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Moody's affirms Mongolia's B1 sovereign rating

May 26, 2014

Moody's Investors Service has changed the

outlook on Mongolia's government bond rating to negative from stable.

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 isuer 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 of Mongolia.

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.



Moody's 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


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 in 2013. At 156.8% 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 352.0% in 2013

from 162.2% 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 as of January 2014, from $4.1 billion 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


Third driver -- Rapid credit growth

Loose monetary policies pursued by the central bank since 2013 have fueled

rapid credit growth, which will cross our definitional threshold for a

credit boom if this year's pace matches the 104.9% 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.

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Source: EMBIN (Emerging Markets Business Information News)

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