PETALING JAYA, Jan 22 — Adopting an "odiousness” rating system for bonds could be the most effective way to deal with bad public debts incurred by corrupt governments, a US law professor said, as the 1Malaysia Development Berhad (1MDB) scandal continues to send ripples worldwide.

Mitu Gulati from Duke University said the idea was first proposed by economists Ricardo Hausmann and Ugo Panizza in 2017 following the economic crisis in Venezuela.

"I think the best suggestion out there, which is to do early a process of bond issuance, a kind of odiousness rating for the bond where you really use the ability of the financial market to rate bonds in terms of how a particular corrupt bond issuance is. For example, they got proper legislative approval, was audited properly,” he told Tracy Alloway, the co-host of Bloomberg programme Odd Lots, in a podcast interview yesterday.

The programme was focused on what lessons could be learned from the 1MDB scandal on the nature of public debt.

Gulati said public debt restructuring experts worldwide have been trying to come up with a system to improve the quality of sovereign borrowings and "in particular to reduce the amount of corrupt borrowing”, but added that "we have largely failed”.

In the aftermath of the 1MDB scandal, experts are now able to study it and see that there were "clear markers” of irregularities in the sovereign investment fund and that it was not managed properly, he said.

"If we have a public rating system that investors can look at, then maybe we would have a market mechanism to do what the court system and the existing international financing standard system have not been able to do,” Gulati said.

He said that 1MDB did not operate how "normal” sovereign investment funds were supposed to do, that is secure investments in Malaysia.

"It was a sovereign wealth fund that did not have wealth of the sovereign. It was accumulating wealth by borrowing from outside investors and then siphoning out these to corrupt financiers who were running it.”

Gulati also described the new Malaysian government’s attempt to slap new guarantees on corrupt 1MDB bonds as "bizarre” following the Pakatan Harapan coalition’s victory in the May 9 general election last year.

"Malaysia could have gotten out of the 1MDB debt obligation by presenting evidence of corruption to the court which will then stick the loan to the banks or agents that were corrupt.

"Instead, they did the opposite, which is to embrace the loan and say even though its corrupt, we are going to stick our taxpayers with it,” he said.

He explained that one of the plausible reasons the Malaysian government continued to service 1MDB’s debts was to portray the country as a good borrower to improve its credit rating or lower borrowing costs similar to the post-apartheid South African government that took over debts from its predecessor and paid them in full.

"It is a theoretical conjecture that it will improve your reputation as a borrower.

"But in 1MDB, you have a corrupt debt that the country could repudiate but it just goes on repaying it. Some of the 1MDB debts did not have state guarantees on them and the guarantees were slapped on afterwards.

"This allows us to empirically test whether or not markets for other Malaysian bonds actually improve and we can measure quite precisely whether the benefit from slapping the guarantee was greater than the cost of guarantee,” he said.

But Gulati said research data obtained from a study conducted with Panizza at the Graduate Institute, Geneva to date has so far provided no evidence that such a guarantee is of benefit to Malaysia.

"We can’t find any evidence of even the slightest benefit to Malaysia. Their yields did not go down at all. It’s basically just a huge loss to the Malaysian people and government,” he said.

Asked if there was a technical reason for the debt repayment, which could potentially cause a cross default on other debts if 1MDB bonds were not honoured, the US-based academic said the 1MDB bonds did not have cross default provisions with other bonds.

"There is a possibility some people in the current government who were either involved or who knew the people involved in the corruption do not want a trial where that corruption would get uncovered,” he said.