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Mongolia Country Risk Report Q2 2015

Mongolia Country Risk Report Q2 2015

Core Views

The formation of the 'super coalition' government in early December2014 will improve the policy-making process in Mongolia, as thevarious parties set aside their differences to tackle the multitudeof problems faced by the slowing economy. We forecast real GDPgrowth of 7.0% in 2015 as the investment and export outlook remainweak, marking a significant slowdown from the 11.9% reading in2013. Persistent uncertainties clouding Mongolia's business environmentoutlook suggest that risks remain to the downside. The restartof the second phase expansion of the Oyu Tolgoi (OT) copper andgold mine, which we expect to commence in 2015, will improve theinvestment outlook.

We are bearish on the Mongolian togrog owing to the country'sweak economic fundamentals and break of technical support ataround MNT1,900/USD. Notably, elevated inflation and signs ofincreasing external vulnerability, point towards further weakness inthe Mongolian togrog over the longer term. We forecast the unit toaverage MNT2,000/USD in 2015 and MNT2,100/USD in 2016.

Headline inflation will remain in double-digit territories, stoked bythe Mongolia's still-large fiscal deficit and weak currency. That said,headline inflation will ease a gradual pace on the back of the Bankof Mongolia's (BoM) tight monetary policy.

The Mongolian government continues to make considerable expenditurethrough the Development Bank of Mongolia (DBM), whichis operating off-budget. We remain concerned about the country'soverall fiscal deficit over the coming years as it will remain elevated.

Fiscal revenue growth will be significantly lower than expendituregrowth owning to weak commodity prices, particularly copper and coal,presenting huge risks to the country's long-term fiscal sustainability.

Major Forecast Changes

We have downgraded our real GDP forecast for 2015 to 7.0%,from 8.0% previously, as Mongolia's investment and export outlookremains poor. With elevated twin current account and fiscal accountdeficits stoking inflationary pressures higher and the Mongoliantogrog weaker, we believe the risks to growth are to the downside,and note that the country has requested to begin discussions ofpossible support from the IMF.

We have downgraded the government's reported budget deficit asa share of GDP to 4.4% in 2015, from 0.2% previously, as fiscalrevenue growth will be significantly lower than expenditure growthowing to weak commodity prices.

We have revised our average 2015 and 2016 currency forecast toMNT2,000/USD and MNT2,100/USD, respectively (from MNT1,825/USD and MNT1,750/USD previously) and expect the unit to remainunder depreciatory pressures over the coming months.

Executive Summary
Core Views
Major Forecast Changes
Key Risks To Outlook
Chapter 1: Political Outlook
SWOT Analysis
BMI Political Risk Index
Domestic Politics
'Super Coalition' Government To Improve Policy Enactment
The formation of a 'super coalition' government in early December 2014 will improve the government's ability to implement policies.
On the foreign policy front, Mongolia continues to strengthen its relations with Japan, which will help to further enhance trade and
investment between the two countries over the coming years.
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 Activity
Growth To Remain Downbeat In 2015
We have downgraded Mongolia's real GDP growth forecast for 2015 to 7.0% (versus 8.0% previously) due to the poor investment and
export outlook. This implies that the economy will slow down further from our 2014 estimate of 7.4% in 2014.
table: Economic Activity
Fiscal Policy
Weak Commodity Prices A Bane For Fiscal Deficit
Mongolia's fiscal sustainability will remain at risk in 2015, as fiscal revenue growth will be significantly lower than expenditure growth,
owing to weak commodity prices. We forecast the government's reported budget deficit as a share of GDP to come in at 4.4% in 2015
versus an estimate of 3.8% in 2014. That said, increased accountability as stipulated by the 'Glass Account' law will put pressure on the
government to reduce its expenditures over the coming years.
table: Fiscal Policy
Monetary Policy
Inflation To Remain Elevated Despite Further Declines
Headline inflation in Mongolia will continue easing at a gradual pace over the coming months on the back of tight monetary policy by the
Bank of Mongolia. That said, the country's still-large fiscal deficit and a weak currency are likely to keep CPI in double-digit territory. This
is reflected in our average headline CPI forecasts of 11.0% in 2015 versus our estimate of 12.0% in 2014.
table: Monetary Policy
Exchange Rate Policy
MNT: Poor Fundamentals Elicit Togrog Downgrade
The Mongolia togrog's break of technical support at around MNT1,900/USD and poor economic fundamentals have led us to downgrade
the unit's 2015 average forecasts to MNT2,000/USD from MNT1,825/USD previously. The country's elevated inflation and signs of
increasing external vulnerability will put downside pressure on its currency over the coming years.
table: Current Account
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, and we expect the country to remain one of the fastest-growing economies globally through to 2024 (at
an annual average clip of 6.7%). 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
Operational Risk Index
Chapter 5: BMI Global Assumptions
Global Outlook
Weaker EMs To Weigh On Growth
Table: Global Assumptions
Table: Developed States, Real GDP GrowtH, %
Table: Emerging Markets, Real GDP Growth, %

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