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ViewpointMay 28 2012

Georgia's local regulation in a global economy

The governor of the National Bank of Georgia has to tailor his maintenance of local financial stability to a banking sector with high levels of foreign ownership and aspirations to expand across the Caucasus region and beyond.
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Georgia's local regulation in a global economy

Giorgi Kadagidze took charge of the National Bank of Georgia (NBG) in February 2009, at the height of an exchange rate and economic crisis triggered by the unfortunate confluence of the global financial squeeze and the country’s war with Russia in the previous year. The managed exchange rate had just been devalued, and Mr Kadagidze further liberalised the exchange regime, while avoiding any bank bail-outs.

In the three years since, inflation has averaged just 5.3%, inside the NBG’s 3% to 6% target, and the economy grew by 6.8% in 2011 – far outpacing International Monetary Fund expectations of 5.5%. The exchange rate is back in an appreciating trend, already stronger than immediately after the devaluation. Georgia’s sovereign ratings were upgraded by two agencies in 2011, and official foreign exchange reserves have more than doubled since Mr Kadagidze took charge.

He is modest in attributing progress to the wider Georgian authorities, in particular the administrative reforms undertaken by the government that have helped lift Georgia’s ranking in the World Bank Ease of Doing Business surveys by 40 places, to 72, since 2005. The finance ministry has also kept government debt at just 32% of gross domestic product (GDP).

But Mr Kadagidze himself has played a central role, taking important steps in the financial sector. He has introduced central bank refinancing instruments in Georgian lari, and switched foreign exchange interventions from the interbank market to an auction process.

“High dollarisation in the banking sector has limited the transmission channels for monetary policy, but we are introducing tools to build a local yield curve and enable the financial system to express economic tendencies through it. Dollarisation has fallen to 60%, from a peak of 76%, and local treasury bill yields are tight, as there is growing investment in them,” says Mr Kadagidze.

Healthy balance sheets

The non-performing loan rate in Georgia is strikingly low by regional standards, at 4.6%. The country’s banks have avoided the bursting real estate bubbles that blighted banking sectors in Azerbaijan and Ukraine with high default rates on loans to property developers, and construction and building materials companies.

“The key strengths of the Georgian banking sector are tough regulation of capital adequacy and liquidity, sound corporate governance and low overall bank penetration, with bank assets of about 52% of GDP leaving room to grow safely,” says Mr Kadagidze.

The corporate governance reflects a sector where 95% of banks have some non-resident ownership, including a London Stock Exchange listing for the country’s largest, Bank of Georgia, and multilateral development institution participation in several banks such as TBC Bank, the second largest.

The sector is also relatively concentrated, with Bank of Georgia and TBC holding a market share of more than 50%, and the top six banks controlling 90% of the market. The tight regulation, combined with relatively high interest rates and short loan maturities, have served to keep loan-to-value ratios and debt interest payments to salaries very conservative.

Regional expansion

Mr Kadagidze acknowledges that credit availability and affordability could be better. But he says there is plenty of competition, and an economy that is 4.5 times larger than a decade ago hardly suggests that credit conditions are too tight. He anticipates, and would welcome, other foreign entrants in the market, especially banks from trading partner Turkey and hydrocarbon-rich Azerbaijan. Russia’s VTB is already active in Georgia.

“Our strategy is to be open for everyone, there is no discrimination by origin," says Mr Kadagidze, adding that Russian businesses are welcome in the country.

With a domestic population of 4.5 million, Georgia’s own banks will inevitably look to expand if they outgrow the local market. But these forays will need to be well considered: Bank of Georgia exited subsidiaries in Belarus and Ukraine in 2010 and 2011, respectively, with banking market conditions difficult in both countries. The NBG will keep a close eye on cross-border developments.

“The most successful Georgian banks must eventually go overseas, but will need to be very careful that the strategy is accurate, and that they know well enough the conditions in the new markets they choose. We cannot regulate everything that goes on abroad, but we can make sure the capital is there to keep the banks safe, that is the aim of a prudent regulator,” says Mr Kadagidze.

He adds that Georgia cannot expect to be fully immune from the economic fall-out of events elsewhere in the world, and is particularly vulnerable to any fall in remittances from expatriate workers or hike in oil prices given its dependence on imported energy. But investors so far appreciate the advantages of a government that runs a balanced budget on current expenditures, with 3.5% of the GDP deficit purely from capital and infrastructure spending.

“We aim to be transparent, we do not try to hide the challenges, but we make sure investors fully understand the climate, and let them make up their own mind,” says Mr Kadagidze.

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