While it appears likely that Mongolia will need another IMF bailout, hopes are high that the newly elected MPP government's austerity package could introduce the transparency and fiscal reforms necessary to stabilise the economy for good. Stefania Palma reports.

Rio Tinto Mongolia

Overspending, overborrowing and an over-reliance on Chinese export demand as well as on the extractives industry mean Mongolia is now in the ‘bust’ end of its economic cycle. Gross domestic product (GDP) growth has fallen from 17.5% to 1.4% in just five years and the country may ask for International Monetary Fund (IMF) support to reach fiscal consolidation.

In a bold and unusual move, the newly elected Mongolian People’s Party (MPP) has thrust the country’s dirty fiscal laundry out in the open. Now, a strategy to strengthen fiscal discipline, re-engage with foreign investors and diversify the economy could help Mongolia break its continual economic cycles of boom and bust.

Spending spree 

In 2016 the World Bank put Mongolia’s budget deficit at more than 18% of GDP. That is 14 percentage points above the statutory limit, which was avoided by having multiple and unconsolidated budgets. Government spending accelerated in the lead up to the June 29 elections (between January and July 2016 it grew 33% year on year) as the then governing Democratic Party rolled out social programmes – dubbed cash handouts by some critics.

In an emergency parliamentary session that started in August, the MPP – by now in power – proposed an austerity package that included tax hikes, higher gold royalties and lower wages for members of parliament to squeeze the budget deficit. 

But Mongolia needs growth to fix the deficit issue, according to Graeme Knowd, managing director, financial institutions group, at Moody’s Investor Services. “You cannot have fiscal consolidation just with cost cuts in a country such as Mongolia,” he says.

Debt frenzy

What is more, government debt has ballooned to 90% of GDP. Mongolia faces bond repayments in 2017, 2018 and 2022. First up is a $580m bond issued by the Development Bank of Mongolia that matures in March 2017. The market expects the sovereign to roll the bond over, which would mean paying a coupon at least 6.5 percentage points above the original 4.5%.

Other repayments involve a $1.5bn Chinggis bond due in 2018 and 2022, an extendable $2.4bn swap line with the People’s Bank of China due in 2017 and a Rmb1.1bn ($161.1m) dim sum bond maturing in 2018. 

Overborrowing during Mongolia’s boom years and unproductive public spending are largely seen as the causes of today’s fiscal fiasco. “Maturity needs to be developed at institutional level,” says Tuyen Nguyen, the International Finance Corporation’s representative in Mongolia. 

Foreign help

But for now, Mongolia is likely to ask for IMF help to put the books in order. The MPP’s austerity package ticks many boxes required for IMF support, as does the central bank’s 450bps policy rate hike to 15%, which halted the tugrik’s freefall in August when the currency lost 8% in just two weeks.

An IMF delegation had not visited Mongolia at the time of writing in mid-September, though it was thought to be imminent. Failing that, a Mongolian delegation may discuss the matter at the IMF and World Bank annual meetings in Washington, DC in early October. 

If Mongolia does ask for IMF help, it will be a repeat of 2009, when an economic crisis triggered by falling commodity prices pushed the sovereign to take out a $229.2m IMF loan. This was repaid early thanks to the mining sector boom of 2011.

While welcomed by the IMF, others find Mongolia's proposed austerity package and the 450bps rate hike extreme, if not out of touch with the real economy. “The rate hike was too abrupt and might have a negative effect on unemployment, which is already rising while salaries are either dropping or staying the same,” says Damba Lkhagvasuren, associate professor at Concordia University and consultant at the Independent Research Institute of Mongolia. “The US Federal Reserve gets signals for rate moves from employment data. We get ours from the US dollar.”

Border anxiety

Besides the IMF, pundits are not excluding China as a creditor of last resort for Mongolia. But this might erode regional economic independence, according to James Liotta, chairman of the American Chamber of Commerce in Mongolia.

China remains crucial to Mongolia, however. It takes more than 80% of its exports and is the second largest source of foreign direct investment (FDI) in the country, according to greenfield investment monitor fDi markets. 

The gold and copper Oyu Tolgoi (OT) mine – 66% owned by Rio Tinto and 34% owned by the government – is Mongolia’s key FDI source today yet it relies on China for its power supply. “We would prefer using domestic power in terms of cost and security of supply,” says Mr Munkhsukh Sukhbaatar, country director, Mongolia, at Rio Tinto.

China will also be the key buyer of OT’s copper and gold. However, Rio Tinto is keen to move into the markets of South Korea, Taiwan and Japan. “It is prudent to diversify,” says Mr Munkhsukh.

China is also at the heart of the debate when it comes to building railways in Mongolia, a landlocked country where key exports (minerals) are still transported via trucks. But building railways in Mongolia that are compatible with China’s means giving the neighbouring giant easy access to a country of about 3 million, an imbalance Mongolians are mindful of. “China could easily shut the border whenever it wants,” says one market participant, who recalls how China blocked trains at the Mongolian border in 2006 when the Dalai Lama visited Ulaanbaatar.

Bringing investors back

The new MPP government is also tasked with attracting foreign investors back to the country after delays in mining projects such as the OT mine drove them away. FDI dropped by $400m just between May and June 2016, according to the World Bank.

An impasse between Rio Tinto and the government after the official agreement had been signed stopped OT’s underground development for two years. This kind of unpredictability has generated investor fatigue, according to Mr Liotta. “Instability of the rule of law has driven investors away. Investors need to know what they need to put in to get a licence, for instance, and what they’ll get out of it,” he says.

As a resource-rich country, mining will continue to drive Mongolia's economy. The reopening of OT will generate $1bn of FDI per year and once the underground mine is completed in the early 2020s, Mongolian exports could grow four to five times, says Mr Nguyen.

Mining projects could also help Mongolia meet its high infrastructure investment needs, and Rio Tinto has set up a consortium of Japanese and Mongolian investors to build a power plant in the south Gobi desert region.

Not just mining

While the size of the mining sector makes Mongolia’s economy vulnerable to swings in commodity prices, strengthening other sectors could minimise the impact of price shocks. Agriculture is one of Mongolia’s largest untapped potentials. Despite having a large capacity of 60 million livestock, Mongolia still imports 5000 metric tonnes of milk powder a year from New Zealand because it lacks the infrastructure to get raw material to market and to process them into higher value added products. 

Poor allocation of public money is part of the problem. Gantulga Bulgan, CEO at Mongolia’s largest dairy manufacturer Suu, says a five-month delay in receiving government funding will force him to wait till the harsh winter is over to deploy these funds. “We are essentially paying interest on a loan we’re not using,” he says.

He is, however, optimistic. Policy decisions should be quicker since the MPP win ended the coalition government, and the MPP is to cut back on costly, inefficient social programmes, he adds.

Tourism could also prop up the Mongolian economy. The arrival of a Shangri-La hotel and shopping centre in Ulaanbaatar a year ago leaves market participants hopeful. Although Mongolia's business cycles may be a concern, the country remains attractive for foreign investors with a long-term approach to investment. 

Nonetheless, increasing infrastructure investment will be necessary for the tourism industry to take off. “Infrastructure is a concern; there needs to be a push to improve infrastructure before even tackling the question of tourism,” says one foreign investor. 

A Soviet satellite just 25 years ago, Mongolia has come a long way when it comes to building a market economy. The model is not yet perfect: vested interest and poor transparency have marred institutions’ accountability. But the frank acknowledgement of the economy’s difficulties now signals a maturing market, which is striving to break free from the toxic cycle of boom and bust.


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