Mongolia -- Preliminary Conclusions of the 2011 Article IV Mission
IMF News, February 16, 2011
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- Published: February 16, 2011
Recent developments
- Growth rebounded strongly last year to 6.1 percent.
- Severe winter led to a sharp contraction in agriculture, especially animal husbandry.
- Shock to food supply helped drive inflation into the double digits for much of the year, led by rising meat prices.
- Higher copper prices and a rapid increase in coal production are fueling strong export growth and have helped boost international reserves to an all-time high.
Outlook
- Growth this year is projected to remain strong and is set to accelerate to around 10 percent.
- The large increase in fiscal spending underway is creating excess demand that will result in higher inflation and surging imports.
- Inflation could reach some 20 percent by year-end.
- Over the medium-term growth will be driven by an increase in mining output, with an especially large boost around 2013 when production from Oyu Tolgoi starts.
2011 Budget — assessment and risks
- Around one-third of Mongolians living below the poverty line motivates government desire to provide immediate support.
- The large increase in spending this year will:
- increase inflation, dissipating any immediate benefits;
- crowd out private sector activity;
- cause faster real exchange rate appreciation;
- potentially reduce real household purchasing power;
- surge imports as imports become cheaper relative to domestically produced goods;
- reduce local competitiveness with knock-on effects for investment and employment.
- 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.
- Fiscal management objectives include:
- (i) smoothing economic growth through counter-cyclical fiscal policy;
- (ii) leaving room for the private sector to thrive;
- (iii) providing buffers against a downturn in global commodity prices.
- The adoption of the fiscal stability law last year was a landmark achievement.
- The 2011 budget is a big step backwards; the fiscal stability law will succeed only if strictly adhered to in letter and spirit.
- Practical implications:
- Expenditure restraint is required, for example by keeping spending frozen in real terms, to bring the fiscal position in compliance with the numerical rules that start in 2013.
- Avoid circumventing the law via off-budget vehicles or government guarantees.
- Quasi-fiscal risks include the Development Bank, public-private partnerships, and public guarantees; such operations need to be managed prudently and in line with international good practices.
Structural fiscal reforms
- Ongoing efforts to advance structural fiscal reforms are welcome and should proceed.
- Top priorities:
- introduction of a targeted poverty benefit as part of social transfer reform to help the most vulnerable and increase fiscal flexibility;
- adoption of an integrated budget law to modernize intergovernmental fiscal relations, strengthen budget execution, and improve public investment and medium-term fiscal planning;
- continued strengthening of the large taxpayer office to provide better taxpayer services and more efficient revenue collection.
- Warning: increasing exemptions or using the VAT to target preferred sectors would be highly inefficient and ineffective, complicate tax administration, and risk revenue leakage.
Monetary policy
- Inflation is already too high; the substantial increase in fiscal spending underway will push it up further.
- There are limits to what monetary policy can achieve if budget spending is not scaled back.
- Recommendation: 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.
- Rationale:
- The central bank policy rate is already very negative in real terms and will become even more so as inflation rises.
- Higher interest rates are essential in tempering the rise in inflation.
- Trade-offs:
- Tighter monetary policy will lessen credit availability and slow private activity (crowding out), but this is preferred to allowing inflation pressures to build.
- Responsibility for crowding out lies with the decision to implement a very loose fiscal policy that monetary authorities now need to offset.
- Additional recommendation: give the central bank a more explicit mandate to make inflation the primary objective of monetary policy.
Macroeconomic policy mix
- The combination of expansionary fiscal policy and the need for tighter monetary policy is inefficient, resulting in macroeconomic volatility and higher inflation.
- Higher inflation carries large social costs, disproportionately hurting the poor and those on fixed incomes.
- Preferred mix:
- Significantly scale back the increase in government spending this year;
- Reduce the amount of monetary tightening needed;
- Achieve lower inflation this year and next, a smoother growth path, lower interest rates, and less real exchange rate appreciation;
- Improve competitiveness of the local economy and create a better environment for the private sector.
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 has succeeded in dampening excess volatility from large and lumpy foreign exchange flows; this intervention strategy remains appropriate.
- Nominal appreciation last year helped tighten monetary conditions and reduced the increase in inflation.
- Looking forward, the flexible exchange rate regime will:
- help control inflation;
- provide a shock absorber against external shocks;
- facilitate the real exchange rate adjustment likely over the medium-term with rapid growth in the mineral sector.
Banking system
- A healthy banking system is important for private sector development, access to credit, and safeguarding depositors via supervision and regulation.
- Recent progress in strengthening banking supervision is welcome.
- Priorities:
- strictly enforce existing regulations and replace supervisory forbearance with resolute action against noncompliant banks;
- implement the Empowering the Banking Sector and Capital Support Program to provide transparent and fair temporary support to banks needing time to comply;
- prompt passage of this legislation should be a top priority.
- All existing and future costs of bank restructuring should be promptly covered by the budget and not borne by the central bank.
Medium-term outlook and policy imperatives
- The Mongolian economy has a bright future with mineral sector development offering substantial growth and an opportunity to spread prosperity.
- Success is not guaranteed; the “resource curse” risk is real and Mongolia’s recent crisis illustrates high costs of failure.
- Required disciplined macroeconomic policies:
- (i) contain fiscal spending pressures and strictly adhere to the fiscal stability law;
- (ii) gear monetary policy toward containing inflation, including timely adjustment of interest rates in line with evolving price pressures;
- (iii) maintain a flexible exchange rate regime;
- (iv) safeguard the banking system through prudential regulation and supervision.
- Pursuing this policy combination would help ensure mineral wealth translates into strong, sustained, and equitable growth.
Mongolia -- Preliminary Conclusions of the 2011 Article IV Mission, February 16, 2011.