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; export product; garment producer; garment products; garment quota; export to the United States; Foreign direct investment; Imports
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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.

III. Developments in Trade and Impacts of Eliminating Textile Quotas1

1. With the completion of the phased elimination of import restrictions on textiles and clothing (TC), concerns about impacts on Mongolia’s exports have increased. All remaining quotas under the Multifibre Agreement (MFA) were removed at the beginning of 2005, completing a phased process, which had started in 1995. As the lifting of restrictions under the phased program was backloaded, the consequences for the Mongolian economy are expected to be larger than those at the previous stages of quota elimination.

2. This chapter takes a closer look at how the lifting of MFA restrictions might affect the Mongolian economy. Our analysis mainly focuses on garment exports to the U.S. market, which is the most important destination for Mongolia. Garments have become a major export product over the past several years, accounting for 20 percent of total exports in 2004.2 As Mongolia had quota free access to the market of United States and European Union, Mongolia’s accessibility to these markets remains unchanged after the quota elimination. Relative to other exporters that had been subject to quotas in the major importing countries, however, Mongolia’s competitiveness in garment exporting would tend to be reduced.

3. This chapter concludes that MFA quota elimination is likely to have a significant adverse impact on Mongolian garment exports. In particular, Mongolia’s garment exports to the U.S. market would fall sharply over a relatively short period of time, leaving copper and gold as the only two major export products. Given the large fluctuations of international prices of these two products, promoting other exports would become increasingly important to reduce vulnerability to terms of trade shocks. Section A discusses recent developments in exports, then Section B describes the recent development of the garment sector. Section C discusses the impacts of quota elimination, and Section D lays out the challenges for the external sector. Section E concludes.

A. Background on Mongolia’s Development of Exports

uA02fig01

Mongolia: Export growth and copper price change

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A003

4. Mongolia relies heavily on international trade, but its export base is narrow and commodity-based. Mongolia’s strong commitment to the WTO agreement3 and its open trade regime, with low uniform level of import tariff and a limited number of export taxes, have laid ground for recent strong economic performance. Total trade (exports plus imports) has reached around 130-140 percent of GDP since 2000, which is among the highest in Asia. However, a large proportion of total exports consist of just a few products. Copper, which was developed with substantial assistance and participation of the former Soviet Union, continues to be the most important export product, making Mongolia’s export performance highly vulnerable to copper price fluctuations. Exploitation of the country’s significant gold deposits largely got underway in the early 1990s. Recently, these two products have accounted for more than half of Mongolia’s total export (60 percent in 2004). In addition, garments (including cashmere) have become a major export product—especially, the share of non-cashmere garments in total export reached 11 percent in 2004.

5. In geographical terms, whereas the Soviet Union was the dominant trade partner before the economic transition of 1990s, China has emerged in recent years as a major trading partner. The shares of export and import to China are 48 percent and 25 percent respectively in 2004. Exports to G7 countries, mainly the United States, are also significant, at more than 30 percent of share in recent years. This partly reflects an increase in non-cashmere garment export to the United States. The Russian Federation remains a key trading partner even during the transitional period because of Mongolia’s continued dependence of energy imports from Russia and the joint Mongolian/Russian ownership of the large Erdenet Copper Mine.

uA02fig02

Mongolia: Foreign Exchange Inflows

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A003

6. Despite the narrow export base and commodity price fluctuations, Mongolia’s overall balance of payment has been relatively stable. This performance largely reflected a thriving service sector, a sharp increase in unrequited private transfer (i.e. workers’ remittances), and donor support through loans and grants. Service receipts, mainly in the tourism industry, increased at an average annual growth rate of 25 percent from 1995 to 2004. Workers’ remittances from the increasing numbers of Mongolians living in China, Korea, and the United States have also become important sources of foreign cash inflow.4 Donor assistance has averaged around 16 percent of GDP every year, reaching US$216 million in 2004. Loans are mostly provided by the World Bank, the Asian Development Bank, and Japan with concessional terms, while grants are largely from other bilateral donors. As a result, Mongolia’s level of official foreign reserves increased from 9 weeks of imports in 1996 to 17 weeks in 2002, despite large volatility in copper prices. The settlement of pre-1991 Russian debt resulted in a sharp decline of the reserves to 9 weeks again in 2003, but a boom in copper exports helped the government reconstitute its reserves in 2004.

7. Mongolia’s balance of payments has also been strongly influenced by the developments in the garment sector. As the world’s second largest producer of raw cashmere, cashmere garments initially played a key role in the initial development of the garment sector. Cashmere exports, however, fluctuated due to unsatisfactory government policies together with a series of external shocks such as unfavorable economic conditions during the transition in early 1990s, the Asian crisis in late 1990s, and unstable weather conditions.5 On the other hand, foreign direct investment in the non-cashmere garment sector started in late 1990s, and the industry has since developed into a key export sector, overtaking cashmere, with annual sales on the order of US$100 million.

Table III.1.

Mongolia: Garment Exports

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Source: The Bank of Mongolia and Fund staff estimates.

B. Developments in the Non-Cashmere Garment Sector

8. The expansion of non-cashmere garment exports was led by foreign direct investment by Chinese textile companies. Chinese exports to the United States and the European Union were restricted by garment quotas under the MFA. Since Mongolia had quota free access of its garment export to the United States and the European Union, foreign exporters who were facing restrictive quotas had incentives to locate their production facilities into Mongolia. In addition, Mongolia was in a favorable position compared to other low income countries in Asia as the U.S. and E.U. also put quota restrictions on the import from those countries under the MFA.6

9. Almost all of the approximately 100 companies in the non-cashmere garment sector have benefited from significant foreign investment. China accounts for the largest number (37 percent), followed by Korea (19 percent), Hong Kong SAR (13 percent), and Taiwan Province of China (8 percent)). These companies are taking advantage of the absence of the U.S. quota restrictions on garment imports. In 2003, 98 percent (US$78 million) of Mongolia’s sewn clothing exports and 37 percent (US$ 13 million) of knitted clothing exports were sent to the U.S. market.

10. Non-cashmere garment exports have declined substantially since 2002 with the third and final phase of quota elimination. The MFA quotas were to be phased out progressively over the 10-year period, starting in 1995.7 The integration under the third phase was only 18 percent of WTO members’ garment imports in 1990. Major affected categories were cotton apparel, silk knitted shirts/blouses, and silk trousers/shorts. The export value of these products from Mongolia was halved to US$ 4.3 million in 2002 from US$ 10 million in the previous year. The remaining integration in the final phase, which started at the beginning of 2005, amounted to a maximum of 49 percent.

11. China’s quota utilization rates were high for the major categories in which Mongolia concentrated its exports to the U.S. market. High quota utilization rates generally mean that China’s exports to the quota imposed markets are competitive but restricted. Therefore, Chinese foreign direct investment is likely motivated primarily by quota restrictions on these products.

Table III.2.

Major garment exports from Mongolia and China’s quota utilization rate

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Sources: US-OTEXA, and chinaquota.com

C. Effects of the Final Quota Elimination

12. In the first half of 2005, Mongolian garment exports to the United States declined by 27 percent in value terms, and 37 percent in volume terms compared with a year earlier. Almost all the categories indicate substantial declined, including one showing complete shutdown. These numbers are consistent with reported observations of Chinese investors suspending operations in Mongolia, either temporally or permanently. Conversely, garment exports from China have grown rapidly since the final phase of the quota elimination. The U.S. garment imports from China increased by over 40 percent in volume terms during the first half of 2005, while imports from Mongolia (and one other Asian exporter—Nepal) fell by more than one third. Contrary to initial expectations, garment exports from a number of other Asian producers have also increased.8 For example, Cambodia, where most of garment producers are foreign owned, increased its export to the United States by 15 percent in the first half of 2005.

Table III.3.

Mongolian Garment Exports to the US

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Source: US OTEXANote: The products included in the safeguard are i) cotton knit shirts and blouses (Category 338/339), ii) cotton trousers (Category 347/348), and iii) cotton and manmade fiber underwear (Category 352/652). Mongolia does not export the products in category 352/652.
Figure III.1.
Figure III.1.

Volume and Price Changes of Garment Exports to the United States from Selected Asian Low Income Countries in the First Half of 2005

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A003

13. In light of the surging imports from China, in May 2005 the government of the United States announced its decision to impose safeguard limits on the amount of garments imported of three categories from China. These categories were cotton knit shirts and blouses (category 338/339), cotton trousers (category 347/348), and cotton and man-made fiber underwear (category 352/652). Two of these categories (338/339 and 347/348) represented about 70 percent of Mongolian garment export to the United States. This safeguard action allows exports from China in the three categories to increase by only 7.5 percent annually. The question, therefore, is whether Chinese investors will maintain or even expand their Mongolia operations to escape the current or possible future safeguard actions in foreign markets.

14. Government actions have not successfully arrested the declining garment exports. The government has taken decisions to mitigate the impacts of quota elimination. Two major actions have already been taken: i) halving the level of social security contributions by employers for affected firms, from the current 19 percent of the wage bill, and ii) exempting the import tax on raw materials for garment products. The government also plans to establish a textile industrial park in Ulaanbaatar, and intends to take as-yet unspecified measures to promote diversification in the sector. In addition, the government is trying to obtain a favorable bilateral treatment from the European Union.

D. Challenges for Policymakers

15. Because Mongolia’s garment sector relies heavily on imported raw materials, the net impacts of the sector on the balance of payments and GDP are still relatively small. Almost all of Mongolia’s non-cashmere garment exports are made from imported materials, whose share against the export value is estimated to be more than 70 percent. Therefore, the share of GDP is also very small—perhaps less than 2 percent, and the net impact of trade balance would not be substantial. Given this relatively small sized and current favorable international commodity markets, Mongolia would not face a major balance of payment risk from the decline in garment exports.

16. However, the social and employment impacts could be serious. The number of full-time workers (mostly women) in the non-cashmere garment sector declined to 13,800 as of April 2005 from 18,400 as of April last year due to the closure of factories. The government needs to facilitate the transition of these workers so that they could be absorbed in other sectors, where Mongolia is likely to have a more durable comparative advantage, based on its rich endowments with minerals resources and cashmere. Given that different skills are required even in the cashmere sector, the unemployed workers would need to be provided with necessary training.

17. Continuing efforts are therefore needed to ensure that Mongolia is able to benefit from its areas of comparative advantage and to respond flexibly to changes in the international environment. Development of mineral industries with large reserve potentials continues to be a major engine of economic growth in Mongolia. The exploration has just started. In order to attract foreign direct investment for mineral development, it is critically important to maintain a stable and predictable legal and regulatory framework. The potential of cashmere industry is high, but not fully exploited. A recent study by the World Bank identified a series of shortcomings in the cashmere sectors, including supply distortions, inadequate marketing and distribution systems, and weak public and private institutional capacity to guide the industry’s development.9 A current proposal to impose new export tariffs on low cashmere would not be consistent with Mongolia’s open trade strategies and could introduce additional distortions. The government, therefore, needs to promote market-oriented strategies to support efficient cashmere market development.

18. Mongolia’s large territory, its landlocked position, the small size of the domestic market, and often harsh weather conditions all pose particular challenges for policymakers. Over the medium term, therefore, further investment will be needed to upgrade the country’s infrastructure. Given the large scale and very high cost of such investments, it will be crucial for Mongolia to set coherent investment priorities and to obtain advice and financing for such projects from multilateral and bilateral donors on concessional terms.10

E. Conclusions

19. The impacts of MFA quota elimination on Mongolia are likely to be substantial and greater than in most other Asian countries, calling for strong action to offset the decline. While some of the neighboring Asian countries have managed to increase their garment exports even after the quota elimination, Mongolia’s non-cashmere garment exports have suffered a major decline. In the longer term, Mongolia has very limited rationale for a garment industry reliant on imported raw materials, far from the main market, and with high transport costs. Mongolia therefore needs to lay the foundations for the exploitation of its areas of comparative advantage—such as mineral resources, cashmere, and new areas like tourism—through the maintenance of market-oriented policies to enable the private sector to respond flexibly to changes in the international environment, the careful identification of public investment priorities, and a continued reliance on concessional foreign financing, supported by an open environment for foreign direct investment. The windfall of higher international commodity prices provides only temporary breathing room for Mongolia. It is imperative to make good use of this breathing space to improve a business environment that creates opportunities to invite foreign investors in various industries.

STATISTICAL APPENDIX

Table 1.

Mongolia: Selected Economic and Financial Indicators, 1999–2004

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Sources: Mongolian authorities; and Fund staff estimates and projections.

The outturn for 2003 reflects the impact on fiscal, monetary and external accounts of the $250 million settlement of the TR debt.

Includes IMF loans, guarantees and arrears.

Includes treasury bills outstanding, and gross claims of the BoM on the government.

Calculated based on 5 percent discount rate from 2004 onwards.

Seasonally adjusted figures for broad money velocity.

Annualized yield on end-period auction of 14-day bills.

Includes errors and omissions. From 2004 onwards, revised estimates for remittances in the current account, offset by adjustments mainly in capital account.

Beginning December 2000, includes commercial banks’ foreign exchange deposits with the Bank of Mongolia.

Table 2.

Mongolia: Gross Domestic Product, 1999–2004

(At current prices)

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Sources: National Statistical Office, and Ministry of Finance and Economy.
Table 3.

Mongolia: Gross Domestic Product, 1999–2004

(At 2000 constant prices)

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Sources: National Statistical Office, and Ministry of Finance and Economy.
Table 4.

Mongolia: Output of Major Agricultural Products, 1999–2004

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Sources: National Statistical Office, and Ministry of Finance and Economy.
Table 5.

Mongolia: Output of Basic Industrial and Mining Products, 1999–2004

(In thousands of metric tons, unless otherwise specified)

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Sources: National Statistical Office, and Ministry of Finance and Economy.
Table 6.

Mongolia: Gross Industrial Output at 1995 prices, 1999–2004

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Sources: National Statistical Office, and Ministry of Finance and Economy.

Includes electric and thermal energy.

Table 7.

Mongolia: Coal Mining Sector, 1999–2004

(In thousands of metric tons)

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Sources: National Statistical Office, and Ministry of Finance and Economy.

Consumption by thermal power stations.

Table 8.

Mongolia: Petroleum Imports, 1999–2004

(In thousands of metric tons)

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Sources: National Statistical Office.
Table 9.

Mongolia: Electricity Sector, 1999–2004

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Sources: Ministry of Fuel and Energy.
Table 10.

Mongolia: Employment by Sector, 1999–2004

(Number of employees, in thousands at end of year)

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Sources: National Statistical Office, and Ministry of Finance and Economy.

Excludes foreign employees.

Table 11.

Mongolia: Ulaanbaatar Consumer Prices, 1999-2005 1/

(December 2000 = 100)

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Source: National Statistical Office.

The number of commodities comprising the consumer basket increased from 205 to 239 from December 2000.

Table 12.

Mongolia: Ulaanbaatar Consumer Price Inflation, 1999-2005

(12-month percentage change)

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Source: National Statistical Office.
Table 13.

Mongolia: Retail Prices, 1999–2005

(End of period; in togrogs per kilogram, except where stated)

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Sources: National Statistical Office; and Neft Import Concern.