Key political risks to watch in Mongolia

BEIJING Jan 3 (Reuters) - 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 $6 billion Oyu Tolgoi project, jointly owned by Toronto-listed Ivanhoe Mines , global mining giant Rio Tinto and the Mongolian government, will be the world's biggest copper mine outside top producer 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.

To read a multimedia special report on the Oyu Tolgoi copper and gold deposit, click here: r.reuters.com/nas97p

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 large neighbours, Russia to the north and China to 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 5-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and legal uncertainties, including local ownership requirements and a windfall tax on mining profits that was only rescinded in 2008.

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 116th in its 2010 corruption perception index, up from 120th in 2009 but down from 102nd in 2008.

Mining is set to transform the Mongolian economy, with investment in the Oyu Tolgoi project set to reach $2.3 billion in 2011, but there has been growing public frustration about how the dividends are spent, as well as the impact of mining on Mongolia's fragile environment. Armed activists recently opened fire at a foreign-invested gold mine accused of violating regulations.

The government may also struggle with humanitarian pressures. Last year, sub-zero temperatures and heavy snow saw the death of millions of heads of livestock in rural Mongolia, forcing thousands of nomads to flee the prairies and head for the cities and towns. This year's winter could put further pressure on the capital Ulan Bator's crumbling infrastructure as more stricken farmers drift in.

What to watch:

-- 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? Overall investment in Oyu Tolgoi alone will stand at roughly the equivalent of the country's entire GDP of 2009.

-- Will it learn the lessons of last year and find a better way of protecting a rural population at the mercy of extremely cold winter temperatures?

REGULATORY RISK

In April 2010, Mongolia's president ordered a halt to the issuance and transfer of mineral exploitation licences until the government enacts a stricter law on mining investment. The directive has rekindled some of the uncertainty that for years surrounded mining investment in the country.

It is unclear how long it would take to pass a new law. President Tsakhia Elbegdorj's proposed amendments were discussed by the Great Khural, Mongolia's parliament, in June, but a final decision has not yet been announced.

Analysts say that while the move is unlikely to affect major projects already agreed like Oyu Tolgoi, it further raises the risk levels of doing business in Mongolia.

One of the big casualties has been Canadian exploration company Khan Resources Inc , which saw its two subsidiaries lose their uranium mining and exploration licenses.[ID:nSGE66J0J7]

In November, the Ministry for Energy and Mineral Resources said it would suspend a further 254 gold mining licenses and review another 1,700 believed to contravene the country's Water and Forest Law.

What to watch:

-- Hints on the likely shape of the new law.

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

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.

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. [ID:nTOE65G05P]

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. Talks continue on a Russia-Mongolia joint venture to explore and produce uranium.

Dynamics between the three countries even complicate transport infrastructure, with the location, direction and gauge of planned rail projects subject to geopolitical wrangling. [ID:nTOE68607M]

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 rejected the bid for Khan Resources by state nuclear firm CNNC after Ulan Bator revoked the company's licenses. Is Russia now in the driving seat in the battle to secure more Mongolian uranium? What will be China's next move?

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 . Mongolia eventually decided to cancel an auction for the property and offer production licenses instead.

What to watch:

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

-- Mongolian mining minister Dashdorj Zorigt told Reuters last September that the government would maintain 100 percent ownership of the Tavan Tolgoi property, but would sell stakes to foreign bidders in the next phase of its development. Will this be the ownership model in other key "strategic resource" projects, or will Mongolia be forced to sell properties outright in order to kickstart economic growth?

(Editing by Daniel Magnowski)


Source:Reuters News Wire services