Macroeconomic Outlook

2. Compared to the average 9 percent real growth during 2004–08, this year’s growth has shrunk due to the globally-evolving crisis and the sharp decline in the price of copper. Nonetheless, it is very encouraging that the authorities and staff have agreed that the Mongolian economy is bottoming out and stands ready to recover at a strong pace to above 8 percent next year. A major international agreement for the development of the Oyu Tolgoi (OT) mine in October 2009 has provided meaningful momentum for this recovery, concurrently stimulating significant structural changes in the economy. The role of the mining sector will likely increase with OT mining production starting in 2013, thus the medium-term macroeconomic outlook seems favorable. However, given the policy challenges in the period ahead, the authorities will strive to adopt prudent and premeditated macroeconomic management to maximize the contribution of their mineral wealth into economic success.

3. Double-digit high inflation rate in the recent boom-bust period has dropped sharply and will be stabilized at a stable low level of 2 percent at end-December and below 8 percent at end-2010, compared to staff’s projection of 6 percent at end-2010. The current account balance has considerably improved from -14 percent of GDP last year to around -4 percent this year, owing to the big drop in imports and increasing copper price. Although there will be some deterioration in the current account balance in the near future in relation to OT-related investments and imports, the current account in the medium-term is expected to show large surpluses as OT mining starts production soon while, in the interim, expected short-term deficit could be financed by FDI inflows and private loans.

Program Performance and Objectives Forward

4. As well noted by staff, all performance criteria for the third review were successfully met. The scope of the breach in the indicative target of the government deficit for end-September is minimal enough to be addressed. Related to this, the authorities are confident that the end-December fiscal target will be comfortably observed, given the expected pick-up in mineral revenue in the fourth quarter. Even though there is a modest delay in some structural benchmarks, these are mostly technical matters and, accordingly, the authorities have displayed meaningful progress at the crucial points and are committed to achieving them in due course.

5. The authorities reaffirmed their strong commitment to the policy objectives forward, as well pointed out in their Letter of Intent. Aiming to achieve a strong, sustainable and equitable growth coupled with low inflation and prudent public finances, they place a strong emphasis on crucial reform measures, targeting at strengthening the banking system, restoring health to the budget and maintaining a flexible exchange rate. Given the considerable risks in the years ahead, they will take prompt and decisive actions to cope with imminent problems on one hand, and take forward-looking and productivity-enhancing measures on the other hand.

Fiscal Policy

6. Despite the determined fiscal consolidation undertaken this year, the first priority still remains to make public finance healthier and sustainable. The authorities fully agree with staff that fiscal restraint will be warranted for several years ahead to bring government finance into a sustainable path. Thus, they are committed to sticking to the budget deficit of 6½ percent of GDP for 2009 and 5 percent in 2010. With regard to the gold mining-related loan that was carried out earlier this year, the authorities will try their best to encourage banks to repay their budget for the net lending to the gold mining sector.

7. It is pleasing to note that the authorities’ debt distress level remains low and their debt outlook is expected to recover and improve over the medium term owing to foreseen mineral revenues starting in 2013, despite some increase in debt ratio over the next two years. Staff’s various concerns with respect to the 2010 budget were fully delivered to the authorities, encouraging their cautious and deliberate implementation of the budget. Going forward, the fiscal situation in the near future will deteriorate with the elimination of the windfall profit tax in 2011, as well as the decrease in donor budgetary support. Staff’s well-prepared briefing on the medium-term projection with regard to expected mineral revenues has helped the authorities to fully recognize the importance of fiscal prudence in a consistent manner. In this environment, the authorities reaffirm that any possible revenue shortfall lower than that projected in the budget will be fully compensated by a reduction in spending, while more revenue surplus than the budget forecast will be saved for future needs and for counter-cyclicality purposes. Mindful of staff’s advice on the need for observing fiscal prudence until the time of sustainable mineral revenues, the authorities strongly commit to continue their efforts for fiscal adjustment in 2010 and onwards.

8. From the institutional viewpoint, the authorities will submit to Parliament by end-December a Fiscal Responsibility Law, as well as a complementary organic budget law, with the aim of obtaining approval for them by February 1, 2010. These laws would substantially contribute to promoting fiscal discipline by establishing numerical rules that would effectively control fiscal balance, government debt, and spending growth.

9. A social transfer is another big item for both better assisting the poor and the needy and creating fiscal saving by better targeting. Although there have been some setbacks in the upgrading system thus far, the authorities will soon submit the new social transfer reform law to Parliament in order to achieve the aforementioned goals, aiming at passing the law by February 1, 2010. Given that one major concern for the delay in this reform was institutional weakness in identifying the poor, the authorities will strive to improve their capacity for effective means-testing. In this light, the authorities appreciate the support of donors in preparing this reform, and will stand receptive to the advice from the World Bank and the Asian Development Bank.

Monetary and Exchange Rate Policies

10. The authorities have weathered the turbulent period with well-considered monetary policy–the hike in policy rate earlier this year and the timely and appropriate reduction consistent with market situations–following the Fund’s advice. For the time being, their key objective for monetary policy will remain unchanged at maintaining low inflation and contributing to macroeconomic stability. While closely monitoring the inflation development, the Bank of Mongolia (BOM) will continue to take a vigilant and cautious stance in preserving international reserves and adjusting interest rates, which should be prudent and in line with evolving market conditions. Going forward, for the medium-term goal of introducing an inflation targeting framework, they will invest sufficient efforts to lay the technical foundation step by step, including by improving inflation forecasting and advancing the monetary transmission channel.

11. The authorities fully agree with staff that a flexible exchange rate would be an undisputable factor to relieve terms of trade volatility and prevent higher inflation which would mainly emanate from operation of OT mining in 2013. In light of this, their intervention will focus on smoothing excess volatility caused by temporary imbalances and thus make the exchange rate determined in line with market conditions. They welcome staff’s estimation that the current level of the real exchange rate is broadly in line with fundamentals.

Banking System

12. The authorities are well cognizant that, despite the recent success in addressing the crisis by the help of the program, fragilities in the banking sector respectively and as a whole still remain as the Achilles’ heel to the Mongolian economy, for the time being. The authorities highlight that bolstering the integrity of and confidence in the banking system are one of the key objectives to be achieved at current juncture, so that they are committed to responding proactively and vigorously to deal with problems in individual banks, as they arise.

13. The issue of Anod and Zoos banks has been timely addressed by the authorities’ suitable measures depending on their own situations, such as appointing a receiver and accelerating the liquidating process. In particular, proactive measures are being considered in dealing with Zoos Bank, coupled with an external audit currently underway. On the other hand, the authorities are now striving to prevent the recent deposit outflow at Zoos Bank from happening at the other banks. The injection of public money, which is ensured to restructure the banking system, will be deliberately implemented in a way to improve governance and facilitate structural reforms at the recipient bank.

14. The authorities fully note that the banking system itself still faces challenges, like increasing non-performing assets and deteriorating capital adequacy ratios, along with some concern about the integrity of the current loan provisioning system. In dealing with the latter problem, the authorities intend to increase the effectiveness of such system by clarifying the definition and tightening the relevant rules, as well as by obligating regular reporting. They welcome the well-deliberated discussion with staff on contingency plans in case of additional bank distress, and also continue to strengthen their supervision efforts and to fully enforce all regulatory requirements on hand for all banks. In terms of legal framework, they will redouble their efforts in passing the pending revised Banking Law and continue to seek the options for a robust legal and regulatory system.

Other Issues

15. There has been some reshuffling in the cabinet in late-October after the presidential election in May 2009. The newly-elected Prime Minister clearly delivered his and his administration’s firm political ownership of the Fund’s program during the meeting with the mission team, while commending the Fund for its timely and insightful policy advice in getting out of the crisis. In detail, the authorities are committed to keeping the non-concessional debt within the program ceiling by prudent management and continue to maintain the current prohibition on government guarantees as a disciplinary measure. They also underscored their sustained commitment to resolve the remaining bilateral official arrears within the foreseeable future.

16. As a resource-abundant country, the authorities have made progress in becoming a member of the Extractive Industry Transparency Initiative (EITI). Increased transparency in the mining sector, along with fiscal consolidation efforts, would constitute a conduit for preventing recurrence of the past boom-bust cycle and ultimately contribute to sustainable and stable economy. The government’s free trade and investment policies need to be pursued more rigorously in preparation for the after-crisis period.

Conclusion

17. Given that the authorities are not free from various policy challenges, they continue to maintain a cautious and proactive stance in managing their economic policies. Rather than being complacent with achievements made thus far, they intend to focus on possible threatening matters which they could face during the recovery period, while robustly contemplating on the possible optimal options. The authorities believe that the frequent and close consultations with the Fund on the important policy measures are essential in swiftly stabilizing economy. In this regard, staff deserve the credit for their timely and effective advice on fiscal and banking areas. Spurred by the assistance from the Fund and donors, the authorities stand ready to take additional measures, if necessary, to accomplish the government’s social and economic objectives under the SBA.

18. In conclusion, my Mongolian authorities wish to express their exceptional appreciation to the Fund and its staff for their sustained and appropriate policy advice in resolving the current crisis and further instituting the fundamentals of a sustainable economy. They also extend their deepest gratitude to the Fund’s mission chief, Mr. Steven Barnett, and his team for their hard work and precious advice in setting up Mongolia’s economic reform program.