A complicated, dynamic, sometimes violent yet sensual dance between Foreign Investors and the Mongolian Government.
It seems that recent press articles concerning Mongolia have been universally negative, so are we to understand that the Eternal Blue Skies of Mongolia are finally turning grey. Have investors finally fled Mongolia for good?
Let's have a look at recent political and economic developments in Mongolia and examine the country’s fundamentals in attempt to clarify the potential for future investments.
There is an analogy that is possibly adequate for the current situation, its called the Mongolian Tango, the M.A.D. dictionary describes it as:
1 - A Sensual, exotic, enticing and sometimes near erotic dance between Foreign Investors and the Mongolian Government that is often violent and is considered to be a show of skills and strength. 2 - The Mongolian Tango is known for its two steps forward and one steps backwards moves. 3 - Depending on mutual performance of the dance, it may or may not lead to a long lasting relationship.
So the question today is clearly, at which stage of the relationship do we currently find ourselves in, and are we heading towards that much promised long-lasting relationship?
Lets maybe start by having a look at recent international news headlines that have come out of Mongolia over the past 4 months.
“The spectre of resource nationalism in Mongolia has come to haunt Rio Tinto once again” - Trefis
“A string of missteps and delays have made Erdenes Tavan Tolgoi JSC look inept” - Reuters
“ Royalty and tax proposals threaten OT project” - The New York Times
“The new foreign investment law and continuing political uncertainty could potentially derail foreign investment in the industry.” - Asia Legal Business
“Parliament, earlier this year, pushed through a half-baked law on investment in strategic sectors that violates every free-market rule in the book.” - National Interest
“... the country is on the verge of becoming yet another failed post-socialist experiment in democracy.” - Wall Street Journal
“ The crowd has disappeared from Mongolia like a fart in a windstorm ” - Capitalist Exploits
When analysts look at Mongolia, they often mention the “Dutch disease”, the Wikipedia page on the same topic provides some insight into the phenomenon and, after having read through it, it could be imagined that within a few years, Wikipedia might well rename the page as the “Mongolian Disease”.
The dutch disease is defined as:
"The apparent relationship between the increase in exploitation of natural resources and a decline in the manufacturing sector". It is comprised of two sectors: "the booming sector, and the lagging sector".
"The booming sector is usually the mining of gold, copper, diamonds or bauxite"
"The lagging sector generally refers to manufacturing, but can also refers to agriculture"
"The resource boom will increase the demand for labor, which will cause production to shift towards the booming sector, away from the lagging sector"
“This leads to a decrease in the price competitiveness, and thus the export, of the affected country's manufactured goods as well as an increase in imports”.
Does this sound at all familiar?
Eventually this leads to higher inflation and a number of other social and monetary problems for the country and it’s citizen’s. Despite the apparent difficulties and the fact that we are clearly in such a position, it must also be recognised that Mongolia is attempting to improve the situation but the effects are so far still to be felt.
From a macro perspective, the world is still in a global crisis and this is leading investors to hold-off from their most exotic investments such as Mongolia. Further to this China has experienced a slow down in its economy which means it is now buying less coal from Mongolia and this is negatively impacting the Mongolian economy. So can the recent downfall be blamed entirely on the macro situation or should we rather be looking closer to home?
It is often frustrating to read the local papers and see what actions the government is taking, it often seems like the government’s “to-do list” is not prioritised as it should. A simple example of this (amongst the many available) is the new securities law. Without it, the MSE cannot develop properly nor can the TT IPO move forward. This is just one of many vital reforms that are needed to establish solid future foundations for the development of Mongolia, yet it has been on the agenda for the government for over 3 years and is still to be passed.
Despite those pressing issues, the biggest news coming out of Mongolia in October was the decision to remove the statue of Lenin from Central Ulaanbaatar to be auctioned off.
A Comedy of Errors?
An outsider looking into Mongolia, might be forgiven for thinking that the summer of 2012 has been little more than a comical series of errors in judgement and in policy on the part of the Government and its key stakeholders.
It started with the Chinalco / South-Gobi sands debacle which has led to a poorly drafted and executed knee-jerk FDI law being rushed through Parliament. While FDI regulations are clearly essential to the development of any country, they need to be well formulated and thought through properly, Mongolia’s new FDI laws fail to define a number of terms and leaves so much to interpretation that investors dare not test its meaning.
The country then moved rapidly towards Parliamentary elections in early June, based it seems, entirely on a populist platform of resource nationalism. This was followed by a long period of uncertainty as to who had actually been elected and constant bickering amongst politicians which continues to this day.
This game was further played out on a background of constant demands for the re-negotiations of the Oyu Tolgoi agreement (yet again). This has led Rio Tinto and other large scale investors to feel like they are caught in a dangerous hostage situation with no easy wait out.
The government has recently admitted that the cash hand-outs of the 2008 election were a mistake and contributed to the inflation and the drop in standard of living yet it just announced that it would give out 20,000 MNT allowance a month to every child and youth in the country, this amounts to handouts of 13 million USD a month, this is money that could be put to better use to heat schools, feed kids, buy textbooks and so forth.
Now that the winter has firmly arrived in Ulaanbaatar, its residents have witnessed the near collapse of the infrastructure in the city, in particular energy and heat shortages, yet the new power station still seems to be a far away dream plagued by constant delays and change of hearts on the part of the Government.
Politicians failing their voters
The Mongolian society, as a whole, has not seen much improvement, if any at all, in their lifestyles. High inflation has often meant a higher cost of living for a considerable part of the population. The oft reached conclusion is to blame foreign companies and the arrival of foreign investors for all their ills. This gradual mistrust has reached a crescendo this summer with regular demands for more cash hand-outs, for renegotiations of the OT agreements and for fewer foreign workers to be allowed in the country.
Should the situation not improve dramatically, there is a serious risk that the precarious balance between the Foreign Investors and the Mongolian Government will fail and that investors take their wallets elsewhere.
Mongolia has to realise that it cannot develop its economy without a steady flow of foreign investments into the country to improve its trade balance. Lets not forget that Mongolia is not a manufacturing country and thus needs to import practically everything it needs, its sole exports on the other hand are raw (under-valued) commodities and its cashmere.
After all this depressing news, is it still worth investing in Mongolia? Does it have opportunities which are worthwhile?
How long until Mongolia gets back on track and pushes forward with improved stability and a good working environment?
Will the current grey skies of Mongolia remain eternally so or will we return to the previously beautiful blue skies the country was so famous for?
Before we start looking at investment opportunities, lets first cover the basic essentials of what is Mongolia today.
The country is landlocked, sandwiched between Russia and China but it is made up of a surprisingly large territory of over 1.5 million square kilometres. This is the equivalent of France, the UK, Germany and Italy put together, with a little left to spare (probably the Vatican or Lichtenstein).
The country is very much driven by its capital of Ulaanbaatar with over half the population currently residing in the city. In terms of infrastructure, Mongolia still has much progress to do with a single railway track running from China to Russia and only 5% of its roads (what few roads there are) paved.
Surprisingly, Mongolia has a population of 33 million heads of cattle for only 2.7 million inhabitants. It is the only country in the world to have such a high ratio of people versus cattle.
In terms of foreigners in the country, according to the latest official census, there are only 16,500 officially registered foreigners resident in Mongolia. Of which 52% are Chinese, 22% are Westerners, 15% Russians and the remaining 11% are split between Kazakhs, North Koreans, Vietnamese, Turks and so forth...
Mongolia benefits from having an extremely young population with nearly half of its population still in education and soon to join the workforce. 46% of the population is of working age and only 5% are considered ageing (above 60 years of age), a fairly unique situation in the region, particularly when compared to China, Russia and Japan that all have massively ageing populations.
Of the 2.7 million population in the country, 70% live in an urban environment while 30% still lead a nomadic lifestyle tending to cattle.
Education in Mongolia is a legacy from the Soviet Union days but it still achieves a staggering 97% literacy rate, one of the highest in Asia and no small feat when you consider that Mongolia still has the lowest population density in the world.
In terms of religion, Mongolia is well balanced and there are no religious tensions amongst the population. Just over half of the population is Buddhist while 40% are Atheist. Only 3% declare themselves to be Islamist, mostly from the western Kazakh regions. Interestingly, only 2% of the population is registered as being of Christian belief.
Importantly, Mongolia has a single unifying language, written on two scripts, primarily the new Cyrillic alphabet for day-to-day use while the old Mongolian script is gradually coming back into fashion. Most important of all is the use of language in itself and today Mongolia benefits from having considerable freedom of speech.
People vote in fair and democratic elections every 4 years, they have just voted for a new Parliament and the people of Mongolia will vote for the President in about 7 months time. The new parliament is split fairly evenly between the Democratic party at 46% and the MPP at 33% while the justice coalition only has about 14% and the Civil Will-Green party as well as the independent candidates make up the rest.
Mongolia practices its now famous "third-neighbour policy" with great efficiency, it essentially means that when given a choice they would much rather trade with any country other than China or Russia. The closest "third-neighbours" are generally considered to be the US, South Korea, Japan, Australia, Canada and the EU.
GDP growth in the country has been staggering, and while we are now at about 4,000 USD per capita we expect to reach a GDP per capita of nearly 12,000 USD by 2016.
The currency, the Mongolian National Togrog, has been extremely stable overall against the USD and is considered to be a reasonably solid currency by international watchdogs.
Monthly average disposable income has been going up consistently over the past 6 years and we see little reason for it to slow down any time soon. Interestingly, of the 1.3 million inhabitants of Ulaanbaatar, only about 40% live in an actual building with solid walls, the vast majority - 60% - still live in the traditional nomadic type of housing known as "a ger".
Ulaanbaatar is a crowded city with an average household size of about 6 people. Quite a lot for an average apartment size of only 65 square meters. UB is sometimes called a horse-riding city, despite Mongols swapping the horse for the car the principal remains the same. There are a staggering 170,000 cars for only 125,000 property titles.
The 125,000 property titles include all types of built-up property, not only residential but also commercial, retail, industrial and so forth. Of the 170,000 cars officially registered in UB, over 50% of them have a value of over 20,000USD.
In terms of real estate, we have seen considerable growth over the past few years and currently average prices per square meter stand at:
- Low-to-mid residential is between 1,500 USD and 3,000 USD per square meter.
- Mid-to-high end residential is between 2,500 and 10,000 USD per square meter.
- Grade A & B office is between 2,000 and 6,000 USD
- Grade A & B retails currently sells at anywhere between 2,000 and 7,000 USD.
When looking at Mongolia, it is important to keep a sense of perspective compared to other countries.
Politicians the world over have populist ideals and rarely make the right decisions, the new French president Mr. Hollande is a clear example of that with his 75% tax on the rich that has only now been repelled.
China's FDI regulationsare considerably more stringent and unstable than Mongolia's.
Australia introduced controversial new mining taxes that pushed back the Australian economy considerably and it is thought cost the Prime Minister his job.
In October 2012, Canada denied Petronas of Malaysia mining rights in Western Canada, just as Mongolia recently did for Chinalco and South Gobi Sands.
Belgium, went through 18 months without government so a little in-fighting in the government is nothing new and is sometimes healthy.
Beyond that, lets not forget that Mongolia is still the best performing economy globally (11.9% GDP growth in 2012), in particular when compared to China (7.7%) and the new poster child of emerging markets: Myanmar (5.5%). Lets not even talk about Europe which is still firmly in a recession.
There is litle doubt that the Mongolian economy is a roller-coaster economy and will remain so for the next couple of decades, it is still laying today the foundations of the economy but despite its ups and downs, the direction is most certainly positive.
It is now time for foreign investors and the Mongolian government to lay the first foundations of a real relationship, initially a simple, shaky ladder will do but it will eventually develop into a solid bridge between our two cultures.
There are still a number of exciting opportunities available to those foreign investors able to look to the horizon and Mongolia’s extraordinary potential.
The best opportunities are not in building yet more mega-projects or large shopping malls, it is found in sourcing those niche products that provide an excellent return on investment, are easy to put in place and simply make sense. For instance, it is clear that there is a considerable need for self storage solutions in UB, there is practically no affordable housing solutions and we must develop Mongolia’s secondary cities, not to talk of the need for serviced apartments or offices in UB.
Mongolia needs to achieve food security, during the Soviet years, the country was a net exporter of wheat and other crops to the Soviet Union. There is no reason why this can’t be replicated in a more sustainable and economically functional way.
Mongolia’s future growth is dependent on massive investments into its infrastructure and this presents real opportunities for large scale investments alongside the Government, in particular in roads, rails and the energy sectors.
Mining Supply Chain:
Regardless of who actually ends-up mining Mongolia, mining activity in the country will boom over the coming years and be the country’s main industry for the foreseeable future. The mining supply chain in Mongolia is still in its infancy and presents considerable opportunities for investors.
With nearly half of the population that is still in the schooling and university age, incredible opportunities exist in the education sector. We have already seen considerable progress over the past few years with a British school recently opened as well as the new American University but much remains to be done.
Auditing & Valuations:
In terms of auditing and valuation services, while the big 4 all have small offices in the country, the waiting lists are long. There are absolutely no property valuators in the country and a big lack of tax specialists. As the economy of the country develops and grows, there is going to be increased demand for such services.
Mongolia is going through the biggest construction boom of its history and along with the mining boom is in much need for construction materials. This means cement, steel, tiles and everything in between.
Mongolia is a vast country with huge energy needs yet only Newcom seems to have grasped the opportunity that this represents. Wind farms are perfect for Mongolia. It will become a serious sector of investments in the near future.
It is clear that the year 2013 will be an exceptional year for investments in Mongolia, the slow down is bringing out worthwhile opportunities across the board, it is actually giving Mongolia the chance to settle down and strengthen their offering and bring stability to the country. We might even see fewer "cowboy" investors and more smart money coming into the sector.
If on the-other-hand, Mongolia is not able to present a united front with a stable fiscal and political regime for Foreign Investors then those Investors will not stick around in the hope that Mongolia eventually gets its act together, if the situation does not improve soon this might well become the "Last Tango in Ulaanbaatar".
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