Mongolia

Recent Economic Development and Challenges

July 2014

The World Bank in Mongolia

Recent Economic Developments

Economic growth is slowing due to weakening non-mineral economic activities.

Growth further softened to 7.4 percent

in the first quarter of 2014.

Quarterly Mineral and Non-mineral Real GDP

Growth (yoy, %)

-10

-5

0

5

10

15

20

25

30

35

40

I II III IV I II III IV I II III IV I II III IV I

2010 2011 2012 2013 2014

Non-mineral GDP Growth (%)

Mineral Growth GDP (%)

Total GDP growth (%)

Mineral sector remains robust but

domestic industry is weakening.

Real GDP growth contribution by sectors (%p)

-10

-5

0

5

10

15

20

25

Q1

-09

Q2

-09

Q3

-09

Q4

-09

Q1

-10

Q2

-10

Q3

-10

Q4

-10

Q1

-11

Q2

-11

Q3

-11

Q4

-11

Q1

-12

Q2

-12

Q3

-12

Q4

-12

Q1

-13

Q2

-13

Q3

-13

Q4

-13

Q1

-14

Agriculture Mining

Other services Manufacturing

Construction Wholesale & retail trade

Electricity, comm. & residual Transportation

GDP

Inflation remains at double-digit level.

Inflation has accelerated to over 13

percent in May.

Headline inflation and core inflation (%)

Recent double digit inflation is driven

by growing demand-side pressure.

Headline inflation and Monetary Indicators

0

2

4

6

8

10

12

14

16

0

5

10

15

20

25

30

35

40

45

Jan-1

3

Feb-1

3

Mar

-13

Apr-

13

May

-13

Jun-1

3

Jul-13

Aug-

13

Sep-1

3

Oct

-13

Nov-

13

Dec-

13

Jan-1

4

Feb-1

4

Mar

-14

Apr-

14

May

-14

Core Inflation (3mma, yoy):RHS

M2 Growth (3mma, yoy): LHS

Currency Depreciation (yoy, % depreciation): LHS

High inflation weighs on purchasing power of households and domestic demand.

Inflation rate is exceeding the growth of

nominal household income.

Household income growth and CPI inflation (%)

Growth contribution of consumption

and investment dropped.

Quarterly real GDP Growth by Expenditures (%p)

-60

-40

-20

0

20

40

60

Q1-0

9

Q2-0

9

Q3-0

9

Q4-0

9

Q1-1

0

Q2-1

0

Q3-1

0

Q4-1

0

Q1-1

1

Q2-1

1

Q3-1

1

Q4-1

1

Q1-1

2

Q2-1

2

Q3-1

2

Q4-1

2

Q1-1

3

Q2-1

3

Q3-1

3

Q4-1

3

Final consumption

Gross capital formation

Net exports

GDP

Three year’s high economic growth came with excessive current account deficit that cannot be sustained without strong FDI.

Current account deficit jumped to over

30% of GDP during the double digit

growth period between 2011-2013.

Mounting current account deficit was

driven by large increase in imports

from 2011.

-40%

-30%

-20%

-10%

0%

10%

20%

2008 2009 2010 2011 2012 2013

Current Transfers

Income Balance

Services Balance

Trade Balance

Real GDP Growth (%)

FDI was a main driver of growth and financed the CA deficit for the last three years but continues to drop in 2013 and 2014.

FDI dropped to an half in 2013…

Annual FDI inflow (in percent to GDP, %)

… and continues to decline in 2014.

Monthly FDI trend (in millions of US$, 3 month

moving average)

-5%

0%

5%

10%

15%

20%

0%

10%

20%

30%

40%

50%

60%

2008 2009 2010 2011 2012 2013

Net FDI Inflow in

percent to GDP (%):

Left Axis

GDP Growth (%):

Right Axis

Large balance of payments imbalance put pressure on currency value and international reserve.

External financing gap became

significant due to large CA deficit and

dropping foreign capital inflow.

As a result, currency value weakened

and international reserves dropped.

Annual Balance of Payments (in millions of US$)

And the current account deficit is narrowing.

Current account is narrowing…

Monthly CA and Trade Balance (in billions of US$)

… and the adjustment is occurring

through import compression and

robust copper and oil exports.

Y/Y Growth of Exports and Imports (%, 3 months

moving average)

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

1,800

-500

-400

-300

-200

-100

0

100

2011-0

3

2011-0

5

2011-0

7

2011-0

9

2011-1

1

2012-0

1

2012-0

3

2012-0

5

2012-0

7

2012-0

9

2012-1

1

2013-0

1

2013-0

3

2013-0

5

2013-0

7

2013-0

9

2013-1

1

2014-0

1

2014-0

3

CA Balance (billions of US$)

Trade Balance (BoP data, billions of US$)

Nominal Exchange Rate (MNT/USD): Right Axis-50

0

50

100

150

200

Jan-1

0

Apr-

10

Jul-10

Oct

-10

Jan-1

1

Apr-

11

Jul-11

Oct

-11

Jan-1

2

Apr-

12

Jul-12

Oct

-12

Jan-1

3

Apr-

13

Jul-13

Oct

-13

Jan-1

4

Apr-

14

Exports

Imports

Economic Prospects and

Challenges

In 2014, the economic growth will likely soften as a result of the large economic imbalances.

The real GDP growth will likely moderate to a single digit level but still remain high relative to most of other countries in the region.

- Strong mineral GDP growth will continue due to revamped copper production of OT mine.

- Non-mineral output will likely remain under pressure from high inflation and heavy balance of payments pressure.

Slowing economic growth reflects an adjustment of the economy expected in response to high inflation and the large external financing gap.

The economy faces downside risks from the heavy BoP pressure and weakening financial soundness.

Despite the narrowing CA deficit, the

BoP deficit still remains high due to

falling FDI.

Amidst policy-induced rapid credit

growth, non-performing loans and past-

due loans are increasing fast.

Key Monthly BoP Trend (3 month

moving average, billions of US$)

-

5

10

15

20

25

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

Jan-1

0

Mar

-10

May

-10

Jul-10

Sep-1

0

Nov-

10

Jan-1

1

Mar

-11

May

-11

Jul-11

Sep-1

1

Nov-

11

Jan-1

2

Mar

-12

May

-12

Jul-12

Sep-1

2

Nov-

12

Jan-1

3

Mar

-13

May

-13

Jul-13

Sep-1

3

Nov-

13

Jan-1

4

Mar

-14

May

-14

NPL (% growth, yoy): LHS

NPL + Past due Loans (% growth, yoy): LHS

(NPL + Past due loans)/Total Loans (%): RHS

Non-performing loans and Past-due

loans (yoy growth, %)

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4(0.4)

(0.2)

0.0

0.2

0.4

0.6

0.8

2011-0

1

2011-0

3

2011-0

5

2011-0

7

2011-0

9

2011-1

1

2012-0

1

2012-0

3

2012-0

5

2012-0

7

2012-0

9

2012-1

1

2013-0

1

2013-0

3

2013-0

5

2013-0

7

2013-0

9

2013-1

1

2014-0

1

2014-0

3

2014-0

5

Th

ou

san

ds

Overall BoP Balance

Financial and Capital Account

Current Account: Right Axis

Rapid growth in housing market may lead to overheating situation.

MNT 2 trillion of cheap credit has been

provided to construction and housing

market in 2013.

Housing price has been picking up fast

over the past three years.

Commercial Bank Loans to

Construction and Housing Market

Housing Price Index (2007=100)

10%

15%

20%

25%

30%

35%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Q4 Q4 Q4 Q4 Q4 Q4 Q1

2008 2009 2010 2011 2012 2013 2014

Real Estate Loans (Left Axis, billion MNT)

Construction Loans (Left Axis, billion MNT)

Propoerty Market Loans/Total Commercial

Bank Loans (Right Axis, %)

100

120

140

160

180

200

220

240

260

2008.IV

2009.I

2009.II

2009.III

2009.IV

2010.I

2010.II

2010.III

2010.IV

2011.I

2011.II

2011.lI

I

2011.lV

2012.l

2012.Il

2012.IIl

2012.IV

2013.l

2013.Il

2013.IlI

2013.IV

2014.l

Rising household debt also needs close monitoring.

Household loans increased over 50

percent led by rapid growth of housing

mortgage loans.

Average household debt to annual

household income rose close to 60

percent in 2013.

Commercial Bank Loans to

Households and Mortgages Household Debt Ratios to Annual

Income and GDP

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0%

20%

40%

60%

80%

100%

120%

140%

2010 2011 2012 2013

Total Individual Loan Growth (%): Left AxisMortgage Loan Growth (%): Left AxisMortage Loan/Total Individual Loan (%): Right Axis

0%

10%

20%

30%

40%

50%

60%

2009 2010 2011 2012 2013

HH debt to GDP Ratio

(%)

HH debt to Annual HH

Income (%)

So, what is needed?

Pro-cyclical economic policies increased economic vulnerability.

Key macro-economic policy indicators

show economic policies have been pro-

cyclical over the past three years.

Between 2011-2012, the economy displayed strong

economic growth led by surging FDI…

and economic policies further fueled the FDI-

induced high economic growth by (i) expanding

budget deficits and (ii) allowing strong credit boom

created by surging FDI inflow.

In 2013, economic policies faced a challenge

between slowing growth momentum from

weakening FDI/minerals market and the large BoP

imbalance…

and chose to stimulate economic growth through

off-budget spending and quantitative easing.

Large CA deficit close to 30% of GDP remained and double-digit inflation re-emerged in 2013.

-12

-10

-8

-6

-4

-2

0

2

4

6

8

-120

-100

-80

-60

-40

-20

0

20

40

60

80

2008 2009 2010 2011 2012 2013

Off-budget deficit to GDP(%): Right Axis

On-budget deficit to GDP(%): Right Axis

Private Sector Loan Growth(%): Left Axis

Restoring economic and financial stability is urgent.

Does economic stability mean “maintaining double-digit growth at the expense of internal and external economic balances”?

- Current economic vulnerability came amidst overheating of the economy.

- Economic stability means stabilizing prices and reducing balance of payments pressure through prudent economic policies.

- Ensuring economic stability enables the economy to grow on a sustainable and stable path toward future prosperity in the long term.

Need for structural shift of economic policies from growth-stimulus to economic and financial stability.

- Tightening of monetary and fiscal policy

- Strengthened supervision of banking sector soundness.

Monetary policy needs to be tightened and focus on maintaining soundness of the banking system.

Recent monetary indicators show loose

monetary policy has been gradually

tightened.

Gradual tapering of expanded policy-

induced credit will help moderate inflation

over time.

Tightening monetary policy will also help

ease the pressure on the currency value.

Banking supervision needs to be

strengthened given the deteriorating bank

assets.

Loose enforcement of prudential

regulations on policy-induced credit needs

to be normalized.

Flexible exchange regime needs to be

maintained.

Exchange rate movement is one of key

adjustment mechanism of the economy to

large economic imbalances.

Central Bank Loans to Commercial Banks

18

Fiscal policy needs to restore prudent path according to the FSL.

Under the current trend, fiscal deficit will

reach 10% of GDP in 2014.

Continued large fiscal deficit through off-

budget spending will boost imports and

exacerbate economic imbalances.

Weakening fiscal strength amidst continued

large fiscal deficit will likely adversely affect

credit-worthiness of the country in the

international financial market.

Political consensus would likely be essential

to curb excessive spending and adhere to

the FSL.

It is time to think about managing mineral

revenues more effectively.

A good sovereign wealth fund system may

provide a tool to start saving for rainy days

and for the future generation.

On-budget and Off-budget Deficits (in percent to

GDP)

19

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

Additioanal Budget Deficit (DBM)

Official Budget Balance