Source: ResCap                     Date: 08 December, 2010

The MNT, up 17% y-t-d, is the best-performing currency against the dollar this year. The recently approved 2011 budget envisages a steep increase in government spending, together with a sharp rise in the fiscal deficit to 9.9% of GDP, compounding existing inflationary pressures from the economic rebound and lack of spare capacity in the economy. The World Bank estimates that the budget will add 15% inflation on top of existing inflation of around 10%, which may undermine confidence in the currency.

Mongolia could be following a well-trodden path adopted by many other resource rich economies such as the Netherlands in the 1960s, after which the infamous term ‘Dutch Disease’ is coined. Large discoveries of vast natural gas deposits in the North Sea and new found wealth caused the Dutch guilder to rise. Limited supply of currency, a small economy, large inflows of foreign direct investment and significant subsidies to citizens resulted in upward wage-price spirals proving difficult to control and feeding domestic asset prices. A recipe for potential further advances of the MNT in 2011.