Reform Spurs Growth: Q&A with Byadran Lkhagvasuren, Central Bank Governor Of Mongolia

Byadran Lkhagvasuren, Central Bank of Mongolia, shares thoughts on the country’s reincorporated banks.

Author: JONATHAN ROGERS

Global Finance: What is Mongolia’s economic growth outlook for 2023–2024?

Byadran Lkhagvasuren: Mongolia's economic outlook for 2023–2024 looks promising. In the first half of 2023, the country experienced a strong GDP growth rate of 6.4%, indicating a healthy economic performance. The primary drivers behind this growth are the recovery in Mongolia's mining sector and favorable commodity markets. The mining sector, a significant contributor to the economy, is rebounding, supported by factors such as coal exports and ongoing underground mining activities at projects like Oyu Tolgoi.

Inflation has been decelerating; by July 2023, it had reached single digits. This is a positive economic development as lower inflation can increase consumer purchasing power and encourage private investment. It's essential for maintaining overall price stability and economic health.

As a central bank, we are cautious about monetary policy due to ongoing global economic uncertainties. We closely monitor the situation and may adjust monetary policy as needed to ensure economic stability and sustained growth.

GF: The International Monetary Fund (IMF) has stressed the need for a flexible exchange rate policy from the Bank of Mongolia (BOM). Is this required, and if so, how has it manifested?

Lkhagvasuren: The Bank of Mongolia intervenes in the foreign exchange market to reduce sharp fluctuations in the Mongolian Tugrik (MNT) exchange rate against foreign currencies. This intervention is primarily in response to short-term imbalances in the supply and demand of foreign currency. However, it's important to note that this intervention is conducted while maintaining a flexible exchange rate regime, which is aligned with the country's macroeconomic fundamentals.

Maintaining a flexible exchange rate consistent with macroeconomic fundamentals is crucial for ensuring macroeconomic stability. In the case of Mongolia, various factors, both domestic and external, influence the exchange rate. External factors, such as the economic situation of our trading partners and global economic conditions, significantly impact Mongolia's foreign exchange market. For instance, during the COVID-19 pandemic, border restrictions affected domestic business activity.

Mongolia's foreign trade structure is characterized by smaller-sized importers compared to exporters, but there are many importers in terms of quantity. When the pandemic hit, border restrictions disproportionately affected importers, while export earnings remained relatively high compared to imports. This dynamic created a situation where the tugrik did not experience significant fluctuations against the US dollar despite the challenging circumstances.

To enhance the Bank of Mongolia's risk-bearing capacity, measures were taken to increase foreign currency reserves. This is a prudent step in uncertain times, as having sufficient foreign currency reserves can help stabilize the exchange rate and ensure the country's financial stability.

GF: Did the policy rate tightening and macroprudential adjustments of 2022 meet their objectives?

Lkhagvasuren: In 2022, the Monetary Policy Committee (MPC) took significant steps to tighten monetary policy. The policy rate was raised five times, resulting in a cumulative increase of seven percentage points. Alongside this, macroprudential measures, such as changes in the required reserve, were taken to manage credit growth, capital flows, and dollarization. These measures were part of a broader effort to maintain economic stability.

The early signs of success are now becoming evident. The policy rate tightening and macroprudential adjustments have played a role in preventing second-round effects on inflation. For instance, services inflation has stabilized at 7.5% as of July 2023, down from a peak of over 10% in late 2022. Similarly, food price inflation (excluding meat and imported foods) has decreased to 18% in July 2023 from a peak of 33.4% a year ago. The full impact of these measures is anticipated to materialize over the coming quarters. While the early signs are promising, policy adjustments often take time to influence the economy and inflation dynamics fully.

Despite the measures taken, both global and domestic uncertainties persist. These include unpredictable global market conditions and domestic factors like rising subsidies and wages in the public sector, which could influence inflation expectations. As a result, the Bank of Mongolia remains vigilant and closely monitors economic activity. It is also prepared to take timely actions in line with economic and inflation outlooks and consider the global situation.

Credit growth decelerated in 2022, and non-performing loans remain high in the banking sector.

GF: What action is required to return these variables to optimality?

Lkhagvasuren: In 2022, credit growth in Mongolia accelerated, mainly due to the implementation of the “MNT 10 trillion comprehensive plan for economic recovery.” This plan injected liquidity into the economy and incentivized lending. However, credit growth slowed significantly due to policy rate hikes in 2021 and 2022. As a result, banks began to shift their investments towards low-risk assets.

The initial public offerings (IPOs) process of systemically important banks [SIBs] impacted bank behavior. It prompted banks to exercise restraint in their lending activities. This cautious approach is often seen during significant events like IPOs, as banks assess their capital and risk positions.

The breakdown of loans by economic sector between 2022 and 2023 shows growth in several sectors. Specifically, the trading sector, consumer sector, and household loans all exhibited growth during this period.

The trend in non-performing loans (NPLs) has increased, with NPLs reaching MNT 2.06 trillion [approximately $592 million] compared to MNT 1.9 trillion in 2022. This represents a 7.0% increase compared to 2022 and a 13.4% increase compared to 2021. However, it's important to note that the NPL ratio has decreased by 1.4 percentage points, reaching its pre-pandemic level of 8.1 %. This decrease suggests that new lending growth is occurring. The banking system's loan provision coverage ratio also stands at 97.7%, surpassing international averages.

Going forward, the policies and measures implemented by the Bank of Mongolia will improve asset quality, promote further lending, and strengthen the creditworthiness of existing and potential borrowers. This will involve effectively changing or modifying current regulatory requirements on banks in alignment with the economic and financial cycles. The goal is to ensure a stable and healthy banking sector in Mongolia.

GF: What is BOM’s approach to adopting a central bank digital currency (CBDC)?

Lkhagvasuren: Mongolia's current payment system environment is relatively advanced compared to other nations with similar development levels. We have a real-time, non-stop payment system, a fully integrated payment card network with extensive contactless capabilities, standardized payment QR codes, and a growing presence of fintech companies issuing e-money and digital micro-loans. Diverse services and intense competition characterize our retail payment market.

The Bank of Mongolia is taking proactive steps to explore the potential benefits of a Central Bank Digital Currency (CBDC) through a dedicated project. This initiative reflects a forward-thinking approach to adapting to the changing landscape of payments and finance. This effort can provide an additional payment instrument and infrastructure for the public in an environment of declining cash usage.

In recent years, we have explored CBDC prototypes and their associated technologies. Throughout this journey, we have examined decentralized models utilizing blockchain and distributed ledger systems and centralized systems. The insights gained from our research have highlighted certain limitations of decentralized models regarding their agility for payment applications. On the other hand, centralized systems are like the existing real-time payment mechanisms like ACH (Automated Clearing House) and RTGS (Real-Time Gross Settlement) system.

The Bank of Mongolia remains open to new and innovative CBDC technologies and projects. Our institution will continue researching and exploring potential CBDC-based solutions that align with our country's needs and objectives.

GF: How will the systemically important bank (SIB) IPOs alter Mongolia’s economic landscape?

Lkhagvasuren: Mongolia's banking sector has undergone significant policy reforms to improve its efficiency and governance. In January 2021, the Parliament approved amendments to the Banking Law. These amendments introduced requirements for banks to change their ownership from limited liability companies to joint stock companies, focusing on SIBs becoming open joint stock companies. Additionally, the amendments imposed ownership caps, limiting single shareholder ownership to 20 % and ownership of multiple banking institutions to 5 %. As a result, six out of 12 banks in Mongolia, including all five SIBs, successfully reorganized as open joint-stock companies.

The transition from limited liability companies to joint stock companies, often facilitated through IPOs, represents a significant change for these banks. It allows them to raise funds from the securities market and subjects them to tighter regulations. Furthermore, open joint stock companies must publicly disclose their audited financial reports, promoting transparency and information symmetry among stakeholders.

The IPOs and transition to open joint stock companies have had several positive effects on the banking sector. The newly reincorporated banks' lending capacity and capital adequacy have significantly increased. Their operational and financial indicators have also improved. These changes have occurred during challenging economic circumstances, demonstrating their positive impact.

The overarching goal of these reforms is to increase transparency and improve the governance of banking institutions. This, in turn, enhances investor protection and information access. Recent policy actions have also focused on establishing a sound regulatory framework to attract foreign investment in the banking sector. Drafting regulations for foreign bank branches and ratifying the Specialized Investment Banking Law are steps in this direction. These reforms aim to transition Mongolia's banking system into a modern, investor-centric one, focusing on fostering investment, deepening financial markets, and driving long-term economic growth.