Recent depreciation of GEL vis a vis USD caused the widespread commotion among business community and general public in Georgia. Many public figures expressed their opinions about the issue, some of which are relevant, though most of them are based on far-fetched assumptions, without proper analysis. The major purpose of this paper is to present the theory based, objective analysis of GEL/USD exchange rate dynamics and provide the fundamental macroeconomic factors, which have the direct influence on exchange rates. .

This paper is intended for general public and investors, rather than policy makers, consequently we focused on nominal rather than real exchange rate. Our purpose is to analyze GEL/USD exchange rate movements during relatively short periods of time, since short term exchange rate analysis is more relevant for the target readers than long term analysis. Periodicity for parity approaches and for the econometric model are annual and quarterly respectively..

Parity approaches provide the extended periods of over and under valuations of GEL vis a vis USD; this result was not unexpected since the parity conditions are generally more efficient in the long run.

Based on Purchasing Power Parity (PPP) approach GEL has been undervalued vis a vis USD by roughly 3% for past four years and based on Uncovered Interest Rate Parity (UIRP) approach GEL has been overvalued vis a vis USD by roughly 6% between years 2016-2018 and slightly undervalued (2%) in year 2019. The contradicting result for parity approaches derive from higher risk premiums for investments in Georgia than defined by UIRP approach.

The econometric model in contrast to parity approaches does not provide what GEL/USD exchange rate should be but provides the general sense about GEL movements, based on economic fundamentals. Generally, econometric models do better in the short run than parity approaches, though much less so in comparison to random walk.

The econometric model provides logically satisfying results, identifying the economic factors, which effect GEL/USD exchange rate movements. Statistically significant variables, explaining GEL/USD fluctuations are: 1. level of GEL deposits in local banks, 2. interest rate spread on loans, denominated in GEL and USD in local banks, 3. GDP growth differential between Georgia and US and 4. main trade partners’ currency fluctuations vis a vis USD. The coefficients for the former two factors are statistically significant at 0.05 level and the coefficients for the latter two factors are statistically significant at 0.01 level.

The econometric model performs relatively well during moderate GEL/USD exchange rate fluctuations and relatively poor during considerable GEL/USD exchange rate fluctuations. We respectfully remind the reader that the economics is not a natural science, providing the bulletproof laws of universe and exchange rate analysis is considered one of the most intricate issues in the field. The analytical approaches presented in this paper are by no means exhaustive and further research is warranted.

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