Raging Inflation and Countermeasures
“FDI inflow contraction, limited crediting in USD, and inefficient management of public expectations are key factors provoking the depreciation national currency”, Merab Kakulia, vice president of the National Bank of Georgia (NBG) told BusinessPartner.
The Georgian economy has been growing at a higher-than-expected pace over the past few years. Crediting and external trade indicators have also improved in November; however, the inflationary burden was not alleviated. The figure is expected to hit 7.2% by the end of 2019, according to forecasts by the International Monetary Fund (IMF).
The extreme depreciation of the GEL has deepened inflationary trends. It is a very primitive approach that would lead you to assert that the GEL has devaluated more than the fundamental factors have preconditioned, Kakulia noted.
“Extreme depreciation of the GEL exchange rate has provoked an extreme rise in prices. I have released many statements that our authorities show a very primitive and unwise attitude regarding the GEL exchange rate. For example, we assert that the fundamental factors are healthy, while the current account deficit is the key fundamental component for the exchange rate formation. At the same time, we have confirmed that the current account deficit has shrunk.
A narrowing current account deficit has decreased capital inflows, foreign currency inflows. I mean, foreign direct investments, first of all. We should not forget that over the past few years, major infrastructural transit projects such as the construction of gas pipelines used to determine the FDI dynamics. These projects have been completed. We expect no similar major projects to start in the near future. Therefore, we will not receive the same volume of foreign direct investments if we do not take these decisions, and these decisions do not give an immediate effect. This is a very fundamental factor that may become one of the primary reasons for exchange rate devaluation”, Kakulia explained.
Limited crediting in USD has become one of the key factors resulting in GEL depreciation. The limited crediting in USD was driven by the Larization program, Kakulia added.
“Nobody objects to Larization. I have always backed this program, but experience across the world shows that prohibitions cannot bring desirable effects. The Larization program has decreased crediting in foreign currencies. Foreign currency denominated crediting generates serious demand for the national currency. Consequently, in due time this program has brought about positive effect for the GEL exchange rate; that is, a fundamental factor for FDI inflows was shut off, and USD supply was also put on hiatus.
This second factor may not be behind the GEL depreciation process, but it has an important effect in combination with declining FDI inflows, and the exchange rate devaluation expectations. The more the exchange rate falls, the higher expectations for its decline, and it is not a secret that we have had problems with management, not only now, but we had this problem in the past as well. Inefficient management of these expectations may be one of the reasons behind the current deprecation”, Kakulia explained, and added that if the exchange rate keeps declining, naturally, inflation will stop. While maintaining the current exchange rate, the downward trend’s effect on price dynamics will shrink, he noted.
The GEL may strengthen, but not in the forecast scales. The National Bank holds certain instruments, including the monetary policy rate that the regulator raised three times over the past months, Kakulia noted.
“I believe the NBG will continue this policy. Anyway, this policy will be continued until the emergence of an inflation rate slowdown. Naturally, this will have a negative effect on economic growth; however, there are factors balancing this out, including growth in credit, including on infrastructure projects. These two factors may somehow negate the negative effects from raising the interest rate”, Kakulia said.