Recent months have highlighted the extent of the impact of negative expectations on Georgian macro environment. Growth remained strong at 5.7% in 3Q19, but excessive GEL depreciation saw inflation rise to 6.9% in October – higher than initially forecast. External demand and fiscal policy remain the key growth drivers in 2019. Separately, construction has recovered in recent months and domestic investment is increasing, supported by bank credit. In addition, S&P followed Fitch and Moody’s in upgrading Georgia’s sovereign credit rating by one notch in October 2019.
Amid a continued improvement in the external balance, the GEL, at close to 3.0/US$, was significantly undervalued through July-October. With currency weakness triggering inflation, the NBG conducted currency interventions, tightened policy, and decreased the reserve requirement on FX deposits, but to no great effect. We do not see the need for further rate hikes to address medium-term inflation trends (annual inflation is already likely to converge to the 3.0% target from 2Q20), but we expect the NBG to relax FX liquidity further to support the GEL. We also believe that the NBG needs to adopt a more balanced approach to de-dollarization as growth in GEL lending along with a lack of confidence in the GEL and a related increase in dollar deposits have proved to be one of the major factors in the currency’s weakness lately. In our view, this could be addressed by reducing the floor on GEL lending. This is also desired considering reduced FDI and government’s shift to domestic borrowing in 2019 revised budget and beyond. We acknowledge benefits of de-dollarization process, but we see this as a long-term process through capital market development.
If the GEL stabilizes at the current level of 2.96/$ over the next few weeks, this would imply that annual inflation could remain close to 7.0% through end-year. Deceleration in price growth from 2Q20 will likely enable the NBG to cut rates by 100-150 bps in 2020, in our view.
After recent monetary policy tightening, we keep our growth forecast at 4.5% for 2019, but see pressure on growth in 2020. Monetary policy rate hikes will soften demand for GEL lending, but growth in FX liquidity will keep FX interest rates low, thus supporting bank lending in FX. Therefore we expect bank lending to grow above the nominal GDP growth rate in 2020.
Strong growth in exports and a drop in oil and import-intensive FDI have improved the external balance markedly, resulting record low current account deficit of 4.6% of GDP in 1H19. We expect a weaker currency to trigger further improvement in the trade balance, supporting a better-than-expected improvement in the current account deficit to below 5.0% of GDP in 2019.
Budget spending is smoother this year with fiscal deficit at 37% of annual plan in 9M19, compared to the surplus a year ago. 2020 budget framework remains healthy with the deficit at 2.7% of GDP and current spending at 23% of GDP despite significant growth in social spending.
We expect Georgia to deliver 4.7% growth in 2020, supported by external demand and domestic investment. If the NBG keeps the policy rate unchanged throughout 2020 and parliamentary elections weigh on business confidence, 2020 growth could soften to 4.0%. If Russia’s ban on direct flights is lifted, this could produce a positive shock to growth. Additionally, Georgia’s Prime Minister has recently met with a number of corporate sector representatives to address different issues hindering business decision-making in the country, which bodes well for future growth. Government also requested extension of ongoing IMF program by one year to strengthen credibility of government policies.
