From Coal to Equity: Mongolia’s Challenge of Sustaining Growth and Reducing Poverty

Mongolia's coal-driven economic growth has elevated it to upper-middle-income status, supported by strong domestic demand and fiscal transfers that reduce poverty and inequality. However, reliance on mining, rising imports, and fiscal inefficiencies pose risks, requiring progressive reforms for sustained and inclusive growth.

Mongolia’s recent economic transformation driven by a booming mining sector in recent years has elevated the country to upper-middle-income status in 2024, as highlighted by the World Bank’s Mongolia Economic Update. The coal industry, particularly exports to China, has fueled economic growth, significantly boosting private sector incomes and public finances. Domestic demand has surged, supported by rising household incomes, wage growth, and government-led infrastructure investments. However, these gains are accompanied by vulnerabilities, including a widening current account deficit as imports outpace revenues, reliance on global commodity markets, and continued exposure to external shocks. While growth remains robust, the economy must address structural challenges to maintain fiscal sustainability and ensure inclusive development.

Rising Domestic Demand and Inflationary Trends

Economic growth in Mongolia has been largely fueled by rising domestic demand, supported by increased public spending and higher real incomes. Private consumption saw a dramatic rise in 2024, growing by nearly 17 percent year-on-year—its fastest pace in a decade. Government investments in infrastructure projects, coupled with wage and pension increases, have further stimulated domestic demand. However, this demand has led to a significant increase in imports, particularly machinery and consumer goods, contributing to the reemergence of a current account deficit, which reached 5.6 percent of GDP. While inflation moderated to 6.7 percent in 2024, driven by declining global food and fuel prices, strong domestic demand and fiscal spending continue to exert upward pressure. In response, the Bank of Mongolia cut policy rates by 300 basis points, easing credit conditions and encouraging business and consumer lending. Despite these measures, lending rates remain high, signaling limited monetary policy transmission, even as credit growth accelerates across sectors.

Fiscal Gains Amid Spending Pressures

Mongolia’s fiscal system has delivered strong results, with the government recording a budget surplus of 3.1 percent of GDP in the first nine months of 2024. Higher revenues, particularly from coal royalties, corporate income tax, and VAT, have outpaced expenditures. Public sector wages saw a substantial increase, particularly in education, health, and administration, contributing to household income growth. Pension benefits were also increased, further boosting private consumption. However, fiscal spending remains high, with significant investments directed toward infrastructure projects as part of the government’s four-year action plan. While this spending supports economic momentum, it raises concerns about sustainability, especially given Mongolia’s dependence on volatile mineral revenues. Public debt-to-GDP ratios improved to 38.2 percent, a notable reduction from 44.4 percent in 2023, though risks remain if revenue streams weaken due to global commodity price fluctuations.

Tackling Poverty and Inequality through Transfers

The World Bank’s analysis of Mongolia’s fiscal system highlights its effectiveness in reducing poverty and income inequality, primarily through direct transfer programs. The poverty rate, which stood at 35.6 percent before fiscal interventions, declined to 33.8 percent after accounting for transfers such as the Child Money Program (CMP), social welfare pensions, and food support initiatives. Direct transfers are the most impactful, with the CMP alone representing 2.6 percent of GDP and lifting significant portions of the population out of poverty. However, the broad-based nature of these programs limits their efficiency, as higher-income households also benefit. Programs like the Food Support Program, while modest in scale, are highly cost-effective, with more than half of its benefits reaching the poorest decile. The inequality-reducing effect of these transfers is substantial, with Mongolia’s Gini coefficient dropping by 5.4 points, outperforming many upper-middle-income peers. Nevertheless, targeted reforms are needed to ensure resources are directed toward the most vulnerable households, maximizing poverty reduction outcomes while enhancing fiscal efficiency.

The Tax System: Limited Redistributive Impact

Mongolia’s tax system, though critical for revenue generation, has limited redistributive impact due to its flat structure and significant tax burdens on low-income households. Personal income tax (PIT) contributes significantly to government revenues but imposes a disproportionate burden on poorer households, particularly in urban areas with formal employment. The absence of progressive tax rates and limited exemptions for low-income earners reduces PIT’s ability to mitigate inequality. Meanwhile, indirect taxes such as VAT and excise duties, though necessary for revenue collection, are mildly regressive, as they represent a higher share of income for poorer households. Subsidies, particularly for energy and housing mortgages, exacerbate inequality by disproportionately benefiting wealthier households who consume more services and qualify for mortgage loans. Housing mortgage subsidies, while expensive, provide minimal benefits to poorer households, highlighting the need for reform to redirect funds to more progressive initiatives.

Long-term Reforms for Inclusive Growth

Looking ahead, Mongolia’s economic outlook remains positive, with growth expected to accelerate to 6.5 percent in 2025, driven by increased copper and gold production from the Oyu Tolgoi mine and a modest recovery in agriculture. However, sustaining this momentum will require balancing short-term fiscal spending with long-term structural reforms. The World Bank recommends enhancing fiscal sustainability through progressive tax reforms, reducing subsidies that disproportionately benefit the wealthy, and reallocating resources to cost-effective programs like the Food Support Program. Investments in human capital, infrastructure, and climate resilience are essential for ensuring inclusive and sustainable growth. Strengthening social safety nets, improving the efficiency of transfer programs, and addressing regional disparities will be critical to reducing poverty and inequality. Moreover, enhancing the independence of the central bank and fostering exchange rate flexibility will bolster macroeconomic stability and resilience to external shocks.

Mongolia’s economic success offers a foundation for long-term development, but careful policy reforms are needed to ensure sustained growth and inclusivity. While the fiscal system has proven effective in reducing poverty and inequality, inefficiencies in tax structures and transfer programs must be addressed to maximize impact. By prioritizing progressive reforms and long-term investments, Mongolia can build a more resilient economy capable of weathering global uncertainties while delivering broad-based prosperity for its people.