Mongolia: Staff Report for the 2015 Article IV Consultation—Debt Sustainability Analysis
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
30 Apr 2015
eISBN:
9781484346341
Language:
English
Keywords:
ISCR; CR; deficit; DBM spending; GDP; authority; DBM governance; swap line; current account; debt service; percent of GDP; Real GDP growth; Government debt management; Debt sustainability analysis; Public and publicly-guaranteed external debt
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Medium- to long-term prospects are promising given Mongolia’s large natural resources.

Abstract

Medium- to long-term prospects are promising given Mongolia’s large natural resources.

A. Background

1. Based on the LIC-DSA framework and a broad coverage of public debt, this DSA concludes that Mongolia faces a high risk of debt distress under the baseline scenario. This DSA assesses public debt, including general government debt, Euro bonds issued by the Development Bank of Mongolia, the drawing of the PBOC swap line by the Bank of Mongolia (BOM), and also borrowing by, and government guarantees for SOEs, which were not included in the previous DSA as such data were not reliably available at the time.3 External public and publicly guaranteed (PPG) debt reached more than 56 percent of GDP by end-2014, and key external debt indicators have breached, or are projected to breach, the relevant indicative thresholds; debt-service ratios spike in various years when external bonds mature, and some of these breaches are significant in magnitude and persist for extended periods under both baseline and stress tests. Public debt stood at 77 percent of GDP, and will stay above the benchmark for almost the entire projection period (2015–2035).4 Total external debt rose to 170 percent of GDP—reflecting, in large part, intercompany lending in the mining sector—undermining the economy’s resilience to external shocks. The elevated debt ratios have also raised market concern—credit rating agencies have downgraded Mongolia’s sovereign rating several times since the issuance of Eurobonds in late 2012 and have maintained a negative outlook, and Mongolia’s sovereign spreads are among the highest of all frontier economies.

2. Debt dynamics have worsened since the 2013 DSA, mainly reflecting a substantial increase in domestic public debt and external PPG debt. The “strong policy scenario” of the 2013 DSA, which envisaged significant fiscal restraint and monetary tightening, did not take place. Instead, the 2014 on-budget deficit reached 4¼ percent of GDP compared to the FSL limit of 2 percent, and off-budget spending by the Development Bank of Mongolia (DBM) amounted to 6¾ percent of GDP, keeping the consolidated fiscal deficit at 11 percent of GDP, similar to 2013. Debt dynamics have deteriorated substantially, reflecting extensive borrowing by the DBM, further drawing of the swap line by BOM, and large amounts of domestic bonds issued close to end-2014 (see table 1). Moreover, exchange rate depreciation caused external debt to increase further relative to GDP. The expansion of public debt coverage to include borrowings by, and government guarantees for, SOEs, raises the reported debt ratio by 8¾ percent of GDP in 2013.5 But the elevated debt risk is mainly attributable to aggressive borrowing rather than this expansion of coverage. On the authorities’ definition—i.e., in NPV terms, and excluding the PBOC swap drawings—public debt amounted to 55 percent of GDP at end-2014, in excess of the FSL’s 40 percent limit.

Table 1.

Mongolia: External Debt Sustainability Framework, Baseline Scenario, 2012–2035 1/

(in percent of GDP, unless otherwise indicated)

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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).

3. The institutional framework of debt management has also been altered. Even the authorities’ estimate—i.e., considering their calculation of debt NPV with the Bank of Mongolia’s swap line excluded—shows public debt amounted to 54.7 percent of GDP at end-2014 and thus far exceeded the 40 percent threshold enshrined in the FSL. Recent amendments to the FSL and a new Debt Management Law narrowed the definition of debt to government debt only by excluding SOE borrowing and government guarantees secured by government securities. This legal framework also laid out a path for bringing the deficit and government debt back to the original limits within a few years. The new laws will thus provide additional room for the government to contract debt and provide guarantees in the near term. Staff does not support the narrowing of public debt coverage, nor the temporary increase of debt ceiling. Staff also explained the need to include all DBM spending and BOM swap line drawing in public debt for the following reasons:

  • DBM spending. All DBM activities should be included in the statistics (revenue, expenditure, deficit, and financing) of general government for Mongolia. This practice reflects the institutional unit approach as stated by international statistical manuals (GFSM 2014, SNA 2008 and BPM6). Although in limited circumstances international statistical manuals allow for commercial or market activities of general government units to be split out, but the current activities undertaken by DBM clearly do not satisfy the requirements.

  • BOM swap. Since this DSA covers the entire public sector, BOM’s liability relating to the swap should be included.

Composition of Public Debt (percent of GDP)

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4. Mongolia’s long-term prospects remain bright, but liquidity risks are high in the near term. The country’s resource wealth is estimated at $1 trillion to $3 trillion, and this is assumed to continue being realized gradually. Mongolia is thus projected to be solvent given the strong projected revenues from mining over the long term. It does, however, face serious liquidity pressures and risks in the short run, before mining exports ramp up. Until then, financing outsized prospective fiscal and BOP deficits will be difficult, and thus policies should be focused to avoid building up excessive debt and manage BOP pressure.

5. The authorities have embarked on policy tightening, but more needs to be done. Part of DBM’s spending has been brought on budget, and the consolidated fiscal deficit is expected to decline this year. The authorities target ambitious deficit reduction (to 5 percent of GDP this year, and 2 percent by 2018, excluding “commercial” DBM spending) but this is not likely to materialize on current policies. (Responding to these concerns, the authorities envisage a government resolution to cut spending administratively, to be backed up by a second supplementary budget later in the year). The BOM has hiked the policy rate twice, slowed the pace of PSP and mortgage lending, and proposed transferring the existing stock of PSP loans to the government’s balance sheet; nonetheless, credit growth is higher than desirable. The authorities have redoubled efforts to reach agreement with investors on large projects and introduced other structural measures to boost exports and reduce imports. Steps have been taken to strengthen the banks and to improve bank supervision and crisis preparedness. Nevertheless, these policy adjustments may not be sufficient to ensure macro-stability. Under the baseline, the consolidated fiscal deficit (including all DBM spending) would decline but remain above the FSL limit (2 percent of GDP). A large BOP financing gap, estimated at about $2 billion over the next three years (discussed below), will be financed at least partly by public borrowing or debt contracted with government guarantees.6

6. Baseline assumptions differ significantly from those in the “strong policy scenario” used in the previous DSA:

  • The previous DSA projected the fiscal deficit to fall below 2 percent of GDP in 2016, while here it drops to 4 percent from 2019.

  • The previous DSA projected a complete phaseout of unconventional monetary easing programs, which helped to bring credit growth down to around 13½ percent, while here some of these programs continue, albeit on a smaller scale, and credit growth is around 16 percent.

  • Reflecting updated information on OT-1 output, mining growth is revised down from an average of 5½ percent to 3½ percent, while nonmineral growth is revised down from 6½ percent to 5½ percent, on account of weakened near-term investor confidence. Given weaker activity, this DSA also revises CPI inflation down from a medium-term average of 7½ percent to 7 percent. The real exchange rate is assumed to remain constant.

  • Finally, while there was no BOP financing gap in the previous DSA, the current BOP envisages a financing gap (relative to zero reserves) of $2 billion mainly because of weaker capital and financial inflows.7 It is assumed that 62 percent of the financing gap will be filled by government borrowing or debt with government guarantees—this ratio is consistent with the share of public external debt in total external debt (excluding intercompany lending). This borrowing also reflects additional borrowing space created by the revised legal framework (the revised FSL and the new DML).

B. Debt Sustainability under Baseline Scenario

7. Debt is not on an ever-increasing path under the baseline scenario. Both external and public debt scaled by GDP would fall after an initial period.8 This reflects promising prospects of the mining sector in outer years and fiscal adjustment measures enshrined in the legal system. Nevertheless, the debt path is sensitive to external shocks. Meanwhile, disputes surrounding OT-2, which is assumed to be addressed by end-2015 under the baseline, add to economic uncertainty. Should it be further delayed, growth prospects would be dampened, fiscal risk would rise, and BOP financing gap could be wider, but the debt path would still trend down slowly. To put the debt trajectory on a more sustainable footing, more needs to be done. Below is a summary of the debt indicators under the baseline scenario:

External DSA

8. Mongolia’s external PPG debt indicators have all breached, or are projected to breach, the thresholds, and will remain above these thresholds, in some cases for a prolonged time. The detailed results are as follows:

  • The present value of external PPG debt reached 57 percent of GDP by end-2014, far above the indicative threshold of 40 percent.9 It is expected to peak at 64½ percent of GDP in 2016, and gradually moderate to below the threshold in 2025 onwards.

  • The present value of external PPG debt would peak at 170½ percent of exports in 2017, and stay above the threshold of 150 percent in about half of the projection period.

  • The present value of external PPG debt in relation to revenue would slightly breach the threshold only in 2016–17. It would peak at 259¼ percent in 2017, and decline steadily, falling to 113 percent in 2035.

  • Debt service indicators, i.e. debt service-to-exports and debt service-to-revenue, would briefly breach the thresholds several times (each time for just one year), including in 2017 and 2022, when the Chinggis bonds mature.

9. Meanwhile, these debt indicators are susceptible to various standard shocks such as a sharp exchange rate depreciation and decline of BOP inflows. Given a one-time 30 percent exchange rate depreciation, the present value of external PPG debt would peak at 89½ percent of GDP in 2017 and stay above the indicative threshold for almost the entire projection period; the present value of external debt-to-revenue would peak at 359 percent and stay above the threshold for seven years; and debt service-to-revenue would peak at 70percent in 2017 and stay above its threshold until 2027. In the case of a one-standard deviation shock to non-debt creating BOP flows, the present value of debt-to-exports would peak at 235¼ percent in 2017 and stay above the threshold through the whole projection period; and debt service-to-exports would breach its threshold in 14 out of the 21-year projection period.

10. The standard “historical scenario”—where key variables follow historical paths and debt ratios thus decline rapidly—does not seem to represent a possible outcome. For example, FDI inflows peaked at more than $4 billion per year in 2011–12, and have since dropped sharply to just $542 million in 2014. Even if OT-2 is launched soon, FDI would likely peak at only $2½ billion in the next few years. By the same token, real GDP growth would also be more moderate in the future barring the investment boom observed in 2011–12.

Public DSA

11. Public ratios would remain elevated across the projection period. The present value of public debt-to-GDP ratio peaks at 95¾ percent of GDP in 2017 and then falls gradually, to 53 percent by end-2035. This ratio has been far above the benchmark (56 percent), and is expected to decline below the benchmark only in 2032 onward. The present value of public debt-to-revenue ratio would peak at just below 400 percent in 2017, and thereafter falls gradually to just above 200 percent in 2035. The debt service-to-revenue ratio would spike several times, peaking in 2017 at 71 percent and hovering around 40 percent in most of the projection period. Debt could rise further if some banks need to be recapitalized, and if this requires fiscal resources.

12. The alternative scenarios and bound tests indicate that the projected paths of debt indicators are sensitive to alternative assumptions. In particular, the scenario in which the primary balance is fixed at the level prevailing in 2014 illustrates a steadily rising trend of debt ratios, underscoring the urgent need for fiscal consolidation.

13. The uncertainty surrounding OT-2 represents an important downside risk, but debt ratios would still decline steadily even if the project were delayed by three years. In this context, the present value of external PPG debt would peak at 70¾ percent of GDP in 2017, and decline thereafter steadily, to 27 percent of GDP at the end of the projection period; meanwhile, the present value of public debt would reach 103 percent of GDP, and then decline consistently, to 53 percent of GDP by 2035. The present value of external PPG debt would stay above its threshold for 10 years, and the most severe shock would cause this ratio to peak at 98¼ percent of GDP in 2017, though it would fall over time, to below the threshold close to the end of the projection period. Spikes of external debt service ratios would be more severe than under the baseline assumption of no delay in OT-2.

C. Debt Sustainability under Policy Adjustment Scenario

14. Macro policies need to be tightened to keep current account deficits at more manageable levels and to improve the fiscal position. One possible adjustment scenario is summarized below:

  • Fiscal. The fiscal path needs to be secured with Parliamentary approval for measures to control spending, both on-budget and off, as part of a coherent, medium-term macro framework. In the adjustment scenario, all DBM spending is brought on-budget and the fiscal deficit would be reduced to 2 percent of GDP in 2017 onward.

  • Monetary. The BOM should cease all unconventional easing programs targeting particular industries or involving direct lending to the private sector, returning to traditional central-banking functions; these programs should, if desired, by conducted by the government, competing with other spending priorities for funds within the budget. The monetary stance should be tightened further, to control credit growth and support the BOP. Credit growth slows to about 12 percent (y/y) in the adjustment scenario.

  • Exchange rate policy. Foreign-exchange intervention should be limited to dealing with episodes of excessive volatility, and the exchange rate should be allowed to move flexibly.

  • Growth and inflation. Given the policy tightening, non-mining growth would initially slow to 1 percent in 2015 and then gradually pick up to 6½ percent over the medium term. Real exchange rate is assumed to depreciate by 4 percent per year in 2015–17 barring BOM intervention. The exchange rate depreciation will have pass-through effects on inflation, which would stay high at 9½ percent in 2015 and gradually moderate to 6½ percent.

  • Balance of payments. Macro policy tightening, lower growth and real exchange rate depreciation will all help compress imports. Current account deficit will decline by about $800 million in the next three years, compared to the baseline. As a consequence, the balance of payments will have no financing gap and FX reserves will stand at 1¾ months of imports by end-2017.

15. Debt dynamics improve significantly under the policy adjustment scenario. The present value of external PPG debt would peak at 63¾ percent of GDP in 2017, and decline to below its threshold in 2023 (compared to 2025 in the baseline). Unlike in the baseline, the present value of debt-to-export and debt-to-revenue will not breach their relevant thresholds under the policy adjustment scenario. Debt service ratios would still breach their thresholds several times, but by a smaller margin than under the baseline. The present value of public debt would peak at 83½ percent of GDP in 2017 (compared to 95¾ percent in the baseline), and falls steadily thereafter, to below the benchmark in 2024 onward.

A03ufig1

Mongolia: PV of Public Debt (Percent of GDP)

Citation: IMF Staff Country Reports 2015, 109; 10.5089/9781484346341.002.A003

D. Authorities’ Views

16. The authorities generally concurred with this assessment, but highlighted a few observations. First, they doubted whether the BOM swap line should be included in the public debt, wondered if this practice is broadly applied, and noted that, as a swap, and not an outright loan, there is a counterpart asset in togrog. They noted that public debt as defined in the FSL does not include the central bank’s debt, and that public debt is calculated in NPV terms. Second, their calculation of public debt in NPV terms differs from staff’s estimate. Third, the budget only includes non-commercial activity of the DBM, while staff include all DBM lending. As a consequence, staff’s estimates of the fiscal deficit and of debt are larger than those presented by the authorities.

E. Conclusion

17. This DSA concludes that Mongolia suffers from high risk of debt distress. In recent years, the authorities have embarked on borrowing to finance rapidly growing budget and off-budget spending. External PPG debt has almost doubled from around 30 percent of GDP to just below 60 percent in the past four years. Public debt stood at below 80 percent of GDP by end-2014, and could further increase given the lax fiscal policy and loosening of borrowing limits offered by the DML. Although debt indicators, mainly external and public debt scaled by GDP, would decline steadily under the baseline, they would remain elevated for prolonged periods.

18. The debt dynamics exhibit a high vulnerability to shocks and bound tests. External PPG debt ratios would rise dramatically in the case of a sharp exchange rate depreciaiton or negative shocks to BOP inflows. Public debt would be on an ever-increasing trajectory should the primary deficit remain at the level prevailing in 2014. Moreover, total external debt, both public and private, has reached about 140 percent of GDP, and this has made the macro-financial stability highly susceptible to exchange rate movements and flucutation of BOP flows.

19. These risks call for immediate policy actions. Although some fiscal adjustment measures have been announced, they are not sufficient to safeguard macro-financial stability and to ensure debt sustainability in case of adverse shocks. Staff suggests more pronounced policy tighening instead. Under a policy adjustment scenario, debt indicators improve significantly—external debt indicators either do not breach their thresholds, or breach them with a smaller margin; public debt as a share of GDP would fall below the benchmark more quickly than under the baseline.

Macroeconomic Assumptions

The baseline scenario assumes the authorities’ current policies, including those proposed under the CMAP framework (but not the latest fiscal cuts that are under consideration). The details are summarized below:

  • Real sector. It is assumed that OT-2 will start construction from late 2015 and begin operation in 2020.

  • Fiscal. The authorities target the fiscal deficit at 5 percent of GDP for 2015, and aim to bring the deficit down to 2 percent of GDP by 2018. However, given certain unrealistic assumptions and the need to reflect all DBM spending in the budget, staff project the fiscal deficit to remain close to 10 percent of GDP in 2015, and gradually to decline to 4 percent of GDP from 2019 onward.

  • Monetary. While the BOM has raised the policy rate twice in recent months and scaled down some monetary easing programs, other unconventional programs have continued and expanded. Given these developments, staff project credit growth at about 16 percent over the medium term.

  • Balance of payments. The current account deficit is projected to average 13½ percent of GDP over the medium term, before OT-2 starts to export mining commodities in 2020. FDI would average about 2½ billion per year on account of OT-2 related investment. In 2017, maturing debt of more than $1½ billion would exert heavy pressure on the BOP. A large financing gap is expected to emerge, and it is assumed that about two-thirds of this gap will be filled by public borrowing.

  • Exchange rate. Staff project a constant real exchange rate, along with declining reserves.

The adjustment scenario instead assumes that: (i) the fiscal deficit, with all DBM spending brought on budget, is brought down to 2 percent of GDP from 2017 onward; (ii) unconventional easing programs at the BOM are transferred to the budget or discontinued altogether, and credit growth drops to 12 percent; (iii) the exchange rate is allowed to move flexibly; and (iv) market rollovers are easier. With these assumptions, BOP financing gaps are closed.

Figure 1.
Figure 1.

Mongolia: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2015–2035 1/

Citation: IMF Staff Country Reports 2015, 109; 10.5089/9781484346341.002.A003

Sources: country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a One-time depreciation shock; in c. to a Non-debt flows shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock
Figure 2.
Figure 2.

Mongolia: Indicators of Public Debt under Alternative Scenarios, 2015–2035 1/

Citation: IMF Staff Country Reports 2015, 109; 10.5089/9781484346341.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025.2/ Revenues are defined inclusive of grants.
Table 2.

Mongolia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012–2035

(in percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Debt data reflects general government debt (including quasi-sovereign bonds issued by DBM) only before 2013, and starts to cover SOE debt from 2013 onwards.

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.

Table 3.

Mongolia: Sensitivity Analysis for Key Indicators of Public Debt, 2015–2035

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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.

Table 4.

Mongolia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2015–2035

(in percent)

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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 assuming an 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.

1

The low-income country debt sustainability framework (LIC DSF) recognizes that better policies and institutions allow countries to manage higher levels of debt, and thus the threshold levels are policy-dependent. Mongolia’s policies and institutions, as measured by the World Bank’s Country Policy and Institutional Assessment (CPIA), place it as a “medium performer”, with an average rating of 3.43 during 2011–13. The relevant indicative thresholds for this category are: 40 percent for the NPV of debt-to-GDP ratio, 150 percent for the NPV of debt-to-exports ratio, 250 percent for the NPV of debt-to-revenue ratio, 20 percent for the debt service-to-exports ratio, and 20 percent for the debt service-to-revenue ratio. These thresholds are applicable to public and publicly guaranteed external debt.

2

This DSA is based on end-2014 debt data. The fiscal year for Mongolia is January–December. The 2013 DSA (see IMF Country Report No. 14/64) was based on end-2013 debt data.

3

The authorities’ definition of public debt excludes the BOM swap line. And debt as defined under the FSL and DML has recently been changed to exclude SOE debt and secured government guarantees. Moreover, the authorities consider debt in NPV, not nominal, terms.

4

The public debt benchmark is derived on an empirical basis, and varies among countries with their respective CPIA score.

5

This broad coverage is in line with the DSA Guidance Note (2013).

6

The financing gap is defined as the shortfall of BOP financing after FX reserves fall to zero. Considering the need to build up FX reserves, the financing needs could be even larger.

7

An important difference is that the current DSA baseline assumes no rollover of the maturing sovereign and quasi-sovereign bonds in 2017, while the previous DSA assumes a full rollover of these debts.

8

Residuals reflect large capital outflows under “currency and deposits” and change of FX reserves.

9

The discount rate is 5 percent, according to the DSA guidelines.

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Cover IMF Staff Country Reports
Mongolia: 2015 Article IV Consultation—Staff Report; Press Release; and Statement by the Executive Director for Mongolia
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2015: Issue 109
Publisher:
International Monetary Fund
ISBN:
9781484346341
ISSN:
1934-7685
Pages:
89
DOI:
https://doi.org/10.5089/9781484346341.002
  • View in gallery

    Mongolia: PV of Public Debt (Percent of GDP)

  • Figure 1.
    View in gallery
    Figure 1.

    Mongolia: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2015–2035 1/

  • Figure 2.
    View in gallery
    Figure 2.

    Mongolia: Indicators of Public Debt under Alternative Scenarios, 2015–2035 1/

Mongolia: PV of Public Debt (Percent of GDP)
Figure 1.

Mongolia: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2015–2035 1/
Figure 2.

Mongolia: Indicators of Public Debt under Alternative Scenarios, 2015–2035 1/