By Institute for National Strategy.
“Vertrouwen komt te voet en vertrekt te paard.” This is a famous Dutch proverb translated as “Trust comes on foot and leaves on horseback.” In the current context of the Mongolian investment climate, this could be reworded as “investors come on foot and leave on horseback”.
In just a few short years since the boom times of 2009-2011, Mongolia has gone from being an international “investment showcase” to a “basket case”. Investors and financiers are extremely cautious and most have lost interest.
The new Minister for Special Projects, M.Enkhsaikhan, sums it up, “While the U.S. led economic sanctions are causing the ruble to depreciate, our self-imposed economic sanctions are doing the same to the tugrik.”
Prime Minister Saikhanbileg has been equally blunt:
• “Let us quit using patriotism and populism about who loves the people more. Let us discuss issues with common sense and without emotion.”
• “It is time for absolutely required decisions. If the situation continues as is, I will have to admit the possibility of a country-level default.”
• “We are facing a 2008-09 balance of payments crisis, which, if extended, could become even worse…”
• “We now see that we do not have the correct policy, investment, skilled labor, and equipment; no matter how many resources we have, we will continue to just sit on them.”
• “In just three years, investment has collapsed 7.5 times, and if we keep making hostile policies that force others to flee, we will become Robinsons left on an isolated island.”
From Marx to market – and the keys to recovery
Since transition from a centrally planned economy to a market economy, private sector led investment has played a very significant role in driving Mongolian economic growth. The private sector now accounts for 85 percent of all employment and the vast majority of government revenue through VAT, income taxes, royalties, and charges.
Despite this move from government to private sector activity, investors have experienced a thrilling and traumatic ride – especially over the past 9 years.
The keys to recovery are:
• recognize past mistakes
• resolve outstanding issues
• put in place effective mechanisms to foster future growth and prosperity
A combination of policy missteps and investment disputes are at the core of Mongolia’s current economic problems, including:
• Windfall Profits Tax Law (WPT), 2006
• Law on Prohibiting Mineral Exploration and Extraction Near Water Sources, Protected Areas and Forests (the “Long Named Law”), 2010
• Progressive Royalty Law, 2011
• Strategic Entities Foreign Investment Law (SEFIL), 2012
In the mid 2000s, Mongolia was fast becoming a major destination for mineral exploration by both foreign and domestic exploration and mining companies. However, the WPT on gold and copper decimated the junior exploration sector. The juniors abandoned Mongolia and took their exploration funds elsewhere. Grassroots exploration expenditure on gold and copper all but evaporated. As a result, the Mongolian economy lost thousands of exploration related jobs, both directly from exploration companies shedding staff, and also indirectly through loss of income by service sector companies such as hotels, laboratories, drilling, transportation and logistics companies. This situation continued until the WPT was repealed.
Unfortunately, not many of those companies have returned. The government introduced new sliding scale royalties at punitively high rates, which once again discouraged new explorers. The new royalty system and government setting of reference prices has contributed to the contraction of the fledgling coal industry, almost to the point of bankruptcy.
SEFIL placed limitations on foreign investment into a number of “strategic” sectors in the Mongolian economy, immediately halting investment in new projects. In order to enforce the law, the government needed an institutional framework to enable companies to apply for and be granted approvals to invest. This never happened and companies were left without investment opportunities and took their projects and funds elsewhere.
Investment disputes have compounded policy missteps.
An exploration or mining license, and the investment agreements which support these licenses, constitute fundamental property rights. Investment decisions are made by investors based on the rights conferred by the license and the provisions of those agreements or contracts. Any time the government or its agencies act to arbitrarily change the terms of a license, or move to re-negotiate an investment agreement, constitutes a breach of trust and calls into question the reliability of the government as a partner in development.
Recent examples of breaches of property rights by the government, both within and outside the mining industry, include the following:
• Renegotiation of the Boroo Gold stability agreement
• Nationalization of the Khan Resource Uranium licenses
• Nationalization of the Energy Resources Rail concession to construct the Tavan Tolgoi to Gashuun Sukhait Railway
• Seizure and cancellation of hundreds of mining and exploration licenses under the Long Named Law
• Renegotiation of the Oyu Tolgoi shareholders agreement and investment agreement
There are a number of contracts which have been the subject of protracted disputes, both in Mongolia and at international arbitration. These disputes include:
• Disputes over the Oyu Tolgoi investment agreement
• Disputes with investors over the annulled 106 exploration licenses
• Erdenes Tavan Tolgoi (ETT) dispute with Chalco over the coal off-take agreement
• Non-payment of invoices to McMahon Mining contractors by ETT
• Failure to honor the payment terms of the PPA with Salkhit Wind Farm
• MTZ’s failure to make payments to Samsung C&T for construction of the UHG-Gashuun Sukhait Railway development
Especially frightening to investors is the cancellation of exit visas for expatriate staff, contractors, and consultants from a number of foreign companies, in cases where no criminal charges have been laid. These have been reported by international media as a failure by Mongolia to honor human rights and freedom of movement.
Learn new paradigms
Trust needs to be rebuilt. This will not occur through fancy PR programs or recent fixes to negative legislation. The private sector is not the enemy of Mongolia or Mongolians – rather it is the engine room that every government, in every country, relies upon.
Quickly resolve disputes and avoid making the same mistakes again
Some of these disputes may be painful and costly to resolve in the short term, but in the longer term will result in renewed investment and broader economic growth. Resolution of the other disputes will cost Mongolia nothing, but a few leaders will need to swallow their pride.
Government also needs to make a paradigm shift in the way it negotiates future agreements that it is a party to. To date, government has been unwilling to seek international legal advice to assist in the preparation of major agreements. While costly, it will give government more confidence that it has entered into appropriate long-term agreements.
Another critical issue with investment agreements is the need to put them beyond the reach of partisan politics. International investors and banks will not invest where it believes it is common practice for a new government to undo or renegotiate everything done by the previous government.
Change the role of the State
Effective governments in modern market economies see themselves as facilitators of private sector development within a guiding regulatory framework. The recent approach in many government agencies in Mongolia appears to be that of a gate-keeper rather than facilitator of safe and efficient development. An example is the excessive numbers of permits required for simple and often non-essential tasks. This creates opportunities for bureaucrats to become gate-keepers and block major developments over minor technicalities. In the most recent “Doing Business Survey” by IFC, Mongolia scores 107th on the issue of getting permits.
Many other countries provide specific assistance to developers to navigate through the development process in order to speed up project developments and bring forward the economic benefits of the project. One such example is the Queensland Department of State Development, Infrastructure and Planning in Australia. Their mission statement is below:
“…(DSDIP) exists to deliver Queensland’s economic prosperity by championing the interests of business and industry. We achieve this by driving business and economic growth, leading infrastructure policy and planning for the state, reforming Queensland’s planning system, and assessing, approving, facilitating and delivering major projects.”
Other developing countries, such as Papua New Guinea – which has a mining industry much larger than Mongolia, now have government institutional arrangements where dedicated project coordinators guide and assist project developers through the development process to facilitate investment in a timely manner.
Mongolia not only needs similar agencies to facilitate growth, but also a general change in mindset across government to promote development.
The close relationship between business and politics in Mongolia has from time to time resulted in decisions which favor particular business interests rather than economic efficiency or quite simply block economic development.
Leverage the private sector for infrastructure development
It is right and proper for governments to ensure that appropriate regulations and standards are met by the developers of any major project. However, government has pressed for full, or majority, ownership of major infrastructure developments when it has no capacity to deliver them, either from a financial or technical capacity standpoint.
Examples include the Energy Resources rail project from UHG to Gashuun Sukhait. This project was fully funded by the private sector and was under construction and due for completion in 2015 when it was halted, with the state taking ownership of the project. Since then, it has re-commenced development only to be halted again due to a lack of financial resources. It will not be delivered in 2015, contributing to ongoing high costs for coal exporters with a corresponding loss of economic growth.
Similar examples exist in the energy sector, where private sector developers have been ready to construct major power plants but are unable to get necessary government approvals or power off-take agreements. The IFC business report ranks Mongolia at 162nd in the world for access to electricity, well below most African countries. These are cases where government officials have stood in the way, preventing economic growth and delivery of essential services.
Build a more effective dialogue with business
Many countries have developed structured consultation mechanisms where government and the business community come together with the express purpose of identifying and resolving impediments to business. In this way, those items which most directly impact growth can be resolved at the earliest possible opportunity. Mongolia has well developed private sector associations that are well placed to provide knowledgeable senior business leaders to engage with government.
Source:Institute for National Strategy
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