By David Stanway and Terrence Edwards
ULAN BATOR (Reuters) - Mongolia's bid to discredit one of its most popular opposition politicians, a staunch supporter of resource nationalism, could backfire and strengthen his party in approaching elections, putting at risk mining investments in the central Asian nation.
Former president Nambar Enkhbayar, freed on bail this week over corruption charges his family says were fabricated, is the most popular figure fighting the June 28 election, opinion polls showed just before his arrest on April 13.
Conspiracies abound in Mongolia, a former Soviet satellite that has become one of the world's most attractive investment destinations with first-quarter GDP growing 16.7 percent, and some speculate the robustly nationalist stance of Enkhbayar, president from 2005 to 2009, played a role in his arrest.
He wants to renegotiate a landmark 2009 deal that gave 66 percent of the huge Oyu Tolgoi copper project to Canada's Ivanhoe Mines, and also says the 7.5-billion tonne Tavan Tolgoi coal mine - expected to be listed on overseas stock exchanges next year - should remain in Mongolian hands.
Enkhbayar is likely to emerge stronger as a result of his arrest, said Luvsandendev Sumati, director of the Sant Maral Foundation, which polled voters in April.
"I think the aura of victimization will boost his popularity," he said, adding that a surge in his support would make it less likely that a single party could form a government.
Enkhbayar leads the Mongolia People's Revolutionary Party (MPRP), a breakaway faction of the ruling Mongolia People's Party (MPP). Before his arrest, he was expected to be a kingmaker in the new parliament.
"He is the father figure for resource nationalism, and the MPRP will definitely try to capitalize on this and maximize their chances to get more MPs in parliament," said Dale Choi, an analyst with Ulan Bator-based Frontier Securities.
"In parliament they will pursue their resource nationalism agenda, which will create more trouble for foreign investors."
ANTI-INVESTOR LAWS, DELAYS
More anti-investor legislation would be worrying, but an extended period of post-election uncertainty could also further delay action on crucial issues such as new mining laws and the development of Tavan Tolgoi.
The Tavan Tolgoi pact has been postponed several times, and its IPO has been delayed as the government struggles to find a way to satisfy domestic and foreign interests.
"We aren't sure who will win (the election) and I don't think this uncertainty is very helpful if Mongolia is to pass the laws it needs to pass," said a foreign mining executive.
Foreign investors have long coveted Mongolia's largely untapped mineral reserves, which have been valued at about $1.3 trillion, banker Macquarie says, even though just 27 percent of the country has been geologically mapped.
Its coal and copper deposits are among the biggest in the world, and southern neighbor China is a guaranteed market.
But while worries about Mongolia's frail legal system and volatile politics may have been sharpened by the arrest, few think the country - central Asia's only democracy - faces an extended period of disruption.
"I genuinely see it as electioneering and jostling by the candidates," said Eric Zurrin, chief executive of Resource Investment Capital, a fund with interests in Mongolia.
Foreign investors were already alarmed by a bid by vote-hungry rebel lawmakers to pass a law to ensure majority state ownership in strategic sectors such as mining and banking, but Zurrin said stability would return once votes are counted.
"Naturally foreign investors are cautious but this is exactly what we saw in Peru last year prior to the election, which then calmed substantially after a new government was brought in."
Experts say Mongolia's courts remain weak and vulnerable to political pressures, and even Enkhbayar's fiercest critics concede the case against him has been handled badly.
"The main political troublemaker in this country is Enkhbayar himself, and there has definitely been an attempt by our political elite to isolate and neutralize him," said Sumati.
Critics say Mongolia's showboating lawmakers have grown accustomed to parliamentary democracy, but remain ill-equipped to tackle tougher issues, preferring instead to draw up laws designed just to please voters.
The law to limit foreign investment, passed in diluted form on Thursday, was submitted by a group of rebel backbenchers who were also behind a much-criticized windfall tax imposed in 2006 and repealed in 2009.
"This law was not submitted because it is important for Mongolia - it's because election time is coming and they need to be loved and need to be liked," said Sambuu Demberel, head of the Mongolian National Chamber of Commerce and a prospective parliamentary candidate.
Mongolia's willingness to put populist politics first was in evidence recently with SouthGobi Resources. The new foreign investment laws were prompted by SouthGobi's parent company Ivanhoe's plans to sell its majority stake to Chinese aluminum giant Chinalco. SouthGobi has since seen its licenses suspended pending a corruption investigation.
Fears about China were central in another case involving a Canadian miner, Khan Resources, which is suing Mongolia after being stripped of rights to develop uranium in the country's northeast.
Khan, accused of trying to sell out to the China National Nuclear Corporation, said it only turned to China after it became clear Mongolia was trying to kick out the company to appease Russia.
Enkhbayar won bail after a hunger strike and a global campaign by his family and legal team.
"The current actions of the government have proved Mongolia is not a democracy, and it clearly shows the rule of law doesn't work over here," said Batshugar Enkhbayar, a former investment banker with J P Morgan and the ex-president's son.
"The MPRP has very strong support and therefore, my father's opponents made these false charges right before the elections."
Though Enkhbayar's family said the government broke its own laws to defeat him, critics of the former president said his arrest was proof that Mongolia's legal system had improved and that no one is above the law - not even elder statesmen.
"For me, and as far as investors are concerned, it is a positive development because there seems to be some progress in enforcement of anti-corruption regulations," said Choi.
But the election was unlikely to produce a government willing to turn against foreign investors, he said.
"Economic realities mean the ordinary Mongolian is more concerned about getting a job and not about transactions involving Chinese corporations."
(Editing by Clarence Fernandez)