Ever since the lari began depreciating last year, a multitude of factors responsible for this was named, some of them directly contradicting each other. The government claims it does not see a cause for panic in the currency’s sudden and sharp depreciation and declares that it is caused by purely external factors, while laying part of the blame on the National Bank for the crisis. In turn, this blame game has given rise to talks about the government’s incompetence and poor choice of policy. In order to determine the reasons for the lari’s devaluation, correctness of National Bank’s policy and many other things, Mari Javakhishvili, a correspondent of BPN (Business Press News) and Georgian Journal sat down with Azim Sadikov, representative of International Monetary Fund in Georgia.

– What are the key factors behind the lari’s unprecedented deprecation?

– The lari has depreciated by more than 30 percent against the dollar over the past 12 months, with most of this depreciation taking place in the period following last year’s November. There are two main factors behind this depreciation. First, the US dollar has strengthened worldwide over the last year as the Federal Reserve ended its quantitative easing program and the markets expect it to start raising interest rates later this year. It is not only the hryvnia and the ruble - Ukraine and Russia are facing visible economic difficulties as well - that have depreciated against USD. Many of Georgia’s other trading partner currencies have depreciated too. For example, the euro has fallen by more than 20 percent against the dollar, while the Turkish lira by almost 30 percent. The second reason for the lari’s depreciation is the impact of external shocks affecting the region and Georgia. Georgia’s exports and remittances have fallen by25-30 percent, which is quite significant. This drop in foreign currency inflow has widened Georgia’s current account deficit and the external financing gap, leading to pressure on the lari.

– The government insists that a lion’s share in lari’s deprecation was caused by external factors.

Could these factors have been predicted and was it possible for the Georgian government to have taken necessary steps to avert such a deep crisis?

– Indeed, the lari’s decline against the dollar is almost completely due to external factors. Both factors mentioned in my response to the first question would have been impossible to predict. Regarding the dollar’s worldwide strengthening, while many economists predicted that it would happen as the American economy recovers, no one could have predicted the timing or the magnitude of the dollar’s strengthening. This depends mainly on what markets make of the data on the U.S. economy and how they interpret moves by the Federal Reserve. As for the second factor, i.e. external shocks affecting the region, it is doubtful that anyone could have predicted how the conflict in Ukraine would unfold or that oil prices would drop so sharply.

The bottom line is that it is difficult to predict when external shocks will hit the economy, whether they are going to be large or small, permanent or temporary. These things are outside of policy-makers’ control. But, what policy-makers can do is pursue policies that prepare the economy for potential shocks, reduce its vulnerabilities and strengthen its resilience. Indeed, the authorities’ economic program supported by the IMF’s Stand-By Arrangement aims to reduce the current account deficit and maintain a healthy level of foreign reserves.

– What steps should Georgian government take in order to somewhat reduce the impact of foreign currency fluctuations on Georgian economy?

– We think that letting the lari float, and depreciate if needed, is the best response to external shocks. This allows the exchange rate to absorb most of the shock and thus relieve pressures on the real economy.

However, in a highly dollarized economy like Georgia, we should acknowledge that large depreciation means that borrowers in USD - households and corporations alike - have experienced a significant shock as their debt service obligations in lari have increased. It is therefore important in the short term to understand how they are coping with this shock and what can be done to relieve their pain –at leastpartially. In the mid-term, the authorities should continue their efforts to de-dollarize the economy so that currency fluctuations only have a limited impact.

– Judging from the picture we have today, what would you say about the lari’s long-term future?

– Just like Georgia, the lari has a bright future. Despite its depreciation against USD, there is still trust in this currency. We did not see widespread conversions from the lari during the depreciation episode, and the lari continues to maintain its purchasing power,as evidenced by low and stable inflation. The increased flexibility of the exchange rate will serve Georgia’s mid-term development well.

– How would you comment on Georgian government pressuring and heaping responsibility for the currency crisis on the National Bank of Georgia? How would you access the policy of NBG in general?

– The IMF fully supports the NBG’s policy of allowing the lari to float. The floating lari is the best policy for Georgia, because it allows the exchange rate to absorb external shocks rather than pass them on to the real economy. The floating exchange rate allows the NBG to focus on its main monetary policy objective - delivering low and stable inflation. This objective isspelled out in the constitution and the organic law applying to the NBG. Preserving independence of the NBG so that it can independently choose tools and policies to achieve its inflation target will further strengthen its credibility and trust in the lari, ultimately benefitting the economy.

– Does it [the National Bank], as the government implies, really have a leverage to stop or at least slow down the currency’s deprecation?

– Before I answer this question, let me remind you that while the lari has depreciated significantly against the dollar, it has depreciated by much less against other currencies. In fact, the lari has strengthened against some currencies, including the hryvnia and the ruble. Against the basket of trading country currencies, the lari has depreciated only by about 5 percent compared to the last year.

Macro policies can help support the lari. The government could reduce its budget deficit by cutting spending or increasing revenue while the NBG could tighten monetary policy by raising the policy rate. This will contain domestic demand and accelerate the ongoing contraction in imports, helping close the external balance gap sooner. However, fiscal and monetary tightening could depress the economy, possibly pushing it into a recession. So, there is a clear trade-off here between temporary stability of the lari and economic growth.

In the mid-term, the strength of the lari will depend on how productive the economy is, how it can compete in international markets by exporting, bringing tourists, and attracting foreign investment. This is why it is important to continue structural reforms to further improve the business environment, strengthen the economy’s competitiveness and increase its production potential.

– What will be the consequences of the currency’s depreciation?

– Key point here is that the lari’s depreciation against the dollar has allowed Georgia to preserve competitiveness by preventing imports from becoming too cheap and exports too expensive. This would hurt Georgian businesses, which would then negativelyaffect employment and peoples’ income.

Of course, depreciation also means that borrowers in USD who have incomes in GEL now face a higher debt service burden. These families and businesses are struggling now because they have less money left to cover their other expenses.

This is why it is important that the authorities continue their efforts to de-dollarize the economy. If Georgia’s economy was not highly dollarized, most people would focus solely on inflation and would not be affected by exchange rate fluctuations much. Businesses would probably even welcome a more competitive lari. Good examples of countries that have successfully de-dollarized are Israel and Turkey.

To provide a relief to borrowers with loans in USD, Georgian banks have announced their readiness to lengthen the loan maturity and thus reduce the debt service burden. Similarly, banks will need to work with their corporate clients that are struggling to service their USD loans. Most banks in Georgia can afford to rework such loans to viable borrowers because they have built up solid capital buffers.

– What would be your recommendations to Georgian government in their quest to stabilize the currency?

– The government objective is to adopt policies that stabilize the economy, help close the external financing shortfall, and create conditions for mid-term economic growth and development.

To improve Georgia’s mid-term prospects, it is crucial to focus on policies that will makeit a more attractive place to do business and visit as a tourist. If successful, such policieswill boost exports and tourism, as well as attract investment, helping stabilize the external accounts, create jobs, and modernize the economy.

Author: Mari Javakhishvili