FINANCE MINISTER OUTLINES INFLATION GOALS, TACTICS; DONORS

UNCLAS SECTION 01 OF 04 ULAANBAATAR 000276

C O R R E C T E D C O P Y (PARA NUMBERING)

SENSITIVE
SIPDIS

STATE FOR EAP/CM, EAP/EX AND EB/IFD/OMA
STATE PASS FEDERAL RESERVE, USTR, EXIM, OPIC
STATE PASS PEACE CORPS
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: FINANCE MINISTER OUTLINES INFLATION GOALS, TACTICS; DONORS
CONFER ON MONGOLIA'S RESPONSES

Ref: A) 07 Ulaanbaatar 0686; B) Ulaanbaatar 0116;
C) Ulaanbaatar 0221

ULAANBAATA 00000276 001.4 OF 004


SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION.


1. (SBU) SUMMARY: On May 15, Finance Minister Ulaan outlined the
Government of Mongolia's (GOM) assessment of the growing inflation
problem, Mongolia's worst since 1996. He outlined the GOM's
responses to higher petroleum, meat, and flour prices. The
following week, in response to a GOM request, partner/donor
organizations met to come up with advice on how the country can
fight inflation, which in April stood at 26.4% compared to the same
period last year. Food prices alone rose 44.4% during the same
period. Donors agreed that the GOM needs to reduce its spending on
welfare and wage increases for civil servants while supporting the
most disadvantaged Mongolians through well-designed subsidies.
USAID, which has encouraged the GOM to reduce and make more
transparent its massive subsidies to the energy sector, felt the
inflation crisis adds momentum to calls for a reduction in these
subsidies. All participants in the meeting agreed that proposed GOM
measures to create a food-stamp-like program were good steps, as
were measures to cut import and VAT taxes. However, there was
concern that bureaucracy and election fever would dull
implementation of these efforts. END SUMMARY.

FINANCE MINISTER LAYS OUT ANTI-INFLATION GOALS
-------------- -


2. (SBU) Finance Minister Ch. Ulaan outlined the extent of the
inflation problem and GOM actions at the UNDP's monthly donor
meeting on May 15 (then-Charge and USAID Director attended).
Minister Ulaan began by noting he'd just come from Parliament where
MPs were discussing a Democratic Party (DP) motion to dismiss the
Minister of Food and Agriculture for failing to keep his promise
regarding flour price increases. He said Prime Minister Bayar had
outlined a plan to address inflation which included: 1) a review of
the flow of goods to ensure adequate supplies to reduce pressure on
prices, 2) develop price stabilization methods for implementation,
and, 3) review prospects for limiting the impact of oil price
increases, recognizing the GOM could not continue to provide
subsidized prices having already spent Tugruk 12.3 billion (about
US$11 million) between November 2007 and March 15, 2008, when the
GOM ceased subsidizing local fuel distributors.

DEALING WITH HIGH PETROLEUM PRICES:
SEEK NEW SOURCES, SUBSTITUTE AND SUBSIDIZE
--------------


3. (SBU) Regarding petroleum prices, Mongolia would seek to expand
and diversify its petroleum sources. President Enkhbayar had
visited the Gulf states in 2007 for this purpose, hoping to lessen
Mongolia's near total dependence on Russia for its petroleum supply.
Ulaan said the GOM planned to review whether it could discontinue
exporting its small domestic oil production (about 200,000 barrels
per year) or trade it for refined product, since Mongolia has no
refinery capacity. Ulaan hoped in the long-run that additional
petroleum discoveries would be made in Mongolia, enabling it to be
self-sufficient, including developing refinery capacity. (Note: We
understand a small, used refinery is being assembled north of
Ulaanbaatar, but have no details on when it might become
operational. End Note.) Ulaan said controversy swirled around
Rosneft's proposal to maintain sub-market prices for its petroleum
sales to Mongolia in return for permission to establish 100 gas
stations (see ref C). He said the deal would require changing
Mongolia's law which prohibited any firm from controlling more than

ULAANBAATA 00000276 002.4 OF 004


10% of the market, but that the GOM had been thinking of
liberalizing this sector to encourage competition, lower prices, and
better service. And, the GOM would also give greater attention to
alternative energy supplies, such as wind and solar energy.

MONGOLIA NEEDS MORE WHEAT,FLOUR; SEEKS SELF-SUFFICIENCY, DONATIONS,
AND BUFFER STOCKS
--------------


4. (SBU) Turning to flour prices, Minister Ulaan said growing demand
for wheat and flour greatly outstripped both domestic production and
imports. He noted flour alone constituted 40% of the local diet.
The GOM had set self-sufficiency in wheat product as a goal to be
achieved by 2010 and had allocated Tugruk 90 billion (about US$76
million) from its budget for this purpose. The GOM also planned to
pay subsidies of T80,000 per metric ton to domestic
farmers/producers. Russia had offered to provide 15,000 MT of
flour and 100,000 MT of wheat at discount prices. He said this
year's snows and rains improved prospects for this autumn's harvest,
following last year's drought. The GOM was considering constructing
grain storage silos around the country to give it some buffer stock
capacity to address short-term shortages and thereby stabilize
prices. The GOM would also seek to barter/exchange food or other
goods with neighboring Russia and China. He said Mongolia is
dependent on imports for most food products, including for example
sugar and rice, and so was susceptible to the rising cost of food
worldwide.

40 MILLION ANIMALS SO WHY HIGH MEAT PRICES?
--------------


5. (SBU) Minister Ulaan said meat prices had risen from Tugruk 1,000
to 1,500 per kilo to Tugruk 1,300 to 3,500; he and others were
surprised by this given Mongolians own 40 million sheep, goats,
cows, camels, and horses. He said the GOM's ability to stockpile
beef to influence short-term prices was limited by a lack of storage
capacity. Nonetheless, between
November 2007 and March 2008, the GOM had accumulated 7,000 MT of
meat, which has been released for sale at subsidized prices in the
poorer areas of UB and elsewhere. Ulaan was concerned that
inflation and high food prices had exacerbated a growing income gap.


MINISTER'S Q&A SESSION: INFLATION'S IMPACT ON THE POOR, EDUCATION,
HEALTH CARE, TRANSPORTATION, CONSERVATION
-------------- --------------


6. (SBU) During a wide-ranging question and answer session, Minister
Ulaan admitted that a portion of Mongolia's inflation was
home-grown, generated by government spending and both personal and
commodity subsidies. The FRG Ambassador stressed that subsidizing
oil prices simply delayed inevitable consumer price hikes. The
Asian Development Bank (ADB) rep urged the GOM to develop effective
targeting of subsidies to the nation's poorest population. The
World Health Organization rep expressed concern about the impact on
the poor of the 30% increase in transportation costs and the even
higher increase in health care costs. Some reps urged the GOM to
pay more attention to energy and heat conservation; Ulaan retorted
that the GOM had significantly reduced it SUV fleet by 300 vehicles
and was looking at using hybrids.

GOM ASKS DONORS' ADVICE ON INFLATION RESPONSES
-------------- -


7. (SBU) A week later, post's USAID Country Rep and Econoff attended

ULAANBAATA 00000276 003.4 OF 004


a donor meeting hosted by the World Bank on May 23 to discuss
formulation of a united response to the GOM's call for advice on how
to combat Mongolia's record high inflation rate. At 26.4% this rate
is now the highest in East Asia and Mongolia's highest rate since

1996. (Note: Although several donor organizations reported receiving
similar requests for assistance, the Embassy and a few other donors
present at the meeting said they had not been contacted by the GOM
in this regard. End Note.)

GOVERNMENT'S SPENDING NEEDS TO BE REDUCED
--------------


8. (SBU) Participants generally agreed with the IMF rep's assessment
that the best way to address the high rate of GOM spending (which
contributed to the inflationary crisis) would be for the GOM to
reduce its spending on civil-service wage increases and to cut back
on subsidies. Instead, they argued, targeted subsidies should be
used to help the country's poorest citizens deal with soaring fuel
and food prices. Otherwise, the participants said, the GOM should
allow market forces to determine prices.

OPPORTUNITY TO REFORM ENERGY SECTOR
--------------


9. (SBU) The USAID Country Rep opined that the current inflation
crisis, and the need to introduce well-designed and targeted subsidy
programs, may present an opportunity for the GOM to halt its current
energy and heating subsidies to the general public in urban areas.
(Comment: The GOM's current subsidization of energy users at large
has led to under-investment in operations and maintenance of the
existing generation, transmission and distribution systems. This
should be replaced by a subsidy program, made explicit in the annual
state budget, that targets the vulnerable segments of society and
which is administered by the Ministry of Social Welfare. This would
allow the energy sector to start operating on a commercial basis, by
raising and collecting heating and electricity tariffs that cover
the costs of service delivery, and to meet the country's future
energy and heating needs. End Comment.)

GOM'S STRATEGY: TAX CUTS AND FOOD STAMPS
--------------


10. (SBU) According to the World Bank, the GOM's current strategy to
battle price increases includes legislation aimed at providing food
cards to children (much like the U.S. food stamp program),and the
reduction of import taxes and VAT on imported food items. The ADB
rep called the GOM's action plan so far a disappointment, but
conceded that the GOM lacks the capacity to develop and implement a
policy of targeted subsidies.

INFLATION REDUCES LIQUIDITY, TUGRIKS DISAPPEARING
-------------- --------------


11. (SBU) In discussing some of the causes behind the rising
inflation, the IMF reported that Mongolia's capacity to absorb
increased GOM spending has hit a wall. The GOM had doled out wage
increases of 80% to 90% to civil servants over the past two years.
The Government's current budget surplus stands at 1% of GDP. Some
commercial banks have been forced to tighten their loan portfolios,
complaining that the Bank of Mongolia's move to raise reserve rates
by 50 basis points has sucked up too much liquidity. The IMF rep
countered that the banks themselves are to blame, as they
over-exposed themselves with frenzied lending over the past two
years. (Note: Commercial banks' collective loan portfolios grew by
nearly 70% last year. End Note.) The IMF rep also said liquidity is

ULAANBAATA 00000276 004.4 OF 004


drying up because inflation has led to a slowdown in loan
repayments. The sudden dearth of liquidity has reduced demand for
Bank of Mongolia (BOM) bonds. Nevertheless, the BOM is expected to
further tighten fiscal purse strings later this year.

ELECTIONS, BUREAUCRACY MAKE QUICK ACTION DIFFICULT
-------------- --------------


12. (SBU) Participants agreed that the matter is urgent, as high
food prices threaten to push larger segments of Mongolia's
population into poverty. Over 30% of Mongolians live in poverty and
spend more that 40% of their incomes on food. Long-term planning on
fighting inflation is nearly impossible, as June 29 Parliamentary
elections are only weeks away and quick government action would be
stymied by parliamentary bureaucracy (and the absence of most MPs,
who are out campaigning). The World Bank argued that even if the
GOM fails to act before the elections, immediate donor activity is
necessary to push the agenda forward and to spark debate that would
carry past the elections and could be taken up by less distracted
minds.


13. (SBU) The group agreed to meet again in the coming month to
discuss progress on addressing the issue.

Minton