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On paper, Malaysia (NYSEARCA:EWM) has one of the emerging world's strongest economies. Its role as a commodity exporter and low cost manufacturer enables consistent trade surpluses of greater than 10% of GDP. Its currency, the Ringgit, has steadily appreciated against the US dollar since the 1997-1998 Asian financial crisis and the Malaysian central bank has one of the best track records in the emerging world. Malaysia also is the only country in Asia not to have either defaulted on its debts or to not have a year with greater than 20% inflation since its independence from the British Empire in 1963.

Malaysia shows economic promise, but I expect it to underachieve versus other ASEAN nations. The pluses in favor for Malaysia include greater disposable income within the domestic population, low housing and consumer prices, low unemployment, advanced infrastructure and low inflation. However, after a further analysis of economic data and my recent visit to the country, the economic outlook going into the future is not as strong as recent development may imply. Malaysia will still experience growth in the long run, but I do think it will be around world averages and will under perform its neighbors in Southeast Asia such as Vietnam, Singapore, Thailand, and Indonesia.

The reasons for Malaysia's future underperformance include a brain drain of skilled labor within the country's Chinese minority, a higher GDP per capita base needed for growth, growing Islamic extremism, and a poor track record of leadership since the retirement of Matathir Mohammad, the former prime minister who turned around the nation's economy during his twenty two years of service (1981-2003).

The issues of the brain drain along with entitlement amongst the ethnic Malay population are a product of affirmative action based policies that favor ethnic Malays in job placement, education, and entry in to politics. The Buminepetera system has institutional preferences granted to economically underperforming Malays and this has caused members of the Malaysian Chinese minority with education and capital to emigrate to other countries such as Singapore, Australia, China, the US, and Europe. Racial issues were the reason why Singapore was kicked out of Malaysia in the first place.

Malaysia peaked with the retirement of Matathir Mohammad in 2003. There still has been growth, but it has slowed down considerably since the Asian financial crisis. Infrastructure has declined slightly in Kuala Lumpur, but it is more noticeable in smaller cities such as Johor Bahru. From my observations visiting the country, it seems like the vast majority of construction was built fairly recently (10-15 years ago), but little maintenance has been done since. Economic numbers are currently good, but they are weakening. Unemployment has slightly ticked up and Malaysia posted a -3.2% GDP figure for the first quarter of 2012.

The culture has not caught up to infrastructure development, An example of this comes from the haphazard architectural designs of interiors of buildings. When observing the stores of a one of the largest mall in Malaysia (Berjaya Times Square, Kuala Lumpur), it lacks the top international brands and is filled with knock off products. Taxis do not use meters as a means to hustle tourists, and observance of traffic lanes disappears during rush hour.

Natural resource independence is strength for Malaysia, but at the same time its reliance on tin, palm oil, and crude exports may be a double edged sword. In a global slowdown demand for these products will decline and hurt Malaysia's economy. Palm oil is supposed to be more unhealthy than competing olive and soy based cooking oils, so a slowdown in palm oil demand may go beyond typical economic cyclicality.

Overall, Malaysia's economy looks stronger to foreigners reading its data than the actual change in living standards in the country. Human and financial capital flight are my main concern when it comes to the future of the country. Based on my experiences in Malaysia and meeting with Malaysian business owners in the region, the outlook is weaker than the government leads on.

I'm not saying that Malaysia is a weak economy; I just think that there are much better options (such as Indonesia, Thailand, Vietnam, or Singapore) to use that capital in other countries in the ASEAN region. Indonesia, Thailand, and Vietnam do not have the same intensity of ethnic tensions as Malaysia and also have lower income bases which eases growth. Singapore, on the other hand, has the advantage of being the economic, trade, and financial center of Southeast Asia due its strong rule of law and favorable business climate.

Source: Why Malaysia Will Underperform Against Southeast Asian Neighbors