Managing Fiscal Policy in Resource-Rich Economies: Lessons from Mongolia


May 5, 2023

Countries with significant natural resource reserves, such as Mongolia, tend to be prone to boom-and-bust cycles. This is because their governments rely heavily on revenues from their natural resources, which are susceptible to highly volatile prices and production levels. As a result, these countries experience higher levels of underlying volatility, while their governments tend to exacerbate the fluctuations with procyclical fiscal policy, i.e. increasing expenditures during economic expansions and decreasing them during recessions.

Mongolia's economy relies heavily on the mining sector, specifically on coal and copper, which account for approximately 80% of its exports and 30% of its total government revenue. Our analysis suggests that this dependence on raw material mining and exports is most likely to increase even further in the next few years, with copper production projected to more than double by 2028. Given these circumstances, it is highly advisable for Mongolia to move away from procyclical fiscal policies and instead set current expenditures independently from the actual terms of trade and the cyclical position of the economy.

To assess the cyclical nature of Mongolian fiscal policy, we calculated the correlation between the cyclical component (as measured by the Hodrick-Prescott filter) of real government expenditures and real GDP. A positive correlation between the cyclical components indicates above-trend spending during an overheated economy, providing evidence of procyclical fiscal policies. Additionally, we compared these correlations regionally to assess Mongolia’s fiscal performance against that of its peers.

Source: OGR calculation

Based on our calculations, procyclical fiscal policies were predominant in CIS countries during the period of 2001-2009, and all of them made some improvements in the last decade. Most notably, Armenia, Georgia and Kazakhstan managed to shift their fiscal policies towards a countercyclical approach, in line with best practices. While all the other countries, Azerbaijan, Mongolia, Kyrgyztan, Uzbekistan and Tajikistan made some progress in reducing the procyclical nature of their fiscal policies, the magnitude of the improvement differs. The two commodity exporters, Azerbaijan and Mongolia still stand out as prone to boom and bust cycles.

One potential solution to mitigate the impact of boom-and-bust cycles is to direct windfall gains from favorable commodity prices into a sovereign wealth fund, rather than using them for current expenditures. For example, Kazakhstan's Samruk-Kazyna wealth fund, established in 2008, currently holds assets worth $70 billion, equivalent to 30% of GDP in 2022. However, many resource-rich economies, especially those with weaker institutions, struggle to commit to such self-limiting practices.

Mongolia has also established two wealth funds, the Fiscal Stability Fund and the Future Heritage Fund, with a third fund currently under construction. However, despite the initial intent to implement strict rules for wealth fund management, the accumulated assets of the two funds account for only around 2% of GDP. Loose fiscal policies, such as diverting royalties from the Future Heritage Fund to finance the current expenditures, are undermining Mongolia's initial efforts to break the tradition of boom-and-bust cycles.