As the economic effects of the COVID-19 pandemic unfold, the most severe casualties of “The Great Lockdown” are resource-dependent economies with limited institutional capacity to respond to the crisis. Their supply chains have been cut off, their markets are disrupted, and their investors are crowding out. Many of these countries have high external debt and an obligation to repay it in the medium term or they will face the trilemma of registering a double-digit growth, accruing further debt, or defaulting.
Come 2021, Mongolia, a superlatively resource-dependent economy, will be at the center of this trilemma. The immediate cause of Mongolia’s current state is its inconsistent fiscal expenditure and its undiversified mining economy. Over the years, fiscal mismanagement of the previous administration overshot the country’s sovereign debt while little was done to save the economy from commodity price shocks. The inability to repay this debt put Mongolia in a financial crisis even before the pandemic. Now that a subsequent and even worse crisis is underway, there is greater reason for fiscal prudence. The central question becomes: Can Mongolia spread the risk of its default?
Before addressing Mongolia’s crossroads, the question of how it reached this crisis is crucial to answer. In 2013, the Democratic Party’s (DP) government in power began to overshoot its capital expenditure through the Development Bank of Mongolia (DBM). These were off-budget expenses aimed to win over votes in the 2016 Parliamentary Election. The DP government began subsidizing household mortgages, student loans, and credit for herders. Nonetheless, it lost to the Mongolian People’s Party (MPP) in 2016. A mammoth task for the new administration was to repay a $1.5 billion bill for its Chinggis 5-year bond in 2017-18. Without the capacity to repay this debt and experiencing an ongoing commodity-price crisis, the new government instead swapped the old bonds for new $700 million worth of ‘Gerege bonds’ at an interest and sought the IMF’s Extended Fund Facility (EFF) for the remainder. In return, the IMF required Mongolia’s government to implement a Fiscal Stability Law (FSL). The FSL limits the government’s budget expenditure (thereby prioritizing what expenses are important and what are not) and secure a Fiscal Stability Fund (FSF) of 5% of GDP independent of government interference.
Over the years, the EFF has helped Mongolia avoid off-budget capital expenditures and the country’s reserves have grown, but it has also put Mongolia on a low-growth trajectory, whilst the debt and its service coverage has swollen. The country’s ability to repay approximately $4.8 billion in maturities during the pandemic and until 2024 now rests on the assumption of high mineral exports.
Mongolia heavily relies on copper and gold exports to China and Switzerland to sustain its economy. In recent years, price increments in both commodities have favorably improved Mongolia’s reserves. However due to the pandemic, major supply chain cuts have caused a 20% decline in copper prices—effectively reducing export value. On the other hand, a recession has triggered a gold rush, appreciating gold value by 20%. Naturally, Mongolia’s government is relying on gold exports to pay off its debt. This dependence on solely mineral exports is extremely risky. If a second wave of pandemic creates a household liquidity crisis in Europe, the market for gold will wane and the cost of Mongolia’s debt will increase to a high of 17%. Therefore, the goal should be to minimize not only external government debt but also the preconditions of a “Dutch Disease” that could eventually cause a bailout.
One quick way to roll over this existing debt is through swaps as the Mongolian government did with the People’s Bank of China (PBoC). Over time though this practice only creates a debt overhang and increases financing costs. Right now, Mongolia has no option but to minimize its capital expenditure until 2025. This means limiting quasi-fiscal spending, such as mortgage relief beyond the $99 million given by IMF’s Rapid Credit Facility (RCF) for COVID-19 recovery. It also means putting other infrastructure projects on hold.
Another way to mitigate the government’s risk would be to invite privatization through equity in the mining supply chain. However, this requires a shift in the parliamentary ideology towards foreign equity and legislative changes towards corporate taxation. In all likelihood, the government will end up focusing more on taxation policy recommendations by the World Bank instead of taking over a stake in various mining projects. It is this endowment effect mentality that put Mongolia into this debt cycle in the first place, and it seems an attitude shift is politically unlikely. Policies like improving investment tax credit for short term projects and reducing expensing will help stabilize the primary balance but also put the country on a growth trajectory.
At the same time, the role of the Fiscal Stability Fund (FSF) needs to radically shift from stockpiling mining and non-mining cash to acting as an investment vehicle. The FSF needs to move its investments towards non-mineral sectors to avoid “Dutch Disease.” Investments in dairy livestock industries tend to generate high fiscal multipliers during recessions like the one caused by COVID-19. Given Mongolia’s competitiveness in this sector, the FSF can make investments based on asset quality, whereas using the IMF’s Rapid Credit Facility stimulus can generate immediate recovery. Of course, these interventions work only if the FSF functions independently of parliamentary interests and is not diverted to off-budget expenditures.
Mongolia being debt-free remains a far-off dream and its mineral-driven driven growth is unsustainable. What it needs is less external financing and more prudent internal public investment management frameworks that limit bad loans. It needs a fiscal revenue stream that steers away from minerals, a market economy that can rebuild private investor confidence after the pandemic, and most importantly steady leadership that prioritizes financial discipline over ‘stop-and-go’ measurements. Otherwise, it faces a sovereign default that will come to be just another example of the dreaded resource curse.