China at the Gates: China’s Impact on Mongolian Natural Resource and Investment Policy
May 3, 2013
By Oliver Backes
The mining sector—driven by an influx of foreign investment, much of it from China—has been the engine of Mongolia’s impressive economic growth. Hungry for Mongolia’s coal, metals, and other minerals, China has dominated the Mongolian economy, stoking fears in Ulaanbaatar of even greater Chinese control. This has prompted the imposition of strict new laws mandating government oversight of foreign investment, especially from foreign sources. Ulaanbaatar has created a two-tiered system of “China-phobic” resource nationalism that could alter the future trajectory of the mining industry.
Mongolia has risen! A burgeoning natural resource and mining sector is expected to make Mongolia’s the second fastest growing economy worldwide in 2013, building upon over a decade of rapid economic expansion. Of course, Ulaanbaatar has not achieved such heights alone. Rich in resources yet lacking the infrastructure, human and economic capital, and technological expertise necessary to develop them, Mongolia’s mining boom has been driven almost entirely by foreign investment. The importance of such investment to the Mongolian economy makes Ulaanbaatar’s recent policy shifts towards greater resource nationalism all the more puzzling.
Reforms to laws governing foreign investment and mineral resources laws in recent months stand as an unambiguous departure from two decades of Mongolia’s favorable investment climate. This shift has spooked foreign investors, with foreign direct investment (FDI) falling 17 percent year-on-year in 2012. Yet, Mongolia’s approach to its natural wealth remains seemingly inconsistent. Ulaanbaatar has lifted restrictions on private investors while deepening constraints and expanding oversight for state-owned investment. This incongruity raises the question: what is driving decision-making in Ulaanbaatar? The answer can be found to Mongolia’s south. The Mongolian government’s recent shift towards greater resource nationalism has been the result of the coalescence of fears about Chinese economic dominance, leading to the development of a two-tiered policy of “China-phobic” resource nationalism.
The People’s Republic looms large over the Mongolian economy, and fears abound in Ulaanbaatar about the prospects of becoming Beijing’s newest natural resource appendage. Such fears are not entirely unfounded. In the two decades since Mongolia’s transition to a market economy in 1990, China has accounted for roughly 50 percent of the FDI in Mongolia. No other country has even come close, with only three others (Canada, the Netherlands, and South Korea) providing more than 5 percent of FDI each. Moreover, economic relations with Beijing account for 75 percent of Mongolia’s total economic activity and over 90 percent of its exports, most of which are raw materials. Combined with China’s geographic and demographic dominance (China’s population is 480 times larger than Mongolia’s), alongside a long and troubled history that includes close to three hundred years of direct Chinese rule under the Qing dynasty and a 1919 occupation by Chinese forces that continues to stoke Mongolian fears of reintegration, policy makers in Ulaanbaatar and the Mongolian public are understandably wary of China’s massive economic clout.
However justified these fears may be they have made for bad policy. In May 2012, Mongolia passed the Strategic Entities Foreign Investment Law (SEFIL), under which the State Khural, the Mongolian Parliament, would have to approve all foreign investment in strategic sectors, including mining, that exceeds 70 million dollars. It was a transparent – and ultimately successful – attempt to block the takeover of SouthGobi Resources, a coal mining company and Rio Tinto subsidiary, by Chalco, China’s largest state-owned mining conglomerate (after five months, Chalco finally threw in the towel). Soon thereafter the Mongolian government proposed significant changes to the Minerals Law, which would grant the state the right to take a free stake in most mining projects, and could allow the government to mandate output targets for producers regardless of market conditions through a “Deposit Development Agreement.” A breach of these provisions could carry a fine, or even result in the revocation of a mining license.
In the wake of criticism from private foreign investors, the government has backed off both pieces of legislation, and repeatedly clarified that the SEFIL distinguishes between private FDI, which Mongolia favors, and state-controlled FDI, which it seeks to regulate. This distinction was codified in an amendment passed on April 19, 2013 that removes the mandatory parliamentary review of investment projects for non-state-owned investors and exempts private foreign investors from the onerous conditions and restrictions contained within the SEFIL. The amendment also mandates government approval for all investment by state-owned enterprises, regardless of the financial stake and triggers automatic parliamentary review and approval procedures for any investment resulting in a stake greater than 49 percent in a strategic enterprise. Furthermore, Ulaanbataar has chosen to defer debate on the draft Minerals Law until after the presidential elections this coming June to ensure that policy is not shaped by the nationalist fervor that could surround the issue of mining during the election. The now tighter restrictions on foreign investment that will remain in force should grant the Mongolian government much greater control over how, or if, state-affiliated capital from China enters the country.
In a 2009 article, Ian Bremmer and Robert Johnston put forward a brief taxonomy of resource nationalism. Mongolia exhibits what Bremmer and Johnston call the “economic” variant of resource nationalism (as opposed to the “revolutionary,” “legacy,” or “soft” variations), which prioritizes state control of natural resources so that those resources may further a country’s long-term economic development. Such “economic” resource nationalism is not inherently opposed to foreign investment; in fact, it often welcomes FDI, albeit on terms favorable for the state. This is exactly the policy that Mongolia has pursued – welcoming foreign investment on the whole, while also asserting control over both which investors are allowed into the country and how much they can invest.
Even with a recent amendment which favors private investment now on the books, the strict policies enacted over the past year have been a shock to a mining industry that, since the early 1990s, has operated in an economic environment that prioritized an open investment climate to attract sorely needed foreign capital and expertise. Mongolian natural resource development policy has always been a delicate balancing act between resource nationalism and the free market. For the past two decades, beginning in the early stages of its post-Soviet economic revival, an open investment regime has largely prevailed. This does not mean that Mongolia’s policy was not “economically” resource nationalist; rather, as Bremmer and Johnston write, Mongolia had, until recently, recognized that its efforts to control investment or renegotiate terms could not be “so punitive that international companies exit the country.” The version of SEFIL passed in March 2012 upended the prevailing status quo, shocking the private investors with the specter of new onerous restrictions. As outlined above, investor outrage has prompted a second rebalancing, with Mongolia pursuing diametrically opposed strategies towards private investment and investment from foreign, state-owned (read: Chinese) enterprises.
The shift towards greater control over investment is the result of a growing desire to draw greater benefit for the state and local population from mining activities, as well as historically high minerals prices. Most importantly, however, it implies a belief that a tougher government stance on investment will not deter all, or even most foreign investors seeking to tap into Mongolia’s burgeoning mining sector. Ulaanbaatar understands that foreign investment remains critical. In fact, Mongolia explored the possibility of development projects undertaken exclusively by Mongolian state-owned enterprises, but the government acknowledged that such an undertaking would proceed much more slowly without foreign capital, infrastructure, and technical capabilities. Before the recent amendment softened the SEFIL legislation, Mongolian President Tsakhia Elbegdorj argued that the new restrictions contained in SEFIL and the renegotiation that it has prompted is “tarnishing” Mongolia’s reputation.
Mongolia’s turn to resource nationalism was prompted not by an aversion to foreign investment per se, but specifically by the sale that would have given Chalco a majority stake in the company that operated the strategically important Ovoot Tolgoi coal deposit. That sale entered the public view in the run-up to the 2012 parliamentary elections, setting off a wave of public discontent focusing on China’s position in the economy and prompting politicians to seek to capitalize on it. China, and not foreign investment more generally, was the focus on this public and legislative backlash. Mongolia’s swift assertion of this “China-phobic” resource nationalism has left policymakers in Ulaanbaatar scrambling to ensure that other private, non-Chinese investment flows do not dry up. But while Ulaanbaatar may have some minor success in stemming the tide of Chinese investment, Mongolia is still destined to remain almost entirely dependent on China economically for lack of other options. In the words of Battsengel Gotov, the CEO of the Mongolian Mining Corporation, “we have two big superpowers as neighbors. Virtually, we have one customer.”
Neighbor number two, of course, is the Russian Federation, which has ranked ninth in FDI with 2.24 percent over the past twenty years. That trails such economic powerhouses as Bermuda and the UK Virgin Islands. Even though Russia is right next door, it is unlikely to ever serve as an effective counterweight to China. Recent bilateral meetings between Russia and Mongolia have reaffirmed political and military ties; however, expanded economic ties, beyond early discussions of transportation and export routes for Mongolian commodities through Russia, seem to have been given short shrift. Unlike China, the Russian Federation has little need for Mongolian coal, copper, or other minerals, and even less desire to finance their development. Russia, rather, remains primarily concerned with the development and expansion of its own stagnating natural resources sector. Additionally, while Russia has shown interest in oil and gas investment projects throughout Central Asia in recent years, it is unlikely that they will do so in Mongolia. The oil and gas industries are practically nonexistent in Mongolia and the oil and gas reserves have largely not been surveyed and remain unproven. Chinese FDI in Mongolia in 2010 dwarfed Russian FDI by a factor of close to seventy-five; thus, even if Russian investment in Mongolia were to increase, it would have to grow at an unrealistic rate to genuinely challenge China’s stranglehold on Mongolia’s economy. Together, China’s existing dominance and the improbability of a massive influx of Russian investment into Mongolia’s natural resources sector make it very unlikely that in the near- to mid-term Russia will provide a viable alternative for Ulaanbaatar for either exports or foreign investment. This lack of a Russian alternative is likely another factor driving Mongolia’s imposition of increasingly stringent restrictions on Chinese investment.
To ensure its future economic growth and diversification, Mongolia must reconcile its inevitable economic dependence on China with its desire to protect its economic sovereignty, especially in mining, while keeping the private investments flowing. To do so, it will be necessary for Ulaanbaatar to decouple, both in policy and in rhetoric, its support for private foreign investment from its “China-phobic” resource nationalism. While the amendment to the SEFIL, which stands steadfast against Chinese investment while encouraging private FDI, is a step in the right direction, the seed of more intense, and more detrimental, resource nationalism has been planted in Ulaanbaatar. China is not going away; on the contrary, the People’s Republic will remain Mongolia’s primary economic partner in both trade and investment. Consequently, the phobias prompted by China’s economic dominance—and the temptation to strengthen resource nationalism—will not go away either. Mongolia’s government must remain vigilant, especially with a consideration of the draft Minerals Law set to take place in only a few months, ensuring that fear of Chinese dominance does not force it to further compromise its message of openness to private foreign investment.