What's happening to Lari?
Lari is setting anti-records. The government is seeking reasons outside. What’s actually going on?
As of November 30, official exchange rate of Georgian Lari against US dollar reached 2.53. It’s a record, or, to be more precise, anti-record. Since October 1995 until present, i.e. throughout the history of its existence, Georgian national currency has never faced such devaluation.
Until now, Lari’s record exchange rate against US dollar made 2,50, which was reported on January 28 this year.
Lari started devaluating end of 2013. Lari exchange rate against US dollar made 1,66 then. Since that time Lari has depreciated by 51%.
The second wave of devaluation came at the end of August, when US dollar rate against Georgian Lari made 1/2,28. And this wave has continued until present, with Lari exchange rate against US$ amounting to 2, 61, as of December 1.
How is Lari rate formed?
Georgian Lari has the so-called free exchange rate, which means that the exchange rate isn’t formed either by the government or the National Bank.
Lari exchange rate is formed based on US$ demand-supply. If population need more dollars than there actually are in circulation, then US dollar increases in value and Lari is depreciated. The volume of dollars available in the country depends on the dollar inflow or outflow. The need for US dollar is basically conditioned by procurement of imported goods and loan servicing.
What may also trigger Lari devaluation is that if dollar volume remains unchanged, but the volume of Lari in the country increases. This means that people will get more Laris to buy dollars.
Another factor seriously influencing the exchange rate is the population’s expectation with regard to the change in exchange rates. For example, if people expect further devaluation of Lari (increase in dollar value), they will buy more dollars than they actually need today and will thus facilitate Lari devaluation.
What’s the reason for Lari devaluation?
It’s the foreign policy that basically determines the amount of dollar inflow and outflow in Georgia. Dollar flows are also determined by such factors as: foreign trade (export-import); tourism; money transferred by immigrants; international grants, loans and investments.
Dollar inflow-outflow in Georgia is fully recorded in the so-called Balance of Payments, which is published in Georgia on a quarterly basis, but with a 3-month delay. For instance, today we know, what the situation was as of June 2016, but we’ll learn about the situation in November only at the end of March next year.
Foreign trade in goods is the field where Georgia loses most of its dollars. In 2014, imports exceeded exports by US$ 4,2 billion, i.e., as a result of foreign trade the dollar outflow was by US$4,3 billion more than the inflow. In 2015, the negative trading balance increased up to US$ 4,4 billion, whereas in January-October 2016 – up to US$4,15 billion. Exports from Georgia dropped by US$1,1billion in 2015, as compared with 2014.
Earlier, imports also exceeded exports in Georgia, resulting in outflow of billions of dollars. However, this loss was compensated from other sources. One of the major sources of Georgia’s income – international money transfers, has shrunk by US$400,million per year. A drop in exports and reduction of money transfers are 2 major reasons that led to approximately US$1,5billion loss and caused Lari devaluation in Georgia.
The number of international visitors, foreign investments and loans increased in Georgia in 2015-2016, as compared with 2013. However, other sources turned out to be insufficient to cover the increased US dollar loss and Lari devaluated again.
Lari started strengthening in spring 2016. The exchange rate dropped down to GEL2,13/1US$. After publication of the Balance of Payments it became clear that it was the increased external debt that made Lari stronger. In addition, the Lari supply reduced, i.e. the volume of Lari that population needed for purchase of US dollar decreased.
How the situation developed after August? Why is Lari devaluating again?
No information is available yet so as to give a comprehensive answer to this question.
Though, certain conclusions could be already made. As is known, no decline has been reported in the foreign trade balance and money transfers in the recent months, as compared with 20015. The number of international visitors has increased. Thus, we may assume that the problem lies in reduction of foreign investments and funding (loans, grants). The fact that Georgian government has failed to absorb donors’ allocated US$200million budget support grant and loan is also indicative of reduced funding. Since country’s budget lacked up to US$200 million proceeds, the government has spent those funds through taking an internal debt exceeding the initially planned amount and using residual amounts, which has affected Lari exchange rate.
Lari volume has increased by approximately GEL1billion over the past 7 months, resulting in increased demand for US dollar. The government is well-aware that the increase in Lari volume will affect its exchange rate, but there is no other way out. If it doesn’t increase Lari supply, the country’s economy won’t develop. Moreover, it may go to recession (decline), resulting in reduction of population’s revenues and growth of unemployment.
The situation is further aggravated by parallel devaluation of the currencies of Georgia’s trading partner states, hampering the growth of export of Georgian products and preventing the country from getting additional incomes.
Consequences of Lari devaluation
Lari devaluation has several negative consequences:
1. those, who have taken loans in US dollars have to pay more for loan servicing
2. Georgia has to pay more for external debt service
3. Product prices show an upward tendency and
4. there is a growing uncertainty, a risk level increases and this seriously affects country’s development.
65% of loans in Georgia have been issued in US dollars. Today, a legal or natural person has to pay by GEL95 more per US$100 than at the end of 2013.
Georgia’s external debt totals US$4,4billion, which is paid from the state budget. Since state budget proceeds are in Lari, we will now have to accumulate more revenues to cover the debt.
Prices have increased not only on imported goods, but also on the local products, since imported raw materials are often used in local production, or the manufacturers have to cover other expenses in US dollars (e.g. loans). Prices have increased by approximately 12% over the past 3 years.
What should the government do?
On November 29, Georgian government introduced a new action plan, which is supposed to stop Lari devaluation process. The government intends to limit imports through raising the excise tax rates (excise duties on tobacco, oil products and imported vehicles will be increased) and to restrict issuance of bank loans in US dollars. And also, the banks will be urged to convert already issued US$ loans into Lari.
The aforesaid measures will have positive effect on Lari exchange rate, though it will hamper country’s economic development, in general.
The government failed to suggest the measures that would have brought rapid economic development and would have strengthened Lari exchange rate
There are two ways the government can influence the Lari exchange rate: 1.through the state budget. There should be a balanced budget with a maximally low level of deficit; all current costs should be reduced (e.g. administrative resources) and no internal debts should be taken; 2. through improved business environment. More foreign investments should be attracted and goods and services export growth should be boosted.