## _cr1176

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---

### Macroeconomic context and recent developments
- Economy rebounded strongly last year to 6 percent.
- Growth projected to remain strong and accelerate to around 10 percent in 2011.
- Inflation has returned to double digits and "could reach some 20 percent by year-end."
- Severe winter caused a sharp contraction in agriculture, especially animal husbandry, contributing materially to food-price driven inflation.
- Higher copper prices and a rapid increase in coal production are fueling strong export growth and boosting international reserves to an all-time high.

### Fiscal policy stance, risks, and the Fiscal Stability Law (FSL)
- 2011 budget substantially increased spending by nearly 7 percent of GDP relative to the SBA commitment.
- Universal cash transfers increased by some 4 percent of GDP relative to 2010; these universal transfers are noted to expire after the 2012 elections.
- Nominal spending already accounts for more than 60 percent of non-mineral GDP and is set to increase by some 35 percent.
- Replacement of the windfall profits tax with a resource tax regime will reduce revenue by some 3½–4 percent of GDP.
- Staff projects the underlying fiscal position will deteriorate significantly in 2011.
- Authorities committed to the Fiscal Responsibility Law and numerical targets that take effect in 2013; staff projections assume spending is sufficiently restrained in 2012–13 to meet the 2013 structural deficit target.
- FSL — three numerical ceilings:
  - Floor of structural balance: deficit of 2 percent of GDP; provision takes effect in 2013.
  - Ceiling of expenditure growth: non-mineral GDP growth rate (greater of 12-year moving average and budget year growth); provision takes effect in 2013.
  - Net present value of public debt ceiling: cannot exceed 40 percent of GDP; provision takes effect from 2014 with a transition period.

### Inflation dynamics and transmission
- Inflation has been in double digits for several months and is becoming more broad-based.
- Contributing factors: strong demand; 30 percent increase in pensions and civil servant wages implemented in October; large planned increase in budget spending for 2011; rising global and Chinese food prices; signs of resurgent credit growth; booming mineral sector.
- Staff projects that without scaling back budget spending, inflation would surpass 20 percent later this year.
- Inflation was 14 percent in December, "a full 3 percentage points above the prevailing policy rate."

### Monetary policy stance and considerations
- Central bank policy rate has not been increased despite rising inflation; the policy interest rate is negative in real terms.
- Staff recommended an immediate hike in interest rates to offset fiscal impulse and argued monetary policy has been too passive.
- Central bank noted limits to how much monetary policy could offset fiscal expansion and preferred to watch incoming data.
- Agreement on benefits of moving to a monetary policy regime with a more explicit focus on inflation in the medium term.
- Foreign currency intervention has been largely sterilized via increased issuance of central bank bills; broad money is growing faster than reserve money.
- Credit growth has recovered but remains somewhat sluggish as banks hold cash in central bank paper or excess reserves.

### Exchange rate and competitiveness
- Authorities remain committed to a flexible exchange rate regime; intervention used to smooth large and lumpy foreign exchange inflows given a thin interbank market.
- Foreign currency auction system effective for central bank intervention; reforms to develop the interbank market are being considered.
- Nominal appreciation in 2010 helped tighten monetary conditions by allowing real exchange rate adjustment to feed through the nominal exchange rate instead of prices.
- Mongolia experienced relatively more real appreciation over the past five years than many resource-dependent economies, with much of the adjustment occurring through inflation.
- Authorities aim to smooth real exchange rate adjustment by restraining fiscal spending, improving infrastructure, and building up human capital.

### Structural fiscal and tax reforms; social transfers
- Agreement on benefits of introducing a targeted poverty benefit to replace universal transfers; with about one-third of Mongolians living in poverty, a targeted benefit is essential.
- Authorities working with ADB and World Bank to pass social transfer reform law submitted last summer.
- Aim to adopt a modern integrated budget law to improve intergovernmental financial framework, medium-term programmatic budgeting, public investment planning, and budget implementation flexibility.
- Progress on strengthening the large taxpayers’ office, including plans to increase staffing.
- Staff cautioned against replacing or weakening the VAT; increasing exemptions or using VAT to target sectors would be highly inefficient and risk revenue leakage.

### Banking system and financial sector reform
- Indicators of banking system soundness improved by end-2010, but ratios likely to deteriorate with tighter rules on related-party lending and restructured loans effective January 1.
- Staff favored implementation of the Empowering the Banking Sector and Capital Support Program to provide temporary government capital support; authorities lacked parliamentary support and would pursue bank-by-bank negotiations as a second best.
- Staff emphasized strict enforcement of bank supervision regulations and replacement of supervisory forbearance with resolute action to deal with distressed banks.
- Authorities plan to have the budget cover bank restructuring costs and reimburse the central bank for expenses already incurred.
- Planning has begun to replace the blanket deposit guarantee with a deposit insurance system as market conditions allow.
- Authorities working to expand and deepen the non-bank financial sector, including strengthening the local equity market, legal environment, and insurance market development.

### Debt and reserves; Debt Sustainability Analysis (DSA) findings
- Updated DSA concludes Mongolia continues to be classified as low risk of debt distress.
- Mongolia has a strong capacity to repay the Fund, supported by DSA, favorable medium-term growth prospects, and projections of continued rise in international reserves.
- Public debt key figures (selected projections):
  - Total public debt (percent of GDP): 2009 (Prel.): 46.6; 2010: 43.0; 2011 (Proj.): 38.6; 2012 (Proj.): 37.1.
  - External debt (percent of GDP): 2009 (Prel.): 43.3; 2010: 30.8; 2011 (Proj.): 22.8; 2012 (Proj.): 19.8.
  - Public debt (in millions of US$): 2009 (Prel.): 1,977; 2010: 2,023; 2011 (Proj.): 2,064; 2012 (Proj.): 2,097.

### Box: Key considerations for raising the policy interest rate
- Is output growing faster than potential?
  - Measuring the output gap is challenging; Blanchard-Quah method "appears to perform better than standard filters."
  - According to this measure, the output gap, though negative at the end of last year, is projected to rise significantly in 2011.
- Does food inflation reflect demand or supply shocks?
  - Severe winter and rising global and Chinese food prices explain a large part of current food inflation.
  - Econometric evidence finds demand factors also play a role: spending on social transfers is found to increase food prices.
  - Planned increase in universal transfers for 2011 could push up food prices by as much as 10 percentage points.
- Are interest rates already too high?
  - Interest rates in Mongolia are structurally high due to banking system weaknesses and inflation volatility.
  - Policy rate is negative in real terms (inflation was 14 percent in December, 3 percentage points above the prevailing policy rate).
  - Preferred remedy: reduce inflation volatility and strengthen the banking system rather than lower nominal policy rates.
- Would higher interest rates attract more capital inflows?
  - Possible, but no signs of widespread speculative inflows; loan to deposit ratio in foreign currency is falling, and exchange rate has been fairly stable during minimal intervention.

### Box 2 — General Equilibrium Model: Simulating a Mineral Boom (Gleneagles model)
- Model examines an increase in government spending financed by fiscal revenue from a surge in mineral exports; calibration to Mongolia is uncertain.
- Central bank sterilization: simulation findings
  - Growth broadly the same with or without sterilization.
  - Real currency appreciation is the same regardless of sterilization.
  - Inflation is lower with sterilization because real exchange rate adjusts through the nominal exchange rate reducing domestic price pressures.
- Fiscal spending composition: simulation findings
  - Tilting fiscal spending toward public capital expenditure ("Benchmark") yields higher growth due to public capital as an input to production.
  - Effectiveness of public capital depends on governance, project selection, and procurement practices.
- Multiple currency practices (MCPs) and staff recommendations
  - MCP from multi-price auction system: staff recommends Executive Board approval to extend maintenance by Mongolia of this measure until March 15, 2012, or the next Article IV consultation, whichever is earlier.
  - MCP from official exchange rate (reference rate) used for government transactions: criteria for approval are not present; staff does not recommend Executive Board approval of this MCP.

### Staff appraisal — macroeconomic policy advice and medium-term outlook (selected recommendations)
- 2011 budget:
  - The large increase in fiscal spending this year "will do more economic harm than good."
  - Recommendation: The 2011 budget should be amended to reduce spending substantially.
- Medium-term fiscal framework:
  - Practical objectives for managing public spending growth: (i) help smooth economic growth; (ii) leave room for private sector to thrive; (iii) provide buffers against a downturn in global commodity prices.
  - Fiscal Responsibility Law must be strictly adhered to; compliance will entail expenditure restraint, e.g., keeping spending roughly frozen in real terms to reach the 2013 structural deficit target.
  - Avoid circumventing the law via off-budget vehicles or government guarantees.
- Monetary policy:
  - Inflation is already too high, and substantial increase in fiscal spending will push it up further.
  - Central bank should be more proactive and promptly initiate a tightening cycle, starting with an up-front hike in interest rates.
  - Give the central bank a more explicit mandate to make inflation the primary objective of monetary policy.
- Macroeconomic policy mix:
  - Current expansionary fiscal policy and concomitant need for tighter monetary policy is inefficient; recommended to significantly scale back government spending increase to reduce needed monetary tightening.
- Banking system priorities:
  - Strictly enforce existing regulations and replace supervisory forbearance with resolute action against non-compliant banks.
  - Prompt passage of Empowering the Banking Sector and Capital Support Program should be a top priority.
- Exchange rate policy:
  - Flexible exchange rate regime has been working well over the past 1½ years and remains appropriate; intervention to dampen excess volatility from large inflows is appropriate.

### Recommendation on consultations and MCP
- Staff recommends the next Article IV consultation takes place on the standard 12-month cycle and extension of the approval of Mongolia’s MCP arising from the multi-price auction system.

### Key macroeconomic indicators and projections (selected exact figures)
- Nominal GDP (2009): US$4,574 million
- Population, end-year (2009): 2.74 million
- Per capita GDP (2009): US$1,668
- Poverty incidence (2007/08): 35.2 percent
- Quota: SDR 51.1 million

- Real GDP growth:
  - 2009 (Prel.): -1.3
  - 2010: 6.1
  - 2011 (Proj.): 10.3
  - 2012 (Proj.): 7.6

- Consumer prices (period average):
  - 2009 (Prel.): 6.3
  - 2010: 10.2
  - 2011 (Proj.): 16.4
  - 2012 (Proj.): 16.0

- Consumer prices (end-period):
  - 2009 (Prel.): 1.9
  - 2010: 14.3
  - 2011 (Proj.): 20.0
  - 2012 (Proj.): 12.0

- GDP deflator (percent change):
  - 2009 (Prel.): 1.8
  - 2010: 18.0
  - 2011 (Proj.): 14.1
  - 2012 (Proj.): 8.9

- Fiscal operations (percent of GDP):
  - Total revenue and grants: 2009 (Prel.): 30.2; 2010: 37.2; 2011 (Proj.): 35.1; 2012 (Proj.): 35.0
  - Total expenditure and net lending: 2009 (Prel.): 35.2; 2010: 36.0; 2011 (Proj.): 38.5; 2012 (Proj.): 38.9
  - Overall balance (including grants): 2009 (Prel.): -5.0; 2010: 1.2; 2011 (Proj.): -3.5; 2012 (Proj.): -3.9
  - Non-mineral overall balance: 2009 (Prel.): -11.8; 2010: -10.6; 2011 (Proj.): -13.3; 2012 (Proj.): -11.8
  - Structural balance: 2009 (Prel.): -6.8; 2010: -2.8; 2011 (Proj.): -6.3; 2012 (Proj.): -6.5

- Monetary aggregates and reserves:
  - Broad money (percent change, annual): 2009 (Prel.): 26.9; 2010: 61.6; 2011 (Proj.): 45.0; 2012 (Proj.): 23.5
  - Broad money (in billions of togrog, end-period): 2009 (Prel.): 2,880; 2010: 4,655; 2011 (Proj.): 6,750; 2012 (Proj.): 8,333
  - Reserve money (end-period): 2009 (Prel.): 733; 2010: 947; 2011 (Proj.): 1,231; 2012 (Proj.): 1,477
  - Net international reserves (NIR) (millions of US$, end-period): 2009 (Prel.): 925; 2010: 1,704; 2011 (Proj.): 3,004; 2012 (Proj.): 3,580
  - Gross official international reserves (end-period, US$ millions): 2009 (Prel.): 1,328; 2010: 2,290; 2011 (Proj.): 3,586; 2012 (Proj.): 4,127
  - Gross official reserves (in months of next year's imports): 2009 (Prel.): 4.1; 2010: 4.9; 2011 (Proj.): 7.1; 2012 (Proj.): 8.8

- Balance of payments (selected, US$ millions):
  - Current account balance: 2009 (Prel.): -410; 2010: -931; 2011 (Proj.): -1,302; 2012 (Proj.): -1,438
  - Trade balance: 2009 (Prel.): -194; 2010: -278; 2011 (Proj.): -1,049; 2012 (Proj.): -1,107
  - Exports: 2009 (Prel.): 1,876; 2010: 2,899; 2011 (Proj.): 3,825; 2012 (Proj.): 4,083
  - Imports: 2009 (Prel.): -2,070; 2010: -3,177; 2011 (Proj.): -4,874; 2012 (Proj.): -5,190
  - Foreign direct investment: 2009 (Prel.): 496; 2010: 1,574; 2011 (Proj.): 1,130; 2012 (Proj.): 548
  - Copper price (US$ per ton): 2009 (Prel.): 5,165; 2010: 7,501; 2011 (Proj.): 9,000; 2012 (Proj.): 8,500
  - Oil price (US$ per barrel) (memorandum): 2009 (Prel.): 62; 2010: 79; 2011 (Proj.): 90; 2012 (Proj.): 90

- Other indicators:
  - Interest rate on 7-day central bank bills, end-period (percent): 10.0 (2009 Prel.), 11.0 (2010)
  - Broad money velocity (GDP/BM): 2.3 (2009 Prel.), 1.8 (2010), 1.5 (2011), 1.5 (2012)
  - Nominal effective exchange rate (end-period; percent change): -15.8 (2009 Prel.), 3.4 (2010)
  - Real effective exchange rate (end-period; percent change): -11.1 (2009 Prel.), 11.3 (2010)

### Debt sustainability and DSA summary
- Joint IMF/World Bank DSA (March 1, 2011) main conclusion: Mongolia’s risk of debt distress is low based on indicators of external and public debt.
- External and public debt ratios rose during 2009 due to front-loaded foreign financing; projected to improve substantially over the medium term with mining projects.
- Fiscal Stability Law (FSL) adopted in 2010 anchors fiscal discipline (2 percent ceiling on structural fiscal deficit, limits on expenditure growth, ceiling on debt).
- Projections incorporate development of Tavan Tolgoi and 2011 budget assumptions.
- Baseline projection: public debt ratio peaked in 2009 and projected to fall substantially over the medium term as mineral output increases.
- Stress tests: most extreme combination of shocks can temporarily raise PV debt-GDP ratios (e.g., to 39 percent in 2012 under one stress), but indicators fall thereafter.
- Policy implication: maintain adherence to FSL framework during the bridging period before mining-derived revenues materialize.

### Fund relations, safeguards, and operational recommendations (selected)
- Membership: Joined: February 14, 1991; Article VIII.
- Quota: 51.10 (SDR Million) — 100.00 (Percent Quota).
- Stand-by Arrangement approved 04/01/2009 (Amount Approved (SDR Million): 153.30; Amount Drawn (SDR Million): 122.64); program completed on October 1, 2010.
- Safeguards assessment update for the Bank of Mongolia finalized on June 17, 2009; improvements noted and follow-up actions taken (auditors granted vault access end-2009 and end-2010).
- Exchange arrangement: de jure floating; BOM reserves the right to intervene; foreign exchange auction instituted March 24, 2009; since 2011 authorities no longer disclose quantity of FX bought or sold in the auction and just publish the cut off rate.
- Multiple Currency Practices (MCPs):
  - Multi-price auction system MCP: staff recommends extension until March 15, 2012, or the next Article IV consultation, whichever is earlier.
  - Official exchange rate (reference rate) MCP: staff does not recommend approval as criteria are not present.
- Recommendation: next Article IV consultation on standard 12-month cycle and extension of approval of MCP arising from the multi-price auction system.

*Prepared by the Asia and Pacific Department; March 1, 2011. Source: IMF staff report — "1. Considerations for Raising Interest Rate", Box 1, Box 2, Annexes, and selected tables (extracted content).*

### 1. Considerations for Raising Interest Rate .......................................................................... 9

### 1. Considerations for Raising Interest Rate

### Macroeconomic context and recent developments
- The economy rebounded strongly last year to 6 percent.
- Growth is projected to remain strong and accelerate to around 10 percent in 2011.
- Inflation has returned to double digits and "could reach some 20 percent by year-end."
- Severe winter caused a sharp contraction in agriculture, especially animal husbandry, and contributed materially to food-price driven inflation.
- Higher copper prices and a rapid increase in coal production are fueling strong export growth and boosting international reserves to an all-time high.

### Fiscal policy stance and risks
- The 2011 budget substantially increased spending by nearly 7 percent of GDP relative to the SBA commitment.
- Universal cash transfers are being increased by some 4 percent of GDP relative to 2010.
- Nominal spending already accounts for more than 60 percent of non-mineral GDP and is set to increase by some 35 percent.
- Replacement of the windfall profits tax with a resource tax regime will reduce revenue by some 3½–4 percent of GDP.
- Staff projects the underlying fiscal position will deteriorate significantly in 2011.
- Authorities committed to the Fiscal Responsibility Law and numerical targets that take effect in 2013; staff fiscal projections assume spending is sufficiently restrained in 2012–13 to meet the 2013 structural deficit target.
- Fiscal risks from ending the ban on government guarantees, implementing PPPs, and establishing a development bank were highlighted; authorities agreed to fully report guarantees as part of government debt.

### Inflation dynamics and transmission
- Inflation has been in double digits for several months and is becoming more broad-based.
- Contributing factors: strong demand, 30 percent increase in pensions and civil servant wages implemented in October, the large increase in budget spending planned for 2011, rising global and Chinese food prices, signs of resurgent credit growth, and the booming mineral sector.
- Staff projects that without scaling back budget spending, inflation would surpass 20 percent later this year.
- Inflation was 14 percent in December, "a full 3 percentage points above the prevailing policy rate."

### Monetary policy stance and considerations
- The central bank policy rate has not been increased despite rising inflation; the policy interest rate is negative in real terms.
- Staff argued monetary policy has been too passive and recommended an immediate hike in interest rates to offset fiscal impulse.
- The central bank noted limits to how much monetary policy could do to offset fiscal expansion and preferred to watch incoming data.
- There was agreement on benefits of moving to a monetary policy regime with a more explicit focus on inflation in the medium term.
- Foreign currency intervention has been largely sterilized via increased issuance of central bank bills; broad money is growing faster than reserve money.
- Credit growth has recovered but remains somewhat sluggish as banks hold cash in central bank paper or excess reserves.

### Exchange rate and competitiveness
- Authorities remain committed to a flexible exchange rate regime; intervention is used to smooth large and lumpy foreign exchange inflows given a thin interbank market.
- Foreign currency auction system has been an effective means for central bank intervention; reforms to develop the interbank market are being considered.
- Nominal appreciation in 2010 helped tighten monetary conditions by allowing real exchange rate adjustment to feed through the nominal exchange rate instead of prices.
- Mongolia experienced relatively more real appreciation over the past five years than many resource-dependent economies, with much of the adjustment occurring through inflation.
- Authorities aim to smooth real exchange rate adjustment by restraining fiscal spending, substantially improving infrastructure, and building up human capital.

### Structural fiscal and tax reforms
- Agreement on benefits of introducing a targeted poverty benefit to replace universal transfers; with about one-third of Mongolians living in poverty, a targeted benefit is essential.
- Authorities working with ADB and World Bank to pass social transfer reform law submitted last summer.
- Authorities aim to adopt a modern integrated budget law to improve intergovernmental financial framework, medium-term programmatic budgeting, public investment planning, and budget implementation flexibility.
- Progress on strengthening the large taxpayers’ office, including plans to increase staffing to improve taxpayer services and revenue collection efficiency.
- Staff cautioned against replacing or weakening the VAT; increasing exemptions or using VAT to target sectors would be highly inefficient and risk revenue leakage.

### Debt and reserves
- Updated debt sustainability analysis (DSA) concludes Mongolia continues to be classified as low risk of debt distress.
- Mongolia has a strong capacity to repay the Fund, supported by the DSA, favorable medium-term growth prospects, and projections of continued rise in international reserves.

### Box: Key considerations for raising the policy interest rate
- Is output growing faster than potential?
  - Measuring the output gap is challenging given data shortcomings, volatility, structural changes, and large role for supply shocks.
  - The Blanchard-Quah method, which links the output gap directly with inflation, "appears to perform better than standard filters."
  - According to this measure, the output gap, though negative at the end of last year, is projected to rise significantly in 2011.
- Does food inflation reflect demand or supply shocks?
  - Severe winter and rising global and Chinese food prices explain a large part of current food inflation.
  - Econometric evidence finds demand factors also play a role: spending on social transfers is found to increase food prices.
  - The planned increase in universal transfers for 2011 could push up food prices by as much as 10 percentage points.
- Are interest rates already too high?
  - Interest rates in Mongolia are structurally high due to banking system weaknesses and inflation volatility.
  - The policy rate is negative in real terms (inflation was 14 percent in December, 3 percentage points above the prevailing policy rate).
  - The preferred remedy is to reduce inflation volatility and strengthen the banking system rather than lower nominal policy rates.
- Would higher interest rates attract more capital inflows?
  - This is possible, but there are currently no signs of widespread speculative inflows.
  - Evidence: loan to deposit ratio in foreign currency is falling, and the exchange rate has been fairly stable during a period of minimal intervention.

*Source: IMF staff report — "1. Considerations for Raising Interest Rate" (extracted content).*

### Box 2. Mongolia––General Equilibrium Model: Simulating a Mineral Boom

### Box 2. Mongolia––General Equilibrium Model: Simulating a Mineral Boom

### Model purpose and scope
- The Gleneagles model of scaling up aid is used to simulate a mineral boom.
- The model examines an increase in government spending financed by fiscal revenue from a surge in mineral exports.
- Quantitative findings should be discounted because available research makes it difficult to caliberate the deep parameters more specifically to Mongolia.
- Simulation results are based on S. Park, “Mongolia: Macroeconomic Impacts from a Large Scale Fiscal Spending,” IMF Working Paper (forthcoming). The Gleneagles model is from A. Berg, J. Gottschalk, R. Portillo, and L. Zanna, “The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios,” IMF Working Paper 10/160.

### Central bank sterilization: simulation findings
- Growth is broadly the same with or without sterilization. Fiscal spending boosts growth, but the extent does not depend on sterilization.
- Real currency appreciation is the same regardless of sterilization. Higher government spending increases demand for non-tradables, driving up non-tradable prices and thereby appreciating the real exchange rate. The extent of real appreciation is not affected by sterilization.
- Inflation is lower with sterilization. Sterilization allows the adjustment of the real exchange rate to happen through the nominal exchange rate reducing domestic price pressures and inflation.

### Fiscal spending composition: simulation findings
- A scenario based on the increase in spending in the 2011 budget (tilted to cash transfers) is compared to one where a larger share of spending is on public capital expenditure (“Benchmark”).
- Tilting fiscal spending toward capital expenditure would yield higher growth. This derives from the model’s inclusion of public capital as input to production.
- The effectiveness of public capital spending depends on how that spending is turned into productive public capital, which depends on the strength of governance, project selection, and procurement practices.

### Multiple currency practices (MCPs) and staff recommendations
- Mongolia maintains two multiple currency practices subject to Fund jurisdiction:
  - One arises from the multi-price auction system since there is no mechanism to ensure the exchange rates of accepted bids at the multi-price auction do not deviate by more than 2 percent from the commercial rates.
  - Staff recommends the Executive Board to approve a further extension of the maintenance by Mongolia of this measure until March 15, 2012, or the next Article IV consultation, whichever is earlier.
  - The other MCP arises from the official exchange rate (reference rate), which the government is required to use for its transactions, because it lacks a mechanism to ensure that the commercial rates and the reference rate do not deviate by more than 2 percent.
  - Given that the criteria for approval of this MCP are not present, staff does not recommend Executive Board approval of said measure.

### Banking system and financial sector reform (staff observations)
- Indicators of banking system soundness had improved by end-2010, but ratios are likely to deteriorate with the tighter rules on the treatment of lending to related parties and restructured loans that took effect January 1.
- Staff argued that implementation of the Empowering the Banking Sector and Capital Support Program would offer a transparent and fair means of providing temporary government capital support to any bank that needs time to come into full compliance.
- The authorities agreed on the merits but lack parliamentary support; as a second best, the central bank would start bank-by-bank negotiations and agree to time-bound restructuring plans.
- Staff emphasized strict enforcement of bank supervision regulations, replacing supervisory forbearance with resolute action to deal with distressed banks.
- The authorities intend to have the budget cover all bank restructuring costs and reimburse the central bank for expenses already incurred.
- Planning has begun to replace the blanket deposit guarantee with a deposit insurance system as market conditions allow.
- Authorities are working to expand and deepen the non-bank financial sector, including plans to strengthen the local equity market by partnering with a foreign stock exchange, improve the legal environment, and foster development of the insurance market.

### Staff appraisal — macroeconomic policy advice and medium-term outlook
- 2011 budget:
  - The large increase in fiscal spending this year will do more economic harm than good.
  - Immediate benefits will be dissipated through higher inflation, crowding out of private sector activity, and faster real exchange rate appreciation.
  - Real household purchasing power could go down; imports will surge; local business will become less competitive with knock-on effects for investment and employment.
  - International experience shows high inflation concentrated in staple food items will have an especially hard impact on the poor.
  - Recommendation: The 2011 budget should be amended to reduce spending substantially.
- Medium-term fiscal framework:
  - A sound fiscal policy is necessary to ensure mineral wealth leads to lasting prosperity.
  - Practical objectives for managing public spending growth: (i) help smooth economic growth (counter-cyclical fiscal policy); (ii) leave room for the private sector to thrive; and (iii) provide buffers against a downturn in global commodity prices.
  - The Fiscal Responsibility Law must be strictly adhered to in letter and spirit; compliance will entail expenditure restraint, for example, by keeping spending roughly frozen in real terms to reach the 2013 structural deficit target.
  - Avoid circumventing the law via off-budget vehicles or government guarantees; manage Development Bank, public-private partnerships, and public guarantees prudently and in line with international good practices.
- Structural fiscal reforms:
  - Top priority: introduction of a targeted poverty benefit as part of social transfer reform.
  - Other priorities: adopt an integrated budget law and strengthen the large taxpayer office.
- Monetary policy:
  - Inflation is already too high, and the substantial increase in fiscal spending will push it up further.
  - There are limits to what monetary policy can achieve if budget spending is not scaled back.
  - The central bank should be more proactive in fighting inflation and promptly initiate a tightening cycle, starting with an up-front hike in interest rates.
  - A tighter monetary policy stance will lessen credit availability and slow private activity, but this is preferable to allowing inflation pressures to build further.
  - Give the central bank a more explicit mandate to make inflation the primary objective of monetary policy.
- Macroeconomic policy mix:
  - The expansionary fiscal policy and concomitant need for a tighter monetary policy is an inefficient policy mix, resulting in macroeconomic volatility and higher inflation.
  - A better mix: significantly scale back the increase in government spending this year to reduce monetary tightening needed, yielding lower inflation, a smoother growth path, lower interest rates, and less real exchange rate appreciation.
- Exchange rate policy:
  - The flexible exchange rate regime has been working well over the past 1½ years.
  - International reserves are at an all time high, and the nominal exchange rate has evolved in line with market conditions.
  - The central bank’s intervention strategy to dampen excess volatility stemming from large and lumpy foreign exchange flows remains fully appropriate.
  - The flexible exchange rate regime will continue to help control inflation, provide a shock absorber against external shocks, and facilitate the real exchange rate adjustment likely to take place over the medium term with rapid growth in the mineral sector.
- Banking system (policy priorities):
  - Strictly enforce existing regulations and replace supervisory forbearance with resolute action against non-compliant banks.
  - Prompt passage of Empowering the Banking Sector and Capital Support Program should be a top priority.
- Medium-term outlook summary:
  - Development of the mineral sector will lead to substantial growth and an opportunity to spread prosperity, but success is not guaranteed.
  - To avoid the “resource curse,” Mongolia must pursue disciplined macroeconomic policies including:
    - (i) containing fiscal spending pressures and strictly adhering to the Fiscal Responsibility Law;
    - (ii) gearing monetary policy toward containing inflation, including by timely adjusting interest rates in line with evolving price pressures;
    - (iii) maintaining a flexible exchange rate regime; and
    - (iv) safeguarding the banking system through strict supervision and enforcement of existing prudential regulations.
  - Pursuing this policy combination would help ensure mineral wealth translates into strong, sustained, and equitable growth.

*Source: _cr1176 - Box 2. Mongolia––General Equilibrium Model: Simulating a Mineral Boom*

### 25.      Other. Staff recommends that the next Article IV consultation takes place on the

### 25. Other. Staff recommends that the next Article IV consultation takes place on the standard 12-month cycle and extension of the approval of Mongolia’s MCP arising from the multi-price auction system.

### Recommendation
- Staff recommends the next Article IV consultation takes place on the standard 12-month cycle and extension of the approval of Mongolia’s MCP arising from the multi-price auction system.

### Key macroeconomic indicators and projections (selected)
- Nominal GDP (2009): US$4,574 million
- Population, end-year (2009): 2.74 million
- Per capita GDP (2009): US$1,668
- Poverty incidence (2007/08): 35.2 percent
- Quota: SDR 51.1 million

- Real GDP growth:
  - 2009 (Prel.): -1.3
  - 2010: 6.1
  - 2011 (Proj.): 10.3
  - 2012 (Proj.): 7.6

- Consumer prices (period average):
  - 2009 (Prel.): 6.3
  - 2010: 10.2
  - 2011 (Proj.): 16.4
  - 2012 (Proj.): 16.0

- Consumer prices (end-period):
  - 2009 (Prel.): 1.9
  - 2010: 14.3
  - 2011 (Proj.): 20.0
  - 2012 (Proj.): 12.0

- GDP deflator (percent change):
  - 2009 (Prel.): 1.8
  - 2010: 18.0
  - 2011 (Proj.): 14.1
  - 2012 (Proj.): 8.9

### Fiscal operations (summary and projections)
- Total revenue and grants (percent of GDP):
  - 2009 (Prel.): 30.2
  - 2010: 37.2
  - 2011 (Proj.): 35.1
  - 2012 (Proj.): 35.0

- Total expenditure and net lending (percent of GDP):
  - 2009 (Prel.): 35.2
  - 2010: 36.0
  - 2011 (Proj.): 38.5
  - 2012 (Proj.): 38.9

- Overall balance (including grants) (percent of GDP):
  - 2009 (Prel.): -5.0
  - 2010: 1.2
  - 2011 (Proj.): -3.5
  - 2012 (Proj.): -3.9

- Non-mineral overall balance (percent of GDP):
  - 2009 (Prel.): -11.8
  - 2010: -10.6
  - 2011 (Proj.): -13.3
  - 2012 (Proj.): -11.8

- Structural balance (percent of GDP):
  - 2009 (Prel.): -6.8
  - 2010: -2.8
  - 2011 (Proj.): -6.3
  - 2012 (Proj.): -6.5

- Memorandum items:
  - Overall balance including banking sector restructuring costs (percent of GDP): -5.0 (2009 Prel.), -0.3 (2010), -4.6 (2011), -3.9 (2012)
  - Mineral revenue (percent of GDP): 6.8 (2009 Prel.), 11.8 (2010), 9.8 (2011), 7.9 (2012)
  - Non-mineral revenue (percent of GDP): 23.0 (2009 Prel.), 24.9 (2010), 24.9 (2011), 26.7 (2012)

### Monetary aggregates and reserves
- Broad money (percent change, annual):
  - 2009 (Prel.): 26.9
  - 2010: 61.6
  - 2011 (Proj.): 45.0
  - 2012 (Proj.): 23.5

- Broad money (in billions of togrog, end-period):
  - 2009 (Prel.): 2,880
  - 2010: 4,655
  - 2011 (Proj.): 6,750
  - 2012 (Proj.): 8,333

- Reserve money (end-period):
  - 2009 (Prel.): 733
  - 2010: 947
  - 2011 (Proj.): 1,231
  - 2012 (Proj.): 1,477

- Net international reserves (NIR) (millions of US$, end-period):
  - 2009 (Prel.): 925
  - 2010: 1,704
  - 2011 (Proj.): 3,004
  - 2012 (Proj.): 3,580

- Gross official international reserves (end-period, US$ millions):
  - 2009 (Prel.): 1,328
  - 2010: 2,290
  - 2011 (Proj.): 3,586
  - 2012 (Proj.): 4,127

- Gross official reserves (in months of next year's imports of goods and services):
  - 2009 (Prel.): 4.1
  - 2010: 4.9
  - 2011 (Proj.): 7.1
  - 2012 (Proj.): 8.8

### Balance of payments (selected)
- Current account balance (including official transfers, US$ millions):
  - 2009 (Prel.): -410
  - 2010: -931
  - 2011 (Proj.): -1,302
  - 2012 (Proj.): -1,438

- Current account balance (in percent of GDP):
  - 2009 (Prel.): -9.0
  - 2010: -15.2
  - 2011 (Proj.): -15.1
  - 2012 (Proj.): -13.6

- Trade balance (US$ millions):
  - 2009 (Prel.): -194
  - 2010: -278
  - 2011 (Proj.): -1,049
  - 2012 (Proj.): -1,107

- Exports (US$ millions):
  - 2009 (Prel.): 1,876
  - 2010: 2,899
  - 2011 (Proj.): 3,825
  - 2012 (Proj.): 4,083

- Imports (US$ millions):
  - 2009 (Prel.): -2,070
  - 2010: -3,177
  - 2011 (Proj.): -4,874
  - 2012 (Proj.): -5,190

- Foreign direct investment (US$ millions):
  - 2009 (Prel.): 496
  - 2010: 1,574
  - 2011 (Proj.): 1,130
  - 2012 (Proj.): 548

- Copper price (US$ per ton):
  - 2009 (Prel.): 5,165
  - 2010: 7,501
  - 2011 (Proj.): 9,000
  - 2012 (Proj.): 8,500

- Oil price (US$ per barrel) (memorandum):
  - 2009 (Prel.): 62
  - 2010: 79
  - 2011 (Proj.): 90
  - 2012 (Proj.): 90

### Public and publicly guaranteed debt
- Total public debt (percent of GDP):
  - 2009 (Prel.): 46.6
  - 2010: 43.0
  - 2011 (Proj.): 38.6
  - 2012 (Proj.): 37.1

- Domestic debt (percent of GDP):
  - 2009 (Prel.): 3.4
  - 2010: 12.2
  - 2011 (Proj.): 15.8
  - 2012 (Proj.): 17.3

- External debt (percent of GDP):
  - 2009 (Prel.): 43.3
  - 2010: 30.8
  - 2011 (Proj.): 22.8
  - 2012 (Proj.): 19.8

- Public debt (in millions of US$):
  - 2009 (Prel.): 1,977
  - 2010: 2,023
  - 2011 (Proj.): 2,064
  - 2012 (Proj.): 2,097

### Other notable indicators and projections
- Interest rate on 7-day central bank bills, end-period (percent): 10.0 (2009 Prel.), 11.0 (2010)
- Broad money velocity (GDP/BM): 2.3 (2009 Prel.), 1.8 (2010), 1.5 (2011), 1.5 (2012)
- Nominal effective exchange rate (end-period; percent change): -15.8 (2009 Prel.), 3.4 (2010)
- Real effective exchange rate (end-period; percent change): -11.1 (2009 Prel.), 11.3 (2010)

*Prepared by the Asia and Pacific Department; March 1, 2011.*

### ANNEX I. MONGOLIA––FUND RELATIONS

### ANNEX I. MONGOLIA––FUND RELATIONS

### I. Membership
- Status: Joined: February 14, 1991; Article VIII

### II. General Resources Account (SDR Million; Percent Quota)
- Quota: 51.10 — 100.00
- Fund Holdings of Currency: 173.61 — 339.74
- Reserve Position in Fund: 0.14 — 0.27

### III. SDR Department (SDR Million; Percent Allocation)
- Net cumulative allocation: 48.76 — 100.00
- Holdings: 47.23 — 96.87

### IV. Outstanding Purchases and Loans (SDR Million; Percent Quota)
- Stand-by Arrangements: 122.64 — 240.00
- ESAF/PRGF Arrangements: 5.70 — 11.15

### V. Latest Financial Arrangements
- Stand-by
  - Approval Date: 04/01/2009
  - Expiration Date: 10/01/2010
  - Amount Approved (SDR Million): 153.30
  - Amount Drawn (SDR Million): 122.64
- ECF / Formerly PRGF
  - Approval Date: 09/28/2001
  - Expiration Date: 07/31/2005
  - Amount Approved (SDR Million): 28.49
  - Amount Drawn (SDR Million): 12.21
- ECF / Formerly PRGF
  - Approval Date: 07/30/1997
  - Expiration Date: 07/29/2000
  - Amount Approved (SDR Million): 33.39
  - Amount Drawn (SDR Million): 17.44
- Note: 1/ Formerly PRGF.

### VI. Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs)
- Forthcoming Principal:
  - 2011 Principal: 2.44
  - 2012 Principal: 22.71
  - 2013 Principal: 61.03
  - 2014 Principal: 40.24
  - 2015 Principal: 1.92
- Charges/interest:
  - 2011 Charges/interest: 1.65
  - 2012 Charges/interest: 1.60
  - 2013 Charges/interest: 1.10
  - 2014 Charges/interest: 0.34
  - 2015 Charges/interest: 0.02
- Total:
  - 2011 Total: 4.09
  - 2012 Total: 24.31
  - 2013 Total: 62.13
  - 2014 Total: 40.58
  - 2015 Total: 1.94

### VII. Safeguards Assessments
- An update safeguards assessment of the Bank of Mongolia (BOM), conducted with respect to the Stand-by Arrangement approved in April 2009, was finalized on June 17, 2009.
- Previous safeguards assessments: March 2002 and November 2003.
- 2009 update assessment findings:
  - BOM has continued to improve its safeguards framework since the 2003 assessment.
  - BOM’s financial reporting and audit practices generally comply with international standards.
  - Recommendations to:
    - (i) strengthen certain aspects of the BOM’s oversight mechanism,
    - (ii) remove external audit qualifications caused by lack of access to central bank’s vaults,
    - (iii) improve the timeliness of audit completion and publication of the bank’s financial statements.
- Authorities’ follow-up:
  - Auditors were granted access to vaults at end-2009 and end-2010.
  - Timing of audit completion has improved.

### VIII. Exchange Arrangement
- Key dates and regime:
  - On May 27, 1993, Mongolia moved from a fixed exchange rate against the U.S. dollar to a floating exchange rate system.
  - De jure exchange rate arrangement: floating.
  - BOM’s official exchange rate: midpoint of the same days’ average buying and selling rates of transactions in the interbank market and transactions between banks and their clients; announced each weekday except national public holidays.
  - BOM reserves the right to intervene in the foreign exchange market.
- Classification changes and auctions:
  - Effective February 2, 2009, de facto classification changed from a conventional pegged arrangement to a stabilized arrangement, retroactively to April 30, 2008, due to revision of classification methodology.
  - Due to rapid currency depreciation between October 2008 and February 2009, exchange rate arrangement reclassified to “other managed arrangement” from a stabilized arrangement as of November 1, 2008.
  - On March 24, 2009, BOM instituted a foreign exchange auction; effective March 24, 2009, de facto exchange rate arrangement reclassified to floating.
  - Since 2011, authorities no longer disclose the quantity of foreign exchange bought or sold in the auction and just publish the cut off rate.
- Monetary policy framework:
  - Mongolia has no explicitly stated specific nominal anchor; instead monitors various indicators in conducting monetary policy.
- Article VIII obligations:
  - Mongolia accepted the obligations of Article VIII, Sections 2, 3, and 4 on February 1, 1996.
- Multiple Currency Practices (MCPs) subject to Fund jurisdiction:
  - Multi-price auction system:
    - Gives rise to an MCP because no mechanism ensures accepted bids at the multi-price auction do not deviate by more than 2 percent.
    - Executive Board approved the multi-price auction MCP until June 22, 2010 (Decision No. 14365 of June 23, 2009), and extended until June 22, 2011 or the next Article IV consultation whichever is earlier (Decision No. 14669 of June 23, 2010).
    - Staff recommends further extension until March 15, 2012, or the next Article IV consultation, whichever is earlier.
  - Official exchange rate (reference rate) for government transactions:
    - Mandatorily used for government transactions, creating market segmentation.
    - Order No. 699 of the Central Bank of Mongolia sets the reference rate as the weighted average of market rates used from 4 PM of the previous day to 4 PM of the current day.
    - Staff view: Order No. 699 does not eliminate market segmentation or multiplicity of effective rates; absence of mechanism ensuring commercial and reference rates do not deviate by more than 2 percent means this measure gives rise to an MCP subject to Fund approval and remains unapproved.
- Exchange restrictions:
  - 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 (11/4/94).

### IX. Article IV Consultation
- The 2009 Article IV consultation (IMF Country Report No. 10/52) was concluded by the Executive Board on December 22, 2009.
- Mongolia is on a 12–month cycle.

### X. ROSC Assessments
- Data Dissemination, May 2001 (www.imf.org)
- Fiscal Transparency Module, November 2001 (Country Report No. 01/218)
- Fiscal update, May 2005 (www.imf.org)
- Data Dissemination, April 2008 (www.imf.org)
- Monetary and Fiscal Policy Transparency, September 2008 (www.imf.org)
- Banking Supervision, September 2008 (www.imf.org)

### XI. Recent Financial Arrangements
- Stand-by Arrangement:
  - 18-month Stand-by Arrangement in an amount equivalent to SDR 153.3 million (300 percent of quota) approved on April 1, 2009.
  - Reviews: first review completed on June 23, 2009; second on September 21, 2009; third on December 22, 2009; fourth on March 19, 2010; combined fifth and sixth on September 8, 2010.
  - Program completion date: successfully completed on October 1, 2010.
- ESAF (1993):
  - Three-year arrangement equivalent to SDR 40.81 million (80 percent of quota), first annual arrangement SDR 18.55 million (36.3 percent of quota), approved on June 25, 1993.
  - Second annual arrangement SDR 11.13 million (21.8 percent of quota) approved on November 23, 1994.
  - ESAF arrangement lapsed on June 24, 1996.
- ESAF/PRGF (1997–2000):
  - Three-year arrangement equivalent to SDR 33.4 million (65.4 percent of quota), first annual arrangement SDR 11.13 million (21.8 percent of quota), approved on July 30, 1997.
  - First year arrangement lapsed on July 30, 1998.
  - Second annual arrangement SDR 14.8 million (29 percent of quota) approved on June 16, 1999.
  - First review completed in January 2000; arrangement lapsed on June 15, 2000.
  - ESAF/PRGF arrangement lapsed on July 29, 2000.
- PRGF (2001–2005):
  - Three-year arrangement equivalent to SDR 28.49 million (55.8 percent of quota), first year SDR 12.21 million (23.9 percent of quota), approved on September 28, 2001.
  - First and second reviews completed on September 12, 2003.
  - Executive Board approved extension of the PRGF through July 31, 2005.
  - Arrangement expired on July 31, 2005 without completion of the third and subsequent reviews.

### XII. FSAP Participation
- Mongolia participates in the Financial Sector Assessment Program (FSAP).
- FSAP missions: May 2007, September 2007, and November 2010.
- Latest report published: IMF Country Report No. 08/300, September 2008.

### XIII. Technical Assistance
- Missions (selection by topic and date):
  - Strengthening LTO operations (FAD), April, July and November 2010
  - Monetary Policy (MCM), October 2010
  - National Statistics (STA), August 2010
  - Fiscal Decentralization (FAD), June–July 2010
  - Tax Policy (FAD), June 2010
  - Banking Supervision (MCM), January–February 2010
  - Strengthening LTO operations (FAD), November 2009
  - Budget Preparation and Budget Legal Reforms (FAD), January, June, July, and December 2009
  - External Sector Statistics (STA), November 2009
  - Banking Restructuring (MCM), October–November 2009
  - Monetary and Financial Statistics (STA), September 2009
  - [Additional missions listed covering 2007–2008 and earlier back to 2000; see source for full chronology]
- Resident Advisors:
  - Budget Planning (FAD), June 2009–June 2011
  - National Accounts Statistics (STA), August 2001–September 2003
  - Treasury Reform (FAD), June 1999–November 2003
  - Balance of Payments (STA), March 1999–May 2001
- Note: Technical assistance for the period May 1995–October 1999 is reported in Annex II of the Staff Report for the 1999 Article IV consultation.

### XIV. Resident Representative
- Mr. Parmeshwar Ramlogan has been the Fund’s resident representative in Mongolia since July 2009.

*Source: ANNEX I. MONGOLIA––FUND RELATIONS (As of December 31, 2010).*

### Appendix I. Mongolia: Bank and Fund Planned Activities in Macro-Critical Structural

### Appendix I. Mongolia: Bank and Fund Planned Activities in Macro-Critical Structural Reform Areas, September 2010–August 2011

### Bank Work Program
- Products / Activities:
  - Development Policy Credit 2 (DPC2)
  - Quarterly Economic Updates
  - Development Policy Credit 2 Implementation Completion Report
  - Policy notes on selected economic topics
  - Gender economic analysis
  - Banking sector restructuring TA
  - Supervision missions multi-sectoral TA Credit (Banking, social welfare, fiscal policy)
  - Study tours to Poland and Estonia for parliamentarians and government officials on budget systems and fiscal decentralization, coordinated with FAD
  - Supervision Governance Assistance Project and Economic Capacity TA Project, focused on fiscal reform agenda
  - Supervision Mongolia Statistical Capacity-Building Project
- Expected delivery dates / status:
  - Development Policy Credit 2 Implementation Completion Report: Oct. 2011
  - Quarterly Economic Updates: Oct. 2010 (done); Oct. 2010 (done), Jan. 2011 (done), April 2011, July 2011
  - Policy notes on selected economic topics: Ongoing until June 2011
  - Gender economic analysis: October 2010? (listed under dates as Sept. 2010, February 2011, June 2011 — see corresponding missions)
  - Banking sector restructuring TA: April 2011
  - Supervision missions multi-sectoral TA Credit: June 2011
  - Study tours: March 2011
  - Supervision Governance Assistance Project and Economic Capacity TA Project: Ongoing
  - Supervision Mongolia Statistical Capacity-Building Project: December 2010

### Fund Work Program
- Products / Activities:
  - Article IV / PPM Mission
  - Article IV / PPM Staff Report and Board Meeting
  - PPM Mission
  - PPM Board meeting
  - STA: National account statistics
  - FAD: Tax administration for large taxpayers, mineral taxation regime
  - MCM: Banking supervision
  - Financial stability module FSAP mission
- Expected delivery dates / status:
  - Article IV / PPM Mission: February 2011
  - Article IV / PPM Staff Report and Board Meeting: March 2011
  - PPM Mission: August 2011
  - PPM Board meeting: September 2011
  - STA, FAD, MCM activities: Ongoing
  - Financial stability module FSAP mission: November 2010

### Asian Development Bank (AsDB) — Relations and Activities (Annex III)
- Membership and strategy:
  - Mongolia became a member of AsDB in February 1991.
  - Poverty Partnership Agreement (PPA) with the Government of Mongolia in 2000.
  - AsDB formulated Country Strategy and Program for 2006−08; preparing Country Partnership Strategy (CPS) through 2015.
- Lending and TA portfolio (as of December 15, 2010):
  - Loans for 37 projects totaling $734.7 million in agriculture, education, energy, financial, health, industry, telecommunications, transport, and urban development.
  - Technical assistance portfolio: 25 TA projects totaling $23.4 million.
  - Japan Fund for Poverty Reduction (JFPR) projects: 11 projects totaling $24.79 million.
- Grant and active portfolio (as of December 15, 2010):
  - Mongolia eligible for ADF grant financing for the period 2007–10.
  - Twelve grant projects/programs totaling $169.7 million approved as of December 15, 2010.
  - Total active loan and grant portfolio as of December 15, 2010: 8 loans amounting to a net total of $182.6 million and 12 grants totaling $156.2 million.
- Project performance:
  - 30 projects completed and closed as of December 31, 2009.
  - Of 25 project completion reports: 8 rated generally or highly successful, 10 successful, 5 partly successful, 1 unsuccessful; one had no rating.
  - Project performance evaluations (1996–2009) for 16 projects: 3 highly successful, 7 successful, 6 partly successful.
- Crisis response and programs:
  - Country Operations Business Plan 2009–12 prepared to address deterioration in economic environment.
  - Social Sector Support Program (SSSP) approved June 24, 2009; effective since 15 July 2009; co-financed by AsDB and JICA.
    - First tranche of $40 million released July 2009.
    - Second tranche pending passage of social welfare law and completion of nationwide identification of poor households through proxy means test.
- Forward program (2010–13):
  - Total lending program envisaged: $530 million for 2010–13.
    - $200 million from ADF resources.
    - $184 million from OCR financing subject to Mongolia’s reclassification from Group A to B, resource availability, access to regional ADF allocation and country-performance based allocation.
  - An average of $6 million in TA resources expected annually.

### Statistical Issues and Data Adequacy (Annex IV) — As of January 31, 2011
- General assessment:
  - Data provision to the Fund is broadly adequate for surveillance.
  - Priority areas for improvement: national accounts and government finance statistics.
- National Accounts:
  - Compiled by National Statistics Office (NSO) broadly in line with 1993 SNA.
  - Weaknesses: estimation of capital formation, estimation of GDP price deflators, coverage of informal sector and small-scale activity (especially services).
  - NSO plans to disseminate annual expenditure-based GDP series in value terms and to pilot quarterly estimates of GDP by expenditure in 2011.
- Price Statistics:
  - CPI rebased January 2008 with weights from the 2005 Household Income and Expenditure Survey.
  - NSO publishes national CPI for Ulaanbaatar and 21 aimags since January 2008, and a housing price index since October 2008.
  - Priority improvement: data on wages and earnings.
  - NSO plans to disseminate a producer price index and a retail price index in 2011.
- External Sector Statistics:
  - Bank of Mongolia (BOM) follows BPM5 and expected to begin implementing BPM6 recommendations in 2012.
  - Coverage broadened by extending ITRS to nonbank financial institutions and increasing direct reporting private enterprises.
  - BOM compiled an experimental IIP for 2007 and plans to publish IIP in 2011.
- Monetary and Financial Statistics:
  - BOM’s statistics conform to MFSM methodology; recommendations of June 2008 and September 2009 missions implemented.
  - Coverage expanded beginning February 2010 to include Savings and Credit Cooperatives (SCCs); since May 2010 data for other financial corporations (NBFIs) disseminated in BOM monthly bulletin.
  - Standardized report forms for BOM and other depository corporations in International Financial Statistics began in November 2009.
- Government Finance Statistics:
  - Concepts and definitions generally follow GFSM 1986.
  - No formal decision on migration path to GFSM 2001 but no substantial problems anticipated for achieving GFSM 2001 presentation.
- Data Standards and Quality:
  - Mongolia participates in GDDS and maintains efforts to subscribe to SDDS.
  - A data ROSC mission visited Mongolia in September 2007; report published April 2008.

### Table of Common Indicators Required for Surveillance (As of January 31, 2011) — selected entries and data quality assessments
- Exchange rates: Date of latest observation 1/31/11; Date received 1/31/11; Frequency of data D; Frequency of reporting M; Frequency of publication D.
- International reserve assets and reserve liabilities of the Monetary Authorities: 1/31/11; 1/31/11; D; M; M.
- Reserve/base money: 12/2010; 1/20/11; M; M; M. Data quality—Methodological soundness: O, LO, LO, LO; Accuracy and Reliability: O, O, O, O, LNO.
- Broad money: 12/2010; 1/20/11; M; M; M.
- Central bank balance sheet: 12/2010; 1/20/11; M; M; M.
- Consolidated balance sheet of the banking system: 12/2010; 1/20/11; M; M; M.
- Interest rates: 12/2010; 1/20/11; M; M; M.
- Consumer price index: 12/2010; 1/20/11; M; M; M. Data quality—Methodological soundness: O, LO, O, O; Accuracy and Reliability: LO, LO, LO, O, O.
- Revenue, expenditure, balance and composition of financing – general government: 12/2010; 1/20/11; M; M; M. Methodological soundness: LO, LNO, LO, O; Accuracy and Reliability: LO, O, LO, LO, LNO.
- Revenue, expenditure, balance and composition of financing – central government: 12/2010; 1/20/11; M; M; M.
- Stocks of central government and central government-guaranteed debt: 2009; 2/2010; A; A; A.
- External current account balance: Q4 2010; 1/2011; Q; Q; Q. Data quality: O, O, O, LO; Accuracy: LO, O, LO, LO, LO.
- Exports and imports of goods: 12/2010; 1/20/11; M; M; M.
- GDP/GNI: 2010; 1/2011; A; A; A. Data quality: O, LNO, O, LO; Accuracy: O, LO, LO, LO, LNO.
- Gross external debt: 2009; 2/2010; A; A; A.

### Selected Social and Development Indicators (excerpts)
- Employment to population ratio, 15+, total (%) — 1995: 52; 2000: 51; 2005: 52; 2008: 52
- Employment to population ratio, ages 15-24, total (%) — 1995: 42; 2000: 39; 2005: 36; 2008: 35
- Income share held by lowest 20% — 1995: 7.0; 2000: 7.0; 2005: 7.0; 2008: 7.0
- Malnutrition prevalence, weight for age (% of children under 5) — 2000: 12.0; 2005: 5.0
- Poverty headcount ratio at $1.25 a day (PPP) (% of population) — 1995: 19; 2000: 15; 2008: 2
- Share of women employed in the nonagricultural sector (% of total nonagricultural employment) — 1995: 47.9; 2000: 50.4; 2005: 53.1; 2008: 53.1
- Immunization, measles (% of children ages 12-23 months) — 1995: 85; 2000: 92; 2005: 97; 2008: 97
- Mortality rate, infant (per 1,000 live births) — 1995: 61; 2000: 49; 2005: 33; 2008: 26
- CO2 emissions (kg per PPP $ of GDP) — 1995: 2.0; 2000: 2.0; 2005: 1.0; 2008: 1.0
- Improved sanitation facilities (% of population with access) — 1995: 49; 2000: 49; 2005: 49; 2008: 50
- Net ODA received per capita (current US$) — 1995: 92; 2000: 91; 2005: 84; 2008: 93
- Mobile cellular subscriptions (per 100 people) — 1995: 0; 2000: 6; 2005: 22; 2008: 67

### Millennium Development Goals (Annex V)
- Listed goals:
  - Goal 1: Eradicate extreme poverty and hunger
  - Goal 2: Achieve universal primary education
  - Goal 3: Promote gender equality and empower women
  - Goal 4: Reduce child mortality
  - Goal 5: Improve maternal health
  - Goal 6: Combat HIV/AIDS, malaria, and other diseases
  - Goal 7: Ensure environmental sustainability
  - Goal 8: Develop a global partnership for development
- Source: World Bank, World Development Indicators database.

### Main Websites of Data (Annex VI) — selected institutional data offerings
- National Statistics Office (www.nso.mn): National Accounts; Consumer Price Inflation; Agricultural and Industrial Production; Petroleum Imports; Electricity Production and Consumption; Coal Production; Retail Prices; Employment; Exports and Imports.
- Bank of Mongolia (www.mongolbank.mn): Monetary Survey; Consolidated Balance Sheet of Commercial Banks; Distribution of Bank Credit to the Nongovernment Sector; Net Credit to Government; Interest Rates; Balance of Payments; Services and Income Accounts; Official Reserves of the Bank of Mongolia; Selected Indicators of Commercial Bank Foreign Exchange Operations; Nominal and Real Exchange Rates; Securities Market Data; Government Budget Accounts.
- Ministry of Finance (www.mof.gov.mn): Government Budgetary Operations.
- National Development and Innovation Committee (www.ndic.gov.mn): Long- and medium-term development strategy; Economic and social policies; Investment policy coordination; Development Bank of Mongolia.
- Financial Regulatory Commission (www.frc.mn): FRC decisions; Total assets of regulated entities; Consolidated income statements of regulated entities.

### Joint IMF/World Bank Debt Sustainability Analysis — Key introductory findings
- Date: March 1, 2011.
- Main conclusion: Mongolia’s risk of debt distress is low based on indicators of external and public debt.
- Recent context:
  - External and public debt ratios rose during 2009 due to front-loaded foreign financing to recover from a major terms of trade shock in late 2008.
  - With economic recovery entrenched and several large mining projects on the horizon, external and public debt ratios are projected to improve substantially over the medium term.
- Policy framework:
  - A landmark Fiscal Stability Law (FSL) was adopted in 2010 to anchor fiscal discipline.
  - FSL calls for a 2 percent ceiling on the structural fiscal deficit, defined using smoothed mineral prices (based on a more than 10 year moving average), limits on expenditure growth, and a ceiling on debt.
- Projections:
  - Projections incorporate updated assumptions on development of Tavan Tolgoi and fiscal projections based on the 2011 budget.

*Source: _cr1176 - Appendix I. Mongolia: Bank and Fund Planned Activities in Macro-Critical Structural Reform Areas, September 2010–August 2011 (IMF PDF).*

### Box 1: Three Ceilings in the FSL

### Box 1: Three Ceilings in the FSL

### Fiscal Stability Law (FSL) — Three numerical ceilings
- Floor of structural balance: deficit of 2 percent of GDP.
  - Structural balance calculated using the moving average price of major minerals—currently copper and coal—over 16 years (past 12 years, current year, and future three years).
  - Provision takes effect in 2013.
- Ceiling of expenditure growth: non-mineral GDP growth rate, determined as the greater between its 12-year moving average value and the budget year’s GDP growth rate.
  - Provision takes effect in 2013.
- Net present value of public debt ceiling: cannot exceed 40 percent of GDP.
  - Excludes any borrowing in which the government has agreed to contribute into the paid-in capital of a foreign invested mining entity and which is repayable from the future profits of the entity.
  - Provision takes effect from 2014, with a transition period specified for the preceding years.

### External public debt stock and composition (end-2009)
- Total external debt stock: US$2.1 billion (46 percent of GDP).
  - Public or publicly guaranteed debt (PPG): US$2.0 billion (reported by Ministry of Finance).
  - Estimated private external debt: US$0.1 billion.
- Composition of public debt (End-2009 Nominal / % of GDP / Present Value):
  - Public debt: 1,977 / 43.3 / 1,452
  - Multilaterals: 1,253 / 27.4 / 878
    - IMF: 182 / 4.0 / 160
    - World Bank: 392 / 8.6 / 239
    - AsDB: 627 / 13.7 / 447
  - Official bilaterals: 650 / 14.2 / 494
    - Paris Club: 508 / 11.3 / 380
    - Non-Paris Club: 142 / 3.1 / 114
  - Commercial: 75 / 1.6 / 80
- Creditor mix: about 63 percent of external debt contracted with multilateral creditors on concessional terms, 33 percent with official bilateral creditors on relatively concessional terms, and 4 percent with commercial banks.

### Recent fiscal and financial developments
- IMF SBA-supported program completed on October 1, 2010.
- Overall fiscal balance: recorded a small surplus at the end of 2010 (first since 2007).
- International reserves: at an all time high (as of end-2010).
- Government plans and actions:
  - 2011 budget: government spending and the deficit are set to rise; deficit to be financed through domestic borrowing and prepayments from Oyu Tolgoi (US$100 million) and Tavan Tolgoi (yet to be negotiated).
  - Fiscalization of banking sector restructuring: bonds issued in 2010 amounting to Tog 100 billion to recapitalize a bank; planned fiscalization in 2011 for Anod Bank around Tog 120 billion. No other bank restructuring costs included in projections.
- Debt management improvements in 2010:
  - Revised debt management strategy developed for 2010–12, approved by Cabinet and published.
  - Introduction of internal audits in addition to external audits.
  - Strengths: inputs on debt during budget preparation, clear separation between monetary policy and debt management, information sharing between MoF and central bank.
  - Area for improvement: making more information publicly available.
  - A Debt Management Performance Assessment is underway.

### Macroeconomic baseline assumptions and projections
- Mining projects underpin outlook: investment in Oyu Tolgoi and expansion in Tavan Tolgoi expected to drive structural changes.
- Real GDP growth:
  - Bottomed at minus 1.3 percent in 2009.
  - Hit 6.1 percent in 2010.
  - Production from Oyu Tolgoi expected to start by 2013.
  - Tavan Tolgoi expected to ramp up to over 10 million tonnes per year by 2014 and reach full capacity by 2016.
  - GDP growth expected to rise to over 20 percent in 2013 mainly as Oyu Tolgoi comes on stream.
  - Real GDP growth expected to average 13 percent over the medium term (2013–18).
- Commodity price assumptions:
  - Copper and coal price projections through 2016 based on WEO projections as of December 17, 2010 and assumed constant in real terms afterwards, net of transportation costs for Mongolia.
- Inflation and monetary policy:
  - Near-term inflation to rise sharply given economy operating close to capacity and expansionary fiscal stance in 2011.
  - Projected to converge to about 5 percent over the long term with medium-term fiscal sustainability ensured by the FSL and monetary tightening.
- Balance of payments:
  - Current account deficit around 14 percent in 2011 and 2012 due to imports of mining-related investment goods and higher non-mineral imports.
  - Once Oyu Tolgoi and Tavan Tolgoi produce, current account will jump into a large surplus.
- Fiscal trajectory:
  - Fiscal deficit expected to converge to numerical targets in the FSL starting from 2013.
  - Fiscal revenues expected to reach around 35.5 percent of GDP in 2020.
  - Stabilization Fund to be established in 2011 to save a substantial fraction of mineral revenues.
  - Overall balance projected to gradually converge from surpluses to around zero by 2030.
- Prepayments:
  - Prepayments for budget support from Tavan Tolgoi in 2011 are included, with terms and repayment assumed identical to those for Oyu Tolgoi.

### Financing and concessionality assumptions
- Transition to non-concessional financing as Mongolia moves to middle-income status:
  - Eligibility for non-concessional borrowing from IBRD and AsDB phased in starting in 2013.
  - Grant element of new external borrowing projected to decline from 35 percent in 2011 to 24 percent by 2030.
  - Interest rates reflect IDA blend terms and AsDB terms for concessional borrowing and market conditions for commercial loans.

### Debt sustainability assessment — External DSA
- Risk level: Mongolia remains at low risk of debt distress.
- Rationale:
  - Brighter medium-term macroeconomic outlook and large increase in mineral production keep debt indicators below thresholds.
  - PV of external public debt forecast to fall from 22.4 percent in 2010 to 6.4 percent of GDP at the end of the projection period.
- Stress test (most extreme combination of shocks: real GDP and export growth one-half of a standard deviation below historical averages in 2011–12):
  - PV of debt-GDP ratio climbs to 39 percent in 2012 but falls back thereafter.
- Note: historical-scenario stress tests are less relevant given Mongolia’s major structural shift in growth and current account.

### Debt sustainability assessment — Public DSA
- Baseline:
  - Public debt ratio peaked in 2009 at just below 50 percent of GDP.
  - Projected to fall substantially over the medium term as budget benefits from increased mineral output.
  - Debt rose in part due to loans from local subsidiary of Oyu Tolgoi to finance government’s investment share; these will be repaid from expected dividends and prepayments.
  - Baseline includes fiscalization of banking sector restructuring costs via domestic bond issuances; public sector domestic debt service ratios projected to increase around 2014 when payments fall due.
- Alternative scenario / extreme stress test (GDP growth in 2011–12 one standard deviation below historical average):
  - PV of debt-GDP ratio rises from 35 percent in 2010 to 63 percent in 2030.
- Policy implication: before increased mining-derived revenues materialize, fiscal policy should continue to adhere to the FSL framework to guard against overheating and commodity-price volatility.

### Authorities’ view
- Authorities concur with the overall assessment.
- Recognized need for a cautious approach during the bridging period until revenues from Oyu Tolgoi and Tavan Tolgoi enter the budget and that fiscal consolidation will be needed.
- Acknowledged vulnerability from high public debt to commodity price changes or financing constraints.
- Noted that the debt ceiling rule in the FSL and adherence to FSL numerical targets will help prevent excessive borrowing and reinforce fiscal sustainability commitments.

*Source: _cr1176 - Box 1: Three Ceilings in the FSL*

### 13.  The overall assessment has not changed since the last DSA and the external DSA

### _cr1176 - 13.  The overall assessment has not changed since the last DSA and the external DSA

### Overall assessment
- The overall assessment has not changed since the last DSA and the external DSA indicates that Mongolia remains at low risk of external debt distress.
- Compared to the previous DSA, the overall medium- to long-term macroeconomic outlook has improved, as development of Tavan Tolgoi becomes nearer and is thus included in the projections.
- The inclusion of increased mining production affects projections but does not lead to a different assessment from the external DSA.

### Short-term risks and vulnerabilities
- Short-term risks remain:
  - The budget remains vulnerable to financing shocks in the period before increased mining production (2013).
  - The expansionary 2011 fiscal stance risks overheating the economy.

### Medium-term outlook and public debt trajectory
- Public debt ratios are projected to have peaked last year and then fall steadily over the medium term with the rapid growth in the economy.
- This projected decline in public debt ratios does not change the external DSA assessment of low risk of external debt distress.

### Stress tests, alternative scenarios, and indicators (summary of presented tests)
- Figures and tables present indicators of public and publicly guaranteed external debt under alternative scenarios, 2010-30, including:
  - Debt accumulation (Figure a).
  - PV of debt-to-GDP ratio (Figure b).
  - PV of debt-to-exports ratio (Figure c).
  - PV of debt-to-revenue ratio (Figure d).
  - Debt service-to-exports ratio (Figure e).
  - Debt service-to-revenue ratio (Figure f).
- Footnotes on stress tests:
  - "The most extreme stress test is the test that yields the highest ratio in 2020. In Figure b, it corresponds to a combination of shocks; in c, to a exports shock; in d, to a combination of shocks; in e, to a exports shock; and in f, to a combination of shocks."
  - Revenues are defined inclusive of grants.
  - The most extreme stress test in Figure 2 corresponds to growth.

### Key quantitative indicators and projections (selected exact figures from tables)
- External debt (nominal) entries (selected): 37.2; 31.8; 45.9; 41.6; 42.9; 55.1; 40.9; 30.9; 25.8; 12.1; 8.1.
- Of which: public and publicly guaranteed (PPG): 36.1; 31.0; 43.3; 30.8; 22.8; 19.8; 14.7; 13.4; 13.2; 10.2; 7.9.
- Change in external debt: -4.4; -5.4; 14.2; -4.4; 1.3; 12.2; -14.2; -10.0; -5.1; -0.5; -0.4.
- Identified net debt-creating flows (selected): -22.8; -11.1; 5.3; -12.6; -1.0; 5.7; -15.7; -13.9; -17.0; -7.6; -2.2.
- Noninterest current account deficit entries (selected): -6.6; 12.6; 8.5; 2.7; 6.8; 14.7; 14.8; 13.2; -4.0; -7.8; -13.2; -6.8; -1.0; -5.9.
- Net FDI (negative = inflow) entries (selected): -8.5; -14.9; -10.8; -8.0; 3.5; -25.7; -13.1; -5.2; -4.6; -2.5; -2.5; -1.0; -1.0; -1.1.
- Endogenous debt dynamics (selected): -7.6; -8.8; 7.6; -1.6; -2.8; -2.3; -7.1; -3.5; -1.2; 0.2; -0.3.
- PV of external debt (selected): 34.4; 33.1; 36.8; 49.8; 36.9; 27.3; 22.3; 9.6; 6.6.
- PV of PPG external debt (selected): 31.8; 22.4; 16.7; 14.4; 10.7; 9.7; 9.6; 7.8; 6.4.
- PV of PPG external debt in percent of exports (selected): 63.6; 40.5; 33.2; 33.1; 22.0; 19.0; 18.6; 18.4; 18.8.
- PV of PPG external debt in percent of government revenues (selected): 106.4; 60.9; 47.9; 41.6; 33.7; 31.4; 28.9; 22.2; 20.4.
- Debt service-to-exports ratio (in percent, selected): 4.3; 2.8; 3.8; 4.4; 2.0; 3.0; 9.0; 13.9; 9.8; 3.8; 1.5.
- PPG debt service-to-exports ratio (in percent, selected): 2.0; 2.0; 3.8; 4.4; 1.9; 2.6; 2.5; 1.8; 1.1; 1.0; 1.5.
- PPG debt service-to-revenue ratio (in percent, selected): 3.2; 3.3; 6.3; 6.6; 2.7; 3.3; 3.8; 2.9; 1.8; 1.2; 1.6.
- Total gross financing need (millions of U.S. dollars) (selected): -531.9; -46.0; 1.8; -502.5; 272.4; 1044.2; -542.5; -480.9; -1968.4; -2005.1; -779.8.
- Noninterest current account deficit that stabilizes debt ratio (selected): -2.2; 18.0; -5.6; 19.1; 13.5; 1.0; 10.2; 2.2; -8.1; -6.3; -0.6.

### Key macroeconomic assumptions (selected exact series)
- Real GDP growth (selected entries): 10.2; 8.9; -1.3; 6.0; 4.0; 6.1; 10.3; 7.6; 22.9; 15.7; 9.0; 11.9; 0.8; 4.9; 5.6.
- GDP deflator in U.S. dollar terms (change in percent) (selected): 12.3; 21.6; -17.4; 10.0; 11.7; 26.2; 27.8; 14.3; 10.8; 3.1; 1.3; 13.9; 1.6; 2.1; 2.4.
- Effective interest rate (percent) (selected): 1.1; 1.1; 1.2; 1.6; 0.6; 1.4; 0.9; 1.0; 5.4; 5.4; 4.7; 3.1; 2.4; 1.6; 2.1.
- Growth of exports of G&S (U.S. dollar terms, in percent) (selected): 24.2; 18.9; -23.8; 17.1; 20.7; 48.4; 28.0; 6.7; 52.5; 25.4; 11.1; 28.7; -2.3; 3.4; 5.2.
- Growth of imports of G&S (U.S. dollar terms, in percent) (selected): 28.5; 57.4; -30.5; 16.7; 22.1; 49.3; 43.3; 6.6; -6.6; 7.9; 3.3; 17.3; 1.9; 6.5; 7.5.
- Government revenues (excluding grants, in percent of GDP) (selected): 37.5; 32.9; 29.9; 36.8; 34.8; 34.7; 31.8; 31.0; 33.3; 35.3; 31.3; 34.8.

### Policy findings and recommendations (extracted from Executive Board Assessment and PIN)
- Fiscal policy:
  - Directors called on the authorities to amend the 2011 budget and cut public spending to bring the fiscal stance back in line with cyclical requirements and the medium-term objectives of the Fiscal Responsibility Law.
  - Directors considered the adoption of a better targeted social transfer system to be a priority.
  - Directors urged caution with the planned establishment of a development bank, the provision of government guarantees, and the implementation of public-private partnerships due to potential for large quasi-fiscal liabilities.
- Monetary policy:
  - Directors saw considerable scope for a more proactive monetary management to curb inflation, starting with an immediate hike in the policy interest rate.
  - Directors generally supported a move over the medium term toward a monetary framework with a more explicit focus on inflation.
  - Measures to improve liquidity management and the economy’s capacity to absorb capital inflows are necessary.
- Exchange rate and financial sector:
  - Directors agreed that the flexible exchange rate regime has worked well and encouraged removal of remaining multiple currency practices as soon as conditions permit.
  - Directors welcomed progress in strengthening financial oversight and implementing the recommendations of the Financial Sector Assessment Program.
  - They highlighted the importance of strict enforcement of existing regulations and urged enactment of a law governing the provision of public support for bank restructuring and recapitalization.
  - Directors encouraged early establishment of a deposit insurance system to replace the blanket deposit guarantee.
- Program evaluation:
  - The Ex Post Evaluation found the SBA contributed to stabilizing a rapidly deteriorating macroeconomic situation and facilitating structural reforms.
  - Lessons include that large financing packages with streamlined conditionality can stabilize crises; timely technical assistance facilitates program implementation; securing durable commitment to post-program reforms remains a future challenge.
- Authorities’ commitments and actions:
  - Authorities plan to amend the 2011 budget to secure more fiscal restraint if inflationary risks are aggravated.
  - Authorities are committed to meeting the numerical target for structural budget deficit of 2 percent of GDP in 2013.
  - Universal cash transfers are increased by around 4 percent of GDP in 2011 and are to expire after the 2012 elections.

*Sources: Mongolian authorities; and IMF staff estimates and projections.*

### 2. Medium-term Fiscal Framework. The adoption of the Fiscal Stability Law (FSL)

### 2. Medium-term Fiscal Framework. The adoption of the Fiscal Stability Law (FSL)

### Medium-term fiscal framework and credibility
- The adoption of the Fiscal Stability Law (FSL) last year was a landmark achievement for avoiding the boom and bust policies of the past.
- Staff assessed that the 2011 budget could be a big step backward and it could undermine the law’s credibility.
- Authorities indicated continued commitment to observing the FSL to enhance medium-term fiscal credibility and sustainability.
- Authorities faced pressure to show tangible benefits from the signing of the Oyu Tolgoi investment agreement in the aftermath of the hardship from the crisis.
- Debt Sustainability Analysis (DSA) shows Mongolia remains low risk of debt distress supported by a bright medium and long-term macroeconomic outlook.
- Public debt ratios are projected to fall steadily from 2011.
- Debt management improvements include introduction of internal audits, clear separation between monetary policy and debt management, and information sharing between the Ministry of Finance and the Bank of Mongolia.

### Structural fiscal reform
- Significant progress in improving budget transparency, but considerable room for improvement in public investment management.
- Several draft laws under discussion: the Integrated Budget Law, the Law on Development Policy and Planning, and a revised Law on Public Procurement.
- Implementation of public-private-partnerships (PPPs) is being considered.
- Authorities plan to establish a Development Bank during this year that will use a portion of the proceeds from the Fiscal Stability Fund to finance essential infrastructure needs.
- Staff and authorities concur that PPPs and the Development Bank should not be used to increase off-budget activities and should be set up based on international good practices and transparency.
- Approval of the Social Transfer Reform Law (submitted to parliament last year) will substantially strengthen the social safety net through introduction of a more targeted poverty benefit transfer system.

### Monetary policy
- Bank of Mongolia recognizes threat of escalating inflation, but limits exist on what monetary policy can contain given substantial fiscal spending increases and capital inflow pressure.
- Staff judged the crowding out effect of higher interest rates, while undesirable, preferable to allowing inflation pressures to build further.
- Support for giving the central bank a more explicit mandate to make inflation the primary objective of monetary policy.
- Central bank measures include increasing reserve requirements of banks, raising the policy rate, and allowing greater exchange rate flexibility.
- In its meeting at the end of February, the Bank of Mongolia Board decided to keep the policy rate unchanged and increase the rate of reserve requirements by 400 basis points to 9 percent to tighten monetary policy stance and strengthen the banking sector’s risk-resistance.

### Exchange rate policy
- Central bank has been trying to dampen excess volatility in exchange rate stemming from large and volatile capital inflows.
- The real appreciation of the Mongolian currency (MNT) last year was about 20 percent, which was helpful in reducing inflation.
- The exchange rate has been fairly stable this year, and foreign reserves have been maintained at an all time high.
- Authorities concur with staff that the flexible exchange rate regime will continue to be appropriate for containing inflationary pressure and providing a buffer to external shock.
- Authorities are seeking structural ways to enhance absorptive capacity and harness capital flows to support productive investment and potential growth through deepening financial markets and strengthening the institutional framework.

### Banking system
- Indicators for banking system health have improved and bank loans as a share of GDP has declined since the 2008 crisis thanks to a strong economic recovery, but NPLs and loans in arrear still stand high.
- Real interest rates on deposits are falling, while MNT deposits continue to rise, fuelled by currency appreciation expectations under the blanket deposit guarantee system adopted during the crisis.
- Interest rates on US dollar time deposits reach 14 percent, reflecting continued perception of risk in the market.
- Framework for banking supervision and restructuring has been strengthened as part of structural benchmarks under the SBA.
- Authorities are enforcing prudential regulations strictly against non-compliant banks.
- Passage of the Empowering the Banking Sector and Capital Support Program will offer a transparent means to provide temporary financial support to banks needing time to come into full compliance.
- Authorities warned that a fragmented decision-making system and the turnaround of the economic situation could cause some delay in executing reform measures.

### Medium-term outlook
- Development of the mineral sector is expected to lead to substantial growth and an opportunity to spread benefits from resource wealth to all Mongolian people without harmful effect from “Resource Curse”.
- Staff projection: per capita income of Mongolia will almost quadruple in 8~10 years, from current amount of just above US$2,000, based on rapid growth in mining sector and currency appreciation.
- Prosperity is not guaranteed; the recent crisis illustrates that “Resource Curse” risks cannot be ruled out.
- Increasing public awareness of such risks would help control excess demands and focus on macroeconomic stability in the long run.

### Conclusion and policy implications
- Mongolia successfully recovered rapidly from a severe downturn due to the global financial crisis and has favorable medium-term prospects, but challenges remain:
  - Pro-cyclical fiscal stance in the pre-election period.
  - Ailing momentum for institutional reforms.
- Authorities admitted recent pressure to increase government spending as fiscal financing constraints eased due to higher resource prices and a substantial payment from a major mining development project.
- Authorities remain committed to implementing sound macroeconomic policies and a broad range of structural reforms.
- Authorities request continuous engagement and policy advice of the Fund to strengthen macroeconomic stability and sustain high growth with low inflation for poverty reduction and job creation, while keeping imminent overheating pressures in check.

*Source: _cr1176 - 2. Medium-term Fiscal Framework. The adoption of the Fiscal Stability Law (FSL)*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1176.pdf_