1. The Stand-By Arrangements is part of a comprehensive socio-economic strategy in close cooperation with the EU and international financial institutions.
In its document “Georgia 2020”, the government of Georgia has formulated its medium-term economic and social objectives. It is implementing a comprehensive and coherent economic policy strategy to achieve its ambitious socio-economic goals. Political and economic integration with the EU is a cornerstone of Georgia’s strategy. Close cooperation and financial support from the World Bank, the EBRD and the Asian Development Bank are integral parts of the strategy. So is the Stand-By Arrangement with the Fund. It will enhance credibility of the government’s macroeconomic policies and strengthen the country’s balance-of-payments position.
The goal is robust sustainable inclusive economic growth of 6 percent annually that benefits all layers of the population. Specific measures are identified to improve the environment for private sector development, human capital and the financing of enterprises.
On June 27 2014, Georgia has signed an association agreement with the EU. It also provides for a Deep and Comprehensive Free Trade Area (DCFTA). This agreement is of prime strategic importance for Georgia. It will deepen political and economic relations with the EU. It will enable Georgia to gradually integrate its economy in the EU’s internal market, the largest single market in the world. This agreement requires that Georgia implements, with the support of the EU, core structural reforms in areas such as public governance, justice, law enforcement, consumer protection, and sectors such as energy, transport, environmental protection, industrial development, social protection and education. Under the DCFTA Georgia will modernize its trade relations and develop its economy through the progressive removal of custom duties, tariffs and quotas, and harmonizing laws, norms and regulations in various trade related sectors. The agreement will also facilitate investment. This is particularly important for Georgia which needs further foreign investment to boost its economic growth. All this will allow the Georgian economy to catch up with the EU and the rest of the world in terms of competitiveness. The most sensitive sectors of the Georgian economy will benefit from sufficiently long transition periods to ensure the smooth adaptation of Georgia’s economy.
Georgia will receive macrofinancial assistance from the EU once it makes purchases under the Fund arrangement. The negotiations on the MOU with the EU for this financial support are well advanced. Depending on the speed of subsequent internal EU procedures, a first tranche of euro 23 million may become available by mid-October 2014.
On May 8, 2014, the World Bank adopted its country partnership strategy for Georgia for the next three years. This strategy aims at supporting (a) social sector programs in a fiscally sustainable way, in particular improving the effectiveness and efficiency of public services that reduce extreme poverty and boost shared prosperity; (b) enabling private sector-led job creation through improved competitiveness. In the current fiscal year, the remaining IDA allocation of US$ 71 million will be fully used. It may be complemented by US$ 325 million IBRD lending. For next years the indicative IBRD lending envelope for Georgia is almost US$ 300 million per year. In addition, subject to market demand and available viable investments, IFC is planning investments between US$ 250 million and US$ 350 million with the goal of mobilizing additional financing from the private sector and other IFIs.
The EBRD’s latest lending and investment strategy for Georgia has been adopted in September 2013. It supports the government’s structural reform policies by fostering private investment, reforming the energy sector and supporting Georgia’s regional and economic integration. With a cumulative investment commitment of euro 1.9 billion, and an outstanding portfolio of euro 550 million, the EBRD remains committed to further support the Georgian economy with significant amounts of financing which are for about 80 percent supporting private sector projects.
With a loan portfolio of US$ 1.35 billion, mainly in the transportation and ICT sectors, the ADB is an important development partner of Georgia. The SBA with the Fund will facilitate additional ADB lending to Georgia.
Obviously, a Stand-By arrangement with the Fund will provide for a stable macroeconomic framework on which the success of the financing and investments by other IFIs and private investors depends.
2. The program’s macroeconomic framework.
The Georgian authorities have formulated their macroeconomic objectives and policies in their Letter of Intent.
The authorities estimate that, thanks to the structural reforms which are now being implemented, the potential growth rate is above 6 percent. However, because of uncertainties, they conservatively assume a growth rate of 5 percent for this and the next year.
The public debt ratio which might reach almost 34 percent of GDP this year should steadily decline over the medium-term towards 31 percent after 5 years. This requires that the budget deficit estimated at 3.7 percent of GDP this year, declines steadily to 2.5 percent of GDP over the course of the 3-year program period.
With improved external competitiveness, the current account deficit, projected to reach 8.4 percent of GDP for this year, would gradually decline to 5 percent of GDP over the next five years.
With inward foreign direct investment conservatively estimated at 6 percent of GDP, the country’s relatively high level of external debt is scheduled to drop by 10 percent of GDP over the next 5 years, to reach about 56 percent of GDP, excluding inter-company loans. At the same time, under a flexible exchange rate regime, gross international reserves should steadily rise from a low level of US$ 2.7 billion this year to US$ 4.8 billion over the next 5 years thereby increasing the import coverage from 3 months now to 4 months.
Lastly, the central bank will target a stable, moderately low inflation rate of 5 percent over the next 3 years horizon.
We will now succinctly review in some more detail macroeconomic policies on the basis of which the authorities request the Fund’s financial support.
3. Fiscal policy.
Keeping public debt comfortably below 40 percent of GDP is the overarching objective of fiscal policy. In fact, under the program’s baseline scenario, the public debt to GDP ratio is projected to decline to about 31 percent by 2019. This will build room for countercyclical policies and allow for reducing the trade deficit.
To reach this ambitious goal the government has taken measures to reduce this year’s budget deficit from 3.9 percent to 3.7 percent of GDP. The government has already specified all needed fiscal measures to reduce the 2015 fiscal deficit to no more than 3 percent of GDP.
The fiscal expansion of the current fiscal year mainly reflects increased spending on targeted social assistance from 1 percent to 1.8 percent of GDP as part of the government’s commitment to make sure that the benefits of economic growth are shared more widely.
In the face of a more difficult environment created by the slowdown in Russia and the crisis in Ukraine, two important trading partners of Georgia, and, as far as Russia is concerned, the main source of remittances, the government considered it necessary and the staff agreed, to avoid a sharp drop in domestic demand which would be caused by an aggressive reversal of the fiscal expansion.
However, in order to secure a prudent fiscal stance and positive public debt dynamics, the program outlines all necessary measures to secure a 0.7 percent of GDP fiscal consolidation in 2015. These measures are primarily based on containing current spending, supported by specific revenue measures.
After an overall growth of social expenditures of well over 20 percent in 2014, in 2015 social benefits will be kept constant in nominal or real terms, depending on the category of the benefit.
Spending on goods and services, wages and salaries will also be kept constant in real terms. As a revenue measure, increased excises on cigarettes should generate revenues equal to 0.2 percent of GDP.
These planned measures generate sufficient savings to secure the needed fiscal consolidation in 2015 while also creating room for additional public spending to enhance the economic potential.
Reaching agreement on the government’s draft 2015 budget that includes all necessary measures to secure a deficit of no more than 3 percent of GDP in 2015 will be an important topic of the first review scheduled for October/December 2014.
To keep the decline of public debt ratio on the intended trajectory, the government will handle the assumption of contingent liability with great care. The government currently has no plans to issue guarantees. If issuing guarantees would be considered, the government will consult with the IMF and the World Bank. Such guarantees will be included in the fiscal risk statement attached to the annual budget. In the same vein, the structure and modalities of operation of a possible public financial vehicle to facilitate private investment and improve access to finance will be such, as outlined in paragraph 16 of the LoI, that they minimize, if not exclude, risks for the budget. Here again, the government will consult with the IMF and other development partners before introducing legislation for such a public financial vehicle.
4. Monetary and Financial Sector Policies.
The National Bank of Georgia’s independence is enshrined in the constitution and its organic law. The government reaffirms in the LoI the existing strong institutional and financial independence of the NBG. At the same time, both the government and the NBG recognize the importance of consistency of their respective policies.
The NBG expects inflation to reach 5 percent by year’s end which is the new, reduced inflation target for 2015, under an enhanced inflation targeting regime and a flexible exchange rate regime.
The central bank will improve its inflation modeling and refine its communication strategy, including quarterly publication of an inflation report and press conference on a fixed schedule.
Consistent with Fund policy, the NBG will consult with the IMF staff if actual inflation deviates more than 2 percent from the target. If the deviation exceeds 3 percent, the Board will be involved in the consultation.
The NBG is planning to purchase foreign currency in the remainder of this year to boost gross reserves to US$ 2.7 billion by the end of 2014, assuming that there are no depreciation pressures by the time of purchases.
At about 60 percent, both loan and deposit dollarization is still high, even if it is gradually being reduced. The program of placing long-term government deposits with commercial banks is helping to promote long-term Lari-lending. Additional risk-weighting on FX loans and higher reserve requirements on FX liabilities will help reduce dollarization.
A World Bank-Fund mission is updating the FSAP for Georgia. Its finalization is expected by October. The authorities and the staff will assess to what extent implementing FSAP recommendations could be included in program conditionality.
5. Structural Reform.
Georgia will implement a comprehensive set of structural reforms following the recently signed association agreement with the EU, and as part of the recently adopted Country Partnership Strategy with the World Bank. Under the requested Stand-By Arrangement, Georgia has outlined a set of macro-critical structural reforms in the areas of tax administration, public financial management and national statistics, as described in more detail in paragraphs 26 to 30 of the LoI. In each of these domains, the authorities have asked for technical assistance from the Fund. They are committed to make use of Fund TA as effectively as possible.
The other area of structural reforms as part of the Fund supported program are streamlining the business environment, with particular focus on SMEs, improving labor market matching services through a system of labor market mediation and easing access to finance for businesses, in particular SMEs.
In this connection, the authorities will conduct an assessment of access to finance for enterprises (structural benchmark for September 2014), take measures to remove market imperfections and promote domestic capital markets. Establishing a public financial vehicle to facilitate private investment to overcome market imperfections will be carefully considered in consultation with the IMF and other development partners in order to ensure its sound operation and avoiding undue fiscal risks.
6. The balance-of-Payments Outlook and Access
Georgia’s relatively large current account deficit and maturing external debt obligations result in external financing requirements exceeding US$ 2 billion annually. With continued sound economic policies, as outlined under the program, and with financing programs adopted by other IFIs and macrofinancial assistance from the EU, access under the Stand-By Arrangement can be of a catalytic nature and can be limited to SDR 100 million for the entire 3-year period. Yet, in light of the uncertainties created by Russia and Ukraine, the observed drop in exports and remittances, the rather low level of external reserves and US$ 257 million repayments to the Fund in 2014, disbursing SDR 40 million on the occasion of the approval of the program and again after the first review, would provide useful support for the balance-of-payments in 2014. In tandem with program implementation, these drawings will help bolster creditor and investor confidence.
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The authorities firmly own their policies and are strongly committed to make their cooperation with the Fund and other international partners highly successful.