## _cr0730 — Executive Summary

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### Background
- Mongolia’s economic performance:
  - Annual real GDP growth has averaged 7 percent since 2002.
  - Inflation has been reduced to mid-single digit levels.
  - The budget and current account balances recorded growing surpluses in 2005-06.
- Near-term risks:
  - Fiscal position expected to weaken in 2007 due to social spending and wage increases, tax cuts, and somewhat lower copper prices.
  - Continued rapid monetary growth and fiscal stimulus could increase inflationary pressures.
- External and reserve position:
  - Nominal and real effective exchange rates of the togrog have appreciated moderately.
  - International reserves have increased to nearly 3½ months of imports of goods and services.
- Institutional steps:
  - Authorities have taken initial steps to strengthen central bank governance, in line with Fund recommendations.

### Fiscal policy — findings, recent developments, and implications
- Preserve recent reduction in public debt burden; target social welfare spending more effectively; advance civil service reforms.
- Recent fiscal developments and indicators:
  - Overall budget balance shifted from a deficit of 4 percent of GDP in 2003 to a surplus of 3 percent in 2005, projected to widen to 9 percent of GDP in 2006.
  - Mining revenues increased sevenfold between 2003 and 2006.
  - Total expenditure fell from 42 percent of GDP in 2003 to an estimated 31½ percent in 2006, despite a 30 percent wage increase in 2006 and an expansion of social welfare transfers.
  - Net present value (NPV) of public debt dropped from 80 percent of GDP at end-2003 to 45 percent at end-2005, and is expected to fall further to 35 percent at end-2006.
- Windfall tax and Development Fund (June 2006):
  - 68 percent tax rate applies to copper revenues from prices exceeding the sum of a base price (US$2,600 per ton) and smelting costs (projected at US$1,580 per ton), and gold revenues from prices exceeding US$500 per ounce.
  - Development Fund allocation rules: (i) one third of total for saving; (ii) one third for capital expenditure; and (iii) one third for children and family allowances.
- Mining regime changes:
  - Doubling of royalties on metals from 2.5 percent to 5 percent.
  - Increase in mining license fees and shortening of license duration.
  - Doubling (up to 30 years) of the maximum duration for investment contracts, with possible stability clauses.
  - Government equity participation up to 34 percent in “strategic deposits,” up to 50 percent for strategic deposits discovered with government support.

### Fiscal policy — 2006–2007 and medium-term fiscal stance (mission recommendations)
- 2006 outturns and projections:
  - Budget surplus could widen to 9 percent of GDP in 2006.
  - External current account surplus (including official transfers) expected to widen from 1½ percent of GDP in 2005 to 5 percent of GDP in 2006.
  - Gross international reserves expected to reach US$626 million (3½ months of imports of goods and services) by end-2006.
  - NPV of external public debt expected to fall to 32 percent of GDP (half the level at end-2003).
- 2007 budget and risks:
  - 2007 budget projects an overall deficit of nearly 5 percent of GDP.
  - Nonmineral deficit projected to widen from 4½ percent of GDP in 2006 to 16½ percent in 2007.
  - Authorities assume average copper price in 2007 will be US$6,000 per ton; recent actual prices in recent months have remained around US$7,000 per ton.
  - The amended 2006 budget copper price assumption is US$5,200 per ton, while actual price generally remained above US$7,000 per ton for the second half of the year.
- Tax and spending measures in the 2007 budget (fiscal impact estimates):
  - Unification of the personal income tax (PIT) at the lowest of the previous rates (10 percent) — estimated cost 0.5 percent of GDP.
  - A five percentage point cut in each of the two corporate income tax (CIT) rates along with a thirty-fold increase in the higher rate’s threshold, elimination of tax holidays for foreign investors, introduction of loss carry-forward provisions, and use of investment tax credits in priority sector — estimated cost 1.7 percent of GDP.
  - Increases in excises on vehicles and gambling — estimated revenue gain 0.1 percent of GDP.
  - Other changes: a further 30 percent increase in civil service wages, a 0.8 percent increase in civil service employment, a substantial increase in the child allowance, and an increase in capital spending by 4.4 percent of GDP.
- Mission recommendations for 2007 and medium term (selected):
  - Contain the overall deficit to 2 percent of GDP in 2007 (a nonmineral deficit of 13½ percent), financeable entirely by concessional foreign borrowing.
  - Most short-term fiscal adjustment to occur on expenditure side:
    - Scale back the very large increase in the child allowance and reintroduce means testing for the benefit.
    - Cap the size of the civil service at current levels until the civil service census and functional ministerial reviews are completed.
    - Limit the near-term increase in public investment spending to no more than 2 percentage points of GDP.
  - Be prepared to reverse some tax rate cuts if minerals prices fall more than currently projected; reverse at least part of the 5 percentage point cut in the VAT rate if required.
  - Consolidate the Development Fund with the rest of the budget and clarify how much windfall revenue will be spent, over what timeframe, and for what purposes.
  - Medium-term objective: bring the nonmineral deficit back down to around 7 percent of GDP and achieve a gradual reduction in the NPV of public debt to below 30 percent of GDP.

### Monetary policy and financial sector
- Monetary aggregates and policy stance:
  - Reserve money growth picked up from 20 percent (year-on-year) in December 2005 to 27 percent in September 2006.
  - Broad money increased by 38 percent in the year to September (2006).
  - Staff encouraged authorities to contain reserve money growth to 15 percent in 2007 to keep inflation in the mid-single digits.
  - To achieve reserve money target, the Bank of Mongolia (BOM) should increase issuance of CBBs at market-clearing interest rates.
- Institutional/operational recommendations:
  - Government should ensure the central bank remains adequately capitalized; conversion of a noninterest-bearing central bank advance to the government into interest-bearing bonds noted as a positive step.
  - BOM should better integrate operations of its International and Monetary Policy Departments to ensure changes to reserve money driven by purchases of gold from domestic producers are appropriately sterilized.
  - Technical assistance mission by MCM scheduled for December 2006 to advise on monetary policy instruments.
- Mortgage finance and capital markets:
  - Establishment of the Mongolian Mortgage Corporation (MIC) welcomed; MIC expected to provide well-secured lending and facilitate development of a secondary market.
  - Mission cautioned BOM to refrain from providing guarantees or large liquidity injections to support MIC operations.
- Financial sector supervision and risks:
  - Nonperforming loans (NPLs) reduced from 23½ percent of total loans at end-2000 to 9 percent at end-2005; ratio remained relatively stable in 2006.
  - NPLs at some small and medium-sized banks have increased; profitability has deteriorated in these banks.
  - Recommendations:
    - Intensify supervision of banks with high credit growth or rising NPLs.
    - Draw up contingency plans for resolution of problem banks.
    - Proceed very cautiously with plans to introduce a bank deposit insurance scheme; exclude SCCs and other nonbank financial institutions from any bank deposit insurance scheme.

### Central bank governance, reserves, and gold exposures
- Governance improvements:
  - BOM appointed two non-executive directors to its Board of Directors in September 2006.
  - Authorities are examining changes in the Central Bank Law to shift key decision-making authority from the Governor to the Board of Directors.
  - Mission encouraged strengthening the BOM’s external Supervisory Board and moving toward full compliance with the 2003 Safeguards Assessment.
- International reserves and gold:
  - International reserves should be held in low risk, unencumbered assets.
  - BOM’s exposures in the gold market could raise risks; recommendations include preparing a timely exit strategy from the gold market, adopting more prudent guidelines for gold risk exposures, and ceasing risky positions in gold derivatives and other speculative instruments.

### External sector and exchange rate
- External performance:
  - Minerals sector and high world prices for copper and gold underpin strong export performance.
  - International reserves reconstituted after heavy drawdown in late 2003 and are nearly 3½ months of imports of goods and services.
  - Togrog appreciated moderately in nominal and real effective terms.
- Exchange rate and reserves projections:
  - REER appreciated by about 18 percent since end-2004.
  - Togrog depreciated by ½ percent in 2005 but appreciated by 4½ percent during the first nine months of 2006 (in terms of the U.S. dollar).
  - Gross international reserves expected to reach 4 months of import cover at end-2007.
- External borrowing and trade recommendations:
  - Continue borrowing exclusively on concessional terms.
  - Refrain from granting external loan guarantees on behalf of domestic borrowers.
  - Strengthen collection of on-lent funds.
  - Resist pressures for protectionism: adhere to schedule to eliminate the raw cashmere export tax and resist raising import duties.

### Mining sector prospects (summary of Box 1)
- Non-fuel mineral sector:
  - Contributes 25 percent of GDP.
  - Accounts for about 70 percent of export earnings and 16 percent of tax revenue.
  - Direct employment share is 2.4 percent of the labor force.
- Key mines and prospects:
  - Erdenet: annual copper concentrate output about 130,000 tons; ore reserves of 1.54 billion tons; 30-year lifespan.
  - Oyu Tolgoi (Ivanhoe): initial annual copper concentrate output would be 300,000 tons with a 1 million ton peak to be reached within six years; copper ore reserves would provide for a 40-year lifespan; commercial production expected to begin in 2009 (subject to finalizing investment contract).
  - Gold: accounted for 31 percent of exports in 2005; prospects depend on development of Oyu Tolgoi and Gatsuurt (Boroo).
  - Other resources: fluorite, Tumurtiinovoo zinc (14-year lifespan), phosphate at Burenkhaan, coal reserves at Tavan Tolgoi (5 billion tons), Turmurtei iron deposit (229 million tons), and identified natural gas and petroleum reserves.

### Governance, structural reforms, poverty, and social policy
- Political and reform environment:
  - Current coalition formed in January 2006 (MPRP plus three smaller parties).
  - MPRP gained an absolute (one-seat) majority in Parliament after a September 2006 by-election.
  - Government’s ability to implement reforms constrained by parliamentary actions (examples: imposition of a windfall tax, VAT rate cut, and increases in untargeted social spending).
  - Next national elections slated for mid-2008.
- Poverty and targeting:
  - Poverty remains high at 36 percent.
  - Staff recommends saving most of the large revenue windfall from high commodity prices to achieve fiscal sustainability without disruptive cuts in government expenditure.
  - Specific concern: universal child allowance in 2007 budget would provide the equivalent of 10 percent of per capita GDP to 40 percent of the population; staff recommends reintroducing means testing and scaling back the increase.
- Structural reforms and transparency:
  - Adoption of the Anti-Corruption Law and endorsement of the Extractive Industries Transparency Initiative (EITI).
  - Public enterprise reforms: Savings Bank privatized; bidding underway for privatization of Gobi Cashmere; energy sector enterprises slated for restructuring.
  - Staff urged consolidation of the Development Fund with the budget and clearer rules on windfall revenue use.

### Outlook, risks, and staff appraisal
- Growth outlook:
  - Near-term prospects favorable, supported by high minerals prices and large-scale foreign investment.
  - Growth estimated at 7 percent in 2006 and projected at about 7 percent in 2007.
  - Staff medium-term scenario envisages real GDP growth averaging 6-7 percent over the medium term with inflation contained to 5 percent, provided fiscal and monetary discipline maintained.
- Key risks:
  - Significant decline in copper prices as projected by the WEO could complicate objectives.
  - Other vulnerabilities: still-high level of public debt, harsh climate, large landlocked and sparsely populated territory, weak economic infrastructure.
- Staff appraisal highlights:
  - Rapid monetary growth indicates reintermediation and improving banking confidence, but continued rapid growth could fuel higher inflation; sell central bank bills to mop up liquidity.
  - Maintain flexible exchange rate and limit interventions to smoothing short-term movements.
  - Continue to avoid nonconcessional external borrowing and external loan guarantees.

### Debt sustainability and stress tests (ANNEX I highlights)
- Baseline DSA assumptions:
  - Real GDP growth: 7 percent in 2006; 7 percent from 2007 to 2009; 11 percent in 2010; declines to 6-5.5 percent between 2010 and 2014; 5 percent after 2015.
  - New borrowing only on concessional terms, projected at around US$150 million annually over the medium term; average concessionality assumed around 40 percent.
- Baseline DSA findings:
  - Public debt falls from about 68.3 percent of GDP at end-2005 to 46.3 percent at end-2011 and continues to decline thereafter.
  - NPV public debt temporarily decreases to 84.4 percent of revenues in 2006, then rebounds to 110.6 percent by the end of the decade (mainly because of sharp decline in mineral revenue).
  - Under the baseline, NPV of external debt-to-GDP and debt-service ratios remain below their respective thresholds.
- Alternative scenarios and risks:
  - Terms of trade shock (Mongolia-specific bound test): copper and gold prices decline by 35 and 25 percent, respectively, in 2010; NPV of debt-to-GDP ratio and debt-to-export ratio deteriorate substantially; NPV of debt-to-GDP ratio will stay above the 40 percent threshold even in the long term.
  - Main risk: decline in GDP growth is primary risk to fiscal debt sustainability; under a scenario of growth falling to last decade’s average, NPV of debt-to-revenue ratio could reach around 170 percent at end-2011 and about 270 percent at end-2026.
- Conclusion:
  - Mongolia assessed at moderate risk of debt distress over the medium term, although the debt burden likely to remain sustainable over the long term if borrowing remains concessional and the external environment evolves per baseline.

### Key macroeconomic facts and selected indicators (selected data points)
- Nominal GDP (2005): $2,066 million
- Population (2005): 2.56 million
- Per capita GDP (2005): $806
- Poverty incidence: 36 percent
- Gross official international reserves (end-period; millions of US dollars): 178 (2003); 208 (2004); 333 (2005); 626 (2006); 800 (2007)
  - In months of next year's imports of goods and services: 1.5 (2003); 1.6 (2004); 2.1 (2005); 3.4 (2006); 3.9 (2007)
- Real GDP growth: 6.1 (2003); 10.8 (2004); 7.0 (2005); 6.8 (2006); 7.0 (2007)
- Consumer prices (period average): 5.1 (2003); 8.3 (2004); 12.1 (2005); 5.6 (2006); 5.6 (2007)
- Total public debt (percent of GDP): 113.0 (2003); 93.0 (2004); 68.3 (2005); 53.6 (2006); 50.6 (2007)
- NPV of total public debt (percent of GDP): 79.5 (2003); 59.9 (2004); 44.7 (2005); 34.6 (2006); 32.5 (proj. 2007)
- Mineral revenue/total revenue and grants (percent): 7.4 (2003); 11.2 (2004); 13.3 (2005); 23.4 (2006); 33.2 (2007)
- Broad money annual growth (selected): 49.7 (2003); 20.3 (2004); 20.6 (2005); 24.3 (2006); 34.4 (2007 proj.)
- Nonmineral overall balance (percent of GDP): -7.0 (2003); -6.3 (2004); -1.5 (2005); -11.1 (2006); -4.5 (2007)

*Source: IMF staff Executive Summary and associated annexes (content unit: _cr0730).*

### Executive Summary.......................................................................................................

### Executive Summary

### Background
- Mongolia’s economic performance has been very strong in recent years:
  - Annual real GDP growth has averaged 7 percent since 2002.
  - Inflation has been reduced to mid-single digit levels.
  - The budget and current account balances recorded growing surpluses in 2005-06.
- The fiscal position is expected to weaken in 2007 due to social spending and wage increases, tax cuts, and somewhat lower copper prices.
- Inflation currently is moderate, but there is a clear risk that continued rapid monetary growth and fiscal stimulus could increase inflationary pressures.
- The nominal and real effective exchange rates of the togrog have appreciated moderately, reflecting the strong balance of payments and improvement in the terms of trade.
- International reserves have increased to nearly 3½ months of imports of goods and services.
- The authorities have taken initial steps to strengthen central bank governance, in line with Fund recommendations.

### Key Issues and Policy Discussions (overview)
- Mongolia’s mineral resource endowment and its location between two large, fast-growing economies provide a good basis for sustained medium-term growth.
- Economy remains vulnerable to external shocks, including the possibility of declining copper prices, and poverty remains high.
- Addressing vulnerabilities requires:
  - Continued macroeconomic stability.
  - Improvements in infrastructure.
  - Structural reforms to promote private sector development.

### Fiscal Policy (findings and implications)
- Fiscal policy needs to preserve the recent reduction in the public debt burden.
- Need to target social welfare spending more effectively and move forward with civil service reforms.
- Some of the tax cuts coming into effect in 2007—particularly the 5 percentage point VAT cut—may need to be partly reversed in the future, if copper prices fall as much as the WEO projections.
- Recent fiscal developments:
  - Overall budget balance shifted from a deficit of 4 percent of GDP in 2003 to a surplus of 3 percent in 2005, projected to widen to 9 percent of GDP in 2006.
  - Mining revenues increased sevenfold between 2003 and 2006.
  - Total expenditure fell from 42 percent of GDP in 2003 to an estimated 31½ percent in 2006, despite a 30 percent wage increase in 2006 and an expansion of social welfare transfers.
  - Net present value (NPV) of public debt dropped from 80 percent of GDP at end-2003 to 45 percent at end-2005, and is expected to fall further to 35 percent at end-2006.
- The “windfall” tax introduced in June 2006:
  - 68 percent tax rate applies to copper revenues from prices exceeding the sum of a base price (US$2,600 per ton) and smelting costs (projected at US$1,580 per ton), and gold revenues from prices exceeding US$500 per ounce.
  - A Development Fund was established with allocation rules: (i) one third of total for saving; (ii) one third for capital expenditure; and (iii) one third for children and family allowances.
- Changes under the 2006 mining regime include:
  - Doubling of royalties on metals from 2.5 percent to 5 percent.
  - Increase in mining license fees and shortening of license duration.
  - Doubling (up to 30 years) of the maximum duration for investment contracts, with possible stability clauses.
  - Government equity participation up to 34 percent in “strategic deposits,” up to 50 percent for strategic deposits discovered with government support.

### Monetary Policy and Financial Sector
- Monetary aggregates have been growing rapidly:
  - Reserve money growth picked up from 20 percent (year-on-year) in December 2005 to 27 percent in September 2006.
  - Broad money increased by 38 percent in the year to September (2006).
- Monetary policy should aim at mopping up excess liquidity.
- The central bank should:
  - Continue governance reforms.
  - Ensure prudent management of its international reserves.
  - Develop an exit strategy from gold operations over the medium term.
  - Fully enforce prudential supervision, particularly of banks with rapid lending growth.

### External Sector and Reserves
- Minerals sector and high world prices for copper and gold underpin strong export performance.
- International reserves have been reconstituted after being heavily drawn down in late 2003 and are nearly 3½ months of imports of goods and services.
- The togrog has appreciated moderately in nominal and real effective terms, reflecting strong balance of payments and improved terms of trade.

### Mining Sector Prospects (summary of Box 1)
- Non-fuel mineral sector:
  - Contributes 25 percent of GDP.
  - Accounts for about 70 percent of export earnings and 16 percent of tax revenue.
  - Direct employment share is 2.4 percent of the labor force.
- Key mines and prospects:
  - Erdenet: annual copper concentrate output about 130,000 tons; ore reserves of 1.54 billion tons; 30-year lifespan.
  - Oyu Tolgoi (Ivanhoe): initial annual copper concentrate output would be 300,000 tons with a 1 million ton peak to be reached within six years; copper ore reserves would provide for a 40-year lifespan; commercial production expected to begin in 2009 (subject to finalizing investment contract).
  - Gold: accounted for 31 percent of exports in 2005; prospects depend on development of Oyu Tolgoi and Gatsuurt (Boroo).
  - Other resources: fluorite, Tumurtiinovoo zinc (14-year lifespan), phosphate at Burenkhaan, coal reserves at Tavan Tolgoi (5 billion tons), Turmurtei iron deposit (229 million tons), and identified natural gas and petroleum reserves.

### Governance, Structural Reforms, and Poverty
- Authorities have taken initial steps to strengthen central bank governance in line with Fund recommendations.
- The government formation and political environment:
  - Current coalition formed in January 2006 (MPRP plus three smaller parties).
  - MPRP gained an absolute (one-seat) majority in Parliament after a September 2006 by-election.
  - Government’s ability to implement reforms has been constrained by parliamentary actions (examples: imposition of a windfall tax, VAT rate cut, and increases in untargeted social spending).
  - Next national elections slated for mid-2008.
- Poverty remains high at 36 percent.
- Staff recommends saving most of the large revenue windfall from high commodity prices to achieve fiscal sustainability without disruptive cuts in government expenditure, and additional reforms to improve central bank governance and strengthen the financial system.

### Outlook and Risks
- Near-term economic prospects remain favorable, with growth likely to be sustained by still-high minerals prices and large-scale foreign investment in a major new mining project.
- Growth is estimated to have risen by 7 percent in 2006 and projected to remain at about 7 percent in 2007.
- Risks:
  - Significant decline in copper prices as projected by the WEO could complicate objectives.
  - Other vulnerabilities include a still-high level of public debt, harsh climate, large landlocked and sparsely populated territory, and weak economic infrastructure.

*Source: IMF staff Executive Summary (content unit: _cr0730 - Executive Summary).*

### 1.7 percent of GDP; (ii) unification of the personal income tax (PIT) at the lowest of the previous rates

### _cr0730 - 1.7 percent of GDP; (ii) unification of the personal income tax (PIT) at the lowest of the previous rates

### Fiscal policy — 2006–2007 and medium-term fiscal stance
- 2006 outturns and projections:
  - Budget surplus could widen to 9 percent of GDP in 2006.
  - External current account surplus (including official transfers) expected to widen from 1½ percent of GDP in 2005 to 5 percent of GDP in 2006.
  - Gross international reserves expected to reach US$626 million (3½ months of imports of goods and services) by end-2006.
  - NPV of external public debt expected to fall to 32 percent of GDP (half the level at end-2003).
- 2007 budget and risks:
  - 2007 budget projects an overall deficit of nearly 5 percent of GDP.
  - Nonmineral deficit projected to widen from 4½ percent of GDP in 2006 to 16½ percent in 2007.
  - Authorities assume average copper price in 2007 will be US$6,000 per ton; recent actual prices in recent months have remained around US$7,000 per ton.
  - The amended 2006 budget copper price assumption is US$5,200 per ton, while actual price generally remained above US$7,000 per ton for the second half of the year.
- Tax and spending measures in the 2007 budget (fiscal impact estimates):
  - Unification of the personal income tax (PIT) at the lowest of the previous rates (10 percent) — estimated cost 0.5 percent of GDP.
  - A five percentage point cut in each of the two corporate income tax (CIT) rates along with a thirty-fold increase in the higher rate’s threshold, elimination of tax holidays for foreign investors, introduction of loss carry-forward provisions, and use of investment tax credits in priority sector — estimated cost 1.7 percent of GDP.
  - Increases in excises on vehicles and gambling — estimated revenue gain 0.1 percent of GDP.
  - Other budgetary changes include a further 30 percent increase in civil service wages, a 0.8 percent increase in civil service employment, a substantial increase in the child allowance, and an increase in capital spending by 4.4 percent of GDP to address infrastructure needs.
- Mission recommendations for 2007 and the medium term:
  - Contain the overall deficit to 2 percent of GDP in 2007 (a nonmineral deficit of 13½ percent), financeable entirely by concessional foreign borrowing.
  - Most short-term fiscal adjustment to occur on expenditure side:
    - Scale back the very large increase in the child allowance and reintroduce means testing for the benefit.
    - Cap the size of the civil service at current levels until the civil service census and functional ministerial reviews are completed.
    - Limit the near-term increase in public investment spending to no more than 2 percentage points of GDP due to limited implementation and absorptive capacity.
  - Be prepared to reverse some tax rate cuts if minerals prices fall more than currently projected; in particular, reverse at least part of the 5 percentage point cut in the VAT rate if required.
  - Ensure mining tax regime leaves Mongolia an internationally competitive producer; authorities requested technical assistance from the Fund on mining taxation.
  - Resist proposals to compensate tax cuts by raising import duties.
  - Consolidate (numerically and conceptually) the Development Fund with the rest of the budget and clarify how much windfall revenue will be spent, over what timeframe, and for what purposes.
  - Medium-term objective: bring the nonmineral deficit back down to around 7 percent of GDP and achieve a gradual reduction in the NPV of public debt to below 30 percent of GDP.

### Monetary policy and financial sector
- Monetary and inflation objectives:
  - Staff’s medium-term scenario envisages real GDP growth averaging 6-7 percent over the medium term if appropriate policies are pursued, with inflation targeted to be contained to 5 percent throughout the period, provided fiscal and monetary discipline is maintained.
  - Mission encouraged authorities to contain reserve money growth to 15 percent in 2007 to keep inflation in the mid-single digits.
  - To achieve reserve money target, the Bank of Mongolia (BOM) should increase issuance of CBBs at market-clearing interest rates.
- Institutional and operational recommendations:
  - Government should ensure the central bank remains adequately capitalized; conversion of a noninterest-bearing central bank advance to the government into interest-bearing bonds noted as a positive step.
  - BOM should better integrate operations of its International and Monetary Policy Departments to ensure changes to reserve money driven by purchases of gold from domestic producers are appropriately sterilized.
  - A technical assistance mission by MCM to advise on monetary policy instruments was scheduled for December 2006.
  - On mortgage finance and capital markets:
    - Establishment of the Mongolian Mortgage Corporation (MIC) welcomed; MIC expected to provide well-secured lending and facilitate development of a secondary market.
    - Mission cautioned BOM to refrain from providing guarantees or large liquidity injections to support MIC operations.

### External sector, exchange rate, and debt
- Exchange rate and reserves:
  - Real effective exchange rate (REER) of the togrog appreciated by about 18 percent since end-2004.
  - Togrog depreciated by ½ percent in 2005 but appreciated by 4½ percent during the first nine months of 2006 (in terms of the U.S. dollar).
  - With increased inflows of direct investment in the mining sector and recovery in concessional official loans disbursements, gross international reserves expected to reach 4 months of import cover at end-2007.
- Current account and external debt projections:
  - Current account balance expected to revert to a deficit of 2 percent of GDP in 2007 owing to strong growth in investment imports financed by increased foreign direct investment.
  - Mongolia’s external debt is still moderately high but debt dynamics have improved markedly; under baseline scenario with sustained output and export growth and continued concessional borrowing, external debt ratios would decline over the long term.
  - Debt distress indicators could deteriorate and become unsustainable under plausible shocks, especially a severe terms of trade shock.
- Policy recommendations on external borrowing and trade:
  - Continue borrowing exclusively on concessional terms.
  - Refrain from granting external loan guarantees on behalf of domestic borrowers.
  - Strengthen collection of on-lent funds.
  - Resist pressures for protectionism: adhere to schedule to eliminate the raw cashmere export tax and resist raising import duties.

### Policy diagnostics, risks, and governance
- Macroeconomic diagnosis:
  - Strong recent performance driven by favorable external factors and sustained implementation of structural and financial reforms; large infrastructure investments needed to achieve growth potential.
  - Rapid monetary growth has not yet fed into inflation due to reintermediation, rising incomes, improved confidence in banking system, and gradual appreciation of the exchange rate.
- Key vulnerabilities and recommendations:
  - Economy remains vulnerable to external shocks, notably lower copper prices.
  - Staff encouraged saving most of the large revenue windfall from high commodity prices to keep public debt sustainable.
  - Fiscal policy should be grounded in a transparent medium-term framework to ensure sustainability, reduce vulnerability to shocks, and avoid procyclical demand impulses.
  - Improve transparency and credibility: consolidate Development Fund with the budget, align spending of the Development Fund with priorities, and base budget projections on realistic assessments of capacity constraints and implementation pace.
- Specific factual and programmatic figures noted:
  - Child allowance in 2007 budget would provide the equivalent of 10 percent of per capita GDP to 40 percent of the population.
  - The BOM had provided a 10-year noninterest-bearing advance to the government of US$100 million and a US$37 million, interest free, short-term loan at end-2003 to help finance settlement of pre-1991 Transferable Ruble debt.

_Italic: Source — IMF staff report content provided in the supplied PDF excerpt._

### 29.      Weaknesses in central bank governance, in areas including central bank oversight,

### Weaknesses in central bank governance, in areas including central bank oversight,

### Central bank governance and oversight
- Weaknesses in central bank governance—including central bank oversight, banking supervision, and the management of international reserves—have been viewed as potential risks to financial stability.
- The BOM made a good start in implementing reforms to strengthen its governance structures.
- In September 2006, the BOM appointed two non-executive directors to its Board of Directors, in line with technical assistance advice from the Fund.
- Authorities are examining possible changes in the Central Bank Law to shift key decision-making authority from the Governor to the Board of Directors, another Fund staff recommendation.
- The mission encouraged strengthening the BOM’s external Supervisory Board, which conducts oversight of the central bank.
- Staff encouraged the BOM to move toward full compliance with the 2003 Safeguards Assessment.

### International reserves and gold exposures
- Prudent management of international reserves is crucial for safeguarding financial stability.
- International reserves should be held in low risk, unencumbered assets.
- The BOM’s exposures in the gold market could raise risks to reserves management.
- Given limited capacity and appetite of banks to engage in complex gold operations, an immediate withdrawal from domestic gold purchases was not considered necessarily desirable.
- Recommendations:
  - Begin preparing a timely exit strategy from the gold market.
  - Adopt more prudent guidelines for gold risk exposures.
  - Cease immediately from taking risky positions in gold derivatives and other speculative instruments.
- Reiterated in staff appraisal: include a reduction in gold risk exposures and preparation of an exit strategy from the gold market.

### Banking system performance and risks
- Nonperforming loans (NPLs) of the banking system:
  - Reduced from 23½ percent of total loans at end-2000 to 9 percent at end-2005.
  - The ratio has remained relatively stable in 2006.
- NPLs at some small and medium-sized banks have increased, and their profitability has deteriorated.
- Rapid loan growth can make detection of incipient loan quality problems more difficult.
- Recommendations:
  - Intensify supervision of banks with high credit growth or rising NPLs.
  - Draw up contingency plans for the resolution of problem banks.
  - Proceed very cautiously with plans to introduce a bank deposit insurance scheme.
- Staff appraisal points:
  - Rapid credit growth and fraudulent LCs illustrate need for vigilant enforcement of prudential regulations.
  - High priority: monitoring banks with fast credit growth and rising NPLs, strengthening banks’ governance, and establishing contingency plans for problem banks.
  - Public sector should not bail out insolvent savings and credit cooperatives; these institutions are not to be included in any future deposit insurance scheme for banks.
  - Staff urges authorities to continue resisting calls for administrative measures to reduce high bank lending rates.

### Supervisory and regulatory actions
- Authorities reported additional steps to strengthen banking supervision:
  - Several banks with rapid credit growth subject to intensified supervision.
  - BOM is strengthening capacity to enforce fit and proper requirements for major bank shareholders.
  - All 16 banks have complied with the doubling of the minimum capital requirement set by the BOM.
  - Some progress in identifying final borrowers in a fraud scheme involving letters of credit from a Korean supplier.

### Nonbank financial institutions and SCCs
- Solvency problems have emerged at a number of saving and credit cooperatives (SCCs).
- Financial Regulatory Commission (FRC) established in 2006 to supervise SCCs and other nonbank financial institutions.
- FRC actions:
  - Reviewing applications for licenses from SCCs; some applications rejected.
  - Initiated on-site examinations.
  - Plans to intensify supervision of securities firms, insurance companies, and other nonbank financial institutions.
- Mission stressed SCCs and other nonbank financial institutions should be excluded from any deposit insurance scheme for the banking system, if one is developed.

### AML/CFT and Financial Intelligence Unit
- Recent adoption of the AML/CFT Law was welcomed.
- Authorities plan to establish a Financial Intelligence Unit (FIU) within the BOM.
- Some issues remain to be addressed to ensure full compliance with FATF recommendations.
- Authorities intend to strengthen further the AML/CFT framework as needed to meet international standards.

### Structural reforms, poverty reduction, and statistics
- Tax administration, regulatory, and public enterprise reforms aimed to strengthen private sector development.
- Adoption of the Anti-Corruption Law expected to help remove impediments to doing business, though the law still needs further strengthening to meet international requirements.
- Authorities have endorsed the Extractive Industries Transparency Initiative (EITI).
- Public enterprise reforms under way:
  - Savings Bank recently privatized.
  - Bidding underway for privatization of Gobi Cashmere.
  - Energy sector enterprises slated for comprehensive restructuring under a forthcoming World Bank-supported energy sector reform project.
- Socio-Economic Guidelines finalized to strengthen the poverty reduction strategy.
  - Poorly targeted social welfare programs, such as the universal child allowance and lump-sum awards to newlyweds and newborns, dilute resources for poverty alleviation.
  - Staff reiterated need to reintroduce means testing where possible and to scale back the very large increase in the child allowance provided in the 2007 budget.
- Statistical improvements:
  - Work underway to expand coverage of national accounts data.
  - An STA mission in September 2006 made progress reconciling discrepancies on domestic bank financing in the monetary data and government finance statistics.
  - Mongolia participating in the pilot program for introduction of the Government Finance Statistics Manual (GFSM) 2001 methodology.
  - Authorities requested World Bank and Fund support to implement their Program of Official Statistics Development (2006-2010).
  - Staff welcomes broadened coverage of national accounts, reconciliation of discrepancies between fiscal and monetary data, and participation in GFSM 2001 pilot project; further technical assistance important.

### Staff appraisal — macroeconomic outlook and policy recommendations
- Recent performance and current position:
  - Real GDP growth has averaged 7 percent since 2002.
  - Inflation has been brought back down to the mid-single digits.
  - The budget surplus is expected to widen to over 9 percent of GDP in 2006.
  - The external current account is in surplus.
  - Public debt ratios have declined.
  - International reserves have been rebuilt to more comfortable levels.
- Opportunities and risks:
  - Mongolia’s mineral resources and location between two large, fast-growing economies provide foundation for sustained growth.
  - Medium-term challenges: weak infrastructure, landlocked and sparsely populated territory, harsh climate, and high poverty.
  - Copper price run-up that helped recent expansion could be partly reversed.
  - Overcoming obstacles requires policies to maintain macroeconomic stability, improve infrastructure, reduce structural rigidities, and utilize natural resources effectively.
- Fiscal policy:
  - Fiscal position improved due to strong growth, sharp increase in mining sector revenues, and improved tax administration.
  - Maintaining gains and keeping public debt on a declining path may require policy adjustments, particularly if copper prices decline significantly.
  - The loosening of fiscal policy implied by the 2007 budget would be ill-advised.
  - Staff considers it feasible and desirable to contain the overall budget deficit to 2 percent of GDP in 2007.
  - Revenue-side challenge: maintain a broadly based tax regime not overly sensitive to commodity price shocks.
    - Tax reform package effective January 1, 2007 includes elimination of tax holidays, introduction of loss carry forward, and deductibility of a fuller range of business expenses.
    - Government decision to rely more on mining taxation while cutting nonmining taxes entails risks.
    - Authorities may need to undo some tax rate cuts if copper prices decline significantly.
    - Reversing part of the 5 percentage point cut in the VAT rate would be the least distortionary way to accomplish this.
    - Keep mining regime under close review to limit risks to the public sector balance sheet while maintaining international competitiveness.
  - Expenditure reform needed to improve efficiency and effectiveness of government spending.
    - Universal coverage of some welfare benefits strains the budget; reintroduce means testing where possible.
    - Scale back the very large increase in the child allowance in the 2007 budget; further reductions may be needed.
    - Move forward with civil service reforms to pay for increases in public sector wages.
- Monetary policy and liquidity management:
  - Rapid monetary growth indicates reintermediation and improving banking confidence, but continued rapid growth will feed into higher inflation.
  - Authorities should step up sales of central bank bills to slow growth in reserve money.
  - BOM requested Fund technical assistance to develop additional monetary policy instruments and strengthen liquidity management.
- Exchange rate and external policies:
  - Flexible exchange rate regime, prudent external borrowing policies, and open trade regime have facilitated orderly adjustment and should be retained.
  - Strengthening of the togrog has been warranted by commodity price developments and the strong balance of payments.
  - Intervention should remain limited to smoothing short-term movements.
  - To prevent increased external debt service burden, government and central bank should refrain from nonconcessional external borrowing.
  - Staff encourages prompt agreement with foreign creditors on outstanding obligations and debt disputes.
  - Staff urges phase out of export duty on raw cashmere and resist calls to raise import duties to protect domestic industries.
- Financial sector recommendations (summary):
  - Strengthen central bank governance: shift decision-making authority from BOM Governor to Board of Directors.
  - Reduce gold risk exposures and prepare exit strategy from gold market.
  - Monitor and enforce prudential regulations, especially for banks with rapid credit growth or rising NPLs.
  - Strengthen banks’ governance and establish contingency plans for problem banks.
  - Do not include SCCs and other nonbank financial institutions in any bank deposit insurance scheme; do not bail out insolvent SCCs.
  - Continue institutional reforms to support private sector development and improve public enterprise operations, especially in the energy sector.

*IMF staff report content.*

### 49.      The staff recommends that the next Article IV consultation with Mongolia take

### _cr0730 - 49. The staff recommends that the next Article IV consultation with Mongolia take place on the standard 12-month cycle.

### Staff recommendation
- The staff recommends that the next Article IV consultation with Mongolia take place on the standard 12-month cycle.

### Key macroeconomic facts and projections
- Nominal GDP (2005): $2,066 million
- Population (2005): 2.56 million
- Per capita GDP (2005): $806
- Poverty incidence: 36 percent
- Quota: SDR 51.1 million
- Nominal GDP (billion togrogs): 1,474 (2003); 1,926 (2004); 2,489 (2005); 3,306 (2006); 3,306 (2007)
- Nominal GDP (million U.S. dollars): 1,285 (2003); 1,615 (2004); 2,066 (2005); 2,788 (2006); 2,788 (2007)
- Real GDP growth: 6.1 (2003); 10.8 (2004); 7.0 (2005); 6.8 (2006); 7.0 (2007)
  - Mineral: -2.3 (2003); 34.3 (2004); 10.9 (2005); ... (2006); 5.2 (2007)
  - Nonmineral: 7.1 (2003); 8.1 (2004); 6.5 (2005); ... (2006); 7.3 (2007)
- Consumer prices (period average): 5.1 (2003); 8.3 (2004); 12.1 (2005); 5.6 (2006); 5.6 (2007)
- Consumer prices (end-period): 4.7 (2003); 11.0 (2004); 9.5 (2005); 7.0 (2006); 5.0 (2007)
- GDP deflator: 11.6 (2003); 18.0 (2004); 20.7 (2005); 24.1 (2006); 24.1 (2007)

### Fiscal sector (general government; percent of GDP and levels)
- Revenue and grants: 37.6 (2003); 37.0 (2004); 33.7 (2005); 33.2 (2006); 40.6 (2007); 35.9 (2006 est.); 35.5 (2007 proj.)
- Expenditure and net lending: 41.8 (2003); 39.1 (2004); 30.7 (2005); 36.6 (2006); 31.7 (2007); 40.9 (2006 est.); 37.5 (2007 proj.)
- Current balance: 7.5 (2003); 8.6 (2004); 9.3 (2005); 6.5 (2006); 16.4 (2007); 6.8 (2006 est.); 7.8 (2007 proj.)
- Primary balance: -3.0 (2003); -0.9 (2004); 3.8 (2005); -2.6 (2006); 9.6 (2007); -4.4 (2006 est.); -1.4 (2007 proj.)
- Overall balance (including grants): -4.2 (2003); -2.1 (2004); 2.9 (2005); -3.4 (2006); 9.0 (2007); -5.0 (2006 est.); -2.0 (2007 proj.)
- Nonmineral overall balance: -7.0 (2003); -6.3 (2004); -1.5 (2005); -11.1 (2006); -4.5 (2007); -16.3 (2006 est.); -13.6 (2007 proj.)

- Selected fiscal levels (millions of US dollars):
  - Total revenue and grants: 553.9 (2003); 713.1 (2004); 837.9 (2005); 1,097.6 (2006); 1,343.4 (2007)
  - Total expenditure and net lending: 615.8 (2003); 753.7 (2004); 764.6 (2005); 1,209.2 (2006); 1,046.5 (2007)
  - Overall balance (incl. grants): -61.9 (2003); -40.6 (2004); 73.3 (2005); -111.6 (2006); 296.8 (2007); -189.9 (2006 est.); -76.6 (2007 proj.)
  - Mineral revenue/total revenue and grants (percent): 7.4 (2003); 11.2 (2004); 13.3 (2005); 23.4 (2006); 33.2 (2007)

### Monetary sector and financial indicators
- Broad money (end-period; billions of togrogs): 704 (2003); 846 (2004); 892 (2005); 1,009 (2006); 1,112 (2007); 1,162 (2006 est.); 1,205 (2007 proj.)
- Annual broad money growth: 49.7 (2003); 20.3 (2004); 20.6 (2005); 24.3 (2006); 34.4 (2007); 37.3 (2006 est.); 35.1 (2007 proj.)
- Domestic credit (end-period): 601 (2003); 740 (2004); 747 (2005); 805 (2006); 828 (2007)
- Claims on nonbanks: 449 (2003); 646 (2004); 682 (2005); 757 (2006); 821 (2007)
- Annual growth of credit to nonbanks: 90.3 (2003); 43.7 (2004); 34.1 (2005); 33.5 (2006); 34.7 (2007)
- Reserve money (end-period; billions of togrogs): 201 (2003); 235 (2004); 253 (2005); 296 (2006); 297 (2007)
- Annual reserve money growth: 14.7 (2003); 16.8 (2004); 10.5 (2005); 20.4 (2006); 16.3 (2007)
- Broad money velocity (GDP/BM, seasonally adjusted): 2.1 (2003); 2.3 (2004); 2.3 (2005); 2.2 (2006); 1.9 (2007)
- Annual interest rate on central bank bills (annualized yield on end-period auction of 14-day bills): 15.0 (2003); 15.8 (2004); 3.7 (2005); ... (2006 as of end-September 2006)

- Banking sector indicators (selected):
  - Nonperforming loans/total loans (percent): 8.2 (2003); 10.9 (2004); 11.2 (2005); 10.0 (2006); 10.0 (2007)
  - Loans to deposits: 92.8 (2001); 100.0 (2002); 113.1 (2003); 116.6 (2004); 121.8 (2005)
  - Liquid assets/total assets: 41.3 (2001); 39.9 (2002); 35.3 (2003); 31.6 (2004); 36.0 (2005)

### External sector and balance of payments
- Current account balance (excluding official transfers; millions of US dollars): -148 (2003); -60 (2004); -59 (2005); ... (2006); 55 (2007); ...; -159 (projection)
  - In percent of GDP: -11.5 (2003); -3.7 (2004); -2.8 (2005); ...; 2.0 (2007); ...; -5.2 (proj.)
- Current account balance (including official transfers; millions of US dollars): -99 (2003); 272 (2004); 29 (2005); 145 (2006); ...; -67 (proj.)
  - In percent of GDP: -7.7 (2003); 1.6 (2004); 1.4 (2005); ...; 5.2 (2006); ...; -2.2 (proj.)
- Trade balance (millions of US dollars): -199 (2003); -149 (2004); -155 (2005); 16 (2006); ...; -169 (proj.)
  - Trade balance (percent of GDP): -15.5 (2003); -9.2 (2004); -7.5 (2005); 0.6 (2006); ...; -5.5 (proj.)
- Exports, f.o.b. (millions of US dollars): 627 (2003); 872 (2004); 1,069 (2005); 1,548 (2006); 1,635 (2007)
  - Exports (percent change): 19.7 (2003); 39.0 (2004); 22.5 (2005); ...; 44.8 (2006); ...; 5.6 (2007)
- Imports, c.i.f. (millions of US dollars): 827 (2003); 1,021 (2004); 1,224 (2005); 1,532 (2006); 1,804 (2007)
  - Imports (percent change): 9.8 (2003); 23.5 (2004); 19.8 (2005); ...; 25.2 (2006); ...; 17.7 (2007)
- Foreign direct investment (millions of US dollars): 132 (2003); 129 (2004); 258 (2005); 329 (2006); 499 (2007)

- Gross official international reserves (end-period; millions of US dollars): 178 (2003); 208 (2004); 333 (2005); 626 (2006); 800 (2007)
  - In months of next year's imports of goods and services: 1.5 (2003); 1.6 (2004); 2.1 (2005); 3.4 (2006); 3.9 (2007)

- Export prices (U.S. dollar, percent change): 6.6 (2003); 23.1 (2004); 13.6 (2005); ...; 40.4 (2006); ...; 0.0 (2007)
- Import prices (U.S. dollar, percent change): 5.4 (2003); 15.1 (2004); 11.0 (2005); ...; 11.6 (2006); ...; -0.5 (2007)
- Terms of trade (percent change): 1.1 (2003); 7.0 (2004); 2.3 (2005); ...; 25.8 (2006); ...; 0.5 (2007)

### Public and external debt metrics
- Total public debt (In percent of GDP): 113.0 (2003); 93.0 (2004); 68.3 (2005); ...; 53.6 (2006); 50.6 (2007)
  - Domestic debt (In percent of GDP): 14.8 (2003); 7.6 (2004); 4.2 (2005); ...; 2.6 (2006); 2.0 (2007)
- External debt (millions of US dollars): 1,237 (2003); 1,361 (2004); 1,308 (2005); ...; 1,405 (2006); ...; 1,480 (2007)
  - External debt (In percent of GDP): 98.2 (2003); 85.4 (2004); 64.1 (2005); ...; 51.0 (2006); ...; 48.6 (2007)
  - External debt (In percent of total public debt): 86.9 (2003); 91.8 (2004); 93.9 (2005); ...; 95.1 (2006); ...; 96.1 (2007)
- Net public debt (In percent of GDP): 105.2 (2003); 88.0 (2004); 62.4 (2005); 50.1 (2006); 41.2 (2007); ...; 36.9 (proj.)
- NPV of total public debt (In percent of GDP): 79.5 (2003); 59.9 (2004); 44.7 (2005); ...; 34.6 (2006); ...; 32.5 (proj.)
- Debt service: 284.0 (2003); 91.2 (2004); 42.8 (2005); ...; 41.8 (2006); ...; 49.8 (proj.)
  - Debt service (In percent of exports of goods and services): 34.0 (2003); 7.5 (2004); 2.9 (2005); ...; 2.1 (2006); ...; 2.4 (proj.)

### Medium-term framework highlights (2003–11 select projections)
- Real GDP (percent change) projected range: 7.0 (2007); 11.0 (2008); 6.0 (2009)
- Nominal GDP (millions of U.S. dollars) projections: 3,092 (2007); 3,228 (2008); 3,477 (2009); 3,917 (2010); 4,199 (2011)
- Per capita GDP (U.S. dollars): 806 (2005); 1,075 (2006); 1,179 (2007); 1,217 (2008); 1,296 (2009)
- Copper prices (US$ per ton) memoranda: 3,676 (2005); 6,300 (2006); 6,000 (2007); 4,000 (2008); 3,200 (2009)
- Gold prices (US$ per ounce) memoranda: 445 (2005); 610 (2006); 670 (2007); 705 (2008); 745 (2009)

### Policy implications and vulnerabilities (based on indicators presented)
- Large swings in mineral-sector activity drive volatility in growth, fiscal balances, and external accounts (e.g., mineral revenue/total revenue rising from 2.8 percent in 2003 to 33.2 percent in 2006).
- Despite high headline growth in some years, nonmineral balances show recurring deficits (Nonmineral overall balance: -7.0 (2003); -6.3 (2004); -1.5 (2005); -11.1 (2006)).
- External vulnerability indicators improved with rising reserves (Gross official international reserves: 178 (2003) → 626 (2006) → 800 (2007)) but external debt and debt-service metrics remain material (External debt/GDP: 98.2 (2003); 51.0 (2006)).
- Monetary expansion and strong credit growth (Annual broad money growth and annual growth of credit to nonbanks) highlight the need for continued macroeconomic and financial supervision.

*Sources: Data provided by the Mongolian authorities; and Fund staff estimates and projections.*

### ANNEX I. Mongolia—Debt Sustainability Analysis

### ANNEX I. Mongolia—Debt Sustainability Analysis

### A. Introduction
- Joint debt sustainability analysis (DSA) of the IMF and the World Bank staff.
- Mongolia is rated as a medium performer with regard to its policies and institutions under the joint IMF-WB DSA framework for low-income countries.

### B. Baseline scenario — Assumptions
- Real GDP growth assumptions:
  - 7 percent in 2006.
  - 7 percent from 2007 to 2009.
  - 11 percent in 2010 when the main Ivanhoe Mines’ production starts.
  - Declines to 6-5.5 percent between 2010 and 2014.
  - 5 percent after 2015.
- Growth drivers: ongoing development of the Oyu Tolgoi (Ivanhoe) Mine, start up of additional new mining sector and infrastructure projects, continued development of the service sector.
- Fiscal assumption: 2007 overall budget deficit assumed to be 2 percent of GDP (3 percentage points lower than the 2007 budget proposal of the Government), conditional on implementation of additional policy measures recommended in the Article IV document.
- Balance of payments:
  - Export growth: strong in 2006; slowdown in 2007-09 as copper prices revert to long-term trend; substantial pick up in 2010 when the main Ivanhoe Mine begins production.
  - Imports: higher due mainly to equipment for mining operations and infrastructure development.
  - Long-term assumptions: export growth 6.5-7.5 percent beyond 2015; imports about 7 percent over the long term.
- New borrowing:
  - Only on concessional terms.
  - Projected at around US$150 million annually over the medium term.
  - Increase by about 2½ percent annually over the longer term.
  - Average concessionality of new external borrowing assumed at around 40 percent.

### B. Baseline scenario — Fiscal DSA (Table 1a) — Key findings
- Public sector debt trajectory:
  - Public debt falls from about 68.3 percent of GDP at end-2005 to 46.3 percent at end-2011 and continues to decline thereafter.
- NPV metrics relative to revenues:
  - NPV public debt temporarily decreases to 84.4 percent of revenues in 2006, then rebounds to 110.6 percent by the end of the decade (mainly because of sharp decline in mineral revenue).
- Debt service-to-revenue ratio:
  - Declines below 3.3 percent in 2006, then steadily increases through the forecast period.
- NPV of government debt as share of GDP:
  - Declines to 30 percent by the end of this decade and remains below 30 percent thereafter.

### B. Baseline scenario — External DSA (Table 2a) — Key findings
- NPV of debt-to-GDP ratio:
  - 40 percent at end-2005 (only indicator initially above its threshold).
  - Expected to decline to 32 percent in 2006, mostly due to substantial nominal GDP growth (nominal GDP in US dollar expected to increase substantially in 2006 (33 percent) driven by high GDP deflator growth).
  - Expected to stay at similar levels in near term before further dropping in the longer term.
- NPV of debt-to-export ratio:
  - Would stay well below the corresponding threshold (150 percent) during the entire projection period, though expected to increase in the near term with slowdown of export growth.
- Debt service ratio:
  - Would stay below 3.5 percent of exports under the baseline scenario, against the 20 percent threshold.
- NPV of debt-to-revenue ratio and debt service-to-revenue ratio:
  - Would stay well below the 250 percent and 30 percent thresholds, respectively.

### C. Alternative scenarios and bound tests — Fiscal DSA (Table 1b) — Findings and policy implication
- Main risk: decline in GDP growth would be the primary risk to fiscal debt sustainability.
- Scenario: decline in growth rates to the last decade’s average:
  - NPV of debt-to-revenue ratio would reach around 170 percent at end-2011 and increase to about 270 percent at end-2026.
- Scenario: unchanged nonmineral primary balance:
  - Yields much lower debt indicators because it does not include recently passed tax cuts that apply from 2007.
- Policy recommendation:
  - Authorities should continue to strengthen competitiveness of the private sector and improve the business climate to support baseline growth.

### C. Alternative scenarios and bound tests — External DSA (Table 2b) — Findings
- Terms of trade (commodity price) shock (Mongolia-specific bound test, case B.2):
  - Assumptions:
    - Copper and gold prices decline by 35 and 25 percent, respectively, in 2010, and each rises by 1 percent annually thereafter.
    - Real GDP growth reduced by 0.5 percent in 2010, and by 0.25 percent thereafter compared with the baseline.
  - Impacts:
    - NPV of debt-to-GDP ratio and debt-to-export ratio deteriorate substantially.
    - NPV of debt-to-GDP ratio will stay above the 40 percent threshold even in the long term.
    - Debt-to-export ratio will reach 119 percent by 2026.
- Other adverse shocks:
  - If interest rate on new borrowing is 2 percentage points higher than in the baseline (with unchanged grace and maturity periods):
    - NPV of debt-to-GDP ratio would reach 34 percent by 2009, before declining to 25 percent by 2026.
  - Lower growth and current account balance, as well as lower non-debt inflows, would also lead to higher debt burden in the medium term, though debt level would remain manageable in the long term under some scenarios.

### D. Conclusion
- (No additional text provided in source.)

*Source: ANNEX I. Mongolia—Debt Sustainability Analysis*

### 10. Mongolia is at moderate risk of debt distress over the medium term, although

### 10. Mongolia is at moderate risk of debt distress over the medium term, although the debt burden is likely to remain sustainable over the long term

### Summary finding
- Mongolia is assessed to be at moderate risk of debt distress over the medium term, although the debt burden is likely to remain sustainable over the long term if authorities continue to borrow exclusively on concessional terms and the external economic environment evolves broadly as envisaged in the baseline scenario.
- The risk classification is unchanged if the three-year-average CPIA Index (2003-05) is used instead of the 2005 CPIA Index. (footnote as in source)

### Debt indicators and baseline projections
- Under the baseline scenario, all debt indicators would stay below their respective thresholds through the medium-to-long term.
- Public sector debt (percent of GDP): 2003: 113.0; 2004: 93.0; 2005: 68.3; 2006: 53.6; 2007: 50.6; 2008: 51.3; 2009: 50.2; 2010: 47.2; 2011: 46.3; 2016: 38.6; 2026: 36.9.
- Public sector foreign-currency denominated (percent of GDP): 2003: 98.2; 2004: 85.4; 2005: 64.1; 2006: 51.0; 2007: 48.6; 2008: 49.8; 2009: 49.1; 2010: 46.4; 2011: 45.9; 2016: 38.9; 2026: 24.3.
- NPV of public sector debt (percent of GDP): 2003: 14.8; 2004: 7.6; 2005: 44.5; 2006: 34.3; 2007: 32.5; 2008: 33.1; 2009: 32.4; 2010: 30.6; 2011: 30.2; 2016: 25.9; 2026: 29.6.
- NPV of public sector debt-to-revenue ratio (percent): 2003: 39.3; 2004: 20.5; 2005: 132.2; 2006: 84.4; 2007: 91.6; 2008: 105.4; 2009: 110.3; 2010: 110.0; 2011: 110.6; 2016: 96.5; 2026: 117.8.
- Debt service-to-revenue ratio (percent): 2003: 57.8; 2004: 6.3; 2005: 5.6; 2006: 3.3; 2007: 4.3; 2008: 5.4; 2009: 5.8; 2010: 5.8; 2011: 5.9; 2016: 4.7; 2026: 7.8.
- Gross financing need (percent of GDP) (table row): 2006: 24.7; 2007: 3.2; 2008: -1.9; 2009: -8.3; 2010: 2.9; 2011: 5.2; 2016: 4.0; 2026: 4.5.

### Vulnerabilities and stress-test results
- The NPV of debt-to-GDP ratio would breach its threshold in the medium term under various shock scenarios.
- Debt sustainability is particularly vulnerable to severe terms-of-trade shocks.
- Selected sensitivity / bound-test outcomes (NPV of debt-to-GDP ratio and related indicators shown in tables/figures):
  - Table 1b scenarios (NPV of public sector debt-to-GDP ratio projections across scenarios): Baseline and multiple alternative and bound tests show elevated ratios under shocks (see tables and figures in source for year-by-year series).
  - External debt (nominal, percent of GDP): 2003: 98.2; 2004: 85.4; 2005: 64.1; 2006: 51.0; 2007: 48.6; 2008: 49.8; 2009: 49.1; 2010: 46.4; 2011: 45.9; 2016: 38.9; 2026: 24.3.
  - NPV of external debt (percent of GDP): 2006: 40.3; 2007: 31.7; 2008: 30.5; 2009: 31.5; 2010: 31.3; 2011: 29.8; 2016: 29.7; 2026: 26.2; later: 17.0 (table entries).
  - Thresholds for public and publicly guaranteed external debt indicators shown in source: NPV of debt-to-GDP threshold 40 percent; NPV of debt-to-exports threshold 150 percent; debt service-to-exports threshold 20 percent.

### Key macroeconomic and fiscal assumptions used in projections
- Real GDP growth (percent): 2003: 6.1; 2004: 10.8; 2005: 7.0; 2006: 4.3; 2007: 2.9; 2008–2011 baseline: 7.0 (each year); 2016: 11.0; 2026: 6.0; 2012-26 average: 7.5; additional rows: 5.0; 5.0; 5.1.
- Average nominal interest rate on forex debt (percent): 2003: 1.2; 2004: 1.2; 2005: 1.1; 2006: 1.4; 2007: 0.3; subsequent years generally around 1.2.
- Inflation rate (GDP deflator, percent): 2003: 11.6; 2004: 18.0; 2005: 20.7; 2006: 11.8; 2007: 8.2; 2008: 24.1; 2009: 6.5; 2010: 0.6; 2011: 3.8; 2016: 4.6; 2026: 4.2; 2012-26 average: 7.3; additional: 6.5; 6.7; 6.6.
- Growth of real primary spending (percent): 2003: 1.0; 2004: 3.5; 2005: -15.7; 2006: 4.4; 2007: 11.6; 2008: 11.1; 2009: 27.0; 2010: 1.1; 2011: -2.5; 2016: 5.5; 2026: 4.6; 2012-26 average: 7.8; additional years: 4.4; 4.7; 4.6.
- Grant element of new external borrowing (percent): table shows repeated cell values of 40 in memorandum for residual financing.

### Policy recommendations and risk management
- The analysis calls for continued prudent debt management and a close watch of debt sustainability.
- The government should refrain from any nonconcessional borrowing or loan guarantees.

*Sources: Data provided by the Mongolian authorities; and Fund staff estimates and projections (tables and figures as presented in the source PDF).*

### ANNEX II. Mongolia––Fund Relations

### ANNEX II. Mongolia––Fund Relations

### I. Membership
- Status: Joined: 02/14/1991; Article VIII

### II. General Resources Account (SDR Million; percent Quota)
- Quota: 51.10 — 100.0
- Fund Holdings of Currency: 50.97 — 99.74
- Reserve Position in Fund: 0.14 — 0.27

### III. SDR Department (SDR Million; percent Allocation)
- Holdings: 0.06 — N/A

### IV. Outstanding Purchases and Loans (SDR Million; Percent Quota)
- ESAF/PRGF Arrangements: 21.04 — 41.17

### V. Financial Arrangements (Approval Date, Expiration Date, Amount Approved (SDR Million), Amount Drawn (SDR Million))
- PRGF: Approval Date 09/28/2001; Expiration Date 07/31/2005; Amount Approved 28.49; Amount Drawn 12.21
- ESAF/PRGF: Approval Date 07/30/1997; Expiration Date 07/29/2000; Amount Approved 33.39; Amount Drawn 17.44
- ESAF: Approval Date 06/25/1993; Expiration Date 06/24/1996; Amount Approved 40.81; Amount Drawn 29.68

### VI. Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs)
- Forthcoming
  - 2006 Principal: 0.59
  - 2007 Principal: 4.30
  - 2008 Principal: 3.19
  - 2009 Principal: 4.22
  - 2010 Principal: 3.04
- Charges/interest
  - 2006 Charges/interest: 0.05
  - 2007 Charges/interest: 0.09
  - 2008 Charges/interest: 0.07
  - 2009 Charges/interest: 0.05
  - 2010 Charges/interest: 0.03
- Total
  - 2006 Total: 0.65
  - 2007 Total: 4.39
  - 2008 Total: 3.26
  - 2009 Total: 4.28
  - 2010 Total: 3.07

### VII. Safeguards Assessments
- A full safeguards assessment of the Bank of Mongolia (BOM) was conducted with respect to the PRGF arrangement approved 09/28/2001.
- An on-site safeguards assessment of the BOM was completed on September 10, 2003.
- Staff recommendations: strengthen external audit mechanism and financial reporting framework.
- Implemented measures: BOM has implemented several recommendations; staff continues to monitor efforts to:
  - (i) commit to full adoption of International Accounting Standards (IAS) and disclose guarantees and pledges in financial statements;
  - (ii) disclose the fair value of derivatives in its net international reserve position and financial statements.
- At the conclusion of the December 2002 PRGF discussions, BOM agreed to implement special semi-annual audits of NIR to provide further assurance on the NIR position and to identify any related pledges or guarantees.

### VIII. Exchange Arrangement
- On May 27, 1993, Mongolia moved from a fixed exchange rate against the U.S. dollar to a floating exchange rate system.
- The official exchange rate is set daily on the basis of transactions in the interbank market.
- At end-November 2006, the official midpoint rate was Tog 1,164 per U.S. dollar.
- The official exchange rate is applied to State budget and customs transactions, including debt-service payments, and to trade and service transactions conducted under bilateral payments arrangements.
- Mongolia accepted the obligations of Article VIII, Sections 2, 3, and 4 on February 1, 1996, and maintains an exchange system free from restrictions on payments and transfers for current international transactions.
- Mongolia imposes exchange restrictions for security reasons in accordance with United Nations Security Council Resolution No. 92/757 concerning certain transactions with the Federal Republic of Yugoslavia (Serbia and Montenegro) that have been notified to the Fund under Decision 144-(52/51).

### IX. Article IV Consultation
- The 2005 Article IV consultation (Country Report No. 05/396) was concluded by the Executive Board on September 21, 2005.
- Mongolia will be on the 12–month cycle.

### X. ROSC Assessments
- ROSC, Data Module, May 4, 2001 (www.imf.org)
- ROSC, Fiscal Transparency Module, November 8, 2001 (Country Report No. 01/218)
- ROSC, Fiscal update, May, 2005

### XI. Recent Financial Arrangements (summary of past ESAF/PRGF/PRGF arrangements)
- ESAF (approved 06/25/1993): three-year arrangement; SDR 40.81 (80 percent of quota); first annual SDR 18.55 (36.3 percent of quota); second annual SDR 11.13 (21.8 percent of quota) approved 11/23/1994; arrangement lapsed 06/24/1996.
- ESAF/PRGF (approved 07/30/1997): three-year arrangement; SDR 33.4 (65.4 percent of quota); first annual SDR 11.13 (21.8 percent of quota); second annual SDR 14.8 (29 percent of quota) approved 06/16/1999; first review completed January 2000; arrangement lapsed 06/15/2000 and 07/29/2000.
- PRGF (approved 09/28/2001): three-year arrangement; SDR 28.49 (55.8 percent of quota); first year SDR 12.21 (23.9 percent of quota); first and second reviews completed 09/12/2003; Executive Board approved extension through 07/31/2005; arrangement expired 07/31/2005 without completion of third and subsequent reviews.

### XII. Technical Assistance (Missions and Resident Advisors)
- Recent missions (selected; with department in parentheses and date):
  - Government Finance and Monetary and Financial Statistics (STA), September 2006
  - Improving Banking Supervision and Reserve Management (MCM), September 2006
  - Value Added Tax, Income Tax and Excise Tax Legislation (LEG), August 2006
  - Cooperation between Mongolia’s NSO and STA, May 2006
  - Management Structure of the Bank of Mongolia (MFD), April 2006
  - Monetary and Financial Statistics (STA), October 2005
  - Banking supervision and payment systems (MFD), June 2005
  - Options for Expenditure Savings and Efficiency Improvements (FAD), January 2005
  - Banking supervision and prudential framework (MFD), October 2004
  - Reforms of Tax Policies (FAD), October 2004
  - Government Finance Statistics (STA), August 2004
  - Balance of Payments Statistics (STA), July-August 2004
  - Banking supervision and prudential framework (MFD), May-June 2004
  - AML/CFT Action Plan and legislative awareness, May 2004
  - Banking supervision and accounting (MFD), October 2003
  - Government Finance Statistics (STA), August 2003
  - AML/CFT (MFD), June 2003
  - Banking supervision and accounting (MAE), November 2002
  - Revenue administration (FAD), September 2002
  - Banking supervision and accounting (MAE), May 2002
  - Review of treasury and intergovernmental fiscal reforms (FAD), August 2001
  - Banking supervision and accounting (MAE), May–June 2001
  - Money and banking statistics (STA), May 2001
  - Government finance statistics (STA), March 2001
  - Fiscal transparency and ROSC (FAD), March 2001
  - Intergovernmental fiscal relations and budget reform (FAD), January 2001
  - Visits by MAE peripatetic experts on banking supervision, payments system, monetary policy, and accounting and audit, November 2000
  - Consumer price statistics (STA), September–October 2000
  - ROSC: data module (STA), May 2000
  - Restructuring bonds and other securities (MAE), March 2000
  - National accounts statistics (STA), February 2000
- Resident Advisors
  - National accounts statistics (STA), August 2001–September 2003
  - Treasury reform (FAD), June 1999–November 2003
  - Balance of payments (STA), March 1999–May 2001
- Technical assistance for the period May 1995–October 1999 is reported in Annex II of the Staff Report for the 1999 Article IV Consultation.

### XIII. Resident Representative
- Mr. Jang has been the Fund’s resident representative in Mongolia since April 1, 2006.

*ANNEX II. Mongolia––Fund Relations (As of November 30, 2006)*

### 2.    Outstanding    Issues

### 2.    Outstanding    Issues

### National accounts and GDP measurement
- Quality of GDP estimates could be improved, particularly with respect to the current deflation methods for constant price estimates.
- A proper methodological treatment of animal losses due to harsh winters has been finalized.
- Coverage gaps remain in the informal sector and small-scale activity, especially in the services sector.
- Raw data could be refined with a view to producing reliable quarterly estimates of GDP.
- Construction of expenditure-based national accounts in constant price terms would serve as a useful check for the production side estimates.

### Price statistics and producer price index
- Progress in implementing STA recommendations to develop a producer price index has been limited mainly due to resource and capacity constraints.

### Labor market and wages data
- There are deficiencies in the data on wages and earnings.
- Development of labor market statistics through the establishment of quarterly sample surveys would help mitigate these shortcomings.
- The government conducted a survey of the civil service in May 2002, which should help to produce a detailed database on civil service employment and wages.

### Monetary and fiscal statistics conformity
- The September 2006 GFS and MFS mission identified a number of issues to ensure that the monetary statistics would conform with the Monetary and Financial Statistics Manual, and the fiscal data with the GFSM2001 methodology.
- The Bank of Mongolia (BOM) and Ministry of Finance (MOF) are following up on the recommendations of the mission.
- BOM and MOF are also addressing the large discrepancy between the fiscal and monetary statistics for 2005.

### Balance of payments and external position data
- Work has commenced on revising the register of businesses for balance of payments statistics, which was last updated in 2002.
- The authorities plan to produce and publish a complete international investment position statement in the period ahead.

*Source: _cr0730 - 2.    Outstanding    Issues*

### 8.8 percent at end-2005, and the ratio has remained broadly stable in 2006. To safeguard the

### _cr0730 - 8.8 percent at end-2005, and the ratio has remained broadly stable in 2006. To safeguard the

### Macro outlook and growth prospects
- Real GDP growth has averaged 7 percent annually since 2002.
- Staff medium-term scenario: real GDP growth can average 6-7 percent over the medium-term, if appropriate policies are pursued.
- Inflation prospects: Inflation could be contained to below 5 percent, provided that appropriate fiscal and monetary policies are in place.
- Key commodity price assumptions and developments:
  - WEO projection of copper prices in 2007: US$5,500 per ton.
  - Authorities’ assumed average copper price in 2007: US$6,000 per ton.
  - 15-month future (buyers) price for copper recorded on January 2, 2007 in the London Metal Exchange: US$6,050 per ton.
- Risks to the outlook:
  - Adverse weather conditions.
  - Terms-of-trade shocks from sharp declines in copper and gold prices and soaring oil prices.
  - Fiscal sustainability risks from loosening fiscal stance and inadequate mineral resource management.

### Fiscal policy and public expenditure
- Recent fiscal performance:
  - 2005 overall balance moved markedly into surplus.
  - 2006 overall fiscal balance is estimated again as a solid surplus.
- 2007 budget and stance:
  - Staff assesses Mongolia’s 2007 fiscal stance as a “loosening of fiscal policy.”
  - 2007 budget projects an overall deficit of 3.9 percent of GDP (based on final 2007 budget approved by Parliament).
  - Parliament calls for the overall deficit to remain constant at 4 percent of GDP through to 2009.
- Staff recommendations to safeguard fiscal sustainability:
  - Reduce the non-mineral fiscal deficit by containing growth in the civil service wage bill.
  - Better target social welfare spending.
  - Move forward with civil service reforms.
  - Realistically plan and prioritize capital spending.
  - Consider formulating a medium-term fiscal framework.
  - Reverse at least part of the 5 percentage point cut in the VAT rate (staff recommendation), while acknowledging political constraints.
- Specific expenditure items:
  - Staff argues against the large increase in child allowances; authorities note child allowance supports resident registration and non-discriminatory redistribution to under 18 year olds.
  - 2007 budget provides for a 20 percent increase in civil service wages.

### Public debt and debt sustainability
- Public debt trends (Selected Indicators, 2003-06 table):
  - Total public debt: 113.0 (2003), 93.0 (2004), 68.3 (2005), 53.6 (2006) (in percent of GDP).
  - External debt: 98.2 (2003), 85.4 (2004), 64.1 (2005), 51.0 (2006) (in percent of GDP).
  - Domestic debt: 14.8 (2003), 7.6 (2004), 4.2 (2005), 2.6 (2006) (in percent of GDP).
  - NPV of external debt: 64.2 (2003), 52.3 (2004), 40.3 (2005), 31.7 (2006) (in percent of GDP).
- Debt service (in percent of exports of goods and services): 34.0 (2003), 7.5 (2004), 2.9 (2005), 2.1 (2006).
- Debt Sustainability Analysis (DSA) results (public and publicly guaranteed external debt):
  - Thresholds for Medium Performer: NPV of debt in percent of GDP threshold 40; Debt service in percent of exports threshold 20; other threshold 150/200 noted for multiple indicators.
  - 2007 Baseline Projections: NPV of debt 44 (in percent of GDP), Debt service 2.3 (in percent of exports).
  - 2016 Baseline Projections: NPV of debt 46 (in percent of GDP), Debt service 2.5 (in percent of exports).
- Authorities’ debt management actions:
  - Seeking agreements with bilateral creditors on disputed claims.
  - Loan arrears to an Italian supplier cleared in mid-2006.
  - Bilateral discussions underway with Russia on post-1991 Russian debt (US$16.7 million in principal as of end-2005).
  - Seeking to normalize a loan with Finnvera (export credit guarantee agency of Finland).

### Monetary policy, reserves, and exchange rate
- Monetary indicators (Selected Economic Indicators, 2003-06 table):
  - Broad money growth: 49.7 (2003), 20.3 (2004), 37.3 (2005), 34.9 (2006) (percent change).
  - Domestic credit: 147.0 (2003), 23.0 (2004), 22.3 (2005), -5.0 (2006) (percent change).
  - Claims on nonbanks: 90.3 (2003), 43.7 (2004), 40.1 (2005), 39.2 (2006).
  - Reserve money: 14.7 (2003), 16.8 (2004), 19.7 (2005), 16.5 (2006).
  - Interest rate on central bank bills (annualized yield on end-period auction of 14-day bills; as of end-September 2006): 15.0 (2003), 15.8 (2004), 3.7 (2005), 5.8 (2006) (percent per annum).
- Gross international reserves (end-period, in millions US dollars): 178 (2003), 208 (2004), 333 (2005), 626 (2006).
  - Reserves in months of next year’s imports of goods and services: 1.5 (2003), 1.6 (2004), 2.1 (2005), 3.4 (2006).
- Exchange rate:
  - Togrogs per US dollar (end-period): 1,170 (2003), 1,209 (2004), 1,221 (2005), 1,164 (2006).
- Staff concerns and recommendations:
  - Rapid growth in broad money could fuel higher inflation.
  - Increase issuance of central bank bills (CBBs) at market-clearing interest rates to absorb excess liquidity.
  - Upgrade monetary policy framework and develop sound liquidity management instruments (supported Fund technical assistance).
  - International reserves should be held in low risk, unencumbered assets; prepare a strategy to exit the gold market over the medium term and reduce gold risk exposures.
- Authorities’ stance:
  - Share concern about rapid broad money growth but view it as deepening intermediation and improving banking confidence.
  - Maintain commitment to a flexible exchange rate and limit foreign exchange interventions to smoothing short-term volatility.
  - Agree to phase down domestic gold purchases as practicable in the medium to long term.

### Banking system, financial sector, and prudential measures
- Recent developments:
  - Nonperforming loans (NPLs) of the banking system as a whole have been substantially reduced during recent years.
  - Significant reintermediation and improving confidence in the banking system.
- Supervisory and regulatory actions:
  - Enforcement of prudential requirements intensified, especially for banks with rapid credit growth.
  - Newly-created Financial Regulatory Commission is addressing solvency of a number of credit and saving cooperatives and strengthening supervisory framework for nonbanks.
  - Authorities requested to subscribe to the Financial Sector Assessment Program (FSAP).
- Staff and Directors’ cautions and recommendations:
  - Financial system remains vulnerable; rapid credit growth can cause loan quality to deteriorate.
  - Strengthen enforcement of prudential regulations at weaker banks.
  - Increase sales of central bank bills to absorb excess liquidity.
  - Avoid administrative measures to lower bank lending rates, avoid bailing out insolvent savings and credit cooperatives, and avoid including these cooperatives in any future bank deposit insurance scheme until cautionary measures are in place.
  - Plans to introduce a bank deposit insurance scheme should be preceded with great caution.

### Structural reforms, governance, and private sector development
- Central bank governance:
  - Bank of Mongolia appointed in September 2006 two non-executive directors to its Board of Directors.
  - Plans to shift decision-making authority from the Governor to the Board of Directors; Directors encouraged to move forward with this.
  - Strengthen external Supervisory Board and shift weight to Board of Directors.
- Legal and institutional reforms:
  - AML/CFT Law adopted in mid-2006, providing for establishment of a Financial Intelligence Unit within the Bank of Mongolia.
  - Anti-Corruption Law adopted to strengthen the business environment.
- Privatization and public enterprise reform:
  - Privatization of the Savings Bank completed.
  - Bidding underway for the Gobi cashmere factory.
  - Privatization of two large public enterprises welcomed by Directors.
  - Energy sector reform urged; SOEs in energy planned for comprehensive restructuring under a Bank-supported energy sector reform project.
- Business environment and tax reform:
  - Recent efficiency-enhancing tax reform welcomed, including elimination of most VAT exemptions and new tax holidays.
  - Directors noted some tax cuts might need to be partially reversed to ensure fiscal sustainability, starting with the cut in the VAT rate.
  - Directors encouraged authorities to keep mining regime under review to ensure an internationally competitive tax regime and supported Fund technical assistance in this area.
  - Authorities have taken measures for broadening the non-mineral tax base and cutting tax rates to reduce distortions and support growth.

### Executive Board assessment and recommendations
- Commendations:
  - Robust economic performance: vigorous growth, a decline in inflation, emergence of fiscal and current account surpluses, and reduced debt ratios.
  - Mongolia’s mineral wealth and improved macroeconomic stability provide foundation for sustained growth.
- Main Board cautions and recommendations:
  - Mitigate vulnerability to shocks (harsh weather, decline in copper prices) and reduce high poverty rate.
  - Focus on managing mineral wealth efficiently, improving infrastructure and the business environment, and targeting poverty alleviation policies carefully while maintaining macroeconomic stability.
  - Reduce non-mineral fiscal deficit, contain civil service wage bill growth, better target social welfare spending, and proceed with civil service reforms.
  - Realistically plan and prioritize capital spending and consider a medium-term fiscal framework.
  - Strengthen monetary policy instruments and liquidity management; increase central bank bill issuance.
  - Upgrade management of international reserves, reduce gold risk exposures, and prepare a strategy to exit the gold market over the medium term.
  - Maintain flexible exchange rate and limit FX interventions to smoothing short-term volatility.
  - Phase out the export duty on raw cashmere and resist raising import duties to protect domestic industries.
  - Maintain a prudent debt management strategy, relying on concessional borrowing where appropriate.
  - Continue efforts to strengthen data quality for surveillance (national account, fiscal, and monetary data).

### AML/CFT and statistics
- AML/CFT:
  - AML/CFT Law passed in mid-2006.
  - Financial Intelligence Unit established within the Bank of Mongolia.
  - Legal Department dialogue with authorities about possible technical assistance.
- Statistics:
  - Continued improvement in statistics acknowledged.
  - Outstanding issues remain (e.g., quality of GDP estimates).
  - Authorities seeking ongoing technical assistance from the Fund’s Statistical Department.

*Source: IMF staff and Executive Board documents contained in the provided content unit.*

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