Default risk climbs for Malaysia as Najib probe outweighs Fitch

The Edge
July 10, 2015

(July 10): Less than two weeks after Fitch Ratings refrained from downgrading Malaysia, the cost of insuring the nation’s debt is at a six-month high amid a graft probe involving Prime Minister Najib Razak.

Five-year credit-default swaps protecting sovereign notes climbed as much as 12 basis points in July to 148 after the Wall Street Journal reported last week that $700 million of a state investment company’s funds may have ended up in Najib’s bank accounts, a claim he is disputing. The contracts could rise toward 200, a level last seen in 2011, according to Macquarie Bank Ltd.

Heightened credit risk is lifting bond yields, raising funding costs to build railways, roads and power plants as Najib presses ahead with a $444 billion development program. It’s also weighing on the ringgit, which has led losses among Asian currencies this year as lower oil prices hurt Malaysian exports. Brent crude is down 7.2 percent this month and is 49 percent cheaper than it was from its high a year ago.

“Everything seems to conspire against Malaysian bonds and the ringgit in the last couple of weeks,” said Nizam Idris, head of currency and fixed-income strategy at Macquarie Bank in Singapore. “The political scandal involving the prime minister was a big surprise that hit market sentiment” and the CDS price could surpass 160 and head toward 200, he said.

Credit protection on Malaysia’s bonds may rise to 150, said Tim Condon, the Singapore-based head of Asia research at ING Groep NV. The swaps reached a high of 213 in October 2011 in the midst of the European debt crisis.

‘Too Early’

The extra yield investors demand to hold Malaysia’s 10-year government notes over those due in three years has widened 28 basis points in 2015 to 73, data compiled by Bloomberg show. It increased to 89 on July 6, the most since February last year.

The political strife revolving around Najib, which has led to calls from former premier Mahathir Mohamad for him to step down, may drive up the 10-year yield to 4.5 percent, said Macquarie Bank’s Nizam. It last reached that level in 2008 in the wake of the global financial crisis and was at 4.02 percent on Thursday, up from 2015’s low of 3.72 percent in February.

A task force that includes the Auditor General, police and the central bank is investigating the alleged money trail. Investigations so far haven’t shown any suspicious activity, Public Accounts Committee Chairman Nur Jazlan Mohamed said on Thursday, referring to an interim report from the Auditor General. Najib ordered the 1MDB investigation in March.

“It is still too early to come to any conclusion as the A- G will take till the end of the year to complete his work,” Jazlan said, referring to the Auditor General.

‘Lagged Impact’

The yield spread on 1MDB’s dollar-denominated bonds due in 2023 over U.S. Treasuries widened to a record 562 basis points on Wednesday before narrowing to 498 on Friday.

The political uncertainty has prompted PineBridge Investments to take an underweight position on the nation’s local-currency bonds.

“We would prefer to assess the expected lagged impact of lower energy prices on government revenues and for the political noise to subside before changing our stance,” said Anders Faergemann, who helps oversee $3.7 billion of emerging-market debt as a senior fund manager at PineBridge in London.

Malaysia’s credit-default swaps have risen above those of lower rated Thailand and the Philippines, with the swaps for those countries at 105 and 96, respectively. When Fitch refrained from cutting Malaysia’s A- debt rating on June 30 and instead lifted its outlook to stable from negative, the contracts for the Southeast Asian nation declined for three days to 129 on July 2.

‘Najib’s Prospects’

The ringgit has fallen 7.6 percent this year as the plunge in Brent crude prices from a 2014 peak erodes government revenue for the net oil exporter. It declined beyond 3.8 a dollar this week, the level it was pegged at from 1998 to 2005, and was at 3.7865 as of 12:13 p.m. in Kuala Lumpur on Friday.

Najib might eventually be forced to resign and that also means sovereign support for 1MDB could be in doubt, widening the bond yield premium investors demand to own 1MDB debt over government notes, ING’s Condon said.

“At this point, the rating change outlook is totally forgotten,” said Condon. “We’ll probably hit 150 again and then we may trade in a new higher range on the five-year CDS that reflects the increased uncertainty about Mr. Najib’s prospects for staying in power.”

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