Incoming prime minister Abdullah Ahmad Badawi will inherit a modern and progressive Malaysia when his mentor Dr Mahathir Mohamad steps down today, but he will also be confronted with an array of tough political and economic challenges.

Looming general elections, a serious budget deficit and the need to bolster economic competitiveness and woo investment will weigh heavily on the new premier.

"It will be a baptism of fire for Abdullah in all senses soon after taking office," said Nizam Idris, a regional economist with Singapore-based IDEAglobal.

The first new prime minister in 22 years has a relatively firm foundation to build on. The economy is healthier than most of its Southeast Asian neighbours after bouncing back from the 1997/98 regional financial crisis.

Malaysia has made progress cleaning up its corporate image, with some of its most prominent businessmen ousted and their companies seized as the government sought to recover bank debts.

It bristles with some of the most advanced infrastructure in the world. Mahathir, 77, single-mindedly drove the country towards the digital age by carving out an ambitious high-tech hub in 1996.

Drop in FDI

Race relations in a country where majority Muslims have enjoyed more than three decades of privileges under an affirmative action program to help them close the gap with the wealthier Chinese minority are mainly good.

But the picture is not all rosy.

Foreign investment, which fuelled high-speed growth before the Asian crisis, has slumped since 2001 with most diverted to China and other regional rivals like Thailand.

Fiscal pump-priming to boost the economy has seen Malaysia run seven straight budget deficits, leaving little room for Abdullah to manouevre in the event of a global slowdown.

He also has to deal with the peg of the ringgit currency at 3.80 to the dollar, imposed by Mahathir in 1998 as part of capital curbs, most now lifted.

There is no immediate pressure on the peg as the dollar's current weakness gives a competitive edge to exports, but if left in place for too long, economists warn, it may damage Malaysia's free-market credentials and hurt investment.

Then there is the deeply-rooted political patronage system linking the corporate sector with the ruling Umno, that often led to the award of government contracts without open tender and restricted healthy competition needed to spur productivity.

No new initiatives

The government's tendency to rescue troubled companies and protect local industries is also criticised in the face of market liberalisation.

But to undo such excesses will disrupt the comfort zone for many vested parties and Abdullah, who has railed against corruption and told mismanaged firms to shape up, will not be in a hurry to change the system.

"To go against corporate Malaysia he needs to have muscles," said Abdul Razak Baginda, director of the Malaysian Strategic Research Centre.

"There will be more continuity than change, at least in the short-term," he said.

"There will be no new initiatives except to reinforce what Mahathir has done. What we need now is a soothing effect because Malaysia is fearful of the post-Mahathir era."

Abdullah, 63, has pledged to maintain his predecessor's policies, although his management style will be different as he is seen as a team player with a more liberal approach.

For now, economic issues are likely to take a backseat as Abdullah focuses on consolidating his grip on Umno, the lynchpin of the ruling coalition, to face a general election widely expected early next year.

Despite the growing influence of the hardline opposition Islamic Party, which already controls two out of 13 states, most predict Abdullah will lead the ruling coalition to an easy election victory.

The deputy

A rally which took the stock market to an 18-month high last week is seen by analysts as a vote of confidence in the new premier.

But the political and business community are waiting in suspense to see who Abdullah will pick for his new cabinet.

Up for grabs will be the country's esteemed number two post - with the deputy prime minister seen as next in line for premiership - the influential finance portfolio previously held by Mahathir and the powerful home minister post held by Abdullah.

Mahathir has endorsed Defence Minister Najib Razak, an Umno vice-president, as deputy premier, but Abdullah has refused to give any indication of who he wants as his number two and there is speculation he will not name a deputy until after elections. - AFP