through a classic boom-and-bust cycle from 2005 to 2009, with the non-mining deficit (i.e., expenditures relative to non-mining revenues) increasing from a deficit of 1 percent of GDP in 2005 to a deficit of over 15 percent of GDP in 2008 (Figure 1, left panel), which required large expenditure cuts in capital and operations (goods and services), and donor assistance.

**Figure 1: Mongolia’s public expenditure patterns, 2003-2010**

<!-- Start of picture text --> Expenditure Main government expenditures (% of GDP)<br>Mining-related revenue<br>60 Non-mining revenue 8,000 40%<br>Budget balance 35%<br>50 Non-mining balance 7,000 30%<br>Copper price (end-year, right axis)<br>40 6,000 25%<br>20%<br>30 5,000<br>15%<br>20 4,000 10%<br>5%<br>10 3,000<br>0%<br>0 2,000 2003 2004 2005 2006 2007 2008 2009 2010<br>2003 2004 2005 2006 2007 2008 2009 (June budget<br>-10 amend) 1,000 Wages and salaries Subsidies<br>Transfers Purchase of goods and services<br>-20 -<br>Investment<br>Percent GDP<br><!-- End of picture text --> _Source_ : Ministry of Finance The use of the windfall mining revenues provide a good measure of policy-makers‘ preferences as it is like ―manna from heaven‖ that can be spent without requiring an additional tax burden on citizens (Figure 1, right panel). The 2005 to 2008 boom was used to finance massive increases capital expenditures (from 3% of GDP in 2005 to 8% of GDP in 2008), across-the-board wage increases for civil servants (from 6% of GDP to 9% of GDP), and social transfers (from 8% of GDP to 10% of GDP). Within public investments, the roads and transport, and fuel and energy sectors received a bulk of the resources (roughly half of the capital expenditures were on these two sectors), followed by education and health. The social transfers were in general untargeted and involved significant cash handouts to all Mongolian citizens with children.<sup>4</sup> The expenditure categories that were neglected, relatively, were operations (purchase of goods and services, which declined from 11% of GDP to 8% between 2005 and 2008) and in particular capital repair and maintenance, as described in more detail below.

The problem in Mongolia, unlike many other developing countries, is therefore not under-spending on capital but the poor quality of spending, as elaborated below. It should also be noted, that apart from its broader macro-stability implications — the spending effect resulting in the overheating of the economy and real exchange rate appreciation, thereby hurting the non-resource tradables sector — a fiscal cycle itself compromises investment quality. The rapid increase in expenditures — in nominal terms, public capital expenditures increased seven-fold in three years — puts a strain on the systems for planning and execution, and results in the misallocation of resources. In other words, if capital expenditures grow this rapidly then it is highly likely that they are financing many bad projects as the systems for appraising and selecting projects cannot grow in capacity and sophistication at a similarly rapid pace. Equally importantly, the local construction sector usually cannot handle this surge in demand for public projects, resulting in myriad implementation problems. Both smoothing expenditure fluctuations to avoid the problem of many new projects that then cannot be funded during the downturn, and controlling expenditure growth to preserve the quality of the capital asset portfolio is therefore imperative for a resource-dependent economy.

> 4 The Child Money Program

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