Macroeconomic Development and Program Performance

2. Spurred by constructive help from donors and the Fund, the Mongolian economy has been put back on a brisk recovery path in a short period, marking a momentous turnaround. The authorities’ growth forecast is expected to be at least 7.5 percent this year (staff’s projection at 8.5 percent) and will clearly bottom out from last year’s negative area (-1.6 percent), with investment in the mining sector and a rebound in copper prices playing a role. Exports are growing rapidly due to the boom in mineral exports, including copper, coal and other minerals, and thus Gross International Reserves have much improved at around 1.6 billion dollars as of end-August from 0.65 billion dollars at end-2008.

3. The main policy challenge now is the risk of overheating and the possible recurrence of the boom-and-bust cycle which happened in the past. This point has been repeatedly discussed and well recognized within the authorities. All the variables which could have an impact on price level, including food prices and higher government wages as well as pensions later this year, will be closely monitored and entail the authorities’ prompt intervention, if deemed necessary.

4. As well noted by staff, all end-June and continuous performance criteria (PC) have been successfully met, with the indicative target of fiscal deficit also met in comfortable margin. One of the important structural benchmark, fiscal responsibility law (FRL), was approved at the parliament with a slight delay, consistent with the recommendation of Fund technical assistance. Another benchmark, the passage of a comprehensive social transfer reform, has not yet been met, but is waiting for approval in the upcoming fall session of parliament, which starts in early October. Despite some delay, the authorities will strive to get parliamentary approval within this session, in pursuit of both a targeted poverty benefit and fiscal saving.

Fiscal Policy

5. The authorities fully recognize staffs recommendation that fiscal restraint is warranted for several years ahead to bring government finance into a sustainable path. It is thus encouraging that the authorities’ projection runs a deficit comfortably below the target in the originally approved budget, as a result of very strong mineral revenues.

6. In fact, the fiscal situation has much improved, mainly due to a surge in fiscal revenues, helped by strong copper prices and the economic recovery, as well as large cash payments in the budget arising from the Oyu Tolgoi investment agreement. However, on the other hand, such fiscal enhancement has produced considerable political and public pressure for higher spending, which has been viewed as a threat to macroeconomic stability at this juncture. With abundant efforts and compromise to balance both economic and political considerations, the 2010 budget has been amended to allow for an increase in spending of 3 percent of GDP. Being well aware of the detrimental impact of repeated boom-bust policies of the past and threatening vulnerability to a downturn in copper price in the future, the authorities are very eager to pursue fiscal prudence and restrain spending to a level that is consistent with macroeconomic stability. Thus, they committed to under-execute the 2010 budget spending to limit actual spending to no more than 2 percent of GDP, following the precedent of the past few years.

7. In the area of structural fiscal reform, a comprehensive fiscal responsibility Law (FRL) has been successfully passed, with a one-week delay compared to the target date of June 15. This is a clear evidence of the authorities’ fiscal prudence commitment in the period ahead, as this legislation can make long-awaiting fiscal discipline be pursued in systemic and legal way. With this law’s comprehensive coverage of all fiscal spending and numerical rules (which start to apply from 2013), the authorities are fully committed to enhancing fiscal credibility and ultimately contributing to macroeconomic stability. The authorities’ effort to modernize the mineral taxation regime and improve tax administration continues to be pursued as standing policy goals.

8. In parallel, another big goal of better assisting the poor and creating fiscal saving by better targeting will be achieved by the passage of social transfer law, which is still pending in Parliament, waiting for approval in the October session. To finalize this reform, the authorities will do their best to secure as much political support as needed to pass the law by hosting more outreach.

Monetary and Exchange Rate Policies

9. The key objective for monetary policy remains unchanged at maintaining low and stable inflation and finally contributing to macroeconomic stability. While being partly sympathetic to staffs call for preemptive rate hike, the authorities strive to see both the evolving inflation risks and burgeoning mitigating factors. They stand vigilant to monitor the inflation pressures and committed to continue to do so, focusing on the possibility of food price-inducing supply shocks. In addition, they are being cautious in assessing whether to adjust interest rates, taking into consideration the strength of both the economic recovery and severity of inflation pressures. Toward the medium-term goal of an inflation targeting framework, the central bank will continue to lay the technical foundation as necessary, including by improving inflation forecasting and advancing monetary transmission channel.

10. The authorities stand fully committed to a flexible exchange rate, given the positive advantage of flexible rates in relieving terms of trade volatility and preventing higher inflation, mainly arising from OT mining income. Their intervention will be limited to smoothing excess volatility caused by temporary imbalances, such as the late-July through August purchase of foreign currency to smooth a seasonal imbalance in foreign exchange market.

Banking System

11. The authorities’ proactive effort needs to be continuously invested in the banking sector, where we see some room for further improvement. It is crystal clear that the authorities remain eager to bolster the integrity of and confidence in the banking system.

12. In terms of banking supervision, a revised banking law passed in January 2010 has worked as the main foundation for prudential requirements, consolidated supervision, and improved resolution framework. Based on this, the authorities have submitted to parliament the Empowering the Banking Sector and Capital Support Program, which is expected to function as a comprehensive restructuring framework. As well explained in box 2 in the staff paper, this program clearly deliberates the main principles and entailing procedural mechanism in maneuvering such restructuring process ahead, including the use of public funds tied to recipient banks’ capital situation. As a complementary step, the authorities are also accelerating the process of setting up bank-by-bank plans, which need to be implemented as soon as the above-mentioned program is passed. In this regard, the authorities will not spare any effort to pass and implement this program, as soon as possible, and finalize bank-by-bank plans in a timely manner.

13. With regard to banking systemic risks, the authorities issued new regulations in August, which aim to increase provisioning standard and tighten the rule of related-party loans. Staffs further recommendation in banking regulation will be fully considered and adopted, tailored to its circumstances. More importantly, through the whole process, the authorities will do their best to proactively respond to newly-burgeoning problems in individuals banks on one hand, and to strengthen the stability of and public confidence in the banking system as a whole on the other.

Conclusion

14. Given the clear policy objective for achieving strong, sustainable, and equitable growth together with low inflation and healthy public finances, the authorities are firmly committed to doing their best in sustaining the economic development as well as maintaining low and stable inflation. The past experiences of boom-bust cycle and current global crisis would function as invaluable alarm for all the relevant authorities not to lose good and timely insight for appropriate policy implementation as well as vigilant monitoring. While being wary of complacency with achievement thus far, the authorities will continue to press ahead with comprehensive reform policy and try to create a more enabling environment in the lead up to economic prosperity.

15. Finally, the Mongolian authorities wish to express their sincere appreciation to the Fund and its staff for their comprehensive and insightful policy advices, which have helped overcome the current crisis and expedited the pending economic reform necessary to achieve their strong, sustainable and equitable growth in the future. Things start with a crisis, but with staff’s help, they finally end with another big leap for a better future. In this regard, the authorities also extend their deepest gratitude to the Fund’s mission chief, Mr. Steven Barnett, and his team, for their devoted work and invaluable advices in sophisticating Mongolia’s economic reform program.