Ulaanbaatar, February 13, 2024 /MONTSAME/. Fitch Ratings, an international credit rating agency based in New York City and London has affirmed Mongolia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with a Stable Outlook.

KEY RATING DRIVERS

Strong Growth, External Vulnerabilities: Mongolia's ratings are underpinned by favourable medium-term growth prospects and high per capita income relative to 'B' rated peers. The ratings are constrained by the country's high reliance on external funding and commodity exports to China amid high external debt, modest foreign-exchange (FX) reserves and a record of procyclical economic policy. Mongolia scores well on World Bank Governance Indicators (WBGIs) relative to 'B' peers, but has suffered from political volatility around issues of resource nationalism.

Structural Improvements; Short-term Risks: Development of the mining sector has significantly expanded Mongolia's economy over the past decade, raising GDP per capita and supporting a decline in public and external debt burdens. Nevertheless, it has also contributed to high volatility in key credit metrics, and the durability of these improvements will be tested again as Mongolia enters a parliamentary election year with record-high mining exports and expansionary fiscal policy.

Mining-led Growth: Preliminary estimates point to GDP growth of nearly 7% in 2023, from 5% in 2022, driven mainly by a surge in mining activity. Growth will likely slow to 4% in 2024 as exports stabilise, despite a pick-up in domestic demand. Higher coal exports reflected more efficient customs clearance on the Mongolia-China border, as well as improving transport links. The strategic Oyu Tolgoi copper mine's underground phase started production in March 2023, although volumes will only rise significantly from 2025. Other mining and infrastructure projects could support medium-term growth.

Temporary Current Account Surplus: Mongolia's current account (CA) swung to a surplus of about 1% of GDP (USD200 million) in 2023, from a deficit of over 13% in 2022, on strong mining exports and subdued domestic private investment. We expect exports to weaken and domestic demand to accelerate in 2024-2025, returning the CA to a deficit of an average of 6% of GDP (over USD1 billion) in 2024-2025, although this will likely be covered by inflows of FDI. External surpluses bolstered FX reserves to USD5 billion at end-2023, from just over USD3 billion at end-2022.

External Finance Risks Remain: Net external debt, at about 150% of GDP at end-2023, will be around 7x the 'B' median, although over 30% of this is FDI, and over 20% is the government's bilateral and multilateral loans on concessional terms, both of which we expect will continue to be stable sources of funding. Foreign reserve coverage ratios, albeit improved, remain weak given Mongolia's dependence on external funding and narrow economic base. Reserves net of a swap of around USD1.5 billion with the People's Bank of China and FX liabilities to domestic banks are significantly lower.

Manageable Maturity Schedule: Just over USD500 million in government external debt is due in 2024, including USD170 million in Eurobonds maturing in March, following a tender offer for these bonds as part of a USD350 million issuance in November 2023. The Development Bank of Mongolia (DBM) repaid its December and October maturities without recourse to the government. Government external debt maturities in 2025 are nearly USD400 million, all relating to bilateral and multilateral borrowings

Fiscal Surpluses Will Not Last: The general government surplus reached about 3% of estimated GDP in 2023, from nearly 1% in 2022, as booming revenue outpaced spending. We forecast overall fiscal deficits of 2% of GDP in 2024 and 1% in 2025, reflecting lower commodity price assumptions compared with a broadly balanced 2024 budget target, which assumes 14% growth in revenue and 22% growth in expenditure relative to 2023 results (41% and 34% growth compared with the original 2023 budget).

Underlying Fiscal Stance Expansionary: We expect the non-mineral primary deficit to widen to over 15% of non-mining gross value added in 2024, from 12% in 2022-2023, but still below the historical high of 21% in 2020. In our view, the expansionary 2024 budget reflects both the approach of legislative elections in June 2024 and a pro-cyclical response to higher commodity export revenue in 2023, with the fiscal stability law providing only a weak anchor for fiscal policy, despite recent amendments.

Commodity Dependence, Vulnerabilities: The outlook for external finances is highly sensitive to commodity revenue, which accounts for 90% of total external receipts and 30% of government revenue. For example, a 10% shortfall in coal volume relative to our baseline would imply a 4% of GDP hit to the CA deficit in 2024 and a nearly 1% of GDP hit to the fiscal deficit, all else being equal.

Lower Government Debt; Contingent Liabilities Significant: Government debt including guarantees declined to 49% of estimated GDP by end-2023, from 58% in 2022, on strong nominal growth and a fiscal surplus. We expect the partial reversal of these factors to push debt to 53% of GDP in 2024, after which debt could resume a gradual downward trend broadly in line with the 'B' median. Potential contingent liabilities include unguaranteed state-owned enterprise debt of about 11% of GDP and the Bank of Mongolia's (BOM) negative equity position of about 7% of GDP.

Inflation Peaking; Monetary Stance Unchanged: We expect headline inflation to average 8% in 2024 and 7% in 2025, coming within the BOM's 4%-8% target range, from over 10% in 2023. Normalisation of trade with China and lower global commodity prices have reduced inflationary pressures. Domestically driven inflation remains contained so far, but expansionary fiscal policy poses a risk. The BOM has held its policy rate at 13% since December 2022, after cumulative rate hikes of 700bp.

Banking System Stable: Non-performing loans have edged down to less than 8% of total loans, although underlying asset quality issues may be masked by high nominal growth, with credit to the private sector expanding by about 20% in 2023, driven by consumer lending. All five of Mongolia's domestic systemically important banks have conducted initial public offerings as part of an effort to reduce shareholder concentration, in line with BOM requirements, and the BOM is strengthening the regulatory framework.

ESG - Governance: Mongolia has an ESG Relevance Score of '5[+]' for Political Stability and Rights and '5' for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the WBGIs have in our proprietary Sovereign Rating Model. Mongolia has a medium WBGI ranking at the 46th percentile.