Will IMF intervention help save Mongolia from Dutch disease?

Mongolia is holding its breath as the government rushes to close a deal with the IMF to get its hands on badly needed foreign currency. This would ease the pressure on its budget and help it cope with another year of flat growth.

A final agreement, expected by the end of February, would help the government to meet a $580m repayment for a note issued by the state-owned Development Bank of Mongolia due in March, which makes up almost half of the country's current foreign reserves. It would also set the agenda for a fiscal consolidation that can no longer be delayed.

“It’s not only about bringing in some necessary foreign currency, but more importantly bringing in technical advisors to help the Mongolian government implement their own macroeconomic discipline programme in terms of cutting fiscal expenditure, looking at ways to raise revenues, but also making sure that social spending remains in place for poor and key [areas such as] education and health,” says Tuyen D Nguyen, the resident representative of the International Finance Corporation in Mongolia.

“Only with that will the foreign investors be able to start looking [again] at Mongolia. Without macro stabilisation, FDI will not come back.”

Boom and bust

Isolated, sparsely populated and commodity-rich, Mongolia hit the headlines several years ago when it became the darling of frontier market enthusiasts. At the time, Rio Tinto led a mining frenzy that unveiled the country’s vast, largely untapped mineral potential. Foreign investment spiked up to unprecedented levels reaching $4.7bn, or 53% of GDP in 2011, propelling annual economic growth to 17.5%.

However, the slowdown of neighbouring China (the only buyer of its mining exports), combined with the end of the commodity super-cycle, swiftly ended the economic boom and highlighted the weakness of Mongolian institutions that was largely ignored in the more prosperous years. Economic growth waned, foreign investment dried up, while the fiscal deficit and sovereign debt ballooned, all signs of the ‘Dutch disease’ – where a country becomes over-reliant on one sector to the detriment of others within its economy – that had taken hold.

The authorities pinned their hopes on a long-stalled multi-billion-dollar underground expansion at Rio Tinto’s massive copper and gold deposit, Oyu Tolgoi, to bring back investment and growth. Although works finally kicked off in 2016, it could not prevent the country from becoming stuck in an economic malaise. Its GDP shrank by 1.9% in the first nine months of 2016, from 9.1% growth a year earlier, while the total fiscal deficit rose to 19.5% in full-year 2016 and the tugrik depreciated by 24% against the US dollar.

FDI also plummeted, and the country experienced a net outflow of more than $4.12bn in 2016, from a positive net inflow of $121.5m a year earlier, according to figures from the Bank of Mongolia.

“Going forward, [Mongolia] will have to try to find different avenues to build the economy underneath mining so that you have some shock-absorption capacity there,” says John Bell, CEO of Khan Bank, the country’s largest bank. “One area I’d be interested in seeing developed is renewable [energy], and I think also tourism is an area that can be explored, with new infrastructure outside Ulaanbaatar.” 

Diversification efforts

While the mining sector alone still accounts for 25% of GDP and 67% of exports, Mongolia has recognised the potential for development in other fields such as solar and wind power, with a handful of renewable energy projects coming online in spite of the country's antiquated transmission system.

Additionally, its combination of pristine steppes and centuries-old nomadic culture make it a quirky and increasingly popular destination for tourists. With a real recovery not expected until 2018, the ruling Mongolian People’s Party, which returned to power with a landslide electoral victory in 2016, now seems committed to securing a deal with the IMF.

After this, it must make good on its promises to stabilise the economy if it is to lure back investors and develop the country's economy beyond mining. If not, Mongolia could struggle to recover from the Dutch disease that has hindered its development.