.45

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The regulatory framework for investments is laid out in the Promotion of Investments Act of 1986 (PIA) and the Industrial Coordination Act of 1975. A more concise framework has been promised. Total foreign ownership is now permitted in the manufacturing sector. In 2003, a requirement for manufacturers to export a minimum proportion of output was removed. In many sectors foreign stakes are restricted and joint ventures are the norm. Incentives are provided in selected industries. For example, foreign investors in the Multimedia Super Corridor (MSC) hi-tech investment zone near Kuala Lumpur benefit from tax and regulatory breaks. Biotechnology and tourism are among other sectors where FDI is actively pursued with incentives. Areas were FDI is not aggressively sought include financial services, agriculture and construction. Foreign investment in the oil and gas industries is also restricted and is arranged mainly through production sharing agreements. Since 1998, foreign investors have been permitted to hold up to 61% of telecoms companies. Foreign entities can also hold 70% of shipping companies, 51% of insurance firms and 49% of forwarding agencies. Domestic earnings by foreigners, including salaries, interest payments, and dividends, may be transferred to foreign currency and repatriated abroad. Malaysia is a member of the World Intellectual Property Organization (WIPO), the Berne Convention and the Paris Convention for the Protection of Industrial Property.

Leading Sources And Sectors

The US, the UK, Japan and Germany are consistently among leading sources of foreign investment in the Malaysian economy. Sectors attracting the biggest FDI flows include oil and gas, manufacturing and financial services.

TABLE: MALAYSIA, ANNUAL FDI INFLOWS

2000 Inward FDI, US$bn - % change y-o-y - FDI as % of GDP - FDI per capita (US$)
Source: UNCTAD, BMI.

2001 0.6 -85.4 0.6 23.6

2002 3.2 478.3 3.4 133.6

2003 2.5 -22.8 2.4 101.2

2004 4.6 87.0 3.9 185.8

3.8 4.2 164.7

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Foreign Trade Regime

Overview
As one of the developing worlds larger manufacturing and exporting economies, Malaysia is aiming to boost its position through a series of free trade agreements and by making its tariff regime more attractive. However, Malaysias import licensing system is not seen as totally transparent and has been used to protect domestic industry.

Trade Agreements
Malaysia has been a member of the WTO since its creation in 1995. The country is also a member of the ASEAN Free Trade Area (AFTA), where the tariff regime is currently being overhauled. Founding members Malaysia, Indonesia, Singapore, Thailand, the Philippines and Brunei have agreed to cut import duties to 5% or less by 2010. (Later members Vietnam, Laos, Burma, and Cambodia are to do the same by 2015.) Trade agreements are also being negotiated bilaterally and/or in conjunction with ASEAN with Australia, China, India, Japan, Korea, New Zealand, Pakistan and the US. The EU said in mid-2005 it was also considering an FTA with Malaysia.

Tariffs/Non-Tariff Barriers
The government has been gradually lowering tariffs over the last decade. Tariffs tend to be lower on raw materials and higher on processed goods or those with high value-added content. Malaysia adheres to the Harmonised Tariff System (HTS) for the classification of goods. Import duties are in the 0%-50% range. The top end of the scale applies to luxury goods and protected sectors. Around a fifth of Malaysias tariff categories are also subject to import licensing intended to protect industries considered sensitive or strategic. Sectors to which import licensing mainly applies are the automotive, construction equipment, forestry and logging, agriculture and minerals businesses. TABLE: TOP EXPORT DESTINATIONS, US$MN
2000 United States Singapore Japan China Hong Kong Total exports Top 5, % of total 20,162 18,050 12,780 3,028 4,440 98,153 59.6 2001 17,816 14,913 11,770 3,821 4,063 88,198 59.4 2002 18,826 15,958 10,530 5,253 5,307 93,385 59.8 2003 20,540 16,523 11,222 6,810 6,784 104,966 59.0 2004 23,749 18,994 12777 8,460 7,549 126,507 56.5 Q105 6,456 5,866 3,477 3,955 2,025 36,732 59.3

Source: IMF, Direction of Trade Statistics.

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Import duties on vehicle imports were cut in 2004 and 2005, however excise duties on vehicles were increased leaving the overall tax on them unchanged. Domestic vehicle producers receive a 50% rebate on excise tax. A sales tax of 10% is charged on most imported goods (see below), but it is not levied on machinery used in export-oriented production. Almost all Malaysian goods covered by the AFTA Common Effective Preferential Tariff (CEPT) scheme are subject to duties of less than 5%; of these products, around two-thirds are subject to zero tariff. Malaysia benefits from generalised system of preferences (GSP) advantages from the EU and others, including the Russian Federation and Switzerland. Malaysia has Free Zones (FZs) for export-oriented production and warehousing. These are split into Free Industrial Zones (FIZ), for manufacturing and assembly, and Free Commercial Zones (FCZ), for warehousing commercial goods. Those operating in FZs must use mainly imported inputs and export 80% or more of their production.

Tax Regime
Overview
Malaysias tax regime is seen as fairly typical of its regional peer group of countries. The current sales tax and service tax are to be replaced by a new goods and services tax in 2007. There are also plans to reduce individual and corporate taxation in 2007.
Corporate tax: The main corporate tax rate is 28%. A lower rate of 20% applies to the first MYR500,000 of income for firms with capital of under MYR2.5mn. Tax is payable only on income from Malaysia for both residents and non-residents. Lower rates are payable in the Labuan offshore financial centre. An equalisation tax is deducted from dividends paid by companies.

Individual tax: Residents are taxed at progressive rates up to 28%. Non-residents are taxed at a flat rate of 28%. Tax is payable only on income from Malaysia for both residents and non-residents. Remittances from foreign sources into Malaysia by resident or non-residents are not taxable.

Sales tax: The standard rate is 10%. A 5% rate applies to some foodstuffs, building materials and timber. A 15% rate applies to beer, wine and cigarettes. There is no sales tax on computers and computer components, basic medical equipment, bicycles, mineral products and some food items. A 5% service tax is payable on some goods or services. All manufacturers and importers are subject to the sales tax, where applicable.

Capital gains: Gains from the sale of property or shares in a property company are taxable at 0%30%. The 30% rate applies to resident companies and individuals if a property is sold within two years of being bought. A 20% rate applies if the period is two to three years. A 5% rate applies if it is three to five years. Companies also pay 5% on property owned for over five years, but individuals are exempt.

Withholding tax: This is levied on 10% of royalties and technical fees, and 15% of interest.

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