The Parliament of Mongolia will convene for an irregular session next week to discuss ways to overcome the current economic decline and bring back the foreign investment that has been flowing out of the country.
The underlying reasons for the present economic downturn are increased government involvement in economy, huge amounts of deficit run by state-owned companies, growing government debt, strong persistence of corruption and over-dependence on mining industry. However, it is not clear at the moment which of these problems will be focused on the upcoming parliamentary session.
What is clear is that the parliament is going to address a new law that will supposedly bring equality between domestic and foreign investors, encourage them to make more investment and create stability in tax environment. They also seek to replace the ‘long-named law’ that makes things confusing for everyone and revoke not only the foreign investment law but also the strategic entities foreign investment law.
The adventures Mongolia had in the recent years suggest that it is now time for us to look back at the achievements and failures we experienced in the last 20 years and pass a new foreign investment law as well as a mining law that are clearly written and can be implemented without great difficulties.
Foreign investment
The most important thing is that the foreign investment policy has to be as clear as possible so that any confusion can be prevented. Foreign investors should be able to clearly see what they are required to do in order to make an investment. The requirements regarding permits, timelines or favorable conditions must be fully understood by an investor before any investment takes place. Therefore, this kind of information should be made available in many languages.
Mongolians commonly hold the view that foreign investment is essential to boosting economic growth and development and improving the livelihood of citizens. The government also supports foreign investment because it creates jobs, favors innovation, introduces new technology, opens doors to foreign markets, and encourages competition in the industrial sector.
However, there should be an Investment Council established in order to carefully assess whether a foreign investment is coherent with the national interest or not. Also, taking the national interest into account, this council can offer insight on the appropriate amount of foreign investment in a given economic sector.
Establishing such council, which exists in Australia and Canada, will offer a flexible mechanism where discussions regarding whether a given foreign investment should be allowed to take place. The council would not interrupt foreign investment or disrupt the flow of investment. It will be a better mechanism than passing strict laws and enforcing them forcefully.
Our foreign investment policy should clearly set out that the government must take into account the interest of local community when making decisions regarding foreign ownership in a given Mongolian property. Also, it should have a clause that says any business decision coming from a foreign investor shall be regarded as aligned with the national interest of Mongolia only when the decision has derived from purely economic grounds with no non-strategic or non-commercial reasons and interests.
Furthermore, the new foreign investment policy ought to set out that any foreign investment proposals involving the interests of foreign governments or foreign-state owned companies should be sent to the Investment Council first.
Stability cannot be bought
Next week the parliament is going to discuss a draft law that allows establishment of a ‘stability agreement’ in order to attract foreign investment. The proposed stability agreement will allow foreign investors to be exempt from any change in law occurred after establishing the agreement for 15 years if their investment is more than 500 billion MNT (300 million USD) or 8 years if it is more than 50 billion MNT.
A stability agreement is only needed when there is a distrust. Many years ago former communist countries used to sign stability agreements in order to create trust in their relations with foreign investors. Ironically, those stability agreements gradually created instability. It can also be seen from Mongolia’s past experiences.
If the draft legislation is enacted next week, Mongolia will start establishing stability agreements with big investors. It means that there will be hundreds of different, independent legal environments in Mongolia, which will cause implementation issues when new laws are passed in the future. In other words, due to too many different legal environments, new laws will not be able to be implemented in some cases. It will violate the constitutional article that states “All persons lawfully residing within Mongolia are equal before the law and the Court.” Furthermore, establishment of stability agreements requires taxation agencies to work under greater pressure because they are faced with endless work of calculating taxes of huge companies that have thousands of employees with different rates varying by the time of signing the stability agreements.
On top of that, stability agreements are unenforceable in the long term. Therefore, in order to ensure legal stability in business environment, it is more efficient to actually create stability rather than establish an agreement.
Stability in mining industry
We have to pay special attention to mining industry as it is different from the others. A mining business requires long-term investment that includes huge amounts of fixed assets and its profitability is more dependent on the market than the company. Also, it is difficult to predict final selling prices in this industry.
Central governments can receive three types of fees from mining companies. Firstly, the government can receive cash payments by auctioning the mining license. Secondly, they can impose production tax on mining companies. The third way is to receive tax imposed on income and profits of a mining company. Auctioning the mining license usually produces a final sum of money that is lower than expectations because there are not many bidders to raise the price high enough. Production tax is almost no longer being used because it is based on production only and not dependent on profitability. The profit-based tax, on the other hand, can favor the interests of both the government and the mining company when used properly.
The government of the Republic of South Africa receives tax based on profit to revenue ratio from their gold mining companies. They used the idea of Mongolia’s windfall profits tax in a wiser way and impose no tax if the company makes no profits (or low profits at around 5 percent of total revenue). Also, the companies with a profit to revenue ratio of 15 percent pay 30 percent corporate tax while those with a ratio of more than 30 percent pay 37.5 percent tax imposed on their profits.
Australia, which has vast experiences in mining industry, employs the Foreign Investment Review Board (FIRB). A proposal to establish a council that has similar functions as the FIRB is included in the new draft law to be discussed by Mongolian parliament next week. Last year Australia passed a law to establish the Minerals Resource Rent Tax (MRRT), which stirred up a large controversy in the country and divided the public opinion.
In Brazil, minimum and maximum rates of royalty rates are preset and the government issues a resolution each year to announce in advance which rates will be used in the year. An approach that is being widely used is that parties agree the methodology of determining tax rates in a written agreement beforehand. For example, when calculating the cost of capital, parties can agree to use a formula that uses third-party rates (LIBOR adjusted as agreed).
In order to create stability in the long term, we have to look at international experiences such as described above, reflect them in our case wisely and find a good balance between the interests of the government and investors. Only then we will have favorable conditions to attract foreign investment and Mongolia will be regarded as a reliable partner who meets their agreed commitments. Without foreign investment, it is unimaginable for any country to bring about development in the globalized world we are living in today.
2013.09.11