Wedged between two of the world’s largest economies, Mongolia’s trade and investment policies are something of a balancing act. Reliant on transit neighbours for both trade and the infrastructure to support it, this small, open economy has integrated with the global one by developing relationships with “third neighbours” to improve its terms of trade. As surging mineral exports in the past half-decade have exposed Mongolia to the volatilities of global commodity markets, the government aims to leverage the nation’s abundant natural resources to develop value-added production and diversify away from exports of raw materials.

Although inconsistent policies on foreign direct investment (FDI) during the 2012-13 electoral cycle have damaged investor sentiment, parliament passed a raft of new laws in October 2013 that are markedly probusiness. Much still depends on resolving disputes with key investors, especially with Rio Tinto over phase two of the Oyu Tolgoi copper and gold mine. Rebuilding credibility may be slow, and could be further held up by the government reshufflings of late 2014 as new agencies settle into their new roles. Yet Mongolia, which needs significant FDI to achieve its development goals, has strong motives to win back investor support. A series of large deals agreed with Russia and China in mid-2014 could also yield some of the infrastructure needed for its next wave of private investment, as could a new trade pact signed with Japan in February 2015.

Drivers of Trade

A small market with a narrow industrial base, Mongolia runs an open trade policy under its commitments through the World Trade Organisation, which it joined in 1997, applying 5% “most-favoured-nation” tariffs and 5% export tariffs on key minerals. The country is heavily reliant on trade, with total trade equivalent to 94.3% of GDP in 2013 and the largest imports being refined fuel and vehicles.

To feed China’s huge appetite for energy, Mongolian coal exports surged from 5.12m tonnes in 2008 to 22.5m in 2011, before easing to 18.2m in 2013 as Chinese demand slowed. In 2014, coal exports again rose, by 6.1% to 19.5m tonnes. Between 2009 and 2013, copper lost its long-held dominance over coal as a share of exports, softening Mongolia’s exposure to the metal’s more volatile price. Coal’s share of exports surged from 7% in 2008 to 47% in 2011, before falling over the next two years to 43% and 26% as both output and prices declined. Between 2008 and 2012, total exports nearly doubled from $2.53bn to $4.39bn, before declining to $4.3bn in 2013, according to IMF data.

Just as coal exports were taking off, in October 2009 the government struck a deal with Rio Tinto to develop Oyu Tolgoi into the world’s second-largest copper mine, unleashing $6.2bn in investment over the next four years. Local consumer demand, plus industry’s rising need for foreign capital goods, drove imports up from $3.25bn in 2008 to $6.74bn in 2012, falling to $6.4bn in 2013 as the mine’s phase one wrapped up.

Structure & Direction

As minerals’ dominance as a share of exports has increased, from 82.6% in 2007 to 87.1% in 2013, so has China’s share of them, which rose from 74.2% to 90.1% in that span. The share going to developed countries, meanwhile, declined – Canada’s from 9.5% to 3.6%, the EU 27’s from 5.6% to 2.3%, the US’s from 3.4% to 0.5% and South Korea’s from 2.2% to 0.7%. China is also a key supplier, especially of food and equipment: its share of imports rose from 31.1% to 37.7% in those five years. Russia, the country’s fourth-largest export market, remains its second-largest source of imports – though its share of these has shrunk from 34.3% to 27.6% as Mongolia strives to diversify fuel imports away from Rosneft (see Energy chapter).

The third neighbour strategy has thus yielded more fruit in imports than in exports. The US nearly doubled its share of imports from 2.4% to 4.3%, while South Korea’s went from 5.6% to 6.2% and the EU 27’s from 9.2% to 10.1%. Of all third neighbours, only Japan saw its share of imports drop from 5.1% to 4.6% between 2007 and 2013, although both governments aim to expand this as their Economic Partnership Agreement signed in February 2015 is implemented (see analysis).

Frontier Market

Rated “B2” by Moody’s and “B+” by Standard & Poor’s, Mongolia’s appeal to foreign investors has fluctuated as widely as any frontier market’s. The Oyu Tolgoi Investment Agreement (OTIA) signed in October 2009 was not only the largest project-finance package in Mongolia’s history; it also boosted the government’s credibility in doing large deals. Key to concluding the OTIA was the repeal of a 68% windfall tax on gold and copper sales above a low price threshold, which had hindered investment since its introduction in 2006. The agreement came amid Mongolia’s fifth IMF bailout since 1990, when inward FDI had averaged $500m a year for the previous five years. Buoyed by investment in mining and energy as well as trade and services, FDI surged from $624m in 2009 to $1.7bn in 2010 and $4.7bn in 2011, before easing back to $4.5bn in 2012, according to World Bank figures.

In the absence of data on beneficial ownership, Mongolia’s network of double taxation treaties explains the skewed nature of investment flows. Four of the five biggest investors over 2009-13 were tax-efficient jurisdictions: the Netherlands (31.16% of the $13.53bn in FDI over the five years), Luxembourg (8.89%), the British Virgin Islands (7.45%) and Singapore (5.01%). China ranked second with 15.36% of the total. Other smaller yet strategically important third neighbour investors are Australia (1.78% of FDI in 2009-13), the US (1.54%), South Korea (1.43%), Canada (1.1%) and Russia (1.08%).

Investment Crunch

After 16 months of elections, the government launched a reform programme in 2014 to rebuild investor confidence amid growing pressures on the country’s balance of payments. While the narrowing trade deficit (and shift to a surplus from August 2014) curbed the current-account deficit from 32.6% of GDP in 2012 to 27.4% in 2013 and 13% in the first half of 2014, the sharper contraction in FDI – by 52% in 2013 and 62% y-o-y in the first half of 2014 – left a large external financing gap, equivalent to 5% of expected half-year 2014 GDP, according to World Bank estimates. This put downward pressure on the tugrik, which fell 27% against the dollar in 2013 and another 14% in the year-to-August 2014 (see Economy chapter).

Restrictive legislation like the Strategic Entities Foreign Investment Law of May 2012 dampened enthusiasm just as commodity prices began to slump. Yet no issue steered investors’ views of Mongolia more than the Oyu Tolgoi shareholder dispute. The discord centred on a $2bn cost over-run on the initial $4.2bn estimate for the open-pit phase one, as well as Rio Tinto’s management fee, funding costs, water usage and withholding taxes. The dispute caused delays of two years on the project’s underground phase two, which covers the other 80% of the Oyu Tolgoi deposit, holding up the $5.1bn in required FDI. At the height of tensions in November 2012, the government unilaterally cancelled four double taxation treaties, though the OTIA insulated Oyu Tolgoi from the impact (see analysis).

Courting Investors

In its 2014 “action plan” to turn around the economy, the government named three pillars: carrying out legislative reforms, jump-starting public-private partnerships (PPPs) in infrastructure and resolving investor disputes. Parliament passed a flurry of reforms in quick succession: the Securities Law in May 2013, the Investment Law in October 2013, then the Investment Fund Law, the amended Minerals Law, the Petroleum Law and the “Glass Account” transparency law. Mongolia is also negotiating its 44th bilateral investment treaty, with Canada, due to finish in early 2015. Once compliance guidelines are published, the government expects the mining and petroleum reforms, which extend licensing terms and clarify procedures, to yield $1bn in new investment from 2015.

While such changes will support investment in the longer term, investor disputes remained the key bottleneck in 2014. “The Oyu Tolgoi issue has become a barometer for investor confidence in Mongolia,” O. Chuluunbat, former vice-minister of economic development, told OBG. “Mongolian politicians have now learnt the lesson that they can damage the economy with too much resource nationalism.” Although Oyu Tolgoi shareholders missed another deadline in 2014 for project financing on phase two, the project did secure a deal to source power from a planned mine-mouth plant at Tavan Tolgoi from 2017, and a feasibility study for phase two of the project was submitted.

Recent events may help revive investor sentiment. In March 2015, an international tribunal ordered Mongolia to pay $100m to Canada’s Khan Resources for uranium mining licences cancelled in 2009. In early 2015 many of the 106 licences revoked in 2013 were retendered or returned to their former holders, including Canada’s Kincora Copper, with others set to follow.

Infrastructure PPPS

Resolving the Oyu Tolgoi dispute will not only help rebuild investor confidence in mining, but also push forward the pipeline of public infrastructure projects. Since it first formulated its PPP Policy in 2009 and passed a Concessions Law a year later, the government of Mongolia has developed (with help from the Asian Development Bank) a list of 50 PPP projects, including 17 in road transport, 12 in energy and seven in infrastructure. Such projects are typically conducted on a “build-transfer” model, whereby contractors front the costs and are repaid from the state budget (there are 19 of these), but the current list also includes eight “build-operate-transfer” (BOT) projects and 11 with a “build-operate-own” scheme.

By mid-2014, the approved PPPs included a 17-year BOT concession valued at MNT88bn ($88m) to build a 50-km mining road from Nariinsukhait to Shiveekhuren; a 28-year BOT valued at $5bn for a 997-km highway linking Altanbulag to Ulaanbaatar (UB) and ZamynUud; a 23-year BOT worth CNY1bn ($162.6m) for a 100-MW wastewater hydropower plant in UB; and a 22-year BOT to develop a 100-MW thermal power plant worth $183m at Telmen. A fifth 25-year BOT agreement for the long-awaited 450-MW CHP5 in UB, covering investments of $1.2bn, was awarded in mid-2014 to a consortium of GDF Suez, POSCO, Sojitz and Newcom. Responsibility for coordinating PPPs shifted in 2012 from the State Property Committee to the new Ministry of Economic Development (MED), and then back to the Ministry of Finance after the ministerial restructuring of late 2014. Nonetheless, negotiations are on-going for new concessions, including a 25-year BOT for the 600-MW Changdana mine-mouth power plant, worth $1.3bn; a 17-year BOT worth MNT440bn ($440m) for a 435-km mining road linking Tavan Tolgoi to Khanbogd and Hangi; and a 20-year BOT to redevelop Dalanzadgad’s existing airport (see Transport chapter).

Regional Integration

Mongolia is also using the growing integration between its two larger neighbours to improve regional connectivity. As Russia (which owns half of the Trans-Mongolian Railway) has drawn closer to China (which made up 55.1% of Mongolia’s total trade in 2013) amid international condemnation over the conflict in Ukraine, Mongolia has sought to leverage its position. “Given the small size of the Mongolian market, it is crucial for us to maintain good relations with our two neighbours so that companies can use Mongolia as a base to sell into those markets,” Chuluunbat told OBG. “Developing our infrastructure to further integrate with these two countries is key.”

In 2014, Russia’s Gazprom secured deals to supply China with natural gas from 2018, agreeing on an initial $400bn deal for 38bn cu metres per year for 30 years in May, then expanding this in November by another 30bn cu metres per year. While lobbying for the planned pipeline to cross Mongolia, the government secured pledges in areas far beyond energy during state visits by the Chinese and Russian presidents in August 2014 and a trilateral summit in September.

The aim is to double trade with China and quintuple it with Russia, growing each to $10bn a year by 2020. While most of the 15 agreements signed during the Russian state visit are non-binding, the two sides aim to launch a dual-tracking and electrification of the Trans-Mongolian Railway to raise its yearly capacity from 20m tonnes to 100m tonnes, and to look into additional rail-spurs to Russia. Other talks covered visa-free access for tourists, starting up the Asgat silver mine, and removing tax and duties on both sides.

The Chinese visit yielded more immediate results, expanding the countries’ bilateral currency-swap line from CNY10bn ($1.63bn) to CNY15bn ($2.44bn) and a $162m loan from the China Development Bank to the Development Bank of Mongolia. The 26 agreements inked during President Xi Jinping’s second single-country visit since his taking office in March 2013 place Mongolia at the centre of China’s vision of a “Silk Road economic belt” backed by its new $40bn infrastructure fund. Under its “comprehensive strategic partnership”, China pledged support for projects in infrastructure from railways and highways to education and health care. Parliamentary approval of a policy on rail gauges in October 2014 paved the way to develop much-needed railways linking Mongolia’s coal deposits to the Chinese border. The government next plans to upgrade and expand key border crossings. Already required to grant transit rights for goods along its railways and ports, China pledged to expand quotas and reduce tariffs, and proposed a bilateral free trade zone.

Mongolia’s two neighbours want to set up an economic corridor linking the three countries with power lines, highways and railways, and have voiced support for Mongolian membership in the Asia-Pacific Economic Cooperation and the Shanghai Cooperation Organisation. This would advance Mongolia’s diversification plan, the 2008 Comprehensive National Development Strategy, by channelling FDI into value-added clusters. One such is the Sainshand ore-processing industrial park, which would need $4bn just for the infrastructure, though its feasibility has been questioned. For this and other projects, the Asian Infrastructure Investment Bank, of which Mongolia was a founding member in late 2014, could be a source of long-term financing.

Business Climate

While such outlays will ease bottlenecks in hard infrastructure, authorities are also striving to improve the business climate beyond its recent legislative reforms. Mongolia’s drop in the World Bank’s “Doing Business” ranking – from 52nd out of 112 in 2007 to 72nd out of 189 in 2014 – shows the damage done by resource nationalism, especially since 2012. While tax rates remain low overall, the sheer multiplicity of taxes is cumbersome to business, despite being simplified in the fiscal reforms of 2007.

Governance is another issue. The country ranks 83rd out of 177 in the corruption perceptions index compiled by Transparency International, which opened an office in UB in 2013. A number of high-profile cases, prosecuted under the 2006 anti-corruption act, have been highly politicised. The shift to online tax payment from August 2014 should help stamp out petty corruption in tax collection, while the Glass Account transparency law passed in July, mandating full disclosure of all public payments, should curb misuse of public funds. Although Mongolia has polished its rankings for electricity access, property registration, construction permits, minority investor protection, payment of taxes and cross-border trade, it has become more challenging there to start a business, access credit and sort out insolvencies. With new public entities like Invest Mongolia Agency, the government aims to lower such hurdles, though the pace of applications under the new Investment Law stayed low in 2014 (see analysis).


Mongolia’s last FDI cycle was driven by the landmark Oyu Tolgoi project, but the next stage will be broader-based, supported by new projects in rail, road and power. After two years of large public investments to sustain double-digit growth, the government is actively courting private investors for PPPs in both infrastructure and extractive sectors. With the legal framework for strategic sectors overhauled, the imperative in 2015 will be to resolve the Oyu Tolgoi dispute and unlock the $5bn phase two investment. As the economy achieves a soft landing with lower growth rates in 2014 and 2015, the government expects a pipeline of large projects in mining, power and infrastructure to re-ignite growth in an economy whose size is still a mere $11.5bn.