103115 Mongolia Economic Brief January 2016 http://www.worldbank.org/ mongolia In the last three months of 2015, exports 43.5% drop in oil product imports in the sharply declined amid a deepening minerals fourth quarter. Machinery and equipment market downturn. Exports dropped 36% (y/y) imports, however, rebounded by 18.7% and in the last three months, a weakening from a 6.8% (y/y) in Nov and Dec respectively after 12% drop in the previous nine months. Coal continuous sharp declines since late 2012, exports fell 43% (y/y) in the same period, signaling a possible rebound in 2016. suffering from weaker export price and volume due to subdued demand from China. The balance of payments recorded a $ 95.6 Copper concentrate exports also fell 37 % million deficit in Oct-Dec. The current (y/y) amid a 43% drop in export prices, account deficit reached $135 million in the despite the higher export volume by OT. fourth quarter, with a $420 million deficit in Annual total exports declined to $4,669 services and income accounts offsetting a million in 2015, a 19.1% fall from $5,774 trade surplus. Net FDI inflows rebounded to million in 2014. $216 million in the same period due to increased intercompany lending in Dec. A Falling oil prices and subdued domestic $100 million ADB loan and $257 million bank demand, however, kept the trade balance in loans also helped reduce the balance of a $188 million surplus in the fourth quarter. payments deficit. On the back of the Total imports (C.I.F. terms) fell by 21% (y/y) in mitigated balance of payments pressure in the fourth quarter. Annual imports declined Oct-Dec, the BoM repaid $234 million to the to $3,797 million in 2015, a 27.5% decline bilateral currency swap line facility with the from $5,236 million in the previous year. A People’s Bank of China in Dec, after a $632 collapse in global oil prices translated into a million drawdown in Jan-Sep. This Economic Brief was prepared by MFM Mongolia Team, composed of Taehyun Lee (Senior Country Economist), Altantsetseg Shiilegmaa (Economist), Davaadalai Batsuuri (Economist), under the guidance of Mathew A. Verghis (Practice Manager). Gross international reserves moderately relatively stable balance of payments declined to $1,323 million in Dec, about conditions. In January, depreciation pressure three months’ import cover, after seems escalating amid the heightened maintaining the $1.4 billion level in Sep-Nov. volatility in the global financial market. Gross reserves fell by $326 million over the twelve months, from $1,649 million at the The project financing agreement on OT’s end of 2014. underground mine was signed on Dec 16, 2015. The project financing is expected to The exchange rate against the US$ bring US$4.4 billion into Mongolia over the weakened to MNT 2,011 in Jan. The nominal coming years, supporting Mongolia’s growth exchange rate stayed in the range of MNT and external accounts. The actual timing and 1,900-2,000 per US$ since mid-Aug despite size of investment in 2016 are likely to substantial depreciation in most of the depend on subsequent steps to be taken in commodity-dependent currencies. Following the first half of the year, including the heavy intervention in Jul-Sep, the central completion of 2015 feasibility study, formal bank significantly reduced its intervention in decisions by the boards of related companies, the foreign exchange market in the final three and the issuance of necessary permits. months of last year on the back of the Figure 1. Sharp weakening of exports weighs on the current Figure 2. Exchange rate depreciated above MNT 2,000 against the account despite continued import compression. US$ in Jan. Current account balance and trade in goods (%, y/y, 3 month Daily nominal exchange rate (MNT/USD) rolling sum) 2020 Exports (y/y, %): LHS 2000 60 Imports (y/y, %): LHS 300 1980 40 CA balance (million $): RHS 200 1960 20 100 1940 0 0 1920 -20 -100 1900 -40 -200 1880 1860 -60 -300 1840 -80 -400 Jun-12 Jun-13 Jun-14 Jun-15 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Dec-12 Dec-13 Dec-14 Dec-15 Source: BoM, NSO GDP growth remains slow. Growth slowed to by 1.8% (y/y), indicating continued sluggish 1.8% (y/y) in the third quarter from 3% in the growth in the final three months of 2015. previous six months. A 36.1% drop in investment continued to dampen growth in Mining industrial production growth slowed the third quarter. Final consumption grew to 6.2% (y/y) in the fourth quarter, signaling 5.7% (y/y) in the same period, led by an 8.4% a slowdown in mineral GDP growth. A sharp increase in private consumption, offsetting a drop in coal production and moderating 7.7% y/y decline in government consumption. copper concentrates production growth from An improvement in net exports supported the OT mine have dampened mining growth, with sharp import compression industrial production. In January, OT reported outpacing declining exports. In Oct-Dec, that its copper and gold production rose by industrial production only slightly increased 36% and 10.9% respectively in 2015. The mining company, however, expected a 2 decline in its gold and copper production in in Jan showed that the number of livestock 2016, which could weigh on Mongolia’s increased by 9.2% over the last year but crop growth and the current account. harvests declined due to drought by 59% (Cereals and wheat), 31% (vegetables), and Non-mining industries remained 12.7% (hay) in 2015. substantially weak in Oct-Dec. Manufacturing industrial production fell by Headline inflation further slowed to below 19.8% (y/y) in the fourth quarter. Electricity 2%. Nation-wide and UB-city consumer price production also remained subdued, inflation rates decelerated to 1.9% and 1.1% increasing by only 2% (y/y) in the same respectively in Dec on a yearly basis. The period. Leading indicators for transportation recent disinflation trend is largely attributed and communication industries (e.g., carried to sharp drops in meat prices, driven by freight and passengers, communication increased meat supply from herders. Core services sale) also weakened in the fourth inflation also slowed to 4.8% in Dec. quarter. The annual agriculture data released Figure 3. Industrial production indicates subdued growth in Figure 4. CPI inflation continued to fall to below 2% in Dec, Q4 2015, following a 2.5% GDP growth in Jan-Sep. driven by a falling meat price. Real GDP growth (y/y, %) and industrial production (3 month Food and non-food inflation (Ulaanbaatar, y/y, %) rolling sum, y/y %) 20% Headline inflation Food inflation Non-Food inflation Overall GDP 15% Non-mining 45.0 Mining 10% 35.0 Industrial production (3m rolling sum, y/y) 4.9% 5% 25.0 1.1% 15.0 0% 5.0 -5% -7.2% - 5.0 -10% I II III IV I II III IV I II III IV I II III IV I II III IV Oct-14 Oct-15 Sep-14 Jan-15 Feb-15 Mar-15 Sep-15 May-14 Nov-14 May-15 Nov-15 Apr-14 Jun-14 Apr-15 Jun-15 Jul-14 Aug-14 Dec-14 Jul-15 Aug-15 Dec-15 2011 2012 2013 2014 2015 Source: NSO, WB staff calculations Mongolia’s external financing conditions than its 10-year counterpart’s, indicates have considerably tightened in late Jan, with higher short-term risks facing Mongolia in its benchmark sovereign bond yields rising 2016-17 perceived by international investors. over 11%. The market yield of the 5-year Significant short term liquidity was injected Chinggis bonds soared to over 11% on Jan 21, by the BOM to commercial banks in Dec a sharp increase from around 9% in the through its various lending facilities previous week, after a gradual rise from less including overnight loans. The BoM’s claim than 8% in early Dec. The tighter external on banks jumped from MNT 1,299 billion in financing conditions came amid an overall Nov to MNT 1,686 billion in Dec. The BoM has increase in the borrowing costs of emerging been providing short-term liquidity to the economies in recent months. However, the banking sector at the end of each year since recent sharper tightening of Mongolia’s 2011, to improve end-year prudential external financing conditions compared to its indicators and to ease liquidity strain of the peers in Jan seems to reflect recent political banking system. As a result of the liquidity developments. The market yield of the 10- injection, the system-wide reserve ratio of year Chinggis bond picked up to over 10% in banks rose to 28% of total deposits in Dec, late Jan, from 9% one month ago. The from 15.8% in Nov—a level which was close sovereign dim sum bond yield also jumped to the legal reserve requirement ratio of 12%. close to 14% from lower than 12% over the same period. The inverted yield curve, the The BoM lowered its policy rate by 100 bps higher bond yield of the 5-year Chinggis bond to 12% on Jan 14, 2016 amid tight credit 3 conditions. The decision came as bank loan drop in VAT and excise taxes while higher growth to the private sector, including the gasoline tax and royalty payments provided securitized mortgages, continued to slow to limited buffers to tighter fiscal conditions. 2.7% (y/y) and the NPL ratio remained close Annual general government spending was to 7.1% in Dec, while inflation further contained at MNT 7,136 billion, close to the decelerated to below 2%. previous year’s level, in response to the revenue shortage. The revenue outturn fell The 2015 budget recorded a MNT 1,163 short of the first supplementary budget billion deficit, close to the MNT 1,176 billion adopted in January by 10% (MNT 600 billion), target of the second supplementary budget. underscoring the importance of realistic Annual budget revenues declined to MNT revenue projections for credible fiscal 5,976 billion, a 5.4% drop from the 2014 planning. revenue outturn. The weak revenue performance was largely due to a substantial Figure 5. Mongolia’s bond yields soared to over 11% in late Figure 6. BoM lowered its policy late to 12% in Jan, following January, a sharper rise than its peer countries. substantial liquidity injection to the banking sector in Dec. Sovereign bond yields (%) BoM’s monthly liquidity injection to banks and the Policy Rate 12 Sri Lanka Vietnam BoM's claims on banks (monthly change, tn MNT):LHS 11 1.5 16 Chinggis 10yr Chinggis 5yr Policy rate (%): RHS 10 1.0 14 9 8 0.5 12 7 0.0 10 6 5 -0.5 8 4 -1.0 6 3 -1.5 4 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Source: Bloomberg, BoM In January, the authorities proposed measures to: (i) further expand the subsidized Housing Mortgage Program by lowering subsidized interest rate from 8% to 5% and providing support for down payments; and (ii) transfer the existing mortgage assets of the BoM to the government. The intention to transfer the mortgage program to the Ministry of Finance from the Central Bank is welcome, but the following issues could be further considered in the subsequent regulations and measures to be taken:  The cost of the program should be properly recorded as budget spending and financing should be on-budget rather than through the Central Bank.  Spending for the mortgage program should be decided within an affordable budget envelope, competing with other spending priorities, particularly given the tight fiscal situation.  Targeting of mortgage eligibility is needed to reduce the fiscal burden while effectively supporting affordable housing for low and middle-income families. It is not clear how the government will pay the BoM for the mortgage assets. Without proper compensation, the BoM’s balance sheet may suffer a large capital loss. Weak economic prospects also demand careful assessment on whether it is sustainable and prudent to support the construction sector by continuously boosting housing demand through BoM’s liquidity 4 injections or budget subsidies. 5