Mongolia never learns its lesson
Mongolia is a sparsely-populated country located right in the middle of two world superpowers. It is not a superpower, despite its earnest wishes to be considered one. Mongolia is a country we have been optimistic about and we have been wrong about.
In 2013, we wrote about the trouble in the equity market and then we provided an overview of how to invest in Mongolia shortly thereafter. We hoped for a quicker recovery and wiser policy decisions from the government. We were wrong and it provided us with a lot of lessons. The country has been in a downward spiral for 6+ years that we think may have finally come to an end, with the IMF, World Bank and Asian Development Bank agreeing to bailout the country with a $5.5bn package at the end of February. This the 6th time since 1924 that Mongolia has needed the help of a foreign government or organization. This issue came to a head when the government said it would be unable to pay a +$500mm note due in March from the Development Bank of Mongolia. Mongolia did a good job of communicating with investors who swapped bonds due 2017 for 2024 bonds and the country was able to offer an additional $124mm in debt, which was 6x oversubscribed. Part of the reason for this though, in our view is irrationality from investors who largely missed out on the recovery of coal and copper prices.
The countries foreign reserves have plummeted since peaking in 2011 at ~$5bn and the country now has less in foreign reserves than its deficit of -$1.5bn in 2016. The country’s government lacks the resources to build and grow in the way that Russia and China can (build first and have people come after), but it is unable to escape this command economy style of growth. The expansionary policies of the last five years have been largely disastrous.
Mongolia has had weak leadership since PM Batbold was unseated in August 2012. PM Erdenebat who took office last July has been weak to date but is benefitting from a strong rally in the commodities that drive Mongolia’s economy (coal and copper). We do not have a lot of faith in Edenebat to drive the economy forward but are cautiously optimistic that he will not actively do anything to take the economy off its rails. Expectations with the bailout package and with commodity prices strong are for the economy to grow 7-8% in 2017. This would be a welcome relief for the undercapitalized mining sector which desperately needs foreign investment to push costs down and develop the infrastructure needed to compete on price with Latin America for copper and with Australia/China for coal.
The government also needs to develop consistency with how it negotiates with mining companies. Its interactions with Rio Tinto and Turquoise Hill over Oyu Tolgoi have been terrible for the country’s credibility. Similar to a Mafioso, Mongolia has repeatedly returned to the table demanding more from the mine’s operators because Mongolia has been unable to grow its economy. The hope is that the country has learned its lesson, though we remain unconvinced.
The stock market has rallied almost 15% since November as you can see in the chart below.
One of the key areas of reform associated with the IMF bailout is a diversification of the economy away from mining, this makes sense over the long-term but we think it is foolish to focus on in the immediate-term. Mining is Mongolia’s future for the foreseeable future. The way to survive the next downturn is by coming down on the cost curve for production, not to shy away from your most abundant resource (estimated value of $3 trillion).
The arrogance in Mongolia that came with growth has resulted in a limited vision for glaring weaknesses in the economy, the financial sector is in tatters and lacks a coherent economic or social policy. The last 5 years may be summed by inefficient capital expenditure that had no clear objective.
What would we like to see?
Before we make a bullish call on Mongolia, we would like to see the following:
- A coherent approach to mining investment and infrastructure. In particular, the elimination of the ‘strategic’ designation for mining assets that enables the government to step in and renegotiate previously agreed terms.
- An open immigration policy that aggressively encourages high population-growth centers such as East Africa and South Asia to immigrate to Mongolia. This will take time, as racism has been an issue in Mongolia, but that has not stopped economic growth or immigration in other countries. Mongolia simply put, lacks the population it needs for a country of its size. For reference, Mongolia has the lowest population density in the world. As it gets wealthier, Mongolia’s population growth will turn negative very quickly, and immigrants must be welcomed and provided citizenship for the country to have any chance at success.
- A consistent approach to social services across the country. To date, improvements in education or healthcare have been entirely focused on Ulan Bator rather than on smaller centers like Erdenet and Darkhan. We think it is critical to Mongolia’s long-term interests that the entire country be improved to basic levels. Mongolia does not have the population size to be able to grow in a way that South Korea could, with its focus on Seoul.
If we see a movement from the government towards this, then we would quickly become bullish on the country that has so much potential. Until then, we watch and we wait.