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Turning Crisis to Opportunity in Mongolia

Mar 31, 2014 Written by  Alexander Benard, Guest Contributor

The Mongolian economy, not long ago the darling of the global investment community, has hit another rough patch—with a bank collapse, slumping commodity exports, a devaluing currency, and a sharp slide in government bond prices all conspiring to produce a string of bad news. Mongolia’s recently re-elected president has reacted with dismay, and financial firms that track Mongolia are sounding alarm bells. Indeed, this October the government called an extraordinary session of parliament, the same month that the World Economic Forum hosted a special session in Ulaanbaatar to discuss possible solutions to Mongolia's economic travails.

In fact, however, Mongolia’s economic road bumps are a blessing in disguise. With the right corrective measures, the Mongolian government can help the country avoid the Dutch Disease symptoms from which it was already beginning to suffer and reduce its economic dependence on China, thereby setting the country on a path of more balanced growth in the decades to come.

For years now, Mongolia has confounded economic analysts who have been predicting that the country, with its vast mineral resources, is on track to become the world's next Saudi Arabia with expected annual growth rates of over 20 percent. Instead, a series of crises have dampened hopes that those expectations will be met. Just in the last few months—and right after Mongolia's president, Tsakhiagiin Elbegdorj, won reelection on campaign promises to restore strong economic growth—the insolvency of the Savings Bank, Mongolia’s fifth-largest lender, required a government take-over to soothe a troubled investment community. Global commodity prices for several of Mongolia’s key natural resource exports have declined and the country has also been hit by weakening demand from China due to the slowdown of the Chinese economy. In addition, Rio Tinto announced this past summer that it will be delaying further investment into Oyu Tolgoi, a massive gold and copper mine that is supposed to account for a third of Mongolia’s GDP by 2020, in part because of lingering disputes with the Mongolian government. Meanwhile, Mongolia’s currency has devalued by almost 20 percent over the past 12 months, and the World Bank has revised its growth projections for the country.

In response, President Elbegdorj is proposing to take immediate steps to accelerate the development of its mining sector so that Mongolia can resume the growth pattern that economists had been forecasting for the country. But this would be a mistake. In fact, even the country's current, lower-than expected growth rates have been causing worrisome distortions in the Mongolian economy. Before the recent slowdown, the country’s currency had actually been performing fairly well, causing a strain on non-mining exports. And wages in the mining sector had been moving higher faster than in other sectors, draining the Mongolian labor market of workers to the point where it had become almost impossible to find good human resources for non-mining jobs. In addition, because most Mongolian commodities are exported to China, Mongolia was growing increasingly dependent on Beijing.

For those who follow relations between China and Mongolia, this last point is especially ironic. Mongolians have historically been fearful of China, suspecting that the Chinese government’s intention is to dominate Mongolia and control its resources. For that reason, the Mongolian government balked last year when Rio Tinto attempted to sell a subsidiary that mines coal in Mongolia to a state-owned Chinese company without first obtaining the Mongolian government’s permission. But of course, if China is buying all of Mongolia’s off-take, it achieves a high degree of control all the same.

The mining sector will regain its footing in due course, but in the meantime, Mongolia should view the current reprieve as an opportunity to set the foundations for healthier economic growth.

Specifically, Mongolia should take advantage of the weaker currency and the softening of its mining industry to encourage the development of non-mining export sectors. A great example of this is cashmere. Mongolian cashmere is among the highest quality cashmere in the world, but the industry has suffered in recent years due to underinvestment, difficulty competing on price, and severe labor shortages—classic symptoms of Dutch Disease. The Mongolian government can now help to revive the sector by focusing on training, investment promotion, and building relationships in key export markets like the United States, Europe, Russia, and the Middle East. The United States and Europe should do their part, too. Mongolia is a pro-Western democracy in a part of the world where most other countries are authoritarian vassals of China. Because of its mineral wealth, Mongolia will only become a more important player in the years to come. Western countries should therefore make Mongolia a key pillar of their Central Asia strategy. But unfortunately, although the EBRD has been fairly active in Mongolia over the years, the U.S. has instead recently slashed USAID’s budget in Mongolia to approximately $6 million per year—one of the smallest USAID budgets in the world—and in general has been far less active in the country than its European and Asian counterparts.

There are some positive signs are on the horizon. The country recently established a new agency called Invest Mongolia, which is tasked with streamlining market-entry for foreign investors. It also managed, at the special parliamentary session in October, to pass a new law that reduces the number of regulatory approvals required of foreign investors. The law also provides various tax and other incentives to promote investment into certain sectors of the economy as well into certain of the country's less developed regions.

But sustaining this momentum will require a fundamental recognition on the part of Mongolia and its partners that the country's potential is about more than just resource exports. To be sure, the resources with which Mongolia is blessed will significantly lift the country’s GDP, and with it the living standards of the Mongolian people. The question is whether that growth will be balanced, whether other sectors of Mongolia’s economy will be able to coexist alongside the country’s natural resource sector, and whether Mongolia will be able to avoid dependence on China. Mongolia now has a unique opportunity to improve its odds on all of those fronts.

Alexander Benard is Chief Operating Officer of Schulze Global Investments, a U.S. private equity firm with an office in Mongolia. He is the author of a Foreign Affairs article on investment strategy in emerging and frontier markets.

This article was originally published in the Diplomatic Courier's March/April 2014 print edition.

Photo: Bankwatch (cc).

Tagged under Mongolia    economy    resources    mining    commodities    China    World Bank   
Last modified on Sunday, 30 March 2014 21:36

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