## _wp06173 ## Source details **Canonical URL:** [_wp06173](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06173.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06173.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06173.pdf.json) --- ### Macroeconomic context and recent history - Several crises in emerging markets and developing economies have been rooted in balance-sheet mismatches in government, banking, other financial corporations, or the private nonbank sector. - After the FSU collapse many economies accumulated substantial public external debt denominated mostly in foreign currency, increasing vulnerability to external shocks. - The Russian crisis in 1998 forced many central banks to abandon pegs and devalue; Georgia was seriously affected. - Georgia: the National Bank of Georgia (NBG) abandoned its strongly managed float in early December 1998 after reserves reached a low of three weeks of imports of goods and nonfactor services. - Exchange rate movements: - Bilateral exchange rate against the U.S. dollar depreciated by almost 40 percent within a week in late 1998. - Depreciated by about 70 percent between the end of October 1998 and the end of February 1999. - Real economic impact: - Some commercial banks ceased operations. - GDP contracted by 2.6 percent in the fourth quarter of 1998 (year-over-year) and remained almost flat in the first quarter of 1999. ### Dollarization and sectoral balance-sheet features - High degree of dollarization remains a source of vulnerabilities, especially regarding foreign exchange liquidity and solvency. - Deposit dollarization: - about 50 percent at the introduction of the lari in 1995. - more than 85 percent in 2003. - about 72 percent by the end of 2005. - Commercial banks’ asset dollarization: - Reached 88 percent in September 2004. - Decreased by 11 percentage points since September 2004 as lending in domestic currency grew faster than foreign currency lending. - Highly dollarized balance sheets are vulnerable to exchange rate fluctuations, particularly domestic currency depreciation. ### Purpose, methodology, and focus of the Balance-Sheet Analysis (BSA) - BSA aims to gauge vulnerabilities from mismatches in the denomination and maturity/structure of assets and liabilities at the sectoral level and to examine ensuing macroeconomic risks. - Types of mismatches identified: - Financial (currency) mismatches between assets and liabilities. - Maturity mismatches between assets and liabilities. - Capital structure mismatches (debt versus equity). - Weak asset quality (credit risk). - Crisis transmission mechanisms: - Interest rate and rollover risks can affect mismatches and manifest as liquidity or solvency problems. - Intersectoral balance-sheet linkages can transmit vulnerabilities from one sector to others when liabilities are not matched by corresponding intrasectoral assets. - The paper applies a stock-oriented BSA framework (building on Allen and others (2002)) to complement flow-based macro vulnerability analysis; stock-oriented BSA is not a substitute for dynamic analysis. ### Data sources, empirical scope, and limitations - Dataset based on the new standardized report forms (SRFs) for monetary statistics. - Special attention to currency mismatches in sectoral Georgian balance sheets and associated liquidity problems due to high dollarization. - Rationale: - Most of Georgia’s international borrowing is multilateral and concessional, implying rollover and interest rate risks are rather contained. - Limitations: - The paper does not report on or discuss aggregate (domestic and foreign currency) positions. - Available data on the (nonfinancial) private sector in Georgia are too sparse to enable analysis of risks deriving from imbalances in the structure of liabilities. ### Key statistics (verbatim) - Reserves low point: three weeks of imports of goods and nonfactor services. - Exchange rate depreciations: - almost 40 percent within a week (late 1998). - about 70 percent between end-October 1998 and end-February 1999. - GDP contraction: 2.6 percent in the fourth quarter of 1998 (year-over-year). - Deposit dollarization: - about 50 percent (1995). - more than 85 percent (2003). - about 72 percent (end-2005). - Commercial banks’ asset dollarization: - 88 percent (September 2004). - decreased by 11 percentage points since September 2004. ### Section V — Main findings and overview - From a BSA perspective, macroeconomic vulnerabilities in Georgia are manageable, since levels of currency mismatches are generally improving and a foreign-currency liquidity problem is unlikely. - The high level of dollarization continues to create currency mismatches and vulnerabilities to exchange rate shocks. - Overall level of currency mismatches had been falling until very recently, although trends vary across sectors. - Georgia’s overall liquidity position has deteriorated somewhat as commercial banks’ liquid foreign currency assets have fallen as a share of official reserves, while the economy’s foreign currency liabilities have remained stable (as a share of official reserves). - Policy recommendations highlighted: - Accumulate further foreign reserves. - Facilitate development of the domestic securities market. - Maintain a flexible exchange rate. - Strengthen prudential oversight, possibly by introducing additional regulations regarding banks’ interest rate and market risk management. ### Background and recent macroeconomic performance (selected) - Since 2001, economic growth averaged 7 percent in real terms. - Inflation: single-digit range since late 1999—except early 2005 and mid-2006 flare-up. - Marked increase in the external current account deficit since 2003 mainly related to imports of capital goods, including for two major pipeline projects. - Fiscal situation until 2003: frequent sequestration, accumulated domestic expenditure arrears (including on pensions and wages). - Political regime change led to a sustained fiscal turnaround, ambitious privatization program, and official disbursements easing fiscal financing constraints. ### Core economic indicators (2000–2006) — selected values from Table 1 - Real GDP: 2000: 1.9; 2001: 4.7; 2002: 5.5; 2003: 11.1; 2004: 5.9; 2005: 9.3; 2006 (Prel. Est. Proj.): 6.4 - Consumer price index (average): 2000: 4.0; 2001: 4.7; 2002: 5.6; 2003: 4.8; 2004: 5.7; 2005: 8.3; 2006 (Prel. Est. Proj.): 5.3 - Net change in expenditure arrears: 2000: 1.4; 2001: 0.2; 2002: -0.4; 2003: 1.4; 2004: -2.6; 2005: -0.9; 2006 (Prel. Est. Proj.): -1.1 - Overall balance (cash basis): 2000: -2.6; 2001: -1.6; 2002: -1.9; 2003: -1.3; 2004: -0.2; 2005: -2.4; 2006 (Prel. Est. Proj.): -2.2 - Current account deficit: 2000: 6.0; 2001: 6.5; 2002: 5.8; 2003: 7.4; 2004: 8.3; 2005: 7.4; 2006 (Prel. Est. Proj.): 7.1 - Current account deficit (net of pipeline imports): 2000: 6.0; 2001: 6.5; 2002: 5.5; 2003: 2.8; 2004: 3.5; 2005: 4.1; 2006 (Prel. Est. Proj.): 5.8 ### Public and external debt dynamics - External debt stock declined from close to 60 percent of GDP to around 46 percent of GDP in 2003 and is projected to drop to about 23 percent of GDP by the end of 2006. - As of end-2005, about 60 percent of Georgia’s external debt is held by multilateral creditors; the World Bank accounts for almost two-thirds of that share. - Major bilateral creditors: Russia and Turkmenistan, which together represent two-fifths of Georgia’s bilateral external commitments. - Georgia’s domestic-currency debt is about 7 percent of GDP and is almost exclusively held by the central bank; securitization planned at an annual rate of about GEL 40–50 million. - In May 2006, parliament approved legislation that rules out direct lending from the NBG to the government. ### Financial sector structure and developments - End-2005: deposits amounted to 10 percent of GDP, and private-sector lending to 15 percent of GDP. - 18 banks operate in Georgia; two are foreign subsidiaries. More than 85 percent of the financial system’s assets, liabilities, and deposits are held by the top six banks. - Nonbank financial sector is very small and limited to a few credit unions and insurance companies. - No controls on movements of capital into and out of Georgia. - In 2005, credit from the commercial banking system to the private sector grew by 83 percent. - Stock of outstanding loans denominated in lari tripled, but about three-quarters of total loans are still denominated in foreign currency, down from almost 90 percent in late 2003. ### Analytical framework and data sources - Focus: balance-sheet vulnerabilities in dollarized economies—currency mismatches between foreign-currency liabilities and domestic-currency assets. - Net foreign currency position defined as foreign currency assets minus foreign currency liabilities; a large negative (positive) position indicates vulnerability to depreciation (appreciation). - Strategies to reduce vulnerabilities: - Increase assets (buffers): liquid assets (reserves), capital, positive foreign-currency cash flow. - Limit liabilities (hedges): reduce sensitivity to shocks, avoid maturity/currency mismatches. - Create contingent assets (insurance): mechanisms contingent on specific events. - Data sources: - Domestic: standardized banking report forms; authorities’ data on external public debt. - International: BIS member banks loan reports; external liabilities of nonfinancial corporations from BIS reports and JEDH; short-term external debt estimates from BIS. - Some data gaps (private external debt, certain claims) assumed negligible for currency mismatch analysis. ### Foreign currency mismatches — aggregate and sectoral - Aggregate mismatch: - Net exposure recovered to about 25 percent of GDP at end-2005 from about 60 percent of GDP in mid-2002. - Improvement reflects mainly a fall in public external debt in 2004–2005 and continued increase in foreign currency assets. - Very recently, foreign currency liabilities have started to grow as a share of GDP and the situation appears to have stabilized. - Sectoral mismatches (2001–2005 trends): - Central bank (public sector, nonconsolidated): net foreign currency position improved by about 8 percent of GDP since 2001 to some positive 5 percent of GDP; liquid foreign reserves increased to about 8 percent of GDP from about 5 percent of GDP. - Government (public sector, nonconsolidated): net foreign currency position improved drastically since 2001, reflecting a reduction in public external debt (percent of domestic-currency GDP); recent reductions in 2004–2005 were due partly to large payments on external debt falling due and some early repayments enabled by the fiscal turnaround. - Commercial banks (financial private sector): net foreign currency position remained stable and very small at around 1–2 percent of GDP; foreign currency assets increased from about 7 to about 12 percent of GDP, offset by liabilities rising from about 5 to about 10 percent of GDP. ### Government liquidity and banking-sector dynamics - Government holds a balance averaging GEL 26.7 million in 2005 on its foreign currency account with the NBG. - Transit revenues when pipelines come on stream estimated at about 1 percent of GDP over the medium term, most likely in the form of in-kind gas. - Most government foreign currency debt is concessional and predominantly owed to multilateral creditors, limiting rollover risk. - Banking system assets grew by about 50 percent in 2005, mainly fueled by rapid growth of lending to the private sector. - Additional lending in foreign currency in 2005 about GEL 518 million, almost double new domestic-currency lending, though growth rate of lari loans outpaced foreign-currency loans due to lower base. - Maturities of outstanding loans increased during 2005, as did average loan amount. - Expansion in banks’ liabilities fueled by higher deposits and borrowing from abroad. ### Banking sector dollarization and funding (2005) - By offering higher interest rates on lari-denominated deposits, commercial banks managed to attract lari deposits, but the degree of dollarization, at around 70 percent, is still high. - Only two commercial bond issuances have taken place in Georgia, both in domestic currency. - To finance additional lending, leading banks have borrowed from abroad in foreign currency: - A large part comes as developmental financing mostly from IFIs including the EBRD and the IFC, making it rather resistant to rollover risk. - Larger banks are starting to explore commercial borrowing abroad, unsecured and on market terms. ### Commercial banks’ foreign-currency positions and nonfinancial private sector - Commercial banks’ foreign-currency liabilities vis-à-vis the corporate sector have remained broadly stable as a share of GDP; they increased somewhat vis-à-vis households. - Commercial banks’ foreign-currency assets remained broadly stable vis-à-vis households, but increased vis-à-vis corporations—indicating lending to corporations occurred mainly in U.S. dollars during the credit boom. - The remaining (other private) sector has improved slightly but remains modest and negative at around 5 percent of GDP. - In 2004 most improvement for the nonbank private sector occurred due to accumulation of foreign currency assets and reduction in foreign currency liabilities—reflecting appreciation of the lari. In 2005 both foreign assets and liabilities of the private nonbank sector grew at a similar pace. - Lower interest rates on U.S. dollar-denominated loans could lead to a growing mismatch once commercial banks gain better access to foreign capital and consumers are willing to borrow. ### Maturity mismatches and liquidity (short-term foreign-currency liquidity position) - Short-term external liabilities have generally remained between 30–40 percent of official reserves since 2001; for most of 2005 they have been below the 30 percent mark. - Nonresident deposits remain small at less than 3 percent of reserves and do not pose a liquidity problem (the spike in late 2005 is related to a privatization operation). - Foreign currency deposits in the banking system decreased somewhat from the peak of around 80 percent of official reserves in late 2003 due to the strong increase in reserves in 2004—but are lately on a rising trend. - Commercial banks’ liquid foreign assets recently fell from about 60 percent of official reserves in late 2003 to about 30 percent of official reserves. - The augmented reserve ratio is characterized by strongly cyclical behavior but appears to be on a rising trend, indicating a weakening liquidity position of domestic banks. - Georgia’s short-term foreign-currency liquidity position (maturity mismatch) has continued to gradually deteriorate. ### Strategies applied to address balance-sheet vulnerabilities A. Increasing Available Foreign Currency Assets (Buffers) - Since the end of 2000, the NBG more than quadrupled its foreign currency reserves, which amounted to about 2.1 months of nonpipeline imports at the end of 2005. - NBG’s scope to sterilize interventions is limited given its small set of monetary policy instruments. - In 2002, minima for tier one and regulatory capital (as a share of total risk-weighted assets) were lowered from 12 percent and 15 percent to 8 percent and 12 percent, respectively. - In September 2002 the NBG provided that commercial bank loans in foreign currency receive a weight of 200 percent when calculating risk-weighted assets. - Commercial banks’ gross foreign currency assets increased by 195 percent—or more than US$200 million—between the end of 2000 and the end of 2005. - Foreign currency deposits rose from 4 percent of GDP to 7¼ percent of GDP at the end of 2005. - Government deposits held at the NBG corresponded to 1½ percent of GDP at the end of 2005. - The required minimum capital for banks was accelerated to GEL 12 million by the end of July 2007 (initially planned for the end of 2008). B. Limiting Liabilities and Overall Exposure (Hedges) - Foreign currency public sector debt has fixed interest rates, mainly long maturities, and specific commitments of the Georgian authorities (e.g., no guarantees for private external debt). - Prudential requirements include a limit on the open foreign exchange position in place since 2002. - Similar dollarization ratios on the asset and liability side contribute to a better hedge. - Longer loan and mortgage maturities are made possible by an increasing stock of long-term savings, triggered by higher interest rates on the corresponding accounts. - Some businesses quote prices in U.S. dollars payable at the daily exchange rate; many households receive foreign-currency remittances (estimates of remittances vary between 4 and 10 percent of GDP; for 2005 official channels amounted to about 6 percent of GDP). C. Creating Contingent Foreign Currency Assets (Insurance) - Georgia reached two agreements with the Paris Club on rescheduling its outstanding debt, including some arrears it accumulated in the run-up to the 2004 rescheduling. - Georgia could apply to the IMF’s Exogenous Shock Facility (ESF) within the PRGF Trust or request an augmentation of the existing program in case adverse shocks worsen Georgia’s balance sheet. - The banking system is developing credit lines from IFIs or private consortia under IFI guarantees. - Introduction of a deposit insurance scheme has been discussed for about two years; limiting coverage to domestic-currency deposits could lower dollarization but the scheme should be introduced only when the banking sector is in good shape. ### Conclusions and key statistics - End-2005: Georgia’s gross overall foreign exchange exposure (liabilities) amounted to around 60 percent of GDP, of which roughly half is due to public external debt. - The NBG and the banking system hold foreign currency assets on the order of 7 percent and 15 percent of GDP, respectively. - The likelihood of an overall liquidity and solvency problem appears moderate—but the current situation could deteriorate quickly given the small size of the economy and the still-rather-low level of reserves. - Progress in reducing foreign currency vulnerability has been uneven across sectors: - Government exposure reduced significantly. - NBG strengthened its position by accumulating reserves. - Financial sector liquidity position has deteriorated somewhat recently as banks’ liquid foreign currency assets have fallen (as a share of official reserves). ### Main policy recommendations - Strive for prudent fiscal policies and reexamine trade-offs associated with different public debt strategies. Foreign currency proceeds from the privatization process will decline, and fiscal deficits will have to be financed in other, noninflationary ways. A program to start issuing treasury bills again would reduce the government’s foreign currency exposure, since treasury bills can be issued in domestic currency. - Continue to accumulate foreign reserves in both the central bank and the commercial banking system while containing reserve money growth. Reserve accumulation should not result in an overly expansionary monetary stance. - Develop domestic securities markets: primary and secondary markets for central bank and government securities to improve monetary policy conduct and enable sterilization of interventions. Consider not repaying securitized debt held by the NBG when it falls due to increase the amount of monetary instruments. Develop private bond and liquid equity markets to widen financing sources and reduce private sector exposure. - Strengthen prudential oversight: carefully supervise commercial banks during the credit boom; strict enforcement of existing regulatory framework; consider additional prudential limits (e.g., on interest rate and market risks, or on foreign currency lending to the nontradables sector). - Further reduce incentives for unhedged borrowing: maintain a flexible exchange rate, additional prudential requirements to strengthen hedges, and development of new financial products (including options trading). - Take actions to decrease degree of dollarization: build trust in the banking system and promote use of the lari as a market-driven approach to dedollarization; consider other measures if dollarization persists after prolonged sound monetary and fiscal policies. *Content based on the Introduction, Section V, and accompanying material in _wp06173.* ### References.............................................................................................................. ### _wp06173 - References ### Macroeconomic context and recent history - Several crises in emerging markets and developing economies have been rooted in balance-sheet mismatches in government, banking, other financial corporations, or the private nonbank sector. - After the FSU collapse many economies accumulated substantial public external debt denominated mostly in foreign currency, increasing vulnerability to external shocks. - The Russian crisis in 1998 forced many central banks to abandon pegs and devalue, with adverse consequences for growth, employment, and poverty; Georgia was seriously affected. - Georgia: the National Bank of Georgia (NBG) abandoned its strongly managed float in early December 1998 after reserves reached a low of three weeks of imports of goods and nonfactor services. - Exchange rate movements cited: - Bilateral exchange rate against the U.S. dollar depreciated by almost 40 percent within a week in late 1998. - Depreciated by about 70 percent between the end of October 1998 and the end of February 1999. - Real economic impact referenced: - Some commercial banks ceased operations. - GDP contracted by 2.6 percent in the fourth quarter of 1998 (year-over-year) and remained almost flat in the first quarter of 1999. ### Dollarization and sectoral balance-sheet features - High degree of dollarization remains a source of vulnerabilities, especially regarding foreign exchange liquidity and solvency. - Deposit dollarization timeline: - About 50 percent at the introduction of the lari in 1995. - More than 85 percent in 2003. - About 72 percent by the end of 2005. - Commercial banks’ asset dollarization: - Reached 88 percent in September 2004. - Decreased by 11 percentage points since September 2004 as lending in domestic currency grew faster than foreign currency lending. - Highly dollarized balance sheets are vulnerable to exchange rate fluctuations, particularly domestic currency depreciation. ### Purpose, methodology, and focus of the Balance-Sheet Analysis (BSA) - BSA aims to gauge vulnerabilities from mismatches in the denomination and maturity/structure of assets and liabilities at the sectoral level and to examine ensuing macroeconomic risks. - Types of mismatches identified: - Financial (currency) mismatches between assets and liabilities. - Maturity mismatches between assets and liabilities. - Capital structure mismatches (debt versus equity). - Weak asset quality (credit risk). - Crisis transmission mechanisms highlighted: - Interest rate and rollover risks can affect mismatches and manifest as liquidity or solvency problems. - Intersectoral balance-sheet linkages can transmit vulnerabilities from one sector to others when liabilities are not matched by corresponding intrasectoral assets. - The paper applies a stock-oriented BSA framework (building on Allen and others (2002)) to complement flow-based macro vulnerability analysis; stock-oriented BSA is not a substitute for dynamic analysis. ### Data sources, empirical scope, and limitations - The analysis takes advantage of a detailed dataset based on the new standardized report forms (SRFs) for monetary statistics. - Focus of the paper: - Currency mismatches in sectoral Georgian balance sheets and associated liquidity problems receive special attention. - Rationale for focus: - High dollarization in Georgia. - Most of Georgia’s international borrowing is multilateral and concessional, implying that rollover and interest rate risks—more typical of emerging market economies—are rather contained. - Limitations noted: - The paper does not report on or discuss aggregate (domestic and foreign currency) positions. - Available data on the (nonfinancial) private sector in Georgia are too sparse to enable analysis of risks deriving from imbalances in the structure of liabilities. ### Key statistics and cited figures (verbatim) - Reserves low point: three weeks of imports of goods and nonfactor services. - Exchange rate depreciations: - almost 40 percent within a week (late 1998). - about 70 percent between end-October 1998 and end-February 1999. - GDP contraction: 2.6 percent in the fourth quarter of 1998 (year-over-year). - Deposit dollarization: - about 50 percent (1995). - more than 85 percent (2003). - about 72 percent (end-2005). - Commercial banks’ asset dollarization: - 88 percent (September 2004). - decreased by 11 percentage points since September 2004. ### Analysis implications and policy-relevant directions (as presented) - Stock-oriented BSA can highlight sectoral linkages that contribute to macroeconomic vulnerability even in economies not classified as emerging markets. - In highly dollarized economies like Georgia, currency mismatches and associated liquidity and solvency risks warrant particular scrutiny. - Given that most international borrowing is multilateral and concessional, policy attention shifts toward managing currency mismatches and liquidity risks rather than rollover and interest rate risks typical of higher-risk sovereign borrowing. - The paper describes strategies to deal with potential solvency and liquidity problems (detailed strategies are presented in subsequent sections of the paper not included in this excerpt). *Content based on the Introduction and accompanying material in _wp06173 - References.* ### Section V discusses general ### _wp06173 - Section V discusses general ### Main findings - From a BSA perspective, the macroeconomic vulnerabilities in Georgia are manageable, since the levels of currency mismatches are generally improving and a foreign-currency liquidity problem is unlikely. - The high level of dollarization in Georgia continues to create currency mismatches and vulnerabilities to exchange rate shocks. - The overall level of currency mismatches in the economy has been falling until very recently, although trends vary across sectors. - Georgia’s overall liquidity position has deteriorated somewhat as the commercial banks’ liquid foreign currency assets have fallen as a share of official reserves, while the economy’s foreign currency liabilities have remained stable (as a share of official reserves). - Policy recommendations highlighted: - Accumulate further foreign reserves. - Facilitate the development of the domestic securities market. - Maintain a flexible exchange rate. - Continue to strengthen prudential oversight, possibly by introducing additional regulations regarding banks’ interest rate and market risk management. ### Background and recent macroeconomic performance - Georgia is still recovering from the breakdown of the Soviet Union but has managed to perform rather well over the last few years. - Since 2001, economic growth has picked up markedly, averaging 7 percent in real terms. - Inflation has been in the single-digit range since late 1999—except for a short period in early 2005 and the most recent flare-up in mid-2006. - The marked increase in the external current account deficit since 2003 is mainly related to imports of capital goods, including for two major pipeline projects. - Fiscal situation until 2003 was dire: frequent sequestration, accumulated domestic expenditure arrears (including on pensions and wages). - Political regime change led to a sustained fiscal turnaround and an ambitious privatization program; official disbursements from multilateral and bilateral sources have eased fiscal financing constraints. ### Core economic indicators (2000–2006) — selected values from Table 1 - Real GDP: 2000: 1.9; 2001: 4.7; 2002: 5.5; 2003: 11.1; 2004: 5.9; 2005: 9.3; 2006 (Prel. Est. Proj.): 6.4 - Consumer price index (average): 2000: 4.0; 2001: 4.7; 2002: 5.6; 2003: 4.8; 2004: 5.7; 2005: 8.3; 2006 (Prel. Est. Proj.): 5.3 - Net change in expenditure arrears: 2000: 1.4; 2001: 0.2; 2002: -0.4; 2003: 1.4; 2004: -2.6; 2005: -0.9; 2006 (Prel. Est. Proj.): -1.1 - Overall balance (cash basis): 2000: -2.6; 2001: -1.6; 2002: -1.9; 2003: -1.3; 2004: -0.2; 2005: -2.4; 2006 (Prel. Est. Proj.): -2.2 - Current account deficit: 2000: 6.0; 2001: 6.5; 2002: 5.8; 2003: 7.4; 2004: 8.3; 2005: 7.4; 2006 (Prel. Est. Proj.): 7.1 - Current account deficit (net of pipeline imports): 2000: 6.0; 2001: 6.5; 2002: 5.5; 2003: 2.8; 2004: 3.5; 2005: 4.1; 2006 (Prel. Est. Proj.): 5.8 ### Public and external debt dynamics - External debt stock declined from close to 60 percent of GDP to around 46 percent of GDP in 2003 and is projected to drop to about 23 percent of GDP by the end of 2006. - As of end-2005, about 60 percent of Georgia’s external debt is held by multilateral creditors; the World Bank accounts for almost two-thirds of that share. - Major bilateral creditors: Russia and Turkmenistan, which together represent two-fifths of Georgia’s bilateral external commitments. - Georgia’s domestic-currency debt is about 7 percent of GDP and is almost exclusively held by the central bank; securitization planned at an annual rate of about GEL 40–50 million. - In May 2006, parliament approved legislation that rules out direct lending from the NBG to the government. ### Financial sector structure and developments - At end-2005, deposits amounted to 10 percent of GDP, and private-sector lending to 15 percent of GDP. - 18 banks operate in Georgia; two are foreign subsidiaries. More than 85 percent of the financial system’s assets, liabilities, and deposits are held by the top six banks. - The nonbank financial sector is very small and limited to a few credit unions and insurance companies. - No controls on movements of capital into and out of Georgia. - In 2005, credit from the commercial banking system to the private sector grew by 83 percent. - The stock of outstanding loans denominated in lari tripled, but about three-quarters of total loans are still denominated in foreign currency, down from almost 90 percent in late 2003. ### Analytical framework and data sources - Focus on balance-sheet vulnerabilities in dollarized economies—currency mismatches between foreign-currency liabilities and domestic-currency assets. - Net foreign currency position defined as foreign currency assets minus foreign currency liabilities; a large negative (positive) position indicates vulnerability to depreciation (appreciation). - Strategies to reduce vulnerabilities: - Increase assets (buffers): liquid assets (reserves), capital, positive foreign-currency cash flow. - Limit liabilities (hedges): reduce sensitivity to shocks, avoid maturity/currency mismatches. - Create contingent assets (insurance): mechanisms contingent on specific events. - Data sources: - Domestic: standardized banking report forms presenting assets and liabilities by instrument, sector, and currency; authorities’ data on external public debt. - International: BIS member banks loan reports assumed captured in banking system data; external liabilities of nonfinancial corporations from BIS reports and JEDH; short-term external debt estimates from BIS. - Some data gaps (private external debt, certain claims) are assumed negligible for the currency mismatch analysis. ### Foreign currency mismatches — aggregate and sectoral - Aggregate mismatch: - Net exposure recovered to about 25 percent of GDP at end-2005 from about 60 percent of GDP in mid-2002. - Improvement reflects mainly a fall in public external debt in 2004–2005 and continued increase in foreign currency assets. - Very recently, foreign currency liabilities have started to grow as a share of GDP and the situation appears to have stabilized. - Sectoral mismatches (2001–2005 trends): - Central bank (public sector, nonconsolidated): net foreign currency position improved by about 8 percent of GDP since 2001 to some positive 5 percent of GDP; liquid foreign reserves increased to about 8 percent of GDP from about 5 percent of GDP. - Government (public sector, nonconsolidated): net foreign currency position improved drastically since 2001, reflecting a reduction in public external debt (percent of domestic-currency GDP); recent reductions in 2004–2005 were due partly to large payments on external debt falling due and some early repayments enabled by the fiscal turnaround. - Commercial banks (financial private sector): net foreign currency position remained stable and very small at around 1–2 percent of GDP; foreign currency assets increased from about 7 to about 12 percent of GDP, offset by liabilities rising from about 5 to about 10 percent of GDP. - Government liquidity and rollover considerations: - Government holds a balance averaging GEL 26.7 million in 2005 on its foreign currency account with the NBG. - Transit revenues when pipelines come on stream estimated at about 1 percent of GDP over the medium term, most likely in the form of in-kind gas. - Most government foreign currency debt is concessional and predominantly owed to multilateral creditors, limiting rollover risk. - Banking sector dynamics: - Banking system assets grew by about 50 percent in 2005, mainly fueled by rapid growth of lending to the private sector. - Additional lending in foreign currency in 2005 about GEL 518 million, almost double new domestic-currency lending, though growth rate of lari loans outpaced foreign-currency loans due to lower base. - Maturities of outstanding loans increased during 2005, as did average loan amount. - Expansion in banks’ liabilities fueled by higher deposits and borrowing from abroad. ### Policy implications and recommended strategies - Accumulate further foreign reserves to strengthen buffers. - Facilitate development of the domestic securities market to deepen monetary management tools and reduce reliance on banks as sole providers of capital. - Maintain a flexible exchange rate to absorb external shocks and avoid building up currency mismatches. - Strengthen prudential oversight, possibly by introducing additional regulations regarding banks’ interest rate and market risk management. - Pursue measures to limit currency and maturity mismatches: increase assets (buffers), limit liabilities (hedges), and consider contingent asset mechanisms (insurance). *Source: _wp06173 - Section V discusses general* ### 2005. By offering higher interest rates on lari-denominated deposits, commercial banks ### _wp06173 - 2005. By offering higher interest rates on lari-denominated deposits, commercial banks ### Banking sector dollarization and funding - By offering higher interest rates on lari-denominated deposits, commercial banks managed to attract lari deposits, but the degree of dollarization, at around 70 percent, is still high. - So far, only two commercial bond issuances have taken place in Georgia, both in domestic currency. - To finance additional lending, the leading banks have borrowed from abroad in foreign currency: - A large part comes as developmental financing mostly from international financial institutions (IFIs) including the EBRD and the International Finance Corporation (IFC), which makes it rather resistant to rollover risk. - Larger banks are starting to explore commercial borrowing abroad, unsecured and on market terms. ### Commercial banks’ foreign-currency positions and nonfinancial private sector - Commercial banks’ foreign-currency liabilities vis-à-vis the corporate sector have remained broadly stable as a share of GDP, whereas they increased somewhat vis-à-vis households. - Commercial banks’ foreign-currency assets remained broadly stable vis-à-vis households, but increased vis-à-vis corporations—an indication that lending to corporations in the context of the recent credit boom occurred mainly in U.S. dollars. - The remaining (other private) sector has improved slightly but remains modest and negative at around 5 percent of GDP. - In 2004 most of the improvement for the nonbank private sector occurred due to an accumulation of foreign currency assets and a reduction in foreign currency liabilities—reflecting the appreciation of the lari. In 2005 both foreign assets and liabilities of the private nonbank sector grew at a similar pace. - Going forward, the somewhat lower interest rates on U.S. dollar-denominated loans could lead to a growing mismatch once the commercial banks gain better access to foreign capital and consumers are willing to borrow. ### Maturity mismatches and liquidity (short-term foreign-currency liquidity position) - Short-term external liabilities have generally remained between 30–40 percent of official reserves since 2001; for most of 2005 they have been below the 30 percent mark. - Nonresident deposits remain small at less than 3 percent of reserves and do not pose a liquidity problem (the spike in late 2005 is related to a privatization operation). - Foreign currency deposits in the banking system decreased somewhat from the peak of around 80 percent of official reserves in late 2003 due to the strong increase in reserves in 2004—but are lately on a rising trend. - Commercial banks’ liquid foreign assets have recently fallen from about 60 percent of official reserves in late 2003 to about 30 percent of official reserves. - The augmented reserve ratio is characterized by strongly cyclical behavior but appears to be on a rising trend, indicating a weakening liquidity position of domestic banks. - Georgia’s short-term foreign-currency liquidity position (maturity mismatch) has continued to gradually deteriorate. ### Strategies applied to address balance-sheet vulnerabilities: buffers, hedges, insurance A. Increasing Available Foreign Currency Assets (Buffers) - Since the end of 2000, the NBG has managed to more than quadruple its foreign currency reserves, which amounted to about 2.1 months of nonpipeline imports at the end of 2005. - The NBG’s scope to sterilize interventions is limited given its small set of monetary policy instruments. - In 2002, minima for tier one and regulatory capital (as a share of total risk-weighted assets) were lowered from 12 percent and 15 percent to 8 percent and 12 percent, respectively. - The NBG introduced in September 2002 a provision according to which commercial bank loans in foreign currency receive a weight of 200 percent when calculating risk-weighted assets. - Commercial banks’ gross foreign currency assets increased by 195 percent—or more than US$200 million—between the end of 2000 and the end of 2005. - Foreign currency deposits rose from 4 percent of GDP to 7¼ percent of GDP at the end of 2005. - Government deposits held at the NBG corresponded to 1½ percent of GDP at the end of 2005. - The required minimum capital for banks was accelerated to GEL 12 million by the end of July 2007 (initially planned for the end of 2008). B. Limiting Liabilities and Overall Exposure (Hedges) - Georgia’s foreign currency public sector debt has fixed interest rates, mainly long maturities, and specific commitments of the Georgian authorities (e.g., no guarantees for private external debt). - Prudential requirements include a limit on the open foreign exchange position in place since 2002. - Similar dollarization ratios on the asset and liability side contribute to a better hedge. - Longer loan and mortgage maturities are made possible by an increasing stock of long-term savings, triggered by higher interest rates on the corresponding accounts. - Some businesses quote prices in U.S. dollars payable at the daily exchange rate; many households receive foreign-currency remittances (estimates of remittances vary between 4 and 10 percent of GDP; for 2005 official channels amounted to about 6 percent of GDP). C. Creating Contingent Foreign Currency Assets (Insurance) - Georgia reached two agreements with the Paris Club on rescheduling its outstanding debt, including some arrears it accumulated in the run-up to the 2004 rescheduling. - Georgia could apply to the IMF’s Exogenous Shock Facility (ESF) within the PRGF Trust or request an augmentation of the existing program in case adverse shocks worsen Georgia’s balance sheet. - The banking system is developing credit lines from IFIs or private consortia under IFI guarantees. - The introduction of a deposit insurance scheme has been discussed for about two years; limiting coverage to domestic-currency deposits could lower dollarization but the scheme should be introduced only when the banking sector is in good shape. ### Conclusions and key statistics - At the end of 2005, Georgia’s gross overall foreign exchange exposure (liabilities) amounted to around 60 percent of GDP, of which roughly half is due to public external debt. - The NBG and the banking system hold foreign currency assets on the order of 7 percent and 15 percent of GDP, respectively. - The likelihood of an overall liquidity and solvency problem appears moderate—but the current situation could deteriorate quickly given the small size of the economy and the still-rather-low level of reserves. - While overall foreign currency vulnerability has decreased over the last five years, progress has been uneven across sectors: - Government exposure reduced significantly. - NBG strengthened its position by accumulating reserves. - Financial sector liquidity position has deteriorated somewhat recently as banks’ liquid foreign currency assets have fallen (as a share of official reserves). ### Main policy recommendations - Strive for prudent fiscal policies and reexamine the trade-offs associated with different public debt strategies. Foreign currency proceeds from the privatization process will decline, and fiscal deficits will have to be financed in other, noninflationary ways. A program to start issuing treasury bills again would reduce the government’s foreign currency exposure, since treasury bills can be issued in domestic currency. - Continue to accumulate foreign reserves in both the central bank and the commercial banking system while containing reserve money growth. Higher foreign currency holdings will bolster Georgia’s ability to withstand shocks to the interest and exchange rates, and to roll over existing obligations. To maintain low inflation, it is important, though, that reserve accumulation does not result in an overly expansionary monetary stance (as it did in late 2004). - Develop domestic securities markets. In the short run, primary and secondary markets for central bank and government securities will enable the NBG to improve its conduct of monetary policy. The possibility of sterilizing its interventions in the foreign exchange market would facilitate the NBG’s aim of accumulating foreign reserves without resulting in rather abrupt changes in liquidity and the ensuing consequences for inflation. The authorities should consider not repaying the securitized debt held by the NBG when it falls due to increase the amount of monetary instruments. By developing primary debt instruments denominated in lari, the public sector will be able to better match the denomination of its debt with that of its revenue. In the longer run, developing a private bond market and a liquid equity market would provide a wider range of financing sources to Georgian companies and, at the same time, could contribute to reducing the exposure of the private sector. - Strengthen prudential oversight. Especially in light of the ongoing credit boom, the NBG will have to carefully supervise commercial banks that operate in Georgia to ensure that the current environment does not aggravate the foreign currency mismatches in the economy. Limiting the fallout from an overheating credit boom requires—but may not be limited to—strict enforcement of the regulatory framework already in place. The NBG may consider introducing additional prudential limits not covered at present—for example, on interest rate and market risks, or on foreign currency lending to the nontradables sector. - Further reduce the incentives for unhedged borrowing. Maintaining a flexible exchange rate is an important measure to raise the private sector’s awareness of currency risks. Additional prudential requirements could aim to strengthen the role of hedges in financial transactions. Development of new financial products—including options trading—will enable private companies (and possibly households) to shield themselves better from currency fluctuations. - Take actions to decrease the degree of dollarization of the economy, thereby lowering commercial banks’ foreign currency exposure. Building trust in the Georgian banking system and promoting the use of the lari are cornerstones of a market-driven approach to dedollarization. If, after a prolonged period of sound monetary and fiscal policies, dollarization appears intrinsic, the Georgian authorities could consider other ways to tackle the phenomenon of dollarization hysteresis. *Source: _wp06173 - 2005. By offering higher interest rates on lari-denominated deposits, commercial banks* ### REFERENCES ### REFERENCES ### References list - Allen, Mark, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini, 2002, “A Balance Sheet Approach to Financial Crisis,” IMF Working Paper 02/210 (Washington: International Monetary Fund). - Billmeier, Andreas, and Shuang Ding, 2006, “Financing Economic Development in Georgia,” in Georgia—Selected Issues, IMF Staff Country Report 06/170 (Washington: International Monetary Fund), pp. 4–20. - Billmeier, Andreas, Jonathan Dunn, and Bert van Selm, 2004, “In the Pipeline: Georgia’s Oil and Gas Transit Revenues,” IMF Working Paper 04/209 (Washington: International Monetary Fund) - Billmeier, Andreas, and Konstantin Fedorov, 2006, “Measuring the Shadow Economy: The Impact of the Georgian Anti-Corruption Drive,” in Georgia—Selected Issues, IMF Staff Country Report 06/170 (Washington: International Monetary Fund), pp. 30–40. - Daseking, Christina, 2004, “Thailand: An Aggregate Balance-Sheet Analysis,” in Thailand—Selected Issues, IMF Country Report 04/1 (Washington: International Monetary Fund), pp. 5–15. - Goldstein, Morris, and Philip Turner, Controlling Currency Mismatches in Emerging Markets (Washington: Institute for International Economics). - International Monetary Fund (IMF), 2003, External Debt Statistics: Guide for Compilers and Users (Washington: International Monetary Fund). - ———, 2006, “Georgia,” IMF Country Report 06/175 (Washington: International Monetary Fund). - Keller, Christian, 2004, “Analyzing a Highly Dollarized Economy from a Balance Sheet Perspective,’ in Peru—Selected Issues, IMF Country Report 04/156 (Washington: International Monetary Fund), pp. 17–32. - ———, and Chris Lane, 2005, “Balance Sheet Developments Since the Crisis,” in Reza Moghadam and others, Turkey at the Crossroads: From Crisis Resolution to EU Accession, IMF Occasional Paper No. 242 (Washington: International Monetary Fund), pp. 22–32. - Mathisen, Johan, and Anthony Pellechio, 2006, “Using the Balance Sheet Approach in Surveillance: Framework, Data Sources, and Data Availability,” IMF Working Paper 06/100 (Washington: International Monetary Fund). - Mathisen, Johan and Mariana Torres, 2005, “Balance Sheet Currency Mismatch and Liquidity Analysis,” in Belize—Selected Issues, IMF Country Report 05/353 (Washington: International Monetary Fund), pp. 16–26. - Rosenberg, Christoph, Ioannis Helikias, Brett House, Christian Keller, Jens Nystedt, Alexander Pitt, and Brad Setser, 2005, Debt-Related Vulnerabilities and Financial Crises: An Application of the Balance Sheet Approach to Emerging Market Countries, IMF Occasional Paper No. 240 (Washington: International Monetary Fund. - Roubini, Nouriel and Brad Setser, 2004, Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies (Washington: Institute for International Economics). *Source: _wp06173 - REFERENCES* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06173.pdf_