The Depreciated Currency – a Mirror of Georgia’s Economy

12 February 2015
Georgia’s national currency, the lari(GEL), depreciated twice during last year with respect to the U.S. dollar. The first time was in January 2014 (with 7% depreciation), and the second time was in December 2014 (with 8% depreciation). At some level, instability in the exchange rate reflects problems in the economy: diminished economic growth rate, enlarged trade deficit, and decreased official USD reserves (by 5%) of the country. The sources of Georgia’s economic problems are: 1)an increase in economic regulations (for example, a moratorium on selling land to foreigners, tightening the visa regime), 2)a high state budget deficit (more than 3% of GDP), 3)a slow down in reforms aimed at improving the business environment, 4)the expansion of state subsidies and state control over the economy. The tightening of the visa regime, which went into force on September 1, 2014, has already influenced the number of visitors coming to Georgia. The number of visitors increased by 39% in 2011, in 2012 by 57%, in 2013 by 22%, and in 2014 just by 2%.
"One of the significant factors contributing to the stability of the national currency is GDP growth rate, declining in the last months. The economic growth rate was 5.2% in August, 4.1% in September, 3.5% in October and -0.5% in November."
The budget deficit was 3.5 % of GDP in 2014. In 2015 the deficit is predicted to be 3.7% of GDP. About half of the deficit has been accrued through domestic debt. Increased domestic debt accrual pushes up interest rates on loans. In recent years, the budget deficit has become the main source for increasing cash supply towards the end of the year. The sudden increase in the volume of national currency is then one of the main causes of the GEL’s depreciation. According to the Doing Business index by the World Bank Group, there has been no major reforms in Georgia in the field of business for the past two years. In previous years, the number of reforms aimed at improving Georgia’s business environment was quite high. According to the study, in 2013-2014, Georgia carried out only one reform aimed at making it easier to do business in the country, whereas in 2010 there were four such reforms, four in 2011, and six in 2012. The GEL’s depreciation has already had a negative influence on Georgia’s economy and society: 1) the high volatility of the national currency damages macroeconomic stability. 2) 60% of Georgian commercial bank loans are in dollars. Borrowers now have to buy an expensive dollar to cover their debts, and they are experiencing significant losses. 3) 74% of Georgia’s state debt is foreign debt. As a result of the GEL’s depreciation, state debt burden increased approximately by 500 million GEL (1.5 % of GDP). 4) The official reserves of the country decreased by 5% (112 million USD). The main reason for the depreciation of the GEL is Georgia’s external trade balance, which has significantly worsened compared to the previous year. According to data by the National Statistics Office of Georgia, exports decreased by 1.6% in 2014, while imports increased by 7%. The increase in imports and reduction in exports caused Georgia’s external trade balance to worsen. The deficit is 618 million USD more in 2014 than the previous year. In total, outflow, in the process of external trade, was 5.1 billion USD more than inflow. At the same time, the reduction in the amount of USD in the country causes the GEL to depreciate. Georgia’strade balance was deficient in the previous years as well, which means that import was higher than export. However, the outflow of USD was balanced from other sources, such as trade in services, money transfers from abroad, foreign investments, and credits. In recent years Georgia has a positive balance in trade in services. For the first three quarters of 2014, the balance was positive at 1.1 billion USD; however, this is 47 million USD less compared to the same period of the previous year. From January to December 2014, money transfers reduced by 36 million USD, mainly conditioned by a decrease in money transfers from Russia. In the first three quarters of 2014, inflow of foreign investments and credits increased compared to 2013, but it did not finance the current account balance completely. As a result, the USD currency reserves of the country are decreasing. Accordingly, the demand for USD is increasing whereas the amount of USD is reduced which causes the depreciation of GEL. The National Bank of Georgia was forced to sell 80 million USD in order to stop the depreciation of the GEL. The uneven distribution of the budget deficit month to month also has negative influence on the exchange rate of the GEL. For example, spending was not in deficit in September 2014, whilst the deficit reached 171 million GEL in October, 126 million GEL in November and 264 million GEL in December. One of the significant factors contributing to the stability of the national currency is GDP growth rate, which has been declining during in the last months. The economic growth rate was 5.2% in August, 4.1% in September, 3.5% in October and -0.5% in November. The main point is that the depreciation of Georgia’s national currency is mostly caused by domestic economic problems. The government will have to fundamentally change its economic policy, because the current policy oriented on regulations, state subsidies, and a larger state role in the economy does not appear to be successful.