New Fund Plans Could Divert Mongolia’s Focus from Mining Sector Reforms
Note: This post originally appeared as an op-ed in the June 2018 edition of Mongolian Mining Journal.
Mongolian Minister of Mines and Heavy Industry D. Sumiyabazar has stated that he wishes to create a new “sovereign wealth fund” managed by state-owned miner Erdenes Mongol. This fund would invest inside Mongolia and would be financed from dividends of Erdenes Mongol subsidiaries and possibly by the sale of state mining assets.
Several ideas have been floated, from selling shares of certain mines on a stock exchange to increasing production at state-owned mines. After all, a recent valuation of just three state-owned mines owned by Erdenes Mongol found they are valued in the many billions of dollars.
Based on these statements, the minister seems intent not on creating a sovereign wealth fund—defined by the International Monetary Fund (and our organization, the Natural Resource Governance Institute) as an entity investing partly in foreign assets for a macroeconomic purpose—but rather a “strategic investment fund” managed by Erdenes Mongol.
While we support the minister’s aim to enhance Mongolia’s benefits from the mining sector, such a fund might lack adequate safeguards. We are also concerned that a new fund would divert Mongolia’s scarce government income away from essential public services, such as education and healthcare.
Strategic development funds and development banks, which are similar institutions, have often proven to be sources of patronage, corruption and mismanagement. The Development Bank of Mongolia (DBM), for example, has made a long list of bad loans. It is a major source of the Mongolian state’s indebtedness, which led to an IMF-led bailout last year.
The DBM has provided financing for a number of important development projects, including an hydroelectric plant, apartment construction and renovations to central heating systems. However, some investment decisions were politically motivated. Furthermore, the former CEO was arrested for approving debt issuances without tender.
Of equal concern: strategic development funds often undermine public financial management systems by bypassing parliamentary oversight and general procurement procedures for domestic contracting. The USD 10 billion Russian Direct Investment Fund, for example, invests in domestic companies virtually without independent oversight, creating an unaccountable source of financing for supporters of the ruling regime. The fund is currently subject to U.S. sanctions due to management’s alleged involvement in corruption.
Mongolia already has a plethora of public institutions to manage its mineral wealth. These include Erdenes Mongol, the General Local Development Fund, the Fiscal Stability Fund and the newly enacted Future Heritage Fund, each of which draws money away from the general budget. These allocations, while potentially useful, imply less spending on healthcare, education and public infrastructure. Depending on its design, a new fund could either improve this situation or make it worse.
As such, we believe the Mongolian government should consider alternative proposals to boost mining and better manage the sector.
First, management of Erdenes Mongol itself can be improved. Profitability at Erdenes Mongol-controlled mines generally underperform private sector mines in terms of production and cost effectiveness. While we congratulate the company for making essential information, such as a financial report, publicly available for the first time, more reforms are urgently needed if Erdenes Mongol is to become a world-class mining company.
Second, the government ought to avoid the mistakes of the past when signing mining contracts and tax treaties with other countries. A recent analysis of the Oyu Tolgoi copper mine contract showed that profit shifting and use of a Dutch tax treaty may cost the government up to USD 9.8 billion over the life of the existing mine, notwithstanding the planned expansion. Poor understanding of these types of fiscal devices has led to consistent overestimation of government revenue, meaning even existing funds do not receive the money they expected and do not function as designed.
Third, Mongolia’s mining revenue management can be improved via prudent budget spending and better fiscal management. The government has committed to a number of fiscal rules and development plans to ensure that future generations benefit from today’s mining, but these rules and plans exist mainly on paper. As indicated by high deficits and the threat of defaults, the government budget remains unstable.
If the government is set on creating a new fund, we would suggest that proper governance rules be enacted in law. Following on the good examples of Germany’s Kreditanstalt für Wiederaufbau and the Korean Development Bank, there would be a need for clear ownership policy, legal framework and performance monitoring framework. These institutions are characterized by high degrees of professionalism, effectiveness, transparency and oversight.
Still, success stories such as these are few and far between. The global experience demonstrates that strategic development funds and development banks often divert scarce resources away from public sectors that need them the most. The government may be better served by improving the performance of existing institutions, such as Erdenes Mongol and the Future Heritage Fund, than creating new ones.
Andrew Bauer is a consultant with the Natural Resource Governance Institute (NRGI). Dorjdari Namkhaijantsan is NRGI’s Mongolia manager.
Mongolian Minister of Mines and Heavy Industry D. Sumiyabazar has stated that he wishes to create a new “sovereign wealth fund” managed by state-owned miner Erdenes Mongol. This fund would invest inside Mongolia and would be financed from dividends of Erdenes Mongol subsidiaries and possibly by the sale of state mining assets.
Several ideas have been floated, from selling shares of certain mines on a stock exchange to increasing production at state-owned mines. After all, a recent valuation of just three state-owned mines owned by Erdenes Mongol found they are valued in the many billions of dollars.
Based on these statements, the minister seems intent not on creating a sovereign wealth fund—defined by the International Monetary Fund (and our organization, the Natural Resource Governance Institute) as an entity investing partly in foreign assets for a macroeconomic purpose—but rather a “strategic investment fund” managed by Erdenes Mongol.
While we support the minister’s aim to enhance Mongolia’s benefits from the mining sector, such a fund might lack adequate safeguards. We are also concerned that a new fund would divert Mongolia’s scarce government income away from essential public services, such as education and healthcare.
Strategic development funds and development banks, which are similar institutions, have often proven to be sources of patronage, corruption and mismanagement. The Development Bank of Mongolia (DBM), for example, has made a long list of bad loans. It is a major source of the Mongolian state’s indebtedness, which led to an IMF-led bailout last year.
The DBM has provided financing for a number of important development projects, including an hydroelectric plant, apartment construction and renovations to central heating systems. However, some investment decisions were politically motivated. Furthermore, the former CEO was arrested for approving debt issuances without tender.
Of equal concern: strategic development funds often undermine public financial management systems by bypassing parliamentary oversight and general procurement procedures for domestic contracting. The USD 10 billion Russian Direct Investment Fund, for example, invests in domestic companies virtually without independent oversight, creating an unaccountable source of financing for supporters of the ruling regime. The fund is currently subject to U.S. sanctions due to management’s alleged involvement in corruption.
Mongolia already has a plethora of public institutions to manage its mineral wealth. These include Erdenes Mongol, the General Local Development Fund, the Fiscal Stability Fund and the newly enacted Future Heritage Fund, each of which draws money away from the general budget. These allocations, while potentially useful, imply less spending on healthcare, education and public infrastructure. Depending on its design, a new fund could either improve this situation or make it worse.
As such, we believe the Mongolian government should consider alternative proposals to boost mining and better manage the sector.
First, management of Erdenes Mongol itself can be improved. Profitability at Erdenes Mongol-controlled mines generally underperform private sector mines in terms of production and cost effectiveness. While we congratulate the company for making essential information, such as a financial report, publicly available for the first time, more reforms are urgently needed if Erdenes Mongol is to become a world-class mining company.
Second, the government ought to avoid the mistakes of the past when signing mining contracts and tax treaties with other countries. A recent analysis of the Oyu Tolgoi copper mine contract showed that profit shifting and use of a Dutch tax treaty may cost the government up to USD 9.8 billion over the life of the existing mine, notwithstanding the planned expansion. Poor understanding of these types of fiscal devices has led to consistent overestimation of government revenue, meaning even existing funds do not receive the money they expected and do not function as designed.
Third, Mongolia’s mining revenue management can be improved via prudent budget spending and better fiscal management. The government has committed to a number of fiscal rules and development plans to ensure that future generations benefit from today’s mining, but these rules and plans exist mainly on paper. As indicated by high deficits and the threat of defaults, the government budget remains unstable.
If the government is set on creating a new fund, we would suggest that proper governance rules be enacted in law. Following on the good examples of Germany’s Kreditanstalt für Wiederaufbau and the Korean Development Bank, there would be a need for clear ownership policy, legal framework and performance monitoring framework. These institutions are characterized by high degrees of professionalism, effectiveness, transparency and oversight.
Still, success stories such as these are few and far between. The global experience demonstrates that strategic development funds and development banks often divert scarce resources away from public sectors that need them the most. The government may be better served by improving the performance of existing institutions, such as Erdenes Mongol and the Future Heritage Fund, than creating new ones.
Andrew Bauer is a consultant with the Natural Resource Governance Institute (NRGI). Dorjdari Namkhaijantsan is NRGI’s Mongolia manager.
Authors
Dorjdari Namkhaijantsan
Mongolia Manager
