“Vertrouwen komt te voet en vertrekt te paard.” This is a famous Dutch proverb translated as “Trust comes on foot and leaves on horseback.” However, in the current context of the Mongolian investment climate this could be reworded as – “investors come on foot and leave on horseback”.
Investment, both foreign and domestic, is fundamentally built on trust.
In just a few short years since the boom times of 2009-2011 Mongolia has gone from being an international “investment show case” to a “basket case”. Investors and financiers are extremely cautious and most have lost interest.
The new Minister for Special Projects, M. Enkhsaikhan, sums it up “…while the US led economic sanctions is causing the Ruble to depreciate, our self-imposed economic sanctions is doing the same to the Tugrik”
New Prime Minister Saikhanbileg has been equally blunt…
- .. let us temporarily forget next years election, … let us quit doing patriotism and populism on who loves the people more. Let us discuss issues with common sense and without emotion.
- .. it is time for absolutely required decisions, if the situation continues as is, I will have to admit the possibility of a country level default.
- … we are facing a 2008-09 balance of payments crisis, which if extended could become even worse
- …we now see that we do not have the correct policy, investment, skilled labour and equipment, no matter how many resources we have we will continue to just sit on them.
- .. in just 3 years investment has collapsed 7.5 times and if we keep making hostile policies that force others to flee we will become “Robinsons left on an isolated island”.
The purpose of this article is not to discuss measures to regain macroeconomic stability, or the negative impacts of a global slowdown in commodity markets. The Prime Minister has already indicated a willingness to quickly identify the problems and put in place necessary measures. However, we offer insights into how the new government might create a more welcoming and enticing environment for both domestic and foreign investment. Without this investment Mongolia’s crisis situation will not be resolved.
From Marx to market – and the keys to recovery
Since transition from a centrally planned economy to a market economy, private sector led investment has played a very significant role in driving Mongolian economic growth. The private sector now accounts for 85% percent of total employment and the vast majority of Government revenue through VAT, income taxes, royalties and charges.
Despite this move from government to private sector activity the investors have experienced a thrilling and traumatic ride – especially over the past 9 years. Investors have now fled, and the economic situation will not rectify itself. The wounds have been self inflicted and leaders must administer the medicine for Mongolia to recover.
The keys to recovery are
- recognize past mistakes, then
- resolve outstanding issues, and then
- put in place effective mechanisms to foster future growth and prosperity.
A combination of policy missteps and investment disputes are at the core of Mongolia’s current economic problems. Key policy missteps include:
- The Windfall Profits Tax Law (WPT) of 2006
- The Law on Prohibiting Mineral Exploration and Extraction Near Water Sources, Protected Areas and Forests (the Long Named Law) of 2010
- The Progressive Royalty Law of 2011
- The Strategic Entities Foreign Investment Law (SEFIL) of 2012
In the mid 2000’s Mongolia was fast becoming a major destination for mineral exploration by both foreign and domestic exploration and mining companies. However the WPT on gold and copper decimated the junior exploration sector. The juniors abandoned Mongolia and took their exploration funds elsewhere. Grass roots exploration expenditure on gold and copper all but evaporated. As a result the Mongolian economy lost thousands of exploration related jobs, both directly from exploration companies shedding staff, and also indirectly through loss of income by service sector companies such as hotels, laboratories, drilling, transportation and logistics companies. This situation continued until the WPT was repealed.
Unfortunately not many of those junior exploration companies have returned. And they were right, as the Government introduced new sliding scale royalties at punitively high rates which once again discouraged new explorers. The new royalty system and government setting of reference prices has contributed to the contraction of the fledgling coal industry, almost to the point of bankruptcy.
SEFIL placed limitations on investment by foreign entities into a number of “strategic” sectors in the Mongolian economy, immediately halting investment in new projects. In order to give effect to the Law the Government needed to put in place the institutional framework to enable companies to apply for and be granted approvals to invest. This never happened and companies were left without investment opportunities and took their projects and funds elsewhere in the world to more friendly countries.
Investment disputes have compounded the policy missteps.
Investors have lost trust in Mongolia’s willingness to guarantee the sanctity of contracts, and in particular protect the security of property rights related to mineral developments.
An exploration or mining license, and the investment agreements which support these licenses, constitute fundamental property rights. Investment decisions are made by investors based on the rights conferred by the license and the provisions of those agreements or contracts. Any time the government or its agencies act to arbitrarily change the terms of a license or move to re-negotiate an investment agreement constitutes a breach of trust and calls into question the reliability of the Government as a partner in development.
Recent examples of breaches of property rights by the Government both within and outside the mining industry include the following:
- Renegotiation of the Boroo Gold Stability Agreement;
- Nationalization of the Khan Resource Uranium licenses;
- Nationalization of the Energy Resources Rail Concession to construct the Tavan Tolgoi to Gashuun Sukhait Railway;
- Seizure and cancellation (still without compensation) of hundreds of mining and exploration licenses under the Long Named Law;
- Seizure of 106 Exploration Licenses;
- Renegotiation of the Oyu Tolgoi Shareholders Agreement and repeated attempts to force a renegotiation of the Oyu Tolgoi Investment Agreement;
There are a number of contracts which have been the subject of protracted disputes, both in Mongolia and at international arbitration. Some relate to cases where State Owned Enterprises have failed to make deliveries or payments under contracts resulting in disputes. These disputes include:
- Oyu Tolgoi Investment Agreement Dispute
- Disputes with investors over the 106 Exploration Licenses annulled by the courts
- Erdenes Tavan Tolgoi (ETT) dispute with Chalco over the Coal offtake agreement
- Dispute by McMahon Mining Contractors against ETT for non-payment of invoices
- Failure to honor the payment terms of the PPA with the Salkhit Wind Farm
- Failure of MTZ to meet payments to Samsung C&T for construction of the UHG-Gashuun Sukhait Railway development
Especially frightening to investors is the cancellation of exit visas for expatriate staff, contractors and consultants from a number of foreign companies, in cases where no criminal charges have been laid. These has been reported in the international media as a failure by Mongolia to honor human rights and freedom of movement.
Learn new paradigms
Most importantly “trust needs to be rebuilt”. This will not occur through fancy PR programs or recent fixes to negative legislation. The private sector is not the enemy of Mongolia or Mongolians – rather it is the engine room that every government, in every country, relies upon.
New ways of solving the old problems are required. New ways of thinking about how to build Mongolia into a greater country are urgently needed.
Quickly resolve disputes and protect against making the same mistakes again
Fixing the old fights comes first. This must be done urgently as a slow resolution will hold back the rebuilding of Mongolia’s credibility as a safe location for investment.
Some of these disputes may be painful and costly to resolve in the short term, but in the longer term will result in renewed investment and broader economic growth. Resolution of the other disputes will cost Mongolia nothing, but a few leaders will need to swallow pride. The national good must come before their personal pride or self-belief in the righteousness of their position.
Government also needs to make a paradigm shift in the way it negotiates future agreements that it is a party to. To date Government has been unwilling to seek international legal advice to assist in the preparation of major agreements. While costly, it will give government more confidence that it has entered into appropriate long-term agreements.
Another critical issue with investment agreements is the need to put them beyond the reach of partisan politics. International investors and banks will not invest where it believes it is common practice for a new government to undo or renegotiate everything done by the previous government.
Change the role of the State
Effective governments in modern market economies see themselves as facilitators of private sector development within a guiding regulatory framework. The recent approach in many government agencies in Mongolia appears to be that of a gate-keeper rather than facilitator of safe and efficient development. An example is the excessive numbers of permits required for simple and often non-essential tasks. This creates opportunities for bureaucrats to become gate-keepers and block major developments over minor technicalities. In the most recent “Doing Business Survey” by the IFC Mongolia scores very poorly (at 107th in the world) compared to its peers on the issue of getting permits.
Developing major projects requires a great deal of coordination and cooperation between the project developer and the various levels of Government. Many other countries provide specific assistance to developers to navigate through the development process in order to speed up project developments and bring forward the economic benefits of the project. One such example is the Queensland Department of State Development, Infrastructure and Planning in Australia. Their mission statement is below:
…(we) exists to deliver Queensland’s economic prosperity by championing the interests of business and industry. We achieve this by driving business and economic growth, leading infrastructure policy and planning for the state, reforming Queensland’s planning system, and assessing, approving, facilitating and delivering major projects.
Other developing countries such as Papua New Guinea, which has a mining industry many times the size of Mongolia, now have government institutional arrangements where dedicated Project Coordinators guide and assist project developers through the development process to facilitate investment in a timely manner.
Mongolia not only needs similar “co-ordination agencies” to facilitate growth but also a change in mindset generally across government to promote development rather than be a gate-keeper.
The Government is the prime developer of economic policy. Economic policy needs to be developed with the objective of facilitating broad based economic growth and opportunity rather than for partisan interests. The close relationship between business and politics in Mongolia has from time to time resulted in decisions which favour particular business interests rather than economic efficiency or quite simply block economic development. Policy must be focused on economic outcomes not partisan interests if growth is to be optimized.
Leverage the private sector for infrastructure development
It is right and proper for Governments to ensure that appropriate regulations and standards are met by the developers of any major project. However government has pressed for full, or majority, ownership of major infrastructure developments when it has no capacity to deliver them, either from a financial and technical capacity standpoint.
Examples include the Energy Resources Rail project from UHG to Gashuun Sukhait. This project was fully funded by the private sector and was under construction and due for completion in 2015 when it was halted, with the State taking ownership of the project. Since then it has re-commenced development only to be halted again due to lack of financial resources. It will not be delivered in 2015 contributing to ongoing high costs for coal exporters with a corresponding loss of economic growth.
Similar examples exist in the energy sector where private sector developers have been ready to construct major power plants but are unable to get necessary government approvals or power offtake agreements. At the same time the IFC doing business report ranks Mongolia extremely poorly at 162nd in the world for access to electricity, well below most African countries. These are cases where Government officials have stood in the way, preventing economic growth and delivery of essential services.
Build a more effective dialogue with business
Government and business need to work together to promote prosperity. One way to build this relationship is to create an effective forum for engagement between them. Many countries have developed structured consultation mechanisms where Government and the business community come together with the express purpose of identifying and resolving impediments to business. In this way those items which most directly impact on growth can be resolved at the earliest possible opportunity. Mongolia has well developed private sector associations that are well placed to provide knowledgeable senior business leaders to engage with government.
The most important thing the new government can do in the short term is to resolve existing disputes quickly so that the negative media messaging about Mongolia stops and more positive news will be heard.
The longer term objective should be to create a paradigm shift in the way Government views and interact with the private sector. The shift from being a gate-keeper to a facilitator of private sector development is essential
Building effective and timely consultation mechanisms between business and Government will also assist the government to prioritise policy actions and to remove the impediments to business, creating new and enhanced opportunities for growth.
Authorship note. This article has been co-authored by a group of senior business leaders within Mongolia. INS has facilitated the process.