A financial scandal around the state-run fund isn't fading away but could take a new turn after the surprise results this week of national Malaysian elections.

Just when some of the furore around Malaysia’s scandal-hit 1MDB fund appeared to have died down, the shock results of this week’s national elections are likely to propel its affairs up the global news agenda.

Malaysia is on course to have a new prime minister, with the regime of Najib Razak, beset by an international scandal surrounding 1MDB, ousted in a result deemed a surprise by markets.  The coalition that has been at the helm in the Southeast Asian nation for six decades is out of power.

Mahathir Mohamad appeared to be set as at the time of writing to take up the role of premier and is the man who, at 92, could become one of the world’s oldest leaders. He ruled the country from 1981 to 2003, a period including the Asian financial crisis of 1997-98 that saw exchange rates plunge and austerity measures imposed. His victory is at the cost of the administration of premier Najib Razak, who is accused of siphoning money from the 1MDB fund for personal gain (he denies the claims). Illicit flows connected to that fund via hubs such as Singapore and Switzerland have prompted global probes, with a number of banks in Singapore punished and in some cases (BSI, Falcon Private Bank), stripped of their local licenses. Mahathir has reportedly vowed to investigate the scandal.

The election result could sharpen focus on corruption more generally. According to Transparency International, an organization tracking such issues, Malaysia ranks at 62 out of 180 jurisdictions. TI’s survey for 2017 puts New Zealand at the top (i.e., least corrupt), with Somalia at 180. On a scale of zero to 100, where 100 is the least corrupt, New Zealand's score is 89, while Somalia's is 9. Malaysia's score is 47. (Malaysia is a former UK colony.)

The Mahathir-led alliance of four parties handily beat the Barisan Nasional (BN) coalition of Najib Razak. No single party has won a simple majority of seats in the 222-member parliament, media reports said.

Among the few policy ideas of Mahathir that emerged during the race was a pledge to repeal the goods and services tax (GST), opening questions about how any revenue shortfalls will be plugged.

“The Malaysia election outcome is a huge upset, no pollster was expecting this. This upset ranks up there with Brexit and Trump election. This is as momentous as say PRI being dislodged from power in Mexico. UMNO led Barisan has been unseated for the first time since 1957. I believe the Ringgit will come under pressure as policy continuity will come under a cloud," Aninda Mitra, senior sovereign analyst at BNY Mellon Investment Management, said.

“I think there will be short term volatility. It is a significant course correction following the corruption under Najib. However, I can’t see realistically how they can unwind GST. It contributes as much as around one quarter of total federal government revenue and cannot be easily substituted by other revenue sources. The bottom line is that while a long term fix of governance, institutions and public life is now in sight, near term policy uncertainty will be high. That will take a toll on the Ringgit at least until more clarity emerges," the analyst added.

“It’s a new political dawn for Malaysia, which may see its first ever change of government since its independence from the British in 1957. This was a stunning election outcome that few would have predicted. We would expect some market volatility from the election result and possibly some spillover impact on investments. It is likely that larger companies, many of which are government-linked, will bear the brunt of any index-linked selling which might take place in the near term," Aberdeen Standard Investments Malaysia chief executive Gerald Ambrose said.

“More broadly, some of Pakatan Harapan’s (PH) election pledges may have diverging impacts on the share prices of specific sectors over the short term. PH’s intention to review all infrastructure mega-projects may lead to some initial selling in the construction and cement sectors, while its agenda to mitigate high living costs may enhance consumer sector stocks, such as food manufacturers, consumer staples and retail plays," Ambrose continued. “Over the medium to longer term, we think the election outcome reflects a growing level of political maturity and respect for democracy that would be beneficial for the country’s appeal to foreign investors and economic prospects," he added.

Market surprise
The results weren’t what investors expected. Equities rallied in the run-up to the final voting stage and fell in response to the news. Malaysia five-year credit default swaps – a gauge of confidence in debt repayment - widened as high as 20 basis points and now settled at around 11 bps. The dollar-ringgit exchange rate rose yesterday to 3.949 (source: Union Bancaire Privée).

“Short-term, we may see market volatility given uncertainty around policy implementation. I have been underweight Malaysia for the past few years given risk reward and valuation issues. However, we may see some opportunities should policies move in the right direction," Teera Chanpongsang, portfolio manager at Fidelity International, said.

To read a recent analysis on certain regulatory and tax issues in Malaysia, as provided by Baker McKenzie, the law firm, click here.