Mongolia
Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix analyzes growth and recovery in Mongolia during transition. The paper describes the major sources of economic growth in Mongolia since the early 1980s in the context of a basic growth accounting framework. It discusses Mongolia’s post-transition growth performance relative to other transition countries. This paper also summarizes the main weaknesses of the existing national accounts statistics and reviews the recent developments and prospects for the main components of GDP.

Abstract

This Selected Issues paper and Statistical Appendix analyzes growth and recovery in Mongolia during transition. The paper describes the major sources of economic growth in Mongolia since the early 1980s in the context of a basic growth accounting framework. It discusses Mongolia’s post-transition growth performance relative to other transition countries. This paper also summarizes the main weaknesses of the existing national accounts statistics and reviews the recent developments and prospects for the main components of GDP.

I. Growth and Recovery in Mongolia During Transition1

A. Introduction

1. Like many former socialist countries, Mongolia began its transformation from a centrally-planned economy to a market-based economy in the early 1990s. While there is a large literature on the growth experience of other transition countries, Mongolia has received relatively little attention.2 This paper attempts to fill this gap by focusing on the following questions: (i) What were Mongolia’s sources of growth before and during transition? (ii) How do Mongolia’s growth and recovery compare with those of other transition economies? and (iii) What explains differences in Mongolia’s performance relative to other transition economies?

2. The findings of previous studies about other transition economies include the following stylized facts.3 First, the reforms introduced at the early stages of transition were typically followed by output declines in the short run. Second, traditional factor inputs appear to have had a limited role in explaining growth over time and across countries for transition economies. In particular, econometric studies have found no strong link between the level of aggregate investment and the strength of recovery from the fall in output recorded in the early years of transition. Therefore, most researchers agree that efficiency gains are the main source of growth during the recovery phase of transition, with the development of good institutions playing an important supportive role.

3. The chapter is organized as follows: Section B describes the major sources of economic growth in Mongolia since the early 1980s in the context of a basic growth accounting framework. Section C discusses Mongolia’s post-transition growth performance relative to other transition countries. The main conclusions along with some caveats are summarized in Section D.

B. A Growth Accounting Exercise for Mongolia

Methodology and Data

4. Following the conventional growth accounting framework, we assume that Mongolia’s output performance since the early 1980s can be explained by the following Cobb-Douglas production function:

Yt=AtKtα(qtLt)1α(1)

where K is the physical capital stock, q is a human capital index, and L is labor input. A is total factor productivity (TFP) which captures anything not explained by K, L, or q.

5. Taking logarithms and differentiating, we obtain the following growth accounting equation:

dYY=dAA+αdKK+(1α)dLL+(1α)dqq(2)

Equation (2) decomposes the growth rate of output into the growth rates of TFP, physical capital, labor, and human capital.

6. Physical capital K is calculated by the conventional perpetual inventory method, as discussed in Barro and Sala-i-Martin (2000):

Kt+1=It+(1δ)Kt(3)

where I is the level of real investment and δ is the rate of depreciation of the existing capital stock. Given estimates of the depreciation rate and the initial capital stock, and a time series of the investment data, we can calculate the capital stock series recursively using (3). In this study, the depreciation rate is assumed to be 6 percent, which is well within the range of 4–10 percent used in other similar studies. Since Mongolia’s industrialization began in the early 1960s, 1959 has been selected as the initial year when the capital stock was assumed to be zero.4

7. The time series data used in this study for real GDP (Y), real investment (I), the capital stock (K), labor (L), and human capital (q) between 1980 and 2001 are presented in Table I.1. Data on real GDP and investment in current prices were obtained from the National Statistical Office (NSO).5 Due to the lack of official data on the expenditure deflators, the investment deflator was approximated based on the following equation:

Table I.1.

Mongolia: Estimates of Real GDP and Factor Inputs, 1980–2001

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Sources: Data provided by the NSO; and NSO and UNDP, Living Standards Survey, 1998.

Investment Deflator=w*(Construction Investment Deflator)+(1-w)*(GDP Deflator),

with w being the share of construction in total investment. The construction deflator has been derived implicitly from the real and nominal construction data obtained from Mongolia’s national accounts statistics. Since there are no data for the nonconstruction investment deflator, the GDP deflator has been used as a proxy.6 Labor input has been approximated by total employment, which was obtained from the NSO. Finally, following Lucas (1988), the human capital index is measured by the average number of years of schooling of the Mongolian population aged 15 or above. Data for this variable were obtained from Mongolia’s Living Standards Survey (1998) and are presented in Table I.2. Since only data for two years are available (1989 and 1998), figures for other years were estimated by assuming a constant annual growth rate in the human capital stock.

Table I.2.

Mongolia: Composition of Population Aged 15 or above by Educational Status

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Sources: NSO and UNDP, Living Standards Survey, 1998: and staff estimates.

8. The income share of capital, α, is calculated by a regression approach. Specifically, dividing both sides of (1) by L and q and then taking logarithms, we obtain:

In yt = In At + α In kt,

with, ytYtqtLt and ktKtqtLt. Taking first differences (indicated by a Δ), we obtain the following regression equation which can give us an estimate of α:

ΔInyt=γ+αΔInkt+εt(4)

where γ is average TFP growth and εt is the disturbance term. The regression results are shown below:

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As discussed below, average TFP growth over the period between 1980 and 2000 is sometimes positive and sometimes negative, which is consistent with an estimated intercept not significantly different from zero. The estimate of α of 0.69 may seem large, but it is not out of line with the findings of other empirical studies. For example, Senhadji (1999), using a similar econometric approach as the one used in this paper, found that the average value of α for his sample of 88 countries was 0.53, with some countries having values as high as 0.91. Similarly, Heytens and Zebregs (2000) estimated that α was equal to 0.63 in China, an Asian transition economy, which may share a number of characteristics with Mongolia.

Results

9. As indicated in Figure I.1, the evolution of real GDP and capital and labor productivity since 1990, where the latter are defined as GDP/K and GDP/L, suggests that Mongolia, like many other former socialist economies, experienced a painful “transformational recession” in the first few years during its transition to a market economy before beginning to recover as a result of efficiency gains from market-oriented reforms. Real GDP and capital and labor productivity bottomed out in 1992–93 and began to recover to positive rates of growth thereafter. By 1995, capital productivity had started to surpass its 1990 level, and by 2001, real GDP had reverted to the level prior to the transition. Labor productivity as of 2001, however, was still slightly below the level of 1990, possibly reflecting sluggishness in the shedding and reallocation of labor employed in the less productive state-controlled sector of the economy.

Figure I.1.
Figure I.1.

Mongolia: Output, Capital Productivity, and Labor Productivity, 1990–2001

(1990=100)

Citation: IMF Staff Country Reports 2002, 253; 10.5089/9781451826838.002.A001

Source: WEO; Staff estimates.

10. Mongolia’s sources of growth before and after the transition resemble those in most other transition economies. As is indicated in Table I.3, which summarizes the estimates derived from equation (2), capital accumulation appears to have been the key engine for economic growth before the transition began; however, its role diminished following the launching of market-oriented reforms. Similarly, neither education nor employment appears to have made a considerable contribution to economic growth during the early years of transition. While the growth of factor inputs cannot account for Mongolia’s growth performance during the transition, total factor productivity (TFP) seems to be of paramount importance. In the 1980s, TFP was largely negative, reflecting resource misallocation typical of all planned economies. Then, TFP declined even further at the initial stages of the transition, becoming the primary factor accounting for the collapse in Mongolia’s real GDP in the early 1990s. But as stabilization policies took hold and the foundations were laid for the development of a competitive market economy, TFP turned positive from the mid-1990s. Hence, consistent with the findings of empirical work on other transition economies, efficiency gains, as measured by TFP, appear to have been the main factor accounting for the pick-up of growth in Mongolia as the transition took root.

Table I.3.

Mongolia: Results of Growth Accounting Exercise

(In Percent)

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Sensitivity Analysis

11. Although the above growth accounting exercise is based on arbitrary assumptions about the initial capital stock and its rate of depreciation, sensitivity analysis suggests that the results are robust to different assumptions. Table I.4.A shows the results for the growth accounting exercise under a different assumption about the initial capital stock, with an investment/GDP ratio between 1949–59 that is the same as the average level recorded during the 1970s (38 percent), as opposed to an assumption of a zero capital stock in 1959 in the benchmark scenario. While this probably overstates the initial capital stock by a significant amount, the results in Table I.4.A are only slightly different from those in Table I.3, and the big picture remains the same. Similarly, changes in the depreciation rate do not alter the main results. As shown in Tables I.4.B and I.4.C the relative contributions to growth from factor inputs and TFP show basically the same patterns with a depreciation rate of 4 percent or 10 percent (compared with 6 percent in the benchmark scenario).

Table I.4.

Mongolia: Growth Accounting Exercise: Sensitivity Analysis

(In percent)

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C. Comparison with Other Transition Economies

12. Compared with other transition economies, Mongolia’s speed of recovery has been moderately fast. While Mongolia’s output recovery was slightly more sluggish than in the best-performing countries in Central and Eastern Europe, its growth performance during the transition has been unequivocally superior to those of the Baltics, the Commonwealth of Independent States (CIS) except for Uzbekistan, and the poorer performers in Central and Eastern Europe (Figure I.2 and Table I.5. and Table I.6. While the Baltics and the CIS suffered a cumulative output loss averaging 23.8 percent and 34.2 percent, respectively, during 1990–2001, Mongolia’s output rose by 0.7 percent during the same period. Moreover, between 1990–2001, Mongolia recorded only three years of output decline, compared with an average of 3.9 years in Central and Eastern Europe, 4.7 years in the Baltics, and 5.8 years in the CIS.

Figure I.2.
Figure I.2.

Comparative GDP Performance in Transition Economies, 1990–2001

Citation: IMF Staff Country Reports 2002, 253; 10.5089/9781451826838.002.A001

Source: WEO; staff estimates.
Table I.5.

Comparative GDP Performance in Transition Economies, 1990–2001

Index (1990=100)

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Sources: WHO; IMF Occasional Paper 184; and staff estimates.
Table I.6.

Comparative Growth Performance and Location of Transition Economies, 1990–2001

(In percent, unless otherwise indicated)

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Sources: WEO; IMF Occasional Paper 184; and staff estimates.

13. Mongolia’s relatively fast recovery cannot be easily attributed to any one factor such as geography, historical and economic ties, the level of industrialization, per-capita income, or openness. As Table I.6. shows, despite Mongolia’s physical proximity and historical and economic ties to the CIS, the latter performed more poorly than Mongolia. Similarly, Mongolia’s high growth performance cannot be fully explained by its low level of industrialization (as approximated by the agricultural share in GDP over the period 1990–2001). As Table I.7. shows, countries with a like-sized agricultural sector, such as Armenia and Moldova, recovered more slowly than Mongolia during transition. Nor can Mongolia’s low income level alone account for its relative growth success in light of the poor performance in other low-income countries such as Tajikistan, and the good performance in high-income countries such as Slovenia (Table I.8.). Finally, openness to trade may partly explain Mongolia’s relative growth success. As shown in Table I.9. Mongolia is a fairly open economy, with an exports-plus-imports-to-GDP ratio of about 112 percent. Yet, this factor alone cannot explain Mongolia’s favorable growth performance, compared with the performance in some other highly open economies such as Moldova.

Table I.7.

Comparative Growth Performance and Share of Agriculture in GDP in Transition Economies, 1990–2001

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Sources: WBO; World Bank: World Development Indicators Database; IMF Occasional Paper 184; and staff estimates.

The lower the rank, the better the performance.

Table I.8.

Comparative Growth Performance and PPP-Based Per-Capita Income Level in Transition Economies, 1990–2001

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Sources: WEO; IMF Occasional Paper 184; and staff estimates.

The lower the rank, the better the performance.

Table I.9.

Comparative Growth Performance and Openness in Transition Economies, 1990–2001

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Sources: WEO; IMF Occasional Paper 184; and staff estimates.

The lower the rank, the better the performance.

14. Quite surprisingly, Mongolia’s pattern of growth and recovery resembles more those in the high-growth Central and Eastern European countries, which are very different from Mongolia in terms of geography, history, market structure, and developmental stage. Perhaps, Mongolia’s relatively good performance can be attributed to a combination of policy factors, such as a determined macroeconomic adjustment effort to contain inflation and external imbalances and the rapid establishment of an open exchange and trade system, which helped enhance competition and efficiency, as well as more advantageous initial conditions. The latter may have included Mongolia’s relatively low degree of industrialization, which is likely to have facilitated price liberalization and enterprise restracruring.7

D. Conclusions

15. This chapter has described some of the key stylized facts of Mongolia’s growth and recovery during the first decade of its transition to a market-based system and compared them to those of other transition economies. The major findings have been as follows: (1) As in most former socialist countries, while capital accumulation appears to have been the primary factor accounting for growth in the 1980s, efficiency gains became the main source of growth during the early stages of transition; (2) Mongolia, like most other transition economies, experienced a painful, initial “transformational recession” before the economy began to recover; (3) the speed of Mongolia’s recovery has been moderately fast compared with other transition economies; and (4) Mongolia’s favorable performance cannot be easily explained by any single factor such as, geography, historical and economic ties, the level of industrialization, per-capita income, or openness; rather, it is likely due to a combination of policy factors and relatively advantageous initial conditions.

16. While the above results are instructive, they need to be interpreted with caution in light of the well-known weaknesses in the quality of national accounts and related data in transition economies.8 In particular, comparisons of economic performance before and after the transition, and across countries, along the lines described above, may be subject to a large margin of error. In the case of Mongolia, there are also reasons to question the quality of post-transition national accounts data, as elaborated in the following chapter.

II. Issues in Developing National Accounts Estimates and Projections1

A. Introduction

1. Mongolia’s GDP growth rate is officially estimated to have slowed to 1 percent in 2000–01 from an average annual growth rate of 3–4 percent in the late 1990s, but it is targeted to rise to 5–6 percent in the medium-term macroeconomic framework underlying the government’s Interim Proverty Reduction Strategy paper (I-PRSP). The results of the preceding chapter provide a useful framework for the assessment of Mongolia’s economic growth prospects in the period ahead. Thus, assuming that TFP growth continues to be underpinned by sustained implementation of sound macroeconomic policies and market-friendly reforms, and that continued contributions from employment growth and improved education are supported by a progressive recovery in investment, the achievement of the government’s medium-term growth targets should be within reach. Nevertheless, to better assess the factors underlying the recent trends and medium-term prospects, one has to look also at developments in the key sectoral components of GDP. The performance of the weather-sensitive agricultural sector may be of particular significance in this regard, given its unusually poor performance in 2000–01.

2. At the same time, it should be noted that Mongolia’s national accounts statistics continue to suffer from considerable weaknesses. This suggests that recent national accounts estimates and projections should be interpreted with great caution. This chapter first summarizes the main weaknesses of the existing national accounts statistics and then reviews the recent developments and prospects for the main components of GDP.

B. Weaknesses in Mongolia’s National Accounts Statistics

The Treatment of Animal Losses

3. Mongolia experienced two consecutive years of drought in 1999–2000, followed by exceptionally severe winter weather in 2000–01, which resulted in annual losses equivalent to 10–15 percent of the beginning-of-year herd stock in 2000–01. As illustrated in Figure II.1, such big losses have been extraordinarily rare over the last 50 years, and have occurred only once before in the latel960s. Having two consecutive years of such losses has been an unprecedented event in Mongolia’s recent history.

Figure II.1.
Figure II.1.

Mongolia’s Animal Loss Rates, 1951–2001

(Loss During the Year/Beginning-of-Year Herd Stock)

Citation: IMF Staff Country Reports 2002, 253; 10.5089/9781451826838.002.A001

Source: Data provided by the NSO; and staff estimates.

4. According to the 1993 System of National Accounts and the FAO’s handbook on economic accounts, output of the livestock sector should be calculated as the sum of the changes in the value of the herd stock, and the value produced in the forms of meat, milk, hair, skin, and other raw materials of animal origin.2 While a large loss of animals adversely affects both the value of the herd stock and current production, the former can be expected to have a more significant impact.

5. Table II.1. illustrates the impact of the exceptional weather on total output of the livestock sector. While current production decreased by 20 percent in 2001, after having recorded only a slight increase in 2000, the large decline in the value of the herd stock implies that the relevant component of value added was negative in both years. This negative component accounts fully for the recorded decline in the output of the livestock sector in 2000, and for about half of the decline in 2001.

Table II.1.

Mongolia: Output of Livestock Sector at 1995 Constant Prices and Contributions to its Growth

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Includes eggs, honey, blood horns, feather, and manure.

Source: Data provided by the NSO; and staff estimates.

6. The analytical treatment of such extraordinary losses in the national accounts is an issue worthy of careful consideration. If the weather-related losses are viewed as one-time catastrophic occurrences, then the whole or part of the resulting losses may be excluded from the calculation of GDP.3 However, in the case of Mongolia, harsh winters can be expected to occur with some regularity. In addition, the animal losses resulting from adverse weather are not totally exogenous but may also depend on the extent to which provisions have been made to protect herds from the hardships that can be expected to be associated with Mongolia’s harsh winter. Thus, until 1999, the national accounts methodology used by the NSO did not make any special provisions for the treatment of extraordinary losses in the herd stock.

7. In these circumstances, the authorities are considering three options for the methodology to account for the impact of the unusually large animal losses during 2000–01:4

  • Option A: Distinguish between animals employed as fixed assets (i.e., used for production year after year) and work in progress (i.e., those in the process of being fattened for future slaughter or future employment as productive assets but still in their growth period), and exclude fixed assets from the GDP estimates.

  • Option B: Distinguish between losses that are recurrent or accidental and those that can be deemed as exceptional or catastrophic losses, and exclude exceptional or catastrophic losses from the GDP estimates.

  • Option C: Treat the losses that occurred in 2000–01 like the losses that occurred in previous years, and adhere to the same national accounts methodology used by the NSO for previous years.

8. Mongolia’s GDP growth estimates for 2000–01 are highly sensitive to the choice from among the above options. As illustrated in Table II.2, under Option C, in particular, which reflects the NSO’s methodology until 1999, the estimated rate of growth of real GDP would have to be revised down to significant negative numbers for both years.

Table II.2.

Mongolia: Estimates of Annual Growth Rates of Output, 2000–01

(In Percent)

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Sources: Data provided by the NSO; and staff estimates.

Accuracy and Reliability

9. Even if one abstracts from the issues related to the measurement of output in the animal husbandry sector, the accuracy and reliability of Mongolia’s national accounts are weak. The criteria that can be used to assess data accuracy and reliability include the size of the statistical discrepancy between GDP estimates derived from the production and expenditure sides, comparisons of national accounts estimates of various GDP components with similar estimates derived from other sources, and the size and frequency of revisions to GDP estimates5.

10. Mongolia’s national accounts show substantial discrepancies between the production- and expenditure-side estimates of GDP. Thus, over the 1995–2000 period, GDP calculated from the expenditure side exceeded the corresponding production side estimates by a margin ranging from 3–8½ percent (Table II.3.).

Table II.3

Mongolia: Statistical Discrepancy of GDP between Production Side and Expenditure Side, 1995–2000

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Sources: Data provided by the NSO; and staff estimates.

11. The individual expenditure components of GDP derived from national accounts data sources also show substantial differences from the corresponding estimates derived from government finance and balance of payments statistics. As illustrated in Table II.4, data on public consumption as well as public investment obtained from the fiscal accounts show nonnegligible differences from the corresponding national accounts data, with significant year-to-year variations. Data on net exports of goods and services from the balance of payments show even larger and more variable deviations from the corresponding national accounts data.

Table II.4.

Mongolia: Difference Between Expenditure Data Derived from the National Accounts and Other Source Data, 1995–2000

(In billions of togrogs, unless indicated otherwise)

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Sources: Data provided by the NSO; and staff estimates.

95 percent of current expenditure excluding subsidies, transfers, and interest payments.

Capital expenditure plus gross foreign on-lending.

12. The NSO makes periodic revisions to its national accounts statistics to reflect improvements in methodology, coverage, source data, and other factors. Such revisions are normally expected to result in improvements in the overall quality of statistics. Accordingly, a revised series on GDP estimates from the production side for the period 1995–98 was published in 2000. The main factors underlying this revision were the implementation of the Mongolian Standard Industrial Classification (MSIC) and the associated expansion in industrial detail, especially for services; the incorporation of the results of the 1998 Establishment Census and other new surveys; and a shift in the base year for the constant price estimates from 1993 to 1995. As can be seen from Table II.5, the resulting revisions for nominal GDP were both large and highly variable from year to year, ranging from an upward adjustment by 28 percent in 1995 to a downward adjustment by 6½ percent in 1998, While this pattern of data revisions may be due to legitimate factors, it raises further questions about the reliability and accuracy of Mongolia’s national accounts.

Table II.5.

Mongolia: Magnitude of Revision of GDP Estimates from the Production Side, 1995–98

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Sources: Data provided by the NSO; and staff estimates.

Price Deflators

13. A major difficulty in the estimation of constant price GDP data is the lack of appropriate price indices for deflation. In particular, the NSO does not currently compile a producer price index (PPI). As a result, the national accounts resort to extensive use of consumer price index (CPI) components, or even the total CPI, for deflating production. In the absence of a national CPI, the CPI of Ulaanbaatar city is used as a substitute. Some specific areas of concern with regard to deflation methods are as follows:

  • Wholesale and Retail Trade: The price index used to calculate constant price estimates is the price index for the goods component of the CPI. As this index relates to sales and not value-added, distortions are introduced in the event that there are any changes in the relative sizes of margins, taxes, goods costs, and other inputs.

  • Financial Intermediation: The deflator utilized is the CPI which is unlikely to be a good representation of financial sector wages and profitability. Moreover the high volatility of financial sector profits before and after the banking system crises of the 1990s could not possibly have been captured by the CPI, with the result that the constant price estimates were probably distorted.

  • Public Administration: The deflator used is the CPI for services. As a result, unless wages are indexed to the CPI for services and paid retroactively (which has definitely not been the case in Mongolia in recent years), the constant price estimates are incorrect.

Informal Sector

14. As in most other transition economies, inadequate coverage of a relatively large informal sector poses a particular challenge for the compilation of national accounts in Mongolia. While a sample survey on unincorporated businesses and the informal sector was conducted by the NSO in 1999, its coverage was relatively limited and a number of business activities were excluded. A number of other studies have suggested that the informal sector accounts for a significant fraction of total employment in Mongolia, especially in trade and other services.6 The corresponding level of economic activity accounted for by the informal sector is reported to be equivalent to as much as 30 percent of GDP by some estimates. This would be in line with existing estimates for the size of the informal sector in the CIS states, which share a number of institutional and historical features with Mongolia.7

C. Possible Sources of Growth Over the Medium Term

15. As illustrated in Table II.6, the agricultural and tertiary sectors accounted for the bulk of Mongolia’s economic growth during the late 1990s. A key contributing factor to the dynamism of the agricultural sector was the privatization of herds, which greatly enhanced production and investment incentives in the animal husbandry sector. Thus, the total size of the herd increased from 24.7 million in 1990 to 33.6 million by end-1999. In the tertiary sector, which was dominated by trade, transport, and related services, the early privatization of small and medium-sized enterprises, together with the entry of new firms, was also conducive to rapid growth in activity. While profitable opportunities in gold mining and other mineral extraction also led to sustained growth in the output of the mining sector, manufacturing suffered a prolonged decline. As the former employees of defunct state industries sought new opportunities in herding, trading, and other services, including in the informal sector, the growth of activity in these sectors was amplified.

Table II.6.

Mongolia: Recent Contributions to GDP Growth by Sector and Possible Sources of Future Growth

(In Percent)

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16. The effects of the exceptional weather led to a drastic shift in the pattern of economic growth during 2000–01. The decline in the output of the agricultural sector is estimated to have been largely offset by an upsurge of activity in the tertiary sector, led by wholesale and retail trade and transport and communications. However, there are still questions about the appropriate accounting treatment of the losses in the herd stock, which fell to 25.6 million by end-2001. The mining sector’s contribution to growth also increased in 2000–01, as new gold mines came on stream, production of copper rose, and the sector continued to attract the lion’s share of new foreign direct investment. Manufacturing activity is estimated to have picked up strongly in 2002, especially in textiles, apparel, and dressing and dyeing of fur. However, the exports of these sectors’ products have been lackluster, raising questions about the sustainability of the recent pickup in activity.

17. While the staff’s latest estimates suggest that, on current trends, real GDP can be expected to increase by 3½—4 percent in 2002, the prospects for the medium term are subject to a considerable degree of uncertainty. The government’s I-PRSP envisages a progressive increase in the annual rate of growth of real GDP to 5 percent in 2003 and to 6 percent in 2004. As illustrated in Table II.6, assuming that there is resumed growth in the agricultural sector, albeit at a more modest rate than in the late 1990s, and a sustained expansion of the secondary and tertiary sectors, the government’s medium-term growth targets could be feasible. However, the large weather-related losses of the last two years have raised the possibility that the agricultural sector may be far more vulnerable in the period ahead than it had been over the last fifty years. This could be a result of both endogenous and exogenous factors. On the domestic policy front, the herders’ lack of preparedness to deal with the recent exceptional weather could be seen as a side-effect of the shift from the collective farms of the former centrally planned system. Another possibility is that long-term changes in climatic conditions may imply that the occurrence of drought and extreme cold may not be as infrequent as in the past, with the result that agriculture may become a less reliable source of economic growth than it had been in the 1990s, These considerations reinforce the need for a steadfast implementation of sound fiscal, monetary, and external sector policies, coupled with market-based reforms, to enhance opportunities and incentives for investment in export-oriented activities in sectors that are less vulnerable to the vagaries of Mongolia’s climate.

III. Public Enterprise Reform and Privatization in Mongolia1

A. Introduction

1. A fundamental objective of Mongolia’s reform from the early days of the transition has been to enhance economic growth prospects and foster a more efficient use of the economy’s scarce resources. In addition to macroeconomic stabilization, the program has thus emphasized measures to liberalize prices, strengthen competition, encourage entrepreneurial activity, and develop sound market institutions. The restructuring and privatization of inefficient state-owned enterprises have been critical to the achievement of the above objectives. Privatization has also been important for its signal effect to investors and donors regarding the government’s commitment to the transition to a market system.

2. Given Mongolia’s pre-eminent need to promote medium-term fiscal sustainability, one of the objectives of public enterprise reform and privatization has been to support fiscal consolidation. While, in principle, privatization alone should not be expected to ease the government’s intertemporal budget constraint, as the budgetary receipts generated in the short run would normally be equal to the present discounted value of foregone future dividends, in practice there are at least two channels through which it can facilitate fiscal consolidation. First, to the extent that privatization is accompanied by the imposition of hard budget constraints and market discipline, it should help foster tariff reforms and improved enterprise performance. If the anticipated efficiency gains are factored into the sale price of privatized entities, there would be a clear net gain for the budget. Second, privatization is an important means for the improvement of fiscal transparency and the containment of implicit subsidies and contingent government liabilities. These have posed a particular challenge in the case of Mongolia’s large and inefficient energy sector.

3. As in many other transition economies, the constraints facing the restructuring and privatization of public enterprises in Mongolia have been numerous and daunting. These have included: (1) weak administrative capacity to manage the reform program; (2) lack of a domestic capital market; (3) a legal infrastructure that hardly recognizes private property; (4) price distortions and a thin share market that makes valuation difficult; (5) low domestic savings; (6) high initial start-up costs and/or a need to adjust tariffs and restructure public enterprises prior to privatization; (8) a lack of equitable and uniform enforcement of tax laws, which serves as a deterrent to investors; and (9) the shortage of resources for compensation for social costs resulting from plant closures, the shedding of excess labor, and the discontinuation of the use of public enterprises to achieve social objectives.

B. Developments During 1991–2000

4. Privatization was a key component of Mongolia’s economic reform strategy from the early years of the transition, although important sectors of the economy remained under state control. It initially encompassed separate programs for small and medium-sized enterprises and in agriculture, relying primarily on a mass privatization program through vouchers, which covered the manufacturing, distribution, and service sectors as well as the animal husbandry sector. Altogether, some 4,500 entities were privatized during 1991–96 through the distribution of vouchers to the public. While these early privatizations did not generate any significant receipts for the budget, they definitely enhanced competition and efficiency and, thereby, facilitated the early recovery of output following its initial decline at the onset of transition.2 However, some of the largest state-owned enterprises, including those officially designated as most-valued companies (MVCs), remained outside the scope of the privatization program during this period. In addition, airlines, railroads, telecommunications, and utilities, for which special regulatory regimes often apply, continued to be run by state-owned enterprises.

5. The privatization process speeded up considerably during the late 1990s, but it stalled in 2000 as the political support for reforms waned in the run-up to the Parliamentary elections of mid-2000. While the government’s privatization program was expanded to include some of the larger enterprises, which were now offered for sale through competitive auctions, a select number of MVCs and key economic sectors remained under state ownership. During this period, the State Property Committee (SPC) succeeded in privatizing 910 enterprises and commercial entities. With the help of the improved macroeconomic situation, the recovery of economic activity, and the progressive development of market institutions, privatization during the 1997–2000 period generated about Tog 42 billion or the equivalent of about 5 percent of GDP in financing for the budget. However, as the support for reform within the government began to be eroded, new legislation was approved in 1999 to establish a Negative List of MVCs which could not be privatized without the Parliament’s express authorization. As a result, both the number of privatized enterprises and the resulting receipts for the budget fell sharply in 2000 (Statistical Appendix Table 14).

6. The financial situation of the ailing energy sector also took a turn for the worse in the late 1990s. Energy consumption in Mongolia is especially high, because of the harsh climate and the low population density. Although the economy depends critically on a well run energy sector, as in many other transition economies, one of the legacies of central planning has been an inefficient use of energy. This has been evident in low operational efficiency in generation, large losses in transmission and distribution, tariffs set well below supply costs, and shortcomings in collection, which have been exacerbated by the chronic payments difficulties of Erdenet, a large copper mine that accounts for about one-third of Mongolia’s electricity consumption.3 While the importation of oil at subsidized prices from Russia may have concealed the cost of these problems in the past, after the alignment of oil import prices with world market prices, the gap between Mongolia’s electricity and heating tariffs and supply costs widened to an estimated 25–50 percent in 2000. Largely as a result, the industry’s financial losses deteriorated from US$43 million (0.5 percent of GDP) in 1999 to US$17.1 million (1.8 percent of GDP) in 2000.

7. Although the weak finances of the energy sector may have had a limited direct impact on the budget to date (in the form of tax arrears and the nonpayment of principal and interest on foreign loans on-lent to the energy sector by the government), they have also resulted in other less transparent but potentially more damaging effects. These are as follows:

  • The lack of adequate financial resources has led to a large build-up of energy company arrears to other enterprises, which rose to Tog 35 billion (3.4 percent of GDP) as of 2000. This has been a particularly serious problem to the Bagannuur Coal Company, a state-owned enterprise that is the largest supplier of coal to the Energy Authority.

  • The main public enterprises in the energy and coal sectors have accumulated government-guaranteed external debts amounting to US$400 million since the early 1990s, or almost half of Mongolia’s total external debt outstanding as of January 2000. With repayments scheduled to reach a peak of about US$18–20 million a year by 2025, a heavy burden could be placed on the budget if the financial position of these enterprises does not improve.

  • Reduced expenditures for maintenance have led to a depletion of capital, with plant and equipment becoming increasingly outdated. Over the next few years, both the energy companies and the coal mines will need to significantly increase their expenditures on maintenance and investment. By some estimates, if the needed investment were to be financed through external borrowing, the external debt of the two sectors would have to double to about US$800 million; this could seriously strain Mongolia’s external sustainability.

8. Notwithstanding the difficult political constraints on public enterprise reform, overall progress was impressive during the 1990s. Thus, the economy was essentially transformed during Mongolia’s first ten years of transition, with the private sector, which only accounted for about 4 percent of GDP in 1990, having grown to about 60 percent of GDP by 2000. As indicated in the preceding chapter, the extent of the transformation to a market-based economy is probably understated by these figures, as informal sector growth, which has been considerable, is not accounted for in the official national accounts. The agriculture, animal husbandry, construction, food, small-scale transportation, mining, and trade sectors, in particular, had been largely privatized by 2000. In the energy sector, the new government that took office in August 2000 recognized the urgent need for a rethinking of Mongolia’s energy development strategy and, as a first step, electricity and heating rates on average, were raised by 14.2 and 100 percent, respectively, with effect from December 2000. In addition, a new Energy Law was passed in late 2000, which set the stage for a comprehensive restructuring of the energy sector, including by establishing an independent Energy Regulatory Authority (ERA) vested with the responsibility to regulate tariffs.

C. Developments Since 2000 and Remaining Challenges

9. The government’s public enterprise reform program received new impetus in early 2001 with the approval of the new Guidelines for Privatization for 2001–04. The Guidelines effectively abolished the Negative List that had been introduced by the previous Parliament and proposed an ambitious timetable for the privatization of MVCs while also setting important sector-specific objectives for the reforms of the energy sector and the social sectors. Reforms were also proposed for the road sector, telecommunications, the coal sector, railways, and the geodesy and cartography sectors, although these were not to involve privatization, but rather steps to improve performance along commercial lines.

10. The government’s initial privatization program for 2001 envisaged the privatization of three important MVCs, including a beverage company (APU), the Trade and Development Bank (TDB), which is Mongolia’s largest and most profitable bank, and Gobi, the largest cashmere company operating in Mongolia. In the event, reflecting a combination of factors, including the tragic events of September 11 which led to an overall deterioration in the global climate for foreign investment, only APU could be privatized during 2001, at a sale price of Tog 4.5 billion (0.4 percent of GDP). However, significant progress was also made in preparing the TDB and Gobi for privatization.

11. A tender for the privatization of TDB was issued in early September 2001, but bidding was delayed several times, and a privatization contract was finally signed in May 2002. Both the IFC and the IBRD agreed to take up some shares in the Bank if a qualified strategic investor could be identified who would like such participation. Formal expressions of interest and bids were expected to be placed before the end of 2001, but the deadline was extended several times. The public tender process for the sale of the government’s 76 percent interest in the TDB was finally concluded in May 2002. The State Property Committee (SPC) executed the sale to a consortium of foreign investors for US$12.23 million (1.0 percent of GDP).4 In addition, the foreign investors have agreed to inject at least US$28 million (2.2 percent of GDP) of additional capital into the bank within 24 months following the closing of the transaction, and have proposed to expand TDB’s deposit base over that two-year period at the rate of 25 percent per annum and its loan portfolio at 50 percent per annum. New lending activities for the bank are to include consumer credit and trade and project finance, while new distribution channels are to include a significant increase in the number of ATMs, expansion of regional business centers, and telephone and internet banking services. In due course, TDB would also set up representative offices in nearby regional centers in Russia, China, as well as the USA, to enhance and promote international trade with Mongolia.

12. A tender for the privatization of the government’s 70 percent interest in Gobi was announced in July 2001, but good quality bidders were difficult to come by in the aftermath of September 11. In these circumstances, the State Property Committee decided to close the bidding as of late March 2002. In the meantime, with cashmere prices having fallen by 33 percent since September 2001, it may be necessary to re-evaluate the minimum price; a firm has been contracted through international tender to advise the authorities on an appropriate pricing strategy. The intention was to reopen bidding in the third quarter of 2002, with a view to disposing the government’s entire equity position.

13. The government’s privatization program for 2002 was approved in January 2002. Aside from the continued pursuit of the privatization of Gobi, the program, envisages the privatization of the Neft Oil Concern (NIC), Mongolia’s national airline (MIAT), and two insurance companies. In addition, the remaining four MVCs, including Power Plant No. 2, the Ulaanbaatar Power Distribution Network, the Mongolian Telecommunications Company, and the Agricultural Bank, are to be restructured and prepared for subsequent privatization.

14. The privatization of NIC, an oil and gas distribution company, will probably have to await the resolution of some difficult problems. NIC’s capital has been eroded in recent years by the large quasi-fiscal losses incurred as NIC was required to supply oil to remote rural areas at subsidized prices. As a result, NIC will need to be financially rehabilitated before it can be privatized. To this end, NIC’s receivables could be assigned to offset its overdue debts to the government, which were on the order 1 percent of GDP as of 2001, and it may also be necessary that new capital be infused from the government. Equally importantly, the government will need to make a credible commitment to any prospective buyer to allow flexibility in the setting of future prices and a clear agreement will have to be reached as to who should bear the cost of cleaning up the environmental damage that has resulted from NIC’s past operations.

15. In the case of MIAT, the national airline, which has been plagued by financial and safety problems, a major constraint to privatization is the issue of the internal fare structure. Currently rates for domestic travel are well below costs, and it will probably be politically difficult to raise these rates. No investor would be interested in purchasing the company unless this issue is resolved. Aside from its inadequate fare structure, MIAT is currently overstaffed, its fleet is outdated and underutilized, and its scheduling needs to be overhauled. While the government is keen to resolve these problems expeditiously, with the recent sharp downturn in the profitability of the airline industry world wide, the prospects for an early privatization of MIAT look dim. In these circumstances, the government is considering the possibility of bringing in an external management team to strengthen the airline before privatization is pursued, as was done with the Agricultural Bank.

16. The Agricultural Bank of Mongolia, which is the principal provider of banking services to the rural communities, has recorded an impressive turn-around in its profitability and financial health over the last two years. Poor governance in the context of a lax regulatory environment had brought the bank to the verge of failure in the late 1990s, and the authorities had placed the bank under an external management contract in the summer of 2000, with a view to its rehabilitation and eventual privatization. Under this arrangement, the bank has managed to eliminate its financial losses, has comfortably met the Bank of Mongolia’s increasing minimum capital requirements, and recorded a pre-tax profit of Tog 1.5 billion (0.1 percent of GDP) during the first five months of 2002. The bank has also opened 83 new offices throughout Mongolia, and its network of 352 branches now reaches virtually every territorial unit in the country. While the Agricultural Bank was not among the entities that were to be privatized in 2002 under the government’s privatization program approved in January, an international tender for its privatization was announced in July 2002.

17. The Energy Authority was unbundled into 18 separate generation, transmission, and distribution companies in April 2001, but progress towards resolving the energy sector’s fundamental problems has so far been limited. A key objective of the unbundling exercise was to separate any portions of the company that may be natural monopolies from those that can be effectively privatized and/or opened to competition from new entrants. The recent restructuring makes it difficult to assess the evolution of the sector’s financial position with any degree of accuracy. Nevertheless, the available evidence suggests that the new enterprises continue to sustain financial losses, while accounts receivable and arrears to other sectors have remained high. While electricity tariffs were raised by 15 percent with effect from July 2002, vociferous opposition to the increases by a broad range of political forces has since forced the ERA to partially roll back tariffs. Thus, current electricity tariffs at the retail level are Tog47/Kwh (US$0.042/Kwh), whereas estimates for the marginal cost of producing electricity are in the range of US$0.055/Kwh to US$0.065/Kwh, and the long-run marginal cost is probably on the order of US$0.080/Kwh.5 In these circumstances, despite some progress towards clearing arrears between budgetary entities and the key energy sector enterprises, the problem of inter-enterprise arrears has yet to be addressed. Perhaps more worrying from a medium-term perspective, unless the energy sector can quickly revamp its operations to become commercially viable, there is a risk that investment for the much-needed upgrading of the sector’s plant and equipment will be inefficiently utilized. The ultimate result could then be a sharp increase in Mongolia’s publicly guaranteed external debt, which would undermine efforts to protect fiscal and external sustainability.

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STATISTICAL APPENDIX

Table 1.

Mongolia: Selected Economic and Financial Indicators, 1997–2001

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Sources: Mongolian authorities; and Fund staff estimates.

Includes IMF loans, guarantees and arrears

Excludes unresolved claims by Russia estimated at TR 10.5 billion.

Seasonally adjusted figures for broad money velocity from 1997 onwards.

Annualized yield on end-period auction of 14-day bills.

Beginning December 2000, includes commercial banks’ foreign exchange deposits with the Bank of Mongolia