## tarea2024038

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### Preface — mission, meetings, acknowledgements
- Mission objective:
  - At the request of the National Bank of Georgia (NBG), a Monetary and Capital Markets (MCM) Department mission visited Tbilisi from May 29 to June 9, 2023, to assist the authorities in stress testing the NBG balance sheet and to develop hedging markets.
- Meetings and participants:
  - Met with NBG officials including Archil Mestvirishvili (vice‑governor and acting governor), Papuna Lezhava (vice‑governor), and Nikoloz Gauga (vice‑governor).
  - Met with representatives of Georgia’s Pension Agency, the Georgian Financial Markets Treasuries Association, Bank of Georgia, Basis Bank, Liberty Bank, TBC Bank, RICO Group, NOVA, and Nutrimax.
- Acknowledgements:
  - Thanks to Alexander Khazaradze, Iralki Kvirkvelia, Giorgi Laliashvili, Mamuka Machaidze, Shalva Mkhatrishvili, and David Tutberidze for cooperation and hospitality.

### Core model: accounting identities and balance sheet mechanics
- Equity — two equivalent formulations used as a consistency check:
  - (1) Equity_t = Total Assets_t − Total Liabilities_t
  - (2) Equity_t = Equity_{t−1} + [realized earnings_t + other transfers as specified in the model]
- Realized earnings:
  - Tracked separately from revaluation gains or losses (which go directly to the revaluation account).
- Clearing item (OMO or excess reserves):
  - When excess reserves are low and constant, changes affecting realized earnings are reflected in OMO:
    - OMO_t = OMO_{t−1} + [− ΔFXInt_t − ΔGovBond_t + ΔCiC_t + ΔRR_t + IRIncome_t − Op_t]
  - Components explicitly mentioned:
    - (i) net USD purchases for NFR ΔFXInt_t
    - (ii) net increases in government bond investments ΔGovBond_t
    - (iii) changes in currency in circulation ΔCiC_t
    - (iv) changes in the required reserves ΔRR_t
    - (v) interest income IRIncome_t and operating costs Op_t
  - For NBG, the refinancing loan (i.e., OMO) is the main monetary policy tool, which earns interest at the policy rate.
- Foreign reserve accumulation dynamics:
  - FXRes_t = FXRes_{t−1} + FIRIncome_t + Revaluation_t^{FXRes} + ΔFXInt_t
  - Notes:
    - If net inflow to USD required reserves from financial institutions exists, an additional term ΔFXRes_t would account for the equivalent change in gross foreign reserves.
    - Benchmark assumption: conservative with no such inflow, but model flexible to allow such reserves to increase.
    - Under a zero remuneration rate on USD required reserves, a positive inflow increases foreign interest income because gross foreign reserves (interest‑bearing) increase on the asset side.

### Key satellite models materially impacting equity dynamics
- CiC (Currency in Circulation) dynamics:
  - CiC_t = η_{CiC} NGDP_t ⋅ (i_{0} / i_{t})^{γ_{CiC}}
  - Economic intuition: CiC increases with nominal GDP and decreases with higher policy rate (proxy for deposit rate).
  - Historical Georgian ratio of CiC to nominal GDP (2015–2022):
    - historical average is 8 percent
    - standard deviation is 0.7 percent
- Required reserves in GEL:
  - ResReq_t = η_{Req} NGDP_t + i_{req,t−1} ResReq_{t−1}
  - Interest paid on required reserves is calculated at the policy rate.
- Required reserves in foreign currency:
  - USD_ResReq_t = η_{USDReq} (NGDP_t − NGDP_{t−1}) + (FX_t / FX_{t−1}) USD_ResReq_{t−1}
  - Default parameter setting: η_{USDReq} = 0 (assumes U.S. dollars in the banking system are stable even if nominal GDP changes).

### Application to the National Bank of Georgia (NBG) — financial relations and balance sheet
- NBG equity composition:
  - Charter (authorized) capital: GEL 15 million
  - General reserve fund
  - Revaluation reserve
- Profit transfer rules (per NBG Law):
  - Annual net operating profit (realized earnings) transferred to the reserve fund.
  - Unrealized net gains transferred to the revaluation reserve.
  - Transfers used to fill reserve fund until it reaches 15 percent of reserve money; remaining portion of annual net profit transferred to the State budget within six months after financial year‑end.
  - NBG Board may transfer annual net profits to government before reserve fund reaches 15 percent of reserve money.
- Recapitalization procedure:
  - If capital falls below authorized capital (GEL 15 million), the Ministry of Finance shall, within five months after year‑end, issue circulating government bonds to the NBG to replenish authorized capital to minimum level.
- NBG balance sheet characteristics (March 2023):
  - Total equity (March 2023): GEL 2.3 billion (3.3 percent of GDP)
  - Asset composition: all assets income generating; 75 percent foreign assets; remainder domestic assets (government bonds and OMO)
  - Liability composition highlights:
    - Fund’s EFF and SDR allocations: 15 percent of total liabilities (incur interest costs)
    - 5 percent of total liabilities incur cost at domestic interest rates (relate to GEL required reserves)
    - Non‑interest bearing liabilities: foreign currency required reserves (33 percent of total liabilities) and CiC (32 percent of total liabilities)

### Stress testing the balance sheet — scenarios and quantitative projections
- Base Scenario:
  - Macro assumptions: supported by continued strong tourism, transit trades, and FX inflows.
  - Real GDP forecast: grow 5.2 percent in 2023.
  - USD/GEL exchange rate: relatively stable around 2.7.
  - Inflation: increases marginally from 2.6 percent to 3 percent (long‑term target).
  - Balance sheet outcome: Equity increases from GEL 2.3 billion (3.3 percent of GDP) to GEL 5.7 billion (5.5 percent of GDP) in 2027Q4.
  - Main drivers: realized earnings from GEL interest income on refinancing loans, investment in government bonds, and foreign interest income on international reserves.
- Adverse Scenario:
  - Shocks: increase in commodity prices, slowdown in trading partners’ GDP, decrease in FX inflows.
  - Macro paths:
    - GDP lower in 2023H2 and 2024, then recovers after 2024
    - USD/GEL falls to 2.95 in 2024 and stabilizes
    - Inflation increases from 2.6 percent to 4.3 percent before falling back to 3 percent target
  - Equity outcome: Equity increases from GEL 2.3 billion to GEL 6.3 billion in 2027Q4; equity as percent of GDP increases from 3.3 to 6.2 percent.
  - Main driver: larger currency depreciation yielding larger FX revaluation gain.
- Capital surges, exchange rate depreciation and dollarization impacts:
  - Historical context: USD/GEL appreciated by approximately 19 percent from January 2021 to December 2022.
  - Dollarization satellite model findings:
    - A 25 percent appreciation in the exchange rate (as seen 2021–2022) causes dollarization to increase by approximately seven percentage points (impact delayed).
    - Scenario assumption: dollarization increases by an estimated seven percent over January 2024 to December 2025, then stabilizes over 2026–2027 with a return to long‑term trend of marginal quarterly reductions.
  - Outcomes:
    - Severe depreciation leads to higher short‑term inflation and higher dollarization.
    - Equity in 2027Q4 reaches 7.9 percent of GDP (higher than under base case).
    - Net foreign reserves increase more strongly due to larger FX revaluation gains.
    - Accumulated foreign interest income is larger in terms of GEL.
  - Interpretation: NBG’s balance sheet becomes stronger when dollarization increases because FX revaluation and related income effects dominate.

### Developing hedging markets — financial market context and Pension Agency (PA)
- Financial system structure:
  - Bank‑centric and highly concentrated: banks account for 96 percent of the financial sector; two banks hold around 80 percent of total banking assets.
  - NBFIs largely absent; Pension Agency is a notable recent NBFI.
  - Foreign banks are absent.
- Pension Agency of Georgia (Box 2) — operational and market impacts:
  - PA established in 2018; handles mandatory defined contribution component; regulated and supervised by NBG.
  - PA size: GEL 3.4 billion under management (around 5 percent of GDP).
  - Contribution inflows: PA expected to receive a combined 6 percent of eligible contributors’ salaries.
  - From 2023Q3, funds will be invested in medium‑ and high‑risk portfolios after five‑year transition.
  - Foreign currency exposure: currently capped at 20 percent, expected to increase toward target weights of 20‑40 percent (medium risk) and 40‑60 percent (high risk).
  - Market impact: PA likely to convert significant GEL into foreign currency, creating a steady but moderate supply of GEL in the FX market in the long run.
  - Constraints: exposure limits and IT‑system challenges prevent derivatives usage; Investment Policy prohibits derivatives except for portfolio hedging.
  - Hedging potential once infrastructure is in place: PA could use OIS swaps to hedge domestic fixed income interest rate risk and sell foreign currency forward to mitigate exchange rate risk.

### Dollarization and FX market structure, liquidity, and competition
- Dollarization status:
  - Dollarization remains material at 56 percent for deposits and 45 percent for loans.
  - NBG de‑dollarization program began in 2016 (e.g., banning foreign currency lending for small loans, LCR with higher requirements for foreign currency liabilities).
- Exchange rate and volatility:
  - USD/GEL depreciated by about 5 percent annually between April 2017 and March 2022, amid moderate volatility of 8‑10 percent.
  - Over the last three months, volatility decreased below many other countries: 9.6 percent in advanced economies and 8.2 percent in emerging markets.
  - Capital inflows from Russian immigrants since the start of the war caused USD/GEL to appreciate by about 20 percent, while daily volatility fell to 4 percent from 8‑10 percent previously.
- FX market structure and liquidity:
  - Interbank segment organized as a central limit orderbook (Bloomberg BMatch) accessible to 14 banks and their clients; credit risk limits applied automatically pre‑trade.
  - Daily average interbank volume (including brokered trades): about $12 million, one‑third of which involves the NBG.
  - Dealer‑to‑customer segment: more than $100 million per day, largely offsetting customer flows matched internally within banks.
  - Non‑bank participation includes Microfinance Institutions (MFIs).
  - Bid‑ask spreads:
    - Interbank segment: can be as low as 20 bps.
    - Dealer‑to‑customer activity: remain close to 80 bps.
- FX forwards, swaps, and hedging demand:
  - FX forwards and swap markets activity is very low.
  - Interbank forward activity is largely non‑existent.
  - NFC demand for forwards limited to FX sales by a handful of exporters; importers reluctant to use forwards.
  - FX swap market: most trades are cross‑border with large international names borrowing GEL; onshore, smaller banks and MFIs place FX liquidity in FX swaps with larger banks.
- Money market and government securities:
  - Overnight unsecured money market: liquid with relatively high volume (GEL 150‑200 million daily); NBG manages rates close to announced policy rate.
  - Tbilisi Interbank Offered Rate (TIBR) serves as a reliable overnight benchmark.
  - Repo market activity: light.
  - Government bonds:
    - Currently issued up to seven years, but secondary market illiquid.
    - 90 percent of outstanding government bonds are shorter than five years.
    - 0.3 percent of the portfolio is longer than seven years.
    - Residual maturity of the currently issued 10‑year bonds is eight years.
    - MoF plans to issue 11‑year bonds later this year.
  - Lack of heterogeneity in investor base and buy‑and‑hold strategies hinder price discovery and development of longer‑term interest rate derivatives.

### Interest‑rate derivatives, market infrastructure, and prioritization
- Interest‑rate derivatives and OIS:
  - Short‑term interest rate derivatives are rarely traded.
  - Four market participants regularly provide indicative OIS quotes for short tenors; a handful of OIS have been traded by the biggest banks with non‑resident counterparties but none between two domestic parties.
  - Banks generally lack systems to manage interest rate risks; many treasury systems process trades manually.
  - Joint procurement project: GFMTA with NBG support coordinating shared treasury management system (MX.3 by Murex) for six Georgian commercial banks.
    - Contract expected to be signed in coming months; implementation may take 1‑1.5 years.
  - Initial focus for interest rate derivatives: short‑term OIS tenors (up to 12 months).
- Prioritization of hedging markets:
  - Target FX forwards before FX options.
  - Target local currency OIS before cross‑currency swaps.
  - Rationale: FX risks likely to dominate in open economies with floating exchange rates; BIS 2022 surveys show FX derivatives turnover twice that of interest rate derivatives in emerging markets.
- Enabling conditions and regulatory reforms — four building blocks:
  - (1) Enabling regulatory environment: legal certainty of derivative contracts, close‑out netting, eligible collateral, hedge accounting, margin requirements.
  - (2) Robust market infrastructure: payment and settlement systems, trading platforms, market data providers, trade repositories, treasury and risk systems.
  - (3) Diverse range of financial instruments as underlyings: e.g., overnight interbank money market reference rates for OIS and FX spot markets for FX forwards.
  - (4) Broad user base with heterogeneous risk profiles and sufficient knowledge/incentives to manage financial risks.
- Regulatory reforms implemented:
  - Comprehensive definitions of main derivatives in Georgian legislation following ISDA and ICMA guidelines.
  - Enforceability of derivatives contracts, perfecting netting and close‑out netting, clarifying rights of re‑use of different types of financial collateral.
  - Prudential rule: at least one counterparty in a derivative transaction must be a supervised financial institution.
  - Authorities have chosen not to prescribe binding margin requirements; intermediaries may set initial and variation margins based on internal risk management.
- Market development proposals:
  - Standardized FX forward trading platform on BMatch:
    - Initial fixed maturities: 1‑month, 2‑months, and 3‑months; monthly roll of a new 3‑month contract.
    - Non‑bank users could place limit or market orders via Bloomberg Terminal or via a bank.
    - Clearing, settlement, and margining identical to existing OTC FX forwards.
  - Data and transparency improvements:
    - Revise NBG’s FX forward index to be transaction‑based rather than quote‑based and publish forward rates (not forward points).
    - NBG could publish OIS benchmark rates by soliciting indicative bid and offer quotes at benchmark tenors.
  - Policy on FX interventions and hedging incentives:
    - NBG should assess how its FX intervention strategy influences incentives to hedge; aim to do the minimal amount of intervention necessary to meet primary objectives of price and financial stability.

### Hedge accounting, tax treatment, and market plumbing
- Hedge accounting and tax treatment:
  - Under IFRS, hedge accounting aligns accounting of financial instruments with risk management to minimize profit or loss statement volatility.
  - In Georgia, no distinction between derivatives used for hedging or speculative purposes; all unrealized mark‑to‑market gains on derivatives are taxed.
  - This tax treatment undermines incentives for the use of derivatives since taxes may be incurred where no actual profit has accrued.
- Market plumbing and infrastructure status:
  - RTGS and GSSS facilitate delivery‑versus‑payment transfers.
  - Bloomberg is widely used as the standard data provider and trading platform (BMatch).
  - No central counterparty (CCP) for clearing derivatives trades; recommendation for NBG to undertake full cost/benefit analysis before establishing a CCP.
  - Treasury and risk management systems:
    - Larger banks have modular systems; domestic single‑currency interest rate derivatives cannot currently be processed by banks’ treasury systems.
    - Joint procurement (MX.3) recommended to be concluded swiftly; estimated implementation timeline after contract signing: 1‑1.5 years.
- Market infrastructure availability (selected observations):
  - Close‑out netting: Essential — Yes for FX Forward and OIS.
  - Collateral: Essential — Yes for FX Forward and OIS.
  - Hedge accounting: Good to have — Possible for FX Forward and OIS.
  - Margin requirements: Good to have — No for FX Forward and OIS.
  - Trading platforms or exchanges: Good to have — Bloomberg for both FX Forward and OIS.
  - Central counterparties: Good to have — No for both FX Forward and OIS.
  - Payment and settlement systems: Essential — RTGS, GSSS for both FX Forward and OIS.
  - Treasury and risk management systems: Essential — Yes for FX Forward; In progress for OIS.
- User base and demand constraints:
  - Biggest constraint: lack of heterogeneity of financial risk profiles and appetites due to bank‑centered, highly concentrated sector.
  - Survey findings:
    - Corporates cite lack of need, inadequate price transparency, and relatively high cost as reasons for not using derivatives.
    - Banks view corporate demand for FX forwards as held back by lack of awareness about exchange rate risk.
  - NBG and GFMTA contributions:
    - NBG has contributed to training and set attainment of relevant professional certificates by banks’ treasury staff as precondition for participating in domestic interbank FX market.
  - Recommendations:
    - NBG should continue exploring strategies to broaden and incentivize the investor base and continue supporting targeted education and training coordinated with GFMTA.
    - NBG should investigate potential barriers preventing the Pension Agency (PA) from participating in the derivatives market given its investment mandate and explore regulatory constraints.
- Underlying and supporting products:
  - FX spot and unsecured overnight interbank money markets are liquid, supporting representative and reliable reference rates (including TIBR).
  - OIS development hindered by absence of a liquid market for fixed‑rate paying instruments; fixed‑rate receivers (e.g., insurance companies and pension funds) are largely absent or inactive.
  - Government securities:
    - Outstanding government securities portfolio increased from 3.8 billion GEL to 6.8 billion GEL in last three years (approximately 80 percent in nominal terms).
    - Recommendation: Increasing availability of longer maturity government bonds would help underlying liquidity and derivatives market development.

### Identified priorities and near‑ to medium‑term actions
- Close identified gaps in each building block:
  - Regulatory issues (building block 1): addressed.
  - Infrastructure issues (building block 2): excellent progress, but IT systems and joint treasury procurement need completion.
  - Investor base (building block 3): biggest challenge due to size and structure of economy.
  - Underlying and supporting products (building block 4): further progress possible where competition issues arise.
- Specific near‑ to medium‑term actions:
  - Complete joint procurement and implementation of the shared treasury management system.
  - Assess cost/benefit for a CCP only if volumes justify and after full analysis.
  - Launch standardized FX forward trading on BMatch subject to market intelligence on pricing conventions.
  - Improve price indices and publish transaction‑based forward rates and OIS benchmark rates.
  - Support targeted education, training, and investigate regulatory barriers for institutional investors like the PA.

### Appendix III — modeling transfers to the Ministry of Finance (MoF)
- Reserve money definition:
  - Reserve money is the sum of currency‑in‑circulation and required reserves.
- Transfer rule when reserve funds exceed target:
  - If reserve funds exceed the target level of reserve funds, then the central bank transfers the net profit to the Ministry of Finance (MoF).
  - Transfer equations in the source capture realized earnings, allocation to reserve funds to maintain the target level, and the transfer to the MoF recorded as an increase in government deposits.
- Interpretation:
  - First term in the transfer equation represents realized earnings.
  - Second term represents allocation of these earnings to reserve funds for maintaining the target level.
  - Transfer to the MoF is captured as the increase in the government deposits.

*IMF | GEORGIA Stress Testing the Central Bank Balance Sheet and Developing Hedging Markets — excerpt (content unit: tarea2024038).*

### Preface.................................................................................................................

### Preface

### Mission objective
- At the request of the National Bank of Georgia (NBG), a Monetary and Capital Markets (MCM) Department mission visited Tbilisi from May 29 to June 9, 2023, to assist the authorities in stress testing the NBG balance sheet and to develop hedging markets.

### Meetings and participants
- The mission met with various NBG officials, including Archil Mestvirishvili, vice-governor and acting governor; Papuna Lezhava, vice-governor; and Nikoloz Gauga, vice-governor.
- It also met with representatives of Georgia’s Pension Agency, the Georgian Financial Markets Treasuries Association, Bank of Georgia, Basis Bank, Liberty Bank, TBC Bank, RICO Group, NOVA, and Nutrimax.

### Acknowledgements
- The mission wishes to thank Alexander Khazaradze, Iralki Kvirkvelia, Giorgi Laliashvili, Mamuka Machaidze, Shalva Mkhatrishvili, and David Tutberidze for their cooperation, productive discussions, and their hospitality.

*IMF | GEORGIA Stress Testing the Central Bank Balance Sheet and Developing Hedging Markets | Preface*

### 8. The equations in the core model follow the accounting identities as follows:

### 8. The equations in the core model follow the accounting identities as follows:

### Equity: accounting identities and decomposition
- Two equivalent formulations used as a consistency check:
  - (1) Equity_t = Total Assets_t − Total Liabilities_t
  - (2) Equity_t = Equity_{t−1} + [realized earnings_t + other transfers as specified in the model]
- Realized earnings (components shown in source) feed into Equity dynamics and are tracked separately from revaluation gains or losses (which go directly to the revaluation account).

### Clearing item: OMO or excess reserves
- Depending on the operational framework, either open market operations (OMO) or excess reserves are used as a clearing item to capture changes in assets and liabilities that impact realized earnings.
- When excess reserves are low and constant, changes that impact realized earnings are reflected in changes in OMO, given by:
  - OMO_t = OMO_{t−1} + [− ΔFXInt_t − ΔGovBond_t + ΔCiC_t + ΔRR_t + IRIncome_t − Op_t]
- Components explicitly mentioned:
  - (i) net USD purchases for NFR ΔFXInt_t
  - (ii) net increases in government bond investments ΔGovBond_t
  - (iii) changes in currency in circulation ΔCiC_t
  - (iv) changes in the required reserves ΔRR_t
  - (v) interest income IRIncome_t and operating costs Op_t
- For NBG, the refinancing loan (i.e., OMO) is the main monetary policy tool, which earns interest at the policy rate.

### Foreign reserve accumulation dynamics
- Gross foreign reserve accumulation driven by three terms:
  - (i) foreign currency interest income (FIRIncome_t)
  - (ii) FX revaluation gains or losses (Revaluation_t^{FXRes})
  - (iii) net USD purchases for NFR accumulation (ΔFXInt_t)
- Simplest-case identity presented:
  - FXRes_t = FXRes_{t−1} + FIRIncome_t + Revaluation_t^{FXRes} + ΔFXInt_t
- Notes and caveats from the source:
  - If there is net inflow to USD required reserves from financial institutions, an additional term ΔFXRes_t would account for the equivalent change in gross foreign reserves.
  - Benchmark assumption: conservative with no such inflow, but model flexible to allow such reserves to increase.
  - Under a zero remuneration rate on USD required reserves, a positive inflow increases foreign interest income because gross foreign reserves (interest-bearing) increase on the asset side.

### Key Satellite Models (items materially impacting equity dynamics)
- Satellite models are parsimonious, flexible, and replaceable depending on user needs.
- CiC (Currency in Circulation) dynamics:
  - CiC_t = η_{CiC} NGDP_t ⋅ (i_{0} / i_{t})^{γ_{CiC}}  (as presented in source)
  - Economic intuition: CiC increases with nominal GDP and decreases with higher policy rate (proxy for deposit rate).
  - Historical Georgian ratio of CiC to nominal GDP (2015–2022): historical average is 8 percent, standard deviation is 0.7 percent.
- Required reserves in GEL:
  - ResReq_t = η_{Req} NGDP_t + i_{req,t−1} ResReq_{t−1}
  - Intuition: required reserves grow with nominal GDP; interest paid on required reserves is calculated at the policy rate.
- Required reserves in foreign currency:
  - USD_ResReq_t = η_{USDReq} (NGDP_t − NGDP_{t−1}) + (FX_t / FX_{t−1}) USD_ResReq_{t−1}
  - Default parameter setting: η_{USDReq} = 0 (assumes U.S. dollars in the banking system are stable even if nominal GDP changes).

### Application to the National Bank of Georgia (NBG): Financial relations and balance sheet
- NBG equity composition:
  - Charter (authorized) capital: GEL 15 million
  - General reserve fund
  - Revaluation reserve
- Profit transfer rules (per NBG Law):
  - Annual net operating profit (realized earnings) transferred to the reserve fund.
  - Unrealized net gains transferred to the revaluation reserve.
  - Transfers used to fill reserve fund until it reaches 15 percent of reserve money; remaining portion of annual net profit transferred to the State budget within six months after financial year-end.
  - NBG Board may transfer annual net profits to government before reserve fund reaches 15 percent of reserve money.
- Recapitalization procedure:
  - If capital falls below authorized capital (GEL 15 million), the Ministry of Finance shall, within five months after year-end, issue circulating government bonds to the NBG to replenish authorized capital to minimum level.
- NBG balance sheet characteristics (March 2023):
  - Total equity (March 2023): GEL 2.3 billion (3.3 percent of GDP)
  - Asset composition: all assets income generating; 75 percent foreign assets; remainder domestic assets (government bonds and OMO)
  - Liability composition highlights:
    - Fund’s EFF and SDR allocations: 15 percent of total liabilities (incur interest costs)
    - 5 percent of total liabilities incur cost at domestic interest rates (relate to GEL required reserves)
    - Non-interest bearing liabilities: foreign currency required reserves (33 percent of total liabilities) and CiC (32 percent of total liabilities)

### Stress testing the balance sheet: scenarios and key quantitative projections
- Base Scenario (assumptions and outcomes):
  - Macro assumptions: supported by continued strong tourism, transit trades, and FX inflows.
  - Real GDP forecast: grow 5.2 percent in 2023.
  - USD/GEL exchange rate: relatively stable around 2.7.
  - Inflation: increases marginally from 2.6 percent to 3 percent (long-term target).
  - Balance sheet outcome: Equity increases from GEL 2.3 billion (3.3 percent of GDP) to GEL 5.7 billion (5.5 percent of GDP) in 2027Q4.
  - Main drivers: realized earnings from GEL interest income on refinancing loans, investment in government bonds, and foreign interest income on international reserves.
- Adverse Scenario:
  - Shocks: increase in commodity prices, slowdown in trading partners’ GDP, decrease in FX inflows.
  - Macro paths: GDP lower in 2023H2 and 2024, then recovers after 2024; USD/GEL falls to 2.95 in 2024 and stabilizes; inflation increases from 2.6 percent to 4.3 percent before falling back to 3 percent target.
  - Equity outcome: Equity increases from GEL 2.3 billion to GEL 6.3 billion in 2027Q4; equity as percent of GDP increases from 3.3 to 6.2 percent.
  - Main driver: larger currency depreciation yielding larger FX revaluation gain.
- Capital Surges: exchange rate depreciation and dollarization impacts
  - Historical context: USD/GEL appreciated by approximately 19 percent from January 2021 to December 2022.
  - Dollarization satellite model findings:
    - A 25 percent appreciation in the exchange rate (as seen 2021–2022) causes dollarization to increase by approximately seven percentage points (impact delayed).
    - Assumption for scenario: dollarization increases by an estimated seven percent over January 2024 to December 2025, then stabilizes over 2026–2027 with a return to long-term trend of marginal quarterly reductions.
  - Outcomes:
    - Severe depreciation leads to higher short-term inflation and higher dollarization.
    - Equity in 2027Q4 reaches 7.9 percent of GDP (higher than under base case).
    - Net foreign reserves increase more strongly due to larger FX revaluation gains.
    - Accumulated foreign interest income is larger in terms of GEL.
  - Interpretation: NBG’s balance sheet becomes stronger when dollarization increases because FX revaluation and related income effects dominate.

### Developing hedging markets: financial market context and Pension Agency (PA)
- Financial system structure:
  - Bank-centric and highly concentrated: banks account for 96 percent of the financial sector; two banks hold around 80 percent of total banking assets.
  - NBFIs largely absent; Pension Agency is a notable recent NBFI.
  - Foreign banks are absent.
- Pension Agency of Georgia (Box 2) — key operational and market impacts:
  - PA established in 2018; handles mandatory defined contribution component; regulated and supervised by NBG.
  - PA size: GEL 3.4 billion under management (around 5 percent of GDP).
  - Contribution inflows: PA expected to receive a combined 6 percent of eligible contributors’ salaries.
  - From 2023Q3, funds will be invested in medium- and high-risk portfolios after five-year transition.
  - Foreign currency exposure: currently capped at 20 percent, expected to increase toward target weights of 20-40 percent (medium risk) and 40-60 percent (high risk).
  - Market impact: PA likely to convert significant GEL into foreign currency, creating a steady but moderate supply of GEL in the FX market in the long run.
  - Constraints: exposure limits and IT-system challenges prevent derivatives usage; Investment Policy prohibits derivatives except for portfolio hedging; PA lacks IT-system capacity, but once infrastructure is in place PA could use OIS swaps to hedge domestic fixed income interest rate risk and sell foreign currency forward to mitigate exchange rate risk.

*IMF | GEORGIA Stress Testing the Central Bank Balance Sheet and Developing Hedging Markets — excerpt (content unit: tarea2024038 — section 8).*

### 22. Dollarization remains a major constraint to further development of financial

### 22. Dollarization remains a major constraint to further development of financial markets

### Dollarization and macro-financial context
- The NBG successfully embarked on a de-dollarization program in 2016 which included the banning of foreign currency lending for small loans and liquidity coverage ratios with higher requirements for foreign currency liabilities.
- Dollarization remains material at 56 percent for deposits and 45 percent for loans.
- The NBG has implemented an inflation-targeting regime with a floating exchange rate.
- The USD/GEL depreciated by about 5 percent annually between April 2017 and March 2022, amid moderate volatility of 8-10 percent.
- Over the last three months, this volatility has decreased, falling below the levels observed in many other countries: 9.6 percent in advanced economies and 8.2 percent in emerging markets.
- Capital inflows from Russian immigrants since the start of the war have caused the USD/GEL to appreciate by about 20 percent, while daily volatility has fallen to 4 percent from 8-10 percent previously.
- The NBG’s regular FX interventions aim to accumulate foreign reserves, meet government obligations, and counter excessive volatility.

### FX market structure, liquidity, and competition
- The interbank segment is organized as a central limit orderbook (Bloomberg BMatch) accessible to 14 banks and their clients; credit risk limits are applied automatically pre-trade.
- Daily average interbank volume, including brokered trades, is about $12 million, one-third of which involves the NBG.
- The NBG transacts with MoF Treasury for the benefit of state-owned enterprises at its official exchange rate.
- The dealer-to-customer segment is large (more than $100 million per day), most of which are offsetting customer flows matched internally within banks.
- Non-bank participation includes Microfinance Institutions (MFIs), strengthening competition.
- Bid-ask spreads:
  - Interbank segment: can be as low as 20 bps.
  - Dealer-to-customer activity: remain close to 80 bps.

### FX forwards, swaps, and hedging demand
- Activity in FX forwards and swap markets is very low.
- Interbank forward activity is largely non-existent; customer transaction risks are managed internally or via the spot market.
- NFC demand for forwards is limited to FX sales by a handful of exporters; importers are reluctant to use forwards because they can pass on depreciation risk to domestic clients.
- FX bureaus and other financial institutions buy FX forward in small amounts.
- In the FX swap market, most trades are cross-border with large international names borrowing GEL.
- Onshore, smaller banks and MFIs that cannot lend their FX deposits due to size limits place their FX liquidity in FX swaps with larger banks.

### Money market and government securities
- The overnight unsecured money market is sufficiently liquid with relatively high volume (GEL 150-200 million daily); the NBG manages rates close to its announced policy rate.
- The Tbilisi Interbank Offered Rate (TIBR) serves as a reliable and representative overnight benchmark interest rate.
- Repo market activity is light; market participants manage liquidity within unsecured limits and there is no demand from the NBFI sector for cash- or security-driven repos.
- Government bonds are currently issued up to seven years, but the secondary market is illiquid.
  - 90 percent of the outstanding government bonds are shorter than five years.
  - 0.3 percent of the portfolio is longer than seven years.
- The residual maturity of the currently issued 10-year bonds is eight years. The MoF plans to issue 11-year bonds later this year.
- Lack of heterogeneity in investor base and buy-and-hold strategies (mainly banks and, going forward, the pension fund) hinder price discovery and the development of longer-term interest rate derivatives.

### Interest-rate derivatives, OIS, and market infrastructure
- Short-term interest rate derivatives are rarely traded.
- Four market participants regularly provide indicative OIS quotes for short tenors; a handful of OIS have been traded by the biggest banks with non-resident counterparties but none between two domestic parties.
- Banks have systems to manage foreign exchange risks, but not generally for interest rate risks; current trades are processed and accounted for manually.
- A comprehensive project is underway to modernize banks’ treasury management systems:
  - The GFMTA, with NBG support, has been coordinating the joint procurement of a shared treasury management system (MX.3) by Murex for six Georgian commercial banks.
  - The contract is expected to be signed in coming months, after which implementation of the system may take 1-1.5 years.
- Initial focus for interest rate derivatives should be on short-term OIS tenors (up to 12 months).

### Market demand, user behavior, and microfinance institutions
- Bank and NFC surveys:
  - NFCs view exchange risk as the most important risk.
  - Most NFCs never hedge with FX forwards because they find it too costly; others generate natural hedges (e.g., through FX liability management).
  - Banks’ use of FX forwards is limited since they rarely need it for managing their FX positions.
  - Banks see corporate demand for FX forwards as held back by lack of awareness about exchange rate risks.
- Box 3 (MFIs’ role): MFIs distribute USD into the financial sector via cash conversions, transfers and FX swaps with larger banks because regulatory minimum FX lending size (GEL 100,000) limits their ability to place USD loans. Recent regulatory developments allow MFIs to become microbanks (access to central bank accounts and liquidity facilities) at the cost of intensified supervision. The central bank introduced a cap on local currency settlement fees; banks can still impose substantial fees on the FX transfer leg (not part of RTGS). Further regulatory action suggested: incorporate FX into RTGS and introduce caps on FX settlement fees to foster competition.

### Prioritization of hedging markets and rationale
- Markets to target first:
  - FX forwards before FX options (for derivatives with fewer preconditions).
  - Local currency OIS market before cross-currency swaps for interest rate derivatives.
- Rationale:
  - In open economies with floating exchange rates, FX risks will likely dominate.
  - BIS triennial FX and derivatives surveys (2022) indicate in emerging markets FX derivatives turnover was twice that of interest rate derivatives.
  - FX forwards can strengthen spot market liquidity by allowing domestic actors to hedge opposing exposures arising from global shocks.
  - Georgia is below international comparisons of forward market activity and is an outlier with relatively small forward volumes by NFCs when compared with spot volumes.
- Developing interest rate derivatives is more challenging; initial focus should be on short-term OIS tenors (up to 12 months) given participants’ likely need to insure against adverse monetary policy actions.

### Enabling conditions and regulatory reforms
- Four building blocks for derivatives market development:
  - An enabling regulatory environment (legal certainty of derivative contracts, close-out netting, eligible collateral, hedge accounting, margin requirements).
  - Robust market infrastructure (payment and settlement systems, trading platforms, market data providers, trade repositories, treasury and risk systems of participants).
  - A diverse range of financial instruments as underlyings (e.g., overnight interbank money market reference rates for OIS and FX spot markets for FX forwards).
  - A broad user base with heterogeneous risk profiles and sufficient knowledge/incentives to manage financial risks.
- Regulatory reforms already implemented include:
  - Comprehensive definitions of the main types of derivatives in Georgian legislation following ISDA and ICMA guidelines.
  - Enforceability of derivatives contracts, perfecting netting and close-out netting, and clarifying rights of re-use of different types of financial collateral.
  - A prudential rule that at least one counterparty in a derivative transaction must be a supervised financial institution.
  - Authorities have chosen not to prescribe binding margin requirements; financial intermediaries may set initial and variation margins based on internal risk management processes.

*Source: IMF staff analysis as presented in the provided chapter content.*

### 37. Appropriate treatment of hedge accounting is still to be addressed. Hedge accounting

### 37. Appropriate treatment of hedge accounting is still to be addressed. Hedge accounting

### Hedge accounting and tax treatment
- Under International Financial Reporting Standards, hedge accounting aligns accounting of financial instruments with risk management to minimize volatility in profit or loss statement.
- In Georgia, there is no distinction between derivatives used for hedging or speculative purposes, and all unrealized mark-to-market gains on derivatives are taxed.
- This tax treatment undermines incentives for the use of derivatives since taxes may be incurred where no actual profit has accrued.

### Infrastructure and market plumbing
- Financial market infrastructures implemented:
  - Real-time gross settlement system (RTGS) and securities settlement system (GSSS) facilitate delivery-versus-payment transfers.
  - Bloomberg is widely used as the standard data provider and trading platform (BMatch).
  - NBG requires granular reporting from participants for monitoring financial market risks, including derivatives.
- No central counterparty (CCP) for clearing derivatives trades in Georgia; current low derivatives volumes mean a CCP could not currently be justified.
  - Recommendation: NBG should undertake a full cost/benefit analysis when considering establishing a CCP.
- Treasury and risk management systems:
  - Larger banks have modular treasury management systems; domestic single-currency interest rate derivatives cannot currently be processed by banks’ treasury systems.
  - The NBG has facilitated a joint project: six banks collaborating to finance a new treasury system (shared procurement of MX.3 by Murex).
  - Estimated implementation timeline after contract signing: 1-1.5 years to test and implement.
  - Recommendation: Joint procurement should be concluded swiftly to remove a key bottleneck for onshore derivatives, especially OIS.

### Market infrastructure status (selected availability observations)
- Close-out netting: Essential — Yes for FX Forward and OIS.
- Collateral: Essential — Yes for FX Forward and OIS.
- Hedge accounting: Good to have — Possible for FX Forward and OIS.
- Margin requirements: Good to have — No for FX Forward and OIS.
- Trading platforms or exchanges: Good to have — Bloomberg for both FX Forward and OIS.
- Central counterparties: Good to have — No for both FX Forward and OIS.
- Payment and settlement systems: Essential — RTGS, GSSS for both FX Forward and OIS.
- Treasury and risk management systems: Essential — Yes for FX Forward; In progress for OIS.

### User base and demand-side constraints
- Biggest constraint: lack of heterogeneity of financial risk profiles and appetites among participants due to a bank-centered and highly concentrated financial sector.
- Survey findings:
  - Corporates cite lack of need, inadequate price transparency, and relatively high cost as main reasons for not using derivatives for hedging.
  - Banks view corporate demand for FX forwards as held back by lack of awareness about exchange rate risk and limited knowledge of hedging instruments.
- NBG and GFMTA contributions:
  - NBG has significantly contributed to training and education in collaboration with GFMTA.
  - NBG set attainment of relevant professional certificates by banks’ treasury staff as a precondition for participating in the domestic interbank FX market.
- Foreign participation: Small size of the Georgian economy limits active participation by non-resident banks; structural feature difficult to overcome.
- Recommendation: NBG should continue exploring strategies to broaden and incentivize the investor base and continue supporting targeted education and training efforts coordinated with GFMTA.
- Recommendation: NBG should investigate potential barriers preventing the Pension Agency (PA) from participating in the derivatives market given its investment mandate and explore regulatory constraints.

### Underlying and supporting products
- FX spot and unsecured overnight interbank money markets are liquid, supporting representative and reliable reference rates (including TIBR).
- Alternative assets to hedge derivative positions are partially available.
- OIS development hindered by absence of a liquid market for fixed-rate paying instruments:
  - Fixed-rate receivers (e.g., insurance companies and pension funds) are largely absent or inactive.
  - No net issuances of government bonds over the last three years; secondary market activity subdued.
- Funding markets:
  - Domestic funding markets are accessible for FX forward users.
  - Currently, abundant U.S. dollar funding is available: 45 percent of the deposits in Georgia are in dollars.
  - Availability of funding markets is not essential for OIS development since OIS transactions do not impact liquidity.
- Government securities:
  - During the last three years, the outstanding government securities portfolio increased from 3.8 billion GEL to 6.8 billion GEL. This is approximately 80 percent in nominal terms, but little changed in nominal GDP terms.
  - Recommendation: Increasing availability of longer maturity government bonds would help underlying liquidity and derivatives market development.

### Market development proposals and recommendations
- Standardized FX forward trading platform on BMatch (proposed):
  - Similar to existing FX spot trading; instruments priced as outright forward exchange rates or swap points to be assessed.
  - Initial fixed maturities: 1-month, 2-months, and 3-months; monthly roll of a new 3-month contract.
  - Non-bank users could place limit or market orders via Bloomberg Terminal or via a bank.
  - Clearing, settlement, and margining identical to existing OTC FX forwards.
  - Benefits: easier trading, improved liquidity, concentrated demand/supply on fewer tenors, enhanced price discovery, visibility of trades/prices/volumes to NBG.
  - Trade-off: basis risk for NFCs due to mismatch between forward contract maturity and expected cash flow dates.
- Data and transparency improvements:
  - Revise NBG’s FX forward index to be transaction-based rather than quote-based and publish forward rates (not forward points) for easier market comparison.
  - NBG could publish OIS benchmark rates on its website by soliciting indicative bid and offer quotes at benchmark tenors from a small number of participants to improve transparency even if transactions are sparse.
- Policy on FX interventions and hedging incentives:
  - NBG should assess how its FX intervention strategy influences incentives to hedge; agile interventions can remove exchange rate risk and act as cost-free insurance, reducing perceived need for hedging.
  - Recommendation: NBG should consider tradeoffs and aim to do the minimal amount of intervention necessary to meet primary objectives of price and financial stability, as intervening too early and too often may undermine market-based risk transfer and market development.

### Identified priorities for medium-term strategy
- Close identified gaps in each building block:
  - Regulatory issues (building block 1): addressed.
  - Infrastructure issues (building block 2): excellent progress made, but IT systems and joint treasury procurement need completion.
  - Investor base (building block 3): biggest challenge due to size and structure of economy.
  - Underlying and supporting products (building block 4): further progress possible where competition issues arise.
- Specific near- to medium-term actions:
  - Complete joint procurement and implementation of the shared treasury management system.
  - Assess cost/benefit for a CCP only if volumes justify and after full analysis.
  - Launch standardized FX forward trading on BMatch subject to market intelligence on pricing conventions.
  - Improve price indices and publish transaction-based forward rates and OIS benchmark rates to enhance price discovery.
  - Support targeted education, training, and investigate regulatory barriers for institutional investors like the PA.

*IMF | GEORGIA Stress Testing the Central Bank Balance Sheet and Developing Hedging Markets — Section 37 (Hedge accounting) and related analyses*

### APPENDIX III. MODELING TRANSFERS TO THE MOF

### APPENDIX III. MODELING TRANSFERS TO THE MOF

### Definition of reserve money
- Reserve money is defined as the sum of currency-in-circulation and required reserves:
  - 푅푅푅푅 푠푠푅푅퐴퐴푒푒푅푅 푦푦
    푡푡
    =퐶퐶푅푅 퐶퐶
    푡푡
    +푅푅푅푅푠푠푅푅푅푅푞푞
    푡푡

### Transfer rule when reserve funds exceed target
- If reserve funds exceed the target level of reserve funds (푅푅푅푅 푠푠푅푅퐴퐴푒푒푅푅
  푡푡
  푚푚푚푚푓푓), then the central bank transfers the net profit to the Ministry of Finance (MoF):
  - 푅푅푅푅푠푠푅푅퐴퐴푒푒  푅푅
    푚푚푚푚푓푓,푡푡
    =휂휂
    푅푅푅푅푅푅푅푅푅푅푛푛푅푅
    ⋅푅푅푅푅 푠푠푅푅퐴퐴푒푒푅푅 푦푦
    푡푡

  - 푇푇푒푒푅푅푒푒푠푠 푇푇푅푅푒푒
    푀푀푀푀푅푅,푡푡
    =푅푅푅푅푅푅푅푅푅푅푅푅푅푅푅푅 푅푅푅푅 푒푒푒푒푅푅 푒푒푒푒푠푠
    푡푡
    −
    (
    푅푅푅푅푠푠 푅푅퐴퐴푒푒 푅푅
    푡푡
    푚푚푚푚푓푓
    −푅푅푅푅 푠푠푅푅퐴퐴푒푒푅푅
    푡푡− 1
    )

  - 퐺퐺퐴퐴푅푅퐺퐺 푅푅퐺퐺퐴퐴
    푡푡
    =퐺퐺퐴퐴푅푅퐺퐺 푅푅퐺퐺퐴퐴
    푡푡−1
    +푇푇푒푒푅푅푒푒푠푠  푇푇푅푅푒푒
    푀푀푀푀푅푅,푡푡

### Interpretation of terms
- The first term in the second equation represents realized earnings.
- The second term in the second equation represents the allocation of these earnings to reserve funds for maintaining the target level 푅푅푅푅 푠푠푅푅퐴퐴푒푒푅푅
  푡푡
  푚푚푚푚푓푓.
- The transfer to the MoF is captured as the increase in the government deposits.

*Source: APPENDIX III. MODELING TRANSFERS TO THE MOF, tarea2024038 - APPENDIX III. MODELING TRANSFERS TO THE MOF*

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_Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024038.pdf_