Mongolia's Growing Pains
As I suspect others with a professional interest in Mongolia's transition to democracy and capitalism have found, the country seems to attract attention in a predictable cycle. On the up side, some peripatetic journalist based in Beijing with time to kill discovers the miraculous changes wrought in only two decades after effectively being a Russian colony (complete with mandatory mention of its fabulous blue skies). Then comes the corrective: A jeremiad on Mongolia's incipient slide into self-destructive nationalism and dysfunctional economic policies (with mandatory mention that the skies over the capital, Ulaanbaatar, are the world's most polluted). Publish, forget and repeat.
In the latter half of 2012, the cycle entered the downside. The Economist found the mood "bitter" in Mongolia, while The New York Times warned that "the underlying fundamentals of the country look increasingly shaky," noting that "foreign direct investment plunged" in the closing months of 2012. The Times was echoing complaints from the IMF, the World Bank and foreign embassies. Standard & Poor's was apparently listening, too: in October, it lowered its rating outlook for Mongolia's debt quality.
Growth did fall in 2012, but only to 11 percent, which is the stuff of dreams of most political leaders and talking heads. Moreover, in those apparently foreboding last months of 2012, Mongolia floated its first international bond issue, surprising many analysts by easily selling $1.5 billion of five- and ten-year bonds at rates of 4.125 percent and 5.125 percent respectively (rates below those being offered by Spain at the time). Many countries at Mongolia's level of development could not hope to enter world capital markets -- certainly not with a bond issue so large relative to the size of the economy.
What accounts for the cycles of boom and gloom in media coverage? My own guess is that it's just not very interesting to write about Mongolia's ups and downs as par for the course for a poor democracy struggling to make its way in a very difficult world. Far better to delve into the soap-opera of Mongolian politics, which can be fascinating in a tiny (population three million) country on the verge of a mammoth hard-rock mining boom with China, its resource-guzzling leviathan neighbor, looking hungrily on.
Two events precipitated last year's apprehensions. First, in May 2012, the Mongolian parliament passed the "Strategic Entities Foreign Investment Law," which opens the door to ill-defined political interference in foreign projects. Nevertheless, the law does address a legitimate problem: The fear of the political, economic, and diplomatic spillover effects of vast mining projects -- a fear most relevant when the mining companies are Chinese state-owned enterprises.
This issue is hardly unique to Mongolia. Other countries -- think Canada -- have reacted warily to the prospect of dominance by the global power next door. But Mongolia does not have Canada's soothing track record of pragmatic political decision-making. Nor does it have the institutional capacity and technical expertise to write and enforce mining regulations that are clear and reasonable. Hence those who care about Mongolia worry that the mining rush is a recipe for exploitation, corruption, or populist excess that retards economic development.
Adding to such concerns, the June 2012 election brought to power a government whose members included "resource nationalists" aiming to maintain government ownership and control of natural resources. The mining minister, Davaajav Ganhuyag, made vague statements about wanting to renegotiate the agreement with foreigners investors in the Oyu Tolgoi (or simply OT) copper and gold mine project. He has the unqualified support of only a vocal minority of members of the State Great Hural, Mongolia's parliament. Nevertheless, a more moderate version of his views has found favor across the Mongolian political spectrum. Indeed, the 2013 government budget depends on revenue increases from a successful renegotiation of the OT agreement.
At the moment, almost everything in Mongolia revolves around Oyu Tolgoi, one of the biggest mining projects in the world located in a country with one of the smallest GDP's ($15 billion in terms of purchasing power). The project, effectively controlled by the multinational giant Rio Tinto, began production ahead of schedule in December 2012.
Big doesn't even begin to describe it: This one project is expected to double Mongolia's GDP by 2020. By then, other projects will be coming online. But their size and timing will depend upon how Mongolia deals with OT.
The other side of the coin is that the flow of benefits to Mongolians from OT will be a crucial sign to the electorate of the mettle of politicians. With a thirst for democracy, surprisingly high levels of education (the Soviet Union's only lasting gift to Mongolia) and access to a robust media, that electorate will be following developments very closely.
The western financial press (not to mention western governments) presume that politicians dealing with OT have the discretion to act as if they are simply businessmen signing contracts supported by sophisticated legal systems. Once signed, the thinking goes, contracts should be binding and foreign investors should be given the benefit of doubt on matters of goodwill.
But this probably isn't realistic when so much is at stake for a country that has been isolated for so long from the world economy, and where legal institutions are developing from a base of near zero just two decades ago. Actually, it may not be realistic anywhere. Contracts for such projects are regularly renegotiated in developed economies -- just delve into the history of the United Kingdom and Norway on North Sea hydrocarbons. And don't forget whom Mongolia is dealing with: Rio Tinto's recent episodes of ethical challenge hardly inspire confidence.
There is a huge difference between what Mongolia would earn if it settled for merely a normal competitive market return on its national resources and what Mongolia would earn if foreign companies settled for a normal competitive market return on their capital. The windfalls to be divided -- what economists call the rents -- are mindboggling. And securities markets offer a sense of just how big they are. Back in October 2011, when the Mongolian government reaffirmed its commitment to the original OT agreement after having made noises about forcing a renegotiation, the market value of outstanding Rio Tinto stock increased by $5 billion dollars in a single day.
By the same token, the expected size of the rents to be divided is always changing. Gold prices have nearly doubled since the agreement was signed, while copper prices have increased by over 20 percent -- neither of which were expected in light of lagging resource demand from the advanced industrial economies.
But each new glitch should not be taken as a sign of impending collapse of the OT agreement, but rather another installment in the high-stakes bargaining. One of the earliest insights from economic game theory is that, in negotiations, weakness can lead to strength -- as in, "I'd love to give you better terms, but I am constrained by my sales manager, my dean, my mother-in-law, my political opponents [pick one]. A Mongolian negotiator would be letting down his side if he silenced the resource nationalists who are now stirring the pot. The real test of Mongolia's political class in coming years, then, is its ability to walk the line between populist nationalism and doormat to the global economic powers.
Financial markets could use a reality check here, too. Last December, when one of the smaller parties in the newly elected coalition threatened to decamp, the market value of Mongolia's largely foreign-owned sovereign debt fell by seven percent ($100 million) in a day. In fact, the contretemps had little to do with finance. It was an attempt to pressure the Supreme Court to rule in favor of the party's former leader, who was appealing a jail sentence for corruption.
One day in 1777, Adam Smith was confronted by a panicky young acolyte predicting ruin for Britain after the loss of a battle with George Washington's army. Smith nonchalantly replied that "There is a great deal of ruin in a nation," implying it is all too easy to jump to the wrong conclusions when otherwise successful countries suffer reverses. That surely applies to Mongolia, which can afford a few setbacks in its efforts to reconcile capitalism and democracy before it is time to declare them a failure.
In the latter half of 2012, the cycle entered the downside. The Economist found the mood "bitter" in Mongolia, while The New York Times warned that "the underlying fundamentals of the country look increasingly shaky," noting that "foreign direct investment plunged" in the closing months of 2012. The Times was echoing complaints from the IMF, the World Bank and foreign embassies. Standard & Poor's was apparently listening, too: in October, it lowered its rating outlook for Mongolia's debt quality.
Growth did fall in 2012, but only to 11 percent, which is the stuff of dreams of most political leaders and talking heads. Moreover, in those apparently foreboding last months of 2012, Mongolia floated its first international bond issue, surprising many analysts by easily selling $1.5 billion of five- and ten-year bonds at rates of 4.125 percent and 5.125 percent respectively (rates below those being offered by Spain at the time). Many countries at Mongolia's level of development could not hope to enter world capital markets -- certainly not with a bond issue so large relative to the size of the economy.
What accounts for the cycles of boom and gloom in media coverage? My own guess is that it's just not very interesting to write about Mongolia's ups and downs as par for the course for a poor democracy struggling to make its way in a very difficult world. Far better to delve into the soap-opera of Mongolian politics, which can be fascinating in a tiny (population three million) country on the verge of a mammoth hard-rock mining boom with China, its resource-guzzling leviathan neighbor, looking hungrily on.
Two events precipitated last year's apprehensions. First, in May 2012, the Mongolian parliament passed the "Strategic Entities Foreign Investment Law," which opens the door to ill-defined political interference in foreign projects. Nevertheless, the law does address a legitimate problem: The fear of the political, economic, and diplomatic spillover effects of vast mining projects -- a fear most relevant when the mining companies are Chinese state-owned enterprises.
This issue is hardly unique to Mongolia. Other countries -- think Canada -- have reacted warily to the prospect of dominance by the global power next door. But Mongolia does not have Canada's soothing track record of pragmatic political decision-making. Nor does it have the institutional capacity and technical expertise to write and enforce mining regulations that are clear and reasonable. Hence those who care about Mongolia worry that the mining rush is a recipe for exploitation, corruption, or populist excess that retards economic development.
Adding to such concerns, the June 2012 election brought to power a government whose members included "resource nationalists" aiming to maintain government ownership and control of natural resources. The mining minister, Davaajav Ganhuyag, made vague statements about wanting to renegotiate the agreement with foreigners investors in the Oyu Tolgoi (or simply OT) copper and gold mine project. He has the unqualified support of only a vocal minority of members of the State Great Hural, Mongolia's parliament. Nevertheless, a more moderate version of his views has found favor across the Mongolian political spectrum. Indeed, the 2013 government budget depends on revenue increases from a successful renegotiation of the OT agreement.
At the moment, almost everything in Mongolia revolves around Oyu Tolgoi, one of the biggest mining projects in the world located in a country with one of the smallest GDP's ($15 billion in terms of purchasing power). The project, effectively controlled by the multinational giant Rio Tinto, began production ahead of schedule in December 2012.
Big doesn't even begin to describe it: This one project is expected to double Mongolia's GDP by 2020. By then, other projects will be coming online. But their size and timing will depend upon how Mongolia deals with OT.
The other side of the coin is that the flow of benefits to Mongolians from OT will be a crucial sign to the electorate of the mettle of politicians. With a thirst for democracy, surprisingly high levels of education (the Soviet Union's only lasting gift to Mongolia) and access to a robust media, that electorate will be following developments very closely.
The western financial press (not to mention western governments) presume that politicians dealing with OT have the discretion to act as if they are simply businessmen signing contracts supported by sophisticated legal systems. Once signed, the thinking goes, contracts should be binding and foreign investors should be given the benefit of doubt on matters of goodwill.
But this probably isn't realistic when so much is at stake for a country that has been isolated for so long from the world economy, and where legal institutions are developing from a base of near zero just two decades ago. Actually, it may not be realistic anywhere. Contracts for such projects are regularly renegotiated in developed economies -- just delve into the history of the United Kingdom and Norway on North Sea hydrocarbons. And don't forget whom Mongolia is dealing with: Rio Tinto's recent episodes of ethical challenge hardly inspire confidence.
There is a huge difference between what Mongolia would earn if it settled for merely a normal competitive market return on its national resources and what Mongolia would earn if foreign companies settled for a normal competitive market return on their capital. The windfalls to be divided -- what economists call the rents -- are mindboggling. And securities markets offer a sense of just how big they are. Back in October 2011, when the Mongolian government reaffirmed its commitment to the original OT agreement after having made noises about forcing a renegotiation, the market value of outstanding Rio Tinto stock increased by $5 billion dollars in a single day.
By the same token, the expected size of the rents to be divided is always changing. Gold prices have nearly doubled since the agreement was signed, while copper prices have increased by over 20 percent -- neither of which were expected in light of lagging resource demand from the advanced industrial economies.
But each new glitch should not be taken as a sign of impending collapse of the OT agreement, but rather another installment in the high-stakes bargaining. One of the earliest insights from economic game theory is that, in negotiations, weakness can lead to strength -- as in, "I'd love to give you better terms, but I am constrained by my sales manager, my dean, my mother-in-law, my political opponents [pick one]. A Mongolian negotiator would be letting down his side if he silenced the resource nationalists who are now stirring the pot. The real test of Mongolia's political class in coming years, then, is its ability to walk the line between populist nationalism and doormat to the global economic powers.
Financial markets could use a reality check here, too. Last December, when one of the smaller parties in the newly elected coalition threatened to decamp, the market value of Mongolia's largely foreign-owned sovereign debt fell by seven percent ($100 million) in a day. In fact, the contretemps had little to do with finance. It was an attempt to pressure the Supreme Court to rule in favor of the party's former leader, who was appealing a jail sentence for corruption.
One day in 1777, Adam Smith was confronted by a panicky young acolyte predicting ruin for Britain after the loss of a battle with George Washington's army. Smith nonchalantly replied that "There is a great deal of ruin in a nation," implying it is all too easy to jump to the wrong conclusions when otherwise successful countries suffer reverses. That surely applies to Mongolia, which can afford a few setbacks in its efforts to reconcile capitalism and democracy before it is time to declare them a failure.
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