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Fitch Affirms Mongolia at 'B+'; Revises Outlook to Negative

HONG KONG, December 13 (Fitch) Fitch Ratings has revised the Outlooks on Mongolia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Negative from Stable and affirmed the IDRs at 'B+'. The Country Ceiling is affirmed at 'B+' and the Short-Term Foreign-Currency IDR at 'B'. The issue ratings on Mongolia's senior unsecured foreign- and local-currency bonds are also affirmed at 'B+'. KEY RATING DRIVERS The revision of the Outlook to Mongolia's IDRs to Negative from Stable reflects the following key rating drivers:- - Macroeconomic policy settings are highly expansionary and Fitch believes this poses a growing threat to Mongolia's economic and financial stability. Fitch estimates Mongolia's government deficit at 12% of GDP in 2013, after taking into account off-budget spending, although the deficit could be smaller depending on the rate of spending towards the end of the year. This has rendered the country's Fiscal Stability Law ineffective as a constraint on policy-making. Bank of Mongolia (BoM) has significantly loosened monetary conditions, fuelling credit growth of 53% in the year to October 2013. Inflation was 10% yoy in October, despite a special BoM-funded price-stabilisation scheme. - Gross government debt is projected at about 50% of GDP at end-2013, against a median of 40% for sovereigns rated in the 'B' category (those rated 'B-', 'B' and 'B+') and the median of 36.4% for the 'BB' category. The Mongolian sovereign's government debt is mainly foreign-currency denominated. The sovereign and a public sector entity, the Development Bank (DBM), have borrowed heavily in international debt capital markets since March 2012, to the tune of USD2,080m or 18% of 2013 GDP. Fitch expects DBM to issue a further USD300m of debt imminently. There is marketable debt maturing in 2017 (USD580m from DBM), 2018 (USD500m) and 2022 (USD1,000m). - The external finances are weak and deteriorating. The current account balance plus net foreign direct investment (FDI) flows will swing to a projected deficit of 11% in 2013 from a 9.7% surplus in 2012. FDI is estimated to halve in US dollar terms to about USD2.2bn in 2013. Fitch projects net external debt at USD13.5bn or 119% of GDP at end-2013, up from 96% at end-2012 and 70% at end-2011 (although about USD10.2bn of external debt takes the form of intercompany lending, which is likely to be stable). - External liquidity is weak and projected to deteriorate further. Official foreign reserves are projected at USD2.5bn or 3.1 months of current external payments (CXP) by end-2013, below the medians for 'B' and 'BB' category sovereigns of 3.4 months and 4.4 months respectively. Fitch projects Mongolia's reserves will decline to two months of CXP by 2015 compared with the 'B' category median of around 3.1 months. - Non-performing loans (NPLs) in the banking system grew 83% in the year to October, outpacing the 53% in credit growth, and taking the NPL/total loan ratio up to 5.3% from 3.7% in June. Government subsidies for mortgages are fuelling house prices, which were up 32% yoy in 3Q13. The 24% depreciation of the Mongolian currency, the tugrik, in the year to date may strain the ability of borrowers to repay the 30% of loans denominated in foreign currency. Savings Bank, the country's fifth-biggest, was declared insolvent in July 2013 after a related entity defaulted on a large exposure. - Counterbalancing these factors is Mongolia's five-year average real GDP growth of 9.3%, which is far stronger than the 'B' rating category median of 4.1% or the 'BB' median of 3.6%. Some credit fundamentals including the standard of governance and the business climate (as measured by the World Bank's Ease of Doing Business framework) exceed 'B' medians. The country's long-term prospects are bright, underpinned by a generous endowment of natural resources, including coal, copper, gold and rare earths. However, development of its endowment has largely stalled amid disagreements between developers and the authorities. Resolution of these issues could unlock large FDI inflows in 2014. A reform of the Investment Law that took effect on 1 November 2013 may help bring in FDI. RATING SENSITIVITIES The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade: - Further deterioration of Mongolia's external finances - such as a further rise in net external indebtedness, or sustained declines in international reserves. - A continuation of loose macroeconomic policy settings that leads to an intensification of risks to basic economic and financial stability via pressure on inflation, the trade deficit, bank balance sheets, and the currency. - Emergence of systemic financial stress such as a run on deposits, a further sharp rise in NPLs, and/or a flight out of the tugrik into foreign currency. - A further marked increase in sovereign and quasi-sovereign external borrowing that calls into question fundamental foreign-currency solvency. - A sharp and sustained drop in prices for Mongolia's main commodity exports, in particular copper and coal The current Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to an upgrade. However, future developments that may, individually or collectively, lead to a revision of the Outlook to Stable include: - Progress in resolving policy, financial and regulatory hurdles to the development of Mongolia's natural resource endowment, in particular the large Oyu Tolgoi copper and gold mine, that unlocks substantial FDI inflows above Fitch's expectation of USD2bn in 2014. - Credible and coherent macroeconomic policy-making that increases confidence in Mongolia's basic economic stability. - Strengthening of Mongolia's buffers against commodity-price volatility, for example through a sustained increase in official reserves, a reduction in the budget deficit in line with the Fiscal Stability Law, and structural budgetary reform to bring spending on budget. KEY ASSUMPTIONS Fitch assumes that Mongolia's key trade and investment partner China does not experience a severe, disruptive slowdown in its growth. Fitch assumes Mongolia remains basically politically stable and continues to solicit foreign direct investment, and does not resort wholesale to business-unfriendly practices such as expropriation of assets. Contact: Primary Analyst Andrew Colquhoun Senior Director +852 2263 9938 Fitch (Hong Kong) Limited 2801, Tower Two, Lippo Centre 89, Queensway, Hong Kong Secondary Analyst Art Woo Director +852 2263 9925 Financial Institutions Chikako Horiuchi Director +852 2263 9924 Committee Chairperson Paul Rawkins Director +44 20 3530 1046 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com.">www.fitchratings.com. 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