* Chinese support falls in May
* Affirmative action, cronyism, among chief complaints
* Ebbing Chinese support could make next gov't more Malay, slow reforms
* Malaysia losing talent, capital over pro-Malay policies
By Stuart Grudgings and Siva Sithraputhran
KUALA LUMPUR, June 3 (Reuters) - Ethnic Chinese voters, upset over policies that favour majority Malays, have become increasingly alienated from Malaysia's ruling coalition, raising the risk of racial polarisation and a slowdown in the pace of reforms.
Support for Prime Minister Najib Razak among Chinese voters plunged to 37 percent in May from 56 percent in February, a survey by the independent Merdeka Center showed on Friday. It found 56 percent of Chinese were dissatisfied with the government, compared to 30 percent of Indians and 23 percent of Malays.
Recent state and by-elections underline the trend. The main Chinese party allied with the ruling National Front coalition in eastern Sarawak state lost 13 of 19 seats it contested in local elections last year and the opposition won a by-election in the same state in 2010 largely thanks to Chinese backing.
The Southeast Asian nation's 6.5 million ethnic Chinese turned heavily to the opposition in 2008 polls, handing the National Front, which has ruled uninterrupted since independence from Britain in 1957, its worst election showing.
Malaysia has seen ethnic Chinese voting with their feet, leaving the country for better prospects aboard including to neighbour and rival Singapore, in a troubling brain drain of talent and capital. "Malaysia needs talent to meet its goal of becoming a high-income country," the World Bank noted in a report last year. "But the problem is that talent is leaving."
With elections likely later this year, the government has failed to reverse the tide with voters such as Jack Gan, who complains he had to study much harder than his ethnic Malay peers to get into one of the country's top universities.
"I'm used to the lifestyle here but I don't like the government and the policies," said the 24-year-old law student, referring to decades-old affirmative action policies that favour Malays in education, business and employment.
Government efforts to appeal to minority Chinese and Indians were "just propaganda, not a policy," he added.
Chinese disillusionment is straining relations within the ruling coalition, complicating Najib's efforts to reverse the shocking losses four years ago. Najib has rolled back some repressive security laws in an effort to appeal to middle-class, urban voters but his reforms have not gone far enough for many Chinese.
The main ethnic Chinese party in the ruling coalition, whose parliamentary seats were halved to 15 in 2008, says it won't accept any cabinet posts if it does worse this time, raising the prospect of a government dominated by ethnic Malays.
The trend risks deepening racial fault lines if, as some analysts expect, the lead party in the coalition, the United Malays Nationalist Organisation (UMNO) effectively "gives up" on the Chinese vote and focuses on championing Malay rights to secure support in rural areas.
Some analysts think Chinese voters could be shooting themselves in the foot if a weak showing by Najib in the election hands power back to right-wingers within UMNO and puts the brakes on his reform programme. The three-party opposition alliance is seen as unlikely to win enough seats to form a government.
"The concern I have is that it is going to be a coalition of one (party) plus a few others who are not as strong as they are," said Wan Saiful Wan Jan, the head of Malaysia's Institute for Democracy and Economic Affairs. "It's going to be a very imbalanced mix in the new coalition that will be formed."
The prime minister is stuck on the horns of a Malaysian dilemma: He has promised to reform the 40-year-old affirmative action programme for majority Malays that has long upset Malaysia's minorities; yet to do that he needs Chinese electoral support to strengthen his hand against Malay chauvinists in his party.
In the past, the National Front could rely on sizeable support from the Chinese community, who control most of the country's wealth despite making up only about a quarter of Malaysia's 28 million people. But that support - forged through cozy business ties and strong government support for a separate, Mandarin language school system - has frayed in recent years as Chinese frustration with slow progress on reform has grown.
Malaysia's Chinese, many of whose ancestors came to the country in British colonial times, increasingly lead separate lives from Malays, attending separate schools, speaking Mandarin and socializing with friends from the same race.
"We are not integrated, sadly, and I think it's going to take a long time before we can integrate because economically we are compartmentalized," said Razaleigh Hamzah, a long-serving UMNO member of parliament and former finance minister.
The Chinese account for many of an estimated one million people who emigrate annually, a "brain drain" driven by a lack of education and job prospects that is eroding Malaysia's competitiveness.
Malaysia had been among the best performing economies in the world over the past 50 years under the National Front, which transformed a poor, colonial plantation economy into a modern, middle-income country. Per capita GDP has reached $8,100, almost doubling each decade.
But economists now warn Malaysia has fallen into a "middle-income trap", in which a country is unable to make the next leap to developed nation status -- Malaysia's stated goal by 2020.
Domestic investment has struggled to recover since the 1997/98 Asian financial crisis. Foreign investment, which powered the earlier decades of growth, has stagnated. And the affirmative action policies, aimed at helping Malays better compete in the economy through educational and ownership quotas, have become an impediment to growth by not fully exploiting the human resource potential of the Indian and Chinese minorities.
Critics say the privileges, which include requiring companies to employ at least 30 percent Malays, have also scared off some foreign investors who think it represents too much government interference in the economy.
Najib has tried to unite the country with a highly touted programme called "1Malaysia". His efforts, however, have often been undercut by his own party, whose conservative wing has dug in its heels over protecting Malay privileges.
The government says it has reached out to Chinese under Najib, increasing funding for Mandarin schools and for lower-to-middle income Chinese communities.
"The government is continuing to implement measures under the transformation agenda and all Malaysians - including the Chinese community - stand to benefit," a government spokesperson said.
Nevertheless, the Malaysian Chinese Association (MCA), the main Chinese party in the coalition, could see its seats slashed again in the coming election as it pays the price for corruption scandals in the ruling coalition and perceptions it has failed to defend Chinese interests, analysts say.
One factor driving Chinese voters from the ruling coalition is they now have a viable alternative following the opposition alliance's unprecedented takeover of five state governments in 2008, including the northwestern coastal state of Penang, one of Malaysia's biggest manufacturing hubs.
"A major pull factor is that the DAP is a much stronger party now - it is able to capture the imagination of Chinese voters," said political analyst Ong Kian Ming, referring to the Democratic Action Party, the opposition's ethnic Chinese party.
Penang's Chief Minister Lim Guan Eng is a veteran of Malaysia's hardball politics: He spent 18 months in detention from 1986 under the draconian Internal Security Act (which Najib had repealed) and a year in prison for sedition for making allegations against an UMNO state leader.
He is credited with cutting debt and attracting a flood of high-tech investments into Penang. Ethnic Malay businesses still get the lion's share of state contracts, Lim says, but his move to make all public tenders open through a computerized system has cut down on the cronyism that annoys Malaysians of all races.
"We have broken the myth that Malay contractors cannot compete on the open market," said the 51-year-old Lim, whose father Lim Kit Siang has been a party leader since its beginnings in the 1960s. "It goes to show that Malay contractors can compete. It is only UMNO cronies who cannot compete," Lim told Reuters.
After taking over in 2009, Najib signalled he would take a bolder approach on dismantling affirmative action. In 2010 he introduced the "New Economic Model", with poverty and income, not race, as the main criteria for getting help, and calling for less government interference in the economy. But so far the model has been short on policy implementation with little change to the core privileges that often benefit well-connected Malays more than the poor and have been blamed for fuelling cronyism.
Najib's defenders say he is hoping a strong electoral mandate will strengthen the reformist wing of UMNO -- but he will need Chinese support to make that case.
MCA leader Chua Soi Lek acknowledged the party leadership had been too "low profile." But he told Reuters Chinese voters risked losing influence over policy and ushering in a less business-friendly government if they turned their backs on his party.
"The message to the Chinese community is to choose wisely. We are a business community. The wrong choice of government and everybody suffers but it will affect the business community ... more than everybody else."