Economic Trends and Performance

May 11, 2007 at 8:14 am Leave a comment

The Historical Context

Up to 1990 the Mongolian economy was based on the centrally planned model adopted more than six decades earlier. Nearly all production and distribution activities were concentrated in large-scale state-controlled monopolies. Reflecting Mongolia’s landlocked location and political orientation, more than 90% of both exports and imports took place with other centrally planned economies, principally the members of COMECON. The Soviet Union was the source of almost 100% of industrial inputs (with the exception of raw materials) and consumer goods and was the destination of the vast majority of exports. External technical and financial assistance reached the equivalent of 30% of GDP annually during the 1980s.

Sweeping economic changes were initiated in 1990, when a peaceful revolution ended communist rule. It embarked on an ambitious program of reforms to establish a market-oriented economy, reduce the role of the state, promote the private sector through changes in the legal and institutional framework, and expend and diversify external relations, which included membership of international financial organizations. Early actions included the elimination of restrictions on private ownership of livestock, adjustments in ‘farm gate’ and selected retail prices, customs and income tax reform, the creation of a two-tier banking system, and exchange rate depreciation.

The difficulties were compounded by cessation of external financial assistance, decline of export in prices for copper and cashmere and the decision of CMEA members to value trade and effect settlements in convertible currencies as of 1991. While Mongolia was not unique in suffering from the end of Soviet financing, the impact on the country was devastating in the light of its low per capita income, the short life expectancy of 63 years and widespread social exclusion. In response to these developments, Mongolia’s economy weakened from mid-1990 and continued to deteriorate in the first half of 1991, despite the structural reforms that were implemented. As a consequence, unemployment rose sharply. Budget revenues declined and expenditure rose; credit and monetary expansion accelerated; and inflation, which had previously been almost non-existent, picked up sharply. Between 1990 and 1993, industrial output declined by over 22% and incomes remained over 10% below their 1989 levels.

The period from 1993 to 1996 saw some recovery in the economy, particularly in the services, livestock and mining sectors. In 1996 and 1997, the privatization program coupled with reforms in the public sector as well as increase in world copper prices and a fall in the price of petroleum contributed to an improvement in economic growth, which reached 2.4% and 3.3% respectively. From 1996 to 1997 the inflation fell sharply from 45% to 20%. The exchange rate was stabilized through a package of measures including raising the interest rate on central bank bills. Strong export prices and high export volumes resulted in a small surplus in the external current account. Tax reforms were implemented to reduce excessive tax burdens and to eliminate distortions in the system, including the elimination of most import duties, simplification and reduction of corporate and personal income taxes, widening of the sales tax base, and a rationalization of excise tax.
During 1998–1999, falling world commodity prices for cashmere, gold, and copper on international market, resulted in a terms of trade shock of approximately 9% of GDP and in a collapse of income and fiscal revenues to the Mongolian government.

Bank loan portfolios deteriorated deepening the insolvency of the major commercial banks and non-performing loan portfolios reached 41% as real lending rates approached 40%. Attributable to the re-imposition of a 5% import duty and on the depreciation of the Mongolian national currency in the face of the large external shocks (falling copper prices and increase in fuel prices, 90% of which is imported from Russia) inflation declined to 9.5%. Exports to the US increased by 57.5% in 1999 to US$46.3% million, making the US the third leading market for Mongolian products, behind China and Russia. This is attributable to two factors, the lack of quotas for textiles for the US and a redirection of copper exports from Russia to China. The year 1999 saw an overall stabilization in economic conditions and provided a solid basis for the Mongolian government to move ahead with reforms.

Recent Economic Trends

Economic growth accelerated in 2004 and 2005 (up from 5.6% in 2003 to 10.6% in 2004 and 6.2% in 2005), thanks to sustained favorable weather conditions, livestock increase (+8.8% increase compared to 2004), higher commodity prices in the world market, especially those of gold and copper, expansion in transportation and telecommunications and greater capital inflows. Foreign direct investment (FDI) continued, particularly into the banking, mining, and textile sectors (estimated to be US$93 million in 2004 and US$110 million in 2005).

A recovery in the agricultural sector and continued robust growth in the mining and service sectors also helped. Meanwhile, the processing industry was stagnant and the manufacturing sector was very seriously affected by the expiration of the Multi Fiber Agreement at the beginning of 2005 that led to closures of textile and garment firms and relocation of their activities to China. As a result, the overall, textile industry value added decreased by 40 percent in 2005, and the sectoral contributions of the primary, secondary and tertiary sectors to economic growth were 1.6%, -0.5% and 4.9% respectively.

Given the favorable conditions in the mining and livestock sectors, total exports increased by 21% in 2005 while imports increased by 12.5%. Copper and gold prices increased by 28 and8.6% respectively on average in 2005. Hence the trade deficit fell from 9.4% in 2004 to 5% of GDP in 2005. With sustained capital inflows, including private investment and official capital inflows, net international reserves have almost doubled (from US$164 million at the end of 2004 to US$298 million as of end 2005, which is equivalent to about 13.5 weeks of imports). The tugriks/US dollar exchange rate depreciated at the margin in 2005 by 1 percent, although, over the past 12 months, the nominal and real effective exchange rates have remained stable.

Meanwhile, inflationary pressures which emerged in the economy in 2004 (estimated to be at 11 percent) were contained to an estimated single digit level of 9.5% in 2005. These inflationary pressures originated partly from still rising oil prices, tax increases in oil exporting countries and some key domestic policy measures (such as the adjustment in communication tariffs, rise in meat price and an accommodating monetary policy). A tightening of monetary policy in the second half of 2005 helped contain inflation. Broad money grew at a rate of 20.3 and 31.4 percent (estimate) in 2004 and 2005 respectively. Although following a declining trend since the beginning of the 2000s, lending interest rates remain high at 28.3% at the end of 2005, despite a prolonged growth of private credit in the economy of 41% in 2005. Non-performing loans growth has somewhat slowed down in 2005, accounting for 8.8 percent of total loans at end 2005.

Fiscal consolidation has continued in 2005. The overall government deficit has decreased from 6 percent in 2002 to 1.4 percent in 2004 and to an estimated 3.7% budget surplus in 2005. This improved fiscal performance is due to the boom in copper and gold prices that resulted in a jump in government revenues (tax and profit from the state-owned copper company), but also to improved budget execution. In addition, deployment of the Government Financial Management Information System (GFMIS) contributed towards better fiscal discipline and tighter budgetary controls. Total government revenue (including grants) reached 36.7 percent of GDP in 2005 while total expenditures were reduced from 41.7 in 2004 to 33 percent of GDP in 2005. The authorities have been successful in avoiding any large overruns in public expenditures so as to keep the fiscal budget in check.

However, this has been made possible by a reduction of the envisaged public investment program and much needed recurrent expenditures. Capital expenditures have decreased as a proportion of GDP from 6.7 percent in 2003 to 3.9 percent in 2005. In addition, capital maintenance expenditures have decreased even more rapidly, with a share in total capital expenditures going from 12 percent in 2000 to 5.3 percent in 2005 and a planned 2.7 percent in 2006.

Mongolia’s public external debt remains high but sustainable (at about US$1.38 billion in 2005, equivalent to 74 percent of GDP and about 45 percent of GDP in NPV terms). Public domestic debt remains very limited (4.5 percent of GDP at end-2005). All foreign loans are concessional, implying a low risk and cost for the Government as of 2005. A Debt Sustainability Analysis was jointly conducted by the IMF and the World Bank in June 2005. After the settlement of the pre-1991 Russian Debt, which was equivalent to 10 times GDP, the outstanding stock of external debt was equivalent to 91 percent of GDP as of end-2004 and 55 percent in net present value terms, placing Mongolia at a moderate risk of debt distress over the medium term.

Under the baseline scenario of sustained economic growth and fiscal deficit of 3 percent range financed solely by concessional loans, Mongolia’s external debt ratios would decline substantially in the long term. However, stress tests suggest the debt could become unsustainable if there were especially negative terms of trade shocks. Moreover, this does not allow for large scale nonconcessional loans. Mongolia and China reached a framework agreement at end 2005 on a package loan of $300 millions to be extended at concessional terms. On the reform front, Government’s recent decision to join Extractive Industries Transparency Initiative (EITI) is an important signal of its commitment towards greater transparency in one of Mongolia’s crucial sectors. This will help to initiate a public dialogue on questions related to the management of the mining sector in general and mining revenue management in particular, which contributes significantly to the budget. In addition, the government proposed important amendments of the Tax Law and Minerals Law which were submitted to Parliament. The parliament has promulgated a revised Public Procurement Law that envisages greater decentralization of procurement, improved oversight mechanisms, and greater disclosure. Mongolia joined the UN Convention on Anti-Corruption and both the anti-corruption and anti-money laundering draft laws have been sent to Parliament. Source: Mongolia Macroeconomic Brief, World Bank, 2005

Growing unemployment, with only a poor social safety net, remains the Government’s main concern and a primary cause of poverty. It is estimated that about half the population lives in the capital, many are unregistered and the official population total probably also underestimates the number. The migration of people seeking better access to social services and employment opportunities from remote to urban areas, particularly to Ulaanbaatar. Strong growth in the non-agriculture sectors has resulted in urban employment recovery. At the end of March 2005, the number of registered unemployed was 37.8 thousand that increased by 3.7 percent or 1.3 thousand persons compared to the same period of the previous year. The number of unemployed women was 20.8 thousand, which is 55.1 percent of total registered unemployed. In the first quarter of 2005, 5.4 thousand registered unemployed persons entered into work. Of whom 16.8 percent entered in government or state-owned enterprises and remaining 83.2 percent in joined companies, cooperatives or other types of employers, such as small-scale private businesses.

Foreign Trade. For the first quarter of 2005, total external trade turnover equaled 379.9 mln. US dollars, of which exports 168.4 mln. US dollars and imports 211.5 mln. US dollars. Total external trade balance turned a deficit of 43.1 mln.US dollars. As compared with the same period of the previous year, total external trade turnover increased by 20.1 percent, of which exports increased by 28.1 percent and imports by 14.4 percent respectively. As compared with the same period of the previous year, mineral products exports increased by 26.9 mln. US dollars and natural or cultured pearls, precious metal, jewellery by 6.1 mln. US dollars, which is reflected the increase of total exports. Whereas, raw and processed hides, skins, fur and articles thereof exports decreased by 0.9 mln. US dollars.

The volume of copper concentrate exports increased by 2.0 percent and their value in US dollars by 27.2 percent, compared with the same period of the previous year. For the first quarter of 2004 year, the average price of copper concentrate per ton was 412.0 US dollars. But in the first quarter of 2005, it was 514.0 US dollars and increased by 24.8 percent. Compared with the same period of the previous year, machinery, equipment electric appliances, recorders, TV sets & spare parts imports increased by 26.4 mln. US dollars, base metals and articles thereof imports by 6.1 mln. US dollars, auto, air and water transport vehicles and their spare parts imports by 8.5 mln. US dollars, which are comprised high percentage in the imports. These had an effect on an increase of total imports.

Mongolia had a foreign trade with 98 countries and as a result total turnover of foreign trade for 2005 increased by 358. 4 mln.USD or 19.0 percent and amounted 2249.2 mln. USD in comparison with the 2004 Import exceeded export by 119.5 mln. USD and this difference decreased by 32.0 mln. USD in comparison with the previous year.

Mongolia has exported goods and raw materials to 69 foreign countries including European countries (16.1%), Asian countries (56.7%) and countries of American continent (25.9%) And has imported goods originating from 91 countries including European countries (48.7%), Asian countries (44.5%), which are equal to 93.2 percent of total import.

Compared to other countries in transition, Mongolia achieved tangible results in trade liberalization. Mongolia’s accession to the World Trade Organization (WTO) in January 1997 highlights its relative success in pursuing economic reforms and developing a new trade regime in line with international trading principles. It’s allowed Mongolia to become a part of global trade regime, access full information on WTO member countries, benefit from human resource development in trade field, etc.

Exports (in thousand USD)

2000: 535.8
2001: 521.5
2002: 524.0
2003: 615.9
2004: 869,7
2005: 1064,9

Imports (in thousand USD)

2000: 614.5
2001: 637.7
2002: 690.8
2003: 801.0
2004: 1,021
2005: 1184,3

Turnover (in thousand USD)

2000: 1150,3
2001: 1159,2
2002: 1214,8
2003: 1416,9
2004: 1890,7
2005: 2249,2

In conclusion, despite growing inflationary pressure, Mongolia has achieved some macroeconomic stability. This in turn played important role in providing a favorable environment for domestic industry recovery and for sustaining underlying economic growth. Standard and Poor’s, an internationally reputable ratings company, upgraded Mongolia’s short-term credit rating from C to B and long-term credit rating from B to B+, respectfully. This demonstrates that the business environment has improved and that the market conditions have stabilized. Future economic growth will depend on how quickly the economy can diversify so as to reduce its vulnerability to external shocks. Until then, growth will remain below potential.

Fitch Ratings has assigned long-term foreign currency and local currency rating of B+ to Mongolia. At the same time, the agency assigned the country a short-term rating of B and a country ceiling rating of B+. The outlook on the ratings is stable. Fitch’s rating action reflects Mongolia’s market-friendly environment, healthy international liquidity position, normalized relations with external creditors and low external debt service burden, weighted against a high government debt burden and ongoing development challenges.

In 2005, Mongolia obtained for EU GSP+ to export goods (around 7200 items with zero rate of customs duties to all 25 EU countries) which would assist in attracting more FDI, to diversify Mongolia’s industrial structure into manufacturing and services and to ensure macroeconomic stability. Mongolia has become one of 13 countries which have been granted such a status.

The eligibility to the above status reflects an improved external environment for both foreign and domestic investors in Mongolia. Considering the fact that Mongolia has rather limited types of export items, there is no doubt that in order to fully utilize such a status, there will be a need for the Government to support through its policy initiatives towards increasing the types of export goods and products. It is worth noting that part of the support being offered by the Government can be reflected through the tax incentives that are currently being offered to investors.

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Entry filed under: Economic Trends and Performance.

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Information contained in this web site are partly derived from a CD-ROM "Guide to Investment and Trade-Mongolia", produced by Foreign Investment and Foreign Trade Agency (FIFTA). All trademarks are properties of their own respective owners.

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