COMMENT: Mongolia - a blue-sky opportunity

Roland Nash of Renaissance Capital
December 16, 2009


Mongolia is a country on the point of transformation. On the Chinese border, it has some of the richest mineral deposits globally. Mongolia has an economy about 25% smaller than Moldova's, with copper, coal, gold and uranium reserves rivalling those of Kazakhstan and Australia. As these resources are brought to market, Mongolia stands a good chance of becoming the fastest-growing economy in the world over the next decade.

The transformation will begin in 2010. The signing of a joint venture between the Mongolian government and the Ivanhoe-Rio Tinto alliance in October 2009, to exploit the Oyu Tolgoi copper mine, has set a precedent for the mining industry. The $4bn investment expected over the next nine years in this project alone is roughly equivalent to Mongolia's entire GDP in 2009. And there are several other projects with similar world-class assets.

Despite the scale of the mining projects, Mongolia remains remarkably underdeveloped. In a country the size of Western Europe, there are fewer surfaced roads than in Luxembourg (a country slightly smaller than Rhode Island). Mongolia imports a proportion of its electricity from Russia and much of its fresh produce from China. In the capital, Ulaan Baatar, Louis Vuitton, to much fanfare, opened a branch in October, yet there is very little class-A office space. Opportunities in the secondary industries, from banking to real estate, are arguably greater than those in mining. Resource endowment is not the only reason why Mongolia stands out.

It also has a quite different political and business environment from the rest of Central Asia. Unlike some of its neighbours, Mongolia has a genuinely competitive political system, with a free press and open elections. According to the World Bank, Mongolia ranks in the top third of countries in terms of ease of doing business - above Spain and Poland, and much higher than any of the BRIC countries.


Transition pains
A transformative natural resources windfall has proved a mixed blessing for many countries. Mongolia will face substantial economic dislocation in coming years. The mild populism of its democratic government has tended towards inflationary policy in the past, and its banking system, budget and monetary institutions are unprepared to absorb the scale of the likely change to the economy.

In the longer term, Mongolia faces the difficulty of managing the interests of its two big neighbours. Mongolia's longest border is with China. The three Chinese regions that directly share a border with Mongolia have a population of 74m, compared with Mongolia's 2.6m. The Chinese province of Inner Mongolia is 80% Han Chinese, yet it has a bigger Mongolian population than Mongolia itself. Mongolia's only other border is with Russia, a country that dominated it for 65 years from 1924. To maintain balance with its two neighbours, Mongolia is actively encouraging non-Chinese and non-Russian foreign investors.

Despite the challenges, the transformation of Mongolia now appears unstoppable. According to official estimates, over the next five years, production of coal will double, gold production will treble and copper output will quadruple. The economic transformation will prove a rare test of a largely free and competitive political system to handle a major natural resources windfall.

For portfolio investors, there are currently few investable assets in the country; but Mongolia's geography, geology and business environment make it, in our view, one of the most exciting investment environments among frontier markets.

Source:Renaisance Capital Group (equity research on Mongolia)