Major Misstep

On July 9, police in Kuala Lumpur broke up a rally in support of electoral reform, which the government had declared to be illegal, by arresting dozens of participants and using batons, tear gas, and water cannons to disperse a crowd estimated at more than 50,000. In the days leading up to the rally, police detained hundreds of people traveling to the capital for the protest, and arrested six lawmakers from the Socialist Party of Malaysia (PSM) on suspicion of plotting a coup.

The organizers of the rally, the Coalition for Clean and Fair Elections (Bersih), insisted that they had no intention of destabilizing Prime Minister Najib bin Abdul Razak’s government, and invited members of the governing National Front (BN) coalition to join them in demanding fair elections. In truth, the calls for electoral reform represented an implicit (and, in many cases, explicit) indictment of Najib’s United Malays National Organization (UMNO) and its BN allies, which Bersih contends have maintained heir decades-long hold on power through manipulation of the electoral process.

Predictably, the BN parties declined the invitation, while those belonging to the opposition People’s Alliance (PR) accepted, thereby reinforcing the anti-government tone of the demonstration. The polarizing effect of the rally was exacerbated by the organization of counter-demonstrations by the youth arm of UMNO and Perkasa, a non-party group formed after the 2008 elections to defend the special privileges that the majority Malay population (bumiputera) has enjoyed as a result of the political dominance of UMNO.

Under the circumstances, it was inevitable that the police crackdown would be perceived as an assault on democracy. That PR leader Anwar Ibrahim sustained injuries at the hands of police and the lone fatality was the husband of the head of a local branch of Anwar’s People’s Justice Party (PKR) reinforced the partisan nature of the clash.

The backlash was swift and strong, both at home and abroad. Najib initially responded to the criticism by complaining of “media distortions,” but in mid-August he announced plans to establish a parliamentary panel made up of representatives from the governing and opposition parties to make recommendations for electoral reforms. Bersih leaders commended the prime minister for his decision, but many Malaysians were skeptical, some even speculating that the move was nothing more than a public-relations ploy and that Najib intended to call a general election before any of the recommended reforms were actually implemented.

Logic Points to Early Election

Indeed, the possibility of an early election had been much discussed in Malaysia before the crackdown in the capital. When Prime Minister Najib took office in 2009, replacing the embattled Abdullah bin Ahmad Badawi, he carried with him an ambitious agenda for reform, including a proposal to scale back the affirmative-action program that formed the cornerstone of the New Economic Policy (NEP) introduced by the UMNO-led government in 1971. No election is required until March 2013, but it has been widely assumed that Najib would call an election well before then in order to obtain a mandate to implement his reforms.

Many signs pointed to Najib pulling the trigger in the second half of 2011, following mid-year elections in Sarawak, the country’s largest state and traditionally a bellwether of the national mood, assuming the BN put in a strong performance. In the event, the BN retained its two-thirds majority in the state assembly, but suffered a net loss of eight seats.

On balance, the BN’s performance was mediocre. But developments visible beneath the headline numbers revealed real reason for concern on the part of UMNO and its allies.

The BN’s share of the vote fell from 65% at the last election to just 55% this time around, in large part the result of a shift among younger voters to the opposition parties. If that trend were to carry over to a national level, the PR coalition could expect to build on its strong performance in 2008, when it won 82 seats, in the process denying the BN a two-thirds parliamentary majority for the first time since 1969.

Moreover, the opposition Democratic Action Party (DAP) gained six seats at the expense of the BN-affiliated Sarawak United People’s Party (SUPP). Both DAP and the SUPP compete for the votes of Malaysia’s ethnic Chinese community, and the DAP’s success suggests that the Malaysia Chinese Association (MCA), the second largest party in the BN, could face stiff competition for the nationwide Chinese vote in a general election. That is undoubtedly troubling for the MCA, which lost more than one-half of its 31 seats at the 2008 election, prompting party leaders to openly question the merits of remaining in the governing coalition.

A loss of 30 seats would cost the BN its majority. Although it is not expected to lose that many seats at the next election, a combination of electoral losses and the defection of disaffected parties such as the MCA could leave the UMNO-led coalition dangerously close to surrendering its majority status.

However, it is hard to see how the BN’s prospects might be improved by holding off on an election. The economy is slowing and is unlikely to rebound to any significant degree in 2012, and the expansion of the budget deficit in 2011 will limit the feasibility of generous additional pre-election spending next year.

Moreover, recent changes within the Pan-Malaysia Islamic Party (PAS), another member of the PR coalition, suggest that Najib might be better off seeking a mandate sooner rather than later. Traditionally, the PAS has been led by religious scholars (ulema), in keeping with the party’s goals of transforming Malaysia into an Islamic republic. However, at the party’s annual congress in early June, secular figures were chosen to fill most of the top leadership posts, a move that is clearly designed to broaden the appeal of PAS among moderates and non-Muslims.

The shift is important for two reasons. Although it is doubtful that non-Muslims will be convinced to take another look at PAS, the party might be to attract some moderate Muslim voters who have traditionally backed UMNO. In addition, it may promote stronger ties among the opposition parties, as the discomfort of DAP members with the religious chauvinism espoused by PAS has long been an obstacle to sustaining the unity of the PR.

By delaying an election, Najib risks giving the PAS and the PR time to exploit that potential. But now that he has launched the electoral reform process, an early election will leave him vulnerable to accusations that he is trying to pull a fast one on the Malaysian electorate.

Perhaps with that in mind, the prime minister doubled down on reforms in mid-September, announcing the repeal of the notorious Internal Security Act (ISA), which allows for the indefinite detention of individuals without charge or trial at the discretion of the Ministry of Interior. The opposition and human rights groups have long accused the government of abusing the ISA to silence criticism and undermine challenges to the BN’s dominance. Najib has indicated that other security laws will be repealed or replaced by less draconian measures.

Although the move fulfills one of the pledges Najib made back in 2009, the timing of the announcement suggests that UMNO leaders are anxious to call an early election, but they are not confident of winning, and are hoping that a favorable response to the overhaul of the security laws will improve the BN’s chances. If that is the strategy, a vote can be expected to come shortly after the new measures are in place.

Elections are typically scheduled to coincide with school holidays so that schools can be used as polling places. On that basis, an early election will most likely be held in November-December 2011 or March 2012.

Although the political winds are blowing in the opposition’s favor, the future of the PR remains uncertain, owing to the ongoing legal challenges of Anwar Ibrahim, the leader of the opposition in Parliament. A one-time rising star within UMNO, Anwar’s political career was derailed after crossing swords with former Prime Minister Mahathir Mohammad in the late 1990s. He was imprisoned for corruption and sodomy, but rather than neutralizing Anwar’s influence, the widespread belief that he was a victim of political persecution energized the reformist movement, giving rise to the formation of Keadilan, under the leadership of Anwar’s wife, Wan Azizah Wan Ismail.

His return to politics following his release from prison rejuvenated Keadilan, and he is widely viewed to be the glue that holds the PR together. Anwar is once again standing trial on sodomy charges, which, as in the late 1990s, he contends have been fabricated by his enemies in the government. The uncertainty surrounding Anwar’s legal fate is a handicap for the opposition, a factor that creates an incentive for Najib to call an election before a verdict is delivered.

Anything short of a convincing victory will limit Najib’s ability to move forward with plans to reform an affirmative-action program that has contributed to corruption and limits competition or press ahead with fiscal reforms—including a goods and services tax (GST) and cuts to a range of subsidies—that are sure to be unpopular. Unfortunately, while the BN is expected to avoid defeat, the likely further narrowing of the coalition’s legislative majority will exacerbate tensions within UMNO and among the BN partners, reducing the chances that Najib will be inclined to pursue any bold moves on the policy front.

Resilient Economy

Real GDP growth slowed to 4% (year-on-year) in the second quarter of 2011, following a modest acceleration of the pace of expansion to 4.9% in the first quarter of the year. The slowdown was largely attributable to the effects of disruptions in the regional supply-chain caused by the natural disasters in Japan in March.

Domestic demand will remain resilient as unemployment declines and inflation remains under control, and both private investment and public-sector spending (which is likely to increase as the government gears up for an election) will bolster the economy. Year-on-year growth over the second half of 2011 will be buoyed by the elimination of blockages in the supply chain and a favorable base effect, resulting in an annual growth rate of 5%. However, the potential for economic difficulties in Europe to trigger a sharp slowing of the global economy represents a significant downside risk to the forecast.

The consumer price index rose by 3.3% (year-on-year) in August 2011, pushing the average for inflation over the first eight months of the year up to 3.1%. The rise was largely attributable to the higher cost of food, energy, housing, and transportation, which accounted for more than 75% of the increase in August. Inflation concerns prompted monetary authorities to raise the benchmark overnight policy rate by a quarter-point to 3% in May, but further action is unlikely this year, as international developments result in a shift in policy focus from containing inflation to ensuring stable growth amid a weakening of external demand.

The ringgit has remained fairly steady against the dollar throughout 2011, but the risk of external shocks that trigger capital flight cannot be ruled out. In any case, the central bank will be well equipped to take aggressive action in the event of serious currency volatility that might contribute to imported inflation. International reserves currently amount to more than $130 billion, which is sufficient to finance about nine months of imports and is more than four times the short-term external debt. Consequently, the central bank will be able to intervene as necessary to ensure currency stability without undermining confidence in Malaysia’s external position. On balance, the inflation rate is forecast to increase only modestly, at most, over the remainder of the year, producing an average increase in consumer prices of 3.3%.

The disruption to Japan’s production of components used by Malaysian manufacturers had a negative effect on imports in the second quarter, but given the outlook for external demand, imports are likely to grow at a faster pace than exports over the second half of the year, resulting in a narrowing of the trade surplus. However, generally slower growth in 2011 will be accompanied by a narrowing of the income deficit, resulting in a somewhat larger current account surplus of $30.3 billion this year.