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The inability of state investment fund 1Malaysia Development Berhad (1MDB) to repay its debts may trigger a downgrade in Malaysia's sovereign ratings, dealing yet another blow to a country already hit by falling oil prices.
"Certainly, the risk is there for a downgrade," said Hak Bin Chua, Asean economist at Bank of America Merrill Lynch.
Ratings agency Moody's warned last week that a worsening in Malaysia's debt dynamics or the crystallization of large contingent liabilities could exert downward pressure on its current A3 rating. Meanwhile, Fitch has an A- rating with a negative outlook on the country, which means a cut is likely within the next 12-18 months, according to a recent statement from the agency.
"Our sovereign credit team also has a negative outlook on the country. From an economics perspective, you can really see the cracks starting to show," said Su Sian Liam, Asean economist at HSBC.
1MDB, whose chairman is Prime Minister Najib Razak, has missed a deadline to repay a $550 million loan to creditor banks three times over the past three months, fuelling worries the company won't be able to service the rest of its obligations.
The company's entire debt load stands at $11.6 billion, out of which nearly $2 billion is guaranteed by the government. Experts say that makes it a serious liability risk for an economy whose finances have been strained by . Crude-related income accounts for 30 percent of government revenues.
"The financial position of 1Malaysia Development Berhad has become a source of uncertainty. Fitch views 1MDB as a close contingent liability of the sovereign because of the nature of its operations and leadership, as well as explicit sovereign guarantees" the agency said.
If 1MDB is unable to meet its obligations, the government will have to step in and that's likely inflate the country's massive public debt, already the largest in Southeast Asia at 55 percent of gross domestic product.
"The government's guarantee may be a small amount, but keep in mind that the budget is already stretched," warned Wellian Wiranto, economist at OCBC Bank.
In normal times, investors wouldn't pay too much attention to this issue, but given the oil-related challenges Malaysia faces and concerns about its budget deficit, the issue of contingent liability has added to concerns about fiscal improvement, Wiranto added.
"It's really too early to call 1MDB's situation a debt default. Looking at the numbers, the amounts aren't large at all so it won't have a big impact on Malaysia even if the government does have to step in," Rahul Bajoria, regional economist at Barclays, told CNBC.
1MDB's situation may not even require government intervention. Last week, the firm announced it may sell some of its property assets, worth over $5 billion, to pay off its debt load, Reuters reported.
Meanwhile, rumors are also abound that billionaire Ananda Krishnan, Malaysia's second-richest man, may lend the company funds to settle its $550 million loan.