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Mongolia and the IMF Press Release: IMF Completes First and Second Reviews of Mongolia's PRGF Program and Approves US$11 Million Disbursement September 12, 2003 Country's Policy Intentions Documents Free Email Notification Receive emails when we post new
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Mongolia—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding August 29, 2003
Mr. Horst Köhler
1. On September 28, 2001, the IMF's Executive Board approved a three-year arrangement for Mongolia under the Poverty Reduction and Growth Facility (PRGF) for SDR 28.49 million (56 percent of quota). The purpose of this letter and the attached Memorandum of Economic and Financial Policies (MEFP) is to: (i) advise on progress to date under the PRGF-supported program; (ii) update the government's macroeconomic policy framework for 2003 and the medium term; and (iii) request waivers for nonobservance of five quantitative and two structural performance criteria pertaining to the second and third disbursements under the arrangement. 2. Macroeconomic performance so far under the PRGF-supported program has been satisfactory. Real GDP growth was largely on track in 2001-02, while inflation fell to under 2 percent in 2002, well below the program target. The general government's overall deficit has been restrained as programmed, with revenue overperformance offsetting overruns in outlays, and the overall balance of payments has recorded large surpluses, allowing for a significantly larger than programmed build-up of net international reserves. 3. The government is taking continuing steps to meet the program's key macroeconomic and poverty reduction objectives. The 2003 budget provides for restraint on civil service wages and pensions, consistent with the need to protect fiscal sustainability, and a prudent medium-term fiscal framework was approved by Parliament in June 2003. Governance and fiscal transparency are being upgraded, including through the implementation of the Treasury Single Account (TSA) and compliance with the IMF's safeguards recommendations, and a comprehensive and sound Economic Growth Support and Poverty Reduction Strategy Paper (PRSP) was recently finalized in close consultation with the IMF and World Bank staffs. 4. In view of the generally favorable macroeconomic performance during the first and second years of the PRGF-supported program and the government's continuing efforts to meet its key objectives, we would like to request waivers for the nonobservance of the following quantitative and structural performance criteria: (i) the floor on net international reserves of the BOM as of end-December 2001; (ii) the ceiling on net credit to government of the BOM as of end-June 2002; (iii) the ceiling on net domestic assets of the BOM as of end-June 2002; (iv) the continuous performance criterion on the nonaccumulation of external arrears as of early 2002 and early 2003; (v) the structural performance criterion on the 2002 budget; and (vi) the structural performance criterion relating to the implementation of the TSA. Given the delays in completing the first and second reviews, the government also requests that the subsequent reviews and disbursements be appropriately rephased and the commitment period for the arrangement extended through July 31, 2005. 5. The government believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Mongolia will consult with the Fund on the adoption of such measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the IMF's policies on such consultations. 6. In continuing with our policy of transparency, we consent to the publication, including on the IMF's website, of the attached MEFP and the accompanying Executive Board documents prepared by the IMF staff. Sincerely yours,
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1. This memorandum reviews program implementation to date under Mongolia's three-year PRGF arrangement (September 2001-September 2004) and sets out the government's policies for the remainder of 2003. It also updates the medium-term macroeconomic framework covering the period 2003-2006 consistent with the Mongolian government's Economic Growth Support and Poverty Reduction Strategy Paper (PRSP), dated July 3, 2003. 2. Mongolia has made great progress toward its transition to a market-based system since the early 1990s, including with the help of three successive PRGF-supported arrangements. However, major challenges remain to promote sustained economic growth and reduce poverty as needed to meet the objectives set under the PRSP. To help meet these objectives, the current PRGF-supported program aims to consolidate the recent progress towards the establishment of macroeconomic stability and, in particular, fiscal sustainability, while also continuing to strengthen fiscal governance and improve the efficiency and pro-poor orientation of public expenditure policies. II. Developments and Performance under the Program During 2001-02 3. Overall macroeconomic performance was broadly on track during 2001-02. Although performance with respect to several quantitative and structural performance criteria and benchmarks was mixed, adequate measures have been taken to bring all the key policies back on track (Tables 1, 2 and 3). On that basis, the government requests waivers for the nonobservance of five quantitative performance criteria (QPCs) and two structural performance criteria (SPCs) as of end-December 2001, early 2002,end-June 2002, and early 2003, as detailed below. 4. Output and inflation performance in 2001-02 have been in line with program targets. Real GDP growth, which was depressed to 1 percent in 2001 by extraordinarily large weather-related losses in the herd stock, recovered to 3.9 percent in 2002, close to the program target of 4 percent. Despite the recurrence of drought conditions through much of the country during the summer of 2002, which resulted in renewed heavy losses in the agricultural sector, growth was sustained by robust performance in the industrial and service sectors together with buoyant domestic demand. The year-on-year rate of inflation, after having been restrained to 8 percent as of end-2001, fell to under 2 percent in 2002, well below the program target, with the help of stable import prices and a leveling off of domestic food prices. 5. The general government's overall deficit was broadly on track in 2001-02, although strong upward pressure on public expenditure has continued to pose a challenge for fiscal management. While the end-June 2002 QPC on net credit to government (NCG) was breached, the overall deficit (including grants) narrowed from 7 percent of GDP in 2000 to 5½-6 percent of GDP in 2001-02, as a significant overperformance on revenues more than offset a continuing surge in government expenditures in relation to GDP. The ratio of public debt to GDP remained on a downward trend, broadly in line with program targets. However, these trends may be difficult to sustain in the period ahead, as Mongolia has no more room to raise the burden of taxation on its private sector, which is evidenced by its already-high ratio of revenues to GDP. In these circumstances, a key challenge for government policies will be to continue to restore the purchasing power of wages and pensions, which suffered a sharp decline during the first half of the 1990s, without undermining medium-term fiscal sustainability. Although the SPC relating to the policy content of the 2002 budget could not be observed following a 20 percent increase in civil service wages and pensions from October 2002, a more disciplined wage and pension policy was adopted under the 2003 budget, which was approved by the Parliament in late 2002. 6. Significant progress has been made over the last two years towards implementing the government's program to strengthen fiscal transparency and accountability. In line with the recommendation of a fiscal ROSC completed in 2001, an effective system was established for the monitoring and control of budget entities' arrears and important steps were taken to improve the quality and frequency of fiscal reporting. In the key area of treasury reforms, a slower-than-programmed start in the piloting of a system for the establishment of a Treasury Single Account (TSA) led to a breaching of the respective SPC for end-December 2001. However, the government took decisive measures to expand and accelerate TSA implementation beginning in July 2002, leading to the establishment of local treasury offices in all provinces and the transfer of most budget entities' accounts from commercial banks to the TSA. 7. The rationalization of intergovernmental fiscal relations, another key element of the government's fiscal reform program, has been largely on track. Beginning in January 2002, taxes were assigned to tiers of government by type of tax rather than tax subject, and a VAT-sharing arrangement was introduced to help eliminate regional disparities in local governments' finances, broadly in line with the program. In addition, efforts have been stepped up to strengthen local tax administration. Following the adoption of the far-reaching Public Sector Financing and Management Law (PSFML) in mid-2002, spending authority equivalent to about 10 percent of GDP has been shifted from local governments to line ministries, with the proceeds from the personal income tax (PIT), the VAT, excises, and royalties reassigned to the central budget. As most transfers from the central budget to local governments have been related to specific outputs, the implementation of a formula-based transfer equalization scheme has no longer been pursued. 8. The growth of monetary and credit aggregates significantly exceeded the PRGF-supported program's targets during 2001-02. To a large extent, these developments are a welcome sign of the improved public confidence in the banking system and the continuing reintermediation in the wake of the sustained implementation of reforms to establish a sound and efficient banking system. However, an easing of monetary conditions also appears to have contributed to the surge in money and credit, as evidenced by a breaching of the end-June 2002 QPC on the net domestic assets (NDA) of the BOM. Despite the rapid expansion of money and credit, inflation has so far remained restrained. Nevertheless, to limit any possible threat to macroeconomic stability, the BOM has recently taken steps to slow the growth of reserve money, as discussed below. 9. Mongolia's overall balance of payments was largely on track during 2001-02. As demand in major export markets slackened and world copper and cashmere prices declined, export performance was lackluster throughout 2001-02. With import growth remaining buoyant, the trade deficit widened significantly, but the balance of payments continued to be underpinned by buoyant emigrant's remittances, increasing foreign direct investment (including in connection with the privatization of the Trade and Development Bank (TDB)), and other private inflows. Gross international reserves rose to the equivalent of about 17 weeks of imports as of end-2002, well in excess of the program target. The BOM's NIR, which had fallen slightly short of the end-December 2001 QPC, comfortably met the QPC as of end-June 2002 and remained largely on track thereafter. 10. Mongolia's external debt situation has remained on track. The stock of external public debt (excluding the large amount of pre-1991 transferable ruble debt to the Russian Federation) leveled off at about 89 percent of GDP in 2001-02. Reflecting the high degree of concessionality of a large share of Mongolia's debt, the net present value (NPV) of external public debt has remained below 60 percent of GDP, in line with program targets. The government has continued to service most of its post-1991 debt in an orderly manner. Delays in the establishment of procedures for in-kind repayments due to the Russian Federation led to a temporary breaching of the continuous QPC on the nonaccumulation of external arrears in early 2002 and, again, in early 2003. However, in both instances, the arrears were cleared within 3-4 months. 11. The BOM pursued a flexible exchange rate policy during 2001-02, although the strength of the balance of payments contributed to the maintenance of a relatively stable exchange rate. The togrog depreciated by a cumulative 3.1 percent vis-à-vis the U.S. dollar in 2001-02. The real effective exchange rate (REER) appreciated by 5 percent in 2001, but this appreciation was largely reversed as inflation eased in 2002. III. Objectives and Policies for 2003 and the Medium Term A. Short-Term Outlook and Macroeconomic Framework 12. The macroeconomic outlook for 2003 is expected to be affected by the continuing uncertainties in the global environment, which have been exacerbated by the outbreak of SARS in neighboring countries. Mongolia's prompt measures to prevent any local transmission of SARS appear to have been effective so far. Even so, the economic fallout of the spread of SARS elsewhere in the region could have significant repercussions. Mongolia's proximity to some of the most affected provinces of China has had a dampening effect on tourism, and this could have unfavorable effects on both economic growth and the balance of payments. The disruption of travel to and from China has also given rise to shortages of some imported food items in Mongolia. Reflecting also a large seasonal increase in meat prices, the twelve-month rate of inflation rose to 6½ percent as of June 2003. In the face of the risks posed by these developments, the government will redouble its efforts to implement policies and reforms conducive to macroeconomic stability and private sector-led investment and growth. 13. Under the government's macroeconomic baseline scenario, which is presented in greater detail in the PRSP, the annual rate of growth of GDP is projected to rise steadily from about 5 percent in 2003 to 5½ percent by 2005-06. A marked improvement in conditions in the agricultural sector, together with continuation of buoyant activity in manufacturing, should help more than offset the effects of the SARS-related decline in tourism during 2003. The manufacturing, mining and service sectors are projected to continue to underpin growth over the medium term as the government's market-friendly reforms help promote faster private sector development. The average annual rate of inflation is targeted to be restrained to 5 percent during 2003 and over the medium term. Gross official reserves are targeted to increase to about $300 million or 18½ weeks of imports by end-2003, and they would rise to about $400 million or 20 weeks of imports by 2006. 14. To meet these objectives while also promoting the achievement of medium-term sustainability, the government will be steadfast in its pursuit of prudent fiscal and monetary policies. The overall fiscal deficit (including grants) will be restrained to 6 percent of GDP in 2003, a level somewhat lower than the initial program target. With NCG remaining on a declining trend, it is expected that the entire stock of the government's high-cost domestic debt to the banking system will have been virtually retired by the end of 2003. While broad money growth is projected to moderate in 2003, the decline in NCG would make room for a continued healthy rate of expansion of credit to the private sector. Although the stock of external public debt (excluding pre-1991 transferable ruble debt) is projected to edge up to 92½ percent of GDP in 2003 reflecting the valuation effects of the recent weakening of the U.S. dollar, the external debt ratio would be placed on a steadily declining path thereafter. B. Budgetary Policy and Reforms to Strengthen Fiscal Governance 15. A strong and transparent fiscal position will be crucial for maintaining a stable macroeconomic environment, achieving debt sustainability, and meeting the government's growth and poverty reduction goals as spelled out in the PRSP (¶ 3.25-3.42). The centerpiece of the government's medium-term fiscal adjustment strategy will be to gradually reduce unproductive current expenditure in relation to GDP, so as to make room down the road for a reduction in Mongolia's high tax burden without impinging on public investment and social sector outlays. Achieving these goals will require improving budget execution and formulation, implementing a comprehensive civil service reform to contain the cost of government and improve public service delivery, and continuing to adopt measures to strengthen fiscal transparency and accountability. 16. The government's medium-term budget framework (MTBF), which was approved by Parliament in June 2003, bodes well for the achievement of the PRSP's objectives. To fully incorporate in the budget the costs associated with the government's regional development strategy, some of which were previously intended to be financed off-budget, public investment outlays are somewhat higher under the MTBF than envisaged in the initial budget for 2003. Even so, with the help of tighter controls on current expenditures, the overall budget deficit is projected to be restrained to about 6 percent of GDP in 2004 and 5½ percent of GDP in 2005, in line with the initial program targets. Completion of some lumpy projects should pave the way for somewhat faster deficit reduction thereafter. The post-1991 stock of public debt is projected to decline steadily in relation to GDP under the MTBF. With the deficit continuing to be more than financed with external loans and privatization receipts, NCG was well within the indicative program ceiling as of end-June 2003. Based on these developments and prospects, the government requests a waiver for the nonobservance of the end-June 2002 QPC on NCG. 17. On the revenue side, the PRSP recognizes that, while Mongolia's relatively high tax burden needs to be reduced over the medium term to encourage private sector-led investment and growth, the need to protect sustainability leaves little room for any significant tax reductions in the short run (¶3.13-3.15). Earlier plans to reduce corporate income tax rates have accordingly been suspended at least until 2005, and will then be implemented only if accompanied by reforms to generate offsetting reductions in current expenditures. On that basis, the PRSP projects that government revenues would level off at about 37-37½ percent of GDP in 2003-04, and would decline to about 36½ percent of GDP thereafter. While revenue performance so far in 2003 has been stronger than envisaged in the MTBF and the PRSP, suggesting that the MTBF's revenue targets probably err on the conservative side, the government is not prepared to amend its fiscal framework at this point, as the MTBF was only recently approved by Parliament. However, the fiscal projections will be updated in the fall of 2003 at the time of the preparation of the 2004 budget. 18. The PRSP relies primarily on a sustained effort to rein in current expenditure to meet the government's fiscal adjustment objectives. To contain the pressure emanating from wage and pension outlays, the granting of any civil service wage or pension increases is ruled out during the remainder of 2003, and pension increases during 2004 are to be limited to no more than the rate of inflation (¶3.28 and 3.215). The government is committed to implementing a broad-based civil service reform program over the medium term. As a first step, a preliminary data verification exercise among a wide range of government entities conducted jointly by the Civil Service Council (CSC) and the Ministry of Finance and Economy (MOFE) was completed in April 2003. A comprehensive civil service census is to be conducted following the establishment of a Human Resource Management Information System (HRMIS). At that point, the government will develop and adopt a credible civil service reform program, and a reliable system for the monitoring and control of the wage bill, in consultation with the World Bank. The government will consider the possibility of granting future increases in civil service wages only in the context of the civil service reform process, and will grant no such increases until a credible mechanism for the containment of the wage bill is in place. 19. With the help of these policies, the PRSP aims to bring current spending down from nearly 34 percent of GDP in 2002 to 32 percent of GDP in 2003-04, and to about 30½ percent of GDP by 2006. The government recognizes that these expenditure reduction targets are highly ambitious and can be achieved within the timetable envisaged in the MTBF only if prompt action is taken to introduce far-reaching expenditure-saving reforms. The targeted pace of expenditure reduction will be revisited at the time of the preparation of the 2004 budget in the fall of 2003. Even if the expenditure targets have to be revised upwards at that point, the government will make every effort to adhere to the PRSP's overall deficit targets, which should still be feasible in light of the expected overperformance on revenues. Based on these prospects and undertakings, the government requests a waiver for the nonobservance of the end-December 2001 SPC relating to the 2002 budget. 20. To create an enabling environment for private investment, the PRSP envisages a sustained increase in public investment on energy, road construction, and other basic infrastructure, especially in some of Mongolia's less developed regions (¶4.29-4.92). Given the lumpiness of some high-priority projects launched under the government's regional development strategy, the ratio of public investment to GDP is projected to edge up in 2003-04, before tapering off and declining thereafter. With the exception of the Durgun hydropower station, which is being financed with nonconcessional suppliers' credits on the order of US$26.5 million (2.2 percent of GDP), all other debt-financed projects will continue to be funded with foreign concessional assistance. To reassure investors and donors that scarce public funds will be put to the most effective use, the government, in consultation with the World Bank, will establish strict economic criteria for the evaluation and tendering of projects to be considered for inclusion in its Public Investment Program. For the major new hydropower projects already under way, the government will develop sound and realistic business plans on both the generation and distribution sides before end-2003, in consultation with the World Bank, with a view to ensuring that the new plants will be economically viable and will not place any new future burdens on the budget. 21. As indicated in the PRSP, the centralization of all government funds in a TSA is key to the government's efforts to strengthen expenditure and cash management and improve fiscal transparency and accountability (¶3.71-3.87). After initial delays in implementing the pilot TSA, the momentum of treasury reform has accelerated since mid-2002. The government has been extending the TSA arrangement to cover the bulk of general government operations by closing remaining individual bank accounts of budget entities, including social insurance funds, and it has begun to account for all revenue and expenditure transactions through treasury ledger accounts. To complete this process expeditiously, steps are under way to identify and close any remaining budgetary accounts in commercial banks and the government is seeking foreign donors' consent to transfer grant and loan accounts to the TSA. As a result of these ongoing efforts, the share of government bank balances held in the TSA at the BOM is projected to have increased to no less than 75 percent by end-August 2003. To further improve expenditure management in the period ahead, a ministerial resolution will be issued to set clear rules for the allocation of budgetary entities' excess own-revenues, and semi-annual and annual fiscal reports will be required to indicate any adjustments to spending plans associated with such revenues. On the basis of these measures and undertakings, which have now more than accomplished the objectives set for 2001-02 under the program's structural conditionality, the government requests a waiver for the nonobservance of the end-December 2001 SPC relating to the TSA. 22. An important objective of the government's treasury reform program is to guard against a re-emergence of public sector arrears. All domestic debt service arrears have been eliminated since late 2000 and interest on government bonds continues to be paid on a timely basis. In addition, a time-bound plan for the reduction of arrears accumulated by budget entities was established in mid-2002 and was broadly adhered to subsequently. The establishment of the TSA has also enabled the Treasury to begin to cross-check payments against budget appropriations. Building on these efforts, the government will adopt a ministerial regulation by end-October 2003 to require budget managers to make commitments strictly in accordance to their monthly apportionments of budget appropriations and report monthly to the Treasury on commitments entered. On that basis, the Treasury will develop cash plans to ensure prompt settlement of due payables. 23. To further strengthen fiscal governance, the government is committed to preventing the emergence of quasi fiscal obligations. The BOM has accordingly cancelled all loan agreements and other contracts previously signed with foreign parties, which would have required it to issue large amounts of loan guarantees to support borrowing by private or joint-venture companies. In addition, the General Budget Law was amended in June 2003 to rule out future recourse to quasi-fiscal operations, except to the extent that they are identified in the MTBF or future government budgets. While a portion of the government's Millennium Road project is to be implemented during 2003-04 through extra-budgetary operations equivalent to US$39 million (3¼ percent of GDP), which were not included in the official accounts, the underlying transactions have been in full conformity with the applicable laws and regulations. More specifically, in accordance with the provisions of the Law on Minerals, a license has been granted to a Mongolian-Chinese joint-venture company to exploit the Ulaan Ovoo coal mine and, in return, that company has undertaken to use its own resources to construct 350 kilometers of road along the route of the Millennium Road. To improve fiscal transparency, the government has indicated in the PRSP that contracts for public works will henceforth avoid barter-like financing arrangements (¶3.36). 24. To enhance program monitoring, the MOFE and the BOM will provide updated information to the Fund on a fortnightly basis with regard to any new contracts for the execution of public investment projects which have been signed or are under negotiation with foreign or domestic nongovernmental entities as elaborated in Section VII.C of the attached Technical Memorandum of Understanding (Attachment III). In addition, the Fund's resident representative will receive fortnightly briefings from the MOFE on any recent or pending cabinet decisions that carry potential implications for Mongolia's public finances, its external debt position, or other issues relating to the implementation of the PRGF-supported program. C. Monetary Policy, Banking System Reforms, and Safeguards 25. To meet the government's inflation and external reserve objectives, the PRSP envisages a moderation of the rate of growth of monetary and credit aggregates (¶3.132-3.137). The annual growth rate of broad money has been targeted to be reduced from about 42 percent in 2002 to 25 percent in 2003. With the rate of growth of credit to enterprises projected to moderate somewhat in 2003, domestic credit growth would level off in 2003. The slower pace of credit expansion should facilitate the achievement of a gross reserve buildup of about US$33 million during 2003. 26. Consistent with the above targets, the BOM will take adequate steps to keep reserve money growth within a prudent range, while leaving the required reserve ratio unchanged. Although reserve money growth remained on an upward trend during the early months of 2003, the BOM is committed to meeting its end-year monetary program targets. The placement of BOM bills was already stepped up beginning in May 2003. As a result, the BOM's NDA have been on a declining trend, and reserve money growth stayed within the indicative program ceiling for end-June 2003. Based on this performance, the government requests a waiver for the nonobservance of the end-June 2002 QPC on the BOM's NDA. 27. Noticeable progress has been achieved in recent years in strengthening the domestic banking system, as evidenced by the steady increase in bank deposits and workers' remittances. The BOM has continued to upgrade its supervisory and prudential framework, and efforts are underway to implement the recommendations set forth in a recently completed assessment against the Basle Core Principles. To address concerns stemming from recent indications of a deterioration in banks' asset quality, the BOM will require banks to submit internal audit reports following a new supervisor's manual by end-October 2003, and provisioning requirements on substandard and doubtful loans will be increased during the first quarter of 2004. In addition, new anti-money laundering recommendations to banks in line with Financial Action Task Force (FATF) guidelines were issued in late 2002, and legislation requiring banks to file reports on suspicious accounts and empowering the authorities to freeze such accounts will be enacted by end-2003. 28. A special effort is under way to strengthen BOM's governance. The Central Bank Law was amended by Parliament in June 2003 to provide for a clear prohibition of quasi-fiscal activities that are not akin to central banking operations and to set up a legal framework for the establishment of an independent Supervisory Board. The draft terms of reference (TOR) for the operation of this Board are being developed in line with the Fund's safeguards recommendations and will be approved by Parliament before end-October 2003. In accordance with these TOR, the Supervisory Board will, among its other functions, ensure that the BOM's financial accounting and reporting framework is fully in line with International Accounting Standards. In addition, it will exercise oversight over the external auditing process, including the appointment of the auditing firm, and will ascertain that external audits are conducted in accordance with International Auditing Standards. The government and the BOM will take all necessary steps in a timely fashion to ensure that the new Supervisory Board will assume its full duties from November 2003. Special external audits of BOM's NIR data as of end-December 2001 and end-June 2002 (the test dates for the second and third PRGF disbursements), which have already been completed, attest to the accuracy and reliability of the BOM's NIR data. The BOM will continue to conduct special audits of its NIR on a semi-annual basis during the remainder of the program period. D. External Sector Policies 29. The BOM will continue to pursue a market-based exchange rate policy in the period ahead, with a view to meeting the program's NIR targets while also smoothing excessive exchange rate fluctuations. To reinforce the responsiveness of the exchange rate to market forces, the BOM began to change its mid-point rate on a daily rather than weekly basis in January 2003. In addition, the buy-sell margin around BOM's mid-point rate was widened from +/- 1 togrog to +/- 2 togrog from April 2003, and to +/- 3 togrog from June 2003. To expand the growth of the interbank foreign exchange market, the government will also take steps to liberalize gold trading, including by removing any remaining laws or regulations that may be discouraging private sector activity in the marketing of gold exports. The NIR of the BOM increased by about US$9 million during the first six months of 2003 and, given the official aid inflows assumed under the program, they are on track to meet the government's end-2003 target. On this basis, the government requests a waiver for the nonobservance of the end-December 2001 QPC on the BOM's NIR. 30. The PRSP reaffirms the government's commitment to the pursuit of a prudent debt management policy and orderly relations with all creditors (¶3.110-3.131). In April 2003, the government cleared its arrears (US$4.1 million) on Mongolia's post-1991 debt to the Russian Federation and came to an agreement on the terms for the payment of debt service due during 2003. Progress was also made in the negotiations on the settlement of pre-1991 transferable ruble (TR) held during the visit of Mongolia's Prime Minister to Moscow in early-July 2003, and there are good prospects for a final agreement on this matter on terms that would not jeopardize external sustainability. Negotiations are also underway to resolve other outstanding claims by foreign creditors (about US$30-40 million), which arose from past issuance of guarantees on nonconcessional external loans to public and private enterprises. During the period of the PRGF-supported program, the Government will continue to service its external obligations on a timely basis and will refrain from contracting or guaranteeing any new nonconcessional debt as defined in Attachment III, other than the obligations already undertaken in connection with the Durgun hydropower project. Based on these developments and undertakings, the government requests waivers for the nonobservance of the continuous performance criterion on the nonaccumulation of external arrears as of early 2002 and early 2003. 31. An open trade and investment regime will remain a linchpin of Mongolia's strategy to promote private-sector led growth and poverty reduction. Although Mongolia's tariff regime is already among the least restrictive in Asia, remaining impediments to trade facilitation and foreign direct investment will be removed during the program period. Accordingly, the government will take further steps during 2003 to simplify and streamline customs controls, licensing, and regulations, especially in connection with quality certification for the import and export of raw materials and minerals. The government will not introduce any new trade-related taxes, quantitative restrictions, voluntary restraints, or any other measures to limit exports or imports during the program period. IV. External Financing Requirements 32. The policies set out in this memorandum are key for reducing Mongolia's external vulnerability in line with the objectives set out in the PRSP (¶3.88-3.109). The current account deficit (including official transfers) is projected to be restrained to about $100 million or about 6½ percent of GDP over the medium term. Assuming that medium- and long-term loan disbursement would average US$88 million annually, additional financial assistance of about US$23 million annually would be required during 2003-05 to cover the financing gaps. These gaps are expected to be filled through program loans from the World Bank, the AsDB and the Fund. V. Program Monitoring 33. The quarterly benchmarks and semi-annual QPCs established under
the program for the period September 2003-March 2004 include: (i)
a ceiling on net banking system credit to government; (ii) a ceiling on
net domestic assets of the BOM; (iii) a floor on net international reserves
(NIR) of the BOM; (iv) a ceiling on government and government-guaranteed
external debt; (v) the nonaccumulation of external arrears; and (vi) the
nonaccumulation of domestic interest arrears. In addition, indicative
ceilings have been specified for reserve money and the net domestic assets of the consolidated banking system. Table 2 and Attachment III provide more details on the settings and definitions of variables to be monitored under the PRGF arrangement. The proposed structural
benchmarks and performance criteria for 2003-04 are presented in
34. To reiterate its commitment to implement the PRGF-supported program, the government has taken and/or will take the following actions prior to the Executive Board's consideration of the first and second PRGF reviews: (i) Secure Parliamentary approval of a Medium-Term Budget Framework in line with the understandings reached with the staff as elaborated in paragraphs 16-22 above; and (ii) amend the Central Bank Law to strengthen safeguards by establishing an independent Supervisory Board and prohibiting the conduct of quasi-fiscal activities, and prepare draft terms of reference for the Bank of Mongolia's new Supervisory Board for consideration by the fall session of Parliament, in line with the understandings reached with the staff (Table 5). 35. Given the delays in completing the first and second reviews, the government requests the rephasing of the subsequent reviews and disbursements under the PRGF arrangement, with each disbursement, review and test date to be postponed by nine months. Accordingly, the third review under the program is expected to be completed by end-January 2004 with performance to be assessed based on the observance of QPCs as of end-September 2003 and the structural benchmarks and performance criteria as of end-October and end-November 2003. The third review will focus primarily on the implementation of the 2003 budget, the approval of a budget for 2004 in line with the principles adopted in the MTBF, and the implementation of the new safeguards arrangements for the Bank of Mongolia. At the time of the third review, the QPCs and structural benchmarks and performance criteria for end-March 2004 will be revised and those for end-September 2004 will be established. 1. This memorandum sets out the definitions for quantitative performance criteria and indicative targets under which Mongolia's performance under the program supported under a Poverty Reduction and Growth Facility (PRGF) arrangement will be assessed. Monitoring procedures and reporting requirements are also specified. I. Quantitative Performance Criteria and Indicative Targets 2. Performance criteria for end-September 2003 and end-March 2004 and indicative targets for June 2003 and December 2003 have been established with respect to
3. Performance criteria that are applicable on a continuous basis have been established with respect to
4. Indicative targets for June 30, 2003 and December 31, 2003 have been established with respect to
II. Institutional Definitions 5. The general government includes all units of budgetary central government, social security funds, extrabudgetary funds, and local governments. See Annex I for the description of units in each of these subsectors. 6. The domestic banking system is defined as the BOM, the existing and newly licensed commercial banks incorporated in Mongolia and their branches. The seven liquidated banks are not included in the consolidated accounts of commercial banks. III. Monetary Aggregates 7. Valuation. Foreign currency-denominated accounts will be valued in togrogs at the program exchange rate between the togrog and the U.S. dollar (Tog 1,125 per U.S. dollar). Foreign currency accounts denominated in currencies other than the U.S. dollar, excluding SDRs, will first be valued in U.S. dollars at actual end-of-period exchange rates used by the BOM to calculate the official exchange rates. SDR-denominated accounts will be valued at the program exchange rate of SDR 1=US$1.362. Monetary gold will be valued at US$325.38 per ounce. A. Reserve Money 8. Reserve money consists of currency issued by the BOM (excluding BOM holdings of currency), commercial banks' deposits held with the BOM, and deposits of nonbanks with the BOM (excluding the general government as defined above). B. Net International Reserves of the BOM 9. A floor applies to the level of net international reserves (NIR) of the BOM. 10. NIR will be calculated as gross international reserves less international reserve liabilities. 11. Gross international reserves of the BOM are defined as the sum of
Excluded from the definition of gross reserves are any foreign currency
claims on residents, capital subscriptions in international institutions,
assets in nonconvertible currencies, and gross reserves that are in any
way encumbered or pledged, including, but not limited to, reserve assets
used as collateral or guarantee for third-party external liabilities. 12. International reserve liabilities of the BOM are defined as the sum of
Excluded from the definition are liabilities arising from balance of payments support of original maturities of more than one year from the World Bank and the Asian Development Bank. 13. Adjusters. The floor on NIR will be adjusted upward by the amount of balance of payments support from official multilateral creditors (excluding the IMF) in excess of the programmed level as set out in the table on quantitative performance criteria. The floor on NIR will be adjusted downward by the amount of balance of payments support from official multilateral creditors (excluding the IMF) falling short of the programmed level as set out in the table on quantitative performance criteria. C. Net Domestic Assets of the BOM 14. A ceiling applies to the level of net domestic assets (NDA) of the BOM. 15. NDA will be calculated as the difference between reserve money and the sum of NIR and other net foreign assets (ONFA) of the BOM. 16. ONFA is defined as the sum of (i) BOM's monetary gold pledged as collateral for external loans to domestic private companies and (ii) other net foreign assets of the BOM, including the difference between accrued interest receivables on gross international reserves of the BOM and accrued interest payables on international reserve liabilities of the BOM. 17. Adjusters. The ceiling on NDA will be adjusted downward by the amount of external budgetary assistance in excess of the programmed level as set out in the table on quantitative performance criteria. The ceiling on NDA will be adjusted upward by the amount of external budgetary assistance falling short of the programmed level as set out in the table on quantitative performance criteria. 18. The ceiling on NDA will be adjusted downward by 80 percent of the amount of NIR of the BOM in excess of the programmed level as set out in the table on quantitative performance criteria. D. Net Bank Credit to the General Government 19. A ceiling applies to the net bank credit flows to the general government
(NBCGG) measured cumulatively from the beginning of the year. 20. NBCGG is defined as the sum of (i) net borrowing from the BOM (ways and means advances, loans, holdings of restructuring bonds, holdings of treasury bills and other government bonds, and the government liabilities to the IMF regarding PRGF/ESAF disbursements minus deposits) and (ii) net borrowing from commercial banks (loans, advances, holdings of restructuring bonds, and holdings of treasury bills and other government bonds minus deposits). 21. Adjusters. The ceiling on NBCGG will be adjusted downward by the amount of external budgetary assistance in excess of the programmed level as set out in the table on quantitative performance criteria. The ceiling on NBCGG will be adjusted upward by the amount of external budgetary assistance falling short of the programmed level as set out in the table on quantitative performance criteria. 22. The ceiling on NBCGG will be adjusted downward by the amount of any transfer, including of profits and provisions, over the program baseline from the BOM to the central government. 23. The ceiling on NBCGG will be adjusted downward by the full amount of privatization receipts in excess of the programmed level as set out in the table on quantitative performance criteria. E. Net Domestic Assets of the Banking System 24. A ceiling applies to the level of net domestic assets (NDABS) of the banking system. 25. NDABS will be calculated as the difference between broad money and net foreign assets of the banking system. 26. Broad money is defined as the sum of currency outside banks and all current, savings and time deposits of nonbanks (excluding the general government as defined above) with the banking system, including foreign currency deposits. 27. Net foreign assets of the banking system are defined as the sum of NIR and other net foreign assets of the BOM (as defined above) and net foreign assets of the deposit money banks (DMBs). Net foreign assets of the DMBs are defined as foreign assets minus foreign liabilities. Foreign assets comprise gold and foreign currency holdings and claims on nonresidents. Foreign liabilities comprise all liabilities to nonresidents. 28. Adjusters. The ceiling on NDABS will be adjusted downward
by the amount of external budgetary assistance in excess of the programmed
level as set out in the table on quantitative performance criteria. The
ceiling on NDABS will be adjusted upward by the amount of external budgetary
assistance falling short of the programmed level as set out in the table
on quantitative performance criteria. IV. Domestic Interest Arrears 29. A continuous performance criterion applies to the nonaccumulation of domestic interest arrears on domestic debt contracted by the central government. Domestic interest payments are in arrears when the payment is not made on the due date, as specified in the contractual agreements. V. External Debt A. Medium-and Long-Term External Debt 30. A ceiling applies to the contracting and guaranteeing by the central government, the BOM, or other agencies on behalf of the central government of new debt with nonresidents with original maturities of over one year. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received. 31. The definition of debt, for the purposes of the program, is set out in Executive Board Decision No. 12274, Point 9, as revised on August 24, 2000 (see Annex II). 32. Excluded from the ceiling are (i) the use of Fund resources; (ii) adjustment lending from the World Bank, the Asian Development Bank and the International Fund for Agricultural Development (IFAD); (iii) debts incurred to restructure, refinance, or prepay existing debts, to the extent that such debt is incurred on more favorable terms than the existing debt; (iv) concessional debts; (v) loans from the Export- Import Bank of China for the Mongolian zinc mine project; and (vi) any togrog-denominated treasury bill and government bond holdings by nonresidents. 33. For program purposes, the guarantee of a debt arises from any explicit legal obligation of the central government, the BOM, or other agencies on behalf of the central government to service a loan in the event of nonpayment by the recipient (involving payments in cash or in kind), or indirectly through any other obligation of the central government, the BOM, or other agencies on behalf of the central government to finance a shortfall incurred by the loan recipient. 34. For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., grant element is equal to (nominal value minus NPV) divided by nominal value). The NPV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the OECD. For debt with a maturity of at least 15 years, the ten-year-average CIRR will be used to calculated the NPV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. For the purposes of the program through December 2002, the CIRRs published by the OECD in January 2002 will be used. For example, based on January 2002 CIRR rates, a U.S. dollar-denominated debt with a 12-year maturity and 5 years of grace would be considered concessional if the interest rate did not exceed 0.99 percent. Loans provided by a private entity will not be considered concessional unless accompanied by a grant or grant element provided by a foreign official entity equal to at least 35 percent of the combined loan. B. Short-Term External Debt 35. A ceiling applies to the contracting and guaranteeing by the central government, the BOM, or other agencies on behalf of the central government of new debt with nonresidents with original maturities of one year or less. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received. 36. For program purposes, the definition of debt is set out in Executive Board Decision No. 12274, Point 9, as revised on August 24, 2000 (see Annex II). The guarantee of a debt is defined in paragraph 33 above. 37. Excluded from the ceiling are (i) debts classified as international reserve liabilities of the BOM; (ii) debts to restructure, refinance, or prepay existing debts; (iii) togrog-denominated treasury bills, government bonds, and BOM bills held by nonresidents; and (iv) normal import financing. A financing arrangement for imports is considered to be "normal" when the credit is self-liquidating. VI. External PaymentS Arrears 38. A continuous performance criterion applies to the nonaccumulation of external payments arrears on external debt contracted or guaranteed by the central government or the BOM. External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreements. However, overdue debt and debt service obligations that are in dispute will not be considered as external payments arrears for the purposes of program monitoring. VII. Reporting 39. The authorities have committed themselves to using the best available data, so that any subsequent data revisions will not lead to a breach of a performance criterion. All revisions to data will be promptly reported to the Fund's Resident Representative, particularly when the changes are significant. The likelihood of significant data changes, including definitional changes, will be communicated to Fund staff as soon as the risk becomes apparent to the authorities. 40. Data required to monitor performance under the program, including those related to performance criteria and indicative targets, will be provided electronically or in hard copy to the Fund's Resident Representative by the 15th day of each month, unless otherwise indicated. The data to be reported are listed below, and the reporting responsibilities are indicated in parentheses. A. Monetary Data (BOM)
B. Fiscal Data (Ministry of Finance and Economy (MOFE)
C. External Sector Data (BOM and MOFE)
D. Other Data (National Statistical Office)
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