Black hole in balance of payments

Tata Lashibaia TSU undergraduate – faculty of economic and business

Georgian economy was growing dynamically during three years (2005-2007. Average rate of real GDP annual growth in 2005-2007 exceeded 10%. 9% growth was forecasted in 2008.

Driving engine of economic growth was intensive flow of foreign capital and steady growth of budgetary expenses. According to official data, the volume of foreign capital increased 4.6 times and made up $2.3 billion or 22.5% of GDP.
In the course of last three years, balance-of-payments deficit increased 2.8 times and exceeded $2 billion. Such dynamics was conditioned by sharp increase of import. The growth of import was a result of consumption boom. Balance-of-payments deficit in this period was covered by foreign investments. The situation has changed since August events in 2008. Hostilities and occupation had negative impact on those branches of country’s economy that were playing major role in GDP formation, including agriculture, and processing industry, trading, tourism, construction, financial institutions. Country’s infrastructure is destroyed.
All the above-mentioned decrease amount of VAT and weakened base of revenue from taxes. At the same time the mentioned factors increased budget’s social burden. According to the data of 2008 balance-of-payments deficit amounts -3911660 thousand US dollars that is by $2881228 thousand more if compared with previous year’s rate. Tendency of current balance-of-payments deficit aggravation is obvious. Coming out from the abovementioned, we can conclude that under conditions of world financial crisis, reduction of foreign investments will considerably aggravate balance-of-payments deficit in 2009. Moreover, export volume diminution is anticipated and this mainly concerns raw materials market. All these have negative influence on balance of payments.
Foreign trade turnover of Georgia (2008, I quarter of 2009)2

One of constituent elements of balance of payments is investments. It represent determinant of currency exchange. Foreign investments encourage hardening of national currency and devaluation of foreign currency toward national. For instance, the past period, foreign investments that entered country’s monetary market caused increase of foreign currency volume and correspondingly danger of sharp hardening of national currency. In order to avoid this, National Bank of Georgia was making interventions at monetary market and buying US dollar. The amount of US dollar purchased by National Bank made up: 195.092 million GEL in 2004, 91.272 million GEL in 2005, 451.378 million GEL in 2008. At the same time, in order to avoid inflation processes, National Bank was retrieving these sums from money circulation by means of deposit certificates. The volume of deposit certificates emitted by National Bank of Georgia was increasing considerably. 380 million GEL in 2006, 4202 million GEL in 2007, 3761 million GEL in 2008. Since August 2008, due to sharp decrease of demand on US dollar, National Bank decreased purchasing of $ and it started to provide market with foreign currency. Starting from August till December, National Bank purchased GEL 809.723 million. As a result official international reserves of National Bank have increased considerably. According to the data of December 2008, the volume of reserves exceeded $1.460 million that is by 7% more as compared with the same indicator of previous year.
Interventions made by National Bank of Georgia3
Million $US

The volume of official international reserves in Georgia (2008)4

Official volume of international reserves in January 2009 made up $1335.8 million and $1269.3 million in February. Significant decrease in foreign investments encourages strengthening of $US. National Bank of Georgia will have to spent significant volume of currency reserves in order to avoid inflation in 2009. Therefore, it is very important to increase National Bank’s foreign currency reserves by means of financial aid from abroad. Main reason of Lari exchange rate fall is deficit of current balance of payments in the country. Despite this, up to present times, national currency was quite stable. This was determined by big amounts of foreign investments (direct portfolio + banking credit). Investments not only cover, but also exceeded current account deficit. Under conditions of Russian aggression and world financial crisis the situation has changed radically. Private capital flows have weakened. As a result the state couldn’t manage to cover current deficit that has its impact on conjuncture of currency market. International reserves are one of the flexible instruments of economic policy. It includes reserve assets that might be used in international payment operation, foreign debt service and other purposes. Management of international reserves is a component of exchange rate management and it majorly depends on the currency exchange rate policy carried out by monetary government. In case of floating exchange rate policy, balance of payments deficit is automatically covered by exchange rate adjustment and monetary government uses international reserves only in case of sharp fluctuations. In order to manage international reserves effectively, the following steps are normally made by the central banks: diversification of foreign currency or formation of “Currency Basket” that implies selection of separate currencies and their volume. International reserves of National Bank of Georgia are diversified by the currencies included in basket of special rights of indebtedness. In order to manage international reserves effectively, National Bank of Georgia should pay serious attention to the selection of financial instruments where international reserves will be put. Besides this, complying with the liquidity demands is of special importance.

Direct investments in Georgia (Million $US)5

Dynamics of GEL nominal exchange rate

Dynamics of GEL real exchange rate

Main task of National Bank of Georgia is to maintain stable prices. In order to maintain stable Lari exchange rate National Bank makes bilateral interventions at Tbilisi interbank monetary exchange. Exchange rate depends on demand-supply of foreign currency. Attracted foreign capital is one of the defining factors of supply. We should differ nominal and effective exchange rates.
Real exchange rates are calculated by multiplying inverse value of corresponding exchange rate indices and consumption price indices ratio of Georgia and its partner countries.

Real exchange rate shows Lari exchange rate index changes in Georgia and its partner countries, taking into account consumption price indices. It is calculated as average weighted geometric value of real exchange rates in Georgia and its 12 main trade partner countries (Azerbaijan, USA, United Kingdom, Germany, Turkey, Italy, Russia, Holland, France, Armenia, Ukraine, and Switzerland).

Increase of real effective exchange rate means actual strengthening of national currency and lowering of export competitiveness and vice versa.
Nominal effective exchange rate is average weighted geometric value of Lari nominal exchange rate index toward currencies of its partner countries.

Balance of payments deficit has negative influence on national exchange rate. Main reason of Lari exchange rate fall is balance of payments deficit.
Fall of national currency exchange rata makes export cheaper and import more expensive. In normal conditions, this is usually followed by trade balance improvement. However, not in our case, as imported products are dominating on Georgian market and at the same time we produce nothing. There are no prospects of replacing imported product with the local one. Finally, this results price growth on imported goods and services.
Investments are diminished five times, reserve funds are decreased either. This increases the chance of GEL exchange rate fall. It is essential to coincide in time foreign financial aid with current macroeconomic processes in the country.
2008 year situation: (Million $US)6
Current account deficit: -3911600
Goods: -3833225
Services: 27515.73
Income: -105950
Current transfers: 1063587
Capital and financial account
Capital account 105071.9
Financial account
Direct investments -312188
Thrid quarter – -74728.5; Fourth quarter – 81402.37;
Portfolio investment -105950 in fourth quarter compared with previous quarter;
-1039 in third quarter. -4611.75 in fourth quarter;
Other investments: – 167648
Third quarter: – 465391; Fourth – 49637.2;
Reserve assets: 130869.2
Lari exchange rate hardness depends on emigrants.
In February 2009 the volume of transferred money from foreign countries made up $52.4 million that is by 19.8% less than the volume of previous year in the same month. This was caused by reduction of transfers from Russia by 30.9% or $12.1 million. The rates of other countries remain almost unchanged. 87.1% of foreign transfers are from seven donor countries. The volume of transfers in February exceeded $1 million. It is notable that the rate in previous year was 89.9%. $5.7 million has been transferred from Georgia to foreign countries in February 2009, while in the same period of 2008 the sum made up $6.4 million. Transfers have decreased to Russia and Armenia by $683.7 thousand, while transfers to USA, Turkey, Ukraine, Israel and Italy increased by $374.3 thousand.
· Export annual reduction of 29.4% is forecasted in 2009, while in case of import the rate is 21.7%. As a result, trade deficit will diminish almost by 17%.
· 27.4% reduction of current account deficit is anticipated compared to 2008. Main account deficit will be defined by trade deficit.
· Supposedly transport balance will be positive in 2009 and credit will increase by 13.2%, while the debit will decrease by 14.3%.
· As regards tourism, in comparison with previous year export increases by 5.3% and import by 8.0%. Considerable changes are not anticipated in other fields of service.
· According to prognosis, in 2009 investment revenues will be $587 million that is 5.8% less than the rate of 2008.
· Income balance will be considerably decreased. Transfer account is expected to reduce either.
· 13-14 percent capital transfer growth is anticipated.
· Financial account 28-29% diminution is anticipated. This will be mainly caused by reduction of portfolio and other investments.
· Reserve assets reduction is expected also.
· In order prognosticate separate articles of balance of payments National Bank of Georgia together with local and foreign companies conducted a survey. Aim of the survey was gathering of information about private foreign capital movement in the country in the course of 2009. 119 companies participated in the survey. Preliminary results of the research are the following: private foreign investment made up $1.74 billion. Aggregate direct foreign investment volume is $815 million. Portfolio investments amounted $33 million. Debts and other sources are forecasted to be attracted in amount of $1 billion.
· Reduction of foreign investment, together with money transfers will aggravate deficit of balance of payments. In order to maintain stability of currency exchange rate monetary reserves of National Bank will be significantly reduced.
· Lack of investments will decrease monetary mass growth in 2009. As a result monetary reserves of National Bank of Georgia will be reduced. The ability of National Bank to maintain stable exchange rate will be weakened. In addition, at the same time, domestic demand will be decreased in the country.