IMF Executive Board Concludes 2006 Article IV Consultation with Mongolia

Public Information Notice (PIN) No. 07/11
January 29, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On January 10, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mongolia.1


Mongolia's macroeconomic performance in 2005-06 has been robust, underpinned by a run-up on copper and gold prices, declining inflation, and budget and external current account surpluses. Real GDP growth in 2005-06 is estimated at 7 percent, in line with the average pace since 2002. The mineral sector has been a key engine of growth, supported by favorable weather conditions, and buoyant recovery in the construction and services sectors. Inflation has eased to about 7 percent in October 2006 (year-on-year), following a spike at about 17½ percent in June 2005. The current account balance (including official transfers) recorded a surplus (1.4 percent of GDP) in 2005, which is expected to widen further to 5.2 percent of GDP in 2006. Gross international reserves have been rebuilt from their end-2003 low level in the aftermath of the settlement of the pre-1991 Russian debt, and are expected to reach this year about 3.4 months of next year's imports of goods and services.

The fiscal position has improved markedly in 2005-06. The budget deficit, which had narrowed significantly during 2000-04, switched to a 2.9 percent of GDP surplus in 2005 for the first time ever, and is expected to widen to 9.0 percent of GDP in 2006. This reflected a sevenfold increase in mining revenue since 2003 in concert with a 10 percentage point of GDP decline in total expenditure over the period, despite a 30 percent public sector wage increase and a significant expansion in social welfare transfers in 2006. Mirroring the improved fiscal performance, the debt burden has eased significantly, with the net present value (NPV) of public external debt halved from 64 percent of GDP end-2003 to an estimated 32 percent at end-2006. The 2007 budget calls for a significant easing in the fiscal policy stance, reflecting large tax cuts and further increases in wages and social welfare transfers.

Monetary aggregates have expanded rapidly in recent years, driven by strong foreign exchange inflows and improved confidence in the banking system. Broad money and reserve money growth accelerated to 37.3 percent and 19.7 percent, respectively, in 2005 and are expected to slow only slightly in 2006. Private credit continued to expand rapidly (40 percent) in 2005, and is expected to rise broadly at the same pace in 2006. Fast private credit growth in 2006, however, has been broadly offset by a sharp decline in net credit to government, as government deposits built up markedly and debt to the central bank was partly redeemed. The subdued inflationary response to date to rapid monetary growth primarily reflects a strong reintermediation process and a gradual exchange rate appreciation.

Strides have been made in strengthening the banking system, but vulnerabilities remain.

Nonperforming loans (NPLs) were reduced from 23.4 percent of total loans at end-2000 to 8.8 percent at end-2005, and the ratio has remained broadly stable in 2006. To safeguard the soundness of the banking system, the enforcement of prudential requirements has been intensified, especially for banks with rapid credit growth. Actions are also underway, under the newly-created Financial Regulatory Commission, to address the solvency of a number of credit and saving cooperatives and to strengthen the supervisory framework for nonbanks.

On the structural front, progress has been made to strengthen central bank governance and promote private sector development. The Bank of Mongolia appointed in September 2006 two non-executive directors to its Board of Directors, thus paving the way for further changes to shift decision-making authority from the Governor to the Board of Directors. An AML/CFT Law was adopted in mid-2006, providing for the establishment of a Financial Intelligence Unit within the Bank of Mongolia. An Anti-Corruption Law aimed at strengthening the business environment was also adopted at that time. Public sector reform is proceeding, with the recent privatization of the Savings Bank and bidding underway for the Gobi cashmere factory.

Mongolia's medium-term outlook for sustained growth and poverty reduction is broadly favorable, but subject to risks. With its considerable mineral endowment and location between two large and fast-growing economies, Mongolia has the potential to achieve real GDP growth averaging 6-7 percent of GDP over the medium term. Inflation could be contained to below 5 percent, provided that appropriate fiscal and monetary policies are in place. The main challenge, however, will be to ensure fiscal sustainability through sound management of the country's mineral resources and steadfast expenditure restructuring, especially civil service reform and social expenditure restraint. Assuming continued fiscal consolidation, Mongolia's external debt ratio would decline substantially over the medium term. In addition to policy risks, medium-term prospects are vulnerable to adverse weather conditions, and terms-of-trade shocks triggered by sharp declines in copper and gold prices and soaring oil prices.

Executive Board Assessment

Executive Directors commended the authorities for Mongolia's robust economic performance in recent years, including vigorous growth, a decline in inflation, the emergence of fiscal and current account surpluses, and reduced debt ratios. Mongolia's mineral wealth and improved macroeconomic stability provide a good foundation for sustained growth. Nevertheless, challenges remain to mitigate the economy's vulnerability to shocks, including harsh weather and a decline in copper prices, and to reduce the high poverty rate. Directors encouraged the authorities to focus on managing mineral wealth efficiently, improving infrastructure and the business environment, and targeting poverty alleviation policies carefully, in the context of continued macroeconomic stability.

Directors welcomed the marked improvement in the fiscal position in recent years. They cautioned, however, that the loosening of the fiscal stance in the 2007 budget could jeopardize fiscal sustainability and revive inflationary pressures. To ensure that public debt remains on a declining path, the non-mineral fiscal deficit should be reduced by containing the growth in the civil service wage bill, better targeting social welfare spending, and moving forward with civil service reforms. Directors stressed the importance of realistically planning and prioritizing capital spending. They recommended that the authorities consider formulating a medium-term fiscal framework, which could facilitate consistency in budget preparation.

Directors broadly supported the recent efficiency-enhancing tax reform, including the elimination of most VAT exemptions and new tax holidays, but observed that some tax cuts might need to be partially reversed to ensure fiscal sustainability, starting with the cut in the VAT rate. Also, cuts in non-mining tax rates could increase the sensitivity of revenues to commodity price shocks. Directors encouraged the authorities to keep the mining regime under review to ensure an internationally competitive tax regime, and they supported Fund technical assistance in this area.

Directors welcomed signs of improving confidence in the banking system, including significant reintermediation. They cautioned, however, that continued rapid monetary growth could raise inflationary pressures, and called for increased sales of central bank bills to absorb excess liquidity. They welcomed Fund technical assistance to upgrade the monetary policy framework and develop sound liquidity management instruments.

Directors commended recent steps to strengthen central bank governance, including the appointment of outside members to the Bank of Mongolia's Board of Directors, and they encouraged the authorities to move forward with plans to shift decision-making authority to the Bank of Mongolia's Board of Directors. Directors called for upgrading the management of international reserves, including reducing gold risk exposures and preparing a strategy to exit the gold market over the medium term.

Directors emphasized that, despite recent progress, the financial system remains vulnerable. As rapid credit growth can cause loan quality to deteriorate, enforcement of prudential regulations at weaker banks should be strengthened. Directors counseled the authorities against using administrative measures to lower bank lending rates, bailing out insolvent savings and credit cooperatives, or including these cooperatives in any future bank deposit insurance scheme.

Directors considered that Mongolia's flexible exchange rate has facilitated orderly adjustments to external shocks, and that the recent appreciation of the togrog reflects the improving external position. They supported the authorities' plan to continue limiting interventions in the foreign exchange market to smoothing short-term volatility. While welcoming Mongolia's continued commitment to an open trade regime, Directors encouraged the authorities to phase out the export duty on raw cashmere and resist pressures to raise import duties to protect domestic industries. Directors underscored the importance of maintaining a prudent debt management strategy, with most Directors emphasizing reliance on concessional borrowing. Directors also looked forward to the resolution of remaining outstanding obligations to foreign creditors.

Directors supported actions to foster good governance and private sector development, including the adoption of Anti-Money Laundering and Anti-Corruption Laws, and the privatization of two large public enterprises. They urged the authorities to proceed further with energy sector reform.

Directors welcomed the progress made in strengthening data quality for surveillance, and called for continued efforts to improve national account, fiscal, and monetary data.

Mongolia: Selected Economic Indicators, 2003-06

  2003 2004 2005 2006

Real Sector (percent change)


Real GDP growth

6.1 10.8 7.0 7.0


-2.3 34.3 10.9 5.2


7.1 8.1 6.5 7.3

Consumer prices (end-period)

4.7 11.0 9.5 7.0

General Government Budget (in percent of GDP)


Revenue and grants

37.6 37.0 33.7 40.6

Mineral revenue

2.8 4.1 4.5 13.5

Nonmineral revenue

34.2 32.5 29.0 27.0

Expenditure and net lending

41.8 39.1 30.7 31.7

Overall balance (including grants)

-4.2 -2.1 2.9 9.0

Nonmineral overall balance

-7.0 -6.3 -1.5 -4.5

Money and Credit (percent change)


Broad money

49.7 20.3 37.3 34.9

Domestic credit

147.0 23.0 22.3 -5.0

Of which: claims on nonbanks

90.3 43.7 40.1 39.2

Reserve money

14.7 16.8 19.7 16.5

Interest rate on central bank bills (percent per annum) 1/

15.0 15.8 3.7 5.8
  (in millions US dollars; unless otherwise indicated)

Balance of Payments


Current account balance (in percent of GDP)


Including official transfers

-7.7 1.6 1.4 5.2

Excluding official transfers

-11.5 -3.7 -2.8 2.0

Exports, f.o.b.

627 872 1,069 1,548

Mineral (in percent of total exports)

58.5 65.1 71.0 ...

Nonmineral (in percent of total exports)

41.5 34.9 29.0 ...

Imports, c.i.f.

827 1,021 1,224 1,532

Terms of trade (percent change)

1.1 7.0 2.3 25.8

Gross international reserves (end-period)

178 208 333 626

(in months of next year's imports of goods and services)

1.5 1.6 2.1 3.4

Public and Publicly Guaranteed Debt (in percent of GDP)


Total public debt

113.0 93.0 68.3 53.6

External debt

98.2 85.4 64.1 51.0

Domestic debt

14.8 7.6 4.2 2.6

NPV of external debt

64.2 52.3 40.3 31.7

External debt service (in percent of exports of goods and services)

34.0 7.5 2.9 2.1

Exchange Rate


Togrogs per US dollar (end-period)

1,170 1,209 1,221 1,164

Real effective exchange rate (end-period; percent change)

-6.8 0.8 7.7 ...

Sources: Data provided by the Mongolian authorities; and IMF staff estimates.

1/ Annualized yield on end-period auction of 14-day bills; as of end-September 2006.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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