Tackling inflation

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					                                     Tackling inflation

                                The other day the Resident Representative of the International Monetary
                                Fund in Georgia, Robert E. Christiansen, called on Georgian authorities to
                                undertake urgent measures to stem inflation and reminded them of
                                recommendations given by the IMF mission during its last visit since
                                August 11 to 18.

                                The mission urged authorities to tighten the current fiscal and monetary
                                policy through the combination of expenditure restraint, a smaller deficit
                                and slower growth of reserve and broad money which might reduce
                                demand pressures.

                                Cutting down the overall fiscal deficit from the current 4% of GDP,
                                totaling 550 million GEL to 2 % of GDP - 340 million GEL - was agreed.
                                Taken together, these measures should curb the inflationary pressure
                                and improve prospects of achieving an inflation rate of around 10% by
                                the end of 2006. Also, a reduction of broad money growth from 38% by
                                July data to 27% was proposed.

                                 “Although Georgia’s economic growth performance continues to be
strong, the economy is now characterized by significant inflationary pressure,” the IMF mission, upset
by the inflation rate figuring 14.5% by July in comparison with 6% benchmarked by end-April 2006,
said.

“The sharp increase in inflation reflects demand pressures in the economy resulting mainly from excess
money supply. The current level of inflation is well above the program’s targets and poses a serious risk
to macroeconomic stability,” the IMF missions’ official paper stipulates.

Inflation a long time coming?

The sharp increase of the inflation rate had been predicted by Georgian experts since last year, even
when the state budget of 2006 was under revision in December of 2005 and a 5%-6% inflation rate was
built into the new fiscal document. Experts met the calculation skeptically and predicted that the rate
would exceed two digits in the spring. Excess in broad money supply was also forecast. It was obvious
that the nearly doubled new budget including the doubled expenditures likewise, as well as huge
investments inflow thanks to underway aggressive privatization process would fuel the inflation above
6%.

Experts also say that the inflation rate exceeded 6% long before the winter of 2006 and was fluctuating
near two digits, and that the much lauded 6% was just an official figure. Only in June did the Ministry of
Finances of Georgia announced that the inflation rate creep up to 11%. The Ministry of Finance together
with the National Bank of Georgia placated society by saying that it would take urgent measures to
reduce the rate soon.

The official explanation of the reasons triggering the inflation process is as follows: the price hike on oil
and oil-products, as well as sugar, on the international markets, plus increases of tariffs on gas and
electricity. The issuance of treasury securities to drain out the exuberance of broad money was
proposed by the Finance Ministry. To this end NBG plans to issue its own certificates of deposits with
short term maturity period including one, three and six months. The auction of the NBG certificates is
scheduled to start since September 18.
                                                   -2-



Georgian officials responsible for the monetary and fiscal policy seem quite optimistic that inflation will
drop starting this fall. However, some independent experts say that the inflation rate is nearly 20%
already and will go higher in the fall as soon as consumption of gas and electricity increase.

“It’s ridiculous to speak of exuberance of excessive money supply in a population that fueled the
inflation, and saying that after reducing this amount the inflation will reduce,“ Gia Khukhashvili, an
independent economic expert said.

According to him the tools undertaken by Georgian authority to handle the inflation are ineffective and
the main cause of the underway inflation is that Georgia lacks a proper economic sector as such. He
says that prices in winter will go higher because the product becomes expensive. And indeed, if fruit and
vegetable costs doubled in summer, there is less chance that their costs will slump in the winter.

Meanwhile, IMF Resident Representative in Georgia Robert E. Christiansen reiterates that the inflation
was caused by an increased demand by businesses, household and government for more goods and
services.

Of particular concern is the rapid expansion of bank credits, which constituted a large part of the money
supply. Since commercial banks increased credits dramatically to the private sector since last summer,
starting from November 2005, and credit growth regularly exceeded 80 percent per annum. Inasmuch
as these loans are part of the broad money supply, credit expansion needs to be slowed for a while.

The recommendation sounds quite unpopular on the background of the booming Georgian banking
sector, which might suffer from it - but in the short-term interval, Christiansen assures. Meanwhile, the
inflation might inflict long-term damages. To cast more light on the troublesome issue, Georgia Today
interviewed Robert E. Christiansen.

GT: The Georgian government and NBG assure that they have been implementing all IMF demands. If
so, how did it happen that the inflation rate went up?

Christiansen: What happens is that our targets pertain only to reserve money, not broad money. There
is a big difference between these two. But we did warn the government that the broad money was
growing too quickly.

GT: When did you first notice the inflation increase?

Christiansen: There was a period of inflation in April 2005 and it reemerged in May 2006.

GT: The official explanation of the underway inflation includes a seasonal effect as well as the increase
of tariffs on gas and electricity.

Christiansen: The seasonal factor is not very significant. Let me give a little bit more explanation. We
calculate the inflation of the last twelve months to take account of some seasonal effects. The August
number that just became available shows that inflation decreased slightly. Inflation in July was 14.5%
and now it is 13.4. However, some categories have seen a very large increase. For example, vegetables
increased by 58% in one year, housing, water, electricity - by 30%. Sugar, jam, chocolate increased by
30%, fruits and grapes – by 50%.

As to tariffs on gas and electricity, yes, it’s going to contribute to price inflation, but if the government
keeps the money supply tight, then other prices will decrease. You need a tighter monetary policy and
smaller government deficit to restrain inflation.

GT: So the problem is with the monetary policy and not with those of gas and electricity tariffs or
reasons like these?
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Christiansen: There are two major factors: monetary policy need to be restrained, and the government
deficit must be cut down.

GT: What did the government say of your recommendations?

Christiansen: We have excellent discussions. We talked about the causes; the last visiting IMF mission
has participated in a seminar with the Prime Minister, Economic Ministers and NBG. And we agreed that
reasonable steps should be taken. Now the government is implementing them. I am confident the
inflation will come down.

GT: What do your recommendations stress?

Christiansen: We focused mainly on monetary and fiscal policies; we talked about the plans for the next
year and recommended that the budget deficit be modest – 2% of GDP. We also talked of bank
supervision. The authorities need to continue strengthening the bank supervision system.

GT: You mentioned that bank credit also contributed to inflation. What do you recommend banks do to
reduce credits disbursement?

Christiansen: We would not give guidance to banks. The banks are operating as they should.

GT: But what can they do?

Christiansen: It is up to NBG to change the environment so that interest rates may go up a little bit,
that fewer credits are issued. The central bank has a number of tools to do that.

GT: Higher interest rates are no enticing prospect to either banks or customers; banks may lose their
clientele. As result it may affect economic growth…

Christiansen: Yes, it could. But ultimately inflation does a lot of damage. It hurts low income groups.
Georgia has a high poverty rate and vulnerable groups may be hurt by inflation. When the inflation gets
above 6% - it starts to hurt the growth: Inflation airs a lot of uncertainty to economy: businesses are
never sure what to expect, sometimes interest rates go up, exchange rates change, and businesses
don’t like uncertainty, so they tend to slow down their investment when inflation is high.

You are right that it is necessary to do things which can be difficult, but this is a short-term difficulty,
whereas the inflation causes problems for a longer period.

                                                                                        The Georgia Today
                                                                                             Nino Patsuria
                                                                                                  7.09.2006