Monica Ellena in Tbilisi -

Is the recent depreciation of the lari, the Georgian currency, a trap or a trump for the country's economy? The answer may be both: it is affecting citizens' purchasing power in the short term, but it could help the struggling economy and bolster the competitiveness of Georgian exports.

The lari started falling last autumn and by January 31 had dropped to as low as 1.78 against the dollar compared with 1.66 in October. As of February 24, it stood at 1.73.

Some economists think the depreciation is due to international factors, namely capital being withdrawn from emerging markets all over the world after the US Federal Reserve eased back on its quantitative easing, which has severely affected other currencies like the Turkish lira.

But Azim Sadikov, resident representative of the International Monetary Fund (IMF) in Georgia, thinks the reasons for the recent depreciation of the lari against the dollar are mainly domestic. "There are seasonal fluctuations, a late start of the ski season, which probably reduced foreign exchange inflows, and a government spending-led pick-up in the economy which resulted in higher imports and therefore greater demand for foreign exchange," Sadikov says. "Indeed, the start of US Fed tapering last December led to retrenchment from emerging markets, but we don't think that it was an important factor in the Lari's performance."

According to Sadikov, a weaker lari versus the dollar could adversely affect debtors who borrowed in dollars but have lari income, as they would have to set more lari aside to service their loans. At the same time, a weaker lari versus the basket of trading partner currencies would strengthen the competitiveness of Georgian goods, both on international and national markets. "This would obviously be good news for the real sector of the economy," he adds.

Georgia recorded robust economic growth between 2003 and 2012, averaging 6.1% annually, following structural reforms that stimulated capital inflows and investment. In 2013, though, growth did not live up to expectations; the initial forecast by the IMF was 6.0%, but it was then cut to 2.5% in October. The Asian Development Bank pointed at investor caution linked to political transition and delays in public infrastructure among the factors. For 2014, the government expects the economy to recover from the slowdown and predicts 5% GDP growth, which the IMF considers possible as long as the government acts to shore up investor confidence and does a better job of explaining policy, Sadikov told Reuters in December.

Cost of living

Ordinary shoppers remain nervous, as prices have already started rising; Besik Namchavadze, economist at Policy and Management Consulting Group (PMCG), told local paper The Financial that the cost of living for people of average income has risen by 3%, while for the poor, whose major expense is food, it has risen by around 9%.

However, many analysts think the depreciation is not necessarily all bad news. "A stable currency is needed to stimulate investment, I think that the Georgian lari was actually overvalued," explains Florian Bierman, economics professor at the International School of Economics at Tbilisi state University (ISET). "A weaker lari makes imported goods more expensive, but it means more export opportunities, hence a revived economic activity, more jobs. It is a trade-off. In my opinion, the counter-effect of higher prices on imported goods is not disastrous for the average Georgian shopper, who mainly purchases Georgian products. Imported goods are a luxury for most Georgians anyway."

Last year's depreciation of the lari was estimated to have raised the inflation rate by about 1 percentage point, which the National Bank of Georgia (NBG) said was contained in its forecast. In January, inflation jumped to 2.9%, the fourth month of rising prices after deflation in most of 2012 and 2013. The central bank targets an inflation rate of 6.0% by end-2014.

"The Central Bank's primary monetary policy objective is inflation targeting. Consistent with that and given the liberalized capital account, Georgia has a floating exchange rate regime," explains Sadikov. "Essentially, the central bank lets the lari move in line with market fundamentals. It can intervene occasionally using its foreign reserves to prevent an excessive short-term volatility of the exchange rate, but it does not resist structural changes in the market. This position has so far proved to work."

On February 12, the NBG raised its benchmark re-financing rate by 25 basis points to 4.0%, saying there was no need to maintain the easy policy stance as economic growth is improving and this trend is expected to continue in the first half of 2014.

In November, Georgia initialled an agreement on free trade and other ties with the EU and the government intends to sign the deal in August. The deal is expected to boost investment in Georgia, which has appointed a new prime minister and president in the past few months and hopes that the period of political instability is over.