The Georgian government in the first quarter of this year has already fulfilled most of its 2012 budget plan to issue GEL 100-million worth of treasury bills. Since the beginning of the year, GEL 85 million in government treasury bills have been issued, including GEL 10 million in ten-year treasury bills issued in March. According to Prime Minister Nika Gilauri, the March issue marked the first time that demand for ten-year transactions was three times higher than the offer with the interest rate at 12 percent. The National Bank of Georgia (NBG) reports that the amount of new treasury bills now in circulation has increased overall by GEL 15 million so far this year.
When the government needs money, it can borrow from private companies and individual investors by selling treasury bills to finance its current deficit. Although the NBG has been prohibited from lending money to the government since 2005, it nonetheless has found an indirect way of doing precisely that. The NBG issues refinancing loans to commercial banks, which use those loans to purchase government treasury bills. Under that scheme, commercial banks receive loans from the NBG at a lower interest rate only to lend that money to the government at a higher rate. By issuing refinancing loans to commercial banks, the NBG artificially devalues money and decreases the interest rate.
According to NBG data, the average interest rate on loans to legal and natural persons was 21 percent in January 2012, while the weighted average interest rate at the auction for NBG refinancing loans that same month was only 6.56 percent. Consequently, commercial banks have no incentive to attract deposits on which they would have to pay an interest rate higher than 20 percent when the NBG lends them that money at a rate nearly three times lower. Commercial banks naturally prefer to invest free money in risk-free treasury bills on which profit is actually guaranteed.
In order to maintain interest rates at artificially lower levels, the money supply must necessarily be increased; on the other hand, when money is cheap, the demand for loans increases and the money supply grows. That is the functional equivalent of minting new money. The State Treasury thereby obtains new money at its disposal – money which has not come from the private sector. At the end of the day, all market players walk away with the same amount of money they started with and only the State Treasury ends up with more.
According to the NBG data, the money supply in Georgia has been increasing annually since 1995. In 2011, the increase in money supply was 15 percent more than it was in 2003. As data of the Georgian statistics service show, the annual amount of production output lags behind the increase in money supply. With such an increase, customers have more money to spend. If production does not grow simultaneously, product prices increase. There is then no demand for new Treasury money and, as a result, the purchasing power of the money already in circulation diminishes. However, the problems do not stop there. Customers react self-defensively to a rise in product prices: in an attempt to increase the purchasing power of their money, they start saving it.
Thus, it turns out that financing the deficit with inflationary methods automatically generates additional demand for money. This closed circle leads to another problem – an increase in debt. As NBG data for the years 2003-2011 show, the domestic debt has been growing annually since 2008.
Yet another negative effect of the NBG policy is a rise in inflation. In 2010, inflation in Georgia reached its record-high indicator – 11.2 percent. That same year, the Ministry of Finance sold an especially large amount of treasury bills, offering securities worth GEL 608 million on the market. NBG data for 2010 show that treasury bills then in circulation increased by GEL 186 million while the money supply for the same year grew by GEL 2.3 billion.
When new money enters into circulation, it is never distributed evenly. In this case, commercial banks have the privilege of being so-called “first spenders” while their customers do not enjoy the same low interest rate. Accordingly, the only participants in NBG auctions are commercial banks. The banks themselves do not offer treasury bills on the secondary market because they would then have to share their profit with natural persons.
Under these circumstances, the financial market does not, in reality, become healthier. Even more, when the state mobilizes financial resources at the expense of treasury liabilities, it in fact crowds out private capital from the free market and limits free initiatives.
The only possibility for job creation is an increase in capital (investments). Based on the Gross Domestic Product (GDP) and employment indicators for the year 2011, one can calculate how much revenue a capital holder must receive in order to employ one person.
According to data provided by the USAID-funded Economic Prosperity Initiative program, the GDP in 2011 totaled GEL 22.5 billion. Thirty percent of that amount was salary while the remaining seventy percent was income on capital, which included the use of the capital and profit of capital holders. That same year, around 1.6 million people were employed. Creation of one additional job thus costs a capital holder GEL 9,500.
The more GEL-9,500 amounts that the government leaves for companies to use on the free market, the more money individuals will be able to earn and spend and the faster the state deficit will be covered. Until then, there will be a constant threat that the deficit will be financed by inflationary methods – by minting money, either directly or indirectly.
This article first appeared in Tabula Georgian Issue # 92, published 19 March 2012.