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Mongolia Country Risk Report Q2 2016

Mongolia Country Risk Report Q2 2016

Core Views

Parliamentary elections are scheduled to take place by June 2016,and Mongolia’s political environment will be volatile ahead of theelections. The two major parties, namely the Democratic Partyand the Mongolian People’s Party, are unlikely to win a convincingmandate, and we expect a coalition government to be formed.

This means that the business environment will remain challengingfor investors.

The Mongolian economy will begin a gradual recovery in 2016, andwe forecast real GDP growth to average 7.9% over the next decadeas investment recovers owing to the second phase expansion of theOyu Tolgoi copper and gold mine, which is estimated to commence inthe middle of 2016. However, the landlocked economy will continue toface headwinds due to a cooling Chinese economy, which will preventthe Mongolian economy from growing at a faster pace.

We remain bearish on the Mongolian togrog against the USdollar, and forecast the unit to average MNT2,075/USD in 2016 andMNT2,178/USD in 2017. The country’s widening current accountdeficit and signs of increasing external vulnerability will put downsidepressure on its currency. However, the return of foreign inflows dueto the second phase development of the Oyu Tolgoi gold and coppermine will prevent any excessive weakness.

Following the decision by the Bank of Mongolia (BoM) to reduceits 1-week central bank bill by 100 basis points (bps) to 12.00% inlate-December 2015, we forecast that the central bank will cut itskey policy rate by another 100bps to 11.00% by the end of 2016,with the aim of supporting the country’s sluggish economy. Fallingheadline consumer price inflation due to shrinking money supplywill provide scope for the central bank to ease its monetary policystance over the coming months.

Mongolia will continue to run fiscal deficits in the coming years asstructurally low commodity prices temper revenue growth while publicexpenditure growth remains elevated as the government strugglesto reduce spending in 2016 as parliamentary elections loom. Thecountry is increasingly at risk of a credit event as Mongolia and itsstate-linked entities are facing significant bond repayments beginningfrom 2017.

Major Forecast Changes

We have downgraded our 2016 real GDP growth forecast to 3.2%(versus 4.5% previously) as the country’s economic fundamentalsworsen and a further deceleration in the Chinese economy, whichaccounts for approximately 90% of the demand of Mongolia’soverall exports.

We have revised weaker our average currency forecast to MNT2,075/USD in 2016 (versus MNT2,000/USD previously) as the country’swidening current account deficit due to a pick up in imports andsubdued export growth amid continued elevated external indebtednesswill put downside pressure on the togrog.

We have downgraded the government’s reported budget deficit asa share of GDP to 6.2% in 2016 (from 6.0% previously) as austerityby the government is unlikely to be successful in a parliamentaryelection year, keeping expenditure elevated. Meanwhile, governmentrevenues will remain weak as any recovery in the Mongolianrecovery is likely to be gradual.


Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Gradual Recovery In 2016 As Challenges Remain
Mongolia's headline real GDP growth continued to trend slower in Q315, moderating to a fresh multi-year low of 1.9% y-o-y, but we
expect growth to head marginally higher to 3.2% in 2016 (versus an estimated 2.5% in 2015). Although the second phase development
of the Oyu Tolgoi gold and copper mine will provide support to investment when it commences in the middle of 2016, the landlocked
economy will continue to face headwinds from a slowing Chinese economy and poor agricultural production.
GDP By Expenditure Outlook
TABLE: GOVERNMENT CONSUMPTION FORECASTS
TABLE: GDP GROWTH FORECASTS
TABLE: PRIVATE CONSUMPTION FORECASTS
TABLE: FIXED INVESTMENT FORECASTS
TABLE: NET EXPORTS FORECASTS
Currency Forecast
MNT: Still At The Mercy Of Downside Risks
The Mongolian togrog is yielding to downside pressure against the US dollar so far in 2016, despite holding firm in the last quarter of
2015 due to management by the Bank of Mongolia, and we maintain that further weakness is in store for the currency over the medium
term. The country's widening current account deficit and signs of increasing external vulnerability will put downside pressure on its
currency. However, the return of foreign inflows due to the second phase development of the Oyu Tolgoi gold and copper mine will
prevent any excessive weakness.
TABLE: BMI CURRENCY FORECAST
Outlook On External Position
TABLE: MAIN EXPORT & IMPORT PARTNERS
TABLE: MAIN EXPORTS & IMPORTS
TABLE: CAPITAL & FINANCIAL ACCOUNT BALANCE
Monetary Policy
BoM To Cut Rates Further As Inflation Eases Amid Gradual Recovery
Following the Bank of Mongolia (BoM)'s decision to cut its 1-week central bank bill rate by 100bps to 12.00% during its December 22
2015 monetary policy meeting, we forecast the central bank to reduce its benchmark policy by another 100bps to 11.00% by the end
of 2016. In an environment in which inflation is likely to remain relatively muted over the coming months, we believe there is increasing
space for the central bank to ease interest rates, in an attempt to support the sluggish domestic economy.
Monetary Policy Framework
Fiscal And Public Debt Outlook
Public Finances To Worsen In 2016
Mongolia's public finances continue to deteriorate, and we expect their fiscal accounts to worsen further in 2016 owing to poor revenue
collection and insufficient expenditure cutbacks due to the government's poor discipline. Therefore, we forecast Mongolia's reported
fiscal deficit as a share of GDP to widen to 6.2% in 2016 (versus an estimated rate of 4.9% in 2015). Meanwhile, significant external
bond repayments are due beginning from 2017, and the risks of a credit event are rising given that the country's vulnerabilities stemming
from its twin deficits will persist over the coming years.
Structural Fiscal Position
TABLE: MAIN REVENUE AND EXPENDITURE CATEGORIES
Chapter 2: 10-Year Forecast
The Mongolian Economy To 2025
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 2025 (at
an annual average clip of 7.9%). 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 3: Political Outlook
SWOT Analysis
BMI Political Risk Index
Domestic Politics
Political Uncertainty To Remain Elevated
Mongolia's political environment remains highly volatile, and we do not expect such uncertainty to abate anytime soon ahead of the
country's parliamentary elections, which are set to take place by the middle of 2016. Coupled with deteriorating macroeconomic
fundamentals stemming from its twin fiscal and current account deficits, we expect the country's currency and bonds to remain under
considerable downside pressures.
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 4: Operational Risk
SWOT Analysis
Operational Risk Index
Chapter 5: BMI Global Macro Outlook
Global Macro Outlook
Downside Risks Gather Momentum
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %
TABLE: MACROECONOMIC DATA & FORECASTS

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