33248 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Currency Equivalents 1 US Dollar equals 1130 Tugrugs (MNT) Weights and Measures Metric System Fiscal Year January 1 – December 31 Abbreviations and Acronyms ADB Asian Development Bank Au Gold Cu Copper EEOITL Economic Entity and Organization Income Tax Law GDNT General Department of National Taxation GDP Gross Domestic Product GIC Geological Information Center GMIA Geological and Mining Inspection Agency ILO International Labor Organization IRR Internal Rate of Return MGS Mongolian Geological Survey MIT Ministry of Industry and Trade MMSD The Mining, Minerals and Sustainable Development project MNE Ministry of Nature and Environment MNA Mongolia Mining Association Mo Molybdenum MoFE Ministry of Finance and Economy MRAM Mineral Resources Authority of Mongolia MW Mega Watt SE-EW Solvent Extraction Electro Winning SME Small and Medium Enterprises SOE State Owned Enterprise OGMC Office of Geological and Mining Cadastre Oz Troy ounce PHI Public Health Institute PRSC Poverty Reduction Strategy Credit PRSP Poverty Reduction Strategy Paper PSMFA Public Sector Management and Finance Act PTRC Population and Teaching Research Center t Metric ton UNDP United Nations Development Program VAT Value Added Tax Zn Zinc Report Management Vice President: Jemal-ud-din Kassum Country Director: Ian Porter Sector Manager: Tamar Manuelan Atinc Sector Director Homi Kharas Task Team Leaders Charles Husband and Vera Songwe TABLE OF CONTENTS TABLE OF CONTENTS EXECUTIVE SUMMARY i CHAPTER 1. OVERVIEW OF MONGOLIA’S MINING SECTOR 1 Geological Setting and Mineral Potential 3 The Mining Sector 4 Current Mining Operations 10 New Mines Under Development 12 Interesting Exploration Prospects 13 Indirect Economic Impacts of Mining 14 The Importance of Government Policies 15 Regional Economic Development 16 Infrastructure Requirements 18 CHAPTER 2. ARTISANAL MINING 21 Background 22 Artisanal Mining and Poverty in Mongolia 23 The Development Dilemma of Artisanal Aining 24 Distinguishing Characteristics of Artisanal Gold Mining in 25 Mongolia 27 Current Issues and Institutional Responses 29 Conflict and its Resolution 30 Human Rights 30 Stakeholder Perspectives 31 Artisanal Growth Prospects 32 Recommendations CHAPTER 3. FISCAL AND REVENUE MANAGEMENT OF THE MINING SECTOR 35 Mongolia’s Tax System 36 International Competitiveness 38 Revenue Management 44 CHAPTER 4. THE LEGAL, REGULATORY, AND INSTITUTIONAL FRAMEWORK 49 Introduction 50 Overview of Mineral Sector Policy and Legislation 51 Assessment of Regulatory and Implementing Institutional Capacities 52 Priority Mineral Sector Management Issues 55 Immediate Initiatives 55 Proposed Minerals Law Amendments 55 Conclusion 60 CHAPTER 5. PROJECTED ECONOMIC IMPACT OF MINING SECTOR 61 Macro Economic Impact of Mineral Sector Growth 65 CHAPTER 6. RECOMMENDATIONS AND OPTIONS 69 ANNEXES Annex I. Current Mining Operations 73 Annex II. Indirect Economic Impacts of Mining 91 Annex III. Regional Economic Development 97 Annex IV. Overview of Tax Law 107 Annex V. International Competitiveness 113 Annex VI. Revenue Management 123 Annex VII. Overview of Mineral Sector Policy and Legislation 133 Annex VIII Classification of Mineral Reserves and Resources. 145 Annex IX. Comparison of International Taxation Regimes 147 Annex X. Cash flow Models of Typical Mines 150 Annex XI. General Characteristics of Artisanal Mining 153 Annex XII. Proposed Law on Artisanal Mining 160 Annex XIII. Private Sector Mining Investment Climate Survey 166 BOXES Box 1.1 Mining Reform in Argentina 2 Box 1.2 Environmental Aspect of Laws and Institutions Governing Mineral Exploration and Mining 5 Box 2.1 Mercury Usage 28 Box 2.2 Child Libor 28 Box 3.1 Stability Agreement Coverage 38 Box 3.2 Tax Exemptions 39 Box 3.3 The Chilean Model 40 Box 3.4 Revenue Management Examples 42 Box 3.5 Revenue Management in Botswana and Trinidad and Tobago 44 Box 3.6 Mongolia: Weaknesses in Public Finance 45 Box 3.7 The Community Development Forum 46 Box 3.8 The Alaska Permanent Fund 47 Box III.1 The Development Forum in Papua New Guinea (PNG 103 Box III.2 The Rossing Foundation 104 Box VI.1 Revenue Management in Botswana and Trinidad and Tobago 126 FIGURES Figure 1.1 Mining’s Contribution to Gross Industrial Output 4 Figure 1.2 Gold and Copper Production and Prices 5 Figure 1.3. Land Held as Mining Licenses 7 Figure 1.4 Mining Licenses held by Company 7 Figure 1.5 Land Held as Exploration Licenses 8 Figure 1.6 Exploration License Holders, April 2003 8 Figure 1.7 Estimated World Copper Cost Curve, 2002 10 Figure 1.8 Placer Gold Production by Company 11 Figure 2.1 Estimated Informal Gold Miners in Principal Mining Aimags 23 Figure 5.1 Projected Growth in Industrial Output 63 Figure 5.2 Mining Sector Growth Forecast 54 Figure Annex 1.1 Estimated World Copper Cost Curve, 2002 75 Figure Annex 1.2 Fluorspar Flow Sheet 77 Figure Annex 1.3 Mongolrostvetsment Cost Structure 77 Figure Annex 1.4 Placer Gold Production by Company 2002 78 Figure Annex 1.5 Placer Mines Cost Structure and Cost Curve 80 Figure Annex 1.6 Boroo Gold Flow Sheet 81 Figure Annex 1.7 Borro Gold Ltd Cost Structure (%total costs) 82 Figure Annex 1.8 Tumurtiin Flow Sheet 82 Figure Annex 1.9 Tumurtiin Cost Structure (%total costs) 83 Figure Annex VII.1 Institutional Structure of MIT 134 Tables Table 1.1 Impact of Mineral Sector Reforms 3 Table 1.2 Mongolian Mineral Production, 1997-2002 4 Table 1.3 Estimated Income Multiplier Effects in South American Mines 15 Table 1.4 Mongolian Mines, Prospects and Major Infrastructure 18 Table 5.1 Projected Mineral Production 53 Table 5.2 Mining Sector Expected Contribution to GDP 55 Table 5.3 Comparison of the Current and new Projects on Copper Unit 55 Table 5.4 Government Mining and Revenues Projection 56 Table 5.5 Erdenet and Oyu Tolgoi Contribution to Government 57 Table 5.6 Impact of Copper Exports on Balance of Payment 58 Table Annex 1.1 Fluorspar Mines with 2002 Production 76 Table Annex 1.2 Placer Production Statistics, 2000-2 80 Table Annex 1.3 Other Mining Activities 81 Table Annex 1.4 Ouy Tolgoi – Summary of Mineral Resources (as of Nov 2003) 85 Table Annex 1.5 Projected Production of Largest Placer Gold Mines (top 70 percent) 2002-10 85 Table Annex III.1 Typical Products and Services Required by the Mining Sector 100 Table Annex III.2 Mongolian Mines and Prospects and Major Infrastructure 105 Table Annex IV.1 Summary of Tax Collection (tg billions) 108 Table Annex IV.2 Social Insurance Rates 111 Table Annex V.1 Large Scale Base Metal Mine 119 Table Annex V.2 Small-Small Gold Mine 120 ACKNOWLEDGEMENTS This report presents the findings of a study “Mongolia Mining Sector Sources of Growth” undertaken by the Oil, Gas, Mining and Chemicals Department of the World Bank. The review was sponsored by East Asia Poverty Reduction and Economic Management department to contribute towards a proposed Country Economic Memorandum on the sources of growth in Mongolia. The team acknowledges the generous support of officials of the Ministry of Trade and Industry and the Mineral Resource Authority of Mongolia who also provided valuable comments on the final draft; the significant contributions drawn from background reports on environment, artisanal mining, and economic impacts of mining that were prepared by Rheinbrau Engineering, Bill Murray and Robin Grayson, and Fernando Loayza respectively; and the insights drawn from numerous consultations with the investment community. The project team was lead by Charles Husband (Lead Mining Specialist, COCPD) and Vera Songwe (Senior Economist, EASPR) and included Jeffery Davidson (Artisanal) of the World Bank, and specialist consultants Jack Garnett (Legal Regulatory Framework), John Gowen (Mining Engineering), Fernando Loayza (Mineral Economics), and Bob Parsons (Fiscal). The comments of the peer reviewers, John Strongman (Mining Advisor, COCPD) and Vikram Nehru (PRMHP), were incorporated into the report and are gratefully acknowledged. Editorial support, publication and distribution of the report were supervised by Nancy Mensah. The report was prepared under the overall guidance of Messrs/Mme. Homi Kharas (Chief Economist and Sector Director, EASPR), Ian Porter (Country Director, EACSM), Tamar Manuelyan Atinc (Sector Manager, EASPR) and Peter van der Veen (Sector Manager, COCPD) EXECUTIVE SUMMARY i INTRODUCTION 1. This study is based on field work undertaken in the Spring of 2003 and builds on previous projects undertaken by the World Bank in Mongolia1. It assesses the medium-term growth potential of Mongolia’s non-fuel minerals industry and its potential contribution to economic growth, poverty reduction, and regional development. The study evaluates the current state of the mining sector to identify favorable factors for development and potential constraints, review investor perceptions and international case studies of best practice on how to address these constraints, and recommends options for government actions to improve industry management and the investment climate. 2. Its main objectives are to: Assess the medium-term growth potential of Mongolia’s non-fuel minerals industry and SME supply chain linkages, and their contribution to gross domestic product, economic targets, and regional development; Diagnose the state of the Mongolian mining sector and identify problems, constraints and bottlenecks to new investment, growth and increased contribution of mining to the national and regional economy; Provide international comparisons and examples of best practices as to how other countries have addressed the issues, problems and constraints that are identified; and Formulate possible options and alternatives that may be considered by the government to improve efficiency, competitiveness, sector management, and the investment climate. THE MINING SECTOR 3. Mongolia is a landlocked country in the heart of the Asian continent. It has a population of 2.5 million and vast tracts of desert, semi-desert and mountainous terrain. Agriculture and mining are the dominant economic activities. In 2002 gross domestic product was US$1 billion.