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1 Messy Debt Business

14 Aug 2015 By Una Galani

Malaysian Prime Minister Najib Razak is fighting for political survival after being dragged into the centre of a scandal surrounding state fund 1Malaysia Development Berhad (1MDB). Here’s a breakdown of what is at stake for the southeast Asian country.

Why is the Prime Minister under scrutiny?

 Najib is in the hot seat after almost $700 million was found to have landed in his personal bank account. The transfers were made after moving through agencies, banks, and companies linked to quasi-sovereign fund 1MDB, according to documents from a government investigation published by the Wall Street Journal but not verified by Reuters.

The revelations have triggered a political crisis and added to concerns about Malaysia’s already-fragile economy. It is the latest twist in a saga involving local tycoons, the investment bank Goldman Sachs, and state-backed companies from the Gulf. These had already made 1MDB a target for Najib’s political opponents.

Najib insists he has never taken any money for personal gain. Malaysia’s anti-corruption commission says the cash came from a donor in the Middle East and had no connection to 1MDB. It has also said it will ask Najib for an explanation.

What is 1MDB and why is it in trouble?

Najib set up the vehicle in 2009 to invest in projects of national importance with a remit to “be bold and daring”. Previously, it had been a sovereign wealth fund for the Malaysian state of Terengganu.

The prime minister remains chairman of 1MDB’s board of advisors. Though the fund is owned by the Ministry of Finance it is not strictly a sovereign entity as it was designed to remain off the government’s balance sheet.

1MDB owns Malaysia’s second-largest independent power producer, the new financial centre in Kuala Lumpur, and a landmark development around the terminus for a planned high-speed rail link with Singapore.

The problem is that 1MDB has racked up large debts through acquisitions and opaque investments alongside entities from Saudi Arabia and Abu Dhabi. It also paid inexplicably high fees to Goldman Sachs for helping it raise $6.5 billion from three bond issues in 2012 and 2013.

Before revelations of the payments into Najib’s accounts, 1MDB had pledged to dismantle itself and had outlined a plan to sell its power assets and find equity partners for its real estate projects.

How bad is 1MDB’s financial position?

At the end of March 2014 – the last period for which it has published accounts – the fund reported net debt of 38 billion ringgit ($9.3 billion).

Since then, 1MDB has settled 6.1 billion ringgit of debt owed to banks. It has also agreed a bailout worth almost 20.4 billion ringgit with the Abu Dhabi International Petroleum Investment Company, an equally untransparent state fund. For that deal to be completed, 1MDB must hand over unspecified assets to Abu Dhabi by June 2016.

Meanwhile, Chinese, Qatari and Malaysian buyers are said to be interested in buying the power assets. Sources have told Reuters that potential buyers may pay around 10 billion ringgit.

If agreed, the lifeline from Abu Dhabi and sale of power assets could reduce 1MDB’s debt to 1.5 billion ringgit. But it is not clear if these two deals can be completed in the current turmoil. Besides, 1MBD may have incurred new loans or costs during the past year.

How bad could the financial fallout be?

If 1MDB can’t fix its own financial problems, it will need government help. This could happen in various ways. For example, Malaysia could ask state-backed companies to lead a purchase of the energy assets or become equity partners in the real estate projects. Failing that, the government may have to take on 1MDB’s borrowings.

Malaysia already explicitly guarantees 5.8 billion ringgit of 1MDB debt. Extending this to cover the fund’s estimated current borrowings would increase the state’s contingent liabilities to almost 19 percent of GDP from 16 percent at the end of the fourth quarter. That is on top of federal government debt already at 52.1 percent of annual output.

The crisis has spooked investors at a time when fading growth and the prospect of higher U.S. interest rates are fuelling capital outflows. The falling oil price has undermined exports. The cost of insuring Malaysia’s debt against default has soared while the ringgit has plummetted. The currency fell as much as 2.5 percent on Aug. 14, hitting a new 17-year low against the U.S. dollar.

In its efforts to defend the currency, Malaysia has running down its foreign exchange reserves, prompting worries the country might be forced to impose capital controls.

What is the potential political fallout?

Najib has sacked his deputy Muhyiddin Yassin, who publicly criticized him in relation to 1MDB, and four other ministers. He has also replaced the attorney general who was leading an investigation into the scandal and has suspended leading newspapers.

Najib accuses influential former Prime Minister Mahathir Mohamad, who is 90 years old and has a reputation for meddling, of leading a smear campaign to oust him.

One possibility is a vote of no confidence against Najib’s leadership of The United Malays National Organisation, which has dominated the country’s political landscape since independence. But it may be hard for party members to rally the numbers required to make that happen.

A vote of no confidence in parliament would only be successful if members of the ruling Barisan Nasional coalition were prepared to break ranks and work alongside the weak and divided opposition.

A protracted power struggle seems likely, which could throw up new allegations. Street protests may grow. The deteriorating economic situation could further undermine support for Najib.

It is also possible that Najib’s party may pressure him to resign, as his predecessor was forced to do. For now, though, the embattled prime minister appears to have bought himself some time.


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