FACTBOX-Key political risks to watch in Mongolia

Thomson Reuters






By David Stanway

BEIJING, Aug 2 (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 $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 large 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 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mining profits that was only rescinded last year.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.

Analysts also complain about the weakness of Mongolia's
political parties and its poor regulatory capacity.

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 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.

REGULATORY RISK

In April, 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.

The announcement came just days after Mongolia's Nuclear
Energy Agency (NEA) invalidated the mining and exploration
licences of two subsidiaries of Canadian exploration company
Khan Resources Inc citing violations. [ID:nSGE63C0HN]

The move to strip Khan's licenses was subsequently declared
illegal by a court in Mongolia but that is unlikely to be the
end of the matter. [ID:nSGE66J0J7]

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,
and a final decision is expected to be reached before the fate
of Tavan Tolgoi is settled later in the year.

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

"The purpose of the suspension appears to be aimed more at
creating more regulatory oversight in the mining sector by
weeding out the thousands of small, domestic miners who may
have obtained licences illegally. But it is also a government
response to a popular clamour against 'selling out' the
country's resources," said Eurasia Group analyst Damien Ma.

"As a result, the government may revisit a plan to change
the mining law regime or draft new legislation during
parliament's spring session. If the changes are eventually
approved, it could make the mining licence regime more
onerous."

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.

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.
[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.

The problem of competing influences even complicates
transport infrastructure, with the location, direction and
gauge of planned rail projects subject to geopolitical
wrangling. Round one was won by Russia, with the Mongolian
government recently agreeing to build a rail link between Tavan
Tolgoi and the Russian border.

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
. 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. A final
decision on the ownership of Tavan Tolgoi is expected later
this year.

What to watch:

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

-- The government now appears to be leaning towards
privatising the Tavan Tolgoi property, and is likely to offer a
30 percent stake to a foreign bidder while offering shares in
the project to private citizens. How much state control will it
maintain? Will 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 Andrew Marshall)