There is no refraining from default

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The entire world can see that Mongolia’s government is unable to move, shackled by its internal and external debts. Our government has barely managed to avoid declaring default by negotiating with investors and basically replacing the Development Bank loan of 580 million USD with the long-term Khuraldai bond, which has a higher interest rate.

The key to avoiding a significant crisis was the agreement on our participation in an extended fund facility program, made at an operational level between Mongolia and the International Monetary Fund (IMF). However, the plan to approve the IMF deal during a special session of Parliament this month, required to get approval for enrollment from the IMF executive board, has changed.

The executive committee of the Mongolian People’s Party (MPP) made a political decision, and said, “The parliament will not have an extraordinary session. It will be discussed during the parliamentary session scheduled for April along with budget amendments.”

The reason why they made this decision is connected to their expectation that the IMF’s conditions to increase taxes and reduce budget expenditure will not be favorable in the opinion of voters. This is a political concern in light of the presidential election being held in three months’ time.

Also, demand for the Khuraldai bond was five times higher than what was expected. It got our politicians’ heads spinning, the same ones who are now thinking of backing out of the IMF deal. What will this lead to? How can Mongolians break free from the debt chain?

DE FACTO INSOLVENCY

There is a strong likelihood that the reckless MPs from the MPP, who believe that the economy can be repaired by political means, will refrain from approving enrollment in the extended fund facility (EFF) program. They are increasingly thinking about the upcoming presidential election and taking into account the end of mining’s downturn with an outlook for a growth period, an increase in gold extraction, and the extension of the currency swap agreement with China. Also, they tend to believe that there is strong demand in the external market if the government issues new bonds.

It would have been impossible to issue the Khuraldai bond if the government had not reached an agreement on the EFF program with the IMF at an operational level. The Khuraldai bond, worth 600 million USD, sold out quickly only because investors estimated that Mongolia would improve its financial and economic situation by participating in the IMF program and meet its debt obligations with 5.5 billion USD coming into the country.

There was an order to buy 3.3 billion USD in bonds only because banks such as JP Morgan and Credit Suisse, who worked as underwriters for the Khuraldai bond, guaranteed that Mongolia would be able to successfully issue it.

If Parliament refrains from enrolling in the EFF program, Mongolia’s  reputation will be completely tarnished on the international scene, and the government will never be able to raise capital from foreign markets again. It will then cause Mongolia to declare a de facto default when the time comes for the government to pay off the 500 million USD debt for the Chinggis bond in January next year.

Withdrawal would also embolden the investors who purchased Khuraldai bonds to sue the Mongolian government and the underwriting banks for giving false information and misleading investors.

The people must know what the consequences will be if the country declares default. The consequences are grave, and would slow down our development for decades. First, the country would completely lose its reputation, resulting in no one being able to trust the government again. There is also a risk of capital and cash abroad being impacted, and state-owned aircraft would be the first state property to be impounded. Second, the country would become fully isolated from the international financial market. Neither the government nor the private sector would be able to raise loans from abroad if the sovereign credit rating hit the floor.

If the flow of foreign capital into Mongolia stops, the tugrug will weaken and lose its value. People would start taking their savings out of banks before their cash became worthless. It would trigger the government to exact capital control, restricting the business hours of banks and limiting the amount of cash an individual could withdraw from the bank per day. When people start racing with each other to turn their cash into goods, there will be shortage of goods and materials on the market, which will result in price increases and a hike in inflation. Soon, the government would have no choice but to print money. For example, Zimbabwe printed so much cash that they produced a 100 billion note. When the government starts printing more money, we will be carrying our cash in wheelbarrows instead of wallets, and it won’t be enough to buy a loaf of bread. It would start monetary reform, marking the beginning of a new economic cycle. While all this happens, the corrupt will put their foreign currency into offshore accounts. Everyone will be trying to get their cash for an escape abroad. The poor would be supporting some type of dictator and spending the rest of their lives begging for foreign aid.

HOW TO BREAK FREE FROM THE GREAT DEBT CHAIN?

Mongolian political parties have spent years promising people non-existent wealth, distributing cash, and buying votes. As mining income increased, they kept acquiring more loans, and the government became corrupt. Because of corruption, the powerful few were the only ones to gain and become wealthier from natural resources, and they borrowed more and more money. It appears that when the time comes to pay off the debt of the wealthy, the people are the only ones left standing for accountability, while the politicians who benefitted from the loans are nowhere to be found. It looks like the current government will be closing one debt by taking on  another loan, sending the country deeper into a bottomless swamp.

In order to break free from the chains of huge debt, we have no option but to stop corruption and free our economy. Mongolia has become a bucket with holes. When there are holes, the bucket will never become full, no matter how much water is poured into it. Similarly, Mongolia’s economy will not recover as long as there is corruption – regardless of how much foreign capital and loan financing flows in. Therefore, our top priority must be fixing the nation’s holes and getting rid of corruption. The deep-seated corruption in all government institutions traces back to our political parties. In a country where the people cannot oversee the government they have elected at all levels, public governance becomes corrupt and the country will face demise.

The experiences of some countries suggest that there are three phases to stopping corruption. First of all, you must catch the corruption “tigers”, hold them accountable under the law, seize their properties, and pay back the damage that was done to the public. This helps scare the “flies”, and government officers would start avoiding bribes and corruption, which will send the right message to the people. The next step is to set up capable institutions that prevent corruption. Such institutions would ensure that even if a government officer wants to receive a bribe, it is not possible. The third phase is to achieve a state where government officials cannot fathom engaging in corruption and do not feel the need to commit the act. While our southern neighbor is already in its second phase, Mongolia has not even really started its fight against corruption, despite being full of words and promises. Our people are frustrated about the current situation and have started expressing it in various ways.

As we fight corruption, we need to fully transition our economy to market principles. We should free up all the prices that we can, ensure that the market sets prices, direct social care to those who do not have purchasing power, privatize state-owned companies, reduce the expenditures of public governance, and increase the effectiveness of our government institutions. When doing all these tasks, the latest technology should be deployed creatively. Mongolia can pay its debt back fully only when we stop corruption and make our economy competitive. But can Mongolians do it? Dear MPs, you might be able to avoid the IMF’s EFF deal, but you can never avoid  imminent default.

 

 

2 COMMENTS

  1. It’s not ALWAYS the case where a default leads to many years of economic stagnation and rapid currency debasement… Iceland is an example where default was probably the good option. But while I disagree with the notion that a default is ALWAYS a bad thing, I do agree that in Mongolia’s case it probably would be a bad move. And I wholeheartedly agree that the corruption is playing a primary role in the mess the country is in. Many of Mongolia’s politicians do not seem to appreciate the concepts of fiscal restraint or long-term thinking, and if they default they would likely just repeat the same mistakes again. And yet the IMF is not to be trusted either. History has shown they are more than happy to make loans to corrupt leadership who they KNOW will either pocket the money or waste it, then use that outstanding debt to later force the sale of national assets to outside interests or force economic policies not in the country’s own best interest. Sometimes the IMF makes good recommendations (privatization is usually a good thing as long as the ownership doesn’t get transferred to too many outside interests), but other times the IMF has acted like a predatory lender and so can’t be trusted to do what’s best for Mongolia.

    Not a good situation to be in, but all in all I’d say the IMF loan is probably the least bad option… as long as Mongolians can force their leadership to get their act together. Borrowing from the IMF is a double-edged sword, so they better treat this as an intervention of sorts to restore some sanity and purge corruption, rather than as an excuse to keep kicking the can (of debt) down the road.

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