As Mongolia develops its mining industry to foster economic and social development, two challenges are key to the country’s long-term prospects: how can Mongolia’s economy move beyond its focus on resources, and how can its resource wealth be used for sustainable development?

One possible answer to these questions, which came up repeatedly during discussions at the World Economic Forum’s Strategic Dialogue on the Future of Mongolia, is to set up a sovereign wealth fund (SWF).

Modeled in part on the success of Norway in turning its oil wealth into a sustainable source of government financing through its Government Pension Fund Global (GPFG), such funds have become widely used by Gulf states as well as throughout Asia, where some SWFs have a strong focus on strategic investments for geopolitical or industrial development goals.

In the Mongolian context, suggestions for the creation of a SWF focus on the need to balance fluctuations in revenue streams to the state stemming from resource activities, to seek a fiscally sustainable benefit from exhaustible resources, and to fund diversification strategies.

However, using a SWF for diversification investment is at odds with frequent calls at the Strategic Dialogue for a withdrawal of the Mongolian government as an active participant in economic activities, to a role that is focused on enabling and regulating business. If investors and financial markets do not want the Mongolian state to continue its involvement and ownership in the resource sector, why does investment in green technologies, for example, seem desirable? What makes the proponents of a liberalization of mining activities believe that the Mongolian state would be particularly good at “picking winners” in efforts to diversify the economy?

Given the Mongolian government’s track record in running state-owned companies, the use of a SWF for diversification investments would raise many concerns about profitability and the likelihood of patronage and corruption in such investments.

To the extent that a SWF can balance fluctuations in revenue streams that are caused by commodity prices, Mongolia already has a Fiscal Stability Fund for this purpose. While this fund is limited in its investment opportunities due to the requirement of constant liquidity, once fully funded, it does allow the government to budget for mining revenues that are based on 10-year running averages of prices rather than on annual oscillations.

One of the express purposes of a SWF is to seek geographic diversification away from the dependence on the domestic economy, which is dominated by resources. Many such funds, including the Norwegian GPFG, are expressly prohibited from investing domestically to avoid distortions in exchange rates, but also out of concern over an investment strategy that increases rather than limits exposure to country risk. Tasking a Mongolian SWF with investment in diversification prevents such a fund’s efforts to reduce exposure to the Mongolian economy and is thus counterproductive.

That is not to say that investment for diversification should not be pursued, but it is unclear whether a SWF is the appropriate vehicle for such efforts. While investments for sectoral diversification should be pursued, a broadly defined SWF is not the appropriate vehicle for such efforts.

Proposals for a Mongolian SWF aimed narrowly at financial stabilization also neglect opportunities for a wider impact that could be built into such a fund. If a SWF could be a model of transparency in investment, this could be a catalyst for deepened transparency in other sectors. Investment choices made by the SWF could be the basis for a concerted effort not only to document these choices, but also to make this documentation available and accessible to the general public.

The activities of such a fund could also be used to structure capacity building in the financial sector. For example, the running of a fund could be contracted primarily to foreign financial professionals initially, but with a clear plan for the education of Mongolian financial managers within such a fund and a gradual shift of management to Mongolian participation keeping in mind the overall aim at maximizing financial benefits.

A SWF is important for Mongolian policy-makers to consider once they overcome current blockages of revenue streams. However, such thinking needs to be targeted very specifically at specific goals. A SWF could do some very important things for Mongolia in the future, but it cannot be expected to be a fix-all.

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Author: Julian Dierkes is an Associate Professor and Coordinator of the Program on Inner Asia at the Institute of Asian Research at the University of British Columbia, Vancouver, Canada. He blogs at mongoliafocus.com. Follow him @jdierkes.

Image: A small-scale miner holds his gold that was melted together at a processing plant north of the Mongolian capital city Ulan Bator in this April 5, 2012 file picture. REUTERS/David Gray/Files