Issue 1, 2015. February-March



(February 6-9, 2015) spoke with Azim Sadikov, the International Monetary Fund's representative in georgia, about the depreciation of the lari, the National Bank of Georgia's reaction and what we can expect in 2015.

Facing double shocks

The lari's slide against the dollar - a drop in December, followed by a brief recovery, and more recently a loss of around 10 percent - has captivated the country.

Concerns about growing prices, falling purchasing power and climbing costs for dollar loans have worried businesses and consumers alike.

The root of the lari's depreciation, according to the IMF's Azim Sadikov, lies mainly in the country's external payments gap that has opened up due to the deepening recession in Russia and its impact across the region. First signs emerged in the autumn of 2014 when Georgia's exports and remittances started to drop. Coupled with relatively modest foreign investment numbers, Sadikov said, this led to pressures on the lari, causing it to lose value.

"We saw sharp drops in remittances and exports in November and December, by about 20-25 percent compared to a year earlier," he said.

"Georgia is earning less foreign currency than it needs to spend on imports and that eventually puts downward pressure on the lari exchange rate. The supply of foreign currency has gone down and this inevitably should lead the market to correct itself."

That equation has spelled depreciation for the lari. Georgia is not alone: the drop in remittances and exports and weak tourist numbers are directly tied to the shocks rippling through the region due to the deepening crisis in Russia.

Another factor for the lari's fall against the US dollar has been the strength of the world's leading currency.

While Georgia will benefit from the sharp fall in the oil prices thanks to a lower import bill, Sadikov said, part of these gains will be offset by the decline in external demand and investment from many of Georgia's oil-dependent economic partners, such as Russia, Azerbaijan, Kazakhstan, and investors from the Middle East.

Regional impact

While the lari has dipped against the dollar, it is actually faring strongly against other trading partners currencies, Sadikov said, noting that the lari has strengthened to the ruble, hryvnia, euro and has been stable to the Turkish lira and the Armenian drahm.

Sadikov noted that the National Bank of Georgia's decision to allow the lari to float has helped keep the lari from becoming too expensive, especially for Georgia's neighbors whose currience has weakened.

"If you look at the actions of the National Bank of Georgia, allowing the lari to float freely and move inline with new market realities was absolutely the right decision," he said.

"The lari depreciation was inevitable and also it was desired because if the National Bank of Georgia tried to defend the consequence of that would have been that Georgia would have become very expensive in the region for Armenians, Russians, Ukrainians, and others."

If the lari had appreciated even more against the ruble and the drahm, or any other regional currency, it would have made it even more difficult for the Georgian economy to correct itself - exports would have been pricier for Georgia's trading partners, Georgian resorts would have been too expensive for tourists from neighboring countries and imports would have become cheaper, squeezing Georgian producers. This could have thrown the economy into a sharp slowdown or even outright recession, Sadikov explained.

The hardest hit from the lari's fall against the dollar have book those with lari incomes and dollar loans - a common occurrence in mortgage loans and loans to the commercial sector. These borrowers now have to set aside 15-20 percent more lari to service their debt. This means households and companies will have less money to consume or invest, which can have an impact on the economy, Sadikov said.

The National Bank of Georgia's main objective is to maintain price stability by targeting a certain low level of inflation (5 percent in 2015).

Consistent with inflation targeting is a floating exchange rate regime, with the lari's price determined by market forces. That means it is impossible to predict how the exchange rate moves in the near term.

It is beleived the shocks Georgia is exeperiencing - the fall in the oil prices and the Russian recession - are "permanent" in nature, Sadikov said, which most likely oil prices will stay low and the troubles in the Russian economy will continue for some time.

The right policy response to such permanent shocks is to let the economy adjust to the new realities, including by letting the lari float, he added.

Sadikov said that, while it is impossible to predict how the exchange rate will behave over the next few months, the economy has already been adjusting to the brunt of the shocks.

"Quite a bit adjustment has already happened, but it is obviously difficult to say with confidence that the adjustment has run its course. We will see this in the coming months," he said.

"We need to see how exports and imports are reacting to the recent adjustment in the exchange rate. Was this adjustment sufficient to bring Georgia's balance of payment to a balanced position? If it is not balanced, the economy may need to adjust more."