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Mongolia Monthly Economic Update-March, 2010

May 9, 2010

Mongolia Monthly Economic Update - March, 2010

March, 2010 - In the first quarter of 2010, the trend improvement in the fiscal deficit stalled as the positive impact of improving revenues was offset by expanding expenditures. If expenditures were to continue to rise in step with mining-related revenues, Mongolia risks returning to the boom-and-bust cycle of the pre-crisis years. However, fiscal consolidation is necessary, given the difficult financing conditions projected for the next few years. In particular, 2011 will be a difficult year for the budget as the Windfall Profits Tax will have been abolished.

A related challenge is how to manage public investment expenditures within the current fiscal space while helping to meet Mongolia’s infrastructure challenge. The current public investment planning and execution process suffers from a number of weaknesses which are examined in Box 1 through the lens of investment in the road sector. Wages and salaries are another major expenditure item within the budget and face upward pressures. Box 2 presents preliminary details of the latest survey in determining the level of public sector wage increases. At senior levels, the total cash compensation in the civil service is approximately 60 to 70 percent relative to bench-marked private sector jobs. However, pay and benefit levels are not unattractive when benefits and job security are factored in. And low level civil service jobs had similar or higher levels of total cash compensation compared to private jobs.

Mongolia’s trade deficit has stabilized in recent months on a 12-month rolling basis. The sustained recovery of Mongolia’s exports has been supported by upward momentum in metal prices and increasing imports from Mongolia to China, its largest trading partner. The exchange rate against the US dollar has been stable, while foreign exchange reserves are close to record levels.

The economic recovery and the prospects of strong growth in 2010 have contributed to recent consumer prices rises. While rising price pressures may be expected during recovery, the challenge going forward is to ensure that this does not develop into the overheating seen during previous booms.

In the banking sector, total lending growth remains muted as nominal lending and deposit rates remain high. On an aggregate level the commercial banks realized a profit of MNT 2.8 billion in March after reaching a loss of MNT 143.4 billion through 2009. The ratio of non-performing loans to total loans stabilized in March but is still at 22 percent while principal in arrears is increasing. A bank restructuring strategy was recently drafted by the Bank of Mongolia, reflecting lessons from international experience (including those of the Turkish banking crisis of 2000/2001, as detailed in Box 3). Timely endorsement of the plan by Parliament is crucial so as to align Mongolia with international best practices that limit the potential economic and fiscal cost associated with any government support and restructuring.

In the real sector, the severe impact from the dzud, which marked a record disaster affecting over 80 percent of Mongolia’s territory, will be felt across major sectors, including the banking sector. Up until now, herder loans have been relatively well performing (Box 4) but, with the number of livestock losses increasing to over 7 million (16 percent of total herd), upward pressure on non-performing loans is likely to increase.

Currently, the Mongolian Parliament is discussing the enactment of a number of important reforms including the Fiscal Stability Law and an Integrated Budget Law which will put in place a fiscal framework for managing mining revenues as well as a commitment to prudent fiscal policy. Such important moves to improve the policy framework in key areas will help Mongolia to avoid boom-and-bust cycles and promote sustainable growth into the future.