Mongolian Economic Review

Mongolian Economic Review

While Mongolia can look back on a year that began with high expectations for a steady rise in mining-generated wealth, reports of slowing growth and concerns among investors about the risk of resource nationalism cast a shadow over the second half of 2012. The successful raising of $1.5bn in a two-part government bond release in November underlined that investor interest in the country's vast coking coal and copper mines -- and strategic location near China and Russia -- is still strong. The $500m, five-year issue had a coupon rate of 4.125%, and the 10-year, $1bn-part sold at 5.125%. The offering was 10 times oversubscribed, attracting some $15bn in bids, nearly twice the GDP of $8.5bn. The buyer confidence came despite the government confirming in October that growth had fallen to 13.2% in the first half of this year from 17.3% in the last.
However, while the adoption of a foreign investment law in May that tightened approval requirements for international companies has so far failed to weaken investor interest, the new requirements, combined with a restructuring of a crucial deal with global mining giant Rio Tinto, could make investors more cautious in 2013.
The controversial law, which requires any foreign entity with a holding of more than 5% in a company doing business in Mongolia to be regulated by the Foreign Investment Regulations and Registration Department, has been described by some as a form of “resource nationalism”. Concerns also remain over how the law will be implemented.
Critics also noted that Mongolia’s vulnerability to a downturn in commodities exports was exposed by a drop in demand from its biggest customer, China, in 2012. Mongolia’s expansionary fiscal policy was also blamed for double-digit inflation and balance of payments pressures.
The IMF in particular targeted spending levels this year, linking them to June elections. In the lead-up to the vote, the Mongolia People’s Party oversaw cash handouts and measures such as raising civil servant wages by more than 50%. But this didn't stop the Democratic Party taking power by winning six more seats in the 76-member parliament.
"In the six months leading up to the end-June elections, government spending rose by 57%," the IMF said in a November report. "Public spending needs to be reined in, in order not to risk undermining stability and growth prospects".
Following the election, which was praised as free and fair by the US, the Democratic Party has moved to stress its commitment to political stability, putting forward an action plan designed to reduce the budget deficit, curtail inflation and reassure foreign investors.
Domestic demand, which pushed up imports, led to inflation hitting 15% at the end of the year. The IMF noted the steps taken by the central bank to address rising inflation, which included increasing its policy rate and reserve requirements. “These tightening measures contributed to a marked slowdown in credit growth, from 72% in 2011 to 36% in September 2012 (year-on-year),” it wrote in November.
The beginning of 2012 witnessed a wave of confidence in the banking sector, led by a rise in the loan to deposit ratio and a move by Goldman Sachs to buy a 4.8% stake in the Trade and Development Bank of Mongolia. However, banks’ liquidity dipped from 50% in January 2011 to under 40% at the start of 2012. In May, Moody’s downgraded the ratings of four of Mongolia’s banks to B1, citing a “relatively low level of cross-border diversification in their operations”.
The downturn in the banking sector was in sharp contrast to last year’s surge. Foreign direct investment, which totalled $4.6bn in 2011, fell to $3bn this year, and fears mounted that smaller institutions were heading for a crisis.
Mongolia’s stock exchange, which has matured considerably in recent years, also struggled in 2012, with the Wall Street Journal reporting in November that its worth had fallen 30%. Efforts are now under way at the exchange to revive growth, including plans to work with parliament on a law that would enable companies listed overseas to sell shares domestically. The Mongolian Stock Exchange is teaming up with the London-based FTSE Group to introduce a Mongolian index, as it prepares to obtain FTSE’s frontier-market status.
The year was marked by wrangling between the government and international mining companies, culminating in November with a decision to delay the selection of companies that will develop part of the nation’s largest coalfield until next year.
Government plans to raise the royalty taxes on the Oyu Tolgoi copper mine, which were originally set in 2009 for a 30-year period in the Oyu Tolgoi Investment Agreement, has also sparked controversy. The tax hikes, which were outlined in the proposed 2013 budget, look set to maintain political pressure on the mining sector next year.
While talk of declining growth and foreign investor concerns may threaten overall confidence, the sheer size of Mongolia’s resource wealth and potential give reason for optimism in 2013. The volatility that was evident in the latter half of 2012, however, will remind Ulanbaatar that it will need to balance sound domestic fiscal policy with an awareness of Mongolia’s vulnerability to outside factors.