Ariel Cohen in Washington -

Mongolia is in the midst of a self-inflicted political crisis over foreign investment in the country's lucrative mineral sector. On April 7, the Mongolian Parliament opened its spring session, during which it will continue its drawn-out deliberations over the crucial mineral resources law. Until now, an extraordinary session of the Parliament had discussed draft amendments to the mineral resources law.

The March announcement in Ulanbaatar that the Canadian mining company Ivanhoe Mines had discovered yet another major new gold and copper deposit in southern Mongolia has highlighted both the potential and pitfalls of developing natural resources in this faraway land.

The Heruga deposit, containing an estimated 4m tonnes of copper and 379.8 tonnes of gold adjoins the southern boundary of Ivanhoe's giant Oyu Tolgoi copper and gold development project. In March last year, Ivanhoe determined that its Oyu Tolgoi deposit contained over 32m tonnes of copper and almost 1,000 tones of gold. And last year, Ivanhoe's 81%-owned subsidiary, SouthGobi Energy Resources, raised $117.9m and is preparing to open its first coal mine in Mongolia.

This should have been Mongolia's turn to celebrate. This should have been a bonanza for the poor, but highly literate, distant Buddhist country, which rarely makes the news. Nevertheless, the parliamentary session on April 2 was disrupted by a walkout and boycott by the opposition Democratic Party. Still, the leaders of two main political forces, the ruling Mongolian People's Revolutionary Forces Party and the Democratic Party, stated earlier that they had reached an understanding over the proposed changes in the mineral resources law.

According to the proposed changes, the government can claim a minimum of 51% in a foreign state-run project, and 34% of any private project. The proposed amendment said that up to 51% of state interest in a strategically significant mineral deposit explored by private funding would be subject to negotiation under an investment agreement. "We need an additional legal regulation that says that when a strategic investment partner has recovered its initial capital investment in certain number of years, the 34% would be raised up to 51% then. So the final government's stake will be 51% anyway," said Ts. Damiran, a member of parliament.

High natural resource prices should be an engine of economic and social development. Yet instead Mongolia is facing a political crisis, rising resource nationalism and government corruption.

Between 2006 and 2008, Mongolia's rating on development indices has fallen precipitously. The Fraser Institute's Policy Potential Index lowered Mongolia from 33rd place with a score of 54/100 to 61st (out of 68) with a score of 19/100. With the bottom rating for Regulatory Duplication and Inconsistencies, Fraser Institute put Mongolia on its 2007 "Annual List of Worst Places to Mine."

The Heritage Foundation's 2008 Index of Economic Freedom states that: "Mongolia's enforcement of laws protecting private property is weak and judges generally do not understand such commercial principles as the sanctity of contracts, regularly ignoring the terms of contracts in their decisions."

Western investors are knocking on Mongolia's doors despite the high risks, lured by the glitter - and high prices - for gold and copper. Rio Tinto and Ivanhoe have committed to develop Oyu Tolgoi - one of the largest copper and gold mines in the world with a 30-year commitment to invest $7.3bn.

So far, the Ivanhoe and Rio investors have sunk over $600m into the project, and are spending $30m-40m a month to keep the infrastructure going. The project has already generated 4,000 jobs and, once operational, will bring to the Mongolian Treasury billions of dollars of revenue. The project is located hundreds of miles from the capital Ulanbaatar, and 80 kilometres from the Chinese border. Its wealth would do wonders for the economic and social development of Mongolia, boosting estimated GDP growth by up to 30%.

There are no railroads to export the metals - the investors will need to build them - yet the booming Chinese market is just next door, and from Chinese ports metals can be sent all over Asia - and the world.

The Mongolian government, however, has been dragging its feet for five years. With political parties taking turns at the helm of government, and with new committees being set up to review the project, the government approval process for the project has stalled.

Meanwhile, Mongolia's politicians have their hands out. To capture revenue, they passed a draconian mineral law, allowing for 65% windfall profits on copper and gold, with up to 100% of equity ownership in mineral projects.

It goes without saying that the Mongolian government has neither the expertise nor the financing to undertake Oyu Tolgoi on its own. The Russians, however, think they do.

Russian in

Since the beginning of the decade, Russia has increasingly exported resource nationalism and developed under-the-table arrangements with local politicians that put Western companies at a disadvantage. One could call it "the ties that bind." School ties, party ties - this is why and how the rulers of Uzbekistan and Turkmenistan, no great friends of Western democratic ideas, have committed their extensive gas reserves to be developed and exported exclusively by Gazprom.

Mongolia, with its regular democratic elections and robust market reforms of the 1990s should have been different. However, Prime Minister Sanjaagiin Bayar, the leader of the post-communist Mongolian People's Revolutionary Party, has strong ties to Moscow. He was a military officer and a journalist in the era when those jobs were controlled by the Mongolian communist party and its Soviet supervisors. Bayar, who graduated from Moscow's super-prestigious Institute for International Economics and International Relations (MGIMO), speaks fluent Russian and was his country's Ambassador to Russia from 2001-2005. Russian companies, especially the secret services-dominated Russian Technologies, headed by Vladimir Putin's friend Sergey Chemezov, want Mongolia's copper and gold.

The Soviets dominated Mongolia for the better part of the 20th century. Today, Russia co-owns Mongolian railroads and have stakes in the country's lucrative mining such as Erdene copper. With world prices for minerals skyrocketing, the Russians want more.

The government of Mongolia seems to be undertaking delaying tactics to figure out how to benefit from the mineral resources development. Prime Minister Bayar has called upon the World Bank and the European Bank of Reconstruction and Development to "advise" his country with regards to contract negotiations. Instead, Bayar's duty to his people should be to make the project efficient; ensure that the revenue it brings flows into the Treasury in a transparent fashion; and that its expenditures are controlled by the parliament and the government.

Mongolians should benefit from highly paid jobs and the infrastructure that would be developed in parallel with Oyu Tolgoi. The world would benefit from additional supply of scarce metals and from lower prices. It is a win-win proposition. Yet if the Mongolian government kills the goose that lays the golden egg - or turns the magic goose into the Russian bear - the circle of people benefiting from the super-mine will narrow to a select group of politicians, "mongoligarchs" and Russian partners, all feathering their nests.

The US government is aware that corruption in Mongolia is on the rise. The anti-graft group Transparency International in its 2006 report ranked Mongolia 99th out of 163 countries, which indicates "cabinet-level corruption." Nevertheless, the US government it is providing Mongolia with $285m in Millennium Challenge Corporation grants, including a $23m Property Rights Project, while the Parliament in Ulanbaatar is attempting to pass a law limiting foreign stakes in mineral projects to 49%. Yet Mongolians keep talking a good game. Foreign Minister Sanjaasuren Oyun has recently declared: "For us, balancing trade and economic relations with two main neighbours is important, but also we ought to attract investment from what we call 'third neighbour' countries. We don't have one country in mind, but we would like to have as good relations as possible with these countries, as if they were our neighbours."

Natural resource nationalism, corruption and bureaucratic opacity breed poverty and discontent. As one Mongolian politician noted, his country, sandwiched between Russia and China, knows that faraway friends (and their ways of doing business) are sometimes better than those of close neighbours. With China increasingly unstable and Russia increasingly corrupt, it's time for Mongolia to face the West.

Ariel Cohen, Ph.D., is Senior Research Fellow at the Heritage Foundation

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