World Bank Offers Prescriptions for Investment Climate

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