AKIPRESS.COM - The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mongolia on Thursday, September 14, considered and endorsed the staff appraisal without a meeting, the IMF press service notes.

Growth rebounded to 5% 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% 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.

Fiscal consolidation and adherence to fiscal rules are imperative to preserve Mongolia's hard-won recent economic stabilization. An adjustment of 4% 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 Bank of Mongolia 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.