Georgia’s macroeconomic performance in 2005 was impressive. Recent calculations show that real GDP grew by 9.3 percent, reflecting a significant improvement over 2004 when growth was about 6 percent. The 2005 growth rate has been broad-based with double-digit growth in several sectors like construction, communications, financial intermediation and agriculture. This broad-based growth is a crucial element of the authorities’ policy to expand job opportunities and reduce poverty. At the same time, sound and coordinated monetary and fiscal policies kept inflation under control. Real growth of GDP in 2006 is projected to be 6.5 to 7.5 percent and end-period inflation for 2006 is estimated to stabilize around 5-6 percent. Moreover, last December, Georgia received its first international credit rating. Standard and Poor’s Rating Service assigned a ‘B+’ long term and ‘B’ short-term sovereign credit rating with a positive outlook, emphasizing the ‘authorities’ strong political commitment to prudent financial policies and market-oriented structural reforms.’
The cooperation between the Georgian authorities and the Fund has been fruitful. The authorities are pleased that all but two end-September performance criteria in the program supported by the Poverty Reduction and Growth Facility have been met, in most cases even with wide margins, in particular in the fiscal field.
In 2005, the authorities continued their impressive fiscal consolidation policy. Efforts to strengthen tax administration, crack down on corruption, smuggling and tax evasion and contain expenditures resulted in a general government deficit of 2.4 percent of GDP, well below the budgeted 4.8 percent. The impressive fiscal performance was specifically underpinned by continuous strong revenue collection, in particular by a reorganized and streamlined customs department, where subsequently collected revenues increased by 66 percent compared with 2004. More in general, despite the reduction in tax rates and the number of taxes as part of the liberalization of the Tax Code, tax revenues in 2005 still rose to 19.7 percent of GDP, which is a 26.4 percent increase compared with 2004. For 2006, expansion of the tax base and improvements in tax administration will continue. The 2006 budget prudently projects tax revenues of 19.3 percent of GDP, leading to an overall fiscal deficit of 2.6 percent of GDP (cash basis), financed by privatization proceeds. Part of the revenue collection will be derived from the gains of the new Customs Code in terms of more simplified procedures, which is expected to take effect this year.
Improved revenue collection will allow the government to increase expenditures in several key areas, for example in the social area. Total allocations for social spending will increase compared to last year and are now budgeted at 8.6 percent of GDP. A priority in the authorities’ social policy agenda is the eradication of extreme poverty. To this end, the authorities increased the minimum pensions and they will introduce a targeted poverty benefit program in June this year. As of now, already 300 thousand statements were submitted from people eligible for social assistance by the government. Ways will also be explored to make the poverty program instrumental for compensating low-income households for the higher gas tariffs. The authorities are also in the process of drafting their PRSP progress report, which is expected to be completed by end-September this year. The structural performance criterion on preparing a medium-term expenditure framework (MTEF) was met.
In the area of fiscal transparency and accountability, significant progress has been made. In particular, in early 2004, several quasi-fiscal funds were established outside the government to meet critical expenditure requirements in the aftermath of the Rose Revolution. Now, after two years when the need for these separate funds has subsided, the authorities decided that, in order to enhance budget transparency and avoid any off-budget spending, these funds would cease their operations on January 1 this year and would be liquidated by the end of March. One remaining fund will be converted into an NGO and will be privately financed and controlled.
Privatization is an important component of the economic reform process in Georgia, and will continue to play a distinctive role in the economic development of the country going forward. The authorities will continue to aim at carrying out privatizations in a transparent manner with an emphasis on enterprises in the energy distribution, power generation and communication sectors.
Prudent fiscal policies also contributed to containing the current account deficit. Moreover, recent preliminary data show that export growth actually increased compared to last year while import growth has been slower. For 2006, the current account deficit is projected to stabilize around 7 percent of GDP.
Monetary policy and financial sector reform
Sound monetary management has continued to underpin macroeconomic stability, aiming for low inflation as the primary objective, while maintaining a flexible exchange rate regime. Despite concerns in early 2005 about significant foreign currency inflows, the appreciation of the lari has been modest and smooth (the lari appreciated by 3 percent in real effective terms). Consumer price inflation in 2005 equaled 6.2 percent which is well below the expectation of 7 percent and the 2004 level of 7.5 percent. The target on arrears clearance was missed given the authorities’ concerns over the possible inflationary consequences of making these payments at the end of last year. At the same time, the process of verifying claimed arrears continued and this year, the authorities are strongly committed - as laid down in the Memorandum of Economic and Financial Policies - to complete the evaluation of all arrears claimed as of end-2005 and clear all those that are verified by the end of 2006. For 2006, the NBG will continue to carefully manage liquidity and is fully committed to the objective of maintaining single-digit inflation around 5-6 percent. Gross foreign reserves will increase to about 2.3 month of non-pipeline imports.
As highlighted by staff, the banking sector has performed well in 2005 and credit to the private sector grew by 83 percent, albeit from a very low level. Nonetheless, Georgia’s level of monetization remains below 20 percent of GDP, resulting in a much lower credit to the private sector than seen in most other transition economies. Moreover, as stated in the interesting Selected Issues paper, the expansion of credit in the banking sector is accompanied by longer maturities, lower lending rates and de-dollarization. Some of the factors contributing to the rapid credit expansion have been the increased confidence in future prospects for the country, legalization of businesses that started in 2004 and continued in 2005, increased banking competition and improved access to relatively low-cost credit. At the same time, the National Bank of Georgia (NBG) is committing equal efforts to guide this substantial credit expansion in a prudent manner by strengthening its supervisory activities. Draft legislation concerning the introduction of a deposit insurance system is ready and the process of imposing increased minimum capital requirement has been brought forward and is now expected to be implemented in July next year. Moreover, work is continuing to increase transparency and consolidation of the overall financial sector and ease the entrance of foreign banks.
Furthermore, the NBG is committed to stimulate the development of financial markets, foster financial sector stability and strengthen the independence of the NBG, as reflected in its upcoming Banking Sector Development Strategy. In addition, the NBG together with the government reached agreement on an overall reform package to streamline NBG’s balance sheet and operations and strengthen the NBG’s ability to conduct monetary policy by increasing the NBG’s portfolio of marketable securities, including the total amount of government debt held by the NBG. An FSAP update mission has visited Georgia recently and the authorities are in the process of studying the staff’s recommendations.
The World Bank recently ranked Georgia among the top global reformers in the CIS region. According to the Doing Business study, reforms in Georgia have made it easier to start a business, have cut the number of activities that require licenses from 950 to 150, eased the cost of separating redundant workers and cut the time and cost to register property. At the same time, there are still areas that need attention, such as further simplifying tax collection and enhancing investors’ protection.
Furthermore, after an extensive consultation process, the authorities submitted ambitious legislation to parliament concerning their trade policy. When adopted, the new tariff regime will be considerably liberalized, by moving from 16 bands to 3 and reducing the maximum tariff from 30 percent to 12 percent for 2006. Further consultations to ultimately eliminate tariffs altogether will continue going forward. The implementation of the new trade regime will dramatically enhance the prospects for trade, investment and economic growth. In addition, the European Union and Georgia are enhancing their cooperation through the EU/Georgia Action Plan, which will encourage and support Georgia’s objective of further economic integration.
The end-September structural performance criterion concerning the parliamentary submission of the Customs Code faced some delay due to the need to ensure extensive and satisfactory consultations with the private sector on provisions of the proposed law. The Customs Code was nonetheless submitted to the parliament in October and passage is expected soon.
As highlighted by staff, the authorities chose - in the context of improving government services - to convert some budgetary organizations into Legal Entities of Public Law (LEPLs). In this way, reforms could be implemented in a more straightforward manner, while the LEPL Management would still ensure that activities were performed according to existing standards. Although the authorities believe this reform will promote more efficiency and therefore constitutes the way forward, they do recognize some potential risks associated with this reform, such as a weakening of monitoring and reporting practices. Therefore, as recommended by staff, the authorities are finalizing a database of all LEPLs through which effective financial monitoring of LEPL activities can be facilitated. In addition, operational guidelines are being prepared concerning financial management and reporting requirements which will be completed by end-June 2006. Moreover, the authorities will continue to study international best practices.
The authorities are also committed to rehabilitate 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 1.9 percent of GDP to investment in the energy sector. Furthermore, parliament adopted in December last year legislation that would assure compliance of Georgian legislation on provisional measures and confiscation of property with the provisions of the Strasbourg Convention.
The authorities request a waiver for nonobservance of the two performance criteria for end-September 2005 and subsequently request completion of the third review under the PRGF. This will signal to the international and business communities that Georgia is well on track with its ambitious reform agenda. In closing, we would, on behalf of the authorities, like to once again thank staff and management for their dedicated work and policy advice to Georgia.