Koba Gvenetadze, governor of the National Bank of Georgia, explains how policymakers are coping with fallout from the Kremlin’s ban on flights between Russia and Georgia following anti-Russia protests.
Global Finance: Earlier this year, you were quoted as saying you didn’t expect any major fluctuations in the Georgian lari. Since then, the exchange rate has deteriorated, posing a risk to price stability. What is the central bank doing to prevent a further worsening of the situation?
Koba Gvenetadze: At the beginning of the year, we expected stronger economic growth of about 5% and a faster pickup in aggregate demand over 2019. Meanwhile, external imbalances were improving. After a significant reduction in the current account deficit in 2018, positive trends continued in 2019. However, due to the introduction of an air-travel ban to Georgia by the Russian Federation and elevated turbulence in the global economy, the National Bank of Georgia revised its 2019 real GDP growth forecast down to 4.5%, which is still robust growth.
Our neighbor’s decision to ban flights to Georgia has weighed on Georgia’s growth and current account through the reduction in tourism revenues. The anticipated reduction in foreign exchange inflows resulted in depreciation of the Georgian lari, as negative expectations have picked up—even more than the estimated size of this shock would suggest.
As the exchange rate pass-through to inflation intensified and upward risks to inflation persisted, the Monetary Policy Committee at its September meeting increased the policy rate by 0.5 percentage points. The NBG will further tighten monetary policy as needed, until pressures from the exchange rate and inflation recede to ensure price stability in the medium term.
GF: How might Russian sanctions and the flight ban threaten the Georgian economy more broadly?
Gvenetadze: The Russian Federation is one of Georgia’s major trading partners. However, over the past decade, the dependence on the Russian market has significantly declined, while external linkages with other regional and EU countries have intensified. For example, in terms of exports of goods, Russia’s share of total exports was 13% in 2018 (compared to 18% in 2005), while the share from EU countries comprises one quarter of total exports from Georgia. A similar trend is observed in terms of remittances. Money transfers from Russia accounted for 29% of the total in 2018, while just five years ago it was more than half. The share of Russian FDI inflows is rather negligible.
The air-travel ban that started in July 2019 has had a direct negative impact on the Georgian economy through the tourism export channel. As opposed to exports or remittances, the presence of Russian tourists in the Georgian tourism sector is much larger. In 2018, Russian travelers made up 16% of total international travelers and accounted for 26% of total earnings from the export of travel services.
We estimate the losses due to this restriction to reach about $300 million in 2019. This loss will be offset partially by exchange rate adjustments and by tourism revenues from other countries. Largely owing to the improved connectivity and increased worldwide awareness, Georgia is attracting a growing number of visitors to its four-season tourism industry, year after year, and there is further potential to diversify the visitor base. According to current estimates, despite this shock, the current account deficit is still expected to significantly improve in 2019 thanks to Georgia’s floating exchange rate.
GF: What are the central bank’s growth expectations for the economy this year?
Gvenetadze: In the first and second quarters of 2019, real GDP grew annually by 4.9%. The growth was primarily driven by strong external demand, which was reflected in an increase in net exports. However, the National Bank of Georgia expects growth of around 4.5% in 2019 and 2020, all things being equal. Despite elevated uncertainty, net exports are still projected to remain a significant driver of economic activity, being supported by a competitive exchange rate. In addition, on the back of moderate credit growth and planned fiscal spending, consumption and investment will also positively contribute throughout the forecast horizon.
Overall, we saw a considerable decline in dollarization indicators starting from 2017 up to now (end of July 2019): 10.7 percentage points for loans, 10.1 percentage points for deposits and, even more importantly, 15.1 percentage points for individual loans. We know that de-dollarization is a long run endeavor, but with the right and balanced policies we foresee a positive dollarization trend going forward, which is necessary to strengthen the system’s resilience to potential negative external shocks.