Mongolia’s Monthly Economic Update by World Bank

World Bank’s seventh monthly economic update report was released last Friday. Following is highlighted excerpts from the report.
Mineral prices held up well since the last Monthly Update of September. And economic growth in China—Mongolia’s main export destination—continues to be strong, fueled by a massive fiscal and monetary stimulus package. In Mongolia, however, depressed economic conditions made the trade deficit narrow further, as imports continue to fall faster than exports (on a 12-month rolling basis). Industrial production continues to contract, particularly in the manufacturing sector, with Mongolia facing a sharp GDP growth slow down for 2009 as a whole.


Only coal exports are up on a year-on-year basis, on the back of extremely strong demand in China which imported record quantities in September. With the Chinese economy growing strongly, the expectation is that the fall in overall exports to China has now bottomed out and will pick up going forward. In addition, the decline in the imports of machinery and equipment seems to have turned the corner.

Mongolia has now benefited from a stable exchange rate since April this year, due to strong policy actions taken under the IMF program and favorable copper prices. This has also allowed the Bank of Mongolia (BoM) to accumulate international reserves. Real interest rates are now, however, very high, because the economy is experiencing deflation with prices falling by 1.9 percent (year-on-year) in September, while nominal interest rates on both savings and loans have not come down significantly.

High real interest rates on savings are responsible for the continued growth recorded in MNT savings, but pose problems for borrowers in a depressed economy. In addition, most banks remain cautious, preferring to purchase less risky central bank bills, and depositing their foreign exchange with the central bank.

Fortunately, signs of new lending to individuals are emerging. Overall, the banking sector’s balance sheet has weakened further: a worrisome trend which is now almost a year old.

The fiscal balance remains under pressure despite a slight improvement in the 12-month rolling fiscal balance in September. Given the limited financing options available, the next two to three years will require a continued fiscal effort to bring the budget back to a sustainable path. New fiscal management legislation designed to support this effort will be presented to Parliament.

The second annual public Economic Policy Conference (EPC) and a high-level workshop between parliamentarians and international experts aimed to build a better understanding as to why and how Mongolia was so badly affected by the recent boom and bust cycle and what types of reforms could be implemented to create a stronger framework for both the financial sector, as well as fiscal management.


External sector developments are supportive, as mineral prices continue to rise and economic growth in China—Mongolia’s main export destination—continues to be strong, fueled by a massive fiscal and monetary stimulus package.


International prices of copper, gold and zinc held up well during October. The copper price in October 2009 averaged US$6286/tonne, slightly up from 6195/tonne in September. Gold prices also rose slightly to $1043/toz on average in October, up from $996/toz in September.
Mongolia’s main trading partner, China (accounting for almost three quarters of exports) looks set to grow by around eight percent this year, with overall industrial profit growth accelerating to 6.5 percent in Q3. Industrial production in China grew by 13.9 percent in September compared to a year earlier, up from 12.3 percent in August, and well above the 5 percent year-on-year (on a three-month average basis) growth rate seen at the beginning of 2009. Industrial production in Mongolia’s other major partners also showed improvements in recent months.

Industrial production continues to contract, particularly in the manufacturing sector, with Mongolia facing a sharp GDP growth slow down for 2009 as a whole.

Industrial production (on a three-month moving average basis to smooth fluctuations) contracted by 15.0 percent yoy in September 2009. Manufacturing activity was hit especially hard, with two key activities (manufacturing of textiles and basic metals) contracting by 35.8 percent yoy.

The consensus view on the economic growth projections for 2009 is around zero, with the differences in projections largely attributed to different estimates of this year’s agricultural growth. The consensus view for 2010 is a sharp turnaround due to the impact on economic value added from the large foreign direct investments associated with the OT and other mining projects.

Mongolia’s goods trade deficit narrows further: imports are falling faster than exports

The goods trade deficit narrowed to $0.51 billion on a 12-month rolling basis by September from a recent peak of US$1.1 billion in February. Imports continue to fall faster than exports, underlining the depressed economic conditions

Only coal exports are up on a year-to-year basis

Goods exports over January-September are down 34.3 percent in dollar terms from a year earlier with declines across most commodities (Figure 5). The drop is mainly due to lower prices, not to lower volumes. For instance, the dollar value of copper exports fell 52.7 percent in the first nine months of the year due entirely to the decline in copper prices.

Only coal exports, both in value and volume, are now up in September, on a year-to-year basis. Coal exports increased by 56.7 percent in dollar terms and 65.1 percent in volume on an annual basis due to extremely strong demand in China which imported record quantities of coal in September.

China’s coal imports skyrocketed by 167 percent, year on year, to 85.7 million tons in the first three quarters of this year. China’s coal use is roughly evenly divided between industry and electricity generation (80 percent of which is coal fueled). Much of China’s energy demand in the medium to long term is expected to be met by coal. This bodes well for the development of Mongolia’s Tavan Tolgoi (TT) coal deposits which hold an estimated of 6.5 billion tonnes of coking coal. Expectations are that the negotiations for the fully government-owned TT deposits will be concluded much faster than the OT negotiations.

The export of greasy cashmere is a purely seasonal activity, which has now come to a halt. For the year, the greasy cashmere export volume increased by over 111 percent and its dollar value increased by 34.4 percent compared to the same period last year. Chinese traders took advantage of the low cashmere prices in Mongolia and a reduction in trade barriers due to the lifting of quality restrictions and an increase in the number of border posts authorized to trade cashmere with China over the past year. This was a timely trade liberalization which may have helped cushion the downturn for the rural population. The downturn of cashmere prices at the beginning of this season provided Chinese processors a good opportunity to enter the market and build up stock. Chinese cashmere spinners and knitters have reported that overall order levels were satisfactory and were supported by the low value of the raw material, the low Euro/Rmb and Yen/Rmb rates and by growing Chinese demand for exclusive products.

Mongolia’s exports to China closely follow Chinese real industrial value added. While on a year to year basis, Mongolia’s exports to China are still down by 13.7 percent, the expectation is that this trend has now bottomed out and will pick up going forward.
Goods imports remain sharply down…

Goods imports over January to September were down by 38.8 percent in dollar terms from the corresponding period in 2008. Imports of mineral products (mainly fuel) are still sharply down, but the trend in machinery and equipment seems to have bottomed out. This is related to increased activity in the mining sector.

The US dollar exchange rate remains stable with some minor depreciation

The IMF-supported stabilization measures undertaken earlier in the year, combined with the increase in mineral prices, have been responsible for a stable exchange rate since April this year. They have also allowed for a substantial accumulation of international reserves by the Bank of Mongolia. In October, the average monthly exchange rate against the USD depreciated slightly by 1.4 percent compared with September.

Prices have now deflated for two months in a row

August and September inflation rates were minus 0.9 and 1.9 percent yearon-year, respectively. Core inflation is still positive, but falling to 4.6 percent year-on-year (yoy) in September.

Despite deflation, nominal interest rates on both savings as well as loans have not come down

The nominal interest rates on local and foreign currency deposits have now stayed virtually the same for two years despite large fluctuations in inflation. The maximum advertised nominal interest rates on local and foreign currency deposits have stayed around 19 percent and 13 percent while the weighted average rates have been around 13 percent and 7 percent respectively for the last two years.
However, since the real interest rates have fluctuated markedly, this has shifted the burden of large fluctuations in the real interest rates onto depositors and borrowers. High real interest rates on savings are responsible for the continued growth recorded in MNT savings, but pose problems for borrowers in a depressed economy.
Due to extremely attractive MNT deposit rates, MNT deposits grew to MNT 1,072 billion September 2009. This is MNT 184 billion higher than the level at the height of the deposit outflow crisis in January 2009, but still lower (by MNT 77 billion) than in March 2008, when MNT deposits peaked. Foreign exchange (FX) deposits remained at around the same level of MNT 580 billion, compared to August. FX deposit rates remain highly attractive at 14 percent nominal interest rate on time deposits.

Most banks continue to purchase less risky central bank bills and deposit their foreign exchange with the central bank, but signs of new lending to individuals are emerging

The banks are, however, not significantly increasing their lending to the private sector. Instead, they are lending to and depositing their foreign exchange with the Mongol Bank.

However, nominal advertised deposit rates are 19 percent for local currency bills and 14 percent on foreign exchange deposits which puts downward pressure on the profitability of the banking sector. With the fall in inflation, the real return on central bank bills now stands at an annualized 11.9 percent.

However, there are some signs that banks are starting to increase lending to the private sector, but to individuals, not companies. Total loans outstanding to individuals in September increased by MNT 14.8 billion over August, while to the private sector it decreased by MNT 45.2 billion.

Banking sector balance sheets have weakened further

On average, loan quality, in particular to the private sector, continues to deteriorate, reflecting portfolios that are exposed to sectors experiencing a strong slowdown.

Non-performing loans and loans with their principal in arrears (which, if the borrower does not improve repayment, will eventually turn into NPLs) now stand at 23.7 percent of all loans. Excluding Anod (the failed bank), the number is 18.6 percent, or MNT 497 billion.

Non-performing loans (NPLs) to residents and nonresidents rose to MNT 435 billion or 16.3 percent of outstanding loans in September, up from 14.9 percent in August 2009. Loans with principal in arrears reached MNT 198 billion in September (7.5 percent of outstanding loans).

The impact of the losses on aggregate bank capital is increasingly apparent: it declined by around 12 percent from August to September. These trends point to an urgent need for the Mongol Bank to take decisive action. The lessons of international experience for dealing with and averting banking crises are clear: speed, preparedness and transparency.

Registered unemployment continued to decrease marginally in September…

Registered unemployment remained the same at 3.7 percent of the labor force in September 2009 although continued to rise on a 12-month moving average basis. The results of the September informal labor market survey commissioned by the World Bank, suggest a slight improvement in the average unskilled workers’ real wages from April 2009 to September 2009, after their earlier collapse. In the markets surveyed, it seems that the number of workers also increased by about 25 percent compared to April, 2009.

The fiscal balance improves slightly on a 12-month rolling basis

The fiscal balance had been on a protracted decline since mid 2008, although on a 12-month rolling basis, the fiscal deficit improved slightly to 10.3 percent of GDP. The adjusted deficit (which excludes the loan made by the government to the gold sector) now stands at 8.5 percent of GDP. The deterioration of the deficit has been mostly due to falling mining revenues whereas expenditures have been fairly constant as a share of GDP.

The collapse in copper prices at the end of last year severely undermined Mongolia’s mining sector receipts which account for roughly 40 percent of corporate income tax and 90 percent of dividend revenues. But copper prices have since regained some ground with signs that this is feeding through to revenues. Total revenue and grants collected in the first nine months of 2009 were lower by 24 percent in real terms over the previous year, in comparison to a fall of 61 percent in January, 2009 over January, 2008.

Still, with copper prices currently well below last year’s peak, corporate income tax and the Windfall Profit Tax revenues were respectively 40 percent and 75 percent lower (in real terms) than last year. In addition, indirect tax revenues which amount to about a third of total government receipts also fell, reflecting the underlying weakness of the economy.

However, non-mining receipts are showing signs of recovery, in particular, personal income taxes which rose 6.6 percent in real terms for the period January to September, 2009, against the same period of 2008, and property tax revenues (up by 20.4 percent). Meanwhile, non-tax revenue increased by 17 percent but this was mainly due to the substantial increase in dividend payments (of a 187 percent) which were meant to have been received in 2008 but were instead shifted to this year.

Total expenditure and net lending from January to September 2009 has decreased by 5.3 percent in real terms, compared to the same period a year ago. Wages and salaries, which account for a quarter of total expenditure and lending, were stable in real terms increasing by only by 1.0 percent while major cuts were visible in fuel, transportation and communication spending, current repairs, domestic investment and capital repairs.

Offsetting these however were social security contributions paid by employers, which rose by 8 percent. Subsidies and transfers were stable in real terms, but within this expenditure item, social insurance transfers rose by 248 percent while reimbursements went up by 175 percent for the reported period.

Interest payments also increased by 38 percent while net lending rose by 11.7 percent mainly due to external budget supports flowing into the government accounts.

Overall, the government is succeeding in controlling spending although continued restraint is necessary, given the difficult financing conditions for the fiscal deficits which are projected for the next years. In particular, 2011 will be a difficult year for the budget as the Windfall Profits Tax will have been abolished and donor funding for budget support will have dwindled.

Over the medium-term, Mongolia is expected to experience a huge revenue inflow from the development of its OT copper and TT coal deposits. However, the domestic spending of these revenues carries the risk of Dutch Disease whereby Mongolia’s non-resource sectors lose competitiveness and contract.

The new fiscal responsibility framework currently under consideration should help the government prevent harmful Dutch Disease effects and also help avoid harmful boom-bust cycles by stabilizing government spending.