Funds turn cool on Malaysia as 1MDB scandal swells debt to $250 billion

Plagued by heavy debt and questions about its management and investment decisions, 1MDB fund became a scandal that culminated in global probes into alleged embezzlement and money laundering

The escalating scandal around troubled state-investment-fund 1MDB is turning bond funds against Malaysia.

The disclosure that the nation’s debt is almost 60 per cent higher than previous estimates at 1 trillion ringgit ($250 billion), largely because of hidden liabilities tied to the troubled state investment fund, is convincing even fans of the country’s bonds to cut their holdings. Throw in the removal of a goods and services tax last month, and Prime Minister Mahathir Mohamad’s new government faces an increasing fiscal squeeze.

“Uncertainty over how the fiscal deficit will pan out will overhang,” said Wilfred Wee, a fund manager in Singapore at Investec Asset Management Ltd., which oversees $146 billion. “Until the dust settles, we have reduced our still overweight exposure to Malaysia, recognizing that Malaysia’s current account and overall fundamentals remain by and large still attractive versus peers.”

A one-time crystallizing of 1MDB’s debt and writing off its assets may cost almost 3 per cent of gross domestic product, Wee said. Rating agencies are likely to downgrade Malaysia sooner rather than later if its fiscal health deteriorates significantly due to liabilities arising from 1MDB, Brown Brothers Harriman said in a report this month.

Alleged Embezzlement

1Malaysia Development Bhd. took shape in 2009 under former Prime Minister Najib Razak as a vehicle to drive investment into Malaysia and boost its assets abroad. Plagued by heavy debt and questions about its management and investment decisions, the fund became a scandal that culminated in global probes into alleged embezzlement and money laundering.

After the opposition’s shock election victory last month, new Finance Minister Lim Guan Eng revealed that government debt and liabilities had jumped to 1.087 trillion ringgit, inflated by state guarantees for borrowing at 1MDB. That compares with the federal debt of 685 billion ringgit estimated by the Ministry of Finance in 2017.

Markets were spooked by the disclosure, with the ringgit sliding to a five-month low and overseas ownership of the nation’s bonds dropping to the lowest since August. The Malaysian currency weakened beyond 4 per dollar for the first time since January on Monday. Global funds sold almost 10 billion ringgit of Malaysia’s sovereign debt in May, the most since March 2017.

“We hold a cautious view on Malaysia due to fiscal and political uncertainty, potential negative ratings action and uninspiring valuations,” said Roland Mieth, emerging markets portfolio manager in Singapore at Pacific Investment Management Co., which oversees $1.77 trillion. "The replacement of GST with service and sales taxes adds uncertainty to Malaysia’s fiscal trajectory.”

GAM Overweight

Concerns about the country’s worsening debt levels are overdone, according to GAM (UK) Ltd.

The government remains on track to meet its 2018 budget deficit target of 2.8 per cent of GDP, and the economy is growing fast enough to ensure the debt-to-GDP ratio will gradually decline, said Michael Biggs, emerging-market fixed-income investment manager in London at GAM, which oversees the equivalent of $163 billion.

“We have a modest overweight on Malaysian government bonds,” he said. “Inflation has remained contained, Malaysia’s balance of payments appear solid, foreign reserves are rising, and both real and nominal yields are at attractive levels.”

BNY Mellon Investment Management believes bond supply may need to increase to compensate for a decline in revenue caused by the removal of the goods and services tax.

“We would prefer to not be heavily exposed to Malaysian bonds until the fiscal uncertainty abates,” said Aninda Mitra, senior sovereign analyst at the company in Singapore. “On many metrics the ringgit remains a relatively cheap currency to own. But, we are likely to see a prolonged tussle between policy uncertainty and a broader loss of confidence, which could overwhelm any lingering perception of value.”