## 1.   Oyu Tolgoi Mining Project

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---

### Background and short-term outlook
- Growth and activity
  - Real GDP growth revised to ½ percent for this year, recovering to 3 percent in 2010.
  - Economy grew only ¾ percent in the second quarter.
  - Higher-frequency indicators: industrial production weak; imports and nonmineral exports declining sharply; private sector credit moribund.
  - Copper prices are considerably higher than previously assumed, and negotiations for a large mining project (Oyu Tolgoi) are advancing, providing upside potential.
- Inflation and monetary conditions
  - Overall inflation declined to 3 percent in July.
  - Nonfood inflation has declined more slowly and remains in the double-digits.
  - The policy rate was lowered 125 basis points in mid-June; corresponding reduction in interest rates along the yield curve.
  - Lower policy rates have had little effect on expanding private credit.
  - Authorities have intervened to sell U.S. dollars, limiting exchange-rate pass-through of looser monetary policy.
- Fiscal developments
  - Revenue weak, largely due to falling taxes on imports.
  - Petroleum excise tax lowered in July, implying an annual revenue loss of around ½ percent of GDP.
  - Government restrained spending to remain within program targets; budget amended to protect social transfer spending and maintain existing social programs for the rest of this year.
- Banking and supervision
  - New banking and central bank laws submitted to parliament in July (end-June structural benchmark) after a slight delay.
  - Central bank received capital reinforcement plans from banks below regulatory minimum; has identified potential problem banks and is formulating a supervisory enforcement plan with USAID assistance.
  - Central bank increased on-site examiners and intensified off-site monitoring with JICA assistance.

### Box: Oyu Tolgoi project — scale, timing, and economic impact
- Production and fiscal/export implications
  - At peak capacity, copper production at the mine could account for 6 percent of world production.
  - Staff project annual production to peak in 2019 at approximately 900,000 tons of copper and 50 tons of gold.
  - Corresponding export revenues could approach 55 percent of GDP with government revenue reaching 20 percent of GDP.
- Investment and employment
  - So far, US$1 billion have been invested and an additional US$4 billion could be invested over the next five years.
  - Resumption of development could immediately create around 1,000 jobs, increasing to 5,000 during construction, and stabilizing at 4,000 during operation.
  - Secondary employment effects described as large.
- Project life and risks
  - Production could start within three years of resumption of development and will proceed in two stages—open-pit followed by underground.
  - Based on existing registered reserves, the initial life of the mine is expected to be 45 years.
  - The mine is a complex and risky project technologically, and there is considerable uncertainty regarding production during the first 10 to 15 years.
- Leakage risk
  - Much of the FDI could leak out via higher imports.

### Program performance and immediate issues
- End-June performance criteria for the second review were met.
- All but two end-June structural benchmarks implemented, with some delay.
- Creation of a screen-based system for interbank foreign exchange transactions not completed; foreign exchange auction system is working well.
- Anod bank: a foreign investor expressed interest in buying the bank; authorities plan a due diligence review and delay an announcement of a resolution to end-October (paragraph 7, MEP).

### Program and policy discussions — Fiscal policy
- Fiscal context and legacy imbalances
  - Fiscal revenue projected to increase substantially as Oyu Tolgoi reaches capacity; in the interim fiscal policy constrained by limited financing.
  - Compared to pre-boom averages, the nonmineral balance had worsened by some 10 percent of GDP due to reductions in the VAT rate, lower social security contributions, large increases in civil service wages, and rapid expansion of untargeted social transfers.
  - Restoring fiscal sustainability remains a central program priority.
- Fiscal indicators (selected observations)
  - Nonmineral revenue in recent years: 37.3, 38.7, 35.2, 32.5, 33.6, 34.7, 33.4, 32.9 (as percent of nonmineral GDP across years shown).
- Deficit targets and policy measures
  - Overall balance targets loosened to a deficit of 6½ percent of GDP for this year and 5 percent of GDP for 2010 (paragraph 2, MEP) to allow automatic stabilizers to operate.
  - For 2010, adjustment measures include: reforming social transfers, reversing the recent reduction in fuel excises, freezing the nominal wage bill, and raising social security contributions.
  - Passage of a budget in line with the program is a structural benchmark for December 1, 2009.
- Financing and reserves
  - Additional fiscal financing from a slightly slower pace of accumulation of international reserves—by around US$30 million each year—for 2009 and 2010.
  - Under SDR allocations Mongolia will receive US$75 million to bolster gross reserves.
  - Despite additional resources deployed to finance a larger fiscal deficit, by end-2010 gross reserves will be broadly the same level assumed under the original program.
- Structural fiscal reform
  - Authorities pursuing comprehensive social transfer reform this year (structural benchmark), designed with World Bank and ADB, to consolidate benefits (from over 60 to less than 20), reduce untargeted universal transfers, and introduce a new benefit for those in poverty.
  - Preparing a new Fiscal Responsibility Law (end-year structural benchmark) and an organic budget law, supported by FAD technical assistance; expected to be effective starting with the 2011 budget.
  - Fiscal Responsibility Law focuses on numerical targets to ensure sustainability and reduce procyclicality, plus procedural reforms to strengthen budget discipline.

### Program and policy discussions — Monetary and exchange rate policy
- Monetary policy stance
  - Broad agreement that monetary policy should switch to a neutral bias; further rate cuts unlikely to provide much support for the real sector.
  - Private credit growth sluggish despite reductions in the policy rate; banks have ample liquidity but concerns over future credit quality and weak demand constrain lending.
  - Primary objectives: steadily bring down inflation and rebuild international reserves.
- Exchange rate policy and intervention
  - Authorities sold U.S. dollars in July to resist downward pressure and maintained the rate within a narrow band.
  - Going forward, intervention should be used more sparingly, geared toward avoiding large day-to-day movements while opportunistically building international reserves.
  - If downward pressures intensify, central bank agreed it would adjust interest rates to ensure program reserve targets and market stability.
  - Twice-weekly foreign exchange auctions working well and will be maintained.
  - Central bank moving to strengthen interbank FX market, developing the existing screen-based system as main interbank trading platform.

### Banking sector issues
- Anod bank resolution
  - Foreign investor interest prompted authorities to undertake due diligence and delay resolution announcement; any costs associated with resolution would be fiscalized through issuance of government bonds by end of the year (paragraph 7, MEP).
  - Staff cautioned against linking resolution timing to concerns about possible lawsuits by minority shareholders.
- Systemic bank restructuring and asset quality
  - Asset quality appears weaker than official indicators suggest; large amounts of restructured loans are classified as performing under existing rules.
  - The three largest banks hold around 60 percent of the market and exceed the minimum 12 percent capital adequacy ratio by some 2 percentage points.
  - Central bank seeking international assistance for a broader restructuring scheme; staff will discuss loan classification improvements in the next review.
  - With World Bank support, authorities plan external audits of all banks.
  - MCM TA mission examined need for and potential costs of bank restructuring, including comprehensive stress testing.
  - Any restructuring/recapitalization must be accompanied by governance and structural reforms: changes in management and senior staff, enhanced internal control and risk management, operational restructuring to cut costs and improve revenue, and efficient NPL resolution.
- Supervision of small and mid-sized banks
  - Authorities closely monitor small and mid-sized banks that do not meet prudential norms; these banks together represent around 20 percent of system assets.
  - Central bank prefers to include these banks in a comprehensive reform strategy, concerned that early enforcement could destabilize the system; will act promptly in the event of severe stress or deposit outflows.

### Other issues and program matters
- External financing and safeguards
  - Authorities negotiating a swap arrangement with China that could be signed in the near future; Article VIII concerns discussed in the last staff report have been resolved.
  - Program counts drawings under the swap arrangement toward the ceiling on long-term nonconcessional borrowing.
  - Authorities agreed to proceed cautiously on further nonconcessional external borrowing and keep prohibition on government guarantees in place.
  - External borrowing of US$75 million on-lent to gold mines remains committed to be repaid to the budget by end of the year.
  - Authorities are following up on safeguards assessment recommendations and working to reach agreement on outstanding arrears to bilateral creditors (paragraph 10, MEP).

### Staff assessment — key judgments
- Program implementation and macro impact
  - Authorities met all quantitative targets and most structural benchmarks; program is stabilizing market conditions and lowering inflation.
  - The external shock is having a stronger-than-foreseen impact; targets recalibrated to reflect revised growth outlook.
  - Revised targets balance need for economic adjustment with supporting growth via some fiscal easing.
- Financial sector priorities
  - Slowing economy is weakening banks; strengthening the financial system is a priority.
  - Staff emphasized need for improved loan classification, external audits, stress testing, and governance-enhancing reforms to accompany any restructuring or recapitalization.

### Key macroeconomic and fiscal statistics (as presented)
- Nominal GDP (2008): US$5,243 million
- Population, end-year (2008): 2.68 million
- Per capita GDP (2008): US$1,956
- Poverty incidence (2007/08): 35.2 percent
- Real GDP growth: 10.2 (2007), 8.9 (2008), 0.5 (2009), 3.0 (2010 rev), 2.7 (2009 proj), 4.3 (2010 proj)
- Consumer prices (period average): 8.2 (2007), 26.8 (2008), 8.5 (2009), 7.9 (2010 rev), 10.1 (2009 proj), 7.9 (2010 proj)
- Overall balance (including grants): 2.8 (2007), -4.8 (2008), -6.5 (2009), -5.0 (2010 rev), -6.0 (2009 proj), -4.0 (2010 proj) — (percent of GDP)
- Nonmineral overall balance: -10.6 (2007), -14.9 (2008), -12.1 (2009), -9.0 (2010 rev), -9.9 (2009 proj), -9.1 (2010 proj) — (percent of GDP)
- Gross official international reserves (end-period): 1,001 (2007), 657 (2008), 920 (2009 rev), 1,069 (2010 rev), 822 (2009 proj), 1,075 (2010 proj) — (in millions of US$)
- Copper price (US$ per ton): 7,132 (2007), 6,963 (2008), 4,000 (2009), 4,100 (2010 rev), 3,500 (2009 proj), 3,800 (2010 proj)
- Total public debt (percent of GDP): 39.4 (2007), 33.1 (2008), 49.1 (2009), 52.1 (2010), 46.8 (2009 proj), 47.8 (2010 proj)
- Exchange rate Togrogs per US$ (end-period): 1,170 (2007), 1,268 (2008)

---

### 1.   Oyu Tolgoi Mining Project .........................................................................................

### 1.   Oyu Tolgoi Mining Project

### Background and short-term outlook
- Growth and activity
  - Real GDP growth revised to ½ percent for this year, recovering to 3 percent in 2010.
  - Economy grew only ¾ percent in the second quarter.
  - Higher-frequency indicators: industrial production weak; imports and nonmineral exports declining sharply; private sector credit moribund.
  - Copper prices are considerably higher than previously assumed, and negotiations for a large mining project (Oyu Tolgoi) are advancing, providing upside potential.

- Inflation and monetary conditions
  - Overall inflation declined to 3 percent in July.
  - Nonfood inflation has declined more slowly and remains in the double-digits.
  - The policy rate was lowered 125 basis points in mid-June; corresponding reduction in interest rates along the yield curve.
  - Lower policy rates have had little effect on expanding private credit.
  - Authorities have intervened to sell U.S. dollars, limiting exchange-rate pass-through of looser monetary policy.

- Fiscal developments
  - Revenue weak, largely due to falling taxes on imports.
  - Petroleum excise tax lowered in July, implying an annual revenue loss of around ½ percent of GDP.
  - Government restrained spending to remain within program targets; budget amended to protect social transfer spending and maintain existing social programs for the rest of this year.

- Banking and supervision
  - New banking and central bank laws submitted to parliament in July (end-June structural benchmark) after a slight delay.
  - Central bank received capital reinforcement plans from banks below regulatory minimum; has identified potential problem banks and is formulating a supervisory enforcement plan with USAID assistance.
  - Central bank increased on-site examiners and intensified off-site monitoring with JICA assistance.

### Box: Oyu Tolgoi project — scale, timing, and economic impact
- Production and fiscal/export implications
  - At peak capacity, copper production at the mine could account for 6 percent of world production.
  - Staff project annual production to peak in 2019 at approximately 900,000 tons of copper and 50 tons of gold.
  - Corresponding export revenues could approach 55 percent of GDP with government revenue reaching 20 percent of GDP.
- Investment and employment
  - So far, US$1 billion have been invested and an additional US$4 billion could be invested over the next five years.
  - Resumption of development could immediately create around 1,000 jobs, increasing to 5,000 during construction, and stabilizing at 4,000 during operation.
  - Secondary employment effects described as large.
- Project life and risks
  - Production could start within three years of resumption of development and will proceed in two stages—open-pit followed by underground.
  - Based on existing registered reserves, the initial life of the mine is expected to be 45 years.
  - The mine is a complex and risky project technologically, and there is considerable uncertainty regarding production during the first 10 to 15 years.
- Leakage risk
  - Much of the FDI could leak out via higher imports.

### Program performance and immediate issues
- End-June performance criteria for the second review were met.
- All but two end-June structural benchmarks implemented, with some delay.
- Creation of a screen-based system for interbank foreign exchange transactions not completed; foreign exchange auction system is working well.
- Anod bank: a foreign investor expressed interest in buying the bank; authorities plan a due diligence review and delay an announcement of a resolution to end-October (paragraph 7, MEP).

### Program and policy discussions — Fiscal policy
- Fiscal context and legacy imbalances
  - Fiscal revenue projected to increase substantially as Oyu Tolgoi reaches capacity; in the interim fiscal policy constrained by limited financing.
  - Compared to pre-boom averages, the nonmineral balance had worsened by some 10 percent of GDP due to reductions in the VAT rate, lower social security contributions, large increases in civil service wages, and rapid expansion of untargeted social transfers.
  - Restoring fiscal sustainability remains a central program priority.

- Fiscal indicators (selected observations from staff table)
  - Nonmineral revenue in recent years: 37.3, 38.7, 35.2, 32.5, 33.6, 34.7, 33.4, 32.9 (as percent of nonmineral GDP across years shown).
  - Nonmineral balance and overall balance figures shown in table; cyclically adjusted nonmineral balance and fiscal effort metrics reported in text table.
  - Real nonmineral GDP growth and output gap metrics provided in memorandum items.

- Deficit targets and policy measures
  - Overall balance targets loosened to a deficit of 6½ percent of GDP for this year and 5 percent of GDP for 2010 (paragraph 2, MEP) to allow automatic stabilizers to operate.
  - For 2010, adjustment measures include: reforming social transfers, reversing the recent reduction in fuel excises, freezing the nominal wage bill, and raising social security contributions.
  - Passage of a budget in line with the program is a structural benchmark for December 1, 2009.

- Financing and reserves
  - Additional fiscal financing from a slightly slower pace of accumulation of international reserves—by around US$30 million each year—for 2009 and 2010.
  - Under SDR allocations Mongolia will receive US$75 million to bolster gross reserves.
  - Despite additional resources deployed to finance a larger fiscal deficit, by end-2010 gross reserves will be broadly the same level assumed under the original program.

- Structural fiscal reform
  - Authorities pursuing comprehensive social transfer reform this year (structural benchmark), designed with World Bank and ADB, to consolidate benefits (from over 60 to less than 20), reduce untargeted universal transfers, and introduce a new benefit for those in poverty.
  - Preparing a new Fiscal Responsibility Law (end-year structural benchmark) and an organic budget law, supported by FAD technical assistance; expected to be effective starting with the 2011 budget.
  - Fiscal Responsibility Law focuses on numerical targets to ensure sustainability and reduce procyclicality, plus procedural reforms to strengthen budget discipline.

### Program and policy discussions — Monetary and exchange rate policy
- Monetary policy stance
  - Broad agreement that monetary policy should switch to a neutral bias; further rate cuts unlikely to provide much support for the real sector.
  - Private credit growth sluggish despite reductions in the policy rate; banks have ample liquidity but concerns over future credit quality and weak demand constrain lending.
  - Primary objectives: steadily bring down inflation and rebuild international reserves.

- Exchange rate policy and intervention
  - Authorities sold U.S. dollars in July to resist downward pressure and maintained the rate within a narrow band.
  - Going forward, intervention should be used more sparingly, geared toward avoiding large day-to-day movements while opportunistically building international reserves.
  - If downward pressures intensify, central bank agreed it would adjust interest rates to ensure program reserve targets and market stability.
  - Twice-weekly foreign exchange auctions working well and will be maintained.
  - Central bank moving to strengthen interbank FX market, developing the existing screen-based system as main interbank trading platform.

### Banking sector issues
- Anod bank resolution
  - Foreign investor interest prompted authorities to undertake due diligence and delay resolution announcement; any costs associated with resolution would be fiscalized through issuance of government bonds by end of the year (paragraph 7, MEP).
  - Staff cautioned against linking resolution timing to concerns about possible lawsuits by minority shareholders.

- Systemic bank restructuring and asset quality
  - Asset quality appears weaker than official indicators suggest; large amounts of restructured loans are classified as performing under existing rules.
  - The three largest banks hold around 60 percent of the market and exceed the minimum 12 percent capital adequacy ratio by some 2 percentage points.
  - Central bank seeking international assistance for a broader restructuring scheme; staff will discuss loan classification improvements in the next review.
  - With World Bank support, authorities plan external audits of all banks.
  - MCM TA mission examined need for and potential costs of bank restructuring, including comprehensive stress testing.
  - Any restructuring/recapitalization must be accompanied by governance and structural reforms: changes in management and senior staff, enhanced internal control and risk management, operational restructuring to cut costs and improve revenue, and efficient NPL resolution.

- Supervision of small and mid-sized banks
  - Authorities closely monitor small and mid-sized banks that do not meet prudential norms; these banks together represent around 20 percent of system assets.
  - Central bank prefers to include these banks in a comprehensive reform strategy, concerned that early enforcement could destabilize the system; will act promptly in the event of severe stress or deposit outflows.

### Other issues and program matters
- External financing and safeguards
  - Authorities negotiating a swap arrangement with China that could be signed in the near future; Article VIII concerns discussed in the last staff report have been resolved.
  - Program counts drawings under the swap arrangement toward the ceiling on long-term nonconcessional borrowing.
  - Authorities agreed to proceed cautiously on further nonconcessional external borrowing and keep prohibition on government guarantees in place.
  - External borrowing of US$75 million on-lent to gold mines remains committed to be repaid to the budget by end of the year.
  - Authorities are following up on safeguards assessment recommendations and working to reach agreement on outstanding arrears to bilateral creditors (paragraph 10, MEP).

### Staff assessment — key judgments
- Program implementation and macro impact
  - Authorities met all quantitative targets and most structural benchmarks; program is stabilizing market conditions and lowering inflation.
  - The external shock is having a stronger-than-foreseen impact; targets recalibrated to reflect revised growth outlook.
  - Revised targets balance need for economic adjustment with supporting growth via some fiscal easing.

- Financial sector priorities
  - Slowing economy is weakening banks; strengthening the financial system is a priority.
  - Staff emphasized need for improved loan classification, external audits, stress testing, and governance-enhancing reforms to accompany any restructuring or recapitalization.

*Source: IMF staff report text (Oyu Tolgoi Mining Project).*

### 18.      Fiscal policy. The authorities’ fiscal restraint is welcome, and a continuation of this

### _cr09311 - 18.      Fiscal policy. The authorities’ fiscal restraint is welcome, and a continuation of this

### Fiscal policy
- The authorities’ fiscal restraint is welcome, and a continuation of this discipline will ensure they meet their deficit targets.
- The 2010 budget is ambitious and the needed adjustment will be achieved through better quality measures than that which underpinned the 2009 fiscal program.
- The planned comprehensive social transfer reform:
  - Will generate fiscal saving.
  - Will protect the poor.
  - Will yield a lasting improvement in public finances.
- Social transfer reform and wage restraint in 2010 are in line with recommendations from FAD technical assistance.
- Scope for future savings includes:
  - Better prioritizing investment spending.
  - Reforming subsidies.
- Planned adoption of a Fiscal Responsibility Law and an organic budget law will promote prudent fiscal management and help contain procyclicality.

### Monetary and exchange rate policy
- The program’s quantitative targets provide a clear framework for the conduct of monetary and exchange rate policy.
- Foreign currency intervention should be limited and the exchange rate should be allowed to move flexibly in line with market conditions.
- Flexible exchange rate and limited intervention will lay the foundation for macroeconomic stability and low inflation going forward.
- From Figure 2 and related text:
  - The inflation-induced real appreciation since 2007 has largely been unwound by a nominal depreciation.
  - The exchange market has stabilized, with the foreign currency auction system working well.
  - Until recently, the central bank was a net buyer of foreign exchange at the auctions, helping build reserves.
  - The central bank twice lowered the 7-day CBB interest rate, facilitating an even larger decline in the 12-week rate.
  - A sharp increase in reserve money in June contributed to an easing of monetary conditions.
  - Broad money growth remains sluggish as the expected remonetization is proceeding slowly.

### Banking system
- The slowing economy is putting additional stress on the banking system.
- The central bank should:
  - Monitor the situation closely.
  - Implement enforcement measures against banks that fail to conform to prudential regulations.
- Any public financial support to banks should be tied to governance and structural reforms to strengthen future prospects for the system as a whole.
- From monetary tables and figures:
  - The stock of private credit is still contracting, although there are some preliminary signs that it is bottoming out.
  - Annual growth of credit to nonbanks: 67.7 (2007), 28.7 (2008), 3.2 (2009), -5.0 (2010), 6.9 (2009 rev), 8.1 (2010 proj), 14.0 (2010 rev).

### Risks
- The authorities’ strong program implementation is helping to reduce risks on many dimensions but weaker-than-expected economic activity is providing a new source of pressure.
- Managing existing and prospective weakness in the banking system will be challenging and could require difficult decisions in the coming months.
- Meeting targets for international reserve accumulation will require net foreign exchange purchases by the central bank, which may lead to some exchange rate depreciation.
- Should market pressures return, interest rates may need to move higher.
- The fiscal adjustment remains ambitious and steadfast expenditure restraint will be needed to achieve the fiscal targets for this year and next.

### Program performance and staff recommendation
- The Mongolian authorities’ strong performance so far under the program is encouraging, and their revised program remains ambitious.
- Staff recommends the approval of the second review.

### Key macroeconomic and fiscal statistics (as presented)
- Nominal GDP (2008): US$5,243 million
- Population, end-year (2008): 2.68 million
- Per capita GDP (2008): US$1,956
- Poverty incidence (2007/08): 35.2 percent
- Real GDP growth: 10.2 (2007), 8.9 (2008), 0.5 (2009), 3.0 (2010 rev), 2.7 (2009 proj), 4.3 (2010 proj)
- Consumer prices (period average): 8.2 (2007), 26.8 (2008), 8.5 (2009), 7.9 (2010 rev), 10.1 (2009 proj), 7.9 (2010 proj)
- Overall balance (including grants): 2.8 (2007), -4.8 (2008), -6.5 (2009), -5.0 (2010 rev), -6.0 (2009 proj), -4.0 (2010 proj) — (percent of GDP)
- Nonmineral overall balance: -10.6 (2007), -14.9 (2008), -12.1 (2009), -9.0 (2010 rev), -9.9 (2009 proj), -9.1 (2010 proj) — (percent of GDP)
- Gross official international reserves (end-period): 1,001 (2007), 657 (2008), 920 (2009 rev), 1,069 (2010 rev), 822 (2009 proj), 1,075 (2010 proj) — (in millions of US$)
- Copper price (US$ per ton): 7,132 (2007), 6,963 (2008), 4,000 (2009), 4,100 (2010 rev), 3,500 (2009 proj), 3,800 (2010 proj)
- Total public debt (percent of GDP): 39.4 (2007), 33.1 (2008), 49.1 (2009), 52.1 (2010), 46.8 (2009 proj), 47.8 (2010 proj)
- Exchange rate Togrogs per US$ (end-period): 1,170 (2007), 1,268 (2008)

*Source: IMF staff report (excerpts provided in the content unit).*

### 1. Macroeconomic outlook. The economy is slowing more than expected. Growth is

### _cr09311 - 1. Macroeconomic outlook. The economy is slowing more than expected. Growth is

### Macroeconomic outlook
- Growth is projected to be around ½ percent this year largely as a result of the difficult global environment.
- The fall in copper prices has caused a sharp decline in export earnings and fiscal revenue necessitating a difficult adjustment in policies to unwind the procyclical policies of the past.
- The chosen policy path is described as building the foundation for sustainable growth and low inflation in the coming years.
- Next year inflation is expected to be maintained in single digits and a recovery to begin in the spring.

### Fiscal policy
- Commitment to restoring health to public finances; targeted fiscal adjustment is ambitious and designed to protect the poor and reflect government fiscal priorities.
- Plan to provide some modest additional support to the economy for this year and next, in line with additional financing sources identified.
- Fiscal targets:
  - Target a fiscal deficit of 6½ percent of GDP this year.
  - Target a fiscal deficit of 5 percent of GDP in 2010.
- Measures for current year:
  - Accommodate a higher deficit in line with weaker-than-expected revenues but maintain nominal spending at the levels identified in the budget as amended in March.
  - Rationale: avoid further procyclical spending cuts, facilitate budget execution, and ensure planned investment can be undertaken before the winter.
- Measures for 2010 budget:
  - Freeze nominal spending on wages and salaries at the 2009 level.
  - Comprehensively reform social transfers.
  - Reverse the excise cut on fuel implemented in July.
  - Raise social security contributions (partly unwinding the reduction implemented in 2008 and helping reduce the operating deficit in the pension system).
- Structural fiscal reform:
  - Submission of a Fiscal Responsibility Law to parliament by the end of this year to promote fiscal transparency, enhance medium-term fiscal planning, and limit procyclicality.
  - Submission of a complementary organic budget law to strengthen budget preparation and execution.
  - Plan for comprehensive social transfer reform with intent to pass legislation by end-November, safeguarding the poor through improved targeting to yield fiscal savings through efficiency gains.
  - Continued cooperation with the World Bank and Asian Development Bank on social transfer reform.

### Monetary and exchange rate policies
- Exchange rate policy:
  - Full commitment to a flexible exchange rate to provide a shock absorber against terms of trade volatility and to safeguard international reserves.
  - Intervention strategy guided by goals of achieving net international reserve (NIR) targets and allowing the exchange rate to move with market conditions while smoothing excess volatility due to temporary imbalances.
  - Twice-weekly foreign exchange auctions are working well and will continue for the time being.
  - Consultation with Fund staff planned if, during any 30 day period, net sales in the foreign exchange auctions exceed US$30 million.
- Monetary policy:
  - Primary objective is to achieve and maintain low inflation.
  - The Bank of Mongolia (BOM) will continue to adjust interest rates in line with evolving market conditions to achieve monetary and NIR targets.

### Banking system reforms
- Strengthening banks:
  - Measures already taken include revising the deposit guarantee system, requiring banks to meet a 12 percent capital adequacy ratio, and enhancing supervision.
  - Commitment to monitor the banking system and take further action as needed.
  - Work with banks not meeting prudential norms to ensure compliance with regulatory requirements.
  - An international external audit of all banks has begun to enhance the supervisory information base.
- Anod bank:
  - Commitment to resolving Anod bank in a way consistent with banking system stability.
  - A foreign investor expressed interest in buying the bank; a due diligence review of the potential purchaser will be undertaken while exploring other resolution options.
  - Intend to announce the plan for the bank by end-October.
  - If government financial resources are needed for resolution, the BOM would initially finance the costs to facilitate prompt actions, and costs would be brought onto the government’s fiscal accounts by end-2009 through issuance of government bonds to the BOM.

### Other policies
- External financing:
  - Negotiating a swap arrangement with China to facilitate trade and bolster confidence.
  - Commitment to prudently managing any further nonconcessional borrowing within program ceilings.
  - Maintain the current prohibition on government guarantees.
- Safeguards assessment:
  - Working with the General Intelligence Agency to grant external auditors access to the vaults and have enhanced audit oversight of the Supervisory Board.
- Arrears:
  - Progress in settling arrears to Paris Club creditors, resuming negotiations with Finland, and indicating to Russia intention to repay part of the debt.
  - Commitment to resolving remaining bilateral official arrears.

### Quantitative performance criteria and indicative targets (highlights)
- Net international reserves (NIR) of the BOM (floor, eop stock, in million US$) — sample table entries:
  - 3/31/2010 Actual: 495
  - 6/30/2010 Prog.: 315
  - 9/30/2009 Adjusted Outcome: 360
  - 12/31/2009 Prog.: 475
  - 3/31/2010 Rev. Prog.: 455
  - 6/30/2010 Prog.: 537
  - 9/30/2010 Prog.: 575
  - 12/31/2010 Prog.: 595
  - 3/31/2011 Prog.: 600
  - 6/30/2011 Prog.: 535
- Net domestic asset (NDA) of the BOM (ceiling, eop stock, in billion togrog) — sample table entries:
  - 3/31/2010 Actual: -171
  - 6/30/2010 Prog.: 14
  - 9/30/2009 Adjusted Outcome: -56
  - 12/31/2009 Prog.: -243
  - 3/31/2010 Rev. Prog.: -195
  - 6/30/2010 Prog.: -302
  - 9/30/2010 Prog.: -332
  - 12/31/2010 Prog.: -343
  - 3/31/2011 Prog.: -331
  - 6/30/2011 Prog.: -224
- Net credit to government (NCG) (ceiling, cumulative from the beginning of the fiscal year, in billion togrog) — sample table entries:
  - 3/31/2010 Actual: 130
  - 6/30/2010 Prog.: 156
  - 9/30/2009 Adjusted Outcome: 86
  - 12/31/2009 Prog.: -19
  - 3/31/2010 Rev. Prog.: 72
  - 6/30/2010 Prog.: -69
  - 9/30/2010 Prog.: 81
  - 12/31/2010 Prog.: 64
  - 3/31/2011 Prog.: 87
  - 6/30/2011 Prog.: 227
- New nonconcessional external debt maturing in one year or more, contracted or guaranteed by the government or the BOM (ceiling, eop stock since April 2009, in million US$):
  - Program entries: 0, 200, ..., 100, 200, 200, 200, 200, 200, 200, 200
- Indicative target — General government fiscal deficit (ceiling, cumulative since the beginning of fiscal year, in billion togrog) — sample table entries:
  - 3/31/2010 Actual: 296
  - 6/30/2010 Prog.: 325
  - 9/30/2009 ...: ...
  - 12/31/2009 Prog.: 248
  - 3/31/2010 Rev. Prog.: 290
  - 6/30/2010 Prog.: 315
  - 9/30/2010 Prog.: 380
  - 12/31/2010 Prog.: 405
  - 3/31/2011 Prog.: 125
  - 6/30/2011 Prog.: 200
- Memorandum items:
  - Support from bilateral and multilateral donors excluding IMF (cumulative since the beginning of the year, in million US$), program level — sample entries: 0, 30, ..., 0, 80, 112, 145, 147, 20, 40
  - Disbursed new nonconcessional external debt (eop stock, in million US$), program level — sample entries: ...0...75...75...75750

### Structural benchmarks and actions (selected)
- Completed and pending actions with dates and status:
  - Revising relevant laws to require Erdenet to pay taxes in togrog. Date: 6/30/2009. Status: Completed on July 9.
  - Establishment of screen-based system for inter-bank foreign exchange transactions. Date: 6/30/2009. Status: Not completed. No longer macro-critical as central bank will continue to use auctions.
  - Announcement of a resolution plan for Anod bank based on diagnostic assessment of the external auditor. Date: 6/30/2009. Status: Delayed to end-October.
  - Comprehensive review of transfer programs resulting in revision of relevant laws to streamline transfer programs and safeguard the social safety. Date: 6/30/2009. Status: Completed late June, reform plan approved by Cabinet-level Working Group.
  - Submission to the parliament of a revised banking law and other pertinent laws and legislations (multiple specified enhancements). Date: 6/30/2009. Status: Completed on July 24.
  - Submission to parliament of Fiscal Responsibility Law consistent with Fund technical assistance. Date: 12/31/2009. Status: In progress, FAD provided TA in July.
- Proposed new structural benchmarks:
  - Pass a comprehensive social transfer reform that saves money and protects the poor through better targeting. Date: 12/1/2009.
  - Pass a 2010 budget consistent with the IMF supported Stand-By Arrangement. Date: 12/1/2009.

### Technical Memorandum of Understanding — key definitions and rules
- Performance criteria established for end-September 2009, end-December 2009, end-March 2010, and end-June 2010 with respect to:
  - Floors on NIR of the BOM.
  - Ceilings on NDA of the BOM.
  - Ceilings on net bank credit to general government.
  - Ceilings on contracting/guaranteeing new medium- and long-term external debt.
  - Ceilings on contracting/guaranteeing new short-term external debt.
  - Ceiling on accumulation of domestic payment arrears of the central government.
- Continuous performance criteria: ceilings on accumulation of new external payment arrears of the central government and the BOM.
- Indicative targets: ceilings on the general government fiscal deficit for the same test dates.
- Institutional definitions:
  - General government includes all units of budgetary central government, social security funds, extrabudgetary funds, and local governments.
  - Domestic banking system defined as the BOM, existing and newly licensed commercial banks incorporated in Mongolia and their branches.
- Valuation and exchange rates:
  - Program exchange rate: Tog 1,560 per U.S. dollar.
  - SDR valuation: SDR 1 = US$1.509.
  - Monetary gold valued at US$880 per ounce.
- NIR adjustments:
  - Floor on NIR adjusted upward (downward) by support from bilateral and multilateral donors (excluding IMF) in excess (short) of program level.
  - Floor adjusted upward by nonconcessional borrowing disbursed in excess of program level, except amounts drawn under a swap arrangement with China.
  - Floor adjusted upward by cumulative additional SDR allocations up to the test date.
- Definitions:
  - Gross international reserves: monetary gold holdings of the BOM; holdings of SDRs; Mongolia’s reserve position in the IMF; foreign currency assets in convertible currencies held abroad under direct and effective control of the BOM and readily available for intervention or financing balance of payments imbalances and are of investment grade or held with an investment-grade institution.
  - Exclusions from gross reserves: capital subscriptions in international institutions, assets in nonconvertible currencies, and gross reserves encumbered or pledged.
  - International reserve liabilities: all outstanding liabilities of Mongolia to the IMF; foreign convertible currency liabilities of the BOM to nonresidents with original maturity up to and including one year; commercial bank foreign currency deposits held at the BOM, commercial bank foreign currency current accounts held at the BOM, any foreign currency claims on residents.
  - NDA adjustments: ceiling on NDA adjusted downward (upward) by support from bilateral and multilateral donors (excluding IMF) in excess (short) of program level; ceiling adjusted downward by nonconcessional debt disbursed during program, except amounts under a swap arrangement with China.
  - NCG adjustments: ceiling on NCG adjusted downward (upward) by support from bilateral and multilateral donors (excluding IMF) in excess (short) of program level; ceiling adjusted downward by nonconcessional debt disbursed during program.
- Fiscal deficit definition and treatment:
  - Fiscal deficit is total general government revenue and grants minus total general government expenditure and net lending.
  - Principal costs of resolving Anod bank are excluded from expenditure and net lending, but corresponding interest payments are included.
- Domestic payment arrears:
  - Measured as stock of government payables and liabilities overdue by more than 60 days.
  - If this stock is equal or smaller than Tog 3.5 billion, domestic arrear accumulation is considered zero; if it exceeds Tog 3.5 billion, the difference is domestic arrear accumulation. The program aims for zero domestic arrear accumulation.
- External debt ceilings:
  - Ceiling on contracting and guaranteeing new nonconcessional borrowing with original maturities one year or more by central government, BOM, or agencies on behalf of the central government.
  - Swap arrangements with People’s Bank of China: only amounts actually drawn count toward the ceiling and are considered to have an original maturity of more than one year.
  - Exclusions from the ceiling: use of Fund resources; lending from the World Bank, the Asian Development Bank, and IFAD; debts incurred to restructure/refinance/prepay existing debts on more favorable terms; concessional debts; and togrog-denominated treasury bill and government bond holdings by nonresidents.

*Source: _cr09311 - 1. Macroeconomic outlook. The economy is slowing more than expected. Growth is*

### 23.      For program purposes, the guarantee of a debt arises from any explicit legal

### _cr09311 - 23.      For program purposes, the guarantee of a debt arises from any explicit legal

### Guarantees and Concessional Debt: Definitions and Calculation
- Guarantee of a debt arises from any explicit legal obligation of the central government, the BOM, or other agencies on behalf of the central government to service a loan in the event of nonpayment by the recipient (involving payments in cash or in kind), or indirectly through any other obligation of the central government, the BOM, or other agencies on behalf of the central government to finance a shortfall incurred by the loan recipient.
- A debt is concessional if it includes a grant element of at least 35 percent.
- Grant element calculation:
  - Grant element = (nominal value of the debt − net present value (NPV) of debt) expressed as a percentage of the nominal value of the debt.
  - NPV at contracting is calculated by discounting the future stream of debt-service payments using currency-specific commercial interest reference rates (CIRRs) published by the OECD.
  - For debt with maturity of at least 15 years, the ten-year-average CIRR will be used.
  - For debt with maturity of less than 15 years, the six-month average CIRR will be used.
  - Margins for differing repayment periods (added to both ten-year and six-month averages) are:
    - 0.75 percent for repayment periods of less than 15 years,
    - 1 percent for 15 to 19 years,
    - 1.15 percent for 20 to 29 years,
    - 1.25 percent for 30 years or more.
- Loans provided by a private entity are not concessional unless accompanied by a grant or grant element provided by a foreign official entity and both components constitute an integrated financing package with a combined grant element equal to at least 35 percent.

### Short-Term External Debt: Ceiling and Exclusions
- A ceiling applies to contracting and guaranteeing by the central government, the BOM, or other agencies on behalf of the central government of new nonconcessional borrowing debt with nonresidents with original maturities of less than one year.
- The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received.
- Exclusions from the ceiling include:
  - (i) debts classified as international reserve liabilities of the BOM;
  - (ii) debts to restructure, refinance, or prepay existing debts;
  - (iii) togrog-denominated treasury bills, government bonds, and BOM bills held by nonresidents;
  - (iv) normal import financing (a financing arrangement for imports is “normal” when the credit is self-liquidating);
  - (v) amounts drawn under any swap arrangements with People’s Bank of China.

### External Payment Arrears: Performance Criterion
- A continuous performance criterion applies to the nonaccumulation of external payments arrears on external debt contracted or guaranteed by the general government or the BOM.
- External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreements.
- Overdue debt and debt service obligations that are in dispute will not be considered external payments arrears for program monitoring.

### Data Provision: Reporting Requirements and Frequency
- Authorities committed to use the best available data; subsequent data revisions must not lead to a breach of a performance criterion and all revisions must be promptly reported to the Fund’s Resident Representative.
- Data to be provided by the 20th day of each month unless otherwise indicated. Reporting responsibilities are indicated in parentheses in the source.
- A. Monetary Data (BOM)
  - The monetary survey, the balance sheet of the BOM, and the consolidated balance sheet of the commercial banks: monthly, except BOM balance sheet weekly within five working days of week end.
  - Net international reserves and interventions of the BOM in the foreign exchange market: daily.
  - Interest rates and volume on standing facilities and market operations: weekly within five working days of week end.
  - Detailed breakdown of net credit to government from the BOM and the commercial banks.
  - Stock of monetary gold in both thousands of fine troy ounces and U.S. dollars; report any monetary gold transactions, accounting rates, purchases from domestic sources, refining of nonmonetary gold (prices and volumes), and any liabilities guaranteed or backed by gold.
  - Detailed breakdown of “other items net” for BOM and commercial banks, including valuation changes from exchange rate changes and/or revaluation of gold.
  - Outstanding balances of all deposit accounts of the general government in commercial banks, including extrabudgetary funds.
  - Outstanding balances of any new deposit accounts of the general government opened for grants and loans received from multilateral or bilateral donors, including associated counterpart funds.
  - Bank-by-bank list of required reserves and actual reserves.
  - Results of each central bank bills auction within five working days: amount offered, amount demanded, amount sold to each bank, announced rates, cut-off rates.
- B. Fiscal Data (Ministry of Finance (MOF))
  - Consolidated accounts of central, local, and general government, with detailed data on tax, nontax, and capital revenues, current and capital expenditures, net lending, and financing; financing separated into foreign (cash, project, program loans) and domestic (bank and nonbank).
  - Classified transactions of all social insurance funds.
  - Domestic payment arrears of the general government.
  - Noninterest outstanding payables by each subsector of the general government, including social security funds, with detailed breakdown by major categories and remaining maturity.
  - Results of each treasury bills auction within five working days: amount offered, amount demanded, amount sold to each bank and nonbanks, and the average yield in percent per month.
- C. External Sector Data (BOM and MOF)
  - Complete list of new contracts for public investment projects signed or under negotiation, including amounts, terms, and conditions of current or future debt or nondebt obligations.
  - Outstanding stock, disbursements, amortization, and interest payments of short-term external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.
  - Outstanding, disbursements, amortization, and interest payments of medium- and long-term external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.
  - Daily midpoint exchange rates of the togrog against the U.S. dollar, including official, interbank, and parallel market exchange rates (BOM).
  - Arrears on the external debt contracted or guaranteed by the government or the BOM by creditor in original currency and U.S. dollars.
- D. Other Data (National Statistical Office (NSO))
  - Monthly consumer price index and detailed breakdown by major categories of goods and services included in the consumer basket.
  - NSO’s monthly statistical bulletin, including monthly export and import data.

### Guidelines on Performance Criteria with Respect to Foreign Debt (Excerpt of Executive Board Decision No. 12274)
- Debt is defined as a current, i.e., not contingent, liability created under a contractual arrangement through provision of value (assets or services) requiring obligor payments in future periods to discharge principal and/or interest.
- Primary forms of debt include:
  - (i) loans: advances of money including deposits, bonds, debentures, commercial loans, buyers’ credits, and temporary exchanges of assets equivalent to fully collateralized loans (repurchase agreements, official swap arrangements);
  - (ii) suppliers’ credits: contracts permitting deferred payments after delivery of goods or services;
  - (iii) leases: present value (at inception) of all lease payments expected during agreement excluding payments for operation, repair, or maintenance.
- Arrears, penalties, and judicially awarded damages arising from failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation not considered debt under this definition will not give rise to debt.

### IMF Press Release and Executive Board Decision: Second Review and Disbursement
- IMF Executive Board completed the second review under an 18-month Stand-By Arrangement (SBA) with Mongolia and approved a disbursement equivalent to SDR 15.33 million (about US$24.2 million).
- Total disbursements under the arrangement after this disbursement: SDR 91.95 million (about US$145.7 million).
- The SBA was approved on April 1, 2009 for an amount equivalent to SDR 153.3 million (about US$242.9 million) or 300 percent of Mongolia's quota.
- IMF Deputy Managing Director and Acting Chair Mr. Takatoshi Kato emphasized:
  - Stabilization of market conditions and reduction in inflation due to authorities’ strong policy implementation.
  - Economic recovery likely slower than previously expected due to stronger-than-projected external shock; policy targets recalibrated to provide greater fiscal support.
  - Rebuilding international reserves and allowing flexible exchange rate adjustment are key; central bank should confine foreign exchange sales to preventing sharp movements and adjust interest rates to maintain low and stable inflation.
  - Strengthening the banking system is a top priority, including international external audit of all banks and prompt resolution of Anod Bank.
  - Importance of pressing ahead with mining sector agreements and strengthening institutions to manage mineral wealth.

### Statement by Mongolian Authorities: Key Policy Positions and Actions
- Introduction and program context:
  - Authorities report end-June Performance Criteria for the second review were successfully met.
  - Macroeconomic framework revised to provide additional support to the economy and lower income groups due to slowing growth.
- Fiscal policy:
  - Authorities restrained expenditure through end-June and contained fiscal deficit consistent with the Fund program.
  - Fiscal stimulus requires relaxation of the fiscal deficit target to support growth.
  - Commitments and measures:
    - Freeze nominal spending on wages and salaries at the 2009 level.
    - Comprehensive social transfer reform to consolidate social benefits to less than 20; planned passage by end-November.
    - Reverse the excise tax cut on fuel implemented in July.
    - Raise social security contributions in 2010.
    - Passage of a new Fiscal Responsibility Law and an organic budget law to be passed this year and effective from the 2011 budget.
  - Positive fiscal outlook contingent on mining developments:
    - Copper price currently priced at more than US$6,000 per ton compared with US$3,500 per ton assumed in the original program.
    - Negotiations progressing, e.g., agreement with Rio Tinto-Ivanhoe to develop Oyu Tolgoi (OT) mine; authorities hopeful OT agreement could be finalized in the near future.
- Monetary and exchange rate policy:
  - Current monetary framework providing a clear nominal anchor.
  - Monetary policy should be aligned with evolving economic and market conditions to achieve low inflation and international reserve targets; further interest rate cuts could be considered in consultation with the Fund.
  - Authorities support keeping exchange rate flexible, using interventions only to avoid large day-to-day movements or to build reserves.
  - Twice-weekly foreign exchange auctions will be maintained.
  - Upgrade of the screen-based system for interbank FX transactions to serve as main trading platform following Fund advice.
- Banking sector:
  - Resolution of ANOD bank to be handled carefully; due diligence on potential purchaser and guarantor ongoing; announcement of resolution plan delayed to end-October.
  - International external audit of all banks launched with World Bank assistance.
  - Central bank received capital reinforcement plans for all banks below the 12% capital adequacy ratio.
  - New banking and Central Bank laws drafted and submitted to parliament in July to bolster legal framework and prudential supervision.
- Other issues:
  - Swap arrangement with China has not been signed yet; consistent with prior commitment not to sign until Fund ensures compliance with Article VIII obligations. Authorities will keep staff informed on any major changes.
- Conclusion:
  - Authorities remain committed to close policy dialogue with the Fund and stand ready to take additional measures to accomplish social and economic objectives under the SBA.
  - Request completion of the second review based on program success and observance of end-June targets.

*Excerpted from IMF document _cr09311 (selected sections).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09311.pdf_