June”s parliamentary election proved
inconclusive, and the coalition government that is still taking shape is
certain to involve parties hostile to foreign mining firms, a move that will
worry investors.

The key risk for the mining firms – the engines
of economic growth in Mongolia – is that resource nationalist lawmakers, who
were the big winners in the poll, exert pressure on the coalition to
renegotiate key contracts, and pass legislation to limit foreign ownership of
mineral deposits.

The priority for Mongolia is the development of
its tiny but fast-growing economy, and foreign investors want to know if the
government can create a stable legal environment while pleasing its impatient
citizens as well as its two giant neighbours, Russia and China.

Following is a summary of key political risks
to watch:

INVESTMENT POLITICS

The makeup of the new government will determine
the investment climate, and the pace at which Mongolia”s huge mineral deposits
are brought to production.

The coalition, to be led as prime minister by
Democratic Party (DP) chief Norov Altanhuyag, will include minority parties
such as the Mongolian People”s Revolutionary Party and Mongolian National
Democratic Party, both of which want to limit foreign investment in the booming
mining sector.

A key figure in a environment of increasing
hostility, at least outwardly, towards foreign mining corporations, is former
president Nambar Enkhbayar, chief of the Mongolian People”s Revolutionary
Party.

He wants to review the contract for Rio Tinto”s
giant Oyu Tolgoi copper and gold project, and also says the 7.5-billion tonne
Tavan Tolgoi coal mine – expected to be listed on overseas stock exchanges –
should remain in Mongolian hands.

Enkhbayar”s political grouping is likely to
press for laws demanding more from foreign investors, which could delay mine
development.

Few major Mongolian projects are progressing
smoothly.

The government wants to launch a $3 billion initial
public offering of the Tavan Tolgoi or “Five Hills” coal deposit.
State-owned Erdenes Tavan Tolgoi had been planning to list 29 percent of the
company in London and Hong Kong by May, but it cannot until Mongolia”s
parliament passes a securities law.

An initial proposal to hand development rights
in the project to China”s Shenhua, Peabody of the United States and a
Russian-Mongolian consortium was suspended, and the government is trying to
devise another deal that will include Japanese and South Korean partners.

After struggling for years to find the right
investors, Mongolia might yet choose to develop Tavan Tolgoi”s western block on
its own, an executive with the state-owned firm in charge of the project said
in April.

In mid-May, Mongolia”s parliament passed a
controversial law aimed at capping foreign ownership in “strategic”
industries such as mining, but investors expressed relief that the legislation
was weaker than first anticipated.

The bill was watered down considerably since
first drafted by a group of backbench lawmakers who were alarmed by a decision
by Canada”s Ivanhoe Mines to sell its 58 percent stake in coal miner SouthGobi
Resources to the Aluminum Corporation of China (Chalco).

It stipulates that foreign investors are
allowed to own a maximum of 49 percent of companies involved in the mining,
finance, media and telecommunications sectors before being subject to scrutiny
by a government panel, but it now only applies to deals valued at above $75
million, or ones involving state-owned companies like Chalco.

What to watch:

– Precise formation of the coalition, the
strength of resource nationalist representation in parliament, and whether they
can force the government to review contracts. Building a durable coalition in
Mongolia”s especially fractious, factional political atmosphere will not be
easy.

– Whether the government can produce an
investment agreement for Tavan Tolgoi that will satisfy foreign partners and
keep the public happy, and whether it can do it in time.

– More inward investment. In November,
commodities trader Trafigura and private equity investor Origo Partners Plc ,
formed a joint venture to develop Mongolian coal and iron ore deposits for
export, and in February Goldman Sachs bought a 4.8 percent stake in a Mongolian
bank.

THE RESOURCE “CURSE”

Mongolia”s economy grew at 16.7 percent
year-on-year in the first quarter of 2012, according to the World Bank, more
than double the pace of China, making it the fastest-growing in Asia.

The country is already showing classic symptoms
of “Dutch disease”, including soaring inflation and high interest
rates.

In July, ratings agency Fitch said “rising
systemic risks” could leave Mongolia vulnerable to a repeat of the
boom-and-bust cycle it experienced in 2007-2009, should commodity prices fall
rapidly. The risks are a result of an extremely loose credit environment, high
inflation despite interest rates of 13.25 percent, and a widening fiscal
deficit, the agency said.

The government is trying to bring in structures
that will protect it against fluctuating commodity prices, and wants to use the
proceeds from mining to pay for infrastructure, health and education, and
develop other sectors.

It is under pressure to spread the wealth, and
has already extracted pre-payments from foreign firms involved in both the
Tavan Tolgoi and Oyu Tolgoi projects in order to give money to the public.

What to watch:

– Economic indicators, especially signs of
overheating.

– How Mongolia uses the income 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
well as inflation as foreign investment transforms the country”s mainly rural
economy.

– The International Monetary Fund has warned
that Mongolia”s economic policies are creating inflationary pressures.

GETTING ON WITH THE NEIGHBOURS

Many of Mongolia”s 2.7 million citizens are
concerned about growing Chinese and Russian influence, and their fears were not
allayed by the plan to hand the majority of Tavan Tolgoi”s western block to
Chinese and Russian interests last year – a decision that was later reversed.

China already dominates Mongolia”s economy,
buying 90 percent of the country”s exports in the first half of 2011, though
the government wants to bring this number down and diversify Mongolia”s
markets.

Mongolia”s reliance on Russia and China for
fuel, power and transportation also poses a major risk to its mining sector.
Russia has been known to turn off supply taps, and China is not averse to
closing crucial railway links.

Mongolia also depends on Russia”s railway
network to fulfil plans to deliver coal to Japan and South Korea. Mongolia”s
plans to build itself a railway network capable of transporting coal to foreign
markets is likely to be delayed.

What to watch:

– Will efforts to ease dependence on China
increase Russia”s influence, and vice versa?

– Is the Chinese market for coal and other
minerals its only option in the short term?

– How will the government handle growing
nationalist sentiment, and fears about the role of foreign firms and workers?

By David Stanway

Source: Reuters