2012 Article IV Consultation and Third Post-Program Monitoring

Mongolia has made impressive progress in developing its economy over the past ten years. Medium-term prospects are promising as mining output is projected to expand by more than 20 percent per annum, on average, over the next five years. However, the prospects for sustained, rapid and inclusive non-mineral growth depend on the implementation of the stability-oriented fiscal framework that has been adopted in the aftermath of the 2008/09 balance of payments (BOP) crisis. This framework was designed to dampen volatility, mitigate risks to economic and financial stability, and strengthen long-term natural resource management. The expansionary fiscal policy of the past year is causing double-digit inflation and BOP pressures. Public spending needs to be reined in, in order not to risk undermining stability and growth prospects, and in view of Mongolia’s vulnerability to a downturn in commodities exports.


Mongolia has made impressive progress in developing its economy over the past ten years. Medium-term prospects are promising as mining output is projected to expand by more than 20 percent per annum, on average, over the next five years. However, the prospects for sustained, rapid and inclusive non-mineral growth depend on the implementation of the stability-oriented fiscal framework that has been adopted in the aftermath of the 2008/09 balance of payments (BOP) crisis. This framework was designed to dampen volatility, mitigate risks to economic and financial stability, and strengthen long-term natural resource management. The expansionary fiscal policy of the past year is causing double-digit inflation and BOP pressures. Public spending needs to be reined in, in order not to risk undermining stability and growth prospects, and in view of Mongolia’s vulnerability to a downturn in commodities exports.

Recent Economic Developments and Outlook

A. Introduction

1. Mongolia has made impressive progress in developing its economy. Spearheaded by the foreign direct investment (FDI)-financed development of the mining sector, growth averaged 8 percent per annum over the past 10 years, among the highest in the region. As a result, per capita GDP increased five-fold, to about US$3,000, and Mongolia gained market access and has become eligible for non-concessional borrowing from the World Bank and Asian Development Bank.

2. But there is scope to improve the track record on poverty reduction and macrostability. Inflation has been higher and more volatile than in regional peers. Despite strong growth and a substantial decline in poverty in 2011, about 30 percent of the population still lives in poverty, unemployment remains high, and inequality is rising (Figure 4).

3. An 18-months Stand-By Arrangement (SBA) was completed in October 2010. The program, which was supported by a SBA with access of 300 percent of quota (SDR 153.3 million), aimed to smooth adjustment to the large terms of trade shock triggered by the onset of the global financial crisis, restore health to the country’s fiscal finances, allow for exchange rate flexibility in line with market conditions, address weaknesses in the banking system, and protect the most vulnerable from the burden of the needed adjustment. In addition, the program outlined a macroeconomic framework to provide the basis for the authorities to approach the broader international community for financial support.

4. Since the end of the program, fiscal discipline has steadily eroded, jeopardizing the stability gains. Government spending has been ramped up—similar to what was observed in the two years leading up to the SBA—contravening recommendations in the 2011 Article IV consultation and the authorities’ own efforts to put in place a new fiscal framework. In line with staff advice, this framework was designed to address the key challenge of medium-term natural resource management, anchored by the 2010 Fiscal Stability Law (FSL), the 2011 Integrated Budget Law (IBL), and the 2012 Social Welfare Law (SWL).1 The direction of the authorities’ other macroeconomic policies during the past year has been broadly in line with staff advice. Monetary policy has been tightened markedly and the authorities have continued to operate a flexible exchange rate regime, albeit with intermittent interventions to limit the togrog’s depreciation.

5. The June Parliamentary elections led to a change in government. The elections were won by the Democratic Party which had been a minority in the previous coalition government with the Mongolia People’s Party until it broke away in January to focus on its campaign. The Democratic Party has formed a coalition government with three smaller parties. Local and presidential elections will be held in November 2012 and June 2013, respectively. A new Bank of Mongolia (BOM) governor was appointed in mid-September.

B. Overheating Pressures Continue amid Decelerating Growth

6. Growth is decelerating from the very rapid pace in 2011. The expansion of the economy slowed to 10 percent during the first nine months of 2012 (y/y), down from 17 percent in 2011. Growth has been buoyed by expanding coal and copper production, the ongoing development of new large mining projects, a relatively mild winter boosting agriculture, and highly expansionary fiscal policy (Table 1, Figure 1).

Table 1.

Mongolia: Selected Economic and Financial Indicators, 2008–13

Nominal GDP (2011): US$8,709 million 1/

Population, end-year (2011): 2.81 million

Per capita GDP (2011): US$3,097 1/

Poverty incidence (2011): 29.8 percent 2/

Quota: SDR 51.1 million

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Sources: Mongolian authorities; and IMF staff projections.

Estimate, based on period average exchange rate.

Based on national poverty headcount index with the Household Socio-Economic Survey 2010-11.

As defined in the Fiscal Stability Law, which uses smoothed instead of actual commodity prices to calculate revenue.

Domestic debt in 2009-2011 includes the Oyu Tolgoi tax prepayment.

Figure 1.
Figure 1.

Mongolia: Macroeconomic Developments

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

7. However, inflation remains high and the BOP is under pressure. Inflation in other Asian countries has decelerated owing to slowing demand and moderating energy and food prices. By contrast, inflation in Mongolia is still around 15 percent, primarily due to rapidly rising government spending. Strong domestic demand is driving up imports of consumption goods, and the resulting BOP pressures are compounded by slowing FDI inflows and decelerating export growth. In recent months, coal exports to China slumped amid China’s overall decelerating imports.

8. Monetary policy has been tightened. Over the past year, in response to inflation rising substantially above the official target of less than 10 percent, the central bank increased its policy rate—by 225 basis points, to 13.25 percent—and reserve requirements—by 700 basis points, to 12 percent. These tightening measures, which coincided with a deceleration of deposit inflows into the banking system, contributed to a marked slowdown in credit growth, from 72 percent in 2011 to 36 percent in September 2012 (year-on-year, Figure 2).

Figure 2.
Figure 2.

Mongolia: Monetary Developments

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

9. But fiscal policy has remained excessively expansionary.

  • The overall fiscal balance worsened by 5⅓ percentage points of GDP in 2011, to a deficit of 4¾ percent of GDP (Table 2). Revenue surged, thanks to VAT and customs duties collected on imports of capital goods for mining sector development. But this was more than offset by a 62 percent increase in government spending.

  • Government spending continued to soar during the first half of 2012. In the six months leading up to the end-June elections, government spending rose by 57 percent (year-on-year) as civil servants’ wages were raised by more than 50 percent, cash handouts were stepped up, and capital expenditures were brought forward. As revenue collection fell short of the ambitious targets, a large domestic financing need arose which was met in part by borrowing about 1½ percent of GDP from the BOM.

Table 2.

Mongolia: Summary Operations of the General Government, 2008–13

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Sources: Ministry of Finance; and IMF staff projections.

10. BOP pressures have mostly been reflected in a decline in Mongolia’s Net International Reserves (NIR). The BOM has intervened intermittently to limit the togrog’s depreciation. Over the past year, the togrog/U.S. dollar exchange rate has depreciated by 7 percent while NIR have declined by a third (US$0.7 billion) to a two-year low of US$1.5 billion. The effect of the BOP pressures on gross international reserves (GIR) has been offset by BOM drawings on the swap line with the central bank of China (US$0.2 billion) and BOM deposit taking from the Development Bank of Mongolia (US$0.4 billion) and commercial banks (US$0.2 billion). Thus, while gross international reserves remains near an all-time high of US$2.6 billion (6.7 months of prospective non-mining imports), the share of borrowed reserves has risen to 43 percent, from 15 percent a year ago.

C. Outlook and Risks

11. The near-term outlook for growth is favorable, but inflation is projected to remain elevated:

  • Notwithstanding a deceleration from last year, growth is projected to remain in double digits in 2012. Rising coal production is expected to boost mineral GDP by 6.8 percent. Non-mineral GDP growth is projected at 12.8 percent, thanks to the ongoing development of the Oyu Tolgoi (OT) copper mine and Tavan Tolgoi (TT) coal mine (Box 1), alongside expansionary fiscal policy.

  • Growth is projected to accelerate in 2013. Mining GDP is set to increase by over half as the massive Oyu Tolgoi copper mining project starts to produce and coal production from the Tavan Tolgoi mine expands further. Non-mining GDP growth is projected at 5½ percent in 2013, supported by government and DBM capital spending.

  • Inflation is projected to remain in double digits throughout 2013. Meat prices, which have a large weight in Mongolia’s CPI basket, are projected to moderate in the coming months. However, the continued strong growth of domestic demand is expected to prevent a rapid decline in inflation (Box 2).

12. The external position is projected to remain under pressure in 2013. Mongolia’s coal export capacity will expand further in 2013, and the start of operations at the Oyu Tolgoi mine should boost copper exports. However, imports will also rise, owing to the DBM’s public investment projects, and the net BOP effect of the start of Oyu Tolgoi operations will be limited in 2013 as the gross export proceeds will mostly be used for repayment of investment costs.

13. Mongolia’s medium-term prospects are promising. The ramp-up of coal and copper production is projected to keep the growth of mineral GDP at over 20 percent per annum, on average, during 2013–17. Activity outside the mining sector is also projected to remain buoyant, although this would need to be supported by continued reforms to strengthen the business climate.

14. However, a number of challenges need to be addressed as the new government embarks on implementing its Action Plan for 2012–16. Importantly, policies need to be set against the continued uncertainties in the global economic outlook. While growth in China appears to have bottomed out, the near-term outlook for global growth offers only a very gradual pickup in activity amid considerable downside risks, in particular with regard to euro-area developments.

Mongolia: Two Large Mining Projects

Exports of copper and coal are set to rise significantly over the medium term:


Copper: Export Volume

(In ths. tons, refined copper equivalent)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Sources: Mongolian authorities; and IMF staff estimates.

Coal: Export Volume

(In ths. tons)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Sources: Mongolian authorities; and IMF staff estimates.
  • The Oyu Tolgoi mine, located in the south near the border with China, will be one of the largest copper and gold mines in the world. The government owns 34 percent of the mine, and the rest is owned by Turquoise Hills Resources (Canada), in which Rio Tinto (UK) has a 51 percent stake. Production is expected to start in early 2013.

  • Tavan Tolgoi, also located in southern Mongolia, is one of the world’s largest untapped coal deposits with estimated reserves of about 6.4 billion tons. Erdenes Tavan Tolgoi LLC, a subsidiary of a 100 percent state-owned enterprise, has the mining license for what is called the eastern block (East Tsankhi) as well as the western block (West Tsankhi). An operating contract with foreign companies for the eastern block was concluded in October 2011. An initial public offering of 20 percent of Erdenes Tavan Tolgoi shares is expected to take place in the first half of 2013. The modalities for developing the western block are under discussion.

Export earnings and fiscal revenue will rise considerably thanks to exports from these mines. Staff projects that export proceeds from these mines could total US$2 billion in 2013, rising to US$7 billion by 2020. Fiscal revenue is projected to grow in tandem, though with some delay, as much of the initial export proceeds from the Oyu Tolgoi mine will be used to repay advance tax payments and a loan used to finance the government’s equity stake. However, by 2018 fiscal mineral revenue is projected to quintuple compared with 2011, and U.S. dollar GDP per capita could triple.

Inflation Dynamics in Mongolia 1/

Inflation in Mongolia is more volatile but less persistent than in other copper-producing countries. The higher volatility may be related to food price volatility and procyclicality in government spending. The relatively low persistence of inflation suggests that a tightening of macroeconomic policies may translate quickly in a deceleration of inflation.

  • Food price volatility is a key driver of inflation volatility. Supply shocks to agriculture, such as the severe winter in 2010–11, can have an important effect on overall inflation. Food items represent about 30 percent of the CPI basket.

  • Underlying inflation, which excludes food prices and administered prices, is more responsive to domestic demand conditions. For instance, there is clear evidence that government wage hikes push up underlying inflation. In addition to the direct impact from the increase in government employees’ income, there is an indirect effect through higher private sector wage demands. Empirical evidence also confirms the role of the output gap, in line with a Phillips-curve relationship.

Mongolia and other copper producers 1/

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Source: IMF staff estimates.

Quarter-on-quarter, seasonally adjusted inflation rate. Mongolia for 2001 to 2011, and other countries for 1995 to 2011.

Volatility is measured with the coefficient of variation.

Persistence is measured by the coefficient from a first order autoregressive process.


Inflation: Contributions to Change

(In percent)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Sources: Mongolian authorities; and IMF staff estimates.

Mongolia: Inflation and Fiscal Spending

(In percent, 4-quarter moving average, year-on-year)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Sources: Mongolian authorities; and IMF staff estimates.
1 Based on Steve Barnett, Julia Bersch and Yasuhisa Ojima, “Inflation Dynamics in Mongolia: Understanding the Roller Coaster,” WP/12/192.

Potential spillovers are significant, affecting export volumes, commodity prices, and FDI inflows. A significant fall in non-oil commodity prices and volumes would have an important impact on the fiscal and external accounts (see the Risk Assessment Matrix). Other key risks refer to a continuation of the overly loose fiscal policy and the possibility of renewed problems in the banking sector, for instance triggered by declining real estate prices.

15. Against this background, it is important to adopt policies that ensure macroeconomic and financial stability and that harness the country’s long-term growth potential. In particular:

  • The laws that have been enacted in recent years to strengthen the fiscal policy framework—Fiscal Stability Law, Integrated Budget Law, and Social Welfare Law—now need to be implemented to ensure that Mongolia’s resource wealth sustains the pace of economic development, and that this results in a generalized improvement in living standards and reduction in poverty.

  • Achievement of the government’s economic objectives will require: (i) an improvement in the efficiency of public investment, to ensure that Mongolia can fund its critical economic and social investments within the existing resource constraints; and (ii) the continued implementation of structural reforms aimed at improving the business climate and private sector productivity (see paragraph 47).

Authorities’ views

16. The authorities broadly agreed with the staff’s assessment of the economic outlook. However, they noted that the recently adopted Government Action Plan 2012–16 (see paragraph 50) aims to reduce inflation to single digits and contain the budget deficit to 2 percent of GDP. They were confident that a seasonal decline in meat prices would bring inflation to single digits going into next year. The authorities emphasized the need to increase investment in infrastructure. They viewed this as essential to facilitate exports, reduce the economy’s reliance on the mining sector, and ease supply-side inflationary pressures, by improving the connections of traders and farmers to markets.

17. The authorities also expressed concern about the elevated downside risks. In view of the uncertain outlook for exports, a working group has recently been established to initiate contingency planning. The group includes senior officials from the Ministry of Finance (MOF), the Ministry of Economic Development (MOED), and the BOM.

Macroeconomic Policy Discussions

18. While the economy’s prospects are promising as mining output is set to expand considerably over the next five years, macroeconomic policies need to be strengthened to mitigate risks to macroeconomic and financial stability. Against this background, discussions centered on: (i) the need to tighten fiscal policy in the near-term to address pressures on the external position and put inflation on a sustained downward trajectory; and (ii) the agenda to upgrade the broader framework for managing macroeconomic policies, the financial system, and long-term natural resource management.

A. Fiscal Policy

19. On current policies, including spending by the DBM, the overall fiscal deficit in 2012 could exceed 9 percent of GDP, up from 4¾ percent of GDP in 2011:

  • The general government budget is projected to record a deficit of more than 5 percent of GDP. Steps announced in the context of the Supplementary 2012 Budget, including hikes in excises on diesel, alcohol and tobacco effected in September and a scaling down of capital spending, will not be enough to offset shortfalls in VAT and customs duties which were due to the 2012 Budget’s extrapolation of favorable revenue trends in 2010 and 2011, which overlooked the deceleration in FDI-financed imports of capital goods in 2012.

  • Off-budget spending by the DBM will add to demand pressures. The international bond issuance earlier in the year has put the bank in a position to spend up to 6 percent of GDP. Some two-thirds of this amount (US$400 million) is expected to be spent by end-2012, including on roads construction in Ulaanbaatar and other cities (US$150 million), railways construction (US$100 million), utility projects (heating, and power and water supplies, US$50 million), urban housing (US$60 million), and industrialization (US$30 million).

20. Unrealistic revenue projections in the 2013 budget and off-budget DBM operations risk undermining stability and growth prospects (Box 3). The 2013 budget sent to Parliament targets a general government deficit of 1.2 percent of GDP in 2013. This is consistent with the FSL’s structural deficit ceiling of 2 percent of GDP. However, revenues are overestimated by as much as 6¾ percent of GDP. In addition, considerable capital spending will be channeled through the DBM. This spending is not included in the budget. It is also not covered by the FSL’s limits on the structural deficit or expenditure growth.

21. Revenue shortfalls will likely force the authorities to compress on-budget spending but off-budget DBM spending could still cause the overheating pressures to persist. In the staff’s baseline projections, revenue shortfalls and limited availability of domestic financing would in the end restrict the growth of on-budget spending to 13 percent in 2013. As a result, the FSL’s structural deficit ceiling would be breached by about 1 percent of GDP. Moreover, overheating pressures could still persist depending on the magnitude of off-budget foreign financed capital spending by the DBM, which is currently projected at 4 percent of GDP. In any case, the integrity and meaningfulness of the FSL would be undermined.

The 2012 and 2013 Budgets and Off-Budget Spending

The 2012 and 2013 budgets include overly optimistic revenue projections:

  • The Supplementary 2012 budget was approved in mid-September. It did not take into account the full extent of the ongoing deceleration of revenue growth. The collection of VAT and customs duties has been particularly weak, in part owing to base effects related to the deceleration of capital goods imports for the OT mining project.

  • The draft 2013 budget was sent to Parliament at end-September. While the budget is based on reasonable assumptions regarding economic growth, it took the unrealistic revenue projections from the Supplementary 2012 budget as a starting point, setting the stage for a potential revenue shortfall of 3 percent of GDP. Moreover, the budget counts on about 2½ percent of GDP in revenue that is predicated on the renegotiation of the 2009 OT investment agreement. The outcome and timing of this renegotiation, and hence the expected additional revenue, are highly uncertain.


Mongolia: Fiscal Spending

(In percent of non-mineral GDP)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Sources: Mongolian authorities; and IMF staff estimates and projections.1/ IMF staff projections.

Overly optimistic revenue projections give the incorrect impression that there is ample room to expand government spending, while still observing the FSL with its 2-percent-of-GDP structural deficit ceiling (see text chart).

The staff’s baseline projections assume that the bulk of the expected revenue shortfalls will be offset by compressing expenditure compared to the budget, particularly in 2013. This is consistent with the government’s intentions (see paragraph 29). The government is looking to borrow from the social security fund through the sale of treasury bonds in the last quarter of 2012 and the modalities for the issuance of treasury bonds in the open market are being finalized. However, financing from domestic treasury bonds will likely prove very expensive, making it likely that the government will instead opt for spending cuts.

Nevertheless, the overall fiscal stance in 2013 could still be more expansionary than in recent years, depending on the magnitude of off-budget foreign financed capital spending by the DBM, which is currently projected at 4 percent of GDP.

Mongolia: Fiscal Indicators, 2008-13

(In percent of non-mineral GDP, unless otherwise indicated)

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Sources: Mongolian authorities; and IMF staff calculations.

22. Recently announced plans for DBM borrowing of up to US$5 billion (50 percent of GDP) over the next few years also raise efficiency concerns. A recent World Bank report notes three key concerns. First, capacity constraints in the construction sector raise doubts about the extent to which the government’s ambitious infrastructure plans can be realized without compromising project quality, appraisal and implementation. Second, because of supply bottlenecks, the price of building materials (e.g., cement) has been rising rapidly. Third, considering the size of the population and the contribution to economic growth, the capital and other growth centers have been receiving a disproportionately low share of infrastructure spending.

23. A clear policy needs to be drawn up to ensure that the DBM can help meet the long-term infrastructure needs of Mongolia in a macro-economically sustainable manner. It is imperative that the government clarify that: (i) there are limits on the aggregate lending of the DBM to ensure alignment with the principles of the FSL, in particular the expenditure growth limit; (ii) the DBM only funds revenue-generating projects; or (iii) if it were to fund social benefit projects, the amount of lending for such projects would be reflected in the state budget and thus be fully covered by the FSL. Experience in other countries shows that without a clear policy there is a risk that the DBM will be used as a non-transparent way to finance non-priority or non-viable infrastructure projects, or to bypass fiscal limits, which ultimately requires costly budget-funded bailouts.

24. Also, the Law on the DBM should be amended to bring it in line with international best practice. Accordingly, the law should clarify that the DBM can only finance viable projects that would generate revenue and achieve cost recovery. The independence and supervision of the DBM and its Board members should be strengthened and the MOF should have a more prominent role in the Board of the DBM. Finally, the DBM’s authority to lend should be constricted by lowering the maximum loan-to-equity ratio to what is common internationally among the better performing development banks.

25. In view of the uncertain external outlook there may be a need for additional measures to safeguard macroeconomic stability over the coming year. Contingency planning could be facilitated by the preparation of a prioritized list of all capital expenditure items in the 2013 budget. The initiation and funding of lower-priority items could be deferred until later in the year, provided revenues are on track and external pressures have eased. The uncertain outlook makes it all the more important to strengthen policy coordination between the MOF and the newly created MOED.

26. Implementation of the SWL should be a priority. The SWL, which was adopted earlier this year, represents a significant step forward in efficiently fighting poverty. It introduces a means-tested benefit that would reach the poorest households and replace the existing costly universal cash transfers. Multilateral donors have provided considerable support to help set up the means-tested benefit system. The government should now move forward and roll out this system.

27. The Debt Sustainability Analysis (DSA) suggests that Mongolia’s risk of debt distress remains low. To take into account the likely extent of external borrowing by the DBM, the staff’s baseline macroeconomic projections assume the issuance of US$500 million in new government-guaranteed international bonds each year for the next five years (Appendix I). Because of the projected strong growth of the economy over this period the ratio of public and publicly guaranteed external debt to GDP would decline by 2 percent of GDP to 24 percent of GDP in 2017. However, the increased rate of debt accumulation would increase Mongolia’s vulnerability to shocks. To limit vulnerability, recourse to non-concessional foreign financing should be limited to commercially viable projects.

28. The establishment of a sovereign wealth fund (SWF) would be an important complement to the FSL’s fiscal policy framework. Staff welcomes the efforts underway to determine the modalities of a SWF that would best fit Mongolia.

Authorities’ views

29. The authorities indicated that they remained committed to the FSL while acknowledging that revenue targets were ambitious. They noted that revenue shortfalls would be largely offset by lower-than-budgeted spending, particularly capital spending. They advised that government wages would not be raised in 2013 following the large increases in 2012. The authorities concurred with the need to prioritize on-budget public investment projects. In this regard, they noted that with the IBL now fully operational, the 2013 budget would only include public investment projects for which feasibility studies have been completed and which are aligned with national development priorities.

30. The authorities confirmed that the main purpose of the DBM is to finance bankable projects. However, the work to identify and develop efficient and bankable projects is mostly still ongoing. In the meantime, the authorities would like to proceed with disbursements for projects even if it is not assured that these will generate an adequate cash flow to service the debt. Over time, DBM funding for non-bankable social benefit projects would decrease.

31. The authorities agreed that the progress made in setting up a system to identify the poorest household should not be lost. At the same time, they indicated that a review would be undertaken of the existing multitude of social welfare programs as well as the Social Welfare Law itself. Subsequently, the government publicly announced the reintroduction of universal child allowances, effective October 20, 2012. The authorities noted that local governments would be responsible for administering social programs from January 1, 2013, using central government funding.

B. Monetary and Exchange Rate Policy

32. While monetary policy has been tightened, inflation remains high and the future course of monetary policy should be set depending on how inflation and fiscal policy evolve. Inflation remains considerably in excess of the BOM’s stated target for 2012 (“inflation in single digits”). Monetary policy has been tightened substantially over the past year, togrog liquidity remains tight, in part owing to ongoing sales of foreign exchange, and meat prices are expected to ease in the coming months. Going forward, there is no scope to loosen monetary policy unless fiscal policy adjusts to conform with the FSL and inflationary pressures abate. Conversely, the monetary authorities will have no choice but to tighten further in case fiscal policy remains expansionary.

33. The BOM’s intention to move to an inflation targeting framework is appropriate (Box 4). In conjunction with a floating exchange rate regime (see below), this would complement and support the countercyclical fiscal policy implied by the FSL. The next steps to strengthen the monetary policy framework would involve the development of the government bond market and an interbank money market.

Strengthening the Monetary Policy Framework1

The authorities’ intention to move to an inflation-targeting regime is appropriate. A cross-country study of commodity-exporting countries in the April 2012 WEO concluded that an inflation-targeting regime with a flexible exchange rate renders a countercyclical fiscal policy such as implied by Mongolia’s FSL more effective. In such a framework, countercyclical fiscal policy would aim to dampen macroeconomic volatility arising from commodity price fluctuations and monetary policy would aim to reduce inflation volatility.

Good progress has been made to facilitate the adoption of inflation targeting:

  • The BOM communicates to the public through its annual Monetary Policy Guideline that the aim of monetary policy is to achieve low and stable inflation. The 2012 Guideline states that inflation will be kept at a single-digit level in 2012 and below 8 percent in 2013–14. Since 2007, the BOM targets the policy rate of seven-day central bank bills (CBBs) which is set at monthly meetings of the monetary policy board whose policy decisions are announced to the public. The BOM has been making good use of IMF technical assistance to strengthen monetary policy operations. As a result, the seven-day CBB rate increasingly converges around the announced policy rate, improving the BOM’s credibility. And the CBB rates are affecting short-term money market rates.

  • A floating exchange rate regime was adopted in the context of the 2008/09 crisis to help absorb external shocks and safeguard international reserves.

  • The FSL provides for a countercyclical fiscal policy. The recent adoption of the IBL and the SWL should serve to reinforce the fiscal policy framework.

But important challenges remain:

  • Government spending in 2012 is set to nearly double from the level in 2010, pushing inflation above the BOM’s target. Much depends on whether the FSL will be effectively adhered to once it becomes fully operational in 2013. For instance, non-revenue generating DBM operations should be fit within the FSL framework (see paragraph 23).

  • The monetary transmission mechanism remains weak and unreliable, as in many other countries at an early stage of financial development (see e.g., WP/10/223 and WP/12/143). Policies and reforms conducive to financial deepening should remedy this over time, including the development of the government bond market (paragraph 46). Meanwhile, macro-prudential policies could be used in part to complement the weak transmission from policy rates to bank credit (paragraph 39).

  • Dollarization, which undermines monetary policy autonomy, remains significant and should be actively discouraged (paragraphs 40–41).

  • The foreign exchange market remains thin and needs to be developed further (paragraph 42). Appropriately tight macroeconomic policies and a deeper foreign exchange market would allow a larger share of the balance of payments pressures to be absorbed through adjustment of the exchange rate (paragraph 34).

1 Prepared by Yasuhisa Ojima (APD) and Jongsoon Shin (OAP).

34. The floating exchange rate regime and auction system should be maintained. Intervention should be limited to smoothing excessive exchange rate volatility without changing the underlying trend in the exchange rate. In the staff’s view, a disproportionate share of the balance of payments pressures over the past year has been absorbed through sales of official reserves. If external pressures continue, this may not be sustainable. To support the external position and exchange rate regime, it is critical to pursue appropriate fiscal and monetary policies, along the lines recommended above, while efforts to deepen the foreign exchange market should continue.

35. International reserves are still adequate for precautionary purposes, even though they are on a downward trajectory. Mongolia’s reserves are adequate for the near term and its obligations to the IMF coming due in the next two years (about SDR 100 million in total or about 6 percent of gross reserves) should be manageable. However, the declining trend in net international reserves—taking into account the swap with China and the deposits taken by the central bank from the DBM and commercial banks—is not sustainable in the longer term, underscoring the need for appropriately tight policies. Mongolia’s outstanding credit to the Fund is projected to fall below the threshold for post-program monitoring (200 percent of quota) by January 2013.


Gross International Reserves

(2011, in percent of GDP)

Citation: IMF Staff Country Reports 2012, 320; 10.5089/9781475581485.002.A001

Source: Assessing Reserve Adequacy (ARA) tool.

36. The real exchange rate is broadly in line with macroeconomic fundamentals (Box 5). However, the exchange rate assessment critically depends on FSL implementation. Mongolia’s recent experience shows that looser fiscal policy would quickly lead to considerable overvaluation.

Authorities’ views

37. The authorities shared the staff’s views regarding monetary policy and reaffirmed their commitment to the floating exchange rate regime. They noted that Mongolia’s foreign exchange market remains shallow and that smoothing operations, around the prevailing trend, are regularly required to prevent lumpy transactions from causing jumps in the exchange rate and disorderly market conditions. The authorities expressed broad satisfaction with the level of gross and net international reserves. They expected the DBM and a commercial bank, which recently raised funds abroad, to sell some of their foreign exchange to the BOM, which would raise the net international reserves (NIR).

C. Financial Sector Issues

38. The BOM has continued to take steps to improve banks’ resilience, amid tightening liquidity (Table 7, Figure 3). The liquidity ratio was raised from 18 to 25 percent, effective January 1, 2012. The five systemically important banks were required to raise their capital adequacy ratios to 14 percent from 12 percent (to be phased in by end-2013).

Table 3.

Statement of Operations and Stock Positions of the General Government, 2009–13

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Sources: Ministry of Finance; and IMF staff projections.
Table 4.

Mongolia: Monetary Aggregates, 2008–13

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Sources: Mongolian authorities; and IMF staff projections.

Evaluated at end-2011 exchange rate for 2012 and 2013.

Previously referred to as net international reserves under program definition. The definition of NIR has been revised in line with the recommendation of the IMF Safeguard Assessment, and does not include commercial bank and development bank of Mongolia foreign currency deposits and foreign currency current accounts held at the Bank of Mongolia. Evaluated at end-2011 exchange rate for 2012 and 2013.

Table 5.

Mongolia: Balance of Payments, 2008–13

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Mongolian authorities; and IMF staff projections.

Including copper, coal, gold and others.

This covers Oyu Tolgoi copper project and Tavan Tolgoi coal project.

Starting in 2009, investment-related grants have been reclassified in the capital account per BPM5.

Table 6.

Mongolia: Selected Economic and Financial Indicators, 2008–17 1/

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Sources: Mongolian authorities; and IMF staff projections.

The medium-term projections are based on the assumption that the Fiscal Stability Law will be adhered to starting from 2014.

Based on period average exchange rate, and population (end of year).

Includes the expected fiscalization cost of bank restructuring, the financing of the government’s equity share in Oyu Tolgoi, and the Oyu Tolgoi tax prepayment.

Table 7.

Mongolia: Financial Soundness Indicators of the Banking Sector

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Sources: Mongolian authorities; and IMF staff estimates.

The FSIs reported for 2010 onwards exclude Anod, Zoos, and Post Bank.

The sectoral distribution of loans is taken from the quarterly loan report of the Bank of Mongolia, based on a survey.

NPL according to the new regulation (introduced in 2004), i.e., past due loans are not included.

NPL according to the old regulation, i.e., past due loans are included.