Mongolia: Succumbing to the Resource Curse?
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Mongolia: Succumbing to the Resource Curse?

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Mongolia, rich with coal, gold, and copper has been riding high on the global natural resource boom. The country’s proximity to China makes its resources even more attractive. Over the past decade, mining sector development has led to significant foreign investment and growth in government spending, provided a boost to household incomes, and has moved much of the country beyond its nomadic herding past. In 2012, Mongolia was one of the world’s hottest economies, clocking GDP growth of 12.3 percent. However, political risks emerging over the past year put this positive frontier market story at risk.

Short-Term Risks: The Mining Sector

Amidst the hustle and bustle of the capital, Ulan Bator, trouble is brewing. In June of 2012, the Democratic Party of Mongolia came to power as part of a coalition after years of rule by the Mongolian Peoples Party. The new government has taken a more aggressive stance regarding FDI and is ratcheting up criticism of the country’s largest investor, Rio Tinto and its management of the $13 billion Oyu Tolgoi copper and gold mine (commonly abbreviated OT), which has been in development for close to two decades.

The government is refusing to support Rio Tinto’s efforts to raise an additional $4.5 billion to finance the second stage of OT that is seen as key to the long-term economic viability of the ore body. Lawmakers in Mongolia’s parliament are seeking to secure a greater share of the wealth extracted by quadrupling royalties from the current 5% to 20%. Meanwhile, the country’s president has accused Rio Tinto of mismanagement and wants to secure a greater say in the mine’s operations. The government’s moves come as gold and copper prices have been tumbling on global markets, adding to the pressure on OT.

Thus far Rio Tinto has refused to renegotiate its agreement with the government, but support is seen as essential to raising stage two funding and for successful operation of the mine. Rio Tinto and the government made an initial effort to resolve the dispute in February, but failed.  Following those conversations, Rio Tinto CEO Sam Walsh went so far as to state he had serious concerns regarding “recent political signals within Mongolia calling into question some aspects of the investment agreement” between the company and the government.

Meanwhile there are problems elsewhere at Tavan Tolgoi (TT), a massive coking coal deposit near the Chinese border and the most important mining operation in the country besides OT. Development has been delayed several times for financial reasons, as the government-owned operator, Erdenes Tavan Tolgoi, is reported to have presold coal to the Aluminum Corp of China at a price below the cost of production. It is also rumored that that deal was rushed in order to underwrite pre-election cash handouts to the population by the previous government, which according to Batsuur Yaichil, the head of Erdenes, cost the firm $669 million in 2012. Erdenes has since asked the government for a $500 million dollar bailout. An IPO expected to raise cash for the firm in 2012 has been put off until at least 2014.

Longer-Term Risks: Fiscal Sustainability

The situations at OT and TT point to larger, long-term risks associated with the populist ruling coalition’s questionable fiscal management. Since coming to power, the government has issued $1.5 billion dollars in sovereign bonds, introduced a draft mining law that would dramatically change the regulatory environment and raise royalty rates, fired TT’s previous top executive, and halted coal shipments to China.

The parliament also voted in a 2013 budget heavy on spending and backed by poor revenue assumptions. The budget increases expenditures and net lending by 18% bringing it to a projected to 42% of GDP. This comes after spending almost tripled between 2009 and 2012.

Making matters worse, current policies have lead to double-digit inflation. Thus far, inflation has not reached the record high levels of 2008, when it peaked at 33.7%, but inflation in 2012 was approximately 15%, driven by skyrocketing food prices, which according to the World Bank are undermining the real income and spending power of the population, a third of which still lives below the poverty line.

Several issues complicate Mongolia’s future further. The first is $1.5 billion in sovereign debt issued in 2012, representing almost 12% of GDP. During the lending roadshow the government suggested that the proceeds would be used to finance infrastructure projects, which are sorely needed to sustain growth and lift the population out of poverty, but the recent handouts to the population suggest short-term priorities have intervened.

A second complicating factor is the revenue assumptions made by the government. The government currently projects corporate income taxes to swell by $320 million, approximately half of which is expected to come from a renegotiated investment agreement with Rio Tinto. The source of the other half of new corporate income taxes is not explained.

Perhaps more worrisome are poor assumptions regarding the major trends in global commodity prices and volumes. The copper price assumptions made in late 2012, during the budget drafting process, were approximately 5% above the forecasted averages for 2013. Making matters worse the price of copper, along with gold and coal, has continued to fall in 2013 as demand in China has eased. To mitigate exposure to commodity price volatility, the government established a stabilization fund but it is woefully underfunded, amounting to only 2% of GDP for one year.

If ongoing negotiations with Rio Tinto are not resolved equitably the smooth start of operations at OT, slated for this summer, appears in peril. Additionally, should Rio Tinto and the Government fail to settle their dispute further fresh foreign investment will likely dry up. 

Comments
9
Well, it's the truth
July 2, 2013 at 02:28

Mogi, man! Nothing disappointing in this news! This independent news, unlike the state and oligarchs contrlled news in Mongolia,  don't have to feed lies to you to  make you not disappoint!! This is the true image of Mongolia! Mongolia is running down the hell in the long run having accumulated large debt of $13 billion USD. Unless miracle happens, Mongolia is next Nigeria in 10 years!! Right, everyone is fed and satisfied with this fake democratic elections underneath which canning greedy, vicious bustards plundering the state wealth!!! Poor Mongolians fed by false democracy is hopelessly hoping for better future that will never come under current state! It's your loss idiots!!

Nick
May 24, 2013 at 17:03

I agree with this article. But I blame the half or quarter-Chinese politicians like Ts. Elbegdorj, or Sanjijav bayar-tsogt, former minster of finance who signed the OT agreement, inthe Mongolian Resource Curse. It is ultimately china's policy and intention to take over Mongolia through their Loyal sons and grandsons like Ts. Elbegdorj and S. Bayar-tsogt.

My Mongolian friends tell me that the Chinese eat not only dogs, cats, or rats but their onw babies as well. Scary!

C
May 24, 2013 at 16:28

This is way out of date.  Bond proceeds haven't been used for cash handouts, and cannot be under the terms of the issuance.  OT is about to get approval to export concentrate.  There are obviously concerns about government spending and revenue, but articles like this just add to the slowing down of FDI.

HF Mongol Khan
May 24, 2013 at 12:03

ok that is the internet curse!

There is something happening in Mongolia and everybody wants to be involved, including writing articles mixing just anything, most of it OUTDATED FACTS, in order to have all the KEY WORDS  for the article to be picked up by GOOGLE SEARCH and de facto gain "expert" status.

That's life, we'd better get use to it. It's probably just the beginning…then Mongolians have to sort out all the great (mostly biased/framing) advices they are getting from all around the world.

There may be quite a number of issues where Mongolia, its government and MPs deserve some bad marks (not for everything for sure) but that article is superfical, outdated, presenting a misleading picture of Mongolia, all this already covered by Mogi.

 

That being said, GOM'd better understand how perceptions develop …and then how it can affect its future. Mongolia is NOW connected to the world and that is not a free lunch.

 

 

R
May 24, 2013 at 11:06

As usual, Julian Dierkes and Mogi are right on. It is really wonderful to see a group of informed and engaged commentators emerging to provide analysis on Mongolian current events.

Nick, seriously? Do you also think Obama is a terrorist, communist, Kenyan robot from the planet Zorg?

Julian Dierkes
May 24, 2013 at 08:11

I agree with Mogi's and R's comment that this article is misleading and presents a merely superficially informed view of the situation. It's alwaus easy to throw around terms like "Resource Curse", "resource nationalism" to express the fears of international investors, it's less obvious that those terms are analytically meaningful, or that this analysis takes into account a Mongolian perspective.

It is important to note that Monoglian policy-makers are operating in an enormouse experience and information deficit vis-a-vis a project like OT. Yes, they have ample experience with some aspects of the mining of such a project given the decades-long production at Erdenenet, but the interaction with a foreign investors and, over the past two years given the kind of interest that this article represents, foreign financial markets, is new. Perhaps they are not always going about their search for solutions in the most straight-forward or desirable (but to whom?) way, but they are seeking a regulatory set-up that maximizes benefits to Mongolians, as they well should. This quest will continue to lead to some conflict, but the public nature in which this conflict has been carried out this year makes it an opportunity not just for populist politicians, but also for investors and citizens to inform and be informed. Ultimately, this democratic search for solutions will strengthen Mongolia is an investment destination, but it will also bring some level of prosperity to some large number of Mongolians.

The article is right to point to spending as an area of concern. The main concern would be a downturn in commodity prices that would reduce future income, an eventuality that policy-makers do not seem to be taking into account very much, again partly out of lack of past experience. In the meantime, the proceeds from the Chinggis Bond are being invested (primarily) in infrastructure projects. While you might question the wisdom of specific projects, surely that investment will encourage further economic activities.

Mogi
May 24, 2013 at 00:15

Disappointing and factually wrong in too many instances. Intentionally written and cherry-picking events to put a one-sided bad image on Mongolia

Nick
May 23, 2013 at 21:44

Mongolia's so-called Democrats lead by populist President Ts. Elbegdorj and Prime-Minister N. Altan Huyag are really killing the country by distributing cash handouts in order to get votes in elections. Mongolia is really heading towards the Resource Curse.

By the way, I heard from Mongolian friends that President Ts. Elbegdorj is a half-chinese and his ancestors moved from Gansu province in china to Mongolia at the beginning of 20th century. If that is the case, then, what do you expect of a half-chinese President except the betrayl and sell-out of the country to the Chinese.

R
May 23, 2013 at 18:58

Your analysis is out of date and you are mixing and matching your facts. The conflict with OT is winding down. OT management stated as much on last week's call. Cash hand outs stopped months ago. Inflation is now under 10%. Your fiscal analysis is right on but everything else is months out of date. This is what happens when you use Bloomberg for fact checking on a distant and poorly understood market.

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