May 20, 2015 / 9:01 PM / 4 years ago

Mongolia leans on China as it waits for copper mine-led revival

ULAN BATOR, May 21 (Reuters) - Cash-strapped Mongolia’s deal to expand the $6.5 billion Oyu Tolgoi mine is a big step towards stabilising its economy, but as it waits for the investment boost to feed through it is leaning on once-feared China to help shore up its finances.

The landmark agreement with Rio Tinto to resume construction of the underground copper mine ended a two-year dispute during which foreign investors had shunned the country and slumping coal exports left it short of reserves.

The mineral-rich country’s heavy reliance on the mining sector has led to boom-bust cycles and credit downgrades by ratings agencies worried over weak external liquidity.

Foreign investment fell 87 percent in 2014, which slowed growth to 7.8 percent from 12.3 percent the year before. China helped Mongolia’s central bank stave off economic collapse with a currency swap agreement to help it maintain reserve levels.

The Oyu Tolgoi project is the biggest single foreign investment in Mongolia and the deal with Rio rekindles hopes for a slew of other stalled projects.

“Mega projects lift long-term growth equilibrium upwards,” the Bank of Mongolia’s chief economist Sandagdorj Bold told Reuters, referring to hopes it will lead to a revival of foreign investment.

In the meantime, the swap agreement with China was “one of the tools to absorb the shock of balance of payments pressures”, said Bold.

The swap agreement, which works similarly to a credit line, also comes with fees and interest paid to the PBOC, but without many of the strings that are typically attached to an international bailout. “The cost is very reasonable,” said Bold, adding he could not disclose the terms of the agreement.

BOOM AND BUST

Swings in global commodity prices and foreign investment flows have left Mongolia’s economy lurching between boom and crisis in recent years.

The country burned through its reserves in 2009 as copper prices collapsed in the wake of the global financial crisis (GFC), and needed a bailout loan from the IMF and other international lenders, and the launch of the first phase of Oyu Tolgoi, to avert a full-on crisis.

Rising coal prices and a revival of copper drove growth to a 17.5 percent peak in 2011, but in recent months the economy has been weighed down by a slowdown in China, the main consumer of its resources, and government meddling that made investors less enthusiastic about its mining sector than three years ago.

“The government had assumed that the post-GFC surge in commodity prices was permanent,” Tim Condon, chief Asia economist at ING in Singapore, wrote in a research note. “Populist visions of being the Saudi Arabia of copper and coal drove negotiations with foreign investors.”

The latest downturn had prompted an IMF warning that Mongolia’s foreign reserves were likely to fall too low to finance its trade deficit, underlining the importance of the swap line with Beijing.

Lkhagvasuren Amar, a senior economist at the Asian Development Bank, using central bank figures from March, estimated that Mongolia had drawn down an equivalent of $1.7 billion out of a maximum $2.5 billion from the currency swap.

“I would find it a quite healthy buffer,” said Amar.

The central bank declined to comment on how much it had drawn down from the facility. China’s central bank did not respond to Reuters’ requests for comment.

WARY OF CHINA

The People’s Bank of China (PBOC) has inked swap agreements with 24 central bank to promote the yuan as a global currency. China’s close proximity, as well as its position as a lead investor and top trade partner, makes the yuan a unique fit to the Mongolian economy.

Mongolia has historically been cautious of China after centuries of political dominance. In 1921, it allied with the Soviet Union as a means of freeing itself from the rule of the Manchu dynasty, ushering in more than half a century of Soviet control and isolation from the rest of the world.

But Prime Minister Chimed Saikhanbileg and his predecessor Norov Altankhuyag have been more open to Chinese investment. During a visit by President Xi Jinping last August that signalled warmed relations between the countries, Mongolia renewed its swap agreement with the PBOC, increasing its size by 50 percent from the previous deal announced in 2012.

Chief economist Bold said the central bank was being careful to maintain “comfortable room” below the facility’s 15 billion yuan ($2.42 billion) ceiling.

Bold said the resolution of the Oyu Tolgoi dispute, and other mining projects set to launch or expand, could help lift growth this year to between 8 and 10 percent.

Others take a more conservative view, pointing out that it will take time before the economy feels any benefit from the restart of Oyu Tolgoi, which had been stalled by disputes between Mongolia and Rio over taxes and building costs.

Projecting 3 percent growth for this year, the Asian Development Bank wrote in March that Oyu Tolgoi would not likely have any impact on growth until 2016.

Ratings agencies agree.

“The resolution of the dispute averts the risk of default,” said Fitch analyst Andrew Fennell. “But by itself, will not turn the corner.” ($1 = 6.2040 Chinese yuan renminbi) (Editing by Alex Richardson)

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