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Moody's Investors Service has today affirmed Mongolia's government bond rating at B2. The outlook on the rating remains negative. Concurrently, Moody's has affirmed the government's B2 issuer rating, its senior unsecured MTN rating at (P)B2 and the short-term Not Prime issuer rating.
The affirmation of the rating signifies Moody's view that Mongolia's credit profile will remain in line with B2 peers over the medium term, with current credit-negative trends dissipating over the coming one to two years. Key credit supports include strong potential growth and abundant mineral resource wealth.
The decision to maintain a negative outlook reflects Moody's view that while some of the credit pressures that drove our assignment of the outlook in July 2014 have diminished, others have emerged. The external environment has worsened, particularly in relation to Mongolia's major commodities exports. Until such time as a ramp-up in production and exports from large mining projects occurs, risks stemming from the country's external position will remain elevated. At the same time, the government's debt burden has not fallen and fiscal space is limited.
Mongolia's long-term local currency bond and bank deposit ceilings are unchanged at Ba3. The long-term foreign currency bond and bank deposit ceilings are unchanged at B1 and B3, respectively. The foreign currency short-term bond and bank deposit ceilings are unchanged at Not Prime.
These ceilings act as a cap on ratings that can be assigned to the foreign and local currency obligations of entities domiciled in the country.
RATIONALE FOR AFFIRMING THE B2 GOVERNMENT BOND RATING
Moody's decision to affirm Mongolia's rating reflects the rating agency's view that growth and inward investment flows will, over time, reduce the domestic and external pressures that the country currently faces, and support its credit profile at a level commensurate with a B2 rating.
Moody's downgrade of Mongolia's government bond rating to B2 from B1 in July 2014 took into account a worsening external liquidity position and the government's expansionary policy stance. The decision to maintain a negative outlook at that time highlighted the risk of an additional decline in foreign exchange reserves, continued rapid credit growth and the potential for further deterioration in debt metrics.
Some of the pressures we identified have since abated. The external liquidity position, including the current account balance and the level of reserves, deteriorated initially but has now stabilized. The central bank has tightened monetary policy. Credit growth has cooled. And the government has taken steps -- albeit haltingly -- to arrest the deterioration in debt metrics.
At the same time, the external environment has worsened. The combination of falling commodities prices and lower growth in China (Aa3 stable) has undermined export revenues and related investment flows that drive output in Mongolia. Accordingly, we expect growth to decline to 2.5% in 2015, from 11.6% in 2013. The government has struggled to cope with the impact of the shock. Moody's estimates that the fiscal deficit remains high, at around 6.6% as of the end of 2015. General government debt levels have climbed further, to just under 50% of GDP in late 2015 (excluding public sector liabilities outside the general government ring fence), and Moody's does not expect them to peak until 2017, at close to 60%. Economy-wide external debt has continued to rise.
Moody's projects it to hit 181.8% of GDP in 2015 and closer to 190% in 2016. Mongolia's External Vulnerability Indicator, which measures the adequacy of foreign reserves relative to short-term and maturing long-term external debt, should peak at over 300% in 2017.
However, beyond that horizon, there is a strong prospect of growth and inward investment flows resuming to adequate levels to address these vulnerabilities. The key driver for the affirmation of the B2 rating is our expectation of an improvement in the outlook for growth over the medium-term, led by foreign direct investment in large mining projects - in particular the development of the second phase of the Oyu Tolgoi copper and gold mine over the next seven years. Although the external liquidity position will remain strained for some time, future export and investment revenue streams from the projects should result in credit risks moderating towards the end of this decade.
A resumption in growth would support the authorities' efforts to rein in rising domestic and external debt. The government's medium-term fiscal framework sets out a programme for reducing first primary deficits, and subsequently fiscal deficits, towards the end of the decade. While the framework rests on a number of optimistic assumptions, our view is that growth should keep Mongolia's economic and debt metrics consistent with a B2 rating. Over time, despite the persistence of credit-negative pressures in recent years, most of Mongolia's key credit metrics, including growth, the fiscal balance and the debt burden, should converge with those of similarly-rated sovereigns over the rating horizon, if mining projects materialize as Moody's anticipates.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook illustrates our view that credit risks will remain biased to the downside over the next 12 to 18 months. Future growth continues to rest on inward investment flows that have yet to materialize, and on mining projects that have still to come to fruition. External vulnerability risks, arising particularly from Mongolia's exposure to lower commodity prices and to slowing growth in China, are likely to remain elevated. Foreign reserves, although stable, are low relative to maturing long-term debt and short-term external debt, and rely heavily on the Bank of Mongolia's near-complete draw-down on a swap line with China. Such vulnerabilities could turn more acute as long-term debt repayments, scheduled for 2017, 2018 and 2022, approach.
Although the authorities have reversed many fiscal and monetary policy stimulus measures undertaken in 2012 and 2013 that resulted in credit deterioration, Moody's projects budgetary imbalances to widen over the next year due to shortfalls in mining revenues, and the debt burden to increase.
WHAT COULD CHANGE THE RATING - UP
There is very little prospect of upward pressure on Mongolia's rating emerging over our forecast horizon. A prior condition of any such pressure would be steps to address Mongolia's structural weaknesses including weak institutions and extremely volatile growth, which in turn reflects very high reliance on commodities. We would expect any such action to be accompanied by positive credit indicators such as: (1) a replenishment of official foreign exchange reserves and reduction in external funding vulnerability; (2) predictability in mineral resource development that bolsters fiscal, external payments and economic prospects; and (3) a strengthening of government finances.
WHAT COULD CHANGE THE RATING - DOWN
The current rating level assumes a strong and reasonably imminent resumption in growth, and that the government then proves able to reap the fiscal benefits that that brings. Should either expectation prove unfounded, we would likely downgrade the rating. Other more immediate factors that could trigger a downward movement in the rating include: (1) a continued rise in external debt relative to official international reserves; (2) a sharp increase in credit or in inflationary pressures; (3) an increase in government debt; (4) a significant decline in foreign direct investment that places additional strain on the balance of payments.
GDP per capita (PPP basis, US$): 11,919 (2014 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 7.8% (2014 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 11.0% (2014 Actual)
Gen. Gov. Financial Balance/GDP: -3.8% (2014 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -11.7% (2014 Actual) (also known as External Balance)
External debt/GDP: 173.9% (2014 Actual)
Level of economic development: Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 12 January 2016, a rating committee was called to discuss the rating of the Mongolia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
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