Mongolia Quarterly Economic Update - October 2012
October 30, 2012
- The Mongolian economy is at the start of a huge expansion as it begins to develop its mineral wealth. The construction of the Oyu Tolgoi (OT) copper-gold mine – among the five largest in the world – lifted GDP growth above 17 percent in 2011 and the economy has since continued to grow in double-digits, albeit at a slower pace.
- Mongolia’s medium term prospects are promising as the OT and Tavan Tolgoi (TT) mines go into production, with economic growth projected to be in the double digits, with sustained increases in exports and fiscal receipts.
- The economy, however, faces significant risks in the near term, as reflected in the steep drop in exports in July and August. These risks reflect an uncertain global economic outlook and slowing growth in China, and pro-cyclical fiscal policy over the past three years with large increases in government spending contributing to high inflation and pressure on the balance of payments. Any delay in commercial production at the OT mine could also impact the near term growth outlook.
- The 2013 budget, being discussed in the on-going fall session of Parliament presents an opportunity to mitigate these risks by reining in spending and anchoring fiscal policy to the Fiscal Stability Law that goes into effect on January 1, 2013.
- Growth slowed in Q2 to 11 percent year-on-year (yoy) from 16.5 percent in Q1, but should remain in double digits for 2012 as a whole, barring any severe negative shock.
- Exports fell by 39 percent yoy in August, the largest fall since mid-2009, driven mainly by a drop in exports (mostly coal) to China.
- The current account deficit meanwhile has continued to widen, although it currently remains funded by Foreign Direct Investment (FDI) flows. However further deterioration is possible with exports falling faster than imports. FDI flows are also expected to start easing next year as the construction of the OT mine comes to a close.
- Due to intermittent intervention by the Bank of Mongolia (BoM) to limit the depreciation of the togrog, net foreign exchange reserves (excluding BoM borrowing from the Chinese central bank, deposits by the Development Bank of Mongolia and by domestic banks) have been declining steadily and are at a two-year low of US$ 1.4bn.
- Inflation has eased slightly in recent months, but remains persistently high, due to high food prices and expansionary fiscal policy which has led to demand side pressures in an already overheating economy. The headline rate was 15.9 percent in August, with the increase in the index driven mostly by the increase in food, notably meat, prices.
- On account of weak revenue growth due to the slowdown in exports and lower commodity prices, and sustained expenditure increases, the fiscal deficit for 2012 is projected to increase from the original target of 1 percent to 4.2 percent as per the September amended budget.
- The financial market also remains vulnerable. Although monetary tightening over the past year has helped to slow the pace of credit growth from 73 percent at the end of 2011 to 37 percent in August, it is still high.
- Given the macroeconomic risks and the expected continued slow growth of the global economy, Mongolia’s policy-makers need to be cautious. The immediate requirement is a more conservative fiscal policy stance – it does not call for an austerity plan but requires that government spending does not increase faster than the GDP and is prioritized in a way that unlocks infrastructure bottlenecks and promotes long-term growth through investments in social sectors.
- The ongoing parliamentary budget session provides an opportunity to rein in government spending and to abide by the rules of the Fiscal Stability Law (FSL) that goes fully into effect in January 2013.
- The BoM should maintain the floating exchange rate regime with interventions in the foreign exchange market limited to smoothing out excessive volatility in the exchange rate without attempting to reverse the underlying trend. The BoM will also need to remain vigilant with respect to banking sector risks.
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