September 12, 2003
- There is a constructive policy dialogue between the Mongolian authorities and the Fund which has contributed to a significant improvement in the policy framework.
- Economic performance under the program has been significant. Growth is accelerating, inflation is under control, the fiscal position has improved, reserves have increased and debt is at manageable levels.
- The authorities recognize, as outlined in the recently completed PRSP, that fiscal consolidation is central to meeting the objectives of the program. In particular expenditure control is necessary to provide room for reducing the high tax burden and ensuring that essential infrastructure projects are advanced while public sector debt levels are kept under control.
- A medium term policy orientation has been established.
- Substantial progress with the authorities structural reform agenda has been achieved, including the privatization of some key banking institutions.
A constructive policy dialogue with the Fund
While there has been a delay in bringing the First and Second Reviews under the PRGF to the Board for completion, this should not be seen as indicating any stalling in Mongolia’s progress in establishing macroeconomic stability and advancing a structural reform agenda that will promote sustained economic growth and a reduction in poverty.
A great deal has been achieved since the PRGF program was approved in September 2001, notwithstanding the delays in the program reviews. This progress has built upon the remarkable achievements that have been made over the past decade in Mongolia’s transition to a market based economy.
The Fund, along with the Multilateral Development Banks, have made an important contribution to Mongolia’s reform achievements and our authorities would particularly like to extend their appreciation to the support that they have received from the staff and management of the Fund. As is evident from the staff report, there is a very constructive policy dialogue between Mongolia and the Fund. Importantly, the authorities have been very responsive to the advice they have received.
Issues have arisen over the course of the program which have delayed the competition of the reviews, such as the disclosure of quasi-fiscal and extra budgetary activities undertaken by the Government and the Bank of Mongolia (BOM). The authorities action in this area did not represent a move away from the objectives of the PRGF, but rather the result of capacity limitations and shortcomings in institutional arrangements. However when the staffs concerns were raised, the Government moved decisively to implement a range of significant policy measures to address the situation.
Economic developments are encouraging.
The overall economic performance under the program has been relatively strong, despite unfavorable weather and external conditions, including the impact of SARS. The economy grew by 3.9 per cent in 2002, with contributions from the processing industry and service sectors, compared with 1 per cent growth in 2001, when growth was significantly affected by heavy-weather related herd loses. Inflation fell to 1.6 per cent in 2002, although has risen in the first half of 2003 due to seasonal factors and the impact of SARS. Notwithstanding weak international prices for a number of Mongolia’s main exports, large capital inflows resulted in an overall surplus in the balance of payments and a rise in the international reserves position to about 17 weeks imports. The exchange rate has remained relatively stable.
A medium term policy framework has been adopted
A number of key policy documents have recently been completed and adopted, including the Economic Growth and Poverty Reduction Strategy Paper (PRSP), which establish the medium term policy objectives of the Government. The PRSP is the main policy document which outlines the medium-term task towards achieving sustained economic growth and there are two alternative growth scenarios. As noted in the staff report, the main macroeconomic objectives of the medium-term framework underpinning the PRGF have been aligned with the PRSP’s baseline scenario.
Importantly, the authorities also adopted a medium-term budget framework in June 2003 which is consistent with the pursuit of the PRGF’s objectives. The adoption of the Public Sector Management and Financing Law by Parliament and its enforcement this year is seen by the Government as an important step towards improving budget accountability.
Fiscal consolidation is the key to macroeconomic stability and sound debt dynamics.
The authorities are committed to prudent fiscal policy, and this is a central element of the PRSP. The general Government’s overall deficit narrowed from 12.5 per cent of GDP in 1999 to 5.9 per cent in 2001–02, reflecting a surge in revenue, and was well below the initial program target. The budget deficit is projected to rise slightly in 2003 due to the incorporation into the budget of new large investment projects.
The fiscal deficit was around 12-13 percent of GDP in 1998-1999, with the current balance also in deficit. The significant improvement over the past few years, which has seen a reversal in the downward trend in the current fiscal balance, reflects in particular the implementation of measures towards improving public expenditure management.
The exceptionally strong revenue performance over the past year reflects the impact of tax enhancing measures coupled with a strengthening of tax and customs administration. As the staff report notes, however, the tax level in Mongolia is very high, with tax revenue and social security contributions projected at nearly 30 per cent of GDP in 2003. The authorities strongly feel that the corporate tax burden has to be reduced in order to provide greater incentive to private sector development. However, they fully recognize that action can not be taken on this front which would undo the hard-won gains to date in the battle to achieve fiscal sustainability. It is with this in mind that the plan to reduce the corporate income tax rate in 2003 was postponed until 2005.
Given the need to reduce the tax burden combined with the task of further lowering the fiscal deficit in order to improve Mongolia’s debt dynamics, this means that the priority must be placed on lowering public sector expenditure. However there is also the need to improve the country’s infrastructure. Some of the public sector investment projects that are planned will facilitate private sector development in the rural areas where unemployment, poverty and migration are high. In addition, there is considerable pressure to increase public sector wages and pensions, which was one of the Government’s election promises. The only way these various tensions can be reconciled is through improving the efficiency of public sector expenditure and reducing unproductive outlays.
The authorities have established a high level task force with the objective of reducing public sector expenditure. Some of the proposals that were considered included the privatization of components of social sector budget entities along with civil service retrenchments. As noted previously, the Government has been very receptive to Fund advice and after consultations with the Fund and the World Bank it was agreed that many of the proposed expenditure reduction plans were short-term and a more sustainable approach was required.
The task force is continuing its work in identifying areas for a sustainable reduction in expenditure. This has proved to be a challenging task given data deficiencies and they have planned a number of functional reviews of major ministries. The focus is on the reform of the civil service and with the assistance of the World Bank, a comprehensive overhaul of the civil service should be completed by 2004.
The staff have noted that revenue and expenditure projections are traditionally cautious/understated. The authorities believe that it is prudent to take a cautious approach to revenue estimation and that this has served them well. Nevertheless they fully endorse the need for all budget projections to be as realistic as possible and a considerable effort has been directed towards improving budget planning and expenditure control. In particular the reforms relating to the treasury system, and the introduction of the Treasury Single Account has already significantly improved the monitoring and control of Government expenditures, along with improving the quality and reliability of the fiscal reports. Timely budget allocations have increased the confidence of budget entities and ensured timely expenditure payments. Arrears from budget entities have been substantially eliminated and the bank restructuring bonds have been retired ahead of schedule and borrowing through T-bills reduced. These latter steps have lowered high-cost domestic sources of budget financing.
Increased confidence in the banking sector and prudent monetary policy settings
Major structural changes have helped improve public confidence in the banking system. To quote the headline in a recent Oxford Analytica article on Mongolia; ‘Banks are better after a decade of reform’. This progress is a critical element in Mongolia’s transition to a market economy and the authorities recognize that a strong and efficient financial sector is a precondition to sustained economic growth and poverty alleviation. The changes that are underway in the financial sector do, however, complicate the interpretation of monetary and credit developments. In recent years money and credit growth has expanded at unprecedented rates although this has not translated into appreciably higher inflation. During the program period bank deposits nearly doubled from Tog 222.2 billion at end 2002 to Tog 436.8. There was a similar increase in credit growth to the private sector. As noted, this increase should primarily be viewed as an indication of the improved confidence in the banking sector and, despite the high growth in money and credit supply, NPLs were reduced. Underpinning this improvement in confidence is greater competition in the sector and improvements in the legal environment and central bank supervision. Importantly, there have been recent moves to amend the central banking law in order to strengthen the governance procedures for the central bank (BOM) with the establishment of an independent supervisory body. As outlined in the staff report, there have also been decisive moves to prohibit the BOM from undertaking any quasi-fiscal activities.
With the rise in inflation in the early months of 2003, the BOM has increased the rate on central bank bills in order to slow monetary growth. Inflation is currently trending down.
Structural reforms continue to be advanced
The Government is decisively pursuing policies to deepen structural reforms. An important achievement was the privatization of two commercial banks to strategically important investors. In addition, in July 2003 an international management team took control of the Mongolian airline, MIAT. This is a significant step towards the privatization of the company, which is the Government’s objective.
The privatization of NIC, one of the largest oil importing companies was also successfully completed. The biggest local insurance company has been offered for sale and seven bids have been received. The tender is expected to be completed in late September, 2003. A new tender for the sale of the Government’s 70 per cent share in Gobi, the cashmere company, will be announced in the latter half of 2003.
Foreign investment has risen in recent years. This reflects steps by the Government to promote foreign investor interest in Mongolia and, in particular, improvements in political and economic developments along with enhancements in the legal framework. The Government sees this development as an important factor in maintaining sustainable economic growth.
The Government has adopted a sustainable energy sector development strategy to cover the period 2002–2010. As part of this strategy, a restructuring of the energy sector is currently underway which includes the establishment of an independent energy regulatory authority.
Energy generation, distribution and transmission companies are being restructured and some are being prepared for privatization, with a power generation station and two distribution companies to be privatized this year. In 2002 an energy construction company was privatized and at the start of v2003 two local power stations were privatized.
Risks to the program are manageable
The staff report notes that there are risks to the implementation of the ambitious reform program which underpins this program, particularly in the lead-up to the parliamentary elections in 2004. In many respects this is a fact of life in any democracy and the risks to policy settings associated with the political cycle are not unique to Mongolia. However the authorities are committed to maintaining and building on the significant gains that have been made in Mongolia’s transition to a market economy. That will not give up the progress that has been made on fiscal consolidation and the reform of the banking and financial sectors. With the continued strong support of the donor community, along with the assistance provided by the Fund and other international agencies, the authorities are confident that progress will be maintained and they believe that they are well placed to meet the many challenges that lie ahead.