POLITICS

Could Wars Be Avoided?

OP-ED BY NUGZAR B. RUHADZE

Albert Einstein - 'I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.' I’ve been taking this famous quote by the genius very seriously since the Russian president’s recent verbal threat of nuclear assault resonated throughout the world. Scary, wasn’t it?

To bring my negatively-impressed self to senses, I went to one of wonderful Albert’s more encouraging thoughts that peace cannot be kept by force but can only be achieved by understanding. These words fi ll my boggled mind with some confi dence that wars can be avoided if Man starts thinking more rationally and a little wiser than, let’s say, in the time of Mongolian invasions 700 hundred years ago, which resulted in 60 million deaths. Incidentally, the Second World War went something over that fi gure, which means that Homosapiens have not changed their attitude about violence as such in the thousands of years they have been around. Isn’t this funny? We are still killing each other with the same medieval ease and determination, all the while raising the gravest questions about modern human behavior.

The thinking part of the world might still remember that in the recent past, the well-known brief encounter between United States President Donald Trump and North Korean Leader Kim Jong-un gave impetus to a frightening awareness that Mankind is moving closer to a nuclear war. Putin’s hot remark (let’s reservedly call it ‘remark’) on the same subject has strongly substantiated that ominous presumption. Auspiciously, the scientifi c forces in the field of psychological research are not idle and seem to be optimistic when it comes to the question of whether wars could be avoided.

Provided the answer to this question is positive, another one pops up forthwith: How to do that? How to actually prevent war and make our beautiful earth a safer place to live? Well, if in the past several millennia, Man has not been able to get its act together and fi nd a way to establish stable peace on planet Earth, how could a regular contemporary researcher do the job overnight? But “There is Still Hope, Brother” – this is the optimistic phrase in the fi nale of the 1959 Stanley Kramer’s post-apocalyptic science fi ction drama fi lm ‘On the Beach’, depicting the aftermath of a nuclear war. Having seen that movie, one would not only not threaten their fellow planetdwellers with nuclear attack, but would never think about it even in their most vicious imagination.

Writing this, I certainly have in mind the current Russian-Ukrainian war and the possibility of avoiding it if the parties to it, as well as their outside ‘helpers’, had acted more wisely and more rationally, as a result of which the unwanted and totally unjustifi ed bloodshed could have been prevented. I will only attempt here to construct a hypothetical model of a happier development of events: A healthily and pragmatically thinking third party was found and assigned by the international community to take on a logically-strong mediation- honestly, professionally and perseveringly looking for solutions to the dispute between USA-NATO and Russia to resolve the prolonged prewar confl ict between them. In doing so, said mediator tried to let both Russia and Ukraine save face and maintain a positive moral image, not letting any of the sides lose sense of their long-earned international authority. The chosen mediator was moderately successful in building trust, encouraging communication among all actors in the given version of prewar interaction, being sure that all parties had a genuine trust of the mediator. The mediator arranged give-and-take exchanges between the confl icting parties, reducing hostilities and building trusting relationships with fi nal confl ict-defusing mutual proposals. The extant psychological research suggests that distrust can be reduced and peace promoted if confl icting nations or groups are engaged in specifi c cooperative ventures with mutual benefi ts, and the mediating interventions are most effective when they involve interactions, considering equal status, common goals and cooperation. More attention needs to be given to developing and implementing prevention strategies that remove the conditions for confl ict and war, which was not verily done by America, NATO and Russia before the war became inevitable. Adopting preventative strategies based on cooperative ventures with mutual benefi ts is invaluable. The social network threats can simply fuel the fi re of confl ict, but wellthought-out strategies for mediation and cooperation may well help to extinguish it. And there is no doubt whatsoever that prevention is better than cure.

Georgia’s Balancing Game

ANALYSIS BY EMIL AVDALIANI

Russia’s war on Ukraine is transfi xing the world, and for obvious reasons. The sheer brutality and the size of the attack on Europe’s second-biggest state grab all the attention. But under the radar, there lurks another place where Russia’s actions are closely watched, feared, and even anticipated should the offensive in Ukraine present even short-term opportunities to the Kremlin.

Georgia is the other country mentioned in Russia’s security demands made in December and addressed to NATO and the EU. The country has waged war with Russia, in 2008, has been invaded, and has two regions occupied (Abkhazia and Tskhinvali, often incorrectly referred to by the Soviet-invented term of South Ossetia.) As you would expect, Georgia is focusing very closely indeed on developments.

Russia’s decision to confront its “Ukraine problem” is only a part of a larger program of pushing Western infl uence away from its immediate neighborhood and restructuring the European security order. And Georgia is a critical piece of the puzzle. The fear is that if Russia is victorious, it would turn its attention to Georgia. An immediate military campaign is unlikely, but the Kremlin might plausibly extend demands that the country renounces the promise made through NATO’s 2008 Bucharest summit that it will one day become a member. Russia could use its small, but heavily armed forces in Abkhazia and Tskhinvali to threaten Tbilisi, which is some 50-60 kilometers away from the occupied zones.

This fi ts the new order Russia has been seeking in the South Caucasus following the Second Nagorno-Karabakh war of 2020. The 3+3 initiative which aims to gather together the three small South Caucasus states and Russia, Turkey, and Iran, is viewed with suspicion by most Georgians. But if Russia wins in Ukraine, Georgia may fi nd it hard to resist the pressure.

This partially explains why the Georgian government has been so careful about its position on Russia’s invasion. The mood is febrile, as indicated by days of anti-government demonstrations following Prime Minister Irakli Garibashvili’s statement that his country would not impose sanctions on Russia. Later on, Georgian volunteers were reportedly prevented from fl ying to Ukraine (later denied by the Ukrainian ambassador himself), which caused President Volodymyr Zelenskyy to recall his envoy from Georgia.

Internal pressures and wider geopolitical motives put Georgia in a precarious geopolitical position. It needs to simultaneously look attentively at how Ukraine-EU ties develop, not anger Russia, and also respond to wider proUkrainian sentiment. Many remember how Ukrainian President Victor Yushchenko enthusiastically supported Georgia in 2008 and even visited the capital when Russian troops were just 30 kilometers away.

By attempting a nuanced approach, Georgia may be running a risk. In an age of near-unifi ed sentiment against Russia, neutrality could be harmful to a country that made its formal application for European Union (EU) membership on March 3. The war in Ukraine also indicates the status quo ante is no longer feasible. The EU is now emerging as a geopolitical player following its actions against Russia in the last week and the European Parliament has backed Ukrainian membership. Moldova too has applied.

Much will depend on how far Russia’s invasion progresses in Ukraine. Cracks in Western resolve will only embolden the Kremlin and push it to act against other neighboring states seeking EU and NATO membership. This precarious geopolitical situation and Georgia is trying to walk a fi ne line.

But here a longer term perspective should prevail: the sudden and nearunprecedented Western unity of 2022 is likely to remain.

Russia is turning into what analysts refer to as a “fortress” and is preparing to launch a battle, non-military or otherwise, from the Baltic to the Caspian Sea. Despite its dismal military performance in Ukraine, Russia has signifi cant military and intelligence capabilities; the West has enormous economic, diplomatic and soft power. In the end, the democratic world will prevail against a Kremlin that has painted itself into a corner.

How we get from here to there is a question that may present some diffi cult answers.

THE ISET ECONOMIST

A BLOG ABOUT ECONOMICS AND THE SOUTH CAUCAUS www.iset-pi.ge/blog

The ISET Policy Institute (ISET-PI, www.iset-pi.ge) is an independent think-tank associated with the International School of Economics at TSU (ISET). Our blog carries economic analysis of current events and policies in Georgia and the South Caucasus region ranging from agriculture, to economic growth, energy, labor markets and the nexus of economics, culture and religion. Thought-provoking and fun to read, our blog posts are written by international faculty teaching at ISET and recent graduates representing the new generation of Georgian, Azerbaijani and Armenian economists.

Dollarization of Bank Deposits in Georgia: What Everyone Should Know

BY ARCHIL CHAPICHADZE, YAROSLAVA BABYCH

The term “dollarization,” commonly used among academic economists and finance specialists, has already entered Georgians’ everyday vocabulary. Few people, however, understand what dollarization is, how it comes about, and why they should care. Below, we try to fi ll this gap, explaining some basic concepts and discussing why and how dollarization affects ordinary people’s lives.

WHAT IS DOLLARIZATION, EXACTLY?

The term dollarization offi cially refers to the legal substitution of domestic currency by a foreign currency (De Nicolo et al., 2003). Examples include Zimbabwe, a country that struggled with rampant infl ation before legalizing the use of the US dollar alongside the domestic currency in 2009, and then, six years later, completely suspending the use of domestic currency. Unoffi cially, however, the term dollarization is used to denote the usage of foreign currency that is not legal tender alongside the domestic currency (Yeyati, 2006). This typically means that while the use of foreign currency is prohibited in offi cial transactions, foreign currency is still used very commonly, for example, to index certain types of transactions (like selling or renting real estate in Georgia), or to store value (e.g., saving money in USD or Euros instead of Georgian Lari).

HOW CAN WE MEASURE THE EXTENT OF DOLLARIZATION, AND HOW DOLLARIZED IS THE GEORGIAN ECONOMY?

There is not one single way to measure the extent of dollarization. For example, we can never know exactly the share of renters in Tbilisi that pay their rent in USD or USD equivalent (although one can guess that the percentage is quite high). But there are some proxy measures, i.e., easily observable indicators, which can tell us about the general trend in dollarization. One such measure is the share of bank deposits denominated in foreign currency. This indicator directly shows which currency people prefer for their savings, and, indirectly, to what extent people are tied to the use of foreign currency in various fi nancial transactions. In Georgia, the process of bank deposits being dollarized has been slowing down recently. However, dollarization levels have been well above 50% for the last 20 years (Graph 1).

This is not just a problem for Georgia. Dollarization of bank deposits (also known as asset dollarization) tends to be a particularly stubborn problem affecting many emerging economies. In this group, Georgia stands among the highlydollarized cohort.

WHY IS DOLLARIZATION SO PERSISTENT IN EMERGING ECONOMIES?

As one can see from the graph, in 20022004, deposit dollarization hovered around 85%; at the end of 2020, the deposit dollarization ratio was 62.75%— much lower but still quite high. Financial dollarization is so stubbornly persistent precisely because it is not a black and white phenomenon. Like many things in life, it has both positive and negative sides. First, let’s discuss the possible benefi ts offered by dollarization. 1. Some argue that the biggest advantage of fi nancial dollarization is the hedging of exchange rate risk for commercial transactions. Imagine a Georgian fi rm that has foreign partners who have to be paid in dollars. Would it not be more natural to keep dollar deposits to make the transaction process easier? That would also eliminate exchange rate risk (imagine having to pay more in terms of GEL because of an unexpected jump in the exchange rate. That would not be an issue if the transactions were made using dollar deposits). It should be emphasized, however, that if the payments need to be made in Euros or other non-USD currency, dollarization won’t provide the benefi ts mentioned above. This counterargument is valid for Georgia too, which has trade relations mostly with Turkey and the Eurozone. 2. Financing transactions that are defacto dollarized (e.g., real estate purchases). Because in emerging economies, including Georgia, many construction companies rely on foreign investors for fi nancing, and payments of dividends may be tied to the dollar, it is more convenient to express prices in dollar terms. Moreover, since some materials have to be imported, just as in the previous case, it is easier to keep dollar deposits to make dollar payments. 3. Another reason is obvious to anyone who remembers life in the region in the 1990s: clearly, asset dollarization guarded against high infl ation and protected savings from the erosion of value. The roots of the dollarization problem in Georgia in particular can be traced to the unstable political and economic environment after the fall of the Soviet Union. The accelerating infl ation and volatile political setting during the transition to a market economy eroded confi dence in the national currency. Underdeveloped fi nancial markets and dependency on money transfers from abroad nourished dollarization in the Georgian economy. 4. People/businesses may also keep their liquid assets in foreign currencies due to other considerations: a) The procyclical nature of exchange rate risk in emerging market economies: during periods of recession or low growth, emerging economies typically observe devaluation of their currency against the US dollar (Cordella & Gupta, 2014). If a Georgian business has a loan denominated in USD, then during a recession they will face a double burden: devaluation increases the GEL value of their debt, even as their GEL revenues decline. Hence, a business may choose to keep part of their deposits in USD to protect themselves during a recession. During times of strong economic growth, the opposite may happen: dollar deposits may lose their value due to appreciation of the GEL. This effect, however, is dampened as the negative impact is less noticeable because of the growing economy. b) Devaluation could translate into price increases for imported goods. We do see evidence of the correlation between import price infl ation rates and GEL/ USD exchange rate changes in Georgia (graph 2). Hence, for people and businesses who rely heavily on imported goods for consumption/production, keeping savings/assets in USD provides a hedge against import price increases. 5. Finally, the high volatility of the exchange rate may in itself contribute to a high level of dollarization in the economy, as people become increasingly uncertain about the value of the domestic currency.

WHAT ARE THE DRAWBACKS OF DOLLARIZATION?

The high level of dollarization is a serious challenge for the country. There are a number of reasons why dollarization may hurt the economy, but those immediately obvious to a non-expert are the following: if the economy is highly dollarized, the risks in the banking system rise; the real economy becomes more unstable and exchange rates become more volatile. Imagine having liabilities in USD and income in GEL. Hence, if you expect the GEL to depreciate, you are likely to start buying dollars. When a lot of people behave this way, the demand for GEL decreases and it loses value, depreciates against the dollar, as anticipated. The most interesting part of this mechanism is that the expectations might have arisen without any logical explanation, bringing real changes to the economy and increasing its volatility. The increased volatility of the exchange rate then feeds into the process of dollarization, creating a vicious cycle that prevents dollarization levels from falling and giving rise to a so-called “dollarization hysteresis” (a phenomenon that is responsible for persistence of dollarization even as the exchange rates stabilize). That could affect the debt burden and the profi tability of such fi rms. The expectations mechanism is further augmented by the common nature of currency mismatch in Georgia, meaning that many citizens’ assets and liabilities are expressed in different currencies. It has already been mentioned that a signifi cant part of Georgian citizens’ debt is denominated in USD, because of the lower interest rate offerings by domestic banks on loans in USD. Consequently, the balance sheet of such debtors is prone to exchange rate risk, because their source of income is in a currency different from USD. These debtors might be particularly responsive to expected changes in the exchange rate, buying dollars when they expect the GEL to depreciate or buying GEL when they expect the GEL to appreciate. These transactions will bring forward changes in the exchange rate, which might be based solely on these expectations and the actions from debtors in response to expected changes in the exchange rate.

WHAT CAN BE DONE TO REDUCE DOLLARIZATION?

As we saw, while asset dollarization can make sense to individual market actors, it poses signifi cant risks for a country and fi nancial system as a whole. Reducing dollarization has been high on the Georgian government’s agenda. In 2016, the National Bank of Georgia (NBG), together with the Georgian government, adopted a 10-point Larization plan. As part of the Larization policy, loans of less than 100,000 GEL could only be issued in local currency. Since 2019, the threshold has moved to 200,000 GEL. It has also become compulsory to denote real estate prices in GEL. Moreover, the government offers subsidies to induce citizens to de-dollarize their loans. However, despite the Larization policies currently in place, the dollarization level of deposits still remains high in Georgia (the 2020 average rate was 66.36% (NBG)). Clearly, people who keep their deposits in USD are not irrational. For the reasons already discussed above, if the overall dollarization level in the economy is high, it can make more sense for individuals to keep their assets in dollars as well. Given that bringing down the average dollarization level in the economy is not an easy task (it takes time), we can expect that the asset dollarization problem in Georgia will persist for some time.

IS IT POSSIBLE THAT DOLLARIZATION WILL DECREASE IN GEORGIA IN THE LONG RUN?

In the long run, we can look forward to lower dollarization levels if certain conditions are met. To name a few: a) When businesses have access to and are able to use various fi nancial instruments to hedge against foreign exchange risk (rather than just storing their deposits in USD which, as we saw, is an imperfect hedging instrument in the Georgian context) b) When all sectors of the economy become gradually and fully de-dollarized (e.g., the real estate sector). c) To the extent that the Larization policy works well, the exchange rate should become less volatile in the long run and will in turn reduce the need for dollarization.