Mongolia hopes for a phase of economic stability

May 30, 2015 by Lee Cashell


Mongolia’s economy had a bruising year in 2014 with barely a week passing without the currency hitting a new low against the US dollar and foreign investment dropping by a precipitous 74 per cent year-on-year. But last month’s announcement that the Mongolian government has broken the deadlock in negotiations with Rio Tinto for the development of the second phase of the Oyu Tolgoi copper mine signals that a new round of foreign investment will begin flowing into the country.

Saikhanbileg Chimed, the prime minister, has been building a clear case that Mongolia’s economic growth will stall without foreign investment, appearing on national television in January to hold an X-factor SMS style vote on the question of whether Mongolians want austerity or prosperity. The majority of the country’s 3m citizens texted “prosperity” which he has taken as a mandate turn the green light back on for foreign investment.

Foreign direct investment (FDI) plunged to $507.6m last year from $4.45bn in 2012, but the slowdown has given the country breathing room to prepare for the next cycle of FDI.

When the dollars begin to flow again, Mongolia is in a much better position to absorb investment than it was at the height of the commodities super-cycle in 2011 when GDP growth surged to 17.5 per cent. There is over $10bn – almost as much as the country’s annual GDP – of pent up investment which will enter Mongolia over a two-year-period once Rio Tinto begins work on the second phase of its flagship mine and other confirmed mining projects come online.

Since the slowdown, the government has been steadily improving Mongolia’s infrastructure. Railway agreements have been signed with the Chinese, the Japanese have financed the construction of bridges and a new international airport, and Ulaanbaatar’s city center is unrecognisable from two years ago – a whole network of new roads being installed spanning far beyond the city limits. There are also plans for a new power plant and in January 2015 a tender was awarded to a consortium of firms to develop Tavan Tolgoi, one of the largest coalmines in the world.

These infrastructure improvements are reason to be optimistic that the economy will not overheat as sharply as in the fourth quarter of 2011 when inflation spiraled to 12 per cent from 4 per cent in just nine months with sharp price hikes for food, real estate and construction materials.

In a more developed economy, the state could have reacted more adeptly in order to increase infrastructural capacity. For Mongolia however, the government had very little access to international project finance and lacked the expertise to execute large-scale developments in such a short period of time, leaving it without the tools to accommodate extraordinary growth.

As Mongolia’s largest real estate group, our construction and cement business was squeezed by higher prices caused by a two-day back up of imports at the border with China at the height of summer 2011, which ultimately led to increased prices for construction materials.

Four years on, we are more confident about the fundamentals as the country’s middle class matures. Mongolia’s economic growth hit 7.8 per cent last year – a rate that neighbouring China and Russia would envy, and with the Rio Tinto project back online is set to surge once more.

Mongolia is a growth story. Back in 2000, GDP per capita was less than $475 per annum at prevailing exchange rates, with average incomes even lower. The mining and service sector boom and low birth rates pushed GDP per capita to $4,000 by 2013 and that is likely to rise to $5,000 per capita in coming years. That is a nearly 10-fold increase in the space of a decade.

However, Mongolia is still a frontier market and together with the vast opportunity in the country there are still cautionary notes to sound, primarily related to political risk and resource nationalism issues. In February 2015, the president pardoned Justin Kapla and two other former executives at South Gobi Resources who had been imprisoned under tax evasion charges after not being allowed to leave the country for two years.

The case illustrates flaws in the legal system and the potential for a lack of due process – both of which have given foreign investment the jitters. However, some sectors – such as property — have been well served by the courts. Foreigners and locals enjoy essentially the same property rights, and the ownership of immovable property is a well-entrenched legal concept and actively promoted and protected by the courts

A review of the tax and legal framework around property investment in Mongolia provides a very favourable framework when benchmarked against many other countries in the Asia Pacific region, and has been a driving force behind the ability of the country to attract foreign investment into the property and construction sectors.

It is one reason we are confident that Mongolia’s economic fundamentals are strong and now that the tide is turning on FDI, this new phase of growth will be more sustainable.

Lee Cashell is CEO of Asia Pacific Investment Partners

SOURCE: Financial Times