What to do if stage 1 visa expires and stage 2 is under processing?

You cant leave without a passport. Yes, the stage II can be applied for once you get your replacement passport. Ask these questions to the Indian High Commission. They can provide appropriate documentation as well.

Thank you for the reply Gravitas,
I asked the high commission of india, they did not know the answer and one of them said I may have to get a special pass from Malaysian embassy.

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Hi, just to update the thread in case anyone else may face a similar problem in future. (I pray that no one does)

I received my passport with a different passport number around 3 weeks from the date I submitted the application for the new passport.

The next step was to get a fresh Confirmation letter from MDEC. The MDEC has to issue a new confirmation letter since the passport number has changed. This process took 2 weeks. I could not go directly to an Enforcement Cell to get a Special Pass because I entered Malaysia on a Stage 1 visa (Calling Visa).

Next, I went to Malaysian Immigration Office at  Putrajaya along with my company representative (who had some forms and company profile along with him) and got a Special Pass. (advice- you have to be at the Malaysian Immigration Office before 6AM to take a token number, since there will be many people or you won't get a token number. Also, for me, the officer who gives the token number did not accept the application because he did not understand and asked me to go back to MDEC and get a letter/memo. I had to talk to the main head officer and explain everything ). The fee for Special Pass is RM100.

Once I got the Special Paas. The passport was submitted back to MDEC for stage two visa (employment pass) processing. It's been there since more than 2 weeks now and is still in progress.