Key political risks to watch in Mongolia

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

Analysts say it could become one of the world's fastest growing economies and is already a key investment target for resources giants like Rio Tinto and Peabody Energy .

Mongolia aims to become a major force in the regional coal market by developing the billion-dollar Tavan Tolgoi or "Five Hills" mine, the world's biggest untapped deposit of its kind.

Erdenes MGL, the mine's state-owned operator, has chosen banks to list the eastern part of the property next year. A shortlist of investors for the western section has also been drawn up, including consortia from Japan and South Korea as well as Peabody, Xstrata and ArcelorMittal , with the winner due to be announced in June. [ID:nL3E7E70CI]

The $6 billion Oyu Tolgoi project, jointly owned by Toronto-listed Ivanhoe Mines , Rio Tinto and the Mongolian government, will be the world's biggest copper mine outside top producer Chile once full operation starts in 2013.

After decades on the remote fringes of the Soviet bloc, Mongolia is developing its economy almost from scratch, and foreign investors are watching to see whether the country's democratic government can maintain stability, build infrastructure, improve rule of law and negotiate its way through the 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 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and legal uncertainties, including local ownership requirements and a windfall tax on mining profits that was only rescinded in 2008.

The frequent replacement of key personnel at the top levels of Mongolia's government has also caused concern, with 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 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 Oyu Tolgoi 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.

Around 200 herdsmen pitched tents in Ulan Bator's central square in April and called on the government to resign for "betraying national interests in mining deals."

In May, nationalist parliamentarians angry at the way mining agreements have been struck with foreign firms again called for the sacking of mining minister Dashdorj Zorigt.

Public anger about how the Oyu Tolgoi project was sold has had an impact on its handling of Tavan Tolgoi. While partial stakes in the project will eventually be transferred to foreign investors, the government aims to keep half of the eastern block, with 30 percent listed on an overseas stock exchange, and 20 percent handed out to local enterprises and residents.

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 Tavan Tolgoi provides the ownership model for other "strategic resource" projects, or Mongolia sells other properties outright.

REGULATORY RISK

Last April, Mongolia's president ordered that no more mineral exploitation licences be issued until the government enacts stricter environmental laws. A final decision has not yet been announced and the uncertainty raises the risk levels for foreign mining firms.

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 shape of the new law.

-- How the government handles populist pressures to maintain greater control over the country's strategic assets.

DEPENDENCE ON CHINA, ROLE OF RUSSIA

China already dominates Mongolia's economy, buying 84 percent of the country's exports last year, adding to the perennial sense of unease in Ulan Bator about the intentions of its giant southern neighbour.

In mid-April, Mongolia blocked coal deliveries to China from its South Gobi region, some say in retaliation against the temporary closure of a border crossing. [ID:nL3E7FK0LO]

The sparsely populated country recently announced new policies to manage the flow of migrant labour as it embarks upon a massive construction programme, but many Mongolians fear an influx of Chinese workers.

Mongolia has for years sought to balance carefully the interests of its neighbours China and Russia, and this has already had an impact on the development of the Tavan Tolgoi mine. China offers a guaranteed market for Mongolian coal, but Ulan Bator will deliver coal east rather than south to a processing centre still under construction in Sainshand, where it can then be dispatched to Russia's far eastern Pacific coast. Analysts have questioned the economic feasibility of the plans.

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. China dominates Mongolia's foreign trade and economics, and will have much to say on where and how Mongolia builds its roads and railways. (Editing by Daniel Magnowski)

Comments

  1. All are in the hand of the players. If they will be right in their path there is no one who can do wrong in the system.

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