## Mongolia: Assessment Letter for the Asian Development Bank (October 23, 2008)

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### Contact
- Contact person: Ms. Meral Karasulu (mkarasulu@imf.org, (202) 623-7113)

### Recent macroeconomic developments and policy performance
- Growth and inflation
  - Real GDP grew by 10 percent in 2007, and is projected to grow at the same rate in 2008.
  - Inflation rose from 6 percent (yoy) in June 2007 to 34 percent in August, before declining to 32 percent in September.
  - Demand-side inflation drivers: large increases in civil servant wages and rapid expansion of credit.
  - Supply-side inflation drivers: soaring food and oil import prices.
  - Policy measures to stabilize food and fuel prices: temporary exemptions on VAT and customs duties on wheat and flour imports; measures to build up wheat, flour, and meat reserves; temporary subsidies to reduce interest expenses of petroleum importing companies.

- Fiscal performance
  - Overall fiscal surplus narrowed from 8 percent of GDP in 2006 to 3 percent in 2007.
  - The 2008 budget envisaged a 2½ percent of GDP deficit; a recent budget amendment calls for a 0.3 percent deficit.
  - Fiscal outcome was broadly balanced up to September 2008.
  - Drivers: robust mineral revenue (high copper and gold prices) and strong nonmineral revenue (tax collection and import tax increases), alongside sharply higher expenditures on wages, transfers, and capital spending.

- Monetary and financial conditions
  - Bank of Mongolia (BOM) actions: increased the pace of foreign exchange sales (togrog appreciated against the US$ by 2 percent) and increased the policy rate by 185 basis points since January.
  - Monetary aggregates: broad money growth slowed from 57 percent (yoy) at end-2007 to 16 percent in September; growth of reserve money remained at single digits on average during the past six months.
  - Credit and real lending rates: credit grew 47 percent in August and lending rates remained negative in real terms.
  - Recommendation noted: reversing recent reduction in reserve requirements and enhancing the interest rate mechanism.

- External sector
  - Current account: turned to a deficit of 14 percent of GDP in August 2008 from a surplus of 2½ percent at end-2007, driven by rapid import growth for mining-related capital goods and high food and oil prices.
  - Gross international reserves: $880 million in September 2008, covering about 3½ months of nonmining imports.
  - Net present value of external public debt (mostly concessional): estimated at 20 percent of GDP at end-2008.

### Outlook and risks
- Near-term outlook
  - Real GDP projected to slow to about 8 percent in 2009 from 10 percent in 2008, consistent with global outlook and declining mineral prices.
  - Balance of payments effect of lower mineral prices expected to be broadly neutral due to lower exports and imports; fiscal impact could be significant.

- Risks
  - Downside risks: larger-than-expected declines in mineral prices reducing exports and fiscal revenues; sharp curtailment of mining-related FDI if foreign-owned mining companies face financing constraints amid global financial turmoil.
  - Medium-term upside potential: opening of two world-class mines (Oyu Tolgoi and Tavan Tolgoi) could sustain strong growth.
  - Other risks to medium-term outlook: weather-related shocks, delays in mining development, and a prolonged slump in copper prices.

### Policy recommendations and medium-term reforms
- Near-term macro policy stance
  - Maintain tight fiscal policy to bring inflation down and create fiscal space for emerging risks.
  - IMF staff welcomes authorities’ plan to tighten fiscal policy in 2009 and reverse recent expansionary trend.
  - 2009 budget proposal calls for a balanced budget, reducing the nonmineral deficit by about 3 3/4 percentage points of GDP from 10 percent of GDP, consistent with achieving a staff-recommended medium term fiscal anchor of 8 percent deficit in the non-mineral balance by 2010.
  - Maintain tight monetary policy and a flexible exchange rate to ensure domestic and external stability.
  - BOM should avoid relying solely on foreign exchange operations for monetary tightening if reserve coverage is at risk; move away from uni-directional sales of international reserves and allow market adjustments to external shocks.
  - Reverse the recent reduction in reserve requirements to help rein in credit growth; enhance the interest rate mechanism to make the policy rate more effective.

- Fiscal framework and resource management
  - Strengthen the macro-fiscal framework to cope with mining-related volatility and uncertainty.
  - Move from targeting the same overall budget balance percent of GDP over three years toward a nonmineral balance target as a medium-term fiscal anchor.
  - As experience is gained, consider a structural balance target and a separate limit on the growth of spending to reflect absorptive capacity and avoid overheating.
  - IMF staff engaged in close consultation with authorities to strengthen the medium-term fiscal framework.

- Borrowing and distribution of mineral wealth
  - Authorities should move cautiously on large-scale commercial borrowing and on plans to distribute mineral wealth directly to citizens.
  - Parliament authorized commercial foreign borrowing up to $1.2 billion (20 percent of GDP in 2008) to finance additional capital spending.
  - Election promise envisaged distributing up to Tog 1.5 million to each citizen (about $1,300 per person or 55 percent of projected 2009 GDP) starting in 2009.
  - Risks: large borrowing and spending could aggravate inflation and raise debt-to-GDP ratio.
  - Recommended approach: rely primarily on concessional borrowing in the near term; explore other distribution options such as public investment in education and infrastructure, aligned with the medium-term fiscal framework.

- Financial sector strengthening
  - Progress: joint IMF-World Bank FSAP found the financial system developing and performing well; BOM’s banking supervision framework generally well developed.
  - Actions taken: strengthened capacity of the Financial Regulatory Commission (FRC); FRC working to relicense saving and credit cooperatives, insurance companies, and other nonbank financial institutions; BOM enhancing risk management capacity.
  - Remaining priorities: continue strengthening supervisory capacity (including monitoring large exposures and enacting draft laws for nonbank supervision) and closer monitoring of bank loan quality given rapid credit growth.

### Fund relations and engagement
- The 2008 Article IV consultation was concluded on June 4, 2008, and Board documents have been published.
- More than 20 technical assistance missions have taken place since January 2007.
- Total outstanding obligations to the Fund at end-September 2008 amounted to SDR 14 million (27 percent of quota).
- Staff expects to remain engaged in close policy dialogue with the authorities, coordinated with the World Bank and the Asian Development Bank.

*Source: IMF assessment letter for the Asian Development Bank, Mongolia, October 23, 2008.*

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