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Georgia

Author(s):
International Monetary Fund
Published Date:
October 2008
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I. Introduction

1. The Georgian authorities have requested support for their economic program in the form of a front-loaded 18-month $750 million Stand-By Arrangement (SBA). Given that Georgia’s quota is SDR 150.3 million (about $236 million), this would constitute exceptional access since it would exceed limits of 100 percent of quota annually and 300 percent of quota (net of scheduled repurchases) cumulatively. The request is based on a balance of payments financing need reflecting the likely impact of the early August armed conflict on investor confidence. Pressures on the capital account stemming from the jolt to market confidence have been reflected in a large loss of international reserves, a fall in bank deposits, increased Eurobond spreads, and strong signs of a decline in net private inflows. Access under the program is designed to build up gross reserves to a level that, along with the macroeconomic policies described in the attached Memorandum of Economic and Financial Policies (MEFP), would help restore confidence. Phasing is designed to make significant resources available upon approval because of the urgent need to replenish the reserves lost during and after the conflict. The authorities intend to draw on the initial purchase. Decisions on the other purchases will be subject to developments in market conditions.

2. While Georgia is a PRGF-eligible country, its per-capita income has risen rapidly in recent years. Per-capita income reached over $2,300 in 2007, and Georgia has recently become an IDA/IBRD-blend country. Fund credit outstanding stood at SDR 138.9 million (92 percent of quota) as of end-August 2008. The last Article IV consultation was concluded in March 2006. Due to the May elections and the August conflict, the next Article IV consultation is now scheduled at the time of the second program review.

II. Background

A. Political Developments

3. Tensions remain high after the early-August armed conflict. A ceasefire was agreed in mid-August but uncertainty remains, and the longstanding frictions regarding the two breakaway regions of South Ossetia and Abkhazia have increased.

4. The domestic political context is also challenging. Following an eruption of public discontent in late 2007, President Saakashvili was reelected in January 2008 and his political movement won a 60 percent majority in the May parliamentary elections. The president’s popular support rose after the recent events, but tensions remain as the opposition has been demanding higher participation in political life and greater attention to social issues.

B. Recent Economic Developments

5. The economy depends heavily on large foreign inflows. Impressive economic reforms and the government’s aggressive privatization program have spurred substantial foreign direct investment.1 Portfolio investment was given a jumpstart when the largest private bank placed bonds in international capital markets last year. Despite the political events of late 2007 and election uncertainty, private inflows reached a record level of $2.2 billion (22 percent of GDP) in 2007 and $1.5 billion in the first half of 2008.

Net Private Capital Inflows to Georgia

(In percent of GDP)

Source: National Bank of Georgia.

Net Foreign Direct Investment

(In percent of GDP)

6. Driven by foreign inflows, economic growth reached double digits amid rising inflation and a widening current account deficit.

Main Contributions to Real GDP Growth

(In percent)
  • Real GDP grew by 12½ percent in 2007—exceeding the impressive 2003–07 average of around 10 percent—and by 9¼ percent (year-on-year) in the first quarter of 2008. Growth has been broad based, with manufacturing, trade services, construction, and financial intermediation as the leading drivers.

  • Inflation—which the authorities have been struggling to contain since 2006—peaked at 12¼ percent in March 2008 before slowing to 9¾ percent in July. Strong domestic demand and the global rise in food and energy prices, which account for more than half of the consumption basket, drove the increase.

  • The external current account deficit reached 20 percent of GDP in 2007 and rose to about 26 percent in the first half of 2008 reflecting strong domestic demand, FDI-related imports, and higher commodity import prices, only partly offset by growing remittances and the recovery of export growth from the effect of Russian trade restrictions.2 Private capital inflows fully financed the deficit, and gross international reserves increased by $104 million to $1.5 billion (2.5 months of imports) by end-July 2008.

  • The REER continued to appreciate during 2007 and the first semester of 2008 due to high domestic inflation and accelerated nominal appreciation in response to massive capital inflows. The lari appreciated by 13 percent vis-à-vis the U.S. dollar during the first seven months of the year.

Current Account Balance

REER and NEER Dec. 2003 - June 2008

(2000=100)

12-Month CPI Inflation

(In percent)

C. Macroeconomic and Financial Sector Policies Before the Conflict

7. The authorities modified their policy framework in early 2008 in an attempt to entrench sound macroeconomic policies amid political opposition. Some of the provisions contained in that framework, for example, the legal commitment to permanent fiscal surpluses (counting privatization earnings as fiscal revenues) may prove too rigid in the face of the recent shock. Others, such as the declaration of price stability as the main monetary policy objective (in preparation for a formal inflation-targeting framework in 2009), the strengthening of central bank accountability, and the creation of a FSA as an independent legal entity will contribute to sound macroeconomic management in the face of this temporary shock.

8. Political events contributed to rapid increases in budgetary spending. Successive budget supplements—reflecting fast spending prior to the elections in January and May 2008, and higher defense outlays—eroded the fiscal stance relative to the original budgets. The increased expenditure was largely matched by strong revenue performance and high privatization proceeds, and the fiscal deficit reached 4½ percent of GDP in 2007 and 6 percent in the first half of 2008.

Fiscal Deficit

(In millions of lari)

Source: Ministry of Finance.

Expenditures

(In millions of lari)

9. Monetary policy focused on resisting inflationary pressures. The NBG increased interest rates aggressively (by 6 percentage points on 90-day CDs up to July) and allowed significant lari appreciation. These policies reduced the annual growth of broad money and credit to 27 percent and 48 percent, respectively in July, compared with 50 percent and 70 percent at end-2007. Dollarization remains high (60 percent of deposits and 65 percent of lending).

10. Financial soundness indicators remained generally adequate, but tight liquidity has exposed vulnerabilities in the banking sector. With slower deposit growth, banks have increasingly relied on foreign borrowing despite rising borrowing costs, and their exposure to indirect credit risk from lending in foreign currency (as well as to the potential deterioration of the property market) is significant. While bank profitability remains robust, and aggregate capital adequacy is well above the regulatory minimum, falling liquidity ratios and rising nonperforming loans (NPLs) signal increasing vulnerabilities. Liquidity was squeezed on two occasions earlier this year, forcing NBG liquidity injections and FSA intervention in two small banks. The increasing level of NPLs may still not fully reflect the impact of the credit boom on loan quality.

Text Table 1.Georgia: Prudential Indicators of Commercial Banks, 2004–08
20042005200620072008
Mar.Jun.
Capital adequacy ratio (in percent)18.817.520.616.015.615.7
Nonperforming loans (in percent of total loans)6.23.82.52.63.03.4
Loans in foreign exchange (in percent of total loans)86.776.273.868.665.964.9
Net open foreign exchange position 1/7.47.53.75.03.51.5
Liquidity ratio (in percent)45.033.341.537.236.833.3
Source: National Bank of Georgia.

Percent of Total Regulatory Capital.

Source: National Bank of Georgia.

Percent of Total Regulatory Capital.

11. The issuance of Georgia’s first international sovereign bond represented a change in the authorities’ debt management strategy. Previously, public borrowing had been almost exclusively on concessional terms. The $500 million five-year Eurobond was issued in April 2008,3 and its proceeds were intended to bolster the country’s liquid resources for dealing with future shocks. About three-fourths of the proceeds were invested in newly created sovereign wealth funds, and the remainder ($130 million) was deposited in a government account in the NBG. Notwithstanding this operation, the public external debt-to-GDP ratio fell significantly from 50 percent of GDP in 2000 to 17½ percent in mid-2008, reflecting strong economic growth and real lari appreciation.

III. Initial Consequences of the Conflict

12. With the assistance of development partners, the government is assessing the physical damage resulting from the conflict. The assessment has not been finalized, but damage to civilian infrastructure is tentatively estimated by the authorities at about $1 billion. There is a need to resettle the internally displaced persons, address interruptions in transportation, electricity and gas supplies, rebuild infrastructure, and remove bottlenecks that impede private sector activities.

13. The erosion of confidence that emerged during and immediately after the conflict was substantial. The authorities focused on preventing disruptions to the payments system. Aided by temporary measures to avoid further market uneasiness (see Box 1), they met all liquidity needs, which were volatile and directly related to the evolving developments.

  • Gross international reserves fell significantly reflecting a sharp slowdown in net foreign inflows. Reserves declined by $330 million (23 percent) between August 6 (the day before the conflict) and August 31, reflecting NBG intervention in the foreign exchange market (sales of $187 million in contrast with net purchases of $360 million in January–July), the decision to temporarily waive reserve requirements on foreign exchange deposits, and government imports. The pace of reserve losses has slowed in early September.

  • There were significant withdrawals of bank deposits. Bank deposits declined by about 400 million lari (14 percent). Both corporations and households contributed to the withdrawal, and the demand for foreign exchange increased, while interbank lending declined substantially. Small deposit inflows occurred in the third week of August but outflows have continued into early September and the situation has not yet fully stabilized.

  • Country risk rose sharply. Georgia’s sovereign bond spread over comparable U.S. treasuries reached its peak at 775 basis points during the conflict, 240 points higher than the pre-conflict level, and has remained at over 700 basis points. Standard and Poor’s and Fitch lowered Georgia’s sovereign and banks’ external debt ratings by one notch.

Gross International Reserves and Intervensions

(In millions of U.S. dollars)

Source: National Bank of Georgia.

Deposits in the Banking Sector

Source: The National Bank of Georgia

Sovereign Eurobond Spreads

(In basis points, over comparable U.S. treasuries)

Source: Bloomberg.

Box 1.Georgia—Actions to Address the Temporary Liquidity Needs

The authorities introduced the following actions in the wake of the conflict:

  • Pegged the exchange rate, on a temporary basis, to calm the market, and intervened heavily in the market to fully meet the demand for foreign exchange.

  • Declared a one-day bank holiday on August 12 because of a shortage of dollar banknotes.

  • Imposed temporary limits on deposit withdrawals and new credit operations (now lifted). Banks resumed normal operations at end-August.

  • Waived the reserve requirements for two consecutive periods with the intention of restoring them gradually.

  • Redeemed NBG securities before maturity.

  • Activated an uncollateralized lending facility in lari at a penalty interest rate (20 percent) up to a limit of $200 million for the system. Three banks used the facility.

  • Lowered the NBG policy rate by 100 basis points to signal readiness to keep banks adequately liquid and the financial system functioning.

  • The FSA monitored banks daily to identify emerging liquidity pressures, the pace of deposit outflows, and possible relaxation of borrowers’ payment discipline.

14. The direct damage to the banking sector seems to have been contained but further liquidity shortages and asset quality deterioration are matters of concern. In response to the tightening of liquidity conditions, banks sharply curtailed their lending, and the pullback in the availability of financing will challenge the sector’s growth model and could weaken the quality of individual banks’ portfolios. A key concern is credit to construction and mortgages, which accounts for one-fifth of the system’s credit, and has boomed, driven by rising real estate prices. This needs to be considered alongside the high reliance on real estate for loan collateral. Maturing external liabilities in the next 12 months are estimated at $600 million, about 13 percent of total liabilities. In addition, early repayment clauses attached to some outstanding external loans may be activated if confidence is not fully restored.

IV. The Program

15. Georgia’s near-term growth prospects have been hit by recent events, but the economy is well placed to recover from the shock. The impressive record of adjustment and reform over recent years has strengthened the structure of the economy and its ability to deal with the economic consequences of the shock. After having addressed the immediate effects, the authorities are now focusing on adapting their short-term macroeconomic policies to the changing circumstances, with a view to maintaining macroeconomic stability and strengthening financial sector soundness. This should help maintain a business climate favorable to investors, facilitate Georgia’s reentry into global capital markets, and allow it to quickly return to the path of high economic growth.

16. The Fund SBA is intended to mitigate the impact of the shock on the balance of payments and help restore investor confidence.4 Due to the size of the current account deficit and reliance on large FDI inflows to finance it, and the links between foreign inflows and domestic financial intermediation, a large external financing gap has emerged because of the shock. The authorities believe that the Fund support for their policies will provide the needed financial assurances to help restore investor confidence and limit the risk of more serious disruptions. Backed by some adjustment, Fund financing would help replenish gross reserves and address the existing pressures in the capital account.

A. Macroeconomic Framework

17. Program discussions centered on a macroeconomic framework that shows a significant slowdown in private inflows in 2008–09 and a recovery in the medium term. Based on the expectations of foreign investors, the banking sector and the business community, a complete stall or reversal of inflows does not appear likely. Nonetheless, the authorities and the staff project a sharp slowdown in private inflows (FDI, bank loans, portfolio investment), which would decline to $313 million in the second half of the year (from $1.5 billion in the first half), followed by a moderate recovery to $1.8 billion in 2009 (about half of the level expected before the conflict). In 2010 and beyond, private inflows are projected to recover. The decline in inflows (factoring in an associated drop in imports) would lead to a cumulative gap in the balance of payments of about $1.2 billion during 2008–09 (see Box 2). The size of the gap is subject to a high degree of uncertainty given the nature of the shock, unpredictability of investor sentiment, and the pace of recovery of foreign inflows.

Text Table 2.Georgia: Balance of Payments Indicators, 2008-09(In millions of USD)
20082009
Jan-Jun 1/ prel.Jul-Decproj.
Current account (in millions of USD)-1,549-1,208-2,618
Private capital inflows1,5313131,825
FDI8573801,198
Non-FDI flows, net673-67628
(bank loans, portfolio investment and other short-term capital)
Memorandum items:
Gross international reserves (with SBA; in millions of USD)1,5261,2701,755
Gross international reserves (without SBA; in millions of USD)1,5269201,080
Sources: National Bank of Georgia; and Fund staff projections.

For the first quarter, official actual data is available. Q2 is based on preliminay estimates.

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

For the first quarter, official actual data is available. Q2 is based on preliminay estimates.

Box 2.Georgia—Sources of the Balance of Payments Gap

A financing gap of $550 million (about 4 percent of 2008 GDP) will emerge in the second half of 2008 as:

  • A small net outflow (some $70 million) of short-term capital (primarily bank loans and portfolio investment) is projected for the second half of the year. This implies a reversal of about $700 million (5½ percent of GDP) compared to the first six months.

  • FDI is anticipated to decline by $450–$500 million in the second half of the year compared to the first half. The net impact of the shortfall in FDI on the balance of payments—given its high import content—is estimated at around $200 million (1½ percent of GDP).

  • The current account deficit is projected to narrow (from $1.5 billion in the first half of 2008 to $1.2 billion in the second half). Higher reconstruction imports will broadly offset lower imports associated with the economic slowdown, and remittances are projected to increase.

  • Whereas gross reserves increased by $165 million in the first half of the year, they are expected to fall by $256 million in the second half notwithstanding the disbursement of $350 million from the SBA.

The $650 million (4¾ percent gap of GDP) BOP financing gap projected for 2009 is based on the following assumptions:

  • Private capital inflows (including FDI) are expected to recover in 2009 and reach $1.8 billion, but will remain well below pre-conflict expectations.

  • The spending of the $370 million foreign assets of the sovereign wealth funds in 2009 would help lower the financing gap, but the net impact on the BOP would depend on the import content of government spending of these assets.

  • The current account would narrow somewhat as exports recovery and strong remittances will offset reconstruction-related imports.

  • NBG intervention in the foreign exchange market would contribute to the BOP gap. In contrast to the second half of 2008, the NBG reserves (net of purchases under the SBA) are expected to increase by $160 million in 2009.

18. The macroeconomic outlook points to considerably slower growth and, in the absence of a Fund program, a continuing loss of gross international reserves.

Text Table 3.Georgia: Macroeconomic Framework, 2007–10
2007200820092010
actualpre-conflict 1/post-conflictpre-conflict 1/post-conflictpre-conflict 1/post-conflict
Real sector indicators(Annual growth rates)
Real GDP growth12.49.03.59.04.08.06.0
Inflation11.08.08.07.08.06.06.0
Balance of payments indicators
Gross international reserves (with SBA; in millions of USD)1,3611,2701,7551,951
(In months of next year’s imports of goods and services)2.32.12.62.7
Gross international reserves (without SBA; in millions of US1,3611,5289201,8821,0802,2351,201
(In months of next year’s imports of goods and services)2.32.11.52.31.62.41.7
Current account (in percent of GDP)20.016.920.816.218.715.015.9
Total private capital inflows (in percent of GDP)22.017.713.916.613.115.314.1
FDI (in percent of GDP)15.312.39.312.68.611.99.2
Non-FDI private inflows (in percent of GDP)6.75.44.64.04.53.44.9
Financing gap (in millions of USD)0055006500200
Fiscal indicators(In percent of GDP)
Operational balance4.22.51.03.72.93.93.6
Deficit-4.7-3.3-6.3-1.2-3.8-0.8-1.6
Monetary indicators(Annual growth rates)
Broad money growth (including foreign currency deposits)49.623.614.028.018.0
Credit growth68.936.721.229.115.2
Sources: Georgian authorities; and Fund staff estimates.

April 2008 projections based on 2008 Q1 data.

Sources: Georgian authorities; and Fund staff estimates.

April 2008 projections based on 2008 Q1 data.

  • Real GDP growth would slow to 3½ percent in 2008 (compared to 9 percent projected before the conflict) driven by a significant drop in private investment and consumption in the remainder of the year. Growth would recover to 4 percent in 2009 and 6 percent in 2010, aided by an upturn in inflows and investment for reconstruction.

  • The external current account deficit would reach about 20¾ percent of GDP in 2008, which implies a contraction compared to the first half of the year. It would then narrow to 18¾ percent in 2009 owing mainly to the expected drop in FDI-related imports, despite increasing reconstruction imports and slower export growth.

  • Gross reserves would be used to finance the fourth quarter balance of payments gap. Reserves would further decline to $920 million (1.5 months of imports) by end-2008 and remain at about this level of import cover in 2009. The use of Fund resources would allow reserves to be maintained at a more adequate level of $1.27 billion by end-2008 and $1.76 billion by end-2009, equivalent to 2.6 months of imports, 137 percent of projected reserve money, and 51 percent of projected broad money.

  • Even though the NBG expects a one-off hike in prices due to food shortages and transportation disruptions, inflation would likely decline to 8 percent in end-2008 (as predicted before the conflict) given the slowdown in demand. Inflation is projected to remain at this rate in 2009 and decelerate gradually thereafter.

V. Program Discussions

19. Discussions focused on the need to continue implementing sound policies that will be flexible enough to respond quickly to short-term fluctuations in foreign inflows. The envisaged policies to deal with the temporary withdrawal of private sector financing following the conflict consist of strengthening underlying fiscal discipline to limit financing needs and refocus priorities on reconstruction spending; adjusting the monetary stance to protect international reserves while returning to a flexible exchange rate regime as soon as confidence is restored; and ensuring that plans to mitigate potential banking system vulnerabilities are in place. Given the underlying strength of private sector growth prior to the conflict and the expected temporary nature of the shock, the authorities considered that, on balance, policies should rely more on financing than on achieving a sharp contraction of the current account deficit through monetary and fiscal tightening.

A. Entrenching Macroeconomic Stability

Fiscal Policy

20. On the fiscal front, the program is based on strengthening the underlying position to allow room for higher reconstruction and recovery spending. The authorities recognize that the substantial increase in defense spending in recent years has limited fiscal space. They now intend to cut current spending in a way that would lead to a significant increase in public savings (from 0.3 percent of GDP in the first half of 2008 to 1.7 percent in the second half and 2.9 percent in 2009). In particular, defense spending during the second half of 2008 is expected to drop to less than half the spending in the first half of the year. On the revenue front, the tax-to-GDP ratio is expected to decline reflecting the cuts in income and dividend tax rates approved recently by parliament, which the authorities believe are important to maintain private sector confidence. In all, the overall fiscal deficit is set to increase to around 6 percent of GDP in 2008, and to decline to 3¾ percent in 2009 following a further cut in defense spending. These targets provide relatively little room for recovery and reconstruction spending that could be accommodated within the budget, and therefore will be subject to adjustors of up to 2 percent of GDP in 2008 and 3 percent of GDP in 2009 in the event that concessional donor financing exceeds declared pre-conflict commitments.

Fiscal Deficit

(In percent of GDP)

Sources: Ministry of Finance; and Fund staff estimates.

Text Table 4.Georgia: Trends in Defense Spending, 2006–09
2006200720082009
H1 spendingH2 spending proj.Total proj.proj. 1/
Defense spending
In millions of lari6891,4961,0534921,5451,000
In percent of GDP5.08.88.04.6
Source: Ministry of Finance.

This preliminary estimate was used in the Basic Data and Directions Document, which is the MoF’s medium-term budget framework, published in spring 2008.

Source: Ministry of Finance.

This preliminary estimate was used in the Basic Data and Directions Document, which is the MoF’s medium-term budget framework, published in spring 2008.

21. The fiscal deficits will be largely financed by privatization proceeds and use of government deposits, and complemented by additional donor financing. While the large privatization proceeds that financed the deficit in the last few years are expected to slow, these receipts, along with the use of government deposits, are expected to finance the 2008–09 deficits. For this purpose, in the fourth quarter of 2008, the government plans to use the $130 million of the Eurobond proceeds that are deposited in a NBG account, and in 2009 it will use the $370 million (remainder of the Eurobond proceeds) that it holds in the sovereign wealth funds. In line with its fiscal consolidation strategy, the government has been using external and domestic borrowing carefully and does not have significant disbursements in the pipeline. As such, the identified financing and grants are modest, and there is therefore a need for donor support for the reconstruction and relief effort. Some donors have announced their intention to provide assistance. The U.S. has pledged a $1 billion multi-year package, of which about half has been identified as additions to the Millennium Challenge grants, investment guarantees, humanitarian assistance, and budget support ($210–$240 million); and the World Bank has identified additional budget support of $30 million. The EU, EBRD, and ADB are also considering supporting pledges. However, the size, pace, and composition of all donor support are not yet fully defined.

22. The authorities are planning to give an additional push to structural fiscal reforms. They intend to submit to parliament an organic budget system law, thereby locking in significant rule-based limits on fiscal policy.5 The authorities see this as an essential tool to curtail unproductive spending in the face of the difficult geopolitical environment, and to limit state agencies’ deviations from budgeted spending. They also plan to improve the medium-term public expenditure strategy, complete the implementation of a risk management system for tax and customs administration, and strengthen transparency in the fiscal accounts (see paragraphs 24 to 31 of the MEFP).

Monetary and Exchange Rate Policy

23. In the very short term, the NBG will continue to focus on meeting the unusually high liquidity needs of the banking system. To address the tight monetary conditions resulting from the deposit withdrawal and slowdown in foreign inflows, which are expected to return gradually to normal, the NBG introduced a 7-day refinancing facility collateralized by government and central bank securities at interest rates determined in weekly auctions. Given that the existing stock of collateral in the market (about 165 million lari) may not suffice to meet the immediate needs, the authorities are considering the establishment of an (unsecured) credit facility at penalty rates to meet potential additional liquidity shortages and possibly a temporary reduction of the reserve requirement (to replace the current waiver). An important factor affecting liquidity conditions going forward will be the banks’ willingness to resume lending to the private sector, which has been brought to a near halt in the current uncertain environment.

24. The authorities are determined to avoid an excessive reserve loss by reintroducing exchange rate flexibility as soon as the situation in the banking system has stabilized. They are aware of the pressures that continued liquidity injections could place on the foreign exchange market and international reserves. Accordingly, they will monitor closely monetary conditions to achieve the net international reserves floors set in the program. In the aftermath of the conflict, the NBG intervened heavily in the foreign exchange market as it viewed exchange rate stability as essential for maintaining depositor confidence and limiting the risks from the large foreign currency exposure. Nonetheless, as market conditions become more stable (e.g. when deposit outflows stop), the exchange rate will have to adjust to the expected lower supply of foreign exchange. Prior to the conflict, staff’s analysis pointed to moderate overvaluation of the real effective exchange rate and suggested that the large current account deficit posed some risks to external stability. The authorities’ commitment to sound policies and far-reaching structural reforms to maintain external competitiveness should contribute to limiting this risk.

25. A framework for liquidity management is a renewed priority for the NBG. The need to shift policies quickly (from mopping to injecting liquidity) has highlighted the advantage of having a well-structured liquidity framework, compared to the current use of ad-hoc instruments to deal with changing circumstances. The NBG is committed to developing such a scheme to enhance the efficiency of monetary policy and to strengthen the transmission mechanism in preparation for the envisaged formal inflation-targeting regime (see paragraph 32 of the MEFP).

Debt Issues

26. The staff’s debt sustainability analysis shows that Georgia’s external debt is low and will remain sustainable despite the adverse impact of the conflict. Public debt will rise in 2008–09 on account of the $500 million Eurobond and the new conflict-related borrowing. Over the long term, all relevant debt solvency and liquidity indicators are well below the applicable thresholds and show resiliency to a number of stress tests. The large projected debt service in 2012–13 is a risk to the debt outlook (see Attachment IV).6

B. Strengthening Financial Sector Soundness

27. Aided by tight prudential requirements, the banking system has been resilient to the current pressures, but there are concerns about liquidity and asset quality. The current downturn was cushioned by strong prudential ratios, including high liquidity requirements, stringent capital adequacy ratios (12 percent), and higher risk weighting for foreign-currency lending.7 However, the maturing external liabilities and slow deposit growth could put additional pressure on liquidity and funding if foreign financing remains inaccessible in this environment. Also, there are concerns about the impact of the economic slowdown on banks’ indirect foreign exchange rate exposure and asset quality, particularly given their large exposure to the real estate sector.

28. In the face of these challenges, clear action plans need to be developed to assess bank vulnerabilities and mitigate risks. The supervisory authorities are working with banks on plans to maintain liquidity, preserve asset quality, and meet solvency standards, including, if necessary, by raising additional capital. These plans will be assessed in the context of subsequent program reviews. The FSA needs to ensure that banks are realistically assessing their business position, adequately provisioning for rising NPLs, and taking a conservative approach to collateral valuations in an environment of limited liquidity and falling prices in the property market.

29. To support these efforts, there is a need to build up the capacity of the FSA. Efforts by the FSA to step up bank supervision in the wake of the conflict have been successful, and are expected to be complemented by upgrading offsite supervisory capacities based on deeper analysis and additional bank inspections when issues of concern arise. The authorities intend to enhance risk management practices by banks and strengthen supervision on a consolidated basis to avoid regulatory arbitrage, and to align financial sector regulation to the recent changes in legislation. They also have plans to further enhance the independence of the FSA (see paragraph 43 of the MEFP).

30. The authorities intend to strengthen the lender of last resort (LOLR) facility to reduce incentives for excessive risk taking by banks and safeguard the strength of the NBG’s balance sheet. The NBG’s emergency liquidity provision instruments were effective in providing short-term support to banks during the recent turbulence. Going forward, however, the authorities see the crucial need to strengthen the LOLR, including by refining the type of securities that can be used as collateral, redefining access limits and maturity, and ensuring that emergency liquidity is provided only to solvent and viable banks. The FSA has an important role to play in determining that banks only face liquidity difficulties and in exercising oversight on the institutions accessing the facility.

31. Cooperation between the NBG and the FSA will be enhanced. Both institutions are working on a memorandum of understanding that will define roles and responsibilities, and introduce practical and legal arrangements for information exchange (see paragraph 42 of the MEFP).

VI. Risks to the Program

32. Even though the authorities are committed to maintaining macroeconomic stability, considerable downside risks remain. Escalations of regional or domestic tensions or a less benign international economic environment are major risks for this program. These events could result in a greater-than-anticipated deterioration of investor confidence that could add pressures to the capital account. If events trigger a loss of depositors’ confidence, a prolonged period of tight liquidity and credit conditions and a worsening of credit portfolio could result in a weakening of bank soundness.

33. The program is based on a macroeconomic scenario under which the outlook remains difficult, but a full-blown crisis does not erupt. The authorities indicated that they stand ready to implement additional measures as needed in consultation with Fund staff. These measures would depend on how the circumstances develop. There could be a need to tighten monetary and fiscal policies, allow for faster exchange rate depreciation, and seek additional financing to react to a larger-than-anticipated shock. The mission discussed with the authorities the need to strengthen the bank resolution framework—in particular, to clarify the roles that the NBG, the FSA, and the government would play if banking difficulties of systemic importance were to arise.

VII. Program Access, Monitoring, and Capacity to Repay the Fund

34. The proposed SBA would involve exceptional access. In light of the significant contribution of foreign inflows to the capital account, the shock to confidence has already produced large external financing needs that have been covered by a loss of 23 percent of international reserves (140 percent of quota). In addition, inflows are not expected to fully recover until the security situation stabilizes, adding to the financing gap. Staff believes that Georgia meets the four criteria for exceptional access (see Attachment V).

35. The external financing gap is expected to be filled by the Fund and other donors’ support. The program envisages that the SBA will fill about 60 percent of the 2008–09 financing gap, with the remainder expected to be met by donors, who are now assessing the size, pace, and modalities of their contribution. In 2008, the SBA will cover $350 million of the $550 million financing gap, the World Bank will contribute $30 million, and the U.S. the remaining $170 million.8 Details of how the 2009 financing gap will be closed will be provided at the time of the first program review.

36. Georgia has established a record of timely servicing its obligations to the Fund, and its capacity to repay is expected to remain strong. The public external debt-to-GDP ratio is projected at 25 percent of GDP by 2010, even amid a marked slowdown in economic growth. This ratio includes the impact of the drawdown of the full amount of the proposed SBA (2½ and 2¼ percentage points of the external public debt-to-GDP ratio in 2008 and 2009, respectively) as well as the effect of the Eurobond issue and the conflict-related borrowing. Based on these debt indicators, Georgia’s capacity to repay the Fund is strong. Nevertheless, this capacity would be substantially impaired if any of the downsize risks of the program materialize.

37. Conditionality is proposed to be driven by the authorities’ reform agenda, and is considered critical to achieve the program objectives. The program includes two key structural performance criteria and four structural benchmarks to be completed in the next nine months focused on macroeconomic and financial sector soundness (see Box 3). Additional structural conditionality to follow up on these objectives will be discussed during future program reviews.

38. An updated safeguards assessment of the NBG has been initiated and will be completed no later than the first review. Staff monitoring since the previous safeguards assessment (2004) indicates that the NBG continues to comply with key safeguards requirements. The NBG publishes IFRS financial statements that have been externally audited in accordance with international standards. The update would aim to confirm the findings of the off-site monitoring and identify any emerging safeguards issues.

Box 3.Georgia: The New Stand-By Arrangement

Objective of the Program. Finance the external gap emerging from pressures to the balance of payments and provide the needed financial assurances to help restore investor confidence.

Access. SDR 477.1 million

Phasing. SDR 161.7 million will be made available upon the Board’s approval of the arrangement to address the urgent need to replenish reserves. Subsequent two tranches of SDR 63.1 million each could be made available in November 2008 and February 2009. Thereafter, the program builds on four equal purchases of SDR 47.3 million made available on a quarterly basis.

Conditionality

Quantitative Performance Criteria

  • A ceiling on the financing of the overall fiscal balance.

  • A floor on the NBG’s net international reserves.

  • A ceiling on the net domestic assets of the NBG.

  • A ceiling on the contracting or guaranteeing of new nonconcessional external debt.

  • Nonaccumulation of public external arrears during the program period.

Structural Performance Criteria

Introduction by the NBG of a LOLR facility (critical for liquidity management in the face of financial sector vulnerabilities).

Submission to parliament of a new organic budget system law (critical for ensuring fiscal discipline and boosting investor confidence in the wake of the conflict).

Structural Benchmarks (critical for strengthening fiscal and financial institutions).

FSA and NBG to sign and implement a memorandum of understanding to strengthen cooperation.

Submission to parliament of a state budget for 2009 with an overall deficit of no more than 3¾ percent of GDP (subject to an adjustor for donor-financed reconstruction spending of up to 3 percent of GDP).

NBG to develop and publish a liquidity management framework.

Appointment of the remaining members of the FSA Board.

Expected Reviews: Quarterly reviews and quarterly performance criteria.

39. During the period of the arrangement, the authorities will maintain the usual close policy dialogue with the Fund. Georgia’s office was downsized in August 2008, and there is currently no resident representative. Until the post is filled, the senior resident representative in Lebanon will visit Tbilisi periodically to help monitor the program.

VIII. Staff Appraisal

40. Georgia’s economy is well positioned to deal with the temporary shock it is facing. Its impressive record of adjustment and reform has strengthened the structure of the economy and its ability to address the economic consequences of the recent armed conflict. The overall policy framework prior to the conflict was sound and the immediate response to the shock was appropriate and consistent with Fund’s advice. Now the authorities are centering their attention on restoring investor confidence to allow Georgia to return to the path of high economic growth as quickly as possible. Financing of the balance-of-payments gap is critical toward this end.

41. The authorities see Fund’s support for their program as an essential piece of their strategy. Fund resources will not only replenish the large loss in gross international reserves since the conflict erupted and help finance the 2009 financing gap, but would also act as a catalyst to boost investor confidence and facilitate other donors’ support for the reconstruction effort.

42. The proposed program involves exceptional access since it would exceed limits of 100 percent of quota annually and 300 percent of quota cumulatively. Georgia’s case meets the criteria for such an access given that the drop in inflows is placing exceptional pressures on the capital account, the debt position is sustainable even after the required post-conflict financing, renewed access to private capital markets after conditions stabilize is likely, and the authorities are committed to sound reforms, although there are risks regarding the prevailing geopolitical situation.

43. The Fund program will support the authorities’ efforts to limit the deterioration in the external account by containing the fiscal deficit and maintaining a vigilant monetary stance, while strengthening financial sector resilience. Given the temporary nature of the shock and the strength of the underlying macroeconomic conditions going into the conflict, the program targets only a moderate adjustment in the current account in 2008– 09. Dealing with the external imbalance through a sharp tightening of fiscal and monetary policies at this stage would carry excessive costs. The program supports the authorities’ short-term strategy of avoiding liquidity disruptions and accepting higher fiscal spending on reconstruction, while retaining the main direction of economic policies in place prior to the conflict.

44. On fiscal policy, the plan is to reduce current expenditures in order to free resources for relief and reconstruction, and move as planned with reductions in the tax burden. This strategy would allow for a more efficient expenditure mix, and along with tax administration improvements, would lead to a sustainable fiscal position in the medium term. As the authorities have stressed, reversing the already announced income tax rate cut could give the wrong signal to investors at a time when reassuring them of the government’s pro-business policies is essential for restoring investor confidence. Capital expenditure will be led by reconstruction and infrastructure needs. The 2008–09 deficits are anticipated to be mainly financed by the use of resources deposited in the sovereign wealth fund (proceeds from the $500 million Eurobond issue early this year) and privatization receipts. Concessional loans and grants to be provided by multilateral and bilateral partners—in an amount that is still uncertain at this time—are expected to finance further reconstruction needs, and will be accommodated within the fiscal targets.

45. Monetary policy has to deal with the dilemma of providing sufficient liquidity to the banking system while stabilizing the exchange rate and protecting the international reserve position. The authorities have adjusted some of their policy instruments to inject liquidity in the face of deposit withdrawals and lower capital inflows. However, given the limited international reserve buffer, continued provision of liquidity could undermine the central bank’s ability to stabilize the exchange rate and with it inflationary expectations. The staff supports the authorities’ policy of avoiding short-term volatility in the exchange rate, but stresses the importance of the program’s floors on net international reserves and the need to return to a flexible exchange rate regime as soon as market conditions allow. This might require raising interest rates further. To facilitate a return to more normal liquidity conditions, the authorities’ plans to phase out the reserve requirement waiver introduced in the wake of the conflict and to make progress in strengthening liquidity management and improving the LOLR facility during the first six months of the program are crucial. With the expected slowdown in economic activity, inflation is expected to remain moderate. The introduction of an inflation-targeting regime should help anchor inflation over the medium term.

46. The banking system has been resilient to the current pressures, but there are concerns about liquidity and asset quality. To address these challenges, the supervisory authorities are planning to work with banks on plans to assess bank vulnerabilities and mitigate risks. To support these efforts, the program envisages actions to build up the capacity of the FSA, strengthen its independence, and enhance cooperation between the NBG and the FSA. Once market uneasiness subsides, there is a need to improve contingency planning for bank resolution.

47. Risks to the program are considerable. Escalations of regional or domestic tensions and a less benign international economic environment are major risks, as these events could be followed by a greater-than-anticipated deterioration of investor confidence that could add pressures to the capital account. A weakening of bank asset quality and reduced access to foreign borrowing is another substantive risk for the macroeconomic outlook and the program. If these scenarios emerge, the authorities are prepared to act quickly by strengthening policies and mobilizing financing.

Figure 1.Georgia: Financial Indicators

Source: Bloomberg.

Figure 2.Georgia: Monetary Indicators

Sources: National Bank of Georgia; and Bloomberg.

Table 1.Georgia: Selected Macroeconomic Indicators, 2006–12
2006 Act.2007 Prel.2008 Proj.2009 Proj.2010 Proj.2011 Proj.2012 Proj.
National accounts(Annual percentage change, unless otherwise indicated)
Real GDP growth9.412.43.54.06.06.07.0
Population (million)1/4.34.44.44.44.44.44.4
Consumer price index, period average9.29.210.07.67.06.06.0
Consumer price index, end-of-period8.811.08.08.06.06.06.0
GDP per capita (US$)1,8002,3242,8953,1673,5924,0364,577
Poverty rate (in percent)31.0
Unemployment rate (in percent)13.613.3
(In percent of GDP)
Investment and saving
Investment25.628.123.722.222.424.025.1
Public2.53.43.65.64.04.24.3
Private23.024.720.116.618.419.820.8
Gross national saving9.78.12.93.56.59.812.7
Public5.94.21.02.93.64.24.2
Private3.73.81.90.62.85.68.5
Saving-investment balance-15.9-20.0-20.8-18.7-15.9-14.2-12.4
(In percent of GDP)
Consolidated government operations
Revenue26.729.227.726.025.525.125.0
Expenses20.825.026.623.121.820.920.8
Operational balance5.94.21.02.93.64.24.2
Capital spending and net lending9.09.07.36.75.24.84.5
Total balance-3.0-4.7-6.3-3.8-1.6-0.6-0.3
Statistical discrepancy0.00.20.30.00.00.00.0
Total financing (program definition)3.04.55.93.81.60.60.3
Domestic-1.7-0.91.3-0.3-0.3-0.2-0.2
External-0.40.21.53.10.80.30.4
Of which: use of Sovereign Wealth Fund resources0.00.0-2.82.50.00.00.0
Privatization receipts5.25.23.20.91.00.60.1
(Annual percentage change, unless otherwise indicated)
Monetary sector
Reserve money19.225.619.012.0
Broad money (including foreign exch. deposits)39.349.614.018.0
Private credit53.468.921.215.2
External sector
Exports of goods and services (percent of GDP)33.131.727.629.230.430.229.4
Annual percentage change17.626.113.111.517.511.510.5
Imports of goods and services (percent of GDP)56.857.853.452.950.548.645.5
Annual percentage change33.034.020.04.17.98.06.3
Current account balance (in millions of US$)-1,235-2,047-2,757-2,618-2,513-2,510-2,501
In percent of GDP-15.9-20.0-20.8-18.7-15.9-14.2-12.4
Gross international reserves (in millions of US$)8811,3611,2701,7551,9512,0802,173
In months of next year’s imports of goods and services1.82.32.12.62.72.72.7
Foreign direct investment (percent of GDP)13.915.39.38.69.29.28.5
Sources: Georgian authorities; and Fund staff estimates.

Excludes Abkhazia residents.

Sources: Georgian authorities; and Fund staff estimates.

Excludes Abkhazia residents.

Table 2:Georgia: Annual Consolidated Government Operations, 2006–10 1/
2006200720082009201020062007200820092010
(In millions of lari)(In percent of GDP)
Revenues3,6784,9725,3565,6446,27926.729.227.726.025.5
Taxes3,1524,3904,7785,1695,83522.925.824.723.823.7
Direct1,3511,9362,0832,1952,4409.811.410.810.19.9
Indirect1,8012,4542,6952,9743,39613.114.413.913.713.8
Other revenues3584804022972982.62.82.11.41.2
Grants1681021761781461.20.60.90.80.6
Social expenses0000000000
Current expenditure2,8614,2545,1575,0135,38120.825.026.623.121.8
Compensation for employees5656761,0221,0791,1604.14.05.35.04.7
Use of goods and services7741,5801,7541,5271,5565.69.39.17.06.3
Subsidies3873993913413872.82.32.01.61.6
Grants7141210110.00.10.10.00.0
Social expenses7098511,2381,3681,5525.15.06.46.36.3
Other expenses3176366025215902.33.73.12.42.4
Interest104981371681250.80.60.70.80.5
To nonresidents363979110590.30.20.40.50.2
To residents68595958660.50.30.30.30.3
Operational balance8177181986318985.94.21.02.93.6
Capital spending and net lending1,2371,5241,4101,4461,2809.09.07.36.75.2
Capital1,0701,4651,3251,4211,2477.88.66.86.55.1
Net lending167598525331.20.30.40.10.1
Total balance-420-806-1,211-815-382-3.0-4.7-6.3-3.8-1.6
Statistical discrepancy3360000.20.30.00.0
Total financing4207731,1518153823.04.55.93.81.6
Domestic-237-149242-67-67-1.7-0.91.3-0.3-0.3
Amortization-64-30-61-67-67-0.5-0.2-0.3-0.3-0.3
Use of deposits at the NBG and banks-173-11930300-1.3-0.71.60.00.0
External-6234283681198-0.40.21.53.10.8
Borrowing1731669202322821.31.04.81.11.1
Repayment-234-132-96-92-85-1.7-0.8-0.5-0.4-0.3
Use of Sovereign Wealth Fund resources00-54154100.00.0-2.82.50.0
Privatization receipts7198896242002525.25.23.20.91.0
Memorandum item:
Nominal GDP13,78416,99919,35321,73724,654
Total financing including adjustor
Adjustor3876522.03.0
Adjusted deficit ceiling1,5381,4677.96.8
Source: Ministry of Finance; and Fund staff estimates.

Consolidated government includes central and local governments and the Sovereign Wealth Funds.

Source: Ministry of Finance; and Fund staff estimates.

Consolidated government includes central and local governments and the Sovereign Wealth Funds.

Table 3.Georgia: Quarterly Consolidated Government Operations, 2008–091/
20082009
Q1 ActualQ2 ActualQ3 Proj.Q4 Proj.Annual Proj.Q1 Proj.Q2 Proj.Q3 Proj.Q4 Proj.Annual Proj.
(In millions of lari)
Revenues1,3101,4021,1591,4875,3561,0881,3221,5191,7155,644
Taxes1,1201,2651,0901,3014,7781,0131,1971,3921,5675,169
Direct5175654855142,0834535405716322,195
Indirect6037006067862,6955616578219352,974
Other revenues1571196560402397878103297
Grants3318312617636484945178
Current expenditure1,2901,3971,3391,1315,1579591,1041,3121,6385,013
Compensation for employees2352572612701,022
Use of goods and services5255724721851,754
Subsidies9769102123391
Grants632112
Social expenses2873293133091,238
Other expenses116146161180602
Interest25222863137
To nonresidents108134879
To residents1514151559
Operational balance195-18135619812821820777631
Capital spending and net lending2014313564231,410269546571601,446
Capital1834053134231,325263517614271,421
Net lending182643085629-433325
Total balance-182-426-537-67-1,211-141-328-36417-815
Statistical discrepancy4119006000000
Total financing141407537661,151141328364-17815
Domestic-43-20042560242-16-21-10-19-67
Amortization-15-19-9-17-61-16-21-10-19-67
Use of deposits at the NBG and banks-28-1814347830300000
External1622868-27283133314314-79681
Borrowing277809321920105279275-426232
Amortization-10-13-26-47-96-11-35-11-36-92
Use of Sovereign Wealth Fund resources0-5400-1-541387050383541
Privatization receipts168379443362425356080200
Memo:
Nominal GDP4,1834,8004,9935,38019,3534,5875,3475,6526,15221,737
Source: Ministry of Finance; and Fund staff estimates.

Consolidated government includes central and local governments and the Sovereign Wealth Funds.

Source: Ministry of Finance; and Fund staff estimates.

Consolidated government includes central and local governments and the Sovereign Wealth Funds.

Table 4.Georgia: Summary Balance of Payments, 2006–12(In millions of U.S. dollars)
200620072008200920102011201220082009
Act.Act.Proj.2009201020112012H1H2H1H2
Current account balance-1,235-2,047-2,757-2,618-2,513-2,510-2,501-1,549-1,208-1,253-1,365
Trade balance-2,019-2,877-3,491-3,520-3,508-3,649-3,684-1,819-1,672-1,694-1,827
Exports1,6672,1042,4852,7503,2633,6744,1011,2941,1911,3711,379
Imports-3,686-4,981-5,976-6,270-6,771-7,323-7,785-3,113-2,863-3,065-3,205
Services and income (net)343245-121-1977176175-78-430-19
Transfers (net)4415858559219199631,008348507441480
Capital and financial account balance1,6172,3882,1522,4812,5312,7012,8711,7314201,1561,325
Capital account16912613823418618518137101116118
Financial account1,4482,2622,0132,2472,3462,5162,6901,6943191,0401,206
Public sector-917170422127791471646212210
Portfolio investment001303700001300185185
Assets, investments in SWF (- increase)00-370370000-3700185185
Liabilities (+ increase)005000000500000
Other investment (including to/from official creditors)-9174052127791473462725
of which: Disbursements1091011159218113820248684745
of which: Debt repayments-124-45-79-41-53-60-55-17-62-20-20
Private sector1,4572,2451,8441,8252,2182,4372,5441,531313829996
Foreign direct investment
(including privatization receipts)1,0761,5621,2371,1981,4521,6301,714857380593604
Other private capital (net)
(includes bank loans, portfolio)382683606628766807830673-67236392
Errors and omissions58-24-430000-43000
Overall balance439317-648-13718191370140-788-96-41
International reserves and exceptional financing
Gross reserves (- increase)-439-379131-485-196-129-92-125256-241-244
Exceptional financing (incl. debt relief, rescheduling)760300003000
Use of Fund resources-72-35-28-22-61-278-18-18-13-15
Financing Gap00-550-650-200000-550-350-300
Financing of the gap550650200550350300
IMF (SBA Purchases)35032575350175150
Other financing200325125200175150
U.S.170
World Bank30
Memorandum items:
Nominal GDP7,76410,22713,28113,97315,77217,72120,099
Current account deficit (percent of GDP)15.920.020.818.715.914.212.4
Trade deficit (percent of GDP)26.028.126.325.222.220.618.3
Merchandise export growth (percent)13.226.318.110.618.712.611.6
Merchandise export volume growth (percent)2.715.43.66.713.67.610.8
Merchandise import growth (percent)37.235.120.04.98.08.26.3
Merchandise import volume growth (percent)16.215.94.54.35.38.97.1
Gross international reserves (end of period)8811,3611,2701,7551,9512,0802,173
(in months of next year imports of goods and services)1.82.32.12.62.72.72.7
Public and publicly guaranteed external debt (nominal)1,6971,7902,7903,6183,7973,8183,689
(in percent of GDP)21.917.521.025.924.121.518.4
Public debt service198143181181190234445
(in percent of exports of goods and services)7.74.44.94.44.04.47.5
Total external debt 1/2,3283,1364,6005,7456,2296,6906,980
(in percent of GDP)30.030.734.641.139.537.834.7
Total external debt service 1/2692655126267398231,141
(in percent of exports of goods and services)10.58.214.015.315.415.419.3
Capital inflows to private sector (percent of GDP)18.822.013.913.114.113.812.7
Sources: Georgian authorities; and Fund staff estimates.

For private debt starting in 2008, estimates based on the survey by the National Bank of Georgia and Fund staff assumptions.

Note: The change in gross international reserves does not equal the increase in reserves because the increase in reserves does not include valuation/reclassification effects as per Balance of Payments Manual 5.
Sources: Georgian authorities; and Fund staff estimates.

For private debt starting in 2008, estimates based on the survey by the National Bank of Georgia and Fund staff assumptions.

Note: The change in gross international reserves does not equal the increase in reserves because the increase in reserves does not include valuation/reclassification effects as per Balance of Payments Manual 5.
Table 5.Georgia: Accounts of the National Bank of Georgia, 2006–09
2006200720082009
Dec.Dec.Mar.Jun. Act.Sep. Proj.Dec. Proj.Mar. Proj.Jun. Proj.Sep. Proj.Dec. Proj.
(In millions of lari)
Net foreign assets 1/1,0061,4601,5001,5949598469331,0381,1171,162
Net domestic assets18738-876765938788804817836
Net claims on general government407329315149554618618618618618
Claims on general government (incl. t-bills)785776776776778778778778778778
Nontradable govt. debt785737689689689689641641641641
Securitized debt (marketable)03987878989137137137137
Deposits-378-447-461-627-223-159-159-159-159-159
Claims on rest of economy9910333333333
Claims on banks-255-304-392-180139249114116117116
Other items, net-65-90-1334686752667898
Reserve money1,1931,4991,4141,6001,7231,7841,7211,8421,9341,998
Currency in circulation9301,3101,2871,4131,6201,6391,5701,6761,7601,808
Required reserves 2/225100000000
Balances on banks’ correspondent accounts 3/39187126187103144151166174190
(Percent contribution, compared to reserve money at the end of previous year)
Net foreign assets66.338.02.78.9-33.5-41.04.910.815.217.7
Net domestic assets-47.2-12.5-8.3-2.248.560.0-8.4-7.5-6.8-5.7
Net claims on general government-23.9-6.5-0.9-12.015.019.30.00.00.00.0
Claims on rest of economy0.70.3-6.6-6.6-6.6-6.60.00.00.00.0
Claims on banks-25.4-4.1-5.98.229.536.9-7.6-7.5-7.4-7.5
Other items, net1.4-2.15.18.210.510.5-0.8-0.10.61.7
(Percentage change, relative to end of previous year)
Reserve money19.225.6-5.76.815.019.0-3.53.38.412.0
Currency in circulation14.641.0-1.87.823.625.1-4.22.27.410.3
Required reserves 2/73.0-99.5-0.1-0.1-0.1-0.10.00.00.00.0
Balances on banks’ correspondent accounts 3/-35.0377.7-32.40.0-44.7-22.74.814.720.531.4
Memorandum items:
Net international reserves
(in millions of USD, at prog. exchange rates)1,060602537572639690719
Net domestic assets (in millions of lari, at prog. exchange rates)36765989878904924948
Reserve money (in percent, 12-month growth)19.225.622.622.424.919.021.815.112.212.0
Sources: National Bank of Georgia; and Fund staff estimates.

New classification of gross international reserves reported since the beginning of 2007.

The required reserve regime was modified in May 2007. Under the new regime, tha lari reserves are deposited at banks’ corresponding accounts, the foreign-currency reserves have been gradually converted into the required currency (USD) and included in net foreign assets as both asset and liability.

Including the lari required reserves and overnight deposits from banks.

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

New classification of gross international reserves reported since the beginning of 2007.

The required reserve regime was modified in May 2007. Under the new regime, tha lari reserves are deposited at banks’ corresponding accounts, the foreign-currency reserves have been gradually converted into the required currency (USD) and included in net foreign assets as both asset and liability.

Including the lari required reserves and overnight deposits from banks.

Table 6.Georgia: Monetary Survey, 2006–09
2006200720082009
Dec.Dec.Mar.Jun. Act.Sep. Proj.Dec. Proj.Mar. Proj.Jun. Proj.Sep. Proj.Dec. Proj.
(In millions of lari)
Net foreign assets 1/621274199-40-561-554-483-425-502-613
NBG1,0061,4601,5001,5949598469331,0381,1171,162
Commercial banks-385-1,186-1,301-1,634-1,520-1,400-1,416-1,463-1,619-1,775
Net domestic assets2,0403,7063,8284,2284,8265,0924,9765,2695,6465,968
Domestic credit3,2195,0325,3365,6826,1266,3426,2266,5396,9377,218
Net claims on general government41329326585520598598598598598
Credit to the rest of the economy2,8064,7395,0715,5985,6065,7445,6285,9416,3396,620
Other items, net-1,178-1,326-1,508-1,454-1,300-1,250-1,250-1,270-1,291-1,250
Broad money (M3)2,6623,9814,0274,1884,2654,5384,4934,8445,1455,355
Broad money, excl. forex deposits (M2)1,3892,1322,2592,4172,5682,6582,5872,8002,9793,117
Currency held by the public8271,1521,1231,2351,5201,5391,4651,5711,6551,703
Total deposit liabilities1,8342,8292,9042,9522,7452,9993,0283,2733,4903,651
(Percent contribution, compared to broad money at the end of previous year)
Net foreign assets26.7-13.0-1.9-7.9-21.0-20.81.62.81.2-1.3
Net domestic assets12.562.63.113.128.134.8-2.63.912.219.3
Domestic credit39.668.17.616.327.532.9-2.64.313.119.3
Net claims on general government-11.5-4.5-0.7-5.25.77.70.00.00.00.0
Credit to the rest of the economy51.172.68.321.621.825.3-2.64.313.119.3
Other items, net-27.0-5.5-4.6-3.20.61.90.0-0.4-0.90.0
(Percentage change, relative to end of previous year)
Broad money (M3)39.349.61.25.27.214.0-1.06.713.418.0
Broad money, excl. forex deposits (M2)29.853.56.013.420.424.7-2.75.312.117.3
Currency held by the public12.439.2-2.57.231.933.6-4.82.17.510.6
Total deposit liabilities56.154.22.74.4-2.96.01.09.116.421.8
Memorandum items:
Growth of M3 (in percent, 12-month growth)39.349.650.628.915.014.011.615.720.618.0
Growth of M2 (in percent, 12-month growth)29.853.565.446.833.224.714.515.816.017.3
Growth of credit to the rest of the economy
(in percent, relative to end of previous year)53.468.97.018.118.321.2-2.03.410.415.2
Growth of credit to the rest of the economy
(in percent, 12-month growth)53.468.962.453.930.721.211.06.113.115.2
M2 multiplier 2/1.161.421.601.511.491.491.501.521.541.56
M3 multiplier 3/2.232.662.852.622.482.542.612.632.662.68
M3 velocity6.035.125.495.195.054.644.684.504.194.10
Foreign exchange deposits in percent of total deposits69.465.460.960.061.862.762.962.562.161.3
Sources: National Bank of Georgia; and Fund staff estimates.

New classification of gross international reserve reported since the beginning of 2007.

M2 divided by reserve money.

M3 divided by reserve money.

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

New classification of gross international reserve reported since the beginning of 2007.

M2 divided by reserve money.

M3 divided by reserve money.

Table 7.Georgia: External Vulnerability Indicators, 2006-15
200620072008 Proj.2009 Proj.2010 Proj.2011 Proj.2012 Proj.2013 Proj.2014 Proj.2015 Proj.
Value of exports of goods and services, percent change17.626.113.111.517.511.510.58.87.87.0
Value of imports of goods and services, percent change33.034.020.04.17.98.06.37.35.94.8
Terms of trade (deterioration -)-6.9-5.6-0.73.01.85.31.51.50.00.2
Current account balance (percent of GDP)-15.9-20.0-20.8-18.7-15.9-14.2-12.4-11.8-10.6-9.7
Capital and financial account (percent of GDP)20.823.416.217.816.015.214.313.012.310.9
External public debt (percent of GDP)21.917.521.025.924.121.518.415.213.913.1
in percent of exports of goods and services66.155.376.288.679.171.462.453.350.347.9
Debt service on external public debt
(in percent of exports of goods and services)7.74.44.94.44.04.47.516.64.74.5
External debt (percent of GDP)30.030.734.641.139.537.834.731.529.628.9
in percent of exports of goods and services90.796.9125.6140.7129.8125.1118.1110.5107.5105.7
Debt service on external debt
(in percent of exports of goods and services)10.58.214.015.315.415.419.329.318.018.3
Gross international reserves

in millions of USD
8811,3611,2701,7551,9512,0802,1732,0942,2622,446
in months of next year’s imports of goods and services1.82.32.12.62.72.72.72.42.52.5
in percent of external debt37.943.427.630.531.331.131.129.530.431.2
in percent of short-term external debt491549454669874818761676716721
Sources: IMF Finance Department; and Fund staff estimates and projections.
Sources: IMF Finance Department; and Fund staff estimates and projections.
Table 8.Georgia: Indicators of Fund Credit, 2006–16(In millions of SDR)
200620072008 Proj.2009 Proj.2010 Proj.2011 Proj.2012 Proj.2013 Proj.2014 Proj.2015 Proj.2016 Proj.
Existing Fund credit
Stock 1/157.1159.2137.1119.1105.087.167.247.629.414.04.2
Obligations34.226.722.818.614.718.420.319.918.415.59.8
Proposed SBA
Disbursements224.8205.047.30.00.00.00.00.00.0
Stock 1/224.8429.8477.1456.9303.190.75.90.00.0
Obligations 2/2.013.520.841.7172.1222.087.06.00.0
Principal (repayments/repurchases)0.00.00.020.2153.8212.484.85.90.0
Charges and interest2.013.520.821.418.39.52.20.10.0
Stock of existing and prospective Fund credit 1/157.1159.2361.9548.9582.1544.0370.3138.335.314.04.2
In percent of quota104.5105.9240.8365.2387.3361.9246.492.023.59.32.8
In percent of GDP3.02.44.46.25.94.92.91.00.20.10.0
In percent of exports of goods and nonfactor services9.07.515.821.319.316.210.03.40.80.30.1
In percent of gross reserves26.217.945.749.647.541.727.210.62.50.90.3
Obligations to the Fund from existing and prospective Fund arrangements34.226.724.832.135.560.0192.4241.8105.421.59.8
In percent of quota22.817.816.521.323.639.9128.0160.970.114.36.5
In percent of GDP0.60.40.30.40.40.51.51.70.70.10.1
In percent of exports of goods and nonfactor services2.01.31.11.21.21.85.26.02.40.50.2
In percent of gross reserves5.73.03.12.92.94.614.118.57.51.40.6
Sources: IMF Finance Department; and Fund staff estimates and projections.

End of period.

Repayment schedule based on repurchase obligations.

Sources: IMF Finance Department; and Fund staff estimates and projections.

End of period.

Repayment schedule based on repurchase obligations.

Table 9.Georgia: External Financing Requirements and Sources, 2006–12(In millions of U.S. dollars)
2006200720082009201020112012
Total requirements-1,418-2,185-3,251-2,331-2,602-2,963-3,238
Current account deficit-1,235-2,047-2,757-2,618-2,513-2,510-2,501
Capital outflows 1/-183-138-494287-89-453-737
Total sources1,4182,1852,7011,6802,4022,9633,238
Capital inflows1,8082,4622,5672,1652,5983,0923,331
Project grants169126138234186185181
Foreign direct investment1,0761,5621,2371,1981,4521,6301,714
Disbursements to public sector10910161592181138202
Private sector net inflows 2/4556725776417791,1391,234
Financing (incl. exceptional)4810230000
IMF (PRGF)414200000
Change in arrears, net (- decrease)-69-27-10000
Debt rescheduling, pre-payment (net)3/768730000
Change in reserves (- increase)-439-379131-485-196-129-92
Financing gap00-550-650-20000
Financing of the gap550650200
of which: IMF (SBA)35032575
Memorandum items (in percent of GDP):
Total financing requirements-18.3-21.4-24.5-16.7-16.5-16.7-16.1
Total sources18.321.420.312.015.216.716.1
Capital inflows23.324.119.315.516.517.516.6
Exceptional financing0.61.00.00.00.00.00.0
Change in reserves (- increase)-5.6-3.71.0-3.5-1.2-0.7-0.5
Sources: Georgian Statistics Department; National Bank of Georgia; and Fund staff estimates.

Including scheduled public sector amortization and principal payments to the IMF.

Includes errors and omissions.

Assumes rescheduling of 2003 arrears in 2004 and of principal maturities falling due during 2004-06. Includes comparable treatment by non-Paris Club bilateral creditors.

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

Including scheduled public sector amortization and principal payments to the IMF.

Includes errors and omissions.

Assumes rescheduling of 2003 arrears in 2004 and of principal maturities falling due during 2004-06. Includes comparable treatment by non-Paris Club bilateral creditors.

Table 10.Georgia: Prudential Indicators of Commercial Banks, 2004–08
20042005200620072008
Mar.Jun.
Capital adequacy ratio (in percent)18.817.520.616.015.615.7
Leverage ratio 1/27.925.930.725.926.724.8
Nonperforming loans (in percent of total loans)6.23.82.52.63.03.4
Specific provisions (in percent of total loans)4.32.41.71.71.92.2
Loans collateralized by real estate (in percent of total loans)33.530.831.143.843.640.5
Loans in foreign exchange (in percent of total loans)86.776.273.868.665.964.9
Net foreign assets (in millions of lari)54.6-231.5-385.1-1276.0-1394.5-1742.4
Net foreign assets (in percent of total assets)3.2-9.1-9.1-17.7-17.2-20.2
Net open foreign exchange position 2/7.47.53.75.03.51.5
Liquidity ratio (in percent)45.033.341.537.236.833.3
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 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 Regulatory Capital.

Table 11.Georgia: Review and Disbursements Under the 18-Month SBA
DateActionAssociated Disbursements (in millions of SDR)
On or after September 15, 2008Approved 18-month arrangement161.7
After November 15, 2008Completed first review based on end-September performance criteria63.1
After February 15, 2009Completed second review based on end-December performance criteria63.1
After May 15, 2009Completed third review based on end-March performance criteria47.3
After August 15, 2009Completed fourth review based on end-June performance criteria47.3
After November 15, 2009Completed fifth review based on end-September performance criteria47.3
After February 15, 2010Completed sixth review based on end-December performance criteria47.3
Total477.1
Source: Fund staff.
Source: Fund staff.
Attachment I. Georgia: Letter of Intent

September 9, 2008

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C.

Dear Mr. Strauss-Kahn:

In the five years since the Rose Revolution, Georgia’s macroeconomic management and cooperation with the International Monetary Fund (IMF) have been excellent. In mid-2004, the IMF approved a Poverty Reduction and Growth Facility (PRGF) arrangement to support a wide range of the economic reforms. The three-year PRGF arrangement, which was completed successfully in September 2007, laid the foundation for our recent strong growth and moderate inflation.

This year, tensions with Russia over the two breakaway regions of Georgia intensified and, in August, culminated in a conflict with Russia. A ceasefire agreement was signed on August 16 and Russian troops began withdrawing on August 22. In addition to the loss of life, systematic destruction of our military infrastructure and damage to personal property, economic activity was disrupted and Georgia’s civilian infrastructure was seriously damaged.

Perhaps most damaging to Georgia’s near-term growth prospects was the erosion of investor confidence. The government of Georgia is confident that the economy will recover from the conflict as we succeed in sustaining investor confidence. Therefore, it is of the utmost importance that measures be implemented that will reassure both the domestic and foreign business community as soon as possible.

The attached Memorandum of Economic and Financial Policies (MEFP) describes our economic policies and strategies for the next 18 months, which we understand will form the basis for continued IMF support. On the basis of the policies and the specific targets for the next year described herein, and due to the extraordinary external financing requirement created by the conflict with Russia, we hereby request a Stand-By Arrangement for the period of September 2008 to March 2010 in the amount of SDR 477.1 million (approximately $750 million), equivalent to 317.4 percent of quota.

The government believes that the policies set forth in the MEFP are adequate to achieve the objectives of the program, but it is prepared to consider taking other measures that may become appropriate for this purpose, in consultation with the Fund. During the period of the arrangement, the authorities of Georgia will maintain the usual close policy dialogue with the Fund, assisted by the continued presence of a resident representative should the IMF decide to maintain the post open.

Sincerely yours,

/s//s//s/
Lado GurgenidzeNika GilauriDavid Amaglobeli
Prime Minister of GeorgiaMinister of FinanceActing President
Attachment II. Georgia: Memorandum of Economic and Financial Policies for 2008 and 2009

This memorandum sets out the economic and financial policies of the Georgian government for September 2008–December 2009. These policies are the basis for the 18-month IMF-supported Stand-By Arrangement (SBA).

A. Recent Economic Developments

1. Since 2004, we have implemented a policy of comprehensive and exemplary economic reform. At the heart of our reform effort is a commitment to foster economic growth through private sector investment. To this end, we have eliminated barriers to private sector activity by aggressively deregulating the economy, privatizing most state assets, reducing and simplifying taxes, dramatically liberalizing the trade regime, investing in infrastructure, and significantly reducing bureaucratic barriers and as a result reducing corruption. In 2007, we were the leading economic reformer in the world. Our standing in the World Bank and IFC survey of business environments (“Doing Business”) jumped from 137th place in 2004 to 18th in 2008.

2. The macroeconomic results of our efforts have been inspirational and significant. Growth of GDP averaged 8.3 percent during 2004–06, was 12.4 percent last year and 9.3 percent in the first quarter of this year. In large part, Georgia’s extraordinary economic performance has been driven by private capital inflows. In 2004, these inflows were only $0.5 billion. By 2007, private capital inflows had increased to $2.3 billion, which is 22½ percent of GDP. Further, FDI inflows come from geographically diverse sources and the breadth of international institutional investors investing in Georgia—over 300—is unusual for such a small country. In April 2008, Georgia successfully issued its first sovereign Eurobond, raising $500 million in an offer that was heavily oversubscribed.

3. Against a background of rapid economic growth, inflationary pressures are inevitable. In mid-2006, 12-month inflation exceeded 14 percent. Recognizing the social damage of inflation as well as its contribution to macroeconomic instability, we intensified efforts to return to single-digit inflation. Our efforts have been greatly complicated by the global environment of high energy and food prices. Nonetheless, the combination of fiscal and monetary restraint has succeeded in reducing 12-month inflation to 9.8 percent as of end-July this year.

4. On balance, our macroeconomic performance has indeed been impressive. We believe that this record of growth and stability can be continued in the future. In order to overcome the dire consequences of our recent conflict with Russia, we must redouble our efforts to improve macroeconomic conditions and reassure investors that Georgia will continue to be an attractive place for business.

Fiscal performance

5. A key indicator of Georgia’s economic success is our greatly improved revenue performance that has allowed us to modernize the state and civil service, enhance the social safety net and invest in infrastructure. In 2003, tax revenues (including social contributions) accounted for only 14.6 percent of GDP. By 2007, tax revenues accounted for 25.8 percent of GDP. This achievement was the result of greatly improved tax administration, a simplified tax code and procedures, better taxpayer services and infrastructure, and, most important, fewer taxes and lower rates.

6. In July 2008, parliament approved legislation stipulating that state budget expenditures should not exceed 29 percent of GDP in 2009 (compared with our budget estimate of 30.3 percent for this year), should decline to 25 percent of GDP by 2011, and remain at or below this level thereafter. Additionally, parliament approved further liberalization of the tax regime and the establishment of two sovereign wealth funds—the Stabilization Fund and the Future Generations Fund—as a means of sheltering surplus revenues.

7. During the first half of 2008, revenue collection exceeded our projections by 2.6 percent and increased by 31.3 percent compared with the same period last year. In the first six months of 2008, privatization proceeds were $352 million, exceeding the forecast by 68 percent and exceeding substantially the proceeds in any previous calendar year. At the same time, expenditures have been higher than projected because of the need for greater defense spending, which was originally projected to decline as a share of GDP this year. Capital expenditures, as well as social and other expenditures, were in line with targets for the first half of the year. The major part of the Eurobond proceeds were transferred to the Future Generations and the Stabilization Funds. Thus, the effect of these proceeds on the consolidated budget deficit was neutral.

Monetary policy

8. In March 2008, parliament approved amendments to the law governing the National Bank of Georgia (NBG), which make price stability the primary objective of the NBG. Financial stability and support for sustainable economic growth are secondary objectives. The new law also requires the NBG to target single-digit inflation. If this inflation target is not met (with a 2-percentage-point margin of error), then certain sanctions, including possible dismissal of the president of the NBG, are imposed. Moreover, under the new law, banking supervision was separated from the NBG and a unified Financial Supervision Agency was created. The board of the NBG will be downsized from nine to five members and the Monetary Policy Committee was created as the key decision-making body on monetary policy issues.

9. The legislative changes approved by parliament reflect a broad consensus within Georgia that inflation must be controlled. From November 2007 through July 2008, the NBG had been tightening monetary policy. The NBG’s main policy rate was introduced and that rate was raised by 500 bps from November 2007 through July 2008. The NBG’s certificates of deposits (CDs) and government notes have been used to conduct open market operations. As a result of the development of the interbank lending market due to prior changes in the reserve requirements regulation, the NBG started daily calculation and publication of Tbilisi Interbank Rates (TIBR) for overnight and up to seven-day loans.

10. As a result of these measures, reserve money growth was limited to 21 percent in the 12 months to mid-August 2008, while broad money growth was 28 percent as of end-July 2008. These compare favorably with the figures for end-March 2008 of 22 percent and 51 percent, respectively. While the growth of bank credit was high (55 percent in the 12 months to end-July 2008), it has slowed significantly this year and was only 23 percent in the first seven months of this year.

11. Since late 2007, the NBG has allowed much greater flexibility in exchange rates. For the first seven months of 2007, the nominal exchange rate of the lari against the U.S. dollar appreciated by 3 percent, while in the first seven months of 2008, the nominal appreciation was nearly 13 percent. This policy shift has allowed the NBG to intervene less frequently and subsequently made a significant contribution to our ability to reduce inflation.

12. As the economy has modernized and re-industrialized with the support of large capital inflows, the current account deficit has increased. In 2007, the current account deficit was $2.0 billion or about 20 percent of GDP. In the first half of 2008, we estimate the deficit was about $1.5 billion. In large part, the current account deficit has been self-financing, since about 60 percent of capital inflows is for import financing. Over the past four years, we have seen a significant diversification of exports and average annual growth of 26 percent (2003– 07). To aid export growth, we have negotiated a free-trade agreement with Turkey (which is awaiting ratification by Turkey), requested a free-trade agreement with the U.S., and are benefiting from GSP+ with the EU.

Structural reform

13. In addition to the foregoing reforms, we have given especial emphasis to structural reform as a means of fostering competitiveness and growth.

14. In order to improve the quality of financial sector regulation, we created the Financial Supervision Agency (FSA). The FSA is a fully independent agency with its own supervisory board. The FSA is currently in the process of implementing a system of consolidated supervision of banks, insurance companies and securities firms.

15. An early activity of the FSA was to strengthen and refine our AML/CFT legislation. The relevant legislation was approved by parliament in March this year. In July, MONEYVAL completed its biannual review of Georgia and fully endorsed our AML/CFT legislation framework. We have also modified our banking laws with respect to fit and proper requirements for managers and owners. As a result, we no longer take a relatively simplistic approach of assessing the nominal owners and, in addition, identify and assess the actual beneficial owners of the institutions.

16. In an effort to increase the professionalism and efficiency of the NBG, we recently restructured and downsized the central bank. Since October 2007, total staff at the NBG has been decreased by 350 or about 56 percent. We believe that a more professional central bank will enhance our ability to achieve our main policy objectives and boost public confidence. These measures will also contribute to macroeconomic stability and long-term sustainable economic growth of the Georgian economy.

17. In addition, we have implemented numerous other structural reforms that are vital to economic growth, including deregulating the natural gas market; streamlining securities regulation; demutualizing the stock exchange; removing operational constraints in and facilitating entry into financial markets; liberalizing the issuance of building permits; simplifying export and import procedures; passage of a new law on insolvency and new foreclosure procedures; further simplifying business registration procedures; and introducing a comprehensive healthcare sector reform that entails full privatization of health care provision facilities and provides health care insurance for low-income groups.

B. Economic Policies Going Forward

18. Georgia is committed to enhancing macroeconomic stability and fostering economic growth through private sector investment. While we recognize the critical role of the public sector, especially in the realm of improving conditions for vulnerable groups, we believe that economic growth can only be led by the private sector. Hence, our emphasis is on creating an environment that is highly conducive to private sector growth. At the same time, we aim to improve the quality of government services whilst limiting the overall size of public expenditures.

19. The macroeconomic outlook has deteriorated sharply as a result of the conflict.

  • Prior to the conflict, we were projecting continued high real GDP growth (about 9 percent) in 2008 and lower inflation of 8 percent by the end of the year. The medium-term prospects were strong. While we believe we may still be able to maintain our 2008 inflation objective, the expected sharp slowdown in private inflows (from $1.5 billion in the first half of the year to $0.5 billion in the second half) would lead to lower real economic growth (now projected at only 3½ percent).

  • Private inflows are anticipated to pick up modestly in 2009 (to $1.7 billion), which could support real GDP growth of 4 percent. Inflation would remain in single digits but the narrowing of the external current account deficit is not expected to be commensurate with the slowing of economic growth, reflecting the impact of higher imports for reconstruction, and high import prices.

  • In the medium term, inflows are expected to recover and sustain higher investment, while export growth is expected to increase gradually. As a result, real GDP growth is projected to recover to mid single digits, while inflation would decline gradually.

  • Under this scenario, in the absence of increased international support, Georgia’s international reserves would decline sharply over the remainder of this year and next, to a level that would cover just a few weeks of imports. This would substantially weaken Georgia’s external position. Strong international support will therefore be essential to allow the maintenance of an adequate level of reserves, covering 2¾ months of imports by end-2009. The financing gap of about $1.2 billion over the 2008–09 period is expected to be covered by the IMF SBA and by grants and concessional financing provided by other IFIs and bilateral donors and creditors.

Fiscal policy

20. Consistent with the legislative changes approved by parliament this year, we are committed to minimizing the size of the fiscal footprint on the economy, ensuring fiscal prudence and preventing the underlying fiscal stance from contributing to inflationary pressures. Nonetheless, we are committed to rebuilding the infrastructure damaged by the conflict, which will require an increase in reconstruction-related spending. Given that we expect that much of this spending will be financed by donor grants, we feel that it can be accommodated within a sound macroeconomic framework that would help spur domestic demand while maintaining price stability. While some temporary increase in the fiscal deficit is inevitable during 2008 and 2009, we are determined to return to our medium term strategy of containing our fiscal footprint fiscal as soon as feasible.

21. For 2008, we will endeavor to delay all nonessential expenditures and will ensure that the overall fiscal deficit as defined in the attached Technical Memorandum of Understanding (TMU) is less than 6 percent of GDP (subject to quarterly performance criteria for end-September and end-December). This overall deficit includes the initial reconstruction spending that will be carried out in 2008. It will be subject to an upward adjustor of at most 2 percent of GDP, in the event that concessional donor financing exceeds currently declared commitments.

22. The government will submit to parliament a state budget for 2009 that will target a fiscal deficit of no more than 3¾ percent of projected GDP, with an upward adjustor of no more than 3 percent of GDP in the event that concessional donor financing exceeds currently declared commitments (structural benchmark for end-December 2008).

23. In addition to implementing the legally required tax rate reductions, we will not introduce any new taxes, duties or fees, or increase any tax rates in 2009.

24. We will submit to parliament legislation to upgrade the Budget System Law (BSL) to an organic law (structural performance criterion for end-June 2009). Further, we will ensure that direct purchases of civilian good and services will not be more than 15 percent of overall approved expenditures for each state agency.

25. We will limit the contracting of public and publicly-guaranteed non-concessional external debt to no more than $250 million during the remainder of 2008 and $250 million during the first half of 2009 (subject to quarterly performance criteria). Additionally, during 2009, we will not increase public and publicly guaranteed domestic debt by more than GEL 100 million.

26. The Basic Data and Directions (BDD) document is being developed so that it sets out with greater clarity the government’s medium-term fiscal and public expenditure strategies and plans. The quality of the BDD analysis will be improved and extended to include realistic resource ceilings for subsequent detailed budget planning. The BDD will also be disseminated more widely. The Ministry of Finance of Georgia will ensure that medium-term action plans are extended to include all spending agencies and will include clear statements of strategic directions (goals) and performance indicators (performance indicators will be developed for at least three ministries in 2010), as well as detailed costing. We will continue to improve the budget process and format, consistent with the findings of the World Bank and European Commission Public Expenditure Framework Assessment (PEFA).

27. The processing of financial transactions is being improved, with the Treasury Single Account (TSA) established and most revenues and expenditures flowing through a single process. During 2009, we will consolidate foreign currency deposits into a singe account at the NBG and make progress towards implementation of a modern E-Treasury system.

28. In 2007, the Revenue Service of the Ministry of Finance of Georgia (RS) was formed and began developing risk based customs control and tax audit systems. In 2009, the RS will finish the implementation of the risk management system and will initiate risk assessment based tax audits. For the full implementation of risk-based custom controls, a post-clearance system needs to be introduced. This requires amendments to the Customs Code, which we will submit to parliament by June 2009 in conjunction with modernization of the Tax Code.

29. The RS will continue to give priority to improving taxpayer services. The MoF will ensure that the e-filing system is developed further and captures all types of taxes by 2009. Additional effort will be made to develop electronic systems in tax administration (e.g. e-lean system), in order to increase the efficiency in tax arrears collection. We will seek to receive, in 2008 Q4, technical assistance and consultancy services to prepare for the transition by 2012 to the self-assessment regime with regard to personal income tax, delivering a seamless online and offline service to tax resident individuals regardless of their location.

30. Over the past two years, the tax disputes internal resolution system proved its effectiveness, but rising number of tax disputes (reflecting increased taxpayer confidence in the MoF dispute resolution committee) need to be addressed. The MoF will finish the necessary structural reforms in 2009, which will establish an independent dispute resolution office within the MoF, and a hearing system.

31. To increase transparency, from 2009 the Ministry of Finance will produce annual reports on (i) consolidated (including government, LEPLs, and state-owned enterprises) public expenditures and (ii) public arrears and debt. The government of Georgia will ensure the information on revenues/expenditures of the public services providing LEPLs is transparent and is provided in the state budget.

Monetary policy

32. We are strongly committed to low inflation and, in the current environment, believe that maintaining single-digit inflation and reducing it gradually in the medium term is essential. To aid with our efforts to meet inflation targets, we plan to adopt an inflation-targeting regime during 2009. Although we realize that there are certain constraints in implementing full-fledged inflation targeting immediately, we believe our efforts will be successful in ensuring low and stable inflation in the medium term. In the immediate future, our monetary policy will be guided by quarterly targets (performance criteria) for the net international reserves and net domestic assets of the National Bank of Georgia, as set out in the TMU.

33. We are concerned about the impact on bank liquidity of the loss of confidence resulting from the conflict. In the wake of the conflict, the NBG waived the reserve requirements on a temporary basis, and activated an uncollateralized lending facility. To help preserve financial stability and ensure a smooth functioning of the payments system, we intend to enhance our instruments for liquidity management.

34. Now that the immediate emergency is over, we will develop and publish a liquidity management framework that outlines the objectives of liquidity management, describes the instruments, and assigns the instruments to these objectives (structural benchmark for end- March 2009). This framework, which would also facilitate the implementation of the inflation-targeting regime, will inter alia(i) provide a clearer planning horizon for banks by enforcing the reserve requirement while adjusting the rate to the liquidity needs of the system and (ii) introduce a refinancing mechanism as the main liquidity providing instrument at interest rates determined by the market.

35. We will also revise the NBG lender of last resort (LOLR) facility to ensure that the availability of LOLR would not encourage excessive risk-taking by financial institutions. To minimize moral-hazard concerns, it is the NBG’s policy to provide LOLR only to those institutions that are judged by the FSA to be solvent. We will also be more specific about the limits and size of the LOLR facility. The revised LOLR framework will be finalized by end- December 2008 (structural performance criterion).

36. We are fully committed to a flexible exchange rate policy. During the crisis-management period, the NBG defended the lari to prevent further uneasiness in the market. Under the SBA, a first drawing would serve to replenish reserves. Under the program, priority will be given to maintaining the targeted level of international reserves, and the exchange rate will be allowed to adjust to a shortfall in foreign inflows in the remainder of 2008 and 2009.

37. We plan to continue building a modern central bank. To this end, we plan to strengthen our human resource management practices, introduce a new payments system for commercial banks and the treasury, automate our banknote processing system, build a new cash center, introduce new investment management and accounting software, strengthen cooperation with partner central banks, and start participation in the World Bank RAMP project.

Structural reforms

38. We recognize the importance of continued structural reform as a means of enhancing competitiveness and fostering economic growth. Our goal is to remain among the world’s top economic reformers by pursuing vigorous free-market structural reform consistent with the Anglo-Saxon economic model.

39. We will continue our policy of aggressively privatizing state-owned assets. By the end of 2009, we intend to privatize at least two-thirds of the shares of the Georgian State Electricity Company; at least 24 percent of Poti Sea Port; Georgian Post; about 100,000 hectares of agricultural land; several regional airports; and numerous other state-owned assets.

40. In order to maintain the competitiveness of the Georgian economy and to encourage further capital inflows, we will avoid introducing any laws or regulations that may reduce labor market flexibility, including the labor code. Additionally, in order to address the structural labor market shortages with regard to certain categories of professionals and to enhance Georgia’s appeal as a tourism and retirement destination, we will further liberalize our migration and employment policy.

41. Regarding the financial sector, we are especially pleased with the overall stability and resilience the sector has demonstrated during the recent conflict. The NBG and FSA worked well together to ensure the smooth operation of the payments system, as well as maintain public confidence in the lari and the banks. The FSA has started to assess any potential vulnerabilities in the banking sector emerging after the conflict by conducting on-site inspections. It is evaluating banks’ liquidity positions and loan portfolios, looking into the situation of the main borrowers. Next, the FSA will make sure that the banks have contingency plans readily available to mitigate potential liquidity and capital pressures in the near future.

42. We recognize the need to strengthen further the cooperation between the FSA and the NBG. Accordingly, these two institutions will sign and implement a memorandum of understanding (structural benchmark for end-October 2008). This memorandum will define the areas of cooperation and accountability between the two institutions, containing inter alia practical and legal arrangements for information exchange on individual institutions’ data, specific requirements to share promptly any possible irregularities in the financial system, and opportunities to review newly planned regulations before they are enacted.

43. Further, to strengthen the independence of the FSA and NBG, we will appoint the remaining members to the FSA board by end-June 2009 (structural benchmark for end-June 2009) and restructure the NBG board by end-2009. Additionally, we will submit to parliament during the fourth quarter of 2008 a Financial Code that will unify and consolidate banking, insurance, and securities regulation while avoiding any additional regulatory burden on financial institutions that is not envisaged in the recently passed legislation.

44. We will continue to build capacity at the FSA to adopt modern practices of risk-based supervision on a consolidated basis. We would welcome a streamlined and focused Financial Sector Assessment Program (FSAP) update mission in the second half of 2009 to assess developments in the financial sector and review the new regulatory framework.

45. In order to avoid an unnecessary regulatory burden on enterprises operating in Georgia, in the aftermath of the conflict with Russia we will avoid any amendments to or new legislation or regulation in the areas of anti-trust policy and consumer protection, as we believe any such measures would be meaningless for a small open economy like Georgia.

46. Among the other structural reforms we plan to introduce in the near future are a modern regulatory framework for water utilities; further energy sector deregulation; modernizing regulations for the use of forests and mineral resources; and implementing a merit based civil service reform. Of particular importance is our commitment to continue healthcare reform, including the completion of hospital and financing reform, licensing medical professionals and education, and reduce regulatory barriers to the entry of pharmaceuticals.

47. We will introduce a new draft Law on Statistics to parliament by year-end 2008, with the aim of creating a modern and independent statistical service that is able to deliver relevant and high quality statistics. An supervisory board will be established, including independent board members, and an advisory panel will be set up to oversee improvements in methodology and effectiveness.

C. Program Monitoring

48. The program will be subject to quarterly reviews, and quarterly performance criteria as set out in the TMU. Completion of the first two reviews under the SBA, scheduled for November 2008 and February 2009, will require observance of the quantitative performance criteria for end-September and end-December 2008 in Table 1 and the structural performance criteria for end-December 2008 shown in Table 2.

49. We authorize the IMF to publish the Letter of Intent and its attachments, and the related staff report.

Table 1.Georgia: Quantitative Performance Criteria and Indicative Targets, 2008–09
Cumulative Change from end-June 2008Cumulative Change from end-December 2008
Jun-08Sep-08 Performance CriteriaDec-08 Performance CriteriaMar-09 Indicative targetsJun-09 Indicative targets
Actual /2Prog.Prog.Prog.Prog.
(In millions of lari)
Ceiling on cash deficit of the consolidated government537603141469
(In millions of U.S. dollars)
Ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector….0250250250
Stocks at the end of the period
(In millions of lari)
Ceiling on net domestic assets (NDA) of the NBG 1/36765989878904
(In millions of U.S. dollars)
Floor on net international reserves (NIR) of the NBG 1/1,060602537572639
Ceiling on accumulation of external arrears 2/00000
Sources: Georgian authorities; and Fund staff estimates.

Actual figures for June 2008 and quantitative targets are based on program exchange rates.

The continuous performance criterion for external arrears is defined in paragraph 14 of the TMU.

Sources: Georgian authorities; and Fund staff estimates.

Actual figures for June 2008 and quantitative targets are based on program exchange rates.

The continuous performance criterion for external arrears is defined in paragraph 14 of the TMU.

Table 2.Structural Benchmarks and Performance Criteria
ActionTiming
FSA and NBG to sign and implement a memorandum of understanding to strengthen cooperation.End-October 2008
NBG to introduce revised LOLR facility (structural performance criterion).End-December 2008
Submission to parliament of a state budget for 2009 with an overall fiscal deficit of no more than 3¾ percent of projected GDP (subject to an adjustor of at most 3 percent of GDP as set out in the TMU).End-December 2008
NBG to develop and publish a liquidity management framework, including the introduction of a refinancing mechanism as the main instrument to provide liquidity.End-March 2009
Appointment of the remaining members to the FSA board.End-June 2009
Submission to parliament of a law to upgrade the Budget System Law to an organic law (structural performance criterion).End-December 2008
Attachment III. Georgia: Technical Memorandum of Understanding (TMU)

September 9, 2008

1. This memorandum sets out the understandings between the Georgian authorities and the IMF staff regarding the definitions of quantitative and structural performance criteria and indicative targets, as well as respective reporting requirements for the Stand-By Arrangement (SBA). These performance criteria and indicative targets are reported in Tables 1 and 2 of the Memorandum of Economic and Financial Policies (MEFP), attached to the letter dated September 9, 2008.

Table 1.Program Exchange Rates
Currency NameCurrency/US$
SDRSpecial Drawing Rights1.58
GELGeorgian lari1.41
EUREuro1.48
Table 2.Projected Foreign Borrowing of the Consolidated Government 1/(in millions of U.S. Dollars)
September 30, 20088.7
December 31, 200850.4
March 31, 20097.0
June 30, 200929.4

Cumulative from June 30, 2008 for 2008; for 2009, cumulative from the beginning of the calendar year.

Cumulative from June 30, 2008 for 2008; for 2009, cumulative from the beginning of the calendar year.

2. The exchange rate for the purposes of the program of the Georgian lari to the U.S. dollar is set at GEL 1.41 = $1. The corresponding cross exchange rates are provided in Table 1.

Consolidated Government and the Public Sector

3. Definition: The consolidated government is defined as the central government, local governments, extrabudgetary funds, public services providing general government system LEPLs, and the Sovereign Wealth Funds (Future Generations and Stable Development Funds). In case the government establishes extrabudgetary funds, they will be consolidated within the consolidated government. The public sector consists of the consolidated government and the National Bank of Georgia (NBG).

4. Supporting material: The Treasury Department of the Ministry of Finance (MOF) will provide to the IMF detailed information on monthly revenues, expenditures, and arrears of the consolidated government. In addition, data will be provided on the cash balances in the accounts of the Ministry of Finance.

Quantitative Performance Criteria, Indicative Targets, and Continuous Performance Criteria: Definitions and Reporting Standards

A. Ceiling on the Cash Deficit of the Consolidated Government

5. Definition: The cash deficit of the consolidated government will be measured from the financing side at current exchange rates, and will be defined as equal to the total financing. Total financing will be defined as the sum of (i) net domestic financing from banks and nonbanks, (ii) net external financing, and (iii) privatization receipts.

  • Net domestic financing consists of bank and nonbank financing to the consolidated government which will be defined as follows:

  • (i) Loans provided by commercial banks to the consolidated government minus accounts held by the consolidated government at commercial banks. These accounts and loans will be monitored based on the NBG’s monetary survey. Any other securities issued by the consolidated government (for example, promissory notes) are also included in domestic financing.

  • (ii)Loans provided by the NBG to the consolidated government minus accounts of the consolidated government held at the NBG in lari and foreign currency. Accounts that are outside of the MOF’s control are excluded from domestic financing. These accounts include VAT refund account; earmarked grants account; account for state agencies deposits; account for local government revenues for the day to be transferred to their account; national disaster fund account; and investment grant and credit account. As of June 30, 2008, cash balances in these accounts were Lari 160.5 million. These accounts will be monitored based on the changes in cash balances as recorded by the Treasury Department.

  • (iii)Treasury bills that have been securitized and sold by the NBG, including the bills that have been purchased by nonbanks.

  • Net external financing is defined as the total of loans disbursed to the consolidated government for balance-of-payments support and project financing (capital expenditure and net lending), net change in external arrears, change in the accounts of the consolidated government abroad, including the accounts of the Sovereign Wealth Fund, minus amortization. Amortization includes all external debt-related payments of principal by the consolidated government. Amortization to external creditors via third parties is accounted for at the time and in the amount of payment by the budget to the third party, rather than at the time of recognition of amortization by the external creditor.

  • Privatization receipts consist of all transfers of monies received by the central and local governments in connection with the sale of central or local government assets, including privatization proceeds which were transferred to the Sovereign Wealth Funds. This includes receipts from the sales of shares, the sale of assets as well as leases and the sale of licenses with duration of 10 years and longer.

6. Adjustor: The fiscal deficit target will be subject to an upward adjustor of up to 388 million Georgian lari (equivalent to 2 percent of projected GDP) for 2008 and 652 million lari (equivalent to 3 percent of projected GDP) for 2009, in the event that concessional donor financing exceeds current declared commitments (Table 2).

7. Supporting material:

  • Data on domestic bank and nonbank financing will be provided to the IMF by the NBG and the Treasury Department of the MOF within four weeks after the end of the month.

  • Data on external project financing as well as other external borrowing will be provided to the IMF monthly by the Debt Unit at the MOF (specifying projects by creditor) within two weeks of the end of each month.

  • Data will be provided at the actual exchange rates.

  • Data on the accounts of the Sovereign Wealth Funds will be provided by the NBG.

  • Data on privatization receipts will be provided by the Treasury Department of the MOF to the IMF on a monthly basis within two weeks of the end of each month. The data will be consistent with the revenue account(s) in the NBG.

  • Data on treasury bills that have been securitized and sold by the NBG, including the bills that have been purchased by nonbanks, will be reported by the NBG on a monthly basis within two weeks of the end of each month.

B. Floor on the Net International Reserves of the NBG

8. Definition: Net international reserves (NIR) of the NBG in U.S. dollars are defined as foreign assets minus foreign liabilities of the NBG. Foreign assets of the NBG include gold, gross foreign exchange reserves, SDR holdings, and the reserve position in the IMF. Gross foreign exchange reserves of the NBG are defined as liquid, convertible currency claims of the NBG on nonresidents that are readily available. Pledged or otherwise encumbered assets, including (but not limited to) assets used as collateral (or guarantee for third party external liabilities) are excluded from foreign assets. Foreign liabilities shall be defined as outstanding liabilities to the IMF and any other liabilities of the NBG. This defined, the definition of NIR excludes foreign assets stemming from foreign currency deposits of financial institutions at the NBG. For program monitoring purposes, the stock of foreign assets and foreign liabilities of the NBG shall be valued at program exchange rates as described on paragraph 2 above. The stock of NIR amounted to $1,060 million as of end-June 2008 (at the program exchange rate).

9. Supporting material: Data on net international reserves (both at actual and program exchange rates) and on net foreign financing (balance of payments support loans; cash grants to the consolidated government; amortization (excluding repayments to the IMF); interest payments on external debt by the MOF and the NBG) will be provided to the IMF in a table on the NBG’s foreign exchange flows (which include details of inflows, outflows, and net international reserves) on a monthly basis within two weeks following the end of the month.

C. Ceiling on Net Domestic Assets of the NBG

10. Definition: Net domestic assets of the NBG are defined as the difference between its net foreign assets and reserve money. Thus defined, the net domestic assets are the sum of net claims on the government (the sum of loans and treasury bills purchased by the NBG, less deposits of the government with the NBG), claims on banks, claims on the rest of the economy, and other items net (comprising the NBG capital accounts, net unclassified assets, counterpart funds and exchange rate revaluation). Performance against the NDA target will be measured at program exchange rates.

11. Supporting material: The NBG will provide to the IMF its balance sheet, which includes data on its net domestic assets, on a monthly basis within two weeks of the end of each month. Data will be provided using both actual and program exchange rates.

D. Ceiling on Contracting or Guaranteeing of New Nonconcessional External Debt by the Public Sector

12. Definition: Nonconcessional external loans are defined as loans from lenders other than the IMF with a grant element of less than 35 percent of the value of the loan. The grant element is to be calculated by using currency-specific discount rates reported by the OECD (CIRRs).1 For maturities of less than 15 years, the grant element will be calculated based on six-month averages of commercial interest rates. For maturities longer than 15 years, the grant element will be calculated based on 10-year averages. This performance criterion applies not only to debt as defined in point No. 9 of the IMF’s Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) August 24, 2000) but also to commitments contracted or guaranteed for which value has not been received.2 Previously contracted nonconcessional external debt that has been rescheduled will be excluded from the definition of “new debt” for the purposes of this performance criterion.

13. Supporting material: Details of all new commitments and government guarantees for external borrowing, with detailed explanations, will be provided by the MOF to the IMF on a monthly basis within two weeks of the end of each month. Data will be provided using actual exchange rates.

E. Continuous Performance Criteria on Nonaccumulation of External Arrears

14. Definition: During the period of the arrangement, the consolidated government and the NBG will not accumulate any new external payment arrears on debt service obligations to official creditors, including the IMF and the World Bank. Official external payment arrears are defined as unpaid debt service by the consolidated government and the NBG beyond the due date. The performance criterion on nonaccumulation of external debt is continuous.

15. Supporting material: Details of official arrears accumulated on interest and principal payments to creditors will be reported to the IMF within one week from the date of the missed payment. Data will be provided using actual exchange rates.

Attachment IV. Georgia: External and Public Sector Debt Sustainability Analysis1

The staff’s debt sustainability analysis shows that Georgia’s external debt is low.2Although the debt ratios will rise over the next two years as the government receives foreign financing for post-conflict reconstruction in the wake of the recent conflict, the debt outlook is expected to recover and improve over the medium term. Key medium-term risks involve large debt service in 2012–13 associated with the repayments to the Fund (under the proposed SBA) and the 2008 Eurobond.

A. Background

1. This update reflects the macroeconomic framework underlying the new SBA and staff projections through 2028. It assumes that implementation of prudent macroeconomic policies and further improvements in the business climate will help Georgia overcome the adverse economic and financial consequences of the recent armed conflict. In particular, investor confidence is restored by 2010, when capital inflows return to pre-conflict levels, spurring economic growth and export diversification.

2. Georgia’s stock of external debt as of end-2007 is estimated at $3.1 billion (30¾ percent of GDP).3 For the first time the DSA includes actual data on private sector debt based on a survey conducted by the National Bank of Georgia.4 Of the total amount, $1,790 (57 percent of total) represents public or publicly-guaranteed (PPG) debt, while the remaining amount consists of private debt incurred by the corporate and financial sectors. The average grant element of the PPG debt is 25 percent.

Georgia: Structure of External Debt, 2007
In USDIn percent of GDPNet Present Value, USD
Total External Debt313630.7
Public debt179017.51349
World Bank8838.6531
IMF2492.4207
Paris Club4294.2357
Others2292.2253
Private debt134613.2
Corporate sector2872.8
Financial sector105910.4
Source: Georgian authorities; and Fund staff estimates.
Source: Georgian authorities; and Fund staff estimates.

3. Several years of strong growth and prudent debt management policies have helped to reduce Georgia’s external PPG debt burden. Over the last decade, the PPG debt has fallen from 50 percent of GDP in 2000 to about 17½ percent in 2007. While in 2000 almost 15 percent of export receipts was directed to service the PPG debt, the ratio fell to 5 percent in 2007. The composition of PPG debt by creditor has shifted from bilateral creditors to multilateral institutions, resulting in a higher degree of concessionality.

4. Large private capital inflows have been among the key drivers of Georgia’s strong growth in recent years. These inflows increased from $½ billion in 2004 to $2.2 billion in 2007 contributing to a build-up of sizeable private external debt. While FDI has continued to make up 70 percent of private capital inflows in recent years, the debt- creating inflows (primarily corporate and bank loans) have almost tripled since 2005.

B. Developments in 2008

5. This year marked a shift in the debt management policy as the government tapped international markets with a $500 million Eurobond issue in April 2008. The proceeds were intended to bolster the country’s liquid resources for dealing with future shocks.

6. The near-term debt outlook will be adversely affected by the August armed conflict. First, some of the recent gains in debt ratios will be temporarily reversed as the government resorts to external financing to address the balance-of-payments pressures in Georgia’s capital account and to pay for large reconstruction in the wake of the conflict. Part of the balance-of-payments gap is expected to be filled with the proposed $750 million SBA from the Fund. Second, the weakened investor confidence has reduced the availability of external financing and increased borrowing costs for Georgian banks.

C. Underlying Assumptions

7. The medium- and long-term macroeconomic projections and assumptions regarding the composition and terms of new borrowing are as follow:

  • Growth is expected to remain low in 2008 and 2009, but would recover to 6–7 percent in the medium term. As Georgia progresses toward a higher income level, the growth rate would stabilize at its long-term level of 4.5 percent.

  • Exports volume growth is projected to average more than 8 percent over 2008–12, reflecting a strong rebound from the recent conflict. Over the long term, export growth would be sustained at 5–5½ percent, supported by strong FDI and favorable external demand. Imports would remain buoyant with annual growth of more than 6 percent over the medium term, before converging to the long-term growth of about 4½ percent, consistent with the assumed GDP growth.

  • The current account deficit is expected to widen to 20¾ percent of GDP in 2008. Thereafter, strong exports growth, especially in services, will contribute to a decline in the deficit, bringing it to 7¾ percent by the end of the DSA’s horizon.

  • Fiscal revenues, which are projected at 28 percent of GDP in 2008, would gradually converge to the long-term level of 24 percent of GDP, reflecting the government’s intention to limit the role of the government in the economy. Expenditures will decline too, reaching 21 percent of GDP by the end of projection period. This implies a decline in the overall deficit from about 5¾ percent of GDP in 2008 and 2009 to a balanced budget by 2012–13, followed by small surpluses over the remaining projection period.

  • The government would continue to contract new loans at concessional terms. Nevertheless, following the 2008 Eurobond issue, this DSA assumes that an increasing share of financing will come from private markets at commercial terms. As a result, the grant element of the new public borrowing would decline from the projected 26 percent in 2009 to 5 percent by the end of the projection period.

  • The DSA assumes that a friendly business environment and prudent macroeconomic policies will continue to make Georgia attractive to foreign capital notwithstanding the temporary impact of the recent conflict. Capital inflows would help sustain the high rates of growth and finance the relatively large current account deficit. As a result, private external debt is expected to reach 15–16 percent of GDP over the medium term and remain at that level thereafter.

D. Assessment of Debt Sustainability

8. Georgia’s public debt ratios will remain low despite the need to resort to increased foreign financing in 2008 and 2009.

  • Substantial one-off borrowing in the wake of the conflict would lead to a temporary increase in the level of external public debt.5 The external public debt will peak in 2009 at 26 percent of GDP (compared to 17½ percent in 2007), but is expected to decline gradually over the medium– to long-term. By the end of the projection period, the external public debt is estimated to fall below 7 percent of GDP, with the net present value (NPV) at 6 percent of GDP.

  • Since external debt accounts for more than 90 percent of total public debt, the public DSA results are similar to the external DSA findings. They show a continued decline in solvency ratios as the NPV of debt-to-revenue ratio is projected to decline from 75 percent of GDP in 2008 to 32 percent of GDP by 2028. The debt service ratios are manageable and remain on a declining path.

9. The maturity structure of debt contracted in 2008 could present some repayment challenges in 2012–2013. The external public debt service will remain manageable with debt service-to-revenue ratios falling over the DSA horizon. However, the repayment of the $500 million 2008 Eurobond maturing in 2013 could put a serious strain on the budget unless the government manages to successfully rollover its debt. In addition, the purchases under the SBA are expected to fall due in 2011–2014, putting pressure on the balance of payments. Reflecting these repayments, the external public debt service-to-exports ratio is expected to peak at 16½ percent in 2013 before falling back to 3–4 percent over the long term.

10. Georgia’s debt outlook shows resiliency to a number of exogenous shocks as demonstrated by the results of alternative scenarios and stress testing. External public debt solvency and liquidity ratios would remain well below the thresholds applicable to Georgia under most scenarios. The NPV of debt-to-GDP ratio is most vulnerable at a 30 percent nominal depreciation relative to the assumed baseline, while the NPV of debt-to-exports ratio would deviate most from its baseline path under the rate of export growth one standard deviation below the historic average. The stress tests shown in the table on public debt suggest that keeping the primary balance unchanged from 2008 on would imply a major deterioration in the debt ratios, with the NPV of debt-to-revenue ratio approaching 250 percent. This result is somewhat misleading and should be interpreted with caution as the primary balance deficit in 2008 is the result of a large one-off spending in the wake of the recent conflict. To test the sensitivity of debt outlook to large nonconcessional public borrowing, staff conducted a stress test that assumes new borrowing of $500 million over 2008–2009 (program limit) at commercial terms. The results point to a deterioration in debt ratios in the near term, with the NPV of public external debt-to-GDP-ratio reaching 25 percent in 2009—5 percentage points above the baseline scenario. Debt service ratios would also be substantially above those under the baseline assumptions.

Figure 1.Georgia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2008-2028 1/

Source: Staff projections and simulations.

1/ The most extreme stress test is the test that yields the highest ratio in 2018. In figure b. it corresponds to a Non-debt flows shock; in c. to a Exports shock; in d. to a Non-debt flows shock; in e. to a Exports shock and in picture f. to a Non- debt flows shock

Figure 2.Georgia: Indicators of Public Debt Under Alternative Scenarios, 2008–2028 1/

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

1/ The most extreme stress test is the test that yields the highest ratio in 2018.

2/ Revenues are defined inclusive of grants.

Table 1a.Georgia: External Debt Sustainability Framework, Baseline Scenario, 2005-2028 1/(In percent of GDP, unless otherwise indicated)
ActualHistorical 6/Standard 6/Projections
AverageDeviation2008-20132014-2028
20052006200720082009201020112012201320182028
External debt (nominal)1/32.730.030.734.641.139.537.734.731.426.621.9
o/w public and publicly guaranteed (PPG)27.121.917.521.025.924.121.518.315.211.06.9
Change in external debt-9.0-2.70.73.96.5-1.6-1.7-3.0-3.3-1.0-0.4
Identified net debt-creating flows-4.9-3.6-2.510.68.84.52.91.61.71.10.6
Non-interest current account deficit11.114.818.79.64.918.916.613.812.110.49.77.57.07.4
Deficit in balance of goods and services17.723.826.225.923.620.118.416.115.012.211.6
Exports34.133.131.727.629.230.430.229.428.527.732.5
Imports51.856.857.853.452.950.548.645.543.539.944.1
Net current transfers (negative = inflow)-4.6-5.7-5.7-5.70.7-6.4-6.6-5.8-5.4-5.0-4.7-4.0-3.7-4.0
o/w official-0.6-0.8-0.3-0.2-0.10.00.00.00.00.00.0
Other current account flows (negative = net inflow)-2.0-3.3-1.7-0.6-0.4-0.5-0.9-0.7-0.6-0.6-0.9
Net FDI (negative = inflow)-8.5-13.9-15.3-8.44.5-9.3-8.6-9.2-9.2-8.5-8.2-6.8-7.0-6.9
Endogenous debt dynamics 2/-7.5-4.6-5.91.10.8-0.10.0-0.30.20.40.6
Contribution from nominal interest rate0.81.11.31.92.12.12.12.02.01.61.6
Contribution from real GDP growth-3.2-2.5-2.8-0.8-1.3-2.2-2.1-2.3-1.9-1.2-0.9
Contribution from price and exchange rate changes-5.2-3.2-4.4
Residual (3-4)3/-4.10.93.2-6.7-2.3-6.2-4.6-4.6-5.0-2.1-1.0
o/w exceptional financing-1.0-0.1-0.60.00.00.00.00.00.00.00.0
PV of external debt 4/26.430.935.534.233.130.828.124.121.0
In percent of exports83.2112.0121.6112.3109.7104.998.787.164.7
PV of PPG external debt13.217.320.318.716.914.511.816.68.66.17.9
In percent of exports41.762.669.561.656.049.241.556.730.918.727.5
In percent of government revenues46.062.478.773.866.658.548.564.736.925.433.8
Debt service-to-exports ratio (in percent)17.014.313.711.712.412.213.317.327.115.717.714.316.0
PPG debt service-to-exports ratio (in percent)10.59.74.44.94.44.04.47.516.67.04.93.54.1
PPG debt service-to-revenue ratio (in percent)12.212.64.94.95.04.75.29.019.48.05.84.85.1
Total gross financing need (Billions of U.S. dollars)0.50.40.81.71.91.61.41.72.42.23.3
Non-interest current account deficit that stabilizes debt ratio20.117.518.014.910.115.413.813.513.08.57.4
Key macroeconomic assumptions
Real GDP growth (in percent)9.69.412.46.63.73.54.06.06.07.06.05.44.54.54.5
GDP deflator in US dollar terms (change in percent)14.110.717.210.08.125.51.26.56.06.06.08.51.91.01.7
Effective interest rate (percent)5/2.54.05.73.11.08.06.55.86.06.06.66.56.17.36.7
Growth of exports of G&S (US dollar terms, in percent)32.817.626.118.014.313.111.517.511.510.58.812.27.17.47.3
Growth of imports of G&S (US dollar terms, in percent)33.133.034.017.017.320.04.17.98.06.37.38.96.56.86.4
Grant element of new public sector borrowing (in percent)5.725.626.227.727.30.418.810.24.88.6
Government revenues (excluding grants, in percent of GDP)29.225.528.627.725.825.425.424.724.423.223.823.5
Aid flows (in Billions of US dollars)7/0.10.20.20.61.51.81.91.81.62.12.3
o/w Grants0.10.10.10.00.00.00.00.10.10.10.1
o/w Concessional loans0.10.10.10.61.51.81.81.81.52.02.2
Grant-equivalent financing (in percent of GDP)8/0.51.80.50.20.70.50.50.30.4
Grant-equivalent financing (in percent of external financing) 8/5.727.329.328.748.115.035.425.132.3
Memorandum items:
Nominal GDP (Billions of US dollars)6.47.810.213.314.015.817.720.122.632.856.7
Nominal dollar GDP growth25.121.131.729.95.212.912.413.412.414.36.55.56.3
PV of PPG external debt (in Billions of US dollars)1.32.32.83.03.02.92.72.83.4
Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [rgr(1+g)]/(1+g+r+gr)times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = 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 PV 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.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [rgr(1+g)]/(1+g+r+gr)times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = 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 PV 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.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 1b.Georgia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2008-2028(In percent)
Projections
20082009201020112012201320182028
PV of debt-to GDP ratio
Baseline17201917141296
A. Alternative Scenarios
A1. Key variables at their historical averages in 2008-2028 1/1718161412953
A2. New public sector loans on less favorable terms in 2008-2028 21725232118161312
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2009-201017212018151296
B2. Export value growth at historical average minus one standard deviation in 2009-2010 3/172226242118126
B3. US dollar GDP deflator at historical average minus one standard deviation in 2009-201017201918151296
B4. Net non-debt creating flows at historical average minus one standard deviation in 2009-2010 4/172630282421137
B5. Combination of B1-B4 using one-half standard deviation shocks172225232017116
B6. One-time 30 percent nominal depreciation relative to the baseline in 2009 5/172927242117129
PV of debt-to-exports ratio
Baseline6369625649413119
A. Alternative Scenarios
A1. Key variables at their historical averages in 2008-2028 1/6362534639321610
A2. New public sector loans on less favorable terms in 2008-2028 26385777063554836
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2009-20106369625649413119
B2. Export value growth at historical average minus one standard deviation in 2009-2010 3/63821039585755124
B3. US dollar GDP deflator at historical average minus one standard deviation in 2009-20106369625649413119
B4. Net non-debt creating flows at historical average minus one standard deviation in 2009-2010 4/63901009283744821
B5. Combination of B1-B4 using one-half standard deviation shocks6380938576674521
B6. One-time 30 percent nominal depreciation relative to the baseline in 2009 5/6369625649413119
PV of debt-to-revenue ratio
Baseline6279746759493725
A. Alternative Scenarios
A1. Key variables at their historical averages in 2008-2028 1/6271645547371914
A2. New public sector loans on less favorable terms in 2008-2028 26296928374645749
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2009-20106279776961503826
B2. Export value growth at historical average minus one standard deviation in 2009-2010 3/62861029383725027
B3. US dollar GDP deflator at historical average minus one standard deviation in 2009-20106278776961503826
B4. Net non-debt creating flows at historical average minus one standard deviation in 2009-2010 4/6210211910999875828
B5. Combination of B1-B4 using one-half standard deviation shocks62861009182714926
B6. One-time 30 percent nominal depreciation relative to the baseline in 2009 5/621121059583695236
Debt service-to-exports ratio
Baseline544481753
A. Alternative Scenarios
A1. Key variables at their historical averages in 2008-2028 1/543461321
A2. New public sector loans on less favorable terms in 2008-2028 254443321
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2009-2010544481753
B2. Export value growth at historical average minus one standard deviation in 2009-2010 3/5557102195
B3. US dollar GDP deflator at historical average minus one standard deviation in 2009-2010544481753
B4. Net non-debt creating flows at historical average minus one standard deviation in 2009-2010 4/545691884
B5. Combination of B1-B4 using one-half standard deviation shocks545691984
B6. One-time 30 percent nominal depreciation relative to the baseline in 2009 5/544481753
Debt service-to-revenue ratio
Baseline555591965
A. Alternative Scenarios
A1. Key variables at their historical averages in 2008-2028 1/554471531
A2. New public sector loans on less favorable terms in 2008-2028 255444322
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2009-2010555592065
B2. Export value growth at historical average minus one standard deviation in 2009-2010 3/5556102085
B3. US dollar GDP deflator at historical average minus one standard deviation in 2009-2010555592065
B4. Net non-debt creating flows at historical average minus one standard deviation in 2009-2010 4/55671121105
B5. Combination of B1-B4 using one-half standard deviation shocks5556102085
B6. One-time 30 percent nominal depreciation relative to the baseline in 2009 5/5777132887
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/33333333
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.

Table 2a.Georgia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2005-2028(In percent of GDP, unless otherwise indicated)
ActualAverage 5/Standard Deviation 5/EstimateProjections
2005200620072008200920102011201220132008-13 Average201820282014-28 Average
Public sector debt 1/34.227.922.424.528.626.223.119.716.612.58.5
o/w foreign-currency denominated27.121.917.521.025.924.121.518.315.211.06.9
Change in public sector debt-10.6-6.3-5.62.14.2-2.5-3.0-3.4-3.1-0.7-0.3
Identified debt-creating flows-9.31.23.24.43.7-2.4-2.5-2.6-3.7-2.4-4.1
Primary deficit-5.51.03.8-2.63.84.94.71.4-0.4-0.7-2.41.3-2.1-4.0-2.5
Revenue and grants30.126.729.227.726.025.525.425.124.923.624.1
of which: grants0.91.20.60.00.20.10.00.40.50.40.3
Primary (noninterest) expenditure24.627.733.132.630.726.825.024.422.521.520.1
Automatic debt dynamics-7.4-5.0-5.8-3.7-0.4-2.3-1.9-1.9-1.3-0.30.0
Contribution from interest rate/growth differential-4.3-3.3-3.4-0.4-0.6-1.2-1.0-1.1-0.6-0.3-0.1
of which: contribution from average real interest rate-0.4-0.4-0.30.30.40.40.40.40.50.30.3
of which: contribution from real GDP growth-3.9-2.9-3.1-0.8-0.9-1.6-1.5-1.5-1.1-0.6-0.4
Contribution from real exchange rate depreciation-3.1-1.7-2.4-3.30.2-1.1-0.9-0.8-0.7
Other identified debt-creating flows3.65.25.23.2-0.6-1.5-0.20.00.00.00.0
Privatization receipts (negative)3.65.25.23.2-0.6-1.5-0.20.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)0.00.00.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes-1.3-7.5-8.8-2.30.5-0.1-0.5-0.80.61.63.7
Other Sustainability Indicators
PV of public sector debt7.26.018.020.823.120.918.515.913.310.17.6
o/w foreign-currency denominated13.217.320.318.716.914.511.88.66.1
o/w external13.217.320.318.716.914.511.88.66.1
PV of contingent liabilities (not included in public sector debt)
Gross financing need 2/-3.5-1.24.75.87.06.83.31.72.2-0.1-1.8
PV of public sector debt-to-revenue and grants ratio (in percent)23.822.661.775.088.881.972.963.253.442.731.5
PV of public sector debt-to-revenue ratio (in percent)24.523.763.075.089.482.272.964.354.543.431.8
o/w external 3/46.062.478.773.866.658.548.536.925.4
Debt service-to-revenue and grants ratio (in percent) 4/14.213.86.06.67.47.07.410.821.08.27.4
Debt service-to-revenue ratio (in percent) 4/7.36.93.54.85.35.15.16.410.94.22.9
Primary deficit that stabilizes the debt-to-GDP ratio5.17.39.42.80.53.82.72.70.7-1.3-3.7
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)9.69.412.46.63.73.54.06.06.07.06.05.44.54.54.5
Average nominal interest rate on forex debt (in percent)1.71.71.52.30.64.33.53.13.02.93.83.42.83.83.1
Average real interest rate on domestic debt (in percent)-3.9-2.4-8.3-5.73.0-14.38.05.29.113.415.76.215.513.315.4
Real exchange rate depreciation (in percent, + indicates depreciation)-14.5-8.8-18.1-8.212.0-29.0
Inflation rate (GDP deflator, in percent)14.110.717.210.08.125.51.26.56.06.06.08.51.91.01.7
Growth of real primary spending (deflated by GDP deflator, in percent)0.50.20.30.20.20.00.0-0.10.00.00.00.00.00.00.0
Grant element of new external borrowing (in percent)5.725.626.227.727.30.418.810.24.8
Sources: Country authorities; and Fund staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

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

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

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 excluding 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.

Table 2b.Georgia: Sensitivity Analysis for Key Indicators of Public Debt 2008-2028
Projections
20082009201020112012201320182028
PV of debt-to GDP ratio
Baseline212321191613108
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages2119171615162442
A2. Primary balance is unchanged from 20082120171616162757
A3. Permanently lower GDP growth 1/2123222018162046
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2009-20102124232119181823
B2. Primary balance is at historical average minus one standard deviations in 2009-201021201815131075
B3. Combination of B1-B2 using one half standard deviation shocks2118141210865
B4. One-time 30 percent real depreciation in 20092130272522191616
B5. 10 percent of GDP increase in other debt-creating flows in 20092133302724211713
PV of Debt-to-Revenue Ratio 2/
Baseline7589827363534331
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages757365625963102177
A2. Primary balance is unchanged from 2008757567656266116238
A3. Permanently lower GDP growth 1/75908579726685192
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2009-20107591906878717697
B2. Primary balance is at historical average minus one standard deviations in 2009-20107576696152423121
B3. Combination of B1-B2 using one half standard deviation shocks7569554840312422
B4. One-time 30 percent real depreciation in 2009751171088087766765
B5. 10 percent of GDP increase in other debt-creating flows in 20097512611810796847056
Debt Service-to-Revenue Ratio 2/
Baseline7777112187
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages77679192232
A2. Primary balance is unchanged from 200877689202544
A3. Permanently lower GDP growth 1/777812241737
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2009-2010777914251519
B2. Primary balance is at historical average minus one standard deviations in 2009-2010776891776
B3. Combination of B1-B2 using one half standard deviation shocks775551465
B4. One-time 30 percent real depreciation in 20097891116321617
B5. 10 percent of GDP increase in other debt-creating flows in 200977101214331113
Sources: Country authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by 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 length of the projection period.

Revenues are defined inclusive of grants.

Attachment V. Georgia: Exceptional Access for Request of Stand-By Arrangement

A. Introduction

1. The amount of Fund resources requested by Georgia under the proposed SBA constitutes exceptional access. The total access under the SBA would equal SDR 477.1 million (317 percent of quota), of which SDR 161.7 million would become available upon the Board’s approval of the program.1 Both the cumulative and annual access under the program would exceed the normal access limits, requiring an evaluation of the case for exceptional access based on consideration of the four substantive criteria under the exceptional access framework.2

2. This appendix evaluates the case for exceptional access under the proposed SBA. The evaluation is based on the four substantive exceptional access criteria in capital account crises, as required under the Fund’s framework for exceptional access.

B. Exceptional Access Criteria in Capital Account Crises

3. Criterion 1—The member is experiencing exceptional balance of payments pressures on the capital account resulting in a need for Fund financing that cannot be met within normal limits. In the wake of the early August armed conflict, investor confidence has weakened, leading to substantive pressures in Georgia’s capital account. This has been reflected in a large loss of international reserves, a fall in bank deposits, and increased Eurobond spreads. Staff estimates that private sector capital inflows could fall to some $300 million in the second half of 2008, $1.2 billion below the record level attained in the first six months, and that gross reserves in the absence of a Fund program would fall to $920 million (1 ½ months of imports). In this context, private inflows would not be adequate to meet the total external financing requirement of $3.2 billion and $2.3 billion in 2008 and 2009, respectively, leading to a cumulative balance of payments gap over 2008–10 of $1.4 billion ($1.2 billion in 2008–09). In addition, reconstruction needs are expected to result in a higher current account deficit than expected before the conflict. The large financing need also reflects the need to replenish the weak international reserve position of the NBG in 2008 and 2009.

4. Criterion 2—A rigorous and systematic analysis indicates that Georgia’s debt is low and that there is a high probability that it will remain sustainable. Staff’s DSA (Attachment IV) shows that Georgia’s public debt ratio will rise over 2008–09 on account of the $500 million Eurobond issued earlier this year, purchases under the proposed SBA, and the post-conflict reconstruction-related borrowing on concessional terms. Accordingly, the external public debt would reach 26 percent of GDP by end-2009 compared to 17½ percent at end-2007. Nevertheless, over the medium term, debt ratios are projected to remain on a firm downward path supported by the government’s prudent fiscal policies as demonstrated prior to the conflict. Under a baseline scenario, the external public debt-to-GDP ratio would decline to 15 percent by 2013. Public debt service ratios will remain manageable, but key medium-term risks include large repayments of the 2008 Eurobond and repurchase obligations under the proposed SBA in 2012–13. Another potential vulnerability stems from the rapidly increasing private external debt—mainly by Georgian banks.

5. Criterion 3—The member has good prospects of regaining access to private capital markets within the time Fund resources would be outstanding, so that the Fund’s financing would provide a bridge. Georgia successfully tapped the markets for the first time by floating a $500 million Eurobond earlier this year. Access and terms have been substantially eroded by the adverse impact of the conflict, with Georgia’s sovereign bond spread over comparable U.S. treasuries remaining at 240 points above the pre-conflict level and its sovereign and banks’ external debt ratings being lowered by one notch. In staff’s view, Georgia should be able to progressively regain market access through 2009 provided that i) regional tensions subside and investor confidence is restored, and ii) government policies (under the program) preserve macroeconomic and financial stability. In this context, the government’s strong track record in implementing reforms and attracting FDI, including through privatization, provides grounds for optimism. The program allows for non-concessional debt of up to $500 million in the event the authorities find an appropriate opportunity to tap the markets during the program period.

6. Criterion 4—The policy program of the member country provides reasonably strong prospects of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment. Georgia established a strong record of policy implementation under the program supported by the PRGF arrangement—which expired last September. This provides a large measure of confidence in the authorities’ commitment and ability to implement the policy framework under the proposed SBA aimed at maintaining a prudent macroeconomic policy course and implementing a structural reform effort to restore investor confidence, strengthen the resilience of the financial sector, and spur growth. However, there are significant risks that may imperil the capacity to deliver the adjustment. These involve continued tensions over the two breakaway regions and the domestic political context.

C. Overall Assessment

7. Staff supports the authorities’ request for a 18-month SBA. The proposed access would be at the low- to mid-end of other exceptional access cases (see Table). The authorities established a strong record of accomplishment under their PRGF-supported program and have formulated a strong policy framework that addresses the key vulnerabilities facing Georgian economy as a result of the recent crisis. In providing financial support at this critical juncture, when financing needs are large, the Fund can assist Georgia in the needed buildup of reserves and lay the basis for a lasting exit from future Fund financial assistance. The authorities have indicated that decisions on whether to draw future purchases beyond the first one under the proposed SBA will depend on market conditions.

Georgia: Proposed Access, 2008-2010
High-Access Cases 1/Normal Access Cases
Proposed ArrangementProposed Arrangement (Percentile)20th Percentile80th PercentileAverageProposed Arrangement (Percentile)20th Percentile80th PercentileAverage
(Ratio)(Ratio)
Access
In millions of SDRs47712,89414,6359,1578636409359
Average annual access (percent of quota)21255119358249100205039
Total access in percent of:2/
Actual quota31727272790611100307562
Gross domestic product5.6552.88.36.5980.72.71.8
Gross international reserves 3/826927121979254141
Exports of goods and nonfactor services204111.146.435.2961.97.05.5
Imports of goods and nonfactor services111614.464.836.9921.66.44.8
Total debt stock

Of which: Public
339261615
External24965151199264
Short term302100195145
M242895242995112102
Source: Executive Board documents, MONA database, and Fund staff estimates.

High access cases include all available data at approval and on augmentation for the 25 requests to the Board since 1994 which involved the use of the exceptional circumstances clause or SRF resources. Exceptional access augmentations are counted as separate observations. For the purpose of measuring access as a ratio of different metrics, access includes augmentations and previously approved and drawn amounts.

The data used to calculate ratios is the actual value for the year prior to approval for public and short-term debt, and the projection at the time of program approval for the year in which the program was approved for all other variables.

For Georgia, excludes the purchases under the SBA.

Source: Executive Board documents, MONA database, and Fund staff estimates.

High access cases include all available data at approval and on augmentation for the 25 requests to the Board since 1994 which involved the use of the exceptional circumstances clause or SRF resources. Exceptional access augmentations are counted as separate observations. For the purpose of measuring access as a ratio of different metrics, access includes augmentations and previously approved and drawn amounts.

The data used to calculate ratios is the actual value for the year prior to approval for public and short-term debt, and the projection at the time of program approval for the year in which the program was approved for all other variables.

For Georgia, excludes the purchases under the SBA.

In the World Bank’s Doing Business survey, Georgia has moved up by 95 positions since 2004, reaching position 18 out of 178 countries in 2008.

Since 2006, Russia has banned all Georgian exports.

At a spread of 474 basis points over comparable U.S. Treasury securities (a yield of around 7.5 percent), the cost of this issue was comparable to that of similarly rated sovereign issues (those rated B+ by S&P).

Even though Georgia is PRGF eligible, a PRGF is not appropriate at this time because it cannot accommodate the level of high access needed in this case, and Georgia does not require the type of comprehensive reform that a PRGF arrangement is designed to address. Moreover, the requirement of a PRSP would be time consuming.

The authorities indicated that an organic law requires a qualified majority for parliament to amend it, and takes precedence over normal laws such as the annual budget law.

A joint debt sustainability analysis with the World Bank will be carried out in the context of the next Article IV consultation.

According to the FSA, the banks’ loan-loss provisioning would have to increase two-fold to bring the capital adequacy ratio down to a minimum 12 percent.

The U.S. contribution in 2008 may be larger. However, the amount of cash disbursements is unknown, as a significant part of the pledges is expected to be associated with imports.

SDR 382.5 million (254 percent of quota) would be made available during the first year of the arrangement.

There is a presumption that exceptional access in capital account crises will be provided using resources of the Supplemental Reserve Facility (SRF) where the conditions for the SRF apply. In Georgia’s case they do not apply. Given that private sector financing is primarily in the form of FDI, a decline of such inflows would likely be protracted and contribute to continued pressures on the capital account. The maturity of the SRF obligations would therefore be too short relative to the likely duration of Georgia’s balance of payments need.

An electronic spreadsheet file that shows the relevant discount rates reported by the OECD (CIRRs) will be provided on a periodic basis by IMF staff.

Point No. 9 of the IMF’s guidelines reads as follows: “(a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts and take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the leaser retains the title to the property. For the purpose of the Guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property. (b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.”

This is a Fund staff update to the joint World Bank/IMF DSA presented in the report for the Fourth Review under the PRGF (Country Report No. 06/395). The joint World Bank/IMF DSA will be prepared on the occasion of the next Article IV consultation.

Georgia is rated as a strong performer based on the World Bank’s Country Performance and Institutional Assessment Index. The relevant policy-dependent thresholds are 50 percent for the NPV of the debt-to-GDP ratio, 200 percent for the NPV of debt-to-exports ratio, 300 percent for the NPV of debt-to-revenue ratio, 25 percent of the debt service-to-exports ratio, and 35 percent of the debt service-to-revenue ratio.

The public external debt data used for this exercise were updated by staff using information provided by the authorities for the stock of debt as of end-2007.

Private debt stock data could be subject to further revisions. For debt service on existing debt no actual data are available and staff had to approximate debt service projections based on tentative terms.

The existing guidelines require staff to justify growth projections if the baseline includes very large upfront borrowing (an increase of NPV of debt of 5 percent of GDP or more). This, however, would not be fully applicable to the case of Georgia, as the assumed large borrowing is necessitated by the financing needs in the wake of the conflict. Furthermore, staff’s growth projections are conservative, especially when compared with the recent impressive growth rates.

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