WESTERN INTEREST AND INVESTMENT IN CENTRAL ASIA

By T. Byambanaran

The European Union is urgently seeking to boost investment in the mining sector to reduce its dependence on imported mineral raw materials, decrease vulnerability, and enhance competitiveness. The EU is also prioritizing financing projects through long-term loans to help stabilize the supply of critical minerals.

It is now evident that many European countries are actively investing in Central Asia with the goal of collaboratively developing proven mineral deposits and building reserves to meet growing demand. For example, in 2023, the German company HMS Bergbau AG announced an $8 million investment in lithium exploration in Kazakhstan. If significant reserves are confirmed, this investment could increase to as much as $500 million.

In August 2024, the European Bank for Reconstruction and Development (EBRD) acquired a 17.36% stake in Sarytogan Graphite, a graphite mining company based in Kazakhstan's Karaganda region. Earlier, in March, the French company Orano signed a long-term investment agreement with Uzbekistan's Navoiyuran to develop a uranium project. Additionally, German banks KfW IPEX and AKA agreed to provide €146 million in financing for the construction of a new copper smelter at Uzbekistan's Almalyk Mining and Metallurgical Plant. This project is expected to significantly enhance the country's refining capacity and generate substantial employment opportunities.

Furthermore, the European Commission has pledged €10 billion in 2024 to develop the Trans-Caspian Transport Corridor-also known as the Middle Corridor-a strategic trade route linking Europe directly to China via Central Asia, the Caspian Sea, and the South Caucasus. Unlike China's Belt and Road Initiative, this project will be primarily financed by private sector investment. If successfully implemented, the corridor would help eliminate major infrastructure bottlenecks, significantly reduce transportation costs, and provide a route that bypasses countries at risk of international sanctions, such as Russia and Iran.

All these developments indicate that the international focus on Central Asia will continue to grow, making the region increasingly strategically important, especially in the wake of the Russia-Ukraine war.

The 27th Global CEO Summit, organized by PwC, brought together 4,702 CEOs from 105 countries, including more than 30 representatives from Mongolia. A survey presented at the summit revealed that overall investor confidence remains. subdued, mainly due to geopolitical tensions, inflation, and a shortage of skilled labor.

Conference participants noted that investment flows are increasingly focusing on the Central Asian region, particularly Uzbekistan, Kazakhstan, and Kyrgyzstan. Among these. Kazakhstan is perceived as offering a more favorable business environment compared to Mongolia.

WELCOMING INVESTORS WITH ONE HAND, PUSHING THEM AWAY WITH THE OTHER

Several factors continue to deter foreign investment in the mining sector of Mongolia. These include an unstable legal environment, limited support for the private sector, excessive state intervention, and a burdensome tax regime all of which pose significant challenges for potential investors.

On May 29, the American Chamber of Commerce in Mongolia (AmCham Mongolia) hosted a monthly meeting titled "Cracks in the Foundation: Investor Confidence in Mongolia. The event covered a broad range of topics, including the current investment climate, the legal framework for investor protection, and the critical importance of transparent and reliable government services.

During the discussion, Ts. Baigalmaa, a Counsel at the law firm Melville & Erdenedalai LLP, noted: "The Law on National Sovereign Wealth Fund was passed in April 2024. Alongside, several unexpected provisions were introduced into the Law on Minerals. Notably, Article 5.4 of the revised law states that 'The State may participate up to 50% jointly with a private legal person in the exploitation of a mineral deposit of strategic importance where state-funded exploration was used to determine proven reserves. The percentage of the State's share shall be determined by an agreement on the exploitation of the deposit, taking into account the amount of investment made by the State. The State's share determined by the agreement may be replaced by a royalty for mineral deposits of strategic importance."

Secondly, the law includes a provision stating that "the share of a single investor in the total assets of a legal entity holding a license for mineral deposits of strategic importance in Mongolia shall not exceed 34%, unless that entity has signed an Investment Agreement with the Government of Mongolia and includes local participation." This effectively means that the government must hold a stake in strategically important deposits, making it mandatory for private investors to partner with the state.

But how reliable is the Mongolian government as a business owner and partner? I believe this concern should be addressed through taxation and mining royalties, so that, where possible, the government avoids holding direct ownership stakes.

Additionally, she emphasized that "If there is no state participation and no investment agreement with the Mongolian Government, a single shareholder cannot fully manage the project, and additional investors-second or even third-must be brought in."

In Mongolia, a 2007 Parliamentary resolution designated 16 deposits as strategic. The resolution also ordered an assessment of the reserves of 39 additional deposits to determine whether they should also be classified as strategic. Based on this process, it is likely that the government will officially recognize these 39 deposits as strategic in the future.

"So, it is possible that while a foreign investor is operating a deposit, the government could classify it as a 'strategic deposit' and claim partial ownership. In addition, the government may also require the involvement of second or even third investors. Therefore, Mongolia is simultaneously welcoming investors with one hand while pushing them away with the other," she warned.

"The Law on the National Sovereign Wealth Fund is essentially a 'copy' based on the laws of Singapore and Norway. However, this creates a significant difference in substance. Norway's wealth is primarily derived from 'liquid wealth'-namely oil and natural gas-which typically have very high profit margins, often generating earnings far exceeding extraction costs. In contrast, our country's wealth is based on hard resources such as coal, gold, copper, iron ore, and rare earth elements, which generally have lower profit margins. Despite this, the government is focused on rapidly establishing the Wealth Fund and advancing large-scale mega projects.

Sudden changes in legislation have created significant challenges for mining operators and investors. The government's abrupt and unpredictable decisions have undermined confidence and limited opportunities to attract investment in the sector.

"Not only are we unable to implement mega projects and establish a wealth fund, we are even seeing a decline in investment. The government should adopt smarter policies that create more space for the private sector to grow and thrive," she concluded. >

IN SOME CASES, TAX BURDEN NEARS 100%

Tax burdens have become a major concern for investors in Mongolia. Addressing this issue, R. Khishignemekh, Partner leading International Tax and Transaction Services at EY Mongolia Audit LLC. stated:

"The tax environment is one of the primary challenges facing investors in Mongolia. In particular, the tax burden on the country's mining sector is significantly higher than in many other jurisdictions. Globally, a total tax rate of 40-50% is generally considered reasonable and balanced for the mining industry.

In a balanced system, approximately half of a mine's total profit and revenue goes to the government through taxes, royalties, and related payments, while the other half remains with investors to support continued exploration, operations, and environmental responsibilities. In Mongolia, however, the government's share ranges from 60% to 80%, and in some cases, it nears 100%. As a result, investment in the sector is becoming increasingly unviable."

He added, "Beyond the already high tax rates, royalties remain elevated, further increasing the overall financial burden. This leaves mining companies with minimal-if any-profit margins. Another critical issue is the transfer tax applied to early-stage investments.

This tax can be especially punishing for mining projects, in some cases approaching the full value of the investment itself. As a result, many IPOs, private equity deals, and strategic investment initiatives have failed. There are even cases of companies pushed to the brink of bankruptcy due to major tax disputes with the Mongolian tax authorities.

It is true that investors are leaving our market due to overwhelming tax burdens. However, it is encouraging that the government has begun implementing tax reforms and is actively considering suggestions and recommendations from the private sector."

THE ONLY CERTAINTY IN MONGOLIA IS "UNCERTAINTY"

According to the Counsel Ts. Baigalmaa, discussions about improving the investment climate in Mongolia tend to focus too narrowly on the Law on Investment-its amendments, implementation, and application. However, investment is a complex system that extends far beyond a single piece of legislation.

To attract investment in the mining sector, a comprehensive review of all relevant laws and regulations is essential-particularly the Law on Minerals as well as the broader tax environment. While Mongolia's Law on Investment provides robust legal protections for investor rights, the real challenge lies in implementation and its alignment with other laws. As discussed earlier, last-minute legislative changes and the introduction of unexpected provisions have created significant uncertainty for investors.

The government must also address fundamental issues surrounding long-term contracts. For example, several foreign- invested companies currently operate in Mongolia's renewable energy sector under power purchase agreements (PPAs), typically set for 20 years. Recently, however, problems have emerged with the enforcement of these agreements.

The Energy Regulatory Commission has pressured companies to renegotiate tariffs previously agreed upon for the full contract period. In some instances, the government has failed to uphold key clauses outlined in these PPAs. Once a contractual decision is made, it must be honored even if it results in a financial loss. Backtracking undermines investor confidence. Mistakes should be seen as opportunities to learn, paving the way for more realistic tariff approvals in future projects.

Only by demonstrating a consistent commitment to honoring its agreements can Mongolia build investor confidence and signal that it takes contractual obligations seriously, conference participants emphasized.

Shaukat Tapia, Country Managing Partner at PwC Mongolia and PwC Azerbaijan, stated: "For investors, the only certainty about Mongolia is its uncertainty. What investors value most is regulatory stability, clarity, and predictability. In some Central Asian countries, like Azerbaijan, the rules may be strict-but they are stable. In Mongolia, legal regulations and their interpretations change constantly, making long-term planning virtually impossible."

Despite these challenges, interest in Mongolia's renewable energy sector-both domestic and foreign-is growing. This renewed optimism is driven by recent policy reforms and the country's abundant natural resources.

According to S. Baasansuren, Associate Director and Senior Banker at the EBRD Mongolia, "If the legal and regulatory environment remains stable, the renewable energy sector could attract over $1 billion in investment. In the near future, Mongolia must begin to shift its focus from coal to copper and gold."

Like other Central Asian nations such as Kazakhstan, Mongolia is rich in natural resources. As the world pivots toward renewable energy and critical minerals, Mongolia must overcome key challenges if it hopes to attract substantial foreign. direct investment based on its unique resource base. First, it must establish a stable and predictable legal environment. Second, it should build a unified system that provides investors with transparent and accessible information.

Another significant deterrent to investment is Mongolia's tax environment. It is therefore crucial for policymakers to incorporate the perspectives and recommendations of the private sector, legal experts, and foreign chambers of commerce into the decision-making process, ensuring their full participation in the reform process.