OFFICIAL c IE. Dr. Jim Yong Kim DOCUMENT sident MINISTER OF FINANCE OF MONGOLIA he World Bank 15160 S.Danzangiin gudamj 5/1, Washington DC, 20433 Zasgin gaznin II bair, Chingeltel duureg, USA Ulaanbaatar, MONGOLIA Tel/Fax:(976-51) 26-02-47, http://www.mof.gov.mn Date 18 1 jolI Ref 0 - i / 6 cs- Subject: Mongolia: Letter of Development Policy Dear Mr. President, On behalf of the Government of Mongolia, I would like to express my sincere gratitude to the World Bank for its strong partnership to support Mongolia. The World Bank has been the most valuable development partner to Mongolia over the past two and half decades, providing critical financial resources as well as global knowledge and development experience. I believe that the new Economic Management Support Operation First Development Policy Financing (EMSO-1), which helps Mongolia overcome current economic difficulties and pursue critical economic reforms, offers another great opportunity to further solidify our close partnership. Mongolia's future is promising, given vast mineral resource endowments, great diversification potential in agriculture and tourism, and a well-educated population. In recent years, however, our economy has been facing challenges from a sudden deterioration in the external environment. The sharp declines in commodity prices and foreign direct investment have significantly reduced growth and budget revenue over the last years. The major shocks have also put growing pressure on our balance of payments, causing a sharp depreciation of the local currency and a significant loss in international reserves. Previous policy errors have compounded these shocks. Expansionary economic policy to buffer the external shocks increased public debt and exacerbated external imbalances. Elevated economic vulnerabilities have raised concern about the sustainability of our fiscal and external accounts, triggering a series of downgrades in sovereign credit ratings in 2016. A new Government was formed, at this critical juncture, with a mandate to successfully overcome these immediate economic challenges and bring our economy back to a stable and sustainable growth path. Recognizing the seriousness of the current difficulties, we are continuing the implementation of corrective actions that started under the previous Government, including "Economic Recovery Program" which was adopted in close consultation with the World Bank and other key development partners and termination of the one off spending programs that contributed to the large budget deficit in 2016. We are also continuing discussions on major foreign investment projects that could help unlock our significant growth potential. Despite the efforts, difficult fiscal and external challenges lie ahead in the coming years. The most pressing challenge is to significantly reduce the high budget deficit that reached 17 percent of GDP last year, while ensuring that the poor and vulnerable population are properly protected. Approaching repayments of large non-concessional debt in 2018 is also 051.3 posing a significant risk, considering our insufficient reserves and still fragile investor confidence. We are committed to policies and economic reforms to overcome both immediate and medium term challenges, and hope that multilateral and bilateral partners will support our efforts through concessional financing to ease pressure on the fiscal and external accounts. Against this backdrop, the Government of Mongolia reached an agreement on a three-year Extended Fund Facility with the IMF, and has adopted the first supplementary budget for 2017 on April 14, 2017 and preparing the second supplementary budget for 2017 in correspondence with the fiscal adjustment measures. Mr. President, financial and technical support under the Economic Management Support Operation (EMSO) of the World Bank will be vital for bolstering our reform momentum and overcoming the current economic challenges. Concessional budget support loan from the World Bank, together with other donors' support, will not only help us ease pressure on our fiscal account by reducing the cost of budget financing, but catalyze successful refinancing of the next large debt repayment due in January 2018. The reform programs supported by the EMSO are an integral part of our reform agenda, especially for (i) implementing a strong fiscal adjustment through key expenditure and revenue measures; (ii) protecting the poor and improving the sustainability and efficiency of the social protection system; and (iii) strengthening the structural resiliency of the economy by improving the business and trade environment, the competitiveness of livestock exports, and the strength of the financial safety net. I am pleased to inform you that we have recently made good progress in the reform areas supported by the EMSO-1. First, beginning with the 2017 budget, following the recommendation of the World Bank, we have terminated the Development Bank of Mongolia's (DBM) financing of capital expenditure through DBM's non-commercial loans. The existing non-commercial loan portfolio of the DBM was also transferred to the Government at the end of 2016. These measures will disengage the DBM from fiscal activities, thereby strengthening fiscal transparency and effectiveness. We will undertake an external special review on the DBM's operations in 2012-16 and an annual audit for the 2017 operations to ensure that the DBM stays accountable and disengaged from fiscal activities under the newly revised DBM law. Second, the Bank of Mongolia has discontinued net financing of the Housing Mortgage Program. Starting with the 2017 first supplementary budget, the Government will transparently reflect the interest-financed expansion of the mortgage program as government net lending. We will restructure the Housing Mortgage Program to better serve the purpose of affordable housing in a more cost efficient way and prepare a time bound plan for the Bank of Mongolia to fully exit the program, with the World Bank's technical assistance. Furthermore, the Bank of Mongolia will also conduct an independent external review on the quasi-fiscal operations and plans and publicly disclose the results. Third, we have revised the Personal Income Tax Law and the Excise Tax Law to strengthen revenue mobilization by imposing higher taxes on richer income groups, and on tobacco and alcohol. The revised Personal Income Tax Law also includes a gradual increase of the annual minimum income tax threshold to reduce tax burden on lower income groups. Going forward, with the World Bank's technical support, we will further deepen reform efforts in tax expenditure and international taxation to expand the tax base and reduce tax erosion. Fourth, with the goal of reducing capital expenditures to a sustainable level, we discontinued the Promissory Notes Program, a major cause of increased of expenditures in 2016. Termination of the program will allow us to avoid using deferred payments as a means of financing investment projects in the future. We will also reprioritize existing investment projects by applying the Public Investment Rationalization Guideline that will be prepared with World Bank assistance. Fifth, we have maintained the budget allocation to poverty-targeted social welfare programs, including the Food Stamp Program, from the 2017 first supplementary budget. Furthermore, we will scale up the coverage and the benefit size of the Food Stamp Program in 2018 budget, which will strengthen protection of the poor population during the economic adjustment. Sixth, we have begun to take actions to improve the financial sustainability of the pension system. As a first step, we have adopted legal amendments that, starting from 2018, gradually increase the pension contribution rate and retirement age. We will implement more comprehensive reforms to the pension system with the World Bank's technical support. Seventh, we have strengthened investor protection by establishing and making operational an Investor Protection Council (IPC) with a well-defined membership and mandate. The IPC will allow us to prevent investor grievances from escalating to fully-fledged disputes through coordinating responses to grievances across different ministries, agencies, and levels of the government. To further improve the business environment, we are also planning to revise the Permit Law in 2018 to list all existing licenses and permits, while reducing their numbers. Eighth, we have submitted the new Animal Health Law to the Parliament. Livestock is one of our key non-mineral exports, and holds significant potential for export diversification. But the competitiveness of our livestock products have been challenged by hygiene and animal health issues. The new Animal Health Law will allow us to more systematically control animal disease through improved vaccination, surveillance, and emergency responses, eventually improving the competitiveness of livestock exports. Ninth, our Parliament approved the World Trade Organization Trade Facilitation Agreement (TFA) in November, 2016. Lowering costs and administrative inefficiency in trade is one of the most important tasks for achieving export diversification. Full implementation of the TFA will enable us to promote trade by reducing costs and delays, improving transparency and predictability, and using more efficient border management procedures. With the World Bank's technical support, we will adopt the institutional framework for proper implementation of the TFA's key requirements in the coming months. Dear Mr. President, based on the reform progress that has been made, we request the World Bank's assistance through the Economic Management Support Operation. We believe that, with continued support from the World Bank through this operation, Mongolia will successfully overcome the immediate financing challenges, and will solidify its economic reform momentum. We look forward to a continued close partnership with the World Bank as the leading development partner in Mongolia's journey toward poverty reduction and shared prosperity. Sincerely, KHUR BAATAR himed