A worsening dispute between the state funds of Malaysia and Abu Dhabi over complex billion-dollar transactions is threatening to trigger a major financial crisis for Prime Minister Najib Razak's government.
The row has to do with US$3.54 billion (S$4.8 billion) in payments that 1Malaysia Development Berhad (1MDB) says it made in 2012 to units of International Petroleum Investment Company (IPIC), the Abu Dhabi state fund. But IPIC maintains it never received the monies.
Last week, IPIC informed 1MDB that the KL entity was in default of a complex bond agreement between the two, according to Malaysian government officials and financial executives close to the situation.
The monies are part of payments under a May 2012 agreement, where the London-listed IPIC guaranteed 1MDB bonds valued at US$3.5 billion. In return, 1MDB agreed to make payments as collateral to IPIC's subsidiary Aabar.
The impact of this unravelling dispute will be tested in the coming days because interest payments of about US$50 million to 1MDB bondholders are due tomorrow.
Under the bond agreement, which saw IPIC swapping debt for assets from 1MDB, IPIC must make the interest payments.
Malaysian government officials, who spoke to The Straits Times on condition of anonymity, said IPIC has informally told 1MDB that it has no intention of honouring the interest payment because of the alleged default of the bond agreement. For its part, the Najib government has taken the position that it will not step in to cover the payment because it has done nothing wrong.
1MDB, the Prime Minister's brainchild set up shortly after he took office in 2009, is the subject of alleged corruption probes in at least seven countries, including Singapore.
The latest twists in the ongoing saga surfaced last week when IPIC declared in a statement to the London Stock Exchange that it had not received the billions of dollars in payments that 1MDB says it made.
IPIC said it was aware from media reports that 1MDB had sent money to a company - Aabar Investments PJS Ltd - in the British Virgin Islands, but that the firm "was not an entity" in its stable of companies.
After a flurry of meetings last week with 1MDB's top management, along with lawyers and Finance Ministry officials, Datuk Seri Najib took the position that any corporate liability had to be borne by Abu Dhabi and its state-owned entities.
His decision, according to government officials and financial executives close to the situation, was grounded on the fact that IPIC had honoured and paid over US$100 million in interest payments last October and November. Kuala Lumpur is also puzzled why it took IPIC more than three years to declare it had not received any monies.
"The Malaysian government's position is very clear; 1MDB has honoured all payments through its dealing with the highest leadership of IPIC and Aabar," said a senior government official. IPIC and Aabar could not be reached for comment.
The implications of this face-off are far-reaching for Malaysia and regional financial markets.
Senior financial executives familiar with the details of last week's meetings said Mr Najib, who is also Finance Minister, was advised that non-payment of the interest instalment this week would put 1MDB in default of the US$3.5 billion bond issue. That, in turn, could trigger so-called cross-defaults on 1MDB's other commitments. That means 1MDB's other creditors could demand early settlement or accelerated payments on its other obligations, which now stand at about US$5.1 billion.
What's more, the complications at 1MDB could also adversely impact Malaysia's efforts to raise much-needed funding in international bond markets, and hurt its credit ratings. This will make it more expensive for its government-linked firms and private entities to borrow funds.