NBG forecasts 3% strengthening of Lari by the end of 2021
By Natalia Kochiashvili
Tuesday, August 24
The National Bank of Georgia has published macroeconomic scenarios. Under the baseline scenario, the lari's nominal exchange rate against the US dollar remains stable, although the central bank is optimistic that the national currency will strengthen against the dollar by 3% by the end of this year. NBG predicts an additional 3% strengthening in the upcoming year 2022.
In the optimistic scenario, the change in interest rates by the US Federal Reserve and the European Central Bank is similar to the baseline scenario. Since the growth of economic activity in developed countries is accompanied by an improvement in production potential, inflationary pressures are negligible and the need for early tightening of monetary policy is not on the agenda. Consequently, fiscal financial conditions in the capital markets remain, which ensures unhindered access to financial resources for countries with growing and developing economies.
Under the optimistic scenario, the growing economic activity in the trading partner countries will increase trade and investment flows from the current year. The restoration of international tourist flows is gaining momentum from 2022. Improved market sentiment and the maintenance of a relaxed monetary policy in developed countries also increase the inflow of portfolio investment into the local economy. As a result, the GEL exchange rate shows a tendency to strengthen. Given the growing demand for GEL assets, the country's risk premium is further reduced compared to the baseline scenario.
In the event of a pessimistic scenario, the GEL exchange rate is expected to depreciate by 10% against the current level this year and by an additional 5% in 2022. In such cases, the spread of new waves of pandemics in trading partner countries continues to lead to restrictions, which worsen expectations and hamper economic activity. As a result, the positive dynamics observed in trade flows in the first half of the year are lost.
"Restrictions on movement and economic activity, as well as uncertainty over their duration, will harm investment activity, international tourism flows, and remittances. Deteriorating external balance and increased risks lead to the depreciation of the lari.
In 2023, against the background of economic recovery, the GEL will strengthen by 5%. "The depreciation of the nominal effective exchange rate is relatively moderate during this period, as global trends also harm the currencies of trading partner countries," the Central Bank said.
According to the NBG, inflation will remain above the target level this year, which poses risks to the growth of long-term inflation expectations. In response to these risks, the Central Bank plans to maintain a relatively long monetary policy. The pace of exit from the tightened monetary policy regime will depend on the reduction of inflation expectations
In the baseline scenario, inflation will remain above the target this year, which is largely due to the sharp rise in commodity prices in the international market. The rise in oil and food commodity prices in international markets have been compounded by additional inflationary pressures stemming from rising utility costs. However, the disinflationary effect of weak demand in previous periods has ended in the wake of economic activity growth. In the resulting high inflation environment, short-term inflation expectations have increased. It is expected that with the exhaustion of temporary factors acting in the direction of growth in inflation together, under the tighter monetary policy, inflation will begin to decline from 2022 and approach the target in the medium term. Maintaining high inflation targets in the baseline scenario this year also poses risks of rising long-term inflation expectations.
According to the document, which provides the forecast given in the monetary policy report for August 2021 and additional information available for the current period, in 2021 economic activity in the country will gradually recover.
Improved management methods and enhanced vaccination of Covid-19 are expected to control the spread of the pandemic, reducing uncertainty and improving market sentiment. The rapid recovery of the global economy will also contribute to the gradual recovery of international trade and tourism flows.
According to the baseline forecast, global economic activity in 2021-2022 will grow at a higher rate than the previous forecast. This is the result of unprecedented fiscal support programs implemented in developed countries and growing consumer spending in the face of improved epidemiological conditions. The world's leading central banks continue to pursue a relaxed monetary policy to support economic recovery, as reflected in the Federal Reserve and the European Central Bank's minimized interest rates and massive asset purchasing programs. However, in recent years, in the wake of increased economic activity, there have been signs of rising inflation, which may accelerate the process of normalization of monetary policy in developed countries.
The vulnerability of these countries to the possible tightening of global financial conditions is exacerbated by the increased external debt during the pandemic period and the deepening current account deficit. In the baseline scenario, as a result of the stabilization of the epidemiological situation, economic activity in the trading partner countries will increase from the current year, which will lead to an increase in investment and trade flows. The dynamics of remittances are also growing. Due to the changing epidemiological situation between the countries this year, only a partial recovery of international tourist flows is expected. As a result, the current account will start to improve, with a more active recovery of tourist flows, from next year, and the external imbalance will be further reduced. This ensures the stability of the nominal effective GEL exchange rate in the medium term.
The nominal exchange rate of the lari against the US dollar also remains stable. In the context of economic growth and a stable exchange rate, the burden of existing external debt is reduced. All this reduces the economy's vulnerability to external factors and maintains a reduced level of sovereign risk premium.
According to the baseline forecast, economic activity is expected to grow by 8.5% in 2021. The recovery of the economy is mainly driven by local demand, which will be supported by the continuation of the expected fiscal stimulus throughout the year and credit growth. Strong growth in local demand for consumers and businesses this year along with the improved mood, reflects the effect of delayed demand during the pandemic period. External demand remains relatively weak this year, due to only a partial recovery of international tourist flows. From 2022, following the reduction of uncertainty related to the pandemic, foreign demand and investment activity will increase significantly, although domestic demand remains the leading factor in economic growth.
