2. Outline
I. The International Financial System
II. Global Financial Crises
III. Mongolian Financial System
IV. How the International System Affects Mongolia
V. What Can Mongolia Do to Protect Itself from the Boom
and Bust Cycles of Commodity Exporting Countries?
Main message: Mongolia is now more than ever interlinked
with the global financial developments
3. I. THE INTERNATIONAL FINANCIAL SYSTEM
• System depends on structure, structure
depends on its parts, and how it all works
• Structure and parts: Banks, capital
markets, international multilateral
institutions, regulatory framework, why?
• Financial markets are different, because of
systemic problems
4. History of the International Financial System
• The Gold Standard (1876-1914)
• Gold has served as a medium of exchange since the early
B.C. days of Greeks and Romans
• In late 19th century, there arose a need for a more formalized
system for settling trade balances
• Under this standard:
• Each country set the rate at which its currency could be converted
to a weight of gold ($20.67/ounce in the US, £4.2474/ounce in
GB)
• Central banks could not issue more currency than its gold
reserves
• Worked until the WWII interrupted trade flows
5. History of the International Financial System
• War years (1914-1944)
• WWI began, need for government spending increased (to
pay for the war), printed large amounts of currency
• Many of the trading currencies lost their convertibility into
other currencies. USD was the only currency that continued
to be convertible.
6. History of the International Financial System
• The Bretton Woods System (1944-1971)
• As the WWII drew to a close in 1944, the Allied Powers (the
anti-German coalition consisted of 44 nations) met in Bretton
Woods, New Hampshire to create a new system.
• Established a USD-based international monetary system:
• USD was the only currency converted into gold ($35/ounce).
• Other currencies were exchangeable at a fixed rate against the
dollar.
• Also established two institutions: the IMF and the World Bank
7. History of the International Financial System
• Collapse of the Bretton Woods (1971)
• Inflation in the US
BOP deficits in the US
BOP surpluses around the world
forcing inflation upon other countries
not effective anymore
• Break of the link between value of currency and gold
• Risks of printing money
8. Present System
• Institutions:
Governments
Multilateral
Central Banks IMF
Development Banks
Private Institutions
(private capital flows)
9. The Balance of Payments (BOP)
• Monitors how much money is going in and out of a
country during a specific period of time
• Affects important factors of the economy such as the
exchange rate, interest rates, inflation, and the GDP
• 3 accounts:
• Current Account(trade)
• Capital and Financial Account (investments)
• Foreign reserves
• Surplus: money in>money out
• (ex: KFA surplus: foreign investments>domestic investments in
foreign country)
• Deficit: money out>money in
• (ex: CA deficit: imports>exports)
10. II. GLOBAL FINANCIAL CRISES
1. Crises of the 1990’s
• Mexican Peso Crisis (1994)
• The Asian Financial Crises (1997-98)
• Russia and Brazil (1998-99)
Similar characteristics:
Market liberalization/deregulation
Capital mobility
Speculative attacks
Insufficient reserves
Devaluation of the currency
Stock markets crashing
11. II. GLOBAL FINANCIAL CRISES
2. Crisis of 2008, but it has not over
• The financial crisis of 2007–2008, also known as the
Global financial Crisis and 2008 financial crisis, is
considered by many economists to be the worst financial
crisis since the Great Depression of the 1930s.
•This time originated in the developed markets, Bear
Sterns, Lehman Brothers collapse affecting the world
12.
13. II. GLOBAL FINANCIAL CRISES
3. The Euro Debt Crisis (now)
• Eurozone countries losing control of their
finances and become unable to repay their
government debts
• Greece was the first to take a multi-billion pound
bailout from other European countries last
May, followed by Portugal and Ireland.
• The ―contagion effect‖—one country’s financial
problem spilling over to another country.
14. III. MONGOLIAN FINANCIAL SYSTEM
• Banking Sector
• Bank dominated about 95% of the total financial system assets
• 14 commercial banks
• Banks are exposed to credit and market risks
15. III. MONGOLIAN FINANCIAL SYSTEM
• Capital Markets
• markets are small but financial flows affect
the exchange rate
• Market capitalization 2.2 trillion MNT as of
2011 (about 20% of the GDP)
• limitations in terms of legal
framework, infrastructure, and liquidity
• because MSE is underdeveloped, companies
seek funding from overseas markets
16. III. MONGOLIAN FINANCIAL SYSTEM
• Correlation of commodities and government finances
• Government finances dependent on commodity exports
• First it was Erdenet, now from coal, soon from copper exports from
OT
• Decline in exports negatively impacting government finances
17. Risks: banks, inflation
• Vulnerability in the banking system
• Highly dollarized (more than 1/3 of bank loans and bank deposits
are denominated in USD)
• High non-performing loans (NPLs)
• Risk management weak
• High inflation
• reached 16.7% in April (y.o.y), 14.8% in September (still above the
BoM’s target of a single-digit inflation)
18. Risks: fiscal deficit
• Increasing
government deficit
expenditures
increased 25.6%
percentage points
more than the
revenues (y.o.y)
Source: National Statistical Office, September 2012
19. Risks: Fiscal deficit
Mongolia’s fiscal deficit
rose to 4.2% of the
GDP in April 2012
although the
government revenue
growth was the highest.
Source: The World Bank, Mongolia Quarterly Update, June 2012
20. Risks: Export growth
• Export growth
negative for the
first time in April
• Further
sluggishness
likely
Source: The World Bank, Mongolia Quarterly Update, June 2012
21. Risks: Trade deficit
• Widening trade
deficit
$2.1bn in March
2012, up from
$0.7bn in 2011
Source: The World Bank, Mongolia Quarterly Update, June 2012
22. • Risks: CA deficit 35% of GDP in March 2012 (was 18% in 2011)
Source: The World Bank, Mongolia Quarterly Update, June 2012
23. Risks: Exchange rate
• Depreciation of the MNT
Nominal and
Real Exchange
Rates
Source: The World Bank, Mongolia Quarterly Update, June 2012
24. IV. HOW THE INTERNATIONAL
SYSTEM AFFECTS MONGOLIA
The Transmission Mechanisms
1. International Monetary Flows, monetary base
increases/decreases
• Inflation
• Demand side pressures
government spending
• Supply side pressures
MNT depreciation imports more expensive
Supply-food shortages
26. The Transmission Mechanisms
3.Monetary base, money supply
• Interest Rate Differentials
• also affects the transmission system
E.g. flows of Korean funds during the 2008-2009 crisis
• Real interest rates important for people who live in the
country
• With inflation accelerating, real deposit and lending rates
falling.
27. Real deposit rate now negative (-6.7%)
Real lending rate barely positive (0.6%)
Source: The World Bank, Mongolia Quarterly Update, June 2012
28. The Transmission Mechanisms
• Monetary Policy
• Expansionary versus contractionary (tightening)
• BoM tightened the policy by raising the benchmark rate to
13.25% and the banking sector reserve requirement ratio to
11%
29. The Transmission Mechanisms
• Fiscal Space still constrained
• Rising fiscal deficit more vulnerability when there are
global economic uncertainties
• ―boom-and-bust‖ cycle
• Brings into focus the need to manage resource curse issues
30. The Transmission Mechanisms: Rising
Expectations
• Off-Budget Financing
• government borrowing, that should be invested in productive
assets to be repaid later
• The Development Bank of Mongolia issued 5-year $580mn
worth of foreign currency bond offering in March 2012
• Debt issued by the DBM is of relatively short term raising
exposure to external shocks or to unexpected delays in
mining projects that effect commodity revenues (there is still
uncertainty in the global financial system)
31. V. WHAT CAN MONGOLIA DO TO
PROTECT ITSELF FROM BOOM-BUST
CYCLES?
• Fiscal Stability
• Fiscal Stability Law becoming effective in January 2013
(Structural deficit ceiling of 2% of GDP)
• Need to make sure that the lending of the DBM is within the
framework of the FSL
• Look at other countries and how they have managed mineral
rich economies
32. Structural deficit
6.1% of GDP as
of April, 2012—
Source: The World Bank, Mongolia Quarterly Update, June 2012
33. Chile’s example—
• Chile
• Chile produces about 1/3 of world’s copper Structural balance
• Copper exports55% if its export means the
difference between
• Copper revenues18% of fiscal revenues trend revenues
• Adopted Structural Balance Rule and public
expenditures
Objectives:
1. to protect public spending from the effects of changes in
commodity prices
2. to improve government’s net asset position to meet contingent
obligations
34. Chile’s example
• Chile’s Fiscal Rule
Fiscal Responsibility Law:
• Each administration must announce structural balance target
within 90 days of taking office
• Sovereign wealth funds:
• Pension Reserve Fund
helps cover pension guarantees
• Economic and Social Stabilization Fund
receives budget surplus after payments (fiscal buffer)
Resource of the two funds are invested abroad
35. Chile’s example
• Chile’s Fiscal Rule
• Transparency of the rule
• Independent expert committees set up the main parameters of the
rule, therefore protected from political interference
• Well understood by both public and market participants
• Detailed explanations, implementation reviews, targets, all published
• Methodological improvements over time
• To incorporate changes in other sources of fiscal revenue
36. V. WHAT CAN MONGOLIA DO TO
PROTECT ITSELF FROM THEBOOM-
BUST CRISIS?
• Recognize interdependency of Mongolia on global
flows, factors
• Managing Inflation
• Managing Expectations—fiscal side; Chilean example
• Policy Certainty—credibility—foreign investment
37. V. WHAT CAN MONGOLIA DO TO
PROTECT ITSELF FROM THE CRISES?
• Monetary side
Sterilization of the financial flows
• Central bank can sterilize capital inflows
• Otherwise currency appreciation and inflation
• METHODS:
• Domestic component of monetary base (bank
reserves and currency) is reduced
• Encourage private investment overseas
• Conduct Open Market Operations of central bank –
selling more of treasury bills, reduce monetary base
• Widen band of exchange rate movements
38. V. WHAT CAN MONGOLIA DO TO
PROTECT ITSELF FROM THE CRISES?
• Funds: saving for a rainy day? Chilean example and other
countries
• Human development fund
• Stabilization fund
• Managing these funds are the issue, how much is still saved
for difficult times?
39. V. WHAT CAN MONGOLIA DO TO PROTECT
ITSELF FROM THE BOOM-BUST CRISES?
• Minimize off-budget financing
• Although about 40% of the funds raised by the DBM is to
finance important mining related infrastructure, the remainder
is to be used for projects that will not generate much revenue
(undermine the goals of the FSL)
40. Recent Headlines…
“”Tax proposals in Mongolia threatens Rio Tinto project”
New York Times
“Mongolia's white-hot growth slows on China woes”
AFP
“…the advice to Mongolian policy makers is to „hold your
horses‟ and adopt a more cautious macroeconomic stance”
The World Bank
“Mongolia: can‟t live with China, can‟t live without China”
Financial Times
“Mongolia‟s new investment law: deterrent or clarification?”
Financial Times
41. MAIN MESSAGE
Mongolia is now more than ever interlinked with the global
financial developments
It is even more important to be able to manage complex
financial developments
42. Activity…
What would you do if you were…
• Central bank governor
• Ministry of Finance, Minister of Finance
• Member of the Parliament
• in managing the ―boom-bust‖ crises
• Private investors of large global companies
• What impacts above government actions have on private investments
