The FINANCIAL — Dollarization is the state when residents of a country use foreign currency instead of the local currency.
According to American specialists, 60-70 % of USD is in circulation or being kept in deposits outside of the USA, being a source of dollarization in recipient countries. A high dollarization rate causes problems in the economy including an instable economic environment and an increased currency risk.
In 2000, when saving deposits in commercial banks was very low, Georgia had a deposit dollarization of almost 36 % which caused its move into the group of countries where the dollarization rate is high rather than the group of normally dollarized countries. The rate of dollarization has been increasing since than until recently, when National Bank of Georgia (NBG) has declared de-dollarization is one of the main goals for the coming years. Giorgi kadagidze, Governor of the NBG, talked to The FINANCIAL about the problems which might be caused by the high level of dollarization and the evolvement of de-dollarization (some people call this process as larization).
Q. What is the dollarization rate of commercial banks at the moment? What was the rate at the same time last year?
A. Currently for the total liabilities of commercial banks, the dollarization rate is 70.6 % which is the lowest level for recent years. Last year it was 77.2 % and before the war and crises the lowest rate of dollarization – 71.9 % was observed in March 2008. Deposit dollarization is slightly lower and in July stood at 67.7% down from last year’s 74.6%.
Continuous and sustainable reduction of the dollarization rate is one of the mail goals of the NBG. Moreover, in this process it’s important to rely on market mechanisms, without imposing any administrative measures.
Q. What is the total amount of deposits and loans of commercial banks? What is the share of GEL and USD in the total amount?
A. According to July 2011 data the total deposits in commercial banks is 4,992 million GEL. Among them 1,611 million is in GEL and 3,381 million is in foreign currency. The whole amount of loans issued by commercial banks is 2,016 million GEL in local currency plus loans in foreign currency equivalent to 5,006 million GEL. As of August deposits, without the exchange rate effect , have increased by 37 % annually (o/w GEL deposits by 45 %), while loans have increased by 30 % (GEL loans by 35 %). Magnitude of growth is quite impressive.
Q. In your opinion, why do people tend to keep deposits and take loans mostly in USD?
A. At the beginning of the nineties – soviet roubles, than coupon and during Russian crisis the GEL behaved as unstable currencies. From this experience, USD was perceived as the most stable currency in Georgia and as in other soviet countries. Naturally USD became the main instrument of the accumulation of savings. As savings in commercial banks begin to increase, deposit dollarization start to increase as well.
Another contributing factor is the exchange rate regime that existed in Georgia till 2009. Under the managed float exchange rate, the short-term fluctuation of currency was restricted. By that time, this type of FX policy was the optimal for Georgia, but it made more difficult to observe and evaluate foreign exchange risk and to make proper decision which currency to use. If risks are not adequately assessed and taken into consideration while taking loans, this can be a problem for servicing a loan when risks do materialize.
Such behaviour is gradually changing. Individuals prefer more GEL loans, than they used to do before. This process was also reinforced by the NBG’s consumer protection policy. Regulation obliged all commercial banks to disclose in advance information to physical persons about all expenses related to loans, including FX risks. I believe gradually legal entities will pay more attention to FX risks, and borrowing in local currency will increase by companies as well.
Q. Which is better to keep money in: GEL or USD? Why?
A. The decision of which currency to choose to keep money depends on several considerations, including currency denomination of our future spending and the interest rate. We keep money on deposits to buy more goods in the future than we could do today. To measure how many goods we can buy in the future, we use ‘real interest rate’. This simply means the nominal interest rate (which we receive from the bank) minus the expected inflation of the goods we are going to buy. The more stable environment is, the more accurately we can calculate the real interest rate. If the bank pays 10 % and the expected inflation is 6 %, it means that we receive a real profit of 4 %, which is quite a large amount. But if we keep money in USD for spending money in GEL, the calculation of the real interest rate becomes almost impossible, as movement of any exchange rate is theoretically unpredictable. This is because, all known future information that might alter FX rate are already included in today’s rate.
Besides of abovementioned, interest rates of USD deposits are far behind the rates of GEL deposits. In addition the NBG with its instruments, supports commercial banks in effective liquidity management in GEL, therefore banks can afford more attractive rates on GEL deposits than on USD. I should emphasize, that the NBG’s monetary policy instruments are by definition in local currency therefore we can assist commercial banks to increase their effectiveness only in GEL.
For non-residents, deposits in foreign currency are more acceptable as they spend money outside of Georgia. But those who are going to spend money in Georgia should think twice. Prices of some durables in Georgia might be expressed in USD, but dynamics are influenced by Georgian economy and not by the US. For example, for the last several years, sale and rental prices of real estate expressed in GEL are more stable than those in USD. In my opinion, development companies will soon start pricing housing retail in GEL and not in USD.
If we look at recent statistics, in most cases savings in GEL earned more in real terms than saving in USD. I think this data is a good answer for your question.
Q. How important is it to reduce the level of dollarization?
A. It is important to reduce the dollarization of the country in order to maintain macroeconomic stability. With a low dollarization, the currency risk in the country is better managed and external shock would have less of an impact on the economy. This is important for borrowers as well. For example, if our income is in national currency (at the moment 75% of the total economy generates income in local currency), and we have loans denominated in foreign currency, we face a huge foreign exchange risk. FX risk, as all risks, can be considered as an additional cost. Based on today’s data the annual insurance of GEL/USD exchange risk for large contracts can be arranged for 6-8%. It means that people who receive income in GEL and have loans in USD, pay additional 6-8 percentage points above their annual loan rate. It also means, if difference between GEL and USD loan rate is less than 6%, then GEL loan is more advantageous for prudent borrower. Rates, including hedging, are changing on a daily bases, the main idea of de-dollarization is to improve availability of GEL. As mentioned above, de-dollarization can effectively reduce the interest rate burden, i.e. expenses for resident borrowers.
Besides, with lower dollarization monetary policy of the NBG will be more effective. That in turn means that economic stability will be achieved with less public costs. In addition, the reduction of dollarization will improve the sovereign credit rating of the country, which will help the private sector to attract funds with better terms.
Q. Please, tell us about the steps taken by the NBG in order to reduce dollarization.
A. De-dollarization is a by-product of the development of the financial markets and macroeconomic stability. Those are one of the main goals of the NBG and we constantly are working for that. As the recent measures I would emphasize the following:
Since May 2009, we have changed foreign exchange policy by introducing the FX auctions. , Exchange rate flexibility has increased. As the result short-term fluctuations of the exchange rate became unpredictable and therefore speculative pressure on the exchange rate has reduced and the long-term stability of the FX has improved. Readers can acknowledge that despite short-term fluctuations, the rate of GEL currently is more stable than it was before 2009.
Another important step for the development of the money markets was the enhancement of the operational framework of the NBG, in April 2010 when we activated the stand-by instruments, amended required reserves and enhanced refinancing loan instrument. This reforms, have stabilized short term interest rates, liquidity at interbank money market has increased and banks were able to lend-out excess reserves, which they have accumulated by that time. Most importantly new monetary policy framework made possible for commercial banks to improve liquidity management in GEL. As a result, the attractiveness of local currency funds has increased for banks, which is an additional incentive for them to attract more funds in GEL. At the same time, liquidity management of GEL reduces the costs for banks and this benefit are transferred to the economy through lower margins and reduced interest rates.
In 2010, NBG made changes in required reserves regulation. Initially borrowed funds in FX became subject to reserve requirements. This change applied equal treatment to funds from foreign and domestic market. Later the reserve requirement rate for foreign currency liabilities increased from 5 % to 15 %. The process started in September 2010 and finished in February 2011. The change was implemented to ensure that the commercial banks have greater motivation to attract funds with optimal currency composition for the whole economy and not just for particular institution.
The resumption of the Treasury bill emissions by the Ministry of Finance in August 2009 was important for financial markets development and therefore supportive for de-dollarization. From the NBG’s part we contributed to successful development of the treasuries market, by creating effective, transparent and risk-free trading and settlement infrastructure and enhancing liquidity of the Government financial papers.
Positive results of de-dollarization can already be seen. For example, long-term mortgage loans in GEL have appeared last year for the first time in Georgia. Lending to the economy has increased, which at the beginning was mainly due to the loans denominated in GEL. Maturity margins for long term interest rates have also reduced. For example, as for today the difference between 1, 2 or 5 year GEL Government papers and 7 day GEL resources are respectively only 1.5, 3 and 6 percentage points. For comparison in 2005, the difference between one year and one week resources was more than 10 percentage points. The exchange rate market is stable without the NBG’s interventions.
Q. What are the future plans of The NBG to increase de-dollarization?
A. In the near future the NBG in cooperation with commercial banks plans to support creation of interbank market for the FX forwards (used for FX hedging). Adequate infrastructure is being prepared and we’re going to hold trainings for users in a first half of October. Training will include conceptual issues of hedging and use of trading tools. Later in October NBG will host workshop in collaboration with EBRD, where we will discuss advance methods of Assets and Liability management, which will include risk management and explanation of all available instruments in Georgia.
And as always, NBG will continue its efforts towards the macroeconomic stability and the development of the financial markets, which as I have said earlier is a prerequisite for low dollarization.
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