## 1. Georgia’s VAT Claims ## Source details **Canonical URL:** [1. Georgia’s VAT Claims](https://www.imf.org/-/media/files/publications/cr/2017/cr17361.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17361.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17361.pdf.json) --- ### Context and macroeconomic backdrop - Executive Board approved a three-year EFF in April 2017 supporting the authorities’ Four Point Reform Plan. - Real GDP growth: 4.7 percent year-on-year (y–o–y) through September 2017. - Inflation: peaked at 7.1 percent in June 2017, declined to 6.2 percent in September 2017; core inflation hovered around 3-4 percent. - External: current account deficit narrowed to 9.4 percent of GDP in 2017H1, from 12.8 percent of GDP in 2016. - Through August 2017: goods exports and tourism receipts rose by almost 30 percent y-o-y, remittances 20 percent, and imports 9 percent. - Net FDI: 9.2 percent of GDP in 2017H1. - Gross international reserves (GIR) increased following a $130 million purchase to $3 billion at end-September 2017. - Public debt: declined to 42 percent of 2017 GDP by end-September 2017. - Program performance: all quantitative program conditions and indicative targets through mid-2017 were met. ### Size and composition of VAT claims (key statistics) - Stock of VAT claims: 4.8 percent of GDP (2016). - Only a small share refunded each year: about 0.5 percent of GDP, or 11 percent of the refundable claims. - Claims older than 3 years: 30 percent of the total stock and cannot be audited (and refunded in cash), but could be compensated with tax liabilities. - Revenue overperformance in 2017: GEL200 million (0.5 percent of GDP); authorities plan to allocate 0.4 percent of GDP to high-priority investment and 0.1 percent of GDP to repayments of VAT claims. ### Causes of the VAT claims buildup (staff findings) - GRS refunds claims only upon taxpayers’ requests; hence outstanding VAT claims do not constitute arrears. - Taxpayers reportedly believe maintaining outstanding balances in tax accounts reduces audit probability. - No statute of limitations on tax claims. - GRS follows overly strict criteria for processing automatic refunds and historically low request rates for refunds. - The stock “mainly reflects low request for refunds and low percentage of claims that are refunded.” ### Action plan and tax administration reforms (measures, timelines, and commitments) - Action plan developed with IMF Technical Assistance (TA); agreed approach: an orderly, gradual, and transparent process to address the backlog (structural benchmark, end-September 2017). - Specific measures and indicative timelines (structural benchmarks / program dates preserved as in source): - Expand the risk-based automated system for VAT refunds (target: expand automated risk-based refund checks by September 2018). - Propose legal changes to implement the action plan (new SB, end-March 2018). - Create a specialized VAT unit focusing on validating VAT claims (new SB, end-June 2018). - Draft 2018 budget envisages GEL200 million in VAT repayments; budget includes a GEL200 million repayment of VAT credits, subject to an adjustor under the program (TMU, ¶14). - Staff proposes an adjuster on the augmented fiscal deficit for any repayment above/below program amounts. - Revenue service (GRS) reorganization and modernization: - MoF committed to restructure the GRS headquarters into a function-based organization to modernize tax administration (new SB, end-February 2018). - Objectives: improve filing compliance and audit capacity; improve the taxpayer register; enhance compliance risk analysis. - Prior steps already taken: - Abolished the alternative audit program. - Written off uncollectable tax liabilities. - Introduced single taxpayer accounts. - Piloted risk-based automated refunds. - Started moving towards full electronic mode (from May 2017) to increase capacity to process refunds. ### Fiscal framework, adjustors, and financing implications - 2017 augmented fiscal deficit projected at 3.6 percent of GDP (in line with original budget); 2018 draft budget projects augmented deficit at 3.0 percent of GDP. - Authorities commit that 75 percent of 2017 revenue overperformance will be used to increase public investment by 0.4 percent of GDP; remaining overperformance used to repay VAT claims. - Staff proposes an adjuster to the augmented fiscal deficit ceiling for VAT repayments above/below program amounts. - Implementation of VAT repayments requires close cooperation with the Treasury and fiscal space management; authorities stand ready to take additional measures if needed, including a modernized property tax or a temporary VAT increase. ### Staff recommendations and risks - Recommended approach: - Adopt an orderly, gradual, and transparent process to address VAT claims. - Expand automated risk-based refunds and improve VAT refund procedures to prevent future buildup. - Enact required legal changes and create a specialized VAT unit. - Apply an adjuster to the augmented fiscal deficit for deviations in VAT repayments from program amounts. - Risks to outlook: staff assessed risks as balanced overall but noted downside risks including vulnerability to regional developments, more inward-oriented policies in partners, tighter global financial conditions, and a stronger U.S. dollar that could deteriorate debt dynamics. _Italic: IMF staff report content (cr17361), "Georgia’s VAT Claims" section._ ### 1. Georgia’s VAT Claims __________________________________________________________________________ 17 ### 1. Georgia’s VAT Claims __________________________________________________________________________ 17 ### Context and Program Background - In April 2017, the Executive Board approved a three-year extended arrangement under the Extended Fund Facility (EFF), supporting the authorities’ Four Point Reform Plan. - Lower growth in major trading partners exposed structural weaknesses, put the external position under stress and weighed negatively on growth. - Following a government reshuffle in November 2017, the authorities reaffirmed their commitment to the program. ### Recent Economic Developments Relevant to VAT and Fiscal Space - Real GDP growth reached 4.7 percent year-on-year (y–o–y) through September 2017. - Inflation: peaked at 7.1 percent in June 2017, declined to 6.2 percent in September 2017; core inflation hovered around 3-4 percent. - External: current account deficit narrowed to 9.4 percent of GDP in 2017H1, from 12.8 percent of GDP in 2016. - Through August 2017: goods exports and tourism receipts rose by almost 30 percent y-o-y, remittances 20 percent, and imports 9 percent. - Net FDI was 9.2 percent of GDP in 2017H1. - Gross international reserves (GIR) were boosted by a $130 million purchase to $3 billion at end-September 2017. - Public debt declined to 42 percent of 2017 GDP by end-September 2017. ### Program Performance and VAT Claims - All quantitative program conditions and indicative targets through mid-2017 were met; end-June PCs on Net International Reserves (NIR), the augmented deficit, the cash deficit and new borrowing by the Partnership Fund (PF) were met by large margins. - Structural benchmarks (SBs) met included: increase of minimum regulatory capital for commercial banks; MoF–NBG memorandum for liquidity forecasting; submission of deposit insurance legislation; introducing liquidity coverage ratio with preferential treatment for GEL deposits; submitting amendments to enhance the resolution framework; and adopting an action plan to address outstanding VAT claims. - The stock of VAT claims is identified as 4.8 percent of GDP (Box 1 referenced in source). - Revenue overperformance in 2017 is estimated at GEL200 million (0.5 percent of GDP); authorities plan to use revenue overperformance for high-priority investment (0.4 percent of GDP) and repayments of VAT claims (0.1 percent of GDP). - The stock of VAT claims "mainly reflects low request for refunds and low percentage of claims that are refunded." ### Action Plan and Tax Administration Reforms for VAT Claims - With IMF Technical Assistance (TA) support, Georgia’s revenue service (GRS) developed an action plan to address outstanding VAT claims (SB, end-September 2017). - Agreed approach: an orderly, gradual, and transparent process to address the backlog. - Specific measures and timelines: - Expand the risk-based automated system for VAT refunds. - Propose legal changes to implement the action plan (new SB, end-March 2018). - Create a specialized VAT unit (new SB, end-June 2018). - Draft 2018 budget envisages GEL200 million in VAT repayments. - Staff proposes an adjuster on the augmented fiscal deficit for any repayment above/below program amounts. - MoF committed to restructure the GRS headquarters into a function-based organization to modernize tax administration (new SB, end-February 2018), with objectives to: - Improve filing compliance and audit capacity. - Improve the taxpayer register. - Enhance compliance risk analysis. - Prior steps already taken: abolished the alternative audit program, written off uncollectable tax liabilities, introduced single taxpayer accounts, and piloted risk-based automated refunds. ### Fiscal Policy and Medium-Term Framework Implications - 2017 augmented fiscal deficit projected at 3.6 percent of GDP (in line with original budget). - Draft 2018 budget projects augmented deficit at 3 percent of GDP; small negative fiscal impulse (0. 3 percent of potential GDP). - Current spending projected to remain constant in real terms except pension reform costs (0.3 percent of GDP). - Net acquisition of nonfinancial assets and budget lending projected at 7.7 percent of GDP (2018 projection in budget tables). - Memo figures (Text Table 2): Nominal GDP (in million of GEL) 37,260 (2017), 40,148 (2018), 43,289 (2019), 46,811 (2020). Public debt: 42.3 (2017), 42.7 (2018), 42.8 (2019), 42.7 (2020) (percent of GDP). - Authorities will issue a supplementary budget by year-end to allocate the revenue overperformance. - Authorities stand ready to take additional measures as needed to meet fiscal targets, including a modernized property tax or a temporary VAT increase. ### Recommendations and Risks Related to VAT Claims Management - Staff urged authorities to address the backlog of VAT claims while continuing to improve revenue administration. - Staff recommended: adopt an orderly, gradual, and transparent process; expand automated risk-based refunds; enact required legal changes; create a specialized VAT unit; and apply an adjuster to the augmented fiscal deficit for repayments deviating from program amounts. - Risks to outlook: balanced. Downside risks include vulnerability to regional developments, more inward-oriented policies in partners, tighter global financial conditions, and a stronger U.S. dollar that could deteriorate debt dynamics. ### Monetary and Exchange Rate Policy Context - The NBG increased the policy rate by 25 basis points in both January and May 2017 to anchor inflation expectations after excise tax hikes. - Monetary stance is broadly neutral after 2017H1 hikes. Conditional on the NBG’s interest rate path (a decline of about 100 basis points (bps) over the next two years), inflation is projected to decrease sharply in early 2018 before gradually converging to the 3 percent target by end-2018. _Italic: IMF staff report content (cr17361), "Georgia’s VAT Claims" section._ ### 17. The authorities are taking further steps to strengthen liquidity management (MEFP, ¶17). ### 17. The authorities are taking further steps to strengthen liquidity management (MEFP, ¶17) ### Liquidity management actions by the NBG - Introduced a one-month monetary instrument and broadened the collateral base for monetary operations. - In August 2017, narrowed the policy rate corridor by 100 bps to strengthen the transmission mechanism and reduce interbank rate volatility. - Auctions add a longer-maturity liquidity provision instrument to the financial sector; auctions have been well coordinated with the NBG to ensure smooth functioning of liquidity provision. ### Exchange rate policy and reserves - The NBG remains committed to exchange rate flexibility, limiting FX intervention to smoothing excessive volatility and/or building up reserves (MEFP, ¶16). - Staff argued that lari appreciation pressures would provide room to build reserves; the NBG reiterated commitment to exchange rate flexibility and to limiting intervention to prevent excessive volatility and cautiously rebuild reserves. - The NBG noted that a higher volume in the FX forward market could help smooth exchange rate seasonality. - Staff urged continued progress on regulating derivatives transactions. - The NBG and staff agreed to revise up the 2017 end-December NIR target by $40 million to further strengthen the reserve position. - Program modification: increase the end-December floor on the NIR target in 2017 by $40 million (to $1,390 million). ### Communication and transparency - The NBG started issuing press releases with elements of forward guidance after every Monetary Policy Committee (MPC) meeting. - A press conference follows every second MPC meeting. - The monetary policy report is published on a fixed and pre-announced schedule, with a meeting with experts held at launch. - The NBG is working on guidelines for monetary policy operations. ### Financial sector policies — larization and dollarization - Larization plan focused on increasing long-term lari funding, promoting lari pricing, and reducing FX-related credit risk. - Loan dollarization declined from 65 percent in December 2016 to 57 percent in August 2017—despite higher interest rates on GEL loans. - Deposit dollarization decreased by 6 percentage points, to 66 percent of total deposits. ### Strengthening banks’ resilience - Capital buffers: - Minimum regulatory capital increased to GEL50 million for commercial banks, to be phased in by 2019 (SB for end-June 2017). - Effective December 1, capital requirements will be anchored on loan-to -value and payment-to-income ratios, with favorable treatment for local currency loans. - In December, the NBG will publish guidelines to implement Pillar II of Basel III and new capital surcharges for domestic systemically important banks (DSIBs) (SB for end-December 2017). - These two measures will increase Tier-I capital by about 30-40 percent for DSIBs. - NBG proposal to extend the phase-in period from three to five years after consultations with banks. - NBG will introduce regulations on leverage ratios in line with Basel III principles (SB end-September 2018). - Liquidity buffers: - From September 2017, banks are subject to new liquidity coverage ratios (LCRs), compliant with Basel III regulations (SB for end-September 2017). - Banks have adjusted balance sheets to comply with LCRs since 2013; reduced deposit concentration and increased non-withdrawable certificates of deposits, especially for non-resident and FX deposits. - Oversight and consumer protection: - Legislation submitted to Parliament will give the NBG oversight powers over credit bureaus (SB for end-December 2017), enabling prudential regulation, fines, consumer protection, and limits on business continuity risks. - NBG created a new financial stability department to provide forward-looking macro-financial analysis, analyze trade-offs between monetary and macroprudential policies, support IFRS9 implementation, and prepare financial stability reports. ### Transparency, accounting, governance, and oversight - NBG introduced disclosure requirements for commercial banks in accordance with Pillar III of the Basel III framework. - Progress toward IFRS9 reporting standards; plans to publish guidelines by March 2018 for calculating credit losses. - Plans to introduce regulations to align banks’ real estate appraisal to International Valuation Standards (SB for end-June 2018) and corporate governance guidelines to Basel principles (SB for end-September 2018). - Authorities submitted amendments to the NBG’s law to allow supervision on a consolidated basis. ### Crisis preparedness and resolution framework - Deposit insurance agency created in July 2017; expected to start collecting contributions in January 2018. - Before end-2018, its board should approve by-laws guiding operational aspects, including contributions and sanctions, internal controls, and risk management. - Agency to prepare its medium-term strategy by June 2018. - Parliament received amendments to the NBG law to clarify the definition of a “problem bank” and to empower resolution tools, including enhancing temporary administration (SB for end-September 2017). - NBG is working with D-SIBs to finalize recovery and resolution plans. - Authorities requested IMF TA to improve the legal framework for bank resolution to clearly state the NBG’s resolution authority, including right to override shareholders’ interests and to allow resolution tools and powers. - Authorities and staff agreed to identify legal amendments to design an effective emergency liquidity assistance (ELA) framework by mid-2018, including: - Removing unsecured lending by the NBG, - Introducing penalty rates for ELA, - Clarifying the role of the Ministry of Finance in providing public guarantees during financial stress. - An upcoming TA mission will coordinate an action plan. ### Supervision of non-banking sector and consumer protection - In June, authorities submitted legislative changes for the NBG to regulate and supervise microfinance institutions; staff recommended light-touch regulation for non-deposit taking institutions. - NBG has mandate to protect users of financial services; consumer protection rules apply to all financial institutions, including non-deposit takers. - NBG sets disclosure requirements and caps fees for early repayments; the Civil Code establishes maximum effective interest rates and maximum penalties on all loans. ### Correspondent banking relationships (CBRs) — risks and monitoring - Some international banks have interrupted direct relationships with small banks due to additional requirements on CBRs. - Affected banks retain access to the international payment system through the two largest Georgian banks or, for subsidiaries, through parent banks—raising concentration risks. - While not an immediate threat, disruptions in CBRs would negatively affect financial intermediation. - Authorities should continue to monitor CBRs, strengthen compliance with AML requirements, and effectively communicate efforts to address AML concerns. *Source: cr17361 - 17. The authorities are taking further steps to strengthen liquidity management (MEFP, ¶17).* ### 41. Medium-term fiscal commitments should be completed as currently envisaged, and ### Medium-term fiscal commitments should be completed as currently envisaged, and require progressing with institutional fiscal reforms ### Fiscal policy and institutions - Staff welcomes the authorities’ commitment to fiscal consolidation while accelerating high-priority infrastructure investment. - A stronger framework for managing public investment will help improve efficiency in the use of public resources. - The authorities’ commitment to comprehensively assess and monitor fiscal risks should be clearly reflected in the 2018 Fiscal Risk Statement. - Efforts to improve budgetary processes and fiscal reporting that will improve fiscal transparency and accountability include: - improving the coverage and measurement of fiscal aggregates to reflect activities of LEPLs and SOEs; - elaborating on compliance with fiscal rules; - strengthening macroeconomic and fiscal forecasting. ### Monetary policy and financial stability - Monetary policy remains rightly focused on price stability, supported by the flexible exchange rate and efforts to strengthen the transmission mechanism. - The NBG’s monetary policy stance is appropriate, but the authorities need to remain vigilant on monetary and financial developments, including related to credit growth. - The inflation targeting framework, combined with the floating exchange rate regime, has served Georgia well. - Foreign exchange intervention should remain limited to smoothing excessive exchange rate volatility and building reserves. - The NBG’s steps to strengthen liquidity management, de-dollarize the economy, and improve communication will help strengthen the monetary framework. - Proposed legal amendments would: - expand the role of the central bank in regulating and supervising non-banks and credit bureaus; - enhance the bank resolution framework; - supervise banks on a consolidated basis. - The authorities’ efforts to identify legal amendments to adopt an effective ELA framework are commendable. ### Structural reforms and growth - Continued efforts to advance structural reforms are key to achieving higher and more inclusive growth. - Reform priorities and expected effects: - Upgrading infrastructure and strengthening trade integration will boost growth prospects. - The new insolvency law for non-financial corporations and the Business House will help improve the business environment. - The pension reform will increase the availability of domestic savings to support investment, as long as contributions are enforced. - Improved capital market infrastructure, by facilitating mobilization of funds, will support capital accumulation. - Advancing on education reform is critical to further support growth. ### Program review and policy adjustments - Staff supports the authorities’ request for completion of the First Review under the Extended Fund Facility and the modification of three quantitative performance criteria. - Staff supports: - eliminating the reference to implicit guarantees in the ceiling on new public guarantees; - expressing the ceiling on the PF’s new borrowing in net terms; - modifying the 2017 end-December NIR performance criterion. - Strong program implementation in macroeconomic policies and structural reforms provides confidence that the program will meet its objectives. ### Box 1 — Georgia’s VAT Claims: findings and actions - Key facts: - VAT claims amounted to 4.8 percent of GDP in 2016. - Only a small share is refunded each year: about 0.5 percent of GDP, or 11 percent of the refundable claims. - Claims older than 3 years constitute 30 percent of the total stock and cannot be audited (and refunded in cash), but could be compensated with tax liabilities. - Causes of the buildup in VAT claims: - GRS refunds claims only upon taxpayers’ requests; hence the outstanding VAT claims do not constitute arrears. - Taxpayers reportedly believe that maintaining outstanding balances in their tax accounts with the GRS makes them less likely to be audited. - There is no statute of limitations on tax claims. - The GRS follows overly strict criteria for processing automatic refunds. - Actions taken and planned: - Starting in May 2017, the GRS has embarked on a program to move towards full electronic mode and increase the ability to effectively process tax refunds. - With IMF support, the GRS is improving VAT refund processing and building capacity for risk-based tax compliance. - An action plan has been developed to address the stock of VAT claims, including repayment of credits that have been audited and validated, and improving risk-based review and VAT targeted audit, preferably via a specialized VAT audit. - Implementation requires close cooperation with the Treasury. - Reducing the existing credit stock should be accompanied by a change in the VAT refund procedures to prevent further build up. *International Monetary Fund — cr17361* ### Box 2. Georgia’s Trade with the European Union (EU) ### Box 2. Georgia’s Trade with the European Union (EU) ### Trade developments and composition - Georgia fully opened its market to the European Union after signing the Deep and Comprehensive Free Trade Area (DCFTA) in June 2014. - Exports to the EU increased from 21 percent of total exports in 2013 to 27 percent in 2016. - Georgia exports a limited set of products to the EU, including minerals and metals, and chemical and agricultural products. - Imports from the EU increased from 28 percent of total imports in 2013 to 31 percent in 2016. ### Market access and regional integration milestones - Georgia’s admission to the Pan-Euro-Mediterranean Convention on Rules of Origin in September 2016 was a milestone in expanding market access. - The agreement allows Georgia to import raw materials from the member countries and re-export to the EU with “made in Georgia” labels. - Georgia has used the DCFTA as a platform to conclude other FTAs, including with EFTA, China, and Hong Kong SAR (final stage). ### Standards, regulatory alignment, and remaining constraints - Further efforts are needed—especially in reducing non-tariff barriers (NTBs) and standard compliance—to expand export potential. - Food safety: - To date, only two animal-related products—wool and honey—can be exported to the EU. - Harmonizing food safety standards requires adopting 272 EU directives and regulations by 2026. - Industrial product safety: - About 7,000 (out of 25,000) standards are now in compliance with international and the EU standards. ### Trade promotion, procedural reforms, and policy priorities - In addition to reducing trade barriers, trade promotion could be strengthened through streamlining procedures and capacity development. - Key areas for reform and promotion include: - Simplifying customs service. - Providing mutual access to public procurement markets. - Modernizing and strengthening intellectual property rights protection. - Promoting competition. - Progress in all areas has been made in line with the EU commitments; nonetheless, further legal convergence is needed to further enhance trade relations. *International Monetary Fund.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Overview and methodology - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - Relative likelihood definitions (staff’s subjective assessment): - "low" = probability below 10 percent - "medium" = probability between 10 and 30 percent - "high" = probability between 30 and 50 percent - Time horizons: - "Short term" = could materialize within 1 year - "Medium term" = could materialize within 3 years - Non-mutually exclusive risks may interact and materialize jointly. - The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. ### Major global shocks (staff assessments, likelihood, and expected impacts) - Protectionism - Staff assessment: High - Relative Likelihood/Time Horizon: High / Short Term - Expected impact: - Could jeopardize Georgia’s plans to become a transit hub. - Could reduce Georgia’s exports and—possibly—capital inflows. - Economic growth could be lower and lower external financing would put pressure on the lari. - Financial conditions (Tighter global financial conditions; European bank distress; Reduced correspondent banking services "de-risking") - Staff assessment: Medium (overall), with specific entries: - Tighter global financial conditions - Likelihood: Medium / Short Term - Expected impact: - Fed normalization and tapering by ECB increase global rates and term premia, strengthen the U.S. dollar and the euro vis-à-vis the other currencies, and correct market valuations. - Adjustments could be disruptive if there are policy surprises. - Higher debt service and refinancing risks could stress leveraged firms, households, and vulnerable sovereigns, including through capital account pressures in some cases. - Higher lari volatility and depreciating pressures could generate negative balance-sheet effects and negatively affect financial stability. - European bank distress - Likelihood: Medium / Short Term - Expected impact: - Strained bank balance sheets amid a weak profitability outlook could lead to financial distress in one or more major banks with possible knock-on effects on the broader financial sector and for sovereign yields in vulnerable economies. - Reduced financial services by correspondent banks ("de-risking") - Likelihood: High / Short to Medium Term - Expected impact: - Significant curtailment of cross-border financial services in emerging and developing economies. - De-risking would likely affect smaller banks more forcefully, likely resulting in further concentration in the financial sector. - Concentration of CBRs through the two largest banks after international banks curtailed relationships with some smaller domestic banks. Pressures on CBRs of large Georgian banks would negatively affect financial intermediation. - Weaker than expected global growth - Staff assessment: Medium - Relative Likelihood/Time Horizon: Medium / Short to Medium Term (with some entries Medium / Short Term and High / Medium Term) - Scenarios and expected impacts: - Significant China slowdown and its spillovers - Likelihood: Medium / Short to Medium Term - Expected impact: - Efforts to rein in financial sector risks expose vulnerabilities of indebted entities and reduce near-term growth. - Over the medium term, overly ambitious growth targets lead to unsustainable policies, reducing fiscal space, and further increasing financial imbalances. - A sharp adjustment would entail weak domestic demand, lower commodity prices, roiled global financial markets, and reduced global growth. - Significant slowdown in other large EMs/frontier economies - Likelihood: Medium / Short Term - Expected impact: - Resource misallocation and policy missteps exacerbate the impact of declining productivity and potential growth. - Turning of the domestic credit cycle generates disorderly household and corporate deleveraging, with potential spillbacks to advanced economies. - Structurally weak growth in key advanced economies (U.S., the Euro Area, and Japan) - Likelihood: High / Medium Term - Expected impact: - Low productivity growth, a failure to fully address crisis legacies and undertake structural reforms, and persistently low inflation undermine medium-term growth in advanced economies. - Aggregate expected impact on Georgia: - Worsening regional growth prospects will lower remittances and exports hampering Georgia's growth (Staff assessment: High). ### Georgia-specific shocks and vulnerabilities - Cyber-attacks - Staff assessment: Medium - Relative Likelihood/Time Horizon: Medium / Short to Medium Term - Expected impact: - Cyber-attacks on interconnected financial systems and broader private and public institutions that trigger systemic financial instability or widely disrupt socio-economic activities. - Georgia has adopted cybersecurity legislation, but its effectiveness could prove challenging depending on the nature of the attack. - Financial risks - Staff assessment: Medium - Expected impact: - Reduced financial buffers, especially for unhedged borrowers, will limit the capacity to absorb further exchange rate depreciation. - Risks could stem also from the non-banking sector. - Fiscal risks - Staff assessment: High - Expected impact: - Materialization of contingent liabilities, together with possible off-balance sheet spending, could deteriorate public debt dynamics. - Political risks - Staff assessment: Medium - Expected impact: - Political backlash or/and reform fatigue could undermine structural reforms. - Retreat from cross-border integration (protectionism / economic isolationism) - Staff assessment: Medium - Relative Likelihood/Time Horizon: Medium / Short to Medium Term - Expected impact: - A fraying consensus about the benefits of globalization leads to protectionism and economic isolationism, resulting in reduced global and regional policy collaboration with negative consequences for trade, capital and labor flows, sentiment, and growth. ### Key contextual points from staff commentary embedded in the RAM - Higher lari volatility and depreciating pressures could generate negative balance-sheet effects and negatively affect financial stability. - De-risking would likely affect smaller banks more forcefully, increasing concentration in the financial sector and pressuring correspondent banking relationships (CBRs). - Weaker demand in other emerging economies and potential spillovers to Georgia's main trading partners would risk the envisaged economic recovery. Lower economic growth could reduce buy-in on structural reforms for economic diversification and more inclusive growth. *Source: cr17361 - Annex I. Risk Assessment Matrix* ### 5. The attached MEFP, which updates and extends the previous one, will enable us to ### cr17361 - 5. The attached MEFP, which updates and extends the previous one, will enable us to ### Memorandum purpose and commitments - The attached MEFP updates and extends the previous MEFP to achieve the objectives of the economic program. - Continuous monitoring in consultation with the IMF; readiness to take further measures if needed. - Commit to consult with the IMF in advance of any revisions to policies included in this Letter of Intent according to IMF consultation policies. - Provide the IMF with information requested for monitoring program implementation. - Authorize the IMF to publish this Letter of Intent and its attachments (including the MEFP and TMU) and the related Staff Report; these documents will also be posted on official Georgian government websites after IMF Board approval. ### Macroeconomic Framework — recent performance and outlook - Real GDP increased by 4.7 percent year-on-year (y-o-y) through September 2017, higher than the 3.5 percent expected for the whole year under the program. - Goods exports, tourism receipts, and remittances (in lari terms) have increased almost 30 percent y-o-y. - Inflation peaked in June at 7.1 percent y-o-y and has started to come down, remaining within the program’s consultation bands. - FX reserves have remained well above the program ceiling. - Larization policy has led to a decline in both deposit and loan dollarization. - Moody’s upgraded Georgia’s sovereign rating. - Georgia ranked among the top 10 performers in the 2018 Doing Business Report, with improvements in getting electricity, protecting minority shareholders and resolving insolvency. Projections and outlook - Expect economic growth to stay robust in 2018; believe that growth of over 4.5 percent is achievable in 2018. - Program uses a cautious growth assumption of 4.2 percent for 2018. - Growth projected to gradually accelerate over the medium term due to higher investment, structural reforms, and an expected improved external environment. - Stronger-than-expected activity has resulted in higher government revenues, enabling higher infrastructure spending and faster rebuilding of fiscal buffers. - Robust exports of goods and services and remittances will improve the current account deficit in 2017 by 2.4 percentage points of GDP compared to 2016. - Current account deficit projected at 10.4 percent of GDP in 2017 and 10.6 percent of GDP in 2018. - External financing will continue to rely mostly on FDI. International reserves will continue to increase over the medium term. Risks and policy stance - Upside risks: stronger domestic demand and a more supportive external environment. - Downside risks: inward-looking policies in some countries and weaker-than-expected growth in advanced and emerging economies. - Policy buffers: flexible exchange rate and a well-capitalized and liquid banking system. - IMF arrangement viewed as an additional anchor against negative shocks. ### Economic Policies — Fiscal Policy (A) Fiscal consolidation and capital spending - Target: reduce the augmented cash deficit of the general government (TMU definition) to 2.8 percent of GDP by 2020. - Aim to reduce primary current spending (excluding budget lending activities) from almost 25 percent of GDP in 2016 to 21.1 percent of GDP by 2020. - Commitment: use revenue over-performance or additional savings in current spending toward high priority growth-enhancing capital spending; under-execution in investment will be diverted toward a lower deficit. 2017 fiscal stance and allocation of over-performance - 2017 augmented deficit projected at GEL1,328 million or 3.6 percent of GDP, below the program ceiling (GEL1,335 million, performance criterion). - Through end-June 2017, augmented deficit ceiling met by a wide margin, mostly due to higher revenues. - Commit that 75 percent of the 2017 revenue overperformance will be used to increase public investment by 0.4 percent of GDP; remaining overperformance used to repay VAT claims. - Target to keep primary current expenses below GEL8,685 million (indicative target), while increasing net acquisition of nonfinancial assets and net lending to GEL2,908 million (7.8 percent of GDP). 2018 budget and contingent measures - 2018 budget projects the augmented fiscal deficit at GEL1,206 million (3.0 percent of GDP) (structural benchmark, December 2017). - Maintain primary current spending constant in real terms; social security expenses expected to increase above inflation due to pension reform. - Budget includes a GEL200 million repayment of VAT credits, subject to an adjustor under the program (TMU, ¶14). - Stand ready to adopt contingency measures to bring augmented deficit below the 2018 program ceiling. Fiscal risk containment — binding rules and limits - Commitments and performance criteria: - Will not accumulate any general government’s external debt payment arrears outside those under negotiation (performance criterion). - Will not accumulate net domestic expenditure arrears of the general government (indicative target). - Will not issue new public guarantees (performance criterion), or comfort letters. - Request elimination of reference to implicit guarantees in the ceiling on new public debt, noting only the MoF is authorized to issue public guarantees and these are explicit. - Partnership Fund (PF): - PF will pursue only commercial objectives, will not run a cash deficit (performance criterion), or issue guarantees. - Request ceiling on PF’s new borrowing be expressed in net rather than gross terms. - New net borrowing of the Partnership Fund limited to $20 million in 2017 (performance criterion). - Commit to maintain a non-negative cash position at the Partnership Fund by end-June 2018 and limit its net borrowing to $20 million by June 2018 (cumulative from the beginning of the EFF program, performance criterion). - PPPs and PPAs: - Refrain from initiating any Public-Private Partnerships (PPPs), including Power-Purchasing Agreements (PPAs), until PPP law and institutional framework operationalized. - Partial PPAs currently under negotiation permitted to proceed (prior to new PPP law) only under specified constraints: - Guaranteed purchase period shall not be more than 8 months in each year. - Guaranteed purchase tariff shall not be more than US 6c kWh. - Cumulative installed capacity of these projects under negotiation will not exceed MW500. - Two PPAs under negotiation (Namakhavani HPP Cascade Project and Koromkheti Hydro Project) — cumulative capacity MW600 — outside the above terms; allowed to proceed only after thorough fiscal risk analysis and conditions: - Government will not sign these projects before conducting a thorough fiscal risk analysis for the projects and comprehensively for all fiscal risks, in consultation with the energy expert of the World Bank and the IMF. - Risk assessment will update analysis of gross exposure of all signed PPA projects and these two projects; analyze net risk exposure with different demand, price and exchange rate assumptions; scenario analysis defined in coordination with the IMF. - Risk assessment will describe and quantify other risk-sharing contractual obligations (including termination risk or construction risk). Export Credit Agency (ECA) fiscal risk limits - Will coordinate with the IMF on preparation of the charter creating the ECA to ensure: - ECA will only provide guarantees and insurances related to export operations. - ECA will be subject to insurance regulation and supervision. - ECA will not receive explicit government guarantees. - ECA capital: $20-million equity injection by the Partnership Fund distributed over 3 years. - A revolving fund for potential losses totaling GEL50 million will come from the state budget. Adjustors and spending flexibility - Request increase in adjustor related to foreign-financed project loan disbursements for the augmented cash deficit from $30 million to $60 million (0.4 percent of GDP, TMU, ¶13). - Continue rationalizing current spending by: - Containing the wage bill and administrative expenses. - Improving targeting of subsidies and social assistance programs. - Reducing transfers and privatizing loss-making SOEs. - Improving performance-based budgeting. - Maintain existing social safety net and increase basic public pension. - Do not plan to extend the dividend distribution model to financial institutions and insurance companies in 2019, limiting potential revenue loss (up to 0.5 percent of GDP). - Commit to identify additional contingency measures, if needed, in coordination with the IMF, including revenue-side measures within the fiscal framework. ### Economic Policies — Structural Fiscal Policies (B) Revenue administration reform (three-year program) - Objective: strengthen revenue administration to secure full and equitable compliance and improve taxpayer services, following the 2016 Tax Administration Diagnostic Assessment. - Key elements and initial steps: - Organizational structure: restructure the GRS headquarters into a function-based organization (new structural benchmark, February 2018). Core functional groupings include taxpayer service, returns filing and payment, audit, appeals, arrears management, policy and interpretations, and compliance management; strong HQ department to provide operational policy and consistency. - Improve filing compliance: establish key performance indicators (in consultation with the IMF) to improve filing compliance and enable early and effective action where returns are overdue; improve the taxpayer register; submit legal amendments so that an unfiled declaration is no longer deemed to be a nil declaration where the GRS requires a declaration; set up an organizational unit to deal with filing default and late filing. - VAT refunds: expand a risk-based automated system to check VAT refund claims by September 2018, replacing the manual system. Approved action plan (with IMF TA) to address outstanding VAT claims (structural benchmark, September 2017). Create a steering committee with MoF, GRS, and GTS by end-2017; steering committee to propose necessary legal amendments or ministerial decrees to facilitate the action plan (new structural benchmark, March 2018). Create a new specialized VAT unit focusing on validating VAT claims (new structural benchmark, June 2018). - Tax audits: increase audit capacity, efficiency, and impact using risk-based audits, improved compliance risk analysis, better data management, audit case management system to enhance audit timeliness and productivity, and systematic approach to terminate non-productive audits. Civil service reform - New Civil Service Law introduced grade structures. - Submitted to Parliament a civil service remuneration law (structural benchmark, December 2017) to set salary ceilings for different civil service grades (compensation grid) and consolidate bonuses and supplements into base salary; ensure wage bill consistency with the projected medium-term wage bill under the program. Fiscal risk management — SOEs, PPPs, and PIMF improvements - Commit to adopt a new PPP law and associated regulations with assistance from the WB, ADB, EBRD, and IMF. Submitted the PPP Law to Parliament (structural benchmark, December 2017). Law to include: - Wide institutional and sectoral coverage of PPPs (including PPAs) and clear definition focused on optimal risk sharing. - Strong integration of PPP projects with overall investment strategy and budget cycle. - Strong role for MoF in approval process using cost-benefit and VfM analysis, checking budget affordability, and assessing fiscal risks (Fiscal Risk Management Unit). - Transparent and competitive procurement processes and transparent reporting, accounting, and auditing of all PPP arrangements, including a ceiling on government exposure from such partnerships. - Call for establishment of a ceiling on PPP and PPA obligations to be included in the budget law; establishment of a PPP unit at the Prime Minister office to provide technical support. - Commitment to consult with the IMF on secondary legislation planned by March 2018. - Fiscal Risk Statement (FRS) widening in the 2018 budget (structural benchmark, December 2017): - Report more comprehensively all existing PPP-associated firm and contingent liabilities. - Include quantitative reporting of quasi-fiscal relationships. - Expand analysis of SOEs’ contingent liabilities, including: - Expand historical analysis of SOEs’ contingent liabilities by up to five years. - Describe historical trends of the size of the SOE sector relative to the economy. - Provide conclusive analysis of factors driving SOEs’ aggregate and individual financial performance and position. - Identify and evaluate quasi-fiscal relationships. - Develop methodology for sensitivity analysis and stress tests examining impact of changes in key variables on SOE financial performance and fiscal risks. - Improve the Public Investment Management Framework (PIMF): - Strengthen MoF’s role in public investment management by creating a dedicated public investment unit at the MoF to centralize project information. - Unit will evaluate projects based on cost/benefit and other analyses to establish a single project pipeline, support project evaluation, prioritize investments, identify financing, and integrate projects within the multi-annual budget process. - PIMF will cover PPP-type projects to ensure they are assessed alongside traditionally-procured projects. - Requested IMF TA to conduct a Public Investment Management Assessment to help strengthen the PIMF. *Attachment I. Memorandum of Economic and Financial Policies (MEFP), as provided in the source content.* ### 14. We believe that accurate and transparent public financial management is a cornerstone ### 14. We believe that accurate and transparent public financial management is a cornerstone ### Public financial management and fiscal framework - Committed to improving fiscal rule to safeguard fiscal sustainability; initiated a review of the fiscal framework, including fiscal rules, with IMF support to ensure support for medium-term fiscal objectives while granting flexibility over the economic cycle. - Will explore enhancements to the fiscal framework in consultation with the IMF, including improving corrective mechanisms, escape clauses, accountability and transparency. - Within the review of the fiscal rule, will upgrade presentation of public finances from GFSM 2001 to GFSM 2014 classification. - Issue guidelines for new budget lending operations, requiring reasonable expectation of repayment (structural benchmark, December 2017). - Prepare the 2019 State Budget applying the GFS classification of equity injections and on-lending, per the reasonable commercial return test; if the test is not met, these will be treated as subsidies or transfers. - Commit to comply with international accounting standards: produce an annual consolidated general government sector financial report on an International Public Sector Accounting Standards (IPSAS) basis starting in 2021. - Improve the quality of fiscal reports: - Explain revisions to medium-term budget estimates in the annual budget document. - Include LEPLs’ revenues and expenditures in budget documentation starting in the 2018 state budget. - Assess existing LEPLs by end-2018 and create rules for classifying them as general government units or non-general government units, based on international statistical standards. - Improve treasury account management: MoF has started auctioning its deposits to the banking sector. *Source: cr17361 - 14. We believe that accurate and transparent public financial management is a cornerstone* ### Monetary policy - Committed to inflation targeting (IT) framework to maintain price stability. - Lowered inflation target to 4 percent in 2017 and 3 percent from 2018 onwards. - Acknowledge inflation was above the target during 2017 due to a one-off price increase from higher excises and import prices; project inflation to return to the target in 2018. - Continue to abide by the Inflation Consultation Clause (ICC) under the program; monitor inflation via dual consultation bands set symmetrically around the central point for headline CPI: - Inner consultation band: ± 2 percent (NBG will consult with IMF staff if breached). - Outer consultation band: ± 3 percent (consultation with the IMF Board triggered if breached). - Maintain a flexible exchange rate regime; limit FX interventions to smoothing excessive volatility. - Build up international reserves throughout the program; monitored by a floor on net international reserves (performance criterion). - Increased end-December 2017 NIR performance criterion by $40 million to $1,390 million. ### Monetary transmission, liquidity, and communication - Strengthen monetary policy transmission mechanism; progress on larization plan. - Improved lari liquidity facilities and monetary instruments by introducing a one-month liquidity instrument and broadening eligible collateral pool. - Interbank market functioning: interbank interest rates close to the policy rate; interest rate corridor narrowed since August 2017. - Signed memorandum of understanding on information sharing for liquidity forecasting between MoF and NBG (structural benchmark, June 2017). - Submit to Parliament legal amendments to allow derivatives and repo transactions, including netting and close-out netting provisions by March-2018. - Plan to strengthen lari liquidity management by extending open market operations to outright sales and purchases of treasury securities by mid-2018. - Improve monetary policy communication: - Continue publishing quarterly monetary policy reports on a fixed pre-announced schedule with associated meetings with experts. - Every second monetary-policy meeting to be followed by a press conference. - Introduce forward guidance and issue a manual for monetary policy operations with IMF TA. ### Financial sector policy — objectives and broad measures - Policies aim to strengthen financial sector stability to help the banking sector cope with shocks and improve financial intermediation by: - Further strengthening supervisory and regulatory framework. - Improving safety nets and the bank resolution framework. - Incentivizing use of domestic currency to reduce dollarization. - Developing capital markets and implementing pension reform. ### Strengthening regulation and supervision (accomplishments and planned actions) - Introduced liquidity coverage ratios (LCRs) for commercial banks with preferential treatment for GEL deposits (structural benchmark, September 2017). - Introduced limits on loan-to-value and debt-service capacity ratios, with preferential treatment for local currency. - Submitted legal amendments to give NBG oversight power for credit information bureaus (structural benchmark, December 2017). - Adopted regulations to increase minimum regulatory capital for commercial banks to GEL 50 million to be phased in by 2019 (structural benchmark, June 2017). - Introduced Basel’s Pillar 3 disclosure requirements to promote market discipline through regulatory disclosures. - Submitted amendments to the NBG Organic Law to allow NBG supervision of banking groups (enabling consolidated requirements on capital, liquidity, leverage, governance, disclosure, accounting, and reporting). - NBG and State Insurance Supervision Agency developing supervision framework for financial conglomerates. - Established a financial stability analysis department at NBG with responsibilities including macro-financial analyses, macro-stress testing, publication of a forthcoming financial stability report, and support for IFRS9 implementation. - With IMF TA support, started calibrating a macro-financial model tailored to the Georgian economy. - Progress toward IFRS reporting: - By March 2018 plan to introduce impairment guidelines for IFRS 9 credit loss calculations. - Prepare a roadmap to transition to IFRS regulatory reporting by June 2018. - Ultimate aim to transfer regulatory reporting in commercial banks to IFRS framework through EU FINREP/COREP forms. ### Continued regulatory enhancements and timelines - In line with FSAP recommendations, issue regulations to phase-in additional capital requirements for systematically important banks (structural benchmark, December 2017). - Overhauled overall capital adequacy framework, including Pillar II; consider extending the phase-in period from 2020 to 2022 to facilitate smoother transition. - Work on General Risk Assessment Program (GRAPE) guidelines to increase transparency of Pillar 2 capital requirements, expected publication by December 2017. - Introduce regulations on: - Leverage ratios based on Basel Principles and relevant EU regulations (new structural benchmark, September 2018). - Credit information bureaus (set requirements and limits, issue guidelines and apply fines, protect consumers, limit business-continuity risks) following parliamentary approval of NBG powers. - Bank real estate appraisal of collateral in line with International Valuation Standards (new structural benchmark, June 2018). - Corporate governance guidelines in line with Basel Principles (new structural benchmark, September 2018). - With IMF TA, enhance regulation, supervision and oversight of non-banks: - Bring all non-bank lending institutions under prudential regulation or non-prudential oversight depending on funding source. - Submitted legislative amendments to empower NBG to supervise and regulate micro-financial institutions (MFIs) and to oversee currently unregulated lenders; expect parliamentary approval by end of 2017. - Regulations regarding MFIs and other lenders to be introduced by end-June 2018 and end-September 2018, respectively. - Improved consumer protection: created consumer protection and financial literacy department within NBG; amended regulations on product disclosure and effective interest rates; extended regulatory perimeter to micro finance institutions and credit unions. ### Financial safety nets and resolution framework - Submitted amendments to NBG Organic Law to give NBG authority to resolve a bank through temporary administration at an early stage (structural benchmark, September 2017). - With World Bank and ADB support, submitted to Parliament a law to introduce deposit insurance (structural benchmark, June 2017). - Deposit Insurance Agency established in July 2017 and expected to become operational on January 1, 2018. - Approve a medium-term strategy for the deposit insurance system by June 2018. - Request largest banks to strengthen recovery plans based on Financial Stability Board’s principles; strengthen bank resolution framework in line with international best practices, including clarifying NBG’s resolution authority and powers over bridge banks and shareholders’ economic interests. - Strengthen capacity to act as lender of last resort by identifying legal amendments to remove possibility to give unsecured lending, mandate a penalty rate for emergency liquidity assistance (ELA), and clarify role of MoF for an effective ELA framework. ### Larization and capital markets - Implement larization strategy to reduce FX risks and improve monetary transmission: - Comprehensive plan to increase long-term lari funding, reduce FX credit risks, and promote pricing in lari. - Mortgage conversion program resulted in conversion of mortgages amounting to $80 million. - Since July 2017, prices must be displayed in lari. - Capital market development to support larization and reduce external vulnerabilities: - Upgrade exchange infrastructure to a single settlement system for all Georgian securities with two participating CSDs (one for commercial bonds and shares, another for government bonds); enable delivery-versus-payments settlements and full integration with Georgian Stock Exchange and OTC trading platforms; expect system to be fully operational by the summer of 2018. - Submitted to Parliament amendments to the tax code (in consultation with IMF TA) to ensure taxation of financial instruments including securities interest, dividend and capital gains, REPOs, securities lending and derivatives. - Publish a multi-year plan of government bond issuance to develop benchmarks along the yield curve (structural benchmark, December 2017), in addition to current quarterly calendar. - Submit law establishing investment funds to Parliament in early 2018. - Help develop a primary dealer institute and introduce mandatory third-party vehicle insurance to develop the insurance sector. - Continue to align legal framework with EU directives, including on securities holding, insolvency and securities market. ### Structural reforms for growth and inclusion - Implement comprehensive structural reform agenda supported by partners (WB, ADB, EBRD, EIB, European Commission) to: - Scale-up infrastructure spending. - Improve education and vocational training. - Improve business environment, foreign trade relations, and land reform. - Boost long-term growth, diversify the economy, create jobs and reduce poverty while protecting the most vulnerable with targeted social assistance and health care. - Infrastructure and spatial planning: - Aim to finalize East-West highway and South-North corridor by 2020. - Additional projects including ports, airports, and railways to transform Georgia into a transport and logistics hub. - Developing radial roads to better connect regions. - Improved public procurement to enhance public investment efficiency and transparency. - Government support for tourism development (including water and electricity infrastructure) to turn Georgia into a four-season touristic destination. - Job creation and education reform: - Education reform (including vocational training) to improve job creation, productivity and wages. - Commit to setting curriculum standards, a new teacher policy framework, introducing vocational training and adult learning. - Encourage employer participation in curriculum design and support job seekers with guidance, preparation and retraining. - Pension reform and savings: - Introduce a funded pension pillar in 2018; submit a pension law establishing a Pilar II pension system (structural benchmark, December 2017). - Create an independent pension agency (new structural benchmark, June 2018). - Develop a private pension savings system (Pillar 3) in 2018. - Basic public pension currently amounts to GEL180 per month; committed to increase basic monthly pension to GEL200 and GEL220 per month in 2019 and 2020, respectively; further increases will follow indexation rule in pension reform. - Business environment improvements: - Improved tax system, tax dispute resolution mechanism and taxation environment to promote savings and investments. - Bank accounts of taxpayers no longer garnished without a court ruling; tax audit timeframe is regulated. - Establish a Business House by 2019 to provide public services to enterprises under a one-stop shop. - Plan to introduce IFRS for corporations and submit a new insolvency law to Parliament to support restructuring for viable non-financial corporations. - Apply regulatory impact assessments on businesses to analyze impacts of major policy decisions. - Land registration and rural development: - Simplified land registration, especially for agricultural land plots, through a fee waiver program. - Assist citizens in searching for property ownership documents and facilitate dispute resolution through mediation. - Since the launch of the project, the number of citizens’ applications has increased by 57 percent. ### 31. Deepening trade relations with the rest of the world is one of Georgia’s key priorities. As ### 31. Deepening trade relations with the rest of the world is one of Georgia’s key priorities. As ### Trade integration and FTAs - Deepening trade relations is a key priority for Georgia as a small open economy to mobilize FDI in tradable sectors, improve competitiveness, reduce external vulnerabilities, and generate balanced growth. - Existing and planned trade agreements: - Deep and Comprehensive Free Trade Area (DCFTA) with the EU (in place). - FTA with the European Free Trade Association (EFTA) signed in June, 2016. - FTA with the People’s Republic of China will become effective in early 2018. - FTA negotiations concluded with Hong Kong Special Administrative Region; agreement expected to be signed in the first half of 2018. - Negotiations with Turkey aiming at expanding the current FTA. - Commitment to pursue other FTAs with priority countries, including the United States and India. ### Strengthening statistics (policy actions and timelines) - Commitment to strengthen statistics as a precondition for strong economic policy-making; IMF technical assistance acknowledged in national accounts, external sector statistics, and financial and sectoral accounts. - Specific actions, deliverables and timing: - Quarterly unemployment figures: publication delayed due to technical issues related to the new census; will start publishing by September 2018 (had planned to start in May 2017). - Broaden coverage of employment statistics by publishing hours worked. - Conduct an earnings survey in 2018 to provide a detailed view of the population’s living standards. - Complete back-calculations for population figures in the first half of 2018 to reconcile differences between the 2014 and the 2002 census results. - Start publishing national accounts based on the NACE 2 sectoral classification by November 2019. - Along with migration to NACE 2 classification, compute GDP based on supply and use tables and publish quarterly GDP by expenditure in constant prices (capitalizing on IMF TA). ### Program monitoring, safeguards, and institutional measures - Program monitoring framework: - Monitored through quantitative performance criteria, indicative targets, an inflation consultation clause, and structural benchmarks. - Semi-annual program reviews based on December and June test dates. - All quantitative performance criteria and indicative targets listed in Table 2; structural benchmarks in Table 3. - A Technical Memorandum of Understanding (TMU) describes definitions of quantitative PCs, inflation consultation clause, and data provision requirements. - National Bank of Georgia (NBG) safeguards and governance measures: - NBG maintains a strong safeguards framework and internal controls environment. - Submitted to Parliament amendments to the NBG Organic Law on: - (i) Audit Committee’s definition and mandate; - (ii) specifying the Chief Internal Auditor eligibility criteria and grounds for dismissal; - (iii) early appointment of external auditor for NBG. - Will continue to engage independent external audit firms to conduct the audit of the NBG in accordance with international standards. ### Inflation consultation bands (Table 1 summary) - Inflation defined as the 12-month percentage change of the consumer price index (CPI) as measured and published by GEOSTAT. - Consultation mechanism: - If observed year-on-year inflation for test dates falls outside the outer bands specified in Table 1 of the MEFP, authorities will complete a consultation with the IMF Executive Board; access to Fund resources would be interrupted until consultation and review are completed. - If inflation falls outside the inner bands, authorities will consult with IMF staff on reasons and proposed policy response. - Table 1 (Inflation Consultation Bands for CPI, in percent): preserved as published (table formatting in source). ### Quantitative performance criteria and indicative targets (Table 2 highlights) - Performance criteria and indicative targets set for end-December 2017 and end-June 2018; monitored cumulatively from the beginning of the calendar year, except where noted. - Selected quantitative targets and outturns (all amounts cumulative from the beginning of the calendar year, millions of GEL unless otherwise indicated): - Ceiling on augmented General Government deficit (in mn lari, cash basis): - End-June Target: 330 - End-June Adjusted Target: 359 - End-June Outturn: 1021 - End-Dec. Proposed revised targets: 1,335 (End-Dec.), 1,335 (End June? — preserved as per source layout) - End-June 2018 target: 430 - In Percent of GDP entries (preserved as presented): 0.9 1.0 0.3 3.7 3.7 0.7 - Floor on NIR of NBG (End-period stock, in mn US$): - End-June Target: 1,210 - End-June Adjusted Target: 1,247 - End-June Outturn: 1,366 - End-Dec. Proposed revised targets: 1,350; 1,390; 1,450 - Ceiling on the accumulation of external debt arrears of the Public Sector (continuous criterion) (in mn US$): 0 - Ceiling on new public guarantees (continuous criterion) (in mn lari): 0 - Ceiling on the cash deficit of the Partnership Fund (in mn lari): 0 - Ceiling on the new net borrowing of the Partnership Fund (in mn US$, cumulative from beginning of EFF program): 20 (and repeated entries of 0/20 preserved in table) - Indicative target: Ceiling on Primary Current Expenditures of the General Government (in mn lari): entries include 8,685 (end-2017/2018) and 4,675 (mid-2017) as presented. - Note: The NIR target is set at a program rate defined as the exchange rate on December 31, 2016, which for the GEL/US$ was 2.6468. ### Structural benchmarks (Table 3 highlights and status) - Financial sector and financial stability: - Introduction of LCR for commercial banks, with preferential treatment of GEL-deposits (MEFP ¶19): End-September 2017 — Met. - Adoption of regulation on capital add-ons in CAR for systemically important banks (MEFP ¶20): End-December 2017 — In progress. - Submit to Parliament legislation giving NBG oversight power over credit information bureaus (MEFP ¶19): End-December 2017 — Met. - Increase in minimum regulatory capital for commercial banks to GEL50 million, phased in by 2019 (MEFP ¶19): End-June 2017 — Met. - Capital markets, monetary policy operations, deposit insurance, and bank resolution: - Publication of a multi-year calendar for government benchmark bonds (MEFP ¶23): End-December 2017 — In progress. - Signing MoU between Ministry of Finance and NBG on information sharing for liquidity forecasting (MEFP ¶16): End-June 2017 — Met. - Submission to Parliament legislation establishing deposit insurance as of January 1, 2018 (MEFP ¶21): End-June 2017 — Met. - Submit to Parliament amendments to NBG Law to grant authority to resolve a bank through temporary administration (MEFP ¶21): End-September 2017 — Met. - Fiscal and public financial management: - Submission to Parliament a 2018 budget consistent with the fiscal deficit in the Fund-supported program (MEFP ¶7): End-December 2017 — In progress. - Adopt a remuneration law for public civil service (MEFP ¶11): End-December 2017 — In progress (expected Fall 2017). - Action plan to address accumulated outstanding VAT refunds in an orderly manner (MEFP ¶10): End-September 2017 — In progress. - Public-Private Partnership (PPP) and fiscal risk: - Submission of a public-private partnership law to Parliament (MEFP ¶12): End-December 2017 — In progress (expected Fall 2017). - Include all PPP and PPA liabilities and expand contingent liabilities analysis in 2018 Annual Fiscal Risk Statement (MEFP ¶12): End-December 2017 — In progress. - Pension reform and other governance: - Submission of a pension law establishing a 2nd pillar pension system and introducing indexation of basic public pensions (MEFP ¶27): End-December 2017 — In progress. - Further structural benchmarks and target dates (as listed in source): - Restructure the GRS headquarters into a function-based organization: Feb-18. - Steering committee to propose legal amendments or ministerial decrees to facilitate VAT claims action plan: Mar-18. - Create a new specialized VAT unit focusing on validating VAT claims: Jun-18. - Introduce regulation on bank’s real estate appraisal in line with International Valuation Standards: Jun-18. - Establish an independent pension agency: Jun-18. - Introduce regulation on leverage ratio based on Basel Principles and relevant EU regulation: Sep-18. - Introduce regulation on banks corporate governance in line with Basel Principles: Sep-18. ### Technical Memorandum of Understanding (TMU): definitions, reporters, and program assumptions - Program assumptions and exchange rates (Table 1, Program Exchange Rates): - SDR Special Drawing Rights: 0.7439 - GEL Georgian lari: 2.6468 - AUD Australian dollar: 0.7227 - CAD Canadian dollar: 0.7419 - EUR Euro: 1.0556 - Institutional definitions: - General government comprises the central government and local governments, excluding Legal Entities of Public Law (LEPLs); includes any new funds or special budgetary or extra-budgetary entities of a fiscal nature per GFSM 2001; excludes state-owned companies and the Partnership Fund. - Public sector consists of the general government, LEPLs and public financial and non-financial corporations, including the NBG. - Reporting commitments and timelines: - Treasury Department to provide detailed monthly revenues of general government within two weeks of end of each month. - Monthly expenditures and arrears of central government within four weeks of end of each month. - Stock of general government debt, by currency and original maturity, within one month from the end of each quarter. - Daily cash balances in all accounts of the general government provided by the Treasury on a daily basis as of the end of the previous business day. - Quantitative program targets and monitoring (summary): - Program assessed through performance criteria (ceilings/floors), indicative targets, and a consultation clause on 12-month inflation rate. - Performance criteria include ceilings on augmented cash deficit, floors on NIR of NBG, continuous ceilings on external debt arrears, ceilings on new guarantees and Partnership Fund deficits/borrowing, and indicative caps on domestic expenditure arrears and primary current spending. - Monitoring frequency: end-December 2017 and end-June 2018 test dates; cumulative basis from the start of calendar year (except NIR monitored as stock; Partnership Fund borrowing from program approval); continuous criteria monitored continuously. - Adjustors to the augmented cash deficit ceiling: - Adjusted upward/downward by cumulative total amount of foreign-financed project loan disbursements above/below program amounts, subject to a cap of $60 million per year. - Adjusted downward by cumulative receipts from sale of non-financial assets above program amounts. - Adjusted upward/downward by the amount of VAT refunds above/below program amounts. - Projected financing for cash deficit of the general government (Table 2, in millions of GEL, cumulative from beginning of calendar year): - Disbursements of foreign-financed project loans: December 31, 2017 = 915; June 30, 2018 = 673. - Receipts from sale of non-financial assets: December 31, 2017 = 185; June 30, 2018 = 69. - VAT refunds: December 31, 2017 = 180; June 30, 2018 = 50. - Reporting and supporting material requirements (selected): - Data on domestic bank and nonbank financing: provided by NBG and Treasury within four weeks after end of each month. - Data on external project financing and other external borrowing: provided monthly by Ministry of Finance within two weeks of end of each month, specifying projects by creditor. - Data provided at actual exchange rates. - Data on receipts from sales of non-financial and financial assets: monthly within two weeks of end of each month. - Data on securitized debt sold by the NBG, including securities purchased by nonbanks: monthly within two weeks of end of each month. - Data on repayments of VAT claims. - Definitions related to specific targets: - Augmented cash balance of general government: revenues minus expense, minus net acquisition of non-financial assets (GFSM 2001), minus net budget lending. - Net budget lending: net acquisition of financial assets for policy purposes by the general government (GFSM 2001). - Primary current expenditures: expense (GFSM 2001) on a cash basis, minus interest payments. - External debt and arrears: defined consistent with Guidelines on Public Debt Conditionality (Decision No. 15688-(14/107) adopted on December 5, 2014); external payment arrears consist of all overdue debt service obligations arising in respect of any debt contracted, guaranteed, or assumed by central government, NBG, or any agency acting on behalf of general government; ceiling on new external payments arrears applies continuously and does not apply to arrears arising from external debt being renegotiated where creditor agreed no payment pending negotiations. - Domestic expenditure arrears: non-disputed payment obligations overdue; arrears arise when non-debt liabilities not paid after 60 days of contractual payment date or—if no contractual date—after 60 days of receivable; wage, pension or other entitlement obligations not paid after 30 days from due date are in arrears. *IMF staff report (excerpts) — cr17361* ### 22. Supporting Material: The accounting of new domestic expenditure arrears (if any) will be ### 22. Supporting Material: The accounting of new domestic expenditure arrears (if any) will be transmitted within four weeks after the end of each month. ### Guarantees - For the purpose of the program, a guarantee of a debt arises from any explicit legal obligation of the public sector to service such a debt in the event of nonpayment by the recipient (involving payments in cash or in kind). ### Partnership Fund — Ceiling on the Cash Deficit of the Partnership Fund - Definition: The cash deficit of the Partnership Fund will be measured as its expenditures minus its revenues. - Revenues comprise: - the dividends from its assets and investments, - the interest earnings from the loans it provides, - the fees it charges for the services and guarantees it provides, - any other income earned from its assets. - Expenditures comprise: - all current and capital expenditures. - Current expenditures comprise compensation of employees, the purchase of goods and services, transfers to other entities, other account payables and domestic and external interest payments. - Capital expenditures comprise the net acquisition of nonfinancial assets as defined under GFSM 2001. - The Partnership Fund’s purchase of financial assets (e.g. lending and equity participation) will not be considered part of its expenditures. ### Partnership Fund — Ceiling on New Net Borrowing by the Partnership Fund - Definition: Net borrowing by the Partnership Fund is defined as contracted debt liabilities minus principal repayments. - Supporting Material: The Ministry of Finance will provide to the IMF detailed information on the Partnership Fund’s quarterly revenue, expenditure, and amounts related to new contracted debt and principal repayments, within four weeks of the end of each quarter. ### Net International Reserves — Floor on the Net International Reserves of the NBG - Definition: 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, including all of Georgia’s liabilities to the IMF. - Foreign assets of the NBG include: - gold, - gross foreign exchange reserves, - Georgia’s SDR holdings, - 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 (at face value), - Georgia’s SDR allocation, - any other liabilities of the NBG (including foreign currency deposits of financial institutions at the NBG and currency swaps and foreign exchange forward contracts with financial institutions), - excluding the foreign exchange balances in the government’s account with the NBG. - Valuation: 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. - Stock of NIR: The stock of NIR amounted to $1,366 million as of June 30, 2017 (at program exchange rates). ### Budget Support Definitions and Adjustors for NIR - Budget support definitions: - Budget support grants to the general government are grants received by the general government for direct budget support from external donors and not related to project financing. - Budget support loans to the general government are disbursements of commercial loans and loans from bilateral and multilateral donors for budget support. - Adjustors for the floor on NIR (program purposes): - Upward (downward) by the cumulative amount of any excess (shortfall) by any FX privatization revenue in foreign exchange above (below) the programmed amounts. Privatization receipts are defined as the proceeds from sale, lease, or concessions of all or portions of entities and properties held by the public. - Upward (downward) by the cumulative amount of any excess (shortfall) of budget support grants and loans compared to program amounts (Table 3). - Upward/downward for any excess/shortfall related to net issuance of the Eurobond from the general government relative to program amounts (Table 3). - Upward/downward by 75 percent for any excess/shortfall related to disbursements of the project loans and grants to the treasury single account at the NBG relative to the projected amounts (Table 3). ### Table 3. Projected Balance of Payment Support Financing (in millions of U.S. dollars, cumulative from the beginning of the calendar year) - December 31, 2017 / June 30, 2018 - Projected privatization revenue: 0 / 0 - Budget support grants from external donors and not related to project financing: 73.2 / 6 - Budget support loans, including bilateral and multilateral donors for budget support: 193.3 / 58.4 - Net issuance of the Eurobond from the general government: 0 / 0 - Disbursements of project loans and grants: 204.1 / 114.1 ### Supporting material for NIR reporting - Data to be provided weekly (within three working days following the end of the week) in a foreign exchange cash flow table: - net international reserves (both at actual and program exchange rates); - net foreign financing (balance of payment support loans, cash grants to the general government, amortization (excluding repayments to the IMF), interest payments on external debt by the Ministry of Finance and the NBG); - conversions for government imports; - the cash flow table includes details of inflows, outflows and net international reserves. ### Appendix to the TMU: The Partnership Fund — A. Organization and Operational Structure - Legal Structure and Corporate Governance: - The Partnership Fund (PF) is incorporated as a Joint Stock Company (JSC). Under civil law, JSCs are profit maximizing entities, organized with value creation as their main objective. - The PF is organized as a commercial financial institution. Its governance structure includes: - An investment board, currently composed of internal members (CEO, CIO, portfolio officers) and can add external members (like experts and private sector representatives), which approves business cases and initiates projects; - A risk management committee, composed of internal members (CFO, Chief Legal Officer, and Chief Accountant), which advises on project risks to be reflected in project implementation agreements; - A supervisory board (i.e. board of directors), which approves projects (based on the feasibility studies, risk assessments, and business cases presented by the investment board and risk committee) and approves budget for project development needs. The supervisory board includes members of the government and is chaired by the Prime Minister; - In cases of equity participation in projects, the PF needs government approval. ### Appendix to the TMU: The Partnership Fund — B. Corporate Mandate and Portfolio Management - Corporate Mandate: - The corporate mandate of the PF is approved by the supervisory board and the government. - The PF will provide project financing through equity participations, senior loan, quasi-equity through subordinated convertible debt, and performance bonds/guarantees. - Investments will focus on the following sectors: energy, agriculture, manufacturing, and real estate. - Under its corporate mandate, the PF is not allowed to provide financing to the service industry. - The PF will charge market rates for services provided. - Portfolio Management Strategy: - The PF’s portfolio management strategy has been developed. It sets portfolio limits, performance management objectives, and project evaluation guidelines, and will be based on the following principles: - The PF will participate only in commercially viable projects; and - The PF’s performance will be monitored on the basis of the following evaluation criteria: IRR, adjusted present value, sharp ratio, and risk adjusted return. - Project Development Methodology: - The PF will only participate in projects in which a corporate investor, with sufficient experience in industry, expresses its willingness to take an equity participation that represents at least 51 percent of the project’s total equity. - PF financing (debt plus equity plus guarantees) will not be allowed to exceed 100 percent of the equity of the private partner in the project. - The PF will pursue only commercial objectives. - Reporting and Auditing: - The PF will engage an internationally recognized auditing company to conduct IFRS audits of its financial statements. - The PF will hire on a permanent basis the services of rating agencies, which will prepare regular ratings reports—there will no minimum rating requirement for the PF. - The PF’s audited financial statements, as well as the ratings reports will be available on permanent basis to a broad audience. - Fiscal risk limitations associated with the PF: - All liabilities of the PF are limited to its own balance sheet; - The PF has its own revenue sources, namely: the dividends from its investments, the interest earnings from the loans its provides, the fees it charges on the guarantees it provides, and the proceeds of asset sales; - The PF may decide to borrow from credible financial institution with recourse to its balance sheet facility and without state guarantee. *Source: cr17361 - 22. Supporting Material: The accounting of new domestic expenditure arrears (if any) will be* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17361.pdf_