Political leadership and putting the economy first

By Cameron McRae, former director of OT LLC and director of
Institute of National Strategyin Ulaanbaatar, Mongolia
Prime Minister Saikhanbileg addressed the nation on Sunday evening, and focused on the need to turnaround the economy and address the issues causing the current situation in Mongolia. INS has analyzed the speech and the first 100-day track record of the new coalition government.
Institute of National Strategy commentary
Congratulations to Prime Minister Saikhanbileg and to the President and Mr. Tsagaan who have spoken of the hardships and lessons learned over the past three years, and the need to do things differently moving forward. This theme was amplified at Mongolia Economic Forum last week. Instead of blaming the world, they have put the focus onto the accountability and responsibility of Mongolia’s leadership.
Most importantly the PM is indicating that Mongolia’s greatest modern day economic triumph, and ironically, the source of Mongolia’s biggest FDI dispute, is likely to have it’s second phase restarted shortly. This will see nearly six billion USD invested over five years and OT revenues into the country triple when the richer underground moves into production.
For those who continue to question the fairness of the investment agreement, an interesting fact is that the government share of free cash-flow from 2010 to 2021 will equate to almost 80 percent – and well over three billion USD in taxes and royalties alone. This is for zero cash outlay, with all cash inflows provided by the foreign investor.
And these returns to the government do not count the multiplier effect on the economy, employment, secondary business development, and additional taxes.
The misleading debates over cost overruns and long-term returns to the country need to stop, but why? Because what Mongolia has enjoyed for the past two years is 100 percent of nothing, plus damage to its international reputation as a safe and reliable place for investment.
The PM has stated that his focus is all about the economy, and his speech on Sunday evening reinforced the essential need to put a growth-focused base under the economy. He emphasised the need to reignite the confidence and positivity of all Mongolians and foreign investors alike.
The PM has admitted this will be hard work and several Mongol specific factors need to be overcome – specifically populism and inept officialdom. He has indicated his determination to overcome these cancers to economic growth – and to force through tough decisions which are in the interest of Mongolia as a whole.
The PM claims many issues have been settled already and that work is underway. However the ability to turnaround a stalled economy, to reduce inflation and interest rates, to rebuild foreign currency reserves and strengthen the exchange rate is not done overnight. Indeed returning to a good position is only step one, maintaining a winning position over time is the real objective.
Mongolians cannot realistically expect to see the full effects of an economic recovery prior to the next election in mid 2016, especially when one looks at the condition of the global economy and the prices of mineral products internationally. There is no upside kicker from high minerals prices for Mongolia.
Nevertheless the PM made many positive and sensible announcements, in addition to a solution at OT and the establishment of a new consortium at TT.
Very important will be those actions that structurally impact the government’s ability to stimulate the non-mining economy and to reduce unnecessary drains on the government’s budget. Namely these are:
• the removal of government subsidies from energy, petrol and oil, flour and wheat, and other agricultural products
• the removal of wasteful people and practices in bureaucracy
• actions that stop price manipulation on imported products
Missing from the PM’s speech was the need to reduce subsidies to building companies and to look at measures that do not create another price bubble. The disparity between housing prices and incomes needs to be closed, and it is clear that the real estate market needs to self-correct.
The drive to formalize a savings pool through development of a pension scheme makes sense, especially if this is directed back into new and focused real estate development. Better buildings in better locations with better social services and thoughtful traffic planning are critically needed. UB already has too many skyscrapers without living space, services and year round parking.
INS has been clear and consistent in a call for government to exit business and to support the business sector to grow the economy. The government is best placed to provide educational, social, and essential services – but even today there is a growing and successful trend to outsource this to public-private partnerships and the private sector.
The PM has emphasized some important privatization decisions around the MSE, MIAT and putting Mongolia’s state owned enterprises (SOE) under a Temasek structure. INS strongly recommends the full privatization of loss making business, and that a Temasek-type structure should focus on investing in companies but not operating them. Getting the existing suite of SOE assets into better shape for privatization should be one urgent focus of Mr. Byambasaikhan, the new CEO of Erdenes Mongol.
The GoM should finish its love affair with strategic mineral deposits. It should encourage competent and responsible mining companies to do the exploration, development studies, and ultimately, to fund, construct and operate them. The government has been blind-sided on OT and TT for far too long, and it cannot afford to be so distracted in the future.
Mongolia definitely needs a “solution for UB pollution” and has the resources and ability to become energy self-sufficient, and possibly a net exporter. Remember, this will only happen if China is prepared to receive power across the border at a price sufficient to underwrite the power station investment inside Mongolia. Having the most cost (and environmentally) effective plants is essential to turn this into profitable business and for Mongolia to make use of its lower quality coal resources.
There are at least four coal to liquid project promoters in Mongolia, but these projects are technically complex and globally tend to have marginal economics. The government cannot afford to subsidize another loss-making venture and needs to be careful. Of course, the long term solution to UB’s pollution is modern power and heat plants servicing well laid out suburbs in the UB region. This is a long term issue but also a great economic opportunity. The ger districts need to be transformed into a new way of people living together, that is sustainable and attractive for the families and businesses that will reside there.
Importantly, Mongolia must upgrade its country-wide power generating capacity, plus invest heavily into the transmission network for both domestic usage and exporting to China.
Of critical importance is the need for the government to increase its tax base, and this will occur as it brings more people and enterprises into the formal economy. As real wages increase, a share of that increase will be captured as tax and should be reinvested in essential infrastructure.
While the tax base remains small, it is important that the government exercise restraint on pensions and salaries for public servants. Downsizing public service is one way of increasing productivity while allowing an increase in salaries without an increase in the salary bill.
The PM has focused on exploration – which can be a driver of long term economic growth – but only if the exploration results in new mines being built. This takes time, expertise, lots of money injected into development work, and inevitably, many failures along the way. The PM has rightfully looked at a new royalty tax-sharing regime with the “mine-hosting aimags and soums”. This is innovative and practiced in several progressive countries.
On a negative front, INS is afraid that the re-commencement of issuing of exploration permits may see the same negative outcome that led to the implementation of the exploration moratorium in 2010.
INS suggests the PM seek independent review on what is currently happening, as the current arrangements appear very loose and are more likely to lead to development of a secondary market in trading licenses. What is really needed is to attract expert and financially capable players. It would be very interesting to know who the 130 licenses have been issued to – but MRAM is not publishing this information, and it is difficult to trace company ownership in Mongolia to individuals.
The PM will build confidence with his speech. But there are challenges that his cabinet must also overcome as they roll out the recovery plan. It is critical that they focus on the key macro-economic targets of:
• Sustainable levels of government debt (on and off balance sheet)
• Significantly reduced inflation and interest rates
• A stabilized foreign exchange rate
These three factors are considered seriously as investors assess political risk, valuations and eventual exit strategies for their investment proposals.
In summary, the PM has shown leadership by confronting the harsh realities facing Mongolia and its economy – and political courage to do this with elections scheduled in mid 2016.
Of course the parliament will review and comment on the PM’s plans, and let us hope the MPs act together to support the recovery and growth agenda.
Let us also hope that the forthcoming election period will see the political parties campaign on the basis of economic discipline and playing to Mongolia’s strategic strengths. Resorting to populist scare campaigns is not compatible with the emergency agenda facing Mongolia today.

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