COMMENT: Resource-rich Mongolia hit hard by drop in commodity prices

By bne IntelliNews July 28, 2009

Alisher Ali Djumanov of Eurasia Capital -

Mongolia, sandwiched between two major economies, China and Russia, and with a population of about 2.6m, has huge and largely untapped natural resources, with over 6,000 mineral deposits scattered across its vast territory, which is three times larger than France. The most significant are copper, gold, coal and uranium. The Mongolian economy is highly sensitive to commodity price changes, as the country earns about 70% of total export revenues from copper and gold. Prices for the nation's major mineral exports have plunged due to weakened global demand. Economic slowdown in neighbouring countries, Russia and China, which absorb about 60% of total exports, is exerting further pressure on the country's economy. As a result, growth of the national economy, according to the International Monetary Fund (IMF), will slow to 2.7% this year from 8.9% in 2008. As export earnings plunge, the country's current account deficit has swollen to about 8.7% of GDP, while the budget deficit grew to about 5% in 2008.

Being severely hit by the global economic downturn amid shrinking copper export revenues, Mongolia is now facing economic and social challenges. With currency reserves fast depleting, the country has taken out a number of external loans to ease the negative impact from the global crisis. Almost $1bn in rescue packages from international financial institutions and loans from China and Russia were pledged to support the economic stabilization in Mongolia. In May, the IMF approved a $229.2m, 18-month stand-by arrangement for Mongolia, which equals 300% of the country's quota. The World Bank, ADB, and countries like Japan and Australia have also committed a total of $165m. For financing its plans, Mongolia turned to China and Russia to support its economy while battling a deepening budget deficit. China reportedly finalized a $300m loan for road and railway infrastructure in Mongolia, while Russia also committed a $300m loan for Mongolia's agriculture sector. In addition, Mongolia and Russia have recently agreed on jointly implementing $7bn worth of railway, coal and copper projects in Mongolia.

Oyu Tolgoi and Tavan Tolgoi are cornerstones of Mongolia's prosperity

Rio Tinto Group, the world's third-largest mining company, and Ivanhoe Mines won approval from Mongolia's parliament to develop Oyu Tolgoi, known as Turquoise Hill. This is the world's largest undeveloped porphyry copper-gold deposit with 36m tonnes of copper and 45m ounces of gold resources, located in the south Gobi region of Mongolia, 80 km north of the Chinese-Mongolian border. On July 16, the Mongolian parliament authorized the government of Mongolia to conclude an investment agreement with Ivanhoe Mines and Rio Tinto for the development and operation of the deposit. According to Ivanhoe, it expects that further negotiations will be held with the government in order to conclude a final agreement. Ivanhoe has been trying for more than five years to get final approval for the project and benefit from demand in China, the largest copper consumer.

If the project goes ahead, it is estimated that at today's prices it could generate $2.3bn revenue each year, almost half of Mongolia's GDP last year. Annual production could reach on average 400,000 tonnes per year of copper, or $2bn in sales, and 300,000 ounces per year of gold, or $300m, and in total $69bn over the next 30 years. The Mongolian government budget could enjoy $1.5bn in revenue every year from exporting the metals produced from the deposit. Foreign investors are keeping an eye on the progress around the project, and signing the deal will give strong impulse to foreign investment flows into the country and trigger spill-over effects into the wider economy.

Mongolia's other world-class deposit is Tavan Tolgoi, reportedly the world's biggest untapped coking coal deposit with 6.5bn tonnes in reserves, located 150 km to the north of China. It is estimated that at annual production of 15m tonnes per year at today's prices, annual revenue could reach $2.25bn or almost half of Mongolia's last year GDP. The government is reportedly planning to sell a stake in the Tavan Tolgoi coal deposit for strategic investors. JP Morgan and Deutsche Bank are assisting the government in concluding the deal. The emergence of China as one of the main commodity consumers and recent increases in coal prices turned the deposit into a major attraction for the world's largest coal mining companies. China's massive $586bn stimulus package and infrastructure construction projects in the north and west of the country should provide immediate and long-lasting demand for the deposit's coal.

Weathering the effects of the crisis on the Mongolian economy and getting the major mining projects started are the top priority for the new president, Tsakhiagiin Elbegdorj from the opposition Democratic Party, who won the presidential election on May 24 this year, in a tight race with ex-president Nambariin Enkhbayar from the ruling Mongolian People's Revolutionary Party. Presidential election results validated our positive outlook for Mongolia since the election was held fairly based on democratic principles and Mongolia confirmed its commitment to further promote democracy, outperforming other countries in the Eurasia region. We view this as positive for the nation's long-term growth and stability that should make the resource-rich nation an attractive destination for foreign investors.

Stock market has major growth potential

Admittedly, Mongolia has a small and illiquid stock market. The total market capitalization of all the companies listed on the Mongolian Stock Exchange (MSE) has dropped to $320m (a mere 7% of GDP), down 72% from its peak reached last year. Despite its small size and limited liquidity, the domestic equities market has strong growth potential. Most of the local listed companies are currently substantially undervalued. Several international investment funds are active in the market by holding sizable stakes in the listed companies, including those in the MSE Top 20 index.

Signing the Oyu Tolgoi and Tavan Tolgoi deals and adopting pro-business regulatory changes will lead to growth in Mongolia's stock market. This will happen through privatization of the state-owned companies by selling shares in the local stock market and IPOs in the local stock exchange by large private business groups and internationally listed companies with major operations in Mongolia. Investors would be interested in purchasing stakes in the companies being privatized, especially in the resources sector. Now the government has a plan to privatise several state-owned companies in the coming years, including in the resources sector such as coal miners Baganuur and Shivee Ovoo. Several major business groups such as MCS Group, Newcom Group, Bodi Group, Tavan Bogd Group and Monnis Group, which have attracted multimillion- dollar investments from the EBRD and IFC, and private equity firms, are also next major contenders for going public.

Alisher Ali Djumanov is CE of Eurasia Capital

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