2009 MONGOLIA INVESTMENT CLIMATE STATEMENT

UNCLAS SECTION 01 OF 24 ULAANBAATAR 000119



SIPDIS



STATE FOR EAP/CM AND EEB/IFD/OIA

STATE PASS USTR



E.O. 12958: N/A

TAGS: EINV, ECON, OPIC, KTTB, USTR, MG

SUBJECT: 2009 Mongolia Investment Climate Statement



REF: 08 STATE 123907



ULAANBAATA 00000119 001.4 OF 024





1. As requested ref, post provides the 2009 Mongolia Investment

Climate Statement.



A.1 OPENNESS OF GOVERNMENT TO FOREIGN INVESTMENT



In its specific policies, laws, and general attitude, the Government

of Mongolia (GOM),supports foreign direct investment (FDI) in all

sectors and businesses. Its industrial and economic strategies do

not discriminate actively or passively for or against foreign

investors. Mongolia screens neither investments nor investors,

except in terms of the legality of the proposed activity under

Mongolian law.



Mongolian law does not discriminate against foreign investors.

Foreigners may invest with as little as US$100,000 cash or the

equivalent value of capital material (office stock, structures,

autos, etc.). In both law and practice, foreigners may own 100% of

any registered business with absolutely no legal, regulatory, or

administrative requirement to take on any Mongolian entity as a

joint venture partner, shareholder, or agent. The only exceptions

to this flexible investment regime are in land ownership, petroleum

extraction, and strategic mineral deposits.



Limitations on Participation in Real Estate, Petroleum Extraction,

and Strategic Minerals Deposits



Only individual Mongolian citizens can own real estate. Ownership

is currently limited to urban areas in the capital city of

Ulaanbaatar, the provincial capitals, and the county seats, or

soums. No corporate entity of any type, foreign or domestic, may

own real estate. However, foreigners and Mongolian and foreign

firms may own structures outright and can lease property for terms

ranging from three (3) to ninety (90) years.



Mongolian law also requires oil extraction firms to enter into

production sharing contracts with the government as a precondition

for both petroleum exploration and extraction.



In 2006, the Mongolian Parliament (State Great Hural, or SGH)

amended the 1997 Minerals Law of Mongolia. In doing so, it enacted

the concept of the strategically important deposit. The amendments

gave the Government of Mongolia (GOM) the right to obtain up to a

50% share of any mine on such a deposit. The 1997 law had no concept

of "strategic deposits" or state equity in mines.



The 2006 amended law defines "mineral deposit of strategic

importance" as "a mineral concentration where it is possible to

maintain production that has a potential impact on national

security, economic and social development of the country at national

and regional levels or deposits which are producing or have

potential of producing above 5% of total GDP per year." Ultimately,

the power to determine what is or is not a strategic deposit is

vested in the State Great Hural (SGH). For practical purposes, the

GOM currently seems to define these deposits as world class copper

and coal reserves and all deposits of rare earths and uranium.



If a mineral deposit is determined to be strategic and if the state

has contributed to the exploration of the deposit at some point, the

GOM may claim up to 50%. This applies to all exploration conducted

during the socialist era, primarily by Soviet geologists. If the

deposits were developed with private funds and the GOM has not

contributed to the exploration of the deposit at any time, it may

acquire up to 34% of the deposit.



State participation (or share) is determined by an agreement on

exploitation of the deposit considering the amount of investment

made the state; or, in the case of a privately-explored strategic

deposit, by agreement between the state and the firm on the amount

invested by the state. The SGH may determine the state share using

a proposal made by the government or on its own initiative using

official figures on minerals reserves in the integrated state

registry.



It is important to note that the state equity provision does not

seem expropriatory on its face as the GOM has committed itself to

compensating firms for the share it takes at fair market value.

Although experience is limited with the new law, so far the GOM has

honored this commitment.



ULAANBAATA 00000119 002.2 OF 024







Windfall Profits Tax on Copper and Gold



The Windfall Profits Tax Law of 2006 (WPT) has drawn criticism

regarding the GOM's commitment to creating an open, predictable, and

fair environment for foreign direct investment. The speedy

legislative process for passing the WPT was unprecedented. This

bill was passed in six days without any consultation with outside

stakeholders on any its provisions. The entire process has raised

concerns among investors about the stability and transparency of

Mongolia's legislative and regulatory environment.



In May, 2006, the SGH the WPT in an effort to: 1) assuage

wide-spread public fears that Mongolia was being stripped of its

mineral assets and 2) to increase revenues for new social spending

on pensions and children.



The WPT imposes a 68% tax on the profits from gold and copper mining

respectively. The WPT for gold originally kicked in when gold the

price for gold hit US$500 per ounce; however, in late 2008

Parliament raised the threshold to US$850. For copper, the

threshold is US$2,600 per ton. Mining industry sources claim that

the 68% tax rate, when combined with other Mongolian taxes, makes

the effective tax 100% on all proceeds above the copper threshold

price. In theory, the WPT proceeds are set aside in a special fund

for a combination of social welfare expenditures and a reserve fund.





Revisions of the Mongolian Tax Code



Problems with the WPT aside, major reforms to the Mongolian Tax code

in 2006 were designed to improve the business environment in

Mongolia for both foreign and domestic investors. Before the

reforms, a World Economic Forum survey of Mongolian business

executives cited tax rates and the complexity of tax regulations as

two of the top five problems for doing business in Mongolia. The

tax reforms benefited from two years of technical assistance from

USAID's Economic Policy Reform and Competitiveness Project (EPRC).

The reforms affected the Personal Income Tax (PIT) and Corporate

Income Tax (CIT) codes, as well as the VAT and excise tax codes.

(EPRC has a number of useful and informative guides on their

website: http://www.eprc-chemonics.biz.)



The old corporate income tax system's lack of a loss carry-forward

provisions as well as arbitrary caps on deductions for business

expenses discouraged investment; businesses could easily end up

owing tax, even if they lost money. The old law was so at variance

with world norms that it was a prime reason why foreign investors

sought tax holidays under stability agreements.



The new laws became effective January 1, 2007. In general, the new

laws reduce tax rates, flatten the tax schedule, remove

discriminatory loopholes and exemptions, and introduce appropriate

deduction opportunities for corporate investment.



The new corporate income tax law allows firms loss carry-forward for

two years after incurring the loss, potentially encouraging

investment and accommodating firms experiencing temporary negative

shocks. While most businesses approve of this provision, many note

that the two year carry-forward limit is insufficient for projects

with long development lead times, as is typical of most large-scale

mining developments. The new law allows firms to deduct more types

of legitimate business expenditures: training, business travel,

cafeteria expenses, etc. The new law levels the playing field

between foreign and domestic investors, eliminating the majority of

discriminatory tax exemptions and holidays (most of which favored

international investors).



Unfinished Business (Including Customs Rates)



There is unfinished business, however. Parliament was scheduled to

take up additional tax reform measures in 2007 but has not done so

and has made no substantive progress since. These measures include

revisions to the law on customs and customs tariffs. While the

exact nature of the proposed changes in the customs law has been

murky, the GOM states that changes will be consistent with

Mongolia's WTO obligations and investment climate enhancement

goals.



Despite overall solid, positive changes, international financial



ULAANBAATA 00000119 003.2 OF 024





institutions warn that last year's tax reforms by themselves are

insufficient to improve Mongolia's business environment. They

report that reform efforts need to go beyond changes to the tax code

to restructure the operations of the key agencies - the tax

department, the customs administration and the inspections agency -

that directly interact with private firms and individuals.



2006 Amendments to the Law on State Procurements



Amended in late 2006, the revised Law on State Procurement (LSP) has

two provisions that raise investor concerns. First, the new LSP

bars international competitors from participating in government

procurements under US$10 million, which covers 999 of the 1,000

projects budgeted for fiscal year 2007. The old law set a much

lower bar for participating in state procurements of about US$1

million. In addition, the amended law specifically exempts power

and transport projects from competitive procedures, as they were

under the terms of the old law. In these two sectors, ministries

may procure the services for the GOM by direct contracting for

projects under US$10 million and where local capacity is lacking.

Issues in the Telecom and Aviation Sectors



While the Mongolian government supports FDI and domestic investment,

domestic and foreign investors report that individual agencies and

elements of the judiciary often use their respective powers to

hinder investments into such sectors as meat production,

telecommunications, aviation, or pharmaceuticals. Investors report

similar abuses of inspections, permits, and licenses by Mongolian

regulatory agencies.



Abuses in Mongolia's telecom and information technology sector have

raised public and business concerns. The state-owned telecom

company, Mongol Telecom (MT) uses its regulatory and technical clout

to forestall or attack competition. As the monopoly supplier of

land-based lines through which much internet traffic flows, MT

charges predatory rates for access to all other Internet Service

Providers (ISPs) at a rate 10 times the charges assessed to the

state-owned ISP. These per-minute charges add up and are hard for

competitor ISPs to absorb. In addition, the GOM, in an effort to

make Mongol Telecom more attractive for privatization, is inclined

to make MT the sole portal for all telecommunication into Mongolia.

The apparent intent here is to require licenses for both

telecommunication services and technology, which only MT could

satisfy. There has been significant lobbying against this policy by

ISPs, voice-over IP providers, cellular rights holders,

multi-lateral organizations, and diplomatic missions as contrary to

Mongolia's own competition law and long-term interests. So far

these efforts have delayed the passage of any damaging legislation.



Compounding these problems are the non-transparent activities of the

Mongolian Information and Communication Technology Agency (ICTA),

which is charged with providing policy guidance to the Communication

Regulatory Commission of Mongolia (CRC). Companies report that this

agency routinely embarks on maneuvers that seem to have no basis in

law or regulation but that have hurt American interests, not to

mention those of other investors. For example, ICTA has attempted

to order internet service providers to charge set access prices,

without recourse to the market. Most recently this government

intervention has taken the form of setting floor prices for hook up

charges on wireless, voice over IP, etc., but without setting

ceiling prices for charges. The four big cellular providers

dominating the market favor this approach because it protects their

respective market shares. However, competitors cannot offer similar

services at a price that might undercut the market leaders, harming

and limiting consumers' rights to low cost communication

alternatives.



ICTA has justified these acts by claiming that these low-cost

providers would have offered services at such low prices that the

dominant Mongolian cellular providers would have been driven out

business, thus depriving the state of the benefits of cellular

service.



The state also involves itself in the domestic aviation sector.

Mongolia has two domestic service providers, the privately owned

Aero Mongolia and EZNIS. Government regulation recommends maximum

ticket prices that airlines may charge for all domestic routes, but

the law does not strictly forbid airlines from charging fees higher

than the state carrier. However, the GOM frowns on domestic

airlines that charge more for service. These state prices are well



ULAANBAATA 00000119 004.2 OF 024





below operating costs and inhibit the private carriers from charging

a break-even fee. However, the private carriers seem to have

decided to shake off GOM prohibitions and are charging rates that

might yield profits and support safe and efficient flying

arrangements.



State-owned MIAT formerly ran domestic operations which were heavily

subsidized, primarily through its foreign routes. This

state-subsidized competition with private carriers has inhibited

investors from participating in the provision of private domestic

service; and consequently limited the aviation products and services

that U.S. firms might sell into the Mongolian market. . However,

MIAT and the GOM have failed to upgrade the domestic air fleet,

letting it slowly wither. This tacit policy seems to have opened

the field for private investment into the aviation sector.



The Mongolian Judiciary and the Sanctity of Contracts



We find no concerted, systematic, institutional abuse specifically

targeted at foreign investment. In the case of the

judiciary-corruption aside (see A. 11 Corruption)-most problems

arise from ignorance of commercial principles rather than antipathy

to foreign investment. In principle, both the law and the judiciary

recognize the concept of sanctity of contracts. However, the

practical application of this concept lags, with both foreign and

domestic investors reporting inconsistent enforcement of contracts

by the judiciary. This inconsistency comes from the slow transition

from Marxist-based jurisprudence to more market oriented laws and

judicial practices. Recent decisions in banking and land use cases

in which contract provisions were upheld reflect a growing

commercial sophistication among Mongolia's judges. As more judges

receive commercial training and as Soviet era (1921-1990) jurists

retire, we expect to see the gradual improvement of the entire

judicial system.



Privatization Policies and Resistance of Mongolian firms to Foreign

Investment



Privatization policies have actually favored foreign investment in

some key industries, including banking and cashmere production. The

bidding processes for privatizations and other tenders have

generally been transparent, and after some legal disputes among the

winners and losers lasting from late 2006 through mid-2008, most

participants have accepted the results.



Foreign companies and investors are subject to the same legal regime

imposed on Mongolian domestic firms regarding incorporation and

corporate activities For example, casinos are illegal under

Mongolian law, and so, neither Mongolians nor foreigners may own or

operate them (except in one specifically designated free trade

zone).



Generally, Mongolian private businesses want foreign participation

in all sectors of the economy. They seek foreign partners and

equity. That said, some Mongolian businesses use Mongolian

institutions to stop competitors, if they can. These activities

represent no animus against foreign investment as such; rather, they

reflect individual businesses desire to keep competitors, Mongolian

or foreign, at bay.



Key Investment Laws



The Foreign Investment Law of Mongolia (FILM) transformed the

anti-business environment of the Soviet era into today's

investor-friendly regime. Under the old system, everything not

provided for in law was illegal. Because such economic activities

as franchising, leasing, joint venture companies were not

specifically mentioned in earlier Mongolian statutes, they were

technically illegal. In 1993, the GOM enacted FILM to legalize all

manner of foreign investment in Mongolia (amended in 2002 to allow

for representative offices and franchises). This law and subsequent

amendments define broad ranges of activity that would otherwise have

limited validity under Mongolian law. It also defines the meaning

of foreign investment under the civil code without limiting

activities that foreign investors can conduct. FILM also establishes

registration procedures for foreign companies. Specifically, the law

requires that any investment with 25% or more of foreign content

must register as a foreign-invested firm with the government. The

law creates a supervisory agency, the Foreign Investment and Foreign

Trade Agency (FIFTA),that runs the registration process, liaises



ULAANBAATA 00000119 005.2 OF 024





among businesses and the Mongolian government, and promotes in- and

out-bound investments.



In 2008, the Parliament of Mongolia amended the FILM. The stated

intent of the revision was to improve FIFTA's ability to track

foreign investment and to enhance the services provided by FIFTA to

foreign investors. The amendments apply only to investments

registered after the new law came into force in summer 2008. The

new law has raised the minimum level for new foreign investment from

US$1,000 to US$100,000 and imposed a series of requirements on

foreign investors seeking registration. Registered foreign

companies must now have FIFTA certify that their by-laws,

environmental practices, their technologies, etc., comply with

standards determined by FIFTA.



FIFTA officials admit that procedures are still under development

and that because they lack specific expertise in most of these

areas, they will have to consult with the relevant ministries and

agencies as they assesses each firm's request for investment

registration. FIFTA has also not clearly defined what the precise

processes it will use to evaluate investments, what the exact

standards will be for any given investment, how it will determine

those standards, and how an investor might seek redress if FIFTA

denies a registration request. Foreign investors have expressed

concern over what they perceive as FIFTA's broad and seemingly

un-transparent regulatory authority; however, we have not received

any complaint of abuse of these new powers to date.



New Ministerial Structure Impacts Foreign Investment

In early 2009, the Parliament re-organized the government structure

by combining various ministries and agencies in an effort to

streamline government functions. Relevant to foreign investors,

Parliament took trade policy and trade promotion functions that had

been vested in the former Ministry of Industry and Trade and FIFTA

respectively and merged them with the Ministry of Foreign Affairs.

The new Ministry of Foreign Affairs and Trade (MOFAT) has assumed

direct control all formulation and execution of trade policies and

promotion efforts, which includes export promotion and in-bound

investment efforts. FIFTA is now under MOFAT's direct supervision.



Ministry officials have stated that the government will concentrate

on promoting Mongolian exports and foreign investment into Mongolia.

They want FIFTA to resemble counterpart agencies in South Korea,

Japan, or the U.S.; and have told both us and businesses that they

plan to get FIFTA out of the regulatory business. The intent is to

limit FIFTA's activities to supporting business in their efforts to

work in Mongolia and to registering in-bound investment for purposes

of investment tracking only.

A.2 CONVERSION AND TRANSFER POLICIES



The Mongolian government employs a limited regulatory regime for

controlling foreign exchange for investment remittances and

maintains exceptionally liberal policies for these transactions.

Foreign and domestic businesses report no problems converting or

transferring investment funds, profits and revenues, loan

repayments, lease payments into whatever currency they wish to

wherever they wish. There is no difficulty in obtaining foreign

exchange, whether the investor wants Chinese Renminbi, Euros,

English Pounds, Rubles, or U.S. Dollars. The ongoing global

financial crisis has made dollars scarcer, with banks and

individuals reporting difficulties in exchanging into the currency.

This currency shortfall, however, appears to have occurred because

of challenging economic circumstances rather than policy changes.



The Mongolian government wants funds to flow easily in and out of

the nation, with one exception. Foreign-held interest bearing

dollar accounts remain subject to a 20% withholding tax. The bank

retains 20% of all such interest payments sent abroad, and remits

this withholding to the Tax Authority of Mongolia. Otherwise,

businesses report no delays in remitting investment returns or

receiving in-bound funds. Most transfers occur within 1-2 business

days or at most a single business week.



Ease of transfer aside, foreign investors criticize Mongolia's lack

of sophisticated mechanisms for converting currencies and parking

money. Letters of credit are difficult to obtain, and legal

parallel markets do not exist in the form of government dollar

denominated bonds or other instruments for parking funds in lieu of

payment. Many Mongolian financial institutions lack experience with

these arrangements. Moreover, Mongolian banking law currently



ULAANBAATA 00000119 006.2 OF 024





provides no secure statutory grounds for the activity to take place.

Banks may hesitate to use instruments that may be technically

illegal under Mongolian law. The immediate impact has been to limit

access to certain types of foreign capital, as international

companies resist parking cash in Mongolian banks or in local debt

instruments.

A.3 EXPROPRIATION AND COMPENSATION



Mongolia respects property rights as they apply to most asset types.

We detect no changes in policies, statutes, or regulations related

to the use and ownership of private property. Foreigners face no

legal bias in asset ownership (except that only citizens of

Mongolian may own land) or how they structure ownership. Foreign

investors need not seek local partners or share ownership of most

assets or endeavor as a condition of doing business. However, in

the crucial mining sector, with extensive foreign participation,

some note governmental actions that might represent "creeping

expropriation" coupled more broadly with some renewed "statist

tendencies," meaning gradual increases in government ownership of

and participation in Mongolia's economy.



Security of Ownership



Mongolia and the United States signed and ratified a Bilateral

Investment Treaty (BIT) which entered in force in 1997, and which

specifically enjoins both signatories from expropriatory acts

against private property and investments. In addition, both

Mongolian law and the national constitution recognize private

property and use rights and specifically bar the government from

expropriation of such assets. To date, the government of Mongolia

(GOM) has not expropriated any American property or assets. Thus,

we have no precedent from which to assess how the Mongolian system

would respond to seizure and compensation.



As can most governments, the Mongolian government can claim land or

restrict use rights in the national interest. Currently, this means

little, as most land outside Mongolia's urban centers remains

government property, as provided in Mongolia's constitution. The

government has no plans to privatize these vast countryside

holdings, but it leases parcels for such economic activities as

mining, pasturage, timbering, etc. This practice remains in flux

because the government must still determine how to let these rights

and what fees to charge. Except for mining, most foreign firms

remain inactive in these sectors.



Since May 2003, land in the urban areas has been privatized to

citizens of Mongolia or leased to both citizens and foreigners for

periods ranging from 3-90 years. The legislation and implementing

regulations are evolving, but so far investors believe that the GOM

generally respects recently enacted property rights and leases.



I: Implications of the Current Minerals Law



We closely watch the key mining sector, Mongolia's major foreign

exchange earner. The 2006 amendments to the Minerals Law have

several provisions that raise red flags for investors and observers

alike. The law does not allow the GOM to usurp rights to explore

and exploit natural mineral, metal, and hydrocarbons resources per

se. Instead, the amended law has imposed new procedural

requirements and extends new powers to central, provincial, and

local officials - new powers that, if abused, might prevent

mineral's license holders from exercising their exploration or

mining rights. The current law has the potential to deny the rights

holder access to his rights without formally revoking use rights. .



An example is the new tender process for apportioning some

exploration rights. The old law awarded exploration rights on a

"first come, first served" basis, a process that gave little

discretion to government officials to intervene. The new law lays

out a different procedure for obtaining exploration rights on land

explored with state funds or lands where the current holder has

forfeited exploration rights. The Mineral Resources Authority of

Mongolia (MRAM) will tender such exploration rights only to firms

technically qualified to conduct minerals work. The new tender

procedure neither requires nor allows for a cash-bid. Only the

technical merits of exploration proposals will determine who gains

exploration rights. MRAM staff has the authority and responsibility

to assess the merits of proposals to determine who wins the

tenders.





ULAANBAATA 00000119 007.2 OF 024





Both MRAM and its supervising authority, the Ministry of Mineral

Resources and Energy, now have broad discretionary authority to

select who will get tenements. This authority disturbs miners, who

fear this power will be the source of corruption and arbitrary

decisions by MRAM. Evidence suggests that local mining guilds will

define an expert in Mongolian mining as a person who received a

degree from a Mongolian institution, such as the National

University, rather than an internationally recognized institution.

While this enforced employment program for Mongolian geologists

would be an annoyance, the discretionary power MRAM now has

generated the most concern. If MRAM rejects a firm's experts and

mining plan as unqualified, no recourse is spelled out under the new

law, and the firm will in effect lose its rights.



The concept of "expertise" allows another potential avenue for

expropriation of rights by denying or preventing their use. The law

has the potential to limit the ability of rights holders to seek

financing, because it forbids transfer of mining licenses and

exploration rights to non-qualified individuals. Consequently, a

miner will not be able to offer his licenses as secured collateral

to banks or to any lender lacking the professional qualifications to

receive these rights if the miner defaulted on his debt obligations.

A given bank is unlikely to set up a "qualified" mining firm just

to receive a pledged license offered as collateral. Thus, the law

limits the investment pool that a mining firm might tap to finance

its mine, which might prevent bringing a property into production,

again denying licensees access to their legal economic rights.



The amended law removes the Mongol word for exclusive from the grant

of exploration rights. The old article read, "To conduct exclusive

exploration for minerals within the boundaries of an exploration

area in accordance with this law." The new article reads, "To

conduct exploration for minerals. . . ." It is unclear what, if

anything, this deletion means. However, the deletion would seem to

allow the government to apportion mineral rights per metal or

mineral rather than as a whole, which has been the standard

practice. The deletion was done intentionally, as the word appeared

in earlier drafts, right up to the passage of the law.



Investors and observers are also concerned about new authority

granted to the MRAM Chairman to approve transfers of existing and

new licenses. The law grants final approval authority to the MRAM,

without specifying any check or balance on this official's

authority. This power is not a revocation but if abused would

certainly prevent exercise of economic rights.



Complicating matters is that in early 2009 MRAM had been moved

under the direct authority of the Ministry of Mineral Resources and

Energy in a sweeping re-organization of the government. Prior to

this restructuring, MRAM had been a quasi-independent agency, the

acts of which did not require ministerial approval. In the new

structure, the ministry can intervene in the registration and

transfer of exploration and mining licenses. The ministry seems to

have only intervened in cases where the license involves a

"strategic" deposit. (See A.1 Openness to Foreign Investment for

explanation of strategic deposits.) In this specific category,

ministerial officials have ordered MRAM to freeze all transfers and

transactions involving properties near or in strategic deposits,

which includes uranium deposits of any size and massive coal and

copper deposits near the Chinese border. Further, these same

officials have indicated that the government may then revoke the

rights of those holding exploration rights or mining licenses in or

near strategic deposits. Although the law seems to allow for

compensation, the ministry has not presented formal compensation

packages to those potentially affected by its actions.



Acts of Provincial Administrations:



With regard to the issuance of both exploration permits and mining

licenses, provincial officials increasingly appear to use their

authority to block arbitrarily access to mining rights legally

granted under the current law. For example, reports regularly

circulate that some provincial government officials abuse their

authority to designate land as "special use zones" to usurp mining

exploration tenements. In a common technique, provincial governors

often reclassify property that has never felt the touch of the plow

or felt the tread of a tourist for agricultural use or cultural

tourism respectively, although the central government has legally

granted exploration rights to miners. In one case, a miner could

not gain access to the subsurface resources because the provincial



ULAANBAATA 00000119 008.2 OF 024





government claimed that doing so would damage a potato farm that had

suddenly appeared over the site.



Other miners harshly criticize the misuse of the local officials'

rights to comment on permits for water use and mining licenses.

Comments are advisory, and have limited legal force regarding

disallowing activity, but the central government routinely hesitates

to reject a governor's negative comment no matter the motives behind

it. The effect has been to stop progress for months, limiting

access to the resource and costing rights holders' time and money.



Whatever the motives, these provincial actions are often seen as a

creeping bureaucratic expropriation through denial of access and use

rights. The 2006 Minerals Law provides no clear limit on provincial

control of permits and special use rights or guidance on how to

apply these powers beyond codifying that the provincial and local

authorities have some authority over activities occurring in their

provinces and soums (counties). Faced with these unclear boundaries

of authority, the central government often interprets the rules and

regulations differently from the provincial authorities, creating

administrative conflicts among the various stakeholders. The

central government acknowledges the problematic ambiguity but has

yet to definitively clarify the situation in law or practice, even

though the situation threatens accessing one's rights. Mongolian and

foreign permit holders have advised the government that letting this

problem fester raises perceptions among investors that they may risk

losing their economic rights, which can scare away inbound

investors.

A.4 DISPUTE SETTLEMENT



The GOM consistently supports transparent, equitable dispute

settlements, but executing good intentions has proven problematic.

These problems come from a lack of experience with standard

commercial practices rather than from any systemic intent by public

or private entities to target foreign investors. The framework of

laws and procedures is functional, but many judges who adjudicate

disputes remain ignorant of commercial principles.



Problems with Dispute Settlement in Mongolia's Courts



The court structure is straightforward and supports dispute

settlement. Disputants know the procedures and the venues.

Plaintiffs bring cases at the district court level before a single

district judge or panel of judges, depending on the complexity and

importance of the case. The district court renders its verdict.

Either party can appeal this decision to the Ulaanbaatar City Court,

which rules on matters of fact as well as matters of law. It may

uphold the verdict, send it back for reconsideration or nullify the

judgment. Disputants may then take the case to the Mongolian

Supreme Court for a final review.



Problems arise for several reasons. First, commercial law in

Mongolia and understanding of it are in flux. New laws on

contracts, investment, corporate structures, leasing, etc. have been

passed or are being considered at both the ministerial and

parliamentary levels. Mongolian civil law does not work on

precedents but from application of the statute as written. If a law

is vague or does not cover a particular commercial activity, the

judge's remit to adjudicate can be severely limited or non-existent.

For example, until recently leasing did not exist in the Mongolian

civil law code as such, but seemed to be covered under various

aspects of Mongolian civil law regarding contracts and other

agreements. But judgments on leasing made under these laws might

not have applied to an arrangement not otherwise specifically

recognized under its own exclusive law. Further, because precedents

are not legally relevant or binding on other judges and Mongolian

courts, decisions reached in one case have no legal force in other

suits, even when the circumstances are similar or even before the

same court and judges.



Trained in the former Soviet era, many judges lack training in or

remain willfully ignorant of commercial principles. They dismiss

such concepts as the sanctity of the contract. This is not a

problem of the law, which recognizes contracts, but of faulty

interpretation. In several cases courts have intentionally

misinterpreted provisions regarding leases and loan contracts.

Judges regularly ignore terms of a contract in their decisions. If

someone defaults on a loan, the courts often order assets returned

without requiring the debtor to compensate the creditor for any loss

of value. Judges routinely assert that the creditor has recovered



ULAANBAATA 00000119 009.2 OF 024





the asset, such as it is, and that is enough. Bad faith and loss of

value simply do not enter into judicial calculations of equity.



Replacing old-school judges is not an option. It is politically

impossible-if not functionally impractical-for the Mongolians to

dismiss this cadre of Soviet-era judges. There is a realistic hope

that young justices, trained in modern commercial principles by

American and European experts, will gradually improve judicial

protections for commercial activities in Mongolia. Lately, we have

seen better decisions in several cases involving Americans seeking

to recover on debts and contractual fees and to hold Mongolian

government entities to the terms of their respective contracts and

regulations, but these results tend to be limited to courts where

modern-educated judges preside.



Bankruptcy and Debt Collection



Mongolia's bankruptcy provisions and procedures for securing the

rights of creditors need serious reform. Mongolian law allows for

mortgages and other loan instruments backed up with securitized

collateral. However, rudimentary systems for determining title and

liens and for collecting on debts make lending on local security

risky. Banks frequently complain that onerous foreclosure rules are

barely workable and unfair to the creditor.



Although a system exists to register immovable property-structures

and real estate-for the purpose of confirming ownership, the current

system does not record Qting liens against immovable property

has. In addition, no system exists to record ownership of, and liens

on, movable property. Consequently, Mongolian lenders face the

added risk of lending on collateral that the debtor may not actually

own or which may have already been offered as security for another

debt.



Overall, the legal system does recognize the concept of

collateralized assets provided as security for a loan, investment

capital, or other debt-based financial mechanism. The legal system

also provides for foreclosure, but this process has proved

exceptionally onerous and time consuming. A 2005 change to

Mongolian law simplified the process by allowing creditors to

foreclose without judicial review. Prior to the new law, all

creditors had to go to court to collect on securitized collateral,

thus adding months to the entire collection process. However, the

Constitutional Court of Mongolia voided the law on constitutional

grounds, slowing down debt collection to pre-2005 levels. Waits of

up to 24 months for final liquidations and settlement of security

are not uncommon.



Once a judgment is rendered, the disputant faces a relatively

hostile environment to execute the court's decision. For example, a

bank collecting on a debt in Mongolia must allow debtors to put

forward assets for auction and set the minimum bid price for those

assets. If assets do not sell, a second round of auctions occurs in

which a reduced minimum bid is put forward. The State Collection

Office (SCO) supervises this process but does not set the price.

However, the SCO receives 10% of the sales price, or of the second

auction minimum price even if there is no sale.



The SCO does not allow collateralized assets to be valued by neutral

3rd parties. Because it derives income from the forced sale of

assets, the SCO has a conflict of interest; and, anecdotally, seems

to have failed as an impartial arbiter between debtors and

creditors. For banks, this has meant that forcing a company into

bankruptcy may be the safest way to recover rather than forcing

piecemeal sales of assets. This approach automatically puts all

assets into play rather than those selected by the debtor. However,

it is an onerous procedure without a clear process behind it.



Purchase financing is also tricky. For example, a local car dealer

financed an auto for US$20,000 down and US$60,000 in credit,

complete with a local bank guarantee. The buyer subsequently

defaulted on the loan, the bank refused to honor its guarantee, and

the dealer took the buyer to court. Under current Mongolian law,

interest payments are suspended for the duration of the case, from

first filing to final appeal before the Supreme Court of Mongolia.

Possibly months of interest-free time can pass while the asset rusts

in an impound lot. In this case, the dealer simply reclaimed the

car and dropped the lawsuit, swallowing the lost interest payments

and loss in value on the car. Domestic and foreign businesses often

respond by requiring customers to pay in cash, limiting sales and



ULAANBAATA 00000119 010.2 OF 024





the expansion of the economy.



Binding Arbitration: International and Domestic



The Mongolian government supports and will submit to both binding

arbitration and international settlement procedures. However,

glitches remain in local execution. Mongolia ratified the

Washington Convention and joined the International Centre for

Settlement of Investment Disputes in 1991. It also signed and

ratified the New York Convention in 1994.



To our knowledge, the government of Mongolia has accepted

international arbitration in four disputes where claimants have

asserted the government reneged on a sovereign guarantee to

indemnify them. In all cases the government has consistently

declared that it would honor the arbitrators' judgments. However,

this resolution has not been put to the test, as Mongolia has won

each case.



More widely, Mongolian businesses partnered with foreign investors

accept international arbitration, as do government agencies that

contract business with foreign investors, rather than avail

themselves of the Arbitration Bureau operated by the Mongolian

National Chamber of Commerce and Industry. They seek redress abroad

because they perceive that domestic arbitrators are too politicized

and self-interested to render a fair decision.



Although arbitration is widely accepted among business people and

elements of the government, support for binding international

arbitration has not penetrated local Mongolian agencies responsible

for executing judgments. In two cases, the Mongolian-state-owned

copper mine lost two international arbitral cases. The awards were

certified and recognized as valid and enforceable by Mongolian

courts. But the local bailiff's office has consistently failed to

execute the collection orders. Local business people routinely cite

the failure of SCO and the bailiffs to enforce court-ordered

foreclosures and judgments as the most common problem threatening

resolution of debt-driven disputes.

A.5 PERFORMANCE REQUIREMENTS AND INCENTIVES



Mongolia imposes few performance requirements on, and offers few

incentives to, investors. The few requirements imposed are not

onerous and do not limit foreign participation in any sector of the

economy. Performance requirements are applied somewhat differently

to foreign investors in a limited number of sectors.



2006 Amendments to the Tax Law of Mongolia did away with most tax

incentives and exemptions. (Certain staples, such as flour, and

sectors targeted for growth, most recently, the agriculture sector,

have and continue to receive exemptions on import duties and on

Mongolia's value-added tax.) The GOM seems willing to let current

agreements run their course. Foreign investors have accepted phasing

out of tax incentive provisions since the amendments bring other

world-standard practices to the tax code. These include provision

for loss-carry-forwards, five-year accelerated depreciation, and

more deductions for legitimate business expenses including but not

limited to marketing and training expenses.



Few Restrictions on Foreign Investment



The government applies the same geographical restrictions on both

foreign and domestic investors. Existing restrictions involve border

security, environmental concerns, or local use rights. There are no

onerous or discriminatory visas, residence, or work permits

requirements imposed on American investors. Generally, foreign

investors need not use local goods and services, local equity, or

engage in substitution of imports. Neither foreign nor domestic

businesses need purchase from local sources or export a certain

percentage of output, or have access to foreign exchange in relation

to their exports.



Although there remains no formal law requiring the use of local

goods and services, the GOM encourages firms to do value-added

production in Mongolia, especially for firms engaged in natural

resource extraction. Certain senior officials and politicians have

made in-country processing a consistent feature of their public and

private policy statements regarding the development of mining. For

example, the 2006 windfall profits tax on copper and gold applies

the tax to copper concentrate, but exempts metallic copper produced

in Mongolia. Recent negotiations on strategic copper deposits in



ULAANBAATA 00000119 011.2 OF 024





the Gobi between the GOM and private Western firms ended with

commitments by the companies to explore copper smelting in Mongolia.

Government talks on coal production constantly feature discussions

of power generation and coals-to- liquid processing in Mongolia.

The recently-passed Government Action Plan also calls for increased

investment in businesses and activities that keep the "value" of a

resource in Mongolia. As a result, firms should continue to expect

the GOM to aggressively press them for value-added production in

Mongolia.



Generally, foreign investors set their own export and production

targets without concern for government imposed targets or

requirements. There is no requirement to transfer technology. As

a matter of law, the government imposes no offset requirements for

major procurements. Certain tenders may require bidders to agree to

levels of local employment or to fund certain facilities as a

condition of the tender, but as matter of course such conditions are

not the normal approach of the government in its tendering and

procurement policies.



Investors may finance as they see fit. Foreign investors need sell

no shares to Mongolian nationals. Equity stakes are generally at

the complete discretion of investors, Mongolian or foreign.

Investors, not the Mongolian government, make arrangements regarding

technology, intellectual property, etc.



Regarding employment, investors can locate and hire workers without

using hiring agencies-as long as hiring practices are consistent

with Mongolian Labor Law. However, Mongolian law requires companies

to employ Mongolian workers in certain labor categories whenever a

Mongolian can perform the task as well as a foreigner. This law

generally applies to unskilled labor categories and not areas where

a high degree of technical expertise not existing in Mongolia is

required. The law does provide an escape hatch for all employers.

Should an employer seek to hire a non-Mongolian laborer and cannot

obtain a waiver from the Ministry of Labor for that employee, the

employer can pay a fee of around US$140 per employee per month.

Depending on the importance of a project, the Ministry of Labor may

grant an employer a 50% exemption of the waiver fees as an

incentive.



Limited Performance Requirements



Performance requirements are sparingly imposed on investors in

Mongolia with the exception of petroleum and mining exploration

firms. The Petroleum Authority of Mongolia (PAM) issues petroleum

exploration blocks to firms, which then agree to conduct exploration

activities. The size and scope of these activities are agreed upon

between PAM and the firm in writing and are binding. If the firm

fails to fulfill exploration commitments, it must pay a penalty to

PAM based on the amount of hectares in the exploration block, or

return the block to MPPAM. These procedures apply to all investors

in the petroleum exploration sector.



The 2006 amendments to the Minerals Law of Mongolia made receiving

and keeping exploration licenses contingent on conducting actual

exploration work. Under the terms of the 1997 Minerals Law, mining

companies holding exploration tenements or extraction licenses

needed neither explore nor mine so long as they paid annual fees

associated with their holdings and provided annual reports of their

activities to the government of Mongolia.



The amended law imposes more stringent work requirements. Each year

and subject to annual verification by the Minerals Authority of

Mongolia (MRAM),exploration firms must submit a work plan and

report on the execution of the previous year's performance

commitments. Commitments expressed in terms of US dollar expenses

per hectare per year:



--2nd and 3rd years miners must spend no less than US $.50 per

hectare on exploration



--4th to 6th years miners must spend no less than US $1.00 per

hectare on exploration



--7th to 9th years miners must spend no less than US $1.50 per

hectare on exploration



MRAM has the authority and right to inspect the exploration sites to

verify that work is being done. Failure to comply with work



ULAANBAATA 00000119 012.2 OF 024





requirements may result in fines, suspension, or even revocation of

exploration rights.



In addition to these performance requirements, the law also requires

holders of mining licenses for projects of strategic importance to

sell no less than 10% of company shares on the Mongolian Stock

Exchange. Vaguely presented in the statute, there is still no formal

clarification in law or regulation of what this provision means in

practical terms or how it is to be implemented.



All foreign investors must register with the Foreign Investment and

Foreign trade Agency (FIFTA). The Foreign Investment Law of

Mongolia requires all foreign investors to show a minimum of

US$100,000 in assets (cash, working stock, property, etc.)

registered in Mongolia as a precondition for registration. In

addition to this particular requirement, all foreign investors must

pay an initial processing fee of some 12, 000 Mongolian tugriks or

about US$8.00. Foreign Investors must then pay a yearly

prolongation fee of 6,000 Mongolian tugrik or about US$4.00.



In addition to these fees, foreign investors must annually report on

their activities for the coming year to the government through

FIFTA. Businesses need not fulfill plans set out in this report,

but failure to report may result in non-issuance of licenses and

registrations and suspension of activities. This requirement differs

from that imposed on domestic investors and businesses. Local

investors do not have a yearly reporting requirement. Mongolians

pay lower registration fees, which vary too much to say with any

precision what the fees actually are.



FIFTA explains that the higher registration costs for foreign

investors arise from the need to compensate for the services it

provides to foreign investors, including assistance with

registrations, liaison services, trouble-shooting, etc. The

different reporting requirements provide the government with a

clearer picture of foreign investment in Mongolia. Foreign

investors are generally aware of FIFTA's arguments and largely

accept them, but they question the need for annual registrations.

Investors recommend that FIFTA simply charge an annual fee rather

than require businesses to submit a new application each year.



Regarding reports, foreign businesses are concerned about the

security of their proprietary information. Several foreign

investors have claimed that agents of FIFTA routinely use or sell

information on business plans and financial data. We have yet to

verify these claims, but FIFTA acknowledges that data security

largely depends on the honesty of its staff, as there are few

internal controls over access to the annual reports.



Tariffs



Mongolia has one of Asia's least restrictive tariff regimes. Its

export and import policies do not harm or inhibit foreign

investment. Low by world standards, tariffs of 5% on most products

are applied across the board to all firms, albeit with some concerns

about consistency of application and valuation. However, some

non-tariff barriers, such as phyto-sanitary regulations, exist that

limit both foreign and domestic competition in the fields of

pharmaceutical imports and food imports and exports. The testing

requirements for drugs are extremely unclear and onerous. When

companies attempt to clarify what the rules for importing food or

drugs into the country are, they receive contradictory information

from multiple agencies.



WTO TRIMS Requirements



Mongolia employs no measures inconsistent with WTO TRIMs

requirements, nor has anyone alleged that any such violation has

occurred.



A.6 RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT



Mongolia has one of Asia's most liberal ownership and establishment

regimes. Unless otherwise forbidden by law, foreign and domestic

businesses may establish and engage in any form of remunerative

activity. All businesses can start up, buy, sell, merge; in short,

do whatever they wish with their assets and firms.



Diminishing Competition from the State-Owned Sector





ULAANBAATA 00000119 013.2 OF 024





Mongolia passed and implemented a competition law applying to

foreign, domestic, and state-owned entities active in Mongolia. As

a practical matter, competition between state-owned and private

businesses has been declining for the simple reason that most

parastatals have been privatized. The exceptions are the

state-owned power and telecom industries, an airline, the national

rail system, several coal mines and a large copper mining and

concentration facility.



Currently, three firms -- one a Mongolian company and the others

Chinese state-owned entities -- are actively seeking opportunities

for power generation. Few want to enter the power generation field

until the regulatory and statutory framework for private power

generation firms up and tariffs are set at rates allowing profits.

In the railway sector, a recent law allows private firms to build,

operate, and transfer railroads to the state. Under this new law

several private mining companies have proposed rail links from their

respective coal mines to the Chinese border or to the currently

operating spur of the Trans-Siberian Railroad. Mongolia has no

plans to privatize railroads jointly held with the government of

Russia.



Although the trend has been for the GOM to extract itself from

ownership of firms and other commercial assets, the current Minerals

Law of Mongolia lets the state back into mining. Under this law,

the GOM gained the right to acquire equity stakes of up to 50% in

certain deposits that it deems of strategic value for the nation.

Once acquired, these assets are to be placed with a state-owned

management company, Erdenes MGL, that will invest them for the

benefit of the Mongolian people. The role of state as an equity

owner, in terms of management and operation of the mining asset, is

unclear at this point. There is some concern that the GOM will

have to deal with conflicts of interest arising from its dual

position as regulator and owner of these strategic assets.

Specifically, firms are worried that the GOM's desire to maximize

returns in order to provide a revenue stream to the Mongolian people

may comprise the long term commercial viability of any mining

project.



A.7 PROTECTION OF PROPERTY RIGHTS



The right to own private, movable and immovable property is

recognized under Mongolian law. Regardless of citizenship (except

for land which only citizens of Mongolia can own),owners can do as

they wish with their property. One can collateralize real and

movable property. Should a debtor default on such secured loans,

the creditor does have recourse under Mongolian law to recover the

debt by seizing and disposing of property offered as security. The

only exceptions to this liberal environment are recent changes to

the mining law that prevent transfer of exploration and mining

licenses to third parties lacking professional mining

qualifications.



Mongolia's Current Regime to Protect Creditors



The current protection regime for creditors is functional but needs

reform. The legal system presents the greatest pitfalls. Although

the courts recognize property rights in concept, they have a

checkered record of protecting and facilitating acquisition and

disposition of assets in practice. Part of the problem is ignorance

of, and inexperience with, standard practices regarding land,

leases, buildings, and mortgages. As noted in A.4 Dispute

Settlement, some Soviet-trained judges, largely out of ignorance of

the concepts, have failed to recognize these practices. Newly

trained judges are making a good faith effort to uphold property

rights, and need time to learn how to adjudicate such cases.



Mongolia's bankruptcy provisions and procedures for securing the

rights of creditors need serious reform. Mongolian law allows for

mortgages and other loan instruments backed up with securitized

collateral. However, rudimentary systems for determining title and

liens and for collecting on debts make lending on local security

risky. Banks frequently complain that onerous foreclosure rules are

barely workable and unfair to the creditor.



Although a system exists to register immovable property-structures

and real estate-for the purpose of confirming ownership, the current

system does not record if immovable property has any liens against

it. In addition, no system exists to record ownership and liens of

movable property. Consequently, Mongolian lenders face the added



ULAANBAATA 00000119 014.2 OF 024





risk of lending on collateral that the debtor may not actually own

or which may have already been offered as security for another debt.





Overall the legal system does recognize the concept of collaterized

assets provided as security for a loan, investment capital, or other

debt-based financial mechanisms. The legal system also provides for

foreclosure, but this process has proven exceptionally burdensome

and time consuming. A September 2005 change to Mongolian law

simplified the process by allowing creditors to foreclose without

judicial review. Prior to the new law, all creditors had to go to

court to collect on securitized collateral, thus adding months and

expense to the entire collection process. However, the

Constitutional Court of Mongolia voided the law on constitutional

grounds, slowing down debt collection to pre 2005 levels where waits

of up to 24 months for final liquidations and settlement of security

were not uncommon.



Debt Collection Procedures



However, even with the delays, getting a ruling is relatively easy

compared to executing the court's decision. The problem is not the

law but the enforcement. A judge orders the State Collection Office

(SCO) to move on the assets of the debtor. The SCO orders district

bailiffs to seize and turn those assets over to the state, which

then distributes them to creditors. However, foreign and domestic

investors claim that the state collection office and the district

bailiffs frequently fail in their responsibilities to both the

courts and the creditors.



In some cases, bailiffs refuse to enforce the court orders (see the

Erdenet case mentioned in A.4). The perception is that they do so

because they have been bribed or otherwise suborned. Bailiffs are

often local agents who fear local retribution against them and their

interests if they collect in their localities. In some cases,

bailiffs will not collect unless the creditor provides bodyguards

during seizure of assets. Creditors also have reason to believe

that the state collection office accepts payments from debtors to

delay seizure of assets.



Protection of Intellectual Property Rights



Mongolia supports intellectual property rights in general and has

protected American rights in particular. It has joined the World

Intellectual Property Organization (WIPO) and signed and ratified

most treaties and conventions, including the WTO TRIPS agreement.

The WIPO Internet treaties have been signed but remained un-ratified

by the State Great Hural, Mongolia's Parliament. However, even if a

convention is un-ratified, the Mongolian government and its

intellectual property rights enforcer, the Intellectual Property

Office of Mongolia (IPOM),make a good faith effort to honor these

agreements.



Under TRIPS and Mongolian law, the Mongolian Customs Authority (MCA)

and the Economic Crimes Unit of the National Police (ECU) also have

an obligation to protect IPR. MCA can seize shipments at the

border. The ECU has the exclusive power to conduct criminal

investigations and bring criminal charges against IPR pirates. The

IPOM has the administrative authority to investigate and seize fakes

without court order. Of these three, only the IPOM makes a good

faith effort to fulfill its mandates.



Part of the problem is ignorance of the importance of intellectual

property to Mongolia and of the obligations imposed by TRIPS on

member states. Customs has been particularly hesitant to seize

shipments, saying that their statutory mandate does not allow

seizure of such goods, but Mongolian statutory and constitutional

law recognizes that international treaty obligations take precedence

over local statutes and regulations. A clear legal basis exists for

Customs to act, which has been recognized by elements of the

Mongolian Judiciary, the Parliament, and the IPOM. In any case,

Customs officers do occasionally seize fake products, but it seems

that Mongolian customs law will have to be brought into compliance

with TRIPS before Customs will actively fulfill its obligations.

The ECU has also been lax. The ECU hesitates to investigate and

prosecute IPR cases, deferring to the IPOM as the lead agency.

Anecdotal evidence suggests that ECU officials fear political

repercussions from going after IPR pirates, many of whom wield

political influence.





ULAANBAATA 00000119 015.2 OF 024





The IPOM generally has an excellent record of protecting American

trademarks, copyrights, and patents. However, its small budget

limits the scope of its actions. In most cases, when the U.S.

Embassy in Ulaanbaatar conveys a complaint from a rights holder to

the IPOM, the IPOM quickly investigates the complaint. If it judges

that an abuse occurred, it will (and has in every case brought

before it to date) seize the pirated products or remove faked

trademarks, under administrative powers granted in Mongolian law.



We note two areas where enforcement lags. Legitimate software

products are rare in Mongolia. Low per capita incomes have given

rise to a thriving local market for cheap, pirated software. The

IPOM estimates pirated software constitutes at least 95% of the

market. The Office enforces the law where it can but the scale of

the problem dwarfs its capacity to deal with it. The IPOM will act

if we bring cases to their attention.



Pirated optical media are also readily available and subject to

spotty enforcement. Mongolians produce no fake CD's, videos, and

DVD's, but import such products from China, Russia, and elsewhere.

Products are sold through numerous local outlets and sometimes

broadcast on private local TV stations. The IPOM hesitates to move

on TV stations, most of whom are connected to major government or

political figures. Nor does the IPOM raid local ("street") DVD and

CD outlets run by poor urban youth; IPOM argues that such action

would not halt sales and only alienate the public. Again, when an

American raises a specific complaint, the IPOM acts on the

complaint, but IPOM rarely initiates action on its own.



2006 Amended Mining Law Restricts Transfer of Licenses in Certain

Cases



The current Minerals law of Mongolia would seem on its face to

prevent transfer of exploration or mining rights to any third party

lacking professional mining qualifications as determined by the

Mineral Resources Authority of Mongolia (MRAM).



Under the Minerals Law, the concept of mining expertise can either

qualify or disqualify any entity from acquiring, transferring,

securitizing exploration and mining rights. The law has the

potential to limit the ability of rights holders to seek financing,

because it forbids transfer of mining licenses and exploration

rights to non-qualified individuals. Consequently, a miner might

not be able to offer his licenses as secured collateral to banks or

to any lender lacking the professional qualifications to receive

these rights if the miner defaulted on his debt obligations.



At a stroke the law seems to limit the investment pool that a mining

firm might tap to finance its mine, which might prevent bringing a

property into production, again denying licensees access to their

legal economic rights.



A.8 TRANSPARENCY OF THE LEGISLATIVE AND REGULATORY PROCESS



Generally, Mongolia's problem is not lack of laws and

regulations-Mongolia has passed more than 1,600 laws since

undertaking its transition to a market economy over 18 years ago-but

a lack of knowledge on the part of the lawmakers on what is needed

and a history of not consulting with affected and potentially

affected communities. Corruption aside, the fact that laws and

regulations change without much consultation creates a chaotic

situation for all parties. Many laws and regulations, as well as

behavior, still require amendment and adjustment; but, overall, the

trend is positive. We have seen definite improvement in the mining

sector and in the foreign investment statutes.



Problems with the Drafting Process for Legislation and Regulations



Normally, laws can be crafted in two ways. Once rare but now more

common, Members of Parliament and the President of Mongolia may

draft their own proposals for direct submission to the Parliament.

Such bills need not be submitted to the Cabinet of Ministers but can

be delivered directly to the Speaker of Parliament for consideration

by the relevant Standing Committee. The relevant Standing Committee

may either reject the bill (in which case it dies in committee) or

pass it on to the Parliament's plenary body, unaltered or revised

for a general vote. More common is when Parliament or the Cabinet

of Ministers requests legislative action. These institutions send

such requests to the relevant ministry. The Minister relays the

request to ministerial council, which in turn sends the request to



ULAANBAATA 00000119 016.2 OF 024





the proper internal division or agency within the respective

ministry, which in turn forms a working group. The working group

prepares the bill, submits it for ministerial review, makes any

recommended changes, and then the bill is reviewed by the full

Cabinet of Ministers. Relevant ministries are asked to comment and

recommend changes in the legislation.



Prior to a final vote by the Cabinet of Ministers, the National

Security Council of Mongolia (NSC)-consisting of the President of

Mongolia, the Prime Minister, and Speaker of Parliament-can review

each piece of legislation for issues related to national security.

Although the legal and constitutional authority of the NSC to veto

entirely, or to recommend changes to, draft legislation has not been

clarified to outside observers, the Cabinet to our knowledge will

not and has never overruled NSC recommendations.



Once through NSC and Cabinet reviews, the bill goes to Parliament.

In Parliament, the bill is vetted by the relevant Standing

Committee, sent back for changes or sent on to the full Parliament

for a vote. The President can veto bills, but his veto can be

overcome by a two-thirds (2/3) vote of Parliament.



For regulations, the process is truncated. The relevant minister

assigns the task of writing the regulations to the working group

that wrote the original law. This group submits their work to the

minister who approves or recommends changes.



The Ministry of Justice and Home Affairs (MOJHA) plays an important

role in drafting both laws and regulations. MOJHA vets all statutes

and regulations before they are passed for final approval. In the

case of legislation, MOJHA is supposed to reconcile the language and

provisions of the law with both existing legislation and the

constitution of Mongolia, after which the law is supposed to pass to

the Cabinet and then Parliament. In the case of regulations, MOJHA

vets the regulations to ensure consistency with current laws and

provisions of the constitution. In either case, MOJHA can, in

effect, veto legal or regulatory provisions that it finds

inconsistent with the statutes and constitution.



Absent from these drafting processes is a statutory, systematic,

transparent review of legislation or regulations by stakeholders and

the public. Ministerial initiatives are not publicized until the

draft has passed out of a given ministry to the full Cabinet.

Typically, the full Cabinet discusses and passes bills on to

Parliament, without public input or consultations. Parliament

itself issues neither a formal calendar nor routinely announces or

opens its standing committee or full chamber hearings to the public.

While Parliament at the beginning of each session announces a list

of bills to be considered during the session, this is very general

and often amended. New legislation is commonly introduced,

discussed and passed without public announcement or consideration.

For example, in 2006, Parliament passed the Wind Fall Profits Tax

Law bill in six days without consulting any business, NGO, or other

entity about the impact and desirability of the bill. In 2007,

Parliament significantly amended the Law on State Procurement within

thirty days without any public notification or comment regarding new

limits competitive, transparent bidding practices and limits on

access tender opportunities to foreign bidders. In 2008 and 2009,

key mining agreements were negotiated by the government and simply

presented to Parliament for quick votes without formal public

comment and review.



The U.S. Embassy in Ulaanbaatar and foreign and domestic investors

have repeatedly urged the Mongolian government to utilize the

government's Open Government web site to post draft and pending

legislation for public consultation and review before it is

finalized and sent to Parliament. Over the past couple of years, we

have noticed some improvement in the timeliness and completeness of

the postings.



To supplement this effort, the U.S. Embassy and local business

organizations have jointly created an informal system to identify

legislation and regulations under review. Once identified, we meet

with working groups, provide information on how other nations have

handled such legislation, share stakeholders' points of view, and

widely distribute publicly available draft bills, preferably before

they reach a minister's desk. Should a piece of vital legislation

pass on to the Minister, Cabinet, or Parliament, these organizations

are prepared to lobby at the appropriate level. Over the last three

years we have found that many agencies and Members of Parliament



ULAANBAATA 00000119 017.2 OF 024





welcome our advice and information, particularly if given in a

non-confrontational way that respects Mongolia's political process

and right to deliberate.



Regulators also resist consultation when it comes to implementation.

Bureaucrats are only slowly becoming comfortable with the concepts

and practices of broad, public consultation and information sharing

with their own citizens, let alone foreigners. Many times

businesses ask for a clear copy of the current regulations, only to

be met with blank stares or outright refusals. The government has

acknowledged that the Soviet-era State Secrets Law requires

substantial amendment. Currently, most government

documents-including administrative regulations affecting investments

and business activities-are technically classified and cannot be

released to the public. This gives both bureaucrats and regulators

a convenient excuse to deny requests for information or, more

commonly, to demand extra-legal fees to provide documents. The

legacy of secrecy has also resulted in cases where government

officials themselves cannot get up-to-date copies of the rules.

Mongolia is considering a freedom of information law, but it is only

in its formative stages.



High officials acknowledge the value of and need for a more open,

transparent system. While laws are easy to fix, the behavior of

individual bureaucrats, Members of Parliament, and the judiciary

will only gradually change, with training and experience. Already a

younger generation of professionals, many trained abroad, is

beginning to take hold and to move into senior positions of

authority. This bodes well for Mongolia's continuing transition to

a private sector-led, open, market economy underpinned by good

government and corporate governance.



The Role of NGOS and Private Sector Associations in relation to FDI



The Mongolian government actively protects its prerogatives to

legislate, regulate, and administer economic activities in its

domain. While NGOs and private sector associations are given wide

latitude to run their activities, the government of Mongolia has

never allowed any non-governmental entity-be it business, civil

society, trade union, etc.-to have anything more than an advisory

role over the formulation and execution of the both laws and rules,

which also applies to setting standards for various industries.

Based on recent experience, the GOM routinely resists any expanded

role for civil society and NGOs. This tacit but unarticulated

policy of the government of Mongolia applies to both domestic and

foreign entities.



Laws, Regulations, and Policies that Impede FDI



While the GOM supports FDI and domestic investment, individual

agencies and elements of the judiciary often reportedly use their

respective powers to hinder investments into such sectors as meat

production, telecommunications, aviation, or pharmaceuticals. Both

domestic and foreign investors report similar abuses of inspections,

permits, and licenses by Mongolian regulatory agencies. However,

we have noted no consistent, systematic pattern of abuse

consistently initiated by either government or private Mongolian

entities aimed against foreign investors in general or against US

investment in particular. The impediments more often than not are

opportunistic attempts by individuals to misuse contacts to harass

U.S. and other foreign investors with whom the Mongolian entity is

in dispute. Alternatively, other reports suggest that they induce

well-placed regulators at all levels to extract extra-legal payments

from both foreign and domestic businesses or otherwise hinder their

work. In the latter case the general approach is to demand some

sort of payment in lieu of not enforcing work, environmental, tax,

health and safety rules, otherwise imposing the full weight of a

contradictory mix of Soviet Era and the current reformed rules on

the firm. Most foreign businesses refuse to pay bribes, and in turn

accept the punitive inspections, concede to some of the violations

found, and contest the rest in the City Administrative Court. In

our experience companies that show resolve against such predatory

abuse of statutory and regulatory power will face impediments at the

start; but these usually ease over time as state agents look for

easier targets.



A.9 EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT



Mongolia currently lacks experience and expertise to sustain

portfolio investments. It has no regulatory apparatus for these



ULAANBAATA 00000119 018.2 OF 024





activities, and both the state and private entities are just

beginning to engage in them. However, Mongolia has active capital

markets. The Mongolian government imposes few restraints on the

flow of capital in any of its markets. Multilateral institutions,

particularly the IMF, find the regime too loose, especially in the

crucial banking sector. Although the government has clear rules

about capital reserve requirements, the Mongol Bank, Mongolia's

central bank has historically resisted restraining credit flows at

commercial banks. In response to the current global financial

crisis, however, Mongol Bank has responded to the decreasing

availability of capital and liquidity in Mongolia by tightening

reserve requirements and the interest it charges to local banks for

funds, and currency controls. That said, most foreign businesses

have approved of the ease with which they can access financial

resources.



Capital and Currency Markets



Although liquidity is quite high in Mongolia, affordable capital

remains scarce. Local credit interest rates for customers range

from 12% for the most credit worthy to perhaps 90% per annum (or

more) for the least, with inflation peaking at around 40% in 2008

before settling at 24%. Foreign investors can easily tap into

domestic capital markets. However, they seldom do, because they can

do better abroad or better locally by simply taking on an equity

investor, Mongolian or otherwise.



Mongolia's currency, capital, and equity markets took major hits in

2008. Over the last three years the currency had proved resilient,

holding its value against most international currencies. This

resiliency has largely been attributed to the commodities boom,

which saw Mongolia selling such raw materials as copper, gold, and

coal, primarily to China. In mid 2008, the commodity markets began

to cool and Mongolia's foreign trade began to fall, leading to

growing trade deficit as imports no longer balanced or exceeded

exports. Subsequently, the once strong tugrik has begun to slide

and by March 2009 had lost 40 % of its value relative to the U.S.

dollar, affecting all import-related trade. Complicating matters,

major banks and other institutions that formally had access to

international capital flows (in the form of dollars, yen, renmimbi,

Euros, etc, which were parked in high-interest yielding tugrik

accounts),found international in-flows reversing as foreign

depositors repatriated their funds, either because these entities

needed the money to weather their own financial crises or they fear

that the tugrik's collapse would eat away the value of their

deposits. Banks no longer had access to easy capital and liquidity,

and began to restrict lending to almost all clients, who in turn

found they lacked funds to finance construction projects, trade, and

other activities.



After several months of tapping reserves to slow the tugrik's

decline, Mongol Bank has curtailed such infusions. Instead, the

Bank will sell dollars into the system via an auction to the local

commercial banks and will let the market decide the value of the

exchange rate rather than attempt to set the rate or artificially

support it.



Equity Markets



Investors do not use stocks to raise equity for investment but to

gain control of companies listed on the exchange. As most of the

firms have been bought up, the market sees little trading.



Mongolian firms do not use shareholding relationships to restrict

foreign investment at this point. Part of this arises from lack of

experience with such devices. It also arises from the fact that

Mongolians prefer to concentrate ownership in their own hands,

rather than disperse it through complicated shareholding

relationships. They perceive such devices as weakening their

ability to control the companies, which is more important than

safeguarding the firm from foreign or domestic raiders. If a

foreign company wanted to purchase a Mongolian firm, the foreign

entity would have to contact the shareholders and buy them out.

These could not be hostile takeovers, because few outstanding shares

remain on the market to buy. Eager to take on equity partners or

sell businesses entirely, the Mongolians would employ few defenses

beyond sharp negotiating.



The current Minerals Law of Mongolia recently imposed a provision

that requires that holders of mining licenses for projects of



ULAANBAATA 00000119 019.2 OF 024





strategic importance must sell no less than 10% of the resulting

entity's shares on the Mongolian Stock Exchange. Vaguely presented

in the statute, what this new provision means in practical terms and

how it is to be implemented has yet to be spelled out in regulation.





The Banking Sector



Weakness in Mongolia's banking sector concerns all players,

including the International Monetary Fund (IMF: http://www.imf.org).

Small by American standards, the total assets of Mongolia's sixteen

(16) banks adds up to just over US$2 billion. The system has been

through massive changes since the Soviet era, during which the

banking system was divided into several different units. This early

system failed through mismanagement and commercial naivety in the

mid-90s, but over the last decade has become more sophisticated and

better managed.



Mongolia has three large, generally well-regarded banks owned

primarily by Japanese and, Mongolian interests respectively. They

follow international standards for prudent capital reserve

requirements, have conservative lending policies, up-to-date banking

technology, and are generally well managed. If a storm should

descend on Mongolia's banking sector, these banks appear

well-positioned to weather it.



However, concerns remain among these bankers about the effectiveness

of Mongolia's legal and regulatory environment. As with many issues

in Mongolia, the problem is not of lack of laws or procedures but

the will and capacity of the regulator, Mongol Bank, to supervise

and execute mandated functions, particularly in regard to capital

reserve requirements and non-performing loans.



From 1999 through late 2008, Mongol Bank had consistently refused to

close any private Mongolian bank for insolvency or malpractice. In

late 2008, Mongol Bank took Mongolia's fourth largest bank into

receivership. Most deposits were guaranteed and their depositors

paid out. Mongol Bank survived the crisis, which cost it around

US$150 million -- not an inconsequential sum in an economy with a

US$5 billion per annum GDP. However, most observers noted that the

bank in question had shown signs of mismanagement, non-performing

loans, and ill-liquidity several years before the central bank moved

to safeguard depositors and the financial sector; and they argued

that that Mongol Bank had not shut any bank, fearing that closure

would signal weakness to the general public or because regulators

within the Mongol Bank, as Mongolia's central bank, have financial

interests in the troubled banks that would be threatened by

regulatory action. The latest crisis led to a new Mongol Bank

governor, and the institution has tightened some but not all of the

reserve requirements and formally indicated to banks that it will

not indemnify them for deposits they park in any bank which

subsequently goes bankrupt.



No accurate figures exist on non-performing loan (NPL) rates.

American and foreign bankers and the IMF believe that central bank's

methods for tracking NPLs understate the rate, and as such are

concerned that several banks may teeter near insolvency.



A.10 POLITICAL VIOLENCE



Mongolia is peaceful and stable. Political violence is rare.

Mongolia has held eight peaceful presidential and parliamentary

elections in the past 15 years. However, a brief but violent

outbreak of civil unrest followed disputed parliamentary elections

on July 1, 2008. Accompanied by some property destruction and

bodily injury, the unrest was quickly contained and order restored.

There has been no repeat of this civil unrest since July 1.



Mongolia has an ethnically homogenous population: 97% of the

population is Khalkh Mongol. The largest minority, numbering an

estimated 90,000 people, is Kazakh (Muslim),concentrated in the far

western part of the country.



There have been no known incidents of anti-American sentiment or

politically motivated damage to American projects or installations

in at least the last decade. However, there has been a gradual and

perceptible level of rising hostility to Chinese and, to a lesser

extent, Russian nationals in Mongolia. This hostility has led to

some instances of improper seizure of Chinese-invested property; and

in more limited cases acts of physical violence against the persons



ULAANBAATA 00000119 020.2 OF 024





and property of Chinese nationals resident in Mongolia. Other

Asians living in Mongolia have expressed concern that they may

inadvertently become victims of this hostility.



A.11 CORRUPTION



In mid 2005, the USAID Mission to Mongolia, in collaboration with

USAID/Washington and The Asia Foundation (TAF),funded a corruption

assessment conducted by Casals & Associates, Inc. (C&A).(the

complete report is available at http://www.usaid.gov/mn). Follow up

surveys of the problem show that the results of this assessment

remain valid in 2009. The study found that opportunities for

corruption have and continue to increase in Mongolia at both the

"petty" or administrative and "grand" or elite levels. Both types of

corruption should be of concern to Mongolians, but grand corruption

should be considered a more serious one because it solidifies

linkages between economic and political power that could negatively

impact or ultimately derail democracy and development, as it has in

other post-Communist countries. Several inter-related factors

contribute to Mongolia's corruption problem:



--A profound blurring of the lines between the public and private

sector brought about by endemic and systemic conflict of interest

(COI) at nearly all levels;



--A lack of transparency and access to information, stemming in part

from a broad State Secrets Law that surrounds many government

functions and undermines nearly all aspects of accountability by

contributing to an ineffective media and hindering citizen

participation in policy discussions and government oversight;



--An inadequate civil service system that gives rise to a highly

politicized public administration and the existence of a "spoils

system;"



--Limited political will and leadership to actually implement

required reforms in accordance with the law, complicated by

conflicting and overlapping laws that further inhibit effective

policy implementation;



--Weak government control institutions, including the Central Bank,

National Audit Office, parliamentary standing committees, Prosecutor

General, Generalized State Inspection Agency, State Property

Committee, and departments within the Ministry of Finance.



The aforementioned systemic shortcomings have allowed for an

evolution of corruption in Mongolia that "follows the money,"

meaning that graft on the most significant scales generally occurs

most often in the industries and sectors where there is the most

potential for financial gain. During the early 1990s, opportunities

for increased corruption emerged during the transition toward

democracy and market economy and process of reconnecting to the

international community. Two areas that offered particular

opportunities for grand scale corruption at that time were foreign

donor assistance and privatization of state-owned enterprises.

Later, as Mongolia embarked on further policy changes to install

capitalistic practices, corruption reared its head in the process of

privatizing public land. Now that most of the small amount of

high-value land has been doled out and the overall economy continues

expanding, based in part on extractive industries, emerging areas

for corruption include the banking and mining sectors. As in many

developing countries, there also are several areas that provide

stable and consistent opportunities for corruption, both grand and

administrative in nature, such as for procurement opportunities,

issuance of permits and licenses, customs, inspections, the justice

sector, among high-level elected and appointed officials, and in the

conduct a variety of day-to-day citizen- and business-to-government

transactions, notably in education, health care, and city services.



Despite the fact that few of the conditions to prevent corruption

from getting worse are in place, the situation has not reached the

levels that are evident in many other countries with contexts and

histories similar to that of Mongolia. Perhaps more importantly,

there are a number of nascent and rudimentary efforts underway to

actively combat corruption, including:



--Government commitments to international anti-corruption regimes

and protocols, such as the Anti-Corruption Plan of the Asian

Development Bank/Organization of Economic Cooperation and

Development (ADB/OECD) and the United Nations Convention Against



ULAANBAATA 00000119 021.2 OF 024





Corruption (UNCAC);



--Development of a National Program for Combating Corruption and

formation of a National Council for coordinating the Program and a

Parliamentary Anti-Corruption Working Group;



--Implementation of an anti-corruption law that has included the

formation of an independent anti-corruption body;



--Short- and medium-term anti-corruption advocacy and "watchdog"

programs initiated by civil society organizations, often with

international donor support.



There is, in fact, time for Mongolians and the international

community to nurture these efforts and take further action before

the corruption problem gets out of hand. In general, the main need

in Mongolia is for effective disincentives for corrupt behavior at

both the administrative and political level. In its broadest

configuration, this implies a strategy of increasing transparency

and effective citizen oversight, as well as intra-governmental

checks and balances. Without these major changes, administrative

reforms may provide some small improvements, but they are unlikely

to reverse current trends. Specifically, the report makes several

strategic recommendations, including:



--Diplomatic engagement focused on keeping anti-corruption issues on

the policy agenda, promoting implementation of existing laws related

to anti-corruption, and highlighting the need for further measures

to promote transparency and improved donor coordination;



--General programmatic recommendations to address conflict of

interest, transparency/access to information, civil service reforms,

and the independent anti-corruption body, with a definitive focus on

engaging civil society and promoting public participation utilizing

UNCAC as a framework;



--Specific programmatic recommendations to address loci of

corruption, such as citizen- and business-to-government

transactions, procurement, privatization, customs, land use, mining,

banking, the justice sector, and the political and economic elite



In addition, the reputable international anti-corruption NGO

Transparency International (TI) opened a national chapter in

Mongolia in 2004. (See: www.transparency.org) U.S. technical

advisors are working with TI to train Mongolian staff to monitor

corruption and to advocate on behalf of anti-corruption legislation

and, TI first included Mongolia in its annual "Perceptions of

Corruption" survey in September 2004. In that initial survey,

Mongolia ranked 85 out of 145 countries and its score of 3 on the

Corruption Perception Index was "poor." (TI's CPI Score relates to

"perceptions" of the degree of corruption as seen by business people

and country analysts and ranges between 10 (highly clean) and 0

(highly corrupt). TI's 2005 Survey ranked Mongolia 85 out 158; and

again Mongolia earned a "poor" score of 3. In TI's 2006 survey,

Mongolia had dropped to 99 out of 163 countries, being on par with

Mali, Mozambique, and the Ukraine, receiving a score of 2.8-poor.

In 2007, Mongolia was still 99 but out of 179 nations and had

achieved a score of 3.0, slight uptick but still poor. 2008 saw

Mongolia drop to 102 out 180 nations, maintaining its poor score of

3. In short, Mongolia has become neither more nor less noticeably

corrupt.



2006 Anti-Corruption Law



In 2006, Parliament passed an Anti-Corruption Law (ACL),a

significant milestone in Mongolia's efforts against corruption. The

legislation had been under consideration since 1999.



The ACL created an independent investigative body, the Independent

Authority Against Corruption (IAAC). The IAAC has four sections.

The Prevention and Education Section works to prevent corruption and

educate the public on anti-corruption legal requirements. The

Investigation Section receives corruption cases and executes

investigations. The third section collects, checks, and analyzes the

legally required property and income statements of government

officials. The fourth section, the IAAC's Secretariat, handle s

administrative tasks. The IAAC formally began operations in August

2007. (For a review of the IAAC's activities from its inception

through late 2008 and a general assessment of the public's current

views of corruption in Mongolia see the series of Mongolia



ULAANBAATA 00000119 022.2 OF 024





Corruption Benchmarking Surveys prepared for USAID Mongolia:

http://www.usaid.gov/mn; and The Asia Foundation:

http://asiafoundation.org/publications)



U.S. Foreign Corrupt Practices Act (FCPA)



The U.S. Embassy in Ulaanbaatar reminds U.S. entities and citizens

active in Mongolia that both they and their agents are subject to

the provisions of the FCPA. For information about the FCPA visit

the U.S. Department of Justice web site at

http://www.usdoj.gov/criminal/fraud/fcpa/.



A.12 BILATERAL INVESTMENT AGREEMENTS



(For Agreement list see UNCTD: http://www.unctad.org)



Taxation issues of Concern to American Investors



Taxation remains an area of key concern for American, other foreign

investors, and Mongolian domestic investors and businesses. 2006

saw major reforms of the Mongolian tax system, most of which, with

the exception of the windfall profits tax on gold and copper, were

greeted positively by most foreign and domestic investor in

Mongolia.



Windfall Profits Tax on Copper and Gold



The Windfall Profits Tax Law of 2006 (WPT) drew sharp criticism of

the GOM's commitment to creating an open, predictable, fair

environment for foreign direct investment. (See Section A.1 for

discussion of the WPT.)



Revisions of the Mongolian Tax Code:



Problems with the WPT aside, major reforms to the Mongolian Tax code

in 2006 greatly improved the business environment in Mongolia for

both foreign and domestic investors. Before the reforms, a World

Economic Forum survey of Mongolian business executives cited tax

rates and the complexity of tax regulations as two of the top five

problems for doing business in Mongolia. The tax reforms benefited

from two years of technical assistance from USAID's Economic Policy

Reform and Competitiveness Project (EPRC). The reforms affected the

Personal Income Tax (PIT) and Corporate Income Tax (CIT) codes as

well as the VAT and excise tax codes. (EPRC has a number of useful

and informative guides on their website:

http://www.eprc-chemonics.biz. See Sections A.1 and A. 5 for

description of these tax reforms.)



Unfinished Business (Including Customs Rates)



There is unfinished business, however, as Parliament continues to

consider additional tax reform measures. These include revisions to

the law on customs and customs tariffs. While the exact natures of

the proposed changes in the customs law have been murky, the GOM

states that changes will be consistent with Mongolia's WTO

obligations and investment climate enhancement goals.



Institutional Impediments Remain a Concern



Despite these solid, positive changes, international financial

institutions and other observers warn that these recent legislative

changes by themselves are insufficient to improve Mongolia's

business environment. Reform efforts need to go beyond changes to

the tax code, requiring fundamental reform in how such key agencies

as the tax department, the customs administration and the

inspections agency directly interact with private firms and

individuals.



Specifically, tax authorities charged with enforcing the tax codes

require a more customer-based approach to dealing with their

business clientele and a more detailed and rigorously enforced

regulatory framework under which to audit company accounts. Many

foreign and domestic investors argue that the lack of such a clear,

implementable code of ethics and enforceable set of guidelines leads

to arbitrary, capricious, or predatory tax audits.



A.13 OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS



Recently OPIC (www.opic.gov) has become more active in Mongolia.

OPIC has issued and plans to issue direct loans to American firms



ULAANBAATA 00000119 023.2 OF 024





providing a variety of services in Mongolia. Loans and political

risk insurance to American investors involved the banking, tourism,

mining, and equipment sectors are in process. Because the amounts

required are relatively small, OPIC seems willing to make direct

loans rather than provide loan insurance to projects.



In 2006, the U.S. Export-Import Bank (EXIM) opened in Mongolia for

short-, medium-, and long-term transactions in the public sector and

for short- and medium-term transactions in the private sector.

(www.exim.gov).



Mongolia is a member of the Multilateral Investment Guarantee Agency

(MIGA: www.miga.org).



A. 14 LABOR



The Mongolian labor pool is generally well educated, relatively

young, and adaptable, but shortages exist in most professional

categories requiring advanced degrees or training. Only time and

investment in education and training will remedy this deficit of

trained skilled labor. Unskilled labor is sufficiently available.

Shortages exist in both vocational and professional categories

because Mongolians who obtain such skills frequently go abroad to

find higher wages. Why stay in Mongolia if one cannot recover the

outlay on the training from a Mongolian-based job? Foreign invested

companies are dealing with this situation by providing in-country

training to their staffs, raising salaries to retain employees, or

hiring expatriate workers to perform functions not available

locally. In addition, the USG funded Millennium Challenge

Corporation (MCC) is underwriting a five-year training and

vocational education program (TVET) to develop sustainable programs

to help Mongolia meet its needs for skilled blue- collar workers

(http://www.mca.mn or http://www.mcc.gov).



Mongolian labor law is not particularly restrictive. Investors can

locate and hire workers without using hiring agencies -- as long as

hiring practices are consistent with Mongolian Labor Law. However,

Mongolian law requires companies to employ Mongolian workers in

certain labor categories whenever a Mongolian can perform the task

as well as a foreigner. This law generally applies to unskilled

labor categories and not areas where a high degree of technical

expertise nonexistent in Mongolia is required. The law does provide

an escape hatch for all employers. Should an employer seek to hire

a non-Mongolian laborer and cannot obtain a waiver from the Ministry

of Labor for that employee, the employer can pay a fee of US$140.00

per employee per month. Depending on a project's importance, the

Ministry of Labor can exempt employers from 50% of the waiver fees

per worker.



Foreign and domestic investors consistently argue that they bear too

much of the social security costs for each domestic and foreign hire

under the amended 2008 Social Insurance Law enacted in July 2008.

Foreign employees became liable for social insurance taxes if they

reside within Mongolia for 181 days within a 365 day period. Under

this law, foreign and domestic workers pay up to 108,000 tugrik (US$

67) for this tax, no matter their respective rates of pay.

Employers must pay a tax equivalent to 13% of the annual wage on

both domestic and foreign workers. Given that state pensions have

yet to broach even US $100, Employers argue that pensions are not

commensurate with worker contributions, especially those of

highly-paid ex-patriot employees. In addition, workers must pay in

for twenty years in order to be vested, highly unlikely for many

ex-patriot employees, who reside in Mongolia for less than three

years on average. Local and foreign business associations are

working with both the government/Parliament to address perceived

inequities.



Regarding ILO conventions See ILO at http://www.ilo.org



A. 15 FOREIGN TRADE ZONES/FREE PORTS



The Mongolian government launched its free trade zone (FTZ) program

in 2004. Currently there are two FTZs located along the Mongolia

spur of the trans-Siberian highway: one in the north at the

Russia-Mongolia border town of Altanbulag and the other in the south

at the Chinese-Mongolia border at the town of Zamyn-Uud. Both FTZs

appear moribund, with no development at either site. The port of

entry of Tsagaan Nuur in Bayan-Olgii province is being considered as

the site of third FTZ.





ULAANBAATA 00000119 024.2 OF 024





Management for the Zamyn-Uud Free Trade Zone (ZUFTZ) was originally

tendered to a Chinese firm. In 2006, the GOM voided the agreement

for non-compliance of the terms of the tender. The GOM re-tendered

the management contract in 2006, but later voided the contract,

alleging that the current holder of the management rights in the

ZUFTZ had failed to live up to the terms of the tender.



So far, there are no indications that government will not keep

promises to open the zone to any who satisfy the relevant legal

requirements. However, there are concerns about the Mongolian free

trade zones in general and Zamyn-Uud in particular. In April 2004,

the USAID sponsored Economic Policy Reform and Competitiveness

Project (EPRC: http://www.eprc-chemonics.biz/) made the following

observations of Mongolia's FTZ Program. In 2009, these issues

remain concerns:



--Benchmarking of Mongolia's FTZ Program against current successful

international practices shows deficiencies in the legal and

regulatory framework as well as in the process being followed to

establish FTZs in the country.



--Lack of implementing regulations and procedural definitions

encapsulated in transparency and predictability quotient required to

implement key international best practices.



--A process of due diligence, including a cost-benefit analysis, has

not been completed for the proposed Zamyn-Uud FTZ.



--Identifiable funding is not in place to meet off-site

infrastructure requirements for Zamyn-Uud and Altanbulag sites.



--Deviations from international best practices in the process of

launching FTZs risks repeating mistakes made in other countries and

may lead to "hidden costs" or the provision of subsidies that the

government of Mongolia did not foresee or which will have to granted

at the expense of other high priority needs



A. 16 FOREIGN DIRECT INVESTMENT STATISTICS:



Comment on the data sources for foreign direct investment in

Mongolia. The Foreign Investment and Foreign Trade Agency (FIFTA)

provides most of the data for tracking FDI in Mongolia. However,

the data has limitations:



A. Incomplete reporting and data collection:



--Many foreign firms provide FIFTA with inaccurate or incomplete

data on their annual investment amounts. FIFTA's registration

regime requires companies to document business plans and total FDI

for the coming year. FIFTA uses these amounts to determine FDI for

the year. However, firms reportedly believe FIFTA may not be able

to guarantee the confidentiality of proprietary business

information, and so they withhold complete data on their actual

activities.



--Mongolia also suffers from promised investment that does not

materialize or which comes in at a lower level than originally

stated. FIFTA does not update reports to account for these or

other changes to investments during the year. (See Chapter 6,

Section A.5: Performance Requirements and Incentives).



--In addition, many of Mongolia's largest foreign- owned or

foreign-invested entities are in the mining sector, which because of

a quirk of the current Minerals Law of Mongolia are not necessarily

defined as foreign-invested firms. The current minerals law

specifies that only domestically registered mining firms can have

mining licenses registered in their names, which means that foreign

investments associated with mining may not be recorded by FIFTA,

even though the investment is demonstrably foreign. For example,

the investment by Ivanhoe Mines Mongolia (a Canadian company) into

Mongolia has reached at least US$ 800 million, yet this investment

is not recorded among the data provided by FIFTA.



B. Data not Available: Neither FIFTA nor any other Mongolian agency

to our knowledge tracks Mongolia's direct investment abroad.



MINTON