The threat of capital flight

The threat of capital flight

By B.Chintushig

Centerra Gold’s recent sale of its Mongolian business unit for 35 million USD has brought forward concerns that foreign investors and companies are losing confidence in the country’s stability and economy. The worry is that eroding trust in Mongolia’s political and judicial system in addition to increasing resource nationalism will cause capital flight on a scale that has not been seen since 2016. But the question is, is this concern warranted?

Capital flight is a large-scale exit of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls. In the case of capital flight of 2016, plummeting commodity prices and depreciation of the tugrug was one of the biggest culprits. An unstable political and judicial system definitely did not help matters but is not seen as the biggest factor.

Even in the most unstable countries, multinational mining corporations continue to operate as the reward outweighs the risks. Past experience shows us that some multinational mining companies thrive in unstable regions through using kickbacks and briberies to leverage their way into disadvantageous agreements.

In Centerra Gold’s case, the company was ostracized by the public and the local media. Popular movements aimed at preserving Mount Noyon situated nearby the Gatsuurt gold project essentially made it impossible for the company to begin production. At the recommendation of the Canadian government, the Toronto-based miner tried to engage more with the local communities, rather unsuccessfully. What followed was years of legal proceedings and countless attempts to negotiate with the government. All of this culminated in the company selling its entire Mongolian business unit in what it described as an effort to improve the quality of its asset portfolio.

This essentially signified that the company admitted that the risks and burden of the project outweighed the reward. The Gatsuurt project was a specific case that eventually ended in the company exiting Mongolia. Now that Centerra Gold has officially left Mongolia, our efforts are better served to not overanalyze this one case but to look at the bigger picture. The bigger picture question is, “can this happen again”? The Centerra Gold controversy will be consequential for years to come. It has set both set a bad and partially good precedent, depending on your views on the merits of the arguments that both sides made.

The partially good precedent is that if the mine was indeed causing harm to the environment and local population, it is good that NGOs and local communities can mobilize to prevent such damaging practices.

However, on the other hand, it creates a dangerous precedent that interest groups could use to sabotage legitimate mining projects. If the allegations against the mine’s effects on the local population and environment have been exaggerated or fabricated in order to advance an agenda, it can prove to be quite harmful. This type of resource nationalism is a major factor in actively discouraging future investment and encouraging capital flight.

In the case of Gatsuurt, the protest of NGOs and the local community has only resulted in one foreign company being swapped with another foreign company. The movement against the Gatsuurt project would have been better suited to demand better safety standards and environmental protection rather than demanding the revocation of the Gatsuurt mining license. Mongolia is a commodity dependent country and gold is especially a valuable resource that the central bank has been actively seeking to increase production of. It was never realistic to permanently shut down any mining operation efforts at the project.

In all honesty, in the short to mid-term Mongolia will likely not experience large capital flight due to the certain security and stability that comes with an IMF program and the fact that commodity prices are relatively high. But as we have seen, all of that is temporary. The IMF program will end in 2020 and commodity prices will drop, this is inevitable. What is not inevitable is the flight of capital. Even in times when commodity prices are low, good transparent governance, stable macroeconomy, and fair judicial system can nudge a foreign company to ride the bust cycle out. The fact that Mongolia has a fairly unstable political environment and notoriously unstable judicial system essentially acts as an incentive for foreign companies to cut their losses and leave in times when commodity prices are not so favorable.

Mining giants like Rio Tinto are here to stay because they have invested too much time, effort, and money into Mongolia to exit at the first sight of trouble. But we cannot bank on that fact alone in encouraging foreign invested mining companies to stay. The reality is there is not enough capital in Mongolia to sustainably finance any large-scale mining project. There is a reason why the government is about to offer around 30 percent of Erdenes Tavan Tolgoi on the international stock market. Seeing as we can’t finance any major projects on our own, kicking out mining companies or making it so hard that they have no choice but to leave is basically shooting ourselves in the foot.

But this does not mean we should or can tolerate everything a mining company does. As with any business, a mining company is a for-profit entity. As such, they will look to cut costs wherever possible to maximize its profit margins. Unfortunately in the case of mining, this usually means less money expended for rehabilitation and promoting development of the local communities. Therefore, ensuring responsible and sustainable mining that is not harmful to the local population or the environment through laws and regulation is the critical balance we must find on this issue.

Chintushig Boldsukh