Mongolia's new government faces old problems

By bne IntelliNews September 27, 2012

Oliver Belfitt-Nash in Ulaanbaatar -

The term "Dutch Disease" may have originally been coined in relation to a gasfield in The Netherlands, but Mongolia is finding out that it can just as well apply to coal. This "black gold" that propelled Mongolia's economic growth to a record 17.3% in 2011 is now in a sudden glut and Chinese demand has dropped off a cliff, and the country's new government is learning the hard way about how reliance on a few commodities can endanger the economy.

Mongolia shipped 21.1m tonnes of coking coal to China in 2011 worth $2.25bn, up 26% in volume and a staggering 155% in terms of value from the previous year. The coal excitement reached its peak exactly a year ago in September 2011, when 2m tonnes were sent across the country's southern border to rake in $380m for those in on the deal. The country overtook Australia as China's main coal supplier and the previous government's coffers began to swell with royalty and tax revenue, which it swiftly dealt out to its citizens in preparation for the elections in June this year. But the handouts didn't work, and now a new government has taken the reins.

Uphill battle

The Democratic Party has an uphill battle to keep the economy on track. It takes office at a time when coal export prices have fallen to their lowest level in 10 months and volumes have been cut sharply since June to around 1m tonnes for August. The global slowdown has dulled investors' appetite for risk, the country's biggest project is under fire from resource nationalist fragments of the party, and China's hand has been slapped away from acquiring a mine in the Gobi desert. "This country needs foreign direct investment now more than ever," says Jargalsaikhan Dambadarjaa, a Mongolian economist and political commentator. "We need to use the mining revenues to diversify away from mining."

Dambadarjaa warns that "Dutch Disease" - where an increase in the exploitation of natural resources is accompanied by a decline in the manufacturing sector - is taking hold. "We are still fully dependent on coal and copper - these two commodity prices are behind everything."

To add fuel to the fire, parliament passed a new resource-nationalist "Foreign Investment Law" in May in order to veto a bid by the Aluminum Corporation of China (Chalco) for a Canadian-owned coal miner based in Mongolia, SouthGobi Resources. The law's intention was evident, but its consequences have reached far beyond the single deal. The legislation states that any investment over $75m designed to own over 49% of a Mongolian company will be subject to approval by a government panel. Many investors have seen this as a red light and reversed, leaving the new government short of cash. "Any rational-minded Mongolian would oppose this law," says Jargalsaikhan. "We wanted them to cut the hair, not the head! We need technology and know-how, but this will be a backwards step from diversification."

The new government has promised measures to deal with the slowdown. A four-year plan was released mid-September outlining the policies that will drive its term of office. Many of the clauses are encouraging, highlighting the importance of "cooperat[ing] with foreign direct investors on a mutually beneficial basis," as well as an entire section on economic diversification. "The key economic policy objective of the government is the reduction of dependency on the mining sector, achievement of a long-term sustainable development and creation of a competitive and diversified economy," the document states.

Plans have been drawn up to encourage industrialisation, wool and cashmere production, livestock and meat, tourism, technology, import replacements and services. Projects such as the Sainshand Industrial Park, which aims to add value to export commodities before shipping them on to China, will be pushed hard. Alongside these bold plans it's mandated that inflation will be kept in single digits and the state deficit will remain under 2%, yet August figures showed annual inflation at 16.6% and the deficit already at 4.4% of 2011 GDP.

"What will be the government's role in these efforts?" asks Jargalsaikhan, referring to the Sainshand project. "I don't believe the government can do it. All state-owned enterprises are losing. CEOs are picked politically, not on merit. It will not be competitive - this was the whole reason for our transition."

Indeed, government-funded companies operating in the cashmere sector show how hard this will be to pull off. Loans were made to the sector at reduced rates, hoping to spur growth, but while cashmere exports rose 20% in the first eight months of this year, they still only account for 4.7% of the total exports in dollar terms. "If you think one reform will solve everything, you're fooling yourself," Dr James Riordan, former director of Chemonics International, said at a recent economic development conference. "You have to focus on the buyers. Diversification will come slowly, little by little."

Unfortunately, commodity crashes do not come slowly, and despite all the naysayers Mongolia's new government is promising a much brighter future than the past left by their predecessors. As their world crumbles, the band keeps on playing.

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