## 1. Achievements and Challenges in Revenue Mobilization

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### Context and overarching assessment
- Georgian economy resilient to the 2014 external shock; growth higher than peer average since 2010.
- Policy mix underpinning resilience:
  - Fiscal: fiscal deficits effectively managed; 2017 budget combined tax increases and cuts in current spending to generate space for public investment.
  - Monetary: monetary policy focused on price stability; NBG increased policy rate three times in 2017 by 25 basis points each to 7.25 percent.
  - Financial: strengthened prudential regulation and supervision in banking.
  - Structural: reforms initiated to remove growth bottlenecks.
- Growth trends:
  - Average annual growth: 9.7 percent (2003–07), 5.6 percent (2010–14), 3.6 percent (2015–17).
- Key structural constraints: poor infrastructure, limited production base, significant skill mismatches.
- Authorities’ Four-Point Reform Plan objectives:
  - (1) improve infrastructure and connectivity;
  - (2) reform education to promote skills development, labor productivity, and job creation;
  - (3) improve governance and government efficiency;
  - (4) enhance the role of the private sector as an engine for growth.
- Extended Fund Facility (EFF) arrangement supports home-grown reforms.

### Recent economic and financial developments (highlights)
- GDP and demand:
  - Real GDP growth: 5 percent in 2017 (2.8 percent in 2016).
  - 2017 growth driven by net exports and household consumption.
- Inflation and monetary policy:
  - Annual inflation: 6.7 percent at end-2017; 2.5 percent in April 2018.
- External sector:
  - Current account deficit: 8.7 percent of GDP in 2017 (12.8 percent in 2016).
  - Export volume growth: about 20 percent in 2017.
  - Net FDI flows: 10.5 percent of GDP in 2017.
  - Gross international reserves: increased by $283 million to $3 billion (3.3 months of imports).
- Fiscal outcomes:
  - Augmented fiscal deficit (net lending/borrowing minus budget lending): 2.9 percent of GDP in 2017 (3 percent of GDP in 2016).
  - Revenues increased by 0.7 percentage points of GDP in 2017.
  - Corporate income tax reform effects: losses of 1.1 percentage points of GDP (CIT changed from profit to dividend-distribution tax); compensating gains from higher excise rates of 0.7 percentage points of GDP.
  - Capital spending and net budget lending increased by 2 percentage points of GDP in 2017.
  - Structural primary deficit fell by 0.4 percent of potential GDP.
  - Public debt close to 45 percent of GDP (public debt does not include unrefunded VAT credits estimated at 4.7 percent of GDP in 2017).
- Financial sector and credit:
  - Private sector credit growth (constant exchange rates): about 20 percent year-on-year in March 2018, driven by household credit (mortgage lending).
  - Household debt: reached 34 percent of GDP at end-2017; doubled over the last five years from a low base.
  - Corporate credit: stable at 25 percent of GDP.
  - Deposits grew about 20 percent year-on-year as of March 2018 (constant exchange rates).
  - Banking sector indicators (January 2018):
    - Capital adequacy ratio: close to 20 percent.
    - Average liquidity ratio: 37 percent (41 percent in January 2017).
    - Nonperforming loans (NPLs): 2.9 percent of total loans (January 2018), down from 3.8 percent a year earlier.
    - Return on equity (assets): close to 20 percent (3 percent).
- Dollarization and larization measures and outcomes:
  - Loan dollarization fell by about 10 percentage points to 55 percent (March 2018) since December 2016.
  - Deposit dollarization fell by about 8 percentage points to 63 percent (March 2018).
  - Household loan dollarization declined by 15 percentage points to 43 percent during this period.
  - Larization measures included: Basel III liquidity coverage ratio with preferential treatment for local currency; prohibition of loans in foreign currency under GEL100,000 in non-banks; mortgage conversion program; differentiated loan-to-value and payment-to-income ratios; mandated prices quoted only in lari.

### Program performance (2017) and structural benchmarks
- Quantitative targets for end-December 2017 met:
  - Inflation within inner band of consultation clause (5–7 percent).
  - Fiscal deficit 0.5 percent of GDP lower than the program ceiling.
  - Net international reserves $100 million higher than the adjusted program floor.
  - Partnership Fund (PF) ran a small surplus.
  - Indicative target on current primary spending missed by 0.3 percent due to higher donor disbursements.
- Structural benchmarks (SBs) — selected:
  - Met: publication of calendar for government benchmark bonds for 2018; submission of a budget consistent with EFF parameters; adoption of public civil service law; restructuring of Georgia Revenue Service (GRS) headquarters into function-based organization; issuance of guidelines for new budget lending operations; submission to Parliament of second-pillar pension reform, PPP law, and proposed legislation giving NBG oversight over credit bureaus; 2018 Fiscal Risk Statement disclosure on PPPs and PPAs and analysis of contingent liabilities associated with SOEs.
  - Delayed: legal amendments to implement action plan to reduce outstanding VAT liabilities delayed from March to May 2018.
  - NBG adopted regulation on additional capital for domestic systemically important banks, to be fully effective by 2020.

### Outlook and risks
- Growth and inflation projections:
  - GDP growth projected at 4.8 percent in 2018 (0.6 percentage points higher than at the first review).
  - Inflation projected below target of 3 percent at end-2018 (2.5 percent in April 2018).
  - Medium-term GDP growth projected at 5.2 percent, conditional on structural reforms.
- Public debt and external metrics:
  - Public debt expected to remain firmly below 45 percent of GDP under baseline, absent materialization of fiscal risks.
  - Current account deficit projected to narrow to about 7.5 percent of GDP in the medium term; mainly financed by FDI.
  - Reserve coverage projected at 93 percent of the ARA matrix by end-2018, increasing to 105 percent by 2020.
  - External debt projected to remain elevated, maintaining vulnerabilities.
- Risk assessment:
  - Risks balanced. Upside risks: stronger domestic and external demand; larger-than-anticipated reform impacts.
  - Downside risks: demand pressures requiring policy tightening; vulnerability to regional developments and market volatility in main trading partners; weaker growth among key trading partners affecting export recovery; retreat from cross-border integration undermining export diversification; political fatigue or deviations from fiscal discipline reducing medium-term growth.
- Authorities’ stance: agree on outlook and risks; committed to advancing structural reforms and maintaining fiscal discipline; concerned about adverse spillovers from regional market volatility.

### Article IV policy discussions — Preserving medium-term fiscal sustainability
- 2018 fiscal stance and uses of 2017 additional revenues:
  - Augmented fiscal deficit in 2018 projected at 2.8 percent of GDP (0.2 percent of GDP lower than in the budget).
  - Additional revenues in 2017 amounting to GEL 300 million (0.7 percentage points of GDP).
  - Uses of additional 2017 revenues: double repayments of outstanding VAT liabilities to GEL400 million for the year; reduce the deficit by GEL56 million; remainder toward additional capital spending.
- Medium-term fiscal strategy and measures:
  - Fiscal policy projected to remain broadly neutral and consistent with anchoring public debt below 45 percent of GDP.
  - Continued fiscal consolidation contingent on sustained revenue performance and tight control on current spending.
  - Baseline projections indicate additional fiscal measures of 0.8 percent of GDP in 2019 needed to ensure consolidation over the medium term.
- Public investment and education priorities:
  - Scale up infrastructure and improve education to address structural bottlenecks and raise potential growth.
  - Near-term additional spending to prioritize identified infrastructure projects; emphasis on productive and well-managed projects.
  - Strengthening public investment management to improve efficiency of public and PPP investments.
  - Medium-term spending focus to shift toward education reform; education reform should be fiscally sustainable, targeting efficiency gains and compensating measures.
- Constraint from the Economic Liberty Act:
  - The Act requires a referendum for any permanent increase in central government taxes (except excises), constraining options for permanently mobilizing more revenues; tax increases would thus need to be temporary if additional capital spending cannot be covered by current spending cuts.

### Fiscal risks: SOEs and PPAs
- Main fiscal risks arise from contingent liabilities associated with SOEs and PPAs.
- 2017 Fiscal Risk Statement (FRS) findings:
  - Half of the SOEs are considered high-risk.
  - Total liabilities of high-risk SOEs stood at 12.8 percent of GDP in 2016.
  - One SOE unable to service its debt to the government; the state budget serviced debt amounting to GEL34 million on behalf of this SOE, payment guaranteed by property and equipment.
- Policy actions and recommendations:
  - Authorities plan to require financial reporting of the largest SOEs to be IFRS compliant by October 2019.
  - Authorities agreed on need for legal/regulatory changes to institutionalize, standardize, and centralize supervisory powers on SOEs.
  - Staff recommendation: institutional framework should provide the MoF and the Ministry of Economy and Sustainable Development (MoE) explicit authority to oversee SOEs and limit fiscal risks.
- Net fiscal exposure to PPAs:
  - Authorities’ calculation: 3.6 percent of GDP under current export/import electricity prices (net present value terms).
  - Regulatory risk: public finances exposed if electricity tariffs are not adjusted to fully reflect guarantee prices under PPAs.

### Revenue mobilization: achievements, challenges, and reforms
- Historical trajectory:
  - Tax revenues rose from 12 percent of GDP in 2003 to 22 percent of GDP in 2007; since 2008 tax revenues plateaued at around 25 percent of GDP.
- Structural constraints:
  - Georgia does not collect social security contributions, so total revenues are significantly below the average in Emerging and Developing Europe.
  - The 2011 Economic Liberty Act requires a referendum for any permanent increase in central government taxes (except excises), making mobilization of additional revenues challenging.
  - The 2017 corporate income tax reform led to an estimated revenue loss of 1.1 percent of GDP.
  - Compensating increases in excise rates on tobacco and imported vehicles yielded less in revenues than expected due to shifts in consumption and increased smuggling.
- Tax administration and policy reforms underway:
  - Improving taxpayer services by streamlining documentation requirements; simple online filing, service centers, and independent dispute resolution mechanisms already in place.
  - Modernizing the Georgia Revenue Service (GRS): new organizational structure, improved taxpayer register, modern risk management tools, performance tracking of GRS units; FAD TA recommends creating a large taxpayer office.
  - Modernizing the tax code: remove presumed zero-liability where no return is filed; revise overly rigid penalty regime to be more proportionate.
  - Easing access to information: authorities committed to providing GRS automated access to risk-relevant data from other agencies (real estate, corporate ownership, construction permits, suspicious financial transactions). Staff view: require automatic reporting of bank information to GRS.
- SME tax reform proposal (selected elements):
  - Lower turnover tax rate for small businesses to 1 percent (from 3 percent) while removing tax exemptions on salaries.
  - Entrepreneurs with turnover between GEL100,000 and 500,000 could opt to pay the turnover tax instead of income tax on profits.
  - Expand cash register requirements to small businesses and require accounting for all transactions.
  - If all medium-sized firms choose the turnover tax regime, the reform would have a small fiscal cost in the short term but could improve compliance and reduce shadow economy.
- VAT refund system and commitments:
  - Current VAT refund flaws lead to accumulation of VAT credits that deprive businesses of working capital.
  - For 2018, authorities committed to reducing the stock of VAT credits by refunding GEL400 million, up from GEL225 million in 2017.
  - VAT administration reform measures and targets:
    - Aim to reduce by at least 50 percent by end-2021 the outstanding stock of unrefunded VAT credits that are within the limitation period for audit.
    - Commit to risk-assess 100 percent of declarations for the stock of existing credits within the next two years.
    - Creation of a specialized VAT unit in GRS’s audit department (structural benchmark, June 2018).
    - Automatic risk assessment for all new VAT declarations starting January 2019; fully automated system by end-2018.
    - By June 2019, 90 percent of new declarations with the lowest risk score to be immediately eligible for a refund if requested and no outstanding tax liabilities.

### Fiscal rule: need for strengthening and recommended improvements
- Current fiscal rule elements (Economic Liberty Act):
  - Ceiling on state debt: 60 percent of GDP.
  - Ceiling on consolidated general government deficit: 3 percent of GDP.
  - Ceiling on general government expenditures: 30 percent of GDP.
- Observations and concerns:
  - Debt and deficit ceilings have been adhered to; expenditure plans marginally exceeded the ceiling in 2014 and 2015 by a small margin.
  - Constitution requires referendum for permanent increase in state taxes (except excises), reducing fiscal flexibility and potentially increasing reliance on excises or administrative fees.
- Staff recommendations to strengthen the fiscal rule:
  - Replace the expenditure rule with nominal expenditure ceilings embedded in the MTBF to reduce procyclicality and discourage avoidance of public investment.
  - Shift focus to fiscal outturns rather than plans; strengthen definitions of fiscal aggregates and escape clauses; enhance transparency and monitoring.
  - Fiscal rule should cover all general government operations, including revenues/expenditures by LEPLs and quasi-fiscal operations by SOEs; revise accounting practices in line with GFSM 2014 standards.
  - Clarify escape clause definitions and processes (e.g., define “recession” and process for determining exceptional circumstances).
  - Enhance credibility through independent oversight: include budget execution reports discussing compliance, independent evaluation of assumptions and monitoring, and a legally and operationally independent verifying institution with full access to relevant information.
- Authorities’ plans:
  - Revamp the fiscal rule in line with FAD recommendations while implementing GFSM2014 in fiscal reports.
  - Increase accountability toward compliance with the fiscal rule and maintain current deficit and debt ceilings with strengthened definitions, escape clauses, and corrective mechanism.

### Monetary and financial frameworks: stance, prudential measures, and resilience
- Monetary stance and inflation:
  - Monetary stance assessed as adequate; estimated neutral real interest rate: 2 percent.
  - Real policy rate: 1.6 percent.
  - No evidence of price and wage pressures; subdued core inflation.
  - Authorities plan to reduce the interest rate in the second half of 2018; NBG stands ready to postpone lowering the policy rate or tighten further if price pressures materialize.
- NBG institutional and operational enhancements:
  - Strengthening IT framework; inflation-targeting regime remains appropriate.
  - Improved liquidity management with a new one-month liquidity facility.
  - Regular press briefings after Monetary Policy Committee meetings improve communication.
  - New manual for monetary operations (with IMF TA).
- Prudential measures and macroprudential recommendations:
  - NBG cap on loans to households without verifiable income: 25 percent of banks’ regulatory capital.
  - Staff supports targeted, market-based macroprudential measures rather than broad administrative limits on FX lending.
  - Staff proposed measures:
    - Increase capital and/or provisioning for FX loans.
    - Establish lending limits on FX loans based on PTI and LTV ratios.
    - Higher premium on dollar deposits for the deposit insurance scheme.
    - Enhance dissemination of risks of FX borrowing and financial education.
- Banking sector resilience and crisis management:
  - 2015 lari depreciation showed banking sector resilience due to strong prudential regulation and supervision.
  - Remaining needs: improve emergency liquidity assistance (ELA) and bank resolution for systemic institutions; clarify role of public stakeholders in line with 2014 FSAP recommendations.

### Financial sector reforms (2017–18 highlights) and program modalities
- Prudential and liquidity reforms:
  - Capital buffers: three systemically important banks (SIBs) identified with additional capital requirements of 1.5–2.5 percentage points phased in by 2021.
  - Countercyclical capital buffer effective December 2017.
  - Risk-based capital buffer on retail loans effective after November 30, 2017; risk weights on newly issued consumer loans increased on average from 75 to 135 percent (about 0.3 percentage points of additional capital).
  - Liquidity buffers: Basel III LCR effective September 2017; lari LCR can fall to 75 percent if the overall LCR remains above 100 percent.
  - Basel III net stable funding ratio to be introduced in 2019.
  - Differentiated reserve requirements by currency to incentivize de-dollarization.
- Supervision and oversight expansion:
  - NBG oversight extended to non-bank lenders, microfinance institutions, bank holding companies, credit information bureaus, and other unregulated lenders (December 2017 legal amendments).
- Deposit insurance and resolution:
  - Deposit insurance effective January 2018, covering 90 percent of total deposit accounts (GEL 5,000 insured amount).
  - Amendments to the Organic Law give NBG authority to resolve a bank through temporary administration.
- Responsible lending, consumer protection, and financial literacy:
  - NBG amended product disclosure and effective interest rate regulations.
  - Responsible lending framework to restrict issuance of loans without detailed customer creditworthiness assessment; limits on PTI and LTV; expand to non-banks.
  - Programs underway to enhance financial education and sensitize households on risks associated with financial imprudence and FX borrowing.
- Institutional reforms for macro-financial analysis:
  - Financial Stability Committee (FSC) operational framework strengthened: meets quarterly; decisions on countercyclical capital buffer communicated via press release; twice per year FSC meetings followed by press conference.
  - Financial stability analysis department created in 2017.
  - IMF-supported macro-financial model development to analyze risks, conduct macro-stress tests, and support macroprudential policy; renewed Financial Stability Report planned for 2019.

### Program financing, targets, and safeguards
- Program modalities and financing:
  - Proposed adjustments to NIR targets: increase floor to $1.49 billion by end-June 2018; end-December target $1.55 billion.
  - New structural benchmarks for end-December 2018 and for 2019 (expanding 2019 FRS; adopting decree to implement PPP law; revised penalty regime; new fiscal rule framework; pension indexation mechanism; legal amendments for crisis management; automatic refunding of 90 percent of validated VAT refund requests by end-June 2019).
  - Program fully financed for next 12 months with support from the European Union and Agence Française de Développement.
- Safeguards and arrears:
  - NBG maintains strong safeguards; NBG Organic Law amendments adopted December 2017 implemented Fund safeguards recommendations.
  - Negotiations of arrears with Turkmenistan continue.

### Staff appraisal — macroeconomic and policy recommendations (selected)
- Macroeconomic context:
  - Improved macroeconomic environment provides opportunity to cement stability and advance structural reforms.
  - Inflation declined toward NBG target; external position strengthened; fiscal position improved; banking sector liquid, profitable, and well capitalized.
- Fiscal policy guidance:
  - To maintain fiscal prudence while creating space for investment in infrastructure and human capital:
    - contain current spending;
    - improve revenue administration;
    - manage fiscal risks.
  - Advance institutional fiscal reforms, including revamping the fiscal rule and expanding monitoring of fiscal risks.
- Monetary and financial sector guidance:
  - Monetary policy should remain focused on price stability, supported by exchange rate flexibility.
  - Limit FX interventions to smoothing excessive volatility and building reserves.
  - Strengthen liquidity management and communication; address dollarization with targeted, market-based prudential measures.
  - Consider establishing a crisis management framework, including emergency liquidity assistance.
- Structural reform priorities:
  - Focus on improving infrastructure, competitiveness, and education in line with the Four-Point reform plan.
  - Strong implementation of PPP framework to mobilize private investment.
  - Improve business climate, adopt new insolvency law, establish Business House, modernize vocational training, and pursue further education reforms.

### Risk assessment and contingency responses (Annex II overview)
- Key risks and policy responses:
  - Retreat from cross-border integration (Medium / Short to Medium Term): flexible exchange rate; accelerate structural reforms; strengthen fiscal and financial resilience.
  - Tighter global financial conditions and migration outside banking (High / Short to Medium Term; Medium / Medium Term): flexible exchange rate; continue de-dollarization; strengthen financial stability framework.
  - Weaker-than-expected global growth (High / Medium Term): flexible exchange rate; accelerate structural reforms; strengthen social safety nets.
  - Cyber-attacks (Medium / Short to Medium Term): strengthen banking regulation and supervision preparedness.
  - Georgia-specific financial and fiscal risks (Medium/High): flexible exchange rate; accelerate reforms; strengthen fiscal transparency and SOE oversight.

### Selected quantitative and monitoring items (highlights, as reported)
- Real GDP growth (selected historical and projections): 2.9, 2.8, 4.3, 5.0, 4.2, 4.8, 4.8, 5.0, 5.2, 5.2 (2015–23 Real GDP table rows).
- CPI, Period average and End-of-period: period averages include 4.0, 2.1, 5.8, 6.0, 2.8, 2.8, 2.9, 3.0, 3.0, 3.0, 3.0; end-of-period include 4.9, 1.8, 5.6, 6.7, 3.2, 2.7, 3.0, 3.0, 3.0, 3.0.
- Gross international reserves (in billions of US$): 2.5, 2.8, 3.2, 3.0, 3.4, 3.3, 3.6, 4.0, 4.3, 4.8, 5.3 (2015–23).
- Current account balance (percent of GDP): -12.0, -12.8, -10.4, -8.7, -10.6, -9.2, -9.2, -8.8, -8.4, -7.8, -7.5 (2015–23).
- Public debt (percent of GDP): 41.4, 44.4, 42.3, 44.9, 42.7, 42.8, 43.5, 44.0, 43.6, 42.8, 41.2 (2015–23).
- Augmented balance (Program definition, percent of GDP): -2.7, -3.0, -3.6, -2.9, -3.0, -2.8, -2.6, -2.5, -2.4, -2.3, -2.2 (2015–23).
- Deposit dollarization (percent of total): 66.8, 69.9, 64.8, 63.7, 64.1, 59.7, 57.5, 55.1, 54.0, 52.6, 50.8 (2015–23 projections / Mar 2018).
- Credit-to-GDP ratio (Table 1): 49.2, 54.9, 55.3, 57.8, 58.5, 60.6, 61.9, 63.3, 63.6, 63.6, 63.6 (2015–23).

### Implementation priorities and scheduled benchmarks (selection)
- VAT administration: create specialized VAT unit (Jun-18); automatic risk assessment and automated refund system (end-2018/Jan-2019); automatic refunding of low-risk claims (targeted by Jun-19).
- Fiscal rule and transparency: submit revised fiscal framework to Parliament (Dec-18); implement GFSM2014 in fiscal reports.
- SOE oversight and PPPs: assess need for legal/regulatory changes to centralize SOE supervision (Dec-18); adopt government decree implementing PPP law (end-Dec-18).
- Financial sector: finalize prudential regulation for MFIs (Jun-18); extend non-prudential regulation to other lenders (Jan-2019); submit legal amendments for ELA and resolution frameworks (May-2019).

*International Monetary Fund — cr18198 (chapter: 1. Achievements and Challenges in Revenue Mobilization)*

### 1. Achievements and Challenges in Revenue Mobilization _______________________________________ 10

### 1. Achievements and Challenges in Revenue Mobilization

### Context and overarching assessment
- Georgian economy resilient to the 2014 external shock; growth higher than peer average since 2010.
- Policy efforts underpin resilience: fiscal deficits effectively managed; 2017 budget combined tax increases and cuts in current spending to generate space for public investment; monetary policy focused on price stability; strengthened prudential regulation and supervision in banking; structural reforms initiated to remove growth bottlenecks.
- Growth trends:
  - Average annual growth: 9.7 percent (2003–07), 5.6 percent (2010–14), 3.6 percent (2015–17).
- Key structural constraints: poor infrastructure, limited production base, significant skill mismatches.
- Authorities’ Four-Point Reform Plan objectives:
  - (1) improve infrastructure and connectivity;
  - (2) reform education to promote skills development, labor productivity, and job creation;
  - (3) improve governance and government efficiency;
  - (4) enhance the role of the private sector as an engine for growth.
- Extended Fund Facility (EFF) arrangement supports home-grown reforms.

### Recent economic and financial developments (highlights)
- GDP and demand:
  - Real GDP growth: 5 percent in 2017 (2.8 percent in 2016).
  - Contribution to 2017 growth driven by net exports and household consumption.
- Inflation and monetary policy:
  - Annual inflation: 6.7 percent at end-2017; 2.5 percent in April 2018.
  - NBG increased policy rate three times in 2017 by 25 basis points each to 7.25 percent.
- External sector:
  - Current account deficit: 8.7 percent of GDP in 2017 (12.8 percent in 2016).
  - Export volume growth: about 20 percent in 2017.
  - Net FDI flows: 10.5 percent of GDP in 2017 (partly driven by high reinvested earnings).
  - Gross international reserves: increased by $283 million to $3 billion (3.3 months of imports).
- Fiscal outcomes:
  - Augmented fiscal deficit (net lending/borrowing minus budget lending): 2.9 percent of GDP in 2017 (3 percent of GDP in 2016).
  - Revenues increased by 0.7 percentage points of GDP in 2017.
  - Corporate income tax reform effects: losses of 1.1 percentage points of GDP (CIT changed from profit to dividend-distribution tax); compensating gains from higher excise rates of 0.7 percentage points of GDP.
  - Capital spending and net budget lending increased by 2 percentage points of GDP in 2017.
  - Structural primary deficit fell by 0.4 percent of potential GDP.
  - Public debt close to 45 percent of GDP (public debt does not include unrefunded VAT credits estimated at 4.7 percent of GDP in 2017).
- Financial sector and credit:
  - Private sector credit growth (constant exchange rates): about 20 percent year-on-year in March 2018, driven by household credit (mortgage lending).
  - Household debt: reached 34 percent of GDP at end-2017; doubled over the last five years from a low base.
  - Corporate credit: stable at 25 percent of GDP.
  - Deposits grew about 20 percent year-on-year as of March 2018 (constant exchange rates).
  - Banking sector indicators (January 2018):
    - Capital adequacy ratio: close to 20 percent.
    - Average liquidity ratio: 37 percent (41 percent in January 2017).
    - Nonperforming loans (NPLs): 2.9 percent of total loans (January 2018), down from 3.8 percent a year earlier.
    - Return on equity (assets): close to 20 percent (3 percent).
- Dollarization and larization measures:
  - Since December 2016, loan dollarization fell by about 10 percentage points to 55 percent (March 2018).
  - Deposit dollarization fell by about 8 percentage points to 63 percent (March 2018).
  - Household loan dollarization declined by 15 percentage points to 43 percent during this period.
  - Larization measures included: Basel III liquidity coverage ratio with preferential treatment for local currency; prohibition of loans in foreign currency under GEL100,000 in non-banks; mortgage conversion program; differentiated loan-to-value and payment-to-income ratios; mandated prices quoted only in lari.

### Program performance (2017)
- Quantitative targets for end-December 2017 met:
  - Inflation remained within the inner band of the consultation clause (5–7 percent).
  - Fiscal deficit was 0.5 percent of GDP lower than the program ceiling.
  - Net international reserves (NIR) were $100 million higher than the adjusted program floor.
  - Partnership Fund (PF) ran a small surplus.
  - Indicative target on current primary spending missed by 0.3 percent due to higher donor disbursements.
- Structural benchmarks (SBs):
  - Met: publication of calendar for government benchmark bonds for 2018; submission of a budget consistent with EFF parameters; adoption of public civil service law; restructuring of Georgia Revenue Service (GRS) headquarters into function-based organization; issuance of guidelines for new budget lending operations; submission to Parliament of second-pillar pension reform, PPP law, and proposed legislation giving NBG oversight over credit bureaus; 2018 Fiscal Risk Statement disclosure on PPPs and PPAs and analysis of contingent liabilities associated with SOEs.
  - Not met on schedule: legal amendments to implement action plan to reduce outstanding VAT liabilities delayed from March to May 2018.
  - NBG adopted regulation on additional capital for domestic systemically important banks, to be fully effective by 2020.

### Outlook and risks
- Growth and inflation projections:
  - GDP growth projected at 4.8 percent in 2018 (0.6 percentage points higher than at the first review).
  - Inflation projected below target of 3 percent at end-2018 (2.5 percent in April 2018).
  - Medium-term GDP growth projected at 5.2 percent, conditional on structural reforms.
- Public debt and external metrics:
  - Public debt expected to remain firmly below 45 percent of GDP under baseline, absent materialization of fiscal risks.
  - Current account deficit projected to narrow to about 7.5 percent of GDP in the medium term; mainly financed by FDI.
  - Reserve coverage projected at 93 percent of the ARA matrix by end-2018, increasing to 105 percent by 2020.
  - External debt projected to remain elevated, maintaining vulnerabilities.
- Risk assessment:
  - Risks balanced. Upside risks: stronger domestic and external demand; larger-than-anticipated reform impacts.
  - Downside risks: demand pressures requiring policy tightening; vulnerability to regional developments and market volatility in main trading partners; weaker growth among key trading partners affecting export recovery; retreat from cross-border integration undermining export diversification; political fatigue or deviations from fiscal discipline reducing medium-term growth.
- Authorities’ stance: agree on outlook and risks; committed to advancing structural reforms and maintaining fiscal discipline; concerned about adverse spillovers from regional market volatility.

### Article IV policy discussions — Preserving medium-term fiscal sustainability
- 2018 fiscal stance and measures:
  - Augmented fiscal deficit in 2018 projected at 2.8 percent of GDP (0.2 percent of GDP lower than in the budget).
  - Additional revenues in 2017 amounting to GEL 300 million (0.7 percentage points of GDP).
  - Uses of additional 2017 revenues: double repayments of outstanding VAT liabilities to GEL400 million for the year; reduce the deficit by GEL56 million; remainder toward additional capital spending.
- Medium-term fiscal strategy:
  - Fiscal policy projected to remain broadly neutral and consistent with anchoring public debt below 45 percent of GDP.
  - Continued fiscal consolidation contingent on sustained revenue performance and tight control on current spending.
  - Baseline projections indicate additional fiscal measures of 0.8 percent of GDP in 2019 needed to ensure consolidation over the medium term.
- Public investment and education:
  - Authorities recognize need to scale up infrastructure and improve education to address structural bottlenecks and raise potential growth.
  - Near-term additional spending to prioritize identified infrastructure projects; emphasis on productive and well-managed projects.
  - Strengthening public investment management to improve efficiency of public and PPP investments.
  - Medium-term spending focus to shift toward education reform; education reform should be fiscally sustainable, targeting efficiency gains and compensating measures.
- Revenue mobilization constraints:
  - Economic Liberty Act constrains options for permanently mobilizing more revenues; tax increases would thus need to be temporary if additional capital spending cannot be covered by current spending cuts.

*International Monetary Fund — cr18198 (chapter: 1. Achievements and Challenges in Revenue Mobilization)*

### 19.      Fiscal risks remain significant. Staff welcomes the improved coverage and reporting of

### 19.      Fiscal risks remain significant. Staff welcomes the improved coverage and reporting of

### Fiscal risks: SOEs and PPAs
- Main fiscal risks arise from contingent liabilities associated with SOEs and PPAs.
- According to the 2017 FRS:
  - Half of the SOEs are considered high-risk.
  - Total liabilities of high-risk SOEs stood at 12.8 percent of GDP in 2016.
  - One SOE is currently unable to service its debt to the government; the state budget has serviced debt amounting to GEL34 million on behalf of this SOE. The payment has been guaranteed by property and equipment.
- Authorities plan to require financial reporting of the largest SOEs to be IFRS compliant by October 2019.
- Authorities agreed on the need for legal and/or regulatory changes to institutionalize, standardize, and centralize supervisory powers on SOEs.
- Staff recommendation: institutional framework should provide the MoF and the Ministry of Economy and Sustainable Development (MoE) explicit authority to oversee SOEs and limit fiscal risks.
- Net fiscal exposure to PPAs:
  - Authorities’ calculation: 3.6 percent of GDP under current export/import electricity prices (net present value terms).
  - Under the domestic electricity pricing mechanism, guaranteed prices will be fully passed on to end-users, limiting cost of PPAs to state-owned electricity companies; however, losses could arise from exporting surplus electricity if export prices are below guaranteed prices.
  - Staff and authorities agree public finances are exposed to regulatory risks if electricity tariffs are not adjusted to fully reflect guarantee prices under PPAs.

### Revenue mobilization: achievements, challenges, and reforms
- Historical achievement:
  - Tax revenues rose from 12 percent of GDP in 2003 to 22 percent of GDP in 2007 after the 2003 Rose Revolution.
  - Since 2008, tax revenues have plateaued at around 25 percent of GDP.
- Constraints and impacts:
  - Georgia does not collect social security contributions, so total revenues are significantly below the average in Emerging and Developing Europe.
  - The 2011 Economic Liberty Act requires a referendum for any permanent increase in central government taxes (except excises), making mobilization of additional revenues challenging.
  - The 2017 corporate income tax reform led to an estimated revenue loss of 1.1 percent of GDP.
  - Compensating increases in excise rates on tobacco and imported vehicles yielded less in revenues than expected due to shifts in consumption and increased smuggling.
- Tax administration and policy reforms underway:
  - Improving taxpayer services by streamlining documentation requirements; Georgia already has simple online filing, service centers, and independent dispute resolution mechanisms.
  - Modernizing the Georgia Revenue Service (GRS): new organizational structure, improved taxpayer register, modern risk management tools, performance tracking of GRS units; FAD TA recommends creating a large taxpayer office.
  - Modernizing the tax code: removing presumed zero-liability where no return is filed; revising overly rigid penalty regime to be more proportionate.
  - Easing access to information: authorities committed to providing GRS automated access to risk-relevant data from other agencies (real estate, corporate ownership, construction permits, suspicious financial transactions). Staff view: require automatic reporting of bank information to GRS.
  - SME tax reform proposal:
    - Lower turnover tax rate for small businesses to 1 percent (from 3 percent) while removing tax exemptions on salaries.
    - Entrepreneurs with turnover between GEL100,000 and 500,000 could opt to pay the turnover tax instead of income tax on profits.
    - Expand cash register requirements to small businesses and require accounting for all transactions.
    - If all medium-sized firms choose the turnover tax regime, the reform would have a small fiscal cost in the short term but could improve compliance and reduce shadow economy.

- VAT refund system and commitments:
  - Current VAT refund flaws lead to accumulation of VAT credits that deprive businesses of working capital.
  - For 2018, authorities committed to reducing the stock of VAT credits by refunding GEL400 million, up from GEL225 million in 2017.

### Fiscal rule: need for strengthening and recommended improvements
- Current fiscal rule elements (Economic Liberty Act):
  - Ceiling on state debt: 60 percent of GDP.
  - Ceiling on consolidated general government deficit: 3 percent of GDP.
  - Ceiling on general government expenditures: 30 percent of GDP.
- Observations:
  - Debt and deficit ceilings have been adhered to.
  - Expenditure plans marginally exceeded the ceiling in 2014 and 2015 by a small margin.
  - Constitution requires referendum for permanent increase in state taxes (except excises), reducing fiscal flexibility and potentially increasing reliance on excises or administrative fees.
- Areas for improvement recommended by staff:
  - Replace the expenditure rule with nominal expenditure ceilings embedded in the MTBF to reduce procyclicality and discourage avoidance of public investment.
  - Shift focus to fiscal outturns rather than plans; strengthen definitions of fiscal aggregates and escape clauses; enhance transparency and monitoring.
  - Fiscal rule should cover all general government operations, including revenues/expenditures by LEPLs and quasi-fiscal operations by SOEs; revise accounting practices in line with GFSM 2014 standards.
  - Clarify escape clause definitions and processes (e.g., define “recession” and process for determining exceptional circumstances).
  - Enhance credibility through independent oversight: include budget execution reports discussing compliance, independent evaluation of assumptions and monitoring, and a legally and operationally independent verifying institution with full access to relevant information.
- Authorities’ plans:
  - Revamp the fiscal rule in line with FAD recommendations while implementing GFSM2014 in fiscal reports.
  - Increase accountability toward compliance with the fiscal rule and maintain current deficit and debt ceilings with strengthened definitions, escape clauses, and corrective mechanism.

### Monetary and financial frameworks: stance, prudential measures, and resilience
- Monetary stance and inflation:
  - Monetary stance assessed as adequate; financial conditions slightly loose due to easy global monetary and liquidity conditions.
  - Estimated neutral real interest rate: 2 percent.
  - Real policy rate: 1.6 percent.
  - No evidence of price and wage pressures; subdued core inflation.
  - Authorities plan to reduce the interest rate in the second half of 2018.
  - Headline inflation projected to remain below, but close to, the target of 3 percent by the end of 2018.
  - NBG stands ready to postpone lowering the policy rate or tighten further if price pressures materialize.
- NBG institutional and operational enhancements:
  - Strengthening IT framework; inflation targeting regime remains appropriate.
  - Improved liquidity management with a new one-month liquidity facility.
  - Regular press briefings after Monetary Policy Committee meetings improve communication.
  - New manual for monetary operations (with IMF TA) to clarify operational aspects.
  - Staff support for enhanced communication, including on exchange rate policy.
- Prudential measures to contain household credit risks:
  - NBG established a cap on loans to households without verifiable income: 25 percent of banks’ regulatory capital.
  - Staff supports targeted, market-based macroprudential measures rather than broad administrative limits on FX lending.
  - Staff proposed measures:
    - Increase capital and/or provisioning for FX loans.
    - Establish lending limits on FX loans based on payment-to-income (PTI) and loan-to-value (LTV) ratios.
    - Higher premium on dollar deposits for the deposit insurance scheme.
    - Enhance dissemination of risks of FX borrowing and financial education.
- Banking sector resilience and crisis management:
  - 2015 lari depreciation showed banking sector resilience due to strong prudential regulation and supervision.
  - NBG has strengthened prudential regulation, supervision, and integrated macro-financial analysis.
  - Remaining needs: improve emergency liquidity assistance (ELA) and bank resolution for systemic institutions; clarify role of public stakeholders in line with 2014 FSAP recommendations.
- Prudential reforms implemented (2017–18 highlights):
  - Capital buffers: three systemically important banks (SIBs) identified with additional capital requirements of 1.5–2.5 percentage points phased in by 2021.
  - Countercyclical capital buffer effective December 2017.
  - Risk-based capital buffer on retail loans effective after November 30, 2017, anchors risk-weights on PTI and LTV ratios; higher requirements for FX loans.
  - Risk weights on newly issued consumer loans with low credit standards increased on average from 75 to 135 percent, cumulatively resulting in about 0.3 percentage points of additional capital.
  - Liquidity buffers: Basel III liquidity coverage ratio (LCR) effective September 2017.
  - Banks reduced deposit concentration and increased non-withdrawable certificates of deposit, especially for non-resident and FX deposits.
  - Calibration details: LTV ranges from 80 to 90 percent for Lari-denominated loans and 75 to 85 percent for FX loans; PTI ranges from 30 to 50 percent for hedged borrowers and 25 to 45 percent for unhedged borrowers.

*International Monetary Fund. Georgia: Article IV Consultation — selected chapter excerpts.*

### Box 3. Reforms to Build Financial Sector Resilience, 2017–18 (concluded)

### Box 3. Reforms to Build Financial Sector Resilience, 2017–18 (concluded)

### Liquidity and de-dollarization measures
- The lari LCR can fall to 75 percent if the overall LCR remains above 100 percent.
- The Basel III net stable funding ratio will be introduced in 2019, helping improve liquidity management over a one-year horizon.
- Differentiated reserve requirements by currency aim to incentivize de-dollarization in addition to mitigating liquidity risks.

### Strengthened supervision and oversight
- The NBG now has oversight over non-bank lenders, such as microfinance institutions and bank holding companies on a consolidated level.
- Legal amendments (December 2017) granted NBG oversight power to credit information bureaus and all other unregulated lenders, under the umbrella of consumer protection in financial-related activities.

### Deposit insurance and bank resolution
- Deposit insurance became effective January 2018, covering 90 percent of total deposit accounts (GEL 5,000 insured amount).
- Amendments to the Organic Law give NBG the authority to resolve a bank through a temporary administration.

### Responsible lending, consumer protection, and financial literacy
- The NBG amended regulations on product disclosure requirements and effective interest rates calculations.
- Programs are underway to enhance financial education and sensitize households on risks associated with financial imprudence, over-indebtedness, and FX borrowing.
- To address increasing household indebtedness, the NBG will be launching a responsible lending framework to restrict issuance of loans without detailed assessment of the customer's creditworthiness.
- Limits will be introduced on PTI and LTV, and the corresponding changes will be implemented to expand those regulations to non-banks.

### Institutional reforms for macro-financial analysis and transparency
- The operational framework of the Financial Stability Committee (FSC) has been strengthened:
  - The FSC meets once a quarter to analyze systemic risks, assess the cyclical position of the financial sector, and make decisions on countercyclical capital buffer and other macroprudential tools.
  - These decisions are communicated via a press release.
  - Twice per year, FSC meetings are followed by a press conference.
- A financial stability analysis department was created in 2017, responsible for macro-financial analyses.
- With IMF support, the NBG has started developing a macro-financial model, incorporating interlinkages between the real economy and the financial system to:
  - analyze financial and macroeconomic risks scenarios,
  - conduct macro-stress tests,
  - provide analytical support for macro-prudential policy.
- The NBG has published macroeconomic risk scenarios to assist financial institutions’ transition to IFRS 9 accounting rules, which will drive more forward-looking provisioning.
- The model will also serve as a tool for a renewed financial stability report, which is planned for 2019.

*Source: cr18198 - Box 3. Reforms to Build Financial Sector Resilience, 2017–18 (concluded).*

### 40.      Financial sector reforms are progressing (MEFP ¶18–26). The authorities met their

### 40.      Financial sector reforms are progressing (MEFP ¶18–26)

### Financial sector reforms and supervision
- The authorities met their commitments for the second review (MEFP Table 3).
- With help from MCM TA, the central bank introduced regulation and started supervision of non-bank financial institutions.
- Prudential regulation framework for microfinance institutions (MFIs) will be finalized by June 2018.
- Non-prudential regulation to other lenders will become effective in January 2019.
- To strengthen asset valuation, the NBG will introduce:
  - regulations on banks’ real estate appraisal of collateral in line with international valuation standards (SB, June 2018);
  - regulations on banks’ corporate governance in line with Basel principles (SB, September 2018);
  - leverage ratios based on Basel Principles and relevant EU regulations (SB, September 2018).
- To strengthen the crisis management framework, the authorities will submit to Parliament legal amendments to establish the emergency liquidity assistance and bank resolution frameworks (new SB, May 2019).
- The NBG is preparing guidelines to assess household credit worthiness.

### Structural policies and reforms
- The authorities emphasize implementing a comprehensive structural reform agenda to support robust and inclusive growth (MEFP, ¶27–34), aiming to:
  - scale infrastructure;
  - improve education;
  - improve the business environment;
  - strengthen foreign trade relations;
  - implement land reform.
- Expected benefits: boost long-term growth, diversify the economy, strengthen the external position, create jobs, and reduce poverty.
- Actions under way:
  - Creation of an independent pension agency (SB, June 2018), noting parliamentary discussions may delay implementation.
  - Government will submit to Parliament legislation (prepared in consultation with the IMF) to establish a rule-based mechanism to index basic pensions (new SB, February 2019).
  - Establishment of the Business House in 2019 to create a one-stop shop for businesses.
  - Introduction of IFRS for corporations to standardize financial reporting and promote a deeper domestic capital market.
  - Submission to Parliament of a new insolvency law (April 2019) to support restructuring of viable non-financial corporations.
- Note: The IMF provided technical assistance on the insolvency law reform in May 2018.

### Program modalities, financing, and targets
- Authorities and staff agreed on modifying targets for one quantitative performance criterion and updating conditionality (MEFP, Tables 1–4).
- Proposed adjustments:
  - Increase the floor on the NIR target to $1.49 billion by end-June 2018.
  - Establish the end-December target at $1.55 billion.
- New structural benchmarks (SBs) proposed for end-December 2018 on:
  1. expanding the 2019 FRS;
  2. adopting a decree to implement the PPP law;
  3. submitting to Parliament a revised penalty regime for taxpayers;
  4. submitting to Parliament a new fiscal rule framework.
- New SBs proposed for 2019 on:
  1. submitting to Parliament a proposal for a rule-based mechanism to index basic pensions (end-February 2019);
  2. submitting to Parliament legal amendments to strengthen the crisis management framework (end-May 2019);
  3. refunding automatically 90 percent of the validated VAT refund requests, upon request and after offsetting against existing tax liabilities (end-June 2019).
- Financing assurances:
  - The program is fully financed for the next 12 months, with support from the European Union and Agence Française de Développement.
  - Good financing prospects are in place for the remainder of the program.
- Debt and repayment capacity:
  - Georgia’s capacity to repay remains adequate.
  - Georgia’s debt profile continues to warrant low scrutiny under the Emerging Market Debt Sustainability Analysis.
  - Repayments to the IMF would peak at 0.4 percent of GDP or 1.9 percent of gross reserves in 2018, reflecting obligations under the previous Stand-by arrangement (Table 8).

### Risks, safeguards, and arrears
- Risks to the program are manageable; improved growth outlook may reduce short-term fiscal and external risks but could lead to complacency in structural reform implementation.
- The authorities’ strong commitment and ownership provide mitigation of these risks.
- The NBG continues to maintain a strong safeguards framework (MEFP, ¶35). With approval of the NBG Organic Law by Parliament in December 2017, the NBG has implemented the Fund’s safeguards recommendations.
- Negotiations of arrears with Turkmenistan continue; arrears predate the program and were covered under the Paris Club Agreement. The authorities continue negotiations on penalties.

### Staff appraisal — macroeconomic and policy recommendations
- Macroeconomic context and priorities:
  - Improved macroeconomic environment provides an opportunity to cement macroeconomic and financial stability and to advance structural reforms for higher and more inclusive growth.
  - External demand and domestic consumption have supported Georgia’s growth momentum; risks to the outlook remain.
  - Inflation has declined toward the NBG target, the external position has strengthened, and the fiscal position has improved.
  - The banking sector remains liquid, profitable, and well capitalized.
- Fiscal policy guidance:
  - To maintain fiscal prudence while creating space for investment in infrastructure and human capital:
    - contain current spending;
    - improve revenue administration;
    - manage fiscal risks.
  - The 2018 budget appropriately supports fiscal consolidation.
  - Financing additional public investment requires containing current spending, improving revenue administration, and strengthening public investment management.
  - Advance institutional fiscal reforms, including revamping the fiscal rule and expanding monitoring of fiscal risks.
- Monetary and financial sector guidance:
  - Monetary policy should remain focused on price stability, supported by exchange rate flexibility.
  - Continue close monitoring of price and wage pressures, and developments in monetary and financial conditions.
  - Foreign exchange interventions should remain limited to smoothing excessive exchange rate volatility and building reserves.
  - Strengthen liquidity management and improve communication to further improve the monetary policy framework and support exchange rate flexibility.
  - Address dollarization concerns with targeted and market-based prudential measures to internalize FX risks.
  - Consider establishing a crisis management framework, including emergency liquidity assistance, to guide decision-making in times of systemic stress.
- Structural reform priorities:
  - Focus on improving infrastructure, competitiveness, and education in line with the authorities’ Four-Point reform plan.
  - Strong implementation of the new PPP framework will help mobilize private investment.
  - Improving the business climate will increase productivity and competitiveness.
  - The new insolvency law for non-financial corporations and the Business House are positive steps.
  - Modernize vocational training and pursue major further reforms to improve education at all levels.
- Program endorsement:
  - Staff supports the authorities’ request for the completion of the Second Review under the Extended Fund Facility and the modification of a quantitative performance criterion.
  - Staff supports modifying the end-June 2018 NIR target and establishing the end-December 2018 quantitative performance criteria.

*cr18198 - 40.*

### 55.      Staff recommends that the Article IV Consultation with Georgia takes place on the

### cr18198 - 55.      Staff recommends that the Article IV Consultation with Georgia takes place on the

### Recommendation
- Staff recommends that the Article IV Consultation with Georgia takes place on the 24-month cycle, in accordance with Decision No. 14747-(10/96) on consultation cycles.

### Real sector and inflation developments
- Growth has accelerated supported by the recovery of the external environment.
- The lari started appreciating since the end of 2017.
- The NBG increased the policy rate to 7.25 percent in 2017.
- Inflation and monetary indicators from figures:
  - Real GDP growth (selected projections and historical): 2.9, 2.8, 4.3, 5.0, 4.2, 4.8, 4.8, 5.0, 5.2, 5.2 (see Table 1 rows: 2015–23 Real GDP).
  - CPI, Period average: 4.0, 2.1, 5.8, 6.0, 2.8, 2.8, 2.9, 3.0, 3.0, 3.0, 3.0 (Table 1).
  - CPI, End-of-period: 4.9, 1.8, 5.6, 6.7, 3.2, 2.7, 3.0, 3.0, 3.0, 3.0 (Table 1).

### External sector developments
- The current account deficit remains high but improved in 2017 thanks to exports, tourism, and remittances.
- Direct investment remained the dominant source of financial inflows in 2017 and was concentrated in transport and energy sectors.
- Reserve and intervention notes:
  - NBG’s intervention is mostly two-sided. Despite increasing, reserves remained low.
  - Gross international reserves (Table 1): 2.5, 2.8, 3.2, 3.0, 3.4, 3.3, 3.6, 4.0, 4.3, 4.8, 5.3 (2015–23, in billions of US$).
- Current account balance (percent of GDP) (Table 1 / Table 2 memorandum): -12.0, -12.8, -10.4, -8.7, -10.6, -9.2, -9.2, -8.8, -8.4, -7.8, -7.5 (2015–23).
- Trade balance (percent of GDP): -28.1, -26.9, -25.8, -25.3, -26.4, -27.2, -27.1, -27.2, -26.8, -26.3, -25.9 (2015–23).

### International Investment Position and external debt
- Net IIP continued to deteriorate in 2017, mostly due to higher FDI, while foreign assets increased especially in the banking and non-banking sectors.
- External debt dynamics are driven by the private sector; external public debt has long maturity and low interest rates.
- Gross external debt (Table 1): 107.6, 109.3, 106.9, 112.8, 106.4, 107.9, 107.9, 108.1, 108.7, 109.8, 108.5 (2015–23, percent of GDP).
- Gross external debt, excl. intercompany loans (Table 1): 86.1, 91.8, 87.4, 95.6, 86.5, 90.9, 90.6, 90.4, 90.7, 91.5, 88.8 (2015–23, percent of GDP).

### Fiscal sector developments
- The augmented fiscal balance has improved since 2016, driven by strong revenue performance and contained current spending; public investment is expanding.
- Public debt below 45 percent of GDP is exposed to FX risks.
- Key fiscal figures (Table 1):
  - Revenue and grants (percent of GDP): 28.1, 28.3, 28.9, 29.0, 28.6, 27.9, 27.3, 27.2, 27.2, 27.1, 27.0 (2015–23).
  - Total Expenditures (percent of GDP): 32.0, 32.5, 33.0, 32.7, 32.0, 31.1, 31.0, 30.8, 29.9, 29.7, 29.3 (2015–23).
  - Augmented balance (Program definition, percent of GDP): -2.7, -3.0, -3.6, -2.9, -3.0, -2.8, -2.6, -2.5, -2.4, -2.3, -2.2 (2015–23).
  - Public debt (percent of GDP): 41.4, 44.4, 42.3, 44.9, 42.7, 42.8, 43.5, 44.0, 43.6, 42.8, 41.2 (2015–23).

### Financial sector developments
- Banks are liquid and well capitalized; NPLs and watch loans are declining.
- Financial performance continues strong though declining; high profitability in a highly concentrated market.
- Selected banking indicators (Table 6 and Figures):
  - Nonperforming loans (national definition, percent of total loans): 7.5, 7.3, 6.0, 5.6 (2015–Mar 2018).
  - Loans collateralized by real estate (percent of total loans): 54.8, 59.2, 59.0, 58.7 (2015–Mar 2018).
  - Loans in foreign exchange (percent of total loans): 64.3, 65.4, 57.1, 55.2 (2015–Mar 2018).
  - Capital adequacy ratio (Basel I national definition, percent): 17.5, 15.0, 15.2, 19.0 (2015–Mar 2018).
  - Return on equity (cumulative through the year, annualized): 15.4, 19.2, 20.7, 20.6 (2015–Mar 2018).
  - Credit to private sector (annual percent change) (Table 1): 22.1, 19.6, 10.1, 17.6, 14.3, 14.1, 10.6, 10.5, 9.0, 8.4, 8.3 (2015–23).

### Macro-financial developments
- Georgia’s credit-to-GDP is comparable to peers and the credit gap is closing.
- Household debt driven by consumer and mortgage loans; household debt service remains manageable; no signs of pressures in real estate market or corporate debt service pressures.
- Credit-to-GDP ratio (Table 1): 49.2, 54.9, 55.3, 57.8, 58.5, 60.6, 61.9, 63.3, 63.6, 63.6, 63.6 (2015–23).

### Macro-structural challenges
- Social and structural indicators displayed in Figure 7 include:
  - GINI Coefficient (2004–2014 range shown with Georgia relative to CCA and SEE averages).
  - PISA Scores, 2015: Reading/Math/Science indexes with Georgia vs SEE Average.
  - Logistics Performance Index and Export Diversification indices show room for improvement relative to peers.
  - Global Competitiveness Index components highlight institutional, infrastructure, macroeconomic environment, health & primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation (2017–18).

### Public Debt Sustainability Analysis (DSA)
- As of May 02, 2018, key DSA projections and indicators (Figure 8, Figure 9, and tables):
  - Nominal gross public debt projections (percent of GDP): 35.9, 44.4, 44.9, 42.3, 42.6, 43.0, 42.5, 41.8, 40.3 (years 2016–23 in DSA table header).
  - Public gross financing needs (percent of GDP): 4.4, 4.9, 4.3, 6.1, 6.2, 6.3, 8.0, 5.5, 5.6 (2016–24 in DSA table header).
  - Real GDP growth assumptions in baseline: 4.7, 2.8, 5.0, 4.8, 4.8, 5.0, 5.2, 5.2, 5.2 (2016–24 baseline table).
  - Inflation (GDP deflator) path: 5.0, 4.2, 6.5, 3.8, 3.3, 3.0, 3.0, 3.0, 3.0 (2016–24).
  - Primary balance projections (percent of GDP) show small deficits and narrow variances across scenarios (see Figure 9 underlying assumptions).
- Alternative scenarios presented include Historical Scenario and Constant Primary Balance Scenario with associated debt trajectories (Figure 9).

### External debt sustainability and bound tests
- External debt (percent of GDP) baseline and shock tests (Figure 10 and Table 10):
  - Baseline external debt series and scenario averages: baseline around 89 (index reference in Figure 10), historical scenario values higher (e.g., historical 142 in one box).
  - Shocks considered include interest rate shock, current account shock, growth shock, combined shocks, and real depreciation (30 percent one-time depreciation in 2018).
  - Gross external financing need (in billions of US dollars, Table 10 / DSA): 4.9, 4.7, 5.3, 5.4, 6.0, 6.0, 6.3, 6.6, 6.9, 7.3 (2014–23 where indicated).

### Selected economic and financial indicators (highlights from tables)
- Nominal GDP (in billion of laris) (Table 1): 31.8, 34.0, 37.3, 38.0, 40.1, 41.4, 44.8, 48.4, 52.5, 56.9, 61.6 (2015–23).
- Nominal GDP (in billion of U.S. dollars) (Table 1): 14.0, 14.4, 15.0, 15.2, 16.3, 16.9, 18.3, 19.8, 21.5, 23.3, 25.2 (2015–23).
- Gross national saving (percent of GDP) (Table 1): 19.5, 19.9, 20.6, 23.2, 22.5, 25.5, 26.0, 26.7, 27.2, 27.4, 26.9 (2015–23).
- Investment (percent of GDP) (Table 1): 31.5, 32.7, 31.0, 31.9, 33.1, 34.7, 35.2, 35.5, 35.6, 35.2, 34.5 (2015–23).
- Deposit dollarization (percent of total) (Table 4 / Table 1): 66.8, 69.9, 64.8, 63.7, 64.1, 59.7, 57.5, 55.1, 54.0, 52.6, 50.8 (2015–23 projections / Mar 2018).

### Balance of payments and financing
- Summary Balance of Payments (Table 2, selected line items, in millions of US$):
  - Current account balance: -1,681 (2015), -1,840 (2016), -1,563 (2017 preliminary), -1,316 (2017 EFF 1st Review), -1,729 (2018), -1,555 (2018 projection), -1,681, -1,738, -1,796, -1,827, -1,899 (2019–23 projections).
  - Trade balance: -3,935 (2015), -3,869 (2016), -3,881 (2017 prelim), -3,841 (2017 EFF 1st Review), -4,292 (2018), -4,582 (2018 projection), -4,968, -5,391, -5,769, -6,134, -6,535 (2019–23).
  - Direct investment (net): 1,267 (2015), 1,177 (2016), 1,377 (2017 prelim), 1,594 (2017 EFF 1st Review), 1,459 (2018), 1,480 (2018 projection), 1,678, 1,826, 1,993, 2,197, 2,400 (2019–23).
  - Financial account (percent of GDP, memorandum): 10.8, 13.6, 10.5, 8.6, 10.8, 9.1, 9.8, 9.8, 9.6, 9.7, 9.2 (2015–23).

*Source: IMF staff.*

### Annex I. Status of Staff Recommendations Made in the

### Annex I. Status of Staff Recommendations Made in the 2016 Article IV Consultation

### Fiscal Policy
- Authorities have implemented prudent macroeconomic policies and several policy recommendations from the 2016 Article IV Consultation.
- Key measures in 2017:
  - Introduced revenue and spending measures to compensate for projected revenue losses associated with the corporate income tax reform (introduction of the Estonian dividend taxation system) and to create space for increasing capital spending.
  - Measures included increases in fuel and tobacco excises and freezes in current spending in real terms.
  - Civil service reform helped streamline the wage bill.
- Fiscal rule and risk management:
  - Based on recent IMF technical assistance, the government is considering ways to strengthen the fiscal rule.
  - The latest fiscal risk statement included a comprehensive analysis of major SOEs with detailed financial information, and incorporated a first assessment of fiscal risk exposures associated with PPAs in the energy sector.
  - A new framework for managing PPPs and PPAs is being developed.

### Financial Sector Policies
- Institutional and regulatory changes:
  - The government overhauled the draft law proposing to separate financial supervision from the central bank.
  - The NBG reaffirmed its independence and strengthened prudential regulation for banks.
  - Introduced LTV and PTI for mortgage loans.
  - Created a new department responsible for macro-financial and macro-prudential analysis.
- De-dollarization and FX risk mitigation:
  - Announced a conversion program for mortgages to reduce FX risks in the household sector.
  - Made lari pricing mandatory.
  - Banned foreign currency lending for all loans smaller than GEL100,000.
  - Introduced LCRs with preferential treatment for lari-denominated liabilities.
- Supervision extension:
  - Nonbanking institutions and credit bureaus have come under the supervision of the NBG, with regulatory requirements under way.

### Monetary and Exchange Rate Policies
- The NBG remains committed to its inflation-targeting regime with a flexible exchange rate.
- FX interventions are targeted toward smoothing excessive volatility and/or accumulating FX reserves.
- Liquidity management:
  - Expanded instruments with one-month open market operations.
  - The MoF started auctioning its deposits and issued a multiyear calendar for benchmark bonds.

### Structural Reforms
- Pension and PPP frameworks:
  - Authorities submitted to Parliament the pension reform establishing a funded pension pillar.
  - A new framework for PPPs was approved by Parliament.
- Other reforms and institutions:
  - Authorities are revamping the insolvency law and formulating a comprehensive education reform.
  - The deposit insurance agency was created in December 2017.

*Italic: Source: Annex I, "Status of Staff Recommendations Made in the 2016 Article IV Consultation."*

---

### Annex II. Risk Assessment Matrix — Key Risks, Likelihood, Time Horizon, Impacts, and Policy Responses

### Global Shocks
- Retreat from cross-border integration
  - Relative Likelihood/Time Horizon: Medium / Short to Medium Term
  - Expected impact if materialize: Medium — could jeopardize Georgia’s plans for economic diversification and to become a regional transit hub; reduction in exports and FDI will reduce growth; increase in external imbalances could put pressure on the lari.
  - Policy response:
    - Flexible exchange rate should serve as a first line of defense.
    - Accelerate implementation of structural reforms to enhance confidence and improve competitiveness.
    - Strengthen fiscal sustainability and financial stability to weather external shocks from a stronger position.

### Financial Conditions and Nonbank Risks
- Tighter global financial conditions; migration of activities outside traditional banking
  - Relative Likelihood/Time Horizon: High / Short to Medium Term (tighter global financial conditions); Medium / Medium Term (migration outside banking)
  - Expected impact: Medium — higher lari volatility and depreciating pressures could generate negative balance-sheet effects and negatively affect financial stability; increased financing costs given large external financing requirements.
  - Policy response:
    - Flexible exchange rate as first line of defense.
    - Continue de-dollarization efforts on both loans and deposits, supported by policies compatible with market-driven outcomes.
    - Strengthen financial stability, bolster inflation targeting and bank resolution frameworks.

### Weaker-than-expected Global Growth
- Drivers include structurally weak growth in key advanced economies and potential China slowdown
  - Relative Likelihood/Time Horizon: High / Medium Term (structurally weak growth); Low/Medium / Short to Medium Term (China slowdown)
  - Expected impact: Medium — weaker global demand risks envisioned economic recovery; lower growth could reduce buy-in for structural reforms.
  - Policy response:
    - Flexible exchange rate as first line of defense.
    - Accelerate structural reforms, including on education.
    - Strengthen fiscal sustainability and financial stability.
    - Strengthen social safety nets.

### Cyber-attacks
- Cyber-attacks on interconnected financial systems and broader institutions
  - Relative Likelihood/Time Horizon: Medium / Short to Medium Term
  - Expected impact: Medium — Georgia has adopted cybersecurity legislation, but effectiveness could be challenging depending on attack nature.
  - Policy response:
    - Strengthen banking regulation and supervision to ensure preparedness to address risks, including from cyber-attacks.

### Georgia-Specific Risks
- Financial risks
  - Relative Likelihood/Time Horizon: Medium / Medium
  - Policy response: Use flexible exchange rate; accelerate structural reforms; strengthen fiscal sustainability and financial stability.
- Fiscal risks
  - Relative Likelihood/Time Horizon: High / High
  - (Policy responses emphasized in fiscal and macro sections above.)
- Political risks (reform fatigue/backlash)
  - Relative Likelihood/Time Horizon: Low / Medium

*Italic: Source: Annex II, "Risk Assessment Matrix."*

---

### Annex III. External Sector Assessment — Findings, Indicators, and Projections

### Current Account and Real Exchange Rate: Findings
- 1. Current account performance in 2017:
  - CA deficit in 2017: 8.7 percent of GDP.
  - Improvement: about 3 percentage points better than the 2014–16 average.
  - Factors:
    - Lower trade deficit, strong tourism receipts, and robust remittances’ growth.
    - Terms of trade: a 3 percent decline year-over-year.
    - Tourism receipts grew 30 percent year-over-year, driven by strong tourist arrivals.
    - Income account deficit deteriorated to 5.4 percent of GDP in 2017 due to large profit repatriation from FDI.
- 2. Structural reform needs:
  - Export product diversification is relatively low versus comparators.
  - Ongoing free trade agreements with the European Union, China, and Hong Kong SAR expected to expand export opportunities.
  - Over the medium term, current account deficit is projected to narrow to 7.5 percent of GDP.
- 3. Exchange rates and reserves opportunity:
  - At end-2017, nominal and real effective exchange rates stabilized around end-2016 levels.
  - Improved CA in 2017 led to appreciation of NEER and REER up until April 2017, providing an opportunity to strengthen FX reserves.

### Quantitative Assessment (EBA-lite and REER approaches)
- 4. EBA-lite results:
  - CA method suggests a current gap of -0.3 percent of GDP in 2017, down from -2 percent of GDP during the first review.
  - The CA gap corresponds to a REER overvaluation of 0.6 percent (5.1 percent during the first review).
  - Cyclical and structural drivers: residuals (-1.7 percent of GDP) may reflect underdeveloped financial system and weak education system.
  - Policy gap contribution: 1.5 percent (supports narrowing of CA gap).
- Annex Table 1 (selected entries, in percent):
  - Second Review CA-Projected: -8.7
  - First Review CA-Projected: -10.4
  - Cyclical Contributions (from model): 0.2 (Second Review), 0.1 (First Review)
  - Cyclically adjusted CA: -8.9 (Second Review), -10.5 (First Review)
  - CA-Norm: -8.4 (Second Review), -8.4 (First Review)
  - CA-Gap: -0.3 (Second Review), -2.0 (First Review)
  - Policy gap: 1.5 (both reviews)
  - Elasticity: -0.4 (both reviews)
  - REER Gap: 0.6 (Second Review), 5.1 (First Review)
- 5. Adjusted REER (PPP-based) approach:
  - A regression following Rodrik (2008) implies a 10 percent increase in GDP per capita leads to a 3.5 percent appreciation of the real exchange rate.
  - This implies a 5 percent overvaluation of the real exchange rate for Georgia.

### External Balance Sheets and Capital Flows
- 6. International Investment Position (IIP) and liabilities:
  - As of end-2017, Georgia’s liabilities to non-residents exceeded its foreign assets by 150 percent of GDP (negative net IIP).
  - During 2014–17, gross foreign liabilities increased by almost 70 percentage points of GDP, to 211 percent of GDP.
  - More than half of the increase is explained by FDI.
  - As of December 2017, the stock of FDI increased by almost 40 percent to about 115 percent of GDP.
  - Remaining increases in liabilities explained by nonbank, general government, and bank loans.
  - NIIP is expected to deteriorate further but at a slower pace as the CA deficit improves over the medium term.
- 7. External sustainability approach:
  - Suggests an overvaluation of 7.7 percent, assuming a NIIP anchor of -60 percent of GDP.
  - Under that assumption, CA norm in 2023 would need to be -5.6 percent of GDP versus a projected CA deficit at 7.7 percent of GDP, implying REER overvaluation of 5.4 percent.
  - Sensitivity: anchoring NIIP at -80 percent of GDP would imply CA norm of -7.1 percent of GDP, equivalent to a 1.7 percent overvaluation.
- 8. Capital and financial flows:
  - FDI has been a major source of CA financing: about 11 percent of GDP during 2014–17.
  - FDI inflows concentrated in transports and communication, construction, real estate and energy.
  - Completion of a large energy-related project in 2018 may slow FDI in the near term.
  - FDI inflows are expected to stabilize at about 10 percent of GDP in the medium term.
  - Government access to external loans: most are concessional with favorable interest rates, long maturity, and grace periods.
  - Banks and nonbank sectors have undertaken external loans and portfolio investment.
  - In 2017, the Bank of Georgia issued a GEL-denominated bond internationally.

### Reserves and FX Intervention
- 9. Reserves:
  - Gross international reserves (GIR) increased by $283 million to $3 billion in 2017.
  - GIR at 90 percent of the ARA metric — assessed to be below its adequate level for Georgia.
  - Authorities committed to further reserve accumulation under Georgia’s IMF-supported program.
  - GIR projected to reach 125 percent of the ARA metric by 2023.
- 10. NBG FX intervention:
  - NBG committed to a floating exchange rate regime; FX intervention not targeting any specific exchange rate value.
  - To fulfill conditionality on the floor of NIR under the EFF program, as of April 2018 the authorities purchased FX ($20 million), taking advantage of the appreciating lari.

*Italic: Source: Annex III, "External Sector Assessment."*

### 2.      Robust economic growth provides an opportunity for steadfast implementation of our

### 2.      Robust economic growth provides an opportunity for steadfast implementation of our

### Macroeconomic developments and recent performance
- Growth in 2017 was 5.0 percent, higher than the 3.5 percent projected at the time of the program approval.
- Inflation declined significantly in early 2018 after being temporarily above the NBG’s target in 2017 due to higher excise taxes and import prices.
- The current account deficit narrowed to 8.7 percent of GDP in 2017, from 12.8 percent of GDP in 2016, driven by growth in exports, tourism and remittances, and subdued import growth.
- Foreign direct investment reached $1.86 billion in 2017.
- Strengthened external position allowed boosting FX reserves above the program ceiling.
- Larization measures and improved confidence led to a decline in both deposit and loan dollarization.
- Georgia ranked 9th in the World Bank’s Doing Business Report and 5th in the Open Budget Survey.
- In March (2018) Moody’s upgraded the credit rating from Ba3 to Ba2; Fitch Ratings improved the credit outlook from stable to positive.

### Program performance, financing, and requests
- All end-December quantitative performance criteria have been met; inflation has remained within the inflation consultation clause (ICC).
- Most structural benchmarks through end-March have been adopted; the indicative target on net primary expenses for end-December was marginally missed.
- Request to modify a quantitative performance criterion and complete the Second Review under the Extended Fund Facility and release the related purchase.
- Intention to purchase a further SDR 30 million, bringing drawings under the program to SDR 90 million.
- Program monitoring: quantitative performance criteria, an indicative target, and an inflation consultation clause with end-June and end-December test dates, and continuous performance criteria; structural benchmarks set out in MEFP Tables 1–3 and TMU definitions.
- Review schedule: Third Review based on end-June 2018 performance criteria, expected on or after October 26, 2018; Fourth Review based on end-December 2018 performance criteria, expected on or after April 12, 2019.

### Outlook and projections
- Expectation of continued robust growth in 2018 supported by a favorable external environment, domestic consumption, and public investment.
- Current account deficit projected at 9.2 percent of GDP in 2018, before declining gradually to below 8 percent of GDP over the medium term.
- External financing will continue to rely mostly on FDI; stronger external position will allow building international reserves over the medium term.
- Risks to the medium-term outlook are balanced: upside from stronger domestic and external demand; downside from regional developments, retreat from cross-border integration, weaker growth in advanced economies, and fiscal risks.
- Policy buffers: commitment to sound macroeconomic policies, a flexible exchange rate, and a well-capitalized and liquid banking system; IMF-supported program provides an additional anchor.

### Fiscal policy: recent outcomes and 2018 stance
- 2017 augmented fiscal deficit (TMU definition): GEL1,113 million or 2.9 percent of GDP, below program ceiling GEL1,335 million or 3.6 percent of GDP.
- Augmented deficit target for 2018 (performance criterion): GEL1,150 or 2.8 percent of GDP; end-June ceiling on the augmented deficit: GEL430 million.
- Plan to refund GEL400 million in VAT credits in 2018 (doubling the initial budget projection); any additional refunds accommodated through an adjustor (see TMU ¶14).
- Commitment to keep current primary spending constant in real terms; introduced new civil service law and civil service remuneration law (structural benchmark, December 2017).
- Marginal excess of indicative target on primary current expenses by GEL28 million related to donor-financed projects.
- Fiscal strategy: use revenue over-performance or savings to accelerate capital spending and high priority net acquisition of non-financial assets; under-execution in investment to be used toward a lower deficit if needed.
- Medium-term objective: reduce augmented cash deficit of general government to 2.5 percent of GDP by 2020 while significantly increasing capital spending.
- Targets for primary current spending: from almost 25 percent of GDP in 2016 to 20.4 percent of GDP by 2020.
- Not planning to extend the dividend distribution model to financial institutions until 2023 (would limit revenue loss up to 0.5 percent of GDP); may consider earlier move for the insurance sector in consultation with the Fund.
- Commitment to avoid domestic/external debt payment arrears and other fiscal risks:
  - Will not (i) accumulate any general government’s external debt payment arrears outside those under negotiation (performance criterion); (ii) accumulate net domestic expenditure arrears of the general government (indicative target); or (iii) issue new public guarantees (performance criterion), or comfort letters.
  - Partnership Fund (PF) constraints: pursue only commercial objectives; not run a cash deficit (performance criterion) or issue new guarantees; new net borrowing of PF limited to $20 million at end-June and end-December 2018 (cumulative from the beginning of the EFF program, performance criterion); maintain a non-negative cash position at PF by end-June and end-December 2018 (performance criterion).
  - Refrain from initiating any PPPs, including PPAs, until PPP framework is operationalized; PPAs currently under negotiation permitted to proceed only under specified terms (guaranteed purchase period ≤ 8 months/year; guaranteed purchase tariff ≤ US 6c kWh; cumulative installed capacity of projects under negotiations will not exceed MW650).
  - Decision not to pursue Koromkheti HPP (MW150); negotiations on Namakhvani HPP Cascade Project (MW433) ongoing.
  - Export Credit Agency (ECA): capital to be constituted by a $20-million equity injection by the Partnership Fund distributed over 3 years; a revolving fund for potential losses totaling GEL50 million from the state budget; ECA to provide guarantees and insurances related to export operations, be subject to insurance regulation and supervision, and not receive explicit government guarantees.
  - Considering a credit guarantee scheme (CGS) for SMEs designed to limit fiscal risks (limited size, targeted, easy to dismantle, transparently incorporated in the budget, market-based operations).

### Structural fiscal policies and revenue administration reforms
- Implementing a 3-year plan following 2016 Tax Administration Diagnostic Assessment and IMF TA, focused on:
  - Organizational restructuring of Georgia’s Revenue Services (GRS) into a function-based headquarters (structural benchmark, February 2018); transfer of all core HQ functions from field offices to headquarters completed in May 2018.
  - Improving VAT tax administration:
    - Aim to reduce by at least 50 percent by end-2021 the outstanding stock of unrefunded VAT credits that are within the limitation period for audit.
    - Established a steering committee (MoF, GRS, GTS) which proposed necessary legal amendments or ministerial decrees in May 2018.
    - Commit to risk-assess 100 percent of declarations for the stock of existing credits within the next two years.
    - Creation of a specialized VAT unit in GRS’s audit department (structural benchmark, June 2018) to review VAT declarations; fully operational by June 2018.
    - Automatic risk assessment for all new VAT declarations starting January 2019; fully automated system by end-2018.
    - Under the automated system, 90 percent of new declarations with the lowest risk score will not be subject to further manual review and will be immediately eligible for a refund if requested and no outstanding tax liabilities (new structural benchmark, June 2019). The 90 percent target to be achieved within six months from the start of the automated repayment system. The 10 percent highest risk declarations to be reviewed by the specialized VAT unit.
    - From January 2020, all risk-assessed new credits approved by the system will be either offset against existing liabilities or refunded without need for an explicit request for refund; VAT declaration form will be changed accordingly.
  - Compliance improvements with IMF TA on compliance risk analysis and data management; plan to increase audit capacity and adopt risk-based audits; pilot audit case management system in early 2019.
  - Filing compliance: key performance indicators established; by end-2018 GRS to improve the taxpayer register, submit legal amendments so an unfiled declaration is no longer deemed a nil declaration where GRS requires a declaration, and set up an organizational unit to deal with filing default and late filing for all revenue types.
  - Penalty regime: submit to Parliament a revised penalty regime with gradual tax-geared penalties depending on degree of culpability (new structural benchmark, December 2018).
  - Automatic access to third-party information from appropriate government agencies (tentatively by end-2018): (i) National Agency of Public Registry on real estate, rentals and leases, and on JSC partners and changes in company equity; (ii) municipalities on construction permits; (iii) Financial Monitoring Service on suspicious transactions as defined in the law on facilitating the prevention of illicit income legislation.

*Source: cr18198 - 2.      Robust economic growth provides an opportunity for steadfast implementation of our*

### 12.      We are committed to contain fiscal risks to safeguard fiscal sustainability. We understand

### 12.      We are committed to contain fiscal risks to safeguard fiscal sustainability. We understand

### PPPs, PPAs, and legislative reforms
- Adopt a new PPP law and associated regulations.
  - Submitted a PPP Law to Parliament (structural benchmark, December 2017) that includes sound elements following best international practices, with assistance from the World Bank (WB), the Asian Development Bank (ADB), the EBRD, and the IMF.
  - Parliament approved the new PPP law in May.
  - Commit to consult with the IMF on secondary legislation, PPPs ceilings, and PPPs guidelines.
  - Government decree implementing the PPP law will incorporate IMF recommendations, including:
    - (i) coverage, notably explicitly incorporating PPAs, to the coverage of the PPP law;
    - (ii) definitions, specifically, of the principle of value for money (VfM);
    - (iii) protecting the gatekeeper role of the MOF;
    - (iv) a requirement for any PPPs agreed as a result of direct negotiations (except for those in the national security sector) to be fully transparent i.e. the PPP contract and its appendices to be published, including a summary of the project key financial indicators and the feasibility study, with PPP contracts in the energy sector above 100MW requiring an independent feasibility study;
    - (v) limiting the participation of public sector entities in institutional PPPs;
    - (v) requirements regarding pre-feasibility studies and components thereof;
    - (vii) transparency of PPPs and the selection process.
  - In consultation with the Fund, adopt the government decree implementing the PPP law (new structural benchmark, end-December 2018).

### Fiscal Risk Statement (FRS) enhancements
- Continue strengthening the Fiscal Risk Statement accompanying the budget.
  - 2018 FRS reported fiscal risks on all existing PPP-associated liabilities; and expanded the analysis of SOE’s contingent liabilities, including a quantitative reporting of quasi-fiscal operations (structural benchmark, end-December 2017).
    - Expanded historical financial analysis of SOEs to five years.
    - Described historical trends of the size of the SOE sector relative to the economy.
    - Provided analysis of factors driving financial performance and position of both key individual and overall SOEs.
    - Identified and evaluated major quasi fiscal activities.
  - 2019 FRS will expand analysis of fiscal risks stemming from PPPs and PPAs, and SOEs (new structural benchmark, December 2018).
    - For PPPs and PPAs, the 2019 FRS will disclose:
      - (i) in addition to the NPV, the total nominal value of the aggregate exposure per year for the complete lifespan of these projects;
      - (ii) the aggregate total nominal exposure of the riskiest top 3/5/10 projects, by year for the period of the agreements, and their NPVs;
      - (iii) the total nominal net payments for the base case and alternative scenarios, and their NPVs.
    - The 2019 FRS will also include financial baseline projections for major SOEs, covering the year of the FRS and the year after, which will be used as the basis for sensitivity analysis.
  - For the MoF fiscal risks management unit:
    - Commit to recruit new staff with practical corporate finance experience.
    - Intensify training in corporate finance of existing staff.

### Strengthening SOE monitoring and supervision
- Ensure largest SOEs (first and second category SOEs as defined by legislation) will be IFRS-compliant by October 2019.
- MoF and MOESD will collect comprehensive data on SOEs at least annually, including:
  - performance information;
  - transfers between the state and SOEs and among SOEs;
  - borrowing;
  - guarantees;
  - any litigation.
- By December 2018, assess the need for legal and/or regulatory changes to institutionalize, standardize and centralize powers for supervision of SOEs under the MOESD and MOF to support adequate financial performance and control of SOEs.

### Public Investment Management Framework (PIMF) improvements
- Strengthen MoF’s role in public investment management.
  - Created a dedicated public investment unit at the MoF to centralize information on public investment projects.
  - The unit will evaluate investment projects based on cost/benefit analysis and other relevant analyses.
  - Objectives:
    - establish a single project pipeline;
    - support adequate project evaluations;
    - help prioritize investment projects and identify their financing;
    - integrate projects within the MTBF.
  - PIMF will cover PPP-type projects to ensure they are prioritized and assessed alongside traditionally-procured projects.
  - In coordination with the IMF, commit to strengthen further the PIMF following IMF TA recommendations from the Public Investment Management Assessment conducted in May 2018.

### Fiscal transparency, rules, and reporting
- Improve 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 and flexibility over the economic cycle.
  - Submit to parliament a revised fiscal framework following IMF recommendations in the TA report of November 2017 (new structural benchmark, December 2018).
  - Revised fiscal rule will:
    - apply to fiscal outturns;
    - clarify definitions of aggregates and escape clauses;
    - enhance coverage, communication, transparency, and oversight.
- Guidelines for new budget lending operations.
  - Issued guidelines requiring reasonable expectation of repayment of budget lending operations (structural benchmark, December 2017), in consultation with the IMF.
  - Prepare the 2019 State Budget applying the GFS classification of equity injections and on-lending, per the reasonable commercial return test; if not met, these equity injections will be treated as subsidies or transfers.
- Improve quality and coverage of fiscal reports.
  - Explain revisions to medium-term budget estimates in the annual budget document.
  - Included 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 GFSM2014 standards.
  - Upgrade public finances presentation from GFSM 2001 to GFSM 2014 classification in the context of the 2019 budget.
- Comply with international accounting standards.
  - Starting in 2021, produce an annual consolidated general government sector financial report based on International Public-Sector Accounting Standards (IPSAS) basis.

---

*Source: cr18198 - 12.      We are committed to contain fiscal risks to safeguard fiscal sustainability. We understand*

### 26.      Achieving more robust and inclusive growth will require advancing our comprehensive

### Achieving more robust and inclusive growth will require advancing our comprehensive structural reform agenda

### Structural reform objectives and partner support
- Reform partners: World Bank (WB), the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB), KfW Development Bank, Agence Française de Développement (AFD), and the European Commission.
- Stated aims of the reform program:
  - Scale-up infrastructure spending.
  - Improve education and vocational training.
  - Improve the business environment.
  - Strengthen foreign trade relations.
  - Implement land reform.
  - Boost long-term growth, diversify the economy, strengthen the external position, create jobs and reduce poverty.
  - Continue targeted social assistance and health care to protect the most vulnerable.

### Infrastructure and spatial planning
- Key projects and goals:
  - Finalize the East-West highway and the South-North corridor by 2020.
  - Additional projects: ports, airports, and railways to transform Georgia into a transport and logistics hub connecting Europe with Asia.
  - Develop radial roads to better connect regions and urban and rural areas.
  - Improve public investment efficiency and transparency by aligning public procurement with international standards.
  - Government support for tourism development (including water and electricity infrastructure) to turn Georgia into a four-season tourist destination.

### Education and labor market reform
- Comprehensive education reform areas to be designed with partners:
  - (i) early childhood education; (ii) secondary education; (iii) vocational education and training; (iv) higher education; and (v) science and research.
- Reform objectives:
  - Improve job creation, productivity and wages.
  - Address reported lack of qualified labor force and high unemployment and underemployment indicating skill mismatches.
- Reform elements:
  - Set curriculum standards.
  - Implement a new teacher policy framework.
  - Provide more effective vocational training and adult learning.
  - Encourage employer participation in curriculum design.
  - Support job seekers with guidance on job selection, preparation and retraining.

### Pension reform and social protection
- Commitments and timeline:
  - Introduce a funded pension pillar in 2018 to promote savings and create an institutional investor for long-term lari assets.
  - Submitted to Parliament a law establishing a Pilar II pension system (structural benchmark, December 2017).
  - Creation of an independent pension agency (structural benchmark, July 2018).
  - Commit to formulate a private pension savings system (Pillar 3) in 2018.
- Basic public pension amounts and changes:
  - Current basic public pension: GEL180 per month.
  - Increase to GEL200 per month in 2019.
  - Increase to GEL220 per month in 2020.
- Further action:
  - In consultation with the IMF, submit to Parliament legislation proposing a rule-based mechanism to index basic pensions (new structural benchmark, February 2019).

### Business environment reforms
- Planned measures:
  - Establish a Business House by 2019 to provide public services to enterprises under a one-stop shop.
  - Introduce IFRS for corporations.
  - Submit to Parliament a new insolvency law by April 2019 to support adequate restructuring for viable non-financial corporations.
  - Improve VAT tax system efficiency.
  - Widely apply regulatory impact assessments for major policy decisions.

### Land registration and rural development
- Policy actions:
  - Simplify land registration, especially for agricultural land plots, through a fee waiver program.
  - Assist citizens in searching for property ownership documents.
  - Facilitate dispute resolution through mediation.
- Current coverage:
  - Registered land plots amount to 1.8 million, where 25 percent of those were registered within the land reform launched on August 1, 2016.

### Trade policy priorities
- Rationale: As a small open economy, FTAs help mobilize FDI in tradable sectors, improve competitiveness, reduce external vulnerabilities, and generate balanced growth.
- Existing FTAs:
  - EU (Deep and Comprehensive Free Trade Area), EFTA, People’s Republic of China, Turkey, and the Commonwealth of Independent States countries.
- Negotiations and expected agreements:
  - FTA negotiations concluded with Hong Kong Special Administrative Region; agreement expected to be signed by June 2018.
  - Negotiating with Turkey an expansion of the current FTA.
  - Committed to pursue other FTAs with priority countries, including the United States, India, and others.

### Strengthening statistics and data dissemination
- Areas of IMF technical assistance: national accounts, external sector statistics, and financial and sectoral accounts.
- Publication and survey plans and milestones:
  - Quarterly unemployment figures: delayed due to census technical issues; commit to publish by September 2018.
  - Broaden employment statistics by publishing hours worked.
  - Conduct a structure of earnings survey in 2018.
  - Completed back-calculations for population figures to reconcile differences between the 2014 and 2002 census results.
  - Plan to publish the new population data by April 2018.
  - Start publishing national accounts based on NACE 2 sectoral classification by November 2019.
  - Compute GDP based on supply and use tables and publish quarterly GDP by expenditure in constant prices.
  - Publish updated poverty figures in May 2018.
  - Start publishing quarterly statistics on inbound tourism in the first half of 2018 to strengthen balance of payments statistics.

### Program monitoring and safeguards
- Monitoring framework:
  - The program will be 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.
  - Quantitative performance criteria and indicative targets listed in Table 2; structural benchmarks in Table 3; Technical Memorandum of Understanding attached to describe definitions and data provision requirements.
- National Bank of Georgia (NBG) safeguards actions:
  - Submitted and Parliament approved 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; and (iii) early appointment of external auditor for NBG.
  - Continue to engage independent external audit firms to conduct the audit of the NBG in accordance with international standards.

### Selected quantitative and benchmark items (as reported)
- Inflation consultation mechanism:
  - Inflation identified as the 12-month percentage change of the consumer price index (CPI) as measured and published by GEOSTAT.
  - Inflation consultation bands set for each test date; consultations triggered if inflation falls outside inner or outer bands.
- Example fiscal and reserves targets (from program tables):
  - Ceiling on augmented general government deficit (program definition) — sample figures reported: Proposed End-December Target 1,335; Outturn 1,113; Status Met.
  - Floor on NIR of NBG (end-period stock, million of U.S. dollars) — sample figures reported: Proposed End-December Target 1,350; Outturn 1,416; Status Met.
  - Ceiling on the accumulation of external debt arrears of the Public Sector (continuous criterion) — reported targets/outturn: 0 / 0 / Met.
  - Ceiling on new public guarantees (continuous criterion) — reported targets/outturn: 0 / 0 / Met.
  - Ceiling on the cash deficit of the Partnership Fund — sample reported target/outturn: 0 / 22 / Met.
  - Ceiling on new net borrowing of the Partnership Fund (million of U.S. dollars, cumulative from the beginning of the EFF program) — sample reported target/outturn: 20 / 20 / Met.
  - Indicative target: Ceiling on Primary Current Expenditures of the General Government (in mn lari) — sample figures reported: Proposed End-December Target 8,685; Outturn 8,713; Status Not Met.
- Structural benchmarks (selection of completed and scheduled items):
  - Met (examples):
    - Introduction of LCR for commercial banks, with preferential treatment of GEL-deposits — End-September 2017 — Met.
    - Adoption of regulation on capital add-ons in CAR for systemically important banks — End-December 2017 — Met.
    - Submit to Parliament legislation giving NBG oversight power over credit information bureaus — End-December 2017 — Met.
    - Increase in minimum regulatory capital for commercial banks to GEL50 million, phased in by 2019 — End-June 2017 — Met.
    - Publication of a multi-year calendar for government benchmark bonds — End-December 2017 — Met.
    - Signing of a Memorandum of Understanding between the Ministry of Finance and the NBG on information sharing for liquidity forecasting purposes — End-June 2017 — Met.
    - Submission to Parliament legislation establishing deposit insurance as of January 1, 2018 — End-June 2017 — Met.
    - Submit to Parliament amendments to NBG Law to give authority to resolve a bank through temporary administration — End-September 2017 — Met.
    - Submission of a pension law establishing a 2nd pillar pension system, and introducing indexation of basic public pensions — End-December 2017 — Met.
  - In progress / Not met / Scheduled (examples):
    - The steering committee to propose legal amendments to facilitate the action plan to address outstanding VAT claims — Mar-18 — Not met.
    - Create a new specialized VAT unit focusing on validating VAT claims — Jun-18 — In progress.
    - Introduce regulation on bank’s real estate appraisal in line with International Valuation Standards — Jun-18 — In progress.
    - Establish an independent pension agency — Jun-18 / Jul-18.
    - Introduce regulation on leverage ratio based on Basel Principles and relevant EU regulation — Sep-18 — In progress.
    - Introduce regulation on banks corporate governance in line with Basel Principles — Sep-18 — In progress.
    - Proposed benchmarks with completion dates include: Dec-18 and Feb-19 and May-19 and Jun-19 items such as expanding fiscal risk analysis in the 2019 FRS, adopting government decree implementing the PPP law, submitting a revised penalty regime, submitting a new fiscal rule framework, proposing a rule-based mechanism to index basic pensions (Feb-19), and legal amendments on banking resolution and lender-of-last-resort roles (May-19). One target: "90 percent of the VAT refund requests approved by the system will be automatically refunded, upon request, after offsetting against existing tax liabilities (MEFP II 11)" — Jun-19.

*Source: IMF staff and Georgian authorities, as presented in the program documentation.*

### 9.      Definition: The augmented cash balance of the general government is defined as: revenues

### 9–30: Definition and Monitoring of the Augmented Cash Balance, Expenditure Ceilings, Arrears, Partnership Fund, and Net International Reserves (Georgia)

### Definition: Augmented Cash Balance of the General Government
- Augmented cash balance = revenues minus expense, minus net acquisition of non-financial assets (as defined by GFSM 2001) minus net budget lending (as defined below).
- A negative augmented cash balance is a deficit.
- Measurement (financing side) at current exchange rates established by the NBG at the date of the transaction.
- Augmented cash deficit measured by:
  - i) net acquisition of financial assets (including changes in balances of the revenue reserve account), excluding net budget lending as defined by GFSM 2001;
  - minus ii) net incurrence in domestic and foreign liabilities as defined in GFSM 2001.

### Definition: Net Budget Lending
- Consistent with GFSM 2001, net budget lending is defined as the net acquisition of financial assets for policy purposes by the general government.

### Adjustors to the Ceiling on the Augmented Cash Deficit
- Adjustor (foreign-financed project loan disbursements):
  - The ceiling on augmented cash deficit will be adjusted upward (higher deficit)/downward (lower deficit) by the cumulative total amount of foreign-financed project loan disbursements above/below the program amounts (Table 2), subject to a cap of $60 million per year.
- Adjustor (receipts from sale of non-financial assets):
  - The ceiling will be adjusted downward (lower deficit) by the cumulative amount of receipts from sale of non-financial assets above the program amounts (Table 2).
- Adjustor (VAT credits refunded in cash):
  - The ceiling will be adjusted upward (higher deficit)/downward (lower deficit) by the amount of VAT credits refunded in cash above/below the program amounts (Table 2).

### Table 2: Projected Financing for Cash Deficit of the General Government (in millions of GEL, cumulative from the beginning of the calendar year)
- June 30, 2018 / December 31, 2018
  - Disbursements of foreign-financed project loans: 673 / 1214
  - Receipts from sale of non-financial assets: 69 / 150
  - VAT refunds: 200 / 400

### Reporting and Supporting Material for Augmented Cash Balance
- a. Data on domestic bank and nonbank financing will be provided to the IMF by the NBG and the Treasury Department of the Ministry of Finance within four weeks after the end of each month.
- b. Data on external project financing as well as other external borrowing will be provided to the IMF monthly by the Ministry of Finance (specifying projects by creditor) within two weeks of the end of each month.
- c. Data will be provided at actual exchange rates.
- d. Data on receipts from sales of non-financial and financial assets of the general government will be provided by the Treasury Department of the Ministry of Finance to the IMF on a monthly basis within two weeks of the end of each month.
- e. Data on securitized debt sold by the NBG, including the securities that have been purchased by nonbanks, will be reported by the NBG to the IMF on a monthly basis within two weeks of the end of each month.
- f. Separately for VAT and non-VAT tax credits, data for the previous month will be provided by the Georgia Revenue Service by the end of each month on:
  - Opening balance of tax credits (stock) and of new tax credits declared by taxpayers,
  - Tax credit balance adjustments made by GRS after desk check / audit,
  - Credit refunds paid in cash, offset against existing VAT liabilities, and offset against existing non-VAT liabilities,
  - Other flows,
  - Closing balance of tax credits (stock) and of tax credits older than three years (stock),
  - Number of claims for cash refund received,
  - Total amounts claimed for cash refund, and
  - Number of refunds made, number of refunds made automatically and total amounts refunded automatically.

### Ceiling on Current Primary Expenditures of the General Government
- Definition: primary current expenditures = expense (as defined by GFSM 2001) on a cash basis, minus interest payments.
- Supporting material:
  - Data for monitoring expenditures will come from the accounts of the general government covered under the ceiling on the augmented cash deficit of the general government (including autonomous regions).
  - The Ministry of Finance is responsible for providing reporting according to the above definition.
  - Data on expense and net acquisition of non-financial assets of the general government should be reported to the IMF within four weeks after the end of the quarter.

### Continuous Performance Criterion: Accumulation of General Government External Debt Arrears
- Definition of debt: as set forth in point No. 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements (Decision No. 15688-(14/107) adopted on December 5, 2014).
- External debt is defined by the residency of the creditor.
- For the program, external payment arrears consist of all overdue debt service obligations (i.e. payments of principal or interest, considering contractual grace periods) arising in respect of any debt contracted or guaranteed or assumed by the central government, or the NBG, or any agency acting on behalf of the general government.
- The ceiling on new external payments arrears shall apply on a continuous basis throughout the period of the arrangement.
- Exclusions: It shall not apply to external payments arrears arising from external debt being renegotiated with external creditors, specifically where a creditor has agreed that no payment needs to be made pending negotiations.
- Supporting material:
  - The accounting of non-reschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted on a monthly basis, within two weeks of the end of each month.

### Continuous Indicative Target: Accumulation of General Government Domestic Expenditure Arrears
- Definition:
  - Domestic expenditure arrears are non-disputed (in or out-of-court) payment obligations whose execution term has expired and became overdue.
  - They can arise on any expenditure item, including debt service, wages, pensions, and goods and services.
  - Arrears will arise from non-debt liabilities that are not paid after 60 days of the contractual payment date or—if there is no contractual payment date—after 60 days of the receivable.
  - Any wage, pension or other entitlement obligation of the general government that is not paid after a 30-day period from the date that they are due, is in arrears.
- Supporting material:
  - The accounting of new domestic expenditure arrears (if any) will be transmitted within four weeks after the end of each month.

### Guarantees (Program Definition)
- 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: Ceilings and Definitions
- Ceiling on the Cash Deficit of the Partnership Fund:
  - Definition: cash deficit = expenditures minus revenues.
- Revenues:
  - Dividends from its assets and investments, interest earnings from the loans it provides, fees it charges for services and guarantees, and any other income earned from its assets.
- Expenditures:
  - All current and capital expenditures.
  - Current expenditures: compensation of employees, the purchase of goods and services, transfers to other entities, other account payables and domestic and external interest payments.
  - Capital expenditures: 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.
- Ceiling on New Net Borrowing by the Partnership Fund:
  - Definition: Net borrowing = 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 (NIR) of the NBG — Floor and Adjustors
- Definition:
  - NIR in U.S. dollars = 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 include gold, gross foreign exchange reserves, Georgia’s SDR holdings, and the reserve position in the IMF.
  - Gross foreign exchange reserves = 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 assets used as collateral (or guarantee for third party external liabilities) are excluded from foreign assets.
  - Foreign liabilities of the NBG = the sum of Georgia’s outstanding liabilities to the IMF (at face value), Georgia’s SDR allocation, and 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.
  - 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, 416 million as of December 31, 2017 (at program exchange rates).
- Adjustors to the NIR Floor (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 defined as 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)
- June 30, 2018 / December 31, 2018
  - Projected privatization revenue: 0 / 0
  - Budget support grants from external donors and not related to project financing: 6 / 45.7
  - Budget support loans, including bilateral and multilateral donors for budget support: 130.8 / 166.4
  - Net issuance of the Eurobond from the general government: 0 / 0
  - Disbursements of project loans and grants: 114.1 / 306.8

### Reporting and Supporting Material for NIR and Balance of Payment Support
- Data on 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; and conversions for government imports will be provided to the IMF in a foreign exchange cash flow table on a weekly basis within three working days following the end of the week.

*IMF staff report text (selection) from cr18198.*

### Appendix to the TMU: The Partnership Fund

### 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.
- Governance structure components:
  - 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.

### B. Corporate Mandate and Portfolio Management — Corporate Mandate
- The corporate mandate of the PF is approved by the supervisory board and the government.
- Financing instruments the PF will provide:
  - equity participations
  - senior loan
  - quasi-equity through subordinated convertible debt
  - performance bonds/guarantees
- Investment sector focus: 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.

### B. Corporate Mandate and Portfolio Management — Portfolio Management Strategy
- The PF’s portfolio management strategy sets portfolio limits, performance management objectives, and project evaluation guidelines.
- Fundamental principles:
  - The PF will participate only in commercially viable projects.
  - 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 Containment and Funding
- Fiscal risks associated with the PF will be limited since:
  - 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; and the PF may decide to borrow from credible financial institution with recourse to its balance sheet facility and without state guarantee.

*Appendix to the TMU: The Partnership Fund — IMF staff report excerpt*

### 2007. The goal is to support development in Georgia and promote closer integration with the

### GEORGIA

### EIB Lending and Project Support (2007–17)
- Since 2007, the EIB has supported 21 operations in different sectors.
- Following the Association Agreement and the DCFTA entry into force in 2016, the EIB effectively doubled its lending portfolio in the country to € 1.55 billion.
- As of the end of 2017, lending to the sovereign represented 85 percent of the EIB loan portfolio in Georgia.
- Cumulative EIB signatures by sector (2007–17) include:
  - Transport: 48%
  - SME and Midcap access to finance: 14%
  - Social infrastructure: 13%
  - Water and wastewater: 12%
  - Energy: 5%
  - RE & EE: 2%
  - Others: 6%

### Development of Social and Economic Infrastructure
- Transport:
  - Investment loans: Georgia East West Highway I and II projects for a total EIB financing of €249 million.
  - Framework loan: Georgia Transport Connectivity project, €500 million.
  - Project implementation supported by a technical assistance grant from the Neighborhood Investment Facility.
- Environment / Water:
  - Two loans of €40 million each to modernize water infrastructure across over 50 cities.
  - Kutaisi Waste Water project: € 100 million loan for improving wastewater collection and treatment.
  - Project implementation supported by EPTATF technical assistance and an NIF investment grant to enhance climate mitigation effects.
- Municipal Infrastructure:
  - First EIB framework loan: €100 million (signed February 2016) for emergencies and short-term priorities in Tbilisi and municipal/tourism infrastructure.
  - Second framework loan: € 100 million (signed December 2016) to finance municipal investments.
- Renewable Energy:
  - Rehabilitation of Enguri and Vardnili HPPs: €23.5 million loan.
  - Construction of high-voltage transmission lines: €80 million loan.
- Energy Efficiency:
  - A joint EIB-European Commission-other IFIs mission (2017-18) identified improving energy performance of existing buildings as a priority area of intervention.

### Support for Private Sector Development
- EIB instruments: credit lines and direct investment loans targeting (1) EU based (or global) companies; (2) local sizable companies, including commercially managed public sector companies; and (3) mid-caps with strong development potential.
- To date:
  - 7 loans for SMEs credit lines (approximately €165 million).
  - Direct investment loan of € 21.5 million to Georgian Water and Power for water and wastewater infrastructure development.
- DCFTA Initiative East:
  - $4.2 million loan to Credo Bank for micro and small enterprise lending.
  - SME loan guarantees in 2017: ProCredit (€2.4 million) and TBC Bank (€2.4 million).
- InnovFin:
  - Two InnovFin guarantee agreements: ProCredit Bank JSC enabled to provide €60 million in loans; TBC Bank enabled to provide €80 million in loans to innovative SMEs and small midcaps.
- Two programs—DCFTA Initiative East and InnoFin—support SMEs’ access to finance via intermediated financing, risk-sharing products, and capacity-building.

### Supporting Georgian Counterparts in Project Preparation and Implementation
- NIF (launched 2008): supports energy infrastructure projects, transport, environment, and private sector development.
  - NIF has provided almost €43 million of investment and technical assistance grants to support EIB-funded projects in Georgia.
- EPTATF (established 2010): supports project preparation and implementation.
  - EPTATF has allocated to Georgia €5 million out of €30.4 million operations approved by EPTATF so far.
  - Priority sectors: (1) development of social and economic infrastructure; (2) climate change mitigation and adaptation; and (2) local private sector development, particularly support for SMEs.

### Statistical Issues (As of May15, 2018)
- General assessment: Data provision has some shortcomings but is broadly adequate for surveillance.
- Key shortcomings: room for improving compilation and dissemination of price, national accounts, and external sector statistics; insufficient price and economic activity indicators to assess underlying inflation and output trends.
- IMF technical assistance has been provided (Annex I, Table 1).
- Georgia graduated to the IMF’s SDDS on May 17, 2010, after participating in GDDS since 2006.
- Data ROSC: published March 2012; the 2012 data ROSC mission noted serious source data deficiencies due to absence of an economic census, under-reporting, shortcomings in the business register, and incomplete coverage of some activities.

### Assessment of Data Adequacy for Surveillance — National Accounts and Prices
- National Accounts:
  - Follow System of National Accounts 1993.
  - Preliminary national accounts estimates in current prices by production approach available after 80 days; final estimates after 11 months.
  - Since 2012 GEOSTAT updates: use of administrative sources for business register; compulsory reporting under amended Law on Statistics; better benchmarking of QNA; NACE rev. 2 implementation by end of 2018 planned.
  - Since 2015 GEOSTAT started publishing volume estimates of GDP by the expenditure approach for 2010-14.
  - Ongoing TA (2013-17) supported benchmarking, new methods for taxes on products volumes, compilation of unit values for imports, and deflator improvements.
  - Scope for improving constant price estimates and developing supply and use tables.
- Price Statistics:
  - CPI scope limited to urban areas; owner-occupied housing not covered.
  - PPI structure relies on output concept; product-based indices compiled at lowest level.
  - Export price indices available monthly from 2014; import price indices available monthly from January 2017.
  - Agricultural price index survey ceased.
  - IMF launched a two-year TA project with GEOSTAT in April 2018 to develop a residential property price index and expand PPI coverage to key services.

### Government Finance, Monetary and External Statistics
- Government Finance Statistics:
  - Ministry of Finance advancing reforms to fully adopt GFSM 2001 and IPSASs; staged introduction of accrual recording aiming by 2020.
  - Decree 101 (February 10, 2006) sets strategy; some steps require amendments to Budget System Law.
  - Since 2008, budget classification follows GFSM 2001.
  - Deficiencies: sectorization of LEPLs; securities not recorded at market value.
  - Authorities report annual and monthly GFS compiled on a cash basis in GFSM 2001 framework; Balance Sheet only comprises liabilities; financial assets and holding gains/losses not reported.
- Monetary and Financial Statistics:
  - NBG compiles monetary data in line with MFSMCG and STA SRFs; reports regularly to STA for IFS publication.
  - 2016 TA supported expansion to include OFC sector, production of financial accounts, and flow-based monetary statistics.
  - Since early 2017, NBG regularly reports quarterly data on OFCs to STA.
  - Financial surveillance: NBG supervises banks and other entities; depository corporation data monthly; core and encouraged FSI published quarterly, with improved monthly FSI reporting to STA after 2017 TA.
- External Sector Statistics:
  - Improvements: amendment of Law on Official Statistics; implementation of online SEEA; improved IMTS; improved CDIS reporting; enhanced GEOSTAT–NBG cooperation.
  - Remaining issues: accuracy of trade in goods data (consistency between customs and BOP) and FDI; need to improve revision and dissemination procedures.
  - GEOSTAT and NBG made significant progress implementing 2016 mission recommendations.

### Data Standards and Quality
- Country subscribed to SDDS since May 17, 2010.
- Data ROSC published March 2012.
- Table of Common Indicators Required for Surveillance (as of May 22, 2018) lists latest observations and reporting frequencies for key datasets (exchange rates, reserves, reserve/base money, broad money, central bank balance sheet, banking system balance sheet, interest rates, CPI, government finances, external account, GDP/GNP, gross external debt, international investment position) with data quality assessments noted in ROSC.

### Executive Board Statements and Macroeconomic Outlook (June 2018)
- Staff statement notes new information since June 14, 2018 did not change staff appraisal.
- Political developments:
  - June 13, 2018: Prime Minister Kvirikashvili announced resignation; government dismissed.
  - June 20, 2018: Parliament approved new government led by Mamuka Bakhtadze (former Minister of Finance); authorities committed to policies in Letter of Intent of May 31, 2018 and associated MEP and TMU.
- Authorities’ statement:
  - New cabinet approved June 20, 2018; continuation of IMF program is number one priority.
- Macroeconomic performance and outlook:
  - Growth and macroeconomic stability consolidating; growth exceeded expectations; inflation returned close to target.
  - April preliminary estimate of economic activity: advance of 6.5 percent.
  - Inflation fell at the beginning of 2018 below but close to 3% target. Inflation expected to stay around 2,5% for the remainder of the year and then to converge again toward the target inflation rate.
  - Baseline forecast for 2018 growth: 4.8 percent; early months suggest growth for the whole year may again surpass the baseline, but external risks increased, notably from depreciation of the Turkish Lira.
  - Authorities consider risks to outlook relatively balanced.

### Fiscal Policy: Consolidation and Investment Scaling
- 2017 augmented fiscal deficit was lower than programmed due to higher GDP growth and lower losses from corporate income tax reform.
- Revenue over-performance used to accelerate capital spending and refund higher VAT claims.
- Authorities plan to build precautionary buffers for identified fiscal risks.
- All new measures and reforms with significant fiscal impact will be incorporated in the multi-year budgetary framework, aiming for neutral impact on projected deficit path.
- Fiscal consolidation targets to create space for public investment by reducing current spending from 25 percent of GDP in 2016 to 20.4 percent in 2020 via:
  - Containing wage bill and administrative expenses.
  - Better targeting subsidies and social assistance.
  - Privatizing loss-making SOEs.
  - Improving performance-based budgeting.
- Social safety net to be maintained; basic public pension will be increased.
- Revenue administration reforms:
  - 3-year plan based on 2016 TADAT and IMF TA; GRS restructured; focus on VAT administration (automatic risk assessment, risk-based auditing, automatic refund of new VAT credits), eliminating accumulated unrefunded VAT, streamlining filing, revising tax penalty regime, and providing third-party information for risk analysis.
- Fiscal risk management:
  - Monitor SOEs and PPPs (including PPAs in energy).
  - New PPP law compliant with best practices approved May 2018.
  - Measures to widen and improve Fiscal Risks Statement and strengthen SOE monitoring.
  - Ministry of Finance created a public investment unit to evaluate projects based on cost/benefit analysis.
- Fiscal rule revision to apply to fiscal outturns, clarify aggregates and escape clauses, and enhance coverage, communication, transparency and oversight.

### Monetary Policy, Financial Sector, and Structural Reforms
- Monetary policy:
  - Continue inflation targeting with exchange rate flexibility.
  - FX interventions limited to smoothing excessive volatility and strengthening reserves.
  - Gross international reserves currently below IMF ARA metric level; will be raised throughout the program.
  - NBG strengthened transmission: introduced one-month monetary instrument; propose legal amendments to support derivatives and repo transactions; plan to extend open market operations to outright purchases of treasury securities by mid-2018.
  - Interbank and policy rates are closely aligned.
  - Dollarization remains relatively high despite larization measures and improved confidence.
  - NBG measures to support de-dollarization:
    - Widen differential of Payment-to-Income and Loan-to-Value limits between local and foreign currency loans.
    - Decrease required reserves ratio for local currency liabilities from 7% to 5%.
    - Decrease remuneration for Required Reserves in Foreign currency by additional 150 bps.
  - NBG enhancing communication: manual for monetary policy operations; regular press conferences and regional press briefings started in 2017.
- Financial sector policies:
  - Continue to strengthen supervisory and regulatory framework, macroprudential tools, and financial safety nets.
  - Priorities: finalize prudential regulation for microfinance institutions; non-prudential regulation for other lenders; develop supervision for financial conglomerates; issue regulations on leverage ratios, credit information bureaus, bank real estate appraisal of collateral, corporate governance; net stable funding ratio.
  - Macro-financial model being developed with IMF TA to inform macroprudential policy and a new Financial Stability Report starting 2019.
  - Legislative changes in 2019 to implement emergency liquidity assistance and resolution frameworks in line with international best practices.
  - Build institutional and informational infrastructures to foster capital market development.
- Structural reforms:
  - Government’s Four Point Plan priorities: (I) reforming education; (II) accelerating core infrastructure; (III) improving governance and government efficiency; (IV) enhancing private sector role.
  - Education reform (with the World Bank) to set curriculum standards with employer participation and promote vocational training and adult learning.
  - Scaling-up infrastructure and spatial planning to develop radial roads and support tourism to transform Georgia into a transportation, logistical and tourism hub.
  - Business environment improvements by 2019: introducing IFRS requirements for corporations, reforming insolvency law, establishing a one-stop shop for public services to business.
  - Land registration support to protect property rights and foster rural and agricultural development.
  - Deepening trade relations to mobilize FDI in tradable sectors and diversify the economy.

*Source: IMF staff report material (as provided).*

### Conclusion

### Conclusion

### Growth ambition and integration
- With good institutions and favorably located at the cross-roads of regional markets, Georgia has the ambition to further integrate in the global economy to reach its growth potential.

### Institutional record and policy implementation
- This ambition is reflected in the authorities’ strong record of implementing the current program’s policies and reforms.

### Risks and reform continuity
- The new cabinet fully recognizes the need to remain vigilant, carefully monitor the risks, and resolutely continue the reform efforts to address structural obstacles to growth.

*Source: cr18198 - Conclusion*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18198.pdf_