MONGOLIA ECONOMIC UPDATE Fiscal Space for Growth – The Role of Public Investment Spending Efficiency JULY 2018 This report is a product of the staff of the International Bank for Reconstruction and Development/The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the World Bank, the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this report. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. 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MONGOLIA ECONOMIC UPDATE Contents Abbreviations and Acronyms ................................................................................................................. iv Acknowledgements ................................................................................................................................ vi List of figures . ........................................................................................................................................ vii Executive Summary ................................................................................................................................. x I. PERFORMANCE AND PROSPECTS . .............................................................................................. 1 A. Recent Economic Developments ........................................................................................... 1 B. Outlook and Risks ................................................................................................................ 30 C. Closing the Productivity Gap – The Role of Public Investment Efficiency ............................ 32 II. THE ROLE OF PUBLIC INVESTMENT EFFICIENCY FOR GROWTH – A ROAD MAP FOR REFORM . ..................................................................................................... 35 A. The Rise and Fall of Capital Expenditures Since 2010 ................................................................ 35 B. Efficiency of Mongolia’s Public Investment Program.................................................................. 36 C. PIM – Legal and Institutional Issues............................................................................................ 39 D. A Road Map for PIM Reforms..................................................................................................... 41 References ............................................................................................................................................. 47 Annex: Growth Accounting Modelling .................................................................................................. 48 iii MONGOLIA ECONOMIC UPDATE mongolia - GOVERNMENT Fiscal Year January 1 – December 31 Currency Equivalents (Exchange Rate Effective as of June 1, 2018) Currency Unit = Tugrik (MNT) US$ 1.00 = MNT 2450.65 Abbreviations and Acronyms AQR Asset Quality Review BoM Bank of Mongolia BOT Build-Operate-Transfer BT Build-and-Transfer CBB Central Bank Bill CIT Corporate Income Tax DBM Development Bank of Mongolia DIB Department of Investment Budget DICOM Deposit Insurance Corporation of Mongolia (under the Ministry of Finance) EAP East Asia and Pacific FDI foreign direct investment GAAR General Anti-Avoidance Rule GDP Gross Domestic Product GNI Gross National Income GoM Government of Mongolia GTL General Taxation Law H1 First half H2 Second half IADI International Association of Deposit Insurers LICs Low Income Countries LMICs Lower Middle Income Countries LTD Loan-to-Deposit MDA Ministries, Departments, and Agencies MNT Mongolian Tugrik MoF Ministry of Finance MTBF Medium-Term Budget Framework MTFF Medium-Term Fiscal Framework NDA National Development Agency NEER Nominal Effective Exchange Rate NPLs Non-performing Loans iv MONGOLIA ECONOMIC UPDATE NSO National Statistics Office PBOC People’s Bank of China PIF Pension Insurance Fund PIM Public Investment Management PIMA Public Investment Management Assessment PIP Public Investment Program PIT Personal Income Tax PPP Public Private Partnership Q1 First quarter Q4 Fourth quarter REER Real Effective Exchange Rate RMBS Residential Mortgage-backed Securities SDV 2030 Sustainable Development Vision 2030 SGK State Great Khural (the Mongolian parliament) TFP Total Factor Productivity TOT Terms of Trade UB Ulaanbaatar UPN Unique Project Number VAT Value Added Tax y/y Year-on-Year Vice-President: Victoria Kwakwa Country Director: Bert Hofman Country Manager: James Anderson Global Practice Director John Panzer Practice Manager: Deepak K. Mishra Task Team Leader: Jean-Pascal Nganou v MONGOLIA ECONOMIC UPDATE Acknowledgements This paper was prepared by a core team led by Jean-Pascal Nganou (Senior Economist, TTL) and comprised of Davaadalai Batsuuri (Economist, MTI), Sulaiman Nyanzi (Consultant), and Altantsetseg Shiilegmaa (Economist, MTI). The team is grateful for comments and guidance received from Bert Hofman (Country Director), Deepak K. Mishra (Practice Manager), and James Anderson (Country Manager). We also wish to thank the peer reviewers Sudhir Shetty (Chief Economist, East Asia and Pacific Region) and Ekaterine T. Vashakmadze (Sr. Country Economist, DECPG). Sincere appreciation goes to Diane Stamm (Consultant) and Xavier De la Renaudiere (Consultant) for an excellent editing of the report. The team is grateful to Indra Baatarkhuu (Communications Associate, AEAPEC) for her advice on the dissemination of the report. Angar (Program Assistant, MFM) provided outstanding operational support of the report. vi MONGOLIA ECONOMIC UPDATE LIST OF FIGURES Figure (ES).1 Net FDI inflows versus Real GDP growth (US$ billion; y/y, %), 2006-17 xii Figure (ES).2 Budget revenue, expenditures and deficit (% of GDP), 2003–17 xii Figure (ES).3 A proposal of a road map for PIM reforms xiv Figure I.1 Contribution to economic growth — Demand-side factors (in %) 2 Figure I.2 FDI and gross fixed capital formation (% of GDP), 2005–17 2 Figure I.3 Private consumption recovered significantly, while government consumption remained sluggish in real terms 2 Figure I.4 Strong recovery in real household income boosted private consumption 2 Figure I.5 Real GDP growth by activity, 2011 Q1–2018 Q1 3 Figure I.6 Production growth of key commodities (3-month rolling sum; y/y, %) 3 Figure I.7 Inflation significantly rebounded in 2017 driven mainly by a surge in non-food, non-oil inflation reflecting demand shocks; meanwhile, food inflation seems to be stabilizing at near the target as the one-off factors dissipated 4 Figure I.8 The disinflationary cycle during 2014–16 is consistent with declining aggregate demand during the period, reflected in a contracting output gap; similarly, the rebound in inflation is consistent with a change in output gap 4 Figure I.9 After a downward trend, unemployment rate slightly increased in 2018 Q1 reflecting seasonal effects 6 Figure I.10 Industrial sector has been driving labor market while shifting away from agriculture 6 Figure I.11 Workers in mining sector are paid relatively higher wages… 7 Figure I.12 Improved market conditions also raised household income while growing inflation has been eroding real wage growth 7 Figure I.13 Adjustment in the unsustainable current account was done between 2014 and mid-2017 8 Figure I.14 Despite strong export performance, the current account deficit has slightly worsened since mid-2017, mainly due to a rising profit repatriation by mining companies 8 Figure I.15 Imports have been growing fast with escalation of investment, while exports performance has been robust 8 Figure I.16 Terms of trade significantly improved in 2017 due to higher commodity prices 8 Figure I.17 Surge in coal exports significantly boosted exports since late 2016… 9 Figure I.18 ... supported by rising export prices of key commodities 9 Figure I.19 Imports of capital goods and fuel have been rising strongly since late 2016 amid large FDI and investment 10 Figure I.20 Imports of consumption goods have also been rising since late 2016 10 Figure I.21 Strong recovery in FDI has helped ease pressure on the balance of payments, covering current account financing needs 11 Figure I.22 More than US$ 1.4 billion was mobilized in 2017 to reduce the BoP pressure through debt financing 11 Figure I.23 Large FDI inflows in mineral sector and official sector support improved the balance of payments… 11 vii MONGOLIA ECONOMIC UPDATE Figure I.24 …and resulted in a US$ 1.7 billion rise in international reserves (15 percent of GDP) in 2017 despite strong import growth 11 Figure I.25 The Nominal exchange rate has stabilized since early 2017 after years of depreciation… 13 Figure I.26 …while the currencies of most resource-rich countries have broadly strengthened against the U.S. dollar 13 Figure I.27 Expenditure, revenue, fiscal balance, 2011–17 15 Figure I.28 Public debt and components, 2012–17 15 Figure I.29 Spending consolidation performance (% of GDP), 2016 and 2017 16 Figure I.30 MTFF: Growth Profile 17 Figure I.31 MTFF: Debt Profile 17 Figure I.32 Interbank rates have been on the decline since November 2016, in tandem with lower policy rates 18 Figure I.33 Average lending rates and deposit rates have also marginally declined in recent months amid improving funding conditions 18 Figure I.34 M2 growth has been strong, with rising net foreign assets and credit to the private sector 19 Figure I.35 Strong money supply growth has mainly been driven by a rise in local currency deposits 19 Figure I.36 Expanded BoM’s balance sheet has been slowing since October 2017, mainly due to the limited subsidy to the housing mortgage program 20 Figure I.37 BoM’s policy credit has been declining with the phase-out of Price Stabilization Program and mortgage loans, but remains high 20 Figure I.38 Reserve accumulation and phase-out of policy loans have contributed significantly to strengthening of reserve money supply since the beginning of 2017 21 Figure I.39 Fast-rising net foreign assets have been contributing to reserve money growth since mid-2017 despite fiscal tightening and phase-out of policy loans by the BoM 21 Figure I.40 BoM projection on inflation 22 Figure I.41 BoM projection on economic growth 22 Figure I.42 Bank loans had steeply declined in 2014–15 with weak loan demand and phasing out of policy loans by the BoM 23 Figure I.43 Bank loans growth has been accelerating since late 2016 mainly driven by individual loans 23 Figure I.44 Funding conditions for banks are relaxing with accelerating local currency deposit growth despite declining BoM funding 24 Figure I.45 Accelerating deposit growth is mostly driven by a surge in local currency deposits 24 Figure I.46 The loan-to-deposit ratio has been declining since late 2016, with fast-growing deposit 25 Figure I.47 Excess liquidity conditions are reflected in a surge in Central Bank Bill (CBB) holdings by banks 25 Figure I.48 Credit conditions are still tighter in most sectors except the mining sector, which posted a strong recovery in loans 24 Figure I.49 Individual credit growth has been a key driver of total credit growth 26 Figure I.50 Household debt ratios to GDP and income have increased substantially 26 Figure I.51 Individual credit growth has been a key driver of total credit growth, while corporate loans have seen moderate growth 27 viii MONGOLIA ECONOMIC UPDATE Figure I.52 Mortgage loan growth has slowed, driven by the limited subsidy of the BoM to the housing mortgage program 27 Figure I.53 The loan quality ratio has stabilized with the strong economic recovery and speedy credit growth … 28 Figure I.54 … while deterioration of loan quality has mainly been driven by loans to the private sector 28 Figure I.55 Global growth is projected to continue to moderate in the coming years… 32 Figure I.56 Growth in EAP region will gradually moderate in 2019-20 32 Figure I.57 Potential output growth decomposition 34 Figure I.58 Real government consumption gap and output gap 34 Figure I.59 Relationship between fiscal impulse and output gap 34 Figure II.1 Co-movement between public investment and growth 37 Figure II.2 Correlation between public investment and economic growth 37 Figure II.3 Mongolia’s total investment is among the highest in EAP 37 Figure II.4 Evolution of public and private investment, EAP 2017 37 Figure II.5 Efficiency of public spending ranking 38 Figure II.6 Measure of public investment efficiency in Mongolia (Ratio of GDP growth to government capital spending, % of GDP) 38 Figure II.7 PIM Institutional Arrangements: Roles and Responsibilities of Key Institutions 41 Figure (A).1 Results of Growth Accounting by Dutu (2017) 49 Figure (A).2 Results of Growth Accounting by Bank of Mongolia (2013) 49 Figure (A).3 A comparison of trends of the capital output ratio using various assumptions 50 LIST OF TABLES Table (ES).1 Key Economic Indicators (2014-20) xiii Table (ES).2 Capital expenditures and main sources of funding (in percent of GDP) xv Table I.1 Mongolia: Average results of growth accounting 33 Table II.1 Capital expenditures and main sources of funding (in percent of GDP) 36 Table II.2 Debt incurred through off-budget investment funding in 2016 (MNT billion) 36 Table II.3 Key Institutions involved in management of public investment 40 LIST OF BOXES Box I.1 Slow progress toward achieving Sustainable Development Vision 2030 amid strong economic recovery 5 Box I.2 Key fiscal adjustment reforms adopted by the Government of Mongolia in 2017 14 Box I.3 The Medium-Term Fiscal Framework for 2019–21 17 Box I.4 Monetary Policy and Financial Sector Guideline for 2018–20 21 Box I.5 Goals of the amendment to the central bank law 22 Box I.6 Household loans and debt 26 Box I.7 Mongolian banks Asset Quality Review and results 28 Box I.8 Benefits resulting from the Banking Law and Deposit Insurance Law amendment 30 Box I.9 Global and Regional Outlook and Risks – Key Highlights 32 Box II.1 Current legal documents regulating public investment management 39 Box II.2 Purpose of prescreening 42 Box II.3 Example of rationalization criteria 44 ix MONGOLIA ECONOMIC UPDATE EXECUTIVE SUMMARY This Report and this Summary: (i) Review the recent economic and fiscal performance of Mongolia; (ii) Outline current medium-term prospects of Mongolia’s economy; (iii) Discuss short-term risks and structural vulnerabilities; and (iv) Comment on the efficiency of past public investment programs and practices. I. A STRONG ECONOMIC RECOVERY IN 2017 AND 2018 2017 was a good year for Mongolia. A strong economic recovery, accompanied by moderate inflationary pressures, led to lower fiscal and Balance of Payment (BoP) deficits and triggered a slight decline of the country’s public debt. Mongolia’s economic performance is likely to further improve in 2018 and current prospects for the next couple of years assume continued or accelerated growth, and continued improvements in the country’s public finance and balance of payments position, provided the government continues to implement its ongoing adjustment program with the support of its development partners. Mongolia’s economic performance improved dramatically in 2017 and at the beginning of 2018 with the GDP growth rate increasing from 1.2 percent in 2016 to 5.1 percent in 2017 and 6.1 percent during x MONGOLIA ECONOMIC UPDATE the first quarter of 2018. Strong growth was accomplished without excessive inflationary pressures. Indeed, the consumer price index (CPI) increased from 1.3 percent in 2016 to 6.4 percent in 2017 (6.1 percent in May 2018), but remained below the central bank target of 8 percent. The economic recovery was not due – at least initially – to strong growth in the mining sector. Despite a rebound of coal production, the mining sector contracted in 2017 because of the decline of the more important copper sub-sector still affected by unfavorable global commodity prices and geologically lower gold content in Oyu Tolgoi (OT)’s production. In 2018, copper production and exports increased significantly and, despite the mediocre performance of coal, there was a general rebound of the mining sector. The main factor behind the strong economic growth of the past eighteen months was large inflows of foreign direct investments, attracted by promising mega-projects in the mining sector in an increasingly positive external environment. The country’s good economic performance had a positive impact on public finances. The primary fiscal deficit, which had reached 12.5 percent of GDP in 2016, turned into a small surplus (2.1 percent of GDP) in 2017. The overall fiscal deficit including all DBM spending declined from 16.4 percent of GDP in 2016 to a low 1.9 percent in 2017. Improvements in the fiscal performance were due to a dramatic increase in government revenue and effective control of public spending, both recurrent and capital expenditures. On the revenue side, a gain of close to 5 percent of GDP was achieved, as government revenue increased from 24.4 percent of GDP in 2016 to 29.2 percent in 2017. This was not the result of significant tax policy adjustments, as most of the tax changes passed by Parliament in 2017 would not take effect until 2018, and some were then reversed. Consequently, the growth of revenue was entirely due to the economic recovery and substantial increases in mining-related revenue. On the public spending side, the gain was more than 9 percent of GDP (from 40.5 percent of GDP to 31 percent in 2017). The reduction of recurrent expenditures was equivalent to less than 2 points of GDP (from 27.2 percent of GDP in 2016 to 26.6 percent in 2017). More radical were the cuts in capital expenditures (from 10.9 percent of GDP in 2016 to 4.3 percent in 2017), a welcome development since public capital spending in Mongolia, compared with similar countries, was extremely high, as well as poorly managed and largely responsible for large and growing fiscal deficits from 4.1 percent in 2011 to 16.4 2016. Improvements in Mongolia’s economic performance also had a positive impact on external accounts. Exports increased by 26.1 percent in 2017 (mainly coal) and by 14.6 percent during the first five months of 2018 (mainly copper). Imports increased by 29.1 percent in 2017, due to a combination of imports of capital goods (linked with FDI-financed investments) and consumer goods (linked with the general economic recovery). Despite the strong rebound of imports, the trade balance slightly improved, but the deficit of the income balance increased due notably to large and growing payments on the public debt and the repatriation of profits by mining investors. Nevertheless, the balance of payments improved and a $1.4 billion surplus in 2017 replaced a $18.2 million deficit of 2016. Improvement in the BoP was mainly due to massive inflows of FDI, strong donor support and the successful refinancing (on better terms) of government guaranteed bonds maturing in 2017 and 2018. xi MONGOLIA ECONOMIC UPDATE Improvements in the balance of payments ended a long period of depreciation of the Tugrik. A slight appreciation of the Mongolian currency was observed in 2017. This led to a moderate appreciation of the real effective exchange rate which had no significant impact on the country’s competitiveness. Figure (ES).1 Net FDI inflows versus Real GDP growth Figure (ES).2 Budget revenue, expenditures and (US$ billion; Real LHS 2006-17Net FDI inflows (billion $): RHS y/y, %), GDP growth: deficit (% of GDP), 2003–17 20 Real GDP growth: LHS 5.0RHS Net FDI inflows (billion $): 40.0 20 5.0 4.0 40.0 15 30.0 4.0 15 30.0 Overall budget balance 3.0 20.0 10 3.0 Total revenues Overall and grants budget balance 20.0 10 10.0 expenditures Totalrevenues Total and grants 2.0 10.0 Total expenditures 2.0 5 0.0 5 1.0 0.0 1.0 -10.0 0 -10.0 0 0.0 0.0 -20.0 -20.0 -5 -5 -1.0 -1.0 20062008 2006 2007 2008 2010 2007 2009 2011 2011 2009 2010 2012 2012 20142014 20132013 2015 2016 2015 2017 2016 2017 Sources: NSO; World Bank staff estimates. II. A POSITIVE OUTLOOK By and large, the country’s short- and medium-term prospects remain positive. The recovery should continue, perhaps accelerate (a GDP growth rate of over 6 percent in 2019-20). As in 2017-18, economic growth should be driven by large FDI-financed investments in mining. However, almost all the sectors would benefit, notably industry (including mining) and trade, transport and other services. Agriculture (mainly livestock) – which was severely affected by harsh weather conditions during the winter – should grow more slowly. Inflation will likely rise although modestly – putting at risk the BOM medium term target of 8 percent as food and petrol prices are expected to continue to increase. Private consumption is also projected to further improve over the medium term. Accordingly, BOM is likely to gradually tighten monetary policy to contain inflation. Poverty should decline, at least in urban areas. As the poverty rate is higher in rural areas, a better performance of agriculture and a more significant decrease of rural poverty are essential to support the fight against poverty. Economic growth, higher exports and higher commodity prices should continue to have a strong positive impact on government revenue. Fiscal deficits should therefore continue to decline, provided the government implements effectively most of the measures included in its Economic Reform Program, which form part of the adjustment programs supported by the country’s development partners, including the IMF and the World Bank. The debt-to-GDP ratio should therefore continue to decline. Despite higher investment-related imports, economic growth supported by stronger exports and higher commodity prices, should also have a strong positive impact on the external sector. Despite large public debt payments and repatriation of profits, the balance of payments should continue to improve, owing to large FDI inflows and donor assistance. The following Table summarizes current economic projections for 2018-20, as envisaged in ongoing Bank-IMF supported adjustment programs. xii higher commodity prices, should also have a strong positive impact on the external sector. Despite large public debt large public payments and debt payments repatriation of and repatriation of profits, profits, the the balance of payments balance of should continue payments should continue to to improve, owing to improve, owing to large large FDI FDI inflows inflows and donor assistance. and donor assistance. MONGOLIA ECONOMIC UPDATE The following Table The following summarizes current Table summarizes current economic economic projections projections for for 2019-20, as envisaged 2019-20, as in ongoing envisaged in ongoing Bank-IMF supported adjustment programs. Bank-IMF supported adjustment programs. Table (ES).1Key (ES).1 Table KeyEconomic Indicators Economic Indicators (2014-20) (2014-20) Table (ES).1 Key Economic Indicators (2014-20) 2014 2015 2016 2017e 2018f 2019f 2020f 2014 2015 2016 2017e 2018f 2019f 2020f Real GDP growth, at constant market prices 8.1 2.5 1.5 5.1 5.5 6.6 6.2 Real GDP growth, at constant market prices 8.1 2.5 1.5 5.1 5.5 6.6 6.2 Pri va te Cons umpti on 6.3 7.2 -8.2 4.3 5.1 6.3 6.7 Pri va te Cons umpti on 6.3 7.2 -8.2 4.3 5.1 6.3 6.7 Government Cons umpti on 12.2 -4.7 11.0 -3.2 -1.8 0.5 4.2 Government Cons umpti on 12.2 -4.7 11.0 -3.2 -1.8 0.5 4.2 Gros s Fi xed Ca pi tal Forma ti on -21.7 -34.4 7.8 32.8 11.8 34.7 9.4 Gros s Fi xed Ca pi tal Forma ti on -21.7 -34.4 7.8 32.8 11.8 34.7 9.4 Exports , Goods a nd Servi ces 53.2 1.2 12.6 13.4 7.9 3.9 2.2 Exports , Goods a nd Servi ces 53.2 1.2 12.6 13.4 7.9 3.9 2.2 Imports , Goods a nd Servi ces 6.8 -11.5 12.4 25.0 8.4 12.3 4.0 Imports , Goods a nd Servi ces 6.8 -11.5 12.4 25.0 8.4 12.3 4.0 Real GDP growth, at constant factor prices 7.9 2.4 1.2 5.1 5.5 6.6 6.2 Real GDP growth, at constant factor prices 7.9 2.4 1.2 5.1 5.5 6.6 6.2 Agri cul ture 13.7 10.7 6.2 2.3 3.5 3.6 3.8 Agri cul ture 13.7 10.7 6.2 2.3 3.5 3.6 3.8 Indus try (i ncl mi ni ng) 12.7 9.9 -0.6 -1.4 5.5 7.3 7.7 Indus try (i ncl mi ni ng) 12.7 9.9 -0.6 -1.4 5.5 7.3 7.7 Servi ces 7.8 0.6 1.5 8.8 6.1 7.1 5.8 Servi ces 7.8 0.6 1.5 8.8 6.1 7.1 5.8 Inflation (Private Consumption deflator) 11.0 1.1 0.9 6.4 8.1 8.2 7.1 Inflation (Private Consumption deflator) 11.0 1.1 0.9 6.4 8.1 8.2 7.1 Current account balance (% of GDP) -11.5 -4.8 -6.3 -10.5 -8.2 -8.1 -6.9 Current account balance (% of GDP) -11.5 -4.8 -6.3 -10.5 -8.2 -8.1 -6.9 Financial and Capital account (% of GDP) 8.7 3.6 7.9 31.3 9.5 16.6 10.5 Financial and Capital account (% of GDP) 8.7 3.6 7.9 31.3 9.5 16.6 10.5 Net Forei gn Di rect Inves tment (% of GDP)* 2.3 1.6 1.1 13.1 13.2 15.2 12.6 Net Forei gn Di rect Inves tment (% of GDP)* 2.3 1.6 1.1 13.1 13.2 15.2 12.6 Fiscal Balance (% of GDP)** -10.4 -8.6 -16.4 -1.9 -4.7 -4.6 -2.8 Fiscal Balance (% of GDP)** -10.4 -8.6 -16.4 -1.9 -4.7 -4.6 -2.8 Primary Balance (% of GDP) -8.5 -5.4 -12.5 2.1 -1.0 -1.5 -0.1 Primary Balance (% of GDP) -8.5 -5.4 -12.5 2.1 -1.0 -1.5 -0.1 Debt (% of GDP)*** 57.9 60.1 87.2 84.4 79.3 76.3 72.4 Debt (% of GDP)*** 57.9 60.1 87.2 84.4 79.3 76.3 72.4 Memo i tems : Memo i tems : Nomi na l GDP (mi l l i ons US$) 12196 11728 11056 11021 12560 14219 15800 Nomi na l GDP (mi l l i ons US$) 12196 11728 11056 11021 12560 14219 15800 Nomi na l GDP (bi l l i ons MNT) 22227 23150 23936 27161 30978 35295 40073 Nomi na l GDP (bi l l i ons MNT) 22227 23150 23936 27161 30978 35295 40073 * In 2016, Net FDI number excluded the transactions of OT-2 project financing in May-June, 2016. * In 2016, Net **On-budget FDI number plus excluded the transactions of OT-2 project financing in May-June, 2016. DBM spending **On-budget plus DBM spending ***General government debt data excludes SOE's debt and central bank's liability from PBOC swap line. ***General government debt data excludes SOE's debt and central bank's liability from PBOC swap line. III. RISKS AND SHORT-TERM RISKS STRUCTURAL VULNERABILITIES AND STRUCTURAL VULNERABILITIES III. III. SHORT-TERM SHORT-TERM RISKS AND STRUCTURAL VULNERABILITIES The list The list of possible short- of possible and medium-term short- and risks is medium-term risks long. It It includes is long. political risks, includes political regional instability, risks, regional instability, climate shocks, climate shocks, natural disasters, and natural disasters, sudden changes and sudden changes in the overall overall external in the environment and external environment global and global shocks, natural disasters, and sudden changes in the overall external environment and global commodity prices. However, the most critical xii risk is a sudden relaxation of the government’s commitment to full implementation of its adjustment xii program. This is what happened in 2010, when, encouraged by booming exports, high commodity prices, and growing government revenue, the government stopped implementing its own program and increased public spending, planting the seeds for the next public finance crisis. This, however, is not the most probable scenario. It is true that some measures aimed at increasing revenue (a progressive personal income tax) and reducing the cost of the pension system (increasing the retirement age), which were expected to be effective in 2018, were approved by the Parliament only to be rescinded. So far, however, the government has been implementing all the most important components of its adjustment program, including drastic cuts in both recurrent expenditures (e.g., a hiring freeze) and capital expenditures. Perhaps more critical is the analysis of Mongolia’s long-term structural vulnerabilities. The first is the extreme vulnerability of Mongolia’s economic performance to the fluctuations of global commodity prices. The second is the fact that most of the country’s economic growth seems to come from physical capital accumulation, not from factor productivity. xiii MONGOLIA ECONOMIC UPDATE All the reviews of Mongolia’s past and recent economic developments demonstrate the extreme vulnerability of the country’s economic performance to frequent changes in global commodity prices. The mining sector, whose performance depends on the performance and prospects of the world economy, accounts for only 20 percent of GDP, but produces 90 percent of the country’s exports and in good years 20 percent of total government revenue. Minimizing this vulnerability to the external environment is intellectually easy but politically difficult. Substantial savings during the good years can create effective buffers against some of the worse effects of depressed commodity prices. This was well understood by the authors of Mongolia’s Fiscal Stability Law of 2010, which limited fiscal deficits to 2 percent of GDP, calculated based on average commodity prices over 16 years. The rules of the Fiscal Stability Law, however, were not implemented. Political pressures were strong, and the governments did not resist the temptation to increase public spending when the economy was booming and government revenue increasing. Another critical long-term vulnerability of the Mongolian economy is what reveals a growth accounting model. Apparently, most of the past economic growth came from physical accumulation of capital, not from improvements in factor productivity. The two structural vulnerabilities of the Mongolian economy are in fact closely related. Most of the accumulation of capital is financed by large inflows of FDI, which, of course, are based on the judgment of external investors on the medium- and long-term prospects of the country’s mining production and exports. Clearly the best long-term protections against these two vulnerabilities would be the diversification of the Mongolian economy. Consequently, government and donor policies should give a high priority to an economic diversification agenda that helps counter the ups and downs of the mining sector. Investment in human resources and developing the country’s technical and technological capacity are probably the best way to support diversification, together with sound investments in the most appropriate infrastructure and systematic development of the country’s economic institutions. IV. EFFICIENCY OF CAPITAL SPENDING The analysis of Mongolia’s public investment performance shows that most of the recent public investment programs were overambitious and unrealistic and were largely responsible for the fiscal crisis of the past few years. It also indicates that the mediocre quality of the programs created inefficiencies that must be addressed in the future years. The surge in capital expenditures until 2015 was the key factor behind the large increase of public finance deficits and the public debt. In 2013, Mongolia’s capital expenditures accounted for about 16 percent of the GDP, much higher than the 6.1 percent average of East Asian countries. This was not due to an increase of capital spending in the state budget. As the rules of the Fiscal Stability Law limited structural budget deficits, the increase in capital spending was entirely financed by off-budget funds, including DBM financing, promissory notes authorized by the Parliament since 2014, and more recently Build-Transfer (BT) operations.1 1 A cash budget does not show the cost of promissory notes or BT operations until the government makes a payment. xiv MONGOLIA ECONOMIC UPDATE Table (ES).2 Capital expenditures and main sources of funding (in percent of GDP) 2010 2011 2012 2013 2014 2015 2016 2017 Total Capital Expenditures 6 9.7 12.1 16.3 14.9 9.1 10.4 4.3 - On-Budget 6 9.7 9.1 7.8 8.4 6 9.3 6.1 - Investment 5.4 8 8.2 6 6.5 2.6 3.1 3.3 - Maintenance 0.3 0.4 0.3 0.5 0.4 0.5 0.2 0.3 - Foreign-Funded 0.3 1.3 0.6 1.3 1.1 1.1 2.3 2.4 - Off-Budget (DBM) 0 0 3 8.5 6.5 3.1 1.1 -1.8 Source: MoF data; World Bank staff estimates In 2015, the government took several measures aimed at improving fiscal management. Reducing capital spending was a major component of the country’s adjustment program. In effect, capital spending decreased from 14.9 percent of GDP in 2014 to 9.1 percent in 2015, rose to 10.4 percent in 2016 (as the government repaid outstanding promissory notes authorized since 2014), but declined again to 4.3 percent in 2017. At the same time, DBM-financing of non-commercial projects was included in the state budget and the use of promissory notes was stopped in 2016.2 The large public investment program implemented over the past five years did not produce the expected benefits. It did not prevent a sharp decline of GDP growth rates since 2011. In fact, the main legacy of the program was a major increase in public finance deficits and public debt, which will have a lasting impact on the country’s economic and fiscal performance. Cross-country benchmarks highlight the inefficiency of Mongolia’s public investment. The country ranks 124th on efficiency of public spending in the Global Competitiveness Index. Similarly, according to the 2016 IMF Public Investment Management Assessment (PIMA), Mongolia’s scores are much lower than for other emerging market comparators. Three main factors explain the mediocre quality of Mongolia’s past public investment programs. The first one is a policy bias. Too many Mongolian governments encouraged line ministries, government agencies and local governments to identify, finance and implement many new projects, large or small, without adequate consideration for the sustainability of the policy and the quality of the proposed operations. The second factor was an excessive decentralization and fragmentation of the decision- making process. The Ministry of Finance is only responsible for projects financed by the state budget. The use of off-budget financing techniques (DBM and promissory notes) enabled a wide variety of ministries and agencies to launch a large number of new projects outside any national strategic vision about the country’s development priorities. Third, very few efforts were made to develop and disseminate adequate guidance on effective project appraisal techniques. Poor investment planning and project selection led to ineffective implementation of approved operations. Actual public spending is only a fraction of amounts planned in the budgets and disbursement rates for capital expenditures are particularly low. Another efficiency issue is the lack of adequate funding for maintenance. Despite the recent increase in public investment, the capital maintenance budget did not increase substantially over the past ten years. The GDP ratio of maintenance spending increased from 0.3 percent of GDP in 2003-09 to an average of 0.4 percent in 2014-15 before declining to less than 0.2 percent in 2016. More importantly, the ratio of maintenance 2 But BT financing continues. xv MONGOLIA ECONOMIC UPDATE to total capital expenditures sharply declined from 5.1 percent in 2010 to 1.9 percent in 2016. The shortage of maintenance expenditures reduces the benefits and shortens the economic life of ongoing and new investments in infrastructure and other sectors. To conclude, Mongolia needs to review and reshape its public investment policies and decision- making processes. The pre-screening of projects should be based on well-conceived national and sector strategies. The approval of investment programs should be based on realistic revenue forecasts and sound medium-term economic and fiscal frameworks. The roles and responsibilities of the various stakeholders should be clarified. A central public investment management unit should be able to review project proposals for quality assurance purposes. A project data base should be developed and become the main source of information for all public investment projects. Finally, the ongoing investment program should also be rationalized, including restructuring or eliminating non-performing ongoing projects. A proposal of a road map to improve public investment management is presented below (Figure (ES).3). Figure (ES).3 A proposal of a road map for PIM reforms Source: World Bank (2018c). Source: World Bank (2018c). xvi MONGOLIA ECONOMIC UPDATE I. PERFORMANCE AND PROSPECTS A. Recent Economic Developments Following a period of considerable economic and financial turbulence, Mongolia’s economy recovered strongly in 2017, supported by a surge in foreign direct investment, high global commodity prices, and restoration of macroeconomic stability. Economic recovery in 2017 was stronger than anticipated, as real gross domestic product (GDP) increased by 5.1 percent from 1.2 percent in 2016, following a prolonged period of a slowdown in growth. The growth momentum of 2017 continued into 2018 Q1, as the economy grew at 6.1 percent following a robust recovery of the mining sector and strong private consumption. Despite bottlenecks at the border with China and a harsh winter, the mining sector expanded in 2018 Q1 from a contraction in 2017 and barely any growth in 2016. On the demand side, investment and private consumption are the two main factors explaining the recent growth acceleration of Mongolia (Figure I.1 ). Investment demand continued to grow during 2017 buoyed by new inflows of foreign direct investment (FDI) as market expectations improved. In fact, there is a strong correlation between FDI and gross fixed capital formation. Both FDI and gross fixed capital formation peaked in 2011, and when FDI almost dried, investment plummeted by almost a half (Figure I.2 ). Gross fixed capital formation grew by 36.2 percent in 2017, almost double the growth in 2016 after two consecutive years of contraction. On average, net FDI inflows finance about 60 percent of private investments. 1 fact, there fact, there is a strong correlation between FDI and gross FDI and gross fixed fixed capital capital formation. BothFDI formation.Both andgross FDIand gross fixed capital fixed when FDI capital formation peaked in 2011, and when FDI almost almost dried, dried,investment plummetedby investmentplummeted almostaa byalmost half (Figure half formation grew (Figure I.2 ). Gross fixed capital formation by 36.2 grew by 36.2 percent percentin 2017,almost in2017, doublethe almostdouble growth thegrowth in in 2016 2016 after MONGOLIA ECONOMIC after two consecutive years of contraction. contraction. UPDATE average, On average, On net FDI net inflows finance FDI inflows about60 finance about 60 percent of percent private investments. of private Figure I.1 Figure Figure Contribution Contribution to I.1 Contribution I.1 economicgrowth to economic — growth — — FigureI.2 Figure Figure I.2FDI I.2 FDIand FDI andgross and gross gross fixed fixed fixed capital capital capital formation Demand-side Demand-side factors Demand-side (in %) factors (in %) formation formation (% (% of of GDP), (% of GDP), 2005–17GDP), 2005 2005 –– 17 17 Household Household consumption consumption Government consumption Government consumption Grosscapital Gross formation capitalformation FDI FDI Gross capital Gross capital formation formation export Net export 60 60 30 30 GDP GDP 25 25 50 50 20 20 15 15 40 40 10 10 55 30 30 00 20 20 -5 -5 -10 -10 10 10 -15 -15 -20 -20 00 2007 2008 2006 2007 2006 2009 2010 2011 2012 2013 2014 2015 2008 2009 2016 2017 2015 2016 2017 2005 2006 2005 2006 2007 2007 2008 2008 2009 20102011 20092010 20122013 20112012 20132014 20142015 20152016 20162017 2017 NSO; World Sources: NSO; Sources: Sources: NSO; World World Bank Bankstaff estimates. staff estimates. consumption recovery Private consumption Private Private consumption recovery waswas supported supported supportedby by positive bypositive positivedevelopments developments developmentsin in in the the the labor labor labor markets markets markets and and and creditgrowth strongercredit stronger stronger credit growthperformance performancein 2017. in2017. Private 2017.Private consumption, consumption, Privateconsumption, which which which had had had significantly significantly significantly contracted contracted contracted in in 2016, 2016, grew grew by 4.3 percent in 2017, and 9.6 9.6 percent percent in in the the first first quarter quarter of of 2018. in 2016, grew by 4.3 percent in 2017, and 9.6 percent in the first quarter of 2018. The recovery in2018. The The recovery recovery in in consumer optimism optimism reflects a strong rebound consumer optimism consumer reflects a strong rebound reboundin in individual individualcredit inindividual credit and creditand real andreal income realincome income growth, growth, growth, following following following positive positive developments developments in the labor market (Figure (Figure positive developments in the labor market (Figure I.4 ). I.4 I.4 ). ). Figure I.3 Private consumption recovered Figure I.4 Strong recovery in real household significantly, FigureI.3 Figure while I.3Private Private government consumption consumption consumption recovered recovered income Figure FigureI.4boosted I.4Strong private Strongrecovery recoveryconsumption inreal in realhousehold household remained sluggish significantly, significantly, whilein while real terms consumption government government consumption incomeboosted income privateconsumptio boostedprivate n consumption remained sluggishin sluggish Growth contributions remained inreal terms termsand government of private real Real average household income growth (y/y, %) Growth contributions of private consumption (% government and point) Real average household income growth (y/y, %) Growth contributions of private and government Real average household income growth (y/y, %) consumption (% point) Real HH Monetary Income (y/y, %): National consumption (% point) 40% 100% Government Consumption (%p) Individual Real Credit Growth HH Monetary Income(y/y, (y/y,%): %):RHS National 25 Private consumption Government (%p) (%p) Consumption 1 1 40% 30% Individual Credit Growth (y/y, %): RHS 100% 80% 25 20 Final Consumption growth Private consumption (%p) (y/y, %) 30% 80% 60% 20 15 Final Consumption growth (y/y, %) 20% 60% 15 40% 10 20% 40% 10 10% 20% 5 10% 20% 5 0% 0 0% 0 0% 0% -5 -20% -5 -20% -10% -10 -10% -40% -10 -40% -15 -15 -20% -60% -20% -60% -20 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 -20 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Sources: NSO; World Bank staff estimates. Sources: NSO; World Bank staff estimates. In contrast In contrast to the four to the previous years, four previous years,netnet exports netexports were were exportswere not not a source of growth in 2017; in fact, net In contrast to the four previous years, not aa source source of of growth growth inin 2017; 2017; inin fact, fact, netnet exports dragged down GDP growth by 7.3 percentage points. As private absorption strongly recovered, exportsdragged exports dragged downGDP growthby GDPgrowth 7.3percentage by7.3 percentagepoints. points.AsAs private absorption strongly recovered, imports growth downoutpaced exports growth. private absorption strongly recovered, imports growth outpaced exports imports growth outpaced exports growth. growth. On the supply side, growth recovery in 2017 was driven mainly by the non-mining sectors (services, On On thesupply the side, supplyside, manufacturing, and growth growth recovery recovery agriculture), andinin by 2017 2017 net was was driven driven taxes mainlyby mainly on products. by thenon-mining the Their non-mining expansion sectors sectors continued (services, (services, through manufacturing, manufacturing, 2018 Q1 (Figure and and agriculture), I.5).agriculture), The growth of and andthe by by net net taxes servicestaxes on products. on manufacturing, products. Theirand sector, Their expansion expansion continued continued taxes was mainly due through through to the 2018 strong 2018 Q1 Q1 (Figure link I.5). The to domestic (Figure I.5). The growth demand. growth of of the Services the services services sector,manufacturing, sector, expansion was mainly driven manufacturing, and and taxes was by higher taxes was mainly growth mainly due in dueto the the to strong link transport, to domestic wholesale and demand. retail Services trade, and expansion communicationswas mainly subsectors. driven The by manufacturing the strong link to domestic demand. Services expansion was mainly driven by higher growth in the higher growth sector in the also grew strongly, transport, transport, with quarterly wholesale wholesale andretail and growth retail rates trade,and trade, exceeding 20 percent andcommunications communications in 2017. subsectors. subsectors. The The This trend continued manufacturing manufacturing sector sector in also 2018 also Q1 following positive developments in electricity generation activities. grew strongly, with quarterly growth rates exceeding 20 percent in 2017. This trend continued in 2018 Q1 following positive developments in electricity generation activities. The construction sector showed some signs of recovery in 2018 Q1 after a prolonged period of 2contraction. The construction sector shrank during most of 2017 but signs of recovery appeared at the The construction sector showed some signs of recovery in 2018 Q1 after a prolonged period of end of 2017 and in 2018, with strong growth rates of 18 percent and 15 percent for two consecutive contraction. The quarters (2017 Q4construction sector shrank during most of 2017 but signs of recovery appeared at the and 2018 Q1). end of 2017 and in 2018, with strong growth rates of 18 percent and 15 percent for two consecutive MONGOLIA ECONOMIC UPDATE grew strongly, with quarterly growth rates exceeding 20 percent in 2017. This trend continued in 2018 Q1 following positive developments in electricity generation activities. The construction sector showed some signs of recovery in 2018 Q1 after a prolonged period of contraction. The construction sector shrank during most of 2017 but signs of recovery appeared at the end of 2017 and in 2018, with strong growth rates of 18 percent and 15 percent for two consecutive quarters (2017 Q4 and 2018 Q1). The performance of the agriculture sector has been severely affected mainly by exogenous factors including weather conditions. The contribution of agriculture to growth was positive during 2017. However, because of a severe winter, the sector contracted by 6 percent year-on-year (y/y) in 2017 Q4 and posted only a minuscule growth rate in 2018 Q1. The mining sector recovered modestly in 2018 Q1 following a contraction episode that began in 2014. The mining sector was a major drag on economic activity in 2017 (but rebounded in 2018, growing at 4.2 percent in 2018 Q1). The activity of the sector declined in 2017, despite a spectacular performance of the coal subsector due to favorable global commodity prices and weathering of bottlenecks at the border with China. Although coal production reached a historical peak, growing by 33 percent in 2017 (Figure I.6 ), the entire mining sector declined by 6.9 percent in 2017, as copper, which accounts for 40 percent of the production of the mining sector and 15 percent of GDP, contracted by 9 percent. During 2018 Q1, the negative growth of coal production was more than offset by a recovery in copper production, which is likely to continue and stimulate growth in 2018. Figure Figure Figure I.5I.5 I.5 Real Real Real GDP GDP GDP growth growth growth by by by activity, activity, activity, 2011 2011 2011 Figure Figure Figure I.6I.6 I.6 Production Production Production growth growth growth of of of key commodities key key Q1Q1–2018 Q1 –– 2018 2018Q1 Q Q11 (3-month commodities rolling commodities(3-month sum; y/y, % (3-monthrolling ) sum;y/y, rollingsum; %) y/y,%) Other Other non-mining non-miningindustries industries 140 140 Coal Coal Crude Crude oil oil Copper Copper concentrate concentrate Net Net Tax Tax 120 120 20 20 Services Services Mining Mining 100 100 Agriculture Agriculture 80 80 GDP GDP at market at prices market prices 60 60 10 10 40 40 20 20 00 00 -20 -20 -40 -40 -60 -60 -10 -10 Feb-15 Feb-15 Feb-16 Feb-16 Feb-17 Feb-17 Feb-18 Feb-18 Nov-14 Nov-14 Nov-15 Nov-15 Nov-16 Nov-16 Nov-17 Nov-17 May-14 May-14 May-15 May-15 May-16 May-16 May-17 May-17 May-18 May-18 Aug-14 Aug-14 Aug-15 Aug-15 Aug-16 Aug-16 Aug-17 Aug-17 Q1-13 Q1-13 Q2-13 Q2-13 Q3-13 Q3-13 Q4-13 Q4-13 Q1-14 Q1-14 Q2-14 Q2-14 Q3-14 Q3-14 Q4-14 Q4-14 Q1-15 Q1-15 Q2-15 Q2-15 Q3-15 Q3-15 Q4-15 Q4-15 Q1-16 Q1-16 Q2-16 Q2-16 Q3-16 Q3-16 Q4-16 Q4-16 Q1-17 Q1-17 Q2-17 Q2-17 Q3-17 Q3-17 Q4-17 Q4-17 Q1-18 Q1-18 Sources: Sources: Sources: NSO; NSO; NSO; World World World Bank Bank Bank staff staff staff estimates. estimates. estimates. Inflationarypressures Inflationary Inflationary pressures pressures rebounded rebounded rebounded in 2017 in in2017 after 2017 a protracted after after disinflationary aaprotracted protracted period, disinflationary disinflationary as spare period, period,as capacity as spare spare in the capacity in capacity economy in the continued the economy to decline, continued to economy continued and adverse supply-side to decline, and adverse decline, and shocks adverse supply-side including international supply-side shocks oil prices including shocks including and bad weather international international oil oil affected prices prices and growth and bad badand higher taxes. weather weather Nonetheless, affected affected growthinflation growth and remained higher and higher taxes.below taxes. the Central Nonetheless, Nonetheless, Bank target. inflation inflation remained remainedbelowbelowthe CentralBank theCentral target. Banktarget. Inflation Inflationsteadily Inflation steadily increased steadilyincreased increasedin in 2017, in2017, reaching 2017,reaching reachingan an average averageof anaverage 6.4percent. of6.4 of 6.4 percent.This percent. This Thiswaswasaa was reversalof areversal reversal ofthe of the the disinflationary trajectory that saw inflation collapse from 15 percent in 2012 disinflationary trajectory that saw inflation collapse from 15 percent in 2012 to 0.9 percent in 2016 to 0.9 percent in 2016 (FigureI.7 (Figure The The I.7).).The rebound rebound rebound in in in inflation inflation inflation cancan can be be be attributed attributed attributed to toto a recovery recovery aarecovery in in aggregate inaggregate aggregate demand, demand, demand, increases increases increases in in internationaloil international prices,exchange oilprices, exchangerate passthroughto ratepassthrough toprices, prices,and taxincreases andtax implementedduring increasesimplemented during 2017in 2017 thecontext inthe contextof theongoing ofthe ongoingeconomic economicadjustment adjustmentprogram. FigureI.8 program.Figure plotsthe I.8plots businesscycle thebusiness cycle 33 measuredby measured bythe Hodrick theHodrick –– Prescott(HP) Prescott (HP)filter filter andthe and productionfunction theproduction approach.ItItshows functionapproach. showsthatthat 3 therewas there reductionin wasaareduction aggregatedemand inaggregate demandsincesince2014, 2014,which whichcan explainthe canexplain disinflationtrajectory. thedisinflation trajectory. Accordingto According tothe productionfunction theproduction approach,demand functionapproach, demandrebounded reboundedin 2017,and in2017, andis thusconsistent isthus with consistentwith therecovery the recoveryin inflation.But ininflation. Butthe recoveryin therecovery indemand demandcannot cannotfully explainthe fullyexplain bigjump thebig jumpin inflation. ininflation. MONGOLIA ECONOMIC UPDATE in international oil prices, exchange rate passthrough to prices, and tax increases implemented during 2017 in the context of the ongoing economic adjustment program. Figure I.8 plots the business cycle measured by the Hodrick–Prescott (HP) filter3 and the production function approach. It shows that there was a reduction in aggregate demand since 2014, which can explain the disinflation trajectory. According to the production function approach, demand rebounded in 2017, and is thus consistent with the recovery in inflation. But the recovery in demand cannot fully explain the big jump in inflation. The other factors that explain inflationary trends are tax increases, increases in the international oil prices, and a revision of the consumer basket by the National Statistics Office (NSO). Drought conditions during the summer of 2017 explain the food price inflation in Ulaanbaatar (UB), which reached 11 percent (y/y) in October 2017, as does the harsh winter, which caused increases in prices for some food components such as meat. However, as the impact of short-lived shocks such as drought conditions and the effects of taxes on prices faded away, inflation stabilized at around 6.4 percent in the first quarter of 2018. Going forward, inflation is likely to accelerate and stabilize around the central bank target due to increases in demand and central bank actions. Figure I.7 Inflation significantly rebounded in Figure I.8 The disinflationary cycle during 2017 driven Figure Figure I.7 Inflation I.7 mainly by Inflation a surge inrebounded non-food, significantly significantly rebounded non- in 2014 –16 Figure Figure is I.8I.8 The consistent The with declining disinflationary disinflationary cycle cycle aggregate during during oil 2017 ininflation 2017driven reflecting drivenmainly mainly demand by a surge by shocks; a surge non-food, inin non- non- demand 2014–16 2014–16 during is the period, is consistent consistent with with reflected declining declining in a aggregate aggregate meanwhile, food, non-oil oil inflation food inflation inflation reflecting seemsshocks; reflecting demand to be demand contracting demand demand duringoutput during the gap; period, the similarly, period, the reflected in rebound reflected a in a shocks; stabilizing meanwhile,meanwhile, at near food the food inflation target inflation seems be to seems as the to one-off contracting inflation output incontracting consistent is outputgap; similarly, gap;with rebound thethe a change similarly, in rebound be stabilizing stabilizing at factors dissipated at near near thethe target target as as thethe one-off one-off in inflation in inflation output gap is consistent is consistentwith a with change a change in output in factors factors dissipated dissipated Consumer price inflation (y/y, %): Ulaanbaatar gap output gapcompared to non-food price inflation Food price Consumer price inflation Consumer Ulaanbaatar (y/y, %):(y/y, price inflation %): Ulaanbaatar price compared Food Food to non-food price compared price inflation to non-food price inflation (y/y, %): Ulaanbaatar 16% (y/y, %): Ulaanbaatar(y/y, %): Ulaanbaatar Food 16% 14% OilFood 14% Oil 12% Others 12% Others 10% Headline 10% Headline 8% 8% 6% 6% 4% 4% 2% 2% 0% 0% -2%-2% Sources: NSO Sources: Bulletin; NSO World Bulletin; Bank World staff Bank estimates. staff estimates. Sources: NSO Bulletin; World Bank staff estimates. The The unemployment unemployment rate was on the downward trend in most of 2017 with the solid economic The unemploymentrate ratewas wasononthe thedownward trend in downward trend of2017 most of in most 2017with withthe thesolid solideconomic economic recovery, recovery, despite slow progress to achieve Mongolia’s Sustainable Development Vision 2030. 2030. recovery, despite despite slow slow progress progress toto achieve achieve Mongolia’s Mongolia’s Sustainable Sustainable Development Development Vision Vision 2030. Despite a rapid decline - although partly reversed - during 2010-16 in the incidence of poverty Despite Despite aa rapid rapiddecline decline although - - although partly reversed- -during during2010-16 partlyreversed 2010-16 in the incidence in the incidence of of poverty poverty supported mainly by higher wages and transfers, Mongolia’s progress toward achieving its supported mainly by higher wages and transfers, Mongolia’s progress toward achieving its supported mainly by higher wages and transfers, Mongolia ’s progress toward achieving its Sustainable Development Vision 2030 (SDV 2030) has been slow (Box I.1 ). The official poverty Sustainable Sustainable Development Development Vision Vision 2030 (SDV2030) (SDV 2030) has has beenbeenslowslow (Box (Box I.1). I.1 official The ). The poverty poverty official statistics statistics indicate that the poverty rate in Mongolia declined from 38.7 percent in 2010 to 21.6 percent statistics indicate in 2014, indicate that the but rosethat the poverty poverty again rate to rate in Mongolia in Mongolia 29.6 percent in 2016, declined declined from 38.7 reflecting from 38.7 percent percent in 2010 deteriorating to 2010 in economic to 21.6 percent percent 21.6 conditions in during 2014, 2014, in2014-16. but but rose rose again again to 29.6 to 29.6 percent percent in 2016, in 2016, reflecting reflecting deteriorating deteriorating economic economic conditions Rural poverty rates have been regularly higher than urban rates, but the gap has narrowed conditions during during 2014-16. 2014-16. over Rural the years.poverty Box I.1 rates have that indicates been regularly progress than urban higher achieving towards rates, SDV 2030 buthasthe gapslow been has innarrowed terms of over The Hodrick–Prescott filter is a tool used mainly in real business cycle macroeconomic theory, to remove from data the thethe Box I.1 indicates years.socioeconomic that progress towardsreal achieving SDV 2030 has been slow in terms of 3 selected indicators. cyclical component of a time series. For example, GDP growth and GNI per capita, and human the selected socioeconomic indicators. For example, real GDP growth and capital index all remain below their 2014 baseline values. However, the recent economic recovery hasGNI per capita, and human capital remain index all the also impacted labor below market. their 2014 baseline values. However, the recent economic recovery has also impacted the labor market. 4 I.1 Slow progress toward achieving Sustainable Development Vision 2030 amid strong economic recovery Box Box I.1 Slow progress toward achieving Sustainable Development Vision 2030 amid strong economic recovery The Sustainable Development Vision 2030 (SDV 2030) was adopted through Resolution No. 19 of the State Great Khural The of Mongolia Sustainable (the parliament) Development on (SDV Vision 2030 February 2030)5, 2016. was The main adopted objective through is to No. Resolution make19Mongolia an Great upper- of the State MONGOLIA ECONOMIC UPDATE Rural poverty rates have been regularly higher than urban rates, but the gap has narrowed over the years. Box I.1 indicates that progress towards achieving SDV 2030 has been slow in terms of the selected socioeconomic indicators. For example, real GDP growth and GNI per capita, and human capital index all remain below their 2014 baseline values. However, the recent economic recovery has also impacted the labor market. Box I.1 Slow progress toward achieving Sustainable Development Vision 2030 amid strong economic recovery The Sustainable Development Vision 2030 (SDV 2030) was adopted through Resolution No. 19 of the State Great Khural of Mongolia (the parliament) on February 5, 2016. The main objective is to make Mongolia an upper-middle income country within a decade. To achieve this objective, SDV 2030 would have to rely on sound macroeconomic and fiscal policies and a gradual diversification of the country’s economy, lessening its dependence on the production and export of minerals. The 10 goals of SDV 2030 are to: 1. Increase Mongolia’s GNI per capita to US$ 17,500 and become an upper middle-income country based on its income per capita 2. Ensure average annual economic growth of not less than 6.6 percent during 2016–30 3. End poverty in all its forms Reduce income inequality and have 80 percent of the population in the middle- and upper-middle-income classes 4. Increase the enrolment rate in primary and vocational education to 100 percent and establish a lifelong learning system 5. Improve the living environment of the Mongolian people to lead a healthy and long life, and increase life expectancy at birth to 78 years 6. Rank among the first 70 countries on the human development index 7. Preserve the ecological balance and rank among the top 30 countries on the Green Economy Index 8. Rank among the top 40 countries on the Doing Business Index and the top 70 countries on the Global Competitiveness Index 9. Build professional, stable, and participative governance, free of corruption, that is adept at implementing development policies at all levels. Table B8.1. Progress on 8 selected key results indicators (out of 20 Indicators) on the performance and implementation of Mongolia SDV 2030 Baseline Progress to Target Indicator Unit (2014) date (2017) (2030) Annual average economic growth % 7.8 5.1 6.6 Gross National Income per capita US$ 4166 3196.8 17500 Human Development Index rank 90 92* 70 Life expectancy years 69.57 69.1** 78 Global Competitiveness Index rank 104 101*** 70 Doing Business Index rank 56 62 40 Share of the population with social insurance coverage in % 84.4 82.9** 99 the total economically active population million Number of foreign tourists traveling in Mongolia 0.392 0.469 2.0 persons Note: * = recent data available in 2015; ** = recent data available in 2016; *** = recent data available in 2017- 18. 5 MONGOLIA ECONOMIC UPDATE Labor market conditions improved following a strong economic recovery as suggested by key labor market indicators. The unemployment rate declined to 7.3 percent in the last quarter of 2017 compared to 8.6 percent a year ago (Figure I.9 ), reflecting a strong economic performance. Total labor force was estimated at 1.3 million persons in the end-2017 and the labor force participation rate reached 62.4 percent in the same period (Figure I.10 ). However, in 2018 Q1 the unemployment rate increased to 9.7 percent, reflecting Mongolia’s highly seasonal patterns due to difficult work conditions in the winter, especially in construction, agriculture and mining sectors. There is evidence of a sectoral shift of labor force from traditional agriculture sector into non- agriculture reflecting mainly the developments in the mining sector. Agriculture employed 25.1 percent of total number of jobs in 2018 Q1, lower than its employment share (36 percent) in 2012 Q1 reflecting a structural transformation driven by mining; the share of industrial sector including mining, manufacturing and construction rose to about 20 percent in end-March 2018 from 13.2 percent in the same period of 2012. Service sectors also absorbed a large proportion of the labor force that migrated from agriculture (54.4 percent from 50.7 percent). Despite the capital-intensive nature of mining, its employment share rose from about 4 percent of total employment since 2010 Q1 to 6.3 percent in the same quarter last year, reflecting a sharp recovery of the mining industry especially in coal (Figure I.10 ). Figure I.9 After a downward trend, Figure I.10 Industrial sector has been driving Figure Figure I.9 I.9 After After aa downward downward trend, trend, Figure Figure I.10 Industrial I.10 sector Industrial sector has has been been driving driving unemployment rate slightly increased in 2018 labor market while shifting away from unemployment unemployment rate rate slightly slightly increased inin increased 2018 2018 labor labor market market while while shifting shifting away away from from Q1 reflecting seasonal effects agriculture Q1Q1 reflecting reflecting seasonal seasonal effects effects agriculture agriculture Unemployment Unemployment Unemployment rate rate rate (%) (%) (%) Percentage Percentage Percentage share share shareof ofof employment employment employmentby by sectors by sectors (%) (%) sectors (%) 1414 Services Services Sector: Sector: LHSLHS Agriculture: Agriculture: RHS RHS Industry: Industry: RHSRHS 11.6 11.6 70 70 50 50 1212 9.79.7 60 60 45 45 1010 8.68.6 40 40 7.37.3 50 50 8 8 35 35 30 30 40 40 6 6 25 25 30 30 4 4 20 20 20 20 15 15 2 2 10 10 10 10 0 0 5 5 Q1 2014 Q1 2014 Q2 2014 Q2 2014 Q3 2014 Q3 2014 Q4 2014 Q4 2014 Q1 2015 Q1 2015 Q2 2015 Q2 2015 Q3 2015 Q3 2015 Q4 2015 Q4 2015 Q1 2016 Q1 2016 Q2 2016 Q2 2016 Q3 2016 Q3 2016 Q4 2016 Q4 2016 Q1 2017 Q1 2017 Q2 2017 Q2 2017 Q3 2017 Q3 2017 Q4 2017 Q4 2017 Q1 2018 Q1 2018 0 0 0 0 Source: Source: NSO, NSO, WBWB staff estimates staff estimates Source: NSO, WB staff estimates While While the the national national level level of of wages wages has has trended trended upward upward over over thethe last last fewfew years, years, the the average average wages wages inin While mining mining the national activities activities level exceeded exceeded of wages has significantly significantly trended that that ofof upward other other over sectors. sectors. the last Following Followingfew the years, the the positive positive average developments wages developments inin in the mining themining mining activities sector sector ininexceeded thethe past past significantly fewfew years, years, that this this of other sector sector isis sectors. attracting attracting Following more more labor labor the positive offering offering developments higher higher wages. wages. The The in the mining average average wage wage sector growth growth in the pastto increased increased few 10.2 to years, 10.2 this in percent percent sector 2017 in 2017isQ4 attracting Q4 from from 2.9more 2.9percentlabor percent offering 2015 inin 2015 higher Q4. Q4.InIn wages. 2018 2018 Q1, Q1, The average average average wage wagewage growth to continued continued increased growat togrow to 10.2 at4.1 percent percent(y/y). 4.1percent in 2017 (y/y).As Q4 As percent from 2.9 above, discussed discussed in 2015consumption private above,private Q4. In 2018 consumption recovered recovered Q1, average wagein strongly strongly 2017 in 2017 continued while while to inflationat pressures inflation grow pressures 4.1 percent continued continued (y/y). As to to build builddue discussed due toto aa above, combination combination ofof demand demand private consumption and and supply-side supply-side recovered factors. factors. strongly in 2017 while inflation pressures continued to build due to a combination of demand and supply-side factors. Figure Figure I.11 I.11 Workers Workers inin mining mining sector sector are are paid paid Figure Figure I.12 I.12 Improved Improved market market conditions conditions also also relatively relatively higher higher wages… wages… raised raised household household income income while while growing growing inflation inflation hashas been been eroding eroding real real wage wage growth growth Wage Wage level level byby sector sector Household Household income income growth growth and and Real Real wage wage growth (%) growth (%) Agriculture Agriculture Income Income total, national total, national Real Wage Real Wage growth (yoy, growth %):%): (yoy, RHS RHS 3000 3000 Mining Mining 60% 60% 35% 35% 2500 2500 Manufacturing Manufacturing 50% 50% 30% 30% Trade Trade 40% 40% 25% 25% 2000 2000 Thousand MNT Thousand MNT National National average average 20% 20% 30% 30% 1500 1500 15% 15% 20% 20% 61000 1000 10% 10% 10% 10% 5%5% 500 500 0%0% 0%0% -10% -10% -5%-5% 0 0 I III III I III III II IV III IV II IV I III III III IV III IV I III III II IV III IV II IV III IV II IV I III III II IV I III III III IV II IV I III III I III III II IV III IV I I III IV -20% -20% -10% -10% 2 3 2 3 4 4 7 8 7 8 mining activities mining exceeded significantly activities exceeded that of significantly that of other other sectors. sectors. Following the positive Following the developments in positive developments in the mining the sector in mining sector the past in the few years, past few years, this this sector sector is attracting more is attracting labor offering more labor higher wages. offering higher The wages. The average wage average growth increased wage growth increased toto 10.2 10.2 percent percent in 2017 Q4 in 2017 Q4 from from 2.9 percent in 2.9 percent 2015 Q4. in 2015 In 2018 Q4. In Q1, 2018 Q1, average wage continued average wage continued to MONGOLIA to grow grow at 4.1 percent at 4.1 ECONOMIC percent (y/y). UPDATE (y/y). As As discussed discussed above, private consumption above, private consumption recoveredstrongly recovered stronglyin 2017while in2017 inflationpressures whileinflation pressurescontinued continuedto builddue tobuild duetotoa combinationof acombination demand ofdemand andsupply-side and factors. supply-sidefactors. Figure I.11 Workers in mining sector are paid Figure I.12 Improved market conditions also Figure Figure I.11 I.11 Workers Workers relatively higher wages…in in mining mining sector sector are are paid paid Figure Figure raised I.12Improved I.12 Improved household market incomemarket while conditions conditions also also growing inflation relativelyhigher relatively wages… higherwages… raised raised household household income income while while has been eroding real wage growth growing growing inflationhas inflation beeneroding hasbeen realwage erodingreal growth wagegrowth Wage level by sector Household income growth and Real wage growth (%) Wage Wage levelby level sector bysector Household Householdincome incomegrowth andReal growthand wagegrowth Realwage (%) growth(%) Agriculture Agriculture Incometotal, Income national total,national RealWage Real Wagegrowth growth(yoy, %):RHS (yoy,%): RHS 3000 3000 Mining Mining 60% 60% 35% 35% 2500 2500 Manufacturing Manufacturing 50% 50% 30% 30% Trade Trade 40% 40% 25% 25% 2000 2000 MNT Thousand MNT Nationalaverage National average 20% 20% 30% 30% Thousand 1500 1500 15% 15% 20% 20% 10% 10% 1000 1000 10% 10% 5% 5% 500 500 0% 0% 0% 0% -10% -10% -5% -5% 00 I I IIIIIII III IVIVI I IIIIIII III IVIVI I IIIIIII III IVIVI I IIIIIII III IV III IVI I IIIIIII IVIVI I IIIIIII III IV III IVI I IIIIIII IV III IVI I IIIIIII IVIVI I -20% -20% -10% -10% Sep-12 Sep-12 Feb-13 Feb-13 Oct-14 Oct-14 Sep-17 Sep-17 Feb-18 Feb-18 Mar-10 Mar-10 Jan-11 Jan-11 Nov-11 Nov-11 Mar-15 Mar-15 Jan-16 Jan-16 Nov-16 Nov-16 Jun-11 Jun-11 May-14 May-14 Jun-16 Jun-16 Apr-12 Apr-12 Jul-13 Jul-13 Apr-17 Apr-17 Aug-10 Aug-10 Dec-13 Dec-13 Aug-15 Aug-15 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 20172018 2017 2018 Source:NSO, Source: WBstaff NSO,WB estimates staffestimates Source: NSO, WB staff estimates Externalsector: External Afteryears sector:After ofdeclining years of decliningcurrent currentaccount accountdeficits causedby deficitscaused realexchange byreal rate exchangerate External sector: After years of declining current account deficits caused by real exchange rate depreciation depreciation and and slower slower domestic domestic demand, demand, the the current current account account position position started started depreciation and slower domestic demand, the current account position started to deteriorate again to to deteriorat deteriorat as e againas eagain profit repatriationas profit profit from repatriation repatriation mining companies from from mining miningcompanies increased. companiesincreased. increased. Despite a Despite significant surplus a significant in goods surplus in goods trade, trade, the the current current account deficit continued account deficit continued to worsen in to worsen 2017 in 2017 Despite a significant surplus in goods trade, the current account deficit continued to worsen in 2017 as import as demand for import demand services escalated, for services escalated, interest interest payments payments on external debt on external increased, and debt increased, mining and mining as import demand for services escalated, interest payments on external debt increased, and mining companiesrepatriated companies profits. The repatriatedprofits. currentaccount Thecurrent accountdeficit, deficit,which whichdeclined declinedfrom from43.6 percentof 43.6percent GDPin ofGDP in companies repatriated profits. The current account deficit, which declined from 43.6 percent of GDP 2012to 2012 to6 percentin 6percent in2016, 2016,increased increasedagainagaintoto1010percent percentin 2017(Figure in2017 I.13). (FigureI.13 ).In Infact, fact,the deficiton thedeficit the onthe in 2012 to services services 6 percent account account in 2016, worsened worsened increased from from 12 percent 12 again to percent in10 in percent 2016 2016 to to 16 16in 2017 (Figure percent percent in ). In fact, the deficit I.13overwhelming in 2017, 2017, overwhelming the on goods the goods the trade trade services surplus, surplus,account which which worsened marginally marginally from 12 percent improved improved from from in 2016 11.5 11.5 to 16 percent percent percent to to 12.2 12.2in 2017, overwhelming percent. percent. In addition, In theprimary the addition, the goods primary trade surplus, deficit worsened income deficit income which marginally worsened by by 0.7 improved 0.7 percentage from percentage points 11.5 points of percent of GDP GDP to to to 7.5 12.2 percent. 7.5 percent, In percent, widening addition, widening the the the current primary account current account deficit. deficit worsened by 0.7 percentage points of GDP to 7.5 percent, widening the current account income deficit. deficit. 66 The sharp adjustment of trade in goods since 2012 was mainly due to declining imports of goods caused by weakening FDI inflows and rapid exchange rate adjustments. Goods imports posted an average decline of 12 percent between 2012 and 2016, while exports grew on average by 5 percent during the same period (Figure I.14 ). The return of FDI in 2017 brought about a recovery in imports, which grew by 26 percent in 2017, while exports grew by 22 percent. The trade surplus (Free-On-Board terms) rose to US$ 1,490 million in 2017 from US$ 1,337 million in 2016 and US$ 562 million in 2015. The income account deficit also significantly increased to US$ 1,613 million in the same period from US$ 911 million the previous year, with growing investment income payments on external debt and large profit repatriation of mining companies. The deficit in transportation services also increased compared with a year ago, reflecting the strong external trade and recovering domestic demand. 7 terms) rose to US$ 1,490 million in 2017 from US$ 1,337 million in 2016 and US$ 562 million in 2015. The income account deficit also significantly increased to US$ 1,613 million in the same period from US$ 911 million the previous year, MONGOLIA ECONOMIC with growing investment UPDATE income payments on external debt and large profit repatriation of mining companies. The deficit in transportation services also increased compared with a year ago, reflecting the strong external trade and recovering domestic demand. FigureI.13 Figure Adjustmentin I.13Adjustment inthe theunsustainable unsustainable FigureI.14 Figure I.14Despite Despitestrong exportperformance, strongexport performance, currentaccount current wasdone accountwas between2014 donebetween 2014and and the currentaccount thecurrent deficithas accountdeficit slightlyworsened hasslightly mid-2017 mid-2017 since sincemainly mid-2017, worsened duemainly mid-2017, to a rising dueprofit to a repatriation by mining companies rising profit repatriation by mining companies Current account Current balance account (% of GDP), balance (% of2005–17 GDP), 2005–17 Monthly Monthly current account current balance account balance (US$ million, 3- (US$ million, 3-month rolling sum) month rolling sum) 20 20 Trade Balance Trade Balance Services Balance Services Balance Income Balance Income Balance Current Transfers Current Transfers Current Account Current Account 300 300 10 10 200 200 0 0 100 100 0 0 -10 -10 -100 -100 -20 -20 -200 -200 Trade Balance Trade Balance -300 -300 -30 -30 Services Balance Services Balance -400 -400 Income Balance Income Balance -500 -500 -40 -40 Current Transfers Current Transfers -600 -600 CA CA -50 -50 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 Sources:BoM; Sources: Bank WorldBank BoM; World staff staff estimates. estimates. robust growth in exports drove improvements in trade despite a significant imports surge explained A robust A growing oil by growing by oil prices and investment. Imports increased by 45.5 percent in the first five months of 2018, following a 29.1 percent increase in 2017, amid a continued inflow of FDI and growing real income growth of growth of households. Exports performed households. Exports performed very well since since late very well 2016, with late 2016, with higher commodity prices higher commodity prices and and increased external demand, particularly from China. Total exports grew by 14.6 percent in the increased external demand, particularly from China. Total exports grew by 14.6 percent in the first fivefirst five months of months of 2018, following a 2018, following 26.1 percent a 26.1 increase in in 2017 percent increase on the 2017 on the back back of historically high of historically coal exports. high coal exports. 4 4 Exports slightly weakened in January and February. Terms of trade 4 substantially improved throughout Exports slightly weakened in January and February. Terms of trade substantially improved throughout 2017, with sharp rises in commodity prices. 2017, with sharp rises in commodity prices. Figure I.15 Figure Figure I.15 Imports havebeen Imports have I.15 Imports have beengrowing been growingfast growing fast fast Figure FigureI.16 Figure I.16Terms I.16 Terms Terms of of oftrade trade tradesignificantly significantlyimproved significantly with escalation with with escalation escalation ofof investment,while of investment, investment, whileexports while exports exports in 2017 due improved improved into in higher 2017 2017 due duecommodity to to higher prices commodity higher commodity performance has performance performance has been been robust has been robust robust prices prices Imports and exports (%, y/y) Terms of trade change Imports and Imports exports (%, and exports (%, y/y) y/y) Terms of Terms trade change of trade change Exports(y/y, Exports %):LHS (y/y,%): LHS Imports Imports(y/y, %):LHS (y/y,%): LHS 80% 80% %%change changeininterms termsofoftrade trade(y/y): RHS (y/y):RHS 80% 80% 60 60 Exportprice Export index(y/y, priceindex (y/y,%)%) 50 50 60% 60% 60% 60% Importprice Import index(y/y, priceindex %) (y/y,%) 40 40 4 4 30 30 40% 40% 40% 40% Terms of trade (ToT) is defined as a relative price of exports measured in terms of imports. The TOT is measured by a ratio of 20 20 export 10 10 price index to import price index, which shows the amount of imported goods that can be purchased by a unit of export 20% 20% 20% 20% goods. 0 0 Lower terms of trade mean that the same amount of exports can buy fewer imported goods, which would be used for 0% 0% 0% 0% domestic -10 -10 consumption or investment. -20 -20 -20% -20% -20% -20% -30 -30 -40 -40 7 -40% -40% -40% -40% Jan-12 Jan-12 May-12 May-12 Jan-13 Jan-13 May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 May-13 Jan-14 Sep-12 Sep-12 Sep-13 May-14 Sep-14 Jan-15 May-15 Sep-15 Sep-13 Jan-16 Sep-16 Sep-17 Sep-14 May-16 Jan-17 Sep-15 May-17 Jan-18 Sep-16 May-18 Sep-17 Aug-11 Aug-11 Dec-11 Dec-11 Apr-12 Apr-12 Aug-12 Aug-12 Dec-12 Dec-12 Apr-13 Apr-13 Aug-13 Aug-13 Dec-13 Dec-13 Apr-14 Apr-14 Aug-14 Aug-14 Dec-14 Dec-14 Apr-15 Apr-15 Aug-15 Aug-15 Dec-15 Dec-15 Apr-16 Apr-16 Aug-16 Aug-16 Dec-16 Dec-16 Apr-17 Apr-17 Aug-17 Aug-17 Dec-17 Dec-17 Apr-18 Apr-18 Sources: NSO; Sources: BoM; World NSO; BoM; Bank staff World Bank estimates. staff estimates. Sources: NSO; BoM; World Bank staff estimates. The continued The continued strong performance of strong performance of coal coal exports exports and the recovery and the recovery of copper exports of copper boosted exports boosted 4 Terms Mongolia’s of trade (ToT) is mineral exports exports during Mongolia’s mineral defined as during January a relative price January– of exports –May May 2018.measured 2018. The in terms The strong of imports. performance of strong performance The TOT is of the measured the coal by coal sector sectora ratio (133 (133 of export price index to import price index, which shows the amount of imported goods that can be purchased by a unit of percent percent growth growth in in 2017), 2017), which which stimulated stimulated trade trade and and transport transport activities, activities, was was aa key key driver driver export goods. Lower terms of trade mean that the same amount of exports can buy fewer imported goods, which would be of of the the solid solid economic used forrecovery economic recovery in in 2017. 2017. The domestic consumption The volume of volume or investment. production and of coal coal production exports rose and exports by about rose by about 30 percent (y/y) 30 percent (y/y) in 2017. in During January 2017. During January– May 2018, –May 2018, the the value value of coal exports of coal exports grew grew more more moderately, moderately, by 9.8 percent by 9.8 percent (y/y), from (y/y), US$ 1 from US$ billion during 1 billion during thethe same same period period the the previous year. Positive previous year. price developments Positive price offset a developments offset a 8 decline (16 decline (16 percent) percent) in the volume in the volume of of exports exports during during January January– May 2018. –May 2018. In addition to In addition some base to some base effects, the effects, driving factors the driving behind the factors behind slowdown in the slowdown in coal coal exports include ongoing exports include bottlenecks at ongoing bottlenecks the at the border with border China and with China seasonal effects and seasonal effects (for (for example, example, a harsh winter a harsh slightly affected winter slightly coal production affected coal production 200 20% 0% 20% 0% 10 -10 0 -20 0% -20% 0% -20% -10 -30 -20 -40 -30 MONGOLIA ECONOMIC -20% -40% UPDATE -20% -40% Jan-12 May-12 Jan-13 May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 -40 -40% -40% Jan-12 May-12 Jan-13 May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Sources: NSO; BoM; World Bank staff estimates. The NSO; BoM; strong continued Sources: World Bank performance staff estimates. of coal exports and the recovery of copper exports boosted Mongolia’s The continued mineral strong exports during January–May performance of coal exports 2018. Thethe and strong performance recovery of copperof the coal sector exports (133 boosted percent The growth continued in strong 2017), which performance stimulated of coal trade exportsand transport and the activities, recovery Mongolia’s mineral exports during January–May 2018. The strong performance of the coal sector (133 was of a copper key driver exports of the boostedsolid Mongolia’s economic percent mineral recovery growth exports in 2017. in 2017), during January Thestimulated volume which of May –trade 2018. coal productionThe strong and transport performance and activities, exports rose wasby aof the about key coal driver of the (133 sector 30 percent (y/y) solid percent in 2017. growth During in 2017), January–Maywhich stimulated 2018, the trade value ofand transport coal exports activities, grew economic recovery in 2017. The volume of coal production and exports rose by about 30 percent (y/y) more was a key moderately, driverby of the 9.8 solid percent economic (y/y), in 2017.from recovery During in 2017. US$ January 1 billion The during –May volume 2018, theof the same coal period value production of coalprevious the exports and year. exports grew rose Positive more by about price moderately, 30bypercent developments (y/y) offset 9.8 percent in 2017. (y/y), a decline During from(16 US$ January 1 billion in percent) –May during 2018, the same the volume the value of period of exports coal the exports previous during grew more year. Positive January–May moderately, 2018.price by In developments 9.8 addition to some percent offset basea (y/y), declinefrom US$ 1 billion during the same period the previous year. Positive price developments offset a the percent) effects, (16 in the behind driving factors volumethe of exports slowdown during January in coal exports–May 2018. ongoing include In addition to someat bottlenecks base the decline (16 percent) in the volume of exports during January–May 2018. In addition to some base effects, border withthe driving China and factors behind seasonal the slowdown effects (for example, in coal exports a harsh include winter ongoing slightly affectedbottlenecks at the coal production effects, the driving factors behind the slowdown in coal exports include ongoing bottlenecks at the border volume, with whichChina and felland seasonal by less effects than effects 5.1 (for example, percent). a harsh winter After contraction slightly affected in mid-2016 coal production border with China seasonal (for example, a harsh winter slightly and late 2017, affected the growth coal production volume, of exportswhich of fell by less copper than 5.1 percent). concentrates rebounded After and contraction accelerated in to mid-2016 30.2 and late percent in 2017, May the growth 2018 followingof volume, which fell by less than 5.1 percent). After contraction in mid-2016 and late 2017, the growth of exports a cyclical exports of copper of recovery concentrates in gold content copper concentrates rebounded rebounded and in Oyu Tolgoi’s accelerated to copper production. and accelerated 30.2 percent to 30.2 percentOwing in in May higher to May 2018 oil prices, 2018 following following crude a a cyclical recovery oil exports cyclical grew recovery ininbygold 15 content gold contentin percent in Oyu (y/y) Oyu inTolgoi the ’s Tolgoi copper ’scopper first production. five months production. Owing of 2018. Owing The higheroil toexport to higher prices, oilprices, volume crude ofcrude crude oil oil oil exports increased exports grew grew by 15 15 by by 15 percent percent, percent with(y/y) (y/y) in a 28.5 in thethe first percent five growth first five months months of in price, 2018. of 2018. The volume but The export export volume plunged volume by ofof 10.5crude oil percent crude oil increased increased compared by by 15the 15 with percent, percent, with aathe with same period 28.5 28.5 percent percent previous growth growth year in price, in price, (see Figure I.17 but butand volume volume plunged plunged Figure I.18 ). by 10.5 percent by 10.5 percent comparedwith compared withthe thesame periodthe sameperiod previousyear theprevious year(see FigureI.17 (seeFigure I.17 and FigureI.18 andFigure I.18). ). I.17Surge FigureI.17 Figure Surge incoal Surgein coal exports coalexports significantly exportssignificantly significantly Figure Figure Figure I.18 I.18 I.18... ... ...supported supported supportedby rising by by rising risingexport prices export export boosted exports since late late2016… sincelate boosted exports since 2016… 2016… of key commodities pricesof prices ofkey commodities keycommodities Growth Growth in Growth in inexport exportof export of of key key keycommodities commodities (3-month commodities rolling (3-month rolling Exports Exports Exports price pricechanges price (3-month moving changes (3-month changes moving average; average; (3 - month sum;y/y, y/y,%) sum; rolling %) sum; y/y , %) (3 - y/y,month %) y/y,%) moving average; y/y, %) Copper Copper concentrate concentrate exports exports Copper Copper concentrates concentrates 500% 500% 140% 140% Coal Coalexports exports Coal Coal Oil Oilexports exports 100% Crude Crudeoil oil 100% 300% 300% 60% 60% 20% 100% 20% 100% -20% -20% -100% -100% -60% May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 -60% May-13 Jan-14 May-14 Jan-15 Sep-13 May-15 Jan-16 Sep-14 May-16 Jan-17 Sep-15 May-17 Jan-18 Sep-16 May-18 Sep-17 May-11 Jan-12 May-12 Jan-13 May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 May-11 Jan-12 May-12 Jan-13 May-13 Jan-14 May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sources: NSO; World Bank staff estimates. Sep-17 Sources: NSO; Sources: NSO;World WorldBank Bankstaff estimates. staff estimates. Imports of capital and consumer goods increased substantially due to escalation of investment and a Imports solid of capital economic and consumer recovery. goodsof After years increased substantially adjustment due to with cooling escalation economic of investment activity, and a total imports Imports of solid economiccapital and recovery.consumer After goods years increased of adjustment substantially with due to escalation of investment and reached US$ 2.1 billion during January –May 2018, up by percenteconomic 45.5cooling (y/y), led activity, by a large total imports increase in economic a solid of reached imports US$ 2.1 billion investmentrecovery. during goods After and oilyears January of adjustment –May products, 2018, mainly by with 45.5 cooling upreflecting percent economic (y/y),construction the ongoing activity, led by a large total phase imports increase of thein imports of investment goods and oil products, mainly reflecting the ongoing construction reached US$ 2.1 billion during January–May 2018, up by 45.5 percent (y/y), led by a large increase in phase of the imports of investment goods and oil products, mainly 8 reflecting the ongoing construction phase of the 8 Oyu Tolgoi underground mine. Imports of capital goods have been rising significantly since early 2017 as sharp rises in FDI led to a recovery in investment demand. During January–May 2018, imports of machinery and equipment increased by 42.6 percent, following a 140 percent increase in 2017. At the same time, imports of consumer goods grew by 19.5 percent (y/y), following a 19 percent decline at end-2017. Oil product imports continued to increase sharply (by 40 percent), reflecting higher oil prices. 9 Oyu Tolgoi Oyu underground mine. Tolgoi underground Imports of mine. Imports of capital capital goods goods have have been rising significantly been rising since early significantly since 2017 as early 2017 as sharp rises sharp in FDI rises in led to FDI led a recovery to a recovery in in investment investment demand. During January demand. During January– May 2018, –May imports of 2018, imports of machinery machinery and and equipment MONGOLIA equipment increased increased by by 42.6 ECONOMIC percent, 42.6 percent, UPDATE following following a 140 a 140 percent percent increase increase in 2017. At in 2017. the At the same time, same imports of time, imports consumer goods of consumer grew by goods grew by 19.5 19.5 percent percent (y/y), following a (y/y), following 19 percent a 19 decline at percent decline at end-2017. Oil end-2017. product imports Oil product continued to imports continued to increase increase sharply sharply (by (by 40 percent), reflecting 40 percent), higher oil reflecting higher prices. oil prices. Figure I.19 Imports of capital goods and fuel Figure I.20 Imports of consumption goods have Figure I.19 Figure Imports of I.19 Imports capital goods of capital goods and and fuel fuel Figure I.20 Figure Imports of I.20 Imports consumption goods of consumption have goods have have been rising strongly since late 2016 amid also been rising since late 2016 have been have rising strongly been rising since late strongly since late 2016 2016 amid amid also been also rising since been rising late 2016 since late 2016 large FDI and investment large FDI large and investment FDI and investment Imports of Imports Imports of ofdurable durable durablegoods and and goods goods mineral products mineral and mineral products (3- products (3- Imports ofof Imports Imports consumption of consumption consumptiongoods and mineral goods goods and products mineral and mineral products products (3-month rolling sum; y/y, % change) (3-month rolling sum; y/y, % change) month rolling month sum; y/y, rolling sum; y/y, % change) % change) (3-month (3-month rolling sum; y/y, rolling sum; % change) y/y, % change) ManufacturingIP Manufacturing IP Totalimports Total imports 60% 60% Food product Food product Capitalgoods Capital goods Fuels Fuels Consumptiongoods Consumption goods 40% 40% Consumption goods Consumption goods 105% 105% 50% 50% 90% 90% Mineral product Mineral product 40% 40% 75% 75% 20% 20% 60% 60% 30% 30% 45% 45% 20% 20% 0% 0% 30% 30% 10% 10% 15% 15% -20% -20% 0% 0% 0% 0% -15% -15% -10% -10% -40% -40% -30% -30% -20% -20% -45% -45% -60% -60% -60% -60% -30% -30% May-14 Jan-15 May-15 Jan-16 May-16 Jan-17 May-17 Jan-18 May-18 Sep-14 Sep-15 Sep-16 Sep-17 Oct-16 Oct-17 Oct-14 Oct-14 Oct-15 Oct-15 Oct-16 Jan-17 Oct-17 Jan-18 Jan-15 Jan-16 Jan-15 Jan-16 Jan-17 Jan-18 Apr-17 Apr-18 Apr-14 Apr-14 Apr-15 Apr-16 Apr-15 Apr-16 Apr-17 Apr-18 Jul-16 Jul-17 Jul-14 Jul-14 Jul-15 Jul-15 Jul-16 Jul-17 Sources: NSO; Sources: World Bank NSO; World staff estimates. Bank staff estimates. Sources: NSO; World Bank staff estimates. Balance-of-payment (BoP) Balance-of-payment pressures were (BoP) pressures eased thanks were eased thanks to to large large FDI inflows. After FDI inflows. years of After years substantial of substantial Balance-of-payment pressures, pressures, the overall the overall BoP pressures (BoP) BoP balance balance improved were eased improved in thanks 2017, posting in 2017, to largea posting aFDIUS$ US$inflows. 1.4 billion 1.4 After surplus billion years ofinstead surplus substantial instead of a of a pressures, deficit of deficit of US$ the US$ 18.2 overall 18.2 million BoP million in balance in 2016. 2016. Thisimproved This was the result was the in 2017, result ofposting of strong a US$ strong coal 1.4exports, a coal exports,billion surplus a significant significant increase instead of increase ina deficitnet in net of US$ FDI FDI inflows18.2 inflows million (about (about in 2016. US$ US$ 1.3 This was 1.3 billion), billion), and and the result of donor significant significant strong coal donor assistance. exports, assistance. a significant Market Market confidence confidence increase also also in net FDI improved improved inflows due due to (about to policy policy US$ 1.3 changes changes billion), and supported supported by the by significant the country’s country’s donor assistance. development development Market including partners partners confidence including the also the World Worldimproved Bank,due Bank, IMF, IMF, to Asian the the policy changes supported Development Asian Development Bank, by Bank, Japan, Japan, country’s the China, China, and and development the the Republic Republicpartners Korea. of Korea. of including Owing to Owing to an World the an improved improved Bank, IMF, external external the Asian position, position, Development gross gross international international Bank, Japan, China, reserves reserves increasedand the increased from from Republic US$ 1 US$ 1 of Korea. billion billion in Owing in February February to an2017 2017 improved (its (its lowest external lowest level level position, since since August August gross 2008) 2008)international to US$ to US$ 3 reserves billion 3 billion (about (aboutincreased five months five from US$ months of imports) of 1 billion imports) for for February in2017. 2017. For For the 2017 the first first (its fourlowest four months months level of of since despite 2018, 2018, despite2008) August an to US$ 3 increase an increase inbillion in the (aboutof deficit the deficit five of months of imports) investment-related investment-related for 2017. services services and andFor the first income, income, BoPfourpressures BoP months pressures remained of 2018, moderate remained moderate despite increase continued anfollowing following continued in the deficit FDI FDIof inflows. inflows. investment-related services and income, BoP pressures remained moderate following continued FDI inflows. To make To make large external payments, large external payments, the the government government was able to was able mobilize considerable to mobilize considerable amounts amounts of of external external To make financing. financing. large external For many For many years, years, the payments, the government government the government had had implemented implemented was able to mobilize expansionary expansionary economic economic considerable policies, policies, amounts which which led led to to high high fiscal fiscal deficits deficits and and rising rising debt. debt. These These of external financing. For many years, the government had implemented expansionary economic policies policies included included a a major major increase increase in in public public investment, investment, policies, which led to by supported supported large by large high international fiscalinternational borrowings. rising debt.A deficits andborrowings. A US$ US$ 580 These 580 million policiesmillion government-guaranteed government-guaranteed included a major increase bond bond of of the the Development Development Bank Bank of of Mongolia Mongolia in public investment, supported by large international borrowings. A US$ 580 (DBM) (DBM) became became due due in in March March 2017. 2017. million Two Two other large other government- large repayments repayments were also were also due due in 2018. Thanks in 2018. Thanks to improved investor to improved guaranteed bond of the Development Bank of Mongolia (DBM) became due in March 2017. Two other confidence, buoyed investor confidence, buoyed by by the the announcement of announcement donor support of donor support in February 2017, in February 2017, the the US$ US$ 580 million DBM 580 million DBM bond bond was successfully was successfully large repayments were also due in 2018. Thanks to improved investor confidence, buoyed by the refinanced through refinanced through a bond exchange, a bond exchange, with with new new investment investment of of US$US$ 600 million with 600 million with a seven-year a seven-year announcement of donor support in February 2017, the US$ 580 million DBM bond was successfully maturity at maturity at a a rate rate lower lower than than the prevailing market the prevailing market rates. rates. In October 2017, In October 2017, to to pay pay the bonds maturing the bonds maturing in in refinanced through a bond exchange, with new investment of US$ 600 million with a seven-year 2018, the 2018, government issued the government issued a new sovereign a new sovereign bond bond (named (named the “Gerege” bond) the “Gerege” bond) of US$ 800 of US$ million with 800 million with maturity at a rate lower than the prevailing market rates. In October 2017, to pay the bonds maturing in a 5.5-year a maturity and 5.5-year maturity and a 5.625 percent a 5.625 percent rate, rate, which which was also lower was also lower than than the the rate rate that that the government the government 2018, was was the government paying paying on the on bonds the bonds issued beinga new being sovereign rolled rolled over. bond over. The The US$ (named US$ 500 500 the “Gerege” million million bond) bond sovereign sovereign of bond US$due 800 in due million in 2018 2018 with was was a 5.5-year successfully repaid successfully maturity repaid on and a on January 5.625 January 5, percent 5, 2018. 2018. With rate, With the which the easing was easing ofalso lower of financing financing needs, than the rate needs, the that the central bank the central government bank has has notnot was paying drawn drawn down down from on from thethe the bonds bilateral bilateralbeing rolled swap currency currency over. The facility swap facility US$ 500 with with the themillion People’s Peo sovereign ple’s Bank Bank ofof bond China China due (PBoC) (PBoC)in 2018 since since waslate late successfully 2016, 2016, and the and the repaid on January outstanding outstanding amount amount 5, 2018. remained remained With at at theUS$ US$ easing 1.8 of financing 1.8 billion billion (Figure I.21 (Figure needs, I.21 and and the central Figure Figure I.22bank I.22 ). has not ). drawn down from the bilateral currency swap facility with the People’s Bank of China (PBoC) since late 2016, and the outstanding amount remained at US$ 1.8 billion (Figure I.21 and Figure I.22 ). 9 9 10 MONGOLIA ECONOMIC UPDATE Figure Figure I.21 I.21 Strongrecovery Strong recovery inFDI helped FDI hashelped than US$ I.22 More than 1.4billion US$1.4 billionwas Figure I.21 Strong recoveryinin FDIhas has helped Figure Figure I.22 More than US$ 1.4 billion was was Figure ease I.21 Strong pressure on recovery the balancein FDI of has helped payments, Figure I.22 More than US$ 1.4 billion was ease easepressure pressure on onthe thebalance balanceof ofpayments, payments, mobilized in in 2017 mobilized 2017 to 2017 to reduce reducethe to reduce BoPpressure theBoP the BoP pressure pressure ease pressure covering covering on current current the balance account account of payments, financing financing needs needs mobilized through in 2017 debt to reduce financing financing the BoP pressure covering current account financing needs through debt financing covering Current Current current account account deficit andFDI financing FDI inflows needs (US$ billion) through debtdebt financing financing (US$ billion) Figureaccount Currentaccount Current I.21 Strong account Net Net deficit deficitrecovery deficit external external and and FDI inflows and needs debt-financing debt-financing FDI inflows in needs FDI (CA (CA (US$ inflows has deficit deficit (US$ helped billion) (US$ FDI):LHS - -FDI): billion) LHSbillion) Net Figure Net external external More I.22debt financing than (US$ financing US$ Net external debt financing (US$ billion) (US$ 1.4 billion) billion was billion) ease 2.02.0 pressureNet Net FDI Net FDIon the inflows: inflows: external LHS balance LHS debt-financing needs of payments, (CA deficit - FDI): LHS -2.0 -2.0 mobilized in 2017 Central bank's net to reduce net debt-financing debt-financing Net the BoP Netportfolio portfolio pressure investment investment ++ loans loans covering current Current account account Current Net FDI account inflows: LHS RHS deficit: deficit: financing RHS needs through debt netfinancing Thousands Thousands 2.0 -2.0 2.0 Central bank's 2.0 debt-financing Net portfolio investment + loans Current account deficit: RHS Thousands 1.51.5 -1.5 -1.5 2.0 Current 1.5 account deficit and FDI inflows (US$ billion) -1.5 Net external debt financing (US$ billion) 1.5 1.5 Net external debt-financing needs (CA deficit - FDI): LHS 1.01.0 -1.0 1.5 2.0 Net FDI inflows: LHS -1.0 -2.0 1.0 -1.0 1.0 Central bank's net debt-financing Net portfolio investment + loans Current account deficit: RHS 1.0 Thousands 2.0 1.0 0.50.5 1.5 -0.5 -0.5 -1.5 0.5 -0.5 0.5 0.5 1.5 0.5 0.00.0 1.0 0.0 0.0 -1.0 0.0 0.0 0.0 0.0 1.0 0.0 (0.5)0.5 (0.5) (0.5) 0.5 -0.5 0.5 0.5 Q1Q1 Q1Q3Q3Q1 Q3 Q3 Q1 Q1 Q3 Q3Q1 Q1Q3 Q1 Q3 Q3Q1 Q1 Q1Q3 Q1Q3 Q3Q1 Q3 Q1 Q3Q1 Q1Q3 Q3 Q1 Q1 Q3 Q3Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q1 -0.5 0.5 -0.5 -0.5 2010 2011 2010 2010 2011 2013 2014 2012 2013 2011 2012 2012 2013 2014 2015 2014 2015 2016 2015 2016 2017 2016 2017 20172018 2018 2018 Q1 Q3 Q1 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q1 Q3 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q3 Q1 Q1 Q3 Q1 Q3 Q3 Q1 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q1 0.0 0.0 0.0 2010 2010 2011 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 2018 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018 (0.5) 0.5 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 -0.5 Sources: Sources: Sources: Sources: BoP/External BoP/External BoP/External 2010 2011 BoP/External debt debt debt 2012 2013 debt statistics statistics statistics (BoM); 2014 (BoM); statistics 2015(BoM); (BoM); World World 2016 World 2017 World Bank Bank Bank 2018 Bank staff staff staff estimates. staffestimates. estimates. estimates. Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2010 2011 2012 2013 2014 2015 2016 2017 2018 International International International reserves reserves reserves improvedsignificantly improved improved significantlyto toreach reachUS$ reach US$ 3 US$ 3 billion billion inin 2017. Foreign 2017.Foreign exchange exchange Foreignexchange reserves reserves International Sources: BoP/Externalreserves improved debt statistics significantly (BoM); World Bank to reach staff US$ 3 estimates. billion in 3 billion in 2017. 2017. Foreign exchange reserves reserves had had had fallen fallen from from a a peak peak atat US$ US$ 4.1 4.1 billion billion in in December December 2012 2012 to to a a low low US$ US$ 11 billion billion in in February February 2017. 2017. Since Since fallen from a had fallen from a peak at US$ 4.1 billion in December 2012 to a low US$ 1 billion in February 2017. Since peak at US$ 4.1 2012 to a low US$ 1 billion in February 2017. Since then then reserves reserves have increased gradually, supported by a strong recovery of coal exports and FDI inflows. then then reserveshave reserves International The issuance have have in increased reservesincreased increased October improved 2017 gradually, gradually, gradually, of significantly the US$ supported supported 800 million by by by to reach a a strong strong aUS$ strong Gerege recovery recovery recovery 3 billion sovereign ofcoal of of in 2017. bond coal coal and exports exports exports Foreign the andFDI and and exchange purchase FDI FDI of inflows. inflows. inflows. reserves gold by The The had Theissuance issuance fallen from issuance inin in October October a peak at October 2017 2017 US$ 2017 ofof 4.1 of the the billion the US$ US$ US$ 800 in800 800 million million December million Gerege Gerege 2012 to Gerege sovereign sovereign a low US$ sovereign bond bond bond andthe 1 billion and and the in purchase the purchase February purchase ofgold 2017. of ofgold gold Since byby the BoM from individuals and companies (US$ 700 million in 2017) were also important contributing the by then theBoM the BoM BoMThe from reserves from from individuals haveindividuals increased individuals andand companies companies gradually, and companies deficit (US$ (US$ supported 700 (US$ 700700 bymillion million a strong million inin 2017) 2017) recovery in 2017) were wereof also also coal also important important exports important and contributing contributing FDI inflows. contributing factors. overall balance-of-payments was moderate during the first four months (US$ 47 factors. factors. The issuance factors. The The overall overall in balance-of-payments Octoberbalance-of-payments 2017 of the US$ deficit 800 was was million moderate moderate Gerege during during sovereign the the bond first first and the four four months months four monthsof purchase (US$ (US$gold47 47 by million) Thethanks overall mainly balance-of-payments to FDI inflows in the deficit wassector mineral moderate(Figure I.23 the during first international ). Gross (US$ reserves47 million) the BoM million) million) thanks from thanks stood atthanks US$ 2,963mainly to individuals mainly mainly to million FDI FDI to FDI inflows and companies inflows inflows (about in five in the months mineral (US$ 700 the mineral sector million sector sector of imports (Figure in (Figure of goods 2017) (Figureand I.23 I.23were I.23 ). ). Gross also Gross important international ). GrossFigure services; international international reserves contributing reserves I.24 ) byreserves the end factors. stood stood atat The2,963 US$ US$ overall 2,963 balance-of-payments million million (about (about five months deficit of was moderate imports imports of of goods goods during and and the first services; services; four I.24 Figure Figure months by I.24)))by (US$ thethe 47 end end stood at US$ of February 2,963 million (about five months of imports of goods and services; Figure I.24 2018. by the end ofmillion) ofFebruary February thanks 2018. 2018. mainly to FDI inflows in the mineral sector (Figure I.23 ). Gross international reserves of February 2018. stood at US$ 2,963 million (about five months Figure I.23 Large FDI inflows in mineral sector of imports of goods Figure I.24 …andand services; resulted in Figure a US$ I.24 1.7 by the end ) billion Figure I.23 of February and Figure I.23Large official 2018. sector Large FDI FDI inflows support inflows in inmineral improved mineral sector the sector Figure Figure I.24 international rise in I.24 …and and resulted … …and resulted reserves ina in a US$ (15 US$ 1.7billion percent 1.7 billion of and balance and official of officialsector payments sector support … support improved improved the the rise GDP) rise in international in 2017 despite international in international reserves strong reserves (15 import (15 percent growth percent ofof and Figure official I.23 sector Large support FDI inflows improved in mineral thesector rise in Figure I.24 … and reserves resulted in a(15 US$ percent 1.7 of billion balance Monthly balance of payments BoP of … (3-month moving developments payments… Gross in GDP) GDP) 2017 international in despite 2017 despite strong reserves despite strong (US$ import billion) import growth growth balance and official average; of US$ payments sector million) … support improved the GDP) rise inin 2017 international LHS import strong Gross Reserves (bnreserves US$): growth (15 percent of Monthly BoP developments (3-month moving Gross international reserves (US$ billion) Monthly balance Monthly BoP developments of developments BoP payments (3-month … Balance Overall moving of Payment Gross GDP) Gross 4.5 international reserves Nominal exchange in 2017 international despite reservesrate (MNT/USD): RHS strong(US$ billion) import growth 2600 average; (3 - month 1,000 US$ million) moving average; US$ CA (values million) in reverse order) (US$ Gross Reserves (bn US$): LHS billion) Monthly US$ average; BoP million) developments Overall Balance Financial (3-month and of Payment Capital moving Account Gross 4.0 4.5 Gross Reserves international (bn reserves Nominal exchange US$): LHS (US$ billion) rate (MNT/USD): Nominal exchange rate (MNT/USD): RHS RHS 2600 2400 Overall Balance of Payment 4.5 2600 average; 1,000800 US$ million) CA (values in reverse order) 3.5 Gross Reserves (bn US$): LHS Program 4.0 Nominal exchange rate (MNT/USD): RHS 1,000 CA (values Financial Overall and reverse inCapital Balance order) Account of Payment 4.5 4.0 2400 2600 2200 800600 1,000 Financial CA (valuesand in Capital reverseAccount order) 3.0 3.5 2400 Program 800 4.0 Financial and Capital Account 3.5 2400 2200 Program 2.5 2000 400 3.0 Recovery 600 800 3.5 2200 Program 600 3.0 2.0 2200 1800 2000 400 200 600 2.5 3.0 Recovery 2.5 1.5 2000 400 Recovery 0 2.0 2.5 2000 1600 1800 Economic 400 Recovery 200 1.0 2.0 1800 200 1.5 2.0 1800 -200 200 1400 0 0.5 1.5 1600 Economic 0 1.5 1.0 1600 Aug-17Economic -400 0 0.0 1600 1200 1.0 Dec-17 Economic -200 1400 Oct-10 Mar-11 Sep-13 Feb-14 Oct-15 Mar-16 May-10 Jan-12 Nov-12 May-15 Jan-17 Nov-17 Jun-12 Jun-17 Aug-11 Apr-13 Jul-14 Dec-14 Aug-16 Apr-18 1.0 Apr-12 Apr-12 Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Dec-12 Dec-12 Dec-13 Dec-13 Dec-14 Dec-14 Dec-15 Dec-15 Dec-16 Dec-16 Dec-17 Dec-17 Aug-12 Aug-12 Aug-13 Aug-13 Aug-14 Aug-14 Aug-15 Aug-15 Aug-16 Aug-16 Aug-17 0.5 -200 1400 -200 0.5 1400 -400 0.5 0.0 1200 Oct-10 Mar-11 Sep-13 Feb-14 Oct-15 Mar-16 May-10 Jan-12 Nov-12 May-15 Jan-17 Nov-17 Jun-12 Jun-17 Aug-11 Apr-13 Jul-14 Dec-14 Aug-16 Apr-18 -400 Apr-18 -400 0.0 1200 Sources: BoM (BoP); World Bank staff estimates. 0.0 1200 Oct-10 Mar-11 Sep-13 Feb-14 Oct-15 Mar-16 May-10 Jan-12 Nov-12 May-15 Jan-17 Nov-17 Jun-12 Jun-17 Aug-11 Apr-13 Jul-14 Dec-14 Aug-16 Apr-18 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Oct-10 Mar-11 Sep-13 Feb-14 Oct-15 Mar-16 May-10 Jan-12 Nov-12 May-15 Jan-17 Nov-17 Jun-12 Jun-17 Aug-11 Apr-13 Jul-14 Dec-14 Aug-16 Apr-18 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Sources: BoM (BoP); World Bank staff estimates. The country’s Sources: Sources: BoM BoM (BoP); (BoP); improved World World Bank Bank external staff staff estimates. estimates. position and effective policy adjustment eased exchange Sources: BoM (BoP); World Bank staff estimates. rate pressures. The country’s improved external position and effective policy adjustment eased exchange country’s The Tugrik The country’s improved improved Thepressures. depreciated external external against position position the U.S. and and dollar by effective effective almost policy policy 80 percent adjustment in adjustment eased eased nominal terms exchange exchange between March rate rate pressures. 2013pressures. rate and January 2017, trading at MNT 2,490:US$ 1 compared to MNT 1,392:US$ 1 in 2013. The depreciation The Tugrik was caused depreciated by the deterioration against of the external balance following nominala substantial decline in The Tugrik depreciated theU.S. againstthe U.S.dollar dollarbyby almost 80 percent almost 80 percent in in nominal terms terms between between March 11 March The 2013 2013 Tugrik and and depreciated January2017, January against 2017,trading tradingat the U.S. at MNT dollar by almost MNT 2,490:US$ 2,490:US$ 1 80 percent compared to 1 compared inMNT nominal to MNT terms between 1,392:US$ 1,392:US$ 11 in March 2013. in 2013. The The 2013 and depreciationJanuary was 2017, caused bytrading the at MNT 2,490:US$ deterioration of the10 1 compared external to balance MNT 1,392:US$ following a 1 in substantial2013. decline depreciation was caused by the deterioration of the external balance following a substantial decline in The in depreciation was caused by the deterioration of the external balance following a substantial decline in MONGOLIA ECONOMIC UPDATE The country’s improved external position and effective policy adjustment eased exchange rate pressures. The Tugrik depreciated against the U.S. dollar by almost 80 percent in nominal terms between March 2013 and January 2017, trading at MNT 2,490:US$ 1 compared to MNT 1,392:US$ 1 in 2013. The depreciation was caused by the deterioration of the external balance following a substantial decline in exports and a sharp fall in FDI. In early 2017, the balance of payments improved, thus easing depreciation pressures on the Tugrik (however, a sharp depreciation of the currency was observed in June and July 2017, during the presidential electoral season). The adjustment of the exchange rate started in February 2017, buoyed by strong coal exports and the February 2017 announcement of the government’s economic recovery plan supported by major donors including the IMF and the World Bank. In addition, sovereign bonds maturing in 2018 were refinanced at relatively lower interest rates. In 2017, as the balance of payments recorded a surplus of US$ 1.4 billion due to strong mineral exports and large FDI inflows, the nominal exchange rate appreciated by 2.5 percent (y/y) against the U.S. dollar. Fearing growing appreciation pressures, the central bank appropriately used the country’s improved external position to accumulate reserves rather than encouraging an appreciation of the local currency. Accordingly, the central bank interventions on the foreign exchange market were significantly reduced, with the net sales of foreign exchange dropping to only US$ 86 million in 2017 from US$ 1.6 billion on average during 2013–17. Gross international reserves substantially increased to US$ 3 billion (five months of imports) from US$ 1 billion (two months of imports). The rate of currency depreciation slowed in recent months despite the strengthening of the currencies (against the U.S. dollar) of neighboring and commodity-dependent countries. The persistent depreciation trend was reversed shortly in April and May 2016, before the parliamentary election, with strong intervention by the BoM. After the two-month appreciation, the Tugrik sharply depreciated by 30 percent to its peak of MNT 2,570 per US$ 1 in November 2016 from MNT 1,962 per US$ 1 in late June 2016. This sharp weakening was mainly attributed to early signs of slower intervention by a new administration at the BoM and reduced business confidence triggered among others by an announcement by the new government of a worsened state of the economy. With strong coal exports and early signs of approval of the government’s economic recovery plan supported by development partners, the Tugrik has been moderately appreciating since early 2017. Generally, despite a moderate strengthening since early 2017, the Tugrik depreciated by 22.6 percent over the last two years (June 2016 to May 2018). In contrast, most of the currencies in other commodity-dependent countries have appreciated at a moderate rate in recent months (Figure I.25 and Figure I.26 ). 12 others by an intervention byannouncement by the new a new administration at government the BoM and of areduced worsened state of confidence business the economy. With strong triggered among coal by others an announcement exports and early signs by the of new government approval of a worsened of the government’s state economic of the economy. recovery With strong plan supported by coal exports and development early signs partners, of approval the Tugrik has been of the government’s moderately appreciating economic since early recovery plan supported 2017. Generally, despite by a moderatepartners, development the Tugrik strengthening MONGOLIA since has earlybeen 2017, theECONOMIC moderately Tugrik appreciating depreciated UPDATE since by 22.6 early 2017. percent Generally, over despite the last two a moderate years (June strengthening 2016 to Maysince 2018). early 2017, the In contrast, Tugrik most depreciated of the currencies by in 22.6 otherpercent over the last two commodity-dependent years (June 2016 to May 2018). In contrast, most of the currencies in other countries have appreciated at a moderate rate in recent months (Figure I.25 and Figure I.26 ). commodity-dependent countries have appreciated at a moderate rate in recent months (Figure I.25 and Figure I.26 ). Figure I.25 Figure I.25The Nominal TheNominal exchange exchange rate rate has has Figure Figure I.26I.26 …while …while the the currencies currencies of most of most stabilized Figure I.25 since The early 2017 Nominal after years exchange rate of has resource-rich countries have broadly stabilized since early 2017 after years of Figure I.26 …while the currencies resource-rich countries have broadly most of depreciation… stabilized since early 2017 after years of strengthened resource-rich against the countries U.S. have dollar broadly depreciation… strengthened against the U.S. dollar depreciation… MNT per US$: May 2016–May 2018 strengthened Foreign exchange rate per the against U.S. US$ in dollar countries resource-rich MNT BoM’s per netUS$: May foreign 2016–May exchange sales 2018 in spot foreign exchange Foreign (2015 exchange Dec = 100) rate per US$ in resource-rich MNT US$: pernet May 2016– May in2018 Foreign exchange rate per US$ in resource-rich BoM’s auctionsforeign exchange (US$ million) sales spot foreign exchange auctions countries (2015 Dec = 100) BoM’s net foreign (US$ million) exchange sales in spot foreign exchange auctions countries (2015 Dec = 100) (US$ million) 130 Indonesia The BoM's net sales of foreign exchange: LHS 130 Indonesia The BoM's net sales of foreign exchange: LHS 350 Monthly FDI flows: LHS 2,700 Monthly FDI flows: LHS 120 South africa 350 USD/MNT: RHS 2,700 120 South africa 250 USD/MNT: RHS 2,500 250 2,500 Chile 110 110 Chile 150 2,300 150 2,300 in million US$ Kazakhstan in million US$ 50 2,100 100 Kazakhstan 50 2,100 100 (50) (50) 1,900 1,900 90 RussiaRussia 90 (150)(150) 1,700 1,700 Malaysia Malaysia 80 80 (250)(250) 1,500 1,500 Mongolia Mongolia (350)(350) 1,300 1,300 70 70 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Oct-16 Oct-17 Feb-16 Feb-17 Feb-18 Jun-16 Jun-17 Apr-16 Apr-17 Apr-18 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Oct-16 Oct-17 Feb-16 Feb-17 Feb-18 Jun-16 Jun-17 Apr-16 Apr-17 Apr-18 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 China China Sources: Sources: BoM. BoM. Sources: BoM. The real The effective real exchange effective rate(REER) exchangerate saw a moderate (REER) saw appreciation moderateappreciation with with higher higher inflation. inflation. TheThe REER REER The hashas beenreal onon been effective a slower exchange a slower rate since appreciation appreciation (REER) saw since the the a moderate end end 2016, with 2016, withappreciation rising rising withIn higher inflation. inflation. In inflation. contrast, contrast, thethe The nominal nominalREER has been on a slower appreciation since the end 2016, with rising inflation. In contrast, the nominal effective exchange rate (NEER)5 has been moderately weakening, reflecting the weaker performance of the Tugrik relative to other currencies. 11 Fiscal policy and debt sustainability: Fiscal performance 11 was strong in 2017 and consolidation has remained on track in 2018 Q1. Following the economic slowdown of 2014-16, decisive measures were taken by the government, which began its term in July 2016, to reduce the budget deficit and restore macroeconomic stability. The parliament approved the Economic Recovery Program in November 2016, which combined short-term measures aimed at restoring fiscal sustainability and long-term actions aimed not only at consolidating fiscal reforms but also at diversifying the economy, improving the business environment, and attracting foreign investment for stable growth (Box I.2 ). 5 The NEER is a weighted average of exchange rates with major trading partners. The REER further adjusts the NEER by accounting for Mongolia’s price level relative to those of its trading partners. The NEER and REER are measured as an index and are regarded as a measurement of the external sector’s competitiveness compared to the country’s trading partners. 13 MONGOLIA ECONOMIC UPDATE Box I.2 Key fiscal adjustment reforms adopted by the Government of Mongolia in 2017 Table B1.1 presents the key fiscal adjustment measures contained in the supplementary budget for 2017 adopted by the Government of Mongolia. Table B1.1 Key fiscal adjustment measures Key measures Importance Progress to date To restrict Parliament’s power to increase the Pay-as-you-go Approved under 2017 budget expenditure envelope reflected in the budget (PAYGO) amendment and is currently effective. presented by the MoF (effective 2018 onward). To improve fiscal discipline in compliance with Established in November 2017 under the FSL through preparing independent budget the parliamentary budget standing Fiscal Council forecasts and costings of policy proposals from committee. Being a body under this members of parliament, prevent off-budget parliamentary committee may affect its expenditures. independence. Revised CIT law submitted to Parliament Corporate Income Tax (CIT): Tax simplification. in May 2018, but rejected as concerns Entities with up to MNT 50 million annual sales were raised on apparent additional income to pay 1 percent tax rate out of its benefits to multinational companies taxable income and to submit simplified financial operating in Mongolia on top of their statement once a year. Entities with annual sales existing tax breaks. income less than MNT 1.5 billion to get 90 percent of their paid taxes refunded. Progressive PIT became effective January 1, 2018, but was reversed by Personal Income Tax (PIT): the government on January 29, 2018, Tax reforms • To introduce a progressive tax rate and yield due to political pressure mainly due to additional revenues. abrupt decrease in take-home incomes • Mongolia’s current flat PIT rate is among the for high-income earners. lowest in the world. Transfer pricing rule, which is defined Introduce international taxation rules such as broadly under the existing GTL, has General Anti-Avoidance Rule (GAAR), transfer been spelled out in the revised GTL pricing. Mongolia’s General Taxation Law (GTL) is requiring related business entities to currently missing a GAAR provision that is now charge one another the same price standard in most countries’ tax legislation. as unrelated entities on the sale of comparable goods and services. Fiscal transfers to the Pension Insurance Fund (PIF) reached 2.2 percent of 2017 GDP and are projected Parliament raised the pension age to substantially increase to about 6 percent in in November 2017, but reversed the Pension 2030, raising concerns over fiscal sustainability of decision on January 29, 2018, due to reforms the PIF. This requires a package of pension reforms social pressure claiming that retirement including raising the retirement age and private age extension was unrealistic at best. contributions. Prevent new concessions: no new build-transfer Public Approved in November 2017 with (BT) operations, and transfer payments for ongoing investment annual budget. BTs based on audit opinions. efficiency The preparation of guidelines is Select Public Investment Programs based on reforms underway. Rationalization Guidelines approved by Cabinet. So far, Mongolia’s fiscal performance under the Economic Recovery Program has been significant. The primary fiscal accounts markedly improved in 2017, posting a surplus of 2.2 percent of GDP, an enormous improvement compared to a primary deficit of 13.1 percent of GDP in 2016. The strength of 14 investment ongoing BTs based on audit opinions. The preparation of guidelines efficiency ongoing BTs based on audit opinions. The preparation of guidelines is is efficiency Select Public Investment Programs based on underway. reforms Select Public Investment Programs based on underway. reforms Rationalization Guidelines approved by Cabinet. Rationalization Guidelines approved by Cabinet. MONGOLIA ECONOMIC UPDATE So far, So far, Mongolia’s Mongolia’s fiscal fiscal performance performance under under thethe Economic Economic Recovery Recovery Program Program has has been been significant. significant. TheThe primary fiscal accounts markedly improved in 2017, primary fiscal accounts markedly improved in 2017, posting a surplus of 2.2 percent of GDP, anan posting a surplus of 2.2 percent of GDP, the fiscal accounts enormous improvement to the combined is duecompared to effects a primary of fiscal deficit measures of 13.1 percentimplemented of GDP underThe in 2016. Economic the strength enormous improvement compared to a primary deficit of 13.1 percent of GDP in 2016. The strength of of Recovery the fiscal Program,isadue accounts strong to domestic the combined economic effects performance, of fiscal a strong measures mining sector, implemented under andthe improved Economic the fiscal accounts is due to the combined effects of fiscal measures implemented under the Economic global commodity Recovery Program, prices, which a strong generated domestic strongerperformance, economic than planned a revenues. strong mining sector, and improved Recovery Program, a strong domestic economic performance, a strong mining sector, and improved global global commodity commodity prices, prices, whichwhich generated generated stronger stronger than than planned planned revenues. revenues. The overall fiscal deficit declined to 1.9 percent of GDP in 2017, a dramatic improvement over the 17 The The overall overall percent fiscal fiscal deficit of deficit deficit 2016 declined declined (Figure to I.27 ). 1.9 to 1.9 percent 2016of percent The of GDP GDP deficit in 2017, in 2017, resulted from a high dramatic a dramatic improvement improvement off-budget spending over over the during the1717 the percent percent deficit deficit election season of of 2016 2016 channeled I.27I.27 (Figure (Figure through ). ). The The the20162016 DBM todeficit deficit bypass resulted resulted fromfrom the ceiling high onhigh off-budget off-budget structural spending spending deficit set by during during the thethe Fiscal election election season season channeled channeled through through the the DBM DBMto to bypass bypass the the ceiling ceiling on on structural structural Stability Law. Because of debt accumulation, interest payments more than tripled in the last five years deficit deficit set set by by the the Fiscal Fiscal Stability Stability to 4.1Law. Law. Because Because percent of debt of GDP inof debt 2017. accumulation, accumulation, interest interest payments payments moremorethanthan tripled tripled in in the the last last fivefive years years 4.1 percent to percent to 4.1 of GDP of GDP in 2017. in 2017. Figure I.27 Expenditure, revenue, fiscal balance, Figure I.28 Public debt and components, Figure Expenditure, I.27 I.27 Figure revenue, Expenditure, fiscal revenue, fiscal Figure I.28 Figure Public I.28 debt Public and debt components, and components, 2011–17 2012–17 balance, 2011 balance, –17 –17 2011 2012 –17 2012 –17 of% (in %(in (in % of GDP) GDP) of GDP) (in % (in (inof % of GDP) %GDP) of GDP) Total revenue Total revenue Total Expenditures Total Expenditures Balance OverallOverall Balance Primary Balance Primary Balance 35 35 25 25 33.8 33.8 29.8 15 15 29.8 30.9 30.9 27.9 27.9 25.3 25.3 24.1 24.1 29.2 29.2 5 5 -5 -5 -15 -15 -25 -33.9 -33.9 -31.1 -31.1 -25 -37.9 -37.9 -38.9 -38.9 -38.3 -38.3 -35 -40.1 -40.1 -40.5 -40.5 -35 -45 -45 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017 Sources: BoM; Sources: Sources: International BoM; BoM; Monetary International International Fund Monetary Monetary (2018). Fund Fund (2018). (2018). Improvements Improvements Improvements in public in public in spending public have spending spending been have have considerable been been considerable considerable (Figure (FigureI.29 (Figure ). ). I.29 I.29 Total ).Totalpublic Total publicspending, public spending, spending, which which which reached 40.5 reached percent 40.5 of percent GDP of in GDP 2016, in contracted 2016, to contracted 31 to percent 31 percent in 2017. in 2017.TheThebulk reached 40.5 percent of GDP in 2016, contracted to 31 percent in 2017. The bulk of the adjustment bulkofofthe theadjustment adjustment came from came came reduced from from capital reduced reduced expenditures, capital capital contracting expenditures, expenditures, from contracting contracting 6.66.6 from from percent 6.6 percent percent GDP of of ofto GDP 4.3 GDP to percent to 4.3 in in 4.3 percent percent 2017. in 2017. Actual recurrent 2017. Actual spending recurrent also declined, spending also relative declined, to planned, relative to following planned, Actual recurrent spending also declined, relative to planned, following the followingthe reduction the reduction inin interest interest in interest payments and and payments the the impact of hiring freeze thethe on on wage bill. The decline in incurrent expenditures came payments and the impact of hiring freeze on the wage wage bill. bill. The The decline decline incurrent current expenditures expenditures came came from the reduction of all spending components except interest payments. However, Mongolia’s total from the from reduction of all spending components the reduction components except except interest interest payments. However,Mongolia’s payments.However, Mongolia’stotal total public spending remains higher than the average of commodity-dependent countries (29.5 percent of public spending public remains higher than the average spending remains average ofof commodity-dependent commodity-dependentcountries (29.5percent countries(29.5 percentof of GDP). GDP). GDP). 13 13 15 MONGOLIA ECONOMIC UPDATE Figure I.29 Spending consolidation performance (% of GDP), 2016 and 2017 Figure I.29 Spending consolidation performance (% of GDP), 2016 and 2017 40% 1.0% 35% 30% 10.3% 7.3% 25% 3.6% 4.0% 20% 15% 10% 21.1% 21.5% 5% 0% -5% -1.7% 2016 2017 Recurrent Primary expenditures Interest Payment Capital Exp and Net Lending Off-Budget Spending (DBM commercial portfolio) Sources: MoF data; World Bank staff estimates. Sources: MoF data; World Bank staff estimates. Higher than Higher than expected revenue was expected revenue buoyed by was buoyed royalties from by royalties coal exports exports and from coal related revenue and related and revenue and strong economic activity thatthat lifted import-related taxes. Total revenue increased from 23.5 percent from 23.5 of percent of 29.2 percent GDP in 2016 to 29.2 in 2017, percent in 2017, higher higher than than initial initial projections. Mining-related revenue projections. Mining-related increased revenue increased from 15 percent of total revenue and 3.3 percent of 3.3 percent of GDP GDP to 21 percent to 21 percent of revenue and of revenue and over 6 percent over 6 of percent of GDP in 2017. in 2017. This This shows shows Mongolia’s Mongolia’s strong strong dependence dependence on global on global commodity commodity prices prices and mineral and mineral exports exports and its vulnerability and its vulnerability to globalto global economic economic conditions. conditions. Non-mineral Non-mineral revenue revenue also also increased increased by 24 by 24 percent in percent duemostly in 2017, 2017, mostly due to value-added to improved improved value-added tax (VAT)following tax (VAT) collection following implementation collectionimplementation of of a new VAT a new law, VAT law, which which became became effective ineffective 2015, and inincreased 2015, andcustoms increased customs duties. duties. Increased capital Increased spending, financed capital spending, financed byby off-budget off-budget resources resources and high domestic and high and foreign domestic and foreign borrowing, led to a sharp increase in public debt, up to 88 percent of GDP in 2016. The fiscal borrowing, led to a sharp increase in public debt, up to 88 percent of GDP in 2016. The fiscal adjustments approved by the government in 2016 to improve its fiscal credibility are beginning to bear adjustments approved by the government in 2016 to improve its fiscal credibility are beginning to bear fruit and the public debt decreased slightly to 84.5 percent of GDP in 2017 (Figure I.29 ). fruit and the public debt decreased slightly to 84.5 percent of GDP in 2017 (Figure I.29 ). External government debt and guarantees jumped to US$ 6.6 billion (69 percent of GDP) in 2016, External government accounting for over 76 debt and guarantees percent jumped of the increase to US$ in total 6.6 billion government (69 Total debt. percent of GDP) external in 2016, guarantees accounting reached US$ 1.6over for 76in billion percent 2016, due the of to increase inguarantees government total government of bonds debt. Totalissued external and loans guarantees or contracted reached US$ 1.6 by public and private entities. The direct external debt of the government amounted to US$ contracted billion in 2016, due to government guarantees of bonds and loans issued or 4.9 billion public including by 2016, in and private entities. US$ The direct 2.2 billion external debt in sovereign bondsof and the government amounted a US$ 0.3 billion to US$ 4.9 syndicated billion loan. in Total 2016, including US$ 2.2 billion in sovereign bonds and a US$ 0.3 billion syndicated loan. government direct and guaranteed debt reached US$ 9.4 billion in 2017, approximately 84 percent of Total government directIn GDP. netguaranteed and present value debtterms, total reached government US$ 9.4 billiondebt accounted in 2017, for 74.4 percent approximately of GDP 84 percent (at current of GDP. In net prices) in 2017. present value terms, total government debt accounted for 74.4 percent of GDP (at current prices) in 2017. Planning forward, Planning Mongolia’s new forward, Mongolia’s new Medium -Term Fiscal Fiscal Framework Medium-Term (MTFF) for Framework (MTFF) for 2019 –21, recently 2019–21, recently discussed in the Parliament, projects a stronger growth outlook and a relatively lower public discussed in the Parliament, projects a stronger growth outlook and a relatively lower public debt. debt. The governme nt’s new MTFF for 2019 – 21 submitted to the parliament on April 30, 2018, along The government’s new MTFF for 2019–21 submitted to the parliament on April 30, 2018, along with with the socioeconomic guideline for 2019, indicates that real GDP is projected to grow at 8 percent the socioeconomic guideline for 2019, indicates that real GDP is projected to grow at 8 percent in in 2019 before settling at about 6 percent, on average, in 2020–21. The government argues that this optimistic growth outlook is predicated on an accelerated implementation of mega-projects including those 16 14 MONGOLIA ECONOMIC UPDATE 2019 before settling at about 6 percent, on average, in 2020–21. The government argues that this optimistic growth outlook is predicated on an accelerated implementation of mega-projects including those articulated in its recently launched “Three Pillars Development Policy,” as well as the expected positive impact of its tax reforms. Managing key risks, including delays at the border with China, as well as the risk of potential decline in FDI following various disputes with Oyu Tolgoi, will be instrumental in articulated articulated achieving in itsits in this recently recently ambitious launched launched objective “Three “Three (Box Pillars I.3 Pillars DevelopmentPolic ). Development y, Policy,” as well ” as well as the expected expected positive positive impact impact itsits of of taxtax reforms. reforms. Managing Managing key key risks,including risks, delaysat includingdelays at the the border well as border with China, as well as the the risk of of risk potential potential decline decline inin FDI FDI followingvarious following variousdisputes disputes with with Oyu Tolgoi, will be instrumental Oyu Tolgoi, instrumental in in Box achieving I.3 achieving The this this Medium-Term ambitious ambitious Fiscal objective objective Framework (Box (Box I.3 I.3 ).). for 2019–21 The Medium-Term Fiscal BoxFramework BoxI.3I.3 The The (MTFF) for 2019–21 Medium-Term Medium-Term Fiscal FiscalFramework (Ministry Framework of2019 for for Finance, 2019 – 21 2018) was approved by the –21 parliament in May 2018 together with the Socio-Economic Guidelines for 2019. The MTFF for the next three The years The aims at implementing Medium-Term Medium-Term Fiscal Fiscal Framework the Government Framework (MTFF)for (MTFF) Action for2019 2019 –– 21 21 Plan for 2016–2020, (Ministry (Ministry of Finance, of Finance, and to strengthen 2018) 2018) was approved approvedfiscal by bystability the the parliament parliament through May in May infurther 2018 2018 together together accelerating with with the economictheSocio-Economic Socio-Economic growth, reducing Guidelines Guidelines the fiscalfor for 2019. 2019. deficit and The The MTFF for the MTFF government nextand debt, three three years years tightening aims aims at at fiscal implementing implementing discipline. thethe Government Government ActionPlan Action Planfor 2016 for2016 –– and to 2020, and 2020, strengthen fiscal stability to strengthen stability through through further further accelerating accelerating economic economic growth, growth, reducingthe reducing fiscaldeficit thefiscal and government deficit and government debt, and tightening tightening fiscal fiscal discipline. discipline. Mongolia’s MTFF for 2019–21 projects a stronger growth outlook and a relatively lower public debt. Real GDP is projected to grow at 8 percent in 2019 before settling at about 6 percent on average in 2020–21. The Mongolia’s Mongolia’s government MTFF MTFF forfor 2019– 2019– argues that2121 thisprojects projects aa optimisticstronger stronger growth growth growth outlook outlookoutlook andaa relatively relatively and is justified lower public lower by the successful Real GDP debt. Real implementation GDP ofis isits projected projected recentlyto to growgrowat at launched 8 8 percent percent “Three in 2019 in 2019 Pillars before before Development settling settling at at about about Policy,” as66 as aon percent percent well on average average positive in 2020 –from in outcome 21. Theitsgovernment government proposed tax argues argues that reform. that this optimistic this Despite optimistic growth growth a stronger outlook growthoutlook isis outlook,justified the by justified bythe new the successful MTFFsuccessful assumes implementation implementation that the fiscal ofdeficit recently its recently launched launched for 2019–20 will “Three “Three Pillars Pillars Development Development Policy,” Policy,” asas well well asasa a positive positive outcome outcome from from its its proposed proposed remain almost unchanged (at 6.2 percent of GDP) compared to the previous MTTF (6.1 percent) resulting tax tax reform. Despite Despite a a stronger stronger from growth growth outlook, outlook, higher the spending. the newnew MTFF MTFF assumes assumes that that the the fiscaldeficit fiscal 2019 deficitfor for2019 –– 20 will 20 will remain unchanged (at remain almost unchanged (at 6.2 6.2 percent percent of GDP) of GDP) compared compared the toto theprevious previous MTTF MTTF (6.1 (6.1 percent) percent)resulting resultingfrom higher spending. fromhigher spending. Public debt is also expected to decline faster than initially envisaged in the previous MTTF, as the government’s Public Public debt debt is also is also expected expected toto decline decline faster faster than than initiallyenvisaged initially envisagedin in the the previous MTTF, as the government’s previous MTTF, government’s medium-term debt strategy will focus on rolling out build-and-transfer (BT) projects and other state medium-term medium-term debt debt strategy strategy will will focus focus onon rolling rolling out outbuild-and-transfer build-and-transfer (BT) projects and (BT) projects guarantees, and other state guarantees, guarantees, while relying only on long-term, low-cost, concessional borrowing to ease the debt burden. As a while while relying relying only onlyonon long-term, long-term, low-cost, low-cost, concessional concessionalborrowing borrowingto ease the toease the debt debt burden. burden. As a result, the net result, the net result, present present theof value value net of present public public value debt debt is is of public to projected projected debt to is projected decline decline to decline from74.4 from 74.4 percent percent fromin 2017 in 74.4 percent 2017 to 55.3 to in 2017 to 55.3 percent in 55.3 2019percent 2019 before in before 2019 further further before dropping dropping further dropping gradually graduallytoto about about gradually 4848 to about percent percent in 48 percent 2020 in2020 and and4141in 2020 and percent percent of 41 GDP of GDP percent in GDP inthe of below in 2021, 2021, 2021, the below the regulatory regulatory regulatory threshold thresholdof of threshold 7575percent percent of for for75 2019, percent 2019, 70 70 for percent 2019, percent for for 70 2020, percent 2020, and and60 for 2020, 60percent and percentfor 60 for2021. 2021.percent for 2021. The The The economic economic economic outlook outlookoutlook projected projected projected by by the theby the government, government, government, which which which seems seems seems optimistic, optimistic, optimistic, couldcould could only materialize only only materialize if some someif of some of the of the key the key key downside downside downside risks risks are risks are are successfully successfully successfully mitigated.mitigated. mitigated. These These Theseinclude include includethe the thedelayed delayed implementation delayed implementation of major implementation of major projects, projects, projects, and and the and the risk the of risk risk decline of of declinein decline FDI in FDIflowsin if flows FDI the if flows the if the ongoing ongoing ongoing probe probe inintheprobe theminingin sector mining the mining sector is sector is mishandled, is mishandled, mishandled, the as well as the as well as the bottleneck bottleneck bottleneck issues issues at the at the issues border border at with with the China.border with China. China. Figure Figure Figure I.30I.30 I.30 MTFF: MTFF: Growth MTFF: Profile Growth Profile Growth Profile Figure FigureI.31 Figure I.31 I.31MTFF: Debt DebtProfile MTFF:Debt Profile Profile (y/y, (y/y, (y/y, %) %) %) (%(% (%of ofGDP, of NPV) GDP, GDP, NPV) NPV) Source: Source: Ministry Ministry of of Finance Finance (2018) (2018). . Source: Ministry of Finance (2018). Monetary Monetary and and exchange exchange rate rate policies:Monetary policies: conditions improved Monetary conditions improved owing to the strong the strong performance performance ofof the the external sector, external sector,leading leading toaarebound to reboundof private sector ofprivate growth. sector credit growth. Although Although monetary monetary policy policy has has been been easingin easing thelast inthe lastfew fewyears, years, mainly mainly reflecting reduced inflation reflecting reduced inflation 17 pressures, pressures, it has it has only only slowly slowly translated translated intolower into lowerinterest interestrates. rates. After persistent high interest After persistent interest levels levels between between mid-2014 mid-2014 and and late late 2016, 2016, the the interbankmarket interbank rateshave marketrates have been been on on the with four the decline, with four cuts cuts in in thethe central central bank bank policy policy rate rate from from 15 15 percentin percent inNovember November2016 to 10 2016 to percent in April 2018. 10 percent 2018. During During MONGOLIA ECONOMIC UPDATE Monetary and exchange rate policies: Monetary conditions improved owing to the strong performance of the external sector, leading to a rebound of private sector credit growth. Although monetary policy has been easing in the last few years, mainly reflecting reduced inflation pressures, it has only slowly translated into lower interest rates. After persistent high interest levels between mid-2014 and late 2016, the interbank market rates have been on the decline, with four cuts in the central bank policy rate from 15 percent in November 2016 to 10 percent in April 2018. During the same period, overnight loan rates declined to less than 10 percent from 16.2 percent (Figure I.32 The ). Thegovernment government limited limited issuance its its issuance of domestic of domestic security, andand security, the the one-year one-yeargovernment government bond yieldyield also bond sharply also fell to 12 sharply fell to The government percent limited in 12 percent October its issuance 2017 in October from of domestic 18 percent from 18 and 2017 security, at its percent peak in the one-year January at its peak 2017, in January government largely 2017, bond reflecting largely yield also increased reflecting sharply fell excess increased reserves. to 12 percent excess in Bank reserves. October deposit Bank 2017 rates have deposit from 18 been rates percent posting have at itsbeen peak a posting gradual in Januaryareduction gradual reduction 2017, largelysincereflecting October since 2017, amid increased October excess 2017,improving amid funding reserves. improving conditions Bank deposit funding and rateslowered conditions policy andbeen have lowered rates posting as policya well asas gradual rates increased reduction excess sincereserves. well as increased October excess Domestic 2017, amid reserves. currency improving Domestic deposit funding currency rates —which conditions deposit were and lowered rates—which stable wereat around policy stable at13 rates percent as well13 around ason average increased percent during onexcess average most of reserves. during 2017 — Domestic slightly declined currency deposit to 12.8 rates — percent which in were April stable 2018. at Almost around 13 flat percent most of 2017—slightly declined to 12.8 percent in April 2018. Almost flat deposit rates reflect a strong depositon rates average reflect during a strong most of competition 2017—slightly competition among declined among banks banks to forfor 12.8 deposits. Meanwhile, percent Meanwhile, deposits. in April 2018. bank bank lending Almost lending flatrates have deposit rates have also rates also reflect been been gradually a strong gradually declining declining since September 2017, as a result of growing excess reserves and lowered policy rates. competition since September among banks 2017, for as a deposits. result of Meanwhile, growingbank excess lending reserves rates and have lowered also been policy gradually rates. Weighted declining average Weighted average lending rates of new domestic currency loans fell to 19.3 percent in April rates. since lending September rates 2017, of new as a domestic result of currency growing loans excess fell to 19.3 reserves percent and in lowered April 2018 policy from 2018 Weighted 20.4 percent average a yearlending ago (Figure of new ratesI.33). domestic However, currency interest loansto channel fell to 19.3 lending percent rates in April through the2018 from interbank from 20.4 percent a year ago (Figure I.33). However, interest channel to lending rates through the 20.4 percent market remaineda year ago (Figure limited, possiblyI.33). However, due to theinterest fact that channel to lending loans (a) substantial rates through were issued the interbank at fixed interbank market remained limited, possibly due to the fact that (a) substantial loans were issued at market remained subsidized rates under limited, possibly the Price due to the Stabilization fact that Program and the substantial (a) housing loans were mortgage program,issued andat(b)fixed the fixed subsidized rates under the Price Stabilization Program and the housing mortgage program, and subsidized lending rates rates ofunder the Price commercial Stabilization loans seem to Program have been and the more housing mortgage affected program, by deposit ratesand(a (b)high the (b) the lending lending rates rates of of commercial commercial loans loans seem seem to to have have been been more more affected affected by by depositrates deposit (a high rates (a high concentration of depositors in the banking system). concentration of concentration depositors in of depositors the banking in the banking system). system). Figure I.32 Interbank rates have been on the Figure I.33 Average lending rates and deposit Figure decline Figure I.32 since I.32 Interbank November Interbank rates rates have 2016, havein been tandem been on on thethe Figure rates Figure Average I.33Average have I.33 also lending marginally lending rates declined rates and and in deposit recent deposit decline with declinelowersince since November policy Novemberrates 2016, 2016,in intandem tandemwith rateshave months rates haveamid also also marginally improving marginally declined funding declined in recent conditions in recent with lower lower policy Interbank policy rates market rates rates and BoM policy rate (%) months months Weighted amid amid average improving improving funding lending funding and deposit conditions conditions rates Interbank Interbank market market rates BoMBoM and and rates policy policy rate (%) rate (%) Weighted (domestic Weighted average currency, average lending rates rates and deposit %) and deposit lending (domestic (domestic %) %) currency, currency, Interest spread (lending - deposit rate, bps): RHS BoM policy Interest rate (lending - deposit rate, bps): RHS spread Interbank deposit rate Overnight Loans Avg BoM bank rate rate lending policy 12 week T-bills Interbank deposit rate BoM rate policyLoans Overnight Avg bank deposit Avg bank lending rate rate 12 week T-bills BoM policy rate 21 1000 18 Avg bank deposit rate 21 19 900 1000 18 16 19 800 900 17 16 800 700 17 15 14 700 600 14 15 13 600 500 12 13 500 400 11 12 400 11 300 10 9 300 200 10 9 7 200 100 8 7 8 5 100 0 5 0 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 6 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 6 BoM. Source:BoM. Source: Source: BoM. Money supply (M2) recovered in 2017, following a slump in 2016 and a protracted period of Money supply (M2) recovered in 2017, following a slump in 2016 and a protracted period of Money supply slowdown since(M2) 2014. recovered in 2017, The recovery gainsfollowing continueda slump in 2018,in with and agrowth 2016credit protracted periodto increasing of31 slowdown since 2014. The recovery gains continued in 2018, with credit growth increasing to 31 slowdown percent since in April 2014. 2018 The recovery (compared gains to minus 6 continued in 2018, with percent in December credit 2016). growth On the assetincreasing side, credittoto31the percent percent in in April April 2018 2018 (compared (compared to to minus minus 6 6 percent percent in in December December 2016). 2016). On On the the asset asset side, side, credit credit to to public sector and net foreign assets switched roles in terms of driving money growth. The main driver the public the public sector sector and net and net foreign foreign assets assets switched roles switched roles in in terms terms of driving of driving money money growth. growth. The The main mainof during driver the first quarter of 2018 was the accumulation of net foreign assets posting growth in excess during the driver during first quarter the first of 2018 quarter of 2018 waswas the the accumulation accumulation of net foreign of net assets posting foreign assets growth in posting growth in excess of excess of 20 percent, which 20 percent, which reflected reflected limited limited central central bank interventions in bank interventions the foreign in the foreign exchange exchange market, strong market, export revenue, strong export and strong revenue, and strong donor donor support support coupled with improved coupled with market sentiment improved market sentiment (Figure 18 I.34 (Figure I.34 ).). The growth The growth of of net net domestic domestic assets was stimulated assets was stimulated byby the the recovery of credit recovery of to the credit to private sector, the private sector, which grew by over 10 percent during the first quarter of 2018, as monetary policy eased and loan which grew by over 10 percent during the first quarter of 2018, as monetary policy eased and loan MONGOLIA ECONOMIC UPDATE 20 percent, which reflected limited central bank interventions in the foreign exchange market, strong export revenue, and strong donor support coupled with improved market sentiment (Figure I.34 ). The growth of net domestic assets was stimulated by the recovery of credit to the private sector, which grew by over 10 percent during the first quarter of 2018, as monetary policy eased and loan demand rebounded. Private sector credit growth had declined since 2014, reaching negative growth of 2 and 8.4 percent in 2016 before the beginning of a recovery in 2016 H2. The growth of credit to the public sector averaged 16 percent in 2017 but declined substantially in the first quarter of 2018. By April 2018, its growth was - 19 percent, reflecting fiscal consolidation measures that stopped the issuance of new treasury bonds and off-budget spending through BOM and DBM credit to the government measures measures that and the stopped that stopped thepublic the sector. issuance issuance of new of treasury bonds new treasury bonds and and off-budget off-budget spending through BOM spending through BOM andDBM and creditto DBMcredit tothe thegovernment governmentand thepublic andthe sector. publicsector. On the liability side, money was mainly driven by strong growth in local currency deposits, which On the On liability side, the liability money was side, money was mainly mainly driven driven by by strong growth in strong growth local currency in local deposits, which currency deposits, which averaged over 40 percent in the last quarter of 2017 and the first quarter of 2018. The growth of local averagedover averaged over4040percent percentin thelast inthe quarterof lastquarter of2017 2017and andthe firstquarter thefirst quarterof of2018. 2018.The growthof Thegrowth local oflocal currency currency currency deposits deposits deposits wasstrong strongin was was strong in2017, in 2017,averaging 2017, averaging 28 averaging 28 28 percent, percent, compared compared to percent, compared to only 6.6 only to only 6.6percent 6.6 percentin percent in2016. in 2016. 2016. Growth Growth Growth ininforeign in foreign foreign currency currency currency deposits, deposits, deposits,although although although on on onaarecovery arecovery recovery path, path, path, remained remained remained weak weak weak (Figure (FigureI.35 (Figure I.35).). I.35 ). Figure Figure Figure I.34 I.34 I.34 M2M2 M2 growth growth growth has has has been been been strong, strong, strong, with with with Figure FigureI.35 Figure I.35 Strong I.35Strong Strongmoney supplygrowth supply moneysupply money growthhas growth has has rising rising rising net net net foreign foreign foreign assets assets assets and and and credit credit toto credit tothe thethe private mainlybeen mainly drivenby beendriven byaarise risein inlocal localcurrency currency private private sector sector sector deposits deposits M2 M2M2 growth growth growth decomposition decomposition decomposition byassets by by assets assets (y/y,%), (y/y, %),April (y/y, %), April M2 M2 M2 growth growth growth decomposition decomposition decomposition by liabilities (y/y, (y/y, byliabilities by liabilities (y/y,%), %), %), 2011 2011 April –– April2018 April 2011–April 2018 2018 April April April 2011 2011 ––April April 2011–April 2018 2018 2018 Non-bank Non-bank private private sector sector Govt Govt&& Public Public Sector Sector Foreign Foreign currency currency deposits deposits MNT MNT deposits deposits Net Net foreign foreign assets assets Net Net domestic domestic credit credit (y/y, (y/y, %) %) Currency Currency outside outside banks banks M2 M2 growth growth (%, (%, y/y) y/y) M2 M2 growth growth (%, (%, y/y) y/y) 80% 80% 100% 100% 70% 70% 60% 60% 75% 75% 50% 50% 50% 50% 40% 40% 30% 30% 25% 25% 20% 20% 0% 0% 10% 10% 0% 0% -25% -25% -10% -10% -50% -50% -20% -20% Apr-11 Apr-11 Apr-12 Apr-12 Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Apr-18 Aug-11 Aug-11 Dec-11 Dec-11 Aug-12 Aug-12 Dec-12 Dec-12 Aug-13 Aug-13 Dec-13 Dec-13 Aug-14 Aug-14 Dec-14 Dec-14 Aug-15 Aug-15 Dec-15 Dec-15 Aug-16 Aug-16 Dec-16 Dec-16 Aug-17 Aug-17 Dec-17 Dec-17 Apr-11 Apr-11 Aug-11 Aug-11 Apr-12 Apr-12 Aug-12 Aug-12 Apr-13 Apr-13 Aug-13 Aug-13 Apr-14 Apr-14 Aug-14 Aug-14 Apr-15 Apr-15 Aug-15 Aug-15 Apr-16 Apr-16 Aug-16 Aug-16 Apr-17 Apr-17 Aug-17 Aug-17 Apr-18 Apr-18 Dec-11 Dec-11 Dec-12 Dec-12 Dec-13 Dec-13 Dec-14 Dec-14 Dec-15 Dec-15 Dec-16 Dec-16 Dec-17 Dec-17 Sources:BoM; Sources: WorldBank BoM;World staffestimates. Bankstaff estimates. Sources: BoM; World Bank staff estimates. The The The phasing phasing phasing outof out out ofthe of the Price Price Stabilization thePrice Program and Stabilization Program Stabilization Program and the and the reduction the reduction of reduction of subsidies of subsidies subsidiesto tothe to thehousing the housing housing mortgage program mortgage program have slowed the have slowed expansion of the expansion of the the central bank’s balance central bank’s sheet, though balance sheet, though its its mortgage program have slowed the expansion of the central bank’s balance sheet, though its domesticassets domestic remainsubstantial. assetsremain substantial. The domesticassets Thedomestic assetsof thecentral ofthe centralbank declinedmoderately bankdeclined moderatelyto to domestic assets remain substantial. The domestic assets of the central bank declined moderately MNT 4.6 MNT 4.6 trillion trillion in in April April 2018, from MNT 2018, from MNT 5 5 trillion trillion peak peak at end-2016 (Figure at end-2016 I.36). The (Figure I.36). central bank The central bank to MNT 4.6 trillion in April 2018, from MNT 5 trillion peak at end-2016 (Figure I.36). The central gradually tapered gradually tapered off some of off some of its its quasi-fiscal quasi-fiscal activities activities under under the Economic Recovery the Economic Recovery Program.Program. bank gradually Injection Injection of tapered of liquidity liquidity off some through through theof the Price Price quasi-fiscal Stabilizationactivities its Stabilization Programunder Program has been has beenthealmost Economic almost fully fully Recovery phased phased out, Program. out, with with Injection of outstanding amount the outstanding the liquidity through the amount declining Price declining to Stabilization MNT 1.6 to MNT Program billion in 1.6 billion has in April April 2018been almost compared to 2018 compared fully phased to MNT MNT 2.8 out, with trillion by 2.8 trillion the by outstanding end-2013. end-2013. The amount declining Economic Recovery The Economic to MNT Recovery Program 1.6 billion Program also in April limited BoM also limited 2018 compared BoM and to and government MNT 2.8 government financing financing of trillion by end- of thethe 2013. subs subs housing Recovery The Economic idized idized housing mortgageProgram mortgage program. program. also limited BoM’s BoM’s BoMon claims claims and on thegovernment the housing financing program, mortgage housing mortgage of the subsidized program, which which housing peaked peakedat mortgage atMNT MNT3.7 program. trillionin 3.7trillion BoM’s inOctober claims October2017, on the 2017,declined housing declinedto mortgage toMNT MNT3.1 program, trillionin 3.1trillion which April2018, inApril peaked 2018,of at ofwhich MNT whichMNT MNT3.7 trillion 2.6 billion 2.6 in October billion in 2017, declined in securitized securitized mortgage mortgageto MNT loans loans 3.1 trillion in April (residential (residential 2018, of whichsecurities) mortgage-backed mortgage-backed MNT 2.6 billion securities) in securitized transferred transferred from from commercialbanks commercial banksto BoM’sbalance toBoM’s balancesheet.sheet.TheTheBoM,BoM,which whichalso providedMNT alsoprovided MNT700 billionin 700billion liquidity inliquidity supportvia support banksto viabanks tothe thecorporate sectorsince corporatesector sincethe theend endof 2014,expects of2014, expectsto tobeberepaid repaidstarting startingin 2019. in2019. Despitethe Despite slowgrowth theslow growthof housingmortgage ofhousing mortgageloans,loans,the outstandingamount theoutstanding amountof policyloans ofpolicy provided loansprovided by by the the BoMBoM remains remains substantial, substantial, with with the the one-off one-off corporate corporate sectorsector financial financial support support reaching reaching over 19 over MNT4.6 MNT trillionin 4.6trillion inApril April2018, 2018,oror26 percentof 26percent oftotal totaldomestic domesticcredit creditof theeconomy ofthe (FigureI.37 economy(Figure I.37). ). MONGOLIA ECONOMIC UPDATE mortgage loans (residential mortgage-backed securities) transferred from commercial banks to BoM’s balance sheet. The BoM, which also provided MNT 700 billion in liquidity support via banks to the corporate sector since the end of 2014, expects to be repaid starting in 2019. Despite the slow growth of housing mortgage loans, the outstanding amount of policy loans provided by the BoM remains substantial, with the one-off corporate sector financial support reaching over MNT 4.6 trillion in April 2018, or 26 percent of total domestic credit of the economy (Figure I.37 ). Figure I.36 Expanded BoM’s balance sheet has Figure I.37 BoM’s policy credit has been been I.36 Figure Expanded Expanded slowing BoM’s balance BoM’s since October balance sheet sheethas 2017, mainly has due Figure Figure I.37 BoM’s I.37 declining BoM’s with policy policy the credit has credit phase-out ofbeen has been Price been slowing to the since since limited October October subsidy 2017, 2017, to the mainly mainly housing due due mortgage declining declining with with Stabilization the the phase-out phase-out Program andof of Price loans, Price mortgage subsidy to to the limited subsidy thehousing to the housingmortgage mortgage Stabilization Stabilization Program Program and and mortgage mortgage loans, but loans, program but remains high program remains but remains high high BoM domestic asset (MNT trillion) Outstanding BoM credit to policy loans (MNT BoMdomestic BoM domestic asset asset (MNT (MNT trillion) trillion) trillion) BoM Outstanding Outstanding creditto BoM credit topolicy policy loans loans (MNT (MNT trillion) BoM claims on government BoM claims on companies trillion) 8.0 BoM claims on government 5 BoMBoM claims claims on non-bank FIs on companies 60% 8.0 5 BoM claims on banksFIs BoM claims on non-bank 60% 7.0 % share of BoM credit to total domestic credit: RHS BoM claims on banks 7.0 % share of BoM credit to total domestic credit: RHS 50% 6.0 4 50% 6.0 4 5.0 40% 5.0 3 40% 4.0 3 30% 4.0 3.0 2 30% 3.0 2 20% 2.0 20% 2.0 1 1.0 10% 1.0 1 0.0 10% 0.0 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 0 0% Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 0 0% Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-11 Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Credit to PSP Housing mortgage credit to banks Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-11 Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 BoM Credit holdings of mortgage loans to PSP BoM Housing to banks depositcredit mortgage to banks BoM Credit Corporate to of holdings Sector mortgage loans BoM deposit to banks Credit to Corporate Sector Sources: Sources: World Bank BoM;World BoM; Bank staff staffestimates. estimates. Sources: BoM; World Bank staff estimates. Thechanging The changing composition composition of of reserve money (or (or monetary monetary base) illustratesthe base)illustrates theeffects effectsof ofmonetary monetary The andchanging composition fiscal policies policies since the of reserve moneyAfter (or monetary base) illustrates the effects of monetary and fiscal since end of 2016. 2016. After years years of of persistent persistentdecline,decline,BoM’s BoM’snet netforeign foreign assets assets and fiscal policies recovered since since remarkably the end of 2016. 2017, November After years boosting of persistent official decline, BoM’s international net foreign reserves to US$ assets 3 billion recovered remarkably since official international reserves to US$ 3 billion recovered due to remarkably BoM’s increased since November gold purchases, 2017, boosting donor support,official and international stronger reserves capital inflows.to US$ 3 billion Limited foreign due to due BoM’sincreased toBoM’s increased goldgold purchases, purchases, donor donor support, support, and and stronger stronger capitalcapital inflows.inflows. LimitedLimited foreignforeign exchange exchange market market interventions interventions by by the the central central bank bank supported supported thetheexpansion expansion of the of monetary the monetary base by base exchange absorbing market interventions less local currency by the central liquidity bank from supported the banking the expansion system. Theof the centralmonetary bank base by claims on by absorbing absorbing less less local local currencycurrency liquidity liquidity from from the the banking banking system. system.The the The central central bank bank claims claims on on nongovernment nongovernmententities entities entities (the (the financial financial and and the the corporate corporate sectors) sectors) reflect reflect the impact impact on reserve on reserve money money nongovernment supply of phasing out BoM’s (the financial and quasi-fiscal the corporate activities. sectors) After a rapid rise the reflect impact in 2013 –14, onthe reserve money monetary base supply of supply phasingout ofphasing out BoM’s BoM’s quasi-fiscal quasi -fiscal activities. activities. AfterAftera a rapid rapid rise rise in in 2013–14, 2013 – 14, the the monetary monetary base base impact of quasi-fiscal activities steadily declined and was eventually phased out. Another important impact impact of quasi-fiscal activities steadily declined and was eventually phased out. Another important factor of quasi-fiscal behind changes activities declined steadily money in the reserve and was supply since eventually early 2017 phased was the out. Another important reduction of DBM’s off- factor factor behind behind changes changes ininthethe reserve reserve money money supply supply since budget expenditures. In November 2017, US$ 400 million from the “Gerege” bond sinceearlyearly 2017 2017 was was the the reduction reduction of DBM’s of DBM’s and off- off- financial budget budget support expenditures. expenditures. from donors were In November November placed (as 2017, 2017, US$ 400 US$deposits) Tugrik million 400 million at fromfrom the “Gerege” the central the “Gerege” bank. This bond bond ledand and to a financial financial support large increase support from donors were placed (as Tugrik deposits) at the central bank. central the at deposits) Tugrik (as from in BoM’s net foreign assets and government deposits (that is, a sharp drop in net claims onBoM’s donors were placed bank. This This led toled a to largea large increase increase in the in netBoM’s foreign government net foreign assets in andassets November and government government 2017). The deposits deposits drop in(that is, a(that net claims sharp on the a is,drop sharp in net government drop isin claims alsonet on claims on the byin the government partly explained government November in November 2017). the government’s Thenewdrop 2017). in net policy The on dropon claims treasury in the net claims government single on theis account government partly explained also October since is also 2017. partly explained by the The by of government’s combination the new government’s policy reducing oncentral the new bank’s policy treasury single on quasi treasury -fiscalsince account single account October programs and2017. since tight TheOctober on2017. combination control public The of combination reducing spending the ofcentral decelerated reducing bank’s reserve the central quasi-fiscal money growth bank’s programs quasi in 2017and -fiscal programs tight control (Figure I.38 and on and public Figure tight spending I.39 control ). on public spending decelerated reserve money growth in decelerated reserve money growth in 2017 (Figure I.38 and Figure I.39 ). 2017 (Figure I.38 and Figure I.39 ). 20 MONGOLIA ECONOMIC UPDATE FigureI.38 Figure Reserve Reserveaccumulation I.38Reserve accumulation accumulation and and and phase-out phase- phase- Figure Figure Figure I.39 I.39 I.39 Fast-rising Fast-rising Fast-rising net netnet foreign foreign foreign assets assets assets have have have of out outpolicy of loans ofpolicy policy have loans loans contributed have have significantly to contributed contributed been been been contributing contributing contributing totoreserve to reserve reserve money money money growth growth growth strengthening significantlyto significantly toof reserve money strengthening strengthening of of supply reserve reserve since the money money since since since mid-2017 mid-2017 mid-2017 despite despite despite fiscal fiscal fiscal tightening tightening tightening and and and beginning supplysince supply of 201 sincethe 7 thebeginning beginning of of 2017 2017 phase-out phase-out phase-out of policy ofofpolicy policy loans loans loans by byby the thethe Bo BoM M BoM Money Money Money decomposition decomposition decomposition –– assets assets – assets side side side (MNT (MNT (MNT trillion) trillion) trillion) Money Money Money growth growth growth decomposition decomposition decomposition –– – assets assets assets (y/y, (y/y, (y/y, %) %) %) NFA NFA Net Net claims claims onon govt govt BoM BoM claims claims on non-govt on non-govt sectors sectors Net claims Net claims on govt on govt Net Net claims claims onon non-govt non-govt entities entities Monetary Monetary base base NFA NFA Reserve Reserve money money y/y growth y/y growth (%) (%) 7.0 7.0 200% 200% 6.0 6.0 5.0 5.0 4.0 4.0 100% 100% 3.0 3.0 2.0 2.0 0% 0% 1.0 1.0 0.0 0.0 -1.0 -1.0 -100% -100% -2.0 -2.0 -3.0 -3.0 -4.0 -4.0 -200% -200% Apr-11 Apr-11 Apr-12 Apr-12 Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Apr-18 Aug-11 Aug-11 Dec-11 Dec-11 Aug-12 Aug-12 Dec-12 Dec-12 Aug-13 Aug-13 Dec-13 Dec-13 Aug-14 Aug-14 Dec-14 Dec-14 Aug-15 Aug-15 Dec-15 Dec-15 Aug-16 Aug-16 Dec-16 Dec-16 Aug-17 Aug-17 Dec-17 Dec-17 Apr-11 Apr-11 Apr-12 Apr-12 Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Apr-18 Aug-11 Aug-11 Dec-11 Dec-11 Aug-12 Aug-12 Dec-12 Dec-12 Aug-13 Aug-13 Dec-13 Dec-13 Aug-14 Aug-14 Dec-14 Dec-14 Aug-15 Aug-15 Dec-15 Dec-15 Aug-16 Aug-16 Dec-16 Dec-16 Aug-17 Aug-17 Dec-17 Dec-17 Sources:BoM; Sources: Sources: BoM; BoM; World World World Bank Bank Bank staff staff estimates. estimates. staff estimates. Box Box I.4 I.4 Monetary Monetary Policy Policy and and Financial Financial Sector Sector Guideline Guideline for for 2018 2018 –20 –20 Box I.4 Monetary Policy and Financial Sector Guideline for 2018–20 The new The MonetaryPolicy new Monetary Policyand andFinancial Financial Sector Sector Guideline Guideline for for 2018 2018 (Bank (Bank of of Mongolia Mongolia (2017)) (2017)) was was approved approved thethe by by The new Monetary Policy and Financial Sector Guideline for 2018 (Bank of Mongolia (2017)) was approved by Parliamenton Parliament November onNovember 16, 16, 2017, 2017, and and includes includes the the following following measures. measures. the Parliament on November 16, 2017, and includes the following measures. Monetarypolicy Monetary policy Monetary policy ToTo  • To limit limit inflation limitinflation to to inflation 8 8 percent percent to 8 during during percent during 2018 2018 –20 –20 2018–20 ToTo  • To implement implement macroprudential macroprudential policies policies consistent implement macroprudential policies consistentconsistent with with monetary monetary with policies policies monetary to to policies avoid avoid accumulation accumulation to avoid of risks of risks accumulation of in the in the financial financial sector sector risks in the financial sector ToTo  • To strengthen strengthen strengthen communication communication communication channels channels on channels on monetary monetary policies policies on monetary toto improve to implementation improve policies implementation improve and and effectiveness implementationeffectiveness and of of monetary monetary policies policies effectiveness of and and enhance enhance monetary transparency transparency policies and enhance transparency ToTo  • To maintain maintain maintainaa flexible flexible exchange exchange a flexible rate exchangerateinin rate in with line line macroeconomic with line macroeconomic with fundamentals fundamentals macroeconomic to to fundamentals support support domestic domestic to support production, production, domestic exports, exports, and and production, overall overall competitiveness competitiveness exports, ofof thethe economy. economy. and overall competitiveness of the economy. a. a. a. Banking Banking supervision supervision Banking supervision ToTo  • To implement implement implement bank bank bank recapitalization recapitalization and and recapitalization other other othermeasures measures measures aimed aimed aimed at atat improving improving improving thethe financial capability financial financial capability capability and and and riskrisk absorption absorption capacity capacity risk absorption ofof the the capacity banks, banks, of promoting the promoting banks, financial financial promoting inclusion inclusion financial and and strengthening strengthening inclusion financial financial and strengthening stability stability financial stability ToTo  • To develop develop develop aa a better better better risk-based risk-based risk-based supervision supervision supervision framework. framework. framework. b. b. b. Development Development Development of of of financial financial financial infrastructure infrastructure infrastructure and and and institutions institutions institutions •  To To efficiently efficiently Toefficiently implement implement implement newly newly newly approved approved approved and and and amended amended amended laws laws lawsand and and regulations regulations regulations •  To To improve To improve improve the the payment paymentand the payment and settlement andsettlement settlementsystem system and systemand create and create create a consolidated a a management consolidated consolidated management of payment management of of payment payment instruments instruments instruments ToTo  • To prepare prepare prepare the the the legal legal legal framework framework framework of ofofanan an asset asset asset management management management institution for institution institution for the forthe management the management management of of growing of growing growing non- non- non-performing performing performing loans loans loans ToTo  • To improve improve improve the the the financial financial financial literacy literacy literacy of ofof the the the public public public in inin support support support of ofof international international international financial financial financial institutions institutions institutions andand and thethe the private private private sector. sector. sector. Therecent The BoMinflation recentBoM report inflationreport (Bank (Bank ofof Mongolia Mongolia ) stated (2018) (2018) ) stated that that despite despite a solid a solid economic economic recovery, recovery, inflation inflation will will remainunder remain underthethe agreed agreed target target inin 2018 2018 –19, –19, with with waning waning high high base base effects effects duedue to to increased increased taxes taxes in 2017 in 2017 andand some some one- one- offfactors off includingchanges factorsincluding changes inin thethe Consumer Consumer Price Price Index Index basket. basket. It It alsoalso noted noted that that 2018 2018 growth growth will will exceed exceed 5.15.1 percent percent in2017, in 2017,with withlarge large FDI FDI inflows inflows and and strong strong credit credit growth growth and and cyclical cyclical recovery recovery in in OyuOyu Tolgoi’s Tolgoi’s copper copper production. production. 21 19 19 MONGOLIA ECONOMIC UPDATE The recent BoM inflation report (Bank of Mongolia (2018)) stated that despite a solid economic recovery, inflation will remain under the agreed target in 2018–19, with waning high base effects due to increased taxes in 2017 and some one-off factors including changes in the Consumer Price Index basket. It also noted that 2018 growth will exceed 5.1 percent in 2017, with large FDI inflows and strong credit growth and cyclical recovery in Oyu Tolgoi’s copper production. Figure Figure I.40 Figure I.40 BoM I.40 BoM projection BoM projection projection on on inflation on inflation inflation Figure Figure I.41BoM I.41 Figure BoM I.41 projection projection BoM onon economic economic projection growth growth on economic growth Annual Annual Annual headline headline headlineinflation inflation inflation (y/y, (y/y, %) (y/y, %) Quarterly Quarterly real Quarterly GDP realgrowth real GDP growth (y/y, GDP growth %) (y/y, %)(y/y, %) Sources: Summarized by World Bank staff based on Bank of Mongolia (2017; 2018). Sources: Sources: Summarized Summarized by World by World Bank Bank staff staff based on Bank based of Mongolia on Bank (2017; of Mongolia 2018).2018). (2017; Box I.5 Goals of the amendment to the central bank law BoxBox I.5 Goals I.5 Goals of the the amendment of amendment to theto the central central bank law bank law The amendment to the central bank law was approved on January 12, 2018, by the parliament with 69.1 percent of the vote. The goal of the amendment is to improve the legal status of the central bank (Bank of The The amendment amendment the to to the central bank central law law bank waswas approved approved on January 12, 2018, on January by the 12, 2018, by parliament the parliament with 69.1 with 69.1 percent percent of the of the Mongolia), strengthen its independence, improve its decision-making process in line with international best vote. vote. The The goal goal of of the amendment the amendment is to to improve isimprove the legal the legal status of the status the central ofcentral bank (Bank bank (Bank of Mongolia), strengthen of Mongolia), its strengthen its practices and principles of central banks of other countries, and stop its quasi-fiscal activities. The amendment independence, independence, improve improve its its decision-making decision-making process process in line in with line with international international best practices best practices and principles and principles of central of central to the central bank law and other related laws became effective on April 1, 2018. It is in line with the economic banks banks ofof other other countries, countries, and stop and its quasi-fiscal stop its quasi-fiscal activities. activities. The amendment The amendment to theto the central central bank law bank law and andrelated other other related recovery plan (Parliament Decree № 71 in 2017), the recommendations of the economic standing committee’s laws laws became became effective effective on on April 1, 2018. April 1, 2018. inis It is It line in line the economic withwith the economic recovery recovery plan (Parliament plan (Parliament DecreeDecree № 71 in № 71 in 2017), 2017), assessment of central bank operations (Parliament Decree № 43 in 2017), and the ongoing IMF Extended Fund the the recommendations recommendations of the of the economic economic standing standing committee’s committee’s assessment assessment of central of central bank operations bank operations (Parliament (Parliament Decree Decree Facility program. The key features of the amendment: № № 4343in in 2017), 2017), and the and ongoing the ongoing IMFIMF Extended Extended Fund Facility Fund program. Facility program. The keyThe key features features amendment: of the of the amendment: • Limit budgetary operations (mainly quasi-fiscal operations implemented during 2013–16), which are Limit   Limit budgetary not related operations budgetary operations to the (mainly (mainly monetary quasi-fiscal quasi-fiscal policy operations objectives operations implemented implementedduringduring 2013–16), 2013 –16), are which whichnotare not related related to the to monetary the monetary policy objectives policy objectives • Clarify financial transactions and other relations between the central bank and the government Clarify   • financial Clarify Improvefinancial thetransactions transactionsandand decision-making other relations other process between relations through betweenthe central legalizing the bank and the central following bankthe andgovernment the government committees:   Improve Improve the decision-making the decision-making process through process legalizing through the legalizing following the committees: following o The monetary policy committee, which is composed of seven members—the governor, the two committees: o o The The deputy monetary monetary policy governors, policy and committee, committee, four which external which is composed members is composedof seven appointed ofby members seven members —the governor, the parliament — the for governor, six the two years deputy the two deputy governors, governors, and four and four external external members members appointed appointed by theby the parliament parliament o The supervision committee, with a view to increasing transparency and accountability in for six years for six years o o The Thesupervision decisions supervision related committee, to committee, withpolicy supervision a view with a view to increasing to increasing transparency transparency and accountability and accountability in decisions in decisions related relatedto supervision to supervisionpolicy policy • Authorize the central bank to implement macroprudential policy Authorize   • Authorize the Strengthen central the central the bank to implement bank supervision to framework implement macroprudential macroprudential for bank operationspolicy policy Strengthen   • Strengthen the supervision the supervisionframework framework Improve the legal framework for central for bank for operations bank operations loans to banks. Improve   Improve the legal the framework legal framework for central for central bank loans bank to banks. loans to banks. The law is expected to contribute to sustainable economic growth and to price and financial stability by The strengthening Thelawlaw is is expected expected the legal to to framework, contribute contribute the independence to sustainable to sustainable economic economic growthof andcentral the growth and to tobank, price and financial price and financial sound implementation stability by strengthening stability of by strengthening the monetary the framework, legal legal policy.the framework, independence the independence of the of the central bank, central and sound bank, and soundimplementation implementation of monetary of monetary policy. policy. Sources: BoM; Sources: Sources: BoM; BoM; legalinfo legalinfo legalinfo 22 MONGOLIA ECONOMIC UPDATE The banking The sector funding banking sector conditions have funding conditions have been easing,but beeneasing, deterioration butdeterioration ofof asset asset quality quality has has remained remained substantial. substantial. The The growth banking of outstanding sector bank loans have funding conditions (y/y) accelerated been easing, to but percent6 in April 16.5 deterioration of 2018 asset from quality5.8 The has remainedgrowth percent in 2016 of outstanding despite a context characterized by high lending rates and uncertainty surrounding substantial. bank loans (y/y) accelerated to 16.5 percent 6 in April 2018 from 5.8 percent of thedespite in 2016 a context characterized loanby high lending rates and uncertainty surrounding The the findings growth of outstandingAsset Quality bank loansReview. (y/y)Bank accelerated growth tohas16.5rapidly recovered percent 6 in Aprilsince mid-2016 2018 from and 5.8 the findings accelerated of furtherthe Asset throughout Quality 2017, Review. mainly Bank driven loan by growth individual percent in 2016 despite a context characterized by high lending rates and uncertainty surrounding has loans rapidly recovered (non-mortgage since individual mid-2016 loans), and accelerated reaching the findings 20the of percentfurther Asset (y/y) throughout in April Quality 2018. Review. 2017, Corporate Bank mainly drivensaw loans loan growth by individual has strong recovered arapidly loans (non-mortgage recovery in the second since individual mid-2016 half of and loans), accelerated reaching further 20 percent throughout (y/y) 2017, in mainlyApril 2018. driven Corporate by individual loans loans 2016, but growth moderated in 2017. In 2012–13, bank loans almost doubled, largely driven by a saw a strong (non-mortgage recovery in individualthe second loans), of percent half 20 reaching 2016, substantial BoM but growth (y/y) credit into moderated April banks2018. in 2017. Corporate (Figure I.42 ). In 2012–13, loans After saw yearsabankof loans strong sharp almost recovery increases,doubled, in theloan largely second growth halfdriven of has 2016, by a but substantial growth BoM moderated credit in to banks 2017. In (Figure 2012 – 13,I.42 ). bank After loans years of almost sharp doubled, significantly declined with the deterioration of economic activity and an inevitable gradual tapering of increases, largely loan growth driven by has a significantly quasi-fiscal activities by the BoM (Figure I.43 ). As the funding conditions of banks began to improve of substantial BoM declined credit with to the banks deterioration (Figure I.42 of ). economic After yearsactivity of and sharp an inevitable increases, gradual loan tapering growth has significantly declined withby quasi-fiscal since the activities beginning of the deterioration the 2016, BoM (Figure bank of loan growth economic I.43 ). As the started activity funding to and conditions rise steeply,an inevitable of banks but mainly gradual in began tapering to improve individual loansof quasi-fiscal since activities the beginning by ofthe BoM 2016, (Figure bank loan I.43 growth). As the funding started tosector. conditions rise steeply, of banks but mainly began to loans in individual improve amid amid high levels of non-performing loans in the corporate the levels since high beginning of 2016, bank of non-performing loan loans ingrowth started the corporate to rise steeply, but mainly in individual loans sector. amid high levels of non-performing loans in the corporate sector. Figure I.42 Bank loans had steeply declined in Figure I.43 Bank loans growth has been Figure I.42 Bank loans had steeply declined in Figure I.43 Bank loans growth has been 2014 Figure –15 I.42 with Bank weak loans loan had demand steeply and phasing declined in out accelerating Figure I.43 Bank since lategrowth 2016 mainly driven by 2014–15 with weak loan demand and phasing accelerating sinceloans late 2016 mainly has driven been by 2014of policy –15 out with of loans weak policy by the loan loans BoM the BoMand phasing out bydemand individual accelerating individual loans loanssince late 2016 mainly driven by Growth of policy Growthloans of outstanding ofoutstanding by the BoM loans loans (y/y, (y/y, %), %), April 2012–April Growth individual Growth outstanding of loans of outstanding loansloans (y/y, %), 2015–18 (y/y, %), 2018 Growth outstanding of2012–April April loans (y/y, %), April 2012–April 2018 Growth of outstanding loans (y/y, %), 2015–18 2015–18 Total loans Corporate Loans 2018 Securitized mortgages: LHS 25% loans loans Individual Total Policy Rate: Corporate RHS 16 Loans Bank loans: LHS 25% Individual loans Policy Rate: RHS 14 16 Securitized mortgages: LHS 20% credit to banks: LHS BoM LHS Bank loans: Loanto growth (incl. 14 16 BoM credit banks: LHSsecuritized mortgages): RHS 80% 20% 15% 12 Bank deposit growth: RHS (trillion MNT) 16 14 Loan growth (incl. securitized mortgages): RHS 80%70% 12 Bank deposit growth: RHS 15% 10 (trillion MNT) 14 70%60% 10% 12 10 60%50% 10% 8 12 10 50%40% 5% 8 10 5% 6 8 40%30% 6 8 30% 0% 20% 0% 4 6 20% 4 6 10% -5% 2 4 10% -5% 2 4 0% 0% -10% 0 2 2 -10% -10% 0 -10% Feb-15 Oct-15 Feb-16 Oct-16 Feb-17 Oct-17 Feb-18 Jun-15 Jun-16 Jun-17 Apr-15 Apr-16 Apr-17 Apr-18 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Feb-15 Oct-15 Feb-16 Oct-16 Feb-17 Oct-17 Feb-18 Jun-15 Jun-16 Jun-17 Apr-15 Apr-16 Apr-17 Apr-18 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 0 0 -20% -20% Dec-17 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 BoM;BoM; Sources: Sources: World World BankBank staffstaff estimates estimates Sources: BoM; World Bank staff estimates Funding conditions Funding Funding conditions of banks conditions of have ofbanks banks been have have beenimproving. been improving. improving. After After aa After rapid rapid a increase rapid increase increase in infunding funding in fundingin 2013 in in 2013 2013 and and andearly early early 2014, with 2014,with 2014, massive withmassive central massivecentral bank central bankfunding bank funding and funding strong and andstrong deposit strong deposit depositgrowth, growth, growth, it substantially it it substantially substantiallyweakened weakened weakened in 2014 in in 2014 2014 and early 2016, particularly in local currency deposits, straining banking system liquidity. This sharp andearly and 2016,particularly early2016, particularlyininlocal local currency currency deposits, deposits, straining straining banking banking system systemliquidity. liquidity. ThisThis sharp sharp weakening in funding conditions was mainly attributed to a deterioration of economic activity and a fast weakeningin weakening infunding funding conditions conditions was was mainly mainly attributed attributed totoaadeterioration deterioration ofofeconomic economic activity activity andand a fast a fast increase in non-performing loans (NPLs) and tapering of policy loans by the BoM. At the same time, the increasein increase innon-performing non-performing loans loans(NPLs) (NPLs) and and tapering tapering ofofpolicy policy loans loans growth of foreign currency deposits—which account for 30 percent of total deposits—had been robust bybythe theBoM. BoM.AtAtthethesame same time, time,thethe U.S. of bothgrowth growth in offoreign dollar andcurrency foreign currency local deposits currency —which deposits—which values. account account However, for for 30 domestic30percent percent currencyofoftotal totaldeposits deposits —had deposits—had have been been been robust increasingrobust both both in inU.S. U.S. dollar dollar and and local currency local currency values. values.However, However, domestic domestic currency considerably since early 2017, with a high deposit rate and growing loan demands amid a sharp currency deposits have deposits have been been increasing increasing considerably considerably recovery of economicsince early 2017, since activity. 2017, This with with aahigh increased high deposit deposit liquidity raterate hasandsoandfar growing growing been loan loan demands mostly demands amid a absorbed amid sharp by sharp a recovery increasing recovery excessof economic reserves, with only activity. of economic activity. This This increased increased limited impacts liquidity on bank liquidity has so has soin far loan growth beenfar the been mostly mostly sector corporate absorbed absorbed by dueby to increasing increasing excess high level reserves, excess of NPLs. with only reserves, with limited impacts only limited on bank impacts onloan bank growth in the corporate loan growth in the corporate due to due sector sector highto level high of NPLs. level of NPLs. 6 Our definition of outstanding loans includes mortgage loans that have been securitized by the Mongolia Mortgage Corporation since 2013. Ninety percent of the securitized mortgage loans (residential mortgage-backed securities) were transferred to BoM’s balance sheet from commercial banks and are now excluded from commercial banks’ balance sheets. 6 Our definition of outstanding loans includes mortgage loans that have been securitized by the Mongolia Mortgage Corporation since 2013. Ninety percent of the securitized mortgage loans (residential mortgage-backed securities) were s. 23 6 Our to transferred definition of outstanding BoM’s balance loans sheet from mortgage includes banks commercial loans and are that now have been excluded from securitized commercialby the balance Mongolia banks’ Mortgage sheet Corporation since 2013. Ninety percent of the securitized mortgage loans (residential mortgage-backed securities) were transferred to BoM’s balance sheet from commercial banks and are now excluded from commercial banks’ balance sheet s. 21 MONGOLIA ECONOMIC UPDATE s been Figure I.47 Excess liquidity conditions are owing Figure I.44 reflected in a Funding surge inconditions for banks Central Bank are Bill (CBB) Figure FigureI.45 I.45Accelerating Accelerating deposit deposit growth growth isis mostly Figure I.44 relaxing Funding with conditions accelerating local for banks currency are deposit Figure mostly I.45 driven Accelerating by a surge indeposit local growth currency driven by a surge in local currency deposits is holdings by banks relaxing deposit growth with growth despiteaccelerating despite declining declining local currency BoM funding BoMtrillion): funding mostly deposits driven by a surge in local currency ent Bank liquid asset composition (MNT 2010 – 15 deposit Growth growth componentsdespite of declining commercial BoM bank funding funding deposits Growth of outstanding loans by currencies (y/y, %) Growth components of commercial bank funding sources Growth of outstanding loans by currencies Growth components of commercial bank funding sources (y/y, %) (y/y, %) Growth of outstanding loans by currencies (y/y, %) (y/y, %) sources (y/y, %) bank bills (tn MNT): LHS Central Foreign currency Got bond holdings (tn MNT): LHS 50.0 Local currency Foreign currency Deposits External borrowing Govt deposit BoM funding Total private Local bank deposit growth (%) currency 160% 8.0 Excess reserves excl. CBB (tn MNT): LHS 40% 50.0 80% Deposits External borrowing Govt deposit BoM funding Total private bank deposit growth (%) Excess reserves to deposit ratio (%): RHS Millions 140% 7.0 80% 35% 40.0 70% 70% 40.0 120% 6.0 60% 30% 60% 30.0 100% 5.0 50% 25% 30.0 50% 80% 4.0 40% 20% 40% 20.0 60% 3.0 30% 15% 20.0 30% 40% 2.0 20% 10% 10.0 20% 10.0 20% 1.0 10% 10% 5% 0% 0.0 0% 0% 0% 0.0 0.0 -10% Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-17 Apr-18 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Aug-16 Dec-17 -10% -20% -10.0 -10.0 -20% Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-18 Aug-11 Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Aug-11 Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Dec-16 Aug-17 Dec-17 Sources: BoM; Sources: WorldBank BoM;World Bankstaff staffestimates. estimates. Sources: BoM; World Bank staff estimates. redit growth loan-to-deposit (LTD) (LTD)ratio ratiohas hasbeen beendeclining declining since mid-2015, with deposit growth exceeding The loan-to-deposit Figure I.48 Credit conditions since The mid-2015, loan-to-deposit with deposit (LTD) growth ratio exceeding has been t mining due Figure loan I.48 growth. Credit The conditions LTD ratio, areare which still still istighter tighter commonly in used to assess bank liquidity capacity against possible loan growth. in most The sectors LTD ratio, except which is the sector, commonly miningwhich sector, used to assess declining bank since liquidity mid-2015, capacity with against deposit possible growth n economic most sectors withdrawals ofexcept deposits, the mining from100 rosefrom 100 percent withdrawals which posted of deposits, a strong rose recovery in loans percent atatthetheendend ofof exceeding 20122012 loantoto135 135 growth. percent percentThe inLTD in late late 2014 ratio, 2014due which due to is to conditions posted a large increasesstrong increases in recovery in policy policyloans in loans loansfunded fundedby by the central bank. The LTD ratio has been gradually declining large Bank loan loanby growth sectors by(y/y, %) (y/y, %) the central bank. commonlyThe LTD used ratio has to assess beenbankgradually liquidity declining capacity sectors (for with the Bank withdrawal growth of policy sectors loans and slower loan growth, reaching 95 percent in April 2018 amidst with the withdrawal of policy loans and slower loan growth, possible 95 against reaching percent in April withdrawals 2018 amidst of deposits, rose holesale and depositgrowth. higher deposit NPLs growth.Total (tn MNT): RHS Totaldeposits deposits of banks Agriculture excluding government deposits reached MNT 15.6 trillion s recovered higher Mining of banks Manufacturing excluding government from 100 deposits percent reached the end of at residential MNT 15.6 trillion 2012 to 135 in April 2018, Trade while the total outstanding Construction loans of banks (except for mortgage-backed iven by the April 2018, in 160% while the total outstanding loans Mortgage banks (except of percent in latefor 2014 residential due to large mortgage-backed increases in securities) was MNT 15.1 trillion. 1.4 securities) was MNT 15.1 trillion. Millions 140% ng sector has 120% 1.2 policy loans funded by the central bank. The 7, reflecting Reserve 100% buffers of the banking system have increased 1.0 LTD significantly ratio has mainly beenwith with no issuance gradually declining T-bills of with Reserve 80% buffers of the banking system have increased significantly mainly no issuance of T-bills ing industry. since60% October 2017. Bank reserves excluding central 0.8 bank bills the bills stood withdrawal at 16.6 percent of total deposits in since April40% October 2017. Bank reserves excluding central 2018, well above the 12 percent reserve requirement 0.6 bank at of stood However, ratio. 16.6policy percentloans bank of excess and slower total deposits reserves loan in have loan growth April20% growth, reaching 95 percent in April 2018 amidst been 0%2018, well above on a sharply rising the 12 percent trend since Octoberreserve2017, requirement 0.4 leading to ratio. higher However, demand bank excess of government reserves have bonds with redit growth higher deposit growth. Total deposits of banks been the -20% on a sharply rising trend since October 2017, 0.2 leading to higher demand of government bonds interest rates of one-year government bonds declining to 11.6 percent, down from 17.6 percent with at n affected by -40% excluding government deposits reached MNT 15.6 the interest -60% end-2016. To rates reduce interest government of one-year payments, the bonds 0.0declining government to 11.6 has stopped percent, down issuing from domestic 17.6 percent T-bills at of in favor or, and weak Mar-13 Nov-13 Mar-14 Nov-14 Mar-15 Nov-15 Mar-16 Nov-16 Mar-17 Nov-17 Mar-18 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 end-2016. To reduce interest payments, the government trillion has in April stopped 2018, issuing while domesticthe total T-bills outstanding in favor of ast, loans to concessional financial support from development partners, including the IMF and World Bank. As of concessional April 2018, Sources: BoM; financial outstanding World Bank support T-bill staff from development amounts estimates. declined to loans partners, MNT 1.9of banks from including trillion (except the IMF MNT for andresidential 3.6 World trillion atmortgage- Bank.itsAs of in peak anufacturing Sources: BoM; World Bank staff estimates. backed securities) was MNT 15.1 trillion. April 2018,In July 2017. outstanding the meantime, amounts T-billbank holdingsdeclined to MNT of central 1.9 bills trillion from reached its peakMNT of 3.6 MNT trillion at its peak 4.4 trillion comparedin July to MNT 2017. the meantime, Intrillion 1.5 in July 2017. bank holdings ofexcess Substantial central bills reached reserve was also peak of its partly MNT 4.4in reflected trillion compared high level of NPLs. n portfolio away toReserve from1.5 MNT buffers the private trillion ofinthe sector, July banking 2017. system have undermining Substantial growth excess reservesignificantly increased was also partly mainly with in reflected nohighissuance level of T-bills of NPLs. since October 2017. Bank 5–16, outstanding bank loans increased by 17.8 percent in Mayreserves excluding central bank bills stood at 16.6 percent of total deposits in 6, largely due toApril 2018, well increase a substantial above the in 12 percent credit reserve requirement ratio. However, bank excess reserves have to households nt contraction atbeenend-2015). on a sharply Household rising trend loanssince represent October almost 2017, leading to higher demand of government bonds with d its stock has risen to nearly the interest 27 percent rates of one-year of the 2017 GDP bonds government from declining to 11.6 percent, down from 17.6 percent at ans were largely driven by end-2016. To the expansionary reduce interest housing payments, mortgage the government has stopped issuing domestic T-bills in favor n 2013–14, which was substantially of concessional financial scaled support down from 2015–16 in development partners, including the IMF and World Bank. As of ia faced after 2014. This loan category has recently picked up April 2018, outstanding T-bill amounts declined to MNT 1.9 trillion from MNT 3.6 trillion at its peak in d consumer loans. In thethe Following July 2017. rise in the meantime, bank average holdings loan to of central bills reached its peak of MNT 4.4 trillion compared ebt-to-income to ratio (including residential mortgage-backed MNT 1.5 trillion in July 2017. Substantial excess reserve was also partly reflected in high level of NPLs. st quarter of 2017, up from 40 percent in 2012. Meanwhile, ng but remained weak, posting a 4.5 percent increase in March 16, despite a stronger than expected economic recovery. To 24 23 22 MONGOLIA ECONOMIC UPDATE Figure Figure Figure I.46 The I.46 I.46 loan-to-deposit The The loan-to-deposit ratio loan-to-deposit ratio ratiohashas hasbeen been been Figure FigureI.47 Figure I.47 I.47 Excess Excess Excessliquidity conditions liquidity liquidity are are conditions conditions are declining declining declining since since since late late2016, late with 2016, 2016, fast-growing with with fast-growing fast-growing reflected reflectedin reflected inina aasurge surge surge in in Central in Bank Central Central BankBill Bank (CBB) Bill Bill (CBB) (CBB) deposit deposit deposit holdings holdings holdings by byby banks banks banks Loan Loan Loan to to to deposit deposit deposit ratio ratio ratio (%)(%)(%) excluding excluding excluding government government government Bank Bank Bank liquid liquid liquid asset asset asset composition composition composition (MNT (MNT (MNT trillion):2010 trillion): trillion): 2010–– deposits deposits deposits 1515 2010–15 Bank Bank loanloan growth growth (y/y, (y/y, %):%): LHSLHS Central Central bank bank bills bills (tn(tn MNT): MNT): LHS LHS Bank Bank deposit deposit growth growth (y/y, (y/y, LHS %):%): LHS Got Got bond bond holdings holdings (tn (tn MNT): MNT): LHS LHS 60%60% Loan Loan to deposit to deposit ratio ratio (%):(%): RHSRHS 160% 160% 8.08.0 Excess Excess reserves reserves excl. excl. CBB CBB (tn (tn MNT): MNT): LHS LHS 40% 40% Excess Excess reserves reserves to to deposit deposit ratio ratio (%): (%): RHS RHS Millions Millions 140% 140% 7.07.0 35% 35% 40%40% 120% 120% 6.06.0 30% 30% 100% 100% 5.05.0 25% 25% 20%20% 80% 80% 4.04.0 20% 20% 60% 60% 3.03.0 15% 15% 0% 0% 40% 40% 2.02.0 10% 10% 20% 20% 1.01.0 5% 5% -20% -20% 0%0% 0.00.0 0% 0% Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Apr-18 Aug-12 Aug-12 Dec-12 Dec-12 Aug-13 Aug-13 Dec-13 Dec-13 Aug-14 Aug-14 Dec-14 Dec-14 Aug-15 Aug-15 Dec-15 Dec-15 Aug-16 Aug-16 Dec-16 Dec-16 Aug-17 Aug-17 Dec-17 Dec-17 Sources: Sources: BoM; BoM; World World Bank Bank staff staff estimates. estimates. Sources: BoM; World Bank staff estimates. Despite the strong economic recovery, credit growth remains moderate in most sectors except Despite Despite mining the due the strong higheconomic strong to economic level of NPLs. recovery, recovery,Following credit credit growth contraction during 2014–16, credit conditions angrowth economic remains remains moderate moderate in in substantially deteriorated in riskier sectors (for due mostmost sectors sectors except except mining mining due Figure example, FigureI.48 I.48Credit conditions are Creditconditions mining, construction, and wholesale and still tighter are still tighter to to high high levellevelof ofNPLs. NPLs.Following Following an economic in an economic most sectors inmost sectors except except the the mining mining sector, sector, retail). Credit growth, however, has recovered moderately mid-2017, sinceposted which which posted a a largely strong strong driven by recovery recovery in in the loans loans mining contraction during contraction during 2014 2014 –16, credit –16, conditions credit conditions sector. Credit growth in the mining sector has significantly improved since by March 2017, reflecting recent substantiallydeteriorated substantially deterioratedin in riskier riskier sectors sectors (for (for Bank Bank loan loan growth growth by sectors sectors (y/y, (y/y, %) %) strong developments in the mining industry. Meanwhile, trade and services sectors loan growth has example, example, mining, mining, construction, construction, and wholesaleand andwholesale and NPLs NPLs (tn(tn MNT): MNT): RHS RHS Agriculture Agriculture been recovering quickly. However, credit growth in the construction industry has still been affected by retail).Credit retail). Creditgrowth, growth, however, however, has recovered has recovered Mining Mining Trade Trade Manufacturing Manufacturing Construction Construction a large inventory moderately moderately since in since the mid-2017,real mid-2017, estate sector, largelydriven largely and drivenby weak bythe and the 160%cooling 160% mortgage Mortgage lending. In contrast, loans to Mortgage 1.4 1.4 the agriculture (mainly to herders) and manufacturing sectors has increased. Millions Millions 140% 140% mining mining sector. sector. Credit Credit growth growth in inthe the mining mining sector sector has 120% has 120% 1.2 1.2 significantly significantly improved improved since since March March 2017,reflecting 2017, reflecting 80% 100% 100% 80% 1.0 1.0 Banks recent recent have increasingly strong strong developments developments shifted their in in thethe loan mining mining portfolio away from industry. industry. 60%60% the private sector, undermining growth0.8 0.8 40%40% prospects. Meanwhile, Meanwhile, After trade trade a large and and correction services services in sectors2015–16, sectors loanloan outstanding growth 20% growth bank 20% loans increased by 17.8 percent in May 0.6 0.6 0%0% 0.4 0.4 2018 has has from beenbeen 5.3recovering recovering percent in December quickly. quickly. However, However, 2016,creditlargely credit growth growthdue to -20%a -20% substantial increase in credit to households 0.2 0.2 (20 in in percent thethe in April construction construction 2018 from industry industry has has astill still 12 percent been been contraction affected affected by by -40%-60% at end-2015). Household loans represent -40% -60% 0.0 0.0 a a large large almost 50inventory inventory percent inofin the the total real real loans estate estate sector, sector, in Mongolia, andand and weak weakits stock has risen to nearly 27 percent of the 2017 Mar-13 Mar-13 Nov-13 Nov-13 Mar-14 Mar-14 Nov-14 Nov-14 Mar-15 Mar-15 Nov-15 Nov-15 Mar-16 Mar-16 Nov-16 Nov-16 Mar-17 Mar-17 Nov-17 Nov-17 Mar-18 Mar-18 Jul-13 Jul-13 Jul-14 Jul-14 Jul-15 Jul-15 Jul-16 Jul-16 Jul-17 Jul-17 and GDPand cooling cooling from 21mortgagemortgage percent lending. inlending. 2015. InIn Initially, contrast, contrast, household loans loans to loans to were largely driven by the expansionary housing Sources: Sources: BoM; BoM; World World Bank Bank staff staff estimates. estimates. the the agriculture mortgageagriculture program (mainly (mainly managedtoto herders) herders) by the andand manufacturing manufacturing central bank in 2013–14, which was substantially scaled down in sectors sectors 2015–16 has has increased. increased. because of economic difficulties Mongolia faced after 2014. This loan category has recently picked Banks Banks up substantially, have have increasingly increasingly largely shifted shifted driven their their by loan loan salary portfolio portfolio andawayconsumer away from from loans. the the Following private private sector, the sector, rise in the average undermining undermining growth growth loan to prospects. households, prospects. AfterAfter the a large a large average correction correction household inin 2015 2015 debt-to-income –16,–16, outstanding outstanding ratio bank bank (including loans loans residential increasedby increased by17.8 mortgage-backed 17.8 percentin percent May inMay securities) 20182018fromfrom reached 5.3 5.3 percent percent 80 percent in in December December in the first 2016, 2016, quarter largely largely of due due 2017, toto aa up from substantial 40 substantialincrease percent increasein in 2012. incredit creditto Meanwhile, households tohouseholds corporate (20 (20 percent percent loan in in growth AprilApril2018 has 2018 been fromfrom a 12recovering a 12 percent percent but remained contraction contraction at weak, atend-2015).posting end-2015). a 4.5 percent Household Household loans loans increase represent represent in almost March almost 2018 50 50 from of percent percent 9.2 of percent totaltotal loans loans in November in in Mongolia, Mongolia, 2016, andand its despite its stock stock hasa risen hasstronger risen toto than nearly nearly expected 27 27percent percent economic ofthe of the2017 recovery. 2017 GDPfrom GDP To from support 2121 percent private percent in in 2015. 2015. sector activity, Initially, Initially, the household household central loans loans bankwere were has reduced largely largely driven driven its bypolicy by the the rate by 500 expansionaryhousing expansionary basis points housingmortgage since mortgage program program November managed managed 2016, and byby the the the central central government bank bank has inin 2013 2013 limited – –14,14, its whichwas which issuance was substantially substantially of domestic scaled T-billsscaled sincedowndown November in 2015 in 2015 –– 2017. 16 16 because because of of economic economic difficulties difficulties Mongolia Mongolia faced faced after after 2014. 2014. On June 15, 2018, the Bank of Mongolia set a debt-to-income limit at 70 percent in response to fast- This This loan loan category category has has recently recently picked picked up up substantially, substantially, growing individual largely largely loans driven driven (seeby Box by salary salary I.6). andand consumer consumer loans.Following loans. Followingthe theriseriseininthethe average average loan loan to to households, households, the the average average householddebt-to-income household debt-to-income ratio (including residential ratio (including mortgage-backed residential mortgage-backed securities) securities) reached reached 8080 percent percent inin thethe first first quarter quarter of of 2017,up 2017, upfromfrom40 percentin 40percent 2012. Meanwhile, in2012. Meanwhile, corporate corporate loan loan growth growth has hasbeenbeen recovering recovering butbut remained remained weak, weak, posting posting aa 4.5percent 4.5 increasein percentincrease March inMarch 20182018fromfrom 9.2 9.2 percent percent in in November November 2016, 2016, despite despite aa strongerthan stronger thanexpected expectedeconomic recovery.25 economic recovery. To To 23 23 support private sector activity, the central bank ECONOMIC MONGOLIA has reduced itsUPDATE policy rate by 500 basis points since support private sector activity, the central bank has reduced November 2016, and the government has limited its issuance of domestic its policyT-bills rate by basis points 500November since since 2017. November 2016, and the government has limited its issuance of domestic T-bills since On June 15, 2018, the Bank of Mongolia set a debt-to-income limit at 70 percent in response to fast- November 2017. June 15, 2018, On individual growing loansthe (see Box of Bank Mongolia set a debt-to-income limit at 70 percent in response to fast- I.6). Box I.6 individual growing Household loans loans and (see debt Box I.6). Box I.6 Household loans and debt To improve banks’ quality of assets, Box the BankI.6 Household of Mongolia loans and debt (BoM), Mongolia’s central bank, introduced an To improve importantbanks’ quality of assets, macroprudential policy the byBank setting of a Mongolia limit on (BoM), Mongolia’s central the debt-to-income bank, introduced ratio. Following the meeting an To importantofimprove the Monetarybanks’Policy macroprudential quality policy ofby Committeeassets, onthe setting Bank a limit June 15,on of the 2018, Mongolia the BoM (BoM), debt-to-income decided Mongolia’s ratio. to keep central Following its policy bank, theratemeetingintroduced unchanged of the atan important Monetary 10 Policy percent. macroprudential Committee Moreover, onthe policy JuneBoM by setting 2018, the a 15,introduced a limit BoMceiling on decidedthe on the debt-to-income keep its policy rate to debt-to-income ratio. Following ratio unchanged for consumer the meeting at 10 loans of percent. at 70 the Monetary Moreover, the BoM percent Policy to curb Committee introduced individual a on June ceiling loans, 15, on the which 2018, have the BoM debt-to-income decided grown substantially to ratioover keep its for consumer policy the last few rate loans unchanged months. at 70 The percent at 10 BoM indicated percent. to curb Moreover, individual loans, that the BoM which the nationwide have introduced a ceiling grown substantially inflation rate remainedonoverthemoderate debt-to-income the last few at 6.1months.ratio percent consumer for (y/y) The BoMin indicated May loans 2018 at 70 that the and percent nationwide expected to curb to individual inflation rate remained remain loans, which under itsmoderate have 8 percentat grown target substantially 6.1 percent in the medium over (y/y) in May the last term,2018 few despite months. andcontinued The BoM expected demand-side indicated to remain under that the nationwide its 8 percent pressures from a targetinflation in the medium stronger rate remained economic term, moderate despite recovery. at 6.1 percent continued demand-side (y/y) in May 2018 pressures from and expectedeconomic a stronger to remainrecovery.under its 8 percent target in the medium term, despite continued demand-side pressures from a stronger economic recovery. Moreover,Moreover, they argued they argued that household that household debt debt gradually gradually increased increased in earlier in earlier years years but but hashas beenrising been rising quickly quickly in recent Moreover, recent months. months. they argued Average Average householdthat household householddebt at debt debt gradually at end-2018 end-2018 Q1 is Q1increased is estimated estimated inatearlier at MNT MNT years 10.7 10.7 butmillion. million.has Total been Totalbank rising bank loans quickly loans to in recent individuals months. individuals including Average including residential household residential mortgage-backed mortgage-backeddebt at end-2018 securities Q1 securities is estimated have have significantly at MNT significantly 10.7 increased, million. increased, especially Total especially bank driven loans driven by byto the individuals the housing subsidized including subsidized housing mortgage residential mortgage program mortgage-backed ofprogram the BoM thesecurities ofand and have BoM increases large large significantly increases in overdraft in increased, overdraft (salary) and especially (salary) consumerand driven consumer pensionby the loans.subsidized pension Using housing loans. individual mortgage Using loans as anprogram individual loans indicative ofas theanBoM measure and indicative large measure for household increases in overdraft for household financial liability, recentand (salary) financial consumer liability, data recentpension indicated data that indicated loans. individual Using loans that individual grew individual more than loansloans as an grew three-fold more overthan indicative measure the three-fold last six over household foryears the MNT from last six financial 3 years liability, trillion from MNT During in recent 2012. 3 trillion data in 2012. indicated the same that period, During individual mortgage the loanssame loansgrewperiod,more quintupled mortgage loans three-fold thanmainly due quintupled over to thethe last mainly subsidized due housing six years to the subsidized from MNT 3 trillion mortgage housing program. mortgage in 2012. During In May program. the same 2018, In May period, outstanding 2018, outstanding mortgage mortgage loansaccounted loans mortgage quintupled for loans mainly 50 percentaccounted due to of the for total 50 subsidized loanspercent loans of total mortgage housing to individuals, to individuals, a significant program. increase a significant In May from2018,30 percent in 2012. from increase outstanding mortgage Meanwhile,30 percent loans in 2012. accounted overdraft Meanwhile, (salary) for and50 percent pensionoverdraft of total loans (salary) loans to represented and pension individuals, over 40a loans represented significant percent increase of total over from individual 4030 percent MNT in loans,percent at of 3.1 2012. trillion individual in 2018 loans, totalMeanwhile, Q1 at MNT overdraft compared 3.1 (salary) to MNT trillion and968 in billion pension2018 loans Q1 at compared represented end-2012. to MNT over 96840 billion percent at of end-2012. total individual loans, at MNT 3.1 trillion in 2018 Q1 compared to MNT 968 billion at end-2012. Following the risethe Following in the rise in the average average loan to households, loan to households, the average the average household household debt-to-income debt-to-income ratio reached ratio reached around around Following 80 percent in 201880 percent the Q1, rise upin the in from 2018 average Q1, 39 percent up loan to from 39 inhouseholds, percent 2012. The household in 2012. the average The household debt-to-income debt-to-GDPhousehold debt-to-GDP ratio also rose to ratio ratio also rose 35 reached percent to around from 35 percent 80 percent 18.4 percent over inthefrom 2018 18.4 sameQ1, periodpercent up from over 39 percent (Figure the I.49 in same and period 2012. Figure TheI.50(Figure household I.49 ). The BoM and Figure debt-to-GDP I.50 decision ratio on the). The also BoM rose rate policy decision to 35 andpercenton the Debtfrom to Income policy 18.4 Ratio rate percent overDebt and is welcome the amidto Income same period a Ratio (Figure continued is welcome I.49 and economic amid Figure a continued recovery I.50and ). The economic BoMdebt rising recovery decisionburden.on the and The rising policysharp debt rate and burden. increase Debt in to household sharp The loans Income Ratio increase seemsis welcome to inreflect household amid Mon loans a continued golia’s seems to reflect economic economic Mongolia’s recovery difficulti es and economic in 2014rising anddebtdifficulties burden.which beyond, inThe2014 sharp andincrease increased beyond, the in poverty which household headcountincreased loans ratio the by poverty seems 9 to headcount reflect percentage Mon points ratio golia’s by 9 percentage economic between 2014 difficulti and 2016. points es inThe between 2014 and 2014 gradual rise and beyond, 2016. The which in household gradual increased income, the rise poverty especially in household headcount non-mineral income, ratio byin income, especially 9 recent percentage non-mineral quarters points hasbetween income, been eroded in 2014 and recent by 2016. quarters a sharp The increasehas gradual in been rise eroded in household household by a debt, sharp income, and in householdincome, increase non-mineral especially debt, and therefore in recent could has quarters weaken been household eroded byconsumption a sharp increase and accumulate in household risk in the debt, and therefore could weaken household consumption and accumulate risk in the financial sector and hurt growth. Data financial therefore sector and could weaken householdhurt growth. Data on consumption the debt-service-to-income and are accumulate ratio riskincreasing, in the financial are not available but are sector and hurt growth. likely to Data be on the debt-service-to-income ratio are not available but likely to be as well. onincreasing, as well. the debt-service-to-income ratio are not available but are likely to be increasing, as well. Figure I.49 Individual credit growth has been a key Figure I.50 Household debt ratios to GDP and driverFigure Figure of totalI.49 I.49 Individual Individual credit growth credit creditgrowth growth hashasbeen a key been a key Figure Figure income I.50 Household haveI.50 debt Household increased ratios debt to substantiallyGDP and ratios to GDP and driver driver of of total total credit credit growth growth Average individual bank loan per borrower (MNT income have income increased have substantially increased substantially Household debt (in % of GDP, % of annual Averageindividual Average million) individualbank bankloan perper loan borrower borrower (MNT Household debt Household household (in debt income) % of GDP, (in % of GDP, % of annual (MNT million) million) % of annual household income) Others Salary loans Pension Loans Consumer loans household income) Others Entreprenuers Pension Loans Mortgage 90% RMBS HH debt to GDP ratio From 8% to 5% Salary loans Consumer loans 81% 82% Total household loan RMBS 5% 79%refinanced From 8% to 5% 8.0 Entreprenuers Mortgage HH 80% 90% HH debt debt to to GDP Annual HHratio income 82% 79% Total household loan 8% housing 5% mortgage 81% 79%refinanced Annual Growth (%): RHS 7.0 8.0 70% 80% HH debt to Annual HH income 79% million MNT 3.5 8% housing mortgage 62% 250000% Annual Growth (%): RHS 6.0 7.0 70% trillions 60% million MNT 3 3.5 62% 250000% 5.0 6.0 50% 200000% trillions 50% 60% 3 2.5 43% 50% 4.0 5.0 39% 200000% 40% 50% 33.0% 32.3% 33.3% 34.9% 150000% 2 2.5 32% 43% 39% 3.0 4.0 27% 29.1% 34.9% 30% 40% 2 24.3% 33.0% 32.3% 33.3% 150000% 2.0 1.5 32% 100000% 3.0 27% 18.5% 18.4% 29.1% 20% 30% 24.3% 1.0 2.0 10.7% 13.7% 1 1.5 18.5% 18.4% 100000% 50000% - 1.0 10% 20% 0.5 1 10.7% 13.7% 50000% 10% 2008Q4 2009Q2 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 2016Q2 2016Q4 2017Q2 2017Q4 - 0% 0.5 0 0% 2008Q4 2009Q2 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 2016Q2 2016Q4 2017Q2 2017Q4 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Apr-13 Jul-13 Apr-14 Jul-14 Apr-15 Jul-15 Apr-16 Jul-16 Apr-17 Jul-17 Apr-18 0% 0 0% Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Apr-13 Jul-13 Apr-14 Jul-14 Apr-15 Jul-15 Apr-16 Jul-16 Apr-17 Jul-17 Apr-18 Sources: BoM; World Bank staff estimates. Sources: Sources World BoM;World : BoM; Bank Bank staff staff estimates. estimates. 24 24 26 MONGOLIA ECONOMIC UPDATE Mortgage loan growth has been cooling with limited state (BoM and government) funding to the Mortgage Mortgage subsidized loan loan growth growth housing has hasbeen mortgage been cooling cooling program. with with Total limitedstate limited outstanding state (BoM (BoM mortgage and and loans government) government) slowed funding funding to 3.5 percent in totothe Aprilthe subsidized subsidized 2018 comparedhousing housing mortgage tomortgage 13.3 program. program. percent Total a year Total ago outstanding outstanding and 5.8 percent mortgage mortgage at end-2017. loans loans slowed slowed This toto 3.5 3.5 deceleration percent percent inin was mainly April April 2018 2018 compared compared to to 13.3 13.3 percent percent a a year year ago ago and and 5.85.8 percent percent at at end-2017. end-2017. This This caused by a substantial decline in state funding to the subsidized housing mortgage program as part deceleration deceleration was was mainly mainly caused caused of the bybyaa substantial substantial economic decline decline recovery inin program. state state funding The funding housingtoto the the mortgage subsidized subsidized program housing housing mortgage has beenmortgage run as program program as as a revolving part part fund of of the the economic economic recovery recovery program. program. The The housing housing mortgage mortgage program program has has been been run since early 2017, using only principal repayments and interest inflows for additional loans. However,run as as a a revolving revolving fund fund since since early the 2017, early 2017,using subsidizedusing only principalrepayments onlyprincipal housing mortgage repayments program and andinterest remained interest inflows inflows a key driver forforforadditional total additional mortgageloans. loans.However, credit However, growth sincethe the subsidized subsidized housing housing mortgage mortgage program program remained remained a a key key driver driver for for total total mid-2013. Mortgage loans that were originated under the housing mortgage program reached MNT 3.2mortgage mortgage credit credit growth growth since since mid-2013. trillion inMortgage mid-2013. Mortgage April 2018, loans loans that that accounting were were for 77 originated originated under under total the percent of the housing housing mortgage mortgage mortgage loans. program program Meanwhile, MNT reached reached MNT MNT 2,580 billion 3.2 3.2 of trillion trillion inin April April 2018, 2018, accounting accounting for for 77 77 percent percent ofof total total mortgage mortgage loans. loans. Meanwhile, Meanwhile, housing mortgage loans were securitized into residential mortgage-backed securities via the Mongolia MNT MNT 2,580 2,580 billion billion of of housing mortgage housing mortgage loans loans were were securitized securitized into into residential mortgage-backed securities residential mortgage-backed Ipotek Corporation, and the BoM purchased 90 percent of the residential mortgage-backed securities via the securities via the MongoliaIpotek Mongolia Corporation,and IpotekCorporation, andthetheBoM BoMpurchased purchased90 percentof 90percent theresidential ofthe mortgage-backed residentialmortgage-backed (Figure I.52 ). securities securities (Figure (Figure I.52 I.52 ).). Authorities are restructuring the design of the housing mortgage program, which will be transferred Authoritiesare Authorities restructuringthe arerestructuring designof thedesign ofthe thehousing housingmortgage program,which mortgageprogram, whichwill betransferred willbe transferred from from the from the BoM to the BoMBoM to the to the government. the government. government. The The current The current program program design current program design involves design involves features involves features that that features that make make make ititit unsustainable, unsustainable, unsustainable, distortive, distortive, distortive, andfiscally and and inefficient, fiscallyinefficient, fiscally including inefficient,including the theloose includingthe loose loose criteria criteria criteria for for foreligible eligible eligible borrowers borrowers borrowers andand and properties propertiesto properties to tobe be mortgaged, bemortgaged, mortgaged,and and unduly andunduly complicated undulycomplicated mechanisms complicatedmechanisms using mechanismsusing underdeveloped usingunderdeveloped asset-backed asset-backed underdevelopedasset-backed instruments. instruments. instruments. InIn In this this this regard,the regard, regard, government thegovernment the governmentand and the andthe BoM theBoM arecurrently are BoMare currently currently improving improving improving thethe the design design designof ofthe of the the housing housingmortgage housing mortgage program programand mortgageprogram and andplanplan plantoto transfer totransfer the transferthe mortgage mortgageasset themortgage asset of assetof the ofthe theBoM BoM BoMto to the tothe government, government, thegovernment, which which which is isis expected expected expected toto tobe be be completedby completed completed by by September September September 2018. 2018. 2018. Figure Figure FigureI.51 I.51 I.51 Individual Individualcredit Individual credit credit growth growth growth has has has been been been Figure Figure FigureI.52 I.52 I.52 Mortgage Mortgage Mortgage loan loan loan growth growth growth has has has slowed, slowed, slowed, aakey a key driver key driver oftotal of total totalcredit credit credit growth, growth, growth, while while driven driven driven by by by the the the limited limited limited subsidy subsidy subsidy of of of the the the BoM BoM BoM to to to the corporate corporate corporate loans have loanshave have seen seen seen moderate moderate moderate growth growth growth the the housing housing housing mortgage mortgage mortgage program program program Individual Individualbank Individual bank bank loan loan loan growth growth growth (y/y, (y/y, (y/y, %) %) %) Outstanding Outstanding Outstanding mortgage mortgage mortgage loans loans (MNT loans (MNT(MNT trillion) trillion) trillion) 30% 30% Mortgage Mortgage loans loans RMBS RMBS From From 8% toto 8% 5%5% Other Other consumer consumer loans loans 5%5% refinanced refinanced Consumer Consumer Loans Loans 8%8% housing housing mortgage mortgage Commercial Commercial 20% 20% Salary Salary loan loan Annual Growth Annual Growth (%): (%): RHS RHS Total Total individuals individuals loans loans 4.5 4.5 160% 160% Corporate Corporate loans loans trillions trillions 4.0 4.0 140% 140% 10% 10% 3.5 3.5 120% 120% 3.0 3.0 100% 100% 0%0% 2.5 2.5 80% 80% 2.0 2.0 60% 60% -10% -10% 1.5 1.5 1.0 1.0 40% 40% 0.5 0.5 20% 20% -20% -20% 0.0 0.0 0%0% Oct-13 Oct-13 Oct-14 Oct-14 Oct-15 Oct-15 Oct-16 Oct-16 Oct-17 Oct-17 Jan-13 Jan-13 Jan-14 Jan-14 Jan-15 Jan-15 Jan-16 Jan-16 Jan-17 Jan-17 Jan-18 Jan-18 Apr-13 Apr-13 Apr-14 Apr-14 Apr-15 Apr-15 Apr-16 Apr-16 Apr-17 Apr-17 Apr-18 Apr-18 Jul-13 Jul-13 Jul-14 Jul-14 Jul-15 Jul-15 Jul-16 Jul-16 Jul-17 Jul-17 Sources: Sources: BoM; BoM; World World Bank Bank staff staff estimates. estimates. Sources: BoM; World Bank staff estimates. Deterioration Deterioration of bankasset ofbank qualityhas assetquality hasslowed slowedsomewhat. somewhat.After After yearsof years deterioration,the ofdeterioration, fast-rising thefast-rising Deterioration of bank asset quality has slowed somewhat. After years of deterioration, the fast- non-performingloans non-performing (NPLs)of loans(NPLs) bankshave ofbanks havestabilized stabilizedsince sinceearly 2017,with early2017, withthe strongeconomic thestrong economic rising non-performing loans (NPLs) of banks have stabilized since early 2017, with the strong economic recovery. recovery. The The NPL NPL ratio ratio was was55 percent percent at at the the end end ofof 2014 2014 and and jumped jumped to to 8.5 8.5 percent percent atat end-2017 end-2017 (Figure (Figure recovery. The NPL ratio was 5 percent at the end of 2014 and jumped to 8.5 percent at end-2017 (Figure I.53).Private I.53). sectorproblematic Privatesector problematicloans loanswerewereaakey keydriver driverof substantialdeterioration ofsubstantial deteriorationof totalloan oftotal loan I.53). Private sector problematic loans were a key driver of substantial deterioration of total loan quality. quality. quality. NPLs NPLs rose rose by by 4.7 4.7 percent percent inin the the first first four four months months of of 2018, 2018, reaching reaching MNT MNT 1.2 1.2 trillion trillion inin April. April. The The NPLs rose by 4.7 percent in the first four months of 2018, reaching MNT 1.2 trillion in April. The ratio ratioof ratio NPLsto ofNPLs totaloutstanding tototal outstandingloansloanswas wasrelatively relativelyflat flatin 2017,averaging in2017, around8.6 averagingaround percent,with 8.6percent, with of NPLs rising rising creditto growth. credit total outstanding growth. Past-due Past-due loans loans loans was ― ― relatively which which are flat in 2017, areoverdue overdue for averaging forless lessthan than90around 90days days 8.6 ―― percent, more more than than with risingin doubled doubled in the credit the first growth. first nine nine Past-due months, months, loans―which reaching reaching MNT MNT arebillion 978 978 overdue billionininfor Aprilless April than 2018 2018 90 days―more from from MNT MNT 823 823 than doubled billion billionatat the the endin the end of first 2017. of2017. The nine The loanmonths, loan share share reaching of past-due of MNT past-due 978 loans loans billion reached reached in April 6.8 6.8 2018 in percent percent from in MNT April, April, 823 billion slightly slightlyupupfromat the from 6.2 6.2end of 2017. percent percent at at The loan end-2017. end-2017. share of past-due loans reached 6.8 percent in April, slightly up from 6.2 percent at end-2017. 27 MONGOLIA ECONOMIC UPDATE FigureI. Figure Figure I.53 I.53 Theloan The 53 The loan qualityratio quality loanquality ratio ratiohas hasstabilized has stabilizedwith stabilized Figure I.54 Figure I.54 … Figure I.54 … whiledeterioration …while while deteriorationof deterioration of loan loanquality ofloan quality quality has with with the the strong the strong strong economiceconomic economic recovery recovery recovery and speedy and and speedy speedy credit has mainly has mainly mainly been been been driven driven driven by by loans by loans loans toprivate to to the the private the private sector credit credit growth … growth growth …… sector sector NPLs NPLs NPLs and and and past-due past-due past-due loans loans loans as percent of as percent as percent outstanding of outstanding Problematic Problematic Problematic loans loans loans = = NPLs NPLs = NPLs + past-due + past-due + past-due loans loans (MNT loans (MNT loans loans of (%) loans (%) (%) outstanding billion) billion) (MNT billion) 18 18 NPL NPL 2,500 2,500 15 15 Individual Individual Past Due Past Loans Due Loans 2,000 2,000 12 12 Private Sector Private Sector 1,500 1,500 of MNT MNT 9 9 billions of 1,000 1,000 in billions 6 6 3 3 in 500 500 0 0 0 0 May-09 Jan-10 May-10 Jan-11 May-18 Sep-09 Sep-10 May-11 Jan-12 Sep-11 May-12 Jan-13 Sep-12 May-13 Jan-14 Sep-13 May-14 Jan-15 Sep-14 May-15 Jan-16 Sep-15 May-16 Jan-17 Sep-16 May-17 Jan-18 Sep-17 Jun-10 Jun-10 Jun-11 Jun-11 Jun-12 Jun-12 Jun-13 Jun-13 Jun-14 Jun-14 Jun-15 Jun-15 Jun-16 Jun-16 Jun-17 Jun-17 Dec-09 Dec-09 Dec-10 Dec-10 Dec-11 Dec-11 Dec-12 Dec-12 Dec-13 Dec-13 Dec-14 Dec-14 Dec-15 Dec-15 Dec-16 Dec-16 Dec-17 Dec-17 Sources: BoM Sources: Bulletin; World BoM Bulletin; Bank staff World Bank estimates. staff estimates. Sources: Note: BoM Note: NPLs NPLs Bulletin; and and past-due past-dueWorld loansBank loans includestaff include estimates. liquidated liquidated banks. banks. Note: NPLs and past-due loans include liquidated banks. In response In In response response to deteriorating asset to deteriorating quality,several quality, asset quality, several measures measureswere severalmeasures were were taken taken taken to totoimprove improve improve the thetheresilience resilience resilienceof of the the banking banking system. system. Since Since 2014, 2014, the the central central of the banking system. Since 2014, the central bank has introduced bank bank has has introduced introduced several several measures measures to to strengthen strengthen strengthen prudentialregulations. prudential prudential regulations.Some regulations. Some Someof ofthese of these measures measuresinclude thesemeasures include(a) include (a) imposing (a) imposinghigher imposing higher risk weights risk higher risk weights (120 (120 percent) weights (120 percent) percent) on foreign on on foreign currency foreign currency loans currency loansloans toto unhedged unhedged borrowers, to unhedged borrowers, and borrowers, and (b) (b) raising raising raising the and (b) the general the general provisioning provisioning ratio general provisioning ratio of ratio of of normal normal loans loans to to 1 1 percent percent from from zero. zero. In In April April 2015, 2015, the the BoM BoM normal loans to 1 percent from zero. In April 2015, the BoM raised the minimum paid-in capitalraised raised the the minimum minimum paid-in paid-in capital capital requirementfor requirement requirement forbanks for banks from banks from MNT from MNTMNT 16 16 billion billion to 16 billion to MNT to MNT 50 MNT 50 billion, 50 billion, which billion, which went into went which went into effect into effect from from 2016 effect from 2016 for 2016 for for systemically important systemically important banks banks andand from 2018 for from 2018 for small small banks. banks. As the government As the government and the central and the bank central bank systemically important banks and from 2018 for small banks. As the government and the central bank has started has to implement started to implement the economic reform the economic reform plan plan since since May 2017 with May 2017 the support with the support of donors, Asset of donors, Asset has started to implement the economic reform plan since May 2017 with the support of donors, Asset Quality Review Quality Review has been done has been done by by an independent consultancy an independent consultancy firm (PricewaterhouseCoopers), which firm (PricewaterhouseCoopers), which Quality Review has been done by an independent consultancy firm (PricewaterhouseCoopers), which covered 91 covered percent of 91 percent corporate loans of corporate loans of of the the banking banking system system and identified a and identified capital shortfall a capital of 2 shortfall of 2 covered percent of percent 91 percent of GDP GDP (MNT (MNT of corporate 543 543 billion). billion). A loans of the deadline A deadline of banking of nine months nine system months was was and identified granted granted by by the the capital aBoM BoM to shortfall to ailing ailing banks banksof to 2 to percent of GDP recapitalize, recapitalize, and and (MNT this 543 billion). exercise this exercise is expected is A deadline expected to of nine months conclude to conclude by by end-2018 was granted end-2018 (see Box (see Box the by I.7 I.7 ).BoM ). The to The ailing banks authorities authorities are are to recapitalize, currently working currently and working on this exercise on improving improving the is expected and regulatory legal and the legal to conclude by regulatory frameworkend-2018 framework for (see NPL resolution. for NPL Box I.7 ). resolution. The authorities are currently working on improving the legal and regulatory framework for NPL resolution. Box I.7 Box Mongolian banks I.7 Mongolian banks Asset Asset Quality Quality Review and results Review and results In February In 2018, the February 2018, Bank of the Bank Mongolia, the of Mongolia, Box I.7 Mongolian banks Asset Quality the country’s central country’s Review central bank, and results published the bank, published the results results of the Asset of the Asset Quality Review Quality (AQR) in Review (AQR) the context in the context of of the the country’s country’s economic recovery program economic recovery supported by program supported many by many development In February partners. development partners. 2018, This the This Bank exercise, exercise, performed performed of Mongolia, by by PricewaterhouseCoopers PricewaterhouseCoopers the country’s central bank, published in cooperation in cooperation the results with with national national of the Asset supervisors, supervisors, reviewed reviewed Quality Review (AQR) the theinbalance balance sheetsof sheets the context of ofthe14 14 commercial commercial banks, of banks, country’s economic ofrecovery which one which one was was state program state owned. Over owned. Over supported six six by many month month s, s, 230 230 professionals professionals worked worked on on the the AQR AQR using using aa methodology methodology based based on on the the development partners. This exercise, performed by PricewaterhouseCoopers in cooperation with national European European Central Central Bank’s Bank’s AQR AQR manual adapted manual supervisors, adapted reviewed tothe to thebalance the Mongolian Mongolian of 14This context. context. sheets This assessment assessment commercial included included banks, a of whicha review review one wasof of the the quality quality state of banking of banking owned. Over six sector sector assets assets and and a a forward-looking forward-looking stress stress test test to to determine, determine, among among other other things, things, months, 230 professionals worked on the AQR using a methodology based on the European Central Bank’s eventual eventual recapitalization recapitalization needs needs of the of AQR manual individual the individual adapted to banks. banks. AA key key feature the Mongolian feature of of this context. this This AQR AQR compared compared assessment to other to other included AQRs is AQRs a review is ofthetherisk the risk management management quality of banking assessment assessment of of banks, banks, particularly particularly banks banks that that use use mining mining licenses licenses as as loan loan collateral. collateral. sector assets and a forward-looking stress test to determine, among other things, eventual recapitalization needs The The AQR AQR of the individual covered covered banks’ banks’ loans, banks. loans, A key feature receivables, receivables, of this AQR guarantees, guarantees, compared other other credit to other AQRs credit-equivalent -equivalent is the letters guarantees, guarantees, risk management letters of credit, of credit, assessment other off-balance-sheet other of banks, particularly off-balance-sheet assets, banks assets, and that use and third-level mining third-level assets. licenses assets. The as loan The consultingcollateral. company executed consulting company executed the following the following evaluation steps: evaluation steps: The AQR covered banks’ loans, receivables, guarantees, other credit-equivalent guarantees, letters of 1. other credit, 1. off-balance-sheet Processes, Processes, policies, policies, and assets, and and accounting accounting third-level assets. The consulting company executed the following review review evaluation 2. steps: 2. Review Review of of credit risk management credit risk framework management framework 3. Loan 3. data integrity Loan data validation integrity validation 4. Sampling 4. Sampling 5. Credit 5. review Credit review 6. Collateral 6. and real Collateral and estate valuation real estate valuation 28 26 26 MONGOLIA ECONOMIC UPDATE 1. Processes, policies, and accounting review 2. Review of credit risk management framework 3. Loan data integrity validation 4. Sampling 5. Credit review 6. Collateral and real estate valuation 7. Distribution of sampling results 8. Collective provision analysis 9. Level 3 fair value exposure review 10. Configuration on required capital. The AQR assessment of the soundness of bank balance sheets reveals that the Mongolian banking sector is in relatively good shape. As mentioned, the AQR, which covered 91 percent of corporate loans of the banking system, identified a capital shortfall of 2 percent of GDP (MNT 543 billion), which represents about 6.9 percent of budget revenue and 3.5 percent of total deposits in the banking system. The BoM gave ailing banks 9 months to recapitalize, and this exercise is expected to conclude by end-2018. The banking system remains resilient and capable of recapitalizing, as evidenced by bank capital adequacy and liquidity ratios, estimated at 17.1 percent and 44.6 percent, respectively, in March 2018. In the meantime, the Bank Recapitalization Law was approved by the parliament in June 2018. The approved law aims at improving the legal and regulatory framework for bank resolution mechanisms and, ultimately, for strengthening financial stability. It would do that by improving the legal framework for how government bailouts can be implemented to support systemic banks in the event of a capital shortfall. The recapitalization law addresses issues such as financial stability, governance of the public recapitalization process, burden sharing, restructuring, strict oversight, and exit scenarios. The AQR results were less alarming than anticipated. However, banks have increasingly shifted their loans portfolio away from the private sector, which is concerning as it could undermine the financial sector stability. Thus, recent macroprudential measures undertaken by the monetary authorities including raising the debt service to income ratio on consumer loans are expected to limit excessive growth of household loans and its associated risk. In addition, the effective implementation of recommendations of the AQR including recapitalization of some banks will be crucial for financial stability. Source: BoM 29 MONGOLIA ECONOMIC UPDATE Box I.8 Benefits resulting from the Banking Law and Deposit Insurance Law amendment The Mongolian parliament passed the amendment to the central bank law on January 18, 2018. The amendment aimed to ensure financial stability and reduce operational risks of banks by strengthening their governance and supervision framework. The amendment and related laws went into the effect April 1, 2018. Key features of the amendment: • Improve requirements for shareholders, executive management, and board members • Upgrade rules on related party loan exposure and final beneficial owners • Improve risk management and internal controls at banks, including limiting concentration risks in loan portfolios • Introduce a “Risk based supervision framework” for the central bank supervision policy from “Compliance based,” in line with international standards and elements of Basel II and Basel III standards • Improving the early intervention framework • Strengthen bank resolution legislation, funding, and the cooperation framework to meet best international standards in cooperation with the Ministry of Finance and the Deposit Insurance Corporation of Mongolia (DICOM) • Grant the BoM power to apply levies on banks to cover the cost of supervision, including AQRs. The Bank Deposit Insurance Law was also amended by the parliament on February 18, 2018, to bring it in line with International Association of Deposit Insurers (IADI) Core Principles for Effective Deposit Insurance Systems. The law also improved data sharing between DICOM and the BoM to ensure faster payout of deposits where appropriate. Sources: International Monetary Fund (2018); Legalinfo.mn. B. Outlook and Risks Despite some base effects, the signs of strong economic performance in 2018 Q1 are expected to continue for the rest of the year. Economic growth would improve modestly from 5.1 percent in 2017 to 5.5 percent in 2018, and then would accelerate to over 6 percent in 2019–20. Private investment will remain a key driver of growth in the medium term, especially in mining, trade, and transport services. Despite reduced depreciation pressures on the exchange rate, inflation is likely to rise (modestly), with risks tilted to the upside to the extent of overshooting the BoM medium-term target of 8 percent, as food and oil prices are expected to continue to increase. Private consumption is projected to further improve over the medium term. Consequently, the BoM is likely to tighten monetary policy to contain inflation. Agriculture is projected to grow modestly in 2018 (below its 2014–15 performance because of the adverse effects of a harsh winter, which resulted in the death of more than 700,000 animals) and to strengthen to about 4 percent over the medium term. Industry is projected to grow around 7 percent in 2018–20, as substantial developments are expected in mining. The growth of the services sector would be supported by strong links between mining and transport. Moreover, trade and transport may also gain from the intensification of relations with Russia. The fiscal deficit would further decline in 2018, buoyed by strong revenue performance supported by higher commodity prices, provided the government remains committed to implementing the fiscal consolidation program agreed with its development partners, despite recent policy reversals. Declining 30 MONGOLIA ECONOMIC UPDATE deficits will lead to continued debt reduction over the medium term. The balance of payments will continue to face structural vulnerabilities exacerbated by the debt situation. Despite robust export growth, investment-related construction imports over the next two years will rise and put pressure on the current account balance. Exchange rate depreciation would continue to subside following the disbursement of donor support and new FDI inflows, unless rising current account deficit put downward pressure on the currency. Moreover, gross international reserves would significantly improve to 6.8 months of imports in 2019 from 4.9 months in 2017. Given the positive macro outlook, poverty rates are expected to start declining in 2018. However, unless economic activity improves in rural areas (where nearly half the poor live), gains in terms of reduction of urban poverty may be partly offset by protracted rural poverty. Risks to the outlook While growth was stronger in 2017, Mongolia’s underlying structural issues have not disappeared and there are substantial domestic and external exogenous risks to the outlook. These risks include persistent political and policy uncertainty, which could affect FDI and delay implementation of mega projects in the mining sector; commodity market volatility; bottlenecks at the border; and regional instability. Recent policy reversals, including returning to a flat PIT rate and reversing the increase in the retirement age, have undermined the government’s credibility and its commitment to the fiscal consolidation program supported by donors. Relatedly, if mishandled, the ongoing investigations attempting to establish the responsibilities of former prime ministers, ministers of finance, and other executives, in the signing of the investment agreement with Oyu Tolgoi could deter FDI inflows and affect market sentiments and FDI. In contrast, if the government maintains fiscal discipline and promotes policies aimed at attracting FDI, Mongolia’s prospects for growth and poverty reduction are more positive. Weather-related shocks will remain an important challenge. Livestock is the main source of income in rural areas, and further growth is key to raising living conditions in the countryside. Adaptation to climate change should be prioritized to mitigate food and livestock production shocks. Sluggish regional demand (mainly from China) and commodity market volatility are likely to affect Mongolia’s growth prospects (Box I.9). Improving government management of mining revenue is therefore critical. Recent efforts to promote export diversification through improved trade cooperation is a positive step. Worsening of non-trade barriers at the southern border and resumption of coal imports by China from the Democratic People’s Republic of Korea could affect Mongolia’s coal exports. The recent visit of the Prime Minister of Mongolia to China helped relieve some of these pressures. However, an unsuccessful implementation of the recommendations of the Asian Pacific Group (APG) to address the deficiencies of Mongolia’s Anti-Money Laundering/Counter-Financing of Terrorism (AML/CFT) regime is an additional risk for the macro outlook as it could potentially impact on FDI and the financial sector. 31 the Democratic People’s Republic of Korea could affect Mongolia’s coal exports. The recent visit of the Worsening of non-trade barriers at the southern border and resumption of coal imports by China from Prime Minister of Mongolia to China helped relieve some of these pressures. However, an unsuccessful the Democratic People’s Republic of Korea could affect Mongolia’s coal exports. The recent visit of the implementation of the recommendations of the Asian Pacific Group (APG) to address the deficiencies of Prime Minister of Mongolia to China helped relieve some of these pressures. However, an unsuccessful Mongolia’s Anti -Money MONGOLIA ECONOMIC Laundering/Counter-Financing of UPDATE Terrorism (AML/CFT) implementation of the recommendations of the Asian Pacific Group (APG) to addressregime is an additional the deficiencies of risk for the macro outlook as it could potentially impact on FDI and the financial sector. Mongolia’s Anti-Money Laundering/Counter-Financing of Terrorism (AML/CFT) regime is an additional risk for the macro outlook as it could Box potentially I.9 Global impact and Regional on FDI Outlook and and the– Risks financial sector. Key Highlights Box I.9 Global andBox Regional Outlook I.9 Global and Risks and Regional – Keyand Outlook Highlights Risks – Key Highlights Global growth has eased, but remains robust, and is projected to reach 3.1 percent in 2018 (World Bank, 2018a). It Global will Global then growth growthslightly has hasmoderate eased, eased, but but remains an toremains average robust, ofis3projected robust, and percent and to2019 in is projected reach –to 20, 3.1 reflecting reach percent 3.1 in percent a 2018 gradual in slowdown 2018 (World (World Bank, in advanced Bank, 2018a). economies It will2018a). It will moderate then slightly(Figure I.55). then slightlyto moderate an average toofan percentof 3average in 3 –20, in percent 2019 2019–20, reflecting a reflecting a gradualin gradual slowdown slowdown advanced in advanced economies I.55). (Figure I.55). economies (Figure Growth in the East Asia and Pacific region is expected to gradually moderate from 6.3 percent in 2018 to 6.1 Growth Growth percent in theon the Asia inEast average EastinAsia and Pacific 2019-20 and Pacific (Figure region region I.55). is expected The is expected modest to gradually slowdown to gradually moderate in regional moderate from from growth 6.3 is 6.3 percent percent largely due in to 2018 in 2018 the to gradual to 6.1 6.1on and percent percent planned average on average structural in 2019-20 in 2019-20 slowdown (Figure (Figure in China. I.55). I.55). The The Activity modest in modest the slowdownrest in slowdown of the region regional regional in is growth expected growth is largely todue largely isto peak at 5.4 the due to in percent gradual the gradual 2018 and planned and and planned remain structural steady, around slowdown its slowdown structural in China.potential Activity inChina. in rate in 2019. the Activity rest The of the in the rest outlook region is of the region ispredicated expected onpeak to is expected broadly at 5.4 peak to commodity at stable percent in andpercent 5.4 2018prices in thein remain 2018 next steady, twoand remain years, around steady, strong its butaround potential gradually rate its moderating in 2019.potential rate The outlook inis global 2019. The outlook demand, predicated and is predicated a gradual on broadly stable on broadly tightening commodityof global stable financing prices in the commodity conditions. next prices strong in the next two years, two years, but gradually strong but global moderating gradually and a global moderating demand, gradual demand, tighteningandofa gradual global tightening financing of global financing conditions. conditions. Figure I.55 Global growth is projected to continue Figure I.56 Growth in EAP region will gradually Figure toI.55 Figure I.55 Global Global moderate growth growth in the projected is years… is projected coming to continue Figure to continue Figure I.56Growth I.56 moderate Growth in in EAP in 2019-20 EAPregion will region gradually will gradually to moderate to moderate in in the the coming coming years… years… Global real GDP growth contribution projections moderate moderate in in 2019-20 2019-20 Real GDP growth (y/y, %) Global Global realGDP real GDP growth growth contribution contribution projections Real GDP growth (%p) Real GDP growth (y/y, %) (y/y, %) projections (%p) (%p) 2017 2018 2019 6 Emerging Markets & 7 2017 2018 2019 6 Developing Emerging Markets &Economies 7 5 4.5 5 Developing Economies 4.5 6 4 6 4 World 3.1 5 3 World 3.1 5 3 4 2 4 2 Advanced 2.2 3 1 Advanced 2.2 3 China Malaysia Lao PDR Myanmar Mongolia Vietnam Thailand Cambodia 1 economies China Malaysia Lao PDR Myanmar Mongolia Vietnam Thailand Cambodia economies 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 f f f f f f Source: World Bank (2018a; 2018b). Source: Source: World Bank Bank World (2018a; (2018a; 2018b). 2018b). The growth of China, the main trade partner to Mongolia, is itself subject to uncertainty. The GEP of the World The growth The growth of China,main of China, the main trade partner to Mongolia, is itself subject to uncertainty. The of GEP the World ofWorld Bank (June 2018) the assumes thattrade partner China’s to Mongolia, growth is projected is itself to edge subject downto touncertainty. 6.5 percent in The GEP 2018 the and slow further Bank Bank to(June (June 2018) 2018) assumes assumes that that China’sChina’s growth growth is projected is projected to to edge downedge down to 6.5 to 6.5 percent percent in in 2018 2018 and slow further 6.3 percent on average in 2019-20, as export growth moderates and deleveraging takes hold.and slow further In addition, policy to to 6.3 6.3 percent on percent on average accommodation average is expected in 2019-20, in 2019-20, as as export to further export growth diminish growth moderates asmoderates authoritiesand and continue deleveraging deleveraging takes to tighten takes hold. In hold. In addition, macroprudential addition, policy regulation policy accommodation accommodation and gradually is expected is expected remove their to to furtherfurther diminish supportive diminish fiscal as authorities authorities asstance. continue Downside continue riskstoto to tightentighten macroprudential macroprudential the outlook stem fromregulation regulation and and financial sector gradually gradually remove remove and vulnerabilities their their supportive ansupportive intensificationfiscal fiscal stance. stance. of trade tensions Downside Downside risks to the amid increased risks to the outlook stem protectionism outlook stem in key from from trading financial financial partners. sectorsector vulnerabilities vulnerabilities and anand an intensification intensification of tradeof trade tensions tensions amidamid increased increased protectionism protectionism in key intrading key trading partners. partners. Oil prices are substantially higher than previously expected, and other commodity prices have also risen. Oil prices Oil are prices While substantially are substantially near-term higher projections than higher for previously than commodity expected, previously prices have and expected, been other and commodity other revised up, they prices commodity also havehave prices are expected risen. to also level While risen. off While later in theprojections near-term near-term for commodity projections forecast horizon. Oilcommodity for prices prices havehave prices are expected been revised been to average up,70 revised US$ they up,per are they expected barrelareinexpected 2018 level toand to level US$ off69later off in the later in 2019, in upthe forecast horizon. forecast from Oil prices an horizon. average Oil$53 of are prices per expected are into expected barrel average 2017. average to Metals US$ 70 per US$ prices 70 barrel rose per barrel modestlyin 2018in andfirst in 2018 the US$ 69 in69 andquarter US$ 2019, in2018; 2019, of up from however,an an up from average of prices $53 per posted barrel gains in in 2017. April, Metals after the prices rose imposition modestly of sanctionsin the on first a average of $53 per barrel in 2017. Metals prices rose modestly in the first quarter of 2018; however, quarter large of aluminum2018; however, producer. prices Metal posted prices are posted in April, gainsgains after the in April, after the imposition of sanctions on a large aluminum producer. Metal prices are expected to 9 expected to rise 9 imposition percent thisof sanctions year, reflectingon a large strong aluminum demand, butproducer. then Metal moderate prices in 2019.are expected to rise rise 9 percentyear, percent this reflecting this year, strong reflecting demand, strong demand, but then moderate but then moderate in 2019.in 2019. Source: Vashakmadze (2018). Source: Vashakmadze Source: (2018). Vashakmadze (2018). C. Closing the Productivity Gap – The Role of Public Investment Efficiency A productivity gap characterizes Mongolia’s current growth model. The growth accounting exercise 29 reveals that during the last decade, almost all the29 growth came from physical capital accumulation, with a limited role for total factor productivity (TFP).7 This is not unexpected in low-income countries 7 See details in Annex 1. 32 MONGOLIA ECONOMIC UPDATE (LICs) and lower middle-income countries (LMICs). However, with the transition to higher income, the role of TFP should gradually increase and sustain growth. Potential growth accelerated from an average of 1 percent in the 1990s to about 7 percent since 2008, with capital accumulation contributing over 92 percent of this growth up from 68 percent in the first half of the 2000s (Table I.1 and Figure I.57 ). This reflects the high gross investment rate, which more than doubled to an average 40 percent of GDP between the 1990s and the 2010s. Table I.1 Mongolia: Average results of growth accounting 1981–2010 1981–90 1991–2000 2001–07 2008–10 2011–17 Output per Worker 1.7 1.3 -1.0 3.8 6.0 5.1 Capital per Worker 2.3 2.9 0.1 2.6 6.0 5.2 Average Potential Growth 3.9 3.7 0.8 6.2 7.7 7.1 Total Factor Productivity -0.6 -1.6 -1.2 1.1 -0.1 -0.1 Capital 3.7 4.4 1.3 4.2 7.2 6.5 Employment 0.8 0.9 0.7 0.9 0.7 0.7 Working-age Population 0.8 1.0 1.6 0.9 Labor Force Participation -0.9 0.1 -0.5 0.0 Employment Rate 0.1 0.1 -0.9 0.1 Gross Investment Rate 21.4 17.0 17.4 22.2 39.4 40.9 Source: World Bank staff estimates. Note: The analysis assumes: initial capital = 2.1, share of capital in income = 63 percent, and depreciation rate = 5 percent. Actual and potential growth in Mongolia has been fluctuating. As Figure I.57 indicates, actual and potential growth rates in Mongolia have been fluctuating due to a number shocks. Actual and potential growth exceeded 10 percent during 2008–12, declined during 2012–16, but returned to an upward path in 2017. This can be explained by negative TFP growth due to institutional weaknesses and an unfavorable external environment that may have triggered a decline in FDI. During 2012–13, the terms of trade declined by 12 percent, and again by 18 percent (y/y) between the second half of 2015 and the first half of 2016. On the institutional front, the poor fiscal management that led to skyrocketing debt levels (from 58 percent of GDP in 2014 to the unsustainable level of 87 percent in 2016) could have triggered fears among investors with respect to the quality and safety of their funds. This would mean a structural upward shift in the country’s risk premium and inefficient capacity utilization in such an uncertain and unsustainable environment. The lack of credibility and flexibility of macroeconomic policies adds to this uncertainty, creating a lack of confidence. It also affects the economic policy space necessary to respond to exogenous shocks which magnify or prolong the negative impact of exogenous shocks with deleterious effects on long-term growth. A major institutional weakness has been the procyclicality of Mongolia’s fiscal policy. Historically, the fiscal impulse8 is positively related to the output gap in Mongolia (Figure I.58): the fiscal policy is expansionary during boom years and contractionary during recessions, thus magnifying and/or prolonging the impact of shocks. This is further confirmed by the strongly positive correlation between government consumption and the business cycle (Figure I.58). Consistent with the general view that the efficiency of fiscal policy and thus the size of its multiplier depend on the cyclical position of the 8 The fiscal impulse is referred to as the negative change in structural fiscal balance. 33 MONGOLIA ECONOMIC UPDATE economy so that it is mostly productive during recessions compared to booms, procyclical fiscal policy in Figure Figure I.57 I.57 Potential Potential output output growth growth decomposition decomposition Mongolia would diminish productivity. Capital output TFP I.57 Capital TFP Figure Potential Labour Labour GDP GDP growth decomposition Figure 16 16 I.57 Potential output growth decomposition 12 12 TFP Capital Labour GDP 16 88 12 44 8 00 4 -4-4 0 -8-8 -4 -12 -12 -8 -12 -16 -16 1981 1984 1981 1984 1987 1990 1993 1987 1990 1996 1999 1993 1996 1999 2002 2005 2008 2008 2011 2002 2005 2014 2017 2011 2014 2017 -16 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Figure Figure Figure I.58 I.58 I.58 Real Real Real government government government consumption consumption consumption gap gap gap Figure Figure Figure I.59 I.59 I.59 Relationship Relationship Relationship between between between fiscal fiscal fiscal impulse 999 1010 and and output output output Figuregapgap gap I.58 Real government consumption gap and output impulse impulse Figure and gap and I.59 output output 10 gap gap Relationship between fiscal and output gap9 100 100 impulse 1212 and output gap10 Government Consumption Gap Government Consumption Gap 12 80 100 80 Government Consumption Gap 77 60 80 60 Fiscal Impulse Fiscal Impulse 7 60 Fiscal Impulse 40 40 40 22 20 20 2 20 00 -3-3 0 -3 -20 -20 -20 -40 -40 -8-8 -40 -8 -20 -20 -10 -10 00 10 10 20 20 -8-8 -6-6 -4-4 -2-2 0 0 2 2 44 66 88 -2 -8 -6 -4 Output 0 Gap -10Output Gap Output Gap 0 10-20 20 Output Gap 2 4 6 8 Output Gap Output Gap Sources: Sources: NSO; NSO; MoF; MoF; World World Bank Bank staff staff estimates. estimates. NSO;NSO; Sources: Sources: MoF;MoF; World World Bank Bank staff staff estimates. estimates. Themuted The muted The muted rolerole ofTFP role of TFP of (Figure (Figure TFP I.57), I.57), (Figure which which I.57), whichisisunexpectedly unexpectedly is unexpectedly negative, negative, negative, isis linked islinked linked to institutional toinstitutional to institutional The muted weaknesses role and of TFP (Figure probably the I.57), which limited roleis unexpectedly of knowledge negative, and is linked technological to institutional spillovers fromweaknesses the mining weaknesses and weaknesses probably and the probably limited the role limited of role knowledge of knowledge and technological and technological spillovers spillovers from from the the mining mining and — sector sector probably — the the the limited largest largest sector sector role and and of knowledge the the main main and technological recipient recipient ofof foreign foreign spillovers direct direct from the investment investment — — mining toto other other sector—the productive productive sector—the largest sector and the main recipient of foreign direct investment—to other productive largest This sectors. sectors. sector This and the should should be be amain a recipient signal signal toto the the of foreign direct authorities authorities that that investment—to they they need need to to other a consider consider productive a number number sectors. of of This institutional institutional sectors. This should be a signal to the authorities that they need to consider a of institutional andshould other andother andbe a signal structural structural other to the reforms structural authorities reforms to reforms that boost toboost to they TFP boost TFP need and and TFP to and consider economic economic economic a number of institutional diversification. diversification. diversification. InIn In this this and area, thisarea, other area,the structural fiscaland thefiscal the fiscal and and reforms to institutional institutional institutional boost reformsTFP reforms and reforms startedeconomic started started inin 2016diversification. in 2016 2016 are are a a are positive positive In a positive this area, development. development. development. the fiscal and These These These institutional reforms reforms reforms should should reforms bebe be started implemented implemented implemented in 2016 are a effectively effectively effectively positive and and and efficiently. These reforms should be implemented effectively and efficiently. development. efficiently. efficiently. 910 9 The real government consumption gap is the difference between the actual value of real government consumption and the trend 9 real govt consumption estimated using the H-P filter. 99 The The realThe real real government government government consumption consumption consumption gap gap gap is is the isdifference the difference the difference between between between the the the actual actual actual value value value of ofof real real real government government government consumption consumption consumption and andthe the 10 The output gap is the difference between the actual real GDP and the trend real GDP estimated using the H-P filter. and the trend trend trend real real govt govtreal govt consumption consumption consumption estimated estimated estimated using using using thethe the H-P H-P H-P filter. filter. filter. 10 1010 The output gap is the difference between the actual real GDP and the trend real GDP estimated using the H-P filter. TheThe output output gap gap isis the the difference difference between between thethe actual actual real real GDP GDP and and the the trend trend real real GDP GDP estimated estimated using using the the H-P H-P filter. filter. 34 31 31 31 MONGOLIA ECONOMIC UPDATE II. THE ROLE OF PUBLIC INVESTMENT EFFICIENCY FOR GROWTH – A ROAD MAP FOR REFORM A. The Rise and Fall of Capital Expenditures Since 2010 Mongolia has been hooked on projects. The Government of Mongolia (GoM) has recently been dealing with unconventional practices such as quasi-fiscal expenditures (see paragraphs below) and unsustainable volumes of loans for new projects that have arisen since the economic slowdown in the mid-2010s. For at least the last five years, it seems the driving motivation behind public investment management activity has been the need to start as many projects as possible in the shortest period while at the same time deferring the fiscal consequences for as long as possible. The surge of capital expenditures until 2014 was the key factor behind the dramatic increase in consolidated public finance deficits and the public debt. Capital expenditures rose from 4.2 percent of GDP in 2000–06 to 7.2 percent in 2007–10 as strong revenue linked with growing mineral exports helped finance a huge infrastructure development program. The increase in capital expenditures continued after 2010 financed first by high revenue until the end of the commodity boom, and then by external borrowing when a sharp decline in mineral exports slowed economic growth and drastically reduced government revenue. As a result, capital spending averaged 11.5 percent of GDP during 2012– 14, a level that far exceeded the 6.1 percent average of East Asian countries in 2014. 35 MONGOLIA ECONOMIC UPDATE Off-budget spending was the main driver of the growth of capital expenditures from 2012 to 2014. The combination of sluggish government revenue and the deficit control rules of the Fiscal Stability Law prohibited the use of regular budget spending to finance the large public investment program that the government launched to stimulate economic growth. In fact, on-budget funding of capital expenditures declined from 9.7 percent of GDP in 2011 to an average of 8.5 percent during 2012–14. The increase in capital spending was therefore entirely financed through off-budget funding, notably through transferring the proceeds of foreign loans to the government (or government-guaranteed loans) to the Development Bank of Mongolia (DBM) for the financing of non-commercial (public) projects. In 2014 the parliament authorized the issuance of promissory notes to finance a variety of projects initiated by ministries, agencies, and local governments, which also used a new funding technique (called build-transfer, or BT, financing). Cash budgets do not show the cost of ongoing projects financed by promissory notes or BT operations, which are not accounted for until the government makes a payment. Table II.1 Capital expenditures and main sources of funding (in percent of GDP) 2010 2011 2012 2013 2014 2015 2016 2017 Total Capital Expenditures 6 9.7 12.1 16.3 14.9 9.1 10.4 4.3 - On-Budget 6 9.7 9.1 7.8 8.4 6 9.3 6.1 - Investment 5.4 8 8.2 6 6.5 2.6 3.1 3.3 - Maintenance 0.3 0.4 0.3 0.5 0.4 0.5 0.2 0.3 - Foreign-Funded 0.3 1.3 0.6 1.3 1.1 1.1 2.3 2.4 - Off-Budget (DBM) 0 0 3 8.5 6.5 3.1 1.1 -1.8 Sources: MoF data; World Bank staff estimates Reducing capital expenditures was a major component of the government’s economic recovery program. Indeed, capital expenditures declined from 11.1 percent of GDP in 2014 to 6.0 percent in 2015; rose to 9.3 percent in 2016, when the government repaid outstanding promissory notes; and declined again to 6.1 percent of GDP in 2017. At the same time, the DBM financing of non-commercial projects was included in the budget since 2015, and the use of promissory notes was stopped in 2016, but BT financing continues. Table II.2 shows the lasting impact of past off-budget financing on the public debt. Table II.2 Debt incurred through off-budget investment funding in 2016 (MNT billion) Debt Incurred Repaid Outstanding Promissory Notes 672 672 0 DBM (non-commercial projects) 2,528 20 2,508 Build-Transfer 2,300 72 2,128 Total 5,400 764 4,636 Sources: MoF and DBM data B. Efficiency of Mongolia’s Public Investment Program The large public investment program implemented in recent years in Mongolia has not produced the expected benefits. It did not prevent a sharp decrease of GDP growth rates after 2011 and, in fact, its main legacy is a major increase in public finance deficits and public debt, which will have a lasting impact on the country’s economic and fiscal performance. While public investment correlates positively with 36 Sources:MoF Sources: andDBM MoFand data DBMdata B. B. Efficiencyof Efficiency ofMongolia’s PublicInvestment Mongolia’sPublic Program InvestmentProgram Thelarge The B. B. large publicinvestment public Efficiency Efficiency investment of of Mongolia’s Mongolia’s program program Public Publicimplemented implemented Investment Investment in in recentyears recent Program Program yearsin inMongolia Mongoliahas notproduced hasnot producedthe the expectedbenefits. expected benefits.It Itdid didnot notMONGOLIA prevent preventaasharp sharpECONOMIC decreaseof decrease ofGDP GDP UPDATE growthrates growth ratesafter after2011 2011and,and,in fact,its infact, its The large The public investment large public investment program implemented in program implemented in recent recent years years in Mongolia has in Mongolia not produced has not produced the the main legacy main legacy is major increase is aa major increase in in public public finance finance deficits deficits and public debt, and public which will debt, which have aa lasting will have lasting expected benefits. expected benefits. It did not It did not prevent prevent a sharp decrease a sharp decrease of of GDP GDP growth rates after growth rates 2011 and, after 2011 and, in fact, its in fact, its impacton impact onthe country’seconomic thecountry’s economicand andfiscal fiscalperformance. performance.While publicinvestment Whilepublic correlatespositively investmentcorrelates positively main main economic legacy legacy is is a growth major a major in Mongolia,increase increase a in public finance in public cross-country finance deficits and deficits comparison and public shows public debt, that debt, in which which 2017, will have will have a lasting a lasting with economic with economic growth growth inin Mongolia, Mongolia, aa cross-country cross-country comparison comparison shows shows that that ininMongolia 2017, spent 2017, Mongolia Mongolia more spent spent impact impact on publicon on the the capital country’s country’s spending economic economic than its and and East fiscal fiscal Asia performance. performance. and Pacific While While (EAP) public public comparators. investment investment China correlates correlates tops the positively listpositively of EAP moreon more onpublic publiccapital capitalspending spendingthan thanits EastAsia itsEast Asiaand andPacific Pacific(EAP) comparators.China (EAP)comparators. topsthe Chinatops list thelist of of with with countries EAP countries EAP economic economic growth growth characterized countries characterized characterized in in Mongolia, Mongolia, by their by level aa their of by their cross-country cross-country level level public of comparison comparison investment of public public relative investment investment shows shows to their relative relative that that tolevel to in in their their2017, 2017, income oflevel level Mongolia Mongolia of per of income income spent spent capita. per per more more Mongolia capita. capita. on on public public is ranked Mongolia Mongolia capital capital is second. isranked ranked spending spending second. second. than than itsits East East Asia and Pacific Pacific (EAP) Asia and comparators. China (EAP) comparators. tops the China tops list of the list of EAP countries EAP characterized by countries characterized their level by their level of of public public investment investment relative relative to their level to their of income level of income per per capita. Mongolia capita. Mongolia is ranked second. is ranked second. FigureII.1 Figure Co-movement II.1Co-movement Co-movement between between between public public public Figure Figure Figure II.2 II.2 II.2 Correlation Correlation Correlation between between between public public public investment investment investment and and and growth growth growth investment investment investment and and and economic economic economic growth growth growth Figure II.1 Figure Co-movement II.1 Co-movement Public Public Investment Investment incl. between incl. between all all DBM DBM public public spending spending(%(%of GDP) of GDP) Figure II.2 Figure II.2 Correlation Correlation between between Mongolia public public (2000-17) Mongolia(2000-17) 20 20 20 20 investment investment and and Real Real GDP GDP growth growth Growth Growth (y/y, (y/y, %)%) investment and investment and economic economic growthgrowth %) (y/y, %) 1515 PublicInvestment Public Investmentincl. incl.all DBMspending allDBM (%of spending(% ofGDP) GDP) Mongolia (2000-17) Mongolia(2000-17) 20 20 20 20 15 15 %)(y/y, RealGDP Real Growth(y/y, GDPGrowth %) (y/y,%) (y/y, %) growth growth growth 10 1510 15 15 15 (y/y, 10 10 55 growth == yy 0.3x 0.3x 5.7 ++ 5.7 Economic Economic 10 10 10 10 55 0 550 yy= 0.3x+ =0.3x 5.7 +5.7 Economic Economic 5 05 0 -5 -5 00 -4 -4 -2 -2 00 22 44 66 88 10 12 14 10 12 14 16 18 20 16 18 20 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 Public Public Investment Investment (% (% of of GDP) GDP) 00 -5 -5 Sources: Sources: NSOdata; NSO WorldBank data;World Bankstaff staffestimates. estimates. -4 -4 -2 -2 00 22 44 66 88 10 10 12 12 1414 1616 18 18 20 20 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 Sources: NSO data; World Bank staff estimates. PublicInvestment Public (%of Investment(% GDP) ofGDP) Sources:NSO Sources: data;World NSOdata; Bankstaff WorldBank estimates. staffestimates. Figure II.3 Figure Mongolia’s total II.3 Mongolia’s investment is total investment is Figure Figure II.4 Evolution of II.4 Evolution public and of public private and private Figure among among II.3 the the Mongolia’s highest highestin intotal EAP investment is among EAP Figure II.4 Evolution investment, investment, EAP EAP2017 2017 of public and private the highest Figure Figure Gross Gross II.3 in II.3 investment investment EAP Mongolia’s Mongolia’s in in 2017 2017in inEAP total (% total countries EAPcountries investment investment (%of ofGDP) GDP) is is investment, Figure Figure Gross Gross II.4 EAP II.4 investment investmentbyby 2017 Evolution Evolution public public and and of public of public private, private,2017 2017(% (%and and of of private GDP) GDP) private among among Gross the highest the highest investment in 2017 in in inEAP EAP EAP countries investment, investment, Gross investmentEAP EAP 2017 2017 by public and private, (% of investment Gross Gross GDP) in2017 investmentin inEAP 2017in EAPcountries countries(% (%of ofGDP) GDP) 2017 Gross(% Gross of GDP)by investment investment bypublic publicand private,2017 andprivate, (%of 2017(% GDP) ofGDP) Sources:NSO Sources: data;World NSOdata; Bankstaff WorldBank estimates. staffestimates. Sources: Sources: NSO Sources:NSO data;World NSOdata; data; World World Bank Bank Bank staff staff staff estimates. estimates. estimates. Moreover, public expenditure efficiency in Mongolia is low; the country ranks 124th on efficiency of public spending on the Global Competitiveness Index 33 (World Economic Forum, 2016, Figure II.5 ), and 33 has been on a declining trend (Figure II.6 ). The 2016 IMF Public Investment Management Assessment 33 33 (PIMA) for Mongolia revealed the poor performance in terms of public investment management (PIM) practices. Mongolia’s scores are much lower than those for other world and emerging market comparators, some of which invest far less than Mongolia. Weak PIM led to poor project selection, long project implementation delays, high cost overruns, and a rapid deterioration of existing assets (see above), thereby contributing to low spending efficiency. This report argues that successful implementation of a road map aimed at improving public investment efficiency is the highest priority. The proposal includes actions organized around six themes: (a) developing a comprehensive and consolidated approach to PIM, (b) clarifying roles and responsibilities, (c) developing a PIM database, (d) rationalizing the ongoing Public Investment Program portfolio, (e) managing the existing build- 37 comparators, comparators, some some ofof whichinvest which investfar lessthan farless thanMongolia. Mongolia. Weak Weak PIM selection, long PIM led to poor project selection, long project implementation delays, high cost overruns, and a rapid project implementation delays, high cost overruns, and a rapid deterioration deterioration of existing assets (see existing assets (see above), thereby contributing to low spending above), thereby contributing to low spending efficiency. This efficiency. This report argues that successful that successful implementation implementation of of aaroad roadmapMONGOLIA map aimed aimedat ECONOMIC atimproving improving public investment public UPDATE investment efficiency is the highest highest priority. priority. Theproposal The includes actions proposalincludes actions organized organized around around six six themes: (a) developing a comprehensive themes: (a) comprehensive and and consolidated consolidated approach approach to to PIM,(b) PIM, (b)clarifying rolesand clarifyingroles andresponsibilities, responsibilities, (c) developing a PIM database, database, (d) (d) (BT) the rationalizing rationalizing transfer the ongoing ongoing activities and Public Public Investment Investment strengthening Program portfolio, Program portfolio, (e) build-operate-transfer (e) managing managing the existing (BOT)/public-private build-transfer build-transfer partnership (PPP) (BT) activities (BT) activities management, andand and strengthening strengthening (f) upgrading build-operate-transfer build-operate-transfer the allocation (BOT)/public-private (BOT)/public-private partnership of maintenance expenditures. (PPP) partnership (PPP) management, management, and and(f) upgradingthe upgrading (f) theallocation allocationofofmaintenance maintenance expenditures. expenditures. Figure Figure II.5 FigureII.5 Efficiency Efficiency II.5 of Efficiencyof public ofpublic publicspending spending Figure Figure II.6 Figure II.6 Measure II.6 Measure of public investment investment Measure of public investment ranking ranking spending ranking efficiency efficiencyin efficiency inMongolia in Mongolia(Ratio Mongolia (Ratioof GDPgrowth ofGDP growth growthto to to government capital government capital government spending, % of GDP) capital spending, % of GDP) GDP) 2.4 2.4 2.0 2.0 1.6 1.6 1.2 1.2 0.8 0.8 0.4 0.4 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Sources: World Sources: Sources: World Economic World Economic Economic Forum Forum Forum (2016). (2016). (2016). The The fragmentation fragmentation of thedecision-making ofthe decision-makingprocess; the absence process; the absence ofof aa coordinated coordinated approach approach based based on on The fragmentation sound national andof the decision-making sector development process; the strategies; absence generally of a poor coordinated project approach preparation, based appraisal, on and sound national and sector development strategies; generally poor project preparation, appraisal, and sound national selection and sector procedures; and development lowpriority thelow strategies; priority givento generally maintenance tomaintenance poor project have preparation, strong a strong negative appraisal, and selection procedures; and the given have a negative impact impact on on the the selection quality, quality, procedures; and effectiveness, effectiveness, and and the low priority efficiency efficiency ofthe of given to maintenance program. theprogram. The Ministry The of Ministry ofhave a strong Finance Finance is only is onlynegative foron impact responsible responsible for the the selection the quality, selection ofof programs and effectiveness, programs and and projects efficiency projects financed financed by the of the program. by the state state budget. of The Ministry budget. Direct Finance Direct lending is only lending by by ministries, responsible ministries, departments, for the selection departments, agencies, of programs agencies, andlocal and local and governments through projects financed governments through promissory state budget. by promissory the and notes and notes BT lending Direct BT financing financing byenable enable them ministries, them toto short-circuit short-circuit whatever whatever controls controls are are in in place place to to moderate moderate the the size size and and growth growth of of the the program program and and departments, agencies, and local governments through promissory notes and BT financing enable them improve improve the quality the quality of individual of individual projects. projects. to short-circuit whatever controls are in place to moderate the size and growth of the program and improve the quality The National of individual Development projects. Agency (NDA) is expected to play a strategic coordinating role in the PIM The National Development Agency (NDA) is expected to play a strategic coordinating role in the PIM system. For a long time, however, the main objective of most government ministries, departments, and system. For a long time, however, the main objective of most government ministries, departments, and The National agencies agencies was Development Agency was to prepare, finance, to prepare, finance, (NDA) and and is expected implement implement the to play possible the largest largest a strategic possible coordinating number number role in of projects, of projects, the PIM rather rather than than adopting system. For a strategic approach a long time, however, integrating the main public investment objective planning government of most planning and project selection into broad, adopting a strategic approach integrating public investment andministries, departments, project selection and into broad, well-conceived, agencies and realistic was to and prepare, economic finance, and sector development and implement strategies. The ofNational projects,Development well-conceived, realistic economic and sectorthe largest possible development number strategies. The National rather than Development Plan includes major infrastructure projects that seem to lack a basic analysis of prospective demand. adopting Plan major approach a strategic includes integrating infrastructure projectspublic that investment seem to lack planning a basicand project analysis of selection intodemand. broad, prospective The NDA is also responsible for checking the quality of projects developed under the concession law, The NDA is also and well-conceived, responsible realistic for checking economic andthe quality sector of projectsstrategies. development developed under The the concession National Development law, which regulates concession and PPP contracts, including BT operations, which can be large. However, which Plan regulates includes concession major lack and infrastructure PPP contracts, projects that including seem to lackBT operations, which can be large. However, there is a critical of capacity in NDA, and its role in a basic that analysis area of prospective is likely demand. to be transferred toThe the there is a critical lack of capacity in NDA, and its role in that area is likely to be transferred to the NDA is also responsible for checking the quality of projects developed under the concession law, which regulates concession and PPP contracts, including BT 34 operations, which can be large. However, there 34 is a critical lack of capacity in NDA, and its role in that area is likely to be transferred to the Ministry of Finance, which also does not have the staff and capacity to play a major role in project appraisal, and monitoring. Poor investment planning and project selection lead to ineffective implementation of approved projects. Low execution rates, weak management structures and performance, and other administrative capacity constraints limit absorptive capacity. This institutional capacity issue cuts across all levels of government. 38 MONGOLIA ECONOMIC UPDATE Modest and falling budget allocations for operation and maintenance are a major drawback. Despite the recent increase in public investment, the capital maintenance budget has not increased substantially over the last 10 years. The GDP ratio of maintenance spending increased from 0.3 percent of GDP during 2003–09 to an average of 0.4 percent during 2014–15 before declining to less than 0.2 percent in 2016. More importantly, the ratio of maintenance to total capital expenditures sharply declined from 5.1 percent in 2010 to 1.9 percent in 2016. The average in comparator countries is about 6.2 percent. The short- and long-term efficiency of Mongolia’s public investment program is seriously affected by the shortage of maintenance expenditures, which reduces the benefits and shortens the economic life of new infrastructure and other projects. C. PIM – Legal and Institutional Issues Legal Issues The legal framework for the management of capital expenditures is a set of budget and investment laws regulating a variety of public finance management procedures. Box II.1 summarizes several of the principal pieces of legislation regulating public investment management and other budget expenditures. Box II.1 Current legal documents regulating public investment management The Integrated Budget Law, which is the organic budget law, also is the most important legal document for the public investment management (PIM) system. It provides clear legal mandates and specifies requirements for public investment programming and budgeting. Chapter 5 clarifies the roles and responsibilities of key stakeholders. It describes in detail the PIM planning process, including submission of project proposals, prioritization mechanisms for integration of specific proposals in the public investment program, and approval of the program by the State Great Khural (the Mongolian parliament). The Fiscal Stability Law controls total public spending, including capital expenditures, through rules limiting public finance deficits based on actual government revenue over several years. The Law on the Development Bank of Mongolia created new types of PIM projects that are not affected by the public finance deficit rules of the Fiscal Stability Law. As a result, most of the increase in capital expenditures during 2012–15 was financed by the DBM. DBM non-commercial projects are now integrated into the state budget and subject to the same rules and regulations as investments financed by that budget. The Law on Concessions deals with concessions and PPP contracts. This is the law that regulates the fairly large number of build-transfer projects that have been implemented in recent years. The Public Procurement Law establishes procurement rules for both recurrent and capital expenditures. The selection of procurement procedures depends on threshold values assigned by the Cabinet. Source: World Bank (2018c). The main issue, however, is less the legal framework itself, than its implementation. No specific technical, practical, and operational guidance has been developed regarding feasibility studies and project implementation, including financing and execution of the DBM’s non-commercial projects and the structure of BT projects. In fact, actual project planning, appraisal, and budgeting processes are managed through internal negotiations and informal agreements among key stakeholders, including the Ministry of Finance and the line ministries concerned. 39 MONGOLIA ECONOMIC UPDATE The lack of clear guidelines has had a negative impact on some of the programs approved by the government. For instance, most BT projects do not require private partners to assume real risks and responsibilities with respect to the financing and implementation of the projects, but the government is legally obligated to repay private contractors upon the transfer of the assets to the government. This means that BT projects have become another form of promissory note. Institutional Issues The PIM institutional landscape includes many stakeholders (Table II.3). The State Great Khural is the highest body, which approves capital investment policies, plans, and projects. The National Development Agency and the Ministry of Finance have similar responsibilities for the preparation of investment programs and budgets. It is not clear how the two institutions coordinate their activity. In practice, line ministries tend to deal directly with MOF’s Department of Investment Budget (DIB). Line ministries separately manage investment and recurrent expenditures with a dual budget system. Maintenance and other recurrent costs of capital projects are incorporated in the State Budget when the investment project concerned is completed. According to DIB and external observers, the funds available for operations and maintenance are clearly insufficient. Line ministries submit procurement plans for projects financed by the State Budget before receiving the funds for approved projects. DIB is responsible for budget execution and procurement but delegates the function to line ministries and other spending agencies. Table II.3 Key Institutions involved in management of public investment Institution Role in public investment management Approves State Budget, including decisions concerning public investment policies, State Great Khural (SGK) plans, and projects Reviews and adopts public investment policies and projects and submits the State The Cabinet Budget to the Great Khural National Development Prepares and manages the public investment program, which provides the basis for Agency (NDA) the selection of projects in the State Budget Prepares the State Budget and manages budget execution; estimates resources Ministry of Finance (MoF) available for funding Department of Investment Manages budget execution (including procurement) for domestically financed Budget (MoF) projects Department of the Treasury Manages single Treasury account (MoF) Line Ministries and Prepare budget and project requests; provide financial and progress reports to Agencies MOF; implement – and report on – public investment projects Source: World Bank (2018c). A review of the roles and responsibilities of key institutions reveals gaps in PIM practices (Figure II.7). There is no independent review and no ex-post evaluation of investment projects. The gatekeeping oversight role of the MoF (in the upstream decision process and the downstream implementation process) is generally limited, and almost nonexistent in the case of BT and BOT projects. These weaknesses allow fiscal risks to go unmanaged until it is too late. 40 MONGOLIA ECONOMIC UPDATE Figure II.7 PIM Institutional Arrangements: Roles and Responsibilities of Key Institutions Figure II.7 PIM Institutional Arrangements: Roles and Responsibilities of Key Institutions Source: World Source: World Bank Bank(2018c). (2018c). Note: National Note: National Development Development Agency (NDA), Agency Line Ministries (NDA), (LMs)),(LMs)), Line Ministries of Finance MinistryMinistry of(MOF), Not Finance Available (MOF), Not(N/A), Public (N/A), Available Investment Department (PID), Treasury Department of MoF (TD), Ministries, Departments, and Agencies (MDAs). Public Investment Department (PID), Treasury Department of MoF (TD), Ministries, Departments, and Agencies (MDAs). D. A Road Map for PIM Reforms D. A Road Map for PIM Reforms The current practice of preparing and executing public investment projects in Mongolia does not exhibit good practice for a PIM system. The arrangements are completely fragmented and there is no way current The practice to identify of preparing the efficiency and and executing effectiveness ofpublic investment development projects activity. in Mongolia A road does not map for improving exhibit good practice public investment for a PIM in management system. arrangements Theincludes Mongolia are completely 17 actions fragmented organized around and there six themes, is no including way to identify the efficiency and effectiveness of development activity. A road map (a) developing a comprehensive and consolidated approach to PIM, (b) clarifying roles and for improving public investment management responsibilities, in Mongolia (c) developing includes (d) a PIM database, 17 rationalizing actions organized around the ongoing six PIP themes, (e) portfolio, including managing (a) developing a comprehensive and consolidated approach to PIM, (b) clarifying roles and existing BT activity and strengthening BOT/PPP management, and (f) upgrading the allocation of a responsibilities, (c) developing maintenance a PIM database, (d) rationalizing the ongoing PIP portfolio, (e) managing existing BT budget. activity and strengthening BOT/PPP management, and (f) upgrading the allocation of a maintenance Developing a Comprehensive and Cohesive Approach to a PIM System budget. All development activity should be framed by the expected results of the investment project rather Developing than through a Comprehensive and Cohesive the source of funding. Approach The source to a PIM of funding System should become the secondary consideration after projects have been identified as being of value to the nation. To that extent, all (regardless of All source or activity development funding should type) initial be framed project proposalsby in the expected Ministries, results of the Departments, investment and project should rather Agencies (MDAs) than through be assessed the source through of funding. a standard The source prescreening of funding template thatshould shouldbecome the secondary be completed by projectconsideration proposers. The template after projects would become have been the single identified as point ofentry being of valuetotothe thePIM system nation. Toin Mongolia. extent,Implementing that all (regardless this of source the would remove funding “funding or type) bias” initial that project favors projects proposals that have in Ministries, identified non Departments, and-budget Agencies external (MDAs)funding should regardless be assessedof whether through a the project standard and regardless is a priority template prescreening of the be that should direct and contingent completed by projectliabilities that proposers. be incurred maytemplate The result. the single point of entry to the PIM system in Mongolia. Implementing this as abecome would would remove the “funding bias” that favors projects that have identified non-budget external funding In a successful regardless PIM system, of whether the project project the is proposal a priority should be and regardless driven of the byand direct either national contingent or sectoral liabilities that policies. This would provide may be incurred as a result. the authorities with a useful tool that could be used, when necessary, to contain expansionary pressures on the public investment program. In a successful PIM system, the project proposal Box II.2 Purpose of should be driven by either national or sectoral prescreening policies. This would provide the authorities with a useful tool that could be used, when necessary, to Prescreening contain represents expansionary a common pressures point on of entry the public into a formal investment PIM system. It prevents financial and human program. resources from being wasted on feasibility studies for projects that would never be funded and assists in 37 41 MONGOLIA ECONOMIC UPDATE Box II.2 Purpose of prescreening Prescreening represents a common point of entry into a formal PIM system. It prevents financial and human resources from being wasted on feasibility studies for projects that would never be funded and assists in reducing pressures on the budget by keeping the project pipeline at a manageable level. If implemented properly, it is also an effective tool in reducing the possibility of unsustainable extrabudgetary finances being sourced without consideration of the wider fiscal consequences. Prescreening is also an important first quality step that allows the proposing authorities to test the robustness of a project concept in terms of logic, risk, and sustainability. It is also in the interests of the proposing authorities that their projects provide real solutions to real problems and that they are planned and implemented effectively to avoid constant problems throughout the operational life of the project. In good practice countries, all projects, large or small, are expected to follow the same formal prescreening process. A positive decision at this first stage of entry into the PIM system requires that the strategic policy relevance, rationale, and realism of the project proposal is demonstrated to the satisfaction of the decision makers and a convincing case has been made to justify expenditure, whether it is to consider funding to directly implement a small project or on further planning and appraisal for larger ones. Source: World Bank (2018c). As a public investment planning tool, the GoM should consider the development of a rolling forecast for annual public investment expenditure within an MTFF or Medium-Term Budget Framework (MTBF). This would not only provide guidance to line ministries as they plan future projects, but it will help the MoF’s Investment Budget Department to withstand unrealistic demands during the budget round each year. Given the unpredictability of government revenues due to commodity price fluctuations, the forecast should predict a range of scenarios (loosely “Base Case,” “Best Case,” and “Worst Case”) that might be called upon closer to the actual budgeting period when revenues are more likely to have a greater prospect of accuracy. The forecast should also identify and estimate the associated recurrent costs of projects and indicate the impact of the year in which they are completed. For this reason, also, the forecast should cover commitments for other forms of finance such as BOT and foreign-financed projects, which, when they are completed, often incur significant recurrent costs. The GoM should gradually move quickly toward a rules-based PIM system, with new regulations and templates that are also backed with guidance. This is to ensure consistency in the system and even- handed treatment in the way that projects are identified, prepared, appraised, and selected. To achieve consistency in project appraisal, project proposers should follow a standard template system that covers all the required steps of appraising a project. A project proposal should only enter the PIM system formally with a Unique Project Number (UPN), which is assigned when it has been successful in the initial prescreening. This allows tracking of the project as it moves through the various stages of appraisal and, if ultimately selected, implementation. The UPN would be a foundation of the proposed project database and would allow all contracts and related expenditures to be tracked against the original proposal. This would make project monitoring and (eventually) project completion reports and ex-post evaluations easier to undertake, yielding valuable lessons to the GoM, which could be used to improve the formulation of future projects. When projects have been successfully prescreened and allocated a UPN, they should be formally appraised to a degree that is commensurate with the scale of the project. Project appraisal should 42 MONGOLIA ECONOMIC UPDATE become a default position for all projects. Unlike on large projects, which require full feasibility studies and cost-benefit analysis, appraisal need not be a complex and time-consuming exercise for small projects, but the necessary time and effort should be dedicated to proving the need for the project and that it is a worthwhile and efficient use of public funds. The type and scale of appraisal should be proportional to the nature of the project, and the government should regulate appropriate thresholds at which they apply. Clarifying Roles and Responsibilities As the entity responsible for managing the public finances, it is essential that the MoF is fully aware of and able to manage the commitments that MDAs are making on behalf of the Government of Mongolia. The present unsatisfactory situation regarding unmanaged PIM activity and debts accumulated through extrabudgetary funding has happened while the role of the MoF has been restricted to somewhat limited direct budget-funded activities. The MoF should be made aware of all financial commitments related to projects before they approved. This should be made mandatory through an appropriate regulation. The role of some institutions engaged in PIM appears to be in flux and quickly needs to be clarified. The amended Concession Act implies a reduced role for the NDA with a rebalancing of authority back to the MoF. Clarification of these amended roles needs to be accompanied by adequate resources to fulfil them. Furthermore, the powers of line ministries to enter into extrabudgetary funding arrangements needs to be curtailed. The GoM should identify and empower a single entity (for convenience, hereafter, the “PIM Unit”) to develop and manage the PIM system and the Public Investment Program within in a single cohesive framework. Although MDAs and local governments should retain responsibility for identifying, preparing, and executing public investment projects, all this activity should come under the overview and supervision of a PIM Unit regardless of the form of procurement, the form of contract, or source of funding. In addition, the MDAs should prepare their projects within the PIM framework, which would be strengthened and monitored by the PIM Unit. The PIM Unit would also be responsible for reviewing and checking project proposals for quality assurance purposes (see below). PIM Units are often found in ministries of finance, but not exclusively. If a PIM Unit is not located within the MoF, it is still essential that the highest level of cooperation is undertaken with the Department of Investment Budget in the MoF. Alternatively, this department could be converted into the PIM Unit. A quality management system should be developed to check the quality of project proposals through identification, preparation, appraisal, and readiness for implementation stages. This should start with the prescreening step, which would check whether projects have been correctly identified and whether they are appropriate. Further checks should then be developed after the appraisal stage prior to the procurement procedure and again following implementation prior to the project becoming operational. The proposed PIM Unit would be responsible for the development of the quality management system, its implementation, and its subsequent operation. The overall objective of the quality management system would be to ensure that only correctly identified, fully prepared project proposals with credible implementation plans are selected for funding (regardless of the source of that funding). 43 MONGOLIA ECONOMIC UPDATE Developing a PIM Database A project database that is a single source of information for all public investment projects should be developed. To create a cohesive picture of all development activity in Mongolia, all projects regardless of the source of funding would be assigned a UPN on condition that a proposal passes through the first quality check at the prescreening stage. This UPN would stay with the project throughout its useful life into the operational phase or until activity ceases in the case of rejected or abandoned projects. This will allow all capital estimates to be updated and expenditure to be tracked against individual projects across multiyear implementation and across all contracts that are related to the realization of the project. It should also include for the first time a tracking item that includes and updates projected operational and maintenance costs related specifically to the project throughout its development phase. This will help the Investment Budget Department at the MoF to forward plan budgets based on future as well as existing commitments and planned expenditures on an aggregate basis, thus helping them identify an available envelope for possible new projects with more confidence. This can be taken forward after the rationalization of the Public Investment Program. Rationalizing the ongoing Public Investment Program Portfolio Rationalize the Public Investment Program (PIP) to restructure and/or remove non-performing ongoing projects from the portfolio so that the financing demands of the portfolio can be prioritized and more effectively aligned with available fiscal resources. Similar rationalization efforts have already been made in the governments of Romania (World Bank, 2016a) in 2015 and Ukraine (World Bank, 2016b) in 2016–17. Portfolio rationalization is an urgent issue in Mongolia, because many public investment projects, including more than 480 state budget projects (including 119 projects transferred from the DBM non-commercial investment projects), around 55 BT or BOT projects with contracts signed, and many other projects under preparation and/or appraisal to be adopted, are already in the PIM pipeline seeking their own funding. A major part of the portfolio has been seriously underfunded, which has led to a huge and unaffordable overhang of partially implemented projects. Box II.3 Example of rationalization criteria Rationalization guidelines could be established through a resolution of the Cabinet, providing clear guidance and criteria for how underperforming ongoing projects can be effectively screened, identified, prioritized, resolved, and managed. The objective of portfolio rationalization guidelines is to improve the effectiveness and efficiency of public investment expenditure under deteriorated fiscal space conditions by prioritizing well- performing ongoing projects or restructuring underperforming ones from the PIP. For the scope and coverage of the rationalization guidelines, the guidelines would cover the portfolio of all ongoing/uncompleted state- level, public capital investment projects, whether funded by the State Budget (former DBM included), BT, BOT, or foreign-financed. The proposed rationalization procedure will focus on (a) identifying underperforming projects from within the overall PIP; and (b) removing or suspending these projects from the PIP and subjecting them to a rationalization procedure to resolve their status. This would involve re-costing, restructuring, postponing, closure, and liquidation, or curtailed completion and handover. In the absence of a comprehensive PIP database, it will be necessary to carry out a detailed survey or review of uncompleted projects led by the MoF and Line Ministries (LMs). 44 MONGOLIA ECONOMIC UPDATE Possible examples of the rationalization criteria include checking the strategic relevance or importance, project implementation progress, and project feasibility. The “strategic relevance/importance” criterion is to ensure the relevance/importance of the project in medium-term and long-term national and sectoral plans. The “implementation progress” criterion checks whether the physical construction is over 50 percent or another percentage, and whether the remaining funding requirement is less than the percentage of total estimated cost. The “project feasibility” criterion is to assess the socioeconomic feasibility with information on demand estimates. This analysis, however, cannot include economic feasibility in the assessment criteria, due to the lack of sufficient cost and time to collect and assess individual feasibility studies (feasibility studies shall be done again for some selected ones only if necessary). As an auxiliary criterion, contractual obligation is also checked. Projects financed by foreign loans or grants often have contractual obligations, and these projects should be additionally prioritized. Similarly, projects that already signed concessions also receive additional consideration. Source: World Bank (2018c). Managing BT Activity The system of BT financing for projects should be closed permanently by removing loopholes created by the amendment to Resolution 37. BT represents a form of borrowing that deliberately aims to defer the cost of payment for projects to future years. It is an expensive form of finance and represents a huge distortion to the present PIM system. The PIP therefore needs to account for the future repayment schedule of the BT projects that are currently under implementation. There is a risk that these repayments will eventually crowd out budgetary investment projects under tight revenue conditions. Its continuing presence is also a major constraint to any reform program aimed at moving PIM practices in Mongolia to what might be considered good international practice. BT repayments should be prioritized to clear the arrears as soon as possible, with the contracts incurring the most punitive penalties and interest charges being cleared first. BT schemes represent an expensive form of finance that is already accruing interest and penalty charges for late payment— making it more expensive still. The current slow rate of repayment adds significantly to the arrears and runs the risk that some of the investments made under BT will no longer be in operation or will be obsolete before they are paid for. Strengthening BOT/PPP Management The increasing scale and volume of BOT/PPP projects in Mongolia demands that urgent action be taken to strengthen implementing and monitoring capacity. Unlike BT procurement, BOT is a more credible form of public-private partnership (PPP) as it usually involves some genuine risk taking by the private partner. Already the value of investments through BOT have reached more than MNT 3.7 billion and appear set to increase further as project proposers see other non-budget funding options being closed. If done correctly, BOT/PPP projects can bring efficiencies into public investment projects and deliver effective outcomes. Furthermore, maintenance provision is the responsibility of the private provider. However, if they are done incorrectly, the fiscal consequences could last decades. Given the stark contrast between success and failure, it is imperative to dedicate sufficient capacity to the subject area and to ensure that the regulatory and institutional arrangements are appropriate. 45 MONGOLIA ECONOMIC UPDATE All further activity related to PPP should be focused on identifying and preparing opportunities for implementing projects with BOT/PPP within a single cohesive PIM system. PPP projects should not be generated through separate and parallel legal and institutional arrangements, but as a part of the integrated PIM system that recognizes projects of value to the nation regardless of the form of financing and implementation. Therefore, PPP should not be used as a creative accounting technique; instead it should be employed when it is more efficient and effective to do so and it can be assessed qualitatively that a PPP implementation is likely to deliver a better outcome than more conventional procurement. The GoM will need to focus on the following additional areas in addition to other normal considerations in preparing an investment project: (a) the feasibility of the project or its interest to investors as a PPP— soft market test results are required to make this assessment and judgement; (b) a value-for-money assessment compared with conventional implementation; and (c) fiscal risks, which require analysis. Fiscal risks that come with all BOT/PPP contracts should be understood, quantified, recorded in accordance with the Debt Management Law (DML), and monitored. The current stock of BOT/ PPP projects, estimated at MNT 3,767 billion, contains unknown contingent liabilities, and there is an existing legal requirement to report them. An urgent exercise should be undertaken to evaluate existing BOT/PPP contracts and assess the contingent liabilities contained within. These should then be reported to the Debt Management Division of MoF. New BOT/PPP projects should not be signed until the fiscal consequences have been identified and quantified with MoF. This includes an assessment of both explicit and contingent liabilities within the final draft contract prior to signature. An assessment of the cumulative effects of new liabilities on top of existing ones should also be undertaken. The GoM may also wish to consider capping the total amount of PPP liabilities it incurs. Upgrading the Allocation of Maintenance Budget – Investing in Existing Assets Maintenance costs and all other operational costs should be estimated at an early stage of project preparation. Projects should not be selected without sight of these costs. Without adequate maintenance, assets resulting from investments quickly deteriorate, leading to underperformance, increasingly disappointing outcomes and, ultimately, increased pressure to replace them earlier than expected. It is also impossible to adequately appraise an investment project without an appraisal of the operating costs. There is no “golden rule” for the provision of maintenance budget levels, which in any case are usually provided for in the operational recurrent budgets of MDAs. In the case of BOT/PPP projects, the provision, and therefore the cost, of maintenance is almost always the responsibility of the private company.11 This means that the future maintenance costs are estimated by the private company in its business plan prior to submitting its tender for the project. Similar behavior is therefore required of public entities in preparing their project proposals for appraisal. The costs of future maintenance should therefore be estimated as a matter of course along with all other future operational costs associated with the project. For instance, in a school building proposal, the operational costs should include annual teacher and other staff costs, the heating and other utility costs, as well as the costs of the provision of other goods and services that needed in a school. This comprehensive approach of estimation of operational costs will enable the MoF to better plan its future recurrent budget provisions for completed projects. This is not the case in BT projects where the maintenance cost falls to the responsible public entity—another example of 11 why BTs are not PPP projects. 46 MONGOLIA ECONOMIC UPDATE References Bank of Mongolia, 2013. “Growth Accounting.” Internal Note. Ulaanbaatar, Mongolia. Bank of Mongolia, 2017. Monetary Policy Guideline for 2018. Government Document. Ulaanbaatar, Mongolia. Bank of Mongolia, 2018. Inflation report (2018 Q1). Government Document. Ulaanbaatar, Mongolia. Dutu, R., 2012. Long‐Term Growth and Macroeconomic Stability in Mongolia. Technical assistance report on macroeconomic modelling and risk analysis. Multi‐Sectoral Technical Assistance Project (MSTAP). Ulaanbaatar, Mongolia. Cheng, K., 2003. “Growth and Recovery in Mongolia During Transition.” IMF Working Paper No. 03/217. Washington, DC. USA. International Monetary Fund, 2018. Mongolia: Third review of the Extended Fund Facility Program. Staff report. Washington, DC. USA. www.legalinfo.mn Ministry of Finance, 2018. Medium Term Fiscal Framework for 2019-21. Government Document. Ulaanbaatar, Mongolia. Piketty, T., 2014. Capital in the Twenty-First Century. The Belknap Press of Harvard University Press. Cambridge, Massachusetts. USA. World Economic Forum, 2016. Global Competitiveness Index 2016–17, Insight Report. Vashakmadze, E., 2018. Global and Regional Outlook and Risks – Key Highlights. Box prepared for the Global Economic Prospects report (2018), World Bank, Washington, DC. USA. World Bank, 2016a. Romania: Rationalizing the Existing Public Investment Portfolio. Technical assistance reports. Washington, DC. USA. World Bank, 2016b. Ukraine: Development and Introduction of a Methodology for Public Investment Portfolio Cleaning. Technical assistance reports. Washington, DC. USA. World Bank, 2018a. Global Economic Prospects. Washington, DC. USA (June). World Bank, 2018b. The Commodity Markets Outlook. Washington, DC. USA (June). World Bank, 2018c. Mongolia: Public Expenditure Review. Washington, DC. USA (forthcoming). 47 MONGOLIA ECONOMIC UPDATE Annex: Growth Accounting Modelling The growth accounting methodology aims to explain the growth rate of aggregate output in terms of the growth contributions from the various factors of inputs including capital, and labor, as well as the growth of Total Factor Productivity (TFP). The analysis normally assumes a standard neo-classical production function of type Cobb Douglas: Y = AL1-αKα. Where; K is capital stock, L is employment (Labor), α represents the capital share in output, and A is the TFP, also referred as the Solow residual. At the macroeconomic level, the TFP captures the efficiency of capacity utilization and the rate of capacity utilization. The TFP can change due to efficiency — a desired long-term phenomenon such as technological or institutional changes or due to short term phenomenon of increasing or fall in the rate of capacity utilization from boom or bursts cycles. Due to lack of data on capital stock in most countries including Mongolia, the growth accounting normally begins by assuming an initial capital output ratio (K/Y)0 in a certain period; in our case in this report, 1980. This is used to determine the initial capital stock, K0 = Y0 * (K/Y)0. The perpetual inventory method is used to generate a series of capital stock using the gross fixed capital formation (It) data and the rate of depreciation (δ) following the equation of motion of capital — Kt = (1 ‒ δ)Kt-1 + It . The assumption about (K/Y)0 is of paramount importance because if it is set too high, the incremental contribution of capital would be less and thus would be assigning a higher role to productivity. This is why rich countries can hardly increase their growth by accumulating more capital, yet low-income countries, which are capital deficient and thus with low capital-output ratio, command higher return on the scarce capital which may attract new capital to achieve higher growth. In this analysis, we assume a capital output ratio of 1.5 (150 percent) in 1980. This assumption is reasonable in our view for two reasons. First, at the time the country was under the influence of Soviet Union and under the socialist system poor countries could hardly accumulate capital due to lack of private incentive. Secondly, this would yield a capital output ratio of 3.3 (330 percent) in 2017 which is quite reasonable compared to ratios ranging between 5-6 for wealthy nations (Piketty, 2014). Dutu (2012), a study financed under the World Bank’s Multi‐Sectoral Technical Assistance Project (MSTAP), assumes that the K/Y ratio in 2005 is 200 percent, far below the 560 percent by Bank of Mongolia for the same period. In addition to the assumption about capital-output ratio, the Mongolia Economic Update assumes as it is common in the literature that δ is 5 percent. The Bank of Mongolia study uses 6.8 percent, but this should not yield substantial differences in the results. With the assumptions on initial capital and depreciation, capital stock series are generated. The last assumption made in the growth accounting analysis concerns the capital share in output, α. This report uses the input output table for 2011-2015 and estimates an average α of 63 percent, compared with 74 percent in Dutu (2012) and 51.6 percent in the Bank of Mongolia study of 2013 (Bank of Mongolia, 2013). We apply HP-filter on employment and the estimated TFP to generate potential GDP implied by these assumptions and decompose its growth to establish the potential growth in Mongolia. 48 MONGOLIA ECONOMIC UPDATE Our results are similar to those obtained by Dutu (2012) (Figure (A).1) indicating that capital accumulation is the main driver of potential growth in the recent decade. The results in Bank of Mongolia (2013), informed by the Penn World Tables, seem less plausible as the capital output ratio implied in their analysis dramatically rises in the early -1990s and then rapidly falls from 7.6 in mid- 1990s to 5.9 in 2005 to 3.6 in 2013, yet this was a period of rapid investments in physical capital in the country (Figure (A).2). The Bank of Mongolia results assigns a higher role to TFP in explaining growth as a falling ratio implies that real GDP is growing much faster than the stock of capital or the latter is falling. While a K/Y ratio of 7.5 surpasses that for many other high-income countries, its trend does not seem countrycountry to (Figure capture(Figure (A).2). the (A).2). The emergenceThe BankBank of of the of Mongolia Mongolia capital results results stock assigns assigns fueled by FDIa higher a higher roleto role that Mongolia toTFP TFP ininexplaining explaining experienced growth in the growth recentas as a a falling falling decade,ratio ratio implies making implies thatoneGDP that real Mongolia real GDP of the is isEAP growing growing much countries,much faster faster after than than China, the the with stock thestock of highest capital of total capital or the investment (as is latter or the latter a is falling. falling. WhileWhile a K/Ya K/Y ratio ratio of 7.5 of 7.5 surpasses surpasses that that for for manyother many high-income countries, other high-income countries, its trend its trenddoes does not not share of GDP) in 2017. In contrast, the estimates implied by the assumptions in this Update, appear to seem seem to capture to capture the the emergence emergence of of thethe capitalstock capital fueled by FDI stock fueled FDI that that Mongolia Mongolia experienced experienced in in thethe recent capture recent adequately moremaking decade, decade, making the recent Mongolia Mongolia one decade one of of ofthetherapid EAP EAP investments countries, and countries, afterthus capital China, with after China, accumulation withthe the highest seen highest in total total Mongolia investment investment (Figure (as a (as (A).3). a share share of GDP) of GDP) in in 2017. 2017. InIn contrast,the contrast, the estimates estimates implied impliedby by the the assumptions assumptions in this in this Update, Update, appear appear to capture to capture more more adequately adequately therecent the recent decade of rapid decade of rapidinvestments investmentsand thus and capital thus capital The growth accounting accumulation accumulation seenseen results in Mongolia in Mongolia in this (Figure (Figure report are also broadly in agreement with those of an earlier (A).3). (A).3). The working The IMF growth growth paper (Cheng, accounting accounting results results 2003), in in this which this report covered report are are a broadly also also period broadly up into early 2000. agreement agreement This with with paper those those also ofof anan assumed earlier IMF earlier IMF an working initial working paper capital paper of zero (Cheng, (Cheng, in 1959, 2003), 2003), which which a capital share covered covered in output a aperiod period up to 69 up of to percent, early early 2000.and 2000. This Thisa depreciation paper paperalso assumed also rate ofan assumed 6 an percent. initial initial capital This capital IMF of zero working of zero paper in 1959, in 1959, a concluded capital a capital sharethat sharein outputaccumulation capital inoutput of 69 percent, of was percent, the and and aamain engine of depreciation depreciation growth rate of of rate 6 6 before percent. percent. the This 1990s, This IMF IMF but working working TFP became paper paper positive only concluded concluded from that that the late capital capital 1990s up to accumulation accumulation 2000. was was the the main mainengine engine growth of of growth beforebefore the 1990s, the 1990s, butbut TFP TFP became became positive positive only only fromthe from thelate late 1990s 1990s upupto to2000. 2000. Figure Figure Figure (A).1 (A).1(A).1Results Results Results of of Growth of Growth Growth Accounting by Figure by by Accounting Accounting Figure Figure (A).2 (A).2 (A).2Results Resultsof Growth Results Accounting of of Growth Growth by Accounting by by Accounting DutuDutu Dutu (2017) (2017) (2017) Bankof Bank Bank Mongolia of of Mongolia Mongolia (2013) (2013) (2013) Source: Source: Source: Dutu Dutu Dutu (2012).(2012). (2012). Source:Bank Source: Source: Bank of Bank Mongolia Mongolia of Mongolia of (2013). (2013). (2013). Figure (A).3 Figure A comparison (A).3 trends of of A comparison ofof trends the capital the output ratio capitaloutput various usingvarious ratio using assumptions assumptions 49 45 45 MONGOLIA ECONOMIC UPDATE Figure (A).3 A comparison of trends of the capital output ratio using various assumptions 8.5 7.5 6.5 5.5 4.5 K/Y ratio implied by PWT assumptions 3.5 K/Y ratio implied by Our assumptions 2.5 1.5 Source: Penn World Tables (PWT); World Bank staff estimates. Source: Penn World Tables (PWT); World Bank staff estimates. 46 50 MONGOLIA ECONOMIC UPDATE 51 MONGOLIA ECONOMIC UPDATE 52