Mongolia: we want to be Chile

What do you do if you’re a small country, rich in minerals that went from boom to bust when the bottom fell out of the commodities market? Copy Chile, is the answer.

Chile’s experience as a small, copper-dependent economy that prudently stashed cash during the boom years, allowing it to ride out the 2008-09 world economic crash and uncork anti-cyclical spending, was the perfect case study for Mongolia.

The central Asian country is poised for a eye-popping boom: its economy is expected to treble in size in the coming years as giant projects come onstream, among them Oyu Tolgoi, which is due to start up next year and to become one of the world’s five biggest copper-gold mines. Non-mining investment is also growing fast.

But only three years ago, Mongolia’s economy was in flames. After growth of above 9 per cent on average from 2004-08, it contracted 1.3 per cent in 2009, triggering a banking crisis and exposing flaws in an economic management that had relied too heavily on mineral revenue. While it did save some of that, it frittered away money on unsustainable social projects, salaries and inappropriate investment projects.

Mongolia’s finances were righted after help from the World Bank, IMF and Asian Development Bank, but the country needed to address the root causes. As the World Bank says in a report:

In the fiscal sector, the objective was to isolate the budget from mineral price fluctuations, avoid excessive real appreciation of the currency, minimize “pork barrel” public spending, and raise the quality of public investment planning and management. In the social sector, policy makers aimed to provide a fiscally sustainable social safety net to ensure the poor were protected from the inevitable boom-and bust cycles associated with mining economies. These reforms were made all the more urgent by the OT deal and other major mining projects on the horizon.

Time for a chat with Chile, then. The South American country, the world’s biggest copper producing nation, is vulnerable to similar pressures, but since the late 1980s – and especially with the implementation of a so-called structural balance rule in 2001 and a fiscal responsibility law in 2006 – Chile has managed outlays with a close eye on copper prices.

Six Mongolian parliamentarians went first to Chile in 2009, then to the US for workshops organised by the World Bank and IMF, then shared their experiences in a workshop in Ulaanbaatar attended by nearly half of Mongolia’s members of parliament. A repeat US study tour followed in 2010 (the Chilean leg had to be scrapped because of a devastating earthquake).

South-south cooperation continued in 2010-11 with visits to Chile, Canada, the US and Botswana to study mining policies; Estonia, Poland and Slovenia to study organic business laws; and the Philippines to study conditional cash transfers.

The upshot? A fiscal stability law, modelled on that of Chile, was passed by a bipartisan majority in parliament in 2010, mandating savings of windfall revenues, a portion of these to be invested overseas. It also passes an integrated budget law, a public procurement law and a social welfare law.

Of course, lessons from the experts can only go so far. As the report notes:

In Mongolia, the implementation of the new laws is already being severely tested by politicians’ attempts to spend the mining revenues off budget through special funds and new development financing institutions. Time will tell whether the new legislative framework is underpinned by the type of political commitment that is able to enforce the rules during the boom period—when they are actually most needed—to ensure the sustainability of public expenditures during the bust.

But still. Mongolia is now in the running to be included by the FTSE Group in as a frontier market because of the strides it is making in improving its market infrastructure to attract investment.

Its inclusion could come at the expense of another commodities-rich country, one that has also gone from booming growth to a sharp slowdown, and where fiscal policy sets some observers’ hair on ends.

That country is Argentina. But that’s another story.

Related reading:
Guest post: Mongolia’s bid to dodge the resource curse through green power, beyondbrics
Boomtown Mongolia, FT Magazine
Central Asia: A rocky road to riches, FT
Mongolia: can’t live with China, can’t live without China, beyondbrics