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Rating Action:

Moody's downgrades Mongolia's rating to Caa1; changes outlook to stable

18 Nov 2016

Singapore, November 18, 2016 -- Moody's Investors Service ("Moody's") has downgraded Mongolia's government long-term issuer and senior unsecured ratings to Caa1 from B3 and the senior unsecured MTN rating to (P)Caa1 from (P)B3 as well as affirming the NP short-term issuer rating. A stable outlook was assigned concluding the review for downgrade opened on 26 August 2016.

Moody's decision to downgrade Mongolia's issuer and bond ratings to Caa1, from B3, is driven by the following factors:

1. Heightened uncertainty regarding the government's ability to meet its direct and indirect debt service obligations over the next two years and to shore up Mongolia's external liquidity

2. Moody's expectation that the budget deficit will remain wider for longer than previously expected, which, combined with a weaker growth outlook in the coming 2 years, will raise the government's debt burden to elevated levels

The stable outlook reflects Moody's view that different factors potentially affecting Mongolia's credit profile are broadly balanced.

Moody's has today maintained the local-currency bond and deposit ceilings at Ba3. The long-term foreign currency deposit ceiling is revised to Caa2 from Caa1, while the foreign currency bond ceiling is also revised to B3 from B1. All short-term foreign currency ceilings remain 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.

RATINGS RATIONALE

DETAILED RATIONALE FOR DOWNGRADE TO Caa1

Moody's review period started as a very sharp increase in government financing needs had become apparent. The deterioration in these metrics has raised domestic and external liquidity pressures and exacerbated the sovereign's already high exposure to a reversal in investor sentiment. Moody's review focused on assessing the government's plans to address the worsening fiscal position, and their impact on growth and external liquidity.

We have concluded that the government's fiscal strength, and the Mongolian economy's external position, have deteriorated significantly. Short-term external liquidity risks have increased further during the review period and will remain elevated. To meet its obligations, the government is reliant on securing external finance from a combination of multilateral and bilateral sources, the availability of which is not ascertained.

While we recognize that the authorities have made progress in recognizing off-budget spending and defining transparent, short- and medium-term corrective actions, we expect that Mongolia's debt metrics will continue to deteriorate in the next two years while fiscal challenges will be compounded by a sharp slowdown in economic growth which places further pressure on the fiscal and external positions.

The downgrade to Caa1 reflects the uncertainties surrounding the government's ability to deal, quickly, with multiple challenges in order to service its own direct and indirect obligations and to avoid a balance of payments crisis.

First Driver: Uncertainty on the government's capacity to refinance upcoming obligations and shore up external liquidity

The review period has provided further clarity on the government's means to address the acute fiscal challenges and on the extent of short-term rollover risks.

Short-term liquidity pressures are acute. It is likely that the government will have to support the Development Bank of Mongolia LLC in meeting a payment of $580 million due in March 2017 on debt guaranteed by the government. Overall, the government faces over $0.8 billion in external debt service obligations in 2017, or 7.5% of GDP. Refinancing these debt service obligations would compound the government's already high reliance on market debt, in an environment in which demand for its debt has fallen and interest costs have risen.

This comes at a time when gross borrowing requirements have considerably increased. Despite significant fiscal tightening being implemented, we expect that the government's financing needs will remain elevated in 2017, as they include the financing of a fiscal deficit that we expect at around 12% of GDP, after 19.5% in 2016. Financing of the deficits and repayments of existing government debt will push the government's gross borrowing requirements to more than 26% of GDP in 2016, and more than 20% of GDP still in 2017. These are amongst the highest gross borrowing requirements amongst the sovereigns rated by Moody's.

The relatively high share of foreign-currency debt among maturing market debt will exacerbate already severe external pressures, with falling foreign exchange reserves posing further risks to the government's own liquidity position. Reserves have fallen to a 7-year low of $1.1 billion as of September 2016 (with unrefined gold and the unutilized portion of a swap line with China's central bank being additional sources of liquidity) and remain under pressure. The current account deficit has widened and we project it to amount to $1.5 billion (13.1% of GDP) in 2017, while we estimate that Mongolia has $3.4 billion in short-term external debt and long-term debt maturing in 2017 although this includes the swap line with China, which is likely to be rolled over.

The sustainability of Mongolia's external payments position will depend on the government's capacity to secure further bilateral and multilateral funding and roll over existing obligations. Mongolia receives assistance in the form of a swap line extended by the People's Bank of China, while the prospect of IMF support could catalyze further lending by international and bilateral institutions. However, it remains unclear whether the authorities will be able to unlock enough funding to meet their large and immediate external financing needs.

Such financing needs will impose strains on the domestic banking system, too. Mongolian banks have already seen their liquidity and asset quality profiles deteriorate. Tighter liquidity is reflected in a gradual increase in the system's foreign currency loan-to-deposit ratio, while the ratio of non-performing loans is relatively high, at 8.6% as of June.

Second Driver: Higher debt burden and weaker debt affordability, expected to continue well into 2017, compounded by lower growth prospects

Mongolia's core economic and fiscal fundamentals have worsened materially and are no longer commensurate with those of B-rated countries. Based on the government's supplementary budget for 2016, we now expect the budget deficit will reach 19.5% of GDP from just 5% of GDP in 2015, the largest in Moody's sovereign rating universe. This, along with the crystallization of contingent liabilities, is likely to increase the government debt burden to 81% of GDP from 53.6% of GDP in 2015. Combined with weaker GDP growth, we anticipate further increases in the government's debt burden to around 90% of GDP by 2018, markedly higher than most B-rated sovereigns.

Despite the authorities' commitment to fiscal consolidation, including through the cancellation of welfare programs and a detailed economic stabilization plan, reversal of the particularly steep fiscal deficit in 2016 will take many years. With limited room to cut spending or generate revenues until mining production and exports significantly ramp up, deficits will remain in double digits in 2017 and 2018.

Meanwhile, real GDP growth will be lower than previously envisaged in 2016 and 2017, driven by lower private consumption reflecting fiscal consolidation and monetary tightening, and a decrease in net exports in 2017 as a result of lower grade concentrates produced by the Oyu Tolgoi (OT) mine. Real growth was -1.6% from January to September 2016 and we expect it to pick up only slightly in 2017. Nonetheless, we still expect mining-related Foreign Direct Investment (FDI) to recover and lead to a material pick-up in growth from 2018 onwards, culminating with the coming on stream of Oyu Tolgoi Phase 2.

RATIONALE FOR STABLE OUTLOOK

The stable outlook reflects a fine balance between potentially different outcomes, one of which could improve Mongolia's credit profile, while the other could further undermine it.

On the one hand, success in securing bilateral and multilateral support would stabilize the government's liquidity position and the economy's external position for a period, providing the government with time to address the decline in its fiscal strength until mining output comes on stream and supports growth and the government's finances. Mongolia's natural resources wealth is largely untapped and, if effectively harnessed could generate very strong GDP growth in the medium to long term. In turn, as the country's growth potential is realized, government revenues would rise sharply and the government's debt burden would fall, possibly at a rapid pace.

On the other, failure to secure financing, particularly in the context of a further deterioration in growth and debt dynamics, would raise the risks of a balance of payments crisis and debt restructuring. With uncertainty about the impact on growth of the marked fiscal and monetary tightening currently implemented, market financing may only be available at very high costs for the government, leading to further liquidity and external constraints.

WHAT COULD MOVE THE RATINGS UP

Upward pressure on the rating could build if the government is able to rollover short-term obligations and secure concessional financing to finance its deficit, combined with fiscal consolidation measures that place government debt on a downward trend in the near to medium term. These developments would be accompanied by a rebound in international reserves and increased certainty about the government's ability to meet public-sector debt repayments.

WHAT COULD MOVE THE RATINGS DOWN

The rating may come under additional downward pressure if the government's ability to service its debt worsens, or it faces challenges in rolling over maturing debt. Continued pressure on foreign exchange reserves may also trigger a negative rating action. These risks would likely arise if the government fails to secure sufficient support from multilateral and bilateral donors.

GDP per capita (PPP basis, US$): 12,179 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.4% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.9% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -5.0% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4.8% (2015 Actual) (also known as External Balance)

External debt/GDP: 185.6% (2015 Actual)

Level of economic development: Low level of economic resilience

Default history: At least one default event (on bonds or loans) has been recorded since 1983.

On 16 November 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 institutional strength, including its debt profile, has materially increased. The issuer's susceptibility to event risks has materially increased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

The Local Market analyst for this rating is Mathias Angonin, +971 4 237 9548.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Marie Diron
Associate Managing Director
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Atsi Sheth
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

No Related Data.
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