Key political risks to watch in Mongolia

By David Stanway

BEIJING Aug 1 (Reuters) - Mongolia sits on vast quantities of untapped mineral wealth, and foreign investment in gigantic mining properties is expected to transform its tiny economy in the next decade.

Already a key investment target for resource giants, Mongolia could become one of the world's fastest growing economies.

But after years on the fringes of the Soviet bloc, the landlocked country is developing its economy almost from scratch, and foreign investors need to know if its democratic government can maximise growth while handling the pressures exerted by its two giant neighbours, Russia and China.

Following is a summary of key political risks to watch:

TAVAN TOLGOI FALLOUT

The billion-dollar Tavan Tolgoi or "Five Hills" coal mine is the world's biggest untapped deposit of its kind, and along with the giant Oyu Tolgoi copper mine, it is expected to drive growth in the next decade.

But concerns about the ownership of the mine have caused delays, and Mongolia needs to act fast if it is to complete a much-anticipated initial public offering next year and fulfil pledges it made to voters before 2012 parliamentary elections.

Erdenes MGL, the mine's state-owned operator, has chosen banks to list the eastern part of the property , but the timing will depend on an investment agreement for the western block.

Early in July, the government said China's Shenhua , Peabody of the United States and a Russian-Mongolian consortium had been chosen, but it backtracked after excluded Japanese and South Korean partners complained.

Those problems have drawn attention to the country's chaotic and opaque approval procedures, and improving governance has become a major challenge.

Analysts also complain about the weakness of Mongolia's political parties and its poor regulatory capacity, and the frequent replacement of key government personnel is also a cause of concern. Changes are often accompanied by promises to secure more control over the country's assets.

With elections looming , the government hopes to avoid the hostility that greeted the $6 billion Oyu Tolgoi (Turquoise Hill) project, set to be the world's biggest copper mine outside Chile once full operation starts in 2013.

Nationalist legislators continue to complain about the way a controlling stake in the project was granted to Canada's Ivanhoe Mines in 2009.

Investment in Oyu Tolgoi is set to reach $2.3 billion in 2011, but there has been frustration about how the dividends are spent, as well as the impact of mining on the environment.

What to watch:

-- How Mongolia uses 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 it deals with rapid economic change as foreign investment transforms the country's mainly rural economy. Overall investment in Oyu Tolgoi alone will stand at roughly the equivalent of the country's entire GDP in 2009.

-- Whether a divided government can come out with an investment agreement for Tavan Tolgoi that will satisfy all its foreign partners and keep the public happy.

DEPENDENCE

Mongolia's plan to hand the majority of Tavan Tolgoi's western block to Chinese and Russian interests demonstrated how dependent the country is on its two giant neighbours.

China already dominates Mongolia's economy, buying 90 percent of the country's exports in the first half of 2011.

Mongolia's growing dependence on Russia and China for fuel and power also poses a major risk to its mining sector. Mongolia relies on imports from Russia for around 4 percent of its current power use and is in talks to import power from China.

Dependence on foreign sources for energy makes Mongolia vulnerable to supply shocks and price rises, especially as Russia has been known to turn off supply taps.

Transportation is also a big issue. In April, Mongolia blocked some coal deliveries to China amid concerns about the dangerous numbers of Chinese truckers arriving in the region in search of cheap supplies.

Mongolia also depends on Russia's railway network to fulfil plans to deliver coal to Japan and South Korea through Russia's far eastern Pacific ports.

What to watch:

-- Any power import deals signed, and the talks leading up to them.

-- How mining firms source their power, and whether on-site plants will be designed to supply a national power grid.

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

Source:Reuters news service