Mongolian Togrog (MNT): A Fundamentals-Driven View

1. ResCap
Nov October 2012
30, 2010
November 30, 2010
Resource
Investment
Capital
Equity Research | Mongolia
A fundamental perspective on the Mongolian togrog (MNT)
Mongolian Togrog (MNT): A Fundamentals-Driven View
EXECUTIVE SUMMARY
Country data
Capital city
Land area
Population
Language
Currency
Fiscal year
Ulaanbaatar
1,566,500 sq. km
2.8 million (2010 census)
Mongolian
Togrog (MNT)
FX rate 2011: MNT1,266:US$1
January – December
Economic indicators (2011)
GDP (per capita) (US$)
Real GDP growth (%)
CPI (%)
Foreign reserves (US$)
8.5bn (3,045)
17.3
10.2
2.5bn
Political structure
Official name
Mongolia
Form of state
Republic
Legislature
Single-chamber parliament
with 76 members
President
Elbegdorj Ts. of the
Democratic Party
Prime
Altankhuyag N. of the
Minister
Democratic Party
Elections
June 2012 (parliamentary)
and May 2013
(presidential)
Central bank
Purevdorj L.
governor
Parliamentary
Enkhbold Z. of the
speaker
Democratic Party
Nagi Otgonshar
+976-7010 0095
nagi.otgonshar@resource-cap.com
Enkhbayar Davaatseren
+976-70 100095
enkhbayar@resource-cap.com
The Mongolian economy experienced a robust recovery from the 2009
financial crisis, recording economic growth of 6.4 percent in 2010 and 17.3
percent in 2011. This rapid expansion has continued through the first half of
2012 with real GDP growth of 13.2 percent outpacing many other emerging
and frontier nations. The contents of this report discuss key macroeconomic
trends and policy factors in Mongolia and their potential effects on the
Mongolian currency (MNT).
Since the implementation of a flexible exchange rate mechanism in 2009, the
togrog has experienced substantial volatility. The global financial crisis and
sharp declines in commodity prices contributed to a 38 percent depreciation
relative to the US dollar between October 2008 and March 2009. However,
with a rapid economic recovery, the togrog became the world’s second bestperforming currency in 2010, finishing the year 13 percent higher against the
US dollar behind the South African rand, which appreciated 14 percent.
After an 11.4 percent depreciation against the US dollar in 2011 on the back of
global risk aversion, the togrog has appreciated markedly in the first half of
2012, rising from Tg1,396.4:US$1 at the end of December 2011 to
Tg1,329.8:US$1 at the end of June 2012. Bank of Mongolia (BoM) intervention
in the currency market has helped curb the togrog’s appreciation, which we
believe was tied to political motivations prior to the June 2012 election.
An important characteristic of the MNT is the very small speculators market
which does not impact the movement, unlike other major global currencies.
The MNT is driven predominantly by capital flows which we forecast are tied
very closely to the prospects of Oyu Tolgoi and Tavan Tolgoi mining projects in
Mongolia.
The dynamic macroeconomic environment in Mongolia will exert both upward
and downward pressure on the local currency. In the short-term (6-12
months), we expect the togrog to experience continued volatility and
downward pressure, driven by high domestic inflation, a widening trade deficit,
rapid money supply expansion, declining commodity prices, and global
macroeconomic risks. Political risk, particularly given the uncertain policy
environment after the recent change of government, will be another source of
volatility for the togrog. In the medium- and longer-term, however,
macroeconomic trends and policy factors are expected to support modest
currency appreciation. This will be driven by strengthening export prospects
contributing to trade surpluses driven by Oyu Tolgoi exports, effective fiscal
and monetary policy, political reform and the robust recovery of the financial
sector in Mongolia, among other factors.
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2. ResCap
November 30, 2010
Resource
Investment
Capital
Equity Research | Mongolia
A fundamental perspective on the Mongolian togrog (MNT)
Mongolian Togrog (MNT): A Fundamentals-Driven View
Table of Contents
EXCUTIVE SUMMARY............................................................................. 1
MACROECONOMIC OVERVIEW ............................................................................. 2
Economic growth ........................................................................................... 3
External sector ............................................................................................... 5
Commodity prices .......................................................................................... 6
Foreign direct investment .............................................................................. 7
Fiscal policy .................................................................................................... 8
Monetary policy ............................................................................................. 9
Banking sector .............................................................................................. 13
Exchange rate ............................................................................................... 14
CASE STUDY : THE ECONOMIC IMPACT OF OYU TOLGOI……………………………….….16
SUMMARY AND CURRENCY IMPLICATIONS ........................................................ 17
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3. Resource
Investment
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ResCap
November 30, 2010
Equity Research | Mongolia
A fundamental perspective on the Mongolian togrog (MNT)
Mongolian Togrog (MNT): A Fundamentals-Driven View
Macroeconomic overview
Economic growth
Mongolia’s transition from a centrally-planned economy to a marketoriented economy began in 1990 with the country’s democratic revolution.
The period between 1990 and 2000 was fraught with challenges for the
transition, including periods of hyperinflation, high unemployment, food
and production shortages, natural disasters, and the Asian and Russian
financial crises. Gross Domestic Product (GDP) growth reached a low of 1.3
percent in 2000, and began to improve in the mid-2000s as the private
sector developed and the country’s mineral wealth became exposed to
global markets. By 2003, the private sector comprised 70 percent of
Mongolia’s GDP. Figure 1 presents an overview of Mongolian GDP and
growth trends as compared to the Organization for Economic Cooperation
and Development’s (OECD) Asia-5 nations (Indonesia, Korea, Malaysia, the
Philippines and Thailand), those most affected by the financial market
turmoil since 1997.
Figure 1: Mongolian GDP (US$bn) and Growth (%) Compared to Asia-5 (OECD)
35.0
20.0
17.3 17.2
30.0
25.0
14.0
10.2
11.8 12.2
15.0
10.0
20.0
15.0
(%)
(US$ billion)
Mongolia’s economy recovered
strongly from the domestic
downturn of 2009, with GDP
nominal growth of 6.1 percent in
2010 and 17.3 percent in 2011
5.0
10.0
0.0
5.0
0.0
-5.0
2005 2006 2007 2008 2009 2010 2011 2012F 2013F 2014F 2015F 2016F 2017F
Mongolian GDP (LHS)
Asia-5 GDP growth (RHS)
Mongolian GDP growth (RHS)
Source: Bank of Mongolia, Bloomberg
Mongolia was hit hard by the global financial crisis in 2009, largely due to its
reliance on trade with China, sensitivity to global commodity prices, and
unusually harsh weather conditions (known locally as “zud”) between 2008
and 2010. However, the Mongolian economy recovered well, with GDP
growth of 6.1 percent in 2010 and 17.3 percent in 2011, outperforming
many other emerging and frontier economies. Figure 2 shows the origins of
GDP in 2011, with the largest contributing sectors as industry (25.1 percent)
and mining (16.4 percent).
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Figure 2: Origins of GDP, 2011 (% of total)
Other, 17.8%
Industry, 25.1%
Trade, 11.7%
Mining, 16.4%
Transport and
communications,
15.4%
Agriculture, 13.7%
Source: Economic Intelligence Unit
First quarter growth in 2012 has
been driven by the services,
transport, and agricultural
sectors
In the first quarter of 2012, the Mongolian economy continued its growth
trajectory with 16.7 percent year on year (y-o-y) GDP growth (Figure 3).
This has been driven largely by the services, transport, and agricultural
sectors: wholesale and retail trade grew 51 percent y-o-y, transport grew
11.7 percent y-o-y, and agriculture grew 13.6 percent. Agricultural sector
growth is notable, as it signals a recovery from the effects of the 2009-2010
zud, which will improve earnings prospects and livelihoods particularly for
rural populations, which were most severely affected by the natural
disaster.
Figure 3: Real GDP Growth in 2012Q1 (%)
Greece
-6.5
Portugal
-2.2
Italy
-1.4
Hong Kong
0.4
USA
1.9
Vietnam
4
Australia
4.3
Russia
4.9
India
5.3
China
8.1
Mongolia
-10
-5
16.7
0
5
10
15
20
Source: Bank of Mongolia, Bloomberg
The mining sector contributed 1.6 percentage points (pp) to GDP growth,
with the development of Oyu Tolgoi (OT) in particular spurring growth in
sectors across the entire economy (For more information on OT, refer to
case study on page 16). Mining-related foreign direct investment (FDI) and
government spending are also expected to be key drivers of GDP growth
going forward. FDI reached a record-high US$5.3bn or 62 percent of GDP in
2011, and is forecasted to grow at an average of 26 percent per annum in
2012 and 2013, according to the Economic Intelligence Unit (EIU). Both
exports and imports are expected to rise starting in 2013 as Oyu Tolgoi (OT)
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developed by Turquoise Hill Resources (formerly Ivanhoe Mines) will
complete construction and expand production. The EIU forecasts that
Mongolia will again be among the fastest growing world economies in 2012,
with 14.8 percent y-o-y real GDP growth.
According to the National Statistics Office (NSO), in the first half of 2012 the
Mongolian economy expanded by 13.2 percent y-o-y in real terms (25.1
percent in nominal terms) based on the production approach to GDP.
External sector
The country’s trade is highly
concentrated among China and
Russia
Historically, Mongolia has experienced trade deficits, but with a narrow
trade gap. This was exacerbated during the global financial crisis, as exports
declined dramatically and the development of the mining sector has
required substantial imports of goods and services. Mongolia’s main trading
partners and traded goods are shown in Figures 4 and 5 and Table 1 below.
Since the country’s trade is highly concentrated among China and Russia,
Mongolia’s trade balance is highly sensitive to the economic patterns of its
neighbors.
Figure 4: Main Trading Partners for Imports
China,
26.7%
Figure 5: Main Trading Partners for Exports
Russia,
1.5%
Other,
4.5%
Other,
46.3%
Russia,
27.0%
China,
94.0%
Source: Economic Intelligence Unit
Table 1: Main Traded Goods, 2010
Imports
Main traded
goods
Machinery and transport equipment, manufactured goods,
food and fuel
Exports
Mineral products, natural or cultured stones, precious metal,
jewellery, coins, textiles & textile articles live animals, animal
origin products, raw & processed hides, skins, fur articles
Structurally, Mongolia’s exports are concentrated among a few
commodities, and almost all consumer goods are imported from abroad. As
shown in Figure 6 below, the trade deficit has widened over the past year,
reaching US$1.7bn in December 2011, or 20 percent of GDP.
We believe the trade deficit will
reduce significantly in 2013
Imports required for OT construction are the most significant contributor to
the trade deficit, comprising 70 percent of total imports in 2011, according
to the World Bank. With the completion of OT construction by the end of
2012 and commercial production beginning in 2013, we believe the trade
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deficit will reduce significantly, despite continued import growth due to
rising domestic demand. As evident from Figure 6, trade shows a tendency
towards increasing from the beginning to the end of a year, and we expect
imports in 2012 to continue following this pattern. However, with the
recent Chinese deceleration in growth and world price fluctuations, the
export pattern will be more variable since commodity exports in Mongolia
remain highly dependent on Chinese demand for coking coal and copper.
0.2
0.0
(0.2)
(0.4)
(0.6)
(0.8)
(1.0)
(1.2)
(1.4)
(1.6)
(1.8)
(2.0)
7.0
(US$ billions)
6.0
5.0
4.0
3.0
2.0
1.0
Trade balance
Export
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
0.0
(US $ billions)
Figure 6 : Trade Balance, 2010-2012
Import
Source: Bank of Mongolia, Bloomberg
Commodity prices
Mongolia’s economy is highly
sensitive to changes in
commodity prices
Minerals comprise over 80 percent of Mongolia’s exports. The development
of substantial mineral deposits including copper, coal, molybdenum, tin,
tungsten, and gold have made the Mongolian economy more susceptible to
commodity prices in recent years. This manifested itself in the increased
value of exports leading up to the financial crisis, until sharp drops in
commodity prices caused exports to drop 26 percent from US$2.5bn to
US$1.9bn and the local currency to depreciate approximately 38 percent
against the US dollar. The price of copper, one of Mongolia’s main exports,
fell by up to 65 percent from US$8,700 per ton in April 2008 to US$3,000
per ton in March 2009.
Starting in late 2008, commodity prices surged once again, driven by strong
Chinese demand. The 3-month active copper contract and New Castlequoted coking coal prices increased by nearly 200 and 50 percent
respectively between December 2008 and mid-July 2011. During this period,
the Mongolian economy benefitted from boosts in prices of these two main
commodities.
After another run up in commodity prices until September 2011, a decline in
prices owing to the sluggish economic recovery in the US, the on-going
sovereign debt crisis in the euro zone, and the economic slowdown in China,
once again negatively impacted the trade balance. For example, the World
Bank forecasts copper prices to rise to US$8,500 in 2012 before steadily
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declining in 2013 and beyond, putting pressure on Mongolian exports.
Figure 7 shows price growth for key commodities from 2008 to present.
Figure 7: Commodity Price Growth, 2009 - 2012 (%)
250%
200%
150%
100%
50%
0%
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
-50%
Coking Coal (New Castle)
Copper (3m active contract)
Gold
Source: Bloomberg
Foreign Direct Investment
Dramatic increases in FDI
Mongolia is classified as a frontier market with a favorable tax regime,
relatively high ease of doing business, functioning democracy, and a vast
supply of untapped natural resources. FDI into Mongolia has been steadily
increasing since 2001, driven by a favorable investment and legal climate,
and foreign investment in mining-related projects. In 2008, FDI surpassed 10
percent of GDP for the first time. As the OT project drives a majority of
capital flows, FDI is expected to decrease in the coming years upon the
completion of OT construction, which is nearly 95% complete at the time
this report was published.
The country’s FDI increased three-fold in 2011 reaching an all-time high of
US$5.3bn or approximately 62 percent of GDP. China, the single major
export destination for Mongolian commodities, has also remained the
largest investor in Mongolia ahead of South Korea, Japan and Russia.
Foreign inflows have historically financed Mongolia’s widening trade deficit,
and will continue to do so in the near term. Consequently, the togrog is
expected to appreciate modestly in 2013 due to export growth and
continued mining-related FDI flows. Figure 8 presents an overview of recent
FDI trends.
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Figure 8: FDI and Current Account, 2008 - 2011 (US$bn)
1.5
(US$ billion)
1.0
0.5
0.0
-0.5
-1.0
2008
2009
FDI
2010
IV quarter
III quarter
II quarter
I quarter
IV quarter
III quarter
II quarter
I quarter
IV quarter
III quarter
II quarter
I quarter
IV quarter
III quarter
II quarter
I quarter
-1.5
2011
Current account
Source: Bank of Mongolia
Fiscal policy
Government’s expansionary fiscal
policy is a double-edged sword
The government’s expansionary fiscal policy and a sharp plunge in world
commodity prices (mainly copper) in 2008 contributed to a much larger
contraction of GDP in Mongolia than experienced in other resource-rich
countries. However, large scale election-driven cash hand-outs and miningrelated capital expenditures have also been significant contributors to
Mongolia’s economic growth. Expenditures climbed to 44.2 percent of GDP
in 2011, while revenues reached only 40.6 percent, both driven by the
mining sector. The 2011 y-o-y growth of total expenditures and net lending
was 56 percent, whereas total revenue and grants grew by 41 percent. This
led to a larger fiscal deficit in 2011 than in 2010, at MNT 391bn. Figures 9
and 10 provide a breakdown of increases in government expenditures and
revenues respectively.
Figure 9: Government Expenditure Growth, 2010 - 2011 (%)
250%
236%
2011
2010
200%
150%
104%
100%
81%
59%
56%
50%
33%
43%
40%
26%
24%
33%
32%
29%
12%
0%
Total exp. &
Net lending
Curr. Exp.
Wages &
Salaries
Goods &
Services
Subsidies &
Trans.
Capital Exp.
Net Lending
Source: Bank of Mongolia, Ministry of Finance
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Figure 10: Government Revenue Growth, 2010 - 2011 (%)
250%
2011
2010
200%
150%
91%
100%
75%
50%
41%
35%
40%
43%
9%
0%
Total Rev &
Grants
Curr. Rev.
Corp. income Indiv. income
tax
tax
VAT
Excise tax
Taxes on FT
Source: Bank of Mongolia, Ministry of Finance
The IMF, among other agencies, has warned Mongolia against highly
expansionary fiscal policy and high domestic inflation. Mongolia will soon
introduce its Fiscal Stability Law, which aims to shield the economy from
boom-bust cycles in the dominant mining sector. The legislation caps the
structural deficit at 2 percent of GDP and establishes a Stabilization Fund,
aimed to save revenue generated from high commodity prices in order to
buffer the economy from unforeseen shocks. According to Fitch, Mongolia
has so far saved only 2 percent of its GDP in this fund, which is considered
insufficient to provide the country with fiscal flexibility and shelter its
currency from shocks, should price declines affect Mongolia’s main export
commodities. Despite the legislation, the fiscal deficit has expanded to 7.6
percent of GDP in May 2012, and the government has continued to
announce major spending programs on transfers and public-sector salaries.
On the other hand, enhanced fiscal prospects from Mongolia’s rapid
economic growth and increasing taxable activity in all sectors of the
economy are expected to offset the spending planned for 2012.
Monetary policy
Inflation remains a primary
threat to the togrog
Inflation. Over the past decade, inflation has been relatively high and
volatile, compared to benchmark economies such as the ASEAN-5
(Association of Southeast Asian nations), as seen in Figure 11. The
Consumer Price Index (CPI) reached 26.8 percent in 2008, fell to 6.3 percent
in 2009 during the financial crisis, and returned to double digits during the
recovery period thereafter. This volatility and recent upward trend in
inflation has also been reflected in the exchange rate.
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Source: Bank of Mongolia
Most recently, headline inflation rate in Ulaanbaatar was 15.1 percent y-o-y
in June 2012 while the national rate was 14.7 percent y-o-y. Both are
significantly higher than the BoM’s inflation target of 9-12 percent in 2012
and 8 percent by 2013. It is also higher than 2011 average inflation of 9.5
percent. Inflation thus remains a major threat to the togrog, the overall
economy, and political stability, and a priority for the BoM. In the 2013
government budget proposal, inflation is forecasted to be 9.8 percent in
2013 and 10.4 percent in 2014, in addition to being targeted at a single digit
in the new government action plan in 2012-2016. We believe that this
would be a tough target to reach for the government without significant
fiscal tightening in addition to bold moves by the BoM on monetary
tightening.
Mongolia imports a majority of its non-meat foods from China, thus food
price movements in Mongolia follows Chinese trends. The current decrease
in Chinese food price inflation implies that this element of inflation in
Mongolia should also continue to decelerate (after a period of rapidly rising
food price inflation). Furthermore, potential fuel cost increases from Russia,
a main energy supplier to Mongolia, can also add to inflationary pressures.
Rapid money supply growth
attributable to increases in
deposits and money in circulation
Money supply. Money supply growth has also fuelled inflation in Mongolia.
From 2000 to 2008, money supply has grown at an average of 34 percent
per year, reaching MNT 2.5 trillion in August 2008, prior to the financial
crisis (Figure 12). Mongolia’s relatively speedy recovery is reflected in the
money supply growth experienced in late 2009. In 2011, money supply
experienced tremendous growth on a y-o-y basis attributable to increases in
both deposits and money in circulation. Indeed, the Central Bank
intervened to stabilize the exchange rate and contain inflation. In April
2012, money supply increased to a record-high of MNT 3.5tr, representing
an 80 percent y-o-y increase, while currency issued in circulation grew 41
percent y-o-y. Such rapid growth rate has fuelled inflation, which started
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rising again from June 2011 onward. Money supply growth decelerated to
24 percent on average during the first half of 2012, reaching MNT 7tr in
June 2012.
Figure 12: M2 (MNT trillion) and M2 Growth (%), 1998 - 2012
8.0
90%
7.0
80%
70%
6.0
60%
5.0
50%
4.0
40%
3.0
30%
20%
2.0
10%
Jan-12
Jun-11
Nov-10
Apr-10
Sep-09
Jul-08
Feb-09
Dec-07
Oct-06
M2, MNT trillion (LHS)
May-07
Mar-06
Jan-05
Aug-05
Jun-04
Apr-03
Nov-03
Sep-02
Jul-01
Feb-02
Dec-00
Oct-99
May-00
-10%
Aug-98
0.0
Mar-99
0%
Jan-98
1.0
M2 rate YoY (RHS)
Source: Bank of Mongolia
Interest rates. The 1-week Central Bank Bills (CBB) is the main monetary
policy instrument of the BoM and represents the BoM policy rate that
guides the interbank money market.
CBB climbed to MNT 1tr at the end of 2009 from just over MNT 100bn prior
to the financial crisis. In mid-2010, the BoM changed its policy towards less
intervention, reducing the CBB amount to MNT 557bn by May 2012 (Figure
13).
Figure 13: Net CBB (MNT billion) and CBB Rate (%), 2009 - 2012
1.4
14.0%
1.2
13.0%
1.0
(MNT billion)
Policy rate increased twice in
2012 to 13.25 percent
12.0%
0.8
11.0%
0.6
10.0%
0.4
9.0%
0.2
0.0
Dec-09
8.0%
May-10
Oct-10
Mar-11
Net CBB (LHS)
Aug-11
Jan-12
CBB rate (RHS)
Source: Bank of Mongolia
The BoM has taken significant policy action by raising the policy rate three
times from 11 percent to 12.25 percent in 2011 and twice again to 13.25
percent in 2012 to control inflation. However, inflation also grew by 15.1
percent y-o-y in June 2012, in large part due to a misalignment between
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Mongolia’s monetary and fiscal policies. While the BoM attempts to curb
inflation by increasing the policy rate, the government’s expansionary fiscal
policy adds upward pressure to inflation, which, on net, continues to grow
on a y-o-y basis.
Nevertheless, the BoM has left rates unchanged at 13.25 percent since April
2012 on the back of a deteriorating global growth outlook and declining
commodity prices. As the 10 percent inflation target has not been reached,
the BoM remains prepared to take further measures to cool down an
overheating domestic economy, and further rate hikes are likely in 2012
and 2013, according to EIU forecasts. However, monetary policy may
continue to have limited effectiveness because of the linkage between
inflation and global commodity and food price trends, driven in large part
by Chinese demand.
In March 2012, the People's Bank of China (PBOC), the country's central
bank, extended its currency swap agreements with the BoM, doubling the
scale of a 2011 bilateral swap deal. The agreement allows the two central
banks to swap CNY 10bn / MNT 2tr in order to maintain regional financial
stability and facilitate bilateral trade and investment between the two
countries. The BoM has already sold CNY 269m to commercial banks.
Foreign reserves reach recordhigh US$2.91bn in June 2012,
approximately 30 per cent of GDP
Foreign reserves. Foreign reserves exceeded US$1bn in mid-2007 but were
halved by January 2009 at US$0.55bn as a result of the financial crisis.
However, the adoption of a flexible exchange rate regime has allowed
Mongolia to rebuild its reserves, which climbed again to US$1bn in
September 2009 and reached a record-high US$2.91bn in June 2012 and
showing y-o-y growth of 14.4 percent. The flexible exchange regime has
been widely praised by the World Bank and the International Monetary
Fund (IMF) as a tool to help smoothen out exchange rate volatility and
opportunistically build up international reserves. Prior to 2009, Mongolia
utilized a tightly controlled exchange rate regime which contributed to the
dramatic decline in foreign reserves during the financial crisis. Figure 14
shows recent trends in FDI.
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Figure 14: Foreign Reserves (US$bn) and Growth Rate (%), 2009 - 2012
3.5
25%
20%
3.0
15%
2.5
(US$ billion)
10%
2.0
5%
1.5
0%
-5%
1.0
-10%
0.5
0.0
Jan-09
-15%
-20%
Jul-09
Jan-10
Foreign Reserve (LHS)
Jul-10
Jan-11
Jul-11
Jan-12
Month-to-Month change (RHS)
Source: Bank of Mongolia
Banking sector
Banking sector assets and bank
assets-to-GDP ratio reach new
highs
Banks have recovered well from the financial crisis, improving the quality of
their balance sheets and trending towards greater financial sector stability.
Reflecting an expanding economy, banking sector assets have now surged
to MNT 9.4tr (US$6.7bn) and bank assets-to-GDP have reached 86.5
percent. Figure 15 shows that total outstanding loans have almost doubled
to MNT 6tr from December 2010, peaking at 74.7 percent y-o-y growth in
November 2011. A similar trend has been observed in total deposit growth,
Figure 16, reaching 72.7 percent y-o-y growth in April 2011. Growth has
since decelerated, but upon speaking with top management of commercial
banks in Mongolia, we believe that the banks are actively controlling the
pace of credit growth recognizing vulnerabilities in the global economic
outlook and also the recent decline in commodity prices.
Since the Development Bank of Mongolia’s successful bond issuance in
March 2012, Mongolian commercial banks also have planned to tap into
international capital markets to increase capital Trade and Development
Bank of Mongolia(TDB) was the first to re-enter the market, recently raising
US$300 million at a record low yield of 8.5 per cent.
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Figure 15: Total Outstanding Loans (US$m) and Growth Rate (%), 2010 - 2012
7.0
80%
74.7%
70%
6.0
60%
5.0
Millions
50%
4.0
44.1%
40%
3.0
30%
2.0
23.0%
20%
1.0
10%
0.0
Dec-10
0%
Apr-11
Aug-11
Dec-11
Outstanding loan
Apr-12
Loan Growth, YoY
Source: Bank of Mongolia
Figure 16: Deposits (US$000s) and Growth Rate (%), 2008 - 2012
7.0
80%
72.7%
70%
6.0
60%
Thousands
5.0
50%
40%
4.0
30%
3.0
23.9%
20%
10%
2.0
0%
1.0
-10%
-
-20%
Dec-08
Jun-09
Dec-09
MNT deposits
Jun-10
Dec-10
FX deposits
Jun-11
Dec-11
Total Deposit, Growth YoY
Source: Bank of Mongolia
Exchange rate
Exchange rate has been highly
volatile since adoption of flexible
exchange rate regime in 2009
Until 2009, BoM followed a fixed-rate policy regime, keeping the exchange
rate within a certain fixed band which is evident in Figure 17. After the
implementation of flexible exchange rate policy in 2009, the togrog become
more volatile. The same year, the global financial crisis and sharp declines in
commodity prices contributed to a 38 percent depreciation between
October 2008 and March 2009. As the economy recovered quickly in 2010,
the togrog became the world’s second best-performing currency in 2010,
finishing the year 13 percent higher against the US dollar behind the South
African rand, which appreciated 14 percent.
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Figure 17: MNT/USD Exchange Rate, 2000 - 2012
Financial crisis hits Mongolia harder than in other
resource-rich countries
1800
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FDI reaches record
high of $2.91bn
1700
1600
1500
1400
Flexible exchange rate introduced as part of IMF
agreement with GoM in 2009
1300
1200
1100
1000
MNT becomes the second best performing currency
900
Jan-00
Apr-00
Jul-00
Oct-00
Jan-01
Apr-01
Jul-01
Oct-01
Jan-02
Apr-02
Jul-02
Oct-02
Jan-03
Apr-03
Jul-03
Oct-03
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
800
Source: Bloomberg
Strong capital inflows and BoM
intervention have supported
MNT appreciation in the first half
of 2012
In 2011, the togrog depreciated by 11.4 percent against the US dollar,
reflecting a substantial increase in the current account deficit and a
significant reduction in net foreign exchange inflows. The drivers of this are
considered to be high domestic inflation, rising global risk aversion on the
back of the euro zone crisis, and declining commodity prices. However, the
togrog has once again appreciated markedly in the first half of 2012, rising
from Tg1,396.4:US$1 at end-December 2011 to Tg1,329.8:US$1 at end-June
2012. Strong capital inflows and BoM intervention in currency markets have
helped curb the togrog’s fall with timing of appreciation linked to the
national election in June 2012. After the election, the currency has
depreciated by 7 per cent to MNT 1410:US$ 1 at the end of September
2012.
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Case study: The Economic Impact of Oyu Tolgoi
Oyu Tolgoi (OT) is a large open pit and underground mine located in the south Gobi desert in Mongolia. Upon completion,
it is expected to produce 450,000 tonnes of copper and 330,000 ounces of gold per year at full capacity, establishing it as
one of the world’s largest copper and gold mines. The mine has been under construction since 2010 and is expected to
start exporting in 2013. The extraction process is estimated to last a minimum of 50 years. OT is a joint venture between
Turquoise Hill Resources (66 percent) and the Government of Mongolia (34 percent). Since December 2010, it has been
fully managed by Rio Tinto, the majority shareholder in Turquoise Hill Resources (formerly known as Ivanhoe Mines).
Statistics:




Total Phase I development capital expenditures (capex) : US$6.2bn
o Mongolian government benefit from capex : US$950m
o Mongolian private sector benefit from capex : US$1.385bn
o Total Mongolia benefit from capex: US$2.335 (37.6 percent)
Phase 1 : 94 percent completion in August 2012, exports will start after power issue is resolved
Phase 2 : the underground mine will start production in 2015
Private sector involvement in OT development: 1,000+ Mongolian firms
Figure 18: The OT effect on Mongolian real GDP, 2010 - 2045
Figure 19: The 2013-transition period, phase 1
Source: BAEconomics
According to a study by BAEconomics, the Mongolian economy would be 36 percent larger in 2019 because of the OT
project. The study further concludes that with OT, wages will be 30 percent higher, the value of exports will increase by 60
percent and the value of imports by 20 percent. These factors together will allow economic growth in the 2013-2020
period to average 11.7 percent, as compared to 7.7 percent without the OT project. OT is also expected to contribute an
average of 30 percent of government revenues in the coming years, representing up to US$626m each year over the life of
the project. According to the IMF, the government of Mongolia will receive 55 percent of the project cash flows through
taxes, royalties, fees and dividends. An additional $500-800m per annum is expected to be distributed through
procurement to the private sector. 2013 is widely considered to be a transition year, from a period of significant FDIfinanced expenditures to one of significant export-led revenues. According to OT estimates, 37.6 percent (or US$ 2.3bn) of
the total development capex has gone to the government via fees and taxes, and to the private sector through local
procurement for goods and services. We believe that until OT export pick up in the first half of 2013, the decline in FDI
associated with the completion of OT construction could lead to a possible depreciation of the togrog in the short-run.
However, the scaling-up of OT exports in the medium- and long-run support an appreciation of the local currency.
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Summary and currency implications
The Mongolian economy experienced a robust recovery from the 2009
financial crisis and zud, recording economic growth of 6.4 percent in 2010
and 17.3 percent in 2011. This rapid expansion has continued through the
first quarter and half of 2012, with real year-on-year GDP growth of 16.7
and 13.2 percent respectively outpacing BRIC and other nations. GDP
growth is expected to remain close to 15 percent in 2012.
GDP growth continues to be led by mining-related FDI and government
spending. FDI reached a US$5.3bn or 62 percent of GDP in 2011, and is
forecasted to grow at 26 percent per annum in 2012-13 according to the
EIU. Government expenditures were US$3.496bn, which represented
approximately 41 percent of GDP in 2011 and is forecasted to grow another
32 percent in 2012, with increased tax revenues supporting social welfare
spending, among other priorities. Key risks to economic growth include
continued high inflation that hampers consumer confidence, economic
slowdown in China and declining global commodity prices, which would all
place pressure on economic expansion.
Exports surged between 2010 and 2011 from US$2.90bn to US$4.78bn or 56
percent of GDP, as a result of high global commodity prices and strong
Chinese demand. However, imports grew even faster, from US$3.3bn in
2010 to US$6.5bn in 2011, to expand Mongolia’s trade deficit to a recordhigh US$1.7bn (as compared to US$379m in 2010). Imports almost doubled
in 2011, driven by mining-related purchases and fuel as well as private
domestic demand for foreign products. According to the World Bank,
exports will climb to US$5.2bn in 2013 reflecting strong external demand
(particularly from China, which comprises almost all of Mongolia’s sales). As
a result, a greater than expected contraction in the Chinese economy poses
a risk to Mongolia’s export earnings. Imports will also grow in 2013 on the
back of strong domestic demand, contributing to a widening trade gap in
the short-term before the trend reverses. However, the overall balance of
payments is expected to remain positive with foreign capital inflows
financing the trade deficit expansion. Therefore, widening trade deficits in
the near term are likely to place some pressure on the togrog, but this is
counteracted by the positive and growing capital account, which results in
increased demand for the local currency and thus a higher exchange rate
relative to other currencies.
As previously mentioned, a main driver of exports in Mongolia is commodity
price, notably for coking coal, copper and gold. In 2011, soaring prices for all
these commodities improved the terms of trade in favor of Mongolia.
However, according to the World Bank’s June 2012 price forecast, prices for
these commodities are generally forecasted to fall and stabilize in the
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medium term, beginning in 2012. In the short-term, the togrog has and will
continue to benefit from favorable commodity prices, until price declines
materialize. Despite forecasted price declines, however, the anticipated rise
in commodity exports starting in the fourth quarter of 2012 is likely to place
upward pressure on the currency. For example, in addition to demand for
raw materials from Mongolia’s main trading partners, Russia and China, the
country is actively building closer links with other regional economies such
as South Korea and Japan, which may support longer-term growth in export
volumes. Thus despite commodity pricing pressure, increasing export
volumes may support increased demand for the togrog. A second order
implication of this is known as the Dutch Disease, where currency
appreciation due to commodity exports make exports in other sectors such
as manufacturing and agriculture less competitive. This is also a real risk for
the Mongolian economy.
The government experienced a budget deficit in 2011 and has continued to
announce and execute major spending programs on infrastructure, publicsector salaries, transfers, and other programs. In May 2012, Mongolia
recorded a widened fiscal deficit of 7.6 percent of GDP. In response to
potential fiscal vulnerabilities, the government has enacted a Fiscal Stability
Law that is scheduled to take effect in January 2013. This law prohibits the
government from incurring large budget deficits by setting a 2 percent
ceiling to the structural deficit, and also requires the country to set aside
revenue generated from mineral sales. This is necessary since the country’s
fiscal position is highly sensitive to commodity price declines, as
experienced in 2008 and 2009. Therefore, while growing fiscal deficits have
placed downward pressure on the togrog, this tightening of fiscal policy, if
effective, would place upward pressure on money demand and
consequently, appreciate the local currency. Strong economic growth and
increased taxable activity and tax revenues, from mining and all other
sectors, should support public spending, improve the fiscal position and
favor an upward trend for the currency in the long-term.
Inflation has been a major threat to the togrog, the overall economy, and
political stability. Headline inflation (y-o-y) in Ulaanbaatar was 15.1 percent
in June 2012, significantly higher than the BoM’s target inflation rate of 9-12
percent in 2012 and 8 percent by 2013. The BoM has responded by
gradually increasing interest rates, with further rate hikes likely in the
remainder of 2012 and 2013. The BoM has already increased the 1-week
CBB twice in 2012, from 12.25 percent to 13.25 percent. This has also been
reflected in foreign exchange researches, which climbed to US$2.91bn in
June 2012, representing a y-o-y increase of 14.4 percent. Another driver of
international reserves growth has been a US$580M bond issuance by the
Development Bank of Mongolia.
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While tightening monetary policy typically could lead to a local currency
appreciation, this has not been the case in Mongolia. According to the
World Bank and IMF, an overheating economy has counteracted the
expected effects. Another explanation for the limited effectiveness of
monetary policy is the linkage between inflation and global commodity and
food price trends, driven by Chinese patterns and demand. Money supply
and loan growth have also fuelled inflation in Mongolia. The M2 measure of
money supply expanded by 22.2 percent y-o-y in June 2012 and bank
lending has grown to MNT 6tr. Dramatic increases in bank lending have
contributed to rising inflation by furthering money supply growth. On the
other hand, the banking sector has recovered well from the financial crisis
by improving the quality of their balance sheets, notably through deposit
growth and decreases in non-performing loans (NPLs). These improvements
point to greater financial sector stability, consumer confidence, and a
favorable effect on the togrog in the long run.
Political risk, particularly given the uncertain policy environment after the
recent change of government, will be another source of volatility for the
togrog. In the past, the government has taken several steps to enhance the
country’s credibility among investors. For example, international institutions
highlight the benefits of the flexible exchange rate regime implemented in
early 2009 that limited intervention and built transparency. As well, the
CNY-MNT swap deal was subscribed by many companies including the
Mongolian Mining Corporation, the largest Mongolian coal miner, with
US$600M in debt financing for infrastructure such as railroads. These
measures further support favorable currency trends.
The factors affecting the togrog are both wide-ranging and complex, and so
are their effects. In the short-run (6-12 months), the global macroeconomic
landscape, widening trade deficit, declining commodity prices, high
domestic inflation, loose fiscal and monetary policy, and renewed political
uncertainty will drive volatility and potential depreciation of the togrog. In
the long-run, however, rapid economic growth, favorable trade and fiscal
balances, tightened monetary policy, banking sector recovery and political
reform are likely to be the drivers of togrog appreciation.
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Ulaanbaatar, Mongolia with a dedicated focus advising on Mongolian-related transactions. ResCap seeks to foster long-term, seniorlevel relationships with clients and offers the services to both Mongolian and international enterprises focused on natural resources
and related infrastructure projects.
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