OREANDA-NEWS. An agreement between the Mongolian government and Rio Tinto to proceed with the phase 2 expansion of the Oyu Tolgoi gold and copper mine would help stabilise the sovereign credit profile from the current Negative Outlook, says Fitch Ratings.

A deal could have potentially transformative effects for the country's external accounts and macroeconomic position, catalysing billions of dollars in new foreign capital inflows, accelerating economic activity, and providing relief to many of the country's key credit constraints.

In turn, this would reinforce Mongolia's favourable development prospects. The potential for rapid growth in per capita incomes is substantial considering the country's mineral and other resource wealth. However, this is dependent on Mongolia being able to successfully attract investment to harness its natural resources.

Fitch maintains Mongolia's sovereign Issuer Default Rating on Negative Outlook, and has specifically highlighted weak external liquidity as one of its principal credit sensitivities. Mongolia's access to external liquidity is heavily dependent on a swap facility with the People's Bank of China (PBOC), and Fitch estimates that - under current trends - the country only has sufficient external liquidity to meet projected requirements for the next two years. Failure to reach an agreement on Oyu Tolgoi risks further undermining the country's economic fundamentals, potentially triggering more serious pressure on external liquidity.

Expansionary fiscal and monetary policy has pushed public debt to an estimated 59% of GDP as of end-2014, exceeding its 'B' rated peers. In turn, a growing reliance on external capital markets in conjunction with a sharp decline in FDI has significantly raised refinancing risks for the sovereign. Sovereign and sovereign-guaranteed entities face a combined USD1.1bn in US dollar bond maturities in FY17 and FY18.

Mongolia's prime minister announced on 5 April that his government had reached an agreement in principle with Rio Tinto to proceed to the second phase of the Oyu Tolgoi, although a formal agreement has yet to be officially confirmed by both sides. The roughly USD5bn phase 2 expansion has been stalled for more than two years owing to disagreements over financing, cost overruns and taxes for the project.