The governor of the National Bank of Georgia outlines his country’s response to the Covid-19 pandemic.
Koba Gvenetadze
In the wake of the global crisis caused by Covid-19, the world has faced unprecedented healthcare, economic and financial stability challenges. As the International Monetary Fund (IMF) puts it, this is a crisis like no other that has hit virtually every country in the world. Economies have come to a sudden halt and the decline has been steeper than it was during the global financial crisis of 2007-2008. Unprecedented times require unprecedented measures; consequently, bold and rapid policy decisions have been taken by governments and central banks worldwide to address these challenges. The decisive and timely actions by the National Bank of Georgia (NBG) have helped to cushion the effects of the pandemic on the Georgian economy.
Our past experience shows that external shocks are quite frequent for small, open economies like that of Georgia. However, a global overarching shock like the pandemic we are currently experiencing further highlights that continuous crisis preparedness is vital. The Georgian financial sector met this shock well prepared, owing to proactive and consistent measures taken in the pre-crisis period.
Preparedness for the crisis
At the NBG we constantly monitor developments in the financial sector and support the sound operation of the financial system in order to maintain stability. The Georgian financial system faced the Covid-19 outbreak well prepared and remained resilient due to the financial policy measures implemented in recent years.
Since 2016 we have materially increased the size and quality of capital and liquidity buffers in the banking system. The profits generated by commercial banks in the past and the additional capital requirements imposed by the NBG have allowed banks to accumulate sufficient capital buffers to deal with the crisis efficiently. An accelerated phasing in of additional requirements was eased by solid financial performance, strong shareholder support and access to international markets: Georgian banks are mostly foreign-owned, while the two largest institutions are listed on the London Stock Exchange.
Furthermore, in the years leading up to crisis, we employed a number of macroprudential measures to reduce the levels of household indebtedness and loan dollarisation. These helped reduce vulnerabilities in the non-financial sector and increased the resilience of the financial system. Additionally, we have introduced a liquidity coverage ratio and a net stable funding ratio, to ensure market liquidity and the stability of banks’ funding sources. We have also established the deposit insurance scheme and adopted the banking resolution framework for effective crisis management. On top of that, the NBG strengthened its risk-based supervisory framework to improve efficiency in resource allocation.
To bring credit growth down to a sustainable level and facilitate sound lending, the NBG introduced a regulation on responsible lending to natural persons. Timely enactment of this regulation, which was criticised by the public and some experts at the time of its adoption, has considerably improved credit standards. The annual growth of household lending has slowed down to a more sustainable level, while greater funds became available for the financing of legal entities to boost business lending and investments.
The measures described above led to comfortable capital and liquidity buffers, strong asset quality and non-performing loans at historic lows. All of these features meant that the Georgian financial sector was well prepared for the Covid-19 crisis. As the situation unfolded, of course, more challenges have come to light. The unprecedented nature of this shock is also reflected in the policy response it required.
NBG’s measures
The recession caused by the pandemic is fundamentally different to earlier crises. The economy is affected in numerous ways. The healthcare response has shifted not only the aggregate demand in the economy, but also its supply capacity. The pain felt by the financial sector has been reflected in all sorts of risk premium increases, from liquidity to credit risk. Capital flows reacted markedly, leading to large exchange rate movements. Hence the NBG had to use multiple instruments to address this situation.
Temporary measures: provision of liquid funds and easing of supervisory requirements. The NBG has introduced and implemented a number of extraordinary measures in response to the Covid-19 crisis: it expanded the toolkit for providing liquidity to the system to ensure the continuation of credit flow to the real economy; assisted the small and medium-sized enterprise (SME) sector with a new instrument similar to targeted quantitative easing; augmented access to resources under the ongoing IMF-supported programme; relaxed capital adequacy; announced a temporary moratorium on developing and introducing supervisory requirements; suspended on-site inspections and encouraged banks to announce moratoria on loan repayments in a clear and orderly manner; and introduced a moratorium on fines, in cases where a breach emerged due to the crisis.
In terms of liquidity supply, the banking sector in Georgia currently operates under a short-term liquidity deficit. This is why monitoring liquidity demand is important, especially in light of the pandemic-induced drop in liquidity. Commercial banks and microfinance organisations were supplied with liquidity through swap operations, in which the NBG buys foreign currency with national currency for a period of one month at a spot rate, provided it is sold back at the forward rate.
Moreover, starting from June 1, 2020, the NBG launched a liquidity supply tool to facilitate lending to SMEs, the sector hit hardest by the pandemic. The new instrument allows commercial banks to receive liquidity from the NBG in exchange for strengthening its SME loan portfolio. At the same time, microfinance organisations, with the support of the NBG, are able to attract loan resources from commercial banks against their loan portfolio, assuming they meet the NBG’s criteria. The new liquidity management mechanism will operate with the possibility of monthly renewal until the end of 2023 (with a phase-out beginning in 2022), while the price is determined by the one-month interbank money market index. The NBG provides the required amount of short-term liquidity to ensure that interest rates in the interbank money market vary around the policy rate. All these instruments have ensured that the commercial banks were confident enough to continue lending, assisting the economic recovery.
Standard monetary policy measures
Clearly, alongside the aforementioned temporary measures, the NBG also used its standard policy tools to alleviate the economic effects of the pandemic. The backbone of standard policy responses, however, remains intact: achieving price stability in the context of a floating exchange rate regime. At the onset of the pandemic, the NBG eased its policy rate from 9% to 8% to support the economic recovery, and kept it at the latter level. The reason for such a cautious response was the presence of higher-than-targeted inflation expectations, mostly induced by exchange rate depreciation and supply-side disruptions linked to virus-related lockdown.
With the deployment of multiple tools aimed at reducing the impact of the crisis, we expect the economy to recover fairly quickly, if no additional hurdles arise. According to our current baseline forecast, inflation is still expected to remain above the target (3%) in the short term, as supply-side factors continue to outweigh the effect of reduced aggregate demand. However, beyond the short-term horizon, weak demand is expected to pull inflation down. In light of this declining inflation forecast in the medium term, a gradual decrease in our policy rate is expected, which should support the recovery of the Georgian economy as well.
Looking ahead
The NBG’s policy of ‘fixing the roof while the sun is shining’ has helped prepare our financial system well for the crisis. However, we consider efforts to strengthen the resilience of the financial system and support economic and financial stability as a continuing work in progress. Besides working on policy measures to tackle the ongoing challenges of the economy, we also focus on more long-term policies to boost inclusive and sustainable growth of the economy.
Fintech initiatives remain one of the priorities on our agenda. In addition, we started developing a Sustainable Finance Framework in 2017, once we joined the International Finance Corporation-supported Sustainable Banking Network. One of the most important steps that we have taken in that regard is the launch of a Sustainable Finance Roadmap for Georgia in April 2019. The roadmap combines all possible steps planned by the NBG for supporting sustainable finance over the next few years.
Koba Gvenetadze is governor of the National Bank of Georgia.
