Financial and economic crisis in Mongolia: Causes, lessons learnt and

recommendations Workshop organized by the Ministry of Finance for Parliament

on fiscal reformOctober 30, 2009

Ix Tenger complex

Rogier van den BrinkLead Economist for MongoliaPoverty Reduction and Economic Management East Asia RegionWorld Bank

Mineral prices collapsed in mid-2008

Index=100 in January 2004

The copper price shock was not observed by a flexible exchange rate

Budget surplus became a budget deficit

% of GDP

Major trading partners’ industrial production dropped dramatically between June 2008 and

first quarter of 2009 % year-on-year change, 3-month moving average

Large trade deficit developed

$ mn (12-month rolling sum)

Source: National Statistical Office, World Bank

The copper price collapse hit an overheated banking sector

High inflation led to negative real interest rates on MNT deposits leading to large MNT deposit

outflows

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

Note: Interest rate deflated by CPI inflation. Source: Bank of Mongolia, National Statistical Office, World Bank

Note: Numbers are the end-August stocks of MNT and FX deposits in MNT billion.Source: Bank of Mongolia, World Bank

While attempting to defend USD peg, BoM lost about $500 million in international reserves,

before external sector stabilized

$ billion, stock $ million, month-on-month change

Note: Number is box is end-August stock of BoM international reserves in $ million.Source: Bank of Mongolia, World Bank

How did other copper exporters experience global downturn?

Export concentration index (right axis, bar), copper share in exports in 2007 (left axis, line)

Mongolia harder than the world’s other major copper exporters, e.g. Chile, Peru, Papua New Guinea and Zambia

GDP growth decline 2008-09*, non-mining fiscal balance in 2008% change (GDP decline), % of GDP (balance)

Fiscal balance (% of GDP)

Chile Peru PNG MNG Zambia

-16

-12

-8

-4

0

GDP growth decline

Non-mining fiscal balance

2006 2007 2008 2009*-6

-2

2

6

10 ChilePeruPNGMNGZambia

2006 2007 2008-15

-10

-5

0

5

Chile PeruPNG MNGZambia

Current account% of GDP

2003 2004 2005 2006 2007 20080

5

10

15

20

25

Chile PeruPNG MNGZambia

CPI inflation (% year-on-year change)

But beginning of 2009 strong policy actionsGovernment policy action Expected impactPublic investment cut Curtails poorly planned and low-priority new investments, and projects

unlikely to be implemented this fiscal year due to lack of absorption capacity

Expenditure cut on wages and salaries of public servants; hiring freeze

Saves on excessive bonuses, and stop rapidly growing civil service

Interest payments on foreign loans cut

Constrains recourse to non-concessional foreign borrowing

BoM raised the policy rate to 14% from 9.75%

Avoids overshooting of exchange rate; preserve FX reserves; restores confidence in tugrug

FX auction introduced Moves to more flexible exchange rate; improve transparency of FX allocation

International reputable auditor for Anod Bank

Sets standard for dealing with future bank failures

BoM increased capital adequacy requirements

Strengthens capital base of those banks who are able to meet the higher requirements; encourages banks to address portfolio quality issues and reduce weight of riskier assets in portfolio

BoM revised and clarified deposit guarantee law

Avoids abuse and unnecessary fiscal costs; strengthens public confidence in deposit guarantee

External financing requirements

$ million 2009f 2010f

Gross financing requirement: 1,291 1,195 Current account deficit 502 499 Amortization of medium- and long-term debt 93 54 Gross reserve accumulation 165 253 Other items 531 389Available financing: 1,007 1,042 Grants 240 230 Disbursements to public sector 96 144 Disbursements to private sector 355 337 Foreign direct investment 317 330Financing need: 284 153 IMF SBA 139 93 Donor support requested 145 60

The exchange rate stabilized

Last observation: October 1, 2009.Source: Mongolian Financial Association, World Bank

Inflation fell

Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09-5

0

5

10

15

20

25

30

35Energy and fuels

Meat, milk and cheese

Core inflation

CPI inflation

Percentage point contribution to CPI inflation yoy, %

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

But fiscal balance remains under pressure

Aug-08 Nov-08 Feb-09 May-09 Aug-0930

32

34

36

38

40

42

44

46

48

50

-11

-9

-7

-5

-3

-1

1

3Revenue & grantsTotal expenditure and net lendingTotal expenditureFiscal balance (right axis)Adjusted fiscal balance** (right axis)

% of GDP*, 12-month rolling sum

* GDP interpolated using actual 2008 GDP (MNT 6,130 billion) and projected 2009 GDP (MNT 6,209 billion). ** Adjusted fiscal balance excludes net lending from expenditure, leaving current and capital expenditure only. Source: Ministry of Finance, World Bank

NPLs and loans in arrears risen strongly

Total loan growth come to standstill, as bank prefer safe CB bills

Source: Bank of Mongolia, World Bank

% year-on-year change % year-on-year change

Industrial production continues to contract, particularly in the manufacturing sector, with Mongolia facing a sharp GDP growth

slow down for 2009 as a whole

% year-on-year real change, 3-month moving average

Tota

l sal

es re

venu

e

Expe

nse

befo

re ta

x

Inco

me

befo

re ta

x

Taxe

s pai

d

-70

-60

-50

-40

-30

-20

-10

0% change Q2 2008 to Q2 2009

Source: National Statistical Office, World Bank Source: Top 180 companies financial statements, National Tax Administration, World Bank

With the poor hurt the most…informal wages fell sharply between 2008 and 2009..

Daily wages of unskilled workers in selected informal labor markets in UB

Informal labor market

Total number of workers in the

market (estimated)

Daily wages (MNT thous.) Average real wage

per hour (MNT thous.)

Change in average real wages per hour

(vs. Apr-08) (vs Apr-09)

  Apr-09 Sep-09 Apr-09 Sep-09 Apr-09 Sep-09 Apr-09 Sep-09Railway cargo unloading in UB "44" area: Triangle bridge district 500 700 3.0-7.0 4.0-5.0 0.4 0.43 -73 2Container loading and unloading for freight companies 200 300 8.0 8.0-9.0 0.9 1.1 -64 21Cement loading at “Botanic” market at Amgalan district 100 20 8.0-30.0 2.7-2.9 1.3 0.4 -56 -73Supermarket shipments loading and unloading at “Bars” market 25 100 5.0-10.0 6.0-10.0 0.8 0.9 -56 8Merchandise carter Narantuul “Black market” in UB 400 400 5.0-6.0 7.0-8.0 0.4 0.6 -47 43Construction materials delivery “100 family” district 30 50 5.0-10.0 10.0-15.0 0.7 1.3 -56 70 Total (estimated) 1255 1570     Average  -59 12

Lessons learnt and recommendations

• Implement fiscal responsibility framework to avoid repeat of boom-and-bust spending pattern

• Improve planning and budgeting for public investments, including infrastructure maintenance—critical during the downturn

• Take decisive action on implementing resolution for individual banks and banking sector reforms

• Protect poor during downturn: start to target currently untargeted social grants (CMP) (ADB and World Bank technical support to government)

• Use recent experience gained during negotiations of OT investment agreement to improve overall policy environment in mining sector