The Mineral Curse

One of the main reasons investors are hesitant to invest in Mongolia is due to it’s abundance of natural resources. It’s called The “Paradox of the Plenty” and it has proved fatal for many mineral rich nations. This is paradox is expressed through something known as the Resource Curse, or the Dutch Disease. The path to oblivion can occur in a few ways. First is through revenue volatility. Quite simply this is danger created in an under developed market where the vast majority of the revenues are coming from the export of one commodity. If the spot price of that commodity were to shift more than expected, it could cause havoc in the producing nations economy (seen in Angola). Second is the classic example of excessive borrowing. Believing they can secure future debt payments many mineral rich nations have borrowed great amounts; some have not been able to pay them back. Third is the more specific concept of the Dutch Disease. It goes like this: Nation becomes rich from exporting natural resources; its currency appreciates. Because of this the nation’s exports become more expensive for other nations, leading to the nation’s manufacturing sector becoming less competitive.

The three reasons above are key in understanding how governments of mineral rich nations often lead their country into economic blunder. However there have been exceptions. Batswana, Canada, China and Norway among others have all proved the resource curse to be avoidable.

So how is the resource curse to be turned into a mineral blessing?

The secret lies in good governance and accountability stemmed from trusted institutions such as NGOs and pressure groups. Their job is to lobby for new resource revenues to be constructively distributed among various social infrastructure projects including healthcare, education, housing, pension fund improvement and creating more job opportunities. Nations have tried to simply give their citizens ‘cash handouts’. Currently Mongolia gives its citizens a cash handout of $20 each day. This does not work, and if increased will likely boost Mongolia’s alcoholism problem.

Something that would work would be the creation of a stabilization fund. Mongolia’s former Country Manager for the World Bank, Arshad Sayed, writes about the importance of this type of fund.

“The importance of fiscal policy across the ups and downs of commodity prices, suggests that much like the herder in Mongolia who saves, and dries his curds, meat and other things in preparation of the winter, some form of a stabilization fund, that accumulates the extra revenues that come suddenly, would be important.  These revenues would ideally be managed by an entity that has no authority to spend the money.  The rules for when and which revenues should be accumulated and when they should be spent should be very strict and transparent.  The stabilization fund can be helpful to smooth government revenues and thereby spending over the commodity price cycle.  Second, it might help in smoothing growth. Because the fund accumulates money when commodity prices are high, the money can be spent in years when the prices fall. As such it can prevent the economy from overheating when it is growing very fast and provide a stimulus when it begins to slow.”

Where does Mongolia currently stand?

Mongolia’s president Tsakhia Elbegdorj is aware of a need more stringent government action. In a CNN article, he claims that the government is working on laws to strengthen mining regulations, increase transparency, and avoid over-exploitation and eliminate corruption.  

One notable step is Mongolia’s compliance with Extractive Industries Transparency Initiative (EITI). This initiative, endorsed by the World Bank, increase transparency over payments by companies to government and/or non-government entities such as the above stabilization fund. It’s statement of principles can be seen here. This is a very important step the government has taken to move forward and eliminate corruption while increasing the confidence of foreign investors.

Another development worth noting is the expected late 2011/early 2012 IPO of Erdenes Tavan Tolgoi, a state owned company witch owns massive untapped coal reserves in the Gobi Desert. According to Raw Materials Group, a data provider company based in Stockholm, the coalfield is the second largest in second largest in the world, behind Shengli in China.

The interesting part about this IPO is how its structures. Only 50% of the shares will be issued as stock. 30% of those will be sold to investors listen on the Hong Kong and/or London sock exchanges, 10% to wealthy Mongolian private business owners, and 10% to Mongolian citizens. Thats right, 10% of half of the expected $1.5bill - $5bill IPO will be given to local Mongolians, the vast majority of witch live below the poverty line. If these sums are structured in a way where the local people cannot simply sell them off but must keep them for a period of time, allowing them to appreciate in value, it could provide for a healthy long-term fiscal foundation the nation could build on.