MONGOLIA ECONOMIC UPDATE Sustaining the Gains Special Focus – Distributional Impacts of Mongolia’s Fiscal System November 2024 MONGOLIA ECONOMIC UPDATE Sustaining the Gains November 2024 2 Mongolia Economic Update – November 2024 © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. Cover Photo: © Myroslav / Adobe Stock Chapter 1 Photo: © Michal / Adobe Stock Chapter 2 Photo: © Kertu / Adobe Stock Mongolia Economic Update – November 2024 3 CONTENTS Executive Summary 7 Chapter 1: Recent Economic Developments and Outlook 13 1. Recent Economic Developments 14 Economic growth is driven by mineral production and boosted through domestic 1.1. 14 demand Headline inflation gradually declined, prompting the central bank to cut its policy 1.2. 17 rate 1.3. Despite continued high spending, the budget remains in surplus 19 1.4. Amid soaring imports bill the current account balance shifted to a deficit 23 2. Outlook, Risks, and Policy Recommendations 25 Chapter 2: Distributional Impacts of Mongolia’s Fiscal System 29 1. Distributional Assessment of the Fiscal System 30 1.1. The fiscal system is effective in reducing poverty and income inequality 30 Direct transfers yield the greatest impact on both poverty and inequality while 1.2. 32 taxes have marginal redistributive effects 2. Policy Recommendations 36 4 Mongolia Economic Update – November 2024 List of boxes, figures, and tables Box 1. Government Action Plan 2024-2028 20 Box 2. The Newly Established Sovereign Wealth Fund: Structure and Purpose 22 Boxes Box 3. Global and commodity price outlook 27 Box 4. Impact of fiscal interventions on households of different income levels 32 Box 5. Assessment of the impact of in-kind transfers on income inequality 35 Figure 1. Mongolia is re-classified as an upper middle income country after nearly a decade 14 Figure 2. The loss in agriculture production was mainly offset by greater activities of trade, services, and 15 mining Figure 3. … with the mining sector still dominated by coal 15 Figure 4. Increased domestic demand drove economic growth, though part of this was offset by rising 16 imports Figure 5. … and loss of adult livestock undermining investment growth 16 Figure 6. A substantial rise in household real income fueled the growth in private consumption 17 Figure 7. Labor force participation improved beyond its pre-pandemic average 17 Figure 8. Inflation pressure from imported prices moderated … 18 Figure 9. … while domestic food prices (excluding meat) remain elevated 18 Figure 10. Headline inflation fell within the BOM’s target range, prompting a reduction in the policy rate 19 Figure 11. Lending to businesses recovered 19 Figure 12. Public sector wages strongly increased 19 Figure 13. Taxes on income and trade were notably high 21 Figures Figure 14. Budget revenue remained highly dependent on mining associated revenues, especially on coal 21 exports Figure 15. Government budget is in surplus for the second consecutive year 22 Figure 16. The current account deficit re-emerged with a shrinking goods trade balance 23 Figure 17. The import bill increased strongly, driven by greater imports of capital goods and consumer 24 goods Figure 18. Export earnings growth was modest amid weaker coal price 24 Figure 19. FDI inflows improved, partially offseting the weaker current account balance 24 Figure 20. Direct transfers have greater effectiveness in reducing poverty 31 Figure 21. It also has a strong impact on reducing income inequality 31 Figure 22. Direct transfers are more redistributive and poverty reducing, but costly on the budget 33 Figure B.1. Global economic growth is projected to stabilize at a moderate level 27 Figure B.2. Commodity prices are expected to weaken 27 Figure B.3. Households in lower income deciles receive greater fiscal benefits, in absolute terms… 32 Figure B.4. … and relative to their pre-fiscal income 32 Figure B.5. Public education services mostly benefit the poor, while the impact is mixed for health benefits 35 Table ES.1. Selected macroeconomic indicators 11 Tables Table 1. Selected macroeconomic indicators 26 Table 2. Fiscal interventions modeled in the CEQ 30 Mongolia Economic Update – November 2024 5 ABBREVIATIONS BOM Bank of Mongolia CEQ Commitment to Equity CIT corporate income tax CMP Child Money Program CPI consumer price index DBM Development Bank of Mongolia DF Development Fund ES executive summary FDI foreign direct investment FHF Future Heritage Fund FSF Fiscal Stabilization Fund FSP Food Support Program (former Food Stamp Program) GDP gross domestic product HSES Household Socio-Economic Survey LFPR labor force participation rate LMIC lower-middle-income country MEU Mongolia Economic Update MOF Ministry of Finance, Mongolia MUB Municipality of Ulaanbaatar NPL non-performing loan NSO National Statistics Office, Mongolia OT Oyu Tolgoi PBOC People’s Bank of China PF Provident Fund PIT personal income tax PPP purchasing power parity PPI producer price index SOE state-owned enterprise SSC social security contributions SWF Sovereign Wealth Fund UMIC upper-middle-income country VAT value added tax 6 Mongolia Economic Update – November 2024 ACKNOWLEDGEMENTS This edition of the Mongolia Economic Update was prepared by Undral Batmunkh (Economist), Jose Luis Diaz Sanchez (Senior Economist), Dulmaa Enkhtuya (Extended Term Consultant), and Erdenebulgan Ganbat (Consultant). Chapter 2 draws from the forthcoming World Bank report "Commitment to Equity" prepared by Lydia Kim (Economist, EEAPV). The MEU was prepared in under the guidance of Mara K. Warwick (Country Director), Sebastian Eckardt (Practice Manager), Tae Hyun Lee (Country Manager), and Elitza Mileva (Lead Economist). The team is grateful to Javkhlan Bold-Erdene (External Affairs Associate) for the support on communication affairs and Angar Enkhtur (Program Assistant) and Sukhchimeg Tumur for administrative support. ar The findings, interpretations, and conclusions expressed in this update are those of World Bank staff and do not necessarily reflect the views of the Executive Board of the World Bank or the governments they represent. For information about the World Bank and its activities in Mongolia, please visit https://www.worldbank.org/en/country/mongolia. For questions and comments on the contents of this publication, please contact Undral Batmunkh (ubatmunkh@worldbank.org). The cutoff date for this edition of the MEU is September 30, 2024. Mongolia Economic Update – November 2024 7 EXECUTIVE SUMMARY Mongolia's coal-driven economic growth since growth in public consumption and investment, 2023 has elevated the country to upper-middle- both increasing by over 45 percent y-o-y in the first income status (UMIC) in 2024 (Figure ES1). The half of the year. Private consumption surged by mineral boom has significantly boosted both 16.9 percent y-o-y, the highest in the past decade, private sector incomes and public finances, fueling supported by rising real incomes from gradually a surge in domestic demand. However, this surge declining inflation, wage growth, improved is putting pressure on the balance of payments, labor market conditions, and an acceleration in as imports outpace revenues from commodity consumer lending. Meanwhile, private investment exports. While advancing major infrastructure rose by 10.9 percent y-o-y in H1 2024, bolstered projects could prop up growth, the rapid scale-up by bank lending and foreign direct investment of investments and procyclical fiscal spending (FDI). However, the strong growth in domestic also risks creating inflationary pressures and demand led to a sharp increase in import volumes, imbalances in both external and fiscal accounts. particularly for investment goods and consumer Additionally, ongoing reliance on mining leaves durables, which rose by about 20 percent y-o-y. Mongolia vulnerable to external shocks while the This import surge more than offset the positive focus on coal further exacerbates climate and contributions from robust exports to GDP growth. development challenges (Figure ES1). Headline inflation remained within the central Real GDP growth has remained robust, driven by bank’s target range (6±2 percent), prompting mining and transport services, despite a sharp the Bank of Mongolia (BOM) to lower the contraction in the agriculture sector. Economic policy rate by a total of 300 basis points in growth held steady at 5.7 percent year-on-year 2024. Inflation fell to 6.7 percent by September (y-o-y) in the first half of 2024, with recent high- 2024, down from 7.9 percent at the end of 2023. frequency data indicating continued momentum Imported inflation eased gradually, supported by into the third quarter (Figures ES2). The strong declining international food and fuel prices and performance is largely attributed to a sustained a stable exchange rate, while price increases for surge in mining (principally coal, and, to a lesser domestically produced goods (excluding meat) extent, copper) and transportation services moderated throughout the year. In response to for exports, supported by strong demand declining inflationary pressures, the BOM reduced for Mongolian coal from China. In contrast, the policy rate three times in 2024, from 13 agricultural production experienced a substantial percent to 10 percent (Figure ES4). Although this decline due to the most severe dzud—a natural easing has had limited impact on lending rates disaster marked by extreme cold and heavy — partly due to the continuation of substantial snowfall—since 2009–2010. Other sectors, such subsidized lending programs — credit growth has as trade and other services, showed solid growth, accelerated, fueled by strong expansion in both supported by rising incomes. consumer and business lending. On the demand side, domestic demand was a Boosted by increased income and trade-related key driver of growth, while the contribution of revenues, the fiscal balance remained in surplus net exports to economic growth turned negative despite sustained high spending (Figure ES5). despite strong export performance (Figure ES3). Higher wages in both the private and public sectors Procyclical fiscal spending fueled significant and increased corporate income (including from 8 Mongolia Economic Update – November 2024 coal revenue) contributed to robust revenue public investment under the government’s four- gains. At the same time, both current and capital year action plan and private investment bolstered expenditures rose significantly. Overall, in the first by expanded bank lending amid a less restrictive nine months of 2024, Mongolia recorded a budget monetary policy, are also projected to sustain surplus of 3.1 percent of GDP, as strong revenue growth. However, this impact may be partially growth outpaced the rise in spending. Combined offset by an increase in imports of investment with strong nominal GDP growth, this surplus goods. helped reduce the public debt-to-GDP ratio to 38.2 percent by mid-2024, down from 44.4 percent at Robust domestic demand is expected to drive the end of 2023. inflationary pressures, and lead to moderate fiscal deficits and sizable current account The current account balance shifted to a deficit deficits. Procyclical fiscal spending, combined amid a soaring import bill, limiting reserve with rising household incomes, is projected to accumulation despite improvements in net FDI revive demand-driven inflation in the second inflows (Figure ES6). While increased coal exports, half of 2024, pushing average headline inflation and to a lesser extent, copper exports, supported to 7.0 percent for the year and to rise further steady export revenue growth, a rapid expansion to 8.0 percent in 2025. These factors are also of imports—driven by strong domestic demand— expected to result in a moderate fiscal deficit for pushed Mongolia’s current account back into the next two years (0.8 percent of GDP in average deficit (5.6 percent of GDP by September 2024, over 2024-2025), despite sustained mining and compared to a surplus of 2.1 percent during the non-mining revenues. Together with declining same period in 2023). Despite improved net FDI commodity prices, robust domestic demand is inflows, weaker current account performance, expected to result in widening current account increased interventions by the BOM to stabilize deficits (7.0 percent of GDP in average over the the nominal exchange rate, and BOM's repayment same period). of US$620 million on its currency swap line with the People's Bank of China, constrained reserve The medium-term growth outlook remains accumulation. As a result, gross international favorable, supported by both mining and non- reserves remained broadly stable at US$4.7 mining sectors. After the 2025 surge in OT's billion (equivalent to 3.0 months of imports) by mineral output, mining production is projected September 2024, down from US$4.9 billion at the to moderate, with non-mining sectors—such end of 2023. as trade and services, and agriculture—driving economic growth, which is forecast to average After steady growth in 2024, Mongolia’s 6.0 percent in 2026-2027. On the demand side, economic expansion is expected to accelerate public consumption and investments under the in 2025, driven by increased OT mining government’s four-year action plan are expected production more than offsetting weaker coal to fuel growth. output. Growth is projected to reach 5.3 percent in 2024, supported by strong private consumption The outlook is subject to significant downside and procyclical fiscal spending(boosted by the risks. Domestically, greater-than-expected fiscal 2024 supplementary budget), though tempered spending could stimulate economic growth by rising imports. In 2025, growth is projected but also stoke inflationary pressures and widen to rise to 6.5 percent (Table ES1), with the boost fiscal and current account deficits. Climate primarily coming from higher OT mine production change heightens the risk of more frequent and and a modest recovery in agriculture following the severe natural disasters with potential significant 2024 dzud which together will compensate for economic consequences, especially for poor lower coal production. On the demand side, public and vulnerable households, as highlighted in the and private consumption are expected to remain World Bank’s 2024 Mongolia Country Climate robust and continue to drive growth. Exports— and Development Report. Externally, Mongolia led by increased copper and gold—together with faces potential challenges from slower-than- expected global growth, which could weaken Mongolia Economic Update – November 2024 9 external demand and lower prices for key export In addition, Mongolia should consider reforms commodities. Additionally, escalating geopolitical to its fiscal system to enhance its effectiveness tensions could drive up fuel prices, resulting in and efficiency in tackling poverty and income higher imported inflation, increased production inequality. The special chapter of this MEU costs, and a larger import bill. (Chapter 2) summarizes the findings from a forthcoming World Bank analysis (“Commitment Maintaining the macro-fiscal gains from the to Equity”) on the distributional impacts of the ongoing mineral export boom will require Mongolia’s fiscal system. This analysis reveals prudent macroeconomic management. A recent that while the fiscal system—encompassing World Bank report¹ recommends policies to both taxation and transfers—has a marginal strengthen fiscal sustainability and support an effect on reducing poverty, it exhibits strong independent monetary policy to anchor inflation broad-based redistributive effects. The chapter to enhance macroeconomic stability. Fiscal proposes recommendations for achieving more reforms should focus on: (i) gradually scaling back equitable outcomes while further reducing pandemic-era social assistance while making it poverty. The chapter recommends: i) undertaking more progressive and responsive; (ii) reforming revenue reforms to enhance the fiscal system’s subsidies in energy, agriculture, and pensions; and redistributive effect; ii) allocating revenue to more (iii) reducing fiscal risks from contingent liabilities. cost-effective and poverty-targeting transfer Phasing out quasi-fiscal activities, such as the programs; and iii) establishing a comprehensive subsidized mortgage program, and prohibiting reform strategy that balances measures for such financing under the central bank’s mandate short-term poverty and inequality reduction will enhance the central bank’s independence and with those that offer longer-term benefits, credibility in anchoring inflation, while enabling such as investments in human capital, physical for greater exchange rate flexibility. infrastructure, and institutional development. Mongolia is re-classified as an The loss in agriculture production Figure ES. 1 upper middle income country after Figure ES. 2 was mainly offset by greater nearly a decade activities of trade, services, and mining GNI per capita, Atlas method, in US$ Contributions to GDP y-o-y growth, by production sectors 14% Agriculture Mining & transportation 5,000 Other industry Other services Upper middle Trade & taxes GDP growth income threshold 4,000 9% 3,000 4% 2,000 -1% 1,000 Lower middle income threshold 0 -6% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2021 2022 2023 2024H1 Source: NSO; World Bank staff estimates. Source: NSO. Note: Bars reflect percentage contributions to y-o-y GDP growth 1 World Bank, 2024. “Agenda for Action: Key Policy Recommendations for Mongolia’s Sustainable Development Vision”. 10 Mongolia Economic Update – November 2024 Increased domestic demand drove Headline inflation fell within the Figure ES. 3 economic growth, though part of Figure ES. 4 BOM’s target range, prompting a this was offset by rising imports reduction in the policy rate Contributions to GDP y-o-y growth, by demand components Monetary policy rate, inflation target, and headline inflation Private consumption Public consumption Lending rate Policy rate Headline inflation Gross fixed investments Net exports GDP growth 20% 30% 15% 20% 10% 10% 0% -10% 5% -20% 0% -30% Jan Mar May Jul Sep Nov Jan Mar May Jul Sep 2021 2022 2023 2024H1 2023 2024 Source: NSO. Source: BOM and NSO. Note: Bars reflect percentage contributions to y-o-y GDP growth. Note: The figure shows the average lending rate on newly issued loans outside the government’s subsidized programs. Government budget is in surplus for The current account deficit re- Figure ES. 5 the second consecutive year Figure ES. 6 emerged with a shrinking goods trade balance Fiscal balances, percent of GDP Current account balance and its components, in percent of GDP 20% 4% Goods balance 15% Services balance 2% Income balance 10% Current account balance 0% 5% 2.1% -2% 0% Overall balance - 5.6% -4% -5% Structural balance - 9.8% -6% -10% Primary balance -8% -15% - 10.0% - 10.2% -20% Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep 2020 2021 2022 2023 2024 Average of Average of 2022 2023 2024 2018-19 2020-21 Sources: MoF; World Bank staff estimates. Source: BoM. Note: Structural balance is defined by the government as the overall fiscal balance net of fiscal saving funds. Mongolia Economic Update – November 2024 11 Table ES. 1 Selected macroeconomic indicators 2022 2023 2024f 2025f 2026f 2027f Real GDP Growth, at constant market prices 5.0 7.2 5.3 6.5 6.1 5.9 Private Consumption 8.1 9.7 8.4 5.0 6.8 6.4 Government Consumption 6.9 3.2 22.0 4.6 6.8 5.9 Gross Fixed Capital Formation 13.2 5.3 18.0 7.9 6.2 4.1 Exports, Goods and Services 32.3 33.2 5.1 23.9 2.4 5.7 Imports, Goods and Services 29.1 18.9 10.2 15.9 3.9 5.5 Real GDP Growth, at constant factor prices 4.2 7.5 5.3 6.5 6.1 5.9 Agriculture 12.0 -8.9 -23.0 5.0 6.5 4.5 Industry (including mining) -4.5 12.9 8.3 11.5 6.1 6.2 Services 6.9 9.9 11.0 4.1 6.1 6.0 Inflation (CPI, period average) 15.2 10.4 7.0 8.0 8.5 8.5 Current Account Balance (% of GDP) -13.2 0.6 -7.8 -6.2 -7.1 -10.9 Net FDI, Inflow (% of GDP) 13.9 7.3 8.7 6.7 6.2 8.0 Fiscal Balance (% of GDP) 0.7 2.6 -0.9 -0.7 -1.0 -1.1 Primary Balance (% of GDP) 2.1 4.2 0.6 0.8 0.6 0.3 Debt (% of GDP) 62.1 44.4 43.3 42.2 42.0 40.6 Source: World Bank staff estimates. Note: Public debt does not include the BoM’s liability under the PBOC swap line (3.4 percent of GDP as of Sep 30, 2024). 12 Mongolia Economic Update – November 2024 Mongolia Economic Update – November 2024 13 CHAPTER 1 RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK Mongolia's coal-driven economic growth since While major infrastructure projects could prop 2023 has lifted the country to upper-middle- up growth, the rapid scale-up of investments and income status (UMIC) in 2024 (Figure 1). The fiscal expansion also poses risks of inflationary mineral boom has significantly boosted both pressures, fiscal inefficiencies, and imbalances private sector incomes and public finances, in both fiscal and external accounts. Additionally, sparking a surge in domestic demand. However, continued reliance on mining leaves Mongolia this surge is generating balance of payments vulnerable to external shocks. The focus on pressures as imports outpace revenues from coal further exacerbates both climate and commodity exports. development challenges.² 2 Mongolia first attained UMIC status in 2015, following years of a mineral boom. However, this status was short-lived, lasting only a year, as external shocks to the mineral sector and expansionary macroeconomic policies led to a twin crisis in 2016. 14 Mongolia Economic Update – November 2024 Figure 1. Mongolia is re-classified as an upper middle income country after nearly a decade GNI per capita, Atlas method, in US$ 5,000 Upper middle income 4,000 threshold 3,000 2,000 Lower middle income 1,000 threshold 0 Source: NSO; World Bank staff estimates. 1. RECENT ECONOMIC DEVELOPMENTS 1.1. Economic growth is driven by mineral production and boosted through domestic demand Mongolia's economic growth has remained as the Oyu Tolgoi (OT) underground copper mine strong, driven by mining and transport services continues to build the infrastructure required for offsetting a decline in agricultural production. full capacity, copper concentrate output increased Growth reached 5.7 percent year-on-year (y-o-y) by just 4.3 percent y-o-y in the first half of 2024. in the first half of the year, down from 7.2 percent Nevertheless, this modest growth partially offset in 2023, with more recent higher-frequency data declines in the production of other commodities, indicating that this momentum continued into such as crude oil and gold. the third quarter. The mining and transportation sectors expanded by 15.4 percent and 24.7 The agriculture sector was severely impacted percent y-o-y, respectively, contributing nearly by the dzud, a natural disaster. This extreme half of total economic growth in H1 2024 (Figure weather event, marked by severe cold and heavy 2). Coal production surged by 36.4 percent snowfall, struck Mongolia at a scale not seen y-o-y, accounting for almost the entire mining since the devastating dzud of 2009–2010. The sector’s growth (Figure 3),³ and driven by strong disaster led to the loss of 8.1 million livestock by demand from steel producers and power plants the middle of the year, representing 12.5 percent in northern China.4 As a result, total freight of the national herd, with nearly half of the transported via road (principally coal) increased breeding stock either miscarrying or perishing. As by 34.0 percent y-o-y, becoming the main driver of a result, the agriculture sector contracted by 26.7 the transportation sector’s expansion. In contrast, percent y-o-y in the first half of 2024, following an 3 By mid-2024, Mongolia’s coal production (both coking and thermal coal) reached 47.8 million tons, rising further to 72.2 million tons by September, a 28.0 percent y-o-y increase. Approximately one-third of this total was produced by the state-owned coal miner, Erdenes Tavan Tolgoi JSC. 4 Despite a weakening property market in China, overseas demand for Chinese steel remained strong this year, driving high demand for coking coal. Mongolia's coking coal was also preferred due to its discounted price (a 30 percent discount compared to its competitors). Mongolia Economic Update – November 2024 15 8.9 percent decline in 2023, marking the second This was largely fueled by increased activity in consecutive year of decline due to harsh winters. wholesale and retail trade and other services sector, supported by rising incomes and fiscal Other sectors, such as trade and other services, expansion. The construction sector also experienced robust growth driven by accelerating contributed to this growth, albeit to a lesser extent, demand. Excluding mining, agriculture, domestic demand. domestic driven by significant public capital investments in and transportation services, growth in the infrastructure projects (see subsequent section remaining sectors surged to 9.4 percent in the on demand). first half of 2024, up from 6.3 percent in 2023. The loss in agriculture production was … with the mining sector still Figure 2. mainly offset by greater activities of Figure 3. dominated by coal trade, services, and mining Contributions to GDP y-o-y growth, by production sectors Contributions to nominal growth of gross fixed capital formation 14% Other services Mining & transportation Coal Copper Mining production growth Trade & taxes Agriculture Gold Others Other industry GDP growth 40% 9% 30% 20% 23.4% 4% 10% 15.4% 0% 0.8% -1% -10% -20% -15.3% -6% -30% 2021 2022 2023 2024H1 2021 2022 2023 2024H1 Source: NSO. Source: World Bank staff estimates based on NSO database. Note: Bars reflect percentage contributions to y-o-y GDP growth. Note: Bars reflect percentage contributions to y-o-y growth in mining GDP. On the demand side, public consumption and Private investment also increased by 10.9 percent investment were key drivers of growth. Public y-o-y in H1 2024, bolstered by bank lending and consumption surged by 46.9 percent y-o-y in foreign direct investment (FDI).5 However, the H1 2024, while public investment grew by 49.1 severe loss of adult livestock due to the harsh percent (see Section 1.3). Public consumption weather conditions significantly depleted livestock alone contributed 9.3 percentage points to overall capital, leading to a reduction in inventories as GDP growth, with public investment adding an fewer offspring were born (Figure 5). additional 3.1 percentage points. 5 See Sections 1.2 and 1.4 for details on bank lending and foreign investment. 16 Mongolia Economic Update – November 2024 Increased domestic demand drove … and loss of adult livestock Figure 4. economic growth, though part of this Figure 5. undermining investment growth was offset by rising imports Contributions to GDP y-o-y growth, by demand components Contributions to nominal growth of gross fixed capital formation Private consumption Public consumption 40% Gross fixed investments Net exports GDP growth 30% 30% 20% 20% 10% 10% 0% 0% -10% Intangible assets -10% Cultivated biological assets Machinery and equipment -20% -20% Building Gross fixed capital formation -30% -30% 2021 2022 2023 2024H1 2021 2022 2023 2024 H1 Source: NSO. Source: NSO. Note: Bars reflect percentage contributions to y-o-y GDP growth. Note: Nominal decomposition of gross fixed capital formation is depicted due to data availability. Cultivated biological assets mostly refer to the herd of adult livestock. Private consumption expanded significantly Labor market conditions improved, marked by in the first half of 2024, driven by rising real rising labor force participation and sustained incomes and strong growth in personal lending. employment growth. In the first half of 2024, Private consumption growth accelerated to the labor force participation rate averaged 61.7 16.9 percent y-o-y, up from 9.7 percent in 2023, percent, surpassing its pre-pandemic average contributing 12.1 percentage points to overall (2018–2019) for the first time in four years economic growth (Figure 4). This momentum (Figure 7). Growing labor demand, as reflected in was largely fueled by a substantial increase employment growth of 5.8 percent in H1 2024— in household real income, which rose by 18.5 particularly in the trade and services sectors— percent y-o-y (Figure 6). Over 70 percent of the combined with rising wages, encouraged real income boost came from rising wages and previously inactive individuals to reenter the improved labor market conditions.6 Additionally, workforce. Discouraged workers and women two rounds of pension increases since mid-2023, returning from maternity leave were key drivers of along with the distribution of dividend earnings this recovery. The unemployment rate remained from a state-owned coal mine (Erdenes Tavan low at 5.4 percent in the first six months of 2024, Tolgoi JSC)—equivalent to about 40 percent of well below the pre-pandemic average of 8.9 the average household's monthly income—further percent (2018–2019). bolstered private consumption. The gradual decline in inflation (Section 1.2) also enhanced households' purchasing power, further supporting consumption growth. 6 The national average wage increased by 20.5 percent y-o-y in real terms (or by 27.6 percent in nominal terms) in H1 2024. Wage increases were particularly pronounced in the public sector, with nominal raises of approximately 50 percent in public administration, 40 percent in public education, and 30 percent in public health sectors. In the private sector, nominal wages rose by an average of around 20 percent. Additionally, the legal minimum wage was raised by 20 percent, effective January 1, 2024. Mongolia Economic Update – November 2024 17 A substantial rise in household real Labor force participation improved Figure 6. Figure 7. income fueled the growth in private beyond its pre-pandemic average consumption Contributions to household real income y-o-y growth Labor force participation rate (LFPR) 63% 20% 62% Pre-pandemic 10% average for LFPR 61% 0% 60% Other income -10% Pension & social welfare Wage income Household real income growth 59% -20% Real private consumption growth 58% Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 2023 2024 2023 2024 Source: NSO. Source: NSO. Note: Bars reflect percentage contributions to y-o-y growth of household real income Despite strong coal exports, the contribution of This decline occurred as exports of other net exports to economic growth turned negative commodities remained weak, while real imports in H1 2024. While Mongolia's coal export volume of goods and services, particularly non-durable increased by 39.1 percent y-o-y in the first half consumer goods and investment goods (see of 2024, the net export contribution to growth Section 1.4), surged by 20.6 percent y-o-y, deteriorated sharply to -21.9 percentage points, compared to 18.9 percent in 2023. down from 1.8 percentage points in 2023. 1.2. Headline inflation gradually declined, prompting the central bank to cut its policy rate Headline inflation remained within the central Consumer price increases for domestically bank’s target range, primarily due to a gradual produced goods, excluding meat, eased decline in imported inflation. Nationwide, throughout the year. This reflected a gradual headline inflation dropped to 6.7 percent y-o-y in decline in producer price inflation, driven by lower September, down from 7.9 percent at the end of production costs from flour and flour related 2023 (Figure 8). This decline is largely attributed goods (Figure 9). However, the recent dzud led to lower import prices, as imported inflation to reduced domestic meat supply, keeping meat fell from 5.8 percent y-o-y at the end of 2023 to prices elevated throughout the year. Additionally, 4.6 percent y-o-y by September 2024, driven by price growth in services was fueled by rising decreasing global food and fuel prices and a household incomes, which increased demand stable exchange rate. pressures. 18 Mongolia Economic Update – November 2024 Inflation pressure from imported prices … while domestic food prices Figure 8. moderated … Figure 9. (excluding meat) remain elevated Headline inflation, and its contributors Y-o-y change in consumer and producer prices of food Imported goods Services PPI of food manufacturing Other domestic goods Headline inflation Price of domestic food excl. meat Meat 14% 40% 30% 9% 20% 4% 10% -1% 0% Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Jan Mar May Jul Sep Nov Jan Mar May Jul Sep 2023 2024 2023 2024 Source: NSO. Source: NSO. Note: Bars reflect percentage contributions to y-o-y headline inflation. In response to declining inflationary pressures, weak monetary policy transmission. Nevertheless, the Bank of Mongolia (BOM) cut the policy rate outstanding credit grew by 31.4 percent y-o-y in three times in 2024, by a total of 300 basis September 2024 (Figure 11). Consumer loans points. Despite rising household consumption backed by wages and pensions experienced robust and fiscal expansion continuing to exert demand- growth, contributing about one-third of the total side pressures, the BOM reduced the rate from credit expansion by September 2024. Business 13.0 percent, maintained since December 2022, lending also accelerated from early 2024, adding to 10.0 percent by September 2024 (Figure 10).7 another one-third to the overall credit growth. The latest interest rate cut was accompanied by Improvements in the quality of business loans, additional policy measures. These included an along with strong economic activity, likely reduced increase in banks' reserve requirement ratio on banks' risk aversion toward business lending. For domestic currency liabilities (from 8.0 percent instance, the non-performing loan (NPL) ratio for to 10.0 percent), aimed at “preventing excessive business loans declined from 12.0 percent at the credit growth and ensuring financial stability.” This end of 2023 to 9.5 percent by September 2024, policy mix reflects the BOM's cautious stance, as businesses in sectors such as construction, signaling concerns about financial stability and real estate, and mining flourished. Additionally, the potential risk of overheating in the economy. various government lending programs with subsidized interest rates contributed to overall Credit growth accelerated, fueled by strong credit growth. These included the long-standing expansion in both consumer loans and business subsidized housing mortgage program and lending, despite persistently high lending rates. agriculture-related programs, which together Although the BOM lowered its policy rate, lending accounted for 19.6 percent of total outstanding rates remained elevated (Figure 10), indicating loans by September. 7 In its 2025 Monetary Policy Guidelines, the BOM plans to reduce its inflation target from the current 6 ± 2 percent to 5 ± 2 percent starting in 2027, reflecting expectations of lower inflation in the medium term. Mongolia Economic Update – November 2024 19 Headline inflation fell within the BOM’s Figure 10. target range, prompting a reduction in Figure 11. Lending to businesses recovered the policy rate Monetary policy rate, inflation target, and headline inflation Y-o-y growth of total outstanding credit Lending rate Policy rate Other Regular mortgage loans Headline inflation Subsidized mortgage loans Consumption loans Business loans Total loans outstanding 20% 40% 31.4% 15% 30% 22.4% 10% 20% 13.6% 5% 10% 0% 0% Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Jan Mar May Jul Sep Nov Jan Mar May Jul Sep 2023 2024 2023 2024 Source: BOM and NSO. Source: BOM. Note: The figure shows the average lending rate on newly issued loans Note: Total outstanding loans include mortgage loans securitized by the outside the government’s subsidized programs. Mongolian Mortgage Corporation, which are removed from the banks’ balance sheets. Bars reflect percentage contributions to total credit growth, y-o-y. 1.3. Despite continued high spending, the budget remains in surplus Fiscal spending experienced a procyclical surge, Figure 12. Public sector wages strongly increased with both current and capital expenditures rising significantly. In the first nine months of 2024, total Contributions to y-o-y growth of budget expenditure public expenditure grew by 34.4 percent y-o-y, 40% reaching 24.1 percent of GDP by September, up 34.4% from 20.7 percent of GDP during the same period in 2023. A significant portion of this increase 30% 7.7% was driven by higher public sector wages and pensions, which together accounted for about 18.2% 2.2% three-quarters of expenditure growth. Spending 6.2% on public wages and performance-based bonuses 20% 5.3% more than doubled y-o-y by September, following two rounds of salary increases in July 2023 and 9.6% April 2024, contributing 18.0 percentage points to 10% 18.0% overall expenditure growth (Figure 12). Pension 3.2% spending also rose by 31.6 percent y-o-y after consecutive increases in the same months. In 0% 3.9% addition, capital spending, mainly focused on infrastructure projects in Ulaanbaatar, accounted -5% for 4.8 percent of GDP during the first nine Jan-Sep 2023 Jan-Sep 2024 /Jan-Sep 2022 /Jan-Sep 2023 months of the year. For the remainder of 2024, the newly formed government plans to accelerate Wages Pensions Social transfers capital spending through a recently approved Capital spending Others Total expenditure supplementary budget, aligned with its four-year Sources: MoF; World Bank staff estimates. government action plan (see Box 1 and Section Notes: Stacked bars indicate decomposition of budget expenditure in 2). percentage points. 20 Mongolia Economic Update – November 2024 Box 1. Government Action Plan 2024-2028 The newly established coalition government’s four year action plan is structured around four pillars: regional development, human development, economic policy, and human rights and governance. Following the parliamentary election held in June 2024, a coalition government of three parties was formed, and on August 27th, the parliament enacted the government action plan for 2024-2028. While the plan aligns with existing medium-long term priorities (such as Vision 2050, the New Recovery Policy, and the Regional Development framework) introduced by the previously ruling party, it now also incorporates priorities of the two other coalition parties aiming at ensuring timely, effective, productive, and sustainable collaboration. Key features of the four main pillars include: a • Regional Development: Grouping the country into six regions and establishing hubs for industry, agriculture, tourism, and energy based on each region’s comparative advantages. Re-branding Ulaanbaatar city as a “20-minute city” by addressing its energy, transporation, and housing crisis. • Human Development: Supporting the Mongolian people to address their health, education, and housing needs by allocating funds through the newly established Sovereign Wealth Fund (Box 2), maintaining the Child Money Program, and continuing the subsidized housing mortgage program under a National Housing Corporation. • Economic Policy: (i) Improving the business environment, implementing tax reforms, ensuring macroeconomic stability and pursuing economic diversification by investing in mineral industrial parks, border ports and transport-related infrastructure, implementing a wide range of energy projects, and liberalizing the energy sector.b (ii) Continuing the President’s initiatives including, New Cooperative and White Gold movements, Wealthy Herder program, Food Supply and Security, and the Billion Tree national movements. • Human Rights and Governance: It includes policies in the areas of public sector reform, press freedom, fight against corruption, digital governance (such as automating public services using AI technology), foreign policy (e.g., fostering economic cooperation and free trade agreements with South Korea, China and the Eurasian Economic Committee), among others. The four-year plan aspires to reach impressive socioeconomic outcomes by 2028. Upon successful completion of the action plan, the government projects GDP per capita to reach US$10,000 (around 80 percent increase from the 2023 level of US$5,956), halving the current poverty rate, maintaining economic growth above 6.0 percent, keeping inflation under 5.0 percent, and achieving a stable sovereign credit rating. Other socioeconomic outcomes cover the areas of human development, business environment, innovation, governance, corruption, privatization, economic freedom, and international competitiveness. Source: Synthesized from the Government Action Plan 2024-2028 published on www.legalinfo.mn and www.parliament.mn. Notes: a. The action plan includes a total of 620 objectives under these four pillars. b. The action plan envisages 14 mega-projects in transportation, energy, water, and mining-related heavy industry sectors with an estimated total cost of US$40 billion (180 percent of current GDP). Many of these projects have been under discussion for several years and are currently in the process of securing funding, revising feasibility studies, and/or selecting contractors. Mongolia Economic Update – November 2024 21 Fiscal revenue saw a significant rise, driven by extent, royalties.8 CIT and royalties from coal higher personal and corporate income as well mining firms accounted for 5.5 percent of GDP as taxes from trade. In the first nine months of in the first half of 2024, as coal export volume 2024, total fiscal revenue grew by 26.6 percent more than offset the lower prices (Figure 14). y-o-y, reaching 27.1 percent of GDP, up from 24.8 Additionally, stronger demand for imported percent during the same period in 2023 (Figure goods further boosted VAT, but also increased 13). Strong growth in both private and public excise taxes and customs duties. With improved sector wages contributed to a 27.0 percent revenue prospects, in August, it was decided to increase in revenues from personal income tax transfer revenue worth 1.6 percent of GDP to the (PIT) and social security contributions (SSC). Sovereign Wealth Fund (SWF) in 2024 and help Sustained production growth, particularly in the finance the government’s subsidized programs mining sector, led to higher corporate income (see Box 2 for details). tax (CIT), value-added tax (VAT), and, to a lesser Taxes on income and trade were Budget revenue remained highly Figure 13. notably high Figure 14. dependent on mining associated revenues, especially on coal exports Contributions to y-o-y growth of budget revenue Main components of budget revenue, percent of GDP Coal mining revenue 50 Non-coal mining revenue 30% Non-mining revenue 27.1% 20% 24.9% Coal export (million tons, RHS) 24.8% 40 22.9% CIT 1.0% 5.5% 19.3% 15% 3.0% 20% 1.0% 30 PIT and Social 4.7% 2.2% 2.2% 2.3% contributions 10% Taxes on trade 20 10% 11.3% 10.4% Royalty 5% 10.2% 10.4% 10 Total revenue 0% 0% 0 Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep 2021 H1 2022 H1 2023 H1 2024 H1 2020 2021 2022 2023 2024 Sources: MoF; World Bank staff estimates. Sources: MoF; World Bank staff estimates. Note: Taxes on goods and trade comprise of VAT on domestic and imported goods, excise taxes and customs duties. Mongolia's overall fiscal account remains in down from 44.4 percent at the end of 2023. surplus, contributing to a reduction in public However, some public and publicly guaranteed debt. In the first nine months of 2024, the country borrowing occurred this year, including borrowing recorded a budget surplus of 3.1 percent of GDP, taken by the Development Bank of Mongolia as strong revenues outpaced the rise in spending (DBM) and the Municipality of Ulaanbaatar (Figure 15). This improved fiscal position enabled (MUB).¹0 Public debt reduction, combined with the repayment of US$150 million in public and sustained economic growth, led to an upgrade in publicly guaranteed debt. Combined with strong Mongolia’s credit rating from “B” to “B+” by Fitch nominal GDP growth, this helped lower the public and S&P. debt-to-GDP ratio to 38.2 percent by mid-2024,9 8 CIT collected from mining firms constitute about 60 percent of total CIT revenue. 9 The public debt includes publicly guaranteed debt of the DBM but does not include contingent liabilities or the BOM’s liability under its swap line with the PBOC (equivalent to an estimated 3.5 percent of GDP in 2024). 10 This includes a US$60 million state-guaranteed loan obtained by the DBM from the China Development Bank in May 2024 to finance a major energy project, a US$150 million domestic bond issued by the MUB in June 2024 for energy and infrastructure projects, and a US$152 million external bond issued by the DBM without an explicit state guarantee. 22 Mongolia Economic Update – November 2024 Figure 15. Government budget is in surplus for the second consecutive year Fiscal balances, percent of GDP 5.4% 4.1% 4.2% 3.0% 3.1% 1.7% 1.8% 1.2% 0.4% 0.1% -1.8% Overall balance -2.9% Structural balance -4.1% Primary balance -5.6% -7.2% Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep 2020 2021 2022 2023 2024 Sources: MoF; World Bank staff estimates. Note: Structural balance is defined by the government as the overall fiscal balance net of fiscal saving funds (FSF and FHF). Box 2. The Newly Established Sovereign Wealth Fund: Structure and Purpose Mongolia has opted to finance parts of its social and investment expenditures through its newly established sovereign wealth fund (SWF). The Parliament of Mongolia approved the Law on SWF on April 19, 2024. This law, along with subsequent implementing secondary legislation, governs the management of the country’s mineral revenues. The newly established SWF incorporates the existing intergenerational Future Heritage Fund (FHF), along with two new funds, the Provident Fund (PF) and the Development Fund (DF), without adding new funding sources. The accumulation rules for these three funds are as follows: 1. The PF will be managed by the Ministry of Family, Labor and Social Protection. It will collect dividends from all existing state-owned mineral projects, limited to dividends on ownership shares of up to 34 percent. The fund’s assets will be earmarked to notional individual accounts for Mongolians citizens. Once additional regulations and digital infrastructure are established, the current generation of Mongolians will be able to draw from these accounts to finance certain health, education, and housing expenses. Currently, the fund is set to finance only housing expenses. In 2024, MNT500 billion was saved in this fund (held at the BOM) to support the subsidized Housing Mortgage Program. 2. The DF will receive half of the revenue that would have previously been allocated to the Fiscal Stability Fund (FSF)a in years when the structural balance is in surplus. The Ministry of Economy and Development will manage the fund and finance large strategic projects that would support the country’s long term economic development and diversification agenda. 3. The FHF will remain as an intergenerational savings fund for future generations. It will continue to save 65 percent of royalties from mineral projects, after allocation to the FSF. However, it will no longer include dividends from existing state-owned mineral projects as these are now collected in the PF. An accompanying law to the SWF law, now allocates only 20 percent of royalties (after the allocations to the FSF) to this fund for 2024 (as opposed to the usual rule of 65 percent).b Source: Synthesized from the general SWF law and accompanying laws. Notes: a. The FSF accumulates funds as follows: when revenue from any single mineral (e.g., coal, copper) exceeds 3 percent of total fiscal revenue, the excess amount—calculated as the difference between the market price and a “structural price” (essentially a long-term average price)— is saved in the FSF. b. The FHF’s reserves will remain frozen until they are transferred for investment in international financial markets in 2030. Mongolia Economic Update – November 2024 23 1.4. Amid soaring imports bill the current account balance shifted to a deficit A rapid expansion of imports pushed Mongolia's which more than offset the effects of declining current account back into deficit. In the first nine import prices. In line with strong investment months of 2024, the current account registered activity (Section 1.1), imports of machinery and a deficit of 5.6 percent of GDP, compared to a equipment for investment projects and mining surplus of 2.1 percent during the same period operations, along with consumer durables like in 2023. This shift was primarily driven by a passenger vehicles, grew strongly and collectively shrinking trade surplus (Figure 16), as import contributed 19.3 percentage points to overall surged by 27.4 percent y-o-y. The strong growth in import growth (Figure 17). imports was fueled by robust domestic demand, Figure 16. The current account deficit re-emerged with a shrinking goods trade balance Contributions to y-o-y growth of budget expenditure Goods balance Services balance Income balance Current account balance 20% 15% 10% 5% 2.1% 0% - 5.6% -5% - 9.8% -10% -15% - 10.0% - 10.2% -20% Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Average of 2018-19 Average of 2020-21 2022 2023 2024 Source: BoM. Export revenue growth remained steady, percent y-o-y, with both higher volumes and primarily driven by increased coal exports, with prices (3.0 percent and 9.6 percent, respectively), higher copper revenues providing additional contributing 2.3 percentage points to overall support. In the first nine months of 2024, export export growth. During the same period, services revenue grew by 4.3 percent y-o-y, fueled by export revenue declined by 1.0 percent y-o-y, coal export revenues, which saw a 3.7 percent as lower transportation service exports (due to increase despite an 18.5 percent decline in coal reduced transport costs) offset a 12.1 percent prices (Figure 18). Copper exports rose by 13.2 increase in tourism-related revenue. 11 Average food price at the international market declined by 4.8 percent y-o-y in the first nine months of 2024 (Source: FAO). 12 For instance, the number of imported passenger cars surged by 75.8 percent y-o-y, resulting in a 60.0 percent y-o-y increase in the total import bill for these vehicles. 24 Mongolia Economic Update – November 2024 The import bill increased strongly, Export earnings growth was modest Figure 17. driven by greater imports of capital Figure 18. amid weaker coal price goods and consumer goods Goods imports bill growth and percentage contributions Goods exports growth and percentage contributions Fuels Capital goods Consumer goods Agricultural goods Others Iron ore 40% Intermediate goods and Total imports bill (y/y, %) Coal Copper Gold Total exports revenue (y/y,%) industrial materials 60% 27.4% 30% 40% 20% 13.1% 20% 10% 4.3% 9.3% 0% 0% -5% -20% Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep 2021 2022 2023 2024 2021 2022 2023 2024 Source: BoM. Source: BoM. Note: Stacked bars indicate growth decomposition of total imports bill in Note: Stacked bars indicate growth decomposition of total exports earnings percentage points. in percentage points. Despite higher net FDI inflows, weaker current of 2024. Additionally, pressure on the MNT/ account performance constrained reserve USD nominal exchange rate prompted further accumulation, further impacted by increased central bank interventions, further limiting reserve interventions by the BOM to stabilize the accumulation.¹³ The BOM supplied US$4.6 billion nominal exchange rate. Net FDI inflows in the in foreign exchange to the market during the first first nine months of 2024 rose to 8.1 percent nine months of 2024, compared to US$3.0 billion of GDP, up from 6.8 percent during the same in the same period of 2023.¹4 As a result, gross period in 2023, largely driven by greater inflows international reserves declined slightly to US$4.7 to the mining sector (Figure 19). However, foreign billion by the end of September 2024, down from reserve accumulation was hampered by the US$4.9 billion at the end of 2023. The rapid rise current account deficit and the BOM's repayment in imports has gradually eroded reserve coverage, of US$620 million on its currency swap line which stood at 3.0 months by September. with the People's Bank of China in the first half Figure 19. FDI inflows improved, partially offseting the weaker current account balance 20% Foreign direct investment inflow, percent of GDP 10 10% Current and capital account 10.9% 6.8% 5 9.2% 9.3% Net FDI inflow 5.9% 8.1% 0% 0 Other financial account flows -5 Official foreign reserves -10% (RHS, months of import) -10 -20% -15 Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep Jan-Sep 2019 2020 2021 2022 2023 2024 Source: BoM. 13 The nominal exchange rate of the MNT experienced a broad-based appreciation against major trading currencies, with an average y-o-y gain of 2.6 percent against the USD during the first nine months of 2024. 14 Reserve accumulation is influenced by net FX interventions, which are calculated as gross FX interventions minus the BOM’s direct FX purchases from key mineral exporters. However, data on net interventions is not publicly available. Mongolia Economic Update – November 2024 25 2. OUTLOOK, RISKS, AND POLICY RECOMMENDATIONS After steady growth in 2024, Mongolia’s Strong coal revenues are anticipated to raise economic expansion is expected to accelerate in 2024 revenue to 35.7 percent of GDP, while 2025, driven by increased OT mining production, total expenditure is forecast to be higher at 36.7 despite weaker coal output. Growth is projected percent under the 2024 supplementary budget, to maintain its momentum from the first half of resulting in a fiscal deficit of 0.9 percent of GDP. the year, reaching 5.3 percent in 2024, supported In 2025, government revenues are expected to by strong domestic demand, though tempered remain strong at 35.8 percent of GDP, supported by rising imports. In 2025, growth is expected to by robust revenue from both mining and non- rise to 6.5 percent (Table 1), with the boost largely mining activities, though negatively impacted by stemming from higher production at the OT mine, lower coal prices. Expenditures are projected to a modest recovery in agriculture following the outpace revenue growth and remain elevated at 2024 dzud, and despite lower coal production. 36.5 percent of GDP, resulting in a fiscal deficit of 0.7 percent of GDP. Despite the moderate On the demand side, sustained consumption, fiscal deficits, accelerating economic growth is investment, and exports are expected to drive expected to lead to a slight reduction in public growth, though higher imports are anticipated to debt, projected to fall to 42.2 percent of GDP in weigh against overall growth. Public and private 2025.¹5 consumption is expected to remain strong, though it is anticipated to moderate slightly in A current account deficit is expected to reemerge 2025 due to smaller wage and pension increases. in 2024 and 2025. Declining commodity prices, Exports—led by increased copper and gold—along particularly for coal, coupled with rising imports with public investments under the government’s driven by strong domestic demand, are projected four-year action plan and private investments to result in current account deficits of 7.8 percent supported by expanded bank lending amid a less of GDP in 2024 and 6.2 percent in 2025. The slight restrictive monetary policy, are also projected to improvement in 2025 is attributed to increased further support growth. However, their impact gold and copper exports from the OT mine. may be partially offset by rising imports of External debt repayment pressures are anticipated investment goods. to remain minimal in 2025, with the next major payments—US$600 million in sovereign bonds Robust domestic demand is expected to and US$800 million from the Bank of Mongolia’s drive inflationary pressures. Procyclical fiscal FX swap with the People's Bank of China—falling spending, as outlined in the 2024 supplementary due in 2026. budget, combined with rising household incomes, is projected to revive demand-driven inflation In the medium term, growth is expected to in the second half of 2024, elevating average remain strong, though fiscal and current account headline inflation to 7.0 percent for the year. imbalances are likely to widen. After the 2025 Inflation is forecast to rise further to 8.0 percent in surge in OT's mineral output, mining production 2025, driven by sustained demand pressures from is projected to moderate, with non-mining increased public consumption, rising incomes, sectors—such as trade and other services, and and robust lending activity, supported by recent agriculture—driving economic growth, which is monetary easing and ongoing subsidized lending forecast to average 6.0 percent in 2026-2027. On programs. the demand side, increased public consumption and investments under the government’s four- Expenditures are expected to outpace revenue year action plan are expected to fuel growth. growth, leading to moderate fiscal deficits. However, fiscal and current account imbalances 15 The MUB plans to issue a US$500 million external bond in H2 2024 to finance key infrastructure projects. 26 Mongolia Economic Update – November 2024 are expected to widen as public investment management. Macroeconomic stability is continue to expand. imperative for promoting sustainable growth and fostering economic resilience, by providing Downside risks persist both domestically and certainty and confidence to businesses and externally. Domestically, greater-than-expected investors, encouraging long-term investments fiscal spending could stimulate economic growth and innovation, and boosting productivity and but also elevate inflationary pressures and widen economic expansion. It also helps ease the fiscal and current account deficits. Additionally, severity of economic cycles by minimizing the climate change heightens the risk of more adverse effects of economic downturns. As frequent and severe dzuds and flooding, which recommended in a recent World Bank report,¹6 could have significant economic consequences, macroeconomic stability requires policies to especially for poor and vulnerable households, improve fiscal sustainability and ensure an as highlighted in the World Bank’s 2024 Mongolia independent monetary policy to anchor inflation. Country Climate and Development Report. These reforms should focus on: (i) gradually Externally, Mongolia faces potential challenges scaling back pandemic-era social assistance from slower-than-expected global growth, which while making it more progressive and responsive; could weaken external demand and reduce prices (ii) restructuring subsidies in energy, agriculture, for key export commodities (Box 3). Furthermore, and pensions; and (iii) reducing fiscal risks from escalating geopolitical tensions could drive up contingent liabilities, particularly state-owned fuel prices, leading to higher imported inflation, enterprises (SOEs). Phasing out quasi-fiscal increased production costs, and a larger import activities, such as the subsidized mortgage bill. program, and prohibiting such financing under the central bank’s mandate will enhance the central While Mongolia's ongoing mineral export boom bank’s independence and credibility in anchoring is delivering positive macro-fiscal outcomes inflation, while enabling for greater exchange rate for the second consecutive year, sustaining flexibility. these gains will require sound macroeconomic Table. 1 Selected macroeconomic indicators 2022 2023 2024f 2025f 2026f 2027f Real GDP Growth, at constant market prices 5.0 7.2 5.3 6.5 6.1 5.9 Private Consumption 8.1 9.7 8.4 5.0 6.8 6.4 Government Consumption 6.9 3.2 22.0 4.6 6.8 5.9 Gross Fixed Capital Formation 13.2 5.3 18.0 7.9 6.2 4.1 Exports, Goods and Services 32.3 33.2 5.1 23.9 2.4 5.7 Imports, Goods and Services 29.1 18.9 10.2 15.9 3.9 5.5 Real GDP Growth, at constant factor prices 4.2 7.5 5.3 6.5 6.1 5.9 Agriculture 12.0 -8.9 -23.0 5.0 6.5 4.5 Industry (including mining) -4.5 12.9 8.3 11.5 6.1 6.2 Services 6.9 9.9 11.0 4.1 6.1 6.0 Inflation (CPI, period average) 15.2 10.4 7.0 8.0 8.5 8.5 Current Account Balance (% of GDP) -13.2 0.6 -7.8 -6.2 -7.1 -10.9 Net FDI, Inflow (% of GDP) 13.9 7.3 8.7 6.7 6.2 8.0 Fiscal Revenue (% of GDP) 33.8 34.1 35.7 35.8 35.1 34.9 Fiscal Expenditure (% of GDP) 33.1 31.5 36.7 36.5 36.2 35.5 Fiscal Balance (% of GDP) 0.7 2.6 -0.9 -0.7 -1.0 -1.1 Primary Balance (% of GDP) 2.1 4.2 0.6 0.8 0.6 0.3 Debt (% of GDP) 62.1 44.4 43.3 42.2 42.0 40.6 Source: World Bank staff estimates. Note: Public debt does not include the BoM’s liability under the PBOC swap line (3.4 percent of GDP as of Sep 30, 2024). 16 World Bank, 2024. “Agenda for Action: Key Policy Recommendations for Mongolia’s Sustainable Development Vision”. Mongolia Economic Update – November 2024 27 Box 3. Global and commodity price outlook Global and regional outlook The global economic outlook for 2025-2026 is expected to be subdued, with growth in China anticipated to continue slowing. After stabilizing at 2.6 percent in 2024, global growth is projected to edge up slightly to an average of 2.7 percent over 2025-2026, remaining 0.4 percentage points below the pre-pandemic average (2010-2019) (Figure B.1). The slight increase is primarily attributed to modest growth in trade and investment, alongside cautious monetary policy easing in both advanced and emerging market economies. While growth in emerging markets (EMDEs) is projected to decrease slightly from 4.0 percent in 2024 to 3.9 percent over 2025-2026, China’s growth is expected to slow more substantially, from 4.8 percent in 2024 to an average of 4.2 percent over 2025-2026. This slowdown is driven by a softening labor market, which curbs household consumption, and a contracting property sector, which weakens investment. Global risks are skewed to the downside and include rising trade fragmentation, prolonged high interest rates due to persistent inflation, policy uncertainty, weaker-than-expected activity in major economies, and climate-related disasters. Figure B.1. Global economic growth is projected to stabilize at a moderate level Global and regional growth, percent 10.0 8.0 Advanced economies 6.0 EMDE China 4.0 Mongolia 2.0 World 0.0 2021 2022 2023 2024f 2025f 2026f Source: Macro Poverty Outlook, October 2024 and World Bank Global Economic Prospects, June 2024. Commodity prices are expected to decline, with larger drops in oil and coal prices anticipated in 2025-2026. Overall, commodity prices are expected to decrease by 5 percent in 2025 and 2 percent in 2026, following a 3 percent softening in 2024. The most significant declines are forecasted for coking coal (metallurgical coal) prices, with projected drops of 12.4 and 12.5 percent over the next two years, driven largely by reduced global coal consumption led by China. Assuming no prolonged geopolitical tension, increased supply from the non-OPEC+ producers is expected to push oil prices down by 8.6 percent in 2026, following price stabilization in 2025. Greater supply of grains and other agricultural commodities, amid favorable growing conditions, is expected to keep food prices low, with a 4.0 percent decline in 2025, followed by stabilization in 2026. A moderate pace of industrial growth in key economies including China, mainly explains the projected 8.6 percent drop in copper prices in 2026, after stagnation in 2025. Meanwhile, gold prices are expected to remain elevated through 2025-2026, buoyed by strong central bank demand following a record-breaking 21.4 percent increase in 2024; however, this effect is likely to taper as the global economy stabilizes. Figure B.2. Commodity prices are expected to weaken Price of selected commodities, prices are indexed to 100 = 2010. 200 Copper 150 Crude oil Metallurgical coal 100 Gold Food 50 0 2022 2023 2024e 2025f 2026f Source: World Bank Commodities Outlook, October 2024. Source: This box draws from analysis and projections in the World Bank’s Global Economic Prospects (June 2024), the World Bank East Asia and Pacific Economic update (October 2024), and the World Bank Commodities Outlook (October 2024). 28 Mongolia Economic Update – November 2024 Mongolia Economic Update – November 2024 29 CHAPTER 2 DISTRIBUTIONAL IMPACTS OF MONGOLIA’S FISCAL SYSTEM Fiscal policy plays a crucial role in tackling the largest stimulus packages in the region. While poverty and inequality by shaping the this package significantly reduced fiscal buffers, distribution of resources within a country. some social transfer programs were made Fiscal strategies encompassing taxation, social permanent. The reduced fiscal space now limits assistance programs, and public spending on the government’s ability to respond to future social services and basic infrastructure can shocks, underscoring the need for a thorough significantly influence the income distribution and assessment of the effectiveness and efficiency promote inclusive growth and poverty reduction. of Mongolia’s fiscal system in addressing poverty To protect the poor and vulnerable, Mongolia’s and inequality. fiscal system has largely relied on expansive, costly, and broad-based social transfer programs. In this special chapter of the MEU we examine Most recently, in response to the triple shock of the distributional effects of the Mongolian the COVID-19 pandemic, trade disruptions, and fiscal system, notably the impact of taxes and geopolitical tensions, Mongolia introduced one of social spending on poverty and inequality. 30 Mongolia Economic Update – November 2024 This chapter summarizes the main findings more equitable outcomes while reducing the and recommendations from the World poverty. The CEQ constructs household income Bank’s Commitment to Equity (CEQ) report levels before any fiscal interventions (pre-fiscal (forthcoming). By analyzing the equity and poverty income) and compares it with actual household impact of the fiscal system (both public spending income levels. The analysis is based on the and taxation, see Table 2), the CEQ report aims 2022 Household Socio-Economic Survey (HSES) to provide policymakers with insights into how complemented with administrative data (e.g., different fiscal interventions influence household number of taxpayers and beneficiaries of social welfare, and how they can be adjusted to achieve programs). Table. 2 Fiscal interventions modeled in the CEQ TAXES TRANSFERS Child Money Program, Social welfare pension, Personal income tax, Mother benefits, DIRECT Property tax, Food Support (former Food Stamp) Program, Non-pension contributions of the SSC¹7 Cash subsidies to herders, Other direct social welfare benefits Energy price subsidy, Value-added tax INDIRECT Discounted mortgages under the Housing Excise taxes Mortgage Program 1. DISTRIBUTIONAL ASSESSMENT OF THE FISCAL SYSTEM 1.1. The fiscal system is effective in reducing poverty and income inequality Mongolia’s fiscal system reduces poverty, as line. Mongolia’s fiscal system has a comparatively the negative impact of taxes is partially offset strong impact on poverty reduction by international by transfer programs. Taxes inherently increase standards. At the upper-middle-income country poverty (by 12.4 percentage points), but this (UMIC) poverty line of US$6.85 per day (in 2017 impact is largely counteracted by transfers. The PPP), fiscal interventions reduce poverty by 2.9 national poverty rate, estimated at 35.6 percent percentage points—well above the UMIC average based on pre-fiscal income, declines by 1.8 reduction of 1.0 percentage point. At the lower- percentage points to 33.8 percent after fiscal middle-income country (LMIC) poverty line of interventions are considered (Figure 20). Among US$3.65 per day (in 2017 PPP), Mongolia’s fiscal these interventions, direct transfers are the most system achieves an impressive 7.1 percentage- effective, reducing the national poverty rate by point reduction in poverty, the largest reduction 13.3 percentage points and lifting around 40 among LMICs. percent of poor households above the poverty 17 Social security contributions (SSC) for old-age pensions are not treated as taxes in the CEQ, as they represent contributions that individuals make toward their future pension benefits. As such, old-age pension contributions resemble insurance premium payments or deferred income savings rather than a tax. Mongolia Economic Update – November 2024 31 Mongolia’s fiscal system is highly redistributive. Gini points.¹8 This reduction in inequality is larger Fiscal interventions significantly reduce than the averages for LMICs (2.5 points) and inequality, with the Gini coefficient dropping by UMICs (3.4 points). The difference is primarily 5.4 points from 37.8 (pre-fiscal income) to 32.4 due to Mongolia’s generous and extensive direct after interventions (Figure 21). Direct transfers transfer programs, given the limited redistributive play a key role, improving income equality by 5.6 impact of its tax system (see Box 4). Direct transfers have greater It also has a strong impact on reducing Figure 20. effectiveness in reducing poverty Figure 21. income inequality Poverty rates after various fiscal interventions are layered Gini coefficient after various fiscal interventions are layered National poverty $6.85 in 2017 PPP $3.65 in 2017 PPP 40 40 37.8 35.6 35.5 38 33.8 30 27.1 Gini coefficient 36 22.3 Poverty rate (%) 20 34 32.2 32.4 32.0 10 32 31.4 0 30 Pre-fiscal +Direct +Direct +Indirect +Indirect Pre-fiscal Direct Direct Indirect Indirects income transfers taxes taxes subsidies income transfers taxes taxes subsidies Source: World Bank 2024, forthcoming analysis on CEQ. Source: World Bank 2024, forthcoming analysis on CEQ. Note: Fiscal interventions are added to the pre-fiscal income one-by-one. Note: Fiscal interventions are added to the pre-fiscal income one-by-one. Bar Bars on the far-right side indicate poverty levels after cumulative impacts of on the far-right side indicates Gini coefficient after cumulative impacts of all the fiscal interventions considered in this CEQ. the fiscal interventions considered in this CEQ. Lower Gini coefficient indicate greater income equality. 18 Inclusion of in-kind benefits, particularly education benefits, further reduces the income inequality by 3.0 Gini points (see box 5). 32 Mongolia Economic Update – November 2024 Box 4. Impact of fiscal interventions on households of different income levels The inequality-reducing effect of Mongolia’s fiscal system can be attributed to a greater concentration of generous direct transfers among poorer households. The poorest 40 percent of households in the pre-fiscal income distribution benefits more from the fiscal system in net terms, as they receive more in transfers than they pay in taxes (Figure B.3). Notably, the poorest 10 percent of households receive benefits equivalent to almost 90 percent of their pre- fiscal income, with direct transfers making up the largest benefit. The net benefit declines as income levels rise, with the richest decile contributing, on average, 14.7 percent of their pre-fiscal income to the fiscal system (Figure B.4). In comparison, indirect transfers are relatively small and tend to benefit the richer more due to greater access to and consumption of services with price subsidies such as electricity and heating (see section 1.2 for more details). Figure B.3. Households in lower income deciles Figure B.4. … and relative to their pre-fiscal receive greater fiscal benefits, in absolute income terms… Concentration of fiscal system (billion MNT) Incidence of fiscal system (percent of pre-fiscal income) 600 Indirect transfers (subsidies) 150 Indirect taxes 300 Percent of pre- fiscal income 120 Direct transfers 0 87.9 Direct taxes 90 Billion MNT -300 Net benefit 60 -600 Indirect transfers (subsidies) Indirect taxes 30 -900 Direct transfers 0 Direct taxes -1200 Net benefit -30 - 14.7 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 Deciles of pre - fiscal income Deciles of pre - fiscal income Source: World Bank 2024, forthcoming analysis on CEQ. Note: Households are divided into 10 income deciles where D1 reflects the poorest 10 percent, while D10 the richest in terms of pre-fiscal income. Source: Synthesized from World Bank 2024, forthcoming analysis on CEQ. 1.2. Direct transfers yield the greatest impact on both poverty and inequality while taxes have marginal redistributive effects Direct transfer programs are generally pro-poor share of these direct transfers goes to poorer and redistributive. For instance, households in households, the distribution of these benefits the bottom income decile by pre-fiscal income is not as progressive as it could be, as many receive direct transfers equivalent to 115 programs are categorically targeted, instead of an percent of their income, and the large size of the income-based targeting. For instance, the CMP is direct transfer is sufficient to lift 36 percent of effectively pro-poor because poorer households households considered poor by pre-fiscal income, have more children, but a significant portion of out of poverty. Much of these impacts are due total transfers (15 percent) still goes to the richest to the generous Child Money Program (CMP, 20 percent of households.¹9 representing 2.6 percent of GDP in 2022 and half of the direct transfers received by the households Meanwhile, several programs including the Social in bottom decile) and other broad-based direct Welfare Pension and the Food Support Program benefits that target certain demographic (FSP) are more pro-poor, with the latter being the categories including benefits to mothers (Figure most progressive. More than half of FSP benefits 22, upper right quadrant). Although a larger go to the poorest decile. 19 Within the total direct transfer programs, the richest two deciles receive more than 14 percent of benefits, while the poorest two deciles receive 29 percent. Mongolia Economic Update – November 2024 33 Figure 22. Direct transfers are more redistributive and poverty reducing, but costly on the budget 4 CMP Inequality reduction → 3 2 PIT 1 Non - pension contributions Social welfare pension Mother benefits Electricity subsidies Poverty reduction → 0 FSP -8 VAT -6 -4 -2 0 2 4 6 8 10 Excises Other indirect subsidies -1 -2 Source: World Bank 2024 (forthcoming CEQ analysis). Note: Size of the balloon reflects cost of the benefits program and/or revenue generated by taxes, both in percent of GDP. Dark purple circles indicate direct transfers, light purple circles indirect transfers, dark blue circles direct taxes, and light blue circles indirect taxes. Cost-effectiveness analysis highlights and pro-poor programs such as the FSP would opportunities to reallocate direct transfers enhance the impact of direct transfers at a lower spending to enhance its impact. While the cost on the budget. FSP’s impact on poverty reduction and inequality reduction are the smallest among the social Indirect transfers, mostly in the form of price welfare programs, it is mainly due to low subsidies, have marginal impact on poverty coverage and modest benefits.²0 Indeed, the FSP reduction, while exacerbating income inequality, demonstrates the greatest cost-effectiveness due to disparities in access to and consumption in reducing both poverty and inequality, with a of subsidized services. Indirect subsidies 4.1-percentage-point decrease in the poverty gap for electricity, heating, water, and mortgages and a 2.5-point decrease in the Gini coefficient for overwhelmingly benefit the richest households, each percentage point of GDP spent.²¹ In contrast, with about 27 percent of total subsidies going to the CMP has lower cost-effectiveness in reducing the richest decile and about 2 percent going to the inequality and poverty, but with significantly high poorest decile (Figure 22, lower right quadrant). cost at 2.6 percent of GDP. Reallocating spending This disparity is primarily driven by limited access to more cost-effective (therefore more efficient) to subsidized services among poorer households and lower consumption levels among those with 20 With only about 3 percent of households benefitting from the FSP and transfers representing just 6 percent of pre-fiscal income among recipient households, the program is insufficient to yield substantial impacts on poverty or inequality despite being well targeted. 21 The poverty gap measures how far, on average, the incomes of poor people fall below the poverty line. 34 Mongolia Economic Update – November 2024 access. For instance, poorer households who In 2022, among the poorest decile about 40 predominantly live in ger districts have limited percent of total income came from formal wages access to district heating, clean water, hot water, subject to PIT, while the share is about 70 percent and wastewater services. Meanwhile, electricity for the richest decile. Significant exemptions on price subsidies slightly reduce inequality, though PIT for agricultural income undoubtedly benefit this outcome is atypical; in many middle-income the poor, but there is a lack of tax exemptions countries, such subsidies tend to increase (zero-rate band) and limited deductions for low- inequality. The free nighttime electricity policy for income wage earners (mostly in urban areas). In ger districts in urban areas is the main driver of this addition, the flat PIT is relatively ineffective when exception, as households in these areas tend to be it comes to reducing income inequality. Fiscal poorer. However, these subsidies are an inefficient revenue equivalent to 1 percent of GDP generated measure, as they provide greater absolute through the PIT results in only a 0.3-point decrease benefits to wealthier households and create price in the Gini coefficient. distortions that encourage overconsumption, undermining the financial viability of the energy Indirect taxes are marginally regressive as sector. Finally, housing mortgage subsidies stand poorer households bear a relatively larger out as the most regressive and expensive among burden in relation to their incomes. VAT and the indirect transfers.²² About 9 percent of the excise taxes increase income inequality by 0.4 total households benefit from this program with Gini points (Figure 22, left side). The regressivity is nearly half of total subsidies going to the top primarily driven by excise taxes (mostly on alcohol decile and less than one percent to the poorest and tobacco), as it represents a larger burden for decile. Richer households have greater access poorer households in relation to their income, because they have higher chances of qualifying resulting in a higher effective tax rate. While richer for the mortgage loans for apartment purchases. households contribute more to VAT revenues, for poorer households VAT payments still constitute Direct taxes in Mongolia have a marginal a significant share of their income. Additionally, redistributive impact mostly due to flat personal the VAT has minimal redistributive impact partly income tax and limited tax expenditures for low- due to the VAT rebate, which disproportionately income earners. Direct taxes collectively improve benefits richer households. In absolute terms, income equality by 0.9 Gini points but increase richer households spend more on items subject poverty by 6.4 percentage points, with most to the VAT, and therefore benefit more from VAT impacts attributable to the personal income tax rebates.²4 (PIT) (Figure 22, upper left quadrant).²³ While the fiscal system collects majority of its PIT revenue Finally, in-kind transfers strengthen the from richer households – consistent with their redistributive impact of the fiscal system. larger income – the flat income tax burdens In Mongolia, as highlighted in Box 5, in-kind are also significant for poorer households benefits—especially those related to education, due to relatively high formality and limited tax and to a lesser extent health—enhance the equity expenditures for low-income earners in Mongolia. of the fiscal system. 22 Note that this is technically a quasi-fiscal transfer rather than a fiscal transfer, as the program is financed by the central bank rather than through the budget. 23 Government subsidy for health insurance premiums is also considered a direct tax and it contributes to the overall progressivity. About two-thirds of the population benefit from these subsidies, with a higher concentration among poorer households due to increased vulnerability and lower formal employment rates. Without these subsidies, health insurance coverage may be lower, especially among poorer households, or households would be forced to bear the financial burden themselves. 24 In 2016, Mongolia introduced a consumer VAT rebate of up to 20 percent of the VAT paid at registered businesses. Through the e-BARIMT system, consumers can register their purchases on a mobile app by scanning a unique QR code provided on receipts. This reform has led to a sharp increase in the number of firms filing VAT returns, boosting compliance and VAT revenues. However, from an equity perspective, the richest decile receives an estimated 26 percent of total rebates, reflecting their higher consumption levels, reduced informal purchases (or greater access to businesses that provide electronic receipts for the app) and a greater likelihood of reporting purchases. Mongolia Economic Update – November 2024 35 Box 5. Assessment of the impact of in-kind transfers on income inequality Public education benefit drives much of the progressive impact of in-kind benefits, reducing the Gini coefficient by 3.0 points. A greater share of education benefits is directed towards poorer households. This is mainly due to greater number of children in poorer households (over 40 percent of the poorest decile have three or more children compared to less than 10 percent of the richest decile). However, access and affordability issues constrict the poorer households from sending their children to pre-primary education, resulting in less progressive distribution of pre-primary benefits (Figure B.5). Figure B.5. Public education services mostly benefit the poor, while the impact is mixed for health benefits Incidence of fiscal system, in-kind benefits (percent of pre-fiscal income) 60 Pre-primary education Percent of pre-fiscal income Primary education 40 Secondary education Private education Inpatient care Outpatient care 20 Medicine & other Education fees Health fees 0 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 Deciles of pre-fiscal income Source: World Bank 2024, forthcoming analysis on CEQ. Note: Households are divided into 10 income deciles where D1 reflects the poorest 10 percent, while D10 the richest in terms of pre-fiscal income. Health in-kind benefits reduce income inequality by 0.5 Gini points only, as access to health services vary. The distribution of benefits for outpatient care (i.e., not requiring overnight stay in hospital) tends to be relatively equal across the income distribution, reflecting widespread access and similar utilization rates among households of different income levels. However, benefits related to inpatient care (i.e., requiring overnight stay or longer), medicine and auxiliary healthcare services exhibit regressive patterns due to the richer households’ greater access to and utilization.a Location of district general hospitals and specialized hospitals pose accessibility challenges to poorer households residing in more remote areas. A larger portion of health and education user fees and co-payments are borne by richer households, resulting in a reduction in inequality. Health user fees and co-payments have an inequality-reducing effect as richer households are more likely to access medical services that may not be covered by health insurance, such as preventative and diagnostic tests and elective treatments. However, while richer households also pay significant fees for pre-primary and tertiary education, these fees increase inequality as they constitute a larger income share of poorer households. In net terms, education and health fees reduce income inequality as the health fee effect dominates. Source: World Bank 2024, forthcoming analysis on CEQ. Note: a. Approximately two-thirds of the benefits related to medicine are allocated to inpatient treatment, which is fully covered by health insurance, while medicine for outpatient care incurs varying rates of co-payments. 36 Mongolia Economic Update – November 2024 2. POLICY RECOMMENDATIONS Revenue reforms should be pursued to enhance Mongolia needs to balance fiscal reforms that the fiscal system’s redistributive impact. achieve short-term poverty and inequality Priority should be given to reforms that enhance reduction with those that offer longer-term the progressivity of the PIT system, such as benefits. Broad-based development policies implementing progressive tax rates and increasing such as investments in infrastructure, human taxes on income sources primarily associated capital, climate adaptation strategies, and public with high-income households. Additionally, administration are essential for inclusive growth offering tax deductions and exemptions for low- in the longer term, but its immediate impacts income earners can further enhance PIT's impact on poverty and inequality might be limited. In on reducing inequality and mitigating poverty. contrast, short terms measures such as indirect transfers through price subsidies could have The burden of taxes on poor households can immediate redistributive impact but have negative be mitigated by allocating funds to more cost- externalities in the medium to long term (e.g., effective programs. Reallocating funds to agricultural subsidies resulting in environmental programs that have greater cost effectiveness in degradation or energy tariff subsidies affecting reducing poverty and inequality is an important the financial sustainability of the energy sector). priority. Poverty-targeted programs should be scaled up while spending on large, broad-based programs such as the CMP should ideally be reduced through targeting or lowering benefits in real terms. In the absence of comprehensive records of individual and household income, improving the efficiency of social spending will require a reliable and well-developed social registry. 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