Author: Tuvshintugs Batdelger, National University of Mongolia
Mongolia experienced drastic changes in its macroeconomic environment in 2014.
The economy is expected to grow by 7 per cent in 2014. This is a healthy pace. But the majority of this growth has come from the mining sector, which experienced a significant boost from the production ramp up in the first phase of the Oyu Tolgoi project.
Mongolia faced several challenges on the economic front in 2014. The country needed to address these issues in order to avoid falling into another recession similar to that of 2008–09. Since the beginning of the year, unfortunately, the economic environment has not improved. Some might even argue it worsened.
Developments in the general economic environment can be described by looking at the three interrelated major macroeconomic variables: the balance of payments, inflation and the fiscal balance.
Currently, perhaps the most significant difficulty is related to the sharp deterioration in Mongolia’s balance of payments. There are two factors to this sharp deterioration: the unfavourable terms of trade and the government’s harsh policies towards foreign investment.
According to the Bank of Mongolia, the terms of trade have fluctuated but remained weak for the last two years. Prices of the country’s major export commodities — such as copper and coal — declined significantly during this period and are expected to remain at these deflated levels for the foreseeable future.
More importantly, the impact of falling export prices was exacerbated by some critical policy decisions taken by the government on foreign direct investment (FDI). For instance, there is a continued struggle to push forward with the second phase of the giant Oyu Tolgoi project, as well as prolonged discussions and delays surrounding the construction of a railway, which is expected to significantly decrease the cost of selling coal to China.
At the same time, the unfriendly treatment of some expatriates in regard to tax issues as well as uncertainty as to policy decisions — whether general macroeconomic decisions or specific project-oriented decisions — all led foreign investors to downsize their exposure to the Mongolian economy. As a result, the country suffered a staggering 81 per cent deterioration in its financial account as of October 2014. In particular, annual inward FDI fell from US$1.8 billion in 2013 to US$0.8 billion in 2014. This is a significant fall. By comparison, in 2012 Mongolia attracted over US$4.4 billion dollars of inward FDI.
As can be expected, the sharp decrease in the financial account put tremendous pressure on the Mongolian currency, the togrog, to depreciate. In 2014 alone, the togrog depreciated by 13 per cent. This depreciation is related not only to the decrease in FDI and the deterioration in the financial account, but also to the central bank’s increasingly expansionary monetary policy during this period. In the first three months of 2014, the annual growth rate of reserve money was on average 33.7 per cent.
Specifically, the increase in the monetary base can be attributed to two programs carried out by the central bank. First is the so-called price stabilisation program, whereby the central bank provides subsidised loans to some sectors of the economy for the purpose of stabilising prices in these sectors. Second is the initiation of the subsidised mortgage program, whereby the central bank provides highly subsidised mortgages to qualified households through commercial banks. This increase in the highly liquid money supply eventually led to an increase in the inflation rate. As of the end of November 2014, the annual inflation rate stood at 11.5 per cent, well above the target rate of 8 per cent.
Mongolia’s economic vulnerabilities were aggravated further by increasingly expansionary fiscal policies. By the end of 2014, it is expected that the fiscal deficit will be around 15 per cent of GDP, including investment activities by the Development Bank of Mongolia.
This significant imbalance in the fiscal condition was not isolated to 2014 alone. In the last 15 years, spending has doubled every three years. The Fiscal Stability Law, enacted in 2010, puts restrictions on the growth rate of government expenditures and the fiscal deficit. But these restrictions led to overly optimistic budget revenue projections, making expenditure expansions appear affordable. As a result, since 2012, the country consistently and widely missed the budget revenue target. In 2014, fiscal revenue is expected to have fallen short of projections by some 16.2 per cent, leading to increased government borrowing from the domestic market to finance the resulting budget deficit.
Expansionary monetary and fiscal policies combined with a weak terms of trade mean Mongolia finds itself in an unstable economic environment with limited room for policy manoeuvre. It remains to be seen what policies the government will undertake to stabilise the economy, but it is obvious that promoting foreign investment will go a long way to addressing these issues.
Tuvshintugs Batdelger is an associate professor at the National University of Mongolia and Director of the Economic Research Institute based at the university.
This article is part of an EAF special feature series on 2014 in review and the year ahead.