The appreciation was primarily due to a combination of tightening monetary policy, central bank intervention in the forex market and strong capital inflows.
Policy rate. On March 19, the Bank of Mongolia (BoM) raised the policy rate by 50 basis points to 12.75%. The increase intended to slow down inflation and lower the pressure on the MNT exchange rate, the central bank announced. Nationwide CPI reached 12.5% y-o-y in February 2012, whilst CPI in capital city Ulaanbaatar hit 13.3%. Expansionary fiscal policy could be contributing to inflation by fuelling the domestic demand.
Forex market interventions. According to the Bank of Mongolia, it sold US$242.75mn to commercial banks y-t-d as part of its efforts to avoid the downward pressure on MNT caused from surging imports. BoM allowed gradual depreciation of the tugrik in 2011, from its peak MNT1,195 to MNT1,396 by the end of last year. Amid strong political pressure on controlling the inflation and containing MNT depreciation, the central bank became active in forex market since November 2011 to ease the tensions before the June 2012 Parliamentary elections. Based on the BoM auction data and changes in Net International Reserves, we estimate the central bank spent at least US$200mn to prop up MNT in 2011. The bank's stated policy is to intervene only to prevent sudden swings in exchange rate in either direction.
CNY-MNT swap deal. The recent agreement between BoM and People's Bank of China (PBOC) to expand swap agreement to CNY10bn-MNT2tn provides additional support to MNT. BoM sold CNY269mn to commercial banks y-t-d. China is the largest trading partner of Mongolia, accounting for over 90% (US$814mn) of exports and 21% (US$304mn) of imports in 1Q2012. Last year China overtook Russia as Mongolia's largest imports market.
Strong FDI inflows. The Mongolian Tugrik has also been supported by strong FDI inflows. FDI worth US$395mn in 2M2012 have largely offset current account deficit of US$474.1mn in the same period. FDI hit record high of US$3.8bn in 2011. FDIs are expected to remain robust and continue supporting MNT. Through Ivanhoe Mines, Rio Tinto alone budgeted US$2.1bn for 2012 to advance further its flagship Oyu Tolgoi project.
International bonds. Development Bank of Mongolia (DBM) and Mongolian Mining Corporation (MMC) have recently raised almost US$1.2bn in international debt markets. DBM, a state-owned policy bank raised US$580mn to kick-start government initiated major infrastructure and housing projects in the country. MMC, the Mongolia's largest coal miner issued US$600mn debt to finance infrastructure and development projects. Extensive capital raising in international capital markets by Mongolian banks and corporates would provide further support for MNT.
Eurasia Capital maintains its long-term bullish view on MNT while short-term volatility may occur in 2012. Expansionary fiscal policy and rising inflation may force aggressive monetary tightening in 2H2012. We expect the central bank to continue supporting MNT in the coming months due to political and public pressure before the Parliamentary elections. However, the national currency should find its own strength in the near future. We expect trade balance to start improving from 2013 onwards. At the same time Fiscal Stability Law coming into effect in 2013 will restrain currently profligate fiscal policy.
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