Off the beaten track in Asia: Mongolia

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The quick view

• Mongolia is rich in natural capital, which presents compelling growth potential.
• Much remains to be done, but we think the country is heading in the right direction to ensure future growth is sustainable.
• Its recent commitment to fiscal prudence has earned Mongolia credibility and support from international financial institutions.
• Although unlikely to be smooth or linear, the path to sustainably higher growth has solid foundations. This is frontier market worth watching.

We have written quite extensively about China this year, but some of the lesser-known names in Asia’s diverse investment universe are more than worthy of investor attention. Not least China’s northern neighbour, Mongolia. We asked our Asia expert, Mark Evans, to share some of the key takeaways from his recent trip.

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What was your overall impression of the country?

With its population of over 3 million people, a land mass three-times that of France, almost 70 million farm animals and some of the world’s largest untapped mineral deposits, it’s hard not to be impressed by Mongolia. There’s a real sense of opportunity for this developing economy.¹

How likely is Mongolia to attain sustainable growth?

Mongolia’s enviable stock of natural capital – minerals and animal products – provide solid foundations for a higher-quality growth path. Infrastructure investment will hold the key to unlocking the country’s full potential, so careful and targeted use of the wealth harnessed from its natural capital will be vital. Although a socialist past does not typically lend itself towards the creation of the sort of institutional framework needed to underpin this, Mongolia is not short of steady hands to guide it: the IMF and World Bank are just two of the institutions currently working closely with Mongolia.

There’s a real sense of opportunity for this developing economy

While much remains to be done – not least on corruption, social housing and pollution – various initiatives are in progress to improve the population’s living standards. In short: Mongolia seems committed to forging a sustainable growth path for its economy and people, leading us to believe it is heading in the right direction from an ESG perspective.

What impressed you most about the country from a macroeconomic perspective?

The key positives which shone through for us were the government’s commitment to fiscal prudence and the strong support it has from the international financial institutions.

Many developing countries fall into the trap of overextending their public finances, often driven by political motivations ahead of elections. Mongolia did just this in 2016, when it racked up a humiliating fiscal deficit of 18%. However, thanks to a commodity price rebound and expenditure restraint, within two years the government printed a fiscal surplus, siginificantly better than IMF projections. Indeed, the IMF noted that the adjustment has meant the history books have been re-written. And a meeting with the Ministry of Finance suggested the indignity the country suffered in 2016 has left it with no appetite for a repeat. Ministry of Finance estimates point to a continued impressive trend for Mongolia’s government debt/GDP ratio, potentially falling to 40% in 2021 from over 60% in 2018. And by accumulating assets in two sovereign wealth funds the country has proven its desire to save for a rainy day.

Mongolia enjoys strong support from the key international financial institutions.

Thanks in no small part to this fiscal restraint, Mongolia enjoys strong support from the key international financial institutions. A planned IMF lending programme – currently on hold pending the completion of an audit on bank recapitalisation and subject to the go-ahead by Mongolian authorities – is entirely feasible, in our view. The IMF representative we met pointed to the country’s impressive macroeconomic performance. And for its part, the World Bank has taken the unusual step of extending $100 million of support to Mongolia, highlighting the credibility earned by its policymakers.

What key risks should investors be aware of?

The first key risk relates to the Oyu Tolgoi copper mine in the South Gobi Desert, which has added $2.4 billion to Mongolia’s public coffers since 2010. The government is currently scrutinising its agreement with the mine’s majority owner, which introduces a risk – albeit small, by our estimates – of deterring future investment. To further muddy the outlook, recent analysis revealed greater complexity and higher costs than initially estimated for the second phase of the mine’s development; the extent of potential delays and financial impact won’t be clear until investigations conclude in 2020.

Second, Mongolia remains very vulnerable to a potential sharp drop in commodity prices. And third, although partly mitigated by the prudent fiscal stance as noted above, forthcoming elections loom large and may be called as early as the end of October. This introduces a risk that the government will abandon its fiscal prudence in favour of making vote-winning handouts. But we think this is unlikely, given the 2016 experiences mentioned above. Plus we get the sense that Mongolia’s citizens want good macroeconomic policy, not cash handouts which end up costing them more in the long term

Investors should be mindful that young democracies often make missteps in their journey to greater things

More broadly, investors should be mindful that young democracies often make missteps in their journey to greater things. We doubt Mongolia will be immune to such growing pains so the path to prosperity is unlikely to be smooth.

To conclude: while some key reforms are needed to put the economy firmly on the right track, there is much for investors to get excited about in this frontier market.

¹ Source for population and land mass: UNDP. National Statistics Office of Mongolia for livestock figures.

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