IMF Finalizes 2023 Article IV Mongolia Consultation

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation^[1]with Mongolia on Thursday, September 14, 2023, considered and endorsed the staff appraisal without a meeting.

Growth rebounded to 5.0 percent in 2022 and the external position stabilized as a result of China's reopening, the government's determined efforts to boost exports, and private sector financing inflows. After peaking in mid-2022, headline inflation gradually declined to 10.6 percent in June 2023 largely reflecting falling global prices. Core inflation also started to moderate. In light of the improving economic situation, a supplementary budget for 2023, passed in June 2023, introduced large and permanent increases in wages, benefits, and pensions. Strong mining sector activity and the fiscal expansion are expected to help sustain robust growth in 2023.

The procyclical fiscal expansion is expected to boost growth initially. However, with unchanged fiscal policies, inflation is expected to rise and remain above the target range set by the Bank of Mongolia (BOM) over the medium term, and external pressures could re‑emerge. These factors are likely to weigh on the non-mining sector and growth outlook from 2024 onwards. Without consolidation measures, the overall fiscal balance is expected to deteriorate from a surplus in 2022 to a large deficit by 2024, placing public debt on an upward trend, and posing a risk to Mongolia's economic stabilization.

The risks surrounding the baseline outlook are tilted to the downside. Mongolia's high external debt, limited external buffers, and dependance on imports and commodity exports makes it vulnerable to external shocks. Additional policy slippages before the June 2024 Parliamentary elections could pose further risks to macroeconomic stability, as could lower than targeted coal exports.

Executive Board Assessment^[2]

In concluding the 2023 Article IV consultation with Mongolia, Executive Directors endorsed staff's appraisal as follows: Mongolia's economy has stabilized from a difficult position in 2022. After multiple global shocks and policy excesses, China's reopening, the government's successful efforts to facilitate exports and rollover external debt, greater ER flexibility and tighter domestic financial conditions gradually began to yield economic dividends. The external position stabilized by late 2022 but remained weaker than the level implied by medium-term fundamentals and desirable policies. GIR improved and inflation moderated through 2023H2, supported by stronger exports, and weaker global food and energy prices. The full operationalization of OT's underground copper mine in 2023Q1 was a major economic milestone. A supplementary budget for 2023 introduced large and permanent increases in wages, benefits, and pensions in anticipation large revenue gains from record high coal exports.

The procyclical fiscal stimulus is likely to boost near term growth and inflation but also increases risks of macroeconomic instability. With the stimulus, inflation is likely to rise, remaining high for longer, and external pressures could re-emerge. The economic boost from the fiscal stimulus is likely to be temporary and start fading as higher inflation erodes real incomes despite continued support to growth from the mining sector. Despite stronger exports, external buffers are likely to remain low in 2023‒25, due to a terms of trade deterioration, stronger imports related to public sector infrastructure, FDI and consumer goods, and weaker net financing inflows due to tighter global financing conditions. Downside risks dominate, including tighter global financial conditions, commodity price volatility, slower growth in China and the risk of further domestic policy slippages. Should a subset of these risks materialize, and the government's ambitious coal export targets fall short, the economic implications could be significant.

Fiscal consolidation and adherence to fiscal rules are imperative to preserve Mongolia's hard-won recent economic stabilization. An adjustment of 4 percent of GDP in 2023‒24 underpinned by fiscal reforms could help achieve an orderly resolution of macroeconomic and external pressures, while improving debt dynamics. Such adjustments would be in line with the stated intentions to adhere to the FSL. Fiscal reforms should prioritize capital expenditures to projects with high returns and strong performance; contain the wage bill by reversing pay supplements, holding real wages constant for a few years and gradually rationalizing civil servants; reducing tax arrears and tax expenditures; targeting social assistance; allowing greater PIT progressivity; and undertaking pension reforms.

The BOM should continue to allow ER flexibility and opportunistically accumulate GIR. Given tighter global financial conditions, the external liability management plans of domestic entities and their ability to raise adequate external financing to fund domestic operations and maintain credit lines with foreign banks should be closely monitored. The government should repay DBM's external liabilities through new external borrowing and ensure adequate enforcement of Mongolia's currency settlement law and SOE repatriation requirements.

Domestic financial conditions should be tightened to contain inflation. The effective enforcement and harmonization of macroprudential policies across banks and NBFIs could help contain salary-based consumer lending, as could the permanent cessation of quasi-fiscal operations. Domestic debt issuance through market auctions can help contain excess liquidity. While the current monetary policy stance remains appropriate, the BOM should stand ready to tighten further if inflationary pressures or dollarization increases. Strengthening BOM's operational autonomy and the monetary policy framework would help build credibility and improve policy transmission. While ending the BOM's quasi-fiscal operations is a welcome development, the outstanding balances should be transferred to the government without involving any state-owned intermediaries.

Though broadly stable, the financial sector could be vulnerable to macroeconomic pressures. Supervision should be strengthened across the financial sector and intensified for high-risk banks and operations. The key priorities are to ensure effective offsite supervision; more frequent onsite supervision of D-SIBs; avoid regulatory forbearance; and align supervisory actions with BOM communications. The end 2023 deadline for shareholder diversification should be delayed, to provide banks with more time to attract fit and proper investors. Raising shareholder limits to facilitate the improved management and operation of banks and aligning withholding and capital gains taxes with international norms, could be helpful. The BOM should urge D-SIBs to develop time-bound plans for diversification and clarify the penalties and contingency plans in case the deadline is not shifted. Aligning the AML/CFT framework with FATF requirements and enhanced implementation for high-risk sectors and activities, is crucial.

Policies to improve the business climate, address corruption and strengthen governance are critical to attracting FDI and strengthening economic resilience. The strengthened Investment Law should be urgently enacted and implemented effectively to cut red tape, the Minerals Law overhaul should be accelerated, and the insolvency framework modernized. The effective enforcement of SOE governance reforms, a decisive resolution of DBM's governance challenges, and a strong judiciary would be important. The draft Whistleblower Law should be approved by Parliament without further delay.