TBC Capital published Weekly Update From The Chief Economist. According to the document, last week, from the local data release, the NBG international reserves updated data became available with no major surprises and the subject is already addressed in our 31 October weekly update. At the same time, international markets were at focus as US inflation slowed more than expected in October, fueling hopes that the peak has passed and the Fed can slow the pace of rate hikes and perhaps finish them earlier. However, the jobs market remains tight and month-on-month seasonally adjusted print is still higher than required to get inflation at 2% target. In particular, annual inflation print came in at 7.7% below consensus forecast of 7.9%, with MoM seasonally adjusted value of 0.4%.
More importantly, core inflation also showed signs of normalization as its print came in at 6.3% YoY and 0.3% MoM versus consensus forecast of 6.5%/0.5% and core inflation w/o housing rent turned even negative MoM seasonally adjusted. Slower inflation in US is certainly an upside for Georgia as among other macro variables, this implies lower US 10 year benchmark yield and weaker USD.
Greenback weakness is well expected, though more in the medium, rather than in the near term. However, possible continuous normalization of inflation in the US coupled with some, even temporary solution in Ukraine, may push the USD from the recent highs to closer to its medium term estimates.
This is certainly the GEL positive as the EUR/GEL has more aligned cycle as compared with the USD/GEL.
Therefore, on the back of the recent developments, we are now more bullish on the GEL and change our long standing end of year USD/GEL target from around 2.80 to around 2.70 probably still with only some GEL weakness in 2023 due to low inflation outlook in Georgia and likely some Ruble and other regional currency adjustments despite the most expected scenario of the continuation of the adjustment in USD value.
What the recent EUR/USD pair and the outlook may imply when taking an FX risk with the GEL income stream. Judging from the fact that the GEL is more stable against the EUR, rather than against the USD – and given that growth appears to be more stable in EUR and that the EUR/USD is likely appreciating over the medium term in the baseline scenario – EUR/USD diversification appears to be the optimal solution, though now probably with a somewhat higher share of USD for business borrowers. It is important to highlight that while a stronger USD scenario may be less likely, in such a case the adverse impact would be much higher, thereby supporting the argument for EUR credit, even under a EUR strengthening baseline. Lower interest rates are also an argument in favor of the EUR. As well as the diversification with at least some share of the GEL is always a wise decision as the elasticity of NPLs to exchange rate depreciation is non-linear and has low impact during relatively low rates of depreciation.
