The Government of Mongolia took a further step away from a balance of payments crisis on Monday after raising $500 million from the international bond markets.
The B2/B/B rated credit's ability to access the market at all underscores just how much conditions have improved since mid-February when the sovereign's existing bonds were trading nearly 10 points wider.
The government had originally hoped to raise funds in January but had been forced to step back because of volatility across the whole of the emerging and frontier markets.
This time round it had to pay up to achieve its fundraising goal and investors also received fairly full allocations after the order book closed around the $780 million level.
However, syndicate bankers said participating investors were largely existing holders of Mongolian bonds and viewed the new deal as an opportunity to get hold of liquid paper in sizeable chunks at a time when sovereign credit fundamentals are showing signs of improvement.
"Many accounts were previously underweight emerging markets but have now switched to a neutral or overweight position as the dollar has weakened and commodities have stabilised," said one syndicate banker. "US and European emerging markets benchmark funds were the biggest buyers of this deal, with a tilt to the former."
Pricing for the five-year Reg S/144a deal came at the tight end of revised guidance between 10.875% and 11%. Final pricing was fixed at 99.99% on a coupon of 10.875% to yield 10.877%
The sovereign's two main existing benchmarks comprise a $500 million 4.125% January 2018 deal and a $1 billion 5.125% December 2022 deal.
Until very recently the sovereign curve was inverted because of fears about the government's short-term liquidity position. In mid-February, for example, the 2018 bond hit a peak yield of 13.76%, while the 2022 bond was trading at 12.1%.
That has now reversed. On Monday, the 2018 bond was bid at 91.10% to yield 9.738%, while the 2022 bond was at 76.90% on a yield of 9.935%.
The new 2021 bond has, therefore, priced just over 100bp wider than the existing 2022 bond despite being one-and-three-quarters of a year shorter in duration. "On top of wanting a new issue premium, investors also wanted to be compensated for the fact that the existing bonds are trading at a deep discount," the syndicate banker added.
The emerging markets have been rallying for the past month-and-a-half but investors will need to decide whether Mongolia is still at the beginning of a new upswing, or coming to the end of one.
At their most recent peaks, in mid-May 2015, the 2018 bond was bid on a cash price of 98.50% and yield of 4.74%, while the 2022 bond was at 94% to yield 6.13%.
Pakistan trumps Mongolia
The extent to which Mongolia has fallen out of favour is demonstrated when compared to Pakistan, which has a one-notch lower rating of B3/B- from Moody's and Standard & Poor's but the same B rating from Fitch.
Its 7.25% April 2018 bond is trading around the 5.5% level, some 420bp tighter than Mongolia's comparable 2018 bond.
Mongolia is on negative outlook from Moody's and was downgraded by Standard & Poor's and Fitch last November. Once the darling of frontier market investors, the country has been on a downward track for the last few years.
It has been hit by declining commodity prices, its reliance on China, which accounts for 90% of its exports and a series of anti-foreigner laws, which caused foreign direct investment (FDI) to shrivel up.
Parliamentary elections this summer add a large dose of political risk to investors’ calculations but many believe a new government may consolidate recent moves to make the country more investment friendly again, not to mention financially solvent.
"The elections this summer will be very important towards forming a government that can get growth back on track. The current government, which was elected in 2012, was effectively the opposition party for much of its history," said Marius Toime, a partner at law firm Berwin Leighton Paisner with project finance experience in Mongolia's mining and infrastructure sector.
He added, "Foreign investors and many in the local business community think its inexperience led to some very negative acts such as the Strategic Foreign Investment Law, which created the crisis Mongolia now finds itself in.
"Mongolia is in the middle of a very harsh winter, or dzud, both in terms of the physical and economic climate," he continued. "Much livestock has died and economic growth has almost ground to a halt. It's a very challenging situation and I would expect more defaults along the lines of Mongolian Mining Corp.”
Just over one week ago, the coking coal producer defaulted on a $200 million loan triggering cross-default clauses over its other debt.
“The situation could get worse before it gets better but, having said all that, there are investors waiting on the sidelines for the right moment to pick up distressed assets," added Toime.
Balance of payments crisis easing
At the end of last year, the World Bank forecast GDP growth of just 0.8% in 2016, a far cry from the 17% level Mongolia enjoyed in 2011. However, in its most recent update this February, the supranational noted that Mongolia's balance of payments crisis is easing although this has been accomplished by taking on more foreign debt.
It said the balance of payments deficit dropped to $95.6 million during the final three months of 2015 compared to a $172 million deficit in September and $743 million the year before that.
The government has even paid back $234 million of the money it owes China through its Rmb15 billion ($2.31 billion) bilateral swap arrangement. The World Bank said it had previously drawn down $632 million of the amount from January through to September to help it through the global commodities rout.
The World Bank also flagged a marginal improvement in foreign exchange reserves, which stood at $1.32 billion in December, or roughly three months import coverage.
FDI is also on an improving trend again. In the fourth quarter it amounted to $216 million compared to $156.5 million during the first nine months of the year.
However, this is still a far cry from the $4.4 billion level it hit in 2012. Mongolia's reputation as an investment black spot was sealed after a series of spats with foreign investors in its mining sector.
The most serious dispute concerned revenue sharing agreements at the Oyu Tolgoi project - the world's third largest copper mine, which is majority owned by Rio Tinto. Work was disrupted in 2012 and the matter only settled in May last year when Mongolian bonds last hit their peak. .
A second more symbolic issue concerned Khan Resources disputed uranium mining licenses. Last year, a UN tribunal awarded it $100 million in damages and the Canadian firm recently said the government has agreed to pay it $70 million on or before May 15.
Key for many investors will be when these big mining projects start to generate the kind of cash flow that will bolster government finances. During 2016, S&P said they will help push the country's current account deficit back into double digit territory because of the costs associated with equipment imports.
However, once it is fully operational, Oyu Tolgoi could contribute up to one third of Mongolia’s GDP.
In the meantime, Mongolia is likely to be extremely happy that it has been able to bank a further $500 million and create more of a financial buffer. According to World Bank figures it has about $1.3 billion public debt falling due in 2017, of which the largest chunk comprises a $580 million bond issue for the Development Bank of Mongolia, which matures next March.
A further $653 million in international bonds fall due in 2018, according to S&P Global Market Intelligence figures.
Mongolia's debt load is also being pressured by the tugrik's slide. The rating agencies say roughly half the sovereign's debt is denominated in foreign currencies.
Meanwhile, the currency is hovering very close to the central bank's psychological MNT2,000 level against the dollar. In November, it stood at MNT1,858. On Monday it was trading New York hours around the MNT2,048 level.
As a result, the country’s external debt to GDP rose to 180% last June, according to the World Bank, compared to 162% a year earlier. Government debt has also breached a previous limit of 50% to rise to 58.3% at the end of 2015.