Mongolia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
15 Nov 2005
eISBN:
9781451826883
Language:
English
Keywords:
ISCR; CR; Mongolia; export; loan; revenue; garment export; price; VAT revenue; Mongolia's revenue effort; royalty revenue; revenue yield; revenue growth; Corporate income tax; Government debt management; Social security contributions; revenue shortfall
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This Selected Issues paper and Statistical Appendix presents an overview of the fiscal developments in Mongolia since the late 1990s. It assesses the “quality” of the ongoing fiscal adjustment. The paper examines the dramatic expansion of bank credit to the private sector over the last five years, asking what its sources are and what its consequences may be, particularly for the maintenance of macroeconomic and financial stability. The paper also describes recent developments in the garment sector in Mongolia.

Abstract

This Selected Issues paper and Statistical Appendix presents an overview of the fiscal developments in Mongolia since the late 1990s. It assesses the “quality” of the ongoing fiscal adjustment. The paper examines the dramatic expansion of bank credit to the private sector over the last five years, asking what its sources are and what its consequences may be, particularly for the maintenance of macroeconomic and financial stability. The paper also describes recent developments in the garment sector in Mongolia.

I. Fiscal Issues and Prospects1

A. Introduction

1. Between 1997–2000 and 2001–04, Mongolia achieved an impressive consolidation of its general government budget. The average overall budget deficit (after grants) was reduced by more than half, from 10.6 percent of GPD during 1997–2000 to 4.4 percent of GDP during 2001–04, and the budget deficit reached a low of 2.2 percent of GDP in 2004. Strong revenue performance more than offset the growth of government expenditures. Rising commodity prices, increasing imports, and the successful introduction of the VAT, were all major contributors to the higher revenues. Meanwhile, overall expenditures increased from 39.3 percent of GDP during 1997–2000 to 43 percent of GDP during 2000-03.

2. The purpose of this chapter is to assess whether the size and composition of the ongoing fiscal adjustment could lead to a permanent consolidation of the budget sufficient to support sustained economic growth over the medium term. The main conclusion reached by the empirical analysis is that the sustainability of current spending levels is subject to substantial risks in the short and medium terms. At any time it may be necessary to adjust expenditures to deal with weather-related calamities and the volatile behavior of commodity-dependent revenues (gold and copper).

3. The remainder of the chapter is devoted to analyzing changes in the size and composition of Mongolia’s general government deficit between 1997–2000 and 2001–04, with particular attention to issues connected with the fiscal adjustment. The breakdown of public expenditures and revenues by category shown in Section B is aimed at assessing the factors contributing to the fiscal balances during these periods. Section C summarizes the main features of Mongolia’s revenues and expenditures. Section D reports recent trends in the budget under alternative definitions of the fiscal deficit, and reviews the outstanding fiscal policy issues. The final section, Section E, presents the conclusions of the exercise.

B. Changes in the Structure of Revenues and Expenditures

4. Mongolia’s very high revenue and expenditure levels make it different from the other PRGF countries in the region. Indeed, at over 40 percent of GDP, spending by the Mongolian government is even higher than that of the CIS-72 countries. (Table I.1).

Table I.1.

Mongolia and CIS 7: General Government Expenditures and Revenues, 2003

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Source: GFS data and Mongolian authorities

5. The composition of revenues changed sharply between 1997–2000 and 2001–04 periods (Figure I.1). Revenues from the mining sector increased substantially in parallel with the rise in world copper and gold prices and the accompanying increase in mining activity. Important reforms such as the VAT were introduced to broaden the tax base, and tax rates were adjusted to bring closer to those in other countries. Overall, the share in total general government revenues of direct taxation, including the corporate income tax (CIT) and the personal income tax (PIT) decreased, while the share of social contributions remained relatively unchanged, and indirect taxes3 increased substantially. Other revenues4 declined (see Figure 1). The increased share of indirect taxes results from the successful implementation of the VAT and the increasing openness of Mongolia’s economy (imports have increased from 50 percent of GDP in 1997 to almost 70 percent of GDP in 2004.)

Figure I.1.
Figure I.1.

Government Revenue by Category,

(Percent of total)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A001

6. The composition of total expenditures has also undergone significant changes (Figure 2). The composition of spending has shifted toward current spending in recent years. Between 1997–2000 and 2001–04, current expenditures increased from an average of 27 percent of GDP to 31.5 percent, due to increases in real wages and pensions and an upsurge in expenditures for other goods and services. During the same period, capital expenditures declined from an average of 12.4 percent of GDP to 11.5 percent, reducing their share in total expenditures from 35 percent to 26 percent. Transfers to pension funds accounted for 18 percent of expenditures during 2001–04, up from 11 percent during 1997–2000. The shares of social spending and non-discretionary interest spending remained relatively unchanged, but social spending is expected to show an increase starting in 2005 due to the government’s child allowance initiative.

Figure I.2.
Figure I.2.

Government Expenditure by Category

(Percent of total)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A001

C. Main Features of Mongolia’s Tax System and General Government Expenditures

7. Mongolia’s total revenue collection compares favorably with those of other countries at similar levels of development. The revenue productivity of some taxes, especially the VAT, is significantly higher than that of many other developing countries, yet tax rates are broadly in line with other countries in the region, and lower than those of many developing countries (Table I.2). This high revenue productivity stems partly from the broadness of the tax base and the efficient functioning of the tax and customs administrations. It also reflects a significant amount of cascading under the VAT, a personal income tax threshold that is substantially lower than in many developing countries, and the fact that the base of the enterprise tax is ill-defined compared with the standard in many countries.

Table I.2.

Mongolia and CIS Countries: VAT and CIT Rates

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Sources: International Bureau of Fiscal Documentation (IBFD), “Taxation and Investment in Central and East European Countries,” (Loose-leaf: Amsterdam), Corporate Taxes 2003-2004, Worldwide Summaries (Pricewaterhouse Coopers); and “Corporate Tax Rate at a Glance” (Deloitte).

8. Accounting for 24 percent of total revenues, the VAT represents Mongolia’s most important single source of tax revenue (Table I.3). 5 VAT revenues increased by 3 percent of GDP during 2001–04, compared to 1997–2000. The VAT has a relatively broad base, a single positive rate, and a zero rate for exports. The substantial rise in import levels, together with the increased VAT rate, accounts for this performance. At 60 percent, the revenue productivity of Mongolia’s VAT is higher than the OECD average of 41 percent.6 However, this high productivity level is partly due to a failure to pay refunds appropriately.

Table I.3.

Mongolia: General Government Revenues by categories, 1997–2000 and 2001–04

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Sources: Ministry of Finance; and Fund staff estimates

9. The CIT is Mongolia’s second most important revenue source, accounting for some 12 percent of total revenues. During 1997-2000 and 2001-04, CIT payments remained constant at 4.5 percent of GDP. However, the composition of CIT payments has changed dramatically. In particular, CIT payments by the Erdenet Copper Mine (A Mongolian-Russian joint venture) increased from 1 percent of GDP, on the average, during 1997–2000 to 1.7 percent of GDP during 2000–04, in parallel with the rise in world prices for copper. But the CIT payments of other enterprises declined from 3.5 percent of GDP to 2.8 percent, reflecting in part the authorities’ reduction of the top rate for CIT from 40 percent to 30 percent at the end of 2003.

10. The revenue yield from PIT is relatively high for a country at Mongolia’s stage of development. The combined revenues from PIT and social security contributions amounted to almost one-fifth of total revenue during 2001–04. Of this, social security contributions accounted for around 12 percent. In line with the increase in incomes, PIT revenues almost tripled between 1997 and 2004 to reach 2.5 percent of GDP. More than 80 percent of PIT is collected from wages and salaries.

11. Excise taxes account for around 10 percent of all revenues. During 2001–04, the ratio of excise revenues to GDP increased by 1 percent of GDP over 1997–2000. Increases in the consumption of oil, domestically produced vodka, and imported beer accounted for most of this increase, rather than an increase in rates. Mongolia has a low, uniform import duty rate of 5 percent, and the revenue yield of import taxes is about 2 percent of GDP.

12. In parallel with the increase in mining activity and world prices for copper and gold, royalty revenues increased to 1.4 percent of GDP in 2004, up from 0.4 percent of GDP in 1997. Similarly, revenue from mining exploration and license fees grew from almost none in 1997 to 0.7 percent of GDP in 2004. The increases in mining activity and the associated revenues suggest that the current minerals sector tax regime is not acting as a significant disincentive to investors.

Expenditures

13. Between 1997–2000 and 2001–04, the ratio of expenditures to GDP increased by 3.7 percentage points of GDP. This increase was mainly driven by the effect of increasing current expenditures on wages, transfers, and goods and services.

14. Mongolia’s spending on other goods and services is relatively high, partly due to overlapping and redundant government activities. Between 1997–2000 and 2001–04, expenditure on goods and services increased from an average of 11.3 percent of GDP to 13.3 percent. The relatively high level of spending on other goods and services is partly due to specific characteristics of Mongolia. Long and often very severe winters generate high costs for heating and maintenance (the heating season lasts 8 months) while providing public services to small population centers in remote regions is expensive. However, the high level of spending also reflects widespread inefficiencies, related to the government continuing to perform functions that are duplicative in a market economy.

Table I.4.

Mongolia: General Government Expenditures by Categories, 1997-2000 and 2001-04

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Sources: Ministry of Finance; and Fund staff estimates

15. Mongolia currently spends around 12 percent of GDP on capital projects and net lending. However, its investment decisions are not guided by a comprehensive strategy. Lending decisions are often made by cabinet outside the normal budgetary process and on an ad hoc basis. The government extends credits to organizations and students many of whom have no intention and no incentive to service the loans. Even profitable organizations are in arrears to the budget for on-lent loans. Because government lending is not subject to hard budget ceilings, it is often abused to circumvent the budget appropriation process.

16. Between 1997–2000 and 2001–04, transfer payments increased from an average 6.8 percent to 8.1 percent of GDP, and the share of transfer payments in overall expenditures likewise increased from 17 percent to 20 percent. This increase is mostly due to pension payments. The pension system is running deficits of almost 2 percent of GDP in spite of highly favorable demographics. This is due to low retirement ages, a limited contribution base, and a minimum pension that is high relative to the average wage. High contribution rates are needed to support such a system, but this will hamper private sector development. To solve these risks to the viability of the pension system in the short and medium terms will require a package of comprehensive reforms, which should include increasing retirement ages, changing the benefit formula, broadening the base, and improving the administration of social contributions.

17. Spending on social assistance has been steady at around 1.2 percent of GDP through 2004, but these expenditures are expected to double in 2005 and onwards. This is mostly due to the planned introduction in 2005 of a new child allowance scheme, but increases in other benefit levels have also played a part. In 2005, the government established a new child allowance to poor households with three children or more (so-called “child money”), and afterwards extended this allowance to all poor households with children. Families are to receive a monthly benefit of Tog 3,000 per month for each child. This joins the government’s support for poor and vulnerable groups, which takes the form of a patchwork of poorly targeted social benefits. To rationalize the system of social assistance, it will be key to reduce the number of benefits while developing mechanisms for accurately channeling the scarce government resources to the most needy.

18. Mongolia’s spending of over 8 percent of GDP on the civil service is too high and crowds out other expenditures. Containing the public sector wage bill will be critical for maintaining short-term fiscal discipline and medium-term fiscal sustainability. Public sector employment remains high, accounting for 14 percent of the working population and civil service salaries are very compressed. Implementing changes in the civil service will be very difficult, however, given the very limited scope for civil servants in remote regions of the country to find alternative employment. Civil service employment is seen as a social good and in some soums (local centers) it is the only source of employment.

D. Trends in Fiscal Deficit

19. Mongolia’s budget deficit was cut by more than half between 1997–2000 and 2001–04, mainly through increases in revenue. The average overall budget deficit (after grants) was reduced from a historically high level 14.3 percent of GDP in 1998 to 2.2 percent of GDP in 2004.

20. The magnitude of the fiscal consolidation can be observed in the primary fiscal deficit. The fiscal deficit (excluding interest payments) shows a steep decline produced by the strong revenue performance. The primary deficit fell from 8.7 percent of GDP during 1997–2000 to only 3 percent during 2001–04. The primary deficit reached a low of 1 percent of GDP in 2004. During these periods, revenues increased by almost 10 percent of GDP and more than offset the increase (of 4.2 percent of GDP) in non-interest expenditures.

Table I.5.

Mongolia: Trends in Fiscal Deficit 1997-2004

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Sources: Ministry of Finance; and Fund staff estimates and projections

22. Revenues from copper and gold account for a sizable share of total revenues (Figure 3). The share in total revenues of direct revenues from gold and copper has increased from 6.2 percent during 1997–2000 to 6.8 percent during 2001–04. The rise in world copper and gold prices has increased this ratio to more than 11 percent in 2004, and it is expected to reach 13 percent in 2005. The revenues from gold mainly consist of royalty payments, and have therefore been increasing in line with increases in mining activity and the price of gold. When the deficit is measured by using trend prices rather than actual prices for copper and gold, the result is a deficit close to the overall deficit, with exception made for 2004, when world copper prices increased substantially over previous years. In 2004, the deficit calculated with trend prices for copper and gold would have been 2 percent of GDP higher than the actual deficit.7 When dividends from Erdenet are included into this calculation with the assumption that the company will be disbursing its dividends fully, the deficit would have been higher by more than 3 percent of GDP.

Figure I.3.
Figure I.3.

Revenues from Mining Sectors, 1997-2004

(Percent of total revenue)

Citation: IMF Staff Country Reports 2005, 400; 10.5089/9781451826883.002.A001

23. While the windfall from the high level of copper prices could continue for a number of years to come, the government should try to accumulate financial assets during the period of high copper prices, so that it can maintain its expenditures when copper prices decline. Erdenet’s CIT payments have been increasing in line with copper prices, but the company has not been distributing in full to the government its share of the profits. For example, not until 2005 did the government receive a sizable portion of the profits earned in 2003 (0.8 percent of GDP). Assuming that Erdenet will retain 10 percent of its after-tax profits, and will pay dividends to its shareholders on time (51 percent going to Mongolia and 49 percent to Russia), it is possible that by 2011 the Mongolian government could accumulate approximately 10 percent of GDP from dividend payments alone.

24. The sustainability of Mongolia’s current spending levels is subject to substantial risks in the short and medium terms. Expenditures may have to be adjusted at any time in response to weather-related calamities and the volatile behavior of commodity-related revenues (gold and copper). In addition, the political process adds to the short-term pressures on government spending. Pre-election promises to significantly increase social protection expenditures, and lobbying pressures on parliamentarians to increase investments in their constituencies outside the normal budgetary process, have weakened the macro-fiscal framework. A reduction in the tax burden may be needed in the medium term, and would require that spending be reduced as well. In addition, the upward trend of pension system deficits casts doubt on the sustainability of the present social security arrangements.

E. Conclusion

25. During 2001–04, Mongolia underwent an unprecedented large fiscal consolidation. The consolidation was achieved through the successful introduction of new taxes, an increase in foreign trade, and an overall broadening of the tax base. At 39 percent of GDP in 2004, Mongolia’s revenue effort compares favorably with those of countries at similar levels of development. The revenue productivity of taxes, especially the VAT, is significantly higher than that of many other developing countries, despite the fact that Mongolia’s tax rates are broadly in line with, or lower than, rates elsewhere in the region.

26. The government will have to reduce spending before it can cut taxes. At over 40 percent of GDP, the Mongolian government’s spending is high in comparison with that of the transition countries. And despite the large reduction in the budget deficit, expenditures have largely escaped adjustment. Rapid revenue growth has allowed overall expenditures, and especially current expenditures to increase substantially. Excessive spending requires high taxation and borrowing that reduce the resources available to the private sector, and increases the incentives to flee the formal sector. In view of the already high revenue-to-GDP ratio, limiting the deficit to a prudent level will mainly depend on reducing primary spending.

27. The size of the adjustment is robust to alternative definitions of fiscal balance, but Mongolia’s vulnerability to terms-of-trade shocks and natural disasters represent additional risks that have fiscal implications. A large decline in commodity prices, especially gold and copper prices, would severely undermine Mongolia’s fiscal position. Large revenue shortfalls would emerge as royalties and corporate income tax contributions and dividend payments from major SOEs begin to dry up. Therefore present fiscal policy should aim at accumulating assets during the present period of high copper prices in order to increase its ability to maintain expenditures and reduce the volatility of fiscal deficits when prices decline. Failure to adopt such a fiscal strategy could require substantial fiscal adjustment or lead to explosive debt dynamics as soon as copper prices decline. Also, it will be recalled that in the year 2001, Mongolia suffered a series of natural disasters. A summer drought and a harsh winter killed millions of farm animals, worsening the rate of poverty in rural communities and forcing the government to provide additional relief. The government needs to pursue prudent fiscal policies when revenues are robust, in order to preserve the ability to provide relief during disasters without causing macro imbalances.

1

Real growth was thus equally substantial, as inflation averaged about 6 percent over the same period.

1

This chapter was prepared by Selim Cakir.

2

The CIS-7 is an especially relevant comparator group because it closely resembles Mongolia in a number of respects, including Mongolia’s recent (and in some respects still on-going) transition from central planning to a market economy.

3

VAT, customs duties, and excise taxes.

4

Including non-tax revenues, grants, property taxes, royalties, petroleum tax and others. The largest single contributor was Erdenet Copper Mine dividends, but there have been fairly low is recent years, in 2005 this dividend rose sharply.

5

The VAT was introduced in 1998 with a single rate of 10 percent, which was raised to 15 percent in 2001.

6

Revenue productivity is calculated as total VAT revenue as a percent of GDP divided by the VAT standard rate.

7

The trend prices were calculated by using the Hodrick-Prescott filter. Erdenet’s dividend payments were excluded from this calculation because the correlation between copper prices and Erdenet’s payments has been very weak.

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Cover IMF Staff Country Reports
Mongolia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 2005: Issue 400
Publisher:
International Monetary Fund
ISBN:
9781451826883
ISSN:
1934-7685
Pages:
81
DOI:
https://doi.org/10.5089/9781451826883.002

Government Revenue by Category,

(Percent of total)

Government Expenditure by Category

(Percent of total)

Revenues from Mining Sectors, 1997-2004

(Percent of total revenue)