Country Economic Memorandum - Mongolia Sources of Growth

1. Mongolia’s transition from a planned economy to a market economy, which began in the early 1990s, has proceeded quite well relative to most other countries in similar circumstances. Fundamental economic reforms have been undertaken by the Government in the areas of price liberalization, privatization and the establishment of market institutions. Concurrently, progress has been made towards reducing the incidence of poverty. While Mongolia has suffered bouts of inaction on reforms and attendant crises in the past decade, it is noteworthy that there has been no reversal of the overall reform path towards a market-oriented economy. Unlike several Eastern European countries, Mongolia’s transition was largely unhindered by widespread social or political unrest, although the young democracy is still being perfected.

2. Today, one is seeing a country with a strong macroeconomic performance—in terms of GDP growth and low inflation—buoyant prices of its main mineral exports copper and gold, widening current account and fiscal surpluses, and has seen an appreciating nominal and real exchange rate for the Togrog vis-à-vis the U.S. dollar. The associated gains in economic well-being have occurred while at the same time Mongolia has, by and large, protected the high levels of human development that are a legacy of its socialist period. The biggest turnaround over the past five years has been in the tertiary/services sector in Mongolia, especially retail and wholesale trade, transport, communications and financial services, where average value-added growth has been at around 8 percent per annum during 2001-2004 and 9.1 percent in 2005. Foreign direct investment has been rapidly growing in mining and construction activities. The average share of FDI in Mongolia’s GDP of 5.2 percent for the 10-year period (1996-2005) was higher than the average for the East Asia region, and more than three times that for the low-income country group to which it belongs. Clearly, despite political uncertainties, these are good times.

…the sources of real GDP growth have become very concentrated, and heavily dependent on mining and livestock sector activities.

3. Looking deeper into these overall trends, one cannot escape from concluding, however, that some of the very developments that have shaped recent economic conditions and history are likely to become constraints to Mongolia’s continued prosperity and sustained high growth. Mongolia’s heavy dependence on the exports of a few key commodities—gold, copper, cashmere—has made its economy particularly vulnerable to fluctuations in commodity prices and natural disasters. Employment generation has been elusive despite having a young and educated labor force. The population of the country is becoming more concentrated in and around Ulaanbaatar.

4. Formidable challenges remain in managing Mongolia’s “tyrannies of distance and isolation;” delivering services equitably and cost effectively; and generating growth that is broadly shared regionally and across income groups. The country faces the challenge of creating new opportunities for its rural population and urban unemployed/discouraged workers. Progress in reducing maternal mortality rates, as well as in improving water and sanitation services, has been less than required to meet the Millennium Development Goals (MDGs)—and is particularly lagging in the western part
of the country. The recent World Bank Poverty Assessment (2006) for Mongolia finds that of all househo lds with household heads engaged in some form of activity, the herder households had the highest incidence of poverty (41.2 percent). Analysis of household survey (HIES-LSMS) data indicates that livestock mortality shocks translate directly into lower consumption levels for herder households. It also found that the most pressing poverty challenges in Mongolia are related to widespread livestock mortality risks, attrition before upper secondary schooling, and the exorbitant heating cost burden of households. At times, these challenges may all seem daunting, but the prevailing good times provide a politically difficult but fruitful opportunity to use the gains to address the vulnerabilities that Mongolia’s transition to a market economy brings and make prudent policy decisions to benefit a wide spectrum of Mongolian citizens (rural and urban) over the medium- term.

5. The Government’s strategy to deal with these challenges, and instruments to implement it, are being formulated under its draft National Development Strategy (NDS). This is being linked to its medium-term budget framework (MTBF), its associated annual budgets, and its Socio-economic Guidelines (SEG) documents that are all discussed in Parliament. The public investment program (PIP) remains to be formulated in a manner consistent with the MTBF with a view towards maintaining fiscal sustainability, and with consistent sector strategies covering the same time-frame. The Government has made commendable efforts to finalize its medium-term Health and Educatio n Master Plans, while it is at an advanced stage in articulating its Infrastructure Development Strategy.
Meanwhile, a medium term Public Debt Management Strategy needs to be articulated by the Government and communicated to market participants. Capacity building efforts are underway in the Government in collaboration with its external development partners, including the World Bank, to put in place institutional arrangements, regulations and appropriate staff to get these tasks done.

6. This Economic Report aims to inform the ongoing debate on the Government’s long term development priorities in Mongolia. It discusses the key facts and potential implications the Government would need to consider when determining its public spending, public investment program, fiscal space, and borrowing strategy going forward. In this context, the objective is to identify reforms where the direct beneficial effect could be the largest in terms of broad-based employment generation and sustainable growth.

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