On December 11 the National Bank of Georgia raised its benchmark interest rate for the fourth time this year, by 50 basis points to 9 percent, a dramatic policy reversal for a central bank that had lowered rates twice earlier in 2019.
Interest rates are one of the key levers through which a central bank tightens (by raising rates) or loosens (by lowering rates) monetary policy. A rate reduction is usually intended to boost economic growth by making it easier to borrow – often when a country is facing economic headwinds. An increase is usually a sign that an economy risks overheating, or that inflation is getting out of control.
Price stability, ensuring that inflation remains at a low and stable level, is the main mandate of Georgia’s central bank. Contrary to the bank’s expectations at the beginning of the year, inflation has accelerated since March and averaged 7 percent in November – a big jump on 2018, when it averaged 2.8 percent.
The Georgian economy overall is doing quite well. According to central bank data, output grew at an average rate of 4.7 percent year on year in the first half of 2019, roughly the same as the 4.8 percent averaged across 2018. Employment numbers are also encouraging.
The same cannot be said about the Georgian lari, however.
One reason inflation has ticked up so sharply this year is the lari’s depreciation against major currencies. A weaker lari means domestic inflation, since imports cost more. The lari fell from an average of 2.53 against the dollar in 2018 to about 2.95 by September 2019. (It has since recovered slightly.)
Exchange rate movements are determined by factors such as the balance of trade, net financial inflows and general market perceptions. In Georgia’s case, the Russian embargo on Georgian tourism in June (in a year when foreign investment had already started to stumble) hit confidence, though the real effect of the Russian ban has been muted. According to a central bank estimate, tourism revenues increased between January and November by about $35.4 million to just under $3.1 billion. But receipts did slip during the peak July-September holiday season. Without the ban, revenues would likely have been higher.
Despite the aggressive rate hikes in recent months, it appears there is not too much cause for worry. Central bank data show that the lari is still undervalued, which means that it should appreciate over the medium-term. This, coupled with the tighter monetary policy, will eventually ease imported inflation and bolster the currency. As for overall output, the bank forecasts decent growth through 2020: about 4.5 percent.
Sam Bhutia is an economist specializing in the former Soviet Union.