GEORGIA'S CENTRAL BANK GOVERNOR UNDER FIRE

C O N F I D E N T I A L SECTION 01 OF 02 TBILISI 001140 SIPDIS SIPDIS STATE FOR EUR/CARC AND EB/IFD/OMA COMMERCE FOR 4231 DANICA STARKS TREASURY FOR OIA E.O. 12958: DECL: 05/16/2017 TAGS: PGOV EFIN GG SUBJECT: GEORGIA'S CENTRAL BANK GOVERNOR UNDER FIRE REF: TBILISI 1065 Classified By: Ambassador John F. Tefft, reason 1.4(b) and (d). ¶1. (C) Summary: Roman Gotsiridze, the president of the National Bank of Georgia (NBG),Georgia's central bank, came under withering criticism in Parliament after he presented the Bank's annual report on May 10. Parliamentary criticism reflected a less than exact understanding of the interplay between the causes of inflation and the reasons for the continuing pressure for appreciation of the lari. However, it did indicate a weakening of Gotsiridze's heretofore relatively secure position at the head of the central bank, which he has maintained despite some real questions, by real experts, as to his ability to manage the country's monetary policy. The NBG's report must be approved by Parliament. If Parliament fails to do so, it may trigger Gotsiridze's resignation or removal. End Summary. ¶2. (SBU) The Chairman of the Parliamentary budget committee, Irakli Kovzanadze, took issue with the NBG annual report's conclusion that inflation (8.8 percent in 2006) is mainly due to "external factors" including the Russian embargo and rising prices for energy. The influential Speaker of the Parliament, Nino Burjanadze, expressed her disapproval of his performance as well. Gotsiridze defended himself, saying that "no one could prevent inflation when there has been a fourfold increase in gas prices since 2005." ¶3. (SBU) Besides inflation, Kovzanadze also questioned the NBG's recent more relaxed attitude toward appreciation of the lari, which is to a large extent driven by inflows of foreign investment, such as last year's successful USD 150 million stock offering on the London Stock Exchange by the Bank of Georgia (a commercial bank, not to be confused with the NBG). However, fighting both inflation and currency appreciation at the same time is a difficult trick for any central bank. A tighter money policy, designed to attack inflation, tends to put upward pressure on the currency as the supply of domestic exchange is reduced. Thus, the IMF has counseled the NBG to be more flexible regarding the lari. The IMF has also pointed out to the GOG more than once that increases in government spending also tend to push up inflation, and suggested that excess revenues go to reduce indebtedness. It is Kovzanadze's Parliament that approved two supplemental budgets in 2006 and is looking at another one now that will increase overall spending by 20 percent over 2006 in 2007 (reftel). ¶4. (C) What experts have found wrong with Gotsiridze's leadership is his failure to support creation of effective tools for managing Georgia's money supply. The NBG has begun packaging government securities into marketable bonds, but has been reluctant to offer interest rates high enough on them to attract the interest of commercial banks without sweeteners -- such as the exchange of the Bank of Georgia's entire proceeds from its IPO in London in return for its purchase of bonds at lower rates than it would otherwise accept. The amount of such securities that the bank has been offering is rather small to affect the money supply in a meaningful way. Besides bonds, the bank is also marketing its own certificates of deposit (CD's). It has begun to offer rates that are making the CD program more effective. The NBG needs to take a more pragmatic approach to pricing its securities and CD's in order to manage the currency inflows the government is expecting, including the likely prospect of USD 132 million from the sale of UEDC to the Czech company Energo Pro. Gotsiridze has been slow to recognize that the real purpose of open market operations is promoting price stability and fighting inflation, not making a profit on his portfolio. ¶5. (SBU) On a more optimistic note, after a visit to the New York Federal Reserve Bank in April by many of its members, the NBG board took the New York Fed's recommendation and is introducing a new reserve requirement policy. The NBG's policy is aimed at encouraging a more proactive approach from commercial banks in their reserve management operations. It is the first step towards creating a fully functioning inter-bank market in Georgia and will make the development of a fully functional open market desk at the NBG much easier. The new policy will begin to be implemented in May and all new requirements will be mandatory on January 1, 2008. The NBG is working now to familiarize the banks with its new policy. ¶6. (C) April 2007 monthly inflation was 0.3 percent, which TBILISI 00001140 002 OF 002 brought twelve-month inflation ending April 2007 to 8.11 percent, compared to 9.72 percent for the twelve months ending in March. Even though reported inflation has now dropped to a less troublesome level, it continues to be at a level requiring more effective tools in the hands of the NBG, and more responsibility for inflation must be accepted at the Ministry of Finance for the Government's relatively loose fiscal policies. There is enough blame to go around. The public and parliamentary focus now seems to be on Gotsiridze, although perhaps not for the right reasons. TEFFT