Summary
On Oct. 26, less than a month after Mongolia's parliament voted to scrap a foreign investment law designed to prevent Chinese state-owned enterprises from gaining footholds in strategic sectors, Mongolian Prime Minister Norovyn Altankhuyag completed a four-day state visit to China. Throughout his visit, Altankhuyag reassured Chinese investors and political leaders that Mongolia, a darling-turned-pariah for investors in emerging markets, welcomed the friendship and business of its southern neighbor.
Nonetheless, as China's leaders are well aware, Mongolia can be a fickle business partner. With interests in Mongolian resources that are both strategic and economic, Beijing knows that no shift in the tone of Chinese-Mongolian relations is likely to be a permanent one. Still, the recent scrapping of the investment law and Altankhuyag's visit could signal a change in Mongolia's attitude toward investment from China.
Analysis
Altankhuyag's visit, which included stops at the West China International Fair, a major investment forum held annually in Sichuan province, and meetings with Chinese President Xi Jinping and Premier Li Keqiang, comes at a critical moment for Mongolia. In just over one year, Mongolia has seen its investment reputation and economic fortunes spiral downward -- a process that began with the government's move to block a $926 million bid in 2012 by state-owned Chinese aluminum enterprise Chalco to take over SouthGobi Resources, which operates the massive Ovoot Tolgoi coal project near the Mongolia-China border.
To formalize that block, Mongolia's parliament rushed to pass the Strategic Entities Foreign Investment Law in May 2012. The law required parliamentary approval for all foreign investments of more than $60 million in strategic sectors such as coal mining and banking, thus giving Ulan Bator the legal right to overturn Chalco's bid and to prevent future foreign investments that it believes would threaten Mongolian strategic interests. Indeed, passage of the law resulted in Chalco's ending its takeover bid. It also raised concerns among non-Chinese foreign investors over the country's long-term political and regulatory stability. These concerns have only been exacerbated in 2013 by Ulan Bator's wrangling with Australia-based mining company Rio Tinto over the ownership structure of Oyu Tolgoi, a multibillion-dollar gold- and copper-mining project.
Foreign investment in Mongolia plummeted nearly 50 percent year-on-year in the first eight months of 2013. Investors, especially in the mining sector, which accounts for around 20 percent of Mongolia's gross domestic product and has seen the most foreign investment in recent years, have fled the country over the past year. They were spooked by a combination of falling international commodities prices and unpredictable legal and political systems in Mongolia. In an emergency effort to counteract declining foreign investor confidence in those systems, Mongolia's parliament approved the draft of a new investment law Oct. 3, following an emergency session in late September.
The new law largely does away with the earlier Strategic Entities Foreign Investment Law, eliminating its most controversial measures (such as the government approval requirement) while promising a more stable tax regime and full legal protection of future investments. Since the introduction of the new law, there have been small, tentative signs of thawing investor sentiment toward Mongolia. Negotiations with Rio Tinto seem to have pushed beyond their earlier deadlock, and several smaller Canadian, Australian and French firms have expressed renewed interest in the country's mining sector. But it remains to be seen whether the new law will be enough to rekindle long-term investor confidence, especially at a time when stagnant or falling prices for most major commodities have forced many of Mongolia's largest potential investors -- multinationals like Rio Tinto -- to cut back on capital expenditures elsewhere and refocus on more secure opportunities.
Against this backdrop, Altankhuyag's visit to China may be an attempt at a detente of sorts between the two countries, or a show of penitence on Mongolia's part. The visit was not ostensibly tied to the passage of the new investment law or Mongolia's recent troubles -- it was scheduled long in advance of the Oct. 3 vote. Nor did it result in any concrete new investment agreements between the two countries. But given the circumstances, the message of Altankhuyag's visit was clear. Mongolia badly needs capital (Ulan Bator's long-term ability to finance the debt it has racked up in recent years is contingent on the resumption of foreign investment), and China is one of the few countries able and willing to provide capital on a substantial scale. At the very least, as Ulan Bator understands, Mongolia cannot afford to further alienate China, which will continue to be Mongolia's only real customer for many years to come.
During Altankhuyag's visit to Liaoning province, provincial governor Chen Zhenggao complained of "problems with transportation and logistics infrastructure" between the two countries, and asked Altankhuyag to "solve these problems," according to Mongolia's state news agency. In response, Altankhuyag noted that the government would consider building a railway between Sukhbaatar province and Liaoning's capital, Shenyang. It is unclear if the line would be for freight or passengers, but if it were the former, it would be a significant step forward for cross-border trade (currently, all Mongolian natural resource shipments cross into China by truck; the Mongolian government has resisted cross-border rail lines for freight). In any case, the governor's comment, like the rest of Altankhuyang's visit to China, suggests a shift in the balance between the two countries. With the market glutted, prices falling and private investment flows anemic, Mongolia may be forced to reopen its doors to Chinese capital.
For now, however, Chinese-Mongolian relations -- and Chinese investment in Mongolia -- could remain at a standstill. Notably, the new investment law does not eliminate government approval on investments by state-owned firms -- an implicit rebuttal to Chinese mining companies, virtually all of which are state-owned. But until wider market sentiment improves enough to make Mongolia an attractive business environment rather than simply a strategic-investment target for China, Ulan Bator will likely take a more conciliatory approach to China's overtures.
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