In the first quarter of 2010, the trend
improvement in the fiscal deficit stalled as the positive impact of improving
revenues was offset by expanding expenditures. If expenditures were to continue
to rise in step with mining-related revenues, Mongolia risks returning to the
boom-and-bust cycle of the pre-crisis years. However, fiscal consolidation is
necessary, given the difficult financing conditions projected for the next few
years. In particular, 2011 will be a difficult year for the budget as the
Windfall Profits Tax will have been abolished.

A related
challenge is how to manage public investment expenditures within the current
fiscal space while helping to meet Mongolia’s infrastructure
challenge. The current public investment planning and execution process suffers
from a number of weaknesses which are examined in Box 1 through the lens of investment in
the road sector. Wages and salaries are another major expenditure item within the
budget and face upward pressures. Box
2 presents preliminary details of the latest survey in
determining the level of public sector wage increases. At senior levels, the
total cash compensation in the civil service is approximately 60 to 70 percent
relative to bench-marked private sector jobs. However, pay and benefit levels
are not unattractive when benefits and job security are factored in. And low
level civil service jobs had similar or higher levels of total cash
compensation compared to private jobs.

Mongolia’s trade deficit has
stabilized in recent months on a 12-month rolling basis. The sustained recovery
of Mongolia’s exports has
been supported by upward momentum in metal prices and increasing imports from Mongolia to China, its largest trading partner.
The exchange rate against the US dollar has been stable, while foreign exchange
reserves are close to record levels.

The economic
recovery and the prospects of strong growth in 2010 have contributed to recent
consumer prices rises. While rising price pressures may be expected during
recovery, the challenge going forward is to ensure that this does not develop
into the overheating seen during previous booms.

In the banking sector, total lending growth remains muted as nominal lending
and deposit rates remain high. On an aggregate level the commercial banks
realized a profit of MNT 2.8 billion in March after reaching a loss of MNT
143.4 billion through 2009. The ratio of non-performing loans to total loans
stabilized in March but is still at 22 percent while principal in arrears is
increasing. A bank restructuring strategy was recently drafted by the Bank of
Mongolia, reflecting lessons from international experience (including those of
the Turkish banking crisis of 2000/2001, as detailed in Box 3). Timely endorsement of the plan by
Parliament is crucial so as to align Mongolia with international best
practices that limit the potential economic and fiscal cost associated with any
government support and restructuring.

In the real
sector, the severe impact from the dzud, which marked a record disaster
affecting over 80 percent of Mongolia’s territory, will be felt across major
sectors, including the banking sector. Up until now, herder loans have been
relatively well performing (Box
4) but, with the number of livestock losses increasing to over 7
million (16 percent of total herd), upward pressure on non-performing loans is
likely to increase.

Currently, the Mongolian Parliament is discussing the enactment of a number of
important reforms including the Fiscal Stability Law and an Integrated Budget
Law which will put in place a fiscal framework for managing mining revenues as
well as a commitment to prudent fiscal policy. Such important moves to improve
the policy framework in key areas will help Mongolia to avoid boom-and-bust
cycles and promote sustainable growth into the future.