Inflation & Interest

According to National Statistics Office of Mongolia, inflation was 10.8% yoy in Ulan Bator and 10.8% nationwide in January 2012. According to World Bank, inflation is forecasted at 17% for 2011 and 17% for 2012(CPI (% year-on-year change) According to IMF in November 2011, Consumer prices (period average)are forecasted to rise at 10.2% for 2011 and 18.7% in 2012, Consumer prices (end-period) are forecasted at 15.1% in 2011 and 17.9% in 2012.

According to World Bank in October 2011, with budget expenditures being hiked up sharply in 2011 and 2012, overheating pressure will increase, feeding inflation which is already running in low double-digits. The 2012 budget envisages a 57 percent increase in wages and 40 percent increase in transfers on the 2011 approved budget. There is therefore a substantial risk of a wage-price spiral, if higher inflation expectations become entrenched. Rising inflation, if not matched by pre-emptive tightening of interest rates, will push real interest rates close to zero or into negative territory, as happened in the run-up to the previous bust. High domestic inflation also causes the currency to appreciate in real terms, hurting the export sectors. Although the Bank of Mongolia has been quick to raise policy rates and reserve requirements, its efforts to control inflation will be more than offset if the extraordinarily large fiscal injections planned by the government for the remainder of this year and next year materialize as planned.

According to IMF in November 2011, too expansionary 2011 budget was major source of the persistent inflationary pressures. 2012 approved budget is still highly expansionary and will continue to be major source of the persistent inflationary pressure in 2012. Government spending, which was slated to grow by some 30 percent in the original budget, accounts for some two-thirds of the non-mineral economy and is thus a key determinant of aggregate demand. Any further increase in spending this year, therefore, is clearly not warranted. Additional spending this year would further overheat the economy, hurt the poor by driving up inflation, increase the vulnerability to a global commodity shock, and undermine credibility in fiscal policy and the fiscal responsibility law. Monetary policy, moreover, would not be able to offset a fiscal stimulus of this magnitude but in trying would inevitably lead to a crowding out of private sector activity.

The consensus view is that although 2012 budget is still highly expansionary, more realistic projections in 2012 budget are reflection of start of buildup of political will to restrain inflation which is more widely perceived greater macro risk in case of prolonged fiscal expansion. 2012 is election year and therefore there would accentuation of politically motivated actions such as cash handouts. End result inflation in 2012 would be dependent on fiscal intentions and political commitments.