Is Mongolia's Resource Boom on the Brink of Collapse?

Mongolia was the world’s fastest growing economy last year, driven by foreign investment and rapid developments in its rich coal, copper and gold mining sectors. Now it looks like all of that development could fall apart and the nation’s economy could collapse, all due to an ill thought out law.

In late 2009, Rio Tinto (NYSE:RIO) the international mining giant, negotiated a contract with the Mongolian government to develop Oyu Tolgoi, the world’s largest new copper mine. The mine would cost around $10 billion to build and Rio Tinto’s investment would be secured with the assurance that all taxes and royalty payments to the government would be fixed for the first 30 years.

Encouraged by the cooperation between Rio Tinto and the Mongolian government other foreign investors got involved in Mongolia and its natural resources. Wealth in the country started to increase significantly, sky scrapers were being built all around Ulan Bator, and the economy grew by a massive 17.5%.

Then in May the government introduced the Strategic Foreign Investment Law, and everything changed.

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The law restricts foreign investment in the country in the important strategic sectors of mining and banking (which happen to also be the most attractive).  The law demands that parliament approves any foreign investment in assets in the afore mentioned strategic sectors.

Investors have complained about the lack of clarity in the law as the government have still not specified exactly how it would work in practice. Needless to say that foreign investment has plummeted, and coupled with the fall in coal revenue as Chinese demand continues to fall, Mongolia is now facing some financial difficulties.

John Finigan, the CEO of Golomt Bank, the nation’s second largest bank, explained that “there are a series of elements that have built up less-than-welcoming attitudes to Mongolia at a time when the macroeconomic situation is deteriorating.”

In September 2012 foreign investment was down 44% compared to the year before. An anonymous executive at a company which has made major investments in Mongolia, has admitted that, “we haven’t made any new investments. It is a horrible law. It is very menacing and unclear. At a time when investors are scared of allocating capital anyway, it’s definitely had a negative impact.”

Now in order to try and summon some extra revenue the Mongolian government is determined to try and renegotiate its deal to increase the taxes and royalties that Rio Tinto pays to the sum of an extra $319 million a year; this would be four times higher than the original deal.

Mongolia must be careful, the arrival of Rio Tinto heralded the economic boom, but forcing the mining giant to leave could scare all other foreign investors away and see the country’s economy collapse.

By. Charles Kennedy of Oilprice.com