Regaining investors' credibility …..

Problem statement by INS
Mongolia’s ability to attract third neighbor investors and financiers to support funding of it’s huge development agenda has deteriorated. Providers of capital are seeking answers to 2 basic questions while considering lending or investing into Mongolia.
  1. Is the Government of Mongolia supportive of an empowered private sector and is it proactively resolving business disputes?
  2. What is the winning strategy that will turbocharge the economy?
Opinion by Cameron McRae
“In the Democratic Transition, Mongolia committed to three fundamental reforms: respect for human rights; open, democratic government; and an economy led by the private sector, not dominated by domestic or foreign state-owned companies. Mongolia’s support for human rights and political participation is beyond question. Where Mongolia has struggled is in the third reform:  developing an independent, private-sector economy. Our Six-Point Plan will advance Mongolia rapidly to this goal of developing competitive industries that create jobs. With government’s focused leadership, we are confident that business will create the growth and employment that Mongolia needs”.
This is the closing paragraph from a paper written by six Mongolian business leaders, myself and an international bank, aided by McKinsey and the Economic Policy and Competitiveness Research Centre (EPCRC), Mongolia, that was presented to President Elbedorj in August 2012. The report was titled “A six-point action plan for Mongolia: Enabling business to create employment and growth”.
The six pillars of this action plan were:
  1. Stabilize the economy;
  2. Create policy and regulatory stability;
  3. Reduce government’s role in business and streamline bureaucracy;
  4. Develop a prioritized and fundable infrastructure plan;
  5. Stabilize and strengthen the mining sector; and
  6. Deliver critical infrastructure projects.
The six-point action plan (6PAP) thesis was that with government creating an enabling environment and proactively supporting private sector businesses, both domestic and international, then business would attract international finance and investors-partners for high quality projects which would fuel sustainable growth. The 6PAP did not only look at mining and infrastructure but recognised that these projects types were huge, that new infrastructure and infrastructure upgrades were essential for a modern Mongolia and provided the foundation for fast and sustainable economic growth.
From a strategic perspective the 6PAP recognized the continuing importance of agriculture, the upside from tourism, some potential viable areas of downstream processing, the potential for exporting power and the prospects for a mining service sector. This was not meant to preclude strategic consideration of other areas of economic endeavor but rather to focus attention on where Mongolia may build a competitive position relatively quickly.
So let’s attempt to answer the international investors 2 questions – firstly by looking at economic and political events since August 2012 and then referencing the current situation to the 6PAP (of 2012).
From August 2012 to today…. Some background information
The 2012 general election had just been held and the constitution of the government, the Cabinet, and senior positions in every ministry remained unclear. When the dust settled in late 2012 we saw a government made up of 4 political parties, a brand new, and inexperienced, cabinet and a complete change-out of senior public servants in every Ministry. This came on top of SEFIL (the Strategic Enterprises Foreign Investment Law)  – passed in Q2 2012 – which was an overly nationalistic response to a takeover offer by a Chinese state owned enterprise (SOE) of a small Mongolian coal miner located in the Gobi Desert.
The 2013 Presidential election was also a close race and was played out on a background of populist and nationalistic policies and the Oyu Tolgoi (OT) dispute between Rio Tinto and the Government of Mongolia (GoM). This dispute was a public affair until Q3 of 2013 when the parties moved discussions behind closed doors. The mothballing of the US$ 5 billion OT underground development in Q3 was an unavoidable consequence of the protracted dispute around critical “value issues” which had been running for two years. The US$ 6 billion project finance package, the largest ever in the mining industry, remains approved by the large banking syndicate, but is unable to be consummated.
The success of the US$ 1.5 billion Chinggis bond raising in late 2012 was a surprise to some, but the subsequent blowout in bond yield and devaluation of the Tugrik was not met with surprise by economists. They point to the shortfall in 2013 GoM budgetary revenues and the actions to prop up the economy and manage inflation with Quantitative Easing (QE) programs such as the Price Stabilization Program and other “off balance sheet” measures.
In 2013 other “business related” disputes and slowness in declaring policy positions on key pieces of essential legislation also added to the consternation of international financiers and investors and local businessmen alike. Investor confidence remained low and new international financial inflows scarce, despite the PR message that the GoM was repositioning the Mongolian investment environment for an economic resurgence driven by the private sector.
This low confidence occurred against an international backdrop of widespread economic problems. Economic slowdowns in the US and Europe, and a change of economic policy in China, have all contributed to a more austere outlook on the minerals industry – which is essential to Mongolia. International capital that was available to the mining industry has gravitated to big projects with many smaller mining focused companies finding fundraising for exploration and “early stage” marginal projects extremely difficult. The mining giants, such as BHPB and Rio Tinto, have driven massive capital expenditure programs over the past 3-4 years but are now in cost cutting and capital rationing mode, and little capital is being apportioned to projects in the so-called riskier “emerging and frontier markets”.
Since late 2013 we have seen significant symbolic movements, including the President’s launch of the “From big government to smart government” initiative, more advice taken from international advisors which has been at a higher level than at previous times, and the Cabinet commissioning the World Economic Forum to develop economic scenarios for Mongolia.
The GoM has also announced a raft of policy changes, with the introduction of new legislation and modifications to existing legislation. This program of change is being pursued in a fast manner, and not always with high levels of consultation or the ability to lobby for change until late in the piece.
Now, let’s review the six pillars of the 6PAP.
Pillar 1.           Stabilizing the economy
For the longer term, stabilization mechanisms to manage highly variable commodity revenues are seriously being considered as is a sovereign wealth fund for investing surplus wealth generation.
However the last two years is characterized by a reduction in capital spending at OT, and a lack of progress at Tavan Tolgoi and other mega projects. The Mongolian economy has relied on the deployment of the Chinggis Bond, the PSP (price stabilization program), and the 8% mortgage scheme to keep road works and housing activity in play.
The reality is that government debt continues to rise quickly, credit lines are shrinking and becoming much more expensive. Balance of Payments deficits continue and FX cover has dwindled to 3 months. Given the state of the national finances it is difficult for the GoM to continue stimulating the economy with large QE measures alone. Encouraging stimulatory programs driven and funded by the private sector, to build a stronger Mongolian economy takes the pressure of the GoM balance sheet.
Pillar 2.           Create policy and regulatory stability
Mongolia has had a history of political populism and unpredictability towards international investors, and in particular towards the flagship OT project. While the OT dispute remains unresolved it is salutary that the GoM’s PR engine is now much less populist and more balanced in how it deals with the issues of supporting investment, both international and domestic. Resolution of the OT dispute in a way that is seen to honor the existing agreements will be very well received by the major banking institutions and international investors.
Tax stabilization, a key and controversial feature of the OT Investment Agreement, has now become a feature of the proposed Investment Law and is available to both domestic and international investors. The removal of SEFIL reinforces this positive initiative.
While Mongolia has a strong need to expand and grow its tax base, it is showing discipline in the use of the tax rates, thus recognising that this is a lever that improve Mongolia’s competitiveness as a destination for international capital. Mineral royalty arrangements however are being partly used in a way to minimize “transfer pricing”, by placing the onus of achieving bench-mark prices or mine owners. I believe this creates problems for new investors as they do not know how royalty payments will be calculated over time.
Generally improving the consultative process and proposed minimum periods for consultation on proposed legislation will generate better outcomes, as will improving the linkages between the GoM and business associations. The onus to improve is on both business and GoM.
Regardless of the logic and competitiveness of laws, the true test of legislation is how it plays out with the bureaucracy; is it easy and quick to start, implement, and commission a project or business initiative? The 6PAP highlighted that the current decision making and approval processes within Ministries and between the national, aimag, and soum levels of government were far too slow, complex, and opaque. This is reinforced by WEF and IMD benchmarking studies and is recognized by GOM as needing improvement.
The move from “big to smart” will not be easy and will require strong leadership at the cabinet level and excellent change management at the critical ministries. The rationalization of powers at the soum and aimag levels is a political issue, but one that must be urgently addressed.
Image is important and the most consistent message back from investors is for the GoM to rebuild its “credibility” brand – by proactively resolving the significant unresolved legal disputes. Putting resolution of these issues into a single point of accountability should be considered.
Pillar 3.               Reduce GoM’s role in business and streamline bureaucracy
The parliament is debating the concept of not owning and over-managing the economy, which is understandable since Mongolia was once part of a strict communist regime. The reality today is that the GoM cannot afford to adequately fund government companies, or buy into new ventures (such as the strategic mining deposits), and the track record in running SOE’s without political interference and  to international standards is poor.
Putting in place an SOE privatization program will bring about two benefits – realization of cash which can be used for debt reduction or strategically placed programs, and the transformation of these SOEs into more profitable and internationally competitive entities.
Government agencies that interface with complex infrastructure and mining projects still need to be organized along “delivery unit” lines, and hopefully the GoM is working through this as part of the “smart government” initiative. The current arrangements have significant room for improvement. Blowouts in project costs are inevitable of due to long-winded permitting and approval processes are tolerated.
Pillars 4 and 6. Develop a prioritized and fundable infrastructure plan PLUS deliver critical infrastructure projects
Mongolia has ambitious plans to develop it’s infrastructure, but has been hampered by available and reasonably priced finance, and tedious approval processes. The 6PAP recommended a) a short list of priority projects be developed and intensively supported through all stages of development, and b)  that projects pass a “market needs test” and can be commercially funded.
Prioritising the GoM’s strategic projects list and rectifying the issues raised in pillars 1 to 3 is required and is not an easy political task. It is also vital that other viable projects brought to the table by private sector sponsors, with their own funding are also well supported.
The 6PAP targeted 5 critical development areas, which would provide a significant economic stimulus over a 3-4 year period, and also improve Mongolia’s competitiveness and international credibility. Progress and issues are highlighted.
  1. Power and heat generation: Little committed progress has been made on this front and resolution is critical from an urban and industrial perspective. This remains a key investment opportunity. However realistic tariffs for investors need to be mandated by the GoM, which has enjoyed low priced power from Russia and Mongolia’s obsolete fleet of UB power and heat plants.
  2. Power and heat transmission: The growth and upgrade of the grid remains a strategic challenge.
  3. South Gobi to China rail links: A rail project between Tavan Tolgoi and the Chinese border has started, however this project appears to have stalled. More rail links are planned and needed but, again, funding and politics remains a
  4. Urban roads and airport: The UB international airport has been committed, with Japanese funding, and the paved national road network has been extended during
  5. Water sector: Progress in this area is not clear. Tariff and licensing issues remain an impediment to investment.
Pillar 5.           Stabilize and strengthen the mining sector
Identifying and utilizing Mongolia’s mineral heritage is the most strategic of issues. Mining projects bring the transfer of technology and business practices, infrastructure development, national business development, and employment and training, in addition to foreign exchange earnings.
Finalization of a competitive and world-class mining policy and the ensuring legal changes is critical and long overdue. This is work in progress and it is imperative that the GoM gets this 100% right. Mongolia is seen as a frontier mining economy and it needs to be extremely competitive in all stages of the mining process to ensure that international companies and financiers support “high standard” junior, mid and large scale exploration and mining.
Importantly, Mongolia can demonstrate the huge world-class copper mining operation in the Gobi Desert that was built ahead of schedule in an area devoid of infrastructure, power, and water. It is an achievement of international standing and thousands of Mongolians and hundreds of Mongolian companies have participated and learnt from their involvement in the OT project and operating business.
Resolution of the outstanding “106 licences dispute” – in favor of the original licence holders is essential. The Mining Ministry must be perceived as fairly supporting a market in exploration permits and mining permits – which is critical for attracting qualified exploration and mining investors. Credible Mongolian mining houses that partner with international firms are also going to deliver larger mines with easier financing, more efficiently run projects, and a better chance of achieving international terms for the “export products”.
And finally, the GoM’s failed experiment in state ownership of mining enterprises should be wound up. This would send a huge message to investors, that Mongolia will not require you to give up to a 34% interest in anything you may find!
Author’s summary
Mongolia’s needs are huge and real, and re-positioning to attract serious international finance requires more than public relations and quick legislative changes. There is hard but essential work to be done – for both GoM and the business associations.
INS Commentary
Senior leaders are thinking deeply about the Mongolian situation. They know that advancing Mongolia’s economy requires access to international capital, best technologies, and to the right business partners.
To attract these essential components to Mongolia is no simple job, especially when the developed world is working through its own economic challenges and the developing and frontier economies are all fighting to attract any available capital and investors. Remember, the world is made up of over 200 countries – all fighting for credibility and access to the limited global capital pool.
Changing a country’s destiny is not an overnight or one-year task; it requires a clear vision, unfaltering dedication, and the strength of conviction to see the execution of that vision. Fortunately, some significant steps have been taken but show stoppers also remain in place. Now it is critical that the government, business associations and international experts consult, collaborate, and execute strategies and policies that position Mongolia as a competitive and reliable frontier investment destination.
More importantly, a new populism needs to take hold in Mongolia; whereby Mongolia is promoted as a country preparing to be a world-class economy, comprising highly competitive businesses and a business enabling government sector.
Winning the confidence of banks, investors and world class companies should be the highest priority for the political parties of Mongolia.

Source:Institute of National Strategy
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