Open field: Recent regulatory and economic reforms make the business environment more attractive

From a closed Communist system two decades ago, Mongolia has become one of Asia’s most open economies. Hand-in-hand with the rise of democracy, economic reform has led to radical changes in the business climate. Growth is now led by the private sector and investors from around the world are welcomed.

Mongolia’s economy is relatively open and pro-business, though improvements could still be made. Regulatory reform has not yet spread to all areas, and issues of infrastructure and occasional administrative challenges arise. “We’re happy with the investment climate – it couldn’t be much better,” Lee Cashell, the chairman and managing partner of Asia Pacific Investment Partners, which has a range of interests in Mongolia, told OBG. “Taxes are very low, the currency is convertible, you can repatriate profits and it’s pretty easy to set up a business. Mongolia is actually a much better investment destination than China and its taxes are lower than Hong Kong and Singapore.”

Indeed, Mongolia benefits from a low and relatively flat tax regime. Personal incomes are taxed at 10% and corporate earnings at the same rate until they exceed MNT3bn ($2.34m), after which the level rises to 25%. Employers are required to pay an 11% social security contributions for their employees.

DOING BUSINESS: Mongolia is middle-ranking both in the world and the East Asia and Pacific region in terms of its investment climate, according to the World Bank’s “Doing Business 2012” report . The country ranks 86th in the world for 2012, which is the exact average of the countries within its region. Mongolia is thus above its neighbours China (91) and Russia (120) but below Kazakhstan (47) and, understandably, the most developed countries of the region, such as Korea (8) and Taiwan (25). However, it is worth noting Mongolia also performed better than such developed countries as Italy, Greece and Argentina, as well as some other emerging market darlings, including India and the Philippines.

In terms of factors related to business regulation and the legal environment, Mongolia has and continues to perform well, thanks to its programme of pro-investment reform during recent years. It ranks 26th for registering property, 29th for investor protection, 33rd for enforcing contracts and 57th for ease of paying taxes.

POWERING UP: The lowest indicator ranking is for “getting electricity”, at 171st. It takes on average 156 days to hook up to the power grid, according to the report; this is likely to reflect limited infrastructure and output more than regulation. Mongolia also performs poorly on “trading across borders”, ranking 159th. This is partly associated with the high cost of transport in a large, landlocked country with limited infrastructure. Indeed, the report calculates export and import costs per container average $2265 and $2400, respectively, more than twice the regional mean.

As Mongolian trade officials themselves acknowledge, export-import procedures are still too numerous and time-consuming. The Ministry of Foreign Affairs and Trade is working to streamline the process, which should benefit small and medium-sized enterprises (SMEs) in particular. It should be noted that cost and red tape have not prevented Mongolia’s trade volumes from growing rapidly in recent years (see analysis). Mongolia also ranks low for “resolving insolvency”, at 124th. This is due to the extended time it takes, as well as low recovery rates, and is likely a symptom of relatively low administrative capacity and lack of legal clarity.

CREDIT: For 2012, Mongolia has risen eight places to 67th in “getting credit”, reflecting growth in the banking system and concerted government efforts to increase access to capital for SMEs. The country has fallen 10 places on “starting a business”, to 97th. However, this underestimates the real ease of opening a business for most investors. Only seven procedures are required – in line with the regional average – and the process takes 13 days, which is also the average for OECD member states. Costs, at 2.9% of income per capita, are much lower than OECD and regional averages. The ranking is skewed by the high level of minimum paid-in capital, the equivalent of 36% of GDP per capita. This reflects Mongolia’s income levels more than a disproportionate burden on entrepreneurs.

O. Adiya, the head of secretariat at the Consultative Council on Investment Climate and Private Sector Development (CCIC-PSD), a government think-tank, told OBG he was sceptical of the report’s findings, which he argues are based on patchy responses from businesses, though he acknowledged Mongolia still had some ways to go in cutting back overregulation and costly bureaucracy. “Regulatory issues include company registration, obtaining licences and the bureaucracy associated with hiring expatriate workers,” he told OBG. “Additionally, while laws can be changed quickly, implementation and interpretation is a major issue, and there is some conflict between legislation.”

B. Lakshmi, the manager of the Ulaanbaatar-based Economic Policy and Competitiveness Research Centre agrees that contradictory legislation is a challenge for businesses, as is a related lack of clarity over the responsibilities of government agencies.

OPEN FOR BUSINESS: Mongolia has investment agreements with more than 40 countries, according to Z. Batsuuri, the second secretary at the Foreign Trade and Economic Cooperation Department of the Ministry of Foreign Affairs and Trade. Despite concerns that the global economic situation may see protectionism rise internationally, Mongolia, well aware of the benefits of openness, will stay the course on liberalisation. But the government is also conscious that the country must not be over-reliant on foreign direct investment (FDI).

“We are maintaining an open investment policy,” Batsuuri said. “FDI is important as it brings technology, skills and capital to the country. But we also need self-sufficiency and should not become too dependent on FDI. Due to the rise of mining, the government is being very careful about the wording of specific deals.”

CORRUPTION: Lakshmi asserts that patronage and corruption also remains an issue. Mongolia performs moderately well on the 2011 Corruption Perceptions Index drawn up by Transparency International, an anti-corruption organisation. It currently ranks 120th in the world, with a score of 2.7 out of 10, with 10 being no corruption perceived. This is similar to many other comparable countries (Russia scores 2.4, Kazakhstan 2.7, China 3.6 and Indonesia 3.0, for example).

Though corruption and bribery certainly exist, most foreign and local investors do not find it an impediment to business. Mongolia’s democracy is one of the soundest in Asia, and while this means parties’ economic policies are influenced by the need to get re-elected, it also means that politicians can be held accountable.

A number of civil society organisations and donors are engaged in tackling corruption and making government processes more transparent and accessible for citizens. One such is the Open Society Forum, which has been working with the authorities on increasing transparency for some years.

CATALYST FOR CHANGE: To support improvements to the business environment, in 2007 the government set up the CCIC-PSD, a public organisation chaired by the prime minister, with the minister of finance as deputy chairperson. The CCIC-PSD works with private sector associations, regulators and donors to identify the challenges faced by businesses. After research and consultation with a number of stakeholders, the council recommends legislative changes.

The CCIC-PSD holds quarterly meetings and discussions with specific sector organisations on reforms they would like to see. It acts as a catalyst for change initiated by trade associations. For example, in June 2011 the Mongolian Bankers Association approached the council with suggestions for amendments to the tax law, while in October discussions were held with representatives of the software industry and focused on issues such as intellectual property rights. One of the most important initiatives was the development of a draft law on concessions, which is now being used by the government as an overall framework for public-private partnerships. The council was also involved in the tax holidays for the construction industry, which helped revive the sector after the 2009 crisis.

Donors are actively involved, including the European Bank for Reconstruction and Development, the World Bank and the US Agency for International Development. The CCIC-PSD works with industry associations to avoid bias, and thus many foreign investors come to it through the Business Council of Mongolia. “Previously, a lack of transparency and engagement of the private sector from the government were a major issue,” Adiya told OBG. “That is what we are here to improve, and we give businesses the opportunity to articulate what changes they would like to see.”

OVERALL IMPROVEMENT: Mongolia’s business environment receives widespread praise for its openness to private and foreign investment, as well as its low tax rates and generally light regulatory touch. Challenges certainly remain, with time-consuming and expensive over-regulation in some areas, a degree of legislative overlap and a lack of infrastructure. Over the next several years, as investment in infrastructure feeds through, progress is likely to be made on many of these issues.