Macroeconomic performance

Economic growth, underpinned by a mining boom, has been decelerating. From the peak of 17.3 per cent in 2011, GDP growth slowed to 12.3 per cent in 2012 and further to 11.7 per cent year-on-year in 2013, and then to 5.3 per cent in the first half of 2014. While commercial shipment of copper concentrate from Phase I of Oyu Tolgoi, one of the largest copper and gold deposits in the world, started in July 2013, work on the second phase of the project has been suspended as the government and Rio Tinto, the majority owner of Oyu Tolgoi, seek to agree on issues related to the terms of investment and tax payments.

Mongolia’s external position has been adversely affected by a combination of lower coal exports, a softening of copper prices and a drop in inward foreign direct investment (FDI). FDI declined from the record-high levels of 2011 and 2012 (over 50 per cent of GDP and over 35 per cent of GDP, respectively) to 18 per cent of GDP in 2013. As a result, inflows of FDI no longer fully cover the current account deficit, which narrowed slightly in 2013 but remained large (estimated at 27 per cent of GDP). Consequently, external debt has been rising rapidly, the international reserves have declined, and the togrog has been depreciating against the US dollar.

Procyclical fiscal policies contribute to economic vulnerabilities. The effective budget deficit in 2013 is estimated to have exceeded 10 per cent of GDP if quasi-fiscal operations of the Development Bank of Mongolia, a state development bank created in 2011, are taken into account. This goes against the spirit of the Fiscal Stability Law, which came into force in 2013 and imposes a structural deficit ceiling of 2 per cent of GDP. Against this background, yields on dollar-denominated bonds issued in 2012 rose by several hundred basis points, and in April 2014 the ratings agency Standard & Poor’s downgraded Mongolia’s long-term sovereign debt by one notch, to B+. Inflation has remained volatile, predominantly at elevated levels (15 per cent at the end of June 2014), reflecting pressures from higher import prices as well as expansionary fiscal policies.

Output growth is expected to moderate but remain relatively strong. It will continue to be underpinned by large mining projects and the substantial investment they bring, provided that an agreement can be reached in a timely manner between the government and the private investors in Oyu Tolgoi. At the same time, as Mongolia’s dependence on copper, coal and gold grows, the economy may become increasingly vulnerable to sharp corrections in commodity prices.

Major structural reform developments

A new investment law came into force in November 2013. It replaced the Law on Foreign Investment in Strategic Industries adopted in May 2012 and subsequently amended in April 2013. Under the new law, which in general provides for national treatment of private foreign investment, investors are able to apply for special certificates grandfathering them from changes in the tax regime over a period of 5 to 22 years. At the same time, foreign-controlled investments in strategic industries, including mining, banking and telecommunications, will still be subject to special government approval if foreign investors are partially or fully owned by the state. The exact modalities of the approval process in these cases are yet to be fully developed. They may to a large extent determine whether the adopted changes will be effective in helping to scale up investment.

A new securities law strengthened the legal framework for capital market development. The law, which became effective in January 2014 and replaced legislation dating back to 2002, introduces dual listing of shares on Mongolian and international stock exchanges and strengthens disclosure requirements for listed firms, including information about shareholders, management and the organisational structure of firms. The law also spells out 14 activities that are subject to licences issued by the Financial Regulatory Commission of Mongolia (FRC). These include credit rating services, securities brokering and dealing, and investment fund and asset management activities. In particular, by developing the industry of domestic credit rating agencies that rate medium-sized companies listed or preparing to be listed on the Mongolian Stock Exchange, investors should be able to obtain information on potential investee companies more easily.

The new securities law also explicitly covers depository receipts and custodian banks and introduces a distinction between nominal and beneficial owners of securities. It is complemented by the new Investment Funds Law, which also came into effect in January 2014. The FRC approved a number of implementing regulations in connection with the new laws, while in some areas sub-law regulations are yet to be developed. Work on a number of other pieces of financial markets legislation, including pension funds and foreign exchange derivative products, is ongoing.

A number of recent reforms aim to improve the overall business environment. Some requirements relating to the registration of a new firm have been abolished, and procedures for obtaining a construction permit for projects deemed to pose low and medium risks have been streamlined. Certain fees for electricity connections have been eliminated. There is scope for streamlining various regulations further, as Mongolia ranked 72nd out of 189 countries in terms of ease of doing business according to the World Bank Doing Business 2015 report. In July 2014 parliament passed amendments to the minerals law, which increase the area available for mining exploration, lengthen the exploration period to a maximum of 12 years and end the suspension of the issuance of mining licences. Amendments to the petroleum law, also adopted in July 2014, provide for an extension of the exploration period, clarify the role of the government in production-sharing contracts and explicitly allow for the export of crude oil. In the same month Mongolia signed a free trade agreement with Japan.

Access to finance and land, trade regulations and customs, and inadequate workforce skills are all perceived as key obstacles to doing business. These are among the main findings of the latest round of the Business Environment and Enterprise Performance Survey (BEEPS V) conducted by the EBRD and the World Bank. Around 22 per cent of respondents to the BEEPS, who are top managers of surveyed companies, consider access to land to be a major or very severe obstacle to their firm’s operations. This is a higher percentage than in the previous survey conducted in 2008-09. The percentage of managers who view lack of skills as a major or very severe obstacle has also increased since 1999.

In May 2014 parliament adopted a broad economic reform agenda, referred to as the hundred-day programme. The programme seeks to: streamline public spending and strengthen budgeting; further develop key infrastructure, including through use of private-public partnerships; streamline tax administration; introduce a new law on movable pledges; strengthen corporate governance at the Development Bank of Mongolia; support small and medium-sized enterprises; and review policies in a number of sectors, including mining.