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Georgian monetary officials have made progress in "larization"
that is, in reducing dollarization in the economy. This is
reflected in increased trust in the lari in the banking
sector.
Also Georgia's external finances have structurally
strengthened; supported by the evolving tourism industry, the
service account surplus in the current account now clearly exceeds
the less dependable surplus in the secondary income account.
These structural improvements in the financial and external
sectors put Georgia in an improved position to face the currently
rising inflation and exchange rate risks.
Georgian monetary policy decisions taken in a
challenging environment
The recent mix of Georgian monetary policy decisions reflects
the complicated operating environment, characterized by
dollarization and still developing institutions. For example, the
National Bank of Georgia (NBG) in July saw it appropriate to
combine an interest rate cut with an increase in reserve
requirements for foreign currency financing for banks, in order to
keep supporting the relative attractiveness of lari (GEL)
funds.
The lari is vulnerable to the current volatility of
international financial markets, in particular as it pertains to
key trading partner Turkey, currently battling a currency crisis.
Turkey in the first half of 2018 accounted for 9.7% of Georgian
goods exports. Moreover, it provided 15.2% of total FDI inflows in
2017.
Georgian inflation is currently coming to the end of its recent
easing path. Over the first half of 2018, the lari strengthened by
7.6% cumulatively in real effective terms. The strength of the
exchange rate has a direct suppressing impact on inflation, given
Georgia's continued dependence on imports. Inflation in July
reached its target rate of 3.0% year-on-year (y/y), while the
output gap is closing. Meanwhile, exchange rate pressures are
rising, as the significant weakening of the Turkish lira, is likely
to have a downward impact on the lari, as will any major
depreciation of the Russian ruble. In international financial
markets the overall sentiment is turning away from riskier
investments. Consequently, further rate cuts may again be combined
with tightening moves elsewhere, the intention being to uphold
attractiveness of lari assets.
Current account reflects strengthening tourism service
exports
Having come in at around 9% of GDP in 2017, Georgia's persistent
external deficit marks a major set of credit risks on Georgian
sovereign credit profile. Moreover, the current account in the
first quarter of 2018 deteriorated in annual comparison for the
first time since the fourth quarter of 2016. The outlook in the
near term is clouded by the weakened prospects of external
demand.
However, the deteriorating near term outlook and rising external
risks come against structural improvement. Indeed, full-year 2017
external accounts data confirmed that the service account surplus
has now solidified its position as the leading positive current
account component, leaving the secondary income account in the
second place. This puts Georgian foreign currency inflows on a more
solid footing. Moreover, the success of the tourism sector will
benefit also related service fields such as domestic trade and
transport. Furthermore, this can be expected to have positive
consequences also for the developing banking sector.
Also remittance data have recently shown some notable structural
changes. Indeed, the latest figures on workers' remittances show
that, for the first time, remittance inflows from the European
Union (EU) countries exceeded inflows from Russia in the first half
of 2018. This development marks a welcome fall in Georgian
dependence on Russian economic fortunes for foreign currency
inflows, mirroring its success in diversifying its energy importers
and export markets.
Banking sector shows increasing trust on
lari
Also the Georgian monetary sector is facing these rising
inflation and exchange rate risks from a strengthened position. The
monetary authorities have taken measures to encourage the
"larization" in the banking sector. The NBG has made efforts to
widen the tools of monetary policy and to make lari funding more
attractive. The interest rate differential of 20 basis points
between reserve requirements on lari- and dollar denominated funds
encourages banks to attract lari funds. Moreover, the Basel III
liquidity coverage ratio favors lira-denominated funds.
As a result, the share of foreign currency-denominated deposits
has in recent years declined, as has the the share of foreign
currency loans. In addition, the maturity structure of domestic
currency deposits has lengthened.
Georgia is well positioned for further needed
success
For now, the lari remains supported by reasonably healthy
foreign currency inflows on the current account. Thus, any abrupt
lari weakening would be mostly the result of contagion effects from
volatility of other currencies, rather than reflective of any major
external financing difficulties of Georgian origin.
Banking sector reforms and efforts to strengthen the export base
need to continue in Georgia, however. Encouragingly, Georgia's
economic transition program with the International Monetary Fund
(IMF) outlines further financial sector reforms and
de-dollarization steps among program prioritizes, as means to help
in anchoring inflation expectations and in helping to increase the
efficiency of monetary policy. Given that Georgia has already
progressed well in developing its monetary policy framework and
successfully implemented the flexible exchange rate regime, further
progress in reforms is likely, notwithstanding the recent changes
in government. Continued progress in financial sector development
is necessary to support long-term growth potential, as only a
banking sector that acts as an efficient financial intermediary is
able to guarantee development of a dynamic, inclusive private
sector in the economy.
Posted 17 September 2018 by Venla Sipilä-Rosen, Principal Economist, Europe and CIS, Sovereign Risk Service Coordinator, Economics & Country Risk, IHS Markit