Mining to pull Mongolia out of economic doldrums

Wedged between China and Russia, Mongolia has undergone an economic boom in recent years. Since 2000 GDP has grown between 8% and 10% annually, though this figure would be even higher if remittances and other grey market activities were taken into account. Over the past year, however, development has slowed.
 
"Our economic problems are different to the problems in many places," says Peter Morrow, CEO of Mongolia's largest bank, Khan Bank. "We don't have a financial crisis -- our banks are generally OK. Khan Bank doesn't own any toxic assets, no mortgage-backed securities, complicated derivatives, or foreign exchange futures. We don't have any financial assets outside of Mongolia."
 
In a recent interview with FinanceAsia, Morrow notes that the problems facing Mongolia have come in a group, with inflation at the forefront. In 2006 inflation was at less than 5% and the local currency, the tugrik, depreciated by just 1% against the dollar. By 2007, inflation was up to 15%, mostly off the back of rising prices for petrol, as well as foodstuffs.
 
Leading up to an election in 2008, the government increased both wages and pensions, while new welfare programmes were also introduced. Inflation continued to rise to 20% last summer, peaking at 34% in September. And while it has dropped back down to around 18%, it remains an economic pressure.
 
"The inflation resulted in negative real interest rates. Because we had loan and deposit rates in the high-teens and inflation over 30%, people started taking their money from the banks and spending it. So the banking system lost about 10% of its deposits in the last half of 2008," says Morrow.
 
"New lending came to a halt. The banks couldn't expand loans -- so, for example, the construction industry ground to a halt," says Morrow. "We've now started growing again, but nowhere near the level that we were seeing before."
 
The other main problem relates to trade. Mongolia is one of the world's largest producers of cashmere, a mainstay of the country's sizable agricultural sector. But during the Olympics last year, Beijing closed the land borders between China and Mongolia leading to a sharp drop in the price of cashmere, seriously impacting the rural economy.
 
And then there was the bursting of the commodities bubble. Mongolia, with its abundant natural resources, had been filling up its coffers for years by selling raw materials. Even though key resources, such as copper, have more than halved in price over the past year, commodities remain the economic fix, says Morrow.
 
"The Mongolian government knows full well that this is the answer to their problems. There is no other answer," says Morrow. He compares Mongolia's wealth under the ground to that of other countries with small populations like Kuwait and Brunei. "It's not just copper. There is oil, gas, coal, iron ore and uranium."
 
The largest major project currently underway, on a scale that it will be long-term enough to see through a succession of commodity cycles, is the Oyu Tolgoi project. By some measures it will become the world's largest copper and gold mine. As a project worth $5 billion, it is equivalent to an entire year's worth of Mongolian GDP. "So Mongolia is one of the only countries in the world to have a second GDP ready to go -- the building will take three years and cost about $200 million to $300 million a month."
 
The Oyu Tolgoi mine is a joint venture between Rio Tinto, Ivanhoe Mines and the Mongolian government. Australia's Rio Tinto has the right under the deal to acquire up to 43% over the next four years at pre-determined prices. The project has been years in the making and is currently in the process of acquiring parliamentary approval.

Mongolians are watching Chinese acquisitions of international resources companies very carefully. A few years ago, when the Ovu Tolgoi project was conceived, the idea that a Chinese state-owned company could buy a chunk of Rio Tinto would have been highly implausible, Morrow says. Now, Aluminum Corp of China (Chinalco) owns a 12% stake, and it has its eyes on more. The Mongolians "have noticed that there is no good reason that the Chinese government couldn't own the rest of Rio", says Morrow. 

Relations between China and Mongolia have been sensitive for hundreds of years, with each having ruled the other at different points in history. In recent decades, during the cold war, when China and the USSR fell out, Mongolia became a frontline for disputes.

Relations are better now, he says, and the Mongolians know that their market is China. "The problem is how to take advantage of that and get the economic benefits without the other worries...and they want to make sure that their key resources are under their own control."

The degree to which the Mongolians succeed at this will play a big role in how soon Mongolia pulls itself out of its economic mire.