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p. 19 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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 Asia The Pacific III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Mongolia

The economy grew faster in 2003 as agriculture recovered (due to improved weather conditions) and services expanded. The fiscal deficit was contained, though it was largely financed externally. The resolution of the debt issue with the Russian Federation, solid progress in the privatization program, gold-related FDI inflows, and high commodity prices for the main exports augur well for sustained growth in 2004-2005-but favorable weather conditions will be important. Greater efforts are needed to translate growth into reduced poverty incidence.

Economic Assessment

On the back of brisk agricultural performance and a buoyant services sector, the economy grew by 5.5% in 2003, exceeding the Government’s target of 5.0%. Agriculture, which employs one third of the work force, expanded by 4.5%, recording the first rise in output since 1999, as weather conditions improved after several extremely harsh winters (dzud). Growth in crops was particularly strong, while livestock registered a modest increase.

In contrast, industrial expansion was disappointing at 0.9% due to weakness in production of textiles and metal ores. Rapid development in Ulaanbaatar led to 8.0% growth in construction. Services increased by 8.6% as a result of sustained expansion in wholesale and retail trade, as well as transportation and communications. The regional outbreak of SARS reduced GDP by an estimated 0.2 percentage point, mainly in the areas of tourism, transportation, and trade.

Continuing economic growth helped improve living standards and raise incomes by 12.0% in 2003. Average monthly wages reached MNT83,100 ($72), but salaries in the capital city are almost double those in the provinces.

Unemployment has been declining in recent years as the economy picked up, and, according to official figures, stood at 3.8% in 2003, although unemployment is significantly underreported because of a lack of incentives to register.

Available assessments indicate that the poverty incidence-36% of the population live below the poverty line-has not changed since 1998. Poverty in Mongolia is defined using the minimum living standards approach, and currently the poverty line is in the range of MNT19,500-25,000 ($17-21) per capita a month, depending on the region. Income inequality has widened as a result of the uneven distribution of the benefits of the economic transition and there is a widening gap in access to basic social services between urban and rural areas, exacerbated by poor infrastructure. The incidence of poverty is particularly high in large households and in those headed by a woman. Insufficient economic growth, unemployment, and underemployment are the primary causes of poverty.

The fiscal deficit remained within the IMF Poverty Reduction and Growth Facility (PRGF) target of 6.0% of GDP for the third year in a row. The deficit narrowed to 3.6% of GDP from 5.6% in 2002 as revenues exceeded the IMF target. Fiscal accountability improved after the implementation of the Public Sector Management and Financial Law, a medium-term fiscal framework, and a single treasury account that centralizes the Government’s cash management. These benefits more than made up for problems caused by SARS, which eroded revenues and required additional government spending to contain it. Foreign funding, mainly through concessional finance, continues to cover about 70% of the fiscal deficit.

SARS also had an impact on consumer prices. Prices of oil and food increased sharply in the spring, pushing inflation to 5.7% in May. However, moderate price rises in the second and third quarters brought down the rate to 4.7% by year-end (Figure 2.4).

Money supply (M2) rose by 49.7% in response to faster economic growth and an easing of monetary policy. A continued surge in bank deposits reflected rising public confidence in the banking system. The banks, in turn, expanded credit to the corporate sector, but this generated concerns about the need to strengthen credit risk analysis and the banks’ capital adequacy. Subsequently, the Bank of Mongolia (BOM), the central bank, raised the minimum capital requirement for banks to $4.0 million. Reported NPLs remained at a moderate 8.2% as both bank deposits and lending rose, but evidence from some banks suggests that the actual overall level of NPLs is higher.

Interest rates were broadly stable, although margins for banks narrowed because of competition from an increasing number of nonbank financial institutions following the liberalization of the sector. Rates remained at 12-18% for loans denominated in dollars, and 15-30% for local currency debt. The togrog depreciated by 4.3% in nominal terms against the dollar, the biggest depreciation since 2000, helping export businesses.

Total trade increased to $1.39 billion in 2003, with merchandise exports up by 14.5% as a result of higher exports of gold, copper, and cashmere. This represented a turnaround from a 3.9% decline in exports in 2002. Imports also rose significantly in 2003, by 14.0%, triggered by growing demand for capital goods and food. The trade deficit widened from 12.8% of GDP in 2002 to 15.7%.

The direction of trade continued to follow recent trends, with the PRC absorbing an increasing share of exports and the Russian Federation providing the largest share of imports. The current account deficit narrowed to 14.7% of GDP from 16.0% (excluding official transfers), while the overall balance of payments recorded another year of surplus as a result of remittances from overseas workers, the rising gold price, large inflows of external assistance, and growing FDI flows. Attracted by promising new gold prospects, FDI strengthened by 94% to $113 million.

After 10 years of negotiations, the pre-1991 debt to the former Soviet Union was resolved. Following Paris Club practice, the 11.4 billion transferable ruble debt was taken to be the equivalent of $11.4 billion. The Russian Federation agreed to write off 98% of the debt for an immediate cash payment of the balance of $250 million. The Government in December repaid this amount, which represents the equivalent of about 20% of GDP, partly by drawing $100 million from international reserves. This took reserves down to $180 million, equivalent to 9 weeks of imports. Total external debt was $1.1 billion, equal to 91% of GDP. Since most of the debt consists of concessional loans from multilateral or bilateral sources, the debt situation remains manageable, with a debt service ratio of 5.4% of exports.

Policy Developments

The Government aimed to reinforce macroeconomic stability, with overall policy guided by the PRGF. Mongolia was in full compliance with the first and second reviews under the PRGF. The strategy involves fiscal measures to restrain growth in public expenditures and a program of privatization. The IMF criteria for success are achieving 6.0% GDP growth by the end of its program in 2005, reducing consumer price inflation to 5.0%, containing the budget deficit to 6.0% of GDP, and building gross official foreign exchange reserves to 4 months of import cover.

Mongolia completed drawing up an Economic Growth Support and Poverty Reduction Strategy in 2003. This plan, which reflects the Government’s vision for growth, poverty reduction, and the achievement of the Millennium Development Goals, will be implemented from this year.

The country has made good progress in addressing non-income poverty, with increasing school enrollment rates, declining infant and under-5 mortality rates, and improved overall health care. Maternal mortality is declining, though it remains high compared with other countries at similar income levels.

The benefits of these improvements have not been shared equally, however. Rural areas and settlements of urban ger (traditional circular tents) on the outskirts of Ulaanbaatar lag well behind established urban areas in nearly all health and education indicators. In terms of gender equality, the country has higher tertiary enrollment rates for women than men, but women are underrepresented in private sector management and in the top echelons of government. The most challenging goal­-in a context in which poverty has become more severe and income inequality has widened since 1998-is to halve the incidence of poverty by 2015.

Fiscal policies have focused on improving budget planning, execution, and control. In the first year of the implementation of the Public Sector Management and Financial Law, the sourcing of budget expenditures was transferred to a new system with the focus shifting from short- to medium-term planning.

The 2004 budget was approved by Parliament in the fourth quarter. Planned budget revenues are MNT553 billion, and planned expenditures MNT639 billion. This would keep the budget deficit to within the IMF target. However, the recent settlement of the Russian Federation debt and the possibility of a more lax fiscal policy ahead of parliamentary elections this year might put pressure on the budget. In addition, corporate and personal income tax rates were reduced in December, and the budget is providing for a 25% increase in salaries for public servants and for significant increases in pensions.

Monetary policy has focused on price and exchange rate stability, while ensuring an adequate supply of money. An easing of monetary policy in the fourth quarter of 2003, however, caused a greater than targeted increase in reserve money, and the growth in credit to the enterprise sector was high. As a result, BOM stepped up sales of BOM bills, aiming to bring reserve money growth into line with the IMF target. It also plans to raise banks’ minimum capital requirements to $6.0 million later in 2004.

To strengthen BOM governance, Parliament approved a new supervisory board for the central bank, which will include outside representatives from the business world and academia, as well as former governors. The BOM exchange rate policy, including the use of intervention, helped avoid sharp swings. A widening of the BOM buy-sell margin has improved exchange rate flexibility.

The privatization program has generally been successful, and the private sector now accounts for 85% of the economy. Agriculture Bank and the largest insurance company, Mongol Daatgal, were privatized in 2003. NIC, an oil company, was privatized early in 2004 and a tender for Gobi, the largest cashmere manufacturer, is expected to be completed in the second quarter of 2004. A 12-month contract was awarded in July 2003 to a foreign company to manage the state-owned airline, MIAT, in preparation for its privatization.

Outlook for 2004-2005

Mongolia has made substantial progress in achieving macroeconomic stability, but its narrow economic base makes it highly vulnerable to the weather and to volatility in world commodity markets. This limits its long-term development prospects, particularly as revenues from key commodities are the main source of the Government’s income and the country’s foreign exchange earnings.

Projections about the economy must depend on heavy assumptions about the weather and commodity prices. The underlying assumptions are (i) a strengthening global economy and growing external demand; (ii) increasing prices of gold, copper, and cashmere; (iii) favorable weather conditions; (iv) continued growth in the main trading partners (the PRC and Russian Federation); and (v) internal political stability after this year’s elections.

Economic growth is expected to be close to 6% in 2004 and 2005. Milder winters, improved livestock-breeding techniques, and expanding crop areas will lift agricultural production. Manufacturing and mining are set to grow, helped by higher quality standards for cashmere production and meat processing, and by the initial operations of a new gold mine. Construction and services, the latter accounting for more that 50% of GDP, are projected to expand in line with rapid development in the capital city and growing demand for more sophisticated services. Tourism’s recovery from a 21% drop in 2003, caused largely by SARS, will contribute to growth in the services sector.

The settlement of the pre-1991 debt to the former Soviet Union is regarded in Mongolia as a sign of independence from the Russian Federation and opens up the prospect for an improved trade and investment relationship. However, the substantial cash payment raises questions about fiscal stability and debt sustainability that could put at risk compliance with the IMF targets.

Although the donor community regards the settlement as a positive development, its terms might exert significant pressure on the 2004 budget. For example, some taxes payable in 2004 were collected in advance in 2003 and the Government borrowed from BOM to repay the debt. Other factors (i.e., more lax fiscal policy, lower income tax rates, and pension and salary increases) could also put pressure on the budget. Still, official estimates have the fiscal deficit staying within the IMF target as a result of improvements in revenue collection, restrained expenditures, and privatization receipts. Macroeconomic stability must remain a priority for the Government, and renewed efforts are needed to reduce poverty and to deliver public services to rural areas.

The BOM guidelines for 2004 and 2005 aim to maintain inflation at around 5% and contain the money supply within appropriate limits, while the exchange rate is expected to remain fairly stable. BOM also plans to strengthen regulation and surveillance of the financial sector. In 2004, a new system for interbank payments will be introduced and the Government intends to promulgate laws to fight money laundering.

A growing demand for consumer goods stemming from improved living standards, and for capital goods to supply the expanding construction and mining sectors, will keep the current account deficit at around 14% of GDP (excluding official transfers) in 2004-2005. Nevertheless, the deficit can be covered by the likely increases in overseas worker remittances, foreign aid inflows, and FDI in mining. Higher prices for gold and copper will help fill the gap in international reserves left by the debt settlement. International reserves could recover by $60 million a year. However, the Government should ensure that its borrowing is prudent and restricted to concessional loans to avoid putting pressure on debt servicing.

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