March 10 (Bloomberg) -- Malaysia's political world has been upended. The March 8 election left the government of Prime Minister Abdullah Ahmad Badawi hobbled though still in power, its legalized system of preferences for ethnic Malays under attack.

When the dust settles, the most powerful man in Southeast Asia's third-largest economy may be opposition leader Anwar Ibrahim, a former deputy prime minister. Anwar, 60, spent the 2004 election in prison after being ousted from the government and prosecuted on criminal charges -- later overturned -- of having homosexual relations.

``Anwar Ibrahim is back and a political force to be reckoned with,'' said Andrew Aeria, a political analyst for Enterprise LSE, the commercial arm of the London School of Economics. ``This massive shift in electoral support reflected an unprecedented cross-ethnic mood for change.''

The ruling National Front coalition's worst-ever performance will force Abdullah, 68, to face Anwar's emboldened opposition as it presses to scrap race rules that disadvantage ethnic Chinese and Indians in housing, jobs and education. The opposition also wants to increase aid for the poor and fight corruption.

The opposition parties yesterday quickly moved to implement their policies, announcing plans to drop race rules in a state where they won control -- Selangor, which is Malaysia's most populous area and surrounds the capital, Kuala Lumpur.

1969 Loss

For now, Malaysia is in uncharted territory, with the government facing meaningful opposition for the first time since 1969, when the National Front, also known as Barisan Nasional, last was denied a two-thirds supermajority in parliament.

After winning 91 percent of the legislature in 2004, the National Front won just 63 percent this time, worse than its 1969 performance by three percentage points. In the new parliament, the National Front will have 140 of the 222 seats.

Malaysia's stock index today slumped as much as 7.6 percent, set for the biggest drop in almost 10 years, and the ringgit weakened.

The opposition alliance -- Anwar's multiethnic People's Justice Party, the Chinese-based Democratic Action Party and the Pan-Malaysian Islamic Party, or PAS -- won the remaining 82 seats, up from 19. Among the losers were Indian and Chinese leaders in Abdullah's Malay-dominated government. Five of 12 states contested fell into opposition hands, including Penang, a manufacturing base for Intel Corp. and Motorola Inc.

Anwar got his start in politics as a student activist at the University of Malaya and helped found the Muslim Youth Movement of Malaysia, many of whose members supported PAS.

Malay Champion

He shocked allies in 1982 by joining the United Malays National Organisation, the Malay party that heads the National Front. For a time, he championed the pro-Malay policies he now opposes.

After successfully backing UMNO's Mahathir Mohamad for prime minister, Anwar rose to became deputy prime minister in 1993. In 1998, Mahathir fired Anwar amidst speculation that the deputy was moving to oust him, eventually choosing Abdullah as his successor instead.

Imprisoned from 1998 to 2004, Anwar was barred from competing as a candidate until April and didn't run. He plans to take one of 31 seats won by his members of his party, including wife Wan Azizah Ismail and daughter Nurul Izzah, 27.

``I have plenty of choices and a lot of work to do,'' he said in an interview yesterday.

Najib Razak

The opposition benefited from attacks on Abdullah's administration by Mahathir, 82, who said the prime minister should step down in favor of his deputy, Najib Razak, 54.

``He's going to resist to the very end,'' Mahathir said in an interview with Bloomberg Television today.

``People are disappointed with the prime minister and the leadership,'' he said. ``They're uninterested in figures of growth of 6 percent or how many reserves we have. That doesn't affect them in the least. They're looking at the price of oil, inflation, and all kinds of other things that make life more difficult for them.''

The state-owned Bernama news agency said Abdullah won't resign because he has the support of UMNO leaders, including Najib.

The prime minister was sworn in by Malaysia's King, Mizan Zainal Abidin, at 11:15 a.m. local time today. Abdullah met the supreme council of UMNO in the early afternoon, and will gather leaders of the coalition parties at 3 p.m.

Public Confidence

Deputy Prime Minister Najib called on his party to rally behind the prime minister and said the coalition will attempt to regain the public's confidence.

``We ask UMNO members to close ranks in facing this challenge,'' Najib said in a statement today issued by state news service Bernama. ``I will assist'' the prime minister ``in facing this big challenge.''

An adviser to the prime minister said Abdullah probably will step down in favor of Najib before the next election, due within five years. The adviser, who spoke on the condition that he not be identified, said Abdullah will try to rebuild the coalition first.

That will be a challenging task, said Mushtaq Ibrahim, who manages about $1.4 billion at Amanah SSCM Asset Management Bhd. When UMNO and its partners -- the Malaysian Chinese Association and the Malaysian Indian Congress -- lost their supermajority in 1969, they regained it by persuading some opposition parties to join their coalition.

`Weak Components'

``You now have three very weak component parties,'' Mushtaq said. ``They have to go back to the drawing board to find ways of winning back the confidence of the voters.''

Malaysia was calm in the immediate aftermath of the election. In 1969, Chinese opposition celebrations were followed by clashes that killed hundreds and prompted the government to impose pro-Malay preferences. This year, Abdullah urged supporters to accept the results. Musa Hassan, the country's police chief, promised to maintain order by enforcing a ban on victory parades.

To contact the reporter on this story: Douglas Wong in Kuala Lumpur at Dwong19@bloomberg.net

Last Updated: March 10, 2008 01:45 EDT