Maintaining its edge: Solid foundations help build maturity and diversity

At the heart of Malaysia’s growth story is the transformation of its industrial base from a resource extraction and export-driven economy to that of a high-tech, value-added manufacturing and services sector. As Malaysia increases its global trade via participation in trade agreements such as ASEAN and the Trans-Pacific Partnership Agreement (TPPA), enhancing efficiencies and competencies is becoming crucial for the country to maintain its economic edge.

These efforts are reflected in the government’s Economic Transformation Programme (ETP), launched in the wake of the 2007-08 global financial downturn and which focuses on building modern industrial sectors including electronic, chemical, biotechnology and health care industries, as well as expanding downstream applications for existing exports such as oil and gas and agriculture. A key contributor to the national economy, manufacturing accounted for 24.5% of Malaysia’s GDP in 2013, ranking it second only to the services sector (55.2%) and well ahead of mining (8.1%), agriculture (7.1%) and construction (3.8%), as per data from the Central Bank of Malaysia (CBM).

Although these priority sectors have been receiving encouraging levels of investment as a result of fiscal incentives and other enticements, a sluggish global recovery led to a slowdown in manufacturing exports in 2013 before rebounding in Q1 2014. At the same time, domestic demand has been surging as a result of high levels of government infrastructure spending, strong lending and rising consumer demand fuelled by civil-servant pay raises and cash handouts.

On The Mend

With 75-80% of manufacturing activity export oriented, the sector remains susceptible to global economic fluctuations as evidenced in the slowdown experienced in 2013. Export-oriented industries accounted for 74.8% of the manufacturing sector that year, led by the electronics and electrical products (E&E) cluster, along with other primary clusters of chemicals and chemical products, petroleum products, rubber products and off-estate processing. “China is still unable to compete with Malaysia in the production of rubber gloves and rubber products used in engineering and construction industries,” Lim Kuang Sia, CEO of Kossan, a local group producing rubber products, told OBG. “This is mainly due to the fact that Malaysian producers have stronger research and development (R&D) capability and a higher degree of automation in production, which reduces the reliance on manual labour and provides better consistency in product quality.”

Domestic-oriented industries were split relatively evenly between consumer-related clusters, which include transport equipment (primarily motor vehicles), and food, beverage and tobacco products. Together they accounted for 13.8% of manufacturing and 11.3% of construction-related clusters, according to the Department of Statistics Malaysia (DSM).

Overall manufacturing growth in 2013 stood at 3.4% and was driven largely by domestic-oriented industries as a result of robust private consumption and resilient construction activity, according to the CBM. Low demand for Malaysian exports was particularly challenging in the first half of 2013, during which manufacturing expanded by 0.3% and 3.3% in the first two quarters, with export-oriented industries registering growth of -0.5% and 1.8%, while domestic-oriented products picked up the slack, increasing by 2.4% and 8.3% in the first two quarters, respectively.

By The Numbers

Both foreign and domestic demand gathered momentum in the second half of 2013, owing to stronger sales for E&E products, with the former expanding by 4.2% in Q3 and 4.5% in Q4. Driven by demand for transport equipment, domestic manufacturing industries grew by 4.4% and 8% in the same period, leading to overall growth of 4.2% and 5.2% over the second half of 2013. As the global recovery continued into 2014, these gains were built upon growth rising to 6.8% in Q1 2014, which was broken down into 6.9% for exports and 7.2% for domestic goods. This was supported by E&E exports, particularly semi-conductors and domestic consumer-related clusters such as transport.

Capacity utilisation has also rebounded from lows in early 2009, when overall capacity fell to almost 50%, but which has remained relatively stable at around 80% since 2010. Domestic-oriented utilisation rates tend to fluctuate more with seasonality and were slightly lower at 75% in late 2013 compared to export-oriented factories, where capacity has remained steadier and posted a utilisation rate of 82% in second-half 2013.

Policy

In order to boost per-capita income and modernise Malaysia’s economy, a number of important reforms need to take place. Similar to many developing nations, Malaysia has relied on inexpensive labour, tax breaks and subsidies to attract investment and support domestic businesses. However, with trade barriers set to come down with the country’s inclusion into various trade agreements such as ASEAN and TPPA, the government must, at some point, push through key reforms to foster increased efficiencies from domestic companies. The linchpin of this success is creating an educated workforce with the skills needed to compete in more advanced high-tech industries.

“It will be a long process towards moving the economy towards a high value-added sector,” Stewart Forbes, executive-director of the Malaysian International Chamber of Commerce and Industry (MICCI) told OBG. “The three legs supporting this evolution are, first, improving innovation and skills of the domestic labour force through improved educational institutions and research. The second is growing government support for new start up ventures and small and medium-sized enterprises (SMEs) in need of capital. In the meantime, foreign workers need to be brought in to bridge the gap and provide necessary skills.”

One of the more relevant policy shifts for the industrial sector is the liberalisation of employment for businesses which recruit highly skilled foreign workers to fill positions in high-tech industries.

In a bid to make domestic industries more globally competitive, the government is seeking to make it easier for companies to bring in more employees with the ability to perform the tasks they need rather than just meeting government quotas. In 2013 the authorities began to relax some long-term work permits targeting this sub-section, most notably by extending work permits to five years for qualified positions, up from two to three years previously, according to MICCI. In addition, a 10-year work permit is now tied to an individual rather than to a business, giving employees more freedom to move between companies, while higher ranking executives such as CEOs are also allowed the extra benefit of a spousal work privilege.

Innovation

Further, in recent years specific government agencies have also been established to facilitate the growth of priority industries.

These include TalentCorp Malaysia, which was created in 2011 and is tasked with developing initiatives to build up skilled labour to meet the needs of the country’s economic transformation. This is based on the creation of local education and training programmes, building up a pool of foreign talent and recruiting Malaysians currently working overseas to return home.

The Malaysian Innovation Agency (MIA), meanwhile, was set up in 2010 to help stimulate the expansion to the SME segment in the country. The body is responsible for increasing the linkages between the government, Rakyat, academia and the private industry. In addition, the initiatives of the MIA also include exposure to innovation at early levels of education via the i-THINK, International Baccalaureate and Genovasi programmes, formulation of a national biomass strategy, a food industry innovation platform and the creation of a national innovation index to measure the performance of government-linked companies.

With the most domestic banks generally risk-averse to lending to SMEs, the government is also taking direct equity stakes of qualified new enterprises (generally for a period of two to three years), while reaping an internal rate of return of up to 25%, according to MICCI.

Investment

As the global economic recovery begins to accelerate, investment into Malaysia’s industrial sector is rebounding from an off year, with the country attracting 29% more approved capital inflows in 2013 than the previous year. All in all, the Malaysia Investment Development Authority (MIDA) approved a record RM216.6bn ($67.6bn) in direct investments for the country in 2013, spread over 5669 projects, a significant increase on the RM167.5bn ($52.3bn) seen in 2012, according to MIDA. Approved foreign direct investment (FDI) rebounded strongly in 2013, spiking 24% on the year to RM38.8bn ($12.1bn) compared to RM31.1bn ($9.71bn) in 2012.

The services sector represented around two-thirds of investment on the year, at RM144.7bn ($45.2bn), with the manufacturing sector accounting for RM52.1bn ($16.3bn), or 24.1% of the total, with the remaining funds spent on the primary sector. Within the manufacturing sector, FDI accounted for nearly three-quarters of expenditure, some RM30.5bn ($9.52bn). Of this total, RM22.8bn ($7.11bn) was channelled into new projects, with the remainder going towards expansion and diversification efforts. The E&E segment accounted for most foreign investments, totalling RM8.5bn ($2.65bn) on the year, with one RM2.8bn ($873.8m) photovoltaic production plant accounting for the largest single outlay in the industry. Other industries with significant levels of FDI were basic metal products at RM4.4bn ($1.37bn), chemicals and chemical products with RM3.8bn ($1.19bn), petroleum products including petrochemicals with RM3.2bn ($998.7m), and food manufacturing at RM2.3bn ($717.8m).

Focus On Building Up

Many of the largest of these planned investments were in industries earmarked under the government’s ETP, with RM89.9bn ($28.1bn) of approved investments going to the 12 different National Key Economic Areas. One of the single biggest expenditures is being made by processor giant Intel, which is planning a new RM4.4bn ($1.37bn) global service centre focusing on R&D for semi-conductors and other computing devices. Other notable projects include Hershey’s new RM816m ($254.7m) chocolate and sugar confectionary plant, AB io Orthopaedics RM34.7m ($10.8m) surgical device plant, a new RM299m ($93.3m) chemical plant and R&D facility being built by Lhoist, a RM55m ($17.2m) optical electronics component plant and R&D facility by Inari South Keytech, and DFRAN Research Technologies’ new RM39.53m ($12.3m) R&D centre for electronic devices.

Staying Strong

Domestic manufacturing investments approved in 2013 totalled roughly RM21.6bn ($6.74bn), which accounted for 41.4% of the sector’s total, with the majority going towards new projects (RM15.3bn, $4.78bn). The transport equipment industry was the most attractive sub-sector in 2013, accounting for RM4.4bn ($1.37bn), or some 20.4% of the total investment, followed by petroleum products, including petrochemicals, with RM2.9bn ($905m); rubber products with RM2.8bn ($873.8m); food manufacturing with RM2.1bn ($655.4m); and chemical and chemical products with RM2bn ($624.2m).

The heavily industrialised states of Johor, Penang and Selangor were the most active in terms of new investment, with the three states comprising a total of 544 new projects, or 69% of all manufacturing investments. Johor received the greatest portion of investment in 2013, with RM14.4bn ($4.49bn); followed by Selangor, RM9.8bn ($3.06bn); Sarawak, RM8.3bn ($2.59bn); Penang, RM3.9bn ($1.21bn); and Sabah, RM3.4bn ($1.06bn); with the five states accounting for 77% of total investment approved in 2013.

Challenges

In spite of the gains made in 2013, Malaysia still has work to do in terms of attracting FDI. This is reflected in the decline of realised investment in the country’s ETP projects over the past three years. After starting out strongly in 2011, with RM179.2bn ($55.9bn) in investments spread over 110 projects, expenditure on ETP projects fell off sharply to RM32.1bn ($10bn) in 2012 and RM8bn ($2.5bn) in 2013.

According to A T Kearney’s 2013 “FDI Confidence Index”, which ranks countries on how political, economic and regulatory changes will affect FDI, Malaysia ranked last among the 25 nations included in the survey. This represents a significant decline from recent years in which the country placed among the top-10 in 2012, after being ranked at 21 a year earlier. The survey was not all bad for Malaysia though, with 24% of respondents displaying a positive outlook regarding their confidence in the country going forward, which compared to just 11% holding a negative view.

E&E 

Long the backbone of manufacturing exports, the E&E segment contributed almost an equivalent value to the manufacturing industry in 2013 (24.2%) as the entire domestic-oriented sub-sector (25.2%), according to data from the DSM. Even as export-oriented industries contracted by 1.3% in Q1 2013, electronics production expanded by 10.2% during the same period. This was before spiking 25.4% in Q4 compared to the same quarter the previous year, and recording an annual increase of 18.6% for 2013. The electrical products sub-sector fared less well, falling off by 9.2% year-on-year (y-o-y) in Q1, with a 5.1% decline for all of 2013. The E&E industry as a whole, however, still managed annual growth of 3.3%. As in other sectors, global and regional growth has maintained this momentum into 2014, with the sector expanding another 15.5% in Q1, led by electronics with growth of 19.8%.

From its beginnings as a labour-intensive industry in the early 1970s, the E&E industry has evolved into a major base for the global electronics industry and a significant contributor to the country’s exports and employment. As a key part of the ETP, the E&E sector boasts 20 entry point projects. These are intended to facilitate the development and manufacturing capability of a wide array of products, ranging from modern light-emitting diode lighting and semiconductors to electric vehicle components and solar panels. In all, the sector is projected to add 157,000 new jobs and generate RM53.4bn ($16.7bn) in GDP by 2020.

Diverse Offerings

The Malaysian E&E industry is subdivided into four sub-sectors: consumer electronics consisting of televisions, DVD players, electronic game consoles and similar goods; electronic components such as semiconductors, passive components and printed circuits; industrial electronics including multimedia and information technology products such as computers, telecommunication products and office equipment; and electrical products such as lighting and solar power components, as well as household appliances including air-conditioners, refrigerators, washing machines, vacuum cleaners and more.

By developing itself as a leading E&E manufacturer in the region, Malaysia has attracted major global producers to its shores. Important manufacturing and R&D investors include Sanyo, Sony, Texas Instruments, Agilent Technologies, Intel, Motorola, Philips, Western Digital, Inari South Keytech, Toshiba, Panasonic and DFRAN Research Technologies, among others.

Auto

Catering to both the domestic and export markets, the automotive industry continues to make strides in expanding its production capacity. More recently, the sector has been moving into higher value-added activities, including niche markets such as energy efficient vehicles (EEVs), as well as expanding its production base via increased assembly capacity and growth across the value chain. As of 2013 Malaysia ranked third behind Thailand and Indonesia in the ASEAN region in terms of total vehicle production and sales.

Annual investments in the automotive industry increased from RM700m ($218.5m) in 2009 to RM5bn ($1.56bn) in 2012, with 2013 investments totalling RM3bn ($936m) through October, as per data from the Malaysian Automotive Association (MAA). While production has increased in recent years as a result of greater demand, the sector was still operating at around 75% of capacity as of mid-2013, with the lowest rates of utilisation at the two large Proton plants.

After a slow start to 2013, in which transport manufacturing constricted by 1.6% in Q1, production then recovered strongly in the latter part of the year, with y-o-y manufacturing spiking 23.4% in Q4 for a cumulative annual gain of 13.8%, according to DSM data.

Driven by ongoing domestic economic growth and employment stability, this trend continued into 2014 with a Q1 expansion of 17.1%. Other contributing factors included the availability of low interest financing, the introduction of new models and seasonal promotional campaigns rolled out in the middle of the year.

Malaysia exceeded the 600,000-unit barrier again in 2013, with a total industry volume of 655,793 units, surpassing by 4.5% the previous record of 627,753 set the previous year, according to MAA statistics. The lion’s share of these were produced and assembled domestically, with 601,407 vehicles assembled in 2013. Passenger cars accounted for the bulk of these, with 543,892 rolled out along with 57,515 commercial vehicles. Within the passenger vehicle category, sedans maintained their position as market leader, accounting for 77.5% of autos followed by multi-purpose vehicles with 16.5%, four-wheel drive (4x4)/sport utility vehicles (SUVs) with 4.9%, and window vans adding another 1.1%. The 4x4/SUV market has experienced its strongest growth uptick recently, with production rising from 18,867 in 2012 to 28,465 in 2013.

Accounting for more than two-thirds of output, pickup trucks represented 67.7% of commercial vehicle production in 2013, followed by trucks (23.9%), panel vans (5.8%), prime movers (1.5%) and buses (1%).

Domestic Carmakers

Local carmakers Proton and Perodua continue to dominate the domestic market, accounting for more than half of all automobiles registered in 2013. Perodua led all car makes with 196,071 vehicles on the year, accounting for 29.9% of the total, followed by rival Proton with 138,753 vehicles, or 21.2% of the market. Toyota ranked a distant third with 91,185 vehicles (13.9%), followed by other regional competitors Nissan (8.1%), Honda (7.9%), Mitsubishi (1.9%) and Hyundai-Inokom (1.9%).

Looking forward, the EEV market should continue to expand due to a combination of extended import exemptions and other financial incentives, as well as rising fuel prices at the pumps, as the government moves forward with plans to cut energy subsidies.

There are a variety of vehicles within this sub-sector, which is defined as vehicles that meet a specific set of carbon emission levels (CO sumption rates (L/km). These include more conventional fuel-efficient internal combustion engine vehicles, in addition to newer technologies such as hybrids, electric vehicles and alternative fuelled vehicles such as compressed natural gas, liquefied petroleum gas, biodiesel, ethanol, hydrogen and fuel cell.

Since an emphasis was placed on EEVs in 2010, hybrid car sales in the country have accelerated rapidly from the baseline of 332 in 2010 to 15,355 by 2012, with another 6812 sold in 1H 2013, as per MMA data.

Expanding this sub-sector to cater to domestic consumers, while establishing Malaysia as the only EEV production centre in ASEAN, will be a crucial step for achieving MAA targets. These include producing 1.35m automobiles (1.15m of which are EEVs) by 2020, along with exports of 250,000 units per annum.

Chemicals

Capitalising on the downstream applications of Malaysia’s sizeable oil and gas reserves, and the financial clout of the state-owned energy group Petronas, the petrochemicals industry has also expanded rapidly in recent years.

Aggressive investment by both Petronas and other international energy and chemical companies has expanded both the capacity and variety of outputs in the sector, with Malaysian factories now turning out a raft of products including olefins, polyolefins, aromatics, ethylene oxide, glycols, oxo-alcohols, ethoxylates, acrylic acids, phthalic anhydride, acetic acid, styrene monomer, polystyrene and expanded polystyrene, ethylbenzene, polyvinyl chloride, numerous varieties of polyethylene, and polyethylene terephthalate resins.

Current production is based in three industrial complexes: Kertih, Terengganu (which produces ethylene, propylene, para-xylene, benzene and syngas); Gebeng, Pahang (which produces propylene and syngas); and Pasir Gudang-Tanjung Lnagsat in Johor (which makes ethylene, propylene and benzene).

Petronas and the privately owned Lotte Chemical Titan (LTC) of South Korea control the lion’s share of petrochemicals production in the country, with LTC operating two of Malaysia’s four ethylene plants, at a combined capacity of 720,000 tonnes per annum (tpa), according to the Malaysian Chemical Association.

The second-largest polyolefin producer in Southeast Asia, LTC also operates eight plants producing the chemical on two integrated sites in Pasir Gudang and Tanjung Langsat, Johor. Petronas operates the remaining two ethylene plants in joint ventures (JVs) with BP and Japan-based Idemitsu, with a combined capacity of 1m tpa in addition to a number of other JVs located at its Kerteh and Gebeng complexes.

Other prominent players from Japan, the UK, Germany and Taiwan, among others, include many of the world’s preeminent chemical companies, namely BASF, Dow Chemical, Royal Dutch Shell, ExxonMobil, Eastman Chemical, Mitsui, Toray Industries, Kaneka, Polyplastic, Dairen Chemicals and Thirumalai.

Most recently in 2013, French chemical group Arkema and South Korean biotechnology firm CJ Cheil Jedang teamed up to build a new $400m chemical plant to produce a key ingredient in poultry feed, named methionine, along with sulphur compounds for the gas and petrochemicals industries.

Going Forward

Growth prospects for the sector remain bright considering the plentiful availability of domestically sourced feedstock as a result of the substantial investment by Petronas. Indeed, the state operator is bolstering its production through aggressive development of new oil and gas plays, as well as refocusing efforts on marginal and maturing fields. Some of this new supply will be channelled towards new petrochemicals complexes, which are expected to have a combined projected price tag of RM65bn ($20.3bn). They include the Refinery and Petrochemicals Integrated Development (RAPID) in Johor and the Sabah Ammonia Urea (SAMUR) in Sabah.

The largest greenfield investment to date, RAPID will be located within Pengerang Integrated Petroleum Complex in Johor and will eventually house a 300, 000-barrel-per-day-capacity crude oil refinery, a 3m-tpa naphtha cracker and 22 downstream plants, with a combined output of 7.7m tpa upon opening in 2019. The SAMUR project, located in the Sipitang Oil & Gas Industrial Park, will house a fertiliser plant with a urea capacity of 1.2m tpa upon opening in 2015.

Outlook

With Malaysia’s natural resource base able to provide a wealth of inputs for downstream applications, in addition to the country’s strong base of supporting services, cost competitiveness and strategic location within ASEAN, the domestic manufacturing sector is well placed for further expansion. Continued economic growth should drive domestic demand for manufactured goods, while the slow but persistent recovery of the regional and global economy should help fuel a resurgence in export markets.

With the domestic economy projected to grow between 5% and 5.5% in 2014, private consumption is set to increase by 6.2%, with exports expected to rise by 2.5% due to improving external demand. Despite a wider slowdown in 2013, investments in key priority economic areas are likely to push the industry towards more high-value added and innovative industries, provided that Malaysia can attract or develop a technically skilled workforce that is capable of sustaining growth.