## 1mngea2019002 ## Source details **Canonical URL:** [1mngea2019002](https://www.imf.org/-/media/files/publications/cr/2019/1mngea2019002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1mngea2019002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1mngea2019002.pdf.json) --- ### PRINCIPAL GOVERNANCE CHALLENGES — overview - Improving governance is crucial for Mongolia to achieve sustainable and inclusive growth; governance shortfalls have manifested in foregone FDI, higher public debt, and pressures on correspondent banking relationships related to AML/CFT concerns. - Discussion is organized into six categories: A) Anti-Corruption Framework, B) Rule of Law and Regulatory Framework, C) Fiscal Governance, D) Financial Sector Oversight, E) Central Bank Governance and Operations, and F) AML/CFT. - Recent public scrutiny highlights opaque financing of political parties and vested interest groups; governance reforms are critical to support the government’s Economic Recovery Plan. - Policy recommendation: Pair anti-corruption legal and institutional improvements with broader governance reforms across rule of law, regulatory framework, fiscal and central bank governance, financial sector oversight, and AML/CFT. ### A. Anti-Corruption Framework - Historical and institutional background: - Anti-Corruption Law adopted in 1996; Mongolia ratified the United Nations Convention against Corruption in 2006; Criminal Code revised in 2017. - Independent Authority Against Corruption (IAAC) established in 2007; first anti-corruption strategy covered 2002–10; next strategy covers 2016–23. IAAC prepares an annual report submitted to Parliament. - Mongolia participates in the Istanbul Anti-Corruption Action Plan (OECD-ACN). - Current assessment: - The 2019 OECD-ACN Monitoring Report finds corruption remains widespread and implementation of action plans has been limited and uneven. - IAAC lacks independence, resources, and necessary support from state bodies to fully exercise its mandate. - Selected recommendations from the 2019 OECD-ACN Monitoring Report: - Address gaps in the legal framework, including criminalization of all corruption offences. - Strengthen capacities and guarantee independence of IAAC, the Judiciary and the General Prosecutor’s Office. - Ensure transparent selection and accountability of Public Council members overseeing IAAC. - Strengthen implementation of National Anti-Corruption Strategy and Action Plan and provide cooperation to IAAC. - Intensify detection, investigation and prosecution of high-profile corruption cases; eliminate immunity; protect whistleblowers. - Address politicization of the civil service and high turnover after political changes. - Ensure systematic and objective verification of income and asset declarations by Politically Exposed Persons (PEPs) and follow-up. - Ensure proactive and systematic engagement with civil society. ### B. Rule of Law and Regulatory Framework - Assessments: - Worldwide Governance Indicators (WGI) place Mongolia above peers in Asia but below regional averages; legal framework has loopholes and unintended consequences. - Key reform areas and recommendations: - Review and amend laws to ensure a level playing field between foreign and local investors; ensure local courts enforce non-discriminatory protections. - Upgrade Investor Protection Council (IPC) capacity through training and more funding. - Judiciary improvements: appoint new judges, provide specialized training, and improve IT; develop arbitral institutions, professionals, practice and case-law. - Reform insolvency and creditor rights regime in line with IMF and other advice to facilitate collateral recovery. - Enforce existing regulations (including “use it or lose it”) to limit rent-seeking in mining license distribution. - Reduce laws and regulations that discriminate between local and domestic investors and reduce areas closed to FDI. - Consider 2019 OECD-ACN recommendations to strengthen judicial institutions. ### C. Fiscal Governance — key findings and recommendations - Context and indicators: - WGI Government Effectiveness score: -0.26 (scale -2.5 to 2.5). - Mongolia has a fiscal rule-based system embedded in the Fiscal Stability Law of 2010 (FSL) and the Integrated Budget Law, but adherence has been uneven with serious macroeconomic implications. - Institutional priorities: - Ensure clear roles and responsibilities across National Audit Office, Fiscal Stability Council, Ministry of Finance and Parliamentary offices. - Revenue administration — findings and policy actions: - Asia Foundation’s 2018 survey finds Tax Office, Specialized Inspection Agency, and Customs are highest among government agencies creating obstacles for business. - Implement fully and consistently the revised tax laws: General Tax Law, Corporate Income Tax Law and Personal Income Tax approved by Parliament in March 2019. - GDT to formulate a detailed action plan for new regulations, tax forms, instructions, administrative processes, information systems and training. - Formalize Compliance Risk Management (CRM) process with differentiation across four taxpayer segments and a simplified regime for smaller businesses; allocate adequate budgetary funding. - Build data management, research, and analytics capability; adopt Tax Administration Integrated System (TAIS). - Remove tax expenditures: tax expenditures were estimated at 3.2 percent of GDP, accounting for nearly 14 percent of total revenues in 2017; Corporate Income Tax and Value Added Tax exemptions amounted to 1.15 and 0.75 percent of GDP, respectively, in 2017. - Initiate comprehensive evaluation (cost-benefit analysis) of tax expenditures; enhance transparency in establishing tax expenditures. - Avoid tax amnesty schemes; consider alternatives such as payment instalment agreements, voluntary disclosure programs (VDPs), simplification of tax policy regime, and strengthening legal framework. Note: poorly designed VDPs can harm tax morale. - Expenditure policy and PFM concerns: - Four main concerns: - Mongolia’s capital expenditures averaged about 11 percent of GDP in 2010-16, far exceeding 4.8 percent for lower middle-income countries and 3 percent for East Asia and Pacific countries. - Mongolia ranks 124th globally regarding efficiency of public spending in the World Economic Forum’s Global Competitiveness Index. - High volatility of annual aggregate public investment spending causes planning difficulties, project delays, arrears, and cancellations. - History of public-private partnerships associated with higher costs and poor selection. - Recommendations to improve investment efficiency and reduce corruption vulnerabilities: - Estimate sustainable levels of public investment spending separate from proposed levels and publish in the Medium-term Budget Framework. - Require all projects, regardless of financing source (including concessions), to be appraised prior to the budget process and approved through the budget process. - Establish and publish project selection criteria consistent with planning guidelines. - Establish and publish a consolidated methodology for determining appropriate maintenance funding by sector. - Improve payables reporting to control execution of public investment projects and monitor arrears. - Expand MTFF and annual budget narrative to highlight maintenance needs and allocations for routine maintenance, capital repairs, ongoing investment projects and new investment projects. ### D. Development Bank of Mongolia (DBM) - Background and concerns: - DBM established in 2011 to finance large-scale projects; in 2012–16 government used DBM as major off-budget financing vehicle with allocations averaging 5.2 percent of GDP. - National Audit Office and PwC special audit confirmed significant weaknesses in corporate governance, policies and procedures, and internal control during 2012–17. - 2017 DBM Law revisions as part of EFF commitments strengthened independence and restricted DBM to commercial activities; asset quality remains a major concern due to legacy loans. - Recommendations for DBM governance and operations: - Adopt a Conflict of Interest policy and clearly define conflict situations. - Approve a risk strategy and develop a robust risk management framework for all material risks; manage, control and monitor risks on a consolidated level. - Adopt an internal control framework and define overall methodology components of ICS. - Improve credit granting process; rely more on debtor’s ability to repay from cashflow. - Review methodology for defining NPLs and adopt methodology for identification of forborne exposures. - Update collateral valuation methodology. ### E. State-Owned Enterprises (SOEs) - Role and challenges: - SOEs operate in utilities, energy, transport, and mining; they are central to output and can create fiscal liabilities. - Ownership, management and activities are typically opaque; limited data on balance sheets and unclear integration with development strategy. - Erdenet copper mine is traditionally the largest taxpayer; Erdenes Mongol holds the country’s strategic mining assets. - Recommendations to lower fiscal risks and improve governance: - Make SOE ownership and reporting structures transparent; improve fiscal oversight of hidden subsidies and fiscal costs, particularly in the energy sector. - Improve accountability and transparency of Erdenes Mongol given its strategic role. - Ensure SOE compliance with government procurement standards. - Create a level playing field with private sector in tendering, competition policies, and disclosure. - Advance the privatization process to encourage competition and best corporate governance standards; allow foreign participation. ### Special funds, PPPs, Procurement, and Fiscal Transparency - Special funds: - As at end 2018 there were 29 special funds; public reports of financial mismanagement prompted a special examination in 2018 and early 2019 by the Ministry of Finance. - Deficiencies found: provision of direct loans to PEPs, lack of public oversight, and absence of risk management practice. - Future Heritage Fund (FHF) approved in February 2016 is likely to increase substantially as mining revenues increase and will need strong governance. - Key recommendations: greater disclosure and accountability for each fund; better integration into annual budgetary process; ensure governance and independence of the FHF align with best international practices. - Public-private partnerships (PPPs): - PPPs have sometimes bypassed the deficit constraints of the Fiscal Stability Law and parliamentary oversight; projects often entered the budget only when payments were due. - Under the EFF, such practices have stopped and MOF strengthened gatekeeping role. - Recommendation: Formalize safeguards relating to contract management, integration with the budget, risk allocation, and government guarantees including through a new PPP Law. - Procurement and e-procurement: - Public Procurement Law (PPL) introduced in 2000 (last amendments in 2019); Government Procurement Agency (GPA) established in 2012. - Law on Glass Accounts requires all contracts be made available online. An e-procurement system introduced in December 2016 (from notice through award). - Volume of procurement using the electronic system increased more than seven-fold during 2015–18. - Recommended reforms: ensure Procurement Agency independence and adequate budget/staff; ensure all procurements use e-procurement system. - Fiscal transparency: - Law on Glass Accounts (2014) requires government agencies and SOEs to make information publicly available. - Open Budget Index (OBI) score dropped from 60 (out of 100) in 2010 to 46 (out of 100) in 2017. - Score on opening opportunities for citizen participation: 7 out of 100 points. - Fiscal Council established in 2018 lacks sufficient autonomy and budget. - Recommendations: regular public dialogue in budget formulation and monitoring; legislative hearings with public/civil society testimony; formal mechanisms for public participation in audit investigations; ensure independence of Fiscal Stability Council. ### Public Financial Management (PFM) controls and reforms - Weak PFM with limited monitoring, reporting, and control mechanisms is macro critical. - Ministry of Finance adopted a Public Financial Management Reform Strategy for 2018-2020 in September 2018. - Key reform areas: - Integrating the Accounting and Reporting Frameworks: - Financial reporting remains fragmented due to absence of a fully integrated Government Financial Management Information System (GFMIS). - Success of PFM reforms depends on successful implementation of the new version of GFMIS. - Need to improve the Chart of Accounts (COA). - Enhancing Accounting Policies: - Limited compliance with International Public Sector Accounting Standards (IPSAS) raises fiscal risks and is macro critical. - Government formulated an IPSAS action plan 2017–22 and is gradually moving towards achieving full compliance. - Better consolidation of Financial Statements: - Lack of consolidation limits monitoring and raises fiscal risks. - Consolidated financial statements exclude part of government-controlled entities and other government engagements with the private sector. - Despite improvements in implementing E-tailan, consolidation and elimination still involves manual processes and require developing additional guidelines. ### Financial sector oversight: banking sector weaknesses and recommendations - Weak management and supervision contributed to boom-bust cycles, including the recent economic crisis. - Regulatory forbearance allowed weak banks to expand credit rather than build capital, boosting overheating pressures and undermining reserves accumulation. - Recommendations for regulators: - Strengthen corporate governance and ensure implementation of international best standards: - Ensure full transparency of beneficial ownership and maintain arms-length relationships in dealings with shareholders, directors, and intra-group entities. - Require banks to explore listing on the Mongolian Stock Exchange to raise new capital, diversify ownership, and enhance market discipline and disclosure. - Be proactive on regulation of related-party transactions with a sufficiently broad definition and ensure effective monitoring and strict enforcement. - Upgrade credit risk management: TA on asset classification and provisioning; collateral valuation; NPL management; loan origination/risk management. - Supervision of non-bank financial institutions: FRC should address adequacy of human (qualified staff) and IT resources first; TA on non-banks’ regulatory and supervisory framework could follow. - Enhance financial sector infrastructure and professional skills such as accounting, auditing, and valuation through better training and enforcement of standards. ### Central Bank (BOM) governance and operations - Governance weaknesses have had macro-economic consequences; reforms are macro-critical. - KPMG “Special Review of Quasi-Fiscal Policy Activities” (November 15, 2018) highlighted governance weaknesses leading to high levels of quasi fiscal activities, politicized monetary policy decisions, and weak supervision with a culture of forbearance and lack of transparency. - Amendments enacted in January 2018 delivered notable improvements: redrafted mandate, limiting monetary financing of the government, prohibiting quasi-fiscal activities, and appointment of MPC non-executive members by the Economic Standing Committee of Parliament rather than just the Governor. - Remaining weaknesses and recommended improvements: - Institutional autonomy: sharpen BOM mandate to highlight maintaining price and financial stability; BOM should be autonomous and not obliged to seek approval or instructions from Government or Parliament. - Personal autonomy: strengthen incompatibility criteria for appointment of key BOM officials; revisit appointment (double veto) and dismissal procedures; terms for Supervisory Board members need explicit provision; legal immunity for banking supervisors removed in 2018 but should be reinstated in the BOM law. - Financial autonomy: emergency liquidity support should be accompanied by safeguards such as penalty interest rates and limits on coverage to illiquid or (possibly) insolvent banks which would require a state guarantee. - Oversight: strengthen the Supervisory Board’s oversight with fiduciary responsibilities aligned with an audit committee. - Accountability: complement autonomy improvements with stronger independent oversight, increased transparency, and other checks and balances. ### AML/CFT — assessment and priorities - APG second mutual evaluation (2016) found a low level of compliance with the FATF 40 Recommendations and a low level of effectiveness of the AML/CFT system: - A low level of effectiveness was found in 9 out of 11 rubrics and moderate in 2 rubrics. - Technical Compliance Ratings: regime was either partially compliant or non-compliant in half the rubrics. - Weaknesses affecting governance: risk-based supervision, monitoring PEPs, access to beneficial ownership information, and ensuring fit and proper criteria for bank shareholders. - Effectiveness of law enforcement and criminal justice measures is low with only a small number of prosecutions; inter-agency cooperation is weak but improving. - Key recommendations and priority areas: - Continuous political will, commitment, and prompt decisive action; high level of TA from donors on technical and operational issues will be needed. - Increase risk-based supervisory activities, notably onsite examinations by the BOM, the FIU, and the FRC focused on high-risk areas (TFS, beneficial ownership, PEPs) and high-risk sectors (banks, real estate, DNFBPs). - Improve the legal framework: - Pass and effectively implement additional amendments to laws and regulations relating to AML/CFT and preventative measures and targeted financial sanctions (TFS) on proliferation financing (PF) and terrorist financing (TF). - Put in place provisions relating to TFS and fit and proper requirements for senior management and owners of financial institutions. - Increase powers of the FIU and enforce current TFS regulations. - Increase resources for the FIU, BOM, FRC, and law enforcement agencies; improve FIU operations and analysis quality. - Implement appropriate criminal justice measures and ensure adequate inter-agency coordination. - Resolve constitutional issues relating to the Administrative Court that hears appeals related to fines under the Law on Infringements so that this does not affect existing or future penalties under the Law on Infringements. - The World Bank’s Stolen Asset Recovery (StAR) initiative should play an important role focusing on verification and enforcement. ### Mongolia is struggling to achieve inclusive and job-rich growth — summary and macro challenge - Overall economic growth averaged between 6–7 percent after the 2016 crisis. - Poverty rate: 28.4 percent in 2018 (National Statistics Office). - Unemployment rate increased in the past two years, indicating weak job creation despite strong overall growth. - Livestock sector is the largest employer: "employs 1 in 4 Mongolian" but is low-value-added. - Mining accounts for about a fifth of total value added; mining-led growth is unlikely to deliver job-rich growth because the employment share of mining is small. ### Overgrazing and land-degradation — facts and macro-critical implications - Natural endowments and trends: - Grasslands span 80 percent of Mongolia. - Livestock industry accounts for about 90 percent of agriculture production. - Livestock population has tripled since 1990 to about 70 million animals (NSO data). - Share of goats rose from about 15 percent to about half. - Mongolia has warmed three times faster than the rest of the world and 80 percent of the country is defined as highly vulnerable to climate change (Government of Mongolia TNC report under the UNFCCC, 2018; Batima, 2006). - Desertification affects 76.8% of all Mongolian territory as of 2015 (Government of Mongolia TNC report under the UNFCCC, page 31, 2018). - Government’s 2010 National Livestock Program set limits on livestock numbers, but actual livestock now outnumbers the targets by a ratio of almost 2 to 1. - National Report on the Rangeland Health of Mongolia (2015): “the control of livestock numbers is a fundamental pre-condition for effective rangeland management.” - Four macro-critical implications: 1. Increased severity and frequency of livestock loss: - Harsh winters (‘dzuds’) can cause extreme losses of wealth of up to an estimated 8-12 percent of GDP in a year (Government of Mongolia TNC report under the UNFCCC, page 205, 2018). - Empirical estimates: a 1°C colder winter is associated with a 1.8 percentage points increase in loss of adult livestock. - A 1°C warmer summer is associated with a 1.5 percentage points increase in loss of adult livestock. 2. Decline in sector productivity and value-added per unit of livestock: - Between 1990 and 2018 the value added per unit of livestock declined by about 30 percent. - Absence of culling and strategic breeding contributed to older less productive animals and lower quality products (particularly cashmere). - Mongolia supplies about 1/3 of global supply of cashmere. 3. Socioeconomic costs from herder migration: - About 1 in 4 Mongolian lives in shantytowns (the ger district) on the outskirts of the capital—most of whom are former herders. - Ger districts have the highest PM2.5 emissions in the world. 4. Regional environmental effects: - Over 90 percent of Mongolia’s grassland is prone to some level of desertification; about 77 percent of Mongolian territory has been affected by desertification. - Expansion of goats has accelerated desertification and contributed to intense dust storms (“Yellow Dust”) across East Asia. - Empirical amplification of climate shocks by larger herds (dzud episodes, statistical significance): - Dzud 2000-2002: increase of livestock by 100,000 units in the pre-period associated with a 2.8 percentage points increase in livestock lost (statistically significant at the 1 percent level). - Dzud 2000-2002: increase of goats by 100,000 units in the pre-period associated with a 5.7 percentage points increase in livestock lost (statistically significant at the 1 percent level). - Dzud 1999–2001: increase of livestock by 100,000 units in a given aimag in the pre-period associated with a 1.1 percentage points decline in herders during the dzud episode (statistically significant at the 5 percent level). - Dzud 1999–2001: increase of goats by 100,000 units in the pre-period associated with a 2.6 percentage points decline in herders during the dzud episode. ### Policies to achieve green and inclusive growth — objectives and levers - Overarching objectives: - Increase resilience to climate change by addressing overgrazing and balancing herd size with nature’s capacity for regrowth. - Improve governance, pasture management, and livestock productivity in line with the National Livestock Program. - Recent government action: - December 2018 Cabinet approved a National Program to promote and develop intensive animal husbandry with planned spending of MNT166.3 billion for 2019–23. - Program aims: build capacity of managers and professional associations of intensive animal husbandry; transform into cluster system; import high productive livestock; ensure food safety; introduce technology; boost processing and export of meat; reduce import of milk and other dairy products. - Three macro-level policy levers recommended: - Reintroduce a pasture tax—with an exemption for small/medium herders—to reduce herd size, land degradation, and wealth inequality. - Provide incentives to boost quality of animal products (reducing focus on quantity) to raise sector productivity and value added. - Promote and upgrade the meat industry and meat exports to create a natural limitation on herd size and incentivize higher-quality production. ### Designing and implementing a pasture tax — design features and equity - History and equity concerns: - Before 2009 herders paid between 50-100 MNT (or less than USD 0.1 in 2019 prices) per head of sheep; goats were equivalent to 1.5 sheep for taxation; 20 sheep per member of herder household were exempt. - In 2009 Parliament repealed all taxes on livestock herders; since then herders pay no taxes on livestock holdings. - Microdata analysis (2018): households with below median wealth have about 91 livestock, while top 1% households had about 1835 livestock—20 times more—indicating high concentration of livestock wealth. - Policy options and design features: - The 2015 Asset Tax Law proposal would grant local authorities power to set livestock tax between the range MNT 0-1000 per head of sheep (with all livestock converted to sheep head units); the tax exemption threshold was raised from 20 to 50 heads of sheep in that proposal. - A progressive pasture tax combined with a generous exemption for small/medium herders can equitably address overgrazing. - Example design parameter: an exemption of 100 livestock heads would imply that over half of herder households would be exempt from taxation. - Local governments should be allowed to retain tax revenues and allocate them to improving pasture quality, water resources, and livestock productivity to increase political acceptability. ### Incentives to promote quality (cashmere) and boost meat exports - Cashmere quality measures: - Current bias toward quantity: majority of subsidies under the National Livestock Program are geared toward quantity rather than quality. - Recommended measures: streamline incentive schemes to target quality improvement; implement strategic breeding and culling programs; improve grading and standardization; expand market access of Mongolian traders/processors to world cashmere market. - Meat export performance and potential: - Meat exports: about 2,800 tons in 2015 and about 70,000 tons in 2018. - Estimated potential: meat export potential could be 5-10 times higher than the 2018 exports if Mongolia’s export rate (exports per unit of livestock) matched that of countries like Uruguay or New Zealand (Danforth and Dash, 2017). - Government export targets: 100,000 tons of exports by 2020 and 200,000 tons of exports by 2025. - Major obstacles and short-term priorities: - Identified obstacles: Food safety concerns, notably Food and Mouth Disease (FMD); lack of regulation and standards; poor logistics. - FMD-specific issues: presence of FMD has led many countries to implement import bans; attaining OIE FMD-free status is a significant step; attaining FMD-free status requires significant investment and government action to address institutional weaknesses in animal health services delivery. - Recommended short-term priority: Attaining FMD-free status and improving food safety/disease monitoring remains a critical short-term priority. - Regulation, supply chain, and medium-term investments: - Improve regulation and formal supply chain to effectively monitor food safety and create high quality Mongolian brands. - Medium-term investment needs: infrastructure, storage facilities, scientific labs, and transportation. ### Simulations, pasture tax, and sustainability scenarios - Baseline: meat exports were about 70,000 tons in 2018. - Government goals reiterated: 100,000 tons by 2020 and 200,000 tons by 2025. - Policy interaction and risks: - Promoting exports without a complementary pasture tax can worsen overgrazing and land degradation by incentivizing herders to increase livestock numbers. - The pasture tax is described as a critical complementary tool to achieve sustainability in the sector. - Simulation findings (ceteris paribus): - Combining a pasture tax with gradually increasing meat exports by 50 percent initially (and eventually doubling) can halve the livestock population in line with national targets within a decade. - This policy mix could boost the value added of the sector by shifting focus from quantity to quality, benefiting both the livestock sector and the environment. - Linkages with cashmere: - Higher meat prices will incentivize herders to sell their low-quality/older goats to the meat industry, enabling herders to focus on boosting herd quality, strategic breeding, and improving cashmere quality. ### Role of the international community - Three ways international community can help: 1. Support quality: prioritize quality over quantity for cashmere and meat industries; improve access of Mongolian traders/processors to world cashmere market; improvements in legal and regulatory environment to encourage strategic alliances. 2. Environmentally conscious trade policy by neighboring countries: MOUs to promote meat export can emphasize need to address overgrazing, land degradation, and desertification. 3. Ethical supply chain practices by end consumers and retailers: examples include Patagonia’s shift away from virgin cashmere and Wildlife Conservation Society’s cashmere initiative. ### Fiscal Stability Law (FSL) — effectiveness, challenges, and proposed reforms - Effectiveness and compliance: - Governments frequently did not comply with original parameters due to overly loose budget submissions or weaker than budgeted outturns. - Parliament made four amendments to the debt limit and the structural deficit ceiling in the 2015-17 period. - In 2016, the debt ceiling was lifted permanently from 40 percent to 60 percent in present value terms. - Off-budget quasi-fiscal spending by DBM and BOM aggravated consolidated fiscal deficits and debt. - Three critical challenges with the FSL: - Internal inconsistency: operational expenditure rule contains a cyclical component tied to projected non-mining nominal GDP growth that can permit spending too loose when growth is high. - Loopholes: quasi-fiscal spending by SOEs undermined fiscal outcomes. - Lack of corrective procedure: rules lack procedure requiring Parliament to adjust subsequent budgets to account for past slippages. - Options to strengthen the fiscal rules framework: - Recommendation: A debt ceiling of 50 percent of GDP in nominal terms is proposed as more appropriate for Mongolia. - Rationale: An FAD template calibrated for low income countries suggests 45 percent of GDP; considering Mongolia’s share of concessional lending, adjust upward to 50 percent of GDP. - Expenditure rule — transition and steady state: - Public debt was 73 percent of GDP at end-2018, despite a reduction of 13 percentage points following fiscal tightening since 2017. - Priority: rapid debt reduction to reach the debt anchor. - Transition period (2020-2024): nominal expenditure growth should be capped at 13 percent to reach the debt anchor of 50 percent of GDP by 2024. - Steady state: growth of public expenditure should be capped by long-run average of historical non-mining nominal GDP; revised rule removes cyclical factor and allows automatic stabilizers to operate. - Structural balance rule and Future Heritage Fund (FHF): - Structural balance rule could be suspended because it imposes little extra constraint given a debt ceiling and expenditure rule. - FHF set up in 2016 inherited 1 trillion MNT debt from the Human Development Fund; buoyant revenues in 2017 and 2018 allowed the FHF to pay down all the debt by June 2019. Transfers in 2H2019 will accumulate in the FHF. - Law requires state budget deposits from dividends on public shares of mining-sector SOEs; 65 percent of mineral royalty payments excluding transfers to the Fiscal Stabilization Fund; 20 percent of excess mineral revenues relative to the budgeted amount; and investment income. - Annual inflows are estimated at 2-3 percent of GDP. - The law prohibits withdrawals (other than management fee) until 2030. - Recommendation: Suspend transfers to the FHF until public debt reaches the debt anchor, because public debt remains above 70 percent of GDP and global investment returns are low; debt reduction should take priority over starting a SWF now. - Coverage of public debt and SOE risks: - Extending public debt coverage to include SOEs can help monitor and control state-contingent liabilities. - Quasi-fiscal lending by DBM contributed to 2013-2016 debt buildup; such activities were curtailed in 2017-2019 under the EFF and new Banking and DBM laws. - Authorities have announced intentions for mega projects via SOEs that may pose significant fiscal risks. - Data availability on SOE debt is uneven; efforts underway to include key SOEs in GFS reporting. - Role of an independent Fiscal Council: - Could issue independent assessments of government budget assumptions, assess deviations from fiscal rules, and recommend corrective measures. - Proposed functions in suspension events: analyze reasons for deviations and recommend timeframe for suspension; recommend corrective fiscal actions; submit opinions publicly to the government which would respond publicly and submit revised fiscal plans to parliament. ### Permanent Income Hypothesis (PIH) and mineral wealth — assessment and numerical assumptions - PIH standard procedure: - (i) Put a nominal value on proven mineral wealth. - (ii) Calculate total wealth = mineral wealth + financial assets (reserves and deposits) − liabilities (public debt). - (iii) Create an annuity from total wealth to finance a permanent budget deficit equal to the annuity. - Why Mongolia is ill-suited for PIH guidance: - High uncertainty in mineral quantities and time-profile of extraction (coal reserve estimates range from 3 to 162 billion metric tons). - High public debt: example projected public debt just below 60 percent of GDP in 2024 under current projections. - PIH can suggest deficit targets weaker than debt-stabilizing balances, risking spiraling public debt. - Example: primary balance that would stabilize debt at near-60 percent is about 0.5 percent of GDP; PIH using an intermediate estimate would suggest average primary balance target of 0 percent of GDP. - PIH numerical results and assumptions (selected): - PIH application labeled “medium reserves” assumes: - 37 billion tons of unexplored coal reserves. - Time horizon to spend resource wealth: 70 years. - Under those assumptions, PIH suggests a constant non-mining primary balance of -4.3 percent of non-mining GDP. - If deficits are constant in real terms or on a per-capita basis, PIH-consistent deficit path starts out higher and gradually declines towards -2 percent of non-mining GDP. - Coal reserves estimates cited: 3, 37, and 162 billion metric tons. - Key annex assumptions (percent unless otherwise indicated): - Recovery rate coal (cumulative extraction until 2100/proven reserves): 48.7 - Recovery rate copper: 100.0 - Coal production growth: 3.0 - Copper production growth: 0.1 - Domestic consumption growth of coal: 1.0 - Nominal increase in copper and coal prices: 3.0 - Nominal interest rate MNT: 10.0 - Nominal interest rate USD: 4.0 - GDP deflator inflation: 6.0 - Real interest rate MNT: 3.8 - Real interest rate USD: 2.1 - Annual exchange rate change MNT/USD: 3.0 - Real GDP growth: 3.0 - Real non-mineral GDP growth: 3.0 - Population growth: 1.0 - Share of mineral revenues to budget: 17.0 - Time to reach PIH post WEO projections (years): 5 - Time horizon for modified PIH (years): 70 - Conclusion and policy priorities: - Key objective: reduce volatility in public spending and bring public debt to safe levels. - Suggested improvements: recalibrate fiscal rules around debt ceiling of 50 percent of GDP in nominal terms; adopt a simple expenditure rule with transition cap of 13 percent nominal expenditure growth for 2020-2024; suspend structural balance rule; include key SOEs in public debt coverage; enhance enforcement through an independent Fiscal Council and a legally binding correction mechanism. - Target: bring down public debt to 50 percent of GDP by 2024. *International Monetary Fund (extracted from the content unit).* ### References ________________________________________________________________________________ 15 ### PRINCIPAL GOVERNANCE CHALLENGES ### A. Introduction - Improving governance is crucial for Mongolia to achieve sustainable and inclusive growth; governance shortfalls have manifested in foregone FDI, higher public debt, and pressures on correspondent banking relationships related to AML/CFT concerns. - The note breaks discussion into 6 categories: A) Anti-Corruption Framework, B) Rule of Law and Regulatory Framework, C) Fiscal Governance, D) Financial Sector Oversight, E) Central Bank Governance and Operations, and F) AML/CFT. - Recent public scrutiny highlights opaque financing of political parties and vested interest groups; further governance reforms are critical to support the government’s Economic Recovery Plan. ### B. Anti-Corruption Framework - Historical and institutional background: - Anti-Corruption Law adopted in 1996; Mongolia ratified the United Nations Convention against Corruption in 2006; Criminal Code revised in 2017. - Independent Authority Against Corruption (IAAC) established in 2007; first anti-corruption strategy covered 2002–10; next strategy covers 2016–23. IAAC prepares an annual report submitted to Parliament. - Mongolia participates in the Istanbul Anti-Corruption Action Plan (OECD-ACN). - Current assessment: - The 2019 OECD-ACN Monitoring Report finds corruption remains widespread and implementation of action plans has been limited and uneven. - IAAC lacks independence, resources, and necessary support from state bodies to fully exercise its mandate. - Selected recommendations from the 2019 OECD-ACN Monitoring Report (summary): - Address gaps in the legal framework, including criminalization of all corruption offences. - Strengthen capacities and guarantee independence of IAAC, the Judiciary and the General Prosecutor’s Office. - Ensure transparent selection and accountability of Public Council members overseeing IAAC. - Strengthen implementation of National Anti-Corruption Strategy and Action Plan and provide cooperation to IAAC. - Intensify detection, investigation and prosecution of high-profile corruption cases; eliminate immunity; protect whistleblowers. - Address politicization of the civil service and high turnover after political changes. - Ensure systematic and objective verification of income and asset declarations by Politically Exposed Persons (PEPs) and follow-up. - Ensure proactive and systematic engagement with civil society. - Policy recommendation: - Pair anti-corruption legal and institutional improvements with broader governance reforms across rule of law, regulatory framework, fiscal and central bank governance, financial sector oversight, and AML/CFT. ### C. Rule of Law and Regulatory Framework - Assessments: - Worldwide Governance Indicators (WGI) place Mongolia above peers in Asia but below regional averages; legal framework has loopholes and unintended consequences. - Key reform areas and recommendations: - Review and amend laws to ensure a level playing field between foreign and local investors; ensure local courts enforce non-discriminatory protections. - Upgrade Investor Protection Council (IPC) capacity through training and more funding. - Judiciary improvements: appoint new judges, provide specialized training, and improve IT; develop arbitral institutions, professionals, practice and case-law. - Reform insolvency and creditor rights regime in line with IMF and other advice to facilitate collateral recovery. - Enforce existing regulations (including “use it or lose it”) to limit rent-seeking in mining license distribution. - Reduce laws and regulations that discriminate between local and domestic investors and reduce areas closed to FDI. - Consider 2019 OECD-ACN recommendations to strengthen judicial institutions. ### D. Fiscal Governance - Context and indicators: - WGI Government Effectiveness score: -0.26 (scale -2.5 to 2.5). - Mongolia has a fiscal rule-based system embedded in the Fiscal Stability Law of 2010 (FSL) and the Integrated Budget Law, but adherence has been uneven with serious macroeconomic implications. - Institutional priorities: - Ensure clear roles and responsibilities across National Audit Office, Fiscal Stability Council, Ministry of Finance and Parliamentary offices. - Revenue Administration findings and recommendations: - Asia Foundation’s 2018 survey finds Tax Office, Specialized Inspection Agency, and Customs are highest among government agencies creating obstacles for business. - IMF technical assistance provided to General Department of Taxation (GDT) and MOF. - Recommendations: - Implement fully and consistently the revised tax laws: General Tax Law, Corporate Income Tax Law and Personal Income Tax approved by Parliament in March 2019. - GDT to formulate a detailed action plan for new regulations, tax forms, instructions, administrative processes, information systems and training. - Formalize Compliance Risk Management (CRM) process with differentiation across four taxpayer segments and a simplified regime for smaller businesses; allocate adequate budgetary funding. - Build data management, research, and analytics capability; adopt Tax Administration Integrated System (TAIS) to integrate dispersed tax data and automate reporting for compliance strategies. - Remove tax expenditures: tax expenditures were estimated at 3.2 percent of GDP, accounting for nearly 14 percent of total revenues in 2017; Corporate Income Tax and Value Added Tax exemptions amounted to 1.15 and 0.75 percent of GDP, respectively, in 2017. - Initiate comprehensive evaluation (cost-benefit analysis) of tax expenditures; enhance transparency in establishing tax expenditures. - Avoid tax amnesty schemes; consider alternatives such as payment instalment agreements, voluntary disclosure programs (VDPs), simplification of tax policy regime, and strengthening legal framework. Note: poorly designed VDPs can harm tax morale. - Expenditure Policy and Public Financial Management findings and recommendations: - Four main concerns from IMF and WB reports: - Mongolia’s capital expenditures averaged about 11 percent of GDP in 2010-16, far exceeding 4.8 percent for lower middle-income countries and 3 percent for East Asia and Pacific countries. - Mongolia ranks 124th globally regarding efficiency of public spending in the World Economic Forum’s Global Competitiveness Index. - High volatility of annual aggregate public investment spending causes planning difficulties, project delays, arrears, and cancellations. - History of public-private partnerships associated with higher costs and poor selection. - Recommendations to improve investment efficiency and reduce corruption vulnerabilities: - Estimate sustainable levels of public investment spending separate from proposed levels and publish in the Medium-term Budget Framework. - Strengthen annual budget formulation for public investment by: - Requiring all projects, regardless of financing source (including concessions), to be appraised prior to the budget process and approved through the budget process. - Establishing and publishing project selection criteria consistent with planning guidelines. - Establishing and publishing a consolidated methodology for determining appropriate maintenance funding by sector. - Improve payables reporting to control execution of public investment projects and monitor arrears. - Expand MTFF and annual budget narrative to highlight maintenance needs and allocations for routine maintenance, capital repairs, ongoing investment projects and new investment projects. ### E. Development Bank of Mongolia (DBM) - Background and concerns: - DBM established in 2011 to finance large-scale projects; in 2012–16 government used DBM as major off-budget financing vehicle with allocations averaging 5.2 percent of GDP. - National Audit Office and PwC special audit confirmed significant weaknesses in corporate governance, policies and procedures, and internal control during 2012–17. - 2017 DBM Law revisions as part of EFF commitments strengthened independence and restricted DBM to commercial activities; asset quality remains a major concern due to legacy loans. - Recommendations for DBM governance and operations: - Adopt a Conflict of Interest policy and clearly define conflict situations. - Approve a risk strategy and develop a robust risk management framework for all material risks; manage, control and monitor risks on a consolidated level. - Adopt an internal control framework and define overall methodology components of ICS. - Improve credit granting process; rely more on debtor’s ability to repay from cashflow. - Review methodology for defining NPLs and adopt methodology for identification of forborne exposures. - Update collateral valuation methodology. ### F. State-Owned Enterprises (SOEs) - Role and challenges: - SOEs operate in utilities, energy, transport, and mining; they are central to output and can create fiscal liabilities. - Ownership, management and activities are typically opaque; limited data on balance sheets and unclear integration with development strategy. - Erdenet copper mine is traditionally the largest taxpayer; Erdenes Mongol holds the country’s strategic mining assets. - Recommendations to lower fiscal risks and improve governance: - Make SOE ownership and reporting structures transparent; improve fiscal oversight of hidden subsidies and fiscal costs, particularly in the energy sector. - Improve accountability and transparency of Erdenes Mongol given its strategic role. - Ensure SOE compliance with government procurement standards. - Create a level playing field with private sector in tendering, competition policies, and disclosure. - Advance the privatization process to encourage competition and best corporate governance standards; allow foreign participation to help achieve this. *International Monetary Fund (extracted from the content unit).* ### 13. The government’s ‘special funds’ need greater attention as these have raised ### 13. The government’s ‘special funds’ need greater attention as these have raised ### Special funds: governance concerns and recommendations - As at end 2018 there were 29 special funds; public reports of financial mismanagement prompted a special examination in 2018 and early 2019 by the Ministry of Finance. - Significant deficiencies found included provision of direct loans to PEPs, lack of public oversight, and absence of risk management practice. - Future Heritage Fund Law (FHF) approved in February 2016 is likely to increase substantially in the coming years as mining revenues increase and thus will need strong governance. - Key recommendations: - Greater disclosure and accountability for each fund. - Better integrating these special funds into the annual budgetary process. - Ensuring that the governance and independence of the FHF are in line with best international practices. ### Public-private partnerships (PPPs): fiscal risk - PPPs have been widely used to implement capital projects and have sometimes bypassed the deficit constraints of the Fiscal Stability Law and parliamentary oversight. - Often PPP projects were only brought into the budget when projects had been completed and needed to be paid. - Under the EFF, such practices have stopped and the MOF has strengthened its gatekeeping role regarding PPPs. - Recommendation: Formalize safeguards relating to contract management, integration with the budget, risk allocation, and government guarantees including through a new PPP Law. ### Procurement: enforcement and e-procurement - Framework elements: - Public Procurement Law (PPL) introduced in 2000 (with the last amendments in 2019). - Government Procurement Agency (GPA) established in 2012. - Law on Glass Accounts requires all contracts be made available online. - An e-procurement system introduced in December 2016 (from notice through award). - Progress and gaps: - Volume of procurement using the electronic system increased more than seven-fold during 2015–18. - Large scale of public investment continues to create opportunities for corruption. - Recommended reforms to reduce rent seeking: - Ensure the Procurement Agency is independent and has an adequate budget with well qualified staff. - Ensure all procurements use the e-procurement system. - Under the National Anti-Corruption Strategy, Mongolia aims to transfer all tender processes to the e-procurement system, but this has been slow. ### Fiscal transparency: budgetary and mining sector transparency - Budgetary transparency: - Law on Glass Accounts (2014) requires government agencies and SOEs to make information on budgets and financial matters publicly available. - According to the 2017 Open Budget Index (OBI), Mongolia is among countries that release limited budget information. - Mongolia’s OBI score dropped from 60 (out of 100 points) in 2010 to 46 (out of 100) in 2017. - Mongolia’s score on opening opportunities for citizen participation is 7 out of 100 points. - The Fiscal Council established in 2018 lacks sufficient autonomy and budget. - NRGI highlighted the need to return to original fiscal rule targets adopted in 2010 as part of the FSL and to improve the newly established Fiscal Stability Council’s independence, capacity, transparency, and remit to oversee compliance with the FSL. - Budgetary transparency recommendations: - Undertake regular dialogue with members of the public during formulation and monitoring of the national budget. - Hold legislative hearings on annual budget formulation with public or civil society testimony. - Establish formal mechanisms for public participation in relevant audit investigations and ensure audit processes are reviewed by an independent agency. - Ensure the independence of the Fiscal Stability Council to strengthen budget oversight and compliance with fiscal rules. - Mining sector transparency: - Mongolia is compliant with the Extractive Industries Transparency Initiative (EITI). - Under the Open Government Partnership, government committed in the 2016–18 National Action Plan to the “transparency of contracts of public resource exploitation.” - NRGI noted many important contracts for publicly owned oil, gas, and minerals remain undisclosed. - Recommendation: Strengthen EITI compliance via high level participation in the EITI National Council and ensure comprehensive and consistent publication of all contracts in the mining sector. ### Public financial management (PFM) controls and reforms - Weak PFM with limited monitoring, reporting, and control mechanisms is macro critical. - Ministry of Finance adopted a Public Financial Management Reform Strategy for 2018-2020 in September 2018. - Key reform areas: - Integrating the Accounting and Reporting Frameworks: - Financial reporting remains fragmented due to absence of a fully integrated Government Financial Management Information System (GFMIS). - Success of PFM reforms depends on successful implementation of the new version of GFMIS. - Need to improve the Chart of Accounts (COA). - Enhancing Accounting Policies: - Limited compliance with International Public Sector Accounting Standards (IPSAS) raises fiscal risks and is macro critical. - Government formulated an IPSAS action plan 2017–22 and is gradually moving towards achieving full compliance. - Better consolidation of Financial Statements: - Lack of consolidation limits monitoring and raises fiscal risks. - Consolidated financial statements exclude part of government-controlled entities and other government engagements with the private sector. - Despite improvements in implementing E-tailan, consolidation and elimination still involves manual processes and require developing additional guidelines. ### Financial sector oversight: banking sector weaknesses and recommendations - Weak management and supervision have contributed to frequent boom-bust cycles, including the most recent economic crisis. - Regulatory forbearance allowed weak banks to expand credit rather than build capital, boosting overheating pressures and undermining reserves accumulation. - Recommendations for regulators: - Strengthen corporate governance and ensure implementation of international best standards: - Ensure full transparency of beneficial ownership and maintain arms-length relationships in dealings with shareholders, directors, and intra-group entities. - Require banks to explore listing on the Mongolian Stock Exchange to raise new capital, diversify ownership, and enhance market discipline and disclosure. - Be proactive on regulation of related-party transactions with a sufficiently broad definition and ensure effective monitoring and strict enforcement. - Upgrade credit risk management to improve credit culture; TA areas include regulation and supervision on: (i) asset classification and provisioning; (ii) collateral valuation; (iii) non-performing loan (NPL) management; and (iv) loan origination/risk management. - Supervision of non-bank financial institutions: FRC should address adequacy of human (qualified staff) and IT resources first; TA on non-banks’ regulatory and supervisory framework could follow. - Enhance financial sector infrastructure and professional skills such as accounting, auditing, and valuation through better training and enforcement of standards. ### Central Bank (BOM) governance and operations - Poor governance at the central bank has had macro-economic consequences; reforms are macro-critical. - KPMG “Special Review of Quasi-Fiscal Policy Activities” (November 15, 2018) highlighted governance weaknesses leading to high levels of quasi fiscal activities, politicized monetary policy decisions, and weak supervision with a culture of forbearance and lack of transparency. - 2017 IMF Safeguards Assessment and IMF Legal Department TA recommended thorough review of the BOM Law. - Amendments enacted in January 2018 delivered notable improvements: redrafted mandate, limiting monetary financing of the government, prohibiting quasi-fiscal activities, and appointment of MPC non-executive members by the Economic Standing Committee of Parliament rather than just the Governor. - Remaining weaknesses and recommended improvements: - Institutional Autonomy: - Sharpen BOM mandate to highlight maintaining price and financial stability. - BOM should be autonomous in formulating and implementing policies and not obliged to seek approval or instructions from Government or Parliament. - Personal Autonomy: - Strengthen incompatibility criteria for appointment of key BOM officials and decision-making body members; prohibit government officials, civil servants, and persons with close links to institutions overseen by BOM from occupying BOM positions. - Revisit appointment (double veto) and dismissal procedures; grounds for dismissal are currently too wide and flexible. - Terms of appointment for members of the Supervisory Board need explicit provision in BOM Law. - Legal immunity for banking supervisors was removed in 2018 but should be reinstated in the BOM law. - Financial autonomy: - Emergency liquidity support should be accompanied by safeguards such as penalty interest rates and limits on coverage to illiquid or (possibly) insolvent banks which would require a state guarantee. - Oversight: - Strengthen the Supervisory Board’s oversight; the Board should have fiduciary responsibilities only to BOM and have a mandate aligned with an audit committee. - Accountability: - Complement autonomy improvements with stronger independent oversight, increased transparency, and other checks and balances. ### Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) - The APG second mutual evaluation (2016) found a low level of compliance with the FATF 40 Recommendations and a low level of effectiveness of the AML/CFT system. - A low level of effectiveness was found in 9 out of 11 rubrics and moderate in 2 rubrics. - Technical Compliance Ratings: regime was either partially compliant or non-compliant in half the rubrics. - Weaknesses affecting governance: risk-based supervision, monitoring PEPs, access to beneficial ownership information, and ensuring fit and proper criteria for bank shareholders. - Effectiveness of law enforcement and criminal justice measures is low with only a small number of prosecutions; inter-agency cooperation is weak but improving. - Key recommendations and priority areas: - Continuous political will, commitment, and prompt decisive action; high level of TA from donors on technical and operational issues will be needed. - Increase risk-based supervisory activities, notably onsite examinations by the BOM, the FIU, and the FRC focused on high-risk areas (TFS, beneficial ownership, PEPs) and high-risk sectors (banks, real estate, DNFBPs). - Improve the legal framework: - Pass and effectively implement additional amendments to laws and regulations relating to AML/CFT and preventative measures and targeted financial sanctions (TFS) on proliferation financing (PF) and terrorist financing (TF). - Put in place provisions relating to TFS and fit and proper requirements for senior management and owners of financial institutions. - Increase powers of the FIU and enforce current TFS regulations. - Increase resources for the FIU, BOM, FRC, and law enforcement agencies to support mandates; improve FIU operations and analysis quality. - Implement appropriate criminal justice measures and ensure adequate inter-agency coordination. - Resolve constitutional issues relating to the Administrative Court that hears appeals related to fines under the Law on Infringements so that this does not affect existing or future penalties under the Law on Infringements. - The World Bank’s Stolen Asset Recovery (StAR) initiative should play an important role focusing on verification and enforcement. *MONGOLIA INTERNATIONAL MONETARY FUND* ### 1. Mongolia is struggling to achieve inclusive and job-rich growth. After the 2016 crisis, ### 1mngea2019002 - 1. Mongolia is struggling to achieve inclusive and job-rich growth. After the 2016 crisis, ### Summary of the challenge - Overall economic growth in Mongolia has been strong and has averaged between 6–7 percent after the 2016 crisis. - Poverty rate remains high at 28.4 percent in 2018 (according to the National Statistics Office). - Unemployment rate has increased in the past two years, indicating weak job creation despite strong overall growth. - The livestock sector is the largest employer, as it "employs 1 in 4 Mongolian", but operates as a low-value-added sector. - Mining has driven much of recent growth while accounting for about a fifth of total value added; mining-led growth is unlikely to deliver job-rich growth because the employment share of mining is small. ### The overgrazing and land-degradation problem - Mongolia’s endowments: vast grasslands spanning 80 percent of Mongolia and proximity to large markets in Asia. - The livestock industry accounts for about 90 percent of agriculture production. - Livestock population has tripled since 1990 to about 70 million animals now (based on NSO data). - Share of goats rose from about 15 percent to about half, increasing overgrazing pressures. - Mongolia has warmed three times faster than the rest of the world and 80 percent of the country is defined as highly vulnerable to climate change (Government of Mongolia TNC report under the UNFCCC, 2018; Batima, 2006). - Desertification affects 76.8% of all Mongolian territory as of 2015 (Government of Mongolia TNC report under the UNFCCC, page 31, 2018). - Government’s 2010 National Livestock Program set limits on livestock numbers, but actual livestock now outnumbers the targets by a ratio of almost 2 to 1. - National Report on the Rangeland Health of Mongolia (2015): “the control of livestock numbers is a fundamental pre-condition for effective rangeland management.” ### Four macro-critical implications of land degradation - 1) Increased severity and frequency of livestock loss: - Harsh winters (‘dzuds’) can cause extreme losses of wealth of up to an estimated 8-12 percent of GDP in a year (Government of Mongolia TNC report under the UNFCCC, page 205, 2018). - Empirical estimates: a 1°C colder winter is associated with a 1.8 percentage points increase in loss of adult livestock. - A 1°C warmer summer is associated with a 1.5 percentage points increase in loss of adult livestock. - 2) Decline in sector productivity and value-added per unit of livestock: - Between 1990 and 2018 the value added per unit of livestock declined by about 30 percent. - Absence of culling and strategic breeding contributed to older less productive animals and lower quality products (particularly cashmere). - Mongolia supplies about 1/3 of global supply of cashmere; emphasis shifted from quality to quantity. - 3) Socioeconomic costs from herder migration: - Climate shocks have driven herders to migrate to Ulaanbaatar; about 1 in 4 Mongolian lives in shantytowns (the ger district) on the outskirts of the capital—most of whom are former herders. - Rapid internal migration has outpaced government capacity to provide housing, clean water, sanitation, heating, health care, and education; ger districts have the highest PM2.5 emissions in the world. - 4) Regional environmental effects: - Over 90 percent of Mongolia’s grassland is prone to some level of desertification; about 77 percent of Mongolian territory has been affected by desertification (Government of Mongolia TNC report under the UNFCCC, 2018; Convention of Biological Diversity, 2014). - Expansion of goats has accelerated desertification and contributed to intense dust storms (“Yellow Dust”) across East Asia (China, Japan, and S. Korea), with rising health and economic costs across the region. - Empirical amplification of climate shocks by larger herds: - During the dzud episode of 2000-2002, an increase of livestock by 100,000 units in the pre-period was associated with a 2.8 percentage points increase in livestock lost during the dzud episode (statistically significant at the 1 percent level). - During the same episode, an increase of goats by 100,000 units in the pre-period was associated with a 5.7 percentage points increase in livestock lost during the dzud episode (statistically significant at the 1 percent level). - During the dzud episode of 1999–2001, an increase of livestock by 100,000 units in a given aimag in the pre-period was associated with a 1.1 percentage points decline in herders during the dzud episode (statistically significant at the 5 percent level). - During that episode, an increase of goats by 100,000 units in the pre-period was associated with a 2.6 percentage points decline in herders during the dzud episode. ### Policies to achieve green and inclusive growth - Overarching objectives: - Increase resilience to climate change by addressing overgrazing and balancing herd size with nature’s capacity for regrowth. - Improve governance, pasture management, and livestock productivity in line with the National Livestock Program. - Recent government action: - In December 2018 the Mongolian Cabinet approved a National Program to promote and develop intensive animal husbandry with planned spending of MNT166.3 billion for 2019–23. - Program aims: build capacity of managers and professional associations of intensive animal husbandry; transform into cluster system; import high productive livestock; ensure food safety; introduce technology; boost processing and export of meat; reduce import of milk and other dairy products. - Three macro-level policy levers recommended: - Reintroduce a pasture tax—with an exemption for small/medium herders—to reduce herd size, land degradation, and wealth inequality. - Provide incentives to boost quality of animal products (reducing focus on quantity) to raise sector productivity and value added. - Promote and upgrade the meat industry and meat exports to create a natural limitation on herd size and incentivize higher-quality production. ### Designing and implementing a pasture tax - History and equity concerns: - Before 2009 herders paid between 50-100 MNT (or less than USD 0.1 in 2019 prices) per head of sheep; goats were equivalent to 1.5 sheep for taxation; 20 sheep per member of herder household were exempt. - In 2009 Parliament repealed all taxes on livestock herders; since then herders pay no taxes on livestock holdings. - Microdata analysis (2018): households with below median wealth have about 91 livestock, while top 1% households had about 1835 livestock—20 times more—indicating high concentration of livestock wealth. - Policy options and design features: - The 2015 Asset Tax Law proposal would grant local authorities power to set livestock tax between the range MNT 0-1000 per head of sheep (with all livestock converted to sheep head units); the tax exemption threshold was raised from 20 to 50 heads of sheep in that proposal. - A progressive pasture tax combined with a generous exemption for small/medium herders can equitably address overgrazing. - Example design parameter: an exemption of 100 livestock heads would imply that over half of herder households would be exempt from taxation. - Local governments should be allowed to retain tax revenues and allocate them to improving pasture quality, water resources, and livestock productivity to increase political acceptability. ### Incentives to promote quality of animal products (particularly cashmere) - Current bias toward quantity: - Majority of subsidies under the National Livestock Program are geared toward quantity rather than quality. - Mongolian cashmere fiber has thickened over time; much is unfit for luxury knitted/woven garment industry. - Recommended measures: - Streamline incentive schemes to target quality improvement. - Implement strategic breeding programs and culling programs. - Improve grading and standardization. - Expand market access of Mongolian traders/processors to the world cashmere market. ### Boosting meat exports - Rationale and opportunity: - Livestock population nearing 70 million far exceeds domestic demand. - Proximity to China and Russia offers potential to expand meat exports and reduce reliance on mineral exports. - A December 2017 joint press release by the foreign ministers of China and Mongolia noted Chinese interest in expanding meat imports from Mongolia. - Policy implication: - Upgrading the meat processing and export sector would provide market outlets that incentivize quality over quantity and help rebalance the economy. *Source: IMF chapter "Mongolia is struggling to achieve inclusive and job-rich growth" (content unit 1mngea2019002).* ### 21. However, Mongolia’s meat exports remain significantly below its potential when ### 21. However, Mongolia’s meat exports remain significantly below its potential when compared to other lifestock-intensive countries ### Meat export performance and potential - Meat exports: about 2,800 tons in 2015 and about 70,000 tons in 2018. - Estimated potential: meat export potential could be 5-10 times higher than the 2018 exports if Mongolia’s export rate (exports per unit of livestock) matched that of countries like Uruguay or New Zealand (Danforth and Dash, 2017). - Government export targets: 100,000 tons of exports by 2020 and 200,000 tons of exports by 2025. ### Major obstacles and short-term priorities - Identified obstacles: - Food safety concerns, notably Food and Mouth Disease (FMD). - Lack of regulation and standards. - Poor logistics. - FMD-specific issues: - Presence of FMD in Mongolia has led many countries to implement import bans on meat from Mongolia. - Achieving FMD-free status from the World Organization for Animal Health (OIE) is a significant step; all major suppliers of meat to China have attained this status (Food and Agriculture Organization of the United Nations, 2019). - Attaining FMD-free status requires significant investment and government action to address institutional weaknesses in animal health services delivery, including boosting resources and governance of veterinary services and the national vaccine program. - Current actions: - The government is working with OIE and other development partners to attain FMD-free status and to address food safety/disease concerns more generally. - Recommended short-term priority: - Attaining FMD-free status and improving food safety/disease monitoring remains a critical short-term priority. ### Regulation, supply chain, and medium-term investments - Needed improvements: - Improve regulation and formal supply chain to effectively monitor food safety and create high quality Mongolian brands. - Medium-term investment needs: - Infrastructure, storage facilities, scientific labs, and transportation. ### Simulations, pasture tax, and sustainability scenarios - Baseline: meat exports were about 70,000 tons in 2018. - Government goals reiterated: 100,000 tons by 2020 and 200,000 tons by 2025. - Policy interaction and risks: - Promoting exports without a complementary pasture tax can worsen overgrazing and land degradation by incentivizing herders to increase livestock numbers. - The pasture tax is described as a critical complementary tool to achieve sustainability in the sector. - Simulation findings (ceteris paribus): - Combining a pasture tax with gradually increasing meat exports by 50 percent initially (and eventually doubling) can halve the livestock population in line with national targets within a decade. - This policy mix could boost the value added of the sector by shifting focus from quantity to quality, benefiting both the livestock sector and the environment. ### Linkages with the cashmere industry - Effects of greater meat exports on cashmere: - Higher meat prices will incentivize herders to sell their low-quality/older goats to the meat industry. - This enables herders to focus on boosting herd quality, practice strategic breeding, and improve the quality of cashmere products. - Sectoral outcome: - Incentivizing the sale of low-quality goats to meat processors is expected to improve cashmere quality and value-added. ### Role of the international community - Three ways the international community can help Mongolia achieve green growth and sustainable herding: 1. Support quality: - Luxury goods customers expect consistent high quality and are willing to pay for it. - Prioritize quality over quantity for cashmere and meat industries. - Improving the quality of the national herd would substantially increase the quality of Mongolian cashmere and meat. - International trade partners can improve access of Mongolian traders and processors to the world cashmere market. - Improvements in the legal and regulatory environment that encourage strategic alliances between domestic processors and herders, or foreign markets and the Mongolian industry, would improve profitability and give processors certainty on raw material supplies. 2. Environmentally conscious trade policy by neighboring countries: - Trade policy can align incentives between expanding the meat industry and fighting overgrazing. - Current MOUs between Mongolia and trading partners to promote Mongolian meat export can emphasize the need to address overgrazing, land degradation, and desertification. 3. Ethical supply chain practices by end consumers and retailers: - Example: Patagonia stopped using virgin cashmere and promotes recycled cashmere to avoid contributing to desertification of Mongolian grasslands (Patagonia 2018 environmental and social initiatives report). - Wildlife Conservation Society’s cashmere initiative focuses on sustainability of Gobi Desert region cashmere production and aims to convince herders to keep fewer goats by improving herd quality and encouraging direct price negotiations with clothing manufacturers. - Ethical supply chain initiatives can reduce environmental burden on Mongolian grasslands. ### Final thoughts and policy implications - Policy change is needed to make the livestock sector more sustainable, inclusive, and adaptable to climate change. - Key strategic objective: - Balance livestock population with nature’s capacity to regrow to secure sector sustainability. - Essential approach: - Reduce quantity of livestock while improving the value added of each animal. - Implementation challenge: - Bringing about change will require changing herding approaches and methods, but is essential for inclusive and sustainable growth in Mongolia. *International Monetary Fund — Excerpt from chapter on Mongolia’s livestock sector and associated policy recommendations.* ### 8. The effectiveness of the law has been uneven. For most of the period since 2013, ### 8. The effectiveness of the law has been uneven. ### Effectiveness, compliance, and fiscal outcomes - Governments frequently did not comply with the original parameters in the law because of overly loose budget submissions or significantly weaker than budgeted outturns. - Parliament made four amendments to the debt limit and the structural deficit ceiling in the 2015-17 period. - In 2016, the debt ceiling was lifted permanently from 40 percent to 60 percent in present value terms. - Off-budget quasi-fiscal spending by the Development Bank of Mongolia (DBM) and Bank of Mongolia (BOM) aggravated consolidated fiscal deficits and debt. - Non-compliance and frequent revisions have compromised the credibility of the rules and led to costly volatility in expenditures and sharp increases in public debt. ### Three critical challenges with the Fiscal Stability Law (FSL) - Internal inconsistency: - The operational expenditure rule contains a cyclical component tied to projected non-mining nominal GDP growth; when growth is high, the expenditure rule can permit spending too loose to meet other targets. - Loopholes: - Quasi-fiscal spending by SOEs, including DBM and BOM, undermined fiscal outcomes. - Lack of corrective procedure: - The rules lack a specific procedure requiring Parliament to adjust subsequent budgets to account for past slippages. ### Options to strengthen the fiscal rules framework — overview - The basic structure of the FSL remains sound, but streamlining and strengthening can improve monitoring, communication, and speed of debt reduction. - Several specific changes are proposed to improve credibility and outcomes. ### Debt anchor: calibration and recommendation - Recommendation: A debt ceiling of 50 percent of GDP in nominal terms is proposed as more appropriate for Mongolia. - Rationale and calibration: - An FAD template calibrated for low income countries using stochastic simulations suggests a debt anchor of 45 percent of GDP. - Considering Mongolia’s substantial share of concessional lending, the debt anchor is adjusted upward to 50 percent of GDP. - This proposed anchor is tighter than the current 60 percent of GDP in PV terms and reflects Mongolia’s vulnerability to commodity price and exchange rate shocks. ### Expenditure rule: transition and steady state - Public debt was 73 percent of GDP at end-2018, despite a reduction of 13 percentage points following fiscal tightening since 2017. - Priority for the next five years: rapid debt reduction to reach the debt anchor. - Transition period (2020-2024): - Nominal expenditure growth should be capped at 13 percent to reach the debt anchor of 50 percent of GDP by 2024. - Steady state (when debt is below 50 percent of GDP): - Growth of public expenditure should be capped by long-run average of historical non-mining nominal GDP. - The revised rule removes the cyclical factor in the original expenditure rule and allows automatic stabilizers to operate. ### Structural balance rule and sovereign wealth transfers - Structural balance rule: - Could be suspended because, with a debt ceiling and an expenditure rule, it imposes little extra constraint. - Structural balance is difficult to communicate, challenging to monitor, and can postpone adjustment when commodity prices fall. - There has been no independent body to scrutinize technical assumptions underlying structural revenue projections. - Future Heritage Fund (FHF): - The FHF was set up in 2016 as a sovereign wealth fund and inherited 1 trillion MNT debt from the Human Development Fund; buoyant revenues in 2017 and 2018 allowed the FHF to pay down all the debt by June 2019. Transfers in 2H2019 will accumulate in the FHF. - The law requires state budget deposits from: i) dividends on public shares of mining-sector SOEs; ii) 65 percent of mineral royalty payments excluding transfers to the Fiscal Stabilization Fund; iii) 20 percent of excess mineral revenues relative to the budgeted amount; and iv) investment income. - Annual inflows are estimated at 2-3 percent of GDP. - The law prohibits withdrawals (other than management fee) until 2030. - Recommendation: Suspend transfers to the FHF until public debt reaches the debt anchor, because public debt remains above 70 percent of GDP and global investment returns are low; debt reduction should take priority over starting a SWF now. ### Coverage of public debt and SOE risks - Extending public debt coverage in the fiscal rules to include SOEs can help monitor and control state-contingent liabilities. - Quasi-fiscal lending by DBM was a main contributor to the 2013-2016 debt buildup; such activities were curtailed in 2017-2019 under the EFF-supported arrangement and new Banking and DBM laws. - Authorities have announced intentions for mega projects via SOEs (roads, railroads, power plants, coal-washing plants) that may pose significant fiscal risks. - Data availability on SOE debt is uneven; efforts are underway to include key SOEs in GFS reporting. - The debt anchor could be adjusted after SOE data become available. ### Role of an independent Fiscal Council - A more independent Fiscal Council could build credibility by: - Issuing independent assessments of government budget assumptions. - Assessing deviations from fiscal rules. - Recommending corrective measures when outturns deviate significantly from fiscal limits. - The FSL contains an escape clause for two negative shocks: a sharp fall in commodity prices and a projected recession. - Currently, the government declares suspension conditions; the FSL does not stipulate length of suspension nor correction mechanisms for post-suspension recovery. - Proposed Fiscal Council functions in suspension events: - Analyze reasons for deviations and recommend an appropriate timeframe for suspension. - Recommend corrective fiscal actions to restore compliance. - Submit opinions publicly to the government, which would respond publicly and submit revised fiscal plans to parliament. ### Permanent Income Hypothesis (PIH) and mineral wealth — assessment - The proposal emphasizes fiscal sustainability through public debt and does not explicitly incorporate Mongolia’s mineral wealth into the fiscal rules. - PIH procedure (standard): - (i) Put a nominal value on proven mineral wealth. - (ii) Calculate total wealth = mineral wealth + financial assets (reserves and deposits) − liabilities (public debt). - (iii) Create an annuity from total wealth to finance a permanent budget deficit equal to the annuity. - Why Mongolia is ill-suited for PIH guidance: - Uncertainty: - Quantities and time-profile of mineral extraction are highly uncertain. - Estimates of proven coal reserves range from 3 to 162 billion metric tons; coal may run out in 20 years or last several centuries depending on assumptions. - High public debt: - PIH can suggest deficit targets weaker than debt-stabilizing balances, risking spiraling public debt in the near and medium term. - Example: Projected public debt is just below 60 percent of GDP in 2024 under current projections. - The primary balance that would stabilize debt at this level is about 0.5 percent of GDP under long-run averages. - The PIH, using an intermediate estimate of total mineral wealth, would suggest an average primary balance target of 0 percent (weaker than the 0.5 percent needed for stabilization). - More optimistic mineral wealth estimates would imply even weaker primary balance targets, risking unsustainable public debt over a 50-year horizon. ### PIH numerical results and assumptions (selected) - PIH application labeled “medium reserves” assumes: - 37 billion tons of unexplored coal reserves. - Time horizon to spend resource wealth: 70 years. - Under those assumptions, the PIH suggests: - A constant non-mining primary balance of -4.3 percent of non-mining GDP. - If deficits are constant in real terms or on a per-capita basis, the PIH-consistent deficit path starts out higher and gradually declines towards -2 percent of non-mining GDP. - Coal reserves estimates cited: 3, 37, and 162 billion metric tons. - PIH illustrative outcomes: - PIH-derived average primary balance target of 0 percent of GDP (with intermediate estimate of total mineral wealth) versus debt-stabilizing primary balance of about 0.5 percent of GDP. - Key annex assumptions (selected, percent unless otherwise indicated): - Recovery rate coal (cumulative extraction until 2100/proven reserves): 48.7 - Recovery rate copper: 100.0 - Coal production growth: 3.0 - Copper production growth: 0.1 - Domestic consumption growth of coal: 1.0 - Nominal increase in copper and coal prices: 3.0 - Nominal interest rate MNT: 10.0 - Nominal interest rate USD: 4.0 - GDP deflator inflation: 6.0 - Real interest rate MNT: 3.8 - Real interest rate USD: 2.1 - Annual exchange rate change MNT/USD: 3.0 - Real GDP growth: 3.0 - Real non-mineral GDP growth: 3.0 - Population growth: 1.0 - Share of mineral revenues to budget: 17.0 - Time to reach PIH post WEO projections (years): 5 - Time horizon for modified PIH (years): 70 ### Conclusion and policy priorities - Key objective: Reduce volatility in public spending and bring public debt to safe levels to protect against external shocks and domestic political cycles. - Suggested improvements to the rules-based framework: - Recalibrate fiscal rules around a more prudent debt ceiling (proposed 50 percent of GDP in nominal terms). - Adopt a simple expenditure rule that facilitates debt reduction over the medium term (transition cap of 13 percent nominal expenditure growth for 2020-2024). - Suspend the structural balance rule. - Include key SOEs in public debt coverage. - Enhance enforcement through an independent Fiscal Council and a legally binding correction mechanism. - Target: Bring down public debt to 50 percent of GDP by 2024 to build a safety cushion against commodity cycle volatility and enable a more predictable and sustainable fiscal policy that supports jobs and economic opportunity. *Source: IMF staff report content (1mngea2019002).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1mngea2019002.pdf_