The FINANCIAL — Recent data on GDP growth and FDI supports Fitch’s view that economic activity remains robust in Georgia. However, the leading credit rating agency says that the weaknesses in the external sector could weigh on Georgia’s rating. According to the agency, a prolonged period of exchange rate volatility could also weigh on the investment and business climate, threatening Georgia’s medium term growth prospects. Increasing investment attractiveness and encouraging export to the EU markets is what the Georgian Government should do to minimize ongoing external risks, local research institutions believe.
The Georgian economy has experienced a shock as the exchange rate of the national currency towards USD rapidly devaluated from 1.75 to 2 in a two week term. Reducing remittances from Russia and Ukraine, reduction of tourists, negative trade balance, and oil price slump as well as the strengthening of USD on global markets were the main reasons behind the devaluation of the national currency. As far as the external risks remain ongoing, The FINANCIAL tried to get information from The Ministry of Economy regarding their exact plans for foreign risk minimization. However, for the whole of the previous week the Ministry has not managed to provide a plan.
“Following years of relative stability, the Georgian Lari is currently suffering from high volatility. Although this is mainly due to external factors, the Georgian Central Bank’s reaction was able to calm markets. A deterioration of the current account deficit could lead to further accumulation of external debt, which already constitutes a weakness for Georgia from a rating’s perspective,” Vincent Forest, Associate Director at Fitch Ratings, told The FINANCIAL.
“Furthermore, the high level of dollarization is a distinctive weakness. Although the financial sector is relatively well-capitalized and liquid, further weakening of the exchange rate could weigh on financial stability,” said Forest.
In order to minimize external risks, first of all Georgia should increase its investment attractiveness, Zaza Chelidze, Consultant at PMC Research Center, suggested. “Significant enlargement of FDI will contribute to the inflow of currency, capital and technologies. The growth of export-oriented manufacturing will increase the demand for currency. Competitiveness of the country will increase and unemployment will decrease as well. It is important to have a high indicator of economy. It will boost the demand for the national currency.”
Georgia has a manageable floating exchange rate policy, which includes a free regime with respect to other currencies. It means that the exchange rate varies in accordance with demand and supply on the world exchange market. During its peak of devaluation of the national currency the Minister of Finance of Georgia, Nodar Khaduri, evaded comment on the situation and instead obliged NBG to provide answers.
“Consistent and coordinated action of the monetary and fiscal policy authorities is significant. It will reduce the impact of an increased exchange rate on the economy. They should not simply hint at their competence and evade responsibility,” said Chelidze.
The devaluation of GEL has stopped since the President of NBG, Minister of Economy and Minister of Finance finally delivered positive news to the population two weeks after the ongoing panic.
“The lack of information caused panic among the population. It was additional pressure on the national currency. This was a short-term effect. In the long term market equilibrium will be achieved. It is important that the Government should deliver the right, timely and adequate information to the population,” said Irina Guruli, Programme Manager at the Economic Policy Research Center (EPRC).
According to GeoStat, external Merchandise Trade (excluding non-organized trade) of Georgia amounted to USD 9,431 million in January-October 2014, up 10 percent from the same period of the previous year. The value of export grew by 5 percent reaching USD 2,425 million, while the import grew by 11 percent and amounted to USD 7,006 million with respect to the same period of the previous year. The trade deficit equalled USD 4,580 million and its share in trade turnover constituted 49 percent. Negative trade balance has been named as one of the significant factors that encouraged devaluation of the GEL.
“The CIS makes up 52% of total export markets. In this situation we are importing the economic instability, inflation and devaluated currency from these trade countries. Accordingly, dependence on the Russian market as an export country does not only include the risk of repeating embargo. While choosing trade partners, it is important to prioritize economically stable countries. In sight of this, the Government should encourage and inform entrepreneurs regarding the opportunities of the EU markets. The Government should support potential exporters to meet the demands of the EU, invest heavily in education and dissemination of knowledge in this direction, and upgrade the infrastructure,” Guruli suggested.
“New markets only bring about a positive outcome for the country’s economy. Dependence on one particular market always carries risks, especially when we refer to dependence on the Russian market. Unfortunately we have a negative experience from the recent past. Export to Russia has been increasing during recent years. However, the total export market of Georgia is diversified. For October 2014, the list of the top five export markets comprises: China (19.5%), Armenia (10.2%), Russia (9.7%), Turkey (8%) and the USA (7.7%). The USA entered into the list of the top five export markets from the third quarter of 2014,” said Chelidze.
Chelidze and Guruli think that the state programme – Produce in Georgia – will not manage to replace imported goods in a short term perspective.
“Replacing import with local production especially in line with the campaign Produce in Georgia is a distant prospect. The time it will take for the companies to actually start production, establish themselves on the market, compete with imported goods and replace them will be several years. In addition, according to the available data, this initiative mostly financed industrial production,” said Guruli.
According to Chelidze, Produce in Georgia is focused on the development of production-oriented fields, including agriculture. The total budget of the project is GEL 46 million. Out of it, GEL 30 million should be spent on the production and processing of agricultural products. The remaining GEL 16 million will be spent on industrial production. “Therefore, we should expect an increase in agricultural production and import substitution. As for industrial production, the project finances production of building materials, rubber and paper, pharmaceutical goods, wood processing, mechanical engineering and electrical devices”.
“As for the specific commodity goods and import substitution percentage, it will depend on which direction and terms the funding will be issued in,” said Chelidze.
“Domestically, the reform drive of the current government has supported business confidence, which still has to be transposed into a pick-up in private investment. Georgia has also benefitted from increased political stability, highlighted by improvements of democratic institutions. A reversal of these trends would put negative pressure on the rating,” said Forest.
Forest said that the Georgian economy has proven relatively resilient to domestic and regional turbulence.
“Regionally, the past years have been characterized by the stabilization of the relationship with Georgia’s neighbours. This is also true for the bilateral relationship with Russia, notwithstanding some tensions over the signing of the Association Agreement with the EU or over Abkhazia. A souring of the regional political climate could derail the ongoing improvement in the Georgian investment climate and as a result medium term growth prospects,” Forest, Fitch, told The FINANCIAL.
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