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p. 17 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia Kazakhstan Kyrgyz Republic Tajikistan and Turkmenistan Uzbekistan Mongolia People’s Republic of China Southeast Asia South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : Central Asian Republics, Azerbaijan, and Mongolia

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Mongolia

The economy continued performing much below potential in 2000, with meager economic growth, an increase in inflation, and a slight deterioration in the current account balance. However, with the resumption of stabilization and reform measures after the installation of the new Government, prospects for stronger economic performance have improved.

Recent Trends and Prospects

The economy saw another year of below-potential performance in 2000. GDP grew by a mere 0.5 percent, following 3.6 percent average annual growth during 1997-1999. The country experienced its most severe winter in three decades in 1999/2000, when nearly 10 percent of livestock was lost, affecting the livelihood of about 20 percent of the population. The Government adopted expansionary fiscal and monetary policies, with one eye on the July 2000 elections, leading to the persistence of a substantial fiscal imbalance and a steep rise in the money supply. The fiscal deficit, at 10.8 percent of GDP, breached the 8.5 percent target for 2000 agreed under the Poverty Reduction and Growth Facility of the International Monetary Fund. Money supply (M2) was growing at an annualized rate of about 32 percent by December 1999, and averaged about 35 percent in the first 10 months of 2000, but fell to a more modest 17.6 percent by December 2000.

The expansionary policy stance had three adverse consequences: an increase in domestic inflation, a worsening of the current account balance, and a continued buildup of external debt. The declining trend of inflation was reversed: having fallen from about 37 percent in 1997 to 7.6 percent in 1999, it rose to 11.6 percent in 2000. The increase in food prices was particularly sharp, with the price of meat alone rising by about 30 percent. This had an adverse effect on the living standards of the urban poor, who spend most of their income on food. The current account deficit remained high at close to 15 percent of GDP in 2000. Large current account deficits in recent years have led to a rapid accumulation of external debt, which almost doubled from $532 million in 1996 to about $935 million in 2000, or from 46 percent of GDP to close to 100 percent of GDP. About 53 percent of this debt is owed to multilateral institutions, 40 percent to bilateral institutions, and the remainder to commercial sources.

The landslide victory of the Mongolian People's Revolutionary Party in the general elections of July 2000 ended the political instability that had characterized the country since 1998. This should reverse the economic policy drift of recent years. The new Government has made a modest beginning at macroeconomic stabilization with a budget for the year 2001 that plans to reduce the fiscal deficit from about 11 percent of GDP to 7.4 percent in 2001. As the economy stabilizes, Mongolia should be able to lay the foundations for faster and sustained economic growth over the medium term. GDP growth is likely to pick up to about 3 percent in 2001 and to about 4 percent in 2002. While gross domestic investment is expected to stabilize at a more sustainable rate of about 25 percent of GDP, gross domestic savings should gradually rise from about 19 percent of GDP in 2000 to about 22 percent in 2002. Both these elements should contribute to a decline in the current account deficit to about 10 percent in 2002. In addition, the external economic environment is likely to be slightly more favorable in 2001 and 2002 than in the recent past. The prices of copper and cashmere, two of the most important export items, have improved in the international market, which should reverse the deterioration in the terms of trade that the economy has experienced since 1999, thus easing the balance-of-payments situation. Moreover, growth in the Russian economy has accelerated, which should provide a positive external impetus. With the reduction in the current account deficit, growth in the country's external debt is likely to be contained to modest levels. The stabilization measures should also lead to a decline in inflation to about 8 percent in 2001 and about 6 percent in 2002. Higher growth and lower inflation should enable some dent to be made in the unemployment and poverty figures.

Issues in Economic Management

Any improvement in the economic outlook depends on the Government's commitment to effective economic management, which in particular should focus on progressively reducing the fiscal deficit to levels that concessionary foreign sources can finance, and on strengthening the country's agriculture sector.

Fiscal consolidation is required to bring aggregate demand in line with aggregate supply, and is the most pressing need for macroeconomic stability. Although the 2001 budget plans a significant reduction in the fiscal deficit, it makes very little effort to contain government spending, where the key challenge is to contain current expenditures, especially wages, goods, and services (which together constitute about 17 percent of GDP), and indirect subsidies to state enterprises. While direct subsidies to nonfinancial state enterprises have largely stopped, indirect subsidies through preferential input pricing, noncollection of debts, and exemptions from import duties have increased in recent years. The Government needs to make a concerted effort to contain these costs.

Strengthening agriculture is likely to minimize supply-side shocks to a predominantly agricultural economy, and requires immediate attention from the new Government. Bad weather over the past two years has caused severe harm to the sector and to the people who depend on it. Although the Government has taken measures to promote broad-based agriculture-including deregulation of agricultural prices, privatization of livestock, and liberalization of agricultural trade-the sector faces various constraints. Many of the new private owners have little knowledge of how to manage their assets in a market economy. The supply of critical support services, previously organized and controlled by the Government, has deteriorated and left a vacuum that the private sector has not yet adequately filled. Inadequate rural finance and marketing facilities have further hampered the sector's development.

Policy and Development Issues

The main task facing the Government is to bring down the high poverty rates, in part caused by the low-growth environment of recent years and by a weakened social safety net. The collapse of the command economy and the subsequent steps in the transition to a market economy, including privatization, led to severe unemployment, as well as to reduced public provision of health, education, and other social services, weakening the scope of the social safety net. In response, the Government made some attempts to develop alternative approaches, such as social insurance and health insurance programs. Despite these measures, the social safety net remains inadequate for the many people who have lost their jobs. Since 1995, the proportion of people living below the official poverty line has remained high at about 36 percent, while both the depth and severity of poverty have increased. The poor, especially small livestock herders, the urban poor, and street children, are highly vulnerable to even minor external shocks, adverse weather patterns, and negative effects of the transition process. Besides fiscal consolidation and restoration of macroeconomic stability, progress in poverty reduction over the medium term will depend crucially on the Government's success in generating faster economic growth and employment, and in strengthening overall standards of governance.

A strategy of generating faster growth and hence employment over the medium term should rely primarily on improving the productivity of investment, both in the public and private sectors. At more than 25 percent of GDP, Mongolia's investment rate compares favorably with that of many developing countries with similar incomes. However, the productivity of that investment (as measured by the capital-output ratio) is low and falling. Investment in Mongolia is only about two thirds as productive as investment was in the fast-growing Asian economies before the financial crisis. Domestic investment is roughly split between the public and private sectors; about half the public sector investment is made by the national Government and the remainder by state enterprises.

Efforts to improve productivity of public investment should start with state enterprises, especially in the copper, coal, and power sectors. A combination of low energy prices, production inefficiencies, and inadequate application of commercial principles in financial relationships between enterprises has led to a massive buildup of operational deficits that are financed by interenterprise arrears and borrowings from the domestic banking system. To improve investment returns, restructuring these state enterprises is crucial, and the new Government has committed itself to this, including some privatization. The medium-term strategy to reform them should concentrate on improving technical efficiency, strengthening internal enterprise governance, and imposing market discipline.

Improved productivity of private investment requires the reforming and restructuring of the financial system. Despite recent measures to strengthen the banking system, including the liquidation of two large insolvent banks, the doubling of minimum capital requirements, and the revocation of licenses of banks that do not meet minimum capital requirements, further measures are needed. These include curtailing public sector borrowing from the banks, phasing out the Government's role as owner of the banking system, and reinforcing its role as an arm's length banking regulator.

Efforts to strengthen overall governance standards should focus primarily on reforming the civil service and improving public sector management, and establishing a legal infrastructure to support the private sector and a market economy. At present, the structure and functioning of the civil service are highly centralized, with pay and benefits centrally determined and a single annual entrance examination. New management methods and regulations are required, in particular a more performance-based approach. Recognizing this, the Government has embarked on a 10-year program of public administration reform.

Compared with other small transition economies, Mongolia has made significant progress in laying the foundations for the development of a private sector, which now accounts for about 60 percent of GDP. Despite this progress, the lack of clearly defined property rights, especially with regard to land-ownership, is constraining private sector efficiency. The fact that land leases are not transferable impedes infrastructure development on leased land. Similarly, the prohibition of private ownership of cropland impedes investment in agriculture. Over the medium term, measures to reform the land tenure regime need to focus on amending the Land Law to allow for the transfer of leases, establishing a national land information system, and approving the draft Land Privatization Law and the Land Ownership Law (which were submitted to Parliament in 1997 but have yet to be approved).

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