Үндэсний Стратегийн Хүрээлэн

Institute for National Strategy

Achieving Macro-economic stability (part 2)

INS Problem statement

Last week Mr. Khashchuluun raised the “macro-economic” issues that need to be understood and reconciled by ordinary Mongolians, policy influencers and policy decision makers alike.

Three years of high economic growth have been experienced but at the same time we now have a situation where we rate poorly in terms of inflation, affordable housing, low interest rates, job growth, and improved government service delivery.  At the same time our personal and national debt levels are escalating rapidly and the Mongolian currency is steadily declining in value.

Mongolia now has a significantly higher level of debt, with higher interest and debt repayments to honor and service, and a structural current account deficit to deal with. This situation will not disappear and will only get worse if not addressed immediately.

What can be done?

Authors Opinion – by Cameron McRae, Founding President of INS

The strength of an organization is often measured in how it responds to harsh conditions. Great organizations thrive in the good times and survive well during the hard times. Often these organizations save during the good times to ensure they have resources in place to borrow against for the tough times. Great organisations also take remedial actions quickly when it becomes clear that existing strategies are not working.

Recent global events have conspired against Mongolia – the end of the commodity “super-cycle” has seen huge contractions in new investments, reduced volumes sold and reduced selling prices. All three factors have hit Mongolia hard. But Mongolia has also made its own life more difficult by creating an uncertain investment regime for both international investors and lenders which has led to many projects being stuck on the drawing board.

An immediate improvement in the global mining cycle will provide some relief from the existing operating mines. However it will not alter the structural issues that Mongolia now faces. The ability to ramp up new production and earn extra revenues and taxes – through greenfield projects and brownfield expansions – takes years to occur.

Despite recent improvements to some investment related laws and regulations, international investors remain cautious about Mongolian business opportunites. Certainly resolution of the OT dispute with Rio Tinto will be a good sign but there is more to be done given the number of other sore points that are not yet fixed.

Unfortunately the Mongolian government now has a significantly reduced ability to pursue macro-economic policies that

  • pay for future infrastructure with cheap government raised debt,
  • pay for investments in strategic industries (such as mining)
  • subsidize poorly performing SOE’s
  • subsidize normal citizens through price controls
  • subsidize certain industries through cheap loans

Mongolia has (rightly) increased its focus on leveraging into the growing trade between Russia and China. It is also presenting itself in a less antagonistic manner to China in terms of improving its ability to trade on internationally fair terms. This is smart and building a long term mutually beneficial relationship is imperative work. Achieving internationally benchmarked prices for commodity exports is also a strategic imperative.

 But Mongolia knows well that it cannot afford to put all its eggs into a single basket – so working with competent and significant non-Sino trading partners should remain a strategic imperative.

The GoM is also pursuing government to government support for various large projects – and especially from neighbors within the Asian region. Again this is important work, and the government needs to ensure these projects are gained on economically fair terms and do not restrict future flexibility.

So what can be done about the macro-economic situation? Telling the electorate that things will be OK can be politically justified. However fooling yourself into thinking that you can borrow and spend your way out of trouble is not wise.

Examples of this occurred in Europe and other countries in 2009-10 following the GFC – where already heavily indebted governments increased their spending as the private sector shrunk. These countries are effectively bankrupt and are now undergoing radical restructuring to many areas of their economy and society.

Action 1:          Publicly benchmark Mongolia against a number of international measures (including the Matrich Treaty).

By acknowledging the severity of the situation that Mongolia faces – through publicly released metrics and future (well thought through) targets – should make it easier for citizens to understand the need for modifications to macro-economic policy. Some key measures are:

Matrich Target Mongolian performance
Inflation 3% 3% in 2011,  to a high 17% in 2012 and then 14% in 2013
Budget deficit (% of GDP) 3% max 10% in 2013 when counting off-balance sheet lending
Currency fluctuation 2.5% pa Moved from 1300 in 2011 to a low of 1880 in 2014 – a 44% devaluation in 3 years

Measuring FDI with and without Oyu Tolgoi is important because we need to understand how the rest of the economy is performing and to ensure that the OT business is running at full steam.

Tracking the balance of payments and absolute levels of imports and exports highlights the importance of the performance of the export focused sectors of the economy. A high level of exports allows imports to be purchased without negative impacts on currency reserves, exchange rates and interest rates.

Action 2:         Create a clear view of Mongolia’s total  debt and put back discipline

This is critical. Yes, borrowing and debt repayment is a fact of life – organizations needs to borrow money to pay for capital goods. This is true whether one is a family, a business, or a government. However 2 critical rules are

  • Do not borrow to meet current expenditure needs
  • Only borrow to levels that are sensible and that you can service and repay on schedule.

Action 3:         Address the critical realities that will not self-correct and ensure that government policy takes these factors into account. The critical realities are

  1. Mongolia’s economy runs on several tracks
    • Existing mining businesses and projects under development
    • Future natural resource mega-projects that require huge capital investment and international technology and finance to get them started
    • Future infrastructure projects to support mining, energy and agricultural projects as well as modernizing Mongolia’s transportation and energy transmission
    • Real estate development and the rest of the economy
  2. The GoM now has very high levels of debt and does not have its own money to invest in mining ventures, large infrastructure ventures and energy projects
  3. Mongolia does not have a successful record of bringing on a steady stream of privately funded large projects in mining, energy and infrastructure.
  4. Mongolia may gain revenues from new mining projects in the next 10 years, if it creates an attractive and safe investment environment today. However significant “new” construction starts are unlikely in the next year and significant operational revenues will not flow for 5+ years.
  5. The GoM is heavily subsiding Mongolian companies and individuals through different subsidy schemes. This continues to increase government debt, with no repayment of the subsidies ever likely to occur. Worse still it does not increase productivity or international competitiveness.

Action 4:         Focus government policy measures under two banners – growth and service delivery

Banner 1 is about growing a bigger economic pie and giving the job to those organisations who are best suited to delivering it – cost effectively and with their own sources of capital.

Banner 2 is about supporting Banner 1 and then public service delivery – focusing on government budget deficits, inflation, interest rates, housing affordability and improving government services.

Key macro-economic measures to be acted on include:

  • Stop wasting scarce GoM revenues on subsidies to SOE’s, consumers and private companies
    • Phasing out subsidies should be done quickly with investment incentives being linked to productivity improvements in agriculture and new fields of endeavor.
    • Get all users to pay fair prices for fuel, electricity, etc… YES, it will have a once of hit to inflation but then it will not be reflected going forward.
  • Privatize and then sell SOE’s that are loss making – this will provide immediate relief to the budget
  • Open up the banking sector for fresh injections of capital (which should lower interest rates to commercial borrowers)
  • Create incentives for people to save – and create saving pools to be borrowed against for accommodation mortgages
  • Ensure that future government borrowing is only undertaken where it
    • Replaces higher cost debt with lower cost debt
    • Is invested in sectors whereby economic activity is sustainably increased
    • Is invested in projects that have been transparently tendered and where net economic benefits are obvious and near term

Action 5:         Radically alter the approach to attracting foreign investment and finance.

The government is already addressing the investment climate through regulation and publicity events. It now recognizes the absolute importance of investor confidence in a country’s leadership and each country’s ability to honor existing agreements and provide a reliable legal system to arbitrate over legal disputes. Tax stabilization agreements are now being offered but other measures also need to be considered to win international finance for Mongolian based investments.

  • Provide tax incentives that entice new activity to occur (ie.. incentives that do not exist)
  • Ensure that cabinet and government agencies are set-up to genuinely facilitate the establishment of successful proposals (requiring international finance), and that they absolutely fast-track development once (all) approvals to commence are given.

INS Commentary

Mr. Khaschuluun and Mr. McRae have now written separately on measures needed to rectify the economic situation in Mongolia. Growing the economy and Mongolian standards of living is a highly complex task. Doing it with regard to the needs of our neighbors, trading partners and international investors and banks will yield positive results for Mongolia and its citizens.

Mr. McRae has highlighted that the GoM needs to more clearly explain the macro-economic situation and options to its citizens and take the hard decisions that are now required.

The political parties should NOW clearly lay out their policy positions on macro-economic management – so that voters in the 2016 election can clearly judge who is most competent in this regard.

And finally it is recommended that an independent macro-economic scoreboard be developed for Mongolia so that its citizenship are clearly informed.

Leave a Reply