Analysis of External Debt Sustainability in Mongolia: an Estimated DSGE Approach

Abstract

In this study, we assess the effects of the structural shocks on the external debt sustainability in Mongolia, based on an estimated small open economy (SOE) dynamic stochastic general equilibrium (DSGE) model with the traded, the non-traded, and the mining sectors. The impulse response results show that the traded sector’s productivity shock, the commodity price shock, the mining output shock, and the foreign interest-rate shock have a decreasing effect on external debt accumulation in Mongolia, whereas the non-traded sector’s productivity shock, the household preference shock, and the government spending shock have an increasing effect on the same. Furthermore, we assess Mongolia’s external debt sustainability under the COVID−19 pandemic shock. Under our assumed pandemic scenario, Mongolia’s external debt will increase by 30% from its steady state over the next 10–28 quarters. Our recommended solution in this study is to develop the traded sector, instead of the mining sector, to maintain sustainability of the external debt and to decrease vulnerability of the economy.

An Investigation into the Sources of Depreciations in Mongolian Tugrik Exchange Rate: A Structural VAR Approach

“…This productivity decline implies that the traded sectors' competitiveness is deteriorated significantly relative to China, causing real depreciation in MNT exchange rate due to the decrease in non-traded sector's prices. In contrast, the mining sector's boom in Mongolia tends to result in real appreciation in MNT exchange rate due to the Dutch disease effect (Corden 1984;Ganbayar 2021). If the productivity effect dominates the Dutch disease effect, Mongolia experiences real depreciation and vice versa, ceteris paribus.…”

“…In fact, the BoM intervenes in foreign exchange markets by organizing auctions between commercial banks every Tuesday and Thursday. However, despite the substantially increased external debt in Mongolia (Batsuuri 2015;Ganbayar 2021), the data show that there is insignificant fear of floating in the monetary policy rule of the BoM (Taguchi and Gunbileg 2020). Since the BoM has started managing MNT rate recently according to the IMF (2020), determining the sources of exchange rate fluctuation is vital to participate in foreign exchange rate market effectively.…”

“…The most recent indirect cash handling action backed by mining income was the one-time forgiveness of pension-backed debts in January 2020. At the time of loan cancelation, there were 229.4 thousand pensioners who had taken loans worth 763.3 billion MNT (Ganbayar 2021). These direct and indirect cash handling policies implemented by the GoM increase money supply (nominal shock) substantially and may cause large depreciations in nominal MNT exchange rate (see Figure 2).…”

“…The defining features of the current state of the Mongolian economy are a mining boom and external indebtedness (Ganbayar 2021). Following the recent huge mining developments, the Government of Mongolia (GoM) implemented several "cash handling" policies to distribute mining income to citizens (Dagys et al 2020;Yeung and Howes 2015).…”

“…As a result of these cash handling policies, the money supply in Mongolia increased substantially (Figure 2). On the other hand, the skyrocketed external debt (Batsuuri 2015;Ganbayar 2021), which is primarily in US dollars, causes the Bank of Mongolia (BoM) to manage exchange rate depreciation to secure confidence in domestic currency despite its inflation targeting mandate because there might be an epidemic of the "fear of floating" (Calvo and Reinhart 2002;Taguchi and Gunbileg 2020). As a consequence, the de facto exchange rate arrangement of BoM was recently reclassified twice: (1) to crawl-like from floating, effective 18 September 2017, and (2) to other managed from crawl-like, effective 11 April 2018, according to the International Monetary Fund (IMF (2020)).…”