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ISET Economist Blog

A blog about economics in the South Caucasus.

Is Lari Hitting Our Dinner Tables?

“The Arab Spring was a revolution of the hungry.” So stated The Boston Globe’s journalist Thanassis Cambanis in his 2011 article claiming that in countries where access to food was an issue, “hitting the dinner table” is not a good idea. In order to demonstrate the importance of food prices, he went even further, and reminded his readers that when food price inflation in Egypt reached almost 19%, the president of the country had to resign.

Food price spikes like the grain price spike in 2007-2008 or some other shocks like currency depreciation, can lead to social and economic problems, particularly in the case of developing countries where the share of food expenditures to total expenditure is high. In Georgia, this figure is about 45%; in some countries, the share of food consumption reaches as high as 80% (e.g. Angola).

Volatility of worldwide commodity prices is even more severe for countries which depend on imports. Georgia is a classic example, as it imports around 80% of consumed wheat, and more than 50% of its meat. Given Georgia’s quite high import dependency, the depreciation of the Georgian lari has raised reasonable concerns about food prices. The lari started to depreciate in 2014, and by the end of 2016, the local currency had depreciated by almost 50% in nominal terms. It is believed that depreciated currency inevitably increases food prices, but is this actually the case in Georgia?


A BIT OF THEORY…

Theoretically assuming all else equal, when currency depreciates, imports become more expensive. In the case of exchange rate depreciation, the importing country needs more local currency than previously to purchase the same amount of foreign currency. This results in higher domestic prices for imports, which decrease as a result.  Exports, on the contrary are positively affected by currency depreciation, because depreciated local currency makes exports cheaper for a buyer.

Therefore, there is definitely a link between the exchange rate and food prices. However, this relationship is more complex than it seems at first glance.

The diagram below shows Georgia’s Nominal Food Price and Exchange Rate Indices, which in most cases have quite similar patterns. When the exchange rate increases (currency depreciates), food prices also increase. However, that is not always the case. For example, in March - May 2016, food prices were relatively stable, whereas the exchange rate index first decreased, and then increased again. In July 2016 – August 2016, the exchange rate index dropped, but food prices increased during that period.


FOOD PRICES GOING UP IN GEORGIA?

Over the span of the last two years, the lari has continued to depreciate. After a short period of appreciation in January-May 2016, the currency started to depreciate again in the second half of the year. It should be noted that even in periods of appreciation, the lari never bounced back to its 2014 mark of 1.7-1.8 GEL/USD.

In order to judge whether currency depreciation translated into increased food prices during this period, several important factors should be considered.

The real exchange rate (RER) is the purchasing power of a currency relative to another at current exchange rates and prices.

Source: Wikipedia

 First of all, one has to look at economic indicators in real terms. In nominal terms, the lari depreciated by 49.1% with respect to the US dollar (that is, from 1.78 GEL/USD in November 2014 to 2.65 GEL/USD in December 2016). But if one looks at the GEL/USD real exchange rate (RER), the index figures are considerably lower. The GEL/USD RER dropped by 29.5% for the same period. Thus, there is a depreciation against the dollar both in nominal and real terms, but since the U.S. is not among Georgia’s major trade partners for food imports, it makes sense to look at bilateral exchange rates with Turkey and Russia.  GEL/Lira and GEL/RUB REERs, respectively, show slight – 4% depreciation of Georgian Lari with respect to Turkish Lira, and relatively high depreciation of 20% with respect to the Russian Ruble. Although Georgian currency depreciated against currencies of its major partners, in real terms depreciation was not that high, compared to nominal changes.

As to food prices, by the end of 2016, they increased in nominal terms by 6.7% compared to the end of 2014. Thus, in spite of high import dependency and local currency depreciation, food prices did not increase at the same rate. Moreover, the prices of some products that are widely consumed by the typical Georgian household even decreased. Potato retail prices fell by 6.5%, cheese lost 5.2% in value, and beans became cheaper by 2.2%. Given that the overall food price index increased, most food became more expensive indeed. The biggest increase was for maize flour (the retail price index went up by 26.9%), which interestingly is almost entirely domestically produced. Another noticeable increase happened in the case of sunflower oil, which gained 21.0% in value. Sunflower oil is produced both by Georgian and foreign producers, meaning that imports play an important role in case of this food product.


WHAT ELSE CAN LIE BEHIND CHANGES IN FOOD PRICES?

The weakening of the local currency is definitely part of the story; however, it cannot fully explain food price inflation. The following aspects should be considered as well:

World prices. According to FAO’s food price index, world food prices started falling in 2011. The index went down by 30% from 229.9 in 201,1 to 161.5 in 2016. International prices are transmitted with a lag to local markets, and reduce upward pressure on local prices created by currency depreciation.

Local production. There is a noticeable increase in the production of some crops in Georgia. According to the latest available data, wheat production has more than doubled (by 166%). Meat production has also increased by 13.3%, whereas milk and milk products production has increased by 3%. The increased supply of these products also puts downward pressure on prices.

Stocks. The availability of stocks plays important role in food price volatility, and allows producers to cope better with short-term shocks. For example, according to the latest data, in the case of maize, stocks comprised 38% of the total amount of maize supplied to the market. Potato stocks reached 21% of total potato supply, and wheat stocks equaled 5.7% out of total wheat supply.

It is hard to say which factor has the leading role in causing food price change. The whole story is definitely not only about exchange rates, but a thoughtful food security policy that ensures access to food for many extremely poor Georgians.


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Guest - GB on Tuesday, 14 February 2017 11:05

The lari started to depreciate in 2014, and by the end of 2016, the local currency had depreciated by almost 50% in nominal terms. - this statement needs more clarificataion, because lari has depreciated nominaly against some currencies, while it has appreciated aggainst others. One should look at Nominal (or even more real) effective exchange rate index that volatives +-10% (https://www.nbg.gov.ge/uploads/publications/inflationreport/2017/publish_MR_February_geo_2017.pdf page 31 chapter on exchange rate). When the food imported from Russia becomes expensive (both by high inflation in Russia compared the inflation of Georgia and depreciation of Lari against Ruble) Georgian consumers substitute it with cheapoer Ukrainian alternatives. And it does not matter what is the exchange rate of UAH/USD or USD/GEL. I think we should talk about and emphasize REER and NEER, to formate correct perceptions of your readers. USDGEL changes expectations but not directly the prices.

The lari started to depreciate in 2014, and by the end of 2016, the local currency had depreciated by almost 50% in nominal terms. - this statement needs more clarificataion, because lari has depreciated nominaly against some currencies, while it has appreciated aggainst others. One should look at Nominal (or even more real) effective exchange rate index that volatives +-10% (https://www.nbg.gov.ge/uploads/publications/inflationreport/2017/publish_MR_February_geo_2017.pdf page 31 chapter on exchange rate). When the food imported from Russia becomes expensive (both by high inflation in Russia compared the inflation of Georgia and depreciation of Lari against Ruble) Georgian consumers substitute it with cheapoer Ukrainian alternatives. And it does not matter what is the exchange rate of UAH/USD or USD/GEL. I think we should talk about and emphasize REER and NEER, to formate correct perceptions of your readers. USDGEL changes expectations but not directly the prices.
Salome Gelashvili on Tuesday, 14 February 2017 12:49

Thank you for your comment.
I talk about real exchange rates in one of the paragraphs of the blog in order to make clear that looking at nominal exchange rates only, is quite misleading. I also mention the importance of looking at real exchange rates with major trade partners of Georgia in the same paragraph (http://nbg.gov.ge/uploads/exchangeratesunglisurad/real_exchange_rateseng.xls here you are not limited in time periods as in the publication you linked and can choose reference point yourself) .
As to substitution effect, given that Georgian food market is overloaded with Turkish products, I would not claim that Georgian consumers would necessarily switch to Ukrainian produce if Russian becomes more expensive.

Thank you for your comment. I talk about real exchange rates in one of the paragraphs of the blog in order to make clear that looking at nominal exchange rates only, is quite misleading. I also mention the importance of looking at real exchange rates with major trade partners of Georgia in the same paragraph (http://nbg.gov.ge/uploads/exchangeratesunglisurad/real_exchange_rateseng.xls here you are not limited in time periods as in the publication you linked and can choose reference point yourself) . As to substitution effect, given that Georgian food market is overloaded with Turkish products, I would not claim that Georgian consumers would necessarily switch to Ukrainian produce if Russian becomes more expensive.
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