Georgia
Sixth Review Under the Stand-By Arrangement and Requests for Modification of Performance Criteria, Waiver of Nonobservance of Performance Criterion, Waiver of Applicability of Performance Criterion, and Rephasing of Purchase: Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Georgia.
Author:
International Monetary Fund
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Publication Date:
19 Jul 2010
eISBN:
9781455206520
Language:
English
Keywords:
ISCR; CR; fund staff estimate; NIR PC; dollar; lari; debt service; broad money; GDP growth; net FDI; debt ratio
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The economic recovery has gained strength in Georgia. The corrective policy actions provide adequate assurances that the program objectives are on track. The success in mobilizing additional budgetary support and diversifying their financing sources is commended. Postponing implementation of a referendum requirement on tax increases, until the fiscal deficit has been returned to prudent levels, enhances policy flexibility. The recent tightening of monetary policy is warranted and should continue. The exit strategy has been reinforced by improvements in confidence accompanying the rebound in activity.

Abstract

The economic recovery has gained strength in Georgia. The corrective policy actions provide adequate assurances that the program objectives are on track. The success in mobilizing additional budgetary support and diversifying their financing sources is commended. Postponing implementation of a referendum requirement on tax increases, until the fiscal deficit has been returned to prudent levels, enhances policy flexibility. The recent tightening of monetary policy is warranted and should continue. The exit strategy has been reinforced by improvements in confidence accompanying the rebound in activity.

I. Program Performance

Georgia: Quantitative Performance Criteria (PC) and Indicative Targets, March–June 2010

article image
Sources: Georgian authorities; and Fund staff estimates.

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

The continuous performance criterion for external arrears is defined in paragraph 17 of the TMU.

1. All end-March program targets were met:

  • NIR was well above target, as foreign exchange intervention was kept below agreed limits, despite a shortfall in privatization revenues and project loans.

  • NDA was comfortably below the ceiling due to lower net lending to banks and higher accumulation of government deposits.

  • The fiscal deficit was below the ceiling by a wide margin (1.2 percent of annual GDP) owing to a revenue windfall from higher growth and underexecution of spending—explained in part by implementation delays of foreign-financed capital projects.

2. End-June program targets are expected to be met, with the exception of the NIR target, which will likely be missed due to delayed exchange rate adjustment to pressures in April–May. Corrective measures have been taken to address the underlying imbalance.

II. Recent Developments and Outlook for 2010

3. The orderly conclusion of the May 30 municipal elections removed uncertainty that was weighing on confidence. The ruling party retained control of Tbilisi and major cities.

4. Real GDP growth for 2010 has been revised up from 2 to 4½ percent, on the back of two consecutive quarters of economic expansion. While there are few direct spillover risks from instability in the Euro zone, external risks have increased. CPI inflation dropped to 4 percent in May, but is expected to stabilize at around 5 percent.

5. Despite the acceleration of economic activity, the current account deficit in the first quarter was lower than expected due to improved terms of trade, while private capital inflows remained low. The 2010 current account deficit is now projected at 12.6 percent of GDP. FDI inflows in the first quarter were very weak ($76 million), prompting a downward revision of annual FDI inflows to below the level of 2009. Banks are expected to generate net financial inflows as they repatriate foreign assets to meet recently announced reserve requirements on external liabilities.

uA01fig01

Georgia: Foreign Exchange Market, 2008–10 1/

(In millions of US$)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ June data are as of June 11.
uA01fig02

Georgia: Seasonally-Adjusted Real GDP, 2004–14

(In millions of 2003 lari)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ Trend is calculated using the Hodrick-Prescott filter applied to 2004–2014 data.
uA01fig03

Georgia: Indicators of Economic Activity, March 2008–May 2010

(3-month moving average, y-o-y change in percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig04

Georgia: CPI Inflation, 2007–10

(Year-on-year change, in percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: Georgian authorities; and Fund staff estimates and projections.
uA01fig05

Georgia: Real and Nominal Effective Exchange Rates, 2006–10

(Index, 2000 = 100)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig06

Georgia: External Flows, 2008–10

(3-month moving average, y-o-y growth in percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: National Bank of Georgia; and INS database.

6. There are signs of a nascent recovery of credit growth, supported by a gradual lowering of deposit and lending rates over the past year. All of the growth in lending has been in local currency. The banks’ balance sheets are cushioned by ample levels of capital and provisioning, but the high level of NPLs remains a risk factor.

Georgia: Selected Monetary and Financial Soundness Indicators, 2008–10

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

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

Basel I definition.

Ratio of liquid assets to 6-month and shorter maturity liabilities.

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

IMF definition.

Pre tax.

uA01fig07

Georgia: Lari Interest Rates, 2006–10

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ Weighted-average lari rates on new loans/deposits.
uA01fig08

Georgia: Deposits, 2008–10

(In millions of lari)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig09

Georgia: Domestic Fx Interest Rates, 2006–10 1/

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ Weighted-average fx rates on new loans/deposits.
uA01fig10

Georgia: Credit to the Private Sector, 2008–10

(In millions of lari)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: National Bank of Georgia; and Fund staff estimates.
uA01fig11

Georgia: Capitalization Ratios, 2006–10

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ National definition. Risk weight to forex loans was reduced from 200 to 175 percent in September 2008, and to 150 percent in August 2009.
uA01fig12

Georgia: Nonperforming Loans and Provisions Ratios, 2006–10

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ NPLs are defined as loans in substandard, doubtful, and loss loan categories.2/ NPLs are defined as loans with overdue payments (principle and/or interest) over 90 days.
uA01fig13

Georgia: Liquidity Ratios, 2006–10

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ Ratio of liquid assets to six-month and shorter maturity liabilities.2/ Current assets are assets of one-month and shorter maturity.
uA01fig14

Georgia: Profitability Ratios, 2006–10

(In percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

1/ Pre tax. Cumulative through the year and annualized.Sources: National Bank of Georgia; and Fund staff estimates.

III. Policies for 2010, the Medium-Term Outlook, and the Exit Strategy

Based on an expected easing of seasonal foreign exchange market pressures, policy discussion in early May focused on consolidating the exit strategy in the context of an improved growth outlook.

However, the persistence of exchange rate pressures and the related downward revision of projected FDI inflows in 2010, required policies to be revisited in June in the direction of faster fiscal and exchange rate adjustments, and monetary tightening.

A. Exchange Rate Policy

7. Through April 2010, the exchange rate was managed flexibly, as evidenced by the lari’s depreciation by 5 percent since the beginning of the year vis-à-vis the U.S. dollar (the currency of reference). In the face of seasonal foreign exchange market pressures, exchange rate policy was rebalanced in favor of more depreciation and less intervention, compared with the same period in 2009.

8. However, as exchange rate pressures persisted into May, the authorities increased intervention to contain the rate of depreciation, and will, as a result, likely fail to observe end-June NIR target. This policy choice reflected their view that pre-election uncertainty was driving pressures, which would reverse in June. Eventually, with signs of weaker-than-expected FDI inflows, the authorities acknowledged that the imbalance in the foreign exchange market had a structural component, which would require faster exchange rate adjustment. More expansionary fiscal and monetary policies in the second quarter of the year were recognized as additional contributing factors.

uA01fig15

Georgia: Foreign Exchange Intervention and Exchange Rate, 2008–10

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig16

Georgia: Foreign Exchange Intervention and Exchange Rate Depreciation, 2009–10

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: Georgian Authorities; and Fund staff estimates.

9. On June 4, the authorities took action by reducing considerably the volume of dollars offered at auction. The resulting rapid movement in the rate—which depreciated by 8 percent by the end of the day—required some follow up intervention to stabilize public expectations. As of June 23, cumulative depreciation vis-à-vis the U.S. dollar was 10 percent since the beginning of the year, and market conditions had stabilized.

10. To reinforce exchange rate flexibility going forward, the authorities plan to limit intervention and the frequency of the auctions to once a week (LOI, ¶25). These two factors combined should promote foreign exchange trading within the market and thus ensure faster and smoother exchange rate adjustment. Foreign exchange inflows are expected to pick up due to seasonal factors (tourism and remittances) and an acceleration of private capital inflows in the second half of the year, riding on stronger GDP growth and the orderly conclusion of local elections, as well as a stronger privatization drive.

11. Under the revised program, the projected shortfall in private capital inflows relative to the fifth review (by US$276 million, or 2.6 percent of GDP) is more than offset by improved current flows and higher official transfers. Despite the higher GDP growth, the current account deficit is revised downward by US$189 million, mainly on account of improved terms of trade.

B. Fiscal Policy

12. Based on preliminary information, the budget deficit target of end-June will be met. Revenues are projected to come out above target on account of stronger GDP growth. Spending should come out below the program projection, even with some catch up relative to the under-execution of the first quarter. The increase in spending in the second quarter (which could exceed 20 percent over the first quarter) contributed to the foreign exchange market pressures observed in May.

uA01fig17

Georgia: Government Revenues and Expenditures, 2003–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig18

Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig19

Georgia: Public Debt, 2004–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

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

13. Given the efforts already undertaken to reduce the deficit in 2010, the authorities initially considered that the revenue gain expected in 2010 on account of higher growth should be largely used to finance some of the more pressing capital projects. The authorities underscored the strict wage bill containment and cuts in administrative costs underlying the 2010 adjustment. In the face of large unmet needs, the draft supplementary budget prepared in April allocated 85 percent of the projected revenue gain to new spending authorizations (+1.1 percent of GDP). This increase in spending allocations covered replenishment of reserve funds which were depleted by emergency spending due to natural disasters (earthquake and flooding), housing for internally displaced persons, and capital projects including new customs clearance and border checking infrastructure to facilitate trade, and initial work on the relocation of the parliament to Kutaisi (the second largest city).

uA01fig20

Georgia: Fiscal Balances, 2003–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

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

Georgia: Structural Deficit and Fiscal Impulse, 2009–10

(In percent of GDP)

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Sources: Ministry of Finance; and Fund staff estimates.

The calculation of the two indicators is described in Box 2 of EBS/09/188.

14. In view of exchange rate pressures experienced in May and the need for faster external adjustment, the authorities decided in June to cut back on the proposed spending increase and to introduce new revenue measures in 2010–11. The net impact of these adjustment measures on the 2010 budget is estimated at 0.5 percent of GDP: 0.2 percent of GDP from scaling back the supplementary budget spending request, and 0.3 percent of GDP from new excises coming into effect on August 1, 2010. Additional revenue measures equivalent to 0.9 percent of GDP will come into effect on January 1, 2011, including harmonization of the income tax rate and expansion of the VAT base (LOI, ¶19).1 Parliament is expected to vote on these revenue measures in July 2010, as part of the new tax and customs code, which also defers to (no earlier than) 2013 the planned reduction of the personal income tax rate from 20 to 15 percent.2 The scaled-back supplementary budget spending request was submitted to parliament on June 4 and is expected to be approved by end-June.

15. In all, the 2010 fiscal deficit target is reduced from 7.4 percent of GDP (fifth review) to 6.3 percent, resulting in a nearly 3 points of GDP decline relative to 2009. The structural deficit is marginally higher than envisaged at the time of the fifth review on account of the additional spending, but the withdrawal of fiscal stimulus, as measured by the fiscal impulse, is much larger.3 The authorities will lock in the new level of spending through an explicit ceiling, so that any additional revenue would be directed entirely to faster deficit reduction (LOI, ¶19).

16. While restating their commitment to expenditure-based adjustment over the medium term, the authorities also plan to increase tax policy flexibility by postponing implementation of the proposed referendum requirement for new taxes. This proposed constitutional amendment will now become effective only once the deficit has been reduced to below 3 percent of GDP (LOI, ¶18). No action has been taken to advance the proposed Economic Freedom, Opportunity, and Dignity Act: the draft document, which would enshrine liberal economic principles and set limits on government spending, deficit, and debt, was to be considered as a separate organic law, but has not yet been formally presented to parliament.4

17. With additional long-term official budgetary support becoming available, the authorities will reduce the share of Fund financing that is channeled through the budget in 2010.5 The tranche that would become available upon completion of the sixth review would be the last one to be channeled through the budget in 2010 (LOI, ¶29). The government has tapped successfully into the domestic market, and the maturity structure has been lengthened with issuance of one year and two year paper in order to develop the local securities market. With T-bill rates on the rise, the authorities do not see scope for increasing domestic financing much beyond the current level without the risk of crowding out private sector credit.

Georgia: External Lending and Grants to the Public Sector, 2008–10

(Gross inflows, in millions of U.S. dollars)

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Source: Georgian authorities; and Fund staff estimates.

Includes augmentation of access in 2010–11.

Includes Eurobond in 2008.

Excludes SBA purchases.

Georgia: Fiscal Adjustment, 2009–14

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Sources: Ministry of Finance; and Fund staff estimates. Note: Figures may not add up due to rounding.

Excluding intra-government tax arrears clearance.

Excluding interest payments and intra-government tax arrears clearance.

Shift to insurance system and increase in the number of beneficiaries.

18. The external public debt-to-GDP ratio would peak at 43.2 percent of GDP in 2011, declining thereafter to 32.7 percent by 2015. Vulnerabilities associated with this level of debt warrant continued monitoring. However, the indicative ceiling on nonconcessional public external borrowing no longer appears justified given the authorities’ strong debt management capacity, their fiscal consolidation plans, and their intention to return to market financing as soon as conditions permit. Accordingly, it is proposed that the indicative ceiling be set on total public external borrowing.

19. The medium-term fiscal framework will be adopted by the government in July 2010 (structural benchmark, LOI, ¶21). The authorities are committed to reducing the deficit to 2–3 percent of GDP by 2013 (LOI, ¶18). Current deficit projections imply a contraction of real spending of 3 percent in 2011 relative to 2010. Thereafter, expenditure contraction eases, but government spending in relation to GDP falls by another 4 percentage points by 2014.

20. The authorities plan to move to a full program presentation of the budget by 2012. Based on technical assistance provided by the IMF’s Fiscal Affairs Department, they intend to adopt guidelines for line ministries by end-September (structural benchmark, LOI, ¶21).

uA01fig21

Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig22

Georgia: Public Debt, 2004–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig23

Georgia: Government Revenues and Expenditures, 2003–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

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

C. Monetary Policy and Credit Conditions

21. Monetary policy tightening began in June in reaction to unstable exchange rate market conditions and related concerns about inflation, and has already been reflected in market rates. Steady deposit growth through May and measures taken to improve access to the central bank’s refinancing window (Box 1) reduced banks’ demand for precautionary balances, resulting in an easing of credit conditions and higher local currency lending. Central bank refinancing also increased by the equivalent of 9 percent of reserve money in April–May. As part of the package of corrective measures taken to reduce pressures in the foreign exchange market, the refinancing rate was raised from 5 to 6¼ percent on June 16. The authorities pointed out that market rates (T-bill, CD, and interbank rates) had already begun rising in anticipation of monetary tightening, as evidenced by the upward shift of the yield curve. Considerable dedollarization took place in the first four months of the year. The faster depreciation experienced in June did not trigger any large scale movements out of local currency deposits.

uA01fig24

Georgia: Yield Curve

(in percent)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig25

Georgia: Tbilisi Interbank Overnight Lending Rate (TIBR), 2008–10

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: Georgian authorities; and Fund staff estimates.

Georgia: Measures to Enhance Monetary Policy Effectiveness and Encourage Financial Dedollarization

The following measures became effective April 29:

  • The reserve requirement on lari-denominated deposits is raised from 5 to 10 percent to reduce free reserves and give the central bank’s loan facilities more traction. Required reserve in excess of 5 percent will be remunerated at the policy rate to avoid distortions and lari disintermediation. The reserve requirement on foreign exchange deposits is maintained at 5 percent for the time being.

  • External borrowing will be subject to reserve requirements starting in September 2010, at the same rate that applies to domestic foreign exchange funding sources.

  • Banks are given access to a new standing facility in the form of overnight deposits remunerated at the policy rate minus 200 basis points.

  • Central bank loan facilities are enhanced by guaranteeing access to a new 7-day collateralized refinancing facility at a rate equal to the policy rate plus 100 basis points. Access to this facility is limited to GEL 200 million per week. Banks’ individual limits are based on capital. In addition, access to overnight loans is simplified, and the interest rate set equal to the policy rate plus 200 basis points. These two facilities provide a liquidity safety net to banks, should they fail to secure liquidity through the regular weekly auctions. The policy rate sets a floor for the weekly liquidity auctions.

  • Eligible collateral in operations with the central bank is expanded to include lari-denominated loans of six-month or longer maturity and guarantees provided by IFIs and international commercial banks meeting minimum criteria. Collateralized loans are subject to a haircut and have to satisfy credit risk criteria set by the National Bank of Georgia (NBG). Foreign exchange is no longer allowed as collateral in any operations with NBG.

22. The monetary program is built on an expected continued growth in deposits, but a slight deceleration of credit growth in the second half of the year, in line with recent monetary tightening and possible increase in NPLs due to exchange rate depreciation. Projected annual growth in credit to the economy (adjusted for valuation changes) has been revised up relative to the fifth review, from 6 to 9½ percent. The revision reflects the stronger growth outlook and improved liquidity conditions of banks. Demand for free reserves is expected to decline reflecting enhanced access to central bank refinancing and greater stability of the deposit base. On that basis, the NDA targets for September have been revised down but the end-December ceiling has been raised (relative to the indicative target) on account of higher estimated demand for currency in circulation.

23. Recent exchange rate depreciation will adversely affect banks’ balance sheets, but capital buffers (17.6 percent capital adequacy in May) should be sufficient to absorb the impact for most banks. Stress tests conducted by the National Bank suggest that a one-time 15 percent depreciation would, within 1 year, result in a 5.3 point decline in the banking system’s capital adequacy ratio. Of that, 3.8 points would come from higher provisioning requirements due to the deterioration of the dollar loan portfolio; the rest from valuation effects.6

D. Medium-Term Outlook and the Exit Strategy

24. The current exit strategy from official balance of payments support is predicated on a steady increase in private capital inflows (mainly FDI), which by 2012 should enable Georgia to return to a path of privately financed high economic growth. Starting in 2012, external financing needs would be covered entirely by private sector inflows and regular official financing. After stalling in the first half of 2010, FDI is projected to recover in the second half of 2010 to the level of the same period of 2009, and to increase moderately in 2011. The projected increase in FDI over the medium term is within the range projected for other emerging market economies. In the pre-crisis years, FDI in Georgia was boosted by privatization, which attracted FDI of about 2½ percent of GDP on average in 2006–07. Even with the privatization program winding down, Georgia is well positioned to attract significant green-field FDI, capitalizing on the strength of its business climate, the government’s reformist agenda, and its geographical location linking Europe to Central Asia.

uA01fig26

Georgia: Current Account Balance and its Financing, 2006–15

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig27

Georgia and Comparator Countries: FDI Inflows

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig28

Sovereign Eurobond Spreads

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

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: National Bank of Georgia, Bloomberg, World Economic Outlook, and Fund staff estimates.

25. The authorities have identified contingency measures they would take in the event significant balance of payments pressures reemerged this year. While continuing to rely on exchange rate adjustment, the authorities would first accelerate the pace of monetary tightening and deficit reduction in order to contain the impact of depreciation on the balance sheet of banks (LOI, ¶26).

26. Projected private capital inflows and current account deficits over the medium term have been lowered since the fifth review. This reflects a more conservative outlook on the availability of external private financing, and, on the current account side, a combination of more favorable terms of trade and somewhat lower import growth due to lower FDI.

27. The authorities expect to meet the large debt service peak of 2013–14 by accessing capital markets as soon as conditions permit. Georgia’s Eurobond spreads have been affected in line with those of other emerging market countries by instability in the euro zone. However, market access has been enhanced by an upgraded rating from S&P in April 2010.

Georgia: Ranking Based on Selected Policy Performance Indicators, 2009–10

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Sources: Transparency International; and the World Bank.

Based on assessment of economic management, structural policies, policies for social inclusion/equity, and public sector management and institutions.

E. Risks to the Medium-Term Strategy

  • FDI. A failure of FDI to rebound would adversely affect GDP growth but, because imports would also decline, the resulting external imbalance would be to a large extent self correcting. However, the growth shortfall would widen the fiscal deficit, requiring additional adjustment to preserve debt sustainability (Box 2).

  • Debt Rollover. The Debt Sustainability Analysis (DSA) points to low solvency risks, but relatively high rollover risks in 2013 linked to the cumulation of Fund and Eurobond repayment obligations.

  • Banking Sector. Banking sector risks are tied to the high level of NPLs and the exposure to currency-induced credit risks. Given the solid capitalization, provisioning and liquidity buffers, banking sector vulnerabilities are unlikely to become a crisis trigger. However, they could become a destabilizing factor in the event of another shock to economic activity or the exchange rate.

Georgia: Alternative Scenario with Lower FDI

Reliance on a rebound of FDI to finance investment and to fill the current account deficit exposes the economy to external risks. These risks are explored in an alternative scenario that assumes a stabilization of FDI at its 2010 level (6½ percent of GDP). Assuming an unchanged productivity of capital, the drop in overall investment would reduce real GDP growth to 3½ percent on average over the next 5 years.

Even with an assumed loss of export competitiveness, lower investment and real GDP growth would compress the current account deficit quite sizably. The balance of payments gap (relative to the baseline scenario) would be equivalent to 0.8 percent of GDP on average over the period 2011–15, rising to 1.5 percent of GDP by 2015, and would cause a loss of international reserves of US$466 million by 2015.

An imbalance would also appear in the fiscal accounts. Based on the same fiscal policy of the baseline scenario (same level of real expenditure and same tax-to-GDP ratio), the deficit would begin to rise again and reach 4.3 percent of GDP by 2015. The primary fiscal balance would exceed the debt-stabilizing level by 0.6 percentage point of GDP.

Georgia: Alternative Medium-Term Scenarios (2011–15)

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Sources: Georgian authorities; and Fund staff estimates.

Investment is measured on a net basis (acquisitions minus disposals of nonfinancial assets).

Cumulative 2010–15.

uA01fig29

Georgia: Present Value of Public Debt, 2010–2025

(In percent of revenue)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig30

Georgia: Debt Service, 2010–2025

(In percent of revenue)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

uA01fig31

Georgia: Present Value of Public Debt, 2010–2025

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

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

IV. Program Issues

28. Modifications to the performance criteria for end-September 2010, and establishment of new performance criteria for end-September and end-December 2010 are being proposed as follows (LOI, Table 1):

  • NIR: the floors of end-September and end-December (relative to the indicative target) have been raised to reflect higher projected external inflows which outweigh the impact of higher intervention.

  • NDA: the end-September ceiling has been lowered on account of revised demand for free reserves, but the end-December ceiling has been raised (relative to the indicative target) on account of higher estimated demand for currency in circulation.

  • Budget deficit: the end-September ceiling has been lowered in line with the revised annual deficit target which is reflected in the end-December ceiling (also lower than the previous indicative target). Furthermore, the definition has been modified to cover the general government rather than the consolidated government, which is the measure that is de facto available.

  • Government spending (new performance criteria): ceilings have been set for September and December 2010, in line with the government’s supplementary budget request.

29. The end-June NDA performance criterion is expected to be met, but its status will be reported separately on July 7.

30. The following waivers are requested for end-June performance criteria:

  • Waiver of nonobservance of performance criterion on NIR, justified by the corrective measures taken to address the underlying imbalance, as described above in ¶¶ 2, 9, 14 and 21. The precise status of the performance criterion will be reported separately on July 7.

  • Waiver of applicability of performance criterion on the fiscal deficit, based on the fact that preliminary information through May 2010 indicates that the target will be met, but that the data to verify observance will not become available before July 27.

31. Rephasing of purchases by combining the seventh and eight reviews is requested due to the delay in completing the sixth review and the objective of meeting the balance of payments financing needs in 2010.

Georgia: Structural Benchmarks for 2010

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V. Staff Appraisal

32. The economic recovery has gained strength. Recent global financial market turbulence has shifted the balance of risks in 2010 from domestic to external factors. On the domestic front, the orderly completion of municipal elections and a resumption of credit growth should help sustain the growth momentum.

33. The corrective policy actions taken in June to ensure faster external adjustment provide adequate assurances that the program objectives are on track. Persistent exchange rate pressures in April–May were symptoms of a larger-than-expected structural imbalance (beyond seasonal factors), due to weakness in private capital inflows compounded by relatively expansionary fiscal and monetary policies in the second quarter. Delayed exchange rate adjustment has resulted in the likely nonobservance of the end-June NIR target. However, faster depreciation starting in June, and the tightening of monetary and fiscal policies should address this imbalance. Going forward, exchange rate flexibility remains key to ensuring that the economic recovery is externally sustainable. The constraint placed by the NIR targets on intervention provides assurances against inadequate exchange rate adjustment in the face of new external imbalances.

34. The sizeable reduction in the fiscal deficit targeted for 2010 under the program—by nearly 3 percentage points of GDP—brings the medium-term consolidation target within closer reach. Because of the stronger cyclical rebound, the deficit is considerably lower in terms of GDP than initially estimated, even with the higher spending under the supplementary budget. The adoption of additional revenue measures, and the authorities’ commitment to capping spending in 2010 render fiscal policy appropriately countercyclical going forward.

35. The authorities’ success in mobilizing additional budgetary support and diversifying their financing sources in 2010 is welcome. By allowing to reduce correspondingly the amount of Fund financing channeled through the budget, new external long-term financing helps smooth the government’s debt rollover hump of 2013–14. Steady issuance of T-Bills and the extension of maturities create the foundations for capital market development, with benefits for local currency funding and monetary policy.

36. The decision to postpone implementation of a referendum requirement on tax increases until the fiscal deficit has been returned to prudent levels enhances policy flexibility. Equally welcome is the introduction of new revenue measures in 2010 and 2011. Without undermining the authorities’ emphasis on expenditure containment as the primary means of adjustment, these initiatives strengthen the credibility of the adjustment strategy.

37. The recent tightening of monetary policy was warranted and should continue. Enhanced access to the central bank’s refinancing facilities requires that policy interest rates be adjusted promptly and flexibly to changing conditions, including foreign exchange market pressures or signs of accelerating monetary and credit growth. Higher interest rates would also encourage deposit dedollarization.

38. The balance sheet impact of recent depreciation calls for continued close monitoring of the banking sector. The ongoing economic recovery should limit the adverse real sector impact of rising NPLs, and timely corrective actions can be expected given the close supervision of banks.

39. The exit strategy has been reinforced by improvements in confidence accompanying the rebound in activity, which place Georgia in a good position to reaccess financial markets ahead of the rollover needs of 2013–14. The program is now built on an assumed slower recovery of FDI. While risks remain, they appear to be manageable within the current policy framework. However, a failure of FDI inflows to materialize in the second half of the year would signal the need for much more fundamental policy changes. The authorities’ contingency plans provide assurances that a timely response to such risks can be activated. Beyond 2010, the authorities are encouraged to create stronger buffers against downside risks by targeting an ambitious reduction in the fiscal deficit in 2011, ahead of the 2012 and 2013 election years.

40. On the basis of Georgia’s performance under the SBA and the corrective actions taken to address the causes of the nonobservance of the end-June NIR target, staff supports the authorities’ request for completing the sixth review, modifying and establishing performance criteria, and rephasing purchases by combining the seventh and the eighth reviews as specified in the LOI (¶32 and Table 1).

Table 1.

Georgia: Selected Macroeconomic Indicators, 2008–15

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Sources: Georgian authorities; and Fund staff estimates.

Excludes Abkhazia residents.

Investment is measured on a net basis (acquisitions minus disposals of nonfinancial assets).

Includes grants.

Table 2.

Georgia: Annual General Government Operations, 2009–15 1/

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Sources: Ministry of Finance; and Fund staff estimates.

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

Excluding arrears clearance, provisions and T-bill repayment.

Excluding net lending.

Table 3.

Georgia: Quarterly General Government Operations, 2009–10 1/

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Sources: Ministry of Finance; and Fund staff estimates.

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

Excluding arrears clearance, provisions and T-bill repayment.

Table 4.

Georgia: Summary Balance of Payments, 2008–15

(In millions of U.S. dollars)

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

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

Following the Low Income Countries (LIC) reforms, effective January 7 2010, the PRGF arrangements were renamed Extended Credit Facility (ECF) arrangements.

Table 5.

Georgia: Accounts of the National Bank of Georgia, 2008–10

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

Comprises of required and excess reserves on lari-denominated deposits.

Based on program definition as defined in the TMU.

Table 6.

Georgia: Monetary Survey, 2008–10

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

Comprises of required and excess reserves on lari-denominated deposits.

Table 7.

Georgia: External Vulnerability Indicators, 2008–15

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Source: Fund staff estimates and projections.
Table 8.

Georgia: Indicators of Fund Credit, 2008–17

(In millions of SDR)

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Sources: Fund staff estimates and projections.

End of period.

Following the Low Income Countries (LIC) reforms, effective January 7 2010, the PRGF arrangements were renamed Extended Credit Facility (ECF) arrangements.

Repayment schedule based on repurchase obligations and GRA charges.

Table 9.

Georgia: Schedule of Prospective Reviews and Purchases 1/

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Reflects the augmentation of access by SDR270 million and the extended arrangement through June 2011.

As the authorities did not draw the purchase that became available at the time of the first review, SDR 126.2 million were available and purchased at the second review.

Table 10.

Georgia: External Financing Requirements and Sources, 2008–15

(In millions of U.S. dollars)

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

Including the receipts and the repayment of the Eurobond-2013.

Including errors and omissions.

ECF (formerly known as PRGF) disbursements in 2006 and 2007, SBA purchases from 2008 on, including augmentation in 2010–11.

Table 11.

Georgia: Public External Debt, 2008–09

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Source: Ministry of Finance of Georgia.
Table 12.

Georgia: Private External Debt, 2008–09

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Source: National Bank of Georgia.

Excluding intercompany debt from foreign direct investors.

In line with the recommendations of the Debt Statistics Manual that all currency and deposits be included in the short-term category unless detailed information is available to make short-term/long-term attribution.

Table 13a.

Georgia: External Debt Sustainability Framework, Baseline Scenario, 2007–2030 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+g ρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

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

Table 13b.

Georgia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2010–2030

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 14a.

Georgia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2007–2030

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

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

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 14b.

Georgia: Sensitivity Analysis for Key Indicators of Public Debt 2010–2030

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Sources: Country authorities; and staff estimates and projections.

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

Revenues are defined inclusive of grants.

Figure 1a.
Figure 1a.

Georgia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2010–2030 1/

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2020. In figure b. it corresponds to a Non-debt flows shock; in c. to a Non-debt flows shock; in d. to a Non-debt flows shock; in e. to a Non-debt flows shock and in figure f. to a Non-debt flows shock
Figure 1b.
Figure 1b.

Georgia: Indicators of Public Debt Under Alternative Scenarios, 2010–2030

Citation: IMF Staff Country Reports 2010, 219; 10.5089/9781455206520.002.A001

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2020.2/ Revenues are defined inclusive of grants.

Attachment I. Georgia: Letter of Intent

June 24, 2010

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C.

Dear Mr. Strauss-Kahn:

1. In September 2008, the International Monetary Fund (IMF) approved a Stand-By Arrangement (SBA) for Georgia, which was further augmented in August 2009. On March 19, 2010 the IMF’s Executive Board completed the fifth review of the SBA allowing for an immediate purchase of an amount equivalent to SDR 97.3 million. We are grateful for the assistance which the IMF provides to Georgia.

2. This letter of intent describes the economic policies that we plan to implement during 2010. As always, we are committed to policies that will maintain macroeconomic stability, protect the economy from shocks associated with the global economic crisis and facilitate the process of macroeconomic adjustment. We, of course, remain committed to implementing the measures contained in previous letters of intent, i.e. those dated September 9, 2008, November 28, 2008, March 10, 2009, July 30, 2009, November 25, 2009, and February 25, 2010.

Recent Economic Developments

3. Growth in 2009 amounted to minus 3.9 percent. In the fourth quarter Real GDP increased by 0.4 percent, after 5 consecutive quarters of negative growth. Positive year-on-year growth in the fourth quarter was achieved in electricity, gas and water supply, financial intermediation, health care.

4. Balance of payments data for the fourth quarter of 2009 show that exports of goods and services increased year-on-year by 21 percent and imports of goods and services declined by 15 percent, which reflects lower demand for imports. Worker remittances increased 22.1 percent, and FDI inflows declined by 11.2 percent year-on-year. As a result, the current account deficit dropped to 13.4 percent of GDP in the fourth quarter of 2009, showing slight improvement relative to the same period of the previous year. In 2009 the current account deficit was11.9 percent of GDP compared to 22.7 percent in the previous year.

5. As a result of a broad decline in economic activity and falling global commodity prices, inflationary pressures have declined. Inflation as of end of 2009 was 3.0 percent, rising to 4 percent in May 2010. Taking into account the recent development of global commodity prices and signs of improvement in economic activity, we expect inflation to stay around 5 percent in 2010.

6. Fiscal performance in the first quarter of 2010 has been stronger than anticipated. Tax collection in Q1 2010 increased by 13.0 percent y-o-y in nominal terms (excluding one-off payments). Expenditures in the same quarter were contained at GEL 1441.0 million (general government, including capital expenditures), or 1.7 percent lower than in Q1 2009. In all, the Q1 fiscal deficit reached 0.5 percent of the projected annual GDP, which is below the program target. We also expect the deficit through the first half of 2010 to be below the program target.

7. Consistent with our commitment to increase exchange rate flexibility, starting from May 25, 2009, the NBG foreign exchange interventions are conducted only through the foreign exchange auctions. Less frequent interventions have increased market participation, thus dampening one-way speculative pressures. In first quarter, the interventions have relatively increased in the FX market because of seasonal pressures. External gap in private sector is being financed by public sector inflows. Because of the above and seasonal factors the NBG is expecting more interventions in the first half of the year than in the second. In the first quarter of 2010 NBG FX intervention amounted to USD 124 million, which is 38% less than IMF program incorporates.

8. Seasonal exchange market pressures continued after March. In anticipation that these pressures would be reversed after the May 30 elections, the NBG increased its intervention in April–May to USD 150 million. However, the persistence of pressures points to weakness in FDI inflows in the first half of the year, which has led to a downward revision of projected FDI inflows for the year. The exchange rate (vis-à-vis the USD) has depreciated by 4.6 percent in the first 9 days of June, and by 10.2 cumulatively since the beginning of the year. Intervention volumes remained elevated in the first ten days of June because of the need to stabilize market expectations, but the foreign exchange market has since stabilized.

9. The banking sector continued its positive performance in the first quarter of 2010. Commercial banks’ net profit in the first quarter equaled GEL 15.3 million. Starting from May 2009, the volume of deposits has been growing steadily, posting a 48 percent growth in lari terms by end-May 2010. Bank lending to the economy has picked up, and credit to the economy has increased by nearly 12 percent (4 percent excluding valuation effects) since the beginning of the year (as of June 11). The major part of the increase in credit is attributed to lending in domestic currency. The average capital adequacy was 18.3 at end-March 2010.

10. In order to enhance the safety and efficiency of the international reserves management process, the NBG is implementing a new portfolio management system. The system will cover front-middle-back office and accounting functionality based on Straight Through Processing (STP) principles. The system will be IFRS compliant and will allow NBG to introduce new, more sophisticated financial instruments and investment techniques in its reserves management process. The new system will help NBG bring its reserves management procedures in line with international best practices. NBG has signed the contract on system supply and implementation with WallstreetSystems, leading portfolio management system supplier who has over 30 central banks clients around the world. The system is expected to become fully operational by the end of 2010.

11. We have in place a Contingency Plan (CP) which provides a framework for policy makers to coordinate their policies and actions to mitigate systemic risks to the financial sector and, in case of realization of such risks, to reduce the social cost of any ensuing financial distress. Although the banking system is adequately capitalized, the NBG continues to conduct regular stress tests on system wide and bank by bank level. In line with changes in legislation, which enable the supervisor to conduct risk-based supervision, a reorganization process is under way to enable the NBG to use more effectively its resources for risk based supervision. The move toward a risk based framework is done gradually, to minimize regulatory risk for the industry and enable smooth transition towards the new regulatory framework.

12. We continue to improve the efficiency and effectiveness of public finances. The Ministry of Finance is broadly on track in implementing the Public Finance Management Reform Policy Vision 2009–2013. The Reform Action Plan for 2009 has been successfully implemented. The draft budget code was one of our key priorities in 2009. The new budget code was adopted in December 2009, providing a sound framework for fiscal planning and efficiency gains in the area. The new budget code seeks to consolidate all legislation related to the budget process into a single law, to better integrate the medium-term economic and fiscal framework (BDD) and the public investment program into the annual budget cycle, and to prepare the ground for results-oriented budgets.

13. Furthermore, in 2009 we progressed significantly in ensuring functionality of the risk assessment tax audit system, streamlining tax and customs codes and developing necessary sub-legislation, establishing electronic information exchange system between banks and the Revenues Service, improving capital budget document forms, establishing a customs audit and progressing towards risk-based customs control, fostering full functionality of the electronic treasury system and inclusion of all taxes into the e-filing system. The implementation of these reforms has enhanced efficiency and effectiveness in the use of public financial resources and shall contribute to the overall resilience of the economy both now, in a time of stress, and over the medium term.

Macroeconomic Policies for 2010

14. Our major macroeconomic challenge continues to be the restoration of economic growth while promoting balance of payments adjustment. This will, of course, require the resumption of private capital inflows and domestic lending in support of investment projects. We recognize that many of the extraordinary actions undertaken in response to the economic crisis are not sustainable in the medium term. Hence, our efforts to enhance macroeconomic stability will concentrate on intensifying economic reforms, and achieving a sustainable fiscal and external balance as quickly as possible.

15. Economic decline in 2009 amounted to 3.9 percent. Based on available economic data, we anticipate that real economy will increase by 2 percent in annual terms in the first quarter of 2010. Overall in the 2010 real GDP growth is projected at 4½ percent per annum.

16. The current account deficit for 2010 is expected to be around 12.6 percent of GDP. Exports and imports of goods and services are projected to increase by 20 percent and 14½ percent, respectively. Worker remittances are expected to increase by around 10 percent for the year. Conservatively, we project FDI inflows of just under US$700 million in 2010, somewhat lower than in 2009. Overall, gross reserves in 2010 are expected to increase by about US$100 million.

17. We expect a recovery in private capital inflows to begin in the second half of 2010. Despite considerable fiscal adjustment, the current account deficit is expected to widen marginally in 2010, owing to the economic recovery. In view of the continued high uncertainty in the external environment, there is a need to increase the reserve buffer to more comfortable levels. Accordingly, we have sought the Fund’s continued support in covering a balance of payments gap of around US$450 million in 2010.

18. We consider that restoring a sound fiscal position is critical for the sustainability of the recovery and also to preserve the stability of Georgia’s external accounts. We are therefore committed to an ambitious program of deficit reduction. Based on further expenditure containment, an expected recovery of tax revenues owing to the expected rebound in the GDP growth, as well as new revenue measures to be taken in 2010 and 2011, we are committed to steady reductions in the deficit to 2–3 percent of GDP by 2013. In order to enhance fiscal policy flexibility, the proposed constitutional amendment which introduces a referendum requirement for new taxes would become effective only once the deficit has been brought down below our medium-term deficit ceiling of 3 percent of GDP.

19. Our target is to reduce the deficit to 6.3 percent of GDP in 2010 (SBA definition), well below the 7.4 percent deficit target agreed at the time of the Fifth Review of the program. The revenue gain from the upward revision in GDP growth and an increase in excises coming into effect on August 1, 2010 (with an estimated yield of 0.3 percent of GDP) will enable us to meet this more ambitious deficit target as well as some urgent spending priorities. The supplementary budget consistent with the new level of spending was submitted to Parliament on June 4, and we expect it to be approved by the end of June 2010. The additional revenue measures will be adopted in July based on a revision of the existing tax code. We also intend to cap government spending through the rest of the year at the level of the supplementary budget, so as to ensure that any additional revenue gains would go toward faster deficit reduction. Furthermore, as part of the new tax and customs code, we intend to introduce a package of new revenue measures effective January 1, 2011, which include harmonization of income tax rates and partial elimination of VAT exemptions. Combined with the excise increases of 2010, this package should yield 1.2 percent of GDP annually.

20. We continue to implement our public finance reform program, which we view as an important prerequisite to ensuring transparency, discipline, efficiency and accountability in the public finance area. We progressed significantly in implementing our public finance reform action plan for 2009, which implies implementation of actions in a large number of areas, including developing liquidity management guidelines, preparing the functional and technical specification for the PFMS, developing a new format of the medium-term framework (Basic Data and Directions) document, improving the format of local budgets.

21. Public Finance Management Reform Action Plan 2010 has been approved and is under implementation. Consistently with the new budget code, by end-July 2010 we will seek cabinet approval of the medium-term expenditure framework (Basic Data and Directions) that includes expenditure ceilings applicable to the 2011 budget (structural benchmark under the program). Also, by end-September 2010 we intend to seek cabinet approval of guidelines for pilot Ministries to introduce a programmatic approach to budgeting, in line with the recommendations of the technical assistance from the IMF’s Fiscal Affairs Department (structural benchmark).

22. In pursuance of our reforms aimed at fostering a culture of compliance and streamlining tax and customs administration procedures, we are in the process of discussing legal amendments to achieve cost-efficiency and effectiveness gains within the Revenue Service of the Ministry of Finance. These reforms would enhance the business-friendliness of tax and customs legislation with a view of further promoting private sector-led growth.

23. The monetary policy transmission channel has weakened due to the crises and remains inefficient under current excess liquidity conditions. To restore transmission channel NBG has made reforms to influence short-term interest more effectively. This includes restoring reserve requirements in local currency and activation of standing facilities.

24. In order to increase confidence in the NBG’s refinancing loans and promote efficiency of the monetary policy, the NBG started to provide commercial banks with guaranteed access refinancing loans against collateral at the interest linked to the NBG’s key policy rate. The collateral base for refinancing loans is extended by international bank guarantees and long term local currency loans. We expect the meet the end-June NDA target due to lower-than-expected demand for free reserves by banks. The NBG has begun to tighten monetary conditions by raising its refinancing rate from 5 to 6.25 percent on June 16 to maintain price stability as the economy recovers and to counter recent exchange rate pressures. We project end-period inflation to be 5 percent in 2010. This projection is, of course, sensitive to assumptions regarding the money multiplier and, in turn, commercial bank lending to the private sector, as well as international commodity price developments.

25. Intervention in the FX market in May and in June (to stabilize the market after an initial large depreciation) exceeded the room for intervention under the program, and the NIR target of end-June will likely be missed. Corrective measures have since been taken to reduce pressures, including faster exchange rate depreciation, monetary tightening and the fiscal measures described above. The commitment to a flexible exchange rate is unchanged and will be strengthened by reducing the frequency of auctions. The NBG does not target any exchange rate and will intervene only to smooth extreme volatility, to counter speculative pressures and if too fast and too large depreciation threatens financial stability. Should external developments be more favorable than currently projected, we stand ready to raise the NIR targets for future reviews, so as to strengthen our exit strategy from official balance of payments support.

26. Our current strategy is based on the expected recovery of private capital inflows, and FDI in particular, starting in the second half of 2010. To support that process we have corrected some of the administrative problems faced by investors at the beginning of the year. We consider that the successful completion of the elections also removes a major source of uncertainty for investors. At the same time, we are aware that the current strategy is subject to risks, and that a significant shortfall in the recovery of private capital inflows will require a substantial change in policies. In this regard, should we observe a failure of FDI to resume over the summer, we stand ready to further tighten monetary policy and to cut the budget deficit further, while allowing the exchange rate to adjust. In view of the adverse impact of significantly higher depreciation on the balance sheet of banks—through currency induced credit risk—we would rely to a large extent on monetary and fiscal policy tightening to preserve stability. In order to move swiftly and most efficiently on fiscal policy, we would implement budget cuts across the board at the level of ministries, thus allowing ministries to decide how best to implement the cuts within their budgets given their constraints and objectives.

27. Enhancing the competitiveness of the Georgian economy is, of course, of primary importance to us and is a key to reducing Georgia’s external current account deficit to more sustainable levels over the medium term. Georgia’s sound macroeconomic policies, its extremely favorable business environment and geographic advantages put it in a good position to benefit from a generalized recovery of FDI flows to emerging markets. We expect that additional structural reforms will be at the root of future competitiveness gains. These include further privatization and reductions of the state’s role in the economy.

28. To bring our official statistics in line with international standards, we improved legal framework and reorganized the former State Department of Statistics (new title—Geostat). New Law on State Statistics strengthens the independence of the Geostat and ensures the sustainable production of official statistics. On May 17, 2010, we subscribed to the IMF’s Special Data Dissemination Standard (SDDS), with a view to enhancing the availability of timely and comprehensive statistics provided to the public.

29. Based on our expectation of higher than projected budget support disbursements from IFIs in 2010, we will reduce the Government’s use of IMF financing for the budget. Accordingly, the purchase that would become available upon completion of the sixth review, would be the last purchase to be used for budget support in 2010.

30. We have implemented the recommendations provided in the recent update of the Safeguards Assessment Report. In particular:

  • The new Audit Committee Charter was elaborated based on the best international practice.

  • The Audit Committee composition was modified and includes only non-executive members of the Board.

  • The oversight function of the Audit Committee was strengthened.

  • The assessment of internal audit activities for compliance with the International Standards for Professional Practice of Internal Auditing and The IIA’s Code of Ethics was conducted.

  • The Internal Audit Service reviewed operations of the newly implemented core banking system.

The internal audit of the new RTGS and reserve management systems will be carried out following their deployment.

Program Monitoring

31. We expect end-June performance criteria under the Stand-By Arrangement to be met, with the exception of the NIR target. Based on the corrective measures taken to reduce exchange rate pressures and to meet the program objectives of 2010, we request a waiver for non-observance of the end-June NIR performance criterion, and request the completion of the Sixth Review. We expect to meet the end-June performance criterion on the cash deficit of the general government but we are requesting a waiver of applicability since data to verify this PC will not become available before July 27. We will maintain our usual close policy dialogue with the Fund and are ready to take additional measures as appropriate to ensure that we meet program objectives. The Government will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in this letter, in accordance with the Fund’s policies on such consultations.

32. We also request: (i) a modification of the end-September PCs on the fiscal deficit, NIR and NDA according to the attached Table 1, which also establishes end-December 2010 PCs; (ii) introduction of a PC on total government expenditure for end-September and End-December 2010; and (iii) rephasing of purchases by combining the seventh and the eighth reviews. The seventh and eighth reviews will be based on end-September 2010 performance criteria and are scheduled for completion by end-December 2010; and the ninth review will be based on end-December 2010 performance criteria and is scheduled for completion by end-March 2011. The revised Technical Memorandum of Understanding clarifies the measurement of the PC on government expenditure and of the indicative target on the contraction and guaranteeing of total government debt. Structural benchmarks under the program are described in Table 2.

Table 1.

Georgia: Quantitative Performance Criteria (PC) and Indicative Targets, 2010

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Sources: Georgian authorities; and Fund staff estimates.

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

The continuous performance criterion for external arrears is defined in paragraph 17 of the TMU.

It is proposed to replace the indicative targets on nonconcessional external public debt by indicative targets on total external public debt from the end-June test date on.

Table 2.

Georgia: Structural Benchmarks

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33. We authorize the IMF to publish this Letter of Intent and its attachments as well as the accompanying staff report.

Sincerely yours,

/s/

Nika Gilauri

Prime Minister of Georgia

/s/

Kakha Baindurashvili

Minister of Finance

/s/

Giorgi Kadagidze

President of the National Bank of Georgia

Attachment II. Georgia: Revised Technical Memorandum of Understanding

June 24, 2010

1. This memorandum sets out the understandings between the Georgian authorities and the IMF staff regarding the definitions of quantitative performance criteria and indicative targets, as well as respective reporting requirements for the Stand-By Arrangement (SBA). It replaces the technical memorandum of understanding dated February 25, 2010.

2. These performance criteria and indicative targets are reported in Tables 1 attached to the Letter of Intent dated June 24, 2010. The exchange rate for the purposes of the program of the Georgian lari to the U.S. dollar is set at GEL 1.67 = $1. The corresponding cross exchange rates are provided in Table 1.

Table 1.

Program Exchange Rates

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I. General Government and the Public Sector

3. Definition: The general government is defined as the central government, local governments, and extra-budgetary funds. The public sector consists of the general government and the National Bank of Georgia (NBG).

4. Supporting material: The Treasury Department of the Ministry of Finance (MOF) will provide to the IMF detailed information on monthly revenues of the general government within two weeks of the end of each month, and monthly expenditures and arrears of the central government within four weeks of the end of each month. In addition, the Treasury will provide, on a daily basis, the cash balances in the accounts of the general government as of the previous business day.

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

A. Ceiling on the Cash Deficit of the General Government

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

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

    • (i) Net lending (borrowing net of repayments) provided by commercial banks to the general government plus the use of deposits held by the general government at commercial banks. Monitoring of net lending and government accounts will be based on the NBG’s monetary survey and Treasury data. The change in cash balances of the local government at commercial banks for budget financing purposes will be monitored based on the “budget of territorial unit” account data provided by the Treasury Department. Any securities issued by the general government and purchased by commercial banks (for example, T-Bills) are also included in domestic financing.

    • (ii) Net lending (borrowing net of repayments) provided by the NBG to the general government plus the use of deposits of the general government held at the NBG. Monitoring of net lending and government accounts will be based on the Central Bank survey and Treasury data. The change in cash balances of the central government at the NBG for budget financing purposes will be monitored based on the “GEL TSA state budget” account data provided by the Treasury Department. Any securities issued by the general government and purchased by the NBG (for example, T-Bills) are also included in domestic financing.

    • (iii) Any securities issued by the general government and purchased by the nonbanks (for example, T-Bills or securitized claims on the government sold by the NBG) are also included in domestic financing.

  • Net external financing is defined as the total of loans disbursed to the general government for budget support (including from the IMF), and project financing (capital expenditure and net lending), net change in external arrears, change in the accounts of the general government abroad, minus amortization. Amortization includes all external debt-related payments of principal by the general government.

  • Privatization receipts consist of all transfers of monies received by the central and local governments in connection with the sale of central or local government assets. This includes receipts from the sale of shares, the sale of non-financial assets as well as leases and the sale of licenses with duration of 10 years and longer.

2. Supporting material:

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

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

  • Data will be provided at the actual exchange rates.

  • Data on privatization receipts of the general government will be provided by the Treasury Department of the MOF to the IMF on a monthly basis within two weeks of the end of each month.

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

B. Ceiling on the General Government Expenditures

3. Definition: The ceiling applies to total expenditures of the general government. Total expenditures include all current and capital spending as well as net lending: (i) current expenditures comprise compensation of employees, purchases of goods and services, subsidies, grants, social expenses, other expenses, other account payables and domestic and external interest payments; (ii) capital expenditures include projects financed by foreign loans and grants; (iii) net lending is defined as lending minus repayments to the general government. The Performance Criterion is monitored quarterly on a cumulative basis from the beginning of the year.

4. Supporting material: Data for monitoring expenditures will be derived from the accounts of the general government covered under the ceiling (based on state, local authority, and autonomous republics budgets). The ministry of finance is responsible for such reporting according to the above definition. Data on general government expenditures should be reported within four weeks after the end of the quarter.

C. Floor on the Net International Reserves of the NBG

5. Definition: For the program purposes, net international reserves (NIR) of the NBG in U.S. dollars are defined as foreign assets of the NBG minus the sum of foreign liabilities of the NBG. Foreign assets of the NBG include gold, gross foreign exchange reserves, Georgia’s SDR holdings, and the reserve position in the IMF. Gross foreign exchange reserves of the NBG are defined as liquid, convertible currency claims of the NBG on nonresidents, including cash holdings of foreign exchange that are readily available. Pledged or otherwise encumbered assets, including (but not limited to) assets used as collateral (or guarantee for third party external liabilities) are excluded from foreign assets. Foreign liabilities of the NBG shall be defined as the sum of Georgia’s outstanding liabilities to the IMF, Georgia’s SDR allocation, and any other liabilities of the NBG, excluding the foreign exchange balances in the government’s account with the NBG. Thus defined, the definition of NIR excludes foreign assets stemming from foreign currency deposits of financial institutions at the NBG and foreign assets arising from the currency swaps with financial institutions. For program monitoring purposes, the stock of foreign assets and foreign liabilities of the NBG shall be valued at program exchange rates as described in paragraph 2 above. The stock of NIR amounted to $879.8 million as of December 31, 2008 (at the program exchange rate).

6. Adjustors:

The floor on the NIR of the NBG will be adjusted:

  • (a) upward/downward by 50 percent for any excess/shortfall in the balance-of-payments support loans and balance-of-payments support grants relative to the projected amounts presented in Table 2.

  • (b) upward/downward by 50 percent for any excess/shortfall in the disbursements of the project loans and project grants to the Treasury Single account at the NBG relative to the projected amounts presented in Table 2.

  • (c) upward 100 percent for any shortfall in the amount of conversion for government imports relative to the projected amounts presented in Table 2.

Table 2.

Projected Balance-of-Payments Support Financing 1/

(In millions of U.S. dollars)

article image

Cumulative from the beginning of the calendar year.

7. Supporting material: Data on net international reserves (both at actual and program exchange rates); net foreign financing (balance of payments support loans, cash grants to the general government, amortization (excluding repayments to the IMF), interest payments on external debt by the MOF and the NBG); conversions for government imports and transfers of receipts from the Sovereign Wealth Funds will be provided to the IMF in a foreign exchange cash flow table (which include details of inflows, outflows, and net international reserves) on a weekly basis within three working days following the end of the week.

D. Ceiling on Net Domestic Assets of the NBG

8. Definition: Net domestic assets of the NBG are defined as the difference between reserve money and NIR as defined above in paragraph 9. Therefore, the ceiling on NDA is defined as projected reserve money (as defined in Table 3) minus the target NIR.

Table 3.

Projected Reserve Money

(End-of-period stock in millions of lari)

article image

9. Adjustors:

The ceiling on the NDA of the NBG will be adjusted:

  • (a) upward/downward by 50 percent for any shortfall/excess in the balance-of-payments support loans and balance-of-payments support grants relative to the projected amounts presented in Table 2.

  • (b) upward/downward by 50 percent for any shortfall/excess in the disbursements of the project loans and project grants to the Treasury Single account at the NBG relative to the projected amounts presented in Table 2.

  • (c) downward 100 percent for any shortfall in the amount of conversion for government imports relative to the projected amounts presented in Table 2.

10. Supporting material: The NBG will provide to the IMF its balance sheet, which includes data on reserve money and net domestic assets on a weekly basis within three working days following the end of the week. Data will be provided using both actual and program exchange rates.

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

11. Definition: External debt, based on the notion of the residency of the creditor, is defined as debt contracted by the public sector from lenders other than the IMF. This indicative target applies to debt as defined in point No. 9 of the IMF’s Guidelines on Performance Criteria with Respect to External Debt as amended effective December 1, 2009 (Decision No. 12274-(00/85) August 24, 2000).1 Previously disbursed external debt that has been rescheduled will be excluded from the definition of “new debt” for the purposes of this performance criterion.

12. Supporting material: Details of all new contracted debt and government guarantees for external borrowing, with detailed explanations, will be provided by the MOF to the IMF on a quarterly basis within thirty days of the end of each quarter. Data will be provided using actual exchange rates.

F. Continuous Performance Criterion on Nonaccumulation of External Arrears

13. Definition: During the period of the arrangement, the public sector will not accumulate any new external payment arrears on debt service obligations to official creditors. Official external payment arrears are defined as unpaid debt service by the consolidated government and the NBG beyond 30 days after the due date. The performance criterion on nonaccumulation of external debt is continuous.

14. Supporting material: Details of official arrears accumulated on interest and principal payments to creditors will be reported to the IMF within one week from the date of the missed payment. Data will be provided using actual exchange rates.
1

In particular, the package includes: elimination of the reduced personal income tax rate; enlargement of the capital gain tax base; increase in excises on beer, spirit, and scrap metal; introduction of an excise on telecommunication services; and elimination of VAT exemptions for private education and imported medical equipment.

2

The amended tax code will also remove the planned reduction of the tax on interest and dividends, which remains at 5 percent.

3

The fiscal impulse includes all changes in tax revenues, including the cyclical component. This is the main reason for the negative value in 2010.

4

The proposed Act is described in Box 2 of Country Report No. 09/331.

5

The overall balance of payment need covered by Fund financing in 2010 remains unchanged at US$446 million.

6

The analysis is based on a 5 percent elasticity of NPLs to exchange rate change, which implies an increase of NPLs from 18 percent to 27 percent of the loan portfolio. This elasticity is higher than the elasticity (3.6) which was estimated based on Georgian data with the help of IMF technical assistance in April 2009. The assumed higher elasticity reflects the expectation of a non-linear response of NPLs to large exchange rate changes, such as the one assumed in this exercise. It is also likely to constitute an upper bound. Valuation effects arise because capital and provisions (even against dollar loans) are denominated in local currency.

1

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

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Cover IMF Staff Country Reports
Georgia: Sixth Review Under the Stand-By Arrangement and Requests for Modification of Performance Criteria, Waiver of Nonobservance of Performance Criterion, Waiver of Applicability of Performance Criterion, and Rephasing of Purchase: Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Georgia.
Author:
International Monetary Fund
Volume/Issue:
Volume 2010: Issue 219
Publisher:
International Monetary Fund
ISBN:
9781455206520
ISSN:
1934-7685
Pages:
82
DOI:
https://doi.org/10.5089/9781455206520.002
  • View in gallery

    Georgia: Foreign Exchange Market, 2008–10 1/

    (In millions of US$)

  • View in gallery

    Georgia: Seasonally-Adjusted Real GDP, 2004–14

    (In millions of 2003 lari)

  • View in gallery

    Georgia: Indicators of Economic Activity, March 2008–May 2010

    (3-month moving average, y-o-y change in percent)

  • View in gallery

    Georgia: CPI Inflation, 2007–10

    (Year-on-year change, in percent)

  • View in gallery

    Georgia: Real and Nominal Effective Exchange Rates, 2006–10

    (Index, 2000 = 100)

  • View in gallery

    Georgia: External Flows, 2008–10

    (3-month moving average, y-o-y growth in percent)

  • View in gallery

    Georgia: Lari Interest Rates, 2006–10

    (In percent)

  • View in gallery

    Georgia: Deposits, 2008–10

    (In millions of lari)

  • View in gallery

    Georgia: Domestic Fx Interest Rates, 2006–10 1/

    (In percent)

  • View in gallery

    Georgia: Credit to the Private Sector, 2008–10

    (In millions of lari)

  • View in gallery

    Georgia: Capitalization Ratios, 2006–10

    (In percent)

  • View in gallery

    Georgia: Nonperforming Loans and Provisions Ratios, 2006–10

    (In percent)

  • View in gallery

    Georgia: Liquidity Ratios, 2006–10

    (In percent)

  • View in gallery

    Georgia: Profitability Ratios, 2006–10

    (In percent)

  • View in gallery

    Georgia: Foreign Exchange Intervention and Exchange Rate, 2008–10

  • View in gallery

    Georgia: Foreign Exchange Intervention and Exchange Rate Depreciation, 2009–10

  • View in gallery

    Georgia: Government Revenues and Expenditures, 2003–15

    (In percent of GDP)

  • View in gallery

    Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

    (In percent of GDP)

  • View in gallery

    Georgia: Public Debt, 2004–15

    (In percent of GDP)

  • View in gallery

    Georgia: Fiscal Balances, 2003–15

    (In percent of GDP)

  • View in gallery

    Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

    (In percent of GDP)

  • View in gallery

    Georgia: Public Debt, 2004–15

    (In percent of GDP)

  • View in gallery

    Georgia: Government Revenues and Expenditures, 2003–15

    (In percent of GDP)

  • View in gallery

    Georgia: Yield Curve

    (in percent)

  • View in gallery

    Georgia: Tbilisi Interbank Overnight Lending Rate (TIBR), 2008–10

  • View in gallery

    Georgia: Current Account Balance and its Financing, 2006–15

    (In percent of GDP)

  • View in gallery

    Georgia and Comparator Countries: FDI Inflows

    (In percent of GDP)

  • View in gallery

    Sovereign Eurobond Spreads

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

  • View in gallery

    Georgia: Present Value of Public Debt, 2010–2025

    (In percent of revenue)

  • View in gallery

    Georgia: Debt Service, 2010–2025

    (In percent of revenue)

  • View in gallery

    Georgia: Present Value of Public Debt, 2010–2025

    (In percent of GDP)

  • Figure 1a.
    View in gallery
    Figure 1a.

    Georgia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2010–2030 1/

  • Figure 1b.
    View in gallery
    Figure 1b.

    Georgia: Indicators of Public Debt Under Alternative Scenarios, 2010–2030

Georgia: Foreign Exchange Market, 2008–10 1/

(In millions of US$)

Georgia: Seasonally-Adjusted Real GDP, 2004–14

(In millions of 2003 lari)

Georgia: Indicators of Economic Activity, March 2008–May 2010

(3-month moving average, y-o-y change in percent)

Georgia: CPI Inflation, 2007–10

(Year-on-year change, in percent)

Georgia: Real and Nominal Effective Exchange Rates, 2006–10

(Index, 2000 = 100)

Georgia: External Flows, 2008–10

(3-month moving average, y-o-y growth in percent)

Georgia: Lari Interest Rates, 2006–10

(In percent)

Georgia: Deposits, 2008–10

(In millions of lari)

Georgia: Domestic Fx Interest Rates, 2006–10 1/

(In percent)

Georgia: Credit to the Private Sector, 2008–10

(In millions of lari)

Georgia: Capitalization Ratios, 2006–10

(In percent)

Georgia: Nonperforming Loans and Provisions Ratios, 2006–10

(In percent)

Georgia: Liquidity Ratios, 2006–10

(In percent)

Georgia: Profitability Ratios, 2006–10

(In percent)

Georgia: Foreign Exchange Intervention and Exchange Rate, 2008–10

Georgia: Foreign Exchange Intervention and Exchange Rate Depreciation, 2009–10

Georgia: Government Revenues and Expenditures, 2003–15

(In percent of GDP)

Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

(In percent of GDP)

Georgia: Public Debt, 2004–15

(In percent of GDP)

Georgia: Fiscal Balances, 2003–15

(In percent of GDP)

Georgia: Government Net External Financing, Grants, and Privatization Receipts, 2003–15

(In percent of GDP)

Georgia: Public Debt, 2004–15

(In percent of GDP)

Georgia: Government Revenues and Expenditures, 2003–15

(In percent of GDP)

Georgia: Yield Curve

(in percent)

Georgia: Tbilisi Interbank Overnight Lending Rate (TIBR), 2008–10

Georgia: Current Account Balance and its Financing, 2006–15

(In percent of GDP)

Georgia and Comparator Countries: FDI Inflows

(In percent of GDP)

Sovereign Eurobond Spreads

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

Georgia: Present Value of Public Debt, 2010–2025

(In percent of revenue)

Georgia: Debt Service, 2010–2025

(In percent of revenue)

Georgia: Present Value of Public Debt, 2010–2025

(In percent of GDP)
Figure 1a.

Georgia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2010–2030 1/
Figure 1b.

Georgia: Indicators of Public Debt Under Alternative Scenarios, 2010–2030