Just until recently when the new century began, Mongolia was unable to acquire any loans from international capital markets. It was a time when we did not hold any currency in our hands, but had natural wealth buried underground. Foreign countries used to send us food and provided funds to fix our plants and buy coal so that the capital city would not freeze during the winter. Even the budget deficit was made up with foreign aid.
However, we have been extracting the natural wealth that lies underground using foreign capital and other resources, and selling it to China, our neighbor in the south. As a result, our economy has grown exponentially while GDP per capita today is ten times higher than it was 1990.
As the public budget got bigger, the same thing happened to its deficit. These days the budget deficit is well over ten percent of GDP. Although a law was passed two years ago to keep this deficit at two percent of GDP, the cap was changed to six percent last year. The expansion of economy allowed the government to raise foreign loans by issuing bonds. Any long term, government securities are always low-risk investments that yield regularly. Having low risk means smaller interest rates. The interest rates of bonds issued by local companies, both big and small, are always higher than that of government securities.
Besides being guaranteed, government securities are exempt from taxes and have a great fluidity, making securities available to be easily sold at any time. For this reason, government securities are heavily weighted in the market portfolio.
LEVEL OF RISK OUR GOVERNMENT BEARS
The interest rate of our government securities is too high. Six month securities have an annual interest rate of 16.4 percent, which is bigger than the 13 percent policy rate of our central bank. It is interesting that the government securities have interest rates which are also higher than the saving account rates of smaller banks (State bank 14.2 percent, Capital Bank 14 percent).
Does our government bear such high risks? The main reason is that the budget deficit continues to grow while the government spending is still higher than its revenue. As of the first quarter of 2015, the budget revenue was 1,228.5 billion MNT, which was 88.4 billion MNT short of its target. It appears that the gap will increase to 488.3 billion by the end of the year.
Transactions related to Mongolia’s public budget and debt paymets are made through the State Fund at the Mongolbank. Approximately 370 billion MNT goes through this account for payments related to the public budget. However, their checking account has a negative balance of 674 billion MNT. The public budget is currently coming from other accounts of the State Fund. Any deficits have been made up by domestic loans, i.e. three and six month securities issued by the government.
The interest of those domestic loans is paid with twelve percent of budget revenue. If the budget deficit is not reduced, we will be paying those interests with 25 percent of the budget revenue by the end of this year, and with the entire budget revenue by 2018. What will the government do then? Government securities worth 3.4 billion MNT will be issued this year.
Recognising this reality, in April this year, Standard & Poor’s (S&P) weakened Mongolia’s credit ratings and revised its outlook to negative. The ratings will be downgraded again if contractionary monetary policies are not pursued, off-budget spending is not cut, and domestic loans continue to be raised. Such lowered ratings will make it difficult to issue securities in foreign markets and to make payments on time.
MONETARY POLICY THAT IGNORES BUDGET DEFICIT
The Development Bank, which was established by the government in 2010, has handled approximately 5.6 trillion MNT in total, including its own 143.9 billion MNT, 580 million USD from Eurobonds, 1.49 billion USD from Chinggis bonds, 24.2 million JPY from Samurai bonds, and money from other sources.
The ministers at the time, along with Mongolbank authorities, came up with a ‘wise’ idea to print the equivalent of the incoming 2.4 billion USD in MNT, and inject the money into circulation. They concluded that tugrik would be in shortage and would get stronger when a burst of USD suddenly came into a small economy like ours.
The Government of Mongolia and Mongolbank established a memorandum of understanding on October 22, 2012, and started co-implementing the midterm price stabilisation program that targeted consumer products.
The initial agreement was that Mongolbank would make approximately two trillion MNT in total available: 167 billion for stabilising the retail fuel price, 303 billion for reducing costs of imported consumer goods, 248 billion for stabilising prices of main food products (87 billion for meat accumulation and 100 billion for meat storage), 379 billion for supporting the construction industry, and 800 billion for stabilising housing prices and eight percent mortgage. However, due to changes that took place over time, Mongolbank has put about three trillion MNT into the money market.
Since then Mongolbank has printed 3.1 trillion MNT and injected it into circulation. However, would Mongolbank be able to take the equivalent of the bond payments in cash, out of the money market?
Another step taken by the central bank to keep tugrik rates stable is the establishment of a currency swap agreement with the central bank of China.
The agreement would allow Mongolia receive up to 15 billion RMB (2.5 billion USD) while keeping the agreed amount of MNT in the central bank of China. If Mongolia cannot repay on time, the tugriks will be circulated in the market and used for repayment.
As of today, most of the 15 billion RMB has been used. The government will probably repay using the bonds, or extend the deadline. Mongolbank has transferred the loan balance of the long term housing loan to the relevant housing organisation, and handed over the balance of the price stabilisation program to the government.
The actions taken by Mongolbank look as though they are making up for foreign investment while supporting the balance of payments. However, it has become a silent support to the government in raising even more internal debts. The monetary and fiscal policies must be as independent as possible from each other.
2015.06.17