VZCZCXRO9463
RR RUEHCN RUEHGH RUEHVC
DE RUEHUM #0686/01 3460442
ZNR UUUUU ZZH
R 120442Z DEC 07
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 1715
INFO RUEHUL/AMEMBASSY SEOUL 3067
RUEHOO/CHINA POSTS COLLECTIVE
RUEHFR/AMEMBASSY PARIS 0066
RUEHBK/AMEMBASSY BANGKOK 1642
RUEHLO/AMEMBASSY LONDON 0230
RUEHML/AMEMBASSY MANILA 1550
RUEHBK/AMEMBASSY BANGKOK 1643
RUEHKO/AMEMBASSY TOKYO 2762
RUEHSH/AMCONSUL SHENYANG 0393
RUEHVK/AMCONSUL VLADIVOSTOK 0191
RUEHRC/USDA FAS WASHDC
RHEHNSC/NSC WASHDC
RUEKJCS/SECDEF WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHGV/USMISSION GENEVA 0343

UNCLAS SECTION 01 OF 03 ULAANBAATAR 000686 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS FEDERAL RESERVE, USTR, EXIM, OPIC 
STATE PASS PEACE CORPS 
STATE FOR EAP/CM, EAP/EX, AND EB/IFD/OMA 
TREASURY FOR TTYANG; PASS IMF, WORLD BANK USEDS 
MANILA AND LONDON PASSS TO ADB, EBRD USEDS 
BANGKOK FOR USAID RDMA 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN PGOV ETRD EINV MG
SUBJECT: Mongolia Experiences Highest Inflation in over a Decade 
 
Ref: Ulaanbaatar 0475 
 
ULAANBAATA 00000686  001.2 OF 003 
 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION. 
 
¶1. (SBU) SUMMARY: Mongolia is experiencing its highest inflation 
rate in over a decade as consumer prices have so far risen 14% in 
2007 largely due to skyrocketing fuel, wheat and meat costs.  Prices 
for gasoline, taxi fares, flour and even the national dish huushuur 
(fried meat dumplings) have doubled in the past six months.   Prices 
are also rising for key imports (compounded by the depreciation of 
the Mongolian Tugrik against the Chinese Yuan), administrative fees, 
utilities costs, transportation, education and health services. Some 
local economists argue that the price surges, which they say are the 
result of worldwide inflation and temporary glitches in meat supply, 
should be fully absorbed by the economy next year hailing the return 
to mid-single digit inflation in 2009.  Nevertheless, with just over 
six months to go until national elections, Parliament and the Bank 
of Mongolia (BOM) are furiously trading accusations that each failed 
to react quickly enough to avert the inflation crisis.  Meanwhile, 
the World Bank has warned that Mongolia's economy is at risk of 
overheating as demand for goods and services appears to have 
exceeded the economy's physical capacity to deliver them.  If the 
GOM fails to control current expansionary fiscal and monetary trends 
(increased government spending, excessive wage increases, and 
generous welfare outlays), long-term inflation could become 
systemically and psychologically entrenched.  END SUMMARY. 
 
Food Prices Drive Highest Inflation Rate Since 1997 
--------------------------------------------- ------ 
 
¶2. (SBU) According to officials at the Bank of Mongolia (BOM), 
year-end inflation numbers for calendar 2007 could top 14%, 
primarily driven by food items which comprise 41% of Mongolia's 
Consumer Price Index (CPI) consumption basket.  This is nearly 
triple the targeted inflation rate of 5.5% outlined in Parliament's 
amended national budget earlier this year, and represents the 
highest year on year consumer price increase in over ten years 
(Note: Modest price drops in November/December have led some 
economists to predict a year end inflation rate closer to 13%, still 
a ten year high).  Mongolia suffered triple digit inflation in the 
early nineties after the collapse of the socialist economy, but the 
rate has since been brought down to an annual average of 7.2% from 
1998 through 2006. The inflation rate for 1997 was recorded at 20%. 
According to BOM estimates, price hikes for food accounted for 70% 
of the total inflation rate; education 8%; transportation 5%; health 
4.5%; utilities 6%; and other 6.5%.  Since April 2007, the CPI 
growth rate increased at a rate of over 50% per month. 
 
This Bread Needs No Yeast: Flour Prices Jump 40% 
--------------------------------------------- --- 
 
¶3. (SBU) Global inflation and the Tugrik's depreciation against the 
Yuan have driven prices up for all imported foods.  Prices for 
vegetables from China, for example, were up 22.5%; the price of 
flour imported from Russia increased by 40%.  Mongolia's bread and 
cereals accounted for 3.3% of the 14% year-on-year total. Drought 
conditions in the provinces of Khentii, Selenge, and Tuv  caused 
2007 domestic wheat production to decline, reducing supply and 
placing further upward pressure on prices. According to GOM 
estimates for 2007, total demand for wheat will reach 298,468 metric 
tons (mt), only 121,200 mt (or 40%) of which will be met by domestic 
producers. Mongolia expects to import 91,071.43 mt, mostly from 
Russia, leaving a supply deficit of 27% or 81,715.32 mt. 
 
Not-So-Happy Lunar New Year? 
---------------------------- 
 
ULAANBAATA 00000686  002.2 OF 003 
 
 
 
¶4. (SBU) Despite higher prices, flour is flying off store shelves. 
One flour producer told Econoff that the situation was preventing 
his company from building up reserve stockpiles of flour in advance 
of Lunar New Year (February 8-10), when demand normally soars. 
"This year will be a tough Lunar New Year holiday," he said. 
 
¶5. (SBU)  In response, lawmakers are now circulating draft 
legislation that would waive the import tax and VAT on imported 
wheat and grains from Russia for one year to ease prices.  However, 
Russia's recently levied 10% export tax on wheat and grains would 
likely negate any relief that Mongolia's tax waivers might provide. 
According to press reports, Russia's Agricultural Minister recently 
announced that his country is ready to supply 250,000-300,000 mt of 
grain to Mongolia "at optimal prices" to help stabilize local bread 
prices.  A formal offer is expected to be announced during the 
current visit of an official Russian delegation to Ulaanbaatar.  The 
Russians have also reportedly offered guidance on how to stabilize 
prices. 
 
The Unkindest Cuts: Meat Prices Soar 21% 
--------------------------------------- 
 
¶6. (SBU) Most meat consumed in Mongolia is produced domestically. 
In September, meat prices were up 21 percent from the same month a 
year earlier, due to a convergence of four factors: drought 
conditions earlier this year; a growing tendency among herders to 
raise more profitable cashmere-producing goats; alleged price fixing 
among grey-market meat suppliers; and a rise in demand as net income 
increases.  However, since September, meat prices have declined 
slightly, dropping 4%.  In an effort to rein in price hikes, the 
Ministry of Food and Agriculture (MOFA) organized a meeting with 
meat suppliers and other stakeholders, who agreed to reserve 8,000 
mt of meat in the coming year and keep the price of meat from 
exceeding Tugrik 2,100 per kilogram.  Local residents report that 
the current average cost of a kilogram of meat is 50% higher than a 
year ago.  (NOTE:  Post's FSNs report that their usual weekly 
grocery basket prices have risen 30-40 %.) 
 
Dramatic Rise in Fees, Utility Costs 
------------------------------------- 
 
¶7. (SBU) Public and private university tuition fees have jumped by 
more than 20% this year.  Hospital services (room charges) rose 76% 
during the same period.  In April 2007, water tariffs were increased 
by 74%, on average.  (Note: Prices for education and services have 
been kept down for the last several years by the GOM, fearing public 
protests, and do not remotely reflect real costs.  The price 
increases in this case reflect pent-up needs to pay for 
long-deferred maintenance and to provide relief for institutions 
that have had to absorb input cost increases.) 
 
Monetary Growth and Increased Demand Fuels Inflation 
--------------------------------------------- -------- 
 
¶8. (SBU) According to the BOM, money supply (broad money, or M2) 
increased by 46.4% or US$608 million over last year's figures.  BOM 
officials say mining inflows, remittances, and other commodity 
inflows are flooding liquidity into the Mongolian economy, and the 
BOM's efforts to mop it up by stepping up issuances of bank bonds 
appears to have little effect. The economy has simply expanded 
beyond the BOM's current issuance limits.  Issuing US$30 million in 
bank bonds, for example, has had little impact considering the 
economy has doubled in size over the last five years. 
 
¶9. (U) Increased consumer demand is being driven by a number of 
 
ULAANBAATA 00000686  003.2 OF 003 
 
 
factors: expanding government consumption; increases in public wages 
and social welfare transfers; sustained remittances from Mongolians 
working abroad; and a 5% VAT cut along with the reduction for most 
Mongolians of their personal income tax.  Increased earnings and 
expected annual pay raises combined with falling interest rates have 
encouraged Mongolians to borrow at record levels to purchase such 
big ticket items as property and oversized SUVs (a status symbol in 
Ulaanbaatar).  This, in turn, is generating more money in the 
economy by providing cheaper access to liquidity.  Loans outstanding 
increased by 70.9% compared with last year, reaching US$110 million, 
of which 3.4% were deemed nonperforming.    Meanwhile, the country's 
average saving rate rests at a paltry 6%. 
 
Government Spending Soars 
------------------------- 
 
¶10. (SBU) Year-on-year government spending has grown exponentially, 
further stoking inflationary fires: 62% in 2006; 55% so far in 2007; 
and a proposed 80% for the 2008 budget.  Generous welfare payments 
to new couples, mothers, and children, as well as 30% salary 
increases for civil servants have become an annual ritual, fueling 
increased consumer spending/demand.  A BOM official told the DCM 
that many government workers went out and promptly spent the GOM's 
30% pay hike well before it was actually granted, creating a 
spending splurge and price surge.  Unfortunately, supply has failed 
to keep pace as the country's creaking infrastructure struggles to 
rush imported goods to markets (reftel). 
 
Comment: Getting Beyond the Blame Game 
-------------------------------------- 
 
¶11. (SBU) Parliamentarians have lambasted the BOM for not reacting 
quickly enough to the inflation crisis, which has become a thorn in 
an otherwise rosy economic picture.  The BOM, having successfully 
squashed the previous decade's annual double-digit trend and its 
psychological underpinning amongst the public, responds that it has 
limited power to control fluctuating prices, and that Parliament's 
expansionary fiscal policies are the real culprit.  The truth lies 
somewhere in between. Politics is driving Parliament's urge to spend 
while inflationary concerns have the BOM wanting to act more 
cautiously.  Unfortunately, the lack of complete political 
independence has prevented the BOM from aggressively tackling 
inflation.  If there is any hope of staving off long-term inflation, 
both sides will have to sit down and map out a policy that could 
very well be politically unpalatable, but necessary.  The GOM will 
need to think hard about continuing its policy of increases in civil 
service wages (usually followed in lock-step by the private sector) 
and social entitlements, which are directly contributing to 
inflationary pressures and are politically difficult to roll back. 
 
¶12. (SBU) The BOM and the GOM together will also have to seriously 
consider taking the politically difficult measure of raising 
interest rates, to discourage lending and borrowing.  But with 
Parliamentary elections drawing near, and Mongolians screaming that 
rates are already high enough  (at around 20% per year), such a move 
seems highly unlikely. END COMMENT 
 
Minton