Mongolia: Staff Report for the 2013 Article IV Consultation—Debt Sustainability Analysis
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
06 Mar 2014
eISBN:
9781475572445
Language:
English
Keywords:
ISCR; CR; expansionary fiscal policy; debt service; investment; Mongolia; debt-service-to-revenue ratio; debt ratio; Non-interest current account deficit; debt-to-revenue ratio; debt-to-exports ratio; Public and publicly-guaranteed external debt; Debt service ratios
Download PDF (448.9 KB)

This 2013 Article IV Consultation highlights economic developments and policies of Mongolia between 2003 and 2013. The resulting balance-of-payments (BOP) pressures have been compounded by negative shocks to foreign direct investment (FDI) and coal exports. The IMF report analyzes that various banking sector vulnerabilities and weaknesses in the business climate need to be addressed to steady the progress of the economy. Launch of new investment law is important to be introduced by the government to improve the business climate and encourage FDI inflows.

Abstract

This 2013 Article IV Consultation highlights economic developments and policies of Mongolia between 2003 and 2013. The resulting balance-of-payments (BOP) pressures have been compounded by negative shocks to foreign direct investment (FDI) and coal exports. The IMF report analyzes that various banking sector vulnerabilities and weaknesses in the business climate need to be addressed to steady the progress of the economy. Launch of new investment law is important to be introduced by the government to improve the business climate and encourage FDI inflows.

This year’s debt sustainability analysis (DSA) concludes that Mongolia faces a moderate risk of debt distress. The DSAs prepared in recent years concluded that Mongolia’s risk of debt distress was low.1 However, the large international bond issuances by the Development Bank of Mongolia (DBM) and the sovereign have pushed up Mongolia’s public and publicly-guaranteed external debt. Moreover, the near and medium-term outlook for the balance of payments has deteriorated owing to negative shocks to FDI and coal exports and expansionary fiscal and monetary policies. As a result, even in a “strong policy scenario,” which is used as the baseline scenario in this DSA and which would require the authorities to tighten policies substantially from the current macroeconomic policy stance, Mongolia’s present value of external debt-to-GDP ratio and debt-service-to-revenue ratio breach the relevant policy-dependent indicative threshold in certain years.2 Some other debt-burden indicators breach the thresholds when standard stress tests are applied. Moreover, debt and debt-burden indicators would be even more unfavorable under an alternative “weak policy scenario,” which assumes a continuation of current expansionary macroeconomic policies. Under this “weak policy scenario,” Mongolia would need to be re-classified to a “high risk of debt distress.”

A. Background

1. This DSA is built on baseline medium-term macroeconomic projections which assume that the authorities tighten policies substantially from the current policy stance. Medium-term prospects remain promising given Mongolia’s large natural resource endowment, but macroeconomic policies are currently on an unsustainable path. Negative shocks to FDI and coal exports are compounding balance of payments (BOP) pressures caused by expansionary fiscal and monetary policies. As a result, central bank reserves have been on a declining path and the exchange rate has depreciated by about 22 percent over the past year. Continuation of current policies could lead to a highly vulnerable situation. The important policy decisions facing the authorities are highlighted by a comparison of a “strong policy scenario” with a “weak policy scenario” (see text table on page 7 and Box 1). The “strong policy scenario” illustrates the substantial tightening of fiscal and monetary policy needed to bring the economy back on a sustainable track. This tightening is not yet in hand and the implications of the continuation of current policies are clearly illustrated in this DSA. Nevertheless, in view of some steps that have recently been taken, the “strong policy scenario” is used as the baseline scenario in this DSA. For instance, the authorities announced plans to reduce spending from the 2013 budget by almost MNT 1 trillion (about 6 percent of GDP) so as to stay within the FSL’s 2 percent of GDP ceiling for the structural fiscal deficit for on-budget fiscal operations. Moreover, the pace of spending by the Development Bank of Mongolia (DBM) will be slowed during the last quarter of 2013. With regard to monetary policy, the Bank of Mongolia is discussing plans to unwind some of the monetary stimulus provided during the first half of 2013.

2. Compared to the previous DSA, public and publicly guaranteed external debt is on a higher path, reflecting for the most part the additional sovereign borrowing contracted at the end of 2012 (Box 2):

  • The face value of public external debt3 is now projected to amount to 51.8 percent of GDP in 2013, up from 30 percent of GDP in the previous DSA. The higher public external debt ratio is mostly accounted for by sovereign borrowing (15 percent of GDP in 2012), foreign borrowing by the BOM (7 percent of GDP over the past 2 years) and the US$-value of GDP being 7 percent lower than projected in the previous DSA.

  • The 18 percentage points of GDP projected decline in the face value of public external debt over the next five years is substantially larger than the 5½ percentage points of GDP decline projected in the previous DSA. This reflects the assumption in the strong policy scenario that underlies this DSA that foreign borrowing will be reduced considerably in view of the sharp rise in Mongolia’s external debt in the past two years and the less benign outlook for frontier emerging market economies’ access to international capital markets.

3. Compared to the previous DSA, the main features of the current macroeconomic framework can be summarized as follows:

  • GDP growth is projected to average 8 percent per annum over the medium term (2013–18), compared to 12 percent in the previous DSA. Projections for the nonmining sector have not changed materially from the previous DSA, while the mining output projections have been adjusted downward, reflecting weakening external demand and updated data on production schedules by major mining companies. Moreover, the second stage of the Oyu Togoi has been postponed, which would also affect mining output over the medium term. As such, mining sector growth is projected to average 12 percent per annum during 2013–18, compared to 20 percent per annum in the previous DSA, and is expected to slow gradually over the long run, with annual average growth decelerating to 3.5 percent. Nonmining growth is projected to decline to 5 percent in 2014 reflecting the tightening of macroeconomic policies in the “strong policy scenario” before recovering gradually to 7 percent over the medium term, averaging about 7.3 percent per annum in 2013–18, a level similar to that of the previous DSA.

  • Inflation is projected to rise above 10 percent by end-2013 and remain there until late 2014 on the back of the ongoing acceleration of credit growth and the exchange rate depreciation of the past year. Over the medium and long term, with monetary tightening and fiscal consolidation, inflation is projected to decelerate to about 5 percent. The trajectory of inflation moderation is similar to the previous DSA.

  • The external current account is expected to remain weak despite the start of production at the Oyu Tolgoi mine and increased exports by the Tavan Tolgoi. The current account deficit in relation to GDP is expected to narrow to about 15 percent in 2018 from 33 percent in 2012, reflecting increased mining exports and reduced mining-related imports largely associated with moderating FDI inflows. This contrasts with the projection of the previous DSA that envisages a current account surplus in 2018.

  • The copper and coal price projections through 2018 are based on the WEO projections as of August 2013. These prices are assumed to remain constant in real terms in the years beyond 2018.

  • The on-budget fiscal operations are assumed to be tightened considerably to observe the FSL starting with the 2014 budget. The off-budget program of public investment projects is assumed to be phased out by the end of 2015. While this would represent a tightening from current policies it represents a loosening from the previous DSA which assumed that the consolidated fiscal deficit would be brought in line with the FSL from 2013.

  • The previous DSA did not foresee the large size of Mongolia’s maiden sovereign bond issuance (15 percent of GDP). Therefore, the spikes in the debt service to exports ratio and debt service to revenue ratio in 2017 and 2022 are new in this DSA. This DSA assumes that the 5-year bond and 10-year bond are rolled over.

  • The authorities have announced that they are working on the issuance of a US$600 million (5½ percent of GDP) Samurai bond. The DSA assumes that this issuance will be completed in 2014.

4. A joint IMF-World Bank mission visited Mongolia in April 2013 to help the authorities improve the process of developing and implementing an effective Medium-Term Debt Management Strategy (MTDS). The mission held a workshop on the MTDS toolkit, aimed at enhancing a common understanding of the design and implementation of an MTDS. The mission delivered presentations on quantification of cost and risk under alternative debt strategies, and the MTDS analytical tool. The workshop was attended by participants from the Ministry of Finance, Ministry of Economic Development and Bank of Mongolia.

5. The current institutional set-up for debt management harbors important weaknesses. An MTDS strategy document for 2012–14 was published by the Ministry of Finance in 2012, following a 2011 baseline MTDS mission by the World Bank. The strategy envisaged developing domestic debt markets and reducing external debt with high market risk. However, the large international bond issuance in late 2012 demonstrated the need to revisit debt management in Mongolia. The debt transaction was undertaken under the leadership of the Ministry of Economic Development with limited reference to the medium-term debt management strategy and insufficient involvement of the Ministry of Finance. This underscores the importance of ensuring that all debt management decisions are taken within the framework of an agreed and published medium-term debt management strategy.

6. While the issuance of international bonds was successful from a market perspective, its size and structure has substantially changed the cost and risk profile of public debt. After the issuance, the share of FX-denominated debt increased to 77 percent and substantial refinancing risks have emerged in 2017 and 2022 (about US$ 1 billion repayment is due in both of these years). Despite strong export receipts, with the economy highly vulnerable to commodity price swings, downside risks are large.

7. Strengthening the capacity for domestic financing could help lower the risk profile of debt, by developing a deeper domestic debt market. Over the last year, the authorities have made progress in increasing the size of the domestic debt market. The auctioning of treasury bills was modernized in late-2012. Since then, the outstanding stock of T-bills has risen by 4 percent of GDP. However, demand for government securities in the primary market is still limited to a few domestic banks and investor appetite for longer-dated government debt is uncertain.

B. Debt Sustainability

External DSA

8. Mongolia’s present value of public and publicly-guaranteed external debt to GDP ratio breaches the relevant policy-dependent indicative threshold through 2014, and the debt service-to-revenue ratio exceeds the threshold in 2017 and 2022.4 Some other debt-burden indicators breach the thresholds when standard stress tests are applied. The main results of the external DSA are as follows:

  • The present value of debt in relation to GDP, exports, and revenue are expected to decline over the 20-year projection period in the strong policy scenario that underlies this DSA (Figure 1, Table 1). During the projection period, the PV of the debt-to-GDP ratio decreases from 43 percent in 2013 to about 17½ percent in 2033. However, it is projected to remain above the indicative threshold of 40 percent through 2014. The PV of the debt-to-exports ratio is projected to decrease from around 96¼ percent in 2013 to 38 percent in 2033 (compared to an indicative threshold of 150 percent). The PV of the debt-to-revenue ratio is expected to decline from 125¼ percent in 2013 to 56¾ percent in 2033, compared to an indicative threshold of 250 percent.

  • The debt service to export ratio and debt service to revenue ratio would be high in 2017 and 2022. The debt service-to-export ratio would remain mostly below 10 percent in the next two decades, but would reach 17¾ percent and 13½ percent in 2017 and 2022, respectively. Similarly, the debt service-to-revenue ratio would largely stay around 10–15 percent, but would breach the indicative threshold of 20 percent in 2017 and 2022.

  • The standard stress tests reveal an important vulnerability to exchange rate and export shocks (Figure 1, Table 2). The standard exchange rate shock causes a prolonged breach of the threshold by the PV of the debt to GDP ratio. The standard export shock causes the PV of the debt-to-exports ratio as well as the two debt service indicators to stay above relevant thresholds. This underscores the importance of restraint in borrowing internationally.

  • The standard “historical scenario” does not seem to represent a relevant comparator. According to the way the historical scenario is set up in the standard DSA template, the relatively low FDI projections for the next few years (13 percent of GDP on average for the next 6 years) are replaced with the relatively high FDI inflows observed on average over the past ten years (21.8 percent of GDP, see Table 3a). As a consequence, in this scenario the need to contract new debt is lower and the external debt-to-GDP ratio rapidly declines to zero.

Table 1:

External Debt Sustainability Framework, Strong Policy Scenario, 2010–2033 1/

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1 + g)]/(1 + g + ρ + gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Figure 1.
Figure 1.

Mongolia: Indicators of Public and Publicly Guaranteed External Debt under Strong Policy Scenario, 2013–2033 1/

Citation: IMF Staff Country Reports 2014, 064; 10.5089/9781475572445.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2023. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a Exports shock
Table 2.

Mongolia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt (Strong Policy Scenario), 2013-2033

(In percent)

article image
article image
Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assumingan offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 3.

Mongolia: Public Sector Debt Sustainability Framework, Strong Policy Scenario, 2010-2033

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and staff estimates and projections.

General government gross debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Public DSA

9. In the strong policy scenario which is used as the baseline in this DSA, the PV of public debt-to-GDP ratio peaks at 58½ percent of GDP in 2013 and then falls gradually over the medium term to 44¾ percent of GDP in 2018 before stabilizing at about 39 percent of GDP over the long run (Table 3). The alternative scenarios and bound tests indicate that the projected paths of debt indicators are sensitive to alternative assumptions (Table 4 and Figure 2). In particular, the scenario in which the primary balance is fixed at the level projected for 2013 illustrates the steadily rising trend of the PV of debt-GDP ratio (from 58½ percent in 2013 to 240 percent in 2033). This underscores the unsustainability of the government’s current fiscal policy and the need to follow the consolidation path laid out in the strong policy scenario. In this regard, it should be noted that the strong policy scenario used as the baseline in this DSA produces broadly the same outcomes as the historical scenario in the public DSA. In a way this illustrates that the strong policy scenario is broadly in line with the average fiscal outcomes in Mongolia over the past 10 years and hence should not be regarded as unachievable.

Table 4.

Mongolia: Sensitivity Analysis for Key Indicators of Public Debt (Strong Policy Scenario) 2013-2033

article image
Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Figure 2.
Figure 2.

Mongolia: Indicators of Public Debt Under Alternative Scenarios (Strong Policy Scenario), 2013–2033 1/

Citation: IMF Staff Country Reports 2014, 064; 10.5089/9781475572445.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2023.2/ Revenues are defined inclusive of grants.

External DSA and Public DSA in a Weak Policy Scenario

10. External and Public DSAs were also ran for the case in which a weak policy scenario is used as the baseline. Under the weak policy scenario, continued expansionary policies would cause reserves to be drained in 2015 together with a sharp depreciation of 30–40 percent from end-2013. Subsequently, a large absorption adjustment is inevitable, with an output loss of 15–20 percent over the medium term compared to the strong policy scenario.

11. Under the weak policy scenario, Mongolia would need to be reclassified to being at “high risk of debt distress.” Figure 1 illustrates that the PV of the debt-to-GDP ratio would generally remain above the indicative threshold of 40 percent throughout the 20-year projection period. Moreover, the PV of debt service to revenue ratio would breach the threshold in 2017 and from 2021 onwards.

C. Authorities’ View

12. The authorities broadly concurred with the overall assessment of the Debt-Sustainability Analysis, but made several important observations. First, they did not rule out another international bond issuance in the next couple of years in addition to the Samurai bond they plan to issue in the near term. They pointed out that the current medium-term fiscal framework envisages additional international bond issuances of up to US$3.5 billion (32 percent of GDP) by 2015. The authorities expected that the approval of the new Investment Law, by creating favorable conditions for FDI inflows, would reduce the need for government borrowing to support growth. As a result, they expected the risk of debt distress to decline over the medium term.

D. Conclusion

In the staffs’ view, Mongolia now faces a moderate risk of debt distress provided a strong policy scenario is implemented. In a weak-policy scenario, which illustrates the risks of a continuation of current policies, vulnerabilities would increase and Mongolia would need to be reclassified to being at a “high risk of debt distress.” The overall medium- to long-term economic outlook is favorable given Mongolia’s large natural resource endowments, but macroeconomic policies have been on an unsustainable path. Even in a “strong policy scenario,” which would require the authorities to tighten policies substantially from the current policy stance, Mongolia’s present value of external debt to GDP ratio breaches the relevant policy-dependent indicative threshold through 2014, and the debt service-to-revenue ratio breaches the indicative threshold in 2017 and 2022. Some other debt-burden indicators breach the thresholds when standard stress tests are applied.

Mongolia: Strong Policy and Weak Policy Scenarios, 2010–18

article image
Sources: Mongolian authorities; and IMF staff calculations.

Includes DBM spending.