Saha lecture updated1


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Saha lecture updated1

  2. 2. OutlineI. The International Financial SystemII. Global Financial CrisesIII. Mongolian Financial SystemIV. How the International System Affects MongoliaV. What Can Mongolia Do to Protect Itself from the Boom and Bust Cycles of Commodity Exporting Countries?Main message: Mongolia is now more than ever interlinked with the global financial developments
  3. 3. I. THE INTERNATIONAL FINANCIAL SYSTEM• System depends on structure, structure depends on its parts, and how it all works• Structure and parts: Banks, capital markets, international multilateral institutions, regulatory framework, why?• Financial markets are different, because of systemic problems
  4. 4. History of the International Financial System• The Gold Standard (1876-1914) • Gold has served as a medium of exchange since the early B.C. days of Greeks and Romans • In late 19th century, there arose a need for a more formalized system for settling trade balances • Under this standard: • Each country set the rate at which its currency could be converted to a weight of gold ($20.67/ounce in the US, £4.2474/ounce in GB) • Central banks could not issue more currency than its gold reserves • Worked until the WWII interrupted trade flows
  5. 5. History of the International Financial System• War years (1914-1944) • WWI began, need for government spending increased (to pay for the war), printed large amounts of currency • Many of the trading currencies lost their convertibility into other currencies. USD was the only currency that continued to be convertible.
  6. 6. History of the International Financial System• The Bretton Woods System (1944-1971) • As the WWII drew to a close in 1944, the Allied Powers (the anti-German coalition consisted of 44 nations) met in Bretton Woods, New Hampshire to create a new system. • Established a USD-based international monetary system: • USD was the only currency converted into gold ($35/ounce). • Other currencies were exchangeable at a fixed rate against the dollar. • Also established two institutions: the IMF and the World Bank
  7. 7. History of the International Financial System• Collapse of the Bretton Woods (1971) • Inflation in the US BOP deficits in the US BOP surpluses around the world forcing inflation upon other countries not effective anymore • Break of the link between value of currency and gold • Risks of printing money
  8. 8. Present System• Institutions: Governments Multilateral Central Banks IMFDevelopment Banks Private Institutions (private capital flows)
  9. 9. The Balance of Payments (BOP)• Monitors how much money is going in and out of a country during a specific period of time• Affects important factors of the economy such as the exchange rate, interest rates, inflation, and the GDP• 3 accounts: • Current Account(trade) • Capital and Financial Account (investments) • Foreign reserves• Surplus: money in>money out • (ex: KFA surplus: foreign investments>domestic investments in foreign country)• Deficit: money out>money in • (ex: CA deficit: imports>exports)
  10. 10. II. GLOBAL FINANCIAL CRISES1. Crises of the 1990’s • Mexican Peso Crisis (1994) • The Asian Financial Crises (1997-98) • Russia and Brazil (1998-99) Similar characteristics: Market liberalization/deregulation Capital mobility Speculative attacks Insufficient reserves Devaluation of the currency Stock markets crashing
  11. 11. II. GLOBAL FINANCIAL CRISES2. Crisis of 2008, but it has not over• The financial crisis of 2007–2008, also known as theGlobal financial Crisis and 2008 financial crisis, isconsidered by many economists to be the worst financialcrisis since the Great Depression of the 1930s.•This time originated in the developed markets, BearSterns, Lehman Brothers collapse affecting the world
  12. 12. II. GLOBAL FINANCIAL CRISES3. The Euro Debt Crisis (now) • Eurozone countries losing control of their finances and become unable to repay their government debts • Greece was the first to take a multi-billion pound bailout from other European countries last May, followed by Portugal and Ireland. • The ―contagion effect‖—one country’s financial problem spilling over to another country.
  13. 13. III. MONGOLIAN FINANCIAL SYSTEM• Banking Sector • Bank dominated about 95% of the total financial system assets • 14 commercial banks • Banks are exposed to credit and market risks
  14. 14. III. MONGOLIAN FINANCIAL SYSTEM• Capital Markets • markets are small but financial flows affect the exchange rate • Market capitalization 2.2 trillion MNT as of 2011 (about 20% of the GDP) • limitations in terms of legal framework, infrastructure, and liquidity • because MSE is underdeveloped, companies seek funding from overseas markets
  15. 15. III. MONGOLIAN FINANCIAL SYSTEM• Correlation of commodities and government finances • Government finances dependent on commodity exports • First it was Erdenet, now from coal, soon from copper exports from OT • Decline in exports negatively impacting government finances
  16. 16. Risks: banks, inflation• Vulnerability in the banking system • Highly dollarized (more than 1/3 of bank loans and bank deposits are denominated in USD) • High non-performing loans (NPLs) • Risk management weak• High inflation • reached 16.7% in April (y.o.y), 14.8% in September (still above the BoM’s target of a single-digit inflation)
  17. 17. Risks: fiscal deficit • Increasing government deficit expenditures increased 25.6% percentage points more than the revenues (y.o.y) Source: National Statistical Office, September 2012
  18. 18. Risks: Fiscal deficit Mongolia’s fiscal deficit rose to 4.2% of the GDP in April 2012 although the government revenue growth was the highest.Source: The World Bank, Mongolia Quarterly Update, June 2012
  19. 19. Risks: Export growth • Export growth negative for the first time in April • Further sluggishness likelySource: The World Bank, Mongolia Quarterly Update, June 2012
  20. 20. Risks: Trade deficit • Widening trade deficit $2.1bn in March 2012, up from $0.7bn in 2011Source: The World Bank, Mongolia Quarterly Update, June 2012
  21. 21. • Risks: CA deficit 35% of GDP in March 2012 (was 18% in 2011) Source: The World Bank, Mongolia Quarterly Update, June 2012
  22. 22. Risks: Exchange rate• Depreciation of the MNT Nominal and Real Exchange Rates Source: The World Bank, Mongolia Quarterly Update, June 2012
  23. 23. IV. HOW THE INTERNATIONALSYSTEM AFFECTS MONGOLIAThe Transmission Mechanisms1. International Monetary Flows, monetary baseincreases/decreases• Inflation • Demand side pressures government spending • Supply side pressures MNT depreciation imports more expensive Supply-food shortages
  24. 24. The Transmission Mechanisms2. Foreign Reserves money in  BOP reserves- exchange rates
  25. 25. The Transmission Mechanisms3.Monetary base, money supply• Interest Rate Differentials • also affects the transmission system E.g. flows of Korean funds during the 2008-2009 crisis • Real interest rates important for people who live in the country • With inflation accelerating, real deposit and lending rates falling.
  26. 26. Real deposit rate  now negative (-6.7%) Real lending rate  barely positive (0.6%)Source: The World Bank, Mongolia Quarterly Update, June 2012
  27. 27. The Transmission Mechanisms• Monetary Policy • Expansionary versus contractionary (tightening) • BoM tightened the policy by raising the benchmark rate to 13.25% and the banking sector reserve requirement ratio to 11%
  28. 28. The Transmission Mechanisms• Fiscal Space still constrained • Rising fiscal deficit  more vulnerability when there are global economic uncertainties • ―boom-and-bust‖ cycle • Brings into focus the need to manage resource curse issues
  29. 29. The Transmission Mechanisms: RisingExpectations• Off-Budget Financing • government borrowing, that should be invested in productive assets to be repaid later • The Development Bank of Mongolia issued 5-year $580mn worth of foreign currency bond offering in March 2012 • Debt issued by the DBM is of relatively short term raising exposure to external shocks or to unexpected delays in mining projects that effect commodity revenues (there is still uncertainty in the global financial system)
  30. 30. V. WHAT CAN MONGOLIA DO TOPROTECT ITSELF FROM BOOM-BUSTCYCLES?• Fiscal Stability • Fiscal Stability Law becoming effective in January 2013 (Structural deficit ceiling of 2% of GDP) • Need to make sure that the lending of the DBM is within the framework of the FSL • Look at other countries and how they have managed mineral rich economies
  31. 31. Structural deficit 6.1% of GDP as of April, 2012—Source: The World Bank, Mongolia Quarterly Update, June 2012
  32. 32. Chile’s example—• Chile • Chile produces about 1/3 of world’s copper Structural balance • Copper exports55% if its export means the difference between • Copper revenues18% of fiscal revenues trend revenues • Adopted Structural Balance Rule and public expenditures Objectives: 1. to protect public spending from the effects of changes in commodity prices 2. to improve government’s net asset position to meet contingent obligations
  33. 33. Chile’s example• Chile’s Fiscal Rule Fiscal Responsibility Law: • Each administration must announce structural balance target within 90 days of taking office • Sovereign wealth funds: • Pension Reserve Fund helps cover pension guarantees • Economic and Social Stabilization Fund receives budget surplus after payments (fiscal buffer) Resource of the two funds are invested abroad
  34. 34. Chile’s example• Chile’s Fiscal Rule • Transparency of the rule • Independent expert committees set up the main parameters of the rule, therefore protected from political interference • Well understood by both public and market participants • Detailed explanations, implementation reviews, targets, all published • Methodological improvements over time • To incorporate changes in other sources of fiscal revenue
  35. 35. V. WHAT CAN MONGOLIA DO TOPROTECT ITSELF FROM THEBOOM-BUST CRISIS?• Recognize interdependency of Mongolia on global flows, factors• Managing Inflation• Managing Expectations—fiscal side; Chilean example• Policy Certainty—credibility—foreign investment
  36. 36. V. WHAT CAN MONGOLIA DO TOPROTECT ITSELF FROM THE CRISES?• Monetary side Sterilization of the financial flows • Central bank can sterilize capital inflows • Otherwise currency appreciation and inflation • METHODS: • Domestic component of monetary base (bank reserves and currency) is reduced • Encourage private investment overseas • Conduct Open Market Operations of central bank – selling more of treasury bills, reduce monetary base • Widen band of exchange rate movements
  37. 37. V. WHAT CAN MONGOLIA DO TOPROTECT ITSELF FROM THE CRISES?• Funds: saving for a rainy day? Chilean example and other countries • Human development fund • Stabilization fund • Managing these funds are the issue, how much is still saved for difficult times?
  38. 38. V. WHAT CAN MONGOLIA DO TO PROTECTITSELF FROM THE BOOM-BUST CRISES?• Minimize off-budget financing • Although about 40% of the funds raised by the DBM is to finance important mining related infrastructure, the remainder is to be used for projects that will not generate much revenue (undermine the goals of the FSL)
  39. 39. Recent Headlines…“”Tax proposals in Mongolia threatens Rio Tinto project” New York Times“Mongolias white-hot growth slows on China woes”AFP“…the advice to Mongolian policy makers is to „hold yourhorses‟ and adopt a more cautious macroeconomic stance” The World Bank“Mongolia: can‟t live with China, can‟t live without China”Financial Times“Mongolia‟s new investment law: deterrent or clarification?” Financial Times
  40. 40. MAIN MESSAGEMongolia is now more than ever interlinked with the global financial developmentsIt is even more important to be able to manage complex financial developments
  41. 41. Activity…What would you do if you were… • Central bank governor • Ministry of Finance, Minister of Finance • Member of the Parliament • in managing the ―boom-bust‖ crises • Private investors of large global companies • What impacts above government actions have on private investments