FACTBOX-Key political risks to watch in Mongolia

By David Stanway

ULAN BATOR, Jan 29 (Reuters) - Mongolia's new Prime Minister Norov Altanhuyag starts 2013 with investors increasingly worried about the outlook for the all-important mining sector.

The giant Tavan Tolgoi coal project is facing financial problems and an up to $3 billion initial public offering for the mine will not go ahead this year as originally scheduled, the firm said in January, despite a government handout of $250 million.

Failure to develop projects and execute plans now ranks alongside the influence of resource nationalist lawmakers, who were among the big winners in the 2012 election, for international mining firms.

Until and unless the new coalition government sends signals that it is in favour of foreign investors and does not intend to renegotiate key contracts or pass legislation to limit foreign ownership of mineral deposits, these firms will be wary of making big new commitments to the country.

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. The signs are not good: in December, one of the coalition parties said it would pull out of the alliance, sending Mongolian bonds crashing.

Following is a summary of key political risks to watch:


Few major Mongolian projects are progressing smoothly.

Erdenes Tavan Tolgoi, the state-owned firm running the much-delayed 7.5 billion-tonne development, is shelving the planned $3 billion share sale until the mine has more infrastructure in place.

The company will receive $350 million from the state to help repay its debts and will also try to renegotiate a supply contract with the Aluminium Corporation of China Ltd (Chalco) , but the project is likely to face further delays.

In late January, Chalco said it would seek legal redress if Mongolia breaks the deal.

Tavan Tolgoi is not the first major contract Mongolia has sought to renegotiate with foreign investors.

It remains unhappy about the deal it signed in 2009 to develop the Oyu Tolgoi copper-gold project, and has being trying to persuade current operator and owner Rio Tinto to alter the contract. On Feb. 6, the two sides will hold discussions about spending requirements.

Last year, Mining Minister Davajav Ganhuyag said Mongolia should raise its stake Oyu Tolgoi, adding to worries about increasing hostility towards foreign mining corporations.

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 Ltd to Chinese state-controlled Chalco. That deal collapsed in September when Chalco walked away, blaming the difficulty in winning regulatory approval.

The ownership law says 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 100 billion tugrik ($73.66 million) or ones involving state-owned companies.

What to watch:

- Progress at Tavan Tolgoi.

- The new government's relations with foreign investors, and whether pressure from resource nationalists is brought to bear on lawmaking.


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 bank expects growth of 16.2 percent this year.

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 benefits 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.


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?

($1 = 1357.5000 Mongolian tugriks) (Editing by Daniel Magnowski)