FACTBOX-Key political risks to watch in Mongolia

By David Stanway

BEIJING, May 3 - Landlocked Mongolia sits on vast quantities of untapped mineral wealth and analysts say it could be one of the fastest growing economies of the next decade, as well as a key investment target for global mining giants.

The $5 billion Oyu Tolgoi project, jointly owned by Ivanhoe Mines and the Mongolian government, will be the world's biggest copper mine outside Chile once full operation starts in 2013. Plans are also under way to develop the Tavan Tolgoi coking coal mine, the world's biggest untapped deposit of its kind.

But foreign companies and investors are watching to see whether the country's fledgling democratic government can build the infrastructure required, maintain stability, improve the rule of law and -- most crucially -- negotiate its way through the geopolitical pressures exerted by its two massive neighbours, Russia in the north and China in the south.

Following is a summary of key Mongolia risks to watch:

POLITICAL INSTABILITY

The capricious nature of Mongolia's democratic government can complicate foreign investment projects -- the five-year negotiations on the Oyu Tolgoi property were conducted against a backdrop of damaging political and legal uncertainties, including local ownership requirements and a windfall tax on mining profits that wasn't cancelled until last year.

The frequent replacement of key personnel at the top levels of Mongolia's government has also caused concern, with the changes often accompanied by nationalist rhetoric and populist promises to secure more control over the country's assets.

Corruption -- especially "rent-seeking" activities -- may also prove to be a long-term problem. Transparency International rated Mongolia 120th in its 2009 corruption perception index, down from 102nd in 2008.

What to watch:

-- How will the government handle populist pressures to maintain greater control over the country's strategic assets?

-- How will Mongolia use the proceeds from its mining projects? It has set up education and fiscal stabilisation funds, but it has also promised direct dividends for Mongolian citizens.

-- How will it deal with rapid economic change as foreign investment transforms large parts of the country's mainly rural economy? Investment in the Oyu Tolgoi copper deposit alone stands at roughly the equivalent of the country's entire GDP of 2009.

DEPENDENCE ON CHINA, RUSSIA

The precarious nature of Mongolia's independence was illustrated in 2002 when the exiled Tibetan spiritual leader, the Dalai Lama, was invited to Ulan Bator. Beijing opposed the visit of the man they regard as a separatist and shut down the country's only rail link for two days, stranding 500 passengers.

The People's Republic of China officially relinquished its claims to Mongolia in 1950, but there remains a deep suspicion among Mongolian people that Beijing seeks to reclaim the territory it lost after the collapse of the Qing dynasty in 1911.

China already dominates Mongolia's economy, buying more than 70 percent of the country's exports last year. Some Mongolians fear China's bulging population will increasingly lead to immigration into Mongolia for work -- especially if Chinese firms take over the bulk of its mining sector.

Russia has also been exerting pressure on its former satellite, especially over uranium. Canadian miner Khan Resources has accused Moscow of working behind the scenes to force it out of a deposit in the northeast.

The problem of competing influences even complicates transport infrastructure, with the location, direction and gauge of planned rail projects subject to geopolitical wrangling.

What to watch:

-- The growing dominance of China in Mongolia's economy has prompted many of Mongolia's elite to lean further towards Russia, but China is unlikely to step aside, and will also have much to say on where and how Mongolia builds its roads and railways.

-- China is set to enter the battle for uranium resources with a bid by state nuclear firm CNNC for Khan Resources expected to be approved by the government within weeks. Will it use its clout to block Russia's plans? And how will Moscow respond?

BALANCING "THIRD NEIGHBOURS"

Mongolia has sought to carefully balance the interests of China and Russia, and to press ahead with its "third neighbour" policy aimed at courting allies like the United States, but analysts say no nation has the clout to underwrite Mongolia's independence or undermine Russia or China's influence.

While the country hopes to develop its resources as quickly as possible, many of its bigger projects have been stymied by geopolitical concerns.

The Tavan Tolgoi coal mine attracted the interest of consortia in Japan, South Korea, China and Russia as well as global mining giants Rio Tinto and Peabody , but Mongolia eventually decided to cancel an auction for the property -- a move some thought was partly motivated by a desire not to offend any of the powerful bidders.

What to watch:

-- Will Mongolia's efforts to bring in overseas investment be derailed by the pressures being exerted by Russia and China?

-- Will the Tavan Tolgoi model of maintaining state control of state assets be used in other key "strategic resource" projects, or will Mongolia be forced to sell properties outright in order to kickstart economic growth?


Source:Reuters news service