Resurgent nationalism in mineral-rich Mongolia, which will vote for a new
government this week, will irk foreign investors, but it is unlikely to wreck
sentiment, with politicians still desperate to keep the dollars flowing in.

Foreign investment in Mongolia”s much coveted
mines like the $7 billion Oyu Tolgoi copper project helped expand the economy
at the fastest pace in all of Asia last year. But many of the country”s 3
million voters say the bulk of the nation”s nouveau wealth still lies in the
hands of the political elite.

Thursday”s parliamentary election will see
politicians from two major parties – the Mongolian Democratic Party (MDP) and
the Mongolian People”s Party (MPP) – fight to appease the masses. Foreign firms
such as Rio Tinto can expect a more turbulent ride in the years to come.

“We believe that (resource nationalism)
is broadly bi-partisan and is to increase whichever party wins,” said the
Ulan Bator-based Frontier Securities in a note to clients.

A shift to the left could end up saddling
investors with higher tax bills and make it harder to win approval for new
projects. But the main players in the election remain broadly supportive of
foreign capital, which has turned the dusty former Soviet outpost of Ulan Bator
into a bustling boomtown.

“Even
with popular voter support for resource nationalism, authorities are still realistic
and will not push it too far, because obviously they need high economic
growth,” said Dale Choi, an Ulan Bator-based analyst with Frontier.

Mongolia”s economy grew 17.3 percent in
2011, outpacing all in Asia and trailing only Qatar and Ghana globally.

REDRESSING IMBALANCES

For many voters, the seventh parliamentary
election is another chance to try to redress an imbalance.

The end of Communism in 1990 left the
economy devastated as old Soviet supply lines broke down. Since then, Ulan
Bator”s resource policies have been notoriously laissez-faire as it sought to
attract foreign investment on whatever terms possible.

Expectations are rising that policies could swing too far in the
opposite direction, imposing more controls to redistribute mining wealth in a
way that pleases voters.

Mongolia has already imposed restrictions on
mining in forest or river areas, a moratorium on new licenses and a new law
designed to limit foreign ownership of “strategic” sectors.

President Tsakhia Elbegdorj, a former journalist
and veteran campaigner from 1989, insisted Mongolia remains committed to the
free-market approach to development.

“Open countries succeed in exploring for
and using their mineral wealth, but closed societies fail,” Elbegdorj, who
holds a master”s degree in public administration from Harvard, said in an
interview last week.

But he conceded that the public were
dissatisfied with the way the country”s new wealth has been spread, and the
emphasis of Mongolia”s politics needed to change.

The government has sought to redistribute
wealth by creating social funds using mining profits much like the way Norway
has done with the money it generated from oil. But that has resulted in cash
handouts that have made very little difference to underlying poverty.

SHIFT IN
RHETORIC

While Mongolia”s course of economic
development has been set, there has been a shift in rhetoric, said Sumati
Luvsandendev, a pollster with the Sant Maral Foundation.

“The social justice issue is now at the
top of the agenda,” he said. “The attitude of Mongolians towards
mining is based on an expectation that it will solve many of Mongolia”s
problems, but there is a problem of confidence about decision makers.”

The mining boom has not improved conditions
in large parts of the countryside or in Ulan Bator”s crowded migrant districts.

“I don”t see any benefits (from
mining),” said Altantsetseg Laagansuren, a 29-year old mother of three
living in a crowded ger (tent) in one of the capital”s sprawling makeshift
suburbs. “I don”t see anything changing. I think the people at the top are
sharing and eating up the wealth,” she said.

Amitan Ulam-Undrakh, a camel herder and former township governor in
South Gobi province, is a direct beneficiary of the Oyu Tolgoi project. He has
watched closely as Rio Tinto and Ivanhoe”s billion-dollar investment transforms
the region”s once moribund subsistence economy. But even he has reservations.

“Livestock and traditional sectors used
to be the biggest part of the economy, and we should choose a leader who can
allow mining and the traditional ways of life to coexist,” he said.

President Elbegdorj, from the nominally
free-market MDP, is promising an end to mining overdependence. He has imposed a
moratorium on new licenses and is preparing to approve a new mining law ahead of
his own re-election campaign next year. He also hopes to raise taxes on miners
to as much as 40 percent.

“We all agree (mining is an important
part of the economy) but profits from mining should be invested in other
sectors – infrastructure, human development and in the diversification of our
economy,” he said.

While the 76-member legislature (the Grand
Khural) is sovereign with ultimate powers over laws, the 1992 constitution also
gives equal executive powers to the president, which can lead to deadlock.

REBEL FORCE

The latest polls suggest the MDP has now
sneaked ahead of the centre-left Mongolian People”s Party (MPP). Both parties
formed a grand coalition after the 2008 election and ushered through the Oyu
Tolgoi deal in 2009. The alliance ended in January.

But by hogging the middle ground, the big
parties have left themselves vulnerable to a populist candidate prepared to
exploit popular unease about income disparities. The biggest beneficiary has
been Nambar Enkhbayar.

After his defeat in presidential elections in
2009, Enkhbayar fell out with the MPP and formed his own party using the MPP”s
old name, the Mongolian People”s Revolutionary Party (MPRP). Many in the MPP”s
left wing jumped ship with him.

He expected to contest a seat in the parliamentary election and fight
for the presidency in 2013, but he was arrested in April on corruption charges
that he insists were fabricated.

Unbowed by his subsequent exclusion from the
vote, the former president continues to campaign on a largely left-wing resource
nationalist ticket, and his “justice coalition” could conceivably
hold the balance of power in the new parliament.

After addressing a small but appreciative
crowd near Ulan Bator”s Russian-era State Department Store, Enkhbayar told
Reuters that he was not opposed to foreign capital in industries like
manufacturing, but resources required a different approach.

Foreign firms should be rewarded for their
exploration and development efforts but given a strict timetable to hand mining
properties back to the people, he said.

“With the foreign investment law coming
in and other laws being threatened, we can”t expect an easy ride anymore,”
said an executive with a foreign mining firm. “I worry a bit about
Enkhbayar because despite the corruption scandal, he seems to be stronger than
ever.”

Pollster Sumati said Enkhbayar has become the
“none-of-the-above” candidate for frustrated voters.

“He has become a protest leader, and he
is representing the rebels in both major parties,” he said.

DEBATE

Last year, a group of backbench MPs urged
the government to renegotiate the landmark 2009 Oyu Tolgoi agreement that
granted a 66 percent stake in the project to Canada”s Ivanhoe Mines , now
controlled by Rio Tinto. Many of the lawmakers were also behind a 2007 law to
submit miners to a windfall tax.

Foreign investors were relieved when the bid
to revise the Oyu Tolgoi deal failed, but there were more worries to come.

The same backbenchers responded furiously to an attempt by Ivanhoe to
sell its majority stake in the coal miner SouthGobi Resources, and pushed
through a foreign investment law designed to restrict overseas ownership in
“strategic” sectors. The law was diluted and finally passed in May,
but it still contains worrying ambiguities.

Cameron McRae, country manager for Rio Tinto
and chief executive of Oyu Tolgoi, said that while there were still a number of
“traditional politicians” campaigning against foreign investment,
many more were stressing support.

The Oyu Tolgoi mine is scheduled to start
delivering ore to market by the end of August and will go into full operation
next year. On top of the $7 billion already invested, analysts estimate there
is at least another $6 billion to come.

Sumati said most Mongolians were worried not
about foreign ownership, but by the prospect of being left behind.

Rio Tinto is trying to repel the argument
through a process of “community engagement.” In the small town of
Khanbogd, it is constructing gleaming new schools, roads and government
buildings.

Eyes are also on the massive Tavan Tolgoi
coal mine in the South Gobi region.

Decisions about the mine”s development have
been repeatedly delayed, with Mongolia unable to win the consent of all the
parties involved – including Russia, China, Japan, South Korea and the United
States. An investment accord was supposed to have materialised last year.

The election could have an impact if it
increases the representation of resource nationalists like Enkhbayar who want
to keep it in Mongolian hands and could make the fate of the project a condition
of his party”s participation in a coalition.

By David Stanway and Maxim Duncan

ULAN BATOR, June 27 (Reuters)