Stepping out

By bne IntelliNews November 23, 2011

Ben Aris in Moscow -

Sometimes it pays to be isolated. Mongolia was hurt by the 2008 global crisis that swept the world, but while most major economies were crushed, Mongolia did no more than stub its toe.

Mongolia's economy has been growing nicely now for several years as it finally gets hooked up to the rest of the world. For most of the last few decades, per-capita GDP income was stuck at $2,000 - putting it slightly ahead of both China and India - but since 2007 it has started to move up in tandem with the rest of the world.

The difference was a combination of progress made by what is today one of the most democratic governments in the former communist space and the arrival of big international miners who are interested in the country's treasure trove of raw materials, which are feeding China's insatiable appetite.

The government has identified 15 strategic deposits that between them contain an estimated $1.2 trillion worth of minerals. That in an economy where nominal GDP in 2010 was $6bn. The biggest problem Mongolia has to face in the coming years is what to do with all the money that flows in.

The most advanced is the Oyu Tolgoi (OT) copper and gold deposit that is being developed by Ivanhoe Mines and is due to come online in 2013, which should earn $3bn a year from sales by itself. Altogether it is thought to contain $132bn worth of metals. Then there is the Tavan Tolgoi coking coal deposit that holds an extraordinary $387bn worth of coal, various iron deposits worth $100bn, uranium deposits worth $18bn, and small change in silver and other metals accounting for several more billions of dollars. Currently, the country's main exports are goat skins (better known as cashmere to the shopping public) and copper produced at the Erdenet mine that was set up in Soviet times. Just the copper reserves are the second largest in the world - a quarter of the planet's total - or 236m tonnes. And the 100m tonnes of coal is the world's fourth.

Located about as far away as it is possible to be from anywhere else in the world, the Mongolian story is still one of the best kept open secrets in the world.

Mongolia, the new Azerbaijan

Around 2007, international investors who had made a bundle in emerging markets were moving on to look for new opportunities in the so-called "frontier markets". Mongolia was one of several that attracted attention - and capital - partly as it could sell itself as an adjunct to the China story that obsesses most investors these days.

The economy was already on the fast track before the crisis struck, expanding by nearly 19% in 2006. The crisis of 2008 brought the growth abruptly to a halt, but unlike many of the other emerging markets, the subsequent economic contraction was mild at 1.6%.

Over the last two years, the economy has quickly recovered and put in 6.1% growth in 2010; it should perform even better this year, with analysts expecting growth to hit a historic high of 9.7%, which would put Mongolia on a par with the superstars of the emerging world, Turkey and China.

At the same time, other economic indicators have remained tolerable: inflation is in single digits and forecast to remain at 8% this year. Mongolia really only came to international investors' attention in April 2010 and finished that year with $1.6bn of net inflow of capital, 5.3 times more than in 2009. This year is expected to see at least as much investment arrive again. And the country's gross international hard currency reserves are a comfortable eight months of import coverage, or a bit less than $2.5bn, whereas most developed countries hold only about three months. "The budget is in surplus, we have record high level of cash in our coffers, we have created the stabilisation fund [that is] expected to hold $200m by year-end," Vice Finance Minister Ganhuyag Chuluun Hutagt, said at the World Economic Forum East Asia Summit in June. "There is no immediate, urgent needs for additional funds."

Going forward, growth will depend to a large extent on international commodity markets, which will make it erratic, but it should stay around the 10% growth level. By 2025, Mongolia will reach a GDP level of over $100bn, according to Metatron Capital, overtaking Qatar.

But a better comparison would be with Azerbaijan (which is expected to reach just over $100bn in 2015 from about $15bn in 1995). The only thing that Azerbaijan produces of note, a backward former Soviet vassal state on the Caspian Sea, is oil and gas. Having struggled for most of the decade following its forced independence in 1991, the economy suddenly took off in 2006 when the oilfields were finally hooked up to a pipeline that connected it directly to western markets, bypassing Russia. The economy soared, growing by an extraordinary 35% in the first year and despite the current crisis the economy is expected to grow by at least 3.5% a year for the rest of the decade.

Mongolia should do even better. The forecasts vary, but most analysts agree that like Azerbaijan the economy will take off dramatically around 2013 when the OT mine comes onstream and generates an estimated $3bn a year in revenue. And that is not counting the coal exports that Eurasia Capital estimates could climb to $7bn a year by the middle of the decade.

Inbound direct investment is mirrored in the country's stock market, which more than doubled its capitalisation at the start of this year when a few large investments sent the Mongolian Stock Exchange (MSE) index leaping to over 30,000. One of those was James Passin of US hedge fund Firebird, which started snapping up majority ownership through the open market in several key companies and now owns almost 40% of all shares traded on the exchange. "Last year, Mongolian capital market participants were only dreaming about an MSE with a real pool of financial sources, but today it is being realised," says Dale Choi, chief investment officer at Frontier Securities.

Although the index quickly dropped back to around 20,000 after the Firebird shopping spree stopped, it has remained there for the rest of the year, ignoring the sell-off that hit most bourses in August this year: it seems Mongolian stocks are one of the few "safe havens" in the world for equity investors. The trouble is, with a daily turnover on the exchange of only about $100,000 a day, global investors can't hide more than their lunch money in the MSE. But this year the government retained the London Stock Exchange to oversee reforms to the market that should start to kick in next year.

Mongolia has made a lot of progress in the last couple of years, but it still has a long way to go before it can start to enjoy its newfound prosperity. Late to the party, the country still remains at the very start of the reform process and has nearly everything to do: the lack of infrastructure in what is a largely bucolic economy remains a bottleneck to further growth; it has added no new power generation capacity for over two decades; and business is in desperate need of new rail routes, border crossings and a functioning financial sector. But men like Vice Minister Ganhuyag have a vision for what he dubbed the "Wolf Economy". "We need to dream big and aim high," says Ganhuyag.

A bit of stability on the international markets would also help.

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