Fitch downgrades Mongolia’s ratings to ‘B’, outlook positive

By bne IntelliNews November 25, 2015

Fitch Ratings has downgraded Mongolia’s long-term foreign and local currency issuer default ratings to ‘B’ from ‘B+’ and revised the outlooks to stable from negative, the ratings agency said in a statement.

The issue ratings on Mongolia’s senior unsecured foreign and local currency bonds were also downgraded to ‘B’ from ‘B+’. The country ceiling is downgraded to ‘B’ from ‘B+’ and the short-term foreign-currency IDR is affirmed at ‘B’.

The stable outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could lead to negative action are continued depletion of external liquidity or inability to access external capital markets; emergence of systemic financial stress; and collapse of the Oyu Tolgoi project agreement. At the same time, the main factors that could lead to positive action are implementation of credible and coherent macroeconomic policy-making that increases confidence in Mongolia’s basic economic stability and a track record of meeting stated fiscal targets, contributing to an improved outlook for government debt ratios, Fitch explained.

“The downgrade of Mongolia's IDRs reflects the following key rating drivers: Mongolia’s ratings reflect strained external liquidity, weak public finances, refinancing risks, and deterioration in its 2015-17 growth outlook,” the statement said. “These risks are balanced by recent improvements to its fiscal policy framework, favourable economic growth prospects reinforced by the resolution of the Oyu Tolgoi project dispute, and strong structural indicators.”

Fitch also noted recent commitments to tighter fiscal and monetary policies would likely enhance sovereign creditworthiness over time, but fiscal implementation risks are still high, and do not fully offset anticipated pressures on external and fiscal accounts over the 2015-17 forecast horizon.

Meanwhile, external liquidity remains weak based on foreign-reserve coverage of 3.0x current-account payments versus the ‘B’ median of 3.6x. Headline foreign reserves fell to $1.4bn at end-September 2015, and Fitch estimates that heavy utilisation of the CNY15bn ($2.4bn) swap agreement with the People's Bank of China has left under $300mn of remaining headroom, though the precise value remains unconfirmed by the authorities. The agency expects external liquidity to remain under pressure in 2016 due to a projected widening of the current-account deficit on the basis of weaker commodity exports and limited capital inflows.

Fitch forecasts a 2015 budget deficit of 8.6% of GDP, compared with an estimated 10.9% in 2014 based on its adjusted measure that includes commercial spending by the Development Bank of Mongolia (DBM). The country’s parliament has approved a budget for 2016 which targets an official deficit of 3.4% of GDP based on “somewhat aggressive revenue and economic growth assumptions”. Fitch forecasts a 2016 adjusted deficit of 6.3% of GDP, which incorporates some degree of revenue slippage as well as DBM’s commercial spending targets of approximately 2% of GDP.

General government gross debt (GGGD) will rise to an estimated 66.3% of GDP in 2015, higher than the ‘B’ median of 51.3%, and up from 49.4% in 2013. The authorities are in the process of implementing an aggressive set of fiscal targets under the amended Fiscal Stability Law (FSL), which sets a 2017 GGGD ceiling of 50% of GDP in present value terms (roughly 60% in nominal terms) and also prescribes tight budget deficit targets. Fitch expects GGGD to peak at 68.3% of GDP in 2016 and decline over the medium term, but at a slower pace than envisaged in the FSL due to our lower economic growth projections and a recent history of fiscal underperformance relative to original budget targets, Fitch said.

Fitch considers Mongolia's refinancing risk as “high”, which reflects “its dependency on a large stock of external marketable debt and constrained domestic funding options at short tenors”. The weighted average maturity for domestic government debt securities is currently 2.7 years at an average funding cost of 12.4%. External debt represents more than 70% of the general government debt stock, of which, Fitch estimates, more than half is on commercial terms. Sovereign and sovereign-guaranteed entities face a combined $1.1bn (9.1% of GDP) of external bond maturities in 2017-18.

Macroeconomic performance has deteriorated in 2015. Real GDP rose by 1.9% during the third quarter of 2015, decelerating from 9.3% a year prior. Fitch expects growth to slow to 1.0% in 2016 driven by continued weakness in consumption and a negative contribution from net exports. It forecasts the current-account deficit to widen to 10% of GDP in 2016, from an expected 5.0% in 2015 on account of weaker copper prices, a contraction in export volumes from Oyu Tolgoi’s open-pit mine, and a pick-up in imports to facilitate resumption of the underground project at the mine.

Banking-sector asset quality has weakened in 2015 due to slower economic growth and a further 5% depreciation of the Mongolian tugrik year-to-date. The system non-performing loan ratio rose to 7.2% at end-October 2015 from 5.0% in 2014. Credit conditions have worsened, with private-sector credit expected to contract in 2015 versus nominal growth of 9.3% in 2014. Deposit dollarisation has nevertheless remained stable at about 29% and the gradual unwinding of quasi-fiscal central bank activity combined with enhancements to prudential regulations will help reduce, albeit not remove, contingency risks to the sovereign balance sheet.

Mongolia’s favourable long-term economic growth prospects have been reinforced by the resolution of the Oyu Tolgoi underground project dispute in May 2015. Fitch expects an official signing ceremony to take place in December 2015 and the first disbursement of project loans to occur during the second or third quarter of 2016. Total project costs are approximately $6bn spread over six years, of which $500mn in 2016, it expects. Fitch does not anticipate the forthcoming parliamentary election in June 2016 to undermine Oyu Tolgoi project commitments made under the “super coalition” government.

Structural factors, such as GDP per capita, governance indicators, and savings and investment rates, rank above ‘B’ category peers and provide continued support to the rating at its current level. Mongolia’s small population of under 3mn also suggests that per capita incomes have the potential to rise dramatically over the longer term if the country successfully harnesses its generous natural resource endowments via projects such as Oyu Tolgoi and Tavan Tolgoi, Fitch predicts.

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