The Georgian authorities thank staff for their constructive engagement during the mission and for the fruitful reports. They agree with the thrust of the staff appraisal and confirm their strong ownership of the reforms under the program.

The macroeconomic and structural policies implemented by the Georgian authorities, and supported by the IMF program, continue to safeguard macroeconomic stability and enhance the resilience of the economy. Economic growth remains robust in the face of negative shocks. Fiscal performance is on track and medium-term fiscal plans are in line with program objectives. The external position has strengthened, and current account deficit reached a historic low. The financial sector remains well capitalized, liquid and profitable. The inflation rate has somewhat accelerated, partly driven by one-off effects, but as a result of decisive and prompt actions on the monetary policy front, inflation is projected to return to its target soon.

Building on the overall progress achieved under the current program and recognizing the need to maintain policy discipline throughout the election year, the authorities request a one-year extension of the Extended Fund Facility (EFF) program. In addition to new targets for public finance and inflation the authorities have committed to three new structural benchmarks to further strengthen their debt sustainability and financial stability framework in the extended EFF. The authorities believe that extension of the program will further help implement the existing reform agenda. They reiterate their commitment under the EFF and stand ready to adjust policies in accordance with program objectives.

Macroeconomic outlook

Real GDP growth continues robust at 5.7% in Q3, despite the negative shock stemming from the ban on flights from Russia. Inflation, mainly driven by nominal exchange rate depreciation, increased to 7% but is expected to decline gradually towards target during next year. The current account deficit improved significantly and declined to around 5% in 2019 according to flash estimates. Improvements in the external sector, mainly driven by enhancements in trade balance, and financial stability, are a result of sound macro-prudential policies, including tightening lending standards for consumer loans. Recently, S&P upgraded Georgia’s sovereign rating to BB (October), following the same rating made earlier this year by Fitch. Despite the global economic and geopolitical risks to the outlook, medium-term growth prospects are strong, supported by improving fundamentals, sustained infrastructure investment and steadfast implementation of structural reforms.

Program performance

The authorities remain strongly committed to the program. All end-June quantitative performance criteria were met, except two QPCs which were missed by a small margin (end-June QPCs on augmented fiscal deficit and ceiling on deficit of Partnership Fund by 0.03 percent of GDP and by $0.6 million, respectively). The target on augmented fiscal deficit was missed due to lower disbursements on foreign-financed projects, while higher than expected privatization proceeds enabled increased expenditure. The target on the ceiling of the cash deficit for the Partnership Fund was missed due to delayed SOE dividend payments. Both deviations are temporary and do not undermine the end-year targets.

Three out of five structural benchmarks were implemented and the remaining two will be implemented by end-December and end-March 2020. The new insolvency law, in line with international standards, will be followed by the implementation of a framework to enable the government to start licensing insolvency practitioners. This will improve the protection of creditors rights and a higher efficiency in insolvency procedures. The authorities will submit the new insolvency law to parliament by end-December 2019. Additional TA has been requested by the authorities to complete the classification of SOE into public corporations and general government. Depending on the timing of the technical assistance they expect to complete this SB by end-March 2020.

Fiscal policy

Fiscal discipline remains a high priority on the agenda of the authorities. The 2019 fiscal deficit is projected to be 2.3% of GDP and the authorities agreed on 2.7% in the 2020 budget, implicating a structural deficit of around 1.7% of potential GDP, in line with the objective to keep debt below 45% of GDP. Fiscal space for growth-enhancing public investments continues to be provided by constraining the wage bill and prudent spending on goods and services. Current spending has declined from 25 percent of GDP in 2016 to below 22 percent in the 2020 budget. In addition, all the quasi-fiscal operations and Public-Private Partnerships are strictly constrained in line with program objectives and will be disclosed in the annual Fiscal Risk Statement.

The authorities acknowledge the importance of boosting investments in human capital to achieve higher potential growth. In the overall spending envelope, education spending will gradually increase towards 6 percent of GDP by 2022 and will be maintained at this level as adopted in the budget code. Increasing investment in education is conditioned on the implementation of comprehensive education reform and improving the efficiency of spending. The authorities stand ready to adopt additional measures, in consultation with the IMF, to keep the spending envelope in line with program objectives.

The authorities will continue to protect social safety nets to promote sustainable and inclusive growth. In consultation with the IMF, the authorities will design legislation for a rule-based pension indexation mechanism. Increasing the pension levels, currently at a low level, will support inclusive growth and reduce inequality. Indexation rules should help remove pressure for discretionary increases. At the same time, the authorities well acknowledge the fiscal constraints and agree to conservatively plan considering all fiscal implications.

On the fiscal reforms front, the authorities continue implementing a wide range of structural policies to further enhance debt sustainability. These include improving the efficiency of tax administration, strengthening governance of SOEs, implementing PPP framework, increasing fiscal transparency and improving analytical capacity in the Ministry of Finance.

Monetary and financial stability policies

Over the recent decade, sustained disinflation accompanied with high GDP growth and improving external balance indicate that inflation targeting with flexible exchange rate policy has served the Georgian economy well. Inflation has averaged at around 3.5 percent during 2009 – 2019, down from a double-digit level. Financial dollarization is on a decreasing trend and local currency capital markets are gaining traction. Improved transparency and predictability of monetary policy helped reduce local currency long-term interest rates through reducing inflation expectations and risk premia, making local currency mortgages and business loans more available for the market.

Inflation increased to 7% in November, mainly driven by on-offs. Exchange rate adjustment in response to external shocks continue to put pressure on inflation. The monetary policy rate has increased to 9.0% to curb inflation expectations and neutralize second round effects. The authorities consider the current stance of monetary policy tight and according to projections inflation returns to target during next year. However, the NBG stands ready to further tighten if necessary.

The authorities agree with staff on the priority to accumulate reserves and increase external buffers. FX interventions will be used to strengthen international reserves and smooth excessive volatility. In order to maintain confidence on the local currency markets the pace of reserve accumulation should allow enough flexibility to accommodate uneven FX inflows in the country.

The National Bank of Georgia (NBG) continue efforts to strengthen financial stability by pursuing prudent lending standards, adequately tightening buffers on capital and liquidity, and further strengthening the policy framework. The authorities also continue to develop consolidated supervisory framework of non-banks. The NBG resumed the publication of their Financial Stability Report, providing a forward-looking assessment of risks and vulnerabilities. Additionally, the NBG published a macroprudential strategy, laying ground for transparent and predictable macroprudential policy making.

Structural reforms

To achieve more robust and inclusive growth the authorities continue steadfast implementation of structural reforms. The authorities continue to improve the business environment by, among other measures, implementing a reform to bring the judiciary in line with international standards. The authorities, supported by the Council of Europe and in consultation with other stakeholders, such as civil society organizations, independent experts and academia, have submitted the legislation to parliament.

Catalyzing donor financing from IFIs to scale-up investments in roads, transportation and logistics is high on the authority’s agenda. They also dedicate a lot of time and energy in initiating new free trade agreements that should help attract foreign investments and improve competitiveness.

Conclusion

The authorities reiterate their commitment to sound monetary and fiscal policies to ensure macro stability and promote sustainable and inclusive growth. Structural reforms should help promote private sector led growth and achieve its growth potential. They recognize that the program has supported their reform agenda and appreciate the Fund’s engagement. The authorities look forward to continuing their cooperation with the Fund.