KUALA LUMPUR: State investment fund 1Malaysia Development Bhd's bond default payment last month is not likely to lead to a crystallisation of the existing guarantee obligations of the Malaysian sovereign for 1MDB securities affected by cross-defaults, says Fitch Ratings.
There is little risk to the sovereign credit profile as yet, said its analysts, adding that the risk lies more in the potential for the affair to weaken policy focus or contribute to political instability.
1MDB missed a US$50 million coupon payment on a 5.75 per cent bond due in 2022 but International Petroleum Investment Corp (IPIC), Abu Dhabi's sovereign wealth fund which had guaranteed the bonds under a debt-for-asset swap agreement, subsequently made the payment.
"Market reaction has been relatively modest, but a large or sudden pullback by international investors could create risks to economic performance or financial market stability, given the large non-resident holdings of government securities," they said.
The 1MDB affair has not had a discernible impact on policy-making, as the government has maintained fiscal consolidation and budget reforms.
"However, if its ability to implement economic policy weakened, this could be negative for the sovereign rating. So too could a broader deterioration in political stability, or in governance (already a credit weakness for Malaysia) that damaged the credibility of policy-making institutions," the analysts said.
The affected bonds are not explicitly guaranteed by the Malaysian sovereign but the default on the 2022 bond triggered a cross-default on 1MDB’s RM5 billion (US$1.2 billion) sukuk due in 2039 that benefits from an explicit sovereign guarantee.
The only other 1MDB debt benefiting from an explicit sovereign guarantee is a RM800 million loan from the country's social security organisation (SOCSO). The default on the 2022 bond does not trigger a cross-default on this loan.
The analysts said 1MDB is being viewed as a close contingent liability of the sovereign, given its strong links with the government.
The total RM5.8 billion sovereign guaranteed debt amounts to roughly 0.5 per cent of forecast 2016 gross domestic product (GDP), while total debt currently disclosed by 1MDB is close to RM33 billion, or nearly 2.7 per cent of forecast 2016 GDP.
The federal debt stands at 54.5 per cent of GDP at end-2015, close to Malaysia's statutory 55 per cent ceiling.
"A breach would probably not in itself trigger a negative sovereign rating action, assuming the sums involved were around our estimates," they said.
The 'A' category median debt:GDP ratio is 52 per cent.
Fitch affirmed Malaysia at 'A-'/Stable in February.