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Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : East Asia
MongoliaThe economy surged in 2004 on the back of a stronger performance in agriculture, expanding mining output, and buoyant world copper prices. Rising corporate tax payments helped narrow the budget deficit to historical lows. Economic growth is expected to average 7% over the next 3 years, but sound monetary and fiscal policies as well as further private sector development are necessary to sustain growth and generate employment in order to fight persistent poverty. Macroeconomic assessment of 2004Surging world commodity prices and the positive effect of a milder winter on livestock nearly doubled GDP growth to 10.6% in 2004, in excess of projections and propelling it to the highest rate since Mongolia's economic transition began in 1991 (Figure 2.4). Agriculture grew by 18.9%, driven by rapid development of animal husbandry, though crop production declined. While the contribution of manufacturing was minimal, industry overall progressed by 15.4% as mining expanded with the start of operations of a new gold mine, which lifted gold production by half. Services--mainly wholesale and retail trade, telecommunications, and financial services--rose at a slower pace than in previous years, by 4.0%. Visitor arrivals rebounded by 67%, after being hit by the regional SARS outbreak in 2003. Although continuing economic growth is helping raise living standards, poverty remains persistent in both rural and urban areas: 36% of the population live below the national poverty line equivalent of $0.75 a day. In addition, income inequalities have widened--the Gini coefficient, a measure of income inequality, increased to 0.44 in 2002 (the latest data available) from 0.31 in 1995. Poverty in rural areas is the most severe, with western Mongolia the worst region. This is broadly consistent with changes in the composition of GDP in recent years, as industry and services have boosted their share of the economy while that of agriculture has shrunk, to 25% of GDP in 2004 from 34% in 2000. One result is a significant flow of people moving from the countryside to urban centers. High unemployment--14.2% of the workforce in 2003 according to the National Statistical Office--and underemployment are the major causes of poverty. The services sector is the main source of employment in Mongolia, followed by agriculture and industry. But only 5% of the rural workforce is employed in services, compared with 75% in urban areas. The Government's strategy to reduce poverty consists in maintaining macroeconomic stability, further liberalizing the economy, and improving public services. The fiscal deficit remained below the International Monetary Fund's Poverty Reduction and Growth Facility target (6.0% of GDP) for a fourth year in a row. Despite a fiscal loosening in the approach to June 2004's elections, the deficit narrowed to 1.2% of GDP from 4.2% in 2003, bolstered by higher corporate tax collection, particularly from the mining sector. This enabled the Government to repay $50 million borrowed in late 2003 from a Canadian mining company as part of a debt settlement with the Russian Federation. Higher prices for locally produced food and oil more than doubled inflation to 10.6% in 2004. A tightening of monetary policy in the fourth quarter of 2004 sharply decelerated growth in the money supply (M2) to 16.5% for the year, from 49.7% a year earlier. Lending rates were broadly stable and credit to the corporate sector continued to expand. The togrog depreciated by 3.9% in nominal terms against the dollar. FDI inflows, concentrated in mining, totaled $132 million, similar to 2003 levels. Total trade leaped by 28.3% to $1.9 billion in 2004, on account of a 36.0% surge in exports--led by increases in shipments of copper concentrate, textiles, and precious metals--and a 22.4% upswing in imports--driven by purchases of oil, equipment, and machinery. The trade deficit narrowed to 10.4% of GDP from 15.7% the year before, and the current account deficit, including official transfers, narrowed to 0.3% of GDP from 7.8%. The overall balance of payments recorded a $42.5 million surplus, reflecting the inflow of external assistance and growing remittances from overseas workers. At end-2004, foreign debt amounted to $1.3 billion, equal to 89.5% of GDP. Most foreign loans are on concessional terms, so the country's debt remains manageable. Gross international reserves stood at $205 million (10.3 weeks of imports), indicating a recovery after part of the reserves had been used to repay debt to the Russian Federation in December 2003. Macroeconomic policy developmentsThe new Government of Mongolia, formed as a result of the parliamentary elections in June 2004, defined an Action Plan for the next 4 years, the main objectives of which are to upgrade the quality of public services, deepen legal reforms, sustain higher rates of private sector-led growth, improve living standards, and raise education standards. On economic issues, the Action Plan sets various targets, including a minimum of 6% annual economic growth to be pursued through economic and financial stabilization, private sector-based structural reforms, and increased foreign investment and exports. The Government will pursue macroeconomic stability by maintaining inflation within single-digit levels, the budget deficit at 3% of GDP, and sufficient international reserves to cover 17 weeks of imports.
Privatization will be continued and private investment in infrastructure will be encouraged. To stimulate private sector-led growth and exports, the Government will expand the policy of establishing free economic and trade zones and industrial technology parks. The Action Plan also calls for support to SMEs through better access to credit generally and microcredits in rural areas especially, and through promotion of intensive agricultural techniques and modern farming methods. To create a stable and attractive legal environment for investors, international standards and procedures will be extended and the stock exchange will be resuscitated. The 2005 budget, passed by Parliament in November 2004, aims for a budget deficit equivalent to 3.5% of GDP. It incorporates a new system of cash payments to children in families below the poverty line, fulfilling a promise made during the election campaign. This program will cost about $14 million a year. The budget allocates 20.8% of total expenditures to education and 10.8% for health. The president vetoed the excise tax provisions of the 2005 budget, which will reduce revenues by about $10 million, so a revision to the budget is required. Late in 2004, the Bank of Mongolia raised the interest rate on its bills by 6 percentage points to 15.5% to damp inflationary pressures. This helped contain M2 growth to within relatively moderate levels for the first time since 2001. The slowing growth of the money aggregate indicates that demand for money and the monetization of the economy is decelerating after 3 years of fast growth in bank deposits and credit, a period when public confidence in the banking system improved. The central bank's guidelines for 2005 aim to contain the growth of money aggregates and bring down inflation to 5%. The Bank of Mongolia expects the exchange rate of the togrog to remain fairly stable, its policy having avoided sharp swings in the currency in the past 5 years. In other areas, it plans to strengthen regulation and surveillance of the financial subsector and to draw up laws to fight international money laundering and terrorism-financing practices. In order to project the expected effect of monetary policies on the overall economy, this year the central bank also plans to develop a general equilibrium model for the economy. Outlook for 2005-2007 and medium-term trendsThe economy depends heavily on the weather, which can seriously damage farm production; and on the performance of just three exports (minerals, cashmere, and textiles), which account for more than 80% of total exports. Hence, projections for the economy rest largely on assumptions in these two areas. The following outlook relies on assumptions that external demand will grow; prices of gold, copper, and cashmere will remain strong; weather conditions will be favorable; the PRC and the Russian Federation will continue to grow; and Mongolia itself will remain politically stable. On this basis, economic growth is expected to average 7% in the forecast period. Milder winters and improved breeding techniques should continue to foster animal husbandry, although increases in crop production are less certain because the sector needs restructuring and investment. The boom in investment in mining and minerals is expected to continue, given good prospects for exploration in the Gobi desert and
The budget deficit is likely to remain below 3.5% of GDP in the forecast period, with strong tax revenues from minerals and moves to discourage tax avoidance helping offset the increased costs of the new system of cash payments. Inflationary pressures caused by high oil prices may ease after the replacement of the agreement with a key oil supplier--the Russian company Yukos--with a new agreement to buy oil at lower prices from Kazakhstan. The lower oil prices and tighter monetary policy may be able to keep inflation at around 5% in the next 3 years. Mongolia's dependence on a few commodities that are vulnerable to internationally volatile prices makes reliable projections on trade particularly difficult. There is potential for increased exports to the PRC (especially oil and copper) and to the Russian Federation (animal products), though against this, the sharp increase in global copper prices seen in the past year or so is unlikely to be sustained. Other constraints include the dependence of some of the country's major growth industries on energy consumption, which poses a risk to sustainable development. The resulting air pollution and land and water degradation could hamper future growth. Furthermore, the country's competitiveness suffers from high transport costs, insufficient infrastructure, and limited access to credit. The private sector's share in the economy has increased to 85%, but substantial challenges remain. A large body of legislation to improve the environment for private sector development has been enacted, but a lag remains between enactment and application. Interest rates remain high and terms for lending are short, which restricts investment to big borrowers and limits broad access to credit, hindering the development of SMEs. Although investment remains strong, mobilization of savings is not progressing--indeed, the savings ratio is declining. The gap between saving and investment needs to be covered by foreign funds. Growth has picked up in recent years, but remains vulnerable to the economy's narrow base. Sound monetary and fiscal policy actions, a healthy financial sector, and further private sector development are crucial for sustaining growth and generating employment.
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The financial and banking subsector is to be strengthened through the development of financial markets and financial intermediation, introduction of long-term loans and mortgages, and progressive reduction in interest rates to facilitate wider access to credit and foster domestic investment. 
the PRC's voracious demand for minerals--particularly copper--and energy. Mongolia is affected by the phasing out of the Multifibre Arrangement and could lose garment-making jobs if it cannot upgrade to higher value-added products and compete in international markets, though prospects may brighten following a new bilateral trade agreement with the US. Construction and services, the latter accounting for about half of GDP, are projected to grow in line with rapid development of the capital city and increasing demand for financial and telecommunications services. Tourism is likely to expand further because the country has attracted a growing number of visitors year after year, and the infrastructure for tourism is improving. 
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