By Stuart Grudgings and Mark Felsenthal
KUALA LUMPUR (Reuters) - Malaysian Prime Minister Najib Razak said on Sunday that he and U.S. President Barack Obama had agreed to upgrade bilateral relations but suggested that his country remains far from ready to sign a U.S-led trade pact due to domestic "sensitivities."
Obama's visit to Malaysia follows his swing through Japan, where he failed to clinch a trade deal key to the U.S. "rebalancing" back to Asia. Such a deal would have injected momentum into the delayed 12-nation Trans-Pacific Partnership (TPP) trade pact.
Najib's ambition to bring Malaysia into Obama's flagship trade plan has been undercut by the resurgent influence of traditionalists within his own ruling party following a weak election showing last year.
Early this month, a Malaysian cabinet minister was reported as saying the country was a long way from being able to sign a TPP deal and that the priority should be on economic integration within the Association of Southeast Asian Nations (ASEAN) bloc.
Najib said Malaysia was committed to free trade and denied that Washington was "bullying" the Southeast Asian nation into joining the controversial pact.
"We are working around the sensitivities and challenges which I alluded to in my discussions with President Obama," Najib told a joint news conference with the U.S. leader in the administrative capital of Putrajaya.
"He fully understands our domestic sensitivities and we will sit down and try to iron this out with the intention of trying to work out a deal in the near future."
Obama said that domestic opposition to trade deals wasn't surprising and that the United States was willing to be flexible on particularly sensitive areas, such as prices of life-saving medicines that critics say will jump in countries like Malaysia under the TPP.
"There's never been a trade deal in which somebody's not going to at some point object because they're fearful of the future or they're invested in the status quo," Obama said.
Protesters briefly disrupted Obama's talk later in the day at a town hall-style meeting with young Malaysians at a university, holding up anti-TPP signs before being ushered away by security.
"PEACEFUL RISE" FOR CHINA
The challenge for Obama during his week-long, four-nation regional tour is to convince Asian partners that Washington is serious about its promised strategic "pivot" to increase U.S. influence in Asia, without harming U.S. ties with China, the world's second-biggest economy and a growing maritime power.
In his town hall speech, the Hawaiian-born president who lived in Indonesia as a boy told his audience that the United States has long had connections across the Pacific as well as the Atlantic.
He told students he plans to meet every year with the leaders of the 10-member Association of Southeast Asian Nations (ASEAN), and would work through the Asia Pacific Economic Cooperation forum (APEC) to build trade ties.
"We want to work with old allies and worthy partners and with China," he said. "We want to see a peaceful rise to China."
Najib announced that he had agreed with Obama to upgrade the two countries' ties to a "comprehensive partnership," mirroring a step that Malaysia took with China last year when President Xi Jinping made a state visit.
"This marks a new phase in our relationship, with greater collaboration in economy, security, education, science, technology and more," Najib said.
Human rights groups and members of Malaysia's opposition alliance have urged Obama to speak out on what they say has been a sharp deterioration in religious and political freedoms since the ruling coalition suffered its election setback last May.
Since then, the government has reinstated detention without trial as part of a package of tougher crime laws and renewed what critics call a campaign of judicial persecution against opposition leader Anwar Ibrahim.
In March, a court convicted Anwar on a charge of sodomy and sentenced him to five years in prison. The verdict came days before he was to stand in an election seen as paving the way for him to take charge of Malaysia's richest state.
Asked why he would not be meeting Anwar on his three-day visit to Malaysia, Obama said it was "not indicative of a lack of concern" and that Malaysia had "work to do" on allowing more freedoms. Obama was due to meet civil society leaders later on Sunday.
Najib said he was committed to the rule of law and civil liberties, but that he had to take account complex racial sensitivities in the multi-ethnic nation of 29 million people, where majority ethnic Malays enjoy special rights.
"We have to manage that and that's exactly what Malaysia has done and because of that we are a relatively peaceful, harmonious nation," Najib said.
(Additional reporting by Yantoultra Ngui and Matt Spetalnick; Writing by Stuart Grudgings; Editing by Kim Coghill) nL3N0NJ04O