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Battered Mongolia faces make-or-break moment

Government reforms, commodity upswing set stage for an economic resurgence

Dawn breaks over a smog-shrouded Ulaanbaatar. (Photo by Shinya Sawai)

The roller-coaster ride that was the commodity supercycle sent Mongolia's resource-driven economy pinwheeling from 17% growth in 2011 to an external debt crisis just a few years later. But with commodity prices rebounding and the IMF swooping in for an imminent bailout, many feel the worst may be over. Can the country -- so ripe with potential -- transform this moment into the lasting stability its people and businesses have waited so long for? 

ULAANBAATAR At about 4 o'clock on a mid-January afternoon, the temperature in the Mongolian capital was lower than minus 30 C. In spite of the cold, people could be seen lugging containers of water from a roadside water station to their homes in one of the many ger districts on the outskirts of the city.

These districts are home to more than 700,000 residents, most living in poverty. The districts lack water supply systems, leaving residents no choice but to buy well water at nearby stations for 1 tugrik (0.04 cents) per liter.

BUILT-IN PROBLEMS Ger districts sprang up in post-communist Mongolia when new land laws automatically entitled each citizen to a free 700-sq.-meter plot of land in designated urban areas. This prompted massive urban migration starting in the late 1990s by former nomadic herders looking for better education for their children and a more modern lifestyle. They brought their traditional tents, or gers, onto their plots, and settled down.

The land policy, however, was not accompanied by an urban development policy. Neither the national nor the city government has provided any infrastructure in ger districts other than electric power. Consequently, most of the people living in these neighborhoods -- more than one-fifth of the country's total population of 3.1 million -- have no plumbing, sewage, paved streets or schools.

A woman carries water in one of Ulaanbaatar's ger districts, where many lack access to drinking water. (Photo by Shinya Sawai)

The current recession is hitting these districts particularly hard.

At the edge of one ger district is a small supermarket. The 53-year-old store manager, who calls herself Tugszaya, said 8 out of 10 of the adults she knows have lost their low-skill jobs, such as load handling or truck driving, during the last few years.

"Most people have stopped eating luxury stuff like cakes even for the year-end holidays," she said. "They are cutting [back] on even basic foods to buy fuel for their stoves. Look how few shoppers we have."

One reason for this is the lack of education needed to secure better, more stable jobs. For ger districts lacking even schools for children, adult training centers for former herders remain a distant dream.

BIGGER PICTURE The lack of long-term planning and investment behind the trouble in the ger districts is reflected in the country's economic structure.

The mining sector accounted for as much as 25% of gross domestic product in 2015, coming in at $11.7 billion, while manufacturing accounted for just 9%. Copper, gold, iron ore and other metals made up 67% of exports that year, while coal and crude oil made up 23%.

Diversification is the obvious answer to Mongolia's economic woes, but this also requires broad-based, long-term efforts, such as promoting foreign investment, investing in education, and providing research funding.

Another clear risk to the country's economy is its extreme dependence on China as a trade partner. China took in 83% of Mongolia's exports in 2015 and accounted for 36% of imports to the country. A slight slowdown in demand or supply in this neighboring giant could easily play havoc with the Mongolian economy.

To diversify its trade partners, Mongolia needs to not only diversify its industry, but to also invest more in logistics infrastructure to improve connectivity with other countries.

The first freight train from China to the U.K. departed on New Year's Day from the eastern city of Yiwu and arrived in London later in January without having passed through Mongolia. Such a route would only have been an option if the country had an adequate rail system in place.

The obvious lack of social investment does not, however, mean that the Mongolian government has been short of funds.

Hundreds of thousands of former nomads live in <i>ger</i> tents on the outskirts of Ulaanbaatar. (Photo by Shinya Sawai)

WASTED OPPORTUNITIES Of the last 17 years, the country has achieved double-digit real annual GDP growth in five years and above-5% growth in six others, buoyed by commodity price upcycles. GDP per capita grew eightfold from 2000 to $3,967 in 2015, though this was down from a peak of $4,400 in 2013.

General government revenue grew from less than 500 billion tugrik in the early 2000s to over 5 trillion tugrik in recent years.

On top of that, the government and government-affiliated entities raised billions of dollars through foreign-currency bond issuances and international loans, especially starting from 2011, even though the country had just turned to the International Monetary Fund to rescue it from the 2008 financial crisis. Public external debt mushroomed from about $2.5 billion, or 31% of GDP, at the end of 2010 to $8.5 billion, roughly 85% of estimated GDP, in 2016.

So where has all the money gone? In a word, corruption.

For 70 years, Mongolia was a Soviet satellite ruled as a single-party state by the Mongolian People's Revolutionary Party. This communist leadership was toppled, and the country held its first democratic election in 1990.

Mongolia, in other words, is still a young democracy, and elections have revolved largely around factional power struggles. Politicians eager to get elected are quick to promise voters direct, short-term economic benefits.

In the 2008 election campaign, for example, both the ruling Democratic Party and the opposition Mongolian People's Party promised cash handouts of 1 million to 1.5 million tugrik (roughly $406-$609) for "every Mongolian" as a share of the nation's mining revenue. The coalition government that eventually formed later announced a multiyear plan to give each citizen 1.5 million tugrik, which would theoretically cost 65% of GDP in 2008.

This universal cash handout was actually implemented from 2010 through 2012, adding to the fiscal deficit and eventually increasing the country's dependence on external debt.

A 2012 law banned election promises of cash handouts, but politicians have continued finding loopholes. One involved the government buying back shares in a national mining company that had previously been distributed to citizens.

Conflicts of interest are rife in Mongolian government. Finance Minister Choijilsuren Battogtokh, for example, owns the country's largest real estate development conglomerate, Khurd Group, and is believed to be one of the country's richest people. Byambatsogt Sandag, the justice and internal affairs minister, is the chief executive of a road construction company. Both of these companies are engaged in public projects.

"Ministers and government positions are lucrative businesses," said Batsuuri Haltar, a prominent independent economist based in Ulaanbaatar. "Especially if they have their own businesses, they can make a fortune during their tenure."

Such widespread corruption has repeatedly disappointed foreign investors and aid donors.

A sovereign debt fund set up by the Development Bank of Mongolia in 2011, for example, attracted an over-subscription among foreign investors when it announced issuance of a five-year, $580 million bond the following year. The money was supposed to be invested in industrial zone development and other infrastructure projects under parliamentary supervision.

Around 2013, however, the chief executive of the DBM, who had been appointed by the Democratic Party, started using the fund without approval by the parliament. The Mongolian People's Party took the power in June, and he was arrested on charges of corruption in October.

Old and new rub shoulders as wind turbines rise over pastures outside of Ulaanbaatar. (Photo by Shinya Sawai)

The DBM bond is due on March 21. International lenders and aid donors are watching closely to see whether the Mongolian government, with assistance from the IMF, can make the payment or roll it over, or whether it will default.

ON THE BRIGHT SIDE The picture might look bleak, but January brought some welcome news to the coldest capital city on earth: The economy may have bottomed out last year.

Nyamaa Buyantogtokh, Mongolia's state finance secretary, told the Nikkei Asian Review that the fiscal deficit for 2016 had ended up around 15% of GDP, less than an earlier projection of 18%, thanks to rebounds in commodities prices and production late last year.

General government revenue for 2016 is estimated to have reached 5.85 trillion tugrik, up a half trillion tugrik from the government's previous projection in September. The government managed to cut expenditures by more than 200 billion tugrik from the September projection to 9.52 trillion tugrik.

Gold and coal exports for November and December also turned out to be strong. Exports of copper, which saw a sudden price surge in November, were also robust in late 2016.

These positive surprises in commodity exports may result in the actual growth rate for 2016 coming in slightly better than the Asian Development Bank's latest estimate of 0.3%.

The Bank of Mongolia's tight monetary policy, especially after the general election in June, kept inflation in the latter half of 2016 in negative territory. Low inflation finally halted the tugrik's depreciation against major currencies, with the dollar exchange rate peaking just below 2,500 tugrik in December.

The Mongolian currency hit less than 1,200 to the dollar in spring 2011, the year the economy recorded a record-high 17% growth, and had been depreciating since.

While an improved commodities market provided a major tailwind for the economy, the government can also take some credit. The Mongolian People's Party has implemented a number of much-needed reforms. As a result, the IMF will likely agree to extend a second bailout package in less than a decade (the previous one was in 2009) by mid-February, according to sources close to the matter.

SECOND CHANCE So far so good this year. But the country still faces more than $2 billion in external sovereign debt reaching maturity within five years, and securing a real turnaround in the economy will require some fundamental changes.

Morgan Stanley economist Ruchir Sharma, in his book "The Rise and Fall of Nations," emphasizes the importance for emerging economies to develop less politically driven, more productive industries, such as information and communications technologies, manufacturing and retail. Fortunately for Mongolia, there are signs that these kinds of "good" industries are on the rise.

Uuganbaatar Altanchimeg, a 37-year-old computer scientist, returned to Ulaanbaatar in 2013 after working as a software engineer in Japan for six years. Last summer, he and another engineer who had also come back from Japan founded Bers Solution to develop and market portable equipment for quick diagnosis of diabetes.

Diabetes is the second most common cause of adult deaths in Mongolia, partly due to the scarcity of clinics and hospitals capable of diagnosis. The Bers product enables diagnosis in remote locations by sending patient data to a hospital in a major city.

Uuganbaatar Altanchimeg, left, and Baatarkhuu Enkhtuya, who develop high-tech medical devices, are part of Mongolia's burgeoning startup scene. (Photo by Shinya Sawai)

Uuganbaatar said he hopes to "help the country develop the technology industry" by growing his startup into a midsize business. He plans to hire several new engineers and launch a few new development projects within a year or so. He said he is also thinking about venture-capital fund raising in the near future.

IT is just one of the many promising nonmining sectors in Mongolia.

Last September, Clean Energy Asia, a joint venture of Newcom of Mongolia and SoftBank Group of Japan, announced it plans to start commercial operation of a wind energy farm in the Mongolian Gobi Desert by the end of 2017, with financial support from the European Bank for Reconstruction and Development and the Japan International Cooperation Agency.

SoftBank estimates that Mongolia has the potential to generate enough solar and wind power to meet Asia's entire demand for electricity due to its sunny and windy climate. The Japanese group has launched a joint feasibility study with Chinese, South Korean and Russian partners on the concept of an "Asia Super Grid" that would connect power sources in Mongolia with those in other countries across the region.

Mongolia's tourism industry also has room for growth, and its cashmere wool producers are exploring ways to move higher up the value chain in the fashion industry.

Khashchuluun Chuluundorj, an economics professor at the National University of Mongolia, emphasizes the potential for the private sector to drive economic development. "If the international level of transparency and discipline are put in place in both the government and private sector, the country should be able to proceed on a steadier growth path than in the past," he said.

Mongolia missed its chance to secure stable growth during the last commodities upswings. But with resource prices once again rising, the government finally pushing for reform and the private sector poised for growth, this could be the second chance the country has been waiting for.

Additional reporting by contributing writer Khaliun Bayartsogt in Ulaanbaatar

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