Fitch Ratings-Hong Kong-09 July 2018: Fitch Ratings has upgraded Mongolia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B’ from ‘B-‘. The Outlook is Stable.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The upgrade of Mongolia’s IDR reflects ongoing improvements to fiscal and external metrics and progress in meeting key IMF programme targets.
Fiscal metrics have continued to improve since November 2017 when we revised the Outlook to Positive from Stable. General government revenue through May 2018 rose by 26% yoy, due to stronger than budgeted tax receipts associated with robust customs activity and the broader economic recovery. At the same time, expenditure rose by a modest 6%, broadly in line with the 2018 budget target. As a result, Fitch now forecasts a 2018 general government deficit of 3.9% of GDP, below the authorities’ approved budget target of 5.9%, and consistent with the gross general government debt (GGGD)/GDP ratio remaining on a downward trajectory.
Fitch forecasts GGGD will decline to 75.3% of GDP by end-2018, down from 81.2% in 2017, and well below its 2016 peak of 91.4% following a commodity-price shock, sharp rise in expenditure, and large currency depreciation. The agency’s baseline forecasts suggest GGGD will fall to about 70% of GDP by end-2020, assuming average nominal GDP growth of 12.7%, a budget deficit of 4.0%, and broad stability of the exchange rate. Nevertheless, this scenario will still leave Mongolia’s GGGD/GDP ratio well above the current ‘B’ median of 62%.
The IMF Executive Board completed its fourth review of Mongolia’s three-year Extended Fund Facility in June 2018, citing strong performance under the programme and that all quantitative targets had been met as of end-March 2018. This will enable an additional disbursement of IMF funds and provide a supportive backdrop for other external donors to approve further disbursements under their respective arrangements that together form Mongolia’s IMF-led USD5.5 billion external financing package, initiated in mid-2017.
External buffers have strengthened. Foreign reserves rose to USD3.3 billion by end-May 2018, up from about USD1.0 billion in early 2017, supported by donor inflows tied to the IMF programme. Fitch forecasts foreign reserve coverage will rise to 4.5x current-external payments by end-2018, up from 2.3x at end-2016, to exceed the ‘B’ median of 3.9x. The agency expects the current account deficit to widen further this year, but more than half of the increase will reflect a rise in capital goods imports tied to the Oyu Tolgoi copper mining project, which is funded via FDI.
The growth outlook remains favourable. Real GDP growth accelerated to 6.1% in 1Q18, up from 5.2% in 2017, due to rising consumption and a surge in mining-related investment. Export volumes of coal and copper rebounded following an official visit of Mongolian Prime Minister Khurelsukh to China in April 2018, which appears to have resolved a customs dispute at the Chinese border that crippled the passage of cargo vehicles last winter. Fitch forecasts real GDP growth of 5.2% in 2018 and 6.3% in 2019, which balances our expectation of continued strength in private consumption and investment, with a large drag from net exports owing to a sharp rise in consumer and capital goods imports since early 2018.
The ‘B’ IDR also reflects the following key rating drivers:
The rapid improvement in fiscal metrics has benefitted from a strong external environment and rising commodity prices, which have lifted government revenue in excess of budget expectations. Against this backdrop, however, the authorities have delayed a variety of structural budgetary reforms, including the introduction of a progressive income tax, an extension of the retirement age, and the establishment of a politically independent fiscal stability council. This raises the risk that a waning commitment to further structural reforms could leave fiscal revenue vulnerable to swings in the external environment, or undermine the credibility of recent enhancements to Mongolia’s fiscal policy framework.
Near-term refinancing risk has receded, with the sovereign facing no external bond maturities until after 2020. Nevertheless, Mongolia’s heavy reliance on funding from external debt capital markets exposes the country to shifts in investor sentiment toward emerging market assets. Yields on Mongolia’s 2023 US dollar bonds, for example, have risen by around 150bp since the beginning of the year, a trend shared by many emerging and frontier market issuers as a result of global risk aversion. High commodity export dependence, at 77% of current-account receipts, and export concentration to China, at 86% of exports, also leave Mongolia vulnerable to external shocks and constrains its ratings.
A history of abrupt leadership changes, with Mongolia experiencing four different prime ministers over the previous five years, increases the potential for political shocks or policy reversals. In addition, commercial disputes persist between Rio Tinto, the country’s largest FDI investor, and the government with regards to various aspects of the Oyu Tolgoi project. Fitch expects the disagreements will ultimately be resolved given the mine’s long-term strategic importance for both parties, but this conviction may be tested in the run-up to Mongolia’s parliamentary elections in mid-2020, given the prominence resource nationalism has played in previous electoral cycles.
The completion of the asset-quality review has eased uncertainty over capital adequacy in the Mongolian banking system. The review revealed a system-wide capital shortfall equivalent to 1.9% of GDP, well below prior IMF estimates of up to 7.0%. Banks are expected to raise additional capital by end-2018, though the authorities have yet to specify the impacted institutions. A banking-sector recapitalisation law passed by parliament in June 2018 sets guidelines under which systemic banks can receive public capital injections. If public funds are indeed required, Fitch does not believe the expected amounts would pose a material funding challenge to the sovereign. Newly passed reform measures that give The Bank of Mongolia greater scope to implement macro-prudential policies may soon be tested in the face of rising household debt, which increased by 25% yoy to end-May 2018.
Structural factors, such as GDP per capita, governance indicators and doing business rankings score above ‘B’ category peers and provide considerable support to Mongolia’s rating. Per capita income has the potential to rise substantially over the longer term if the country can successfully harness its substantial natural resources endowments via strategic mining projects, and deliver them more reliably to third markets via planned infrastructure investments.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Mongolia a score equivalent to a rating of ‘B+’ on the Long-Term Foreign-Currency IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:
– External Finances: -1 notch to reflect repeated bouts of external financing stress.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could lead to positive rating action, individually or collectively, are:
– A track record of fiscal discipline supported by reforms to broaden the revenue base that leads to further declines in GGGD/GDP, and brings it more closely in line with ‘B’ rated peers.
– Continued implementation of credible and coherent macroeconomic policy-making that makes the economy less vulnerable to swings in commodity prices and the external environment.
The main factors that could lead to negative rating action, individually or collectively, are:
– Failure to meet IMF conditionality, resulting in the programme falling off track.
– Fiscal policy settings that put GGGD/GDP back on an ascending trajectory.
– Political instability sufficient to significantly disrupt FDI inflows or strategic mining projects.
– The global economy performs broadly in line with Fitch’s Global Economic Outlook
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR upgraded to ‘B’ from ‘B-‘; Outlook Stable
Long-Term Local-Currency IDR upgraded to ‘B’ from ‘B-‘; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at ‘B’
Short-Term Local-Currency IDR affirmed at ‘B’
Country Ceiling upgraded to ‘B+’ from ‘B-‘
Issue ratings on long-term senior unsecured foreign-currency bonds upgraded to ‘B’ from ‘B-‘