In the following interview with The UB Post, Resident Representative of the International Monetary Fund (IMF) in Mongolia Seok Hyun Yoon delves into the ongoing IMF-funded Extended Fund Facility (EFF), upcoming changes to the social insurance system, mortgage program, economic outlook for Mongolia and more.
MONGOLIA IMPROVED EXTERNAL BUFFERS IN 2 YEARS
It’s been around five months since your appointment as the IMF resident representative in Mongolia. What have you been doing over this time?
I took office at the end of July. I was quite excited to work in Mongolia as this is my first field assignment at IMF. Previously, I’d been working at IMF headquarters as a desk economist. I came here several times before I joined IMF. Before coming to IMF, I worked for the Asian Development Bank for four years and at the time, I was embarked on the Mongolia-China Cross Border Trade Facilitation Project. I came here several times in 2006 and 2007 and even got to visit the border area – Zamiin-Uud.
If I compare to 12 or 13 years ago, the landscape in Mongolia has significantly changed. There so many more skyscrapers and the city has totally changed. If I remember correctly, when I touched down at the airport 12 or 13 years ago, it was very boring from the airport to the city center. When I arrived this year, I was amazed.
Can you tell me your view on recent economic developments, FATF grey-listing and outlook for Mongolia?
I noticed that the economy has also significantly improved. This is good and I want to make small contributions to the economy.
Compared to two years ago when the IMF program started, the country has made significant progress. Two years ago, the public debt situation was very dire and the country had a hard time with the rolling over of debt, which led the country to request for the IMF program. Public debt to GDP ratio was close to 89 percent in 2016, but at the end of 2018, the ratio went down below 75 percent. In 2016, on the fiscal front, the primary fiscal balance, which can be controlled by the government, was -12 percent of GDP, and last year, it reached surplus of five percent of GDP. Over two years, a 17 percentage point improvement was seen in the primary fiscal balance, which is amazing. Therefore, public debt-to-GDP ratio has fallen significantly. This is a great achievement.
On the external front, foreign exchange reserves was just one billion USD in end-2016. Now, the latest data shows that the gross international reserves of Mongol Bank are about four billion USD. This means that over the past three years, the country strengthened its external buffers. Now, people aren’t worried about the public debt situation. The external debt situation has significantly improved.
On the other side, growth is the overall indicator to measure the country’s economic activity. In 2016, real GDP was just one percent. Last year, growth reached 6.9 percent and in the first quarter of this year, it reached 8.6 percent and 6.8 percent in the second quarter. Overall, growth in the first half of this year is 7.3 percent. This is quite an important achievement of the country. Since the IMF program started, the country managed to restore macroeconomic stability. The public debt has significantly gone down and the country was able to strengthen its policy buffers. We’re really happy with this and the country should be proud of this achievement.
However, there’s a dark side. Unfortunately, on the structure front, implementation of reform was somewhat slow. Of course, there were some successes in the reform. For example, we asked the government to strengthen their checks and balances function by establishing a fiscal council, an independent entity of the ministry that analyzes the budget revenue and expenditure. They can offer independent views to the Ministry of Finance when it designs the state budget. All advanced countries have checks and balances functions but Mongolia didn’t have it. And so, the country established the fiscal council in 2018.
Another good achievement is the country’s implementation of some steps for pension reform although this was led by the World Bank. However, as you’ve noticed, important structural reforms to improve the business climate to attract more FDIs for boosting country’s economic potential. For example, improving governance, reducing corruption, and strengthening transparency are lagging behind relative to peer countries.
In 2017, the Financial Action Task Force (FATF) warned Mongolia that the anti-corruption framework and implementation are lagging behind the international standard and that if the country doesn’t meet this requirement within two years, the country is going to be placed in the grey list. The government really worked hard, and progress in modernizing the legal framework was made. Nonetheless, some implementation did not fully meet the FATF standard and Mongolia was placed on the grey list.
The country received two warnings two years ago. One of it said that the country’s legal framework is not on a par with international standards and the other was that the implementation of anti-corruption efforts are not taking place. Mongolia made a huge progress in improving the legal framework and this time, FATF was happy with the anti-money laundering framework. The only issue is the implementation of the framework. Normally, the implantation takes time. Now, all government heads are strongly committed to implementing the proper steps. I strongly believe that the country will be able to get off the grey list very soon.
Another unfortunate case was the banking sector reform. In 2017 when we designed the program, we set a clear milestone for the banking sector reform. IMF believes this reform is crucial for the Mongolian economy as the country has an ambition to become a middle-income economy country status. Unfortunately, Mongolia’s banking and financial system remains underdeveloped and financial intermediation is relatively low. Mongolia’s GDP amounts to 12 billion USD but its population is three million people. This is relatively small compared to other countries, but 13 banks are competing against each other, which prevents banks from improving their health.
VOLUNTARY CONSOLIDATION RECOMMENDED FOR HEALTHIER BANKING SYSTEM
Are you suggesting that the number of active banks be reduced?
I’m not suggesting reduction. What I want to say is that out of the 13 banks, five big banks are dominating the market share. The ideal situation is voluntary consolidation of banks -- small banks will be willing to be purchased by big banks. If the economy is competing very well, we don’t need to worry about this.
There is no symptom or sign of consolidation. It’s purely up to bank owners but we want banks to be healthier and so we set some standards on capital adequacy for strengthening their capital buffers. This is important for the Mongolian economy. The country has an ambition to become middle-income economy status and banks have very important function in this. Normally, we describe the banking sector as the blood of the body. If the money or blood is not circulating well in the body (the economy), there will be problems. That’s why we put a lot of emphasis on the banking sector.
Why was there a delay in the forensic audit on banking recapitalization?
We requested for a forensic audit to verify the source of the capitalization of banks that were asked to increase their capital. Initially, the forensic audit was promised to be finished within two months. However, this concept of forensic audit was quite new to both Mongol Bank and the concerned six banks. It was originally seven banks but Capital Bank was closed in April this year.
In the first two weeks of July, auditor, Mongol Bank and the six banks had a hard time understanding the concept of a forensic audit, which took two weeks. So, the audit didn’t finish in August but in mid-September.
The audit discovered that some of the capitalization had problems. They were just accounting exercise without injecting money and some money injections was not allowed under the Mongolian legal system. Our program goal to make the banking sector adequately capitalized. Now, we’re waiting for the banks to fully recapitalize, which is one of the major IMF program conditionality. Until the conditionality is met, the program will continue to be delayed. The ball is now in Mongol Bank’s court.
Basically, the fiscal consolidation was successfully done, macroeconomic stability was achieved, and policy buffers has been strengthened. Unfortunately, the structure reform is a little bit slow and the country was placed in the grey list. But we hope that the country will get out of it soon if the country improves legal implementation.
The Mongolian authority and IMF are on the same page for the banking sector reform, and once the authorities confirm banks are adequately recapitalized, we can come back for the completion of the sixth review.
Do you consider these macroeconomic improvements as results of the IMF program?
It was partially achieved through the program and partially by the government. We put certain targets in the IMF program, but if the government didn’t assure any ownership of the program, this success wouldn’t have been achievable. Therefore, this is a joint success between IMF and Mongolian authorities.
Some people say that next year’s budget is expansionary. Do you agree with this?
We need to see from a balanced view. Compared to two years ago, state budget expenditure increased by about 50 percent. Compared to the 2019 state budget, the 2020 budget expenditure increased by 20 percent. This seems very big but we also need to looks at the revenue side. For the past two years, the revenue projection is undershot. In other words, the actual revenue exceeded revenue forecasts. This time, the Ministry of Finance and IMF looked into the revenue projection and next year, revenue is expected to increase by 17 percent, which means that the overall revenue/ expenditure gap is relatively small.
The election will happen next year. Even though next year’s budget is a little bit expansionary, the overall balance is quite squared. Next year’s budget was formulated to match expenditure in line with revenue increase.
Next year, growth will be about 5.5 percent based on our projection. The government’s projection is around 6.5 percent. The economy is still growing, balanced budget envisages no additional borrowing, and denominator is growing. The public debt-to-GDP will continue to fall. Even though the 2020 budget is a bit expansionary, the overall balance is squared and the debt will continue to go down. IMF did not disagree to the 2020 state budget.
Our recommendation is that the country still needs to maintain the fiscal sustainability because debt-to-GDP is still elevated. Substantial amount of the country’s public debt will mature in 2021 to 2024. To smoothly rollover the existing debt, the country needs to show fiscal prudence to lenders. Given this background, we recommended that Mongolia run one percent GDP of primary fiscal surplus in 2020. This year, we expect about three percent surplus of the primary fiscal balance. Next year, with higher expenditure, the surplus might be lower than this year. Next year’s government budget is broadly aligned with our expectations.
The IMF program will end next year. Do you think you’ll be able to finish the 10 reviews on time?
It’s too early to say. Until banks are fully recapitalized, the review of the current program is not taking place.
Subsequent reviews after 6th review can be discussed after we confirm that banks are fully recapitalized.
You mentioned about Mongolia being placed on FATF grey list. What are the potential risks posed to Mongolia from this?
The immediate impact is quite limited – it’s purely psychological impact. For couple of days after the announcement, exchange rate was under pressure, but now it’s stabilized. People didn’t recognize any immediate impact. From my interpretation, this is purely psychological impact – sentimental impact. Now, people are realizing that there isn’t immediate impact and their confidence in the economy is improving. This is good.
If the country is not able to get off the list soon, there will be some long-term impact. Mongolia has made a huge improvement in this area and only lagging behind in the implementation side. If the country meets the implementation requirement, Mongolia can get off the list. Western banks are still maintaining their relations with local banks. However, if this case goes long, they could increase their compliance cost, which means they will charge higher costs for transactions of customers. So customers will not be too happy about it. It is important for the country to show progress in the implementation.
All development partners and donors, bilateral partners such as embassies are assisting the government. We are getting together oftentimes to check with authorities in which areas they need help and assistance to improve their implementation (of anti-money laundering framework). One of the weakness areas is the customs checkpoint. Mongolia has a huge territory and customs have limited number of staff and limited machines, which means they can’t properly detect money laundering. People can easily carry out cash through their bag but it was not properly monitored at customs. Therefore, FATF raised this issue. This is purely implementation. If your customs do a proper job, there will not be any money laundering through the border. Donors and development partners stand ready to assist the authorities in fixing problems. They can provide the money needed to purchase more machines. Also, next year’s budget has made increases for increasing the concerned staff including police and customs budget and civil workers’ pay. Authority is already making progress. If authorities continue to make progress, FATF will recognize it and get it out of the grey list. We should encourage the government to implement decisive action plans.
MODERATE PENSION INCREASE ADVISED
The next topic I’d like to discuss is the social insurance premium increase for next year. Is it necessary to raise the social insurance premium by two percent?
The pension system in Mongolia plays a crucial role of income redistribution via its support for lower- and middle-income Mongolians. To continue to play such a role, it must be adequately financed. However, the pension deficit has continued to increase due to pension payments exceeding of collected pension premiums.
In the context of the IMF-supported program agreed in 2017, the Mongolian authorities committed to increase the social security contribution rate by five percentage points over three years. In making this commitment, the authorities aimed to strengthen the sustainability of public finances, particularly with respect to the pension system. Particularly, Mongolia’s pension system remains vulnerable. Without increases in the contribution rate, the deficit in the pension system is projected to rise to six percent of GDP in 2030 and 11 percent of GDP in 2050, according to an analysis by the World Bank.
Against this backdrop, therefore planned 2 percent increase of social security contribution rate is a critical step to ensuring the sustainability of the pension system.
IMF only asked to raise tax revenue, not specifically demand the social insurance premium rate be increased. Isn’t it better to raise the number of taxpayers rather than increase the rate?
In general, to make the fiscal budget sound, eventually the country will need to increase the tax revenue. There are two ways to raise tax revenue. One way is to increase the number of taxpayers. The other is to increase the tax rate. On the former, you noticed that Mongolia has a huge informal sector. Some of the people don’t pay tax properly. Therefore, tackling the informal sector is very important and this is connected to corruption. We emphasize the importance of reducing corruption. If the country reduces corruption, the size of the informal sector will fall, the number of taxpayers will increase, and the country’s tax revenue will be higher. This doesn’t happen in a day. It takes time to reduce corruption, reduce the size of informal economy and increase the number of taxpayers. It is a sequence of steps.
Also, increasing the tax rate is quite difficult because people don’t want to pay higher tax. It should be done in the right balance. In the short-term, the focus is on expenditure management. Expenditure growth should be controlled within the revenue increase. Once the revenue increases further by increasing the number of taxpayers and increasing the tax rate, expenditure can increase as well.
I want to emphasize that Mongolia has made significant improvements so far but still the country has not fully overcome the crisis situation and the country should calm down its expectations a little bit.
What kind of expectations do you mean?
I noticed that the Confederation of Mongolian Trade Unions demonstrated because they are not happy with the pension increase. However, compared to two years ago when the IMF program started, this pension increase was put on hold. Now given the better fiscal condition, some of the pension increase was accommodated in next year’s budget. This is somewhat improvement. Of course, this increase was not sufficient to meet the people’s expectation but the increase should be gradual.
What would you recommend to get the informal sector to pay tax?
That is related to corruption. Reducing corruption and improving governance, particularly improving transparency, is important. Every country has informal economy. We don’t know the size of the Mongolian informal sector, which means that it could be quite substantial. Tackling the informal economy doesn’t happen in a day. It’s a long process. Therefore, we’re emphasizing corruption reduction and governance improvement. This is related to the grey list.
TUGRUG LOSES VALUE 6 PERCENT ANNUALLY
There’s also the mortgage issue. IMF urged Mongol Bank to stop all government-funded projects. Can I get your insight to this matter?
Mongol Bank is a central bank. It is responsible of maintaining price stability. If inflation is high, people’s real income will fall so everybody will lose their wealth and benefit.
If you wish to improve people’s standard of living, Mongol Bank should pay attention to controlling inflation. Currently, Mongol Bank’s inflation target is eight percent. Compared to several years ago, eight percent is relatively low. However, if you compare it to other countries, it remains high. For example, the US is targeting to keep inflation at two percent. This means that in general, the Mongolian tugrug currency is losing its value six percent a year (against US dollar). To avoid currency depreciation, Mongolia’s inflation should be the same as US dollar inflation, but two percent inflation is quite far. It’s difficult to achieve because a lot of financing is being provided by Mongol Bank, which will cause tugrug to lose value. Therefore, we’re against the mortgage financing program.
Other institutions such as ADB and Korea Exim Bank are providing housing financing. Money from China will come to finance housing. So there is sufficient mortgage financing even if Mongol Bank stops its financing. We need to look at the broad picture.