Guest Post: A Young Democracy Seeks Investors

Adam Simpson is a Master’s student in the Human Security and Peacebuilding program at Royal Roads University. As a change management specialist and project manager with the Aga Khan Foundation, he is currently overseeing the development of a healthcare infrastructure programme in northern Afghanistan.

This post is based on a policy update to the Canadian Defence & Foreign Affairs Institute which also covered the regulatory framework of resource management for Afghanistan.

Mine-golia: A Young Democracy Seeks Investors

Mongolia has vast and largely untapped mineral deposits of copper, gold and coal, but until recently, has remained largely impoverished. With several big mining projects on the horizon, however, there is promise of an economic boom that will present the government with a very real challenge: how do you manage to successfully exploit these resources without further destabilizing the economy? And how will their proximity to China factor into the equation?

The International Monetary Fund foresees a double-digit annual-growth rate in Mongolia for the next several years, and a quadrupling of GDP per head – from a mere $2,000 – by 2018 (Anonymous, 2010). Two mines in Mongolia’s southern Gobi region – Oyu Tolgoi, a copper and gold deposit, and Tavan Tolgoi, a coal mine – are expected to provide much of the new wealth, both of which will include road and rail links to Mongolia’s hungriest customer: China (Anonymous, 2010).

Legal Constructs

Currently, the Mongolian government stands to profit handsomely from Oyu Tolgoi, of which they own one third (Anonymous, 2010). But in a country where politics is based on patronage, such a windfall could spell disaster. With swollen government coffers, vote-buying and corruption could thrive, and even “virtuous public spending” could push up inflation (Anonymous, 2010). Further, if their economy becomes too dependent on mining, Mongolia becomes highly vulnerable to price shocks and market fluctuations. One recent construct is the adoption of fiscal stability law that sets indices for commodity prices for budgeting purposes. When prices go above the index, excess revenue will be stored in a “stability fund”. If prices fall, the government can tap the fund to cover its costs (Anonymous, 2010).

Other measures are also being implemented to curb the risks, including the passing of new anti-corruption legislation, as well as promises to help boost investments in non-mining sectors, including tourism, finance and outsourcing so that the country does not become dependent on a single industry.

Proximity to China

Mongolia’s neighbour China is one of the largest global consumers of coal and rare earth minerals (Anonymous, 2010). With healthy diplomatic ties established between the two countries, Mongolia is uniquely positioned to start undercutting China’s existing coal suppliers such as Australia and Indonesia, pending the development of appropriate infrastructure.

Analysts estimate that when the Tavan Tolgoi mine opens, Mongolia could deliver coal to China for under $100/tonne, less than half of the $220/tonne for Australian coal (Anonymous, 2010). The main concern, however, is whether or not Mongolia can avoid becoming too economically dependent on China and their insatiable appetite for resources, and grow their mining industry in a sustainable way. To date, they have not been able to establish a solid foundation to achieve this.

Foreign Direct Investment: Shifting Frameworks

Mongolian mining frameworks have historically been poorly defined, shifting dramatically between a keen focus on FDI and a state-protectionist model. After the fall of the Soviet Union – its primary trading partner until the early 1990’s – Mongolia recognized the need to attract new investors (Anonymous, 2011).

Mongolia’s 1997 Minerals Law aimed to attract FDI by reducing investment taxes, strengthening land tenure rights, and increasing transparency, and in 2002, the government further lowered royalty payments on all minerals to 2.5% (Anonymous, 2011). As a result, FDI in Mongolia grew 2,200% to an annual total of $344m in 2006. This economic boom was highlighted by the discovery of the world’s largest copper and gold deposit at Oyu Tolgoi in the south Gobi Desert (Anonymous, 2011), but the government was starting to get nervous about the increasing foreign dominance in the mining sector.

A 2006 revision of the Minerals Law shifted the country to a significantly more protectionist model (Anonymous, 2011). The new regulation doubled royalty rates, imposed a Windfall Profits Tax of up to 68% on copper and gold, and reserved the right for the government to claim ownership of “strategically important” deposits (Anonymous, 2011). It also allowed the state to take up to a 50% equity stake in deposits discovered with government assistance or 34% for privately explored deposits (Anonymous, 2011). But investor backlash, coupled with the spread of the 2008 global financial crisis drove down demand and prices for Mongolian commodities, and in 2009 legislators repealed the Windfall Profits Tax and replaced it with a sliding scale of royalties, effective early 2011 (Anonymous, 2011).

The Role of China: What Should it Be?

The extent of China’s role in the context of growing Mongolia’s national mining industry is far too complex to be intimately addressed in the scope of this paper, but by using China at a high level to illustrate the influence foreign direct investors will have in the future of this emerging economy was worthy of a brief analysis. As Mongolia will continue to rely heavily (if not almost entirely) on FDI to exploit its mineral wealth, regulatory reforms and governance will largely revolve around the relationships with these foreign actors, whether they be private consortiums or state-run companies. Systemically, it is the question of to what extent will FDI govern the future of this industry, and can Mongolia grow and open their mining opportunities to an internationally diverse group of investors?

Mongolia’s Mining Future

Mongolia’s current mining regulatory framework is still a work in progress. While the Mineral Law allows 100% foreign ownership of businesses, only individual Mongolian citizens can own the real estate under mineral deposits to be exploited (Anonymous, 2011). The current tax code is an improvement over its predecessor and provides more opportunities for capital investment deductions, but in a country that is expanding at such a frenetic pace, not only must foreign companies ensure they are well informed of planned regulatory changes before they become law to ensure the viability and long-term stability of their projects (Anonymous, 2011). Perhaps most importantly though, Mongolians themselves must ensure that they keep their mining industry and reliance on China in check by establishing equally viable markets in other industries such as tourism, finance, and outsourcing.

References:

Anonymous (2011). Mongolia rocks. Industrial Minerals, http://proquest.umi.com/pqdlink?did=2259607981&Fmt=2&rqt=309

Anonymous (2010). Nomads no more; Mongolia’s mining boom. The Economist, 397(8705), 52.

About Julian Dierkes

Julian Dierkes is a sociologist by training (PhD Princeton Univ) and a Mongolist by choice and passion since around 2005. He teaches in the Master of Public Policy and Global Affairs at the University of British Columbia in Vancouver, Canada. He tweets @jdierkes
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