Senior Economist at the central bank A.Tsolmon sat down in a recent interview with the central bank’s website to discuss the recent fluctuations in the tugrug to dollar exchange rate and the factors behind the depreciation.
Since the beginning of the third quarter of 2018, the tugrug has been depreciating rapidly against the dollar. Let’s begin our interview with this. What is the reason for the depreciation?
First off, it is necessary to mention that this depreciation is due to a number of external and internal factors.
Looking at the external factors, the US has been appreciating against most currencies in the last few months. Due to a recovering US economy and increasing employment, the US Federal Reserve is gradually tightening its monetary policy for the first time since the 2008 global financial crisis. Even though I say gradually, the Federal Reserve is tightening its policy more rapidly than analysts had predicted. It is expected to tighten even further moving forward. Since 2015, the Federal Reserve has increased its benchmark interest rate a total of eight times. In 2018, it has modified its rate three times. Most recently, the benchmark interest rate was increased to 2.25 percent on September 26. This increases the return on the dollar.
Since the return on dollars has increased, attracting US dollar investments has become more costly. This has led to a mild capital flight in US dollars from developing countries. The supply of US dollars is decreasing globally, this has led to many currencies depreciating against the dollar. According to our research, as of the end of September, 81 of the 170 currencies in the world have depreciated four percent or more compared to the beginning of the year. It’s not just the currency of developing countries, many developed countries have seen their currencies depreciate against the US dollar. Looking at this, since Mongolia is a free-market economy with a floating exchange rate, the depreciation has largely been due to external factors.
What internal factors are contributing to the depreciation then?
The second and third quarter signify an increase in economic activity in Mongolia. Between August and October, increased imports of fuel due to winter preparation, higher demand for consumer imports, and the coinciding repayment of foreign debt obligations has created a surplus of dollar demand on the forex market. As of October 17, the tugrug has depreciated 5.7 percent against the US dollar, 2.5 percent against the euro, and 6.2 percent against the yen. In contrast, the tugrug appreciated 0.3 percent against the yuan and 6.9 percent against the Ruble.
With the expectation of the dollar, yen, and euro, the tugrug has been appreciating against most currencies. This signifies that the depreciation of the tugrug against the dollar has mostly been due to external forces rather than internal. If in fact the tugrug became unstable and lost its purchasing power, it would not appreciate against the yuan or ruble.
Some MPs have criticized Mongol Bank for comparing the tugrug to the currencies of Argentina and Turkey, which are going through political and economic crises. Are the comparisons warranted?
As I mentioned, 81 of the 170 currencies in the world depreciated against the dollar. Argentina and Turkey are clear cases that prove that the US dollar is appreciating on the global forex market whereas most currencies are depreciating.
To put it in context, the Argentinean peso depreciated 94 percent against the US dollar since the beginning of the year. Meanwhile, the Turkish lira has depreciated 47 percent against the US dollar. These two are the highest rates of depreciations this year. But the foreign debt pressure of these countries, the current account deficit, and the foreign exchange reserve of these countries are better than that of Mongolia’s. For example, the foreign debt equivalent to the GDP of Mongolia is 240 percent, Turkey’s debt is only equivalent 29 percent of the GDP and Argentina has 53 percent.
The current account deficit of Mongolia is equivalent to 10 percent of the GDP while Turkey’s and Argentina’s is around five to six percent. Our foreign exchange reserve is equivalent to 26 percent of the GDP, while Turkey and Argentina have seven to 10 percent. In other words, the foundational economic performance of these two countries are better than that of Mongolia’s, yet their currencies depreciated dramatically more. Argentina has over 30 percent inflation and its economy has fallen victim to dollarization. This has led to the central bank increasing its policy interest rate to over 60 percent and spend most of its foreign reserves in an effort to stabilize its exchange rate. This eventually led to an impending economic collapse, which has been decreasing market and consumer confidence, causing massive depreciation. As a result, Argentina is implementing an IMF program and will lend 57 billion USD as part of the program. In Turkey’s case, US sanctions have been the largest factor in the depreciation of the lira. Even though the circumstances surrounding these two countries are different than that of ours, the US dollar is appreciating on a large scale on the global market. It is important to mention that Mongol Bank is not sitting idly by making excuses that the tugrug has depreciated less than the lira or peso.
How involved in the forex market has Mongol Bank been in the past?
Before answering this question, it is necessary to underline one thing. The legal mandate of the central bank is to maintain the stability of the tugrug. This has two sides, one side is regarding maintaining inflation at a stable rate and on the other side, it concerns maintaining the exchange rate against foreign currencies.
Mongol Bank prioritizes maintaining inflation as its main objective but when around 40 percent of the goods in the basket of goods are imported, the central bank has to take into account the effect of the exchange rate on inflation and makes policy decisions accordingly.
It is incorrect to say that Mongol Bank is buying up all the foreign currencies on the market and not supplying foreign currencies to the market in an effort to increase foreign reserves. The depreciation of the tugrug observed in the last three months are believed to be short-term fluctuations that happened due to temporary discrepancies between supply and demand. As a result, the central bank only supplied foreign currencies to the market through auctions where it saw necessary. To be specific, since June 2018, Mongol Bank has supplied 774.4 million USD to the market. This accounts for 87 percent of the total amount of dollars that has been supplied to the market in 2018. Beginning on October 4, the tugrug to dollar exchange rate has been stabilizing, decreasing from 2,568 to 2,564 MNT for one USD. The central bank will be increasing its foreign reserves to prevent any dramatic fluctuations moving forward.
There are many who say that Mongol Bank must intervene on the market now to manage the depreciation. Is there any opportunity for the central bank to intervene on the market more than it has?
Our economy is an open small economy. Therefore, it is futile to take action against large scale changes in the global economy and financial sector. If we attempt to forcefully retain our exchange rate at a certain level, we will deplete our foreign reserves. Eventually, this will be counterproductive as this will only increase demand for US dollars, which increases the exchange rate. Fluctuations in the exchange rate have been relatively stable since 2017, and frankly, we are reacting too sensitively to the recent fluctuations.
An appreciating US dollar puts significant pressure on the public and businesses due to the fact that Mongolia is so dependent on imports. However, this depreciation of the tugrug can have some positive effects of decreasing import demand and increasing demand for domestic products that can serve as alternatives to import products. In short, a higher exchange rate decreases imports and supports exports. This lowers the amount of cash outflow and increases the inflow. Therefore, a floating exchange rate is good for the long-term economic prospects as it prevents from significant shocks in the economy.Of course, the public has a vested interest in maintaining the exchange rate at a certain level. Past experience has shown us that trying to forcefully maintain an exchange rate when the global economy is very uncertain carries some significant consequences and risks. Mongol Bank has learned from its past mistakes and maintains the principle of maintaining a floating exchange rate.