Mongolia’s State of the Macro
We are certainly not the first and will not be the last over this period of the year to try to analyse the direction that Mongolia is taking but we hope that we bring a somewhat more local and pragmatic look at the current situation. Let's start by looking at the macro of the country and follow this up in a second article (Ulaanbaatar Property Market Update 2013) with a more micro look at the Ulaanbaatar property market and include a few of our predictions for 2013.
In late October 2012, M.A.D. made a presentation entitled “The Mongolian Tango” at the Mongolian Investment Conference in Hong Kong. Our presentation highlighted the prevailing negative perceptions of the international press while stating that’s Mongolia’s fundamentals were still extremely strong.
It is now three months later and we continue to see a growing number of businesses that are downsizing their operations, expats are gradually leaving Mongolia for warmer shores and Foreign Investment is being diverted away from Mongolia towards more welcoming lands. Mongolia’s FDI honeymoon is most certainly over and it is now time to realise that the bride might not be as pretty, well endowed and welcoming as initially envisaged. It doesn’t mean that a divorce should be on the cards. Far from it.
We are in a period of transition, between major elections and economic strategy. For the first time in its history, Mongolia has experienced real market-driven economic growth and progress. It is also starting to realise that with increased FDI inflow, comes a responsibility towards improved governance, transparency and accountability not only to its people but also to the global press and the foreign investors who follow the country ever so carefully.
Mongolia with its small population has been forced to grow up, learn a new economic model and hold their own extremely quickly. It is a testament (testimony ?) to the people of Mongolia that it is still a functioning democracy that manages to compete with the biggest international powers and contribute significantly in global diplomatic circle.
The recent downturn in Mongolia’s economy can, in parts, be blamed on the slowdown in China and its reduced coal purchases but an equal proportion of the blame should be allocated to domestic challenges. The SEFIL law, various populist measures and the upcoming Minerals Law, are only adding to the growing malaise being felt by Foreign Investors.
The true impact of those decisions is only now trickling down to the streets of Ulaanbaatar. While it could be argued that over the long term, they might be beneficial to the people of Mongolia, today it is those same people who suffer from the flight of capital away from the country. Foreign Investors always have the potential to seek fortunes elsewhere, few Mongolians have such mobility.
Investors already implanted in Mongolia are now faced with a form of the “fight or flight” phenomenon and it seems that many are indeed choosing to fly out, along with a number of Mongolia’s brightest who are seeking a more stable environment in which to invest.
Case in point of this phenomenon is the “Myanmar - Investment Opportunities” seminar organized by Silk Road capital, which took place last week in Ulaanbaatar. It enticed companies and individuals to consider Myanmar instead, a country with an improving political environment, access to the sea and a large domestic market.
We remain strong believers in Mongolia’s potential, but now realize that growth based on solid foundations might well take a few more years to achieve than originally thought.
In an effort to be constructive, we sought to identify the 10 key improvements that we would like to witness in 2013 (or at least in the near future).
To Do List - 2013
1 - Political Stability - Killing the “Golden Goose”.
Please, please, please and pretty please, cease making threats to re-negotiate the OT agreement. YES, it might not be the best deal in the world, YES the OT mine could do more to employ more Mongolians, YES it is impacting the environment in the Gobi, YES it could be paying more taxes or re-adjust its shareholding BUT constantly putting the agreement into question is damaging the international reputation of the country far more than any potential benefits that could be gained by taking OT hostage in such a manner. The OT agreement should be treated as a good learning experience, moreover, an experience that is likely to contribute 7% GDP growth to Mongolia in 2013.
On a positive note, it seems that over the last few months, attempts to renegotiate OT have been put to rest. As we head towards the presidential election, we pray that they do not resurface again. The international media will look at those renegotiation attempts, however well founded they might be, as a lack of political stability and weakness (not strength) in the Government. If the sanctity of the contract is not respected, few people will have the confidence to invest, including Mongolians.
OT has already contributed massively to the levels of growth and international exposure that Mongolia enjoy’s today. That momentum should be used as leverage in achieving a better negotiating position for the next major deposit.
This, amongst a number of other worrying messages coming out of the country over the past 8 months, is leading international watchdogs to worry about the political stability of the country. The knee-jerk, all encompassing new FDI laws (SEFIL) and the upcoming Mining Laws are other such examples.
For Mongolia to prosper, it needs the private sector to thrive. To be able to do so, investors, entrepreneurs and financiers need to know that the regulatory environment will be stable for the coming years and thus be able to plan for an appropriate investment strategy.
The true impact of such political instability is felt not so much by existing foreign investors, who are sufficiently mobile and liquid to focus on other attractive markets, but by Mongolian businesses and entrepreneurs who are suddenly finding themselves short on investments and whose target market has dramatically reduced in size. It would drain the essential oxygen needed by the people of Mongolia to be able to thrive and prosper.
2 - Mining Nationalism - A populist agenda that benefits no one.
It is nonsense to think that Mongolia will thrive without Foreign Direct Investment, it is also nonsense to think that investors will keep investing regardless of what happens on the ground.
Mongolia is now firmly on the path of being a Global Market-Driven economy. It is too late to turn back and it must therefore play the game as well as it can. In crude terms, Mongolia is now pregnant with capitalism and it is too late to abort.
Continued calls for resource nationalism - predictable in an electoral period as we are now in - call into question the underlying investment potential of the country. We do not dispute the justifications or the suspicions about their neighbours but the same results could be achieved without causing a PR disaster which could take the country years to overcome.
The “Third-neighbour” policy was quite simply a stroke of genius and a brilliantly designed policy, but it is reliant on third neighbours actually being willing to trade and invest in Mongolia. If those third-neighbours are more interested by other markets, Mongolia will be left with the only option of trading with its only remaining partners, its actual neighbours - and this is a trade that is unlikely to go in Mongolia’s favour, let’s not forget that China does not need Mongolia half as much as Mongolia needs China.
The constant welfare spending and cash handouts that the Government insists on giving out as short-term populist measures contribute only to increased inflation, widening the wealth gap and depriving Mongolia of much needed investments in infrastructure and state enterprises (such as Erdenes Tavan Tolgoi). The various populist programs promoted by the Government (the 100,000 homes programs for instance) with little hope of actually becoming a reality are seriously endangering the credibility of the GoM amongst its own people and leading to the general incredulity of investors.
A perfect example of such failed measures, is the much publicized and talked about Erdenes Tavan Tolgoi IPO, it was an integral part of the 2008 election platform, promoted as the best way of giving all Mongolians direct access to its mineral riches. It resulted into 4 years of debates, u-turns, corruption scandals and frustrated international investors.
Worst of all is that funds raised on the back of the proposed listing were used to finance yet more promised cash hand outs to the population rather than dedicate the money to making operations at the mine possible. This has led to a situation where Erdenes Tavan Tolgoi has ceased all operations and the IPO, which was taunted as an absolute certainty for 2013, has just been cancelled until further notice. The subsequently cancelled coal delivery contract with Chalco will reinforce the perception that Mongolia cannot be trusted in the long-term and will thus miss out on exactly what it needs: long-term stable investments with reliable foreign trading partners. Unless Mongolia “graduates” to attracting those long-term partners, it will continue to be plagued by “cowboy” short-term investors who are in for a quick profit before moving on to new destinations. Those investors add little value to the economy.
Recent urbanisation and population migration patterns have left Mongolia needing this mining boom to succeed in making people’s life better. The only way that the urban population could move back to the countryside and lead a semi-nomadic lifestyle, would be in using the windfalls from the mining boom to create the necessary infrastructure (regional schools, hospitals, veterinary centres, cell phone towers, meat processing centres etc... ) allowing them to lead a good life while still remaining nomads - thus easing infrastructure pressure on urban centres.
3 - Improve Government Communication - Create a GoM PR Agency
When compared to some other countries in the region, Mongolia is actually doing extremely well politically and there are many acts, laws and measures it undertakes that should be unanimously applauded as international examples of good governance.
Many of the measures that are being taken make perfect sense once they are explained and put into their right context. The problem is simply put, that the Government lacks a credible mouthpiece, a Press Relations organ that puts decisions, discussions, laws and parliamentary proposals into its proper context, not only for the foreign media but for its own people.
Regular and open press conferences should be held to address controversial and important topics, parliament discussions should be open to the public (such as the C-Span channel in the US) and public participation in debates should be encouraged.
Finally, such a PR agency would allow the Government to speak in one united and consistent voice. Today’s media is filled with interviews from unknown parliament members, keen for the attention, stating that they will push through such and such controversial law, leading to wide spread panic, confusion and overriding perceptions of instability.
4 - Promote a stronger Rule of Law and Land Rights - Security for the people
The fundamental principals of any democracy are a strong rule of law and the undeniable protection of private property.
These are two areas in which Mongolia currently does incredibly well when compared to many other Asian countries. But worrying trends are emerging as of late with increased calls by Government officials seeking to arbitrarily change laws and land rights to suit their own agenda.
Without those two elements in place, corruption will worsen, capital will flee the country in search of a more secure investment and people will never truly invest any significant part of their net-worth in fear of losing it to a sudden change of heart by a mid-level government official.
Mongolians should have clear, transferable, title to their land and be free to do with it as they please (within reason), this would allow a vast mass of the people to unlock essential capital locked into their land holdings and re-invest it into the economy. The multiplier effect of real property rights on the economy is considerable and forms a strong basis to most economic systems today.
A strong and independent judicial system, something that Mongolia is starting to acquire, is essential to protect the rights of investors, landlords, owners, tenants and the people of Mongolia not only against each other but most importantly to keep a system of checks and balances between the people and its Government.
5 - Stamp out Corruption - Reward whistle-blowers
Corruption used to be a catalyst in Mongolia, something used occasionally to speed up processes, permits and authorizations. Today, corruption is becoming a necessary evil for most individuals and businesses in the country not only to obtain documents faster but increasingly to obtain things that are illegal (permits, houses, contracts etc..). This is an issue that has been identified during the 2012 elections by all political parties as being close to the heart of the people and thus became an integral part of their electoral message.
Mongolia has made real efforts to stamp out corruption over the last 6 months and high level public cases are now becoming the norm, only recently 7 high level individuals have been detained in connection with alleged corruption, money laundering and mismanagement of MIAT. Other similar cases have been brought forward against a vast number of very large conglomerates. There is clearly an element of accounts settlement between the oligarchs but it is nevertheless a very significant and positive step in the right direction.
Today, neither the people forced to pay corruption nor those receiving it have any real incentive to amend their ways. There is always the fear of being caught by the Anti-Corruption Agency and sent to prison but the risk of being discovered is relatively low as neither party has any incentive to expose corruption as both could be tried and sentenced equally for it.
A partial solution to the problem could be to financially reward whistle-blowers along with providing them with legal immunity for their involvement in the act, a technique that India has implemented recently with some level of success. If individuals and businesses are incentivised to expose corruption while being immune to subsequent prosecution, those demanding corruption will become increasingly afraid of being framed by those offering to pay it and will become weary of future transactions.
6 - Invest in Education - Highly skilled workers contribute more
Mongolia cannot compete in terms of low skill manufacturing with its neighbours and it has too small a domestic market to create a sustainable manufacturing base. It benefits today from a young, intelligent population that is adaptable, hard working and willing to learn but which lacks the educational and technical support - be it academic or vocational - necessary for professional progression.
The people of Mongolia are the most precious resource that the country has, if intelligent young Mongolians are forced to go abroad to obtain a good education, it not only means that precious capital is leaving the country but most importantly that Mongolia will suffer from a considerable brain-drain that is unlikely to return any time soon unless truly exceptional opportunities exist back home (not probable unless the Mongolian environment out-performs others by a strong margin).
Businesses that establish themselves in Mongolia require a skilled workforce to grow and contribute more fully to the economy. Without it, they will be increasingly forced to look abroad for their HR and might find it more convenient to be altogether based elsewhere and merely provide outsourced services in Mongolia. OT has launched one of the largest vocational training school in Asia within the aimag capital of Dalanzadgad. This “School of the Gobi” is a wonderful improvement over the current educational offer but it is too small to have a significant nationwide impact.
Since the collapse of the Soviet educational system (which was excellent in many respects), Mongolia has done too little too late to promote its educational system. Stories abound of kids sharing desks, textbooks and pens in freezing classrooms with fewer and fewer qualified teachers every year. It is distressing to hear that instead of investing in facilities and teachers, the Government prefers handing out 70,000 MNT per month to every child and student in the country, (at a total cost to the Government of over 5 Million USD per month), money that, more often than not, ends up in the hands of the parents or wasted on alcohol and cigarettes (or both).
Mongolia should look towards Singapore which has become a global reference for highly skilled workers and has, in a short time, become one of the worlds best performing economy on that very foundation.
7 - Streamline the Government - Downsizing would benefit the private sector
Mongolia is lucky enough in a certain sense that it is building nearly everything from scratch. With the technology available today, this should be a golden opportunity to streamline and improve the efficiency of the Government. The answer lies not in creating yet more Ministries and Government agencies but in reducing the number of civil servants, who now represent a staggering 37% of the active population.
With such a small active population as Mongolia’s, the country should truly focus on reducing the number of its civil servants - people that the private sector desperately needs - and improve its various processes so that it may provide more efficient services with fewer human resources. Estonia is a perfect example of an ex-Soviet block country that has managed this brilliantly.
By maximising efficiency, the Government could also collect a greater percentage of the taxes that it is due - it is estimated today that the Government barely collects 25% of taxes due, as inefficiency and bureaucracy continue to plague the system.
Mongolia at a crossroads?
Will foreign investors quickly forgive and forget? Yes absolutely! *
*Provided that Mongolia doesn’t go too far in pushing away the very people it depends on.
The focus of the government today should be on reducing the trade deficit, keeping inflation below double digits, investing in essential infrastructure, passing the securities law and promoting sustainable domestic growth instead of worrying about foreign spouses of parliament members, creating new ministries without true purpose or discussing a new capital in Karakorum.
There are few doubts that over the medium to long term, Mongolia will retain its attractive fundamentals, it has considerable minerals in the ground, a young population, easy access to two massive markets. It has barely scratched the surface of its true potential. The news that Mongolia has raised 1.5Bn USD (oversubscribed 10 times) in the international bonds markets is encouraging, showing that despite all, Mongolia is still more attractive than many other economies. While the bond raise should contribute towards making up the shortfall from Foreign Investment in 2013, it is a short-term measure that, if not spent intelligently, in a manner that will generate long-term revenues for the GoM, will only raise debt levels and cost the Government dearly in future capital and interest repayments.
There is no doubt that Mongolia will still, despite all it current woes, be amongst the top 5 best performing economies globally for 2013. This would indicate that it still has some room to manoeuvre but this might be a misperception as the smallest negative shocks can have a considerable impact. Staggering levels of growth is not difficult for an economy with a GDP of less than 10Billion USD. It is maintaining sustainable levels of growth over the long term that is more challenging.
The past 6 months have clearly demonstrated the inherent fragility of the Mongolian economy, 2013 should be a year dedicated to solidifying the existing foundations into a strong legal system that truly promotes fair and mutually beneficial foreign investments into the country.
SOURCE OF THIS ARTICLE : M.A.D. Investment Solutions
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