Via The East Asia Forum, a report on the uneasy economic relationship between China and Mongolia.  As the article notes:

“…The investment and trading relationships between China and Mongolia seems like a marriage made in heaven. Landlocked and poverty-stricken, Mongolia has an abundance of coal, copper and iron ore that China craves to feed its rapid industrialisation. Mongolia’s proximity to China, its largest customer, also offers it considerable cost advantages against other major commodities suppliers such as Australia and Brazil.

The trade and investment figures between these two countries certainly bear witness to a strong and complementary relationship. China has been the largest investor in Mongolia since 1998 and its largest trading partner since 1999, and it has retained these positions ever since. In 2009, the bilateral trade figure stood at US$2.4 billion with China importing US$1.3 billion worth of commodities, which accounted for more than 70 per cent of Mongolian exports. According to official Mongolian statistics, China invested a total of US$2.3 billion in 2009, which represented more than 60 per cent of total foreign investment in Mongolia.

According to Luvsandagva Davaatsedev, chairman of the Coal Industry Association of Mongolia, almost 100 per cent of Mongolian coal and copper exports went to China in 2009, and the coal export figure could grow by as much as six-fold in the next five years once some of the large coal mines become operational. Mongolia replaced Australia as the largest coking coal exporter to China in 2005.

Sinophobia on the steppes

High dependence on China for trade and investment is causing an unprecedented wave of Sinophobia in Mongolia. This fear has been driven by geopolitical fear, historical legacy and sometimes open racism. Sandwiched between two former imperial masters, Mongolia’s landlocked geography can be described as nothing but a geopolitical nightmare for its leaders. Its national strategy is often a case of a depressing choice between the lesser of two evils. It is understandable that vast and sparsely populated Mongolia, at the doorstep of an emerging superpower, is anxious for anxiety’s sake itself.

The imperial legacy of China still lingers in the minds of some Mongolians and this landlocked country only gained independence from China as late as 1921. Ironically, Taiwan still officially recognises Mongolia as part of its official territory, and it is not uncommon to hear mainland Chinese refer to Mongolia as ‘outer Mongolia’, a dated name alluding to its status as a former imperial possession of China.

The influx of Chinese businessmen and labourers is also provoking racial tension in the country. Whether it be disapproval of Chinese migrant labourers’ behaviour as unhygienic, or Chinese businessmen’s behaviour as philandering, many Mongolians feel alienated by the arrival of large numbers of Chinese. Consequently, anti-China themes are rapidly capturing the airwaves and newspaper headlines, from unfounded allegations of rape and pillage to more justified concerns over Chinese disregard for industrial relations laws and regulations. Chinese construction workers are fast becoming random victims of Mongolian neo-Nazis, and some Mongolian politicians are more than happy to jump on the anti-Chinese bandwagon to attract popular votes.

Challenges of investing in Mongolia

Like Chinese resource investments elsewhere, Beijing’s black gold rush into Mongolia is largely driven by giant state energy companies such as Shenhua and PetroChina. Like regulators elsewhere in the world, Mongolians are fearful of a takeover by China Inc. Its proximity and overwhelming dependence on China have increased that fear a hundred-fold. Despite China’s apparent dominance, Beijing has been assiduously excluded from investing in the crown jewels of Mongolian mining assets such as the prized Tavan Tolgoi coal project and the world’s largest unexploited copper mine at Oyu Tolgoi.

According to the Chinese press, a host of Chinese state energy giants such as Chinalco and Zijin Mining were interested in bidding for the Oyu Tolgoi project in 2002; however, the National Development and Reform Commission (NDRC)-supported deal fell apart after much political opposition from Ulaanbaatar. Even indirect equity participation by Chinalco faced significant opposition last year.

The CEO of Khan Bank, Mongolia’s largest bank, Peter Morrow said on the sidelines of a Euromoney mining conference in Mongolia that ‘Chinalco is unlikely to get involved in Rio Tinto PLC’s massive copper-gold Oyu Tolgoi mining project in Mongolia as a direct partner, since it may trigger political resistance from the Mongolian government’ and ‘that would be a real stick in the eye for the Mongolian government.’

Mongolia’s national railway infrastructure strategy further highlights the government’s weariness towards China. Like many resources-exporting countries caught in the middle of a mining super-cycle fuelled by Chinese demand, Mongolia’s Soviet-era railway is poorly prepared to transport the vast bulk of commodities to China. Given Mongolia’s proximity to China, and that some of its largest mines are less than 100 kilometres from the Chinese border, it seems that this infrastructure bottleneck could be easily remedied.

Yet the Mongolian government made a decision that defied not only geography but also basic business common sense. Instead of building a railway connecting mines with the booming Chinese export market the government decided, in April 2010, that it would build a 5,683-kilometre railway on Russian gauge standard to connect itself with Russian sea ports. The only plausible reason for this curious decision is that Mongolians are desperate to diversify away from reliance on China.

According to research notes prepared by a Chinese broker, the planned new railway track would increase the distance between Tavan Tolgoi mine and the nearest Chinese seaport, Tianjin, by more than 3,000 kilometres and triple transport costs. There is little doubt that the Mongolian government is willing to pay a very hefty price for economic independence, despite Mongolia having been voted as the second worst country in the world for mining investment according to the Survey of Mining Companies 2010 by Canadian think tank the Fraser Institute.

Chinese experience in Mongolia highlights again the worrying trend for policy makers in Beijing that many resources rich countries are wary of state-led Chinese investment. Beijing has to do something about its image of China Inc on a shopping spree. A starting point would be to let firms make their own investment decisions independent of government agencies such as the NDRC. Lack of tact and judgement is a source of much irritation even amongst state-owned energy companies. Demonstration of good corporate citizenship is essential to assure host countries of the benefits of Chinese investments. Sinosteel’s delicate treatment of indigenous heritage sites in Western Australia is an example that could be followed elsewhere.