Countering the cycle: Spending mineral revenues to build up local manufacturing capacity

While Mongolia may seem an unlikely place for export-focused manufacturing, it is becoming less so. The country is remote, it has a small labour pool and it cannot be described as inexpensive. The local market is small and it has little in the way of an industrial tradition. However, the economics of manufacturing work for a rather wide range of goods. Mongolians need and can now afford many products, and in many cases – especially when it comes to foods and beverages – it makes sense to manufacture domestically. The argument in favour of heavy industry and downstream processing is also strong, but it is driven as much by strategy, security and politics as it is by economics. Light manufacturing is driven more by necessity and is expected to remain a compelling proposition for years, especially if the tugrik remains weak. “You can actually produce everything here in Mongolia,” said L. Myagmarjav, managing director of MCS Coca-Cola. “Over the past few years local production has been growing, and it is better for Mongolian consumers and the economy.”

Buy Or Build

For Coca-Cola, the buy-versus-build calculation is constantly being fine-tuned, with varying conclusions being reached. For example, the company runs a bottling line that can handle a wide range of sizes, and it manufactures a number of drinks locally, including Coca-Cola and Bonaqua water. However, it has chosen to continue importing canned drinks, such as Schweppes tonic and soda waters, from Hong Kong for the time being. Building a canning line is a big investment, and at this point the company can serve most of the market with bottles. The Mongolia Beverages Company chooses to import Heineken from Russia rather than manufacture locally. The beer is driven over the border from Irkutsk, where the parent has a brewery. In recent years, some beverage makers in Mongolia have miscalculated in this respect. One company started importing fancy flavoured drinks from Japan. At first, it was a good business decision; Japanese products are popular with Mongolians. However, as the tugrik started to fall and these products began selling for thousands of tugriks, sales dropped.

Changing Tastes & Budgets

Domestic manufacturing is already on the rise and it is likely that the trend will continue (see analysis). While it is impossible to know what will happen with the tugrik, it is clear that the habits, tastes and budgets of the average Mongolian are going to become more realistic as the economy settles. One or two years ago, it was conceivable that the country could simply import everything it needs by spending its mineral wealth, and the shops were teeming with imported goods. The consumer was relatively price insensitive too, given the subsidies they were receiving and the bright future of the country. Now it is more or less certain that it will not be possible to simply ship everything in and that a productive economy is going to have to develop and complement the resources economy. Looked at the other way, this transition will be good for the country, as a manufacturing base will serve to take the edge off future volatility in the mining sector and offer employment to a wide range of people who might not otherwise work.

The country, of course, faces great challenges ahead in building to manufacturing, the main one being China. Mongolia is smack up against the “factory of the world”; the sheer scale and size of China makes it almost impossible to match its quality or price for anything that is mass produced or requires a large capital investment. Because of where Mongolia is situated, with no port, far from any overland markets, and given its poor infrastructure, exports of all but local specialty items and commodity-related goods are very difficult. Mongolia, it should be noted, is not a cheap country for manufacturing. In addition to the high costs, especially in terms of transport, labour is also expensive. In May 2013, the minimum wage went from MNT140,400 ($88) per month to MNT192,000 ($120). While wages may now be higher in China, they are still lower in other manufacturing centres in Asia. Mongolians also lack East Asian perspectives toward work. They seek more to maximise profit, rather than making sacrifices for their vision of the country or the economy.

Wage pressures have been especially high in recent years as the country started to distribute mineral wealth. While the numbers have not been great in absolute terms – the subsidies were never more than $50 a month for most people – the payments do affect the decision-making process of the average Mongolian; for a time it was more economical to not work than to work for very low wages. The mineral wealth has also has an impact on expectations. A few years ago, the people of the country felt that they were going, eventually, to be rich, so there was little interest in manual labour.

Bottlenecks

The state of the labour market is unlikely to change dramatically in the near term. While Mongolia could potentially take advantage of the fact that it borders China, one of the most populous countries in the world, as well as capitalise on its relatively good relations with one of the globe’s poorest nations, North Korea, it cannot simply import labour. Largely due to nationalistic sentiments, the country limits foreign workers to 3% of the population, and foreign workers from any single country to 1%. A 2008 agreement allows North Korean guest workers into the country (and the practice is said to go back to 2004), but the number has never been greater than 5000, or 0.25% of the population.

However, some of the country’s disadvantages may, in the end, have positive outcomes. For example, the isolation makes it costly to bring in manufactured goods, improving the case for domestic production. Coca-Cola said that the bottleneck at Zamyn Uud is particularly problematic, especially when it comes to moving food products. The decision by the company to make Minute Maid products in Mongolia was not an obvious one, due to the availability of the juices in China. However, given difficult transport, it was in the end worth it to make the investment in production facilities and just transport the concentrate rather than the finished product. Higher wages and loyalty to local production also help somewhat. With incomes increasing, domestic demand is strong, and that encourages manufacturing, while national pride pushes sales at the margin more towards Mongolian producers when they exist.

Years Of Decline

The story of industry in the country has been one of rise, collapse and then recovery. With Soviet support, manufacturing grew in Mongolia and just before the democratic revolution accounted for one-third of the economy. Development began in the 1930s with the formation of the Choybalsan Industrial Combine, where a number of basic products were manufactured ( including soap, shoes, blankets and clothes). After the war, industry was further promoted, and while much of the activity was resource related processing, light industrial capacity was also built up. A wide range of products were made, including processed meats, furniture, matches, dairy products, prefabricated housing, carpets, leather coats, paper, candies and biscuits. However, once Soviet subsidies ended, demand dropped and many of the enterprises were unable to remain open. Much of the country’s economic activity was artificially propped up by the Soviets – Mongolia’s debt to the Soviet Union ended up being about 30 times the value of GDP.

Manufacturing dropped steadily for more than a decade after the democratic revolution, and it was dealt another blow in 2005 when the Multi-Fibre Agreement (MFA), which set quotas on clothing-related exports to the developed world, ended. The system gave countries like Mongolia an advantage. Quotas were rationed in such a way that large economies, such as China and India, were limited in how much they could sell, and that gave less competitive economies, such as Mongolia, an opportunity. Once the agreement ended, Mongolian makers were forced out by Chinese competition. It was a big blow for the local manufacturing sector; textiles and garments were estimated at the time to be the number two export (minerals were number one).

The Return Of Manufacturing

But the demise of the MFA did not seem to slow the manufacturing recovery much, and the sector has been growing by most measures since bottoming out around 2000. As a percentage of GDP it has not staged much of a comeback; it has remained at around 7% since 2002, and dipped as low as 6% in 2006. But in that time, the overall economy has been growing fast and manufacturing has been holding steady, increasing with the rapidly rising GDP. While the country has not returned to where it was pre-1990 in terms of manufacturing, it now produces an impressive range of goods locally. The food sector is especially notable in this respect. The economy supports companies making dairy products, pasta, mayonnaise, dumplings, processed meats, sausages, confectionery products, and canned fruits and vegetables. Mongolia also makes garbage bags and paper napkins and a number of construction materials, including bricks, pipes, windows and cement. While it is not a given that the country’s manufacturing sector will ever return to its pre-1990 levels, it is almost certain that given rising demand, a weaker currency, persistent logistical issues, geographical realities and a better investment climate the industrial base will grow.

Some elements in Mongolia are particularly ambitious, and it is possible in the coming years industries will crop up that never existed previously in the country. In early 2014, Mongolia inaugurated its first vehicle manufacturer, Ecobus. The company has already produced 10 buses – the facility has the capacity to produce 120 a year – and it also has plans to manufacture half-tonne trucks. Nomin Holding, a diversified group primarily involved in retail, is behind the venture. The eco-friendly, exhaust-free buses have the capacity to transport 30 passengers, and will be fitted with e-ticket vending machines. While the work was done in the country, the main components, including the axles and electrical components, were imported from Russia, China and Korea.

In 2006, Mongolia started to assemble trollybuses and duobuses locally, under the brand names Electrobus and Monbus, using a number of locally made components, including glass, fibreglass and gears. While it is unlikely that the country will become an automobile production centre, it is possible that it will find a niche in regional markets. Due to the cold weather and urban pollution, expertise could be developed that would result in products good for other cold and crowded cities. Indeed, in 2009 the country exported two duobuses to Kazakhstan. “This factory proves that Mongolian can produce themselves, even buses,” President Ts. Elbegdorj said at the opening of Ecobus. “Before, we thought we had to import everything, but now that is changing.”

Building Materials

Given the need for housing and transportation and rapid developments in the mining sector, the building materials industry has seen considerable activity. Cement plants are one area of focus. While the country already has production capacity from the communist period, the main plants – Khutul Cement and Lime Company, still 100% state owned, and the Arbet Company, 51% state owned – use old technology and have traditionally been unable to run at capacity. They have not been able to keep up with demand during the building boom in recent years, and the country runs a cement deficit.

Other facilities include Central Asia Cement, which was founded in 2003 and has the capacity of about 100,000 tonnes a year, and two smaller plants: Nalaikh Cement (roughly the same size as Central Asia) and Khovd Cement (which is very small at about 30,000 tonnes a year). Demand has increased 10-fold over the past decade and an estimated 80% of cement is brought in from China. Cement is a product that is especially sensitive to the country’s transportation weaknesses, as it is so heavy. Poor roads and delays at the border greatly increase the cost to the end user in Mongolia, and as a result setting up a cement plant within the country is an attractive investment opportunity. A number of projects are under way.

The Khukh Tsav cement plant is being developed by Mongolian Alt Corporation (MAK), one of the country’s larger conglomerates. The facility, which is located in the south-east of the country in Dalanjargalan Sum, Dornogovi, will be able to produce and 2m tonnes a year. It is expected to be up and running in 2014. The Senj Sant plant is also being built in Dornogovi Province and will produce 1m tonnes per year. It is being developed by the Monpolymet Group and has received $20m of funding from the European Bank for Reconstruction and Development. Other projects are also in the works. China Lian He Cement is reported to be building a 1m-tonnes-per-year plant in Sergelen Soum, Tuv Province. In 2012, the Development Bank of Mongolia invested $61.3m in the expansion of the Khutul Cement factory. A project by MIZU, a Chinese venture, has been mentioned in the press, while Yalguun International, a Mongolian-owned company, received funding from the US government to conduct a feasibility study on a 1m-tonnes-per-year project. Remicon, a Mongolian cement mixing company, said it is moving into the cement production business.

Investment In The Future

The government is investing in the expansion of manufacturing, using proceeds from the Chinngis bond to fund the building and improvement of light industry. According to a report in early 2013, $68.8m went to the cashmere sector, $37.7m went to the dairy and milk sector, $45m went to companies making woollen goods, and $13.5m went to sewing operations. The government recognises the need to bring light industry back if it is going to fight off the Dutch disease. The authorities also believes that the lack of locally produced goods contributes to inflation. The high costs of logistics, which won’t be reduced in the near term, feed directly into the high cost of living.

Mongolia has various reasons for encouraging manufacturing. Like other countries, it believes that too much of the value of its resources is going overseas, and it wants to get more into the processing of these materials. Light industry is important to the country’s development, but heavy industries related to resources are seen as the future. Sainshand Industrial Complex is the main focus in this respect. Set out in government proclamations in 2009 and 2010, the idea is to have coal processing, oil refining, construction materials production, copper smelting and a steel plant in the same area near the main transportation links. It is the biggest project of its kind in Mongolia and will drive the economy up the value chain in resources processing and manufacturing. The project will, however, cost $9bn, according to 2012 government estimates. In 2013, the Development Bank of Mongolia agreed to finance MNT14.1bn ($8.8m) of technical studies for the project. While the country does not at present have the fiscal wherewithal to finance Sainshand and global markets are cooling on developing country risk, it is pushing ahead. The government is willing to sell up to 66% of the project and that the partner can be foreign. In March 2013, Prime Minister N. Altankhuyag said that he hoped to see work on Sainshand accelerated. He added that it should not only be an industrial centre, but also a tourist centre and model for development in other provinces. He also mentioned the Zamyn Uud Industrial Park was a top priority. A free trade zone in that border city has been discussed since 1995, and some of the plans have been ambitious. A 2006 proposal include an international airport, hotels, a convention centre and casinos.

The country does have a history of heavy industry. With Soviet support, Mongolia began to move to larger-scale manufacturing in the 1960s and the emphasis was on downstream processing. In addition to the cement works, the country also had timber and metal processing (molybdenum and copper) at Erdenet. And in 1994, the Darkhan metallurgical plant was established. The current hope is to revive much of what existed before and get to a higher level in terms of output and quality. The country also wants the new projects to make more business sense. While large-scale industrial developments are expected to be public-private partnerships, they need to be fiscally sustainable and attractive to international markets. Capacity for the sake of capacity will not do in a time when accounts are transparent and the appetite for long-term subsidisation is low.

Outlook

The potential for industry in Mongolia is under-appreciated. People have long doubted whether such a remote and under-populated area could make, or have the need to make, anything more than the most rudimentary of goods. History suggests otherwise, that the country can produce quite a bit, and recent history suggests it will. Industry is growing in step with, and at times faster than, the general economy. The prospects for the sector are positive, but the country must be careful. The last industrialisation effort resulted in high debt and cost Mongolia two decades of growth. If investments are not made wisely, history could be repeat itself.

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The Report: Mongolia 2014

Industry & Retail chapter from The Report: Mongolia 2014

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