VZCZCXRO6342
RR RUEHCN RUEHGH RUEHVC
DE RUEHUM #0116/01 0770144
ZNR UUUUU ZZH
R 170144Z MAR 08
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 1966
INFO RUEHUL/AMEMBASSY SEOUL 3229
RUEHOO/CHINA POSTS COLLECTIVE
RUEHFR/AMEMBASSY PARIS 0072
RUEHBK/AMEMBASSY BANGKOK 1734
RUEHLO/AMEMBASSY LONDON 0287
RUEHML/AMEMBASSY MANILA 1660
RUEHBK/AMEMBASSY BANGKOK 1735
RUEHKO/AMEMBASSY TOKYO 2914
RUEHSH/AMCONSUL SHENYANG 0474
RUEHVK/AMCONSUL VLADIVOSTOK 0240
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RHEHNSC/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHGV/USMISSION GENEVA 0377

UNCLAS SECTION 01 OF 03 ULAANBAATAR 000116 
 
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: IMF: 17% INFLATION THREATENS MONGOLIA'S ECONOMIC STABILITY 
 
Ref: 07 Ulaanbaatar 0686 
 
ULAANBAATA 00000116  001.2 OF 003 
 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION. 
 
¶1. (SBU) SUMMARY: According to the IMF Article IV Consultation 
mission that visited Ulaanbaatar last week, Mongolia's macroeconomic 
stability is threatened by rapidly rising inflation, measured at 17% 
in January and climbing.  Prices are being pushed upward by 
increased government spending, rapid growth of money supply and 
credit, high international prices and the sinking value of the 
national currency. Government efforts to fight inflation have so far 
proven unsuccessful, and with Parliamentary elections set for late 
June, the GOM is unlikely to heed the IMF's advice to cut back on 
wage increases and welfare transfer programs.  Meanwhile, the 
Central Bank is considering raising capital adequacy requirements of 
commercial banks to as high as 15% and doubling the minimum capital 
requirement to US$13.7 million, to rein in lending and money 
creation.  The de-facto pegging of the tugrik to the U.S. dollar has 
limited the Central Bank's ability to fight inflation in other 
areas. The local IMF office will close in 2009 due to IMF budget 
cuts. END SUMMARY. 
 
IMF TEAM COMPLETES ARTICLE IV CONSULTATIONS 
------------------------------------------- 
 
¶2. (U) Rapidly rising inflation is threatening Mongolia's 
macroeconomic stability, according to the IMF Article IV 
Consultation mission that concluded its visit on March 11.  The IMF 
mission urged Mongolia to make reducing inflation its top priority. 
 
 
INFLATION AT 17.5%; COULD REACH 20% 
----------------------------------- 
 
¶3. (SBU) Inflation reached 17.5% in January, up 2.4% from December 
¶2007.  IMF reps said price increases were due, among other factors, 
to large increases in government spending for civil-service wages 
and social-welfare outlays, especially in the final quarter of 2007; 
rapid growth in broad money supply and banking-system credit; 
soaring import prices, particularly for food and petroleum products; 
and transportation bottlenecks at the borders. Prices for food and 
nonalcoholic beverages, which rose 4%, were a major contributor to 
the CPI's overall increase.  Some economists predict that the rate 
could top 20% before possibly cooling in the autumn. 
 
GOM EFFORTS TO STABILIZE PRICES 
------------------------------- 
 
¶4. (SBU) The GOM has worked to stabilize prices of main products 
such as food and fuel through subsidies and tax breaks, but to no 
avail.  Despite continued subsidies and a stabilization agreement 
with Russia on fuel imports, petrol is expected to increase by 
US$0.17 to US$0.27 per liter from the current US$1 at the pump, 
according to import companies.  Vendors say GOM exemption on VAT for 
domestically produced meat is failing to make up for increasing fuel 
and transport prices. 
 
GOM SPENDING ADDS TO INFLATION 
------------------------------ 
 
¶5. (SBU) According to the IMF, increased government spending has 
aggravated inflationary pressures, and it urged the GOM to avoid 
further increases in civil-service employment wages or the 
introduction of any new spending programs.  But few expect 
Mongolia's politicians to exercise fiscal discipline as the 
elections approach.  In a meeting with the DCM and Econ/Coml Chief, 
 
ULAANBAATA 00000116  002.2 OF 003 
 
 
IMF mission leader Roger Kronenberg said GOM officials seemed to 
take seriously the IMF's advice that proposed revisions to the 2008 
budget -- calling for increased spending and a stimulus program 
providing Togruk 50,000 (US$43) to every Mongolian -- could 
exacerbate inflationary pressures.  But once the IMF team departed, 
the proposed stimulus plan of the ruling Mongolian People's 
Revolutionary Party was back on the agenda.  So was a convoluted 
Democratic Party scheme that would deliver US$1,000 to every 
Mongolian from mining profits. 
 
BUDGET SURPLUS JUST TOO TEMPTING TO THE GOM 
------------------------------------------- 
 
¶6.  (SBU) Higher than expected revenues from high commodity prices 
and recent tax reforms (Mongolia now has some of the lowest income 
tax rates in Asia) have allowed the government to avoid a large 
deficit (beyond the GOM's traditional annual 3% deficit target), and 
Mongolia has experienced a budget surplus for three years running. 
Rather than desperately spend its way into deficit territory through 
mid-year budget revisions, the GOM was encouraged by the IMF to keep 
its eye on longer-term economic fundamentals.  The IMF suggested 
that the GOM maintain a modest budget surplus in 2008, to prevent 
high inflationary expectations from becoming firmly entrenched. 
 
MONEY SUPPLY GROWING TOO 
------------------------ 
 
¶7. (SBU) The IMF mission also recommended that the GOM slow the 
growth of money supply to bring inflation down quickly.  According 
to the Bank of Mongolia, money supply has reached 2,337 billion 
Togruk (US$2 billion), an increase of 50.2% over the past 12 months. 
Mongol Bank explained that money supply suddenly grew in the last 
month of the quarter, despite otherwise being lower.  The increased 
supply of money has been due to government spending on social 
purposes, such as increased wages and pensions.  In particular, 
there has been a dramatic increase in child allowances and 
allowances for newlywed couples. State employees were also given 
increased wages and salaries in the first and fourth quarter of 
¶2007.  Of the whole annual budget expenditure, 50.4%, or 881.9 
billion Togruks (US$753 million), was distributed in the final 
quarter. 
 
CREDIT EXPANDING 
---------------- 
 
¶8. (SBU) The rapid growth of credit is also stoking inflationary 
fires.  Loans issued by Mongolian banks grew 68% over the previous 
year.  At a recent luncheon for the Mongolian Bankers Association, 
Central Bank Governor Batsukh casually floated the idea of raising 
the capital-adequacy requirement of commercial banks from 10% to 
12%.  Another Central Bank employee suggested it could be raised to 
15% and then informed Econoff that the Bank was considering doubling 
the minimum capital requirement from 8 billion Togruks (US$6.8 
million) to 16 billion Togruks (US$13.6 million).  This tightening 
of banking regulation is expected to slow the rate of lending (and 
hence the growth of money) and perhaps weed out two or three of the 
sector's weaker banks, to provide greater stability. 
 
EXCHANGE RATE ADJUSTMENTS LIMITED DUE TO PEG TO US$ 
--------------------------------------------- ------ 
 
¶9. (SBU) The IMF mission also recommended reintroducing greater 
exchange-rate flexibility, in tandem with monetary policy, to help 
bring inflation down, facilitate adjustments to external shocks, and 
maintain external stability.  The value of the Togruk has remained 
stable against the U.S. dollar at 1,170 Togruk/US$1.  Like the 
 
ULAANBAATA 00000116  003.2 OF 003 
 
 
greenback, its value has been decreasing on international exchange 
markets, adding further pressure on imports.  The IMF recently 
re-classified Mongolia's exchange-rate arrangement to a conventional 
peg, which acknowledges the de-facto peg of the Mongolian Togruk 
within margins of plus or minus 1% against the US dollar.  This has 
limited the flexibility of the BOM's monetary policy in addressing 
inflation. 
 
HARD TO ARGUE WITH ECONOMIC SUCCESS 
----------------------------------- 
 
¶10. (U) Mongolia's economic performance in recent years has been 
strong. Real GDP growth measured 9.9% in 2007.  High copper and gold 
prices have strengthened the economy, as has strong investment in 
the mining and construction sectors.  Public debt has been sharply 
reduced, and the Bank of Mongolia is posting a record level 
international reserves.  Per-capita income has doubled since 2004. 
 
LOCAL RESIDENT OFFICE A BUDGET CUT VICTIM - EVENTUALLY 
--------------------------------------------- --------- 
 
¶11. (SBU)  Kronenberg confirmed that the IMF's local resident office 
was being cut as part of the IMF's belt-tightening.  The current IMF 
ResRep would stay in place and the office would remain open until 
his term expires in 2009.  In other news, Kronenberg himself is 
retiring from the IMF.  He noted that working on Mongolia for the 
past 12 years had been one of his "bright spots." 
Minton