According to the National Statistical Office of Mongolia, money supply in our economy (including cash, balances held in checking and saving bank accounts, and foreign currency) reached 10.2 trillion tugrugs by the end of May, 2014. It was 30 percent higher compared to the money supply from the same period last year.Due to loans provided by commercial banks with money generated by government bonds and the housing program with 8-percent mortgage implemented by the government, the total outstanding loans have been increased by 46.5 percent compared to the previous year. Tugrug rate against U.S. dollar has declined by 26 percent while our foreign-exchange reserves fell to 2.2 billion USD decreasing by 38 percent.The rates of inflation and unemployment have reached 13.7 percent and 10 percent respectively.The increased inflation and tugrug decline have negatively impacted both the economy and the livelihood of people.
The government explained as if the economic crisis has solely been caused by reduced foreign investment in mining sector and has started taking actions to bring foreign capital back into the country by offering softer regulations regarding taxations and fees.However, the main reason behind the economic crisis is not that we lacked capital, but we suddenly had excessive capital that were used to fulfill election promises by handing out cash instead of utilizing the mining income to create values.Also, huge foreign loans were acquired by wagering our future income.
In economic terms, such miscalculated, irresponsible actions from the government could be explained by the loss of budgetary discipline, implementation of loose monetary policy, printing of paper money without backing, and having investors lose their trust by failing to have transparency in public governance and establish fair competition.
It is highly doubtful that the investors would come back when there is no guarantee that the past mistakes are fixed or not to be repeated.The biggest mistake is the loss of macroeconomic discipline, due to which budget expenditure has always been greater than its revenue, inflation has been increased, and the national currency has suddenly declined.A selective measure to fix this mistake altogether is to establish a currency board.Currency board was first introduced in the 19thcentury and was used by about 70 countries in the 1980s. Today, many countries have a currency board as well.
Taking this measure that suits Mongolia’s current conditions very well, we can peg tugrug to dollar and establish a currency board.The establishment of such board will allow us to have tugrug rates fixed against dollar rates, ensure free convertibility, reduce budget deficit, and control the balance of trade.
ENSURING CONVERTIBILITY OF TUGRUG TO DOLLAR
If the rate of national currency is fixed against the most commonly used foreign currency in the country, it greatly contributes to expanding foreign trade, accelerating turnover, and boosting confidence of investors.It means that the value of given national currency will be rigidly pegged to the value of another single currency, or to a basket of other currencies, and reserves of the foreign currency will be created to ensure free convertibility. A currency board is established to ensure that national currency in circulation is equal and sufficient to convert to foreign currency reserves.Some former socialist countries such as Estonia, Lithuania, and Bulgaria have successfully established such currency boards and enabled themselves to implement many important reforms and build a more capable and sustainable economy.
We should fix tugrug against dollar at 1800 or 2000, which makes it easier to calculate, stabilize the exchange rates, and ensure convertibility between the two. In order to do so, we will need to create and maintain dollar reserves that are equal to the total money in circulation with the eventual purpose to set the reserves as 110 percent of the base money. The base money, which includes required reserves commercial banks and the total cash in circulation, was 1.8 trillion tugrugs by the end of May 2014. It means that the foreign currency reserves should be around 1 billion USD.
In other words, there should be a separate law to be developed and passed in order to transfer the required reserves of commercia lbanks held by Mongolbank into an account of the currency board.Besides the account that holds those reserves, the responsibility to manage monetary policy will also be transferred to the currency board. It means that Mongolbank would only retain their right to provide oversight on operations of commercial banks. Also, Mongolbank will no longer be authorized to provide soft loans to banks as they do now and print and inject money freely into the market. Experiences of some countries show that a central bank can fulfill the same roles as a currency board.
STRENGTHENING MACROECONOMIC DISCIPLINE
When Mongolbank becomes unauthorized to be involved in the development and implementation of monetary policy, it will no longer be able to purchase domestic capital. As a result, Mongolbank will not be able to buy tugrug bonds that the government issues to make up for their deficit occurred in operating costs. Such conditions would prompt the government to balance their revenue and expenditure. When countries had a currency board that had greater authority than budget management and ensured good budgetary discipline, great success was achieved in a short amount of time.In the absence of a currency board, the central bank prints and injects money freely into circulation and causes inflation levels to go up.When there is a currency board, it is checked whether the national currency in circulation is in balance with the foreign currency reserves before injecting more money. Therefore, printing money is not easily done, which strengthens macroeconomic discipline.
REGULATORY MECHANISM FOR BALANCE OF PAYMENTS
If there is a balance of payments deficit, the money supply gradually decreases and the interest rates go up after some time, which increases incoming capital flows. Higher interest rates increase the value of national currency and causes deflation. Ultimately, it weakens absorptive capacity and reduces the balance of payments deficit.
In 1998, the government led by M.Enkhsaikhan attempted to establish a currency board and fix tugrug rates against dollar at 1,000 tugrugs for 1USD. However, the idea was not supported by the parliament.When there is an expansionary policy in place without being able to control inflation rates and tugrug decline, it would be a wise step from the government led by N.Altankhuyag to make a bold move, change the policy, and establish a currency board.If they realize and fix their past mistake, the government has time to revive the economy before the next elections. It would be better to make a decisive step rather than implementing the same measures from the past while terming them differently as ‘100 days to invigorate the economy.’
If we manage to establish a currency board, the interest rates of commercial banks would be one-digit numbers while the investors will find more faith in tugrug. Also, the value of tugrug will be fixed, thus, people will no longer be worried of losing the value of half of their savings.
The Baltic States that established a currency board 20 years ago achieved rapid development. It proves that such currency board is very suitable to small countries that practice free trade. Likewise, Mongolia needs to discover this opportunity to revive trade and investment, restore economic growth, and achieve sustainable development.
2014.06.18