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UNCLAS SECTION 01 OF 02 ULAANBAATAR 000335 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: PREL PREF MARR EAID KMCA MG IZ KN
SUBJECT: Trade and Economic Issues Briefing for Assistant Secretary 
Hill's June 14-18 Visit to Mongolia 
 
Ref:  Ulaanbaatar 0228 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION 
 
(SBU) The following material is provided in preparation for 
Assistant Secretary Hill's planned visit to Mongolia. 
 
¶1. (SBU) SUMMARY: Mongolia's economy grew 8% in 2006 (yielding GDP 
of US$2.7 billion) and is projected to reach 7.5% in 2007.  Mining 
(copper, coal and gold), cashmere, tourism, and small retail trade 
were the primary economic drivers, coupled with high world commodity 
prices.  Mining prospects improved recently as a major copper/gold 
project investment agreement has nearly been concluded, despite last 
year's ill-considered minerals windfall profits tax.  Major U.S. 
firms have expressed interest in investing in the mining sector, 
which also holds good promise for U.S. equipment sales.  The GOM 
continues to push for a Free Trade Agreement (FTA) with the U.S., 
believing this is a politically driven decision.  Corruption remains 
a serious concern, although some progress has been made (an 
anti-corruption law was passed and is slowly being implemented). 
END SUMMARY. 
 
Economy is Booming Despite the Difficulties 
------------------------------------------- 
 
¶2. (U) Mongolia's primary economic drivers are mining (copper, coal, 
gold), cashmere, tourism and small retail trade and services. High 
world commodity prices and increased production helped spur 6% 
economic growth in 2005 and 8% in 2006, and non-mining sectors such 
as services and agriculture also did well.  GDP growth in 2007 is 
projected to be 7.5%.  Per the Government of Mongolia's (GOM) 
statistics, 2006 GDP amounted to US$2.7 billion, though the 
uncounted "gray" market economy may add 40-50% to this figure. 
(Reftel provides an update and summary on Mongolia's economy.) 
 
¶3. (U) Economically, Mongolia faces daunting challenges: It is 
landlocked, with a severe continental climate, and sparsely 
populated.  The size of Alaska with a population of 2.8 million 
(about the size of Denver City), nearly 40% of the population (one 
million) lives in the capital city, Ulaanbaatar (meaning "Red Hero" 
courtesy of the Russians).  Over the last decade, about 20% or so of 
Mongolia's population abandoned countryside herding and migrated to 
the capital where they live in "ger" (yurt in Russian) suburbs 
surrounding Ulaanbaatar.  A bit less than 40% of the country's 
population still makes a living from nomadic livestock (sheep, 
goats, cattle/yak, camels, and horses, of which there are 33 
million). 
 
Mining: Key for Mongolia and for U.S. Business 
--------------------------------------------- - 
 
¶4. (SBU) Mining is of paramount importance to Mongolia's current and 
future business and investment climate, and offers the U.S. the best 
opportunities for investment and for exports of U.S.-origin goods 
and services.  Two major U.S. mining firms, Peabody Energy and 
Phelps Dodge, have opened or are opening offices in Mongolia to 
pursue coal and copper investment opportunities, respectively.  In 
addition, there are other opportunities for exports of goods and 
services to the mining sector.  Caterpillar, for instance, has a 
flourishing distributor supplying the sector.  Peabody, the world's 
largest coal only mining company, is very interested in coming in as 
part of a consortium to develop the large Tavan Tolgoi coal deposit 
near the Chinese border.  The Mongolians who own the exploration 
rights to the deposit need to settle on the consortium details, then 
begin discussions with the government.  Ivanhoe (Canadian) and /Rio 
Tinto (UK-Australian) have paired up and are poised to conclude an 
investment agreement with the GOM to develop the world class Oyu 
Tolgoi copper and gold deposit also near the border with China. 
 
¶5. (U) However, mining development is a subject of domestic 
political controversy.  Mining does not directly create many jobs 
and many of the locally developed, non-foreign invested mines are 
operated in an environmentally destructive manner.  The largest of 
these mines -- the joint Mongolian-Russian (51%/49%) Erdenet Copper 
Mine and the Canadian-owned Boroo Gold Mine -- have been the target 
of a nationalistic backlash centering on the theme, "Why are so many 
Mongolians poor while foreign companies are profiting from our 
mineral resources?" 
 
¶6. (SBU) In May 2006 the GOM, without consulting stakeholders and 
much to their surprise, hastily enacted a windfall or "excess 
 
ULAANBAATA 00000335  002 OF 002 
 
 
profits" tax on copper and gold to find money to fund expensive 
populist campaign promises for monthly child stipends and a 30% pay 
hike for civil servants.  In July, Parliament passed amendments to 
the Minerals Law which allowed the GOM to take up to 50% equity of 
any mine deemed "strategic" if discovered through state financing, 
34% of any mine discovered through private funds.  While foreign 
mining companies didn't close up shop, exploration virtually stopped 
as confidence plummeted.  The seventh annual Fraser Institute Survey 
of Mining Companies recently listed Mongolia as 62nd out of 65 
countries in attractiveness for mineral exploration, down from 33rd 
the previous year, attributed to regulatory problems and a lack of 
openness. 
 
¶7.  (SBU) Things have moved in a somewhat more positive direction in 
recent months, beginning with the appointment of a well-regarded 
technocrat to head the new government mine equity holding company. 
The GOM and Ivanhoe/Rio Tinto have reached an ad ref agreement on 
the long-stalled Oyu Tolgoi copper and gold mine.  As part of the 
deal, the government would get 34% of the mine equity, but pay for 
it out of its share of the mine profits.  The Tavan Tolgoi coal mine 
looks to be next up for a deal, but sorting out the local ownership, 
the government share, and the share of foreign companies -- many of 
which are beating on the government's door to do a deal -- may take 
a while. 
 
They Want an FTA, We Want Transparency, Let's Deal 
--------------------------------------------- ----- 
 
¶8. (SBU) Mongolia wants a Free Trade Agreement(FTA)  with the U.S., 
arguing that this would be a political and economic endorsement of 
our very friendly bilateral relationship.  GOM officials constantly 
recall the U.S. FTA with Jordan.  At the third Trade and Investment 
Framework Agreement (TIFA) talks in March, Mongolian trade 
representatives continued to lobby for a roadmap by the end of 2007 
towards an FTA with the U.S.  However, trade volumes are low and 
there is no major U.S. business support for an FTA.  Moreover, 
Mongolia's legislative and regulatory systems affecting commercial 
activities need significant and real reform before any comprehensive 
trade agreement is even contemplated. 
 
¶9.  (SBU) At the March TIFA talks, Assistant USTR Tim Stratford 
instead recommended focusing on near-term steps to improve trade and 
promised to report back to the GOM with a suggestion for a concrete 
step.  We expect that step to be unveiled to the GOM next week, 
before A/S Hill visits.  Although still in development, this 
concrete step may deal with the crafting of a transparency agreement 
similar to transparency chapters in existing FTA agreements.  As a 
mark of our sincerity and a test of the GOM's commitment to reform, 
this would address one of our major concerns about Mongolia's 
business climate, while also being a step which could correctly be 
described as a major cornerstone for any future decision to try for 
a bilateral FTA. 
 
Corruption Is a Problem 
----------------------- 
 
¶10. (SBU) Corruption continues to plague Mongolia's business and 
investment climate.  Transparency International ranked Mongolia 99th 
out of 163 nations on its 2006 Corruption Perceptions Index (CPI), 
dropping the country 14 points from the previous year. 
 
¶11. (SBU) This is a time of transition for Mongolia.  We applaud the 
passage of the Anticorruption Act last July.  While there is 
considerable room for improvement, the Act gives Mongolia important 
new tools to fight corruption.  The Anti-Corruption Agency (ACA) is 
beginning operations, and is just starting to get the first asset 
and income disclosure forms from officials.  The GOM needs to fully 
fund and staff the ACA and give it political support to conduct 
operations.  USAID has a small anti-corruption program, through The 
Asia Foundation, which works with the ACA, primarily on public 
education and involvement in anti-corruption efforts. 
 
Minton