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<ul><li><p>Navigating the emerging markets Malaysia Obstacles to success, offset, international relationships, procurement strategies, and defence industrial intelligence Guy Anderson Chief analyst, Janes Defence Industry 19 May 2011 </p></li><li><p>Malaysia Market summary Higher defence spending and greater procurement clarity can be expected, but significant challenges remain </p><p> Higher spending ahead: Malaysia is forecast*1 to commit US$28 billion to defence funding between 2010 and 2015 core spending will rise 48% over the five years </p><p> Spending Clarity: Publication of the 10th Malaysia Plan expected this year commitment to dedicate 10% of government revenues to defence and security spending. </p><p> Economic growth: Greater spending to be underpinned by relatively high economic growth of 5.8% pa (average 2010 to 2015)*2 </p><p>*1 Janes Defence Budgets Jdb.janes.com *2 IHS Global Insight </p><p>Challenges </p><p> Delayed procurement: A series of major programmes (from self-propelled howitzers to multi-purpose support ships) were delayed during the 9th plan. Commitment to focus capital expenditure on delayed programmes during the first two years of the 10th plan but will this leave adequate funds for latter years of the 10th plan? Offset greater demands: Malaysias offset regime to be overhauled during 2011 more arduous demands can be expected </p><p> Limited local capabilities: Meeting technology transfer and local participation demands will be challenging given limited capabilities of local industries </p><p> Politicised procurement and corruption: Major programme decisions often circumvent usual procurement routes. Allegations of improper conduct are not unknown </p></li><li><p>Malaysia In figures </p><p>1.00%</p><p>1.20%</p><p>1.40%</p><p>1.60%</p><p>1.80%</p><p>2.00%</p><p>2.20%</p><p>3</p><p>3.5</p><p>4</p><p>4.5</p><p>5</p><p>5.5</p><p>FY08 FY09 FY10 FY11f FY12f FY13f FY14f FY15f</p><p>Defence spending (USD bn) Defence spending as % GDP</p><p>-3.0%</p><p>-2.0%</p><p>-1.0%</p><p>0.0%</p><p>1.0%</p><p>2.0%</p><p>3.0%</p><p>4.0%</p><p>5.0%</p><p>6.0%</p><p>7.0%</p><p>8.0%</p><p>100</p><p>150</p><p>200</p><p>250</p><p>300</p><p>350</p><p>400</p><p>FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15</p><p>Nominal GDP (USD bn) Real GDP (% change)</p><p>Defence spending (US$ bn v expenditure as % GDP) </p><p>Nominal GDP (US$ bn) v real gdp (% change year on year) </p><p>IHS Global Insight Janes Defence Budgets jdb.janes.com </p></li><li><p>Malaysia Defence spending (trends) </p><p>1.00%</p><p>1.20%</p><p>1.40%</p><p>1.60%</p><p>1.80%</p><p>2.00%</p><p>2.20%</p><p>3</p><p>3.5</p><p>4</p><p>4.5</p><p>5</p><p>5.5</p><p>FY08 FY09 FY10 FY11f FY12f FY13f FY14f FY15f</p><p>Defence spending (USD bn)</p><p>Defence spending as % GDP</p><p>Defence spending (US$ bn v expenditure as % GDP) </p><p>Janes Defence Budgets jdb.janes.com </p><p> Declared and actual spending: Actual defence spending has historically outstripped disclosed defence spending the difference is falling, however (from 25% in 2005 to 5.7% in 2008)*1. </p><p> 2010: 2010 expenditure is likely to have been below the years allocation as a result of programme delays / retrenchment resulting from economic challenges </p><p> Spending as % of GDP: Defence spending as a percentage of GDP is low by global standards (1.57% in 2010 and forecast to average 1.6% 2011 to 2015*2 consistent with regional peers, however) </p><p> Spending plans: 9th Malaysia Plan (2006 2010) dedicated MYR15.3 billion to defence development although MYR18.5 billion was actually allocated. </p><p> Post 2011 - 10th Malaysia Plan (2011 2016) to include defence / security development allocation of MYR23 billion indications that defence spending will be between MYR15-18 billion with remaining funds allocated to security domains *1 Malay Ministry of Finance Economic Reports </p><p>*2 Janes Defence Budgets </p></li><li><p>Malaysia In figures (materiel suppliers - nations) </p><p>*Based on SIPRI Trade Equivalent Units Source SIPRI </p><p>Suppliers of defence materiel (2000 to 2008 - by percentage total value of military imports* ) </p><p>Australia 0.03% </p><p>Brazil 1.49% </p><p>Canada 0.32% </p><p>France 8.79% </p><p>Germany 18.82% </p><p>Indonesia 0.47% </p><p>Italy 6.18% </p><p>Pakistan 0.50% </p><p>Poland 5.13% </p><p>Russia 40.27% </p><p>South Africa 0.62% </p><p>Spain 7.00% </p><p>Sweden 0.35% </p><p>Switzerland 0.56% </p><p>Turkey 2.34% </p><p>UK 4.43% </p><p>US 2.70% </p></li><li><p>Malaysia In figures (trade partners) No correlation between Malaysias broad bilateral trade and defence trade. National investment profile is arguably a greater factor </p><p>0</p><p>50,000</p><p>100,000</p><p>150,000</p><p>200,000</p><p>250,000</p><p>300,000</p><p>350,000</p><p>400,000</p><p>Bilateral trade between Malaysia and principal trade partners US$ billion (total bilateral trade 2000 to 2009 </p><p>Source: IMF </p></li><li><p>Malaysia In figures (procurement spending) </p><p>Procurement spending by service (US$ m) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Army 173 136 129 129 145 152 174 182 Navy 534 436 413 412 462 486 594 624 Air 617 501 492 491 569 598 706 741 Other / joint 33 32 38 38 39 41 48 51 TOTAL 1,357 1,105 1,072 1,070 1,215 1,277 1,522 1,598 </p><p>0</p><p>0.5</p><p>1</p><p>1.5</p><p>2</p><p>Army Navy Air Other / joint</p><p>Procurement spending by services (US$ bn - actual and forecast) </p><p>Source Jane's Defence Budgets </p><p>Army 12% </p><p>Navy 39% </p><p>Air 46% </p><p>Joint / other </p><p>3% </p><p>Procurement spending by services (% of forecast total 2010 to 2015) </p></li><li><p>Malaysia Market opportunities by sector 2011 to 2016 </p><p>C3, 1.88 </p><p>Ground Vehicles, </p><p>2.24 </p><p>Aircraft, 5.70 </p><p>Ships, 1.84 </p><p>Unmanned Systems, </p><p>0.04 </p><p>EOIR, 0.34 </p><p>Radar, 0.57 </p><p>Sonar, 0.06 Precision Weapons, </p><p>0.39 </p><p>Forecast spending by platform / system type - US$ bn * </p><p> Assessment / forecasts based on known programmes and identified opportunities (eg, stated realisable procurement aims during coming spending period) Source: Janes DS Forecast </p><p>Market Sector % total allocated funds - 2011 to 2016* </p><p> C3 14.40% </p><p> Ground Vehicles 17.15% </p><p> Aircraft 43.64% </p><p> Ships 14.09% </p><p> Space Systems 0.02% </p><p> Unmanned Systems 0.31% </p><p> EOIR 2.60% </p><p> Radar 4.36% </p><p> Sonar 0.46% </p><p> Precision Weapons 2.99% </p></li><li><p>Malaysia Procurement procedures </p><p>1. MINDEF Procurement Division draws up programme specification with technical advice from STRIDE and legal support of Attorney General </p><p>2. Anticipated size of procurement determines level of oversight sub US$2.2 million awards handled within MINDEF / US$2.2 million + awards require MoF approval </p><p>3. Tender route chosen: </p><p>A) Open tenders to pre-qualified candidates B) Open tenders to Bumiputra-status companies C) Limited tenders (for small scale procurement sub US$1.6m) D) Direct tenders (v small scale procurement sub US$14k) </p><p>4. Tender documents published at www.eperolehan.com.my and through local / international media (eg, Janes Defence Weekly) </p><p>5. Tender Opening Committee (without sight of bidders details) tasked with opening and recording tenders </p><p>6. Decision taken by MINDEF (or MINDEF and MoF). Larger procurements require approval of Malaysian cabinet. Cabinet intervenes in cases of disagreement between MINDEF and MoF </p><p>7. Letter of Intent (LoI) presented to chosen bidder. Letter of Acceptance subject to further negotiations </p><p>8. Offset agreements (for procurements of US$13 million +) must be agreed / signed before procurement contract conclusion </p><p>9. Contract award </p><p>Broad military procurement process of Malaysia </p><p>External oversight: Malaysian Parliament / Federal Auditor / Independent Commission on Anti Corruption </p></li><li><p>Malaysia Procurement practices </p><p> Politicised major procurement: Major programme procurement decision appear to circumvent MINDEF entirely raises questions of drivers behind decisions / transparency issues. </p><p> Inadequate over-sight: Parliament has the right of oversight, but has not proved an effective watchdog given dearth of information available to representatives. </p><p> Favouring of Bumiputra-status companies: Right to issue tenders directly to ethnic Malay owned companies typically applies to low-tech / low-value requirements given limited indigenous capabilities </p><p> Balancing international procurement: Malaysias procurement relationships have been extremely broad whether this points to appropriate (albeit short-sighted) acquisition, or efforts to balance relations is open to question. </p><p> Graft: Allegations of improper practices are not unknown, but corruption is largely limited to low level contact and smaller contracts (where oversight is minimal) </p><p> Role of middle-men: Emphasis on maximising involvement through offset and awarding contracts directly to domestic organisations in partnership with foreign contractors made emergence of middle-men and local facilitators inevitable. </p><p>Defence acquisitions are subject to fair and open procurement with extensive checks and balances; independent oversight and parliamentary scrutiny. in theory </p></li><li><p>Malaysia Procurement - novel mechanisms? </p><p>Malaysia considered alternative procurement models in the wake of the 2007 global financial crisis </p><p> Private finance initiatives: Malaysia has previously used PFI to underpin procurement (eg, the 2008 Air Combat Manoeuvring Instrumentation Systems accord). Signs as of 2010 / 2011 that the PFI model is gaining favour once again PFI funding vehicles to be used to support development of Malaysia Defence &amp; Security Technology Park </p><p> Islamic Finance: Use of Sukuk *Islamic law-compliant bonds] has been raised by the Malaysian Defence minister. He suggested in 2009 that the Navy should use Islamic finance to fund upgrade programmes. There is a risk that funding mechanisms not compatible / set up in compliance with Islamic law may prove problematic </p><p> Joint Procurement Southeast Asia: Malaysia was a driving force (2009 and 2010 ) behind calls for the Association of Southeast Asian Nations (ASEAN) to pursue greater common procurement and defence industrial collaboration. The body was to be loosely based on the European Defence Agency. Progress has been sluggish to date. </p></li><li><p>Malaysia Defence industrial development Timeline </p><p>1970s: Defence industrialisation follows independence (1957) with some results by 1970s. Ambitions modest: emphasis on MRO and munitions. Eg, Airod (est 1976) and SME. </p><p>1980s: Clear that defence industrial competencies lagging Singapore / South Korea. Sluggish development during the decade </p><p>1990s: More rapid progress and privatisation efforts (eg, Boustead Naval Shipyard (1995)and Malaysia Marine and Heavy Engineering (1991). Main defence companies of today established in 1990s.Post-1997 crisis hits development </p><p>2000s: Efforts to reinvigorate industry. Defence Industrial Blueprint ( first of its kind) published 2005. </p><p>2010s: New Economic Model launched in 2009.. Defence industrial strategy aligned with wider goals . Aim to create higher-value economic output </p></li><li><p>Malaysia Defence industrial development Social and economic drivers </p><p> NEM to 2020: Defence industrial reform yoked to New Economic Model (itself a development of the national Vision 2020 strategy) </p><p> Offset and NEM: Offset reforms ranging from transfer of technology to export facilitation consistent with NEM. Offset policy delayed in 2010 to ensure compliance with NEM </p><p> Export balance of trade: Malaysia keen to use defence development to improve trade balance; hence pending emphasis on materiel counter-trade and export facilitation (eg, Colt M4 license production includes regional marketing rights). Outlook for success is limited </p><p>Employment </p><p> Quality before quantity: Defence industrialisation of previous decades sought to ease poverty / unemployment among ethnic Malays current emphasis will be on quality of jobs given low unemployment (3% 2010 and falling*1) but low average incomes ($3k pa) *2. </p><p> Brain-drain reversal: 305,000 people left the country between March 2008 and August 2009 and 1 million Malaysians currently live/work abroad. *3 Malaysia keen to stem this flow through the creation of meaningful opportunities *1 / 2* IHS Global Insight </p><p>*3 Malaysian Parliamentary Report reported by Asian Sentinel (Malaysias Brain Drain 18 February 2011) </p><p>2.50%</p><p>2.70%</p><p>2.90%</p><p>3.10%</p><p>3.30%</p><p>3.50%</p><p>3.70%</p><p>3.90%</p><p>Malaysia: Unemployment rate (%) </p><p>IHS Global Insight </p><p>Colt M4 carbine. Source Colt </p></li><li><p> Malaysias reliance on imported materiel is high - risk of strategic weak spot is clear: </p><p> Indigenous contributions to procurement programmes stood at 25% in 2009 *1 </p><p> 90% of the inventory of the Malaysian Armed Forces is based on offshore designs (2008) *2 </p><p> External threats regional challenges driving procurement: </p><p>Malaysia Defence industrial development Strategic drivers </p><p>*1 Janes Defence Industry News, Malaysia seeks tech transfer and joint ventures, 10 July 2009 *2 Defence industrialisation in Malaysia: Development challenges and the revolution in military affairs, Kogila Balakrishnan, Summer 2008 </p><p>Spratly archipelago: Disputed by Malaysia, Vietnam, China (PRC and Taiwan), Brunei, Philippines) </p><p>Disputed maritime demarcation zone around Sabah: Disputed by Indonesia, Malaysia, Philippines </p><p>Peoples Republic of China: Regional power projection by Beijing helping to drive Malaysian defence spending </p><p>Malacca Strait: Need to ensure safe passage driving maritime / surveillance procurement and development efforts </p><p>Imag</p><p>e so</p><p>urc</p><p>e: G</p><p>oo</p><p>gle </p><p>Singapore: Desire to maintain parity with increasingly capable armed forces </p><p>Piracy / wider Immigration concerns </p></li><li><p>Malaysia Defence industrial capabilities </p><p>Indigenous defence industrial capabilities are limited and focused on low-technology domains national ambitions to date have been modest, but a change in direction is underway </p><p> Small-scale industrial base - Defence industrial base extends to around 50 organisations and an estimated 20,000 employees </p><p> Development has lagged regional peers (eg, Singapore, South Korea and even Indonesia) </p><p> Indigenous capabilities reflected modest early ambitions to maintain local inventories Therefore abilities concentrated in aerospace maintenance, repair and overhaul; the manufacture of small arms and munitions; ship repair and fabrication; metal working; and basic land systems reflects earlier ambitions to merely maintain local inventories </p><p> Significant capability gaps exist (notably in C4ISR domains, plus more general research, design and development capabilities) </p><p> Offset dependence is notable few indigenous capabilities are self-sustaining </p><p> Offset opportunities wasted during 1990s low value-added counter-trade accords provided economic quick fix following Asian Financial Crisis </p><p> Efforts to reinvigorate domestic industries began in 2000s first ever defence industrial strategy (Defence Industrial Blue-Print) not published until 2005. Efforts currently underway to coral defence industrial development into wider economic development plans </p></li><li><p>RDT&amp;E expenditure as percentage of total defence spending Malaysia ver. regional peers / emerging producers </p><p>Malaysia Limited R&amp;D investment / skills </p><p>0.00%</p><p>2.00%</p><p>4.00%</p><p>6.00%</p><p>8.00%</p><p>10.00%</p><p>12.00%</p><p>14.00%</p><p>FY08 FY09 FY10</p><p>*1 2008. Malaysian govt figs *2 UNESCO 2009 </p><p> Negligible R&amp;DTE investment has hampered development of national capabilities reflects emphasis on foreign procurement / local involvement rather than focus on indigenous solutions </p><p> Malaysias defence industrial workforce is relatively low-skilled just seven research scientists for every 10,000 sector employees*1 </p><p> Relatively skills of population a barrier to development almost 10% are illiterate while almost two thirds do not complete education beyond secondary level*2 </p><p>Janes Defence Budgets jdb.janes.com </p></li><li><p>Malaysia...</p></li></ul>

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