Mongolia is a landlocked and sparsely populated nation in Central Asia, wedged between Russia and China. The country was a Soviet satellite state until 1990, when it began its transition towards democracy and a market economy. The first years of this transition were difficult for Mongolia; the country was dependant on Soviet financial assistance and its economy primarily based on animal husbandry and nomadic herding. Economic collapse saw rampant inflation, food rationing and widespread shortages.
Market reforms eventually began to gain traction, and the economy began to recover from these initial shocks. The discovery of the Oyu Tolgoi copper deposit in 2001 marked the beginning of a new era for Mongolia. Major coal and copper mining projects attracted substantial inflows of foreign direct investment to develop the mines and their related infrastructure. FDI surged from $200 million in 2006 to $4.6 billion in 2011, generating explosive economic growth. Mongolia came onto many investors’ radars for its world-leading growth rates in 2011, over which the economy expanded by 17.1%. The economy’s general trajectory has been strongly upward, and the country’s population has enjoyed rapidly improving living standards. Household income has grown sixfold over the last decade.
Mongolia is overwhelmingly an extractive economy, and the vast majority of its mineral output is exported across the southern border to China. In 2017, 99% of Mongolian coal went to China , and copper output is also almost entirely destined for the Chinese market. This export dependance means that the country has been exposed to fluctuations in global commodity prices, and is closely tied into the Chinese economy. As a result, Mongolia has experienced two marked slow downs since growth began to take off in the early 2000s. During the 2008 financial crisis, slumping mineral prices and weak export demand served as a major shock to the economy, which slid into recession. The economy swiftly got back on its feet as export revenues and FDI resumed, growing at a breakneck pace through 2011 to 2014. In the mid-2010s, Mongolia once again hit the rocks as sliding commodity prices and policy missteps choked the economy of FDI, and brought to the fore structural weaknesses such as poor fiscal discipline and overdependence on the mining sector. This culminated in the agreement of a $5.5 billion IMF package in exchange for key reforms.
Today, Mongolia’s economy is on the rebound as a result favourable commodity market conditions and pragmatic government policy that have stabilised the investment environment and laid the foundation sustainable future growth. The main driver of growth has not been higher prices themselves, but an influx of FDI anticipating progress on major mining projects. In 2017, FDI rose by 136%. The World Bank forecast growth in 2018 at 6.1%. Mongolia is not out of the woods yet, and pushing through the necessary fiscal consolidation and diversification programs will require political resolve and time. In particular, the government faces an urgent need to improve the country’s transport infrastructure if it is to move beyond resource extraction.
The primary challenges facing the Mongolian economy in the short to medium term are fiscal consolidation to reign in sovereign debt and structural reform to ensure more sustainable and less mining-dependant growth in the future.
International institutions have been generally optimistic about Mongolia’s medium term outlook since last year. The World Bank hailed a ‘dramatic’ improvement in the economy this year, whilst Fitch upgraded the country’s long term foreign currency issuer rating to ‘B’ and Moody’s affirmed their outlook as ‘Stable’.
The agreement of the IMF package underpins this; the disbursement of funds from the IMF and regional partners alike has enabled Mongolia to refinance its substantial sovereign debt. Having faced $550m in maturing Chinggis bonds between 2018 and 2022, the package has given the country some fiscal breathing space. The IMF agreement also stipulates important reforms to the country’s taxation and spending. The country has agreed on the creation of a tax authority, as well as making moves to introduce a more progressive tax system. A 20% interest income tax was brought in at the beginning of 2018, alongside a 20% tax on non-resident income. Tax rates have grown in the last year, mostly off the back of higher mineral prices. On the spending side, Mongolia has worked to slash inefficient capital spending, which fell from 10.9% of GDP in 2016 to 4.3% in 2017. This has seen the country’s primary fiscal deficit turn into a small surplus of 2.1% last year. A key challenge in this process will be maintaining the political will to uphold discipline. In the past election cycles, fiscal discipline has fallen prey to political ambition. Recently, the administration was forced to reverse the implementation of progressive income tax in the face of popular discontent. This problem is of course not unique to Mongolia, but managing it is critical to fiscal sustainability in the future.
The agreement itself has shored up creditor confidence in the country. This can be seen in the increased appetite for and improved pricing of government bonds after the package was announced. Before the IMF package, the 2016 bond issuance had orders of c. US$750m for US$500m of available notes. Post-agreement, the 2017 issuance of US$125m saw orders in excess of US$3bn.
Mongolia also needs to diversify its economy, so to insulate it against fluctuations in global commodity prices. The government has pledged a variety of measures to stimulate the development of non-mining industries. A recent example was a ‘State Innovation policy’, announced in August 2018. The policy offers tax exemptions for start-ups and pledges to improve the legal environment for businesses and raise the country’s level of human capital. At the same time, the government has moved to strengthen the financial sector, conducting an asset quality review of the country’s banking system and being ready to recapitalise and restructure those with high levels of toxic assets. A stronger financial sector will catalyse the development of the rest of the economy.
The biggest task faced by the government is to upgrade the country’s physical infrastructure. Mongolia’s poor transport network is a major impediment to the development of its industries. The government has been active in its cooperation with regional partners in order to achieve this goal. The most important of these is Xi Jinping, who’s ‘One Belt One Road’ seeks to develop Mongolian rail infrastructure in order to create a trilateral economic corridor between China, Mongolia and Russia. The plan dovetails with the Ulaanbaatar’s own “Steppe Road” initiative, and aims to raise the country’s annual railroad freight capacity to 1 million tones. In a similar vein, construction has just begun on the country’s first oil refinery. Financed by a $1billion loan from the Export-Import Bank of India, the refinery has a planned capacity of 1.5m barrels per year, and is expected to be completed by 2022. The Ministry of Finance hopes that up to 30 types of manufacturing could be supported by the refinery as a domestic source of processed oil products.