Open for business?: Turmoil over a new law on foreign investment has spooked many

One of the most controversial topics in Mongolia during 2012 was the introduction in May 2012 of a new foreign investment law. Aimed at giving the government and parliament more control over foreign investment activity in the country, the law also led some foreign investors to suggest the investment climate in Mongolia had soured. In January 2013 news came the law would be revised to assuage concerns. Yet whatever the eventual shape of the regulation, the importance of achieving a balance in the country’s development was underscored, while indicating some of the underlying tensions in its recent economic trajectory.

FDI SUCCESS: Over the last decade, the growth in foreign direct investment (FDI) has been one of Mongolia’s success stories. According to data available from the Foreign Investment and Foreign Trade Agency, in 2000 just $90.6m in FDI came into the country. By 2005, this had risen to $316m, with the pattern of growth continuing straight through the global financial crisis to reach $1.03bn by 2010. Data presented in the Financial Times in 2012 also suggests that FDI then continued its exponential growth in 2011, reaching $5.3bn that year. With the country’s total GDP standing at $8.6bn in 2011, FDI thus represented 61.6% of GDP. Looking at the 20-year period from 1990-2010, FDI from some 104 countries and 10,709 foreign companies was registered, with a total standing of $4.8bn, 76.8% of which was registered in the 2005-10 period.

PICKING WINNERS: The sectors to which the FDI has gone also paint a picture of the development of the Mongolian economy itself. Some 65.3% of all FDI between 1990 and 2010 went into geological prospecting, oil exploration and mining. Other sectors receiving large percentages were trade and catering, with 18.9%; banking and financial services, with 2.7%; engineering and construction, with 2.2%; and finally light industry, with a 1.5% share of FDI.

In terms of the source countries, over the same period, China was responsible for 50.9% of total FDI, Canada 8.26%, the Netherlands 6%, the Republic of Korea 5.2%, and Japan 2.86%. US investments totalled 2.39% and Russian investments 2.24%. A large share also came from offshore sources, with the UK Virgin Islands unexpectedly accounting for 4.6%.

In overseas trade, Mongolian central bank figures for November 2012 show China accounting for an overwhelming 92.8% of all Mongolia’s exports, with the next closest country being Russia, at just 1.8%. In terms of imports, China was the origin of 28.2% of all Mongolia’s imports in November 2012, although Russia accounted here for a more comparable 26.9%.

Around 80% of all Mongolia’s exports to China are mineral or mineral-related. This gives the China trade distinct characteristics, some of which have grown increasingly troubling for many Mongolian lawmakers.

Too great a dependency on China, they argue, weakens Mongolia’s bargaining position on prices, while also leading to distorted development, as FDI is channelled into one resource, which, however vast today, is still finite.

The Mongolian government has long been aware of this potential weakness, and in 2008 parliament voted to begin a national development strategy based on achieving the country’s UN Millennium Development Goals. These target a knowledge-based economy rather than a resource-based one, with minerals being used initially to leverage growth in other economic areas, principally manufacturing. The new government, elected in June 2012, endorsed this strategy when it announced its new economic action plan, a key objective of which is to reduce “dependency on the mining sector”.

OVERLY CONCENTRATED?: Evidence from the Economic Research Institute for North-east Asia suggests an over-concentration on mining is currently damaging manufacturing, as both capital and labour shift to it. In terms of labour, also, there is a widespread belief that foreign companies are not big employers, particularly if they bring workers in en masse from their home country, as China is sometimes alleged to do.

This particular point plays too on long-standing suspicions of China and a fear of Chinese dominance, which are undoubtedly major political issues in Mongolia with economic effects.

WORRIES SOUTH: There is a long history of antagonism between the two countries, which exist alongside the concerns of a landlocked country with a population of just 2.8m next door to an emerging global superpower with a population of 1.34bn.

These fears were heightened, and indeed, some analysts suggest, sometimes exploited as the June 2012 general elections approached. The campaign beforehand saw economic nationalism on the agenda of many parties. In addition, news also broke in early 2012 that the Aluminium Corporation of China (Chalco), China’s biggest aluminium producer, was moving to purchase a controlling stake in SouthGobi Resources, the owner of a major coal mine in the Gobi desert.

Chalco was to buy a 60% stake in the company from Turquoise Hill, formerly Ivanhoe Mines, and the $938m deal would have been the largest single Chinese investment in Mongolia. This caused political concerns in Ulaanbaatar, however, that Chinese state-owned companies were once again increasing their influence.

NEW LEGISLATION: Thus, the conditions were laid for parliament’s passing of the controversial Strategic Foreign Investment Law the month before the election – and before the SouthGobi deal could go through.

The law was similar to one drafted back in 2009 but never submitted and is a watered-down version of that original proposal, as a result of opposition from a number of business groups. In its form as of January 2013, the law concerns foreign state and non-state entities purchasing stakes in a Mongolian “business entity of strategic importance” (BESI). The term “strategic” is defined as including the mining, banking, finance, media, information and telecommunications sectors.

If a foreign entity is pursuing a deal that will lead to the acquisition of more than a 33.3% stake in a BESI, or if the acquisition would lead to that foreign entity gaining a range of executive managerial powers, or if the acquisition might affect the price of Mongolian mining exports or create a supplier monopoly, then the acquisition has to be referred to the Foreign Investment Agency. This will then consider the case and recommend to the government within 45 days whether or not it should approve the acquisition.

At the same time, another part of the law states that all foreign investments that would lead to the acquisition of more than a 49% share of a BESI, and which are worth more than MNT100bn ($70m), also must receive approval from the country’s parliament.

Some welcomed the regulation as a sign of clarity – and as a necessary safeguard against foreign control. Later in September 2012, the law helped prompt Chalco to abandon its attempt to buy the SouthGobi stake.

Yet the law was not well received by many foreign investors. The definition of what precisely was included in the strategic sectors was thought vague, while it was unclear whether services industries supporting the strategic sectors were also included. In addition, the regulation adds further risk to an investment and builds in an additional time delay. Concerns were also raised over the way the 49% stake was to be calculated – i.e., whether this would be by market value, the book value or the value of the transaction.

Underlining this concern was a growing feeling of regulatory uncertainty in the country. This had been sparked in late 2011 by calls from some political quarters for the government to renegotiate terms in contracts for giant mining operations, such as the Tavan Tolgoi and Oyu Tolgoi mines.

Indeed, the reasons given by Turquoise Hills for pulling out of SouthGobi in the first place included regulatory uncertainty, as well as the largely flat global coal price. While the latter is a bugbear for any economy heavily dependent on global commodity prices, the former point indicates more longstanding foreign business concern with the investment climate.

MAKING THE CHANGE: On December 28, 2012, in response to criticism of the new law, the Mongolian government announced that it would be making further revisions. Meanwhile, by the end of 2012, little in the way of implementation of the new law had occurred.

As of January 2013, details of any new amendments were unavailable, yet the minister of mining, D. Gankhuyag, told local media that the MNT100bn ($70m) threshold for needing government approval might be increased, by perhaps three or four times.

Indeed, a consensus now seems to be there amongst some key political players, post-election, that the law is in need of change. President Ts. Elbegdorj has even said on national television that the law has been harmful to Mongolia’s investment climate.

Yet the issues the law seeks to address will likely continue to be challenging for Mongolian and foreign investors in the years to come. Finding a balance between protecting legitimate national interests while also allowing the openness and certainty necessary to attract foreign investment and participation is a process that requires finesse – particularly in circumstances where a single foreign investor (in Mongolia’s case, China) will continue to play such a highly powerful role.

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The Report: Mongolia 2013

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