Country Report Mongolia
Mongolia’s economy slowed in 2012 on the back of lower demand from China and slowing FDI inflows. The government has implemented monetary easing and public investment to support growth, which has had some success, but increased risks. A more cooperative stance of the Mongolian government towards foreign investors should help to regain their confidence.
Strengths (+) and weaknesses (-)
(+) Very strong growth prospects
A vast endowment of a range of mineral resources, of which most are untapped, and ample room for further economic development make that Mongolia’s growth potential is big.
(-) Underdeveloped and resource-dependent economy
Mongolia’s economy is underdeveloped (HDI rank 108 out of 187) and the country’s economy depends heavily on the extraction and export of natural resources.
(-) Unstable policy environment
The country’s democracy is young and its institutions are weak. Policies change significantly frequently, which creates uncertainty for investors.
(-) High external vulnerability
Mongolia’s current account balance shows large deficits. Furthermore, as exports consist of commodities, while strategic goods, such as food and fuel, need to be imported, the country is vulnerable to commodity price fluctuations. Moreover, roughly 90% of exports are bought by China, which makes Mongolia vulnerable to adverse developments in its big neighbor.
1. Government spending supports growth, as external demand slows and FDI contracts
Following very strong growth in 2011 (17.3%), real GDP growth slowed to 12.3% in 2012. The slowdown was partly driven by weaker external demand, mainly due to weaker growth in China, Mongolia’s main export partner. The slowdown of Chinese growth reduced demand for coal in particular. As a result, total exports fell by 9% last year, after two years of very strong export growth. Also, continued uncertainty on the policy front regarding regulations for foreign mining companies has reduced investor confidence, resulting in a contraction of FDI inflows by some 19% in 2012. This year, these factors have continued to weigh down on Mongolia’s economic performance, with FDI inflows falling by 43% year-on-year in the first half of the year. In the first quarter of 2013, real GDP growth slowed further to 10.3% year-on-year. Meanwhile, the current account deficit has risen, FX-reserves have continued to decrease and the currency has weakened, increasing the country’s already substantial external vulnerabilities.
To support economic growth, the government increased public investment in infrastructure and eased monetary and credit policies to boost credit expansion. The central bank applied two 100bps policy interest rate cuts in May and June, lowering the rate from 12.5% to 10.5%. Moreover, banks were forced to lower their mortgage rates to 8%, from between 15% and 20% before. As a result, real GDP growth picked up again, to 13.2% year-on-year in the second quarter.
However, the policies come with a number of negative side-effects. Inflation, which was low for Mongolian standards at 11% in the first quarter, will likely increase as a result of the fiscal expansion and monetary easing. This may push up average inflation in 2013 beyond the 12% currently estimated. Furthermore, the government’s financial position may weaken further. A budget deficit of 7.3% of GDP is estimated for this year, a slight improvement from the 8.4% registered in 2012. However, increased off-budget liabilities –such as infrastructure spending, financed by the Development Bank of Mongolia – are not taken into account in this figure. There are positive signs as well. The re-election of Elbegdorj (see next topic) may have positive implications regarding mining policies, which should help to attract increased FDI inflows. Furthermore, in recent months, the economic activity in China seems to be picking up, which is expected to lead to increased demand for Mongolia’s coal, iron and copper exports. As a result, real GDP growth is estimated to pick up to roughly 15% in 2013.
2. Banking sector related risks have increased
In July, Mongolia’s fifth-largest bank, Savings Bank, became insolvent and had to be nationalized after its parent company, Just Group, collapsed. According to the president of the Mongolia Banking Association, the failure was due to weak enforcement of central bank regulations regarding related-party lending (extending credit to executives of a bank and businesses associated with the bank, restricted by the central bank to 20% of total loans). He also said that related-party lending had been responsible for 30 bank failures in Mongolia in the past 22 years. The latest bank failure put this risk on the forefront again at a time that risks for the Mongolian banking sector are rising on the back of weaker economic and export performance. The decrease of FX earnings poses a further risk, as, according to Fitch, 30% of total loans extended in June were in foreign currency while a weakening of Mongolia’s currency has furthermore led to higher local currency debt costs. Moreover, the government induced cap on mortgage rate will further add to banking sector risks, as it will hurt the profitability of banks.
3. More cooperative stance towards foreign investors after Elbegdorj’ s re-election
At the center of Mongolia’s political infighting in the past years has been the debate on the distribution of the country’s huge future mining revenues. In the past years, tougher mining laws that seek to increase Mongolian control and income on foreign investor-led mining projects, in particular the Oyu Tolgoi mine, were imposed. This has spooked foreign investors, leading to a substantial decline of FDI inflows. In response, the Mongolian government has amended some of the laws, but policy instability remained high. The latest parliamentary (June 2012) and presidential elections (June 2013), however, have strengthened the position of the DP. The DP secured 31 out of the 76 seats in parliament and afterwards formed a coalition with two smaller parties. President Tsakhiagiin Elbegdorj was re-elected in June. Since, the government has been trying to restore the lost foreign investor confidence. It has taken a more cooperative stance towards foreign investors and is working on easing restrictions on foreign investments. If this new legislation is passed, this should lead to a rebound of FDI inflows, as well as the potential for stronger export growth in the coming years.
Traditionally, Mongolia’s economy was dominated by herding and agriculture. Mongolia’s is also endowed with large reserves of a wide range of mineral resources and the development of these resources has become the main growth driver in the past decade. The Oyu Tolgoi mine, for instance, which is situated on one of the world’s largest untapped copper reserves, is estimated to produce 500,000 tonnes of copper and 500,000 ounces of gold a year for the next 35 years. As a result, if the country succeeds to manage this natural resource wealth well, Mongolia’s economic medium-to-long term outlook is bright. In spite of these sound growth forecasts, Mongolia’s economic structure remains weak. The Mongolian economy is highly dependent on the production and export of commodities and thus at the mercy of international commodity price fluctuations. Moreover, Mongolia is enclosed by Russia and China and is highly dependent on trade with these countries; Russia supplies nearly all of its fuel and energy needs, while China buys roughly 90% of the country’s total exports. Mongolia is thus particularly vulnerable to adverse developments in China. Furthermore, Mongolia sound economic outlook would be adversely affected by any adverse change in investor sentiment, as the country will need substantial amounts of foreign direct investment (FDI) to reap the benefits of its massive natural resource endowments. Given Mongolia’s large current account deficit, its weak export structure and its dependence on FDI inflows and donor aid, external liquidity risk is high.
Mongolia’s democracy is still young and, as a result, its institutions are immature. Corruption, also among high-ranking officials, remains a problem.