Wednesday, 22 January 2014

Georgia's National Currency Continues to Depreciate

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By Eka Janashia (the 22/01/2014 issue of the CACI Analyst)

2013 saw a significant depreciation of the Georgian national currency Lari (GEL) compared to both the US$ and the Euro. From the beginning of last year until now, the Lari's exchange rate has dropped against the U.S. and EU currency by over 5 and 7 percent respectively. Georgia's Minister of Finance, Nodar Khaduri, Minister of Economy and Sustainable Development, Giorgi Kvirikashvili, and the President of the National Bank of Georgia (NBG), Giorgi Kadagidze, insist that there is no reason for panic. However, the steady and speedy depreciation of the Lari has already triggered undesirable expectations among consumers and the business sector.

The depreciation of the Lari started in May 2013, when US$ 1 cost GEL 1.65. In mid-December, the Lari declined by 1.7 percent against the US$ compared to November, and by 2.8 percent compared to December 2012. The corresponding figures for the fall against the Euro were 3.1 and 7.4 percent respectively. The pace doubled in the middle of January this year when US$ 1 became equivalent to GEL 1.79 and1 Euro to GEL 2.44.This is the Lari’s lowest rate since 2011. The national currency exchange rate was relatively stable between March 2011 and May 2013.

To curb the Lari’s slump, the NBG intervened and sold US$ 80 million in November, but the measure hardly decelerated the process. If the Lari's depreciation prompts inflation, NBG will replicate its intervention in the market, Kadagidze said. Georgia has a floating exchange rate intended to stabilize the current economic progressions automatically. Due to the last two years’ deflation, the NBG's monetary policy has been mollified but in case of rapid inflation it will get stricter, he said.

Likewise, minister Kvirikashvili declared that the Georgian government discourages unhealthy maintenance of the Lari rate at the detriment of international reserves. The government ensures that NBG holds sufficient reserves, amounting to US$ 2.82 billion, to stop the depreciation if necessary.

Initially, minister Khaduri assessed the process as a “seasonal phenomenon” related to the New Year activities when the demand for US$ naturally increases. Later, however, when the Lari continued its depreciation, Khaduri said “the process will be stable and there will not be any difficulties.”

Such a general statement instilled fears among ordinary Georgians with a limited hardly grasp of the complexities of the financial market, and the issue triggered multiple speculations about its causes. Some politicians and economists suggest that the process is induced by the government artificially to deal with the imminent deficit in the state budget. A depreciated Lari will help fill the anticipated budget deficit which may fluctuate between 500 million to 1 billion Lari, according to some economic analysts.

Another set of explanations link the depreciation of the Lari to the unprecedentedly high capital outflow in the third quarter of 2013, to which the government has not adequately responded.

Financial analysts criticizing the country’s monetary policy argue that the Lari rate has always been strongly regulated by NBG rather than floating as it is declared officially. Since nearly 80 percent of goods are imported, Georgian currency is closely related to commodity prices. This linkage requires constant intervention into the currency market to eschew speculative attacks on the Lari. Consequently, NBG has regularly intervened to maintain the Lari’s value high in relation to other currencies. From this point of view, the ongoing depreciation seems to result from a defective monetary policy which failed to intervene in the currency market and made the Lari vulnerable to speculative manipulations. If depreciation is not stopped in a timely manner, the recovery of the Lari will need more international reserves later, market analysts suggest.

Even critics of Georgia's monetary policy agree that the depreciation of the Lari is a temporary problem and is no reason for panic. Nevertheless, it has already had a negative effect on the country’s economy. The prices on fuel and dairy products have increased, and what is worse, the anticipated inflation could further boost the prices of primary food products. This will most negatively affect the socially vulnerable population under the minimum living standards. Another segment that will suffer from the Lari depreciation is those who have loans in US$ but receive their income in national currency.

However, if Lari purchasing power will continue weakening while prices are increasing, the process will affect all Georgians getting their salaries in Lari.

Moreover, the abrupt depreciation is a negative signal for long-term investment as it provides a less predictable financial environment. Finally, it discourages savings in national currency and stimulates the process of “dollarization.”

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The Central Asia-Caucasus Analyst is a biweekly publication of the Central Asia-Caucasus Institute & Silk Road Studies Program, a Joint Transatlantic Research and Policy Center affiliated with the American Foreign Policy Council, Washington DC., and the Institute for Security and Development Policy, Stockholm. For 15 years, the Analyst has brought cutting edge analysis of the region geared toward a practitioner audience.

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