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p. 43 of 77 BACK | NEXT Foreword, Acknowledgments, Contents, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic trends and prospects in developing Asia Central Asia East Asia People's Republic of China Hong Kong, China Republic of Korea Mongolia Taipei,China South Asia Southeast Asia The Pacific III. Routes for Asia's Trade Statistical appendix

Asian Development Outlook 2006 : II. Economic trends and prospects in developing Asia : East Asia

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Mongolia

In 2005, the economy grew at a robust 6.2%. High global prices for copper and gold boosted the mining industry, but manufacturing was hit by the end of global textile and clothing quotas. Inflation rose to double-digit levels. Growth in the medium term is projected at around 5%. Given its narrow base, the economy remains vulnerable to swings in the prices of a few commodities and to weather conditions. Stronger links to neighboring markets would facilitate development.

Economic performance

Gross domestic product (GDP) grew by a solid 6.2% in 2005, although this was below the very rapid pace of 2004 when GDP surged on the rebuilding of livestock herds and expansion of mining. The services sector made the biggest contribution to growth in 2005 (Figure 2.11.1.), bolstered by increased tourism and transit trade. Agriculture also contributed to growth. However, industrial production was hit by cutbacks in the clothing industry after the end of global quotas in major export markets (Box 2.11.1). The mining subsector was supported by high world copper and gold prices and foreign direct investment.

Inflation, spurred to double digits by higher prices for fuel, utilities, and food, eased later in the year as food price inflation slowed. Imports of lower-priced consumer goods from the People’s Republic of China (PRC) reduced prices of clothing and footwear. Consumer inflation averaged 12.7% in 2005. Broad money growth (Figure 2.11.2) exceeded growth of nominal GDP. The Bank of Mongolia, which had been selling central bank bills to contain growth in broad money, held back from this practice in 2005. Net domestic credit continued to rise rapidly, particularly to the wholesale and retail trading, construction, and mining industries. The nonperforming loan ratio at banks increased as credit expanded, heightening concerns about related-party lending and corporate governance at banks. Nevertheless, confidence in the financial system improved, and the savings rate continued its recovery from a sharp decline after banking crises in the 1990s.

Increased corporate tax revenues, a result of the robust economic growth and higher commodity prices, swung the budget into a surplus equivalent to 2.7% of GDP (Figure 2.11.3), the first surplus in many years. Expenditure was broadly maintained as announced in the 2005 budget. An assistance program for poor families with children, which cost about 1% of GDP, was put under review to assess whether it effectively reaches the needy.

Strong copper and gold export prices also helped shrink the trade deficit to an estimated $95 million (Figure 2.11.4). Mongolia’s exports comprise mainly minerals, cashmere, and clothing, with the PRC buying more than half of the total. Shipments of clothing plunged last year as predominantly foreign-owned textile companies stopped production after the global textile and clothing trade quota system ended on 31 December 2004. The net impact on total trade was modest because most inputs for clothing manufacture are imported. The smaller trade deficit, together with capital flows into mining, remittances, and tourism receipts, narrowed the current account deficit for a third consecutive year. The togrog remained relatively stable against the United States dollar in 2005, implying a real effective appreciation of about 4%, which reflects the higher mineral export prices, remittance and foreign direct investment inflows (Figure 2.11.5), and the rebuilding of foreign reserves (Figure 2.11.6).

Economic outlook

This analysis assumes that prices of copper and gold—the most important of Mongolia’s commodity exports—will decline from the highs reached in 2005. The price of cashmere is expected to remain stable, while price increases for imported oil are expected to moderate. The baseline assumes that the Government will sustain supportive fiscal policies and that any policy changes will not be an additional constraint to private sector development. Another important assumption is that the Bank of Mongolia tightens monetary policy, resuming its sale of bills as needed to rein in inflation, and maintains confidence in the banking system.

Prospects for 2006 and 2007

GDP growth in 2006 is projected at 6.0%, slowing to 5.0% in 2007 (Figure 2.11.7), as the livestock sector returns to its trend growth rate after high volume-led growth over 2004–2005. An expected easing in high global copper prices is likely to affect growth in mining. Income from tourism is expected to rise in 2006 as Mongolia holds celebrations for 800 years of statehood. Transport and telecommunications are projected to expand, with an increase in transit trade and extension of telecoms services to the growing urban population.

After last year’s surge in prices, inflation is forecast to decelerate to 5.5% in 2006 (Figure 2.11.8) because of reduced upward pressure from oil prices and expected policy action by the Bank of Mongolia, primarily through market transactions. The current account deficit should be fairly stable at around 8.5% of GDP.

Medium-term outlook

GDP growth over 2006–2010 is forecast to average about 5%. The primary sector is likely to be a more significant contributor to growth in this period. Some medium-sized mines are expected to increase output and new mineral deposits have been discovered, though their commercial viability has yet to be established. Development of larger mineral deposits may be constrained by weaknesses in infrastructure, including power and transport, and by the capacity and commitment of some holders of exploration licenses to develop large deposits. The livestock sector is likely to maintain its trend growth.

In the services sector, tourism, transport, and telecoms are expected to expand over 2006–2010. Growth in tourism could get a lift over the medium term from private sector investments in tourist facilities for this year’s 800th anniversary celebrations. Transit trade should be encouraged by the signing of an agreement between Mongolia, PRC, and the Russian Federation in late 2005. PRC–Russian trade that currently goes via Kazakhstan is expected to be diverted through Mongolia, provided that improvements in infrastructure are made. Development of manufacturing and other nonresource industries will depend partly on overcoming low labor productivity through education and training.

Mongolia’s narrowly based economy is vulnerable to weather-related natural disasters and declines in commodity prices. Agricultural production depends heavily on the weather, which in the past has destroyed as much as 20% of the livestock herd, exacerbated rural poverty, and cut economic growth. Natural disasters also strain the budget and derail development programs, as they did in 2000–2002. The recent credit expansion and associated rise in nonperforming loans have increased the vulnerability of the banking system. As Mongolia accelerates the exploitation of its mineral resources, so the risk of environmental harm increases, particularly given that safeguards are not yet adequate.

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