Mongolia's economic and financial stability is under pressure, says Fitch Ratings, citing recently released Mongolian foreign-reserves data.
According to Fitch, Mongolia has largely failed to build adequate fiscal and external buffers against commodity price volatility to which its economy is becoming increasingly exposed.
Exceptionally loose fiscal and monetary policy amid a challenging external environment is exacerbating external accounts which are already weak, and adding to financial risks.
Mongolian central bank data through to end-May 2014 show gross foreign reserves falling by 27% to US$1.6 billion, from USD2.2 billion at end-2013. As a result, reserves now provide only 1.8 months of external payment coverage, well below the 'B' range median of 3.2 months.
It is also likely that the headline figure is being bolstered by foreign drawings under swap arrangements with other central banks. According to the Bank of Mongolia's latest statistical bulletin, "foreign liabilities" stood at USD960m, which suggests that net reserves could be as low as USD540m.
The Bank of Mongolia announced on 7 July that it has agreed with the People's Bank of China to extend its CNY10bn (USD1.6bn) swap facility for a further three years, and that discussions are in progress for a possible doubling of the arrangement.
The renminbi swap is a meaningful source of external liquidity support - even though the renminbi is not a convertible currency - because Mongolia sources about 30% of its imports from China.
However, the swap offers only short-term liquidity support, and does not address the underlying drivers of deterioration in Mongolia's economic performance and credit profile.
Economic policy has been highly expansionary since key commodity export prices begun to fall amid a general slowdown in China.
The World Bank estimates the public sector deficit to have come in at 10.9% of GDP in 2013 owing to off-budget spending, despite a Fiscal Stability Law which is supposed to limit deficits to 2% of GDP.
Monetary policy has also been extremely loose, with the Bank of Mongolia cutting its policy rate by 275bp since end-2012 while increasing funding to the banking system by MNT3trn (17% of GDP).
Weakening external accounts combined with expansionary monetary and fiscal policy have fed through to the Mongolian currency, which has depreciated by 10.1% against the US dollar year-to-date, following a 17.6% decline in 2013.
The result is that macroeconomic performance continues to deteriorate with rising inflation and slowing growth, despite the extensive stimulus.
Slowdown in FDI
A significant challenge for raising economic activity (and improving external finances) is the slowdown in foreign direct investment (FDI) since the end of construction for the first phase of the multi-billion dollar Oyu Tolgoi copper mine.
FDI inflows have fallen by 64% yoy in the first five months of 2014, contributing to the elimination of the capital/financial account surplus of the balance of payments.
The beginning of the second phase of construction at Oyu Tolgoi is likely to provide a significant boost to foreign-capital inflows and broader economic activity.
However, Fitch feels that ongoing disputes between the government and the mine's developers could push an agreement pushed back into 2015.
This, combined with the weakening currency, will put additional pressure on both the sovereign and other domestic borrowers which have relied heavily on foreign-currency lending.
The aggregate NPL rate fell to 5.1% in May, from 5.3% at end-2013, while total NPL growth came to 95% yoy. This indicates that pressures remain on the financial system, a full year after the failure of the country's then-fifth-biggest lender, Savings Bank, in July 2013.