Global Credit Research reported on Monday that Moody’s Investors Service has changed the outlook on Mongolia’s government bond rating to negative from stable. On May 21, 2014, a rating committee was called to discuss the rating of the Government of Mongolia. Views raised included: The issuer’s fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
Concurrently, Moody’s has affirmed the government’s issuer and bond B1 ratings, the government’s senior unsecured MTN rating at (P)B1 and the issuer’s short-term “Not Prime” issuer rating. In a related rating action, Moody’s has changed the outlook on the rating of the government-owned Development Bank of Mongolia LLC (DBM) to negative from stable, and affirmed DBM’s senior unsecured B1 rating and its senior unsecured MTN (P)B1 rating. Since DBM’s payment obligations carry a credit guarantee of the government of Mongolia, its debt obligations justify a rating at the same level as the government, Moody’s said.
Mongolia’s long-term local currency country risk ceiling is affirmed at Ba3, while the long-term foreign currency bond and bank deposit ceilings are affirmed at Ba3 and B2, respectively. The foreign currency short-term debt and deposit ceilings are affirmed 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 CHANGING THE RATING OUTLOOK TO NEGATIVE
Moody’s said its decision to change Mongolia’s outlook to negative is driven by a rise in the external debt burden over recent years, a sharp fall in foreign exchange reserves, and escalating credit growth since 2013. These developments increase the possibility of a currency or external payments crisis over the next few years. At the same time, elevated inflation and rapid credit growth threaten banking system stability, and could have negative feedback effects on the balance of payments. Unpredictability in Mongolia’s investment regime further exacerbates risks to the external position and to government finances, which are highly reliant on mining revenues.
First driver — A build-up in the external debt burden
In absolute terms, external debt has nearly doubled over the last two years to 18.9 billion USD in 2013. At 156.8 percent of GDP, this is significantly above the median for country peers rated B1 to B3. As a share of current account receipts, the increase is even steeper, rising to 352 percent in 2013 from 162.2 percent in 2011, again above the peer median. Dependence on market funding has also risen in recent years with the issuance of global bonds and a sharp decline in concessional external borrowing. Overall domestic public debt has ratcheted up since 2009. Given that foreign currency-denominated borrowing accounts for a very significant portion of total general government debt, a potentially weakening currency will further increase Mongolia’s repayment burden.
The Bank of Mongolia’s expansionary monetary policy stance — accompanied by off-budget spending and investment that circumvents fiscal responsibility legislation — has resulted in an uptick in external and domestic government liabilities. An equally sharp build-up in private-sector external debt has largely been driven by investment-related intercompany lending.
Second driver — Heightened strains on the external liquidity position
Strain in the external liquidity position has become increasingly evident over the past year with the decline in gross international reserves to 2.4 billion USD as of January 2014, from 4.1 billion USD in December 2012.
Pressures in the balance of payments are evident in both the current and capital accounts. Weak global commodity prices and muted demand from China have resulted in subdued export growth. While this has been accompanied by a contraction in imports so far, expansionary policies are fueling demand pressures that could result in a rise in import growth in the future. Concurrently, FDI inflows have seen a sharp deceleration, due to the completion of the first phase of the Oyu Tolgoi mining project and an uncertain investment policy.
Continued monetary expansion would add to inflationary pressures, increasing the risk of capital flight, and further weaken the external payments position. It would also exacerbate budgetary debt financing costs.
Third driver — Rapid credit growth
Loose monetary policies pursued by the central bank since 2013 have fueled rapid credit growth, which will cross Moody’s definitional threshold for a credit boom if this year’s pace matches the 104.9 percent average increase seen in 2013. This could undermine asset quality and pose substantial systemic risks, given difficulties for banks in fully pricing in borrowers’ credit risks due to loan rate caps, concentrated lending to the real estate sector, and the possibility that refinancing will become a challenge once expansionary policy is withdrawn.
RATIONALE FOR AFFIRMING THE B1 GOVERNMENT BOND RATING
The affirmation of Mongolia’s B1 sovereign rating reflects the fact that although external liquidity is strained, a balance of payments crisis does not appear imminent, since there are no significant maturing debt obligations this year and the first large sovereign bond repayment is not due until 2017.
In addition, a gradual phase-out of monetary stimulus measures has begun. This may help dampen demand pressures, although with a lag.
WHAT COULD CHANGE THE RATING
Key factors that could prompt an upward movement in the outlook and eventually in the rating include: (1) greater price and exchange rate stability; (2) a replenishment of official foreign exchange reserves; (3) a track record of adherence to fiscal rules; (4) steady mineral resource development under a stable and predictable investment regime that would improve the country’s long-term fiscal and economic prospects.
Triggers for a downward movement in the rating include: (1) a continued rapid rise in external debt or decline in official international reserves; (2) the endurance of high loan growth and inflationary pressures; (3) persistent off-budget fiscal spending and slippage in adherence to fiscal responsibility legislation; (4) setbacks to foreign direct investment in Mongolia.
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