Economic Deceleration Not Yet Over
Parliamentary elections are scheduled to take place on June 29 2016, and we expect neither the ruling Democratic Party nor the opposition Mongolian People's Party to win a convincing mandate. Post-elections, the land-locked nation's business environment is likely to remain challenging as policymakers struggle to balance the interests of the public and foreign investors, particularly in the mining sector.
Mongolia's real GDP growth will decelerate to 1.5% in 2016 as net exports will act as a drag while political uncertainty will keep investors cautious. However, we expect a recovery in 2017, and we forecast real GDP growth to average 7.4% over the next decade as investment recovers owing to the second phase expansion of the Oyu Tolgoi (OT) copper and gold mine, which is estimated to commence in the middle of 2016. However, the landlocked economy will continue to face headwinds due to a cooling Chinese economy, which will prevent the Mongolian economy from growing at a faster pace.
We are cautious on the Mongolian togrog against the US dollar, and forecast the unit to average MNT2,044/USD in 2016 and MNT2,088/USD in 2017. 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.
Following the Bank of Mongolia (BoM)'s decision to cut its 1-week central bank bill rate by 150bps to 10.50% at its May 5 monetary policy meeting, we forecast the central bank to reduce interest rates by another 75bps to 9.75% by end-2016. Mongolia's headline consumer price inflation will remain below the central bank's target of 7.0% despite bottoming commodity prices and growth in monetary aggregates. Therefore, there is still room for the central bank to ease monetary policy further as it attempts to support the sluggish domestic economy.
Mongolia will continue to run fiscal deficits in the coming years as structurally low commodity prices temper revenue growth while public expenditure growth remains elevated amid insufficient expenditure cutbacks due to the government's poor fiscal discipline. The country is increasingly at risk of a credit event as Mongolia and its state-linked entities are facing significant bond repayments beginning from 2017, and it is highly likely that the Mongolian government would have to refinance at significantly higher yields, if it were to be successful at it.
Major Forecast Changes
We have downgraded our 2016 real GDP growth forecast to 1.5% (versus 3.2% previously) as as the economy continues to face external headwinds and heightened political uncertainty ahead of the parliamentary elections (to be held on June 29) that would likely weigh on investment in the first half of the year.
We have revised our average 2016 currency forecast stronger to MNT2,040/USD (versus MNT2,150/USD previously) amid a return of global risk appetite, and against a backdrop of US dollar weakness since the start of 2016. That said, we continue to hold a cautious outlook on the Mongolian togrog as the country's widening current account deficit due to a pick up in imports and subdued export growth amid continued elevated external indebtedness will put downside pressure on the currency.
Upside Risk: An early start of the second phase of expansion at the OT project would help galvanise investment activity.
Downside Risk: In a worst-case scenario, a significant slowdown in Chinese economic growth and, by extension, demand for commodity imports would seriously hamper Mongolia's growth prospects. Any deterioration in the country's business environment due to delays in other major mining projects could weaken investor confidence, which could force the BoM to hike rates unexpectedly (to the detriment of the banking sector), in order to shore up the currency.
|f= BMI forecast. Source: BMI, National Sources|
|Nominal GDP, USDbn||12.3||11.7||12.0||12.9|
|Real GDP growth, % y-o-y||8.1||2.4||1.5||4.2|
|Consumer price inflation, % y-o-y, eop||11.0||1.9||5.0||6.5|
|Exchange rate MNT/USD, eop||1,888.50||1,993.00||2,075.00||2,100.00|
|Budget balance, % of GDP||-4.0||-5.0||-6.7||-6.7|
|Current account balance, % of GDP||-11.5||-4.7||-10.1||-11.2|
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