Mongolia Business Forecast Report Q1 2011

We retain our bullish outlook on Mongolia’s long-term prospects, withrising investment and surging exports set to underpin double-digittrend growth over the next five years. The signing of the landmark Oyu Tolgoi Investment Agreement in 2009 will underpin investorconfidence in the government’s pro-business credentials, whichwill support rapid development of the mining sector. Mongolia’sfavourable location next to China should ensure plentiful demandfor its raw materials.

The key risk is inflation, with the decimationof around 20% of Mongolia’s livestock resulting in rocketing meatprices, while grain shortages in Russia have given food prices arenewed push higher. In addition, we remain wary of poor assetquality in the banking sector, though continue to stress underlyingsigns of stability and a reasonably strong pick up in loan growthWe remain relatively optimistiv about Mongolia’s fiscal position, withrobust revenue growth and a commitment to greater spending disciplineset to keep public finances on a fairly secure footing through themedium term. Moreover, we believe that the population is becomingincreasingly aware of the negative impact of direct social transfers,which should reduce demand for destabilising cash handouts goingforward. This should further boost investor sentiment towards Mongolia,adding to an already favourable business climate. While investorswill remain concerned about further populism from the governmentin handing out cash payments to the population, and the potentiallynegative impact this would have on the economy, we believe thatUlan Bator’s pro-business credentials remain strong at this juncture.

Our core views on the Mongolian banking sector remain firmly inplay. Improving asset quality and rising deposits should help to underpinan ongoing recovery in asset and loan growth, which in turnwill support the robust macroeconomic recovery that is underway.

That said, NPLs remain uncomfortably high, while bank restructuringremains a pressing issue, and as a result we expect banks toremain relatively risk averse through 2011. We maintain that theMongolian banking sector is likely to benefit hugely from the longerrun growth opportunities that we expect for the economy, with realGDP growth forecast to average 10.2% between 2011 and 2015.

The government’s Bank Restructuring Program will go a long wayto ensuring that Mongolian lenders have sufficient capital buffersand cleaner balance sheets to be able to take advantage of this.

Pressures on the Mongolian togrog remain fundamentally favourable,and we see scope for further strength for the unit against the US dollarover the medium term. While the Bank of Mongolia will continueto stem appreciation in order to maintain export competitiveness,a hugely positive outlook for real GDP growth and the prospect ofhefty current and financial account surpluses underpin our expectationsfor togrog appreciation through the long term. The risk is thatthis will leave Mongolia heavily exposed to foreign investor risksentiment and commodity prices. We see the togrog appreciatingto MNT1,160/US$ by end-2011, and expect it to hit MNT900/US$at the end of our five year forecast period.

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