Mongolia
Ex Post Assessment of Longer-Term Program Engagement

This paper discusses key findings of the Ex Post Assessment of Longer-Term Program Engagement for Mongolia. The paper assesses Mongolia’s progress in implementing its transition to a market economy, economic stabilization, and reform programs supported by the IMF during 1991–2004, and draws lessons for future IMF involvement. Assessment reveals that macroeconomic stability has been broadly achieved in Mongolia, with growth restored and inflation generally under control. Much of the state structure has been privatized or updated, and the economy and export base have diversified. However, the economy still remains vulnerable to shocks.

Abstract

This paper discusses key findings of the Ex Post Assessment of Longer-Term Program Engagement for Mongolia. The paper assesses Mongolia’s progress in implementing its transition to a market economy, economic stabilization, and reform programs supported by the IMF during 1991–2004, and draws lessons for future IMF involvement. Assessment reveals that macroeconomic stability has been broadly achieved in Mongolia, with growth restored and inflation generally under control. Much of the state structure has been privatized or updated, and the economy and export base have diversified. However, the economy still remains vulnerable to shocks.

I. Introduction

1. This paper assesses Mongolia’s progress in implementing its transition to a market economy, economic stabilization, and reform programs supported by the Fund during 1991-2004 and draws lessons for future Fund involvement. Mongolia is a low-income transition economy; prolonged program engagement by the Fund to assist in tackling the formidable economic and structural challenges can thus be expected.

2. The Fund-supported programs aimed to assist the transition from a centrally planned command system closely linked to the Soviet Union to a market-based economy, and later the tackling of poverty. Critical for such programs’ success would be the establishment of appropriate institutions to cope with the transformation and operate a market economy while reducing vulnerability to shocks (Box 1). Since the break with the past in 1991, Mongolia has clearly changed significantly. Classified as a “mature stabilizer” by the Fund, macroeconomic stability has been broadly achieved with growth restored and inflation generally under control, much of the state structure has been privatized or updated, and the economy and export base have diversified.2 On the other hand, the economy remains very vulnerable to shocks, some key institutions are still functioning poorly, there are few employment opportunities and progress in reducing poverty has been limited.

II. Initial Conditions

3. In the 1980s, Mongolia’s economic structure constituted a formidable obstacle to transformation. Competition in all economic spheres was limited—state enterprises maintained monopoly control over key production activities, financial intermediation went through the State Bank, and almost all capital assets, including the housing stock, were owned by the government. Trading ties were with the other Council for Mutual Economic Assistance (CMEA) member countries, principally the Soviet Union, with which Mongolia had built up a very large negative balance in the decades leading up to the transition. Moreover, in the late 1980s, CMEA members were undergoing fundamental changes, disrupting the supply of key imports and demand for Mongolian goods.

4. However, with abundant natural resources, Mongolia was reasonably well positioned to translate economic reform into growth and higher living standards. About 80 percent of the country’s land was suitable for extensive animal husbandry, and there were large deposits of coal, iron, tin, copper, gold, silver, other metals and semiprecious stones, while petroleum exploration was initiated in the late 1980s. Nonetheless, the remote geographic location was a major barrier to trade diversification, while necessitating relatively large investments to build the infrastructure for domestic economic integration as well as connecting the country with its trading partners. The agricultural sector was confined to low intensity livestock rearing and crop cultivation limited by harsh weather conditions. The results were low incomes and other indicators of extensive poverty.

Mongolia: Fund-Supported Programs, 1991-2005

Since Mongolia became a member of the Fund in 1991, it had four financial arrangements with the Fund. Mongolia: Arrangements with the Fund

Mongolia: Arrangement with the Fund

article image
Bold and underlined numbers: purchases made.

An initial stand-by arrangement laid the foundation for an ESAF arrangement at a time when Mongolia’s was not yet eligible to use concessional resources. The arrangement was envisaged to have one mid-term review, which was completed. The arrangement was extended to end-1992, but the envisaged second review was not completed.

The program supported by the first ESAF arrangement (1993-96) was acknowledged as ambitious at the outset. After the previous SBA had gone off track, an “indicative program”—effectively a staff-monitored program—with quantitative targets in December 1992 and March 1993 laid the basis for approval of the first annual ESAF arrangement. The mid-term review was completed on time, but the second annual arrangement was approved with some delay, while its mid-term review was completed only with a delay of one year.

uA01fig01

Outstanding Fund Credit and Disbursements

(In millions of SDR)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

The second ESAF (since 1999 PRGF) arrangement (1997-2000) concentrated a strong reform effort on the banking system. To ascertain the authorities’ ownership, as well as to re-establish a policy track record following the expiration of the previous arrangement and slippages in policy implementation, it contained a very large number of structural conditions, mainly prior actions, of which the focus concentrated on the financial sector. However, despite the authorities’ strong initial commitment, delays occurred in the completion of the mid-term review of the first annual arrangement. The approval of the second annual arrangement (with a small reduction in access) was delayed even further, and the mid-term review of that arrangement was completed only in 2000, shortly before the commitment period expired, and the arrangement allowed to lapse.

The PRGF arrangement (2001-2005) started more than a year after the previous arrangement had lapsed. It focused on fiscal consolidation, as the public debt level had risen precipitously in previous years. However, only the first review and second reviews were completed, with a year’s delay in 2003. At that time, the arrangement was extended, but no further reviews were completed despite broad achievement of the macroeconomic objectives as governance concerns were highlighted.

5. The transition following the democratic elections in 1990 was also eased by reforms initiated earlier under the communist regime. From the mid-1980s onwards, work started on rationalizing some ministries, public sector enterprises afforded some autonomy, monopolies in state trading eliminated, administered prices raised and in some cases freed, a simple two-tier banking system carved out of the monolithic state bank, new business laws promulgated, tax administration modernized, and the exchange rate significantly adjusted. These actions set the scene for the major structural reforms from 1991 onward that were supported by the Fund arrangements.

III. Evaluation of Experience Under the Fund-Supported Programs

6. The programs supported by the Fund differed in their emphasis, in line with evolving stages of transition, the need to address emerging challenges, and the priorities of different governments. There was much initial enthusiasm for reform on the part of the authorities, with the Fund at times even trying to slow the process so as to allow institution building to catch up. In the immediate aftermath of the early reforms and the withdrawal of Soviet assistance, the focus was on macroeconomic stabilization. To avoid too strong strains on the nascent political system, a cautious approach to economic liberalization was chosen. The decision to proceed gradually, while contributing to a relatively smooth adjustment, foreshadowed later lapses in performance, often associated with elections and frequent government changes (Box 2). Equally, the delay in some fundamental market reforms may have impeded growth and embedded distortions in the economy that developed.

7. Mongolia’s transition has been less painful than in many other post-communist economies, particularly compared with CIS countries (Box 3). The initial output loss was relatively small, though growth has lagged that of the more successful Eastern European transition economies since 1993. Inflation proved harder to control than initially expected and remained above 10 percent for seven years, but, again, compared with other transition economies, performance has been equal or better. Trade has been radically reoriented, from Russia to China and the United States, although Russia continues to provide all oil.

8. Fiscal policy made a significant contribution toward macroeconomic stability, with strong revenue performance but the public sector remains relatively large. The overall fiscal deficit was reduced from about 11 percent of GDP in 1992 to about 2 percent of GDP in 2004. However, a direct unavoidable consequence of the transition strategy was a rapid accumulation of external debt. Government revenue, at almost 40 percent of GDP, is higher than other transition economies, and in particular, most low-income countries. Public investment is also relatively high, but does not appear to have crowded out private investment—principally in mining—which, at about 20 percent of GDP, is at a par with the more successful transition economies. Public consumption levels are high but similar to other transition countries, as the authorities strove to provide social services and a large civil service. Control over aggregate expenditure was inadequate, but much of the increase was clearly part of the strategy of the various governments, which the Fund programs were unable to curb through understandings or conditions.

Mongolia: Political Developments in Mongolia, 1991-2005

Until 1990, the Mongolian Government was modeled on the Soviet system; only the communist party--the Mongolian People’s Revolutionary Party (MPRP)--officially was permitted to function. Mongolia’s first multi-party elections for a People’s Great Hural were held on 29 July 1990. The MPRP won 85 percent of the seats.

In 1992, a new constitution entered into force establishing Mongolia as an independent, sovereign republic—the new constitution created a unicameral legislature, the State Great Hural. The president would be elected by popular vote rather than by the legislature as before, for a 4-year term and limited to two terms. The president is the head of state, commander in chief of the armed forces, and head of the national security council. The government, headed by the prime minister, has a 4-year term. Since that time, the predominant party in Mongolia has been the MPRP. The MPRP’s policies have favored market reforms, but with a strong role for the state sector. The main opposition party has been the Democratic Party, which also favors market reforms, but has closer links to the private sector. In general, there are no sharp political differences.

After the parliamentary elections of 1996, the Democratic Party controlled a governing coalition until 2000.

From 2000 to 2004 the MPRP was back in power, but results of the 2004 elections required the establishing of the first ever coalition government in Mongolia between the MPRP and the renamed Motherland Democratic Coalition (MDC), who obtained 37 and 34 seats respectively in the Great Hural, with 5 seats for other parties.

As part of the coalition agreement, the Prime Minister is currently Elbegdorj of the Democratic Party but the position is to be passed on to the MPRP in 2006.

In the presidential election of May 2005, the Speaker and former Prime Minister, Nambaryn Enkhbayar (MPRP) was elected to succeed Natsagiyn Bagabandi (also MPRP) as President.

9. Public debt rose to about 100 percent of GDP, higher than most comparators, but appears broadly sustainable. The debt is almost all concessional, implying a still-high NPV of external debt of about 60 percent of GDP, or 110 percent of exports. At the same time, Mongolia has been able to extinguish its enormous debt carryover from the CMEA period. In a recent international sovereign rating credit analysis, Mongolia was rated B+ by Fitch, better than most CIS countries and other low-income economies. Prudent macroeconomic policies, with market-oriented reforms, and reform of expenditure policies, would permit the overall fiscal deficit to stabilize at about 3 percent of GDP while the debt ratio would gradually decline.

Mongolia: Comparison with Other Transition Countries

Mongolia’s economic history and geographic position suggests comparisons with ex-soviet countries of Central Asia. However, Mongolia opted for a relatively cautious pace of transition and reforms in a democratic political environment, not unlike slow reformers in Eastern Europe, e.g. Bulgaria and Romania, suggesting that a comparison with the experience of some Central and Eastern European countries is useful.1 A comparison with the Chinese Autonomous Region of Inner Mongolia is instructive as well, due its geographic proximity.

Mongolia has not yet fully regained its pre-reform per capita output. Nonetheless, it compares favorably with other transition countries in the region (with the exception of Kazakhstan and Turkmenistan, which have seen large gains in per capita GDP due to rapidly rising oil and gas production), and more broadly the ex-Soviet Union, with the notable exception of the Baltics, whose output has far surpassed pre-reform levels.

However, Mongolia’s output trough in the initial reform shock was remarkably shallow; only Bulgaria and Romania had comparably small output losses (though a second crisis in 1997/98 in Bulgaria led to a further decline in GDP). This is particularly significant as Soviet assistance before the transition amounted to roughly 30 percent of GDP.

The subsequent output growth has also been weaker than in other transition countries, possibly due to the gradualist approach to macroeconomic and structural reforms. Annual output growth has averaged about 3 percent since 2000, compared with 7¾ percent in the Baltic countries, 5¾ percent in Bulgaria and Romania, and 6½ percent in Tajikistan and Kyrgyzstan. Only Uzbekistan continues to grow slower.

The post-reform price shock was more subdued in Mongolia than elsewhere. While the programs supported under the SBA and ESAF I arrangements envisaged a more rapid decline in inflation, Mongolia” performance was still remarkable. Only the Baltic countries brought inflation under control as rapidly as Mongolia, though not without an average spike of over 800 percent in 1992, far above Mongolia’s high point of 268 percent in 1993. Further into the reform process, Mongolia’s inflation has been comparable to other transition economies.

The role of the state remains comparably prominent. General government revenues account for about 40 percent of GDP, compared with about 30-35 percent in Eastern European comparators, and an average of 20 percent in Central Asian CIS countries. With public consumption broadly comparable to other transition economies, public investment is significantly larger in Mongolia, financed primarily extent from abroad. Correspondingly, public external debt has risen to over 90 percent of GDP (the net present value has been contained at about 60 percent of GDP). This stands in sharp contrast to the Baltic countries, where the average external debt of almost 70 percent of GDP is owed almost entirely by the private sector. In CEE countries, external debt has been reduced during the reform period.

uA01fig02

Public Investment

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

uA01fig03

Consumer Prices

(Index 1990 = 1)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

uA01fig04

Revenue

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

uA01fig05

Real GDP per Capita

(Index 1989 = 100)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

The high level of public investment has not constrained private investment, which has reached levels comparable to Eastern European and far ahead of Central Asian transition economies.

Mongolia is more open to trade than other transition economies, including the Baltics. The ratio of exports to GDP is the highest of the comparator countries; only Estonia reaches the same level. While this is in part the result of favorable terms of trade, export volumes have held up well. In addition, the geographic reorientation of trade from Russia to China and the United States exceeded that experienced in Eastern Europe.

Mongolia and neighboring Inner Mongolia share some similarities in ethnic background and economic structure. Seventeen percent of Inner Mongolia’s population are Mongols, who have the same ethnic background as about 90 percent of Mongolia’s population (more Mongols live in Inner Mongolia than in Mongolia). In 2003, the agricultural sector accounted for about 20 percent of both economies’ GDP, and animal husbandry, with wool and cashmere as “flagship” products, has a strong tradition. Industries have grown up mainly around natural resources: copper and gold in the case of Mongolia; coal and iron ore in Inner Mongolia.

Since 1991, bilateral trade between Mongolia and Inner Mongolia has grown fast. A railway built in 1958, which links Russia and Lanzhou in China, connects their industrial centers and has supported trade. The total value of Mongolia’s trade with Inner Mongolia has increased from $24 million in 1991 to $222 million in 2003. In that year, Mongolia’s imports from Inner Mongolia were $50 million, while exports to Inner Mongolia amounted to $172 million, 27½ percent of Mongolia’s total exports.

However, economic growth of Mongolia lagged behind that of Inner Mongolia. From 1994 to 2003, Mongolia’s annual real GDP growth has averaged 3.3 per cent, compared with 10.8 percent in Inner Mongolia. By 2003, Mongolia’s per capita GDP was $513, only half of Inner Mongolia’s $1,091. An important factor for this outcome has been significantly larger amounts of foreign and domestic investment received by Inner Mongolia.

uA01fig06

External Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

uA01fig07

Private Investment

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

uA01fig08

Exports

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

1 The data underlying the following comparisons should be interpreted with caution given the transition of economic concepts, exacerbated by the difficulty of reliable measurement, and lack of statistical capacity.

10. Overall, Fund involvement appears to have been an important element in assisting the authorities” reform efforts, but ownership wavered.3 The Fund provided a key framework for reform as well as technical expertise that was not otherwise available. However, more than once the easing of financing constraints because of increasing export prices led to programs going off-track. On the other hand, the overloading of programs at a later stage with multiple goals, while understandable when the need for reform is large, appeared to make it more difficult for the government to focus on critical elements.

Figure 1.
Figure 1.

Mongolia: Important Economic and Political Events

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

A. The Stand-By Arrangement—1991–92

11. The Stand-By Arrangement approved in 1991 spelled out the medium-term strategy that was to guide it and the subsequent ESAF arrangement. Its emphasis was to restore macroeconomic stability after the collapse of the CMEA system, and then build the institutional base for a market economy, focusing on privatization and the strengthening of institutions enabling indirect macroeconomic management.

12. The main immediate goals of the Stand-By Arrangement were to contain the decline of output and bring down inflation. To this end, the program aimed at restoring financial discipline, both in the fiscal and monetary sectors, as well as enabling the price mechanism to play its role in the allocation of resources. To support monetary control, guidelines to restrict automatic access to credit by state enterprises were to be developed, and ceilings on credit to commercial banks were introduced, but both measures proved insufficient. Finally, devaluation of the togrog contributed to restoring external viability.

13. Transition proved harder than expected. Growth over 1991-92 was broadly in line with projections, but inflation, which had been expected to slow down by end-1992, shot up briefly to 200 percent. The failure to contain inflation more decisively—partly because of monetary expansion needed to support the ailing state enterprises—caused considerable concern, but this performance proved better than in many other transition countries, where inflation remained higher for longer periods, and the cumulative output contraction was larger. Nonetheless, by the end of the arrangement in December 1992, the program was severely off track, while also because some structural measures were delayed due to a change in government.

uA01fig09

Projections: Consumer Price Index

(Percent change)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

B. Enhanced Structural Adjustment Facility I—1993–96

14. While the impact of inflation had been comparatively benign, there was, nonetheless, a need to bring it down, lest inflationary expectations became entrenched. As excessive credit to state enterprises had been a major source for monetary expansion, the indicative program in September 1992-March 1993 set ceilings on such credit. This helped set the stage for a reduction of inflation—though again considerably slower than projected.

15. Approved in June 1993, the program supported by the first Enhanced Structural Adjustment Facility arrangement (ESAF I) was considered ambitious. It called for restoration of positive economic growth and reduction of inflation to single digits by 1995. In addition, the program projected a substantial recovery of the almost-depleted reserves and the elimination of the external arrears that had accumulated. Substantial amounts of external (concessional) support were expected to be forthcoming, leading to a projected external debt buildup to a peak of over 100 percent of GDP by 2000. Apart from completion of price and more general economic liberalization, and further privatization, a core element of the structural reform agenda was the introduction of instruments for indirect monetary management.

16. Overall, performance under ESAF I was mixed. After an auspicious start, implementation ran into difficulties as financial restraint weakened in 1995 for reforms. Buoyant copper prices eased financing constraints. However, the program NIR targets, which included adjustments for high copper prices, were missed by wide margins. Consequently, the envisaged reduction of inflation to single digits was not achieved. On the other hand, the goal of restoring output to 90 percent of its pre-reform level was almost met. On the structural side, after some success in the introduction of indirect measures of monetary control (notably through central bank bills), the focus shifted back somewhat to reform of public enterprises, as problems in this area—including losses by public utilities—proved more persistent than initially thought.

C. Enhanced Structural Adjustment Facility II—1997–2001

17. By 1996, the reversal of copper prices had led to a slowdown of economic growth, a widening of the budget and current account deficits. Inflation also picked up. Banks’ reserves were depleted, non-performing loans increased, and banks became increasingly illiquid as public confidence waned, prompting the central bank to provide extensive credit to keep the financial system afloat.

18. The scope of the program supported by the next three-year arrangement (ESAF II), approved in mid-1997, was significantly broader than under the previous arrangement. A new government, elected in mid-1996, focused on encouraging the private sector. The program focused on achieving single-digit inflation in its first year, through a re-tightening of financial policies. On the structural front, the program concentrated on financial sector reforms in the aftermath of the banking crisis. However, the program also called, in addition to tax reductions and zero-rating of import duties, for large-scale privatization, the elimination of remaining price controls, modifications to the legal system to strengthen property rights, and a restructuring of the education system. Fund conditionality did not cover all these areas.

19. As with ESAF I, only two annual arrangements were completed. The strong initial commitment of the authorities was undermined by a series of political crises, while spillovers from the Asian Crisis had a negative impact on output, export prices, and banks’ balance sheets. Many of the structural measures agreed under the second annual program in 1999 were not implemented—in particular, actions aimed at privatizing ailing state banks and public enterprises. While the program was brought back on track by early 2000, allowing completion of the mid-term review, policy implementation again faltered in the run-up to elections in mid-2000. The Fund’s counterparts during that period now are of the view that the political climate prohibited a sufficiently medium-term perspective.

20. Overall, while the program accommodated some of the adverse external circumstances, its main macroeconomic achievement was preserved: inflation fell to below 10 percent in 1998 and has remained there until very recently. However, the structural reform agenda proved overly ambitious. While progress was made in bank restructuring—a potentially large crisis was averted—and further privatization and liberalization, overall results fell short of expectations. A relatively high proportion of structural conditions were not fulfilled on time or at all.

D. Poverty Reduction Growth Facility (PRGF)—2001–05

21. When the PRGF arrangement was approved in September 2001, fiscal sustainability had moved to the foreground. Inflation had finally been contained, monetary control improved, and fiscal deficits had largely been financed from abroad. External debt, albeit concessional, had surpassed 90 percent of GDP in 1999. Although that ratio was lower than earlier envisaged and fell to 88 percent in 2000, the new PRGF arrangement focused on restoring fiscal sustainability, necessitating a modest reduction of the fiscal deficits.

uA01fig10

Projections: External Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

22. The structural aspect of the program re-focused on the Fund’s core areas of responsibility. Conditionality was initially aimed at improving fiscal management, but shifted, at the time of the first and second reviews, to the financial sector to strengthen the management and supervision of the banking system. The PRGF-supported program also, for the first time, emphasized the goal of poverty reduction explicitly, though the policy content in the Fund’s core areas of responsibility was not noticeably different from previous programs. With the National Poverty Alleviation program (NPAP) of 1994, the authorities” approach to poverty reduction had already begun to move away from income transfers and social safety nets to human development (Box 4).

23. Strong economic performance helped achieve most of the macroeconomic goals of the program, but the arrangement could not be completed. The easing of financing constraints due to buoyant export prices led to disagreements between the staff and the authorities on the use of this windfall and a delay in the completion of the first review. More recently, the arrangement was held up by governance concerns. Questions focused on the independence, financial integrity, and safeguards of the Bank of Mongolia (BOM), the relationship between the BOM and the government, and the transparency of the settlement of the pre-1991 Russian debt.4 The latter focused on both the basic transaction—an upfront payment of $250 million in December 2003 to the Russians via a third country intermediary—and the full impact of the financing of the transaction on the BOM.5

uA01fig11

Projections: Overall Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

Mongolia: The Role of Poverty Reduction Strategies

Mongolia developed a comprehensive strategy with the direct and explicit aim of reducing poverty only during the most recent Fund-supported program. Under both preceding ESAF arrangements, the authorities” approach to poverty reduction focused on income transfers and social safety net programs. Correspondingly, the Policy Framework Papers guiding ESAF I and II laid out the macroeconomic and structural problems faced by the country and the policies to address them, but did not put the reduction of poverty directly at the center of their strategy. In 1994, the authorities launched a National Poverty Alleviation Program (NPAP), with financial support from the UNDP, the World Bank, the AsDB, and bilateral donors. Within the NPAP, small scale projects were undertaken to, inter alia, create temporary and permanent jobs, support basic education, enhance basic medical services for the rural population, and strengthen the development of social infrastructure.

Poverty reduction became a more central goal of economic policy and was fully integrated with macroeconomic policies with the Interim Poverty Reduction Strategy Paper (I-PRSP), finalized in 2001. In 2003, a full PRSP was completed as the Economic Growth Support and Poverty Reduction Strategy (EGSPRS), incorporating to some extent the Millennium Development Goals. The government has set its own goals for achievement by 2015, committing itself to (i) reduce the number of people in extreme poverty by 25 percent by year 2005, and by 50 percent by year 2015, (ii) provide universal primary education to all people and (iii) reduce infant and child mortality by 50 percent by year 2005.

To achieve these goals, the PRSP includes a considerable number of short-term priorities, including deepening of reforms to ensure macroeconomic stability, improving the health of the banking sector, supporting export-oriented industries, regional development, and infrastructure, but also mainstreaming gender dimensions in poverty interventions to promote gender equality. Medium-term policy is expected to be focused on the expansion of sources of economic growth, prioritizing the development of processing industry based on domestic raw materials, mining and extraction, tourism, IT, and infrastructure.

The PRSP benefited from strong participation by sectoral ministries and civil society—and contains correspondingly strong sectoral strategies. It envisages a shift away of the underlying poverty strategy from income transfers to one centered on growth-promoting macro-structural reforms and sustainable human development, and the poverty reduction strategy is based on a credible macroeconomic framework. However, the Joint Staff Assessment (IMF Country Report No. 03/302) identified a number of challenges for its successful implementation, in particular the tension between the goal of fostering private sector-led growth and the government’s commitment to open trade policies on one hand and the interventionist strategy for regional development and promotion of processing industries on the other.

The recently completed EGSPRS progress report, which reflects the endorsement of the current coalition government of the earlier strategy, concludes that the recent high growth has been beneficial but cannot be the basis for substantial employment given its narrow concentration on mining and primary sector industry. The report further highlights high rural poverty. Areas for future increased attention include deepening education sector reform, strengthening delivery of basic health services, improved governance, and establishing a priority regional development framework. The Joint Staff Advisory Note provides suggestions for improved costing and priority setting, and highlights the need for bringing together the various medium-term strategies and guidelines into a single document—the Medium-Term Budget Framework—while enhancing poverty monitoring.

24. Since March 2004 the authorities have continued to report performance relative to the indicative targets discussed during several staff visits. The visits served to maintain a close policy dialogue between the Fund staff and both the former MPRP government and the new coalition government, culminating in the Article IV discussions in June 2005. Macroeconomic performance was generally on track. Attention focused on rising inflationary pressures and possible tax and spending reforms in the context of the favorable external environment and the need for further progress on fiscal sustainability. The existence of a coalition government suggested the possibility for establishing broad-based ownership of the program medium-term objectives and policies. However, with public attention still focused on election promises, only limited progress has been made on this front.

IV. Key Structural Policy areas

25. The transition from a centrally planned to a market-based economy entailed a very large structural reform agenda. In the Fund’s core area of expertise, key reform efforts aimed at modernizing the fiscal system, and establishing a modern, well-supervised financial sector. Closely related to fiscal issues, restructuring and privatization of public enterprises also featured prominently in the transition strategy.

A. Fiscal System

26. An early transformation of the tax system succeeded in mobilizing revenues, which increased by 15 percentage points of GDP. Fund fiscal technical assistance was extensive, complementary to the programs, detailed and very specific. A Value Added Tax (VAT) was successfully introduced and the extractive industry provided an expanding and easily targeted tax base, although very vulnerable to fluctuations in prices of Mongolia’s exports. Despite provision of extensive technical assistance on public expenditure management (PEM), and the authorities” repeated commitments to reducing and controlling spending, the level of expenditures remained high.

Figure 2.
Figure 2.

Mongolia: Fiscal Indicators, 1991-2004

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

Source: Mongolian authorities and IMF staff estimates.
Figure 3.
Figure 3.

Mongolia: Monetary Indicators, 1991-2004

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

Source: Mongolian authorities and IMF staff estimates.
Figure 4.
Figure 4.

Mongolia: Growth and External Indicators, 1991-2004

Citation: IMF Staff Country Reports 2005, 407; 10.5089/9781451826913.002.A001

Source: Mongolian authorities and IMF staff estimates.

27. With considerable Fund technical assistance, the authorities introduced a range of modern taxes. Customs duties were raised in 1991 and the Harmonized System implemented in 1993. Major market oriented taxes, such as the corporate income tax (CIT), the personal income tax (PIT), the sales tax and excises were introduced in 1993, albeit in rudimentary form. The VAT replaced the sales tax in 1998. The authorities progressively broadened the tax base. They also progressively reduced the number of customs duty exemptions granted.6

28. Mongolia’s tax effort and its revenue productivity (especially that of the VAT) compare favorably with those of countries at similar levels of development. However, the tax system continues to exhibit areas for improvement. The base of the CIT limits deductions and has no provision for loss carry forward. The dual rates create economic distortions. The threshold of the PIT is low, bringing too many low-income individuals into the tax net. The high level of social security contributions imposes a relatively high tax burden on labor. The VAT has a significant amount of cascading, mainly because the refund system does not work well and there are many exemptions. The system of tax incentives is distortionary and is not cost effective. Similarly, export taxes on raw materials are inefficient and inconsistent with Mongolia’s open trade policy.

29. Despite Mongolia’s high level of government spending, the quality of government services is often no better than in countries spending less. In the early years, the sheer magnitude of the task of rebuilding the fiscal management structure made it difficult to focus on more than a few issues. The interlinkages between different areas of reform reinforced this difficulty. The Fund programs did promote expenditure reforms but often with little success. There seems to have been insufficient incentive for the authorities to follow through on the key reforms that would often be to the disadvantage of interest groups. Recent World Bank studies point to the lack of citizen access to government information as a key constraint. Where priorities were not clearly outlined, the government may have been overwhelmed by the complexity of the task (and distracted by many other policy challenges). The size of the civil service remains large, its composition skewed in favor of support staff, and wage scales highly compressed. Key concerns include:

  • Repeated commitments by the authorities in Fund supported programs to implement civil service reform were not met.

  • Key elements for successful reform of the pension system—increased retirement age and reduced minimum pension—were not incorporated in the official strategy. Currently, the pension system is not self-financing and has low retirement ages. The contribution base is narrow relative to the coverage, and there are contribution arrears.

  • In education and health—where the very sparse population outside the capital exacerbates the problems—the reforms failed to eliminate structural inefficiencies.

  • Social assistance for the poor and vulnerable is badly targeted: some groups (families with children) receive overlapping benefits while others (herders) get none.

  • Government net lending often circumvents the budget appropriations process and on-lending granted without hard budget constraints.

30. Since 2002, there has been an enhancement of public financial management. With support from the World Bank, the government has implemented the Government Financial Management Information System to allow improved fiscal reporting and control over funds. A key feature of the system is the consolidation of government cash balances into the Treasury Single Account (TSA), introduced in 2003 with Fund technical support. FAD technical assistance also helped improve fiscal reporting and to prepare Public Expenditure Management legislation. Further recent work has focused on internal and external audit control functions and cash management capacity. Unfortunately, there is as yet no expenditure tracking survey to improve efficiency.

B. Public Enterprise Restructuring and Privatization

31. The restructuring and privatization of state-owned enterprises (SOEs) has been a central element of the authorities” reform strategy. It has been driven by two overriding aims: first, the creation of a market economy after the abandonment of central planning and, second, the restoration of financial viability of SOEs. While the withdrawal of the state from small-scale companies was successful, larger-scale privatizations proved problematic. In addition, many companies remaining in public hands were a heavy burden on the budget, in particular the energy sector, despite tariff increases.

32. Privatization began in 1991 with divestment of small enterprises and agricultural assets through a voucher scheme. The use of vouchers for the privatization of medium and large enterprises proved less successful, as the wide dispersion of ownership impeded effective management and the government retained majority ownership of the largest enterprises. The voucher-based privatization program, completion of which was part of Fund conditionality, was concluded by mid-1994, with a delay of about half a year, and accounted for nearly half of state assets.

33. With the voucher privatization completed, the focus shifted to improving the financial position of SOEs and cash privatization. Conditionality during 1994 concentrated on raising utility tariffs, establishing orderly financial relations between the state and public enterprises, and comprised privatization targets. However, the financial position of state-owned enterprises failed to improve sufficiently, in particular in the energy sector. Consequently, the program supported by ESAF II called for further increases in utility tariffs and a more ambitious privatization program. Conditionality covered the key steps, including revenue targets for asset sales. However, progress was again slower than envisaged, with large privatizations delayed and utility price increases insufficient to achieve cost recovery (though conditionality in these areas was met).

34. The PRGF-supported program in 2001 broadened the restructuring effort, in particular through a comprehensive energy sector reform. The latter, designed by the World Bank, included, for the first time, eventual privatization in this sector. In other areas, the privatization of other “most-valued companies” was to be reinvigorated. Not included, however, was the country’s main exporter and revenue-raiser, the Erdenet Mining Corporation, a joint venture with Russia. In line with streamlining policies implemented at that time, the Fund retreated from conditionality in these areas. This may have been a mistake, but more important would have been monitoring of improvements to operations of the non-privatized enterprises.

35. Overall, the strategy of restructuring and privatization of SOEs suffered from three interrelated problems. First, the authorities could have signaled early in the transition the intention to privatize eventually most SOEs; a negative list of enterprises to remain in state hands might have been useful in providing an incentive for enterprises to improve efficiency even before their sale. Second, the legislative and regulatory framework was inadequate. The existence of such a framework, backed by Fund and World Bank conditionality, might also have encouraged the authorities to contemplate earlier the privatization of the energy sector, as proper regulation is a sine qua non for the efficient and equitable provision of this especially important service. Third, the early focus on asset sales may have drawn attention away from operational improvements, including costs. A review of the current income positions of the state enterprises shows clearly that, while the 8 joint ventures (led by Erdenet) have significant net income, most of the other 68 enterprises still in the public sector consistently lose money—in 2004 Tg. 25 billion (1½ percent of GDP).

36. Looking forward, any new Fund-supported program would need to examine clearly the link between the budget and operations of SOEs, in particular the energy sector. While sector reforms are not in the Fund’s core area of expertise, conditionality can be appropriate, where there are direct linkages with the budget. There may be a case for including some enterprises, for instance in the energy sector, in a broader measure of the public sector deficit.

C. Creating a Modern Financial Sector

37. The current Mongolian financial system is quite extensive, including 17 banks, 115 nonbank financial institutions (NBFI) and 300 savings cooperatives (CSC). With foreign currency deposits accounting for 37 percent of broad money, Mongolia is also highly dollarised.

38. All the key elements of MFD technical assistance relevant for Fund arrangements were identified as early as mid 1993. These included technical assistance in the following areas: monetary management; foreign exchange operations; clearing and payments systems; bank supervision; bank restructuring; and legal issues. Although Fund conditionality was little applied in the early years, Fund arrangements pursued and monitored implementation of recommendations on of these issues.

39. However, the banking sector has remained consistently vulnerable—banking crises occurred in 1994, 1996 and 1998/99. Though they were triggered mainly by outside events, a host of factors contributed to and aggravated them: the government or political groups influenced banks” loan decisions, leading to inherited and directed loans; the weak governance structure of banks resulted in connected lending with asset stripping by major shareholders; and banks themselves lacked experience and skills. Furthermore, inappropriate legal settings for enforcement of loan repayments encouraged “intentional bankruptcy” by borrowers. The NBFIs are monitored, but with few resources allocated to their supervision. Meanwhile, the savings cooperatives are not supervised at all and openly ignore legal restrictions. Lastly, the BOM, instead of strictly applying supervision rules, tended to provide emergency credits under favorable terms to the ailing banks.

40. After the serious banking crisis of 1998/99, the government adopted a comprehensive plan to strengthen the banking system. The strategy sought to restructure ailing banks, reduce government ownership, improve BOM’s ability to enforce compliance with prudential regulations, and strengthen market discipline and incentives for sound bank management. Given its importance, the financial sector accounted for 8 prior actions, 8 performance criteria and a further 12 structural benchmarks in the ESAF II second annual arrangement approved in June 1999.

41. Despite partial implementation, the plan was successful in restoring confidence in the banking sector, fuelling remonetization. The ratio of broad money to GDP, which had been almost flat during the 1990s, rose to 47 percent at end-2004 from 25 percent in 2000. Most leading banks, which have grown rapidly in recent years, maintain relatively good financial positions, and there has been some improvement in loan techniques at some individual banks as well as in the application of prudential regulations by the BOM.

42. However, the financial system is still vulnerable to unexpected shocks, and lending rates remain very high. Non-performing loans (NPLs) have increased, after the recent rapid credit expansion. Several banks have liquidity constraints and two could have solvency problems if some recent letters of credit operations are not resolved favorably. Despite improvements in some banks, lending practices generally are still weak, with little screening of borrowers in many institutions. Therefore, despite low inflation rates, borrowing rates for all but the best customers remain very high, discouraging productive activity in favor of short-term trading.

43. Furthermore, although bank supervision has improved noticeably in recent years, the BOM still needs significant strengthening, in both its operations and its balance sheet.

  • The BOM’s capital position is not sound, with losses recorded at times, because of problems with non-interest earning assets (loans to government) and inadequate internal controls.

  • Several needs identified by the Safeguards Assessments remain, including the gold operations of the BOM, adherence to the central bank law, treatment of losses, and accountability of activities involving foreign exchange reserves. Although progress has been made to establish independent oversight of the BOM’s operations through a supervisory board, that body is not yet sufficiently active.

  • The capacity to take prompt corrective actions against troubled banks needs improvement. Tighter provisioning requirements, issuance of appropriate warnings, more targeted on-site examinations, and the adoption of an effective risk-based approach to bank supervision based on a comprehensive assessment of risks assumed by banks and the effectiveness of their own controls in mitigating these risks would help in preempting difficulties at an earlier stage.

44. Overall, while Fund-supported programs, conditionality and technical assistance have contributed to strengthening the Mongolian financial system, significant weaknesses remain. In any future financial arrangement, the further strengthening of the banking system would need to be a central element of the reform program, in particular in the areas of bank corporate governance, supervision, and strengthening market discipline.

V. Program Conditionality and Compliance

A. Quantitative Performance Criteria and Benchmarks

45. Quantitative conditionality was comparable to other arrangements. Conditions referred to net international reserves (NIR), net domestic assets (NDA of the banking system initially, of the Bank of Mongolia in the PRGF arrangement), net credit to the government, external arrears, and contracting of nonconcessional external debt. Only in the initial SBA was the NDA criterion replaced by one on currency issuance, as the National Bank was split into commercial and central banking entities at the time, precluding the setting of traditional performance criteria on NDA. Some auxiliary performance criteria and indicative targets, designed to monitor specific problem areas, were used in almost all arrangements (Table 2).

Table 1.

Mongolia: Selected Economic Indicators, 1991-2004

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Table 2.

Mongolia: Quantitative Conditionality, 1991-2004

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Of the banking system in ESAF I and II; of the Bank of Mongolia in PRGF.

In the indicative program December 1992 - March 1993 refers to change in reserves.

In the indicative program December 1992 - March 1993 refers to change in arrears.

Bold numbers indicate test dates
Table 2.

Mongolia: Quantitative Conditionality, 1991-2004

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Of the banking system in ESAF I and II; of the Bank of Mongolia in PRGF.

Bold numbers indicate test dates.