Issue 3, 2015. June-July

   

EXCHANGE RATES AND THE CAR MARKET. WHY THE DECLINING GEL IS NOT WHAT YOU THINK

The decline of the Georgian Lari has been at the center of a huge amount of discussion in Georgian politics and business circles. This is not surprising. At its low point in May 2015 the GEL had declined a total of 35% since October 2014. This has obviously increased the price of imports and caused increases in loan payments for anyone with USD-denominated loans. It is therefore a potential risk factor not only for import businesses but for the economy as a whole.

George Welton

The four most commonly cited reasons for the declining lari are decreases in trade, remittances, FDI and tourism. Of these, trade is the most significant. In simple volume terms, exports are about double the size of remittances and three times the size of FDI as sources of foreign currency. It is also clear that the year-on-year drop of exports has been troubling. In the first quarter of 2015, exports were down 28% compared to the same period in 2014.

Most of this decline is generally blamed on the regional market, but the "regional market" explanation misses the fact that more than half of the decline occurred in the car market and is explained by very specific legislative changes in Azerbaijan and Russia, more than it is explained by the broad regional market.

Second, when looking at trade patterns and their impact on the exchange rate, the issue is not how much exports declined, but how much the trade deficit increased. This requires consideration of imports as well.

Dynamics of the Car Trade in Georgia

For a long time, Georgia's biggest export category and its biggest import category has been cars, particularly second-hand cars. This market is huge. In 2013, Georgia exported $704 million in cars and imported $852 million. In the first quarter of 2015, the export of cars dropped by over 62% compared to the same period in 2014 or by $94 million. This represents around half of the overall drop in exports.

So, why did the drop in exports occur without a corresponding drop in imports, and what is the significance of this? The drop in exports may partially reflect a slow regional market, but the bigger part of the story is that in April of last year the Azerbaijani government initiated a regulation which limited car imports. The impact was immediate.

Before the imposition of the ban, exports were growing moderately, but after the ban, they dropped and carried on dropping.

This had a huge impact on Georgia's balance of trade because imports were slow to respond to the drop in demand. In the first quarter of 2015, imports of cars only dropped by 10% compared to the previous year. Therefore, in this single quarter the change in the dynamic of import of cars has created $79 million increase in trade deficit, which is 41% of the total deficit for the quarter. As a comparison, the decrease in remittances year-on-year for the first quarter of 2015 was $74 million, so the changes in the car market had more impact on the larithan the total reduction in remittances for the same period.

Why the slowdown in exports did not result in an immediate slowdown in imports is unclear. It could be the result of confused price signals which resulted from the high-priced dollar. A high priced dollar may make dollar-denominated second hand cars appear cheaper, for example, if they are coming from Europe. It is also partly the result of local demand.

Understanding the dynamics of the car business in Georgian balance of trade is important for a range of reasons. Most obviously it means that the pressure on the currency that was created by the huge trade imbalance is likely to decline in the near future.

Imports dropped by 15% in April 2015 compared to March, and there is strong anecdotal evidence that local car prices have dropped significantly. One would also expect the current economic situation and the value of the local currency to impact the local car market significantly. Altogether, one would expect this to reduce car imports and so reduce pressure on the currency in the next few months.

Another possible option is that since the market has been closed by a legislative issue, it can be corrected by it as well. At the current time, we have been told that high-level discussions are taking place between the Georgian and Azerbaijani governments on exactly this issue.

If successful, this could have an immediate positive effect on the Georgia lari and would be a huge relief to the large car-trading sector of the economy, which had grown significantly in recent years. However, more than that, this seems to suggest that the current difficulties of the lari may not be a long-term necessity of the structural regional circumstances. This gives a far more optimistic interpretation of the potential for short-term improvement. This may, therefore, offer a somewhat more optimistic outlook for the Georgian lari and the economy generally than is currently understood.

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