The UB Post recently sat down with Dr. Ch.Khashchuluun to discuss in-depth Mongolia’s IMF program, woes in the taxation system, and the mining sector. Ch.Khashchuluun is a professor at the Department of Economics, a member of the Academic Council and the board of the National University of Mongolia. In addition to his teaching, Dr. Ch.Khashchuluun serves as an executive director of the Mongolia Oil Shale Association and is managing a number of non-governmental organizations and research consulting activities. From 2010 to 2011, he was appointed as the inaugural chairman of the board of directors to lead the establishment of Development Bank of Mongolia, and from 2006 to 2012, he was a member of the board of directors of the Central Bank of Mongolia.
It has been almost a year since Mongolia entered into the extended fund facility with the International Monetary Fund. There were a lot of expectations at first. Do you believe that those expectations were met and what is your evaluation of the program so far?
The extended fund facility is a program that is usually undertaken in countries that are in a very difficult place economically. The purpose of the program is not only to address the short-term problems but to implement long-term reform to treat the systematic issues that plague an economy. In late 2016, our economy was in a very difficult position and international confidence in Mongolia’s economy was very low. At that time, the balance of payments was in a deficit, the foreign exchange reserves were depleted with some reports even indicating that the reserve was in a deficit. To top it all off, the fiscal deficit was at a very high level. As a result of all this, confidence in Mongolia’s economy and its direction was at an all time low.
Therefore, my personal view is that the IMF program has had very good results in the one year it has been implemented. Firstly, the fiscal deficit was decreased significantly. Second, the reform of the taxation system has begun to be undertaken. Third, the foreign exchange reserve reached its highest levels in the past five years, surpassing three billion USD.
In addition, the tugrug has began appreciating for the first time in a few years, stopping a period where the tugrug depreciated consistently. Another positive has been the balance of payments, which has recovered significantly from a deficit to a surplus. Exports have also surged notably, helping to drive GDP growth above expectations. While it is true that the global and foreign market forces were a large factor to GDP growth, the Mongolian government was able to correct many aspects of the economy through policy, including the financial sector and the fiscal deficit.
Another positive change is the growth of the Mongolian securities market and most notably the twofold growth of the Top 20 Index on the Mongolian Stock Exchange.
Based on this, I think many would say that Mongolia was able to exceed the expectations that were there when the program began.
When the Mongolian government was in discussion to enroll into an IMF program, there was no shortage of criticism. Whether it was criticism of the IMF’s past experience in countries such as Greece or its role in the Asian Financial Crisis or the supposed neoliberal ideology of the organization. Would you say this criticism was or is warranted?
IMF’s policy nowadays is very different from its policy in the 1990’s. This is evident through IMF’s full-fledged support of the United Nation’s Sustainable Development Goals.
In fact, the countries that adopted the Sustainable Development Goals were provided a new credit line by IMF.
In the past, there was this notion that the foundational goals and policy of IMF and the UN were inherently different. On one hand, IMF touted a neo-liberalist policy while the UN prioritized economic growth and reducing poverty. This disconnect has essentially been eliminated and the policy of the UN and IMF is much more intertwined.
Now the UN, IMF, and most of the world has found common ground with three principals that include maintaining a low fiscal deficit for a country, creating or sustaining economic freedom, and reducing poverty through economic growth.
When criticizing IMF, many people like to bring up the example of Greece. But in reality, Greece did not fulfill its obligations to IMF. Another criticism of IMF is the Asian Financial Crisis, where supposedly several economies including the South Korean economy were hit significantly. Many fail to point out that because of this crisis, South Korea was able to undergo major economic reform and modernize its economy, becoming the economic power we know today. South Korea was able to become a global leader in the production of crystal LED screens and some of this can be attributed to IMF.
The aim of IMF is not to sabotage the economies of developing countries. The harsh truth is that countries must know their limits, meaning they cannot borrow too much and must keep their fiscal deficits low. This is not received well by many people, including politicians who want free reign to spend public money but are limited by an IMF program, this results in criticism that IMF is “dictating” Mongolia’s economy. Those who prioritize sustainable economic and financial growth understand that working together with IMF is crucial.
The results of the asset quality review that was undertaken on 14 commercial banks in Mongolia as part of the extended fund facility was recently revealed. The central bank reported that banks had a cumulative capital shortfall equivalent to two percent of GDP. This has been noted as relatively high but in line with Mongol Bank’s forecast before the review. How do you see the results of the review?
When taking into account the Mongolian economy, IMF had to focus a lot on the banking sector. This is because the banking system dominates the nation’s financial market with a 95 percent market share. The recent asset quality review went very in-depth compared to previous studies. The result of the review was considered in general to be satisfactory.
Of course, there are issues that need to be addressed and they will be in due time.
Mongolia has a lot of smaller banks and in some ways this has held back the development of the banking sector as a whole. I believe there will be mergers of banks to a certain extent in the near future. There is no need for a bank that is too small. Moving forward, the role of non-banking financial institutions will likely increase. In fact, some large non-banking financial institutions have outgrown some smaller banks.
Overall, the asset quality review was a very good thing for the banking sector. It helped clear up a lot of uncertainties including the effect of previous policies by the central bank. Moving forward, it is looking like the central bank will be maintaining a traditional monetary policy. The review revealed that the banking sector was stable overall, this allows Mongol Bank to set high standards such as requiring banks to implement the Basel III framework instead of the Basel II.
In addition, the size of banks will likely be increased in the future as the sector requires bigger players.
Cabinet recently introduced a tax reform bill that intends to offset the pressure on businesses and attract foreign investment. You have been a notable critic of Mongolia’s current tax system, specifically the uneven collection of taxes. How do you see the most recent proposed changes? Is it a step in the right direction?
Mongolia’s tax system has been reformed and changed a lot over the years. The current one in place is what has been dubbed the four tens system, which has been in place since 2006. This system has been successful in its own right, helping to increase tax revenue beyond expectations and contributing to the decrease of the fiscal deficit.
The VAT reform also helped reveal a lot of the hidden economy.
With all of that being said, the tax system must inevitably be reformed in the future. That reform needs to be based on several principals. The first is to be more business friendly and that is being discussed to a certain extent in the most recent bill by Cabinet. The prime minister and finance minister have done a good job to get feedback from businesses and making appropriate changes based upon that feedback. Previous negotiations with IMF resulted in changes to taxes that put a lot of tax pressure on an individual. This was corrected and it is a good thing that it was corrected.
One of the most important aspects of tax reform that must be taken into account is the issue of even distribution of taxes. We must look to not increase the rates of tax but to increase the number of taxpayers.
There are three groups of people whose income is not being taxed adequately. The first group of people are merchants who mainly resell goods. There is a perception in Mongolia that merchants are just an individual selling goods but in reality those merchants have operations on the same levels as some companies.
There are several official automobile distributors such as Munkhada operating in Mongolia. On the other hand, there are merchants that are able to sell 300 Toyota Priuses in a year, which is probably not much less than Munkhada’s sales. The difference is that Munkhada is paying all of its taxes including its employee’s social insurance fee, its income tax, and a variety of other taxes.
Meanwhile, the merchant is only subject to customs tax and the government is not able to get much else from them tax wise. This system has to change and I would imagine it is not too difficult to bring that change. Unfortunately, this issue does not only pertain to automobiles.
The second issue in the tax system is the Immovable Property Tax. Currently, a lot of land and immovable property is not in circulation or being maximized to its potential as people are keeping hold of it in hopes to sell it at a high price in the future.
Third and finally, we must talk about livestock. It is said that livestock is Mongolia’s wealth. All livestock is privately owned by herders. These herders can be classified into two groups, the poor herders and the herders with high income.
Since 2008, herders that have less than 200 livestock are considered poor. As the number of livestock increases, the income of the herders increase. Those who own more than a thousand livestock, called “myangat malchin” in Mongolian, now tend to have a higher annual revenue than an average Mongolian company, this is the reality. This is a big error that needs to be corrected in the system.
For example, let’s say a doctor makes 800,000 MNT per month, they probably will only receive 70 percent of that after various taxes. A household of a myangat malchin makes probably around 10 times more than that, but the difference is that it is not taxed.
In addition to not having to pay taxes, many myangat malchin receive subsidies and tax breaks while also receiving pension. This is an unfair system. In terms of poor herders, it is right for the government to support and aid them.
However, regarding herders that own more than one thousand livestock are using state-owned pasture, roads, and water to profit. It is only right that the government receives a portion of that profit.
All mining companies pay royalties to the government. Do you propose that herders have one as well?
Yes, much like the royalty in the mining sector. Herders should have to pay a certain percentage to the government for using state-owned resources for profit.
Through reforms in the tax we could correct this error in the system and help to monetize land better in addition to helping slow down desertification. Studies show that 99 percent of the environmental damage in Mongolia is caused by livestock. The number of goats in the country has increased significantly and goats cause a lot of desertification through overgrazing. The current agricultural sector prioritizes quantity over quality when it comes to livestock.
But we saw how susceptible Mongolian livestock is to diseases such as foot and mouth disease. This cannot be left alone as a herders’ issue. If left alone, herders are not incentivized to vaccinate or install chips in their livestock. This in turn makes Mongolian meat impossible to export as international standards require the genealogy of animals to ensure that livestock is disease-free.
Livestock products are Mongolia’s second largest export but let’s shift topics and discuss Mongolia’s biggest export, mining products. For the most part, Mongolia exports raw natural resources that have not been processed and as a result are relatively cheap. How do you think this issue can be addressed? What is the government’s role in changing this?
The mining sector is in many ways similar to a lot of other sectors. One unique aspect is that it is a sector based on natural resources that are extracted. The issue is simple, Mongolia has two choices, either export those extracted resources immediately without processing or to refine the products and sell them at an added value.
Looking at Mongolia’s current tax and export policy, there is nothing to support refinement over exporting raw resources.
Since there is no measure that requires or supports refining mining products, it is both easier and cheaper to export raw resources. The value-added production is then left to China, who gets the profit of the value added after refining the product. There are only a few mining companies that refine their products before export, that is Oyu Tolgoi and Erdenet for copper and Energy Resources LLC for coal.
In terms of coal, Mongolia has the capacity to refine the extracted product before export, but beginning from the state-owned coal companies to the private coal companies, none of them process their coal.
In order to address this issue, an export tax could be imposed to economically incentivize value-added production. For instance, a 10 USD export tax could be imposed on every ton of raw coal exported.
Currently, only 1,000 MNT is imposed for every ton of coal exported. This will make refining the product more profitable than just exporting raw coal. Moving forward, an export tax will need to be imposed on iron ore, coal, and possibly even petroleum.