OREANDA-NEWS. November 08, 2013. In its newly released semi-annual Mongolia Economic Update, the World Bank said that the persistent large balance of payments imbalance is a key challenge to the Mongolian economy. The World Bank underscored that the current fiscal and monetary policies should be tightened further to address the growing current account deficit and to ensure macro-economic stability going forward.

In 2013, the economy is expected to maintain double digit growth due to expansionary economic policies and the start of production of the Oyu Tolgoi mine. Meanwhile, the current account deficit will reach around 30 percent of GDP in 2013. The large external imbalance reflects weak mineral exports but it also stems from expansionary economic policies that have been boosting import demand since 2011. Macro-economic policies continue to be focused on economic stimulus in 2013, adding to the pressures on the balance of payments and inflation.

The recent amendment of the 2013 budget shows the Government’s commitment to keep the official budget deficit within the ceiling of the Fiscal Stability Law. Yet, the fiscal policy will remain highly expansionary in 2013 and 2014 as a large portion of the Chinggis bond is used to finance public investment projects outside the budget, mainly through the Development Bank of Mongolia (DBM). The budget deficit including the spending by the DBM is expected to reach over 12 percent of GDP in 2013 even though the official budget deficit is contained at 2 percent of GDP.

Monetary policy has been expansionary as well. The Bank of Mongolia has been injecting liquidity equivalent to around 20 percent of GDP in the form of central bank’s policy lending to revamp the credit growth amidst the declining FDI and to support economic growth. As a result, outstanding bank loans increased 62 percent in one year in September. The rapid credit growth has been reflected in volatile exchange rate movement and rising inflation in recent months.

 "These expansionary measures contributed to the double digit economic growth this year and also to the current account deficit as growth has been largely driven by domestic consumption growth and construction boom that are reliant on imports. Compared with other countries in the East Asia region, Mongolia’s economic management has been highly expansionary and resulted in larger current account deficit and higher inflation. The current loose economic policies may not be sustainable going forward.” said Taehyun Lee, World Bank Senior Economist.

Under the current economic policy framework, the large balance of payments pressure will not likely ease in the near future in light of the high import demand and weak minerals market prospects. The downside risk will be exacerbated if the Mongolian economy faces an unfavorable economic environment from further softening of China’s economic growth, adverse impact of likely tapering of global quantitative easing, and the continued weak minerals market.

Considering the growing external imbalances and uncertain global environment, the growth-oriented economic policies need to be tightened toward economic stability. The Government took positive steps in recent months. The recent adoption of the new Investment Law will provide a positive momentum to restore foreign investment in Mongolia. The fiscal consolidation plan including the recent amendment of the 2013 budget is also a step toward a more sustainable fiscal path.

Yet, further efforts are needed in order to address growing current account deficit and be prepared for a possible external shock. Fiscal policy should be tightened further and the off-budget spending should be included in the budget and controlled under the fiscal discipline of the Fiscal Stability Law. The Bank of Mongolia should curb the rapid growth of credit and phase out policy lending programs.

"By slowing down the expansion of investments and by focusing on those investments that will have the greatest economic impact, the government will be able to address progressively the development needs of the country while maintaining economic stability. If one stimulates the economy too much in a global environment that is uncertain, it runs the risk of generating economic volatility which will hurt poor people and will make it hard for businesses to plan and finance their operations” said Ms. Coralie Gevers, the World Bank Country Manager in Mongolia.

The World Bank expects Mongolia’s economy to grow at 12.5 percent for 2013, a downward revision from its previous forecast (13 percent). The revised forecast reflects the facts that  economic growth in China and the recovery of the minerals market have been slower than expected. “Mongolia is expected to show one of the highest growth rates in the world. However  it may come at the expense of economic stability, reflected in large current account deficit and rising inflation. It is time for policy makers to ponder how to maintain economic stability and put economic growth in a more sustainable path.” concluded Taehyun Lee, the Senior Economist of the World Bank.