Day 820: Mongolia Thanks China That Currency Descends Slowly Instead Of Plummeting

February 18 01:14 2015 Print This Article

Mongolia’s government has recently imprisoned American Justin Kapla and Filipinos Cristobal David and Hilarion Cajucom Jr. as part of the government’s ongoing battles with foreign owned mining companies SouthGobi Resources, Turquoise Hill Resources and Rio Tinto. The men are in their 820th day of being detained in Mongolia. During this time, Mongolia’s battles with foreign mining companies have caused a decline in foreign investment that has wreaked havoc on Mongolia’s economy and caused a decline in its Tugrik currency near 50%. Yet the currency would likely be in free fall if not for the geopolitical motivations of China.

As Mongolia tried to learn how to manage the discovery that Mongolia had vast mining wealth for a country populated by about 3 million people, the country legislated a Windfall Profit Tax of 68% in 2006. The recalcitrance of foreigners to continue to put money to work in Mongolia under this structure eventually (with help from the global financial crisis of 2008) led to the currency crisis of 2008-2009 on the below chart of Mongolia’s currency.

Once Mongolia passed the Oyu Tolgoi Agreement (for its world class top five copper-gold mine) and cancelled the Windfall Profit Tax law in 2009, the currency stabilized and then strengthened into 2011. The long-term investment thesis of foreign mining companies and investors from 2010 (that has withered and died since 2012) was that Mongolia had learned from the failure and crisis of the Windfall Profit Tax and would not do anything so stifling to foreign business and investment again.

However, beginning with members of the government – including the Minister of Mining – questioning the Oyu Tolgoi agreement in August of 2011, one can see Mongolia’s Tugrik begins to decline sharply on the below chart. In early 2012, there was some hope about Mongolia’s economy and outlook toward foreign investment stabilizing with (1) the release of former SouthGobi employee Sarah Armstrong from a visa exit ban (before the world was well aware of the same visa exit bans still in effect upon Messrs. Kapla, Cajucom and David that ultimately led to their imprisonment) and (2) optimism about stability being restored after Mongolia’s June 2012 summer elections. Both of these points of optimism slowly came to be understood to be false dawns and the Tugrik began its slip down in value vs. the U.S. dollar (blue line) and Chinese Renminbi (red line).

Bank of Mongolia chart of the historical exchange rate of Mongolia's Tugrik currency vs. the U.S. Dollar (blue line, numbers on left) and Chinese Renminbi (red line, numbers on right).

While many economic and legal factors that have caused this roughly 50% decline in the Tugrik over the last four years have been detailed in the last five articles by me (links at bottom of article), what is not explained is that this could and should be worse. Although Mongolia’s GDP ostensibly grew 7.8% in 2014 according to government data, the government has recently reached outto the International Monetary Fund in hopes of some form of assistance. As the economy did grow according to official data from last year, multiple executives from the business community are convinced there will be no bail out to the economy from the IMF.

As noted in yesterday’s article, Mongolia’s biggest financier, trade partner and investor since problems began in 2012 is China. The notion that this is because China needs Mongolia’s natural resources is erroneous. A colleague that is a China expert once summarized, while Mongolia’s natural resources are a vast spigot of potential wealth for its small population of roughly 3 million people, Mongolia’s natural resources are a “drop in the bucket” that is a tiny rounding adjustment to the resource needs of China’s 1.35 billion people (alternatively, Mongolia’s GDP of U.S. $12 billion vs. China’s $6.8 trillion dollar economy means China’s economy is currently 567 times bigger).

What is likely more important to China is that an independent Mongolia creates a 2,906 mile (4,677 kilometer) buffer zone between China and Russia that has only existed since 1990. Prior to 1990, Mongolia was the first Soviet satellite state and second Communist country in the world from 1921 to 1990 making for a very lengthy border of Soviet presence to China’s north. It is important for China to keep Mongolia stable as instability could lead to broader Russian influence over Mongolia, as Russian influence still loudly echoes in Mongolia in the post-Communist era. Senior international executives working in Mongolia consulted concur that while they expect the Tugrik to slide further in value, they expect any slide to be slow due largely to Chinese financing as the Chinese would not want instability to give Russia the ability to step back into political dominance in the country.

Mongolia Map

On the flip side, one of these senior executives put in a nutshell: “Mongolia’s battles with mining companies is financed by borrowing money from China.”

Frontier Securities, a local brokerage house in Mongolia, issued a report this past Friday on Mongolia’s Foreign Direct Investment (FDI) and its relationship to Mongolia’s economy and Mongolia Tugrik currency valuation. After FDI peaked in June 2012 (the same month as Mongolia’s last parliamentary elections), a steady drop off in FDI can be seen in the below chart.

FDI Mongolia

Making this case clearer in Frontier Securities report is the next chart. On the X axis is Mongolia’s monthly FDI and on the Y axis is Mongolia’s Tugrik valuation. The dots on the left are when monthly FDI has been at its lowest. The dots on the top, which coincide with these months, is when Mongolia’s Tugrik has seen its lowest valuations.

As Mongolia’s battles with mining companies continue and three men are now in its prison system despite five significant violations in their case of Mongolia’s own laws, it remains to be seen how much Chinese and other benefactors can help prop up Mongolia’s Tugrik currency.

Mongolia FDI MNT relationship

Mongolia has an official Third Neighbor policy which refers to alliances beyond its actual two neighbors and principal trade partners: Russia and China. The Third Neighbor policy is fairly erroneous as it sound technically singular – as if there is one third neighbor – whereas it is really a friendly term used for any countries that provide foreign aid or investment to Mongolia. These third neighbors often receive little in return in terms of political and business relations. Countries used in the Third Neighbor scheme include the United States, Japan, Germany, Korea, Switzerland, Kuwait and many other nations.

Thus, while Mongolia deters business by many foreign multinational corporations, Mongolia not only hurts its mining industry but the overwhelming majority of Third Neighbor engagement in the country. Mongolia became the second Communist nation in the world in 1921 to have Soviet help that would ensure its independence from its larger Chinese neighbor to the south. independence in 1990, Mongolia has had to balance relations with both Russia and China. As Mongolia continues legal and economic policies that are a deterrent to most countries and businesses from any engagement with Mongolia, Mongolia is left relying on its two neighbors, and mostly the richer one to the south.

Also in this article series

Day 819: Mongolia’s Mining Squabbles Squander Sovreignty And Gift China Power

Day 818: Mongolia’s Lacking Due Process Versus Families On Social Media

Day 817: Mongolia Has Chance To Shine Or Face Legal Global Image Failure

Day 816: Mongolia Prefers Economic Suicide Over Ending SouthGobi Vendetta

Day 815: American And Filipinos Wrongfully Detained In Mongolia

Follow Jon Springer on Twitter @FrontierWriter or connect via LinkedIn.

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