Bricks and mortar: Conditions are set for ongoing expansion

With surging economic growth and a substantial amount of pent-up demand, Mongolia offers a wide range of opportunities for construction firms and investors. Indeed, figures from the third quarter of 2011 showed the sector expanding by a staggering 67% year-on-year (y-o-y) by value, up from 38% y-o-y growth in the second quarter. A wide variety of projects are currently under way or in the initial planning stages, including new airports, schools, roads, bridges and water initiatives. The building and construction materials industry is also on the rise, as demand for all manner of products – from concrete to rebar to solar panels – is set to increase in the coming years.

CHALLENGE: At the same time, the local construction sector faces a number of challenges. The domestic industry lacks the sophistication found in more developed markets. Consequently, many recent projects have relied on international expertise and financing. The Mongolian government has encouraged international investment, joint ventures and partnerships. In recent years the state has worked to make it easier for global players to get more directly involved in the industry. Similarly, the government has made efforts to boost construction-related training and encourage technology transfer between local and international players.

FALL AND RISE: Prior to 1990 the construction industry was highly integrated and entirely state-controlled. In 1985 the construction materials segment alone employed some 8500 people, while around 28,200 people worked on construction projects. While the 1990 switch from a Soviet-style planned economy to a market-based system freed Mongolia politically, the change was rapidly followed by a number of major challenges in numerous sectors, including construction. While the industry contributed some 4.9% of GDP in 1985, according to government statistics, by 2010 this figure had dropped to just 1.4%.

The withdrawal and collapse of the Soviet Union had a major negative impact on local construction companies, as did a rapid switch to a voucher-based and perhaps ill-thought-out privatisation strategy, which left the sector in a sorry state. According to the UN Industrial Development Organisation (UNIDO), the sector’s contribution to GDP fell at an annual rate of 14-16% over the course of the 1990-95 period, and continued to decline for some time after 1995 as well.

“In 2001 and 2002 Mongolian construction companies were only building around 300 apartments a year,” said O. Chuluunbat, the head of the National Construction Association and a member of parliament. “Looking around Ulaanbaatar, you’d see only one or two cranes working.” In the mid-2000s, however, the sector began a turnaround. The government, aware that action needed to be taken, launched the new “40,000 houses” construction programme in 2005.

PROJECTS: Financed through the Mongolian Housing Finance Corporation, the programme resulted in a substantial number of new projects, with a host of building companies springing up to take on the work. “Since this project, around 2500 construction companies have formed,” said M. Batbaatar, the president of the Mongolian Builder’s Association (MBA). “This includes design firms, architects, construction material producers and builders. Foreign companies from Japan, Korea and Russia are also included in that number.”

The 40,000 houses programme included a handful of major construction projects in Ulaanbaatar, in addition to a variety of major housing projects elsewhere in the country. A substantial percentage of these developments were carried out by international developers. Russian firms were largely behind Moscow Town, for example, while South Korean companies were responsible for Seoul Town, and so on. Additionally, the government-backed programme spurred a substantial number of private developers to launch spin-off projects throughout the capital region, which resulted in Mongolian firms branching out to undertake larger housing developments. The industry was hit hard by the 2008-09 international economic downturn, which caused many private sector building projects to be put on hold. More recently, however, there have been signs of renewed growth and vigour in construction.

Over the course of 2010 and 2011 the number of cranes in Ulaanbaatar has increased substantially, primarily due to a handful of new government projects. According to figures from the National Statistical Office (NSO), in the first quarter of 2011 the residential construction segment was worth over MNT30bn ($23.4m), up from around MNT10bn ($7.8m) in the first quarter of 2010. The figures for most other building types doubled during the same period.

OVERCOMING HURDLES: Development in Ulaanbaatar has accelerated over the past two decades, with the capital region witnessing steady population growth, as increasing numbers of Mongolians have relocated to the capital region from rural areas. Many people settled in unplanned ger (tent) settlements, particularly in the north of the city. This resulted in an estimated 170,000 families living without proper housing or sources of power and heating.

Yet whilst the need for housing is obvious, the 40,000 houses project illustrated some of the challenges facing the sector. For starters, it can be hard for Mongolians to purchase a home. The country lacks a fully developed and reliable mortgage system – many banks simply do not have the financial expertise to offer attractive packages in addition to liquidity and the necessary legal framework. Consequently, many ordinary Mongolians lack access to financing for house purchases, which has impacted demand for new housing.

Another major challenge is related to the fact that most construction materials are imported, with the majority of these coming from China, where prices are increasing. “Every year prices for construction materials increase at 20%, not counting additional currency fluctuations,” said D. Bat-Ulzii, the president of real estate developer Sunday Group. Other than cement and limestone, Mongolian companies do not manufacture construction materials; we are almost entirely dependent on imports.” Additionally, some in the sector complain that the quality of the materials is often sub-standard, and that surging demand in China itself can squeeze supplies to Mongolia. The country was home to many construction material plants during the Soviet era, but most have since gone bankrupt or are unable to produce high-quality materials. Many local cement plants today, for example, are characterised by old and sub-standard equipment and production bottlenecks, with imports making up shortfalls.

A third issue is the lack of trained and experienced professionals to work in the sector, whether as architects, surveyors, engineers or site managers. During the 40,000 houses programme, foreigners were brought in to work on specific projects, filling many of the mid- and upper-level positions. Some skills were transferred, but this was dependent on individual contractors.

DRIVING GROWTH: In recent years the government has responded to these challenges in a number of ways. In 2010 a resolution was passed through parliament that called for the revitalisation of the construction materials segment, with a subsequent 2011 law allowing for tax and Customs exemptions on imported machinery for construction materials plants. Additionally, the government plans to use the newly established Development Bank of Mongolia (DBM), which was set up in 2011 to help mobilise financing for a whole range of projects, to raise funds for a handful of new construction materials plants, provided they bring know-how and technology. “The MBA and the Mongolian government are willing to support anyone who brings in good construction technology,” said M. Batbaatar. The construction materials segment is also expected to benefit from a wide range of inputs, with sands, silicates, clays and limestone present in many regions throughout Mongolia, east to west. The MBA has produced a plan outlining how a number of different aimags (provinces) could establish cement, brick and glass plants to supply their local market, while in areas with better road and rail infrastructure, such as Ulaanbaatar, plants could more easily share resources.

COSTS: The cost of construction materials has been falling in recent years. According to the NSO, between 2008 and the beginning of 2011 brick prices fell by 33.3% and cement prices fell by 10.7%. However, the cost of other materials has fluctuated, in some cases rising rapidly over short periods of time.

Because of the fierce winters, which bring work to a halt from October through April, Mongolia’s construction season is short. The NSO estimates the price of steel and concrete has jumped by around 40% during the warmer working season in recent years. Over the past five years as a whole, prices for locally produced cement have tripled. In 2010-11 cement consumption stood at around 1.5m tonnes a year, with this number set to grow substantially as a result of the “100,000 houses” project (see analysis), which is expected to require some 1m metric tonnes all by itself.

Mongolia is currently home to three cement plants, including Erel, with a capacity of 185,000 tonnes; Hutul, with a capacity of 500,000 tonnes; and Nalgar Tushig, with a capacity of around 150,000 tonnes. Central Asian Cement also operate a grinding unit, and has an annualised production capacity of 150,000 tonnes. The sector is expected to benefit from recent financial changes.

In 2009 the government first allowed the creation of a secondary mortgage market, which has become increasingly popular since it was set up, primarily due to the activities of institutions such as the Mongolian Mortgage Company (MIK), which was launched in 2006 by the Bank of Mongolia and 10 commercial banks. By buying up primary mortgages, MIK has created space for the banks – many of which have faced shortages of capital in recent years due to their mortgage holdings – to issue more housing loans. Currently, mortgages form a substantial part of many banks’ portfolios – generally comprising around 40%.

HUMAN RESOURCES: According to the MBA, there are currently only around 28,000 trained construction workers in Mongolia. With this in mind, the government has taken steps to address the issue of human resources in the construction sector. In 2008 the state launched an updated version of the vocational training programme that was in place during the Soviet era, with funding from the US-based Millennium Challenge Corporation (MCC). The MCC signed a five-year, $285m contract with Mongolia in 2007, with $47.3m of this going towards the Vocational Education Project.

The practice of companies hiring construction workers from abroad – primarily from China and increasingly from North Korea – has come under scrutiny in recent years. Critics of foreign hiring argue that while it may solve the short-term issue of a lack of qualified human resources, it does little to build the indigenous sector for the longer term. In an effort to restrict the use of foreign labour somewhat, the government recently introduced a tariff of around MNT120,000 ($93.60) for each foreign worker brought into the country. At the same time, a handful of individual companies and associations have sponsored groups of students seeking training abroad. Meanwhile, according to the National Construction Association, there has been greater government investment in expanding training facilities for Mongolian construction workers.

NATIONAL INITIATIVE: Indeed, with economic growth surging and the prospect of even greater wealth in the future, thanks primarily to the rapidly developing mining sector, the government is now embarking on a major new construction initiative. The New Development Programme (NDP), which passed through parliament in June 2010 and is set to run through 2016, involves a wide variety of major projects, including roads, railways, affordable housing, rural development and industrial development schemes. Altogether, the programme is expected to require new investment of around $28.6bn. The NDP is overseen by the Economic Standing Committee, a parliamentary body, and the Ministry of Roads, Transportation, Construction and Urban Development (MRTCUD). Unlike some countries, where each construction sub-sector is under a different ministry, MRTCUD pulls together the whole infrastructure development programme under one roof.

One of the NDP’s central components is the 100,000 houses project, which involves the construction of affordable homes, mostly in and around Ulaanbaatar. As of late 2011, 17 different locations had been identified for the new houses (see analysis). According to MRTCUD, the 100,000 houses scheme will require around $6.2bn in investment in total. Part of this scheme includes Undur Buyant Holdings’ plan to start a huge project replacing ger districts with almost 1m sq metres of new apartments at total cost of $700m.

The NDP is organised into eight general components, each meant to address a key challenge. For example, the programme’s urban development and planning component was designed to respond to overcrowding in Ulaanbaatar, while the infrastructure improvement component responds to current transportation bottlenecks. Other challenges addressed in the NDP include high unemployment and the need to create jobs for an expanding population; severe pollution levels, particularly in the capital; ecological deterioration; poverty; and a lack of social infrastructure, particularly in rural areas, which has led to mass urban migration. Policy responses to these include expanding the housing supply; boosting job growth and education; confronting pollution; supporting rural development; boosting business and private enterprise; and finding ways to make rural areas more attractive, thus retaining population.

RUNNING THE ROADS: Major road and highway projects that are expected to be carried out under the NDP include the Trans-Mongolian highway, a 990-km, four-lane road linking the Russian and Chinese borders that will follow the current Trans-Mongolian railway route. The project is an enlargement of the existing AH-1 highway, which is one of three trans-Asian links that currently cross Mongolia (see Transport chapter).

A pre-feasibility study on the project has already been undertaken, with this demonstrating that the bulk of the traffic on the highway will likely be freight vehicles, which use the route as the shortest way to connect the key markets of Russia and China. The new highway will be able to take advantage of current plans by Mongolia’s two giant neighbours to dramatically ramp up trade, with a recent summit between Moscow and Beijing proposing a six-fold increase by 2020.

Another major road project that is expected to be carried out under the NDP is an ambitious scheme to link all 21 aimags to each other and to the capital, Ulaanbaatar. This will require the construction of some 7875 km of new highways. According to MRTCUD, in 2010 work was begun on 1122 km of this total, with 1370 km more started in 2011. A further 4200 km is set to be completed by the end of the NDP in 2016. The total investment in this project is expected to be around $4.8bn. The third major road project under the NDP concerns Ulaanbaatar. The capital has become highly congested in recent years, thanks to a boom in population and vehicle ownership and a lack of new transport initiatives. The average age of the existing roads in the capital is high, with 54% of them more than 25 years old, and maintenance has not always been well executed. The NDP plan involves around 350 km of roads in the capital – 212 km of which will be entirely new – along with seven new flyovers. In 2011 the state was expected to finish rehabilitating 50 km of road.

RIDING THE RAILS: The NDP also includes a major expansion of the rail network, in conjunction with developments in the mining sector, which require the kind of bulk carrying capacity only railways can efficiently provide. Currently the country has one major rail route, the Trans-Mongolian line, a Russian-Mongolian joint venture constructed during the Soviet era. The majority of major mining developments are not on this route. The two most significant mining enterprises currently are Oyu Tolgoi (OT) and Tavan Tolgoi (TT), both of which are to be connected to the Trans-Mongolian at Sainshand via a new southern spur. This will involve the construction of a 1100-km line, connecting with Sainshand and then heading further east to connect at Choibalsan with a second Soviet-era railway in the east of the country. The new southern spur would enable cargo from OT and TT to be transported to Russia, which is key for geopolitical as well as economic reasons.

Mongolia, a landlocked country, does not want to become too export-dependent on China, which is closer geographically to OT and TT and might enjoy a near monopoly on Mongolian mineral exports without an alternate route. This phase of the project is expected to require around $3bn in investment, not including additional funding for related infrastructure projects, such as stations, bridges and rail yards. The second stage of the railway development programme involves the construction of a new southern route to China. The line would feed cargoes into the Chinese rail network in Inner Mongolia. Stage three of the railway development plan envisages two new exits to China in the south-east, where trains could enter Manchuria and link up with a rail network that provides rapid access to China’s Yellow Sea ports, the Korean peninsula and Japan.

INDUSTRIAL CENTRE: In recent years Mongolia’s planners and politicians have been looking at the long-term development of the economy. The government has concluded that in order to ensure stability, the country needs to move away from its current dependence on commodity exports to a future in which it possesses its own value-adding industries.

With this in mind, Sainshand has been selected as the site of a major new industrial park. The Sainshand Industrial Park (SIP) will include six processing and manufacturing plants, with some $13.9bn in investments. The park will also be the transport nexus for cargo coming from eastern Mongolia, the source of most of the country’s oil, uranium, coal and other minerals. In the future, SIP will have facilities for oil refining, cement production and coking, as well as iron pellet plants.

OUTLOOK: With the NDP getting under way and a vast range of new construction projects coming up for tender, contracting and sub-contracting, the local construction sector is expected to grow substantially in the coming years. Given the projected double-digit growth numbers, concerns of overheating are common.

Similarly, some players have called into question the major recent investments in new building materials plants. However, current construction and development plans and high demand, point to major long-term government-led growth for the foreseeable future.