| SINGAPORE/HONG KONG, June 2
SINGAPORE/HONG KONG, June 2 Lurking beneath
Malaysia's solid investment-grade sovereign rating is a risk
posed by a $14 billion investment fund that is not even
generating enough cash from operations to cover interest costs.
Regarded as a cross between a sovereign wealth fund and a
private investment vehicle, with Prime Minister Najib Razak
chairing its advisory board, 1Malaysia Development Berhad (1MDB)
is struggling under the burden of $11 billion in borrowed money.
The government says it only guarantees around 14 percent of
the debt. The investment community assumes it would provide more
if needed, and it is the potential strain on Malaysia's debt
position from these contingent liabilities that raises concern.
"We don't know how well 1MDB is doing," said Christian de
Guzman, senior analyst of sovereign risk group at ratings agency
Moody's Investors Service. "It does pose a risk in terms of the
amount of borrowing they have made over the past few years."
Controversy has dogged 1MDB almost since it was first set up
months after Najib came to power in 2009, and used for funding
projects that form part of his Economic Transformation Program.
Critics have questioned its investment choices, the size of
its debt, $2.25 billion parked in a Cayman Island fund, hundreds
of millions of dollars of revenue earned by Goldman Sachs
for handling its bond issues, delays in its accounts, changes of
auditors, and a perceived lack of transparency.
A $1.9 billion bridging loan that fell due in November has
been rolled over twice, most recently two weeks ago, in order to
give 1MDB more time to launch a $2 billion initial public
offering that would reduce debt incurred buying 15 power
plants. In a statement published on May 23, 1MDB
said the IPO for its power division will take place in the
second half of this year.
In 2013, 1MDB, with liabilities of more than $13 billion,
generated cash flow of 860 million Malaysian ringgit ($267.75
million) from operations, far below the annual interest outgo of
1.62 billion. It would have made a 1.85 billion ringgit loss,
but for a 2.7 billion ringgit revaluation of its property
Opposition leader Anwar Ibrahim was quoted at a news
conference in late April warning; "If we continue with this
culture of accumulating debts, Najib's 1MDB will fail and become
a liability that should be called 1Malaysia's Debt of Billions."
The Prime Minister's Office and 1MDB did not respond to
Reuters' requests for comment.
1MDB defended itself in a statement released in February,
saying that its power assets had strong growth potential.
"All this points to a high value proposition that can be
expected to stimulate markets and bring significant FDI and cash
profits to the shareholder - the Government of Malaysia," it
But independent analysts also have voiced concern that
1MDB's debts could be pushing Malaysia into risky territory.
"1MDB remains somewhat of an enigma," Bank of America
Merrill Lynch economist Chua Hak Bin said in a note. "What
stands out, however, is 1MDB's high leverage, which has raised
concerns that 1MDB could emerge as a serious contingent
liability for the government."
Malaysia's debt-to-GDP ratio stood at 53.8 percent at the
end of 2013, central bank data shows, up sharply from 43 percent
in 2008 and close to an official debt ceiling of 55 percent,
beyond which the government must seek parliamentary approval.
Contingent liabilities, however, stood at 15.9 percent of
GDP, up from 9 percent in 2008, bringing total government and
government-backed debt to 69.7 percent of the economy, and the
off-budget character of 1MDB raises questions.
"It can be viewed as a way to circumvent the 55 percent
ceiling on government debt to GDP, while shielding this spending
from parliamentary scrutiny," said Prashant Singh, a fund
manager at Neuberger Berman in Singapore.
Holding a slim parliamentary majority after a controversial
election victory last year, Najib, who also runs the finance
ministry, can get approval to bust the debt ceiling, but it
could hurt his credibility.
Economists said a further delay to 1MDB's IPO, weaker
financial results and prospect of a further rollover of debt
could put the government on the spot.
"The trigger points which could force investors to price
1MDB risk more seriously into the sovereign could come in
various forms," said Leong Lin-Jing, assistant investment
manager at Aberdeen Asset Management Asia, based in Singapore.
Further explicit guarantees by the government for 1MDB
projects that are regarded as not necessarily beneficial to the
country would send a bad signal, Leong said.
Fitch Ratings cut the outlook on Malaysia's A- rating to
negative from stable last July. Only India and Sri Lanka, in
Asia ex-Japan, have higher debt ratios, according to Fitch.
"Malaysia's negative outlook is driven by factors such as
the rise in guaranteed and contingent liabilities like 1MDB, due
to its sovereign ownership linkage, and the sharp erosion in
current account surplus," said Andrew Colquhoun, Fitch sovereign
analyst for Malaysia told Reuters.
WATCH CDS MARKET
For now, investors remain cautiously optimistic over fiscal
consolidation plans. The government will introduce a new
consumption tax next year at a surprisingly high rate, and has
abolished sugar subsidies and raised property taxes in steps
that were welcomed by ratings agencies.
The government expects its fiscal deficit to fall to 3.5
percent of GDP this year from 3.9 percent last year, helped by
those measures and a robust economy that expanded 6.2 percent in
the first three months of 2014.
"If you look at other A- rated countries, Malaysia does have
in general a faster growth rate, generally lower and more stable
inflation rate and more robust balance of payments," said
Whereas foreign investors hold about 44 percent of Malaysian
bonds, one of the highest concentrations in a domestic
government bond market in the region, offshore trading in
Malaysian sovereign bonds is illiquid.
Any worries over Malaysia's debt would most likely show in
the market for credit default swaps (CDS), which acts as an
early barometer of stress in sovereign credit metrics. So far,
the CDS market appears relaxed over issues surrounding 1MDB.
In the year to date the 5-year CDS contract
has narrowed by 20 bps to 87/92 bps, slightly outperforming the
regional benchmark iTraxx index, which has narrowed
17 bps to 109.75/112.25.
(additional reporting by Yantoultra Ngui and Stuart Grudgings
in KUALA LUMPUR; Editing by Simon Cameron-Moore)