Bond gamble heats up in Mongolia

Funds raised through Mongolia’s first national bonds are set to have an impact on the wider economy, with the government announcing in February that four new major projects will benefit from the so-called “Genghis” bonds. However, critics still fear the issuance could backfire.

Upon their release in November 2012, the government sold $1.5bn worth of bonds, attracting orders for 10 times that amount, with the sales of the five-year bond making $500m at its launch rate of 4.13% yield, while the 10-year bonds, sold at 5.12%, raised $1bn.

“This is a big-bang entry into global capital markets,” Jan Dehn, the co-head of research at the UK-based Ashmore Investment, told the Wall Street Journal (WSJ) on the launch.

The issuance followed an offering by the state-owned Development Bank of Mongoliain March 2012worth $580m in bonds, which was also oversubscribed by 10 times. Government officials have said the country plans to sell a total of $5bn in bonds to finance the infrastructure required to develop its mining sector.

The first project aims to connect Ulaanbaatar, the capital, to all 21 aimags (provinces) with some 1347 km of paved roads by 2016. Meanwhile, a second venture, forming part of a transport overhaul in the capital, will see 33 junctions improved and highways built alongside the Tuul and Selberivers. Elsewhere, a 300-MW power plant will be built near the Tavan Tolgoi coking coal mine, while a 270-km railway line will be built to connect the mine to the GashuunSukhait Port.

Mongolia, which has an abundance of resources, including copper, uranium and coal, has recently stepped up production efforts to take advantage of such mineral wealth. For example,Oyu Tolgoi, the country’s biggest copper and gold mine and the third largest in the world, which is owned by Rio Tinto and the Mongolian government, is set to begin production in 2013.

Some analysts have lauded the potential to build up greater domestic savings through the bond offering, saying that not only will the bonds instil a greater sense of discipline throughout the broader economy, but will also enhance the country’s image in the international capital markets.However, critics have stated that such issuances leave the country open to a number of risks, including over-exposure, liquidity needs and trade effects.

The reality of these risks became apparent in December when the bonds plunged $7-8 following reports that the Mongolian People’s Revolutionary Party (MPRP) was no longer prepared to work with the free-market Democratic Party, the country’s biggest party, following the election in June 2012.

While speaking with Reuters in early December, Vidur Jain, an analyst at Monet Capital, a local investment bank, said the MPRP’s decision to back out of the coalition could affect the yields on the recently issued bonds, and make a second issuance more expensive.

Further risking the confidence underpinning bond sales, in October 2012 the World Bank noted declining demand from China for key coal resources, with exports falling 39% year-on-year in August, the largest fall since mid-2009.

“The use of sovereign-bond proceeds is adding to the concerns regarding the growing tendency to bypass the Fiscal Stability Law,” the bank warned in January. “While it is a sign of growing interest from global financial markets in the Mongolian economy, the new bond issue could become a significant fiscal risk without prudent plans to use the proceeds.”

A crucial test for the bonds will come when the US Federal Reserve starts raising interest rates again. According to the WSJ, “[The bubble] could burst if the situation in the eurozone deteriorates sharply, but then, as that would likely boost demand for dollar assets, dollar bonds such as Mongolia’s could find themselves in favour.”

While some believe the level of debt being generated by the bonds is a cause for concern, for optimists the government is choosing just the right time to cash in on growth. For example, in January The Economistlabelled Mongolia its “star performer” for 2013, outperforming its closest rival, Macau, by 4.6% with a predicted GDP growth this year of 18.1%.

By targeting the infrastructure deficiencies that may limit future growth, such as when mining reserves eventually run dry, the government is taking a long-term view on attracting investment, which will benefit future generations. However, both the ruling parties and the opposition must take note of how domestic political shocks can impact the global economy.