On April 3 the Asian Development Bank joined the International Monetary Fund and World Bank in downgrading its outlook for Mongolia's economy in 2014. One of the world's fastest growing, the Mongolian economy faces problems on several fronts in 2014 that promise to make this year a turning point.
ADB economists now see 2014 GDP growth at 9.5%, down from a previous 14% estimate, according to the latest figures published in the ADB's annual Asian Development Outlook 2014.
With the IMF and the World Bank having already cut their forecasts, a growing consensus over Mongolia's slowdown has now emerged. The country still fares among the world's fastest growing economies - GDP grew by 11.7% in 2013 - but a number of pending issues are taking a toll on its economic cycle and 2014 is set to become a turning point.
A long-awaited agreement over a $6bn expansion of Rio Tinto's copper-gold Oyu Tolgoi (OT) mine is expected in the coming months. OT represents a major barometer for the country's business climate and international investors, whose confidence in this frontier market has flagged over the last 18 months; FDI inflows were down 55% in 2013.
The government successfully bolstered the slowing economy through generous fiscal and monetary policies in 2013, but the ADB report labelled such policies as “unsustainable,” calling on the government to phase them out. All in all, Mongolia's outlook remains “promising,” it said, although there are “downside risks” that have to be taken into account.
"Rapidly declining foreign direct investment (FDI), falling coal exports, compounded by highly expansionary fiscal and monetary policy have created balance-of-payment (BOP) pressures. While the depreciation of the [tugrik] has already stabilized the current account deficit, relieving BOP pressures, stabilizing the MNT and containing inflation will require a tightening of economic policy to rein in domestic demand growth. Mongolia’s economic prospects also remain highly vulnerable to economic trends in [China] and the global economy, while current policies offer little buffers to cope with possible external shocks," the report said.
bne spoke to Jan Hansen, ADB senior country economist, to get a better grasp of the challenges and opportunities that lie ahead for Mongolia dynamic economy.
bne: Mongolia has approved many reforms in 2013 aiming to boost investor confidence and sustain the economic cycle. Yet you sharply reviewed downwards your 2014 growth forecast. What has changed over the last year to prompt such a decision?
Hansen: We didn't expect a 55% drop in 2013 FDI inflows, which is really affecting economic growth. FDI inflows are very important for Mongolia's non-mining sector such as the wider service industry and in particular trading. Even if they largely finance imports, they increase value-added in the service industry, which is labour intensive and creates many jobs, for example. At the same time, the tugrik depreciation (Mongolia's currency has lost 27% against the US dollar since early 2013) is affecting the disposable income of Mongolians through higher import prices. China's decreasing demand for Mongolian coal and the country's struggle to compete with other coal exporting countries has also affected our forecasts (the value of coal exports was down 40% in 2013).
bne: Authorities hailed new FDI legislative framework approved in October as a silver bullet to unleash FDI inflows. But the ADB report reads: “The resumption of significant foreign capital inflows may take some time despite the adoption of the new investment law.” What is still holding back international investors?
Hansen: At this stage, there are no clear indications that sentiment among foreign investors has already substantially improved. If the macroeconomic situation stabilizes, and agreements over major projects such as Rio Tinto's OT and state-owned Tavan Tolgoi proceed, that would probably be seen by international investors as a sign of confidence. All in all, our figures do incorporate a rebound in FDI inflows, starting this year, based on an improved legal framework, but more significantly impacting on the macroeconomic situation rather in 2015.
bne: Reading between the lines of the report it looks like you don't expect the OT expansion to kick off in 2014. Should the current dispute between the government and Rio Tinto continue throughout 2014, what are the risks for the economy as a whole?
Hansen: In the current situation, an immediate agreement is not widely expected. The March 31 deadline for funding commitments is past already. In case of an agreement in late summer or later, economic growth this year would probably not be very much affected. An agreement on the OT second investment phase with clear benefits for all involved parties would probably be seen as a sign of confidence and support other FDI flows - and the other way around. The first OT investment agreement concluded in 2009 supported subsequent FDI inflows.
bne: The report highlights the need to reign in “unsustainable” macroeconomic policies. The banking and construction sectors have largely benefited from generous monetary stimuli and strongly contributed to keep the economy running in 2013 - bank credit increased by 41% year on year in 2013, and the construction sector grew by 66%. Are the two sectors going to face some important distress as the central bank phases out its expansionary programmes?
Hansen: Periods of very high lending growth, as last year for example, often create challenges in banks' portfolios one-two years later when loans are seasoning. Currently, the level of non-performing loans, including in the construction sector, is quite low. Problems in banks’ portfolios often emerge when real economic activity is slowing down significantly, as happened at the end of 2008, but this is not the case in our current forecast of the economy.
bne: The report calls for an incorporation of off-budget spending into the official budget in order to fully comply with the Fiscal Stability Law's (FSL) 2% deficit ceiling. At the same time, total public debt is well above the FSL's 40% ceiling for 2014. This could jeopardize, among other things, some ADB financing programmes that have yet to be approved by parliament, like a widely publicized $320m redevelopment programme of Ulaanbaatar's underprivileged districts. Do you think parliament should increase the ceiling or try to reduce the public debt?
Hansen: There is little borrowing space for the government this year under the current debt ceiling of the FSL. Mongolia as a lower-middle income country is currently at an early stage of the investment cycle to develop the mining industry, diversify the economy and provide essential social infrastructure for the population. Investment in human capital is also essential. A 40% debt/GDP ceiling is not very high, but simply focusing on one particular number for the optimal debt level is therefore not very fruitful. Another critical issue for the quality of investment is planning and project management capacity which needs to be further developed.