Asia Economy

One-time emerging market darling Mongolia is running out of cash

Sunset in Ulaanbaatar city, Mongolia's capital.
GML | Getty Images

In 2012, Mongolia marked its debut in international capital markets with a stunning dollar bond sale that was meant to usher in a new era for the country.

Four years later, the currency is in free fall and concerns are growing that the cash-strapped government will struggle without external assistance.

The reversal of fortune for this sparsely-populated country underscores the impact the slowdown in China is having on economies that have for years depended on supplying raw materials to Chinese factories.

The collapse in commodity prices has taken a toll on the country's once-dominant mining sector. Foreign direct investments into the country's coal- and gold mines have slowed as investors closed their checkbooks.

In first half 2016, Mongolia's gross domestic product (GDP) grew 1.3 percent, compared with the 2.3 percent growth seen in 2015, according to data from Moody's.

Late Friday Asia time, ratings agency Standard & Poor's Global downgraded the country's long-term rating to B-minus from B on a weakening fiscal and growth outlook. It also cut its GDP forecast to an average of 3.2 percent over 2016-19 from a previous estimate of 4 percent. It cut its GDP growth forecast for 2016 to 1.3 percent from a previous estimate of 2.6 percent.

By comparison, World Bank data showed Mongolia grew by as much as 17.3 percent in 2011 at the start of the global mining boom.

The Mongolian tugrik has plummeted nearly 12 percent against the dollar this year, which prompted the Mongolian central bank to lift its policy rate on Thursday by 450 basis points to an all-time high of 15 percent.

The government also announced some austerity measures, in terms of pay cuts for executives and management-level staff at state-owned enterprises.

As of June 2016, Mongolia's foreign reserves stood at $1.296 billion, central bank data showed, which would be equivalent to roughly four months of imports, according to Trinh Nguyen, a senior economist with Natixis.

"Mongolia is having a difficult problem funding itself," Nguyen told CNBC by email on Friday.

"We don't know how much they have left [but] in 2015, Mongolia imported $3.8 billion and in 2014 $5.2 billion ... if we assume they still have $1.3 billion now, then it covers four months ... if that dropped to $1 billion, then the coverage is much lower at three months," she explained.

The precarious foreign exchange position has heightened concerns over the government's ability to repay borrowers.

Thomson Reuters data showed government bonds worth $664.8 million are set to mature in 2017, another $653.27 million in 2018, and $1 billion in 2022.

Many investors have already started yanking funds out of the country.

Bernard Pouliot, chairman of Hong Kong-based financial services group Quam Limited, told CNBC by phone on Friday that he shut down a Mongolia-focused fund last year, valued close to $10 million, which invested in public companies, because he did not see the country bouncing back until 2020. Pouliot started the fund in 2011.

He said Mongolia was too small of a market, and too dependent on politics, to maintain a single-country fund through the on-going slump.

Workers walk along the conveyer belt used to move ore to the concentrator area at the Oyu Tolgoi mine in the south Gobi desert, Khanbogd region, Mongolia. The Oyu Tolgoi (Mongolian for Turquoise Hill) copper and gold mine is a combined open pit and underground mining project.
Paula Bronstein | Getty Images

Mongolia a mirror to a global trend

One fund manager, who is still invested in Mongolia, told CNBC that the country's turmoil reflected the broader trend of "ultra-loose" monetary policies adopted by central banks around the world, which led to a debt binge.

"After several years [of low interest rates], you have a situation where many people borrowed too much money at too low rates and now, even at these rates, are not able to repay. That's the dilemma," Michael Preiss, executive director at Taurus Wealth Advisors, told CNBC by phone.

Some analysts are not convinced that the raising of interest rates will reverse the damage.

"We do not consider the announced measures sufficient in themselves to stem dollar/tugrik buying," said Tim Condon of ING in a morning note on Friday, adding a regime change might be needed in order to halt the buying pressure.

Natixis' Nguyen added raising rates is usually effective in low-rate environments. Instead, Mongolia's rates were already higher than most countries.

Instead, it would make raising funds more expensive when Mongolia can least afford it. If the currency continues to weaken, it will also result in higher import costs and inflation at a time when Mongolia's foreign reserves are dwindling.

Too valuable to go bust?

Experts say another rescue from the International Monetary Fund (IMF) is likely, with many seeing Thursday's rate hike as meeting IMF preconditions for a program.

"An IMF program is not a done deal," Condon cautioned, however. "Mongolia is a serial borrower from the IMF, which we think raises the odds of the authorities successfully negotiating a program ... a breakdown in negotiations would, we think, trigger a balance of payments crisis."

Mongolia last received a bailout from the IMF in 2009.

But most experts agreed that Mongolia is strategically too important for external parties, particularly China, to not intervene if the government's funding situation worsens.

"They're next door to China and it's much cheaper, if logistics are in place correctly, to ship coal, copper and gold from Mongolia, than from Australia or anywhere else," said Pouliot.

Politically, the Mongolian People's Party returned to power in a landslide parliamentary election on June 30, reported Reuters.

This, Pouliot said, meant there would be some political stability in the country. "They can now take decisions, instead of fighting all the time ...[but] it will take time to rebuild credibility, reserves and their economy," he said.

Possible rebound in commodities

Another potentially good news for the resource-rich country is the rebound seen in commodity prices this year.

"The resources sector [in Mongolia] could potentially see a re-rating," said Preiss.

Adding to the prospect of a pickup in the resources sector was the approval of the development of the Oyu Tolgoi underground mine by Rio Tinto, the Mongolian government and Turquoise Hill Resources, announced May 6, 2016. The project is worth $5.3 billion.

"This is the project that is expected to double gross domestic product ... this could be the largest copper and gold mine in the world," said Preiss.

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