TBC Capital published Weekly Update From The Chief Economist. According to the document, recent high growth in GEL monetary aggregates raises questions about the potential implications. Is it inflationary? Should we expect the reversal and the GEL depreciation?
"On the demand side, we note that when asking whether the money supply is inflationary or not, the credit and GDP growth should be looked at in the first place. While economic activity remains strong, we do not see a particular acceleration being correlated with the M2 increase, and the credit remains broadly moderate. In fact, when looking in YoY terms, mainly due to the high base effect, we expect April growth to cool down notably. What we certainly see is a larization of deposits and a dollarization of loans – the shock amplifier adding on the appreciation pressures in good times and depreciation in bad times. Therefore, the excess FX supply is not only on the back of strong net inflows, but also due to improved sentiments related to the GEL strengthening trend and also, in our view, at least to some extent due to seasonal expectations of the GEL appreciation. In this regard, we note once again, that if a large number of market participants believe in exchange rate seasonality, then the seasonality is priced in, and one should expect the seasonal pattern to hold.
So the combination of strong net inflows and improved sentiments led to a higher GEL money supply. Part of NBG FX purchases can be seen as sterilized as the central bank’s net claims on the banking sector went down, though still only a part as the money supply is substantially up. Should interventions be fully sterilized? We say no as a significant part of GEL deposit growth is on the back of higher larization of deposits, or in other words, lower money velocity when measured using Fisher’s original formula with total transactions rather than GDP only. So far so good, but what about reversal risks, even if net inflows remain strong? We think those are considerable. Namely, taking into account the large size of credit and deposit balances relative to GDP or FX turnover in Georgia, for any reason, the shift in sentiments will lead to strong depreciation pressures. While the NBG has accumulated a substantial amount of FX reserves, we don’t bet on equal or even sizable FX sales in this scenario as a) when market believes the currency has to weaken, it is difficult to counteract and b) maybe slight, but still overvaluation of the GEL compared with its estimated long-term trend and cooling down inflation with the likelihood of undershooting the target going forward have to be taken into account", - the document reads.
