“As Georgia Develops it will Place Limits on Capital Flows,” Says IMF

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The FINANCIAL — According to Edward Gardner, IMF Senior Resident Representative in Georgia, “Freedom of capital movements has served Georgia well over the years and has contributed to making Georgia an attractive investment destination”.


But he also added that, “As the country develops, and domestic financial markets deepen and mature, the needs for placing limits on capital flows will change”.

Mr. Gardner also stresses that Georgian banks’ heavy reliance on foreign borrowing to finance domestic credit expansion in the years that preceded the crisis created vulnerabilities that were exposed during the crisis and that required a large injection of foreign capital by international financial institutions.

“The lesson from the crisis, here and elsewhere in Europe, is that along with tighter prudential regulations, limits on these kinds of capital inflows could have prevented the build-up of such vulnerabilities,” noted Gardner.

Mr. Gardner also told The FINANCIAL about the pros and cons of such restrictive policies for Georgia. “I agree that the stringency of the limits has to be based on the underlying risks but should also take into account the resulting costs and distortions. The positive aspects of imposing limits, such as reducing vulnerabilities to external debt, have to be weighed against the possible negative consequences. For instance, limiting risk taking regulation may also limit the upside potential that comes with risky investments. Also, any regulatory limit needs to be designed carefully to avoid creating financial distortions or moving risky activities outside the perimeter of regulation,” said Gardner.

He also noted that on the issues of capital flow management and outright control there has been convergence of views by Georgian authorities when holding discussions with the IMF.

Background — Since the early 90s, the G7 (an international finance group consisting of the finance ministers from seven industrialized nations) and international financial institutions (the International Monetary Fund (IMF) and World Bank) began to take an increasingly critical view of capital controls and persuaded many countries to abandon them, Georgia among them.

But it was during the global recession in 2008 when many developing countries found capital controls a vital policy tool – a fact the IMF recognized and started the rethinking of previously held orthodox approaches because of. Countries such as Brazil, Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and Poland further reviewed the possibility of increasing their capital controls as a response to crisis in 2010.

The Georgian scenario of capital control has had a different background mainly due to the high dollarization of the economy and the negative current account balance which remains still. There is currently no capital control mechanism employed – that’s according to National Bank of Georgia.

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In fact, such an “Open Door” policy towards the inflow and outflow of capital has been a helping hand for investors over these years but as experts claim there are some “black holes” in the system, such as money laundering, to which stringent policies should be applied.

To get a closer view on these issues The FINANCIAL spoke with Michael Tokmazishvili, Senior Researcher at CASE-Transcaucasus and also Head of the Macroeconomic Division-Budget Office, Parliament of Georgia.

“Money is like a commodity good; it is being sold and the changes in supply and demand make up its price. Retaining capital control in Georgia has been very difficult from the very beginning (from the early 90s), due to the fact that 2/3 of transactions in the economy were done in USD thus it was and is very difficult for the National Bank of Georgia (NBG) to limit capital flows inside or outside of the country’s boundaries, except for the inflation sterilization policies carried out by NBG.

In addition the Georgian currency was volatile at that time and its reliability was very low therefore in the event that capital controls were employed by NBG it would make the economy further dollarized.

Due to the above reasoning, as opposed to in Russia where capital control namely on exportation of Roubles was restricted at that time, Georgia enjoyed liberal policies for investment capital movement since the early 90s.

Secondly, as Georgia had a high appetite for investments, it couldn’t allow itself to impose restrictions on transactions made by foreign investors although it was in 1998 when NBG intervened into the activities of money exchange units and made considerable limitations on GEL exchange.

Thirdly money launderers’ activity presents huge risks for the economy and I think that this issue needs to be apprehended by the Government and capital control tools need to be applied to certain amounts of money and where they go from the country.

Q. Through which channels is money flown in from Georgia?

A. Today in Georgia money outflows are done through the following channels: banks and other depository institutions, non bank financial institutions and other money transfer organizations, and lastly by physical persons. The first two of them, controlled by transactions, are not limited/restricted whilst the third in the list is neither controlled nor restricted. Concerning the latter issue NBG is already taking a look at it and we should expect those kind of transactions to be put in a legal framework.

Q. How hazardous is the lack of capital control for the country’s economy and do money laundering-like activities pose a real threat for Georgia?

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A. Let’s put it like this: are free trade agreements good or bad? Well, they are good for some although at the same time underpin certain threats for developing countries; similarly we can argue about capital control. If a country can’t create investment opportunities locally then that accumulated capital may flow out of the country or vice versa. But the only exception is money laundering which definitely needs a stringent approach.

Georgia is not an outbound investment country per se. The capital outflows are mainly due to the negative trade balance we have with our trading partners and this is a very critical issue because local business competitiveness is very low and affects the employment figures as well as the formation of prices in the economy. In this case you cannot restrict capital outflow, thus the only way to do this is to increase local production and decrease imports.

The existing high interest rates in Georgian banks do not stimulate outflow of capital but on the other hand stimulate the inflow of that capital and, as we see, Georgian banks have increased their assets. The problem is the long term perspective of such activity due to the accumulated debt that banks have and the outside risks of decreasing such flows which will definitely be reflected on businesses that were used to moderate rates before. That is why locally attracted deposits represent the safest alternative but unfortunately rates in the latter case aren’t low.


Q. How does the lack of capital control relate to improvement of the investment climate; and does such an open door policy really prove effective?

A. Free capital movement is characteristic for open market economies and this factor gives investors greater comfort. The only limitation should be set on illegal incomes.

The “open door” policy which is employed now should be even more open for investors. Not for speculative investments which increase the value investment through the purchase and sale of real estate, but rather for the ones which increase the country’s production, technological and human resource potential.

Q. What is the impact of such free capital movement on the stability of the Georgian currency – the GEL?

A. The Georgian capital market is very limited therefore it is easy to “attack” and change the balance anytime. Georgia has not yet witnessed “money terrorism” but imagine what would happen if the number of tourists suddenly doubles – the GEL currency will start appreciating which will in fact increase the overall price level so far exacerbated by the low competitiveness of the economy.



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