December 22, 2016 12:00 pm JST

Economic gods may be smiling again on Mongolia

Despite debt downgrade, IMF-led bailout looks realistic as commodities bottom out

KEN KOYANAGI, Editor-at-large, Nikkei Asian Review

The new government in Ulaanbaatar may have to agree to IMF bailout terms sooner rather than later.

TOKYO The international financial community's confidence in the Mongolian government's ability to deliver reforms and service its debt may be improving after a long slump. That was the impression left by an investment conference in Tokyo on Dec. 7, attended by foreign lenders and investors, and officials from the country's central bank and legislature.

The timing of the conference, hosted by Frontier Securities, a Japanese-run Ulaanbaatar-based investment bank, could not have been worse.

Mongolia's sovereign debt rating had been downgraded from "B3" to "Caa1" by Moody's in mid-November, less than four months before the mid-March maturity of a $580 million bond issued by the state-run Development Bank of Mongolia. There appears little hope the bank itself will secure the funds to repay the bond. The former chief executive was arrested in October for arbitrary use of funds raised from the bond issuance.

Mongolia's fiscal deficit has exploded, reaching 20% of gross domestic product this year. In 2016, GDP is projected to stay at around $12 billion, if not contract. Total external debt could be as much as $23.5 billion, of which government debt accounts for about $8.4 billion. Analysts say the government needs to repay $1.7 billion to $1.8 billion over the next two years.

To meet the March deadline for the Development Bank's $580 million bond, many believe the government will need to agree to the International Monetary Fund's loan terms by early February.

Graeme Knowd, a managing director at Moody's Japan, was straightforward on the issue. "There seems to be a large gap in the growth forecasts between the Mongolian government's and the IMF's, and we think it will take some time for them to agree on a consensus."

Knowd also made remarks seemingly contradicting the decision to downgrade the country's debt. "What we are seeing is not an insolvency issue but a liquidity issue. We are quite confident that repayment will be made," he said. "We are just not certain that it will be made on time in March."

Neil Saker, the IMF's representative in Ulaanbaatar, even sounded optimistic. "Regarding the liquidity issue, I am hopeful. We don't really see any big difference [between IMF and the Mongolian government] on the policy framework."

Many now believe the talks are advancing smoothly. Saker also said the IMF is encouraging other international institutions and countries to join in the initiative.

Some attendees said they expected holders of the Development Bank's $580 million would be willing to roll over the debt with coupon rates being in double digits. Such a rate would be attractive enough considering that fundamentals, including commodity prices, mining projects and macroeconomic policies, are starting to improve. "Not many countries have very high interest rates and a bright future at the same time like Mongolia," one said.

On the sidelines, an official of the country's central bank, the Bank of Mongolia, reassured both the IMF and Moody's, "the government will repay on schedule for sure."

He also said the bank is determined to maintain the value of the tugrik for at least a couple of years, despite political pressures. Saker had said that sustained tight monetary policy is a prerequisite for a new IMF loan.

In recent years, a sharp decline in resource prices led to a drop in government revenues from the mining sector and to a deterioration in the balance of payments. On June 29, the Democratic Party lost in a landslide general election to the Mongolian People's Party, with former Finance Minister Erdenebat Jargaltulga becoming prime minister.

The new government immediately started drafting policy involving fiscal restructuring and structural reforms, and started talks with the IMF. In late September, it officially requested a bailout.

Almost all the speakers pointed to a swift rebound in coal and copper prices, both crucial exports. "The economic gods are starting to smile for Mongolia," said veteran American investor Nicholas Edwards. He pointed out that, thanks to the recent price increase, Mongolian coal mines are starting to make money and that copper has been the best performing metal for the past six weeks in international markets.

Every participant agreed that continuous fiscal reforms and economic restructuring are absolute musts for Mongolia in order to attract foreign direct investments.

Saker warned that the government should refrain from spending more. "Rather than increasing expenditure when commodity prices go up, which was the story over the last 10 years, [Mongolians] should save those windfalls into sovereign wealth funds and other effective instruments," he said.

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