Samurai to the rescue: A promising new bond will require better planning

Like the country’s equity market, Mongolia’s bond market had a tough year in 2013. Trading in debt securities dried up on the Mongolia Stock Exchange (MSE), with turnover in corporate bonds going to zero, while pricing on the country’s eurobonds collapsed. As Mongolia’s balance of payments situation worsened, bond investors soured on Mongolian paper. However, as 2013 progressed, talk of a yen-denominated, partly Japan-backed bond began to surface, and the previous issues stated to recover. By the time the terms of the transaction were finalised in late 2013, it was clear that the bond would solve a number of problems, both for the economy in general and for the bond market in particular.

Mongolia has a good number of bonds. According to the MSE, five corporations have had their debt instruments traded on the market – including Gobi, Monfresh Juice and Just Agro – while 30 government issues are available, ranging between one- and seven-year bonds. Mongolia has also been active on the international market. In the past three years, six bonds totalling over $3bn have been issued by Mongolia or Mongolian businesses. The Trade and Development Bank (TDB) sold $25m in bonds in 2010. The Development Bank of Mongolia (DBM) sold $580m in bonds in 2012. The Mongolia Mining Corporation came out with $600m worth of bonds in 2012, and TDB sold another $300m in 2012. Finally, the country came out with two sovereign issues in 2012, selling $500m in five-year bonds and $1bn in 10-year bonds, which are known as the Chinggis bond.

Risky Bet

Bonds issued by Mongolia have always been considered a bit of a gamble. Ratings agency Moody’s assigned a B1 rating to the government for long-term issues. It noted that the country rated low in terms of institutional strengths and that “event risk” was high. The economy, it added, goes through boom-and-bust cycles because it is undiversified and is based on mining and agriculture, meaning it could easily fall victim to the commodity cycle and face setbacks related to severe weather. Moody’s also noted that government spending and monetary policy tend to be pro-cyclical.

The bonds have not fared well as the country very much stuck to the script that so concerned Moody’s.

Political instability, falling coal prices and fiscal troubles led to an almost immediate drop in prices. The Chinggis bond quickly went from yielding 5.12% to more than 8%, while the price dropped from around $98 to under $80. Corporate issues followed the downward trend in sovereign issues. Bloomberg reported that the DBM bond rose from a low of 3.83% in October 2012 to 8.99% in September 2013. While all bonds, including US Treasuries, have done poorly over the period since the Chinggis bond was issued, the Mongolian paper has performed worse, according to Morgan Stanley. It argues that in terms of spreads to major benchmarks, the Chinggis bond has seen more widening than most bonds.

By the end of 2013, the country found itself in a difficult position. Exports and foreign direct investment (FDI) were down and reserves were dwindling.

As it was up against its debt ceiling under the Fiscal Stability Law (FSL), which stipulated a decrease from 50% of GDP in 2013 to 40% in 2014, it was not in a position to issue more bonds. However, in late 2013 DBM managed to get a ¥30bn ($300m), 10-year Samurai bond off the ground. News of the issue had an immediate impact as the tugrik rallied and international Mongolian bonds stabilised.

A New Bond

The Samurai bond will be backed by the Japan Bank for International Cooperation (JBIC), with 90% of the coupon payment guaranteed by the AAA-rated institution. The plan had been to issue $1bn of samurai bonds, but due to weakening conditions, lower appetite and the debt ceiling issue, the sale was scaled down. The transaction seems to have occurred for a number of reasons. For Japan, it may have been geopolitics that got the JBIC to commit, despite economic troubles in Mongolia. The country has always considered Mongolia an important partner in balancing China and, to a lesser degree, Russia. Given the heightening of tensions near the Senkaku/Diaoyu Islands, it is particularly important now to keep Mongolia stable and onside.

For Mongolia, the Samurai issue could give it enough breathing room to stay in the black until projects get back on track and FDI to starts to return. It could also help it return to the international dollar market. While a yen-denominated, semi-backed credit is very different from Mongolia raising money under its own name and in dollars, the hope is that the Samurai bond could revive interest and trading in Mongolian paper. The country and the DBM are both hoping to do a follow-on offering in the euromarket.

Mind The Ceiling

The main issue now is the debt ceiling. Somehow, the DBM’s Samurai bond went through without contravening the law. It is not clear how this happened. Some speculate the government will try to reclassify debt issued by state-backed entities, such as the DBM, as not being subject to the debt ceiling. Others think the bond could be booked in 2014. A higher GDP could get the ratio close enough to not be a political problem. The other possibility is that the issue was done without concern about the ceiling. It is in no one’s interest to contest the bond, as the country desperately needs the money, and so it is very possible that with or without creative accounting the ceiling will not be a problem.

In this way, the bond establishes an important precedent. The FSL may have been a good idea, but the message may be that it will not be followed to the point of inviting economic difficulties. In terms of bond issues, political and bureaucratic Mongolia may prove to be pragmatic. A parliamentary standoff may be avoided and more bonds might quietly get through despite the FSL.

Furthermore, Mongolia must spend the money well. Proceeds from the Chinggis bond seemed to vanish almost overnight. By spring of 2013, only $347m of the original $1.5bn was left. The government argued that it was put to good use. It itemised expenditures, saying the money was invested in road and rail construction, new housing, industry and agricultural support. The list seemed comprehensive and balanced. However, despite the transparency, the international community, as well as many Mongolians, were left wondering how so much money could be raised and the country find itself facing a shortage of foreign reserves less than a year later. It is especially worrying that Mongolia is paying over $200,000 a day in interest, putting the country more into debt.

Too Thin

Critics point out that funds were spread too thin to really make a difference. No major income-generating projects were completed as a result of the bond, and while a lot of infrastructure was built, it did not add up to very much. The various parts do not connect well to each other and are not all that meaningful to the country. A year after the bond, traffic is still a problem in Ulaanbaatar, pollution is still a major issue in the capital, and while connectivity may have been improved to rural areas, the new roads have not added noticeably to the economy.

The World Bank advised early in 2013 that the government needs to better analyse the socioeconomic benefits of its investments and make sure funds are not wasted. It also notes that financing like the Chinggis bond are particularly problematic, as money comes suddenly and in a rush, and politicians hurry to show results. Worthwhile projects need a good deal of advanced planning and feasibility work. The risk is that too much is done too quickly, but little of value is accomplished.

Observers are therefore looking closely as to how the proceeds of the Samurai bond will be used. If the country can demonstrate good planning and make investments that make sense in both the long and short term, investors will be likely to buy follow-on issues. Mongolia is going to have a long-term relationship with the global bond markets. It is already in debt to the tune of $3bn and has to maintain credibility with its existing investors. It has massive projects to undertake down the road, and these are what will make the most difference over time. If the likes of the Mongolian Railway State-owned Shareholding Company are to be properly realised, the government needs to put the Samurai bond to good use.


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The Report: Mongolia 2014

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