October 17, 2003

1. This statement provides an update on economic and policy developments since the issuance of the staff report. These developments do not change the thrust of the staff appraisal.

Macroeconomic developments

2. Recent data confirm that macroeconomic performance in 2003 has been characterized by low inflation and exchange rate stability. The twelve-month rate of inflation rose marginally in September, to 5.2 percent. The lari has remained broadly stable in nominal terms vis-à-vis the U.S. dollar; in real effective terms, the lari depreciated by almost 7 percent in the year ended August 2003. Arrears to official bilateral creditors increased to US$34 million by end-September 2003. Despite a shortfall in external grants, gross official reserves remained practically unchanged in September, at US$195 million.

3. Preliminary data for end-September suggest that the indicative target for overall tax revenues was missed by about GEL 11 million (0.1 percent of GDP). The target for reserve money was met. Data on the other end-September indicative targets will only become available within the next few weeks.

4. The 2004 budget bill was sent to parliament on October 1 according to the statutory calendar, but it will likely be discussed only after the new parliament convenes following the November 2 elections; a vote will probably take place in late 2003 or early 2004. The current budget bill reflects updated information compared with Table 4 of the staff report. In particular, the authorities have introduced downward revisions in external grants, capital outlays, and net lending. Given the limited availability of net foreign inflows and non-inflationary domestic financing, the authorities will probably need to further scale back their original spending plans. A staff team will visit Tbilisi October 23-29 to discuss the 2004 budget and review recent economic performance, and the authorities have indicated that the budget bill will be revised to take into account the mission’s recommendations.

5. The legislative changes designed to bolster the investigative and prosecutorial powers of the Ministry of Finance for economic crimes—including smuggling—became effective October 1. A new investigative unit has been set up and is currently recruiting staff. The authorities anticipate significant improvements in the effectiveness of their anti-smuggling efforts and in the accountability of tax and customs department staff as a result of these legal and institutional changes. They hope this will contribute to improved revenue performance during 2004 in conjunction with other key components of the recently adopted tax reform (described in Box 1 of the staff report), which will become effective on January 1, 2004.

6. The ratio of nonperforming loans to total bank assets fell from 7.5 percent in June to 7.1 percent in August 2003. In response to an acceleration in the growth rate of broad money to 28 percent in the year ended August (from 21 percent in June), the NBG has taken steps to tighten credit conditions. These include a smaller-than-envisaged reduction in reserve requirements on lari deposits to 9 percent (versus the originally planned reduction to 8 percent reported in the staff report), and a cap on the amount of required reserves on lari deposits that can be met with current account balances at the NBG at 4 percent; as a result, banks will be allowed to meet just under half of the total required reserves on lari deposits (i.e., slightly less than indicated in the staff report) with their current account balances at the NBG. Required reserves on foreign currency deposits remain unchanged at 13 percent. The monetary authorities have informed staff that, if a further tightening is warranted over the next several weeks, they stand ready to mop up liquidity by resorting more actively to interbank credit/deposit auctions.

Other issues

7. In the energy sector, recent data show that cash collection rates for both budgetary organizations and direct customers of the Wholesale Electricity Market (GWEM) now meet the 70 percent target set under the PRGF-supported program. Cash collections from the GWEM’s direct customers (mainly large SOEs) amounted to 80 percent in August, bringing the collection rate for the year to date up to 70 percent. The collection rate for budgetary organizations outside Tbilisi rose to 91 percent in August 2003. By contrast, collections by the United Distribution Company (UDC) from households outside Tbilisi have not shown a significant improvement, owing in part to pressures from governors and other local officials to slow the UDC’s drive to cut off non-paying customers, which had started in June 2003. Transfers from UDC to GWEM stood at only about 6 percent of billing in July and August 2003, compared to the indicative floor of 30 percent for Q3 2003 set in the program.

8. According to the latest Corruption Perception Index for 2003 just released by Transparency International, Georgia’s ranking has fallen to 124^th place (out of 133 surveyed countries), compared to the 85^th place it had scored last year (as noted in the staff report). Nevertheless, awareness of the challenges posed by governance problem seems to be increasing in Georgia, and in mid-September, the autonomous Anti-Corruption Bureau (ACB) and a number of resident NGOs forged a new coalition to strengthen anti-corruption efforts. The goal is to leverage the ACB’s mandate and superior access to information with the independence and international experience of participating NGOs in an effort to design new, more specific anti-corruption measures and to strengthen enforcement.