Open Letter of the Monetary Policy Committee

Date: 2018/12/17

Within the framework of legal reform in the banking sector of Mongolia, the Law on Central Bank (Bank of Mongolia) has amended, and through the implementation of this law the Monetary policy committee has established by the Parliament, on May of 2018.

The Monetary Policy Committee delivers this open letter to facilitate central bank's openness and transparency of the policy, and explain the grounds by summarizing the policy decisions issued in 2018.

The Monetary Policy Committee has issued decisions to change the policy rate for the purpose of supporting and stabilizing economic growth without undermining price stability, in accordance with the mandate of the Bank of Mongolia in 2018. Furthermore, within the new functions of the Central Bank, which took effect from April 2018, the macro-prudential policy instrument has been introduced and appropriate measures have been taken to prevent the risk that may accumulate in the banking sector.

With foreign trade partner countries economic growth surged from expectations, prices for key exports kept high, and investment in mining sector has increased, as well as effective coordination of monetary and fiscal policy implementation from the second half of 2016, the economic growth started to recover, from the first quarter of this year. However, as credit growth in the business sector has lagged, the policy rate was reduced by 100 basis point to support non-mining sector and employment growth. This year policy rate has reached to 10 percent and it was the lowest level of the last eight years.

In the first half of 2018, the price of the export goods increased, the economy grew at a rate of 6 percent, unemployment rate declined, external debt repayments were successfully refinanced, supply of business loan increased, loan rate decreased following the decisions on policy rate, and the Moody's Investor Service has increased Mongolia’s long-term issuer rating for the first time in 5 years. All these results prove that fiscal, monetary, and financial policies have been successful in recovering the economy. Given the recovery in the economy, the growth of domestic demand, its future trend, and inflation outlook the Monetary Policy Committee decided to retain the policy rate at 10 percent in the June and September, in order to continue the growth of business lending, the growth of employment, and keep the effectiveness of the policy measures.

Although growth in consumer lending intensified over the last two years, helping to boost economic recovery and internal demand, it is increasing the debt pressure of the people. In addition, consumer credit growth is fueling the consumption of imports, putting pressure on the balance of payments and exchange rates, leading to possible risk accumulation in the banking system. In such circumstances, raising policy rate will only limit total credit growth, hence the adoption of macro-prudential policy instruments for consumer lending would be an optimum policy choice. Therefore, the Monetary Policy Committee decided to set a 70 percent ceiling on debt-to-income ratio for wage, pension and consumer loans and maturity limit of 30 months on non-mortgage consumer credits.

Extending foreign currency credit to unhedged borrowers or households and corporations with limited income in foreign currency, would create pressure on borrower’s debt and augment the vulnerabilities in the economy and financial sector. Consequently, the Monetary Policy Committee decided to raise the risk weight on unhedged foreign exchange loans from 120% to 150%, on September meeting.  In order to reduce the dollar's leverage, the dollar denominated liability in the banking system needs to be reduced. Depending on the foreign capital inflows and foreign exchange rate fluctuations the banks' USD liabilities increases, causing foreign exchange volatility in the domestic market and could diminish monetary policy effectiveness. Therefore, reserve requirements were set at 12 percent in foreign currency and 10.5 percent in domestic currency  to reduce dollar liabilities of the bank and mitigate rapid fluctuations in the exchange rate.

Despite the economic growth, the risks of external environment have increased in the second half of 2018. The growing trade conflicts between the US and China, and numerous increase on the Federal Reserve Bank's policy rates have negatively influenced developing countries’ currencies, as the inflow of capital slowed, and the national currency rates depreciate. With the increase in the balance of payments pressure, the restrictions on coal exports and the domestic political situation brought a negative impact on the confidence of market participants and increased the burden on the national currency, resulting devaluation of tugrik. Thus, the Bank of Mongolia has been combining monetary policy instruments and currency interventions to prevent the escalating surge in exchange rates.

The policy rate has increased by 100 basis point after the Extraordinary Meeting of the Monetary Policy Committee, held on November 27, in order to increase the yield on the tugrik, which will help to maintain confidence in the national currency and maintain the stability of the macro-economy in medium term. Furthermore, thorough currency intervention - auctions over 420 million USD has been supplied to the foreign exchange market since November, to stabilize the exchange rate from the uncertainty, market expectations, and supply fluctuations. The MNT against the USD depreciated by 8.4 percent from the beginning of the year and the real GDP growth accelerated to 6.7 percent in the third quarter. Elseways, the demand-pull inflation was relatively stable. Therefore, at the regular session of December, the Monetary Policy Committee considered to hold the policy rate at 11 percent, due to the effect of previous policy decisions, factors affecting inflation, their prospects, and business activity.

Further policy decision of the Monetary Policy Committee will aim to stabilize the CPI measured inflation at around 8 percent in 2019-2020, while sustaining the economic growth.