Fitch Ratings-Hong Kong/Singapore-24 April 2018: A recent asset-quality review has eased uncertainty over capital adequacy in the Mongolian banking system, says Fitch Ratings. In addition, progress in tackling customs bottlenecks at the Chinese border suggests a potential threat to the growth outlook is being addressed. These developments come against a backdrop of economic recovery, fiscal consolidation, rising foreign-exchange reserves and abating external refinancing risks. However, a risk remains that the authorities’ commitment to IMF reform targets will be diluted by the improved conditions.
The asset-quality review, completed last month as part of Mongolia’s IMF-led three-year Extended Fund Facility, showed banks’ aggregate capital adequacy shortfall was 1.9% of GDP (USD210 million or 1.8% of banking system assets) at end-2017. Deployment of public funds for recapitalisation could set back fiscal improvements, although the authorities expect banks to raise the extra capital themselves and, in any case, we do not believe the estimated shortfall would pose significant funding constraints to the sovereign. The IMF had initially estimated capital needs could be as high as 7.0% of GDP and had earmarked up to 3.5% of GDP from public funds as a contingency.
The banking system total capital adequacy ratio (CAR) appears to have dropped to 13.7% at end-2017, from 18.0% at end-November 2017, but the effect on individual banks was not announced. We do not expect the review to reveal significant shortfalls at Fitch-rated banks – Khan Bank (B-/Positive; Tier 1 CAR/total CAR: 18.8%/23.6% at end-2017) and XacBank (B-/Positive; 11.2%/16.9%). That said, potentially higher Tier 1 buffers following the review could require careful management of growth.
The review and its associated stress-testing exercise should strengthen the comparability of banks’ performance. Meanwhile, newly passed reforms aim to strengthen the independence of the Bank of Mongolia and its use of macro-prudential policies, which is a step towards addressing structural weaknesses in the supervisory framework that previously allowed risks to build. The Bank of Mongolia set the required reserve ratio to 10.5% for domestic-currency liabilities and 12.0% for foreign-currency liabilities at end-March 2018, with the difference aimed at discouraging dollarisation. The policy rate was cut by 1pp to 10.0%.
However, the authorities’ willingness to prioritise financial stability is untested. Banks could still come under pressure to support the economic recovery. Indeed, private-sector credit growth accelerated through 2017 – despite the high non-performing loan ratio of 9.2% in February 2018 – albeit led by lending to households, where balance sheets are generally stronger than in the corporate sector.
The near-term economic outlook remains upbeat, with most immediate risk apparently avoided. Coal exports had been clearly affected since late-2017 by customs bottlenecks at the Chinese border – attributed to more stringent smuggling checks – but rebounded to close to their mid-2017 highs in March (see chart below). Officials reported a further improvement in April, following an official visit of Mongolia’s prime minister to China. We continue to expect GDP growth of 4.5% in 2018 – only slightly slower than in 2017.
Economic recovery, along with spending restraint, led to rapid fiscal consolidation in 2017, with the fiscal deficit falling to 1.9% of GDP, well below our forecast of 7.3% when we put Mongolia’s sovereign rating of ‘B-‘ on Positive Outlook in November 2017. Strong revenue collection in 1Q18 points to a budget deficit of around 5.5% of GDP this year, which would be lower than the approved budget. Fiscal reform progress has been more mixed, with the authorities cancelling or delaying some of the structural benchmarks agreed with the IMF – including a progressive personal income tax, a politically independent fiscal council and a gradual extension of the retirement age.
Source: Fitch Ratings