^{source: World Bank}

February 2009

The World Bank has released statements asserting that if the Mongolian government handles the economic situation smoothly, the nation will be able to manage their fiscal policy and the country will have an opportunity to improve its economy over the next several years. Mining is likely to remain a significant source of public revenue in the medium term as two world-class mines are expected to come online. However, public expenditures have increased rapidly, thereby limiting fiscal flexibility. In addition, parliamentary power over the annual budget is significant, leading to large budget changes without any input from the executive branch.

Here is a summary of the measures that the World Bank recommends Mongolia follow in order to address the economic crisis: 1) Separate public spending decisions from the mining sector each year;  2) Adopt fiscal rules which apply to the medium term budget framework and general budget to keep the non-mineral deficit under control; 3) Review good international practices and conduct consultations; 4) Draft legal provisions according to international standards.

On February 3, the World Bank completed a review called “Mongolian Public Expenditure and Financial Management”. The review was introduced to state organizations, and will continue on February 5 at the Ministry of Education, Culture and Science. The review assesses the achievements and remaining challenges for public expenditures and financial management. It was prepared by a core team lead by Genevieve Boyreau and concluded that Mongolia’s external economic outlook is dramatically changing as it faces sharp reductions in the price of copper, caused by the financial crisis and global downturn.

The review compels the government to drastically cut spending in order to prudently manage the budget. The budget is extremely dependent on mining revenues and the government is taking the right step in proposing a balanced budget for 2009. But further adjustments will be needed given the continuing fall in copper prices. A prudent fiscal stance will also be needed to manage inflation, which accelerated in the past year to over 30 percent (August 2008).

The current situation of Mongolia highlights the need to manage mining revenues more successfully than in recent years. Mongolia preserved little during the boom years, but instead, dramatically increased expenditures on wages and salaries, and poorly-targeted social transfers. Adopting a multi-year fiscal framework—which enforces saving during the boom years, sets limits to expenditure growth and debt, and ensures transparency to the public—can help.

Because a significant amount of the past windfall revenues have been spent (with Parliament in the driver’s seat), the country will enter a down-turn with little savings and high inflation.  This will force the nation to cut expenditures with every drop in the copper price.

To avoid such situations in the future, the government has the opportunity to adopt a transparent, multi-year budget framework for expenditures and investment. This includes adopting a new Fiscal Responsibility Law. It would ensure that the government saves during the “boom” years, so that it can continue to spend during the “bust” years. It would also set limits to expenditure growth and public debt. Within the limits set by this framework, Parliament can then exercise its constitutional rights to amend the budget.
Until recently, Mongolia had seen the most rapid increase in public revenues in decades. Public revenues have more than doubled in real terms in five years, reaching US$1.5 billion (40 percent of GDP) in 2007.

All this happened in the midst of a rapidly growing economy (9 percent over the last 4 years, on average), driven by a boom in mining and high world mineral prices. This mining boom boosted Mongolia’s public finances and fundamentally changed the environment in which fiscal decisions were made. Compared to the previous decade of sluggish growth, budget deficits, and payment arrears, Mongolia is now experiencing dramatic economic expansion, higher revenues, lower public debt, and fiscal surpluses.
Fortunately, financial management controls had been strengthened in public revenues prior to the boom. The promulgation of the Public Sector Management and Finance Law (PSMFL) in 2002 completely changed the legal and institutional environment for public finances, in particular by recentralizing revenue and expenditure management and strengthening budget execution. As a result, the potential for leakages has been reduced to a large extent, and predictability of budget execution has greatly improved (Chapter 2 - Public Sector Financial Management).

The outlook for Mongolia’s medium-term public finances is favorable. High mineral prices have stimulated exploration. With the expected opening of the new Oyu Tolgoi copper mine in 2011, economic growth is expected to remain at 7-9 percent per year until 2010 and to pick up at 12-14 percent in 2011-12. Even in the event of a decline in mineral prices, upcoming developments of world class mines in Mongolia is expected to boost the real economy.  As a result, Mongolia’s economic growth should remain sustained at high levels over the next decade.

The extent to which mining revenues translate into developmental outcomes will depend on how the medium-term fiscal space is managed and spent. Fiscal policy in resource-rich economies typically need to respond to a combination of objectives of macroeconomic stability, expenditure smoothing, accumulating human and physical capital, and long-term international competitiveness in tradables.

Unfortunately, Mongolia seems to be falling prey to the same temptations that have seduced other resource-rich countries. Fiscal policy has turned pro-cyclical in recent years, led by a significant expansion of public outlays (in real terms, an increase of 88 percent in three years, 2005-2007). Incremental public expenditures have been directed to universal social transfers, and public wage increases and new public investments are with unclear prioritization.
In 2007 and 2008, the change in fiscal stance led to a large fiscal impulse that contributed significantly to inflation (15.1 percent by the end–December 2007, and up to 34 percent year over year in 2008).

The World Bank is recommending many things from the framework of the review, and it is not possible to include everything.
Below is a list of what seems most vital in relieving Mongolia’s economic turmoil:
- Adopt transparent fiscal rules as part of the medium term budget framework, in order to manage large increases in revenues and smooth expenditures over
Time.  This will help to mitigate real appreciation and to manage spending in line with the absorptive capacity of the economy and long-term competitiveness of tradables.
-Focus on improving medium term budget planning at the sector ministry level and to consolidate the gains to date.  As part of the budget preparation and approval process, the Minister of Finance should plan and pre-announce a timetable for discussing the executive budget proposal with media and civil society 2-3 weeks before the proposal is submitted to the Parliament.

-Strengthen management, as well as the capacity of Mongolia’s National Audit Office to conduct robust financial audits of Government Financial Management.
-Reduce heating costs by increasing capital maintenance funding; improving heating infrastructure (boiler, pipes, insulation, heat controllers), installation of meters, tying funds to consumption, and providing incentives to save.

- Encourage multigrade and multi-subject teaching in rural schools.
-Consider separating teacher pay from other variable costs by making direct payments to teachers.
-Commission an evidence-based study to assess the main social risks faced by different demographics
 -Work out a time plan for the gradual re-targeting of the Child Money Program to the very poor. This can be done by setting increasingly lower poverty lines over time so that an increasingly small percentage of families will reap the benefits until only very poor families are in need
- Organize consultations, with participation from civil society, in order to gain public support based on the evidence presented by others
- Train local social workers and create mechanisms to make them accountable,
-Set up an individual-level registry to track beneficiaries.