Manufacturers in Mongolia make the most of resources and demand to build the country's industries

Holding up during difficult times and helping to take the edge off the commodity cycle, industry in Mongolia has contributed significantly to the economy. While resource prices have been dropping and related economic activity and foreign direct investment are not at expected levels, manufacturing and processing have been growing, with industrial production up almost 15% in 2013, providing a measure of countercyclical support. The numbers are certainly small. Mongolia has a population of just 3m people and does not produce much. More investment is needed, and many of the most promising industries have been ignored by investors and the government, crowded out by mining and minerals opportunities. Still, the events of recent years have demonstrated that the theoretical benefits of a diversified economy are there when needed.

Steps Ahead

The central bank’s “Foreign Trade Review” shows clearly how the manufacturing sector can help bring balance to the economy. In 2013, as resource prices were easing and mining projects were running into delays, the cashmere and “other” line in the report held up well. Total coal exports dropped 41% in dollar terms in 2013 compared to 2012, and although copper concentrate and iron ore exports were up, total mineral exports were down 5% in that period. During the same time, exports of cashmere (both combed and washed) rose 27%, from 4% of total exports to 6%. Exports of other products climbed 20%, growing from 5% to 6% of total exports. In the first 11 months of 2014 the trend held, with cashmere exports rising 17% and “other” exports jumping 47% (though as a percentage of the total, the two categories were stagnant as copper concentrate exports rose 14-fold). By end 2014, non-mineral exports were greater than coal exports.

Production (for domestic consumption and export) has surged. The manufacturing of beef products jumped 122.7% in 2013 over 2012 in volume terms. Green tea was up 73.6%; juice 26.6%; packaged water 31.8%; combed camel blankets 79.3%; bakery products 35.1%; grade I flour 85%; and mutton 35.9%. Manufacturing went from 22.3% of industrial output in 2011 to 25.5% in 2013. As the Mongolian tugrik declined, local production gained traction as imports became increasingly expensive. The rise of domestic manufacturing has helped the economy considerably. The country went from having a trade deficit to a trade surplus, the balance going into the black in late 2013 and then into substantially positive territory in 2014.

Soda Water Maths

The build-versus-buy calculus can be seen clearly in Coca-Cola’s soda water strategy. The company, which has a bottling plant in Ulaanbaatar and has been active in the country for more than a decade, imports cans of Schweppes-brand soda water from Hong Kong. The beverage is considered a premium item in the country and is not historically favoured by the Mongolian consumer. But much has changed in the country, and Coca-Cola is responding. As the tugrik has fallen, the price of Schweppes brought from Hong Kong has become too expensive for most consumers, especially given the economic slowdown. At the same time, many consumers are becoming more sophisticated and their tastes are changing. In 2014 the firm began to make Schweppes soda water in plastic bottles at its Mongolian facility. It is also planning to manufacture sparkling water under the Bonaqua name, which is a more mainstream brand with an affordable price point. The investment in local production has been justified by current market conditions.

Building the Base

Manufacturing has historically faced a number of challenges in Mongolia. The country has a small population, much of it is relatively poor, especially compared to its southern neighbour, China. Mongolia has not yet had the scale or the critical mass to justify investment in large manufacturing facilities. A shift towards mass-producing exportable products would thus have to deal with the country’s geographical isolation and relative lack of transportation.

During the Soviet era a considerable industrial base had been built up. Factories in Mongolia made shoes, blankets, clothing, matches, carpets, paper and a range of other products. By the Democratic Revolution, manufacturing made up one-third of the economy. The end of Soviet support, alongside the ending of the global Multi-Fibre Agreement in 2005, all in the context of a growing minerals sector, has left industry a relatively small part of the overall economy. Manufacturing now accounts for about 7% of GDP.

For several years, little was done to aid the recovery of industry. For investors, the economics were not compelling given the country’s slow recovery. Legacy equipment was often utilised for production, and attempts to make factories more competitive were undertaken in an irregular and haphazard manner. This can be seen especially in the cement sector. While the country has had five cement plants running in recent years, most of the capacity was prior to the democratic revolution. Even the newer plants used dated equipment and were running far below their output capacity. This caused challenges as the country boomed and demand increased. Mongolia was forced to import most of its cement from China, for example. But the situation is changing, and investment has been picking up rapidly to meet the demands of the growing economy. In terms of cement making, six new greenfield projects have been announced or are in development and one major expansion is in the works. Capacity is set to increase greatly and efficiency should improve overall.

Government Push

The government has also been active in pushing for the development of industry. Of the $1.5bn raised in the Chinggis Bond issue in 2012, more than $160m went to manufacturing. Cashmere, dairy, woollen garment and other garment production were supported. Proceeds from the JPY30bn ($285m) Samurai Bond, sold in late 2013, have also been committed to the development of industry. In the past, cashmere has received significant support. In 2008 the Asia Development Bank (ADB) began a programme to make funds available to cashmere suppliers, while in 2011 the government and the European Bank for Reconstruction and Development (EBRD) made loans to local cashmere producers.

The focus on industrialisation remains, and in some ways the country is redoubling its efforts to increase local production. In early 2014 N. Altankhuyag, the prime minister at the time, declared 2014 The Year of Made in Mongolia and said that MNT1trn ($600m) would be spent in support of industry. He also said the business environment would be improved and that transparency would be increased. The hope is that the country will be able to boost economic growth and at the same time reduce its dependence on imports. A number of significant achievements have been made already in the area of manufacturing. The country has been assembling trolleybuses and duobuses since 2006 and has been able to export vehicles to Kazakhstan. It also began assembling regular buses in 2014.

Focusing on Strenghts

The sector’s main focus is the processing of minerals and agricultural products. In the case of the former, the hope is that facilities can be built that allow for more of the value-added work to be done. As it stands now, resources are for the most part exported raw and processed elsewhere. Outside of the extractive industries, the country’s land provides other resources. Mongolia produces significant quantities of vegetables, grains and meats and aims to make more food products from them in order to become more self-sufficient. It can also sell overseas. Its livestock resources are such that it has the potential to become a more significant exporter of meat products and manufactured woollens. While Mongolia will never be an exporter the way China is, it can be more than just a source of raw natural resources.

Stalled & Scattered

Not all has gone as planned. Mongolia’s key effort in terms of downstream processing, the $9bn Sainshand Industrial Complex, has not advanced beyond the preliminary stages. The project, which was to include a smelter, a power plant, a cement plant and food processing facilities, has been stalled for lack of funding. The government has said that it is willing to give up a majority stake in the park if a suitable partner can be found. Even the more modest investments made with Chinggis and Samurai bond money have not yielded as much as expected. According industry groups, the money was scattered too widely without a coherent strategy. They argue that a more coordinated industrial policy is needed when funds are invested. “There has been much talk of diversifying exports, but it hasn’t become a reality,” G. Yondonsambuu, vice-director of the Mongolian Wool and Cashmere Association, told OBG. “There has been support from the state, but it hasn’t paid off. We need to build new factories, huge organisations with great capabilities.”

Industry faces other considerable challenges. The fall in the value of the tugrik has put a strain on manufacturers, as they invariably have to import many of their inputs and are having trouble passing the higher costs on to the consumers. Poor infrastructure and traffic jams hamper development, as they make transportation difficult and increases overall costs. The importing of production inputs continues to be a major bottleneck, as domestic manufacturers are at the mercy of expensive and inefficient international logistics operations. Shortages often occur; beverage companies report 10-week lead times when sourcing bottles from overseas.

Workforce

While the minimum wage is relatively low at MNT192,000 ($115) per month and workers are plentiful, it is difficult to find and retain qualified staff. Training opportunities are limited, and those who do have skills can be expensive to keep. Firms have trouble balancing personnel resources. They have to keep staff year round and cannot let workers go during the slow winter months simply because of the lack of business. High prices, especially in the capital, make it hard for workers to live on low-end salaries, leading to dissatisfaction, high turnover and low productivity.

Exporting to Russia

Financing remains a problem. While loans are available, the value chains have many links that are unable to get funding for key pieces of equipment, leading to delays, shortages, quality issues and waste. Farmers, for example, are not able to buy tractors that are good enough and large enough, while the dairy industry lacks the proper equipment to chill milk after production. The businesses in need of the money do not have the collateral, while the government has not always recognised what investments must be made. As a result, production can be inconsistent.

Some unexpected opportunities have emerged. Due to its economic troubles and the sanctions placed on it, Russia is looking more closely at Mongolia as a potential source of food products. When Russian president Vladimir Putin visited Mongolia in 2014, a deal was concluded that could take Mongolian exports of beef – which had been stopped completely for a time in 2010 due to concerns about disease – from about 10,000 tonnes a year to more than 100,000 tonnes per year. Russia is also looking to Mongolia as a potential source of milk and butter for its eastern region.

Retail Mixed

The retail sector in Mongolia is growing, in the sense that more supermarkets and malls are being built. Outlets are developing in the mid-market range, between the very expensive grade-A Central Tower and the local shops. Hunnu Mall Company is building the 50,000-sq-metre Hunnu Mall on the road stretching out west toward the airport. The Village@Nukht, also on the way to the airport, was nearing completion in 2015 and will add an addition 10,000 sq metres of retail space to the total.

In the south and east of Ulaanbaatar, where new apartment blocks are rising, individual shops and some highly competitive supermarkets have sprung up. Home Plaza, for example, has a new outlet with a substantial supermarket near the newly developed Olympic Village. This growth has meant the established shopping facilities, such as State Department Store, MaxMall, Ulaanbaatar Mall, Good Price, MetroMall, Misheel Expo and Peace Mall, are starting to face significant competition.

At the same time, the retail sector appears to be struggling. Consumers are slashing spending because of the fall of the tugrik and slowing economic growth. International brands are now more difficult to find on the shelves, and shoppers are more price sensitive than ever. Companies like Nomin are continuing to develop local sourcing initiatives, which will help keep prices under control and volumes from dropping, but the lack of foreign goods is a sign of a significant weakening in consumer demand. Meanwhile, innovation seems to have slowed. Convenience stores remain few and far between – mostly retrofitted alcohol shops – despite the need for outlets of this type. Ulaanbaatar is no longer seen as a destination with great retail opportunity. The sector is holding its own and responding to new residential development. As a sign of the times, global consultancy AT Kearney dropped Mongolia from its Global Retail Development Index.

Outlook

Mongolia’s industrial sector is facing challenges as a result of slowing economic growth. But as the country adjusts, manufacturers are evolving to capture new opportunities. Local production is increasing while markets and malls are working to buy more goods made in the country. The transition will be difficult, but ultimately Mongolia should benefit from increased domestic capacity. Consumers will enjoy lower and more stable prices, and more profit will stay within the economy. The larger projects related to processing may continue to struggle as international financing remains difficult, but any progress that is made on them will add incremental capacity and further boost local industry.