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Monetary Policy Easing Is Absolutely Excluded – Interview With Koba Gvenetadze, Governor of the NBG

Elene Kvanchilashvili
15.09.21 11:30
In about one hour, the NBG will hold a Monetary Policy Committee meeting and announce its decision to tighten the monetary policy even further or to leave it unchanged. The option of easing the monetary policy at the point, when the inflation stands at its 10-year maximum is inexistent – this is what the Governor of the National Bank of Georgia (NBG) Koba Gvenetadze stated in an interview with BMG last week.
Mr. Governor, thank you for your time. Inflation expectations from the leading investment banks in Georgia so far are 13-14% by the end of 2021; 9.4% by the IMF; 9% by the NBG. What drives your outlook?
Our outlook also mentions that the inflation in Georgia this year will be maintained at a high level. In general, inflation has turned out quite a big surprise for the whole world, and when we say that in Georgia inflation scores highest for the last 10 years, the same is true for the US – there this indicator stands at 5.4%, which is the highest since 2008, inflation stands at 3% in the Eurozone, which is the highest since 2011 and the projection is that it is set to increase further. I take part in many international discussions and conferences, and the main challenge today for the Central Banks worldwide is inflation. International organizations name this as the number one challenge of these times. You probably remember that about a month ago, the World Bank organized a seminar with their online presence, and when the discussion touched upon the global trends – you were also present, I remember – it was highlighted there as well that inflation is the main topic on the global agenda.
What can the NBG do to curb inflation? What are you doing now and are there some other instruments that the NBG could use if necessary?
Of course, the NBG has such instruments to curb prices and then approximate inflation to the target in the medium term. One thing I would like to mention – and it might sound a little bit theoretical but still important to highlight – is the fact that the mandate of the NBG is to sustain the stability of the prices in the medium term, within the frame of the target indicator that is set by the Central Bank.
And that’s 3% at this point.
Exactly. If we dig into what this stability means, we will see that there are two features to it, and these are the omnitude and the duration. Now, what does this mean? Omnitude means that prices on all consumer groups go up and the duration means that they go up for a long time. These are the two conditions of price instability. If we look at the first condition, then we can say that today omnitude is present, because the vast majority of products in the consumer basket have already become more expensive. As for the second condition, to see if high prices last, we need a certain time. On the other hand, we have a forecast we make. This forecast is not only the NBG’s forecast but also for instance the IMF, World Bank, investment banks that you have mentioned make their own prognosis. So, right now what we have is the gradual correction of prices that usually follow the crisis.
This means that these are the transitory factors – is that what you’re saying?
Yes. Probably you also follow the literature on a global analysis of inflation that says that these factors are transitory and the next year, after these factors expire, inflation has to start coming down. However, in the majority of cases inflation is caused by the supply-side factors – oil prices, consumer prices are on a historically high level – but because the economic growth is already catching up compared to 2020 and even 2019, risks emerge that the demand-side factors might also generate some inflation pressure. As you know the NBG’s main instruments target demand. So, for inflation not to translate into expectations, we maintain a strict monetary policy. We foresee - and not only us - that the next year inflation will start decreasing and will come closer to its target.
Where do you need cooperation with the government? For example, if the deficit stays high, or vaccination doesn't pick up – will the NBG be able to come down to the inflation target, anyway?
The pandemic was full of surprises and unexpected turns. If we consider different strains, different restrictions that were imposed at different times, etc.
Including that in Georgia quite a small share of the adult population that’s fully vaccinated.
Yes, I always mention and let me stress today as well, that vaccination is very important. But despite these challenges, the economic growth was still quite high.
But, Mr. Governor, the document on the monetary policy on the NBG webpage clearly shows that Georgia’s economic growth doesn’t seem as unprecedented as stated by the government if compared to 2019.
In this case, it would be more appropriate to use this term – unprecedented – while assessing the nature of pandemic rather than growth.
Why do you think that a strict monetary policy is the best solution?
The growth that we have now has given the chance to the state budget to receive more revenue. So, we believe that it will be possible to decrease the budget deficit – as you know, in the last version of the budget it is 6.9% of the GDP - and the next year it will be necessary to decrease this. This is the coordination that should be jointly carried out by the Ministry of Finance and the National Bank of Georgia. Now on the monetary policy side, many developing countries are tightening their monetary policies – Ukraine is the most recent example and many other countries – even when we believe that these are the transitory factors and this is more the gradual correction of the prices rather than the inflationary process, in the economic terms again, and it is crucial for it not to be translated into the expectations. That’s where the strict monetary policy comes at play – and it will be maintained for a certain period, and the future will tell us more on that – to prevent additional pressure stemming from expectations.
You touched upon the budget deficit and debt and let me ask you then – GD’s refusal of the EUR 75 million, the second tranche of the EU loan with the condition to reform the judiciary. This reform is also the question of principle to the IMF. What implication might this refusal have on Georgia-EU relations and also, on the new IMF program that’s in the pipeline of our expectations for 2021?
Let us first identify what this refusal means macro-financially. For us – the NBG it is crucial that the state budget is financed within the parameters that are approved by the Parliament. In this case, there is no threat to the budget financing.
Are you supporting the refusal of this tranche?
No, I am arguing from an economic standpoint.
However, we both know that there is more to this decision than just economic reasons.
Economically, budget financing faces no threat. One more important factor – and this was highlighted by us and the general auditor – is internal debt and thus, increasing the share of securities is important to also boost the development of the capital markets in Georgia. This also needs to be taken into account. Now as for the political aspect …
…Yes, please, in the context of the reform agenda and the perspective of a new IMF program for Georgia…
Of course, I believe it is important to precede cooperation with such an important partner as the EU. At different times there were precedents when the support was left unrealized – not in my term, but I remember that such financial support had been cut in previous years as well. Also, the IMF program had been halted and then the new program started. So, I believe these are the issues that will be solved in the future. Of course, it is very important to maintain and deepen the relations with such organizations as the EU and the IMF.
What will be your update on the new IMF Program – has Georgia upgraded the talks on the negotiation level? Where’s the status of the Program pending now?
I always stress that the IMF’s program is very important because it objectively assesses the reforms, economic trends that take place in the country.
We can guess what may be the assessment of the Judicial Reform…
I can’t tell you. This is not an economic issue that I can comment on.
But it overlaps everything – including what falls under the mandate of the NBG as well…
I still focus on economic topics, in this case. To come back to the IMF Program, it is a good anchor for investors, both - local and foreign. And the fact that we had an active program with the IMF has served Georgia well to draw financial aid during the pandemic.
Shall we have a new Program?
Interest is definitely there. Negotiations haven’t started yet but the economic team of the country has stated its interest in having such a Program.
Mr. Governor, let us proceed with the topic that has been quite arguable especially among the representatives of large businesses, and that’s Lari depreciation. Here is a direct quote from Lasha Papashvili, Vice President of the Business Association of Georgia (BAG): “We met in late June. Lari and the NBG’s policy was the main issue, together with Prime Minister Irakli Gharibashvili. The NBG was also present and we discussed how to 'catch Lari'. And we did it – together. This is what the coordinated work can do, even though our standpoints differ immensely with Koba Gvenetadze. I don’t know exactly what Irakli Gharibashvili thinks of the devaluation. He was more of a mediator in this case. We were debating. He listened and took the decision that straightened the situation with Lari. [The NBG] also eased regulations on Banks. We were even and Irakli [Gharibashvili] took our side”. Do you confirm this?
We definitely meet from time to time and it is necessary. We hold regular meetings with the business community as well. As for the exchange rate, we have explained it a number of times – including to the BAG – when there is such an unprecedented shock, the rate cannot stay unchanged. If the rate was fixed or pegged, then the loss that Georgia incurred from the foreign sector – that’s 3 billion in this case - would have been much higher. Then the demand would go down and interest rates would increase dramatically. I know that you are aware of the latest assessments and if we look at Fitch’s, we can clearly see that the floating exchange rate is the most important instrument that the NBG has. When such unprecedented events unfold, the exchange rate should correct itself. Of course, when it has an impact on the inflationary processes, our approach is different and we had such an approach – we sold USD 916 million last year, we sold dollars this year as well and the medium-term stability must contribute to the decrease of prices. However, in this case, this is not the only factor: For example, during the last 3 months, the exchange rate has appreciated but the petrol prices have increased – so there are other factors as well that have an impact on prices.
Here is what TBC Capital, Georgia’s leading investment bank has written in its recent report: Last year the lack from tourism was almost fully compensated by the debt flows; however, Georgia had a shock amplifier – a lot was saved in foreign currency, lending was in Lari and this has had aggravated situation on the FX market to an important extent. Has the NBG changed its policy today?
First of all, let me state that I do not agree with this assessment because the foreign currency was available to the market. The fact that Georgia had a shortage of 3 billion in revenues and it had received financial aid does not mean that absolutely everything should have come out on the market. This assessment implies that the exchange rate should be fixed. If it is so, then that’s a totally different dimension. For the stability of the market we supplied it with the foreign currency and we continue so. The goal of interventions cannot be fixing the exchange rate to a certain benchmark.
So, what you are telling me is that the business community demands a fixed or pegged exchange rate from you – is that right?
Yes, very often. It’s better for them if the currency is pegged; however, what this means for the economy – especially, in case of such shocks and a very big shortage of almost 19% of GDP that Georgia incurred – this issue stays beyond analysis most often. So, according to the objective assessments the floating exchange rate, especially when dollarization is quite high in the country – is the only lever that gives the country the chance to return to the growth trajectory and maintain financial stability. We should, of course, take into account what the business community has to say – however, we should not make a decision that harms the economy and the financial sector even more.
What should we expect from the upcoming monetary policy committee meeting on September 15?
Elene, what I can say with certainty is that easing is absolutely excluded to avoid demand-side pressures on inflation and the translation of gradual corrections into the expectations. For this, we need a tightened monetary policy. One-off corrections and I would like to use this term again instead of inflationary processes…
However, this won’t change much for the pocket, Mr. Governor…
Well, in the context of pocket as well, if you wish – if interest rates tighten, even more, reaching 15-16%, for instance – this might curb inflation; however, this will mean curbing the demand as well and the growth that we have will be much less in the end. Low economic growth means lost jobs and what is better – and I don’t want to compare apples to pears here – but still let us ask ourselves: what is better if a person has a job and a salary while the prices are relevantly higher or the person is left without a job which results from even stricter monetary policy? Probably it’s still better if a person has a job, right? We have to keep the golden rule. Even if we have raised the policy rate earlier, would that change the global situation? Would oil prices come down? Would the FAO index change? So, we would get relatively the same result but with lower economic growth.
There is one more component there – loans in Lari. Do you analyze the impact here as well? For example, have you studied what impact does inflation has on the budget of the borrowers in Lari vs. increased interest rates?
Elene, this is a very good question, and thank you for asking. Those people having loans in Lari and having revenue also in Lari are still in a better condition than those with loans in foreign currency. Even though their loans have also become more expensive since the high-interest rate will not be there eternally, it will come down by all means and they will have to pay less for their loans. We have to look at this, not from a 1 or 2-year perspective. I understand that it is not easy on them but the pandemic also is not easy to handle. We have to look at the whole term of the loan. Borrowers in Lari are much better protected than if they had a loan in dollar or euro. One more point, when the loan is in the dollar and the depreciation takes place – and I have talked about the reasons for the depreciation of Lari – it becomes to cover the base of the loan and the interest rate.
And inflation is still a bigger burden on their budgets than such loans – is that what you are saying?
Both have an impact. But in the case of dollar loans, the situation is even more aggravated.
And lastly, about the banking sector, we have seen the profit figures and they look quite solid on the background of the pandemic. Can we say that banks are on their way to getting healthy again and should we consider this as the start of the post-pandemic period for this sector?
In 7M21 the banking sector generated GEL 1.2 billion in profits. But let us look at the same figures in 2020, then this figure was negative and stood at GEL -413 million. You know that we asked the sector to evaluate in advance expected losses and banks made reserves for this – GEL 1.1 billion in total. This was about 3.5% of their portfolio. But this was a very good decision since the banks and us, as well, saw what their balance is in reality.