Mongolia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
31 Jan 2007
eISBN:
9781451826937
Language:
English
Keywords:
ISCR; CR; exchange rate; broad money; BOM rate; BOM gold purchase; exchange rate volatility; liquidity constraint; market rate; U.S. dollar sale; Exchange rates; Commercial banks; Currency markets; Interbank rates
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This Selected Issues paper analyzes the main determinants of inflation in Mongolia using empirical tests based on a structural model approach and vector autoregression model, with a view to assessing whether inflation is predominantly affected by commodity prices or by money supply developments. Simulation and impulse response analyses are used to estimate components of the inflation dynamics under various exogenous shocks. The paper also addresses the mineral wealth management issues faced by Mongolia, and describes the mining sector and its envisaged development over the medium term.

Abstract

This Selected Issues paper analyzes the main determinants of inflation in Mongolia using empirical tests based on a structural model approach and vector autoregression model, with a view to assessing whether inflation is predominantly affected by commodity prices or by money supply developments. Simulation and impulse response analyses are used to estimate components of the inflation dynamics under various exogenous shocks. The paper also addresses the mineral wealth management issues faced by Mongolia, and describes the mining sector and its envisaged development over the medium term.

IV. Foreign Exchange Market in Mongolia33

82. Mongolia’s foreign exchange market is still at an early stage of development. Its main component is the interbank market, where commercial banks trade foreign exchange with each other, as well as with the Bank of Mongolia (BOM), their business clients, and private individuals. The market share of foreign exchange bureaus is fairly small.34 Compared with mature interbank markets in developed countries, the bulk of commercial banks’ transactions is with their business clients instead of with other commercial banks35. Interbank trading, which accounts for most of the activity in mature foreign exchange markets, accounts for less than 20 percent of total transactions in Mongolia. In addition, foreign exchange is only traded at spot prices. Although there are a few forward transactions among commercial banks as part of their own reserve management, there is no real forward market, and commercials banks’ ability to hedge foreign exchange risks is limited.

Foreign Exchange Trade of Commercial Banks

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Sources: Data provided by the Bank of Mongolia; and Fund staff calculations.

In 2002, trade with other banks were separated from trade with business units only from June.

Through July 2006.

83. The BOM sets its daily midpoint exchange rate based on lagged exchange rates at the interbank market. The midpoint exchange rate of the togrog against the U.S. dollar is set and announced daily in late afternoon, usually calculated as the simple average of the buying and selling rates from the previous day’s transactions reported by commercial banks. This rate is then used as the next day’s BOM policy rate. Sometimes the midpoint rate is set differently from this rule, especially whenever the BOM decides to keep the BOM rate unchanged, e.g., when the BOM concludes that market fluctuations are temporary. Today’s exchange rates from the largest foreign exchange bureaus are also collected (dubbed “curb rates”) as a reference for setting the midpoint rate. The BOM rate broadly follows the interbank rate with a lag.

A04ufig01

Exchange Rates Movements, 2001 to July 2006

Citation: IMF Staff Country Reports 2007, 039; 10.5089/9781451826937.002.A004

Source: Data provided by the Bank of Mongolia.

84. The midpoint rate is only used in government transactions and customs valuation, for accounting and taxation purposes. All other transactions, including sales of retained foreign exchange by public sector enterprises, take place through the interbank market. Exchange rates for other convertible currencies are calculated on the basis of the cross rates against the dollar in international markets.

85. Interventions are officially limited to smoothing high-frequency fluctuations in the foreign exchange market, using the U.S. dollar as the principal intervention currency. Because the BOM can accumulate foreign reserve through its gold operations, there is usually no need for the BOM to purchase foreign exchange from the market for that purpose. Indeed, the BOM has been a net seller of foreign exchange in the interbank market.

BOM’s Gold Purchases and Reserve Accumulation

(In millions USS$)

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Source: Data provided by the Bank of Mongolia

86. The BOM has deliberately avoided intervening in the interbank market in recent years. Although there were episodes of deliberate intervention in the past, in recent years the BOM’s interventions, which are not sterilized, have been limited to fulfilling requests from commercial banks. The BOM also claims that no interventions for smoothing purposes were made, probably reflecting broad stability of the exchange rate, with the togrog only depreciating by 6 percent against the U.S. dollar during 2001-end-July 2006 and the real effective exchange rate appreciating by 7 percent over the same period.

87. The BOM’s buying and selling rates are set at five togrogs below and above the midpoint rate. This trading margin of ten togrogs is high compared with those of the commercial banks, which are usually four togrogs or less for transactions with business clients. The BOM has deliberately set a large margin to reduce commercial banks’ incentives to trade foreign exchange with the BOM. Occasionally, a different margin (e.g., eight togrogs) was applied.

88. The BOM’s market share in Mongolia’s foreign exchange market has declined significantly in recent years. The BOM’s high margins reduced arbitrage opportunities arising from the difference between the BOM’s rates and market rates. Commercial banks generally only approach the BOM when they are under liquidity constraints, which has led to a decline in the BOM’s market share in recent years. While in 2002 commercial banks purchased 22 percent of their foreign exchange needs from the BOM, this share declined to 8 percent in 2005. Increased foreign exchange inflows in recent years have eased commercial banks’ liquidity constraints, as a result banks rely on the BOM to a lesser extent to meet their liquidity requirements. Exchange rate volatility has increased slightly since 2004.

A04ufig02

Exchange Rate Volatility: 2001 to July 2006 1/

Citation: IMF Staff Country Reports 2007, 039; 10.5089/9781451826937.002.A004

Sources: Data provided by the Bank of Mongolia; and IMF staff calculations.1/ As measured by the first difference of logarithms of the daily exchange rate (see, for example, Frankel and Wei, 1993).

Exchange Rate Volatility, 2001 to July 2006

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Based on data through end-July.

As measured by the standard deviation of the first difference of logarithms of daily exchange rate.

89. The seasonality of the togrog exchange rate against the U.S. dollar appears to have dampened somewhat recently. The togrog usually appreciates in the first half of the year, in response to sales of raw materials (e.g., cashmere, skin and hides) in the spring and inflows of financing for mining operations (usually in the second quarter), and depreciates in the second half of the year, as mining companies pay off loans toward the end of the year.36 With the increase in foreign exchange inflows in recent years, in particular FDI and tourism receipts (which peaks after June), this pattern seems to have dampened somewhat recently, as the depreciation of togrog did not pick up until August in 2005, and the togrog’s appreciation during 2006 has lasted longer.

A04ufig03

Annual Exchange Rate Movements, 2001 to July 2006

(Togrog per US$)

Citation: IMF Staff Country Reports 2007, 039; 10.5089/9781451826937.002.A004

90. The BOM may reject foreign exchange requests from commercial banks. Occasionally, the BOM declines banks’ requests, if it considers they are for arbitrage profits.37 The BOM may also refuse to sell foreign exchange to banks if the BOM considers the level of its international reserves to be low. No explanations are given to commercial banks, however, when their requests for foreign exchange are declined.

91. The impact of the BOM’s intervention on the market rate is limited. The BOM’s interventions are atypical of central banks’ interventions, whereby the central banks buy or sell foreign exchange in order to affect the exchange rate level. Nevertheless, the impact could still be significant, given that these interventions are relatively large. The BOM intervened in the foreign exchange market in 2005 with eight purchases of U.S. dollars totaling $27 million and 74 sales totaling $81 million. However, in general the exchange rate did not move in the anticipated direction (in the near future). This reflects the passive nature of the BOM’s interventions, with U.S. dollar purchases generally made during periods of U.S. dollar depreciation (i.e., when there is an oversupply of U.S. dollars in the market) while U.S. dollar sales generally occurring during periods of U.S. dollar appreciation. The interventions may have reduced the magnitude of the appreciation/depreciation (in other words, the volatility), but have not fundamentally changed the trend of exchange rate movements.

A04ufig04

BOM’s Intervention in the Interbank Market and Exchange Rate Movements in 2005 1/

(Togrog per US$)

Citation: IMF Staff Country Reports 2007, 039; 10.5089/9781451826937.002.A004

Source: Data provided by the Bank of Mongolia.1/ Intervention in thousands of US$ on the left axis, with positive interventions representing purchases of U.S. dollar; Exchange rate movements (togrog/$) on the right axis.

92. The BOM’s midpoint rate seems to affect the market rate. At this rate adjusted by trading margins, the BOM provides the market with an additional source of liquidity and arbitrage opportunities, conceptually it should therefore also affect the market rate. In addition, because the midpoint rate is essentially the lagged market rate, it should help reduce the market volatility. On the other hand, because the BOM has the option to decline foreign exchange requests from commercial banks, the impact of the midpoint rate on the market rate, if any, could be rather limited. Granger Causality tests suggest that the midpoint rate seems to affect the market rate.

Does BOM’s Midpoint Rate Affect the Market Rate?

The following Granger Causality test was used:

yt=α0+α1⁢yt−1+...+α4⁢yt−4+β1⁢xt−1⁢...+β4⁢xt−4+ɛt⁢.

  • Two versions of yt are used: (i) the level; and (ii) the first difference of the interbank rate. For the former, the level of BOM rate is used as xt For the latter, two versions of xt are used: (i) the first difference of the BOM rate; and (ii) the difference of the BOM rate and the lagged interbank rate.

  • Daily data from January 2001 to July 2006 with 4 lags are used, although the results are robust to different lag lengths. The purpose is to test if the current and/or lagged BOM rates can help explain current interbank rates, after controlling for lagged interbank rates.

  • The null hypothesis of no Granger Causality can be rejected in all three cases, with p-values close to zero. This evidence is consistent with the hypothesis that the BOM rate affects the interbank rate. Nevertheless, because the Granger Causality tests are best described as tests of whether x helps forecast y rather than tests of whether x causes y, one needs to be cautious in concluding causation.

STATISTICAL APPENDIX

Table 1.

Mongolia: Basic Data, 2001–06

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Sources: Data provided by the Mongolian authorities; and Fund staff estimates.
Table 2.

Mongolia: GDP by Sector at Current Market Prices, 2001–05

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Source: Data Provided by the National Statistical Office.
Table 3.

Source: GDP by Sector at 2000 Constant Prices, 2001–05

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Source: Data Provided by the National Statistical Office.
Table 4.

Mongolia: GDP Deflator by Sector, 2001–05

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Source: Data Provided by the National Statistical Office.
Table 5.

Mongolia: Gross National Disposable Income and Savings at Current Market Prices, 2001–05

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Sources: Data Provided by the National Statistical Office; and IMF staff estimates.

Including acquisitions less disposal of valuables.

Forced to be consistent with the latest balance of payments data.

Difference between output-based and expenditure-based GDP estimates.

Output-based GDP.

GNI is defined as the sum of GDP and net income from abroad.

GNDI is defined as the sum of GNI and net transfers.

Including statistical discrepancy.

Defined as the difference between GDP and final consumption including the statistical discrepancy.

Defined as the difference between GNDI and final consumption including the statistical discrepancy.

Defined as the difference between current revenue and current expenditure.

Table 6.

Mongolia: Output of Major Agricultural Products, 2001–05

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Source: Data provided by the National Statistical Office.
Table 7.

Mongolia: Output of Basic Industrial and Mining Products, 2001–05

(In thousands of metric tons; unless otherwise indicated)

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Source: Data provided by the National Statistical Office.
Table 8.

Mongolia: Gross Industrial Output at 2000 prices, 2001–05

(In billions of togrogs)

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Source: Data provided by the National Statistical Office.

Includes electric and thermal energy.

Table 9.

Mongolia: Coal Mining Sector, 2001–05

(In thousands of metric tons)

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Source: Data provided by the National Statistical Office.

Consumption by thermal power stations.

Table 10.

Mongolia: Petroleum Imports, 2001–05

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Source: Data provided by the National Statistical Office.
Table 11.

Mongolia: Electricity Sector, 2001–05

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Source: Data provided by the Ministry of Fuel and Energy.
Table 12.

Mongolia: Employment by Sector, 2001–05

(Number of employees; in thousands at end of year)

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Source: Data provided by the National Statistical Office.

Excludes foreign employees.