This article first appeared in The Edge Financial Daily, on May 11, 2016.

KUALA LUMPUR: The ringgit weakened against the US dollar to close at a seven-week low yesterday, ahead of another bond interest payment by troubled 1Malaysia Development Bhd (1MDB) due today.

The local currency slipped 0.86% to end the day at 4.0468 against the greenback on the back of a strong US dollar and as oil prices fell. Brent crude was down 26 US cents at US$43.37 a barrel yesterday.

The FBM KLCI gained 3.65 points or 0.22% to finish at 1635.84 points, propped up by bargain hunting after heavy losses on Monday.

Analysts said a second bond coupon payment default by 1MDB had very much been factored in by the markets after it missed the first one on April 25. The fund did not pay a US$50 million interest payment last month on a US$1.75 billion bond issued by its unit 1MDB Energy (Langat) Ltd, which carries a 5.75% coupon rate maturing in 2022.

“The market has already factored in any negativity during the first default when the KLCI dropped 22.01 points the day after the default, and the same applies for the ringgit which had also started to weaken after the default,” an analyst told The Edge Financial Daily.

“A second default by 1MDB is the most likely scenario as the fund is still in dispute with Abu Dhabi’s International Petroleum Investment Corp (IPIC) (which is the co-guarantor of the bonds). It would be contradicting its earlier stand if it were to make good on this second bond interest payment after defaulting on the first one,” the analyst added.

The second bond has a coupon payment of US$52.4 million, based on a 5.99% coupon rate arranged by Goldman Sachs Group Inc in May 2012. The bond, maturing in 2022, was issued by 1MDB Energy Ltd and proceeds were used to fund the purchase of power assets from tycoon T Ananda Krishnan.

“We have priced in [the] possibility of further ringgit weakness due to the overhang of recent 1MDB developments,” UOB Malaysia economist Julia Goh told The Edge Financial Daily.

“However, we think the main driver for the ringgit will be oil prices and divergent expectations of Fed (US Federal Reserve) rate path in the near term,” she added.

“I believe investors are aware that it is not a matter of insufficient funds on 1MDB’s end, but more on its dispute with IPIC. However, it can’t erase the fact that there is an element of a default by a Malaysian state investment firm and this may not paint a pretty picture for international investors,” said another analyst.

“Perhaps there will be some negative sentiment still lingering among investors on a potential second default, but I doubt it would rattle the market,” he added.

1MDB has been locked in a dispute over debt obligations to IPIC under an agreement reached in May last year. IPIC had claimed that it did not receive any money as a form of indemnity to guarantee the US$3.5 billion bonds issued by 1MDB. However, 1MDB claimed that it had transferred US$3.5 billion to a British Virgin Islands-registered firm called Aabar Investments PJS Ltd, which IPIC had clarified was not a unit of the sovereign wealth fund.

In a statement yesterday, Fitch Ratings said 1MDB’s missed bond coupon payment in April had highlighted ongoing uncertainty around the finances and governance of the state-owned fund.

“The situation is unlikely to lead to an immediate crystallisation of the existing guarantee obligations of the Malaysian sovereign for 1MDB securities affected by cross defaults,” the rating agency said.

“The risk to the sovereign credit profile lies more in the potential for the affair to weaken policy focus or contribute to political instability. However, there is little sign of these risks materialising as yet,” it added.

Fitch noted that the 1MDB affair had not had a discernible impact on policymaking, as the Malaysian government had maintained fiscal consolidation and budget reforms.

“However, if its ability to implement economic policy weakened, this could be negative for the sovereign rating. So too could a broader deterioration in political stability, or in governance (already a credit weakness for Malaysia) that damaged the credibility of policymaking institutions,” it warned.

Nevertheless, it pointed to the recent win by Barisan Nasional in the Sarawak state assembly elections, suggesting that the spillover from the 1MDB affair on politics remains contained so far.

“Market reaction has been relatively modest, but a large or sudden pullback by international investors could create risks to economic performance or financial market stability, given the large non-resident holdings of government securities,” said Fitch.