Tamar the Great looks stern on the 50 Georgian lari banknote. And the first woman to rule Georgia in the country’s golden age in the XII century has reason to worry: in the past 12 months, the value of GEL50 has dropped from $30 to little more than $20. But as the Georgian currency celebrates a bittersweet 20th anniversary with a colourful makeover, economists maintain the devaluation was necessary and effective, and that a stabilising economic environment could make for a brighter 2016.

It’s been a difficult year for the Georgian economy as lower oil prices and Russia’s recession slashed the country's main sources of income. Remittances, over half of which come from Russia, have been one casualty. In the first nine months of 2015, they amounted to $802mn, down 26.7% year on year (y/y), confirming the downward trend of 2014 when private money transfers accounted for 8.7% of GDP. Foreign trade has been another victim as the economies of most of Georgia’s trading partners, namely Russia and others in the Commonwealth of Independent States (CIS), nosedived. Through September, foreign trade totalled $7.3bn, marking a 13% drop y/y, as demand for Georgian goods dropped, in particular exports to CIS countries, by 44% y/y.

Higher inflation risks and currency pressures have led the National Bank of Georgia (NBG) to tighten monetary policy. However, next year regional economies should adjust to the weaker oil price and Georgia could become “healthier” with a stabilising currency and gradually declining inflation and interest rates, maintains Oleg Kouzim, an economist with Renaissance Capital. “We see it roughly flat next year, but the lari could be taken stronger or weaker by the Russian ruble and the Turkish lira,” Kouzim tells bne IntelliNews. “The big adjustment of the lari this year was mainly triggered by the ruble and the Azerbaijani manat.” Azerbaijan is Georgia’s main trading partner.

Georgia has consistently run current account deficits over the last decade – not unusual for a country at Georgia’s stage of economic development. Ricardo Giucci and Stephan von Cramon-Taubadel, economists at the German consultancy Berlin Economics, recently argued in a paper that, “to ensure that the current account deficit does not grow beyond sustainable levels and facing [the] threat of a major loss in international competitiveness, the depreciation of the lari was a necessary response”.

An analysis conducted by the two economists showed that the devaluation led to a drop in the country’s trade deficit in April-August compared with the same period in 2014 by about $500mn.

Let it float

The introduction of the lari, or hoard in Georgian, on September 25, 1995 was regarded as a new beginning after the initial, ill-fated attempt to replace the Soviet-ear currency with the kouponi (aka ‘coupon’). This was introduced in April 1993 at par with the ruble, but the rate held for just a couple of weeks, before Georgia entered a spiral of hyperinflation that in a few months peaked at 15,607%. By September 1994, $1 was worth about 5mn kouponi.

“People would go out with suitcases to buy the few grocery items available,” recalls Badri Japaridze, co-founder and deputy chairman of Georgia’s largest retail bank TBC Bank. “At one stage you needed tens of thousands of coupons to purchase matches.”

The central bank decided to peg the lari to the US dollar in a bid to boost the new currency’s credibility and use. The peg proved unsustainable: by the end of 1998, the pressure on the lari had forced the NBG to significantly deplete its reserves in trying to prop it up. Allowing the currency to float freely from December 7, 1998 triggered an immediate devaluation by 20% against the greenback and a spike in inflation.

Despite the poor start, the lari has proved more resilient over the last decade, fluctuating around GEL1.65 to the dollar. That has not necessarily been a good thing. Yaroslava Babych, assistant professor of economics at the International School of Economics at Tbilisi State University, argues that its “stability may have affected the market’s expectations about the value of the lari, causing households and businesses to ignore the currency risks when deciding in which currency to borrow in”.

As a result, Georgians confidently borrowed in dollars, pushing the dollarisation of the economy to dangerous levels. When the lari began dropping sharply in November 2014, Georgians were caught by surprise. Economists on the other hand were not so shocked, arguing that the local currency was in fact overvalued and has since adjusted to a value that better reflects the country's economic fundamentals. “The lari move was in fact needed to remain in line with the main [trading] partners,” explains Kouzim.

Since the currency started falling, the NBG has intervened a handful of times, but only marginally to prevent major fluctuations, in general opting to safeguard reserves. The central bank governor, Giorgi Kadagidze, uses other countries’ experiences to justify this stance, telling bne IntelliNews in the spring that going against market fundamentals never ends well. “Spending reserves to cover up the fundamental shortages will not help at all – it would only postpone the problem,” he said.

Both national and international financial institutions are on the same page. “It is crucially important that we keep a free floating currency to maintain our competitiveness and that foreign reserves are not burned to keep the lari’s rate artificially [high],” Japaridze contends.

Not everyone agrees. Some politicians of the ruling Georgian Dream coalition accuse Kadagidze, the last high-ranking official left from the previous administration led by former President Mikhail Saakashvili, of failing to protect the lari.

Economists mostly agree that the central bank’s first priority should be to maintain economic stability and that pressure on the central bank to support the lari’s value and ease financial headwinds are “misguided”. “[Strong intervention] would have come at the cost of a major loss in international competitiveness and the risk of destabilising the entire economy,” maintain Giucci and von Cramon-Taubadel, “Furthermore, given the limited foreign currency reserves, the NBG could have pursued this strategy for a limited time.”

However, public concern and calls to “do something” are understandable. Despite the central bank push for a larization of the economy, about 60% of outstanding loans are still in dollars. “It is difficult to motivate people to borrow in lari; households and businesses took out mortgages and loans in dollars even when the lari was stable. However their income is in local currency and suffer when the lari goes down,” explains Japaridize, who advocates for more “eurozation” if it is foreign currency loans that people want. “We mainly trade in euro; trade with the EU was up by 6% in the first nine months. There is no logic in the greenback dominance.”

For Japaridze it is time to go beyond the headlines. “The media failed to explain properly the devaluation – the drop had a strong psychological impact, it will take people some time to regain trust in the lari.”

And that is probably more than any makeover in the currency’s design can achieve.