Scenesetter for TIFA Talks

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SIPDIS

STATE PASS USTR, OPIC, AND EXIMBANK
STATE FOR EAP/CM, EB/TTP, AND EB/IFD/OIA
USAID FOR ANE DEIDRA WINSTON

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TAGS: ETRD PREL EINV PGOV MG
SUBJECT: Scenesetter for TIFA Talks

Sensitive But Unclassified -- Not for Internet.

A Quest for a Political FTA, Skipping the Hard Work
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1. (SBU) The Trade and Investment Framework Agreement (TIFA) talks
have become an important part of our overall bilateral relationship
since 2004. During the third annual round of talks on March 12, the
U.S. delegation will need to fend off Mongolia's efforts to get the
U.S. to agree by the end of 2007 on a "roadmap" toward a bilateral
Free Trade Agreement (FTA). Mongolia's argument for an FTA is
entirely political: agreement on an FTA as a goal would be a public
symbol of our good bilateral political relations, and serve as
Mongolia's reward for its political and economic transformation
since 1990 (AKA, "you did it for Jordan"). The potential economic
gains to Mongolia of an FTA are dubious, given that Mongolia's
exports to the U.S. are currently more than 90% textiles, and that
its overall exports are dominated by minerals. Economically,
Mongolia would do far better to tackle the serious barriers to
increased trade and investment, particularly in the minerals sector,
which the U.S. side will list during the talks.

A Flourishing Bilateral Relationship
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2. (SBU) On January 27, Mongolia and the U.S. celebrated the 20th
anniversary of the establishment of diplomatic relations. Mongolia
has only two real neighbors, China and Russia. While careful to
maintain good relations with both of these giants, Mongolia has
successfully sought to neutralize its geographical handicap by
building strong "third neighbor" relationships with other nations.
The United States is the linchpin of this third neighbor policy. A
July 2004 joint presidential statement coined the phrase of
"comprehensive partnership" for the U.S.-Mongolia bilateral
relationship. U.S.-Mongolia engagement ranges from the Community of
Democracies (Mongolia is a Convening Group member) to Mongolia's
emerging role with U.S. assistance as an international peacekeeping
contributor, and one with boots on the ground supporting Coalition
efforts in Iraq and Afghanistan.


3. (SBU) In a March 5 phone call, President Bush invited President
Enkhbayar to visit the United States this year, reciprocating the
highly successful visit to Ulaanbaatar by the President, First Lady,
and Secretary Rice in November 2005. The dates for Enkhbayar's
visit are still to be determined, but the Mongolian government
recently decided Enkhbayar will represent Mongolia at the signing of
a Millennium Challenge Account (MCA) Compact.


4. (SBU) Eligible for MCA assistance since May 2004, Mongolia has
been frustrated by the delay in reaching a Compact. However,
matters currently look on track for a late 2007 signing. The
Compact likely will include projects to enhance railroad capacity,
boost vocational education, improve property rights registration,
and bolster preventive medicine efforts. The $200 million or so of
projects over five years should give Mongolia a substantial economic
boost -- and, as the MCA project intends, reward Mongolia for making
many correct political and economic choices in the last 17 years.
Amid U.S. budgetary stringencies, other U.S. assistance (through
USAID and with monetized USDA wheat) has dipped in the last couple
of years, but still provides important boosts to: economic policy
reform and competitiveness; entrepreneurial efforts in rural and
urban areas; judicial reform; anti-corruption efforts; and a more
effective parliament.

A Weak Government, but Populism Is Popular
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5. (SBU) Mongolia's current coalition government is not
particularly strong or decisive, but quite likely will stagger along
until parliamentary elections in June 2008. A month rarely passes
without rumors of the government's imminent collapse, and Prime
Minister Enkhbold is currently busy fighting off government
reorganization efforts pushed by rivals in the MPRP. The government
is dominated by the MPRP, which holds a one-seat majority in
parliament after picking up a seat in a by-election last September.
The "Government of National Unity" currently includes two other
small parties, who have a total of seven MPs as compared to the
MPRP's 39. Business leaders, foreign and domestic, are still
celebrating the January jettisoning from the government of mercurial
and undisciplined Industry and Trade Minister Jargalsaikhan and
Health Minister Gundalai; both men are the sole MPs of minor
parties, and parlayed support for the MPRP bringing down the

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previous MPRP-Democratic Party coalition government into Cabinet
posts in the replacement.


6. (SBU) The evenly-balanced parliament and coalition governments
in the last three years have coincided with high world prices for
the mineral commodities Mongolia produces. The results have been
skyrocketing values for mineral exports (leading to Mongolia's first
trade surplus last year),and booming government revenues (producing
government surpluses two years in a row). Another result has been
flourishing populism. While most of Mongolia's mineral resources
remain undeveloped -- development which will need large amounts of
foreign capital -- Mongolia is experiencing what some observers have
termed "pre-seller's remorse." The political argument goes, "Why
should foreigners profit from the mineral wealth of the Mongolian
people while 35% of Mongolians remain poor?"


7. (SBU) The results in 2005 were an abruptly-enacted confiscatory
Windfall Profits Tax on copper and gold, and extensive amendments to
the Minerals Law which created a much worse regulatory environment
and -- in a massive step back from progressive privatization since
1990 -- gave the state the right to take equity stakes in mines on
"strategic deposits." Politicians immediately competed to
distribute revenues raised from the Windfall Profits Tax to voters
through cash stipends for children and payments to newlyweds, and to
vote for major increases in non-competitively tendered
infrastructure projects. In the first negotiation under the new
minerals law, meanwhile, the government is demanding a 34% stake
without any payment or need to contribute to the $1 billion in
additional investments to produce a working mine. Negotiations are
stalled. To the government and parliament's credit, however, major
tax reforms passed last year move Mongolia considerably toward world
norms, and address longstanding tax system complaints of foreign and
domestic businesses.

Rolling Up Our Sleeves
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8. (SBU) The combination of the above will make for a busy and
complex day on March 12. On the one hand, the TIFA talks will
celebrate the close overall bilateral relations and the
considerable, growing cooperation on trade and economic issues. On
the other hand, the U.S. side will need to explain, to the Mongolian
side's disappointment, that there won't be any shortcuts in the TIFA
process, much less a roadmap toward some "FTA Lite" which would skip
the hard details as a nod to those close relations. Rather,
Mongolia and the U.S. will need to roll up our sleeves and
concentrate on addressing the trade and investment climate problems
that handicap not just Mongolia's economic relations with the U.S.,
but also domestically and with the rest of the world. Building the
road to Mongolia's economic prosperity, much less the road toward
any future decisions on an FTA, necessarily will require
considerable hard work to remove such barriers.

Minton