Why is contingent liability a risk?

Low Zhen Ting | Published 31 March 2023

Contingent liabilities, especially loan guarantees, are significant sources of fiscal risk for the federal government.

READ: What is a contingent liability?

For a loan guarantee, the federal government serves as the guarantor of the loan: if the loan defaults, the government will have to repay the outstanding amount first.

If a GLC or FSB is forced to default on a large amount of guaranteed loan, the government will be obliged to service the debt with the federal budget.

The federal government is also often expected to bail out institutions that are “too big to fail”. Bailouts essentially mean the government takes on the institution’s financial burden, which can drain public resources if not well managed. They might also lead to other risks, depending on the form of bailouts.

If not controlled well, the contingent liabilities have the chance to become a part of the government’s fiscal burden when the guaranteed entities have to default on their loans. The burden will eventually fall on the people as the guarantees become public debts.

High levels of contingent liabilities also put pressure on Malaysia’s credit ratings since it is a potential fiscal risk.¹Main rating agencies – Fitch Ratings, S&P, and Moody – take contingent liabilities into account when assessing a country’s fiscal strength.

How is our current level of contingent liabilities?

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A number of loan guarantee recipients are involved in public infrastructure and transportation projects. Danainfra Nasional Berhad and Prasarana Malaysia Berhad, the respective financing entities and operations entities for the MRT projects, are among the major recipients. As of 2022, the loan guarantees for Danainfra and Prasarana reached over RM82 billion and RM42 billion respectively–nearly RM125 billion in total (42% of Malaysia’s revenue in 2022)!

The ability of Danainfra and Prasarana to service their debts will highly depend on the performance of MRT2 and MRT3; if they are unable to sustain themselves financially, the financial burden to pay back the debts will then fall on the government.

Early in May 2022, Tanjong Malim MP and Minister of Science, Technology and Innovation YB Chang Lih Kang has pointed out that if the ridership for MRT2 and MRT3 fails to meet the targeted level, the government would have to service the debt since the entities will not be sustainable financially².