MONGOLIA MONTHLY ECONOMIC UPDATEdocuments.worldbank.org/curated/pt/303761468277496106/pdf/529… ·...

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MONGOLIA MONTHLY

ECONOMIC UPDATE

WORLD BANK

May 2009

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

([email protected]). Copies can be downloaded from http://www.worldbank.org.mn.

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Table of Contents

Sections: Page number

1. Introduction………………………………………………………………………………………… 3

2. Fiscal sector………………………………………………………………………………………… 3

3. Exports……………………………………………………………………………………………… 5

4. Imports……………………………………………………………………………………………… 7

5. Exchange rate………………………………………………………………………………………. 8

6. Financial sector…………………………………………………………………………………….. 9

7. Growth and unemployment…..…………………………………………………………………… 11

8. Conclusion………………………………………………………………………………………… 13

Tables:

1. Revenue has fallen sharply, as predicted…………………………………………………………… 3

2. Expenditure has declined more slowly……………………………………………………………... 4

3. Main drivers of changes in commodity exports……………………………………………………. 5

4. Exports by destination……………………………………………………………………………… 7

5. Informal labor market survey ..…………………………………………………………………… 13

6. Typical fiscal revenue under different scenarios …………………………………………………. 14

7. Mongolia: Key Indicators…………………………………………………………………………. 16

Figures:

1. With expenditure falling as well as revenue, the sharp deterioration of the fiscal deficit

has slowed down…………………………………………………………………………………… 4

2. The trade deficit is narrowing…………………………………………………………………….... 5

3a. The copper price dropped steeply during the second half of 2008………………………………… 6

3b. …but it rebounded recently………………………………………………………………………… 6

4. Mongolia’s main export destinations are projected to slow down…………………………………. 7

5. Global prices of Mongolia’s main commodity imports are forecasted to remain

below their 2008 peaks……………………………………………………………………………... 7

6. The multiple exchange rates started to diverge at the beginning of November 2008

and converged in April 2009.……………………………………………………………………… 8

7. Foreign exchange outflows have reversed, and the exchange rate started to appreciate again……. 8

8. Tugrug deposit outflows have reversed……………………………………………………………. 9

9. NPLs surged in March

while loans with principal in arrears did not decrease by the same amount……………………… 10

10. Growth in loans by banks has fallen……………………………………………………………… 10

11. Inflation continued to fall………………………………………………………………………… 11

12. GDP contracted in the first quarter of 2009 relative to 2008…………………………………….. 12

13. Industrial production stabilized, but unemployment increasing…………………………………. 12

Boxes:

1. Copper price rebound? …………………………………………………………………………….. 6

2. Effective real wages for informal sector workers have decreased about 60 percent……………… 12

3. State equity participation in mining………………………………………………………………. 14

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1. Introduction

The global downturn has hit Mongolia hard, predominantly due to the slump in minerals prices. Its budget

relies heavily on copper revenues and the “bust” has put serious strain on the country’s finances forcing it

to drastically cut spending. During the mining “boom” years, the government did save part of the windfall

in a special development fund, but it also funded large increases in untargeted social expenditures, civil

service wages, and poorly screened investment projects. When the “boom” turned into “bust”, the modest

fiscal surplus quickly turned into a large deficit. At the same time, the current account also switched into

deficit, and the financial sector, which had been overheating during the boom period, ran into serious

problems, with a major bank having to be put under conservatorship. However, in response to the crisis,

the government took a number of strong policy actions. On the basis of these, an agreement with the IMF

was reached, supported by several other development partners. This Economic Update reviews the recent

economic developments in the fiscal sector, exports, imports, the exchange rate, the financial sector,

economic growth and unemployment, and the initial impact of the recent policy reforms.1 The overall

conclusion is that the deterioration seems to have slowed down and stabilized in some areas, but

substantial risks, notably in the financial sector, remain.

2. Fiscal sector

While total revenue fell sharply in 2008 and total

expenditure remained steady, a large fiscal gap

opened by mid-2008, leading to a 5 percent of GDP

fiscal deficit for the 2008 fiscal year.

In the first four months of 2009, compared to the

same period in 2008, total revenue and grants have

fallen by 31.4 percent (see Table 1). The major

contributors to this drop were mining-related

revenues: the Windfall Profits Tax (WPT), royalties

and corporate income tax experienced the largest

declines, and only dividends increased, which reflects

the boom of the previous years.2,3

As a result, certain

1 The analysis is based on the most recent data (April) from the Bank of Mongolia, the National Statistical Office

and the Ministry of Finance. 2 The mining sector provided an estimated 42 percent of corporate income tax and an estimated 89 percent of

dividends in 2008.

Table 1. Revenue has fallen sharply, as

predicted

Change

between year

to April 2008

and 2009 (%)

Total revenue and grants -31.4 Tax revenue, including -35.0 Corporate income tax -45.6 Personal income tax 22.4 Windfall Profits Tax -91.8 Social security contributions -6.2 Value added tax -18.5 Excise taxes -11.1 Taxes on foreign trade -26.2

Royalties -53.2 Non-tax revenue, including -4.4 Dividends 59.5

Source: Ministry of Finance, World Bank

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non-mining revenue components—personal income tax, social security contributions, VAT, excise tax,

and taxes of foreign trade—have become more important as sources of revenue.

However, this large fall in revenues was as predicted. For the year to April, actual revenue was only 1.3

percent lower than the Ministry of Finance’s planned revenue for that period. Tax revenues were slightly

higher than the plan, and non-tax revenues were close to, but slightly below plan. These monthly revenue

plans are based on the amended budget that was approved in March (replacing the previously approved

2009 budget), which shows that the amended budget has more realistic revenue projections than the

previous budget.

Total expenditure and net lending has declined by

3.6 percent during the first four months of 2009

compared to the same period in 2008 (see Table 2).

Current expenditure increased slightly, due to an

increase in expenditure on wages and salaries, while

subsidies and transfers—in particular pensions

(social security fund)—have taken a cut. Social

transfers (social assistance fund) have hardly

changed. Domestic investment was cut sharply by

MNT 8.5 billion.

The sharp deterioration of the fiscal deficit has

slowed down. We take a look at the full year of

revenues and expenditure, and reduce seasonal

effects by taking the 12-month rolling sum of

the fiscal numbers (Figure 1). This 12-month

rolling fiscal balance went into deficit in June

2008. The subsequent sharp deterioration has

been driven mainly by falling revenue. It

started to slow down in March 2009.

3 Box 3 discusses the implications of state equity participation in the mining sector.

Table 2. Expenditure has declined more

slowly

Change

between year

to April 2008

and 2009 (%)

Total expenditure and net lending -3.6

Current expenditure, including 0.4

Wages and salaries 9.5

Subsidies and transfers -4.8

Social security fund -11.7

Social assistance fund -0.8

Capital expenditure, including -6.6

Domestic investment -17.6


Figure 1. With expenditure falling as well as

revenue, the sharp deterioration of the fiscal deficit

has slowed down

MNT trillion, 12-months rolling sum(1)

(1) Sum over previous twelve months to adjust for seasonal

effects.


-0.6-0.5-0.4-0.3-0.2-0.10.00.10.20.3

1.8

1.9

2.0

2.1

2.2

2.3

2.4

2.5

2.6

Apr-08 Jul-08 Oct-08 Jan-09 Apr-09

Revenue

Expenditure

Fiscal balance (right axis)

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3. Exports

The trade deficit ended the year at 11.4 percent of

GDP. However, because imports fell more sharply

than exports during the first few months of 2009, the

trade deficit is gradually narrowing (see Figure 2).

Mongolia’s exports—copper, gold, coal, cashmere,

zinc, and crude oil accounted for 81 percent of goods

exports in 2008 (see Table 3)—dropped by 42 percent

in the first four months of 2009 compared to the same

period in 2008. The decline in the value of the main

export product, copper, and crude petroleum oils were

primarily driven by price, not volume (see also Box

1). However, the picture is more mixed for other exports.

For instance, while the price of gold

hardly changed, as it is considered a

safe investment during crises, the

volume of gold exports dropped

markedly.5 Coal export revenues

increased strongly, driven by an

increase in volume and price.

Cashmere products experienced a

general decline in prices, but exports

volumes have picked up. This

substantial increase in the export

volume seems to have been driven by

Chinese traders taking advantage of the low prices. The positive cashmere trend may continue, however,

because in May quality restrictions on cashmere exports were lifted, ports authorized for cashmere

exports were increased from three to twenty, and the export tax was abolished. The decline in zinc was

caused by both price and export volume declines.

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

For this reason, the data has filtered using seasonal adjustment and a three-month moving average. 5 News sources suggest that the actual volume of exports may be higher, as the WPT may have led to gold being

smuggled out of the country. Another reason may be that producers are holding on their gold stock rather than

exporting it, in the expectation that this tax would be abolished shortly.

Figure 2. The trade deficit is narrowing4

$ million, monthly, seasonally adjusted, 3m mov. avg

Source: Bank of Mongolia, World Bank

Table 3. Main drivers of changes in commodity exports

2008

export

revenues

($ mn)

Change between first 4

months of 2008 and 2009 (%)

Value Volume Unit

price(1)

Copper concentrate 835 -59.4 -2.5 -58.3

Gold(2)

599 -35.8 -32.8 -4.4

Coal 184 129.7 99.3 15.3

Combed goat down(3)

97 -25.6 7.1 -30.5

Raw/Greasy cashmere(4)

77 -4.6 75.3 -45.6

Zinc concentrate 154 -80.1 -57.1 -53.5

Crude petroleum oils 101 -55.0 -3.7 -53.2

(1) Derived from export value and volume. These unit prices may vary

substantially from global benchmark prices, which have been adjusted for

content. (2) Unwrought or in semi-manufactured forms. (3) and (4) are

intermediate cashmere products.

Source: National Statistical Office, World Bank

-150

-100

-50

0

50

100

150

200

250

300

350

Apr-06 Apr-07 Apr-08 Apr-09

Exports

Imports

Trade balance

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The main cause of the decline in Mongolia’s total exports in the first four months of 2009 compared to

the same period in 2008 was the drop in exports to China due to the collapse in copper prices. Exports to

the European Union increased by a little, whereas exports to the US, Canada and Russia fell sharply

(Table 4). Going forward, global prospects are not good. The World Bank6 forecasts a 1.7 percent year-

on-year contraction of real world GDP in 2009, and a 2.3 percent growth in 2010. Except for China,

growth is expected to contract significantly in Mongolia’s main export destinations: the European Union,

Canada, the US and Russia (accounting for 32 percent of total goods exports in 2008), and will slowly

recover in 2010. China, which absorbed about of 65 percent of Mongolia’s goods exports in 2008 (and

about half is copper), is forecasted to slow down substantially to 6.5 percent yoy in 2009, and then to

grow by 7.5 percent in 2010 (see Figure 4).

6 See World Bank (2009), Global Economic Prospects 2009 Forecast Update, March 30, 2009, and World Bank

(2009), China Q1 Quarterly Update, March 2009.

Box 1. Copper price rebound?

Having fallen from $8900/tonne in mid-April 2008 to $2700 in late December 2008, the copper price has gradually

recovered. It reached about $4700 in mid-April and early-May 2009, before falling back slightly (see Figures 3a and

3b). According to market analysts, the following factors explain this surge in copper prices: (i) China’s State

Reserve Bureau has been buying refined metals to support domestic producers in the downturn, but also for strategic

stocks in the case of copper; (ii) China's fiscal stimulus may have also supported copper prices via construction

activity; and (iii) inventories have started to fall, and scrap markets have been very tight, especially for copper. On

the other hand, underlying demand has remained weak, especially outside China. Moreover, China has historically

bought most of its raw materials during the first two quarters of the year, so demand may start to level off. In

conclusion, the market does not expect a sustained rally of copper prices to their 2008 levels.

Figure 3a. The copper price dropped steeply

during the second half of 2008…

Figure 3b. … but it rebounded recently

$/tonne $/tone

Source: World Bank Last observation: May 21. 2009.

Source: London Metals Exchange, World Bank

Source: news sources, World Bank staff

0

2000

4000

6000

8000

10000

Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09

2668

4766 4760

2500

3000

3500

4000

4500

5000

Dec-08 Jan-09 Feb-09Mar-09 Apr-09 May-09

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4. Imports

Three effects have caused the decrease in imports.

First, the slowdown in domestic growth has limited

demand for imports (see Section 7). Second, global

commodity prices, such as energy, food in general

and wheat in particular (a major food import in

Mongolia) have come down from record levels (see

Figure 5). This can be also be seen in Mongolia’s

import data, which shows that unit import prices of

flour, petrol, diesel (accounting for around 40

percent of imports), have fallen by 25, 45 and 36

percent respectively in the first four months of 2009

compared to the same period in 2008. Third, the

depreciation of the exchange rate, 39 percent between end-October and mid-March (see also Section 3),

has made imports less attractive.

Figure 4. Mongolia’s main export destinations

are projected to slow down

Table 4. Exports by destination

% year-on-year change in real GDP

2008 export

revenues

($ mn)

Change between

first 4 months of

2008 and 2009

(%)

China 1,644 -44.4

European Union 435 2.3

Canada 175 -10.8

US 113 -92.0

Russia 85 -29.1

Total good exports 2,539 -42.4

Source: IMF (2009), World Economic Outlook, April 2009;

World Bank (2009), Global Economic Prospects 2009 Forecast

Update, March 30, 2009; World Bank (2009), China Q1

Quarterly Update, March 2009.


Figure 5. Global prices of Mongolia’s main

commodity imports are forecasted to remain

below their 2008 peaks Index=100 in January 2004

Source: World Bank

China

European Union Canada

United States

Russia

-6

-1

4

9

14

2005 2006 2007 2008E 2009F 2010F

0

100

200

300

400

2005 2006 2007 2008 2009 2010 2011 2012

Energy index

Food index

Wheat index

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5. Exchange rate

Two important developments

occurred in the foreign exchange

market. The multiple exchange

rates—official Bank of Mongolia

(BoM) rate, commercial bank rate

and parallel market rate—that had

prevailed since November 2008

have converged, and the exchange

rate has appreciated (Figure 6).

Pressures on the balance of

payments had led to a depreciation

of the tugrug, starting at the end of

October, from MNT 1145 per

dollar to MNT 1591 by mid-March. During this period, the BoM rationed the sale of foreign exchange,

and a parallel market quickly developed. The exchange rate in this parallel market peaked around 1700 by

mid-March, which implied a depreciation of 50 percent since the end of October.

However, as part of a package of

corrective policy measures, the BoM

raised its policy rate from 9.75 to 14

percent on March 11, and instituted an

auctioning mechanism for foreign

exchange on April 1.7 As a result, the

official and parallel market exchange

rates quickly converged, the depreciation

was halted and the BoM was able to add

to its international reserves (Figure 7).

This is an important development,

because the banking system as a whole

had seen almost continuous outflows of international reserves since August 2008, when bank customers

started to move out of tugrug deposits, while the BoM tried to defend the exchange rate.

7 See World Bank (2009) Mongolia April 2009 Monthly Economic Update (available at

http://www.worldbank.org.mn) for more information on the auctioning mechanism.

Figure 6. The multiple exchange rates started to diverge at the

beginning of November 2008 and converged in April 2009

Tugrug per US dollar

Last observation: May 21, 2009.

Source: Bank of Mongolia, Mongolian Financial Association, World Bank

Figure 7. Foreign exchange outflows have reversed, and

the exchange rate started to appreciate again $ million, month-on-month change Tugrug per US dollar

* BoM and banking system’s net international reserves.


1,100

1,200

1,300

1,400

1,500

1,600

1,700

1,800

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09

BoM official rate

Parallel market bid

Parallel market ask

auction FX sell to banks

auction FX buy from banks

1,100

1,200

1,300

1,400

1,500

1,600

-400

-300

-200

-100

0

100

200


Change in total net international reserves*

Exchange rate versus USD (right axis)

http://www.worldbank.org.mn/

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6. Financial sector

Monetary policy

The BoM reduced its policy rate, the one-week CB bill rate, to 12.75 percent from 14 percent. As

inflation has fallen further to 12.6 percent year on year, the policy rate is now just positive in real terms.

After several months of outflows, tugrug-denominated time deposits increased by a record MNT 60

billion from February to March, the largest increase since February 2007, and continued to increase in

April, while FX-denominated time deposits fell for a second consecutive month.

This seemingly renewed confidence is the tugrug

has a number of causes. First, the recent

appreciation has made saving in tugrug more

attractive. Second, the increase in the BoM

policy rate may have shifted market expectations

against the one-way bet against the tugrug. Third,

CPI inflation has come down, increasing the real

interest rate on deposits. And fourth, the

clarification of the deposit guarantee to exclude

certain accounts may have increased its

credibility in the eyes of bank customers.

Banking sector

The aggregate number of NPLs surged first by 117 percent from November to December 2008, and then

again from February to March by 31 percent, reaching 10.6 percent of outstanding loans in April. Loans

with principal in arrears had increased by 70 percent from November to December, having been relatively

steady in the months before November (see Figure 9).

Figure 8. Tugrug deposit outflows have reversed MNT billion, month-on-month change


-80

-60

-40

-20

0

20

40

60


MNT deposits

FX deposits

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The increase in NPLs in March points to a general deterioration of loan quality, as opposed to the earlier

increase (in December), which seems to have been caused by the exposure to the failed bank, because it

was not preceded by a similar-sized increase in loans with principal in arrears.8 While NPLs increased in

March, the loans with principal in arrears did not decrease by the same amount in the same month, which

means that, on the whole, there continue to be significant risks going forward.

Risk management departments of banks are focusing on the quality of existing loans rather than issuing

more loans (see Figure 10). This has led to bank credit to the private sector slowing down significantly,

and bank credit to individuals shrinking. Moreover, recent headline news and anecdotal stories convey

that foreclosures on collateral are picking up while some banks are restructuring a significant portion of

their outstanding loans by extending the time borrowers have to repay.

In response to the worsening NPLs, the BoM required banks to increase their capital adequacy ratio from

10 to 12% in March to strengthen their risk bearing-capacity. At the same time, the BoM reversed its

policy introduced in 2004 that required banks to build up buffers against NPLs. The provision ratio for

NPLs has now been reduced, so that banks are now allowed to use these during the economic downturn.

8 According to the bank loan classification regulation, loans with principal in arrears mechanically become NPLs

after 90 days.

Figure 9. NPLs surged in March while loans

with principal in arrears did not decrease by

the same amount

Figure 10. Growth in loans by banks has fallen

MNT billion % year-on-year change

The numbers in boxes are NPLs as a percentage of total

loans outstanding.



3.3

7.27.4

9.9

10.6

0

50

100

150

200

250

300

Oct-08 Dec-08 Feb-09 Apr-09

Loans with principal in arrears

Non-performing loans

-20

0

20

40

60

80

100

Apr-07 Oct-07 Apr-08 Oct-08 Apr-09

Total

Private

Individuals

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Inflation

CPI inflation (or headline inflation) peaked at 34.1

percent year on year in August 2008, and has been

falling continuously, reaching 12.6 percent year

on year in April 2009 (see Figure 11).

This process of disinflation (reduction of inflation)

started as both food and fuel prices started to fall

in the second half of 2008 (see Figure 6). Core

inflation9 also started to fall, as the domestic

economy has slowed down strongly. However, as

a large part of the food consumption basket is

imported, the previously large exchange rate

depreciation may eventually be transmitted into

the economy.

7. Growth and unemployment

Real GDP contracted by 4.2 percent year on year in the first quarter of 2009 compared to the same period

in 2008 (see Figure 12). The drivers of this contraction were industry and construction, and net taxes on

products. Services and agriculture displayed positive growth, which partly offsets this contraction.

The contraction of total industrial production seems to have bottomed out at 12 percent year on year

(three-month moving average) in February 2009, and recovered slightly in April (see Figure 13). The

main reason is that mining output, which has a large weight in industrial production, has stabilized, while

output of utilities has continued to grow. Manufacturing output, however, is still contracting sharply.

9 Core inflation excludes volatile food and fuel prices, and is a proxy for domestically generated inflation.

Figure 11. Inflation continued to fall Percentage point contribution to CPI inflation % yoy chg


0

5

10

15

20

25

30

35

40

-5

0

5

10

15

20

25


Core inflationMeat, milk and cheeseEnergy and fuelsCPI inflation (right axis)

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Until November 2008 registered unemployment had been decreasing almost continuously to 2.90 percent

of the labor force. However, in January it began to steadily increase for the first time (see Figure 13). This

data captures mainly jobs in the public sector and in large private companies, so the data may not reveal

what is happening in the “informal” sector (see Box 2) and in the rural areas of the country.

Box 2. Effective real wages for informal sector workers have decreased about 60 percent

We conducted a small survey in April to get a snapshot of the daily workers’ income at major unskilled labor

markets in Ulaanbaatar. The results (see Table 5) suggest that the workers’ effective real wages about 60 percent

have fallen for two reasons: (i) the number of hours worked has decreased; and (ii) the real wage has been eroded

due to high inflation. Prior to the onset of the economic crisis, the number of informal sector workers had been

increasing in line with economic growth, especially in the transportation and construction sectors. However, recent

interviews with several of these workers suggest that their daily incomes have been decreased by 50 to 70 percent

due to a decrease in the availability of jobs. This suggests that the reduction in import activity, marked by fewer

cargo and railway shipments coming into the country and an increase in the number of construction sites with no

activity, has led to a decrease in the number of hours worked. With respect to the second reason, the survey

indicated that the rate of hourly wages has remained the same in nominal terms between April 2008 and 2009;

however, the value of their hourly wages in real terms has been eroded as inflation was 12.6 percent over the same

Figure 12. GDP contracted in the first quarter

of 2009 relative to 2008

Figure 13. Industrial production stabilized,

but unemployment(1)

increasing Percentage points contribution to real year-on-year GDP

growth

% year-on-year real change(2)

% of labor

force(3)

Source: National Statistical Office, World Bank (1) Defined as working-age population currently not

working in a paid job and not self-employed, actively

looking for job and registered at the Employment Office. (2)

Real change, 3-month moving average. (3) Seasonally

adjusted, by dividing 12-month moving average number of

unemployed by linearly interpolated labor force.


-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

Q1-07 Q3-07 Q1-08 Q3-08 Q1-09

Net taxes of productsServicesIndustry and constructionAgricultureGDP

2.90

2.92

2.94

2.96

2.98

3.00

3.02

3.04-30

-20

-10

0

10

20

30


Total

Mining and quarrying

Manufacturing

Utilities

Unemployment rate (inverted scale, right)

- 13 -

period (see Figure 12). This survey suggests that, due to reduced job availability and inflation, the effective real

wage in the informal sector has been reduced by about 60 percent.1

The survey also includes basic demographic statistics which indicate that these workers are predominantly males

with secondary level education and that they support their families with their income. However, the effects of

reduced job availability and eroded value of their hourly wages left the workers barely able to cover their daily food

expenses. Moreover, the number of these workers is likely to increase due to rising unemployment rates in the

formal sectors. In addition, there has been an increase in the number of people moving into the city from rural

regions who are looking to find new ways to earn a living after having given up on their livestock due to

foreclosures of their herder loans.

Table 5. Informal labor market survey

Name/location of the market

Total

number of

workers

(estimated)

Average daily

income

(MNT)

Maximum

wage

(MNT/per

hour)

Reduction

in job

availability

since last

year (%)

Reduction

in effective

real wage*

(%)

"44" /Unloading at the railways/

at Triangle bridge district 500 3,000-7,000 585 70 73

Loading/Unloading at private

cargo areas 260 8000 1000 60 64

Botanic market at Amgalan

district /Cement mill factory/ 200 8,000-30,000 2310 50 56

Bars market 75 5,000-10,000 1250 50 56

*The reduction in the effective real wage reflects the estimate of the reduction in availability of jobs and the increase in the

consumer price index between April 2008 and 2009 of 12.6 percent

1 This is confirmed in a different study amongst women whose families have migrated to Ulaanbaatar 2 to 8 years ago, although

there was more concern in this group about the erosion of real wages (stable or even falling nominal wages for longer hours in

the face of continued price rises) than on availability of employment per se.

Source: World Bank staff

8. Conclusion

In the last few months, the economic downturn seems to have reached its lowest level, while the negative

impact on unemployment and wages has now become clear. The sharp deterioration of the fiscal deficit

slowed down, the trade deficit narrowed, the exchange rate stabilized and inflation fell further, bringing

real interest rates back into positive territory. Real GDP fell in the first quarter, but the latest data suggests

that the drop in industrial production has stabilized. Unemployment is rising, and real wages of informal,

unskilled labor have fallen sharply from a year ago. In the financial sector, while deposits have started to

flow back into tugrug accounts, non-performing loans continue to increase and are reason for continued

concern. In short, the deterioration seems to have slowed down and stabilized in some areas, but

substantial risks, notably in the banking sector, remain.

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Box 3. State equity participation in mining

The 2007 Minerals Law allows Mongolia to take equity stakes in strategic mining deposits.1 The objective is to

allow the government to exercise some control to protect the national interest, and generate revenues in the form of

dividends. But what are the implications for revenues if the state needs to borrow the capital for its equity share and

foregoes its share of the dividends? How does that compare to a situation in which the government does not take an

equity share, and obtains its revenues from taxing the dividends? And are there other ways in which a government

can retain control over its mining industry without taking an equity stake?

A government can typically expect the following main types of revenue from a mining project: corporate income

tax, royalties, and dividend withholding tax. If the government takes up equity, it may also receive dividends at

some later time in the mine life. But there are also downsides. First, there is an opportunity cost for providing

capital. For instance, instead of investing in health and education, the state now invests in mining projects.

Alternatively, it borrows the money at the prevailing commercial interest rate. Second, taking up equity exposes the

government to commercial and technical risks. Not all mines are successful and some never make a profit sufficient

to cover the initial investment plus a reasonable rate of return sufficient to pay off the loans with interest.

Table 6 shows the net fiscal revenues under different scenarios for a hypothetical copper mining investment

agreement between the government and a private-sector partner. The first scenario assumes that the government

takes a 34 percent equity stake in a mining project and receives its fair share of the dividends. It finances its share by

borrowing at a commercial interest rate from the investment partner, and makes dividend payments exempt from

taxes (scenario 1). Alternatively, it can decide to take no equity stake at all, but charge a 15 percent tax on the

dividends (scenario 2). Effectively, this scenario yields revenues equivalent to having a 15 percent stake, but without

having to finance it up front and pay any interest. We evaluate both scenarios under two copper price assumptions:

high ($6000/tonne) and low ($3000/tonne).

Under scenario 1, a drop in the copper price from $6000/tonne to $3000/tonne will reduce annual net fiscal revenue

by 54 percent. The reason is that the return on assets, and hence payable dividends, will drop significantly.2 Under

scenario 2 the government does not receive any direct dividend payments, but neither does it have to make any

interest payments on borrowed capital. At a high copper price, the annual net fiscal revenue under scenario 2 will be

Table 6. Typical fiscal revenue under different scenarios

Annual net fiscal revenue, index =100 for scenario 1 under copper price of $6000/tonne

Scenario 1 Scenario 2

Government equity stake 34% No equity stake

Dividend tax 0% 15%

High copper price: $6000/tonne 100 96

Low copper price: $3000/tonne 46 51

Baseline assumptions: initial capital amount of $1.5 billion, if the government takes an equity stake, it will have to borrow

from the investment partner at 10 percent, paid for by dividends; the exchange rate is MNT 1500 per US dollar; initial

output is 600,000 tonnes; operating costs dependent on output value and copper price.

Source: World Bank staff

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4 percent lower than under scenario 1. However, under a “low” copper price, the annual net fiscal revenue under

scenario 2 will be 11 percent higher than under scenario 1.

Recall that the argument for the state to acquire an ownership stake is based on the state wanting to exercise some

form of direct control over the investment. An alternative way for a government to retain control over its mining

industry, but without taking an equity stake, is to adopt a foreign investment and takeover law. For example, the

Australian Foreign Acquisitions and Takeovers Act of 1975 requires foreign investors to obtain approval from the

Foreign Investment Review Board for various categories of investment or takeovers in Australia. Under this law, the

government of Australia is currently reviewing the proposed investment of Chinalco in Rio Tinto, to determine

whether this has any implications for the economic or national security of Australia.

Another example is the United States, which has similar legislation, known as the Defense Production Act of 1950,

which mandates the Committee on Foreign Investment in the US (CFIUS) to review any foreign investment that

potentially poses a threat to US national security. CFIUS is a Treasury-led committee and comprises representatives

of eleven US government agencies. The committee has the power to recommend to the president to block any

takeover by a foreign investor. In 2005, the US rejected a bid by China’s CNOOC to take over Unocal, an American

oil company.

An added advantage of such laws is that they would apply to all strategic economic activities within Mongolia and

not only to those operations where the state happens to hold an equity interest.

Sources: IMF (2008), Mongolia: Selected Issues and Statistical Appendix, July 2008, IMF (2007), World Bank staff

1 The government may take a 50 percent stake for strategic deposits explored with state resources, and a 34 percent stake for

other strategic deposits. 2 In such arrangements, it is common that interest payment due will not exceed the dividend. However, under some arrangements

the outstanding balance borrowed from the partner is allowed to rise with some inflation benchmark, which provides an incentive

to repay quickly.

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Table 7. Mongolia: Key Indicators

2003 2004 2005 2006 2007 2008e 2009f

Output, Employment and Prices

Real GDP (% yoy change) 7.0 10.6 7.3 8.6 10.2 8.9 2.7

Industrial production index .. .. .. 100.0 110.4 113.4 ..

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

Unemployment (%) 3.4 3.6 3.3 3.2 2.8 2.8 ..

Consumer price index (% yoy change) 4.6 10.9 9.6 5.9 14.1 23.2 9.0

Public Sector

Government balance (% of GDP) -3.7 -1.8 2.6 8.1 2.8 -5.0 -6.0

Non-mining balance (% of GDP)(1)

-5.9 -5.8 -1.3 -7.3 -13.4 -15.3 -10.4

Domestic public sector debt (% of GDP) 3.1 1.4 0.1 1.0 0.5 0.0 0.0

Foreign Trade, BOP and External Debt

Trade balance ($ mn) -199.6 -99.2 -99.5 136.2 -52.4 -596.5 -331.0

Exports of goods ($ mn) 627.3 872.1 1066.1 1543.9 1950.7 2532.5 1863.0

(% yoy change) 19.7 39.0 22.2 44.8 26.4 29.8 -26.4

Copper exports (% yoy change) .. .. 14.7 94.8 27.7 3.0 ..

Imports of goods ($ mn) 826.9 971.3 1165.6 1407.7 2003.1 3128.9 2194.0

(% yoy change) 21.6 17.5 20.0 20.8 42.3 56.2 -29.9

Current account balance ($ mn)(2)

-102.4 24.1 29.7 221.6 264.8 -502.7 -261.8

(% of GDP) -7.1 1.3 1.3 7.0 6.7 -9.6 -6.5

Foreign direct investment ($ mn) 131.5 128.9 257.6 289.6 360.0 682.5 316.5

External debt ($ mn) 1240.3 1311.8 1360.0 1413.9 1528.7 1600.5 1795.8

(% of GDP) 87.3 73.7 59.7 44.3 38.9 33.1 46.8

Short-term debt ($ mn)(3)

0.0 0.0 0.0 0.0 0.0 0.0 ..

Debt service ratio (% of exports of g&s)(3)

13.4 9.4 7.6 5.4 4.3 3.5 4.3

Foreign exchange reserves, gross ($ mn) 203.5 207.8 333.1 718.0 1,000.6 656.7 822.1

(month of imports of g&s) 2.3 1.8 2.5 4.6 5.0 2.1 3.7

Financial Markets

Domestic credit (% yoy change) 157.3 25.8 18.8 -3.1 78.4 60.6 ..

Short-term interest rate (% per annum)(4)

.. 15.8 3.7 5.1 8.4 9.8 ..

Exchange rate (MNT/USD, eop) 1168.0 1209.0 1221.0 1165.0 1170.0 1267.5 1640.0

Real effective exchange rate (2000=100)(5)

96.9 95.4 101.8 107.1 109.0 130.2 ..

(% yoy change) -4.8 -1.5 6.7 5.2 1.8 19.5 ..

Stock market index (2000=100)(6)

151.5 120.8 203.6 382.0 2048.0 1181.6 ..

Memo:

Nominal GDP (MNT bn) 1,660 2,152 2,780 3,715 4,600 6,130 6,294

Nominal GDP ($ mn) 1,448 1,,814 2,307 3,156 3,930 5,258 4,035

(1) Non-mining balance excludes revenues from corporate income tax and dividends from mining companies, the Windfall

Profits Tax and royalties. (2) The 2009 projections for the external sector are based on the previous 2008 current account

estimate, rather than the recently published final 2008 figure (which was mentioned in the text). (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,

eop, index=100 in Dec-2000.

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

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