After the third reading and adoption of the “Russian law,” Lari depreciated by 18 Tetri against the US dollar in one month, from 2.68 to 2.86. On three occasions, the National Bank’s intervention and the sale of 169 million dollars halted the depreciation process, but only temporarily.
The depreciation in May-June is mainly attributed to panic and negative expectations. On May 14th, the Parliament approved the “Russian law” in the third hearing. The following day, on May 15th, the exchange rate at currency exchange booths increased by 10-12 tetri, exceeding 2.80. The National Bank sold 60 million dollars at a foreign exchange auction.
On 28 May, the Parliament overrode the President’s veto on the “Russian law.” On the same day, the National Bank again offered 60 million dollars for sale but sold only 49 million. The sale of less than the offered amount was one of the signs that the shock effect had passed.
On 6 June, the United States imposed visa restrictions on approximately 30 high-ranking officials in Georgia. In the following days, the Lari (Georgian currency) began to depreciate again, and on June 11th, the National Bank removed 172 million GEL from the market through another intervention
Maintaining a specific exchange rate is not the direct responsibility of the National Bank; its task is to maintain price stability at a certain level. However, it usually intervenes to minimise damage during fluctuations. In the short term, the most effective way is through foreign exchange interventions.
The Lari was introduced into circulation in October 1995. At that time, the official exchange rate was 1.30 (six zeros were removed from the coupon exchange rate). Over 29 years, the national currency has mainly depreciated, although the need for denomination has not arisen. Despite the general depreciation trend, there have been periods of strengthening. It strengthened the most in January 1996 to 1.23, while the peak of depreciation was reached in March 2020 when the official exchange rate was 3.48. If we take the annual average, in 1996 the exchange rate was 1.26, and in 2021 it was 3.22.
Georgia operates under a floating exchange rate regime; therefore, short-term fluctuations are permissible. The exchange rate is determined by the foreign exchange market.
The National Bank sets the official exchange rate based on interbank trading on the Bloomberg platform. The NBG has levers to influence the exchange rate, but when announcing the official rate, it is guided by the existing reality and does not participate in its formation at the time of announcement.
Both fundamental and short-term factors simultaneously affect the real exchange rate. Fundamental factors refer to the inflow and outflow of monetary flows over the long term: foreign trade, foreign direct investment, tourism revenue, and remittances. In the short term, expectations play a significant role, usually following a certain process or a specific decision.
In the past, the Lari has depreciated significantly several times due to the deterioration of macroeconomic factors. The first time this happened was in 1998-1999. The Asian financial crisis and Russia’s declaration of default also affected Georgia. During a rather difficult time, the Lari managed to maintain stability for three years, but in December 1998, the exchange rate exceeded the 2.00 mark.
From January 2004 to August 2008, the Lari steadily strengthened. Before the start of the Russia-Georgia war, it had strengthened to 1.40, but by the end of the year, the exchange rate reached 1.66.
The third sharp depreciation is associated with 2014-2015. During this time, exports decreased, remittances decreased, and in addition, almost all currencies depreciated against the dollar, including the euro. The currencies of neighbouring countries, except for the Armenian dram, depreciated more than the Lari.
The fourth major depreciation is linked to the pandemic and COVID regulations in 2020.
The current depreciation is so far linked to panic and negative expectations. The already announced visa restrictions, the announced stricter sanctions, the worsened relations with Western partners, the internal political crisis, and the uncertain future create negative exectations.
Regarding fundamental factors, foreign direct investments (FDI) sharply decreased by 64% in the first quarter. In monetary terms, this is a decrease of 365 million dollars, from 566 million to 201 million.
Against the backdrop of declining exports, the negative trade balance increased by 250 million dollars to 3.9 billion dollars in five months, although it decreased by 35 million dollars in May alone. Remittances have also decreased. In four months, 33% less money was transferred to Georgia from foreign countries compared to the same period last year, which means a decrease of 542 million dollars.
Revenues from tourism increased slightly in the first quarter, from 795 million to 808 million dollars.
Despite the deterioration of several macroeconomic factors, it would be wrong to attribute the Lari’s depreciation solely to these reasons. Nothing qualitatively changed in May, and the same or similar processes were ongoing in January-April. However, the Lari began to depreciate on May 15th, the day after the third hearing of the “Russian law.”
To stop the depreciation, the National Bank offered 180 million dollars of reserves for sale, of which 169 million were sold. In times of short-term shocks, spending reserves to calm panic is justified. However, trying to maintain the exchange rate through similar methods during deteriorating macroeconomic factors only delays the depreciation.
As of December 31, 2023, the National Bank held $5 billion in international reserves, the highest amount in monetary terms compared to the same period in previous years. The annual average reached an even higher level of $5.1 billion. Despite this, the reserve adequacy ratio fell below the required level in 2023.
The adequacy of reserves is assessed using the International Monetary Fund (IMF) methodology, calculated by the formula: ARA Metric = 5% × Exports + 5% × Broad Money + 30% × Short-term Debt + 15% × Other Liabilities. It is preferable if the adequacy ratio is within the range of 100%-150%. Reserves first fell within this range in 2006 and remained in the adequacy zone until 2014, except for 2008 and 2012. In 2015, the volume of reserves fell below the minimum 100% threshold, and a return to the adequacy zone was only achieved in 2020. In 2023, it decreased to 95%.
The decline in reserves continued in 2024, decreasing by another 400 million dollars to 4.6 billion dollars in five months. The data for June will be published on 7 July.
What could the depreciation of the Lari cause? It will make loans taken out in foreign currency more expensive for the state, as well as for companies and individuals. Imported products will also become more expensive.
Despite the fact that Georgia is an import-dependent state, the previous few sharp depreciations of the national currency did not lead to a significant increase in inflation, which had its own explanation. In 2020, during the pandemic, the drop in fuel prices and the decrease in demand for certain products postponed price increases. In 2020, inflation in Georgia reached 5.2%, in 2021 it was 9.6%, and in 2022 it reached 11.9%.
In 2014-2015, along with the Lari, the currencies of neighbouring countries also depreciated, including the Ruble and the Manat, which depreciated more than the Lari. In November 2014, 1 Azerbaijani Manat was worth 2.24 Lari, but by December 2015 its price decreased to 1.54 Lari. 100 Russian Rubles also became cheaper, from 4.04 to 3.27. The value of the Turkish lira increased slightly, from 0.80 to 0.82. The euro also depreciated: if in November 2014, 0.8 euros were enough to buy 1 dollar, a year later 0.92 euros were needed.
In 2008-2009, against the backdrop of the global financial crisis, prices did not increase as much as they could have.
Events unfolded differently at the end of the last century. After the hyperinflation of the 90s, the inflation rate decreased to 3.6% in 1998, but then increased again to 19.2% in 1999.
The current depreciation of the Lari does not pose a risk of increasing inflation, but if the decline continues and the exchange rates of trading partners’ currencies remain unchanged, price increases for a whole range of products will be inevitable.
So far, macroeconomic factors have not worsened due to the influence of the “Russian law,” at least there are no reports about it (information about tourism and investments in the second quarter will become known later). It is unknown whether the inflow of additional monetary flows will decrease or whether capital outflow will begin. It is also impossible to determine in advance the extent to which it will affect the exchange rate and whether the National Bank will try to artificially maintain the exchange rate in case of pressure. All these questions will be answered in the coming months
Author: Giorgi Elizbarashvili
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