Jan Hansen, Senior Country Economist, Mongolia Resident Mission, ADB & Enerelt Enkhbold, Associate Investment Officer, MNRM

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Presentation by the Asian Development Bank at the Business Council of Mongolia
Monthly Meeting on 10 December 2012
By Enerelt Enkhbold, Associate Investment Officer and Jan Hansen, Senior Country Economist
Selected Issues on the Economic Outlook for the Mongolian Economy
The global economic slowdown is increasing the vulnerability of the Mongolian economy.
Deteriorating global economic conditions, in particular the slowdown in the People’s Republic of
China (PRC), have negatively impacted exports resulting in a deterioration of overall economic
growth and external balances of the Mongolian economy. Economic growth fell from 20.0% (y-
o-y) in the fourth quarter of 2011 to 16.5% in the first quarter of 2012, 11.0% in the second
quarter and 5.6% in the third quarter of 2012. For the first three quarters of 2012, annual
economic growth was 10.2%. Exports (in current prices) fell by 2.2% (y-o-y) during the first 10
months of 2012, while import growth slowed to 7.2%. Both annual export and import growth fell
over the year and were -39.3% and -7.7% (y-o-y) in September 2012, while export strongly
recovered in October. Notwithstanding the weakening global economy, GDP is forecast to grow
by 10% in 2012 and 12% in 2013 when commercial production from the Oyu Tolgoi mine is
scheduled to begin.
The balance-of-payment (BOP) is increasingly coming under pressure due to strong domestic
demand; decelerating export growth; and slowing foreign direct investment (FDI). During the
first 10 months of the year, the current account deficit increased by 42% to around US$ 2.6
billion, while FDI increased by 3.4% to about US$ 3.4 billion. This means that the basic balance,
i.e. the sum of the current account balance and FDI is still positive, but rapidly falling. The
current account deficit was about 32% of GDP in 2011.
The increasing trade and current account deficit is putting pressure on the togrog. The togrog
depreciated against the US$ by around 8% since April to about MNT 1,400 at the end of last
week. The Bank of Mongolia (BOM) is intervening in the foreign exchange market to limit the
togrog’s depreciation by supplying US$ and CNY. BOP pressures have mostly been reflected in
a decline in Mongolia’s net international reserves which have declined by one third to a two-year
low of US$1.5 billion. The effect of the BOP pressures on gross international reserves has been
offset by BOM drawings on the swap line with the People’s Bank of China and BOM deposit
taking from the Development Bank of Mongolia (DBM). Gross international reserves remain near

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an all-time high of US$2.6 billion (corresponding to about 7 months of prospective non-mining
imports), while the share of borrowed reserves has risen significantly.
Fiscal policy remained pro-cyclical in 2012. The initial government budget projected revenue to
rise by about 40% and expenditure by about 32% and a budget deficit of 1% of GDP. However,
government spending growth has outpaced revenue growth, resulting in an increasing fiscal
deficit. Government expenditure was 37.7% higher in October 2012 (year to date, YTD, basis).
Revenues have failed to grow at the same pace, rising by only 14.2% over the same time period
due to shortfalls in VAT and customs duties. This has flipped the fiscal balance on a cash basis
into a deficit of MNT 554 billion from a surplus of MNT 190 billion in the same period of 2011.
(The budget deficit in 2011 was MNT 529 billion, or 4.8% of GDP). In October 2012, the Fiscal
Stabilization Fund held MNT 270 billion which corresponds to about 2.4% of last years’ GDP.
In mid-September 2012, Parliament amended the budget by cutting the revenue estimate by
10.6%, while the expenditure estimate was cut by 1.8%. The extrapolation of the previous years’
favorable revenue trends in the 2012 initial and supplementary budget does not take into
account the weak collection of VAT and customs duties related to the deceleration of capital
goods imports for the OT mining project in 2012. The government deficit in the supplementary
budget for 2012 was revised to 4.2% of GDP. Meanwhile, the IMF is expecting a cash deficit of
5.2% and a structural deficit of 6.0% of GDP for 2012.
The 2013 budget foresees overall revenue growth of 28%, expenditure growth of 17% and a
budget deficit of 4.8% (cash) and 2% (structural) – formally complying with the Fiscal Stability
Law (FSL). The budget is based on reasonable assumptions regarding economic growth (30%),
but takes the very optimistic revenue projections from the 2012 supplementary budget as a
starting point, setting the stage for a potential revenue shortfall. Moreover, the budget includes
MNT 445 billion (6.3% of overall revenues) revenue that is predicated on the renegotiation of
the OT investment agreement. The outcome and timing of this renegotiation, and hence the
expected additional revenue, are highly uncertain. The government may have to undertake a
very substantial amount of fiscal tightening to comply with the FSL next year.
Off-budget spending by the Development Bank of Mongolia (DBM) is adding to demand
pressures and undermining the integrity and meaningfulness of the FSL. The international bond
issuance earlier this year has put the bank in a position to spend up to 6% of GDP. Off-budget

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spending by the DBM on public investment projects should be taken into account when
determining the macro-economically sustainable level of government spending. A clear policy
needs to be drawn up to ensure that the DBM can help meet the long-term infrastructure needs
of Mongolia in a macro-economically sustainable manner.
Mongolia’s public debt as of the third quarter of 2012 stood at US$ 2.4 billion, which includes
external debt of US$ 1.9 billion and internal debt of US$ 436 million as reported by the Ministry
of Finance. This corresponds to a ratio of 24.2% of GDP. The government plans to issue US$ 5
billion in bonds in the international financial markets, of which US$ 1.5 billion was sold on 28
November 2012. Including the recent issuance of government bonds, the public debt ratio
currently stands at about 40% of GDP. According to the IMF/World Bank Debt Sustainability
Analysis (DSA) 2012, the public debt to GDP ratio is estimated at 56.7 percent in 2012. The
World Bank and IMF apply a wider definition of public debt, including contingent liabilities as the
DBM bonds amounting to US$ 580 million. The 2012 DSA suggests that Mongolia’s risk of debt
distress remains low. However, the 2012 DSA does not include the recent international bond
issue.
Inflation picked up further in 2012 and was 15.0% in October. Price pressures are likely to
continue given strong demand and the two stage increase in pensions and civil servant wages
implemented in the first half of 2012. The ADB projection for inflation is 15% in 2012 and 12% in
2013.
Economic policy need to be set against the continued uncertainties in the global economic
outlook. Further significant falls in global commodity prices would severely impact on Mongolia’s
economy, while putting strong pressure on public finances and current account position. One
major risk is significant weaker growth momentum in the economy of the PRC and further
significant falls in global commodity prices.
The main priority for economic policy is to restrain fiscal spending to contain the fiscal deficit,
ensure funding for core government expenditure. Fiscal policy has been pro-cyclical in the past
years and did not create sufficient reserves which could be used to support public spending and
stimulate aggregate demand in case of a further slowdown of the economy. It is critical that the
FSL will be implemented and complied with, while off-budget spending by the DBM should be
taken into account when determining the macro-economically sustainable level of government

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spending. Instead of implementing universal social welfare benefits as the proposed re-
introduction of the Child Money Program which are fiscally expensive and have limited effects
on poverty reduction, the amended Social Welfare Law should be implemented through
introduction of a targeted poverty benefit. Recent monetary policy tightening helped to contain
inflationary pressures, but may need to be further tightened if inflationary pressure remains high.
In case of a further slowdown of the economy, monetary policy can be eased to stimulate
aggregate demand.
BOM should consistently implement its monetary policy framework based on inflation targeting
and a managed floating exchange rate. The flexible exchange rate is a crucial adjustment
mechanism to stabilize the real economy in case of further commodity price and related
economic and financial shocks. For example, a depreciation of the exchange rate due to less
export revenue from mining sector because of lower coal prices will lower labor costs, improve
competitiveness and increase production in other industries of the economy. Defending an
overvalued exchange rate, on the other side, will lead to falling currency reserves and may
eventually trigger a foreign exchange crises.