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TBC Research: inflation to reach the target in 2020, the GEL should strengthen furth

5e0b2ba464eaa
BM.GE
31.12.19 15:04
634
According to TBC Research, inflation reached 7% YoY in November, close to expectations, thus indicating that at least some pass-through from the weak GEL into consumer prices is still under way. While annual inflation increased by only 0.1 percentage points, primarily due to the base effect, as estimated though, the monthly seasonally adjusted annualized inflation in November was still high at around 7%. Moreover, nominal wages also increased with higher inflation in Q3 2019.

The wage growth amounted to 8.1% YoY in Q3, with compensation in the business sector increasing by around 11% and the public sector by 2.2%. Consequently, unit labor costs (measured as nominal wage per real output per worker) have likely increased, indicating wage pressures on inflation in Q3 2019. The annual inflation for December should increase further to around 7.5% on the back of some pass-through from the exchange rate and, unlike in November, the low base effect a year ago.

At the same time, the first signs of moderating inflation are already evident in the PPI figures, which often serve as a leading indicator for CPI inflation. The annual change in PPI came in at 8.5% in November 2019, down from the approximate 11% YoY increase in Q3 2019. Alongside lower PPI inflation, export and import price inflation also moderated to 9.6% and 8.4% YoY in November, compared to the peak growth of around 16% in July 2019. Similarly, the TBC Research model, which appears to forecast inflation highly accurately, indicates that the pressure on CPI inflation, arising from the weak GEL, will dissipate in the coming months, while the base effect is also supported by recent GEL appreciation.

Though inflation is to return to its target in the second half of 2020, the real effective GEL exchange rate should strengthen further from its current level. Assuming commodity prices remain at their current levels and the exchange rates of the major trading partners against the USD are broadly stable, the GEL REER appreciation required to bring inflation to the target would be equivalent for the USD/GEL exchange rate to be around the 2.75 level. Likely somewhat stronger EUR in 2020 is an upside.
In the baseline scenario, taking into account the stronger external sector, more focus on FX credit, the high GEL/FX interest rate differential and the fact that the GEL tightening is not yet fully transmitted, we expect the GEL to strengthen further. Therefore, we do not foresee additional tightening of the GEL, however, that is not to rule out further FX easing. While in our view aggressive rate cuts are unlikely, we still expect the NBG policy rate to decrease to 8% in 2020, which may be coupled with certain possible policy moves on the quantitative side if required, especially taking into account the GEL policy rate still remains below deposit rates, despite the rate hikes.

In addition, 2020 may be more active, relatively, on the intervention side. In this respect, we view the wording in the latest IMF staff report on FX interventions to be addressing excess volatility as somewhat supporting possible interventions, if deemed necessary. Considering the availability of reserves, the end of 2019 net international reserves (NIR) target was set at 1.490 million USD by the IMF, and this mark has already been met by the NBG, as per IMF estimates. Furthermore, an end of June 2020 NIR target was set at a lower 1.450 million USD, with no need for the central bank to buy reserves, from an IMF benchmark perspective. Concurrently, if the GEL effective exchange rate strengthens substantially, over that required to bring inflation back on target by the end of 2020, the NBG will likely intervene on the FX market from the buying side, thus building reserves and creating room to possibly “lean against the wind”. In fact, in the baseline scenario, with a stronger external sector, a tight GEL and relaxed FX, we expect the NBG to buy reserves in 2020.

“Our estimates for exports, tourism, remittances and FDI inflows exceeds that of imports of goods and services, even without taking into account an additional debt financing increasing broadly in line with GDP growth and unlike 9 months of 2019, stronger FX credit. A weaker than expected external sector, a higher fiscal deficit financed domestically, and election related uncertainties would be a downside. In any case, we think it highly unlikely the NBG will tolerate the above target inflation for the second consecutive year, and consequently we bet on an even more hawkish stance if the GEL effective exchange rate fails to follow its assumed trajectory. As for the larization, we expect it to remain a priority, however, much more dependent on the progress on the liability side”, TBC Research notes.