The latest data from February show that exports are rebounding strongly, buoyed by high copper prices andstrong demand from China, Mongolia’s largest trading partner. Imports are also rebounding, reflecting the improvement in the domestic economy. Foreign exchange reserves are close to record levels, while high real interest rates and expectations of currency appreciation have caused a large increase in MNT deposits. Meanwhile, the fiscal deficit continues to improve, reflecting a combination of stabilizing government revenues and continued expenditure restraint.However, February’s data also show a sharp upturn in inflation which rose to 8.7 percent year-on-year (yoy), roughly double the level in January and up from just 1.2 percent in December 2009. This increase has been mainly driven by a rise in food (mainly meat) prices which in turn reflects large livestock losses during the recent dzud and a distribution of 70000 tugrugs to the citizens.

With rising inflation eroding real incomes and purchasing power, low-income households are likely to be the most severely affected. Moreover, these effects will be felt on top of those from the sharp economic downturn last year and the recent dzud. According to latest information by the Ministry of Food and Agriculture, the total official livestock loss equals 4.1 million. Over 50 percent of the livestock losses are goats, which suggests that the cashmere sector will experience a significant supply shortage in the coming season and that rural livelihoods and incomes will remain under strain.

In the banking sector, there are tentative signs of a stabilization of non-performing loans (NPLs). However this may prove to be a temporary respite given that loans with principals in arrears are continuing to mount (these are categorized as NPLs once they have been in arrears more than 90 days).

Overall through, the economy is continuing to show signs of recovery, following an extremely sharp downturn last year. This recovery is being supported by a favorable external environment, on the back of strong policy actions over the past year.

At its upcoming spring session, the Mongolian Parliament is expected to debate and enact a number of important reform laws. These include comprehensive social welfare reform legislation to consolidate and improve the targeting of existing social transfers in a fiscally sustainable manner. Parliament is also expected to adopt a Fiscal Stability Law and an Integrated Budget Law which will set in place a fiscal framework for managing mining revenues as well as a commitment to prudent fiscal policy. With regard to the banking sector, a restructuring strategy is expected to be finalized soon, laying out a framework for banking sector resolution techniques. Finally, there has been growing pressure to amend the 2010 budget, to exclude public investment program projects lacking feasibility studies.

These reforms will play a crucial role in ensuring that Mongolia minimizes the risk of Dutch Disease associated with the upcoming mining boom and that its budget is protected from volatility in copper prices. Putting in place a targeted poverty benefit will ensure that the poor are protected from future mining boomand-busts in a fiscally affordable manner. Similarly addressing the current problems of the financial sector in a decisive and transparent manner will prepare the sector for the coming upturn in economic activity, investment and capital flows in the years ahead.