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Georgia: Staff Report for the 2006 Article IV Consultation, Third Review Under the Poverty Reduction and Growth Facility, and Request for Waiver of Performance Criteria

Author(s):
International Monetary Fund
Published Date:
May 2006
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I. Developments Since the Rose Revolution

1. The breakup of the Soviet Union brought a steep fall in real GDP in Georgia—almost 75 percent, by most estimates the worst for any transition country. Over the following decade, the government had some success in stabilizing prices (following early hyperinflation), as well as in price liberalization, privatization of state-owned enterprises, and a first phase of legal, fiscal and financial reforms.1

2. From 2000 to 2003, real GDP growth averaged 5.8 percent, while CPI inflation averaged 4.8 percent. Mismanagement and poor tax administration, however, undermined the implementation of policies, leading to low tax collections and rapidly rising domestic arrears. Tax revenues were low—averaging 13.2 percent of GDP—and the cash fiscal deficit, constrained by financing, was 1.8 percent. Domestic arrears totaled 3.4 percent of GDP by end-2003. The Rose Revolution brought in a new government in January 2004.

3. The new authorities embarked on an ambitious agenda of reforms:

  • To reduce graft in tax and customs administration, high-ranking officials were fired or prosecuted, with many making large reparations payments; the state tax department was reorganized; and a financial police was created.

  • To create a business-friendly environment, a simplified and streamlined tax system—eliminating nuisance taxes and reducing burdensome regulations—was initiated.

  • To improve governance in the public sector, measures to restructure the civil service, strengthen management in state-owned enterprises, and reinvigorate privatization were initiated.

4. The restructuring of the public sector led to significant improvements in governmental functions, particularly revenue collection. Tax revenues grew by 3.7 percent of GDP in 2004, and a further 1.6 percent in 2005. With this improved performance, many fiscal initiatives—increasing pensions, upgrading defense capacity, and clearing arrears—could be undertaken while maintaining fiscal stability.

5. The Saakashvili administration continues to attach priority to the reintegration of the breakaway regions of South Ossetia and Abkhazia. Relations with Russia—Georgia’s largest trading partner—are tense, related in part to Russia’s relations with Abkhazia and South Ossetia and in part to Georgia’s dependence on Russia for gas and electricity.

II. Recent Developments

6. Economic activity accelerated and inflation pressures abated in 2005 (Table 1, Figure 1). Real GDP growth is estimated to have been 7.7 percent, supported by a rebound in agricultural production, more stable electricity supply, and continued buoyancy in manufacturing (especially food processing) and communication. Twelve-month CPI inflation hovered around 10 percent in the first half of the year, largely due to expansionary monetary policy, but declined to 6.2 percent by the end of the year, as a much smaller-than-planned fiscal deficit contributed to a slowdown in the growth rate of money. Poverty remained high in 2004 (the latest information available)—with 52 percent of the population living under the official subsistence level and 17 percent in extreme poverty (Table 2).2

Table 1.Georgia: Selected Macroeconomic Indicators, 2004–06
200420052006
CR/05/314Prel. Est.Proj.
(Annual percentage change, unless otherwise indicated)
National accounts
Nominal GDP (millions of lari)9,97011,66011,60013,080
Nominal GDP (US$ million)5,1936,3036,4097,522
Real GDP6.26.47.76.4
Population 1/4.34.34.34.3
Consumer price index, period average5.79.48.35.3
Consumer price index, end-of-period7.57.06.24.7
GDP/capita (US$)1,2031,4611,4851,743
Poverty rate (in percent)52.7
Unemployment rate12.6
(In percent of GDP, unless otherwise indicated)
Investment and saving
Investment26.628.926.426.6
Public2.45.54.23.8
Private24.223.422.122.8
Gross domestic saving18.317.119.019.4
Public5.52.02.71.6
Private12.815.116.317.9
Saving-Investment balance-8.3-11.8-7.4-7.1
Budgetary operations
Total revenue and grants 2/21.721.723.422.9
Of which: Tax revenue18.218.119.819.3
Total expenditure and net lending18.625.224.925.0
Of which: Current expenditure16.219.720.721.3
Primary balance4.3-2.4-0.5-1.3
Fiscal balance, commitment basis3.1-3.5-1.5-2.2
Net change in expenditure arrears-2.6-1.3-0.9-0.4
Statistical discrepancy-0.80.00.00.0
Fiscal balance, cash basis-0.2-4.8-2.4-2.6
Financing0.24.82.42.6
Privatization0.93.43.62.6
External 3/0.20.8-0.3-0.2
Domestic-0.90.6-0.90.3
Public debt46.437.836.230.5
Of which: External debt (P&PG)35.829.427.122.9
(Annual percentage change, unless otherwise indicated)
Monetary sector
Reserve money44.326.019.725.0
Broad money (including foreign exch. deposits)42.631.826.429.0
Velocity of broad money, level (M3 annual average)7.86.86.0
(In millions of U.S. dollars, unless otherwise indicated)
External Sector
Exports of goods and services (percent of GDP)55.034.234.131.2
Annual percentage change48.79.611.07.5
Imports of goods and services (percent of GDP)51.452.447.344.3
Annual percentage change46.923.713.79.7
Net imports of oil233304326389
Current account balance-429-742-472-537
In percent of GDP-8.3-11.8-7.4-7.1
Gross international reserves383493474620
In months of imports of goods and services (excl. pipeline imports)2.02.02.12.3
Foreign direct investment503731415390
Average exchange rate (lari per dollar)1.91.8
Sources: Georgian authorities; and Fund staff estimates.

Excludes Abkhazia residents.

Revenue projections for 2006 are as budgeted.

External financing for 2004-06 includes debt relief from the Paris Club.

Sources: Georgian authorities; and Fund staff estimates.

Excludes Abkhazia residents.

Revenue projections for 2006 are as budgeted.

External financing for 2004-06 includes debt relief from the Paris Club.

Table 2.Georgia: Millennium Development Goals, 1990–2003(In percent, unless otherwise specified)
1990199520002003
1 Eradicate extreme poverty and hunger2015 target = halve 1990 $1 a day poverty and malnutrition rates
Population below US$1 a day
Poverty gap at US$1 a day
Share of income or consumption held by poorest 20 percent6.4
Prevalence of child malnutrition (percent of children under 5)3.1
Share of population below minimum level of dietary energy consumption3927
2 Achieve universal primary education2015 target = net enrollment to 100
Net primary enrollment ratio (percent of relevant age group)97.195.288.7
Primary completion rate (percent of relevant age group)81.093.082.0
Percentage of cohort reaching grade 5
Youth literacy rate (ages 15-24)
3 Promote gender equality2005 target = education ratio to 100
Ratio of girls to boys in primary and secondary education98.299.4100.999.7
Ratio of young literate females to males (ages 15-24)
Share of women employed in the nonagricultural sector44.545.041.246.5
Proportion of seats held by women in national parliament677
4 Reduce child mortality2015 target = reduce 1990 under 5 mortality by two-thirds
Under 5 mortality rate (per 1,000)474545
Infant mortality rate (per 1,000 live births)43414141
Immunization, measles (percent of children under 12 months)637373
5 Improve maternal health2015 target = reduce 1990 maternal mortality by three-fourths
Maternal mortality ratio (modeled estimate, per 100,000 live births)2232
Births attended by skilled health staff (percent of total)96.4
6 Combat HIV/AIDS, malaria and other diseases2015 target = halt, and begin to reverse, AIDS, etc.
Prevalence of HIV, total (ages 15-49)0.10.1
Contraceptive prevalence rate (of women ages 15-49)40.5
Number of children orphaned by HIV/AIDS
Incidence of tuberculosis (per 100,000 people)38.247.282.282.8
Tuberculosis cases detected under DOTS 1/153151.9
7 Ensure environmental sustainability2015 target = various (see notes)
Forest area (% of total land area)43.043.0
Nationally protected areas (percent of total land area)2.72.3
GDP per unit of energy use (PPP $ per kg oil equivalent)1.21.63.44.4
CO2 emissions (metric tons per capita)2.81.11.2
Access to an improved water source (percent of population)76
Access to improved sanitation (percent of population)83
Access to secure tenure (percent of population)
8 Develop a Global Partnership for Development2015 target = various (see notes)
Youth unemployment rate (percent of total labor force ages 15-24)21.1
Fixed line and mobile telephones (per 1,000 people)98.9102.3140.2239.7
Personal computers (per 1,000 people)22.331.6
General indicators
Population (in millions)5.45.14.54.4
Gross domestic product (US$ billion)5.12.13.04.0
GDP per capita (US$)940410686917
Adult literacy rate (percent of people ages 15 and over)
Total fertility rate (births per woman)2.21.41.11.1
Life expectancy at birth (years)72.372.573.5
Public and publicly guaranteed external debt (percent of GDP)64.151.346.4
Investment (percent of GDP)29.123.921.624.4
Trade (percent of GDP) 2/85.667.981.278.8
Sources: World Development Indicators database, April 2005; Georgian State Department of Statistics; and Fund staff estimates.Note: In some cases the data are for earlier or later years than those stated. The goal targets are the following: Goal 1: Halve, between 1990 and 2015, the proportion of people whose income is less than US$1 a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger; Goal 2: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling; Goal 3: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015; Goal 4: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate; Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio; Goal 6: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases; Goal 7: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water; Goal 8: Develop further an open, rule-based, predictable, non discriminatory trading and financial system. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

Directly observed treatment, short-course case detection and treatment strategy (World Health Organization).

Trade is calculated as the sum of imports and exports of goods and non-factor services relative to GDP.

Sources: World Development Indicators database, April 2005; Georgian State Department of Statistics; and Fund staff estimates.Note: In some cases the data are for earlier or later years than those stated. The goal targets are the following: Goal 1: Halve, between 1990 and 2015, the proportion of people whose income is less than US$1 a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger; Goal 2: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling; Goal 3: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015; Goal 4: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate; Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio; Goal 6: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases; Goal 7: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water; Goal 8: Develop further an open, rule-based, predictable, non discriminatory trading and financial system. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

Directly observed treatment, short-course case detection and treatment strategy (World Health Organization).

Trade is calculated as the sum of imports and exports of goods and non-factor services relative to GDP.

Figure 1.Georgia: Inflation and Real GDP Growth, 1998-2005

(In percent)

Sources: Georgian authorities; and Fund staff estimates.

7. The general government deficit was 2.4 percent of GDP in 2005, far below the budgeted 4.8 percent (Table 3). Tax revenues rose to 19.8 percent of GDP. Total expenditure and net lending increased from 18.6 percent of GDP in 2004 to 24.9 percent in 2005, led by an increase in current expenditures of 4.5 percent of GDP, in particular in transfers and subsidies to Legal Entities of Public Law (LEPLs) to buy defense goods. While social spending increased from 7.1 percent of GDP in 2004 to 8.1 percent in 2005 (on a cash basis),3 defense spending more than doubled from an estimated 1.6 percent to 3.5 percent of GDP.4 Privatization receipts (3.6 percent of GDP) financed the deficit, modest net foreign repayments, and an increase in government deposits with the National Bank of Georgia (NBG).

Table 3.Georgia: Operations of the General Government, 2004–06(In millions of lari)
200420052006
Quarterly ProfilePrel.Prog.Quarterly ProfileBudgetProj.
Q1Q2Q3Q4CR/05/314Q1Q2Q3Q4IMF
Total revenue and grants21665595957468162715253263770787577129903129
Total revenue20425485787267592611239561869080870328192954
Tax revenue 1/18114495376366782300210751362473165825272647
Taxes on income2696667728529126374748064293323
Taxes on profits1624358634621022155738058266266
Social tax 1/51609710631522848569099293293
VAT62819523125730598787523028031627811051195
Customs duties1232428353712313527324043143143
Excises1815375817628631963899789339339
Other taxes111131528207666152027278989
Nontax revenue 1/23199419081312289104667744292307
Of which: NBG profit transfers12400004040400004040
Extrabudgetary revenue337
Grants1241117195710413719176768171174
Total expenditure and net lending18535316527919182892293966772392396432763276
Current expenditure16184665546447362400229258963776679027822782
Wages and salaries312100114115123452447117117117117469469
Goods and services2647710593143420602169176207214766766
Transfers and subsidies237183201226259869598206226270276978978
Interest payments1203229273212012232303229123123
Domestic71212021198278181718177070
External491196133944131314135353
Extrabudgetary expenditures 2/304
Local government expenditures380731051831785395246587140153446446
Capital expenditure 3/20862931431624595846978148165461461
Of which: Foreign financed1072750554617819224274564160160
Net lending2745420336399993434
Of which: Foreign financed56454203378131313135252
Overall balance (commitments)31328-57-46-102-177-407-30-16-48-193-287-148
Adjustment to cash basis-3372-31-38-34-102-149-5-15-25-15-59-146
Net change in expenditure arrears (-, reduction)-259-32-37-8-27-104-149-5-15-25-15-59-146
Of which: Domestic expenditure arrears-259-32-37-8-27-104-149-5-15-25-15-59-146
Statistical discrepancy-78345-30-720000000
Overall balance (cash)-2430-89-84-137-279-556-35-31-73-207-346-294
Total financing24-308984137279556353173207346294
Privatization8737226381194193932549126137338338
Domestic-86-53-963114-104670-18-338837-14
Net NBG credit-61-56-825111-76470-18-338837-14
Of which: Government deposits0-56-825615-67470-18-338837-14
Of which: Treasury bills000-6-3-90000000
Of which: NBG recapitalization0000000000000
Net commercial bank credit-123-13-222-3020000000
Nonbank-14-102120000000
External23-14-42154-369710-1-21-17-29-29
Disbursements1731718306012527039397329180183
Amortization-150-31-60-14-56-161-174-29-40-94-46-209-212
Memorandum items:
Overall balance excluding grants (commitments)10517-74-65-159-281-544-49-33-115-261-458-322
Defense spending 4/161389391427427
Social spending (commitments) 5/6248819191,1241,124
Social spending (cash)7089419641,1831,261
Nominal GDP (millions of lari)9,9702,4772,8392,9823,30011,60011,6602,8113,2513,3783,64013,08013,080
Sources: Georgian authorities; and Fund staff estimates.

2005 tax revenue, social tax, and nontax revenue include some back tax payments from corporations privatized that year.

2004 extrabudgetary expenditure have been adjusted to exclude GEL 84 million in payment of pension arrears.

Starting in 2005 capital spending includes expenditure previously undertaken by the Road Fund and recorded as current spending.

Based on Ministry of Defense budget; excludes defense spending from the President’s Fund.

Social spending has been updated to more accurately reflect the authoirities measures in this area.

Sources: Georgian authorities; and Fund staff estimates.

2005 tax revenue, social tax, and nontax revenue include some back tax payments from corporations privatized that year.

2004 extrabudgetary expenditure have been adjusted to exclude GEL 84 million in payment of pension arrears.

Starting in 2005 capital spending includes expenditure previously undertaken by the Road Fund and recorded as current spending.

Based on Ministry of Defense budget; excludes defense spending from the President’s Fund.

Social spending has been updated to more accurately reflect the authoirities measures in this area.

Table 3.Georgia: Operations of the General Government, 2004–06 (concluded)(In percent of GDP)
200420052006
Quarterly ProfilePrel.Prog.Quarterly ProfileBudgetProj.
Q1Q2Q3Q4CR/05/314Q1Q2Q3Q4IMF
Total revenue and grants21.722.620.925.024.723.421.722.621.825.921.222.923.9
Total revenue20.522.120.324.423.022.520.522.021.223.919.321.622.6
Tax revenue 1/18.218.118.921.320.519.818.118.319.221.618.119.320.2
Taxes on income2.72.72.42.42.62.52.32.62.32.41.82.22.5
Taxes on profits1.61.82.02.11.41.81.92.02.32.41.62.02.0
Social tax 1/2.12.13.23.22.72.01.71.72.72.72.22.2
VAT6.37.98.18.69.28.57.58.28.69.47.68.49.1
Customs duties1.21.01.01.21.11.11.21.01.01.21.21.11.1
Excises1.82.22.72.72.32.52.72.32.72.92.52.62.6
Other taxes1.10.50.50.90.60.70.60.50.60.80.70.70.7
Nontax revenue 1/2.34.01.43.02.52.72.53.72.02.31.22.22.3
Of which: NBG profit transfers0.11.60.00.00.00.30.31.40.00.00.00.30.3
Extrabudgetary revenue3.4
Grants1.20.40.60.61.70.91.20.70.52.01.91.31.3
Total expenditure and net lending18.621.423.026.527.824.925.223.722.327.326.525.025.0
Current expenditure16.218.819.521.622.320.719.721.019.622.721.721.321.3
Wages and salaries3.14.04.03.93.73.93.84.23.63.53.23.63.6
Goods and services2.63.13.73.14.33.65.26.05.46.15.95.95.9
Transfers and subsidies2.47.47.17.67.87.55.17.36.98.07.67.57.5
Interest payments1.21.31.00.91.01.01.01.10.90.90.80.90.9
Domestic0.70.90.70.70.60.70.70.60.50.50.50.50.5
External0.50.50.30.20.40.30.40.50.40.40.40.40.4
Extrabudgetary expenditures 2/3.1
Local government expenditures3.83.03.76.15.44.64.52.32.74.24.23.43.4
Capital expenditure 3/2.12.53.34.84.94.05.02.52.44.44.53.53.5
Of which: Foreign financed1.11.11.81.81.41.51.60.90.81.31.81.21.2
Net lending0.30.10.20.20.60.30.50.30.30.30.20.30.3
Of which: Foreign financed0.60.10.20.20.60.30.70.50.40.40.40.40.4
Overall balance (commitments)3.11.1-2.0-1.5-3.1-1.5-3.5-1.1-0.5-1.4-5.3-2.2-1.1
Adjustment to cash basis-3.40.1-1.1-1.3-1.0-0.9-1.3-0.2-0.5-0.7-0.4-0.4-1.1
Net change in expenditure arrears (-, reduction)-2.6-1.3-1.3-0.3-0.8-0.9-1.3-0.2-0.5-0.7-0.4-0.4-1.1
Of which: Domestic expenditure arrears-2.6-1.3-1.3-0.3-0.8-0.9-1.3-0.2-0.5-0.7-0.4-0.4-1.1
Statistical discrepancy-0.81.40.2-1.0-0.20.00.00.00.00.00.00.00.0
Overall balance (cash)-0.21.2-3.1-2.8-4.1-2.4-4.8-1.2-0.9-2.2-5.7-2.6-2.2
Total financing0.2-1.23.12.84.12.44.81.20.92.25.72.62.2
Privatization0.91.58.01.33.63.63.40.91.53.73.82.62.6
Domestic-0.9-2.2-3.41.00.4-0.90.60.0-0.5-1.02.40.3-0.1
Net NBG credit-0.6-2.3-2.91.70.3-0.70.40.0-0.5-1.02.40.3-0.1
Of which: Government deposits0.0-2.3-2.91.90.4-0.60.40.0-0.5-1.02.40.3-0.1
Of which: Treasury bills0.00.00.0-0.2-0.1-0.10.00.00.00.00.00.00.0
Of which: NBG recapitalization0.00.00.00.00.00.00.00.00.00.00.00.00.0
Net commercial banks credit-0.10.1-0.5-0.70.1-0.30.20.00.00.00.00.00.0
Nonbank-0.10.00.00.10.00.00.00.00.00.00.00.00.0
External0.2-0.6-1.50.50.1-0.30.80.30.0-0.6-0.5-0.2-0.2
Disbursements1.70.70.61.01.81.12.31.41.22.20.81.41.4
Amortization-1.5-1.2-2.1-0.5-1.7-1.4-1.5-1.0-1.2-2.8-1.3-1.6-1.6
Memorandum items:
Overall balance excluding grants (commitments)1.00.7-2.6-2.2-4.8-2.4-4.7-1.7-1.0-3.4-7.2-3.5-2.5
Defense spending 4/1.63.43.33.33.3
Social spending (commitments) 5/6.37.67.98.68.6
Social spending (cash)7.18.18.39.09.6
Nominal GDP (millions of lari)9,9702,4772,8392,9823,30011,60011,6602,8113,2513,3783,64013,08013,080
Sources: Georgian authorities; and Fund staff estimates.

2005 tax revenue, social tax, and nontax revenue include some back tax payments from corporations privatized that year.

2004 extrabudgetary expenditure have been adjusted to exclude GEL 84 million in payment of pension arrears.

Starting in 2005 capital spending includes expenditure previously undertaken by the Road Fund and recorded as current spending.

Based on Ministry of Defense budget; excludes defense spending from the President’s Fund.

Social spending has been updated to more accurately reflect the authoirities measures in this area.

Sources: Georgian authorities; and Fund staff estimates.

2005 tax revenue, social tax, and nontax revenue include some back tax payments from corporations privatized that year.

2004 extrabudgetary expenditure have been adjusted to exclude GEL 84 million in payment of pension arrears.

Starting in 2005 capital spending includes expenditure previously undertaken by the Road Fund and recorded as current spending.

Based on Ministry of Defense budget; excludes defense spending from the President’s Fund.

Social spending has been updated to more accurately reflect the authoirities measures in this area.

8. The introduction of a reserve money target strengthened the monetary policy framework and helped maintain price stability (Table 4). Although capital inflows were substantially lower than in 2004—due in part to lower than forecast privatization proceeds and a winding down of pipeline investments—NBG gross international reserves increased by US$91 million (Figure 2). The lari appreciated about 2 percent both nominally against the U.S. dollar and in real effective terms (Figure 3), with limited central bank discretionary intervention (Figure 4). Remonetization of the economy continued (Table 5). Cooperation between the NBG and the treasury in forecasting liquidity conditions improved, but unexpected government spending occasionally still results in swings in reserve money.

Table 4.Georgia: Accounts of the National Bank of Georgia, 2003–06
2003 1/20042005 2/2006 2/
Dec.Dec.Mar.JuneSep.Dec.Jan.Mar.JuneSep.Dec.
ActualActual 1/Actual 2/ActualProg. Est.ActualProg.ActualProg.ActualActualProj.Proj.Proj.Proj.
(Contribution to reserve money growth in percent) 5/
Net foreign assets-4.779.877.1-0.53.416.815.318.022.527.2-0.50.37.421.928.0
Net domestic assets18.6-35.6-32.8-2.70.6-11.70.8-6.43.5-7.5-1.43.9-0.3-6.2-3.0
Net claims on general government5.2-10.5-10.5-6.7-1.7-16.50.2-10.45.6-9.1-0.50.0-1.8-5.13.7
Claims on rest

of economy
6.70.1-3.50.00.00.00.0-0.10.00.00.00.00.00.00.0
Claims on banks1.2-8.2-8.21.31.33.80.15.0-1.74.90.01.0-0.5-2.0-6.0
Other items, net5.4-17.0-10.62.61.11.00.5-0.9-0.4-3.2-0.92.91.90.8-0.7
(Percentage change since end of previous year)
Reserve money

(RM)
13.944.344.3-3.34.05.116.111.626.019.7-2.04.37.115.725.0
Currency in circulation (M0)13.442.942.9-2.74.02.715.810.425.120.0-7.74.26.915.424.6
Required reserves12.713.413.45.811.118.221.532.228.640.62.65.49.319.430.3
Balances on banks’ correspondent accounts 3/29.1169.3169.3-21.8-5.211.111.7-4.731.8-11.565.22.84.211.419.4
(In millions of lari)
Net foreign assets-329134118113146258246268306345340348419565626
Gold222112111222222
Foreign exchange reserves (including BIS account) 4/4138026796886988108068288818828778619481,1101,148
Use of Fund resources-622-549-463-476-454-454-462-462-477-439-439-415-430-447-424
Other foreign liabilities (net)-122-122-100-100-100-100-100-99-100-99-99-100-100-100-100
Net domestic assets909703719696724621725665748656642696653594626
Net claims on general government783722722666707584723635769646641646628595683
Loans

(incl. t-bills)
817841841842842842842836842833833833833833833
Deposits-35-120-120-176-134-258-118-202-73-187-192-187-205-238-150
Claims on rest of economy11811897979797979797979797979797
Claims on banks6-41-41-30-30-9-401-550010-5-20-60
Other items, net2-96-59-37-50-51-55-67-63-87-96-57-68-78-94
Reserve money (RM)5808378378098708799719331,0541,0019821,0441,0721,1591,252
Currency in circulation (M0)4736766766587036957837478468117498468689371,011
Required reserves81929298103109112122119130133137142155169
Balances on banks’ correspondent accounts 3/256868536476766590609962636772
Memorandum items:
Growth of reserve money13.944.344.336.232.734.129.924.926.019.726.929.121.924.225.0
(in percent, relative to same period of previous year)
Growth of currency in circulation13.442.942.941.239.437.829.824.425.120.018.828.524.925.524.6
(in percent, relative to same period of previous year)
Foreign exchange reserves (in U.S. dollar million) 4/192373367372377438436447476477474466512600620
Sources: National Bank of Georgia; and Fund staff estimates.

Net foreign assets are valued at the program rate of 2.15 lari/US$, US$/SDR of 1.49 and US$/Euro of 1.27.

Net foreign assets are valued at the program rate of 1.85 lari/US$, US$/SDR of 1.46 and US$/Euro of 1.21.

Including overnight deposits from banks.

Includes SDR holdings and foreign currency account with BIS which is used for debt service payments.

Contribution is defined as change of asset stock over the end-period stock of reserve money from the previous year.

Sources: National Bank of Georgia; and Fund staff estimates.

Net foreign assets are valued at the program rate of 2.15 lari/US$, US$/SDR of 1.49 and US$/Euro of 1.27.

Net foreign assets are valued at the program rate of 1.85 lari/US$, US$/SDR of 1.46 and US$/Euro of 1.21.

Including overnight deposits from banks.

Includes SDR holdings and foreign currency account with BIS which is used for debt service payments.

Contribution is defined as change of asset stock over the end-period stock of reserve money from the previous year.

Figure 2.Georgia: International Reserves, 1998 - 2005

(In US$ million)

Sources: Georgian authorities; and Fund staff estimates.

Figure 3.Georgia: Exchange Rate Developments, 1998–2005

Sources: Georgian authorities; and Fund staff estimates.

1/ Based on INS exchange rates and CPI. An increase in the rate indicates a depreciation of the lari.

Figure 4.Georgia: Government Securities, 2002–05 1/

Sources: Georgian authorities; and Fund staff estimates.

1/ End-period stock of T-bills at settlement prices.

2/ There was no primary treasury bill issuance after June 2005.

Table 5.Georgia: Monetary Survey, 2003–06
2003 1/20042005 2/2006 2/
DecDec.MarchJun.Sep.Dec.Mar.Jun.Sep.Dec.
ActualActual 1/Actual 2/ActualProg. Est.ActualProg.ActualProg.ActualProj.Proj.Proj.Proj.
(Contribution to broad money growth in percent) 6/
Net foreign assets-0.745.643.2-2.6-0.44.46.24.810.2-4.4-2.2-0.84.45.3
Net domestic assets23.4-3.0-0.61.67.43.314.414.821.630.87.39.614.123.7
Domestic credit27.826.211.72.89.58.116.824.424.647.27.612.319.131.5
Net claims on general government6.1-2.5-2.5-3.5-0.1-9.81.1-7.94.4-7.00.0-0.9-2.71.9
Public-guaranteed borrowing from DMBs0.00.00.00.00.00.00.00.00.00.00.00.00.00.0
Credit to the rest of the economy21.728.814.26.39.617.915.832.320.254.27.613.221.829.5
Other items, net-4.3-29.2-12.3-1.3-2.1-4.7-2.5-9.6-3.0-16.4-0.3-2.7-5.1-7.7
(Percentage change since end of previous year)
Broad money (M3)22.842.642.6-1.07.07.720.619.631.826.45.18.818.529.0
Broad money, excl. forex deposits (M2)14.160.460.4-4.05.85.221.716.135.626.55.79.920.331.7
Currency held by the public13.039.539.5-1.25.73.317.911.427.519.54.77.917.026.9
Total deposit liabilities30.944.844.8-0.87.910.722.525.234.831.15.49.319.430.3
(In millions of lari)
Net foreign assets-2851981731351672392672453271066590191207
Net domestic assets13451314133913621450138915561562166618051944198920742259
Domestic credit16721950179618391940191820502164216825102655274528763111
Net claims on general government766739739687738591755620806633633615582670
Credit to the rest of the economy9061211105711521202132712951545136218772022212922932441
Other items, net-327-636-457-476-489-529-494-602-502-705-711-756-802-852
Broad money (M3)10601512151214971618162818231808199319112009207922652465
Broad money, excl. forex deposits (M2)5278468468128968901029982114810701130117612871409
Currency held by the public442616616609651636726686785736771794862934
Total deposit liabilities61989689688896799210971121120811751238128514031531
Memorandum items:
Growth of broad money (in percent, relative to same period of previous year)42.642.634.036.637.538.036.831.826.434.227.725.329.0
Growth of credit to the rest of the economy (in percent, relative to end of previous year)20.433.734.19.013.725.522.546.228.977.67.713.522.230.1
Growth of credit to the rest of the economy (in percent, relative to same period of previous year)33.734.150.346.762.034.660.628.977.675.560.548.430.1
Growth of credit to the rest of the economy (in percent, relative to same period of previous year, at actual exchange rates)20.639.653.957.173.2
M2 multiplier 3/0.911.011.011.001.031.011.061.051.091.071.081.101.111.13
M3 multiplier 4/1.831.811.811.851.861.851.881.941.891.911.921.941.951.97
M3 velocity 5/8.907.757.757.967.647.146.656.786.816.666.265.98
Foreign exchange deposits in percent of total deposits86.174.374.377.174.774.572.473.670.071.671.070.369.769.0
Sources: National Bank of Georgia; and Fund staff estimates.

Net foreign assets are valued at the program rate of 2.15 lari/US$, US$/SDR of 1.49 and US$/Euro of 1.27.

Net foreign assets are valued at the program rate of 1.85 lari/US$, US$/SDR of 1.46 and US$/Euro of 1.21.

M2 divided by reserve money.

M3 divided by reserve money.

Cumulative GDP over the previous four quarters divided by four-quarter-average M3.

Percentage change is defined as ratio over the end-period broad money stock of the previous year.

Sources: National Bank of Georgia; and Fund staff estimates.

Net foreign assets are valued at the program rate of 2.15 lari/US$, US$/SDR of 1.49 and US$/Euro of 1.27.

Net foreign assets are valued at the program rate of 1.85 lari/US$, US$/SDR of 1.46 and US$/Euro of 1.21.

M2 divided by reserve money.

M3 divided by reserve money.

Cumulative GDP over the previous four quarters divided by four-quarter-average M3.

Percentage change is defined as ratio over the end-period broad money stock of the previous year.

9. The banking sector has performed well. Returns to assets and equity rose in 2005, while credit to the private sector grew 83 percent, albeit from a low base. Although lending continued to be primarily in foreign currency, lari-denominated loans tripled, reducing loan dollarization by about 10 percentage points to 77 percent of total loans. Most of the credit boom was financed through higher deposits, which grew 31 percent, with the rest financed by net borrowing abroad. The share of non-performing loans has fallen from 6.2 percent at end-2004 to 3.8 percent at end-2005 (Table 6). Mirroring developments on the asset side, deposit dollarization declined to 72 percent. Consolidation in the banking sector continued in 2005, with 3 banks merged or closed.

Table 6.Georgia: Prudential Indicators of Commercial Banks, 2003–05(End-of-period)
200320042005
Mar.Jun.Sep.Dec.
Capital adequacy ratio (in percent)20.318.818.317.317.117.5
Leverage ratio 1/33.527.929.328.026.925.9
Nonperforming loans 2/7.56.25.85.43.73.8
Specific provisions 2/4.54.34.13.42.22.4
Loans collateralized by real estate 2/31.933.534.732.632.230.8
Loans in foreign exchange 2/87.786.781.980.776.776.2
Net foreign assets (in millions of lari)42.554.621.0-18.5-22.1-231.5
Net foreign assets (in percent of total assets)3.23.21.2-1.0-1.0-9.1
Net open foreign exchange position 3/8.57.46.05.56.87.5
Liquidity ratio (in percent)43.345.039.134.932.833.3
Source: National Bank of Georgia.

Defined as the ratio of total capital to total liabilities; an increase in the ratio indicates an improvement.

Percent of total loans.

Percent of total regulatory capital.

Source: National Bank of Georgia.

Defined as the ratio of total capital to total liabilities; an increase in the ratio indicates an improvement.

Percent of total loans.

Percent of total regulatory capital.

10. Banking supervision has become more proactive. The authorities took decisive steps to resolve an insolvent bank in February 2006, once the situation was uncovered in an on-site inspection. Temporary administration was put in place, an offer was made to Georgian banks rated CAMEL one or two, and contingent plans were prepared in case viable offers were not received. When these actions were publicly announced, net withdrawals from the bank were insignificant, indicating no loss of depositor confidence. The sale of this bank brings the number of banks to 18.

11. A fiscal stance that was less expansionary by more than 2 percent of GDP compared with the budget helped prevent the projected widening of the current account deficit in 2005 (Table 7). In addition, lower-than-projected official disbursements (mainly reflecting slower than targeted project implementation) and foreign direct investment in the new pipelines slowed import growth. Preliminary data suggest export growth (net of a one-time adjustment for unregistered trade in 2004) also slowed. The strengthening of the lari since the beginning of 2005 may have contributed to this (Box 1). International reserves remained at about 2 months of non-pipeline imports.

Table 7.Georgia: Summary Medium-Term Balance of Payments, 2003–09(In million of U.S. dollars)
2003200420052006200720082009
CR/05/314Prel. Est.Proj.
Current account balance-293-429-742-472-537-447-446-464
Trade balance-598-719-1,235-907-1,048-1,032-1,051-1,101
Exports7301,2721,3861,4031,5221,6451,7691,892
Imports-1,328-1,991-2,620-2,310-2,570-2,677-2,820-2,993
Of which: Gas and oil pipeline-180-250-259-207-100000
Services and income (net)42-569117386495
Services (net)1031758566795118143
Factor income (net)-61-73-49-46-59-57-55-48
Of which: Interest (gross)-55-47-37-28-43-43-43-38
Transfers (net)262345483424503547541542
Official transfers5074194148181212193181
Of which: General government1841742657664332
Other transfers213271289277322335348361
Of which: Remittances166205218238271292313334
Capital account balance244780788586620507535567
Public sector-30-39-4-53-4447130167
Disbursements717014661799598101
Of which: World Bank4439904152454545
Amortization-107-137-150-142-160-149-70-45
Capital grants, incl. from MCC (beginning in 2006) 1/6282838101101111
Private sector274819792639664460405400
Foreign direct investment335503731415390235210190
Of which: Gas and oil pipeline240280324175125000
Other private capital, net-6131661224274225195210
Errors and Omissions39-203-850000
Overall Balance-101484629836089104
Financing10-148-46-29-84-62-90-100
Use of Fund resources, net-48-348-9-83-32-26
Purchases/disbursements0216541414100
Repurchases/repayments-48-55-57-51-49-38-32-26
Program loans02420132015105
Increase in reserves (-)7-192-111-91-146-80-68-79
Change in arrears (+, increase)51-52000000
Debt relief 2/0105575850000
Paris Club rescheduling043575850000
Rescheduling of arrears063000000
Financing gap0000032-4
Memorandum items
Nominal GDP3,9845,1936,3036,4097,5228,3529,25810,065
Current account deficit (percent of GDP)7.48.311.87.47.15.44.84.6
Current account deficit, excl. pipeline-related imports (percent of GDP)2.83.57.74.15.85.44.84.6
Trade deficit (percent of GDP)15.013.819.614.113.912.411.310.9
Merchandise export growth (percent)32.174.19.610.38.58.17.56.9
Merchandise import growth (percent)33.949.930.016.011.34.25.36.1
Nonpipeline-related merchandise import growth (percent)17.251.733.720.817.58.45.36.1
Gross international reserves 3/191383493474620700768847
(In months of imports of goods and services)1.31.71.81.92.22.42.52.6
(In months of imports of non-pipeline goods & services)1.52.02.02.12.32.42.52.6
Public and publicly guaranteed external debt (nominal)1,8491,8581,8521,7351,7201,6871,6541,657
(In percent of GDP)46.435.829.427.122.920.217.916.5
Debt service from the budget (cash)5910611811114318310271
(In percent of exports of goods and services)4.55.45.55.16.17.23.72.4
Total external debt service (cash)129186202189222249165129
(In percent of exports of goods and services)9.89.58.79.49.86.04.4
Sources: Georgian authorities; and Fund staff estimates.

Previously classified as current grants.

Includes the July 2004 Paris Club agreement on terms somewhat more generous than Houston terms.

Projections at program exchange rates.

Sources: Georgian authorities; and Fund staff estimates.

Previously classified as current grants.

Includes the July 2004 Paris Club agreement on terms somewhat more generous than Houston terms.

Projections at program exchange rates.

Box 1.Is Georgia Competitive?

Evidence on the level and trend of Georgia’s competitiveness is mixed (SIP, Chapter V). Georgia’s real exchange rate (RER) has appreciated during the past 24 months because of both strong real GDP growth and foreign exchange inflows related to foreign direct investment and a repatriation of savings. A continued positive external outlook and domestic spending pressures suggest that RER appreciation is likely to persist.

External competitiveness has started to suffer as a result. The share of Georgian exports in the country’s main trading partners’ import markets started to decline in early 2005. Furthermore, Georgia’s cost of doing business indicators continue to rank poorly, even compared to its neighbors. Notwithstanding these facts, U.S. dollar wages are the lowest in the region, and the RER is most likely still undervalued. Furthermore, two recent competitiveness studies indicate that the productivity of Georgia’s economy has improved markedly in 2004–05.

12. Georgia has reached debt rescheduling agreements with most bilateral creditors on terms comparable to those offered by the Paris Club in July 2004 (MEFP, paragraph 12). The authorities have asked the Paris Club to extend the deadline for concluding the remaining discussions to end-February 2006.

13. Structural reforms moved forward in many areas:

  • Fiscal: A comprehensive tax reform took effect in 2005 entailing a significant simplification of the tax code: (i) the number of taxes was reduced from 21 to 7; (ii) personal income tax rates ranging from 12 to 20 percent were unified under a single rate of 12 percent; (iii) the VAT rate was reduced from 20 to 18 percent; (iv) the payroll tax rate was reduced from 33 to 20 percent; and (v) exemptions and special regimes were significantly curtailed. In parallel, the authorities have continued to improve revenue administration. Treasury reforms continued throughout 2005. In early 2006, the Single Treasury Account (STA) became fully operational. LEPLs, however, operate outside the STA. Progress continues toward the goal of compliance with the recommendations of the Government Finance Statistics Manual 2001 (GFSM 2001) by early 2007. While the authorities produced their first Medium-Term Expenditure Framework (MTEF) in 2005, they recognize further work is needed to make this an effective policy tool. A new customs code, which will further modernize customs administration in Georgia, was submitted to parliament in October 2005.

  • Banking: The NBG has started to develop a strategy to guide development of the financial sector over the medium term, and has proposed eliminating restrictions limiting nonbank shareholders to 25 percent of the equity capital in Georgian banks. Also, the major banks have created a credit information bureau, enabling them to better gauge the creditworthiness of potential borrowers.

  • Energy: The technical and financial viability of the energy sector improved somewhat during the year, with quasi-fiscal losses declining from 4.5 percent of GDP in 2004 to an estimated 4 percent in 2005, owing mainly to the significant increase in collections due to the use of communal metering and reinforcement of payment discipline.

  • Business environment: A law was passed in June 2005, reducing the number of businesses for which a license is required from 900 to 150, and reducing the time for applying and processing applications using a “one-window” approval and the “silence is consent” principle.

III. Performance Under the Program

14. The program is broadly on track, with only one missed quantitative performance criterion (Table 8). Fiscal performance was stronger than programmed, with tax revenues well above program levels more than offsetting expenditures slightly above program levels. After slightly exceeding the June indicative reserve money target, the NBG stepped up efforts to contain reserve money growth, observing the end-September quantitative performance criterion and end-December indicative targets on reserve money by wide margins. NIR targets were met comfortably. The one area where performance was poorer than programmed was arrears clearance, as the authorities missed the September performance criterion for clearance of domestic expenditure arrears, and the indicative target for the year. Citing inflationary concerns, the authorities only cleared arrears of GEL 104 million (0.9 percent of GDP) in 2005, compared to the programmed level of GEL 149 million (1.3 percent of GDP).

Table 8.Georgia: Quantitative Performance Criteria and Indicative Targets, 2005 1/2/
Cumulative Changes from
End-December 2004
Mar. 2005Jun. 2005Sep. 2005Dec. 2005
Revised ActualsProgram EstimatesAdjusted targetActualsPerformance CriteriaAdjusted targetActualsIndicative TargetsAdjusted TargetPrelim.
(In millions of lari)
1. Quantitative targets
Floor on general govt. tax revenue448.9963.6985.61565.21621.82106.62299.6
Ceiling on cash deficit of the general govt. 3/-30.4197.4215.958.1418.7408.8141.9556.5535.7278.7
Ceiling on change in domestic expenditure arrears of the general govt.-31.9-60.6-68.5-95.6-76.4-149.2-103.7
Ceiling on net credit of the banking system to the general govt. (NCG)-52.6-1.5-148.016.1-119.767.0-106.1
Ceiling on reserve money-27.433.742.8134.796.9217.5164.9
(In millions of U.S. dollars)
Floor on total net international reserves (NIR) of the NBG-2.415.375.869.381.3101.8122.9
Ceiling on contracting or guaranteeing of
A. Nonconcessional medium- and long-term external debt0.00.00.00.00.00.00.0
B. Short-term external debt (less than one year)0.00.00.00.00.00.00.0
Ceiling on accumulation of external arrears0.00.00.00.00.00.00.0
(In millions of lari)
2. Indicative target
Ceiling on net domestic assets (NDA) of the NBG-23.05.5-97.56.4-53.529.2-62.4
(In millions of lari)
3. Baseline assumption on external project financing 3/25.795.7114.2175.6165.8270.1249.3
Sources: Georgian authorities; and Fund staff estimates.

Section 1 of this table shows quantitative targets for 2005 based on cumulative changes from end-December 2004. The ceiling for the cash deficit of the government is adjusted, as indicated in footnote 3, for deviations from projected external financing, reported in Section 3 of the table. The indicative target is shown in Section 2. The continuous performance criterion for external arrears is defined in paragraph 21 of the July 2005 TMU.

Quantitative targets for 2005 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.

The program target on the cash deficit is adjusted in 2005 for deviations from projected disbursements of external project finance (Section 3) as specified in the July 2005 TMU, subject to a cap on the cumulative upward adjustment of GEL 100 million for 2005.

Sources: Georgian authorities; and Fund staff estimates.

Section 1 of this table shows quantitative targets for 2005 based on cumulative changes from end-December 2004. The ceiling for the cash deficit of the government is adjusted, as indicated in footnote 3, for deviations from projected external financing, reported in Section 3 of the table. The indicative target is shown in Section 2. The continuous performance criterion for external arrears is defined in paragraph 21 of the July 2005 TMU.

Quantitative targets for 2005 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.

The program target on the cash deficit is adjusted in 2005 for deviations from projected disbursements of external project finance (Section 3) as specified in the July 2005 TMU, subject to a cap on the cumulative upward adjustment of GEL 100 million for 2005.

15. One end-September structural performance criterion was met, while the other—the submission of the Customs Code to parliament—was implemented with a short delay (Table 9). Two of three end-September structural benchmarks were also met. The missed structural benchmark (on the submission of the trade liberalization strategy) was delayed to give the business community time to comment, and the authorities time to consider a more radical liberalization. The resulting strategy calls for a reduction of the top tariff rate from 30 to 12 percent in 2006, 5 percent in 2007, and the elimination of import tariffs by 2008. The authorities met the end-December performance criterion for completing the transition to the single treasury account, the benchmarks for proposing upgraded “Fit and Proper” criteria for bank owners, and the preparation of a pension strategy, but missed two of five end-2005 benchmarks.5 The introduction of targeted poverty benefits, which was delayed by inflation concerns and the complexities of proper targeting, is proposed as a performance criterion for end-June 2006. The other missed benchmark—to complete registering taxpayers—is underway.

Table 9.Georgia: Structural Performance Criteria (*) and Benchmarks, 2005
MeasureStatusComments
1. Submit a new Customs Code to parliament, which is harmonized with basic EU norms and standards and incorporates FAD recommendations, as described in paragraph 19 of MEFP.Completed with a delayThe customs code was submitted to parliament in October.
End-September 2005 (*)
2. Prepare a Medium Term Expenditure Framework (MTEF) for 2006-09 as part of the Basic Data and Directions document as mandated under the Budget Systems Law.ObservedThe 2006 budget includes the medium-term expenditure framework for 2006–09.
End-September 2005 (*)
3. Formulate an action plan to reduce significantly the number of regulatory bodies and licenses required by private firms, as described in paragraph 26 of MEFP.ObservedThe law reducing significantly the number of regulatory bodies and licenses was adopted by parliament and signed by the president on June 24.
End-September 2005
4. Publish 2004 oil and gas transit revenue according to international transparency standards, as a first step to annual publication of this data.ObservedGas transit revenues were posted on the GGIC website as of July 23 (http://www.ggic.ge/n1.htm) and oil transit revenues were published in the newspaper Sakartvelos Respublika on September 15, 2005.
End-September 2005
5. Prepare a strategy for reducing the number of import tariff bands and the maximum tariff rate and discuss in parliament.Not observedThe draft law devising the new tariff regime was submitted to parliament at end-February 2006.
End-September 2005
6. Upgrade the Fit and Proper criteria for bank owners and managers to international standards, by submitting revisions to commercial banking law and related decrees.ObservedThe necessary amendments to the commercial banking law were submitted to parliament in October. Changes to supporting regulations will be completed once parliament approves the amendments.
End-December 2005
7. Complete the transition to a treasury single account for central government expenditures and revenues.ObservedOn January 1, 2006 the treasury moved to the Single Treasury Account for general government revenues and central government expenditures.
End-December 2005 (*)
8. Complete electronic re-registration of existing taxpayers and registration of new taxpayers.Not observedThe re-registration has been completed for regions and in 70 percent of Tbilisi. The authorities expect to complete the remainder by end-March 2006.
End-December 2005
9. Introduce a targeted poverty benefit to replace numerous in-kind benefits.Not observedThe authorities have postponed implementation of the benefit scheme until July 2006.
End-December 2005
10. Publish a strategy paper on pension reform to put the social security system on a sounder fiscal footing.ObservedParliament approved legislation that represents the first steps toward pension reform.
End-December 2005

IV. Report on the Discussions

16. Against the backdrop of reasonably low inflation and good growth performance, underpinned by strong and consistent reforms, the Article IV discussions focused on medium-term policies necessary to maintain growth and reduce poverty. Discussions centered on measures to deal with obstacles to growth—including crumbling infrastructure that needs to be addressed by the public investment program, financial sector underdevelopment, and poor institutional quality affecting private sector investment—while maintaining macroeconomic stability.

A. Medium-Term Economic Prospects and Challenges

17. The authorities assess economic prospects in the medium term as strong (Table 10). Their focus on maintaining macroeconomic stability, liberalizing the economy and removing remaining obstacles to businesses, and developing complementary public infrastructure required for private sector activity, should create an environment for steady growth and improvement of living standards in the coming years.

Table 10.Georgia: Macroeconomic Framework, 2004–09
200420052006200720082009
CR/05/314Prel. Est.Proj.
(Percent change)
Output, prices, money, and external trade
Real GDP6.28.57.76.45.05.05.0
Consumer price index (average)5.79.48.35.34.04.04.0
Broad money (M3, lari)42.631.826.429.015.815.516.6
Exports (US$)74.19.610.38.58.17.56.9
Imports (US$) 1/49.930.016.011.34.25.36.1
(In percent of GDP)
General government
Total revenues and grants21.721.723.422.925.024.825.1
Tax revenues18.218.119.819.321.021.522.0
Nontax revenues 2/2.32.52.72.21.81.61.6
Grants1.21.20.91.32.21.71.5
Expenditures and net lending18.625.224.925.025.325.626.0
Current expenditure16.219.720.721.321.321.722.1
Noninterest15.918.619.720.320.521.021.5
Interest1.21.01.00.90.80.80.7
Capital expenditure and net lending2.45.54.23.84.03.93.9
Primary balance4.3-2.4-0.5-1.30.50.0-0.2
Overall balance (commitment basis)3.1-3.5-1.5-2.2-0.3-0.8-0.9
Net change in expenditure arrears-2.6-1.3-0.9-0.40.00.00.0
Overall balance (cash basis)-0.2-4.8-2.4-2.6-0.3-0.8-0.9
Financing0.24.82.42.60.30.80.9
Privatization0.93.43.62.60.70.30.1
Domestic financing-0.90.6-0.90.30.40.00.1
External financing (net)0.20.8-0.3-0.2-0.50.50.7
Disbursements (incl. in-kind)1.22.31.11.41.41.31.1
Amortization-1.5-1.5-1.4-1.6-1.9-0.8-0.5
Saving and investment
Investment26.628.926.426.626.226.426.4
General government2.45.54.23.84.03.93.9
Nongovernment sector 1/24.223.422.122.822.322.522.5
Of which: FDI9.711.66.55.22.82.31.9
Gross domestic saving18.317.119.019.420.921.621.8
General government5.52.02.71.63.63.13.0
Nongovernment sector12.815.116.317.917.218.518.8
Current account deficit 1/8.311.87.47.15.44.84.6
(In millions of U.S. dollars; unless otherwise indicated)
Gross official reserves of the NBG 3/383493474620700768847
(In months of imports of non-pipeline goods and services)2.02.02.12.32.42.52.6
(In months of imports of goods and services)1.71.81.92.22.42.52.6
External debt, public and guaranteed
External debt stock1,8581,8521,7351,7201,6871,6541,657
External debt service, total169180167196225138101
Memorandum items:
Nominal GDP (in millions of lari)9,97011,66011,60013,08014,30715,62417,061
Nominal GDP (in millions of US$)5,1936,3036,4097,5228,3529,25810,066
External debt stock (public and guaranteed; percent of GDP)35.829.427.122.920.217.916.5
Domestic public debt (percent of GDP)10.68.49.17.66.86.25.5
M3-velocity (M3 annual average)7.86.86.05.45.14.8
Social sector expenditures (percent of GDP)6.37.97.68.610.210.711.2
Social sector spending, cash basis (percent of GDP)7.18.19.010.210.711.2
Sources: Georgian authorities; and Fund staff estimates.

Large oil and gas pipeline projects are projected to increase imports, investment, and the current account deficit substantially in 2003–06.

Sustained increase in nontax revenues from 2006 onward reflects transit fees from the BTC oil pipeline and the South Caucasus gas pipeline.

International reserves are reported at current exchange rates and may differ from reserves at program rates as reported in the monetary accounts.

Sources: Georgian authorities; and Fund staff estimates.

Large oil and gas pipeline projects are projected to increase imports, investment, and the current account deficit substantially in 2003–06.

Sustained increase in nontax revenues from 2006 onward reflects transit fees from the BTC oil pipeline and the South Caucasus gas pipeline.

International reserves are reported at current exchange rates and may differ from reserves at program rates as reported in the monetary accounts.

18. The primary focus of the public investment program over the medium term is on improving roads and power supply, which the authorities consider to be key to maintaining growth. The authorities recognize the importance of strengthening their medium-term fiscal planning, and in that context are seeking to improve the Basic Data and Directions (BDD) document, their equivalent of an MTEF. Nonetheless, they view the four supplementary budgets in 2005 as a positive reflection of their strong revenue and privatization performance. Discussions focused on ways to increasingly tie expenditure policy to a well prioritized medium-term strategy that could provide a coherent policy framework in which to prepare supplementary budgets.

19. The NBG and government are preparing a financial sector development strategy for 2006–09. The strategy will focus on (i) streamlining some of the more cumbersome regulations and harmonizing them with Basle principles, (ii) consolidating NBG’s functions and independence; (iii) refining the payments system; (iv) introducing measures to develop capital markets, including for government securities; and (v) easing the entrance of foreign banks into Georgia.

20. Despite substantial progress on reducing corruption and improving governance, the authorities realize that further reforms, particularly in the judicial area, are needed (SIP, Chapter III). The authorities see Georgia becoming a liberal and deregulated market economy, with few opportunities for rent-seeking. In addition, the new trade liberalization strategy, which will eliminate all tariffs by 2008, is seen by the authorities as a key step to integrate Georgia into the global economy.

21. The main challenge facing the authorities is to maintain macroeconomic stability in the face of a significant inflow of resources, election pressures, and regional tensions. With privatization proceeds, remittances, and official assistance—including grants soon to begin from the Millennium Challenge Account (MCA)—financing rural infrastructure and the rehabilitation of the energy sector, the burden of controlling inflation will be on monetary policy. In addition to maintaining the quality of spending given capacity constraints, the fiscal and monetary policy mix may need to be reexamined going forward. In this regard, the authorities recognize that the NBG’s ability to conduct monetary operations needs to be strengthened, and the coordination of policies between the NBG and ministry of finance improved. Finally, regional tensions and political uncertainties represent a risk to sustainable medium-term growth.

B. Near-Term Economic Policies

22. As a foundation for program discussions, the authorities updated the macroeconomic framework for 2006 to reflect the recent robust performance of the economy, keeping in line with underlying PRSP objectives. Real GDP growth is projected to be 6.4 percent in 2006, assuming a slowdown of agricultural growth to a more sustainable level and high oil and gas prices. The fiscal stance is projected to remain roughly unchanged, with a programmed deficit of 2.6 percent of GDP on a cash basis, as all remaining domestic arrears are cleared. While the budget projects the fiscal deficit on a commitment basis to increase to 2.2 percent of GDP, staff projects the deficit to decline to 1.1 percent of GDP (from 1.5 percent in 2005). The monetary program targets a further reserve accumulation of about US$146 million in 2006, which would increase non-pipeline import coverage to 2.3 months, whereas growth of reserve money would be limited to 25 percent, consistent with a targeted decrease of CPI inflation to 4.7 percent by end-December 2006 (MEFP Table 2).

2006 budget

23. The 2006 budget incorporates the following key features:

  • A fiscal framework in line with the PRSP and MTEF;

  • Financing from privatization proceeds and concessional resources;

  • Tax revenues that are projected conservatively against the backdrop of large improvements in tax administration in 2004, and the major tax reform in 2005; and

  • A focus on the quality and sustainability of increased expenditures on infrastructure, energy, and defense, and the replacement of untargeted social programs with well-targeted extreme poverty benefits.

24. The 2006 budget envisages a roughly unchanged fiscal stance, with a deficit of 2.2 percent of GDP on a commitment basis. Clearance of arrears is budgeted to be 0.4 percent of GDP, reflecting arrears claims that have already been verified, leading to a deficit of 2.6 percent of GDP on a cash basis.

25. The budget contemplates an increase in current expenditures (0.6 percent of GDP) and a decrease in capital expenditure (0.5 percent of GDP). The wage bill is expected to remain roughly unchanged as a share of GDP, and defense spending to decline slightly, while social spending is projected to increase to about 9 percent of GDP, reflecting anticipated increases in minimum pensions as well as the targeted poverty benefit program now scheduled for mid-2006.6,7 The budget also includes GEL 35 million in temporary energy subsidies to cushion private gas consumers from the 70 percent increase in gas tariffs, prior to the introduction of the new poverty benefit.

26. The 2006 budget includes a conservative 19.3 percent of GDP revenue projection, as the budget was prepared before the 2005 outturns were known. Actual 2005 tax revenues amounted to 19.8 percent of GDP, reflecting continued gains in tax collections and further improvements in revenue administration. The authorities agree that this strong revenue effort is likely to be sustained, with 2006 tax revenues expected to be about 1 percent of GDP higher than budgeted. They intend to use excess revenues first to finance the clearance of any additional verified arrears, as the government seeks to resolve all arrears claims outstanding as of end-2005 by end-2006 (MEFP, paragraph 16 and Table 1; a planned structural performance criterion for end-December 2006). Notwithstanding the reductions in customs duties, import taxes are expected to be unchanged as a percentage of GDP, as lower rates (including excises on cigarettes) are expected to reduce smuggling.

27. Grants are expected to increase in 2006, partially offsetting declining privatization receipts. The 2006 MCA disbursements comprise the majority of the projected 1.3 percent of GDP in grants. Privatization receipts are projected to be 2.6 percent of GDP.

Monetary and exchange rate policies

28. The monetary program for 2006 targets reserve money growth at 25 percent, consistent with the authorities’ single-digit inflation objective (Box 2, MEFP paragraph 32). The program does not foresee direct borrowing from the central bank, and the authorities intend to introduce legislation prohibiting any such borrowing in the future (an end-March performance criterion).

29. The NBG emphasized that it stood ready to use its indirect monetary policy instruments more actively to affect the monetary base, including sterilizing its foreign exchange interventions. To increase its stock of such instruments, the ministry of finance and the NBG are nearing agreement on securitizing some of the non-tradable government debt held by the central bank (MEFP, paragraph 33).8 In the event of unexpected capital inflows, the NBG will conduct sales of treasury bills and central bank CDs to contain the monetary expansion from any foreign exchange purchases. In light of mounting confidence in the banking system that should allow further dedollarization, the NBG also plans to streamline its reserve requirements by equalizing the requirements for domestic and foreign-currency deposits.9

Box 2.Preparing for Inflation Targeting

Most CIS countries, including Georgia, manage the exchange rate, but are exposed to frequent and sometimes large external shocks. An (implicit) exchange rate peg may not be sustainable, since both reserves and sterilization instruments are limited. Recognizing the importance of low and stable inflation, most countries also monitor monetary aggregates. This strategy, however, can prove difficult in light of money demand instability.

As an alternative monetary policy framework, a growing number of countries have chosen to target inflation directly. Some of the prerequisites of inflation targeting include (i) price stability as the overriding objective of monetary policy; (ii) an independent central bank that has instruments to reach its (assigned and agreed) inflation target; (iii) a strong accountability framework; (iv) a strong and well-understood transmission mechanism from the NBG’s operating target to inflation; and (v) a sufficiently good econometric model to successfully forecast inflation.

While the NBG believes it will not be ready to switch to this paradigm soon, fulfilling these prerequisites would contribute to improving the conduct of monetary policy. Although the NBG is in principle autonomous, it is subject to political pressures to influence the exchange rate and interest rate. A public declaration that price stability is the NBG’s overriding goal (together with a commitment to a more flexible exchange rate) would help reduce these pressures. While the NBG’s legal mandate currently includes price stability, it also includes maintaining the purchasing power of the lari, which could conflict with price stability. The NBG has announced an “estimate” (as opposed to “target”) for the one-year-ahead CPI inflation rate, continues to develop a macroeconomic model, and is aiming to publish a financial stability report. Finally, the NBG recognizes that it should embark on a public campaign to explain its monetary policy actions and report to the public at a higher frequency.

30. Maintaining external competitiveness remains a key policy challenge. The CPI-based real exchange rate and low labor costs suggest the lari may be undervalued. Thus, further upward pressure on the exchange rate stemming from strong international financial support and FDI expected for Georgia over the medium term could well be accommodated. At the same time, surveys of the costs of doing business in Georgia suggest that external competitiveness may be weaker than the real exchange rate comparisons suggest.

31. The authorities reiterated their commitment to a floating exchange rate regime and their general intention to refrain from intervention other than to smooth market fluctuations. However, while recognizing the importance of the inflation target, the authorities voiced concerns about the negative impact of a lari appreciation on exports in the event of larger-than-anticipated foreign exchange inflows. In their view, large U.S. dollar-denominated household assets and income flows would require a more managed approach to appreciation if pressures were to arise.

C. Structural Reforms

32. There have been improvements in fiscal transparency since 2004. However, concerns remained about the persistence of quasi-fiscal funds operating outside the budget with limited accountability and transparency. Two such funds—the Armed Forces Fund and the Law Enforcement Fund—had been widely discussed in Georgia. The authorities explained that these funds had been formed in early 2004 to address specific problems, but noted that there was no longer any need for them. These funds are now closed, and are being liquidated (MEFP, paragraph 30). A third fund, the Reform and Development Fund, which previously financed budget expenses, has been transformed into an NGO.

33. More generally, the authorities are undertaking a program of reforms of LEPLs, which have become the cornerstone of their decentralization strategy. The authorities are committed to decentralizing the provision of government services, and are delegating control and accountability of major government functions to these LEPLs. While having no disagreement with these principles, staff argued that a monitoring and reporting framework needed to be put in place urgently. The authorities agreed it was important to ensure the LEPL reform did not undermine gains in fiscal transparency and accountability (Box 3), and are committed to a number of steps designed to ensure effective monitoring of their activities (MEFP, paragraph 29). It was agreed that progress in this area would be reviewed in the context of the fourth review of Georgia’s PRGF arrangement.

Box 3.Reforming Legal Entities of Public Law (LEPLs)

The authorities view the conversion of fiscal entities into LEPLs as an opportunity to improve government service delivery (SIP, Chapter IV). The conversion of budgetary organizations to LEPL status is designed to provide them greater autonomy, and thus allow them to implement reforms quickly while bypassing bureaucratic red tape. However, insufficient consideration may have been given to ensuring the new LEPLs were accountable for results, or to monitoring their activities. While the exact number of LEPLs is not known, between 1999 and 2003 an estimated 700 budgetary organizations were converted to LEPLs at the local and central government level. In December 2005, the authorities converted about 2,700 individual schools into LEPLs, bringing the estimated number to more than 3,400.

The main fiscal risks associated with the LEPL reform include the following:

  • The LEPL reform in its present state weakens the monitoring and reporting of the fiscal accounts of the general government, with implications for budget transparency and control;

  • The delegation of authority will create problems controlling the quality of spending, particularly as LEPLs have less developed Public Expenditure Management systems; and

  • There is a significant risk that LEPLs may incur debt and arrears.

34. The authorities emphasized the importance of upgrading the Budget Systems Law (BSL) to organic status, but noted that certain technical amendments to the BSL were needed first; after these were passed, they would renew their efforts to get the law upgraded. They reiterated their intention to be GFS 2001 compliant by 2007.

35. Building on the comprehensive tax reforms that took place in 2005, the ministry of finance plans to improve tax administration by focusing on three key priorities: (i) self-assessment, (ii) risk management, and (iii) taxpayer segmentation. An FAD regional tax administration advisor will assist the authorities in these efforts. While acknowledging that the customs code that was recently submitted to parliament represents a significant improvement, staff urged the authorities to strengthen the penalty provisions in this code; the authorities agreed to consider this recommendation.

36. The NBG plans further financial sector reforms (Box 4), including strengthening supervision (MEFP paragraphs 34–39). Consideration is being given to introduction of a deposit insurance system, but the authorities recognize that appropriate conditions are necessary before its introduction. The authorities believe further sector consolidation, by merging or closing weak banks, will be an important step toward creating appropriate conditions for deposit insurance. Finally, an FSAP update is currently underway. The authorities plan to implement recommendations coming from this exercise, which will be reflected in an FSSA to be presented to the Board along with the fourth review.

Box 4.Developing the Financial Sector in Georgia

Financial sector development in Georgia has lagged behind many other transition countries (SIP, Chapter I). Monetization was low after independence, trailing the levels in Central and Eastern European economies and the Baltics (see table). Financial intermediation is shallow, and commercial banks have targeted their activities to a small group of companies and consumers, resulting in lower private sector credit than in the comparable countries.

Over the past year, increased confidence in the Georgian banking system, higher consumer spending, and emerging business opportunities have triggered a credit boom. Since end-2004, commercial banks’ lending to the private sector has increased by more than 80 percent—albeit from very low levels. Some of the additional loans are consumption-related or mortgages, fuelling property prices in Tbilisi.

While economic growth has been high in recent years despite the limited financial market development, a stronger financial sector will be essential to sustain this economic development. Greater financial intermediation, in particular benefiting small- and medium-sized enterprises, should spur investment and job creation. As firms’ financing needs go beyond retained earnings, and equity financing is not viable given shallow equity markets, the banking sector will play a crucial role. For the financial sector in Georgia to catch-up with the advanced transition economies, financial sector reforms such as greater consolidation and foreign entry, and enhanced creditors’ rights, need to gain momentum.

Table 1.Selected Transition Economies: Financial Sector Development, 1996–2005(In percent of GDP)
199619982000200220042005

Est.
Banking system credit to economy
Georgia3.34.77.38.39.515.0
Selected CEE 1/36.535.435.831.335.539.0
Baltics 2/11.816.117.522.437.654.1
Monetization 3/
Georgia6.77.310.311.615.216.5
Selected CEE 1/49.748.051.153.653.355.4
Baltics 2/21.623.628.933.638.747.6
Sources: International Monetary Fund, IFS, WEO, and MCD centralized databases.

Includes Poland, Czech Republic, Hungary; simple average.

Includes Estonia, Latvia, Lithuania; simple average.

M3 where available, M2 otherwise.

Sources: International Monetary Fund, IFS, WEO, and MCD centralized databases.

Includes Poland, Czech Republic, Hungary; simple average.

Includes Estonia, Latvia, Lithuania; simple average.

M3 where available, M2 otherwise.

37. The authorities are increasingly focused on strengthening the energy sector through modernization, privatization and diversification of energy sources. They noted the need to install individual meters for households and adjust electricity tariffs to cost-recovery levels, upon the completion of the tariff review sponsored by the World Bank (Box 5). The authorities plan to privatize six hydropower plants and three distribution companies in 2006. In addition, a draft law has been prepared establishing a debt restructuring committee charged with resolving the long-standing problems in the sector.

Box 5.The World Bank Work Program in Georgia

The World Bank Country Partnership Strategy (CPS) for FY06–09 builds on the government Economic Development and Poverty Reduction Program (EDPRP), as well as emerging government strategic thinking on the development framework. It targets several goals: i) generating growth and job creation by removing barriers to private sector development and improving infrastructure, finance and markets; ii) enhancing human development and social protection through improved education, health, social protection, and community services; and iii) strengthening public sector management and budgetary processes to enable Georgia to better plan and meet its own development goals.

A key component of the CPS is a series of Poverty Reduction Support Operations (PRSO). The PRSO has four pillars:

  • Strengthening public sector accountability, efficiency, and transparency.

  • Improving electricity and gas sector services.

  • Improving environment for private sector development.

  • Improving social protection, education, and health care services.

38. A key goal for the authorities is to create a favorable business climate by liberalizing the economy, and restructuring and privatizing the remaining state-owned enterprises. The EBRD transition indicators show significant accomplishments in these areas, especially in comparison to other CIS countries (Box 6). In addition to a better business environment, several surveys have also reflected improvements in governance, although important challenges remain.

Box 6.Latest Surveys on the Business Environment and Governance

The Georgian authorities have clearly established momentum in reforming the business environment. A series of surveys that came out in 2005 reflect improvements resulting from the policy changes undertaken by the current administration. Most informal views are that the next round of these surveys will reflect even larger gains.

In the World Bank’s Doing Business 2005, Georgia showed the second largest improvement and ranked 100 out of 155 countries. Georgia performed better than other countries in the region in starting a business, rigidity of employment, registering property, and closing a business.

In the World Economic Forum’s Global Competitiveness Index of 2005, Georgia was ranked 86th out of 117 countries, up 8 spots, the seventh largest upward move. The two main areas of improvement were macroeconomic stability and the quality of public institutions.

Heritage Foundation’s Index of Economic Freedom had Georgia jumping from 100th place in 2005 to 68th place in 2006, with its score improving from “mostly unfree” last year to “mostly free” this year. Areas of improvement were concentrated in monetary policy, the financial sector, and foreign investment, while property rights, regulation, and the informal market scores remained poor.

Transparency International’s Corruption Perceptions Index 2005 showed modest improvement from 2 to 2.3.

Figure 5.EBRD Transition Indicators, 2005

Technical assistance and data issues

39. The authorities expressed satisfaction with the technical assistance provided by the Fund during the last two years (Appendix I). While the assistance has been broadly effective, there have been delays in the implementation of some recommendations. These shortcomings can be attributed to capacity constraints and, in certain areas, changing priorities. Future needs involve government finance and balance of payments statistics methodology, as well as implementation of recommendations from the FSAP update currently underway.

40. The quality and timeliness of economic and social statistics have improved over the past few years, although real sector, fiscal, and balance of payments data require further enhancements (Appendix IV). Georgia plans to subscribe to the General Data Dissemination Standard, and the data provided to the Fund are generally adequate for surveillance and program monitoring.

D. Medium-Term Risks and Capacity to Repay

41. The medium-term debt sustainability analysis (Appendix V), shows that Georgia faces a moderate risk of debt distress, as evidenced by the decline in the medium term of all indicators of external indebtedness below the relevant debt-burden thresholds of the NPV of debt (150 percent of exports, 40 percent of GDP, and 250 percent of fiscal revenue).10 Stress tests indicate that Georgia would be vulnerable to adverse external and domestic shocks, or bad policy choices. For example, export value growth less than historical averages—2 percent growth for 2 years—would result in the NPV of debt-to-exports ratio becoming unsustainable at 150 percent, even if the gap were financed at better than commercial terms (30 percent grant element). With official reserves low (at about 2 months of non-pipeline imports), this could erode hard gained exchange rate stability. Overall, Georgia’s capacity to repay the Fund seems strong (Tables 11 and 12).

Table 11.Georgia: Indicators of Financial Obligations to the Fund, 2001–10(In millions of SDR)
2001200220032004200520062007200820092010
Total Fund credit outstanding228.6228.0194.3171.3164.9159.5161.6139.5121.5107.4
In percent of quota152.1151.7129.3114.0109.7106.1107.592.880.871.4
In percent of GDP9.18.76.84.93.83.12.82.21.81.5
In percent of exports of goods and nonfactor services23.522.214.78.77.66.86.45.14.23.5
Disbursements (PRGF)27.022.50.014.028.028.028.00.00.00.0
Total obligations from existing and prospective drawings14.824.935.338.135.334.427.023.219.015.1
Principal (repayments/repurchases)12.023.133.837.034.433.425.922.118.014.1
Charges and interest2.81.81.61.10.91.01.11.11.01.0
Total obligations to the Fund
In percent of quota9.816.623.525.423.522.918.015.412.710.1
In percent of GDP0.50.70.90.70.60.50.30.30.20.1
In percent of exports of goods and nonfactor services1.93.13.72.92.42.11.61.20.90.7
Net credit from the Fund15.0-0.6-33.8-23.0-6.4-5.42.1-22.1-18.0-14.1
Net resources from the Fund12.2-2.4-35.3-24.1-7.3-6.41.0-23.2-19.0-15.1
Sources: Fund Finance Department; and staff estimates and projections.
Sources: Fund Finance Department; and staff estimates and projections.
Table 12.Georgia: Proposed Schedule of Reviews and Disbursements Under the PRGF Arrangement
Test dateBoard dateAmount
Board ApprovalJune 4, 2004SDR 14 million
First ReviewJune 30, 2004December 20, 2004SDR 14 million
Second ReviewDecember 31, 2004July 20, 2005SDR 14 million
Third ReviewSeptember 30, 2005March 31, 2005SDR 14 million
Fourth ReviewMarch 31, 2006July 2006SDR 14 million
Fifth ReviewSeptember 30, 2006December 2006SDR 14 million
Sixth ReviewMarch 31, 2007June 2007SDR 14 million

42. A significant risk this year is the authorities’ commitment to maintain macroeconomic restraint in the face of election pressures while sustaining commitment to pro-poor spending. In addition, relations with Russia are tense, as political tensions remain high regarding the status of the breakaway territories of Abkhazia and South Ossetia. The recent explosions, which interrupted gas and electricity imports from Russia, show that the energy sector continues to be a major source of vulnerability. Energy sector reforms, including privatizations that are transparent and internationally tendered, as well as a further diversification of energy sources, would contribute to the sector’s medium-term viability. Finally, continued progress in structural reforms will be necessary for sustainable medium-term growth.

V. Staff Appraisal

43. The transition, following the Rose Revolution, to better quality fiscal policies underpinned by a determined undertaking of a broad range of reforms, including in tax policy and administration and the business environment, has provided a key foundation for placing the Georgian economy on a strong growth path. The authorities are to be commended for their performance over this period. The challenge ahead is to reinforce the reforms with adequate implementation, while proactively addressing the remaining vulnerabilities.

44. The staff welcomes the effective implementation of the economic program in 2005. All but one of the quantitative performance criteria for end-September 2005 were met. Although the authorities cited inflation as the reason for not clearing the programmed level of arrears, staff believes that clearing back wages and salaries would have had minimal impact on inflation. The staff thus welcomes the authorities’ commitment to clear all remaining arrears by end-2006.

45. Owing largely to the strong revenue performance and restraint on capital expenditures, the deficit was half the budgeted level. Given this positive fiscal position, staff regrets the delay in clearing arrears and introducing a targeted poverty benefit. Moreover, staff believes there is an urgent need to strengthen fiscal planning, and to put it in the context of a meaningful MTEF. The pace of increase in some categories of spending is also cause for concern, such as the increase in current expenditures by more than 4 percent of GDP and the more than doubling of defense spending.

46. The projections underlying the 2006 budget appear conservative. The main risk to the agreed framework is the danger of supplemental budgets to increase spending in an election year. The staff urges the authorities to exercise spending restraint, and to ensure all expenditures are in line with the PRSP and MTEF.

47. The newly created LEPLs have to be monitored carefully to ensure adequate financial control. While acknowledging the authorities’ objective of creating more flexible functions of government, staff is concerned with the rapid movement in this direction without adequate monitoring and reporting procedures. The staff urges the authorities to urgently develop and implement such procedures.

48. The current stance of monetary policy, aimed at lowering inflation to about 5 percent, is appropriate. To attain this target, it will be important to allow the exchange rate to appreciate, especially in the event of higher capital inflows. Foreign exchange intervention should be limited to smoothing exchange rate fluctuations. The level of the exchange rate is possibly somewhat undervalued at the present time; the nominal exchange rate should be allowed to appreciate over the medium term while safeguarding competitiveness through structural reform-induced productivity improvements.

49. While staff welcomes the improved coordination between the ministry of finance and NBG, there is need for further improvement in this coordination to avoid swings in monetary aggregates. Moreover, the authorities should be prepared to actively use the newly created instruments of monetary policy to achieve their inflation targets.

50. The financial sector’s growth in the last year, albeit from a very low base, has been impressive. To ensure the sector remains healthy amid such vigorous expansion, it will be critical to ensure strong and effective banking supervision. In addition, increasing minimum capital requirements, allowing foreign banks to enter and further consolidate the sector, and implementing fit and proper ownership requirements will be important. The adoption of forthcoming FSAP recommendations should further strengthen the financial sector.

51. Notwithstanding the tremendous gains made in the last two years, the structural reform agenda needs to be ambitious to increase competitiveness, sustain growth and reduce poverty. The authorities’ priorities to overhaul and transform transport infrastructure, and the energy and water sectors, to deepen the financial sector, and to improve customs in conjunction with radical trade liberalization that envisages a complete abolition of import tariffs in two years, appropriately target removing the key obstacles to growth. If effectively implemented in the context of macroeconomic stability and a favorable business environment, they will provide reasonable assurance of sustained growth over the medium-term. Notwithstanding the impressive recent improvements, to ensure a favorable business environment, it will be important for the authorities to continue to aggressively work to improve governance and property rights.

52. Staff remains concerned that safety nets are not in place at this critical juncture. While increasing pensions and defraying higher energy costs for households will help the poor, the authorities need to move ahead with clearing wage and pension arrears and introducing the targeted extreme poverty benefit. Going forward, poverty and inequality reduction is essential to keep broad support for the market-based reforms that will deliver higher living standards for all in Georgia.

53. Given Georgia’s good overall performance under the program, and commitments outlined in the MEFP, staff supports the authorities’ request for waivers for the nonobservance of performance criteria and recommends the completion of the third review of the PRGF arrangement. It is proposed that the next Article IV consultations be held in the 24-month cycle.

APPENDIX I Georgia: Fund Relations

(As of January 31, 2006)

I. Membership Status: Georgia joined the Fund on May 5, 1992 and has Article VIII Status.

II. General Resources Account:

SDR MillionPercent of Quota
Quota150.30100.00
Fund holdings of currency150.30100.00
Reserve position in Fund0.010.01

III. SDR Department:

SDR MillionPercent of Allocation
Holdings6.71N/A

IV. Outstanding Purchases and Loans:

SDR MillionPercent of Quota
PRGF Arrangements162.54108.14

V. Latest Financial Arrangements:

TypeApproval

Date
Expiration

Date
Amount Approved

(SDR million)
Amount Drawn

SDR Million)
PRGF6/4/046/3/0798.0042.00
PRGF1/12/011/11/04108.0049.50
PRGF2/28/968/13/99172.05172.05

VI. Projected Payments to Fund: (SDR million; based on existing use of resources and present holdings of SDRs):

Forthcoming
20062007200820092010
Principal33.4425.9422.1117.9614.10
Charges/interest0.720.570.450.350.28
Total34.1526.5022.5618.3114.38

VII. Implementation of HIPC Initiative:

Not applicable.

VIII. Safeguards Assessments:

Under the Fund’s safeguards assessment policy, the National Bank of Georgia (NBG) is subject to an assessment with respect to the PRGF arrangement approved on June 4, 2004. The assessment was completed on December 10, 2004 and concluded that safeguards in place at the NBG appear generally adequate. However, certain vulnerabilities were identified in the internal audit and internal controls areas, and the safeguards assessment recommended measures to address them.

IX. Exchange Arrangements:

(a) Since April 29, 1993, the Tbilisi Interbank Currency Exchange (TICEX), established by the NBG and a group of commercial banks, has conducted periodic auctions to determine the exchange rate of the domestic currency vis-à-vis the U.S. dollar. These auctions are conducted daily. Foreign exchange bureaus are allowed to buy and sell foreign currency bank notes. Georgia’s exchange rate regime is classified as “managed floating.”

(b) Georgia maintains no exchange restrictions on the making of payments and transfers for current international transactions except for exchange restrictions maintained for security reasons, and notified to the Fund pursuant to Executive Board Decision No. 144-(52/51).

X. Article IV Consultation:

The 2003 Article IV consultation was concluded on October 17, 2003.

XI. FSAP Participation:

Two FSAP missions visited Tbilisi during May 1–15, and July 24–August 7, 2001. An FSAP update mission visited Tbilisi during February 15–28, 2006.

XII. Technical Assistance:

See Table 1 of this Appendix.

XIII. Resident Representative:

The fifth resident representative, Mr. Christiansen, took up his post on August 1, 2004, replacing Mr. Dunn.

XIV. National Bank of Georgia Resident Advisors:

Ms. Vance, MAE peripatetic banking supervision advisor to the NBG, commenced a series of visits to Tbilisi in September 1997. Mr. Nielsen, an MAE advisor, provided technical assistance to the NBG in May 1998. Mr. Viksnins was an MAE peripatetic advisor to the NBG president starting in October 1999. Mr. Fish was resident advisor on banking supervision from August 10, 1999 to January 31, 2002. Mr. Bernard Thompson provided peripatetic technical assistance in accounting and internal audit in March and August 2000. Mr. Wellwood Mason provided technical assistance on payment system issues on a peripatetic basis in 2002 and 2003. Mr. Howard C. Edmonds serves since September 2004 as a resident advisor on banking supervision issues.

XV. Ministry of Finance Resident Advisors:

Mr. Sharma was an FAD resident advisor and assisted the authorities in the development of a Treasury beginning in May 1997. Mr. Sainsbury, an FAD advisor, assisted the Ministry of Finance from June 1998 to November 1999. Mr. Chaturvedi was FAD resident advisor in 2001 and 2002 to assist the authorities in continuing the development of the Treasury and the Treasury Single Account, in revising the legislative framework, expenditure control systems, and budgeting issues. Between 2001 and 2003, Mr. Welling was an FAD peripatetic advisor to assist the State Customs Department in preparing and introducing measures for the custom reform and modernization program. In March 2005, Mr. Zohrab started advising the authorities on treasury-related reforms.

Table 1.Georgia: Fund Technical Assistance Missions, 2001–05
SubjectType of MissionTimingCounterpart
Fiscal Affairs Department (FAD)
Public Expenditure ManagementAssessment of Treasury system and preparing work plan for the resident advisorJun. 12–19, 2001Ministry of Finance
Public Expenditure ManagementReview of the draft Budget System LawMar. 14–Apr. 02, 2002Ministry of Finance
Public Expenditure Management and Fiscal ROSCAssessment of Treasury system and of observance of standards and codesJan. 16–30, 2003Ministry of Finance
Public Expenditure ManagementAssessment of Treasury System and implementation of Budget Systems LawSep. 29–Oct. 11, 2003Ministry of Finance
Tax and Customs AdministrationAssistance in taxation of excisable goodsOct. 27–Nov. 13, 2003Ministry of Finance
Tax PolicyReview of Tax PolicyJune 8–21, 2004Ministry of Finance
Public Expenditure ManagementAssessment of Treasury system.Nov. 8–23, 2004Ministry of Finance
Revenue AdministrationModernizing Tax AdministrationNovember 2005Ministry of Finance
Monetary and Financial Systems Department (MFD)
Banking, foreign exchange reserve management, monetary programming, and researchAdvisoryFeb. 26–Mar. 8, 2001National Bank of Georgia
Payment Systems, Bank Supervision and Resolution, Internal Audit, Foreign reserve Management, and ResearchAdvisoryOct. 23–Nov. 6, 2001National Bank of Georgia
Payment Systems and Bank ResolutionAdvisoryMar. 11–19, 2002National Bank of Georgia
Accounting and Audit, Anti-Money Laundering, Bank Supervision, and Monetary OperationsAdvisorySep. 24–Oct 9, 2002National Bank of Georgia
Payment SystemsAdvisoryJune 16–20, 2003National Bank of Georgia
Government Securities Market, Deposit Insurance, Anti-Money LaunderingAdvisoryApril 20–30, 2004National Bank of Georgia
Monetary Operations, Banking Sector CompetitionAdvisoryOct. 24–Nov. 5, 2004National Bank of Georgia
Liquidity management; trends in securities and insurance sectorsAdvisoryApril 18–29, 2005National Bank of Georgia
Statistics Department (STA)
National AccountsFollow-up assistanceMar. 26–Apr. 6, 2001State Department of Statistics
Balance of Payments StatisticsFollow-up assistanceFebruary 13–27, 2002State Department of Statistics
Money and BankingFollow-up assistanceMarch 2–15, 2002National Bank of Georgia
Data ROSCAssessment of observance of standards and codesJuly 15–31, 2002State Department of Statistics, National Bank of Georgia, Ministry of Finance
Balance of Payments StatisticsFollow-up assistanceMay 20–June 3, 2003State Department of Statistics
Government Finance StatisticsFollow-up assistanceNov. 5-18, 2003State Department of Statistics, Ministry of Finance
National AccountsFollow-up assistanceApril 26–May 7, 2004State Department of Statistics
National AccountsFollow-up assistanceApril 18–29, 2005State Department of Statistics
Price StatisticsFollow-up assistanceMay 23–June 3, 2005State Department of Statistics
Balance of Payments Statistics/International Investment PositionFollow-up assistanceJune 15–28, 2005State Department of Statistics and National Bank of Georgia
Legal Department (LEG)
Tax CodeFollow-up assistanceJan. 28–Feb. 9, 2001Ministry of Finance, Tax Inspectorate of Georgia
Tax CodeFollow-up assistanceJul. 13–24, 2001Ministry of Finance, Tax Inspectorate of Georgia
APPENDIX II Georgia: IMF-World Bank Relations

Partnership in Georgia’s Development Strategy

1. The government’s PRSP; Economic Development and Poverty Reduction Program (EDPRP), was presented to the Boards of IDA and the IMF in October and November 2003. A Joint Staff Advisory Note together with the Progress Report on the EDPRP was sent to the Boards of IDA and IMF in June 2005. The IMF completed the second review under the PRGF arrangement in July 2005. On September 15, 2005, IDA endorsed a new Country Partnership Strategy (CPS) for FY06–09, and approved the first in a program of three Poverty Reduction Support Operations (PRSOs).

2. The Fund has taken the lead in assisting Georgia in improving macroeconomic stability and pursuing fiscal reforms. The World Bank has taken the lead in the policy dialogue on structural issues, focusing on: (i) strengthening public expenditure management; (ii) improving performance of the public sector; (iii) reducing corruption; (iv) deepening and diversifying sources of growth; (v) protecting the environment; and (vi) reducing poverty. Georgia is one of the largest IDA borrowers in the CIS, with borrowing of US$816 million for 40 operations. The PRSO has supported further elaboration and implementation of the key elements of the government’s poverty reduction strategy as described in the EDPRP and Progress Report. The PRSO program is built on four pillars: (i) strengthening public sector accountability, efficiency, and transparency; (ii) improving electricity and gas sector services; (iii) improving the environment for private sector development; and (iv) improving social protection, education and health care services. Other support has come in the form of project support and Analytic and Advisory Activities across a broad spectrum of areas including education, health care, social protection, energy, roads, water and sanitation, agriculture, agricultural research and extension, irrigation and drainage, forestry, environment, biodiversity, enterprise development, municipal development, judicial reform, and cultural heritage. A Public Expenditure Review (PER) was prepared in 2002, and a Trade Study in 2003. The PER is being followed by a series of annual programmatic PERs, the first of which is under preparation. A Country Procurement Assessment Report (CPAR) was prepared in 2002 and a Country Financial Accountability Assessment (CFAA) in 2003. Updates of these are scheduled for FY06. A series of annual programmatic Poverty Assessments are being implemented

3. Georgia became a shareholder and a member of IFC in 1995. As of January 1, 2006, IFC has invested around $137 million to finance projects in the financial, power, oil and gas, and manufacturing sectors. IFC continues to explore the investment opportunities in partnership with strategic investors in both the financial and real sectors of the country. In the financial sector, IFC has focused on supporting the development of the housing finance market, providing credit lines and technical assistance to the leading banks—the Bank of Georgia and TBC Bank. To reach small and medium enterprises, IFC helped to establish ProCredit Bank of Georgia, the country’s first bank specializing in lending to micro and small enterprises. Most recently, IFC has provided a credit line to TBC Leasing to support the rapid growth of their portfolio of SME clients; this project grows out of two year’s of technical assistance to the Government and private sector to support the growth of the leasing sector. In oil transit, IFC has provided equity and credit to local and international companies, including investments by British Petroleum and other sponsors in the construction of the Baku-Supsa Early Oil Pipeline and the Baku-Tbilisi-Ceyhan Pipeline. Other investment projects have been in electricity distribution (AES-Telasi), mineral water (GGMW), and glass bottle production (Ksani Glass Factory). IFC has also provided donor-supported technical assistance to strengthen its client banks, introduce new financial products (including leasing and housing finance), support public-private partnerships in the energy sector, and to improve the business climate and corporate governance practices. The Foreign Investment Advisory Service (FIAS), a joint facility of IFC and the World Bank, carried out an Assessment of Administrative Procedures for Doing Business in 2003. FIAS finalized an advisory project in July 2004 to assist the Government in its efforts to remove administrative obstacles to investment to improve the business environment for private businesses, and the Private Enterprise Partnership (PEP) did an extensive study of the barriers to SMEs, finalized in early 2005. PEP and FIAS are currently holding joint consultations with the Government to identify concrete steps to be taken for improvements to the business environment.

4. Table 1 summarizes the division of responsibilities between the two institutions. In a number of areas—for example, the social sectors, rural development, environment, infrastructure, and judicial reform—the Bank takes the lead in the dialogue and there is no related conditionality in the IMF-supported program. The Bank is also leading the dialogue on private sector development and energy, and Bank analysis serves as inputs into the Fund program. In other areas—the financial sector, public expenditure management, and civil service reform—both institutions have worked together. Finally, in areas like monetary policy and domestic customs revenue, the IMF takes the lead.

Table 1.Georgia: Bank-Fund Collaboration on Georgia
AreaSpecialized Advice

from the Fund
Specialized Advice

from the Bank
Key Instruments
Economic Framework/





Management
Monetary policy, exchange rate, fiscal, and trade policies, economic statisticsEconomic growth, economic statisticsIMF: PRGF performance criteria and benchmarks on monetary and fiscal targets.
IDA: The PRSO program; macromonitoring; Trade and Transport Facilitation Project; Financial Sector Advisory Work; Policy Options Report.
BudgetBudget framework, tax policy and administration, customs, debt management, extra-budgetary fundsBudget management, Public Expenditure Review, Country Procurement Assessment, Country Financial Accountability AssessmentIMF: PRGF performance criteria on overall fiscal balance and revenue collection.
Bank: The PRSO program; Programmatic Public Expenditure Review
Public Sector ReformPublic asset management, audit of 3 problematic state-owned enterprisesCivil service reform (including pay and employment reform), anti-corruption agenda, decentralizationIMF: PRGF
IDA: the PRSO program, and the Public Sector and Financial Management Reform Project
Social/PovertyPrioritization of expenditure cuts to protect social spendingPoverty analysis; reforms in education, health, social protection; support to community driven developmentIMF: PRGF
IDA: Support through the PRSO program and IDA Credits for Education, Health and Social Investment Funds, Programmatic Poverty Assessment, SRS support for hospital restructuring, Pensions and Social Assistance Note, Policy work in health sector reform under the MTEF.
Private Sector DevelopmentCosts of Doing Business Surveys. Support for improved legislation and regulatory framework for private sectorIDA: The PRSO program; Business Environment Study, Integrated Trade Development Strategy, Labor Market Study.
IFC: investments and technical assistance.
InfrastructurePrivate sector participation in infrastructureIDA: Support though ongoing and proposed IDA Credits for Municipal Development and Decentralization Project II (MDDP II), Secondary and Local Roads, and Transport, Infrastructure Pre-Investment Facility.
IFC: investments and advisory services.
EnergyReforms and sector improvementsIDA: The PRSO program. Support through ongoing credits for Power, Energy Transit, technical assistance, and joint donor policy dialogue.
Rural developmentReforms in agriculture, irrigation, forestry and, environmentIDA: Support though Rural Infrastructure and Water Resource studies; ongoing rural Credits, and proposed Credits for Rural Development, Rural Telecommunications, Community Based Tourism.

Questions may be referred to Ms. R. Quintanilla (202-473-7673), Ms. Afsaneh Sedghi (202-473-7518), or Mr. A. Cholst (202-458-0324).

IMF-World Bank Collaboration in Specific Areas

Areas in which the World Bank leads and there is no direct IMF involvement

5. In the social sectors, IDA updates Georgia’s Poverty Assessment based on quarterly household data. IDA’s focus has been to improve execution of budgetary expenditures for health, education and poverty benefits and to raise the efficiency in the use of scarce public resources. Through the Social Investment Fund credits, IDA is focusing in particular on areas with high poverty levels to provide basic infrastructure to the poorest communities. Through the PRSO program, IDA is strengthening the dialogue with the government on social protection reform (safety nets, pensions, poverty benefits, labor market institutions and policies).

6. In education, the Adaptable Program Credit addresses a broad spectrum of educational reform issues, aimed at improving learning outcomes of primary and secondary students through curriculum reform, development of a national assessment and examination system, training of teachers, provision of learning materials, and development of capacity to make better use of physical, financial, and human resources. It also tackles key financing issues through the introduction of a per capita based formula for financing basic education. While the investment needs of school buildings are substantially higher than is currently affordable, the Social Investment Fund projects continue to assist in financing urgent repairs to school facilities in many communities. The first PRSO is supporting the government’s efforts in institutionalizing systemic changes initiated with its education reform strategy.

7. In health, IDA credits support the government in improving health care financing, exploring risk-pooling options, introducing a new system of primary health care, and improving the focus of publicly-funded services to the poor and on priority public health interventions. SAC III and the SRS Credit have supported hospital restructuring. In addition, IDA will be engaged in policy work in health sector reform in the context of the Medium-Term Expenditure Framework (MTEF) and the PRSO program.

8. In infrastructure, support is being provided through the Secondary and Local Roads Project, the Municipal Development and Decentralization Project II and the Social Investment Fund Project. These projects provide financing at the community level for critical infrastructure needs, primarily for school and health facility heating and repair, small hydropower schemes to provide electricity, drinking water and sanitation rehabilitation, as well as transportation infrastructure rehabilitation. IFC supported the privatization of Tbilisi electricity distribution through an investment in AES-Telasi, and IFC Advisory Services advised the government on the management contract for UEDC. The recently approved Infrastructure Pre-Investment Facility project is to facilitate infrastructure investments of strategic importance and/or special complexity by providing technical assistance to assess the feasibility and effectiveness of investments, focusing on energy and transport sectors,

9. In rural development, IDA credits have supported development of private sector farming and agro-processing improvements, agricultural credit, irrigation and drainage, and agricultural research. IDA credits have also been supporting creation of local institutions, such as rural credit unions and water users associations. A recently approved Rural Development Project is to develop the productivity and profitability of the private agriculture sector with the aim to increase incomes and employment and reduce poverty in rural areas.

10. A Judicial Reform Project has provided funds for development of new court administration and case management procedures, rehabilitation and construction of courthouses, a computerized network system, assistance for judicial training, and an extensive public information and education outreach effort to inform citizens of their rights and communicate the government’s reform efforts.

Areas in which the World Bank leads and its analysis serves as input into the IMF program

11. The Bank leads the dialogue on structural reforms through the PRSO program. Institution building and technical assistance have been supported through the Structural Reform Support Project. The Bank also leads in the areas of:

  • a) Private Sector Development. The PRSO program focuses on improving investment climate and reducing constraints to private sector development in Georgia. IDA has also been supporting private sector participation in other areas, such as energy, urban services and agriculture. The IMF has worked with the authorities to initiate audits of the accounts of three major state-owned enterprises.

  • b) Energy. The energy system is in poor condition, with unreliable supply and unsustainable debts. However, under the PRSO program, the Georgian authorities have made progress and payment collections and service levels have improved substantially in the power sector. The Government of Georgia has been working with IDA and other donors, including the Fund, to introduce more private management and ownership, and to implement a series of short-term action plans and longer-term steps to improve the overall functioning of the sector. IDA has also provided additional funding to the power sector in 2004. The Fund has been focusing on reducing quasi-fiscal losses in the sector, especially through improved bill collections, while the pursuit of tariff policies at cost-recovery levels would be facilitated by a Bank-assisted review of the tariff policy methodology. The Georgian authorities prepared the Energy Sector Strategic Action Plan for 2005–08 which is being implemented and updated periodically under the PRSO program. In a new operation, the Bank will finance a feasibility study for a major, new hydropower plant that could add about 20 percent to the country’s hydropower capacity.

  • c) Public Sector Management. The first PRSO supports, inter alia, administrative and civil service reform, improvements in public expenditure management and strengthening financial accountability. The recently approved Public Sector Financial Management Reform Support Project is to provide technical assistance and capacity building in the first three areas. The Fund is providing technical assistance in support of tax and customs administration reform.

  • d) Municipal Finance: The Municipal Development and Decentralization Project II has been assisting the government to review the current intergovernmental fiscal relation, and to suggest an equalization transfer system to compensate for horizontal fiscal disparities across local governments.

Areas of shared responsibility

12. The Bank and the Fund have been working jointly in the following main areas:

  • a) Poverty Reduction Strategy. Both institutions have been working closely with the government to support the development of the PRSP (or EDPRP as it is known in Georgia), through seminars and workshops, direct staff input, and donor coordination. A JSAN on the progress with implementation of the government’s EDPRP was issued in June 2005.

  • b) Budget Planning and Execution. The annual programmatic Public Expenditure Reviews and the PRSO program will provide the underpinnings for systemic changes in expenditure management, development of an MTEF, and improvements in financial accountability. The Public Sector Financial Management Reform Support Project will finance technical assistance and necessary investment to support budget planning and management processes within the MoF and line ministries and to support introduction of an integrated public financial management system. The Fund is focusing on treasury reform within the ministry of finance.

  • c) Financial Sector Reforms. The joint Financial Sector Assessment Program has supported: (i) strengthened banking and non-banking supervision; (ii) introduction of international accounting standards; (iii) consolidation of banks through higher capital requirement ratios; (iv) anti money-laundering legislation; (v) strengthening the regulatory environment and removing impediments for development of viable nonbank financial institutions; and (vi) strengthening the payment system. IFC has worked to strengthen the banking sector through investment and technical assistance, and has supported the development of the financial leasing market through technical assistance. The Fund has focused on banking supervision, anti-money laundering legislation, and improvements in monetary control instruments with extensive technical assistance from its Monetary and Financial Systems Department.

Areas in which the IMF leads and its analysis serves as input into the World Bank program

  • a) Fiscal Framework and reforms in tax policy and tax and customs administration. The Fund’s focus on prudent fiscal policy has served as an important framework for IDA’s work on public expenditure management. The Fund’s Fiscal Affairs Department is now taking the lead in the areas of tax policy and tax and customs administration reform.

  • b) Economic Statistics. IMF technical assistance has been conducive to improvements in national accounts, price, monetary and government financial statistics. The Bank’s grant on Statistical Capacity Building will build on the recommendations of Fund TA to strengthen the quality of national accounts statistics.

Areas in which the IMF leads and there is no direct World Bank involvement

  • a) Monetary Framework. The IMF collaborates closely with the NBG in the design and implementation of a monetary program that aims at rebuilding international reserves while keeping inflation low and remonetizing the economy.

A. World Bank Group Strategy

13. On September 15, 2005, the World Bank Executive Board endorsed the new Country Partnership Strategy (CPS) for FY06-09 designed to assist Georgia with deeper institutional reform as well as more fundamental infrastructure improvements. The CPS builds on the EDPRP, as well as emerging Government strategic thinking on the development framework. In doing so, it targets several goals: (i) Generating growth and job creation by removing barriers to private sector development and improving infrastructure, finance and markets; (ii) Enhancing human development and social protection through improved education, health, social protection, and community services; and (iii) Strengthening public sector management and budgetary processes to enable Georgia to better plan and meet its own development goals. Along with the CPS, the first PRSO, of a series of three single tranche annual Poverty Reduction Support Operations was approved of which US$13.5 million is a regular IDA credit and US$6.5 million is an IDA grant. Other recent operations include a US$5 million Infrastructure Pre-Investment Facility Project, a US$3 million Public Sector Financial Management Reform Support Project, a US$24 million Reform Support Credit, a US$20 million Secondary and Local Roads Project, a US$3.6 million Electricity Market Support Project, a US$10 million Rural Development Project, and a US$5 million Irrigation and Drainage Community Development Project Additional Funding for flood control. The Bank continues its discussion with the government on a more comprehensive medium-term reform strategy that would be supported by future Poverty Reduction Support Operations and technical assistance operations.

APPENDIX III Georgia: Relations with the EBRD

(As of December 31, 2005)

1. As of December 31, 2005, the European Bank for Reconstruction and Development (EBRD) had signed 49 investments in Georgia with cumulative commitments totaling US$401.3 million.11 Current Portfolio Stock equals to US$259.8 million. The EBRD’s first operation, a power rehabilitation project, was signed in December 1994. Since then, the pace and composition of portfolio growth has varied significantly from year to year. Current portfolio includes thirty three private sector projects (of which five projects are regional). The ratio of private sector projects in the portfolio now stands at 80 percent.

2. During 2004, all operations signed in Georgia were in the private sector and amounted to US$95.2 million. The energy sector accounted for the largest share of signings – US$78.6 million. The Bank also provided an additional SME line of credit to a local bank for US$2.7 million, an equity increase in a local partner bank and expanded its Trade facilitation program by US$10.9 million. Financial support to the local production sector was also provided, including a US$1.1 million equity investment to a local private sector refreshment drinks producer and a US$1.2 million equity investment in a private local wine producer.

3. During 2005, the Bank signed 18 transactions in Georgia for US$105.9 million in total of which all but one were in the private sector and all were without sovereign guarantees. These included: three DIF equity investments (US$5.3 million) all in agribusiness; two MCFF risk sharing facilities with local banks (US$10.0 million); the first ever municipal transport project with no SG (US$3.4 million); one regional energy project (US$29.4 million); a wine bottling project (US$7.3 million); a SME credit line (US$10.0 million); two MCFF sub-loans (US$5.0 million); two bank capital increases (US$1.5 million); the first ever syndicated loan to a local bank (US$20.0 million in total, of which US$7.0 million on EBRD’s account); the first loan to a local leasing company (US$3.0 million); and TFPs with three partner banks (US$24.1 million).

4. The EBRD is helping Georgia to benefit from its privileged location, transforming it into a regional transportation and natural resources hub. Georgia is part of the ‘Early Transition Countries’ (ETC) initiative. Launched in April 2004, the initiative aims to increase investments in the Bank’s seven poorest countries. The initiative builds on international efforts to address poverty in these countries. Through this initiative, the EBRD will focus its efforts on private sector business development and selected public sector interventions. It aims to stimulate market activity by using a streamlined approach to financing, focusing on smaller projects, mobilizing more investment, and encouraging ongoing economic reform. The Bank will accept higher risk in the projects it finances in the ETCs, while still respecting the principles of sound banking.

Table 1.Georgia: EBRD Portfolio for Georgia As of December 31, 2005(US$, million)
Project NameDate of

Agreement
Outstanding

Amount
Public Sector Projects
Power Rehabilitation Project19-Dec-946.1
Georgia State Electro system22-Dec-9827.0
Georgia: Trans-Caucasian Rail Link Project22-Dec-9811.1
SOCAR - South Caucasus Gas Pipeline (regional)4-Nov-049.0
Private Sector Projects
Bank of Georgia Equity and Convertible Loan16-Jul-982.4
Bank of Georgia – SME Loan27-Jul-033.5
Bank of Georgia Capital Increase16-Nov-051.0
MCFF Bank of Georgia Full Recourse Portion14-Jun-055.0
MCFF TBC Bank Full Recourse Portion13-Jun-055.0
MCFF TBC Bank Lomisi Ltd Sub Loan03-Aug-053.5
MCFF - TBC Bank Nola Ltd Sub-Loan (NRP)2-Dec-051.5
TBC Bank - SME Credit Line19-Dec-036.0
TBC Bank SME Credit Line III26-Sept-0510.0
TBC Bank Syndicated Loan20-Dec-057.0
TBC Leasing, Senior Debt20-Dec-053.0
Intellectbank (Sub Project of Georgia SME)11-Nov-970.5
TbilComBank (Sub Project of Georgia SME)12-Dec-960.6
TbilcreditBank (Sub Project of Georgia SME)12-Dec-960.0
United Georgian Bank20-Nov-973.2
ProCredit Bank, Georgia (Formerly MBG)30-Mar-002.6
ProCredit Bank, Georgia - Senior Loan11-Oct-016.0
TFP: Bank of Georgia (Guarantee & Pre-export)2-Mar-0117.2
TFP: TBC Bank (Guarantee & Pre-export)17-Aug-994.5
TFP: United Georgian Bank31-Mar-011.9
JSC Channel Energy Poti Port19-Mar-0210.2
Tbilisi Public Transport29-Jul-053.7
Georgian Wines29-Sep-990.6
Georgian Wines & Spirits Ltd10-March-057.3
DIF Iberia Refreshments25-Sep-032.2
DIF Teliani Valley20-May-20041.1
DIF Delidor17-June-051.5
DIF-Lomisi Ltd20-Dec-053.0
Baku-Tbilisi-Ceyhan (BTC) Pipeline (regional)03-Feb-0462.5
Lukoil Overseas: South Caucasus Gas Pipeline (regional)28-Jul-0529.4
Regional Fund Investments0.7
Total259.8

US$ amounts calculated at an exchange rate of US$1.183 U.S. dollars per Euro, as of December 31, 2005.

US$ amounts calculated at an exchange rate of US$1.183 U.S. dollars per Euro, as of December 31, 2005.

APPENDIX IV Georgia: Statistical Issues

1. The Fund has provided Georgia with substantial technical assistance in the compilation of macroeconomic statistics (Appendix I, Table 1). Despite improvements in the areas of national accounts, price, monetary, and government finance statistics, the quality of macroeconomic statistics remains poor, reflecting deficiencies in statistical methodologies, coverage, and insufficient resources. Problems are particularly acute in the compilation of national accounts, balance of payments, foreign trade, and fiscal statistics. Nonetheless, the core statistical indicators compiled by the authorities are provided on a timely basis and are generally adequate for surveillance and program monitoring. The data module of the Report on the Observance of Standards and Codes (ROSC), prepared in July 2002 was published on the Fund’s external website on May 27, 2003. In August 2005, the authorities notified the Fund of their commitment to participate in the IMF’s General Data Dissemination System (GDDS), and appointed a national GDDS coordinator. As a next step to formal GDDS participation, the authorities will need to prepare GDDS metadata and plans for statistical improvement.

Real sector

2. National accounts statistics follow the concepts and definitions of the System of National Accounts 1993, with GDP estimates by production and expenditure compiled annually and quarterly. Revisions of the national accounts follow an established schedule. Preliminary national accounts estimates are available after four months, and a final estimates after 13 months. The 2002 data ROSC mission found that data sources used for the compilation of national accounts statistics were inadequate. The coverage of the business register is not comprehensive because of the lack of economic census data. The coverage of units in terms of value added is relatively good for industry, satisfactory for transport and communications, and poor for agriculture, retail trade, construction, catering, and services. Administrative sources used to estimate the non-observed economy are limited, and data for imports and exports of services (taken from the balance of payments) are inadequate. The main weakness of the statistical techniques used for national accounts are the compilation of the constant price estimates as well as the assessment and validation of source data. Given the sizeable infrastructure investment underway, technical assistance will need to focus on refining statistical coverage of such projects. A technical assistance mission in April/May 2004 proposed a number of improvements in the estimation of national accounts from the expenditure side. An April 2005 follow-up mission identified a problem related to the volume measure of taxes on products; as a result, GDP data for 2004 were revised.

Money and banking

3. A March 2002 STA mission found that the authorities had implemented many of the recommendations made by the December 2000 mission, but in a piecemeal manner that left a number of methodological problems unresolved. To address them, the mission advised the National Bank of Georgia (NBG) (1) to break down resident data beyond the subsectors of “general government” and “the rest of the economy,” in order to provide more disaggregated information about the sectoral distribution of credit; (2) to incorporate all Fund-related accounts transparently in the central bank survey; and (3) to distinguish restricted deposits of insolvent banks from the deposit liabilities that qualify for inclusion in broad money. The mission also reviewed implementation of the NBG’s new chart of accounts (introduced January 1, 2001) and associated changes in procedures for compiling monetary statistics to ensure error-free data classification. The July 2002 data ROSC found that most elements in the data quality assessment framework for monetary statistics were fully or largely observed, and recommended improvements in the statistical coverage of nonbank depository corporations and the provision of documentation on metadata. It also recommended increased transparency regarding access by governmental agencies to monetary statistics prior to their release to the public.

4. In response to a request from STA, the NBG has recently compiled and submitted to STA a pilot set of monetary data using the framework of the new Standardized Report Forms (SRF). Subsequent STA review of the data validated the resulting monetary aggregates. STA is in the process of converting its monetary database into the SRF format for publication in the IFS supplement. The NBG has been providing regular updates of these data to STA.

Government finance

5. Government finance statistics (GFS) on a cash basis are reported to STA for publication in the GFS Yearbook. Classification broadly follows the analytic framework of the 1986 Government Finance Statistics Manual, but the concepts and definitions of revenue, expenditure, and financing differ from the international standard in significant respects. In addition, the central treasury and line departments employ differing accounting systems, with the treasury having a single-entry cash basis. The single-entry system hampers the treasury’s capacity to reconcile bank statements and hinders the reporting of information on accounts payable. Another issue concerns the limited budget classifications available for expenditure. Discrepancies can arise when matching budget appropriations with the classified expenditure because the locally developed structure of expenditure codes changes frequently. Consequently, statistical performance and reliable budget reporting could improve once the treasury adopts internationally accepted accounting standards, including a unified treasury general ledger maintained on a double-entry cash basis. There are substantial differences in the classification systems of different government subsectors. Bridge tables linking national classification codes and GFSM 2001 codes were established by a GFS mission in 2003 and used in 2004 to report 2004 GFS in the GFS Yearbook. The authorities plan to compile and disseminate government finance statistics on a Government Finance Statistics Manual 2001 (GFSM 2001) basis starting in 2007.

Balance of payments

6. A June 2005 balance of payments (BOP) statistics mission found that the authorities have partially implemented the recommendations of the 2002 data ROSC and 2002 and 2003 BOP missions. The SDS: (1) expanded the data sources for several of the balance of payments items, such as transportation, travel, insurance, communications, government services, and current and capital transfers; (2) implemented new software for the database of customs declarations; and (3) produced the balance of payments in the standard format recommended by the Fund, with the separate identification of exceptional financing transactions. The mission also found that the Customs Department (CD) improved the trade data collection system by (1) installing in all of the customs offices the ASYCUDA client-server system, which is designed to maintain the customs declarations database in real time; (2) elaborating and implementing the instructions for completing customs declarations; and (3) improving verification of customs declarations. However, SDS failed to improve staffing arrangements; on the contrary, during the latest SDG reorganization, the number of permanent staff was reduced, while communication equipment was upgraded. The June 2005 BOP statistics mission focused on (1) analyzing the situation in which the NBG plans to assume the responsibility for the compilation of the balance of payments; (2) reviewing estimation methods for compiling data on various components of the balance of payments, with particular attention for the estimation of workers’ remittances and compensation of employees; and (3) identifying data sources, collecting preliminary data, and producing a partial international investment position statement.

Georgia: Table of Common Indicators Required for Surveillance(as of February 28, 2006)
Date of latest observationDate receivedFrequency of Data6Frequency of Reporting6Frequency of publication6Memo Items:
Data Quality – Methodological soundness7Data Quality – Accuracy and reliability8
Exchange Rates1/31/062/3/06DWM
International Reserve Assets and Reserve Liabilities of the Monetary Authorities11/31/062/3/06DWM
Reserve/Base Money1/062/3/06MMMO, LO, LO, OO,O,O,O,LO
Broad Money1/062/20/06MMM
Central Bank Balance Sheet1/062/3/06MMM
Consolidated Balance Sheet of the Banking System1/062/20/06MMM
Interest Rates21/31/062/3/06WWM
Consumer Price Index1/062/7/06MMMO,LO,O,OLO,LO,O,O,O
Revenue, Expenditure, Balance and Composition of Financing3 – General Government41/062/21/06MMMLNO,LO,LNO,OLO,O,LO,O,O
Revenue, Expenditure, Balance and Composition of Financing3– Central Government1/062/21/06MMM
Stocks of Central Government and Central Government-Guaranteed Debt501/062/14/06MMM

Domestic not disseminated
External Current Account BalanceQ3/0512/30/05QQQO,LO,LO,LOLNO,LNO, LNO,LNO, LNO
Exports and Imports of Goods and Services01/062/22/06MMM
GDP/GNPQ3/0510/25/05QQQO,LO,O,LOLNO,LNO,LNO, LO,LO
Gross External Debt1/062/14/06MMM

Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A), Irregular (I); Not Available (NA).

Reflects the assessment provided in the data ROSC (published on May 27. 2003, and based on the findings of the mission that took place during July 15 – 31, 2002) for the dataset corresponding to the variable in each row. The assessment indicates whether international standards concerning concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O), largely observed (LO), largely not observed (LNO), or not observed (NO).

Same as footnote 7, except referring to international standards concerning source data, statistical techniques, assessment and validation of source data, assessment and validation of intermediate data and statistical outputs, and revision studies.

Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A), Irregular (I); Not Available (NA).

Reflects the assessment provided in the data ROSC (published on May 27. 2003, and based on the findings of the mission that took place during July 15 – 31, 2002) for the dataset corresponding to the variable in each row. The assessment indicates whether international standards concerning concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O), largely observed (LO), largely not observed (LNO), or not observed (NO).

Same as footnote 7, except referring to international standards concerning source data, statistical techniques, assessment and validation of source data, assessment and validation of intermediate data and statistical outputs, and revision studies.

APPENDIX V Georgia—Debt Sustainability Analysis

1. Georgia is at moderate risk of debt distress. The baseline scenario is sustainable. Domestic debt is negligible and all external debt indicators are well below the relevant debt-burden thresholds. Contributing factors to the moderate risk rating are Georgia’s uncertain regional political outlook and weak record in meeting debt service obligations under the previous administration.

2. Under the baseline scenario, debt ratios are on a rapid downward trend (Table 1a and Figure 1a). Public debt falls from 41.1 percent of GDP at end-2005 to just 21.9 percent at end-2009 and continues to decline thereafter (Table 1a).1 In net present value (NPV) terms, public debt is also expected to fall by about half before the end of the decade. The exercise assumes (i) real GDP growth of just over 5 percent in the medium term and 3½ percent over the long term; (ii) a budget deficit including net lending of 1 percent of GDP over the medium term; (iii) clearance by end-2007 of expenditure arrears of 1.1 percent of GDP at end-2005; and (iv) clearance by end-2008 of energy-related debt to Turkmenistan of more than one percent of GDP at end-2005. The fiscal deficit is funded through external financing and privatization receipts through 2009. The share of concessional debt is declining from over 37 percent of new external borrowing in 2003, to an average of about 24 percent over the medium term. The share of domestic debt is decreasing steadily over the medium and long term.

Table 1a.Georgia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2000–25(In percent of GDP, unless otherwise indicated)
ActualEstimateProjections
200320042005Historical Average 5/Standard Deviation 5/2006200720082009201020112006-11 Average201620252016-25 Average
Public sector debt 1/60.846.441.134.328.924.021.921.321.119.415.5
Of which foreign-currency denominated46.933.927.122.920.217.916.416.016.215.811.5
Change in public sector debt-2.2-14.4-5.3-6.8-5.4-4.8-2.1-0.6-0.2-0.2-0.5
Identified debt-creating flows-4.4-20.2-9.1-5.8-4.0-2.2-0.9-1.0-0.7-1.0-0.4
Primary deficit0.4-4.30.51.63.01.3-0.50.00.2-0.2-0.20.1-0.3-0.2-0.3
Revenue and grants16.221.723.422.925.024.825.125.625.325.025.0
of which: grants0.61.20.91.32.21.71.51.71.10.00.0
Primary (noninterest) expenditure16.617.423.924.124.524.925.425.425.124.724.8
Automatic debt dynamics-4.5-13.9-5.5-4.0-2.4-1.9-1.0-0.8-0.6-0.7-0.2
Contribution from interest rate/growth differential-5.3-7.3-5.4-3.0-2.1-1.7-1.1-0.8-0.6-0.7-0.2
Of which: contribution from average real interest rate1.0-3.7-2.2-1.3-0.4-0.3-0.20.00.20.0-0.2
Of which: contribution from real GDP growth-6.3-3.5-3.2-1.8-1.6-1.4-0.9-0.8-0.8-0.70.0
Contribution from real exchange rate depreciation0.9-6.6-0.1-1.0-0.4-0.30.10.10.1
Other identified debt-creating flows-0.3-1.9-4.1-3.0-1.0-0.3-0.10.00.00.00.0
Privatization receipts (negative)-0.3-0.9-3.6-2.6-0.7-0.3-0.10.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)0.0-1.1-0.5-0.4-0.30.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes2.25.83.9-1.0-1.5-2.7-1.20.40.50.90.0
NPV of public sector debt13.912.534.929.225.221.920.619.719.115.210.7
Of which: foreign-currency denominated0.00.020.917.816.515.715.114.414.211.66.7
Of which: external20.917.816.515.715.114.414.211.66.7
NPV of contingent liabilities (not included in public sector debt)
Gross financing need 2/3.85.15.25.83.53.93.93.63.73.33.2
NPV of public sector debt-to-revenue ratio (in percent) 3/85.857.4149.2127.9101.088.181.977.175.560.942.9
Of which: external89.477.866.363.260.056.256.246.526.8
Debt service-to-revenue ratio (in percent) 3/4/24.224.414.215.212.511.510.210.09.76.93.6
Primary deficit that stabilizes the debt-to-GDP ratio2.610.15.88.14.94.92.30.40.1-0.10.2
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)11.16.27.75.93.36.45.05.05.03.53.54.73.53.53.5
Average nominal interest rate on forex debt (in percent)2.31.21.12.40.90.81.31.11.21.21.21.11.00.81.0
Average real interest rate on domestic currency debt (in percent)5.5-3.3-1.40.74.00.01.23.14.48.18.74.38.01.75.9
Real exchange rate depreciation (in percent, + indicates depreciation)2.0-16.3-0.4-1.514.7-4.1
Inflation rate (GDP deflator, in percent)3.59.68.010.311.56.04.24.04.04.03.04.23.03.03.0
Growth of real primary spending (deflated by GDP deflator, in percent)16.711.148.111.617.47.36.56.77.15.20.85.6-0.43.83.5
Grant element of new external borrowing (in percent)37.434.030.133.83.731.020.322.523.126.325.724.810.50.0
Sources: Georgian authorities; and Fund staff estimates and projections.

Public sector comprised of general government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues including grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sources: Georgian authorities; and Fund staff estimates and projections.

Public sector comprised of general government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues including grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Figure 1a.Georgia: Indicators of Public Debt Under Alternative Scenarios, 2006-2026 1/

Source: Staff projections and simulations.

1/Most extreme stress test is test that yields highest ratio in 2016.

2/ Revenue including grants.

3. Georgia’s external debt level is also deemed sustainable under the baseline scenario with external debt projected to decline steadily from 2006 (Table 1b and Figure 1b). Georgia’s external debt is estimated at around 27 percent of GDP at end-2005, equivalent to less than 100 percent of exports in NPV terms. The projected gross external debt accumulation over the medium term is moderate at about $100 million a year, and total debt is declining as a share of GDP to about half of the end-2003 stock by end-2006. With limited private external borrowing, projected capital flows from FDI and transfers (both private and official, including about $300 million from the MCA) will be the main sources to finance a shrinking trade deficit that is projected to stabilize at about 8 percent of GDP in the long run, provided export values grow at around 6 percent.2

Table 1b.Georgia: External Debt Sustainability Framework, Baseline Scenario, 2000–25 1/(In percent of GDP, unless otherwise indicated)
ActualHistorical Average 6/Standard Deviation 6/EstimateProjections
2003200420052006200720082009201020112006-11 Average201620252016-25 Average
External debt (nominal) 1/46.435.827.122.920.818.416.916.516.716.813.3
Of which public and publicly guaranteed (PPG)46.435.727.022.920.818.416.916.516.716.813.3
Change in external debt-5.3-10.6-8.7-4.2-2.1-2.4-1.5-0.50.2-0.1-0.1
Identified net debt-creating flows-8.9-12.2-5.90.51.51.71.91.70.8-0.40.2
Noninterest current account deficit6.27.66.86.11.26.75.14.74.43.93.04.61.92.52.3
Deficit in balance of goods and services15.013.814.113.912.711.711.310.610.08.47.8
Exports18.324.521.920.220.319.719.418.919.218.717.4
Imports33.338.336.034.233.031.430.629.629.227.225.2
Net current transfers (negative = inflow)-6.7-6.7-6.6-6.7-6.7-6.0-5.5-5.3-5.3-3.9-2.8
Other current account flows (negative = net inflow)-2.10.4-0.7-0.5-0.8-1.0-1.3-1.5-1.7-2.6-2.5
Net FDI (negative = inflow)-8.4-9.7-6.5-6.13.1-5.2-2.9-2.3-1.9-2.0-2.1-2.7-2.1-2.0-2.1
Endogenous debt dynamics 2/-6.7-10.1-6.3-1.1-0.7-0.7-0.5-0.2-0.2-0.2-0.3
Contribution from nominal interest rate1.00.70.50.40.40.30.40.40.40.30.2
Contribution from real GDP growth-4.9-2.2-2.2-1.5-1.1-0.9-0.8-0.5-0.6-0.6-0.5
Contribution from price and exchange rate changes-2.8-8.6-4.6
Residual (3-4) 3/3.61.6-2.8-4.7-3.6-4.1-3.4-2.1-0.50.3-0.3
Of which exceptional financing-1.52.20.31.00.80.60.80.70.51.00.3
NPV of external debt 4/20.917.817.016.215.514.814.612.47.3
In percent of exports95.787.983.982.180.378.376.166.042.3
NPV of PPG external debt20.917.817.016.215.514.814.612.47.3
In percent of exports95.687.883.982.180.378.376.166.042.3
Debt service-to-exports ratio (in percent)26.717.915.815.913.37.55.26.86.75.35.1
PPG debt service-to-exports ratio (in percent)26.717.715.715.813.37.55.26.86.75.35.1
Total gross financing need (billions of U.S. dollars)0.10.10.30.40.40.30.40.40.30.20.4
Noninterest current account deficit that stabilizes debt ratio11.418.215.610.97.27.15.94.32.82.12.6
Key macroeconomic assumptions
Real GDP growth (in percent)11.16.27.75.93.36.45.05.05.03.53.54.73.53.53.5
GDP deflator in U.S. dollar terms (change in percent)5.722.714.73.413.010.22.75.63.55.01.24.73.5-3.42.8
Effective interest rate (percent) 5/2.31.91.82.60.51.81.81.42.22.32.21.91.91.21.8
Growth of exports of G&S (U.S. dollar terms, in percent)32.174.110.333.428.78.58.17.56.96.26.27.36.00.05.6
Growth of imports of G&S (U.S. dollar terms, in percent)33.949.916.025.820.411.34.15.36.25.03.45.96.00.05.2
Grant element of new public sector borrowing (in percent)32.632.032.133.733.633.532.933.20.033.2
Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Figure 1b.Georgia: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2006–25

(In percent)

Source: Staff projections and simulations.

4. Alternative scenarios and bound tests are constructed to examine the sensitivity of the baseline projection of public and publicly guaranteed debt to a range of potential shocks (Tables 2a and 2b). Most of these factors would not jeopardize Georgia’s debt sustainability. On exception is a return of export value growth from about 10 percent in 2005 to about 2 percent (the historical average of 2 1/2 percent minus one standard deviation of about 1/2 percent). Even if limited to 2 years, the NPV of debt-to-exports ratio would reach unsustainable levels of more than 150 percent, even if the gap were financed at better than commercial terms (30 percent grant element). With official reserves low (at about 2 months of non-pipeline imports), this could erode hard gained exchange rate stability. Another exception occurs at long run growth of about 3 percent. At this threshold debt dynamics begin changing and NPV of debt to GDP and debt to revenue rise substantially.

Table 2a.Georgia: Sensitivity Analysis for Key Indicators of Public Debt 2006–25
EstimateProjections
20062007200820092010201120162025
NPV of Debt-to-GDP Ratio
Baseline2925222120191511
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages2926242323232322
A2. Primary balance is unchanged from 20052925222121201918
A3. Permanently lower GDP growth 1/3026232324243049
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2007-20082926242323232526
B2. Primary balance is at historical average minus one standard deviations in 2007-20083029292828272624
B3. Combination of B1-B2 using one half standard deviation shocks3028272626252523
B4. One-time 30 percent real depreciation in 20073033302928272522
B5. 10 percent of GDP increase in other debt-creating flows in 20072933292726252114
NPV of Debt-to-Revenue Ratio 2/
Baseline128101888277766143
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages127106969290929289
A2. Primary balance is unchanged from 2005125101898481817673
A3. Permanently lower GDP growth 1/12910494929296122196
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2007-20081281059693919399105
B2. Primary balance is at historical average minus one standard deviations in 2007-200812911711711210810810596
B3. Combination of B1-B2 using one half standard deviation shocks1291131091041001009991
B4. One-time 30 percent real depreciation in 20071291331201151101089987
B5. 10 percent of GDP increase in other debt-creating flows in 20071271311161081021018257
Debt Service-to-Revenue Ratio 2/
Baseline15131110101074
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages16131210101087
A2. Primary balance is unchanged from 200516131211101086
A3. Permanently lower GDP growth 1/1613121111111014
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2007-200815131211111098
B2. Primary balance is at historical average minus one standard deviations in 2007-2008161312111111109
B3. Combination of B1-B2 using one half standard deviation shocks161312111111108
B4. One-time 30 percent real depreciation in 200716131211111097
B5. 10 percent of GDP increase in other debt-creating flows in 200716131311111196
Sources: Country authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of 20 (i.e., the length of the projection period).

Revenues are defined inclusive of grants.

Sources: Country authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of 20 (i.e., the length of the projection period).

Revenues are defined inclusive of grants.

Table 2b.Georgia: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2006–25(In percent)
EstimateProjections
2006200720082009201020112016201720182019202020212022202320242025
NPV of debt-to-GDP ratio
Baseline181716161515121211111099887
A. Alternative Scenarios
A1. Key variables at their historical averages in 2006-25 1/181514131313111098876559
A2. New public sector loans on less favorable terms in 2006-25 2/18181818171716161515141313121212
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2007-081817171616151312121111109888
B2. Export value growth at historical average minus one standard deviation in 2007-08 3/1819222120201616151413121110109
B3. US dollar GDP deflator at historical average minus one standard deviation in 2007-0818192121201916161514131211111010
B4. Net non-debt creating flows at historical average minus one standard deviation in 2007-08 4/1818171616151312121110109888
B5. Combination of B1-B4 using one-half standard deviation shocks181920191818151514131211101099
B6. One-time 30 percent nominal depreciation relative to the baseline in 2007 5/18242322212117171615141312111110
NPV of debt-to-exports ratio
Baseline88848280787666646259565349464542
A. Alternative Scenarios
A1. Key variables at their historical averages in 2006-25 1/88737168676757535046423834312750
A2. New public sector loans on less favorable terms in 2006-25 2/88919291908986858381787572697068
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2007-0888848280787666646259565349464542
B2. Export value growth at historical average minus one standard deviation in 2007-08 3/88111153149146142120115110104989185787772
B3. US dollar GDP deflator at historical average minus one standard deviation in 2007-0888848280787666646259565349464542
B4. Net non-debt creating flows at historical average minus one standard deviation in 2007-08 4/88888685828069676562585551484744
B5. Combination of B1-B4 using one-half standard deviation shocks88868583817968666361575450474643
B6. One-time 30 percent nominal depreciation relative to the baseline in 2007 5/88848280787666646259565349464542
Debt service-to-exports ratio
Baseline161375775566655555
A. Alternative Scenarios
A1. Key variables at their historical averages in 2006-25 1/14975653333333332
A2. New public sector loans on less favorable terms in 2006-25 2/14976765666666667
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2007-0814976665555555555
B2. Export value growth at historical average minus one standard deviation in 2007-08 3/1410109101010999999899
B3. US dollar GDP deflator at historical average minus one standard deviation in 2007-0814976665555555555
B4. Net non-debt creating flows at historical average minus one standard deviation in 2007-08 4/14976665555655555
B5. Combination of B1-B4 using one-half standard deviation shocks14976665555555555
B6. One-time 30 percent nominal depreciation relative to the baseline in 2007 5/14976665555555555
Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

ATTACHMENT I

March 14, 2006

Mr. Rodrigo de Rato

Managing Director

International Monetary Fund

700 19th Street N.W.

Washington, D.C. 20431

Dear Mr. de Rato:

The attached Memorandum of Economic and Financial Policies (MEFP) describes the 2006 policies supported by the International Monetary Fund as Trustee under a three-year Poverty Reduction and Growth Facility (PRGF) arrangement. The memorandum proposes performance criteria for end-March 2006 and end-June 2006, and outlines our broad macroeconomic objectives and policies for 2006. These policies are consistent with the Economic Development and Poverty Reduction Program (EDPRP) presented to the IMF and World Bank in October 2003 and with the Annual Progress Report of our EDPRP, which was submitted in January 2005.

The Government of Georgia believes that the policies set forth in the attached memorandum will achieve the objectives of the program, but it will take any additional measures that may become appropriate for this purpose. The government will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultation.

We request hereby the completion of the third review under the PRGF arrangement and we request waivers for nonobservance of two structural performance criteria for end-September 2005. The first of these performance criteria required submission of a Customs Code to parliament, but we encountered delays because of the need to ensure extensive consultations with the private sector on provisions of the proposed law. The Customs Code was submitted to the parliament on October 17.

The other structural performance criteria required the clearance of budget arrears by end-September 2005. Given our concerns over the possible inflationary consequences of making these payments, we decided it would be best to delay clearing the arrears. We have subsequently continued clearing arrears and in the attached MEFP have committed to clear the arrears by end-2006. We also propose the deletion of the performance criterion on a floor for general government tax revenue.

Georgia will conduct discussions with the Fund for the fourth review of its program under the PRGF arrangement before end-June 2006.

Sincerely yours,
/s/

Zurab Nogaideli

Prime Minister of Georgia
/s/

Aleksi Aleksishvili

Minister of Finance
/s/

Roman Gotsiridze

President of the National Bank
ATTACHMENT II Memorandum of Economic and Financial Policies

Introduction

1. The government’s economic program for 2006, which is supported by a PRGF arrangement, aims to achieve poverty reduction through sustained, rapid, and equitable economic growth in an environment of low inflation. This Memorandum of Economic and Financial Policies reviews our progress to date in the implementation of the program and describes our economic policies and strategy through 2006.

Current Economic Developments and Performance

2. The government’s economic policies in 2005 ensured macroeconomic stability and improved growth prospects. In the first nine months of 2005, economic growth was 7.7 percent, driven primarily by the rapid expansion of agriculture, banking, trade and communication sectors. Preliminary estimates indicate that real GDP growth in 2005 was about 8 percent. Inflation for 2005 was 6.2 percent. Despite significant increases in prices for tobacco and alcohol (mainly due to increased excise taxes) and petroleum products, inflationary pressures were avoided.

3. Macroeconomic stability was ensured by controlling inflation through careful coordination and implementation of monetary and fiscal policies. The overall fiscal deficit (on a cash basis) for 2005 was 2.4 percent of GDP. This is less than projected and reflects limited administrative capacity in some line ministries and our decision to delay some expenditure because of concerns over inflationary pressure. For example, our decision to postpone clearing some budget arrears was because of our concern for inflationary pressure.

4. Monetary policy has also been supportive of the need to contain inflationary pressures. During 2005, reserve money increased only by 19.7 percent, which is below the target envisaged by the program. Despite concerns in early 2005 about significant foreign currency inflows and the possible instability for the national currency, the appreciation of the lari has been modest and smooth. During 2005, the lari appreciated by 2.5 percent against the U.S. dollar in nominal terms and appreciated by 3.1 percent in real effective terms. Gross international reserves of NBG increased by 24 percent to $474 million in 2005, which is about 2.1 months of non-pipeline imports.

5. Fiscal performance in 2005 was stronger than projected at the time of the second review under the PRGF arrangement. For 2005, the cumulative fiscal deficit on a commitments basis was GEL 177 million compared with a projection of GEL 407 million, while the cash deficit was GEL 279 million. Underpinning the strong fiscal performance last year was strong revenue collection. For 2005, revenues collected by the Customs Department increased by 66 percent as compared with 2004. This improvement is due to restructuring of the Customs Department that included elimination and streamlining operations and functions, introducing a new staff management system, reducing staff by 9.5 percent and increasing salaries. As part of our efforts to strengthen the Customs Department, we are in the process of examining and recertifying the department’s staff. Customs units moved to a one-window principle, which significantly simplified the customs clearance procedures. In addition, technical equipment was improved due to the assistance of donor organizations. As a result of these measures, the level of corruption has been significantly reduced.

6. Tax administration has continued to improve. During 2005, tax revenues increased to GEL 2,300 million, which is a 27 percent increase compared with 2004. The improved collection of tax revenues was due largely to expansion of the tax base and improvements in tax administration. Improvements in tax administration, including the introduction of better data processing and management systems, have allowed continued strong performance in collection of tax revenues, despite a significant reduction in tax rates and the number of taxes as part of the liberalization of the Tax Code. We estimate that the ratio of tax revenues to GDP was at least 19.8 percent for 2005, which is a significant improvement compared with 2004.

7. As part of government’s effort to improve the budget process, we have introduced a medium-term expenditure framework (MTEF). The first stage in this process was the preparation of our Basic Data and Directions (BDD) document, which identified the major trends of the state budget based on the principle of medium-term projection of expenditures. The BDD was submitted to parliament for discussion in May 2005. The second phase of the MTEF process was to apply these expenditure guidelines to the activities of various parts of government. The strategic priorities and spending projections for 2006-2009 for key line ministries were submitted to parliament as part of the proposed budget for 2006. We recognize that the MTEF process should be refined and improved, but believe it has already made a contribution to a more transparent and coherent budget process. For the purpose of strengthening and institutionalizing of MTEF process, government adopted a decree that establishes a clear link between line ministries strategies and strategic priorities reflected in the BDD. Additionally, the format of key documents was revised to facilitate the inclusion of line ministries’ strategies into BDD. Also the calendar for preparing the MTEF was clarified.

8. The government’s structural reform program continues to make good progress, despite some delays. A new Customs Code was developed and submitted to parliament on October 17, 2005. The submission of the Customs Code to parliament was delayed, which meant that the structural performance criterion for end-September was missed, because of the need to ensure extensive consultation with the private sector on the provisions of the proposed law. The new Customs Code will significantly simplify the customs procedures. Since the proposed legislation has been submitted to parliament and passage is expected shortly, we request a waiver for this structural performance criterion.

9. Our civil service reform strategy is under preparation and will serve as the basis for an implementation action plan. Medium-term action plans were developed for each ministry and discussed at a government session. For the purpose of increasing the efficiency, quality and flexibility of the state management, the number of ministries has been reduced from 18 to 13. Additionally, numerous state departments and other units were consolidated and subordinated to their respective ministries.

10. There has been a significant improvement in the business environment since 2003. In June, parliament approved the law on “Licenses and Permissions,” which constitutes a major reform of the legislation governing the issuance of licenses and permits. The main principles of public sector regulation were redefined for the purpose of simplifying the system and eliminating impediments. As a result, the list of the activities for which licenses and permits are required was reduced by about 85 percent. Licensing procedures were improved and simplified by introducing the principles of “one-window for approval” and “silence is consent.” We have also simplified the requirements for standardizing and certifying commodities sold in Georgia. This reform liberalizes the domestic market by reducing excess administrative barriers, introducing voluntary quality standards for commodities while maintaining compulsory technical regulations with respect to safety, and recognizing the technical certification of commodities by other countries.

11. Government recently approved proposals for a significant liberalization of our trade regime. We were unable to submit the proposed legislation to parliament on time (structural benchmark for end-September) because of the need for extensive consultations with the business community. We have, however, completed the consultation process and submitted the proposed legislation to parliament. If approved, the new tariff regime will move from 16 bands to 3 and will reduce the maximum tariff from 30 percent to 12 percent for 2006. Further, the legislation also would eliminate the 12 percent band beginning in 2007 and eliminate all tariffs in 2008. We believe that the implementation of the new trade regime will enhance the prospects for economic growth.

12. The government is continuing negotiations with external creditors under the auspices of the 2004 Paris Club agreement. As of end-February 2006, we signed restructuring agreements with six Paris Club creditors and two non-Paris Club creditors, which leaves four agreements (one with Paris Club members and three with non-Paris Club creditor countries) to be concluded. In order to continue negotiations, we have received another extension from the Paris Club and expect to sign agreements with the remaining external creditors by end-February 2006.

13. Georgia made important steps towards combating money laundering. In particular, we ratified 1990 Council of Europe Convention “on Laundering, Search, Seizure and Confiscation of the Proceeds from Crime” (the Strasbourg Convention), adopted the Law “On Facilitating the Prevention of Illicit Income Legalization” (in force since January 2004) and established the Financial Monitoring Service (FMS) at the NBG. The FMS became a member of the Egmont Group in June 2004. The Service conducts its activities in close cooperation with MONEYVAL and in accordance with Financial Action Task Force (FATF) recommendations and EU directives. The FMS has elaborated detailed regulations on financial monitoring for different kinds of monitoring entities from which it receives information concerning suspicious and above threshold (GEL 30,000) transactions. The information received by the FMS is systemized and analyzed and, in case of raising the grounded supposition that a transaction may be related to illicit income legalization or terrorism financing, is forwarded to Special Service of Criminal Prosecution of Illegal Income Legalization at the General Prosecutor’s Office of Georgia.

14. In 2005, the FMS submitted draft amendments to the Criminal Code of Georgia and Criminal Procedure Code of Georgia to parliament that would assure compliance of Georgian legislation on provisional measures and confiscation of property with the provisions of the Strasbourg Convention. These amendments were approved by parliament in December 2005.

15. The amendment to the legislation which would upgrade the Budget Systems Law (BSL) to an organic law was submitted to parliament in March 2005, where its passage requires a constitutional majority. Passage of the proposed draft has been delayed because of opposition in parliament. Government is now in the process of proposing technical amendments to the BSL. Following their approval, the government will continue to make its best efforts to secure passage of an amendment that would upgrade the BSL to an organic law.

16. We are also requesting a waiver for missing the end-September performance criterion relating to the clearance of arrears. As noted, we have been concerned about the inflationary consequences of making these payments and prefer to delay payments rather than risk higher inflationary pressures. Additionally we wish to ensure that all claims for payment are legitimate and so we are vetting the claims carefully, which is a time-consuming process. As of end-December 2005, the stock of claimed arrears was GEL 182 million, which is greater than at end-June 2005 because more claims have been submitted. The process of verifying claimed arrears and clearing them continues. For 2005, we cleared GEL 104 million of verified arrears leaving a stock of GEL 182.1 million in claimed arrears and GEL 59 million in verified arrears at end-2005. While we cleared fewer arrears in 2005 than anticipated under the program, we feel the delay is justified. During 2006, we plan to complete the evaluation of all arrears claimed as of end-2005 and clear all those that are verified. We will ensure that clearing verified arrears in excess of those included in the 2006 budget will not increase the overall fiscal deficit.

Economic Policies for 2006

17. The government’s economic reform program for 2006 and beyond aims at further improving the macroeconomic environment as a means of encouraging broad-based growth in support of poverty reduction. The main sources of economic growth will continue to be industry, agriculture, trade, transport and communications. The primary areas for reform are privatization of the remaining state-owned enterprises and properties; enhancing the business environment; reforming the judiciary; developing the financial sector; and revising the labor code. As a result of the ongoing reform process, we anticipate further growth of foreign direct investment over the medium term.

18. According to the government’s 2006 Economic Program, real growth of GDP in 2006 is projected to be 6.5 to 7.5 percent and end-period inflation for 2006 is projected to be 5-6 percent. Our target for gross international reserves of the NBG is 2.3 months of non-pipeline imports. The current account deficit is projected to stabilize at 7.4 percent of the GDP. As was true in 2005, our program for enhancing macroeconomic stability will require disciplined fiscal and monetary policies and careful coordination of the two.

19. The MTEF that we prepared in 2005 (and consisted of the BDD and appendices to the 2006 budget law) will be updated during the course of 2006. Particular emphasis will be given to identifying expenditure priorities for 2007-10 and to refining and extending strategies for individual line ministries. In addition, we will ensure consistency between the annual BDD and the subsequent budget. In order to enhance transparency of the budget process, both the BDD and the detailed strategies and spending plans will be posted on appropriate websites.

20. In order to strengthen macroeconomic coordination and planning, we are preparing a medium-term strategic action plan for 2006-09 that incorporates the main elements of strategy documents that were prepared in the past few years, including the EDPRP, Individual Policy Action Plan and the EU Neighborhood Policy Paper. Additionally, we have begun preparing our PRSP progress report, which we expect to complete by end-September 2006.

Fiscal Policy

21. The proposed budget law for 2006 that was approved by parliament projects tax revenues of 19.3 percent of GDP. Additionally, we anticipate continued improvements in tax and customs administration. For 2006, the overall fiscal deficit on a commitment basis is projected at 2.2 percent of GDP. In 2006, we will clear the outstanding stock of verified arrears. Hence, by end-2006 the entire stock of verified arrears will be completely cleared and no new arrears will be accumulated. The overall fiscal deficit on a cash basis is projected to be 2.6 percent of GDP.

22. A large element of the anticipated improvement in tax collections will be derived from reform of the Customs Code and through better administration. We expect the new Customs Code to take effect on April 1, 2006 and believe it will significantly simplify customs procedures. Other reforms include upgrading information and data processing systems, introducing a harmonized system of commodity nomenclature; and improving technical equipment at key customs clearance points. Further improvements in tax administration include simplifying tax declaration procedures and allowing electronic filing of tax returns for selected tax payers.

23. In 2005, the government did not borrow from the NBG and no such borrowing is planned. The NBG will submit to parliament an amendment to existing legislation that prohibits government borrowing from the NBG under all circumstances (structural performance criterion for end-March 2006).

24. Improved revenue collection will allow the government to increase expenditures in several key areas. Total allocations for social spending are budgeted at 8.6 percent of GDP. As part of our effort to increase social sector expenditures, we began a comprehensive reform of the education sector in 2005 that will continue in 2006. The main goal of the reform is to bring the education system of Georgia in compliance with international standards. From 2006, the education system will be funded from the state budget.

25. In line with our EDPRP, another priority in the social sphere is the government’s effort to eliminate extreme poverty. We increased the minimum pension to GEL 28 per month (equivalent to about $15) as of January 1, 2005. In 2006, we plan to increase the minimum pension by GEL 10 to GEL 38 per month, with an increase of 5 lari per month on March 1, 2006 and a further 5 lari on September 1, 2006. Additionally, we plan to introduce our poverty alleviation program on June 1, 2006 (structural performance criterion for end-June 2006). The guiding principle of this reform is that social assistance will no longer be exclusively oriented to certain categories of the population (e.g., single pensioners, disabled, and IDPs). Instead, social assistance will be targeted on those households living below the extreme poverty line. Cash benefits for households below the poverty line shall be determined in accordance to the current level of living conditions and family size. The state will supplement the income of households at least to the level of the extreme poverty line. The main outcome indicator will be that at least 60 percent of those identified as extremely poor will be covered by the program.

26. Beginning January 1, 2006, the cost of gas imported from Russia increased significantly. Whereas the average cost of gas was $64 per thousand cubic meters (tcm) in 2004 and 2005, the cost in 2006 is $110 per tcm. In order to mitigate the impact of higher gas prices, we plan to delay increasing the gas tariff for households until May 2006. The difference between the import price of gas and the price paid by households will be borne by the budget at a projected cost of GEL 35 million. Once our poverty alleviation program is operational (June 1, 2006), we will assess the case for using this vehicle to compensate low-income households for higher gas tariffs.

27. In addition, there will be some new developments in local and central budgets in 2006. Specifically, a draft law on Budget of Local Self-Management Units was submitted to parliament in November 2005. The proposed law will regulate the preparation of local budgets and their approval as well as the methodology for calculating transfers to be received by the local budgets.

28. The privatization process will continue in 2006. The guiding principle for privatization is that the state should own only those properties that are essential for performance of the state functions. During 2006, it is envisaged to carry out privatization in a transparent manner with an emphasis on enterprises in the energy distribution, power generation and communication sectors. The amount generated from this is estimated to be GEL 338 million or 2.6 percent of GDP.

29. We are working to strengthen the financial management of Legal Entities of Public Law (LEPLs). We have begun the process of establishing a database of all central government LEPLs and expect the database to be populated by end-March 2006 (structural performance criterion for end-March). We are currently refining a system for financial monitoring of LEPL activities through the line ministries. We will prepare operational guidelines for financial management and reporting that ensure adequate financial monitoring of LEPLs. The preparation of the operational guidelines is already advanced and will be completed by end-June 2006.

30. In early 2004, several quasi-fiscal funds were established outside the government to meet critical expenditure requirements in the aftermath of the Rose Revolution. In order to enhance fiscal transparency and accountability the Army Development Fund and the Law Enforcement Fund ceased operations on January 1, 2006. Further, in January 2006 it was publicly announced that the two funds would be liquidated by end-March 2006. The Reform and Development Fund now operates as an NGO and does not have any fiscal functions. Any other funds, which continue to operate and finance general government expenditures will report their financial activities on a current basis and will be treated as part of the general government.

31. The reform of the treasury will continue in 2006. As agreed at the time of the second review under the PRGF arrangement, the single treasury account system became fully functional by end-2005. Expenditure and income accounts were merged into a single treasury account. In the mid-term, we will introduce a new classification of the budget and a new methodology of registration, which will be based on cash-based method indicated in GFS 2001. These and all other necessary activities will be introduced in order to continue consolidation of public finances into the treasury system.

Monetary Policy

32. A disciplined monetary program that features a flexible exchange rate regime is central to our macroeconomic strategy for 2006 and beyond. Based on a target for end-year inflation of 5-6 percent, the program projects an increase in money demand of 12 percent during 2006 and an increase in the money multiplier of 3 percent over the same period. Reserve money growth would thus be limited to 25 percent and broad money growth to 29 percent. We plan to increase gross foreign reserves to about 2.3 month of non-pipeline imports or about $620 million. The NBG will intervene in the foreign exchange markets only as necessary for smoothing sharp fluctuations, especially in light of the large capital inflows expected in 2006. Further, we will submit amendments to existing legislation to parliament that would prohibit government borrowing from the NBG under all circumstances (structural benchmark for end-March 2006).

33. We are determined to improve the operation of financial markets in Georgia by fostering the development of markets for safe assets of various maturities and to strengthen the NBG’s ability to conduct monetary policy by increasing its portfolio of marketable securities. By end-March 2006, the government together with the NBG will agree on measures to achieve those objectives, including securitizing all existing NBG claims on the government at the rate of GEL 40–50 million per year with maturities of 2–5 years (structural benchmark for end-March). In addition, the NBG will begin issuing CDs with a maturity of up to one year.

34. To upgrade banking supervisory policy and implement the Basel Core Principles for Effective Banking Supervision, the NBG is planning to make changes to the Law on Activities of Commercial Banks regarding consolidated supervision and definitions of bank insiders, Fit and Proper Criteria for bank administrators and significant shareholders. To improve banking sector transparency, the NBG is publishing standardized forms about financial data of commercial banks in NBG’s bulletin and sending them electronically to each bank. The NBG is planning to prepare the regulation on transparency of commercial banks, which will specify details on information subject to be disclosed regularly. Additionally, as agreed at the time of the second review we will require banks to publish their quarterly statements and to post them on the NBG’s website to improve transparency. The NBG has already completed the consolidation of bank supervision department into a single structure, downsized it and introduced new management there. This process of consolidation and introduction of efficiency gaining measures will be extended to the rest of the NBG.

35. In order to strengthen the commercial banking sector and ensure that it is able to support future economic growth, we plan to enhance the bank supervision function at the NBG. Further, we will prepare a Banking System Development Strategy for 2006-2009 by end-March 2006 (structural benchmark for end-March 2006). At the same time, the NBG will continue closing or merging all commercial banks that do not comply fully with prudential requirements. Additionally, we have submitted legislation to parliament that will eliminate restrictions on the percent of total shares in a commercial bank that can be owned by an individual or legal entity (structural benchmark for end-March 2006). In effect, this will allow an individual or legal entity to own 100 percent of a commercial bank.

36. Following the recent on-site inspection of one Georgia’s larger commercial banks, the NBG concluded that the bank should be either liquidated or sold. In order to avoid a broad loss of confidence in the banking system the NBG, working in collaboration with the government, introduced an interim management to the commercial bank and arranged for the sale of the bank to the most competitive bid from a sound local commercial bank. Furthermore, the buyer requested a short-term credit line from the NBG as a contingency measure. If this credit line is activated, the injection of this additional liquidity into the system may complicate the implementation of the monetary policy. The NBG will, however, use its monetary policy tools (including short-term CDs) to help mop up any excessive liquidity.

37. Further, the NBG will fully implement the recommendations of the 2004 Safeguards Assessment Report of the IMF’s Finance Department, particularly by formally documenting all its internal control processes, including key operating policies and procedures. Moreover, an FSAP update mission visited Tbilisi recently to study some of the important issues, including the recent surge in the private sector credit, pertaining to the financial stability.

Structural Reforms

38. The government recognizes the importance of an aggressive structural reform program as a means of fostering growth and international competitiveness. Of particular importance is the need to improve the business environment and strengthen the protection of property rights.

39. An important element of this reform was parliament’s approval in June 2005 of a new law on Licensing and Permits. This law greatly simplified the regulatory environment for enterprises, not least by reducing the number of licenses and permits from more than 950 to 150. We are currently in the process of implementing this new regulatory framework, which will require amending dozens of individual laws. We are also preparing a new system of government supervision of food and medicine. The proposed legislation will be prepared in parallel with the restructuring of the Ministry of Agriculture. We are also preparing legislation aimed at establishing a system of self-regulation for professional activities/fields. The initial draft on the accounting and auditing fields is already developed.

40. During 2006, the energy sector rehabilitation will be continued. In 2004 quasi-fiscal deficit of the sector amounted to 4 ½ percent of GDP (caused mainly by low collection rates, non-payment of electricity consumed in Abkhazia, and energy theft), financed partially by transfers from the government, but mostly through debt and the run-down of the stock of capital. We are committed to rehabilitating energy sector facilities so that electricity can be supplied 24 hours per day to all paying customers. For these purposes, the 2006 budget has appropriated more than GEL 247 million, about 1.9 percent of GDP, to investment in the energy sector. We project that the quasi-fiscal deficit for 2005 was about 4 percent of GDP and will be reduced further in 2006.

Program Monitoring

41. Completion of the fourth review under the PRGF arrangement, scheduled for mid-June 2006, will require observance of the structural performance criteria for end-March 2006 shown in Table 1 and the quantitative performance criteria in Table 2, while the end-June structural criterion and end-September quantitative performance criteria will apply to the fifth review, currently scheduled for mid-December 2006. The review will focus on progress in resolving arrears and progress toward developing a system of financial monitoring for LEPLs. It will also take stock of ongoing and planned steps to add momentum to structural reforms, especially in the areas of energy, public sector operations, the business climate, and trade liberalization.

Table 1.Georgia: Structural Performance Criteria (*) and Structural Benchmarks, 2005–06
MeasureTiming
Upgrade the Fit and Proper criteria for bank owners and managers to international standards, by submitting revisions to commercial banking law and related decrees.End-December 2005
Complete the transition to a treasury single account for central government expenditures and revenues. (*) (MEFP, para 31)End-December 2005
Complete electronic re-registration of existing taxpayers and registration of new taxpayers.End-December 2005
Introduce a targeted poverty benefit to replace numerous in-kind benefits.End-December 2005
Publish a strategy paper on pension reform to put the social security system on a sounder fiscal footing.End-December 2005
Submit to parliament amendments to existing legislation that would prohibit government borrowing from the NBG under any circumstances. (*) (MEFP, paras 23 and 32)End-March 2006
Submit legislation to parliament that will eliminate restrictions on the percent of total shares in a commercial bank that can be owned by an individual or legal entity. (MEFP, para 35)End-March 2006
Establish and populate a database of all central government LEPLs. (*) (MEFP, para 29)End-March 2006
Prepare a Banking System Development Strategy for 2006-2009. (MEFP, para 35)End-March 2006
Prepare a detailed strategy for securitizing government debt to the NBG with the aim of providing additional tools of monetary policy and improving the operation of financial markets in Georgia. (MEFP, para 33)End-March 2006
Introduce a poverty alleviation program targeted on households living in extreme poverty. (*) (MEFP, para 25)End-June 2006
Table 2.Georgia: Quantitative Performance Criteria and Indicative Targets, 2006 1/2/
Stocks
End-Dec. 2005Mar.JuneSep.Dec.
ActualsPerformance CriteriaIndicative TargetsPerformance CriteriaIndicative Targets
(In millions of lari)
1. Quantitative targets
Ceiling on cash deficit of the general government34.765.4138.2345.6
Ceiling on net credit of the banking system to the general govt. (NCG)633.10.0-17.7-50.737.0
Ceiling on reserve money1001.542.970.8157.4250.4
(In millions of U.S. dollars)
Floor on total net international reserves (NIR) of the NBG186.51.840.2118.7151.6
Ceiling on contracting or guaranteeing of
A. Nonconcessional medium- and long-term external debt0.020.020.020.020.0
B. Short-term external debt (less than one year)0.00.00.00.00.0
Ceiling on accumulation of external arrears0.00.00.00.00.0
(In millions of lari)
2. Indicative target
Ceiling on net domestic assets (NDA) of the NBG656.339.5-3.5-62.2-30.1
Sources: Georgian authorities; and staff estimates.

Section 1 of this table shows quantitative targets for 2006; for stock variables, they are based on cumulative changes from end-December 2005 projections. The indicative target is shown in Section 2. The continuous performance criterion for external arrears is defined in paragraph 21 of the July 2005 TMU.

Quantitative targets for 2006 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.

Sources: Georgian authorities; and staff estimates.

Section 1 of this table shows quantitative targets for 2006; for stock variables, they are based on cumulative changes from end-December 2005 projections. The indicative target is shown in Section 2. The continuous performance criterion for external arrears is defined in paragraph 21 of the July 2005 TMU.

Quantitative targets for 2006 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.

IMF Country Report 03/346 presents a detailed discussion of these policies.

The authorities are currently working with World Bank staff to determine 2005 poverty figures.

The outturn was slightly less than programmed as some social programs were phased out and the targeted poverty benefit meant to replace them was delayed to mid-2006.

These figures exclude defense-related expenditures by LEPLs, for which no data are available. As discussed below, all such expenditures have ceased since January 2006.

These criteria and benchmarks apply to the fourth review of this PRGF arrangement.

Progress toward the implementation of this targeted poverty benefit has been substantial, with a significant share of Georgian families already having applied for the benefit.

Goods and services are expected to increase by 2 percent of GDP. This increase is largely presentational, and mostly offset by lower local government expenditures, as schools were converted to LEPLs, and transfers to LEPLs are recorded as purchases of goods and services.

Discussions on this agreement are currently focused on the government’s desire to see a reduction in NBG administrative costs. Failure to reach agreement would make implementation of the agreed monetary program more difficult, but would not fundamentally undermine the authorities’ economic program.

Reserve requirements are currently 2 percent for lari deposits and 13 percent for foreign currency deposits.

These thresholds are policy-dependent and Georgia is considered a medium policy performer, as measured by the World Bank’s CPIA. The main macroeconomic assumptions of the baseline scenario include real GDP growth of about 5 percent in 2006–11 and 3½ percent in 2016–25, inflation of less than 5 percent after 2006, and an external current account deficit excluding interest payments of less than 5 percent of GDP in 2006–11, falling to less than 2 ½ percent thereafter.

Evaluated at an exchange rate of US$1.183 per Euro.

Public debt is defined on a gross basis and excludes debt owed by state-owned enterprises. It also excludes contingent liabilities from the Soviet era. At the end of 2005, about 75 percent of general government debt was denominated in foreign currency, while debt to the NBG accounted for about 18 percent. General government expenditure arrears and treasury bills accounted for the remaining liabilities.

For further details on recent developments in Georgia’s debt statistics as well as the long run baseline scenario, see The World Bank’s Georgia Country Partnership Strategy, October 26, 2005.

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