Economic Performance in 2005-2006

Mongolia has made considerable progress over the last ten years, moving from a plan-based state economy to one in which private sector competition predominates. Recent economic performance has been very robust, with strong, broad-based growth, declining inflation, growing budget and balance of payments surpluses, and improving confidence in the banking system. The minerals sector has been a key engine of growth, supported by record high prices for copper and gold, some increases in production volumes, and investment into new copper and gold deposits, which has not yet come on stream. Outside the mining sector, growth has also been supported by favorable weather conditions, buoyant residential and commercial construction, and rapid growth in financial services. Growth is projected to remain at about 7-8 percent in 2007.

Mongolia's fiscal framework has evolved significantly since the beginning of 2006. Changes include the addition of new spending measures in the amended budget passed in July, a new mining law, and new personal income tax, corporate income tax, and VAT laws which go into effect on January 1, 2007.

The "windfall" tax introduced in June 2006 is intended to capture a higher share of the revenues accruing to mining companies from high export prices. The 68 percent tax rate tax applies to copper revenues from prices exceeding the sum of a base price (US$2,600 per ton) and smelting costs (projected at US $l, 580 per ton), and gold revenues from prices exceeding US$500 per ounce.

In addition to the "windfall" tax, the new mining regime enacted in July 2006 provides for: (i) a doubling of royalties on metals from 2.5 percent to 5 percent; (ii) an increase in mining license fees and a shortening of the license's duration to discourage speculation and under-utilization of mining licenses; and (iii) a doubling (up to 30 years) of the maximum duration for investment contracts, which may include stability clauses on the tax regime. The mining law also establishes the possibility of government equity participation up to 34 percent in mines deemed to be "strategic deposits," and up to 50 percent for strategic deposits discovered with government support. A Development Fund was also established to ensure that revenues from the "windfall" tax are allocated as follows: (i) one third of total for saving; (ii) one third for capital expenditure; and (iii) one third for children and family allowances.

On the expenditure side, the amended 2006 budget contained several important measures: (i) wages and salaries were increased by 30 percent (retroactive to February 1); (ii) minimum pensions were increased, and the pensions paid to retirees under different systems were aligned; (iii) domestically-financed investment was budgeted to more-" than-double; and (iv) social welfare transfers were raised through an increase in the monthly child allowance and the elimination of its means testing, the introduction of lump sum allowances for newlyweds and newborns, and a modest school lunch program.

The 2007 budget calls for an overall deficit of 5 percent of GDP. Reflecting the' new tax laws that go into effect on January 1, tax revenues are projected to cost some 3.9 percent of GDP. These measures include: (i) a cut in the VAT rate from 15 percent to 10 percent and the abolition of a range of VAT exemptions at an estimated cost of 1.7 percent of GDP; (ii) unification of the personal income tax (PIT) at the lowest of the previous rates (10 percent) at an estimated cost of 0.5 percent of GDP; (iii) a five percentage point cut in each of the two corporate income tax (CIT) rates along with a thirty-fold increase in the higher rate's threshold, the elimination of tax holidays for foreign investors, the introduction of loss carry-forward provisions, and the use of investment tax credits in priority sector, at an estimated cost of 1.7 percent 'of GDP; and increases in excises on vehicles and gambling for an estimated revenue gain of 0.1 percent of GDP. On the expenditure side, the 2007 budget provides for a further 30 percent increase in civil service wages and a 0.8 percent increase in civil service employment, a substantial additional increase to the child allowance, and an increase in capital spending by 4.4 percent of GDP to address infrastructure needs in areas such as roads and housing, it also includes unallocated spending for goods and services (6 percent of GDP), which the authorities now say will not take place.

Real GDP growth has averaged 7 percent since 2002, aided by sharp increases in copper and gold prices and a recovery of livestock herds after three devastating winters. As incomes have grown, the expansion has spilled over to other sectors of the economy, including construction, financial services, and the retail sector. After a brief upward spike in 2005, inflation has been brought back down to the mid-single digits, and the budget and external current account balances have moved into surplus. International reserves, which were heavily drawn down in late 2003 in connection with the settlement of Mongolia's pre-l991 debt to Russia, have been reconstituted to more comfortable levels. Near-term economic prospects remain favorable, with growth likely to be sustained by still-high minerals prices and large-scale foreign investment in a major new mining project. Despite these significant achievements, poverty remains high (36 percent), and much remains to be done to achieve the Millennium Development Goals.

In terms of foreign trade, for the first 11 months of 2006, total external trade turnover equaled 2713.8 mln. US dollars, of which exports 1377.4 mln. US dollars and imports 1336.4 mln. US dollars. Total external trade balance turned a surplus of 41.0 mln. US dollars. This surplus provided by increasing of copper market price and volume of creezy cashmere, tops of cashmere, etc. As compared with the same period of the previous year, total external trade turnover increased by 39.6 percent, exports by 53.3 percent and imports by 27.8 percent respectively

Within infrastructure, the country has moved from a situation of frequent blackouts and limited utility access to spreading the benefits and quality of network connectivity. Urbanization, focused around Ulaanbaatar and mining areas, the exploitation of new mines, and continued growth in Russia-China trade all provide hope for economic expansion, but also demand infrastructure rollout and improvement. At the same time, there is a desire to extend the benefits of wealth to regional growth poles within the country.

Combined with the high technical standards required by equipment that can operate in Mongolia's environmental extremes and the short construction season this makes the construction of new infrastructure very expensive by international standards.

The current long list of proposed new infrastructure investments at the sectoral level adds up to $7.3-7.7 billion over the next ten years, not accounting for any subsidies or transfers to cover operations and maintenance or losses. It is perhaps worth comparing this number to current GDP of around $1.2 billion.

Mongolia's non-fuel mineral sector has been the main pillar of Mongolia's development. It is the fourth largest sector, contributing 25 percent of GDP but accounting for about 70 percent of export earnings and 16 percent of tax revenue. Its output, however, is highly vulnerable to mineral price volatility and its direct contribution to employment has been limited (2.4 percent of labor force), due to its highly capital intensive nature. Dutch disease risks are limited because of idle capacity, including high unemployment but continued appreciation of the togrog in connection with increasing capital flows and foreign exchange earnings may impact nonmineral sector competitiveness in the longer run.

There has been an upturn in mineral exploration since 2001, in the wake of the discovery of the large Oyu Tolgoi copper/gold deposit and in response to strong world prices for copper and gold since 2004. Exploration, however, has been hampered by poor infrastructure and uncertainties on the new mining tax regime.

Eight mining companies have entered Stability Agreements under the previous 1997 Minerals Law. Under the 2006 Minerals Law, such agreements renamed Investment Contracts link agreements' maturities to the investment's size.

Copper output (30 percent of exports), is currently derived exclusively from the Erdenet mine but is expected to be boosted in the medium term by the coming on stream of the Oyu Tolgoi mine and the development of the Tsagaan Suvarga deposit.

Erdenet. Mongolia's largest mine, has been in operation since 1978 under a Russian-Mongolian government joint venture. The mine produces copper concentrate together with molybdeniun and is also engaged in a variety of non­mining activities (e.g., farming) and provides extensive local social support. The mine's output has been declining and is expected to deteriorate further as copper grade decreases with depth. However, investment are underway to compensate the output decline by producing higher value copper cathode. Erdenet's, annual copper concentrate output is about 130,000 tons Its reserves of 1.5~ billion tons have a 30-year lifespan.

Oyu Tolgoi copper and gold deposit. Discussions are underway between the government and some large foreign miners to reach agreement on an investment contract that would pave the way for beginning mining the Oyu Tolgoi deposit in 2009. Initial annual copper concentrate output would be 300,000 tons with a 1 million ton peak to be reached within six years. Copper reserves (28 million tons) would provide for a 40-year lifespan

Gold output (31 percent of exports), has been declining in recent years. Gold is also widely mined by Mongolian and Mongolian-Russian joint ventures, comes as a by-product of the Erdenet copper mine and is subject to widespread artisanal mining ("ninjas" miners). Gold prospects depend on timely development of the Oyu Tolgoi and Gatsuurt deposits, both of which critically hinging upon finalizing investment contracts with the government.

Other minerals. Mongolia is also a significant producer of fluorite under Mongolrostsvetmet, a Russian-Mongolian joint venture and Mongolia's second largest mining company. In addition, the Tumurtiinovoo zinc mine, a Chinese-Mongolian joint venture has been operational since 2005 with an expected 14-year lifespan. Phosphate mining from the Burenkhaan deposit is in the process of being developed. In the longer term, considerable coal reserves from the Tavan Tolgoi deposit (5 billion tons), and the Turmurtei iron deposit (229 million tons), as well as identified natural gas and petroleum reserves are expected to provide further growth impetus.

Mongolia's agriculture industry is potentially attractive to niche international markets. The sector could offer production processes such as chemical free methods, environment friendly practices, free range livestock, combined with its unique culture of nomadic lifestyle, family production, traditional relationship with animals and nature, and boutique practices that contrast with the mass production methods of its neighbors. According to preliminary results of the 2006 livestock census, a number of livestock of Mongolia has reached 34.48 million heads which is 13.4 percent increase compared to the previous year. It is the greatest number reached in the history since the 1924.

In 2006 toursim industry made up 18 percent of GDP while the number of inbound tourists increased by 14 percent.

Mongolian tourism assocation - http://www.travelmongolia.org/

National Tourism Development Board - http://www.tripmongolia.com/ - in 5 languages