Only a few years ago, Mongolia was hailed as the world’s next economic dynamo.
“Mongolia is in the middle of an epic gold rush—think San Francisco in 1849—but it’s copper and coal that have enticed businessmen, investment bankers, and miners from London, Dallas and Toronto by the planeload,” Ron Gluckman wrote in Foreign Policy in 2011. (The publication also dubbed the country “Minegolia.”)
Five years later, things are much different. The economy is likely to contract for the first time in eight years. Unemployment is rising. The tugrug, the national currency, is in freefall, having lost nearly 25 percent of its value against the U.S. dollar since the beginning of the year. Household consumption has dropped by 20 percent in 2016.
The drop since 2011 in prices of commodities—specifically copper and coal, Mongolia’s most valuable natural resources—has played its part (a recent rebound notwithstanding). Foreign investment has dried up as mining companies have cut costs and consolidated operations worldwide. As a result, government revenues are much lower than expected. At 19.5 percent of GDP, Mongolia’s budget deficit will be one of the world’s highest this year.
The commodity price crash is not the only cause of low mineral revenue projections. Several tax agreements covering Mongolia’s biggest mines, Oyu Tolgoi and Tavan Tolgoi, are also of concern. For example, coal giant Tavan Tolgoi’s long-term offtake agreement, designed to repay debt owed by Mongolia’s state-owned mining company, is hampering the government’s ability to benefit from high coal prices in China. Likewise, the government’s double tax treaty with the Netherlands, which is locked into the government’s contract with Rio Tinto, could cost upward of USD 6.5 billion in unpaid withholding taxes over the lifespan of the Oyu Tolgoi mine.
Of course, lower revenues represent just one side of the deficit story. Higher spending constitutes the other. Government spending has tripled in nominal terms since 2010. Fiscal revenues, meanwhile, have only risen by 75 percent.
Unrealistic expectations of massive mining sector revenues fueled a spending spree starting in 2011. Government salaries, infrastructure costs and cash transfers have spiraled. For example, the government wage bill rose by more than 60 percent in nominal terms from 2012 to 2016.
The effects of Mongolia's economic downturn are visible in the capital, with half-finished hotels and office buildings dotting the skyline. (Photo: Andrew Bauer)
Lack of transparency has aggravated the situation. While the rapid deterioration in public finances in recent years was apparent, some opaque arrangements were not counted as official government liabilities. For instance, subsidized household mortgages, Development Bank of Mongolia debt, and loans for herders, students and rural households were kept off the books. The loans and mortgages were financed by the central bank. These programs together added 4 percent of GDP to the exploding deficit in 2016.
To compensate for the budget deficit, the government has resorted to substantial borrowing. Yet even this might not be possible for much longer. The government is already paying more than 10 percent interest on foreign currency-denominated debt. Domestic currency denominated sovereign debt rates generally exceed 16 percent annually.
As we recently wrote in the Mongolian Mining Journal, interest payments on debt alone cost the government in excess of MNT 1 trillion (approximately USD 400 million) in 2016, more than the government spent on healthcare. By next year, interest payments will likely exceed either the healthcare or education budgets. Owing to past mismanagement, the government is essentially transferring money to foreign financial institutions and domestic bank shareholders at the expense of greater social spending and public investment. As interest rates continue to rise, the government will have to radically increase borrowing just to roll over an ever growing debt stock.
Preliminary analysis using NRGI’s forthcoming macroeconomic model confirms that the current trajectory of Mongolia’s public finances is unsustainable in the absence of radical measures. Assuming short-term liquidity pressures are resolved (i.e., debt is rolled over and maturities are lengthened), that the external environment remains accommodating, and domestic growth picks up rapidly, our model projects debt remaining far above the legislated limit and spiraling upward from 2025 onward. This is if creditors do not take a major haircut on their lending to Mongolia and there is no drastic change in government policy.
The model also shows that from 2019 to 2024 there may be a temporary stabilization of headline deficit and debt, fueled largely by windfall revenues from the Oyu Tolgoi mine. After this period, the deficit starts widening again and remains large even if interest payments are excluded. So even if Mongolia had no previous debt, it would be rapidly building up a new debt stock. This shows that Mongolia is facing solvency crisis and debt sustainability challenges and not just a liquidity crisis, as in 2009 when the IMF and other creditors carried the country through a temporary commodity price crash. Without a significant cut in the debt level as well as a rethink of public spending priorities and expenditure controls—not just a temporary shrinking of the deficit or short-term bailout—Mongolia will not return to a sustainable debt path.
In short, Mongolia is facing a debt crisis unlike anything seen since the end of communism. Without debt restructuring or several new mines the size of Oyu Tolgoi coming online prior to 2024—a near impossibility—Mongolia is likely to stagnate under the weight of debt for decades. Furthermore, it may be unwise to bring new mines online quickly as a savior for Mongolia’s woes. Bad deals could set the country back for generations.
What to do?
It is not too late to avoid a chaotic sovereign default, whereby the government is suddenly unable to pay its bills. Several options are available to the government to stem the crisis.
Any bailout package—either from international financial institutions or foreign countries—will contain a mix of possible measures, which are outlined in an upcoming NRGI paper. Creditor conditions should minimize the financial harm inflicted on Mongolia’s most vulnerable citizens, for example by protecting some social programs. It will also be important to find a way to credibly commit to future fiscal sustainability and address financial tricks that have contributed to the crisis, such as borrowing by off-budget entities or central bank lending that principally benefits the wealthy. All major political parties could sign an agreement committing to future fiscal sustainability and creating binding mechanisms for fiscal rules compliance.
Mongolian authorities may wish to heed the lessons of South Korea, Russia and other countries that have faced sovereign debt crises, avoiding unnecessary privatizations that do not generate much revenue and taking a proactive approach to debt restructuring. Any package will likely require Mongolia’s creditors taking a haircut. Otherwise Mongolia’s economic growth could stagnate for years under the weight of high debt service payments. Just ask Greece.