Latest policy interest rate reduction seeks to lower commercial bank interest rates
Unuudur sat down with the Head of the Monetary Policy Department at the central bank B.Bayardavaa to discuss a recent decision by the Monetary Policy Committee to lower the policy interest rate by one percentage point and the effect it will have on the Mongolian financial sector.
The Monetary Policy Committee of Mongol Bank reduced the policy interest rate by one percentage point. The opinion on this decision seems to be divided on whether or not it was too early or timely. What financial and economic goals did the committee have in mind when making this decision?
First let me report briefly on what was discussed and decided by the Monetary Policy Committee. The committee discussed three issues. Firstly, the possibility of reducing the policy interest rate. Secondly, the discussion of decreasing the minimum requirement of reserves in order to alleviate the unofficial dollarization in the economy. The third issue discussed was the strategy for the policy strategy in the macro economy.
The policy interest rate was ultimately brought down to 10 percent. In the past, the minimum assets required to be held by banks in foreign currencies was 12 percent while the assets in required to be held in tugrug was also 12 percent. The most recent decision saw the decrease of the minimum assets required to be held in tugrug to 10.5 percent, while the requirement for the foreign currencies was kept intact.
A working group mandated by the committee began drafting a policy strategy for the macro economy by the decree of the Mongol Bank governor. The policy strategy drafted by the working group was introduced in the committee and a subsequent detailed plan was commissioned.
It is a good thing that economists are debating whether it would be better to increase, decrease, or maintain the current policy interest rate. The biggest factor in the ultimate decision to decrease the policy interest rate was the inflation forecast. In 2018, inflation is expected to remain at the ideal target of Mongol Bank. As of February 2018, national inflation rate is at 6.9 percent while it has reached 8.1 percent in Ulaanbaatar.
According to the forecast of Mongol Bank, inflation will remain around 7.1 percent in 2018. In the next two to three years, we have a stated objective to maintain inflation at around eight percent. As inflation rate is likely to remain below eight percent or in the ideal range, this helped us reach the final decision to decrease the policy interest rate by one percentage point.
Seeing as there was an opportunity to do so, we also saw it was beneficial for activating the business sector while reducing the cost of financing. The season for business activation has also begun.
It is said that monetary decisions have a measurable effect on the economy later down the line. When will we see the effects of the decrease in policy interest rate?
It is generally said that decisions from the monetary policy affect the next four to six quarters; it is also dependent on a number of issues including the economic forecast, market conditions, health of banks, and the financial capacity of lenders. The economy has recovered relatively well and the foreign markets have favorable conditions as of now. In a time when the expectation of market participants has improved, we believe that the policy decisions will have a faster impact.
There is expectation that decreasing the policy interest rate and the minimum amount required to be held in tugrug will contribute in decreasing interest rates. Moving forward, loan supply is set to increase further, which will decrease savings interest rate. By decreasing the policy interest rate, banks will have more of a vested interest in providing loans to the economy rather than buy the securities that the central bank offers.
By our calculations, a sum of these actions will increase loan supply, foster competition, and ultimately reduce the interest rates of loans. The financial capacity and resilience of businesses and companies greatly suffered due to the economic crisis in the past years. On one hand, demand and sales decreasing also had an effect. On the other hand, a lot of companies that had taken out a loan in a foreign currency suffered because of the depreciating tugrug.
Even the businesses that took out loans in tugrug have had substantial debt pressure. Due to the fact that most of the businesses have experienced a deterioration of their finances, the opportunity to receive a loan decreased greatly.
However, beginning in 2017, the economy grew five percent. We are essentially only just getting out of the crisis. Following the resurgence, household income has risen while sales have followed suit.
As sales increase, the revenue and cash flow of businesses also increases, helping speed up the loan repayment process. The decrease in the policy interest rate also allows an opportunity for companies to refinance their existing loans with cheaper loans.
You say that inflation will be stabilized at eight percent. Would this inflation rate count as high or normal?
This is all relative. Looking at the structure, development, and debt of the Mongolian economy, seven to eight percent inflation is seen as stable. Of course, in the long-term, the inflation rate needs to decrease. But if the central bank sets forth the goal of maintaining a five percent inflation rate, it will not be able to do so.
Inflation and the expectation surrounding the economy have not stabilized yet. On one hand, the trust of market participants in legislators and policymakers is low. Therefore, we must seek the confidence of market stakeholders through the decisions of policy makers and their capacity to maintain stability in the economy.
If the expectations of market participants and businesses stabilize, there will be a better opportunity to decrease inflation. However, we must take into account the fact that since Mongolia is highly dependent on mining, the economy is vulnerable to shocks.
In other words, it is an economy with a bad immune system. In this situation, the impacts that foreign currencies can have on the economy are rather significant. In today’s conditions, it would be unrealistic for us to set forth a goal to maintain inflation at flat rates seen in developed economies. However, in the mid-term, more action must be taken to decrease inflation step by step.
By how much will money supply increase as a result of the decrease in the policy interest rate?
Thanks to the funding by Cabinet to alleviate fiscal deficit, money supply increased rather exponentially in 2017. This year, the majority of the money supply will be loans that are provided to the economy. The growth of loans that are provided to the economy is currently at nine to 10 percent.
The majority of these loans are loans by individuals. We are interested in directing loans towards the business sector, helping to create more jobs. Moving forward, the capacity for the bank to increase individual loans is limited. Therefore, banks will search and compete to finance realistic and low-risk projects.
In the end, the projects that support economic activation better and those that create more jobs will be financed more. By our calculations, loan supply will increase by 17 to 18 percent to reach 2.5 billion MNT.
You have mentioned that lowering the policy interest will play a large part in helping decrease the interest rates. How much do you expect the interest rate to decrease by?
It is hard to say that it will drop by an exact figure. There is a calculation that the rates could potentially fall by one to two percent. I will elaborate on why there is no reason for the rates to not go down. The lowering of the policy interest rates changes the asset structure of banks. The benefits from purchasing low-risk investments such as government and central bank bonds have been decreased significantly. By providing new loans to the market, the banks will be forced to search for new ways to maintain the benefits that securities provided. More banks providing more loans result in increased loan supply. Since the Mongolian market is relatively small, there is bound to be fierce competition. If a bank loses out amidst the competition, their revenue and profit will drop.
In order to get ahead of the race, banks have no choice but to provide loans to good projects with low interest rates. In addition, in order to meet the expectation of revenue and profit, the savings interest rate will have to be lowered.
You said that the minimum assets required to be held was decreased in order to alleviate the unofficial dollarization of the Mongolian economy. What was this logic based on?
In order to maintain the integrity of its solvency ratio, a certain portion of the assets held in a commercial bank is always stored at the central bank. The minimum assets that need to be held in tugrug have been decreased while the minimum assets required to be held in foreign currency will remain the same. Storing assets in tugrug decreases the loss opportunity by 1.5 percent.
If banks start receiving more tugrug as assets rather than foreign currencies, loans in tugrug will decrease while loans in foreign currency will increase. This will allow companies to take out loans in foreign currency, helping offset the potential for exchange rate fluctuations.
The risk that comes with foreign currency loans will be reduced while the non-performing loans of banks are expected to also decrease.
Right now, it might be fine, but in the future, the price of commodity exports or its demand decreasing will have a large detrimental effect on the economy. This decision will help build an immunity and reserve to help Mongolia overcome the next shock. It is vital to begin building that immunity and reserve starting now.
Won’t the solvency ratio of banks be worse off if the minimum requirement of held assets is decreased?
The solvency ratio of banks is relatively good right now. In accordance to regulation, 25 percent of an asset with good liquidity must be held in the reserves at the central bank. Most banks have surpassed 40 percent while some have even exceeded 50 percent.
The decision to increase the policy interest rate was mainly explained as a measure to protect and stabilize the exchange rate of the tugrug. How will the most recent decrease affect the exchange rate?
There is a thing called currency crisis. I translate it as a crisis of the national currency. The exchange of tugrug into foreign currencies and the outflow of capital are indicators of this crisis. There are instances where countries fall victim to this. It was less to do with stabilizing the exchange rate but rather preventing the national currency from going under a currency crisis.
If this crisis continues for long, it creates instability in the financial system. The balance of payments of Mongolia is doing relatively well; therefore we do not expect the reduction in the policy interest rate to affect the exchange rate negatively.