AKIPRESS.COM - Mongolia must be a candidate for the unwanted title of the country worst hit by cratering commodity prices and the slowdown in China, Financial Times said.

Coal, copper, iron ore, oil, gold and zinc account for the overwhelming majority of the landlocked Central Asian country’s exports (the next biggest category is animal hair), while almost 88 percent of its wares are bound for neighboring China.

The slowdown in the global mining sector has also undermined foreign director investment flows into the Mongolian economy.

Yet Moody’s, the rating agency, believes it has at least found a crumb of comfort for the struggling, heavily indebted nation of 3m people.

Anushka Shah, an analyst at Moody’s described last month’s visit to the country by Shinzo Abe, the prime minister of Japan, as a “credit positive”.

Abe signed a series of infrastructure deals with Chimed Saikhanbileg, his Mongolian counterpart, including the construction of a rail line to Tavan Tolgoi, one of Mongolia’s largest coal mines, and an airport that will be constructed using concessionary funding from Japan.

The possibility of Japan providing further budgetary support was also raised; official development assistance from Tokyo accounted for 37 percent of assistance received by Ulaanbaatar in 2013, according to the OECD, making Japan Mongolia’s biggest donor.

Abe’s visit followed the ratification of a trade agreement by the Japanese parliament in May that will remove tariffs on 96 percent of the country’s exports to Mongolia within 10 years (up from less than 1 percent currently) and ensure all Mongolia exports to Japan become tariff-free.

“Deeper economic and diplomatic relations with Japan are credit positive for Mongolia,” Shah says. “Besides the longer-term benefits that will accrue from improved bilateral trade flows and funding assistance, tighter relations will support Mongolia’s efforts to counterbalance its reliance on China and Russia for financial assistance and trade – the goal of Mongolia’s so-called third-neighbor policy.”

Improved ties with Japan, while welcome, may prove a drop in the ocean, however.

According to Moody’s, bilateral trade between the two countries totalled $392 mln in 2014, some 4 percent of Mongolia’s total trade.

Yet this trade is highly skewed towards Japanese exports, with just 0.4 percent of Mongolia’s exports heading in the opposite direction. Instead, as the first chart shows, 87.9 percent of the country’s exports are bound for China – far from ideal given the latter’s slowing growth and its long-term shift from industrial development to a consumer society.

The proposed budget support may prove more important than enhanced trade between the two nations.

“Such support, if it materializes, would help limit Mongolia’s external vulnerabilities, which have spiked meaningfully over the past year,” says Shah who adds that with reserve cover “thin”, the country is increasingly reliant on a bilateral swap facility with the People’s Bank of China to meet its financing needs.

With debt repayments due in 2017, 2018 and 2022, Moody’s’ external vulnerability indicator, which measures maturing external debt payments relative to foreign reserves, stands at a worrying 203.7 percent.

“The numbers themselves tell you that default is a serious possibility,” says Charles Robertson, global chief economist at Renaissance Capital.

Figures from Fitch Ratings illustrate the scale of Mongolia’s plight. As the second chart shows, the country has the second-highest net external debt to GDP ratio among the 108 states Fitch rates, at 129.8 percent. Only Iceland has higher liabilities.

Moreover, the third and fourth most indebted states by this measure, Greece and Cyprus, and well as the likes of Spain and Portugal, have the cushion of a powerful central bank buying up their debt, pushing down borrowing costs.

Fitch expects this debt burden to ease only gradually, to 119.8 percent of Mongolia’s GDP by 2017, as economic growth slows from the 14 percent it averaged from 2010 to 2014 to a level of about 4.5 to 5.5 percent.

Given the country’s plight, Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman, suggests Mongolia is heading for a downgrade.

On BBH’s own frontier sovereign rating model, Mongolia slipped two notches between the third and fourth quarter of 2015 to B minus, according to an update released last week. This is one level below Moody’s’ B2 and two notches below the B plus accorded by Fitch and S&P.

BBH now accords Mongolia the third-lowest rating of the 37 frontier economies it rates, below the likes of Argentina, Mozambique and El Salvador, and ahead of only Lebanon (marginally) and Ukraine.

“Mongolia has a strong downgrade risk,” Thin says. “They really benefited from the China story. Now growth has slowed and they have high inflation and current account deficits, the whole knock-on effects of low commodity prices... It’s a slice of what a lot of other countries are seeing, but Mongolia has a much shorter track record of dealing with this.”

Thin says BBH’s B minus rating “is not quite default territory, but it’s close”. His base case is that Mongolia will, if it chooses, be able to agree a program with the International Monetary Fund to borrow money in exchange for reforms.

In May, Mongolia did reach agreement with miner Rio Tinto on development of the second, $5 bln underground phase of the country’s vast Oyu Tolgoi copper and gold mine, a move seen as necessary for paying off or possibly refinancing international debt.

However, there are concerns that a nascent split in Mongolia’s governing “super coalition”, which briefly united almost all of the country’s 76 MPs, could further delay international investment into the $5 bln Tavan Tolgoi coking coal deposit, the other big mining project deemed critical to Mongolian state coffers.