The FINANCIAL -- In this analysis, we will look at the ineffable or unsaid reasons for volatility of the exchange rate (XRT) and devaluation of the Georgian Lari (GEL), which was revealed neither by the Government, National Bank, nor by experts in Georgia, and seek ways for inflation-targeting, referring to new methods offered by foreign and Georgian economists.
It is important to recall history: the XRT of USD/GEL at the beginning of Nov’14 at the rate of 1.75; George Soros’s visit to Georgia mid Nov’14; the beginning of the impairment and instability of the GEL; a rate of USD/GEL 2.40 for the anniversary of Soros’s visit to Georgia in Dec’15.
During the period from Nov’14 to Dec’15 the GEL devaluated by 37%, and if we take into consideration the import dependence of Georgia, the sum of import for the period from Nov’14 to Dec’15 of about USD 7.4 billion, we may assume that Georgian business and society has lost about USD 2.7 billion. It seems to be the standard bet with profiteering for tricky traders to pick up billions from the country’s economy.
George Soros skyrocketed to fame in September 1992, when he wagered USD 10 billion on a single bet against the British pound. This single currency speculation netted the investor a tidy sum of USD 1 billion in profits in a single day, and a total of nearly USD 2 billion over time. Soros received the nickname “the man who broke the Bank of England” or “the man who shorted the British pound”.
The following assumptions are based on empirical research (tested by practical experiences), which seem to be additional possible problems for the GEL, entrepreneurs and society: High bid-ask ‘spread’ (the difference between sale and purchase of currency), offered by Georgian commercial banks. To visualize difference, look at the following recent figures offered by one of the leading Georgian commercial banks to individuals: exchange rate USD/GEL buy (bid): 2.655 sell (ask): 2.735 bid-ask spread: 8 tetri; wholesale XRT offered by a commercial bank, using Bloomberg platform, valid for exchange of 1 million GEL equivalent still very high, within range of 3-4 tetri. It is noteworthy and strange, that a small spread is offered on the secondary currency exchange points in Georgia, which is within 0.5 tetri, while microfinance organizations offer spread within 0.7-1 tetri, in comparison with the offer of the spread of banks to individuals to the amount of 8 tetri.
Therefore, there is reasonable suspicion that commercial banks are deliberately redirecting individuals to secondary markets, where there is less state control for controlling the turnover of black money. While legal entities and businesses are still bound to the banks for the conversion of large amounts, they face high spread problems on the one hand, along with currency volatility and unpredictability on the other.
There is no doubt that exchange points somehow possess a forecasting mechanism offering low spread to individuals, while commercial banks offer high spread to business and society with a precondition for the uncertainty of currency volatility, which seems to be a tragicomedy. In general, currency is considered a liquid asset in the world, and the bid-ask spread in the currency market is one of the smallest. It should not be the opposite in Georgia, intermediaries have to be removed, and spread should be the minimum.
Economic expert Vazha Kapanadze offered an interesting viewpoint relating to the general correlation of the country’s economic growth and the profit of banks, which is upside down in Georgia. He also emphasized the possible speculation on exchange rates, which needs thorough investigation by institutions, including the prosecutor. Under conditions when the economy of Georgia is modestly growing up to 5%, commercial banks are talking about double-digit profit growth. What is the basis for such difference? In order to reply to this, it would be tempting to apply to satirical excursus, and use the famous novel of Nodar Dumbadze: “Me, grandma, Iliko, and Ilarioni”, making a parallel to the dialogue, criticizing the poem written by “Zurikela”, which concurs with the Georgian economy’s current situation and position of the banking sector. “If business has challenges, most of the citizens are in an even worse financial condition, and the country’s economy is not developing with double-digit numbers, what is the basis for Georgian commercial banks’ happiness? Where is their source of super profit?”
Entrepreneurial activity is a lawful number of activities, carried out for making profit. Even with the use of a variety of mechanisms, temptation for ‘pumping out’ a huge amount of money from business and society seems to be great for an entrepreneur. Obtaining a superprofit, if there are no ‘legitimate’ state regulations, is high.
In Europe, a problem of spread has long been eroded by the introduction of the Euro. In 1978, the Dirham adopted a fixed exchange rate to the International Monetary Fund’s special drawing rights. It was then re-pegged to the US Dollar in 1997 at a rate of 1 USD to 3.6725 AED. As an example, to see what the situation is in our neighbourhood, for bid-ask spreads offered by banks, we will see that in Turkey spread is: 0,98 kurus (0.68 tetri); In Azerbaijan spread is: 0,98 qepik (1.56 tetri); in Russia spread is: 2.18 rubles (~10 tetri); and in Armenia spread is: 4 drams (~2.24 tetri). If you look at the difference between buying and selling foreign currency on the FOREX (Foreign Exchange) platform, we’ll see that spread is insignificant.
Georgian Banks offer 6-7% on mortgage loans in USD and 12-13% on loans in GEL. The loan taken in GEL is twice as expensive as a loan in USD. Consequently, individuals or import-dependent businesses prefer loans in USD. If a person wants to take out a loan in USD, the bank replies that due to the limitations of “Larization”, the loan in USD must exceed 100 thousand GEL to overcome the barrier. Accordingly, the mechanism of Larization may have a negative impact rather than a positive one.
Mechanism of the National Bank of Georgia - Inflation Targeting
Economists use the term inflation to describe a situation in which the economy’s overall price level is rising. The inflation rate is the percentage rate of change of a price index over time. The Consumer Price Index (CPI) measures prices of a selection of goods and services purchased by a ‘typical consumer’. Components for determining the CPI is the basket of the main products and quantities that are important for typical customers, then determination of prices and cost of the basket and comparison with the previous period in order to understand the percentage change and level of inflation. CPI is trying to evaluate the amount of income to have the same level of life. Overall, a high and volatile rate of inflation is widely considered to be damaging for an economy that trades in international markets. It is also not good for business confidence partly because they cannot be sure of what their costs and prices are likely to be. This uncertainty might lead to a lower level of capital investment spending. Accordingly, low level of inflation is the main goal of politicians around the world.
Doctor of Economic Sciences, Vladimir Papava notes that the mechanism of ‘inflation-targeting’ used by the National Bank of Georgia (NBG) is outdated. “There is a lot of research that this mechanism is not relevant, especially for highly import-dependent countries.” Papava refers to Nobel Prize-winning economist Joseph Stiglitz, who slams “inflation-targeting” and states that the “moral depravity” of financial institutions has partly caused the global crisis. Papava together with Vakhtang Charaia prepared a publication - The Role of Inflation and its Targeting for Low-Income Countries. In the paper a new statistical indicator - “munflation” is proposed, which reflects price fluctuations on the medication, utilities and nutrition which could be efficient for countries where import exceeds export by several times. It should be clear that calculations must not be made only by the traditional inflation index but also according to their consumer basket made up exclusively of imported goods and services.
Due to the unpredictability of inflation and volatile exchange rates, Georgian import dependence is a heavy burden for society and businesses in a country. Therefore, if the existing mechanism of inflation-targeting used by NBG doesn’t work properly, it’s important to change it for something more efficient and tailor-made for Georgian methods.
Three things are important for promoting the country’s development, community well-being, and healthy business environment: 1. Stability; 2. Reasonable predictability; 3. Providing the possibility to economic agents to operate on equal terms.
Industrial research shows that the absence of institutions and regulatory mechanisms in Georgia contributes to the development of chaotic conditions and increased fatal consequences during critical situations. As a result, the country, society and business cannot develop. On the contrary, such conditions are damaging stakeholders. It is important for the Government to promote and support scientific research, and the development of institutions, in order to have complex analysis that would lead to efficient decisions for the country’s long-term development. Georgia has scientists, economists, experts of specific fields. Hence, their involvement in the right search paths for Georgian development is vital.