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Malaysia's 1MDB looms large over politics as fund is wound down

[KUALA LUMPUR] Long after its demise, Malaysia's state investment company may loom large over the country's politics and the future of Prime Minister Najib Razak.

The brainchild of Najib, debt-ridden 1Malaysia Development Bhd's six-year existence has been dogged by controversy, culminating in a decision to wind it down even before multiple investigations were started into its finances.

With Mr Najib now fending off a Wall Street Journal report that US$700 million connected to 1MDB may have wended its way into his bank accounts, the fund risks having an outsized effect on affairs in Malaysia through to the next election due by 2018. The 1MDB probes could run for months yet, distracting a ruling coalition that won re-election in 2013 in its worst showing since independence in 1957.

"As long as Mr Najib's there, 1MDB will be an issue at the next elections" for his United Malays National Organisation, said Ooi Kee Beng, deputy director of Singapore's Institute of Southeast Asian Studies.

Mr Najib has denied taking funds for personal gain.

For ordinary Malaysians, the troubles at 1MDB and its maze of bonds, syndicated loans and debt guarantees hadn't registered as of a few months ago. A poll by the Merdeka Center for Opinion Research in March showed 69 per cent of voters weren't fully aware what the 1MDB controversy was about, while 75 per cent didn't know its role.

"The only bond that most Malaysians know is James Bond," said Shamsul Amri Baharuddin, a professor at the National University of Malaysia who has researched local politics and the impact of government policies as a social anthropologist.

Still, at a time of slowing economic growth and as Mr Najib's coalition is still bedding down a goods and services tax to help narrow a budget deficit and reduce reliance on oil revenue, the 1MDB scandals are an unwelcome development. The fund's offices were raided last week by the task force investigating the claims against Najib.

Mr Najib's office and 1MDB didn't respond to e-mails and calls seeking comment on the company's impact on politics in Malaysia.

Designed as a catalyst for infrastructure projects, 1MDB amassed about RM42 billion of debt in less than five years, in part to fund the purchase of energy assets and for the development of a new financial district in Kuala Lumpur named after Mr Najib's father.

Then the troubles began. How 1MDB, whose advisory board Mr Najib chairs, conducted bond sales was questioned when it emerged that Goldman Sachs Group Inc made about US$500 million arranging the sale of US$6.5 billion of debt. A Goldman spokesman has repeatedly declined to comment on fees for transactions.

Opposition lawmakers demanded answers on premiums seemingly being paid on power plant acquisitions, and bristled at news the government sold land to the company at a discount.

The company came close to defaulting on debt at the start of this year after missing loan repayments. In February it announced plans to break up assets and wind down operations. Former premier Mahathir Mohamad, once Najib's mentor, started calling for the prime minister to step down as probes of the fund's finances were announced.

On July 3, the Journal reported that about US$700 million may have moved through government agencies, banks and companies linked to 1MDB before apparently appearing in Najib's accounts. 1MDB has said reports that it funneled funds to Mr Najib's accounts are untrue. An interim Auditor-General report on the fund didn't show any suspicious activity.

1MDB had its origins in the Terengganu Investment Authority, created in 2009 to invest oil royalties from the state of Terengganu. When Mr Najib became prime minister the same year, the federal government paid RM1 million to take it over, renamed it 1MDB and made it a national entity. Its funding source was changed to government-backed debt.

Financial Reports The company and government have been opaque about 1MDB's finances. Even as it announced billion-dollar ventures with Middle Eastern countries, the government said in July 2010 it wouldn't table 1MDB's annual financial report in parliament as disclosures weren't required. In subsequent years, it asked for extensions to file the financial statements to the companies commission.

As 1MDB's debt rose, so did the government's contingent liabilities. Fitch Ratings in July 2013 cut Malaysia's sovereign outlook to negative, citing off-balance sheet costs for the government. As Mr Najib pledged to narrow the budget deficit, 1MDB asked for a bridging loan from a bank and sold more bonds.

1MDB's borrowings climbed 16 per cent to RM41.9 billion in the year ended March 2014 from the previous period, it said in November. Its annual report for the year ended in March isn't due yet.

"1MDB is a concern because it is implicitly a sovereign entity that is TBTF: too big to fail," said Alan Richardson, a Hong Kong-based money manager at Samsung Asset Management Ltd.

As investigators stepped up their probe of 1MDB, the ringgit weakened beyond 3.8 against the dollar on July 6 for the first time since the Asian financial crisis of the late 1990s, hindered also by emerging market declines related to turmoil in Greece.

The company's most liquid dollar bonds - its US$3 billion of 4.4 per cent securities due 2023 - are trading at 83.9 cents on the dollar to yield 7.2 per cent and have lost 4 per cent this month, according to prices compiled by Bloomberg. This year, they're down 12.6 per cent. Standard & Poor's rates those notes A-, the same grade it gives the sovereign.

"Malaysia needs this scandal like it needs a hole in the head," said Nicholas Spiro, managing director of Spiro Sovereign Strategy, an advisory firm in London. "There is some nervousness in the markets."