Mongolia’s commodity-dependent economy is facing a sharp slowdown in GDP and export growth, deterioration in the public finances and an erosion in external buffers this year due to the coronavirus shock. Nevertheless, the affirmation of the rating with a Stable Outlook reflects Fitch’s assessment that the impact of the shock will be largely temporary, with the economy rebounding strongly and government debt/GDP starting to decline again in 2021. Significant downside risks are captured at the ‘B’ rating level, and Mongolia’s strong structural factors combined with expected access to financing from multilateral and bilateral creditors provide support to the sovereign ratings.
Fitch forecasts the economy to contract by 2% in 2020, before rebounding to 7.9% in 2021. Our baseline assumes demand from China, which accounts for around 90% of Mongolia’s exports, will pick up during the second half of this year. This is underscored by a gradual improvement in China’s industrial production and investment spending since April. At the same time, downside risks to Mongolia’s growth outlook remain amid uncertainty on how the pandemic develops globally, as well as the speed of China’s recovery.
Real GDP fell by 10.7% yoy in the first quarter, driven in large part by measures to prevent the local spread of the coronavirus. This included a temporary suspension of coal exports to China during February and March, tight restrictions on international flights and railways, and strict social-distancing measures. Mongolia has seen relative success in containing the coronavirus, with 141 officially reported cases.
Fitch forecasts a budget deficit of 7.1% of GDP in 2020, up from a 1.4% surplus last year. Our forecast is wider than the government’s baseline of 2.5%, due mainly to our view that the revenue decline will be more severe. In March, the authorities unveiled an economic stimulus package valued at around 13% of projected 2020 GDP. However, this includes reordering of expenditure priorities, and Fitch estimates that measures that will add directly to the budget deficit are around 4% of GDP. Key fiscal priorities include select infrastructure projects, as well as fiscal and tax relief measures. The risk of a sharp rise in pre-election spending ahead of parliamentary elections on 24 June, as was the case in 2016, has thus far not materialised, and Fitch now anticipates fiscal restraint to remain broadly intact.
Fitch projects that the fiscal deficit and growth contraction will drive up the general government gross debt (GGGD) to around 70% of GDP by end-2020, from 65% of GDP in 2019. We expect GGGD to resume its downward trend in 2021 and decline to 57% by 2024, below the current ‘B’ median level of 60%. Prior to the coronavirus outbreak, Mongolia had made significant progress in reducing public debt from 93% of GDP in 2016, underpinned by strong budget outcomes aided by robust growth and supportive commodity prices.
We forecast foreign-currency reserves (USD4.1 billion in 1Q20) to decline to USD3.1 billion by end-2020, equivalent to 4.1x current-external payments. The sovereign faces no marketable external bond maturities until April 2021, after a USD500 million private-sector external bond carrying a government guarantee matured in May 2020. Fitch forecasts the current account deficit to widen to 14.7% of GDP in 2020 (4.6% of GDP net of FDI, or USD645 million), before narrowing to 11.9% in 2021. Nevertheless, reserves are low and a rating weakness, particularly in view of a substantial step up in amortisation in 2021-2023.
IMF staff have completed discussions on a USD99 million loan under its Rapid Financing Instrument (RFI) to help meet the country’s budgetary and balance of payments needs, and we expect IMF board approval in early June. In completing the discussions, IMF staff noted Mongolia’s progress in reducing public debt and accumulating reserves under the three-year Extended Fund Facility (EFF) that expired on 23 May. The Asian Development Bank (ADB) has also recently approved new loans and a grant worth USD233 million in budget support and project financing. The authorities are also exploring a possible follow-on program to the EFF, as reflected in the IMF’s media statement following staff discussions on the RFI.
The Mongolian parliament unanimously passed a resolution last November requiring the government to review ways to improve the Oyu Tolgoi investment agreement. Fitch believes this underscores the longstanding strained relations between the government and Rio Tinto over taxation, delays and other aspects of the large-scale copper mining project, as well as the potential for heightened political volatility around resource nationalism. However, Fitch does not believe this will lead to a material disruption in Oyu Tolgoi’s development, given the significant implications this would have for Mongolia’s macroeconomic stability, and the considerable investment that Rio Tinto has already deployed into the country.
Mongolia’s rating is supported by World Bank Governance Indicators (WBGIs), GDP per capita, and World Bank Doing Business rankings that are stronger than the ‘B’ range median. GDP growth potential is high. However, net external debt is high at 176% of GDP at end-2019.
Fitch has a negative sector outlook on Mongolian banks, which reflects our expectation that the pandemic will put additional pressure on banks’ asset quality. The banking sector non-performing loan ratio stood at 10.9% as of end-April 2020. A combination of the Bank of Mongolia cutting interest rates by 200bp so far in 2020, slower credit growth than previously expected and a higher credit-loss provision is likely to put pressure on banks’ profitability. (Fitch)