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Mongolia might face 'major macroeconomic instability', says top analyst

Against the backdrop of a more friendly posture towards international investors, Mongolia’s commodity-reliant economy is poised for more cyclical volatility, warns a top central Asian investor.

Mongolia’s economy faces macroeconomic headwinds this year as drivers for expansion – credit growth and commodities – soften against the backdrop of an imbalanced economy, warns a top Mongolian investor.

The comments come despite a  relaxation in Mongolia’s investment law established last May – aimed at encouraging a resurgence in foreign direct investment – which has restored confidence in the country's medium- and long-term growth prospects.

Alisher Ali, founder and chairman of Silk Road Finance

Alisher Ali, founder and chairman of Silk Road Finance, a frontier markets investment group, warns that the country – rich in natural resources, including gold, copper and coking coal – faces weak growth this year amid a slowdown in commodity demand.

“The growth slowdown in China and the decline in commodity prices globally could have a negative effect on the economy in Mongolia,” says Ali. Mongolian export revenues have already been hit. In 2012, China accounted for 92.6% of Mongolian exports, totalling $4.38 billion. In Mongolia, exports declined nearly 8% year-to-date in the first quarter this year. “A recovery in export prices will depend on demand for commodities from China,” says Ali. 

Indeed, the decline in commodity prices and exports hit government revenues at a time of substantial infrastructure and development projects.

“Between 2010 and 2012, government expenditure nearly doubled," says Ali. "At the same time, government revenue increased by only 60%."

In 2012, the budget deficit reached a decade high of 8.4% of GDP. Although Mongolia is expected to maintain one of the highest economic growth rates in the world, uncertainty surrounding economic prospects encouraged the World Bank to lower its estimate for Mongolia’s economic expansion in 2013 to 13% compared with an earlier forecast of 16.2%.

In the first quarter of the year, the economy expanded at a slower-than-expected pace at 7.7% year-on-year compared with 17% over the corresponding period in 2012.

Banking is also under pressure. The sector, which accounts for more than 95% of the financial system in terms of assets, grew by 28% in 2012, reaching MNT11,992 billion ($8.6 billion), down from a record 50% increase in 2011.

“While expansionary fiscal policy and increasing funding demand from household sectors supported growth [in the banking sector], the drop in growth was largely due to the slowdown in economic growth because of lower coal prices and volumes in exports,” says Ali.

Mongolia has also borrowed more than $2 billion in international debt markets to finance infrastructure projects, close to 20% of GDP. “With current spending trend continuing, the government is likely to face the need to balance its budget, whilst paying back foreign debt,” says Ali.

“Mongolia needs a wide political consensus and action on fiscal discipline or face major macroeconomic instability in coming years.”

Reversing the trend

Mongolia made progress when it relaxed a foreign investment law established last May. The Strategic Entities Foreign Investment Law limited international investors to 49% stakes in sectors, including the mining industry, after approval from the government. Restrictions on investment in Mongolia saw FDI into the country drop dramatically, and local investors lacked the ability to support the mining sector and subsequent economic growth. In 2012, investment into the country fell by 17% to $3.9 billion.

An amendment passed on April 19 will make privately owned companies exempt from the law and aims to kick-start investment into the country again. The revision of the investment law sends a good signal to international investors and an important about-face on policies regarding resource nationalism, says Ali, adding: “But although the law has been partially reversed, one of the major challenges faced by Mongolia is to rebuild investor confidence.”

Production from the Oyu Tolgoi mine, one of the world’s largest copper mines and Mongolia’s single largest investment project, is aimed at supporting the economy. The government expects export volumes of copper to nearly double and gold more than double, primarily due to the start of production at Oyu Tolgoi in 2013.

Although Silk Road Finance is bullish on the country's medium- and long-term growth prospects, Ali warned that fiscal indiscipline, growing budgetary pressures, structural inflation and a cooling banking sector pose headwinds for the economy after recent years of breakneck expansion.

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