Mongolia's uncertain future

MONGOLIA IS A country of extremes. Landlocked between its two former colonial rulers in a landmass some three times the size of France live just 2.6 million people. A dwindling, ageing one-third of the population ekes out an increasingly precarious living as nomadic herdsmen on Mongolia's vast steppe facing up to the world's widest extremes of temperature.

Another third - a group that is rapidly increasing - seeks a marginally better life in Mongolia's capital, Ulaanbaatar, whose infrastructure creaks as it takes the demographic strain. With unemployment doubled since 2000, an economy of just $1 billion and external foreign debt of at least the same amount, Mongolia faces an uncertain future.

"Mongolia was the second to join the communist system and the first to leave," says Pete Morrow, CEO of local commercial bank Ag Bank. "Democracy has come fast but a free market is going to take longer."

The government has not stood idly by. Its state property committee, for example, has been busy privatizing state assets. First to go were the two largest banks, Trade Development Bank (TDB) and Ag Bank. Last month, oil and gas distributor NIC was successfully sold. Mongolians are not xenophobic: controlling stakes were sold to foreign buyers. Indeed, all of the privatizations to date have followed the same pattern: foreign managers hired to clean up bankrupt or creaky state businesses. Two Americans run Ag Bank, Dutch bank ING operates TDB. Cleverly, the Mongolians have obtained foreign aid to pay the contracts so they learn western management skills while others pay for them.

MIAT, the state-owned airline due to be privatized next year, is the latest government asset to get the foreign treatment. "MIAT is now under foreign management," says state properties committee chairman Purev Dorj proudly. "The programme is sponsored by the European Bank for Reconstruction & Development."

"They're trying to beautify MIAT," confirms Jim Dwyer, an investment banker who handled both the TDB and Ag Bank sales. "They learned from Ag Bank that you've got to dress up the girl before you take her to the dance."

Also on the block is MDIC, Mongolia's state insurance company; Gobi JSC, producer of arguably the world's finest cashmere; and Mongolia Telecommunications Company. All are expected to go to international buyers.

"Our plan is to sell to foreigners," says Purev Dorj, "because it will bring in more money to Mongolia and more knowledge of western management".

Management, yes - money, well, not a great deal, for despite the impressive list of assets to go under the hammer, Mongolia's economy is so small that sums raised to date are tiny. The three privatizations combined have netted the princely sum of $26.3 million, with investment commitments of a further $62.7 million over the next few years. Tenders are being sought for MDIC at a minimum value of $1.2 million, hardly the sort of sums to make a meaningful dent in Mongolia's $1 billion debt pile.

According to Morrow at Ag Bank, though, size is not everything. "The key is to get these businesses into private hands more than the sums raised," he explains.

That might be true, but Mongolia's debt problems and weak economy are not going away. Copper mining company Erdenet encapsulates just how small the economy is. A joint venture with Russia, it accounts for fully 20% of GDP and 30% of foreign currency income, according to Standard and Poor's. Despite Erdenet's relative size, S&P warns that its finances are shaky. Harry Baumann, who heads Development Alternatives, the USAID-funded economic adviser to Mongolia's government, puts it another way: "I know that things are going reasonably well [at Erdenet] when they pay their electricity bill." Reassuringly, he adds: "They're up to date right now."

Tserendagva Odongua, director at Bank of Mongolia, the central bank, acknowledges S&P's numbers but points to another significant factor. "Personally, I'm not sure about our GDP figures," she says. "It's supposed to be $1 billion but it seems to me much higher. I know there is underestimation. The tax rates are way too high and this encourages tax evasion."

Indeed the shadow economy in Ulaanbaatar is an open secret and, by most estimates, is not small. "There's no question that the informal sector is substantial," says Baumann, "maybe 15 to 20% larger than reported."

Although the lost tax revenue from this grey economy is a serious concern for the government and one it intends to fix, as Baumann explains there is a silver lining to Mongolia's otherwise dark economic cloud. "The economy's so small here," he says, "that it doesn't take much to make a lot of progress." He cites the recently started Boroo gold mine project, which aims to produce 200,000 ounces of gold by 2004.

"That may not sound much," says Baumann, "but with an economy of $1 billion, it's significant. We estimate [Boroo] will add 5% to 7% to GDP."

Another fact that works in Mongolia's favour is that its external debt is all from donors. "It's a little less than $1 billion," says Odongua. "and 100% is on soft terms: ADB is the largest donor, then IBRD."

Certainly a lot of capital has been showered on Mongolia since the Russians pulled out. As the west's chosen reformed communist poster boy, the country has effectively replaced Russian aid with western handouts. The legacy from the communist past has not entirely disappeared however: the Russians are still owed a lot, although Mongolia has been negotiating hard.

"It was 12 billion roubles, but a compromise has been reached on all of it now," says Odongua confidently. "Recently our prime minister paid an official visit to Russia. Both ministers agreed on certain ways to get rid of the debt, but declined to give details."

Everyone in Ulaanbaatar seems tight-lipped about the deal with Russia, but several businessmen tell Euromoney the debt is now in the "few hundred millions".

Although Mongolia's economic condition may not be as parlous as appears at first glance, everyone concedes that the economic realities have bought the country time, not guaranteed prosperity. There is much work to be done and there are dark clouds on the horizon.