Multilaterals to Mongolia - be prepared, so far it seems that only Bank of Mongolia is listening


According to World Bank on February 28,2011 GDP growth in Mongolia accelerated to an unprecedented 17.3 percent in 2011 from 6.4 percent in 2010 and the unemployment rate fell from 13 percent in 2010 to 9 percent in 2011. However, real wages for unskilled workers in the urban informal sector are starting to fall as the inflation rate reached 11.1 percent yoy in December. Sharply rising government spending is the root cause of overheating: government spending rose by 56 percent in 2011 and is budgeted to rise by a further 32 percent this year, fueled by sharply rising resource revenues. This pro-cyclical fiscal policy could result in another “boom-and-bust” cycle Mongolia experienced before, particularly as the global economy could face a substantial slowdown in growth due to the continuing European sovereign debt crisis, and which could result in a sharp drop in mineral prices and subsequently government revenues. 

According to Bank of Mongolia on February 7,2012 IMF Representative to Mongolia Steven Barnett commented on Mongolian economy’s key short-term challenges and risks

Overheating. The economy is overheating or, put more simply, is growing too fast. It may sound funny to say an economy is growing too fast, but more is not always better when it comes to growth. Growing too fast in the short run leads to significant problems, such as high inflation, exchange rate volatility, wage pressures, Dutch disease, and the list goes on. These could also heighten fears about “hard landing” especially if external shocks hit the economy. This macroeconomic instability, in turn, has substantial long

run costs that include making it more expensive to do business in Mongolia, discouraging investment, and making Mongolian firms less competitive globally. The inflation,

moreover, has a particularly hard impact on the poor.

So in sum, the overheating today leads to higher poverty and lower growth in the future. This is a bad tradeoff.

Inflation. Inflation has been stubbornly high in Mongolia, which is not surprising given the phenomenal growth in government spending. Headline inflation is often volatile in Mongolia, due mainly to food price shocks. It is helpful, therefore, to look at a measure of underlying inflation that removes the impact of changes in food and administered prices. This measure has been much more steady and has hovered around 15 percent most of last year and was running at over 16 percent in December. This is also too high and, moreover, is above the policy interest rate. So while the nominal level of the interest rate may seem high—12 ¼ percent—it is actually extraordinarily low in an economic sense. Specifically, adjusted for inflation, the policy interest rate has been negative for much of last year and is still negative today—on the order of -4 percent. A further hike in the policy rate, therefore, is warranted and would help contain inflation. It does so through two complementary channels. First, it slows credit growth by making it more expensive for firms to borrow, thereby reducing demand as a partial offset to the demand impact of surging government spending. Second, it will also help ease the depreciation pressure on the togrog by making it more attractive to hold togrog deposits. And, clearly depreciation of the currency is contributing to inflation by raising the price of imports. Although raising interest rates to contain inflation works, in part, by strengthening the currency, this is fundamentally different and should not be confused with targeting the exchange rate. The exchange rate would remain flexible and evolve in line with market conditions, it is just that the interest rate hike itself alters the market conditions.

According to Bank of Mongolia on 11/3/2011, Governor of Bank of Mongolia L. Purevdorj has said in a speech in Parliament session

  • Economic growth in first 3 quarters of 2011 is record 16.7%
  • Foundation for this growth is rigorous growth of total demand. Capital inflow into Mongolia has increased by start of major mining projects.  Funding for banks has increased dramatically, loans are rapidly increasing and feeding growth of the private sector
  • Although of course there is influence of budget expansion, on the other hand there is rapid increase in personal consumption and imports, there is more demand than the supply and this incites inflation. Credit growth is influencing consumer prices. Price of capital is increasing too.
  • Limiting inflation at single digits  is a maximum limit for economy to grow in stable manner, sustain investment , keep confidence in tugrug and not to lose confidence of foreign investors
  • When inflation goes above 10 per cent it creates uncertainty in making consumption, investment, loan and savings decisions. Even at 10 percent it is clear that it would be significant challenge to keep living standards of the citizens and reduce poverty
  • On the other hand, such level of inflation has become a main obstacle to reducing loan interest
  • Therefore, keeping inflation at single digit is maximum allowable high limit
  • In another words, it is proper to make aim that total impact of budget and monetary policy on consumer price growth  should be within single digits.
  • Bank of Mongolia’s monetary policy is aimed at having economic growth sustainable and stable in medium and long term. This is expressed by a requirement not to have current short term ultra-high economic growth as a premise for medium term depression. Significance of such policy is even more amplified in 2012.


Further, according to World Bank, government spending in 2011 was almost double that in 2009 in real terms, and mainly reflects pre-election year pressures, efforts to make good on earlier political promises for large cash transfers and large increases in capital expenditures. Because of high revenues, the government budget deficit is still modest: the 2011 deficit amounted to 3.6 percent. However, the structural deficit (based on long run commodity prices as defined under the Fiscal Stability Law) is much higher at 8.5 per cent

The IMF Representative commented on fiscal policy

  • The main cause of the overheating and economic volatility is fiscal policy. Specifically, the large and risky increases in government spending. Government spending increased 60 percent last year and is set to rise a further 30 percent this year. This is staggering growth and implies a doubling of government spending in just 2 years. This is simply too much demand and leads directly to higher inflation, a substantial increase in imports, exchange rate volatility, and a squeezing-out of the private sector. So first and foremost, what the Mongolian economy needs is for an immediate scaling back of government spending to a much more prudent rate of growth. 

The Governor of Bank of Mongolia has said

  • there is no choice but to admit that it is improper that in recent years our country is implementing  pro-cyclical policy
  • budget is expanding too fast, we are faced with real economic overheating, state participation is increasing in composition of GDP which is becoming main channel for spread of Dutch disease. Because of high inflation and tugrug appreciation, real exchange rate for tugrug is appreciating.
  • state is increasing and pushing away private sector growth
  • on top of this, high salaries are entering mining sector and sudden hike in salaries of public servants is causing weakening of competitiveness of our private sector and non-mining sectors
  • although the economy is growing, growth of sustainable and stable income of citizens is insufficient
  • we are faced with a necessity to make more wider distribution of growth, increase in productivity and jobs, priority development for private sector including processing industries

At the same time, according to World Bank, there have been major legislative developments in 2011 and early 2012 aimed at strengthening policy institutions and frameworks.

The Integrated Budget Law (IBL) was passed in December 2011:  this organic budget law contains measures to support fiscal sustainability and the successful implementation of the Fiscal Stability Law. It also strengthens the public investment framework by requiring feasibility studies and alignment with national priorities for projects to be included in the Public Investment Program and the budget. This will help permanently lock in prudent fiscal policies and mechanisms in the future alongside the FSL. 

The Social Welfare Law was passed in early January. This mandates the provision of a targeted poverty benefit replacing the existing system of universal cash transfers. This represents a major step towards setting up a fiscally sustainable social protection system while supporting Mongolia’s poor- it is expected to reach about 130,000 poorest households, or one-fifth of all households in Mongolia. 


Further according to World Bank, on the monetary front, the Bank of Mongolia (BoM) took significant action to curb inflation and lending growth in 2011. But with inflation still high, the real policy interest rate negative and bank lending expanding at a staggering pace (73 percent yoy), more tightening is needed. Liquidity risks are also rising and a large amount of NPLs remains on the loan books. Given the easy convertibility between dollar and local currency accounts the banking system remains vulnerable to capital flight, if macro-prudential action is not taken to strengthen it. Such action could include, in addition to the recently introduced additional capital buffers for systematically important banks, the use of additional provisioning requirements for highly volatile sectors such as construction, mortgage and consumer loans.

The IMF Representative commented on policy mix

  • The loose fiscal and tight monetary policy is not a good mix. In effect, it results in a bigger government and a smaller private sector. So yes, monetary policy works by squeezing the private sector to offset the excessive expansion in the government sector. A much better mix, therefore, is to significantly reduce government spending and create more space for the private sector. Fiscal policy therefore must take the lead and start by lowering spending in 2012 budget. At the end of the day, Mongolia will need a much more prudent fiscal policy to succeed in converting its coal and copper resources into an inclusive growth path that spreads prosperity to all Mongolians.

The Governor of Bank of Mongolia has said

  • In order to combat inflation which is caused by continuously increasing demand, Bank of Mongolia has been tightening its monetary policy. Also there was additional reason stemming from rise of certain products with state regulation and fuel in May-June and rise in price of other goods through increasing transportation costs
  • Bank of Mongolia is enforcing on regular updated basis prudential ratios of the banks in countercyclical manner and this work will be intensified in correlation with future developments
  • Capital funding for banking sector has increased and capacity to sustain private sector investment and development has dramatically increased. In Q3 2011 YTD, banking assets have increased by 26.7% to 8.1 trillion MNT, loans have increased 48.2% and reached 4.9 trillion MNT.
  • State policy should be aimed at as full as possible exploitation of increasing capacity of finance sector. Above all, macro condition will play decisive role in this. Specifically, starting from 2013 by latest it would be critical to keep budget expansion at proper level, stabilize inflation at low level and soften monetary policy. Without this it is impossible to support growth of private sector, create stable and sustainable source for income and jobs and substantially reduce poverty


Further, according to World Bank, the togrog depreciated by 11 percent during 2011 reflecting high domestic inflation and declining commodity prices towards the end of last year, factors that similarly impacted the currencies of other emerging mineral-rich economies. Going forward, exchange rate flexibility remains crucial. It will reduce the risk of one-way speculative bets on the currency and allow the economy to better absorb external shocks such as commodity price shocks without transmitting these directly to budgetary and export revenues as in the previous bust in 2008. More significantly, it will help the economy adjust through movements in the nominal exchange rate rather than through sharp cuts in domestic wages, employment and prices that hurt the real incomes and profits of workers and businesses. Finally, exchange rate flexibility is desirable in that it will reduce incentives for the private sector or banks for taking on unhedged risk.

The IMF Representative commented on exchange rate

  • the flexible exchange rate regime is working and must be maintained. Indeed, the flexible exchange rate is the single most important policy difference between today and the last crisis. Going back to targeting or controlling the exchange rate, as was the case in 2008, would be a big mistake and make conditions even riper for a repeat of the last crisis. Exchange rate volatility is unpleasant, so the public and political concern in this area is understandable. The central bank can continue to intervene to smooth excessive volatility. What it should not do, however, is target a specific level of the exchange rate. It simply does not work, and the main effect is a loss of international reserves. While reserves buffers are much higher than in 2008 and even higher if we factor in the welcome swap line with the People’s Bank of China), they are not enough to defend an exchange rate target. While such a policy may seem to work for a short-period, as reserves are run-down the speculative attack would accelerate and the end-result is a large, abrupt, and painful jump in the exchange rate as was seen firsthand in the 2008-9 period. That mistake should not be repeated

The Governor of Bank of Mongolia has said

  • Although nominal exchange rate of of tugrug has been stable YTD, imports with consumer features are rising fast, deficit of balance of payments has dramatically increased, and almost total dependence of export from mining revenues is further weakening immunity of the economy from the external shocks
  • Risk of economic crisis is not declining in case of negative changes such as decline in commodity prices, slowdown in foreign exchange inflows or increase in outflows


Further according to World Bank, the trade deficit reached record levels (US$ 1.7 bn in December 2011) as imports of mining-related equipment and fuel imports have surged. But exports also grew strongly, reaching US$ 4.8 bn in December from US$ 2.9 bn a year ago supported almost entirely by coal shipments to China. The current account deficit widened to 35 percent of GDP from 14 percent in 2010, but was fully funded by record FDI inflows of US$ 5.3 bn or almost 62 percent of GDP on a four-quarter rolling sum basis.




Further, according to World Bank , to ensure macroeconomic stability and to prevent a hard landing for the economy in case of an adverse external shock, Mongolia needs to adhere strictly to prudent fiscal policies as set out in the FSL and IBL and tightening both fiscal and monetary policy to reduce inflation, take macro-prudential action to reduce systemic risks in the banking sector and maintain a flexible exchange rate that will act as the first buffer in any external shock materializes

These are uncertain times for Mongolia. The economy faces growing headwinds from the global economic environment, while the looming elections increase domestic uncertainty. Until a substantial amount of savings has accumulated in the stabilization fund, Mongolia remains strongly exposed to volatility in commodity prices. With global economic prospects diminishing, and with any potential stimulus package from China unlikely to be focused on infrastructure as during the last global financial crisis in 2008-09, extra caution is warranted.

“Be prepared” sums up the appropriate policy advice at this point in time. Mongolia’s policy-makers realized the importance of “being prepared” when they passed the landmark FSL in June 2010. It is now critical to  adhere to the principles contained in this law, in order to ensure that the country’s vast coal and copper resources are converted into sustainable growth that improves the welfare of all current and future Mongolian citizens.

The IMF Representative commented on global risks

  • The global economy is at a particularly dangerous point, and there is a real risk of a substantial slowdown in world growth similar to what happened in 2008. While the biggest concern is the European Sovereign Debt Crisis, no part of the world would be immune from the fallout. For Mongolia, the biggest implication would be from a significant drop in copper and coal prices, just like 2008, which would hit the economy extremely hard. In fact, Mongolian policymakers are repeating the very same mistakes that led to the 2008-9 economic crisis at the worst possible time. The return of boom-bust policies at this dangerous juncture in the global economy makes the Mongolian economy vulnerable to another crisis. The upcoming elections in Mongolia are another source of uncertainty and could lead to a political accident that triggers an abrupt loss of confidence. Fortunately, the economy is not at that point yet but urgent policy action is needed to put the economy on safer footing. 

The Governor of Bank of Mongolia has said

  • World economic uncertainty is prolonging. IMF and World Bank are warning that world economy is going to next economic crisis
  • Growth has stagnated in developed economies , depression has started and growth in China might decline
  • As a negative result of this, there is a risk of decline  our exports revenues especially copper, increase in foreign trade deficit and loss in budget revenues in a short time
  • Therefore probability is rising of repeat of economic crisis of 2008-2009
  • That’s why measures to overcome possible external shocks  should be installed in the budget and monetary policy as wide as possible
  • Our country that has high capital inflow and rapid economic expansion has no choice but to urgently implement proper countercyclical macro policy of reducing vulnerability to economic difficulties and capacity to overcome challenges
  • main criteria of proper macro policy is not fixing negative effects of wrong policy with another policy but in having integrated policy aimed at creating condition for sustainable and stable development

Frontier Securities Conclusion:

It appears that there is multilateral consensus on Mongolian economy’s key short-term challenges and risks as communications from World Bank and IMF echo each other and the keyword is prudence.

Mongolia has no shortage of prudent fiscal policies framework as set out in the FSL and IBL. The question is implementation.

Non-implementation of FSL and IBL , not sticking to promise of ending cash handouts and failure to control inflation would be early indicators of resource curse and Dutch Disease further spreading in Mongolia.

Dale Choi

Chief Investment Strategist,

Frontier Securities