Crashing through ECR’s global rankings, the sovereign’s plight underscores the perils of investing on a risky frontier.
Investors in Mongolian bonds and real assets have reasons to be nervous in light of the sovereign’s rising risk trend, signalling potential repayment problems for bonds maturing over the next few years.
The sovereign, falling 15 places in Euromoney Country Risk’s global rankings this year to 102nd out of 186 countries surveyed, has just slipped into the lowest of ECR’s five tiered categories, synonymous with borrowers either in, or on the brink of, default.
Its fall from grace is harsh for a country with such high-yield potential, but its heightened risk profile became apparent during the second half of 2013, well in advance of Moody’s putting its B1 rating on review for a downgrade last month, and on a par with ratings from Fitch and S&P.
Similarly rated sovereigns Kenya, Serbia and Vietnam are comfortably within ECR’s tier four, with their modestly improving risks in 2014 contrasting starkly with Mongolia’s fading appeal (see chart).
Looming payments crisis
The government’s ability to maintain fiscal control and avoid a damaging payments crisis is questioned by a debt ratio doubling since 2010 to around 65% of GDP, of which the external component has climbed above 50% of GDP.
Mongolia’s impressive double-digit growth potential is constrained by contractual wrangling and pricing pressures in the mining sector, alongside wider concerns over the investor environment with the budget deficit mounting.
Asian Development Bank’s (ADB) forecasts see improvement over the next two years, but also warn of “significant external imbalances because foreign direct investment (FDI) has declined rapidly and some mineral exports remain weak”.
Waning import cover, with foreign-exchange reserves dwindling and a (non-mining related) current-account imbalance climbing precariously into double-digits as a proportion of GDP, highlight the risks.
Meanwhile, rampant private-sector credit growth and currency depreciation keeping inflation high are testing the robustness of Mongolia’s financial system, which is looking more vulnerable to liquidity and capital shocks.
Bank stability, one of four of Mongolia’s economic indicators downgraded during the past year, scores 4.0 out of 10 in ECR’s survey. The government finances score has plummeted to 3.2, with the general government deficit soaring above 13.5% of GDP last year.
While improving scores for corruption and government stability are encouraging in the wake of the smooth legislative and presidential elections process in 2012-13, none of the six political indicators chalks up even half the maximum 10 points available, such is the perceived weakness of Mongolia’s institutions and policymaking.
Structural indicators valuing the infrastructure, demographics and labour market fare no better.
A payments crisis is not a given and the ADB might be proved right if these imbalances correct and the government secures alternative sources of finance to close the financing gap.
However, with vulnerability to negative FDI or commodity price shocks to be wary of, Mongolia’s falling score trend is an indication of the potential pitfalls ahead.
This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.