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Transition Report 2013 Stuck in transition?


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Country assessments

Georgia

Main macroeconomic indicators %
  2009 2010 2011 2012
est.
2013
proj.
GDP growth -3.8 6.3 7.2 6.1 2.0
Inflation (end-year) 3.0 11.2 2.0 -1.4 2.0
Government balance/GDP -9.2 -6.6 -3.6 -3.0 -3.3
Current account balance/GDP -10.5 -10.2 -12.7 -11.7 -7.0
Net FDI (in million US$) 677 679 902 603 600
External debt/GDP 81.8 86.6 79.9 84.4 n.a.
Gross reserves/GDP 19.6 19.5 19.5 18.1 n.a.
Credit to private sector/GDP 30.9 31.8 32.7 34.5 n.a.

2013 sector transition indicators

Corporate

Energy

Infrastructure

FI

Source: EBRD.
Note: Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.

Highlights

  • Political uncertainty has weighed on economic growth. Private foreign and domestic investments declined in the lead-up to, and following, the 2012 parliamentary elections, as the new government reversed many policies of the former administration. The government also slowed disbursement of capital spending.
  • The authorities have pursued socially-oriented economic policies. The government reallocated expenditures to social categories, negotiated a reduction in energy tariffs, and introduced universal coverage of basic health insurance and a minimum income exemption for income tax purposes. A new labour code was adopted that granted greater protection to employees.
  • Progress was made in increasing access to Russian and European markets. After a five-year embargo, Georgia resumed exports of mineral water, wine and other agricultural products to Russia. The authorities also concluded the technical part of negotiations on the draft Association Agreement with the European Union (EU).

Key priorities for 2014

  • The authorities should improve the predictability and communication of their policies to decrease political uncertainty. The government’s medium-term programme should be finalised and communicated openly and widely. Future reform proposals should include extensive consultation with all main stakeholders.
  • New and existing regulatory agencies for various markets should be independent of political influence. Future changes in the energy tariffs should be based on a transparent methodology, to ensure that they do not jeopardise private sector investment in the energy sector. Modern competition legislation should be adopted, and a competition authority should be established.
  • It will be important to ensure a high quality of governance for public and private investment funds. The operations of the sovereign wealth fund should continue to complement, rather than be substituted for, private sector investment. The new private funds should have high corporate governance standards, and avoid conflicts of interest, including special treatment by the government.

Macroeconomic performance

Economic growth decelerated following the 2012 parliamentary elections. After averaging 6.5 per cent between 2010 and 2012, the growth of the Georgian economy has experienced a sharp slow-down, to 1.9 per cent in the first half of 2013. Under-spending of the capital budget by the government, and contraction of capital expenditures by private investors affected by the political and policy uncertainty, have contributed to a recession in construction and a marked slow-down in the industrial sector. Agriculture and trade have remained the main drivers of growth. In the first half of 2013 foreign direct investment (FDI) declined by 4.0 per cent compared to the same period in 2012, to 5.2 per cent of GDP. Consumer prices declined by 1.0 per cent on average, year-on-year, in the period January-August, which is well below the National Bank of Georgia’s inflation target of 6 per cent, prompting the central bank to reduce the policy rate by an additional 200 basis points since October 2012 (to 3.75 per cent at end-August 2013). Deposit rates and lending rates have followed a similar trend. The lari has remained broadly stable against the US dollar, and the central bank repeatedly intervened in the currency market to stem the appreciation pressures coming from capital inflows.

External vulnerabilities remain significant. The current account deficit has remained above 10 per cent of GDP, and its financing has continued to shift from FDI and international financial institution loans to more volatile, market-based sources, such as non-resident bank deposits and corporate loans, and Eurobond issues. In this context, the boosted central bank reserves (at around four months of imports) and the US$ 400 million precautionary arrangement with the International Monetary Fund – which is intended to support completion of the post-crisis (external and fiscal) adjustment process – continue to ensure that the high current account deficit can be financed even if private sector flows are disrupted.

Short-term growth prospects are uncertain. The October 2013 election and uncertainty surrounding future policies may affect investment sentiment in the short term. External demand has also deteriorated, but the recent access of Georgian agricultural exports to the Russian market should temporarily support overall exports and certain specific sectors of the economy. However, to sustain a high growth rate in the longer term, and to overcome acute social challenges, it will be necessary to continue increasing the competitiveness of the Georgian economy, improving the education of the labour force and promoting the reallocation of resources from low value-added to higher value-added sectors.

Major structural reform developments

The new government has pursued various policies to strengthen regulatory frameworks for markets. Georgia retains the highest ranking among the EBRD’s countries of operations in the World Bank 2014 Doing Business report, having achieved tangible results in fighting petty corruption, liberalising foreign trade, starting a business and registering property. However, these achievements were accompanied by the elimination of virtually all regulation of markets. Concerned about the equity implications of such policies, as well as their social costs, the new government has tightened regulations, in particular concerning the labour and land markets, and taxation of natural resource rents. The new Labour Code, which was adopted in June 2013, brought Georgian labour regulations closer to European and International Labour Organization standards. The law expanded workers’ rights, according workers better employment protection and setting the maximum length of a working day. In August 2013 taxation of the agricultural sector was changed, as small agricultural producers with annual revenues of less than 200,000 lari (approximately US$ 120,000) were exempt from income tax until 2017. Also, in July 2013, a two-year moratorium on agricultural land sales to foreigners and its conversion for non-agricultural use was introduced. The same law stipulates that, by 2015, the government should develop a new land ownership policy, and establish a land cadastre, and a unified land tenure system. Taxes on mineral water extraction will triple in October, and anti-monopoly legislation and a competition agency are expected to be introduced by the end of 2013.

The government has commenced operation of the state fund for the support of private investment. The state-owned Partnership Fund, launched in 2011, became operational over the past year, and funded a number of projects, including in the agribusiness, energy, manufacturing and real estate sectors. In April 2013 the government decided to rebrand the Partnership Fund into a sovereign wealth fund. The government also supported the creation of a private equity Co-Investment Fund, launched in October 2013 by a group of international and domestic, private and public investors. The US$ 6 billion fund is intended to make equity investments in private sector projects in the agriculture, energy, industrial, tourism and real estate sectors. Another fund is expected to be established that will provide financing for start-up innovative projects.

Georgia is emerging as a regional economic hub. Long-standing geopolitical strains in the southern Caucasus have led to various difficulties for regional development and trade. Benefitting from Georgia’s open foreign trade regime and efficient customs system, various international firms have selected Georgia as a regional hub and transit centre for goods and natural resources. The project linking Georgia’s electricity system to Turkey’s, which began in 2010, is in its final stage. It will connect the two countries’ electricity systems and make Georgia a net exporter of energy. Other projects, such as the building of a new cargo airport near Tbilisi and a deep sea port on the Black Sea coast, are being considered.

The authorities are pursuing greater access to both European and Russian markets. In July 2013 negotiations with the EU on an Association Agreement, including the creation of a Deep and Comprehensive Free Trade Area, were concluded. The Agreement is expected to be initialled at the Vilnius Eastern Partnership Summit in November 2013. Once implemented, it is expected to boost foreign trade and the inflow of foreign investments. To prepare for the implementation of the Agreement, the government is working to improve hygiene standards for agricultural products, and to harmonise regulations for industrial products. Trade relations with Russia have also improved considerably this year. In May 2013 the two main mineral water producers began shipping their goods to Russia, and in June 2013 wine and brandy products were exported to Russia for the first time in seven years. As at the end of July 2013, 27 companies held permissions to supply their products to the Russian market. In autumn 2013 fruits, vegetables, honey and other agricultural products are expected to gain access to the Russian market. The re-opening of exports to Russia should provide a significant boost to the Georgian economy. Tourism visitors have increased steadily over the last few years, providing the country with a new platform on which to generate foreign currency income.

The government has shifted its expenditure policy away from infrastructure projects towards social spending. Some state-led infrastructure projects were postponed temporarily, including the Baku-Tbilisi-Kars railway, which is intended to connect Turkey, Georgia and Azerbaijan, while some other projects were dropped. Instead, in early 2013 the government introduced a new budget-sponsored country-wide medical insurance programme, with an annual insurance limit of 15,000 lari (approximately US$ 9,000) per person, raised pensions for certain categories of the population, and introduced a tax-exempt income bracket of up to 500 lari per month. In January 2013 electricity tariffs were reduced by around 25 per cent for households consuming up to 300 KWh per month. In March 2013 the government negotiated an agreement with energy distributors – Russia’s Inter-RAO UES and Czech Republic-based Energo-Pro – fixing these lower tariffs for another four and two years, respectively, in return for cancelling these companies’ capital expenditure obligations. It remains to be seen whether the tariffs can be maintained permanently at the reduced level, and without significant fiscal costs or deterioration in the quality and availability of services.

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