China-Mongolia Relations: Challenges and Opportunities

January 6, 2017 Posted by China Briefing Reading Time: 6 minutes

By Zolzaya Erdenebileg

With the signing of the China-Mongolia-Russia corridor in June 2016, Sino-Mongolian relations entered a new era of economic cooperation that will be vital to Mongolia’s economic recovery and long term stability. Mongolia has long aspired to become a logistics and financial center, using its location in North Asia and proximity to Chinese and Russian markets to its advantage. However, a recent visit by the Dalai Lama to Mongolia, and the resulting Chinese backlash, has once again revealed that economic partnership and recovery for Mongolia will be more difficult than the government expects.

A troubled economy

In the past six years, Mongolia’s economic performance has been tumultuous. The country was the darling of emerging market investors from 2011 to 2012, when it boasted one of the fastest growing GDP rates in the world at 17.3 percent. Labeled “Minegolia”, many expected the commodities boom to sail the country into newfound wealth and prosperity, and excited investors bet their money on it. In 2011, foreign direct investment (FDI) as a percentage of GDP reached about 44 percent, a record all-time high in Mongolia’s post-communist era. Four years later, in 2015, this number shrunk to 0.8 percent.

Mongolia’s economic difficulties can be attributed to various causes. First of all, a steady dip in global prices for commodities has dealt a major blow to Mongolia’s export volumes. The price index for all types of coal supplied by Mongolia, its biggest export by volume, decreased by 15 percent from 2014 to 2015. Secondly, a less experienced government, led by the Democratic Party, took a series of protectionist steps to try and increase domestic control over expected riches, but ended up severely eroding FDI rates. In particular, government attempts to renegotiate a deal with mining company Rio Tinto over the terms of the large Oyu Tolgoi copper and gold mining site took a toll on investor confidence.

Several developments, including a new agreement with Rio Tinto, have again placed the country in the limelight. However, to analyze what the future may hold for Mongolia, it is critical to look at the relationship between the country and its biggest economic partner, China.

China’s economic influence in Mongolia

Like most neighbors, Mongolia and China have a long and complicated relationship. For most of modern history, this relationship has been contentious. In fact, until the transition to a market economy began in the early 1990s, Mongolia had been under heavy Soviet influence. Distrust of its large and populous neighbor to the south was widespread.

Nowadays, nowhere else is China’s growing global economic influence felt more keenly than in Mongolia. By far, China is Mongolia’s largest export market. As of early November 2016, about 80 percent of Mongolia’s total exports went to China. By a smaller margin, China is also Mongolia’s largest import market, making up about 30 percent of total imports by early November 2016. The second largest import market was Russia.

Due to economic restructuring within the past few years, Chinese demand for Mongolian exports has slowed. This has had serious repercussions in Mongolia, and 2015 and 2016 have both been difficult years for the country’s economy.

Slowed recovery and debt woes

With commodity prices starting to rise and a new government in place, Mongolia may have already reached the ebbs of its woes. However, it is clear that recovery will not be quick or easy.

According to the most recent statistics released by the Bank of Mongolia (BoM), total trade turnover by early November 2016 fell slightly, by 4.9 percent, compared to the same period the previous year. Exports rose slightly, by 0.8 percent, while imports fell by 11.9 percent. The Asian Development Bank (ADB) forecasts that GDP growth in 2017 will be slightly higher, at 1.4 percent, by no means anywhere near its peak in 2011, but much stronger than the predicted 0.3 percent it experienced in 2016.

Additionally, the new government will have to pay for the sins of the old government. At the peak of its growth, the government decided to issue what was called “Chinggis Bonds” in 2012, raising US$1.5 billion to spend on infrastructure, salaries and subsidized mortgages. However, due to the commodities glut, decrease in FDI and slowdown in demand from China, Mongolia now faces about US$2 billion in public and private debt payments, due as early as March 2017. The budget deficit rose to 20 percent of GDP in 2016, and total external debt is estimated to be US$23.5 billion, US$8.4 billion of which is government debt. In short, Mongolia needs money. To resolve the issue, the government submitted a request for a rescue loan from the International Monetary Fund (IMF) in September 2016. It will still need additional support, however, and for this, the country has turned to its southern neighbor.

Rattled ties with China

The IMF loan request is seen as an attempt by the country to allay its dependence on China, of which Mongolia is wary. Nevertheless, China is still a major player in the Mongolian economy, and the two governments were prepared to negotiate a potential US$4.2 billion loan agreement.

Due to a visit by the Dalai Lama to Mongolia for a convention on Buddhist science, however, the talks were delayed. Afterwards, China released a strongly worded rebuke to Mongolia. In addition, transport surcharges on copper and fees on coal increased at several Chinese border towns through which Mongolian exports pass. Rio Tinto suspended shipments from Oyu Tolgoi over “safety and security concerns”.

After the government assured China that a visit from the Dalai Lama would not occur again, relations stabilized somewhat. However, it is expected that Mongolia will receive a worse loan deal than before the visit.

Future outlook

With Oyu Tolgoi up and running, and loan talks underway, optimism has returned to Mongolia, at least from the long term perspective. The country still holds immense amounts of natural resources, and this will attract investors and buyers.

The short term still holds pitfalls that require careful navigation by the government. Mongolia will have to overcome numerous obstacles as it struggles to deal with debt, growing inflation, and stagnated growth. Of particular concern to the Mongolian government is the extent to which the economy will remain dependent on China. In many ways, Mongolia has always attempted to decrease this influence, mostly famously by espousing a “third neighbor” policy and looking to the U.S. for support.

However, it is clear that in order to grow sustainably, Mongolia will need Chinese support, and China, for the most part, is happy to supply it. The China-Mongolia-Russia economic corridor, under China’s beloved One Belt One Road initiative, will be critical in order to improve trade and logistics between the two countries.

The corridor is expected to increase customs clearance services and e-commerce between the three countries, and bring much anticipated trade activity to Mongolia; although, like many things about Sino-Mongolian relations, this has not yet been the case.

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