ECONOMIC HEALTH CHECK
Mongolia Stages Dramatic Turnaround
By Steven Barnett and Julia Bersch
IMF Asia and Pacific Department
September 13, 2010
- Strong policy response to global crisis offsets fall in exports, copper prices
- IMF program provided space to Mongolian authorities to implement changes
- Bright outlook with pending boom in mineral sector
Mongolia has witnessed a dramatic turnaround in a year and a half. After teetering on the verge of economic collapse, IMF economists now predict strong growth this year for the landlocked country in northeast Asia.
Mongolia's recovery has been assisted, in part, by a loan from the IMF which has given the authorities in Ulaanbaatar the breathing space to adopt the necessary policy measures.
As the global economic crisis unfolded, the Mongolian economy was hit hard. Demand for the country’s exports fell and world copper prices collapsed, putting Mongolia under enormous strain. By early 2009, growth was stalling, international reserves were rapidly being depleted, there was insufficient financing to meet the spending needs of the government, and the banking system was under pressure. The economy was on the verge of collapse.
18 months later, growth is expected to hit 8 percent this year, international reserves are at an all time high, public finances are on a sound footing, and the banking system has been strengthened.
Mongolia’s successful turnaround stems first and foremost from the authorities’ strong policy response to the crisis, supported by significant resources from the international community, including a loan from the IMF. In addition, the beginnings of the global recovery, strong demand from China, and an upswing in copper prices contributed to the rapid reversal of fortunes.
The main goal of the Fund-supported economic program—which included a stand-by loan of around $232 million, and was put in place in early 2009—was to ensure that Mongolia quickly returned to a path of strong, sustained, and equitable growth with low inflation. There were four pillars to this strategy:
• Flexible exchange rate to rebuild international reserves. In early 2009 the authorities implemented a flexible exchange rate regime that limited intervention to smoothing excess volatility and opportunistically building reserves. Intervention was exclusively and transparently carried out through twice-weekly auctions. This new regime was supported by an up-front 400-basis-point hike in the policy interest rate, which was effective in calming markets and attracting capital back into Mongolia. The foreign exchange market stabilized rapidly and international reserves have now reached an all time high of $1.6 billion.
• Restore health to public finances. Financing constraints forced a large fiscal adjustment in 2009, which was achieved mainly through a reprioritization of spending. The fiscal adjustment continued this year and, aided by the rebound in copper prices and the economic recovery, the fiscal deficit is expected to fall to 2 percent of GDP—well below the government’s original target. This year, parliament passed a comprehensive fiscal responsibility law. This is a landmark piece of legislation which builds the foundation for lasting fiscal discipline and an end to the boom-bust fiscal policies of the past.
• Protect the poor from the burden of adjustment. Social transfers were increased during the program period in order to shield the most vulnerable from the impact of last year’s recession. In addition, a new social transfer reform law has been submitted to parliament and is expected to be passed in November. This would introduce a well targeted poverty benefit that will strengthen the social safety net and increase the resources available to protect the poorest, as well as improve fiscal flexibility.
• Bolster the banking system. Confidence in the system is being restored, and risks have been contained even as two important banks were put into receivership. Parliament has approved a revised banking law that will strengthen the regulatory framework. A second piece of legislation to recapitalize the banks has been submitted to parliament. Finally, tougher supervision regulations have been issued and are now being enforced. These steps will serve to bolster the banking system and ensure that banks can play their crucial role in fostering development by providing credit to the private sector.
The Fund-supported program has provided confidence, financing, and breathing space for the authorities to more gradually adjust policies. It has also catalyzed significant financial contributions from the World Bank, Asian Development Bank, Japan International Cooperation Agency, and many other bilateral donors.
The success of the Mongolia program illustrates how the IMF has refocused its lending. The program’s conditions were restricted to those areas necessary to return the country’s economy to strong growth.
The program also adjusted flexibly as economic circumstances evolved. When growth in 2009 turned out to be weaker than expected, the fiscal deficit targets were loosened to support the economic recovery. Likewise, the program was adapted this year to provide scope for a modest increase in spending to raise pensions and civil servant salaries.
Finally, the resources made available to Mongolia reflected the reforms in IMF lending instruments put in place in 2009, with a substantially increased level of financial support. Throughout, the authorities have maintained strong ownership of the program—determinedly meeting every single performance criterion of the 18-month arrangement and passing through every program review—which contributed significantly to the program’s success.
The outlook for Mongolia’s economy is extremely favorable. The signing of a landmark investment agreement in late 2009 to develop the Oyu Tolgoi mine in Mongolia’s South Gobi Desert—referred to by some as the biggest undeveloped copper-gold project in the world—has been a cornerstone for the development of Mongolia’s substantial mineral resources.
The development of other major projects, like the massive Tavan Tolgoi coal deposits in southern Mongolia, is also under way. The economy is growing strongly and this ongoing development of the mineral sector points to a bright future.
The authorities’ policy reforms have laid a solid foundation for managing the pending boom in the mineral sector and ensuring that Mongolia’s substantial mineral wealth leads to a period of sustained economic growth that spreads prosperity to all Mongolians.