The Relationship Between Georgian Lari and Interest Rates

The Relationship Between Georgian Lari and Interest Rates

Blog • 17-06-2024, 11:50

The Georgian Lari (GEL) is the national currency of Georgia, and its value and stability are closely linked to the country's interest rates. Interest rates, which represent the cost of borrowing money and the return on savings, play a crucial role in shaping monetary policy, influencing investment decisions, and determining the attractiveness of the Lari to foreign investors. In this article, we will explore the relationship between the Georgian Lari and interest rates, examining how changes in interest rates can impact the currency's value and the broader economy.

1. Monetary Policy and Interest Rates

The National Bank of Georgia (NBG) is responsible for setting and implementing monetary policy in the country, with the primary objective of maintaining price stability and promoting sustainable economic growth. One of the key tools the NBG uses to achieve these goals is the adjustment of interest rates.

When the NBG raises interest rates, it makes borrowing more expensive and saving more attractive. This can lead to a reduction in spending and investment, as businesses and consumers adjust to the higher cost of credit. Higher interest rates can also attract foreign capital inflows, as investors seek to take advantage of the higher returns available on Lari-denominated assets.

Conversely, when the NBG lowers interest rates, it encourages borrowing and spending, as the cost of credit becomes more affordable. Lower interest rates can stimulate economic activity and support growth, but they may also make the Lari less attractive to foreign investors and potentially lead to currency depreciation.

2. Impact on Currency Value

Changes in interest rates can have a significant impact on the value of the Georgian Lari. When interest rates rise, the Lari tends to appreciate, as the higher returns available on Lari-denominated assets attract foreign capital inflows. This increased demand for the Lari can drive up its value relative to other currencies.

For example, if the NBG raises interest rates from 7% to 8%, foreign investors may find Georgian government bonds or bank deposits more attractive, leading to an increase in demand for the Lari. As more investors buy Lari to invest in these assets, the currency's value appreciates.

On the other hand, when interest rates fall, the Lari may depreciate, as the lower returns on Lari-denominated assets make them less attractive to foreign investors. This reduced demand for the Lari can lead to a decrease in its value relative to other currencies.

3. Inflation and Interest Rates

Inflation, which refers to the rate at which the general price level of goods and services increases over time, is another key factor influencing the relationship between the Georgian Lari and interest rates. The NBG's monetary policy is guided by an inflation-targeting framework, which aims to keep annual inflation within a target range of 3% ± 1 percentage point.

When inflation is high or rising, the NBG may raise interest rates to curb spending and reduce inflationary pressures. Higher interest rates can make borrowing more expensive, slowing down economic activity and helping to bring inflation back within the target range. This can also support the value of the Lari, as the currency becomes more attractive to investors seeking a stable and low-inflation environment.

Conversely, when inflation is low or falling, the NBG may lower interest rates to stimulate spending and prevent deflation. Lower interest rates can encourage borrowing and investment, supporting economic growth and helping to bring inflation back up to the target level. However, this may also lead to a depreciation of the Lari, as the lower returns on Lari-denominated assets make them less attractive to foreign investors.

4. Exchange Rate Regime and Interest Rates

The relationship between the Georgian Lari and interest rates is also influenced by the country's exchange rate regime. Since 2009, Georgia has maintained a managed floating exchange rate system, which allows the Lari's value to be determined largely by market forces, with the NBG intervening only to prevent excessive volatility or misalignment.

Under this regime, changes in interest rates can have a more direct impact on the Lari's value, as the currency is free to appreciate or depreciate in response to market conditions. When interest rates rise, the Lari is likely to appreciate, as foreign investors are attracted by the higher returns available on Lari-denominated assets. Conversely, when interest rates fall, the Lari may depreciate, as the lower returns make the currency less attractive.

However, it is important to note that the relationship between interest rates and the Lari's value is not always straightforward, as other factors such as economic growth, inflation, and global market conditions can also influence the currency's performance.

5. Implications for the Economy

The relationship between the Georgian Lari and interest rates has significant implications for the broader economy. Changes in interest rates and currency value can impact investment decisions, trade flows, and economic growth.

When interest rates are high and the Lari is strong, it may make exports less competitive and imports more affordable, potentially widening the trade deficit and slowing economic growth. High interest rates can also discourage borrowing and investment, as the cost of credit becomes more expensive.

On the other hand, when interest rates are low and the Lari is weaker, it can make exports more competitive and imports more expensive, potentially supporting the trade balance and economic growth. Lower interest rates can also encourage borrowing and investment, as the cost of credit becomes more affordable.

However, it is important to strike a balance between supporting economic growth and maintaining price stability. If interest rates are kept too low for too long, it can lead to excessive borrowing, asset bubbles, and inflationary pressures, which can undermine the stability of the Lari and the broader economy.

Conclusion
The relationship between the Georgian Lari and interest rates is a complex and dynamic one, with changes in interest rates having significant implications for the currency's value and the broader economy. The National Bank of Georgia plays a crucial role in setting and implementing monetary policy, using interest rates as a key tool to maintain price stability and support sustainable economic growth.

When interest rates rise, the Lari tends to appreciate, as the higher returns on Lari-denominated assets attract foreign capital inflows. Conversely, when interest rates fall, the Lari may depreciate, as the lower returns make the currency less attractive to investors. Inflation and the exchange rate regime also influence the relationship between interest rates and the Lari's value.

To navigate this complex relationship and support the long-term stability and competitiveness of the Georgian economy, policymakers need to strike a balance between supporting growth and maintaining price stability. This may involve adjusting interest rates in response to changing economic conditions, while also implementing structural reforms and building resilience to potential shocks.

As Georgia continues to develop and integrate with the global economy, understanding and effectively managing the relationship between the Lari and interest rates will remain a critical priority for the country's policymakers, businesses, and citizens alike.