52935 MONGOLIA MONTHLY ECONOMIC UPDATE WORLD BANK August 2009 The World Bank’s Mongolia Monthly Economic Update provides an update on recent economic and social developments and policies in Mongolia. It also presents findings of ongoing World Bank work in Mongolia. The Mongolia Monthly is produced by a team from the World Bank’s Poverty Reduction and Economic Management (PREM) Sector Unit in the East Asia and Pacific Region Vice-Presidency, with key inputs from other members of the Mongolia country team. Questions and feedback can be addressed to Altantsetseg Shiilegmaa (ashiilegmaa@worldbank.org). Copies can be downloaded from http://www.worldbank.org.mn. Table of Contents Sections: Page number 1. Introduction ………………………………………………………………………………………….. 3 2. Main developments since July 2008…………………………………………………………………. 3 3. Response of government and external partners………………………………………………………. 8 4. Latest developments…………………………………………………………………………………. 11 5. Conclusion…………………………………………………………………………………………… 25 Tables: 1. Summary of policy actions at beginning of 2009 and expected impact……………………………….. 8 2. Highlights of the original, approved 2009 budget and its two amendments………………………….. 9 3. External financing requirements…………………………………………………………………….. 10 4. Fiscal financing requirements………………………………………………………………………... 11 5. Mongolia: Key Indicators……………………………………………………………………………. 26 Figures: 1. Mineral prices collapsed in mid-2008………………………………………………………………… 4 2. Major trading partners’ industrial production dropped dramatically between June 2008 and the first quarter of 2009………………………………………………………. 4 3. Trade balance dragged down the current account surplus……………………………………………. 4 4. The budget has become increasingly dependent on mining revenues………………………………… 5 5a. High inflation led to negative real interest rates on MNT deposits…………………………………… 6 5b. … leading to large MNT deposit outflows…………………………………………………………… 6 6a. Strong depreciation and deviation between BoM and market rates between December 2008 and March 2009, followed by a convergence of rates and appreciation……………………………… 6 6b. While attempting to defend the peg to the USD, the BoM lost about $500 million in international reserves, followed by a recovery as the external sector stabilized…………………… 6 1.1 Export concentration index, copper share in exports in 2007 (Box 1)……………………………….. 7 1.2-5 GDP growth decline, non-mining fiscal balance, fiscal balance, current account, inflation (Box 1)…. 7 7a-b. Selected revenue components, shares in revenue…………………………………………………….. 12 8a-b. Selected expenditure components, shares in expenditure…………………………………………… 13 9. The 12-month rolling fiscal deficit continues to widen, as revenue has been falling, compared to expenditure……………………………………………………………………………. 13 10. The trade balance narrowed as imports have fallen faster than exports…………………………….. 14 11a-b. Selected export commodities, shares in exports…………………………………………………….. 15 12a-b. Selected export destination, shares in exports………………………………………………………. 15 13a-b. Selected import commodities, shares in imports…………………………………………………….. 16 14a. The current account moved into a deficit driven by a widening trade and services deficit…………. 17 14b. ... And FDI inflows and other net inflows dropped from their peaks………………………………... 17 15. The large nominal depreciation has partly restored Mongolia’s export competitiveness…………… 18 16. Inflation has fallen rapidly from its peak, mainly because of the domestic slowdown……………… 19 17. NPLs and loans in arrears have risen strongly, as key sectors in the economy slowed down………. 19 18a. The largest increases in NPLs and loans in arrears occurred in construction, wholesale and retail and mining and quarrying ………………………………………. 20 18b. . … And these sectors now account for the majority of NPLs and loans in arrears…………………. 20 19a. The construction sector has the highest NPLs and loans in arrears relative to outstanding loans…… 21 19b. … And construction accounted for the largest part of the increase in NPLs and loans in arrears…… 21 20. Total loan growth has come to a standstill, as bank prefer safe CB bills……………………………. 21 21a. Large decreases in loan issuance to wholesale and retail, mining, construction and manufacturing.. 22 21b. The loan portfolio is exposed to sectors that suffer from NPLs and loans with principal in arrears… 22 22. Industrial production contracted……………………………………………………………………… 23 23. Wholesale/retail, construction and manufacturing dragged down GDP growth…………………….. 23 24. GDP growth is projected to slow down significantly……………………………………………….. 23 25. Registered unemployment has risen from its trough at the end of 2008…………………………….. 24 Boxes: 1. How did other copper exporters experience the global downturn?........................................................ 7 1. Introduction1 In addition to highlighting the latest developments, this Economic Update also summarizes the main economic, fiscal and financial developments in Mongolia for the year since July 2008, when Mongolia was hit by a large, external shock due to the collapse of the copper price. This shock hit Mongolia harder than other copper producers, because of the country’s particular combination of expansive fiscal and monetary policies, a fixed exchange rate and an overheated financial sector at the time of the copper price collapse. In the Update, we compare Mongolia’s performance during the copper price collapse with that of the other major copper exporters: Chile, Peru, Papua New Guinea and Zambia. The government’s initial slow and inappropriate response led to a period of macroeconomic instability around the end of the year. However, the government took strong policy actions at the beginning of 2009 to address the crisis. Based on the commitment shown by these actions, the country subsequently benefited from substantial financial assistance from its key development partners. The latest developments show that the fiscal balance remains under pressure, as revenues have continue to drop, whereas expenditures remained constant. The trade balance has improved, but this is in part caused by the economic downturn itself, which has seen imports drop faster than exports. In the financial sector, deposits have recovered after large withdrawals earlier in the year. However, non-performing loans have continued to increase, and bank lending to the private sector has come to a virtual standstill, as banks prefer to invest in central bank bills instead. This has put further downward pressure on domestic activity. Formal unemployment has continued to increase since the beginning of the year, and real wages for unskilled labor in the informal sector have been hit very hard. 2. Main developments since July 2008 Mongolia was hit by a large, external shock when mineral prices collapsed in mid-2008…2 The global economic downturn was transmitted to the Mongolian economy through the slump in mineral prices which returned the prices of Mongolia’s main exports back to their 2004 levels. The price of its main export, copper, fell by as much as 65 percent to $3000/tonne in March 2009 from $8700/tonne in April 2008. Prices of other main export commodities—coal, zinc, cashmere, and crude oil also fell significantly. Only the price of gold held up as it was supported by its role as a safe-haven investment (Figure 1). 1 The analysis is based on July data from the National Statistical Office, the Ministry of Finance, and the Bank of Mongolia (bulletin and consolidated banking system balance sheet), and the Q2 loan report. 2 Box 1 compares Mongolia’s performance against other major copper exporting countries. Figure 1. Mineral prices collapsed in mid-2008 Figure 2. Major trading partners’ industrial production dropped dramatically between June 2008 and the first quarter of 2009 Index=100 in January 2004 % year-on-year change, 3-month moving average Coal 20 500 Zinc China 400 Crude oil 10 Russia Copper 300 Gold 0 200 Canada -10 US 100 European -20 Union 0 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Source: World Bank Source: World Bank Mongolia’s main trading partners (accounting for over 95 percent of export revenues) also suffered from a large slowdown in industrial production. Fortunately, China, which accounts for about 70 percent of exports, saw its industrial production only slow down from about 16 percent year-on-year growth in mid- 2008, to 10 percent at the beginning of 2009. But industrial production in Mongolia’s other major partners suffered much larger contractions (Figure 2). Figure 3. Trade balance dragged down the current account surplus The external shock further aggravated Mongolia’s already % of GDP deteriorating trend in the trade and current account balance. 15 10 The added impact of lower commodity prices shifted the 5 current account from a 6.7 percent of GDP surplus in 2007 to 0 -5 a 13.7 percent of GDP deficit in 2008 (Figure 3).3 Trade balance -10 -15 Current account balance The collapse of the copper price hit the budget very hard 2004 2005 2006 2007 2008 because of insufficient savings Source: Bank of Mongolia, World Bank During the boom years (2003-07), the government had run modest fiscal surpluses, but these turned out to be insufficient to absorb the fiscal shock caused by the collapse of the mineral prices. 4 Moreover, the fiscal shock was exacerbated because, during the boom years, the government had shifted the fiscal burden away from the non-mining sector, leaving the budget increasingly dependent on revenues from mining. At its peak in 2007, mining-related revenue, i.e. corporate income tax and dividends from mining companies, the Windfall Profits Tax (WPT), and royalties, contributed nearly 40 percent to total revenue 3 This is the final revision of the 2008 current account. The preliminary estimate was a 9.6 percent of GDP deficit. 4 A 68 percent tax applies to copper and gold revenues if prices exceed $2600/tonne or $850/ounce respectively. This Windfall Profits Tax (WPT) is deposited in the Mongolian Development Fund (MDF). As a rule, 1/3 of revenue is saved for budget stabilization, 1/3 for social transfers and 1/3 for investment. In practice, between 2006 and end-2008, about 30 percent of WPT revenue was saved, amounting to 4.9 percent of GDP, and 70 percent of revenue was allocated to social transfers and investment. -4- or 15.3 percent of GDP. The non-mining fiscal deficit Figure 4. The budget has become increased dramatically from a 7.3 percent of GDP deficit in increasingly dependent on mining revenues 2006 to a 15.3 percent deficit in 2008 (Figure 4). % of GDP 16 Underlying this worsening overall trend were several other 12 8 unsustainable expenditure trends. For instance, while before 4 0 the boom years, social transfers had by and large been targeted -4 -8 to the poor, these transfers proliferated and became -12 universalized during the boom years. The most important -16 social transfer program, the Child Money Program (CMP), Mining-related revenue* disbursing about MNT 140 billion per year (5.6 percent of Budget balance fiscal expenditure in 2008), was almost exclusively dependent Non-mining balance* Note: Central/state and local budget, MDF and on volatile mining revenues: it received three quarters of its social security fund. * Corporate income tax and dividends from mining companies, the WPT, financing from the Mongolian Development Fund (MDF), and royalties. Source: Ministry of Finance, World Bank which in turn was financed by mineral revenue savings. Wages and salaries as a share of GDP increased sharply from 2006 to 2008. Capital expenditure also increased sharply, but projects frequently lacked feasibility studies and insufficient resources were set aside for the proper maintenance of existing infrastructure. The downturn also aggravated problems in the financial sector5 The global downturn also aggravated problems in the financial sector which had been overheating during the boom years. During the boom, very high domestic inflation—33.7 percent yoy in August 2008, the highest in East Asia in 2008—and loose monetary policies led to a credit boom, masking growth in non- performing loans (NPLs). It also led to negative real interest rates on local currency deposits (Figure 5a), resulting in flight of local currency (MNT) savings into FX deposits, where interest rates were as high as 12 to 18 percent in some banks (Figure 5b). When Anod Bank, the fourth largest bank, was taken under conservatorship by the Bank of Mongolia (BoM), at the end of 2008, and major shortages of foreign currency emerged—forcing the BoM to ration FX leading to a substantial deviation between the official BoM exchange rate and the parallel market rate (Figure 6a)—the public started to lose confidence, leading to a generalized flight out of both MNT and FX deposits. To restore public trust in the banking sector, the government issued a blanket deposit guarantee in November, but it left many customers in uncertainty about which deposits were included, 5 Box 1 in World Bank (2009) April Monthly Economic Update describes the developments in the financial sector between 2004 and 2009 in detail. -5- and MNT deposits only started to return in February. Figure 5a. High inflation led to negative Figure 5b. … leading to large MNT deposit real interest rates on MNT deposits… outflows % year-on-year change MNT billion, month-on-month change MNT billion, stock 60 1,200 40 Inflation in Mongolia 985 Real interest rate on MNT deposits 40 1,000 30 20 800 20 0 10 600 -20 617 400 0 -40 MNT deposits, stock -10 FX deposits, stock 200 -60 FX deposits, change -20 -80 MNT deposits, change 0 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Note: Interest rate deflated by CPI inflation. Note: Numbers are the end-July stocks of MNT and FX deposits Source: Bank of Mongolia, National Statistical Office, in MNT billion. World Bank Source: Bank of Mongolia, World Bank This flight out of the local currency was further aggravated by the BoM mopping up MNT as it sold off its international reserves in an attempt to hold on to an ill-advised de facto currency peg to the USD. Other major commodity exporters let their currencies freely depreciate as a first defense mechanism against falling international prices. While the BoM lost $500 million of international reserves between July 2008 and February 2009 (Figure 6b), the currency depreciated anyway, by about 38 percent between the end of October and the middle of March. Figure 6a. Strong depreciation and deviation Figure 6b. While attempting to defend the peg to between BoM and market rates between December the USD, the BoM lost about $500 million in 2008 and March 2009, followed by a convergence of international reserves, followed by a recovery as rates and appreciation the external sector stabilized MNT per USD $ million, stock $ million, month-on-month change 1700 1,100 Stock of BoM international reserves 150 1600 1,000 Month-on-month change (right axis) 100 1500 900 50 1400 800 0 1300 700 684 BoM official rate -50 1200 Parallel market rate 600 Commercial bank rate 500 -100 1100 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 400 -150 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Last observation: September 1, 2009. Note: Number is box is end-July stock of BoM international Source: Mongolian Financial Association, World Bank reserves in $ million. Source: Bank of Mongolia, World Bank -6- As a result of the above combination of expansive fiscal and monetary policies, a fixed exchange rate and an overheated financial sector, Mongolia’s economic downturn was particularly severe, even when we compare its performance to the other major copper exporters in the world. Box 1 assesses the impact of the crisis and finds that sound fiscal policies, such as saving sufficiently during boom times, and monetary policies, and creating the right incentives for investment in the mining sector have so far helped Chile, Peru, Zambia and Papua New Guinea deal with the crisis. Box 1. How did other copper exporters experience the global downturn? The largest copper exporters in the world, in terms of share of copper Figure 1.1. Export concentration index* to total exports, are Zambia, Chile, Mongolia (MNG), Papua New (right axis, bar), copper share in exports Guinea (PNG) and Peru (Figure 1.1). These countries experienced the in 2007 (left axis, line) same global copper price collapse, but the impact on their economies 1.0 60 was different. 77% 50 0.8 All five countries are facing GDP growth declines in 2009, but Peru 0.6 57% 40 44% and Mongolia are facing the largest declines (Figure 1.2). All 30% 27% 30 0.4 countries are projected to have a fiscal deficit in 2009. However, Chile 20 0.2 and PNG had run large fiscal surpluses during the boom times up to 10 2008, whereas Mongolia and Zambia were already in deficit in 2008 0.0 0 (Figure 1.3). And Mongolia’s non-mining fiscal deficit was the largest of all (Figure 1.2). The current accounts of all countries except PNG were also strongly impacted by the copper price collapse. However, Zambia and Mongolia saw the largest drops, and requested external * Herfindahl index: sum of squares of % export assistancea (Figure 1.4). CPI inflation was the highest in Mongolia shares across all commodities (range: 0—100) since 2007, evidence of the Figure 1.2. GDP growth decline 2008- Figure 1.3. Fiscal balance largest domestic boom, 09*, non-mining fiscal balance in 2008 compared to the other four % change (GDP decline), % of GDP (balance) % of GDP countries (Figure 1.5). 10 Chile Chile Peru PNG MNG Zambia Peru Copper export dependence, or 0 6 PNG a high export concentration, MNG Zambia alone does not explain the -4 2 differences in performance -8 GDP growth decline -2 during the crisis. For example, Zambia and Chile -12 Non-mining fiscal -6 are the most dependent on balance 2006 2007 2008 2009* copper exports, but their -16 expected drop in GDP is less Figure 1.4. Current account Figure 1.5. CPI inflation % of GDP % year-on-year change than that of Mongolia and 25 Chile Peru. 5 20 Peru Zambia opened a major new PNG 0 MNG copper mine in late-2008 (the 15 Zambia only country to do so). The -5 10 increase in copper output Chile Peru mitigated the downturn. -10 PNG 5 Zambia also removed the -15 MNG 0 windfall tax on mining to 2006 Zambia 2007 2008 continue to attract new 2003 2004 2005 2006 2007 2008 mining investments and prevent existing operations Note: 2009* is IMF or World Bank projection. Non-mining balance calculated from IMF Article IV , reports. from being scaled down prematurely. It also benefited from debt relief as a result of good economic performance. Peru had accumulated sizeable fiscal surpluses for the -7- last three years, and used the mineral windfall largely by increasing savings and reducing public debt. Chile, finally, finds itself in a good position to weather the storm: it benefited from a fiscal rule which limited expenditure during boom times, inflation targeting, a flexible exchange rate, a copper stabilization fund to help ensure that the fluctuations in copper prices do not spillover into the rest of the economy, and adequate access to foreign financing. Source: UN Comtrade database, Bank of PNG, IMF Article IV reports, World Bank a In response to the crisis, Zambia received a substantial increase in financing of its ongoing IMF poverty reduction program, although its access to IMF financing is still only around 50 percent of its quota, whereas Mongolia received 300 percent. For completeness, Peru has had an IMF Stand-By Arrangement since early 2007, but this is considered precautionary with low access to IMF resources, and Peru has not requested any increase in the loan amount. 3. Response of government and external partners Policy actions taken in the beginning of 2009 to address the crisis… In the absence of sufficient fiscal surpluses from previous years, the government’s fiscal position became difficult once fiscal revenues declined as a result of the sharply lower commodity prices. To keep the fiscal deficit within financeable limits, the government could cut spending or raise revenues, or both. Since raising revenues is inherently difficult during an economic downturn, the government had little choice but to cut spending drastically in its 2009 budget. Table 1. Summary of policy actions at beginning of 2009 and expected impact Government policy action Expected impact Public investment cut Curtails poorly planned and low-priority new investments, and projects unlikely to be implemented this fiscal year due to lack of absorption capacity Expenditure cut on wages and salaries Saves on excessive bonuses, and stop rapidly growing civil service of public servants; hiring freeze Interest payments on foreign loans cut Constrains recourse to non-concessional foreign borrowing Universal social transfers cut Targets social transfers towards the poor BoM raised the policy rate to 14% Avoids overshooting of exchange rate; preserve FX reserves; restores from 9.75% confidence in tugrug FX auction introduced Moves to more flexible exchange rate; improve transparency of FX allocation International reputable auditor for Sets standard for dealing with future bank failures Anod Bank BoM increased capital adequacy Strengthens capital base of those banks who are able to meet the higher requirements requirements; encourages banks to address portfolio quality issues and reduce weight of riskier assets in portfolio BoM revised and clarified deposit Avoids abuse and unnecessary fiscal costs; strengthens public confidence in guarantee law deposit guarantee Source: Mongolian authorities, World Bank The original 2009 budget was approved in November 2008, but when the final 2008 budget outturn and the January and February 2009 figures came in, it became clear that the expected revenue estimate for the full year was unlikely to be realized. Without additional measures, the 2009 budget deficit was heading for 12 percent of GDP. Faced with the reality of the global downturn and its impact on Mongolia, the government initially considered a variety of possible responses, including signing long-term mineral export contracts in -8- exchange for large up-front payments, and implementing a wide-ranging stimulus package to be funded by a $1.2 billion sovereign bond. However, as adverse conditions continued to worsen, and access to international capital markets on reasonable terms seemed very difficult, a bi-partisan consensus began to emerge around a more comprehensive policy response, which could be supported by the IMF and other development partners. These policy changes included strong actions on fiscal, monetary, exchange rate, and financial policies (Table 1). Table 2. Highlights of the original, approved 2009 budget On fiscal policy, in March 2009 and its two amendments Parliament approved an amended 2009 MNT billion, unless otherwise indicated Approved Amendments budget projecting a 5.4 percent of GDP budget March June deficit. This was done mainly by (i) Total revenue and grants 2,224 1,973 2,055 % of GDP 34.3 31.3 32.6 cutting expenditures on low-priority new Total expenditure and net lending 2,620 2,314 2,419 investments, projects for which bidding % of GDP 40.4 36.8 38.4 Mining-related revenues 365 316 395 had not started, and projects for which no % of revenues 16.4 16.0 19.2 Fiscal balance -396 -341 -364 feasibility studies had been conducted; % of GDP -6.1 -5.4 -5.8 (ii) freezing wages and hiring of public Non-mining balance -760 -657 -759 % of GDP -11.7 -10.4 -12.1 servants; (iii) reducing interest payments on foreign loans (effectively a limit on Specific items: MDF revenue (from WPT) 63 51 133 sovereign non-concessional borrowing);6 Child Money Program 143 95 143 and targeting social transfers. The level from central budget 107 38 38 from MDF 36 57 105 of capital maintenance expenditure was Wages and salaries 598 586 586 Interest payment on foreign loans 81 51 51 retained. The March amendment would Newly weds 18 11 11 be followed by a second budget Domestic investment 493 366 423 % of GDP 7.6 5.8 6.7 amendment in June of 2009 to avoid Maintenance 12 12 12 reducing the existing level of CMP % of domestic investment 2.5 3.4 3.9 Source: Mongolian authorities, World Bank payments, and finance the additional costs of on-going, priority projects caused by unexpected increases in the price of certain inputs. The fiscal deficit of the amended budget was 5.8 percent of 2009 GDP, up from 5.4 percent under the March amendment (Table 2). 6 A joint IMF/World Bank debt sustainability analysis (DSA) shows that Mongolia is at low risk of external debt distress. Although debt ratios will rise significantly over the next two years due to front-loaded external support, the debt outlook is expected to recover and improve over the medium term as the Oyu Tolgoi mine comes on stream. Key medium-term risks involve large debt service in 2012-15 due to the repayments of the loan under the IMF’s Stand-By Arrangement. The DSA has been included in IMF (2009) Mongolia: Request for Stand-By Arrangement and World Bank (2009), Program Document for Proposed Development Policy Credit, -9- Correcting earlier macroeconomic policies, the BoM raised its policy rate, the 1-week CB bills rate, to 14 percent from 9.75 percent, and allowed a more flexible exchange rate (initially through an auction), while avoiding overshooting and preserving its foreign exchange reserves. This led to a convergence of the official BoM and market exchange rates (Figure 7b). Another key action was that the BoM appointed an international reputable auditor to undertake a portfolio audit and develop a restructuring plan for Anod Bank to set standards for dealing with possible future bank failures. …External partners responded by pledging balance of payment and budget support The Government presented its Table 3. External financing requirements $ million action plan to the development 2009f 2010f partners on March 14, 2009. On Gross financing requirement: 1,291 1,195 Current account deficit 502 499 April 1, 2009, the IMF Board Amortization of medium- and long-term debt 93 54 approved an 18-month Stand-By Gross reserve accumulation 165 253 Other items 531 389 Arrangement (SBA) of $229 Available financing: 1,007 1,042 million to help Mongolia adjust to Grants 240 230 Disbursements to public sector 96 144 the external shock by stabilizing Disbursements to private sector 355 337 the macroeconomic situation. The Foreign direct investment 317 330 Financing need: 284 153 center piece was a substantial IMF SBA 139 93 Donor support requested 145 60 fiscal adjustment to deal with the Source: IMF (2009), Mongolia: Request for Stand-By Arrangement fall in mineral revenues of 10 percent of GDP. Fiscal deficits of 6 and 4 percent of GDP, in 2009 and 2010, respectively, were built into the program, amounting to a total financing gap of $205 million in 2009 and 2010 (Tables 3 and 4). Additional reforms focus on monetary and exchange rate policies, rebuilding confidence in the banking system, and protecting the most vulnerable from the downturn and the adjustments. To fill the financing gap, the World Bank pledged $60 million ($40 million for 2009 and $20 million for 2010) in the form of two single-tranche development policy credits supporting reforms in the policy areas most affected by the downturn: (i) fiscal policy and management, given the budget’s strong dependence on mining revenues; (ii) social protection, given the impact of the economic downturn on the poor; (iii) the financial sector, which was overheating when the global crisis hit, and which experienced a major bank failure in late 2008; and (iv) the mining sector, given the sector’s importance in driving the recovery.7 7 World Bank (2009), Program Document for a Proposed Development Policy Credit, June (World Bank’s Documents and Reports website: http://go.worldbank.org/ROT5TQLVC0. - 10 - The government obtained equally strong Table 4. Fiscal financing requirements support from the Asian Development Bank MNT billion 2008 2009f 2010f (ADB, $60 million) and Japan ($50 million), Total revenues and grants 2,156 1,936 2,269 and also received several firm pledges from a Total expenditure and net lending 2,462 2,316 2,559 Overall fiscal balance -305 -380 -290 number of bilateral partners. As a result, the % of GDP -5.0 -6.0 -4.0 projected balance of payments and fiscal gaps Financing: 305 390 290 Foreign (net) 43 53 150 were filled. So far, the IMF has disbursed Domestic (net) 262 101 40 about $118 million under the SBA in balance Donor support requested* 0 227 100 * This is the same amount as the support requested in Table 3, of payments support for the central bank, and converted in MNT by the projected exchange rates for 2009 and the World Bank, Japan and the ADB disbursed 2010. Source: IMF (2009), Mongolia: Request for Stand-By Arrangement their pledged amounts for budget support in 2009 ($130 million in total) in July. 4. Latest developments Fiscal balance remains under pressure Total revenue and grants fell by 21 percent in nominal terms and 29 percent in real terms in January-July compared to a year earlier. Corporate income tax, WPT, VAT, excise tax revenue, import duties, and royalties were lower, due to the slowdown in growth, consumption, imports and commodity prices. Revenue from taxes on wages and salaries and social security contributions were higher in real terms. Dividends were 206.5 percent higher in real terms. Between January 2009 and July 2009, there were some tentative improvements in corporate income tax, WPT, royalties, dividend that can probably be attributed to copper prices rising from their December 2008 low of $2700/tonne.8 But VAT and import duties remained at a constant level below the corresponding periods in 2008, reflecting a drop in consumption and import demand (Figures 7a and 7b). 8 Copper prices reached $2700/tonne at the end of December 2008, and have breached $6000/tonne in August. - 11 - Figure 7a. Selected revenue components Figure 7b. Shares in revenue % change cumulative revenue compared to same period last year in real terms. % of total revenue and grants, July 2009 100 Jan-09 Mar-09 207 75 May-09 Import 50 Jul-09 duties, 6.1 25 -29 7 8 Royalty, Dividen Excise 4.3 ds, 9.1 0 taxes, 9.4 -25 Other, 19.3 -11 -50 -19 VAT, Corpora -75 17.7 te -49 -32 -48 -83 income -100 tax, 9.4 Social On seurity WPT, wages contrib 4.7 and utions, salaries, 13.7 6.3 Note: July 2009 number in boxes. Dividend in May and July off the chart. Source: Ministry of Finance, World Bank Source: Ministry of Finance, World Bank Total expenditure and net lending rose by 4 percent in nominal terms, but fell by 7 percent in real terms in January-July compared to a year earlier. There were real cuts in purchases of goods and services, domestic investment and expenditure on maintenance. Subsidies to energy companies increased, but the amount of the subsidies is very small. Wages and salaries fell slightly in real terms. Transfers from the social security fund (e.g, pensions) and from the social assistance fund (e.g., Child Money Program) rose only by a small amount in nominal terms, and fell in real terms. Net lending mostly consisted of a one-off on-lending operation to gold producers (the “gold bond”). However, this is supposed to be repaid in 2009 and should therefore not impact the final outturn of the fiscal deficit.9 Total expenditure alone, excluding net lending, was 11.4 percent lower in real terms. Looking at trends between January 2009 and July 2009 only, expenditure on maintenance is gradually picking up, though still 67 percent lower in real terms than in 2008. Investment is also gradually increasing, as a result of the June budget amendment (Figures 8a and 8b). 9 IMF (2009), Mongolia: First review under the Stand-By Arrangement, August 2009 - 12 - Figure 8a. Selected expenditure components Figure 8b. Shares in expenditure % change cumulative expenditure compared to same period last year in real terms . % of total expenditure and net lending, July 2009 100 Jan-09 76 75 Mar-09 Domesti 50 May-09 Mainte Social c Jul-09 Social nance, 25 security assistan Investm -7 -1 -29 ent, 0.5 fund, ce fund, 0 10.9 Net 16.9 9.7 26 lending, -25 9.5 -6 -26 -50 -8 Subsidie -8 s to Other, -75 public 8.8 -67 -100 transpo rtation, 0.4 Purchas Wages es of and Subsidie goods salaries, s to and 26.5 energy, services 0.8 , 16.1 Note: July 2009 number in boxes. Subsidies to energy, public transportation and Source: Ministry of Finance, World Bank domestic investment in January off the chart, but this is a timing issue. Source: Ministry of Finance, World Bank The 12-month rolling fiscal balance continued to deteriorate in 2009 up to July On a 12-month rolling basis the same Figure 9. The 12-month rolling fiscal deficit continues to trends are shown: revenue has fallen, widen, as revenue has been falling, compared to expenditure % of GDP*, 12-month rolling sum while expenditure was relatively Revenue & grants 50 stable as a share of GDP. The fiscal 48 Total exp&net lending 2 46 Total expenditure deficit in the 12 months to July 44 Fiscal balance (right) 0 Adjusted balance** (right) amounts to 9.8 percent of GDP, after 42 -2 40 a protracted decline since early 2008 38 -4 and a brief slowdown around April. 36 -6 34 Stripping out net lending, this 32 -8 adjusted deficit would be 7.5 percent 30 -10 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 of GDP in the 12 months to July * GDP interpolated using actual 2008 GDP (MNT 6,130 billion) and projected (Figure 9). 2009 GDP (MNT 6,294 billion). ** Adjusted fiscal balance excludes net lending from expenditure, leaving current and capital expenditure only. Source: Ministry of Finance, World Bank - 13 - The goods trade deficit narrowed Figure 10. The trade balance narrowed as imports have fallen faster than exports The goods trade deficit narrowed to $ billion $ billion 4.0 0.2 $0.6 billion on a 12-month rolling basis 3.5 0.0 by July from a recent peak of $1.1 3.0 -0.2 2.5 billion in February, as imports -0.4 2.0 contracted much more sharply than 1.5 -0.6 Exports -0.8 exports in line with the slowdown in 1.0 Imports 0.5 -1.0 domestic spending (Figure 10). Trade balance (right axis) 0.0 -1.2 Jul-06 Jul-07 Jul-08 Jul-09 Source: National Statistical Office, World Bank Goods exports are down 37.4 percent in dollar terms from a year earlier in January-July, driven by declines in shipments abroad of most commodities Exports of copper were down 56 percent in dollar terms due to the decline in copper prices, while export volume hardly changed since 2008. Similarly, zinc exports fell mostly in line with prices, rather than due to volume drops. Exports of crude oil and combed goat down (a cashmere-related product) were down as well, with price declines exceeding volume declines in. Gold exports stagnated, with no shipments in June and July. Gold production has fallen by about 50 percent compared to the same period last year. Gold producers were said to be short of liquidity to finance their operations, but a special gold bond was issued to alleviate this financing constraint. However, some observers argue that this special credit window came too late and was not sufficiently targeted to gold producers to be effective. Another reason for the drop in gold export volumes was that a major gold producer shut down due to a labor dispute and a revoked mining license. However, news sources suggest that the actual volume of exports may be higher, as gold exporters tried to evade the WPT by smuggling gold out of the country.10 By contrast, exports of coal and greasy cashmere were up due to large increases in export volumes. In the case of greasy cashmere, this more than offset the large price drop (Figure 11a and 11b). 10 Another reason may be that producers are holding on their gold stock rather than exporting it, in the expectation that the WPT would be abolished in 2011. - 14 - Figure 11a. Selected export commodities Figure 11b. Shares in exports % change cumulative exports compared to same period last year in USD terms. % of total exports, July 2009 80 65 Other, Jan-09 60 Crude 17.8 Mar-09 petrole 40 19 Copper May-09 um oils, 20 concent Jul-09 4.5 rate, 0 24.8 -20 -40 -24 Zinc -60 -37 -29 concent -56 -49 rate, -80 -46 6.3 Gold, 18.3 Greasy cashme re, 7.9 Combe d goat Coal, down, 16.5 3.9 Note: July 2009 number in boxes. Gold: unwrought or in semi-manufactured forms. Source: Ministry of Finance, World Bank Combed goat down and greasy cashmere are intermediate cashmere products. Source: Ministry of Finance, World Bank … And January to July exports (in dollar terms) to all destinations fell compared to a year earlier Exports to China (accounting for about 70 percent of exports) fell 31 percent. Exports to the EU fell 26 percent. Exports to the US are now 89 percent lower than in 2008.11 Exports to Canada and Russia also fell substantially (Figure 12a and 12b). Figure 12a. Selected export destinations Figure 12b. Shares in exports % change cumulative exports compared to same period last year in USD terms. % of total exports, July 2009 100 Jan-09 Russia, 80 Other, 2.4 60 Mar-09 Canad US, 1.2 1.7 40 a, 5.9 China, May-09 20 73.1 0 Jul-09 Europe -20 an -40 -26 Union, -60 -44 -37 15.7 -31 -45 -80 -100 -89 Note: July 2009 number in boxes. Source: Ministry of Finance, World Bank Source: Ministry of Finance, World Bank 11 From January-May 2009 exports to the EU were higher than in 2008. The reason for the drop in June-July is that no gold exports have been recorded for these months in 2009, in contrast to June-July 2008. Similarly, gold exports to the US in 2008 up to July were $85 million (accounted for 83 percent of exports to the US). This year, no exports of gold to the US have been reported at all, leading to the large drop in export value to the US. - 15 - Goods imports fell by 40 percent in dollar terms from a year earlier in January-July Imports of industrial goods, such as base metals, mineral products, machinery and equipment, fell the most, reflecting the slowdown in industrial production in Mongolia. Imports of food products fell by less, because food import demand is less dependent on the domestic slowdown and exchange rate depreciation than the other types of imports (Figure 13a and 13b). Figure 13a. Selected import commodities Figure 13b. Shares in imports % change cumulative imports compared to same period last year in USD terms. % of total imports, July 2009 20 Food 0 produ Miner -20 Base cts, al metals 7.9 produ -40 -30 -34 -28 , 5.9 cts, -60 -40 -53 23.7 -80 -60 Transp ort Machi equip nery Jan-09 ment, and Mar-09 17.0 equip May-09 ment, Jul-09 20.1 Note: July 2009 number in boxes. Source: Ministry of Finance, World Bank Source: Ministry of Finance, World Bank The narrowing of the goods trade deficit led to a narrowing of the current account deficit12 The current account of the balance of payments—recording the balance of goods and services trade, net investment income, remittances and grants to the government—came in at $720 million deficit in the second quarter of 2009 (15.2 percent of GDP). The deficit has started to narrow, after it peaked in the first quarter of 2009.13 The most important driver of the narrowing of the current account deficit was the goods trade deficit. However, the services balance, another key driver, deteriorated further, as incoming tourism revenues disappointed. Inflows of remittances from Mongolians working abroad net of outflows of foreigners working in Mongolia dropped due to the global downturn. However, this was offset by grants to the government, resulting in stable current transfers. Throughout, net income flows were negative, due to dividends paid to foreigners (Figure 14a). 12 All balance of payments data in this section are on a 4-quarter rolling basis, this means they have been summed over the previous four quarters. This reduces the strong effect of Mongolian seasonal cycles on the data. For notational simplicity, the term 4-quarter rolling has been dropped. 13 Although the current account deficit narrowed in USD terms from end-2008 to the second quarter of 2009, GDP in USD terms had shrunk further, because of the sharp depreciation of the MNT. - 16 - The current account deficit was mainly financed by net foreign direct investment inflows and the IMF loan disbursement The current account deficit was primarily financed by net capital inflows in the financial account,14 which amounted to $644 million (13.6 percent of GDP) in the second quarter of 2009. Direct investment by foreign companies (FDI), mainly in the mining sector, fell from the peak in the third quarter of 2008. Net borrowing from abroad by government jumped in the second quarter of 2009, due to the issuing of the gold bond.15 Other capital inflows, such as trade credit, and short- and long-term lending to the private sector fell from their peaks in the fourth quarter of 2008 (Figure 14b). Figure 14a. The current account moved into a Figure 14b. ... And FDI inflows and other net deficit driven by a widening trade and services inflows dropped from their peaks deficit… % of GDP, 4-quarter rolling sum % of GDP, 4-quarter rolling sum 15 Net portfolio inflows 20 Other net inflows (government) 10 Other net inflows (other) Net FDI inflows 5 15 2.1 4.5 0 10 2.8 -5 -11.7 5 8.7 -10 Current transfers Net income 0 -15 Services balance -5.1 -0.1 Goods trade balance -2.9 -20 Current account balance -5 Q2-07 Q4-07 Q2-08 Q4-08 Q2-09 Q2-07 Q4-07 Q2-08 Q4-08 Q2-09 Note: Numbers on the rights are the values of major balance of payments components as a % of GDP on a 4-quarter rolling basis. The 4-quarter rolling sum nominal GDP in the denominator has been estimated using publicly available data on quarterly real GDP, CPI, trade and commodity prices (copper, gold and coal). Source: Bank of Mongolia, National Statistical Office, World Bank The remaining portion of the current account deficit was financed by a disbursement from the IMF under the SBA ($118 million), FX purchases through the BoM’s auction, and gold purchases from domestic producers. This also allowed the BoM to rebuild its net international reserves to $684 million at the end of July 2009 (Figure 6b). The depreciation against the USD partly restored Mongolia’s export competitiveness The exchange rate against the USD has been very stable since April, as the BoM started selling and buying FX to and from commercial banks by auction, after the sharp depreciation against the USD from 14 The financial account records all transactions between a domestic and foreign resident that involves a change of ownership of an asset. It is the net result of public and private international investment flowing in and out of a country, such as FDI, portfolio investment, and lending and borrowing. 15 Discussed in the section of total expenditure and net lending. - 17 - October 2008 to mid-March 2009, and the partial recovery (Figures 6a and 15). The trade-weighted exchange rate (NEER)16 has closely followed the exchange rate with the US dollar. The reason is that China (Mongolia’s most important import and export partner) carries a large weight, and its currency closely followed the US dollar. This depreciation partly Figure 15. The large nominal depreciation has partly restored Mongolia’s export competitiveness restored Mongolia’s export Index=100 in January 2006* USD per MNT** NEER competitiveness, which is 130 800 REER 120 Bilateral exchange rate (right axis) approximated by the inflation- 1000 110 adjusted, trade-weighted 100 1200 exchange rate (REER).17 90 However, the REER is still 1400 80 about 10 percent higher than in 70 1600 2003-06, at the onset of the Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 copper prices boom. Exports in * Upward movement is appreciation. ** Inverted scale. sectors other than minerals Source: Bank of Mongolia, IMF Direction of Trade, World Bank may therefore lag once global demand picks up. The REER had steadily eroded during the first three quarters of 2008, when Mongolia’s prices rose much faster than those of its trading partners, while its exchange rate did not depreciate in line (Figure 15). CPI inflation has fallen rapidly to 2.9 percent yoy, allowing the BoM to cut its policy rate CPI inflation has fallen rapidly to 2.9 percent yoy at the end of July 2009, from its peak of 33.7 percent yoy in August 2008, when it was the highest in East Asia. This was caused mostly by overheating due to strong domestic growth (evidenced by the large contribution of core inflation18), although increases in global food and fuel prices also contributed. The BoM tried to fight the high inflation by focusing on exchange rate appreciation to reduce the cost of imports, rather than by increasing the policy rate, the 1- week central bank bills rate, to reduce core inflation. As this was ineffective, borrowing and lending rates became more and more negative, leading to a surge in credit growth and a fall in MNT deposits. 16 Also called Nominal Effective Exchange Rate. It records the movements of the tugrug against the currencies of its most important trading partners (mainly China, the European Union, Canada, US and Russia), and is calculated by taking the average of bilateral exchange rates weighted by trade shares. 17 Also called the Real Effective Exchange Rate. It corrects for differences in inflation in Mongolia and the trading partners. 18 Core inflation excludes volatile items such as meat, milk and cheese, and energy and fuels, and is a proxy for domestic activity. - 18 - In March, the BoM hiked its Figure 16. Inflation has fallen rapidly from its peak, mainly because rate by 425 basis points to 14 of the domestic slowdown % yoy change (inflation), % (rate) percentage point contribution to CPI inflation percent from 9.75 percent to Core inflation (right axis) Meat, milk and cheese (right axis) signal a policy change. It 35 Energy and fuels (right axis) 35 CPI inflation then lowered it in two steps 25 BoM policy rate 25 as inflation fell, as global 15 15 food and fuel prices eased, 5 5 and the domestic economy -5 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 -5 slowed down (Figure 16). Source: National Statistical Office, World Bank In the financial sector, MNT and FX deposits have recovered, although there has been structural shift of MNT towards FX deposits …19 MNT deposits reached MNT 985 billion in July 2009. This is MNT 98 billion higher than the level at the height of the deposit outflow crisis in January 2009, but lower (by MNT 164 billion) than in March 2008, when MNT deposits peaked. FX deposits reached MNT 617 billion, higher than the pre-crisis level (Figure 5b). … But non-performing loans are increasing sharply Loan quality continues to deteriorate, as the portfolio is exposed to the sectors that are experiencing a strong slowdown. Figure 17. NPLs and loans in arrears have risen strongly, as key Non-performing loans (NPLs) sectors in the economy slowed down to residents reached MNT 353 MNT billion Loans with principal in arrears 20.4 billion or 13.7 percent of 600 Non-performing loans to non-residents 500 Non-performing loans to residents 17.8 outstanding loans in July, as 400 they continued to increase 10.7 300 strongly from MNT 87 billion 200 5.2 in November. The discrete 100 jump in NPLs from 0 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 November to December was caused by the failure of Anod Note: number in boxes is sum of NPLs to residents and non-residents and loans with principal in arrears as a percent of total loans outstanding. Bank, the fourth largest bank. Source: Bank of Mongolia, World Bank 19 The numbers in the remainder of this section have been provided by the Bank of Mongolia. They include Anod Bank, the bank that was taken under conservatorship by the Bank of Mongolia in December 2008. - 19 - NPLs to non-residents amount to MNT 37 billion at the end of July (96 percent of loans outstanding to non-residents). Most of these loans were already non-performing before July, but were classified as performing loans. At the request of the BoM, this was corrected in July. Loans with principal in arrears20 reached MNT 143 billion in July (5.6 percent of outstanding loans). Although this is down from its peak in May, it means that although some loans in arrears have become non-performing, formerly performing loans are going into in arrears. Total NPLs (to residents and non-residents) and loans with principal in arrears amounted to MNT 534 billion at the end of July or 20.4 percent of loans outstanding to residents and non-residents. This is a large deterioration in the health of the loan portfolio compared to July 2008, when total loans outstanding were about the same, MNT 2.9 trillion, but NPLs and loans in arrears only made up 5.2 percent (Figure 17). … Especially in key sectors of the economy21 Comparing the sectoral composition of the changes in NPLs and loans with principal in arrears between the first quarter of 2009 and the second quarter of 2009, we find that the largest increases were recorded in the construction (MNT 20 billion), wholesale and retail (MNT 19 billion), and mining and quarrying sectors (MNT 11 billion) (Figure 18a). These three sectors also account for 59 percent of the total NPLs (to residents) and loans with principal in arrears at the end of the second quarter of 2009, with construction amounting to MNT 112 billion, wholesale and retail MNT 94 billion and mining and quarrying MNT 56 billion (Figure 18b). Figure 18a. The largest increases in NPLs and loans Figure18b. … And these sectors now account in arrears occurred in construction, wholesale and for the majority of NPLs and loans in arrears retail and mining and quarrying …. Change in NPLs and loans in arrears between Q1 and Q2 2009 % of total NPLs and loans in arrears in Q2 2009, by sector 25 MNT bn change 30 Agricultu Mining 20 % change (right axis) 25 re, 4.2% and Other 15 20 sectors, quarrying 15 19.9% , 12.6% 10 10 5 Manufact 5 uring, 0 0 Wholesal e and 17.2% Wholesale and Other sectors Agriculture Mining and Manufacturing Construction -5 -5 quarrying retail, -10 -10 retail 21.1% Construct ion, 25.0% Source: Bank of Mongolia, World Bank Source: Bank of Mongolia 20 These are loans of which the principal is 1 to 90 days in arrears. After 90 days, they become non-performing loans. 21 The source of the sectoral data on loans is the Bank of Mongolia’s Q2 2009 loan report. - 20 - The construction sector has the highest ratio of NPLs and loans in arrears to total loans in the sector at 28.7 percent, with mining and quarrying a close second at 27.4 percent (Figure 19a). Between the second quarter of 2008 and the second quarter of 2009, NPLs and loans in arrears increased by 274.1 percent. The construction sector accounted for 87.4 percentage points of this increase, with wholesale and retail a distant second at 48.9pp (Figure 19b). Figure 19a. The construction sector has the highest Figure 19b. … And construction accounted NPLs and loans in arrears relative to outstanding for the largest part of the increase in NPLs loans and loans in arrears NPLs and loans arrears as percentage of outstanding loans in sector Percentage point contribution to 274.1% increase in NPLs and loans in arrears between Q2 2008 and Q2 2009 40 Real Other Agricultur Mining 56 112 30 14 estate sectors, e, 10.8 and 77 94 activities, 30.7 quarrying 20 19 16 10.9 , 37.5 10 Transport Manufact 0 ation, Wholesal uring, storage, 36.2 Construction Mining and Transportation, Wholesale and Real estate Agriculture Manufacturing e and quarrying activities 11.7 retail, storage retail 48.9 Construct ion, 87.4 Note: Number in box is MNT value of NPLs and loans in arrears Source: Bank of Mongolia, World Bank Source: Bank of Mongolia, World Bank As banks became more risk-averse, they slowed down lending to the private sector and started to purchase safe central bank bills Figure 20. Total loan growth has come to a Banks have reduced lending and are buying less standstill, as bank prefer safe CB bills % year-on-year change % year-on-year change risky central bank bills instead, making it very Total 100 Private 250 difficult for companies and individuals to obtain Individuals 80 CB bills (right axis) 200 loans. 150 60 Total loan growth has come to a standstill, with 100 40 loans outstanding to individuals contracting by 50 15.6 percent yoy in July 2009, and loans to the 20 0 private sector slowing down to 11 percent yoy. 0 -50 This slowdown occurred as macroeconomic and -20 -100 financial conditions worsened in late-2008. Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Growth in loans outstanding had peaked between Source: Bank of Mongolia, World Bank mid-2007 and mid-2008 as commodity prices boomed. - 21 - Instead, banks have started to buy central bank bills from the BoM, which currently provide a high risk- free return of 11.5 percent and are an attractive investment with inflation on a downward trend (currently 2.9 percent yoy). The BoM recently lowered its policy rate to reduce this bias (Figure 20). Newly issued loans continued to decline in major segments of the private sector Newly issued loans dropped 43 percent to MNT 593 billion in the second quarter of 2009 from MNT 1,041 billion in the second quarter of 2008, when the economy was still booming. The largest decreases in newly issued loans occurred in the wholesale and retail sector at MNT 211 billion, with the construction sector a distant second at MNT 61 billion (Figure 21a). However, the loan portfolio is still exposed for 38 percent to the wholesale and retail, and construction sectors (Figure 21b), the two sectors which recorded the highest increases in NPLs from the first to the second quarter of 2009 (Figure 18a). Figure 21a. Large decreases in loan issuance Figure 21b. The loan portfolio is exposed to to wholesale and retail, mining, construction sectors that suffer from NPLs and loans with and manufacturing … principal in arrears MNT billion, newly issued loans by sector % share of loans outstanding as of Q2 2009 400 Agricultu Mining 300 Q2 2008 re, 6.3% and Other quarrying 200 Q2 2009 sectors , , 8.1% 34.3% 100 Manufact 0 uring, 16.4% Agriculture Construction Manufacturing Wholesale and Mining and Real estate quarrying activities retail trade Wholesal e and Construct retail , ion, 22.3% 15.3% Source: Bank of Mongolia Source: Bank of Mongolia Industrial production contracted, and GDP growth slowed down Industrial production (on a three-month moving average basis to smooth fluctuations) contracted by 11.2 percent yoy in July 2009. Manufacturing activity was hit especially hard, with two key activities (manufacturing of textiles and basic metals) contracting by 30 to 60 percent yoy. After a brief rebound, mining and quarrying also turned to contraction, mainly due to decrease in the mining of gold (Figure 22). Detailed firm-level data confirms this trend. Comparing the first quarters of 2008 and 2009 for a large sample of firms, sales revenue declined by 15.7 percent, and expenses fell by 8.3 percent. This caused income before tax to drop by 64.4 percent, and taxes paid by 60.7 percent. Construction, mining, and gas, fuel and coal wholesale firms also suffered large drops in revenue. 22 22 Box 2 in World Bank (2009), Mongolia June Monthly Economic Update, - 22 - Real GDP grew 0.7 percent yoy in the second quarter of 2009, a rebound from a 4.2 percent yoy contraction in the first quarter of 2009. This followed a period of strong growth of between 7 and 10 percent yoy from 2003 to 2008. The main causes of the rapid slowdown of growth after the third quarter of 2008 were declines in the wholesale and retail, mining, manufacturing, and construction sectors. Agriculture continued to exhibit positive growth (Figure 23). Figure 22. Industrial production Figure 23. Wholesale/retail, construction and contracted manufacturing dragged down GDP growth % year-on-year real change, 3-month moving average Percentage point contribution to growth % yoy real GDP growth 30 15 Agriculture Mining 20 Manufacturing Construction 10 10 Wholesale & retail trade -1.9 Transport & communication 0 -2.6 5 -10 -11.2 0.7 -20 1.0 Total 0 -2.0 -30 Mining and quarrying -28.0 -0.9 Manufacturing -40 Utilities -5 -1.0 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Q1-06 Q3-06 Q1-07 Q3-07 Q1-08 Note: Number in box is July growth. Source: National Statistical Office, World Bank Source: National Statistical Office, World Bank For 2009, Mongolia is facing a major slowdown in growth to an estimated 2.7 percent in 2009 from 8.9 Figure 24. GDP growth is projected to slow down significantly percent in 2008. This reflects developments in key Pcntg point contribution to growth % real growth Transport, storage & communication sectors which have driven growth in recent years: 14 14 Agriculture 12 agriculture, due to falling prices of cashmere and other Mining & quarrying 12 10 10 livestock related products; transportation, storage and 8 8 communication, due to weakening in the mining sector; 6 6 4 and other services sectors (including retail and banking), 4 2 which had been driven by large public expenditure 0 2 increases on social transfers, and wages and salaries. -2 2003 2004 2005 2006 2007 2008 2009F 0 Contributions to growth from the mining sector steadily Source: National Statistical Office, World Bank declined since 2004 (Figure 24). Recently, Parliament voted to approve four draft law amendments necessary for the conclusion of the Oyu Tolgoi (OT) Investment Agreement between the government and Ivanhoe Mines/Rio Tinto. These amendments will invalidate the WPT with effect from January 1, 2011, introduce changes to the corporate income tax (extending loss-carried-forward provision from 2 to 8 years), and permit private sector - 23 - construction and management of roads and water supply facilities. The agreement will also include a pre-payment of taxes of $250 million at an interest rate of 5 percent. If the deal is concluded, the Oyu Tolgoi copper and gold mine (together with the Tavan Tolgoi coal mine) will make a substantial contribution to the economic growth of Mongolia in the near future. Unemployment has been steadily increasing since Figure 25. Registered unemployment* has the beginning of the year as a result of the risen from its trough at the end of 2008… % of labor force contraction in the real sector 3.9 Registered unemployment rate Registered unemployment reached 3.8 percent of labor 3.7 Registered unemployment rate 3.5 (12-month moving avg) force in July 2009, with the number of registered 3.3 unemployed increasing by 29 percent compared to July 3.1 2008. Unemployment had been falling during the boom 2.9 2.7 years, but as the effects of the economic downturn 2.5 moved towards the real sector, employment conditions Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 have been worsening (Figure 25). This underestimates * Defined as working-age population currently not working in a paid job and not self-employed, actively actual unemployment, which according to plausible, looking for job and registered at the Employment Office. unofficial estimates could be as high as 21-26 percent Source: National Statistical Office, World Bank of labor force.23 … Which has adverse consequences for poverty reduction and welfare in the informal sector The latest poverty profile of Mongolia published by the government24 shows, that even during the recent years of high economic growth, poverty was not reduced substantially. The poverty headcount declined little to 35.5 percent in the 2007/08 survey, down from 36.1 percent in the 2002/03 survey, with large regional differences between the Ulaanbaatar and the rural populations. As average incomes rose, this means that inequality has increased significantly.25 Furthermore, economic growth in 2009 has been 23 Using the NSO’s Labor Force Survey of end-2008, we assume, in line with the internationally used definition of unemployment, that out of the unregistered unemployed of working age, those who stated they are looking for work or cannot find suitable work, are part of the labor force and count as unemployed, and the remainder as out of labor force (e.g., child care, housework, not interested to work). Extrapolating these numbers to July 2009, assuming the unemployment numbers increased in line with registered unemployment between end-2008 and July 2009 (36 percent), and out of labor force in line with population growth (about 1 percent), this increases the unemployment rate substantially (also depending on whether to include those who have no clear reason for having no job as unemployed or out of labor force). The NSO is planning to publish a more comprehensive unemployment number in the near future. 24 National Statistical Office of Mongolia (2009), Poverty profile in Mongolia: Main outputs of Household Socio- Economic survey 2007-2008, March 2009 25 One caveat may be that the poverty estimates factor in the food and commodity price inflation in 2008 on the consumption side, but may have missed the parallel increase in incomes and asset values of rural inhabitants during the same period. Future analysis of the poverty data by the World Bank will try to address this question. - 24 - revised downward from 8 to 2.7 percent. Based on the historic correlation between economic growth and poverty estimated by Bank staff, this implies that between 20,000 and 40,000 thousands fewer Mongolians (0.7 percent and 1.4 percent of the population respectively) would be lifted out of poverty in 2009. A recent survey of the informal urban sector and a recently commissioned study on the crisis implications for household in the informal sector found that the effects of the economic slowdown have a widespread social and poverty impact in Mongolia. Real effective income has fallen by about 60 percent in some informal urban labor markets, due to high inflation eroding real wages and due to reduced job availability.26 Employment conditions are also becoming less favorable for informal workers in the rural regions, and herders and informal mining workers are barely able to cope with the decreasing job availability, falling wages and increasing living expenses.27 5. Conclusion Mongolia has been one of the hardest hit countries in East Asia by the financial crisis, although unlike other countries, the crisis was transmitted via the commodity channel, rather than via the financial sector. The Mongolian government deserves credit for the tough reforms it implemented in early 2009, which has led to support from its external partners. These have led to a stabilization of the external sector. The attention is now shifting to the strains in the financial sector and effects of the downturn on the real economy, unemployment, and poverty. Going forward, it is important that the government focuses on implementing a fiscal responsibility framework to avoid a repeat of the boom-and-bust spending pattern that Mongolia has just experienced. It is also important to improve the planning and budgeting for public investments, and to prioritize the protection of infrastructure maintenance—critical during the downturn. Protecting the poor during this downturn is a challenge, but can be achieved by starting to target the currently untargeted social grants (in particular, the Child Money Program). The Asian Development Bank and the World Bank are providing technical support to assist the government in this endeavor. In the financial sector, it should ensure stability by intensifying supervision and taking decisive action in case of bank failures in order to retain confidence in the financial sector. In addition, a restructuring of the banking sector is envisaged, after the completion of a series of loan portfolio audits. In the mining sector, the government can now use the recent experience gained during the negotiations of the OT investment agreement to improve the overall policy environment. 26 Box 2 in World Bank (2009), Mongolia May Monthly Economic Update. 27 World Bank (2009) Study on the Crisis Implications for Household Livelihood, Final Report, May 20-June 30. - 25 - Table 5. Mongolia: Key Indicators 2003 2004 2005 2006 2007 2008e 2009f Output, Employment and Prices Real GDP (% yoy change) 7.0 10.6 7.3 8.6 10.2 8.9 2.7 Industrial production index .. .. .. 100.0 110.4 113.4 .. (% yoy change) .. .. .. .. 10.4 2.8 .. Unemployment (%) 3.4 3.6 3.3 3.2 2.8 2.8 .. Consumer price index (% yoy change) 4.6 10.9 9.6 5.9 14.1 23.2 9.0 Public Sector Government balance (% of GDP) -3.7 -1.8 2.6 3.3 2.8 -5.0 -6.0 Non-mining balance (% of GDP)(1) -5.9 -5.8 -1.3 -7.3 -13.4 -15.3 -10.4 Domestic public sector debt (% of GDP) 3.1 1.4 0.1 1.0 0.5 0.0 0.0 Foreign Trade, BOP and External Debt Trade balance ($ mn) -199.6 -99.2 -99.5 136.2 -52.4 -612.6 -331.0 Exports of goods ($ mn) 627.3 872.1 1066.1 1543.9 1950.7 2534.5 1863.0 (% yoy change) 19.7 39.0 22.2 44.8 26.4 29.9 -26.4 Copper exports (% yoy change) .. .. 14.7 94.8 27.7 3.0 .. Imports of goods ($ mn) 826.9 971.3 1165.6 1407.7 2003.1 3147.0 2194.0 (% yoy change) 21.6 17.5 20.0 20.8 42.3 57.1 -29.9 Current account balance ($ mn)(2) -102.4 24.1 29.7 221.6 264.8 -721.9 .. (% of GDP) -7.1 1.3 1.3 7.0 6.7 -13.9 .. Foreign direct investment ($ mn) 131.5 128.9 257.6 289.6 360.0 585.5 .. External debt ($ mn) 1240.3 1311.8 1360.0 1413.9 1528.7 1600.5 1795.8 (% of GDP) 87.3 73.7 59.7 44.3 38.9 33.1 46.8 Short-term debt ($ mn)(3) 0.0 0.0 0.0 0.0 0.0 0.0 .. Debt service ratio (% of exports of g&s)(3) 13.4 9.4 7.6 5.4 4.3 3.5 4.3 Foreign exchange reserves, gross ($ mn) 203.5 207.8 333.1 718.0 1,000.6 656.7 822.1 (month of imports of g&s) 2.3 1.8 2.5 4.6 5.0 2.1 3.7 Financial Markets Domestic credit (% yoy change) 157.3 25.8 18.8 -3.1 78.4 60.6 .. Short-term interest rate (% per annum)(4) .. 15.8 3.7 5.1 8.4 9.8 .. Exchange rate (MNT/USD, eop) 1168.0 1209.0 1221.0 1165.0 1170.0 1267.5 .. Real effective exchange rate (2006=100)(5) 94.2 93.9 99.6 102.8 104.8 127.4 .. (% yoy change) -4.8 -0.4 6.1 3.2 1.9 21.5 .. Stock market index (2000=100)(6) 151.5 120.8 203.6 382.0 2048.0 1181.6 .. Memo: Nominal GDP (MNT bn) 1,660 2,152 2,780 3,715 4,600 6,130 6,294 Nominal GDP ($ mn) 1,448 1,814 2,307 3,156 3,930 5,258 .. GDP per capita ($) 583 722 900 1,214 1,491 1,960 .. (1) Non-mining balance excludes revenues from corporate income tax and dividends from mining companies, the Windfall Profits Tax and royalties. (2) The 2008 data for the balance of payments are based on the final revision. (3) On public and publicly guaranteed debt. (4) Yield of 14-day bills until 2006 and of 7-day bills for 2007. (5) Increase is appreciation. (6) Top-20 index, end of year, index=100 in Dec-2000. Source: Bank of Mongolia, National Statistical Office, Ministry of Finance, IMF and World Bank staff estimates - 26 -