(Deletes reference to MPRP ruling Mongolia for much of the 20th century in paragraph 5.)
By Terrence Edwards
ULAN BATOR, Dec 5 (Reuters) - One of the members of Mongolia's fragile coalition government has ordered its ministers to leave their posts, a move that has sent the country's bonds into a tailspin and could threaten the passage of crucial legislation.
Mongolian bonds plunged $7-$8 on Wednesday on the news that the populist Mongolian People's Revolutionary Party (MPRP) was no longer prepared to work with the free-market Democratic Party, the country's biggest party, following June elections.
Prime Minister Norov Altankhuyag was in Kyrgyzstan and no one has yet officially accepted the MPRP's resignation.
An end to the coalition, formed after a week of tense negotiations in July, would reflect the country's struggle to balance the interests of foreign investors with the need to appease growing nationalist sentiment at home, but tensions have also been stoked by the imprisonment of the MPRP's leader, Nambar Enkhbayar, on corruption charges.
The MPRP ordered all its members holding ministerial posts to resign during a meeting on Monday. The next day, party general secretary G. Byambasuren said the decision was made as a protest against Enkhbayar's imprisonment.
Last week, Mongolia's $1.5 billion debt offering was 10 times oversubscribed, with investors attracted by the country's copious reserves of coal and copper and its 17.3 percent rate of economic growth in 2011.
The new round of political instability has not only sent bond prices plummeting, but could also dissuade investors to participate in any future offerings.
Mongolia's government has stated that it plans to sell a total of $5 billion in bonds to finance the infrastructure required to develop its flourishing mining sector.
The final outcome of the MPRP's departure could "depend on how the exit is handled", said Vidur Jain, an analyst at local investment bank Monet Capital.
"This may affect the yields on the recently issued bonds, and make a second bond issuance more expensive," he said.
Enkhbayar, the MPRP's founder and leader, was jailed in August on corruption charges he said were fabricated. He is currently appealing against a four-year prison sentence.
The MPRP is one component of the "Justice Coalition", which fought the June parliamentary elections on a largely resource-nationalist platform. The party has called for the renegotiation of the Oyu Tolgoi copper project, now 66 percent-owned by Turquoise Hill Resources, a subsidiary of Anglo-Australian mining giant Rio Tinto .
It has also called for the huge Tavan Tolgoi coal mine, coveted by dozens of investment banks and global mining firms, to remain under domestic ownership.
Jain said the MPRP's departure could eventually be welcomed by foreign investors if it helps lift fears of growing resource nationalism in the country.
"If the current (Democratic Party) government could maintain control it would be positive for investors, provided the fallout is handled effectively, as the MPRP was strongly opposed to foreign investment," he said.
The MPRP's partner in the Justice Coalition, the Mongolian National Democratic Party, said it would remain a part of the coalition government.
The Democratic Party has 34 seats in parliament, five short of an overall majority. The Justice Coalition won 11 seats, including seven allocated to it through a system of proportional representation, which are now expected to be reallocated. (Editing by David Stanway and Nick Macfie)