Mongolia and the IMF

Press Release: IMF Approves US$37 Million PRGF Arrangement for Mongolia

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Mongolia—Letter of Intent, Memorandum of Economic and Financial Policies, Technical Memorandum of Understanding

September 11, 2001

The following item is a Letter of Intent of the government of Mongolia, which describes the policies that Mongolia intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Mongolia, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington DC 20431

Dear Mr. Köhler:

1. The Government of Mongolia has adopted an economic reform program for 2001-04, which aims to maintain macroeconomic stability and increase private sector-led growth as key elements of its poverty reduction strategy. To achieve these objectives, the government is committed to pursuing sound fiscal, monetary, and external sector policies and accelerated structural reforms, with a view to consolidating Mongolia's transition from a centrally-planned to a market-oriented economy. The details of the Government's reform program are set out in the attached Memorandum of Economic and Financial Policies (MEFP) and Interim Poverty Reduction Strategy Paper (I-PRSP). In support of the program, we are requesting a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 28.49 million (56 percent of quota).

2. The Government believes that the policies and measures set forth in the MEFP and I-PRSP are adequate to achieve the objectives of the program, but will take any further measures, in consultation with the IMF staff, which might be necessary for this purpose. The Government will conduct with the Fund the first review of the first-year PRGF-supported program to be completed no later than end-March 2002.

3. The Government will remain in close consultation with the Fund in accordance with the Fund's policies on such consultations and will provide the Fund with any information it requests to monitor economic developments and implementation of policies under the program.

4. To enhance transparency and facilitate wider distribution of the MEFP and I-PRSP, the government of Mongolia has authoritized their publication by the Fund.

Sincerely yours,

/s/
Ch. Ulaan
Minister of Finance
and Economy

    /s/
O. Chuluunbat
Governor
Bank of Mongolia

Mongolia
Memorandum of Economic and Financial Policies for August 2001-July 2002

I. Introduction

1. This memorandum outlines the Government's economic and financial policies for August 2001-July 2002, the first year program under a three-year PRGF arrangement, and the medium-term framework covering the period August 2001-July 2004. This framework is consistent with the Interim Poverty Reduction Strategy Paper (I-PRSP), dated June 28, 2001.

2. Mongolia has made great strides during a decade of transition to a market economy, but it continues to face important challenges. Significant progress has been made in the establishment of a vibrant private sector and the key institutions of macroeconomic management. Market-oriented reforms were accelerated beginning in 1996-97 under a program supported under a PRGF arrangement, and macroeconomic conditions were stabilized despite a large terms of trade shock in 1998. However, economic growth averaged less than 3½ percent a year during the latter part of the 1990s, which was insufficient to make decisive inroads against the country's poverty and left the number of people below the poverty line basically unchanged. Indeed, there are indications that the depth and severity of poverty have increased in recent years, especially in the urban areas, while access to health and education services declined from the levels achieved prior to 1990.

3. On the policy front, the principal challenge is how to make continued progress in the process of transition while also taking prompt steps to redress an unsustainable fiscal situation. With the general government's annual budget deficit averaging about 10 percent of GDP during the second half of the 1990s, the public debt rose to more than 100 percent of GDP by end-1999. While the debt buildup was due in part to extenuating factors, including the need to cover the costs of restructuring a poorly governed and severely undercapitalized banking system, it cannot continue indefinitely. In fact, a lack of adequate financial controls over key areas of the government budget has contributed to a recurrent buildup of arrears on public debt service, pensions, wages, and payments for goods and services. These developments have weakened confidence in government policies and threatened the stability of the banking system. As political support for much-needed adjustments in regulated prices and for privatization began to falter in late 1999, the financial imbalances of the state-run energy authority, coal mines, and the national petroleum company exacerbated the pressures on the budget.

4. With the reform effort flagging, the last PRGF-supported program went off track in the run-up to the general elections in mid-2000. The current government, which took office in August 2000, is strongly committed to reviving the momentum of reform.

II. Recent Developments and Short-Term Prospects

5. Domestic economic performance was mixed in 2000 and prospects for 2001 remain uncertain. The losses of the animal husbandry sector resulting from two consecutive harsh winters (Zud), and from the more recent outbreak of foot-and-mouth disease, have taken a heavy toll on output. An estimated 10 percent of the country's total herd stock was lost during 2000, and the latest projections point to a loss of the same order of magnitude during 2001. While preliminary national accounts estimates point to a resilient performance of the nonagricultural sector, these estimates are subject to a large margin of error. Real GDP growth is estimated to have declined from 3¼ percent in 1999 to about 1 percent in 2000 and is projected to edge up to no more than 1½ percent in 2001. The year-on-year rate of inflation, after having risen to a peak of 15½ percent in mid-2000, fell to 8 percent by December 2000, as a reversal of the earlier increase in meat prices more than offset the effects of increases in water use fees and energy prices. However, inflation accelerated again in early 2001 under the impetus of higher electricity tariffs, and the Zud-related decline in domestic meat supplies, together with recent increases in public wages and pensions, can be expected to exert upward pressure on domestic prices through the first half of the year.

6. The external balance of payments recorded a large surplus during 2000 and short-term prospects remain positive. Export receipts rose briskly in 2000 as international copper prices rebounded and cashmere prices picked up, while imports boomed reflecting the strength of demand in the nonagricultural sector and the need for Zud-relief. Although the current account deficit widened significantly, it was more than covered by increased official grants (largely for Zud relief) and private inflows. Gross official reserves increased by more than $30 million in 2000, rising to a level of $191 million or 14 weeks of imports of goods and services by year-end. Receipts from meat and textile exports were buoyant in the early part of 2001 and import growth moderated, helping to keep the overall balance of payments strong despite a partial reversal of last year's terms of trade gains. Although the outbreak of foot-and-mouth disease has curtailed foreign demand for Mongolian exports of meat and unprocessed animal products, seasonal receipts from cashmere, copper, and gold exports are expected to pick up in the second half of the year, and the pressures on the current account should remain manageable.

7. Fiscal discipline was eroded during the first half of 2000 in the run-up to the parliamentary elections, but the government adopted a supplementary budget in August 2000 to contain the fiscal imbalance. Unrealistic budgeting, together with weak accounting, internal control, and auditing procedures, especially at the local government level, led to substantial expenditure overruns with respect to the initial budget approved in December 1999. These problems were compounded by poor fiscal data quality and weaknesses in fiscal transparency and accountability, which hampered the government's assessment of fiscal policy trends. Following the transfer of some Tog 8 billion from the central government for the payment of local government wages and social security contributions in December 2000, the stock of outstanding local government arrears was contained to Tog 11 billion or 1.1 percent of GDP as of end-2000, while central government arrears more than doubled to Tog 13 billion or 1.2 percent of GDP. The pervasive accumulation of arrears, including by the major public enterprises that are excluded from the fiscal accounts, together with recourse to netting out operations as the principal means to reduce overdue cross debts within the enlarged public sector, have undermined the reliability and analytical content of official data on the general government finances.

8. Revised estimates of fiscal data for 1999 and 2000, using methodology developed with the help of IMF technical assistance, appear to suggest that an unanticipated improvement in revenue performance led to a narrowing of the overall general government deficit from 12 percent of GDP in 1999 to less than 7 percent of GDP in 2000. Receipts from Erdenet rose sharply following the recovery of international copper prices, while the surge in imports, together with the full-year effect of the import duty introduced in mid-1999, bolstered customs duty and excise tax receipts. Although current expenditures exceeded the amended budget target by about 2 percentage points of GDP as fiscal discipline weakened in the wake of the elections, delays in the implementation of foreign-financed capital projects, together with a buildup of arrears, helped keep total spending well below the amended budget target. Reflecting also the repayment by the Bank of Mongolia (BOM) to the treasury of some Tog 4 billion of previously disputed claims, the government's net debt to the domestic banking system declined by Tog 7 billion or 0.7 percent of GDP over the full year, while net foreign financing of the budget was contained to US$59 million or 6½ percent of GDP.

9. Reserve money growth was spurred in late 1999 and early 2000 by the pickup in net international reserves (NIR) as well as a large expansion of net BOM credit to government, but the growth of broader monetary and credit aggregates was temporarily restrained by an apparent shift in the composition of money demand in favor of currency. The year-on-year rate of growth of reserve money peaked at 100 percent in March 2000, before declining to 19½ percent as of end-December, as the earlier increase in BOM credit to government was largely reversed. Broad money growth declined from a peak of 48 percent in March 2000 to 17½ percent by year-end. The yield on BOM bills rose broadly in line with the rate of inflation through the first nine months of 2000, as the placement of bills was gradually stepped up to moderate the increase in excess bank liquidity.

10. Monetary and credit conditions were considerably eased beginning in the fourth quarter of 2000. While the amount of bills sold at auction became insufficient to absorb the liquidity generated by the balance of payments surplus, an apparent rebalancing of money holdings in favor of bank deposits led to increasing intermediation and a rise in the money multiplier. Real BOM bill rates fell sharply beginning in October 2000, and remained mostly negative through the first quarter of 2001. The consequent buildup in excess bank reserves, together with improved confidence stemming from the strengthening of provisions in bank legislation to facilitate loan recovery, led to a sharp pickup in credit growth, with the year-on-year rate of growth of credit to the private sector peaking at more than 100 percent in


June 2001. Since then, however, the BOM has taken decisive steps to increase the placement of BOM bills, including by allowing the cut-off rates to rise towards positive levels in real terms.

11. The BOM has continued to pursue a flexible exchange rate policy, making recourse to intervention primarily to avoid excessive fluctuations in the exchange rate, especially during a period of unusually strong seasonal inflows in early 2000. The value of the togrog, after having temporarily appreciated relative to the U.S. dollar in the early months of 2000, moved in a relatively narrow range thereafter. The togrog depreciated by a cumulative 2¼ percent vis-à-vis the U.S. dollar during 2000, before leveling off at a rate of Tog 1,090-1,100 per U.S. dollar during the first seven months of 2001.

III. Objectives and Policies for 2001-04

A. Overall Strategy and Macroeconomic Framework

12. The government's macroeconomic policies have been developed in the context of a medium-term framework aimed at supporting more rapid, private-sector led growth and poverty reduction. The three-year PRGF-supported program will aim to create a stable macroeconomic environment conducive to higher private investment, with a view to gradually raising the annual rate of GDP growth to 4-6 percent over the program period, while reducing the rate of inflation to the low single-digit range. The external current account deficit will be targeted to be restrained to about 6 percent of GDP by 2004. This should serve to ensure that the external debt service burden remains manageable, while helping to raise the import cover of gross reserves to 16-17 weeks of imports.

13. The government's structural reform program will be guided by the need to strengthen the institutions of macroeconomic management, while also creating an enabling environment for private sector development. In the fiscal area, the highest priority will be given to reforms to improve transparency, accountability, and enforcement mechanisms in budget implementation and to ensure a more efficient allocation of public expenditure. Banking sector reforms will aim to consolidate the shift to a market-oriented system of indirect monetary management, including through measures to strengthen bank supervision and accelerate the privatization of state-owned banks. Efforts will also be stepped up to reform and privatize nonfinancial public enterprises, establish a sound legal and regulatory framework, and maintain an open trade and investment system, including in the strategic energy sector, so as to enhance opportunities and incentives for private participation in infrastructure projects and limit reliance on debt-creating capital inflows.

B. Budgetary Policy and Reforms to Strengthen Fiscal Governance

14. A stable macroeconomic environment, underpinned by a sustainable fiscal position and greater fiscal transparency and accountability, will be key to the achievement of the government's macroeconomic and poverty reduction objectives as articulated in the I-PRSP. The approved general government budget for 2001 aimed to build on the recent improvement in the fiscal position by containing the general government deficit to 7¼ percent of GDP in 2001 and reducing it to around 6 percent by 2004. This should lead to a reduction of the public debt-to-GDP ratio from about 96½ percent in 2000 to 94 percent by 2004.

15. Fiscal adjustment is to be centered primarily on enhanced revenue mobilization during 2001, but policies will be subsequently reoriented to bring about an enduring reduction in the expenditure ratio, including through reforms to strengthen the budgetary process, curtail unproductive public expenditures, and enhance the pro-poor orientation of social programs. As a first step, the initial budget for 2001 introduced a substantial package of measures to bolster the revenue-to-GDP ratio. With effect from January 1, 2001, the VAT rate was raised from 13 percent to 15 percent; a temporary, one-year customs duty surcharge was applied at a flat rate of 2 percent; an excise tax on imported beer was introduced at a rate of 20 cents per liter; the excises on cigarettes, wine, and tobacco were increased by 50 percent; and new taxes were introduced on real estate and on the livestock sector. The government remains committed to avoiding recourse to tax measures that would distort investment, trade, or production incentives. Accordingly, customs duty rates or taxes on exports of unprocessed agricultural products will not be increased to protect national industries nor will tax exemptions or other tax incentives be extended.

16. On the expenditure side, the initial 2001 budget envisaged a containment of current spending to 28 percent of GDP. Despite the large increases in domestic energy prices introduced in late 2000, expenditures on goods and services were budgeted to decrease by almost 1 percent of GDP in 2001. In addition, the public wage bill was to be reduced in relation to GDP through a prudent wage policy. The cumulative increase in public wages was envisaged to be limited to 7 percent during 2001, except in the health sector where the budgeted increase was 14 percent. These increases were to be implemented in a phased manner, with the first installment (8 percent in the health sector and 4 percent in all other sectors) to take effect in April and the second (6 percent and 3 percent, respectively) in October. The budget envisaged an increase of 7 percent in pensions during 2001, to be phased in the same manner as public wages in the nonhealth sector.

17. The key macroeconomic assumptions underlying the initial 2001 budget framework changed significantly following the onset of harsh winter conditions for a second year in a row, which threatened the attainment of the poverty reduction objectives established in the government's I-PRSP. This led to the preparation and submission to Parliament of an amended budget in mid-2001. The amended budget includes more updated projections on revenues and foreign financing, together with increased provisions for selected social programs, without significantly altering the overall deficit. On the assumption that program loan disbursements rise to US$22½ million during 2001, the amended budget targets a net repayment of government debt to the banking system on the order of Tog 7 billion or 0.6 percent of GDP. If program loan disbursements are higher (lower), the reduction of net bank credit to government will be correspondingly higher (lower).

18. Consistent with the I-PRSP's objectives, the amended budget allocates Tog 3½ billion for Zud relief and for the government's livestock vaccination program, while also providing for new expenditures to mitigate the social impact of the measures introduced in the context of the government's energy sector reform program. In line with the agreement reached with the World Bank, the budget assumes responsibility for the payment of Tog 5 billion of subsidies previously provided by the Energy Authority to provincial (aimag) diesel stations. Another Tog 4 billion is to be provided during 2001 to make up for underestimates for fuel and drug expenses in the initial budget, as well as to cover the higher-than-expected public utility bills of budgetary entities resulting from the fact that the structure of tariff adjustments enacted in December 2000 had a somewhat higher inflationary impact than envisaged in the initial budget. An additional Tog 4½ billion is earmarked for the repayment of budget entities' arrears during 2001.

19. To enhance the pro-poor orientation of wage and pension policies, the amended budget provides somewhat higher than initially budgeted increases for selected categories of civil servants and pensioners, while restraining the government's overall wage bill to Tog 86½ billion (7½ percent of GDP) and the pension bill to Tog 60½ billion (5¼ percent of GDP). The wage increases are being introduced in two stages. In the first stage, which took effect on April 15, 2001, about 53,500 civil servants belonging to the lowest-paid administrative category received raises ranging from 3½ to 10 percent, depending on their grade. In addition, some 34,000 employees of hospitals, schools and cultural centers run by aimag governments and municipalities (soums) were granted supplementary salary allowances ranging from 8-20 percent of their salary, with a view to strengthening their incentives to serve in the poorest, remote regions. Altogether, about 77,500 civil servants accounting for 57 percent of public employment were covered by the April wage increases, with an estimated 10,000 benefiting from both schemes. In the second stage, which is to begin in October, the remaining civil servants will receive raises of Tog 3,000 a month (7½ percent to 9.7 percent) if their monthly salary is lower than or equal to Tog 40,000, or Tog 2,500 (3.2-6.3 percent) if their salary exceeds Tog 40,000, as stipulated in a government decree issued following the approval of the amended budget. Pensions were raised by 4½ percent to 10½ percent in April, with the largest increase applying to low-income pensioners receiving up to Tog 17,700 a month. The minimum monthly pension is to increase by another 7.2 percent in October--to a level of Tog 18,850--thus keeping it in line with the anticipated increase in the minimum wage as stipulated in the existing indexation mechanism.

20. The full-year effect of the increases in salaries and pensions is projected to raise the government's wage bill to Tog 89½ billion (7.1 percent of GDP) and the pension bill to Tog 65 billion (5.1 percent of GDP) in 2002. Consistent with the objective of fiscal sustainability, the wage bill has been targeted to decline towards a level of 6½ percent of GDP over the medium-term, so as to reverse a part of the sharp increase recorded in the late-1990s. As a first step, the wage bill during 2002 will be capped at the level of Tog 90 billion by allowing for no wage increases beyond the full-year effect of the increases being granted in 2001, except to the extent that these are compensated by adequate cuts in other current outlays. The scope for additional wage increases will be revisited in the context of the 2002 budget exercise, if the government has in the meantime agreed to generate offsetting savings through clearly identified cuts in public employment and/or nonwage expenditures, including through social safety net reform, in line with the recommendations of the World Bank's Public Expenditure Review (PER) (see below).

21. To prevent slippages in budget implementation, the amended budget has set aside Tog 8 billion (0.7 percent of GDP) of expenditures as a reserve to be used for contingencies, while receipts from privatization have been estimated conservatively. If there are no unanticipated pressures on expenditures, the reserved funds will be used exclusively to bring about a faster-than-targeted reduction of arrears. However, in the event that international copper prices and receipts from Erdenet are lower than projected, the reserve fund will be reduced commensurately. In addition, the Ministry of Finance and Economy (MOFE) has prepared a backup strategy for meeting exceptional shortfalls in the funding of the budget, including a detailed prioritization of expenditures to be approved by the Cabinet. As a part of this strategy, domestically financed capital expenditures budgeted for 2001 have already been classified into four categories, depending on the priority attached to each project. Budgetary allocations on some Tog 5 billion worth of projects classified as lowest-priority will be held in reserve until the third quarter and will be released only if all the other key revenue, expenditure, and financing targets have been met during the first half of the year. The repayment of domestic arrears will also be back-loaded and made contingent on satisfactory revenue performance during the first three quarters of 2001, and on the effectiveness of measures to prevent any further accumulation of arrears. If the government's privatization program generates larger-than-projected receipts during 2001, these will be earmarked for faster-than-programmed retirement of restructuring bonds held by domestic banks.

22. The recent steps toward more realistic budgeting will be complemented by decisive action to strengthen transparency, accountability, and enforcement mechanisms in budget implementation. While a new treasury department has been set up within the MOFE, the treasury function remains highly decentralized; budgetary units still make commitments and payments without communicating them to the treasury; and a disciplined accounting cadre under the technical direction of the Head of Treasury has yet to be fully established. Budgetary units also maintain their own bank accounts, often at commercial banks, and manage these at their discretion. The government has begun to address these problems based on the recommendations of recent technical assistance missions from the IMF's Fiscal Affairs Department (FAD).

23. Important steps are under way to improve treasury monitoring and control over the government's finances. An inventory of all government accounts was completed on May 10, 2001 and a Cabinet resolution has been adopted centralizing the registration of the bank accounts of the whole nonfinancial public sector and requiring all central budget entities and extra-budgetary funds (EBFs) to provide a detailed monthly report on the balances of all their bank accounts, with supporting bank statements. The Cabinet has also issued new regulations on the responsibilities of Chief Accountants clearly specifying the

authority of the Head of Treasury with regard to accounting and payments functions. The requirement to provide certified reports on bank balances will be extended to local budget entities and EBFs and aimag governments by April 2002.

24. Additional measures will be required to ensure that public officials at all levels of government are--and continue to be--held accountable for the faithful implementation of approved budgets while longer-term reforms of public sector financial management are being introduced. To that end, the government will introduce amendments to the Budget Law of Mongolia in the context of the 2002 budget, to clarify the responsibilities of officials at all levels of government, including by specifying the penalties for arrears accumulation, and to ensure that they will continue to be held accountable for the execution of the budget following the enactment of the Public Sector Management and Finance Law. Moreover, any delegation of controls over budget execution to line ministries will be postponed until there is adequate assurance that these responsibilities can be effectively carried out. The devolution of greater fiscal autonomy to other budgetary entities, especially with regard to employment and wage policies, will also be deferred until an adequate framework for safeguarding financial discipline is in place.

25. A Cabinet resolution to establish a Treasury Single Account (TSA) at the BOM was adopted on June 20, 2001 and the transfer to the TSA of all foreign-currency deposits of the central government at commercial banks is well under way. A Cabinet resolution to initiate the pilot phase of the TSA, including a cash warrant system and BOM subaccounts for each budget entity, was adopted on June 20, 2001. During this phase, three large budget entities, including the Ministry of Education, Culture and Sciences, the Ministry of Health, and the Social Insurance Authority will route all their payments through zero-balance commercial bank accounts. In addition, eight smaller budget entities, including the Cabinet Secretariat, the State Financial Inspection Authority, the General Department of National Taxation (GDNT), the Mongolian National University, Hospital Number 1, the Ministry of Defense, the Ministry of Natural Environment, and the State Property Committee (SPC) will have all their payments centrally authorized and processed by the treasury. During the pilot phase, all budgetary entities participating in the TSA will be barred from opening new commercial bank accounts, will close all of their budget and off-budget accounts held at commercial banks, and will transfer all of their own receipts directly to their subaccounts at the BOM. The government will complete the implementation of the TSA for all budgetary units covered in the pilot phase and will extend the TSA to all line ministries and Ulaanbaatar City, including the requirement to close all off-budget accounts, in consultation with IMF staff, by end-December 2001, with a view to having all central government and Ulaanbaatar City deposits and EBFs transferred to the TSA by end-June 2002. Completion of the transfer of all central government and Ulaanbaatar City deposits to the TSA, encompassing the closure of all their off-budget accounts and the routing of at least 75 percent of their total expenditures through the TSA system, will be a structural benchmark for end-June 2002 under the PRGF arrangement.

26. The government is also taking steps to improve the reliability, timeliness, and comprehensiveness of fiscal data reporting. The MOFE is paying particular attention to the need to improve the statistical coverage and reporting of arrears. To that end, a system of accounts-based monthly reporting has been set up on government payments arrears, payables to Customs, the GDNT, and pension funds, and netting out operations. Beginning in September 2001, all government entities, including EBFs, will be required to report semi-annually to the MOFE and the MOFE will prepare semi-annual reports for consolidated central government accounts and available data on local governments, including comprehensive data on public employment. Legislation requiring all general government entities, including EBFs, to report quarterly to the MOFE, including on the number of staff employed disaggregated by agency, will be submitted to parliament in late 2001 in conjunction with the 2002 budget. The government will make available to the IMF staff, as a matter of course and in a timely manner, all official budget documents submitted to Parliament, including accompanying legislation, background tables, local government budgets, and the key underlying macroeconomic assumptions. Semi-annual and quarterly fiscal reports, as well as reports on unanticipated changes in legislation, local government budgets, data reclassifications, or any other factors expected to affect the budgetary outturn, together with needed explanations, will also be provided to the IMF staff in a timely manner.

27. The progressive elimination of public sector arrears is a key objective of the program to improve fiscal governance. The government attaches the highest priority to eliminating debt service arrears. Interest arrears on restructuring bonds and treasury bills were largely cleared in September 2000. While domestic interest arrears have periodically resurfaced, the government has remained current on its interest payments since early 2001. For the period ahead, to restore the government's credit-worthiness and protect the viability of the bank restructuring program, adequate funds for public debt service were allocated in the amended 2001 budget. In addition, to ensure that interest on government bonds is paid in an orderly and transparent fashion, the outstanding stock of restructuring bonds has been standardized and new contracts have been signed between the MOFE and the main bond holders stipulating the terms for the servicing of their restructuring bonds.

28. To also address the problem of noninterest arrears, the treasury will adopt a joint action program with the State Financial Supervisory Agency (SFSA) by end-2001 specifically to monitor budget entities' bank accounts, ensure that payments arrears problems are properly addressed, and establish a time-bound plan for the progressive reduction and elimination of arrears. The amended 2001 budget includes specific provisions for the reduction of arrears in the budget allocations of debtor budgetary entities. Chief Accountants will be instructed by the Head of Treasury to ensure that priority is given to achieving the planned reduction in arrears and that avoidance of new arrears is strictly observed. This will require allocating any higher-than-budgeted own receipts of debtor budgetary entities for the further clearance of their arrears. The MOFE, in coordination with the GDNT, the Customs Department, and the Social Security Funds, is also taking steps to regularize its transactions with public enterprises. To that end, the government has signed memoranda of understanding (MOUs) with the Baganuur Coal Company, the Energy Authority, Erdenet, and the Neft Import Concern (NIC) verifying each entity's outstanding payables and receivables related to the budget and establishing a time-bound plan for the elimination of noncash transactions and the settlement of cross debts.

29. Beginning in 2002, a comprehensive public sector reform program will be implemented to rationalize the tax system, while reducing the cost of government and streamlining its operations. On the revenue side, the 2 percent customs duty surcharge introduced in 2001 will be withdrawn and collection efforts will be focused increasingly on strengthening tax administration. To pave the way for this, the government will submit its 2002 budget proposal to Parliament in conjunction with measures aimed at improving intergovernmental fiscal relations and rationalizing revenue sharing arrangements. In particular, proceeds from VAT collected at all levels of government will be centralized and a fixed percentage of VAT receipts will be assigned to the local government sector as a whole to be distributed among the aimags in a more equitable manner (e.g., on the basis of per capita entitlements). The government will also submit a proposal to Parliament to reassign the corporate income tax and the excise tax on alcohol to the central budget starting in 2002. On that basis, a new transfer equalization model will be developed to be used as a guide for the 2002 budget. This new model will move away from the system of ad hoc subsidies, and will be based on fully specified estimates of the revenue capacity and expenditure responsibilities of local governments.

30. Improved public expenditure management will be key to achieving the social objectives of the I-PRSP without undermining fiscal sustainability. The 2002 budget will include efficiency-enhancing reforms associated with civil service pay and employment, including targets for public employment reduction and wage decompression in 2002 and beyond, in line with the recommendations of the World Bank's PER. The government, in consultation with the World Bank, will design and implement a plan to rationalize the delivery and targeting of social services, with a view to redistributing them in favor of poverty-reducing programs. Policies on public pensions will be guided by the need to protect the solvency of the social security funds. To that end, the existing indexation mechanism will be modified with legislation submitted under the 2002 budget, with a view to establishing a closer linkage between pensions and social security contributions in line with the medium-term pension reform concept plan to be approved by Parliament by end-December 2001. In line with the macroeconomic framework envisaged in the I-PRSP, the 2002 budget will include adequate allocations for a continuing reduction of arrears and a wage and employment policy consistent with the maintenance of current expenditures within the agreed envelope.

C. Monetary and Exchange Rate Policies

31. Monetary policy will be geared to reducing inflation to about 8 percent by end-2001, while continuing to bolster the stock of official reserves. Upward pressures on domestic prices were intensified in the early months of 2001 as the Zud disrupted domestic meat supplies, the energy tariff increases were passed through to consumer prices, and domestic demand was spurred by the increases in public wages and pensions. In these circumstances, an excessive easing of monetary and credit conditions would carry the risk of allowing higher inflation to become embedded in market expectations. To prevent this, the annual rate of growth of broad money has been targeted to be reduced from 22¾ percent in June 2001 to no more than 15½ percent by year-end. This reduction would facilitate the achievement of the external reserve objective, while also providing adequate room for a healthy expansion of credit to the private sector.

32. Consistent with the above objectives, the BOM considers it appropriate to aim to maintain the rate of growth of reserve money to a range of no more than 11 percent in 2001, while keeping the required reserve ratio unchanged at a level of 14 percent. Given that reserve money already rose by more than 16 percent during the first half of 2001, this will require a significant tightening of monetary conditions to bring policies back on track in the second half of the year. The BOM's net domestic assets (NDA) have accordingly been targeted to decrease somewhat during the second half of 2001 from their level as of end-June 2001. Achievement of this target is likely to require a sustained increase in sales of BOM bills. Given the sharp expansion of credit to the private sector since late 2000, the BOM's open market sales will also be guided by the need to guard against an excessive expansion of credit. While much of the increase in the demand for credit during the first half of 2001 was probably of a seasonal nature and should abate in the latter part of the year, the BOM has supplemented the quantitative targets on its net domestic assets with quarterly indicative ceilings for the net domestic assets of the consolidated banking system. This is expected to ensure that credit growth remains within prudent limits throughout the program period.

33. As a first step, sales of BOM bills were stepped up from mid-2001 onwards, and their cutoff rates were raised across the whole spectrum of maturities. The aim has been to keep the BOM's NDA on a downward path, arrest, and begin to reverse, the increase in reserve money that took place in the first half of the year and, thereby, ensure that, by end-August, both of these aggregates get back on track to meet the program's indicative targets and quantitative performance criteria as set out in Table 1. The BOM will keep cut-off rates for its bills at levels which are positive in real terms throughout the program period. It is important that the yields on BOM paper are sufficiently remunerative given their influence on interest rates on restructuring bonds and commercial bank deposits. Maintaining an appropriate structure of rates on these instruments will contribute to the restoration of confidence in the domestic banking system and to the protection of the liquidity and solvency of major state-owned banks. Over time, as more tangible progress is made towards fiscal consolidation, disinflation, and banking system reform, there may be some room for a decline in nominal interest rates, while still keeping rates at positive levels in real terms.

34. The government and the BOM will refrain from either administrative measures or moral suasion to subsidize and/or direct bank credit to favored industrial and other activities during the program period, and they will not provide any implicit or explicit guarantees on external borrowing by private companies, as such measures would undermine the efficiency and soundness of the banking system and could eventually place new burdens on the budget. While concerns may have been raised by the sharp pick-up in lending by some state-owned banks following recent initiatives by the Ministry of Industry and Trade to encourage the growth of low-cost loans to selected companies, the Minister of Finance and Economy has since issued a public statement to reiterate the government's commitment to a market-based system of credit allocation; both the government and the BOM have pledged not to exercise moral suasion on the managements of state-owned banks to extend loans on noncommercial terms. This policy, together with the tangible progress towards keeping aggregate credit growth within prudent limits and the government's commitment to place the privatization of key state-owned banks on a fast track (see below), should serve to reassure market participants that the recent improvement in the soundness of the banking system will be sustained.

35. The government is committed to enhancing the effective independence of the BOM and is taking important steps to better insulate it from pressures to engage in quasi-fiscal activities. During the first half of 2000, extraordinary recourse to government borrowing from the BOM appears to have breached the legal limit for such borrowing, at least by some measures. Since then, a substantial portion of the government's short-term debt to the BOM has been repaid and a new agreement was reached to resolve pending disputed claims between the MOFE and the BOM. Once a track record of orderly public debt servicing has been established, the BOM will begin to convert its holdings of restructuring bonds into marketable government securities and substitute these or other debt instruments (e.g., treasury bills) for BOM bills in its open market operations. To pave the way for this conversion, as already noted, the MOFE has standardized the existing restructuring bonds, irrespective of holder, including by adopting a unified mechanism for the determination of the rate of return on restructuring bonds. The government also intends to submit legislation to Parliament before the end of 2001 to liberalize the domestic gold market, thereby eliminating any pressures on the BOM to act as the sole gold marketing agent and/or guarantor of external nonconcessional loans to domestic gold mining companies. Beginning in March 2001, to facilitate the financing of the domestic gold industry, the BOM entered into a Deposit and Trading Agreement with a foreign metals trading company, whereby US$25 million of short-term credits were provided for the pre-financing of exports by domestic gold mining companies under a BOM administrative guarantee backed by the BOM's monetary gold deposits as collateral. The outstanding credits under this agreement are programmed to decline steadily from US$25 million as of end-June to zero by end-November 2001. In the meantime, the BOM has revoked previously granted guarantees on US$3 million of external nonconcessional loans that are not strictly linked to the pre-financing of gold exports and will not extend any new guarantees under its existing Deposit and Trading Agreement. The administrative guarantee and gold collateralization elements of this agreement will be terminated in November 2001 as soon as all outstanding export-prefinancing loans have been repaid. The BOM will not extend any new loan guarantees thereafter without prior consultation with the Fund.

36. Mongolia will pursue a flexible exchange rate policy during the period of the PRGF arrangement. The togrog is estimated to have appreciated somewhat in real effective terms in 2000. However, in the government's view, the recent appreciation has not had any significant adverse effects on external competitiveness or export performance. The BOM will continue to allow the value of the togrog to be determined primarily by market forces while limiting intervention to smooth excessive exchange rate fluctuations and meet the reserve targets of the program. Given the existing pipeline in official inflows and the additional inflows expected to be catalyzed by the PRGF-supported program, net international reserves (NIR) of the BOM (excluding the portion of BOM's monetary gold pledged as collateral for external loans to domestic private companies and other off-balance sheet reserve liabilities) are projected to increase by US$20 million during 2001, raising the import cover of gross reserves to about 15 weeks by the end of the year. While the current definition of reserve liabilities of the BOM suffers from limitations owing to the existence of yet-to-be-quantified off-balance sheet derivatives transactions, including those entered into according to the aforementioned Deposit and Trading Agreement, the BOM is committed to cooperating with the staff, with a view to fully accounting for all liabilities in the measurement of NIR by the time of the first review under the PRGF arrangement.

D. Banking System Reforms

37. The government will continue to strengthen the legal and regulatory environment in the banking system. In the cases of the ITI Bank and Reconstruction Bank, which are still under liquidation, court action has been taken against past managers who were responsible for the banks' fraudulent activities. The receivers' efforts to improve recovery on the two banks' remaining loan portfolio are being stepped up, while overdue debts on which a court decision has already been issued are being transferred to the bailiff for immediate collection. More difficult-to-recover loans, together with an equivalent amount of government bonds, are to be transferred to the Mongolian Asset Recovery Agency (MARA), whose legal powers will be enhanced through new legislation. Legislation has also been adopted to enable commercial banks to sell collateral on nonperforming loans without undue delays and to make it a criminal offense to provide false information to a financial institution for the purpose of obtaining credit. To reduce commercial bank incentives to under-provision for their nonperforming loans and other assets, the amendments to the corporate income tax law, which were to eliminate the tax-deductible status of asset loss provisions, have been revoked.

38. BOM's prudential standards and their enforcement will continue to be strengthened. Asset classification and provisioning standards will be brought into full compliance with best international practices by the end of 2001 and the quality of banks' financial reports will continue to be upgraded by improving accounting and auditing standards. The BOM will introduce a new, expanded bank rating system, based on the CAMELS components, and will adopt a formal framework for prompt remedial supervisory actions to be automatically triggered whenever a bank's CAMELS ratings fall below specified thresholds. The minimum capital requirement for banks was raised to Tog 2 billion with effect from end-June 2001, thereby contributing to a further consolidation of the banking system. BOM will encourage under-capitalized banks to be merged into, or acquired by, stronger institutions, but it will bar mergers among weak institutions that are unlikely to reconstitute themselves as viable entities, including in the case of state-owned banks. While the Agricultural Bank has made good progress towards rehabilitating itself as a profitable institution during its first year of operation under a donor-financed external management contract, it remains undercapitalized. The government will take early action to settle its remaining debts to the bank and bring its capital position up to prudential norms, with a view to preparing it for privatization within the time frame stipulated in the external management contract. The BOM will apply strict selection criteria for the licensing of new banks, in line with the recommendations of IMF and World Bank staff. In the particular case of foreign bank branches, prospective applicants will be limited only to the largest and most reputable institutions from countries with proven records of effective consolidated supervision. Consistent with these criteria, in July 2001, the BOM suspended the bank license previously granted to an institution based in an offshore center and will reconsider licensing it as a finance company following the approval of new legislation on the regulation of nonbank financial institutions, which is expected to be considered by the autumn session of Parliament.

39. To enhance confidence in the banking system, the government plans to introduce a formal deposit insurance system over the medium term. Given the still precarious financial position of some institutions, and in light of the need to protect the integrity of the insurance fund from moral hazard, deposit insurance will be phased in as and when the above-mentioned legal and regulatory reforms have taken full effect, in consultation with IMF and World Bank staff.

E. Public Enterprise Reform and Privatization

40. The government is committed to an overall reform policy which includes privatizing state-owned assets, increasing private sector participation in the economy, and attracting foreign investment. The government's Privatization Guidelines for 2001-2004 were approved by Parliament in January 2001 and its privatization program for 2001 was approved in February. According to this program, the government will privatize 27 fully or partially state-owned enterprises as well as 66 state-owned unfinished buildings and facilities in 2001. In addition, the government intends to restructure 25 enterprises and organizations and ensure their preparation for privatization.

41. The government intends to privatize several most-valued companies through competitive tender in 2001. More specifically, it will sell controlling stakes in the Trade and Development Bank (at least 70 percent of shares), Gobi Cashmere Company (70 percent of shares), and NIC (80 percent of shares). The government is also embarking on a reform program for the energy sector, whose serious financial difficulties have recently posed a threat for the health of both the real economy and the public finances. Coal, electricity, and heating prices were increased with effect from December 15, 2000, by 15 percent, 15 percent, and 35 percent, respectively. The government, in consultation with the World Bank and donors, secured Parliamentary approval of the necessary legislation on electricity,

heating, and the establishment of an independent regulatory authority on February 2, 2001 and reached agreement with the World Bank in April 2001 on a comprehensive medium-term program of energy sector reform and privatization.

42. The government will develop a transparent policy framework within which to address the impact of recent adjustments in energy prices on the poor. The possible means to deliver and distribute petroleum supplies to the rural areas will be explored in the context of the planned privatization of NIC. To pave the way for privatization, the government will develop, by October 2001, a system for the full accounting and monitoring of arrears among the state-owned enterprises in the energy sector and a credible plan for their elimination. Beginning in 2002, pro-poor outlays in these areas will be fully incorporated in, and explicitly accounted for, in the government budget.

F. External Sector Policies

43. The government is committed to maintaining regular relations with creditors. During the high-level intergovernmental committee meeting in November 2000, an agreement was reached for the clearance of $15.8 million of overdue payments on Mongolia's post-1991 debt to Russia and for the payment of debt service due in 2000 and 2001 ($6.4 million and $5.7 million, respectively). Out of a total amount due of $27.9 million, Mongolia has already paid $2 million in cash and some $5.5 million in kind. Of the remaining obligations due in 2001, it was agreed that about $5 million will be paid in cash and the rest in kind. The government has duly incorporated this schedule of repayments in the amended budget for 2001 and will strictly adhere to it. With respect to the pre-1991 convertible ruble debt, it has been agreed to form a new working group to examine all options for dealing with the problem. The government has also established contact with other potential claimants to initiate the process of resolving disputed external claims arising from the granting of government guarantees on past external debt. The government and the BOM will not incur new external arrears during the program period nor will they provide new public guarantees on private external debt (see also paragraph 35 above).

44. Mongolia's liberal trade regime has served the country well in recent years and will remain key to promoting efficient investment and growth during the next stage of transition. To encourage export-led growth and enhance rural incomes, customs controls and licensing for imports and exports will be simplified and the setting of minimum export prices for meat exports discontinued. The government will introduce no new taxes, quantitative restrictions, voluntary restraints or other measures to discourage exports or imports during the program period and will reduce all import tariffs to a unified rate of 5 percent from January 1, 2002.

IV. External Financing Requirements

45. The above policies are expected to help Mongolia reduce the vulnerability of its external position over the medium term. The current account deficit (including official grants) is projected to narrow from about 7¼ percent of GDP in 2001 to 6 percent in 2004,

with total external debt peaking at about 94 percent of GDP in 2003 and declining steadily thereafter. While medium-and long-term loan disbursements are projected to average about US$80-100 million a year, additional external assistance will be needed to fill external financing gaps on the order of US$15-30 million a year. During the PRGF-supported program period, these gaps are expected to be closed through program loans from the World Bank, the AsDB and other donors, and drawings from the Fund.

V. Program Monitoring

46. The first year of the PRGF-supported program will cover the period August 1, 2001-July 31, 2002. To jump-start reforms and provide a strong signal to the domestic and international community of the government's resolve to implement the PRGF program, a number of prior actions have been taken to: (i) Prepare a sound and realistic mid-term amendment for the 2001 budget; (ii) institute a prudent monetary policy; (iii) strengthen treasury management and control over the government's accounting and payments functions; and (iv) begin to regularize the government's outstanding stock of restructuring bonds. The prior actions are presented in greater detail in Table 2.

47. The attached Table 1 and Technical Memorandum of Understanding provide details on a set of quantitative targets agreed with the IMF staff, for the purpose of monitoring progress under the PRGF arrangement. The program's quarterly benchmarks and semi-annual quantitative performance criteria included in Table 1 are related to: (i) net banking system credit to government; (ii) net domestic assets of the BOM; (iii) net international reserves (NIR) of the BOM; (iv) government and government-guaranteed external debt; (v) external arrears; and (vi) domestic interest arrears. In addition, indicative ceilings have been specified for the net domestic assets of the consolidated banking system. The structural benchmarks and performance criteria for the first year of the PRGF arrangement are described in Table 3.

48. The first review under the PRGF arrangement will be completed by end-March 2002 and will assess economic performance based on the observance of the quantitative targets for end-December and the structural benchmarks and performance criteria as of end-September and end-December 2001. At that time, the quantitative performance criteria for end-June 2002 will also be established. The second review will be completed by end-September 2002 and will assess performance based on the observance of the quantitative targets as of end-June 2002 and the structural benchmarks and performance criteria as of end-April and end-June 2002.

49. To increase the transparency of the government's policy intentions, the government has decided to publish this Memorandum in the Mongolian media and on the IMF Website.

Table 1. Mongolia: Quantitative Performance Criteria and Indicative Targets Under the PRGF arrangement, 2001-021
2001   2002

 
End-June 
Actual
End-Sep.
Indicative
End-Dec.  
Performance
Criteria    
  End-March
Indicative 
Targets15 
End-June  
Performance
Criteria15 
End-Dec.
Indicative
Targets15

Quantitative Performance Criteria
(In billions of togrogs)                                               
1.  Net bank credit to government (ceiling)2,3,4,5 -8.0 -7.1 -16.8   1.5 1.8 -29.6
2. Net domestic assets of the Bank of Mongolia (stock, ceiling)4,6,7,8 -23.7 -24.8 -28.9   -28.9 -29.4 -40.4
3. Domestic interest arrears
(stock, ceiling)9
0.0 0.0 0.0   0.0 0.0 0.0
 
(In millions of U.S. dollars, unless otherwise indicated)               
4. Net international reserves
of the Bank of Mongolia
(stock, floor)7,10
132.0 148.2 160.6   161.0 170.0 185.6
5. New nonconcessional external debt contracted or guaranteed by the government or the BOM (ceiling)
   Maturities of less than
      1 year3,11,12
25.0 10.0 0.0   0.0 0.0 0.0
   Maturities of 1-12 years3,11 0.0 0.0 0.0   0.0 0.0 0.0
6. External payments arrears (stock, ceiling)9,13 0.0 0.0 0.0   0.0 0.0 0.0
 
Indicative Target

Net domestic assets of the banking
system (stock, ceiling)4,7,14
   (In billions of togrogs)

91.1 84.3 70.0   82.7 89.2 64.7
 
Memorandum items:
BOM's monetary gold pledged
   as collateral for external loans
   to domestic private companies
30.0 12.0 0.0 0.0 0.0 0.0
Balance of payments support3
   Excluding disbursements from
   the IMF
5.2 22.5 22.5 0.0 5.2 20.5
External budgetary assistance
   (program loans)3 
   (In billions of togrogs)
5.7 25.4 25.4   0.0 6.1 24.2
Privatization receipts3
   (In billions of togrogs)
1.1 3.4 10.2   0.0 0.0 9.7
Transfer from the BOM to
    government3
   
(In billions of togrogs)
  9.8   9.8 11.3   0.0 0.0 1.7
Reserve money
    (in billions of togrogs)
154.5 151.3 147.6   148.1 157.4 163.6

1The attached technical memorandum of understanding (TMU) sets out the definitions for the above targets under which Mongolia's performance under the program will be assessed.
2Defined as net claims on government in the monetary survey.
3Cumulative from the beginning of the year.
4The targets will be adjusted downward (upward) by the amount of external budgetary assistance in excess of (lower than) that programmed as set out in the above table.
5The targets will be adjusted downward by the amount of privatization receipts in excess of that programmed as set out in the above table.
The targets will be adjusted downward by the amount of transfer from the BOM to government in excess of that programmed as set out in the above table.

6Defined as the difference between net foreign assets of the monetary authorities and reserve money. Foreign currency-denominated items will be valued at program exchange rates.
7The ceilings and floors specified are adjusted to exclude monetary gold pledged as collateral for external loans to domestic private companies.
8The targets will be adjusted downward by 80 percent of the amount of net international reserves of the BOM in excess of that programmed as set out in the above table.
9Applicable on a continuous basis.
10The targets will be adjusted upward (downward) by the amount of balance of payments support, excluding disbursements from the IMF, in excess of (lower than) that programmed as set out in the above table.
11For the definition of external debt, see Annex II of the TMU.
Excludes changes in indebtedness resulting from rescheduling operations (including deferral of interest on commercial debt), disbursements from the Fund, loans from the Export-Import Bank of China for the zinc mine project, normal import-related trade credits, and those with grants element equivalent to 35 percent or more, calculated using a discount rate based on OECD commercial interest reference rates (CIRRs).
12Short-term loans include domestic private company borrowings from an international metals trading company under an administrative guarantee by the BOM which is backed by BOM's monetary gold.
13Excludes external debt in arrears that is in dispute.
14Defined as broad money less net foreign assets of the banking system.
15The indicative targets for end-March 2002 and the performance criteria for end-June 2002 will be revised during the upcoming staff visit in October 2001.

Table 2. Mongolia: Prior Actions for Board Consideration of New PRGF Arrangement
(To be completed by September 14, 2001)

  • Issue government decree specifying the structure of civil service wage increases to take effect during the remainder of 2001 and submit to Parliament an amendment to the 2001 budget, in line with the understandings reached with IMF staff. (Status: largely completed; government decree has been issued and the central government budget has been amended broadly in line with understandings reached with the staff. Aimag budgets have all been amended but the MOFE has not yet consolidated the resulting data for the general government.)

  • Raise cut-off rates on BOM bills and increase quantity of bills sold as needed to bring the monetary program on track to meet the indicative targets for end-September 2001 as set out in Table 1, including by ensuring that the BOM's NDA and reserve money as of end-August are both smaller than or equal to their levels as of end-June 2001. (Status: pending; BOM bill placements and cut-off rates have been increased substantially since the beginning of the year, but end-August monetary data are not yet available.)

  • Complete an inventory of all government bank accounts and adopt a Cabinet resolution requiring all central budget entities and extra-budgetary funds (EBFs) to provide a detailed monthly report on the balances of all their bank accounts, with supporting bank statements. (Status: largely completed; the inventory is to be extended to all government agencies once bank accounts of project implementation units (PIUs) have been registered.)

  • Adopt a Cabinet resolution to establish a treasury single account (TSA) at the Bank of Mongolia (BOM), transfer to the TSA all foreign-currency government deposits owned by central budget entities and EBFs, and send letters to all donors seeking their concurrence to transfer to the TSA all Project Implementation Units (PIUs) and other related government accounts held jointly with donors. (Status: largely completed; Cabinet resolution was adopted and the transfer of foreign currency deposits owned by the central government was initiated in June.)

  • Adopt a Cabinet resolution to initiate the pilot phase of the TSA, institute a cash warrant system and subaccounts in the BOM for all pilot entities, close all their off-budget accounts, and begin to have their payments routed through zero-balance commercial bank accounts or centrally authorized and processed by the treasury. (Status: completed.)

  • Sign memorandum of understanding between the MOFE (in coordination with the GDNT, Customs, and the Social Security Funds) and the Baganuur Coal Company, the Energy Authority, Erdenet, and NIC verifying each entity's payables and receivables related to the budget, and establish monthly reporting and a time-bound plan for the elimination of noncash transactions and the settlement of cross debts. (Status: pending; a working group was set up in June to address the state-owned enterprises' cross-debts with the government, but no information is yet available on signed MOUs.)

  • Standardize stock of restructuring bonds and sign contracts between the MOFE and the main holders stipulating the terms for the servicing of their restructuring bonds. (Status: pending; agreement on an interest rate formula was reached in June, but the ministerial resolution establishing the formula and the contracts between the MOFE and bond holders have not yet been received by the staff.)

  • Finalize the BOM's decision regarding the disposition of recent or prospective bank license applications by foreign institutions consistent with the MEFP's stipulation that applicants be limited only to the largest and most reputable institutions from countries with proven records of effective consolidated supervision, and ensure that the commencement of operations by any new banks is phased in so as not to jeopardize the achievement of the BOM's monetary program targets, in consultation with IMF and World Bank staff. (Status: completed.)

Table 3. Mongolia: Structural Benchmarks and Performance Criteria

Structural Benchmarks

  • Enforce legal requirement to report semi-annually to the MOFE on all government entities, including EBFs, and prepare semi-annual report for consolidated central government and available data on local governments, including comprehensive data on public employment (end-September 2001), with the first semi-annual report to cover data for January-June 2001.

  • Submit bill to the Parliament to reassign the Corporate Income Tax and the excise tax on alcohol to the central budget starting in 2002 and develop a new equalization transfer model to be used as a guide for the 2002 budget (end-December 2001).

  • Adopt joint action program agreed by Treasury and SFSA to monitor budget entities' bank accounts, ensure that payments arrears problems are properly addressed, and establish a time-bound plan for the progressive reduction and elimination of arrears (end-December 2001).

  • Adopt legislation requiring all general government entities, including EBFs, to report quarterly to the MOFE, including on the number of staff employed disaggregated by agency (end-December 2001).

  • Implement arrears reduction plan and meet arrears reduction targets set for each debtor agency under the Treasury/SFSA joint action program (end-June 2002).

  • Complete transfer of all central government and Ulaanbaatar City deposits and EBFs to the TSA, close all off-budget accounts held by central government and Ulaanbaatar City, and ensure that at least 75 percent of total central government and Ulaanbaatar City expenditures are routed through the TSA system (end-June 2002).

  • Adhere to best international standards for the licensing of new banks, including by limiting prospective applicants only to the largest and most reputable institutions from countries with proven records of effective consolidated supervision, and consult with IMF staff about the appropriate interpretation of these standards when considering applications for new bank licenses (Continuous).

Structural Performance Criteria

  • Secure Parliamentary approval of amendment to Budget Law to clarify and strengthen the accountability of local government officials with respect to the control and reporting of bank accounts and the enforcement of Cabinet regulations and directives from the head of treasury, including by specifying the penalties for arrears accumulation and the misuse of public funds (end-December 2001).

  • Secure Parliamentary approval of legislation to centralize the proceeds from VAT collected at all levels of government and assign a fixed percentage of VAT receipts to the local government sector as a whole (end-December 2001).

  • Complete transfer of all pilot entities' deposits to the TSA, adopt a Cabinet resolution to extend the TSA to all line ministries and Ulaanbaatar City and close all their off-budget accounts, and initiate transfer of remaining central government deposits to the TSA (end-December 2001).

  • Require local governments to adopt the same reporting standards on bank accounts as the central government and to provide monthly reports on their account balances (end-April 2002).

  • Obtain parliamentary approval of 2002 Budget in line with the macroeconomic framework agreed with the IMF, including adequate allocations for a continuing reduction of arrears and expenditure saving reforms and a wage and employment policy consistent with the maintenance of current spending within the agreed envelope (end-December 2001).
Mongolia: Technical Memorandum of Understanding

1. This memorandum sets out the definitions for quantitative performance criteria and indicative targets under which Mongolia's performance under the program supported under a Poverty Reduction and Growth Facility (PRGF) arrangement will be assessed. Monitoring procedures and reporting requirements are also specified.

I. Quantitative Performance Criteria and Indicative Targets

2. Performance criteria for December 31, 2001 and June 30, 2002, and indicative targets for September 30, 2001 and March 31, 2002 have been established with respect to

  • ceilings on the level of net domestic assets of the Bank of Mongolia (BOM);

  • floors on the level of net international reserves of the BOM;

  • ceilings on the level of net domestic bank credit to the general government;

  • ceilings on the contracting and guaranteeing by the central government or the BOM of new nonconcessional medium- and long-term external debt; and

  • ceilings on the contracting or guaranteeing by the central government or the BOM of new short-term external debt.

3. Performance criteria that are applicable on a continuous basis have been established with respect to

  • ceilings on the stock of domestic interest arrears of the general government; and
  • ceilings on the stock of external arrears of the central government and the BOM.

4. Indicative targets for September 30, 2001, December 31, 2001, March 31, 2002, and June 30, 2002 have been established with respect to

  • ceilings on the level of net domestic assets of the consolidated banking system.

II. Institutional Definitions

5. The general government includes all units of budgetary central government, social security funds, extrabudgetary funds, and local governments. See Annex I for the description of units in each of these subsectors.

6. The domestic banking system is defined as the BOM, the existing and newly licensed commercial banks and their branches. The seven liquidated banks are not included in the consolidated accounts of commercial banks.

III. Monetary Aggregates

7. Valuation. Foreign currency-denominated accounts will be valued in togrogs at the program exchange rate between the togrog and the U.S. dollar (Tog 1,097 per U.S. dollar). Foreign currency accounts denominated in currencies other than the U.S. dollar, excluding SDRs, will first be valued in U.S. dollars at actual end-of-period exchange rates used by the BOM to calculate the official exchange rates. SDR-denominated accounts will be valued at the program exchange rate of SDR 1=US$1.25. Monetary gold will be valued at US$270.6 per ounce.

A. Reserve Money

8. Reserve money consists of currency issued by the BOM (excluding BOM holdings of currency), commercial banks' deposits held with the BOM, and deposits of nonbanks with the BOM (excluding the general government as defined above).

B. Net International Reserves of the BOM

9. A floor applies to the level of net international reserves (NIR) of the BOM.

10. NIR will be calculated as gross international reserves less international reserve liabilities.

11. Gross international reserves of the BOM are defined as the sum of

  • monetary gold holdings of the BOM;

  • holdings of SDRs;

  • Mongolia's reserve position in the IMF; and

  • foreign currency assets in convertible currencies held abroad that are under the direct and effective control of the BOM and readily available for intervention in the foreign exchange market or the direct financing of balance of payments imbalances and are of investment grade or held with an investment-grade institution.

Excluded from the definition of gross reserves are any foreign currency claims on residents, capital subscriptions in international institutions, assets in nonconvertible currencies, and gross reserves that are in any way encumbered or pledged, including, but not limited to, reserve assets used as collateral or guarantee for third-party external liabilities.

12. International reserve liabilities of the BOM are defined as the sum of

  • all outstanding liabilities of Mongolia to the IMF; and

  • any foreign convertible currency liabilities of the BOM with an original maturity of up to and including one year.

Excluded from the definition are liabilities arising from balance of payments support of original maturities of more than one year from the World Bank and the Asian Development Bank.

13. Adjusters. The floor on NIR will be adjusted upward by the amount of balance of payments support from official multilateral creditors (excluding the IMF) in excess of the programmed level as set out in the table on quantitative performance criteria. The floor on NIR will be adjusted downward by the amount of balance of payments support from official multilateral creditors (excluding the IMF) falling short of the programmed level as set out in the table on quantitative performance criteria.

C. Net Domestic Assets of the BOM

14. A ceiling applies to the level of net domestic assets (NDA) of the BOM.

15. NDA will be calculated as the difference between reserve money and the sum of NIR and other net foreign assets (ONFA) of the BOM.

16. ONFA is defined as the sum of (i) BOM's monetary gold pledged as collateral for external loans to domestic private companies and (ii) other net foreign assets of the BOM, including the difference between accrued interest receivables on gross international reserves of the BOM and accrued interest payables on international reserve liabilities of the BOM.

17. Adjusters. The ceiling on NDA will be adjusted downward by the amount of external budgetary assistance in excess of the programmed level as set out in the table on quantitative performance criteria. The ceiling on NDA will be adjusted upward by the amount of external budgetary assistance falling short of the programmed level as set out in the table on quantitative performance criteria.

18. The ceiling on NDA will be adjusted downward by 80 percent of the amount of NIR of the BOM in excess of the programmed level as set out in the table on quantitative performance criteria.

D. Net Bank Credit to the General Government

19. A ceiling applies to the net bank credit flows to the general government (NBCGG) measured cumulatively from the beginning of the year.

20. NBCGG is defined as the sum of (i) net borrowing from the BOM (ways and means advances, loans, holdings of restructuring bonds, holdings of treasury bills and other government bonds, and the government liabilities to the IMF regarding PRGF/ESAF disbursements minus deposits) and (ii) net borrowing from commercial banks (loans, advances, holdings of restructuring bonds, and holdings of treasury bills and other government bonds minus deposits).

21. Adjusters. The ceiling on NBCGG will be adjusted downward by the amount of external budgetary assistance in excess of the programmed level as set out in the table on quantitative performance criteria. The ceiling on NBCGG will be adjusted upward by the amount of external budgetary assistance falling short of the programmed level as set out in the table on quantitative performance criteria.

22. The ceiling on NBCGG will be adjusted downward by the amount of any transfer, including of profits and provisions, over the program baseline from the BOM to the central government and upward for any shortfall.

23. The ceiling on NBCGG will be adjusted downward by the full amount of privatization receipts in excess of the programmed level as set out in the table on quantitative performance criteria.

E. Net Domestic Assets of the Banking System

24. A ceiling applies to the level of net domestic assets (NDABS) of the banking system.

25. NDABS will be calculated as the difference between broad money and net foreign assets of the banking system.

26. Broad money is defined as the sum of currency outside banks and all current, savings and time deposits of nonbanks (excluding the general government as defined above) with the banking system, including foreign currency deposits.

27. Net foreign assets of the banking system are defined as the sum of NIR and other net foreign assets of the BOM (as defined above) and net foreign assets of the deposit money banks (DMBs). Net foreign assets of the DMBs are defined as foreign assets minus foreign liabilities. Foreign assets comprise gold and foreign currency holdings and claims on nonresidents. Foreign liabilities comprise all liabilities to nonresidents.

28. Adjusters. The ceiling on NDABS will be adjusted downward by the amount of external budgetary assistance in excess of the programmed level as set out in the table on quantitative performance criteria. The ceiling on NDABS will be adjusted upward by the amount of external budgetary assistance falling short of the programmed level as set out in the table on quantitative performance criteria.

IV. Domestic Interest Arrears

29. A continuous performance criterion applies to the nonaccumulation of domestic interest arrears on domestic debt contracted by the central government. Domestic interest payments are in arrears when the payment is not made on the due date, as specified in the contractual agreements.

V. External Debt

A. Medium- and Long-Term External Debt

30. A ceiling applies to the contracting and guaranteeing by the central government, the BOM, or other agencies on behalf of the central government of new debt with nonresidents with original maturities of over one year. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received.

31. The definition of debt, for the purposes of the program, is set out in Executive Board Decision No. 12274, Point 9, as revised on August 24, 2000 (see Annex II).

32. Excluded from the ceiling are (i) the use of Fund resources; (ii) adjustment lending from the World Bank, the Asian Development Bank and the International Fund for Agricultural Development (IFAD); (iii) debts to restructure, refinance, or prepay existing debts; (iv) concessional debts; (v) loans from the Export-Import Bank of China for the Mongolian zinc mine project; and (vi) any togrog-denominated treasury bill and government bond holdings by nonresidents.

33. For program purposes, the guarantee of a debt arises from any explicit legal obligation of the central government, the BOM, or other agencies on behalf of the central government to service a loan in the event of nonpayment by the recipient (involving payments in cash or in kind), or indirectly through any other obligation of the central government, the BOM, or other agencies on behalf of the central government to finance a shortfall incurred by the loan recipient.

34. For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., grant element is equal to (nominal value minus NPV) divided by nominal value). The NPV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the OECD. For debt with a maturity of at least 15 years, the ten-year-average CIRR will be used to calculated the NPV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. For the purposes of the program through December 2001, the CIRRs published by the OECD in January 2001

will be used. For example, based on January 2001 CIRR rates, a U.S. dollar-denominated debt with a 10-year maturity would be considered concessional if the interest rate did not exceed 3 percent.

B. Short-Term External Debt

35. A ceiling applies to the contracting and guaranteeing by the central government, the BOM, or other agencies on behalf the central government of new debt with nonresidents with original maturities of one year or less. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received.

36. For program purposes, the definition of debt is set out in Executive Board Decision No. 12274, Point 9, as revised on August 24, 2000 (see Annex II). The guarantee of a debt is defined in paragraph 33 above.

37. Excluded from the ceiling are (i) debts classified as international reserve liabilities of the BOM; (ii) debts to restructure, refinance, or prepay existing debts; (iii) togrog-denominated treasury bills, government bonds, and BOM bills held by nonresidents; and (iv) normal import financing. A financing arrangement for imports is considered to be "normal" when the credit is self-liquidating.

VI. External Payment Arrears

38. A continuous performance criterion applies to the nonaccumulation of external payment arrears on external debt contracted or guaranteed by the central government or the BOM. External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreements. However, overdue debt and debt service obligations that are in dispute will not be considered as external payment arrears for the purposes of program monitoring.

VII. Reporting

39. The authorities have committed themselves to using the best available data, so that any subsequent data revisions will not lead to a breach of a performance criterion. All revisions to data will be promptly reported to the Fund's Resident Representative, particularly when the changes are significant. The likelihood of significant data changes, including definitional changes, will be communicated to Fund staff as soon as the risk becomes apparent to the authorities.

40. Data required to monitor performance under the program, including those related to performance criteria and indicative targets, will be provided electronically to the Fund's Resident Representative by the 15th day of each month, unless otherwise indicated. The data to be reported are listed below, and the reporting responsibilities are indicated in parentheses.

A. Monetary Data (BOM)

  • The monetary survey, the balance sheet of the BOM, and the consolidated balance sheet of the commercial banks. Data will be provided on a monthly basis, with the exception of the balance sheet of the BOM, which will be provided on a weekly basis within five working days of the end of the respective week.

  • Net international reserves and interventions of the BOM in the foreign exchange market on a weekly basis within five working days of the end of the respective week.

  • Interest rates and volume on standing facilities and market operations on a weekly basis within five working days of the end of the respective week.

  • A detailed breakdown of net credit to government from the BOM and the commercial banks.

  • Stock of monetary gold in both thousands of fine troy ounces and U.S. dollars. If the BOM engages in monetary gold transactions or employs any other accounting rate, directly or implicitly, for valuing gold assets or liabilities guaranteed by gold, this information will be reported to the Fund. Any increase in monetary gold through purchases from domestic sources and refining of nonmonetary gold held or purchased by the BOM will also be reported (both prices and volumes).

  • A detailed breakdown of "other items net" for both the BOM and the commercial banks, including, inter alia, all valuation changes in net international reserves and net other foreign assets arising from exchange rate changes and/or revaluation of gold.

  • Outstanding balances of any new deposit accounts of the general government opened in addition to the existing ones for grants and loans received from multilateral or bilateral donors, including associated counterpart funds.

  • A bank-by-bank list of required reserves and actual reserves.

  • A bank-by-bank list of ceilings on commercial bank lending to nonbanks imposed by the BOM along with the actual stock of outstanding amounts.

  • Results of each central bank bills auction within five working days of each auction, including amount of bills offered, amount demanded, amount sold to each bank, announced rates, and cut-off rates.

B. Fiscal Data (Ministry of Finance and Economy (MOFE))

  • Consolidated accounts of the central, local, and general government, including detailed data on tax, nontax, and capital revenues, current and capital expenditures, net lending, and financing. Financing components should be separated into foreign sources (cash and project loans) and domestic sources (bank and nonbank).

  • Classified transactions of all five social insurance funds, the culture and art development fund, the privatization fund, and the road fund.

  • Interest arrears on domestic debt of the government.

  • Noninterest outstanding payables by each subsector of the general government, including the social security funds, with a detailed breakdown by major categories and remaining maturity.

  • Results of each treasury bills auction within five working days of each auction, including amount of bills offered, amount demanded, amount sold to each bank and nonbanks, and the average yield in percent per month.

  • A detailed breakdown, within one month following the quarterly test date, of the financial accounts of 9 large public enterprises, including budgetary subsidies, grants, and lending, government guarantees, and bank credit (in consultation with the BOM).1

  • Data on civil service employment (semi-annually in 2001 and quarterly in 2002).

C. External Sector Data (BOM and MOFE)

  • Outstanding stock, disbursements, amortization, and interest payments of short-term external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.

  • Outstanding, disbursements, amortization, and interest payments of medium- and long-term external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.

  • Daily midpoint exchange rates of the togrog against the U.S. dollar, including the official, interbank, and parallel market exchange rates (BOM).

  • Arrears on the external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.

D. Other Data (National Statistical Office)

  • The overall monthly consumer price index and a detailed breakdown by major categories of goods and services included in the consumer basket.

  • The NSO's monthly statistical bulletin, including monthly export and import data.

1 Net Import Concern, Gobi Cashmere Company, MIAT, Energy Authority, Baganuur Coal Company, Erdenet, Mongolian Railways, Darkhan Minimetal, and Ulaanbaatar Bus Company.

ANNEX I

Mongolia: Units of General Government

Central Government Units Covered by Central Budget

  1. Cabinet office, constitutional council, general prosecutor's office, ministries, parliament, president's office, and supreme court
  2. Government agencies
  3. Poverty Alleviation Fund
  4. Privatization Fund

Central Government Units with Individual Budgets

  1. Disability Allowance Insurance Fund
  2. Health Insurance Fund
  3. Industrial and Other Accidents Insurance Fund
  4. Social Security Fund
  5. Unemployment Fund
  6. Culture and Art Development Fund
  7. Employment Promotion Fund
  8. Environment Foundation
  9. Food Fund
  10. Fund for Development of Small and Medium-sized Enterprises
  11. Road Fund

Local Government

  1. City and 12 districts of Ulaanbaatar
  2. 21 provinces
  3. 340 districts

Data Coverage

Data on budgetary central government tables cover operations of units 1-4. Units 5-9 are social security funds; units 10-15 comprise extrabudgetary funds. The Cultural and Historical Fund was dissolved in 2000.

Data in local government tables cover operations of units 16-18.

ANNEX II

Guidelines on Performance Criteria with Respect to Foreign Debt

Excerpt from Executive Board Decision No. 12274, as revised on August 24, 2000

9.  a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

(i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

(ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and

(iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

(b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

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