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Georgia: Staff Report for the 2013 Article IV Consultation

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
August 2013
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Economic Developments

A. Context

1. Last October’s elections saw the first peaceful and democratic transfer of power in Georgia’s recent history. 1 The new government is committed to sustaining Georgia’s rapid growth and to strengthening the rule of law, transparency and social inclusion. However, substantial differences between incoming Prime Minister Ivanishvili and President Saakashvili (who will leave office in October) have increased political tensions, with some members of the former government charged with offences. Despite this political uncertainty, the new government has a substantial majority, and its ability to implement social and economic reforms has not been impeded.

2. Over the last ten years, Georgia’s economy has grown rapidly (Table 1). Economic growth averaged 6 percent from 2005-12 despite the global financial crisis and the 2008 conflict with Russia. Growth was driven by private investment and domestic consumption and, on the supply side, was supported by strong physical capital accumulation and total factor productivity (TFP) gains. Growth was broad based, and particularly strong in manufacturing, construction, transport, and financial services. However, agricultural output has continued to decline, reflecting lack of investment and the impact of the 2006 Russian trade embargo.

Table 1.Georgia: Macroeconomic Framework, 2010–14
20102011201220132014
1st/2nd
Act.Act.Est.Rev.Proj.Proj.
National accounts(annual percentage change; unless otherwise indicated)
Real GDP6.37.26.16.04.06.6
Nominal GDP (in billion of laris)20.724.326.128.927.230.2
Nominal GDP (in billion of U.S. dollars)11.614.415.817.016.317.3
GDP per capita (in thousand of U.S. dollars)2.63.23.53.83.63.9
GDP deflator, period average8.59.51.23.50.24.0
Population (in million) 1/4.44.54.54.54.54.5
Unemployment rate (in percent)16.315.115.0
Investment and saving(in percent of GDP)
Gross national saving11.313.417.516.116.018.6
Investment21.626.229.026.125.126.3
Private13.418.521.420.318.720.1
Inflation(in percent)
Period average7.18.5−0.91.0−0.84.5
End-of-period11.22.0−1.43.21.55.5
Consolidated government operations(in percent of GDP)
Revenue 2/28.328.228.827.528.127.9
o.w. Tax revenue23.525.225.425.325.725.5
Expenditures34.931.831.830.431.530.3
Current expenditures26.023.123.223.724.623.8
Capital spending and net lending8.88.88.76.66.96.4
Overall balance−6.6−3.6−3.0−2.8−3.3−2.4
Public debt39.233.832.331.231.831.8
Of which: foreign-currency denominated33.628.827.626.626.826.3
Money and credit(annual percentage change; unless otherwise indicated)
Credit to the private sector18.824.312.825.414.322.6
Credit to the private sector (constant exchange rate from 12 month prior)14.529.513.421.713.117.3
Broad money (incl. fx deposits) 3/23.920.311.420.515.518.5
Broad money (incl. fx deposits, constant exchange rate from 12 month prior) 3/20.923.711.817.914.614.7
Deposit dollarization (in percent)68.663.366.064.865.562.3
Policy rate (in percent, end-of-period)7.56.85.3
Deposit interest rate (in percent, annual average)7.99.48.6
Lending interest rate (in percent, annual average)19.518.719.0
External sector(in percent of GDP; unless otherwise indicated)
Gross international reserves (in billions of US$)2.32.82.92.62.82.7
In months of next year’s imports of goods and services3.43.73.73.23.43.2
In percent of broad money and non-resident deposits62.059.351.941.644.440.3
Current account balance (in billions of US$)−1.2−1.8−1.8−1.7−1.5−1.3
In percent of GDP−10.2−12.7−11.5−10.0−9.1−7.7
Trade balance−22.3−24.2−26.6−24.7−24.8−23.7
Foreign direct investment (inflows)7.07.35.55.75.86.0
Gross external debt84.177.881.477.881.879.0
Gross external debt, excl. intercompany loans62.958.963.459.063.560.9
Exchange rates
Laris per U.S. dollar (period average)1.781.691.65
Laris per euro (period average)2.362.352.12
REER (period average; CPI based, 2005=100)118.5129.6131.8
Sources: Georgian authorities; and IMF staff estimates.

Excludes Abkhazia residents.

Includes grants.

Not including the proceeds of the Georgian Railway eurobond issuance of July 2010, deposited in Georgian commercial banks which placed the corresponding funds abroad.

Sources: Georgian authorities; and IMF staff estimates.

Excludes Abkhazia residents.

Includes grants.

Not including the proceeds of the Georgian Railway eurobond issuance of July 2010, deposited in Georgian commercial banks which placed the corresponding funds abroad.

3. However, in sustaining this rapid growth, the previous government became increasingly interventionist. On first taking office in 2004, the previous government embraced a libertarian/free market approach, focused on improving the business environment and reducing corruption. Some of its reforms, such as the fight against low-level corruption, police reform, restoration of energy supply, and the overhaul of the tax system were fundamental to Georgia’s emergence as a functioning state. Others, such as the very liberal labor code and the limited safety net, were less balanced and left much of the population economically vulnerable. While the strategy at first succeeded, private investment collapsed following the financial crisis and the 2008 conflict with Russia and failed to fully recover afterwards. The government responded by increasing public infrastructure investment, and then in 2011 by creating a Partnership Fund to catalyze private investment through minority public co-financing.

4. The benefits of Georgia’s rapid growth have not been widely shared (Figure 1). From 2003 to 2012, employment fell by 5 percent, and unemployment remains high at 15 percent. Half the labor force is in small-scale agriculture, mostly underemployed. The previous government did create a rudimentary social safety net with: (i) public health insurance for means-tested eligible households, old-age pensioners, and infants; (ii) flat public pensions for all retirees; and (iii) targeted social assistance (TSA), which supports low-income households via direct transfers. However, pensions remain below subsistence, half the population lacks health insurance, and there are no unemployment benefits. Poverty is high, with more than 30 percent of the population living below the US$2 poverty line in 2011, and has increased slightly in recent years. Inequality is among the largest in the region, with a Gini coefficient above 0.4 (2010). Health and education outcomes are mixed, with educational quality lower than comparator countries.

Figure 1.Georgia: Health and Education Outcomes, Poverty, and Inequality

Sources: National Authorities; World Bank, World Development Indicators; Eurostat, Statistics on Income and Living Conditions; OECD, Programme for International Student Assessment 2009.

1/ SEE includes: Albania, Bo snia and Herzego vina, Bulgaria, Croatia, Hung ary, Kosovo, Lithuania, Macedonia, Romania, Moldova, Serbia, and Ukraine.

2/ Includes Armenia, Azerbaijan, and Turkey, except for the PISA aggregate score, where data for Armenia are not available.

3/ Or latest available. PISA data from 2009.

4/ Calculated as the simple average between overall PISA reading, math literacy, and scientific literacy indicators. The scale for scores is 1-699, the hig her the b etter.

5. Georgia’s rapid growth resulted in high current account deficits and significant external indebtedness (Table 2 and Figures 2 and 3). Despite tourism receipts increasing to 9 percent of GDP and remittances to 4½ percent of GDP, the current account deficit has persisted at around 11.5 percent of GDP from 2010 to 2012, one of the highest in the region. Georgia’s trade deficit rose above 25 percent of GDP. With relatively low national savings, the investment needed to support high growth was also financed by capital inflows. While initially mainly FDI, in the last couple of years their composition shifted towards less stable sources of financing, including Eurobond issuance and increases in nonresident deposits (now 15 percent of total deposits). Net external liabilities have risen to close to 100 percent of GDP.

Table 2.Georgia: Summary Balance of Payments, 2011–18(In millions of U.S. dollars)
20112012201320142015201620172018
1st/2nd
Act.Est.Rev.Proj.Proj.Proj.Proj.Proj.Proj.
Current account balance−1,840−1,814−1,694−1,489−1,335−1,314−1,300−1,389−1,460
Trade balance−3,494−4,214−4,193−4,038−4,105−4,252−4,402−4,689−4,940
Exports3,2543,5013,7903,8794,0824,4094,7645,1645,634
Imports−6,748−7,715−7,983−7,917−8,187−8,661−9,167−9,853−10,574
Services7481,1011,2661,2571,4591,5731,7411,9382,094
Services: credit2,0082,5412,7382,7102,9403,1203,3563,6233,889
Services: debit−1,261−1,440−1,472−1,453−1,480−1,547−1,615−1,685−1,794
Income (net)−422−103−173−119−130−144−221−298−356
Of which: interest payments−310−399−391−413−452−434−469−482−452
Transfers (net)1,3291,4021,4071,4101,4411,5091,5821,6601,742
Of which: remittances617710746749787828869912958
Capital account15313485877273737373
General government13612477776262626262
Financial account2,2251,9161,7571,6521,4311,6651,6921,2951,902
Direct investment (net)9026037946797709301,0361,1561,288
Monetary authorities, net 1/210000000
General government31950335535433027917411673
Portfolio investment (net)44106−15−151010101010
Long-term loans received27439636936932026816410663
Other, net101000000
Private Sector, excl. FDI1,00281060961933045648123541
Banks83419244837689226240−342217
Portfolio investment, net8922355202530−115112
Of which: equity liabilities−77315152025303537
Loans received (net)212−87207151148166188−24062
Long-term loans−14200153151168190−23765
Short-term loans213−917−2−2−2−3−3−3
Other, net (currency and deposits)53356236220−7935221343
Assets339−19417017088−13−15−16−18
Liabilities (including NRDs)1942506650−16749362960
of which: NRDs1792646650−16749362974
Other sectors169617161243242230241365323
Portfolio investment, net1510000−11000
Long-term loans received (net)335155197279262251246367326
Other, net−167−47−37−36−20−10−5−3−2
Errors and omissions13−240000000
Overall balance551212148250169423465−22515
Financing−551−212−148−250−169−423−46522−515
Gross International Reserves (-increase)−572−3823810484−345−45028−515
Use of Fund Resources−59−245−385−380−252−79−15−60
Purchases (SBA/SCF)000000000
Repayments (SBA/SCF)−59−245−385−380−252−79−15−60
Exceptional financing807202600000
Sources: National Bank of Georgia, Ministry of Finance; and IMF staff estimates.

SDR allocation included under monetary authorities’ long-term liabilities.

Sources: National Bank of Georgia, Ministry of Finance; and IMF staff estimates.

SDR allocation included under monetary authorities’ long-term liabilities.

Table 2a.Georgia: Summary Balance of Payments, 2011–18 (concluded)(In millions of U.S. dollars)
20112012201320142015201620172018
1st/2nd
Act.Est.Rev.Proj.Proj.Proj.Proj.Proj.Proj.
(in percent of GDP)
Current account balance−12.7−11.5−10.0−9.1−7.7−7.1−6.4−6.3−6.1
excluding official transfers−13.7−12.2−10.3−9.5−7.8−7.1−6.5−6.3−6.1
Trade balance−24.2−26.6−24.7−24.8−23.7−23.0−21.8−21.3−20.5
Net capital inflows to private sector13.28.98.28.06.47.57.55.37.6
(growth rates, in percent)
Exports of GNFS
value growth29.614.87.69.06.67.27.88.28.4
volume growth12.015.08.88.89.77.66.96.77.0
price change15.7−0.2−1.10.2−2.8−0.40.91.41.3
Imports of GNFS
value growth30.514.32.82.33.25.65.67.07.2
volume growth9.518.34.33.15.06.46.46.66.6
price change19.2−3.3−1.4−0.7−1.8−0.7−0.70.40.6
(in billions of U.S. dollars, unless otherwise indicated)
Gross international reserves (end of period)2.82.92.62.82.73.03.53.53.3
in months of next year GNFS imports3.73.73.23.43.23.43.63.33.3
in percent of short-term debt at remaining maturity118102103100105115112116101
in percent of broad money and non-resident deposit595242444039403429
Reserve cover 1/645548525259656156
External debt11.212.913.213.313.714.615.515.516.3
External debt, excluding intercompany loans8.510.010.010.310.511.312.011.912.3
Public4.24.44.44.34.44.64.84.94.9
Private4.35.75.66.06.16.77.37.07.4
Long-term2.83.83.74.14.34.75.24.85.2
Short-term1.61.91.92.01.92.02.12.22.2
Intercompany loans2.72.83.23.03.13.33.53.74.0
(in percent of GDP)
External debt77.881.477.881.879.078.876.970.467.8
External debt, excluding intercompany loans58.963.459.063.560.960.959.653.851.2
Public29.127.526.026.525.424.923.622.120.5
Private29.835.933.036.935.536.036.031.730.7
Long-term19.124.021.824.924.725.325.621.721.4
Short-term10.811.911.112.010.710.710.410.09.3
Intercompany loans18.917.918.818.318.117.917.316.616.6
Memorandum items:
Nominal GDP (billions of U.S. dollars)14.415.817.016.317.318.520.222.024.1
Sources: National Bank of Georgia, Ministry of Finance; and IMF staff estimates.

Gross international reserve in percent of total short-term liabilities plus the current account deficit.

Sources: National Bank of Georgia, Ministry of Finance; and IMF staff estimates.

Gross international reserve in percent of total short-term liabilities plus the current account deficit.

Figure 2.Georgia: Current Account Balance, 2003–12

Sources: National Authorities; IMF World Economic Outlook; and IMF staff estimates.

1/ Region includes: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Georgia, Hungary, Kazakhstan, Kosovo, Kyrgyz Republic, Latvia, Lithuania, Macedonia, Poland, Romania, Serbia, Tajikistan, Turkey, Turkmenistan, Ukraine, and Uzbekistan.

Figure 3.Georgia: Financing of the Current Account, 2003–12

Sources: National Authorities; IMF World Economic Outlook; and IMF staff estimates.

6. Most of the 2011 Article IV consultation recommendations have been implemented. Fiscal consolidation continued as envisaged, with streamlining of public investment creating fiscal space for increased social expenditures. The 2011 Economic Liberty Act diluted the constitutional referendum requirement for new taxes, preserving the government’s flexibility to address unexpected developments. The NBG has made further progress improving its inflation forecasting and modeling capacity. In view of their further increase, the NBG also adopted measures to contain nonresident deposits. While the 2011 Article IV recommended more exchange rate flexibility, though the nominal effective exchange rate has been volatile, the lari-dollar exchange rate has become increasingly stable. The NBG has responded to higher-than-expected capital inflows by purchasing foreign currency.

B. Recent Developments

7. Since mid-2012 the economy has slowed (Figure 4). After growing at around 7 percent from 2010 to the first half of 2012, the economy started to level off in the third quarter of 2012, ahead of the October general elections. Growth fell to 2.7 percent y/y (-2 percent q/q seas. adj.) in the fourth quarter of 2012 and then to 2.4 percent y/y (+0.2 percent q/q seas. adj.) in the first quarter of 2013. On the demand side, causes seem to be weaker private investment (likely reflecting increased business uncertainty) and lower government spending.

Figure 4.Georgia: Real Sector Developments, 2008–13

Sources: National Bank of Georgia; GeoStat; and IMF staff estimates.

8. Inflation has fallen over time and the recent deflation is partly explained by the economic slowdown (Figure 5). Headline inflation has fallen well below the NBG’s 6 percent medium-term inflation target and inflation volatility remains high. After rising to almost 15 percent in May 2011 due to higher food prices, inflation has fallen steadily (to minus 1.7 percent in April 2013). While the nominal effective exchange rate appreciated by 10 percent from end-2010 to end-2012, the lari-dollar rate has been increasingly stable since March 2011, remaining within a ±1 percent band between July 2012 and mid-May 2013 (Figure 5). The sharp decrease in inflation since May 2011 reflects lower food prices, lagged effects of exchange rate appreciation, cuts in administered energy prices and, most recently, subdued domestic demand.

Figure 5.Georgia: Money and Inflation, 2010–13

Sources: National Bank of Georgia; GeoStat; and IMF staff estimates.

9. The NBG has loosened monetary policy in response, but with little effect on credit growth (Tables 4 and 5, and Figures 5 and 6). The NBG cut its policy rate from 8 percent in mid 2011 to 4.25 percent in May 2013. Commercial bank lari deposit rates have fallen more or less in line, except during a short period at end-2012 when some small banks increased rates to attract funds. Despite the cuts in the policy rate, lending rates have barely dropped and private credit growth has declined from around 20 percent to 12–15 percent since October 2012. In addition to weak monetary policy transmission, this seems to reflect lower credit demand and banks’ cautious approach to lending in response to the slowdown. The NBG has increased its foreign currency purchases, already buying US$335 million so far this year, which has helped resist appreciation pressures and lowered the risk of further deflation.

Table 3a.Georgia: General Government Operations, 2012–18 (concluded) 1/
2012201320142015201620172018
1st/2nd
Act.Rev.Proj.Proj.Proj.Proj.Proj.Proj.
(In percent of GDP)
Revenues28.827.528.127.927.928.028.128.0
Taxes25.425.325.725.525.625.725.825.8
Direct taxes11.010.911.210.710.911.011.111.1
Taxes on income6.86.86.86.36.36.46.46.5
Taxes on profits3.33.23.43.43.43.43.53.5
Other Taxes (incl. property)1.01.01.01.11.11.11.21.2
Indirect taxes14.414.314.514.714.714.714.814.7
VAT11.511.611.711.912.012.112.312.3
Excises2.52.42.52.52.42.32.22.2
Custom duties0.30.30.30.30.30.30.30.3
Other revenues2.41.61.71.81.81.81.81.8
Grants1.10.70.70.60.60.50.50.4
Expenditures31.830.431.530.329.929.729.629.5
Current expenditures23.223.724.623.823.623.523.423.4
Compensation of employees4.64.54.84.44.34.24.14.1
Use of goods and services5.04.24.14.03.93.83.83.8
Subsidies and grants2.01.61.71.61.61.61.61.6
Social expenses7.18.79.29.59.59.59.59.5
Other expenses3.53.63.73.33.33.33.33.3
Interest1.01.11.21.01.11.11.01.0
Capital spending and net lending8.76.66.96.46.36.26.26.2
Capital7.56.36.56.26.16.16.16.1
Net lending1.10.40.40.30.20.10.10.1
Overall balance−3.0−2.8−3.3−2.4−2.0−1.7−1.5−1.5
Statistical discrepancy0.00.00.00.00.00.00.00.0
Identified financing3.02.83.32.42.01.71.51.5
Domestic−0.41.51.91.40.60.80.91.2
Net T-bill issuance0.20.50.71.21.11.11.01.0
Amortization 2/−0.2−0.2−0.2−0.2−0.2−0.1−0.1−0.1
Use of deposits at the NBG and banks−0.41.11.30.4−0.3−0.20.10.4
External2.30.90.90.81.10.80.50.3
Borrowing2.62.52.62.32.01.41.21.0
Of which: IMF0.00.00.00.00.00.00.00.0
Amortization−0.4−1.6−1.7−1.6−0.9−0.6−0.7−0.8
Of which: IMF−0.1−0.9−0.9−1.1−0.30.00.00.0
Privatization receipts1.10.50.60.20.20.10.10.0
Memorandum items:
Public debt32.331.231.831.831.130.128.827.3
Of which: foreign-currency denominated27.626.626.826.325.223.922.320.7
End-year government deposits 3/3.21.91.71.21.41.41.20.7
Primary balance−2.0−1.7−2.2−1.4−0.9−0.6−0.5−0.5
Operating/Current balance5.73.83.54.04.34.54.74.7
Structural primary balance 4/−3.1−2.2−2.3−1.7−1.3−1.0−0.7−0.7
Fiscal deficit excluding grants4.03.54.13.02.62.22.01.9
Sources: Ministry of Finance; and IMF staff estimates.

General government includes central and local governments.

Excluding arrears clearance, provisions and T-bill repayment.

Includes Treasury single account, revenue reserve account, and local government deposits.

In percent of potential GDP.

Sources: Ministry of Finance; and IMF staff estimates.

General government includes central and local governments.

Excluding arrears clearance, provisions and T-bill repayment.

Includes Treasury single account, revenue reserve account, and local government deposits.

In percent of potential GDP.

Table 4.Georgia: Monetary Survey, 2010–14
20102011201220132014
Mar.Dec.
Act.Act.Act.Act.Proj.Proj.
(In billions of lari)
Broad money (M3)5.97.17.98.09.110.8
Lari Broad money (M2)3.03.84.14.04.65.6
Currency held by the public1.41.41.61.41.71.8
Lari resident deposits1.62.32.52.63.03.8
Resident foreign exchange deposits2.93.33.84.04.55.3
Net foreign assets0.90.70.81.20.5−0.2
NBG2.53.33.74.04.04.2
Commercial banks−1.6−2.6−2.9−2.8−3.5−4.4
Of which: liabilities−2.8−3.5−4.2−4.0−4.7−5.7
Net domestic assets5.06.47.16.88.711.0
Domestic credit6.47.88.68.410.413.0
Net claims on general government0.20.1−0.1−0.40.40.8
Of which: government deposits at NBG−0.8−0.8−1.0−1.2−0.6−0.5
Of which: T-bills at commercial banks0.40.50.60.70.81.2
Private credit6.27.78.78.89.912.2
Other items, net−1.3−1.4−1.5−1.6−1.7−2.0
Sources of funds of commercial banks7.49.210.510.512.214.8
Resident deposits4.55.76.46.57.59.0
Non-resident deposits0.60.81.31.41.41.2
Other foreign liabilities2.22.72.92.63.44.5
Uses of funds of commercial banks7.49.210.510.212.214.8
Reserves2.12.32.82.63.23.3
Lari domestic credit1.92.63.23.23.84.9
Fx domestic credit4.65.35.85.86.68.1
Other foreign assets0.10.10.10.10.10.1
Other items, net−1.3−1.0−1.4−1.5−1.6−1.7
(Percentage change, year on year)
Broad money (M3)23.920.311.416.415.518.5
Broad money (M3, constant exchange rate from 12 month prior)20.923.711.816.514.614.7
Private credit18.824.312.811.714.322.5
Private credit (constant exchange rate from 12 month prior)14.529.513.411.813.117.3
(Percent of GDP, unless otherwise indicated)
Memorandum items:
Broad money (M3)28.529.230.230.333.535.8
Non-resident deposits (percent of total deposits)10.512.115.317.114.210.4
Private credit29.931.733.333.336.540.4
Nominal GDP (billions of lari)20.724.326.126.327.230.2
Sources: National Bank of Georgia; and IMF staff estimates.
Sources: National Bank of Georgia; and IMF staff estimates.
Table 5.Georgia: Accounts of the National Bank of Georgia, 2010–14
20102011201220132014
Mar.Dec.
Act.Act.Act.Act.Proj.Proj.
(In millions of lari)
Net foreign exchange position2,2182,5962,8583,0933,0113,089
Gross International Reserves4,0134,7074,7604,8754,6624,838
Other foreign assets811445
Foreign currency liabilities1,8032,1131,9021,7861,6561,754
Of which: use of Fund resources1,15098159046220094
Of which: compulsory reserves in USD2457528748659841,156
Net domestic assets−396−457−548−1,088−562−469
Net claims on general government−95−74−425−636−6755
Claims on general government (incl. T-bills)714685529522521521
Nontradable govt. debt601561521482481441
Securitized debt (marketable)1131248404080
Deposits8097599541,159588466
Claims on rest of economy221111
Claims on banks−165−429−172−507−508−330
Bank refinancing19014391115100300
Certificates of deposits and bonds355442563623608630
Other items, net−13843485512−195
Reserve money1,8222,1392,3102,0062,4492,620
Currency in circulation1,6181,7541,9181,7462,0102,110
Bank lari reserves144155200253297378
Banks overnight deposits602301926142132
(Percentage change, year on year)
Reserve money4.517.48.07.16.07.0
Currency in circulation11.08.49.413.24.85.0
Bank lari reserves−49.77.828.919.248.527.4
Memorandum items:
Net international reserves
(in millions of USD, at prog. exchange rates) 1/8821,1521,3261,4821,5491,664
Net domestic assets (in millions of lari) 1/34921695−470−138−159
Sources: National Bank of Georgia; and IMF staff estimates.

Based on 2012 program definition as defined in the TMU attached to EBS/12/46.

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

Based on 2012 program definition as defined in the TMU attached to EBS/12/46.

10. Unexpected fiscal tightening has added to the slowdown. Although revenues were lower than projected in the first quarter (by about GEL 100 million, 0.4 percent of GDP), the government ran a GEL 200 million surplus. The authorities emphasized this apparent tightening was unintentional and reflected procedural delays due to stricter procurement procedures, financial difficulties in some construction businesses, and savings from centralized purchases.

C. Policy Agenda

11. The new government aims to share the benefits of economic growth more widely, focusing on social protection, job creation, and agriculture. Labor Code revisions passed by Parliament in June are expected to enhance workers’ rights, including job security, where previously workers could be fired at will. To support agriculture, the government has increased allocations in the 2013 budget and established an Agriculture Fund (privately funded, but from a foundation owned by the Prime Minister). The government plans to reorganize the Partnership Fund and also a private-equity Fund will be created to stimulate private investment.

12. The new government is redirecting government spending away from capital spending and towards social expenditures (Table 3). Public investment (averaging 8 percent of GDP over the past 5 years) is one of the highest in the region while total social expenditure (pensions, health, and education) has been among the lowest (11 percent of GDP). The government is spending an additional GEL 800 million (3 percent of GDP) on an annualized basis to address high private health care costs, low educational quality, and high rates of poverty and inequality. Reform plans include introducing universal healthcare system, raising pensions, doubling TSA allowances and expanding school vouchers (Box 1). Despite this increase in social expenditures, the authorities remain committed to fiscal consolidation and to meeting the 30 percent limit on spending introduced by the Economic Liberty Act from 2014 onward. While capital spending was reduced to meet these objectives, it would remain above 6 percent of GDP, broadly in line with comparator countries.

Table 3.Georgia: General Government Operations, 2012–18 1/
2012201320142015201620172018
1st/2nd
Act.Rev.Proj.Proj.Proj.Proj.Proj.Proj.
(In millions of lari)
Revenues7,5397,9427,6548,4089,41710,56311,85313,241
Taxes6,6447,2897,0007,6878,6249,69510,90112,196
Direct taxes2,8803,1603,0473,2433,6634,1374,6735,241
Taxes on income1,7651,9551,8561,8882,1332,4092,7213,058
Taxes on profits8519239181,0181,1491,2981,4661,640
Other Taxes (incl. property)264281273337381430486544
Indirect taxes3,7644,1293,9544,4444,9615,5576,2286,955
VAT3,0153,3493,1793,6034,0654,5865,1745,808
Excises6606866797447968659421,027
Custom duties90959597100106112120
Other revenues618450450534597668747835
Grants277203203187196201205210
Budget10675757983858789
Project170127128108113116118121
Expenditures8,3188,7608,5639,13210,09211,20512,48613,948
Current expenditures6,0546,8476,6987,1877,9768,8609,87011,031
Compensation of employees1,2031,2961,2961,3351,4591,5941,7491,955
Use of goods and services1,2981,2251,1261,1951,3031,4341,6041,793
Subsidies and grants526468468479536599670749
Social expenses1,8582,5002,5002,8633,2013,5804,0044,477
Other expenses9171,0459951,0031,1221,2551,4031,569
Interest254314314312356399442487
Capital spending and net lending2,2651,9131,8651,9462,1152,3452,6162,917
Capital1,9711,8101,7621,8662,0602,2952,5662,867
Net lending2931031038055505050
Overall balance−779−819−909−724−675−642−633−708
Statistical discrepancy00000000
Identified financing779819909724675642633708
Domestic−95422506421219285401575
Net T-bill issuance58150200350380400430460
Amortization 2/−44−50−50−52−54−56−59−62
Use of deposits at the NBG and banks−109323357123−107−5930177
External595247253234386307202123
Borrowing690718717702690541495482
Budget996867136139120157156
Of which: IMF00000000
Project591650650566551420338326
Amortization−95−471−464−468−304−233−293−359
Of which: IMF−20−250−246−324−103000
Use of Sovereign Wealth Fund resources00000000
Privatization receipts2801501507070503010
Unidentified financing00000000
Memorandum items:
Public debt8,4428,9958,6579,60310,51211,35812,14012,891
Of which: foreign-currency denominated7,2187,6727,2847,9328,5159,0179,4289,780
End-year government deposits 3/830547474351458517488311
Primary balance−526−505−596−413−319−243−192−221
Operating/Current balance1,4851,0949561,2211,4411,7031,9822,209
Structural primary balance−815−618−628−513−433−360−306−331
Fiscal deficit excluding grants1,0561,0211,112911871842838918
Sources: Ministry of Finance; and IMF staff estimates.

General government includes central and local governments.

Excluding arrears clearance, provisions and T-bill repayment.

Include Treasury single account, Revenue reserve account, and local government deposits.

Sources: Ministry of Finance; and IMF staff estimates.

General government includes central and local governments.

Excluding arrears clearance, provisions and T-bill repayment.

Include Treasury single account, Revenue reserve account, and local government deposits.

Box 1.Georgia: Scaling Up Social Expenditures

The newly established universal healthcare system will cover around 2.5 million previously uninsured individuals and costs about 1 percent of GDP. Since March 2013, emergency health care has been made free of charge for in-patient and out-patient services. From July onwards, individuals previously not covered by state insurance programs (about half Georgia’s population, including children above the age of 6 and adults) will benefit from non-emergency services without having to contribute to the scheme. A newly created Social Service Agency will negotiate rates and procedures and reimburse medical providers, which patients can choose freely. Most medical services will have a substantial co-pay (still to be decided), which could leave a market for existing private insurance companies. Under the basic scheme, most drugs will not be covered, but could be added in the future, together with additional medical procedures. From May 2014 onwards, the Social Service Agency will cover individuals previously covered by state programs (socially vulnerable, pensioners, children below 6) whose insurance was operated by private companies. While substantial savings are expected from centralized purchases and negotiations, the reform plans are estimated to add 1 percent of GDP per year to existing health costs, making health the largest reform area.

Pension increases will narrow the gap with the subsistence minimum. Old-age pensions, a flat basic allowance that includes a GEL 15 health insurance premium, are being increased in two stages: to GEL 125 in April and then to GEL 150 from September. The cost is around 0.8 percent of GDP. Disability pensions rise to GEL 150 and GEL 100 depending on the severity of the disability, and pensions for victims of political repression rise to GEL 100. Disability pensions and pensions for work related injuries are introduced (0.2 percent of GDP). The authorities are working on a mandatory second pillar contribution scheme.

Targeted social assistance (TSA) allowances are being doubled. Georgia’s TSA currently covers around 10 percent of the population, identified by proxy means-testing. Monthly allowances will double: starting in July, the first household member will receive GEL 60 (US$37) and GEL 48 (US$29) for each additional household. This will cost 0.5 percent of annual GDP.

Education spending is being increased slightly (0.2 percent of GDP), mainly for vouchers used by public schools to finance their expenses, and for renovation of public school buildings scheduled for July/August. In addition, teacher salaries were increased in early 2013.

Social Expenditures, 2010–13
2010201120122013 proj.
(In percent of GDP)
Education2.92.72.92.9
Health2.21.61.62.7
Social Protection6.96.46.67.2
Pension14.14.04.14.2
Social assistance11.20.91.01.8
Total12.010.711.112.8
Sources: Ministry of Finance; and IMF staff estimates.

Economic definition

Sources: Ministry of Finance; and IMF staff estimates.

Economic definition

Figure 6.Georgia: Monetary and Banking Sector, 2008–13

Sources: National Bank of Georgia; Board of Governors of the US Federal Reserve System; and IMF staff estimates.

Figure 6a.Georgia: Monetary and Banking Sector, 2008–13 (concluded)

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

Policy Discussions

13. Against the background of the slowdown and the government’s ambition for rapid and inclusive growth, discussions focused on: the size and causes of the current slowdown, and the appropriate policy response; the main economic risks, including reducing the current account deficit to ensure external sustainability; structural reforms for sustained medium-term growth; improvements to the NBG’s inflation targeting regime and financial supervision; and the likely success of the government’s reform initiatives in improving social outcomes.

A. Understanding and Ending the Slowdown

14. The recent slowdown has proved more protracted than originally hoped for. Both the authorities and staff accepted that some slowdown was likely, given investor uncertainty ahead of the elections. Global FDI and partner country growth had also weakened slightly. While lowering the policy rate during the election period would have been risky, the subsequent deflation meant that real interest rates (ex post) have been much higher than anticipated. Though clearer now, uncertainty over the new government’s economic and political orientation probably also contributed. Conflict between President Saakashvili and Prime Minister Ivanishvili had discouraged foreign investors, while companies associated with the previous government have been reluctant to invest.

Global Foreign Direct Investment and Real Trade Partner Economic Growth

15. In light of the recent slowdown, staff projects that growth this year could fall to 4 percent, substantially below potential. The staff’s projection assumes strong policy actions by the authorities (described below), that boost growth to an annualized rate of around 9 percent (seas. adj.) for the remainder of the year. In contrast, the Ministry of Finance expects a stronger acceleration, based on government spending recovering, higher investment once the private-equity funds are established, and opening of the Russian market. The Ministry was also concerned that prematurely releasing lower growth projections (which they argued were subject to considerable uncertainty) could weaken confidence.

16. To support recovery, staff urged the authorities to reverse the shortfalls in government spending and allow the automatic stabilizers to work. The authorities agreed and were confident of executing most budget spending, as several large infrastructure projects had already started in April. Due to the slowdown, revenues are expected to underperform this year by around 1 percent of GDP. With inflation subdued and the current account deficit falling, the mission argued for letting the automatic fiscal stabilizers operate. Lower revenues should only be partly offset by lower government spending, so that the deficit target might need to be increased from 2.8 to 3.3 percent of GDP. This would keep the structural deficit in line with First and Second Review projections. The same principles would apply to 2014, should the slowdown last longer than currently expected and carry over to next year. The authorities were confident that, even if revenue proved lower than budgeted, they would be able to meet the existing deficit target through spending cuts.

17. The mission encouraged the NBG to consider further policy rate cuts, given the slowdown and low inflation. While inflation is about 8 percentage points below the medium-term target, the NBG explained that half this difference reflects supply shocks to which monetary policy should not respond (Text Table 1). Staff noted that Taylor Rule calculations suggested further scope for rate cuts (in light of the output gap and low inflation). However, the NBG argued that its models predict inflation will soon pick up, which would call for future interest rate increases: cutting rates now could create unnecessary fluctuations in the policy rate. In contrast, staff was concerned that if recovery does not materialize, the present deflation and high real interest rates might be unnecessarily prolonged. Staff encouraged the government and the NBG to assess the severity of the slowdown, its likely permanence, and the government’s intended policy response, so that the NBG could better judge whether more aggressive easing of monetary policy was warranted. 2

Text Table 1:Inflation Determinants, March 2013.
Headline inflation−2.1%
Difference from target8.1%
Supply side factors−4.4%
Base effect−2.1%
Imported prices−1.0%
Electricity−0.3%
Utilities−0.3%
Natural gas−0.2%
Mark-up reduction effect−0.4%
Other supply side factors−0.1%
Demand side factors−3.7%
Source: NBG calculations.
Source: NBG calculations.

18. The mission welcomed the NBG’s attempts to improve monetary transmission by steps to encourage long-term lari lending. In light of the steep yield curve, the NBG argued that increasing long-term lari liquidity and lowering long rates was needed. While the mission believed there was still a case for policy rate cuts, it agreed with the NBG’s proposal for the government to issue treasury bills and deposit the proceeds long-term with commercial banks, to encourage long-term lari lending. The NBG’s initiative to encourage flexible rate lari lending by banks, through easing of NBG collateral standards (but in a way that protects the NBG from credit risk), should also help.

19. To reduce business uncertainty, the mission encouraged the government to strengthen communication of its policies and to announce them only once the main details have been agreed. Businesses expressed concern over the proposed Labor Code revisions, and the difficult and drawn-out consultation process, which weakened confidence. Details of the proposed US$3 billion private investment fund are also unclear. To reduce uncertainty, the mission urged the government to develop detailed information about the objectives, implementation, and timetable for new policy initiatives before public announcements. Resolving uncertainty faced by companies perceived as “close” to the previous government could also help.

B. Policies to Ensure External Sustainability and Reduce External Risks

20. Discussions on the medium-term outlook focused on how to lower the current account deficit and reduce external vulnerability without unduly sacrificing growth. Over the medium term, structural reforms are projected to sustain investment, factor productivity, and return growth to its potential of around 6 percent. Inflation would gradually realign with the NBG’s medium-term target (5 percent for 2015), supported by continued improvements to the inflation targeting regime and central bank independence. To ensure external sustainability, the current account deficit needs to gradually decline to around 6 percent of GDP, which would lower the external debt ratio to around 70 percent of GDP by 2017. In addition to structural reforms to improve competitiveness, this will require continued fiscal consolidation. The authorities reiterated their commitment to gradually reduce the fiscal deficit to 1.5 percent of GDP by 2017, consistent with a modest reduction (¼-½ percent of GDP a year) of the primary structural balance from 2014–17.

21. The authorities agreed on the need to improve competitiveness but questioned the magnitude of the exchange rate overvaluation. Using the CGER methodology, with a 2012 current account deficit of almost 12 percent of GDP, staff estimates the exchange rate is approximately 15 percent overvalued, so exchange rate adjustment will likely be needed (Box 2). The NBG questioned the policy relevance of these estimates, given the substantial appreciation pressures currently faced, and noted the wide uncertainty bands attached to them. The authorities were reluctant to sacrifice Georgia’s strong growth for the sake of current account deficit reduction.

22. The authorities argued that structural reforms would be more effective than real depreciation in reducing the trade deficit. While expanding Georgia’s traditional exports (metals and minerals) seems challenging, structural reforms could boost exports in agriculture, hydropower, textile and other light processing sectors, and tourism. The authorities argued that agreement on the EU FTA and introduction of the private investment funds could encourage FDI and improve the financing of the current account. Staff agreed on the importance of these structural reforms, but argued that exchange rate adjustment would likely still be needed given that these reforms are difficult and take time to implement.

23. The authorities believed the main domestic risks were well contained. The government argued strongly that removal of the President’s power to dismiss and install a new government had eliminated the main political risk. Notwithstanding October’s Presidential elections, the government was confident the current political polarization would die down, which would encourage foreign investment. The Ministry of Finance argued that procurement delays had been largely overcome, so there was limited risk of a spending shortfall for the year.

24. The authorities broadly agreed with the mission’s assessment of the main risks from external spillovers. They agreed that a decline in capital inflows, which could be triggered by higher interest rates in advanced economies or weaker growth in emerging markets, was the major downside risk. Conversely, the authorities noted that intensification of capital inflows (for example, if low world interest rates were to persist) was a significant medium-term risk, as it could delay the necessary external adjustment and lead to higher external liabilities. In view of Georgia’s limited economic and financial linkages to the EU, the authorities were less worried by possible recession in Europe unless sufficiently deep to affect other countries in the region. They considered that a slowdown in neighboring Turkey (through the trade channel) or Russia (through the remittances channel) would have greater direct impacts. The authorities also viewed the opening of the Russian market to Georgian products as a two-sided risk, depending on whether this was delayed, or took place more quickly and for a broader range of goods than currently assumed. They agreed with the mission that, if these risks were to materialize, in most cases the policy response would involve exchange rate flexibility, acceleration of structural reforms, mobilization of financing from the IMF and other development partners, along with assessing the scope for a moderate counter-cyclical fiscal response.

Box 2.Georgia: External Stability Assessment

Georgia’s large current account deficit and external indebtedness remain sources of external vulnerability. Improving competitiveness and reducing financing vulnerabilities are critical to ensuring external stability over the medium term.

Despite recent depreciation, using CGER methodologies staff estimates real exchange rate overvaluation of around 15 percent:

  • The macro balance (MB) approach suggests a 15 percent real depreciation is needed to close the gap between the underlying current account deficit (10.3 percent of GDP) and its norm (6.8 percent of GDP). A relatively “healthy” NFL position (60 percent of GDP) is used for the CA norm calculation.1 The underlying current account is the medium-term current account deficit without policy actions or structural changes. The potential impact of structural reforms in reducing the underlying current account deficit is not included, given uncertainty over their magnitude.

  • The equilibrium real exchange rate (ERER) approach points to a smaller overvaluation, of only 5 percent. Projected medium-term improvement in the terms of trade gradually reduces estimated ERER overvaluation from 12 percent in 2012 to 5 percent in the medium term.

  • The external sustainability (ES) approach suggests a substantially higher overvaluation, of about 27 percent. This approach assumes that Georgia lowers its net foreign liabilities to a relatively “healthy” level (60 percent of GDP), which gives a much lower current account norm of 4.2 percent of GDP.

Georgia: Exchange Rate Assessment
MBERERES
Current Account Norm 1/−6.8−4.2
Underlying Current Account 2/−10.3−10.3
CA gap3.56.1
Elasticity0.20.2
Real Exchange Rate Gap 1/3/15.35.127.1

Current account norm and equilibrium real exchange rate are calculated using

Underlying current account is based on actual current account balance in 2012

Movement in real exchange rate needed to close the CA gap between norm and

Current account norm and equilibrium real exchange rate are calculated using

Underlying current account is based on actual current account balance in 2012

Movement in real exchange rate needed to close the CA gap between norm and

However, the results are subject to large uncertainties and are sensitive to assumptions. The estimated CA norm (in MB) and equilibrium REER (in ERER) are based on panel regressions, which may not fit for Georgia given transition-related structural breaks. Based on empirical studies, an NFL position at 60 percent of GDP is assumed sustainable: however, it is very hard to estimate a “sustainable” NFL position for Georgia.

Structural reforms that improve export competitiveness would reduce the need for exchange rate adjustment. Georgia’s weak trade performance appears to reflect both price and quality competitiveness issues. Asymmetric bilateral trade development with the main trading partners (EU and Turkey) explains a large part of the trade deficit worsening. Bilateral regressions show that exports and imports are strongly linked to partner and domestic demand. In contrast, the real exchange rate seems to have a significant impact only for imports, pointing to diversification and quality issues.

Recent deterioration in the quality of external financing raises concerns about potential vulnerability. FDI used to be the main source of external financing, before 2012 accounting for more than 50 percent of foreign inflows. However, in 2012 only one-third of capital inflows were FDI, with SOE Eurobonds and increased nonresident deposits providing a large part of external financing. This decline reflects uncertainties from the election and the political transition, but also more fundamental trends. About 20 percent of the FDI during 2006–08 was privatization-related, which is unlikely to recur. In addition, returns to FDI don’t seem very high: an annual rate of return of around 7 percent from 2007–12, compared to a 9 percent average dollar deposit rate. Restoring business confidence and further improving the business environment are critical for FDI recovery. The NBG decision to increase liquidity requirements for nonresident deposits, which will become effective later this year, should also help reduce financing vulnerability.

Net foreign liabilities remain high but have long maturity. Georgia’s NFL position has been around 100 percent of GDP since 2009, but more than 85 percent of this is in the form of FDI and long-term concessional loans borrowed by the government. However, if financing quality keeps worsening and the current account deficit stays high, the large net external liabilities will be difficult to sustain.

Strengthening the international reserve position could provide better protection. At end-2012, official reserves were broadly adequate, equivalent to 102 percent of short-term debt at remaining maturity, 3.7 months of imports, or 144 percent using the IMF’s composite metric. However, reserves are expected to decrease slightly in 2013–14 due to repayments to the Fund. More active reserve accumulation, as currently being implemented by NBG, is recommended to address these concerns and is also consistent with the finding of overvaluation.

Risk Assessment Matrix1
Nature/source of riskLikelihood of realization in the

next three years
Expected impact on the economy if risk is

realized
Short-term: Financial stress in the Euro area re-emerges (triggered by stalled or incomplete delivery of national and Euro area policy commitments)



Medium-term: Protracted period of slower European growth (larger than expected deleveraging or negative surprise on potential growth)
Staff assessment: Medium (financial stress in Euro area) and High (slower European growth)

The resulting impact on Euro-area growth would likely spillover to Russia and the region.
Staff assessment: Low to Medium Georgia would likely be affected primarily through the trade and external roll-over channels and, to a lesser extent by the FDI and remittance channels. A protracted slowdown would reduce the gains expected from the opening of Russian markets to Georgian goods.
Global oil price shock triggered by geopolitical events (driving oil prices to $140 per barrel)Staff assessment: LowStaff assessment: Medium

Reserves should be sufficient to address an immediate shock, but a prolonged shock would likely require adjustment. The trade impact of such a shock would be partly offset by the spillovers of the positive impact on the Russian economy.
Disorderly external adjustment in Georgia (the external current account deficit remains a source of vulnerability)

Emerging Markets capital flow reversal(associated with a strong unwinding of asset price overvaluation in some countries)
Staff assessment: Medium

A postponement of the external adjustment would result in a further increase of Georgia’s already high foreign liabilities and could result in a sudden stop in capital inflows. Such a sudden stop could also be triggered by a reversal of capital flows to emerging markets.
Staff assessment: Medium

Financing from international reserves and available under the SBA/SCF would need to be complemented by policy and exchange rate adjustment. NBG’s stepped-up purchases on the FX market measures to contain nonresident inflows should mitigate these risks.
Political unrest ahead of the October elections(tension between the governmental majority and the opposition could flare up ahead of the elections)Staff assessment: Medium

Such tensions could prompt the government to increase spending ahead of the elections and to make populist electoral promises.
Staff assessment: Low to Medium

The macroeconomic impact could be long-lasting if the government delivers on populist promises following the elections.
Political uncertainty as a result of the elections(the October presidential election could result in a new cohabitation)Staff assessment: Low to Medium

While the government seems to enjoy strong ratings, the 2012 general elections have shown the difficulty of predicting election results in Georgia.
Staff assessment: Low to Medium

Prolonged uncertainty and a new cohabitation could dent further investor confidence.

This matrix reflects staff views on the source of risks and overall level of concerns as of the time of discussions with the authorities.

This matrix reflects staff views on the source of risks and overall level of concerns as of the time of discussions with the authorities.

C. Structural Reforms to Boost Growth and Competitiveness

25. The authorities agreed on the importance of structural reforms if Georgia is to sustain strong growth. Demographic trends point to a declining labor force, so economic growth will need to rely on capital accumulation but especially TFP gains (around 3-4 percent annually), which will hinge on the following structural reforms:

  • Vocational training to reduce skill mismatches. Reallocation of workers away from subsistence agriculture to higher productivity sectors could generate large TFP increases, as could increase agricultural productivity.

  • Enlarging market size by increasing the Georgian products’ competitiveness and improving access to foreign markets, including through free trade agreements.

  • Encouraging private savings by developing local capital markets, creating contributory pension systems and ensuring macro-economic stability.

  • Strengthening property rights through an independent judiciary that fairly enforces the rule of law, and creation of a competition agency to combat domestic monopolies.

26. To realize Georgia’s huge economic potential in energy, the mission (working with the World Bank) encouraged the government to focus on establishing transparent and fair “rules of the game” (Box 3). The mission questioned recent electricity tariff reductions (negotiated directly with distributors) as these would seem to lower distribution company profitability (unless there is some side-benefit) and could undermine future investment in the energy sector. The authorities emphasized that the distribution companies had agreed with the tariff cuts; investment in the sector would not be affected as there was no room for potential entrants in distribution. The authorities agreed that publishing the contracts would help assuage the mission’s concerns but they would need the companies’ consent to do so. With the World Bank, the mission encouraged the economics ministries to develop an energy policy strategy that would strengthen the regulatory framework, including how prices are set and rules for transmission line access. This would encourage new hydropower investment (three proposed large projects have an estimated cost of around 15 percent of GDP) and could lessen the need for issuing government guarantees. While willing to consider developing a strategy, the Ministry of Energy did not exclude the need to issue PPA guarantees for strategic projects (such as Nenskra, which they consider vital to Georgia’s energy independence).

Box 3.Georgia: Electricity Sector

The hydropower sector is of significant macroeconomic importance in Georgia. Harnessing this domestic source of cheap energy will be critical for sustaining high growth, reducing external energy dependence, and improving the current account balance. This requires sector reforms and investment. If attracting private investment in large hydro projects requires government-backed power purchase agreements, they need to be structured properly to ensure sufficient risk transfer to the private sector and contain public sector risks.

Georgia has large hydropower resources. Water flow patterns make hydropower generation seasonal. Summer surpluses are exported to Russia or Turkey, while winter shortfalls are covered by electricity from gas-based thermal stations and imports. Hydro stations generate about 75 percent of annual output while summer exports offset winter imports.

Growing domestic consumption will lead to higher imports unless matched by increased hydropower capacity. Domestic consumption has outpaced production in recent years. Electricity imports have increased, with Georgia becoming a net electricity importer in 2012 for the first time in almost a decade. Moreover, while higher-cost gas-based generation increased, hydro generation fell. Reversing these trends, which have contributed to a worsening of Georgia’s current account deficit, requires fuller utilization of its hydro potential.

Georgia: Electricity Balance, 2012, million KWh

Higher prices and large summer demand make Turkey an attractive export market. The Turkish market, where wholesale prices are more than 30 percent higher than in Georgia, is expected to grow rapidly, about 7 percent annually. The soon to be launched high-capacity power transmission line from Georgia to Turkey will link the countries’ grids and could boost exports of Georgian electricity.

Hydropower generation costs are set to increase over time. The average generation cost in Georgia is currently low thanks to the fully amortized old hydropower stations. The largest, the half-century old state-owned Enguri plant, accounts for 32 percent of total generation with a very low price of less than 1 US$ cent per kWh. In comparison, electricity generated by new hydro stations would cost approximately 6 US$ cents per kWh. While still internationally competitive, the average generation cost is expected to increase as the share of electricity generated by the already amortized hydropower stations declines.

Recent tariff cuts may undermine investor interest in the sector. Tariffs were cut for low-end consumers in January and again in April, by about 25 percent. To help distribution companies offset the cost, they were allowed to purchase more of Enguri’s cheap electricity. While agreed with distributors, the cut in tariffs went against the inevitable upward trend in the average generation cost. This could potentially undermine trust in the regulatory framework and discourage investment.

The sector needs investment and reforms to meet domestic demand and tap export markets. The electricity sector underwent serious reforms in the past decade. Its liberalization, especially unbundling and privatization of key assets, led to significant improvements in performance: losses were reduced, payment discipline strengthened, and the reliability of electricity supply improved. Further progress will depend on the success of reforms to strengthen the regulatory framework, make price-setting transparent and clear, improve access to the Turkish electricity market, and develop transparent rules for transmission line access.

27. The mission urged the government to clarify the objectives of the various investment funds it is establishing, and to align their governance with international best practice. The authorities have hired an independent adviser to improve governance of the Partnership Fund, which will retain its mandate of using minority financing to catalyze commercially viable projects. The mission urged the authorities to clarify the objectives, governance structure and size of the Agricultural Development Fund (which is expected to disburse around 0.8 percent of GDP in 2013), and the Private Equity Fund (planned size US$3 billion or 20 percent of GDP). It was still not clear what market imperfections the funds were addressing. The mission encouraged the authorities to carefully design the governance of these funds, to ensure that projects sponsored by these funds will not receive preferential treatment, and to avoid appearances of conflicts of interest. The authorities indicated they would provide more information on these funds soon, and ensure they follow best practice in terms of governance.

28. The mission welcomed the government’s focus on agriculture but encouraged the authorities to complement greater financial support with sector reforms. The government is improving irrigation infrastructure and trying to complete the land registry. The Agriculture Fund has distributed vouchers to small farmers to finance seed and fertilizer purchases. Though some vouchers may have been misused and traded, and allegations of misspending by officials led to the Agriculture Minister’s resignation, the result has been a doubling in the area of land under cultivation. In cooperation with commercial banks, the Fund has developed interest-subsidy lending schemes for farmers and for investment in agro-processing.

29. Recent revisions to the Labor Code could make growth more inclusive. An election commitment, the revised code requires employers to pay overtime, increases severance pay (to 1–2 month’s salary), strengthens workers’ rights to challenge employer’s decisions in courts, prohibits firing without clear reasons for dismissal, and guarantees basic working conditions. These changes may increase employer costs (unless overtime pay is offset by a reduction in the basic hourly wage), but should help boost employee morale and productivity and bring labor regulations closer to commitments under the prospective Association and DCFT agreements with EU. While, on balance, welcoming the proposed Labor Code revisions, the mission noted that delays in drafting and the changing government position on the content had added to business uncertainty.

D. New Government’s Social Policies

30. The new government has ambitious plans to match better economic performance with improved social outcomes. The mission discussed these plans with the authorities, given past problems achieving inclusive growth, and because spending on these reforms form a large part of the 2013 budget (an extra 3 percent of GDP).

31. The mission welcomed the government’s plans to introduce universal healthcare system (extra 1 percent of GDP cost in the 2013 budget) but cautioned on implementation risks. While government health spending as a share of GDP is low in Georgia, total health spending is quite high. The mission agreed the planned health care reform could help reduce Georgia’s very high private health costs (and so reduce the risk of individual financial distress) and improve health outcomes. However, the proposed reforms would still leave sizeable co-payments for drugs and left the future role for private insurers unclear. The authorities acknowledged that the speed of reform could create implementation risks, in particular at the outset, and were cooperating closely with the World Bank and WHO to overcome these. The authorities expected the Social Service Agency would achieve major cost savings through centralized procedures and better control of medical services.

32. The mission welcomed the authorities’ plans to improve educational quality and vocational training. The government plans major reforms to address skills mismatches (promoting tertiary education in mathematics and financing new science faculties) and lack of skills, for instance in agriculture. The government has recently made pre-school free, but low quality and bad infrastructure means enrollment has been poor. Teacher salaries have been increased by GEL 60-205 per month (depending on performance) to an average of GEL 413 (US$250) per month, according to the World Bank.

33. Because they are universal rather than targeted, proposed increases in social expenditures might be less effective in reducing inequality. Staff acknowledged the planned reforms and spending increases should improve health, education, and - to some extent - poverty outcomes. However, 80 percent of the new spending is on universal transfers and so may have limited effects on inequality. New health insurance should benefit the (lower) middle classes most, as socially vulnerable households are already covered. Pension increases are completely universal given the flat benefit and no contribution scheme. Instead of doubling the monthly TSA allowance, the mission and the World Bank would have recommended broadening coverage (30 percent of the population still lives below the US$2 poverty line). To lower inequality, the mission suggested complementing these measures with revenue reforms - for example, by making personal income tax more progressive.

E. Monetary and Financial Sector Reform

34. The NBG continues to improve monetary operations and Georgia’s inflation targeting framework. Improvements in monetary operations have seen interbank, NBG CD, and Treasury rates more closely aligned with the policy rate over the last two years. The mission welcomed the NBG’s efforts to improve its forecasting capabilities and to increase transparency by strengthening its communication strategy with an upgraded inflation report and press conferences that discuss economic forecasts and monetary policy performance. The mission recommended these events follow a pre-announced schedule, to improve transparency and accountability, and strongly stressed the importance of preserving the independence of the NBG.

35. Despite these improvements, the mission also discussed possible further refinements to the inflation targeting regime:

  • The mission supported the NBG’s initiatives to strengthen the monetary policy transmission mechanism and to encourage de-dollarization of the financial sector, including the recent

  • introduction of floating-rate lari loans by banks, and the authorities’ goal of developing the corporate bond market and the stock market.

  • Despite price deflation, both sides agreed there was little benefit to lowering the inflation target. For the medium term, staff concurred with the authorities that a relatively high target for headline inflation might need to be retained given Balassa-Samuelson effects plus the difficulty of hitting any specific point target given Georgia’s inflation volatility and weaknesses in the transmission mechanism.

  • Despite recent stability against the dollar, the NBG reiterated its commitment to a floating exchange rate. The mission agreed that recent foreign exchange purchases help address the need to build reserves, resist overvaluation pressures, and avoid further deflation. The true test would come were the lari to face depreciating pressures.

36. The NBG reports that the financial system continues to retain comfortable levels of capital and liquidity (Table 6 and Figure 6). As of April, the system’s capital adequacy ratio (NBG measure) was 18 percent and the liquidity ratio 41 percent, both comfortably above minimum requirements (of 12 and 30 percent). Even though NPLs increased at end-2012, banking sector profitability has been stable so far in 2013, which the NBG argued was due to banks provisioning for these ahead of time. Moreover, the NBG explained that the increase in NPLs reflected idiosyncratic events affecting corporate loans and do not pose financial stability risks given buffers and profits in the banking sector.

Table 6.Georgia: Selected Monetary and Financial Soundness Indicators, 2007–13
2007200820092010201120122013
Dec.Dec.Dec.Dec.Dec.Dec.Mar.
Deposit dollarization (residents and non-residents, in percent)66.174.871.868.663.366.066.7
Deposit dollarization (residents, in percent)62.372.668.865.058.660.460.9
Loan-to-deposit ratio (in percent)130.7155.9124.2107.6105.3106.7104.2
Credit-to-GDP ratio (in percent)27.431.729.029.931.733.333.3
Capital adequacy ratio (in percent) 1/16.013.919.117.417.117.017.7
Capital adequacy ratio (in percent) 2/30.024.025.623.625.625.326.5
Liquidity ratio (in percent) 3/37.228.339.138.737.339.841.5
Nonperforming loans (in percent of total loans) 4/2.612.817.912.58.69.39.5
Nonperforming loans (in percent of total loans) 5/0.84.16.35.44.63.74.5
Loans collateralized by real estate (in percent of total loans)43.843.655.547.553.450.650.8
Loans in foreign exchange (in percent of total loans)68.672.876.974.068.867.566.9
Specific provisions (in percent of total loans)1.76.09.76.54.64.64.8
Net foreign assets (in percent of total as sets)−17.7−19.6−14.9−8.2−13.7−19.7−19.5
Net open foreign exchange position (in percent of regulatory capital)5.01.71.88.15.93.33.3
Return on equity (cumulative through the year, annualized) 6/9.6−12.4−4.39.617.35.810.5
Borrowed funds from abroad-to-GDP ratio 7/9.512.711.612.29.411.49.5
Sources: National Bank of Georgia; and IMF staff estimates.

National definition. Risk weight to forex loans was reduced from 200 to 175 percent in September 2008, and to 150 percent in August 2009, and raised to 175 percent in January 2011.

Basel I definition.

Ratio of liquid assets to all deposits plus other liabilities with 6-month and shorter maturity.

National definition: NPLs are defined as loans in substandard, doubtful, and loss loan categories.

Standard 90-day overdue definition.

Pre-tax.

Borrowed funds include subordinated debt.

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

National definition. Risk weight to forex loans was reduced from 200 to 175 percent in September 2008, and to 150 percent in August 2009, and raised to 175 percent in January 2011.

Basel I definition.

Ratio of liquid assets to all deposits plus other liabilities with 6-month and shorter maturity.

National definition: NPLs are defined as loans in substandard, doubtful, and loss loan categories.

Standard 90-day overdue definition.

Pre-tax.

Borrowed funds include subordinated debt.

37. The mission stressed the risks arising from nonresident deposits, which have become a significant source of funding for banks. Dollarization, at around two-thirds of loans and deposits, continues to pose the main risk to the financial sector. The NBG noted that an increasing fraction of the nonresident deposits were only withdrawable at maturity. New supervisory measures (the end-June 2013 new liquidity requirement for nonresident deposits; liquidity coverage ratio adoption, with assumed higher outflow rates for FX deposits than without taking into account currency denomination by end-2013; and capital add-ons for FX lending risks in 2013 stress tests) should help discourage nonresident deposits and dollarization. Staff supported the NBG’s vision to further deepen the financial sector by developing the local corporate bond and stock markets, for which pension reform would be helpful. These measures, together with maintaining financial sector stability, could also help encourage private savings.

38. The NBG has completed a self-assessment of its banking supervision framework and will share it with staff in the coming weeks. The mission discussed with the NBG and its ADB consultant its current transition to risk-based supervision. The NBG is currently fine tuning the process of submission and review of bank ICAAP forms to better monitor banks’ risk analysis. The mission expressed concern over the removal of insurance supervision from the NBG, but also over delays in establishing a new insurance supervisory body. To maintain the quality of NBG supervision, staff stressed the importance of maintaining competitive salaries. Staff noted the authorities’ request for an FSAP, and hoped that it could start in the coming year.

Staff Appraisal

39. Georgia’s economic performance has continued to be strong, despite a recent slowdown. Real GDP growth averaged 6½ percent in 2011–12, about 1½ percentage points more than projected at the 2011 Article IV consultation. Unemployment has fallen slightly, from more than 16 percent in 2010 to 15 percent in 2012, but remains high. Inflation has fallen steadily, reflecting lower food prices, lagged effects of the appreciation of the nominal effective exchange rate, and cuts in administered energy prices. The exchange rate has faced appreciation pressures but has been kept stable against the US dollar. However, political uncertainty in the run up to the October 2012 elections, policy uncertainty, government under-spending after the elections, and a lackluster global environment have contributed to a marked economic slowdown and the persistence of inflation well below its medium-term target.

40. Georgia needs to overcome a number of challenges to continue this strong performance. In addition to making sure the recent slowdown proves only a temporary pause, these include the need to sustain strong growth while making it more inclusive, reduce the current account deficit to levels consistent with external sustainability, and address structural weaknesses, including in terms of governance and rule of law.

41. Reluctance to recognize that growth in 2013 may be lower than expected has delayed consideration of the causes of the slowdown and the appropriate policy response. This delay could prove costly if the slowdown turns out to be more protracted than the authorities have expected. Earlier acknowledgement that growth may be lower, together with policy measures, would enhance the government’s credibility, increase business confidence, and help support growth.

42. In the short term, more expansionary fiscal and monetary policies are needed to support recovery. The government needs to address the causes of recent budget under-spending, to make sure spending recovers later in the year. Given the fall in inflation and the current account deficit, there could be scope for allowing a higher budget deficit in the near term, to the extent that revenues are lower due to the slowdown. Further monetary loosening also appears warranted, accompanied by measures to strengthen the transmission mechanism, including issuing treasury bills and depositing the proceeds long-term with commercial banks, to encourage longer-term lari lending.

43. Greater clarity and improved communication of economic policies can reduce business uncertainty. While many of the goals of the new government’s reforms are welcome, insufficient detail on major policy initiatives has increased uncertainty. Combined with political tensions, this has deterred private investment, adding to the economic slowdown. The adoption of the Labor Code revisions removes one of the key sources of investor uncertainty, while striking a better balance between the interests of employers and employees, to improve welfare and enhance productivity. The government should also clarify the role and improve the governance of the different investment funds it intends to establish, as well as the barriers to investment they are designed to overcome.

44. Greater cooperation between the government and the central bank is also essential for recovery. The NBG’s moves towards greater transparency, by improving the inflation report and launching regular meetings to explain inflation developments and reasons behind interest rate decisions, are welcome. However, further cooperation between the NBG and the Ministry of Finance, in a way that preserves central bank independence, would make it easier to discuss the slowdown, and to devise a coordinated monetary and fiscal policy response for recovery.

45. Over the medium term, Georgia’s main macroeconomic challenge remains to gradually reduce its current account deficit and foreign indebtedness. Though welcome, the recent decline in the current account appears largely cyclical. To ensure external sustainability, and to strengthen the economy’s resilience to external shocks, the government should aim to gradually lower the current account deficit to around 6 percent of GDP in the medium term through continued fiscal consolidation, higher private saving (through pension reform and deepening of local financial markets), exchange rate adjustment, and structural reforms to improve competitiveness. Continuing reserve accumulation is recommended given the exchange rate overvaluation. The authorities also need to continue to take steps to reduce dollarization, both through regulatory measures and, more permanently, by improving Georgia’s economic and political fundamentals.

46. The government’s agenda of more inclusive growth is welcome, but increased social expenditures might have been better targeted. Substantial increases in social and agricultural spending should help address Georgia’s problems of relatively high poverty, inequality, and unemployment. However, rapid introduction of universal healthcare system may run into implementation delays, and does not seem to address the problem of high drug costs, a main cause of risk and impoverishment. In line with World Bank recommendations, coverage of targeted social assistance might also have been broadened.

47. The authorities’ commitment to tackle structural impediments to growth is welcome. Addressing skill mismatches, opening up foreign markets to Georgian products and improving their competitiveness, strengthening property rights and the rule of law, and promoting competition should build on the previous government’s record in improving the business environment and fighting low level corruption. In the energy sector, the government should aim at establishing transparent and fair rules, monitored by an independent regulator. This would lessen the need to provide investors with guarantees.

48. The staff recommends that the next Article IV consultation be held in accordance with the September 28, 2010 Decision on Article IV Consultation Cycles, as amended.

Table 7.Georgia: Public Sector Debt Sustainability Framework, 2008–18(In percent of GDP, unless otherwise indicated)
ActualProjections
20082009201020112012201320142015201620172018Debt-stabilizing

primary

balance 9/
1Baseline: Public sector debt 1/27.637.339.233.832.331.831.831.130.128.827.3−1.5
o/w foreign-currency denominated23.531.733.628.827.626.826.325.223.922.320.7
2Change in public sector debt6.09.71.9−5.4−1.5−0.50.0−0.7−1.1−1.3−1.5
3Identified debt-creating flows (4+7+12)1.09.12.0−5.4−0.61.5−0.9−1.6−1.7−1.8−1.6
4Primary deficit5.78.25.62.42.02.21.40.90.60.50.5
5Revenue and grants30.729.328.328.228.828.127.927.928.028.128.0
6Primary (noninterest) expenditure36.437.533.930.730.930.329.228.828.628.528.5
7Automatic debt dynamics 2/−1.02.9−2.5−6.3−1.6−0.1−2.1−2.3−2.2−2.1−2.0
8Contribution from interest rate/growth differential 3/−1.72.6−4.0−4.6−1.3−0.1−2.1−2.3−2.2−2.1−2.0
9Of which contribution from real interest rate−1.31.5−1.9−2.20.61.1−0.2−0.6−0.6−0.5−0.5
10Of which contribution from real GDP growth−0.41.1−2.0−2.4−1.9−1.2−1.9−1.7−1.7−1.6−1.5
11Contribution from exchange rate depreciation 4/0.70.31.5−1.7−0.2
12Other identified debt-creating flows−3.7−2.0−1.1−1.6−1.1−0.6−0.2−0.2−0.1−0.10.0
13Privatization receipts (negative)−3.7−2.0−1.1−1.6−1.1−0.6−0.2−0.2−0.1−0.10.0
14Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
15Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
16Residual, including asset changes (2-3) 5/5.00.6−0.20.0−0.8−2.01.00.90.70.40.1
Public sector debt-to-revenue ratio 1/89.9127.4138.5119.6112.0113.1114.2111.6107.5102.497.4
Gross financing need 6/6.910.18.69.05.57.46.76.46.56.97.3
In billions of U.S. dollars0.81.11.01.30.91.21.11.21.31.51.8
Scenario with key variables at their historical averages 7/31.832.633.333.834.134.2−2.7
Scenario with no policy change (constant primary balance) in 2013-201831.832.633.233.533.833.8−1.9
Key Macroeconomic and Fiscal Assumptions Underlying Baseline10-Year Historical Average10-Year Standard Deviation
Real GDP growth (in percent)2.3−3.86.37.26.16.64.74.06.66.06.06.06.0
Average nominal interest rate on public debt (in percent) 8/3.33.33.13.53.13.10.33.73.63.73.83.94.0
Average real interest rate (nominal rate minus change in GDP deflator, in percent)−6.45.3−5.5−6.01.9−3.44.93.5−0.4−1.8−1.7−1.6−1.5
Inflation rate (GDP deflator, in percent)9.7−2.08.59.51.26.54.10.24.05.55.55.55.5
Growth of real primary spending (deflated by GDP deflator, in percent)11.4−0.9−4.0−3.06.813.617.32.12.84.65.25.65.9
Primary deficit5.78.25.62.42.03.03.52.21.40.90.60.50.5

Public sector debt includes general government debt and liabilities of NBG to IMF, and it does not include SOE’s debt. It is reported on a gross basis.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; ande = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flow s) remain at the level of the last projection year.

Public sector debt includes general government debt and liabilities of NBG to IMF, and it does not include SOE’s debt. It is reported on a gross basis.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; ande = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flow s) remain at the level of the last projection year.

Figure 7.Georgia: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Sources: International Monetary Fund; country desk data; and IMF staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks.

2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.

3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2014, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Table 8.Georgia: External Debt Sustainability Framework, 2008–18 1/(In percent of GDP, unless otherwise indicated)
ActualProjections
20082009201020112012201320142015201620172018Debt-stabilizing

non-interest

current account 7/
1Baseline: External debt44.558.762.958.963.463.561.061.059.753.951.2−7.4
2Change in external debt5.714.24.2−4.04.50.0−2.50.0−1.3−5.8−2.7
3Identified external debt-creating flows (4+8+9)3.012.60.0−5.72.72.5−0.7−1.4−2.0−2.2−2.2
4Current account deficit, excluding interest payments19.87.67.510.28.45.94.44.13.53.53.6
5Deficit in balance of goods and services29.819.117.819.019.717.115.314.513.212.511.8
6Exports28.829.834.936.538.240.440.540.740.339.939.5
7Imports58.648.952.755.557.857.555.855.253.552.351.3
8Net non-debt creating capital inflows (negative)−11.1−6.3−5.8−6.2−3.6−4.2−4.4−5.0−5.1−5.2−5.3
9Automatic debt dynamics 2/−5.711.3−1.7−9.6−2.10.8−0.6−0.4−0.4−0.5−0.5
10Contribution from nominal interest rate2.22.92.72.63.13.33.33.02.92.82.5
11Contribution from real GDP growth−0.72.0−3.4−3.6−3.3−2.4−3.9−3.4−3.4−3.3−3.0
12Contribution from price and exchange rate changes 3/−7.26.4−1.0−8.6−1.9
13Residual, incl. change in gross foreign assets (2-3) 4/2.71.64.21.71.8−2.5−1.81.40.8−3.6−0.4
External debt-to-exports ratio (in percent)154.3197.1180.3161.6166.2157.0150.4149.7148.3135.2129.7
Gross external financing need (in billions of US dollars) 5/3.82.62.53.54.24.34.13.94.04.54.5
in percent of GDP29.724.221.624.026.610-Year10-Year26.423.821.119.620.418.5
Scenario with key variables at their historical averages 6/63.556.753.952.047.044.7−13.9
Key Macroeconomic Assumptions Underlying BaselineHistorical AverageStandard Deviation
Real GDP growth (in percent)2.3−3.86.37.26.16.64.74.06.66.06.06.06.0
GDP deflator in US dollars (change in percent)22.9−12.51.715.73.310.010.7−1.0−0.30.72.93.13.2
Nominal external interest rate (in percent)7.25.55.05.15.74.61.45.35.65.25.35.15.0
Growth of exports (US dollar terms, in percent)15.9−13.026.629.614.820.313.39.06.67.27.88.28.4
Growth of imports (US dollar terms, in percent)26.8−29.816.530.514.322.019.52.33.25.65.67.07.2
Current account balance, excluding interest payments−19.8−7.6−7.5−10.2−8.4−11.04.8−5.9−4.4−4.1−3.5−3.5−3.6
Net non-debt creating capital inflows11.16.35.86.23.69.14.14.24.45.05.15.25.3

The external debt does not include inter-company loans.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

The external debt does not include inter-company loans.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 8.Georgia: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and IMF staff estimates.

1/ The external debt does not include inter-company loans. Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2014.

The change in government and the time necessary to form a new economic team explain the slight delay in the Article IV consultation.

Subsequent to the mission, on June 19 the NBG cut its policy rate a further 25 basis points, from 4.25 to 4 percent.

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