By John Holland

Mongolia’s over-reliance on minerals and heavily regulated foreign direct investment has left its economy in a slump. If Mongolia wishes to recover, new strategies are needed.

Though under communism, Moscow had once provided for one-third of Mongolia’s GDP, democracy saw market reforms and extensive privatization usher in a new era for the Mongolian economy. GDP rose and fell during the 1990s, but began to accelerate beginning in the early 2000s. High copper prices and new gold production wrought growth averaging near nine percent per year for 2004-2008. Owing to a decrease in metal prices, and a harsh dzud over the winter that killed many livestock, and thus affected cashmere production, annual growth in 2009 dove to -1.27 percent. Though the economy recovered again in 2010, and reached an all-time high of 17.3 percent in 2011, the good days are now gone.

According to World Bank, Mongolia’s GDP plunged to 12.3 percent in 2012, 11.6 percent in 2013, 7.89 percent in 2014, and 2.3 percent last year. What’s worse, the World Bank this summer re-designated Mongolia as a “Lower Middle Income Country” (downgraded from an “Upper Middle Income Country”), and Asian Development Bank expects annual GDP growth to be below one percent for both 2016 and 2017. So, what went wrong?

Over-reliance on mineral resources

The problem has really been two-fold. First, Mongolia has been over-reliant on its mineral resources. More than half of Mongolia’s GDP is dependent on exports, and about 90 percent of those exports go to China. Mongolia also receives 30 percent of its imports from China, and 90 percent of its energy supplies from Russia, which leaves the economy quite vulnerable to price increases. As in other resource-rich economies, this dependence on mineral resources has left Mongolia at the mercy of boom-bust cycles elsewhere.

“When China sneezes, we get a cold,” said Dale Choi, founder and director of the research firm Independent Mongolian Metal & Mining Research. He was talking about how easily China’s economic slowdown over the past few years has been negatively affecting Mongolia. Although BMI Research estimates Mongolia’s coal production to grow from 36.6 million tons in 2015 to 56.2 million tons in 2020, Chinese demand will continue to decline.

BMI Research says, “We expect China’s steel production, the source of demand for coking coal in the country, to register a steady decline averaging -1.3 percent y-o- y over 2016-2020, compared to a 4.9 percent growth over 2011-2015. Production growth in China, the world’s largest steel consumer, has peaked and will remain weak due to low prices and a slowdown in Chinese fixed asset investment, and thus, the construction sector.”

BMI also expects the Chinese energy market’s demand for coal to fall from 64.4 percent in 2016 to 54 percent in 2025, and that, as revenues from coal decline, “Mongolian miners will increasingly need to look to other markets.”

Besides China’s diminishing demand for coal, Mongolia’s copper and gold production (and thus revenues) at Oyu Tolgoi — one of the world’s largest copper-gold mines — has also been dropping. The mine produced only 51,700 tons of copper and 70,000 tons of gold in the second quarter of 2016. This is down from 55,300 and 238,000 tons in 2015. Although well-known as “Minegolia” in the past, Mongolia must now look to other options to keep its economy afloat.

Heavily regulated FDI

What has also been crippling GDP growth is the over-regulation of foreign direct investment. Gantuya, a project consultant for Asian Development Bank (ADB) in Ulaanbaatar, believes that Mongolia’s current investment environment must be made more attractive.

Gantuya states, “A lot of things should be done… First of all, we should improve the legal environment — make it more kind for [foreign investors]: less taxes, bureaucracy in government, etc. It’s very difficult for them. Also, the instability of government is pushing them away. Every two years, the government changes. So, the legal environment should be stable, the government should be stable, and the business environment should be improved.”

She is not alone in these beliefs. Christopher MacDougall, writing in The Northeast Asian Economic Review last October, has argued, “Mongolia’s political leadership has made several crucial missteps resulting in a drastic decrease in foreign direct investment in the past three years. These have included the introduction and acceptance of several new or amended pieces of legislation that directly contradicted the interest of foreign investors and foreign companies.”

An example he gives is the Strategic Entities Foreign Investment Law, passed in 2012. This legislation ensured state oversight of investment by foreign parties in sectors deemed by the Mongolian government to be “strategic.” These sectors included telecommunications, banking, finance, and mining. The government now had to approve any foreign investment in these areas exceeding 33 percent, and later tried to enact another law, one limiting the maximum shares of non-Mongolian entities in mining projects to just 66 percent. Though the legislation never passed, the proposal severely damaged the foreign investment community’s trust in the business climate, and helped send the message to foreign investors and companies that commercial terms in Mongolia were biased against them.

Another well-known case was when the Mongolian government blocked the sale of the Canadian company SouthGobi Resources Ltd. to the Chinese state-owned enterprise Aluminium Corporation of China Ltd. Such measures worked to destroy foreign investors’ confidence in the Mongolian government. According to World Bank, foreign direct investment in Mongolia plummeted from 4.71 billion USD in 2011 to just 195 million in 2015. Clearly, changes need to be made.

New strategies for economic growth

Perhaps, the new government can consider these few modest proposals to get the Mongolian economy back on its feet.

First, the government must restore foreign investors’ confidence in Mongolia’s market by ensuring stability. The economy is still a developing one with limited domestic capital. In order to reap gains from mineral resource extraction, Mongolia needs the significant upfront investment that non-Mongolian entities can provide. Mongolia’s tax regime must be internationally competitive, and guarantee that mining investors can rely on stable tax rules that will not change. Erdenebat Mungunzul and Taikoo Chang of Daegu University have discussed how tax stability agreements can help in reducing perceived risks.

Also, investors should not have to worry about changes in government. Regardless of who holds office, they should provide favorable laws that will not change on a whim, and a welcoming business environment that is not overly partial to domestic industries.

Second, Mongolia should increase trade with its “third neighbors.” BMI Research contends how continued reliance on China for exports “will increasingly jeopardize Mongolian miners’ expected revenues with slowing demand for coking coal”. Mongolia has already begun to make up for this. The government signed a coal agreement with Germany as far back as 2011, a free trade agreement with Japan went into effect this year, and negotiations for a similar agreement with South Korea are already underway. Moreover, whereas Chinese demand for coal will decline, India’s demand over the next few years is only expected to rise. BMI forecasts that India’s share of global steel production will grow from 3.5 percent in 2015 to 10.4 percent in 2020, and that “lack of transport infrastructure and low coal prices will ensure that India’s demand for seaborne coal remains strong”. So, there are other options for trade. Mongolia just has to absorb the short-term costs for expanding trade deals.

There is also the issue of bringing in Chinese workers who, though cheap, have aroused the ire of many locals, owing both to anti-Sinocism, and lost jobs. An alternative for Mongolia’s government could be hiring more workers from North Korea, with whom Mongolia has no historical grievances. A final idea could be insisting that China employ only ethnic Mongolians, as opposed to Han Chinese.

Third, and finally, Mongolia’s government can promote other industries besides minerals. There has been much talk about investing in agriculture and textiles; though, the former is not stable owing to severe winters, and the latter is expensive. Still, organic food could be a major advantage for Mongolia. Dr. D.Shurkhuu of the Institute of International Studies at the Mongolian Academy of Science has argued, “Untouched nature, unpolluted soil, fresh air, and a harsh climate in Mongolia are fundamental to producing original organic food. We have plenty of opportunities to increase production and import the volume of meat, wheat and vegetables… the country must aim to increase meat export volume to one million tons a year by building intensive livestock farms.” Dr. Shurkhuu is right. I personally knew an English vegan who, despite his dietary habits, admitted that Mongolian meat is more pure than what he could get back home, and actually ate his fill with me one evening.

Ecotourism is another opportunity. Mongolia’s mountains, grasslands, and deserts are pure and plentiful. As the second largest landlocked country in the world, and the least densely populated country in the world, Mongolia could certainly be one of the most inviting places for enjoyment of the earth. According to the Oxford Business Group’s 2015 Mongolia report, “The tourism industry has taken on an increasingly central role in Mongolia in recent years… Most local players agree that Mongolia has the potential to eventually become a sizeable and highly profitable tourist destination. The country’s many tourism assets bode well for growth.”

Another major industry with potential is renewable energy. Mongolia’s vast plans get plenty of sunlight. Furthermore, Power Engineering International (PEi) reports that “Mongolia has a staggering 1,100 GW of potential wind power capacity,” should all windy areas be developed. They recommend that the government and investors “implement structures to attract highly skilled staff and build capacity in the country”. Despite the country’s harsh climate and inexperienced construction industry, PEi insists that, with timely scheduling (working from April to November), experienced contractors, and wise management of equipment, Mongolia still has enormous potential in the renewable energy field.

Mongolia need not be discouraged over its recent economic performance, but it can no longer rely almost entirely on China for trade, nor try to tie the hands of foreign investors. Even though economic improvement may be slow in the short-term, there is tremendous long-term opportunity in the many options available for growth.