Mongolia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
15 Nov 2005
eISBN:
9781451826883
Language:
English
Keywords:
ISCR; CR; Mongolia; export; loan; revenue; garment export; price; expansion pace; NPL ratio; growth to individual; renewal from borrower; loan renewal; Monetary base; Commercial banks; Bank credit
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This Selected Issues paper and Statistical Appendix presents an overview of the fiscal developments in Mongolia since the late 1990s. It assesses the “quality” of the ongoing fiscal adjustment. The paper examines the dramatic expansion of bank credit to the private sector over the last five years, asking what its sources are and what its consequences may be, particularly for the maintenance of macroeconomic and financial stability. The paper also describes recent developments in the garment sector in Mongolia.

Abstract

This Selected Issues paper and Statistical Appendix presents an overview of the fiscal developments in Mongolia since the late 1990s. It assesses the “quality” of the ongoing fiscal adjustment. The paper examines the dramatic expansion of bank credit to the private sector over the last five years, asking what its sources are and what its consequences may be, particularly for the maintenance of macroeconomic and financial stability. The paper also describes recent developments in the garment sector in Mongolia.

II. Credit Boom in Mongolia1

A. Introduction

1. Bank loan expansion in Mongolia has been dramatic in the last four years.2 As of the end of 2004, loans to private sector reached a level 12 times higher than that at end-2000, representing an average annual increase of 87 percent. As a result, the ratio of bank loans to nominal GDP jumped up from below 5 percent to over 32 percent. The loan expansion in Mongolia can be interpreted as a sign for recovery from the past banking crisis as well as for financial deepening, which would be welcomed from the perspective of financial development and longer-term growth prospects.3

2. However, the rapid expansion of bank loans also raises concerns. In general, an excessive credit from banks tends to entail two types of risks, i.e., macroeconomic imbalances and prudential risks. In Mongolia, the macroeconomic impact of rapid loan expansion has been limited to date although there are risks that it could add to inflationary pressures in the future. From the prudential perspective, the banking sector experienced periods of rapid growth in non-performing loans (NPLs), which led to several banking crises in the 1990s. Taking into consideration the vulnerability of Mongolian economy to the external shocks, the recent pick up in the ratio of NPLs is a matter of some concern.

3. This chapter will discuss several issues in connection with recent credit boom in Mongolia. Section B looks into the credit boom in Mongolia in recent years with descriptions about loans by sectors and borrowers, by durations, and other terms. Section C examines the background factors for the credit boom. Section IV discusses the negative impacts of the boom, from the perspective of banking crisis in the past. The final section concludes the major finding and suggests policy recommendations.

B. Facts about the Recent Credit Boom in Mongolia

4. Loan growth increased sharply in 2001, following the completion of a series of banking sector reforms after repeated banking crises in the 1990s.4 Since the transition in early 1990s, the banking sector had experienced a number of crises and bank failures repeatedly—most notably in 1994, 1996 and 1998/99. Up to 2000, the stock of bank lending had remained in a range of 30-40 billion togrog. Since 2001, however, loan growth has been on a sustained rising trend. This timing of loan expansion coincided with the completion of banking sector reform measures.5 Thus, the Mongolian banking sector followed a transformation phase similar to those in transition countries, which involved a series of transition banking sector reforms—especially writing-off large NPLs to SOEs—and the beginning of more standard banking operations.6

Figure II.1
Figure II.1

Loans and Deposits

(Growth Rate, %)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

5. The pace of bank loan expansion since 2001 has by far exceeded the growth of other macroeconomic and banking system aggregates such as broad money, deposits and nominal GDP. For example, during 2000-04, nominal GDP grew at average 15 percent and, as a consequence, the ratio of bank loans to nominal GDP jumped up to 30.8 percent at end-2004 from 4.5 percent at end-2000. Similarly, the growth rates of broad money and deposits were only half or one third of that of loans.

Table II.1.

Comparison of Monetary Figures with GDP

article image
Source: BOM and Fund staff estimates

6. The acceleration in bank lending in Mongolia exceeds what has been experienced in most of the transition economies (Table II.2). During the 2000–03 period, Mongolia recorded annual credit growth rate of 73.4 percent, second only to Belarus with 74.4 percent. However, whereas nominal GDP in Belarus grew by 58.8 percent during the period, nominal GDP in Mongolia increased by just 10.2 percent. As a consequence, the ratio of bank credit to nominal GDP in Mongolia rose drastically from 8.3 percent in 2000 to 32.5 percent in 2003, while Belarus recorded only a slight increase (from 8.9 percent to 11.7 percent) during the same period.

Table II.2.

Credit Expansions in Transition and CIS Countries

article image
Source: IMF, IFS.

7. Most of the loan growth since 2001 has been for credits to individuals. Table II.3 depicts loans by borrower type. The share of loans to individual rose from less than 20 percent of the total in the late 1990s to 35 percent at end-2004. 7 Correspondingly, there have been declines in the share of the corporate sector, which nevertheless remains high (about 60 percent at end-2004), and in credit to the public sector, which fell from 11 percent of total loans in 2000 to 2 percent in 2004. The decline of the public sector’s share in the credit market may be owing to the privatization of SOEs, and thus the crowding-in is one factor to stimulate loan expansion towards the private sector.8

Table II.3.

Loans by Borrower Type

(Share, %)

article image
Source: BOMNote: Discontinuity between years of 2001 and 2002.

8. By sector, loans to non-industrial sector have led the overall loan expansion. The share of loans to the non-industrial sector rose substantially in recent years, from 49 percent at end-2002 to 57 percent at end-2004. Wholesale and retail trade has been the main sources of the increase, although activities of immovable assets renting business have also increased in importance within the industrial sector. Agricultural and construction sectors increased their shares slightly, while the share of lending to mining and manufacturing fell significantly. These trends reflect in part the slowdown of economic activities in textile and garment industries, the largest manufacturing sector in the country.9 On the other hand, the decline of the mining sector’s weight is linked to the improved financial positions of the companies in the sector as a result of high international prices for the products such as copper and gold. Currently the construction activities are very brisk both for housing and other types of buildings.

Table II.4.

Loans by Industry

(Share, %)

article image
Source: BOM

9. The terms of loans are very short, usually with less than one year.10 As shown in Table II.5, about 80 percent of the loans are under less than one year, while long term loans with maturity of five year or more take only 5 percent among total loans. The short term of loans partly reflects the seasonality of the economic activity in Mongolia. Due to the relatively longer winter season and harsh weather during the winter, the weather-affected economic activities such as those in agricultural and mining sector are conducted just for 5-6 months in a year, while suspending their operations during the winter season, which implies they don’t need to borrow funds during this seasonal lull.11 On the whole, market discipline is underdeveloped so that the borrowers do not have a strong incentive to repay the loans. In this situation, the banks have a tendency to set the terms of loans as short as possible in order to check the borrowers’ intention and ability to repay the loans.12

Table II.5.

Loans by Terms

(Share, %)

article image
Source: BOM

C. Background Factors

10. The momentum of the current credit boom was bred in the period following the banking crisis. In 1999, after a repetition of banking crises, the authorities adopted a comprehensive banking sector reform program with help of international financial institutions including the Fund. The reform measures included, along with improvements of insolvent banks’ balance sheets, privatization of major banks, expanding the regulatory powers of the central bank, strengthening prudential regulations and supervision, strengthening creditors’ rights, and other measures for financial market developments.13 Combined with economic recovery, these measures have been successful in restoring confidence in banking sector. In addition, the banks, which could not have conducted their given role as an intermediary due to huge amount of NPLs and disintermediation, began to revive their normal lending businesses as their balance sheets were cleaned up. The recent credit boom is linked to various factors such as catching-up of loans, economic recovery, a return of confidence in banking sector, strengthened bank balance sheets, a more competitive financial market structure, and inflows of foreign capital.

11. The rapid expansion of bank lending relative to deposits is partly a catching-up from depressed levels during the banking crisis. Looking at the trends of loans-to-deposit ratio as shown below, it dropped from 90 percent in early 1999 to below 40 percent in the latter half of 2000. The precipitous drop of this ratio indicates that, during the crisis, banks were very reluctant to provide new loans. Thereafter, however, the ratio gradually rose back to 90 percent in recent months as the financial markets recovered.

uA01fig01

Loans-to-Deposits

(In percent)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

12. The recovery of economic activities in the industrial and service sectors since 2001 has been another important factor driving loan growth. Up to 2001, the overall economic situation was gloomy because of a series of natural disasters (two severe summer droughts in 1999 and 2000 and two consecutive extremely harsh winters in 2000 and 2001, which led to the considerable losses of animal husbandry). However, the non-agricultural sector already began to recover in 2000. While the overall economic growth was merely 1 percent in both 2000 and 2001, the economic growth with exclusion of agricultural sector recorded 12 and 11 percent, respectively.14 Thereafter the economic growth began to accelerate up to over 10 percent in 2004.

uA01fig02

Economic Growth

(In percent)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

13. There has been a big improvement in the financial market conditions as a result of the authorities’ comprehensive approach to banking sector reform following the 1998/1999 banking crisis. Two major troubled banks were liquidated, three small banks had their licenses revoked and the government decided to privatize three state-owned banks.15 In addition, the authorities tried to upgrade the legal and regulatory framework for the banking system along with downsizing the banks for efficiency and raising the banks’ minimum capital requirement.

14. As a consequence, the banking system began to regain the confidence of the depositors around mid-2000. This can be confirmed by the trends of currency ratio (the ratio of currency to broad money). As shown below, the ratio had risen since mid-1990s up to 2000. The rise of currency ratio in the 1990s implies disintermediation that was affected by the repeated banking crises since 1993, as currency was preferred to deposits at banks. Since mid-2000, however, the trend has reverted to a secular decline, indicating reintermediation and an increased willingness to hold bank deposits and thus providing a base for the banks to increase their loans.

15. As confidence in the banking sector was regained, the banks’ liquidity position improved substantially. The chart that follows depicts the trends of excess reserves of the banks, defined by a difference between required reserves and actual reserve holdings, as in percentage of broad money. While the ratio was negative or small positive figures until mid-2000, the ratio picked up to 2 percent and above since the end of 2000 throughout 2003.

uA01fig03

Currency Ratio

(In percent)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

uA01fig04

Excess Reserves

(In Percent of Broad Money)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

16. The effects of abundant liquidity holdings by the banks were compounded by competitive financial market structures. At the end of 2000, 12 banks operated mainly for traditional loans.16 During 2001, three banks and over 200 Credit and Savings Cooperatives were established.17 Thus, the large number of financial institutions led to fierce competition between bank themselves and/or banks and non-bank financial institutions and to rapid growth in bank loans and deposits. Special factors also contributed to banking system loan growth. The November 2003 conversion of a financial institution from an NBFI to a bank (Chinggis Khaan Bank) contributed almost 10 percentage points to the pickup in the rate of loan growth.

17. From the demand side of loans, the loan expansion reflected the ongoing transition to a market economy, with the privatization of many SoEs and the development of new small retails businesses. In this initial stage of transition, the small shop owners relied on external funds, especially from banks, to supplement the modest resources available from their personal savings, which is supported by the data showing rapid growth in credit to individuals. Another factor contributing to credit boom since 2001 has been the strong capital inflows, including foreign direct investment, official grants, and private remittances. This liquidity from abroad further fueled the upgraded capacity of banks’ intermediation to level up their loans to private sector.

D. Its Impacts

18. Credit booms may increase vulnerability of the economy through various channels.18 The risks associated with credit booms can be broadly grouped into two categories: the emergence or worsening of macroeconomic imbalances—notably rising inflation and a deterioration in the balance of payments—and increasing microeconomic vulnerability due to a deterioration in bank asset quality. The two types of risks are closely intertwined, since the macroeconomic situation affects the bank asset quality while weak bank balance sheets, if they reach systemic proportions, can lead to macroeconomic instability.

Puzzle on Macroeconomic Perspective

19. Although the bank loans, along with deposits, expanded rapidly in recent years, this has not – for the time, at least – resulted in significant macroeconomic instability. While the inflation has been rising since mid-2002, the increase, thus far, has been modest relative to the high growth rate of loans and taking into account that some of the increased inflation has been the direct impact of supply-side price shocks, particularly for meat and petroleum products. Indeed, excluding such factors, the core inflation rate, as calculated by the authorities, has remained at around 8 percent over the past years. In addition, import demand has remained quite stable even after the acceleration of loan expansions. Figure 7 indicates that the ratio of imports (good and services, excluding petroleum) to nominal GDP has been declining since 2000. Furthermore, the major components of imports are not consumer goods, but capital goods for mining and construction sector.

uA01fig05

Inflation

(In percent, year-on-year rate)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

uA01fig06

Imports

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

20. Similar type of puzzles has been found in several transition countries. According to Cottarelli, et al. (2003), the puzzle reflects a financial deepening that will eventually benefit the economy, following a series of structural reforms during the transition period such as privatization, public sector retrenchment, improvements of legislations to protect creditors’ rights, and overall progress towards market institutions. In other words, the credit expansion can be interpreted as a shift of IS curve to the right, instead of LM curve, thus without causing many negative impacts on the economy. 19

21. While core inflation has so far increased only moderately, the credit boom has been evident in some important respects. In particular, construction for housing is booming, house prices are rising sharply, financed, at least in part, by the abundant banking system liquidity and rapid loan growth to individuals.20 As the Mongolian authorities allowed private ownership of real estate such as land and houses beginning in 2000, real estate can be used as collateral for the borrowings from banks (although collateralized lending has, so far, remained small).

22. Moreover, inflation began to gain its acceleration in recent months. While CPI inflation remained 5 percent level for 2-3 years since 2002, recently it picked up to two digit level, for example, 17.6 percent in June 2004. Although the higher international oil prices and reforms of domestic meat distribution pushed up overall consumer prices,21 the core inflation, which excludes meat, milk, and vegetables from the whole CPI basket, has risen up to 8 percent level in the first half of this year. This implies that the recent higher inflation might be pulled, at least in part, by demand factors, including an abundant liquidity formed through loan expansions.

Some Concerns from Prudential Perspective

uA01fig07

NPL Ratio

(In percent of total loans)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

23. The credit boom raises some concerns from a prudential perspective. As a result of successful restructuring following the 1998/1999 banking crisis, the non-performing loans in Mongolian banking sector decreased substantially, with the ratio of NPLs to total loans declining to lower 7 percent level in early 2001. Since then, however, the ratio has been rising. As of end-June 2005, the NPL ratio marked 11 percent, almost two times higher than the level at the beginning of loan expansions in 2001.22

24. By borrower type, the increase of NPLs is led by private business corporations and individuals, who absorb almost 90 percent of total loans. The NPL ratios for loans to private entity rose from 7.0 percent in 2002 to 11.8 percent in 2004. In addition, the ratio for loans to individuals rose by more than two times up to 6.8 percent in 2004 from 3.2 percent in 2002.

Table II.6.

NPL Ratios by Borrower Type

(In percent)

article image
Source: BOM

25. Although most banks have managed to remain adequately capitalized, the high level of NPLs increases the vulnerability of the banking system to adverse shocks, such as deterioration of terms of trade or political uncertainty. Currently the total amount of NPLs is around 76 billion togrog, which is equivalent to 45 percent of total banking sector capital and 63 percent of paid-in capital. Furthermore, for a number of individual banks, the NPLs have eroded, fully in part or in total, their capital base.23 In addition, the high NPLs have cut into the profitability of the banking system. For example, return on asset has declined from around 4 percent in 2000 to 2½ percent in 2004. The lower profitability is another indicator for the higher vulnerability of the banks.

26. Moreover, there are reasons to think that the level of officially report NPLs might understate the actual amount. As noted earlier, most loans are at terms of less than one year, and NPLs will be identified only after the completion of loan period. Accordingly, NPLs that may be in the pipeline from loans extended in 2004 have generally not yet been recorded. In addition, the practice of roll-overs of loans is another factor that makes the NPLs level underestimated. In Mongolia, most loans are revolved almost automatically upon the request of loan renewal from borrowers, without any additional scrutiny about the creditworthiness of the borrowers. This practice brings in a delay in detecting NPLs and gives a basis for the judgment on underestimation of NPLs.

27. The high level of NPLs is also one of factors that have kept the spread between deposit and loan interest rates very high at around 10 percentage points. It can be viewed that the high level of NPLs is one of the major obstacles to preventing the lending rates from declining further. In addition, the high levels of lending rates and NPLs can set in motion a vicious cycle and, potentially, financial instability. Given that the rates of returns on the borrowers’ projects are fixed, the higher lending rates over a certain threshold level lead to a greater probability of defaults by the borrowers, which result in more NPLs and thus more losses. In turn, the banks have to raise the lending rates to cover up the losses from the higher NPLs, but, in the end, causing more NPLs.

uA01fig08

Interest Rates

(In percent per annum)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A002

E. Concluding Remarks

28. The rapid rate of loan expansion in Mongolia during the period 2001-04 seems to reflect, on the whole, a process of financial deepening, increased financial intermediation and catching-up from the low level of bank lending following a series of banking crises in the 1990s. Nevertheless, it is a cause for concern that the still less-developed fragile banking system has accumulated relatively large amount of NPLs in light of current credit boom.

29. Considering the interactions between macroeconomic risks and prudential risks from credit boom and the uptick in the headline (unadjusted) inflation rate need to be given attentions from the policy makers. In the near term, it would be desirable to rein the bank lending through monetary policy measures, which aims at slowdown of loan expansion pace. At the same time, the authority should strengthen prudential supervisions over the financial institutions.

References

  • The Bank of Mongolia (BOM), various years, Loan Report.

  • Cottarelli, Carlo, Giovanni Dell’Ariccia, and Ivanna Vladkova-Hollar, 2003, “Early Birds, Late Risers, and Sleeping Beauties: Bank Credit Growth to the Private Sector in Central Eastern Europe and the Balkans,” IMF Working Paper, WP/03/213, November.

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  • Duenwald, Christoph, Nikolay Gueorguiev, and Andrea Schaecher, 2005, “Too Much of a Good Thing? Credit Booms in Transition Economies: The Cases of Bulgaria, Romania, and Ukraine,” IMF Working Paper, WP/05/128, June.

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  • Fries, Steven, and Anita Taci, 2002, “Banking Reform and Development in Transition Economies,” European Bank for Reconstruction and Development, Working Paper, No. 71.

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  • Gourinchas, Pierre-Olivier, Rodrigo Valdes, and Oscar Landerretche, 2001, “Lending Booms: Latin America and the World,” Economia, Vol 1, no. 2.

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  • IMF, 1999, Mongolia—Enhanced Structural Adjustment Facility—Policy Framework Paper, 1999-2001, EDB/99/67, June 1.

  • IMF, various years, International Financial Statistics.

  • Levine, Ross, 1997, “Financial Development and Economic Growth: Views and Agenda,” Journal of Economic Literature, vol.35, no. 2, pp. 688–726.

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1

This chapter was prepared by Jong Kyu Lee.

2

The loan expansion was led by loans to private sector. Thus two terms, bank loan and loans to private sector, will be sometimes used with each other without any clear definition.

3

Levine (1997) summarizes the relationship between financial development and economic growth.

4

The exact timing of bank loans’ switch to a rising trend is around the fourth quarter of 2000. But the year-on-year rate of growth became apparent in April 2001.

5

Those included, along with restructuring of ailing banks, improvements in banking skills, accounting standards, enforcement of financial contracts, divergence of the government from banking sector (including the divestiture of the government’s ownership in the banks), and participation of foreign capital in the banking industry.

6

For the sequencing of banking developments in transition countries, please refer to Cottarelli, et al. (2003).

7

Similar cases can be found in transition countries such as Bulgaria, Romania and Ukraine (Duenwald, et al. 2005).

8

Crowding-in was also a stylized fact in transition countries (Cottarelli, et al. 2003 and Duenwald, et al. 2005).

9

This was largely owing to the removal of import quota by the US.

10

This is an aspect of Mongolian credit boom quite different from those in other transition countries where the longer-term loans are getting higher shares in the recent credit boom period (please see Duenwald, et al. 2005).

11

As the economy becomes more reliant on the economic activities that are not directly related to weather conditions, for example, services, the terms of loans are getting longer as we can see in Table II.4.

12

In the meantime, the banks lack effective facilities/devices to monitor the borrowers during the loan period.

13

For details, please see IMF (1999).

14

The economic recovery was owing to, in part, rebounded international prices for copper and cashmere, and the government’s boosting, for example, the government provided lowcost loans to selected companies through the state-owned banks.

15

Among those, two banks, Agricultural Bank and TDB (Trade and Development Bank) have already been privatized, but the other, Savings Bank, is still under government’s control.

16

Since then, three more banks were licensed, of which one was permitted only to lend to foreign residents, without being able to receive deposits.

17

In 2002, one more bank entered the loan market by obtaining its license.

18

Of course, the lending boom may not be followed by severe crises, macroeconomic or banking distresses as Gourinchas, et al. (2001) argue. But the reason for looking here into the risks in relation to the recent credit boom is to heighten policy attentions from a conservative perspective.

19

Fries and Taci (2002) also expressed similarly a view that the revival of banking activities in the region was associated with progress in structural and institutional reforms.

20

In Mongolia, the construction builders announce for a plan for housing lots and receive applications from the applicants who want to buy the lot after the completion. At the timing of application, the applicants are required to pay in advance the payments for the lots, with which the builders can begin their construction works. Thus this practice doe not give any financial burdens for the builders to borrow funds from outsiders including banks.

21

Ulaanbaatar city ordered the slaughter houses to move out to suburban areas for health issues in 2004, which resulted in additional cost burdens for meat producers.

22

In this paper, the NPLs include past due loans, while the authority’s official statistics on NPLs excludes past due loans since October 2004.

23

Minimum capital requirement will be raised up to 8 billion togrog in 2006 from the current 4 billion togrog.

Same Series

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Cover IMF Staff Country Reports
Mongolia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 2005: Issue 400
Publisher:
International Monetary Fund
ISBN:
9781451826883
ISSN:
1934-7685
Pages:
81
DOI:
https://doi.org/10.5089/9781451826883.002

Loans and Deposits

(Growth Rate, %)

Loans-to-Deposits

(In percent)

Economic Growth

(In percent)

Currency Ratio

(In percent)

Excess Reserves

(In Percent of Broad Money)

Inflation

(In percent, year-on-year rate)

Imports

(In percent of GDP)

NPL Ratio

(In percent of total loans)

Interest Rates

(In percent per annum)