Recent Economic Developments and Outlook

The economy will start to regain growth momentum after 2017. Mongolia’s economic growth is expected to fall slightly in 2017, before modest growth of 1.8 percent in 2018 and stronger growth of 8.1 percent in 2019, driven by further mining investment. While the authorities broadly agree with staff’s assessment of the outlook, they think there is some larger upside risk to economic growth from the mining sector. Growth in the first quarter of 2017 was 1.3 percent. We agree with staff that agriculture and tourism can potentially play a bigger role in the economy, but Mongolia’s economy will remain heavily dependent on the mining sector with large potential reserves yet to be exploited.

Mongolia is rich in mineral resources including copper, coking coal, gold and other minerals. One of the largest copper and gold mines in the world, Oyu Tolgoi will have a second phase development of $US 6 billion investment and together with the coking coal mine Tavan Tolgoi’s expanded production from 2018 they will contribute significantly to economic growth.

The long-term global copper and gold price outlook is stable. Coking coal market prices have tripled compared to last year, which gives a more positive outlook to near-term economic growth. Higher mineral prices will support a recovery in the trade balance and contribute to a tighter fiscal stance but inflation is expected to remain well within the program target.

A significant contribution to the better near-term and medium-term outlook for Mongolia is that it avoided default on foreign debt. The low level of foreign reserves and short-term bond payments due in 2017, 2018 and 2019 totaling around $US1.2 billion posed a risk that Mongolia could not meet its obligations to international creditors and so default on its foreign debt. However, with the announcement on February 16, 2017 that the authorities and Fund staff had reached an agreement on an Extended Fund Facility program, the Government successfully refinanced $US 580 million of Mongolian Government issued euro bonds maturing on 21st March, 2017. In line with staff’s requirements, Mongolia exchanged 79 percent of the debt with existing bondholders to new 7 year bonds and raised the remaining amount from new private sector investors. Upcoming bond payments scheduled for January 2018 and 2019 will be refinanced from the market.

Fiscal Policy

The Medium Term Fiscal Framework’s primary goals is to stabilize public debt. The Mongolian fiscal deficit was financed primarily by local and foreign borrowings which accumulated in high public debt. Over the last four years the Government borrowed heavily through issuance of domestic bonds. Current debt financing costs equal one fifth of the budget and average coupon rates on treasury notes are around 15 percent annually. As the Government still relies heavily on treasury notes to close the gap from revenue shortfalls, budget support lending from donors will be used towards reducing the public debt and debt financing costs. Frontloading of available liquid funds in the first year of the program could significantly reduce the pressure on the Government to issue treasury notes, reduce financing cost of debt from the budget and may effectively signal to the domestic debt market a lower interest rate period. Authorities are strongly committed to reduce public debt by lowering the fiscal deficit and efficient management of public debt.

The Fiscal deficit is expected to decline significantly. Fiscal expansion and quasi-fiscal activities contributed to a significant expansion of the fiscal deficit over the last four years. The fiscal deficit reached 17 percent of GDP in 2016, including quasi-fiscal activities by the Development Bank of Mongolia (DBM) and the Bank of Mongolia (BOM). The authorities are giving high importance to fiscal consolidation and the removal of quasi-fiscal activities. The Government has already significantly cut fiscal expenditures resulting in a decrease of the fiscal deficit by 7 percent of GDP to 10.4 percent of GDP in 2017. The program target is to reduce the fiscal deficit below 2 percent of GDP by 2021.

The Government has already taken significant steps to achieve this target.

On the expenditure side, the authorities have adopted a policy to move away from universal social spending to a policy more targeted to the most socially vulnerable sectors. This is expected to reduce expenditures by 1.5 percent of GDP over the next three years. Significant cuts are also being made to capital expenditures and in the coming years if budget revenue allows it will be spent on much needed infrastructure.

On 14 April, the Parliament approved a number of politically challenging tax increases despite strong opposition from the public. To alleviate fluctuations in fiscal revenue caused by commodity price cycles, the authorities introduced a set of tax policy measures. These include increasing taxes and excise on petroleum, vehicles, alcohol and tobacco, customs duty on tobacco, introducing a progressive personal income tax, raising social security contributions and eliminating the threshold for withholding tax on interest earned. These measures will bring a stable income stream to the budget. The Government’s implementation of politically difficult and unpopular tax increases demonstrates strong commitment to economic reform and the Fund program.

Monetary and exchange rate policy

Monetary policy will remain appropriately tight to achieve the objective of price stability. The BOM will continue to allow the exchange rate to move flexibly consistent with macro fundamentals and will exploit any opportunities to enhance the level of foreign exchange reserves.

As indicated in the staff report for the 2017 Article IV consultation, BOP projection for 2017 and 2018 are under pressure, due to high level of current account deficit.

However, the recent trend shows that current account balance is recovering quicker than expected, due to a sharp pickup in coal exports, and it is expected to continue through the year. In addition, the Government of Mongolia is eager to start big projects such as Tavantolgoi (coking coal mine) and Gatsuurt (gold mine) in the near future. Thus, the BOP outlook could be better than the projection shown in the staff report for the 2017 Article IV consultation.

Due to previous expansionary monetary policy and quasi-fiscal activities by the BOM, foreign reserves decreased from $US 4.5 billion in 2012 to $US 1.3 billion at end of 2016. To avoid previous mistakes, the adoption of a new Central Bank law to clarify central bank’s mandate, improve independence and most importantly to introduce collective decision making on policy issues will be vital. The proposed new Central Bank law will be submitted to Parliament by November this year and enacted by March next year.

Financial sector policies

Financial sector health check and assessment will be done. Financial sector stability is a cornerstone of future solid economic growth. Bank balance sheets deteriorated rapidly over the last few years. The major reasons were the negative impact of exchange rate devaluations on mostly US dollar denominated loans and the overall slowdown in the economy following the commodity price slump. Current NPL ratio stands at 8.2 percent and further detailed analysis and a complete review need to be done on banks’ health. As one of the prior actions identified in the MEFP, the BOM has launched the procurement procedure to hire an independent, internationally reputable expert company to carry out the AQR in consultation with the IMF staff. The BOM announced the invitation for potential consultant companies to express their interest to carry out the AQR which was opened until April 21, 2017. The selection process of candidates may be completed by late June 2017. Depending on the AQR findings, banks will be required to fix their shortcomings and, most importantly, to recapitalize their capital deficiencies if they are found. Authorities will not intervene unless there is a clear systemic risk to the financial sector.

The Fund and the BOM staff have agreed to adopt an amendment to asset classification and provisioning regulation by end-June, 2017. This regulation was already revised based on the recommendations of a prior IMF Technical assistance mission team and has been implemented since December 2017. The BOM remains committed to implementing the amendments but will delay it until other amendments arising from the AQR are implemented. The BOM is concerned that amending the regulation that was introduced only a few months ago could be disruptive for the banks and affect BOM’s credibility with the banks.

Conclusion

Mongolia has strong long-term economic potential due to its abundant natural resources. The Government of Mongolia has met all the prior actions set out in the program, namely discontinuation of quasi-fiscal activities, passage of the supplementary budget consistent with program targets and starting the procurement procedures for the banking sector AQR. The Government of Mongolia strongly believes that the improving economic outlook and sound macroeconomic policies under the Extended Fund Facility program will deliver positive outcomes and the country’s economy will recover soon. The main challenges will be to put in place policy measures to build a diversified and resilient economy to avoid negative effects of future commodity cycles. Above all, the Government is committed to strict fiscal discipline and stringent monetary policy as key conditions for successful program implementation.

The authorities reaffirm their strong commitment to the policies and objectives under the IMF program.