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Mongolia’s sovereign bond has teething problems

Debut bond rebounded after political scuffle; Investment opportunities limited elsewhere

When Mongolia issued its debut sovereign bond in late November, international investors showed immediate and keen interest. But a spat within the coalition government resulted in the bond’s price plummeting dramatically, threatening to completely undermine the initial positive reaction.

In the face of this setback, Mongolia has gone into overdrive in its efforts to paint the bond issue in a positive light.

Alisher Ali, chairman of Silk Road Finance, a frontier markets investment group
Alisher Ali, chairman of Silk Road Finance, a frontier markets investment group

"The first sovereign issue by the Mongolian government was clearly a major success," says Alisher Ali, chairman of Silk Road Finance, a frontier markets investment group. "The sovereign bond was the largest-ever issue among all frontier markets for a debut – the issue broke a number of records." Mongolia issued $1.5 billion in debt in five-year and 10-year tranches. The landmark transaction attracted an order book in excess of $15 billion. Both tranches priced at the tight end of final price guidance, at 4.125% to 4.25% for the five-year tranche and 5.125% to 5.25% for the 10-year tranche.

Bank of America Merrill Lynch, Deutsche Bank, HSBC and JPMorgan were the joint bookrunners for the sale.

The bond’s sudden slump in value by $7 to $8 came after members of Mongolia’s fragile government, the Mongolian People’s Revolutionary Party, announced that the party would quit the ruling coalition, led by the Democratic Party, in protest at MPRP leader Nambar Enkhbayar’s arrest following corruption charges.

"Here in Mongolia, people were actually quite surprised that the international community paid so much attention to what was going on in local politics," says Randolph Koppa, president of the Trade and Development Bank of Mongolia. "[They have] never really cared before, but since the bond, all eyes are on Mongolia. Political activities and the related rhetoric meant mainly for local consumption are being misjudged. Most people in the west do not have any idea how Mongolian politics work as yet."

According to Ali, investors panicked as a result of greater political tension. "The bond issue was so widely distributed and inevitably, some investors – those not fully aware of the political fundamentals in Mongolia – panicked and wanted out," he says.

"The fact is that there has been political volatility in Mongolia since April, and this was priced in."

Indeed, the likelihood that the coalition government in Mongolia would fall apart even if the MPRP decided to withdraw was minimal. A report by Origo Partners, a private equity investment company based in China, highlights that the threat was only meant as a high-profile warning to the authorities by the MPRP.

"The fact that MPRP ministers have not actually submitted their resignations indicates to us that this political action was aimed primarily at influencing the outcome of the court ruling," says the report. "Following the finalization of Enkhbayar’s case we expect the usual condemnation and possibly other political actions of protest from the MPRP, but not the actual exit from... the coalition government."

Moreover, according to the report, the fact that the bonds soon rebounded shows that the market has largely ignored the potential for further political controversy from the MPRP leading to government collapse.

The latest tussle could even be beneficial for Mongolia and bring the frontier market to the fore. "The political [tensions]... brought attention to Mongolia. People are new to the Mongolian story, but the bond issue and the momentary [political] hiccup that followed will demand investor interest," says Ali.

Koppa says: "The week that Mongolia went on the road to drum up interest for their bond, there was no bad news. Talks surrounding the fiscal cliff were just about to start and the Greek crisis looked as if it was cooling down. Investors saw this as a good opportunity, especially for diversification of their portfolios by including a new country from a more dynamic region of the world."

Indeed, the Mongolian bond was popular because investor opportunities elsewhere are limited. Low interest rates in developed economies amid the eurozone crisis and the fiscal cliff have also spurred investors to seek more exotic, high-yielding bonds, while at the same time mainstream emerging market names including Mexico, South Africa and Indonesia have yields at record lows.

"Frontier markets like Mongolia offer yield and diversification and so are a good buy," says Ali.

The size of Mongolia’s debut bond is approximately equal to 43% of the country’s debt to GDP ratio, and is about 15% of GDP in absolute terms. Moreover, the deal, the biggest in Asia for more than a decade, is so large that the country does not have the net international foreign exchange reserves to cover it.

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