ASIAN DEVELOPMENT

OUTLOOK 2015 FINANCING ASIA’S FUTURE GROWTH

ASIAN DEVELOPMENT BANK

Mongolia

Economic growth decelerated in 2014 reflecting a drop in foreign direct investment. Inflation

required monetary tightening, but the current account deficit moderated. Fiscal deficits remained

high, and international reserves continued to shrink. Growth is forecast sharply lower in 2015

and 2016, with lower inflation but current account deficits persisting or widening. A major policy

challenge is to implement prudent macroeconomic management that retains sufficient scope for

productive investment and social protection.

Economic performance

Despite a substantial increase in mining output, GDP growth slowed

to 7.8% in 2014 from 11.6% in 2013. Foreign direct investment (FDI)

continued to fall, and the sizeable monetary stimulus that kept growth

high in the previous year became increasingly difficult to maintain in

light of pressures from inflation and the balance of payments (BOP).

As value added in mining increased by 24.2%, reflecting the

3.12.1 Supply-side contributions to growth

Agriculture

Mining

Other industry

Services

Gross domestic product

Percentage points

first full year of production at the vast Oyu Tolgoi copper and gold

mine, industrial production expanded by 16.1% and contributed 4.8

percentage points to GDP growth (Figure 3.12.1). This came despite

a 16.3% drop in coal production. Agriculture remained a driver of

20

15

10 6.4

5

0

17.3

12.3 11.6

7.8

growth, rising by 14.4% with favorable weather. Growth in services

slowed to 4.8%, however, as plunging mine investment took its toll.

Agriculture and services each contributed 1.5 percentage points to GDP

growth, while the contribution from industry other than mining was

negligible.

FDI dropped by 80.7% following the completion of the first phase

of Oyu Tolgoi and reflecting uncertainty over the economic viability

of projects in light of lower commodity prices, as well as over the

broader investment climate. Gross capital formation contracted by

33.5%, dragging GDP growth down by 18.4 percentage points. Domestic

consumption increased by 8.6% and contributed 6.0 percentage points

to GDP growth, with private consumption accounting for nearly all

of the increase. As exports grew by 51.4% in real terms and imports

by only 4.9%, the trade deficit shrank by 82.7% and the contribution

of net exports to GDP growth expanded to 20.3 percentage points.

Oyu Tolgoi’s contribution to GDP growth thus continued to shift from

investment to net exports (Figure 3.12.2).

The current account deficit narrowed significantly to 8.2% of

GDP from 25.4% in 2013 as the trade deficit crossed into surplus.

Merchandise exports grew by 35.3% as higher exports of copper

−5

2010 2011 2012 2013 2014

Source: National Statistics Office of Mongolia. 2015.

Monthly Statistical Bulletin. January. http://www.nso.mn

3.12.2 Demand-side contributions to growth

Private consumption

Government consumption

Total investments Net exports

Gross domestic product

Percentage points

45

30

15

0

−15

−30

concentrates more than compensated for a decline in other exports.

Merchandise imports fell by 14.4%, largely reflecting a sharp drop in

2010 2011 2012 2013 2014

Source: National Statistics Office of Mongolia. 2015.

Monthly Statistical Bulletin. January. http://www.nso.mn

This chapter was written by Mark Bezemer and Amar Lkhagvasuren of the Mongolia

Resident Mission, ADB, Ulaanbaatar.

Economic trends and prospects in developing Asia: East Asia Mongolia 159

investment-related material and equipment, as well as lower fuel prices.

The services deficit stabilized at $1.3 billion, equal to 11.2% of GDP.

Declining capital inflows generated a BOP deficit equal to 3.9% of GDP

despite nearly $700 million in government-guaranteed borrowing by

the Development Bank of Mongolia (Figure 3.12.3).

Gross international reserves fell to $1.6 billion—cover for 2.9 months

of imports—from $4.1 billion in 2012, and are increasingly financed

by short-term foreign liabilities, including a 3-year currency swap

arrangement with the central bank of the People’s Republic of China

(PRC) (Figure 3.12.4). Raising the currency swap ceiling in August 2014

to CNY15 billion (equal to 20% of GDP) provided a liquidity buffer, but

withdrawals will eventually need to be repaid or renewed. Public and

publicly guaranteed external debt including the foreign liabilities of the

Bank of Mongolia, the central bank, stood at 57.3% of GDP at year-end,

having more than doubled in 4 years and now approaching the $1.5

billion raised through the US dollar-denominated sovereign Chinggis

bond. As capital inflows ebbed, the Mongolian togrog depreciated by

13.8% against the US dollar, having already depreciated by 19.2% in

2013. Meanwhile, ruble depreciation caused the togrog to appreciate in

nominal effective terms by 2.3%, and by 11.0% in real terms because of

comparatively high inflation in Mongolia.

The government continued its highly procyclical fiscal policy in

2014, largely by channeling substantial expenditures off-budget through

the Development Bank of Mongolia and financing them with the

proceeds of the Chinggis bond and government-guaranteed external

borrowing. The consolidated fiscal deficit, which includes off-budget

spending, rose to 11.5% of GDP from 9.8% in 2013. Excluding off-budget

spending, the cash deficit expanded to 4.1% of GDP from 0.9% in 2013,

3.12.3 External indicators

Net goods Net services

Net income Net transfers

Current account balance Foreign direct investments

% of GDP

60

40

20

0

−20

−40

2010 2011 2012 2013 2014

Sources: National Statistical Office. http://www.nso.mn;

Bank of Mongolia. http://www.mongolbank.mn

3.12.4 Gross international reserves and

foreign liabilities

Gross international reserves Central bank foreign liabilities

$ billion

5

4

3

2

1

0

and the structural deficit reached 3.7%, breaching the 2% ceiling under

the Fiscal Stability Law (FSL) (Figure 3.12.5). Budgetary expenditure

remained constant at 32.2% of GDP. However, revenue fell to 28.1% of

GDP from 31.3% in 2013 as receipts increased by only 2.6%, falling short

of the highly optimistic budget partly because of falling commodity

prices. On the positive side, the Glass Account Law will improve the

transparency of procurement, budgets, and finances of government

agencies and legal entities with state involvement.

The ratio of public debt to GDP rose in net present value terms to

54.7% in 2014 (breaching the 40% ceiling of the FSL) and to 77.4% in

nominal terms including the central bank’s foreign liabilities. Interest

payments reached 7.1% of government expenditures in 2014 (Figure 3.12.6).

Debt sustainability is further affected by the rising share of commercial

borrowing since 2012 and the uncertain economic returns of some public

investment projects.

Expansionary monetary and fiscal policies and currency

depreciation drove consumer price inflation to a peak in July 2014 of

14.9% year on year. Facing inflationary and BOP pressures, the central

bank raised the policy rate from 10.5% to 12.0% in July 2014 and 13.0%

in January 2015. Despite starting corporate lending worth 1.6% of GDP,

the central bank’s total quasi-fiscal loans—mainly for housing and

construction at subsidized rates—were reduced to 18.7% of GDP from

23.7% in 2013. Growth in domestic lending slowed markedly to 16.1%,

Jan Jan Jan Jan Jan Jan 2010 2011 2012 2013 2014 2015

Source: Bank of Mongolia. http://www.mongolbank.mn (accessed 14 March 2015).

3.12.5 Fiscal indicators

Budget balance

Development Bank of Mongolia spending

Primary balance

Structural balance

% of GDP

5

0

−5

−10

−15

2012 2013 2014 2015

Budget estimate

Sources: Ministry of Finance; National Statistical Office. 2015. Monthly Statistical Bulletin. www.nso.mn

160 Asian Development Outlook 2015

holding broad money growth to 12.5%. Inflation moderated to 11.0% in

December, having averaged 12.8% for the year (Figure 3.12.7).

The quality of bank assets is under pressure in light of their rapid

expansion in recent years and slowing economic growth. While

3.12.6 Public debt indicators

Public debt Interest payments

% of budget

commercial banks’ stock of nonperforming loans grew by 48.5%, the

ratio of such loans rose only slightly to 3.1% of all loans outstanding.

However, loan growth is slowing rapidly, and the stock of loans past

due—a leading indicator—more than doubled by the end of 2014 to

2.2% of all loans. Moreover, sizeable policy loan programs point

to supervisory forbearance and increased exposure to the cyclical

construction and housing sector. Banks need bolstering by closer

% of GDP

100

80

60

40

20

0

expenditure

20

15

10

5

0

monitoring of asset quality and liquidity buffers, stronger supervision

of risk, the adoption of international capital standards, improved

corporate governance, and forward-looking provisioning. Some positive

steps from January 2015—introducing a 1% provisioning ratio for new

loans and imposing higher risk weights on new foreign currency loans

to unhedged borrowers—should perhaps be gradually extended to

existing loans.

Economic prospects

Despite robust growth expected in agriculture and expanded extraction

at Oyu Tolgoi, albeit less than in 2014, GDP growth is forecast to slow

to 3.0% in 2015 as falling prices for exports are felt and as monetary and

fiscal policy are tightened to contain inflationary and BOP pressures.

Industrial production will grow more slowly than in 2014 as a credit

squeeze affects construction and real estate, and as lower export

prices pressure mine operators. Services are projected to grow only

marginally as other economic activity slows. Assuming a stable external

environment and the resumption of major investment in mining in

2015, economic growth should recover to 5.0% in 2016 even with the

continuation of restrictive fiscal and monetary policies (Figure 3.12.8).

Consumer price inflation will moderate to an average of 8.9%

in 2015 and 7.7% in 2016, reflecting slower growth and fiscal and

monetary tightening (Figure 3.12.9). The forecast assumes that the central bank will prioritize its target of 7.0% year on year for consumer

2010 2011 2012 2013 2014

Sources: Ministry of Finance. http://www.mof.gov.mn; Bank of Mongolia. http://www.mongolbank.mn

3.12.1 Selected economic indicators

(%)

2015 2016

GDP growth 3.0 5.0

Inflation 8.9 7.7

Current account balance -8.0 -15.0

(share of GDP) Source: ADB estimates.

3.12.7 Policy rate, credit growth, and prices

Inflation

Policy rate Credit growth

% %, year on year

15 100

price inflation and achieve it by the end of December 2016. Gross

international reserves are likely to remain under pressure in 2015 as

FDI inflows stay weak and the current account deficit large. The deficit

is forecast to be stable at 8.0% of GDP in 2015 as higher export volume

is balanced by falling prices. When large new mining investments start

to push up imports in 2016, the current account deficit may almost

double to 15.0% of GDP.

12

9

6

3

0

Jan 2011

80

60

40

20

0

Mar 2015

The main risks to the outlook stem from the economy’s

vulnerability to external shocks. If slowdown exceeds expectations in

the PRC—the destination of over 87% of Mongolia’s exports—or if prices

for exports decline further, the BOP, fiscal balance, and growth could

all suffer. The forecast is sensitive to the timing of large FDI projects,

such as underground expansion at Oyu Tolgoi or further development

of the Tavan Tolgoi coal deposits. The possibility of these projects

not going ahead in 2015 constitutes a significant risk to the outlook

Source: Bank of Mongolia. http://www.mongolbank.mn

(accessed 14 March 2015).

Jan Jan Jan

2012 2013 2014

Economic trends and prospects in developing Asia: East Asia Mongolia 161

for 2016. Another major factor is the ability of the government and the

central bank to achieve deficit reduction and keep inflation under

control. The government faces a difficult challenge to prepare and

implement realistic budget that respect FSL ceilings on debt and the

deficit, and the central bank may face pressure to expand its quasi-fiscal

lending—in particular to provide direct credit to corporations—or lower

its policy rates.

Policy challenge—strengthening debt management

In the long run, Mongolia needs to diversify its economy and better

insulate itself from the vagaries of volatile price swings and large-

scale FDI. However, the government’s immediate policy challenge is to

tighten monetary and fiscal policy to address pressure on the BOP,

while safeguarding financial sector stability, debt sustainability—and the

welfare of the population, especially the poor.

Some recent fiscal reforms are steps in the right direction.

Development Bank of Mongolia expenditures that were previously

off-budget are now partly within structural deficit calculations. Further,

the authorities revised the FSL structural deficit and debt ceilings to

bring them in line with reality, and will gradually lower them to more

prudent levels by 2018.

On the other hand, public debt has been redefined to exclude a

number of items as a means to create fiscal leeway without adjusting the

ceilings. Such measures weaken debt management and shift the debate

on debt sustainability to a myopic focus on raising debt and deficit

ceilings or the numeric value of the ratio of debt to GDP. This is

unconstructive as more important issues are debt sustainability with full

appreciation of the nature of different debt instruments as well as

productive use of borrowed funds to ensure their contribution to

repayment. In addition, preparations are urgently required toward

refinancing or repaying in 2017 and 2018 the $580 million eurobond of

the Development Bank of Mongolia, credit withdrawn from the currency

swap facility with the central bank of the PRC, and the $500 million first

tranche of the Chinggis bond.

In light of large consolidated deficits, rising debt and interest

payments, and anticipated depressed commodity prices, these issues

require open and informed discussion toward designing an effective

strategy to manage debt.

3.12.8 GDP growth

%

20

15

10

5

0

2010 2011 2012 2013 2014 2015 2016

Forecast

Source: Asian Development Outlook database.

3.12.9 Inflation

%

15

12

9

6

3

0