Seok Hyun Yoon: Mineral resources alone do not guarantee prosperity

An interview with SeokHyun Yoon, an IMF resident representative on recent economic conditions and future prospects. 

– What policy advice does the IMF give to policymakers at this juncture where cross-country sanctions and geopolitical stability continue to influence the economy and business environment?

– Given the already-high inflation, anemic economic recovery, and large uncertainty, the Russia-Ukraine crisis is underscoring two difficult policy tradeoffs for the government and the Bank of Mongolia (BOM): supporting the vulnerable and rebuilding fiscal and external buffers; and fighting inflation and safeguarding the recovery. The growth outlook is uncertain, while double-digit inflation is likely to continue throughout the year. The anti-pandemic support pushed up Mongolia’s external public debt significantly, and a rise in global interest rates is making debt repayments more costly. At the same time, continued higher mineral export prices may provide some offsetting gains but present complex challenges, given Mongolia’s history of boom-bust cycles.  Against these challenges, policymakers should have in mind the following:

• Fiscal policy will need to tread a difficult path between consolidation and fiscal support. Any additional fiscal support provided to mitigate the impact of economic shocks should be temporary and targeted. Permanent changes in policies—such as large real increases in minimum pensions to boost real incomes or additional permanent increases in universal social transfers—may undermine consolidation efforts and should be avoided. The BOM should remain vigilant to the impact of price pressures on inflation expectations. Policy rates are needed to ensure that forward-looking real rates are positive, and to signal the BOM’s commitment to fighting inflation.
• The current economic uncertainty should not deter the government from its plans to undertake a decisive implementation of strong structural reforms. Such reforms take time to design well and phase in and should stay on track to help Mongolia maximize the growth dividends from the export price boom once the current uncertainty has subsided. These include: strong governance and a reduction in corruption to ensure a conducive business climate; fiscal structural reforms like a pension; public investment management; progressive income taxation; and financial sector reforms.

– The public perceives that the bank IPO was delayed because the Mongolian stock exchange does not have much experience with large IPOs. How will a successful IPO of banks impact the country’s economy?

– We support the banking reform strategy adopted by Parliament which aims to strengthen bank capital and reduce shareholder concentration through bank IPOs. That said, the strategy involves achieving multiple complex reforms within a timeframe specified by Parliament which we consider to be too narrow. We have stressed the need to sequence the various steps carefully to ensure the success of this strategy. An important first step would be to conduct a new asset quality review (AQR) by an independent international auditor ahead of the IPO. The AQR is a critical step that would help the BOM ensure that bank balance sheets have not been adversely affected by the multi-year forbearance measures that were put in place when the pandemic started, and still continue. Against this backdrop, we suggested delaying the IPO deadline until the BOM has been able to examine the bank balance sheets on the basis of the AQR. Therefore, the postponement of the IPO launch to June 2023 is a welcome step. Since there is no history of significantly large IPOs in Mongolia’s thin capital markets, delaying the IPO deadline would allow the necessary pre-conditions for successful IPOs and contingency plans to be put in place. It would also provide time for regulatory reforms, notably insolvency framework and creditor rights, to be enacted as they will be necessary for resolving non-performing loans.

Successful IPOs of banks would contribute to a long-term sustainable, inclusive, and positive economic growth through multiple channels. First, IPOs would strengthen banks’ capital position, which helps banks increase their lending capacity at a cheaper rate to the private sector. Second, IPOs would strengthen external oversight over banks, which will help make banks’ operation more transparent. Third, IPOs would help reduce banks’ shareholder concentration, which will help strengthen banks’ internal governance and controls. Fourth, successful IPOs would strengthen foreign investors’ confidence on Mongolia’s banking system, which will help banks attract more investment abroad.

– June inflation reached 16.5%. What measures the BOM should take to reduce the inflation rate?

 The growth outlook is uncertain, while double-digit inflation is likely to continue throughout the year

– Since August 2021, CPI inflation has been exceeding the BOM’s target (8 percent) on account of supply-side factors—due to border closures with China— affecting import prices. The pace of inflation has recently accelerated as global food and energy prices have risen quite fast in part due to the impact of the Russia-Ukraine crisis. Inflation is expected to remain in double digits throughout the year, largely due to supply side and global factors.  Going forward, it will be critical to ensure that recent inflation increases do not de-anchor expectations and jeopardize its ability to reduce inflation back to the BOM’s target range. In particular: We have long argued for phasing out the BOM’s quasi-fiscal operations because they constrain the BOM’s monetary policy effectiveness. Continued vigilance is needed to ensure that inflation expectations do not become unanchored.

The BOM should carefully monitor the impact of the extension of the anti-pandemic stimulus to end-2022 and the minimum pension increase, and forthcoming minimum wage increases on inflation. In case a wage-price spiral begins to materialize, further tightening will likely be needed. The BOM should also step up its efforts to better understand inflation expectations as it could be a crucial input into its monetary policy decisions.

– Since Jan. 2022, the togrog has depreciated against the USD. In addition, falling international reserves hit hard businesses. Down the road, what measures could be effective in terms of reducing the exchange rate volatility risk and build up international reserves?

– After hitting a peak in April 2021, the BOM’s gross international reserves fell to US$2.9 billion at end-July 2022. This reflects a combination of lower export receipts, a pickup in imports reflecting the domestic economic recovery, the BOM’s efforts to stabilize the US$/MNT exchange rate, and the extremely strong US dollar against global currencies. The BOM’s gross international reserves appear to be adequate in terms of import coverage but remain insufficient given the country’s large external debt and heavy import dependence. 

Against this backdrop, the BOM’s recent move to allow the exchange rates to respond to market forces is appropriate. We would urge the BOM to boost international reserves by opportunistically intervening in the domestic FX market, given improvements in coal exports . At the same time, the government should reduce its external liabilities via fiscal consolidation, structural reforms to reduce longer-term fiscal pressures, continue improvements in external debt management and develop the domestic debt market to reduce reliance on external borrowings. Greater exchange rate flexibility will be a difficult trade-off as it will pass through to inflation.

 The BOM should also step up its efforts to better understand inflation expectations as it could be a crucial input into its monetary policy decisions.

However, given high uncertainty about the external outlook and a significant amount of external debt repayment due in 2023, it is important that the exchange rate continue to help act as a shock absorber at a time when Mongolia is facing a number of external shocks. FX intervention should therefore be limited to disorderly market conditions. Greater exchange rate flexibility would also help improve the incentives for the private sector to properly manage exchange rate risks stemming from their external liabilities.

– Commodity exports are critical to overcoming economic difficulties. At this juncture, how Mongolia should develop and launch its mega mining projects?

– Mongolia’s mining industry is the country’s growth locomotive, and we expect it to remain so in the foreseeable future. Rising export commodity prices contribute to increasing fiscal revenues, which would provide some breathing space to address lingering economic challenges arising from the pandemic. Given this background, we welcome the expeditious renegotiation of the Oyu Tolgoi (OT) investment contract that should help the second phase of the project to begin and help Mongolia reap the economic dividends from rising export prices.  However, cross-country experience suggests that mineral resources alone do not guarantee prosperity: many countries blessed with natural resources have been plagued by boom-bust cycles. Mongolia is not an exception—it has experienced similar economic volatility due to procyclical policies. Therefore, it is important for Mongolia to maintain sound macroeconomic policies to better harness the windfall of rising commodity prices, instead of repeating the boom-bust cycles of the past. Continued strong policies can help ensure that Mongolia’s substantial mineral wealth yields enduring growth that spreads prosperity to all Mongolians.  Given the Parliamentary elections scheduled for mid-2024, 2022, and 2023 provide a critical opportunity for Mongolia to successfully implement bold policy reforms to lay a solid foundation for addressing its longer-term challenges.

– What is the medium and long-term outlook for Mongolian economy from the IMF’s perspective? What should be done to achieve more sustainable and inclusive growth?

–  Although there is considerable uncertainty in the near-term because of the ongoing supply bottlenecks and geopolitical tensions, and a projected slowdown in major trading partners’ growth, Mongolia’s medium-term growth outlook remains strong. The OT underground mine, a key growth driver, is expected to come online in 2023. Provided developments in China do not excessively limit coal exports, growth can be expected to remain strong around 6-7 percent over the medium term and moderating to 5 percent over the longer team. 

More broadly, Mongolia has strong economic opportunities, particularly in mining, agriculture, and tourism. Mongolia’s relatively small population, untapped resources, and access to a large and fast-growing market at its border is a combination that many countries would envy. It would be important to improve the business climate in Mongolia to make the most of these endowments. This would require revamping the insolvency framework, addressing corruption, judiciary and governance reforms, improving physical infrastructure, addressing climate change, and implementing policies that ensure macro-financial stability and sustainability. In this context, we welcome the government’s long-term development strategy, Vision 2050, which rightly prioritizes macroeconomic stability and green and sustainable development goals. 

Similarly, the government’s new economic revival policy which aims at cutting red tape through digitalization and e-governance to harness positive structural change is commendable. The most important challenge will be to design and enact good policies to achieve these worthy policy goals.

– During the IMF mission’s visit last April, Ms. Banerji, the IMF Mission Chief for Mongolia, said that the IMF stands ready to collaborate on tax policy reform. Which areas require a tax policy reform? What is the benefit/significance of this reform?

– The taxation of personal income in Mongolia is somewhat regressive. The personal income tax (PIT) by itself is slightly progressive because the universal credit is relatively more valuable to low-income taxpayers than high income taxpayers, and otherwise all taxpayers pay the same PIT rate of 10 percent. However, the cap on social insurance contributions dramatically reduces the effective tax rate for higher income individuals. As a result, the current PIT system should improve in line with basic taxing principle, i.e., collecting progressively more from those with higher incomes for equity objectives.Against this backdrop, the Government of Mongolia (GoM) intended to explore reform options to introduce progressive PIT and requested the IMF’s technical assistance. The IMF is currently undertaking an analysis of options for increasing progressivity in the current personal income tax.In the short run, the progressive PIT would help reduce income inequality by taxing less for low-income earners and more for high-income taxpayers. In the long run, raising revenues through progressive personal income taxation would be an equitable way to fund vital necessary investments in education, health, and infrastructure to improve medium-term growth prospects.

– Mongolia has large amount of external debt relative to the size of economy. To improve debt management, what are the areas to pay attention? Do you believe that there will be no need for the IMF to propose a program to Mongolia?

– Most of external debt increased during the last decade, due to large investment in mining and rising public external debt. In 2021, Mongolia’s external debt improved marginally. The use of government deposit drawdowns to finance the fiscal deficit and the OT mine external debt repayment helped reduce Mongolia’s external debt. However, external debt remains much weaker than any other resource rich emerging market economies and also is projected to remain very large, although declining. Given this background, the government should reduce its external liabilities via fiscal consolidation, structural reforms to reduce fiscal pressures over the longer-term, continued improvements in external debt management and by developing the domestic debt market. At the same time, the BOM should continue to proactively reduce its foreign liabilities. To improve opportunities for domestic financing, banking sector reform should be pursued. With regard to an IMF-supported program, the authorities have not requested financial support from  the IMF.