ULAN BATOR, Mongolia – For decades, this remote and fabled region -- known for the 13th century dynasty of Genghis Khan and his Mongol hordes, who raided the continent from their base in the country’s windswept, sparsely populated steppes, mountains and deserts -- has relied upon what’s underground to feed its contemporary economy. The effort has brought new prosperity to a nation where a large sector of its population is still nomadic, with the extraction of rich deposits of coal, gold and other minerals has brought a sevenfold increase in per capita income during the last 10 years alone.

With a sparse population of only 2.9 million occupying a vast, landlocked area (600,000 square miles, or 1.5 million square kilometres), the former Soviet satellite state has used mining to produce great wealth: From the end of the Cold War in 1991 to this year, gross domestic product has grown at an average of 5.3 percent.

Lately, though, things have taken an unexpected twist for the worse. Commodity prices have dropped; Chinese demand is slowing. As a result, Mongolians are going from boom to bust.    

“With the coal sector going through the floor, I'm almost out of business,” Batorchiriin Ariguun, the founder of a local marketing research firm, said while working out on a treadmill in a gym in Ulan Bator, Mongolia’s capital. “I might freeze the company for one year waiting for the economy to bounce back in 2015.”

Mongolia is one of mining's last big frontiers, with massive and still untapped deposits of coal, copper, gold and uranium. When global commodity prices were highs, Canadian and Australian junior mining firms rushed in, looking for top-class deposits such as Oyu Tolgoi, the copper-gold deposit that was recently tapped by Rio Tinto plc (LON:RIO); even given the downturn, that mine is set to become the world's third largest of its kind.

During the heyday, other overseas investors followed suit, and Mongolians began enjoying unprecedented levels of economic growth. Skyscrapers and cranes were soon towering over Ulan Bator's apartment blocks and outlying neighborhoods of traditional ger, the Mongolian nomadic tents also referred to as yurts.

But all that came at a price: dependence upon next-door neighbor China, Mongolia’s almost-exclusive trading partner. With China now cutting Mongolian coal imports, worldwide commodity markets turning south and flagging investor sentiment, mining exports have declined this year and foreign investments are drying up. The economy is still expected to grow at more than a 12 percent rate in 2013, but most of that relatively breakneck pace is due to the central bank’s expansionary monetary policy. The central bank has cut interest rates from 13.25 percent to 10.5 percent and pumped money into the system through subsidies mortgages and other measures, with the result that almost 30 percent of the banking system’s total assets are directly dependent upon central bank funding -- more than debt-laden European nations such as Greece, Cyprus and Portugal. Inflation, meanwhile, is running at just under 10 percent, which cuts down real growth to a meagre 2/3 percent. Within this context, entrepreneurs like Ariguun are struggling to make ends meet.

Four Times Bigger Than The Economy?

All of which means that Mongolia’s government is looking to diversify away from China and commodities, and one area it's betting on is potentially lucrative, if far less finite: the growth of its stock exchange. Undercapitalized and illiquid, the Mongolian Stock Exchange (MSE) is still a relative minor player, but the government has big plans.

In a push to make long-term equity capital available for businesses other than mining, the State Great Khural or SGK, Mongolia's congress, passed two sweeping laws overhauling the stock market which will take effect in January 2014. The new laws “will hopefully bring capital markets onto a new stage of development,” Byambaa Losolsuren, a partner at local investment firm United Mongolian Corporation, told IBTimes.

Back in 2011, then-MSE chairman Bold Baatar claimed the market would reach a capitalization of $45 billion within five years -- more than four times the size of the entire economy today. But since then Mongolia’s blue-chip index has lost more than 50 percent, after peaking in February 2011, and today the MSE's overall capitalization is just around $850 million. Because shares are heavily concentrated with majority shareholders, liquidity is dramatically low and daily trading volume averaged under $150,000 this year. Only a third of the 262 listed companies actually trade. 

“The absence of an enabling regulatory framework restricts capital-raising opportunities for Mongolian companies,” a report by the law firm Hogan Lovells concluded.

Things are now set to change. In July, the SGK approved the Revised Securities Law, which expands the range of tradable securities to derivatives, depositary receipts and warrants. It also introduces, among other things, IPO procedures and takeover rules. 

“The Revised Securities Law seeks to overcome the limits and shortcomings of the existing Securities Law and introduce international standard market regulations,” the Hogan Lovells report said.

Later in the year, the SGK passed the Investment Fund Law, which lays the foundation for the development of a local asset management industry. The new law introduces two types of funds: mutual funds, which will be allowed to advertise to raise funds and will be subject to tight supervision, and private funds, in which only institutional investors will be allowed to invest.

“Institutional investors will definitely have a high impact on liquidity and reduce systemic risks,” UMC's Losolsuren added.

More IPOs

With better rules and the liquidity coming from investment funds, IPOs are expected to pick up and stir the appetite of financial investors.

“The overall aim of ongoing reforms is to better intermediate between privately held Mongolian firms looking for cheaper sources of equity, and a growing pool of foreign investors seeking to unlock the value of the market in the coming years,” Oxford Business Group said in its latest country report.

Mongolia's overall economy is currently worth just over $10 billion; it’s unlikely that the MSE will reach a total market cap of $45 billion in five years, as its former chairman had predicted. Still, the MSE is often compared to the stock exchange of neighbouring resource-rich Kazakhstan, whose overall value has grown 30 times since 2001, piggybacking on the country's solid economic growth. Local investment bank Eurasia set a target for the MSE market cap at $20bn by 2020.

“Equity financing is particularly important for sectors other than mining to grow and Mongolia today suffers from a shortage of risk capital,” Asian Development Bank country economist Jan Hansen told IBTimes. 

Established local conglomerates such as MCS Group and Tavan Bogd, with a presence in a wide range of industries from real estate to food and beverage, and telecommunications firm Mobicom, have long been in the list of possible candidates for a market debut compiled by local and international analysts. Overall, analysts suggest they could add as much as $5 billion to the MSE's current market cap. State-owned airline MIAT and several banks are also considered ideal candidates for an IPO. Small and medium enterprises in Mongolia's dairy products, textiles and tourism sectors will also have a chance as liquidity flows in.

90 Percent Mining

Today, mining accounts for 90 percent of Mongolia's exports and 85 percent of investment into the country, and even given its declining output, its contribution to the national GDP (which now stands at 20 percent) is set to steeply increase as OT reaches full capacity and other mines comes online. The resource industry long ago surpassed the traditional agriculture sector as the economy's main engine of growth, though the latter still accounts for 15 percent of the GDP.

“The dual undiversified nature of the economy makes it susceptible to boom-bust cycles, accentuated by the structural shift in economic activity to mining from agriculture,” a report by credit rating agency Moody's said.

Yet diversification is a slow process, and in the meantime, Rio Tinto's Oyu Tolgoi mine, which began production in July 2013, is expected to account for one-third of the country's GDP all by itself by 2020. The state-owned Tavan Tolgoi mine, one of the world's largest untapped coking and thermal coal deposits, is expected to reach full capacity in the next decade. The overall value of the country's 10 largest deposits is about $1.3 trillion, according to figures from Singapore-based investment company Temasek.

As the mining cycle cools off -- OT's US$5.1 billion planned expansion is being delayed, global commodity prices are declining and coal exports to China were down 44.8 percent year-on-year in the first nine months of 2013, muscled out by Australian exports -- symptoms of Mongolia's economic malaise are impossible to ignore, which accounts for the government’s moves toward diversification. Overseas investments decreased 46.8 percent from January to August; the local currency, the tugrik, has lost more than 25 percent to the U.S. dollar this year, plummeting to the lowest level in 10 years; and GDP forecasts continue to be revised downward by international observers such as the IMF and the World Bank. Skepticism is mounting.

“Talk to any Mongolian business owner and you’ll hear that there are considerably fewer customers coming into their stores or requesting their services,” a report by local real estate developer MAD Investment Solutions notes. “High-end shopping malls built on the 2011 consumer hype are deserted and empty on the weekends. There is a discernible drop in the number of expatriates inhabiting the city centre cafes and pubs. And importantly, a bleak and pessimistic sentiment permeates the Ulaanbaatar community, no small fact for a country with such enormous untapped potential.”

But in order for diversification to work, analysts as well as local business owners say, the government will have to ensure that economic growth takes place nationwide. “In Mongolia, if you want to survive you can't do just one business, you have to diversify,” Ariguun observed. “Successful conglomerates all have businesses in every field. Beside market research, I'm also in the meat market, which is definitely more lucrative at the moment. And I would like to start up a metallurgical business. Mongolia exports iron ore, coal; the ingredients for steel production are already here, but somehow there is no domestic metallurgical industry yet.”

Simple extraction, in the view of entrepreneurs like Ariguun, is no longer the answer.

If the government’s stock market plan succeeds, the Mongolian economy may become less of a one-trick pony. A friendlier foreign-investment law could also help bring in capital. The long-awaited law, which took effect Nov. 1, eases restrictions on investment in key sectors such as telecommunications and banking, as well as mining, and stabilizes tax rates over a period of 22 years. And unlike previous legislation, it makes no distinction between domestic and foreign investors, which, the government hopes will open the door for wider economic exploration, from inside and outside the country.