The Bank of Mongolia, the country’s central bank, has a tough job. Not only does it have to contend with international crises and crashes, like everyone else, but it has responsibility for a relatively young and untested banking system. Moreover, and more to the point, it has to deal with extreme money flows caused by fluctuating resource prices and speculative investment, all in an environment lacking capital controls and other safeguards long common in the developing world. Indeed, given the size of the mineral economy relative to the rest of the economy and the waves of optimism and pessimism that have washed over the country in such a short period of time, the challenges it faces may be unlike those faced by any other central bank.
Like most central banks, the Bank of Mongolia works to be countercyclical, and the headline numbers suggest that it has done just that. After the economy started recovering following the global economic crisis of 2008 and as money began pouring in, it increased the policy rate steadily, from 10.00% to a peak of 13.25% between April 2010 and December 2011. Then, as commodity prices fell and as global investors began to cool on the Mongolian economy, it dropped the rate, beginning in January 2013. By June 2013, the rate was 10.25%. The reserve requirement was also increased as the economy strengthened, first in February 2011, when it went from 5% to 9%, then in August 2011, when it was increased to 11%. It was finally taken to 12% in April 2012. Other measures were introduced. The minimum capital for banks was doubled, going from MNT8bn ($4.7m) to MNT16bn ($9.4m) effective May 2013, while the capital adequacy ratio levels were also raised for systemically important banks, from 12% to 14%.
Particularly extreme countercyclical measures have been put into place as economic growth has slowed. These include the 8% mortgage programme, the Price Stabilisation Programme (PSP), and MNT900bn ($529.4m) of special support for banks and loans to the construction sector outside the PSP. The policies have led to a sharp rise in credit. Loans outstanding jumped 53% year-on-year in October 2013 and 47.9%, 46.6% and 41.8% in the three months previously. This is not the fastest pace of loan growth – in late 2011, rates over 70% were recorded – but what is notable about the surge is the source of the money and where it is going. The majority of banking asset growth in Mongolia, according to research by Morgan Stanley, was funded by the central bank. The World Bank concurs. According to data it has published, vigorous efforts by the Bank of Mongolia resulted in an exponential increase in central bank loans to commercial banks, from MNT181bn ($106m) in November 2012 to MNT3.6trn ($2.1bn) by September 2013.
Further analysis of the lending reveals other worrying trends. Not only has credit been increasing fast, but much of it has been pouring into specific sectors. The PSP and the 8% mortgage programmes by their very nature tend to drive funds toward real estate, construction and related businesses. The World Bank warns that growth in credit to the construction industry has been exceptionally fast – 68% in the second quarter of 2013 versus the first quarter – and now a total of 37.7% of loans outstanding are to construction and real estate, more than any other sector.
The pace of credit expansion and the excessive concentration of credit could come with serious consequences. The PSP and 8% mortgage programme are in effect subsidising property, which could lead to a rise in prices and reduced affordability. They could end up exacerbating the very problems they were meant to address. Concern is also growing that the rush of funds through the banking system could lead to a decline in credit quality as banking capacity is stressed and analysis becomes less rigorous. The sectors themselves are by definition problematic. Property is particularly vulnerable to speculation and harsh boom and bust cycles on it own, and it is possible that so much lending to the sector could expose the banking system to more risk.
More Than Quantitative Easing (QE)
The hope, as in most stimulus exercises, is that these programmes will be temporary. Once the economy is stabilised, the monetary authority can back off and the markets can take over. The problem with that vision is that Mongolia is unlike most countries. It lacks a large industrial base, so there is very little to stimulate and not much to recover. The measures therefore are less there to provide stimulus and more to act as stopgaps until foreign direct investment returns and commodity exports and prices pick up. But even if this does happen, the interventions could have a lasting negative impact. The World Bank has wondered whether some firms may have trouble refinancing when the programmes end, with businesses based on exceptionally easy money. Other imbalances may haunt the market. The mortgage programme is seen as especially distorting. Expectations about the cost of financing a home could linger and banks may have trouble reasserting more realistic rates.
What the central bank has been doing is in line with what other central banks have done in the face of extreme instability. Morgan Stanley calls it “Mongolia-Style QE”, and the policies are very much like those practised by monetary authorities in the Western world. However, in some respects, the central bank is going further. The PSP is particularly aggressive and suggests that the Bank of Mongolia may be making larger interventions than most central banks would. Bankers argue that given the level, intensity and intent of what is being undertaken, the independence of the Bank of Mongolia could be in doubt. While at this point the issue may be academic, the credibility of one of the country’s most respected institution could be weakened.
The PSP is directly affecting the market, but the central bank’s conventional monetary policy is not working as effectively as desired. The policy rate has dropped steadily since early 2013, but loan rates have not been falling along with them. The weighted average local currency lending rate was 18.82% as of October 2013, slightly higher than at the end of 2012 (18.12%) and hundreds of basis points up from when the economy was stronger. The central bank has disbursed funds through special programmes, but has not managed to strongly influence rates across the system.
The central bank intervened recently in the currency markets, but indications are that this time it may not resist the fall. When the tugrik collapsed in late 2008 and early 2009, the bank spent an estimated $500m to support the currency. Its efforts were unsuccessful and may have contributed to instability as the country ran low on foreign reserves and confidence weakened. However, a timely rise in the price of copper saved the tugrik from a more serious drop. That experience has not been lost on monetary authorities. Though the central bank intervened in recent months, by the third quarter of 2013 it stopped for fear of running low on foreign reserves. The challenge for the Bank of Mongolia will be to return to a traditional role, draining liquidity from the system while backing off of more aggressive policies, without causing collapse.
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