The National Bank of Georgia (NBG) cut its refinancing rate by 50 basis points to 8.50 percent, its first rate cut since September 2019 when it began tightening its monetary policy stance due to growing inflationary pressures from a fall in the lari's exchange rate.
From September last year until January this year NBG raised its rate four times by a total of 200 basis points before pausing.
The four rate hikes helped the lari rebound from December 2019 but on March 19, 2020 - the day after NBG's monetary policy committee kept the rate steady amid an unprecedented spree of rate cuts by central banks worldwide in response to the spread of the virus - the lari plunged.
Although NBG on March 18 acknowledged a decline in external and domestic demand that will create downward pressure on inflation, it left its interest rate and tight monetary policy steady, "considering the high level of uncertainty."
During the next week, the lari lost some 20 percent and hit record lows, forcing NBG to intervene in the foreign exchange markets and sell some US$60 million at two auctions as it acknowledged the impact of the "economic shock" that will be caused by the coronavirus on the country's economy.
The interventions helped calm foreign exchange markets and on April 8 NBG announced a series of emergency measures in response to the impact of COVID-19, including providing commercial banks and microfinance institutions with US$400 million through swaps.
By mid-April the lari had clawed back some of its losses in March but in the last week it has depreciated further and was trading at 3.2 to the U.S. dollar today, down 10.6 percent this year.
"Given the expected reduction in the demand, there is no need to further maintain such tightened policy stance," NBG said today.
Despite today's rate cut, NBG said its monetary policy remains tight to help ensure inflation returns to its target and it will "exit the tight monetary policy stance gradually and further steps will depend on how quickly inflation expectations recede."
Georgia's inflation rate eased to 6.1 percent in March from 6.4 percent in February and January but the central bank said inflation will remain high for several months before gradually declining and reaching its target level in the first half of next year.
"It should be noted that the reduction in aggregate demand is transmitted to the inflation with a lag, while supply-side factors affect inflation faster," said NBG, which targets inflation of 3.0 percent.
Georgia's economy, which expanded 5.1 percent in 2019, is seen contracting around 4 percent, with exports in March already down 22 percent, revenue from tourism down almost 70 percent, remittances down 9 percent and imports down 13 percent from weaker domestic demand.
The estimate for the decline in growth mirrors that of the International Monetary Fund (IMF), which on April 14 also forecast a 4 percent contraction this year while the deterioration in trade is expected to widen its current account deficit on reduced financial flows and investment, and the fiscal deficit to about 8.5 percent of GDP.
Urgent balance of payments needs from the Covid-19 shock are estimated at about US$1.6 billion in 2020-21 and IMF staff has recommended $375 million in additional funds so total disbursements will amount to some $450 million.
"With the Covid-19 pandemic, Georgia's economic outlook has significantly deteriorated," the IMF said.
The National Bank of Georgia issued the following statement:
"The Monetary Policy Committee (MPC) of the National Bank of Georgia (NBG) met on April 29, 2020, and decided to cut the refinancing rate by 0.50 percentage points to 8.5 percent.
Amid the Covid-19 pandemic and the sharp decline in international oil prices, the economic uncertainty in the world remains high. In Georgia, the annual inflation rate in March was 6.1 percent. According to the NBG's forecast, due to temporary factors, inflation will remain high for several months, then gradually decline, and in the first half of 2021 approach the target level.
The inflation dynamics are determined by the interaction of the both demand and supply side factors. It should be noted that the reduction in aggregate demand is transmitted to the inflation with a lag, while supply-side factors affect inflation faster. Supply factors caused by logistical constraints will delay the decline in inflation over the coming months, however a sharp decline in external and domestic demand due to pandemic will create a downward preassure on inflation over the course of the year. Given the expected reduction in the demand, there is no need to further maintain such tightened policy stance. Hence, the Monetary Policy Committee started the gradual exit from the tightened policy and reduced the policy rate by 0.5 percentage points. Despite the rate cut, monetary policy remains tight, ensuring a return of inflation to the target level in the medium term. The Monetary Policy Committee will exit the tight monetary policy stance gradually and further steps will depend on how quickly inflation expectations recede.
As noted, the sharp decline in demand is expected to exert a downwards preassure on inflation. According to the current forecast, following the decline in domestic and external demand, Georgia's real economic growth will be around -4 percent. According to preliminary data, in March, exports of goods fell by 22 percent and the revenues from international travelers declined by almost 70 percent. There was also a decrease in remittances (-9 percent). At the same time, imports declined by 13 percent, indicating a weakening in domestic demand.
From the supply side factors, the delays in production and supply chains affect companies' costs and, consequently, prices. However, assuming that the strict restrictions imposed by the spread of the covid-19 are only temporary, the latter will only have a temporary effect, hence the monetary policy reaction to this type of shock will be counterproductive. At the same time, the sharp decline of oil prices on international markets are being reflected on the gradual decline in gasoline prices in Georgia, exerting a downwards preassure in inflation. In addition, the expected substantial donor support will help mitigate the impact of the shock on the economic activity and inflation.
Considering current level of uncertainty, both credit and liquidity risks have increased, that was reflected in the growth of market interest rates. To ensure that liquidity risk does not limit credit to the economy, the NBG introduced additional instruments to provide liquidity. The NBG provides liquidity through swaps operations for both commercial banks and microfinance organizations.
The NBG will continue to monitor the developments in the economy and financial markets and will use all means and instruments at its disposal in order to ensure the price stability.
The next meeting of the Monetary Policy Committee is scheduled on June 24, 2020."
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