Oliver Belfitt-Nash in Ulaanbaatar -

In 2010 Mongolia had the best performing currency in the world, but in 2011 it had one of the world's worst, with the togrog falling 11% against the dollar. When the large-scale resource exports begin, few doubt the currency will resume its rise.

It was a combination of huge imports, high inflation and the global recession that dragged the togrog down last year, even though the economy put in an astonishing 17.3% real GDP growth rate last year. Frontier Securities predicts GDP growth of between 15.1% and 16.6% for 2012 - a level of growth that should continue and even rise in subsequent years as the country's giant resource projects come on stream.

Mongolia's biggest story is the development of the gigantic Oyu Tolgoi copper-gold mine, which alone requires $6bn investment before the metals can be dug up and sold. As the country produces little itself, almost all this cash is being used to import machinery and materials to develop the site and house employees, practically creating a new town in the Gobi desert from scratch.

Largely because of this single project, Mongolia's imports outweighed exports by $1.75bn, or around 23% of the country's GDP in 2011. This trade deficit rose six-times from the previous year, and is extremely high compared with the world's average of 9.3% of GDP. "A trade deficit is nothing new, we have to import everything," says Jargalsaikhan Dambadarjaa, CEO of XacLeasing and host of Mongolia's "De Facto" TV talk show. "But now it's suddenly on a much larger scale. We have very high foreign direct investment for the mining sector, but these funds go right back out again to bring in materials for projects like Oyu Tolgoi."

Hard to control

These heavy flows are proving a struggle to control for the Bank of Mongolia, which boldly promises a stable togrog and single-digit inflation past 2012. Unfortunately, its aims have already been undermined as consumer prices rose 10.2% in 2011 and the currency begins its sharp trend reversal.

The rising inflation has caught the eye of the World Bank and International Monetary Fund, which has warned of an "overheating" economy. Even so, the Mongolian government continues to dole out cash to citizens. Some MNT21,000 (around $15) is given out every month to each person as part of a promise made in 2008 to win votes in an election, and is likely to continue at least until the polling stations open again this June. "This money should be spent productively on infrastructure and skills development," says Jargalsaikhan, "but instead it's funding the vodka producers. This careless spending will only increase in the first half of 2012 leading up to elections."

But the politicians aren't the only one to blame. A surge of "hot money" in 2010 bubbled up through Mongolian stocks only to be sucked out again in 2011 on signs of slowing global growth. In the second half of 2011, the European debt crisis spooked investors worldwide, causing risky positions to be closed and money ploughed into the safe haven of the dollar. The sudden rush created a vacuum under commodity prices and Chinese imports from Mongolia seemed at risk. The country suffered a crash in its flagship stocks like Ivanhoe Mines and the togrog was sold from deposits as banks tightened their lending. "We say the Mongolian togrog is pegged to the US dollar, but it would be more correct to say it is pegged to commodity prices," says Jargalsaikhan.

Indeed, coking coal exports boomed 155% in 2011 to account for almost half of everything exported from Mongolia, thanks to companies like Mongolian Mining, dubbed the private sector's "national champion". It's not surprising that since 2010, togrog movements have tracked global coal indices.

Yet the impressive volume of coal exports will soon give way to Oyu Tolgoi's copper and gold, due for shipment in the second half of 2012. The colossal mine is predicted to produce $3.5bn worth of metal exports per year by 2015 and dwarf any previous operation in Mongolia. Thus trade deficits may be a thing of the past when exports begin to soar, putting pressure on the togrog to appreciate as dollars flood into the market. Even if the government makes more election spending promises, tax revenues and its 30% stake in the mine will be a big earner for state coffers.

If the world avoids recession or it's at least a mild one, Mongolia will feel investor confidence return as quickly as it felt the fear. The togrog has already begun to show signs of strengthening since the first week of January. "Global capital is ready to move," says Jargalsaikhan - and Mongolia will move with it.