World Bank’s New Mongolian Monthly Economic Update: November

Executive summary

On November 27, 2009, Parliament approved the 2010 budget which projects a 5 percent of GDP deficit.

However, Parliament had to increase the copper price assumption to achieve the deficit target. A significant increase in total social spending was also approved, including that under a newly created Human Development Fund (HDF) which is earmarked to pay pension and health insurance, housing, education and health services, and cash transfers to Mongolian citizens. Since budget allocations to the “old” cash transfers to newlyweds, newborns, and child money programs, approved during the mining boom years, have been cut, analysts hope that creation of the HDF will pave the way for implementation of comprehensive social welfare reform with the view of moving towards a targeted new poverty benefit, using objective allocation criteria.

With respect to the budget outturn for this year, the 12-month rolling deficit improved somewhat in October, reflecting both reduced expenditures and stabilization of the revenue decline. However, it remains high, at around 9 percent of GDP. While the long-term fiscal outlook looks good, because of future large increases in revenues from the mining sector, the medium-term scenario until 2015 looks more uncertain. In particular, 2011 will see the Windfall Profits Tax disappear and, in the absence of continued donor funding, a series of large fiscal deficits would be difficult and costly to finance.

On the external sector, the trends of recent months have continued—narrowing of the trade deficit and accumulation of international reserves and stability of the nominal exchange rate. Indeed the export contraction seems to be bottoming out and the imports decline moderating. Preliminary balance of payment figures for Q3 indicate a narrowing of the current account deficit to US$470 million (10.9 percent of GDP), after it peaked in the first quarter of 2009.

In banking sector developments, Zoos Bank was taken into receivership at the end of November 2009. Anod Bank was also, finally, put under receivership. To date, the Zoos Bank situation does not seem to have had an adverse impact on overall confidence levels, likely in part reflecting the blanket deposit guarantee which was put in place in November, 2008, in response to the failure of Anod Bank. However, non-performing loans continue to increase across key sectors of the economy including individual lending, construction and agriculture, and banks remain exposed to the failure of large individual borrowers. Real deposit and borrowing rates also continue to be at extremely high levels. Average real loan rates of almost 25 percent are very high by international standards.

Third quarter real GDP data, down by 3.7 percent year-on-year after growth of 0.7 percent in the second quarter, along with recent industrial production figures, highlight the continued weakness in the real sector. The latest World Bank commissioned survey of the daily wage of unskilled workers in key informal labor markets in Ulaanbaatar in December 2009 also shows no improvements in real income relative to September 2009, pointing to continued economic stagnation and the on-set of winter.

New analysis by the World Bank of poverty trends between 2002/3 and 2007/8 using the national household survey data from the National Statistics Office (NSO), but using the same, absolute poverty line in both years, shows a sharp reduction in poverty during that period of high economic growth. Recall that the official consumption-based poverty headcount in 2007/8 was 35.2%, as estimated by the NSO. Working backwards from that benchmark and using a consistent poverty line over time, World Bank staff calculations indicate that the poverty headcount in Mongolia declined from 66.2% in 2002/3. This finding of substantial poverty reduction over this period is robust to the choice of the poverty line used.

Finally, a recently released analysis of the civil service in Mongolia suggests three main challenges to improving its efficiency. First, the civil service grading and compensation system requires significant changes in order to be able to attract and retain high caliber staff. Second, movement in a phased manner towards centralized payroll administration is required in order to increase control over staff numbers and personnel expenditures. Third, the personnel management regime needs to be improved as it presently does not fully protect civil servants from undue political interference.

Budget developments
There was some positive news on the fiscal balance in October as the 12-month rolling deficit showed some sign of improvement. However, the overall fiscal balance on this basis remains high, at around 9.2 percent of GDP, compared with 10.3 percent in the 12-months to September. The fiscal balance in the first ten months of 2009 was MNT 336 billion, compared with a full-year budget target of MNT 364 billion. Further continued fiscal adjustment will be required in order to reverse the deterioration of the past year and to place the fiscal position on sustainable footing.

Total fiscal revenues and grants (rolling 12-month) increased by 1.7 percent in October relative to September. This was due primarily to a rise in windfall tax revenues. On the expenditure-side the fall on this basis from October to September was 1.3 percent. Reduced purchases of goods and services were the main driver of this fall.

On November 27, 2009 Parliament approved the 2010 budget projecting a 5.0 percent of GDP deficit. However, it had to change the copper price assumption from US$5,187 to US$5800/tonne to achieve this. Parliament also approved a significant increase in total social spending (by around MNT150 billion), including spending under a newly created Human Development Fund (HDF). In 2010, the HDF will receive MNT346.7 billion from the budget, earmarked to be used to pay pension and health insurance, housing, education and health services, and cash transfers to Mongolian citizens. The latter are to make good on campaign promises made by both parties in the coalition to distribute cash to the citizenry in an effort to share the mining wealth of the country.

In light of these recent events, it would be important to continue the fiscal effort, and use the existing resources to more effectively protect the poor from the current downturn.

Around 22 percent of total expenditures and net lending in the 2010 budget are allocated to the payment of wages and salaries, down slightly from 24 percent in the 2009 budget. Ensuring that such expenditures are used to finance an effective and efficient civil service remains a challenge, despite the significant transformation over the past two decades and the relatively strong levels of service provision in areas such as health and education. Box 1 highlights three main areas of weakness which are particularly challenging – civil service grading and compensation, payroll administration and personnel management. This area of reform forms part of the wider fiscal reform agenda in Mongolia, different aspects of which have been discussed in previous monthly updates.

External sector
The 12-month rolling trade deficit narrowed to US$451 million in October, from US$511 million in September. This represents an almost halving of the US$1090 million deficit reached in February 2009. The adjustment has been driven by the faster pace of import compression relative to the contraction of exports, reflecting the continued slowdown of the economy.

In October total exports of US$193 million were up slightly on their value a year earlier. This was driven primarily by an increase in gold exports to US$35 million, compared with US$13 million in October 2008. The volume of monthly gold exports doubled. However, the unit price also increased (by around 25 percent), reflecting the rise in international gold prices to about US$1100/toz in November. Most of the gold exports went to the European Union. However, total goods exports over the period from January to October continue to be down by 31.2 percent in dollar terms from a year earlier with declines across most commodities due to lower prices, rather than volume. The strong economic growth in China continues to be supportive for Mongolia’s export recovery with the annual contraction in exports to China falling in recent months.
In October the dollar value of goods imports was down by around 20 percent year-on-year, compared with contractions of over 50 percent in the first half of 2009. In the first ten months of 2009 goods imports were down by 37 percent compared to the corresponding period from 2008.

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 US$470 million deficit in the third quarter of 2009 (10.9 percent of GDP). The deficit has narrowed, after it peaked in the first quarter of 2009. The main driver of the narrowing of the current account deficit was the goods trade deficit. The services balance, another key driver, improved due to a surplus of US$30.2 million in the third quarter of 2009 as transportation and tourism revenues eased. Throughout, net income flows were negative, due to dividends paid to foreigners.

The current account deficit was primarily financed by net capital inflows in the financial account, which amounted to US$689 million (16 percent of GDP) in the third quarter of 2009. Direct investment by foreign companies (FDI), mainly in the mining sector, has increased compared with the second quarter of 2009. Net borrowing from abroad by both government and the private sector jumped in the third quarter of 2009, due to the donor disbursement and loans to the commercial banks. Other capital inflows, such as trade credits and short-term lending to the private sector fell from their peaks in the fourth quarter of 2008.

The remaining portion of the current account deficit was financed by a disbursement from the IMF under the SBA ($24.6 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 US$1062.6 million at the end of September 2009.

The exchange rate against the USD remains stable
The exchange rate against the USD has been stable since April, when the BoM raised its policy rate substantially and introduced an auction system. In addition, the spread between the ask and bid rates in parallel and commercial bank foreign exchange markets, which is often a good indicator of the liquidity, has remained low, after the sharp spikes in late 2008 and early 2009. In November, the average monthly exchange rate against the USD appreciated slightly, by 0.4 percent, compared with October. This stabilization of the exchange rate has allowed the Bank of Mongolia to bring its international reserves back to the levels prior to the collapse of the copper price in mid-2008 and the Bank’s attempts to support a de facto peg against the US dollar by selling its reserves into the market. However, in November, the BoM sold US$19.5 million of foreign exchange in its regular auctions, with no foreign exchange purchases. Instead, reserves were boosted by the receipt of the pre-payment from the OT agreement.

The overall CPI inflation rate was minus 1.1 year-on-year in October, compared to minus 1.9 percent in September. While core inflation remains positive, it fell to 3.9 percent year-on-year in October

Banking sector
Despite the Bank of Mongolia having cut its official policy rate from 11.5 to 10 percent in September, nominal interest rates on both local currency deposits and loans have barely moved. But, with inflation having fallen sharply and turned negative in recent months, real economy-wide borrowing costs have soared. As a result, real borrowing costs are close to 25 percent in Mongolia, which is extremely high compared to real interest rates in comparator countries, and poses a constraint to the recovery in private sector activity. Such high rates also constrain the room the Mongol Bank has to raise rates even further, if macroeconomic conditions would seem to warrant this.

The high real interest rates cause MNT deposits to continue to rise. Indeed, at MNT 1,134 billion in October 2009, local currency deposits are now only slightly below their peak of MNT 1,149 billion in March 2008. While the weighted average interest rate stayed the same on the month for MNT deposits, it was reduced for foreign currency deposits in October to 6.3 percent from 7.0 percent in September. This contributed to the reduction in foreign currency deposits over October by US$13 million to US$391 million at end-October. Still, these are US$115 million higher than corresponding levels in October of 2008.

Following the failure of Anod Bank at the end of 2008, which was taken into conservatorship by the Bank of Mongolia, a second bank in Mongolia was now taken into receivership at the end of November 2009. Earlier, rumors about the insolvency of this publicly-traded bank did not seem to have much adverse impacts on overall confidence levels. For instance, its share price was relatively stable (at around MNT 2,000 compared with around MNT 2,500 at the beginning of the year) prior to the suspension of trading on the Mongolian Stock Exchange. Recall that the government put in place a blanket deposit guarantee since November, 2008 to avert any possibility of a bank run when Anod Bank failed last year. This safety net would explain why the second bank failure has so far not had obvious knock-on effects, such as an outflow of MNT deposits at the time Anod failed. The blanket deposit guarantee is, however, a rather crude measure to ensure continued confidence. It also has several disadvantages, including providing an incentive to the banks for excessive risk-taking in lending.

On average, the banking system remains weak as loan quality, in particular to the private sector, continues to deteriorate. Non-performing loans (NPLs) to residents and nonresidents rose to MNT 443 billion or 16.7 percent of outstanding loans in October, slightly up from 16.3 percent in August 2009. Loans with principal in arrears, which, if the borrower does not improve repayment, will eventually turn into NPLs, reached MNT 201 billion in September (7.7 percent of outstanding loans). As a result, non-performing loans and loans with their principal in arrears now stand at 24.3 percent of all loans. Excluding the two failed banks, the number is still 17.3 percent, or MNT 402 billion.

A comparison of the sectoral composition of the changes in NPLs and loans with principal in arrears between the third quarter of 2009 and the second quarter of 2009 shows that the largest increases were recorded in the “other sectors” (MNT 49 billion) which comprises mortgages, salary and pension advances. The second highest increase was in construction (MNT 27 billion) followed by the agriculture sector (MNT 26 billion). These three sectors also account for 54 percent of the total NPLs (to residents) and loans with principal in arrears at the end of the third quarter of 2009, with “other sectors” amounting to MNT 138 billion, construction MNT 139 billion and agriculture 45 billion.

The construction sector has the highest sector ratio of NPLs and loans in arrears to total loans at 35.5 percent, with mining and quarrying second at 26.4 percent. Between the third quarter of 2008 and the second quarter of 2009, NPLs and loans in arrears increased by around 350 percent. The construction sector alone accounted for 100 percentage points of this increase, i.e. almost one third, with wholesale and retail a distant second at 55 percentage points.

During the crisis period from mid-2008 there was a sharp rise in the share of loans accounted for by the top 50 borrowers by loan size, increasing from around 20 percent of total loans to just over 30 percent. Whilst this ratio has fallen slightly in recent months, the concentration of credit exposures remains high. These figures are on an aggregate basis and individual banks may well have higher exposures. This concentration increases the impact on the health of a bank’s loan portfolio of shocks hitting individual creditors.

Newly issued loans dropped 13 percent to MNT 802 billion in the third quarter of 2009 from MNT 921 billion in the third quarter of 2008. The largest decreases in newly issued loans occurred in the “other sector”, i.e. primarily lending to individuals, at MNT 315 billion, with the wholesale and retail sector a second at MNT 180 billion (Figure 18.a). However, around 48 percent of the loan portfolio remains exposed to the “other sector” and the wholesale and retail sectors, the two sectors which recorded the highest increases in NPLs from the second to the third quarter of 2009.

Total loans outstanding to individuals in October increased slightly over September. However, total loans outstanding to the private sector continued to decrease by 21.5 billion MNT in October.

Aggregate losses of commercial banks increased to MNT 112 billion from an aggregate profit of MNT 64 billion a year ago.
Given the worrying signs in the banking sector, the BoM has been intensifying its partnership with Mongolia’s development partners, including USAID, the IMF, the ADB and the World Bank Group, to ensure continued confidence in the banking sector and implement a range of banking sector reforms to help strengthen the system. A key measure is to complete audits by internationally reputable firms of the majority of the banks to allow for the formulation and implementation of a strategy tailor-made for the Mongolian situation.

World Bank


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