The needs of rapid economic development

Mongolia’s economy is developing rapidly, but fiscal policy must balance the need for macroeconomic stability and support for long-term economic growth that benefits all Mongolians.

Economic growth in Mongolia is forecast at 15 percent in 2012 and 17.5 percent in 2013, driven by mining-related investment and output, according to the Asian Development Outlook 2012 released on 11 April.

Mongolia’s economy however remains highly vulnerable to commodity price fluctuations and developments in international financial markets. Continued uncertainties surrounding the resolution of sovereign debt problems in the euro zone pose the biggest threat to the world economic outlook.

Gross domestic product (GDP) expanded by 17.3 percent in 2011. Economic growth was mainly driven by infrastructure spending related to mining activity. Gross capital formation increased by about 60 percent in real terms, including for equipment, buildings and intermediate goods, and public infrastructure. The first phase of investment in the Oyu Tolgoi copper and gold mine is projected to total $5 billion and the mine is nearing commercial production. Domestic consumption, such as the sum of private and public consumption, was another important driver last year, rising by about 15 percent in real terms.

External trade soared in 2011. The value of exports, driven by increases in the volume and value of coal production attributable to demand from China, rose by 64.4 percent. However, imports more than doubled, largely related to the equipment and machinery needs of the mining sector. Net exports were negative and, therefore, significantly reduced the national accounts measure of overall growth.

While economic growth primarily originated in the mining sector, it was quite broad-based. Domestic trade (wholesale and retail) rose by 42.5 percent, stimulated by large government cash payments to all citizens. The mining and manufacturing sectors rose by 8.7 percent and 16.0 percent, while construction increased by 14.3 percent. Agriculture, which accounts for more than a third of total employment, was flat. 
 
Macroeconomic management of an economy characterized by very rapid development of its natural resources often leads to what is called “Dutch disease”– that is, high inflationary pressures, upward pressure on the exchange rate, crowding out of the private sector, and increasing vulnerability to external shocks. In Mongolia, substantial public investment in infrastructure is needed to develop the natural resource sector in an environmentally friendly and equitable manner; diversify the economy; and create jobs and increase access for all people to essential services like health and education, housing and water and sanitation. 

However, overly expansionary fiscal policy, in particular universal cash payments from the Human Development Fund, have created inflationary pressures and made the economy vulnerable to external shocks. Government expenditure in 2011 increased by 55.6 percent, or 44.2 percent of GDP, for spending on social transfers, wages and cash transfers surged. While the Bank of Mongolia has significantly tightened monetary policy since early 2010, inflation increased to 15.3 percent in March 2012 and is expected to remain in double digits in the coming two years.

The need for expenditure policies that support inclusive growth without undermining fiscal sustainability and macroeconomic balance requires re-direction of government expenditure towards long-term investments. 

The recent introduction of a mean-tested poverty benefit under the amendments to the Social Welfare Law, replacing the universal cash transfers, represents a major step toward a fiscally sustainable social protection system that effectively supports the poorest. The government has also strengthened the legal framework for fiscal policy and budget management through enactment of the Fiscal Stability Law in June 2010 and the Integrated Budget Law in early 2012. The fiscal law aims to ensure that mining revenues are better managed in the future by putting in place three complementary fiscal rules to ensure fiscal discipline: (i) a ceiling on the structural deficit; (ii) a ceiling on expenditure growth and (iii) a debt ceiling. Implementation and enforcement will make an important contribution to insulating fiscal policy from commodity price shocks and smoothing the economy’s adjustment to higher mineral output. In turn, this will facilitate development of the non-mineral economy. The budget law is a comprehensive law which aims to reform the entire budget process from investment planning to budget execution and auditing, and puts in place a new framework for fiscal decentralisation. It is vital that both these laws be implemented in spirit and practice.

The banking sector has recovered considerably since 2009 when it experienced a period of severe financial distress. However, rapid expansion in bank lending – up by around 55 percent year-on-year in March 2012 – is fueling demand and increasing the banks’ vulnerability. It is critical that the central bank closely monitors financial risks and enforces full compliance of Mongolian commercial banks with current prudential regulations.

Worldwide, countries have shown that, paradoxically, an abundance of natural resources can hinder long-term development by increasing macroeconomic volatility, thus reducing incentives to invest in physical and human capital and undermining economic and political institutions. Resource dependence often leads to growing income disparities, as resource extraction creates relatively few jobs and a small proportion of the population may secure most of the income. Mongolia, in recent years has experienced a trend towards increasing inequality which eventually could undermine social cohesion and stability. The mining sector creates 90 percent of exports, 30 percent of government revenue and 20 percent of GDP, but only 1.6 percent of employment. For Mongolia, two important medium-term challenges will be to (i) further improve its economic and political institutions so as to ensure transparent, accountable and equitable management of natural resource revenue and (ii) encourage diversification of the economy and create employment by supporting investment in non-resource sectors. 

The Asian Development Bank (ADB) is a multilateral development bank owned by 67 members, 48 from the region and 19 from other parts of the world. ADB has been Mongolia’s largest source of development finance for two decades and provided financial and technical assistance for projects in agriculture, education, energy, finance health, industry, telecommunications, transport, and urban development.

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