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UNCLAS SECTION 01 OF 03 ULAANBAATAR 000673 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB/IFD/ODF 
TREASURY PLEASE PASS USEDS TO IMF, WORLD BANK 
MANILA AND LONDON FOR USEDS TO ADB, EBRD 
MCC FOR MONGOLIA DIRECTOR HALLMARK 
 
E.O. 12958: N/A 
TAGS: ECON EAID EFIN EAIR PGOV PREL MG
SUBJECT: World Bank Offers Prescriptions for Investment Climate 
Problems 
 
Ref: ULAANBAATAR 576 
 
¶1.  SUMMARY: A recent World Bank report provides a concise, 
well-documented account of the problems -- particularly corruption 
-- affecting Mongolia's investment climate.  It also offers 
recommendations on how to tackle these problems.  While the Spring 
session of Parliament passed tax reform and anti-corruption 
legislation, the Bank noted that, while welcome, these steps would 
not be enough.  Mongolia also needs to make administrative changes 
and increase transparency to reduce opportunities for corruption, 
take steps to make bank lending on collateral less risky, and 
address Mongolia's high transport costs (with one recommendation 
being a partial Open Skies agreement).  The report serves as a 
useful benchmark for the USG and other donors to consider future 
efforts to support the improvement of Mongolia's business climate. 
END SUMMARY. 
 
The World Bank's Report 
----------------------- 
 
¶2.  In late June, the World Bank held a roll-out workshop to 
introduce its new study of Mongolia's investment climate-its 
problems and remedies: "Mongolia: Promoting Investment and Job 
Creation-An investment climate assessment and trade integration 
study".  The report's executive summary can be found at 
www.worldbank.org/mn. 
 
¶3.  The World Bank acknowledged that many previous studies had 
identified the problems which hindered Mongolia's growth.  It sought 
to distinguish its study by relying more on hard data and actual 
practices in its description of the problems, and also to benchmark 
Mongolia against other countries.  It also sought to focus as much 
or more on the solutions to these problems. 
 
The Problems: Corruption and Lack of Transparency 
--------------------------------------------- ---- 
 
¶4.  Six areas were regarded by over half of Mongolian firms as a 
severe obstacle to investment:  corruption; the cost of financing; 
tax rates; access to land; tax administration; and macro-instability 
policy.  The level of concern in Mongolia for these and another 13 
problems was usually much higher than for other countries in East 
Asia, or in Europe and Central Asia.  The Bank added that Mongolia, 
which faces inherent development disadvantages due to its remote, 
landlocked location and severe climate, could ill afford such 
additional investment impediments. 
 
¶5.  Key problems identified: 
 
-- Corruption and lack of transparency.  " The evidence indicates 
that corruption and a lack of transparency and accountability 
pervade almost every sphere of business activity.  Mongolian 
businesses recognize this, and corruption is the most frequently 
cited impediment to doing business in Mongolia.  The analysis 
further suggests that the consequence of this has been the growth of 
a culture of operating in the 'shadow,' which has gotten in the way 
of firms accessing finance, building market relationships, enhancing 
productivity, growing and creating jobs." 
 
-- High finance cost:  "Interest rates have declined in recent 
years, but they continue to be 10-15% higher in real terms than in 
other countries. The degree of bank-based financial intermediation 
in business activity is low. Less than a third of the firms have a 
bank loan.  Unlike firms in China and Malaysia, Mongolian firms rely 
largely on internal funds and finance from informal sources for 
their investment and working capital needs.  Long-term credit 
remains scarce in Mongolia. ... The evidence, however, suggests that 
the interest rates are high not only, or even primarily, because of 
a scarcity of capital.  Rather, the high interest rates are due as 
much to systemic and structural factors that make bank lending a 
risky activity and limit the range of financial products that are 
available." 
 
-- Customs:  " Import tariffs levels are among the lowest in Asia. 
... (However,) customs processes cause delays and are unpredictable. 
...Corruption in the customs valuation and exemptions process is an 
 
ULAANBAATA 00000673  002 OF 003 
 
 
even larger problem.  ...A quarter of firms that export and just 
over a fifth of the firms that import report having to pay a bribe 
in order to expedite customs clearance or avoid excessive duties." 
 
-- Logistical:  " The transport options Mongolian firms have for 
getting goods to and from external markets are limited, costly and 
unreliable. ...Mongolia's external trade is almost entirely 
dependent on a single rail link... Border crossing charges (because 
of the difference in gauge) make up nearly 25% of overall costs of 
transport to the port (of Tianjin).  ...Transit times to port are 
uncertain because of the unpredictability of delays at the border. 
...Inadequate harmonization of customs procedures with Russia and 
China is a major cause of the delays, unpredictability and high 
costs Mongolian firms face.  ... Cross-border road linkages with 
China are hampered by restrictions on the movement of trucks." 
 
Prescriptions for Improvement: Partially Accomplished 
--------------------------------------------- -------- 
 
¶6.  Several among the World Bank's prescriptions for change in June 
were quickly fulfilled.  The Bank had urged major tax reforms and an 
anti-corruption law -- matching longstanding calls by the U.S. and 
other donors -- and these measures were adopted by parliament before 
it adjourned in July (reftel).  However, the World Bank noted that 
these steps would not be enough by themselves. 
 
-- Administrative changes:  " Reform efforts need to go beyond 
changes to the tax code or passage of anti-corruption legislation to 
restructuring the operations of the key agencies-the tax department, 
the customs administration, and the inspections agency-that directly 
interact with private firms and individuals. ... Without reforms in 
tax administration to ...lower the exposure of firms to arbitrary 
and predatory behavior on the part of tax inspectors, reforms in the 
tax code are unlikely to achieve their aim. " 
 
-- More openness:  "Comprehensive reform of administrative processes 
takes time. By adopting immediate measures to promote transparency 
in government-business interactions, Mongolia can facilitate and 
strengthen these reform initiatives by enabling private businesses, 
industry associations and civil society groups to monitor the 
progress of reforms and the degree to which actual practices conform 
to prescribed law." 
 
-- Measures to facilitate lending:  "Existing gaps in the 
institutional and legal framework for contract enforcement in 
Mongolia, primarily in the area of bankruptcy, debt collection, and 
the liquidation of collateralized assets make bank lending risky for 
all banks and limit the range of financial products that are 
offered. Measures to address some of these gaps would, by lowering 
the risks associated with lending, lower the risk premiums that are 
in part responsible for the high cost of finance, and lower the high 
collateral requirements that reduce access to finance." 
 
-- Addressing transport difficulties:  "Completion of the road 
connecting Ulaan Baatar with the Chinese border, construction of 
which is underway, will help.  What can be done in the meantime? 
Initiatives in three areas hold the most promise.  The first is 
reform of customs processes with a view to reducing delays and 
rent-seeking.  The second is completion of the tripartite Agreement 
on Transit Transport with China and Russia. A nd third, the 
government may wish to consider adopting a (partial) open skies 
policy towards charter flights for tourists and air freight 
services.  ... A tripartite Agreement on Transit Transportation 
between Mongolia, Russia and China is essential for Mongolia's trade 
integration. Negotiations on such an agreement have been ongoing for 
over a decade. " 
 
Foreign and Mongolian businesses respond 
---------------------------------------- 
 
¶7.  Overall, the businesses received the World Bank report well, 
agreeing publicly and privately that the data accurately conveyed 
the problems faced.  Everyone agreed that the report's strength was 
in giving firm, clear definitions and real-world examples of 
problems faced, rather than the hazy, opaque anecdotes that have 
filled previous studies. However, post-rollout commentators among 
the business community were quick to identify the key weakness of 
 
ULAANBAATA 00000673  003 OF 003 
 
 
this and other reports: How to implement its proscriptions?  To 
paraphrase the sentiments of one longtime leader of the banking and 
foreign investment community, "The report is the best critique of 
the ills yet, but how can we use its prescriptions, specific as they 
are, to get anything done?" 
 
¶8.  One possibility may be for the USG and other donors to use the 
report as a benchmark consider future efforts -- through pressure on 
the government as well as targeted assistance -- to support the 
improvement of Mongolia's business climate. 
 
GOLDBECK