Technical Assistance Report Project Number: 47199-001 Policy and Advisory Technical Assistance (PATA) December 2013 Mongolia: Public Finance Resource Management The views expressed herein are those of the consultant and do not necessarily represent those of ADB’s members, Board of Directors, Management, or staff, and may be preliminary in nature. CURRENCY EQUIVALENTS (as of 3 December 2013) Currency unit – togrog (MNT) MNT1.00 = $0.00058 $1.00 = MNT1,732.50 ABBREVIATIONS ADB – Asian Development Bank DSA – debt sustainability analysis FSF – Fiscal Stability Fund GDP – gross domestic product GFMIS – government financial management information system GRP – governance reform program HDF – human development fund MOF – Ministry of Finance MSWF – Mongolian Sovereign Wealth Fund TA – technical assistance TECHNICAL ASSISTANCE CLASSIFICATION Type – Policy and advisory technical assistance (PATA) Targeting classification – Targeted intervention—MDGs Sector (subsector) – Public sector management (public expenditure and fiscal management) Themes (subthemes) – Governance (public administration [national, decentralized, and regional]), economic growth (promoting macroeconomic stability), capacity development (institutional development) Location (impact) – National (high), urban (medium) NOTE In this report, "$" refers to US dollars. Vice-President S. Groff, Operations 2 Director General A. Konishi, East Asia Department (EARD) Director Y. Qian, Public Management, Financial Sector, and Regional Cooperation Division, EARD Team leader S. Lee, Financial Sector Specialist, EARD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area. CONTENTS Page I. INTRODUCTION 1 II. ISSUES 1 III. THE TECHNICAL ASSISTANCE 3 A. Impact and Outcome 3 B. Methodology and Key Activities 3 C. Cost and Financing 5 D. Implementation Arrangements 5 IV. THE PRESIDENT'S DECISION 5 APPENDIXES 1. Design and Monitoring Framework 6 2. Cost Estimates and Financing Plan 9 3. Outline Terms of Reference for Consultants 10 The views expressed herein are those of the consultant and do not necessarily represent those of ADB’s members, Board of Directors, Management, or staff, and may be preliminary in nature. I. INTRODUCTION 1. During the reconnaissance mission in June 2013, the Government of Mongolia requested the Asian Development Bank (ADB) to provide technical assistance (TA) to strengthen public finance resource management.1 A TA fact-finding mission visited Ulaanbaatar from 22 to 24 October 2013, where an understanding was reached on the TA impact, outcome, outputs, cost estimates, financing plan, implementation arrangements, and terms of reference for consultants. The design and monitoring framework is in Appendix 1.2 The TA is closely aligned with the country partnership strategy, 2012–2016 for Mongolia, which promotes good governance.3 II. ISSUES 2. The Mongolian economy, traditionally based on livestock herding, has started to grow and transform rapidly because of the discovery of large mineral deposits and the consequent development of a booming mining industry. In 2011, the share of mining in gross domestic product (GDP) reached 20% and contributed about one-third of total government revenue through tax and royalty payments. The export share of minerals reached a peak of 90% of the total value of exports. While the economy of Mongolia grew rapidly by 17.3% in 2011 and 12.3% in 2012, further growth in the coming years will depend to a large extent on commodity prices. The reliance on mineral exports has made the economy vulnerable to the risks associated with commodity price volatility. 3. Mongolia has put in place essential infrastructure for the public finance resource management system and strengthened fiscal discipline by establishing a fundamental legal framework with assistance from ADB.4The government has successfully introduced a legal framework; established medium-term and annual budget planning frameworks; and implemented an effective nationwide government integrated financial management information system (GFMIS) for budget execution, monitoring, and reporting. The passage of the Public Sector Management and Finance Law in 2002 was a major achievement under ADB’s Governance Reform Program Phase 1 (GRP I), which improved the legal and institutional environment for public finances by centralizing revenue and expenditure management and strengthening budget execution. Through ADB’s GRP II, approved in October 2003, institutional capacity to implement reforms to budget, planning, and financial management has been further enhanced. In addition, the Fiscal Stability Law was adopted in 2010 to put strict limits on the structural fiscal deficit (2% of GDP), public expenditure increases (the greater between its 12- year moving average value and the budget year’s GDP growth rate), and public debt (40% of GDP).5 To improve public debt management operation, a debt management law is being drafted that aims to institutionalize the establishment of medium- and long-term debt management strategy, determine the optimal debt level, and create a proper debt register and monitoring framework. 1 The TA is included in ADB. 2013. Country Operations Business Plan: Mongolia, 2013. Manila. 2 The TA first appeared in the business opportunities section of ADB’s website on 13 November 2013. 3 ADB. 2012. Country Partnership Strategy: Mongolia, 2012–2016. Manila. 4 Since 1995, ADB has approved 1 loan and 10 TA projects in support of public sector governance reforms. Through the Governance Reform Program (GRP) I, ADB supported the government in implementing the initial phase of public sector governance reform. ADB continued to support the government through the GRP II and capacity building programs to enhance public finance resource management reform. 5 The recent economic slowdown in the People’s Republic of China and falling commodity prices negatively affected fiscal sustainability, with the structural deficit rising to 8.3% in 2012 from 4.8% in 2011. The decline in public revenues from 40.3% in 2011 to 35.3% in 2012 due to lower mining prices and reduced royalty and tax receipts also tamped down public expenditure from 45.1% in 2011 to 43.7% in 2012. Public debt increased from 45.0% in 2010 to 46.9% in 2011. 2 4. Debt management. There have been several important recent developments in debt management. First, since the adoption of the Fiscal Stability Law in 2010, the Ministry of Finance (MOF) has been able to build a foundation to enhance fiscal discipline, break away from a boom–bust fiscal policy, and contribute toward achieving sustainable growth. Second, the approval and publication of the Debt Management Strategy for 2012–2014 has been an important step toward building a medium-term debt management framework for the MOF that is consistent with the medium-term budget framework. Third, the Integrated Budget Law was passed in 2012 to secure smooth implementation of the Fiscal Stability Law, and now fully accounts for contingent liability.6 However, the MOF has suffered from insufficient staff capacity to establish a debt management strategy, and to effectively identify and manage the contingent liabilities. Furthermore, the government currently engages in multiple activities that may create uncertain demands on future fiscal resources, and therefore complicate fiscal policy. These include provision of loan guarantees, onlending to state-owned enterprises and local governments, and entering into public–private partnerships. These activities and their related risk are growing in range, complexity, and size. For example, the Development Bank of Mongolia could potentially become a major source of contingent liabilities. The initial government guarantee of $600 million for bond issued by the Development Bank of Mongolia is equivalent to 4.5% of 2012 GDP. Depending on how they are structured, public–private partnerships can also create significant contingent liabilities and quasi-fiscal debt. 5. Cash management. Since the GFMIS was set up in 2005, the Treasury Department of the MOF has been able to perform national budget reporting, execution, and monitoring in an efficient manner. However, the lack of a sophisticated government cash flow forecasting model and technical know-how in the Treasury Department exposed the vulnerability of government expenditure management, especially during the rapid boom–bust economic cycle in Mongolia. The current GFMIS cannot generate detailed cash management reports, which makes it difficult for the Treasury Department to effectively monitor cash management and establish a medium- to long-term cash management strategy. During the Treasury Department’s recent initiative to establish a medium-term government cash management strategy, the major challenges identified were developing a government cash flow forecasting model and reporting system, and increasing staff capacity. 6. Sovereign wealth fund management. Normally, sovereign wealth funds in countries with natural resource abundance have two objectives: (i) to act as a stabilization mechanism against fluctuation in natural resource revenues due to volatility in international prices, and (ii) to accumulate wealth for the benefit of future generations.7 In Mongolia, the Human Development Fund (HDF) and the Fiscal Stability Fund (FSF) were established in accordance