Mongolia's Choice on Investment

A sudden sense of economic crisis is spoiling the mood over Mongolia's three years of world-beating economic growth. This crisis stems from the massive decline in foreign investment and ongoing uncertainty surrounding the government's partnership with Rio Tinto in the $10 billion Oyu Tolgoi project. In the coming week, two events seek to address this crisis, one with long-term solutions, the other more immediately.

Mongolia has been on an economic tear with growth rates exceeding 10% for the past three years. This has not only brought rising incomes to many Mongolians and spawned a construction boom in Ulaanbaatar, it has also focused the world's attention on Mongolia in a new way.

The growth has been built almost entirely on mining exploration, coal production and construction associated with the Oyu Tolgoi project. Now, however, growth seems threatened by three challenges: scared foreign investors, a drop in Chinese demand for coal, and uncertainty surrounding Oyu Tolgoi.

Putting aside Rio Tinto's ongoing construction in Oyu Tolgoi, foreign investment has fallen precipitously following the passage of a foreign investment law in May 2012. That law may have been designed to keep out state-owned Chinese companies, but other investors saw it as so vague and comprehensive that they left in droves.

Meanwhile, the relative slowdown of the Chinese economy has led to a steep decline in purchases of Mongolian coal. Aside from the long-running Erdenet copper and gold mine, that was the only part of the mining industry that was actually producing and shipping its product.

Finally, Mongolian politicians and the public have been grappling with the implications of being a part-owner in the Oyu Tolgoi project and the governance and financial challenges that this ownership implies. When Oyu Tolgoi starts producing, it is expected to account for 30% of the country's GDP. But it is difficult to balance the population's expectations of immediate and equitable benefits with the need for foreign expertise and financing, as well as environmental stewardship.

The challenges found their expression in public disputes with Rio Tinto over the construction budget just as the project is poised for production. That led to a financing crunch; the company suspended underground construction activities and let 1,700 workers go.

The next week will see two events in Ulan Bator that will begin to address the sense of crisis that has been brought about by the Oyu Tolgoi firings as well as the tanking of the Tugrik by roughly 20% since the triumphant oversubscription of a Chinggis Bond last November.

At President Elbegdorj Tsakhia's request, World Economic Forum Strategic Foresight, a quasi-consultancy built around the "communities" involved in the annual Davos event, has drafted scenarios for the long-term context of Mongolia's development. Here, the likely focus will be on the further development of a mining industry in Mongolia, but also on its main customer, China, and on diversification opportunities. The scenarios will be presented in a workshop to which Mongolian parliamentarians and other policy makers and stakeholders have been invited to encourage consideration of how they make decisions.

Next, parliament will convene for an extraordinary session to discuss revision of the foreign investment law, as well as proposed changes to the mining law. Hints about the investment law suggest that it will retain controls over state-owned investments but clarify these to create less hindrances for the sale of assets by non-state-owned foreign investors. Specifics of these revisions will show whether they will actually be significant enough to lead to a return of investment, especially if discussions of the mining law remain at a relatively early stage. Neither of these initiatives addresses the on-going challenges surrounding Oyu Tolgoi, which is governed by an investment agreement.

While the lack of research capacity to support decision-making has been lamented in the past, it has become glaringly obvious in the current discussions of governance structures, construction budgets, and the integration of Mongolia into global financial flows. A radical investment in such analysis capacity and governance structures directly involving the Mongolian people may be one of the few solutions here.

Alternatively, a sale of the state's share in Oyu Tolgoi would allow the company access to financing. It would also confine the government's responsibility to regulation and decision-making about revenue streams that now seem threatened.

To continue on its path of rapid economic growth and development, Mongolian leaders will have to take decisive action on mining regulation and Oyu Tolgoi. They will need the backing of the Mongolian people, who continue to enjoy a vibrant democracy. Consideration of long-term scenarios and solutions for a lack of policy analysis capacity and governance challenges will play a crucial role in selecting courses of action.

Mr. Dierkes is an associate professor at the University of British Columbia's Institute of Asian Research and blogs at mongoliafocus.com.

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