Crossroads Asia

China and Japan’s Investment Competition in Mongolia

Recent Features

Crossroads Asia

China and Japan’s Investment Competition in Mongolia

Is the development competition between China and Japan beneficial or detrimental to Mongolia?

China and Japan’s Investment Competition in Mongolia

Japan’s Prime Minister Shinzo Abe, left, is greeted by Mongolia’s President Tsakhiagiin Elbegdorj, right, as he arrives for the 11th Asia-Europe Meeting (ASEM) in Ulaanbaatar, Mongolia, Friday, July 15, 2016.

Credit: AP Photo/Mark Schiefelbein, Pool

China and Japan are two of the most financially influential countries in Mongolia’s proximity. Both have a long history of trade and investment in the latter. Mongolia calls Japan its “Third Neighbor,” which is a term first used in 1990 by then-U.S. Secretary of State James A. Baker who referred to the United States as Mongolia’s “Third Neighbor.” Mongolia then adopted the “Third Neighbor” policy aim at broadening its foreign relations outside of China and Russia to other countries like Japan, the United States and European countries. Japan has traded with Mongolia since the 13th century through the Steppe Road and is currently Mongolia’s third largest source of imports. Since Mongolia became a democratic country in 1990, Japan has consistently provided aid and assistance for its transition to a market economy.

China is one of Mongolia’s closest partners and has traditionally been its biggest trader and investor. By July 2017, China directly invested $4.1 billion in the country which accounted for 30 percent of Mongolia’s foreign investment. However, as China asserts more economic influence in Mongolia via the Belt and Road Initiative, the Tokyo-Beijing relationship has become increasingly complicated. With China’s rise, Japan has felt the urgency to balance and compete with China in the region. Is the development competition between China and Japan beneficial or detrimental to Mongolia? And how can Mongolia maintain and expand its interests within this complicated relationship?

China-Mongolia-Russia Economic Corridor

Since China began its comprehensive strategic partnership with Mongolia four years ago, their partnership expanded their economic cooperation, prioritizing natural resources and infrastructure. They also pledged to strengthen security cooperation through increased political communication. In 2014, President Xi Jinping first initiated the China-Mongolia-Russia Economic Corridor (CMREC) as part of the Belt and Road Initiative, furthering its goal to develop infrastructure and industrial projects to establish free trade and economic cooperation zones in cross-border cities. Some of the more well-known projects include the China-Mongolia Cross-border Economic Cooperation Zone from Erenhot to Zamiin Uud, and the Northern Railway Corridor which extends the national rail network to connect Mongolia with Russia and China.

By contrast, Japan started its development projects in Mongolia in the late 90s and early 2000s. In 2003, Mongolia joined the Central Asia Regional Economic Cooperation (CAREC) Program implemented by Asian Development Bank (ADB) in which Japan is one of the two largest voting powers with 15.6 percent. So far there are 301 ADB projects in Mongolia. Just one year after China announced CMREC, Japan’s Prime Minister Shinzo Abe signed Japan’s first economic partnership agreement (EPA) with Mongolia in 2015. He pledged to reduce tariffs and provide an additional $330 million in loans of 0.1 percent annual interest rate for the construction of a new international airport in the nation’s capital city Ulaanbaatar. Potentially inspired by the CAREC, China’s CMREC intends to compete with it while targeting specifically development in Mongolia instead of all Central Asian countries.

Sino-Japan Competition Open Doors

While China and Japan are funding different projects through their respective frameworks, the results of their projects have the potential to complement each other. For example, while Japan provided $500 million in soft loans to construct a new airport in Ulaanbaatar, the Export–Import Bank of China funded $140 million in soft loans to build a highway connecting the airport to the city. These two projects are inseparable — while an airport without a road leading to it is useless, a road leading to nothing is futile. Together they improve the effectiveness of the country’s infrastructure.

Their competition also provides more options for Mongolia. In 2016, Mongolia invited the Dalai Lama to give lectures on Buddhist teachings to the people. At the time the country was going through a debt crisis and sought a large loan from China, the only country willing to lend money with low interest rates. In order to solicit the loan, Mongolia, a country with ancient ties to Tibetan Buddhism, apologized to China and pledged not to invite Dalai Lama again. This incident demonstrated Mongolia’s dependence on China to the extent that it was willing to forsake faith in search of financial assistance.

Japan can provide this diversity of partnership to alleviate this pressure. While Mongolia and China’s relations were strained by the incident with the Dalai Lama, Japan was able to utilize its resources in financial platforms to help create an international aid framework providing Mongolia approximately $5.65 billion. This framework is backed by the International Monetary Fund, the World Bank, the Asian Development Bank, Japan, South Korea and China to relieve the financial challenges faced by Mongolia. During a time of political tension, diversification of loan sources helped Mongolia.

China and Japan’s Complementary Investments

It is interesting to note the difference between China and Japan’s investment strategy. While China’s investment in Mongolia is done mostly in direct lending between the two countries or through several new Chinese-led multilateral frameworks such as the Asian Infrastructure Investment Bank (AIIB) in which China has 26.6 percent of voting power, Japan contributes through multilateral organizations that have established longer reputation with more experiences such as the Asian Development Bank, the World Bank and the International Monetary Fund.

Each has their own strengths and weaknesses. China’s accumulated experiences in financing and building infrastructure projects and its ambitious Belt and Road Initiative will enable Mongolia to be more connected with Europe and rest of Asia through roads and access to the sea via ports. However, some Chinese investment lacks international oversight and comes with political strings like in the case of the Dalai Lama incident. Meanwhile, Chinese investment in large infrastructure projects drove Mongolia’s capital expenditure surge in 2013, thus contributed to an abrupt rise of debt-to-GDP ratio from 2015 to 2016.

Japanese funding comes from more transparent sources that can help diversify the risks for the borrowing country, in turn providing global knowledge transfer and technical assistance to promote sustainable development. The downfall is that it has a higher threshold for Mongolia whose credit rating is low and whose public debt reached almost 100 percent of GDP last year.

For Mongolia, this is an opportune time to work through China, Japan, other “Third Neighbor” countries such as South Korea and Canada, and international financial institutions to diversify away from raw materials, being selective about the projects that can provide long-term sustainable benefits such as investing in human capital and technology advancement. In this trilateral relationship, each country has something to offer and Mongolia needs to establish its own development strategy based on its national interests in order to prevent itself from being caught between its two stronger neighbors.

Yiyi Chen is a master’s candidate at the Fletcher School of Law and Diplomacy at Tufts University. She studies international law, East Asia foreign affairs, and development economics.