doi.org/10.52340/eab.2025.17.01.12

The exchange rate of a currency plays a critical role in shaping a country’s economy, impacting international trade, investment levels, and ultimately, the well-being of its citizens. For international organizations like the International Monetary Fund (IMF) and the World Bank, exchange rates, alongside inflation, are key indicators used to evaluate a nation's macroeconomic health and determine project feasibility within that country. This is particularly significant for import-dependent nations like Georgia, where approximately 80% of the consumer basket comprises imported goods and services. The volatility of the Georgian Lari (GEL) greatly affects businesses and citizens, creating challenges for long-term planning, price stability, and economic growth.
This study examines the factors influencing the exchange rate of the Georgian lari over short, medium, and long-term periods, analyzing their impacts before the pandemic, during the pandemic, and in the wake of war and sanctions. The findings reveal that inflation, interest rates and market psychology are the three primary drivers of exchange rate fluctuations. While inflation and interest rates provide reliable indicators for medium and long-term predictions, short-term fluctuations are significantly influenced by psychological factors such as market expectations, seasonal trends, speculative activities and unforeseen information, making prediction more difficult.
The exchange rate is superficially determined by the supply and demand for different currencies. For example, if the demand for GEL is lower than its supply while the demand for USD is higher, the exchange rate of GEL/USD will depreciate. However, such explanations do not delve into the underlying forces that affect currency supply and demand. Therefore, this study explores economic theories to better understand and predict exchange rate movements in a more comprehensive manner.
Key determinants of exchange rate fluctuations include inflation, where changes in money supply significantly influence inflation, which in turn impacts currency values; interest rates, which play a role in attracting foreign investments and influencing exchange rates over the medium and long term; and market psychology, where in the short term, factors like speculation, seasonal behaviors, and public sentiment dominate, making prediction challenging.
Several key findings and events have impacted the Georgian Lari. A drop in global oil prices affects the national currencies of oil-exporting countries, such as Russia and Azerbaijan, which in turn influences Georgia’s economy due to reduced imports, investments, and remittances from these countries. For example, between 2014 and 2016, declining oil prices led to a depreciation of the Georgian lari. Georgia's negative trade balance, where imports exceed exports, exerts pressure on the exchange rate, as more foreign currency flows out of the country than flows in, further weakening the currency. Financing budget deficits through foreign borrowing or money printing increases money supply and inflation, further depreciating the Lari.
Global disruptions such as the COVID-19 pandemic had profound effects on the global economy, as countries closed borders and industries halted production to curb the virus, leading to global supply chain disruptions, inflation surges and currency depreciation, including the Lari. Georgia faced higher import prices and inflation due to its dependence on imported goods. Russia’s invasion of Ukraine added further stress to an already fragile global economy, as both countries are major global exporters of wheat, leading to food and energy price hikes. This particularly impacted developing nations, where essential food products like bread account for a significant share of household spending, making inflation a critical concern for policymakers.
Western sanctions on Russia led to increased migration, capital inflows and business relocations to Georgia, strengthening the Lari by boosting foreign exchange inflows. Georgia’s decision not to fully align with sanctions allowed it to indirectly benefit from increased economic activity without disrupting existing supply chains, helping to stabilize the economy.
To ensure exchange rate stability and macroeconomic resilience, Georgia should continue monitoring inflation and interest rates to manage medium- and long-term exchange rate volatility. Efforts should focus on diversifying trade partners and reducing import dependency to mitigate trade deficits. Fiscal policies should address budget deficits prudently to avoid excess money supply, which fuels inflation and weakens the national currency. Policymakers need to account for psychological factors and speculative behaviors influencing short-term currency movements, as these often create unexpected fluctuations.
In conclusion, the Lari’s exchange rate reflects the broader economic challenges and opportunities facing Georgia. By addressing fundamental economic issues, the country can strengthen its currency stability and improve overall economic resilience, particularly in light of global shocks like pandemics, wars and market disruptions. Proactive economic strategies, informed policymaking, and international cooperation will be crucial in ensuring a stable and predictable exchange rate environment, benefiting businesses, investors and citizens alike.

Keywords: Currency exchange rate, monetarism, purchasing power parity theory, the law of one price.
JEL Codes: E31,E42, E52, F31

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