(EnergyAsia, July 21 2014, Monday) — As its resources-dependent economy began to take off at the start of the decade, Mongolia was repeatedly warned to guard against the “resource curse” associated with corruption, waste, internal power struggle, runaway inflation and political instability that has befallen many developing economies. But, Mongolian leaders paid little heed as they voraciously feasted on — as well as shamelessly fought over — the huge windfall brought in by foreign investors queuing up to exploit the country’s vast reserves of coal, copper, gold, uranium and other minerals.

Coal was and remains Mongolia’s biggest lure as China, India and other emerging energy-short economies coveted the world’s largest untapped treasure trove of the fuel sitting in the Gobi region next to the Chinese border. Stirring the world’s appetite, Mongolia’s Ministry of Fuel and Energy claimed in 2010 that the country holds as much as 150 billion tons of coal resources — about 15% of the world’s total — with proved reserves of two billion tons of coking coal and 10.1 billion tons of thermal coal.

But just as quickly as it began, Mongolia’s party mood has ended. In less than five years, the vast landlocked country of less than three million people sandwiched in between Russia and China has developed all the symptoms of the resource curse, and is at risk of becoming another tragic example of a failed state.

Foreign investors are turning their backs on Ulan Bator, inflation is holding stubbornly above 10%, the currency has lost a third of its value since 2011, and China, the market for more than 90% of Mongolia’s exports, has turned to other suppliers for its coal after two years of troubled bilateral ties.

In its latest annual assessment issued in March 2014, the International Monetary Fund (IMF) implicitly criticised the government for weakening Mongolia’s once-bright outlook. The fund also sharply reduced the country’s economic growth forecasts over the next five years.

Warning that international financial markets are becoming concerned about the country, the IMF said Mongolia is increasingly at “serious risk” of suffering a balance of payment crisis due to the sharp decline in foreign direct investment.

“External shocks and the continuation of current policies could expose vulnerabilities in the banking system, exacerbating a negative shock to growth and financial stability,” it said.

This sobering assessment contrasts the glowing report on Mongolia that the IMF had issued four years earlier in 2010.
“Mongolia has a bright economic future. Its vast mineral deposits offer the potential to create strong and sustained growth, lasting economic prosperity, and a substantial reduction in poverty,” said the fund then.

The World Bank was just as hopeful when it upgraded Mongolia’s status from a poor economy with a GDP per capita of US$528 in 2001 to that of a lower middle-earner with an income of US$2,508 in 2011.

Mongolia’s China downfall

Mongolia’s slide began shortly after its economy grew by a record 17.5% in 2011. This was Mongolia’s brief golden period when coal prices soared on the world markets, its exports boomed, and foreign bankers fought each other to lend money and expertise to Asia’s next tiger economy.

With so much power and money at stake, the simmering tensions between Mongolia’s competing political factions burst into open fighting in 2012, leading the government to take two unprecedented actions that seriously damaged the business environment.

In April 2012, President Elbegdorj Tsakhia ordered the arrest and trial of his predecessor and leading opposition leader, Nambaryn Enkhbayar, who was quickly found guilty of corruption and sentenced to four years imprisonment.

Foreign investors barely had time to react to this political bombshell when the government intervened to stop Chinese state-owned aluminum giant Chalco acquiring the majority stake in one of the country’s major coal mining firms for US$926 million. SouthGobi Resources Ltd also said the Mineral Resources Authority of Mongolia (MRAM) suspended its licences to explore and mine the Ovoot Tolgoi mine, which holds an estimated 175.7 million metric tonnes of coal reserves, mostly for export to customers in China.

The two decisions were likely connected as Enkhbayar had strong ties with China and played a key role in opening up the economy to foreign investment that helped launched Mongolia’s economy. Chinese leaders frequently praised him for boosting bilateral ties when he served as Mongolia’s Prime Minister between 2000 and 2004, the Speaker of the Parliament in 2004-2005 and President from 2005 to 2009.

SouthGobi, which had championed Mongolia’s international profile as a reliable and investor-friendly supplier of coal and other minerals to the world, cited government security concerns after main shareholder Ivanhoe Mines (renamed Tourquoise Hills) had announced it wanted to sell its 57.6% stake to China’s state-owned Chalco for US$926 million. Another Chinese state firm, the sovereign wealth fund CIC, held a 13.8% stake, potentially giving Beijing a 70.4% controlling ownership if the deal had been allowed to go through.

The Mongolian government’s decision to openly block the sale not only damaged political and trade ties with its biggest customer and powerful neighbour China, it also scared off other international investors. Most were shocked by the speed and force of the government’s intervention in what was largely a private friendly takeover of SouthGobi Resources, a company listed on the stock exchanges of Toronto and Hong Kong.

Rather than try water down Chinese control of the company or seek a role for Mongolian interest, the government killed off the deal, in the process hurting Canada’s Tourquoise Hills which had largely played by the rules in building up SouthGobi’s value. The share price of once high-flying SouthGobi crashed from the agreed sale price of C$8.48 per share on April 1 2012 to around C$0.65 today.

The government ensured there was no way back for itself when it rushed through nationalistic legislation in May 2012 to protect strategic assets from foreign ownership and control, effectively telling international businesses that the country was no longer open for business.

The impact of the Strategic Entities Foreign Investment Law (SEFIL) on the Mongolian economy was swift and devastating. After reaching a record US$4.7 billion in 2011, foreign direct investments (FDI) into the country slipped to US$4.4 billion the following year before plunging 48% to US$2.29 billion in 2013, according to the Bank of Mongolia. It is expected to fall further over the next few years amid investors’ complaints about the country’s worsening corruption, bureaucratic interference and rising political infighting.

After years of delay, investors and international banks have lost interest in the proposed listing of state-owned Erdenes Tavan Tolgoi (ETT), which has the licence to develop and mine large coal deposits in southern Mongolia. The proposed sale of a minority stake to international investors to raise US$3 to $5 billion in early 2013 has been shelved, confirming Mongolia’s loss of credibility in the business community.

“Mongolia faced a difficult economic outlook in late-2012, owing to the negative shocks to FDI and coal exports,” said the IMF in its latest annual assessment, which included a drastic reduction in its forecasts of the country’s economic growth compared with the pre-crisis report of 2012.

Then, the IMF had projected the Mongolian economy to grow by 12.3% in 2014, 14.5% in 2015 and 14.1% in 2016, based on projections for sustained high coal prices, rising exports to China, sound government policies and political stability. But with these assumptions soon dissipated, the IMF issued a new forecast that slashed Mongolia’s economic growth rates to 9.5%, 8.8% and 7.4% over the next three years. While these growth rates remain high by world standards, they are based largely on government spending and borrowing that potentially sets up the economy for a major bust down the road.

The long road to recovery?
To be sure, Mongolia’s condition is far from fatal as the IMF, World Bank and the Asian Development are supportive of the government’s actions to reverse the country’s slide. A year after SEFIL’s passage, President Tsakhia’s government began a series of moves to restore ties with China and other foreign investors.

In August 2013, he issued a surprise pardon for Enkhbayar, sparing his bitter rival from fully serving his jail sentence. This decision was aimed at healing the country’s divisive politics, although it could yet backfire as Enkhbayar’s supporters are likely to seek revenge.

Earlier this month, the government amended a 2006 law to expand Mongolia’s area for mining and exploration activities, lift a ban on new mining licences and extend exploration periods from nine years to 12. The amendment also provides for the creation of a council to oversee future policy changes that will cover the interest of foreign investors.

The government has set a new target of attracting US$1 billion in new investment to explore the country’s coal, oil and shale gas reserves.

The final version of the new law has yet to be published, but investors are not exactly waiting with bated breath.

Rather, they are watching the government’s next move to resolve several lawsuits and bitter disputes with foreign companies that have led to the detention of senior executives and the trial of government officials on charges of corruption. Accusing some miners of abetting corruption, fraud, evading taxes and breaking contract agreements, the government last year revoked more than 100 mining licences.