As most people, who are even remotely connected to Mongolia know, the much publicised (and long overdue) Mongolian economic boom is set to start in earnest. World analysts have now jumped in and tried to predict the shape of things to come.

Mr. MacNamara, a journalist from the Financial Times has recently written an article about Mongolia’s third neighbour policy, while today the news about Mongolia seems to be all about the pre-IPO road-show of South Gobi Energy trying to raise $400m in HK for its Mongolia projects.  Before that it was the agreement between Areva and Mitsubishi to develop Uranium deposits in Mongolia together. Not a week goes by that Mongolia does not make the international business headlines with a new deal or story about its upcoming growth, it is clear that the world media’s are slowly catching up to the “Mongolia story” but where is that story heading?

Principally, it seems that the main questions asked by analysts are:

• How will Mongolia juggle its appetite for foreign investments while maintaining national and political integrity?
• How will Mongolia play its formidable neighbours to its advantage yet retain a real independence from both?
• Will the much flaunted “third neighbor policy” work and be efficient or is it merely an elaborate trap for foreign investors?

While the Mongolian economy and its democratic movement are notoriously wild and unpredictable, all the signs seem to point towards a real desire from the political class to move in the right direction. All the ingredients for Mongolia to become this decade’s success story are present, now it is simply a case of blending the right mix of ingredients together to obtain a performing economy. This is actually a lot trickier than it sounds. Thankfully, Mongolia is still a functioning democracy and its elected representatives are still answerable to the people of Mongolia, if only through a system of fair elections and a generally free press.

The will to move in the right direction is clearly demonstrated by the new generation of Mongolia’s politicians who are fast becoming a formidable force, Mr. Zorig, the minister for Mineral Resources, has already accomplished much; he not only achieved the completion of the OT agreement but he has also restored Mongolia’s tainted reputation with Foreign Investors. Mrs. Oyun from the Civil Will Party seems to be one of the political shooting starts and also one of the finest and most driven politicians I have ever seen.

Mongolia’s main weakness has always been its isolation, landlocked between two enormous powers. With the correct exploitation of its resources, Mongolia now has the opportunity to turn that weaknesses into a strength and take full advantage of both neighbours. To achieve this, Mongolia will need to thread a fine line and play a tricky political game if it is to come out on top. Mongolia’s position is not an easy one; it is likely to become the setting of the clash of the titans over its resources. Russia’s agenda for Mongolia seems to be more a question of political dominance while China seems to be primarily concerned with securing easy and cheap access to the resources Mongolia is so abundant in and that China so desperately needs. The country itself seems locked in a love / hate relationship with China while it still has ambiguous feelings about Russia.

Concerning Russia, Mongolia seems uncertain as to where its relationship now stands and worries that Russia will increasingly use the carrot and stick method to obtain what it wants from Mongolia, this was demonstrated with the opposition to the Millennium Challenge railway funds as well as the timely reminders of Mongolia’s supposed outstanding debt to Russia. Russia has notoriously used threats, blackmail and occasional symbolic rewards in dealing with its own internal affairs as well as its previous (Soviet) area of influence; the pressure from Russia is likely to come from the Public sector and will be aimed squarely at the Mongolian Government. China on the other hand is more likely to play a more subtle game, using discrete methods of cajoling, bribery, corruption and its own economic dominance to ascertain its power over Mongolia but this is unlikely to be done by the state but rather led by private Chinese entities.

The best way for Mongolia to leverage its enormous resources against its neighbours is to use what has now been termed “The Third Neighbour Policy”, essentially a loose understanding that whenever possible and advantageous, Mongolia will deal with countries or entities that are neither Chinese nor Russian. This policy has a number of clear advantages, the most obvious of which is that Mongolia should be able to retain a greater independence from either of its neighbours but should also be able to obtain greater transparency and accountability from the  “third neighbour” companies such as Rio Tinto, BHP, Peabody and so forth than from its geographic neighbours.

Mongolia’s favoured third neighbours have traditionally been considered to be Japan, Korea, India, the USA and sometimes a few of the European countries. The policy allows them to indiscriminately pick and choose the  most  suitable partner for each project. The next mega project in the pipeline is the famed Tavan Tolgoi project, the huge coal deposit in the South Gobi. It is too big for a single company to exploit and so will have to be divided and its licenses allocated accordingly. The way this will be done will really settle the question of Mongolia’s foreign policy and its use and abuse of the third neighbour policy. Mr. Zorig has announced that they will announce the shape of things to come regarding Tavan Tolgoi early in 2010 and choose its companies soon thereafter. If Oyu Tolgoi was the appetizer, the amuse-bouche even, Tavan Tolgoi will be the main course.

But, for the policy to have any chance of success it is not simply sufficient to wish it so, Mongolia must become an attractive destination for foreign investments. While some progress has certainly been made, it still needs to improve its offering; the corner stones of foreign investments in Mongolia will be the introduction of effective measures against the rising problems of corruption and the creation of a strong, independent, judicial system. The business environment of Mongolia is still good but can be further strengthened with more comprehensive, transparent and accessible information to foreign investors. Improving political stability is a longer term goal but is part of the greater understanding required on the part of Mongolia as to what is essential for the country to remain competitive in an increasingly globalised world.

Mongolia has already learned much with the debacle of the 68% windfall tax, it must carefully manage its fiscal and foreign policies, a too obvious show of greed on the part of the government will force foreign investors to seek their fortunes elsewhere while a too lenient policy will mean that Mongolia gets taken advantage of and will not receive its fair share of revenues.

On the flip side of the coin, if the third neighbour policy becomes truly effective, it may well anger its two very large and powerful neighbours who feel that they are missing out and see their influence diminish within Mongolia. Mongolia depends on those neighbours for its survival as they are (China in particular) Mongolia’s majority trading partners. Furthermore, Mongolia could be perceived as setting a bad example for its neighbours; a democratic and successful economy on their doorstep might set a dangerous precedent, in particular for the inner Mongolian region of China. It does not take a big stretch of the imagination to understand that both Russia and China have every interest to see Mongolia’s democracy and its third neighbour policy fail. A strong Mongolia is the last thing they want to see. How Mongolia handles this potential political and economical backlash from both countries is the most interesting of questions.

In the end it might well be the case that Mongolia’s abundant availability of minerals might end up being  the catalyst that will lead the country to its very own demise. As many other ex-Soviet, resource rich, central Asian countries have already demonstrated, the tightrope balancing act of democracy and good governance is hard to achieve, leaving very little room for errors. It would only be too easy for Mongolia to become a failed state, ruled by despots and only concerned with the well being of its ruling class.

Most people are confident that Mongolia will manage this difficult balancing act well, it will of course make mistakes along the way but as long as it retains a fair system of checks and balances, it will be able to recover from those mistakes and forge ahead. I look forward to seeing Mongolia develop into one of the most successful economies of this decade and will continue to be an avid spectator of this fantastic story.

This article was written by Christopher de Gruben.

More articles by this author available here.