It wasn’t so long ago that Mongolia was the darling of the international capital markets. The country’s stratospheric economic growth – it hit 17.5% in 2011, the highest in the world that year – and its frontier market credentials made it second to none as a must-have investment.
But Mongolia’s fall from grace has been swift and serves as a warning of the perils of “original sin” for countries tempted to fast-track growth thanks to the largesse of international debt market investors.
I have written before about original sin in this column and the bullet points of the concept should be pinned to the desks of any asset managers who are about to go breathless on the attractions of frontier market debt.
Of course original sin – the concept that a developing country dooms its exchange rate when it borrows excessively in hard currency – is rarely a straightforward affair. Indeed, when it comes to original sin it is difficult to divine whether the offshore borrowing is both necessary and sufficient for a subsequent collapse of the foreign exchange rate, or whether other factors are brought to bear.
In Mongolia’s case, the sharp reversal of economic fortunes has been ascribed to the slowdown in neighbouring China, one of its biggest export markets, the collapse in the price of copper, one of its biggest exports, and waning foreign direct investment.
But one wonders if the fall of its currency, the tugrik, which plummeted 23% against the US dollar last year, would have occurred had Mongolia not made its forays into the offshore debt markets. The ruling Mongolian People’s Party, which won a landslide victory in elections held last June thanks to its supposedly pro-business stance, has described the situation in the country as one of economic crisis.
In the face of a series of ratings downgrades last year, and a looming US$580m bond redemption next month for Development Bank of Mongolia (which carries a government guarantee and is now rated Caa1 by Moody’s after two rapid-fire downgrades at the end of last year), the natural assumption would be that the country is going to struggle to meet this debt payment.
IN AN ECHO of 1997 Thailand, citizens are contributing to the looming debt redemption, donating gold, jewellery and that staple of Mongolian culture, horses, although this appears unlikely to be a game changer.
Multilateral institutions are being touted by market insiders as likely to step up to the plate as the day of reckoning approaches. That, of course, wasn’t supposed to be the outcome when the bond priced, but you can’t say that the country hasn’t provided thrills worthy of a nerdy computer game to high-yield and distressed bond traders.
For example, the Trade and Development Bank of Mongolia’s 2020 dollar paper jumped 25 points last year from a February low of near 75 cents on the dollar to surge to 101 on the election victory of the People’s Party.
Meanwhile, with just a month to go before redemption, the Development Bank of Mongolia’s 2017s are at a two-point discount to par to yield 22%, not bad as a money market rate of return, and better than any commercial paper you can see in the market. But I’m not sure I would take that risk, even if a mountain of gold and jewellery (to say nothing of horses) descends on Mongolia’s Treasury between now and the redemption date.
Mongolia might seem like a somewhat irrelevant outlier in terms of its potential to provide a black swan event for global markets, but in this day and age of hair-trigger nerves you never know.
And, in the new political atmosphere around Washington, you would have to wonder whether the will exists for the IMF to emerge with a last-minute rescue package.
ANOTHER POTENTIAL WHITE knight could be the Asian Infrastructure Investment Bank. Helping redeem a bond that financed Mongolian roads wouldn’t exactly sit outside the AIIB’s remit. It would also represent a kind of parachuting of the newly formed institution into the Mongolian project finance landscape, and yet another manifestation of China’s global soft power grab.
Certainly, it might go some way towards preserving the credibility of the frontier sovereign bond as an asset class. A default from Mongolia would set that product back years, in my opinion.
But of course, to go back to the starting point of this column, the dangers of original sin would not be obviated by a rescue. Assuming Mongolia does escape default, the best thing that the AIIB could do as a follow-up would be to issue a benchmark in tugrik, to start the country on the long and necessary path towards weaning itself off the perils of offshore debt issuance.
