Twin ghosts haunt Malaysia’s sovereign fund

By Una Galani
Reuters
March 12, 2015

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Malaysia’s 1MDB faces a daunting task. The six year-old sovereign fund was set up to finance big national projects but expanded too fast, took on heavy debts and is now at the centre of a growing controversy. An ambitious restructuring brings both political and financial risks.

The fund which counts Prime Minister Najib Razak as chairman of its board of advisors has pledged to dismantle itself following a strategic review led by new chief executive Arul Kanda. It plans to stop making new investments and raise cash through an initial public offering of Malaysia’s second largest independent power producer. Selling unused land and finding equity partners for real estate projects that include a new financial centre in Kuala Lumpur and a development built around the terminus for a planned high-speed rail link with Singapore should bring in additional funds.

1MDB’s most pressing objective is to pay down net debt, which stood at around 38 billion ringgit ($10.3 billion) in March 2014. In the same year it made a net loss of 665.4 million ringgit, despite booking a gain from the revaluation of its property portfolio. Absent similar revaluations, it also made a loss in the previous two years.

In the past year, 1MDB has already redeemed $2.3 billion of investments it held in the Cayman Islands and settled a 2 billion ringgit loan. A public offering of an 80 percent stake in its energy unit – which carries debt of around 18 billion ringgit – was initially expected to raise 11 billion ringgit. However, previous efforts to list the business have been delayed. Meanwhile, potential co-investors may shy away from an entity that appears unable to escape controversy.

Past missteps hardly inspire confidence. 1MDB overpaid for the energy assets it has acquired since 2012 from local tycoon Ananda Krishnan and other conglomerates. It has also attracted scrutiny by paying unusually high fees on bond issues worth $4.8 billion arranged by Goldman Sachs in 2012 and 2013. Around $3 billion was earmarked for a joint venture with state-backed Abu Dhabi investor Aabar. Although the two countries retain a strong relationship, the terms of the venture have still not been finalised and an agreement appears unlikely to materialise.

The fund’s lack of transparency has been a particular concern in recent months. Its failure to repay a 2 billion ringgit loan due at the end of November sparked a broader market sell-off as investors worried that 1MDB’s debts might pose an additional burden for a country already grappling with the plunge in global oil prices.

Kanda said on Feb. 15 that the loan had been settled but provided no explanation of how. Even though Krishnan is widely believed to have played a part in clearing the loan in return for a share of the energy business, 1MDB has remained silent on the issue.

Meanwhile, 1MDB has become a target for Najib’s political opponents. Following reports that a local tycoon had siphoned money out of the fund, former Malaysian Prime Minister Mahathir Mohamad called for an investigation into its finances. In an attempt to contain the political storm, Najib on March 4 ordered Malaysia’s auditor-general to verify 1MDB’s accounts.

The risk is that the political controversy makes it harder for 1MDB to clean up its finances. If the fund is unable to reduce its debt, the government may be forced to help out, for example by asking state-backed pension funds and companies to support a listing of the energy business or become equity partners in its real estate projects.

Alternatively, the government may have to support 1MDB’s debt directly. The state has explicitly guaranteed 5.8 billion of the fund’s borrowings. Extending this to all of 1MDB’s net debt at the end of March 2014 would increase the state’s contingent liabilities to 18.1 percent of GDP from 15.1 percent at the end of the third quarter. That’s on top of federal government debt that was already at 52.8 percent of GDP at the end of the same period.

What 1MDB’s many critics really want is a frank and simple explanation of how a fund supported by the Prime Minister ended up in such a financial mess. That would probably draw attention to past mismanagement and costly mistakes. Unless it is able to complete its ambitious clean-up, however, 1MDB’s woes will continue to be a political and financial burden.