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Mongolia: BRIC-ing Up is Hard to Do

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Mention Mongolia, and most people will conjure images of horse-mounted hordes rushing across the Asian steppes, building the largest land empire the world has ever seen. While Mongolians are understandably proud of their heritage, which has included ruling three present-day BRICs (China, India, Russia), much of the Middle East and parts of Eastern Europe, the Mongolia of today is a much smaller affair, consisting of just over three million people—approximately the population of Jamaica—scattered across an area roughly the size of Iran.

Although there are a some attractive features to Mongolia as a frontier market, investors need to be very aware that this is ultimately a very small country with a difficult-to-convert currency, scarce economic data, no direct access to the sea, a very small public stock market, and potentially serious liquidity constraints. Foreign direct investment, particularly in the mining sector, does make sense for multinationals, and investing in companies pursuing ventures in Mongolia may make sense for the portfolio investor. Tourism is another sector that shows promise, as there are still large wilderness areas and a Buddhist cultural history that is peaceful and attractive to those seeking a break from a hectic modern life.

Mongolia shows up on investors’ screens because it has generated impressive economic growth from 2003 up to the 2008 financial crisis and has recovered reasonably well since 2009. Over this period, the economy grew at roughly 9% annually: among the highest rates in the world, and only slightly lower than China itself. During this time, the total market capitalization of the Mongolian stock exchange also rose impressively, growing 10-fold over the 2.5 years between 2006 and mid-2008. These two features naturally caught investors’ eyes, making many wonder if Mongolia could be an up-and-coming China—if not in terms of population and total output, then at least in terms of capital and economic growth.




Table 1 compares Mongolia to other countries in the region and the world. At just under $9.5 billion, its 2009 GDP (at Purchasing Power Parity) is indeed very small, roughly in line with the islands of Malta or the Bahamas. With just over three million inhabitants, the per capita GDP is approximately $3,100 per year, or approximately the level of India, Vietnam, and the Philippines.

Table 1: Mongolia Compared to Select Countries

Table1 Sheet1

Source (accessed August 29, 2010): CIA World Fact Book, World Bank Data (5y growth), Transparency International, Heritage Foundation.

Mongolia does score well in literacy and human capital measures, and also ranks higher on economic freedoms than either China or Russia. An advantage in Mongolia is the equal treatment of foreign and domestic capital, and the relative ease of setting up and shutting down businesses.

The small stock market is a major challenge to portfolio investors. At roughly half a billion in total market capitalization, the entire market is smaller than the smallest S&P 500 component by half. This means that liquidity and absorptive capacity can be a major investing problem, and large investors either have to pursue direct investment or be willing to hold large portion of the entire stock float and stay for the long term on what could be a bumpy ride.




Geography affects all countries, but Mongolia’s constraints are particularly acute. The country is landlocked, with two large BRIC countries—Russia and China—forming its only borders with the outside world. Even air access to international marketplaces is remote, meaning that transporting goods by air is expensive, and land-based freight is dependent on good relations with Russia and China.

Presently, relations with both countries are healthy, but neither can be taken for granted. Russia has been known to cut off oil and natural gas supplies to neighbors as a foreign policy tool and has even invaded neighboring countries, such as Georgia in 2008. Mongolia is almost entirely dependent on Russia for its oil and natural gas.

Relations with China are also positive at present, with China receiving 79% of Mongolia’s exports (mostly mineral inputs to Chinese industry) and providing 43% of imports, according to the Economist Intelligence Unit, but any problems in or with China could prove disastrous for Mongolia’s economy, both from the decline in export income and from the loss of access to finished goods.

Longer term, the Chinese province of Inner Mongolia is historically Mongolian, but did not succeed in establishing independence in the early 20th century. Although this is not presently an issue, it could become a point of contention as Mongolia grows wealthier and establishes a stronger identity independent of both Russia and China. Nationalism is a strong and sometimes uncontrollable force throughout the region.

Figure 1: Mongolian Export Destinations and Import Origins

Principal Export Destinations of Mongolia

Principal Origins of Imports to Mongolia




China’s Manchu Qing emperors conquered Mongolia between 1691 and 1758 and incorporated it into the Chinese Empire. In 1911, as the Qing dynasty collapsed and China fell into warlordism, what was then the province of Outer Mongolia declared independence and established the bounds of present-day Mongolia. Chinese forces attempted to retain control by invading, but when the Soviet Union decided to intervene in 1921 to facilitate the creation of a communist Mongolian state, Mongolia was finally able to expel the Chinese for good and achieve official independence, but effectively only as a Soviet client state.

Mongolia’s politics and economy through most of the 20th were modeled along Soviet lines, including one-party rule under the Mongolian People’s Revolutionary Party (MPRP), a cult of personality, the elimination of private property, collectivized agriculture, and central economic planning. As the Soviets began glasnost and perestroika programs in the 1980s, Mongolia also began to liberalize, and, in 1990, a democracy movement, demonstration, and hunger strike resulted in the resignation of the Mongolian Politburo and opened the Great Khural (national assembly) to multiparty elections.

The MPRP (the communist party) won initial elections in 1990 and 1992 (when a new constitution was adopted), but lost to the opposition Democratic Party (DP) in 1996, and the two parties have alternated majorities in the Great Khural ever since. The MPRP presently holds a majority, but elections frequently involve irregularities and losers accusing the winners of fraud. In 2008, an MPRP victory resulted in demonstrations in which five demonstrators were killed and MPRP party headquarters was set on fire. Elections for a largely ceremonial President went to the DP party this year instead of the MPRP for the first time, and power was transferred without incident.

This history is relevant because much of Mongolia’s political and economic transition was primarily controlled from above by the previous ruling party, which did privatize property and introduce market and electoral reforms, but without ever fully discrediting the previous system. Instead, it was modernized for political expediency, and the long-term commitment to democratic and market principles is therefore difficult to evaluate and should not be taken for granted.

Presently, Mongolia scores higher than either China or Russia on the Heritage Foundation’s economic freedom index, and also Freedom House’s 2010 political freedoms survey. Both of these are substantial accomplishments, but there is slippage through the effects of corruption, particularly within the judiciary. These effects mean that guarantees on paper may not always be enforced effectively and may be subject to changes in the future. For the present, foreign capital generally benefits from this slippage, as foreigners can often provide more attractive patronage than their local competitors.




Figure 2 shows the growth of Mongolian real GDP since 1990, when modern accounting figures became available. The figure shows a contraction of economic activity during the initial transition from a centrally planned economy, followed by slow growth until 2003, when there is a massive spike in GDP production followed by much more rapid growth.

Figure 2: Evolution of Mongolia's GDP 1990–2010

Figure 2: Evolution of Mongolia's GDP


In 2003, Mongolia successfully renegotiated US $11 billion owed to Russia down to $300 million, freeing up both its ability to pay interest payments and its ability to borrow for future investment, resulting in a massive jump in available capital and GDP output. This debt had previously constituted roughly 1000% of GDP and afterward represented only 30%. At the same time, China’s skyrocketing growth and industrial needs provided a ready export market for Mongolian mining products and a source of relatively hard currency to manage debts through the close Yuan-Dollar linkage. These two factors combined to give Mongolia the extraordinarily high GDP growth rate that has caught investors’ attention.

A significant trend in Figure 2 is that Mongolia’s investment GDP component has grown substantially faster than its consumption component, indicating that—to the extent that corruption has not created investment waste—additional capacity is being added that will enable future growth. Exports make up about a third of total domestic production and over half of net GDP, and China’s voraciously growing demand for raw materials suggests that this source of growth will continue to perform, with at least some trickle-down effects on domestic consumption. Mongolia does run a small trade deficit, but this is likely justified by the need for heavy equipment and transportation imports.




The risks to Mongolian fundamentals come from excessive exposure to China for its exports as well as dependence on Russia for oil and China for manufactured imports. As its primary exports are mining products, copper, gold, molybdenum, and other minerals, access to overland transport routes is essential, forcing additional dependence on China, since Russia is largely self-sufficient in these products. Mongolia does sport high literacy rates and a relatively large university-educated population, but it is not truly able to compete internationally in business services.

In addition, investors should be aware that the political and economic configuration favors the development of a rentier state in which profits from mining and quarrying activities accumulate to a small minority class and do not spread substantially throughout the rest of the economy. Not only does this place the growth of other sectors in doubt, but this can be the source of violent conflict as various groups vie to control the country’s most valuable industry. Thus far, this kind of predatory state has been kept at bay, but watchful investors will keep an eye out for this possibility.

Figure 3: CPI Year-on-Year inflation: 2000–08

Annual CPI Inflation in Mongolia

Sources (accessed August 31, 2010): Bloomberg for 1999–2008; Economist Intelligence Unit for 2009.

Mongolia has experienced relatively high but not quite hyperinflationary inflation since 2000, as shown in Figure 3, and it experienced genuine hyperinflation in the early 1990s. Part of the recent inflation may come from the voracious demand for investment in mining, which is capital intensive and draws capital away from the production of other locally needed products. Only 1% of Mongolia’s land surface is arable, and although there is some additional pasture for grazing animals, Mongolia is highly sensitive to inflation in food and agricultural inputs, as well as the cost of energy. In 2007 and 2008, commodity inflation benefited Mongolia through increased export revenues, but the inflation in fuel and food prices hurt.




Mongolia has grown substantially as a raw materials supplier to China, with real GDP growth nearly as high as China’s. This growth story is real and likely to continue over the near-to-mid-term future, but it is not without risk. Mongolia’s economy is relatively un-diverse, highly exposed to China and Russia’s politics and economy, potentially prone to Dutch disease and rentierism. The political environment is presently favorable to investment, but needs continued monitoring. The small market capitalization also makes portfolio investments in Mongolia difficult, but direct investors or investors in multinational companies active in Mongolia can benefit from the dynamic. To the extent that the market is fairly priced, investments in Mongolia should earn a substantial risk premium. But do not confuse a substantial risk premium with an excellent investment opportunity: the high growth rate can be good, but it comes with risk attached.

A follow-up piece will discuss Mongolian stock and currency developments.



Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Global Research and Consulting, an independent consulting firm specializing in macro strategy, including quantitative, emerging market, and SRI research.

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