Opinion

Inflation in Georgia – Causes and Cures

by | Jul 17, 2012

Irina Guruli is program coordinator at the Economic Policy Research Center.

In 2011 inflation can be regarded as one of the major challenges for the Georgian economy, writes Irina Guruli, program coordinator at the Economic Policy Research Center.

Even though Georgia has been successful in suppressing the inflationary pressure down to below two-digit figures over the years, 2011 turned out to be quite a challenge in this regard. Since the second half of 2010, inflation has taken on a growth tendency and equaled to a two digit figure for most of the year 2011, inflation peaked in May 2011 with 14.3% y-o-y change, a record high for the past three years, and started decreasing in line with the decrease in international food prices and continues to do so. Thus, researching major causes of inflation has become essential.

The world has seen acute spikes in oil prices in the beginning of 2011; according to the National Bank of Georgia (NBG) this increase in prices was named as a major cause for elevated inflation in Georgia. Of course, for an economy of Georgia which is import-dependent, changes in global prices on food and oil products have a crucial effect. This is further proved by the statistical data that shows correlation between inflationary peaks in Georgia and global price spikes.

However, we believe that inflation causes are much more complex, interrelated set of circumstances. To name just a few, remittances in their nature are inflationary. According to the information received from NBG, remittances sent to Georgia have exceeded 1 billion USD in 2011 (through formal channels only), which is considerably more than the foreign direct investment (FDI). Even though remittances play a big role in raising the standard of living for the recipients, they can also trigger inflation, since people’s increased purchasing power drives up prices, and domestically produced goods are replaced by imports. Therefore, remittances are viewed as leading to excessive consumption, import dependency, hence contributing to inflation, because the largest share of remittances are believed to be used for consumption, and just a small part of it for saving and investments.

Inflation can also be triggered by constant fiscal deficit and large external state debt. Even through fiscal deficits have decreased in Georgia, deficits remain high, and the donor support are expected to be wound down and debt requirements remain large over the medium term. Deficits in their turn increase foreign obligations, since they are mainly financed through an increased external debt. Excessive foreign debt directed towards financing mainly social obligations are inflationary. Since 2005 there is a close correlation between the pace of increase of foreign debt and social outlays. This means that the primary source for the social assistance programs is provided by the foreign debt facility. Plus, increases in social expenses appear to be driven by conjuncture factors and not by a careful planning process. Abrupt swings in this particular category of the budgetary expenditures can create inflationary pressure on the economy and might deteriorate the government’s liquidity position. Therefore, we believe it was wasteful to distribute food (30 GEL) and energy (20 GEL) vouchers by further burdening the central budget with social obligations. The mentioned vouchers cost 60 million GEL, while it brought little benefit, instead the capital could have been directed to more profitable opportunities bringing long-term benefit and growth, or in extreme case distributed to those most in need.

Therefore, we believe that high inflation in Georgia was largely caused by imported factors and an unbalanced budget, not by major problems in the monetary policy. Abrupt swings in the category of the budgetary expenditures (especial social) heavily contributed to creating inflationary pressure, since this particular category is positively correlated to consumption.

Is the government of Georgia ready to address the above mentioned issues with due diligence? In this regard an initiative concerning a decrease in share of food in the consumption basket is of interest.

Starting from 2012, the National Statistics Office of Georgia has updated the consumption basket by decreasing the share of food in the basket, thus causing controversial views among the public. The controversial issue with the changes is the following: have the shares of the consumption basket been accommodated to show an illusionary low inflation? Major change is a 9.8% decrease in the share of food and non-alcoholic beverages, prices on which has been persistently increasing globally starting from the second half of 2010. This 9.8% has been distributed among other fields: for example, alcoholic beverages increased by 2.6%, transport by 2.4%. Interestingly enough, the share of housing, water, and electricity and gas expenses has decreased in the consumption basket, while the utilities expenses have increased in average households due to an increase in the notorious waste removal service fee. At the same time, the share of communications has increased in the consumption basket, while this field has been undergoing drastic decrease in prices, i.e. with -14,2% in 2011 as compared to 2010.

Even though a decrease in the share of food in the consumption basket will not affect the core inflation indicator, since it excludes prices on food and oil products, the rationale given above might as well cause a biased inflation indicator. How to justify the correctness of the adjustments made to the consumption basket? Generally speaking, the share of food in the consumption basket declines with an increase in the standards of living. In other words, the share of food in the consumption basket is subject to decrease once the country is going through a development path, since the customers with higher disposable income prioritize other activities: such as cultural and entertainment, etc.

When comparing Georgia with other countries with similar economic indicators, IMF shows that Georgia has the lowest share of food in its consumption basket. For example, the share of food in the Azeri consumption basket is just below 50%, with Tajikistan having the largest share with 60%. It is noteworthy that the median weight of food in advanced economies is 17 percent, whereas it is 31 percent for emerging and developing countries.

Moreover, it will be interesting to compare the standard of living for these selected countries and see if the above stated assumption regarding the relationship of living standards with food share in the consumption basket holds true. The rankings for human development index are given for 187 countries, with Georgia currently on 75th place, while for GDP per capita Georgia ranks 145th among 226 countries. Thus, the extent of development that should be the measure for the food share in the consumption baskets does not hold true for Georgia.

To sum up, we believe that the share of food in the consumption basket should coincide with the development index of a country, therefore it does seem a little odd that the consumption basket of Georgia has the lowest share of food in comparison to other countries with similar economic indicators, and is exactly on the developing countries’ threshold of 30%. If this number is not representative we will come up with an overestimating optimistic headline inflation rate. We believe that a decrease in share of food in the national consumption basket shall influence the overall headline inflation figure, and in case of low core inflation, show a slight decrease in headline inflation as well.

Out of the possible causes of inflation the only one under the governmental control is the problem of fiscal deficit which we believe is one of the largest contributors to inflation. Since the rest of the factors are exogenous in nature, the government should increase its efforts towards fiscal consolidation, decreasing unnecessary social expenditures, mostly this concerns one time programs and campaigns that are directed towards increased consumption and represent a heavy toll on the central budget. This capital should be invested in long-term profitable opportunities, instead bringing sustainable paybacks and by this easing the conditions of the socially disadvantaged. Such opportunities might be investments directed towards the production of fruits and higher value vegetables that Georgia has a comparative advantage in. Therefore, we think that an unbalanced budget poses the highest threat to the economy, especially in conjunction with increasing internal and external debt. The recent global crisis proves this postulate. The countries with the highest state budget deficit, unsound fiscal expenditure polices and large debt stocks, suffer the most from poor economic growth.

 



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