Presentation Summary: The Threat of Inflation

Mongolia Lecture Series
Institute of Asian Research, UBC

A Panel Presentation

FAQ Mongolia: Some Answers to the Most Frequently Asked Questions on (Mining) Policy

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Presentation Summary

How is the mining boom affecting the macroeconomic stability and competitiveness of Mongolia?

Bolor Naranhuu

Mining has just started booming in Mongolia.  In six years mineral exports increased by almost 4 times from little over 1 billion to 4 billion US dollars. Especially, coal exports played a gigantic role in skyrocketing exports in the last couple of years. And much greater expansions are underway in the near future.

Although Mongolia is just starting to receive an unprecedented flow of mineral-dollars, it has been challenging to manage them for its development. Due to inexperienced fiscal management and political pressure in the country, the mining boom tends to deteriorate both political and business environment, and even social development.

Technically, the mining boom definitely affects all 4 economic sectors: real, monetary, fiscal, and external sector. It brings massive revenues to government through various taxes and state equity earnings, which push the aggregate demand to a higher level. As a result, the general price level goes up. This inflationary pressure leads the monetary sector to contract, which causes higher interest rates. A substantial amount of foreign currency inflows through private investments as well as export revenues lead the local currency to appreciate, which makes other export-oriented sectors less competitive in the global markets.

In Mongolia, due to less absorptive capacity of the economy, rapid economic growth has generated higher inflation. During periods of higher economic growth the CPI inflation rates were much higher than when the economy grew modestly. On the other hand, political pressure has played a considerable role in the impacts. The inflation rate was higher due partly to political pressure throughout the political seasons (election years). For example, inflation was 15-22 percent per annum during the election years of 2004 and 2008.

The mining boom has brought an enormous amount of windfall revenues to the government. The budget revenue almost doubled just in 3 years (from 2009 to 2012). Unfortunately, the government eagerly increased its expenditures (cash handouts, civil servants wage increases etc.) following its revenue increase. This, rooted in significant political pressure, in turn, raised the aggregate demand at the given unchanged capacity of aggregate supply and as a result, inflation soared. To counter-act against the soaring inflation the central bank of Mongolia needed to tighten its monetary policy, and raised the policy rate several times. However, due to the mining sector indirect effect on other economic sectors – higher aggregate demand in products markets – money supply (credit supply in part) has also had enormously high growth.

The local currency exchange rate against US dollars gradually appreciated until early 2009, and depreciated dramatically just in a couple of months due to the huge balance of payment deficits resulting from the drop in commodity prices. The global commodity market started to stabilize in the second half of 2009, and commodity prices started to recover in late 2009 and for all of 2010. As a result, Mongolia’s balance of payment improved substantially, and the local currency began to appreciate. The local currency appreciation has been one of the negative impacts of the mining boom on the some critical parts of the economy – which are animal-originated goods producers (herders) and export-oriented small and medium scale businesses due to the fact that local currency appreciation results in lower income in local currency and higher prices in foreign currency that causes less competitive power in international markets.

The mining sector has been the strongest competitor in the labour market with the highest offering wages and benefits. Therefore, it absorbs skilled professionals even from other sectors, creating skills shortages and disadvantages for other sectors, particularly the manufacturing sector. Since Mongolia has been considered as having an efficient labour market in the sense that there is no strong government regulation in the labour market, the mining sector’s wage setting determines overall tone of the labour market, and impacts wage levels of the other sectors. As a result, wages make the export-oriented manufacturing sectors costly and increase competitive disadvantages.

In conclusion, just in one decade of the 21^st century the Mongolian mining sector has received a big push from favorable commodity market conditions, but due to inexperienced decision-makers with too much political pressure the mineral windfall revenues tend to hurt the Mongolian macro economy, and lately, the vulnerable low- and middle-income citizens. In fact, the Mongolian mining sector has a great potential to bring a bright future for its people only if Mongolia’s political leaders can build strong institutions, implement consistent and sound macro policies, and value long-term prosperity over short-term populism.

Video Record

50’18” – 1:05’35”

About Bolor Naranhuu

Dr. Bolor Naranhuu is a freelance consultant based in Toronto, Canada. He has been doing policy research in mining industry in Mongolia since 2008. Dr. Naranhuu was a lecturer and an associate professor at the School of Economic Studies, National University of Mongolia in 2008-2010 and 1994-1997, and worked for the Mongolian National Mining Association as a policy analyst, and as an economist for the Development Alternatives Inc. and PA Consulting at the USAID-funded Energy Sector Restructuring Project. He earned a MA degree in economics from University of Kansas, USA, and doctorate degree in economics from Lund University, Sweden.

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