* 1MDB has agreed to pay $1.2 bln to Abu Dhabi's IPIC
* 1MDB & Malaysia's MoF to make payments on two bonds
* Deal bolsters PM Najib ahead of polls
* Moody's analyst says "contingent risks" remain (Recasts, adds background and analyst comment)
By Praveen Menon and Stanley Carvalho
KUALA LUMPUR/ABU DHABI, April 24 (Reuters) - Malaysia moved closer to clearing up the financial fallout of its 1MDB scandal on Monday by resolving a debt dispute with Abu Dhabi, bolstering Prime Minister Najib Razak ahead of elections.
The Malaysian state fund defaulted on its bonds a year ago, sparking a dispute with Abu Dhabi's International Petroleum Investment Co (IPIC), which asked a London court to arbitrate over a claim totalling some $6.5 billion.
1MDB, once a pet project of its founder Najib, is the subject of money-laundering investigations in at least six countries, including Switzerland and Singapore.
1MDB has denied any wrongdoing and Najib, whose office did not immediately respond to a request for comment, has denied all allegations of corruption against him.
The Abu Dhabi deal, under which 1MDB will pay $1.2 billion in two instalments to IPIC, comes at a critical time for Najib, who has to call elections before August 2018. He is fighting to reverse dismal 2013 polls, when his party nearly lost power.
IPIC had guaranteed bonds issued by 1MDB, the two companies said in separate statements, but now 1MDB and Malaysia's Ministry of Finance will assume responsibility for all future interest and principal payments under two bonds issued by 1MDB Group companies, IPIC said in a filing in London.
These include the $1.75 billion 5.75 percent fixed rate notes due 2022 and $1.75 billion fixed rate 5.99 percent notes due 2022, both issued by 1MDB entities.
1MDB said payments will be made to IPIC by monetizing investment fund units.
A source aware of the discussions said both parties will continue talks until December 2020 over $3.5 billion linked to the two bonds, and no legal action will be pursued.
The agreement is conditional on the Arbitration Tribunal in London making a "consent award" by May 31.
The settlement is the first major step towards addressing IPIC's claims, which included $3.5 billion in bonds, plus interest amounting to $4.8 billion, a $1.2 billion loan plus interest, and about $481 million owed to IPIC's subsidiary Aabar, a source who asked not to be named told Reuters.
“Both sides had an interest in avoiding (an) arbitration hearing and that is what has happened,” Christian de Guzman, a Singapore-based senior credit officer at Moody's Investors Service said, adding that "contingent risks" remain for both sides until the 1MDB bonds are fully settled.
Najib's party is still widely expected to win elections, which he may call this year after clawing his way back to the top by purging dissenters, dismantling the opposition and escaping damage from the multi-billion dollar 1MDB scandal.
"The latest act of settling the debt dispute just means that the 1MDB issue is settled ... and this paves the way for elections," Oh Ei Sun, Senior Fellow at S.Rajaratnam School of International Studies, said.
But the polls may still be a close one, as Najib grapples with soaring living costs and economic uncertainties and Malaysia's longest serving premier Mahathir Mohamad has teamed up with opposition forces in an effort to oust him.
Opposition parties slammed the settlement, with Wong Chen, a member of Parti Keadilan Rakyat (PKR), saying it was a bad deal for taxpayers.
"Malaysian taxpayers via the Ministry of Finance are now exposed to more than $6 billion in payments to IPIC for the financial scandals of 1MDB, where not a single person has been arrested by the Malaysian authorities," he said in a statement. Najib faced the biggest challenge to his leadership in 2015 after allegations that hundreds of millions of dollars was misappropriated from 1MDB.
Lawsuits filed by the U.S. Justice Department in July said more than $700 million of misappropriated funds flowed into the accounts of "Malaysian Official 1", who U.S. and Malaysian officials have identified as Najib. (Additional reporting by Saeed Azhar; editing by Alexander Smith)