## cr18373

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**Canonical URL:** [cr18373](https://www.imf.org/-/media/files/publications/cr/2018/cr18373.pdf)

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---

### Program status and financing
- 36-month Extended Fund Facility (EFF) approved on April 12, 2017 with access of SDR 210.4 million (100 percent of quota) is on track.
- All end-June 2018 performance criteria (PCs) were met; all structural benchmarks (SB) but one were observed (missed SB completed with a two-week delay).
- Completion of the review will make available SDR30 million.

### Macroeconomic outlook and risks
- Real GDP growth:
  - Flash estimates: 4.9 percent (y/y) in the first three quarters of 2018, down from 5.4 percent in 2018H1.
  - Revised full-year 2018 growth: 5 percent (0.2 percentage points higher than at the second review).
  - Projected growth: 4.6 percent in 2019; medium-term gradual increase to 5.2 percent, conditional on structural reforms.
- Inflation:
  - Headline inflation: 2.3 percent (y/y) in October.
  - Core inflation: 1.7 percent in October.
  - Inflation expected to stabilize at the NBG’s target of 3 percent by end-2019.
- External sector:
  - Current account deficit: 10.2 percent of GDP in 2018H1; projected 9.0 percent of GDP in 2018 (revised from 9.2 percent at the second review).
  - Net financial flows projected 0.8 percent of GDP lower relative to the second review, primarily due to lower net FDI.
  - External debt: 96 percent of GDP (excluding intercompany loans).
  - End-September 2018 gross international reserves (GIR): $3.15 billion.
  - FX interventions: $112.5 million through end-September; higher FX reserve requirements: $292 million through end-September.
  - FX reserve requirements accounted for 44 percent of GIR as of September 2018.
- Risks:
  - Downside risks increased: trade shocks, regional developments, global trade tensions, weaker global growth.
  - Vulnerabilities from high dollarization and external debt could amplify effects of lari depreciation.
  - A prolonged slowdown in Turkey could hurt growth.
  - A greater-than-expected slowdown in credit growth from new financial regulations and investment delays could temporarily weigh on growth.
  - Reform momentum could slow ahead of the 2020 parliamentary elections.
- Upside scenario:
  - A recovery in oil exporters could strengthen external demand and remittances.

### Fiscal performance and policy recommendations
- Fiscal outturns through September:
  - Augmented fiscal surplus reached 0.9 percent of GDP through September, exceeding program projections by 2.7 percent of GDP.
  - Gross public debt fell to 40 percent of GDP at end-September 2018.
  - Government deposits exceeded 5 percent of GDP at end-September 2018.
  - Stock of outstanding VAT credits reduced by 0.5 percent of GDP to 3.6 percent of GDP (end-September) after accelerated VAT refunds.
- Revenue composition of overperformance through September (percent of GDP contributions):
  - PIT: 0.4 percent of GDP.
  - VAT: 0.2 percent of GDP.
  - CIT: 0.2 percent of GDP.
  - Non-tax revenue: 0.2 percent of GDP.
- Policy guidance and measures:
  - 2019 deficit envisaged to target a broadly neutral fiscal stance providing space for higher capital and social spending.
  - Medium-term fiscal plans, including education reform, need to preserve fiscal sustainability while improving public investment oversight and fiscal risk monitoring.
  - Accelerating VAT refunds to reduce stock of claims would support activity and provide additional fiscal space over the medium term.
  - Maintain prudent macroeconomic policies and advance structural reforms.
- End-2018 fiscal target and outturn:
  - 2018 augmented deficit projected at GEL 972 million, 2.3 percent of GDP, 0.5 percentage points lower than envisaged at the Second EFF Review.
  - Budget deficit in Q4 alone projected to be 3.2 percent of GDP.
  - Text Table 1 (January–September 2018, In Million GEL) highlights variances:
    - Revenue and grants: Prog. 8,359; Proj. 8,670; Actual 311; Diff. 0.7 (In percent of GDP)
    - VAT credit refunds: Prog. -150; Proj. -307; Diff. -157; Diff. -0.4
    - Primary current expenditure: Prog. 6,614; Proj. 6,419; Diff. -195; Diff. -0.5
    - Interest: Prog. 415; Proj. 390; Diff. -25; Diff. -0.1
    - Net acquisition of nonfinancial assets: Prog. 1,648; Proj. 1,265; Diff. -383; Diff. -0.9
    - Capital Expenditure: Prog. 1,752; Proj. 1,453; Diff. -299; Diff. -0.7
    - Privatization: Prog. 104; Proj. 188; Diff. 84; Diff. 0.2
    - Net budget lending: Prog. 424; Proj. 204; Diff. -220; Diff. -0.5
    - Augmented balance: Prog. -742; Proj. 392; Diff. 1,134; Diff. 2.7
    - External project loan disbursements (Memorandum item): Prog. 1,025; Proj. 378; Diff. -647; Diff. -1.6
- 2019 budget stance and measures:
  - Agreed 2019 augmented deficit: 2.6 percent of GDP.
  - Revenue projections incorporate 1.2 percent of GDP in VAT refunds and 0.3 percent of GDP from revenue measures.
  - Social spending increases by 0.4 percent of GDP relative to 2018, including:
    - Monthly targeted child benefits increase five-fold (by 0.2 percent of GDP) from GEL10 per child to GEL20 in cash plus GEL30 in vouchers.
    - One-off allocation (0.2 percent of GDP) related to education reform.
    - Monthly basic pensions will increase by GEL20 to GEL200 in 2019, and to GEL 220 in 2020.
  - Text Table 2 (Impact of 2019 Budget Measures on the Augmented Fiscal Balance, In percent of GDP) shows combined impact: 0.1.
- Education reform:
  - Plan to dismiss low-qualified teachers, train and hire qualified teachers, increase salaries, strengthen curriculum standards and pre-school/vocational/tertiary education.
  - Staff recommendation: formulate a fully-costed comprehensive strategy before implementation.
- VAT administration:
  - VAT unit in audit department operational (SB, end-June 2018).
  - Legal amendment under consideration to allow GRS to refund tax credits without explicit taxpayer request.
  - GRS to obtain access to information from FMS (new SB, end-May 2019).

### Monetary and exchange rate policy
- Monetary stance:
  - Stance of monetary policy judged adequate given downward pressures on inflation from slowing aggregate demand.
  - NBG committed to floating exchange rate regime while building reserves.
  - NBG reduced policy rate by 25 bps (to 7 percent) in July and kept it unchanged since.
  - Space to gradually reduce the policy rate by 50 basis points by end-2019 provided inflationary pressures remain subdued.
  - Authorities anticipate reaching the three-percent target by end-2019.
- Reserve position and FX:
  - Adjusted end-December NIR target expected to decline to $1,403 million from $1,550 million set at the First Review.
  - NIR target set at $1,456 million for end-June 2019.
  - Through end-September, the lari appreciated by 2.5 percent in nominal effective terms and remained stable in real effective terms (y/y) despite some weakening against the dollar.
  - NBG cautioned against rapid buildup in reserves that could weaken the lari; proposed pre-announced rule-based FX put options to accumulate reserves starting in 2019.

### Financial sector developments and policies
- Credit growth and regulatory response:
  - Private credit growth (constant exchange rates): 20 percent (y/y) as of September 2018.
  - Credit by MFIs increased by 20 percent (y/y) in 2018Q2.
  - Measures to limit household over-indebtedness:
    - Maximum effective lending rate reduced to 50 percent (from 100 percent).
    - Since May, limit to banks’ lending to households without verifiable income set at 25 percent of banks’ regulatory capital.
  - Effect: slowed consumer lending growth; mortgage lending, mostly in FX, picked up as interest rates declined.
  - On November 19, private Cartu Foundation offered to purchase all loans below GEL2,000 in distress for at least one year, to forgive debt to about 600,000 households; operation covers approximately one million loans (voluntary participation).
- Banking sector health (as of September 2018):
  - Capital adequacy ratio: 18 percent.
  - Liquidity ratio: 31 percent.
  - Nonperforming loans (NPLs): 2.7 percent.
  - Return on assets: 2.7 percent.
  - Return on equity: 21 percent.
  - Household loan dollarization: 45 percent.
- Regulatory strengthening and reforms:
  - Regulations issued on real estate appraisals; 5-percent leverage ratio requirement starting September 2018; corporate governance regulations (SBs end-June/September 2018).
  - NBG plans to introduce NSFR by September 2019 and to regulate credit information bureaus; daily loan data provision required by January 2019.
  - NBG preparing PTI and LTV limits by income and currency; tighter lending standards expected to reduce credit growth to 13 percent (y/y) by end-2019.
  - Government proposed raising floor for new FX loans from GEL100,000 to GEL200,000 to promote de-dollarization; mission prefers targeted prudential measures.
- Resolution, ELA, and safety nets:
  - Resolution framework to be strengthened (SB, end-May 2019).
  - ELA framework needs strengthening: discontinue unsecured lending by NBG, introduce penalty rates for ELA, clarify MoF role.
  - NBG will resume publishing Financial Stability Report (new SB, end-November 2019).

### Structural policies and reforms
- Priorities:
  - Persevere with structural reforms to increase potential growth and inclusiveness.
  - Education reform critical to generate opportunities and jobs.
  - Funded pension pillar and capital market reforms to mobilize domestic savings for investment.
  - New PPP framework to support investment.
- Implementation:
  - SBs met include regulations on real estate appraisal, specialized VAT unit, leverage ratio rules, and banks’ corporate governance.
  - SB on establishing independent pension agency completed with a brief delay.
  - Authorities and staff agreed to step up efforts to build reserves and monitor credit growth implications.

### Program conditionality updates and new SBs
- Performance criteria proposed for end-June 2019.
- Reformulation of SB on penalty regime to incorporate materiality and to grant GRS powers to refund without taxpayer request (new SB, end-December 2018).
- New SBs proposed:
  - end-February 2019: amend regulation to designate GRS access to FMS information with safeguards;
  - end-July 2019: submit new insolvency law to Parliament;
  - end-September 2019: establish complete inventory of SOEs per GFSM2014;
  - end-November 2019: adopt decree clarifying mandate/governance/reporting of public corporations, and publish a financial stability report;
  - end-December 2019: strengthen public investment management methodology and implement reporting/oversight at MoF.

### Financing and debt outlook
- Program fully financed for the next twelve months, with good prospects for financing the remainder of the program.
- Georgia’s capacity to repay remains adequate.
- Debt classification: low scrutiny under Emerging Market Debt Sustainability Analysis.
- In case of full drawing under the EFF, repayments to the IMF would peak at 0.2 percent of GDP or 0.7 percent of gross reserves in 2023.

### Staff appraisal — macro performance and policy recommendations
- Macroeconomic performance:
  - Growth remains strong; inflation converging to target; external position strengthened.
  - Revenue overperformance and delays in capital spending provide room for additional VAT credit repayments in 2018.
  - Banking sector remains liquid, profitable, and well capitalized.
- Fiscal policy recommendations:
  - 2019 deficit of 2.6 percent of GDP allows accelerating capital spending and increasing social spending while preserving sustainability.
  - Increase in social benefits welcomed; to be offset by revenue measures and containment of other current spending.
  - Recommendation: accompany capital spending increase with improved public investment management.
  - Continue strengthening revenue administration and repaying VAT credits to generate fiscal space for education reform.
  - Transition toward GFSM2014 in the 2020 budget to improve transparency.
- Monetary and reserves recommendations:
  - Monetary policy stance appropriate; space to reduce policy rate by 50 basis points by end-2019 as inflation converges to 3 percent.
  - Recommendation: strengthen liquidity management and transmission mechanism.
  - Efforts to build reserves should be stepped up; recommendation to scale up FX intervention while avoiding excessive exchange rate volatility and consider pre-announced FX put options.
- Financial sector:
  - Regulatory measures on appraisal, leverage, governance, and nonbank prudential rules should strengthen resilience.
  - Monitor tightening of lending standards to avoid negative impacts on activity.
- Structural reforms:
  - Persevering with reforms key to higher and inclusive growth.
  - Funded pension pillar expected to mobilize domestic savings and reduce external financing dependency over time.

### Real sector, external, and fiscal numerical highlights (selected exact figures)
- Real GDP growth: 2018 (Prel.): 4.8 (alternate references: revised full-year 2018 growth: 5 percent).
- Nominal GDP (billion laris): 2018 (Prel.): 41.4.
- Nominal GDP (billion USD): 2018 (Prel.): 16.9.
- GDP per capita (thousand USD): 2018 (Prel.): 4.5.
- CPI Period average: 2018 (Prel.): 2.8; CPI End-of-period: 2018 (Prel.): 2.7.
- NBG policy rate: 7 percent.
- Public debt (percent of GDP): 2018 (Prel.): 42.8.
- Augmented Net lending / borrowing (Program definition): 2018 (Prel.): -2.8.
- Gross international reserves (billions USD): 2018 Proj.: 3.3.
- Current account balance (percent of GDP): 2018 Proj.: -9.2.
- Deposit dollarization (percent): 2018 Proj.: 59.7.
- Credit-to-GDP: 2018 Proj.: 60.6.
- Nonperforming loans (national definition): 2017: 7.5; Aug 2018: 5.7.

### Risk Assessment Matrix — major risks and policy responses
- Global shocks (examples):
  - Rising protectionism: Relative Likelihood/Time Horizon: High / Short to Medium Term; Expected Impact: Medium. Policy response: flexible exchange rate, accelerate structural reforms, strengthen fiscal and financial positions.
  - Sharp tightening of global financial conditions: High / Short Term; Expected Impact: Medium. Policy response: flexible exchange rate, de-dollarization, strengthen financial stability, build reserves.
  - Cyber-attacks: Medium / Short to Medium Term; Expected Impact: Medium. Policy response: strengthen banking regulation and supervision.
  - Weaker global growth: Medium / Medium Term; Expected Impact: Medium. Policy response: flexible exchange rate, structural reforms including education, strengthen fiscal and financial resilience.
- Georgia-specific risks:
  - Tighter macroprudential regulation: High / Medium Term; Expected Impact: Medium. Policy response: monitor impact, adjust PTIs/LTVs as needed.
  - Financial risks from reduced buffers and non-banking vulnerabilities: Medium / Medium Term; Expected Impact: Medium.
  - Fiscal risks from contingent liabilities and project delays: Medium / High Term; Expected Impact: Medium. Policy response: strengthen fiscal institutions and monitoring of PPPs/SOEs.
  - Political risks (backlash or reform fatigue): Low / Medium Term; Expected Impact: Medium.

### Annex II — Spillovers from the Deterioration in the Turkish Economy
- Overall assessment: Georgia’s exposure to Turkey is sizable via trade, remittances, tourism, and FDI; negative spillovers moderate so far and expected limited near-term impact.
- Key figures (2017 unless noted):
  - Imports from Turkey: 9 percent of GDP.
  - Exports to Turkey: 1.4 percent of GDP.
  - Georgia’s trade deficit with Turkey averaged 7.8 percent of GDP over 2015–17.
  - Tourism receipts from Turkey: 2.1 percent of GDP (16.5 percent of total arrivals).
  - FDI from Turkey: 1.8 percent of GDP.
  - Remittances from Turkey: 0.7 percent of GDP.
  - Two Turkish bank subsidiaries in Georgia: 1.07 percent of Georgian banking sector assets as of June 2018.
- Observations:
  - Lari appreciated in first half of 2018 and started depreciating by August; lira depreciation in September 2018 was 43 percent (nominal) and 31 percent (real effective).
  - Lari cumulatively appreciated in real effective terms against TRY by about 38 percent over January–September 2018.
  - Projected near-term effects on current account likely limited due to composition of trade (capital and intermediate goods) and compensating tourism and remittance dynamics.

### Program monitoring, TMU, and data reporting (selected operational details)
- Inflation consultation clause:
  - Test date inflation defined as y/y change of monthly CPI in month of test date (GEOSTAT).
  - If inflation outside outer bands in Table 1 of MEFP, authorities complete consultation with IMF Executive Board; access to Fund resources interrupted until consultation and review completed.
  - If outside inner bands, consultation with IMF staff required.
- Reporting timelines and data provision:
  - Domestic bank and nonbank financing data: NBG and Treasury within four weeks after month-end.
  - External project financing: Ministry of Finance monthly within two weeks after month-end.
  - GRS monthly detailed VAT and refund data to be provided monthly (various items listed).
- Net international reserves (NIR):
  - Stock of NIR amounted to $1, 387 million as of June 30, 2018 (program exchange rates).
  - NIR floor adjustors described, and projected NIR targets provided ($1,403 million end-December 2018; $1,456 million end-June 2019).

*Source: International Monetary Fund — Selected excerpts from staff report (cr18373).*

### 2018. Against the background of high credit growth, the authorities introduced

### 2018. Against the background of high credit growth, the authorities introduced

### Program status and financing
- The 36-month Extended Fund Facility (EFF) approved on April 12, 2017 with access of SDR 210.4 million (100 percent of quota), is on track.
- All end-June 2018 performance criteria (PCs) were met, some with significant margins.
- All structural benchmarks (SB) but one were observed; the missed SB was completed with a two-week delay.
- Completion of the review will make available SDR30 million.

### Macroeconomic outlook and risks
- Real GDP growth:
  - Flash estimates: 4.9 percent (y/y) in the first three quarters of 2018, down from 5.4 percent in 2018H1.
  - Revised full-year 2018 growth: 5 percent (0.2 percentage points higher than at the second review).
  - Projected growth: 4.6 percent in 2019; medium-term gradual increase to 5.2 percent, conditional on structural reforms.
- Inflation:
  - Headline inflation: 2.3 percent (y/y) in October.
  - Core inflation: 1.7 percent in October.
  - Inflation expected to stabilize at the NBG’s target of 3 percent by end-2019.
- External sector:
  - Current account deficit: 10.2 percent of GDP in 2018H1; projected 9.0 percent of GDP in 2018 (revised from 9.2 percent at the second review).
  - Net financial flows projected 0.8 percent of GDP lower relative to the second review, primarily due to lower net FDI.
  - External debt: 96 percent of GDP (excluding intercompany loans).
  - End-September 2018 gross international reserves (GIR): $3.15 billion.
  - FX interventions: $112.5 million through end-September; higher FX reserve requirements: $292 million through end-September.
  - FX reserve requirements accounted for 44 percent of GIR as of September 2018.
- Risks:
  - Downside risks increased: trade shocks, regional developments, global trade tensions, weaker global growth.
  - Vulnerabilities from high dollarization and external debt could amplify effects of lari depreciation.
  - A prolonged slowdown in Turkey could hurt growth.
  - A greater-than-expected slowdown in credit growth, from new financial regulations and investment delays, could temporarily weigh on growth.
  - Reform momentum could slow ahead of the 2020 parliamentary elections.
- Upside scenario:
  - A recovery in oil exporters could strengthen external demand and remittances.

### Fiscal performance and policy recommendations
- Fiscal outturns:
  - The augmented fiscal surplus reached 0.9 percent of GDP through September, exceeding program projections by 2.7 percent of GDP.
  - Gross public debt fell to 40 percent of GDP at end-September 2018.
  - Government deposits exceeded 5 percent of GDP at end-September 2018.
  - The stock of outstanding VAT credits reduced by 0.5 percent of GDP to 3.6 percent of GDP (end-September) after accelerated VAT refunds.
- Revenue composition of overperformance through September (percent of GDP contributions):
  - PIT: 0.4 percent of GDP.
  - VAT: 0.2 percent of GDP.
  - CIT: 0.2 percent of GDP.
  - Non-tax revenue: 0.2 percent of GDP (in part due to higher interest revenue).
- Policy guidance:
  - The envisaged 2019 deficit appropriately targets a broadly neutral fiscal stance that provides space for higher capital and social spending.
  - Medium-term fiscal plans, including those to reform education, need to preserve fiscal sustainability while improving public investment oversight and fiscal risk monitoring.
  - Accelerating VAT refunds to reduce the stock of claims would help support economic activity next year and provide for additional fiscal space over the medium term.
  - Maintain prudent macroeconomic policies and advance structural reforms.

### Monetary and exchange rate policy
- Monetary stance:
  - The stance of monetary policy is adequate given downward pressures on inflation from slowing aggregate demand and muted pressures from salaries and the budget.
  - The National Bank of Georgia (NBG) remains committed to the floating exchange rate regime while continuing efforts to build up reserves.
- Reserve position and FX:
  - Through end-September, the lari appreciated by 2.5 percent in nominal effective terms and remained stable in real effective terms (y/y) despite some weakening against the dollar.

### Financial sector developments and policies
- Credit growth and regulatory response:
  - Private credit growth (at constant exchange rates) remained at 20 percent (y/y) as of September 2018.
  - Credit by micro-financial institutions (MFIs) increased by 20 percent (y/y) in 2018Q2.
  - Above-trend growth in the credit-to-GDP ratio has increased the loan-to-deposit ratio.
  - Measures introduced to limit household over-indebtedness:
    - Maximum effective lending rate reduced to 50 percent (from 100 percent) to limit predatory lending.
    - Since May, a limit to banks’ lending to households without verifiable income set at 25 percent of banks’ regulatory capital.
  - Effect: slowed growth in consumer lending; mortgage lending, mostly in FX, picked up as interest rates declined.
  - On November 19, the private Cartu Foundation offered to purchase all loans below GEL2,000 that have been in distress for at least one year, to forgive debt to about 600,000 households (financial institutions participate on a voluntary basis; operation covers approximately one million loans made by banks, MFIs, and other lending institutions). Authorities indicated impact on financial institutions would be negligible.
- Banking sector health (as of September 2018):
  - Capital adequacy ratio: 18 percent.
  - Liquidity ratio: 31 percent.
  - Nonperforming loans (NPLs): 2.7 percent.
  - Return on assets: 2.7 percent.
  - Return on equity: 21 percent.
  - Household loan dollarization: 45 percent.
  - Dollarization has marginally declined driven by corporate dollarization.
- Policy guidance:
  - Financial regulations to contain rapid credit growth will help promote financial resilience but need to be monitored to prevent a disruptive credit deceleration.
  - Establishing a new insolvency framework for nonfinancial corporations will improve the business environment.

### Structural policies and reforms
- Priorities:
  - Perseverance with structural reforms is needed to increase potential growth and make it more inclusive.
  - Education reform is critical to generate opportunities and jobs.
  - The funded pension pillar, coupled with capital market reforms, should help mobilize domestic savings for investment.
  - The new PPP framework should support investment.
- Implementation and program monitoring:
  - All quantitative PCs and indicative targets were observed through end-June 2018.
  - SBs met include: introducing a regulation on bank’s real estate appraisal in line with international valuation standards; creating a new specialized VAT unit focusing on validating VAT claims; introducing regulations on the leverage ratio; introducing regulations on banks’ corporate governance.
  - The SB on establishing an independent pension agency was not met on schedule but was completed with a brief delay.
  - Staff and authorities agreed to step up efforts to build reserves and to monitor credit growth implications of regulations.

*IMF staff mission discussions held in Tbilisi during October 17–30, 2018; document dated December 4, 2018.*

### 12. The end-2018 fiscal target is expected to be met with a comfortable margin (MEFP, ¶7).

### 12. The end-2018 fiscal target is expected to be met with a comfortable margin (MEFP, ¶7)

### Fiscal outturn and 2018 assessment
- The 2018 augmented deficit is projected at GEL 972 million, 2.3 percent of GDP, 0.5 percentage points lower than envisaged at the Second EFF Review.
- The budget deficit in the fourth quarter alone is projected to be 3.2 percent of GDP.
- Authorities and staff agreed that major backloading of spending to the fourth quarter could put undue pressure on the balance of payments.
- Any shortfalls in spending related to further delays in external disbursements will not be replaced with domestically financed spending.
- To improve project appraisal, selection, and management, the authorities will revise the Public Investment Management methodology in line with FAD TA recommendations and with technical donor support (new SB, end-December 2019).
- Text Table 1 (Budget Execution, January-September 2018, In Million GEL) highlights key variances:
  - Revenue and grants: Prog. 8,359; Proj. 8,670; Actual 311; Diff. 0.7 (In percent of GDP)
  - VAT credit refunds: Prog. -150; Proj. -307; Diff. -157; Diff. -0.4
  - Primary current expenditure: Prog. 6,614; Proj. 6,419; Diff. -195; Diff. -0.5
  - Interest: Prog. 415; Proj. 390; Diff. -25; Diff. -0.1
  - Net acquisition of nonfinancial assets: Prog. 1,648; Proj. 1,265; Diff. -383; Diff. -0.9
  - Capital Expenditure: Prog. 1,752; Proj. 1,453; Diff. -299; Diff. -0.7
  - Privatization: Prog. 104; Proj. 188; Diff. 84; Diff. 0.2
  - Net budget lending: Prog. 424; Proj. 204; Diff. -220; Diff. -0.5
  - Augmented balance: Prog. -742; Proj. 392; Diff. 1,134; Diff. 2.7
  - External project loan disbursements (Memorandum item): Prog. 1,025; Proj. 378; Diff. -647; Diff. -1.6

### 2019 budget stance and measures
- Agreed 2019 augmented deficit: 2.6 percent of GDP — aims at a broadly neutral fiscal stance while expanding social spending and public investment (MEFP ¶7).
- Revenue projections incorporate:
  - 1.2 percent of GDP in VAT refunds
  - 0.3 percent of GDP from revenue measures
- Social spending:
  - Will increase by 0.4 percent of GDP relative to 2018.
  - Monthly targeted child benefits will increase five-fold (by 0.2 percent of GDP) from GEL10 per child to GEL20 in cash plus GEL30 in vouchers for food and medicine (endorsed by donors, including UNICEF).
  - Incentives will be introduced for Targeted Social Assistance beneficiaries to participate in the labor market.
  - Social spending includes a one-off allocation (0.2 percent of GDP) related to the education reform.
  - Authorities preparing legislation on a rule-based mechanism to index basic pensions (SB, end-February 2019).
  - Monthly basic pensions will increase by GEL20 to GEL200 in 2019, and to GEL 220 in 2020.
- Staff view: increase in social benefits welcomed; impact on the deficit is to be more than offset by revenue measures and by further containing other current spending.
- Text Table 2 (Impact of 2019 Budget Measures on the Augmented Fiscal Balance, In percent of GDP):
  - Revenue: 0.2
  - Revenue measures: 0.3
    - o/w permanent: 0.1
  - Pillar II pension reform: -0.2
  - Primary current spending: 0.0
  - Pillar I pensions: -0.4
  - Targeted transfers: -0.2
  - Education (one-off): -0.2
  - Contain other primary current spending: 0.8
  - Capital spending and budget lending: -0.1
    - Capital spending: -0.5
    - Net budget lending: 0.4
  - Combined impact: 0.1

### Education reform
- Authorities plan to:
  - Dismiss teachers with low qualifications, train remaining teachers, and hire qualified new ones.
  - Increase salaries for teachers, school directors, and administrative staff.
  - Strengthen curriculum standards, improve school infrastructure, increase number of teachers with higher qualifications, and strengthen pre-school, vocational and tertiary education.
- Staff recommendation: formulate a fully-costed comprehensive strategy before implementation, including identification of financing to ensure reform fits within targeted fiscal deficit path.
- Education reform includes a one-off allocation (0.2 percent of GDP) in 2019.

### Revenue administration and VAT credits
- Efforts to modernize the Georgian Revenue Service (GRS) and address large stock of outstanding VAT credits ongoing (MEFP ¶12).
- VAT unit in the audit department is operational (SB, end-June 2018).
- Legal amendment under consideration would allow GRS to refund tax credits without an explicit taxpayer request.
- GRS will obtain access to information from the Financial Monitoring Service (FMS, new SB, end-May 2019) and other government agencies to strengthen risk-based auditing.
- GRS will control the taxpayer register in line with international best practice to reduce and better manage compliance risks.

### Fiscal risks and SOE reporting
- Coverage and reporting of fiscal risks continues to improve (MEFP ¶13).
- Upcoming fiscal risk statement will expand on contingent liabilities from purchasing power agreements and selected SOEs.
- Authorities will analyze which SOEs should be included in general government accounts according to GFSM2014 (new SB, end-September 2019).
- Authorities will clarify mandate, governance, and reporting requirements of all SOEs (new SB, end-November 2019).
- Authorities committed to containing fiscal risks from a prospective credit guarantee fund, to be designed in consultation with staff.

### Fiscal rule and medium-term framework
- Draft fiscal rule strengthened (MEFP ¶14):
  - Eliminates the expenditure ceiling, clarifies scope of the deficit and public debt under the rule, applies to fiscal outturns, and defines escape clauses.
  - Will allow more comprehensive coverage of general government according to GFSM2014 and improve parliamentary oversight.
  - Staff welcomed inclusion of contingent liabilities from PPPs under the debt ceiling, but opposed excluding specific spending categories (e.g., education) from the rule.
- Medium-term budget framework could be strengthened to become a more binding declaration of fiscal plans reflecting fiscal priorities, including education.

### Monetary and exchange rate policies
- NBG actions:
  - Reduced policy rate by 25 bps (to 7 percent) in July and has kept it unchanged since.
  - Provides short-term liquidity to banks (outstanding stock at 5 percent of GDP) mainly via one-week refinancing loans and one-month open market operations.
  - Extended open market operations to outright purchases of treasury securities since May 2018.
  - Increased reserve requirements on short-term FX deposits from 20 to 25 percent in July; reduced reserve requirement on short-term lari deposits from 7 to 5 percent.
- Monetary stance and targets:
  - Monetary policy stance remains appropriate (MEFP ¶15).
  - Space to gradually reduce the policy rate by 50 basis points by end-2019 provided inflationary pressures remain subdued.
  - Authorities anticipate reaching the three-percent target by end-2019 — rather than in mid-2019.
- Reserves and external vulnerability (MEFP ¶16):
  - Adjusted end-December NIR target expected to decline to $1,403 million from $1,550 million set at the First Review.
  - NIR target set at $1,456 million for end-June 2019 to keep NIR on a path to reach 96 percent of the ARA metric by end-2019.
  - NBG cautioned against rapid buildup in reserves that could weaken the lari and undermine de-dollarization; staff supported smoothing intervention.
  - NBG proposed pre-announced rule-based FX put options to accumulate reserves starting in 2019.

### Financial sector policies and resilience
- Regulatory strengthening (MEFP ¶19-26):
  - Banks: regulations issued on real estate appraisals (SB, end-June 2018); 5-percent leverage ratio requirement starting September 2018 (above 3-percent Basel recommendation, SB, end-September 2018); corporate governance rules (SB, end-September 2018). NBG plans to introduce NSFR by September 2019.
  - Non-banks: registration of micro-finance institutions with NBG made more transparent; capital adequacy and liquidity ratios effective December 2018; clarified liquidation rules.
  - NBG regulates credit information bureaus since September 2018; all lending institutions will be required to provide loan data daily (under prudential regulation and non-prudential oversight by January 2019).
- Household indebtedness:
  - NBG preparing regulation with limits on payment-to-income (PTI) and loan-to-value (LTV) ratios for retail loans; limits vary by household income and currency denomination, with stricter limits for unhedged exposures.
  - Tighter lending standards expected to reduce credit growth to 13 percent (y/y) by end-2019.
  - Government proposed raising floor for new FX loans from GEL100,000 to GEL200,000 to promote de-dollarization; mission reiterated preference for targeted prudential measures over broad administrative measures.
- Resolution framework and ELA:
  - Resolution framework lacks escalation/sequencing of corrective actions, recovery and resolution planning requirements, and adequate resolution powers and funding provisions; planned strengthening (SB, end-May 2019).
  - ELA framework needs strengthening: discontinue unsecured lending by NBG, introduce penalty rates for ELA, and clarify MoF role in public guarantees during stress.
- Financial stability reporting:
  - NBG will resume publishing a financial stability report (new SB, end-November 2019) with forward-looking assessment of risks and vulnerabilities; NBG established a financial stability department following IMF TA recommendations.

### Structural policies to support medium-term growth
- Authorities committed to comprehensive structural reform agenda (MEFP ¶27–34) focusing on:
  - Improving infrastructure and trade integration; better management of public projects.
  - Comprehensive education reform (see above).
  - Mobilizing domestic savings for investment: funded pension pillar (Pillar 2) established, pension agency created August 2018; agency expected to start collecting contributions starting January 2019; Pillar 3 planned for 2019; upcoming legislation on investment funds and improved trading infrastructure.
  - Corporate insolvency reform: new insolvency law planned for submission to Parliament (new SB, end-July 2019) to ensure creditor protection, timely insolvency processes, and effective rehabilitation framework; planned international financial reporting standards for corporations in 2019; consolidation of public services to enterprises in a one-stop shop by 2020; planned Court of Arbitration with the International Chamber of Commerce to improve dispute resolution.

*Source: IMF staff and Georgian authorities (MEFP and associated tables and notes).*

### 29. Staff proposes to update program conditionality as follows (MEFP, Tables 1-3).

### 29. Staff proposes to update program conditionality as follows (MEFP, Tables 1-3).

### Program conditionality updates
- Performance criteria are proposed for end-June 2019, in line with semiannual projections.
- The SB on submitting to Parliament a more gradual penalty regime based on culpability (set in the First Review for end-December 2018) will be reformulated (MEFP ¶12). The authorities need more time to reflect the degree of culpability in the penalty regime.
- To avoid delays in reducing the stock of VAT credits, the authorities request reformulating the SB to:
  - (i) revise the penalty regime by incorporating materiality (i.e., the penalty will depend on the difference between the tax paid and the GRS assessment of what should have been paid), and
  - (ii) grant the GRS powers to pay out refunds without the need for a refund request (new SB, end-December 2018).
- Intended outcome: These actions should help accelerate VAT refunds in 2019.
- New structural benchmarks (SBs) proposed:
  - end-February 2019: amend a regulation to designate the GRS as a supervisory authority entitled to access information received by the FMS from the monitoring entities, and put in place safeguards that protect the information from any improper use;
  - end-July 2019: submit to Parliament a new insolvency law in line with best international practice;
  - end-September 2019: establish a complete inventory of SOEs clearly identifying those qualifying as public corporations or as general government entities according to GFSM2014;
  - end-November 2019: adopt a government decree clarifying the mandate, governance, and reporting requirements of public corporations, and publish a financial stability report;
  - end-December 2019: strengthen the public investment management methodology that guides project appraisal, selection, and management, and implement reporting and oversight requirements for public investment projects at the MoF.

### Financing and debt outlook
- Financing assurances:
  - The program is fully financed for the next twelve months, with good prospects for adequate financing for the remainder of the program.
- Debt sustainability and IMF repayments:
  - Georgia’s capacity to repay remains adequate.
  - Georgia’s debt profile continues to warrant low scrutiny under the Emerging Market Debt Sustainability Analysis.
  - In case of full drawing under the EFF, repayments to the IMF would peak at 0.2 percent of GDP or 0.7 percent of gross reserves in 2023 (Table 8).

### Risks to the program
- Risks are characterized as manageable.
- Specific risk: Progress under the program in the runup to the 2020 Parliamentary elections could lead to complacency in implementing the reform agenda.
- Mitigants: The authorities stand ready to adopt measures to fulfill their commitments; continued program ownership provides safeguards and mitigate these risks.

### Staff appraisal — macroeconomic performance and policy recommendations
- Recent macro performance:
  - Growth remains strong, inflation is converging towards the target, and the external position has strengthened.
  - Revenue overperformance and delays in capital spending provide room for additional VAT credit repayments in 2018.
  - The banking sector remains liquid, profitable, and well capitalized.
- Fiscal policy:
  - The agreed 2019 deficit appropriately targets a broadly neutral fiscal stance.
  - With an augmented deficit of 2.6 percent of GDP, the 2019 deficit allows for accelerating capital spending and increasing social spending.
  - The increase in social benefits, including higher child benefits, will be more than offset by revenue measures and by the continued containment of other current spending.
  - Recommendation: The increase in capital spending should be accompanied by improving public investment management, to avoid delays and improve efficiency in the use of public resources.
- Medium-term fiscal and institutional reforms:
  - Medium-term fiscal commitments should be consistent with fiscal sustainability, supported by advancing institutional fiscal reforms.
  - Plans toward a comprehensive and fully-costed education reform should be formulated within the new fiscal framework which establishes deficit and public debt rules as anchors for medium-term fiscal sustainability.
  - Efforts to strengthen revenue administration should continue; advancing repaying the stock of VAT credits would help generate fiscal space for education reform while maintaining capital spending plans.
  - Continued progress with assessing and monitoring fiscal risks is commendable and should advance toward improving the mandate, governance, and reporting requirements of SOEs.
  - Transitioning toward GFSM2014 in the 2020 budget will help improve fiscal transparency and accountability.
- Monetary policy and reserves:
  - Monetary policy remains focused on price stability, supported by the floating exchange rate regime.
  - The current monetary policy stance remains appropriate, with space to gradually reduce the policy rate (50 basis points) by end-2019 as planned.
  - As inflation converges to the 3-percent target and expectations remains well anchored, the monetary policy rate is expected to decline to its neutral level.
  - Recommendation: Strengthening liquidity management and the transmission mechanism would enhance the effectiveness of monetary policy.
  - Efforts to build reserves need to be stepped up: reserves remain below the norm for flexible exchange rate regimes.
  - Recommendation: Building up external buffers will require scaling up FX intervention while avoiding excessive exchange rate volatility; pre-announced FX put options will help provide predictability to reserve accumulation without targeting a specific exchange rate level.
- Financial sector resilience:
  - Regulations on banks’ real estate appraisal, the leverage ratio, and banks’ corporate governance, and efforts to enhance nonbanking prudential regulation and supervision should help strengthen financial resilience.
  - Upcoming regulations on healthy lending should help limit household over-indebtedness, promoting financial stability over the medium term.
  - Near-term caution: The NBG should closely monitor the tightening of lending standards as this may negatively impact economic activity.
- Structural reforms for inclusive growth:
  - Persevering with structural reforms is key to achieving higher and more inclusive growth.
  - Georgia’s high ranking in the 2019 World Bank Doing Business report confirms considerable progress in improving the business environment.
  - Authorities’ actions include preparing a new insolvency law, creating a one-stop shop for public services to businesses, and reforming financial reporting standards.
  - A well-designed and comprehensive education reform would enhance the quality of the labor force and increase growth, also making it more inclusive.
  - The funded pension pillar will help mobilize domestic savings for investment, gradually reducing dependency on external financing.

*International Monetary Fund — Selected excerpts from staff report (cr18373).*

### 40. Staff supports the authorities’ request for completion of the Third Review under the

### cr18373 - 40. Staff supports the authorities’ request for completion of the Third Review under the

### Program status and staff recommendation
- Staff supports the authorities’ request for completion of the Third Review under the Extended Fund Facility.
- Staff supports the authorities’ request to reformulate the end-December 2018 structural benchmark on the tax penalty regime.
- Strong program implementation in both macroeconomic policies and structural reforms provides confidence that the program will continue meeting its objectives.

### Real sector and inflation developments
- Real GDP Growth: 2015: 2.9; 2016: 2.8; 2017: 5.0; 2018 (Prel.): 4.8.
- Nominal GDP (in billion of laris): 2018 (Prel.): 41.4.
- Nominal GDP (in billion of U.S. dollars): 2018 (Prel.): 16.9.
- GDP per capita (in thousand of U.S. dollars): 2018 (Prel.): 4.5.
- GDP deflator, period average: 2018 (Prel.): 3.8.
- CPI, Period average: 2018 (Prel.): 2.8; CPI, End-of-period: 2018 (Prel.): 2.7.
- Observations from figures:
  - Poverty reduction stalled in spite of higher growth.
  - Real wage growth fell below labor productivity growth.
  - Growth slowed due to lower construction activity.
  - Inflation remained below target with core inflation subdued.
  - Nominal appreciation in 2018H1 has begun to reverse.
  - NBG policy rate kept constant since July at 7 percent.

### External sector developments
- Current account balance (percent of GDP): 2015: -12.6; 2016: -13.1; 2017: -8.8; 2018 (Proj.): -9.2.
- Exports, tourist receipts, and remittances: strong growth noted in 2017–2018 (figures show YoY growth for these components).
- Financial account components (in percent of GDP, 2018 Proj.): Direct investment dominates financial inflows.
- Net FDI inflows by industry (2013–2018Q2 Average): notable shares include Transports & communications, Energy sector, Construction, Real Estate.
- Gross international reserves (in billions, USD): 2018 Proj.: 3.3.
- Reserve adequacy (In billions, USD): Reserves relative to 3 months of next year imports and IMF metric shown; reserve coverage described as remaining low despite increases.

### International Investment Position and external debt
- Net IIP narrowed in first part of 2018, mostly due to declining FDI liabilities and supported by increasing foreign assets in banking and non-banking sectors.
- External debt slightly increased; external debt dynamics driven by private sector.
- External public debt exhibits long maturity and low interest rates.
- Average interest rate and debt maturity (2018H1): Average Years to Maturity around 2.3; Weighted Average Interest Rate (RHS; in percent) around 2.3–3.5 across years shown.

### Fiscal sector developments and public debt
- Augmented fiscal balance improved since 2016 driven by strong revenue performance and contained current spending, allowing expansion of public investment.
- Consolidated government operations (percent of GDP):
  - Total Revenues: 2018 (Prel.): 27.9.
  - Total Expenditures (incl. Budget Lending): 2018 (Prel.): 31.1.
  - Augmented Net lending / borrowing (Program definition): 2018 (Prel.): -2.8 (Table 1 shows -2.8 for 2018).
- Public debt (percent of GDP): 2018 (Prel.): 42.8 (Table 1: Public debt 42.8 for 2018).
- Public gross financing needs (Figure 10 projection): shown rising in projection years (graphical).
- Fiscal composition and trends (Table 3b, percent of GDP):
  - Tax revenue (2018 Prel.): 25.0.
  - Current expenditures (2018 Proj.): 23.1.
  - Capital spending and budget lending (2018 Proj.): 7.9.
- Public debt dynamics: Change in gross public sector debt (cumulative 2016–2023) and identified debt-creating flows presented in DSA (Figure 9).

### Public Debt Sustainability Analysis (DSA) — baseline and alternative scenarios
- Baseline underlying assumptions (Figure 10):
  - Real GDP growth: 2018: 5.0; 2019: 4.6; 2020: 5.0; 2021: 5.2; 2022: 5.2; 2023: 5.2.
  - Inflation: 2018: 4.2; 2019: 3.4; 2020–2023: 3.0.
  - Primary Balance: 2018: 0.2; 2019: -0.5; 2020: -1.0; 2021: -0.7; 2022: -0.7; 2023: -0.8.
  - Effective interest rate: 2018: 3.4; 2019: 3.2; 2020: 3.3; 2021: 3.1; 2022: 3.4; 2023: 3.5.
- Alternative scenarios shown: Historical scenario and Constant Primary Balance scenario with corresponding projections for gross nominal public debt and public gross financing needs.
- DSA indicators as of November 06, 2018 (Figure 9 excerpt):
  - Nominal gross public debt: 2016: 35.9; 2017: 44.4; 2018: 44.9; 2019–2023 projections shown (e.g., 2019: 43.6; 2020: 43.3).
  - Public gross financing needs (percent of GDP): 2016: 4.4; 2017: 4.9; 2018: 4.3; 2019 onward projections listed (e.g., 2019: 5.7).

### Financial sector and macro-financial developments
- Banks are liquid and well capitalized; NPLs and watch loans stabilized in recent months.
- Key indicators (Table 5 and figures):
  - Deposit dollarization (residents, in percent): 2017: 66.8; Aug 2018: 63.7.
  - Loan-to-deposit ratio (in percent): 2017: 103.9; Aug 2018: 107.6.
  - Credit-to-GDP ratio (in percent): 2017: 57.8; Aug 2018: 59.3.
  - Capital adequacy ratio (national definition): 2017: 17.5; Aug 2018: 18.1.
  - Liquidity ratio (in percent): 2017: 41.2; Aug 2018: 38.9.
  - Nonperforming loans (national definition, percent of total loans): 2017: 7.5; Aug 2018: 5.7.
  - Loans collateralized by real estate (percent of total loans): 2017: 54.8; Aug 2018: 61.0.
  - Loans in foreign exchange (percent of total loans): 2017: 64.3; Aug 2018: 55.7.
- Credit developments:
  - Private sector credit (YoY growth; constant exchange rate): 2017: 17.6; 2018 (Prel. / Aug trends): around 14.1–18.0 depending series.
  - Lending rates and deposit rates broadly stable through 2018.
  - Deposit growth has fallen recently; interest rates on deposits remained stable.
- Macro-financial assessments (Figure 7):
  - Georgia’s credit-to-GDP higher than peers with a positive credit gap.
  - Household debt driven by consumer and mortgage loans; household debt service remains manageable.
  - No signs of pressures in real estate market or in corporate debt-service from available indicators.

### Macro-structural challenges
- Indicators highlight challenges in inequality and human capital:
  - GINI Coefficient shown rising from 2004–2016 with GE O relative to CCA and SEE averages.
  - PISA Scores (2015) and Logistics Performance Index (2018) show comparative standings.
  - Export diversification index and Global Competitiveness Index components presented to highlight structural priorities.
- Areas for structural reforms implied by figures: education outcomes, logistics, export diversification, institutions, infrastructure, and market efficiencies.

### External vulnerability and financing
- Current account balance (in percent of GDP): 2018 Proj.: -9.2 (Table 1/Table 2).
- Gross external debt (percent of GDP): 2017: 113.2; 2018 Proj.: 107.9.
- Gross international reserves (million USD): 2017: 3,039; 2018 Proj.: 3,288; reserves shown as percent of various coverage metrics (e.g., in percent of IMF Composite measure (floating): 2018 Proj.: 93).
- Gross external financing needs (millions of USD): 2017: 3,216; 2018 Proj.: 2,734; subsequent years projected (Table 7).
- Financial account and financing sources include direct investment, medium- and long-term debt, and prospective official financing; prospective IMF EFF purchases listed in schedule of reviews (Table 9).

### Key selected numerical highlights (preserved)
- NBG policy rate: 7 percent (policy rate constant since July).
- Real GDP growth: 2018 (Prel.): 4.8; 2019 projection: 5.0 (Table 1 shows projection series with 5.0 for 2019 in one column and 5.2 in another—Table 1 presents multiple projection columns; cited 2018 Prel. = 4.8).
- Public debt (percent of GDP): 2018 (Prel.): 42.8.
- Augmented Net lending / borrowing (Program definition): 2018 (Prel.): -2.8 (Table 1).
- Gross international reserves (in billions of US$): 2018 Proj.: 3.3 (Table 1: 3.3).
- Current account balance (percent of GDP): 2018 Proj.: -9.2.
- Deposit dollarization (percent of total): 2018 Proj.: 59.7 (Table 1).
- Credit-to-GDP: 2018 Proj.: 60.6 (Table 1).
- Nonperforming loans (national definition): 2017: 7.5; Aug 2018: 5.7 (Table 5).

*Source: IMF staff report (cr18373).*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### Global Shocks

- Rising protectionism and retreat from multilateralism  
  - Relative Likelihood/Time Horizon: High / Short to Medium Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Protectionism could jeopardize Georgia’s plans for economic diversification and to become a regional transit hub. The prospective reduction in exports and FDI will reduce growth.  
    - An increase in external imbalances would 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.

- Sharp tightening of global financial conditions  
  - Relative Likelihood/Time Horizon: High / Short Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Higher lari volatility and depreciating pressures could generate negative balance-sheet effects and negatively affect financial stability.  
    - Georgia has relied mostly on bilateral and multilateral external financing at long-term maturities. However, tighter global financial conditions could increase financing costs against a background of large external financing requirements.  
  - Policy Response:  
    - Flexible exchange rate should serve as a first line of defense.  
    - Continue de-dollarization efforts, supported by market-based policies.  
    - Strengthen financial stability, including by bolstering inflation targeting and bank resolution frameworks, to weather external shocks from a stronger position.  
    - Continue building up foreign reserves. Closely monitor potential FX mismatches and enhance transparency about financial stability.

- Cyber-attacks on critical global infrastructure  
  - Relative Likelihood/Time Horizon: Medium / Short to Medium Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Trigger systemic financial instability or widespread disruptions in socio-economic activities.  
    - Georgia has adopted cybersecurity legislation, but its effectiveness could be challenged by the nature of the attack.  
  - Policy Response:  
    - Strengthen banking regulation and supervision to ensure that the system is prepared to address relevant risks, including from cyber-attacks.

- Weaker-than-expected global growth (Euro Area, U.S., China)  
  - Relative Likelihood/Time Horizon: Medium / Medium Term (Euro Area and U.S.), Low/Medium / Short to Medium Term (China)  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Weaker global demand, including in other emerging economies, and potential slowdown to Georgia's main trading partners’ growth would risk the envisaged economic recovery. Lower economic growth could reduce the buying-in on much-needed structural reforms for economic diversification and more inclusive e growth.  
  - Policy Response:  
    - A flexible exchange rate should serve as a first line of defense.  
    - Accelerate structural reforms, including on education, to enhance confidence and improve competitiveness.  
    - Strengthen fiscal sustainability and financial stability to weather external shocks from a stronger policy position.  
    - Strengthen social safety nets to protect the most vulnerable segments of the population.

### Georgia-Specific Risks

- Risks from tighter macroprudential regulation  
  - Relative Likelihood/Time Horizon: High / Medium Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - The introduction of new income-based limits on PTIs and LTVs may have a higher than expected impact on credit and GDP growth.  
  - Policy Response:  
    - The impact of macroprudential regulations should be closely monitored and NBG should be ready to adjust PTIs and LTVs to strike the right balance between managing household balance sheet risks and preventing over-indebtedness, while avoiding excessive tightening of financial conditions.

- Financial risks from reduced buffers and non-banking sector vulnerabilities  
  - Relative Likelihood/Time Horizon: Medium / Medium Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Reduced financial buffers, especially for unhedged borrowers, will limit the capacity to absorb further shocks. Risks could stem from the non-banking sector.

- Fiscal risks  
  - Relative Likelihood/Time Horizon: Medium / High Term  
  - Expected Impact on the Economy if Risks Materialize: Medium  
    - Materialization of contingent liabilities/fiscal risks could deteriorate public debt dynamics.  
    - Delays in loan disbursements and/or associated delays in the implementation of infrastructure projects could weigh on growth.  
  - Policy Response:  
    - Use the flexible exchange rate as a first line of defense.  
    - Accelerate implementation of structural reforms to improve confidence and competitiveness.  
    - Strengthen fiscal sustainability and institutions and enhance financial stability to weather shocks from a stronger position.

- Political risks (backlash or reform fatigue)  
  - Relative Likelihood/Time Horizon: Low / Medium Term  
  - Expected Impact on the Economy if Risks Materialize: Medium

### Annex II — Spillovers from the Deterioration in the Turkish Economy

- Overall assessment: Although Georgia’s exposure to Turkey through trade, remittances, tourism and FDI flows is sizable, the negative spillovers from the deterioration in Turkey’s economy have been moderate so far and are expected to be limited in the near term. The lari has depreciated against the dollar, in line with previous years and other emerging market currencies but remained broadly stable in nominal and real effective terms. Turkey’s turbulence is expected to have a limited effect on Georgia’s current account inflows.

- 1. Georgia has a sizable exposure to Turkey through trade, tourism, and FDI inflows, whereas financial linkages remain limited. Key figures (2017 unless otherwise stated):  
  - Turkey was the largest trading partner of Georgia in terms on imports (9 percent of GDP).  
  - Turkey was the 3rd largest destination of Georgian exports (1.4 percent of GDP).  
  - Georgia’s trade deficit with Turkey averaged 7.8 percent of GDP over 2015–17.  
  - In 2017, imports from Turkey represented 9 percent of GDP, while Georgia’s exports of goods to Turkey represented 1.4 percent of GDP.  
  - In 2017, tourism receipts from Turkey reached 2.1 percent of GDP (16.5 percent of total arrivals).  
  - FDI from Turkey accounted for 1.8 percent of GDP.  
  - Remittances from Turkey represented 0.7 percent of GDP.  
  - Two Turkish bank subsidiaries operate in Georgia, representing only 1.07 percent of Georgia banking sector assets as of June 2018.

- 2. Volatility in the Turkish lira (TRY) has not significantly affected the lari. Observations and figures:  
  - The lari tends to appreciate during the spring/summer—supported by booming tourism—and depreciates in the last quarter of the year.  
  - In 2018, the lari appreciated in the first half of the year, and started depreciating by August, with an increase in volatility in line with previous years, and comparable to developments observed with the ruble.  
  - In September 2018, the lira has depreciated by 43 and 31 percent in nominal and real effective terms, respectively.  
  - The lari has cumulatively appreciated in real effective terms against the TRY by about 38 percent over January-September 2018, while Georgia’s REER increased 8 percent, cumulative over January-September 2018.  
  - Note on inflation differential: The inflation differential between Turkey and Georgia stood at 15 percent and 22 percent in August and September 2018, compared with 6 percent in January 2018.

- 3. Projected near-term effects on Georgia’s current account (2018):  
  - The exchange rate elasticity of trade flows has declined due to the increasing importance of intermediary goods in good trade.  
  - Georgian exports to Turkey consist of textile products from Turkish companies (31 percent) unlikely to relocate and metal products and Ferro alloys (39 percent) — expected to be little affected in the near term.  
  - The weaker TRY is likely to trigger Turkish imports (now less expensive) to substitute imports from other countries, somewhat compensating the income effect.  
  - A large share of capital and intermediate goods in total imports from Turkey (61 percent of imports from Turkey in 2018H1) means the depreciation of the Turkish Lira could act as a positive supply side shock, somewhat mitigated by the negative effect of lower competitiveness on domestic production (especially of consumption goods).  
  - Reduced tourism to Georgia—driven by TRY depreciation and slower economic activity in Turkey—is expected to be compensated by sustained growth in tourism receipts from other countries.

- 4. Longer or protracted Turkish lira depreciation effects and offsets:  
  - A protracted depreciation of the lira could lead to the relocation of Turkish companies operating in Georgia, notably in the textile sector.  
  - Near term demand for Georgian inputs (raw and intermediate material) by Turkish domestic producers is expected to remain high, given the global value-chain effect.  
  - Prolonged lira depreciation and high inflation in Turkey would limit remittances from Turkey.  
  - In the near and medium term, lira depreciation would curb the financial capacity and risk appetite of Turkish investors in Georgia, affecting new FDI investment inflows.  
  - Continued recovery in Russia and Azerbaijan from higher oil price would help balance those risks.

*Source: cr18373 - Annex I. Risk Assessment Matrix (cr18373 - Annex I. Risk Assessment Matrix, cr18373.pdf).*

### 3.      We are maintaining prudent macroeconomic assumptions for our 2019 Budget and IMF-

### 3.      We are maintaining prudent macroeconomic assumptions for our 2019 Budget and IMF-supported program

### Macroeconomic outlook and external position
- 2018: robust growth supported by domestic demand.  
- 2019: forecast GDP growth of 4.6 percent.  
- Medium term: growth expected to gradually increase due to steadfast implementation of structural reforms and continued growth in main trading partners.  
- Current account projections:
  - 2018 current account deficit projected at 9.0 percent of GDP.
  - 2019 current account deficit projected at 9.5 percent of GDP.
  - Medium term: current account deficit expected to gradually decline to 8 percent of GDP.  
- External financing:
  - Expected to gradually decline over the medium term.
  - Will continue to rely mostly on FDI, but the share of FDI is expected to decline slightly and be replaced by debt over time.
- Reserves: a strong external position and FX interventions will help reach an adequate level of reserves by 2020.

### Structural reform agenda and competitiveness
- Main reform pillars to bolster inclusive growth and external competitiveness:
  - (i) reforming the education system;
  - (ii) improving the business environment (establishing commercial chambers, improving revenue administration, updating insolvency laws and commercial arbitration);
  - (iii) strengthening connectivity by scaling-up public infrastructure and deepening trade relations.
- Objectives: mobilize FDI in tradable sectors, improve competitiveness, and reduce external vulnerabilities.

### Risks to the outlook and policy stance
- Downside risks increased: regional developments, emerging market volatility, retreat from cross-border integration, and weaker global growth.
- Mitigating actions:
  - Structural reforms to mitigate medium-term risks from high external debt, current account deficit, and financial dollarization.
  - First line of defense: commitment to exchange rate flexibility, sound macroeconomic policies to rebuild buffers, and financial policies.
  - IMF-supported program provides an additional anchor to cope with negative shocks.
- Specific risk considerations:
  - Delays in infrastructure projects could lead to an unduly contractionary fiscal impulse.
  - Upside risks: stronger domestic and external demand; if realized and causing overheating, may require tightening macro policies.

### A. Fiscal Policy — recent performance and 2019 stance
- January–September 2018 fiscal performance:
  - Augmented fiscal balance (TMU definition) surplus of GEL278 million through June, compared to an adjusted deficit ceiling of GEL269 million under the program.
  - Continued overperformance through September led to a surplus of GEL392 million.
- End-December 2018 commitment:
  - End-December 2018 augmented deficit to be kept below the program ceiling of GEL1,150 million (2.8 percent of GDP).
  - Given project delays and to avoid excessive contraction, accelerated spending on investment projects.
- 2019 fiscal stance and targets:
  - Committed augmented deficit of GEL1,170 million (2.6 percent of GDP) for 2019, with measures to be announced by mid-December 2018.
  - Performance criterion: achieve an augmented deficit of no more than GEL250 million by end-June 2019.
  - Continue containing current primary spending (indicative target), despite pressures from pension reform and additional social spending.
  - Revenue measures: committed to take revenue measures yielding GEL150 million in 2019, of which about a third would be in permanent revenues.
  - Capital spending: continue to accelerate capital spending in 2019-20, but at a more moderate rate than envisaged at the time of the Second Review under the EFF.
- Pension policy:
  - Basic public pension currently amounts to GEL180 per month.
  - Planned increases: GEL200 per month in 2019 and GEL220 per month in 2020.
  - Structural benchmark: submit legislation proposing a rule-based mechanism to index basic pensions (end-February 2019).
- VAT refunds:
  - Aim to refund GEL400 million in VAT credits in 2018, and GEL250 million in the first half of 2019.
  - Additional refunds, if materialized, will be accommodated under the program through an adjustor (see TMU, ¶14).
- Use of over-performance or savings:
  - In consultation with the IMF, commit to use revenue over-performance or additional savings in current spending toward high priority growth-enhancing net acquisition of non-financial assets, and any under-execution in investment towards a lower deficit.

### A. Fiscal Policy — fiscal risks, contingent liabilities, and safeguards
- Commitment to anchor debt at safe levels and proactive medium-term fiscal consolidation.
- PPPs/PPAs and contingent liabilities:
  - Budgetary effect of PPPs/PPAs intrinsically uncertain; some contingent liabilities have greater likelihood of materializing.
  - Immediate effects would be felt by public enterprises; costs could pass to budget via lower dividends, delayed debt service, or capital injections.
  - With IMF TA, strengthen scenario analysis to estimate plausible fiscal costs and prudently consider additional fiscal measures to build precautionary buffers.
- Measures to create fiscal room and efficiency improvements:
  - Contain wage bill and administrative expenses.
  - Improve targeting of subsidies and social assistance.
  - Reduce transfers and privatize loss-making SOEs.
  - Improve performance-based budgeting.
- Corporate income tax policy:
  - Do not plan to extend dividend distribution model to financial institutions until 2023 to avoid revenue loss (up to 0.5 percent of GDP) in the near term.
  - In consultation with the IMF, consider moving the insurance sector to the dividend distribution model sooner.
- Commitment to identify additional measures with the IMF if needed to achieve deficit target.

### A. Fiscal Policy — fiscal rules and institutional commitments
- Avoidance of arrears and guarantees:
  - Will not accumulate any general government external debt payment arrears outside those under negotiation (performance criterion).
  - Will not accumulate net domestic expenditure arrears of the general government (indicative target).
  - Will not issue new public guarantees or comfort letters (performance criterion).
- Partnership Fund (PF) constraints:
  - PF to pursue only commercial objectives, will not run a cash deficit (performance criterion), or issue any new guarantees.
  - New net borrowing of the PF limited to $20 million at end-December 2018 and end-June 2019 (cumulative from beginning of EFF program, performance criterion).
  - Maintain a non-negative cash position at the PF by end-December 2018 and end-June 2019 (performance criterion).
- PPPs/PPAs moratorium and conditional exceptions:
  - Will refrain from initiating any PPPs, including PPAs, until PPP framework operationalized.
  - PPAs currently under negotiation permitted to proceed (prior to PPP framework operationalization) only if:
    - guaranteed purchase period not more than 8 months in each year;
    - guaranteed purchase tariff not more than US 6c per kWh;
    - cumulative installed capacity of projects under negotiation will not exceed MW650.
- Namakhvani and Koromkheti HPPs:
  - Fiscal risks analysis conducted for Namakhvani HPP Cascade Project and Koromkheti HPP PPAs; Koromkheti project later decided not to be pursued.
  - Namakhvani MoU negotiations ongoing (planned capacity of MW433).
- Credit guarantee scheme (CGS) for SMEs:
  - Proposing a CGS based on international best practices to limit fiscal risks: limited in size, targeted, easy to dismantle, transparently incorporated in the budget, market-based operations.
  - Specific characteristics, including size, to be determined in consultation with the IMF and other international partners.
  - Plans for an export credit agency (ECA) abandoned; if retaken will consult IMF before establishment.

### B. Structural Fiscal Policies — fiscal decentralization and revenue administration reform
- Fiscal decentralization:
  - Starting with the 2019 budget, local governments will keep 19 percent of all VAT proceeds.
  - Claw back clause requiring local governments to surrender additional revenues will be abolished.
  - Capacity building at local governments needed to support adequate spending.
- Revenue administration reform (3-year plan, supported by Revenue Mobilization Trust Fund):
  - Organizational structure:
    - GRS HQ restructured into function-based organization with logical groupings of core functions.
    - Deputy directors general assigned responsibilities in December 2018.
    - Continue building capacity and adequately staffing new HQ departments.
  - VAT administration reforms:
    - Aim to eliminate unrefunded VAT credits and, by end-2021, reduce by at least 50 percent the outstanding stock of those VAT credits within the limitation period for audit.
    - Steering committee (MoF, GRS, GTS) proposed necessary legal amendments or ministerial decrees in May 2018.
    - Risk-assess 100 percent of declarations (within statute of limitations) by mid-2020 for existing credits.
    - New specialized VAT unit in GRS audit department created (structural benchmark, end-June 2018).
    - Automatic risk assessment and risk-based auditing:
      - All new VAT declarations risk-assessed under automated system starting January 2019.
      - Fully automated system by end-2018.
      - 90 percent of new declarations with lowest risk score will not be subject to further manual review and will be immediately eligible for a refund if requested and no outstanding liabilities (structural benchmark, end-June 2019).
      - 10 percent with highest risk score reviewed by specialized VAT unit.
    - Automatic refunding of new VAT credits:
      - From January 2020, all risk-assessed new credits approved by the system will be offset against existing liabilities or refunded without need for explicit refund request; VAT declaration form to be changed accordingly.
      - Option to offset stock of existing credits against new liabilities remains; cash refund option by separate form for stocks within three-year statute of limitations remains.
  - Compliance and audit capacity:
    - IMF TA received on enhancing compliance risk analysis and data management.
    - Committed to increase audit capacity, efficiency, and impact; use risk-based audits to target higher-yield non-compliance.
    - Pilot audit management system by July 2019.
    - Ensure adequate IT strategy and resources at MoF.
  - Filing compliance and taxpayer register:
    - Key performance indicators established to improve filing compliance; initially for VAT, to expand to all tax categories.
    - By end-2018, submit to Parliament legal amendments so that an unfiled declaration is no longer deemed a nil declaration where MoF requires a declaration.
    - Unit established and staffed to deal with filing default and late filing for all revenue types.
    - By end-October 2019, clarify tax registration requirements and give GRS mandate to enforce compliance and control registration process for all tax types, including issuance and allocation of tax identification numbers.
    - GRS to create and maintain a register of employees for tax administration purposes by better utilizing information already received from taxpayers.
  - Penalty regime and refund request requirement:
    - Initial commitment to submit to Parliament a more gradual penalty regime based on culpability (structural benchmark, end-December 2018).
    - Following FAD TA, additional work needed to calibrate auditor discretion in assessing culpability.
    - Reformulated structural benchmark requested:
      - (i) revise penalty regime by incorporating materiality (penalty depends on difference between tax paid and GRS assessment);
      - (ii) approve changes to tax code granting GRS powers to pay out refunds without need for a refund request (new structural benchmark, end-December 2018).
    - These actions aim to accelerate VAT refunds in 2019 and prevent build-up of new VAT credits.
  - Automatic access to third-party information:
    - GRS to be provided automatic access to third-party information from appropriate government agencies, including:
      - (i) National Agency of Public Registry on real estate, rentals and leases, and on JSC partners and changes in company equity (tentatively by end-2018);
      - (ii) municipalities on construction permits;
      - (iii) Financial Monitoring Service on suspicious transactions as defined in law on facilitating the prevention of illicit income legislation.
    - New structural benchmark: submit to Parliament changes allowing GRS access to information received by FMS from Monitoring Entities and put in place safeguards to protect information from improper use (end-May 2019).

*International Monetary Fund — Georgia, program document excerpt*

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

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

### Fiscal risks from SOEs, PPPs, and PPAs
- Carefully studying risks that could arise from state-owned enterprises (SOEs) and PPPs, including PPAs in the energy sector.
- Recognize that PPPs and PPAs can play a pivotal role in Georgia’s development by attracting investment, including FDI.
- Improvements in relevant legislation are required to reap benefits of further PPPs and PPAs.

### Commitments on PPPs and PPP governance (a–d)
- a) Adopt a new PPP law and associated regulations.
  - Parliament approved a PPP law that includes sound elements following best international practices, with assistance from the World Bank (WB), the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), and the IMF.
  - A government decree implementing the PPP law was adopted (structural benchmark, end-December 2018) and incorporated recommendations from the IMF.
  - Committed to issuing guidelines establishing the evaluation methodology for PPPs within the first half of 2019.
- b) Continue strengthening the Fiscal Risk Statement (FRS) accompanying the budget.
  - i. The 2019 FRS will expand analysis of fiscal risks from PPPs and PPAs, and SOEs (structural benchmark, end-December 2018). For PPPs and PPAs, the 2019 FRS will disclose:
    - (i) in addition to the NPV, the expected nominal cost per year for the lifespan of these projects,
    - (ii) the expected nominal cost of the riskiest top 3/5/10 projects, by year, for the period of the agreements, and their NPVs; and
    - (iii) the total nominal net payments for the base case and alternative scenarios, and their NPVs.
  - In consultation with the IMF, the 2019 FRS will also include financial baseline projections and sensitivity analysis for major SOEs (largest 7 SOEs), covering the year of the FRS and the year after, which will be used as the basis for prospective sensitivity analysis.
  - ii. For the MoF fiscal risks management unit, commit to recruit additional staff by mid-2019 with practical corporate finance experience and to intensify the training of its existing staff in corporate finance.
- c) Strengthen the monitoring of SOEs.
  - Ensure MoF and the Ministry of Economy and Sustainable Development (MOESD) collect comprehensive data on SOEs, including performance information, transfers between the state and SOEs and among SOEs, borrowing, guarantees and any litigation, at least, on an annual basis.
  - In consultation with the IMF, will (i) establish a complete inventory of SOEs with a clear determination of SOEs qualifying as public corporations and SOEs qualifying as general government entities under GFSM 2014 (new structural benchmark, end-September 2019); and (ii) adopt a government decree clarifying the mandate of SOEs that are public interest entities, governance and reporting requirements (new structural benchmark, end-November 2019).
- d) Improve the Public Investment Management Framework (PIMF).
  - A Public Investment Management Assessment (PIMA) by the IMF in May 2018 identified weaknesses in project appraisal, selection, and management.
  - Developed a comprehensive action plan and strengthened MoF’s role in public investment management by creating a dedicated public investment council at the MoF to centralize information and evaluate projects based on cost/benefit analysis and other relevant analyses.
  - PIMF will cover PPP-type projects to ensure they are prioritized and assessed alongside traditionally-procured projects.
  - In coordination with the IMF, committed to strengthen PIMF by strengthening public investment management methodology and implement reporting and oversight requirements for public investment projects at the MoF (new structural benchmark, end-December 2019).
  - Enhanced monitoring intended to identify project implementation delays early.

### Public financial management, fiscal rule, and transparency (Paragraph 14)
- a) Improve fiscal rule to safeguard fiscal sustainability.
  - Reviewed fiscal framework with IMF support; submitted to parliament a revised fiscal framework following IMF recommendations in TA report of November 2017 (structural benchmark, end-December 2018).
  - The revised fiscal rule no longer includes an expenditure ceiling; it applies to fiscal outturns and clarifies definitions of aggregates, escape clauses, communication, transparency, and oversight.
  - Revised fiscal framework will help contain fiscal risks by including contingent liabilities from PPPs under the debt ceiling.
- b) Strengthen the Medium-term Budget Framework (MTBF).
  - Documentation accompanying the 2019 budget includes analysis of revisions to the medium-term macroeconomic outlook and revenue projections.
  - The 2020 budget will expand discussion to compliance with respect to the fiscal rule, revisions of expenditure plans and explain any projected breach of expenditure ceilings under the 2019 MTBF.
- c) Follow guidelines for new budget lending operations.
  - Adopted new guidelines governing budget lending operations (Dec. 2017) and prepared the 2019 State Budget applying the Government Fiscal Statistics (GFS) classification of equity injections and on-lending following the “reasonable commercial return test” —If the test is not met equity injections are treated as subsidies or capital transfers.
- d) Improve quality of fiscal reports.
  - Included Legal Entities of Public Law’s (LEPLs) revenues and expenditures in the budget documentation starting in the 2018 state budget.
  - Determined that all LEPLs should be classified as general government units, based on GFSM 2014 standards.
  - Will upgrade public finances presentation from GFSM 2001 to GFSM 2014 classification in the context of the 2020 budget.
- e) Comply with international accounting standards.
  - Starting in 2021, will produce an annual consolidated general government sector financial report based on International Public-Sector Accounting Standards (IPSAS) basis.

### Monetary policy (Paragraphs 15–18)
- 15. Commit to inflation targeting (IT) framework to maintain price stability.
  - Inflation has remained close to the NBG’s target of 3 percent since early 2018.
  - Will abide by the Inflation Consultation Clause (ICC). Inflation developments monitored via dual consultation bands set symmetrically around forecast for headline CPI.
  - If actual inflation is outside inner consultation band of ± 2 percent, NBG will consult with IMF staff; outside outer consultation band of ± 3 percent triggers consultation with IMF Board.
- 16. Flexible exchange rate regime and reserve accumulation.
  - Maintain floating exchange rate regime; FX interventions limited to smoothing excessive volatility and building international reserves.
  - Will continue accumulating gross international reserves (GIR) throughout the program, monitored by a floor on net international reserves (NIR, performance criterion).
  - FX interventions of $50 million in 2018H1 enabled accumulation beyond envisaged end-June program floor.
  - Committed to end-December 2018 adjusted NIR performance criterion currently estimated at$1,403 million (down from $1,550 million at the time of the second review due to lower external disbursements), and $1,456 million by end-June 2019.
  - Starting in 2019, support reserve accumulation through a preannounced rule-based and transparent FX options to facilitate FX purchases without interfering with floating exchange rate regime.
- 17. Strengthen monetary policy transmission mechanism.
  - Strengthened lari liquidity management and extended open market operations to outright purchases of treasury securities since May 2018.
  - Interbank interest rates remain close to the policy rate.
  - Will submit legal amendments to Parliament by end-2018 to support derivatives and repo transactions.
- 18. Improve communication toolkit.
  - Requested IMF TA to strengthen communication.
  - Continue publishing quarterly monetary policy reports on a pre-announced schedule with associated meetings with experts.
  - Every second monetary-policy meeting will continue to be followed by a press conference.
  - Issue a manual for monetary policy operations in line with IMF TA recommendations by March 2019.

### Financial sector policy and stability (Paragraphs 19–26)
- 19. Strengthen financial sector stability.
  - Steps taken: (i) operationalizing macroprudential policy; (ii) strengthening capital requirements, including a countercyclical buffer and additional capital requirements for systematically important banks; (iii) allowing the NBG to supervise banking groups; (iv) empowering the NBG to supervise and regulate micro-financial institutions; (v) improving consumer protection in financial operations; (vi) empowering the NBG to oversee credit bureaus; (vii) strengthening the operational framework of the Financial Stability Committee; (viii) introducing impairment guidelines and publishing macroeconomic forecasts and risk scenarios for IFRS 9 implementation; and (iv) establishing a deposit guarantee agency.
  - Will further strengthen: (i) supervisory and regulatory framework; (ii) financial stability policy framework; and (iii) safety nets and bank resolution framework. Will incentivize domestic currency use and support domestic capital market development.
- 20. Progress on regulation and supervision.
  - a) Roadmap to transition to IFRS regulatory reporting approved in June 2018; aim to transfer banks’ regulatory reporting to IFRS framework through EU standards (FINREP/COREP forms).
  - b) In May 2018, introduced a 25-percent limit of banks’ regulatory capital for loans to households with no verifiable income.
    - Introduced limits on loan-to-value ratios (LTVs) and debt service payments-to-income (PTIs) by income group for retail loans; more binding constraints for FX loans for unhedged FX exposures; limits enter into effect in January 2019.
  - c) NBG and State Insurance Supervision Agency developing supervision framework for financial conglomerates; drafted law on supplementary supervision aligned with EU directives; plan to submit law to Parliament by December 2018.
  - d) Introduced regulations on:
    - (i) leverage ratios based on Basel principles and relevant EU regulations (structural benchmark, end-September 2018);
    - (ii) credit information bureaus (with WB TA) to set requirements, limits, issue guidelines and apply fines, protect consumers and limit business-continuity risks;
    - (iii) bank’s real estate appraisal of collateral in line with International Valuation Standards (structural benchmark, end-June 2018); and
    - (iv) corporate governance in line with Basel principles (structural benchmark, end-September 2018).
    - Will introduce regulations on net stable funding ratio in line with Basel III principles by September 2019.
  - e) With IMF TA, initiated regulation, supervision and oversight of non-bank financial institutions: prudential regulatory framework for MFI’s operational in September 2018; non-prudential oversight of other lenders operational in January 2019.
  - f) With IMF TA, developed a macro-financial model to analyze financial and macroeconomic risk scenarios and conduct macro stress tests.
- 21. Financial Stability Report (FSR) and macroprudential strategy.
  - Will resume FSR as a stand-alone publication with IMF TA; develop a macroprudential strategy document anchored within the NBG.
  - Publication of new FSR (new structural benchmark, end-November 2019) to provide forward-looking assessment of risks and vulnerabilities, detailed private non-financial sector balance sheet analysis, and macro-prudential policy actions.
- 22. Sustainable finance framework.
  - Held Sustainable Finance Workshop in September 2018 with IFC and Sustainable Banking Network (SBN); agreed on NBG’s next steps including publication of a sustainable finance roadmap in 2019.
  - Working with OECD on Environmental, Social and Governance (ESG) Reporting and Disclosure Principles for financial institutions.
- 23. Strengthening financial safety nets.
  - a) Cooperate with banks to strengthen recovery plans.
  - b) Strengthen capacity to act as lender of last resort by identifying legal amendments to prohibit unsecured lending by the NBG, mandate a penalty rate for emergency liquidity assistance (ELA), and clarify the role of the MoF for effective ELA.
    - With TA support, plan to revamp banking resolution framework, enhance crisis management, clarify authorities’ roles, and grant NBG resolution authority.
    - Submit legislative changes to implement effective ELA and resolution frameworks in line with international best practices (structural benchmark, end-May 2019).
- 24. Financial larization and FX risk reduction.
  - Adopted comprehensive plan in December 2016 to reduce loan dollarization; observed decline in loan dollarization and deposit dollarization.
  - Increased FX reserve requirements on short-term FX deposits from 20 to 25 percent; reduced reserve requirements on short-term local currency deposits from 7 to 5 percent.
  - Proposed to Parliament to increase threshold under which only loans in local currency can be issued from GEL100,000 to GEL200,000.
  - Lending rules imposing stricter PTI and LTV limits on FX retail loans to internalize higher risks for FX borrowing (¶20, b).
- 25. Consumer protection, financial inclusion and literacy.
  - Expand financial education to improve household understanding of FX borrowing risks.
  - NBG awarded the 2018 Child and Youth Financial Inclusion Award.
  - Partnered with European Fund for Southeast Europe and Export Development Association for financial education program for micro and small enterprises.
  - Working with Ministry of Education, Science, Culture and Sports to scale-up SchoolBank project and develop educational materials.
  - In September 2018, reduced maximum lending rate to 50 percent (from 100 percent) and maximum penalty rate to 0.27 percent daily (from 0.41 percent daily) and introduced a cap on accrued penalty (150 percent of outstanding overdue amount).
- 26. Capital market development to support larization and reduce external vulnerabilities.
  - a) Law establishing investment funds expected to be submitted to Parliament by December 2018; working on legal/regulatory frameworks for derivatives and securitization.
  - b) Upgrade infrastructure with a single security settlement system for all Georgian securities with two participating central security depositories (CSDs); expect system to be fully operational by end-2018.
  - c) Commit to continue publishing a multi-year plan of government bond issuance to develop benchmarks along the yield curve.
  - d) Align legal framework in securities market with EU directives and strengthen insolvency and securities holding frameworks.
  - e) Clarified taxation of publicly issued securities and committed to further improve laws on taxation of financial instruments, specifically derivatives and investment funds.

*IMF staff report excerpt (cr18373).*

### 27.      Achieving more robust and inclusive growth will require steadfastly advancing our

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

### Structural reform goals and partners
- Reforms aim to: boost long-term growth, diversify the economy, strengthen the external position, create jobs, and reduce poverty; targeted social assistance and health care will protect the most vulnerable.
- Partners listed to support the reform program: the IMF, the WB, the ADB, the EBRD, the European Investment Bank (EIB), KfW Development Bank, Agence Française de Développement (AFD), and the European Commission.

### Infrastructure and spatial planning
- Key projects and timelines:
  - Finalize the East-West highway by 2022.
  - Finalize the South-North corridor by 2023.
- Additional infrastructure priorities: ports, railways, radial roads to better connect regions and urban/rural areas; support for tourism development including water and electricity infrastructure to promote Georgia as a four-season tourist destination.
- Public investment governance: public procurement process brought closer to international standards to improve efficiency and transparency.

### Education, labor skills, and employment
- Rationale: lack of qualified labor is a major problem for doing business; unemployment and underemployment remain high, indicating skill mismatches.
- Comprehensive education reform areas:
  - (i) early childhood education;
  - (ii) secondary education;
  - (iii) vocational education and training;
  - (iv) higher education;
  - (v) science and research.
- Reform components: setting curriculum standards, a new teacher policy framework, more effective vocational training and adult learning, employer participation in curriculum design, and job-seeker guidance on job selection, preparation and retraining.

### Pension reform
- Funded pension pillar (Pillar II) status:
  - Will become operational in 2019.
  - Submitted to Parliament a law establishing a Pilar II pension system with creation of an independent pension agency in August (structural benchmark, end-July 2018).
- Pillar III (private pension savings system) planned to be formulated in 2019.
- Expected benefits: improve standards of living of future retirees, promote savings, and create an institutional investor for long-term lari assets.

### Business environment and financial/legal frameworks
- Planned measures:
  - Establish a Business House by 2020 to provide public services to enterprises under a one-stop shop.
  - Introduce IFRS for corporations.
  - Submit to Parliament a new insolvency law ensuring adequate protection of creditors’ rights, timely and efficient insolvency processes and effective rehabilitation framework in line with best international practices (new structural benchmark, end-July 2019).
  - Apply regulatory impact assessments for major policy decisions.
  - Negotiate establishment of a Court of Arbitration with the International Chamber of Commerce.
  - Improve VAT system efficiency.

### Land registration and rural development
- Importance: cadasters protect property rights, simplify transactions, and provide collateral for borrowing.
- Simplification measures: fee waiver program for land registration, assistance for citizens to search property ownership documents, facilitation of dispute resolution through mediation.
- Current registration statistics:
  - Registered land plots amount to 1.8 million.
  - 30.5 percent (0.55 million) of those were registered within the land reform launched on August 1, 2016.
- Additional initiatives: creation of a farmer’s registry and a geo-information land use system to ensure rational use of agricultural land.

### Trade policy
- Strategic priority: deepen trade relations through FTAs to mobilize FDI in tradable sectors, improve competitiveness, reduce external vulnerabilities, and generate balanced growth.
- Existing FTAs: EU (Deep and Comprehensive Free Trade Area), EFTA, the People’s Republic of China, Turkey, Hong Kong Special Administrative Region and some CIS countries.
- Negotiations and commitments: negotiating with Turkey to expand the FTA; committed to pursue other FTAs with priority countries including the United States, Israel, India, the Gulf Cooperation Council countries, and others.

### Strengthening statistics and data publication calendar
- Recent and planned publications:
  - Quarterly unemployment figures: started August 2018.
  - Hours worked: started October 2018.
  - Reconciled differences between the 2014 and the 2002 census results: June 2018.
  - Poverty figures: published May 2018.
  - Quarterly statistics on tourism: published.
  - Survey on the structure of earnings by occupations and labor costs: published October 2018.
  - National accounts based on NACE 2 sectoral classification: start publishing by November 2019.
  - Compute GDP based on supply and use tables and quarterly GDP by expenditure in constant prices: 2020.
  - Expand coverage of the monthly producer price index (PPI) and develop a quarterly residential property price index (RPPI), both expected to be released in 2020 (with IMF TA support).

### Program monitoring, safeguards, and institutional arrangements
- Program monitoring instruments:
  - Quantitative performance criteria, indicative targets, an inflation consultation clause and structural benchmarks.
  - Semi-annual program reviews based on December and June test dates.
  - Technical Memorandum of Understanding (TMU) attached to describe definitions of quantitative PCs, the inflation consultation clause, and data provision requirements.
- Safeguards: The NBG will continue to engage independent external audit firms to conduct audits in accordance with international standards and maintain a strong safeguards framework and internal controls environment.
- Program assumptions and exchange rates (as specified in the TMU):
  - SDR Special Drawing Rights 0.7439 (Currency/US$)
  - GEL Georgian lari 2.6468
  - AUD Australian dollar 0.7227
  - CAD Canadian dollar 0.7419
  - EUR Euro 1.0556

*Source: IMF staff and authorities’ Letter of Intent and Technical Memorandum of Understanding as presented in the document.*

### 7.      Inflation consultation bands around the projected path for inflation are set for each test date

### 7.      Inflation consultation bands around the projected path for inflation are set for each test date

### Inflation consultation framework
- Test date inflation is defined as the year-on-year percentage change of the monthly consumer price index (CPI) in the month of the test date as measured and published by the National Statistics Office of Georgia (GEOSTAT).
- If test date inflation falls outside the outer bands specified in Table 1 of the MEFP:
  - The authorities will complete a consultation with the IMF Executive Board focusing on: (i) the stance of monetary policy and whether the Fund-supported program remains on track; (ii) the reasons for the deviation; and (iii) the proposed policy response.
  - When such consultation is triggered, access to Fund resources would be interrupted until the consultation takes place and the relevant program review is completed.
- If test date inflation falls outside the inner bands specified in Table 1 of the MEFP:
  - The authorities will complete a consultation with IMF staff on the reasons for the deviation and the proposed policy response.

### Program definitions, adjustors, and reporting requirements (selected themes)
- Data and reporting timelines:
  - Domestic bank and nonbank financing data: provided by the NBG and the Treasury Department of the Ministry of Finance within four weeks after the end of each month.
  - External project financing and other external borrowing: provided monthly by the Ministry of Finance (specifying projects by creditor) within two weeks of the end of each month.
  - Data provided at actual exchange rates.
  - Receipts from sales of non-financial and financial assets of the general government: provided by the Treasury Department monthly within two weeks of the end of each month.
  - Securitized debt sold by the NBG, including securities purchased by nonbanks: reported by the NBG monthly within two weeks of the end of each month.
  - Georgia Revenue Service monthly data (period from the 16th day of the previous month to the 15th day of the current month) to be provided by the end of each month on:
    - Opening balance in taxpayer accounts (stock)
    - New tax credits declared by taxpayers
    - Tax credit balance adjustments made by GRS after desk check / audit and by taxpayers
    - Tax payments to the budget
    - Tax credits offset against tax liabilities
    - Tax credit refunds paid in cash
    - Other flows (residual)
    - Closing balance in taxpayer accounts (stock)
    - Closing balance amounts not eligible for a cash refund (stock)
  - Georgia Revenue Service monthly data for the previous month to be provided by the end of each month on:
    - Number and GEL value of claims for cash refunds submitted by taxpayers, separately for VAT and other taxes
    - Number and GEL value of cash refunds paid, separately for VAT and other taxes
    - Number and GEL value of cash refunds paid automatically (i.e., without manual check or audit), separately for VAT and other taxes

### General government — Ceiling on the augmented cash deficit
- Definition:
  - Augmented cash balance of the general government = revenues minus expense, minus net acquisition of non-financial assets (as defined by GFSM 2001) minus net budget lending.
  - A negative augmented cash balance is a deficit.
- Financing-side measurement:
  - Measured from the financing side at current exchange rates established by the NBG at the date of the transaction.
  - 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.
- Net budget lending:
  - Defined consistent with GFSM 2001 as the net acquisition of financial assets for policy purposes by the general government.
- Adjustors to the ceiling on augmented cash deficit:
  - Adjust 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.
  - Adjust downward (lower deficit) by the cumulative amount of receipts from sale of non-financial assets above the program amounts (Table 2).
  - Adjust upward (higher deficit)/downward (lower deficit) by the amount of VAT credits refunded in cash above/below the program amounts (Table 2).

- Table 2. Georgia: Projected Financing for Cash Deficit of the General Government (in millions of GEL, cumulative from the beginning of the calendar year)
  - December 31, 2018 / June 30, 2019
    - Disbursements of foreign-financed project loans: 1214 / 760
    - Receipts from sale of non-financial assets: 150 / 70
    - VAT refunds: 400 / 250

### 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.
- Reporting:
  - Data for monitoring expenditures will come from the accounts of the general government covered under the ceiling on the augmented cash deficit (including autonomous regions).
  - The Ministry of Finance is responsible for 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 on accumulation of general government external debt arrears
- Definition:
  - Debt defined 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.
- 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 applies on a continuous basis throughout the arrangement period.
  - It shall not apply to external payments arrears arising from external debt being renegotiated with external creditors where a creditor has agreed that no payment needs to be made pending negotiations.
  - Footnote: Arrears to Turkmenistan.
- Supporting material:
  - Accounting of non-reschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted monthly within two weeks of the end of each month.

### Continuous indicative target on 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, goods and services.
  - Arrears 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:
  - Accounting of new domestic expenditure arrears (if any) will be transmitted within four weeks after the end of each month.

### Guarantees
- For the program, a guarantee of a debt arises from any explicit legal obligation of the public sector to service such a debt in the event of nonpayment by the recipient (involving payments in cash or in kind).

### Partnership Fund — ceilings, definitions, and reporting
- Ceiling on the cash deficit of the Partnership Fund:
  - Definition: cash deficit = expenditures minus revenues.
- Revenue composition:
  - Dividends from assets and investments, interest earnings from loans it provides, fees charged for services and guarantees, and any other income earned from its assets.
- Expenditure composition:
  - All current and capital expenditures.
  - Current expenditures: compensation of employees, purchase of goods and services, transfers to other entities, other account payables, domestic and external interest payments.
  - Capital expenditures: net acquisition of nonfinancial assets as defined under GFSM 2001.
  - Purchase of financial assets (e.g., lending and equity participation) will not be considered part of expenditures.
- Ceiling on new net borrowing by the Partnership Fund:
  - Definition: net borrowing = contracted debt liabilities minus principal repayments.
- Reporting:
  - The Ministry of Finance will provide 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) — floor and adjustors
- Definition of NIR (U.S. dollars):
  - NIR of the NBG = 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 are defined as liquid, convertible currency claims of the NBG on nonresidents, including cash holdings of foreign exchange that are readily available.
  - Pledged or otherwise encumbered assets, including assets used as collateral (or guarantee for third party external liabilities), are excluded from foreign assets.
  - Foreign liabilities include 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 foreign exchange balances in the government’s account with the NBG.
  - For program monitoring purposes, 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, 387 million as of June 30, 2018 (at program exchange rates).
- Adjustors to the floor on NIR:
  - Upward (downward) by the cumulative amount of any excess (shortfall) by any FX privatization revenue in foreign exchange above (below) the programmed amounts. Privatization receipts are proceeds from sale, lease, or concessions of public entities and properties.
  - 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. Georgia: Projected Balance of Payment Support Financing (in millions of U.S. dollars, cumulative from the beginning of the calendar year)
  - December 31, 2018 / June 30, 2019
    - Projected privatization revenue: 0 / 0
    - Budget support grants from external donors and not related to project financing: 45.7 / 40.6
    - Budget support loans, including bilateral and multilateral donors for budget support: 166.4 / 165.6
    - Net issuance of the Eurobond from the general government: 0 / 0
    - Disbursements of project loans and grants: 306.8 / 179.4
  - Footnote 1: Cumulative from end-September 2018 to end-June 2019.

- Supporting material on NIR reporting:
  - 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.

### Appendix to the TMU: The Partnership Fund — organization, mandate, and portfolio management
- Legal and governance structure:
  - The Partnership Fund (PF) is incorporated as a Joint Stock Company (JSC).
  - Governance bodies:
    - Investment board: currently composed of internal members (CEO, CIO, portfolio officers) and can add external members (experts and private sector representatives); approves business cases and initiates projects.
    - Risk management committee: internal members (CFO, Chief Legal Officer, Chief Accountant); advises on project risks for project implementation agreements.
    - Supervisory board (board of directors): approves projects (based on feasibility studies, risk assessments, and business cases) and approves budget for project development; includes government members and is chaired by the Prime Minister.
    - In cases of equity participation in projects, the PF needs government approval.
- Corporate mandate:
  - Approved by the supervisory board and the government.
  - PF will provide project financing through equity participations, senior loan, quasi-equity through subordinated convertible debt, and performance bonds/guarantees.
  - Investment focus: energy, agriculture, manufacturing, and real estate.
  - PF is not allowed to provide financing to the service industry.
  - PF will charge market rates for services provided.
- Portfolio management strategy:
  - Sets portfolio limits, performance management objectives, and project evaluation guidelines.
  - Principles:
    - PF will participate only in commercially viable projects.
    - Performance monitoring based on evaluation criteria: IRR, adjusted present value, sharp ratio, and risk adjusted return.
- Project development methodology:
  - PF will only participate in projects where a corporate investor with sufficient industry experience expresses willingness to take at least 51 percent of the project’s total equity.
  - PF financing (debt plus equity plus guarantees) will not exceed 100 percent of the equity of the private partner in the project.
  - PF will pursue only commercial objectives.
- Reporting and auditing:
  - PF will engage an internationally recognized auditing company to conduct IFRS audits of its financial statements.
  - PF will hire on a permanent basis rating agencies to prepare regular ratings reports—there will be no minimum rating requirement for the PF.
  - PF’s audited financial statements and ratings reports will be available on a permanent basis to a broad audience.
- Fiscal risk mitigation:
  - All liabilities of the PF are limited to its own balance sheet.
  - PF has its own revenue sources: dividends from investments, interest earnings from loans, fees on guarantees, proceeds of asset sales.
  - PF may decide to borrow from credible financial institutions with recourse to its balance sheet facility and without state guarantee.

### Supplementary fiscal note (staff update)
- Parliamentary schedule and budget:
  - Parliament is set to approve the 2019 budget on December 13.
  - Parliamentary discussions on the budget were finalized on December 12, and the vote is set for December 13.
  - The budget deficit is expected to be marginally lower than the one envisaged in the staff report.
  - As revenue measures, the government announced the elimination of tax payment benefits and an increase in excise taxes for unfiltered cigarettes (to align prices with filtered cigarettes).
  - The authorities plan to announce a one-off social spending allocation (0.2 percent of GDP) shortly; this allocation is planned for 2019H2 and will require a budget amendment.
  - No program conditionality for this review is associated with this measure.
- Staff view:
  - This information does not change the thrust of the staff appraisal or the basis for the proposal for LOT consideration.
  - Staff continues to support the conclusion of the Third Review.
- Date of staff note: December 12, 2018

*Source: IMF staff report (cr18373, section text supplied).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18373.pdf_