Mongolia’s risk-laden and poorly managed banks are a major threat to national stability, as a bond repayment deadline threatens to trigger a default.
Weak commodity demand has seen Mongolia’s fortunes tumble, with the country going from 17.5% GDP growth in 2011 to stagnation and IMF bailouts in 2017. Having ridden the wave of demand created by China in the 2000s and benefitting from its close proximity to Beijing, Mongolia now finds itself with commodities accounting for more than 90% of exports and with mounting debt. The economy saw a 1.6% contraction in Q4 2016 and national debt now stands at $23 billion – twice Mongolia’s annual national economic output.
To make matters worse, the country’s mining sector, already on a shaky foundation, is being rocked by controversy as the government moves to nationalize one of Asia’s largest mines.
Mongolia recently announced that is is planning on nationalizing a 49% stake in the Erdenet mine (the government already owns the remaining 51%). One of Asia’s leading copper and molybdenum mines, Erdenet is also a top tax contributor. Nationalization comes following a June 2016 probe which concluded that the $400 million sale by state-owned Russian holding company Rostec to little known Mongolia Copper Corp. was unconstitutional, as it went ahead without parliamentary approval. Following the nationalization announcement, Rostec’s CEO sent a letter to Mongolia’s Prime Minister threatening legal action, and complaining of inconsistent practices which threaten to scare away investors.
Mongolia has already been embroiled in a spat with Rio Tinto over the Oyu Tolgoi copper deposit, and had to pay a $70 million fine to Canada’s Khan Resources, after international arbitrators ruled Ulaanbaatar’s revocation of a uranium license illegal. This nationalization announcement could further undermine Mongolia’s efforts to attract investment.
Banks, not mining, are the largest threat
While the nationalization announcement is in itself a major story – the first such event since the early 1990s when Mongolia sold off its state assets – it highlights a deeper threat to Mongolia’s economy: risky banking. The $400 million Erdenet sale was announced by then Prime Minister Chimediin Saikhanbileg on June 28, 2016. The very next day the prime minister lost control of parliament to the rival Mongolian People’s Party. The timing of the announcement and subsequent probe covers the entire affair in a cloak of conspiracy. The chief executive (appointed by Chimediin’s Democractic Party) of the Development Bank of Mongolia (DBM) was also arrested in October 2016, on corruption charges for misusing the nation’s sovereign debt fund.
Furthermore, the transaction was found to be in violation of financing laws, as the transaction was facilitated by multiple shell companies controlled by the largest private bank in the country – the Trade and Development Bank (TDBM). While TDBM has denied any wrongdoing, investigators found that the bank took on too much risk in the transaction, violated banking laws, and used borrowed funds from the central bank to complete the sale.
Another worrying indicator of Mongolia’s financial acumen is the growing protest movement concerning the management of Erdenes TT. Prominent mining, law and finance experts are calling on the population to urge the government to protect the public interest, as 20% of Erdenes TT is owned by ordinary citizens. Established by decree in 2010, Erdenes TT’s mandate is to oversee the management of strategically important coal mines, such as Tavan Tolgoi.
Upon its launch, the government gave each citizen 1,072 shares in the company, yet the benefits accorded to shareholders have not been felt by ordinary citizens. Mongolia’s citizens have been shareholders in name only, and have been unable to vote on key decisions. Moreover, the financial reports and balance sheets that are made available are done so in an inconsistent and confusing manner. There does not even exist any database on how many citizens still own their shares, or which shares have been sold since 2010.
Protesters point to a lack of proper management and professional staff, with the company consistently reporting losses. For every 100 million MNT ($40,300) in income, the company is spending 136 million MNT ($54,800). Hence, despite exporting 24.2 million tons of high quality coal since 2011, Erdenes TT’s accumulated net loss is $182.6 million, with an outstanding debt of $331 million. As a result, at the current rate the company will be bankrupt in eight years. What makes the situation even more grave is that the company’s management is using loans from DBM to cover its losses.
Mining expert L. Naranbaatar notes that “of the accumulated debt, 71% of it is owed to DBM; [much] of which was financed by the Chinngis Bond.” The Chinngis Bond was launched in 2012 during Mongolia’s commodity boom, and the $1.5 billion sovereign debt bond was quickly snapped up. The problem is that a $580 million repayment deadline is fast approaching, and DBM’s mismanagement combined with the economic downturn have left it in dire straits.
Default a very real possibility
These kinds of imprudent business practices have left DBM and other Mongolian banks cash-strapped. As a result Moody’s has implemented a downgrade review for seven Mongolian banks and the country as a whole, citing concerns about the upcoming bond repayments due on March 21st. DBM lacks the funds to finance the repayment itself, and will need outside help to prevent a default. Since the government placed an unconditional guarantee on the bond in 2012, a default by DBM will be considered a default by the sovereign, according to Moody’s. This news has already caused Mongolia’s 2022 $1 billion Eurobond to slump, with the country looking to China and the IMF for emergency assistance.
Already severely beholden to China, Mongolia is hoping to receive aid from the IMF, yet while IMF rescue teams arrived for their second meeting in early February, little progress is being made as disagreements abound over the scale and scope of cuts.
One development has been the approval of a revised law concerning the DBM. Noting the influence of political patronage and the lack of professionalism, MPs have compiled a range of provisions, including 13 recommendations from the IMF. These include banning DBM from holding citizen savings, jointly financing projects and programs with foreign or domestic investors, and limiting board member re-election to two terms. Board members will also be required to not have held political office for five years prior to their appointment.
The revised law is set to become effective on April 1st. While this bill is step in the right direction, Mongolia’s financial fiasco remains no laughing matter.
Jeremy Luedi is a Senior Analyst at Global Risk Insights.
Article as appears on Global Risk Insights: http://globalriskinsights.com/2017/02/radar-mongolia-banks-threaten-economic-crash/