Mongol Bank expects exchange rate to stabilize moving forward

On November 5, disgruntled business owners and individuals gathered in front of Mongol Bank to express their dissatisfaction with recent depreciation of the turgug against the US dollar. Many called on the central bank to take more action in regards to the depreciation...

On November 5, disgruntled business owners and individuals gathered in front of Mongol Bank to express their dissatisfaction with recent depreciation of the turgug against the US dollar. Many called on the central bank to take more action in regards to the depreciation.

The depreciation of the tugrug has affected the livelihoods and the businesses of many people, protestors said. They carried signs that signified the steep depreciation the tugrug was experiencing in addition to other signs and posters mocking politicians.

Many of the protestors expressed their displeasure with the central bank for not following through on its mandate of maintaining stability of the tugrug. The depreciation was especially pronounced in September, which saw the tugrug fall by more than 80 MNT against the US Dollar.

The central bank has explained that they believe the depreciation to be temporary and have pointed to the fact that many other currencies have fallen against the dollar due to a number of factors including changes in the benchmark interest rate of the US Federal Reserve.

Head of the Reserve Management and Financial Markets Department of the Bank of Mongolia A.Enkhjin sat down in an interview with Mongol Bank website to discuss the exchange rate and address the recent protests and public outcry.

A crowd was gathered outside of Mongol Bank demanding that the central bank take action to bring down the tugrug to US dollar exchange rate. They were critical of the fact that despite reserves exceeding three billion USD, the exchange rate stands at 2,560 MNT against one USD. Is there a possibility for the central bank to take action to address this depreciation?

Since the beginning of 2018, the tugrug has depreciated about 5.7 percent. As we have explained in the past, there are both external and internal factors that influence this.

Looking at the external factors, the US has been appreciating against most currencies in the last few months. Due to a recovering US economy and increasing employment, the US Federal Reserve is gradually tightening its monetary policy for the first time since the 2008 global financial crisis. Even though I say gradually, the Federal Reserve is tightening its policy more rapidly than analysts had predicted. It is expected to tighten even further moving forward.

Since 2015, the Federal Reserve has increased its benchmark interest rate a total of eight times. In 2018, it has modified its rate three times. Most recently, the benchmark interest rate was increased to 2.25 percent on September 26. This increases the return on the dollar.

Since the return on dollars has increased, attracting US dollar investments has become more costly. This has led to a mild capital flight in US dollars from developing countries. The supply of US dollars is decreasing globally, this has led to many currencies depreciating against the dollar.

Since 1990, Mongolia’s current account on the balance of payments has always been in a deficit. The deficit as of September 2018 is 1.2 billion USD. The balance of payments overall has a deficit of 475 million USD. What this signifies is that the production and export of Mongolia’s economy has not been enough to cover its expenditure and imports. This discrepancy is covered through foreign investments and foreign aid and loans. Regarding loans, when the interest rate of the dollar increases, it becomes a lot more costly. There are some circumstances where some countries can’t even access outside funding. According to our research, as of the end of September, 84 of the 170 currencies in the world have depreciated four percent or more compared to the beginning of the year.

Therefore, the tugrug has depreciated relatively less than other currencies. Our balance of payments has a large deficit. Following economic recovery, imports have risen 40 percent. In the first nine months of 2018, imports rose by 1.2 billion USD compared to the same period last year. This means that Mongolia has to source 1.2 billion USD from external sources. Therefore, unfavorable external sources only worsen the situation.

On the other hand is the uncertain future of the Chinese economy. In what has been 20 year period of consecutive growth for China, the momentum seems to be slowing down. In addition, the escalating trade war with the US has hurt the Chinese economy. If this continues, this will affect the economic prospects of Mongolia rather significantly. As you know, 88 percent of our exports are mining products and 90 percent of our exports are to China. If the Chinese economy loses momentum, our economy suffers.

The second and third quarter signify an increase in economic activity in Mongolia. Between August and October, increased imports of fuel due to winter preparation, higher demand for consumer imports, and the coinciding repayment of foreign debt obligations has created a surplus of dollar demand on the forex market. The depreciation of the tugrug observed in the last three months are believed to be short-term fluctuations that happened due to temporary discrepancies between supply and demand.

In October, depreciation has largely subsided and we believe this will continue for the near future. In the winter months, the economic activity decreases, therefore we believe the tugrug will stabilize also. The foreign exchange reserves have also reached 3.4 billion USD with the 500 million USD bond issued by Development Bank of Mongolia (DBM). This is the highest it’s been since 2013. We believe since copper and coal prices have been relatively high, this trend will continue.

Is it possible to take policy action to not stabilize the exchange rate but to decrease it?

Since the beginning of 2018, Mongol Bank has provided 813 million USD to the market through auction sales. Therefore, Mongol Bank is not just sitting by idly accumulating its reserves. It has provided almost a billion USD to the market. The fact that the exchange rate is not decreasing when we are providing almost a billion USD to the market signifies that our economy is faulty structurally. The economy is dependent on a few commodities.

In countries with a high current account deficit, currency depreciation signifies a need to decrease imports. In addition, if we do not expand and diversify our economy and the current account deficit trend since 1990 continues, Mongolia will continue to be in a difficult situation economically.

Therefore, it is important for the government to focus on diversification of exports, reform of the economic structure, and reduction of the current account deficit. Foreign direct investment is an important aspect in this. Mongolia can cover its current account deficit through loans and aid or through foreign investment. Loans must be repaid. Investment however does not have to be repaid. The investors carry the risk themselves. As a result, attracting investment is a critical aspect in this issue. For example, if the Erdenes Tavan Tolgoi IPO is successful, this will have a good effect on the exchange rate. If a railway is built, it is said that coal exports can increase by 20 million tons. This will inevitably help in covering the current account deficit.

The 2019 state budget was approved with a pretty large deficit. How do you forecast the fiscal deficit will affect exchange rates? What policy actions must be taken in the future to ensure that the exchange rate is stable?

The 2019 state budget has an expenditure of 12 trillion MNT. When fiscal expenditure is expanding, this sometimes requires that the monetary policy be tightened in reaction. In a country dependent on two or three commodities and largely dependent economically on one country, the foreign exchange reserve is less of a mechanism to influence the exchange rate and more to do with ensuring the national security of the country. Even though we were able to postpone large debt payments in 2016 and 2017, we will need to pay them in 2020. If we do not plan on how to repay these debts, we will have a repeat of 2016 and 2017. If the economy keeps crashing every three or four years, how will we develop? This is why strengthening buffers such as the foreign exchange reserve is so important.

Mongol Bank recognizes that in a situation where 40 percent of our basket of goods is imported goods, any fluctuations in the exchange rate will be hard on the general public. It has been trying to stabilize the exchange rate by pumping 800 million USD into the market. The exchange rate has been stabilizing since October. We believe this trend will continue.

Can you please give us more information about the currency swap agreement with the People’s Bank of China?

In 2017, we extended the agreement by three years. The total amount for the agreement is 15 billion RMB. Around 12 billion RMB has been expended by Mongol Bank. We will not have to repay until 2020, when the swap agreement is up. So it will not be a point of pressure on the reserve until then.