The ousting of Mongolian Prime Minister Norov Altankhuyag by a no-confidence vote on 5 November highlights continuing political instability and uncertainty around the country’s mining sector. Delays to the USD 5.4 bn underground expansion of the Oyu Tolgoi (OT) open-pit mine contributed to Altankhuyag’s fall, and the project remains stalled amid a dispute over investment terms between the government and miner Rio Tinto. OT is a test case for the country’s mining sector, and any delays threaten to damage investor confidence and harm Mongolia’s economic outlook. A failure to resolve the mining dispute before the end of the year could see funding for the project compromised, exacerbating deteriorating economic conditions as a result of declining foreign investment and a drop in mineral prices.
Rio Tinto has failed to agree with the government over investment terms related to the mine, a dispute that contributed to the premier’s ousting and has delayed returns for both the company and the Mongolian government. Rio Tinto’s investment agreement states the government will not see returns until investors have recouped their costs, which could exceed USD 6 bn. The government owns 34 percent of the project and delays mean it will struggle to deliver on spending pledges, including an expensive commitment to cap interest rates on mortgages; a key contributor to the loss of confidence in Altankhuyag. Exact details of proposals to resolve the dispute are unclear, but Rio Tinto is thought to have rejected a renegotiation of the investment agreement and refuses to guarantee Mongolia’s level of dividends from the project. Once complete, the OT complex should produce around 400,000 tonnes of copper annually, making it one of the world’s largest mines and a critical element of Mongolia’s currently struggling economy. At full capacity, the mine could generate a third of the entire country’s GDP, which stood at USD 11 bn in 2013.
The appointment of a new prime minister and the subsequent formation of a new cabinet may not take place until December. This will be a significant issue, as debt packages worth USD 4 bn from international banks, including the European Bank for Reconstruction and Development and the Australian Export Finance and Insurance Corporation, remain pending with commitment deadlines set to expire on 31 December. Rio Tinto had reportedly submitted a proposal to the government prior to the prime minister’s ousting in October, but there has been no government response and the original proposal may now face a lengthy review by the incoming cabinet. Rio Tinto subsidiary Turquoise Hill Resources, which owns 66 percent of the OT project, has said the government change is likely to cause further delays to the project. Should the funding deadline expire with the two parties still at loggerheads, a renegotiation of debt packages could add uncertainty to the future of the project and have a negative impact on the wider investment climate in Mongolia.
The Mongolian economy is heavily dependent on the mining sector, and the government’s future plans and credibility hinge on revenue generation from OT. Some estimates suggest that the dispute has to date delayed production at the underground site to at least 2020, contributing to Moody’s rating agency’s negative outlook on the country’s mining sector. The Mongolian government has formed much of its spending plans around the expected revenues from OT, which means that more delays to the mining sector are likely to have a significant impact on the country’s fiscal health. Its foreign reserves have already contracted from USD 4.1 bn at the end of 2012 to USD 1.4 bn in August 2014, while foreign direct investment fell by 54 percent in 2013, increasing pressure on the government to move forward with the OT. Furthermore, a Fiscal Stability Law will come into effect in 2015, capping the level of debt available to the government and exacerbating its need to generate cash flow. With revenues from OT delayed, any further obstacles could compromise the government’s ability to meet agreed budgetary commitments.
These problems will exacerbate investor concerns over political stability and the predictability of the regulatory environment in the coming months. A foreign investment law passed in 2013 improved foreign investors’ position in the country by bringing them under the same regulatory regime as domestic investors. However, the country’s history of sudden regulatory changes continues to concern businesses, and Rio Tinto’s project will be a key determining factor of the extent to which investors commit to Mongolia in the long term. The successful completion of talks with Rio Tinto and the advance of the OT expansion would go far to stabilise the government and convince foreign investors that the positive trend offered by regulatory reforms in 2013 will persist. However under current circumstances, the ongoing uncertainty is highly likely to continue into the first quarter of 2015 and the government will struggle to maintain credibility amid a worsening economic outlook.