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Wednesday, July 6, 2011

Mongolia Briefing is a magazine and daily news service about doing business in Mongolia. We cover topics relating to the Mongolian economy, the market in Mongolia, foreign direct investment and Mongolian law and tax. It is written in-house by the foreign investment professionals at Dezan Shira & Associates

Mongolia May Face Financial Crisis

Mar. 6 – The European debt crisis may lead to a financial crisis in Mongolia, according to a report released by the World Bank last week.

A global economic slowdown may lead to a sharp drop in mineral prices, which will greatly impact the Mongolian government’s revenue, as it is highly dependent on mineral resources.

“Sharply rising government spending is the root cause of overheating: government spending rose by 56 percent in 2011 and is budgeted to rise by a further 32 percent this year, fueled by sharply rising resource revenues,” the report says.

Government spending in 2011 almost doubled what it was in 2009 due to pre-election pressures, and efforts to make good on earlier political promises for large cash transfers and large increases in capital expenditures.

The World Bank report also indicates that despite the significant efforts made by the central bank to control inflation, the country’s inflation rate still remains high, the real policy interest rate remains negative and bank lending is expanding at a staggering pace.

The report says that due to the easy convertibility between dollar and local currency accounts, the banking system remains vulnerable to capital flight, unless macro-prudential action is taken to strengthen it.

Last year, Mongolia experienced a record-high foreign direct investment inflow of US$5.3 billion; equal to almost 62 percent of GDP on a four-quarter rolling sum basis.

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

GDP growth accelerated to an unprecedented 17.3 percent in 2011 compared to 6.4 percent in 2010, and the unemployment rate fell from 13 percent in 2010 to 9 percent in 2011. However, real wages for unskilled workers in the urban informal sector are starting to fall as the inflation rate reached 11.1 percent year-on-year in December.

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 tighten both fiscal and monetary policy to control inflation
  • Take macro-prudential action to reduce systematic risks in the banking sector
  • Maintain a flexible exchange rate that will act as the first buffer if any external shock materializes

The World Bank closed its report in a relatively pessimistic tone, stating that the up-coming elections will increase domestic uncertainty and the Mongolian economy will be affected by the harsh global economic environment.

“With global economic prospects diminishing, and with any potential stimulus package from China unlikely to be focused on infrastructure as during the last Global Financial Crisis in 2008-09, extra caution is warranted,” the report warns.

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