DALIAN, China -- Mongolia's central bank has lifted the country's key interest rate by 4.5 percentage points to 15% in a desperate move to halt the home currency's decline amid capital flight triggered by plunging resource prices.
Thursday's hike came just months after the Bank of Mongolia cut the rate to 10.5% in May. The central bank defended its drastic hike, citing the tugrik's 7.9% decline against the dollar since late July, saying it acted to "protect the currency and achieve stability in the medium term" and to increase yields on tugrik assets.
Mongolia's economic stagnation led to the troubles that forced the central bank's hand. As a resource-exporting country, it enjoyed double-digit gross domestic product growth during the resource bubble that ran from 2011 to 2013, when prices of coal and copper soared. But with the fall of commodity prices and China's economic slowdown, GDP growth stalled at 2.3% in 2015.
Now foreign investors are pulling funds out of the country en masse. If left unchecked, the falling home currency could send the inflation rate and consumer price index soaring, eroding trust in the tugrik.
The government also announced the same day a series of spending cuts, including reducing the salaries of top officials at state-owned companies and halting public works projects. The country's economic slump, combined with sloppy fiscal management, has resulted in a revenue shortfall, leaving the country without funds to pay for debt redemptions. Foreign-currency-denominated "Chinggis" bonds totaling the equivalent of $2.1 billion are set to mature in 2017 and 2018.
The Mongolian People's Party won by a landslide in June's general elections. The party has promised fiscal reform under the International Monetary Fund's supervision, and has begun preparations to seek assistance. The government has concluded additional austerity measures are inevitable in order to avoid defaulting on its debt.
Yet such austerity measures can sometimes backfire. Interest rates have reached 25% at private-sector lenders, and with the latest hike, that could even rise to 30%. Fiscal austerity could further squeeze private-sector economic activity.