The World Bank Called for Tighter Economic Policies to Restore Economic Stability

by CFI | July 3, 2014 9:31 am

In its newly released Mongolia Economic Update, the World Bank said that the Mongolian economy is facing challenges from the large balance of payments pressure and high inflation. The World Bank underscored that the economic vulnerability will likely continue under the current growth-oriented policies and urged that monetary and fiscal policies be tightened in order to restore economic stability and maintain financial soundness.

Three years of growth-oriented economic policies have successfully supported double-digit economic growth but also led to large economic imbalances. The Government and monetary authorities implemented strong economic stimulus measures in 2013 as the country gradually was losing growth momentum amidst falling foreign investment and the weakening global minerals market. Expansionary policies relying on quantitative easing and external debt-financing contributed to the country maintaining double-digit economic growth last year despite the weakening external environment. The policy-induced high growth, however, also came with significant balance of payments pressure and high inflation. The current account deficit remained close to 30 percent of GDP in 2013 for the third consecutive year, while the foreign direct investment (FDI) in 2013 dropped to half of its level from the year before. Double-digit inflation continued since mid-2013 and picked up to 13.7 percent in May.

“In 2014, the economy is undergoing an adjustment in response to the large external and internal imbalances. Domestic demand is now under growing pressure from high inflation and continued currency depreciation. Inflation rate exceeded nominal household income growth in the first quarter according to the World Bank’s estimation. Annual economic growth is expected to soften to 9.5 percent in 2014 reflecting waning domestic demand. Considering the still high domestic credit growth and currency depreciation, inflation will likely remain at a double-digit level for the remainder of the year.”

– Taehyun Lee, World Bank Senior Economist

Large balance of payments pressure will likely persist in 2014. The current account deficit will likely narrow in 2014 due to weak imports and stronger copper exports. However, surplus of capital and financial account is also dropping amidst further dampening of the FDI. The overall external financing gap of the balance of payments is easing this year compared with the year before but the financing gap of the first five months still remained high, reaching over five percent of expected annual GDP of 2014. The international reserve level in May declined to US$1.6 billion, down by 61 percent from its peak at the end of 2012. The reserve level is still enough to cover around three months of imports and the bilateral currency swap line with neighboring China will be able to provide a significant buffer. However, economic policies need to focus on addressing the large external imbalance to ensure stable and sustainable economic growth.

The World Bank also underscored the importance of close monitoring on deteriorating asset quality of banking sector. As domestic credit increased by over 50 percent over the last twelve months, the size of non-performing loans and past-due loans more than doubled to MNT 1 trillion in May, up from MNT 464 billion in the same month the year before. The NPL ratio remains relatively moderate but the ratio has been also growing in recent months. Close attention is also needed to signs of overheating of the housing market and the rising household debt, added the World Bank’s economic report.

The World Bank called for tighter monetary and fiscal policies and strengthened supervision on the banking system. “The recent signs of weakening aggregate demand reflect inevitable adjustment of the economy to restore domestic and external economic balances. Further economic stimulus relying on quantitative easing and large off-budget spending may not be much effective and will likely add to pressures on inflation and currency value. It would also likely accelerate depletion of international reserves through a slower adjustment of the balance of payments imbalance. Key task for economic policies now is to safeguard the economy from reaching more vulnerable situation. During the adjustment process, economic growth may become slower than previous years but will still remain higher than many other developing countries.” said Taehyun Lee, the World Bank Senior Economist and Acting Country Manager.

Monetary policy needs to be tightened to address high inflation. Recent indicators show signs of a gradual tightening of the expanded balance sheet of the central bank. Continued tapering of quantitative easing would help ease inflationary pressure over time. Financial sector policy should focus on ensuring financial stability and enforce proper prudential regulations to banking operations including policy lending programs. Fiscal policy should adhere to the fiscal discipline of the Fiscal Stability Law. Legal institution for fiscal discipline is already in place, but implementation still remains questionable. Under the current trend, overall fiscal deficit will reach 10 percent of GDP due to continuous off-budget spending after 10.9 percent of GDP last year. Off-budget spending needs to be consolidated into the budget and the fiscal deficit needs to be kept within the target of the Fiscal Stability Law.

“No one can deny the great potential that Mongolia has. The country has proven it over the last three years with amazing growth and reduced poverty rate. Yet, the road to the future prosperity is a long-term process and the economy is facing short-term challenges in the middle of the road that need to be overcome by tighter and stability-oriented economic policies.” concluded Chorching Goh, the World Bank Lead Economist for China, Mongolia and Korea.

Source URL: https://cfi.co/asia-pacific/2014/07/the-world-bank-called-for-tighter-economic-policies-to-restore-economic-stability/

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