ROLE OF THE NATIONAL BANK IN THE FUNCTIONING OF DOMESTIC CURRENCY

NESTAN TSAGAREISHVILI

Formation of optimal currency system is one of the important priorities in the stage of post-communist transformation.

Its necessity is, on the one hand, stipulated by the internationalisation process of economic globalisation and capital objectively promoting inclusion of Georgia in world economy and, on the other hand, it is stipulated by protection of national economy from external economic shocks.
Currency system as an organisational form of economic relations that is connected with foreign currency ownership and disposal, forms the regulating environment on the basis of which a state implements currency policy. Macroeconomic situation of the country as well as its relations with international markets and therefore, development of national economy and GDP growth are much dependent on the efficiency of the policy.
One of the components of currency system is domestic currency market that along with conversion and exchange rates of national currency plays a decisive role in the functioning of country’s currency mechanisms.
Currency policy of the Central Bank has a great effect on the sales opportunities of domestic currency market. This policy is a constituent of currency regulation, namely, its economic aspect.
The main task of the National Bank – universal agency of Georgian monetary policy – is to ensure national currency purchasing ability, price stability and optimal dynamics of GEL exchange rate. The Central Bank puts national currency into circulation, keeps gold and currency reserves of the country and compulsory reserves of commercial banks. At the same time, it is “bank of banks”. It controls and co-ordinates activities of private banks in the country as well as abroad. In Georgia currency policy is determined by the Parliament and implemented by the National Bank – principal subject of currency regulations. The National Bank regulates the mechanism of currency market functioning and in particular, rules of currency operations as well as develops prescriptions, instructions and account forms. It establishes regime of using foreign currency, i.e. regulates ownership and disposal of currency reserves. The National Bank makes an influence on conversion quality of national currency by means of currency restrictions.
As far as we know, state of domestic currency market is greatly influenced by official exchange rates of foreign currency. The rules of determining exchange rates are developed by the National Bank. It determines exchange rate regime in Georgia thereby influencing domestic currency market and implementing currency policy.
According to the banking law of Georgia, commercial banks and exchange offices have the function of financial intermediary in the currency market while licensing is the prerogative of the National Bank. The National Bank also issues licenses for conversion operations in the exchange offices. Besides, it owns, keeps and controls international reserves of Georgia thereby ensuring stability of national currency.
The National Bank performs currency control. It is reponsible for the enforcement of laws in this sphere.
It is noteworhty that functioning of domestic currency had been restricted earlier because till that period the existing practice of Georgia had hampered free movement of currency inflows. For one thing, currency lisence had been issued to banking establishments no less than after one year of their functioning since the issue of banking licenses. For another thing, preference had been given to banks with general licenses that had been authorised to open correspondent accounts in foreign commerical banks, while banks with domestic lisence could perform international accounts operations only through banks that had general lisences. The National Bank decided to abolish such practice and introduce single universal banking lisence.
The National Bank performs principal operations of domestic currency market: management of the activities of commercial banks along with the regulation of the limit of open currency positions. This limit must not exceed 20% of the banks’ total capital.
In case of breach of this lmit, commerical bank is obliged to perform balanced operation, i.e. buy or sell appropriate amount of foreign currency.
Currency interventions are main tools of currency policy of the National Bank in regulating domestic currency market. The National Bank buys and sells foreign currency with the purpose of influencing exchange rates. It is noteworthy that from this point of view Georgia has made a step forward, which is very rare in world practice. The matter concerns full authority in determining the frequency and volume of intervention. The National Bank takes independent decisions in this regard, which is a step forward in the development and implementation of generally accepted principle – monetary policy. It is noteworthy that the US Federal Reserve System lacks this possibility even now. In the USA decisions about currency interventions are not taken without the agreement of Treasury Department.
Nowadays, there are non-sterile currency interventions in Georgia, which is less effective tool for currency policy. Contrasted with world recognised sterile currency tools, it provides for exchange rate regulation by means of either reducing or increasing monetary base. It also provides for reaching the desirable exchange rate, which is not accepted in modern currency regulation practice. The National Bank was not able to introduce sterile intervention practice due to the fact that treasury liabilities market was not developed in Georgia. Therefore, the National Bank performs neutralisation of monetary base growth by means of supplying the most liquid assets to the domestic currency market.
Nowadays, the National Bank realizes currency policy in close relation with monetary policy and with the consideration of the existing economic situation. This is in interests of the National Bank. Otherwise, currency market conditions may deteriorate, which will have a negative effect on price stability. The matter is that in import-oriented transition economy decrease of national currency exchange rate will lead to the increase of consumer prices followed by great inflation effect. Yet, to specialists’ mind, unjustified high rate of national currency will be followed by decrease of currency inflows to Georgia and, therefore, lack of currency reserves.
Domestic currency market has not been developed well in Georgia, though compared with other financial markets, important progress has been made in this sphere. Apart from the National Bank, its agents are commerical banks and exchange offices. As for specialised broker and dealer firms, in fact, there are none of them in Georgia. This, certainly, impedes the development of domestic currency market. At the same time, in the conditions of floating exchange rates, the domestic currency market react very sensitively to extenal economic as well as to internal processes. Contrasted with central banks of other country, the National Bank of Georgia acquires the function of “market creator” in these conditions. Because of the low liquidity of domestic currency market, the National Bank is compelled to act as a buyer in case of excess supply of foreign currency thereby regulating exchange rates. As for commercial banks, their participation in domestic currency market is not equal due to the fact that most of 27 lisenced banks do not effect regular purchase or sale of foreign currency. Only some banks perform exchange operations. Because of it, the National Bank as well as some commercial banks resort to wholesale trade in foreign currency with other banks. This practice is less characteristic of developed countries where the Central Bank does not interfere in the functioning of domestic currency market except in emergency case when there is a danger caused by the breach of exchange parity, etc.
Along with a small group of commercial banks, the National Bank creates interbank currency market that covers stock (deals made in trade square of Tbilisi interbank currency stock) and dealing (operations between commercial banks outside the stocks) markets. Tbilisi interbank currency stock that has functioned since 1993 is an important segment of domestic currency market. Apart from the National Bank, it unites 19 commercial banks and plays an important role in exchange operations (though these operations are not yet free due to low liquidity of domestic currency market). It made up 25% of the total volume of domestic currency market offical turnover in 2002, up from 20% in 2001 and 17% in 2000. In 2002 the share of dealing market was 5% of the total volume of the official turnover of domestic currency market, up from 4% in 2001 and 2% in 2000. As far as we see, dealing market has lagged behind interbank stock market though, compared with the latter, this segment of domestic currency market serves to settle problem of cashing currency. Purchase and sale of currency in dealing market is possible both in cash and non-cash form. In spite of it, the dealing activity of small banks is low. To specialists’ mind, the main reason of it is shift to floating exchange rate. At the same time, it is noteworthy that of late years there have been no sharp market fluctuations either in Tbilisi interbank currency stock or currency market outside the stock. This indicates at close relations between the two segments of the market.
Domestic banking currency market is an important segment of domestic currency market in Georgia. It comprises deals between commercial banks. In 2001 its share was 72,9% of the official turnover of domestic currency market up from 70,7% in 2000. Non-banking exchange offices are one of segments of domestic currency market. They are less organised markets though they make an important influence on all segments of organised market and often play an active role in causing market panic and mini-shocks.
Apart form the mentioned segment of domestic currency market, non-lisenced and non-banking exchange offices have also emerged in Georgia. Currency reserves in these offices are uncontrollable, which becomes a favourable factor for hide economy. They create non-official banknote market thus strengthening spontaneous elements in the functioning of domestic currency market. Representatives of the National Bank report on this non-organised segment and demand adoption of effective measures against them. We think, integration of exchange offices into bank sphere would contribute to the improvement of currency market.
Of the above-mentioned segments of domestic currency market the National Bank participates only in trade sessions of Tbilisi interbank currency stock with the status of buyer. Official exchange rate of GEL against dollar is determined there on the monthly basis. Formation of exchange rate in other segments of the market is independent. In 2001 the total turnover of Tbilisi interbank exchange stock was 98,5 million US dollars of which 35,4 millions (36%) was purchased by the National Bank. A new rule of determining exchange rate of GEL against foreign currency came into effect in 2001. According to this rule, in Tbilisi interbank currency stock, official exchange rate of GEL is determined against dollar. Exchange rate of other currencies is calculated in accordance with cross-rates of dollars, as the number of operations with other currencies is small.
Electronic trading system has been established in the banking sphere of Georgia since 1 January 2000 with the purpose of promoting the development of domestic currency market in Georgia. This makes it possible for banks to perform currency deals in interbank market in real time regime by using electronic formats. Such bank services as international plastic cards (Visa, American Express, Master Card), money transfers (Westren Union) and banker have been introduced in bank sphere.
In spring 2000, currency dealers’ club was formed in Georgia on the basis of currency infrastructure. The objective of the club is to promote introduction of single world-recognised procedures of dealing operations in the currency market of Georgia and its integration into the international financial market. One of the principal directions of the club activities is educational work – informing market participators on important current novelties in the conditions of permanent evolution of financial and currency sphere.
In 24-26 May 2001, forty second congress of international financial market association was held in Singapore. Currency dealers’ club took part in the congress. It is the first organisation from the former Soviet Union Republic that has become an official member of the international financial market association with the status of plenipotentiary national association. As a result of it, Georgia has become sixty-fifth member of the council of international financial market association. This makes it possible for Georgia to establish contacts with participators of world financial markets and to have access to information on situation and novelties in international financial markets.
The decision of the National Bank in 7 December 1998 about the introduction of floating exchange rate regime in Georgia has played a great role in the regulation of domestic currency market. Thus, for three years since lari was launched into circulation in October 1995, managed exchange rate in the country has been changed into floating exchange rate, which was a daring step forward for the National Bank. At the same time, it is noteworthy that the National Bank has not stopped interventions.
It reserved the right to purchase laris in case of excess supply of US dollars. For example, in 2000 it purchased 74 million US dollars in internal currency market and in return, issued additionally 96 millions lari. Therefore, internal self-regulation mechanism was developed in domestic currency market. It helped to avoid undesirable growth of national currency nominal rate and strengthen international reserve positions of the country. On the other hand, it is accompanied by inflation effect leading to the issue of an equivalent number of laris into circulation. The latter breaks supply and demand correlation in currency market, which will have an effect on the growth of consumer prices.
Nowadays, price stability and balance of domestic currency market in Georgia is threatened by state budget deficit and its financing at the expense of the National Bank credits. With this purpose, emitted money aggregates are, as a rule, used for financing such articles of the budget as pensions, salaries, aids, etc. Thus, increased money supply is spent for essentials, which has an adequate effect on the dynamics of consumer prices. At the same time, bank debt of the government has grown considerably. For example, the National Bank allotted credit of 709,7 million laris for covering central budget deficit from 1994 to 1 November 2000 and 199,2 million laris in 2002 that is 123,7 million laris more than credits allotted in the same period of 2001 (75,5 million laris).
The fact that Georgia has passed from the group of moderately dollarised countries to that of high-dollarised countries hampers the use of national currency as single payment means, causing breach of import orientation and budget discipline, stipulating devaluation and decreditation of laris, which will, finally, lead to the aggravation of budget crisis. This creates favourable conditions for the deterioration of budget deficit.
Restriction of lari circulation has resulted in the decreased payment potentials of national currency, which had a depressing effect on the whole system of payment relations. Drawbacks in the domestic currency market have become apparent. It is the prerogative of the National Bank to regulate these drawbacks with the purpose of promoting competitiveness and economic growth of real economy.