Financial crisis could provide Mongolia opportunity for reform


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Image credit: rreichle at Flickr under a Creative Commons license.
Mongolia's steppes are especially beautiful in October. A light dusting of snow on the gentle rolling hills makes them look like a rumpled white blanket. A large share of Mongolia's population still lives a nomadic lifestyle, herding livestock from one grazing area to another and living in the traditional ger, Mongolia's version of the central Asian yurt.

In this beatific landscape, the financial crisis and collapse of global stock markets seem far away -- but Mongolia will be sharply affected. In recent years the government has introduced a host of programs that have made herders' lives less vulnerable and difficult: livestock insurance to protect herders from losses in the terrible freezes that occur every few winters; expansion of cell phone coverage throughout the countryside; and expansion of rural education. The global economic crisis, however, threatens the sustainability of these programs.

Mongolia is in many ways a typical developing country, depending heavily on resource-based exports -- in this case, copper and other minerals. The copper price has boomed in recent years, which has helped Mongolia grow faster and expand public programs. Yet the end of the global boom means the end of the commodity boom. Within a short time the copper price has dropped from over $8,000 per metric ton to under $4,000 today (see chart).

The classic advice to commodity exporters is to save much of the revenue windfall during the boom times, which Mongolia has done to some extent. The country has accumulated 12 percent of GDP, saving an average of 3 percent of GDP for the past four years. But it has spent more of the windfall -- some going to the very good programs noted above. But much of the spending increase has been unfocused, such as raising the government wage bill by 3 percent of GDP and introducing various giveaways to the public, amounting to 4 percent of GDP. Roughly speaking, we can say Mongolia saved about one-third of the windfall and spent the rest.

Now that its revenue is dropping sharply in line with copper prices, Mongolia will have some fiscal problems. This was one of the key topics at an economic policy conference I attended this week in the capital city of Ulaanbaatar. Mongolian President N. Enkhbayar opened the conference, which was also addressed by World Bank chief economist Justin Lin and former Russian Prime Minister Yegor Gaidar. (Read the presentations here.)

Much of the discussion among parliamentarians, government, and civil society reflected a sense that the global economic turmoil presents Mongolia with both challenge and opportunity. Gaidar spoke of the current troubles as a "window of opportunity for reform." During the boom, Mongolia’s decision-makers dithered about reaching agreement with the big international mining firms to develop world-class copper and coal deposits that are as yet untapped. Now, the global environment for mining is much less favorable, so to some extent Mongolia missed an opportunity. But Mongolia can still reach agreements that would be highly favorable to the country once prices rise again -- as they inevitably will some day. Cleverly structured contracts can ensure that Mongolia gets a fair share of future windfalls.

Some see this as a good time to enact fiscal rules that require a larger share of future windfalls be saved. That way, the country can have stable expansion of development programs that are insulated from boom-bust commodity cycles. The challenge for Mongolia is to use the country’s mineral wealth in a way that preserves and enriches the country’s unique natural and cultural heritage.


Join the Conversation

November 03, 2008

I do agree with the "opportunity for reform" but I haven't seen a good sign of the change yet.

November 11, 2008

The enormous market subsidies of industrialized nations to bailout the financial crisis have caused some damage to commodity prices, among other things. If Mongolia finds themselves hard hit by the drop in the price of copper they should consider joining with other copper producing nations and developing nations, in general, to appreciate the value of their currencies. Not every nation is like China that has become economically successful by devaluating their currency. Although devaluation is the textbook method for aiding national trade the Mexican and Asian financial crisis showed that devaluation can also be unwise. The US Dollar and Euro need to devalue to allow trade to salvage their economic growth and offset their enormous financial sector bailout bonds that are disrupting world markets. Does appreciation interest Mongolia?

David Dollar
November 12, 2008

For Mongolia to appreciate the currency would require them to sell dollars and buy local currency to drive up the price of the local currency. Mongolia has a solid amount of reserves but not an overwhelming amount like some other Asian countries. They need to hold onto to these reserves in case commodity prices and their trade positions deteriorates further. So, I think in practice appreciation would be a difficult option. I am sympathetic to your sentiment that large exchange rate moves can be disruptive, but small economies that are dependent on primary exports sometimes have no other option.

December 29, 2008

Since, Mongolians are not heavily dependent on credits like in the U.S. the speed of reform and getting out of financial crisis could be faster.

Countries like Mongolia that has small economy can be faster to recover and also faster to sink.

March 05, 2009

I would like to highlight that it is the first financial crisis experienced by Mongolian Government since democracy. What Mongolia faces is the realities of systematic disorder (I mean here global financial system) and negligence of negative consequences of undisciplined economic policies (sorry, but I don’t agree with some policies taken last few years). I think the symptoms of vulnerability in Mongolia were observed since mid 2008 when oil prices heat up (petrol is about 25% of Mongolian import, 2007 NSO Statistics) leading to one of highest inflation in Asia, too populist social welfare programs that heavily burdened the budget (I would not critique the policies at all, but the way of distribution to all, rather than targeting the vulnerable groups only) and construction industry bubble (40,000 household programme, which provide tax facilitation to construction companies (tax difference went to construction companies rather than to buyers) contributed more to the bubble, as the realized market price on supply/demand rather than discounted price thought by Government. Today real estate price is down 20-30%, which I believe is the actual perceived value).

And many people were optimistic on protections of direct spillover effects from global financial crisis to Mongolia, as Mongolia does not have assets abroad, did not have any investment banks and was quite isolated from global financial system. However it was not true, as Mongolian domestic market is small, its export is not diversified and niched to minerals only. As global demand decreases, global production slows, copper and gold prices go down. Nobody is sure how long the crisis continue, everybody is closely observing what US and EU will do next.

Seriousness of the problem for Mongolia faces is reality of triple crisis: financial, economic and currency. So, Government action to stimulate consumption might have a risk to lead to more tugrug depreciation and further consumer price inflation.

However, I believe the crisis should give much bigger lesson to Mongolians, which is financial discipline. Last few years showed that Mongolia is not in rank among their Asian counterparts who tends to save. Mongolians were like Americans, want to spend if there is an opportunity. Mongolia missed good opportunities to build up reserves to be prepared for future.

I don’t believe faith of Mongolia is only in minerals. Mining sector will act only as a way to mobilize resources. The more important goal is how Mongolia distributes those resources wisely and build-up more competitive, productive and value-added sectors.

The Government should achieve it by putting individual ambitions and short-term visions aside. Otherwise, there is a little hope for rapid growth and Mongolia will remain China’s sub-contractor ever.

David Dollar
March 07, 2009

Batsaikhan: thank you for the excellent comments, with which I agree. Smart countries will take some lessons from the crisis, and I agree with you that a good lesson is to save more in the boom times. Mongolia and many other developing countries used the boom times to borrow even more, and now they have to cut back -- so their fiscal policy is counter-cyclical and exaggerates the cycle rather than mutes it. As big mining deals go ahead in Mongolia and mineral prices eventually rise again, it would be smart to save a lot of the windfall in three ways: (1) some financial savings through foreign reserves and a sovereign wealth fund; (2) putting public money into education, which is a kind of saving; and (3) financing intelligent infrastructure investments (not white elephants), another form of saving. This would be a good time to enact fiscal rules that force parliament to save some of the windfall when the good times return, thanks, David

June 10, 2009

Mongolia had confronted with classic experiences that learnt Australia and Chile before/during/after the Asian/Russian crises. First of all, today’s Mongolia has a very similar condition with above two countries which had open economies with exports that are intensive in volatile commodities. However, today’s Mongolia does not have the degree of financial development and links with international financial markets, which is very similar situation Chile had just a decades ago. Moreover, recent rise/fall shocks proved that their macroeconomic and monetary policies are vulnerable, and institutional framework is not well disciplined, as did well our ancestors 800 years ago. Unfortunately, all this happens mostly thanks to country’s ruling powers. It’s painful to see that narrow minded decision makers are failing its exams and proving that they are not competent enough to make correct decisions. Here are goes lessons to be learnt.

With most of its neighbors crumbling, its terms of trade experienced a significant decline. Seeing the potentially recessionary consequences of such a decline, the Central Bank of Australia loosened monetary policy. At the end of the day, neither consumers nor firms altered their plans. The entire adjustment was absorbed by a current account deficit that rose temporarily from 2 to 6 percent of GDP, and was financed by an increase in capital inflows.

The story of Chile has a similar beginning but a very different conclusion. As its terms of trade (essentially, the price of copper) deteriorated, Chile initially attempted to smooth things with macroeconomic policy, especially fiscal policy. But as the external conditions worsened, Chile’s international capital markets began tightening. Despite very low levels of external debt, a current account deficit of more than 6 percent began to worry many observers. Resident (especially foreign) banks began pulling resources out of the country, and the currency soon was subject to repeated attacks. Monetary policy could not be used to soften the impact of the decline in terms of trade because it was locked into fending off the speculative attacks and attempting to slow down the sharp reversal in capital inflows. When all was said and done (by the end of 1999), the current account had turned into a surplus to accommodate the tight financial conditions and expenditure had declined by about 15 percent relative to its pre-shock trend. Chile’s contraction was nearly ten times larger than it would have been if it had been able to count on unrestricted access to international financial markets.

Many have argued that part of the Chilean adjustment problem was attributable to domestic policy rather than to a sudden stop in capital flows. Perhaps, but that is just a matter of degree of adjustment. This discussion clouds the more important point that prudent emerging economies often experience severe precautionary recessions when the possibility of an open crisis is too close for comfort. These deep precautionary recessions are part of the cost of living in an environment of volatile capital flows. They may be less “spectacular” than open crises are, but cumulatively (across countries and time) they account for a significant fraction of the costs of capital flows’ volatility. Moreover, open crises often are preceded by long periods of precautionary recessions. And, at times, it is the social and political unrest that these periods cause that ends up triggering the full blown crises. If one could smooth these precautionary recessions, many of the crises would be prevented as well.

Source: On the International Financial Architecture: Insuring Emerging Markets
Ricardo J. Caballero
NBER Working Paper No. 9570
March 2003