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Mongolia Monthly Economic Update

World Bank

February 2010

The World Bank’s Mongolia Monthly Economic Update provides an update on recent economic and social developments and policies in Mongolia. It also presents findings of ongoing World Bank work in Mongolia. The Mongolia Monthly is produced by a team from the World Bank’s Poverty Reduction and Economic Management (PREM) Sector Unit in the East Asia and Pacific Region Vice-Presidency, with key inputs from other members of the Mongolia country team. Questions and feedback can be addressed to Altantsetseg Shiilegmaa (ashiilegmaa@worldbank.org). Copies can be downloaded from http://www.worldbank.org.mn.

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Contents

Executive Summary ....................................................................................................................................... 4

Fiscal developments ...................................................................................................................................... 5

External sector .............................................................................................................................................. 7

Inflation ....................................................................................................................................................... 10

Banking sector ............................................................................................................................................. 12

Labor Markets and Poverty ......................................................................................................................... 15

Reform agenda at the upcoming spring session of Parliament .................................................................. 16

Figures

Figure 1 The 12 month rolling fiscal deficit continues to improve ............................................................... 5

Figure 2 …as does the non-mining fiscal balance ......................................................................................... 5

Figure 3 Revenues, expenses before tax, income before tax and total taxes paid are starting to recover, following sharp declines in the first three quarters of 2009….................................................................. 6

Figure 4 …mirroring trends in overall economic activity .............................................................................. 6

Figure 5 Construction, mining and gas, fuel and coal wholesale firms suffered the largest drops in revenue ..................................................................................................................................................... 7

Figure 6 The trade deficit has stabilized ....................................................................................................... 8

Figure 7 …with exports to China rising ......................................................................................................... 8

Figure 8 Copper prices have recovered after dipping slightly in February while gold prices are stabilizing at close to record levels… ......................................................................................................................... 8

Figure 9 …supporting Mongolia’s exports .................................................................................................... 8

Figure 10 …but commodity import demand from China appears to be leveling out .................................. 9

Figure 11 Imports pick up into 2010 ............................................................................................................. 9

Figure 12 The exchange rate remains stable .............................................................................................. 10

Figure 13 BoM international reserves remain close to record levels ......................................................... 10

Figure 14 Inflation continues to pick up… .................................................................................................. 10

Figure 15 …leading to a decrease in real interest rates ............................................................................. 12

Figure 16 Total lending growth remains flat while purchases of Central Bank bills are slowing ............... 14

Figure 17 MNT deposits spike as FX deposits decrease slightly ................................................................. 14

Figure 18 Slight fall in total non-performing loans in December ................................................................ 15

Figure 19 Registered unemployment* has decreased in recent months ................................................... 15

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Tables

Table 1 Average lending rates by loan types in MNT (monthly percentage rate) ...................................... 13

Table 2 Average lending rates by loan types in MNT (monthly percentage rate) ...................................... 13

Table 3 Mongolia: Key Indicators ................................................................................................................ 17

Boxes

Box 1 Corporate balance sheets improving in line with the economy ......................................................... 6

Box 2 Household level impacts of the economic crisis in Mongolia: findings from three rounds of qualitative research ................................................................................................................................ 11

Box 3 High lending rates ............................................................................................................................. 12

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Executive Summary1

The latest data from February show that exports are rebounding strongly, buoyed by high copper prices and strong demand from China, Mongolia’s largest trading partner. Imports are also rebounding, reflecting the improvement in the domestic economy. Foreign exchange reserves are close to record levels, while high real interest rates and expectations of currency appreciation have caused a large increase in MNT deposits. Meanwhile, the fiscal deficit continues to improve, reflecting a combination of stabilizing government revenues and continued expenditure restraint.

However, February’s data also show a sharp upturn in inflation which rose to 8.7 percent year-on-year (yoy), roughly double the level in January and up from just 1.9 percent in December 2009. This increase has been mainly driven by a rise in food (mainly meat) prices which in turn reflects large livestock losses during the recent dzud and a distribution of 70000 tugrugs to the citizens.

With rising inflation eroding real incomes and purchasing power, low-income households are likely to be the most severely affected. Moreover, these effects will be felt on top of those from the sharp economic downturn last year and the recent dzud. According to latest information by the Ministry of Food and Agriculture, the total official livestock loss equals 4.1 million. Over 50 percent of the livestock losses are goats, which suggests that the cashmere sector will experience a significant supply shortage in the coming season and that rural livelihoods and incomes will remain under strain.

In the banking sector, there are tentative signs of a stabilization of non-performing loans (NPLs). However this may prove to be a temporary respite given that loans with principals in arrears are continuing to mount (these are categorized as NPLs once they have been in arrears more than 90 days).

Overall through, the economy is continuing to show signs of recovery, following an extremely sharp downturn last year. This recovery is being supported by a favorable external environment, on the back of strong policy actions over the past year.

At its upcoming spring session, the Mongolian Parliament is expected to debate and enact a number of important reform laws. These include comprehensive social welfare reform legislation to consolidate and improve the targeting of existing social transfers in a fiscally sustainable manner. Parliament is also expected to adopt a Fiscal Stability Law and an Integrated Budget Law which will set in place a fiscal framework for managing mining revenues as well as a commitment to prudent fiscal policy. With regard to the banking sector, a restructuring strategy is expected to be finalized soon, laying out a framework for banking sector resolution techniques. Finally, there has been growing pressure to amend the 2010 budget, to exclude public investment program projects lacking feasibility studies.

These reforms will play a crucial role in ensuring that Mongolia minimizes the risk of Dutch Disease associated with the upcoming mining boom and that its budget is protected from volatility in copper prices. Putting in place a targeted poverty benefit will ensure that the poor are protected from future mining boom-and-busts in a fiscally affordable manner. Similarly addressing the current problems of the financial sector in a decisive and transparent manner will prepare the sector for the coming upturn in economic activity, investment and capital flows in the years ahead.

1 The analysis is based on the most recent data (February 2009) from the Bank of Mongolia (monthly bulletin and monthly

consolidated banking system balance sheet), the National Statistical Office, National Tax Authority and the Ministry of Finance.

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Fiscal developments

The fiscal deficit, measured on a twelve-month rolling basis, continues to improve, reflecting a reduction in expenditures and a recovery in revenues

The 12-month rolling deficit fell to 4.3 as a percent of GDP in February (Figure 1), its lowest level since November 2008 and down from a peak of 10.6 percent in August of last year. Underlying this improvement has been a stabilization in fiscal revenues combined with spending restraint in the second half of last year. Mining revenues, which currently account for about a quarter of total fiscal receipts, steadily increased in recent months, in line with the recovery in international copper prices.

On the expenditure side, continued fiscal restraint has mainly been driven by a sharp fall in capital expenditures, which were down 26 percent in February (on a 12-month rolling basis) on the previous year. Current government spending on goods and services was also about 20 percent lower on the previous year, while subsidies were down by a quarter. However offsetting these declines was an increase in spending on wages and salaries and on social transfers which were up (on a 12-month rolling basis) by 5 and 15 percent respectively year-on-year. For instance, in February, the government, through the Human Development Fund, allocated 87.4 billion tugrug as a first round cash transfer to the citizens as part of fulfilling election promises of paying out 1.5 million tugrug to every Mongolian. On the whole though, total government spending has fallen from a high of 39.4 percent of GDP in September 2009 to 37.4 percent in February, in turn helping to reduce the non-mining fiscal balance (Figure 2).

Figure 1 The 12 month rolling fiscal deficit continues to improve

Figure 2 …as does the non-mining fiscal balance

% of GDP* % of GDP* % of GDP*

Note: *GDP interpolated using actual 2008 and 2009 GDP data and projections for 2010 data. ** Adjusted fiscal balance excludes net lending from expenditure, leaving current and capital expenditure only.

Source: Ministry of Finance, World Bank staff estimates.

Note: *GDP interpolated using actual 2008 and 2009 GDP data and projections for 2010 data. The non-mining fiscal balance excludes mineral revenues and provides an indication of the fiscal stance in mineral dependent economies.

Source: Ministry of Finance, World Bank staff estimates

Revenues and grants (on a 12-month rolling basis) rose to 34.3 percent of GDP in February after falling to 30.8 percent in September 2009. This was primarily due to a rise in windfall profit tax receipts and US$ 10 million of grants provided by US government for the purpose of funding social welfare expenses of the government. Corporate income tax receipts have also recovered strongly, helped by rising copper prices - the mining sector accounts for 40 percent of corporate tax revenues and 90

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percent of dividend tax revenues - and, more recently, due to the stabilization of the economy as a whole (See Box 1).

Overall, although the government is succeeding in controlling spending, continued restraint is necessary given the difficult financing conditions projected for the next few 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. Furthermore the economic outlook depends heavily on a small number of major investment projects, in particular OT, and it is imperative that there are no delays in the development of the OT mine and the associated infrastructure.

Box 1 Corporate balance sheets improving in line with the economy

A sample of firm-level quarterly data from 2008 to 2009 by economic sectors show corporate income picking

up starting Q4 of 2009 (Figure 3). The sampled enterprises contribute 80 percent of corporate revenues to the

state budget. The results indicate that the economic slowdown continued until the third quarter of 2009, with sales revenue declining by about 20 percent, and expenses falling by 14 percent. This caused income before tax to drop by 106 percent, and taxes paid by 20 percent. These year-on-year quarterly declines mirrored the quarterly

GDP contraction across all sectors (Figure 4) with construction and wholesales especially hard hit (Figure 5). The

recovery of sectors such as transportation and communication drove the subsequent turnaround in sales revenues and taxes paid in the last quarter of 2009.

Figure 3 Revenues, expenses before tax, income before tax and total taxes paid are starting to recover, following sharp declines in the first three quarters of 2009…

Figure 4 …mirroring trends in overall economic activity

% yoy % yoy

Source: Top 180 financial company statements,

National Tax Authority Source: National Statistical Office

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Figure 5 Construction, mining and gas, fuel and coal wholesale firms suffered the largest drops in revenue

Source: Top 180 financial company statements, National Tax Administration

Source: World Bank staff

External sector

Mongolia’s export sector is recovering, supported by strong growth in China and buoyant commodity prices

Overall, the 12-month rolling trade deficit declined to US$239.4 million in February (Figure 11), a considerable improvement from the US$1086.3 million in February 2009. Mongolia’s export sector has continued to recover supported by strong economic growth in China, its largest trading partner and also by renewed upward momentum in copper prices (Figure 7 and Figure 8). The latest China Quarterly Update of the World Bank indicates yoy GDP growth of 10.7 percent in the fourth quarter2 as a result of a massive stimulus package that kicked in during the second quarter of 2009. Accordingly, Mongolia’s trade numbers show exports recording increasing yoy growth buoyed by growing coal and copper shipments to China (Figure 9).

For February, on a twelve-month rolling basis, total exports reached US$1,981.9 million, down 15 percent on their value in February, 2009. The main contributors to the reduced export value over the year include gold exports (down 84 percent) and greasy cashmere (down 91 percent). While unit price of gold increased by 11 percent in February, the main driver of the decline in greasy cashmere export values was a sharp decrease in its unit price (down 48 percent) rather than reduced volumes.

Metals and minerals prices declined 5.5 percent in February compared with average January prices, with only nickel prices recording a gain. However, prices for all metals rose later in the month and into early March on expectations of stronger demand. LME inventories, while higher in February for most metals, have recently started to decline3. Copper prices have also resumed their upwards trend after dipping slightly in early February (Figure 8). As a result, copper prices are currently only 17 percent below their historic peak in July 2008.

2 China Quarterly Update, March 2010, World Bank.

3 Commodity Markets Review, DECPG, World Bank

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Figure 6 The trade deficit has stabilized4 Figure 7 …with exports to China rising

$ million, 12-month rolling sum % yoy contributions to export growth by destination

Source: National Statistical Office, Bank of Mongolia

World Bank Source: Bank of Mongolia, monthly bulletin, World Bank

Figure 8 Copper prices have recovered after dipping slightly in February while gold prices are stabilizing at close to record levels…

Figure 9 …supporting Mongolia’s exports

US$/tonne US$/ounce Percentage point contributions to year-on-year growth

Note: the dashed lines indicate the US$2600/tonne

and US$850/ounce thresholds for copper and gold respectively for the WPT. Last observation: March 12, 2010.

Source: London Metal Exchange, World Bank.

Source: National Statistical Office, World Bank

Gold prices are also showing signs of stabilizing at around US$1100/toz going into March. However, Mongolia’s gold exports remain depressed compared to previous years. The volume of exports in the first two months of 2010 is almost 90 percent below that in the comparable period in 2009, in spite of the provision of government-financed credit directed to support gold producers last year. A number of factors may have influenced the reduction in volume of gold exports, including decreased gold

4 Monthly trade data is strongly affected by the seasons in Mongolia, and has strong month-to-month fluctuations. For this

reason, 12-month rolling sums are illustrated.

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production by a major gold exporting company and the existence of the Windfall Profit Tax (WPT). Anecdotal reports suggest that the actual volume of exports may be higher, as the WPT has led to gold being smuggled out of the country. Similarly, producers could be holding on to their gold stock rather than exporting it, until this tax is abolished in 2011.

While overall Chinese import demand remains strong – the latest Chinese trade data show imports rose by 44.7 percent on the year in February – Chinese commodity import demand has leveled out in recent months (Figure 10). With exports to China generating 65 percent of Mongolia’s export revenues, half of which is copper, this suggests that Mongolia’s mining exports may not receive much more tailwind from China.

In February the dollar value of goods imports was up by 44 percent year-on-year, compared with contractions of over 50 percent in the first half of 2009. The latest numbers show sharp increases in imports of minerals products, machinery and equipment, transportation equipment, base metals and food products (Figure 11), although these numbers are likely strengthened by strong base effects from early 2009.

Figure 10 …but commodity import demand from China appears to be leveling out

Figure 11 Imports pick up into 2010

Chinese commodity imports (volume, Jan 2000=100) Percentage point contributions to year-on-year growth

Source: CEIC Source: National Statistical Office, World Bank

The exchange rate against the USD remains stable

The exchange rate against the US dollar has been stable since April 2009 (Figure 12), when the Bank of Mongolia (BoM) raised its policy rate substantially and introduced an auction system. In February, the average monthly exchange rate against the USD appreciated slightly, by 0.6 percent, compared with January.

The stabilization of the exchange rate allowed the Bank of Mongolia to raise its international reserves to a record high level of US$1,145 million as of the end of 2009, although since November the BoM has not made any foreign exchange purchases. Instead, reserves have been boosted by an increase in monetary gold, project funding from international institutions and deposits from commercial banks. In February, international reserves declined slightly but remain close to record levels (Figure 13).

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Figure 12 The exchange rate remains stable Figure 13 BoM international reserves remain close to record levels

MNT per USD Percent $ billion, stock US$ million, month-on-month change

Note: Parallel market rate is mid-point of bid and ask rates. Positive spread over official rate indicates relative depreciation. Ask-bid spread measured as percentage of mid-point of the two. Last observation: March 16, 2010.

Source: Mongolian Financial Association, World Bank.

Note: Number in box is end-February stock of BoM international reserves in US$ million.

Source: Bank of Mongolia, World Bank.

Inflation

The UB CPI inflation rate picked up in February driven by rising meat prices

A severe dzud this winter led to a huge loss of livestock, estimated at over 4 million in March. Consequently, meat prices increased in February by 15.3 percent compared to last month, leading the overall UB headline inflation rate to increase to 8.7 percent yoy in February (Figure 14), roughly doubling from January and up from just 1.9 percent in December 2009.

Figure 14 Inflation continues to pick up…

Percentage point contribution to CPI inflation

Note: This is the UB city CPI. Source: National Statistical Office, World Bank

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Rising meat, milk and cheese prices contributed 2.9 percentage points (ppts) to the headline rate (up from 0.5 ppts in January and minus 0.9 the previous month), with core inflation mostly contributing the rest. Core inflation rose to 7.7 percent yoy in February from 5.4 percent in January mainly driven by a 37.5 percent hike that month in telecommunication tariffs on land lines.

With rising inflation eroding real incomes and purchasing power, low-income households and pensioners are likely to be the most severely affected. Moreover, these effects will be felt on top of those from the sharp economic downturn last year and, more recently, the dzud (Box 2).

Box 2 Household level impacts of the economic crisis in Mongolia: findings from

three rounds of qualitative research

The Asian Development Bank and the World Bank have been collaborating to track household level impacts of the economic crisis in selected rural and urban sites across Mongolia. Over the past ten months, research teams have returned three times to the same sites and, where possible, the same households. Using qualitative research techniques, these teams have gathered information on household experiences of the macroeconomic changes that have occurred over the last year, and documented the strategies used by households to cope with income and price shocks.

Migrant households living in Ulaanbaatar have, over the last nine months, consistently described difficulties in finding work that covers subsistence. Those working in the construction sector report that work has been hard to come by and (as of Jan 2010) had yet to pick up. There has been high competition for work in the informal sector, too, with traders describing reductions in profits and rubbish-collectors reporting that so many people were now engaged in rubbish collection that there was no more rubbish available to collect. Those working in small businesses in the private sector have often managed to retain jobs, but report delays in salary payments, receipt of payments below the contracted amount (generally the minimum wage) and lengthened working hours for the same money. Women reported that increased competition for jobs had accentuated discrimination in the labour market, with many jobs specifying that women wanting to apply should have certain physical characteristics.

High fuel prices have aggravated the costs of commuting for workers living on the furthest outskirts of the city, eroding disposable income to such an extent that some reported withdrawing from paid employment to engage in income-generating activities based around the home or garden. Prices of basic consumption goods have remained high over the research period and households routinely mention limiting the purchase of non-essentials (such as soap and shampoo) to be able to maintain levels of basic consumption.

Households in rural areas describe the impacts of falling prices of livestock products, sometimes crisis-related, sometimes driven by seasonality. The crash in the price of cashmere last spring caused severe hardship for poorer households, who have fewer saving and are less able to choose when to sell their cashmere. In combination with high prices for basic commodities (such as flour, sugar and oil), this terms of trade shock meant that some poorer households had to then sell livestock for meat in order to cover basic subsistence costs, even though meat was also unfavourably priced. While there were no reports of withdrawals of children from school, there were reports of changed health-seeking behavior for services where charges exist. Less poor herding households, with more animals and a more diversified range of income generating options, have been better placed to cope with the price shocks by reducing purchases of non-basic goods.

Discussions during the research suggest that there are a number of non-material impacts from the crisis. Increasing abuse of alcohol was mentioned several times by many groups and was linked to under- or unemployment in some instances (particularly with respect to young, first-time labour market entrants). Women reported an increase in tensions, arguments and violence in the household driven by economic stress, although exceptions were noted when husbands were working such long hours that there was no time left for arguments).

Cash transfers clearly play an important role in helping poorer groups to cope with fluctuations in prices and incomes. This highlights the urgency of the government instituting the poverty-targeted cash transfer program

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envisioned under the social welfare reform law currently before the Parliament.

Source: World Bank staff

Banking sector

Commercial bank lending rates remain high with some signs of easing

Real interest rates are edging down as the inflation rate is picking up (Figure 15). Nominal rates (which have tended to be very sticky and unresponsive to inflation trends in the past) showed signs of easing: weighted average annual deposit rates decreased by 0.6 percent on MNT and 0.4 percent on FX deposits in February, while average lending rates also decreased in February on both local and foreign currencies by 0.8 and 0.4 percent respectively. Although commercial bank nominal rates are starting to come down slightly, Savings and Credit Cooperatives (SCC) are continuing to charge as high as 44.7 percent annually on average (Box 3).

Figure 15 …leading to a decrease in real interest rates

Percent (annual rate)

Source: Bank of Mongolia, National Statistical Office, World Bank.

Box 3 High lending rates

To get a snapshot of the average lending rates in March, 2010, The World Bank surveyed five commercial banks and six savings and credit cooperatives (SCCs) and non-bank financial institutions (NBFIs)

5. The sub-sample

of commercial banks’ lending rates showed an average annual interest rate of 24.7 percent on new loans. Only two out of the six SCCs and NBFIs surveyed are currently lending .These two charge on average 44.7 percent on new loans, while they no longer offer saving services

What explains these high interest rates? It is likely that they reflect a combination of inflation expectations, high lending risks and the high costs of attracting savings. In particular, those banks that are facing liquidity

5 Detailed interviews were conducted with 11 loan officers with regard to interest rates on different types of

loans for a range of maturities. The numbers presented are simple averages of interest rate ranges.

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difficulties could be driving up the deposit rates (the highest rates rose slightly from 19.2 in January to 19.3 in February)

6.

NBFI loans account for only 3 percent of the total loans of the financial sector. However, there were a total of 132 NBFIs and 212 SCCs with an outstanding loan of MNT 87.7 billion (up 15 percent compared to 2008) at the end of 2009. In terms of loan quality, their NPLs increased from 6 percent in 2008 to 8 percent in 2009, when they operated with after-tax profit of MNT 6.8 billion (up 17.0 percent from 2008) with MNT 26 billion of interest income (up 13 percent)

7. However, concerns over credit quality and high funding costs have caused most NBFIs to

stop lending and offer savings services. These non-bank financial institutions (NBFIs) are small and have limited sources of funding, and their reputation has yet to recover as a result of the failure of 32 savings and credit cooperatives accounting for more than half of the assets of the sector in 2006.

Table 1 Average lending rates by loan types in MNT (monthly percentage rate)

Note:* Small and medium enterprises

Table 2 Average lending rates by loan types in MNT (monthly percentage rate)

Note: *Small and medium enterprises

Source: World Bank staff

Lending growth is showing signs of picking up, but remains very weak

Lending growth shows some signs of picking up but is nevertheless muted (Figure 16). Total lending rose by 1.1 percent on the year in February, the third consecutive increase in as many months. Lending to individuals has picked up slightly since November 2009. Lending growth to the private sector also remains in positive territory, although at 4.3 percent yoy in February, it is roughly half the rate of growth

6 The highest nominal rate in the ranges of deposit rates published in February Bulletin by the Bank of

Mongolia.

7 2009 Annual Reports of NBFIs and SCCCs, Financial Regulatory Commission

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seen at the end of last year. The latest February data also show that banks are continuing to purchase less risky central bank bills, but at a slightly slower pace than that seen in recent months.

Meanwhile, high real interest rates and expectations of currency appreciation have caused a large increase in MNT deposits (Figure 17). Local currency deposits rose to a new peak in February at MNT 1,366 billion, which is a 10 percent increase from January. By contrast, although the stock of foreign currency deposits is still quite high (accounting for about a third of total deposits), it fell for the second consecutive month in February to MNT 592 billion after peaking at MNT 622 billion at end-December.

Figure 16 Total lending growth remains flat while purchases of Central Bank bills are slowing

Figure 17 MNT deposits spike as FX deposits decrease slightly

% year-on-year change % year-on-year change MNT billion, month-on-month change MNT billion, stock

Source: Bank of Mongolia, World Bank. Source: Bank of Mongolia, World Bank

There are tentative signs of stabilization in the level of non-performing loans although this may prove to be a temporary respite for the banking sector

The weakness in banking sector balance sheets was clearly exposed by the failure of two major

banks which had to be taken into receivership last year. Overall, the aggregate losses of commercial banks amounted to MNT 73 billion in February compared to an aggregate profit of MNT 11 billion a year ago8. Loan quality, in particular to the private sector, deteriorated markedly. Non-performing loans and loans with their principal in arrears currently stand at 22.6 percent of total outstanding loans. Excluding the two failed banks, the NPLs and loans with principal in arrears as a percent of total loans outstanding are 15.1 percent as of end-February, 2010 (Figure 18).

The steady increase in NPLs seen last year appears to have come to an end with total NPLs amounting to roughly 202 MNT billion in February, down from MNT 209 billion in December. However, loans with principals in arrears9 continue to mount reaching MNT147bn in February, up 20 percent since December, suggesting that NPLs may soon resume their upward trend.

8 Consolidated Loan Report, February, 2010, Bank of Mongolia

9 These are loans of which the principal is 1 to 90 days in arrears. After 90 days, they are categorized non-performing

loans.

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Figure 18 Slight fall in total non-performing loans in December

Figure 19 Registered unemployment* has decreased in recent months

MNT billion MNT billion, month-on-month change MNT billion, stock

Note: The numbers in boxes are the sums of NPLs to residents and non-residents and loans with principal in arrears as a percent of total loans outstanding.

Source: Bank of Mongolia

Note: * Defined as working-age population currently not Source: NSO.

Labor Markets and Poverty

Registered unemployment has declined slightly in recent months

The official unemployment rate, which includes only those who are registered with the Labor and Social Welfare Service Center, has been trending downward since July 2009, falling to 3.2 percent in February (Figure 8). However, the overall number of registered unemployed has continued to increase, up almost one-third compared to December 2008.

Nevertheless, as explained in previous Updates, these numbers likely grossly underestimate the impact of the economic downturn on both the level of unemployment and real wages. According to the 4Q Labor Force Survey, which also takes into account those who are not officially registered as unemployed with the Labor and Social Welfare Service Centers, the unemployment rate stood at 12.8 percent, up from 10.5 percent in September 2009, with some 142 thousand people unemployed from the total labor force of 1120 thousand.

The rural poor and vulnerable are most exposed to the adverse impact of the harsh winter

Increases in livestock size in recent years have been a driving factor for poverty reduction among the rural poor in Mongolia10. The flip-side is that increases in livestock mortality have sizeable negative impacts on household well-being. Indeed evidence suggests that a 1 percent rise in livestock mortality for a household is associated with a reduction in household per capita consumption of 0.3 percent11. Accordingly, rural incomes and livelihoods have been hit hard by the recent dzud conditions and have

10

According to initial World Bank analysis, see World Bank November 2009 Mongolia Monthly Update.

11 World Bank (2006), “Mongolia Poverty Assessment”, http://go.worldbank.org/ZDS4YQSSI0

9.4

19.7 15.1

0

100

200

300

400

500

600

700

800

900

1,000

Feb-09 May-09 Aug-09 Nov-09 Feb-10

Loans with principal in arrears

NPLs to non-residents

NPLs to residents

NPLs of failed banks

2.5

2.7

2.9

3.1

3.3

3.5

3.7

3.9

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

Registered unemployment rate

Registered unemployment rate (12-month moving avg)

16

led to large migrations from rural areas (or dzud-affected regions)12. According to latest information by the Ministry of Food and Agriculture, the total official livestock loss equals 4.1 million. Roughly 50 percent of the livestock losses are goats which suggest that the cashmere sector will experience a significant supply shortage in the coming season, which should further impact rural livelihoods (Refer back to Box 2). In order to help relief efforts related to the Dzud, the World Bank committed USD 1.0 million, UNDP USD 1.5mln and the ADB USD 3.0 million.

Reform agenda at the upcoming spring session of Parliament

At its upcoming spring session, the Mongolian Parliament is expected to debate and enact a number of important reform laws. These include comprehensive social welfare reform legislation to consolidate and improve the targeting of existing social transfers in a fiscally sustainable manner. Parliament is also expected to adopt a Fiscal Stability Law and an Integrated Budget Law which will put in place a fiscal framework for managing mining revenues (both in terms of volatility as well as a long-term increase due to the OT project) as well as a commitment to prudent fiscal policy.

With regard to the banking sector, a restructuring strategy is on the table to improve the functioning of the banking sector and setting in place a transparent mechanism for timely and cost-efficient bank resolution techniques. Existing banking legislation has been amended in January to improve the governance of the banking sector by strengthening the central bank’s intervention powers and sanctions.

These reforms will play a crucial role in ensuring that Mongolia minimizes the risk of Dutch Disease associated with the upcoming mining boom, and that its budget is protected from volatility in copper prices. Putting in place a targeted poverty benefit will ensure that the poor are protected from future mining boom-and-busts in a fiscally affordable manner. Similarly addressing the current problems of the financial sector in a decisive and transparent manner will prepare the sector for the coming upturn in economic activity, investment and capital flows in the years ahead.

Finally, there is also likely to be an amendment to the 2010 budget in the spring parliamentary session. The annual budget law for 2010 was approved by Parliament in November 2009 despite a presidential veto on its public investment program (PIP) that included MNT 76 billion of investment projects allocated for each election constituency, with the majority of PIP projects lacking feasibility studies. This was also confirmed later in an audit carried out by the Mongolian National Audit Office, resulting in growing pressure for an amendment to the Budget to exclude these projects at the upcoming session.

12

It was estimated that over 21,560 people or 7,303 households were on the move due to the dzud while 52,071

households experienced fodder shortages.

17

Table 3 Mongolia: Key Indicators

2003 2004 2005 2006 2007 2008 2009

Output, Employment and Prices

Real GDP (% yoy change) 7 10.6 7.3 8.6 10.2 8.9 -1.6

Industrial production index .. .. .. 100 110.4 113.4 109.6

(% yoy change) .. .. .. .. 10.4 2.8 -3.3

Unemployment (%) 3.4 3.6 3.3 3.2 2.8 2.8 3.3

Consumer price index (% yoy change) 4.6 10.9 9.6 5.9 14.1 23.2 1.9

Public Sector

Government balance (% of GDP) -3.7 -1.8 2.6 3.3 2.8 -5 -5.4

Non-mining balance (% of GDP)(1) -5.9 -5.8 -1.3 -7.3 -13.4 -15.1 -12.9

Domestic public sector debt (% of GDP) 3.1 1.4 0.1 1 0.5 0 6.3

Foreign Trade, BOP and External Debt(2)

Trade balance ($ mn) -199.6 -99.2 -99.5 136.2 -52.4 -612.6 -157.9

Exports of goods ($ mn) 627.3 872.1 1066.1 1542.8 1889 2539.3 1902.6

(% yoy change) 19.7 39 22.2 44.8 22.4 34.4 -25.1

Copper exports (% yoy change) .. .. 14.7 94.8 27.7 12.1 39.9

Imports of goods ($ mn) 826.9 971.3 1021.1 1485.6 2117.3 3615.8 2131.3

(% yoy change) 21.6 17.5 16 25.4 42.5 70.8 -41.1

Current account balance ($ mn) -102.4 24.1 29.7 221.6 264.8 -721.9 -235.1

(% of GDP) -7.1 1.3 1.3 7 6.7 -13.9 -5.6

Foreign direct investment ($ mn) 131.5 128.9 257.6 289.6 360 836 426

External debt (% of GDP) 92.6 76 61.2 45.1 40.1 34.6 50

of which public & publicly guaranteed (% of GDP)

87.3 73.7 59.7 44.3 38.9 33.7 47.1

of which private (% of GDP) 5.4 2.4 1.5 0.7 1.2 0.8 2.9

Debt service ratio (% of exports of g&s)(3) 35.1 7.5 2.7 2.3 2 2 3.7

Foreign exchange reserves, gross ($ mn) 203.5 207.8 333.1 718 1000.6 656.9 1327

(month of imports of g&s) 2.4 2 2.6 4.3 3.8 3 4.9

Financial Markets

Domestic credit (% yoy change) 157.3 25.8 18.8 -3.1 78.4 52.5 -7.5

Short-term interest rate (% per annum)(4) .. 15.8 3.7 5.1 8.4 9.8 ..

Exchange rate (MNT/USD, eop) 1168 1209 1221 1165 1170 1267.5 1442.8

Real effective exchange rate (2006=100)(5) 94.2 93.9 99.6 102.8 104.8 127.4 102.9

(% yoy change) -4.8 -0.4 6.1 3.2 1.9 21.5 -19.2

Stock market index (2000=100)(6) 151.5 120.8 203.6 382 2048 1181.6 ..

Memo:

Nominal GDP (MNT bn) 1660 2152 2780 3715 4600 6020 6055

Nominal GDP ($ mn) 1448 1814 2307 3156 3930 5258 4.203

GDP per capita ($) 583 722 900 1214 1491 1980 1600

(1) Non-mining balance excludes revenues from corporate income tax and dividends from mining companies, the Windfall Profits Tax and royalties. (2) The 2008 data for the balance of payments are based on the final revision. (3) On public and publicly guaranteed debt. (4) Yield of 14-day bills until 2006 and of 7-day bills for 2007. (5) Increase is appreciation. (6) Top-20 index, end of year, index=100 in Dec-2000.

Source: Bank of Mongolia, National Statistical Office, Ministry of Finance, IMF and World Bank staff estimates