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p. 12 of 81 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia People's Republic of China Hong Kong, China Republic of Korea Mongolia Taipei,China Southeast Asia South Asia Central Asian Republics The Pacific III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Mongolia

Despite growing inflationary pressure, Mongolia has achieved some macroeconomic stability. This contributed to a positive environment for stronger private sector-led growth, particularly in the services and industry sectors, which offset the impact of a severe contraction in agricultural output due to a harsh winter. Future economic growth will depend on how quickly the economy can diversify so as to reduce its vulnerability to external shocks. Until then, growth will remain below potential.

Macroeconomic Assessment

In 2001, the economy continued to be affected by exogenous factors, mainly severe natural shocks and declining exports, which kept its performance below potential. As a result, GDP grew at a moderate 1.5%. This growth was due primarily to the expansion of the industry sector that helped cushion a sharp drop in agricultural output. The losses in the livestock sector in 2001, still reeling from the ill effects of two successive harsh winters (dzud) and the outbreak of foot-and-mouth disease, were estimated at 10% of the country’s total herd, or about 4 million animals. As a result, agricultural output, which still accounts for about 30% of GDP, posted an alarming 16% decline. The industry sector grew by 11.8%, driven by its main components, namely mining and manufacturing, which grew by 10% and 23%, respectively. The services sector, accounting for about half of GDP, registered 9.2% growth due to the buoyant outcome of the wholesale and retail trade, financial services, and transport and communications. While domestic invest ment reached 28% of GDP, savings remained low at 18%, and this gap contributed to the current account deficit and the external debt.

Growing unemployment, with only a poor social safety net, remains the Government’s main concern and a primary cause of poverty. The extreme severity of the last two winters revealed the vulnerability of the rural economy and accelerated the migration of people seeking better access to social services and employment opportunities from remote to urban areas, particularly to Ulaanbaatar. Strong growth in the nonagriculture sectors has resulted in urban employment recovery. However, national unemployment, as measured by international standards, stood at 17% in 2000; 60% of the unemployed were under 35 years of age. To enhance the pro-poor orientation of wage policies, the Government announced a 6.1% increase in public sector wages and pensions on 1 October and raised the minimum monthly wage from MNT18,000 ($16) to MNT25,750 ($23).

Mongolia achieved some progress in restoring macroeconomic stability by reducing the budget deficit from 6.8% of GDP in 2000 to 5.1% in 2001. The key macroeconomic assumptions underlying the initial 2001 budget changed significantly as the impact of the second dzud was harsher than expected, leading to amendments to the budget in June 2001. The enhanced revenue collections generated from an introduction of temporary excise taxes and an increase in VAT from 13% to 15% (both measures were budget amendments) permitted a slight expansion in the provision for selected social programs without putting greater pressure on the overall deficit. A privatization scheme scheduled for 2001 was postponed to 2002–2003, removing from the budget the potential benefits of the sales of the major SOEs.

A tighter monetary policy was implemented to limit the effect of inflationary pressure stemming from large price rises for meat, energy, and fuel. However, the effect of this policy was partially offset by an expansion in wages and pensions. The result was an inflation rate of 11.2% (Figure 2.4). Broad money (M2) increased by 27.9% and commercial credit doubled due to the entry of new banks and expanded lending facilities supported by some multilateral and bilateral donors. Real rates on Bank of Mongolia bills fell sharply and remained negative through the first half of the year, but in the second half the Bank of Mongolia took decisive steps to increase the placement of these bills, allowing interest rates across all maturities to rise toward positive levels in real terms. The central bank’s flexible exchange rate policy, applied through recourse to intervention, proved successful in avoiding excessive fluctuation in the exchange rate. Hence the national currency, the togrog, showed no significant deviations from the average level of MNT1,097 to the dollar during 2001.

The current account deficit increased from $167 million in 2000 to $170 million in 2001, or 16.7% of GDP. Total exports decreased by 17.4% as a result of a decline in the international price of export commodities, particularly copper—copper concentrate accounts for nearly 40% of total exports—and cashmere. The volume of cashmere exports also dropped, under the impact of the severe winter. Purchases of capital equipment and the need for imports related to dzud-relief kept imports relatively high, although 9.7% lower than in the previous year. There was a large inflow of external assistance. This led to an increase in the level of international reserves to $209 million from $191 million in 2000, equivalent to about 15 weeks of imports. External debt has doubled since 1996, and is about 90% of GDP. Consequently, debt service obligations have risen, to 7% of exports from 6% in 2000.

Policy Developments

The Government followed its strategic objectives within the context of the Action Program of the Government of Mongolia for 2000–2004. The Action Program emphasizes promotion of sustained higher economic growth and the improvement of living standards by strengthening economic reform, enhancing the provision of social services, narrowing income disparities, and ensuring good governance. The Government is committed to its Poverty Partnership Agreement with ADB. An interim poverty reduction strategy paper, prepared with assistance from the donor community, identified three pillars in the country’s poverty reduction strategy: macroeconomic stability, private sector-led and outward-oriented growth, and more equitable distribution of the benefits of growth. However, the Government had limited success in achieving these strategic objectives.

Poor fiscal data quality and lack of proper accountability were the main factors in unrealistic 2001 budget planning that required subsequent amendments. In spite of that, the stronger revenues resulting from higher VAT and excise taxes financed the increases in social expenditures and permitted a budget deficit of about 2% below the 2001 target. Failure to privatize large SOEs, including Gobi Cashmere, the Trade and Development Bank, Mongolian Civil Air Transport, and the oil importer Neftimport Concern, meant the loss of a substantial funding source.

Restraining monetary measures were insufficient to contain the inflationary forces arising from the sharp rise in credit, higher wages, and increased pension benefits that were introduced in the second half of the year to bolster domestic demand. As a consequence, the inflation rate exceeded the original target by more than 3 percentage points. Policymakers have paid attention to maintaining an appropriate structure of interest rates, thereby fostering confidence in the domestic banking system through protection of the liquidity and solvency of the major state-owned banks.

The global economic slowdown made it difficult for the trade targets to be met. With exports declining faster than imports, the current account deficit widened beyond target and increased the stock of foreign debt. Further efforts to keep the exchange rate stable through central bank intervention, and preliminary steps to bolster domestic savings helped slow the rate of growth of foreign debt by the end of the year.

Outlook for 2002-2003

Unless measures are taken to diversify the economy and reduce its great vulnerability to external shocks, prospects for growth will remain below potential. Projections show moderate but rising rates of growth of 3% and 4.9% over 2002–2003, sustained by a more stable macroeconomic environment. Official projections for the period are for inflation to fall below 7%, and the fiscal deficit to shrink to under 5% of GDP. A growing demand for capital goods to meet the needs of the modernization of the economy will put the current account under pressure and generate a deficit of about 14% of GDP. However, this imbalance should be matched by expected greater inflows from international donors, a sign of their rising confidence in the economy, based on the Government’s commitment to structural reforms. This is likely to result in an expansion of international reserves to 16 weeks of imports.

Sustainable economic growth and poverty reduction in the coming years will be possible only if concerted efforts are made to further develop and strengthen the private sector in a stable macroeconomic scenario. Fiscal policy has to shift its focus toward fiscal accountability and transparency and ensuring a more efficient allocation of public expenditures. Comprehensive public sector reform is vital to rationalize the tax system for achieving higher revenues and better public expenditure management. This remains key to the future expansion of social programs. Additional measures are needed to continue the progress made in developing the private sector, which currently accounts for about 60% of GDP, and to ensure a subsequent reduction in unemployment. In this regard, more decisive steps are needed, targeting (i) banking sector reform, including indirect monetary management, increased bank supervision, restructuring of the state-owned banks, and greater independence of the central bank from the Government; (ii) reform of nonfinancial public enterprises; (iii) strengthening of an open trade and investment system, including the energy sector; (iv) reinforcement of a market-oriented regulatory framework; and (v) progressive reduction of the public sector arrears and removal of indirect subsidies.

Progress in poverty reduction over the medium term will depend crucially on the Government’s success in generating faster and more equitable economic growth. The most vulnerable layers of Mongolian society—small livestock herders, the urban poor, and street children— remain highly vulnerable to even minor external shocks, adverse weather patterns, and the ongoing reform process. Hence, a social safety net for the very poor needs to be built as a matter of urgency. While recognizing the need to address urban poverty through employment generation, policymakers should place strong emphasis on improving the provision of basic social services and infrastructure in rural areas.

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