The Path to Prosperity: Mongolia

Preface

[This is my attempt at trying to do a somewhat comprehensive overview of Mongolia’s economic landscape. It isn’t intended to be considerably technical. I’ve put a decent amount of time into researching this post but by no means does it reflect perfect epistemic confidence: this is just good writing practice and fun to do. Do message me if anything is amiss. I wrote this back in early December 2022, but didn’t post it because I wasn’t very happy with it. A lot has changed since then, most notably, Zero-covid is gone.]

Introduction to Minegolia

What is going on in Mongolia?

Obviously, there’s this guy on top of a mountain praising Genghis Khan.

No but really: what’s going on in Monglia? I mean: Mongolia is a relatively obscure country that most people don’t know (or care) much about. But it’s quite an interesting country, both economically and geostrategically: Mongolia is landlocked country between Russia and China; it’s also a democracy that’s friends with the US; and it has few trillion dollars worth of mineral wealth. Somewhat unsurprisingly, mining is a crucial component of the country’s economy—and will continue to be for many years. “Minegolia” could not be more apt of a name.

Today, there are a few dozen mines scattered across Mongolia. Many of them were developed by the USSR in the 20th century. Mining cooperation between the USSR and Mongolia continued up until the breakup of the USSR—during that time Mongolia received a truly colossal amount of FDI for its small population of only ~2 million.¹ In more recent times, foreign investors have begun to develop colossal mining projects, such as the Oyu Tolgoi mine. This is Mongolia’s largest mine. These mines promise to chart a route for Mongolia on it’s path to prosperity.

The fact Mongolia borders Russia and China and has lots of natural resources helps explain the Mongolian economy’s somewhat polar dynamics. While Mongolia used to export most of its mineral products to the USSR, in the 1990s it reoriented itself towards Asia. High commodity prices and Chinese import demand for raw materials in the mid-2000s catalysed Mongolia’s period of exceptional economic growth. Yet, it seems Mongolia’s vast mineral wealth could become more of a vice than a virtue—over 90% of its exports come from the mining sector, leaving it particularly vulnerable to low commodity prices or lulls in demand. So too, could its relationship with China—just over 80% of all Mongolia’s exports go to China². Mongolia is reliant on its natural resources, China, and high commodity prices.

I want to talk about two factors are constraining Mongolia’s current—and future—economic growth. Let’s explore them in some more detail.

Notice that the second largest export commodity group is “Natural or cultured stones, precious metal, jewellery”. That also sounds like mining (at least mining adjacent) to me.

Binding Constraints on Growth

The first constraint is Mongolia’s infrastructure. For decades, the country’s transporation network for mineral goods, consisting of roads and rail systems built by the Soviet Union, has been relatively poor. Despite recent improvements in road infrastructure, a lack of investment in rail has to led to a reliance on truck transportation. This is not ideal. Mineral products, like coal, are high-weight, low-value goods, making trucks a pretty expensive and inefficient way to transport them. As a result, Mongolia has—somewhat unsurprisingly—significantly higher transportation costs than some of its neighbours. For example, the cost per kilometer of transporting a TEU (twenty-foot equivalent unit) from Mongolia’s capital Ulaanbaatar to Japan is almost 75% more expensive than transporting a TEU from Tashkent in Uzbekistant—a doubly landlocked country—to Japan³!!

To make matters worse, while Mongolia has thirteen border ports with China, ~90% of Mongolia’s exports pass through just three: Gashuunsukhait, Shiveekhuren, and Zamyn-Uud⁴. This immense concentration of export volumes has amplified the congestion that materialises at border ports, often increasing waiting times. Additionally, there is a risk of overcrowding, that is, the volume of exports trying to pass through will exceed the ports’ capacity. It’s important to address this issue: good infrastructure is a precondition to quickly and easily selling your mineral products. If Mongolia is going to hang their hat on mining for the next few years (or longer), then developing rail infrastructure and resolving their congestion issues would go some way towards making their exports more competitive.

The second constraint is China’s Zero-Covid Policy. At the heart of Mongolia’s dilemma for growth is that Mongolia and China differ in their strategy for dealing with Covid. Mongolia’s measures are directed towards adaptation while China is focused on maintaining its Zero-Covid policy, i.e., zero transmission of the virus. The Zero-Covid Policy impedes the volume of Mongolian exports and increases the border crossing time because of the increased required paperwork and quarantine time for truck drivers. As a result, border crossing times have more than doubled.

Tackling these constraints

Given the importance of mining exports to China to the Mongolian economy, in late 2021, the Mongolian government created the New Recovery Policy (NRP) in response to these challenges. One pillar of the NRP is “Border Ports Recovery”. The main thrust of this policy pillar is to increase the capacity of existing ports and to build more roads and rail connections to these ports. If poor transport is a current constraint on exporting more mining products, then these policies will remove them. Considering that the Oyu Tolgoi mine is still ramping up production, this seems to be an appropriate and prudent future planning: when the NRP is completed, the Oyu Tolgoi mine will be running at full capacity.

Problems and challenges

It’s worth pointing out the assumption that I’ve made in thinking about these constraints.

Isn’t the biggest constraint the fact that Mongolia’s economy is almost entirely dependent on mining, leaving it vulnerable to commodity price fluctuations?

Yes, it probably is. But Mongolia is committed to selling mineral products to China. I think they are probably right to, at least for now. In the short term, Mongolia cannot diversify quickly enough to effectively wean themselves off of mining revenues, but they can try to make the most of it. Mining revenues can give the government enough fiscal space to invest in critical infrastructure, education, etc. that will help the economy to diversify into the future.

Putting aside questions about whether Mongolia can complete the NRP, China’s Zero Covid Policy has the potential to continue to be a binding constraint. Even if Mongolia completes the NRP, Beijing will still ultimately decide “the number of trucks transporting coal that cross the border daily”. Rail transport mitigates this constraint to some extent: presumably more goods can be brought across the border for the same amount of paperwork and quarantine time by drivers. In particular, the recently completed Tavan-Gashuunsukhait rail line will help offset some of the delays caused by additional Chinese import requirements. This, by itself, is not sufficient to get around the Zero-Covid Policy. The latest outlook suggests that the Zero-Covid Policy will remain in place for the foreseeable future. Ultimately, Mongolia’s recovery lies in the hands of Beijing.

Yet, China’s Zero-Covid Policy cannot go on forever. It is too costly. If (when?) it is loosened or axed in the following years, the NRP’s new road and rail infrastructure should come online in tandem with the Oyu Tolgoi mine functioning at full capacity. If this outcome is likely, this pillar of the NRP seems to be worth pursuing, allowing Mongolia to potentially triple their exports⁵.

On a consideration of risk, Mongolia’s policy of almost entirely focusing on improving trade connections with China is unavoidable. Transportation costs through other routes are simply too high to be competitive as they must either be flown out or be routed through Russia to a seaport. Beyond mineral exports, the success of the NRP would make all other Mongolian exports more competitive. This is worthwhile pursuing as transportation costs in Mongolia are currently above the global average and—in the long term—Mongolia will need to move away from mineral exports.

But will this demand from China for mineral products continue to exist in the future?

China has committed to achieving peak coal use in 2025 and moving away from using coking coal—Mongolia’s main export—to manufacture steel. Furthermore, China has ramped up its domestic production of coal. From where we currently stand, it is difficult to say whether China will ramp down imports of coking coal.

Mongolia & The Belt and Road Initiative

Mongolia is included in one of the six “economic corridors” that the BRI seeks to establish. This economic corridor is called the “China-Mongolia-Russia Economic Corridor”. Most of the BRI projects are related to transportation and infrastructure. Of the thirteen transportation projects, seven are for railways and four are for roads⁶. Given the key infrastructural challenges I flagged earlier, I think the BRI has the potential to improve (significantly?) the speed at which Mongolia can export to China and to lower transport costs. They’re both important steps in making Mongolia more competitive going into the future.

Risks

It’s not all perfect, though. Given the close relationship Mongolia has with China, some have begun to be quite cautious of the loans Mongolia has taken out, even suggesting that Mongolia will have to sell land to be able to repay Chinese loans. Let’s consider some economic risks Mongolia faces.

• Debt Repayment & Narrow Economic Base. Mongolia’s economy is centred on mining and commodity exports to China, leaving their economy heavily exposed to volatile commodity prices and lulls in Chinese demand. Lower commodity prices or a decline in demand from China would present significant challenges for Mongolia to repay its debt. Furthermore, almost the entirety of (~99.8%) Mongolia’s debt is in foreign currencies making it difficult for Mongolia to hedge for exchange rate risk.
• Chinese Ownership? While other countries within the BRI have had to transfer infrastructure to Chinese ownership, e.g. Sri Lanka’s Hambantota port, as a result of being unable to keep up with its debt payments, it is so far difficult to see China trying to capture BRI-funded assets in Mongolia or Mongolia being unable to repay their “1 billion USD” loan from China.⁷ Commodity prices are high and the Zero-Covid policy begins to ease is gone. Even if China was deliberately trying to own BRI funded infrastructure projects in Mongolia, the BRI projects just aren’t as strategically valuable to China as projects in other countries. The main beneficiary of the new infrastructure will be Mongolia, allowing them to import and export goods in greater volumes and at lower prices. China already has significant leverage over Mongolia as Mongolia’s largest trading partner—BRI loans are not going to be the tipping point.
• Restructuring. Chinese loan conditions are “undisclosed” and likely collateralised by mineral resource generated revenue. As this revenue is volatile, there is a distinct possibility of loan restructuring—some people in Mongolia suggested that Mongolia would have to sell land in order to repay Chinese debt.⁸ Another possibility is that China could institute a ‘materials-for-infrastructure’ deal akin to those it has arranged with Venezuela and their oil for loans partnership.

Overall, I think the BRI is a net positive for Mongolia.

Political and Economic Context

As always, politics and economics are intertwined. I want to examine two recent periods in Mongolia’s political history.

The Democratic Party Policies: 2012-2016

Why did economic growth fall so rapidly in Mongolia? A few different factors all came together.

1. Chinggis Bonds: In 2011, Mongolia’s economic growth rate reached 17.3% on the back of its strong mining industry. The Democratic Party (MDP)—who had just come into power—issued Mongolia’s first bonds, called the Chinggis Bond. The bonds were used to fund infrastructure projects.
   • These bonds were worth $1.5 billion
   • $500 million worth had a duration of 5 years with an interest rate of 4.13%
   • The remainder had a duration of 10 years with an interest rate of 5.125%
   • The condition was to repay $500 million in 2017-2018 and the remainder in 2022.⁹

2. Excessive Spending: In 2013, the MDP used the Development Bank of Mongolia as a vehicle to fund new policies designed to win them votes. These policies subsidised mortgages, student loans, and credit for herders. These policies led to the government exceeding its capital expenditure. ¹⁰

3. Declining Commodity Prices: The price of coal and copper fell steadily from 2011 until 2016. These declining commodity prices coupled with falling demand for China meant that Mongolia was generating less revenue than usual.¹⁰

4. Protectionist Policies & Falling Investor Confidence: The MDP attempted to renegotiate the terms of the Oyu Tolgoi copper and gold mine, which took a toll on investor confidence. Specifically, new tougher mining laws that sought to increase Mongolian control and income on foreign investor-led mining projects were imposed. Additionally, the second phase of the Oyu Tolgoi project struggled to push forward. However, the election of the Mongolian People’s Party in 2016 restored investor confidence, contributing to higher FDI inflows.¹¹ The graphs below speaks for themselves.

The Mongolian People’s Party: 2016 onwards

The Mongolian People’s Party (MPP) came to power in 2016, beating the Democratic Party. Much of the MPP’s work was dealing with the previous policies of the MDP. First, was dealing with the Chinggis Bonds. The new government needed to repay but lacked the capacity. So, what’s the solution?

1. Gerege Bonds: The MPP swapped the old Chinggis Bonds for new Gerege bonds.
   • These new bonds were worth $800 million
   • They were issued in 2017 with a maturity of 5.5 years and an interest rate of 5.62%
   • They were issued to repurchase previous bonds closing in on their maturity ¹²

2. IMF: The government sought the IMF’s Extended Fund Facility to pay for the remainder of the bonds. In 2016, Mongolia received about USD 425 million, which itself was part of a USD 5.5 billion multi-donor financing package supported by Japan, Korea, China, the World Bank, and the Asian Development Bank. In return, the IMF required Mongolia’s government to implement a Fiscal Stability Law, limiting budget expenditure to 5% of GDP.¹³ This explains the large spike in debt held by “Multilateral” on the graph.

Dutch Disease in Mongolia

Due to the high levels of FDI inflows in Mongolia, there has been speculation that Dutch Disease exists in Mongolia. Dutch Disease is made up of two effects. The first is the spending effect. In Mongolia’s case, this is where the export of mineral products and FDI inflows generate and appreciation of the real exchange rate, an increase in government spending, and the expansion of the non-tradable (i.e. services) sector. The second is the resource movement effect. This is the shift in labour from the traditional manufacturing sector to the mining sector. This is because the appreciation of the rel exchange rate negatively influences the export of non-mineral products.

From reviewing the literature, the studies I read all found some evidence of Dutch Disease in Mongolia with varying degrees of strength in their claims. However, most studies did not explicitly claim Dutch Disease exists due to mixed results, unexpected coeffcient values, or mitigating factors etc. I plan to try replicate one of these studies in the future, with the added benefit of increased data.