Avtandil Silagadze, D.Sc. (Econ.), professor, Corresponding Member of the Georgian Academy of Sciences (Tbilisi, Georgia).
CURRENT FINANCIAL AND MONETARY TRENDS IN GEORGIA
This article examines some current trends in the field of public finance, monetary policy and banking in Georgia. These problems are analyzed considering the impact of the global financial crisis and the war with Russia (August 2008). Despite all the difficulties, Georgia has so far maintained positive GDP growth rates, relative stability of the national currency, and public finance stability.
In the early 1990s, Georgia regained its independence, but state building in the country was a complex and contradictory process. Along with successes, there were also negative results: a threat to territorial integrity, a drop in production, a decline in living standards, etc. The country was faced with the inevitability of economic reform, including reform in the financial and banking sectors. The rapid liberalization of the economy implemented at that time was associated with social differentiation, corruption, lack of a competitive market, economic instability, growing external debt, and sharp financial and monetary contradictions. The main purpose of the present study is to examine these problems. There are many interesting works on this subject.1 Materials from the Statistics Department, the National Bank and the Ministry of Finance of Georgia, and also from the Budget Office of the Georgian Parliament were also used in this paper.
General Economic Situation in Georgia
The past two years were a difficult period for the Georgian economy: the war with Russia in August 2008 and the world economic crisis had a negative impact on the country’s economy. The annual inflation rate surged in the first half of 2008, registering a decline in the second half of the year. This was due, among other things, to the fall in the prices of goods in the world market. In the first half of the year, the country had a floating exchange rate.
In order to ensure financial stability, the National Bank of Georgia (NBG) tried to maintain the lari (GEL) exchange rate and temporarily pegged it to the dollar, with a one-off devaluation of the lari in November (as a result, its value against the dollar fell by 16%). Later on, the supply-demand balance in the foreign exchange market was restored. The devaluation of the lari reduced the negative impact on the country’s foreign exchange reserves. Foreign direct investment declined as well, and the GDP growth rate was 2.1% (see Table 1).
Gross Domestic Product (GDP), 2000-2009
GDP growth was significantly affected by such sectors as trade, construction, transport and public administration. The share of industry and agriculture in GDP declined, while that of trade, telecommunications, public administration and education increased (see Table 2).
Structure of GDP (by value added) (% of total)
Exports of domestic products were adversely affected by a significant decline in metal prices in the world market. A positive impact on the Georgian economy was made by budget policy and improvements in tax and customs administration. In particular, 2008 budget revenue exceeded the target, but the country’s external debt increased. International reserves rose due to privatization revenues, an IMF tranche, a budget grant from the United States, financial assistance from EU countries, etc.
Against the background of the war with Russia, there was an outflow of deposits from commercial banks; part of them eventually returned to the banking sector. The increase in deposits was almost entirely due to deposits in domestic (national) currency. Monetary policy was liberalized. Interest rates were reduced, and commercial banks were allowed to redeem securities (certificates of deposits) before maturity. Special credit instruments were introduced.
As noted above, budget policy and improvements in tax and customs administration helped to increase and mobilize budget revenues. In recent years, budget revenues and corresponding expenditures increased significantly. In 2008 and in the first six months of 2009, taxes made up 74.4% and 79.2%, respectively, of total budget revenues and grants (see Table 3).
State Budget Revenues and Grants, 2003-2009 (millions of lari)
In 2008, state budget revenues (including grants) totaled GEL 5.5 billion. In the first half of 2009, they amounted to GEL 2,556.9 million, and expenditures, to GEL 3,146.4 million (see Table 4).
In the structure of tax revenues, the share of indirect taxes exceeded that of direct taxes (on income and profits), although the latter grew faster than indirect taxes. Consequently, the tax burden was heavier for consumers than for producers.
State Budget Expenditures and Net Lending, 2003-2009 (millions of lari)
Increasing budget revenues led to an increase in expenditures to GEL 5.6 billion. In 2008, the ratio of state budget expenditures to real GDP was over 1/3. This means it had a significant impact on domestic demand and price rises. On the revenue side of the budget, there was a significant increase in defense spending (in 2007, it stood at 7.5% of GDP).
The actual deficit of the state budget was GEL 358.0 million (in 2008), which was due to insignificant revenue growth and expenditures in excess of the approved budget. One of the sources for covering the budget deficit was revenue from the privatization of state property. Excluding this amount, according to NBG data, the budget deficit in 2008 reached GEL 927 million (see Table 5) or about 5% of GDP.
State Budget Deficit, 2002-2008 (millions of lari)
In 2008, government deposits increased to GEL 433.0 million. In that period, the country received GEL 350.0 million from external sources, including in the form of soft loans. At the same time, public and publicly guaranteed debt reached about GEL 3.7 billion by the end of the year (rising by GEL 1.3 billion). The country’s total external debt was 21.5% of GDP (compared to 17.5% in 2007); there was an increase in debt to the IMF, the World Bank and the Asian Development Bank (see Table 6). External debt has not reached a critical point, but the government should be more cautious in ensuring proper and effective use of these funds, because the debt should be repaid as a result of efficient functioning of the economy. It would be well to channel funds into infrastructure projects, but today a significant part of these funds should better be used in the real sector (industry, agriculture).
Public Debt, 2003-2009 (millions of lari)
The results of the global financial crisis and the war with Russia had a negative effect on Georgia’s foreign trade as well. In 2008, exports of goods totaled $1.5 billion (17.6% more than in 2007), and imports, $6.3 billion (17.3% more than in 2007). The trade deficit in 2008 was $4,808.5 million, or about 47% of GDP (see Table 7). This is a critical indicator causing a decline in employment and a massive outflow of funds and labor. Parallel to liberalization of the economy, including customs tariffs more attention should be paid to developing a competitive national economy.
Exports and Imports, 2004-2009 (millions of dollars)
Imports were significantly affected by the decline in world prices for oil products, although the declining price trend had a stronger effect on exports of goods (ferrous and non-ferrous metals). According to data from the Statistics Department of the Ministry of Economic Development of Georgia, the main imports were energy resources (16%) and passenger cars (7.6%), while the main exports were ferroalloys (17.8%), ferrous scrap (8.6%), copper alloys and concentrates (7.9%), nitrogen fertilizers (7.0%) and crude gold (6.7%). Georgia’s major export partners are Turkey, Azerbaijan and Canada, and its major import partners are Turkey, Ukraine, Azerbaijan, Russia, U.S. and Germany.
Remittances to the country remain an important factor affecting the state of the consumer market. The point is that a substantial proportion of Georgian citizens work abroad, so that both the social status of their families and overall demand in the country is heavily dependent on their remittances. In 2008, remittances rose by 16% compared to the previous year.
In addition, the country is strongly dependent on foreign investments and funds received from international financial institutions and individual countries. In 2008, for example, the IMF provided $256.8 million in support of the balance of payments. Foreign direct investment in Georgia in the first half of 2008 was $847.1 million, and in the second half of the year it was close to $338.3 million. The total for the year as a whole was $1,185.4 million, or 32% less than in 2007 (see Table 8).
Foreign Direct Investment, 2004-2008 (millions of dollars)
The inflow of transfers was particularly large in the second half of the year, mainly due to assistance from donor countries in the period after the August war with Russia. International reserves increased as well (by $1.5 billion).
The Georgian stock market is still in the initial stages of development and is not a significant source of funds for companies operating in the country. For example, the trading volume on the Georgian Stock Exchange in 2008 was only GEL 256.6 million.
The domestic foreign exchange market is also a reflection of events in the country, although it is marked by a significant increase in turnover. According to NBG data, turnover on the Tbilisi Interbank Currency Exchange in 2008 was GEL 2,246 million, with the share of NBG interventions constituting 90.5%. The trend toward an appreciation of the national currency (lari) was caused by the inflow of large amounts of foreign currency in recent years. After the August war, the inflow of foreign currency was sharply reduced, and NBG interventions were mainly conducted to meet excess demand for foreign currency.
Monetary Policy and the Banking System
The NBG’s main task is to ensure price stability in the country. Naturally, monetary policy oriented toward price stability serves to improve the investment environment, protect household income levels and boost GDP growth. The inflation target for 2008 was 8%, with possible deviations in the event of exogenous shocks. Considering these circumstances, average annual inflation in 2008 was 10%.
Based on the expected dynamics of economic growth, monetization, de-dollarization and other factors (given the priority of price stability), reserve money growth was originally planned within the limits of 10%. In the first quarter of 2008, foreign exchange interventions (dollar purchases) increased in order to avoid wide fluctuations in the lari exchange rate against the background of massive foreign capital inflows. This spurred the growth of reserve money and, consequently, of the total money supply in the economy. Simultaneously, the NBG took measures to mop up excess liquidity through certificates of deposit (GEL 467 million). In these conditions, a 12% discount rate was used to tighten monetary policy.
During the global financial crisis, Georgian commercial banks found it difficult to obtain credit in international markets. They withdrew funds from NBG certificates of deposit, with a resultant increase in the annual growth rate of reserve money. So, a tight monetary policy was necessary to bring the growth rate of the monetary aggregates back within the target range.
The August events and the escalating global financial crisis posed a new challenge to monetary policy, leading to an outflow of deposits from the banking system. In order to meet depositors’ demand without delay, commercial banks were temporarily relieved from compliance with even the minimum reserve requirements (later lowered from 13% to 5%). As a result, tight monetary policy was replaced by an expansionary policy.
The change in monetary policy made it necessary to introduce a new monetary policy instrument: a 7-day refinancing facility (refinancing loans). This instrument, first, enabled commercial banks to manage their liquidity more effectively; and second, changes in the interbank lending rate were a signal for the NBG to gear its monetary policy to the needs of the economy and influence the expectations of economic agents.
These measures proved insufficient to revive bank lending or economic activity in general during the liquidity crunch. That is why the NBG provided additional resources to commercial banks in the amount of GEL 136 billion.
In late 2008, the demand for foreign currency rose in expectation of a decline in the lari exchange rate, and this had an effect on reserve money and ultimately on other monetary aggregates, causing their contraction. According to NBG data, the annual rate of reduction in reserve money was 8% and in the M2 money supply 13.3%; the amount of lari in circulation fell by 1.5%, and the rate of increase in M3 was 7% (see Table 9).
Monetary Aggregates, 2004-2009 (end of period)
A certain role in the implementation of monetary policy was also played by the exchange rate, because it had a considerable effect on inflation expectations. In order to avoid panic buying, the lari was pegged to the dollar. This coincided with a significant appreciation of the dollar against other currencies, which caused a deviation of the lari exchange rate from equilibrium. Expectations of a decline in the value of the lari increased, and this created additional demand for foreign currency.
In response to speculative demand for foreign currency, in early November 2008 the National Bank stopped pegging the lari, followed by a sharp one-off drop in its exchange rate (from 1.42 to 1.66 lari per dollar). Later on, the demand for foreign currency in the foreign exchange market stabilized (see Table 10).
Exchange Rates, 2004-2009
According to NBG data, as a result of a slowdown in the demand for money the monetization of the economy declined relative to GDP from 22.6% to 9.8%. Factors affecting the demand for lari—budget transfers, transaction needs of households—continued to operate. An important source of demand for lari was the increased state budget for 2008. The rising incomes of the part of the population that depends on public funds became a factor contributing the monetization of the economy.
The degree of dollarization of bank deposits fell from 65.3% to 60.2%, although subsequent phenomena and rising expectations of a weakening lari led to an increase in the degree of dollarization to 75.8% (see Table 11).
Deposits, 2004-2009 (end of period)
The main priority of exchange rate policy was to dampen the sharp fluctuations in the lari exchange rate and build up international reserves while keeping the exchange rate under control. Exchange rate policy was implemented within the selected exchange rate regime. Currency interventions were designed to avoid exchange rate volatility. In order to reduce the sharp exchange rate fluctuations, the gap between the demand for foreign currency and its supply was covered by the National Bank. For this purpose, it sold $1,211,236 thousand and bought $821,748 thousand (see Table 12).
Dollar Trading on the Tbilisi Interbank Currency Exchange (thousands of dollars)
The average lari exchange rate against the dollar in 2008 was 1.4902, and at the end of the year it was 1.6670 (see Table 13).
At the end of 2008, NBG international reserves rose to $1,480.2 million. This increase was due to funds obtained from privatization ($121 million), an IMF tranche ($240 million), a budget grant from the U.S. ($250 million), other grants from donor countries, etc.
Exchange Rates: Lari/Dollar, 2008
The supply of money (see Table 9) is determined, among other things, by money demand factors, while the demand for money is created by real economic growth rates, changes in the public sector, inflation and exchange rate dynamics, and also by changes in foreign currency balances and seasonal factors.
Before the August 2008 war, the money supply (M2) grew rapidly, but at the end of the year it shrank by 23.4%. The reserve money indicator (M1) in 2008 fell as well: by GEL 139.7 million (7.8%) to GEL 1,082.6 million at the end of the year. The supply of money was mainly determined by money inflows from abroad, the state budget and NBG interventions. The demand for money was created by economic growth and seasonal factors.
Foreign currency deposits in the banking system increased in 2008 (compared to the previous year) by GEL 564.4 million (23.1%) to GEL 2,442.6 million. They accounted for the entire increase in total deposits, because deposits in domestic currency fell by GEL 217.3 million (21.8%) to GEL 779.9 million.
Slow growth in the deposit base affected the lending capacity of commercial banks, which in turn affected the amount of credit to the economy and pushed up interest rates from 19.3% to 22.9% (see Table 14).
Average Annual Interest Rates on Commercial Bank Loans and Deposits, 2008-2009 (%)
As the NBG tightened its monetary policy, it also used such instruments as certificates of deposit (CDs) and overnight loans. Later on, when the NBG eased its monetary policy, it introduced new instruments: refinancing loans.
The main instrument used to absorb excess liquidity in 2008 was a three-month and one-week certificates of deposit. According to NBG data, in January-August 2008 seven-day CDs worth GEL 1,150.2 million and three-month CDs worth GEL 692.6 million (approximately) were sold at auctions. With the easing of monetary policy and the introduction of a new instrument (refinancing loans), the minimum annual interest rate on seven-day refinancing loans became the NBG’s policy rate.
Refinancing loans were issued by means of auctions against collateral. The average interest rates at these auctions coincided with the monetary policy rate or slightly exceeded it.
The impact of the policy rate was limited because the interbank market in Georgia is insufficiently developed and such loans were not issued every day. At the same time, there was a shortage of participants in market transactions and, consequently, low competition. Ultimately, according to NBG data, the correlation of the policy rate with the TIBR-7 (seven-day loans) and TIBR-1 (one-day loans) indices was 0.58 and 0.56, respectively.
The interest rate on overnight (one-day) loans is usually higher than on longer-term loans. According to NBG data, in 2008 commercial banks obtained overnight loans worth GEL 3,409.2 million (compared to GEL 90 million in 2007).
According to NBG data, in the first half of 2008, with the development of the banking sector, there was an increase in the amount of funds raised by banks and, accordingly, in the amount of required reserves. At that time, the required reserve ratio was 13%. The second half of the year brought a decline in bank lending; there was an outflow of deposits from banks, which seriously reduced their liquidity. In view of this, commercial banks were initially fully relieved from compliance with reserve requirements; later on, they had to maintain 25% of required reserves, and from 2 October the reserve ratio was lowered from 13% to 5%.
Georgia has a two-tier banking sector: the National Bank of Georgia (first tier) and commercial banks (second tier). At present, the banking system includes 20 banking institutions (compared to 19 in 2005, 17 in 2006, and 19 in 2007). Of these, 18 are banks resident in Georgia, and 2 are branches of a Turkish and an Azerbaijani bank. Out of the 20 commercial banks, 17 are banks with foreign capital. Four of the existing banks have an authorized capital of less than GEL 10.0 million, and the rest, more than GEL 10.0 million.
The banking sector grew much faster than other sectors of the economy. According to the 2009 NBG data, in 2008 the total assets of the banking system increased from GEL 7.2 billion to GEL 8.9 billion due to an increase in money funds and net loans, as well as in fixed and intangible assets. The total tax outstanding loans of commercial banks rose by 31%, exceeding GEL 6 billion. The amount of attracted deposits increased as well. In the first half of 2008, the amount of deposits in domestic currency rose from GEL 997.2 million to GEL 1,193.5 million, while the amount of deposits in foreign currency fell from GEL 1,878.2 million to GEL 1,801.6 million. In the second half of the year, this trend was reversed. For example, during the August war the amount of domestic currency deposits fell by 10%.
As a result of economic and financial difficulties in the second half of 2008, bank profitability declined. The total losses of the banking sector in 2008 amounted to GEL 215.7 million. This was mainly due to additional provisioning for loan losses: provisions were increased to 9% of total loans (in 2007, the figure was 3.6%).
At the beginning of 2009, the largest Georgian banks were faced with the need to repay maturing foreign debts. In some cases, they managed to extend the repayment period, but in view of the global financial crisis it was feared that foreign lenders might cease to provide loan extensions.
In order to avert the expected threat, international financial institutions allocated additional funds to Georgian banks. In late 2008, Georgian commercial banks reached agreements to that effect with the International Finance Corporation, the European Bank for Reconstruction and Development, the U.S. Overseas Private Investment Corporation, the German Kreditanstalt für Wiederaufbau (KfW), and the Netherlands Development Finance Company (FMO). Accordingly, excess liquidity in the amount of GEL 150-300 million was transferred to their accounts. These loans were in the main sufficient to enable banks to repay their foreign debts without reducing their own lending.
The Georgian banking sector in 2008 mostly maintained the required capital adequacy ratios. Despite a decline, according to NBG data, they remained above the legally required 12% and constituted 13.9%; the liquidity ratio in the banking sector, measured as total liquid assets divided by total liabilities, fell from 39% to 28% (the required ratio is 20%).
Overall, the Georgian banking sector has passed a difficult test: none of the commercial banks went bankrupt. This is due, on the one hand, to the relative independence of the banking system from attracted funds because of strict supervision requirements and, on the other, to the relatively low impact of the financial crisis.
Despite the financial crisis and the grave consequences of the war with Russia in August 2008, Georgia has so far maintained positive GDP growth rates (+2.1%), relative stability of the national currency, target inflation rates, an effective monetary policy, and public finance stability. Not a single commercial bank has failed. These results have been achieved due to domestic resources and massive financial assistance from the United States, EU countries and international financial institutions; part of this assistance has been utilized, and the rest is to be utilized in the near future.
Even so, analysts expect a slowdown in economic growth, a further decline in foreign investment, a growing trade deficit, difficulties in the development of the real sector (industry, agriculture), and a rise in unemployment. These and other unresolved problems will sharpen financial and monetary contradictions. In order to deal with the expected problems, in 2009 the Georgian government developed a medium-term strategy for 2010-2013, which is fragmented and imperfect. The adopted document should be reworked and completed so as to take the form of an action program designed to meet the expected challenges.
1 See: R. Asatiani, The Georgian Economy: Past, Present and Prospects, Tbilisi, 2002 (in Georgian); T. Basilia, A. Silagadze, T. Chikvaidze, Post-Socialist Transformation of the Georgian Economy on the Threshold of the 21st Century, Tbilisi, 2001 (in Georgian); M. Kakulia, Problems of Development of the Monetary System in Georgia, Tbilisi, 2001 (in Georgian); G. Malashkhia, “The Country’s Economic Vector,” in: Proceedings of the Georgian Academy of Economic Sciences, No. 6, Tbilisi, 2008 (in Georgian); I. Meskhia, “Current Threats and New Challenges to the Georgian Economy,” in: Proceedings of the Georgian Academy of Economic Sciences, No. 7, Tbilisi, 2009 (in Georgian); N. Chitanava, Socioeconomic Problems of the Transition Period (Economic Globalization and Economic Security), Parts 1-3, Tbilisi, 1997-2001 (in Georgian); V. Papava, M. Kakulia, The 2008 Crisis in Georgia: Background, Reality and Prospects, Tbilisi, 2009 (in Georgian); V. Papava, T. Beridze, Ocherki politicheskoi ekonomii postkommunisticheskogo kapitalizma, Moscow, 2005; V. Papava, Necroeconomics. The Political Economy of Post-Communist Capitalism (Lessons from Georgia), 2005; V. Papava, V. Chocheli, Financial Globalization and Post-Communist Georgia, New York, 2003; Nachhaltige Finanz- und Sozialpolitik in Georgien, Hrsg. H. Petersen, S. Gelaschwili, Universitätsverlag, Postdam, 2008; A. Silagadse, M. Tokmazishvli, Challenges of the Post-Communist Financial-Currency Policy, New York, 2009. Back to text