Abstract
This 2013 Article IV Consultation highlights that Georgia’s real GDP growth averaged 6½ percent in 2011–2012, about 1½ percentage points more than projected at the 2011 Article IV consultation. Inflation has declined steadily, reflecting lower food prices, lagged effects of exchange rate appreciation, and cuts in administered energy prices. The exchange rate has faced appreciation pressures, but has been kept stable against the U.S. dollar. However, the economy has slowed down markedly since mid-2012, and unemployment remains high at 15 percent. Despite the slowdown, growth could still reach 4 percent in 2013, rising to about 6 percent in 2014 and beyond.
The Georgian authorities would like to thank the Fund team for fruitful discussions during the mission visit. They broadly agree with staff’s assessment of the main risks facing the Georgian economy, especially those related to vulnerabilities stemming from external spillovers. The authorities continue to attach great importance to making use of Fund advice. They have implemented most of the recommendations from the 2011 Article IV consultation, including in public financial management, monetary policy and ensuring financial stability. The authorities value the sustained support they receive in the process of transformation and modernization of the Georgian economy.
Following the first peaceful democratic transfer of power in recent history, the authorities are strongly committed to sustaining rapid economic growth, and making it more socially inclusive and broad-based. Strengthened social protection, further support of private initiatives through the establishment of investment funds, and focus on modernizing the agricultural sector are high on the authorities’ policy agenda. At the same time, they are committed to preserving fiscal sustainability, pursuing prudent monetary and exchange rate policies, maintaining financial stability, and reducing vulnerabilities in the external position.
Fiscal policy
The authorities remain committed to meeting the fiscal consolidation targets, while reprioritizing government expenditure toward social spending and maintaining key infrastructure projects. To make growth more inclusive the government aims at redirecting public spending from capital investment, which as a share of GDP is one of the highest in the region, to social expenditures, which is one of the lowest among peers.
The authorities are committed to gradually reducing the fiscal deficit to 1.5 percent of GDP by 2017, implying a modest annual reduction of the primary structural balance by ¼ to ½ percent of GDP over the period 2014-2017. The authorities emphasize that the under-execution of the budget this year is mainly due to temporary factors related to the public procurement procedures. This underspending is expected to disappear.
A universal health care system is being introduced. Targeted social assistance allowances will be doubled. The government will increase investment in the quality of education. This being said, capital spending is expected to stay above 6 percent of GDP, comparable with regional peer countries. In order to support agriculture, an Agriculture Fund has been established and the government has increased budget allocations to support this sector.
Monetary and exchange rate policies
Since November 2012 the National Bank of Georgia (NBG) has gradually cut its policy rate from 5.5 to 4 percent in June 2013, in line with staff advice. This gradual easing of monetary policy has been implemented in response to persistent deflationary pressures and some signs of slowing economic activity. Nonetheless, the authorities remain cautious in light of some indications that inflation might soon pick up with a rebound in economic growth.
The NBG has continued to improve its inflation targeting framework, increased transparency, promoted initiatives to strengthen the monetary policy transmission mechanism, and encouraged steps leading to further de-dollarization. The NBG has also continued to improve its forecasting capacities and promote transparency by strengthening its communications strategy with the introduction of an upgraded inflation report that better explains monetary policy performance and deviations from established inflation targets.
The NBG aims at further strengthening the monetary policy transmission mechanism by encouraging long-term lari lending and floating-rate lari lending by domestic banks. In particular, together with the Ministry of Finance they are considering depositing long-term the proceeds from new treasury bills with commercial banks in order to stimulate further long-term lari lending. The NBG also aims at supporting floating-rate lending by easing collateral standards. These measures should also help fulfill the authorities’ goal of further developing the domestic corporate bond and equity market.
The central bank has resisted appreciation pressures with significant foreign exchange purchases that have helped further build up reserves. Because of large uncertainties and specific assumptions included in the staff’s methodology, the authorities are not fully convinced about the staff’s assessment that the exchange rate is overvalued. The authorities reiterate their commitment in principle to a floating exchange rate regime. They emphasize that improved cooperation between the NBG and the government is helpful and that the institutional independence of the central bank strengthens the credibility and effectiveness of monetary policy.
Financial system
The financial system remains profitable, adequately capitalized, and liquid. The capital adequacy ratio further increased to 26.4 percent according to the Basel definition. Liquid assets, excluding short-term loans, account for 28.1 percent of total assets and 51.2 percent of client deposits. While nonperforming loans increased recently, from 3.7 percent to 4.5 percent according to the standard 90-day overdue definition, the authorities do not expect that this small rise represents a risk for financial stability or profitability of the banking sector.
The authorities are fully aware of the potential risks related to recent increases in nonresident deposits and the high level of dollarization. They continue to undertake appropriate measures to contain these risks. In particular, new supervisory measures have tightened the liquidity requirement for nonresident deposits. The new liquidity coverage ratio assumes higher outflow rates for FX deposits than what it would be without taking into account currency denomination. Together with capital add-ons for FX lending risks, these prudential measures are expected to discourage nonresident deposits and FX lending. The NBG’s actions to stimulate long-term and floating-rate lari lending should also help in containing risks.
The NBG has recently developed a framework for monitoring systemically important banks. The NBG also continues to closely monitor developments in the banking system. A Basel III draft framework has been developed and major banks are reporting Basel III capital adequacy ratios on a monthly basis for monitoring purposes. The banks have already shown substantial progress in submitting their first ICAAPs. The authorities have asked the Fund to conduct an FSAP.
Structural reforms
Georgia’s current account position makes implementing a strategy to decisively improve external competitiveness a key priority. Rather than relying on nominal exchange rate depreciation, the government is determined to implement a broad array of structural reforms to improve productivity and competitiveness. Making progress towards the completion of a deep and comprehensive free trade agreement with the EU is a priority.
The revised Labor code, which has been passed by Parliament in June 2013, incorporates comments from businesses and assures a better balance between the interests of employers and employees to improve welfare and enhance productivity. Georgia’s competitiveness in manufacturing will be upgraded by improving education quality in general and vocational training to reduce skill-mismatches in particular. Investment funds with significant resources will actively promote foreign direct investment in Georgia. The agriculture sector has comparative advantages, particularly if its capital base and infrastructure can be improved. The government’s policy will aim at higher productivity for the agriculture sector.
The Universal Health Care (UHC) reform was designed and launched in close consultation with all stakeholders concerned, including the WHO, the World Bank and private insurance companies. The program was designed based on the evidence from the Catastrophic Health Expenditure and Utilization Survey (2010) to tackle the lead causes of impoverishment due to healthcare related costs (hospitalization, chronic diseases and acute conditions) and to reduce inequalities due to health conditions. Drug co-payments are already in place under disease-specific programs (e.g. diabetes) and ongoing for emergency, oncology and maternity services and will be expanded upon creation of stronger regulations for drug utilization control. Concerns about social spending will be adequately addressed within ongoing and planned reforms.
Hydro power sector development in particular has good prospects. To attract foreign investment in this sector and promote regional trading, the regulatory framework will be enhanced in cooperation with the World Bank. Developing domestic capital markets and creating a contributory pension system will facilitate the allocation of capital from savers to investors. Lastly, a vibrant economy, based on investment and employment creation, requires the enforcement of the rule of law and strengthening of property rights.