KUALA LUMPUR – Wan Abdullah Wan Ibrahim, managing director of Malaysia's UEM Land's thought it was a "match made in heaven" when his state-linked property firm bought out Sunrise, a successful property developer owned by ethnic Chinese, in 2010.
Critics, however, saw it as a sign that Prime Minister Najib Razak's promise to roll back the state's overbearing influence in business and dismantle polices favoring ethnic Malays was already ringing hollow less than a year after it was made.
Najib will this month fight what is shaping up to be the closest election in Malaysia's 56-year post-colonial history. Despite his promise, state-controlled firms remain stubbornly dominant in Southeast Asia's third-largest economy and are even moving into new sectors like property.
Some high-profile government divestments turned Kuala Lumpur into Asia's IPO hotspot in 2012. But the enduring role of Malaysia's "GLCs" (government-linked companies) is stunting the private sector and entrenching an economic malaise dating back to Asia's 1997/98 financial crisis, according to a study by two Asian Development Bank (ADB) economists seen by Reuters.
"They can present evidence that they are divesting and yet move into new sectors and move vested interests to new opportunities," said Jayant Menon, one of the senior economists who wrote the report. "It's classic politics."
The GLCs are also central to policies favoring majority ethnic Malays over other races, including the economically dominant Chinese minority.
Najib wants to double Malaysians' incomes by 2020 but the economists' report is a sobering challenge to his contention that his government is breaking Malaysia out of its "middle-income trap".
"SOMETHING TERRIBLY WRONG THERE"
Najib acknowledged in 2010 that the state's overbearing influence on the economy was crimping Malaysia's growth and dynamism. He says the private sector must "return to the driver's seat" of the economy.
The government points to the $3.1 billion listing of palm oil firm Felda in 2012 and the $2.1 billion debut of IHH Healthcare as proof its plan to divest stakes in 33 firms is on track.
But critics point to an expansion of state involvement in other new areas, in particular the property sector, as evidence that vested interests within the bureaucracy and the ruling ethnic Malay party, the United Malays National Organisation (UMNO), have pegged back Najib's early reform ambitions.
The ADB economists say in their report that, under Najib's rule, the real record on state firms was "more of a diversification than a divestment". It said the deterrent effect on private investment was contributing to Malaysia's status as the only major Southeast Asian nation with net capital outflows.
"What we do know is that investment has slumped in Malaysia, both foreign and domestic," said Menon.
"The fact is there is a net outflow of capital in a country that transformed itself with huge inflows in the past. Surely there is something terribly wrong there."
Private investment levels in Malaysia have picked up under Najib but have never fully recovered from the Asian financial crisis in the 1990s that signaled the end of rapid growth fuelled by exports and high foreign direct investment.
Najib dissolved parliament on April 3, paving the way for an election within weeks where he hopes to regain the two-thirds parliamentary majority the UMNO-led coalition lost for the first time in 2008. He came to power a year after that poll debacle.
In early 2010 he set out a transformative "New Economic Model", pledging the government would move away from being an "orchestrator" of the economy to being a "facilitator".
One stated goal of the planned 33 divestments is to help increase the share of national equity held by Malays to a long-held target of 30 percent. So far, 15 have been completed, but the pace slowed to four in 2012 from 11 in 2011.
Announcing the 2012 report card for his economic program last month, Najib hailed a 22 percent rise in private investment, compared with a 12 percent gain the previous year. That, however, includes spending by the GLCs.
Total committed investments under the program fell to 32 billion ringgit ($10.2 billion), down 82 percent from 179 billion ringgit in 2011. Foreign direct investment fell 26 percent to 29.1 billion ringgit in 2012.
GLCs play a big role across Malaysia's economy, taking up 56 percent of banking assets, 67 percent of the communication sector and 88 percent of utilities, according to the ADB.
Defined as companies with commercial goals but with some government control over decisions, they include Malaysia's two biggest banks, CIMB and Maybank.
Seven out of Malaysia's top 10 listed companies are majority-owned by the government, and GLCs make up about 36 percent of the stock market's capitalization.
Their political role has also been underlined in the run-up to the election, with Najib announcing that 40,000 employees of Telekom Malaysia and postal group Pos Malaysia would receive a 500 ringgit ($160) bonus.
He also authorized a 1,000 ringgit bonus for the 40,000 employees of state oil giant Petronas.
"They will think of it as a form of national service," an analyst with an investment bank in Kuala Lumpur, who declined to be identified because of the sensitivity of the issue, said of the pre-election bonuses.
A flurry of recent moves by GLCs into Malaysia's property sector, like the $450 million Sunrise deal, has expanded the state's role in a sector traditionally dominated by Chinese business interests.
Teh Chi-Chang, director of the opposition-linked REFSA think tank, called them "backdoor nationalizations" that deter entrepreneurs in the sector.
In 2011, state investment firm Permodalan Nasional Berhad (PNB) took a controlling stake in Malaysia's biggest property firm, SP Setia Berhad. State-controlled plantation Sime Darby became the largest shareholder in property developer E&O later that year.
The three-party opposition alliance, led by former deputy prime minister Anwar Ibrahim, has an outside chance of upsetting Najib's coalition, according to opinion polls. The alliance points to the expansion of state-linked firms as evidence Najib's reform agenda has stalled.
"Malaysia has one of the most vibrant private property sectors in the world and yet you have the government getting involved," said Tony Pua, a leading opposition politician.
"There's no point in having our GLCs competing on building luxury homes."
Malaysia's GLCs have increasingly gone international in their hunt for yield, despite the government's insistence that there are bountiful investment opportunities at home.
A consortium including Sime Darby, SP Setia, and Malaysia's Employees Provident Fund, bought Britain's Battersea power station for more than $600 million last year and plans to build luxury apartments on the site.
That helped put Malaysians ahead of Russian oligarchs and rich Chinese on the list of the biggest buyers of London property in the first seven months of 2012.
The government rejects accusations it is stifling enterprise in the property market, saying projects like a new publicly funded $8.4 billion financial exchange in the works in Kuala Lumpur will generate opportunities for companies.
Mohd Emir Mavani Abdullah, a director at the government's economic performance unit and a Felda board member, said the move into London property showed that government-linked firms were keen to avoid suffocating private firms at home.
The government also notes that many GLCs are strong performers, with the biggest 20 generating a compound annual return of 14.5 percent from May 2004 to April 2012, far outperforming the Kuala Lumpur market.
($1 = 3.125 ringgit)
(Additional reporting by Niki Koswanage; Editing by Paul Tait)