Georgia
Recent Economic Developments
Author:
International Monetary Fund
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Publication Date:
01 Dec 1995
eISBN:
9781451814385
Language:
English
Keywords:
ISCR; CR; stabilization program; balance of payments; banking system; Georgian authorities; adjustment program; expenditure arrears; government restructuring; low-paid government worker; local government; NBG authority; government guideline; state system
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This paper describes economic developments in the Republic of Georgia during 1995. The paper highlights that in 1995, the economy of Georgia continues to face severe bottlenecks, especially arising from energy shortages. However, there are signs of increased confidence and a recovery in the first half of 1995, fostered by political stability and the initial fruits of financial stabilization and structural reform. In 1995, agricultural output and cargo transport appear to have increased, and retail trade is growing quickly. Industrial and construction activity, however, remains limited.

Abstract

This paper describes economic developments in the Republic of Georgia during 1995. The paper highlights that in 1995, the economy of Georgia continues to face severe bottlenecks, especially arising from energy shortages. However, there are signs of increased confidence and a recovery in the first half of 1995, fostered by political stability and the initial fruits of financial stabilization and structural reform. In 1995, agricultural output and cargo transport appear to have increased, and retail trade is growing quickly. Industrial and construction activity, however, remains limited.

I. Introduction

Georgia’s economy has begun to emerge from four years of turmoil since independence in 1991. During this period, like most other countries of the former Soviet Union (FSU), Georgia has faced severe shocks from disruptions in its traditional trade and payments relations, and sharp increases in the cost of energy imports. In addition, the country has experienced civil unrest and internal conflicts, the war in Abkhazia which created serious refugee problems, and closure or blockage of its trade routes.

By 1994, these developments had ravaged Georgia’s economy, as well as the administrative capacity of the Government and its ability to conduct economic policy. Output was perhaps one third of its level in 1990. Financial imbalances were growing at an alarming pace and the economy was in a free fall. A breakdown of fiscal discipline was at the core of the financial difficulties. Domestic disturbances and hyperinflation had sharply eroded fiscal revenues to less than 3 percent of GDP and severely undermined Government’s ability to perform its most basic functions. Despite extremely low wages, general government expenditures far exceeded revenues, resulting in the emergence of large fiscal deficits, which were financed mainly by heavy reliance on central bank credit as well as accumulation of domestic and external arrears. The unsustainable fiscal position was accompanied by an accommodating monetary policy, fueling hyperinflation of 60-70 percent per month, which, with depleted external reserves, led to sharp depreciation of the external value of the coupon and widespread currency substitution. By early 1994, the domestic currency was being used for a very limited range of transactions and coupons in circulation had fallen to less than 3 percent of GDP. The very limited acceptance of the coupon meant that any credit emission from the central bank rapidly led to a further depreciation of the exchange rate. Thus, the authorities’ ability to garner resources from seigniorage had also been exhausted.

Loss of financial and administrative discipline had other unfortunate consequences. Many non-bank financial companies operating outside the supervision of the National Bank of Georgia (NBG) soon became insolvent, and public confidence in the financial system was eroded. Many enterprises continued to operate without producing marketable products. The Government was increasingly unable to pay for goods purchased from enterprises to make in-kind payments for imports, and these enterprises, partly as a result, did not pay taxes or pay for consumption of energy imports, creating a complicated chain of domestic and external arrears. Despite a sharp decline in living standards, each sector of the economy was living beyond its means. Three years after entering independence with modest external obligations, the country had accumulated a foreign debt of almost US$1.0 billion by the end of 1994.

With improved political stability, in March 1994, the Georgian authorities began to cooperate closely with the Fund and the World Bank to address Georgia’s massive economic problems. It was in this context that they undertook to implement an ambitious program of stabilization and structural reform in support of which the Executive Board of the Fund approved two purchases (equivalent to SDR 55.5 million) under the Fund’s Systemic Transformation Facility (STF) in December 1994 and June 1995, and a stand-by arrangement in an amount equivalent to SDR 72.15 million on June 28, 1995. World Bank Institution Building and Rehabilitation Credits have also played an important role in supporting the authorities’ program.

The program called for reducing hyperinflation at an early stage through adoption of tight financial polices, removal of nearly all restrictions in the financial system, and substantive progress toward full liberalization of prices and domestic and external trade. The stabilization program was designed to break the vicious circle of widening fiscal deficits, central bank credit creation, hyperinflation and further erosion of government revenues. However, in view of the very low level of government revenues, it was essential to provide an initial injection of resources to finance the budget deficit without recourse to central bank credit. Without access to sufficient external finance--other than through incurring arrears on debt service--monetization of external food assistance and a sharp increase in the price of highly subsidized bread was to provide this initial injection of funds to the budget.

The stabilization and structural reform program encompassed a broad range of actions, supplemented by wide-ranging external technical assistance. These actions have included a more than 30 percent reduction in government employment; elimination of almost all price and enterprise subsidies; large increases in the prices of bread, gas, and electricity; increases in most taxes; measures to improve tax administration; a new central bank law and improved bank supervision; elimination of the state order system and liberalization of the trade and exchange system; steps toward normalizing relations with creditors; an end to government guarantees for energy imports; accelerated privatization; and improvements in the quality of economic statistics.

The initial success of reform has been impressive, although the situation remains fragile. Inflation has declined from a monthly average rate of 66 percent in the first three quarters of 1994 to 2.5 percent in the first 7 months of 1995. The exchange rate for the coupon appreciated against the U.S. dollar, from an unofficial rate of about coupon 5 million in September 1994 to coupon 1.3 million in late 1994, where it has been maintained in 1995. Progress so far has been made possible through a determined implementation of a credible adjustment program supported by international financial assistance. While much remains to be done, this initial success marks a very strong beginning for the rehabilitation and restructuring of the Georgian economy over the next several years.

II. The Real Economy and Structural Reform

Output has declined dramatically in the last four years. A number of structural measures have already been introduced. Prices have been liberalized, the state order system has been eliminated, and progress has been made in privatization. Already, there are signs of recovery in agriculture, transportation, and services. However, restructuring of the energy and industry sectors has just begun, and all sectors face important bottlenecks. Further progress in privatization, land reform, infrastructure rehabilitation, government restructuring and development of an appropriate legal framework for a market-based economy are needed for Georgia to realize its promising growth potential.

1. The output decline

Official data indicate that output in 1994 was some 70 percent lower than in 1990 (Appendix I, Table 1 and Chart 1). However, this decline is almost certainly exaggerated, because the statistics concentrate on the large state enterprises which have fared poorly, while neglecting the small, private, service sector firms which have fared better. 1/ Nevertheless, available information suggests that output has declined by at least 50 percent during this period. 2/

CHART 1.
CHART 1.

GEORGIA Macroeconomic Indicators, 1990-1995

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ Before 1993, according to the Retail Price Index; after December 1993 according to a 295-good Laspeyres index using a methodology introduced by a STA mission.

The decline occurred for many reasons. Disruptions in trade and payments relations following the collapse of the Soviet Union hit the Georgian economy hard because of its dependence on other former Soviet republics for inputs, particularly energy, and for export markets. Political instability, including the war in Abkhazia, its associated refugee problems, and civil conflicts have also affected output and internal trade, and have led to a collapse of investment (Appendix I, Table 2). Also the closure--or temporary disruptions--in important northern transport routes and the deterioration of transport and communications infrastructure have contributed to the economic decline.

In 1995, the economy continues to face severe bottlenecks, especially arising from energy shortages. However, there are signs of increased confidence and a recovery in the first half of 1995, fostered by political stability and the initial fruits of financial stabilization and structural reform.

2. Sectoral developments

In 1995, agricultural output and cargo transport appear to have increased, and retail trade is growing quickly. Industrial and construction activity, however, remains limited.

a. Agriculture

In the Soviet era, Georgia was a net agricultural importer, but was an important exporter of wine, tea, fruits and vegetables. Because the agriculture sector has not declined to the same extent as industry, it has become the largest, and now the most vibrant sector of the economy. The years of turmoil following independence adversely affected the state and collective agricultural system, more than in most FSU countries. The Government was no longer in a position to obtain inputs, such as fertilizer, seeds, and fuel, nor to deliver goods to market. 1/

After declining for four years, agriculture appears to be recovering in 1995. The acreage of the spring sowing has increased sharply (Table 1 and Appendix I, Tables 3 and 4), reflecting the restoration of law and order, effective privatization of land, increased confidence in the economy, and, in the case of grain, a 400-fold increase in the price of bread (Box 1).

Table 1.

Georgia: Acreage of Spring Sowing, 1991-1995

(Thousands of hectares)

article image
Source: Ministry of Agriculture.

Increased acreage sowed will not however translate entirely into higher output in 1995, as yields will remain below historical levels, partly due to inclement weather, but also because farms lack basic inputs, such as fertilizer, seeds, energy, spare parts, and animal feed. Irrigation systems have deteriorated, and water management is poor. Transport is difficult, and private markets and distribution networks have not fully developed to replace the state system. Because export markets are inaccessible, farmers are turning away from traditional high-value horticultural production, such as fruit, tea, and grapes. The Government is not yet geared toward supporting private agriculture through extension services.

The State Bread Corporation

The Bread Corporation, a state monopoly, plays a central role in Georgian economy. An increase in the bread price marked the start of Georgia’s stabilization, and the monetization of grant-in-aid wheat and flour (with the consent of the donors) remains an important source of revenue for the government budget.

The United States and the European Union generously provide wheat and flour as humanitarian assistance to Georgia. The Bread Corporation processes this food aid and distributes the bread through a system of ration cards. Before the stabilization program began, the bread was sold at an extremely low price, and budgetary support was necessary to cover the operational costs of the Bread Corporation.

The bread price was increased from coupon 700 (US$0.0003) per kilogram to coupon 200,000 (US$0.08) in September 1994, to coupon 280,000 (US$0.22) in December 1994, and to coupon 300,000 in July 1995 (US$0.23, in each case at current exchange rates). These increases were designed to bring the bread price to market levels, and leave the Bread Corporation sufficient revenues to cover its costs and reimburse the government for the value of wheat and flour consumed. The proceeds from bread sales are an important source of revenue for the government budget, and have played a critical role in the stabilization.

Georgia has begun to move toward a more market-oriented bread industry. Privatization of the Bread Corporation has begun with small bakeries, and should be two-thirds complete by the end of 1995, at which time the bread price will be liberalized. Already, 10 percent of bread is baked privately. Furthermore, increases in the bread price have led to increased domestic production of grain, as evidenced by the spring sowing, which offers encouragement that Georgia is not becoming dependent on humanitarian assistance.

The recovery of private agriculture is also impeded by weak property rights. The 1992 land reform is incomplete; half of arable land has not yet been formally privatized, although most of the remainder is effectively under private control. Tenants of privatized lands do not have basic property rights of lease, sale or inheritance, which prevents land from being used as collateral for loans. Partly as a result, little credit is available for agriculture; the Agrobank now lends more for trade and commerce than for agriculture.

Furthermore, the agroprocessing industry burdened by its own structural difficulties, may have difficulty in handling increased agricultural activity. For instance, the wine and liquor industries have faced difficulties in the procurement of grape harvest for high-value products; home production of low-value wine has increased as a means of avoiding excise taxes. Also, the tea industry cannot buy the tea harvest or the oil to process it. Production of state agroprocessing enterprises is estimated to have declined in first half of 1995 compared to the same period of the previous year. However, this sector is partially privatized, and private enterprises have reportedly done better.

Despite these difficulties, agriculture is performing better than most other sectors of the economy. Private activity is widespread and expanding. There is some evidence that the segment of the population engaged in agriculture enjoys higher living standards than others. Thus, agriculture is recovering in 1995, but that recovery will be restrained. The authorities--in collaboration with the World Bank--are preparing an agriculture sector project which would address some of these bottlenecks. The project would complete land reform, develop competitive input and output marketing systems, privatizate agricultural enterprises, develop rural financing, and improve research, education, and extension. In cooperation with the European Bank for Reconstruction and Development (EBRD), the authorities are also exploring a possible project to develop wholesale agricultural markets.

b. Energy

Georgia inherited an energy-intensive industrial sector that relied upon energy imports priced at significantly below world market levels. In addition, the efficient usage of energy was hampered by lack of infrastructure to charge most households per unit of natural gas and electricity consumed and a tradition of heavily subsidized deliveries.

Until recently the Government guaranteed payment for natural gas imports under a series of annual intergovernmental agreements. Although Georgia could not pay for imports under these agreements, it continued to receive natural gas, with only intermittent interruptions, leading to accumulation of substantial external debt and arrears, especially in 1993 and 1994 after gas import prices were increased to world market levels.

A number of far reaching steps have been taken to encourage efficient use of energy and rationalize energy trade. In April 1994, energy prices to enterprises, which had been eroded in real terms by hyperinflation, were sharply increased. A second round of increases, to bring prices close to import parity for all consumers, was implemented before the start of the Fund-supported program. These increases were to be made effective by concerted efforts to raise the very low levels of collection for energy bills. However, these efforts have been frustrated by technical obstacles to cutting off gas to individual households and the lack of gas and electricity meters. Because payments could not be obtained, natural gas was cut off to all households in Tbilisi in January 1995, and to households in other cities by April 1995. Natural gas imports have fallen sharply over the last few years from 5.5 billion cubic meters in 1990 to 3.0 billion cubic meters in 1994 to an annualized rate of 1.4 billion cubic meters in the first half of 1995 (Chart 2). Nevertheless, although most non-paying consumers no longer receive natural gas or electricity and total consumption of gas and electricity has declined, the collection rate has only reached about 7 percent for the remaining consumers.

CHART 2.
CHART 2.

GEORGIA Annual Imports of Natural Gas Billions of Cubic Meters

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ First seven months at an annual rate.

To end the cycle of non-payment, effective June 1, 1995, the Government declared the intergovernmental agreement on natural gas imports invalid, and ceased its involvement in the import of energy. A temporary credit facility was opened at the NBG to assist with gas imports. In a break with precedent, Georgia has not generated electricity from natural gas since May 1995, and has relied instead on its substantial domestic hydroelectric capacity. However, it can only continue to do so until reservoirs run low in the fall, and in the longer run, the deteriorating infrastructure for generating hydroelectricity badly needs rehabilitation. Many consumers have already turned to other privately imported power sources, such as gas cylinders, diesel generation, or gasoline. Georgia’s limited domestic production of oil, coal, and natural gas has fallen over time due to equipment and energy shortages, and depletion of resources (Appendix I, Table 5). Use of domestic wood fuel has increased sharply to unsustainable levels.

To prepare for the winter, Sakenergo is rehabilitating newer generating blocks, which had been disabled by a fire, with assistance from the German government and the EBRD. The Government is paying for rehabilitation of two older, less efficient blocks. The World Bank is also preparing an energy sector project which would support privatization of the energy companies, improved collections, cost recovery, commercial allocation of energy, rehabilitation of facilities, increased energy efficiency, and improved policy making.

c. Industry and construction

The breakup of the Soviet Union, energy price increases, and more recently closure of transport routes hit the industrial sector harder than other sectors of the Georgian economy. Industry has also suffered from its inability to purchase natural gas and, as a consequence, intermittent interruptions in energy supply. Industrial output in 1994 was at only one-fifth of the level in 1990 (Appendix I, Table 6). 1/

Many state industrial enterprises have continued to operate despite weak cash revenues. These enterprises have either produced for inventory, surrendered goods under the state order system to pay for gas from Turkmenistan, or engaged in barter with other firms. Hard-budget constraints have been imposed on public enterprises to the extent that they no longer receive subsidized credit from the banking system or the Government. Nevertheless, some enterprises have financed their operations through consumption of energy without payment and through tax and wage arrears. The Government has published a list of the 25 largest loss-making state-owned enterprises, and is preparing action plans for each. Much however remains to be accomplished in enterprise reform. Thus, industry has not undergone restructuring to the same extent as agriculture. Nonetheless, energy sector reforms will necessitate a rapid restructuring of this sector. Timely privatization and strong action in enterprise reform will be necessary to lay the groundwork for a future recovery of industry.

The construction sector has also contracted severely; numerous construction sites have not seen any activity since independence. Some construction is underway in 1995 with foreign funding (embassies) or with government funding (road and airport projects), but little privately-funded construction, other than high-value housing, is taking place.

d. Market services

Further evidence of recovery can be seen in market services, particularly in retail trade and transport. Data coverage of the retail sector is extremely poor; most turnover is in markets and kiosks, which are not covered by the traditional statistical system and avoid taxes. Nonetheless, retail trade activity appears on casual observation to have increased sharply, driven by improved law and order. While retail trade’s contribution to output should not be overstated, as it has relatively low value-added, this sector has absorbed excess labor from other sectors; many individuals sell a minimal inventory from the curbside.

Cargo transport has also increased markedly. Rail and sea transport by state enterprises increased by 38 percent and 50 percent respectively in the first half of 1995 (Appendix I, Table 7). 1/ Much of this transport represents transshipment of goods across Georgia, including delivery of humanitarian assistance to neighboring countries.

Several projects have been undertaken to improve conditions in the transport sector. The government is rehabilitating Tbilisi airport, with EBRD assistance, and has built roads to open a new border post with Turkey. The EBRD is also considering a project at the Poti port on the Black Sea. The World Bank is preparing a transport sector project which would rehabilitate the road network, restructure the railways and urban transport, rehabilitate and reorganize the ports, and upgrade air traffic control.

3. Price and wage developments

Monthly consumer price inflation in coupon terms averaged 66 percent in the first three quarters of 1994 (Appendix I, Tables 8 and 9, Chart 3). 2/ The stabilization program began in September 1994 with large administered price increases for heavily subsidized goods, including bread, gas, and electricity, which led to a sharp increase in the Consumer Price Index (CPI). In the fourth quarter, prices in coupon terms fell at a rate of 5 percent monthly as the coupon appreciated against the ruble. Coupon inflation in the first 7 months of 1995 has been held to 2.5 percent monthly.

CHART 3.
CHART 3.

GEORGIA Inflation and Exchange Rates

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ Increase means depreciation.2/ Trading on the TICEX was suspended between August 19, 1994 and September 19, 1994.3/ Measures the level of prices denominated in rubles.

Interpreting measures of inflation in Georgia is complicated by the use of multiple currencies. Purchases from the government, which account for less than 10 percent of all retail purchases, are paid for almost exclusively in coupons, while almost all other purchases are paid for in rubles or in U.S. dollars. The CPI in coupon terms, therefore, converts prices for ruble purchases to coupons at the prevailing unofficial coupon-ruble exchange rate in exchange bureaus. Likewise, the consumer price index in ruble terms converts prices for coupon purchases to rubles at the prevailing exchange rate. Thus, movements in the coupon CPI reflect primarily movements in ruble prices and the coupon-ruble exchange rate, except when coupon-denominated administered prices are adjusted by large amounts (Chart 3). Georgia does not have a producer price index.

Government wages rose considerably slower than inflation in 1993 and the first three quarters of 1994. By August 1994, inflation had reduced public wages to only one percent of their level at end-1992. The purchasing power of wages in budgetary institutions was partially restored by appreciation of the coupon in the fourth quarter of 1994, and wage increases in September 1994, January 1995, and July 1995 (Appendix I, Tables 10 and 11, and Chart 4). However, government wages remain far below levels at independence, in real terms, and below the wage levels in other FSU countries.

CHART 4.
CHART 4.

GEORGIA Real Minimum Wage and Pension 1/

(Deflated by the RPI/CPI, January 1991 = 100)

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ The minimum wage and pension were identical except where indicated.

Reliable data on private wages are not available. However, because these wages are paid in rubles, they were not devalued by depreciation of the coupon and the resulting inflation in coupon terms. Average private wages are roughly US$20-30 per month, while average public wages were raised to US$7.50 in July 1995.

4. Employment

Georgia resembled other centrally planned economies in that its pretransition labor force participation rate (74 percent of the population age 15-64) was above the OECD average. Georgia also resembled many other transition economies when it experienced sharp declines in employment early in the transition.

During 1990-1994, official data indicated that employment declined by one third, while output declined by more than half (Appendix I, Tables 12 and 13). The smaller decline in employment is the result of substantial overstaffing and the inclusion in employment data of enterprises which are operating only a fraction of the time; it is reported that 60,000 employees took forced vacations without pay at some point in 1994. Employment data fail to capture the growth in private employment. For instance, official data show a decline in employment in “Trade and other services” which has most likely expanded in 1994 and 1995. Many public sector employees supplement their low wages with second jobs in the private sector.

The decline in employment since 1990 has not led to open unemployment of the same magnitude (Appendix I, Table 14). Labor exchanges record unemployment of only about 4 percent. However, such a low recorded level can be attributed to negligible unemployment benefits--US$2 a month after an increase in July 1995--instead of underlying developments. 1/ An informal poll in May 1995 found that the unemployment rate was about 11 percent. It is likely that many persons have left the labor force by retiring, emigrating from Georgia, finding employment in unrecorded private activities, or not working.

5. Structural reforms

a. Price liberalization

Price liberalization in Georgia is nearly complete. The majority of prices were liberalized in 1992, and the only prices which remain subject to state control in 1995 are bread, gas, electricity, municipal services, pharmaceutical products, and trolley bus and subway tickets. These administered prices were raised sharply to market levels in 1994, so as to eliminate large government subsidies. The bread price will be liberalized at the end of 1995.

b. Privatization

Georgia has privatized most small enterprises, a few large enterprises, almost all of its housing stock, and half of agricultural land.

The pace of enterprise privatization, which started soon after independence, accelerated in 1994 and 1995. As of August 1995, 4,825 out of 6,500 identified small-scale enterprises had been privatized (nearly half in 1995), and privatization of the remainder should be completed by the end of 1995. 2/ These firms have been privatized through competitive tenders, auctions and direct sales. Of 1,019 medium- and large-scale enterprises, 807 had been corporatized, 425 of these have begun management/employee buyouts, and about 40 have completed this process. Use of buyouts has accelerated privatization, but has not resulted in management changes or infusion of new capital. Thirty-five percent of the shares of each joint stock company are reserved for voucher auctions, which have begun on a limited basis, and will continue through mid-1996. Revenue from privatization through August 1995 was coupon 4.4 trillion (US$3.4 million at the current exchange rate), of which small-scale enterprises accounted for 15 percent.

As mentioned above, almost half of arable land has been privatized since 1992. However, almost all agricultural land and livestock are effectively under private control. Nevertheless, a draft land law is before the Parliament which would strengthen property rights.

Privatization of many health sector services is already underway.

c. Government restructuring

In 1994, the general government (excluding state-owned enterprise) accounted for over 30 percent of national employment; of the 620,000 positions in government, nearly one third were in health and education. Hyperinflation has reduced government wages to minimal levels and made it difficult to retain qualified staff. Many government employees already ask for fees in return for services. The structure of the Government also needs to be revised, as many of its present branches will no longer be needed as Georgia moves toward a market-based economy.

The authorities have, therefore, begun to downsize and restructure the Government. As a first step, the Government cut budgetary employment across-the-board by 75,000 in the first half of 1995. Fundamental reforms have also taken place in the health sector. As an element of a health sector reform program, which has been developed in cooperation with the World Bank, the Government has moved the health sector formally to a fee-for-service basis. As a result, 132,000 health employees were removed from the budgetary payroll in August 1995. Government health expenditure will be focussed on providing a core package of services to the truly needy.

Further reforms are necessary to reduce employment in education, and eliminate ministries which no longer serve a purpose. The Government is receiving assistance from the United Nations Development Program and other international institutions and further restructuring of the Government is expected following the elections, presently scheduled for early November 1995.

d. Legal framework

Further progress is needed in development of a legal framework for a market economy, although new central bank and foreign investment laws were enacted in mid-1995. Draft laws on anti-monopoly and land are before Parliament, and draft banking and bankruptcy laws have been prepared. Enactment of these laws at an early stage will be necessary for promotion of private activities. Enactment of new laws, however, should be accompanied by improvements in enforcement and the court system.

6. Outlook for growth

Georgia’s prospects for economic growth are promising. Agriculture is recovering with significant potential for exports to neighboring countries. Tourism, once a significant industry for Georgia, should also begin to recover with improved political and economic conditions. Stability and economic recovery in the region would revive Georgia’s earnings from the transshipment of goods. Recovery prospects for large parts of the former state sector, especially the more energy-intensive enterprises, remain somewhat uncertain. However, there is substantial scope for domestic production of basic goods to recover.

III. Fiscal Developments

An impressive program of fiscal adjustment is at the core of the authorities’ stabilization program. The overall fiscal deficit has been reduced through revenue measures, monetization of external food assistance, and sharp cuts in expenditures, including elimination of subsidies. Adjustment measures and external financing have minimized the monetary impact of central bank financing of the budget deficit. However, revenue performance is very weak and the situation remains very fragile. Substantial technical assistance is underway to strengthen fiscal institutions.

1. Overview

The overall deficit of the general government, excluding grants and on an accrual basis, increased from 37 percent of GDP in 1993 to nearly 50 percent in the first half of 1994, before the implementation of the adjustment program (Table 2, and Appendix I, Tables 15-17). To finance the deficit, the Government relied on international food assistance, a large accumulation of domestic and external arrears, and on central bank credit. In the first half of 1994, revenues had declined to nearly 2.8 percent of GDP, barely covering 4.6 percent of current expenditure. The expenditure program was heavily burdened with subsidies, at a time when the minimum wage of public sector employees had declined to US$0.02 per month.

Table 2.

Georgia: Summary of General Government Operations, 1992-95

(In percent of GDP)

article image

Against this background, the Georgian authorities adopted a package of policy measures, beginning in September 1994, aimed at drastically reducing the fiscal deficit. The main elements of this package were: the reduction of subsidies through price increases for bread, gas, and electricity; improved monetization of wheat grants; a wide range of measures to improve tax administration and tax policy; a more than 30 percent reduction in the number of government positions during 1995; improvements in expenditure control; and the broadening of the Social Safety Net (SSN) along with increases in SSN benefits and government wages.

The initial impact of the policy changes has been impressive. The overall deficit, excluding grants and on an accrual basis, has declined to 8.5 percent of GDP in the first half of 1995, mainly through sharp cuts in expenditure. The ratio of revenue (excluding grants) to current expenditure has increased from 5.4 percent in the first half of 1994, to 27.2 percent in the second half, and to 53.4 percent in the first half of 1995 (Charts 5 and 6). While new domestic expenditure arrears have been accumulated, expenditure control has improved significantly.

CHART 5.
CHART 5.

GEORGIA Public Finances

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

CHART 6.
CHART 6.

GEORGIA Funding of Expenditures and Net Lending

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ The share of central banking financing was 20 percent in 1993.

2. Revenues and grants

a. Revenues

Hyperinflation and weak tax administration undermined the authorities’ ability to collect taxes, which fell to about 2 percent of GDP in the first half of 1994 from 13 percent in 1992. A wide range of tax policy measures were introduced to halt the decline in revenues and improve the efficiency of the tax system (Box 2). These measures, together with progress in stabilization, the associated reversal of the Tanzi effect, and improved tax administration, increased tax revenue to 3.1 percent of GDP in the second half of 1994, and 3.4 percent in the first half of 1995. 1/ Thus, the recovery has been somewhat disappointing as ratios in Georgia are still very low in comparison with the past and other FSU countries. 2/

Weak tax performance is rooted in pervasive tax exemptions, a narrow tax base, widespread non-compliance with tax laws, an inadequate targeting of large taxpayers, and inefficient tax and customs administration. 3/ The tax code allows for a large number of tax exemptions (Appendix III), most notably for imports by individuals and the patriarchate. In addition to legislated exemptions, the State Tax Service (STS) and the State Customs Committee (SCC) are frequently asked by the Government to allow ad hoc exemptions for specific transactions. Tax revenues also suffer from a narrow base. The number of taxpayers registered at the STS has been stable at around 75,000 since the second half of 1994, but the number of actual taxpayers has declined by almost 20 percent (Appendix I, Table 22), partly because of the financial difficulties of the enterprises. So far, taxing new small-scale enterprises has proven difficult.

Recent Changes in Tax Policy

To strengthen the tax performance and enhance the efficiency of the tax system, a number of tax policy measures were introduced in late 1994 and the first half of 1995, including tax increases, use of presumptive taxes, and removal of exemptions.

In December 1994, the general VAT rate was increased from 14 percent to 20 percent and a 10 percent rate on bread and flour was introduced; the customs tariff was raised from 2 percent to 12 percent; the excise tax on gasoline was increased from 10 percent to 15 percent; the tax on exports to non-CIS countries was abolished; and a VAT threshold of 500 times the minimum wage was introduced for natural persons. In addition, a presumptive tax replacing the personal income and profit tax was introduced in the rest of Georgia for small-scale enterprises as of February 1995; as of May 1995, VAT and customs duties were levied on goods imported from non-CIS countries but arriving via CIS-countries; and as of June 1995, the exemption for excises of goods imported from CIS countries was eliminated. In July and August 1995, the following prior actions for the SBA were implemented: the general exemption for VAT, customs duty, income tax and profit tax of the patriarchate was replaced by an exemption limited to certain institutions and activities of the patriarchate; excise tax rates were increased while the number of excisable goods was reduced, and the VAT on imports of capital goods from non-CIS countries was eliminated (Appendix I, Tables 20-21).

Tax collection is also hindered by inefficiencies in tax and customs administration, partly reflecting the legacy of the Soviet era. The STS has not been able to focus on big taxpayers because of organizational difficulties. Also, the banking system processes tax payments slowly due to frequent breakdowns of the telecommunication system connecting bank branches and clearing centers and other inefficiencies in the payments system. 1/ A determined effort is already underway to strengthen tax administration with technical assistance from the Fund (Box 3). To bring about the necessary improvement in tax revenues, priority should be given in the near future to: implementing the planned reorganization of the STS, including the establishment of the Large Taxpayer Inspectorate; broadening of the tax base and reduction of tax evasion; improving customs administration; and rationalizing the tax code, especially by substantially reducing the number of exemptions.

Measures to Improve Tax Administration

Efforts to strengthen tax and customs administration started with the establishment of an Operations Division within the STS in August 1994 to monitor taxpayer compliance with the tax laws and enhance the collection of tax arrears. In December 1994, a large number of measures was implemented: penalties for failure to comply with tax laws were increased; the interest charged on underpaid tax was raised from 0.3 percent to 0.5 percent monthly; a legal basis was established to enable STS to temporarily close businesses after six months of willful underpayment of taxes; a customs valuation code was introduced enabling the State Customs Committee (SCC) to legally monitor and challenge the valuation of imports for duty collections; and a coupon 150 million penalty on importers who fail to fulfill documentation requirements was imposed. With the support of an IMF resident advisor, a US$500,000 disbursement from the World Bank Institution Building Loan for computer equipment, and aid from bilateral donors; authorities started a fundamental reform of STS at end-1994. As part of this reform, the STS distributed Taxpayer Identification Numbers (TIN’s) to virtually all taxpayers and started a comprehensive taxpayer survey to identify nonfilers. In addition a project was started to restructure STS along functional lines (taxpayer services, registration, audit, and tax collection). In June 1995, two pilot Regional Tax Inspectorates were reorganized, and are to be computerized in the second half of 1995. The 25 largest local tax inspectorates outside Tbilisi and STS headquarters are to be reorganized by March 1996, and the remainder of the STS by June 1996. Finally, preparations for a Large Taxpayers Inspectorate that would perform all tax administration functions for the 250 largest taxpayers, are on track for operations to start on a limited scale by January 1996, and to become fully operational by March 1996.

b. Grants

The contribution of external in-kind grants (wheat and flour) to the budget amounted to 3.5 percent of GDP in 1994 (45.2 percent of total revenue and grants) compared with 7.4 percent in 1993. The monetization of the food assistance accompanied by a sharp increase in the bread price (Box 1), enabled the Government to mobilize more resources for the budget, and to minimize its reliance on central bank financing of the deficit. While external grants have played a crucial role in financing government operations and will be needed in the near future, the authorities’ fiscal program is designed to reduce reliance on external humanitarian assistance.

3. Expenditures and net lending

Total expenditure and net lending has been lowered from 52.3 percent of GDP in the first half of 1994 to 13.3 percent in the first half of 1995, mainly through the virtual elimination of subsidies. The sharp cut in expenditure has been accompanied by a rationalization of the expenditure program. While generalized subsidies have been eliminated, expenditure on wages and social benefits have been modestly increased. However, despite sharp expenditure cuts, expenditure arrears have continued to accumulate, albeit at a slower pace, and will require improvements in expenditure control. A further rationalization of the expenditure program and a restructuring of government is also necessary to improve the efficiency of the Government.

a. Subsidies

Subsidies have been reduced from 39.0 percent of GDP in the first half of 1994 to only 0.1 percent in the first half of 1995. Subsidies from the republican budget for bread, gas, and electricity were eliminated by September 1994, and for city transport by April 1995. 1/ As of mid-1995, the republican budget provided only a negligible subsidy to a number of newspapers as of mid-1995. 2/

b. Government wages and the SSN

In September 1994, government wages were increased to compensate for the erosion of real wages by inflation and the effect of the subsidy reductions, as discussed earlier. As of July 1995, the minimum government wage was raised to coupon 3.5 million per month (US$2.70) and the average wage to coupon 9.7 million a month (US$7.50), compared with a minimum monthly wage of coupon 1.0 million (US$0.43) and an average monthly wage of coupon 3.6 million (US$1.55, at current exchange rates) in September 1994.

Despite severe resource constraints, to partially offset the adverse impact of the price increase on the most vulnerable groups, the Government instituted a more cohesive SSN in September 1994. Additional benefits were provided from the republican budget to pensioners, low-paid government workers, families with children, single mothers, and refugees to bring SSN benefits in line with the minimum wage for government employees. 3/ At the same time, to improve the targeting of the benefits, the number of pensioners receiving pension benefits was reduced from 1.4 million in mid-1994 to around 1 million in mid-1995.

To contain the budgetary cost of the wage increase and as a first step toward a more fundamental civil service reform, the number of government employees has been reduced by some 33 percent, including privatization of health care. Workers leaving the budgetary payroll receive two months of severance pay, after which they are eligible for unemployment benefits from the Employment Fund. A similar personnel reduction is being contemplated for government employees working in education, which would be part of a wider civil service reform that the Georgian authorities are currently preparing in cooperation with the World Bank.

c. The structure of expenditures

As noted earlier, a major rationalization of the expenditure program is underway. With the elimination of the generalized subsidies, the authorities have been able to reduce total expenditure, while increasing wages for government employees and providing more benefits for the most vulnerable groups. Spending on the SSN increased from 0.2 percent of GDP in the first half of 1994 to 2.3 percent in the first half of 1995, and the wage bill increased from 0.8 percent of GDP to 1.8 percent during the same period. However, most other domestically financed expenditures declined. Capital expenditure increased from zero in the first half of 1994, to 1.3 percent of GDP in the first half of 1995, mainly due to construction of a road connecting Georgia with Turkey and a customs post at the border, as well as the initiation of a number of smaller investment projects.

As a share of total expenditure and net lending, subsidies declined from nearly 74.5 percent in the first half of 1994 to 1.0 percent in the first half of 1995, while expenditure on goods and services increased from 17.8 percent to 21.4 percent, the wage bill from 1.4 percent to 13.2 percent, and the SSN from 0.4 percent to 17.4 percent during the same period. The relative share of capital expenditure increased from zero in the first half of 1994 to 9.6 percent of total expenditure and net lending in the first half of 1995.

d. Expenditure control and arrears

In view of the sharp expenditure cuts initiated in September 1994, the Government is under immense pressure to increase spending. The Ministry of Finance (MOF) has tried to contain this pressure by not authorizing expenditure commitments that would threaten the fiscal position and by improving expenditure control. The MOF has proved successful in controlling cash expenditures of the republican government, but has not yet been able to control expenditure commitments and local government spending effectively. This has led to the continued accumulation of expenditure arrears. In the first half of 1995, the Government accumulated expenditure arrears of 2.4 percent of GDP, against 7.1 percent in the second half of 1994 and 21.4 percent in the first half of 1994. Most of the slowdown in the accumulation of arrears was achieved through a reduction of government involvement in energy importing. 1/

The MOF obtained a firm control on cash expenditures by adopting a strict expenditure management system in November 1994. Under this system, the MOF sets monthly spending limits for ministries and Independent budgetary institutions, based on projected fiscal revenues and available financing. The expenditure management system gives the MOF tight control over cash expenditures of spending ministries and independent budgetary institutions. Control over cash spending was also improved by the centralization of the accounts of the republican government in the NBG in August 1994.

Modest progress has also been made in controlling expenditure commitments. A high-level government committee has been established to monitor expenditure arrears and to work out a schedule for meeting the outstanding obligations. To support the work of the committee, spending ministries and independent budgetary institutions are required to report monthly to the MOF on their expenditure arrears as of July 1995. In case of new arrears, the MOF reduces the spending ministry’s budget appropriation for the next month and uses the resulting savings to settle the arrears directly.

In addition, the Government has conducted netting-out operations with taxpayers in which their tax arrears are voided in return for a canceling of their overdue claims on the Government; in 1994, coupon 8.7 trillion (6.9 percent of expenditure arrears accumulated in 1994) in expenditure and tax arrears were cleared through netting out, while in the first half of 1995 coupon 1.1 trillion (3.0 percent of expenditure arrears accumulated in the first half of 1995) in arrears was netted out.

The introduction of the treasury system with assistance of the IMF, World Bank and bilateral donors, will further improve expenditure control. Under this system, spending ministries lose the authority to assume expenditure commitments without the prior approval of the Treasury. When fully implemented, the Treasury would carry out all budget execution functions of the MOF. The principal tools of the Treasury would be the treasury ledger account, the single treasury account with the NBG, and a debt/assets register. The Treasury would consist of a Central Treasury at the MOF that would have a coordinating and managing function, and the Regional Treasury Offices (RTOs), that would perform the treasury tasks for the Government spending units under their jurisdiction. To this end, a small Central Treasury and two pilot RTOs have been established in July 1995, covering 54 spending units as of September 1995. All procedures are currently performed manually, until computer equipment arrives toward the end of 1995.

Control over local government expenditures remains a problem. Information about the size and structure of local government expenditures is scarce and deficient. However, as of August 1994, local governments have been prohibited from borrowing. In addition, the MOF has improved data gathering methods substantially, by introducing new report forms for local government finances based on the economic classification from the Government Finance Statistics (GFS) in July 1995.

A further improvement in the capacity of the MOF to monitor expenditures is urgently needed. The completion of the treasury project will be essential in reaching this goal over time. In the meantime, the roles of the committee for expenditure arrears and the MOF need to be strengthened. Support from the IMF (including the stationing of a Resident Treasury Advisor), from the World Bank (in the form of a US$500,000 disbursement from the Institution Rehabilitation Credit for the purchase of computer equipment), and assistance from bilateral donors is being provided to strengthen these institutions.

IV. Developments in Money and Banking

Tight financial policies have succeeded in halting hyperinflation and stabilizing the exchange rate for the coupon. Substantial progress has been made in strengthening of the NBG and in preparation for the introduction of the new national currency, the lari, all with Fund technical assistance. The financial position of the commercial banks, however, remains weak.

1. Overview

The Georgian coupon was introduced in April 1993 after Russia stopped supplying ruble banknotes. Since then, its fortunes have been very closely tied to the financial policies of the Georgian authorities. Loose policies in the initial months after its introduction led to a rapid erosion in the value of the currency and contributed to its failure to gain wide acceptance. In the face of limited real demand for coupons, continued monetary expansion fuelled hyperinflation in late 1993 and most of 1994 and the authorities’ ability to extract seigniorage dwindled.

A dramatic change in the authorities’ financial policies initiated in September 1994 succeeded in halting hyperinflation and stabilizing the exchange rate. Although there was an initial substantial increase in money supply arising from the monetization of government expenditure arrears and removal of restrictions on the encashment of coupon deposits, its impact was blunted by a sharp rise in the transactions demand for coupons stemming from very large increases in administered prices. In the event, the exchange rate of the coupon appreciated markedly, and prices initially declined in coupon terms.

Notwithstanding the success of the stabilization effort so far, the effectiveness of monetary policy continues to be constrained by the limited sphere in which the coupon operates, 1/ and a limited set of policy instruments. Nevertheless, as shown in Table 3, there appears to be a correlation between developments in broad money and inflation. The establishment of relative monetary stability has significantly improved conditions for the successful launch of a new currency, the lari (Box 4).

Table 3.

Georgia: Money and Inflation

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As confidence in the authorities’ financial policies grows, it is expected that monetary control will be enhanced by greater use of the national currency and the development of new monetary policy instruments such as treasury bills.

Georgia: Introducing the Lari—A Break from the Coupon Ers

Georgia will replace its highly devalued currency, the coupon, to emphasize that a new period of monetary stability has begun. The coupon was introduced as a “temporary” currency in April 1993, in response to a shortage of ruble banknotes, and was expected to circulate alongside and at par with the ruble. Following the demonetization of pre-1993 rubles in Russia in July 1993, the Georgian authorities declared the coupon to be the sole legal tender from August 3, 1993. Within a few weeks of its introduction, the coupon was trading at a discount vis-à-vis the ruble in the unofficial exchange market in Georgia, as the population preferred to continue using the ruble as the principal medium of exchange. During the period when the population was supposed to exchange their ruble holdings for coupons in early August 1993, only rub 177 million (less than 1 percent of rubles emitted in Georgia in 1992) were exchanged.

Rapid expansion in the supply of coupons led to even faster depreciation against the ruble and convertible currencies. The exchange rate fell from coupon 8,000 per U.S. dollar at end-August 1993, to coupon 102,000 per U.S. dollar at end-December 1993, and to coupon 1 million per U.S. dollar by early August 1994. In unofficial trading the exchange rate for coupon deposits, which faced restrictions on encashment, sunk to coupon 5.5 million per U.S. dollar in September/October 1994. The successful halt in hyperinflation and the appreciation and subsequent stabilization of the exchange rate at around coupon 1.3 million per U.S. dollar since the beginning of 1995 has not yet led to widespread acceptance of the coupon by the population.

Plans are at an advanced stage for the introduction of a new national currency—the lari—to replace the coupon in October 1995. The lari will have a subunit called tetra; 100 tetra will be equivalent to one lari. With inflation in check and adequate official foreign exchange reserves, the conditions have been created for a successful break from the coupon era. To bolster domestic acceptance of the lari, the Government and the NBG are considering steps to ensure that the lari cannot be refused in the settlement of transactions within Georgia and that lari prices are available for any transaction. The staff has urged the Government to demonstrate its commitment to its own currency by ensuring that all official transactions within the country—including those by public enterprises—take place only in local currency. The staff has advised the authorities against stronger administrative measures, arguing that acceptance of the lari by the population will hinge critically on the pursuit of responsible financial policies by the Government and the NBG.

The conversion of coupons to lari will be at a uniform rate for cash and bank accounts, without any confiscatory features. During the conversion period, foreign exchange auctions at the TICEX will continue to establish an exchange rate for the coupon against the U.S. dollar, and the NBG will not directly exchange any foreign currencies for lari.

2. Monetary policy

Between December 1993 and August 1994, the NBG took a number of measures aimed at tightening monetary policy, including the introduction of an auction to price refinance credit more appropriately, a reduction in the volume of refinance credit, the curtailment of subsidized credit to favored sectors or enterprises (“directed” credits), and the imposition of reserve requirements on foreign currency deposits. However, these measures were ineffective as the government was able to substantially overdraw its accounts in commercial banks and the NBG in turn allowed overdrafts on the banks’ correspondent accounts. A practice of automatic extension of overdrafts to the former state commercial banks, at zero interest, provided those banks with a source of cheap credit which undermined the effectiveness of the NBG’s refinance credit auction.

Restrictions on the conversion of deposits into cash intensified in the first half of 1994, partly to conserve banknotes in the face of an emerging cash shortage, but also reflecting the authorities’ belief that limiting cash emission would curb inflation. In April 1994, in an effort to stabilize the official exchange rate, the operations of the Tbilisi Interbank Currency Exchange (TICEX) were moved to a cash basis. In the event, the Government continued to issue payment orders which were deposited in the banking system, and a separate market for noncash coupons emerged in which the exchange rate was significantly depreciated compared to the cash exchange rate. This development, while reducing the rate of depreciation of the official exchange rate, did further damage to confidence in the banking system.

From September 1994, the authorities began to take more decisive steps to tighten financial policies and to remove distortions arising from cash restrictions in the banking system and the foreign exchange market. After securing an adequate supply of coupon bank notes, the NBG lifted all restrictions on the conversion of deposits into cash and re-opened the TICEX to non-cash coupon transactions. In order to sterilize partially the impact of the elimination of the cash restrictions and a large monetization of the fiscal deficit, the NBG increased enforcement of penalties for noncompliance with reserve requirements, and increased the required reserve ratio for foreign currency deposits from 15 percent to 20 percent (the level for domestic currency deposits). The overall compliance rate for reserve requirements has increased markedly from 50 percent in September 1994 to 83 percent in June 1995. Other measures introduced to enhance monetary control included the centralization of the MOF’s accounts at the NBG, the sale of the Government’s holdings of foreign exchange and precious metals to the NBG, and the termination of banks’ automatic access to overdrafts from the NBG.

Since December 1994, in line with understandings reached with the Fund staff, the NBG has successfully used foreign exchange operations to moderate the monetary impact of its lending to Government. Thus far, international reserves have been higher than programmed reflecting the authorities’ cautious exchange rate policy.

In order to facilitate more efficient liquidity management by banks and to provide a vehicle for NBG intervention to influence liquidity conditions in the banking system, the NBG instituted an interbank credit auction in seven-day funds in May 1995 (Box 5). Borrowing in the auction is collaterized by reserve requirements held at the NBG. To date, the scale of operations has been disappointing, with participation limited to a few small banks and the NBG; and NBG intervention has tended to be aimed at fostering the development of the market rather than the attainment of monetary policy objectives.

Interbank Credit Auction

As a first step toward the establishment of a money market in Georgia, the National Bank of Georgia (NBG) introduced an interbank credit auction in May 1995. The auction is intended to provide a facility through which commercial banks can improve their liquidity management, and the NBG can influence liquidity conditions in the banking system.

Participation is open to all banks with correspondent accounts at the Tbilisi Settlement Center of the NBG; borrowing and lending transactions at the auctions are conducted via these accounts. Currently, loans have an initial maturity of seven days, and are secured against borrowing banks’ reserve requirements held at the NBG. Up to 75 percent of a bank’s reserve requirements may be used to collaterize borrowing at the auction. The NBG can exclude banks that are not in compliance with specified prudential regulations.

At the start of the auction, an auctioneer informs participants of the highest interest rate bid, and of offers of loans at that or lower interest rates. If the amount bid at the initial interest rate falls short of the amount offered, the auctioneer calls for resubmission of bids at a lower interest rate. Conversely, if the amount bid at the initial interest rate exceeds the amount offered, participants are invited to resubmit bids at a higher interest rate. The auction is halted when either offers and bids match at an announced interest rate, or no further adjustments to bids are made by participants. In the event of a small imbalance at the final interest rate, the NBG may make up the difference; otherwise there is a prorating of bids or offers.

The collaterization of borrowing by reserve requirements is an attractive feature of the auction for both borrowers and lenders: borrowers can “use” their unremunerated reserves at the NBG, and lenders are virtually insulated from the risk of default. However, this feature could undermine the role of required reserves as an instrument of monetary policy. In order to preserve the sterilization effect of required reserves in the event of a default, the NBG must immediately and fully impose the penalties for noncompliance with reserve requirements.

3. Money and credit developments

Financial intermediation is severely limited; deposits have stagnated, and the bulk of credit in the banking system is accounted for by onlending of a foreign loan. Removal of restrictions on the encashment of deposits has led to a sharp increase in the currency-to-deposit ratio, reflecting a lack of confidence in the banking system.

a. The banking system

Because of the large share of foreign currency-denominated items in the banking system, large fluctuations in the exchange rate during 1994 resulted in large swings in the reported monetary aggregates (Appendix I, Table 26). The main underlying developments were a substantial increase in domestic credit financed by the drawdown of a US$50 million line of credit from Turkey, 1/ and a sharp increase in foreign currency deposits toward the end of the year. However, not all the expansion in domestic credit was financed from abroad; government borrowing to finance the budget deficit was a major factor in a near 20-fold increase in coupon broad money during 1994. Chart 7 present developments in nominal and real coupon broad money.

CHART 7.
CHART 7.

GEORGIA Monetary Developments

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

Changes in net foreign assets have continued to partially offset domestic credit expansion in 1995; the main difference being that more credit is going to the government than was the case in 1994. With respect to broad money, currency outside banks has increased slightly and domestic currency deposits have stagnated; the most significant change has been a reduction in foreign currency deposits to more normal levels.

The population’s preference for cash over bank deposits is starkly illustrated by the sharp increase in the currency-to-coupon-deposit ratio from 14 percent in September 1994 to 130 percent in June 1995. During this period, currency grew by 850 percent while coupon deposits increased by 5 percent.

b. The NBG

Reserve money grew by nearly 2,500 percent during 1994 (Appendix I, Table 27). With relatively little change in net international reserves (NIR), the counterpart to movements in reserve money were changes in the NBG’s net domestic assets (NDA), with net claims on the general government accounting for the bulk of the change. Within reserve money, there was a 21-fold increase in currency in circulation, reflecting the lifting of restrictions on the encashment of deposits (Chart 8).

CHART 8.
CHART 8.

GEORGIA Currency Issued 1/

(In billions of coupons and millions of U.S. dollars; log scale)

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

Source: Data provided by the Georgian authorities; and staff estimates.1/ Currency issued during the month. Currency in circulation declined slightly in January and February 1995.

In contrast to 1994, reserve money growth slowed to 25 percent in the first half of 1995. Within this aggregate, currency in circulation grew by 11 percent; movements in the balances in banks’ correspondent accounts at the NBG have been the dominant factor in the evolution of reserve money. These movements could reflect lumpy transfers that occur at the end of the month between the MOF account at the NBG and accounts of spending units and revenue agencies in the commercial banks.

The NBG suspended its refinance credit auctions in May 1994 because of lack of interest on the part of banks. In January 1995, the NBG extended short-term loans totalling coupon 335 billion (less than 1 percent of reserve money) to two banks, and after an 11-month hiatus, three credit auctions (coupon 235 billion total transactions) were held in April 1995. Interest rates (per month) on these refinance credits fell from 60 percent in May 1994, to 15 percent in January 1995 and to 5.0-7.5 percent in April 1995.

c. Commercial banks

Foreign currency deposits account for almost 60 percent of total deposits in the banking system (Chart 9, and Appendix I, Table 28). In absolute amounts, these deposits grew from US$13 million at the end of 1993, to US$21 million in June 1994, to US$32 million in December 1994, and fell to US$17 million in June 1995. While a sectoral breakdown is not available, it is understood that the bulk of these deposits are held by enterprises. Household deposits have fallen sharply in the face of falling real incomes.

CHART 9.
CHART 9.

GEORGIA Bank Deposits

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ Reported data in domestic currency, converted at end-period exchange rate.

Foreign currency denominated credit accounts for 60-70 percent of credit extended by the banking system (Appendix I, Table 29). As noted earlier, a large part of the outstanding credit represents onlending of a foreign exchange loan from Turkey. At the end of 1993, onlending of the Turkish credit accounted for about 34 percent of credit to the nongovernment sectors in the economy. This share rose to over 60 percent in September 1994, and since then has remained between around 50-55 percent. There is very little reliable information on the sectoral distribution of credit. However, the available information suggests that during 1994, most credit went to the trade sector and that the share of credit going to agriculture and industry has declined.

Commercial banks are free to set their interest rates. Since the inception of the stabilization program, nominal interest rates have been on a downward trend but real rates have become positive (Appendix I, Table 30). Coupon deposit rates have fallen from about 30 percent per month in June 1994 to between 3 and 5 percent per month in June/July 1995; comparable coupon lending rates have gone from 40-50 percent to 8-10 percent. Over the same period, the monthly rate on U.S. dollar deposits has fallen from 3-5 percent to 1.5-2 percent, while loan rates have gone from 5-8 percent to 3-5 percent a month. Average monthly coupon inflation rates have fallen from 57 percent in the first half of 1994 to 2.5 percent in the first half of 1995.

Positive real interest rates have not attracted deposits because of lack of confidence in the banking system arising from the recent history of restrictions on the encashment of deposits and the effects of hyperinflation. A widening spread between lending and deposit rates is symptomatic of the structural weaknesses in the banking system, including a heavy burden of nonperforming assets.

4. Structural reforms

a. Legal framework

Parliament approved a new NBG law in June 1995 (Box 6). The new law provides the basis for a strong central bank whose primary focus is to carry out anti-inflation monetary policy and to supervise banks. A draft commercial banking law to complement the NBG law is expected to be submitted to parliament toward the end of 1995. Other legislation is in preparation which is expected to have significant impact on the banking system includes a land law that would remove restrictions on the sale of land and foster its use as collateral for borrowing, as well as a bankruptcy law.

b. Payments system developments

A move from a paper-based to an electronic-mail-based system has improved the payments system significantly. Transfers between Tbilisi and other regions of Georgia which used to take 2-4 weeks to be made now are effected within a week. In the Tbilisi region, transfers are now routinely made within 1-3 days. The former state commercial banks have also started intrabank settlements between their regional offices and sub-regional branches.

When the NBG stopped providing automatic overdrafts to commercial banks, it refused to make payments transfers for banks which did not have adequate balances on their correspondent accounts. This practice initially lengthened clearing delays in the banking system, and led to rapid accumulation of balances on banks’ correspondent accounts at the central bank. The Fund, the World Bank and EU-TACIS are assisting the authorities to shift from the electronic mail system to a higher performance telecommunication network.

c. Bank supervision and licensing

As a result of lax regulation and supervision, as well as easy credit policies in the immediate post-independence period, the commercial banking system is in a perilous state. With the help of technical assistance from the Fund and cooperating central banks, discipline is being gradually established through the enforcement of new prudential regulations, the withdrawal of bank licenses, and improved reporting and inspection procedures. A program of on-site inspections has been instituted. Prudential norms are now applicable to all banks, including the former state commercial banks. The NBG issued new prudential regulations to banks in January and May 1995 (Box 7).

The New Central Bank Law

Parliament enacted a new law in June 1995 to replace the 1991 law that established the National Bank of Georgia (NBG) as the central bank of the newly independent Republic of Georgia. The new law, was drafted with Fund technical assistance, clarifies the main objectives and functions of the NBG, and removes limits on the NBG’s independence contained in the old law.

The 1991 law granted formal independence to the NBG. However, monetary policy was expected to follow Government guidelines, and the President and other members of the NBG Board of Directors served virtually at the pleasure of the President of the Republic. They were appointed by the President (in consultation with the Supreme Council of the Republic) and could be removed without legal cause.

The new law specifies the NBG’s main objectives as: (a) promoting and maintaining of price stability through the pursuit of appropriate monetary policy; and (b) fostering the liquidity, solvency and proper functioning of a stable market-based financial system. To this end, the law grants the NBG authority to license and supervise banking and foreign exchange activities, manage official international reserves, and serve as fiscal agent, advisor and banker to the Government.

The NBG is required to submit annual reports to Parliament that review monetary and exchange rate policy, including analyses and assessments of developments in the preceding reporting period, and outlines policies for the next twelve months.

While the NBG formulates and implements monetary policy, the law allows Parliament to override the NBG if in its view the policies being pursued by the NBG are not appropriate to attain the main objectives of policy specified under the law. In such a situation, Parliament will stipulate what changes are to be made, as well as the reasons for the changes, and their duration.

The law provides for a nine-member Board to oversee and guide the activities of the NBG. The Board comprises the President of the NBG who is also the Chairman of the Board, three Vice-Presidents of the NBG, and five other members. The President is nominated by the Head of State and must be approved by Parliament. The President nominates the three Vice-Presidents and Parliament nominates the other five members of the Board. The normal term in office for a Board member is seven years; he or she may serve two terms. The Head of State, members of Parliament, and cabinet ministers are precluded from serving on the NBG Board. Only Parliament has the authority to remove a Board member from the post. The only grounds for removal from the Board are: appointment to an office that precludes concurrent membership of the Board, criminal conviction, bankruptcy, persistent absences from Board meetings without good cause, incapacitation, and dereliction of duty that inflicts considerable losses on the NBG.

The NBG issued a directive in May 1995, which increased the minimum capital requirement for banks from coupon 500 million 1/ to the coupon equivalent of US$100,000. The directive included a schedule for gradually increasing the required capital, with full compliance expected by June 1, 1995. It is expected that the minimum capital requirement will be increased to US$500,000 by 1998.

New Prudential Regulations for Banks

The NBG has issued new prudential regulations to banks that, inter alia, increase the required capital-to-asset ratio, drastically lower the limit on credits to a single borrower, introduce limits on insider lending, and establish a system for the classification of nonperforming loans.

The main features of the new regulations are as follows:

(a) the ratio of bank capital to total assets should be at least 8 percent (raised from 5 percent);

(b) the ratio of household deposits to capital should not exceed 100 percent;

(c) lending to any one borrower should not exceed 10 percent of bank capital (lowered from 50 percent);

(d) loans to individual “insiders” (shareholders, directors, auditors, employees, and family members of the above groups) should not exceed 5 percent of bank capital;

(e) the sum of all insider loans should not exceed 100 percent of capital;

(f) the ratio of liquid assets to demand deposits should not be less than 30 percent (unchanged);

and

(g) the ratio of long-term loans (more than 1 year maturity) to long-term deposits (more than 1 year maturity) should not exceed 100 percent.

The limit on household deposits to capital is intended to protect depositors, but could hinder the development of a market-based banking system. Other prudential standards such as capital maintenance and improved lending practices are better suited to protect depositors.

With regard to provisions for nonperforming loans, the NBG has introduced a 5-category system that classifies loans according to the degree of collectability. The recommended provisions range from 2 percent for high quality loans to 50 percent for doubtful loans. The commercial banks have not yet fully implemented the new system because of differences between the NBG and the State Tax Service on whether loan-loss provisions are taxable.

Over the last year, the NBG has withdrawn operating licenses from 78 banks; the banks had either failed to meet minimum capital requirements or had persistently failed to report on their activities to the NBG. 1/ In May 1995, the merger of three former state banks (Eximbank, Industrial Bank and the New Georgian Bank, formerly the Savings Bank) was announced by a decree of the Head of State. The NBG subsequently granted a temporary license to the new bank--the United Georgian Bank. In view of the weak financial state in which each of the component banks was in, the NBG has indicated that the issuance of a permanent license will depend on the production of a detailed business plan outlining how the new bank will ensure that its operations are carried out on a sound footing.

d. Restructuring of the banking system

The stabilization achieved so far has brought to the fore structural weaknesses in the banking system. Customers who had became used to operating in an inflationary environment--in which the real value of their liabilities was rapidly eroded--have had difficulty servicing their loans. The proportion of overdue loans in the total loan portfolio of commercial banks is reported to have increased from 8 percent in June 1994, to 25 percent in December 1994, and to 38 percent in June 1995.

A diagnostic study of the five former state banks, conducted by consultants funded under a World Bank Institution Building Credit to Georgia, concluded that each of these banks is seriously undercapitalized and burdened by nonperforming assets. The main reasons for their poor performance include failure to carry out adequate loan assessment and credit worthiness analysis of borrowers, and inability or unwillingness to enforce security on loans. These banks which account for 75 percent of commercial banks’ assets, have been transformed into joint-stock companies. However, there has not been any significant injection of new funds so far.

The authorities have indicated that bank restructuring will be a central part of the next phase of their structural reform efforts. It would include components to address, inter alia, the banks’ needs for technical assistance to improve credit assessment, liquidity and asset management, working out bad loans, implementing international accounting standards, and effective control over branches.

V. External Sector Developments

Georgia has become more reliant on imports of basic goods, and suffered from a sharp increase in energy prices. A large part of Georgia’s food requirements have been met through the provision of grants. However, large current account deficits have also been financed through formal and informal trade credits resulting in a very sharp increase in Georgia’s external debt to almost US$1 billion at the end of 1994, mostly at short maturities with interest payable at commercial rates. The Georgian authorities have approached creditors to request a rescheduling to bring these obligations into line with the country’s currently very limited debt-servicing capacity. In addition, the authorities’ adjustment program has stemmed the growth in Georgia’s external obligations, stabilized the exchange rate and liberalized the exchange and payments system.

1. Balance of payments

Prior to Georgia’s independence, the pattern of trade reflected the degree to which Georgia was integrated into the economic system of the FSU. In the last three years, enterprises whose production--often in the form of intermediate goods--was formerly directed towards the rest of the FSU have suffered a sharp fall in output reflecting a steep decline in demand for these goods and lack of imported inputs. In addition, trade has been disrupted by internal and external conflicts which have at various times closed trade routes. The trading pattern of the old economic system has therefore been largely replaced by informal trade with neighboring countries. At the same time, Georgia has relied upon imports of food aid provided mainly by the United States and the European Union.

This change in the pattern of trade has been accompanied by a deterioration in the quality and coverage of trade statistics. Until 1992, trade statistics were compiled largely through enterprise surveys. However, the disruption of the old trading system and the growth of informal trade rendered these surveys increasingly unreliable as a guide to total trade flows. Trade statistics are now compiled on the basis of customs data. However these data suffer from incomplete coverage as well as valuation problems. Some of the problems of coverage can be overcome relatively easily; for example, alternative data sources can be used to capture imports of natural gas, trade in electricity and humanitarian imports which are not included in customs data. 1/ But in addition, significant private trade flows--including a large part of Georgia’s trade with Turkey--are either not recorded or undervalued. The balance of payments (Table 4, and Appendix I, Table 31), includes estimates of these flows, which are thought to account for more than a third of total imports and exports.

Table 4.

Georgia: External Sector Indicators

(In millions of U.S. dollars)

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Source: Appendix I, Table 31.

Given these data shortcomings, only partial information is available on the composition of trade. Among recorded exports, the most important categories are agricultural goods (including tea, citrus and wine) and metallurgical products (including ferrous alloys, steel and steel pipes). The most important categories of imports are energy, food (including humanitarian aid) and basic goods such as clothing.

Georgia has continued to rely on imported energy, despite a more than five-fold increase in the price charged for gas imports from Turkmenistan in 1993. 1/ In response to this terms-of-trade shock, the volume of natural gas imported in 1993 declined over 14 percent, but the value of gas imported (including transit charges) increased from US$80 million in 1992 to US$363 million in 1993 (Appendix I, Table 32) to account for more than a third of total imports. In 1994, the volume of gas imports declined by a 29 percent, as output fell sharply and there were periodic supply disruptions occasioned by failure to make payments for gas imports. In the first half of 1995, the Georgian gas company shut off supplies to households and some other non-paying customers, and the volume of gas imports declined by a further 58 percent to an annualized rate of less than one third of gas imports recorded in 1992.

In addition to substantial energy imports, Georgia has in the last three years imported an average of close to 800,000 tons of wheat and flour. The bulk of these imports was used to supply the Bread Corporation, with only relatively small volumes distributed by other institutions, including NGOs. These imports, and other smaller humanitarian imports from bilateral donors and the United Nations Consolidated Appeal for the Caucasus, are estimated to have accounted for almost a quarter of total imports in 1994.

Largely as a result of the sharp increase in the value of gas imports, the trade deficit is estimated to have widened sharply from US$378 million in 1992 to US$448 million in 1993. However, reflecting subsequent steep declines in gas consumption, the trade deficit is estimated to have declined to US$363 million in 1994. In the first six months of 1995, the trade deficit declined by 28 percent from the same period a year earlier to an estimated US$159 million.

Although Georgia benefitted from a large tourist income before independence, and has considerable potential to develop in this area, there was no significant tourist income in the period under review. However, in recent years Georgia has recorded significant earnings from transportation, including income from the transshipment of goods from Georgia’s Black Sea ports. Official shipments of grain to the region--which totalled more than 1.3 million tons in 1994--have been a significant source of nonfactor service income. Despite these earnings, the nonfactor service account moved into deficit in 1993 and 1994, reflecting substantial increases in the transit charges levied for shipments of gas from Turkmenistan to Georgia. 1/ The overall service account has moved more sharply into deficit, reflecting a sharp increase in interest due on external borrowings from US$1.5 million in 1992 to US$11.5 million in 1993 and US$32.1 million in 1994.

The current account of the balance of payments, before transfers, has recorded a similar pattern to the trade deficit, with the estimated deficit rising to a peak of US$485 million or the equivalent of 42 percent of GDP in 1993. In line with the narrowing in the trade deficit, the current account deficit narrowed to US$446 million in 1994 (36 percent of GDP) and is estimated to have fallen to US$191 million in the first half of 1995.

Official transfers, including grant-in-aid shipments of food and medicines, have been a significant source of financing for the current account deficits recorded in recent years. 2/ As noted above, the volume of shipments of food aid has been relatively stable over the last three years. However, the total value of official transfers is estimated to have risen from US$71 million in 1992 to US$170 million in 1994, reflecting a decline in the proportion of wheat and flour shipments to the Bread Corporation that were financed with loans. As a result, the current account deficit after transfers is estimated to have declined more steeply from US$354 million in 1993 and US$276 million in 1994.

The capital account of Georgia’s balance of payments has been dominated by official transactions. A large number of joint ventures were registered in 1992 and early in 1993, but available evidence suggests that resulting private capital inflows have been very modest. 1/ In 1992 and 1993, official disbursements were the main sources of capital inflows contributing to recorded surpluses on the capital account. These included trade credits from the European Union and Turkey, and loans from other FSU countries, as well as the conversion of amounts owed on correspondent account balances into new loans. However, in 1994 Georgia failed to meet interest payments due on these loans, and disbursements from the EU and Turkey were halted. At the same time, principal payments arising from earlier commitments rose sharply in 1994 to a total of US$118 million, and the capital account moved into deficit. Disbursements under an IDA Rehabilitation Credit approved by the World Bank in March 1995, began in the second quarter of 1995. However, in the first half of the year, the capital account deficit increased, reflecting a further rise in amortization falling due.

Georgia’s overall balance of payments moved into deficit in 1993. This deficit, and the sharply higher deficit recorded in 1994, was largely financed through the accumulation of arrears. In contrast to the rise in debt-service payments falling due, to US$150 million or the equivalent of over 30 percent of exports of goods and nonfactor services in 1994, actual debt-service payments have been minimal. At the same time, very large arrears have been incurred on deliveries of natural gas from Turkmenistan.

Heavy reliance on arrears to finance the overall deficit also reflected the near exhaustion of official reserves. By the end of 1993, the gross reserves of the NBG had fallen to US$1 million. During the first three-quarters of 1994, the NBG’s reserve position stayed close to this level. However, with the onset of the stabilization program, the reserve position of the NBG began to improve. At the end of 1994, after the first purchase under the STF, gross reserves of the NBG stood at US$41 million, or the equivalent of just under one month of import cover.

2. External debt

In common with most other countries of the FSU, Georgia signed the so-called zero option under which the country gave up its claims on the external assets of the FSU in return for Russia taking over responsibility for Georgia’s share of the external debt of the FSU. As a result, Georgia entered independence with modest external obligations. However, by the end of 1994 Georgia had incurred external obligations of almost US$1.0 billion or the equivalent of 80 percent of GDP (Appendix I, Table 33). More than 80 percent of this debt was accumulated to finance imports, including imports of wheat and energy. In addition, the bulk of this debt was not formally contracted prior to the import of the goods which it financed. Instead, trading partners continued to supply goods, including natural gas, despite a lack of payments by Georgia. As such, much of this debt was initially accumulated--either as arrears or uncleared balances on correspondent accounts--without bilateral discussions on the terms for these credits or an assessment of Georgia’s creditworthiness by the creditors involved.

The bulk of Georgia’s obligations to FSU countries arose out of non-payment for natural gas imports from Turkmenistan after a more than 5-fold increase in the gas price in 1993. At the end of 1993, overdue gas payments of US$181 million were converted into a loan, repayable over two years with no grace period at an interest rate of libor plus 2 percentage points. In 1994, no debt service was paid to Turkmenistan and new gas arrears were incurred; Georgia has recognized a total debt to Turkmenistan as of the end of 1994 (including penalties) of US$440 million.

Net balances on correspondent accounts arising from trade in 1992 and the first half of 1993 with Russia, Kazakhstan, Armenia and Azerbaijan were converted into loans totalling US$175 million. 1/ These obligations, and additional loans of US$20 million contracted in 1993 and 1994 with the same countries, had average maturities and grace periods of 5 years and 1.3 years, and an average margin over libor of 1.1 percent.

At the end of 1994, Georgia’s debt to non-FSU creditors amounted to US$339 million. Although Georgia signed the zero option the Georgian authorities acknowledged a debt to an Austrian commercial bank, which was negotiated by the Tbilisi City Council in a joint venture to construct a hotel. Amounts due in 1993 and 1994 were rescheduled with an Austrian government guarantee with the amount outstanding amounting to US$92 million at the end of 1994. The bulk of the remainder of Georgia’s external debt represents trade credits at maturities of 3 to 4 years from the European Union 1/ and the Turkish Eximbank 2/ which were drawn from 1992 to early 1994. In addition, smaller debts have been incurred with the Islamic Republic of Iran, (US$11.9 million) for gas purchases in the final quarter of 1994 and China (US$3.5 million) for the import of small tractors.

Debt service due to all creditors in 1994 amounted to US$150 million, but, reflecting the near exhaustion of official reserves and the collapse in government revenues, actual debt-service payments were less than US$2 million (Appendix I, Table 34). Including overdue payments for gas imports, Georgia’s arrears to external creditors amounted to US$409 million at the end of 1994. In the first half of 1995, debt service falling due before rescheduling is estimated at about US$119 million, or the equivalent of over 50 percent of exports of goods and nonfactor services. Faced with this very heavy debt burden, the Georgian authorities have approached creditors to request a rescheduling to bring external obligations into line with the country’s currently very limited debt-servicing capacity. In order to establish a track record of debt service payments, quarterly payments of US$8 million to an account administered by the Netherlands Bank began in 1995. These amounts will be used to meet debt-service payments to bilateral creditors when rescheduling agreements consistent with the assumptions of the program supported by the Fund have been reached.

In addition, the stabilization program launched by the government in late 1994 has served to stem the growth in Georgia’s external obligations. The current account deficit of the balance of payments has narrowed sharply, principally as a result of a steep decline in imports of natural gas. In the first half of 1994, Georgia incurred an additional US$134 million in external obligations arising from failure to pay for gas imports; in contrast, in the first half of 1995, payments have been made for the proportion of the gas bill due in cash and the amounts owed in goods for the first half of 1995 totalled to US$29 million. 1/ Georgia made a first purchase under the STF in December 1994 and has subsequently received initial disbursements under a World Bank Rehabilitation Loan.

Georgia’s large debt burden represents one of the most serious problems confronting the government. Normalization of relations with creditors will be essential for the establishment of a strong external sector, reliant on normal instruments of trade finance. But at present Georgia’s external obligations far exceed its payments capacity.

3. Developments in the exchange system

The stabilization program has succeeded in reversing some of the previous very sharp depreciation of the coupon; at the same time, the exchange market has been unified. Further steps have been taken to liberalize the trade system (Box 8).

The external value of the coupon began to come under sustained pressure even before the coupon became Georgia’s sole legal tender in August 1993. In the following twelve months, the coupon suffered a near 1000-fold depreciation against the U.S. dollar. For most of this period, the official exchange rate was determined in the TICEX. 2/ However, beginning in April 1994, a large disparity emerged between the rate determined on this weekly auction market and unofficial rates (Chart 10). Shortages of coupon notes that developed as a result of hyperinflation culminated in the application of restrictions on cash withdrawals from banks. The official auction market--which was a cash market--therefore reflected the shortage of coupon notes, while the more depreciated unofficial rate more accurately reflected the impact of continued large (non-cash) credit expansion by the NBG.

CHART 10.
CHART 10.

GEORGIA Official Versus Unofficial Exchange Rates 1/

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

1/ The unofficial rate is that quoted by foreign exchange bureaus.

Pressure on the external value of the coupon became especially severe while the government was making final preparations for the launch of the stabilization program. Operations of the TICEX were suspended on August 19, 1994; as the exchange rate approached coupon 2 million per U.S. dollar. When the TICEX was re-opened on September 19, 1994 after the government had raised the bread price, the official rate rose coupon 2.4 million per U.S. dollar (Appendix I, Table 35). 1/ This initial jump in the exchange rate, was followed by a gradual appreciation of the coupon to 1.28 million per U.S. dollar at the end of 1994. So far in 1995, the official exchange rate for the coupon has been stable at 1.3 million per U.S. dollar and the difference between the official and unofficial rates had narrowed to less than 2 percent by August 1995. At the same time, the official exchange rate appreciated from coupon 1,030 per ruble just before the stabilization to coupon 460 per ruble at the end of 1994 and 251 per ruble at the end of July 1995.

Trade Liberalization

The program of economic stabilization and reform launched in September 1994 has embraced wide-ranging liberalization of the external trade regime. The government has abolished the main instruments by which trade was directed under the old economic system and opened up the economy to free trade, through the following steps:

  • In December 1994, an 8 percent export tax on goods exported to non-CIS countries was abolished. At the same time, a unified import tariff structure was introduced with a basic rate of 12 percent on imports, with a rate of 20 percent applied to barter imports. (The categories of goods exempt from duty are given in Appendix V).

  • In January 1995, regulations governing trade licensing and prohibitions were streamlined. The government has committed itself to a phased elimination of the remaining licensing requirements and prohibitions. (See Appendix V for a listing of the categories of goods subject to licensing and prohibitions).

  • In June 1995, the state order system was abolished. This move coincided with and was facilitated by the government’s withdrawal from energy procurement. At the time of its abolition, the state order system was primarily used to obtain goods under quotas from enterprises to export in partial payment for natural gas imported under the intergovernmental agreement with Turkmenistan.

Exchange rate developments in 1995 have been strongly influenced by the NBG’s interventions in the TICEX which have served to sterilize the impact of credit expansion to the general government. During 1994, the NBG lacked the resources to conduct such a policy as gross reserves were virtually exhausted; in 1995, the NBG has been able to draw upon gross reserves accumulated as a result of purchases from the Fund and disbursements from the International Development Agency (IDA). The NBG has not, however, been the only seller of foreign exchange in the TICEX. The volume of transactions has increased significantly, although total turnover at an average of US$4.8 million per month has remained low in relation to the volume of non-aid imports, reflecting the continued dominance of foreign currencies in domestic transactions. At the same time, the deviation between the rates established in the TICEX and in parallel market trading has narrowed sharply to under 1.5 percent (Chart 10).

These developments in the external value of the coupon have, over the last year, brought about substantial appreciation in the real effective exchange rate (Chart 11). This appreciation was preceded by a severe depreciation in the real effective rate, which by August 1994 brought the index of the real effective rate to 30 percent of its average value in 1992. By mid-1995, the real effective rate for the coupon was therefore only some 20 percent above of its average value in 1992. The measured bilateral real exchange rate of the coupon against the Russian ruble was still at only half its average rate in 1992. Caution is needed in drawing implications for competitiveness from these movements in the real effective rate, especially in view of the scale of the changes that are taking place in the structure of the economy. 1/ However, they do lend support to the evidence from limited information on average wages that the recent appreciation of the exchange has not undermined competitiveness.

CHART 11.
CHART 11.

GEORGIA Indicators of the Real Exchange Rate

(1992 = 100)

Citation: IMF Staff Country Reports 1995, 112; 10.5089/9781451814385.002.A001

Source: Fund staff estimates1/ Trade-weighted index of nominal exchange rates against partner countries deflated by relative movements in consumer price indices. A decline reflects a depreciation.2/ Bilateral exchange rates, deflated by relative movements in consumer price indices.

APPENDIX I

Table 1.

Georgia: GDP by Origin, 1990-94

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Sources: Data provided by the Georgian authorities; and staff estimates.

NMP for 1994 is not yet available. Official estimates of NMP for 1992 and 1993 have been adjusted for the exclusion of some regions, based upon their share in 1990.

Includes the turnover tax.

Estimate of a July 1995 STA mission.

Table 2.

Georgia: Gross Fixed Investment, 1987-94

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Sources: Data provided by the Georgian authorities.

Including forestry.

Table 3.

Georgia: Production and State Purchases of Selected Agricultural Products, 1989-94

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Source: Data provided by the Georgian authorities.
Table 4.

Georgia: Livestock Production. 1989-94

(In thousands)

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Source: Data provided by the Georgian authorities.
Table 5.

Georgia: Summary Energy Balance, 1980-94 1/ 2/

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Source: Data provided by the Georgian authorities.

This table and Table 33 have been derived using different sources; as a result there are some discrepancies.

Excluding variations in stocks and losses.

Most figures are preliminary estimates.

Includes statistical discrepancies.

Table 6.

Georgia: Production of Selected Industrial Commodities, 1989-94

(In thousands of tons, unless otherwise indicated)

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Sources: Data provided by the Georgian authorities; and staff estimates.

Data for Abkhazia and South Ossetia are not included.

Measured on nutrient content.

Table 7.

Georgia: Transportation by State Enterprises, 1991-1994

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Source: Committee of Social and Economic Information.

Estimated.

Table 8.

Georgia: Retail/Consumer Price Index in Tbilisi, 1992-95 1/

(Index: December 1990 = 100)

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Sources: Data provided by the Georgian authorities; and staff estimates.

Before 1993, according to the Retail Price Index; after December 1993 according to a 295-good Laspeyres index using a methodology introduced by a STA mission.

Table 9.

Georgia: Average Prices for Consumer Goods in State Outlets, 1989-94

(In coupons per unit) 1/

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Source: Data provided by the Georgian authorities.

For the years prior to 1993, the coupon/ruble exchange rate is assumed to be 1:1.

Table 10.

Georgia: Minimum Monthly Wage and Pension, 1991-95

(In coupons) 1/

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Sources: Ministry of Labor and Social Affairs.

For the years prior to 1993, the coupon/ruble exchange rate is assumed to be 1:1.

The nominal wage is deflated by Retail Price Index (Paasche, December 1991-100) prior to December 1993, and is deflated by the CPI (Laspeyres) after December 1993.

Table 11.

Georgia: Average Monthly Wages, 1989-94 1/

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Sources: Data provided by the Georgian authorities.

For the years prior to 1993, rubles are converted into coupons at an exchange rate 1:1. Wages include all cash, compensation, and value of goods-in-kind.

Preliminary estimates.

Average for all services.

Table 12.

Georgia: Employment by Sector, 1989-94

(In thousands, yearly average)

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Source: Data provided by the Georgian authorities.

Preliminary estimates.

Table 13.

Georgia: Population and Employment, 1989-94

(In thousands)

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Source: Data provided by the Georgian authorities.

Includes persons registered in Georgia but living abroad; total population may be significantly overestimated.

Working age is 16-55 years for women, and 16-60 years for men.

Including collective farms and consumer cooperatives.

Including peasant farms and individual subsidiary farming.

Preliminary estimates.

Table 14.

Georgia: Unemployment, 1991-1994

(Number of persons)

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Sources: Ministry of Labor and Social Affairs

Noncumulative, as of December 31 every year.

Table 15.

Georgia: Summary of General Government Operations: Functional Classification, 1992-1994

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Source: Georgian authorities; and staff estimates.

In rubles prior to April 1993. Converted into coupons at 1:1 rate.

For 1992 and 1993, revenues of local governments are not included.

Includes revenue from privatization of state property.

See Table 17.

Includes: (i) the difference between costs and prices paid by consumers of gas, electricity and bread; and (ii) expenditure counterpart of grants.

For 1992, includes coupons 19.2 billion for Savings Bank inflation indexation.

Includes credit to the hydroelectricity company and loans to other utilities financed from borrowing from CIS countries.

For 1991 and 1994, estimated accumulation of domestic payments arrears.

Excludes unreported expenditure.

Table 16.

Georgia: Summary of General Government Operations: Economic Classification, 1994-1995

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Sources: Georgian authorities; and staff estimates.

For 1994, this includes VAT, excises, and customs duties collected on imports, and export taxes up to September 1994. For 1995, this is comprised of duties on imports.

Includes excises, the presumptive tax. the property tax and the ecology tax.

Includes the government’s share of NBG profits, from the third quarter of 1995 onwards, as well as license fees, fines and other user fees.

Comprised of contributions to the Social Security and Employment Funds from non-budgetary organizations, and revenues of the Privatization Fund.

Includes office supplies, food and lodging for the military, and medical supplies.

For 1994, this includes the expenditure counterpart of wheat grants, subsidies for metro and publishing, accrued gas payments up to September 1994 (thereafter the government payments to the Gas Corporation covering non-payment by consumers are included as net lending), and operating costs of the Electricity Corporation up to September 1994. For 1995, this includes subsidies for metro and newspapers printing and enterprise subsidies out of the Privatization Fund.

Includes interest payments on domestic, external and rescheduled debt. For 1995 and 1996 it is assumed that external creditors will agree to limit debt-service payments to US$8 million per quarter.

Includes payment for lari and coupon printing and tetri minting, business travel official presentation, foreign embassy costs, and health expenditure covering minimal expenses of disadvantaged.

Includes pensions and unemployment benefit outlays.

Includes domestic expenditure arrears as identified by the government committee on expenditure arrears and irreconcilable differences in data obtained from different sources. The figure for the increase of arrears in 1994 is considerably larger than the accumulation of identified arrears; this is to be resolved by the committee on expenditure arrears in the near future.

Table 17.

Georgia: Central Government Revenue and Expenditure: Official Presentation, 1992-1994

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Source: Georgian authorities.

In rubles prior to March 1993. Converted into coupons at 1:1 exchange rate.

Includes some excise tax collections in January-April 1992.

Includes reimbursement of tax overpayment, or misreporting.

Capital investment for the total economy (distributed under the various categories below) was coupons 10.6 billion in 1992.

When not shown separately, defense is included under law enforcement.

In 1992, this includes 152 million coupons in earthquake relief, coupons 84 million in riot relief, and coupons 200 million for the acquisition of gold and precious metals to back the possible issuance of a national currency.

Excludes unreported revenues and expenditures shown in Table 15.

Table 18.

Georgia: Revenue Sharing Arrangements for Major Taxes

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Source: Georgian authorities.

This is the general rate that applies to the revenue sharing arrangements with most local governments; some local governments get a larger share however. The average local share in VAT revenues increased from 20 percent in early 1995 to 24 percent in mid-1995.

Table 19.

Georgia: Tax Arrears, 1994-1995.

(end of period)

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Sources: Georgian authorities; and staff estimates.

Presented as a percentage of GDP in the preceding four quarters; except for the stock of arrears at the end of October 1994 which is expressed as a percentage of GDP in 1994.

As a percent of quarterly GDP.

Table 20.

Georgia: Marginal Rates of the Personal Income Tax

(From January 1994)

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Source: Georgian authorities.

A standard deduction of coupon 3.5 million applies.

Table 21.

Georgia: Excise Tax Rates

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Source: Georgian authorities.

As of May 10, 1995, the excise tax on domestically produced wine was reduced to 15 percent.

As of December 1, 1994, the excise tax on domestically produced and imported gasoline was increased to 15 percent.

As of May 7, 1995, the excise tax on domestically produced tea was eliminated.

As of January 30, 1995, the excise tax on china was eliminated.

Table 22.

Georgia: Number of Registered and Active Taxpayers, 1994-1995

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Source: Georgian authorities.

Only enterprises are registered as taxpayers; in the case of wage earners paying personal income tax, the withholding enterprise is registered as the taxpayer.

Active taxpayers are registered taxpayers who actually pay taxes.

Table 23.

Georgia: The Social Safety Net, 1994-1995.

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Source: Georgian authorities.

Until July 1995, the minimum wage was equal to the lowest wage scale for government workers. It mainly served as a reference point for the SSN and the government wage grid and was abolished, together with the minimum income, in July 1995 when the government wage grid and the SSN were de-linked from the minimum wage.

Table 24.

Georgia: Accounts of the Social Security Fund, 1992-1994

(In billions of coupons) 1/

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Source: Georgian authorities.

In rubles prior to 1993; converted into coupons at 1:1 rate.

Table 25.

Georgia: Accounts of the Employment Fund. 1994

(In billions of coupons)

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Source: Georgian authorities.
Table 26.

Georgia: Monetary Survey 1/

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Sources: Georgian authorities; and staff estimates.

Excludes Savings Bank.

Table 27.

Georgia: Accounts of the National Bank of Georgia 1/

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Sources: Georgian authorities; and staff estimates.

The reported data have been adjusted to remove the balance on the special account established for debt service, from foreign exchange reserves and government deposits.

Valued at current exchange rates. This contrasts wiht the treatment in the Staff Report which uses the program exchange rate.

Table 28.

Georgia: Structure of Bank Deposits 1/

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Sources: Georgian authorities; and staff estimates.

Deposits of all commercial banks, including the Savings Bank. For periods When no data is reported for the Savings Bank (September 1993, June, 1994, and September 1994) the most recently reported data is used; with an adjustment to value foreign exchange deposits at current exchange rates.

Including deposits of cooperatives, state companies, and so-called public organizations.

Available data on foreign currency deposits not broken down by instrument or by sector of holder.

Reported data in domestic currency, converted at end-period exchange rate.

Through June 1993, data refer to ruble/US$ exchange rate. The coupon was introduced in April 1993 and circulated alongside the Russian ruble. The coupon was declared the sole legal tender in Georgia in August 1993.

Table 29.

Georgia: Currency Composition of Commercial Bank Credit 1/

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Sources: Georgian authorities; and staff estimates.

Excluding claims of the Savings Bank.

Credit to the nongovernment sectors.

The government of Turkey, through Eximbank (Turkey) extended a credit line in the amount of US$50 million to Georgia in 1993. The loan is administered by Eximbank (Georgia) but is guaranteed by the Government; the Government determined who got the loans.

Reported data in coupons converted at end-period exchange rate.

Table 30.

Georgia: Interest Rates (Commercial Banks), 1994-95 1/

(In percent per month)

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Source: Georgian authorities; and staff estimates.

Interest rates given are ranges across a diverse group of banks, and so are only rough indicators of trends.

Average monthly inflation during the quarter.

Table 31.

Georgia: Balance of Payments

(In millions of U.S. dollars)

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Sources: State Committee for Statistics and Fund staff estimates.

There have been significant changes in the coverage of trade data and, as a result, caution is needed in comparing annual totals.

Includes errors and omissions.

Includes a valuation adjustment.

Arrears and debt relief.

Excludes debt service paid into a special account at the Netherlands Bank.

Before rescheduling.

In months of non-grant imports.

As a percent of exports of goods and nonfactor services.

Table 32.

Georgia: Net Energy Imports

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Sources: State Committee for Statistics and Fund staff estimates.

Refers to fees payable for transit of gas by pipeline from the source country to Georgia.

Table 33.

Georgia: External Debt Outstanding

(In millions of U.S. dollars)

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Sources: Georgian authorities; and Fund staff estimates.

Debts to FSU countries other than Turkmenistan initially arose out of the conversion of correspondent account balances and technical credits from 1992 and the first half of 1993 into interstate loans in 1993. Totals for 1992 do not include balances owed on correspondent accounts which were converted into loans in 1993.

All gas arrears at end 1993 were converted into a 2 year loan at libor plus one percent.

Under a preliminary agreement reached in February 1995, all of Georgia’s obligations to Turkmenistan, including new gas arrears from 1994 and penalties were converted into a new debt of US$452.8 million. After a reconciliation of accounts, concluded in May 1995, this figure was reduced to US$440 million.

Refers to a credit from a commercial bank dating from 1989; included as official, since amounts due in 1993 and 1994 were rescheduled, with an Austrian government guarantee.

Not included in debts listed above.

Gas transit arrears were not included in the end-1993 agreement.

Included in debts listed above; does not include arrears for gas imports.

Table 34.

Georgia: External Debt Service Obligations

(In millions of U.S. dollars)

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Source: Georgian authorities, and Fund staff estimates.

At percent of exports of goods and non-factor services.

Table 35.

Georgia--Exchange Rates, 1992-95 Q2 1/

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Coupon exchange rates are those prevailing on the Tbilisi Interbank Currency Exchange (TICEX). Trading was suspended on the TICEX between August 19, 1994 and September 19, 1994.

The Georgian coupon was introduced in April 1993; prior to that date, exchange rates shown are rubles per U.S. dollar. Data on coupon exchange rates were not gathered until August 1993.

August and September 1993 only.

APPENDIX II: Statistical Issues

The quality of Georgia’s statistics is hampered by an infrastructure which is poorly suited for a market economy. In addition, frequent electrical outages, a lack of resources, poor communication and lack of cooperation has hindered the compilation of economic statistics. However, sufficient progress has been made to meet the minimum need of surveillance. The attached table presents core statistical indicators for Georgia.

1. Consumer Prices

An STA mission that visited Tbilisi in February 1995 helped the authorities to construct a Consumer Price Index (CPI) to replace the retail price index (RPI) as the measure of consumer inflation in Georgia. In line with the mission’s recommendations, the authorities have introduced a 295-item Laspeyres CPI for Tbilisi, that tracks the evolution of both ruble and coupon prices. 1/ A follow-up mission (August 31-September 13, 1995) is assisting the authorities to develop a national CPI covering Tbilisi and four other major cities. While the new indices already allow for better analysis of price developments, it is likely that further technical assistance will be required to review the quality of the work being done.

Georgia does not prepare indices of producer prices or export and import unit values.

2. National Accounts

An STA National Accounts Statistics mission that visited Georgia from July 24 to August 11, 1995 found that the national accounts of Georgia are not yet sufficiently developed to meet the needs of macroeconomic analysis, due to severe problems of undercoverage of economic activities, the absence of standard price indices to use as deflators for deriving constant price estimates, internal consistency, and the lack of quarterly data. Some progress has been made with assistance from the OECD. The STA mission recommended an action program including short- and long-term measures to improve the national accounts. Further technical assistance from the Fund as well as from other agencies such as the OECD is recommended.

3. Government Finance Statistics

The quality of government finance statistics in Georgia is still poor, although some progress has been made with the assistance of STA missions and an FAD treasury advisor to adopt the standards of the Fund’s Government Finance Statistics (GFS) Manual. In particular, the Ministry of Finance has started employing an economic classification for expenditures at the level of the Republican government and has introduced new forms to elicit similar information from local governments. There are essentially three main problems with Georgia’s government finance statistics: (i) inadequate coverage; (ii) poor classification; and (iii) unavailability of data on a timely basis.

On coverage, little information is available on expenditures on a commitment basis, and, thus, on government expenditure arrears. Also, the operations of extrabudgetary funds are not included in the information for central government. In addition, information on fiscal operations of the local governments is only partially available, and in the case of the autonomous republics of Abkhazia and Adzharia virtually nonexistent. The control of the fiscal operations of the local governments is, therefore, exerted through monitoring of transfers from the republican budget and limiting their access to the banking system.

With regard to classification, often no distinction is made between fiscal revenues and government borrowing, while repayments of government loans are recorded as revenue rather than a reduction of net lending. Intergovernmental transfers are recorded on a net rather than a gross basis. Expenditures are classified by function, and available information on economic classification of expenditures is often inaccurate, though some improvement has been made recently after the fledgling Treasury started keeping records on the basis of an economic classification.

There are significant lags in the collection of data by the Ministry of Finance (MOF), especially from local governments. The flow of information between the NBG and the MOF on the financial position of the Republican government has improved significantly. The authorities have recently begun to require more timely information from the local governments.

4. Balance of Payments Statistics

The last STA balance of payments mission to Georgia (July/August 1994) reported that although the authorities had taken steps to develop an institutional capacity to produce balance of payments estimates, overall progress had been slow in implementing recommendations of previous missions with respect to data collection and analysis. In particular, not much progress had been made to expand the coverage of customs data partly because of the lack of trained personnel capable of validating data on customs declaration forms.

Despite these shortcomings, customs data are still the best available source for estimating the value of external trade. However, they need to be supplemented with information on trade from other sources and with estimates of unreported cross-border trade and associated services, especially with Turkey. Data on services, incomes, and transfers are incomplete and weak. Banking system data on financial flows are also unreliable because of accounting problems in the banks. In particular, accounts tend to be classified on the basis of currency of denomination rather than on the basis of residency of account holders. The compilation of balance of payments data is also hampered by delayed and incomplete reporting from other government agencies.

The authorities have requested the placement of a resident expert in Georgia instead of short visits by STA. They believe a longer-term presence would provide more effective training and practical guidance in the compilation of balance of payment statistics. STA is considering the placement of an expert in the region to serve Georgia and two other countries.

5. Money and Banking Statistics

Although substantial progress has been made in the compilation of money and banking statistics in Georgia, classification and valuation problems persist, reflecting weaknesses in accounting systems. In addition, there are significant discrepancies between NBG and commercial bank records on interbank accounts. Particular difficulties relate to foreign currency denominated accounts and the lack of uniform and transparent valuation practices for converting these accounts into domestic currency for reporting purposes. An MAE accounting expert has made detailed recommendations and provided training to NBG staff on the preparation of NBG accounts according to international standards.

A STA mission that visited Georgia in May 1995 made recommendations on using available supplementary accounting information on the NBG’s foreign assets and liabilities to improve the quality of monetary statistics in Georgia. In particular, the mission proposed improving the classification of data by residency, sector, and instrument. The mission designed new call report forms for commercial banks and recommended that a new chart of accounts replace the current accounting system which is based on the old Gosbank system. The authorities have implemented the recommended new report form for the commercial banks.

APPENDIX III: Tax Summary

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APPENDIX IV: The Social Safety Net

The broadening of the SSN in September 1994 was an important step in the transition process. By markedly improving the protection of the poor, the revamping of the SSN removed an important obstacle for a sharp reduction in subsidies and provided a more focussed tool for reducing poverty.

SSN benefits are provided by the Social Security Fund (SSF), the Employment Fund (EF), and the republican budget, while enterprises and local governments provide an unknown amount of benefits, such as maternity benefits and sickness pay. The SSF finances pensions and a number of other benefits such as funeral allowances, while the EF takes care of unemployment benefits and some employment programs. The state provides family allowances, benefits for refugees, and stipends for students.

The SSF was established in 1991, and provides old-age, invalidity and survivors pensions on a pay-as-you-go basis. It collects its own revenue, consisting of a 37 percent payroll tax for state-owned and private enterprises and 26 percent for budgetary organizations, and a mandatory contribution for workers of 1 percent of their wages. Employers are allowed to deduct benefits they pay to their active workers, such as sickness and maternity benefits, from the payroll tax.

Disability pensions are granted liberally, and the general retirement age (60 for men and 55 for women) is low by international standards. Moreover, workers can retire early if they have worked in covered employment for a sufficiently long period of time (25 for men and 20 for women). On the other hand, the flat pension benefit is low; coupon 3.7 million (US$2.85) a month as of July 1, 1995 (see Appendix I, Table 23). Pensioners cannot receive multiple pensions and benefits are in principle withheld from those who have an income from work.

The EF was established at the same time as the SSF in 1991, but is much smaller. It also functions on a pay-as-you-go basis, and collects its own revenues, a 3 percent payroll taxes on non-budgetary institutions. The EF provides an unemployment benefit for those who have been out of work for a period between 2 and 8 months. Moreover, the EF administers the labor exchanges, that collect information on vacancies and the unemployed and actively look for job opportunities, even going as far as leasing land for unemployed individuals to start a farm. The EF also provides employment programs for unemployed refugees.

Out of the republican budget, the Government provides social assistance to families with children, single mothers, refugees and students. As of July 1, 1995, families with at least two children receive a flat monthly child allowance, independent of the number of children in the family. Children can be up to 18 years old for the family to receive the allowance, as long as they attend school and live at home. Before July 1995, child allowances were available for all children satisfying these requirements. Refugees receive a flat cash benefit, supplemented by a benefit for pensioned retirees and, since July 1, 1995, a benefit for refugees living in Tbilisi to compensate for the increased cost of transportation. In addition, the Government spends about coupon 0.7 trillion a month on benefits in kind for refugees, such as housing. Finally, the republican government provides stipends for university students. Universities receive transfers from the MOF, that they allocate to students according to their study results.

In the past, the republican government provided supplementary benefits to pensioners and government workers in the lowest pay scales to guarantee a minimum income. This program was discontinued as of July 1, 1995, when the lowest budgetary wage was increased.

The SSN provides benefits to a large number of people; out of a population of 5.4 million, about 1.4 million people received a pension, refugee or unemployment benefit in the second quarter of 1995. 1/ Without any change in policy, the ratio of benefit recipients to total population will rise markedly due to the progressing aging process.

This threat to the viability of the pension system could be addressed by increasing the retirement age, tighten the eligibility requirements for the invalidity pension, and by allowing and stimulating the development of private pension plans. The targeting of other elements of the SSN should also be improved, for example by eliminating the provision of benefits to refugees who receive an income from work. Furthermore, the raising of revenues by the SSF and EF separately at fairly high marginal rates should be reviewed.

APPENDIX V: The Budgetary Process

1. Coverage funds

The state budget includes the budgets of the republican Government and 65 local governments: the two autonomous republics of Abkhazia and Adzhar, ten administrative regions, and 53 administrative districts. 1/ In addition, as defined in this report, the state budget covers all the extrabudgetary funds, implicit subsidies financed by external food assistance and external arrears. The largest extra budgetary fund, the Social Security Fund (SSF), levies contributions on employers and employees to finance pensions and other social security benefits. Other extrabudgetary funds include the Employment Fund (EF), that uses employer and employee contributions for unemployment benefits and unemployment reduction measures; the Health Fund, that finances the basic health care that the Government is still responsible for after the privatization of a large part of the health sector in August 1995; the State Foreign Currency Fund through which foreign exchange transactions are conducted; the Privatization Fund, containing the proceeds from privatization; the Defense Fund, which was used to cover a large part of the military cost during the civil war; and the Gold Fund, that buys precious metals in raw, semifinished, and finished form from mining enterprises, pawn shops, and other sellers.

2. The budget process

a. Budget preparation

The budget cycle starts in the summer, when the Cabinet of Ministers issues directions for next year’s budget. In August the Ministry of Finance (MOF) receives the budget proposals from the spending ministries and independent budgetary organizations, the draft budgets from the local governments and extrabudgetary funds, and the economic forecasts from the Ministry of Economy. On the basis of this information, the MOF prepares a draft state budget. In the Budget Law of 1993 it is stipulated that the Cabinet of Ministers should receive the draft budget by mid-September. The Cabinet of Ministers has until mid-October to finalize the draft budget and present it to Parliament, that is required to pass a budget law before the beginning of the budget year on January 1.

In 1993 and 1994, no budget was approved before the beginning of the budget year. Instead, Parliament approved quarterly budgets after the quarter had passed and the spending had occurred. In 1995, a budget was approved in time for the beginning of the fiscal year. However, the importance of the budget is greatly reduced by the lack of reliable data and forecasts at the time of the budget preparation, giving rise to frequent deviations during the implementation of the budget.

b. Budget implementation

For the implementation of the budget, the annual budget appropriations are translated into quarterly appropriations and monthly bank credits for the spending ministries. Since November 1994, the MOF limits the monthly bank credits to projected revenues and available financing, taking the budget appropriations as an upper bound. The MOF monitors the budget execution using daily payment reports from the NBG and monthly cash reports from the spending ministries.

The STS is responsible for all tax collections, apart from customs duties, and VAT and excises on imports and exports, that are collected by the SCC. After the tax bill is assessed, the taxpayer deposits the amount due in a local bank. The bank receiving the tax payment divides the revenues between the republican and local government according to the relevant revenue sharing formula, after which the payment is processed by the banking system and credited to the government account at the NBG or deposited in the proper bank account of the local government. Local STS and SCC offices check tax payments and code them. On the basis of this information, STS and SCC headquarters compile overviews of tax payments, which are sent to the MOF once a month. The MOF compares these overviews with revenue information received daily from the NBG.

APPENDIX VI: Exchange Trade and Payments Systems

1. Exchange arrangements

The currency of the Republic of Georgia is the Georgian coupon. The coupon was introduced on April 5, 1993, as a supplementary form of currency to circulate along with the Russian ruble, and was declared the sole legal tender on August 3, 1993. For all commercial transactions, the exchange rates of the coupon are negotiated freely between the banks and foreign exchange bureaus that are licensed by the NBG, and their customers. In addition, the Tbilisi Interbank Currency Exchange (TICEX) holds three sessions a week at which the NBG and the banks, judged by the TICEX to have sufficiently large foreign exchange turnover, participate. At these sessions, all transactions take place at the single exchange rate for each currency which balances supply and demand.

The official exchange rates for the U.S. dollar and the Russian ruble are determined as the exchange rates arising at the most recent weekly TICEX session. Official rates for other convertible currencies are determined on the basis of the cross rates for the U.S. dollar and the currencies concerned in the international market. For the currencies of other FSU countries, official exchange rates are determined on the basis of the official cross rates for the Russian ruble as published by the Central Bank of Russia. Official exchange rates are used for budget and tax accounting purposes, as well as for all transactions between the CBR, the Government and enterprises and other legal entities. These transactions include those arising from the compulsory sale of foreign exchange by exporters to the NBG. Because the official exchange rate is only established three times per week, it may diverge by more than 2 percentage points from the market exchange rate on the day of surrender.

On August 1, 1995 the official exchange rates were coupon 1,300,000 per U.S. dollar and coupons 251 per Russian ruble.

2. Administration of control

The NBG is responsible for administering exchange control regulations, which are formulated in collaboration with the Ministry of Finance. Decree No. 259, of March 5, 1992, on “The First Stage of Liberalization of Foreign Economic Activity” established the legal basis for the conduct of foreign economic activities in Georgia. The main provisions of this decree: (i) allow all enterprises to engage directly in foreign trade; (ii) allow all residents to acquire and hold foreign currency and engage in foreign transactions with a licensed foreign exchange dealer; and (iii) authorize banks to open foreign exchange accounts for all residents.

The NBG has the authority to issue general foreign exchange dealing licenses to banks to permit them to engage in foreign exchange transactions with residents and nonresidents and to open correspondent accounts with banks outside of Georgia. The NBG also has the authority to issue internal licenses to banks which permit them to engage in the same range of foreign exchange transactions as general license holders, except that holders of internal licenses may not open correspondent accounts with banks abroad; all transfers of foreign exchange by holders of internal licenses must be carried out through correspondent accounts held either with the NBG or with a bank that holds a general license. The NBG also has the authority to issue licenses for the establishment of exchange bureaus to engage in exchange transactions of all kinds in banknotes.

3. Prescription of currency

Residents of Georgia may make and receive payments and transfers in any convertible currency as well as in rubles.

4. Resident and nonresident accounts

Resident individuals and enterprises are permitted to open and operate foreign exchange accounts at banks in Georgia. The balances in these accounts may be used for all authorized transactions. The opening of foreign exchange accounts abroad by residents is subject to authorization by the Ministry of Finance and the NBG. Nonresidents may maintain foreign exchange and local currency accounts with banks in Georgia and may freely remit funds from these accounts offshore. The export of cash currency is permitted by non-residents up to a limit equal to the amount of currency originally imported; exports by non-residents in excess of the amount imported are subject to a fee of 10 percent. The export of cash by residents is unrestricted up to an amount of US$500. Beyond this amount, exports of cash, excluding amounts for business travel expenses, are subject to a 2 percent fee, with amounts over US$10,000 subject to a 3 percent fee (Decree No. 1 of January 6, 1995 on Provisional Rules for the Export of Foreign Currency Notes by Citizens, as amended by Decree No. 158 of May 6, 1995).

5. Imports and import payments

Trade with countries other than the states of the FSU is controlled by the State Committee on Foreign Economic Relations (SCFER) (Decree No. 265 on Quotas and licensing of Merchandise Trade of March 31, 1993 and Decree No. 35 of January 23, 1995, on the State Regulations of the Export and Import of Goods and Services). There are no quantitative restrictions on imports, and licenses are not required, except for weapons, narcotics, industrial equipment, industrial waste, pharmaceuticals, agricultural pesticides and various live animals, seeds and plants, which are licensed by the SCFER. A customs duty of 12 percent is levied on all non-barter imports, except humanitarian aid; diplomatic shipments; non-commercial imports for internal consumption by cultural groups; certain institutions and activities of the patriarchate; gifts valued at less than US$3,000 and personal belongings; goods in transit and for re-export; capital goods imports under foreign investment and by joint ventures; imports of gasoline; and various categories of foods and medicines. A customs duty of 20 percent is levied on imports under barter arrangements. All imports are subject to a general customs processing fee of 0.2 percent. Foreign exchange to pay for imports may be purchased freely from authorized banks at market rates.

6. Exports and export proceeds

A limited range of goods are subject to export prohibitions and licensing requirements for export (Decree No. 35 of January 23, 1995, on the State Regulations of the Export and Import of Goods and Services and amendment of February 17, 1995). Export prohibitions apply to antiques and artworks of museum value; weapons and gunpowder; oil and oil products; copper products; timber; raw leather; and scrap metals. In addition, export prohibitions have been applied as a result of domestic shortages of milk and milk products; meat and meat products; corn cereal, pasta products and flour; sugar; and animal fodder. Licenses, are required for the export of coal; ferrous metals and their products; mineral fertilizers; manganese and copper ore; alcoholic liquor; mineral water; and tobacco products which were subject to quotas under the state order system until it was abolished in June 1995. In addition the following goods are also subject to export licensing: ores; concentrates; alloys and residuals of precious metals; precious and semi-precious stones; lead and zinc concentrates and arsenic ores; all pharmaceuticals; raw wool; live game birds and fish; fossils; and wild flora. All exports are subject to a general customs processing fee of 0.2 percent.

Exporters are required to surrender 32 percent of convertible currency proceeds from exports to the NBG.

7. Payments for and proceeds from invisibles

Residents may freely purchase foreign exchange to make payments for invisible transactions or use foreign exchange balances in their foreign exchange accounts with authorized banks without restriction. Proceeds from invisibles are subject to the same regulations and procedures as those applicable to the proceeds from exports. The importation of foreign currency bank notes is unrestricted, but amounts must be declared by non-residents.

8. Capital

Inward and outward capital operations are not restricted.

9. Gold

A license is required to conduct both international and domestic trade in gold.
1/

See Appendix II on statistical issues.

2/

For example, over the same period, natural gas consumption fell by 45 percent, while electricity consumption fell by 51 percent.

1/

World Bank, Agriculture and Food Sector Review, June 1995.

1/

Industrial data covers state enterprises only.

1/

State monopolies continue to run the railway and the ports on the Black Sea at Batumi and Poti.

2/

Based upon a 295-good CPI using a methodology developed with technical assistance provided by Statistics Department of the International Monetary Fund in February 1995.

1/

A household survey is now being conducted according to international standards, and the results should be available later this year.

2/

Small enterprises are those with fewer than 50 employees, and an asset value as of January 1, 1993 of less than Rub 30 million.

1/

In 1994, the VAT accounted for 28.6 percent of total revenue (excluding grants), the profit tax for 19.9 percent, the personal income tax for 5.9 percent, excises for 5.3 percent, customs duties for 3.9 percent, other taxes for 7.1 percent, extrabudgetary revenue for 16.2 percent, and nontax revenue 13.1 percent. Local governments retain a share of tax revenue, specified in Appendix I, Table 18.

2/

Total revenues excluding grants ranged from 9.2 percent of GDP to 13.5 percent in Armenia, Kazakhstan, Moldova and the Kyrgyz Republic in 1994.

3/

The stock of tax arrears increased from 0.6 percent of GDP at end-October 1994, to 1.3 percent of GDP at end-December 1994, and 2.0 percent of GDP at end-June 1995 (Appendix I, Table 19).

1/

In 1994 the time lag between the deposit made by a taxpayer at a local bank and the crediting of the Government account at the NBG varied from two days to two months. Simplification of the process for transferring tax revenues to the Ministry of Finances account at the NBG and the imposition of fines on banks for late transfers, have helped to shorten the lag considerably.

1/

The inability to collect payments for domestic consumption of gas, has resulted in government payments to Turkmenistan the first seven months of 1995.

2/

Little information is available on local government operations.

3/

See Appendix IV and Appendix I, Table 23 for a description of the SSN, and Appendix I, Tables 24 and 25 for accounts of the Social Security and Employment Funds.

1/

Under an intergovernmental agreement between Georgia and Turkmenistan, the Georgian Government guaranteed payments for Turkmen gas deliveries to the gas corporation. This created huge arrears in 1994 as the Government took over large overdue payment obligations for gas imports, but lacked the resources to settle these claims. The Government stopped guaranteeing the import of energy as of June 1995.

1/

The Russian ruble is the principal medium of exchange and unit of account, while the U.S dollar is the preferred store of value. In recent months, the dollar appears to have been gaining ground as a medium of exchange, especially for high-value transactions.

1/

The Turkish credit is administered by Eximbank on behalf of the Government. The Government guaranteed the loan and determined its distribution.

1/

The minimum capital requirement was increased from coupon 200 million to coupon 500 million in February 1994. The value of the minimum capital fell from US$2,500 in February 1994 to US$385 a year later.

1/

The total number of banks has fallen from 227 in mid-1994 to 149.

1/

Imports of official food aid destined for distribution by the government as well as non-governmental organizations are monitored by the World Food Program in Georgia as part of an operation to overcome logistical problems in the delivery of food aid to Georgia, Armenia and Azerbaijan.

1/

In December 1994, the Fund approved a first purchase under the STF in support of Georgia’s economic program. Georgia’s eligibility to draw under the STF was established on the basis of the substantial increase in net energy import costs which was due to a shift from a significant reliance on trading at non-market prices toward world market pricing (EBS/94/221, supplement 1).

1/

The price charged of US$80 per 1,000 cubic meters of gas from Turkmenistan includes a transit fee which for most of the period since prices were increased in 1993 has been set at US$30 per 1000 cubic meters. Under the terms of the former inter-governmental agreements with Turkmenistan, the transit charges have been payable in cash, whereas the gas costs could be paid through barter trade.

2/

Although anecdotal evidence suggests that private transfers may constitute a significant source of external financing, limited data available from banks in Georgia--including a recently opened branch of an international money transfer agency--indicate that private transfers into Georgia have been modest and largely balanced by transfers abroad.

1/

The availability of information on foreign direct investment is also limited by the system of company registration. Under this system, new enterprises are required to register with regional courts, but they are not required to give any details of any foreign participation.

1/

In addition to these amounts that were converted into new loans, small balances remain on correspondent accounts with other countries of the FSU.

1/

The European Union committed three loans to Georgia totalling Ecu 120 million; Ecu 70 million in 1992 and Ecu 10 million and Ecu 40 million in 1993. These loans, which were principally used to finance imports of wheat and flour were mostly disbursed in 1992 and 1993; disbursements of the final loan were halted in mid-1994. For each loan, bullet repayments of principal are due after three years, and interest is charged at a margin of 0.3 percent over libor.

2/

A total of US$50 million was committed, with the amounts to be used to finance imports of wheat and flour, consumer goods and some capital equipment. The bulk of disbursements took place in 1993; when disbursements were halted in 1994, a total of US$42 million had been drawn through letters of credit. This amount is repayable over three to four years in equal annual payments with no grace periods and interest charged at libor plus one and libor plus two percent.

1/

As noted in Section II, the Georgian government has announced that it no longer plays a role in energy procurement; the responsibility therefore rests on private purchasers to negotiate their own supply contacts, without a government guarantee, and on suppliers to determine whether they will discontinue supplies in the event of non-payment.

2/

A detailed description of Georgia’s exchange and payments system is provided in Appendix VI.

1/

The rate reached coupon 4.5 million in unofficial cash trading, and coupon 5.5 million in unofficial trading on bank deposits, which faced restrictions on encashment.

1/

The limited role of the coupon in domestic transactions suggests that few prices are determined in coupons; nevertheless, the calculated real effective rate is useful in providing an indication of the starting point from which to gauge the impact of future movements in the exchange rate as the coupon--and its successor the lari--gain wider acceptance in the economy and begin to exert more influence in domestic pricing. However, it should be noted that the choice of the base year for indices of the real exchange rate is essentially arbitrary and does not imply that the real exchange rate was at an appropriate level in 1992.

1/

The measurement of inflation in Georgia continues to be complicated by the use of multiple currencies--some products can be bought only in rubles, and others only in coupons.

1/

Pensioned refugees are only counted once. The number of unemployed is somewhat inflated due to the laying off of 75,000 government workers during January-May 1995.

1/

Budget information from Adzhar, Abkhazia and South Ossetia is scarce due to a disruption of relations between these areas and the Republic.

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Cover IMF Staff Country Reports
Georgia: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 1995: Issue 112
Publisher:
International Monetary Fund
ISBN:
9781451814385
ISSN:
1934-7685
Pages:
114
DOI:
https://doi.org/10.5089/9781451814385.002
CHART 1.

GEORGIA Macroeconomic Indicators, 1990-1995
CHART 2.

GEORGIA Annual Imports of Natural Gas Billions of Cubic Meters
CHART 3.

GEORGIA Inflation and Exchange Rates
CHART 4.

GEORGIA Real Minimum Wage and Pension 1/

(Deflated by the RPI/CPI, January 1991 = 100)
CHART 5.

GEORGIA Public Finances
CHART 6.

GEORGIA Funding of Expenditures and Net Lending
CHART 7.

GEORGIA Monetary Developments
CHART 8.

GEORGIA Currency Issued 1/

(In billions of coupons and millions of U.S. dollars; log scale)
CHART 9.

GEORGIA Bank Deposits
CHART 10.

GEORGIA Official Versus Unofficial Exchange Rates 1/
CHART 11.

GEORGIA Indicators of the Real Exchange Rate

(1992 = 100)