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p. 1 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Level

Country Strategy and Program Update 2003-2005: Mongolia

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I. Current Development Trends and Issues

A. Recent Political and Social Developments

1. The political situation in Mongolia has been stable since July 2000, when the Mongolian People's Revolutionary Party took office through a landslide victory in parliamentary elections. This stability has helped the Government restore sound macroeconomic fundamentals necessary for growth and poverty reduction. Economic performance was undermined, however, by the unfolding impact of the severe natural disasters (dzud) of the past two winters, drought in the summer of 2001, and unfavorable international market conditions.

2. The second annual review of the implementation of the Partnership Agreement on Poverty Reduction (PAPR), conducted in March 2002, noted that although Mongolia has made progress in maintaining and improving access of the poor to essential services through extensive investment in social services and infrastructure, income poverty remains almost unchanged, with the incidence of poverty remaining at about 36% since 1995. Persistent poverty is the prime social concern.

B. Economic Assessment and Outlook

3. In 2001, Mongolia experienced another year of low growth. Despite strong performance of the nonagriculture sectors, a 17.2% decline in agricultural output caused by the dzud held overall gross domestic product (GDP) growth to only 1.1% (Appendix 1, Table A1.1). Among the nonagricultural sectors, the industrial sector grew at 11.9%, driven by strong growth in manufacturing (20.0%), construction (12.4%), and mining (8.5%). The service sector registered 10% growth due mainly to wholesale and retail trade, development of financing services, and expansion of transport and communication services.

4. With support from the International Monetary Fund (IMF) under the Poverty Reduction and Growth Facility (PRGF)¹, the Government has made progress in restoring macroeconomic stability. The fiscal deficit was reduced to 4.5% of GDP from 7.5% in 2000, mainly through enhanced tax efforts to increase revenue. Despite the increase in public wages and pensions and a sharp increase in prices of meat, fuel, and utilities, the monetary policy of the Bank of Mongolia managed to keep inflation under control with an average consumer price index growing at 8% over the year and prevent the nominal exchange rate of the togrog from fluctuating.

5. The external sector remained in deficit, with the gap between investment (28% of GDP) and domestic savings (18%) financed by external assistance. Exports were severely affected by unfavorable international market conditions for the three major commodities-copper, gold, and cashmere-which account for about 80% of total exports. The international prices of copper and gold declined by 13.3% and 5.1%, respectively, in 2001. The price of cashmere collapsed by about 40% due to weak demand. As a result, exports decreased by 8.4% in 2001. The current account deficit was $163 million or 15.7% of GDP, a slight improvement from 2000 due to a 3% reduction in imports. However, the inflow of external assistance supported an increase in international reserves to $205.6 million at the end of 2001, which is equivalent to about 16.8 weeks of imports.

6. The continued external imbalances and accumulation of external debt may become a cause for concern in the medium term. To improve external debt management, the Government has recently adopted the software and methodology developed by the United Nations Conference for Trade and Development to standardize external debt statistics and centralize the management of external debt at the Ministry of Finance and Economy (MOFE). According to the latest data, external debt (excluding the pre-1991 convertible ruble debt to Russia)² stood at $904.8 million or 87.8% of GDP at the end of 2001. Since most of the debts are loans from multilateral and bilateral official sources on concessional terms, the current external debt situation appears to be manageable, with a relatively low debt service ratio of 7.4% of exports. The challenge lies in the fact that, given its economic structure and vulnerability to external shocks, the country will need to continue borrowing substantially to finance the economic transition. A focused strategy for accelerated growth is needed to help the economy build up its capacity to support the transition and development in a fiscally sustainable manner. Detailed poverty, social, and environment indicators are shown in Appendix 1, Tables A1.2 and A1.3.

7. As noted in the Country Strategy and Program Update for 2002-2004 (the last CSPU), in the long run, Mongolia's economic prospects depend on how the country can diversify its economic base to maximize its potential in the global economy. In the short run, however, the country's future depends largely on the Government's success in maintaining and further improving macroeconomic stability and providing a regulatory and institutional environment conducive to private sector-led growth.

8. To accelerate economic growth, the Government has designated 2002 as the "year of promoting investment" and has identified high interest rates, bureaucratic barriers, and deficiency in tax structure as the main constraints on private sector-led growth. The Government plans to undertake policy initiatives in these areas to encourage foreign direct investment as well as domestic private investment. The Government also attaches great importance to improving public sector expenditure management as a means of enhancing the efficiency of public investment and expenditure.

9. The Government is, however, under growing pressure to increase public sector wages and pensions in 2002, which may threaten recent fiscal improvements and undermine the fundamentals for growth. This situation requires the Government to manage a delicate balance between the need to promote sustainable growth in the long run and the need to maintain social stability by relieving certain immediate social pressures. Government policies and actions to deal with these constraints and their impacts on macroeconomic stability warrant close monitoring.

C. Implications for Country Strategy and Program

10. The last CSPU confirms Asian Development Bank (ADB) assistance in the six strategically selected sectors: agriculture; finance; public sector reform; social (education, health, and social security); urban development; and road. These will remain the focus of ADB operations for 2003-2005. To help Mongolia achieve the Millennium Development Goals (Appendix 1, Table A 1.4), ADB needs to continue to help promote economic growth for job creation and improve provision of essential social services for the poor. Persistent high incidence of income poverty and the growing concern over financial sustainability (para. 6) require greater emphasis on accelerating economic growth as the main means to reduce poverty.

11. Technical assistance (TA) will be provided to undertake a strategic study jointly with the Government to analyze the medium-term sources of growth and the options to diversify the economy to reduce its vulnerability to external shocks. The findings of the joint strategic study will form the basis for formulation of the new country strategy and program that is scheduled to commence in 2003. To address vulnerability in the agriculture sector, a project for improving crop production is being processed. TAs will also be provided to strengthen the Government's capacity for policy formulation, strategic planning, and development management in the agriculture sector and to prepare a loan project to develop the agroprocessing subsector.

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