By Misheelt Ganbold, Integrated Investment Policy Department, National Development Agency of Mongolia
Continued from edition No. 8, 31.8.2017 of TMO
5. Implications for and implementations of state ownership in the context of resource development in Mongolia
The state exercising full or partial ownership over natural resources found within its territory usually implies the state’s sovereign right to control and exploit those minerals (Akpan, 2005). In Mongolia, a growing desire for the state to own and control greater stakes in natural resource development could be explained by several factors and implemented through taking different policy measures which either directly or indirectly promote state participation in resource industries.
The long-held nomadic belief and lifestyle of herders in Mongolia is important factor for shaping such trend. Herders not only profit from traditional livestock husbandry, but also rely on livestock for food, housing, and clothing (World Bank, 2009). Therefore, livestock herding was and remains the single most important source of livelihood for people in Mongolia. As herders move seasonally from one place to another, the grazing land is a vital resource. Hence, nomadic herders are the main users of land and their livestock’s viability is substantially dependent on the availability of land. For this reason, herds and land have been long considered as a foundation of socioeconomic stability in Mongolia (Spadavecchia, 2014).
This belief is fully reflected in the major policy framework governing the mining sector. For instance, Article 6.1 of the Constitutional Law of Mongolia (1992) states that “the land, its subsoil, forest, water, fauna and flora and other natural resources in Mongolia shall belong exclusively to the people and be under state protection”. Further, in the Article 3 of the Law on Subsoil of Mongolia (1988) states that “the subsoil of Mongolia is the property of the State or in other words, it is the property of all people of Mongolia” and gives the highest authority to the Parliament of Mongolia in formulating state policy on the use and protection of subsoil. These two articles are thus shaping the fundamental relations with respect to state ownership and control of mineral resources and could be interpreted as bestowing the ownership of natural resources in Mongolia to the state.
However in the recent years, as mining become widespread across the country, many herders were displaced from their land and lost their livelihood, especially in the southern part of the Gobi region where the majority of the very large mining projects are taking place. The loss of biodiversity has been intensified and a number of wild animals have become extinct, and forests and rivers have disappeared due to resource extraction and associated infrastructure development (UNDP, 2011; World Bank, 2009). Since Mongolians are extremely “protective of their land and natural resources” (Krusekopf, 2016, p. 13), there were rising public demands for protecting the environment and falling reputation of foreign investors among rural communities. As a result, many protective decisions and ‘mining-unfriendly’ legislations were introduced by the different state administration in order to control resource development.
At the Presidential level, and due to national security concerns, ordinances were enacted in 2010 regarding the suspension of the issuance of both exploration and mining licenses. The decision was extended until 2014, when the Parliament of Mongolia enacted the “Law of Mongolia on the Repeal of the Law of Granting Exploration Licenses” on 18 August 2014. In addition to that, the Mongolian Parliament itself adopted the “Law on Prohibiting Mineral Exploration and Extraction Activities in the Headwaters of Rivers, Protected Water Reservoir and Forested Areas” (or often called the law with the long name) on 16 July 2009. As a result of this law, over 346 mining companies’ licenses were suspended.
The second critical factor intensifying the role of state participation in resource development is the growing public awareness toward state majority ownership of certain mineral deposits. A general sentiment exists among the public that the government should hold larger stakes in resource projects. This was also reflected in the revised Law on Minerals (2006), the principle legislative act governing the mineral sector. The revised version of the Law significantly amplified the state’s role in granting and developing mineral deposits by prohibiting foreign investors from directly owning mining licenses, placing minimum quotas for local Mongolians employed in mining projects, and establishing investment agreements with the GoM.
Simultaneously, State Ikh Khural also passed the Resolution No. 27 in 2007 to declare 15 mineral deposits as strategic importance (Fig. 2). This concept was embedded in the Article 5 in the Minerals Law. The Law allowed the state to obtain stakes of 34.0 per cent to 50.0 per cent from those deposits depending on whether exploration was funded by state budget or private entities.
Consistent with that, the political barometer conducted by the Sant Maral Foundation in March 2014 (see Table 4) reveals that 55.8 per cent of the people responded that more than 50.0 per cent of the resource should be owned by Mongolians for those deposits of strategic importance.
A quarter of the general public responded that ownership should be 100 per cent Mongolian. However, only 0.8 per cent of the total respondents deemed that foreign investors should be the full ownership of those deposits. This number is even smaller in rural areas (0.4 per cent), where almost all of the mineral deposits occur. Therefore, public opinion framed by legal provision is supporting the role of state ownership stakes in resource projects.
Changing dynamics of geopolitical power between Russia and China is another reason behind state ownership of resource development. Mongolia has long felt geopolitical anxiety towards its two neighbouring countries, China and Russia. Being sandwiched between two of the world’s largest economies, geographical domination is deeply rooted in the public consciousness and Mongolians are concerned over potential threats that could be (and used to be), made by one or both of the countries both economically and politically. In addition, Russia and China have been, so far, the biggest trading partners and dominant players in the Mongolian resource sector (Spadavecchia, 2014). These historical fears have shaped Mongolian politics for many years and influencing resource sector investment policies.
The situation is more severe when it comes to China. This is due mainly to the fact that since 2013, almost 86.0 per cent of mineral exports, mostly non-valued added natural resources are shipped to China (National Statistics Office, 2013). Further, as shown in Fig. 3, more than 50.0 per cent of the mining licenses were held by Chinese companies at the end of 2015. This effectively makes China the only market for Mongolian mineral commodities and the single biggest investor in mining projects. Moreover, growing trade and investment from China, especially in the resource sector, has resulted in a serious imbalance in the Mongolian economy and the total investment made by Chinese firms has already exceeded the limit specified in investment law.
Geopolitical concern with relation to growing investment from China further deteriorated as Chinese state-owned resource company, Chalco’s proposed takeover of “Ovoot-Tolgoi” coal mine, one of the largest coal deposits in Mongolia, from Canadian South-Gobi Resource Company. This deal confronted with strong opposition from general public polling and reflected in similar stances from major political parties. Such overseas investment related disputes around the mining sector has inflated public anxiety over the national security, in particular the foreign state-owned companies intentions to acquiring and controlling mineral deposits in Mongolia could negatively impact on social and economic stability.
As a consequence, the Parliament of Mongolia introduced a very ambitious law, “the Law on Strategic Entities Investment” in 2012. The Article 21.1 of this law outlines sectors of strategic importance to include: (i) mineral resources; (ii) banking and finance; and (iii) media and communications and imposes restrictions and obligations on foreign state-owned and private companies if such business entities intend to acquire one-third or more than 49.0 per cent of the shares from above-mentioned sectors, they need to obtain approval from either government or parliament depending on the size of investment. Thus, for ordinary Mongolians as well as Mongolian government, maintaining state ownership is seen as vital to retain control over the resource project and to ensure national security in strategically important sector such as mining.
As Mongolia develops its abundant mineral resources, local politicians tend to demand more from both domestic and foreign entities operating in the resource sector. This could be attributed to promises made by candidates running in parliamentary election in Mongolia. During the four years election cycle, political parties often declare rather populist manifestos and offer a wide range of welfare programs to the general public in order to take majority seats in the parliament. For instance, during the parliamentary election in 2004, Mongolian Democratic Party (MDP) proposed “Child Money Program”, offering 10.0 thousand MNT (8.30 USD) per month for every child below 18 years. This universal welfare program brought substantial success to the MDP, “forcing the formation of a coalition government” with the Mongolian People’s Revolutionary Party (MPRP) (Yeung and Howes, 2015, p. 10). As government revenues continued to rise in line with the increasing prices of gold and copper in 2006, GoM increased the fund by an additional 25.0 thousand MNT (21.36 USD) per quarter to 136.0 thousand MNT (116 USD) per child per year in 2007, just before next election term.
Again, in 2012, due to the growing popularity of cash distribution campaign within society, the MDP made more aggressive election promises and pledged to distribute 1.0 million MNT per person (855 USD). Similar campaign was introduced by the rival party, the MPRP, which increased the benefits to 1.5 million MNT or approximately 1282 USD per person. Both parties have no specific financial plan to fund such an enormous cash spurred by populism, apart from excessive optimism towards mineral commodity prices and affiliated revenues.
In June 2016, month before the general election, GoM again announced a new plan to purchase 322 of 1072 Erdenes-Tavantolgoi Company’s free holding shares by all Mongolian citizens at 300.0 thousand MNT. Although it is not mandatory to sell their shares to the government, many citizens preferred to receive a cash instead of reserving the stakes. It was declared by the government that the aim of this ‘share-to-cash’ transfer program was to support economy during the hardship, however, it was unclear how to finance this program as state budget deficit had already reached to 1.02 trillion MNT in the first half of 2016 (Ministry of Finance, 2016).
Therefore, in order to fulfil election promises the most politically expedient way for the parties is to initiate different laws and regulations to maintain state ownership status in the resource sector so as to finance their expensive campaigns through ‘ownership credit’.
No doubt, it is relatively common practice in many mineral rich countries that state participation in resource projects can be implemented by a government backed companies established to hold majority or minority equity in joint companies (Halland et al., 2015). However, in the Mongolian case, overwhelming political interventions and growing conflict of interests in state-owned mining companies exacerbate good governance practices and lead to poor corporate performances (Open Society Forum, 2014). According to the assessment results of the Resource Governance Index, developed by Natural Resource Governance Institute (NRGI), state-owned Erdenes MGL has shown a rather disappointing corporate governance performance, ranked at 25th among the 33 state-owned companies in different countries Relatively promising results on the institutional and legal setting in the resource sector was contrasted with poor transparency, reporting obligation, and shareholders accountability of state owned mining companies (NRGI, 2015). A more detailed study conducted by Open Society Forum and Ministry of Mining also reveals the same picture (Fig. 4 ).
The ratings for the corporate governance performances by fully and partially state-owned mining companies demonstrate that a significant shortcoming was recorded on the enforcement of rule of laws at all mining companies with a government stake. Yet, better ranking was given to Oyu Tolgoi Company, where state holds minority shares. In contrast to Oyu Tolgoi, both Erdenes MGL and Mon-Atom, fully state owned enterprises, received the lowest scores. This poor ownership performances might be explained by political interferences and regulatory burdens on the actions taken by those companies. Because Erdenes MGL and its portfolio companies are the single largest revenue contributors to the “Human Development Fund” (HDF), a government special fund designed to finance almost all the social welfare programs proposed by the government. Hence, it is arguable that either fully or majority owned national resource companies are more likely to seek non-business objectives than minority-owned business entities (Cuervo-Cazurra et al., 2014).
GoM’s intention to direct ownership of major mineral deposits made several valuable mining projects unfeasible. Mismanagement of the strategically important Tavan Tolgoi coking coal deposit, the world’s largest untapped coking coal mine is a case in point. The government’s attempt to develop 6.0 billion tons of coal deposits on its own stalled despite receiving 250.0 million USD from Chinese state-owned aluminium company Chalco as pre-payment for future coal supply. Although the loan was planned to cover funds required to expand the mine infrastructures, GoM redistributed 200.0 million USD to the public as “aims of the motherland” through the HDF in 2012 which led to a derailing of the larger project.
In the late 2014, the GoM introduced a new plan in the West Tsankhi part, one of the five blocks of the entire deposit and reannounced an open tender for selecting the potential investors. This time, consortium led by Japanese Sumitomo, Chinese Shenhua, and the Mongolian Mining Corporation were selected as potential operator. The tender was for the construction of 267 km of railway from the mine site to a Chinese port, the expansion of a coal processing plant, and the construction of related utilities. Unfortunately, negotiation was hampered by political impediments and rising concern about loss of state control over the deposit.
Apart from the Tavan Tolgoi project, many other resource projects such as underground mine expansion of the Oyu Tolgoi project, the Dornod uranium project (owned by Canadian firm Khan-Resources), and the recent negotiation on development of Gatsuurt gold mine by Canadian Centerra Gold and GoM, and most recently, Mongolian Copper Corporation’s acquisition over the state-owned Erdenet mining company’s 49.0 per cent from Russian industrial giant Rostec corporation have been repeatedly facing sanctions from politicians and their supporters.
As more mines develop, both the economy and the state budget have become excessively dependent on the cash generated from mining operations. This makes the overall economy vulnerable to the prices of a few minerals. As a result, minor fluctuation on commodity prices reduces the export revenues from the resource sector substantially, which generates sharp decline of economic growth. For instance, the recent mining downturn led to the Mongolian economy shrink to 2.4 per cent in 2015 from 17.3 per cent in 2011 (National Statistics Office, 2015).
Instead of investing in more productive assets or building up adequate financial reserves during the high resource prices in 2011, GoM’s expenditures on social welfare increased by 56.0 per cent (Wacaster, 2012) and the profits generated from equity participation in mining projects were exhausted on a wide range of social programs. In return, fiscal deficit soared sharply and foreign investments plunged by 80.0 per cent in 2014 (Bank of Mongolia, 2014) when Mongolia experienced the downturn of the mineral cycle. During this time, many enterprises faced insolvency risk and unemployment rose dramatically.
In order to mitigate such adverse impacts, Parliament of Mongolia adopted the “Law of Mongolia on Fiscal Stability” on 24 June 2010 and established a sovereign state fund, the Fiscal Stability Fund. As stated in the Article 16.1 of this law, the fund shall be established for the purpose of ensuring medium term fiscal stability. According to Ministry of Finance (2014), the balance of the fund had reached to 107.8 billion MNT (57.08 million USD) as of 2014, far lower than the initial projection of 500.0 billion MNT by the end of the 2013 fiscal year.
Direct state ownership “puts the government in a conflict of interest position” (Krusekopf, 2015, p. 22) as it is both initiating and imposing rules and regulations for the sector, while also acting as an owner impacted by those rules. This raises important questions about whether the state can introduce and implement sound mining policies which are separate from its desire to control and own resource projects.
The growing role of state ownership in resource development tends to weaken institutional strengths. According to World Bank Governance Indicators, Mongolia entered the resource boom with moderate institutional performance compared to similar resource-rich developing countries such as Kazakhstan, Turkmenistan, and Azerbaijan. However, this performance has declined sharply in the past few years (Isakova, Plekhanov & Zettelmeyer 2012). As the state involved significantly in mining projects, the quality of institutions further deteriorate- corruption, bureaucracy, and abuse of power have become common phenomena- especially at the judiciary, parliamentary and top government officials level (Chene, 2012). All these challenges expose fundamental shortcomings of state ownership in the absence of institutional capacity within the government.
As a resource-rich developing country, Mongolia needs to strengthen the quality of its institutions to better respond to uncertainty in commodity markets and manage its mineral wealth as efficiently as possible. However, the increasing role of state ownership in mining development has led to a perception that efficiencies may be stifled by political interference.
As the state becomes more involved in resource development, local political institutions tend to use direct state ownership to control major mining projects with the aim of capturing greater economic rents from mining for public expenditures. This has been increased by the growing public concern regarding foreign control over the lands and resources belonging to the Mongolian people. Indeed, resource nationalism provided favorable conditions for the emergence of a wide range of populist policies by the state such as cash distributions, windfall profit taxes for major resource commodities such as copper and gold, and restrictions on new exploration licenses.
The dual role played by the state in the mining sector creates a substantial conflict of interest. As the state becomes both the owner and operator of resource projects, the GoM faces inconsistences between policy formation and implementation. Instead of being a responsive regulator and manager of the resource industries, the state tends to accumulate overwhelming financial liabilities through equity participation in mining projects, which pose significant financial and economic risks. As a result, the role of state ownership in mineral projects hinders long term development prospects as Mongolia experiences the pre-maturity stage of resource development.
Therefore, resource nationalism in Mongolia is “revolutionary” in cadence and following a rentier state model; instead of development-oriented, economic resource nationalism to promote industrialization and economic diversification (Wilson, 2015). From this, one may conclude in this context that the fundamental driving force of state ownership in resource projects is not to exercise its sovereign rights over the mining sector, but to gain political advantages.
The state’s misplaced and mistimed equity participations through its subsidy companies made a number of profitable mining projects stagnant and subject to political interests. As the state involves excessively in resource development process, it tends to hinder profitability of the mineral projects and can often postpone the project commissioning period due to internal conflict among local politicians. These delays and ambiguity over the political decisions create a serious lack of confidence among investors and can lead to a diminution in foreign direct investment.
Based on our analysis, we can offer the following policy recommendations on this case:
• Strengthen the institutional capacities and ensure the strong enforcement of rule of laws. It seems that Mongolia has already established a core legal setting in the resource industries, however, this effort was stalled by the poor enforcement of respective laws and regulations. Therefore, the role of state in the mining sector should be to safeguard and improve the legal environment.
• Reduce state intervention in mining sector and adhere to strict budget discipline during the mining boom. This will enable windfall mining revenues to be used to finance social welfare programs and populist policies (Auty and Warhurst, 1993). The formation of a “Spending Rule” (Larsen, 2005, p. 82) which limits public spending (similar to that which applies to Norwegian government profits generated from oil and gas industries), is a possible solution.
• Restructure the HDF and devote its assets into more productive investment alternatives, including public education and health. Although public expenditures in Botswana reached about 30.0 per cent of GDP (per capita of 43.0 per cent) in the early 1990s, far higher than any other developing countries, the investment was directed towards eliminating for the country’s infrastructure bottlenecks and improving education and health services. As a result, average life expectancy extended from 51.9 in 1970 to 65.3 in 1993 while literacy rates increased from 41.0 per cent in 1970 to 74.0 per cent in 1993 (Auty and Mikesell, 1998).
• Accumulation of the resource revenues in “Fiscal Stability Fund” to respond future commodity price fluctuations. Chile established an “Economic and Social Stabilization Fund” while Norway created a “Government Pension Fund” from their partial mining revenues and successfully managed the economy and ensured political stability during the fall in mineral prices (Gylfason, 2011; Gladstone, 2008). In Mongolia, a proposed draft Law on the Sovereign Wealth Fund Management and the establishment of a “Future Heritage Fund” are expected to provide an incentive for future savings.
• Separate and prohibit state interference in the operation of SOEs and allow SOEs more authority to engage in resource projects and provide them with an environment in which they can act independently. Norway’s state-owned resource company Statoil can serve as a sound model in terms of good governance practices and strong commitments made by the corporation itself to managing public assets under the most transparent, responsible, and profitable principles.
While these recommendations may seem unpalatable to the general public in the short-term, if appropriate levels of expectations and timelines are provided they can indeed be sellable. Mongolia’s experience with resource nationalism suggests the need for a more informed engagement with the public on the current capacity of state institutions. International development donors must also consider institutional capacity in resource-rich countries as a priority for aid programs. Such institutional development can facilitate a more positive form of economically expedient resource nationalism in which the state works with foreign companies in a collaborative and professional manner. SOEs have the potential to succeed in delivering development outcomes but they must be a means towards facilitating positive economic activity rather than becoming an end in themselves.
Reprinted with due permission by the author. The article was published inResource Policy academic journal, Edition 53, in 2017. URL – https://doi.org/10.1016/j.resourpol.2017.05.006