DEBT-LADEN 1Malaysia Development Bhd (1MDB) has continued to be a cause for concern over the impact of a potential default on its loans on the country’s economy, with the Ministry of Finance formally acknowledging that its financial position is “unsustainable”.

Last week, the ministry confirmed that the Cabinet has given approval for a RM950 million standing credit to 1MDB.

The concern is not without basis as the government’s strategic investment fund had reportedly accumulated debts amounting to RM42 billion as at end-March 2014.

Malayan Banking Bhd’s loan exposure to 1MDB has been estimated at RM5.5 billion. RHB Capital Bhd, AMMB Holdings Bhd and Affin Holdings Bhd have also given loans to 1MDB.

Bank Negara Malaysia acknowledges in its Financial Stability and Payment Systems (FSPS) Report 2014 that a broader contraction in credit flows to key economic sectors can precipitate a severe economic slowdown.

“A rapid and significant increase in corporate leverage can also raise financial stability risks, particularly where it is accompanied by prolonged low interest rates, compressed risk premiums and a rising share of foreign currency borrowings,” it says.

However, the central bank assures that the debt-servicing capacity of Malaysian businesses is generally sound. “Overall, the financial strength of businesses (including government-linked companies and large and systemic borrowers) is mostly intact, with sustained sound-debt servicing capacity and liquidity positions,” it says.

Bank Negara Governor Tan Sri Dr Zeti Akhtar Aziz has also reaffirmed her stance that no single entity will be allowed to have systemic implications on the domestic economy, and highly-leveraged entities such as 1MDB is no exception.

 Speaking at a media briefing on the central bank’s annual report, Zeti points out that the Malaysian financial system is able to withstand high stresses, as evidenced by a solvency stress test conducted by Bank Negara on banks has demonstrated that there is a strong financial buffer to support debt obligations.

“If there are concerns of any vulnerability to our financial system or that might cause economic dislocation, we will take action well before it happens,” she was quoted as saying.

Bank Negara has also undertaken stress tests that simulated four major shocks under two adverse scenarios on a set of non-financial corporations with total domestic exposures exceeding RM2 billion at each entity.

Findings showed that the direct contagion effects on the financial system arising from potential distressed corporations appear to be “well contained”.

“Even after simulating large withdrawals of deposits by affected sampled corporations, banks’ aggregate liquefiable assets could still withstand an additional 15.9% in deposit outflows within the one-month horizon,” it says.

On the whole, the share of Malaysian corporate debt that represents potential “vulnerable debt”, based on the individual borrowing firm’s leverage and financial indicators, is low compared with its regional peers.

“Corporate leverage of Malaysian firms on aggregate has remained below the level observed before the global financial crisis, in contrast to other emerging economies,” says Bank Negara.

“Strong and relatively stable corporate earnings over the past years have allowed firms to sustainably increase debt levels to fund growing capital expenditure and investments.”

It adds that this has been supported by improved debt-servicing capacity observed at the aggregate and individual firm levels.

Its data also shows that external borrowings of Malaysian corporations increased at a modest annual rate of 4.2% between 2008 and 2014, averaging at 18% of gross domestic product, underpinned by the continued cross-border expansion of larger firms.

About 41% of these external borrowings were in the form of long-dated debt securities, the bulk of which was issued by large home-grown conglomerates with operations in multiple jurisdictions.

According to the central bank, private-sector investment accounted for 64% of total investment in 2014 and public-sector investment, the remaining 36%.

Of the public-sector investment, 72% was undertaken by public enterprises such as Petroliam Nasional Bhd, Tenaga Nasional Bhd and Telekom Malaysia Bhd.

The remaining 28% of public-sector investment was undertaken by the general government, comprising the Federal Government, state governments, statutory bodies and local authorities.

Public-sector investment saw a contraction of 4.9% in 2014 from 2.2% in 2013, following a decline in the Federal Government’s development expenditure and lower capital spending by public enterprises.

This article first appeared in The Edge Malaysia Weekly, on March 16 - 22, 2015.

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