Our friends in the north: Russia may prove an alternative to overdependence on trade with China

As a landlocked country, with two giant nations enclosing its northern and southern frontiers, Mongolia has long seen much of its economic activity dominated by relations with Russia and China. In recent times, though, Ulaanbaatar has been trying to widen its overseas channels, instituting a “third neighbour” policy to provide extra balance – and negotiating power – in its deals with Beijing and Moscow.

Meanwhile, the rapid expansion of the Chinese economy has exercised its centrifugal forces on Mongolia, drawing in a greater and greater share of exports, while also seeing Chinese investment in Mongolia enter a class and scale of its own, compared to that of other nations. There are increasing signs, though, that this Chinese dominance is troubling Ulaanbaatar, with moves to court other foreign investors and trading partners well under way.

At the same time, Russia has been rethinking its approach. In December 2012 President Vladimir Putin announced that “In the 21st century, the vector of Russia’s development is in the east,” indicating a reorientation of policy and economic activity towards Asia and away from Europe, as China overtook Germany as Russia’s number one trading partner. How this reorientation plays out will be one of the key questions for Mongolia over the next decade.

THE ROAD (AND RAIL) TO CHINA: For now, trade relations with China far exceed those with any other nation. According to the Mongolian Central Bank (MCB), in November 2012 monthly exports to China totalled 92.8% of Mongolia’s $4.03bn total, compared with just 1.8% of total exports going to Russia and 5.4% to all other nations combined – proportions that had been similar throughout the year. In terms of imports, the same month saw a total of $6.27bn in goods and services coming from abroad sources, with 28% of this total coming from China, 27% from Russia and 45% from the rest of the world.

Part of the overwhelming role China plays in Mongolian exports is the simple result of geography. As a landlocked country, Mongolia lacks ports from which to export to other nations. The nearest international harbours at the end of existing rail links are all in northern China, at Dalian and Tianjin, the latter the closest, at 1281 km away as the crow flies. The nearest Russian equivalent is Vladivostok, some 2015 km away. By rail, these distances almost double.

Another factor here is the nature of Mongolia’s exports themselves, which have long been dominated by bulky commodities, mainly minerals, that are most economically shipped short distances by rail.

Most of these minerals are also mined in the south of the country, close to the Chinese border and far from Russia. These are mostly destined to feed China’s huge appetite for coal, uranium, copper, iron ore and the other basic feedstocks of its industrialisation, which continues apace, despite recent blips. A year-end 2012 Bloomberg report estimated 7.7% GDP growth for China in 2012, with a poll of economists forecasting 8.1% growth for 2013.

In addition, the region of China adjacent to Mongolia, Inner Mongolia, is a major powerhouse of development. The Hohhot, Erenhot and Baotou districts of this region have long been given state encouragement to establish heavy industries – for which Mongolian minerals are a vital element.

MINERAL EXPORTS: According to the most recent data available from the Ministry of Economic Development’s Foreign Investment Regulations and Registration Department (FIRRD), in 2010 coal made up 35.7% of Mongolia’s exports to China, copper concentrate 31.3%, crude oil 6.3%, zinc concentrate 5.5%, and molybdenium ore and concentrate 0.9%. Thus, 79.7% of exports were minerals or mineral-related.

The normal workings of supply and demand dictate that the overwhelming majority of Mongolia’s mineral output will therefore most likely continue to be destined for China. Indeed, much of the foreign investment into Mongolia is coming precisely because Mongolia’s minerals are in such high demand next door.

This is also true of Chinese investment in Mongolia, which has been growing steadily in recent years, with mining a particular target. The FIRRD data for 2010 shows $176m in registered foreign direct investment (FDI) from China that year, out of a total $1.03bn. This was an unusual year though, in which Canadian ($147.8m) and Dutch ($232.9m) investments challenged China’s dominance of the number 1 FDI spot.

Taken over a 20-year period, the People’s Republic invested $2.47bn of FDI in Mongolia, around 51% of the total $4.84bn of the 1990-2010 period. The next-largest source of FDI was Canada, with 8.26% of the total. Russia was ninth, with 2.24%, behind the US, with 2.39%, and Japan, with 2.86%.

CURRENT CONCERNS: Currently, however, some major questions are being asked in Ulaanbaatar about the future of Mongolian-Chinese trade.

One issue is the effect of Chinese economic growth on the Mongolian economy – particularly in distorting other sectors in favour of the mining industry. A February 2012 presentation by the Economic Research Institute for North Asia in Ulaanbaatar argued that the emphasis being placed on mining was hindering future developments in the country’s manufacturing sector, the expansion of which is a major government objective, as investment was switching away from this to mining. Manufacturing is also a more labour-intensive sector than mining (which is usually open-cast), with this having implications for employment.

At the same time, there are concerns that an over-dependence on China may be both politically and economically harmful. In the latter instance, Mongolia’s bargaining position on pricing may be undermined by lack of competition for its resources.

How these concerns play out has been recently demonstrated by approaches to current bottlenecks in export routes to China. The main rail border crossing is at Zamyn-Uud/Erenhot, where trains have to unload and then load again, due to the different gauges used by the Mongolian and Chinese railways. The former is an inheritance from the many years of Russian dominance, with the rail network operating on the wider Russian gauge, while China’s works to the narrower, Western gauge. Road crossings exist, but the network is undeveloped on the Mongolian side, requiring much new investment to hook up the huge mines at Tavan Tolgoi and Oyu Tolgoi.

For some time, the Mongolian government and parliament have been debating a new rail link, perhaps even allowing dedicated rail lines to cross the border from China to the mines. Yet in December 2012 ground was finally broken on a new rail line that would keep the wider, Russian gauge. This adds some $2-4 per tonne to the costs of transport.

Earlier, Mongolia had enacted a new investment law, following reports that the Chinese state-owned Aluminium Corporation of China was about to buy a controlling stake in mining company SouthGobi Resources. The new law refers all large, foreign investments to parliament for approval – a move that has not gone down well with many non-Chinese foreign investors, too. Mongolia’s relationship with Chinese investment therefore remains a challenging one. ENTER THE BEAR?: The question now is how far Russia might go to capitalise on its long historical ties to Mongolia to provide an alternative to China.

These links, dating to when Mongolia was a close Soviet ally, provide Russia with a number of important stakes within Mongolia, too. Russia is a major stakeholder in Mongolia’s main copper producer, Erdenet Mining Corporation, while also being 50:50 owner of the main Ulaanbaatar railway. This connects to the Russian system, providing potential hook-ups to destinations from Vladivostok to the Polish border. Mongolia also imports most of its petroleum products from refineries in Russia. Russia’s “far east” has no demand itself for Mongolian minerals, however, having mineral wealth of its own and being a sparsely populated region of 5m (by contrast, around 100m people live in China’s Mongolian border provinces).

Ulaanbaatar’s decision to keep the Russian gauge on the railway line south to China likely indicates a desire to continue to develop transport links with Russia. While the cost of transporting Mongolian coal via Vladivostok to Korea, Japan and international markets would be an estimated $100 per tonne higher than going via China, the long-term benefits of having a second export route could outweigh the costs.

Meanwhile, Russia’s focus to the east has also involved developing direct trade links to China – notably the China-Russia oil pipeline, which began delivering in 2011. Original plans to route this through Mongolia were abandoned several years ago, indicating that the strategic manoeuvring in this three-cornered negotiation is not limited to only one player. Indeed, Mongolia has been at pains to widen its trade options in recent years, with overtures to Japan, the US, Canada and the EU aimed at helping broaden possible options in its portfolio. Trade with the neighbours, then, is often highly political, as Mongolia seeks to strengthen its hand between the Dragon and the Bear.