The National Bank of Georgia has released a risk-based macroeconomic forecasts of Georgian economy. The forecast includes both the basic and alternative scenarios where different positive and negative risks affect the country's economy. By the optimistic scenario in 2019 Georgian Lari will appreciate against USD by 10%. Pessimistic scenario includes the depreciation of lari of 15% in 2019. The baseline scenario includes 3% medium inflation and zero change in exchange rate of Georgian Lari.
Baseline Scenario
According to the baseline scenario which, is based on the latest issue of the Monetary Policy Report domestic, and foreign economic conditions continue to improve. Improvement of economic activity is mainly driven by positive developments in the foreign sector. and the growth of domestic demand particular exports, of goods and services and tourism revenue have significantly increased. Remittances also showed a positive trend, In terms of domestic factors, the growth of investments and consumption has had a positive impact on economic activity, which in turn is due to credit growth and improved business and consumer confidence. In the second half of 2018, external risks increased, in the light of regional political and economic tensions while, the growth of domestic demand has decelerated slightly. According to the baseline forecast real GDP annual growth will remain around 5% over the next three years and unemployment will continue to fall. Inflation will be close to the target 3% in medium term. Real estate prices in GEL will rise proportionally to inflation.
In the baseline scenario, the US dollar LIBOR rates continue to increase. As anticipated in the previous issue of the scenarios, there have been two rate hikes in the second half of 2018. However, the pace of Fed’s policy normalization is expected to slow down in upcoming years with only two more hikes in 2019. According to the Fed’s forecast, the policy rate is expected to increase by 0.5-0.75 percentage points during 2019-2021. In this scenario, the European Central Bank exits from its eased monetary policy and increases its policy rate by 1.5% throughout 2019-2021.
In the baseline scenario, it is assumed that the GEL nominal exchange rate against the US dollar remains at its current level. The nominal effective exchange rate will also stay stable. In the face of external risks arising from regional tensions, the NBG has maintained the monetary policy rate at 7.0% in the second half of 2018. Given the regional and global risks, policy rate will continue to decrease at a slow pace. In accordance with the current macroeconomic forecast, the policy rate is expected to go back to a neutral level in the medium term.
Optimistic scenario
The upside scenario considers faster economic growth compared to the baseline, which is due to stronger demand. The strong demand, on the one hand, is driven by improving foreign sector, namely the high growth of export, tourism, remittances and direct investments, and on the other hand, by the improvement of business and consumer sentiment.
In line with stronger demand compared to baseline, real GDP growth is high and unemployment is declining. Given the improved economic growth, the negative output gap closes at a faster pace and increases inflationary pressure.
In this scenario, FED and ECB policy rates increase by the same amount as in the baseline scenario. However, the effective exchange rate as well as the bilateral GEL/USD exchange rate appreciate in the upside scenario given the soaring foreign currency inflows due to high economic growth. According to the scenario, in 2019, the GEL appreciates against the US dollar by 10%, and then by another 5% in 2020. The appreciation is partially offset in 2021.
In order to reduce inflationary pressure caused by strong demand, monetary policy remains tight for a longer period than in the baseline scenario. Consequently, the reduction of policy rate in the upside scenario is relatively modest.
Pessimistic scenario
The adverse scenario considers intensified regional and global economic tensions together with the continued tightening of global financial conditions and reversal of risk appetite. Rising protectionism and policy uncertainty in developed countries contribute to reduced trade in investment flows resulting in weaker global growth. In this scenario, the federal funds rate increases at greater-than-expected rate in 2019-2021 and reaches 4.5% by 2021. In the adverse scenario, the European Central Bank exits from its eased monetary policy at a faster pace and increases its monetary policy rate by 2.5pp throughout 2019-2021.
In line with tightened global financial conditions, investors’ risk appetite towards emerging countries decreases, which leads to the snapback of sovereign risk premiums in these countries from their historically low levels. Risk premium hike in the region is further amplified by the political and economic instability in Ukraine and Turkey. Tightened financial conditions and an increase in risk premiums together with oil price drops reduce capital inflow into Georgia's trading partners with adverse implications for their exchange rates. Therefore, in this scenario, US dollar and partially EURO appreciate against the trading partner currencies. Consequently, the impact of external factors on the GEL exchange rate is negative. The adverse scenario implies that in 2019, the GEL depreciates against US dollar by 15%, and then by another 10% in 2020, which facilitates the elimination of external disbalances. Alongside the economic recovery in 2021, the GEL appreciates by 5%. In these years, the depreciation of nominal effective exchange rate is small as the exchange rates of the trading partners also depreciate due to the global developments.
In line with adverse external environment, during 2019-2021 real GDP growth falls relative to baseline by 7 percentage points cumulatively. Since the currencies of the trading partners along with the GEL depreciate against the USD, the imported inflation does not increase and as a result, the impact on headline inflation is small. In order to anchor inflation expectations, monetary policy is tighter than in the baseline scenario. In the adverse scenario, real estate prices expressed in GEL exhibit volatility by dropping in 2019 only to recover as the shock fades away in later years.
