Recent months have seen turbulence in Emerging Markets (EMs) resulting in a depreciation of EM currencies and a deterioration of economic outlook. Georgia experienced currency depreciation as well. But our analysis shows that contrary to EMs, the problems in Georgia were mainly driven by domestic factors, and timely interventions by the National Bank of Georgia succeeded in smoothing the lari’s fall. As the year-end domestic problems expired, lari regained some of its value and the NBG started to buy foreign exchange through currency auctions. Going forward, the weaknesses in neighboring Turkey, Russia and Ukraine will weigh in 2014, while real appreciation of Euro will benefit Georgian exporters to Europe. Domestic risks consist of a widening fiscal deficit, which will likely be financed through local currency borrowings pushing banks’ financing costs upwards. On the positive side, undeveloped capital market along with a strong sovereign balance sheet will minimize (or entirely negate) possible negative impacts of the Fed’s taper. Moreover, a slight depreciation of the real lari exchange rate vs. euro and expected EU free trade agreement will support the current upward trend of export to Europe. Finally, a cheaper lari will help the tourism industry as well by attracting European visitors.
Despite recent turbulence, Georgia’s net international reserves increased 8% in 2013 to US$ 2.5bn. In 2013, the national bank conducted 41 currency auctions, buying US$ 575mn and selling US$ 240mn, netting at positive US$ 335mn. From November 2013 through to December 2013 the NBG has been selling US$ into the market. As a result, net reserves declined from a peak of US$ 2.75bn in October to US$ 2.5bn in December 2013. Currency sales were necessary to halt and/or smooth a depreciation of the GEL. The market intervention seems to have been successful, especially when compared with the effect of currency auctions in EM peers like Russia and Turkey, whose currencies have lost far more value.
Following temporary depreciation pressures, the lari has appreciated since early February. From October 21, when it began to slide, until the end of 2013, the lari lost 4.4% against the US$, and another 2.7% from December 31 to February 1 when it peaked at GEL 1.7824/US$. Since then, it gained 2.5% to GEL 1.7387/US$ on February 24. This reversal allowed the NBG to re-reverse its auctions and buy FX. Following the sale of US$ 220mn in January, the NBG held four purchase auctions in February and bought US$ 80mn. Still, the GEL continued to strengthen vs US$, which suggests the factors behind the depreciation pressures had already expired. Along with the purchase auctions, the NBG also increased its refinancing rate 25bps to 4% in reaction to positive economic developments. Recovering economic activity and the rate hike will strengthen the local currency but this could be balanced by US$ purchases by the NBG. We believe these pressures largely balance to keep the exchange rate broadly stable at the current level. Although it is higher than the recent historical average, we believe it will be beneficial for the economy, particularly for exports and tourism.
