MONGOLIA MONTHLY BRIEF – AUGUST 2009 (The full report can be downloaded at http://www.worldbank.org.mn) In addition to highlighting the latest developments, the The fiscal balance remains under pressure August Update also summarizes the main economic, % of GDP, 12-month rolling sum fiscal and financial developments in Mongolia for the Revenue & grants year since July 2008, when Mongolia was hit by a 44 Total expenditure and net lending 42 0 large, external shock due to the collapse of the copper Fiscal balance (right axis) price. 40 -2 38 -4 This shock hit Mongolia harder than other copper 36 producers, because of the country’s particular -6 34 combination of expansive fiscal and monetary 32 -8 policies, a fixed exchange rate and an overheated 30 -10 financial sector at the time of the copper price collapse. In the Update, we compare Mongolia’s Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 performance during the copper price collapse with that Notes and source: see Update of the other major copper exporters: Chile, Peru, Papua New Guinea and Zambia. The government’s initial slow and inappropriate response led to a period of macroeconomic instability around the end of the year. However, the government took strong policy actions at the beginning of 2009 to address the crisis. Based on the commitment shown by these actions, the country subsequently benefited from substantial financial assistance from its key development partners (IMF, ADB, Japan and the World Bank). The latest developments show that the fiscal balance remains under pressure, as revenues continue to drop, due to the slowdown in growth, consumption, imports and commodity prices, whereas public expenditures remain constant, leading to a 12-month rolling fiscal deficit of 9.8 percent of GDP in July. The 12-month rolling trade deficit has narrowed to $0.6 billion in July, after peaking at $1 billion in February. This narrowing is caused by the economic downturn, which has seen imports (mainly industrial goods) drop faster than exports (mainly copper and gold). The rolling 4-quarter current account deficit now stands at 15.2 percent of GDP at the end NPLs and loans with principal in arrears increased of the second quarter. It is mainly financed by inflows of MNT billion (numbers are NPLs as % of total loans) foreign direct investment and loan disbursements under the 600 Loans with principal in arrears 20.4 Stand-By Arrangement with the IMF. NPLs to non-residents 17.8 500 14.7 In the financial sector, deposits have recovered after large NPLs to residents 400 withdrawals earlier in the year. However, non-performing 10.7 300 loans plus loans with their principal in arrears have continued 200 to increase, reaching 20.4 percent of total loans outstanding 5.2 in July 2009 (compared to 5.2 percent in July 2008, when the 100 amount of loans outstanding was the same). Bank lending to 0 the private sector has come to a virtual standstill, as banks Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 prefer to invest in central bank bills instead, which offer a high safe return. Notes and source: see Update This has put further downward pressure on domestic activity. Real GDP grew 0.7 percent year on year in the second quarter of 2009, a rebound from a 4.2 percent year on year contraction in the first quarter of 2009. However, industrial production contracted 11.2 percent compared to July 2008. Official unemployment has continued to increase since the beginning of the year, and real wages for unskilled labor in the informal sector have been hit very hard. Going forward, it is important that the government focuses on implementing a fiscal responsibility framework to avoid a repeat of the boom-and-bust spending pattern that Mongolia has just experienced. It is also important to improve the planning and budgeting for public investments, and to prioritize the protection of infrastructure maintenance —critical during the downturn. Protecting the poor during this downturn is a challenge, but can be achieved by starting to target the currently untargeted social grants (in particular, the Child Money Program). The Asian Development Bank and the World Bank are providing technical support to assist the government in this endeavor. In the financial sector, it should ensure stability by intensifying supervision and taking decisive action in case of bank failures in order to retain confidence in the financial sector. In addition, a restructuring of the banking sector is envisaged, after the completion of a series of loan portfolio audits. In the mining sector, the government can now use the recent experience gained during the negotiations of the OT investment agreement to improve the overall policy environment.