## 1. Developing Local Capital Markets in Georgia ## Source details **Canonical URL:** [1. Developing Local Capital Markets in Georgia](https://www.imf.org/-/media/files/publications/cr/2019/1geoea2019001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1geoea2019001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1geoea2019001.pdf.json) --- ### Context and recent macro-financial developments - Growth and labor market - Growth in 2018: 4.7 percent; growth in 2019Q1 (preliminary): 4.7 percent y/y. - Unemployment rate: 12.7 percent (15-year low). - Inflation - Headline inflation in 2018: 2.6 percent (y/y), down from 6 percent in 2017. - Average core inflation: 1.2 percent. - Average inflation January–April 2019: 3.1 percent (y/y). - External sector and reserves - Current account deficit 2018: 7.7 percent of GDP. - Net international investment position: -143 percent of GDP at end-2018 (improved by 7 percent of GDP from end-2017). - External debt (excluding intercompany loans): 95 percent of GDP (declined by 2 percent of GDP). - Gross international reserves (GIR) by end-2018: $3.3 billion (91 percent of the ARA metric). - Increase in FX reserve requirements: $275 million; net FX purchases: $198 million. - NBG foreign exchange purchases in January–May 2019: $186 million, of which $51 million via put options. - NBG sold options worth GEL 650 million (as of end-April 2019). - Fiscal position and public debt - 2018 augmented fiscal deficit: 2.5 percent of GDP. - VAT credit stock reduced by 0.9 percent of GDP, to 3.8 percent of GDP. - Gross public debt: 44.9 percent of GDP. - General government deposits: 2.7 percent of GDP. - Structural primary deficit fell by 0.5 percent of potential GDP. - Monetary and financial sector - NBG policy rate reduced by 50 basis points to 6.50 percent between July 2018 and March 2019. - Credit developments: - Household credit growth: 19 percent in 2018 (y/y), down from 27 percent in 2017. - Credit to corporations: around 17 percent (y/y). - Mortgage credit accelerated in 2018; PTI and LTV ratios and verified income effective January 1, 2019. - Banking sector soundness: - NPLs: 3 percent (March 2019). - Watch loans: 4 percent (March 2019). - Sector remains well capitalized, liquid, and profitable; dollarization remains elevated. - Program performance snapshot - Quantitative program targets met; four of seven structural benchmarks met. - One structural benchmark implemented with one-month delay; two SBs proposed to be reset to year-end. ### Outlook and risks - Growth and inflation projections - Growth expected to remain robust; 2020–21 growth revised down by 0.2 percentage points due to slower capital spending. - Medium-term growth expectation: gradually increase to 5¼ percent (staff projection). - Inflation expected to reach the three-percent target in 2020 after one-off excise effects dissipate. - Current account deficit expected to narrow to 7 percent of GDP over the medium term. - External debt expected to decline gradually. - Key downside risks - Vulnerability to external spillovers, escalating trade tensions, financial market volatility. - High dollarization: risk of large lari depreciation undermining growth and financial stability. - Domestic risk: sharper-than-expected slowdown in credit. - Political risk: increased uncertainty ahead of the 2020 parliamentary elections. ### Policy discussions and recommendations - Overall policy stance - Maintain prudent policies and reform momentum; NBG to keep policy rate on hold and continue building reserves while preserving exchange rate flexibility. - Emphasize structural reforms to promote higher and more inclusive growth. - Fiscal policy and education reform - End-2019 augmented deficit target agreed at GEL 1,170 million (2.6 percent of GDP). - Education reform measures (May 2019): - Severance payments to less qualified teachers, training for others, and higher salaries (by GEL 115) for certified teachers. - Investment in education infrastructure. - Costing: up to 0.2 percent of GDP in one-off payments and permanently 0.1 percent of GDP. - Authorities plan to accommodate these measures within the current spending envelope; medium-term current spending projections incorporate increased education spending from 3.8 percent of GDP in 2019 to 6.2 percent of GDP by 2022. - Staff recommendations: - Adopt a comprehensive and well-costed education reform. - Use a needs-based approach rather than a legislated floor at 6 percent of GDP from 2022; make existing MTBF more binding. - Consider revenue measures (e.g., pro-environment taxes, modern property tax) to moderate slowdown in capital spending. - Fiscal transparency, risk management, and PIM - Include estimates on return of equity and loans held by government in the 2020 Fiscal Risk Statement (new SB, end-December 2019). - Any new government guarantees should be transparently disclosed and assessed in the FRS. - Advance upgrading and enforcing PIM methodology (SB, end-December 2019). - Qualify SOEs as public corporations according to GFSM2014 (SB, end-September 2019); strengthen SOE governance and reporting (SB, end-November 2019). - Shift public finance presentation from GFSM2001 to GFSM2014 in the 2020 budget. - Developing local capital markets (primary focus) - Authorities plan to facilitate budget financing through: - Increase issuance of longer-maturity bonds to enhance liquidity and attract foreign investors. - Invest funds raised through additional domestic issuance in long-term deposits at commercial banks via auctions, keeping public debt—net of government deposits—below 45 percent of GDP. - Promote private participation via draft legislation on investment funds, securities holding, derivatives and financial collateral, and taxation of collective investments (investment funds law to be submitted to Parliament by September 2019). - Transition to a primary dealer system to enhance trading. - Revenue administration and VAT - All new VAT declarations risk-assessed since January 2019; automatic risk assessment system implemented. - Plan for an excise tax on rolling tobacco by mid-2019. - Financial sector regulatory measures - Lending limits (May 2018): limits on lending to households without verifiable income (25 percent of bank’s regulatory capital). - From January 1, 2019: PTI and LTV ratios and verified income requirements for household loans. - On January 23, 2019 authorities doubled the floor (to GEL 200,000) under which new FX loans are prohibited. - Regulation and supervision of non-bank lenders have led to consolidation and liquidation of non-solvent entities. ### Partnership Fund (PF): assessment and recommendations - Assessment - PF is financially constrained due to limited dividends from SOEs. - PF no longer operating consistent with program terms; some investments do not follow commercial objectives and are not limited to minority shares. - Deviation could result in contingent liabilities. - Staff recommendations - PF should operate within terms agreed under the program. - Authorities should reconsider the need for a PF given other support programs, including the newly created credit guarantee scheme for SMEs. - TMU / program constraints on PF - PF will not run a cash deficit (performance criterion). - New net borrowing of PF limited to $20 million at end-June 2019 and end-December 2019 (cumulative from beginning of EFF). - Maintain non-negative PF cash position at end-June and end-December 2019 (performance criteria). - Revisit status and role of PF in coming months in consultation with IMF. - Appendix operational details - PF incorporated as a Joint Stock Company (JSC); organized as a commercial financial institution but practices deviate from commercial objectives and risk governance. - Corporate mandate: provide financing through equity participations, senior loans, quasi-equity, and guarantees; focus on energy, agriculture, manufacturing, and real estate; not allowed to provide financing to the service industry. - Portfolio strategy: sets portfolio limits and IRR-based evaluation, but PF no longer pursues only commercially viable projects; participation sometimes requires private partner equity ≥51 percent yet PF financing can exceed 100 percent of private partner equity. - Reporting and audits: engage internationally recognized auditor for IFRS audits; hire rating agencies; audited financial statements and ratings reports to be publicly available. - Fiscal risk containment: liabilities limited to PF balance sheet; revenues from dividends, interest, fees, and asset sales; PF may borrow without state guarantee. ### Financial stability, reserves, and intervention strategy - Monetary policy and exchange rate flexibility - NBG plans to keep monetary policy on hold; stance appropriately neutral. - With subdued inflation and expectations anchored, NBG gradually lowered the policy rate. - With inflation target expected to be reached in 2020, NBG plans to keep policy rate on hold provided inflationary pressures remain subdued. - NBG provides short-term liquidity via refinancing loans and open market operations, and long-term liquidity via outright purchases of treasury securities. - Reserve accumulation and intervention strategy - FX reserve requirements represented 41 percent of GIR at end-2018 and expected to become 47 percent of GIR in 2019. - NIR target set at $1,520 million for end-December 2019. - Policy to rely primarily on put options for intervention; banks incentivized to utilize put options when the lari appreciates. - Higher FX reserve requirements ($300 million, effective May 2019) expected to help reach 100 percent of the ARA metric by end-2019. - Any liability management operation should not undermine reserve targets. - Strengthening financial resilience - Work on legislation for emergency liquidity assistance and banking resolution framework; legal amendments submitted to Parliament (SB, end-May 2019) and enact legislation (new SB, end-December 2019). - Assess impact of using consolidated IFRS data for prudential requirements and finalize consolidated supervision regulation. - Submit enhanced supervisory framework for financial conglomerates to Parliament soon. - New regulation: banks to maintain 100 percent NSFR starting September 2019; liquid asset requirements for non-resident deposits to be abolished effective January 2020. - Monitor impact of tighter credit standards; preliminary evidence suggests slowed credit growth (credit growth: 13 percent in March 2019 compared to 17 percent in December 2018). - Prepare forward-looking financial stability report (SB, end-November 2019). ### Structural reforms to promote inclusive growth - Education reforms - New teacher policy to align to OECD benchmarks; new funding model for universities to use performance indicators. - Vocational education to focus on short-term programs tailored to labor market needs; could facilitate female labor participation. - Pension agency expected to be fully operational by end-2019; contributions collected; investment board to be formed in early June; investment strategy expected to be approved in September. - Funded pension pillar to mobilize domestic savings and create an institutional investor for long-term lari assets. - Insolvency and business environment - New insolvency law draft to be finalized (SB, end-July 2019) with framework for independent insolvency professionals. - Corporate governance reforms: corporations to publish audited financial statements based on IFRS. - Trade and energy reforms - Feasibility study for Georgia-India FTA finalized; Georgia-Israel FTA study expected by June 2019. - Energy reforms aim at market competition, renewable energy, energy efficiency; move towards third-party access and separation of transmission and distribution starting in 2019. ### Box 2 — Female Labor Force Participation in Georgia (key findings) - Participation and trends - Female labor force participation increased by 4 percentage points since 2008. - 2018: 58 percent of women aged 15+ participated in the labor market. - Comparative 2018 rates: CCA 54 percent; Emerging Europe 48 percent; Advanced economies 55 percent. - Gender gap in participation: around 20 percentage points lower for women than males. - Employment status and sectoral distribution - Women as employers: 1.2 percent of the employed (women) vs. 3 percent (men). - Women performing unpaid work: 28 percent vs. 21 percent for men. - Women concentrated in education, social and personal services, and public administration; men dominate manufacturing, mining, and construction. - Pay and macroeconomic impact - Wage gap in Georgia: 38 percent in 2018. - Gender gaps contribute to a loss of 11 percent of per capita GDP; two thirds of that loss explained by occupational choices. - Greater gender equality in entrepreneurship and labor force participation would raise Georgia’s GDP by 11.3 percent (based on Cuberes and Teignier (2016) estimates). ### Annex I — Risk Assessment Matrix (selected items) - Global shocks - Rising protectionism and retreat from multilateralism: Relative likelihood/Time Horizon: High / Short to Medium Term; Expected impact: Medium. Policy response: flexible exchange rate, accelerate structural reforms, strengthen reserve accumulation and fiscal sustainability. - Sharp tightening of global financial conditions: Relative likelihood/Time Horizon: Low / Short Term and Medium / Short Term; Expected impact: Medium. Policy response: flexible exchange rate, continue de-dollarization, strengthen financial stability, build reserves. - Cyber-attacks on critical global infrastructure: Relative likelihood/Time Horizon: Medium / Short to Medium Term; Expected impact: Medium. Policy response: strengthen banking regulation and supervision. - Weaker-than-expected global growth: Relative likelihood/Time Horizon: Medium to High / Short to Medium Term; Expected impact: Medium to High. Policy response: flexible exchange rate, accelerate structural reforms, strengthen fiscal sustainability and social safety nets. - Georgia-specific risks - Financial risks: Relative likelihood/Time Horizon: Medium / Medium; Expected impact: Medium. Policy response: monitor lending regulations, use flexible exchange rate, strengthen fiscal and financial institutions. - Fiscal risks: Relative likelihood/Time Horizon: Medium / High; Expected impact: High. Policy response: strengthen fiscal sustainability and institutions. - Political risks: Relative likelihood/Time Horizon: Low / Medium; Expected impact: Medium. Policy response: authorities stand ready to adopt measures to fulfill commitments. ### External sector and reserves (selected figures) - CA and external flows - 2018 CA deficit: 7.7 percent of GDP; drivers included lower-than-expected imports (by 1.1 percent of GDP) and higher-than-expected income account balance (by 1.2 percent of GDP). - Merchandise exports growth: 22 percent; Travel receipts growth: 19 percent; Remittances growth: 15 percent. - FDI net inflows in 2018: 5.5 percent of GDP (declined by 45 percent y-o-y). - Reserves and NIR - End-2018 GIR: $3.3 billion (20 percent of GDP), $250 million higher than end-2017. - End-2019 projection GIR: $3.7 billion (100 percent of the ARA metric). - End-December 2018 NIR at program rates: $1.5 billion ($36 million above adjusted NIR target of $1.48 billion). - End-2019 NIR target: $1,520 million. ### Program monitoring, targets, and financing assurances - Performance criteria and indicative targets include ceilings/floors on augmented cash deficit, primary current spending, outstanding VAT credits, net budget lending, NIR, external debt arrears, new domestic expenditure arrears, new guarantees, PF cash deficit and PF new net borrowing. - Adjustors - Annual cap proposed on VAT refunds adjustor: GEL 450 million. - Symmetric NIR adjustor on disbursements of project loans and grants to the TSA raised from 75 percent to 100 percent. - Projected financing for cash deficit (Table 2, cumulative from beginning of calendar year) - Disbursements of foreign-financed project loans: 760 / 1,314 (June 30, 2019 / December 31, 2019). - Receipts from sale of non-financial assets: 70 / 140. - VAT refunds: 250 / 550. - On-lent amounts from project loan disbursements: 200 / 400. - Projected balance of payment support financing (Table 3) - Budget support grants: 40.6 / 87.5 (June 30, 2019 / December 31, 2019). - Budget support loans: 165.6 / 145.4. - Disbursements of project loans and grants: 179.4 / 182.9. - Financing assurances - Program fully financed for the next twelve months; good prospects for adequate financing for remainder of program. - Capacity to repay the Fund remains adequate: full drawing under the EFF would correspond to maximum repayments at 0.2 percent of GDP or 1.0 percent of gross reserves in 2024. ### Staff appraisal: key judgments and program actions - Economic performance robust but downside risks dominate outlook. - Growth resilient, inflation under control, external vulnerabilities reduced. - Fiscal stance - 2019 budget targets a slightly expansionary stance allowing higher capital and social spending, including on education. - Enhanced public investment management to support smoother execution. - Staff cautioned that a legislated floor on education spending could reduce budget flexibility and undermine transparent accounting. - Monetary policy - Rightly focused on price stability with exchange rate flexibility; inflation-targeting framework continues to serve Georgia well. - FX intervention should support buildup in external buffers; liability management should not undermine reserve accumulation. - Structural reforms - Persevering with structural reforms critical for higher and more inclusive growth. - Insolvency reform needs robust framework for regulating insolvency professionals. - Energy market reform will improve economic efficiency and potential growth. - Staff supports completion of the Fourth Review under the EFF with modifications to two QPCs and setting a new QPC, targets for inflation, and a new IT. *Source: 1geoea2019001 - 1. Developing Local Capital Markets in Georgia* ### 1. Developing Local Capital Markets in Georgia __________________________________________________ 15 ### 1. Developing Local Capital Markets in Georgia ### Context and recent macro-financial developments - Growth and labor market - Growth in 2018: 4.7 percent, driven by net exports; growth in 2019Q1 (preliminary): 4.7 percent y/y. - Unemployment rate: 12.7 percent (15-year low). - Inflation - Headline inflation in 2018: 2.6 percent (y/y), down from 6 percent in 2017. - Average core inflation: 1.2 percent. - Average inflation January–April 2019: 3.1 percent (y/y) driven by increased excises on unfiltered cigarettes and higher food prices. - External sector and reserves - Current account deficit narrowed to 7.7 percent of GDP in 2018, mostly financed by FDI. - Net international investment position: improved by 7 percent of GDP from end-2017 to -143 percent of GDP at end-2018. - External debt (excluding intercompany loans): declined by 2 percent of GDP to 95 percent of GDP. - Gross international reserves (GIR) by end-2018: $3.3 billion (91 percent of the ARA metric). - Increase in FX reserve requirements: $275 million; net FX purchases: $198 million. - NBG foreign exchange purchases in January–May 2019: $186 million, of which $51 million via put options. - NBG sold options worth GEL 650 million (as of end-April 2019). - Fiscal position and public debt - 2018 augmented fiscal deficit: 2.5 percent of GDP (in line with adjusted program target). - VAT credit refunds more than doubled; stock of VAT credits reduced by 0.9 percent of GDP, to 3.8 percent of GDP. - Gross public debt: 44.9 percent of GDP. - General government deposits: 2.7 percent of GDP. - Structural primary deficit fell by 0.5 percent of potential GDP. - Monetary and financial sector - NBG policy rate reduced by 50 basis points to 6.50 percent between July 2018 and March 2019. - Credit developments: - Household credit growth: decelerated to 19 percent in 2018 from 27 percent in 2017 (y/y). - Credit to corporations: around 17 percent (y/y). - Mortgage credit accelerated in 2018; tighter lending standards effective January 1, 2019 (PTI and LTV ratios; verified income). - Banking sector soundness: - NPLs: 3 percent (March 2019). - Watch loans: 4 percent (March 2019). - Sector remains well capitalized, liquid, and profitable; dollarization remains elevated. - Program performance snapshot - Quantitative program targets met; four of seven structural benchmarks met. - One structural benchmark implemented with one-month delay; two SBs require more time and are proposed to be reset to year-end. ### Outlook and risks - Growth and inflation projections - Growth expected to remain robust over the medium term. - Growth in 2020–21 revised down by 0.2 percentage points due to slower-than-envisaged capital spending. - Medium-term growth expectation: gradually increase to 5¼ percent (staff projection). - Inflation: expected to reach the three-percent target in 2020 after one-off excise effects dissipate. - Current account deficit: expected to gradually narrow to 7 percent of GDP over the medium term. - External debt: expected to decline gradually, reducing external financing requirements. - Key downside risks (Annex I) - Vulnerability to external spillovers: escalating trade tensions, financial market volatility. - High dollarization: risk of large lari depreciation undermining growth and financial stability. - Domestic risks: sharper-than-expected slowdown in credit could limit short-term activity. - Political risk: increased uncertainty ahead of the 2020 parliamentary elections could dampen reform momentum. ### Policy discussions and recommendations - Overall policy stance - Authorities and staff agreed on maintaining prudent policies and reform momentum given external vulnerabilities. - NBG intends to keep policy rate on hold and continue building reserves while preserving exchange rate flexibility. - Structural reforms emphasized to promote higher and more inclusive growth. - Fiscal policy and education reform - End-2019 augmented deficit target agreed at GEL 1,170 million (2.6 percent of GDP). - Education reform measures announced May 2019: - Severance payments to less qualified teachers, training for others, and higher salaries (by GEL 115) for certified teachers. - Investment in education infrastructure. - Costing: up to 0.2 percent of GDP in one-off payments and permanently 0.1 percent of GDP. - These measures to be accommodated within the current spending envelope; medium-term current spending projections incorporate increased education spending (from 3.8 percent of GDP in 2019 to 6.2 percent of GDP by 2022). - Staff recommendations: - Adopt a comprehensive and well-costed education reform. - Use a needs-based approach rather than a fixed spending floor; staff opposed a legislated floor at 6 percent of GDP from 2022, advocating instead making the existing MTBF more binding. - Consider revenue measures (e.g., pro-environment taxes, modern property tax) to moderate the slowdown in capital spending needed to finance education reform. - Fiscal transparency, risk management, and PIM - Authorities to include estimates on return of equity and loans held by government in the 2020 Fiscal Risk Statement (new SB, end-December 2019). - Any new government guarantees should be transparently disclosed and assessed in the FRS. - Authorities advancing: - Upgrading and enforcing PIM methodology (SB, end-December 2019). - Qualifying SOEs as public corporations according to GFSM2014 (SB, end-September 2019). - Strengthening SOE governance and reporting (SB, end-November 2019). - Shift public finance presentation from GFSM2001 to GFSM2014 in the 2020 budget. - Staff advised clarifying SOE mandates and improving corporate governance and reporting, including corporatization where needed. - Developing local capital markets (primary focus) - Authorities plan to facilitate budget financing through development of local capital markets: - Increase issuance of longer-maturity bonds to enhance liquidity and attract foreign investors. - Funds raised through additional domestic issuance to be invested in long-term deposits at commercial banks via auctions, with public debt—net of government deposits—below 45 percent of GDP. - Promote private participation via draft legislation on: - Establishing investment funds (to be submitted to Parliament by September 2019). - Securities holding, derivatives and financial collateral. - Taxation of collective investments. - To enhance trading, transition to a primary dealer system is planned. - Revenue administration and VAT - Progress noted: all new VAT declarations being risk-assessed since January 2019; automatic risk assessment system for VAT declarations implemented. - Authorities plan an excise tax on rolling tobacco by mid-2019 to address lower-than-expected yield from cigarette excise increases. - Financial sector regulatory measures - Lending limits introduced May 2018: limits on lending to households without verifiable income (25 percent of bank’s regulatory capital). - From January 1, 2019: PTI and LTV ratios and verified income requirements for household loans. - On January 23, 2019, authorities doubled the floor (to GEL 200,000) under which new FX loans are prohibited. - Regulation and supervision of non-bank lenders have led to consolidation and liquidation of non-solvent entities. *Source: 1geoea2019001 - 1. Developing Local Capital Markets in Georgia* ### 17. The authorities need to reassess the role of and rationale for the Partnership Fund (PF). ### 17. The authorities need to reassess the role of and rationale for the Partnership Fund (PF). ### Partnership Fund (PF): assessment and recommendations - With limited dividends from SOEs (the source of PF’s funding), the PF is financially constrained. - The PF is no longer operating consistent with the terms agreed under the program, as some of its investments do not follow commercial objectives and are not limited to minority shares. - This deviation could result in contingent liabilities. - Staff called for the PF to: - operate within the terms agreed under the program; and - have the authorities reconsider the need for a PF, given other support programs, including the newly created credit guarantee scheme for SMEs. ### Monetary policy and exchange rate flexibility - The NBG plans to keep monetary policy on hold (MEFP ¶12). - The monetary policy stance is appropriately neutral. - With subdued inflation and well-anchored inflation expectations, the NBG has been gradually lowering the policy rate. - With the inflation target expected to be reached in 2020, the NBG plans to keep the policy rate on hold, provided that inflationary pressures remain subdued. - The authorities and staff agreed that domestic liquidity conditions remain broadly appropriate. - The NBG continues to provide short-term liquidity via refinancing loans and open market operations, and long-term liquidity via outright purchases of treasury securities. ### Reserve accumulation and intervention strategy - Efforts to accumulate international reserves need to be sustained (MEFP ¶15). - The exchange rate is broadly in line with fundamentals and desirable policy settings (Annex II). - Staff commended the NBG for increasing reserves while maintaining exchange rate flexibility. - The buildup in GIR has been mostly driven by higher FX reserve requirements. - FX reserve requirements represented 41 percent of GIR at end-2018 and are expected to become 47 percent of GIR in 2019. - The NIR target was set at $1,520 million for end-December 2019, in line with reserve accumulation efforts envisaged during the Third Review. - Staff agreed with the NBG’s policy of primarily relying mostly on put options for intervention, while resorting to discretionary purchases if the amounts purchased via FX put options, which will depend on exchange rate dynamics, prove insufficient. - Banks will only have an incentive to utilize FX put options if the lari is appreciating. - The NIR target and higher FX reserve requirements ($300 million, effective May 2019) will help reach 100 percent of the ARA metric by end-2019. - The authorities agreed that any liability management operation to improve the structure of public debt should not undermine reserve targets. ### Strengthening financial resilience - The authorities continue to advance financial sector reforms (MEFP ¶20-21). - Working on legislation to make emergency liquidity assistance and the banking resolution framework consistent with best international practice (MEFP ¶22). - Relevant legal amendments submitted to Parliament (SB, end-May 2019) and enact the legislation (new SB, end-December 2019). - Assessing the impact of using consolidated IFRS data for prudential requirements and finalizing regulation on consolidated supervision. - Planning to submit an enhanced supervisory framework for financial conglomerates to Parliament soon. - New regulation requires banks to maintain 100 percent coverage for the net stable funding ratio starting September 2019, consistent with Basel III. - As a result, the liquid asset requirements, including for non-resident deposits (a residency-based capital flow management measure), will be abolished effective January 2020. - The impact of tighter credit standards should be closely monitored (MEFP ¶19). - Preliminary evidence suggests they have slowed credit growth in line with expectations. - Authorities are considering simplifying the regulations without affecting its fundamental objectives. - Staff cautioned against making changes until sufficient data are available and agreed to continue assessing credit developments ahead of any regulatory changes. - The authorities are preparing a forward-looking financial stability report (SB, end-November 2019) to assess risks and vulnerabilities in the financial system and private non-financial sector balance sheets and discuss priority financial policy actions. ### Structural reforms to promote inclusive growth - Authorities underscored the need to continue advancing structural reforms to increase potential growth and make it more inclusive (MEFP ¶27-35). - Education reforms: - Developing a new policy for choosing school locations and a qualification system for pre-school education professionals (in cooperation with the World Bank). - New teacher policy aims to align teacher standards to the OECD benchmarks. - New funding model for universities aims to establish performance indicators rather than focusing on the number of students. - Vocational education will focus on short-term programs to provide specific skills based on labor market needs, which could facilitate female labor participation (Box 2). - Insolvency law: - Finalizing a new draft insolvency law (SB, end-July 2019) consistent with best international practices. - Reform includes a regulatory framework for independent insolvency professionals (transitioning from a government agency), which should help mobilize investment. - Trade integration: - Feasibility study for the Georgia-India Free Trade Agreement (FTA) was finalized; the one for the Georgia-Israel FTA is expected by June 2019. - Discussions continue on FTAs with the UK, US, and the GCC. - Energy market reforms: - Reforms would increase market competition, promote renewable energy, and enhance energy efficiency. - As of May 2019, some large electricity consumers can access directly the wholesale market. - Goal to move towards a third-party access model, separating transmission and distribution from suppliers, traders, and generators starting in 2019. - Pension agency and funded pension pillar: - The pension agency is expected to be fully operational by end-2019. - Contributions are already being collected, and the investment board will be formed in early June. - The investment strategy is expected to be approved in September, creating an institutional investor for long-term lari assets. - The funded pension pillar will help mobilize domestic savings for investment, complementing local capital market development and gradually reducing dependency on external financing. - Credit guarantee scheme for SMEs (MEFP ¶9): - The scheme will receive an annual budget allocation (GEL 20 million each in the next 5 years) to cover for up to 15 percent of the loan portfolio of each participating bank. - Banks will select the loans. - Staff and the authorities agreed that limiting the size of the credit guarantee scheme was critical to contain contingent liabilities. - To enhance governance, the scheme will be subject to external and internal audits and reporting requirements. ### Program issues and financing - Proposed updates of program conditionality (MEFP, Tables 1-4): - Performance criteria proposed for end-December 2019, consistent with program projections. - New targets for inflation proposed for December 2019. - A new quantitative performance criterion (QPC) proposed on net budget lending operations to support implementation of new guidelines on these operations. - A new indicative target (IT) on the stock of VAT credits (mid-December 2019) to support a further reduction on VAT credits. - Adjustors (from end-June 2019): - An annual cap of GEL450 million is proposed on the adjustor of VAT refunds due to the new automated mechanism. - The symmetric NIR adjustor on disbursements of project loans and grants to the treasury single account at the NBG is proposed to be raised from 75 percent to 100 percent. - Adjustors on budget support loans and net Eurobond issuances are proposed to be modified to safeguard reserves; if program disbursements exceed net Eurobond outflows, the NIR target will be adjusted upward by the difference (TMU, ¶31). - New SBs proposed by end-December 2019: - Adopt a 2020 budget in line with policies agreed at the time of the Fifth Review. - Expand the FRS to cover general government financial asset operations. - Enact legislation on the banking resolution framework. - Submit to Parliament legislation proposing a rules-based mechanism to index basic pension that preserves medium-term fiscal sustainability. - Grant GRS access to information on suspicious transactions from the FMS. - Financing assurances: - The program is fully financed for the next twelve months, with good prospects for adequate financing for the remainder of the program. - Capacity to repay the Fund remains adequate: - The full drawing under the EFF would correspond to maximum repayments at 0.2 percent of GDP or 1.0 percent of gross reserves in 2024. - Risks to the program are manageable: - Political backlash and/or reform fatigue could undermine reform implementation. - Authorities stand ready to adopt measures to fulfill their commitments. - Arrears negotiations: - Authorities are putting best efforts in negotiating arrears to Turkmenistan; they predate the program and were covered under the representative Paris Club Agreement. ### Staff appraisal: key judgments - Georgia’s economic performance remains robust, but downside risks dominate the outlook. - Growth has proven resilient, inflation remains under control, and external vulnerabilities have been reduced. - The 2019 budget appropriately targets a slightly expansionary stance and allows for higher capital and social spending, including on education. - Enhanced public investment management would support smoother execution. - Amendments to the budget code to introduce a floor on spending education could reduce budget flexibility and may undermine transparent accounting and reduce incentives for spending efficiency. - Fiscal institutional reforms need to continue: - Strengthening revenue administration would support medium-term revenue collection. - Access to information from the FMS is critical. - New government guarantees should be transparently disclosed and assessed as part of the fiscal risks statement. - Authorities should clarify the mandate of SOEs and strengthen their governance and reporting requirements, including through corporatization if needed. - Monetary policy: - Remains rightly focused on price stability, supported by exchange rate flexibility. - The inflation-targeting framework, combined with the floating exchange rate regime, continues to serve Georgia well. - Foreign exchange intervention should support the buildup in external buffers. - Liability management operations should not undermine efforts to accumulate reserves. - Structural reforms: - Persevering with structural reforms is critical for higher and more inclusive growth. - Insolvency reform needs a robust framework for regulating insolvency professionals to maximize benefits. - Energy market reform will further improve economic efficiency and enhance potential growth. - Staff supports the authorities’ request for completing the Fourth Review under the Extended Fund Facility, modifying two quantitative performance criteria, and setting a new QPC, targets for inflation, and a new IT. *Source: 1geoea2019001 - 17. The authorities need to reassess the role of and rationale for the Partnership Fund (PF).* ### Box 2. Female Labor Force Participation in Georgia ### Box 2. Female Labor Force Participation in Georgia ### Participation levels and trends - Female labor force participation in Georgia has been increasing by 4 percentage points since 2008. - In 2018, 58 percent of women, aged 15+, participated in the labor market in Georgia. - Comparative participation rates in 2018: - CCA: 54 percent - Emerging Europe: 48 percent - Advanced economies: 55 percent - The gender gap in participation is around 20 percentage points lower for women than for males and has been persistent across time. ### Employment status and sectoral distribution - Women are less likely than men to be employers: 1.2 percent of the employed (women) compared to 3 percent (men). - Women are more likely to perform unpaid work: 28 percent (women) as opposed to 21 percent (men). - As employees, women are concentrated in: - Education, social and personal services, and public administration. - Men dominate: - Manufacturing, mining, and construction. ### Pay and wage gap - The wage gap in Georgia reached 38 percent in 2018. - The wage gap is only partially explained by more flexible jobs; women’s salaries appear to be lower than men across almost all sectors of employment. ### Macroeconomic impact of gender gaps - Gender gaps in the labor market contribute to a loss of 11 percent of per capita GDP. - Two thirds of that loss is explained by occupational choices. - Based on estimates presented in Cuberes and Teignier (2016), greater gender equality in entrepreneurship and labor force participation would raise Georgia’s GDP by 11.3 percent. *Source: World Bank, International Labor Organization, GeoStat, and IMF staff calculations.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Global Shocks — Risks, Expected Impact, and Policy Responses - Rising protectionism and retreat from multilateralism - Relative likelihood/Time Horizon: High / Short to Medium Term - Expected impact on the economy if materialize: Medium - In the near term, escalating and sustained trade actions threaten the global trade system, regional integration, and global and regional collaboration. - Additional barriers and the threat of new actions reduce growth both directly and through adverse confidence effects (increasing financial market volatility). - In the medium term, geopolitical competition and fraying consensus about the benefits of globalization lead to economic fragmentation and undermine the global rules-based order, with adverse effects on growth and stability. - 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 reserve accumulation, fiscal sustainability to weather external shocks from a stronger position. - Sharp tightening of global financial conditions - Relative likelihood/Time Horizon: Low / Short Term and Medium / Short Term (multiple identified triggers) - Expected impact on the economy if materialize: Medium - Causes higher debt service and refinancing risks; stress on leveraged firms, households, and vulnerable sovereigns; capital account pressures; and a broad-based downturn. - Triggers could include market expectation of tighter U.S. monetary policy, sustained rise in risk premium from euro area debt concerns, a disorderly Brexit, or idiosyncratic policy missteps in large emerging markets. - Higher lari volatility and depreciating pressures could generate negative balance-sheet effects and threaten financial stability. - Tighter global financial conditions could increase financing costs and external financing requirements remain large. - 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. - 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 materialize: Medium - Could 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 (U.S., Europe, China scenarios) - Relative likelihood/Time Horizon: Medium to High / Short to Medium Term - Expected impact on the economy if materialize: Medium to High - Weaker global demand and slower growth in Georgia's main trading partners could reduce growth in Georgia, reduce appetite for structural reforms, and weaken domestic demand. - Policy response: - Flexible exchange rate should serve as a first line of defense. - Accelerate structural reforms to enhance confidence and improve competitiveness. - Strengthen fiscal sustainability, reserve accumulation, and be ready to adjust macroprudential measures to avoid undue tightening in financial conditions. - Strengthen social safety nets to protect the most vulnerable. - Continue to expand trade integration to build a more diversified export base and economic resilience. ### Georgia-Specific Risks — Financial, Fiscal, and Political - Financial risks - Relative likelihood/Time Horizon: Medium / Medium - Expected impact: Medium - New lending regulations could risk a sharper-than-expected tightening of lending standards, with stronger negative effects on growth. Risks could also stem from the non-banking sector. - Policy response: - Use the flexible exchange rate as a first line of defense. - Accelerate implementation of structural reforms to improve confidence and competitiveness. - Monitor the impact of the new lending regulations and stand ready to adjust them to avoid an undue tightening in financial conditions. - Strengthen fiscal sustainability and institutions and enhance financial stability. - Fiscal risks - Relative likelihood/Time Horizon: Medium / High - Expected impact: High - Materialization of contingent liabilities/fiscal risks could deteriorate public debt dynamics. - Policy response: - Strengthen fiscal sustainability and institutions (as above). - Political risks - Relative likelihood/Time Horizon: Low / Medium - Expected impact: Medium - Political backlash and/or reform fatigue could undermine efforts to undertake structural reforms. ### External Sector Assessment — Key Findings and Medium-Term Outlook - Overall assessment - Georgia’s external position in 2018 was consistent with fundamentals and desired policies. - Reserve accumulation in 2018 was higher than expected, boosted by the NBG FX intervention, including by the new FX put options. - Over the medium-term, the current account deficit is projected to narrow to 7 percent of GDP, helped by continued prudent fiscal policy, exchange rate flexibility and the timely implementation of structural reforms. ### Current Account and Real Exchange Rate Developments - 2018 current account (CA) deficit - The 2018 CA deficit improved to 7.7 percent of GDP. - Compared to the Third Review projections, the narrowing of the 2018 CA deficit (by 1.3 percentage of GDP) was driven by: - Lower-than-expected imports (by 1.1 percent of GDP). - Higher-than-expected income account balance (by 1.2 percent of GDP due to declining FDI profit repatriation). - Continued strong growth in: - Merchandise exports: 22 percent - Travel receipts: 19 percent - Remittances growth: 15 percent - Imports in 2018 were lower-than-expected owing to lower import prices and declining imports related to FDI and government projects. - 2019 projection: current account is expected to slightly fall to (7.5 percent of GDP), as the fiscal impulse from end-2018 spending is partially offset by lower import prices and receding off-imports. - Medium-term expectation: current account is expected to decline to below 7 percent of GDP, owing to contained domestic spending and strong exports, provided structural reforms are implemented. - Exchange rate and REER developments - The lari depreciated against the dollar from its peak (2.4 GEL/USD) in April 2018 to 2.7 GEL/USD in November 2018; appreciated to 2.67 GEL/USD in December 2018. - Against the euro, the lari depreciation started in August 2018. - The lari exchange rate depreciated in real effective terms from August to December 2018 (by -7 percent), reflecting regional spillovers and seasonal factors. - The REER grew by less than the NEER starting from the 2nd part of 2018, in line with relatively lower inflation in Georgia compared with trading partners. - External Balance Assessment (EBA-lite CA approach) - The CA approach suggests there is no current account gap in 2018 as opposed to a gap of -0.3 percent of GDP during the Third Review. - The CA gap corresponds to a further narrowing compared with the 2017 REER overvaluation (0.6 percent), with a higher contribution coming from macro policies as measured by the policy gap. - The fit of the CA approach’s regression improved with a substantial narrowing of the residuals (by 4 percent of GDP), reflecting structural bottlenecks not captured in the model (e.g., underdeveloped financial system and weak education system). - External sustainability approach (sensitivity note): suggests an REER undervaluation of 3.9 percent and a CA gap of 1.6 percent of GDP under a specific NFA anchor (noted as highly sensitive to anchor choice). ### External Balance Sheets - Net International Investment Position (NIIP) - End-2017: Georgia’s gross liabilities to non-residents exceeded gross foreign assets by 150 percent of GDP; FDI and loans accounted for about 54 percent and 31 percent of total liabilities, respectively. - Rapid accumulation of gross external liabilities over 2014–17 increased by 71 percent of GDP, peaking at 218 percent of GDP in September 2017, mostly attributable to FDI increasing by almost 40 percent of GDP (to 115 percent of GDP). - From 2017Q3, the stock of FDI liabilities fell by 12 percent of GDP, contributing to a decline of total external liabilities to 204 percent of GDP in 2018Q4. - In 2018Q4, Georgia NIIP stood at 143 percent of GDP, 7 percent of GDP lower than in December 2017, and is expected to further decline in the medium term due to expected improvement in the current account and decline in FDI inflows. ### Capital and Financial Flows - Financing structure and trends - Net FDI inflows are the main source of financing of the current account deficit, representing 75 percent of the financial account balance. - FDI net inflows declined by 45 percent y-o-y to 5.5 percent of GDP in 2018, following completion of a large energy-related project. - Medium-term projection: FDI inflows projected to increase at a slower pace than earlier expected, stabilizing around 9 percent of GDP as structural reforms increase competitiveness. - Portfolio inflows in 2018: small net contribution — institutional investor retrenchment in government and bank debt securities ($253 million outflow) was more than compensated by the first international issuance corporate bond in Georgia ($270 million). - Increase (by about 2 percent of GDP) in cross-border bank borrowing ahead of tightening of regulation limiting domestic FX lending helped compensate for declining FDI financing. - 2019 Q1: $200 million international corporate issuance (by Silknet) expected to support net portfolio inflows. - External loans are mostly medium and long term, with concessional/favorable interest rates and grace periods. ### Reserves and Net International Reserves (NIR) - Gross international reserves (GIR) - End-2018 GIR stood at $3.3 billion (20 percent of GDP), $250 million higher than end-2017. - Contributing factors: FX interventions ($197.5 million) and increased FX reserve requirements (by $274 million), partially offsetting declining correspondent bank accounts balances (by $126 million). - End-2019 projection: stock of GIR projected to reach $3.7 billion in 2019 (100 percent of the ARA metric), driven by the increase of FX reserve requirements introduced in March and effective in May (expected to yield $300 million) and FX interventions. - Compared with the Third EFF review, end-2019 reserves were revised upward from 93 to 100 percent of the ARA. - The refinancing of the $500 million Eurobond in 2021, with an expected $200 million foreign participation, is expected to slow down reserve accumulation (by 3 percent of the ARA metric). - Medium-term projection: stock of GIR projected to reach 118 percent of the ARA metric, supported by increasing foreign participation in the domestic bond market. - Net International Reserves (NIR) - End-December 2018 NIR at program rates reached $1.5 billion, $36 million above the adjusted NIR target ($1.48 billion). - Drivers: NBG FX intervention and higher-than-expected program and project financing in Q4 (total of $95 million compared with the Third review) more than offset higher-than-expected outflows. - Outflow spike mostly driven by conversions for government, which grew by 39 percent y/y, likely related to end-2018 project-related spending. - 2019 Q1: BP pipeline transit fees and large FX interventions ($186 million) supported the accumulation of NIR. ### Policy Commitments (from Letter of Intent excerpt) - Government commitment highlights (Tbilisi, June 3, 2019) - Continued commitment to policies detailed in the Letter of Intent (LOI) and Memorandum of Economic and Financial Policies (MEFP) of March 27, 2017, updated on December 4, 2018. - Government program: "Freedom, Rapid Development and Welfare" based on free market principles. - Policy aims: education reform, scaling-up core infrastructure, strengthening governance, supporting SMEs and entrepreneurship, and further integrating Georgia into the global economy. - Central bank commitments: continue strengthening the monetary policy framework and enhancing financial supervision, regulation and safety nets. - Overall commitment: preserve macroeconomic and financial stability as prerequisites for sustainable and more inclusive economic growth. *International Monetary Fund — Annex I. Risk Assessment Matrix (content unit: 1geoea2019001)* ### 2. Resilient economic growth provides an opportunity for steadfast implementation of our ### 2. Resilient economic growth provides an opportunity for steadfast implementation of our ### Recent macroeconomic performance and key indicators - Growth in 2018 stood at 4.7 percent (y/y), supported by strong external demand and prudent policies. - Inflation has remained close to our 3-percent inflation target. - Current account deficit narrowed to 7.7 percent of GDP, supported mostly by FDI. - Gross foreign exchange (FX) reserves reached $3.3 billion by end-2018. - Higher-than-expected revenues and contained current spending led to an augmented deficit of 2.5 percent of GDP for 2018. - Net international reserves (NIR) surpassed the end-December program target with some margin. - De-dollarization has continued, albeit at a slower pace than before. - Credit rating changes: Fitch upgraded our credit rating to BB in February; S&P revised its outlook to positive in April. ### Program performance, financing, and IMF engagement - Met all end-December quantitative performance criteria (QPCs). - Inflation remained within the inflation consultation clause (ICC). - Four out of seven structural benchmarks (SBs) for the fourth review were met. - Initial fiscal risks statement submitted to Parliament in December 2018; revised one month later to be consistent with EFF commitments. - Basic pension indexation design required additional time; proposal to be submitted to Parliament by December 2019. - Expect to provide the Georgia Revenue Service with access to suspicious transactions information from the Financial Monitoring Service by end-2019 after safeguards are developed. - Request completion of the Fourth Review under the Extended Fund Facility and release of the related purchase: intend to purchase SDR 30 million, bringing drawings under this program to SDR 150 million. - Program monitoring instruments: Inflation Consultation Clause (ICC), Quantitative Performance Criteria (QPCs), indicative targets (end-June and end-December test dates), continuous performance criteria, and Structural Benchmarks (SBs) as defined in MEFP Tables 1–3 and the TMU. - Review schedule: Fifth Review based on end-June 2019 performance criteria, expected on or after October 25, 2019. Sixth Review based on end-December 2019 performance criteria, expected on or after March 20, 2020. - Authorization to publish the LOI and attachments (MEFP and TMU) and related Staff Report; documents to be posted on official Georgian government websites after IMF Board approval. ### Economic outlook and medium-term projections - 2019 growth expectation: 4.6 percent, with a stronger contribution of domestic demand compared to 2018. - Medium-term expectation: growth gradually increases due to steadfast implementation of structural reforms and investment in infrastructure. - Current account deficit expected to gradually decline to 7 percent of GDP over the medium term. - External financing will continue to rely mostly on FDI, though its share is expected to decline slightly over time. - Policy objective: reach 100 percent of the ARA metric by end-2019 through a stronger external position and FX purchases. - Downside risks: escalating global trade tensions, financial market volatility, and Georgia’s relatively high but still sustainable external debt; first-line defense is exchange rate flexibility combined with sound macroeconomic and financial policies. ### Fiscal policy: 2018 outcomes and 2019 stance - 2018 augmented fiscal deficit (TMU definition): GEL 1,021 million, 2.5 percent of GDP (compared to adjusted program ceiling of GEL 1,032 million). - Indicative target met on primary current spending: GEL 8,976 million. - Gross VAT credit refunds more than doubled in 2018 versus 2017, reducing VAT credit stock by 0.9 percent of GDP to 3.8 percent of GDP. - Measures taken to reduce project delays and smooth intra-year capital spending. Fiscal policy commitments and measures for 2019: - End-June 2019 augmented deficit target: remain committed to keep below program ceiling of GEL 250 million. - End-2019 augmented deficit target: aim for augmented deficit below GEL 1,170 by end-year (performance criterion). - Limit budget lending operations in net terms to GEL 335 million (new performance criterion). - Continue containing current primary spending (indicative target). - Education reform measures in 2019: financial incentives to pension-age teachers for retirement and wage increases for qualified teachers. - Increased targeted social assistance to address child poverty with more gradual withdrawal to encourage labor market participation. - Revenue measures: increased excise rates on cigarettes; further adjustments to other tobacco product rates; elimination of the “golden list” of taxpayers eligible for delayed VAT payments, yielding GEL 100 million. - Basic public pension: increased to GEL 200 per month; scheduled to increase to GEL 220 per month in 2020. - Pension indexation structural benchmark: initial plan to submit rule-based indexing legislation by end-February 2019 revised; now plan to submit by December 2019 (new structural benchmark). - VAT credit targets: aim to reduce stock below GEL 1,570 million by mid-December 2019 (new indicative target). Expected refunds: GEL 250 million through June 2019, and GEL 550 million for 2019; additional refunds up to GEL 450 million accommodated under program adjustor (TMU ¶14). - Commitment to use revenue over-performance or additional savings in current spending toward high-priority, growth-enhancing net acquisition of non-financial assets; under-execution in investment toward a lower deficit. - Revised fiscal rule submitted to parliament end-2018 (structural benchmark): removes procyclical expenditure ceiling, applies to fiscal outturns, clarifies aggregates, escape clauses, communication, transparency, oversight, and includes PPP liabilities under the debt ceiling. - 2020 budget to be submitted to Parliament consistent with the IMF program (new structural benchmark, December 2019). - Public administration efficiency measures: (i) containing the wage bill and administrative expenses; (ii) improving targeting of subsidies and social assistance; (iii) reducing transfers and privatizing loss-making SOEs; (iv) improving performance-based budgeting. - Decision not to extend dividend distribution model of corporate income taxation to financial institutions until 2025 to avoid revenue loss (up to 0.5 percent of GDP); may consider moving insurance sector sooner in consultation with IMF. Financing strategy and fiscal risk containment: - Publish multi-year plan of government bond issuance to develop domestic benchmarks and encourage foreign investor participation; increase issuance size of domestic benchmark bonds. - Commitments to avoid arrears and new contingent liabilities: - Will not accumulate 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 (performance criterion) or comfort letters. - Partnership Fund (PF) constraints: - PF will not run a cash deficit (performance criterion) or issue new guarantees. - New net borrowing of PF limited to $20 million at end-June 2019 and end-December 2019 (cumulative from beginning of EFF, performance criterion). - Maintain non-negative PF cash position at end-June and end-December 2019 (performance criteria). - Revisit status and role of PF in coming months in consultation with IMF. - PPPs and PPAs: - Refrain from initiating any PPPs, including PPAs, until PPP framework operationalized. - PPAs currently under negotiation permitted to proceed only if: - Guaranteed purchase period ≤ 8 months per year; - Guaranteed purchase tariff ≤ US 6c per kWh; - Cumulative installed capacity of projects under negotiation ≤ MW650. - Namakhvani HPP Cascade Project (planned capacity MW433) PPA outside those terms; detailed fiscal risks analysis conducted. - Credit Guarantee Scheme (CGS) to support SME access to finance: - CGS will receive budget allocations of GEL 20 million per year over next 5 years. - Will guarantee 70 percent of individual loans, subject to losses not exceeding 15 percent of participating banks’ portfolio, and no more than the budgeted amount. - Set up as a program within Enterprise Georgia; subject to internal and external audits and regular reporting. - Plans for an export credit agency abandoned; if retaken, will consult IMF on characteristics. ### Structural fiscal policies: revenue administration and tax measures - Implementing a 3-year plan (supported by the Revenue Mobilization Trust Fund) to improve tax administration following 2016 Diagnostic and IMF TA focus areas: a) Organizational structure: - GRS headquarters restructured into a function-based organization. - Special unit within Audit Department for large taxpayers. - Hired two new deputy directors general and allocated responsibilities. b) VAT tax administration: i. Stock of unrefunded VAT credits: - Commitment to eliminate unrefunded VAT credits: by end-2021 aim to reduce by at least 50 percent the outstanding stock (end-2017 stock GEL 1.4 billion → target GEL 700 million by end-2021) for credits within limitation period for audit. - For the stock of existing credits, committed to risk-assess 100 percent of declarations (within statute of limitations for audit) by mid-2020. - Submitted changes to tax code granting GRS powers to pay out refunds without need for refund request (structural benchmark, end-December 2018). ii. Automatic risk assessment and risk-based auditing: - All new VAT declarations risk-assessed under automated system since January 2019. - Under system: 90 percent of new declarations with lowest risk score will not be subject to further manual review and be immediately eligible for refund if requested and no outstanding liabilities (structural benchmark, end-June 2019). - 10 percent with highest risk score reviewed by specialized VAT unit in Audit Department. iii. Automatic refunding of new VAT credits: - From January 2020, all risk-assessed new credits approved by system will be either offset against existing liabilities or refunded without need for explicit refund request. - VAT declaration form to be changed accordingly. - Option to offset existing stock of credits against new liabilities remains; taxpayers retain option to request cash refund of stock within three-year statute of limitations through separate form. c) Compliance and audit yields: - With IMF TA, plan to use risk-based audits to identify high-yield non-compliant cases. - Pilot audit management system by December 2019 to enhance audit timeliness and productivity and allow systematic termination of non-productive audits. d) Filing compliance: - Established key performance indicators; program initially for VAT to be expanded to all tax categories. - Submitted legal amendments so an unfiled declaration is no longer deemed nil where MoF requires a declaration; MoF to issue order defining cases needing a declaration. e) Taxpayer register: - 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. - Changes would not impact physical “one-stop” business registration window managed by NAPR. - GRS will create and maintain a register of employees for tax administration purposes. f) Penalty regime: - Submitted to Parliament a penalty regime based on materiality (structural benchmark, end-December 2018). - Will continue working toward a regime reflecting degree of culpability and develop guidelines for assessing culpability. g) Automatic access to third-party information: - MoF agreed with ministries and agencies on access to their databases for tax administration purposes. - GRS to gain automatic access to third-party information: - From National Agency of Public Registry on real estate, rentals and leases by December 2019. - From municipalities on construction permits. - Will provide GRS access to data from Financial Monitoring Service (FMS) on suspicious transactions as defined in law on facilitating prevention of illicit income; requested more time to submit legislative changes allowing GRS access and implement safeguards (structural benchmark end-May 2019 revised to new end-December 2019 structural benchmark). - Committed to provide GRS access to information on Joint Stock Companies (JSC) partners and changes in company equity by December 2019. *Memorandum of Economic and Financial Policies (MEFP) — Attachment I, as provided by the Government of Georgia.* ### 12. We are committed to contain fiscal risks to safeguard fiscal sustainability. We are carefully ### 12. We are committed to contain fiscal risks to safeguard fiscal sustainability. We are carefully ### Fiscal risks from SOEs, PPPs, and PPAs — commitments and measures - Recognize PPPs 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. - Commitments: - a) Adopt a new PPP law and associated regulations. - Parliament approved a PPP law in May 2018 that includes sound elements following best international practices, prepared 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 in August 2018 (structural benchmark, end-December 2018) and incorporated recommendations from the IMF. - Commitment to issue guidelines establishing the evaluation methodology for PPPs by end-September 2019. - b) Continue strengthening the Fiscal Risk Statement (FRS) accompanying the budget. - i. Latest FRS expanded analysis of fiscal risks stemming from PPPs, PPAs and SOEs (SB, end-December 2018). - FRS in the 2020 budget law will include a more comprehensive coverage of general government financial asset operations and provide information on the rates of return on general government equity holdings and loans (new structural benchmark, end-December 2019). - ii. Recruitment for the MoF fiscal risk management unit delayed but ongoing; expected to be finalized by September-2019. - c) Strengthen the monitoring of SOEs. - Ensure MoF and Ministry of Economy and Sustainable Development (MOESD) collect 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, commitments: - (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 GFSM2014 (structural benchmark, end-September 2019). - (ii) Adopt a government decree clarifying the mandate of SOEs that are public interest entities, governance and reporting requirements (structural benchmark, end-November 2019). - Policy on interventions: refrain from taking over any SOE debt or providing equity injections to SOEs without a comprehensive strategy that fully supports commercial viability with no further financial support in the future and improves corporate governance; will consult with the IMF on the strategy and on specific measures. - d) Improve the Public Investment Management Framework (PIMF). - IMF-conducted Public Investment Management Assessment (PIMA) in May 2018 identified weaknesses, particularly in project appraisal, selection, and management. - Actions taken: - Strengthened MoF’s role in public investment management; created a dedicated public investment council at the MoF to centralize information on public investment projects. - Council will evaluate investment projects based on cost/benefit analysis and other relevant analyses to establish a single project pipeline, support adequate project evaluations, help prioritize investment projects and identify their financing, and integrate them within the Medium-Term Budget Framework (MTBF). - PIMF will cover PPP-type projects to ensure they are prioritized and assessed alongside traditionally procured projects. - Commitments in coordination with the IMF (structural benchmark, end-December 2019): - (i) Strengthen PIMF by strengthening the public investment management methodology that guides project appraisal, selection and management. - (ii) Adopt a government decree implementing reporting and oversight requirements for public investment projects at the MoF. - Measures will include enforcing existing regulations, notably the gatekeeper role of the Ministry of Finance, updating the PIM methodology, and designing a system for regular intra-year reporting of project implementation progress. *Italicized source attribution line provided by pipeline.* ### 13. Accurate and transparent public financial management — commitments - a) Strengthen the Medium-Term Budget Framework (MTBF). - 2019 budget documentation includes analysis of revisions to the medium-term macroeconomic outlook and revenue projections. - 2020 budget will expand discussion to compliance with respect to the fiscal rule and revised expenditure plans, and any projected deviation of expenditure from the 2018 MTBF. - b) Follow new guidelines for budget lending operations. - 2019 State Budget prepared applying the Government Finance Statistics (GFS) classification of equity injections and on-lending following the “reasonable commercial return test”. - Only on-lending operations will now be reported as budget lending operations. - c) Improve the 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 the GFSM2014 principles. - d) Comply with international accounting standards. - Starting in 2021, produce an annual consolidated general government sector financial report based on International Public-Sector Accounting Standards (IPSAS) basis. ### C. Monetary Policy — framework and operational commitments - 14. Inflation targeting (IT) - Committed to IT framework to maintain price stability. - Inflation has remained close to the NBG’s target of 3 percent since early 2018. - Will continue to abide by the Inflation Consultation Clause (ICC) under the program. - Inflation monitored via dual consultation bands set symmetrically around the forecast for headline CPI: - Inner consultation band: ± 2 percent — NBG will consult with IMF staff if actual inflation is outside this band. - Outer consultation band: ± 3 percent — a consultation with the IMF Board will be triggered if actual inflation is outside this band. - 15. Exchange rate regime and reserves - Maintain a flexible exchange rate regime to protect the economy against external shocks; FX interventions limited to smoothing excessive exchange rate volatility and building international reserves. - Continue accumulating gross international reserves (GIR) throughout the program, monitored by a floor on net international reserves (NIR, performance criterion). - FX interventions enabled accumulation of more reserves (by $36 million) than initially envisaged under the 2018 end-December program floor. - 16. Net international reserves accumulation targets and tools - Commitment to reach 100 percent coverage of the ARA metric by end-2019, helped by increased reserve requirements on FX deposits and FX interventions. - Introduced preannounced and transparent auctions for FX put options to facilitate FX purchases. - Through end-April, purchased $186 million on FX markets, of which $51 million was via FX options. - Intend to primarily accumulate reserves through FX put options, resort to discretionary purchases only if insufficient. - Committed to reach an NIR floor of $1,520 million by end-December 2019. - Request increase in the NIR adjustor from 75 percent to 100 percent on disbursements of the project loans and grants to the treasury single account at the NBG, given uncertainty associated with project disbursements. - 17. Strengthen monetary policy transmission mechanism - Strengthened lari liquidity management and extended open market operations to outright purchases of treasury securities. - Reformed interbank money market index TIBR; now based on actual market transactions, with transparent rules for excluding outliers and fallback scenarios. - Published overnight and term indices to support pricing of swaps and floating rate securities. - By June 2019, will submit legal amendments to Parliament to support derivatives and repo transactions in line with best international practices. - 18. Communication toolkit - In March 2019, published a manual on monetary policy operations in line with IMF TA recommendations. ### D. Financial Sector Policy — stability, supervision, and market development - 19. General objectives - Continue to strengthen financial sector stability through enhanced policy framework, regulation and supervision to support banking sector resilience and financial intermediation. - Focus areas: (i) supervisory and regulatory framework for consolidated banking supervision and non-bank supervision; (ii) financial stability policy framework including publishing the macroprudential strategy document; (iii) emergency liquidity assistance facility and banking resolution framework; (iv) incentivize use of domestic currency and support domestic capital market development. - 20. Recent progress and planned reforms - a) NBG aims to fully transfer banks’ regulatory reporting to IFRS framework through EU standards (FINREP/COREP forms) by 2022 while maintaining some supervisory filters; will request capital adequacy information on a stand-alone and consolidated basis under IFRS. - b) Macroprudential measures for retail credit: - Introduced limits on loan-to-value ratios (LTVs) and debt service payments-to-income (PTIs) by income group for retail loans, with more binding constraints for FX loans for unhedged FX exposures. - Limits became binding in January 2019 and were effective in curbing growth in consumer loans and moderating growth in FX mortgages. - Credit growth: 13 percent in March 2019 compared to 17 percent in December 2018. - Will continue to monitor credit dynamics and assess impact of regulations; will take actions if needed in consultation with the IMF as data becomes available. - c) NBG and the State Insurance Supervision Agency developed a law on supplementary supervision framework for financial conglomerates; shared with Parliament in March 2019. - d) Introduced regulations on net stable funding ratio in line with Basel III principles; banks should maintain 100 percent NSFR starting September 2019. - e) Plan to issue regulation on large exposures in line with Basel principles and relevant EU regulations, and update limits on related-party transactions accordingly by September 2019. - f) Introduce standards for interest rate risk in the banking book in line with Basel and EBA guidelines by end-2019. - g) With IMF TA, initiated regulation, supervision and oversight of non-bank financial institutions: - Prudential regulatory framework for MFI’s became operational in September 2018. - Non-prudential oversight of other lenders became operational in January 2019. - Plan to further strengthen supervision of non-bank financial institutions with IMF TA. - 21. Financial Stability Report (FSR) - Will resume FSR as a stand-alone publication. - Publication of the new FSR (structural benchmark, end-November 2019) will provide a forward-looking assessment of risks and vulnerabilities, detailed analysis of private non-financial sector balance sheet and macroprudential policy actions. - 22. Macroprudential policy strategy - Commit to outline general framework for macroprudential regulation by end-September 2019, consistent with European Systemic Risk Board recommendations and best international practices. - Strategy to be published by September 2019 to improve transparency and predictability for market participants. - 23. Sustainable finance framework - Developing a sustainable finance framework to integrate environmental, social and governance criteria into business or investment decisions. - In April 2019, published the roadmap for sustainable finance aiming at establishing a credible, predictable and stable regulatory framework. - Working with the OECD on Environmental, Social and Governance Reporting and Disclosure Principles for financial institutions. - 24. Financial safety nets and resolution framework - Cooperate with banks to strengthen recovery plans. - Strengthen capacity to act as lender of last resort by submitting 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 to ensure an effective ELA framework. - With IMF TA support, plan to revamp banking resolution framework and enhance crisis management, including clarifying authorities’ role and decision-making process, and granting the NBG resolution authority. - Will submit legislative changes to implement effective ELA and resolution frameworks in line with international best practices (structural benchmark, end-May 2019) and enact this legislation (new structural benchmark, end-December 2019). - 25. Larization measures to reduce FX risks - Increased FX reserve requirements on FX deposits from 25 to 30 percent; reserve requirements on local currency deposits unchanged at 5 percent. - Increased threshold under which loans can be issued only in local currency from GEL100,000 to GEL200,000; revised threshold covers loans issued to legal entities as well. - Lending rules impose stricter payment-to-income and loan-to-value limits on FX retail loans to internalize higher risks associated with FX borrowing and protect consumers. - 26. Consumer protection, financial inclusion and literacy - Commit to strengthen consumer protection, financial inclusion and literacy. - Developed and implemented a financial education program for micro and small enterprises with partners. - Following integration of financial literacy in the education curriculum, working with the Ministry of Education, Science, Culture and Sports to develop educational materials and strengthen teachers’ capacity. - Working to scale up the SchoolBank project to more public and private schools. - 27. Capital market development to support larization and reduce external vulnerabilities - Non-bank financial system is shallow; strategy for capital market development is a key priority. - Planned or ongoing legal and regulatory reforms and infrastructure upgrades: - a) Investment fund vehicles and structured products: - Law establishing investment funds expected to be submitted to Parliament by September 2019; draft law transposes the UCITS Directive (2009/65/EC) and important pillars from the AIFM Directive (2011/61/EU). - Legislation for covered bonds will be initiated by end-2019 to improve access to long-term GEL funding and develop the fixed-income market. - Law on derivatives and financial collateral will be finalized by end-2019 to create environment for money markets’ development. - b) Clarified taxation of publicly-issued securities and committed to further improve laws on taxation of financial instruments, specifically derivatives and investment funds, in cooperation with the IMF. - c) Initiated reforms concerning capital market supervision to support transparent and efficient capital markets and smooth convergence with EU legislation. - d) Upgraded infrastructure by having a single security settlement system for all Georgian securities with two participating central security depositories (CSDs): one for commercial bonds and shares, and another for government bonds. - New system allows for delivery-versus-payments settlements in central bank money for all securities and full integration with the Georgian Stock Exchange and OTC trading platforms. - e) Finalizing legislative framework for securities holding to create sound legal basis for dematerialized securities, aligned with international best practices (The Hague Convention, UNIDROIT Geneva Convention, Belgian (Euroclear)/Frankfurt (Clearstream)/US Law). - Framework will incorporate indirect holding regime where only banks and brokers (“Account Keepers”) will be eligible members of CSD and authorized to hold securities on behalf of their clients. - f) Improve legal framework for government securities to support greater reliance on domestic market borrowing; aim to transition gradually to a primary-dealer system, in consultation with the IMF. - g) Improve transparency in local FX market by adhering to the FX Global Code. - Created the Georgian Financial Markets Treasury Association (GFMTA) to support adoption of the Code locally. - NBG plans to announce its full compliance with principles of the Code by June 2019; other market participants expected to follow gradually. *Italicized source attribution line provided by pipeline.* ### 28. Achieving more robust and inclusive growth will require steadfast implementation of our ### 28–36: Achieving more robust and inclusive growth — Georgia’s reform agenda ### Structural reform agenda and external partners - Comprehensive structural reform agenda intended to: - strengthen Georgia’s connectivity (infrastructure spending and trade initiatives), - improve education and vocational training, - improve the business environment, - implement land and energy reforms. - Expected outcomes: boost long-term growth, diversify the economy, strengthen the external position, create jobs, reduce poverty; targeted social assistance and health care to protect the most vulnerable. - Partners supporting 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, spatial planning, and tourism - Finish investment in core infrastructure to: - transform Georgia into a transport and logistics hub connecting Europe with Asia, - support regional development. - Government support for tourism development (including water and electricity infrastructure) to turn Georgia into a four-season tourist destination. ### Education reform and labor market - Start implementing a comprehensive education reform to improve job creation, productivity and wages. - Reform covers: - (i) early childhood education; - (ii) secondary education; - (iii) vocational education and training; - (iv) higher education; - (v) science and research. - Key reform elements: 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. - Rationale: unqualified labor force cited as one of the most problematic factors for doing business; unemployment and underemployment remain high, suggesting skill mismatches. ### Pension reforms - Funded pension pillar milestones: - Pension agency created and contributions collected. - Investment board to be formed soon. - Investment strategy expected to be approved by December 2019. - Agency expected to become fully operational by end-2019. - Expected benefits: improve standards of living of future retirees, promote savings, create an institutional investor for long-term lari assets. - Commitment to formulate a private pension savings system (Pillar 3) in 2019. ### Business environment, insolvency, and corporate governance - Corporate governance: corporations will gradually be required to publish audited financial statements based on IFRS standards. - Insolvency law: plan to submit a new insolvency law to Parliament to ensure adequate protection of creditor rights, timely and efficient insolvency processes and effective rehabilitation framework in line with best international practices (structural benchmark, end-July 2019). - Tax and regulatory measures: - Aim for an efficient VAT tax system to improve the business environment. - Apply regulatory impact assessments for major policy decisions. - Dispute resolution: MoU signed with the International Court of Arbitration of the International Chamber of Commerce in December 2018. - Business House: establish a one-stop shop to provide public services to enterprises by 2020. ### Land registration and agriculture - Land cadasters prioritized to protect property rights, simplify transactions, and provide collateral for borrowing. - Simplified land registration (fee waiver program), assistance for searching property documents, and mediation for disputes. - Current registration statistics: registered land plots amount to 1.9 million, where 33 percent (0.62 million) of those were registered within the land reform launched on August 1, 2016. - New initiatives: creation of a farmer’s registry and a geo-information land use system to ensure rational use of agricultural land. ### Trade policy - Deepening trade relations as a key priority for a small open economy. - FTAs in place: EU (Deep and Comprehensive Free Trade Area), EFTA, People’s Republic of China, Turkey, Hong Kong Special Administrative Region, and CIS countries. - Negotiations and commitments: negotiating with Turkey to expand the current FTA; committed to pursue FTAs with priority countries including the United States, Israel, India, the Gulf Cooperation Council countries, and others. - Expected role of FTAs: mobilize FDI in tradable sectors, improve competitiveness, reduce external vulnerabilities, generate balanced growth. ### Energy reform strategy - Overall aims: increase market competition, promote renewable energy, enhance energy efficiency. - (a) Market liberalization and third-party access: - As a member of the Energy Community, develop competitive electricity and gas markets based on EU energy market principles. - Goal: move towards a third-party access model, separating transmission and distribution from suppliers, traders and generators starting in 2019, to foster wholesale competition, promote efficient cross-border trading capacity, and open the sector to private investment in renewable energy. - Gradual deregulation of the natural gas sector in parallel. - (b) Renewable energy legislation: - Legislation to be submitted to Parliament in 2019 to: - set mandatory national targets for the share of energy from renewable sources in gross final consumption and energy transportation; - set sustainability parameters for biofuels and bioliquids. - (c) Energy efficiency and security: - Submit a new Primary Law on Energy Efficiency to Parliament to accelerate energy efficiency across the full energy supply in all end-use sectors. - Plan to develop a national energy efficiency target and set up an energy efficiency obligation scheme and/or alternative policy measures for energy savings. - Continue to promote energy savings and independence, and security in energy supply. ### Statistics enhancement - Publish national accounts based on NACE 2 sectoral classification by November 2019. - With migration to NACE 2, compute GDP based on supply and use tables and produce quarterly GDP by expenditure in constant prices in 2020. - IMF TA-supported expansions: - Expand coverage of the monthly producer price index (PPI). - Develop a quarterly residential property price index (RPPI). - Both indices expected to be released in 2020. - Objective: provide a more detailed picture of structural transformations in the economy. ### Program monitoring, targets, and safeguards - Monitoring framework: - Program monitored through quantitative performance criteria, indicative targets, an inflation consultation clause and structural benchmarks. - Semi-annual program reviews based on June and December test dates. - Technical Memorandum of Understanding (TMU) describes definitions of quantitative PCs, the inflation consultation clause and data provision requirements. - Specific operational notes: - For program monitoring, all foreign currency denominated assets will be valued in lari at program exchange rates specified in the TMU; cross-rates as of December 31, 2016 used for currencies other than the U.S. dollar. - Program exchange rates listed include: SDR 0.7439; GEL 2.6468; AUD 0.7227; CAD 0.7419; EUR 1.0556. - Data and reporting commitments: - Treasury Department to provide monthly revenues of the general government within two weeks of the end of each month and monthly expenditures and arrears of the central government within four weeks of the end of each month. - Ministry of Finance to provide the stock of general government debt, broken down by currency and original maturity within one month from the end of each quarter. - Treasury to provide daily cash balances in all accounts of the general government as of the end of the previous business day. - Safeguards: - The NBG continues to maintain a strong safeguards framework and internal controls environment. - Continue to engage independent external audit firms to conduct the audit of the NBG in accordance with international standards. *Source: IMF staff and Georgian authorities (excerpts).* ### 5. The program will be assessed through performance criteria and indicative targets. ### 5. The program will be assessed through performance criteria and indicative targets. ### Performance criteria and indicative targets - Performance criteria and indicative targets are set with respect to: - a performance criterion (ceiling) on the augmented cash deficit of the general government; - an indicative target (ceiling) on the primary current spending of the general government; - an indicative target (ceiling) on outstanding VAT credits; - a performance criterion (ceiling) on net budget lending operations; - a performance criterion (floor) on the net international reserves (NIR) of the NBG; - a continuous performance criterion (ceiling) on the accumulation of external debt arrears by the general government; - an indicative target (ceiling) on new domestic expenditure arrears by the general government; - a performance criterion (ceiling) on the new guarantees issued by the public sector; - a performance criterion (ceiling) on the cash deficit of the Partnership Fund; - a performance criterion (ceiling) on new net borrowing by the Partnership Fund. - The program includes a consultation clause on the 12-month rate of inflation (Tables 1, 2 attached to the Letter of Intent). - Performance criteria and indicative targets are set for end-June 2019 and end-December 2019 and are: - monitored on a cumulative basis from the beginning of the calendar year, except: - the NIR target, monitored in terms of stock levels; and - new net borrowing by the Partnership Fund, monitored since program approval; - continuous performance criteria are monitored on a continuous basis. ### D. Inflation Consultation Mechanism - Inflation consultation bands around the projected path for inflation are set for each test date under the program. - Test date inflation: 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: - the stance of monetary policy and whether the Fund-supported program remains on track; - the reasons for the deviation; - the proposed policy response. - 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 for the test dates: - the authorities will complete a consultation with IMF staff on the reasons for the deviation and the proposed policy response. ### E. Program Definitions, Adjustors, and Reporting Requirements — General Government - Ceilings on (i) the augmented cash deficit of the general government and (ii) net budget lending. - Definition: The 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 (as defined below). A negative augmented cash balance is a deficit. - Measurement: augmented cash balance measured from the financing side at current exchange rates established by the NBG at the date of the transaction. Augmented cash deficit measured by: - i) net acquisition of financial assets (including changes in balances of the revenue reserve account), excluding net budget lending as defined by GFSM 2001; minus - ii) net incurrence in domestic and foreign liabilities as defined in GFSM 2001. - Net budget lending definition: consistent with GFSM 2001, net budget lending is the net acquisition of financial assets for policy purposes by the general government. - Adjustors to the ceiling on the augmented cash deficit of the general government: - Adjust upward/downward 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 by the cumulative amount of receipts from sale of non-financial assets above the program amounts (Table 2). - Adjust upward/downward by the cumulative amount of VAT credits refunded in cash above/below the program amounts (Table 2). The adjustment will not exceed GEL 450 million per year, in absolute terms. - Adjustor to the ceiling on net budget lending: - Adjust upward/downward by the cumulative total amount of on-lent amounts from foreign-financed project loan disbursements above/below the program amounts (Table 2). ### Table 2 — Projected Financing for Cash Deficit of the General Government (in millions of GEL, cumulative from the beginning of the calendar year) - June 30, 2019 / December 31, 2019 - Disbursements of foreign-financed project loans: 760 / 1,314 - Receipts from sale of non-financial assets: 70 / 140 - VAT refunds: 250 / 550 - On-lent amounts from project loan disbursements: 200 / 400 ### Supporting material — general government reporting - 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: provided by the Treasury Department of the Ministry of Finance to the IMF on a monthly basis within two weeks of the end of each month. - Data on securitized debt sold by the NBG, including securities purchased by nonbanks: reported by the NBG to the IMF monthly within two weeks of the end of each month. - Georgia Revenue Service monthly reporting by end of each month for previous month: - 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. ### Ceiling on the Current Primary Expenditures of the General Government - Definition: primary current expenditures = expense (as defined by GFSM 2001) on a cash basis, minus interest payments. - Supporting material: data for monitoring expenditures come from accounts of the general government covered under the augmented cash deficit ceiling (including autonomous regions). The Ministry of Finance provides reporting. Data on expense and net acquisition of non-financial assets should be reported to the IMF within four weeks after the end of the quarter. ### Ceiling on the Outstanding stock of VAT credit refunds - Supporting material: Data for the period from the 16th day of the previous month to the 15th day of the current month will be provided by the Georgia Revenue Service 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) ### 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 defined by residency of the creditor. - External payment arrears: all overdue debt service obligations (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 continuously and does not apply to 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 example: Arrears to Turkmenistan. - Supporting material: accounting of non-reschedulable external arrears by creditor (if any) with detailed explanations 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 = non-disputed (in or out of court) payment obligations whose execution term has expired and became overdue; can arise on any expenditure item, including debt service, wages, pensions, goods and services. - Arrears arise from non-debt liabilities not paid after 60 days of the contractual payment date or—if no contractual payment date—after 60 days of the receivable. - Any wage, pension or other entitlement obligation not paid after a 30-day period from the date due is in arrears. - Supporting material: accounting of new domestic expenditure arrears (if any) 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 and definitions - Ceiling on the Cash Deficit of the Partnership Fund: - Definition: cash deficit = expenditures minus revenues. - Revenues: dividends from assets and investments, interest earnings from loans it provides, fees it charges for services and guarantees, and any other income earned from its assets. - Expenditures: all current and capital expenditures. - Current expenditures: compensation of employees, 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. - The Partnership Fund’s purchase of financial assets (e.g., lending and equity participation) will not be considered part of its expenditures. - Ceiling on New Net Borrowing by the Partnership Fund: - Definition: net borrowing = contracted debt liabilities minus principal repayments. - Supporting material: Ministry of Finance will provide detailed information on quarterly revenue, expenditure, and amounts related to new contracted debt and principal repayments within four weeks of the end of each quarter. ### Net International Reserves — floor and adjustors - Definition: NIR of the NBG in U.S. dollars = foreign assets of the NBG minus the sum of foreign liabilities of the NBG, including all of Georgia’s liabilities to the IMF. - Foreign assets include gold, gross foreign exchange reserves, Georgia’s SDR holdings, and the reserve position in the IMF. - Gross foreign exchange reserves defined as liquid, convertible currency claims of the NBG on nonresidents, including cash holdings of foreign exchange that are readily available. - Pledged or encumbered assets, including assets used as collateral, are excluded from foreign assets. - Foreign liabilities defined as the sum of Georgia’s outstanding liabilities to the IMF (at face value), Georgia’s SDR allocation, and any other liabilities of the NBG (including foreign currency deposits of financial institutions at the NBG and currency swaps and foreign exchange forward contracts with financial institutions), excluding foreign exchange balances in the government’s account with the NBG. - For program monitoring, stock of foreign assets and foreign liabilities valued at program exchange rates as described in paragraph 2. - The stock of NIR amounted to $1,387 million as of June 30, 2018 (at program exchange rates). - Definitions for budget support: - Budget support grants: grants received by the general government for direct budget support from external donors and not related to project financing. - Budget support loans: disbursements of commercial loans and loans from bilateral and multilateral donors for budget support. - Adjustors for the NIR floor: - Upward (downward) by any excess (shortfall) of FX privatization revenue in foreign exchange above (below) the programmed amounts. - Upward (downward) by any excess (shortfall) of budget support grants compared to program amounts (Table 3). - Downward by any shortfall of budget support loans compared to program amounts (Table 3). - Upward by the sum of the total excess of budget support loans compared to program amounts (Table 3) and any negative net Eurobond issuance by the government, if this sum is positive. - Upward by any positive net Eurobond issuance by the government. - Upward/downward by 100 percent for any excess/shortfall related to disbursements of the project loans and grants to the treasury single account at the NBG relative to the projected amounts (Table 3). ### Table 3 — Projected Balance of Payment Support Financing (in millions of U.S. dollars) - June 30, 2019 (cumulative from end-September 2018 to end-June 2019) / December 31, 2019 (cumulative for 2019) - Projected privatization revenue: 0 / 0 - Budget support grants from external donors and not related to project financing: 40.6 / 87.5 - Budget support loans, including bilateral and multilateral donors for budget support: 165.6 / 145.4 - Disbursements of project loans and grants: 179.4 / 182.9 ### Supporting material — NIR and balance of payments 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. *Source: 1geoea2019001 - 5. The program will be assessed through performance criteria and indicative targets.* ### Appendix to the TMU: The Partnership Fund ### Appendix to the TMU: The Partnership Fund ### A. Organization and Operational Structure — Legal Structure and Corporate Governance - The Partnership Fund (PF) is incorporated as a Joint Stock Company (JSC). Under civil law, JSCs are profit maximizing entities, organized with value creation as their main objective. - The PF is organized as a commercial financial institution. However: - The PF no longer pursues only commercial objectives and in its governance structure, the risk management committee is no longer in place; and equity injections are undertaken without government’s approval. - Corporate structure incorporates: - An investment board, including CEO, CIO, and portfolio officers, which approves business cases and initiates projects; - A supervisory board (i.e. board of directors), which approves projects (based on the feasibility studies, risk assessments, and business cases presented by the investment board and risk committee) and approves budget for project development needs. The supervisory board includes four ministers and is chaired by the Prime Minister. ### B. Corporate Mandate and Portfolio Management — Corporate Mandate - The corporate mandate of the PF is approved by the supervisory board and the government. - Financing instruments and sector focus: - The PF will provide project financing through equity participations, senior loan, quasi-equity through subordinated convertible debt, and performance bonds/guarantees. - Investments will focus on the following sectors: energy, agriculture, manufacturing, and real estate. - Under its corporate mandate, the PF is not allowed to provide financing to the service industry. - The PF will charge market rates for services provided. ### B. Corporate Mandate and Portfolio Management — Portfolio Management Strategy - The PF’s portfolio management strategy has been developed and: - Sets portfolio limits, performance management objectives, and project evaluation guidelines, which focus on evaluating PF’s performance based on an internal rate of return. - The PF does not longer participate only in commercially viable projects, taking into considerations non-commercial objectives in its portfolio strategy. ### B. Corporate Mandate and Portfolio Management — Project Development Methodology - Participation conditions: - The PF will mostly participate in projects in which a corporate investor, with sufficient experience in industry, expresses its willingness to take an equity participation that represents at least 51 percent of the project’s total equity. - The PF no longer pursue only commercial objectives and there are projects in which the financing of the PF (debt plus equity guarantees) exceeds 100 percent of the equity contribution of the private partner in the project. ### B. Corporate Mandate and Portfolio Management — Reporting and Auditing - Audit and ratings: - The PF will engage an internationally recognized auditing company to conduct IFRS audits of its financial statements. - The PF will hire on a permanent basis the services of rating agencies, which will prepare regular ratings reports—there will no minimum rating requirement for the PF. - The PF’s audited financial statements, as well as the ratings reports will be available on permanent basis to a broad audience. - Fiscal risk containment: - Fiscal risks associated with the PF will be limited since: - All liabilities of the PF are limited to its own balance sheet; - The PF has its own revenue sources, namely: the dividends from its investments, the interest earnings from the loans it provides, the fees it charges on the guarantees it provides, and the proceeds of asset sales; and the PF may decide to borrow from credible financial institution with recourse to its balance sheet facility and without state guarantee. ### Statement by Mr. Doornbosch, Alternate Executive Director and Mr. Hanson, Advisor on Georgia — June 19, 2019 - Acknowledgements and overall assessment: - The authorities thank staff for their constructive engagement and the Managing Director for her personal interest during her visit from May 19-21, 2019. - The authorities agree that growth has proven resilient, inflation remains under control and external vulnerabilities have been reduced, while noting continued efforts are needed to achieve high and inclusive growth against a background of external risks. - They reiterate their strong commitment to the reforms under the Extended Fund Facility (EFF). - Macroeconomic outcomes and indicators: - Growth remained robust at 4.7% in 2018. - Fitch recently upgraded Georgia’s sovereign rating to BB, while S&P revised its outlook to positive, up from BB- with a stable outlook. - Inflation is close to the 3% target and expectations are well-anchored. - International reserves increased from 88% of the ARA metric in 2016 to 91% in 2018 and are expected to reach 100% by end-2019. - The current account deficit improved from 13% in 2016 to 7.7% in 2018 and will gradually narrow to below 7% in the medium term. - The current account is mostly financed by FDI, which concentrates in the transport and energy sectors. - Program implementation and benchmarks: - The authorities met all end-December quantitative performance criteria. - Five out of seven structural benchmarks were implemented (one with a 1-month delay) and the remaining two will be implemented by end-December: - The authorities have not yet submitted legislation for a rule-based pension indexation mechanism to parliament by end-February. Pension levels are currently marginally higher than the subsistence minimum and a rules-based indexation would support inclusive growth and help reduce inequality. The authorities agree that the fiscal implications of different alternatives need to be further assessed and will continue discussions with staff before submitting a proposal by end-December 2019. - The authorities will provide the Georgia Revenue Service (GRS) with access to third-party information to make tax administration more effective. This includes data from different sources on real estate, construction permits, suspicious transactions and changes in company equity. Access to data on suspicious transactions received by the Financial Monitoring Service from monitoring entities will help fight tax evasion and improve compliance but concerns about privacy and abuse warrant that appropriate safeguards are in place. The authorities are currently working on such safeguards and will submit legislative changes to parliament by end-December 2019. ### Policy Priorities under the EFF - The EFF is aimed at strengthening macroeconomic stability and financial resilience and supporting the government reform agenda focused on four pillars: - (1) education reform to promote skill development, productivity growth and job creation; - (2) investing in road infrastructure to transform Georgia into a transport and logistics hub connecting Europe and Asia; - (3) making the public administration more efficient; and - (4) improving the business environment to boost the private sector as a growth engine. - Progress: - Progress has been achieved and is ongoing in pillars (2), (3) and (4): investments in core infrastructure are on track; a large number of fiscal reforms to strengthen public administration was implemented as part of previous reviews, including a remuneration law for public civil service; authorities will continue efforts to strengthen SOE governance, to automatically refund new VAT credits, and to strengthen public investment management; the business environment will be improved by measures to support local capital market development and the new insolvency law which will ensure adequate protection of creditor rights, timely insolvency processes and an effective rehabilitation framework. ### Education Reform: objectives, financing, and targets - Rationale and design: - Education reform is the remaining pillar of the reform program and a comprehensive reform and ongoing efforts to strengthen macroeconomic stability are key priorities. - A comprehensive reform includes training and certification of teachers, severance of less qualified teachers, investment in school infrastructure and improvement of the curriculum. The reform is based on OECD benchmarks and designed in cooperation with the World Bank. - Labor market context: - Although at its lowest level in 15 years, unemployment remains high at 12.7 percent as skill mismatches and underqualification persist. - Financing and fiscal framework: - The authorities are committed to finance the education reform under the 3% deficit ceiling of the new fiscal rule. - They will continue infrastructure investments, but as core infrastructure projects are finalized in the upcoming years, they will redirect spending towards education. - Education spending will increase from 3.8% of GDP today to 6% of GDP in 2022. - To safeguard their lasting commitment to the reform, they intend to introduce a floor on education spending. They understand staff’s concern about the rigidity of such a floor, and they would welcome engagement with staff about ways to strengthen the medium-term budget framework, but they see a strong multi-annual spending commitment under the deficit ceiling as an important safeguard for the success of this key policy priority. ### Monetary policy and reserve accumulation - Monetary policy: - Monetary policy remains focused on the 3% inflation target. - The National Bank of Georgia (NBG) stepped up efforts to accumulate international reserves with the introduction of a regular auction for FX put options in January. - These put options allow banks to purchase lari in exchange for dollars or euros when the lari exchange rate is above its average during the previous 20 working days. - Banks will have an incentive to exercise these options when the lari appreciates, allowing the NBG to accumulate reserves without disrupting the exchange rate. - As a result, the net international reserve criterion was met with a comfortable margin and the authorities are committed to sustain reserve accumulation efforts. ### Commitments on upcoming structural benchmarks - The authorities are confident that they can meet the three new end-December structural benchmarks: - They will submit to Parliament a 2020 budget consistent with the program. - They will include a more comprehensive coverage of general government financial asset operations and information on the rates of return on general government equity holdings and loans in the fiscal risk statement in the 2020 budget. - In May, they submitted legal amendments to parliament to make emergency liquidity assistance and the banking resolution framework consistent with international best practice. They are committed to enactment of this legislation. *Appendix to the TMU: The Partnership Fund — Statement by Mr. Doornbosch and Mr. Hanson, June 19, 2019* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1geoea2019001.pdf_