REGULATION OF INFLATION AS A PRINCIPAL PROBLEM OF MACROECONOMIC STABILITY

IRKLI MANAGADZE

As recent experience shows, moderately strict financial and credit policy of the National Bank in Georgia made for the halt of inflation rates, and it was minimised to one-digit figure.

Yet, economic crisis, recent years’ expansive fiscal policy and subsequent budget crisis threatens to deepen inflation processes. It is due to the fact that inflation growth rates i.e. increase of demand on money has lately been halted by delay of salaries, pensions, benefits that entailed accrue of indebtedness in the budget of expenditure. In these conditions, special attention should be attached to the significant growth of arrears of wages and pensions and, therefore, increase of indebtedness in the budget of expenditure, which serves to create favourable conditions for the development of inflation processes.
Yet, we think that anti-inflation policy in Georgia should not be aimed at arrest of inflation at any price, but issuing from the interests of national production growth and economic security of the country, it should be aimed at controlling inflation processes by private and public sectors. Some examples in economic literature and in practice show that small-scale inflation increases purchase requirement and, certainly, promotes economic growth (the so-called Mundel-Tobin effect that represents dependence between inflation and growth). The mechanic use of the mentioned model in Georgia is dangerous as it requires appropriate stable macroeconomic environment and developed economic structure of sectors that are based on national production and have export potential. Besides, there is no knowledge or experience in our country as to the regulation of inflation growth of prices.
Experiments in inflation processes can lead the country to catastrophe. Therefore, we think that it should be practically and theoretically excluded on the current stage. It does not matter in which sphere inflation processes will arise as they are characterised by chain reaction and feedback with each stage of reproduction ? production, distribution, exchange and consumption – representing one full and interdependent process. As inflation is a factor causing economic decline and misbalance, it disorganises reproduction process and breaks traditional economic ties. The matter is that unequal growth of prices on certain goods intensifies differences of profit rate and wages and, therefore, causes human resources to pass from one sector of economy to another, mainly, from industry and agriculture to trade and financial sector. Such regularity is characteristic of post-Soviet countries as well as for Georgia. The destructive force of inflation is reflected in the devaluation of savings of economic subjects and population and weakening of interest in entrepreneurial activity. We should hereby note that inflation increases rates and scales of hide economy though the latter does not depend only on inflation processes.
The development of anti-inflation system (anti-inflation policy) should be preceded by a deep economic analysis of factors and conditions that cause inflation. First of all, we should take into account the fact that inflation in transition economies is stipulated by many factors. Among them, we should first of all note such monetary factors as emission of paper currency, money velocity, situation in financial and credit system, national and foreign currency. There are other no less important production factors causing inflation such as monopolisation of industrial projects, competitive relations, high level of production costs. In transition period, inflation processes can be caused by structural reorganisation of national economy and deficit of consumer goods. In the long run, in transition stage inflation factors are reduced to monetary (demand inflation) and non-monetary (expenditure inflation) ones.
Principal macroeconomic indices ? gross domestic product, production volume, export, import, current payments balance, employment level, budget expenses and deficit, interest rates ? are closely connected with inflation processes. In its turn, inflation depends on monetary, structural and social policy of a country. It is evident that money emission, deterioration of budget deficit, growth of salaries that are not caused by labour efficiency makes for the development of inflation processes. Thus, inflation and economic growth are interdependent categories, and the most important task of economic policy should be realisation of anti-inflation measures that would, on the one hand, limit inflation processes and, on the other one, maintain and accelerate economic growth rates. Such “happy medium” is much important in transition market countries as well as in Georgia where economic growth rates do not make for the stability of consumer prices.
Recent years’ dynamics of macroeconomic indices and inflation in Georgia are given in table 1.
As we can see from the analysis of the table, changes in inflation rates (growth or reduction) do not make a directly proportional influence on the dynamics of economic parameters. To be more exact, it is impossible to observe some regularity. This can be explained by two reasons: unreliability of statistic data (at least, partly) and small ratio of real sector in the formation of national economic rates.
To our mind, inflation that implies devaluation of money and, therefore, increase in prices, is characterised by a number of peculiarities in our country. Increase in prices does not always entail growth of money aggregates as followers of monetarism and money quantity theory often assert. Such approach is suitable for western countries where economic relations have long been settled. There are different economic conditions in Georgia having a different impact on inflation nature.
Contrasted with western developed countries where monetary relations are a main way of regulating inflation, completion of initiated economic reforms, formation of civilised market relations and, what is more, growth of national production of commodity and service are more important for Georgia.
Proceeding from the above-mentioned, the first task among other anti-inflation measures is growth of investments as well as investment of funds in priority branches and projects. Due to the fact that in transition period (excepting 1998-1999 – years of oil-main construction) the number of investments was not so large, investment demand is low now, which, in its turn, is stipulated by unavailability of financial and credit resources for industrial sector and insolvency of enterprises. Both public and private sectors should find a way out of the situation. It is, certainly, impossible to meet investment demand by means of internal resources due to difficult economic and financial state. Efforts should be made for attracting foreign capital. But it would not be right to concentrate solely on capital. As far as we see, it is necessary to change budget policy in the way that notwithstanding the crisis would make it possible to increase part of expenses for the restoration and development of priority-strategic real sectors of economy.
Banking system can, certainly, contribute a lot to the increase of investment activity. There is no secret that in the current stage commercial banks attach priority to the short-term crediting of trade and mediatory operations (due to low risk and possibility to invest a small number of credit resources with the purpose of obtaining comparatively greater profit in the shortest possible time) and try to avoid long-term crediting of real industrial sector. It is not surprising and it corresponds to the principles of market relations. The problem is that both private and public sectors are equally interested in the present day with the first one ? public sector ? being interested in the growth of budget revenues and use of expenses for solving current problems and the second one ? private sector ? being interested in obtaining a possibly larger profit. If we analyse activities of the mentioned parties in the perspective, long-term aspect, we will see that both public and private sectors expose monetary system of the country to a great risk and do not take preventive measures for the evasion of inflation processes. We should mention again that neither private nor public sectors would be able to limit inflation autonomously. Inflation processes can be halted only by their joint efforts.
Investments in real sector should become the most important subject of such joint activity. In their own turn, they are the most important source of expansive reproduction, employment level, growth of revenues, stabilisation of prices, cheap credit and other positive economic changes. In this aspect, we can choose different variants for discussion. For instance, issue of state (budget) guarantees for the bank lending of priority spheres, investment of securities in investment projects, establishment of specialised, investment, banking and insurance institutions, etc.
As mentioned above, it is impossible to restore and develop depressive real sector of economy by means of concentration on internal investments only. We should make every effort for the attraction of foreign investments. The mentioned sphere is multilateral, and it is not based on economic indicators only. Country’s external policy, legal order, political agreement, public knowledge plays a great role here. Unfortunately, recent years’ political and macroeconomic environment in Georgia does not make for the attraction of foreign investments. On the contrary, according to the official data, the ratio of foreign investments gradually reduces, which will, certainly, have a negative impact on the formation of economic growth rates in the nearest future.
Presently, among all other anti-inflation measures in Georgia, the principal role belongs to reorganisation of all budget levels and budget reforms, especially, perfection of the mechanism of controlling budget implementation. In the transition period, reforms affected almost all sectors of economy, but we can say that budget system turned out to be an exception here. Settlement of budget problems by means of increasing external and internal debts strengthens dependence of country’s economy on external factors and weakens its economic security.
A positive trend of budget revenue growth has lately been observed though expenses grow fast, too. For instance, in 2001 budget revenues made up 749,3 million GEL and tax levies made up 62,6%, up from 271,3 million GEL and 48,7% in 1995. Downward trend is characteristic of budget deficit. However, the ratio of external financing has significantly grown in the structure of its financing, which is seen as a negative factor from the viewpoint of inflation.
For instance, in 2001 during the financing of budget deficit of Georgia (181,2 million GEL) 159,7 million GEL (88,1%) fell at the share of external sources, up from 104,4 million GEL or 52,7% in 1995. Financing of budget deficit by means of external sources has always caused a danger of inflation, especially, in present situation with there being no real sources for covering debt. Proceeding from the above-mentioned, we think it necessary to gradually reduce the amount of public debt limit and simultaneously strengthen state control over a purposeful and effective use of attracted external sources.
It is noteworthy that a number of other countries cover budget deficit by means of anti-inflation sources. We would like to say that presently inflation can by no means be considered a source for covering budget deficit in Georgia as this can entail negative social-economic consequences.
The most important direction of anti-inflation policy is optimisation of tax system. We should agree to the widespread opinion of society and government structures about the inefficiency of present tax system and the necessity of its reorganisation. At the same time, we should stress the fact that from the viewpoint of anti-inflation it is not justified to pass the whole burden of the perfection of tax system on the reduction of tax rates only. From the viewpoint of inflation, it is dangerous to make risky experiments in the conditions of budget crisis, as reduction of tax rates does not always entail acceleration of economic rates. Therefore, we think that a compromise between fiscal and stimulating functions of taxes should be found. At the same time, all efforts should be aimed at the tightening of tax administration and therefore, legalisation of hide economy. We think that any economic decision should concern inflation problems as temporary economic effect can prove to be unimportant in comparison with negative consequences of inflation.
One of the components of anti-inflation policy is control of monetary factors, namely, emission and regulation of money velocity. Given the interests in limiting inflation, money supply and monetarism ratio in Georgia is still low though it is characterised by growth trend. For instance, in December 2001 money supply was 365,7 million GEL, up from 185,6 million in 1996. If we add to it cash outside banks, monetarism ratio will range from 13-50%, which is, certainly, a very low index as compared with 80-120% in the West.
Regulation of money velocity plays a significant role in anti-inflation policy. It is known that growth of money velocity is tantamount to emission in other equal conditions. During the expectations of low inflation in Georgia, balance has been preserved by means of money velocity. Downward trend has gradually become characteristic of average annual amount of M3 aggregate.
The most important component of anti-inflation policy and economic growth strategy is formation and reorganisation of healthy banking environment. In transition period the Georgian banking system has passed a difficult and thorny way of formation and development. Under international standards, it is too young yet, but the important thing is that it is based on the leading experience of world banking system.
The main trends in Georgian banking system can be formed as follows: safety and stability of banking system gradually increases; the quality of banking supervision improves; commercial banks become optimal; total assets of banking system as well as accounts increase; requirements of minimal authorised capital stock has grown; the amount of foreign investments in banks increases with a greater part of assets and liabilities of banking system being concentrated in foreign currency; branches and regional departments of banks gradually grow; licensing system of exchange booths improves; plan of International Accounting standards was introduced; internal banking audit service was formed; organisational structure of banks as well as professional level of human resources improve; the normative and legal basis of banking system gradually improves, etc. The above-mentioned factors and conditions are, certainly, aimed at the stability and safety of banking system, which, in the long run, promotes regulation and control of inflation processes.
One of the tasks of banking system – control of money aggregates – is realised by means of “targeting” method (“purpose” from English). Its task does not consist only in defining quantitative parameters of money aggregates, but also in providing transparency of the process for all those who use money in economic calculations. If money aggregates grow yearly in accordance with the target rate, market agents adopt to this ‘target” in their calculations and prognoses. The function of the Central (National) Bank is to determine monetary targets.
The inflation targeting policy, mainly, comprises two phases. The first one implies achievement of desirable inflation level, and the second one implies maintenance of the achieved level in perspective. The most difficult problem of inflation control is to determine means of “targeting” method such as particular index that would be viewed as a target. The problem is that it is difficult to form such an index that would adequately reflect stability and change of prices. Many developed countries and the USA that use method of inflation targeting, face the same problem. In fact, inflation index is differentiated by some variations of consumer prices index. The mentioned index is “cleaned” of such components as indirect taxes, prices on foodstuffs, etc. The essence of such approach consists in separating price change caused by monetary effect from changes stipulated by spontaneous economic conjunctive events. The de facto index “cleaned” in this way makes it possible to grade non-monetary factors influencing inflation. During the inflation targeting, the Central Bank should provide for the transparency of its policy, namely, it should explain expediency of establishing inflation target index, define its quantitative parameters and methodology of calculation as well as ways of achieving target index.
Each year the National Bank of Georgia defines target index of inflation. It is reflected in indicative plans of economic and social development of Georgia, and it forms basis of the formation of main directions of fiscal policy. Inflation targeting is, certainly, a new direction of monetary policy in our country, and it requires further perfection and development of its theoretic and methodological basics with the consideration of peculiarities of economic development in our country.
In this aspect, one of important problems is control of imported inflation. Nowadays, in the conditions of world economic integration and globalisation, it is impossible to rule out import of inflation all the more so that demand on foreign currency and especially dollar is very high in Georgia. We should also take into account the existing inflation level in neighbouring countries – trade partners of Georgia where inflation level is quite high as compared with that of Georgia. Presently, dollarisation ratio is quite high in Georgia being characterised by upward trend. This testifies to the fact that national currency does not completely fulfil its functions. Therefore, regulation of exchange market and stability of exchange rate of Georgian currency remains to be one of important directions of anti-inflation policy.
Not only “aspiration” for dollar, but also export of Georgian capital remains to be an inflation factor. Yet, nowadays, it is impossible to determine its burden, but the fact is that due to inner economic and political difficulties, a great amount of capital has drained abroad from transition market countries as well as from Georgia. It is clear that this situation stands in the way of internal investments and, therefore, economic growth and limitation of inflation. Proceeding from the above-mentioned, we consider it necessary to develop such a state policy (programme) that would prevent drain of capital and promote its partly repatriation.
The mentioned programme should comprise such measures that would prevent laundering of “dirty” money and promote legalisation of money as well as limitation of smuggling and hide economy.
As far as we see, it is possible to control and regulate inflation in both a theoretic and practical way. With this purpose it is necessary to use methods of state regulation of economy along with market regulators. Economic and especially, anti-inflation monetary policy in Georgia warrants low level of inflation and, therefore, favourable macroeconomic conditions for the recovery and development of national economy.