World Bank economic report says Mongolia still susceptible to commodity price volatility

A report released by the World Bank in February 2012 indicates that Mongolian GDP growth accelerated to 17.3% in 2011. The unemployment rate fell by 9% in 2011, and by 11% in 2010.


However, real wages for unskilled workers in the urban informal sector are starting to fall as the inflation rate reached 11.1% in December 2011. The report implies that increased Government spending is the root of the overheating: Government spending rose by 56% in 2011 and is budgeted to rise by a further 32% this year.

It is reported that the Mongolian Government funds are largely dependent on mineral resource revenues.

This could be a risk for financial crisis in Mongolia as continuing European sovereign debt problems may result in the slowdown of global economic growth, which will decrease mineral prices and also Mongolian Government revenues.

Government spending in 2011 is almost double of what it was in 2009, mainly due to pre-election pressures.

Although 2011 had a high budget, the deficit was still a modest 3.6%. However, the structural deficit (based on long run commodity prices as defined under the Fiscal Stability Law) is higher at 5.8%.

The World Bank report also indicates that the Bank of Mongolia (BOM) took significant action to decrease inflation and lending growth in 2011. But with inflation still high, the real policy interest rate negative and bank lending expanding at a staggering pace (73% yoy), more tightening is needed. The report says that due to easy convertibility between dollar and local currency accounts, the banking system remains vulnerable to capital flight, unless macro-prudential action is not taken to strengthen it.

The Mongolian tugrug depreciated by 11% in 2011, which reflects high domestic inflation and declining commodity prices towards the end of 2011; factors that similarly impacted the currencies of other emerging mineral-rich economies. The report claims that exchange rate flexibility remains crucial as it will reduce the risk of one-way speculative bets on the currency and allow the economy to better absorb external issues such as commodity price shocks without transmitting these directly to budgetary and export revenues as in 2008. It will help the economy adjust through movements in the nominal exchange rate rather than through sharp cuts in domestic wages, employment, and prices that hurt the real incomes and profits of workers and businesses. The exchange rate flexibility is also desirable in that it will reduce incentives for the private sector or banks for taking on u risks.

The trade deficit reached record levels, USD 1.7 billion in December 2011, as imports of mining related equipment and fuel imports surged. But exports have also greatly increased reaching USD 4.8 billion in December 2011, up from USD 2.9 billion in December 2010. Coal export to China is the main contributor to export revenues.

Major legislative developments occurred in 2011 and 2012. The Integrated Budget Law (IBL) was passed in December 2011, which contains measures to support fiscal sustainability and the successful implementation of the Fiscal Stability Law. It also strengthens the public investment framework by requiring feasibility studies and alignment with national priorities for projects to be included in the Public Investment Program and the budget.

In order to ensure macroeconomic stability, the World Bank suggests that Mongolia adhere strictly to prudent fiscal policies set out in the FSL and IBL and tightening both fiscal and monetary policy to reduce inflation, take macro-prudential action to reduce systematic risks in the banking sector, and maintain a flexible exchange rate that will act as the first buffer if any external shock materializes.

The World Bank closes its report saying that these are uncertain times for Mongolia, as the global economic environment is greatly affecting it. The up-coming elections increase domestic uncertainty. Unless a substantial amount of savings has accumulated in the stabilization fund, Mongolia remains strongly exposed to volatility in commodity prices.

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