FDI to Mongolia: Restrictions, China, and Comparisons with Canada

Ever since the Chalco bid for South Gobi Resources prompted the swift passage of a Foreign Investment Law by the Mongolian parliament I’ve been struck by some of the parallels between this law and its counterpart in Canada. I tweeted about this some weeks ago as well.

Feeding the Hungry Dragon

Now, a very interesting policy update for the Canadian Defence & Foreign Affairs Institute has me jumping off my fence and wanting to weigh in on this topic. The policy update (November 2012 PDF) was written by Charles Krusekopf and Hugh Stephens. These are authors who are definitely worth paying attention to. Charles has been involved in Mongolia and research on Mongolia for quite some time. He is the founder and continues to serve as the Executive Director of the American Center for Mongolian Studies. [Disclosure: I serve on the Executive Committee of the Board of Directors of the ACMS.] The ACMS has established itself in the 10 years of its existence not only as the go-to organization for researchers of all stripes doing research in or on Mongolia, but has become a mainstay of relations between Mongolia and North America. It also houses an ever-growing library that offers access to scholarly materials to Mongolians.

Hugh has had a stellar career with the Canadian foreign service and then in the private sector, mostly in Asia. He knows policy-makers and policy-making processes in Asia intimately.

In their piece, Hugh and Charles (S&K hereafter) argue that Mongolia offers a cautionary tale for the Conservative government as it makes decisions about resource investments in Canada by foreign investors. They base this argument on their view that given the similarities between Mongolia and Canada in terms of the strength of the resource economy, but also the need for foreign direct investment in this sector, the reactions to decisions made in Mongolia may offer a glimpse at reactions that Canadian decisions might prompt.

In their eyes, developments in Mongolia this year are a cautionary tale because the passage of a foreign investment law there has raised the political risk for investments in Mongolia, particularly for Chinese investors, but as a quasi-collateral damage, for all foreign investors.

Their argument was endorsed by a Wall Street Journal “Canada Real Time” blog post by Paul Vieira.

Similarities and Differences between the Mongolian and Canadian Foreign Investment Law

Before I turn to developments in Mongolia, a quick note on the parallels (or lack thereof) between the Canadian and Mongolia Foreign Investment Law.

The greatest similarity obviously is the fact that such a law exists and that this law demands a government review of investments in certain industries triggered by thresholds of the financial volume of these transactions.

Discussions about the application of the Canada Investment Act to the bid by Chinese state-owned for Nexen are ongoing in Canada. The general expectation had been that a Conservative government would welcome such investment. However, this government has actually turned down a number of such bids, swayed by economic nationalism rather than a free trade/capitalist agenda. In the CNOOC bid this debate is sharpened by the fact that the bidder is a state-owned Chinese company. Both, “state-owned” and “Chinese” appears to have raised warning flags in parts of the Conservative government.

S&K are not alone in warning that these discussions in Canada are likely to hurt Canada’s reputation as an investment destination. This is an argument that another highly trustworthy voice on Asia in Canada, Joseph Caron, DFAIT Asian grand slam winner as the former ambassador to China, India and Japan, made in October in the Financial Post.

Earlier in the Fall there had apparently been some discussion in the government about specifying some guidelines that might distinguish bids by state-owned entities from those of non-state companies.

This is a distinction that the Mongolian law has created quite explicitly. The Mongolian law outlines sectors that it applies to (the resource sector is included, naturally) and thresholds at which different kinds of reviews are triggered. A large bid by a state-owned foreign investors would thus trigger a review by parliament. This was a clause in the law that was aimed at the Chalco bid for South Gobi at least in part.

And, in a Canadian context, parliamentary review sounds like a good thing, doesn’t it? In fact, there are voices demanding just this in Canada, though I suspect that they’re not necessarily inspired by the Mongolian example.

Parliamentary review in Canada would offer transparency and would force the government to take a clear stance on a proposed sale. Whatever this decision was, any opposition to it would also want to be clear in its opposition making this decision more approachable to the Canadian public.

Is this what would happen in Mongolia? Would parliamentary review offer more transparency, a more informed and more democratic process? Sadly, I doubt it. Note that I have lots of reasons to believe in Mongolian democracy and its staying power. I continue to keep a close eye on political developments in Mongolia in part to develop a more accurate sense of the political risk involved in investing there.

Parliamentary review in Mongolia would imply a) a politicization of the decision, and b) particularly sadly, an opportunity for parliamentary corruption. Obviously, the latter fear is based on conjecture, though there is so much discussion of endemic corruption in Mongolia and many MPs are so obviously wealthy that it is difficult to dismiss this nagging fear. Note, however, that Transparency International just released its 2012 Corruption Perceptions Index and boosted Mongolia’s ranking from 120th to 94th least corrupt. This may give some cause for optimism that anti-corruption measures are building momentum and that parliamentary review may become just right as a response to foreign investment in the future.

Also, decisions on FDI in Canada would come in the context of a fairly stable regulatory regime that offers predictability and the attempt to balance investors’ expectations with Canadians’ needs. Stability in the regulatory regime has not been the strong suite of Mongolian mining regulation.

So, this is where the parallels in my eyes clearly end. Yes, similar principles, but a very different application thereof.

Mongolia as a Cautionary Tale?

Back to that hungry dragon…

S&K write that “Mongolia’s handling of the China file has been less than stellar, reflecting a deep seated ambivalence about China’s intentions combined with a rise of resource nationalism”.

Resource nationalism has been written about a fair bit in the Mongolian context. This is generally equated with some evil movement aiming at nationalization of resource assets. Hugo Chavez is the example that everyone seems to have in mind. In Mongolia this claim is most commonly linked to the demand by some parliamentarians and parts of civil society that the Investment Agreement for the Oyu Tolgoi mine should be revisited (2011 discussion).

But one observer’s resource nationalism is another person’s attempt to preserve the resource wealth of a country and to reap its benefits for current and future generations. The former is a foreign investor, while the latter is a Mongolian.

I would be the first to agree that the process by which Mongolian policy-makers have arrived at some decisions has not always been ideal (in the sense of a careful decision that is based on a thorough and dispassionate analysis of available information) – in fact, this process has been awful at times – but I cannot fault Mongolians or their leaders for their desire to get this decision “right” and their fears of getting it “wrong”.

Striking the appropriate balance between material needs, social aspirations, environmental and cultural protection, and, yes, financial rewards for investors, is not an easy decision. Jurisdictions in North America that have had decades to arrive at appropriate mechanisms for this decision, are still struggling with these issues.

Yes, there is a deep-seated ambivalence about Chinese investments in Mongolia (but also in parts of Canada). This ambivalence includes fairly rational fears of economic dominance (hey, even the Conservative government in Canada is looking to diversify beyond economic dependence on the U.S.), but also elements of anti-Chinese sentiments. Fellow “Mongolia Today” blogger Mendee has written about the latter aspect in his MAAPPS Master’s thesis. Another fellow blogger, Brandon Miliate, is currently completing his MAAPPS thesis examining the options that Mongolia might have in its foreign policy.

S&K write that Mongolia “has been reluctant to allow Chinese ownership of mineral resources. Its efforts to block Chinese ownership of resources, however, have impacted all foreign investors, raised uncertainty and potentially led to an overall decline in foreign investment.” This is a topic that Mendee and I have both taken up in the past:

• Mendee “Why Mongolia’s China Mining Strategy is NOT a Mistake!” Sept 26, 2012
• Dierkes “Mongolia’s ‘Third Neighbour’ Policy and Its Impact on Foreign Investment” East Asia Forum, Feb 15, 2011

The part of S&K’s statement that I find easiest to agree to is raised uncertainty. There’s no doubt that this is the case. Surely, this has also scared off some investors or made investments dearer. But have enough investors been scared to have an impact on Mongolia? Is the OT mine not such a gigantic project in a resource-hungry world that scaring off some investors might not have a negative impact.

Sure, there is a line where all investors might be scared, but I don’t think that Mongolia has come close to that line. Witness the Chinggis Bond sale last week, raising $1.5b, but attracting orders for ten times that amount. Yes, Mongolia with its BB- S&P rating is paying 5 1/8% on these bonds, but that’s cheaper credit than Italy has been able to get recently, so not too many bond investors seem scared off. In the end, there are so many investors in the world who have read the news that Mongolia was the fastest growing economy in 2011 and who want to participate in this presumed bonanza, that there doesn’t seem to be a shortage of investors, even without any large-scale Chinese investment.

Back to S&K: Yes, Chalco got scared off by the foreign investment law. But that, presumably, was the point. Also, it is very clear that something went seriously wrong in this Chalco bid for South Gobi. Who in their right mind, especially if they had any experience in Mongolia, would announce such a bid without consulting the government extensively? There’s no indication that such consultation occurred. This smacks of hubris on part of South Gobi, or Chalco.

If you’re inclined toward conspiracy theories (as many Mongolians and the Mongolian press seem to be), the most logical explanation of this Chalco bid announcement is one that sees Rio Tinto behind this announcement with a deliberate attempt to drive down South Gobi shareholder Turquoise Hill Resources’ stock price as RT is purchasing Turquoise Hill.

Did South Gobi cease production because of the failed bid? Yes, in the sense that Chalco would have operated the mine, presumably, if the purchase had gone through, but note that it is South Gobi’s coal price (and ultimately its production costs coupled with shrinking demand in China) that has sunk that particular ship. The Chinese ambassador to Mongolia agreed that it is a lack of price competitiveness that has reduced coal exports to China in a recent interview.

Note also that South Gobi is now under some kind of investigation by Mongolian authorities that has stranded an Australian lawyer in Ulaanbaatar for some weeks. Most reporting on this case is focused – once again – on “resource nationalism”, but note that the entire executive team of South Gobi has been fired over the summer one by one and their mine has ceased production. Again, without giving in to temptations of seeing conspiracies, could it not be that there really is something to investigate there?

S&K: “The slowdown in foreign investment has reduced Mongolian government revenue, lowered the credit rating and stock prices of companies working in Mongolia, and slowed ambitious development plans for both mines and critical infrastructure projects.” All true. But if a country is so dependent on mining for its future, is that not a reasonable cost to pay for a more careful (if not always carefully executed, and sometimes even recklessly so) deliberation?

After all, the natural resources in question are unlikely to vanish in Mongolia or in Canada and nor is demand for them, at least in the near or medium-term future.

Of course, S&K and I can only speak in hypotheticals when it comes to considering the impact of legislative changes on investment volume. Any empirical evidence on this would have to analyze a large number of countries in a great variety of different contexts.

It is important to note, however, that foreign direct investment seems to be somewhat of an example of herd behaviour, especially in the mining industry. The perception of political risk might thus be more important in some circumstances than the actual risk. This is certainly more the case for a place like Mongolia where much of the information (including this discussion) is about perception rather than a measured empirical reality.

Conclusions

My understanding of the Canadian oil & gas sector and its regulation or of the Canada Investment Act is too limited to take my slightly different (from S&K) perception of Mongolian developments as a basis for recommendations on the Canadian situation. However, I don’t think that it is an accident that resource-rich countries, whether they are advanced industrialized countries like Canada or Australia, as well as developing and just-on-the-verge-of-booming countries like Mongolia are grappling with similar challenges and are doing so in the context of democratic discourse.

When members of the mining industry in these advanced industrialized countries complain about governance and regulatory uncertainty in places like Mongolia, they would do well to note shared challenges and some of the parallels in the solutions that policy-makers hit upon. With this, I do not have S&K in mind who have offered some thoughtful observations and have taken a well-informed position on the particular challenges facing Canada and Mongolia.

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