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The Oyu Tolgoi

Investment Agreement:Why It Works for Mongolia

A Report byWorld Growth International

April 2009


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2 The Oyu Tolgoi Investment Agreement

Table of Contents

I. Executive Summary ............................................ 3

II. Introduction ........................................................ 5

III. Agreement RecognizesInternational Realities ........................................ 7

IV. International Capital Critical to Mongolia ............9

V. Economic Benefits of Proposed Agreement......11

VI. Sound Framework for Mining Investmentin Mongolia ........................................................ 13

VII. Excessive Tax Rates Deter Investment ............15

VIII.Benefit of Accelerated Mining Development ....19


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During the period before 2008, world prices for met-

als and minerals reached historic peaks. Like many

other resource rich economies, Mongolia changed its

tax and mining laws to increase public revenue over the

short term. Certain NGOs actively promoted such an

approach. Negotiations over the terms of the Oyu

Tolgoi project stalled as the gap between the positions

of the Government and the project investors widened.

Following the national election in 2008, the leader-

ship of both the Mongolian Peoples Revolutionary

Party and the Democratic Party decided that a fresh

approach to the Oyu Tolgoi negotiations was required.The global financial crisis and the economic slow-

down that followed had reduced the capacity and

willingness of foreign investors to undertake major

resource projects.

The Coalition Government restarted the negotiations

in accordance with a Parliament Resolution, taking

into account the greatly altered investment environ-

ment. Terms for proceeding with an Investment

Agreement for Oyu Tolgoi were agreed to by the

Mongolian Cabinet and then the proposed Agreement

was sent to the State Great Hural on 19 February 2009.

The proposed Agreement better realizes the policy goals

of the Mongolian Government than the previous

Agreement and is a good outcome for the country from

an economic perspective. The Oyu Tolgoi project will

generate substantial and comprehensive economic

benefits for the Mongolian people. These will include

substantial increases in

gross domestic product (GDP),

exports,

the participation rate of Mongolians in the labour

market,

the number of Mongolians in employment,

labour productivity,

household disposable income, and

public revenue.

Some still argue for different terms, but the unavoid-able facts are that the total effective tax rate on mining

in Mongolia is already high by international standards

and the risks of investing in Mongolia are perceived to

be high by international investors.

Accordingly, any increase in the total effective tax rate

set by the terms of the proposed Agreement will dis-

courage investment both by the Oyu Tolgoi partners as

well as other investors, and with it the benefits to the

Mongolian economy and the people. Any increase

INTRODUCTION

The Oyu Tolgoi Investment Agreement 3

The Oyu Tolgoi Investment Agreement:Why It Works for Mongolia

I. Executive Summary

For the past five years the Mongolian Government has been negotiating an Investment

Agreement with Ivanhoe Mines and its partner Rio Tinto to develop the mineral deposit at Oyu

Tolgoi in the Southern Gobi. The deposit is huge and will require an investment of more than

US$7 billion to bring it to fruition.

The proposed Agreement better realizes the

policy goals of the Mongolian Government than

the previous Agreement and is a good outcome

for the country from an economic perspective.


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in the uncertainties faced by the investors over the ex-

pected life of the project for example by shortening

the time-period of the Agreement or requiring yet

more analysis of the public finance or economic impli-

cations of the project to be undertaken before it can

proceed would have a similar negative effect.

Any further delays in the Oyu Tolgoi project wouldtherefore be very costly for Mongolia. Moreover, any

further analysis that might be undertaken in the time

period in question cannot throw light on the major

economic and financial uncertainties surrounding the


In the wake of the global financial crisis, the global

economic environment is progressively

getting worse and a turnaround is not yet in sight.

project. The future course of mining technology, input

costs and metal prices are unknowable.

In the wake of the global financial crisis, the global

economic environment is progressively getting worse

and a turnaround is not yet in sight. Russia and China,

Mongolias main trading partners, are not immune

from the economic downturn. Indeed, the Russian

economy is slowing faster than the global average.

As the Mongolian economy is also slowing rapidly,

the economic benefits of the proposed Agreement

now assume an even greater significance for the

country. Even before the downturn, Mongolia was

facing serious challenges in terms of inflation and its

deteriorating fiscal position. The proposed Agreement would help to ensure that Oyu Tolgoi proceeds,

thereby making a major contribution to stabilising

the countrys public finances.


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II. Introduction

By 2001 Mongolia was widely seen as having developed

an attractive policy environment from the perspective

of international mining investors. As a consequence,

minerals exploration increased five-fold between 2001

and 2006. This exploration boom, in turn, led to the de-

velopment of numerous projects for new mines in

Mongolia. The most advanced are Oyu Tolgoi (copper,

gold and molybdenum), Tavan Tolgoi (coal), Tumertei

(iron ore), Asgat (silver), Dornod (uranium), and

Guyvanbulag-Mardai (uranium). Of these, by far the

most important for Mongolia is Oyu Tolgoi.

The huge scale of mining projects and their long time

horizons mean that mining investors are acutely sensi-tive to tax and regulatory settings and the possibility of

changes to them after the initial investment has been

made. To reduce this uncertainty, theMinerals Law of

Mongolia allows the Mongolian Government to enter

into investment agreement with miners to fix specific

tax rates for defined but limited periods of time.1 The

period depends on the total amount to be invested.2

By late 2003 the Oyu Tolgoi project had advanced to

the point where the owner of the mineral licence,

Ivanhoe Mines Mongolia Inc., initiated negotiations

with the Government on an Investment Agreement.The Government submitted a draft Agreement to the

State Great Hural in July 2007 but withdrew it the

following December.

In January 2008 the Government set up a joint

Parliamentary-Government Working Group to revise

the draft Agreements for the Oyu Tolgoi, Tavan Tolgoi,

and Asgat projects.3 Following the Working Groups

consideration of the issues and further negotiations

with Ivanhoe Mines and Rio Tinto, its major partner,

the Government submitted a revised draft of the

Agreement to the State Great Hural for its approval in

February 2009.

Subsequently a number of Non-Government Organi-

zations (NGOs) have strongly and publically criticised

the Oyu Tolgoi Investment Agreement proposed by the

Mongolian Government. Their central contention is

that the key provisions of the proposed Agreement are

not in Mongolias best interest.

This report assesses the benefits and costs to Mongolia

of the proposed Agreement on Oyu Tolgoi. It sets out

the reasons why criticisms of the Agreement run

counter to the national interest given the importance

of substantial investment in Mongolia, particularly

during the current period of economic difficulty.

Best Outcome Possible

The proposed Investment Agreement for Oyu Tolgoi

would achieve the best possible outcome in terms of thepublic policy objectives of the Government of Mongolia.

The substantial benefits of the proposed Agreement

can be objectively demonstrated. Its key provisions

compare favourably with international best practice

as assessed by The World Bank and recommended by

The Bank for application to the entire Mongolian

mining sector.4 Table 1 has the comparisons.

Virtually all the provisions of the Agreement are

consistent with international best practice. The

exceptions are:

INTRODUCTION


1 Article 29, The Minerals Law of Mongolia, Official English Translation, Ulaanbaatar, 30 October 2006. Such Agreements wereformerly known as Stability Agreements (The World Bank 2007,Mongolia: Sources of Growth, Country Economic Memorandum,Report No. 39009MN, The World Bank, Washington, DC, 26 July, p. 124).

2 The time limits are 10 years for projects for a total investment of US$50 to US$100 million, 15 years for projects of US$100 toUS$300 million and 30 years for projects in excess of US$300 million (Article 29.3, The Minerals Law of Mongolia, 2006)

3 At the time the joint Parliamentary-Government Working Group was asked to make its suggestions and recommendations to theMongolian Government by 5 February 2008 (The World Bank 2008, p.10)

4 The World Bank, 2008,Mongolia Quarterly, The World Bank, Washington, DC, 28 January.

The proposed Investment Agreement for

Oyu Tolgoi would achieve the best possible

outcome in terms of the public policy objectives

of the Government of Mongolia.


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acquisition of a substantial equity stake in Ivanhoe

Mines Mongolia, Inc. by the Mongolian Government

(international best practice is for no public equity);

imposition of a resource rent tax (RRT) of 29.9

percent (international best practice relies solely on

the corporate income tax and a mining royalty); and

a gross mining royalty of 5 percent on the value of

the output (international best practice prefers rates

between 2 and 3 per cent);

These provisions are more favourable to Mongolia in

terms of their revenue potential but they are likely to be

inferior to international best practice from an eco-

nomic perspective. They are, however, essential to the

achievement of the Governments policy objectives for

the project and the mining sector.



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III. Agreement RecognizesInternational Realities

In judging the contribution that the proposed

Agreement would make to the achievement of the

Governments policy objectives, one has to keep the

global investment environment in mind and the

importance of mining investment for boosting

Mongolian economic development, public revenue,

and employment.

When the State Great Hural passed theMinerals Law

and the Corporate Income Tax Law in 1997, Mongolia

was widely seen as providing an attractive environment

INTERNATIONALREALITIES


Source: (a) World Bank 2008 & (b) Draft Investment Agreement as at 18 February 2009

Notes: (c) Subject to the taxpayers rights under relevant double taxation treaties with Mongolia. (d) This tax only applies to net cash income, i.e. after recovery

of all capital and operating expenses to that point. In any tax year the total taxes payable by the private investors are limited to 68 per cent of their taxable in-

come from the project, excluding any dividends payable to the Mongolian Government.

Table 1 Key Policy Settings Draft Oyu Tolgoi Investment AgreementReflects International Best Practice

Policy MeasureInternational

Best Practice Setting (a)Provision in Draft 2009 OTInvestment Agreement (b)

Share of equity in the mining development heldby the public sector None

34% with option for anadditional 16%

Corporate income tax rate(maximum marginal rate)

25% to 30% 25%

Corporate income tax rate on dividend, royalty &interest income 25% to 30% 10%

Withholding tax rate on dividend payments tonon-residents 15% Nil

Withholding tax rate on interest payments tonon-residents

15% 20% (c)

Mining royalty rate(ad valorem basis) 2% to 4% 5%

Additional taxes on windfallincome or profits None

30% of the real net cash return> 29.9% per year (d)

Import duty on mining plant& equipment

None None for first 7 years

Export duty on mineral commodities None None

Value-added tax Refundable Refundable

Tax depreciation of mining plant& equipment

Accelerated & pooleddepreciation

Straight-line over 3 years (computers),10 years (plant & equipment) or

40 years (other)

Depletion allowances None None

Ring fencing of tax liability of nominatedactivities from the rest None Yes

Treatment of exploration expenses Amortized over 5 years Amortized over 10 years

Treatment of environmental expenses Expensed Expensed

Treatment of mine closure & rehabilitationexpenses

Tax deductible contributionsto sinking fund

Tax deductible contributionsto sinking fund forlast 7 years of mine

Tax holidays None None

Carry-forward of tax losses Unlimited forever or forup to 7 years

Unlimited for up to8 years


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for mining investment, albeit without achieving inter-

national best practice in its overall tax rate on the

mining sector. Consequently, between 2001 and 2006

minerals exploration in Mongolia increased five-fold

and this led to the development of numerous mining

projects, including Oyu Tolgoi.

In 2004 negotiations resulted in a Stability Agreement

for Oyu Tolgoi to take advantage of rising real metalprices and strong economic growth in China and

Russia. This turned out to be the high-water mark for

new mining projects in Mongolia. Had the mining

policy regime of that time been maintained, the Oyu

Tolgoi project would almost certainly have proceeded

without delay, as would many others.

Collectively these mining projects would have gener-

ated very large, positive impacts on the Mongolian

economy, namely:

increased GDP by US$1.5 billion per year;

45,000 new jobs for Mongolians;

increased exports by US$2.45 billion per year; and

additional public revenue of US$385 million per

year.5

Like many other resource-rich economies, Mongolia

changed its mining and tax laws to secure a higher

financial return to the Government over the short

term. This was actively advocated by certain NGOs.

The Minerals Law was amended to allow the

Government to acquire up to 34 per cent of the equity

in mineral deposits of strategic importance and a

Windfall Profit Tax (WPT) was introduced on copper

and gold mining.

These policy changes were reflected in the

Governments stance in the Investment Agreement

negotiations for Oyu Tolgoi and other mining projects.

As occurred in other parts of the world, the gap

between the Governments position and that of the

long-term investors widened.

The change in Mongolian policy was significant. The

IMF estimated that the tax change alone pushed thetotal effective rate on a large-scale copper mine to over

80 per cent of the net return to its investors6 the

highest total effective tax rate in the worldand more

than twice international best practice.7

In 2007 and 2008 the investment environment

deteriorated further making the negotiations more

difficult to conclude successfully. The Government

withdrew the draft Investment Agreement from the

State Great Hural. With encouragement from other

groups in the community, further changes to the

Minerals Lawwere mooted to raise the public equitystake in mining projects to a minimum of 51 percent

and to change the mining taxation regime further. The

onset of the global financial crisis then worsened

conditions for investors considerably. There were

declines in credit availability, sharp falls in metal and

mineral prices, and a major slow down in global

economic growth.


As occurred in other parts of the world,

the gap between the Governments position and

that of the long-term investors widened.

5 Robert Shapiro and Sonecon LLC, 2009,Economic Modernization in Mongolia: The Impact of Tax and Regulatory Policies on theMining Sector, World Growth Mongolia, Ulaanbaatar, January

6 International Monetary Fund [IMF], 2008a,Mongolia: Selected Issues and Statistical Appendix, IMF Country Report No. 08/201, IMF,Washington, DC, July, accessed at http://www.imf.org/external/pubs/ft/scr/2008/cr08201.pdf

7 James Otto, 2004, International Comparative Tax Regimes,50 Rocky Mountain Mineral Law Institute, 17, pp. 1-45, as reported inJames Otto, Craig Andrews, Fred Cawood, Michael Doggett, Peitro Guj, Frank Stermole, John Stermole, and John Tilton, 2006,MiningRoyalties: A Global Study of their Impact on Investors, Government, and Civil Society, The World Bank, Washington, DC


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IV. International Capital Critical to Mongolia

After the national election in 2008, it was clear to the

leadership on both sides of politics in Mongolia that

measures such as a total effective tax rate of over 80

percent would mean no mining investment and no

investment, in turn, would mean no public revenue, no

new local jobs, and no addition to GDP.

The new Coalition Government set about to reshape

the approach to the negotiation of the Oyu Tolgoi

Agreement in light of the deteriorating economic out-

look in Mongolia and the global economy. The new

approach clearly recognized that international mining

capital and expertise are scarce, particularly at the

present time. Both are essential to Mongolias success-ful economic development. To transform Mongolias

economic potential into reality, international mining

investors have to receive at least the return that they

can obtain elsewhere in the world, after due allowance

for the risks of investing in Mongolia. As the past four

years in Mongolia has repeatedly shown, these risks

are not inconsiderable and are increasing.8

The amount of international investment that

Mongolia can attract for a mining project depends di-

rectly on how much revenue the Government tries to

extract from it. Some have argued the Governmentshould raise tax on the project to increase revenue.

However, maximizing the tax rate can never maximize

the revenue that is collected. If the tax rate is too high,

the investment will not proceed.

From Mongolias perspective, the public revenue pro-

visions in the Oyu Tolgoi Investment Agreement could

only be improved at the expense of the commercial

viability of the project. Any increase in the total effec-

tive tax rate on the project, as provided for by the

proposed Investment Agreement, would lead Ivanhoe

Mines and Rio Tinto to either a scaling back the size

and/or scope of the project, its further deferment, or

ultimately its complete cancellation.

A Great Outcome for Mongolia

On the terms proposed for the Oyu Tolgoi project by

the Mongolian Government, Ivanhoe Mines and

Rio Tinto, the project would generate substantial

economic benefits for the people of Mongolia.

Moreover, by doing so it would significantly reduce

poverty in Mongolia currently some 32 percent of

Mongolian households have to subsist below the

national poverty line.9

Ivanhoe Mines and Rio Tinto propose to invest

US$5 billion over the first five years of the project.Oyu Tolgoi would then produce 500,000 tons of cop-

per and 330,000 ounces of gold a year for the next 45

years, making it one of the largest mines in the world.

Over the life of the project, the companies propose to

invest a total of US$7.5billion in real terms.10

INT

ERNATIONALCAPITAL


On the terms proposed for the Oyu Tolgoi project

by the Mongolian Government, Ivanhoe Mines and

Rio Tinto, the project would generate substantialeconomic benefits for the people of Mongolia.

8 The Fraser Institute, 2008, The Fraser Institute Annual Survey of Mining Companies 2007-08, The Fraser Institute, Vancouver, BC

9 IMF [International Monetary Fund], 2008b,Staff Report; Staff Supplement; Public Information Notice on the Executive BoardDiscussion, IMF Country Report 08/200, IMF, Washington, DC, July, accessed athttp://www.imf.org/external/pubs/ft/scr/2008/cr08200.pdf

10 Ivanhoe Mines limited, 2007,Reference Facts: Oyu Tolgoi Project, 27 June, [accessed at www.ivanhoe-mines.com/i/misc/OTFact.pdf ].Measurement in real terms discounts for inflation.


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V. Economic Benefits of Proposed Agreement

The recent estimates of the economic benefits for

Mongolia from the Oyu Tolgoi project indicate they

would be substantial in extent and comprehensive in

scope,11 including increases in:

gross domestic product (GDP) by 34 per cent in real

terms two-thirds of which from the mining sector

and one-third from the rest of the economy;

exports by over 70 percent;

the participation rate in the labour market by 5.8

percentage points;

employment of Mongolians by more than the 10

percent;

labour productivity, in terms of GDP per employee,

by 21 percent;

disposable income per head of population by

11.5 percent; and

accumulated net public revenue, over the project-

life, by over Tg 9 trillion.12

The fiscal benefit would be one of the largest compo-

nents of the economic impact and its principal sources

are mining royalties on the projects output and its cor-

porate tax payments. As the metal price assumptionsused to prepare the above appear to be conservative, the

economic benefit to Mongolia, as well as its fiscal com-

ponent, could be even greater than estimated,

particularly over the short to medium term.

The additional public revenue that would be generated

by the acquisition of public equity and the imposition

of the resource rent tax (RRT) are inherently difficult

to determine. In large measure, both will depend on

future copper and gold prices. Recent research at the

IMF on the long-term behaviour of metals prices con-

cludes that real metals prices can be expected to decline

by around one percent per year on average, although

price disturbances around that trend are likely to per-

sist for somewhat lengthy, if variable, periods.13

The acquisition of public equity and the method

of financing it will each affect the project financing

chosen by the private investors as well as the divi-

dends distributed to shareholders subsequently. Each

of these decisions, in turn, is likely to defer and/or

dilute the corporate tax payments generated by the

project. The impact of public equity on the net present

value of the public revenue stream without that equity

is difficult to determine with any accuracy. However,

the Government of Mongolia attaches high importance

to securing public equity in the project.

E

CONOMICBENEFITS


The fiscal benefit would be one of the largest

components of the economic impact and its

principal sources are mining royalties on the

projects output and its corporate tax payments.

11 This discussion of the economic benefits of the Oyu Tolgoi project draws on Shapiro and Sonecon 2009 and Ernie Stokes, 2005, TheEconomic and Fiscal Impacts of the Oyu Tolgoi Project on Mongolia: Phase 2, The Centre for Spatial Economics, Toronto, September[accessed at http://www.ivanhoe-mines.com/i/pdf/IDP_Impacts.pdf]

12 These estimates were made with an economic model of the Mongolian economy developed by the Bank of Mongolia, the MongolianMinistry of Finance, and the National Statistical Office of Mongolia. They were based on a 40-year time horizon and conservativeassumptions about future metal prices.

13 See Paul Cashin, Hong Liang, & C John McDermott, 2000, How Persistent are Shocks to World Commodity Prices?,IMF Staff Papers,47(2), International Monetary Fund, Washington, DC, pp. 177-218; and Paul Cashin & C John McDermott, 2002, The Long Run Behaviorof Commodity Prices: Small Trends and Big Variability,IMF Staff Papers, 49(2), International Monetary Fund, Washington, DC, pp. 175-198


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VI. Sound Framework forMining Investment in Mongolia

The estimates quoted above indicate that the proposed

2009 Investment Agreement on Oyu Tolgoi represents a

good outcome for the Mongolian people. Furthermore,

a successful negotiation with the international

investors for that project provides a basis to attract

further international investment to Mongolia.

Imposing the same corporate tax regime on the Oyu

Tolgoi project as is applied in the rest of the

Mongolian private sector represents a good outcome

for Mongolia from both economic and a public policy

perspective. Imposing the same mining royalty regime

on the project as is applied to other mining projects

is also a good outcome for Mongolia from the same

perspectives.

This combination ensures a neutral tax treatment forinvestment across the economy and within the mining

sector. Both are essential to economic development

and the progressive enhancement of living standards

in Mongolia. They recognise public ownership of min-

erals in the ground and that private investment is

essential to realizing the value of those minerals.

They also recognise that international mining

investors have other countries in which they could

invest. The Mongolian people, on the other hand,

could not provide the investment funds that the

Mongolian mining sector requires, if it is to achieve its

very considerable development potential.

Global experience has shown that governments

should not seek to design tax or regulatory regimes

for particular projects. This was one of the constant

failures of governments which tried to attract invest-

ment through central planning. Investments occur

for the wrong reason (favourable tax treatment and

dispensations) or are discouraged. The unintended

consequences, generated by people trying to take

advantage of the differences in the rules tend to mean

worse, rather than better, economic outcomes.

Such highly customised approaches thereforerepresent poor public policy choices and are econom-

ically damaging to the countries that use them.

Broad-based tax and regulatory rules are generally

more effective and more efficient than setting specific

taxes and rules for each project.

S

OUNDFRAMEWORK


Imposing the same corporate tax regime on the Oyu Tolgoi project as is applied in

the rest of the Mongolian private sector represents a good outcome for Mongolia from both

and economic and a public policy perspective.


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VI. Excessive Tax Rates Deter Investment

Some NGOs only rate the value of the Oyu Tolgoi

investment to Mongolia by how much public revenue

it can generate in isolation. Any strategy that involves

increasing the already high effective tax rate on min-

ing in Mongolia, however, would significantly deter

further private investment in the mining sector, and

thereby forego the additional tax revenue and employ-

ment that such additional investment would generate

for the country.

Maximization of the effective tax rate on mining in

Mongolia comes at a steeply rising economic cost.

Such costs would not be eliminated by the introduc-

tion of a resource rent tax, as the information neededto design and administer such a regime so as to avoid

doing so, is very hard to obtain.14

The economic cost of excessive tax rates includes the

following:

Oyu Tolgoi would end up being a smaller and less

productive mine than otherwise would be the case;

other new mining developments in Mongoliawould be scaled back or dropped altogether;

mineral exploration in Mongolia would suffer;

the sectors of the Mongolian economy that provide

goods and services to the mining sector or purchase

its output would suffer.

These costs would be reflected in less economic activity

and lower employment in the economy as a whole, not

just in the mining sector, and accordingly less public

revenue contributed by the rest of the economy.

Moreover swings in the relevant tax and regulatory set-

tings would seriously exacerbate business uncertainty

and undermine investor confidence. These are particu-

larly serious issues in the mining sector where delays are

inherently costly for investors, given the declining long

term trend in its output prices in real terms.15

EXCESSIVETAXRATES


14.00

10.00

6.00

2.00

-2.00

-6.00

2000 2002 2004 2006 2008 2010

GDPGrowth(%)

Year

World

China

Russian Federation

Chart 1 Growth in GDP, the World, China & Russia, percent per annum

Source: OECD 2009 and World Bank 2009a and 2009b

14 A prime example is the minimum risk-weighted rate of return investors require before committing to an investmentin the Mongolianmining sector. This triggers an investors tax liability under a resource rent tax regime.

15 The IMF has most recently highlighted the need for a transparent, stable, and internationally competitive tax regime for the Mongolianmining sector (IMF 2008b)


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Global Economic Situation is More Challenging

The global financial crisis has flowed into the real

economy of most countries, including Mongolias

major trading partners, although the flow-on has

been rather uneven. The global economic slowdown

has significantly increased the strategic value of the

proposed 2009 Investment Agreement on Oyu Tolgoi

for the Mongolian Government.

Chart 1 dramatically highlights this. The latest fore-

cast by the OECD indicates that World GDP would

contract by 2.75 percent in real terms in 2009.16 Much

lower or negative growth has also been forecast for

Mongolias main trading partners in 2009, with Chinas

GDP growing by only 6.5 percent and Russias economycontracting by 4.5 percent.17

The Russian turnaround was particularly dramatic:

its GDP grew by just the equivalent of 1.1 per cent a

year in the final quarter of 2008, having posted the

equivalent of 7.7 per cent a year for each of the first

three quarters of that year.18

The impacts of the Global Financial Crisis on the

real global economy have quickly snowballed. In

November 2008 the World Bank was forecasting

growth in World GDP of around 1 per cent for 2009.19

Just four months later, it had revised its forecast

downwards by 2.7 percentage points, with similar

revisions for its Chinese and Russian forecasts.20 The

substantial uncertainties involved mean that further

downgrades cannot be ruled out.

With the slowdown, world trade has declined substan-


5

4

3

2

1

0

Jan-1980 Jan-1984 Jan-1988 Jan-1992 Jan-1996 Jan-2000 Jan-2004 Jan-2008

IndexofMetalValues

Years

Copper

Tin

Coal

Chart 2 Copper, Coal & Tin Prices, monthly, January 1980 to February, 2009

Source: IMF Primary Commodity Prices

16 OECD [Organisation for Economic Co-operation and Development], 2009, OECD Economic Outlook, Interim Report, OECD , Paris,March, p. 5, accessed at: http://www.oecd.org/dataoecd/18/1/42443150.pdf

17 World Bank, 2009a,Russian Economic Report No. 18, p.1, accessed at:http://siteresources.worldbank.org/INTRUSSIANFEDERATION/Resources/rer18eng.pdf; World Bank, 2009b,China Quarterly Update March 2009, p.13, accessed at: http://siteresources.worldbank.org/INTCHINA/Resources/318862-1237238982080/CQU_March2009_fullreport.pdf ; and World Bank, World Development Indicators, accessed at:http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers&userid=1&queryId=135

18 World Bank, 2009a, p. 3

19 World Bank, 2009b, p. 9

20World Bank, 2009a, p.2


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tially and further declines are predicted to be on their

way. This reflects the fact that the value of interna-

tional trade has historically been much more volatile

that GDP. In 2008 it grew by just 2 per cent,21

on the

heels of a 6 per cent increase in 2007.22 The World

Trade Organisation is expecting a 9 per cent decline

in 2009.23

International trade in minerals and metals have not

been immune from the global economic downturn.

This has been evidenced by very sharp falls in world

prices for base metal and mineral prices since January

1980 see Chart 2.

Clearly the global business outlook for the mining sector

has deteriorated to such an extent that investments ofall types are being reigned in or shelved at a dramatic

rate. Proposed investments in developing countries

where the political risks to mining investment are per-

ceived as being high by the sector and its financiers are

among the most vulnerable to being scaled back,

deferred, or cancelled entirely. While projects where the

technical risks to their development and/or operation

are high are also vulnerable, those that incorporate

both sets of risks are almost certainly commercially

unsustainable in the present investment climate.

The proposed 2009 Investment Agreement seeks toreduce such risks and to lock in the reductions for the

45+ year life of the Oyu Tolgoi project. By doing so,

the proposed Agreement helps to ensure that the

investment required will be commercially sustainable

in what is a much more challenging investment envi-

ronment. To do so, the Agreement needs to ensure that

all the key tax and regulatory settings are locked in

for at least 30 years to begin with, and that this pro-

tection can be extended for another 20 years.

As is the Situation in Mongolia

Along with the rest of the global community Mongoliais facing a more precarious economic future. The Oyu

Tolgoi project has, however, the capacity to make that

future significantly less precarious and the proposed

Investment Agreement would help to ensure that it

went ahead. All that remains is for the Mongolian

Government to complete the formalities.

Prior to the global financial crisis, Mongolia was expe-

riencing strong economic growth. The sustained rise

in base and precious metal prices between 2004 and

2008 Chart 2 shows the experience with copper

helped to drive real GDP growth up to an average of

around 9 percent for the previous four years, with real

income per capita income more than doubling over

this period. At that time, Mongolias external position was comfortable with gross international reserves

reaching record levels.24

Even in such a favourable environment, Mongolia

confronted numerous challenges25

Inflation accelerated sharply from 6 percent for the

year to 30 June 2007 to a year-on-year peak of

34 percent in August 2008.26 This had been caused

by rapid growth in public spending, private sector

credit and import prices.

Fiscal policy was increasingly expansionary. With

the growth in public spending, the budget positionmoved from a surplus of 8 per cent of GDP in 2006


Along with the rest of the global community

Mongolia is facing a more precarious economic

future. The Oyu Tolgoi project has, however, the

capacity to make that future significantly less

precarious and the proposed Investment Agreement

would help to ensure that it went ahead.

21 World Bank, 2009c, World trade 2008, prospects for 2009: WTO sees 9% global trade decline in 2009 as recession strikes, accessed at:http://www.wto.org/english/news_e/pres09_e/pr554_e.htm

22World Bank, 2009c

23World Bank, 2009c

24IMF 2008b

25IMF 2008b

26ADB [Asian Development Bank], 2009,Asian Development Outlook 2009,ADB, Manilla, p. 178


18/20

to a deficit of 5 percent of GDP in 2008.27

Monetary management added to the inflationary

pressures. In 2007, money broadly defined increasedby 57 percent and domestic credit by 67 percent.

At the start of 2008 public revenues were budgeted to

surge to a record 44.5 percent of GDP on the back of

the high tax rate on mining. The revenue bonanza

accelerated public spending with public expenditure in

2008 budgeted at 47 percent of GDP. The expansion

in spending was driven by rapid growth in transfer

payments (a growth of 90 percent in 2007) and public

sector wages (a growth of 49 percent in 2007).

These weaknesses and the sharp fall in export com-

modity prices are expected to lead to a sharp slowdown

in economic growth in Mongolia, although it is ex-pected to remain positive in contrast with elsewhere.

The ADB has estimated that Mongolian GDP will grow

by just 3 percent in 2009 and 4.5 percent in 2010.28

Most of Mongolias previous economic challenges re-

main but they have been overlain with a number of

new ones. These include:

A weakening current account and falling interna-

tional reserves reserves fell from US$1 billion to

US$657 million (or only ten weeks of import cover)

in less than six months;

A downgrading of Mongolias sovereign debt rating in January 2009 Fitch Ratings downgraded

Mongolian debt from B+ to B with a negative out-

look;

Stress in the Mongolian banking system negative

real interest rates on bank deposits due to rapid

inflation and depreciation of the Mongolian tugrug

led to bank withdrawals and a liquidity squeeze; and

Falling public revenue in 2009 Government

revenue is expected to fall by up to 11 percentage

points of GDP.29

Unless the Government substantially cuts back on

public spending, the budget deficit could increase to

more than 10 percent of GDP, which would be an

unsustainable level. Due to the countrys weakening

external and fiscal positions, the Government has

agreed with the IMF on a US$224 million standby

loan facility.30

Inflation is expected to remain relatively high over themedium term, although it should slow somewhat. In

2007 the real effective exchange rate (REER) appreci-

ated by 6 percent, reflecting Mongolias accelerating

inflation relative to its trading partners

The size of the public sector in Mongolia has now

reached the point where it represents a significant risk

to the countrys economic development. That risk

would be exacerbated considerably by any tightening

of business regulation, particularly in the trade exposed

sectors of the Mongolian economy. In the circum-

stances, there is a clear need for decisive action by

government to minimize the tax and regulatory bur-dens placed on the export and import-competing

sectors of the economy, particularly the mining sector

given its pivotal role in Mongolias international trade.


In the circumstances, there is a clear need for decisive action by government

to minimize the tax and regulatory burdens placed on the export and import-competing

sectors of the economy, particularly the mining sector given its pivotal role in

Mongolias international trade.

27ADB 2009, p. 178

28ADB 2009, p. 178

29ADB 2009, p. 178-9

30ADB 2009, p. 179


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VII. Benefit of Accelerated MiningDevelopment

Mongolia has vast potential to accelerate the develop-

ment of its world-class mineral deposits for the benefit

of all the People of Mongolia.

The boom in minerals exploration after 2001 has

meant that there are now six major projects for

new mines, which are at an advanced stage of devel-

opment including negotiation of an Investment

Agreement with the mineral licensee. Moreover, a

continuation of the recent high level of investment in

minerals exploration in Mongolia would see many

more mining development projects added to the list

as time progresses. Collectively they would help totransform the Mongolian economy and the lives of the

Mongolian people.

The negotiation of an Investment Agreement for any

one of the mining projects in the development

pipeline at the present time would not, in theory, affect

the negotiation of an Investment Agreement for any

of the rest. Nevertheless, the provisions agreed for any

one Agreement do provide a benchmark for interna-

tional investors to judge the tax and regulatory stance

that the Mongolian Government is likely to take to the

other projects.

The most advanced projects in the development

pipeline include Tavan Tolgoi (coal), Oyu Tolgoi (cop-

per, gold and molybdenum), Tumertei (iron ore),

Asgat (silver), Dornod (uranium), and Guyvanbulag-

Mardai (uranium). Collectively they are expected to

require inwards foreign investment of about US$5.7

billion, as Mongolia does not posses either the

resources or the technical know-how required for such

large-scale mining developments.

Once these projects are fully operational, they are

expected to generate enormous economic benefits forMongolia over the long term, most notably:

An increase of US$1.5 billion in Mongolian GDP

per year;

45,000 new jobs for Mongolians in mining andelsewhere in the economy;

An increase of US$2.45 billion in Mongolian ex-

ports; and

An additional US$385 million in revenue for the

Mongolian Government.31

The above estimates are long-term averages and the

bulk of the economic benefits would only be generated

once the mines in question were fully operational,

which will take up to five years in most cases. For ex-

ample, mining royalty and income tax payments make

up the bulk of the additional public revenues but will

not begin until the mines in question are producing

their outputs or taxable profits. The same is true for the

additional exports.

With that said, some of these economic benefits would

be clearly evident over the short run before the

mines in question have become operational. Most

of these short term benefits would occur during the

construction phases of the projects. For example, the

six projects in aggregate are estimated to generate

some 2,300 jobs during the construction phases and

around 2,200 of these jobs are expected to be filled

by Mongolians.

ACCELERA

TEDMININGDEVELOPMENT


[Recent high-level investment in mineral exploration]

would help to transform the Mongolian economy

and the lives of the Mongolian people.

31 Robert Shapiro and Sonecon LLC, 2009,Economic Modernization in Mongolia: The Impact of Tax and Regulatory Policies on the MiningSector,World Growth Mongolia, Ulaanbaatar, January


20/20

Third Floor Admon BuildingAmaryn Street-2

Sukhbaatar DistrictUlaanbaatar, Mongolia

(976) - 11 - 330902

www.worldgrowth.mn

About World Growth Mongolia

World Growth Mongolia is a non-profit, non-governmental

organization established to promote sound policies to address

Mongolias economic challenges. At World Growth Mongolia,

we embrace and celebrate the new age of globalization and

the power of free trade to eradicate poverty, improve living

conditions, and create new jobs and opportunities for thePeople of Mongolia. We strongly believe in the need to pro-

mote our five core principles: Economic Freedom; Good

Governance; Rule and Stability of Law; Property Rights; and

Environmental Interdependence. For more information on

World Growth Mongolia, visitwww.worldgrowth.mn.

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