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p. 1 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Country Strategy and Program Update 2007–2009

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I. Current Development Trends and Issues

1. This country strategy and program update (CSPU) for 2007–2009 covers developments since the country strategy and program (CSP) for 2006–2008 was endorsed in October 2005. While the overall program priorities in the CSP remain relevant, changes have been introduced to account for the Government’s recently refined strategic approach, the initial assessment of ADB’s managing for development results (MfDR) agenda, heightened concerns about governance, the priorities identified in ADB’s second medium-term strategy (MTS II),¹ and the need to harmonize ADB’s strategy and program with the priorities of other sources of funds. The CSPU covers private sector operations. A consultation mission in April 2006 confirmed that the Government expected ADB to maintain the program directions of the CSP. A country programming mission from 12 to 20 June 2006 discussed details of the program with the Government. Table A1.1 in Appendix 1 indicates progress toward the Millennium Development Goals (MDGs) and targets.

A. Recent Political and Social Developments

2. The coalition of the Mongolian People’s Revolutionary Party (MPRP) and the Motherland Democracy Coalition (MDC) collapsed in January 2006 following the resignation of MPRP cabinet members. A new cabinet consisting of members of the MPRP and minor parties was formed. Civil unrest in April 2006 over the negotiation of a stability agreement with a major foreign mining company dissipated when protestors and the Government agreed to civil society participation in negotiations. Parliament passed laws on the tax regime, windfall taxes on copper and gold revenues, anticorruption measures, and mineral extraction.

3. Three issues underlie ongoing political debates in Mongolia. The first is the popular perception, sharpened by rising international commodity prices, that Mongolia may not be receiving its fair share of mining sector profits. The outcome has been the passage of windfall profit taxes, which have implications for foreign direct investment.² The second is the recognition that many Mongolians have failed to benefit noticeably from the transition to a market economy. As a result, promises made during the last election resulted in a program to provide cash payments to poor families with children. The program was later extended to all families with children. The third issue, which largely is discussed within Government and Parliament, is the proposition that Mongolia could grow more rapidly by increasing its borrowing. Despite new loans and grants from external funding agencies, some in Government believe that the time has come to go beyond the donor funding that has supported the transition over the last 15 years and seek non-concessional resources to develop infrastructure, industry, and the mining sector.

B. Economic Assessment and Outlook

4. As anticipated by the CSP, the 6.2% growth in gross domestic product (GDP) in 2005 was lower than in 2004, a year marked by the rebuilding of livestock herds and an expansion of mining. The annual GDP growth rates predicted by Asian Development Outlook 20063 for 2006 (6%)³ and 2007 (5%) are likely to be exceeded because of continued buoyancy in international commodity markets. Nevertheless, the medium-term growth outlook is fundamentally unchanged. Mongolia’s undiversified economy remains vulnerable to changes in the prices of a few commodities and to the weather. The amended budget passed by Parliament in May 2006 includes payments for all children under 18 and other social expenditures that many external funding agencies consider poorly targeted. Parliament also passed laws raising the threshold for the dual corporate income tax structure to MNT 3 billion and rates of 10% and 25%; reducing the value-added tax (VAT) rate from 15% to 10%, and instituting a flat personal income tax rate of 10%. These changes will have significant revenue implications and, while windfall taxes on mineral revenues may balance them to some extent in the short term, the longer-term fiscal implications could be serious, particularly if international commodity prices deteriorate.

5. The Government has been pursuing a range of external funding opportunities. In June 2006, Parliament approved a $300 million loan from the People’s Republic of China (PRC). The loan is partly under government guarantee and is mainly in the form of private export credits for investments in infrastructure and natural resources. The Government has been exploring the potential to issue international bonds to raise funds for infrastructure investments and credit lines for the manufacturing sector. Negotiations with the Millennium Challenge Corporation (MCC) are ongoing and a compact could be signed by the end of 2006, potentially making available $300 million of MCC grant funds.

6. The Government has announced its intention to refine its aid coordination efforts in conjunction with its commitments to achieving the MDGs. Efforts are underway to develop a national development strategy based upon the MDGs. This will have sector strategies linked to investment plans that will be presented to external funding agencies. While national development priorities have remained unchanged since the endorsement of the CSP, the explicit link to the MDGs and investment programs will require a more rigorous definition of sector strategies and explicit investment commitments from external funding agencies.

C. Implications for Country Strategy and Program

7. The overall directions of the CSP remain relevant to meeting Mongolia’s development needs and poverty reduction priorities in the medium term and to MTS II priorities in general. However, changes are needed to support the strategic approach being adopted by the Government, respond to an initial assessment of progress in managing for development results (MfDR), increase support for improvements to governance, improve alignment with MTS II priorities, and coordinate better with potentially larger inflows of funds.

8. Supporting the Government’s Strategic Approach. While the Government’s strategic priorities have not changed since the CSP was endorsed, the explicit commitment to achieving the MDGs and the adoption of a strategic approach to investment planning make it crucial for ADB to orient its operations toward formally agreed, rigorously defined, and institutionally supported strategic priorities of the Government in individual sectors. ADB will have to support the Government in defining strategies, align its projects with strategic guidelines, and ensure that support is available for strategy implementation. The Government intends to convene technical meetings with external agencies at 6-month intervals to coordinate their funding with the Government’s development strategy and investment plan. ADB will participate actively in these meetings and will retain sufficient flexibility to allow conclusions to be fed into its program.

9. Continuing the MfDR agenda. The assessment of progress on the MfDR agenda during the latest country portfolio review mission (CPRM) suggested that capacity building for MfDR will be most useful if it is undertaken in association with portfolio management. More systemic issues need to be addressed through a consolidated approach involving the major players. Based on this assessment and with the aim of maintaining a strategic focus on scaling up ADB’s development effectiveness in line with MTS II, projects will need to pay particular attention to MfDR, to strengthening monitoring and reporting systems of sector ministries, and to building capacity at these ministries.

10. Improving Governance Focus. As proposed by the CSP, support is being mainstreamed within projects toward the MTS II priority of improving governance and preventing corruption. Nevertheless, projects will have to pay careful attention to the increased demand from civil society for transparency and good governance, for example by designing projects that reflect transparent results-based management and enable civil society participation in monitoring and implementation. Particular priority will need to be accorded to the key result areas of the Second Governance and Anticorruption Action Plan.⁴ These include strengthening governance and anticorruption policy implementation in program and project design, enhancing program and project administration and portfolio management, and improving functional assignments of accountability and responsibilities, organizational structure, human resources, and access to expertise.

11. Better Alignment with MTS II Priorities. Overall CSP directions are in line with the MTS II strategic priorities of strengthening inclusiveness and promoting regional cooperation and integration. However, individual projects need to focus on catalyzing investments and managing the environment, in some cases by using ADB’s Private Sector Operations Department (PSOD) to catalyze investments and involving the private sector in project design.

12. Harmonization with Other Sources of Funds. Projects will have to explore innovative ways of harmonizing ADB lending with the priorities of other sources of funds. In addition to being in line with ADB’s commitments under the Paris Declaration on Aid Effectiveness, such harmonization is particularly necessary in Mongolia as more alternate sources of funds are now available than at CSP preparation. Greater potential for funding from the private sector has increased the relevance of public–private partnerships and created a need for instruments to reduce borrowing costs. Coordination with private sector funding also reflects the MTS II priority of catalyzing investments. More grant funding makes it necessary to design projects in close coordination with external agencies and ADB will actively participate in the technical meetings convened by the Government and strengthen partnership agreements with other external funding agencies. If grant funds from the MCC are forthcoming, ADB will need to take this into account in any lending in the transport, health, and education sectors.

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