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Mongolia Country Risk Report Q1 2016

Mongolia Country Risk Report Q1 2016

Core Views

Parliamentary elections are scheduled to take place by June 2016, and Mongolia's political environment will be volatile ahead of the elections. The two major parties, namely the Democratic Party and the Mongolian People's Party, are unlikely to win a convincing mandate, and we expect a coalition government to be formed. This means that the business environment will remain challenging for investors.

Weak mining-related investment, subdued export demand due to a cooling Chinese economy and a slowdown in the construction and real estate sectors will continue to act as headwinds to the Mongolian economy in 2015. The second phase expansion of the Oyu Tolgoi (OT) copper and gold mine is estimated to commence in the middle of 2016, and we expect real GDP growth to pick up over the coming years, averaging 7.5% over the next decade.

We remain bearish on the Mongolian togrog against the US dollar, and forecast the unit to average MNT1,975/USD in 2015 and MNT2,000/USD in 2016 owing to the country's weak economic fundamentals and technical picture. Notably, elevated inflation and a deteriorating terms of trade picture point towards further weakness in the Mongolian togrog. Mongolia's wide current account deficit suggests that the currency will remain highly volatile based on investors' perception of the country's macroeconomic prospects.

However, the weakness will not be excessive as foreign capital return to the country owing to the second phase expansion of the OT copper and gold mine.

We forecast that the Bank of Mongolia (BoM) will cut its 1-week central bank bill by 100 basis points to 12.00% by the end of 2016, with the aim of supporting the country's sluggish economy. Falling headline consumer price inflation due to shrinking money supply will provide scope for the central bank to ease its monetary policy stance over the coming months.

Mongolia will continue to run fiscal deficits in the coming years as structurally low commodity prices temper revenue growth while public expenditure growth remains elevated as the government struggles to reduce spending in 2016 as parliamentary elections loom. The country is increasingly at risk of a credit event as Mongolia and its state-linked entities are facing significant bond repayments beginning from 2017.

Major Forecast Changes

We have downgraded our 2015 and 2016 real GDP growth forecast to 3.1% and 4.5%, respectively, (versus 4.6% and 5.8% previously).

We have revised our 2015 and 2016 current account deficit as a share of GDP forecast for 2015 and 2016 to 7.1% and 8.3%, respectively, (versus 10.3% and 9.4% previously). The narrowing of Mongolia's current account deficit in 2015 has been due to an improvement in the goods trade balance, and this is likely to persist for the rest of the year. In 2016, the country's current account deficit will widen as investment picks up due to the second phase development of the OT project.

We have downgraded the government's reported budget deficit as a share of GDP to 5.5% in 2015 and 6.0% in 2016 (from 5.3% and 5.7% previously) mainly due to poorer economic growth while fiscal revenue growth will be significantly lower than expenditure growth.


Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Political Outlook
SWOT Analysis
BMI Political Risk Index
Domestic Politics
Political Uncertainty To Rise As 2016 Parliamentary Elections Loom
Mongolia's political risk profile will continue to deteriorate in the run-up to the country's 2016 parliamentary elections. We expect neither
the Democratic Party nor the Mongolian People's party to win a convincing mandate, and a formation of a coalition government is
highly likely. This suggests that the country's business environment will remain challenging for investors even after the conclusion of the
elections.
TABLE: POLITICAL OVERVIEW
Long-Term Political Outlook
Transforming Minerals Into Wealth
The Mongolian government will face major domestic challenges over the coming decade as the country's mining boom takes off, and it
seeks to strike a balance between distributing the revenues in a way that is acceptable to the population, while avoiding stoking inflation.
Moreover, we believe it will face a tough task in managing the social change that the mining boom will create, including immigration and
the growing gap between rich and poor. In foreign policy, the government's chief priority will remain avoiding falling too much under the
influence of neighbours Russia and China, though we believe the latter in particular will prove almost impossible.
Chapter 2: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Further Weakness Before Picking Up In 2016
Mongolia's Q215 real GDP growth figures showed that the economy slowed considerably due to falling investment and a worsening
external environment, and we have downgraded our 2015 growth forecast to 3.1% from 4.6% previously. However, we expect growth
to bottom out and tick higher to 4.5% in 2016 as the second phase expansion of the Oyu Tolgoi gold and copper mine is estimated to
commence in the middle of 2016 and fiscal spending increases as the country's parliamentary election is scheduled to take place by
June 2016.
GDP By Expenditure Outlook
External Trade And Investment Outlook
MNT To Remain Vulnerable Amid Widening Current Account Deficit
Despite a subdued export performance, Mongolia has managed to maintain a goods trade surplus, which has improved over the course
of 2015 as a result of an even larger collapse in imports. We expect this state of affairs to continue through the end of the year, and we
forecast Mongolia's current account deficit as a share of GDP to narrow to 7.1% in 2015.
TABLE: ECONOMIC ACTIVITY
Outlook On External Position
TABLE: MAIN EXPORT & IMPORT PARTNERS
TABLE: MAIN EXPORTS & IMPORTS
TABLE: CURRENT ACCOUNT
Fiscal Policy Outlook
Fiscal Risks Mounting As Spending Accelerates
Mongolia will continue to run fiscal deficits in the coming years as structurally low commodity prices temper revenue growth while public
expenditure growth remains elevated as the government struggles to reduce spending in 2016 as parliamentary elections loom. As
such, we forecast Mongolia's reported fiscal deficit as a share of GDP to widen to 6.0% in 2016 from an estimated 5.5% in 2015. 19
TABLE: PRIVATISATION OF SOE UNLIKELY TO OFFSET SLIDE IN TAX REVENUES
Structural Fiscal Position
TABLE: FISCAL POLICY
Monetary Policy
Falling Inflation Allows For Monetary Easing
Receding headline consumer price inflation on the back of a contraction in money supply is providing scope for the Bank of Mongolia to loosen its monetary policy over the coming months. Therefore, we forecast the central bank to cut its 1-week central bank bill rate by 100bps to 12.00% by the end of 2016, with the aim of supporting the country's sluggish economy. 21
Monetary Policy Framework
TABLE: MONETARY POLICY
Chapter 3: 10-Year Forecast
The Mongolian Economy To 2024
Fierce But Volatile Growth In Store
At face value, Mongolia's long-term economic prospects appear nothing short of formidable, such is the size of untapped natural resource wealth in the country. We expect the country to remain one of the fastest-growing economies globally through to 2024 (at an annual average clip of 7.5%). That said, we do not expect the coming decade to be smooth sailing. Structural factors such as the magnitude of investment spending, the unprecedented scale of money creation, a gradual erosion of the local business environment and question marks over the sustainability of long-term Chinese commodity demand all point to a more volatile growth trajectory for Mongolia in the years ahead.
TABLE: LONG-TERM MACROECONOMIC FORECASTS
Chapter 4: Operational Risk
SWOT Analysis
Operational Risk Index
Chapter 5:BMI Global Macro Outlook
Global Outlook
Exit The Dragon
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %

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