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Cablegate: Trade and Economic Issues Briefing for Assistant Secretary

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ZNR UUUUU ZZH
R 122331Z JUN 07
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 1181
INFO RUEHBJ/AMEMBASSY BEIJING 5594
RUEHKO/AMEMBASSY TOKYO 2507
RUEHMO/AMEMBASSY MOSCOW 1786
RUEHUL/AMEMBASSY SEOUL 2778
RUEKJCS/SECDEF WASHDC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC 0598
RHEHNSC/NSC WASHDC
RUCPODC/USDOC WASHDC 1291
RUEHRC/USDA FAS WASHDC
RUEHGV/USMISSION GENEVA 0302

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

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