Is the 1MDB a tragedy or a farce?

The Edge
Rakyat Times
10th April 2015

The Malaysian Government’s ambitious investment experiment, 1Malaysia Development Bhd (1MDB), has turned into a political and financial minefield for Prime Minister Najib Razak and his ministers.

In recent months, the debt-laden sovereign wealth fund has made domestic and international headlines with explosive allegations of corruption, widespread mismanagement of public funds, serious political misbehaviour and opaque corporate dealings.

The relentless attacks on 1MDB – which have included public disclosures of confidential e-mail trails highlighting opaque transactions for highly dubious investments – have not only come from the country’s feisty opposition, but also former premier Mahathir Mohamad, who in recent days has publicly called for Najib’s resignation.

“Najib is facing too many scandals, and there are no answers,” Dr. Mahathir told reporters last week, adding that if the country’s dominant party, the United Malays National Organisation (UMNO), which – as the main partner in the Barisan Nasional (National Front) coalition – has helmed Malaysia since independence in 1957, wants to remain in power, then “I think they must change the prime minister”.

Writing Najib’s political obituary, however, may be a little premature, say several senior UMNO officials aligned to the UMNO president and prime minister.

They note that 1MDB has been the invisible pillar that has helped prop up the country’s entrenched patronage-driven political system by indirectly providing financial aid to a clutch of little-known foundations that have in turn helped Najib to fund election campaigns and funnel money to UMNO warlords to keep them loyal.

But the sovereign fund’s worsening financial position continues to send shockwaves over the Malaysian banking system and remains the most serious economic policy challenge for Najib’s administration.

‘Forced to scrap plan’

The most recent episode occurred late last month. Barely a week after appointing regional financial banking group CIMB Holdings to push ahead with the sale of the power-generation assets owned by the sovereign fund, the government was forced to scrap the plan.

That was because it threatened to trigger cross-default clauses in loan agreements that 1MDB had entered into with its international and domestic creditors, who are owed more than US$12 billion, potentially exposing the government to a major financial crisis.

“1MDB has brought governance issues in Malaysia to front of stage, and it now represents a serious contingent liability for the economy,” a senior fixed income asset manager with a Singapore-based foreign bank said.

1MDB is Najib’s brainchild and was set up shortly after he came to power in April 2009 with seed capital of 5 billion ringgit (US$1.37 billion) raised from a government-guaranteed bond issue. The fund was established to pursue strategic international investments, particularly in natural resources.

But the experiment appears to have gone horribly wrong. In just over six years, 1MDB has declared borrowings of over 46 billion ringgit on the back of an asset base of about 51 billion ringgit, made up largely of power-generation assets and potentially lucrative parcels of real estate acquired from the government at steep discounts to the market value.

According to senior administration officials, this dizzying build-up of debt has exposed the Malaysian government to roughly 23.5 billion ringgit in “implicit and explicit guarantees to 1MDB”. In most cases, this wouldn’t be a problem. Malaysia’s international credit worthiness ranks as one of Southeast Asia’s highest.

‘Toxic entity’

But mounting public scandal swirling around 1MDB has turned the sovereign fund into a toxic entity with serious reputational risks. That in turn has crippled its ability to raise new lines of financing and attract strategic investors as partners for its power-generation projects and property development plans. What’s more, its ability to service its debts has also gravely deteriorated, threatening serious volatility in Malaysia’s financial markets.

“The options going forward are very limited. Sell off the assets and pare down whatever debt you can is very much the plan,” acknowledges a senior foreign banker who has been involved in discussions with Finance Ministry officials on restructuring 1MDB. 1MDB has yet to publicly disclose its plans for a strategic business review, but financial executives involved in portions of its restructuring plan say the Najib administration is veering towards dismantling the fund over the next 12 months.

“The gradual winding-up is the overall plan, but a few things have to be put in place first,” says a foreign banker with knowledge of the restructuring. The main priority for 1MDB is reorganising its power assets, which bankers and investment analysts say were acquired at inflated prices and now suffer from the lack of capital to finance the expansion of existing power plants and develop new power-generating facilities.

The power-generation assets, now grouped in a wholly owned subsidiary called Edra Global Energy, cost 1MDB roughly 13 billion ringgit, financed almost entirely by borrowings. And bankers wonder whether the planned listing, which is slated for some time in June, will raise enough cash to cover these. 1MDB’s planned sale of its property assets shows more promise, financial executives believe.

The fund recently sealed an agreement with Australia’s Lend Lease to jointly develop 17 acres of land into a retail and lifestyle district worth an estimated US$2.15 billion. It would be part of a new financial hub called the Tun Razak Exchange (TRX) on the outskirts of Kuala Lumpur.

Financial executives familiar with 1MDB’s restructuring plan say it proposes to retire borrowings of roughly 5 billion ringgit associated with the TRX development that its owes to three state-owned agencies through a debt-to-equity swap for the project. 1MDB’s roughly 450 acres of land in a separate planned development called Bandar Malaysia, just outside Kuala Lumpur, is also drawing strong interest from Middle Eastern and Chinese investors.

Its attraction is that it will house the main terminal for the planned multi-billion-dollar high-speed rail line linking Kuala Lumpur and Singapore. Financiers close to 1MDB say that companies such as China Rail Group Ltd. want to participate in the development project with the hope of snaring the rights to construct the lucrative cross-border rail network.

‘Looks good on paper’

The planned assets sales look good on paper, but bankers and property industry executives are sceptical that the properties would be able to fetch the high values that 1MDB and the Malaysian government hope to receive to settle the fund’s dangerous debt load.

For starters, the reputational troubles that cloak 1MDB could delay the asset disposal plan and force down prices. The timing is also poor. Malaysia, one of the region’s largest petroleum exporters, is grappling with last year’s plunge in oil prices and a ringgit that has weakened by more than 10 per cent against the US dollar over the last six months.

Bankers and financial executives fear the restructuring plan is unlikely to raise enough to resolve 1MDB’s US$12 billion debt load. If it can’t, the size of the hit that Malaysian taxpayers will have to bear in the winding-up of 1MDB could whip up a political storm for the Najib administration. Still, few analysts expect the scandal to cost the premier his job.

After all, Malaysia has a long history of spectacular government financial scandals, particularly during the 22-year premiership of former strongman Dr. Mahathir.

However, the coming months will be fraught as 1MDB’s restructuring plans emerge and are subjected to scrutiny by critics – and a public expecting to have to pick up the bill, but without a clue as to how much it will be. – The Edge Review