For more information, see Georgia and the IMF

Georgia—Enhanced Structural Adjustment Facility
Policy Framework Paper, 1998-2000

I. Introduction

1. Since mid-1994, the Georgian government has been implementing a bold stabilization and structural reform program aimed at addressing the country’s large domestic and external imbalances. The stabilization program has been based on the implementation of prudent financial policies; the liberalization of prices, trade and the exchange system; the phasing out of direct and indirect government subsidies; and the development of key institutions for economic policy management. To promote an appropriate environment for private sector development, the government has also implemented major structural reforms in almost all sectors of the economy.

2. Financial support by the International Monetary Fund (IMF), the World Bank, the EU, and other multilateral and bilateral donors and creditors, together with debt relief or a standstill granted by external creditors, have been instrumental for the successful implementation of the economic reform program. In addition, strong government ownership of the reform program and intense technical assistance from various International Financial Institutions (IFIs) and donor countries have allowed the government to establish and strengthen basic institutions for economic management.

3. The Georgian government intends to continue to pursue the medium-term strategy specified in the Policy Framework Paper for the period 1997-99. The revised program for the period 1998-2000 has been designed in collaboration with the staffs of the IMF and the World Bank in light of recent developments. The government is seeking continuation of Fund support for this program through a third annual arrangement under the Enhanced Structural Adjustment Facility (ESAF). Negotiations on a third Structural Adjustment Credit (SAC III) will start during the second half of 1998. In addition, the government has requested additional debt relief from bilateral creditors amounting to US$79 million in 1998.

II. Recent developments

4. During the last three years Georgia has made major strides in stabilization and structural reform. Owing to prudent financial policies, annual inflation has declined to single digits; the exchange rate has remained stable since the introduction of the lari in October 1995; gross international reserves have increased; and economic growth, which resumed in 1995, picked up strongly in 1996 and 1997 to over 10 percent per annum, fueled by strong growth in agriculture, trade, and construction (Tables 1-3).

5. Fiscal consolidation has been a key element of macroeconomic stabilization. The overall fiscal deficit (on a commitment basis and excluding grants) was reduced sharply from 16.5 percent of GDP in 1994 to 5.8 percent in 1996 and 4.5 percent in 1997. At the start of the stabilization process, the fiscal adjustment resulted from a drastic reduction of public expenditure. However, during 1996 and 1997, the reduction in the fiscal deficit reflected sharp increases in tax revenue, particularly as regards VAT, customs duties, and excise collections. Tax revenue increases reflected the removal of most tax exemptions, the imposition of new taxes, the streamlining of the tax system under the new Tax Code enacted in June 1997, as well as ongoing reforms in tax and customs administration. Despite these favorable developments, however, the tax/GDP ratio remains low by international standards, and the public finances remain highly dependent on external financing and borrowing from the National Bank of Georgia (NBG).

6. As regards the external sector, the overall balance of payments position has strengthened, following a sharp contraction in the current account deficit (excluding official transfers) from over 35 percent of GDP in 1994 to around 10 percent in 1997. The deficit has been financed through long-term concessional lending from IFIs, grants and loans from bilateral sources, and growing foreign direct investment. In addition, Georgia has made substantial progress in normalizing relations with external creditors and thereby benefitted from considerable debt relief. Nevertheless, Georgia’s external position remains vulnerable, as evidenced by the relatively low level of gross official reserves and a net present value of debt-to-export ratio of about 200 percent in 1997. Georgia’s trade and exchange systems are liberal and in December 1996 Georgia accepted the obligations under Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement.

7. On structural reform, the government’s program has targeted a reduction of the role of the state in the economy. Accordingly, a vast array of measures have been implemented in the areas of land reform, privatization of small- and medium-scale public enterprises, energy sector restructuring, banking sector reform, property rights and legal reform, and a reduction in public sector employment (Box 1).

III. Medium-Term Strategy

8. The government’s strategy for 1998-2000 aims at consolidating the gains achieved in macroeconomic stabilization since 1994, making considerable progress toward achieving external viability, accelerating structural reforms, and keeping the economy on a sustainable growth path, while strengthening the social safety net. The main macroeconomic objectives of the 1998-2000 program include: (i) an annual growth rate of 8-10 percent; (ii) a further reduction of the annual inflation rate to 4 percent by 2000; and (iii) an increase in the NBG gross reserves position to an equivalent of 2.3 months of imports of goods in 1998 and about 2.8 months by 2000.

9. Key to achieving the program’s objectives will be a further reduction of the overall fiscal deficit (on a cash basis and including grants) from 3.8 percent of GDP in 1997 to 1.6 percent in 2000, resulting from further improvements in revenue performance and the implementation of a sound public expenditure policy. Prudent monetary policy, together with continued banking sector reform, would also enhance the prospects for non-inflationary growth over the medium term. In addition, the program will aim at removing bottlenecks hampering the growth of private investment and savings, while reducing poverty and protecting the environment. Furthermore, macroeconomic and structural reform policies will seek to make progress on greater transparency, particularly as regards the fiscal accounts, create a level playing field, and enhance competition for all economic agents (Table 4).

1. Sources of economic growth

10. Georgia’s economic growth prospects over the medium term appear quite promising given its educated labor force, liberal external policies, strategic location at the western end of the Eurasian corridor, and its natural endowments. Illiteracy is not an issue and the enrollment rates in higher education are rather high by international standards. Also, Georgia has one of the most liberal trade and exchange regimes among transition economies. It hopes to accede to the WTO by mid to end-1999 and much foreign direct investment interest has already been recorded, particularly in the oil and related sectors. The construction of the pipeline for "early" Caspian Sea oil is scheduled to be completed in early 1999, but the much larger investment operation in the Caspian Sea will require the construction of new pipelines and it is likely that one of them will go through Georgia. In addition, Georgia has gas and oil reserves and the hydro power potential to be a net regional exporter of energy over the medium term. It has reportedly substantial deposits of exploitable mineral resources (including perlite, manganese and copper); it could double its diverse agricultural output; and it has major winter and summer tourism potential. Finally, encouraging progress has recently been made in finding a solution to the issue of Abkhazia, although the issues to be resolved in this area remain complex and could take a long time.

2. Fiscal policy

11. While fiscal revenue has recovered strongly over the last three years, further progress is needed to increase government savings and provide the necessary resources for investment and social expenditure. The medium-term fiscal program aims at increasing general government tax revenue from 8.8 percent of GDP in 1997 to 10.3 percent in 1998, reaching 12.4 percent of GDP by the year 2000. To boost revenue, emphasis will be placed mainly in broadening the tax base. Measures will include: (i) augmenting tax collections on cigarettes and alcoholic beverages; (ii) further strengthening tax and customs administration; and (iii) avoiding the accumulation of new tax arrears to the budget. Also, the fiscal program targets the elimination of remaining tax and customs duty exemptions; the switch to the destination principle for the value-added tax for trade within the CIS once an agreement with other CIS countries has been reached; and a rationalization of the profit and personal income tax.

12. The scope for enhanced taxation of domestic and imported cigarettes and alcoholic beverages appears to be significant. First, potential tax collections from these tax categories are quite substantial (particularly in cigarette taxation) and strict enforcement of these taxes could be a major source for increasing government savings. Second, the move from ad valorem to specific tax rates agreed under SAC II and the 1997 ESAF arrangement--and its steadfast implementation over the coming few years--represents a decisive step toward reducing incentives for transit fraud and tax evasion, and establishing orderly and transparent fiscal operations in line with the recovery of authority of the state and social stability.

13. Substantial improvements in tax and customs administration will also be required to achieve the medium-term revenue targets. Tax administration reform has been underway from the beginning of the economic reform program and has contributed significantly to an increase in revenue collection. In the period ahead, the emphasis will be on enforcing tax legislation, ensuring timely payments of tax obligations, and maximizing the tax revenue from institutional improvements within the tax authorities. To that end, the government intends to establish targets for the reduction in tax arrears; file for bankruptcy taxpayers with arrears to the Tax Inspectorate of Georgia (TIG) older than nine months; maintain and enforce the functional organization of the TIG; expand significantly the coverage of the large tax payer unit; and initiate the issuance of tax identification numbers (TINs) for all individuals, with an objective of completion by end-1999.

14. Customs administration will be improved and computerization will be expanded. The focus will be on improving the collection of taxes at customs borders, through improved valuation assessments, revised procedures for imports, transit, and warehousing, and strict implementation of the Customs Code. These changes will require additional infrastructure and equipment, as well as continued technical assistance. To this end, the government is working with the World Bank and potential donor countries to secure the necessary support for an effective implementation of the customs’ administration plans.

15. The authorities intend to initiate bankruptcy procedures to enterprises with tax arrears older than nine months, while putting in place the necessary measures to avoid the emergence of new tax arrears to the budget. On the latter, the government intends to establish a ministerial-level committee, headed by the Minister of Finance, to deal with the largest enterprises in arrears to the budget; increase the TIG’s administrative authority to enforce compliance with tax liabilities; and enhance the accountability of the people responsible for managing the taxes in state-owned enterprises.

16. Consistent with the macroeconomic and fiscal objectives of the program, total expenditure and net lending (on a commitment basis) will be increased from 14.5 percent of GDP in 1997 to 16.2 percent in 2000. For current expenditures, in line with the recommendations of the World Bank staff, the government intends to secure outlays for basic education and essential health services. There is also some scope for better targeting of social benefits toward the most needy. For capital outlays, the government intends to establish a rolling five-year indicative public investment program, which will prioritize investments within the context of revamped project selection criteria. Capital outlays (including net lending) are expected to increase from 1.2 percent of GDP in 1997 to 2.4 in 2000, in line with increased project financing from external creditors.

17. Core to the fiscal program will be the implementation of a sound public expenditure policy aimed at strengthening the treasury system and increasing public expenditure productivity. Progress with the development of a treasury system in the Ministry of Finance has been substantial over the last couple of years. The next steps in this front will include, inter alia, the closure of special (bank) accounts of higher education institutions by end-1999; an extension of the treasury network to local budgets no later than end-December 1998; and the computerization of all regional treasury offices and the central treasury by end-October 1998, which will be critical for the development of commitment accounting and a timely submission of regional’s treasuries’ budget-execution reports to the central treasury. Also, the standardization of treasury ledger accounts in accordance with the IMF Government Financial Statistics (GFS) classification, together with the computerization of the system, will allow forward cash planning, effective internal financial audits, and the registering of all state financial liabilities, which will enable the government to implement an effective debt-management strategy.

18. The government intends to increase public expenditure productivity through a combination of policies aimed at: (i) reducing less-productive public expenditure; (ii) securing cost-effectiveness of the public goods and services supplied; (iii) assessing the appropriate mix of government expenditures; and (iv) defining a "core" of public-sector outlays with their corresponding financing needs over the medium term. Cuts in unproductive public employment, underused infrastructure, and economic subsidies to loss-making enterprises will make room to raise wages of productive public employees, increase the provision of important public services (e.g., health, education, and social safety net), and protect key public investment programs (e.g., basic infrastructure) aimed at promoting economic growth.

19. While assessing the cost-effectiveness of major programs will remain a complex task, the authorities intend—as a first step in that direction—to devise by end-1998 appropriate timetables for adjusting municipal and public utility tariffs (for transport and communication services and other municipal services) to cost-recovery levels over the coming years. Also, efforts will be strengthened to rank and select possible public investment projects according to their social costs and benefits.

20. The appropriate mix of factors of production is a technical as well as an economic issue. Accordingly, the government will review budgetary allocations across ministries and spending units in terms of the complementaries of wage and nonwage expenditures. In addition, a group of "core" public sector outlays, for which there is a strong case for public intervention (e.g., basic education, essential health services, defense, law and order, regulatory and legal framework) and/or significant costs from delaying spending, will be specified and closely monitored in the context of a medium-term public expenditure policy.

21. The government intends to define more clearly the expenditure assignments of regional governments, and review the revenue-sharing arrangements between the central and regional governments, as well as the formula for transfers from the central government to the regions. An overriding objective will be to continue to require regional governments to balance their budgets (i.e., regions' powers to issue domestic or external debt will continue to be restricted). The financial and administrative skills of regional governments will also be built up to cope with the increased demands arising from the decentralization process.

22. Finally, the fiscal reform program will seek to further systematize the budgetary process within the Ministry of Finance during 1998. To that end, the fiscal program will aim at: (i) integrating the work of the Ministry’s Macroeconomic and Fiscal Forecast Department (MMFD) with the budget preparation process; (ii) enhancing the role of MMFD in analyzing discrepancies between forecast and actual monthly revenue collections, and monitoring the monthly execution of the budget; and (iii) improving the collection of information from ministries and spending units at the early stages of the budget preparation process. On the latter, the goal will be to rank spending units’ expenditure priorities; reduce the level of detail included in budgetary expenditure programs (to allow executive bodies more flexibility to execute their budgets); and improve the dissemination of relevant information to all interested parties before and after the budget is approved by parliament.

3. Monetary and exchange rate policy

23. Monetary and credit policy for 1998-2000 will be geared toward maintaining gains in the stabilization front and strengthening the NBG’s international reserves position. The program for this period assumes a reduction in the velocity of circulation of money and an increase in the money multiplier, in line with increasing confidence in the lari and an expected improvement in financial intermediation, respectively.

24. Supported by prudent aggregate demand policies, Georgia has adopted a managed floating exchange rate regime, which has raised confidence in the lari. The authorities’ strategy has been to intervene in the foreign exchange market if necessary to prevent a depreciation of the lari, provided this was consistent with the NBG’s international reserves target. In the case of capital inflows, the policy was to build up reserves, but let the exchange rate appreciate if these flows were to become very large. At this stage, the stability of the nominal exchange rate appears to have contributed to bringing down inflationary expectations and, with domestic inflation at single digits per annum, the real exchange rate has become more stable. At the same time, the persistence of a vulnerable external reserves position, despite the sizable fiscal adjustment, which has already taken place or is expected for the near future, suggests that exchange rate policy be kept under review.

4. Banking sector reform

25. In keeping with international trends toward financial reform, the Georgian authorities have been implementing a strategic plan for banking sector restructuring over the last three years. Key elements in transforming the banking system have been the bank certification program, the tightening of prudential regulations, and the gradual increase in minimum capital requirements. At the same time, commercial banks have actively worked to diversify their assets, as well as to make appropriate provisions for doubtful loans and writing off bad loans from their balance sheets. By end-May 1998, the number of banks operating in Georgia totaled 48 banks, of which 43 were certified by the NBG, and had an average capital of about lari 2 million.

26. For 1998, the program aims at: (i) further tightening the banking sector prudential regulations, particularly as regards minimum capital requirements, statutory capital/asset ratios, and limits on insider lending; (ii) timely closure of banks that are deemed insolvent; and (iii) the development of a secondary market for treasury bills as well as the development of additional indirect monetary instruments (e.g., repurchase agreements) to enhance the NBG’s efficiency in conducting monetary policy.

27. Over the medium term, the program aims at developing a sound banking system, increasing financial deepening, and reducing financial margins (i.e., interest rate spreads) through increased banking sector competition, and a phased reduction in banks’ liquidity and reserve requirement coefficients. Greater participation by foreign banks could be instrumental in introducing new electronic banking services, developing the interbank money market, and posing a constant challenge to domestic banks to give their customers better service and better returns on their deposits. Close supervision of banking sector’s prudential regulation standards by the NBG and the development of international accounting standards for banks will be critical in securing a successful reform of this sector and an efficient allocation of financial resources over the medium term.

5. Structural reform

28. Progress with structural reform will be an important element of the medium-term strategy. Key reform areas include pressing ahead with privatization of urban land and state-owned enterprises, energy sector restructuring, basic infrastructure development in the transport and water supply sectors, environmental protection, and judicial and civil service reform. In addition, agricultural land reform will remain a key element of the authorities’ reform strategy. Many of the structural reform areas will be covered within the World Bank lending program to Georgia and their timely implementation will be monitored closely under the Fund-supported program. Maintenance of a liberal trade and payments system will remain a key element in the government’s structural reform program.

29. A comprehensive and legally recognized right to private urban land ownership is an integral part of a country’s transition to a market economy. By securing title to the land under or adjacent to their property, private enterprises could enhance their financial viability and become more attractive to domestic and foreign investors. At the same time, land ownership could create a source of collateral for bank borrowing. Under the third annual ESAF-supported program, the scope of urban land reform will consist of a few major components, including: (i) the adoption of the law on private urban land ownership; (ii) the adoption of a condominium law (currently under preparation with assistance from the World Bank); (iii) the revision of the agricultural land lease law; and, foremost, (iv) the continuation of the land privatization process while the title registration (cadastre) system is being developed.

30. While much progress has been made to date on small- and medium-scale enterprise privatization, future efforts will focus on the larger, more significant, public enterprises. The medium- and large-scale privatization program agreed to by the authorities in the context of SAC II includes the privatization, by mid-1998, of: (i) 109 medium-scale enterprises (out of a remaining total of 140) through cash auctions; and (ii) enterprises accounting for at least 25 percent of the book value of a group of 50 large-scale enterprises in heavy industry through various methods, including investment tenders or leases with buy out options. The Georgian government intends to thoroughly implement these measures, while at the same time promote better enterprise governance and restructuring. To accelerate the privatization and restructuring of the large-scale enterprises, the government intends to use a variety of methods, including, for example, sales to strategic investors through individual tenders and contracting out to the private sector the management of these enterprises.

31. Georgia has the potential to be a net energy (including electricity) exporter and the acceleration of the restructuring process of this sector is critical at this point. Privatization of large electricity distribution and generation companies will be among the main priorities in this process. The government’s objective is to start the privatization of the majority of shares of the electricity distribution and generation companies in the second half of 1998 with a view to complete this process by end-2000. In addition, an Electricity Law has been recently approved by parliament and an independent Electricity Regulatory Commission has been established. Steps have also been taken to increase revenue in the energy sector through both tariff increases and better payment collection. The government intends to adjust further electricity tariffs with a view to reaching full cost-recovery levels by end-1998.

32. Improving Georgia’s dilapidated basic infrastructure in the transport and water supply sectors will be key for sustaining rapid growth over the medium term. Due to limited government resources, this will imply both financial rehabilitation through tariff increases and appropriate regulatory frameworks to promote efficiency and attract private investment to these sectors. Sector restructuring is proceeding in many sub-sectors with a view toward privatization. The authorities are currently preparing a water supply master plan for Tbilisi and efforts are underway to improve management and financial performance of water utilities through metering, reviewing of tariffs, cost-recovery and new institutional arrangements. The Georgian government intends to coordinate with the World Bank, EBRD, EU, and various bilateral donors in setting specific reform targets on infrastructure development.

33. An efficient telecommunications sector, with cost-effective access and wide geographical coverage, is crucial for private-sector growth and for promoting Georgia’s tourism potential. While some progress has been made to attract private capital, mainly in the cellular telephone segment, the fixed network remains a de facto monopoly with a coverage and quality of service that falls far short of Georgia’s development needs. The government intends to undertake and complete a study of the sector by end-1998, which would include an analysis of the sector’s productivity and efficiency, and an assessment of the adequacy of the legal and regulatory framework to stimulate competition and promote private-sector investments.

34. The government intends to improve environmental protection and preserve Georgia’s rich bio-diversity and natural resource base for future generations. Implementation of comprehensive protection measures would contribute to economic growth by preventing loss of productive land to soil erosion; reducing threats to public health; helping to balance private interests with stewardship of common good; and contributing to the development of Georgia’s significant eco-tourism potential. The government intends to effectively implement recently approved environmental legislation and will complete its first National Environmental Action Plan (NEAP) in 1998, to articulate Georgia’s needs for institutional reform and investment priorities. The NEAP will also set the basis for bilateral and multilateral cooperation for the environment, prepare a diverse investment portfolio on coastal zone management, national park development, the forest sector, bio-diversity protection, cultural heritage, and eco-tourism.

35. Judicial reform will also be key to the development of a well-functioning market economy. The thrust of the medium-term program will be to secure an effective implementation of the many laws enacted by parliament during the last two years. This requires a broad range of initiatives to be implemented during 1998-2000, including: (i) institution- and capacity-building measures, covering the development of sufficient capacity to plan, organize, administer, and manage the court system; (ii) human resource development of the court personnel, including the appointment of a new cadre of judges; (iii) rehabilitation of court infrastructure; and (iv) the development of a comprehensive strategy for disseminating legal information to the judicial system and the public at large. Donors, including the World Bank, are preparing a comprehensive program of assistance to the sector.

36. Public sector employment remains high in spite of recent cuts. A lean, well functioning--and better paid--civil service is key to improving productivity and securing good governance, and complements the authorities’ efforts to foster a market economy. Employment cuts in the budgetary sphere will remain a critical element of the fiscal policy package for 1998 and beyond. Moreover, over the medium term, streamlining the civil service further will require a comprehensive reform program, including a census of the public sector, a review of the activities of each ministry, and the development of a well-functioning payroll. In this regard, the Georgian authorities will review with the World Bank the possibilities for broadening to other budgetary areas the census work being done in the transport sector.

37. The government believes that agriculture will remain a key source of economic growth over the coming years. With the adoption in 1996 of laws on private ownership of agricultural land, leasing to private sector of land under state ownership, and land titling and registration, the legal basis for the establishment of an efficient land market is already in place. The medium-term objectives are, inter alia,: (i) to complete the privatization program of agricultural land started in 1992; (ii) to lease to the private sector on long-term and competitive basis remaining state-owned land; (iii) to develop a modern land registration and land cadastre system, including training to surveyors; (iv) to rehabilitate irrigation and drainage systems; (v) to promote research, extension, and training programs for high-value crops to foster agricultural exports; and (vi) to foster the establishment of small rural credit unions. To address the reform of the agricultural sector, the government intends to mobilize the required financing and technical expertise from the World Bank, the EBRD, the EU’s Food Security Program, and bilateral financing from Germany and the United States under various technical assistance projects.

38. Georgia’s trade and exchange systems rank among the most liberal of transition economies, particularly if compared against other ESAF countries. Efforts in 1998 will focus on streamlining the systems in place with a view to preparing for Georgia’s accession to WTO by mid- to end-1999. Also, during 1998, the Georgian government intends to replace the current export ban on scrap metal with a temporary tax and also eliminate the current license fee on log exports.

6. Statistics

39. The government recognizes the urgent need for improving the quality and coverage of economic statistics. The priorities in this area are to continue progress in price statistics; strengthen the compilation of national accounts, balance of payments, and external debt statistics; and improve reporting of public expenditure data along the GFS methodology. In the monetary front, a new chart of accounts for the NBG will be initiated in 1998, as well as preparations for the introduction of international accounting standards for commercial banks. To expedite progress in compiling national accounts and balance of payments statistics and retain qualified personnel, the government will increase resources available to the State Department of Statistics (SDS) during the program period. Also, the compilation of government finance and money and banking statistics will remain with the Ministry of Finance and the NBG, respectively, and these institutions will be fully accountable for the quality improvements of these data.

7. Technical assistance requirements

40. To support the government’s reform strategy, extensive technical assistance will continue to be required from the international community. The technical assistance provided by the IMF will be focused on improving further the operations of the fiscal authority, restructuring the banking sector, and improving the quality of macroeconomic statistics. In the fiscal area, particular attention will be given to strengthening tax and customs administration and the operations of the treasury. In coordination with the World Bank, the Fund will also assist the authorities in improving targeting of social safety nets and reorienting budgetary expenditures toward basic health and education. With regard to financial sector restructuring, the Fund will provide assistance on bank supervision, prudential regulation, and diversification of central bank indirect monetary instruments, including the deepening of the treasury bills market. EU-TACIS will continue to assist the NBG in developing a modern banking payments system. Assistance will also be provided by USAID in the area of institution building of the fiscal authority (e.g., budgetary process, treasury bills market) and the development of capital markets. In the area of statistics, the SDS will continue to receive technical assistance from EUROSTAT, ILO, OECD, UNDP, and other agencies to improve estimates of the informal economy, upgrade the quality of the business register, enhance the effectiveness of the survey process as a tool for balance of payments statistics, and use partner country trade data to improve estimates of Georgia’s trade balance.

41. The World Bank will provide technical assistance in almost all areas of structural reform, alone or in partnership with other IFIs and bilateral donors. Consultations with donors, NGOs, and representatives of the private sector and the civil society will remain a critical element in developing and implementing the World Bank’s assistance strategy.

IV. Poverty assessment and the social safety net

42. Poverty alleviation has been a key consideration in the authorities’ reform program. Since mid-1994 corrective measures have been taken to increase social spending and real wages in the budgetary sphere, improve targeting of social safety net benefits, and simplify the pension system. However, poverty remains widespread mainly as a consequence of the sharp economic decline experienced through 1994. A long period of sustained economic growth will be needed before living standards of the population improve significantly and consumption recovers to pre-independence levels.

43. The persistence of poverty calls for continuous monitoring and improved government administrative capacity to readjust social assistance policies and target benefits, as well as adequate ranking of government’s expenditure priorities. In 1997, expenditure in health and education reached 7.3 percent and 11.3 percent of total government expenditure, respectively. Also, 23 percent of total government expenditure was allocated to social transfers. For 1998, the government is committed under SAC II to increase to 13 percent the share of public expenditure allocated to education, while keeping the share of expenditure in health at 1997 levels. In addition, the government is committed to put in place a number of social policies described in paragraphs 44–47 below.

44. In the health sector, key areas for future reform include strengthening primary health care, particularly in remote areas; examining alternative system financing methods, such as private and community-based health insurance schemes; reducing excess sectoral capacity; and strengthening public health promotion as well as maternal and child health care programs. In the long run, the government’s emphasis will be on improving the quality of health services by upgrading the quality of medical graduate and post-graduate education, strengthening medical research, ensuring adequate financing for essential pharmaceuticals and medical supplies, and upgrading medical equipment and health facilities.

45. In the education sector, the government’s reform strategy--backed by the 1997 Education Law--aims at: (i) raising the level of budgetary and private sector resources allocated to the sector; (ii) using resources more efficiently by reducing excess capacity of public sector buildings and staff and restructuring educational services to match changing demand; (iii) maintaining equity through universal access to free basic education and measures to protect disadvantaged children and minorities; (iv) promoting quality education by establishing new academic standards and curricula requirements, certifying teachers, and introducing new courses and support centers; and (v) decentralizing the education system by shifting responsibility for pre-school, general, and vocational education to the municipal level, and increasing the autonomy of schools and higher education institutions.

46. Further targeting of social benefits is also envisaged over the medium term. In particular, the authorities intend to monitor changes in poverty profiles and composition of household expenditures to adjust accordingly the targeting of social assistance programs including refugees. Periodic poverty monitoring and targeting criteria reviews will be based on analysis of regularly produced national household surveys.

47. The pension system requires special attention as it fails to provide a dependable retirement income. The current lack of linkage between contributions and benefits creates disincentives to contribute to the current pay-as-you-go system and threatens the sustainability of the system over the medium term. Over the medium term, the government intends to introduce voluntary pension schemes to supplement the public scheme. A draft law on private pensions has been prepared with support from the World Bank and will be enacted no later than June 1998. The draft law provides for individual savings pensions and for employment-related pensions, while protecting the rights of participants to receive accumulated pension assets.

V. External Financing Requirements and Debt Management

1. Financing requirements

48. Despite the initial success of the stabilization program, the external outlook remains difficult. Georgia inherited virtually no external liabilities when it regained independence in 1991; however, Georgia’s external debt stood at over US$1 billion at end-1994. Most of this debt was contracted on nonconcessional terms and has since been rescheduled. Repayments of this rescheduled debt will impose a heavy debt burden on Georgia over the medium term, and thus complicate the challenge of rebuilding the economy and restoring external viability. Recently, Georgia has reached a draft agreement on the treatment of Georgia’s debt to the EU, which is estimated at about ECU 131 million as of June 1998, all in arrears. Under this agreement, following the settlement of all obligations, Georgia would receive a new loan of ECU 110 million at 10 years' grace, 15 years' maturity, at an interest rate of ECU Libor plus 0.5 percent, and grants over the next 5 years totaling ECU 55 million.

Financing in 1998

49. The current account deficit is projected to widen modestly next year (Table 3), as continued strong export growth is offset by a large increase in imports, related partly to the rehabilitation of a pipeline from Azerbaijan. In addition, several projects in the energy sector financed by the World Bank and bilateral creditors are expected to pick up, causing related imports to rise. As a result of rising amortization payments and the need to build up gross international reserves (in addition to the current account deficit), the total external financing requirement in 1998 is estimated at US$890 million.

50. Official grants from bilateral donors and the EU are projected to reach US$86 million. Some US$209 million in support from IFIs has been identified for 1998. Under the third annual arrangement of the ESAF, the Fund would provide two disbursements in 1998 totaling some US$76 million, while the World Bank, under SAC III and its project loans, would make loan disbursements of some US$85 million. Disbursements by bilateral creditors are expected to reach US$60 million. Negotiations covering much of the needed new commitments have been initiated. Assuming full disbursement of these commitments, US$79 million of financing remains to be found. Georgia has requested debt relief from bilateral creditors to cover the full amount.

Medium-term outlook

51. Georgia’s medium-term external outlook remains weak and, in addition to efforts to increase domestic savings further, considerable external support will be needed to close projected financing gaps. Debt service to export ratios are projected between 20-25 percent during 1998-2002, when most of the repayment on rescheduled debt falls due. At the same time, the net present value of debt to exports is projected to decline steadily during this period (to some 150 percent by the year 2002) provided a prudent external borrowing policy is pursued. Tentative projections indicate large external financing gaps during this period, averaging about US$120 million annually. After this period, debt service would decline to more manageable levels and financing gaps would be greatly diminished.

2. External debt management

52. Given Georgia’s high external debt burden until 2002, the government will abstain from contracting or guaranteeing new external debt with a maturity of five years or less and will strictly limit the contracting or guaranteeing of longer-term debt on nonconcessional terms. Already in 1997, the central government’s total (i.e., domestic and external) debt-service obligations accounted for nearly one-fourth of its total revenue and it would be imprudent for the state to assume yet additional foreign liabilities.

53. The Ministry of Finance will continue to be responsible for the approval of any new external borrowing contracted or guaranteed by the government. The government and the NBG will continue to assure that the Debt Department of the Ministry of Finance obtains all relevant information on public and publicly guaranteed external obligations from branches of the government and the NBG.

Box 1. Progress in Structural Reform

Privatization. Small-scale privatization is virtually complete and privatization of medium- and large-scale enterprises is advanced, with 959 out of 1160 enterprises privatized as of May 1998.

Land reform. About 60 percent of arable land has been distributed to private farmers. This amount represents virtually all arable land inside Georgian territory, except for arable land in Abkhazia and the Tskinvali region (South Ossetia). In addition, most of the remaining agricultural land has already been ceded through long-term leases, which are transferable and allocated on a competitive basis.

New Tax Code. It was enacted by parliament in June 1997. The new Tax Code defines clearly the tax base, the rights and obligations of all taxpayers, as well as the procedures and penalties for noncompliance with tax laws. It also defines corporate and personal income taxation with a view to align these taxes with standard practices in market economies.

Legal reform. In addition to the Tax Code, the main laws passed by parliament in support of the private sector development include the law on customs tariffs (March 1998), the customs code (November 1997), the law on commercial banks (February 1996), the law on privatization (March 1997), the law on entrepreneurs (October 1994), the civil code (June 1997), the law on monopoly activity and competition (June 1996), the law on bankruptcy (June 1997), and laws on agricultural land ownership, registration and leasing (1997). Draft laws on urban land and private pensions are currently under discussion by parliament.

Employment in budgetary organizations has been reduced from an estimated 620,000 at end-1994 to about 340,000 as estimated by the Ministry of Finance and Ministry of Labor (including a reduction of about 19,000 positions during 1997).

Banking sector reform. The NBG has implemented an action plan of bank restructuring including the privatization of the former state banks, limits on operations of banks in difficulties, and encouraging the merger and consolidation of the minor private banks. Out of 103 commercial banks in existence as of January 1, 1996, licenses were withdrawn from 42 banks in 1996 due to noncompliance with minimum capital and other regulatory requirements; the NBG has initiated legal procedures to liquidate 20 of these banks. 47 were certified as healthy commercial banks as of end-1996. In addition, two of the three former state banks were certified in 1997. Bank supervision by the NBG has had a positive impact on banks’ capitalization and loan provisioning for overdue loans. A number of banks, largely of small-scale, continue to have difficulties at times in meeting bank prudential regulations.

Treasury system. Progress in establishing a treasury system in the ministry of finance has been remarkable. During the first half of 1997, all revenue and expenditure accounts of the central government spending units were consolidated under the Treasury Single Account (TSA) with the NBG; and all special accounts of the TIG and the State Customs Department (SCD) were transferred to the TSA; and all accounts of the special state fund were made subaccounts of the TSA, except for Pension Fund bank accounts in regions outside Tbilisi (affecting less than 15 percent of pensioners).

Energy sector. Progress has been made in developing a sound legal and regulatory framework for this sector. All electricity generation and distribution enterprises have been transformed into joint-stock companies; an independent electricity regulatory committee has been established; and the electricity tariff to households was increased to the level charged to enterprises. However, despite an improvement, collection rates of electricity payments were only approximately 70 percent in 1997. A comprehensive privatization program for the sector has been announced by the government.

Statistics. The law on statistics was enacted by parliament in late 1997. The State Department of Social and Economic Statistics is undergoing restructuring and the compilation of basic macroeconomic data is being accelerated.