Local currency lending in Georgia problems and solutions

Transcription

1 Local currency lending in Georgia problems and solutions Otar Nadaraia Deputy Governor National Bank of Georgia The views expressed are those of the author and do not necessarily represent those of the NBG Astana, EBRD, May 2011

2 Outline Dollarization Trends in Georgia and policy measures What works and what does not? Agenda for action Inflation indexation Hedging market development Making inflation targeting consistent with de-dollarization strategy Role of IFIs

3 Overview Georgia has high level of dollarization - about 70% of banking sector s loans and deposits are denominated in a foreign currency. Hyperinflation in early 90s. After introduction of the local currency GEL it remained largely stable % 1000% 7491% 2339% Annual inflation (logarithmic scale) 100% 57% 57% 10% 14% 7% 11% 11% 5% 5% 7% 8% 9% 11% 6% 6% 3% 3% 11% 1% However, as a historic legacy of period of instability high dollarization became broadly persistent. No administrative measures were/are in place, except: GEL is only legal tender for domestic transactions. De-dollarization incentives are embedded in the monetary and prudential policy of the Central Bank.

4 Sep-08 Oct-08 Oct-08 Nov-08 Nov-08 Dec-08 Jan-09 Jan-09 Feb-09 Mar-09 Apr-09 Apr-09 May-09 Jun-09 Jun-09 Jul-09 Aug-09 Aug-09 Apr-10 Apr-10 May-10 Jun-10 Jul-10 Jul-10 Aug-10 Sep-10 Sep-10 Oct-10 Nov-10 Nov-10 Dec-10 Jan-11 Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Policy Measures Monetary Standing facilities and refinancing operations From April, 2010 NBG activated standing facilities overnight loans and deposits with interest rates linked to the monetary policy rate (+/-1.5 pps). Interest rate have stabilized around the policy rate and liquidity of the interbank market has increased. 14% 12% 10% 8% 6% 4% 2% 0% TIBR 1 Activation of Monetary Policy Instruments NBG, up to limited amounts, has extended collateral base to include international bank guarantees and selected GEL denominated loans of commercial banks that increases the liquidity of loans disbursed in GEL. GEL funding has decreased dramatically during distress and thereafter recovered rapidly and remained steady Volume, GEL mln TIBR1 Policy Rate Overnight Loans Overnight deposits Refinancing Loans (GEL mln) Activation of Monetary Policy Instruments Dollar collateral for MOs has been abolished to focus GEL. However, caused higher liquidity needs in GEL

5 Aug-99 Feb-00 Aug-00 Feb-01 Aug-01 Feb-02 Aug-02 Feb-03 Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Policy Measures Fiscal administration and development of government securities market After the Rose Revolution the dramatic improvement in fiscal administration has lead to higher balances on GEL current accounts. From August 2009, Government started to issue treasury securities with maturities up to 2 years. In 2011 Treasury bonds with 5-year maturity were issued. Liquid treasury securities market shall stimulate GEL money/capital market development % 13% Treasury Securities (M. GEL) Yield curve 15.3% 12.6% Compared to 2005 T-securities stock increased 4.5 times, yield curve became flatter and maturities longer. 11% 9% 7% 5% 8.8% 8.9% 9.5% 7.1% 1day Months

6 Policy Measures Macro-Prudential To account for currency induced credit risk a capital charge is imposed on the unhedged position of the borrower. Countercyclical capital adequacy policy using currency induced credit risk weights (from 200% risk weight before distress to 150% after shock and currently up at 175%). Stress tests: top down and bottom up evidence. Macro stress tests indicate very high elasticity of NPL to depreciation. Micro-evidence indicating significant impact of depreciation on defaults when DTI > 30%. Debt payment to income for unhedged borrowers is calculated taking into account deprecation scenario. GEL liability volatility due to high share of current accounts is higher, but liquidity requirements are not as high.

7 Policy Measures Macro-Prudential (2) The NBG raised reserve requirements for foreign currency-denominated liabilities of commercial banks from 5 to 15%, and has broadened the reserve base by including senior loans and maintains preferential regime for GEL-denominated liabilities 10%. Local currency RR s can be maintained on average during the maintenance period and can be used for transactions, while RR for the foreign currency has to be maintained on frozen accounts. Policies targeting increase of consumer awareness (a part of consumer protection framework in financial services): Minimum standardized information for retail credit and deposit contracts includes adverse ER stress scenario. The banks should explain to consumers risks associated with unhedged position and before selling product in FX should propose the similar product in the domestic currency (if available). Dedicated website targeting consumer education on ER risk related issues ( )

8 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Dollarization trends in Georgia 90% Combination of abovementioned effects overall has contributed to an increase in GEL lending. 80% 70% 60% 50% However, dollarization still remains high, especially, in term deposits. 120% 100% 80% 60% Dollarization of loans 97% 75% 58% 51% 89% Dollarization of total deposits 98% 98% 99% 92% 90% 89% 62% Long term wholesale funding is 100 percent dollarized. 40% 20% 0% Current and demand deposits up to one month 1-3 months 3-6 months 6-12 months Above one year Jan-04 Mar-11

9 What does really work? Changing savers behavior There are the various factors contributing to dollarization (including Original Sin problem persistent in capital inflow driven emerging economies) but the fundamental problem stems from the behavior of the local savers saving for long term in FX. Broadly speaking there are 2 ways to change savers behavior: Policies creating cost incentives. Policies targeting trust. The optimal path of de-dollarization should employ a combination of both. However, the improper timing or excessive reliance on the cost incentives can incur heavy costs on the economy and can be counterproductive.

10 Changing savers behavior Cost incentives The cost incentives result in a higher premium for domestic savings. To assess the significance of the premium, a depositor survey was conducted which indicates that the perceived stability of the currency is the main factor when deciding on currency composition of the savings and only 27% give significance to the interest rate premium ( source: Mobilisation of Savings and Financial Capability). Additionally, the sensitivity to the premium was assessed. The results (on the next slide) indicate that the premium should be very high for significant number of the depositors to abandon FX savings. Such a high premium is prohibitively expensive for the borrowers and can contribute to the inefficiency of the economy.

11 Share of Those Willing to Switch Willingness to switch from FX to domestic savings On the example of one year term deposit 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% Interest Rate Premium Source: Mobilisation of Savings and Financial Capability

12 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Dollarization Dollarization Deposit dollarization: nominal exchange rate or premium? ( deposits above one year) Correlation between nominal exchange rate and dollarization 8% 6% 4% 2% Depreciation 0% -20% -15% -10% -5% -2% 0% 5% 10% 15% 20% 25% 8% 6% 4% 2% -4% -6% -8% -10% -4% -6% -8% -10% Correlation between premium and dedollarization 0% -2% 0% 1% 2% 3% 4% Interet rate premium 99% 97% 95% 93% 91% 89% 87% 85% Positive relationship between YoY changes of dollarization and nominal USD rate indicate high sensitivity. At the same time, more volatility of exchange rate at later stage should be considered. Granger causality tests indicate that nominal exchange rate leads changes in dollarization rate. No direct evidence of negative correlation or causality between dollarization and premium. Interest rate premium (RHS) Dollarization (LHS) 4% 3% 2% 1% 0%

13 Changing savers behavior Targeting trust Savers behavior can be a rational response to hedge their future stream of spending against uncertainties about domestic fiat money. Long term nominal depreciation is the crucial factor affecting savers currency composition. To regain the trust decades of nominal exchange rate stability will be needed. This process can be accelerated if another party from which the uncertainty stems is involved in the process. The right incentives can give more credibility to the de-dollarization process. This can justify a more proactive role of the policymakers to solve the market failure expressed in the misalignment of the market expectations and actual monetary policy.

14 Inflation Indexation To increase trust in the currency, inflation indexation should be used. Initially to jump-start the inflation indexed products government should issue T-Notes indexed to inflation. Gradually deposits and other financial products are linked to inflation. For the success a credible inflation index is crucial. Government inflation linked securities will increase the expectation that not only the monetary side, but also the fiscal side will have strong incentives against inflation. It should be noted that pension reform is an important source of local currency funding. Inflation indexation can help to start the reform.

15 Hedging market development Hedging market development is hindered by: the fact that most market participants are on the same side of the market. The price discovery is difficult given that there are no benchmarks. The result is a too expensive hedge like in case of TCX. Hedging market development T-bills in FX by MoF FX swaps by the CB FX forwards by MoF In limited quantities to create benchmark to jump-start hedging market Natural Hedge (in the open economy given small external public debt). Long term costs are zero given the consistent MP. Gov. has better information vs. market who does not trust MP. Along with TCX, there are some market participants who are willing to be long in emerging market currencies for a more or less reasonable price. However, in case of Georgia the amounts are very small and maturities short term.

16 Nominal exchange rates Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 GEL/USD GEL/EUR

17 Minimizing possible negative effects from the de-dollarization policy Rapid de-dollarization can make emerging countries more vulnerable to the external shocks. depreciation can trigger rapid re-dollarization and can increase procyclicality. To mitigate this risk high level of international reserves will be necessary. LLR in FX. To avoid further ER pressures and losses for the CB. Regulatory arbitrage: prudential incentives to de-dollarize can promote regulatory incentives to shift riskier activities towards local currency. De-dollarization during a balance of payment shock can further exacerbate the negative impact as it will increase the cost of external funds.

18 Designing Inflation targeting (IT) regime consistent with de-dollarization strategy IT should target inflation consistent with BSE, minimizing the probability of nominal long term devaluation. Exchange rate appreciation should be the last option to be used against inflation. An undervalued exchange rate will decrease the probability of nominal devaluation in the case of external shocks. Side effect of the above policy will be accumulation of FX reserves which can give further credibility to the domestic currency. As long as capital mobility is limited and hedging market is underdeveloped, use of FX monetary instruments should be at least considered.

19 Role of IFIs EBRD s Local Currency and Local Capital Markets Initiative is highly welcomed. In April 2011, MOU among EBRD, NBG and MOF has been signed. According to the MOU: The EBRD may provide local currency loans to eligible financial and other private sector institutions at interest rates which aim to catalyse the local currency loan markets in Georgia. The MOF and the NBG may apply for technical assistance/cooperation to support dedollarization process. In 2010 EBRD did a preliminary assessment to underline the main issues to encourage the de-dollarization process in Georgia. As a result EBRD provided some recommendations to Georgia. Currency exchange fund (TCX) can be an important initiative to provide long term local currency hedging instrument. Issuance of long term GEL bonds by IBRD should increase investors interest in to provide funding in local currency. IMF assistance in developing macro stress test framework capturing Currency Induced Credit Risk was beneficial.

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