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ADB Project Terminal Report -Part-3 by Tarun Das

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Terminal Report: Part-3


Chapters 6-8 on Financial Planning, Core and Non-Core Functions
And Seven Year (2008-2014) Action Plan
ADB Capacity Building Project on Governance Reforms

Professor Tarun Das1

Ministry of Finance
Government of Mongolia
Ulaanbaatar, Mongolia
31 March 2008

1
Glocom Inc. (USA) Expert on Strategic Planning, ADB Capacity Building Project for Governance
Reforms, Ministry of Finance, Government of Mongolia. Formerly, Economic Adviser, Ministry of
Finance and Planning Commission, Government of India and Professor (Public Policy), Institute for
Integrated Learning in Management (IILM), New Delhi, India.

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Table of Contents

Table of Contents Pages

PART-1 1-70

Contents 2
Acknowledgements 3
Project Team 4
Administrative Units of Mongolia 4
Major macro-economic variables 5
Document history 6-9
List of Abbreviations 10-11

Chapter-1: Major Conclusions and Recommendations 12-51


Annex-1: TOR and Compliance Report 52-58

Annex-2: Policy Matrix – Compliance Report 59-62

Annex-3: Design of a Training Program for capacity building 63-67

Annex-4: List of Experts consulted 68-70

PART-2 71-158

Chapter-2: Strategic Business Planning 73-100


1.
Chapter-3: Output Costing and Output Budgeting 101-115

Chapter-4: Accrual Accounting and Accrual Budgeting 116-132

Chapter-5: Benchmarks and Best Practices 133-157

PART-3 158-214

Chapter-6: Financial Planning 160-191

Chapter-7: Core and Non-core functions 192-205

Chapter-8: Seven Year Action Plan (2008-2014) 206-214

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Chapter-6
Financial Planning Methodology and Policies
1. Ex-ante and ex-post financial planning

As per the Terms of Reference, the International Strategic Planning Expert is required
“to develop a methodology for the preparation of ex ante financial planning (for the
central government)”. In the broad sense, ex-ante financial planning implies assessment
of feasible financial resources and planning revenues and expenditures before the
budgetary commitments are made, while ex-post financial planning means management
of budgeted resources and expenditure. However, both ex ante and ex post financial
planning are integrally related. Therefore, here we deal with methodologies and policies
for both ex ante and ex post financial planning and management.

1.1 Objectives of Financial Planning


Basic objective of government financial planning is to assess the mobilisation, allocation
and management of financial resources keeping in view the Government’s strategic
objectives and sustainability of pubic expenditure within the total available resources and
cash budget limits. This includes developing, promulgating and implementing financial
policies, rules and regulations across the budget entities. It also includes establishing and
strengthening institutions and policy planning for the better management of investment
plans, and development of efficient and vibrant financial, monetary and capital markets.
An effective financial planning serves to provide:
(a) Optimal allocation of resources among competing needs and sectors;
(b) Sustainability of fiscal deficit over time;
(c) Stability and predictability of government financial resources;
(d) Coherence to diverse fiscal objectives for both short and long term interests.

There is of course no universal model, methodology or structure for an effective and


efficient financial planning. Like physical planning, government financial planning must
satisfy the following characteristics:

(a) Transparency –There should be openness for government’s fiscal, monetary,


budgetary and financial policy formulation and implementation. There should
not be any hidden agenda of the government for favoring particular groups.
(b) Accountability – Actions and decision-making processes should be open to
scrutiny by public agencies, Parliament and civil society;
(c) Responsiveness – It should have the capacity and flexibility to respond to
changing national and international circumstances;
(d) Future Orientation – It must have the inherent ability to anticipate future
problems and liabilities and to develop suitable policies;
(e) Rule of Law and Integrity –It must be subject to equitable enforcement of fair
and transparent laws, regulations and codes, so that the basic culture in the
public sector supports ethical behavior and strict actions to fight corruption.

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1.2 Status of Fiscal Planning in Mongolia

1.2.1 New Public Sector Management

Presently Mongolian government is passing through a stage of governance reforms to


improve efficiency and productivity of the public sector. The central government in
Mongolia is in effect moving to a system of “New Public Sector Management”. It has the
following key features:

(a) the separation of policy-making from service delivery and strengthening


agencies to deliver services in health, education, employment and social welfare
and security;

(b) the separation of the provider function and producer function- government has
already privatized and withdrawn from activities where private participation
including foreign investment is more productive and more efficient;

(c) as required by the Public Sector Management and Finance Law (2002)
government is formulating accrual-based output budgets (AOB) and shifting its
emphasis from inputs to outputs and outcomes;

(d) Government is emphasizing on the systematic comparison of activities and


output costs for various budget entities (benchmarking);

(e) Government is developing performance indicators for efficient budget


allocations and for rewarding good performance in achieving set objectives;

(f) Government is strengthening accounting and auditing standards and systems,

(g) Government is upgrading capacity and skill of personnel engaged in planning,


budgeting, accounting and auditing; and strengthening the information
technology system to support the budget modernization process and systems.

2. Public Finance Management in Mongolia

Public Financial Management covers the institutions and processes related to the
management of public resources. This process consists of three stages.
(a) Determination of policies and priorities
(b) Allocation of public resources in accordance with the specified policies
(c) Establishment of financial control, accounting and audit systems to ensure the
economical, effective and efficient acquisition and utilization of public resource

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2.1 Determination of the policies and priorities

For efficient operations, a government is required to make “strategic business plans”


indicating vision, mission, objectives, strengths and weaknesses of the economy and
considering resource constraints in the short and medium terms and to prepare financial
plan and budget to support these policies and objectives. Major line ministries and
budgetary entities in Mongolia are already preparing master plans and strategic business
plans indicating desired outputs and outcomes in the medium term.

The Public Sector Management and Finance Act (27 June 2002) requires preparation of
multi-year output budgeting on the basis of accrual accounting, benchmarks and
performance parameters, accountability by General Managers of Budget Entities, fiscal
transparency, efficient internal financial control, which are major components of modern
financial planning and management.

2.2 Allocation of public resources

Annual Budget prepared by the MOF is the basic financial document of the government
for the allocation of the limited resources, realization of economic plan and policies and
the common public needs as determined by the political choice.

2.3 Establishment of mechanisms for financial control

Financial controls include both Internal Control and External Control, and there could
be both ex-ante control (before disbursement of funds) and ex-post control (after
disbursement of funds). The uniform accounting system and standards are used in all
budget entities within the scope of the general government.
(a) The MOF determines the accounting and reporting standards and frameworks,
Chart of Accounts, period and type of the reports that will be applied by all
budgetary bodies within the scope of general government.
(b) MOF provides guidelines for preparation of the fiscal statistics.
(c) MOF determines rules and regulations for Ex-ante control over the payments,
procurement, control over public revenues and expenditures and mechanism to
prevent irregularities and fraud.

2.4 Internal and Concurrent Audit and Ex Ante Financial Control

It is understand that there is no system of internal auditing or concurrent auditing in the


budget entities. In many countries, like India, Bangladesh, Nepal and Pakistan, there are
Financial Advisers/ Financial Control Officers attached to the Expenditure Department of
the Ministry of Finance but working for various budget entities. An expenditure proposal
approved administratively by any department needs to be examined by the concerned
Financial Adviser before actual disbursement of funds. The Financial Adviser examines
whether it falls within the scope and limits of the approved budget. However, budget
entities have the power to save finances under certain heads and utilize the surplus for
other heads. But the proposal needs be examined and scrutinized by the Financial

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Adviser. Thus the Financial Adviser/ Financial Control Officer helps the line ministry for
the following functions:
(a) allocating appropriations
(b) approving financial commitments
(c) holding tenders and concluding contracts
(d) overseeing purchase of goods or services
(e) overseeing execution of public works
(f) approvals for payment orders

Such Ex ante control mechanism is based on the principle that compliance audit is
performed before the payment is made at various stages of the spending process. It is
understood that the government of Mongolia does not have a system of Financial
Adviser/ Financial Controller/ Internal Auditor. It may be advisable for the Mongolian
government to adopt such a system for ex ante financial control and internal auditor. To
start with, MOF may appoint Financial Advisers/ Financial Control Officer/ Internal
Auditors for the major ministries like MOF, MOECS, MOSWL and MOH.

3. Relation Between Financial Planning and Budget Planning

3.1 Budget Planning and Strategic Planning

Financial planning is an integral part of a sound and transparent budgeting exercise.


Table-1 summarizes the major characteristics of modern budgets as compared with those
of classical budgets.

3.2 Public Sector Management and Finance Act (PSMFA June 2002)

It is well known that the Government of Mongolia enacted the Public Sector
Management and Finance Act (PSMFA) on the 27 June 2002 in order to modernize
budget planning and budgeting systems as per international best practices. We have
outlined a seven year action program to complete these activities in a phased manner.

4. Methodology for Financial Planning for 2009-2011

4.1 Macro-economic framework

In this section we describe a methodology for Financial Planning for the Mongolian
Budget. However, it must be kept in view that there is no unique methodology which can
be applied at all times. Financial Planning depends on the macroeconomic prospects and
on the budgetary and fiscal framework already approved by the Parliament. We make our
fiscal projections on the basic of macro-economic prospects for the years 2008-2011 as
described in the chapter on strategic planning.

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Table-1: Characteristics of Modern Budgets Compared with Classical Budgets

Classical Budgets Modern Budgets

Unbalanced budget with reliance on monetized Balanced budget without any monetized deficit.
deficit financed by the monetary authority with Fiscal deficit is financed by market borrowings
creation of additional money supply. from either domestic markets or from external
sources including bilateral countries and
multilateral funding agencies.
Sectoral financial planning focusing basically on Strategic business planning keeping in view
short-run or sectoral gains broader objectives, vision, mission, strengths and
weaknesses
Input based budgeting- Budgeting in terms of Activity based budgeting- costing and budgeting
wages and salaries, purchases of goods and services of activities required to produce desired outputs
Inputs/ resources budgeting – budgeting for Output/ Outcome budgeting- budgeting for
labor, energy, transport, goods and services specific outputs and outcomes
Cash accounting- accounting revenues and Accrual accounting- accounting revenues and
expenditures when cash is received or paid expenditures when commitments are made or
liabilities are created – it does not matter whether
cash is received or not.
Project budgeting- focusing on completion of Program budgeting- focusing on integrated
individual projects program for a specific purpose such as employment
generation or poverty reduction
Expenditure based budgeting- allocation of Performance based budgeting- allocating finance
money on the basis of expenditures on the basis of performance
Annual budgeting- budgeting for a year Multiyear budgeting- budgeting for a number of
years, generally for the budget year and two
forward years
Non-Transparent budgeting – budgets are Transparency based budgeting – less secretary in
prepared in top secretary preparation of budgets, experts and stakeholders are
consulted, government’s objectives are announced.
No public scrutiny- does not allow scrutiny by Public scrutiny- allows scrutiny by the media and
others the general public
No stakeholders’ consultation- stakeholders are Multi-stakeholders’ consultation- stakeholders
not consulted are consulted before finalizing the budget
Top-Down Approach- MOF first allocates the Bottom-up Approach- Line ministries first
resources to line ministries who then allocate funds prepare their budgets and sends requests to MOF
under various heads who makes adjustments on the basis of resource
constraints and inter-sectoral equity
Complete secrecy in budget preparation Limited secretary and public consultation

Parliament of Mongolia has earlier approved major macroeconomic and fiscal parameters
as medium-term objectives under the Medium Term Budgetary Framework (Table-2).

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For Financial planning during 2009-2011, we consider major macro-economic and fiscal
parameters such that these parameters comply the basic targets under MTBF.

Table-2 Compliance with the 2008 MTBF targets


(As percentage of GDP unless otherwise specified)
Major macro-economic and fiscal MTBF Budget for Financial
parameters 2008 Plan2 for
2009-2011
1. Floor on GDP growth rate (%) 8.7 10.1 10.0
2. Ceiling on inflation rate (%) 5.0 5.5 5.5
3.Ceiling on total budget revenue 40.2 44.0 43.7
4. Ceiling on total budget expenditure 43.2 47.0 46.2
5. Floor on current balance 7.9 7.7 7.7
6. Ceiling on budget deficit -3.0 -3.0 -2.5
7. Floor on capital expenditure 8.0 8.8 9.0
Source: Government of Mongolia Budget 2008 for MTBF and 2008 Budget, and the
author’s estimate for the Financial Plan for 2009-2011.

It may be mentioned here that the Socio-Economic Development Guideline of Mongolia


for the year 2008 has an inflation target of less than 10 percent. This is significantly
higher than the European Union’s inflation target at 3 percent, and the inflation target of
the most of the developing countries at less than 5 percent. Mongolian policy implies a
major departure from the neo-liberal macroeconomic framework that has dominated
policymaking in many developing countries. The neo-liberal model favors strict fiscal
discipline that is pre-occupied with maintaining small fiscal deficits, monetary policy that
has low inflation targets and exchange-rate policy that is committed to be fully flexible
and market-determined. While the government of Mongolia also supports fiscal
discipline (with overall fiscal deficit targeted at less than 3 percent of GDP as in the
European Union) and flexible exchange rate, it is more liberal for the target of inflation
rate. This is because the overall inflation in Mongolia is highly correlated with global
prices of minerals and petroleum products, which had witnessed significant increases
over the past few years.

Higher inflation rate also implies a more expansionary fiscal policy to encourage work
efforts and production, to enhance buoyancy in government revenues and to foster private
investment. Monetary policy can be accordingly designed to support fiscal expansion and
export promotion by achieving low real interest rates for private investment and the
alleviation of public-sector debts.

With higher inflation rate prevailing in the economy, monetary authority (i.e. the Bank of
Mongolia) could take direct measures (such as selective credit controls and higher cash
reserve ratios) to dampen the inflationary pressures resulting from ‘supply shocks’— e.g.,
sharp increases in food and energy prices. They should not hold back economic growth
by raising interest rates and trying to contain inflation at five percent or less. They could
move aggressively to provide increased access to affordable credit, through offering loan
2
Author’s projections in this report. For details, see section 4.2.

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guarantees for productive activities and reviving development banks. They could also
pursue appropriate foreign exchange management policies to reduce volatility in
exchange-rates and to maintain stability in real interest rates.

4.2 Methodology for Financial Planning

Financial planning means forecasting different components of government’s revenues


and expenditures for the financial planning horizon. In this exercise, the current budget
year 2008 has been taken as the base year and the three forwarding years viz. 2009-2011
have been taken as the planning horizon. Trends of different revenue and expenditure
items are examined during 2006-2008 and then one of the following methods, depending
on the pattern of past trends and underlying relationships, are used for projecting these
items for the planning horizon:

(a) Growth method- Average growth rate of an item during 2005-2008 or growth
rate during 2008 or average growth rate in the past excluding extreme values;

(b) Stability approach- Stable value for an item over the planning horizon
implying attainment of satiety or saturation level;

(c) Ratio or intensity approach- Average ratio of an item to GDP at current


market prices.

(d) Elasticity approach- Elasticity of an item with respect to GDP at current


market prices.

The methodology for specific items is described in details in Tables-3A and 3B. If larger
time series data were available, one could have used the usual trend analysis or multiple
regression techniques. Here, very simple but logical techniques have been used for
forecasting an item for financial planning. The results are indicated in Tables-4A, 4B, 5A
and 5B.

Table-3A: Methodology for Financial Planning for the Period 2009-2011

ITEMS Methodology Value


1. TOTAL REVENUE AND GRANTS 2+3+4
2. CURRENT REVENUE 2.1+2.2
2.1 Tax revenue 2.1.1 to 2.1.8
2.1.1 Income Tax PIT+CIT+WT
2.1.1.1 PIT Elasticity with respect to GDP 0.42

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2.1.1.2 CIT Elasticity with respect to GDP 1.15


2.1.1.3 wind fall tax GR in 2008 0.16
2.1.2 Social security contributions Average GR during 2006-2008 22.15
2.1.3 Tax on immovable properties Average GR during 2006-2008 19.53
2.1.4 Sales Tax ( VAT ) Elasticity with respect to GDP 1.10
2.1.5 Excise Tax Elasticity with respect to GDP 0.77
2.1.6 Special purpose revenue Average GR during 2006-2008 17.12
2.1.7 Taxes on foreign trade Elasticity with respect to GDP 1.15
2.1.8 Other Taxes and fees Average GR during 2006-2008 37.83
2.2 Nontax revenue GR in 2008 7.48
3. CAPITAL REVENUE Average GR during 2006-2008 13.91
4. FOREIGN GRANTS Stable at 2008 level
5. TOTAL EXP & NET LENDING 6+7+8
6. CURRENT EXPENDITURE 6.1+6.2+6.3
6.1 Goods and Services 6.1.1+6.1.2
6.1.1 Wages and Salaries Inflation rate 0.10
6.1.2 Purchase of goods/services Inflation rate 0.10
6.2 Interest payment Average GR during 2006-2008 1.71
6.3 Subsidies and transfers 6.3.1+6.3.2
6.3.1 Subsidies GR in 2008 15.12
6.3.2 Transfers GR in 2008 37.78
7. CAPITAL EXPENDITURE 7.1 to 7.4
7.1 Domestic Investment Investment/ GDP ratio in 2008 0.07
7.2 Capital Repairs Average ratio of (7.1) 0.08
7.3 Other capital expenditures Average GR during 2006-2008 40.38
7.4 Road fund by project loan GR of GDP 0.10
8. NET LENDING 8.1+8.2
8.1 Domestic (net) Stable at 2008 level
8.2 Foreign (net) Stable at 2008 level

9. Overall Balance (1)-(5)


10 Current Balance (2)-(6)
11. Mineral balance ----

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Table-3B: Methodology for Financial Planning for the Period 2009-2011


ITEMS Methodology Value
12. FINANCING: 12.1+12.2
12.1 Foreign (net) 12.1.1 to 12.1.3
12.1.1 Project loans Residual after domestic
12.1.2 Cash loans Stable at 2008 level
12.1.3 Amortization As per debt profile
12.2 Domestic (net) 12.2.1 to 12.2.6
12.2.1 Privatization receipts Stabilize at 2008 level
12.2.2 Repayment of Govt bonds As per debt profile
12.2.3 Long term bond New Amortization
12.2.3.1 New GR in 2008 18.44
12.2.3.2 Amortization As per debt profile
12.2.4 IMF ( Net ) As per IMF loan profile
12.2.4.1 Disbursement As per IMF loan profile
12.2.4.2 Amortization As per IMF loan profile
12.2.5 Banking system net credit 12.2.5.1 to 12.2.5.3
12. 2.5.1 Increase in the DF bal Estimated by Bank of Mongolia
12.2.5.2 Net changes in C/A Estimated by Bank of Mongolia
12.2.5.3 Opening Balance No balance
12.2.6 Non-banking system Preferably nil

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Table-4-A: Financial Planning for the Govt of Mongolia for 2009-2011 (Billion MNT)
ITEMS 2005 2006 2007 2008 2009 2010 2011
Outturn Outturn Outturn MOF Forecast Forecast Forecast
Final
.1. . 2. . 3. . 4. . 5. .6. .7. .8.
1. TOTAL REVENUE AND GRANTS 838 1360 1786 2404 2865 3431 4129
2. CURRENT REVENUE 833 1354 1781 2387 2848 3414 4112
2.1 Tax revenue 692 1128 1417 1996 2428 2962 3626
2.1.1 Income Tax 179 477 626 800 945 1118 1325
2.1.1.1 PIT 58 77 70 85 92 99 108
2.1.1.2 CIT 121 222 242 352 433 532 655
2.1.1.3 wind fall tax 0 178 314 363 421 487 563
2.1.2 Social security contributions 96 112 135 174 212 259 317
2.1.3 Tax on immovable properties 6 7 8 11 13 15 18
2.1.4 Sales Tax ( VAT ) 181 241 237 451 550 672 819
2.1.5 Excise Tax 79 100 119 163 188 217 251
2.1.6 Special purpose revenue 11 11 13 17 20 24 28
2.1.7 Taxes on foreign trade 57 72 98 169 208 255 314
2.1.8 Other Taxes and fees 84 108 181 211 291 402 553
2.2 Nontax revenue 140 226 364 391 421 452 486
3. CAPITAL REVENUE 1 2 1 1 1 2 2
4. FOREIGN GRANTS 4 5 4 16 16 16 16

5. TOTAL EXP & NET LENDING 765 1237 1832 2569 3037 3622 4363
6. CURRENT EXPENDITURE 600 982 1414 1968 2335 2798 3391
6.1 Goods and Services 387 692 667 1020 1122 1234 1357
6.1.1 Wages and Salaries 143 197 307 566 623 685 754
6.1.2 Purchase of goods/services 244 496 360 454 499 549 604
6.2 Interest payment 21 18 20 21 22 22 23
6.3 Subsidies and transfers 193 272 727 927 1191 1542 2011
6.3.1 Subsidies 8 12 330 380 437 503 579
6.3.2 Transfers 185 259 397 548 754 1039 1432
7. CAPITAL EXPENDITURE 90 176 312 482 584 706 854
7.1 Domestic Investment 67 146 250 375 450 540 649
7.2 Capital Repairs 5 12 19 27 34 41 49
7.3 Other capital expenditures 7 9 18 17 24 34 48
7.4 Road fund by project loan 10 9 26 63 76 91 109
8. NET LENDING 74 79 106 118 118 118 118
8.1 Domestic (net) -14 -10 19 -44 -44 -44 -44
8.2 Foreign (net) 89 89 87 162 162 162 162
9. Overall Balance 73 123 -46 -165 -172 -191 -234
10 Current Balance 232 372 367 419 513 616 721
11. Mineral balance -49 -190 0 0 0 0 0

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Table-4-B: Financial Planning for the Govt of Mongolia for 2009-2011 (Billion MNT)
ITEMS 2005 2006 2007 2008 2009 2010 2011
Outturn Outturn Outturn MOF Forecast Forecast Forecast
Final
.1. . 2. . 3. . 4. . 5. .6. .7. .8.
12. FINANCING: -73 -123 46 165 172 191 234
12.1 Foreign (net) 90 74 65 170 201 237 298
12.1.1 Project loans 99 98 112 225 280 336 417
12.1.2 Cash loans 11 6 1 6 6 6 6
12.1.3 Amortization -20 -29 -48 -62 -85 -105 -125
12.2 Domestic (net) -163 -198 -19 -5 -30 -46 -64
12.2.1 Privatization receipts 5 30 32 16 16 15 10
12.2.2 Repayment of Govt bonds -14 0 0 0 0 0 0
12.2.3 Long term bond -12 -94 24 -15 -41 -56 -69
12.2.3.1 New 0 0 56 67 79 94 111
12.2.3.2 Amortization -12 -94 -33 -82 -120 -150 -180
12.2.4 IMF ( Net ) -7 -7 -8 -6 -5 -5 -5
12.2.4.1 Disbursement 0 0 0 0 0 0 0
12.2.4.2 Amortization -7 -7 -8 -6 -5 -5 -5
12.2.5 Banking system net credit -135 -126 -67 0 0 0 0
12. 2.5.1 Increase in the DF bal 0 0 317 463 600 600 600
12.2.5.2 Net changes in C/A -135 -126 -384 -463 -600 -600 -600
12.2.5.3 Opening Balance 0 0 0 0 0 0 0
12.2.6 Non-banking system 0 0 0 0 0 0 0
Memo Items
GDP at current market prices 2267 3715 4526 5464 6557 7869 9442
GR of GDP at market prices (%) 19 64 22 21 20 20 20
Real GDP GR (%) 7.0 8.7 10.1 10.1 9.9 9.8 9.8
Overall inflation by GDP deflator
(%) 10.9 50.8 8.2 12.1 10.0 10.0 10.0
CPI inflation rate (%) 9.5 7.0 8.6 5.5 5.5 5.5 5.5

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Table-5-A: Financial Planning for the Govt of Mongolia for 2009-2011


Share of GDP (in percentage)
2005 2006 2007 2008 As % As % As %
Outturn Outturn Outturn MOF Of GDP of GDP of GDP
Final
.1. . 2. . 3. . 4. . 5. .6. .7. .8.
1. TOTAL REVENUE AND GRANTS 37.0 36.6 39.5 44.0 43.7 43.6 43.7
2. CURRENT REVENUE 36.7 36.4 39.3 43.7 43.4 43.4 43.5
2.1 Tax revenue 30.5 30.4 31.3 36.5 37.0 37.6 38.4
2.1.1 Income Tax 7.9 12.8 13.8 14.6 14.4 14.2 14.0
2.1.1.1 PIT 2.6 2.1 1.5 1.5 1.4 1.3 1.1
2.1.1.2 CIT 5.3 6.0 5.3 6.4 6.6 6.8 6.9
2.1.1.3 wind fall tax 0.0 4.8 6.9 6.6 6.4 6.2 6.0
2.1.2 Social security contributions 4.2 3.0 3.0 3.2 3.2 3.3 3.4
2.1.3 Tax on immovable properties 0.3 0.2 0.2 0.2 0.2 0.2 0.2
2.1.4 Sales Tax ( VAT ) 8.0 6.5 5.2 8.3 8.4 8.5 8.7
2.1.5 Excise Tax 3.5 2.7 2.6 3.0 2.9 2.8 2.7
2.1.6 Special purpose revenue 0.5 0.3 0.3 0.3 0.3 0.3 0.3
2.1.7 Taxes on foreign trade 2.5 1.9 2.2 3.1 3.2 3.2 3.3
2.1.8 Other Taxes and fees 3.7 2.9 4.0 3.9 4.4 5.1 5.9
2.2 Nontax revenue 6.2 6.1 8.0 7.2 6.4 5.7 5.1
3. CAPITAL REVENUE 0.0 0.0 0.0 0.0 0.0 0.0 0.0
4. FOREIGN GRANTS 0.2 0.1 0.1 0.3 0.2 0.2 0.2

5. TOTAL EXP & NET LENDING 33.7 33.3 40.5 47.0 46.3 46.0 46.2
6. CURRENT EXPENDITURE 26.5 26.4 31.2 36.0 35.6 35.6 35.9
6.1 Goods and Services 17.1 18.6 14.7 18.7 17.1 15.7 14.4
6.1.1 Wages and Salaries 6.3 5.3 6.8 10.4 9.5 8.7 8.0
6.1.2 Purchase of goods/services 10.8 13.3 7.9 8.3 7.6 7.0 6.4
6.2 Interest payment 0.9 0.5 0.4 0.4 0.3 0.3 0.2
6.3 Subsidies and transfers 8.5 7.3 16.1 17.0 18.2 19.6 21.3
6.3.1 Subsidies 0.4 0.3 7.3 6.9 6.7 6.4 6.1
6.3.2 Transfers 8.2 7.0 8.8 10.0 11.5 13.2 15.2
7. CAPITAL EXPENDITURE 4.0 4.7 6.9 8.8 8.9 9.0 9.0
7.1 Domestic Investment 3.0 3.9 5.5 6.9 6.9 6.9 6.9
7.2 Capital Repairs 0.2 0.3 0.4 0.5 0.5 0.5 0.5
7.3 Other capital expenditures 0.3 0.2 0.4 0.3 0.4 0.4 0.5
7.4 Road fund by project loan 0.5 0.2 0.6 1.2 1.2 1.2 1.2
8. NET LENDING 3.3 2.1 2.3 2.2 1.8 1.5 1.3
8.1 Domestic (net) -0.6 -0.3 0.4 -0.8 -0.7 -0.6 -0.5
8.2 Foreign (net) 3.9 2.4 1.9 3.0 2.5 2.1 1.7

9. Overall Balance 3.2 3.3 -1.0 -3.0 -2.6 -2.4 -2.5


10 Current Balance 10.2 10.0 8.1 7.7 7.8 7.8 7.6
11. Mineral balance -2.2 -5.1 0.0 0.0 - - -

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Table-5-B: Financial Planning for the Govt of Mongolia for 2009-2011


Share of GDP (in percentage)
2005 2006 2007 2008 As % As % As %
Outturn Outturn Outturn MOF Of GDP of GDP of GDP
Final
12. FINANCING: -3.2 -3.3 1.0 3.0 2.6 2.4 2.5
12.1 Foreign (net) 4.0 2.0 1.4 3.1 3.1 3.0 3.2
12.1.1 Project loans 4.4 2.6 2.5 4.1 4.3 4.3 4.4
12.1.2 Cash loans 0.5 0.2 0.0 0.1 0.1 0.1 0.1
12.1.3 Amortization -0.9 -0.8 -1.1 -1.1 -1.3 -1.3 -1.3
12.2 Domestic (net) -7.2 -5.3 -0.4 -0.1 -0.5 -0.6 -0.7
12.2.1 Privatization receipts 0.2 0.8 0.7 0.3 0.2 0.2 0.1
12.2.2 Repayment of Govt bonds -0.6 0.0 0.0 0.0 0.0 0.0 0.0
12.2.3 Long term bond -0.5 -2.5 0.5 -0.3 -0.6 -0.7 -0.7
12.2.3.1 New 0.0 0.0 1.2 1.2 1.2 1.2 1.2
12.2.3.2 Amortization -0.5 -2.5 -0.7 -1.5 -1.8 -1.9 -1.9
12.2.4 IMF ( Net ) -0.3 -0.2 -0.2 -0.1 -0.1 -0.1 -0.1
12.2.4.1 Disbursement 0.0 0.0 0.0 0.0 0.0 0.0 0.0
12.2.4.2 Amortization -0.3 -0.2 -0.2 -0.1 -0.1 -0.1 -0.1
12.2.5 Banking system net credit -6.0 -3.4 -1.5 0.0 0.0 0.0 0.0
12. 2.5.1 Increase in the DF bal 0.0 0.0 7.0 8.5 9.2 7.6 6.4
12.2.5.2 Net changes in C/A 0.0 -3.4 -8.5 -8.5 -9.2 -7.6 -6.4
12.2.5.3 Opening Balance 0.0 0.0 0.0 0.0 0.0 0.0 0.0
12.2.6 Non-banking system 0.0 0.0 0.0 0.0 0.0 0.0 0.0

4.3 Financial Planning for 2009-2011

It may be observed from the above tables that the overall fiscal balance as per the fiscal
planning is projected to decline to 2.5 percent of GDP during 2009-2011 compared with
MTBF ceiling on fiscal deficit at 3 percent of GDP. This implies that the financial
planning for the period is consistent with fiscal sustainability over time. Resource
mobilizations from individual taxes and duties and expenditures by economic
classifications appear to be reasonable and realistic. Government’s financing planning
also appears to be feasible. Needs for foreign project loans will continue and the
government will be able to repay domestic and foreign loans and make associated interest
payments in time without undue pressure on budgets. Underlying parameters for the real
GDP growth rates and the inflation rates for consumer prices are realistic as judged by
past trends. Overall, the fiscal planning as indicated in the Tables 4-A, 4-B, 5-A and 5-B
appears to be realistic and feasible.

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5. Policies for Financial Planning and Risk Management


5.1 Management for Natural Disaster

One of the major objectives of the ex-ante Financial Planning is to deal with contingent
liabilities of the government and risk management for unforeseen events such as
droughts, floods, earthquakes, land slides and other natural disaster. Risk management
and emergency response need to be clearly distinguished. Risk management calls for ex-
ante planning and investments to reduce vulnerability. Emergency response involves ex-
post expenditures for reconstruction, rehabilitation and restoration of public infrastructure
affected by natural disaster, which can be greatly reduced through ex-ante planning and
investments in prevention and mitigation.

While the occurrence of natural events can not be predicted precisely and prevented fully,
there is a possibility to reduce the degree of vulnerability of populations through risk
management. This can be achieved in two ways: (i) planning with the purpose of the
identification and reduction of risk by integrating prevention and mitigation measures
into national development and financial plans and programs and (ii) financial protection
provided by transferring risk partly to the private sector or spreading it over time. The
latter can be achieved by strengthening both life and non-life insurance institutions.

5.1.1 The Credit System

The development of commercial banks, co-operative banks, savings banks, informal and
formal non-banking financial institutions, and micro-credit institutions can contribute to
the mobilization of the resources needed to finance investments in prevention, mitigation,
rehabilitation and reconstruction. The system of contingent credit mechanism makes it
easier to obtain financing in the event of a disaster. In the case of a contingent credit, in
exchange for an annual fee to a general insurance company, the right is obtained to take
out a specific loan amount post-event that has to be repaid at contractually fixed
conditions. In order to tackle the adverse impact of dzuds in Mongolia, if any in future, a
system of contingent credits or crop insurance or herds insurance can be very useful.

5.1.2 Risk Transfer Instruments

Risks can be transferred by creating suitable risk transfer instruments and mechanisms
currently in use in developed countries, especially insurance. Financing through ex ante
credits offers even more incentives to mitigate risk because risk transfer instruments offer
opportunities to contain moral hazards or adverse selection problems.

Ex-ante measures to tackle unforeseen events include prevention and mitigation,


insurance, contingent credit and reserve funds. Mitigation reduces the damages, whereas
risk financing measures reduce losses by transferring risk or sharing risk with others.
Mitigation is directed towards decreasing engineering or physical vulnerability, whereas
risk financing reduces financial vulnerability (Fig. 1).

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natural
hazard
engineering financial economic
engineering damage financial
vulnerability
vulnerability vulnerability
vulnerability loss
exposure mitigation ex-ante instruments

Fig. 1: Mitigation and Risk Financing

Flow of Funds from Three


Instruments Capital Accumulation

+ a) Reserve Fund Fund Payment

-
b) Contingent Credit Credit Payment
+
Administrative Costs Debt Repayment

-
c) Insurance
+ Insurance Payment
Premium

Fig.2- Flow of funds from three ex-ante financing instruments -


Reserve Fund, Contingent Credit and Insurance

Risk transfer provides indemnification against losses in exchange for a premium


payment. Risk is transferred from an individual to a (large) pool of risks through
insurance/ reinsurance, reserve funds and contingent credit systems (Fig.2). Insurance
and reinsurance funds bear part of the risk. In a reserve fund arrangement, liquid funds

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are laid aside so that the fund accumulates over the years without unviable impact on the
present budget. In case an unforeseen disaster takes place, the accumulated funds can be
used to finance the losses.
Contingent credit arrangements do not transfer risk, but rather spread it intertemporally.
As explained earlier, in exchange for an annual fee, the right is obtained to take out a
specific loan amount post-event that has to be repaid at contractually fixed conditions.

5.1.3 Insurance and development bonds

Development of insurance markets requires updating legislation and institutional set up.
This requires development of appropriate rules and regulations, strengthening the
independent regulatory authorities to improve monitoring of the solvency of insurance
companies and eliminate conditions that favor anticompetitive practices.

The possibility of introducing innovative capital market mechanisms such as catastrophe


or natural calamity bonds, commodity futures and weather-related derivatives may be
examined. These instruments, which may be of interest to international financial entities,
avoid the major difficulties related to asset valuation and loss settlement procedures, but
have to be implemented at pool or governmental levels.

The same arguments hold good for life and non-life insurance. But, catastrophe or natural
calamity bonds are difficult to be developed by developing countries like Mongolia
which lack efficient money and capital markets. It may be easier for Mongolia to develop
other kinds of bonds such as “development funds” (viz. municipal, social, urban, rural,
roads, infrastructure development bonds etc.) to meet critical needs for infrastructure
development. This can be helped by international development agencies.

Another instrument that could be highly useful is to establish a “contingent liability fund”
and to make budgetary contributions. Government of Mongolia has already established
such a contingent fund, road development fund and a general Development Fund.

The private sector and the community-wide formal and informal financing instruments
perform a very important role at the local level by supplying resources, particularly in
poorer areas. Regardless of the source of financing, the implementation of these
mechanisms requires close cooperation between the public and private sectors, especially
in reference to the establishment of the appropriate legal and regulatory framework.

Table-6 summarizes various sources of ex ante and ex post disaster financing. The ex
ante non-reimbursable and reimbursable financing mechanisms without risk transfer
include grants and credits. The corresponding risk transfer instruments encompass
insurance and natural calamity bonds, which can cover the damage based on real losses
(indemnification) or the parametric payments.

Ex post financing instruments include grants, taxes, emergency and reconstruction loans,
and refinancing of existing loans. In the event of a disaster, immediately available and
lowest-cost financing options, such as an existing calamity fund or catastrophe bonds,

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insurance and reinsurance, are generally used first. Similarly, part of budgeted resources
from the existing programs can be transferred to meet immediate emergency needs.

In some cases, existing development funds (municipal, social, urban, rural) may also be
used. Government can impose an emergency cess or tax on the existing tax payers. At the
same time, the government could seek as much international aid and donations as
possible and resort to contingency credits.

Table-6 Provisional Classification of Disaster Financing Mechanisms

5.2 Management of Contingent Liabilities

5.2.1 Contingent liabilities- definitions and measurement


Contingent liabilities are defined by the System of National Accounts 1993 as contractual
financial arrangements that give rise to conditional requirements to make payments or to
provide objects of value. A key characteristic of such financial arrangements, as
distinguished from the current financial liabilities, is that one or more conditions must be
fulfilled before a contingent liability takes place. A key characteristic that makes such
liabilities different from normal financial transactions is that they are uncertain.

Fiscal Risk Matrix for Mongolia

Following Polackova (1998), contingent liabilities can be best described in terms of a


Fiscal Risk Matrix classifying sources of potential risks on government finance into four
types: direct or contingent, each of which may be explicit or implicit. Table-9 presents a
typical fiscal risk matrix for Mongolia.

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Table-7: Fiscal Risk Matrix for Mongolia

LIABILITIES Direct Contingent

Explicit • Sovereign debt (domestic and • Direct guarantees for external loans by
external) Aimags, local bodies, budgetary entities and
• Committed Expenditures- public sector enterprises
legal and non-discretionary in • Guarantees on currency risks of foreign loans
the long term (civil service by commercial and development banks, if any
salaries and wages, social • Guarantees on various types of risks
security and insurance (including market, currency, regulatory,
contributions, employment of political) in Built on Transfer (BOT) contracts
specialized staff in rural areas, or other Public-Private Partnership, for the
pension other compensation to development of infrastructure and social
civil servants, Social Welfare sectors
Fund) • Umbrella guarantees for various types of loans
• Benefits to children and poor (agriculture, agro-business, micro-enterprises,
families housing etc.)
• Benefits to SMEs and rural • Deposit insurance of savings and commercial
areas, jobs creation and banks
national development • Guarantees on benefits (unfunded liabilities)
of the social security system
• Future health care financing

Implicit • Future recurrent costs of • Support to insurance and pension companies


public investment projects in case of financial crisis;
• Support to Bank failures (beyond state
insurance or guarantees)
• Support to Bank of Mongolia (the central
bank) in case possible default
• Possible need to further recapitalize week
commercial and development banks
• Cleanup of the past liabilities of privatized
entities
• Support to institutions of national interest (in
case of financial crisis and for non-guaranteed
obligations)

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5.2.3 Lessons from International Best Practices

The issue of managing contingent liabilities in an emerging economy like Mongolia is to


be seen in the broader context of economic development. Provision of government
guarantees per see is not bad. But, problems of contingent liabilities arise when the risks
inherent in such liabilities are not properly assessed and quantified, and adequate
provision is not made for the possible impact of such risks.

An emerging country like Mongolia can adopt several public policy measures to contain
the risk of contingent liabilities. These include the following:

1. As an initial step towards risk management, it is necessary to promote disclosure and


accountability with regard to explicit contingent liabilities. A centralised unit may be
set up in the Department of Fiscal Policy and Coordination in the MOF to identify
and measure the magnitude and associated risk of all contingent liabilities.

2. In its Code of Good Practices on Fiscal Transparency, the IMF has recommended
that countries should disclose the central government contingent liabilities in their
Budget documents, provide a brief indication of their nature and extent, and indicate
the potential beneficiaries.

3. Best management practice for contingent liabilities is to make adequate provision for
expected losses and to hold additional assets against the risk of unexpected losses.

4. It is useful that the said centralised unit designs and issues contingent liability
instruments and monitors the associated risk exposures, and ensures that the
government is well informed of these risks.

5. Once the concepts, definitions, methodology and data problems have been resolved
and key organisational challenges addressed, a computerized recording system for
management of debt and contingent liability could be introduced. Ministry of
Finance, Mongolia is using the UNCTAD Debt Management and Financial Analysis
System (DMFAS) for recording and monitoring external debt. The same system can
be easily extended for management of internal debt and contingent liabilities.

6. A guarantee fee must be charged for all guarantees. The fee needs to be determined
on the basis of the cost of borrowing plus the cost of provisioning. Guarantee fees
collected should not be taken as general revenues; rather be kept in a separate
contingency fund or contingent liability redemption fund. The Government of
Mongolia has already established such a Contingency Fund.

7. Sound risk sharing arrangements would include providing termination dates or sunset
clause for the contingent claims, pricing the contingent liability on a risk adjusted
basis and charging the beneficiaries accordingly.

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8. Risks associated with contingent liabilities can be reduced by promoting sound


governance rules for managing sub-national entities and state-owned enterprises, and
making them accountable for managing their own risks.

9. It is equally important to improve the supervision and regulation of the banking and
insurance system and capital markets, including the use of such instruments as
mandatory risk limits and minimum capital adequacy norms.

10. The odds for the occurrence of a financial crisis and so the risk of implicit contingent
liabilities can be reduced by sound macro-economic policies, complemented by
appropriate legal, regulatory and institutional set-up for effective prudential
regulation, monitoring, surveillance and supervision of the financial system and
improved corporate governance. However, these entail structural reforms with an
unavoidably long-time scale.

5.3 Management of Public Debt

5.3.1 Public Debt of Mongolia

Mongolia’s public debt at around 55 percent of GDP is not high as judged by


international standards, and it does not pose any problem for financing debt services as
the Government of Mongolia has maintained a surplus on current fiscal account for the
last few years. However, government revenues are highly dependent on mineral taxes and
are subject to risk in volatility of international prices of minerals, particularly copper and
gold. Although there is surplus on minerals account, there is a significant deficit on non-
minerals balance.

One of the major challenges for the government to maintain fiscal sustainability is to
reduce non-minerals deficit over time. This can be done by taking a number of measures
such as the following:

(a) To widen tax base to include services which now account for about 55 percent
of Mongolian GDP but remains relatively under-taxed.
(b) It is also necessary to strengthen tax administration for personal and corporate
income taxes and value added tax.
(c) At present the personal income tax is ten percent at all levels of income which
does not satisfy the basic principle of equity for a tax system. It may be
necessary to make it progressive while strengthening the tax administration to
deal with tax evasion.
(d) On the expenditure side, there may be a need to set limits on rise of salaries,
subsidies and social securities as have been explained earlier in financial
planning.

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5.3.2 Debt Sustainability and Fiscal Deficit

Debt sustainability is closely related to the fiscal deficit, particularly to the primary
deficit (i.e. fiscal deficit less interest payments). Sustainability requires that there should
be a surplus on primary account. It also requires that the real economic growth should be
higher than the real interest rate. Countries with high primary deficit, low growth and
high real interest rates are likely to fall into debt trap. Economic theory states that high
fiscal deficit spills over current account deficit of the balance of payments. Persistent and
high levels of current account deficit is an indication of the balance of payments crisis
and needs to be tackled by encouraging exports and non-debt creating financial inflows.

At present, Mongolia does not face these problems. For the past few years, Mongolia has
high economic growth, surplus on both domestic and external current account and very
low (in fact negative) real interest rate on external debt. These positive developments
should not lead to complacency on the part of the government. The main challenge will
be to ensure fiscal sustainability, low inflation rates and stability in real exchange rates by
adopting strict fiscal and monetary discipline and sound management of mineral
resources. Medium term output is vulnerable to unfavourable weather shocks in the
domestic sector and risk of sharp fall of global prices of minerals, which may lead to fall
in government revenues and put constraints on social welfare and investment programs
financed by the windfall profits tax on minerals.

Among other challenges, public investment plan needs to address the environmental
degradation due to overuse and illegal trade in forest products and wild life.
Overexploitation of natural resources, lax control on smaller mines and faster
urbanization may lead to loss of agricultural production, shortage of water supply,
sanitation problems, traffic hazards and pollution. These issues also put constraints for
achievement of primary education and the achievement of environmental targets in the
Millennium Development Goals.

5.3.3 Risk Management Systems for Public Debt

Public debt needs to be managed in such a way that the required amount of financial
resources is raised at the lowest possible medium and long-term cost and with a prudent
degree of risk. Risks include foreign exchange and financial crisis; change in
creditworthiness and insolvency (‘debt distress’); leading to economic crisis and social
instability (as in the case of East Asian crisis in 1997-1999). Ministry of Finance should
have a risk management framework that identifies and assesses the financial and
operational risks for the management of public debt including external debt.
(a) Independent and Integrated Public Debt Office
International best practices indicate that there is generally an independent and integrated
public debt office dealing with both internal and external debt, and in most of the
countries such an office is situated in the Ministry of Finance. Although the MOF in
Mongolia deals with management of domestic and external debt, there is no such well

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structured and integrated office. It may be useful to examine the feasibility of setting up
an independent and integrated Public Debt Office under the Ministry of Finance with the
following functions:

(i) To deal with both domestic and external debt


(ii) To set bench marks on interest rate, maturity mix, currency mix, composition of
debt in terms of domestic debt and external debt.
(iii) Identification and measurement of contingent liabilities
(iv) Policy formulation for debt management
(v) Monitoring risk exposures
(vi) Building Models in Assets Liability Management (ALM) framework

(b) Composition and Function of the Public Debt Office:

An integrated Public Debt Office consists of the following independent debt offices with
associated functions:
(i) Independent Front Offices, which are responsible for negotiating new loans with
multilateral and bilateral funding organisations and other sources of internal and
external finance.
(ii) Back office, which is responsible for auditing, accounting, data consolidation and
the dealing office functions for debt servicing.
(iii)
(iv) Middle office, which is responsible for identification, assessment, measurement and
monitoring of debt and risk, dissemination of data and policy formulation for both
short and medium term, and setting benchmarks for debt composition and currency-
interest rate- maturity mix, and
(v) Head Office, which accords final approval for both internal and external debt.

Some may feel that having a comprehensive debt management system as described here
will be expensive, but not having one may be more expensive.

(c)
Transparency in Risk Management: Debt management objectives should be clearly
defined, documented and disclosed at all levels dealing with debt management. The
measures of cost and risk that are adopted should be explained. Objectives of debt
management and preferred policies and measures should be clearly indicated by the
middle office. Equally important are the rules, regulations, institutional and legal
framework for debt management.

(d) Limits on Public Debt: As regards legal framework, many countries have enacted
Fiscal Responsibility and Budget Management Acts and have set limits on annual
borrowing and total outstanding public debt as a percentage of GDP. Parliament is the
appropriate authority to set new limits of public debt. It will be beneficial for Mongolia to
legislate similar acts with limits on fiscal deficit, annual borrowing, total outstanding
public debt and also separate limits on non-mineral balance.

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(e) Assessment of Risk:

Another task of the Public Debt Office is to define, identify, measure and monitor risk.
There are various models for risk assessment:

(i) To conduct stress tests of the debt portfolio based on economic and financial
shocks.
(ii) Simple scenario models used by the World Bank and IMF.
(iii) To project future debt services over medium and long term.
(iv) To list key risk indicators over time.
(v) To summarize costs and risks for alternative strategies and debt portfolio.

5.4 Management of External Debt

5.4.1 Various Risks of External Debt

External debt of Mongolia constitutes about 95 percent of public debt and is subject to
various risks such as liquidity risk, exchange rate risk, market risk, convertibility risk,
interest rate risk and yield risk (see Box-1). At present, external debt service ratio at 2
percent of exports does not pose any problem for the Mongolian economy, but in future
debt sustainability may be at risk if there is sudden fall of international prices of
Mongolia’s major exports or unexpected rise of prices of major imports. Significant falls
in the global prices of copper, coal, gold and cashmere and substantial rise of prices of
petroleum products may affect adversely the current account of the balance of payments
and may lead to the problem of external debt servicing for Mongolia.

5.4.2 External Debt Sustainability Measurements

Debt sustainability basically implies the ability of a country to service all debts – internal
and external on both public and private accounts- on a continuous basis without affecting
adversely its prospects for growth and overall economic development. It is linked to the
credit rating and the creditworthiness of a country. Various debt sustainability measures
are indicated in Table-8.

5.4.3 Risk Management Policies for External Debt

Although there is no unique solution to tackle various types of risk, general risk
management practices of the government aim at minimizing risk for government bodies
and public enterprises. These include development of ideal benchmarks for public debt

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and monitor and manage credit risk exposures. Typical risk management policies are
summarized in Table-9.

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Box 1. Risks for External Debt


A. External Market-Based Risks

(A1) Liquidity risk. Shortage of revenues, cash and foreign exchange to repay debt and make
interest payments. East Asian financial and foreign exchange crisis during 1997-1999 is the best
example of liquidity crisis.
(A2) Interest rate risks. While fixed interest rate has the advantage of having fixed interest
payments over time, there may be a substantial loss in a regime of falling interest rates. Solution
lies to have a proper mix of variable and fixed interest rates.
(A3) Rollover risk. The risk that debt will have to be rolled over at a high cost or in extreme
cases that it cannot be rolled over at all. To the extent that rollover risk is limited to the risk that
debt has to be rolled over at higher interest rates, it may be considered a type of market risk.
(A4) Credit risk. Central government on-lends external debt to Aimags, local governments and
public sector enterprises. Losses may arise if these investments donot have sufficient yields to
repay debt and pay associated interests.
(A5) Currency risk. Currency risk arises when there is substantial depreciation of the domestic
currency in terms of the currencies in which external dent is denominated.
(A6) Settlement risk: Refers to the potential loss that the government could suffer as a result of
failure to settle, for whatever reason other than default, by the counterparty.
(A7) Convertibility risk: Easy convertibility of the domestic currency may lead to capital
flight at the slight anticipation of crisis.
(A8) Budget/ Fiscal Risk: Fiscal risk may arise from unanticipated shortfalls in revenue or
expenditure overruns. Government should consider both budget and off-budget liabilities and
try to minimize contingent liabilities.

B. Operational and Management Risks

(B1) Operational Risk is the risk that arises from improper management systems resulting in
financial loss. It is due to improper back office functions including inadequate book keeping and
maintenance of records, lack of basic internal controls, inexperienced personnel, and computer
failures. Probability of default is high with inadequate operational and management systems.
(B2) Control system failure risks arise due to outright fraud and money laundering because of
weak control procedures, inadequate skills, and poor separation of duties.
(B3) Financial error risk. Incorrect measurement and accounting may lead to large and
unintended risks and losses.

C. Country specific and political risks influence foreign investment by the multinational
companies. Political and economic stability, scale economies, lower wages, fiscal incentives,
high yields, trade openness and open door policy for foreign investment stimulate non-debt
creating financial flows. Foreign capital is attracted by countries which allow free repatriation of
capital and profits, and donot insist on appropriation of private capital in public interest.

Source: Tarun Das (2006a)

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Table-8: Debt Sustainability Indicators

Purpose Indicators

1. Solvency ratios (a) Ratio of interest payments to exports of goods and services
(XGS)
(b) Ratio of interest payments to foreign exchange reserves
(c) Ratio of interest payments to revenue
(d) Ratio of external debt to GDP
(e) Ratio of external debt to XGS
(f) Ratio of external debt to revenue
(g) Ratio of present value of external debt to GDP
(h) Ratio of present value of external debt to XGS
(i) Ratio of present value of external debt to revenue

2. Liquidity monitoring (j) Debt service ratio: Ratio of total debt services (interest
ratios payments plus repayments of principal) to XGS
(k) Ratio of interest payments to reserves
(l) Ratio of short-term debt to XGS
(m) Ratio of total imports to foreign exchange reserves.
(n) Ratio of reserves to short-term debt
(o) Ratio of short-term debt to total debt

3. Debt burden ratio (p) Ratio of external debt outstanding to GDP


(q) Ratio of external debt outstanding to XGS
(r) Ratio of debt services to GDP
(s) Ratio of public debt to budget revenue
(t) Ratio of concessional debt to total debt

4. Debt structure (u) Rollover ratio- ratio of amortization (i.e. repayments of


indicators principal) to total disbursements
(v) Ratio of interest payments to total debt services
(w) Ratio of short-term debt to total debt
(x) Average maturity of external debt
(y) Currency mix of external debt
(z) Ratio of government external debt to total public debt

5. Public sector (aa) Ratio of public sector debt to total external debt
indicators (bb) Ratio of public sector debt to GDP
(cc) Ratio of public sector debt to XGS
(dd) Ratio of public sector debt to revenue
(ee) Ratio of concessional debt to total external debt
(ff) Ratio of concessional debt to total public debt

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(gg) Average maturity of public debt


(hh) Average maturity of non-concessional debt
(ii) Ratio of foreign currency debt to total public debt
Source: IMF (2003) and Tarun Das (2006a)

Table-9 Policies for Risk Management

Type of Risk
Risk Management Policies
1. Liquidity risk (a) Monitor debt by residual maturity
(b) Maintain certain minimum level of cash balance
(c) Fix limits for short-term debt
(d) Do not negotiate for huge bullet loans
(e) Develop liquidity benchmarks
2. Interest rate risk (f) Fix benchmark for ratio of fixed versus floating rate debt
(g) Use interest rate swaps
3. Credit risk (h) Have credit rating by major credit rating organizations
(i) Have proper project appraisal before lending;
4. Currency risk (j) Fix benchmark for the ratio of domestic and external debt
(k) Fix ratios of short-term and long-term debt
(l) Fix composition of currencies for external debt
(m) Use currency swaps and have policies for use of market derivatives
(n) Try to have natural hedge by linking dominant currency of exports
and remittances to the currency of external debt
5. Convertibility risk (o) Gradual approach towards capital account convertibility.
(p) Eencourage initially non-debt creating financial flows followed by
long term capital flows.
(q) Short term or volatile capital flows may be liberalised only at the
end of capital account convertibility.
6. Budget Risk (r) Enact a Fiscal Responsibility Act.
(s) Put limits on debt outstanding, annual borrowing, fiscal deficit
(t) Use government guarantees and other contingent liabilities (such
as insurance and pensions etc.) judiciously and sparingly
7. Operational risks (u) Allow independence and transparency of different offices (such as
front, back, middle and head offices) dealing with public debt
(v) Strengthen capability of different offices
8. Country specific (w) Have stable and sound macro-economic policies
and political risk (x) Have co-ordination among monetary and fiscal authorities
Source: Tarun Das (2006a).

5.4.4 Stress Tests

Stress tests are closely related to the debt sustainability indicators and are useful in
identifying major liquidity risks, as well as strategies to mitigate them. Stress tests can be
used to test a variety of scenarios such as the following:
(a) Types of capital inflows (FDI, trade credit, other credits)
(b) Periods of access to capital markets

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(c) Exchange rate changes/ derivative positions


(d) Risks due to price and interest rate changes
(e) Macroeconomic uncertainties (such as outlook for exports and imports)
(f) Policy uncertainties (fiscal and monetary policies)

(a) Standard Stress Tests

(b) Revenue growth = Baseline GR – 1 SD


(c) Export value growth = Baseline GR – 1 SD
(d) Assets value growth = Baseline GR – 1 SD
(e) Inflation rate = Baseline Rate + 1 SD
(f) Net non-debt creating flows = Baseline Inflows – 1 SD
(g) One-time major nominal or real exchange rate depreciation = Baseline + ½ SD

where GR stands for growth rate and SD for Standard Deviation3 of a variable.

(b) Indications of debt distress episodes

Debt distress indicated by recourse to any of the following forms of exceptional finance:
(a) Arrears: Number of years in which principal and interest arrears to all creditors
is in excess of 5% of total debt outstanding
(b) Debt rescheduling: Year of initial debt restructuring plus two subsequent years
(c) Bailout by financial institutes
(d) Normal times are non-overlapping periods of five years in which no signs of
above mentioned debt distress are observed.

(c) Determinants of debt distress

(1) Traditional Debt Indicators


(i) Present value of debt/exports ratio
(ii) Present value of debt/revenues ratio
(iii) Present value of debt/assets ratio
(iv) Debt service/exports ratio
(v) Debt service/revenues ratio
(vi) Debt service/assets ratio

(2) Measures of Shocks


(i) Real revenue growth

3
If X1, X2 …..Xn be n observations of any variable Xi (i=1, 2 ….. n)
then µ = Σ Xi is the arithmetic mean of X;
VAR = Σ (Xi - µ )² /n is the Variance of X;
SD = √ VAR is the Standard Deviation of X, and
CV = 100 SD/ µ is the coefficient of variation of X.

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(ii) Real depreciations


(iii) Assets value growth

(d) Quality of institutions and policies

1. Substantial value-added can be achieved by reviewing the role of organizational


quality, good governance, policies and shocks in addition to traditional debt
burden indicators when assessing probability of debt distress
2. There is a strong tradeoffs between quality of institutions, policies, systems of
auditing and sustainable level of debt

(e) Indicative Debt and Debt-Service Thresholds (%)

On the basis of experiences of several countries, World Bank has determined thresholds
for various debt indicators for a country depending on the quality of its debt management
policies and systems. These indicators are presented in Table-10. For example, if a
country’s debt management policies and systems are considered to be poor, then the ratio
of net present value of debt to total assets for the country should not exceed 30 percent.
The NPV debt/ assets ratio can go up to 45 percent for a country having medium quality
for debt management system, while the ratio can go up further to 45 percent for a country
having a strong and very efficient system for debt management policies and systems.
Other thresholds have similar interpretations.

Table-10 Thresholds for Debt Indicators (in percentage)


Indicators Quality of Debt Management Policies and Systems
Poor Medium Strong
NPV of debt/Assets 30 45 60
NPV of debt/XGS 100 200 300
NPV of debt/Revenue 200 275 350
Debt Service/XGS 15 25 35
Debt Service/Revenue 20 30 40

(f) Debt Distress Classifications

(i) Low risk— all indicators well below thresholds


(ii) Moderate risk—baseline OK, but scenarios/shocks exceed thresholds
(iii) High risk—baseline in breach of thresholds
(iv)In debt distress—current breach, that is sustained over projection period

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5.4.5 International best practices for external debt management


(a) Legal and Institutional Set Up

As regards legal and institutional set up, International experience suggests that
centralized debt offices in most of the countries are located under the Ministry of Finance
(MOF). The main argument for entrusting the public debt management responsibility
with the Ministry of Finance or Treasury is the proximity of location, which enables the
senior management within the Ministry of Finance to review, assess and monitor public
debt more easily. Another factor, which prompted many governments to locate the debt
office within the Ministry of Finance, is that the public debt has budgetary implications in
terms of payments of debt services, and co-ordination between the budget office and the
debt office facilitates effective management of debt and fiscal deficit.

As regards governance of external debt, most of the countries donot allow Sub national or
provincial governments to borrow directly from the external sources. Only the Central
government borrows from multilateral and bilateral sources and then on-lends money to
the states and local governments.

Government of Mongolia has the system of locating the debt management offices within
the MOF. It is necessary to continue with the system but to strengthen its structure, debt
management policies and to adopt modern techniques for risk management.

(b) Policy Framework

As regards policy framework, international best practices for the management of external
debt leads to the following broad conclusions:

(1) Management of external debt is closely related to the management of domestic debt,
which in turn depends on the management of overall fiscal deficit.

(2) Debt management strategy is an integral part of the wider macro economic policies
that act as the first line of defense against any external financial shocks.

(3) Nearly all of the autonomous debt management offices have adopted an
organizational structure similar to that in leading corporate treasury and investment
banks. They divide functional responsibilities for managing transactions into different
offices within the debt management organization and established procedures to ensure
internal control, accountability, checks and balances. Usual practice is to establish
separate front offices, middle office, back office and head office, as explained earlier.

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(4) For an emerging economy like Mongolia, it is better to adopt a policy of cautious and
gradual movement towards capital account convertibility.
At the initial stage, it is beneficia
l to encourage non-debt creating financial flows (such as foreign investment and equity)
followed by liberalization of long-term and medium-term commercial debt.

(5)
There is need to have a cautious approach on external short-term credit. In many
developing countries, like India, government does not resort to any short term
borrowing from external sources, although the private sector is allowed to borrow short-
term credit externally subject to certain conditions.

(6) Big bullet loans are bad for small economies like Mongolia, as these can create
refinancing risk in future.

(7) It is not enough to manage the government balance sheet well, it is also necessary to
monitor and make an integrated assessment of national balance sheet and to put more
attention on surveillance of overall debt- internal and external, private and public. In each
of the major Asian crisis economies- Indonesia, Korea and Thailand- weakness in the
government balance sheet was not the source of vulnerability, rather vulnerability
stemmed from the un-hedged sort-term foreign currency debt of commercial banks,
finance companies and corporate sector.

(8) It is not sufficient to manage the balance sheet exposures, it is equally important
manage off balance sheet and contingent liabilities.

(9)
It is necessary to adopt suitable policies for enhancing exports and other current account
receipts that provide natural hedge and the means for financing imports and debt
services.

(10)
Detailed data recording and dissemination are pre-requisites for an effective
management and monitoring of external debt and formulation of appropriate debt
management policies.

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(11) It is vital that external contingent liabilities and short-term debt are kept within
prudential limits.

(12) It is important to strengthen public and corporate governance and enhance


transparency and accountability.

(13) It is also necessary to strengthen the legal, regulatory and institutional set up for
management of both internal and external debt.

(14) A sound financial system with well developed debt, money and capital markets is an
integral part of a country’s debt management strategy.

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Selected References

Das, Tarun (1999a) East Asian Economic Crisis and Lessons for External Debt Management,
pp.77-95, in External Debt Management, ed. by A. Vasudevan, April 1999, Reserve Bank of
India (RBI), Mumbai, India.

_______ (1999b) Fiscal Policies for Management of External Capital Flows, pp. 194-207, in
Corporate External Debt Management, edited by Jawahar Mulraj, December 1999, Credit
Rating and Investment Services of India Ltd. (CRISIL), Mumbai, India.

_______ (2000) Sovereign Debt Management in India, pp.561-579, in Sovereign Debt


Management Forum: Compilation of Presentations, November 2000, World Bank, Washington
D.C.

_______ (2002) Management of Contingent Liabilities in Philippines- Policies, Processes, Legal


Framework and Institutions, pp.1-60, March 2002, World Bank, Washington D.C.

______ (2003a) Off budget risks and their management, Chapter-3, Philippines Improving
Government Performance: Discipline, Efficiency and Equity in Managing Public Resources- A
Public Expenditure, Procurement and Financial Management Review (PEPFMR), Report No.
24256-PH, A Joint Document of The Government of the Philippines, the World Bank and
the Asian Development Bank, Poverty Reduction and Economic Management Unit, World
Bank Philippines Country Office, April 30, 2003.

______ With Raj Kumar, Anil Bisen and M.R. Nair (2003b) Contingent Liability
Management- A Study on India, pp.1-84, Commonwealth Secretariat, London.

_______ (2003c) Management of Public Debt in India, pp.85-110, in Guidelines for Public Debt
Management: Accompanying Document and Selected Case Studies, 2003, IMF and the World
Bank, Washington D.C.

_______ (2005) International Cooperation Behind National Borders- A Case Study for India,
pp.1-50, Office of Development Studies, UNDP, UN Plaza, New York, 2005.

_______ (2006a) Management of External Debt: International Experiences and Best Practices,
pp.1-46, Best Practices series No.9, United Nations Institute for Training and Research
(UNITAR), Geneva, January 2006.

_______ (2006b) Governance of Public Debt- International Experiences and Best Practices,
pp.1-23, Best Practices series No.10, United Nations Institute for Training and Research
(UNITAR), Geneva, January 2006.

_______ (2008) Accrual Accounting Rules for Government Finance Statistics, pp.1-36, ADB
Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of
Mongolia, Ulaanbaatar, January 2008.

Das, Tarun and E. Sandagdorj (2007a) Strategic Business Planning- objectives and suggested
structure for Mongolia, pp.1-95, ADB Capacity Building Project on Governance Reforms,
Min of Finance, Govt of Mongolia, Ulaanbaatar, August 2007.

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_______ (2007b) Output costing and output budgeting, pp.1-50, ADB Capacity Building
Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, Ulaanbaatar,
October 2007.

_______ (2007c) Transition from Cash Accounting to Accrual Accounting, pp.1-35, ADB
Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of
Mongolia, Ulaanbaatar, October 2007.

________ (2008) Seven-Year (2008-2014) Action Plan for the Complete Implementation of the
Provisions of Public Sector Management and Finance Act (27 June 2002), ADB Capacity
Building Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, January
2008.

International Monetary Fund (2002) Government Finance Statistics Manual 2001, Statistics
Department, IMF, Washington D.C., August 2002.

_______ (2003a) The Implications of the Government Finance Statistics Manual 2001 for
Country Work in the Fund, GFS Policy Development Taskforce, IMF, Washington D.C., August
2003.

_______ (2003b) External Debt Statistics- Guide for Compilers and Users, 2003, IMF,
Washington D.C.

International Monetary Fund and the World Bank (2003) Guidelines for Public Debt
Management: Accompanying Document and Selected Case Studies, 2003, Washington D.C.

Ministry of Finance, Government of Mongolia (2007) Government Budget 2008, Ulaanbaatar,


December 2007.

Keipi, Kari Juhani and Justin Tyson (2002) Planning and financial protection to survive
disasters, Sustainable Development Department Tech. Studies series: ENV-139, Inter-American
Development Bank, Washington D.C., Oct. 2002.

Reserve Bank of India (RBI) (1999) External Debt Management- Issues, Lessons and
Preventive Measures, pp.1-372, edited by A. Vasudevan, RBI, Mumbai, April 1999.

World Bank (2000) Sovereign Debt Management Forum: Compilation of Presentations,


November 2000, World Bank, Washington D.C.

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Chapter-7
Core and Non Core Functions of the Govt of Mongolia

1. Basic Functions of a Government


1.1 To Repair Market Failures

One of the basic functions of the government is to repair market failures. Market failure occurs
when the free market fails to allocate resources in an optimal and efficient manner. There are four
main sources of market failures viz. (a) existence of externalities, (b) no provision of public
goods, (c) existence of imperfect competition and (d) existence of inequity. According to theories
in welfare economics, allocative efficiency in these situations can happen when marginal social
benefit (MSB) equals marginal social cost (MSC), which cannot be achieved without appropriate
government interventions.

(a) Externalities

Externalities occur when some of the costs or benefits associated with production or consumption
of goods and services spill over onto third parties. There could be positive or negative
externalities depending on the nature of the impact on the society. Positive externalities occur
when society benefits from the consumption or production of a commodity or service such as
basic education, basic health care, sanitation, vaccination, public parks, public libraries etc.
Negative externalities occur when costs are imposed on society from the consumption or
production of a commodity or service such as air and water pollution, road congestion, accidents,
smoking, spreading of communicable diseases, smuggling, terrorism, illegal trade, and immoral
traffic, over-exploitation of natural resources and degradation of environment in general.

Positive externalities are highly correlated with the so-called merit goods, which the society
values most, and judges that everyone should have, for example, basic healthcare, basic
education, public libraries, sanitation, national defense, internal security, individual safety and
protection of environment.

On the other hand, negative externalities are highly associated with the so-called demerit goods,
which the society values least, and judges to be bad for individuals. For example, consumption of
alcohol, cigarettes, prohibited drugs, addiction to gambling, money laundering, terrorism,
smuggling, illegal trade, immoral trafficking. Government needs to develop and strengthen
appropriate legal and institutional set up to prohibit these activities.

(b) No provision of public goods

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A public good is a good or service which is non-rivalrous4, non-excludable5 and non-


contestable6. Examples of public goods include national defense, street lights, internal security
and policing, basic health and basic education, national highways, rural roads, rural
electrification, public transport infrastructure, public parks and public libraries etc. A private
good is one that is both rivalrous, excludable and contestable such as private transport and
automobiles, clothing, food etc.

(c) Existence of imperfect competition

Real markets are neither competitive nor perfect due to existence of various market barriers such
as lack of free entry, existence of licenses, and heterogeneity in the quality of goods and services.
In most of the cases, free market forces do not exist, and we need government interventions for
fair play by the market.

(d) Existence of inequity

The existence of inequity also calls for government intervention.

1.2 Government Interventions

Government needs to intervene in these situations to ensure social justice and social equity.
Table-1 below describes various kinds of government’s interventions and their relative merits
and demerits to tackle these situations. These interventions basically include the following:

(a) Direct provision of public goods/ merit goods at low prices or free of charge;
(b) Enacting laws and regulations, imposing environment tax, and organizing
education campaigns/ advertisements in the case of negative externalities;
(c) Providing subsidies to producers or consumers for positive externalities;
(d) To tackle imperfect market conditions, government interventions include
iimposition of tax or price controls on a monopolist, enacting antitrust laws, and
4
Non-rivalrous – its benefits are not depleted by an additional user. The supply of public goods has no
marginal cost. Thus, for allocative efficiency, price equals zero marginal cost (i.e. P = MC = 0), and public
goods have to be provided at no charge.

5
Non-excludable – impossible (or difficult) to exclude people from its consumption or benefits. Public
good is a ‘free rider’. There is a problem for collecting user charges as no one will pay for what he can get
free. The private firms will not provide public goods as they are unable to charge the consumers. So the
public goods have to be exclusively provided by the government.

6
Non-contestable- A market may be described as perfectly contestable if no barriers to entry or exit exist.
Consequently, contestability can act as a surrogate for competition in markets dominated by a monopoly,
duopoly or an oligopoly firms. However, there could be circumstances when contestability cannot exist.
For example, the private sector may not be willing to develop basic infrastructure such as rail, roads, sea-
ports and air-ports in the initial stage of development of an emerging economy like Mongolia because of
low or negative financial return, high risk, long gestation period, high incremental capital/output ratio
(ICOR) and lumpiness of huge capital etc. Another case of non-contestability arises when there is no
general “trust that the organization producing the good will not engage in 'opportunism' or illegible
activities” (Vining and Weimer 1991, p. 6/7). Best examples of public goods where "trust" is very
essential and justices continued public production are production of critical defense products and cadres of
armed forces.

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ensuring competition through deregulation, delicensing and decontrol of


investment, production and trade;
(e) To reduce inequalities, government interventions include imposition of wealth
tax and inheritance tax; to make the tax system progressive; to provide cash or in-
kind benefits to the poor; unemployment benefits, State pensions, child benefits,
and universal basic healthcare and basic education.
(f) Nationalization of private enterprises engaged in unfair production and trade
practices (for example natural monopolies supplying public utilities).

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Table-1A: Government Interventions

Problem Intervention Evaluation

Zero provision (a) Direct provision of public Advantages


of public goods goods (a) Increases social welfare at lower
(b) Provision of merit goods at public expenditure, for example, the
low prices or free of charge provision of free health services
helps to contain and combat the
spread of disease and so less
expenditure on curative and
hospitalization expenditure;
(b) Social justice: Merit goods should
be provided according to needs and
not ability to pay
(c) Protection of Dependants:
Dependants are subject to their
guardians decision which are not
necessarily the best, so provision of
services like free education and free
dental treatment is needed to protect
dependants from bad decisions

Disadvantages
(a) Puts constraints on public resources.
(b) Non-targeted provision may lead to
misuse and over consumption.

Negative (a) Financial intervention: taxes Advantages


externalities (equal to the monetary value of (a) Leaves space for market forces to
the Marginal Externality Cost) interact
are imposed on individuals or a (b) Generates revenue for the govt
firm, internalizing externality Disadvantages
costs. (a) Difficulty in valuating externality
(b) Legislation: laws and cost.
administrative rules are (b) Overvaluation means output is
passed to prohibit or regulate below social optimum, and
Behaviour that imposes an undervaluation means that negative
Externality Cost, e.g. pollution impact is not sufficiently controlled.
permits (c) Tax effectiveness depends on
externality costs.
(c) Education, campaigns and
(d) Enforcement is difficult and
advertisements solve the
expensive in many situations.
problem of imperfect
information by allowing the (e) Benefits must outweigh the costs of
external costs to be made implementation.
known to the consumer, (f) A lot of time may be needed for
discouraging demand. effects to be felt.

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Table-1B: Government Interventions

Problem Intervention Evaluation

Positive (a) Financial intervention: Advantages


externalities subsidies paid to the producer (a) Considered the most effective way
or consumer of solving under-consumption and
(b) Legislation include regulation it can be easily implementation.
such as seatbelt usage,
compulsory education etc. Disadvantages
(a) Like taxes, the valuation of external
benefit is difficult
(b) High government expenditure is
required and it may put pressures
on government resources.
(c) Okun’s leaky bucket: each dollar
transferred from a richer to a poorer
individual, results in less than a
dollar increase in income for the
recipient. Leaks arise due to high
administrative costs, changes in
work efforts, attitudes etc. as a
result of redistribution
(d) Enforcement requires constant
checking which may translate to
high costs.

Imperfect (a) Imposition of a lump-sum tax Advantages


markets on a monopolist (shifts AC (a) Ensures fair price for consumers.
upwards), and supernormal
profits are taken as tax.
Disadvantages
(b) Governments may also regulate (a) Determination of fair price and
MC/AC pricing for monopolies monopoly profits is difficult.
through price controls. (b) Monopolies will transfer taxes to
the consumers who might actually
(c) Government may impose pay higher prices.
regulations to control monopoly (c) Price controls need to be avoided in
power, unfair production. trade a free market economy. It may be
and business practices: better to remove barriers to entry of
(i) Forbidding the formation of new firms in investment,
monopolies (e.g., antitrust laws) production and trade.
(ii) Forbidding monopolistic Behaviour
(like predatory pricing)
(iii) Ensuring standards of provision.
(iv) Ensuring competition exists (e.g.,
deregulation, delicensing,
decontrol)

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Table-1C: Government Interventions

Problem Intervention Evaluation

Inequity and (a) The tax system can be used Advantages


inequality to reduce inequalities in income (a) Ensures social justice by reducing
and wealth. income differentials.
(i) Progressive taxes:
people earning higher
incomes are taxed a higher
percentage of their income
(ii) Direct tax
imposition on wealth
(inheritance taxes)

(b) Monetary provision:


money raised through the tax
system is paid to low-income
groups to increase their disposable Disadvantages
income
(i) Means-tested benefits (a) Progressive tax may create
are paid to those that fit disincentives to work efforts with
certain criteria, such as excessive progressivity.
unemployment benefits (b) Unemployment benefits are not
(ii) Universal always claimed by those for whom
benefits are paid out to they are designed.
everyone for certain (c) Expensive to administer.
categories of people (d) Low take-up of unemployment
regardless of their income/ benefits due to bureaucracy and
wealth, such as State social stigma.
pensions, child benefits (e) Universal benefits may be very
(c) Direct provision of goods/ services expensive for the govt due to
financed through the tax system. political reasons, and may imply
Free provision means that if paying out money to those who do
services are used equally by all, not need it.
lower income groups gain more (f) Okun’s leaky bucket discussed
benefits leading to reduction of under positive externalities may
income inequality. also arise.
(i) Universal basic
healthcare and basic
education.
Unfair trade and Nationalization Advantages
production Nationalization refers to the public (a) Consumers are protected from high
practices (government) ownership of certain firms prices.
to provide goods and services sold in the (b) Social costs and benefits are taken
market i.e. corporations engaged in into account when production
commercial activities. Government often decisions are made.
takes over natural monopolies engaged in
production and distribution of public Disadvantages
utilities (power, water, gas and sanitation) (a) Cross inefficiency may arise.
to prevent monopoly power. (b) No profit motive may lead to
nationalized enterprises being
allocatively inefficient.

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1.3 Privatisation and Public-Private Partnership

Government should withdraw from those activities where private participation and private
management will be more productive and more efficient. There are various ways of privatization
as indicated in Table-2. Mongolia, like Lithuania and the former Czechoslovakia, adopted the
technique of voucher distribution. Privatisation by vouchers involves the creation and distribution
of vouchers as a form of equity. The vouchers may be share certificates or alternatively they may
award the means of acquiring share certificates in exchange for the vouchers, with or without
cash support. This interesting scheme, whereby vouchers are distributed across the population on
an even basis, is regarded as highly effective in terms of equity and speed of implementation of
privatization programs.

(b) Trade-offs among major alternative privatization routes

Table-2 below indicates the trade-offs among major alternative routes for privatization. As
evaluated by the World Bank, the selected privatization route in Mongolia (i.e. distribution of
vouchers) was fast and fair, but it did not generate enough government revenues and its impact on
the corporate governance, capital market and skill upgradation was doubtful.

Table-2: Trade-offs among major alternative privatization routes


Methods of privatization Objectives of privatization
Better Speed and Better access More Greater
corporate feasibility to capital and government fairness
governance skill revenue
Sale to outside owners Positive Negative Positive Positive Negative

Management -employee Negative Positive Negative Negative Negative


buyout
Equal-access voucher Uncertain Positive Uncertain Negative Positive
privatisation
Complete privatization Uncertain Uncertain Negative Negative Negative
(Outright sale)
Source: World Development Report, 1996, World Bank, p.52

2. Government failures and government imperfections

Another important function of the government, which is not discussed in classical economics, is
to deal with its own imperfections and to ensure good governance. As there are market failures
and market imperfections, there could also be government failures and government imperfections.
Government failure arises when government intervention in the market to repair market failures
worsens the market conditions or increases market distortions and leads to reduction of social
welfare and economic efficiency.

2.1 Factors responsible for government failures

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Government failures arise due to many factors such as the problems of incentives, information,
distribution, bureaucratic inefficiency, long time lags, frequent shifts in government policy and
vicious circle of government intervention.

2.2 Breaks between Government Spending and Outcomes

Government failures may also arise when there are breaks between the government expenditures
and the intended outputs and outcomes of the government activities and resources. One can
identify seven breaks in the chain between government expenditure and its transformation into
intended outcomes. These breaks are described in Box-1.

Box-1: Seven breaks between public expenditures and outcomes

1. Government may not spend money on the right goods and the right people.
2. Even when government spends money on the right goods and the right people, the
composition of spending may not be appropriate.
3. Even when the composition of spending is appropriate, the money may not reach the
intended service provider.
4. Even when the money reaches the intended service provider, it may not have the necessary
capability to implement the project.
5. Even when the service provider has the necessary capability to implement the project,
incentives to provide the service may not be adequate.
6. Even when the incentives are adequate, services may not reach the targeted beneficiaries.
7. Even when the services reach the targeted beneficiaries, there could be huge leakage of
money and only a small portion of public expenditure reaches the targeted beneficiaries. This
is the case of so-called Okun’s leaky bucket (refer Table 1-B under positive externalities).

3. Core Functions of the Government7

3.1 Desirable Roles and Functions of the Government

From above discussion it follows that a government in an emerging economy like Mongolia will
have the following core functions:

(1) Allocative role

This role requires the government to intervene in the allocative functions of the market to ensure
that the market trades and private transactions take place according to established rules and
regulations and are fair and just. This role requires the government to:

(a) Specify and enforce private property rights (i.e. sale, purchase, transfer, ownership, lease
etc. of property) and laws on business contracts;

7
This section is partly based on an earlier “Report on Non-core Activities Review of Pilot Agencies”
prepared by the consultants Public Sector Performance (NZ) Ltd. for the ADB and the Government of
Mongolia in Oct 1999. The present author agrees with their analysis, views and recommendations on the
role of the government.

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(b) Address under-provision of public goods and merit goods such as basic health care and
education, national defense, internal security, individual safety etc.
(c) Address issues relating to existence of positive and negative externalities;
(d) Address the issues relating to existence of imperfect markets or natural monopolies.

(2) Regulatory role

As part of allocative role, government enacts and enforces laws on property rights and contracts
for business. But, government should also protect basic human rights and ensure fundamental
rights of individuals guaranteed by the constitution. This requires that government should also
specify and administer more general system of laws and justice.

(3) Supportive role

The government’s allocative and regulatory roles require the creation and maintenance of
administrative and political functions, including systems and laws for revenue raising and
expenditure allocation among various sectors.

(4) Stabilization role

Another major function of the government is to adopt appropriate stabilization measures (such
as monetary, fiscal, budgetary, exchange rate, wage-income, labour policies and laws etc.) to
tackle adverse impact of high inflation, high interest rates, high unemployment, wide
fluctuations in the exchange rate and imbalances external markets, and thereby to improve
social welfare.

(5) Distributive role

The government should also address the issues relating to income and wealth inequalities and
social injustice by specifying and implementing appropriate taxation and transfer policies.

2.2 Production and Purchase Arrangements

After identifying the functions, next question arises, should government perform all these
functions alone or rely on public-private partnership? Another question is: how to finance these
activities? Thus the output production and purchasing arrangements by the government are very
important to establish the effective and desirable linkages among
resources→activities→outputs→and→outcomes.

(a) Output delivery (Quantity, Quality and Price)

Government is interested in maintaining desirable quantity, quality and price of the outputs
produced or purchased by it. For this, appropriate benchmarks for quality and price need to be
specified by the government.

(b) Organizational Arrangements

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Equally important is the internal structure, quality of management and capabilities of an


organization producing and supplying the public goods and services. To ensure desirable quality
it is necessary to develop, strengthen and improve the capacity building of the government
organisations and institutional set up.

(c) Ownership Arrangements

The appropriate organisational structure (e.g. state enterprise, agency) must be considered
carefully. If the government opts to own an organization, there must be sufficient justification for
that in terms of externalities or market imperfections and inequity. Government should also
explore the possibility of various public-private partnership models such as build-operate-transfer
(BOT), build-operate-own (BOO), build-operate-own-transfer (BOOT) etc.

3. Public Sector in Mongolia

In this section, we compare the role of the public sector and its share in GDP as compared with
those in India which has almost the same level of per capita GDP in terms purchasing power
parity. Before that let us compare the industrial composition in GDP in these two countries.
Table-3 indicates the industrial composition of GDP in Mongolia as compared with India in 2002
and 2005. It may be observed that in terms of broad categories of GDP viz. agriculture, industry
and services, both Mongolia and India have almost similar industrial composition in 2005.
However, within agriculture and allied services, animal husbandry has major shares in Mongolia,
while Agriculture comprising food grains, commercial agricultural crops, horticulture and
floriculture has major share in India. Within industry, manufacturing and construction have major
shares in India, while minerals have major share in Mongolia. Within services, financial services,
real estate, public administration and defense, education and health have higher shares in GDP in
India than those in Mongolia, while wholesale and retail trade and transport have higher shares in
GDP in Mongolia than those in India.

Table-3 Industrial Composition of GDP (in percentage)


Industry India Mongolia
2002 2005 2002 2005
1.Agriculture, animal husbandry, forestry 20.9 18.8 20.7 21.7
2. Industry 26.5 28.9 22.3 27.3
2.1 Mining and quarrying 2.8 2.9 10.1 20.4
2.2 Manufacturing 15.3 15.9 6.3 4.4
2.3 Electricity, gas, water 2.4 2.0 3.8 3.1
2.4 Construction 6.0 8.1 2.3 2.3
3. Services 52.6 52.3 57.0 51.0
3.1 Wholesale and retail trade 14.0 14.9 27.7 24.8
3.2 Hotels and restaurants 1.3 1.5 1.2 1.0
3.3 Transport, storage, communications 7.9 8.5 14.7 12.2
3.4 Financial services 6.4 5.5 3.2 3.9
3.5 Real estate and business 8.2 8.3 1.2 1.3
3.6 Public administration and defense 6.5 5.9 4.5 3.3
3.7 Other services (education, health, social, 8.3 7.8 7.0 5.2

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community, personal and others)


3.7.1 Education NA NA 4.6 3.1
3.7.2 Health and social works NA NA 1.8 1.6
3.7.3 Other social & personal services NA NA 0.6 0.5
Total GDP 100 100 100 100

Table-4 Private sector share by industry (% share in the respective industry)


Industry India Mongolia
2002 2005 2002 2005
1.Agriculture, animal husbandry, forestry 96.1 94.9 98.4 99.8
2. Industry 70.4 72.6 69.9 68.2
2.1 Mining and quarrying 18.1 19.7 64.4 66.3
2.2 Manufacturing 85.0 85.7 87.8 82.8
2.3 Electricity, gas, water -0.6 2.6 3.1 3.1
2.4 Construction 85.9 87.4 93.1 94.1
3. Services 67.9 71.1 69.2 76.4
3.1 Wholesale and retail trade 97.7 98.3 98.2 99.9
3.2 Hotels and restaurants 99.0 99.1 100 100
3.3 Transport, storage, communications 60.3 65.3 60.1 66.0
3.4 Financial services 36.0 42.0 59.9 87.2
3.5 Real estate and business 99.6 99.7 86.0 100
3.6 Public administration and defense 0 0 0 0
3.7 Other services (education, health, social) 66.0 67.8 12.9 17.4
3.7.1 Education NA NA 9.5 13.0
3.7.2 Health and social works NA NA 9.0 13.7
3.7.3 Other social & personal services NA NA 48.5 48.7
Total GDP 74.5 78.3 74.5 77.4

Table-5 Share of Public and Private Sector in GDP in India and Mongolia in 2005
Industry India Mongolia
Private Public Private Public
1.Agriculture and allied sectors 94.9 5.1 99.8 0.2
2. Industry 72.6 27.4 68.2 31.8
2.1 Mining and quarrying 19.7 80.3 66.3 33.7
2.2 Manufacturing 85.7 14.3 82.8 17.2
2.3 Electricity, gas, water 2.6 97.4 3.1 96.9
2.4 Construction 87.4 12.6 94.1 5.9
3. Services 71.1 28.9 76.4 23.6
3.1 Wholesale and retail trade 98.3 1.7 99.9 0.1
3.2 Hotels and restaurants 99.1 0.9 100 0
3.3 Transport, storage, communications 65.3 34.7 66 34
3.4 Financial services 42 58 87.2 12.8
3.5 Real estate and business 99.7 0.3 100 0
3.6 Public administration and defense 0 100 0 100
3.7 Other services 67.8 32.2 17.4 82.6
3.7.1 Education NA NA 13 87
3.7.2 Health and social works NA NA 13.7 86.3

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3.7.3 Other social & personal services NA NA 48.7 51.3


Total GDP 78.3 21.7 77.4 22.6

Table-4 indicates the share of private sector in GDP in 2002 and 2005 in Mongolia and India.
Table-5 indicates the shares of private and public sectors in GDP by industrial composition in
2005 in Mongolia and India. It may be observed from Table-5 that public sector has a share
around 22 per cent (less than one-fourth) in both Mongolia and India. This implies that most of
the sectors have been open for private sector and only a few sectors have been kept for public
investment for strategic reasons. This also implies that there is limited scope for further
privatisation. In both these countries, public sector has nominal share in agriculture and allied
sectors (comprising forestry, animal husbandry and fishery) which are basically driven by private
sector investment and activities.

As regards industry, public sector has a share of only 27 per cent (slightly above one-fourth) in
India and 32 per cent (slightly less than one-third) in Mongolia. However, there are significant
differences for separate sectors within industry. In Mongolia, private sector has a major share
(two-thirds) in mining, while public sector has a major share (four-fifths) in Mining in India as
Indian government has not privatized natural resource based industries such as plantations and
mining due to political ideological reasons. In both the countries, private sector has predominant
share in manufacturing and construction, while there is public monopoly in public utilities viz.
electricity, gas and water supply in both Mongolia and India.

As regards services (excluding education, health and social and personal services), private sector
has a dominant share (around three-fourths) in both Mongolia and India, although there are
differences for the separate sectors. Almost all wholesale and retail trade, hotels and restaurants,
real estate and business activities are operated by the private sector in both the countries. Private
sector has also dominant share in transport and communications in both the countries. Public
sector has a major share (58 percent) in financial sector in India, while private sector has
dominant share (87 percent) in financial sector in Mongolia. On the contrary, public sector has
dominant share in education and health in Mongolia; while private sector has dominant share in
education and health India.

Above discussion indicates that the role of the public sector in Mongolia is not very much
different from that in other developing countries at similar levels of living. In fact, most of the
sectors, where private initiatives and investment will be more productive and efficient have been
kept open for private participation. There is no presence of public sector in wholesale and retail
trade, hotels and restaurants, real estate and commercial business. Public sector has dominant
share only in public utilities (electricity, gas and water supply), education and health. It is well
known that the public utility sectors are characterized by high incremental capital-output ratio,
lumpiness of huge capital, long gestation period, high risk and low return. Because of these
reasons, private sector is not willing to invest in these sectors unless there is sharing of risk by the
both private and public sector. For example, in India, most of the power is generated and
transmitted by the public sector, while private sector is engaged in its distribution to the
consumers and collecting tariff charges. So the public-private partnership on the basis of sharing
of cost, risk and benefits may be feasible for supply of electricity, gas and water.

As regards education and health, Mongolian public sector has a predominant share. This is
justified because the Millennium Development Goals (MDGs) place high priority for achieving
universal education and nutrition. If all people are healthy and educated and live longer, they can
participate fully in the development process and gain more from it.

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4. Programs in Selected Ministries

We have examined the programs of selected ministries viz. MOECS and MOSWL as have been
approved in the Budget for 2008, and observed that the public sector participation in these sectors
and programs are justified on one or more of the following criteria:
(a) Allocative role, (b) Regulatory role, (c) Supportive role, (d) Stabilization role and (e) Re-
distributive role.

5. Concluding Observations

Mongolia and India have almost the same level of PPP adjusted per capita income, although they
differ significantly in the size of population and overall GDP. While India has a vast size of
population and GDP, Mongolia is a small economy in terms of population and economic size.
However, they have strikingly similar industrial composition of GDP and also the similar role of
the private and public sectors in overall GDP. Like India, Mongolia has allowed private
participation and private investment in all the sectors. Private sector has predominant share in
GDP in agriculture, mining and quarrying, manufacturing, construction, wholesale and retail
trade, hotels and restaurants, transport, storage and communications, financial services, real estate
and business services, and social and personal services. The role of public sector is limited to
defense, public administration, public utilities (comprising electricity, gas and water supply),
education, health and social welfare.

An examination of the existing programs of the MOECS and MOSWL in Mongolia leads to the
conclusion that these programs are justified to be operated by the public sector because of their
allocative, distributive, regulative, market stabililizing roles, although there is scope for further
enhancing the role of public-private partnership and involvement of stakeholders in policy
planning and execution of projects. Mongolia is already involving NGOs and other civil society
groups in pre-school education, vocational education, higher education, science and culture,
various poverty alleviation programs, employment generation programs, health and nutritional
programs. These efforts should continue and may be strengthened in future.

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Selected References

Baumol, W.J. (1982) Contestable Markets: An Uprising in the Theory of Industry Structure,
American Economic Review (March).

Baumol, W. J., Panzar, J. C. and Willig, R. D. (1982) Contestable Markets and the Theory of
Industrial Structure. New York: Harcourt Brace.

Das, Tarun (1996) Policies and Strategies for Promoting Private Sector’s Role in Industrial and
Technological Development in Asia, pp.1-171, ST/ESCAP/1696, UN, New York, 1996.

_______ (1997) Foreign Investment- Technology Transfer- and Growth Nexus in Asian
economies, pp.1-158, ESCAP, United Nations, Bangkok, Oct 1997.

_______ (1998) Private Sector Development Programmes in Selected Asian Economies and
Lessons for Africa, pp.1-165, Economic Commission for Africa, UN, Addis Ababa, November
1998.

_______ (2003) Economic Reforms in India- Rationale, Scope, Progress and Unfinished Agenda,
pp.1-80, published by the Bank of Maharashtra, Planning Department, Pune, February 2003.

_______ (2006) Role of foreign investment for development of utilities, in Proceedings of the
International Conference on Foreign Investment, Institute for Integrated Learning in
Management (IILM), New Delhi, February 2006.

Das, Tarun and E. Sandagdorj (2007a) Benchmarks Setting and Best Practices For Output
Costing and Output Budgeting- Part-1: Basic Concepts and Methodology, pp.1-31, ADB
Capacity Building Projects on Governance Reforms, Ministry of Finance, Government of
Mongolia, Ulaanbaatar, Mongolia, December 2007.

_______ (2007b) Benchmarks Setting and Best Practices For Output Costing and Output
Budgeting- Part-2: Applications for Mongolia, pp.1-36, ADB Capacity Building Projects
on Governance Reforms, Ministry of Finance, Government of Mongolia, Ulaanbaatar,
Mongolia, December 2007.

Dollery, Brian and Worthington, Andrew (1996) The Evaluation of Public Policy: Normative
Economic Theories of Government Failure, Journal of Interdisciplinary Economics, Volume 7(1),
pp. 27-39.

Hillman, Arye L. (2003) Public Finance and Public Policy, Responsibilities and Limitations of
Government, pp.1-766, Cambridge University Press.

Holden, Paul and Sarath Rajapatirana (1995) Unshackling the Private Sector – A Latin
American Story, World Bank, Washington D.C.

International Finance Corporation (IFC) (1995) Privatization – Principles and Practice,


International Finance Corporation, World Bank, Washington.

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Kikeri, Sunita, John Nellis and Mary Shirley (1994) Privatization: Lessons from the Market
Economies, World Bank Research Observer, Vol. 9 (2), July.

Perlmann, Candice S and Harry Zarenda (1997) Is privatisation a public good? A review of
recent literature, The Free Market Foundation (FMF) Monograph No. 15, University of the
Witwatersrand, The Free Market Foundation, Sandton, South Africa.

Public Sector Performance (NZ) Ltd. (1999) Report on Non-core Activities Review of Pilot
Agencies, submitted to the ADB and the Government of Mongolia under TA.No.2931-MON on
Program Preparation for Governance Reforms, October 1999.

UNCTAD (1995) Comparative Experiences with Privatization: Policy Insights and Lessons
Learned, United Nations, New York.

Vining, A. R. and Weimer, D. L. (1991) Government Supply and Government Production


Failure: A Framework Based on Contestability, Journal of Public Policy, Volume 10.

Wilson, Robin (2002) Private Partners and Public Good, Briefing Paper GOV/BP/2002/1,
Institute of Governance, Public Policy and Social Research, Queen’s University Belfast, Belfast
BT7 1NN, www.qub.ac.uk/gov

World Bank (1996) World Development Report 1996, From Plan to Market, New York: Oxford
University Press.

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Chapter-8

Seven Year (2008-2014) Action Plan


For Complete Implementation of PSMFA 2002

1. Public Sector Management and Finance Act (27 June 2002)

The current budget planning arrangements in Mongolia are comprehensive in coverage. As a part
of wider governance reforms and to modernize planning and budgeting systems, government of
Mongolia enacted the PSMFA 2002 (Public Sector Management and Finance Act, 27 June 2002).
The complete implementation of the provisions of the Act requires the following activities on the
part of the government:

(1) To prepare Medium Term Strategic Business Plan8 for each budgetary body indicating
objectives and outputs specified by category, quantity, quality and costs9.

(2) To estimate output cost on the basis of accrual production cost including management
overheads and capital charges.10

(3) To sign output purchases agreement between the “Portfolio Minister” and the budgetary
bodies specifying terms of delivery and prices of output11.

(4) To set accounting policies for budgetary bodies in conformity with International
Accounting Standards and implement these policies12:

(5) To prepare Financial Statements containing operating statement, balance sheet, and
statements of cash flows, net assets and contingent liabilities13.

(6) To prepare Medium Term Fiscal Framework Statement indicating the public investment
plans, forecast balance sheet and cash flow for the budget year and two forward years14.

(7) To conclude Performance Agreement between the Portfolio Minister and the General
Managers (GM) of a budgetary body within one month from the date of the approval of the
State Budget by the State Great Hural15.

(8) The Act also specifies systems for the Assessment of Performance Agreement16 .
2. Progress until now
Government initiated measures to implement the PSMFA almost immediately since its inception
in June 2002. Good progress has been made as regards:
8
Article 26.1 of the PSMFA (27 June 2002).
9
Article 26.2 of the PSMFA
10
Article 26.3 of the PSMFA
11
Article 23 of the PSMFA.
12
Article 9 of the PSMFA.
13
Article 37 of the PSMFA.
14
Article 25 of the PSFMA.
15
Article 18 of the PSMFA.
16
Article 47 of the PSFMA.

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a) Introduction of Strategic Business Plans in major line ministries;


b) Formulation of Medium Term Fiscal and Budgetary Framework,
c) Preparation of consolidated financial statement for general government,
d) Time bound execution of budget and
e) Improved fiscal reporting on cash basis with some steps towards accrual accounting.
MOF is implementing two major capacity building projects being financed by grants and loans
from the World Bank and the Asian Development Project. Significant progress has been made as
regards:
a) Development of basic concepts,
b) Preparation of methodological papers, guidelines and manuals
c) Strengthening the information technology (IT) system and
d) Creating general awareness about usefulness and necessity of modern techniques for
output budgeting and accrual accounting.
Currently, annual budgets are based on multi-year Strategic Business Plans (SBPs) for the HQ
and the agencies under the pilot ministries viz. MOF, MOECS, MOSWL and MOH. For 2008,
three pilot ministries viz. MOECS, MOFA, MOSWL have introduced Program Budgets linked to
outputs and outcomes. These budget formulations are in the right direction. Program budget, as in
many other countries, is the first step towards output budgeting and accrual accounting. These
ministries need to be congratulated and complemented for their pioneering and excellent works.
Similar budgets need to be prepared other line ministries and all budgetary entities including the
agencies.

Despite these efforts and good results during the last five years, progress towards full
implementation of the PSMFA remains slow due to some structural problems. Assessments
made by the IMF and ADB experts and the present consultants have indicated the following
constraints:

(a) There is absence of specialized units in budgetary entities, which have adequate
expertise in strategic planning, output costing and accrual budgeting;

(b) The issues and activities involved in budget modernization are complex, but the real
background was not studied carefully and in a timely manner.

(c) Assessment of national capabilities for implementation of the law such as outlining of
required human resources, suitable organizational structures, and adequate information
technology was neglected.

(d) A hustled approach was adopted to complete the full implementation of the framework
within 2-3 years without adequate capacity building and necessary infrastructure, which
is responsible for slow progress and partial success.

(e) In a way, the Act was passed in a hurry without assessing the capabilities in terms of
manpower, skill and ICT. In fact, the Act has not provided an implementation plan.

(f) The Act is over-ambitious for a developing country like Mongolia. It contains all the
components of Budget Modernization, which in fact at present are being implemented
by only the most advanced countries like Australia, Canada, New Zealand, UK, USA17
17
In the USA, there is an elaborate system and well established infrastructure to prepare strategic
plans, budgets and to evaluate budget performance. The Office of Performance Budge ting and
Strategic Planning is the focal point of Treasury's budget and performance integration efforts. The

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and selected OECD countries. Even these countries (having much higher per capita
income, advanced information technology and skilled manpower) have taken more than
two decades to reach to this stage. Such a leap-frogging may not be feasible for a
developing country like Mongolia.

Complete implementation of the PSMFA (2002) will require major actions on planning, costing,
accounting and auditing as indicated in the Box given below.

3. Seven-Year Action Plan for 2008-2014


For Complete Implementation of the PSMFA (2002)

Above observations lead to the conclusion that the successful implementation of the PSMFA
(2002) as regards strategic business plans and output budgeting on the basis of accrual accounting
and benchmarks will require the following actions on a priority basis by the present government
of Mongolia:

(1) To consolidate the progress made until now by proper documentation in both
English and Mongolian;
(2) To build up necessary institutions for modernizing budgets;
(3) To build up capacity and skill of the personnel engaged in planning, budgeting,
accounting and auditing;
(4) To strengthen and upgrade the information technology system to support the
budget modernization process and systems.
(5) To conduct all these works in a time-bound systems framework but step by step
and in a phased manner.

Office oversees the USA President's Management Agenda and provides guidance to the Bureaus (i.e.
Agencies) on policy issues. There is also a separate Department on Strategic Plan in the Treasury
which prepares and implements medium term Strategic Plan for the Fiscal Years 2007 – 2012. It
indicates goals, objectives and strategies for the diverse activities under the strategic plan. There is also
an Office of Management and Budget (OMB) in the USA Congress to assist the USA President in
overseeing the preparation of the federal budget and to supervise its administration in Executive
Branch agencies. As compared to this, the institutional set up in Mongolia is constrained due to lack of
resources and technical manpower. At present, most of the substantial works are being carried out by
the international and national consultants under the capacity building projects being funded by the
Asian Development Bank and the World Bank. There is need to establish permanent internal units in
each ministry to deal with all these aspects of budget modernization.

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1. Budget Planning
1.1 MOF should develop a new budget framework based on outcomes, outputs, activities,
inputs and performance parameters to measure quantity, quality and timeliness of outputs
and outcomes.
1.2 A Strategic Business Plan should be prepared, at least once in three years, indicating
priorities for the budget year and three forward years
1.3 Once in three years, a Medium Term Budget may be prepared indicating expenditure for
the previous year, and forward estimates for the budget year and three forward years using
the budget outcomes and outputs framework.
1.4 Budgets for agencies must indicate responsibilities of each unit/ manager for executing
outputs and outcomes.
1.5 A new budget preparation and approval cycle should be established that allows explicit
consideration of reliable information on financial and non-financial performance during at
least first half of the financial year.
1.6 A new chart of accounts should be established that links revenues and expenses to
activities, outputs and outcomes.
1.7 The role of Accounting and Audit Divisions in recording, maintaining and reporting
financial accounts and the systems coordination should be strengthened.
1.8 There will be greater responsibility and accountability for operations managers to ensure
efficient and effective use of resources.
1.9 It can be achieved by specifying performance parameters on outputs and outcomes at the
operational level, and more accurate costing information for each activity and output.
1.10 MOF should provide estimates for budgetary allocations for all portfolio ministries for the
budget year and three forward estimates as early as possible, so that line ministries can
prepare comprehensive strategic plans in time.
2. Output Costing and Output Budgeting
2.1 Need to move to an output and outcome budgeting and planning framework.
2.2 The new framework should include a system for monitoring and reporting cost
information on a timely and accurate basis.
2.3 Ideally the system should be fully computer based to improve speed and efficiency.
2.4 A new costing system should be developed within an outcome and output framework, and
an attribution matrix for linking activities and resources.
2.5 Costs will include both direct and indirect costs, but at the first phase, major capital costs
(i.e. depreciation and capital charges) may be excluded from calculations.
2.6 Specification of outputs should include definition of quantity and quality so that unit costs
can be measured.
2.7 An internal audit system may be introduced. Specific staff may be recruited for
maintaining and analyzing cost data as part of their duties, and this should be a priority
area of works for the internal audit team.
2.8 When accurate cost data is produced on a uniform basis for a number of years or for
alternative providers, agencies should consider setting benchmarks for costing goods and
services.
3. New Accounting Heads and Codes

3.1 Develop a new chart of accounts to facilitate output budgeting and accrual accounting.
3.2 Purchase of a standard software package for Financial Management Information System
(FMIS) may help to automate processes for entry, checking, verification and authorization
of transactions.
3.3 The selected FMIS will also provide the checklist of standards required for accounting
platforms.
3.4 Some changes to existing accounting procedures and standards may be required to be
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1. Budget Planning
1.1 MOF should develop a new budget framework based on outcomes, outputs, activities,
inputs and performance parameters to measure quantity, quality and timeliness of outputs
and outcomes.
1.2 A Strategic Business Plan should be prepared, at least once in three years, indicating
priorities for the budget year and three forward years
1.3 Once in three years, a Medium Term Budget may be prepared indicating expenditure for
the previous year, and forward estimates for the budget year and three forward years using
the budget outcomes and outputs framework.
1.4 Budgets for agencies must indicate responsibilities of each unit/ manager for executing
outputs and outcomes.
1.5 A new budget preparation and approval cycle should be established that allows explicit
consideration of reliable information on financial and non-financial performance during at
least first half of the financial year.
1.6 A new chart of accounts should be established that links revenues and expenses to
activities, outputs and outcomes.
1.7 The role of Accounting and Audit Divisions in recording, maintaining and reporting
financial accounts and the systems coordination should be strengthened.
1.8 There will be greater responsibility and accountability for operations managers to ensure
efficient and effective use of resources.
1.9 It can be achieved by specifying performance parameters on outputs and outcomes at the
operational level, and more accurate costing information for each activity and output.
1.10 MOF should provide estimates for budgetary allocations for all portfolio ministries for the
budget year and three forward estimates as early as possible, so that line ministries can
prepare comprehensive strategic plans in time.
2. Output Costing and Output Budgeting
2.1 Need to move to an output and outcome budgeting and planning framework.
2.2 The new framework should include a system for monitoring and reporting cost
information on a timely and accurate basis.
2.3 Ideally the system should be fully computer based to improve speed and efficiency.
2.4 A new costing system should be developed within an outcome and output framework, and
an attribution matrix for linking activities and resources.
2.5 Costs will include both direct and indirect costs, but at the first phase, major capital costs
(i.e. depreciation and capital charges) may be excluded from calculations.
2.6 Specification of outputs should include definition of quantity and quality so that unit costs
can be measured.
2.7 An internal audit system may be introduced. Specific staff may be recruited for
maintaining and analyzing cost data as part of their duties, and this should be a priority
area of works for the internal audit team.
2.8 When accurate cost data is produced on a uniform basis for a number of years or for
alternative providers, agencies should consider setting benchmarks for costing goods and
services.
3. New Accounting Heads and Codes

3.1 Develop a new chart of accounts to facilitate output budgeting and accrual accounting.
3.2 Purchase of a standard software package for Financial Management Information System
(FMIS) may help to automate processes for entry, checking, verification and authorization
of transactions.
3.3 The selected FMIS will also provide the checklist of standards required for accounting
platforms.
3.4 Some changes to existing accounting procedures and standards may be required to be
MOF, Govt. of Mongolia 213 Glocoms Inc. (USA)
ADB Project Terminal Report -Part-3 by Tarun Das
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3.1 An Action Program for 2008-2014

On the basis of the above observations and conclusions, a seven year Action Program for the
period of 2008-2014 has been prepared by the government. This is described in the Table-1
indicating desired actions by all budgetary bodies in a phased manner during 2008-2014. All the
budgetary bodies including agencies and Aimags are directed to study Table-1 carefully and to
take note of the following tasks:

1. In the first phase (2008-2010), MOF will prepare guidelines and manuals with
precise concepts, methodologies and examples on strategic planning, output costing and
output budgeting, modified accrual accounting18, benchmarks and performance
parameters. MOF will advise line ministries and provide training for preparation of
strategic business plans, output budgeting and accrual accounting.

2. During the first phase the line ministries will prepare strategic business plans
consistent with national plan, sectoral master plan and MDGs. They will prepare output
budgets on the basis modified accrual accounting and provide guidance to the agencies
under them for preparation of strategic plans and output budgets.

3. In the second phase (2011-2012) all agencies will move towards full accrual
accounting i.e. depreciation costs will be considered as a part of output cost. MOF will
conduct pilot studies on performance based budgeting19.

4. During the last phase (2013-2014) there will be complete implementation of the
provisions of the PSMFA. To support this transition, there is need to develop and
strengthen the accounting and auditing norms. Works are in progress for strengthening
both software and hardware for accounting and auditing. These works will continue and
be brought to their logical ends.

5. Government of Mongolia gratefully acknowledges the valuable financial and


technical assistance received from international development organizations, other donors
and bilateral countries during the last few years. It is expected that in future similar
technical assistance will be provided by these donors for capacity building and upgrading
the technical manpower of line ministries/ Agencies/ Aimags and other budgetary bodies.

18
Modified Accrual Accounting also called cash-plus-accrual accounting means preparing budgets
basically on cash accounting but using accrual accounting wherever possible such as for government’s
contributions to employees’ insurance, social security, reserve fund, natural calamity and contingent
liability funds. Depreciation costs for assets may not be considered until all assets (both financial and non-
financial) have been fully listed and assessed at market prices.
19
Under performance based budgeting, outputs, outcomes, costs, planning and execution of projects,
physical and financial performances of the line ministries/ agencies of the previous year are tracked and
evaluated by the MOF as per prescribed performance parameters, and budget for the next year is
determined on the basis of this performance. MOF also provides suggestions for improvement of
performance parameters.

MOF, Govt. of Mongolia 214 Glocoms Inc. (USA)


ADB Project Terminal Report -Part-3 by Tarun Das
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Table-1: Major Components of a Phased Action Plan for 2008-2014


Major Components First Phase Second Phase Third Phase
of Action Plan (2008-2009) (2010-2012) (2013-2014)
1. Strategic 1.1 Set up a 1.4 Review the system 1.6 Review the system
Management of specialized and upgrade it as and upgrade it as
Institutional Set- organization (similar demanded by needs demanded by needs
Up (Priority to the USA Office of and changing and changing
Action and Performance circumstances. circumstances.
Continual Review Budgeting and 1.5 Set up a specialized
and Upgrading) Strategic Planning) to unit in all Agencies
oversee preparation of and all Aimags.
SBPs, manuals and
guidelines on SBPs,
output costing,
performance
budgeting etc.
1.2 If (1.1) is not
feasible, then
strengthen and enlarge
the Fiscal Policy and
Coordination Dept in
MOF for planning and
coordination of SBPs
at the national level
and in line ministries.
1.3 Set up a specialized
unit (with at least 3
professionals) in all
line ministries, major
Agencies and selected
Aimags
2. Comprehensive 2.1 Have a systematic 2.3 Review the system 2.4 Review the system
Human Capital and comprehensive and upgrade it as and upgrade it as
Strategy (Priority plan for capacity demanded by needs demanded by needs
Action and building through and changing and changing
Continual Review regular training, and circumstances circumstances
and Upgrading) upgradation of IT
for each line
ministry and agency
2.2 Formulate
manpower planning
and policy
indicating size,
composition and
salary structure of
technical people
3. Strategic Planning 3.1 Prepare manual on 3.3 Prepare SBPs for all 3.4 Prepare SBPs on
scope and uniform line ministries and the basis of full
structure of SBPs Agencies with accrual accounting
3.2 Prepare SBPs for output budgeting on
major ministries the basis of cash
and Agencies on the accounting and
basis of cash and feasible accrual
feasible accrual accounting
accounting

MOF, Govt. of Mongolia 215 Glocoms Inc. (USA)


ADB Project Terminal Report -Part-3 by Tarun Das
________________________________________________________________

Major Components First Phase Second Phase Third Phase


of Action Plan (2008-2009) (2010-2012) (2013-2014)
4. Output costing and 4.1 Prepare guidelines 4.3 Introduce 4.5 Move towards
output budgeting and manuals on performance based output costing, and
output costing and output budgeting in performance based
output budgeting on major ministries output budgeting on
the basis of cash and major Agencies the basis of full
accounting and 4.4 Extend the initial accrual accounting.
feasible accrual system of output
accounting costing and output
4.2 Apply the methods budgeting to all
to major line ministries, agencies
ministries and and Aimags
major agencies
5. Strengthen cash 5.1 Move towards 5.8 Strengthen and 5.12Develop and
accounting and move Activity Based consolidate these approve Public
towards accrual Costing and systems on output sector accrual
accounting Management budgeting at all line accounting rules
(ABC/M) system. ministries, agencies and procedures
5.2 Strengthen data and Aimags 5.13Develop system and
base for Activity 5.9 Develop fully methodology for
Based Costing computerized valuation and
(ABC) on the basis systems for recording of assets
of cash accounting. accounting and (both financial and
5.3 Develop budget auditing non-financial
accounting rules 5.10Develop technical assets)
and procedures for cadre on modern 5.14Develop
cash accounting. accounting and methodology for
5.4 Develop accrual auditing as per estimation of fixed
accounting for international best assets depreciation
interests and social practices and capital charge
insurance systems, 5.11 Make a complete in the public sector
5.5 Develop additional List of stocks and 5.15 Move towards full
codes for outputs assets (for both accrual accounting
and performance in financial and non- for output costing
the Master Chart of financial assets) in and output
Accounts. all line ministries budgeting
5.6 Strengthen and Agencies
government internal
audit in the HQ and
line ministries
5.7 Conduct pilot
implementation of
output costing and
output budgeting in
selected agencies
and selected
Aimags

MOF, Govt. of Mongolia 216 Glocoms Inc. (USA)


ADB Project Terminal Report -Part-3 by Tarun Das
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Major Components First Phase Second Phase Third Phase


of Action Plan (2008-2009) (2010-2012) (2013-2014)
6. Performance Based 6.1 Develop systems 6.6 Develop systems 6.10Build capacity in
Budgeting and methodology for Cost Accounting line ministries and
for performance for Performance- agencies for accrual
budgeting and Based Budgeting- accounting,
performance 6.7 Develop new performance-based
evaluation, accounting budgeting, and
managerial cost principles and performance
accounting systems, standards and evaluation
with an emphasis budget systems that 6.11Extend
on Activity-Based can support implementation of
Costing (ABC) and comprehensive performance-based
cost management. Performance budgeting, output
6.2 Prepare a White Management at all and outcome
Paper on levels of the performance rating
Performance-Based organization. and reporting,
Budgeting. This 6.8 Develop monitoring and
paper should Performance audit to all line
explain what a Management ministries, agencies
Performance System to ensure and Aimags
Budget is, what are that an agency’s
its scope and administrative and
objectives, key support functions
steps in its (budget, financial
development, and management,
how it may be used. human resources,
6.3 Prepare a Guide to information
Performance-Based technology,
Budgeting. This procurement, etc.)
guide should directly and
include tables and explicitly serve the
charts illustrating a needs of program
step-by-step managers in
approach on how a meeting the
government agency agency’s strategic
may develop an and annual goals.
effective 6.9 Conduct pilot
performance implementation of
budget. performance-based
6.4 Develop Program budgeting, output
Assessment Rating and outcome
Tool (PART). performance rating
6.5 Apply these and reporting,
techniques for one monitoring and
line ministry and audit in selected
one Agency. Line ministries,
selected agencies
and selected
Aimags

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