Wednesday, August 20, 2014

Trade and infrastructure to top Xi's agenda in Mongolia

Mongolia welcomes Chinese investment, as President Xi Jinping prepares to visit the country. But as analyst Neil Ashdown tells DW, Mongolia will likely remain heavily dependent on China as an export destination.

Xi is set to become the first Chinese president to visit Mongolia in over a decade. The state visit - scheduled for August 21 to 22 - will be Xi's first to the neighboring country since assuming office two years ago. The trip is viewed by analysts as a reflection of Mongolia's growing importance to its southern neighbor as Beijing tries to expand its influence in Central Asia. China is expected to sign agreements to give the landlocked and resource-rich Mongolia easier access to Chinese territory for its exports.

The visit follows Mongolian President Tsakhiagiin Elbegdorj's trip to China in May for the Conference on Interaction and Confidence-Building Measures in Asia (CICA) summit in Shanghai as dialogue between the two countries has expanded in recent months.

Neil Ashdown, a Mongolia expert and senior Asia-Pacific analyst at IHS, says in a DW interview that Xi's visit represents an opportunity for the two sides to put in place agreements that will shore up Mongolia's economic and fiscal situation. He also stresses that rail and road construction are likely to be a high priority, along with discussions over the possibility of pipelines linking Russia and China.

DW: This is the first visit by a Chinese head of state to Mongolia in more than a decade. How significant is this trip, and what will be the key issues on Xi Jinping's agenda?

Neil Ashdown: For Mongolia this is a very significant visit. Most importantly, it has to be seen in the context of Mongolia's current economic situation. While the economy is still growing, there are reasons for concern about its future direction.

Foreign direct investment (FDI) has dropped off dramatically - it fell 70 percent in the first half of 2014 - the value of the currency has fallen steadily, inflation is in double figures, and the government's fiscal position has been weakened by significant lending through the Development Bank of Mongolia. As a result, we expect GDP growth to fall to 9.4 percent in 2014, down from 11.5 percent in 2013.

The government has responded to criticism from foreign investors, taking positive steps to improve the regulatory environment. However, this has not been enough to attract investors back. Most seriously, an ongoing dispute with mining corporation Rio Tinto over the proposed expansion of the Oyu Tolgoi copper mine has become a sticking point. Until this dispute is resolved, it is unlikely we will see a significant reversal of the downturn in foreign investment.

As such, Xi's visit represents an opportunity for the two sides to put in place agreements that will shore up Mongolia's economic and fiscal situation. These will primarily be focused on putting in place the infrastructure necessary to ensure a continuing flow of mineral exports from Mongolia to China. Rail and road construction are likely to be a high priority, along with discussions over the possibility of pipelines linking Russia and China.

What does Mongolia expect from China in return?

The main thing that Mongolia is expecting from China is for it to continue to purchase its mineral exports. Ahead of the visit, Mongolian politicians have been discussing the potential for an expansion of Chinese tourism, Chinese assistance in developing Mongolia's domestic processing capabilities for its mineral, and access to Chinese ports for Mongolian goods.

If these developments go ahead they would help diversify the Mongolian economy, and potentially reduce its dependence on China as an export customer. However, it is likely that these proposals will take a backseat to negotiations over trade and infrastructure.

Mongolia, a landlocked country, is now talking with China about a trade route directly south to China. How important would this route be for both countries?

Mongolia's infrastructure connections with its neighbors are underdeveloped. The main rail line runs north-south, connecting Russia and China. There is a second line in eastern Mongolia that connects to the Russian rail network. However, the mineral-rich southern belt of the country is largely unserved by rail infrastructure. This has made its mineral exports less competitive – for example, in the absence of rail connections, coal is currently trucked to loading stations, and then to the Chinese border. This process is expensive and time consuming.

The game-changer for cross-border trade would be the expansion of rail links into China – which takes 90 percent of Mongolia's exports. The key issue here is the gauge used for the line. In recent years, Mongolia has veered between favoring the Chinese and Russian rail gauges.

The Chinese gauge would further reduce the cost of Mongolia's mineral exports to China – removing the need to move from one gauge to the other at the border – but precisely for this reason, Mongolian policymakers and the general public are concerned that it could make China the only competitive destination for its exports. That is why, over the last two years, Mongolia has set out a proposal of an expanded network that favors the Russian wide gauge and connections with its northern neighbor, aimed at accessing markets other than China.

However, in the face of economic realities, this preference has been weakening this year. In April, China's largest coal producer, Shenhua Group, confirmed that it would participate in a joint venture with a Mongolian company to construct a rail link to carry coal across the border – using the narrow Chinese gauge.

How important is trade between the two neighbors?

China is by far Mongolia's biggest export destination; in 2013 China took 90 percent of Mongolia's exports. It is also the biggest source of imports for the Mongolian economy, accounting for 37.8 percent of the total in 2013, compared to Russia at 27.6 percent. Minerals make up the majority of those exports – primarily copper and coal.

Aren't Mongolians wary of a potential economic over-dependence on China?

Mongolians have historically been ambivalent about their country's relationship with China. In particular, there are deep-seated historical issues around the control of resources. We have seen this play out in parliament in recent years, most notably with the introduction of the - now defunct - Strategic Entities Foreign Investment Law in 2012, which was aimed at preventing Chinese state-owned company Chalco taking majority ownership of a Mongolian coal miner.

It is likely that opposition will also manifest itself at the grassroots level, although this is unlikely to result in more than small protests in public places in Ulaanbaatar. More widespread social unrest or outbreaks of violence are unlikely to occur.

China is clearly aware of this sentiment and is working to ensure positive relations with Mongolia. This is likely to be the reason that Chinese diplomats are currently talking about facilitating "transshipment" of Mongolia's exports – raising the prospect that goods will transit China to be sold onto buyers in Asia and further afield – and promoting "two-way trade". In reality, Mongolia will remain heavily dependent on China as an export destination and it is unlikely that the majority of goods crossing Mongolia's southern border will be going anywhere other than China.

How do you expect Sino-Mongolian ties to develop in the foreseeable future?

In China, the visit is being portrayed as a way to further develop Beijing's already strong relationship with Mongolia. The Chinese press recently quoted Mongolian President Tsakhiagiin Elbegdorj as referring to his country's relationship with China as a "strategic partnership."

In contrast, Mongolia has traditionally sought to maintain balanced relationships between its two neighbors – Russia and China – while simultaneously cultivating relations with so-called "Third Neighbors" such as the US and Japan. While the basic thrust of this strategy are likely to remain in place, so long as concerns remain over the future direction of Mongolia's economy, Ulaanbaatar is likely to find itself leaning more towards China.

Mongolia had ambitions to become China's top coking coal supplier, largely through the development of one of the world's biggest untapped mines at Tavan Tolgoi, near the Chinese border. Is this still the case?

In 2011, when Oyu Tolgoi appeared to be a done deal, there was major interest in Tavan Tolgoi's globally significant coal deposits. The Mongolian government had an ambitious plan to internationalize the development of the project – bringing in companies from both its neighbors and beyond with the aim of ensuring the project did not become dependent on one partner.

The West Tsankhi bloc, which is already producing coal, would be mined under contract by a group of US, Russian, and Chinese companies. East Tsankhi would be developed by a Mongolian company, Erdenes Tavan Tolgoi, which would fund the work through a simultaneous IPO on three stock exchanges (London, Hong Kong, and Ulaanbaatar). Mirroring the West bloc, that process was to be supervised by a number of international banks.

Three things happened. Ahead of the 2012 elections, the Mongolian government intervened to halt talks over West Tsankhi. Reports at the time cited a range of factors including the absence of South Korean and Japanese companies from the proposed consortium. Given the timing of the decision, however, it is likely that political maneuvering also played a role.

Secondly, international coal prices took a tumble, which given Mongolia's high transport costs and dependence on China as an export destination, reduced the commercial attractiveness of coal exports. The third development was the emergence of the dispute over Oyu Tolgoi. Until this is resolved it is unlikely we will see further progress on Tavan Tolgoi.

Recently, the CEO of Erdenes Tavan Tolgoi said that company's IPO would not be held until 2016. While this timeline could credibly cover the resolution of the Oyu Tolgoi dispute and a return of investor confidence in Mongolia, it also brings the proposed listing into close proximity with the next legislative elections, due in June 2016.

Neil Ashdown is a Mongolia expert and senior Asia-Pacific analyst at IHS, a global information and analytics firm.

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