A step ahead: The government and private sector continue to identify and optimise areas of growth

Just a few decades after the shift from Mongolia’s communist era to a market economy, the country’s industrial base remains small. Government support for the sector and some significant natural resources work in its favour, but several factors present obstacles to growth. They include geography, infrastructure, corruption and bureaucratic hassle, and the lack of a systematic approach to developing industries or a marketing effort for the finished products.

Being situated next to China means that Mongolia is unlikely to be competitive in the region – it lacks the sheer number of workers and the economies of scale that China has, and therefore China is likely to be able to supply Mongolia with manufactured goods cheaper than the latter can supply itself. Instead of competing with those that have significant competitive advantages, the challenge for the country is to find appropriate niches to fill.

NEW STRATEGIES: Broadly speaking, there are three options: to further develop the mining sector and see what opportunities emerge from there; to modernise traditional activities; and to find new ones. The strategy that is evolving in Ulaanbaatar is a mix of all three. Mongolia is set to see a surge in mining activity and is studying what post-extraction opportunities make economic sense. It is also looking to improve on several existing industries, such as cashmere and animal husbandry, which are already two of the country’s main economic activities.

Going beyond the identification of focus areas, industry leaders are also eyeing a more comprehensive approach to marketing Mongolian products in foreign countries. The idea is that the global perception of the country as an exotic and unspoiled destination can be applied to its exports, giving them an elite aura that could support premium pricing. Mongolian meat could be marketed as grass-fed organic beef or lamb, for example.

HISTORICAL CONTEXT: Industrialisation first came to Mongolia during its communist period. In 1924 the sector was limited to a coal mine, a power plant and handicrafts. By 1940, after following a strategy focused on resource extraction recommended by political allies in Moscow, industrial output accounted for 8.5% of national income, and that figure grew to 14.6% by 1960, according to a history of the sector produced by the US government.

The 1970s saw an expansion in areas of focus and by 1985 industrial activity accounted for about a third of national income. Factories were clustered in urban centres such as Choibalsan, which hosted a meatpacking plant, a wool-scouring mill and a foodstuffs combine; or Darkhan, a centre for light industry, food processing and construction materials. In Erdenet was a copper smelter, a factory turning wool into carpets, and facilities for timber processing. Ulaanbaatar hosted coal and energy production, food processing, livestock handling and textiles.

But the 1990 transition to a market economy brought with it collapse. Removing the stability of the era meant a long period of decline. Manufacturing output shrank by 60% in a decade. From a 12% share of GDP in 1995, manufacturing activity declined to less than 5%. In 2010 industrial output rose 10% to MNT1.87trn ($1.46bn), up 10% from 2009, according to Montsame, a local news agency. The figure includes mined materials such as coal.

Activities are still clustered in the same cities – Ulaanbaatar, Choibalsan, Darkhan and Erdenet – but employed just 48,000 people as of 2008, according to a UN study, below the levels that were reached during the communist era. There are now three main categories of goods that account for about four-fifths of all industrial production: food and beverages, at about 32% as of 2008, according to the UN study; the mining sector’s production of basic metals, at 23.6% (see Mining chapter); and textiles, at 22.6%.

CASHMERE: Mongolia estimates that it has the capacity to supply 30% of global cashmere, and revenues usually average about $180m annually. About four-fifths of production is exported raw. As of 2011 around 20-25% of what is produced undergoes some type of processing before export. That would include washing the raw material and spinning it into a yarn, said C. Tumenbayar, the president of the Mongolian Cashmere Corporation. He said there are industry plans to increase that figure to 60%.

There are three vertically integrated cashmere producers: Gobi Joint Stock Company, the fifth-largest cashmere producer in the world; the 100%-Mongolian-owned Altai Cashmere; and Goyo Cashmere. In addition, about 30 companies are focused on washing and about 40 knitting factories turn yarn into finished goods. Almost all of these finished goods are exported, Tumenbayar told OBG.

Mongolia also produces wool, but only about 1% of the wool produced is of a quality fine enough for the garment industry. Instead, most of the output is used to make blankets and carpets. Three state-owned manufacturers have been privatised – two in Ulaanbaatar and one in Erdenet. Domestically produced leather is mostly exported to China.

FOOD & BEVERAGE: Several companies in the food and beverage segment have drawn international attention from the small but growing number of investors in foreign countries who have become Mongolia enthusiasts. John Polomny, who writes an investment newsletter and blog called the Actionable Intelligence Alert, highlighted Suu Joint Stock Company (SUU), a dairy processor, as a potentially good investment. He believes that as Mongolia adds infrastructure and as companies such as SUU gain efficiency, they will be well-placed to replace imported goods that typically come from China.

Local market participants also expect the beverages sector to grow. “The fast-moving consumer goods sector has tremendous potential. For example, if we look at Coca-Cola products, average consumption in leading markets is 2-3 times a day, and in Mongolia that figure is five times lower,” L. Myagmarjav, the managing director of MCS Coca Cola, told OBG. Consumption of beer is also at present quite low, about 16 litres per capita. By comparison, Chinese consumers drink about 32 litres a year on average, and Russians 81, according to market research by the Ulaanbaatar office of Eurasia Capital, an investment firm focused on Central Asia.

Eurasia Capital’s analysts also expect the mining industry to provide a growth opportunity for the food and beverage industry. One company, APU, has the contract to provide drinking water to Oyu Tolgoi, the massive gold and copper mining project in the Gobi Desert. Once other major projects are in operation, such as the coal deposit at Tavan Tolgoi, demand for these types of services is certain to rise. Beverages demand is satiated by five companies, according to Eurasia: APU, Spirit Bal Buram, MCS Mongolia, GEM International and Chinggis Shar Airag.

The meat industry is also considered one with great potential. The country consumes about 85% of what it produces, according to a World Bank report, and the Mongolian Meat Association estimates that 2010 production available for export was likely around 111,400 tonnes, with about 89,000 of that total accounted for by goat meat. Market prices remain about $1 per kilogram.

According to a report from the World Bank, Mongolian meat producers should study and copy the Australian meat industry’s model, which gets prices about three or four times higher for its exports. Mongolia’s meat buyers and sellers, unlike most worldwide, do not categorise meats by quality. That means the sellers lose out on higher prices for premium cuts, and also removes an incentive to herders to raise the highest-quality stock possible.

THE NEXT STEPS: Mongolia has for now identified its cashmere and meat producers as those most likely to find success exporting, and, as a result, the government is working on a marketing plan. One important step has been to nurture Mongolia’s brand and reputation. During the communist period, when there was more to export, 80% of output was shipped to the Soviet Union. That means that consumers elsewhere are, at best, only somewhat acquainted with Mongolian products. From this blank slate Mongolia has the opportunity to craft its own narrative, and as of late 2011 it appeared that this identity would be geared toward consumers willing to pay a premium for what they perceive as higher quality or more sustainable goods (such as Mongolia cashmere or grass-fed cows).

“Mongolia has as a natural advantage for certain products like cashmere because the quality depends on the climate. The more severe the winter, the finer the quality of the cashmere,” Sergey Gromov, the chairman of Chinggis Khaan Bank, which has a stake in Blue Sky Cashmere, told OBG.

Mongolia’s image abroad may help local businesses in their attempts to attract well-heeled consumers, according to a report by the Asian Development Bank (ADB). “Origins in the unique, mysterious, and remote steppes and forests provide the basis for origin-based premium,” its authors wrote. “Mongolian products permit consumers to assume some of the unique spiritual and cultural qualities of the producers and feel that they are contributing to some common good or a better world remote from their urban industrial lifestyles.” To be sure, there are environmental concerns about cashmere – an increase in goats has led to fears of overgrazing and desertification. Regardless, the marketing of Mongolian cashmere as a sustainable and organic product is under way. Industry trade unions are now conducting market research, spreading the word to foreign suppliers at trade shows, and honing its message.

FINANCIAL SUPPORT: Other government actions to boost animal products include getting financing in order. The Ministry of Finance in September 2011 accepted a $500m loan from the Export-Import Bank of China, and the money will be used to set up factories, build a grain elevator and build infrastructure, according to a local media report. Also taking place in September, the ministry offered MNT300bn ($234m) in bonds to investors, with the money earmarked for the cashmere sector to develop small and medium-sized enterprises and to support herders who sell to domestic factories.

Financial support for herders is also an important part of the mix, according to the ADB, which said in its report that herders and producers would have better relationships if both sides had more ability to manage cash flow. Herders in need of liquidity often get it from Chinese buyers, according to the ADB, who show up ahead of Mongolian festivals, when herders need money the most, and buy raw materials in this context at lower prices. Domestic producers with inconsistent cash flow cannot always pay a premium for higher-quality cashmere. If they could and did, and if herders therefore were rewarded for producing better raw materials, the industry as a whole would find it easier to make its argument to global suppliers about the quality of Mongolian cashmere.

INDUSTRIAL PARK: Another crucial part of Mongolia’s vision for its industrial sector is the plan to build a $10bn industrial complex in Sainshand, in the country’s central-eastern region. It is situated at the intersection of the north-south railroad and an east-west railroad that has not yet been built. This second rail line would pass by several potential commercial mining sites as yet undeveloped, and then head southeast toward the massive coal, copper and gold deposits of the Gobi Desert. It would then proceed north-east toward Choibalsan, where it would link up with a spur of the Trans-Siberian Railway heading into Russia. The idea is to pick up various raw materials and ore along the way, deposit it at Sainshand for use by its factories, and from there transport finished goods east to ports on Russia’s Pacific coast.

As of late-2011, the plan for Sainshand included a coal handling and processing plant, a copper smelter, a plant to make iron pellets, an oil refinery, and more space for smaller ventures, services firms and other industrial enterprises. However both Sainshand and the railway were only concepts at that point. The railroad plan, which would also include spurs going to northern China from the Gobi mines, may be built as part of a larger mining contract or perhaps by the government. The first phase, from Sainshand to Choibalsan, was expected to cost $3bn.

OUTLOOK: Industrial output is far from getting back to or surpassing its former levels, but as of 2010 a broad strategy and specific tactics were in the early stages of implementation. With help from donor agencies, Mongolian officials and business leaders are getting a better sense of where and how to apply their resources, as well as learning about how to market their goods on a global basis. For the future, once transportation links are better, costs should fall, making more manufacturing ventures commercially viable. A spot to watch for the future is Sainshand. Once Mongolia decides exactly how it will renovate and expand its railroad network, the path is clear for Sainshand to become the industrial focal point and the lynchpin of Mongolia’s industrialised future.

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The Report: Mongolia 2012

Industry and Retail chapter from The Report: Mongolia 2012

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