Policy adjustments and new laws in Mongolia expected to reinvigorate foreign investment flows

Given its small, open economy with abundant resources including coal, copper, gold, zinc and fluorspar, Mongolia faces the same boom-and-bust cycles of any resource-dependent nation. The country has the natural endowments to provide opportunities for its 3m citizens. However, managing fluctuating growth rates, ranging from -1.3% in 2009 to 17.3% in 2011, as well as investment, trade and fiscal revenues, remains a key challenge. While expansionary policies have helped achieve a soft landing for the economy since 2012, these were adjusted by parliament in February 2015 in order to improve the external balance.

The coalition government has sought to rebuild investor confidence with a slew of legislation since October 2013, although a rebound in foreign direct investment (FDI) will take time to emerge. While lower economic growth will be the price to pay for macroeconomic stability, the government hopes to catalyse foreign investment in mining, petroleum and infrastructure to jump-start the next phase of development.

Double Digits

Mongolia recovered swiftly from its last balance of payments (BoP) crisis in 2009, when it turned to the IMF for its fifth bailout in 20 years. The October 2009 Oyu Tolgoi Investment Agreement (OTIA) generated $6.2bn investment in the copper and goldmine’s first phase, as well as a flood of other mining projects. Inward investment, 85% of which was in mining, ballooned from under $2bn in 2010 to $4.73bn in 2011 and $3.78bn in 2012, driving GDP growth from 6.4% to 17.5% and 12.4%, respectively, in the same span, according to the Bank of Mongolia (BOM). FDI has since tapered off, dropping to $2.27bn in 2013 and $963.66m in 2014, with corresponding GDP growth figures slowing to 11.7% and 7.8%, respectively. From 2011 to 2014, the FDI to GDP ratio dropped from 45% to 3%.

While copper has historically dominated Mongolia’s exports, surging coal exports to China, which rose from 4.2m tonnes in 2008 to 21.1m tonnes in 2011 and 20.9m tonnes in 2012, tied Mongolia closer to the more volatile mineral resource at the height of the commodity super-cycle. However, while high growth sucked in imports, driving the current account deficit (CAD) from 14.9% of GDP in 2010 to 31.7% in 2011 and 32.8% in 2012, high FDI levels provided sufficient cover.

Election season coincided with a slump in Chinese demand to cause a perfect storm in mid-2012. Having placed a moratorium on new mining licences in 2010, parliament rushed through legislation in May 2012 restricting foreign takeovers in strategic industries such as mining, in order to fend off a Chinese state-owned suitor. Amidst growing political pressure to renegotiate the OTIA, and as mine construction neared completion, investor sentiment swung sharply, sending FDI plunging 52% in 2013. As growth slowed, the government loosened fiscal and monetary policies to provide a soft landing for the economy, mainly through off-balance-sheet quasi-fiscal spending by the Ministry of Economic Development (MED) – which was subsequently absorbed into the Ministry of Finance (MoF) – and unconventional monetary policy by the BOM.

Domestic consumption replaced FDI and sustained 11.7% growth in 2013, according to Asian Development Bank (ADB) figures, driven by the stimulus-related construction sector (66.5% growth year-on-year, yo-y), industry (20.1%) and mining (20.7%) as Oyu Tolgoi (OT) ramped up production in the first half of 2013. Clement weather supported 13.5% growth in agriculture, while services grew at a slower 10%.

Sharing Dividends

Rapid growth raised incomes for Mongolia’s youthful population, 45% of which are under 24, although dividends have been uneven. Despite successive cash hand-outs in the run-up to the 2012 elections, double-digit inflation largely eroded higher incomes. The country’s ranking in the UN Human Development Index rose marginally from 117th to 103rd between 2003 and 2013. With 40% of its citizens nomadic, periodic cold winters, known as dzuds and mining-related employment exacerbated rural-urban differences. The national poverty rate declined from 38.7% of the population in 2010 to 27.4% in 2012, although this obscures the large contrast between rural and urban poverty, which stood at 35.5% and 23.2%, respectively. Ulaanbaatar is the main destination for migrants, who account for the 60% of the city’s population that inhabit ger (traditional felt tent, or yurt) districts without roads or water connections, even if the capital’s poverty rate stood at a low 19.8% in 2012.

The government ceased cash handouts from the Human Development Fund in 2012 but has switched to a basic food-stamps programme since then, covering 88,000 recipients by 2014. Lay-offs from mining and related sectors since 2012 have hit particularly hard, as each high-paying mining job sustains up to eight family members, according to estimates by the Ministry of Finance (MoF). As OT’s phase 1 was completed in mid-2013 and with phase 2 mothballed, staffing fell from 18,000 at peak-construction to 7200 in mid-2014, symptomatic of broader mining lay-offs. The number of registered unemployed rose from 39,000 in 2012 to 55,000 in 2013, before falling to 33,900 by June 2014 given rapid growth in construction, industry and agriculture. Yet with 69% of the unemployed under the age of 34, Mongolia faces the social challenge of youth unemployment despite a Soviet legacy of high secondary school enrolment of 98% for girls and 93% for boys.


As foreign investment plunged, public spending filled the gap to sustain double-digit rates since 2012. Constrained by the 2010 Fiscal Stability Law (FSL), limiting budget deficits to 2% of GDP and total debt to 40% of GDP, the majority of investment was off-budget through the newly-created Development Bank of Mongolia (DBM), under the MED.

While the MoF curbed the budget deficit from 7.4% of GDP in 2012 to 1.4% in 2013, DBM’s off-budget spending ballooned from 3.5% of GDP in 2012 to 9.6% in 2013, according to ADB figures, pushing the aggregate deficit (including contingent liabilities) from 10.9% to 11.1% in the same span.

Whilst designed to finance commercially-viable infrastructure projects, roughly 60% of DBM’s projects are “social” given their lack of financial returns, according to the World Bank, including roads, power plants and railways – although the absence of detailed financial reporting by DBM obscures the full picture.

The bank has drawn funding from both sovereign and guaranteed bullet-bonds: a $580m DBM bond in March 2012, a $1.5bn two-tranche sovereign (the Chinggis) bond in November 2012, JPY24.3bn ($230.9m) in DBM’s Japan Bank of International Corporation-guaranteed samurai bonds in December 2013 and a series of private placements including $162m from China Development Bank and $300m from Credit Suisse in August 2014. While DBM and the MoF agreed in 2013 to include repayment of DBM loans to social projects from 2015, it remains unclear how line ministries will report their borrowing from DBM (see analysis). In 2014 alone DBM still had around $1bn of bond proceeds available, keeping the aggregate budget deficit above the 10%- of-GDP mark, according to the World Bank.

Monetary Easing

In parallel with such quasi-fiscal spending, the BOM eased monetary policy, both through benchmark interest-rate cuts and three unorthodox instruments. Reversing its tightening stance of 2012, when it raised rates by 100 basis points to 13.25% to tame inflation, the BOM cut rates three times by a total of 275 basis points to 10.5% by June 2013 in order to avoid a potential credit crunch, broad money contraction or economic crisis. The central bank went much further, expanding its balance sheet through three unconventional interventions that together injected MNT4.1trn ($2.46bn), or 20% of GDP, in new liquidity into the banking system in 2013 alone.

The first initiative, the Price Stabilisation Programme (PSP), was launched in late 2012, and aimed to curb supply-shock inflation by providing sub-market-rate financing for the warehousing of key commodities including gasoline, meat, grain and flour. This channelled MNT600bn ($360m) in one-year loans at between 0.5% and 4% to banks that were then on-lent at up to 7% to clients in targeted sectors, while the BOM sold forward-exchange contracts to banks at preferential rates to offset currency depreciation. Second, as banks’ loans-to-deposit ratios exceeded 100% in early 2013, the BOM intervened directly to provide credit support to commercial banks, placing MNT900bn ($540m) in one-year time-deposits at 7% in mid-2013.

However, the third and largest intervention has been in the housing market, with the BOM extending MNT1.2trn ($720m) in 20-year mortgages subsidised at 8% in 2013, compared to prevailing market rates of 18%, and another MNT779.2bn ($467.5m) in 2014. By the end of 2014 around 71% of outstanding mortgages were subsidised at 8%. The BOM also extended MNT530bn ($318m) in subsidised loans to construction materials and property development firms to support new housing supply.

While the mortgage scheme launched in June 2013 targeted wage-earners buying units under 80 sq metres, the exemption of such loans from prudential ratios has caused adverse selection and moral hazard according to the IMF. The government views the scheme as a means of shifting household consumption towards saving. While the BOM had securitised MNT536.1bn ($321.7m) of these mortgages through the Mortgage Corporation by August 2014, the low price of the securities means the subsidised mortgage scheme will continue to be backed by the state.

As a result of DBM and BOM interventions in the housing market, credit growth accelerated from 26.4% y-oy in January 2013 to a peak of 57.6% in November 2013, driven by bank lending to construction and mortgages, before subsiding to 16.1% by the end of 2014.

External Imbalances

While expansionary fiscal and monetary policies offset declining FDI to help achieve a soft landing for the economy in 2013, growing external imbalances weighed heavily on Mongolia’s BoP. Lower demand from China, which accounts for over 90% of exports, and slumping commodity prices caused exports to contract by 9% in 2012 and 2.6% in 2013. The ramp-up of OT copper output from July 2013, to 63,000 tonnes per month in December 2013, only partly offset the 40.7% y-o-y decline in coal exports to China in 2013. As the mine’s output rose, copper exports grew 144% y-o-y in the first half of 2014, helping drive the 35% growth for the year.

At the same time, completion of OT’s construction brought a drop-off in capital equipment imports, causing imports to contract by 5.7% in 2013, although this was partly offset by the impact of government investment. Meanwhile, as the currency’s depreciation trickled through to import prices, imports declined by 15.4% y-o-y in the first half of 2014. However, while the CAD narrowed slightly from 31.5% in 2011 and 32.6% in 2012, to 27.4% in 2013 and 13% by August 2014, the sustained fall in FDI – by 17% in 2012, 52% in 2013 and 62% y-o-y by June 2014 – left a large external financing gap, equivalent to 5% of expected half-year 2014 GDP, according to World Bank estimates.

Acting as a pressure valve, the currency fell 17.6% against the US dollar in 2013 and a further 14% in the year to August 2014 to a trough of MNT1892:$1, before rebounding 4% by October according to ADB figures. As the BOM intervened through its bi-weekly foreign exchange (FX) auctions to ease volatility, its international reserves dropped from a peak of $4.13bn in December 2012, bolstered by the proceeds of bond issues, to a low of $1.32bn by June 2014, close to the prudent three-month import cover (see analysis).


While inflation had fallen from 14% in 2012 to 8.3% by June 2013, as the impact of cash handouts in 2012 subsided and the PSP helped stabilise key commodity prices, the currency’s depreciation started feeding through in the second half, pushing full-year 2013 inflation to 10.4%. Although this kept the real effective exchange rate’s fall to 7.2% in 2013, inflation accelerated to 14.9% y-o-y in July 2014, BOM figures show, before dropping back to 9.3% for February 2015. High inflation in property prices also raised concerns over banks’ exposures to potential loan defaults.

Although banks’ liquidity and capital adequacy ratios remain above regulatory floors, high loan growth of 55% y-o-y in May 2014 has outpaced deposit growth of 31.6% y-o-y, pushing the sector’s loan-to-deposit ratio to 125% in May 2014. Stimulus-related sectors dominated lending growth in the first quarter of 2014, including construction (117.5% y-o-y), real estate (72.7%), mining (63.2%) and trade (53%). House prices have increased significantly on the back of the mortgage scheme, rising 32% nationwide in the year to June 2014, but this has followed several years of real estate inflation, with 122% growth in Ulaanbaatar property prices between 2011 and 2013.

This, combined with rapidly-rising household debt, which reached roughly 60% of GDP by end-2013, has put the spotlight on banks’ asset quality. “The concentration of bank lending to construction and mining is a concern, as is the build-up in mortgage payment arrears even if the absolute value remains low,” L. Amar, economics officer at the ADB, told OBG.

Although banks’ non-performing loan (NPL) ratio declined from 5.3% in December 2013 to 3.5% in the first quarter of 2014 and 2.8% the following quarter, the build up in distressed loans, with 100% growth in sub-standard loans and a 70% rise in those in arrears over the two quarters, hints at higher NPL rates going forward. In total, World Bank figures show that the ratio of problematic loans to total lending rose from 6.3% in December 2013 to 8.3% in May 2014.

Shifting Gears

While fiscal and monetary expansion was effective in sustaining growth in the near term, rebuilding a pipeline of foreign-invested projects will be key. The government has sought to rebuild investor confidence, after a 16-month political cycle that culminated in presidential elections in June 2013. Damaged by legislation restricting FDI in May 2012 and a dispute with Rio Tinto over the OT mine that delayed construction of phase 2 by two years, FDI had fallen to a quarter of its 2012 peak. Following the new Investment Law in October 2013, which placed foreign and local investors on an equal footing, and the pro-business State Policy on Mining in January 2014, parliament passed in its spring session the amended Minerals Law, a new Petroleum Law and a landmark transparency-minded Glass Account Law that requires open reporting of government spending. With new incentives for mining and upstream oil, the government hopes to catalyse some $1.1bn in new exploration investment in 2015. Parliamentary approval of a resolution on railway gauges in October 2014 removes a key roadblock for building much-needed railways to transport coal to China. The impact of such legislative changes on inward investment will take time, however, pending implementing guidelines. “Despite the series of pro-business legal reforms we have implemented, the economy has not revived because we have largely lost the market’s confidence through unpredictable and unstable policies,” O. Chuluunbat, former deputy minister of economic development, told OBG. “It will take time to rebuild trust.”

“While auditing, accounting and taxation procedures have improved over the past few years, further legislation and regulatory clarifications are needed,” D. Altansukh, CEO of BDO Audit, told OBG. “For example, there could be categories of companies with respect to the accounting framework – public interest entities, large companies, and micro, small, and medium-sized enterprises (MSMEs) – but the legislative framework provides no indication as to how to differentiate between large companies and MSMEs, making the application of such rules both unclear and difficult.”


Facing pressure on foreign currency reserves, a declining currency and rising inflation, the government started easing its expansionary policies over the summer of 2014. Support from neighbours also helped, with presidential visits from China and Russia in August including series of memoranda of understanding covering trade and infrastructure. The most tangible immediate benefits came from China with the expansion of the bilateral swap line from $1.6bn to $2.4bn and a $162m loan to DBM.

As the BOM eased the pace of intervention and the proceeds from DBM’s two private placements were transferred onshore, reserves rebounded by 3.3% to $1.36bn in two months to August 2014. The external sector started to rebalance in 2014, with exports growing 35% y-o-y and imports contracting by 15% in the first eight months of 2014, as OT output ramped up and the depreciating currency hit imports.

Although the country’s coal exports rose by 2.5m tonnes in volume, the 31% y-o-y fall in coal prices ensured that coal earnings stayed below 2013 levels. As Mongolia switched to a trade surplus of $335.6m in August 2014, its CAD fell 63% y-o-y to $905.7m, 13% of GDP, while the decline in FDI inflows started to stabilise from 62% y-o-y in June to 59% in August.

With surging copper exports having curbed excessive current account imbalances, the BOM also adjusted its policies in mid-2014 to reduce inflationary pressures and promote macroeconomic external balance. Credit rating downgrades – Standard & Poor’s downgraded Mongolia from BB- to B+ in April, while Moody’s downgraded it from B1 to B2 in July – over rising external imbalances and lower fiscal and monetary buffers also played a role. The central bank delayed tightening its interest rate to 12% to late August 2014 to reduce the impact on growth to 2015, and issued new prudential rules for banks to curb currency mismatches in the corporate sector (see Banking chapter). It has tapered its unconventional interventions, by reducing direct liquidity support to banks from MNT900bn ($540m) at end-2013 to MNT150bn ($90m) by March 2014, while outstanding BOM credit to banks was reduced from MNT4.3trn ($2.6bn) to MNT2.9trn ($1.7bn) in the same span. Having already shifted PSP support towards other instruments – like selling FX-forwards – the government is set to phase out the PSP entirely in 2015, although the mortgage scheme will continue.

“Given the popularity of the mortgage programme, it is unlikely that the BOM will phase the scheme out, supporting credit growth that is more rapid than similarly rated economies,” Anushka Shah, Moody’s sovereign analyst on Mongolia, told OBG.

Although the mortgage programme will not be phased out, banks tightened lending criteria in 2014 while the number of eligible borrowers has fallen as home-ownership has risen. Mortgages grew rapidly from 6% of GDP in 2012 to 14% at end-2014, but lending growth has fallen sharply, from 64% in 2013 to 16% by the end of 2014, according to the BOM. “The contraction in liquidity as banks refrain from lending is one of our biggest concerns,” Chuluunbat told OBG. Yet the BOM expects its tapering to help curb inflation to below 12% for the full year, closer to its 8% target.

Fiscal Reforms

The government has additionally come under pressure to rein in spending, faced with lower than targeted revenue and slowing economic growth. The economy expanded by 5.3% y-o-y in the first half of 2014, with growth driven by mining (16.1%), agriculture (16.3%) and logistics (11.9%).

In line with slowing growth, the government has faced persistent budgetary shortfalls since 2012. A 13% shortfall on budget revenue projections in 2013 forced it to cut spending by 17% in the revised budget in November 2013. With revenue projections in 2014 some 17% above actual 2013 receipts, fiscal income rose only 7.7% y-o-y by July 2014, according to the World Bank, which forecasts a 10% shortfall for 2014.

Budget spending sharply outpaced revenue growth in the first half of 2014, at 22% y-o-y, driven by a 50% rise in capital spending and 18.7% in recurrent. Although the budget deficit is expected to reach 1.3% of GDP in 2014, including the estimated MNT1.7trn ($1bn) in DBM spending will push the total fiscal deficit beyond 10% of GDP, according to the World Bank.

While the government raised its debt ceiling to 58% of GDP in January 2015, it has also pledged to provision for a $500m Chinggis Bond in the year’s budget (see analysis). Indeed, the MNT5.6trn ($3.4bn) 2015 budget approved mid-November 2014, which includes a higher 1.8% of GDP budget deficit, also has MNT195.6bn ($117.4m) in loan provisioning.

Parliament also approved a government restructuring in October 2014. By reducing the number of ministries from 16 to 13 – and crucially merging the MED and MoF – the prime minister expects to better control both budgeted and quasi-fiscal spending, ahead of the $1.1bn bulge in bond repayments in 2017. The government will need to implement broader structural reforms to rebuild its fiscal stability in the long term.

It announced plans in early 2014 to sell some of the 98 firms it holds stakes in, with nine slated for full privatisation and an additional nine for partial divestment. Furthermore, a bill submitted to parliament in October 2014 aims to establish a sovereign wealth fund to replace the Human Development Fund, which would be phased out by 2018. To successfully rebuild financial buffers, however, the government will need to respect the spirit as well as letter of the FSL by bringing all public spending on budget.


Facing considerable BoP pressures, the authorities are seeking to rapidly rebuild investor confidence as they reach the limits of public-sector intervention. Drawing on support from its two neighbours in the short term, the government is trying to navigate a soft landing ahead of an expected rebound in investment in 2015, as a raft of new legislation takes effect. Key disputes with existing investors like Rio Tinto have become bellwethers of government credibility, but this seemed close to resolution in early 2015 (see Trade & Investment chapter). As the government consolidates its expansionary policies in 2015, it will need to accept slower growth in the interests of economic stability.

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The Report: Mongolia 2015

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