By Una Galani
Breakingviews
Reuters
April 19, 2016

Malaysia’s effort to contain the financial fallout from its wayward sovereign fund is unravelling. Scandal-hit 1Malaysia Development Berhad is embroiled in a scrap with a state-backed investor in Abu Dhabi over a $4.5 billion debt deal. The risk for the southeast Asian nation is that its finance ministry will have to bear the burden. That’s exactly the outcome the fund championed by Prime Minister Najib Razak has been trying to avoid.

To recap, 1MDB racked up massive debts on a string of questionable deals. After it ran into trouble, it negotiated a lifeline last year from International Petroleum Investment Company, which is backed by Abu Dhabi royal Sheikh Mansour bin Zayed al-Nahyan.

IPIC agreed to lend 1MDB $1 billion and assume responsibility for bonds worth $3.5 billion. The quid pro quo was that IPIC would receive assets of equivalent value from the Malaysian fund by the end of June this year.

Now IPIC has missed an interest payment on 1MDB’s bonds. The details are sketchy, but the Gulf fund says it doesn’t have to honour the debt agreement because 1MDB hasn’t fulfilled its side of the deal.

In the end, both parties look foolish. After all, 1MDB’s financial woes owe much to alleged high-level corruption involving former officials on both sides. The fight looks set to end up in the courts.

IPIC’s apparent decision to walk away from debt it jointly guaranteed with 1MDB – and the subsequent settlement – undermines the widely-held view that Abu Dhabi’s word is water-tight. That matters because IPIC and its subsidiaries rely on external funding.

Meanwhile, Malaysia should be able to cope with the financial consequences. Though 1MDB owed almost $11 billion at the height of its problems, it has repaid all its bank debt and sold assets to reduce the overall burden.

The fund and the government say they will honour their other commitments, which should remove doubts about 1MDB’s last big outstanding liability, a $3 billion bond which already carries a letter of state support.

Yet if the government ends up on the hook, Najib will no longer be able argue that the fund he championed managed to clean up after itself. That will give the Prime Minister’s many critics another stick with which to beat him.