By Stuart Grudgings
KUALA LUMPUR (Reuters) - Malaysia's racially divisive election result has sparked a battle within the country's ruling party that is likely to slow Prime Minister Najib Razak's drive to reform the economy and roll back policies favoring majority ethnic Malays.
Najib's Barisan Nasional (BN) coalition retained power in Sunday's election in the multi-ethnic Southeast Asian nation. But the coalition lost the popular vote and turned in its worst-ever electoral performance as it was heavily abandoned by the minority Chinese and rejected by many voters of all races in urban areas.
Najib was quick to blame the outcome on the swing by Chinese voters to the opposition alliance, putting a racial interpretation on the result that has struck a chord with traditionalists in his United Malays National Organisation (UMNO).
UMNO, which dominates Barisan, now faces a leadership election in October or November that is likely to be fought between traditional and reformist wings.
"The ideological lines have been drawn within UMNO," said Khairy Jamuluddin, a reformist who heads the party's youth wing, in a posting on Twitter. "Game on."
Any major reforms are likely to be postponed until the leadership is decided, although Najib has said he will push for national "reconciliation" and press ahead with a $444 billion economic masterplan aimed at attracting investment and doubling incomes by 2020.
Conservatives have blamed ethnic polarization and Chinese "disloyalty" while reformists have urged Najib to expand steps to make UMNO more inclusive beyond its base of poor, rural Malays.
Utusan Malaysia, a newspaper controlled by UMNO, sought to portray Sunday's election result in racial terms, with one headline saying: "What more do the Chinese want?"
Malaysia's former and longest-serving prime minister, Mahathir Mohamad, a powerful figure in UMNO, was quoted by local media as saying "ungrateful Chinese" and "greedy Malays" were to blame for the result.
"It may be the starting shot of what's to come for Najib," Oi Kee Beng, deputy director of Singapore's Institute of Southeast Asian Studies, said of conservative reactions to the result. "At the same time, I think he is their (UMNO's) best asset despite everything."
Najib also has to deal with a strong opposition that is claiming that Barisan won the election through fraud. On Wednesday, tens of thousands of opposition activists thronged a stadium on the outskirts of the capital Kuala Lumpur in response to a call from opposition leader Anwar Ibrahim.
"This is merely the beginning of the battle between the people and an illegitimate, corrupt and arrogant government," Anwar, a former deputy prime minister, told the crowd, many of whom wore black to symbolize mourning.
Najib, the 59-year-old son of a former prime minister, had far higher approval ratings than his party in the run-up to the election and has few obviously strong rivals to replace him.
Taking power in 2009, he staked his fortunes on reforms aimed at spurring growth, increasing transparency and dismantling affirmative action policies.
But Najib's ambitions have been curbed by conservative interests within UMNO. He has failed to come up with major steps to roll back the ethnic privileges that are seen as having benefited an elite of well-connected Malays more than the poor majority.
The government does not provide an ethnic breakdown of the population, but Malays make up about 60 percent of the 28 million people, while Chinese comprise more than 25 percent. The country also has a significant minority of ethnic Indians.
Barisan won 133 seats in the 222-member parliament, but only 47 percent of the popular vote, compared to the opposition's 50 percent.
"The polarization in this voting trend worries the government," Najib said. "We are afraid that if this is allowed to continue, it will create tensions."
But Barisan has also come in for criticism from younger voters for corruption and patronage politics that critics say have been the hallmark of its 56 years in power.
Liew Chin Tong, an opposition member of parliament from the southern state of Johor, said Najib appeared to be taking the wrong message from the election result.
"It was not just the Chinese who swung against Barisan Nasional. There were many young first-time and second-time voters who voted against the BN," he told Reuters.
Najib now looks more vulnerable to traditionalists in his party who are opposed to his tentative steps to phase out the policies that favor ethnic Malays, introduced two years after traumatic race riots in 1969.
Those policies have been a pillar of UMNO's support but have been a prime cause of ethnic Chinese and Indian alienation and investors say they stunt growth and investment in Southeast Asia's third-largest economy.
Najib's efforts to roll back these policies and other politically sensitive reforms - such as the introduction of a consumption tax to reduce Malaysia's dependence on oil revenues and lowering fuel and food subsidies to tackle a chronic budget deficit - could be put on the backburner for now.
"The outlook for direct investment will remain uncertain until it becomes clearer whether or not Najib's reform-minded policies will continue," HSBC economists said in a note after the result.
The opposition's Liew said Najib's choices of cabinet members in the coming days would be a crucial indication of whether his new government would try to appeal across ethnic groups or only to its Malay base.
"His comments on the Chinese is rhetoric," Liew said. "What we need to see is who he will include in his cabinet. Will it be made up of UMNO extremists or younger members from the middle ground? We also have to see if he will include the Chinese."
(Additional reporting by Niluksi Koswanage, Siva Sithraputhran, Anuradha Raghu and Angie Teo; editing by Raju Gopalakrishnan)