1. This supplement summarizes information on recent developments that has become available since the circulation of the staff report, especially as regards the status of prior actions and economic performance relative to the key program objectives. The new information does not change the staff appraisal contained in the staff report.
2. Both prior actions under the MEFP for the first and second PRGF reviews have now been fully completed.
3. The first prior action relating to the Medium-Term Budget Framework (MTBF) was completed in June 2003, when Parliament approved the government’s first MTBF. In line with the understandings reached with the staff, the MTBF: (i) envisages an adequate reduction of the budget deficit during 2004–06 to meet the program’s debt sustainability objective; (ii) postpones any reduction in corporate income tax rates until at least 2005; (iii) transparently accounts for projected outlays on most public investment projects and debt service obligations, in accordance with GFS guidelines; (iv) rules out the granting of any civil service wage increases during the remainder of 2003, and links future salary increases to the implementation of public sector reforms to be developed in consultation with the World Bank; and (v) stipulates that the government will avoid future recourse to extra-budgetary or quasi-fiscal operations.
4. The second prior action was fully completed on September 4, 2003, when draft terms of reference (TOR) for the new Supervisory Board of the Bank of Mongolia (BOM) were submitted for consideration to the Economic Standing Committee of the Parliament.1 A safeguards assessment monitoring mission carried out at the BOM during September 1–10, 2003 has verified that the draft TOR is in line with the understandings reached with the staff. The safeguards mission has also ascertained that the BOM is taking steps to progressively implement the majority of other priority measures proposed by the previous safeguards assessment in March 2002. In particular, comprehensive and timely external audits of annual financial statements are now being conducted in accordance with International Standards on Auditing; the 2002 audited financial statements reflect nearly complete compliance with International Accounting Standards (IAS), and were provided to Parliament and published in accordance with the CBL; and controls over the management of international reserves are gradually being strengthened. The updated safeguards assessment is expected to be completed by end-October. The staff will assess the implementation of the main safeguards recommendations, including the related conditionality that is already incorporated in the program, in the context of the third PRGF review.2
Recent Economic Developments
5. Economic performance remains on track to achieve the program’s main inflation and external targets. Inflation, after having peaked at 6½ percent (year-on-year) in June–July 2003, declined to 4½ percent in August, and it is on track to be limited, as programmed, to 5 percent in 2003, provided that adequate measures are taken to rein in the growth of money and credit (as discussed below). In the external accounts, preliminary data for January-August 2003 point to a continuing sluggishness in export performance, which can now be expected to give rise to a somewhat larger than programmed increase in the trade deficit over the full year. However, the wider trade deficit is being largely offset by the sustained strength of invisible receipts and private capital inflows. Thus, the BOM’s net international reserves (NIR) rose to US$242 million as of end-August, and are set to comfortably meet the program’s end-September 2003 target.
6. Preliminary data for January-August 2003 suggest that fiscal performance also remains largely on track. Total revenues increased by 17½ percent during January–August 2003 with respect to the same period of the previous year, thus pointing to a likelihood of somewhat stronger than programmed over-performance relative to the budget over the full year. The brisk growth in revenues appears to be underpinned by buoyant receipts from the VAT on imports, customs duties, income taxes and social security contributions. On the expenditure side, outlays on wages and salaries and goods and services have remained largely on track. While capital expenditures have recorded a faster than expected rise as the implementation of recently launched large projects appears to have gathered pace, the continuing over-performance on revenues should still enable the authorities to contain the annual overall government deficit to 6 percent of GDP.
7. Data for January–July 2003 point to continuing rapid growth in money and credit, which calls for a reinforcement of BOM’s efforts to meet its monetary program targets in the period ahead. Broad money growth has declined at a slower than programmed rate, falling from 42 percent at end-2002 (year-on-year) to 38 percent as of end-July 2003. While the over-performance on fiscal revenues has helped to keep net credit to government (NCG) comfortably below the program targets, the rate of growth of credit to the private sector has remained well over 70 percent or 5–10 percentage points in excess of the corresponding program targets. Thus, on current trends, there is a risk that the net domestic assets of the banking system will exceed the program’s indicative target for end-September 2003. Despite a sustained increase in BOM bill rates over the last few months, the expansionary effects of rising NIR have more than offset the impact of a modest decline in the BOM’s net domestic assets (NDA), with the result that reserve money growth accelerated to 13½ percent (year-on-year) as of the first week of September 2003. In such circumstances, the authorities agree that they will need to step up the placement of BOM bills over the next few weeks to ensure that the target for the NDA of the BOM and the indicative program target on reserve money for end-September 2003 will be achieved.