## 1. Real Sector Developments ## Source details **Canonical URL:** [1. Real Sector Developments](https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1geoea2021002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1geoea2021002.pdf.json) --- ### Context - Pre-COVID growth: Real GDP growth averaged 4.9 percent between 2017 and 2019 (compared to 3.5 percent between 2014 and 2016), driven largely by domestic demand. - Current account: Improved from 12.5 percent of GDP in 2016 to 5.5 percent of GDP in 2019, reflecting an increase in tourism revenues. - Policy framework: Fiscal rule, inflation-targeting regime, and robust financial sector regulation and supervision supported macroeconomic and financial stability. - COVID-19 impact (2020): - Real GDP declined by 6.2 percent in 2020. - Government support: 3.8 percent of GDP in 2020. - Fiscal deficit: 9.2 percent of GDP in 2020. - Public debt: 60 percent of GDP in 2020. - Unemployment: increased from 16.6 percent in 2019Q4 to 22.1 percent in 2021Q2 (note: new ILO methodology adopted in 2020 accounts on average for an 8-percentage point increase in the unemployment rate in 2010–19). - Labor force participation: increased from 50.5 to 51.4 percent. - Average household incomes: declined by 4.5 percent in 2020. - Poverty: share below the national poverty line rose from 19.5 percent in 2019 to 21.3 percent in 2020. - Vaccinations and cases (2021): - Around 11 percent of the target population fully vaccinated and 25 percent received at least one dose. - New cases reached all-time highs; goal to inoculate more than half of the population by end of the year. - Political uncertainty: - Opposition boycott of Parliament ended April 2021 after more than six months; related agreement provision could trigger early parliamentary elections in 2022 if the ruling party receives less than 43 percent of votes in local elections in October 2021. ### Recent Economic Developments - Growth and inflation: - 2021Q2: GDP growth 29.8 percent y-o-y; 2021H1 growth 12.7 percent. - 2021 projection: Growth projected to reach 7.7 percent, implying output will exceed its 2019 level in 2021. - Inflation: 11.9 percent y-o-y in July 2021 (17.4 percent m-o-m annualized); core inflation 6.4 percent y-o-y in July. - Inflation drivers: exchange rate depreciation, utility price increases, higher global commodity and food prices; diversion of some types of food for exports. - External and trade developments: - Net money transfers: increased by 35.8 percent (y-o-y) in January through July 2021. - Exports (Jan–Jul): grew 27.8 percent (dollar terms, y-o-y), driven by copper ores and motor cars. - Imports (Jan–Jul): grew 19.3 percent; trade deficit increased by 13.3 percent. - Tourism: signs of faster-than-expected recovery, driven by foreign and domestic tourists. - Exchange rate and reserves: - Lari movements: depreciated by 20.5 percent against the US dollar between February 2020 and April 2021; then appreciated 9.0 percent in May–July 2021. - NBG interventions: sold US$ 248.1 million in January–April 2021; sold US$ 30 million in August; paused interventions otherwise. - Gross international reserves (end-July 2021): US$ 3.9 billion. - Eurobond refinancing (April 2021): USD 500 million at 2.75 percent for 5 years (previous 10-year bond was 6.875 percent). - NEER/REER since February 2020: lari depreciated by 2.5 percent in nominal effective terms and appreciated by 0.8 percent in real effective terms (through July 2021). - Fiscal developments and revenues: - Initial 2021 budget: expected deficit around 7½ percent of GDP, with around 2.2 percent of GDP in COVID-19 tax relief and spending measures. - VAT revenues (April–July): increased on average by 60 percent year-on-year and by around 14 percent relative to 2019. - VAT refunds (Jan–Jul average): GEL 150 million. - January–July 2021 deficit: declined by 0.6 percentage points of GDP compared to 2020; would have fallen by 1.2 percentage points y-o-y in the absence of COVID-19 fiscal measures. - Supplementary budget: GEL 1.2 billion in additional spending; two-thirds of the 2.9 percent of GDP pandemic support package envisaged for the year has been disbursed as of July 2021. - Supplementary budget additional spending breakdown (amounts in GEL): GEL 445 million COVID-19 healthcare costs, GEL 177 million support to agriculture, GEL 75 million social benefits to vulnerable families with children, GEL 255 million capital spending, GEL 260 million other items. - Monetary policy and credit: - NBG policy rate: raised by a cumulative 200 basis points since March 2021; policy rate at 10.0 percent as of August 4, 2021 (highest since 2008). - Credit growth (constant exchange rates): slowed to 7.7 percent y-o-y in March 2021 before picking up in Q2 despite tightening. - Banking sector soundness: - H1 2021: profits rebounded strongly; capital adequacy ratio recovered to 19.2 percent. - NPLs: provisioning at 80 percent; NPL level declined to 6.7 percent by July 2021 (NBG’s more stringent definition); under traditional IMF definition NPLs remained below 3 percent. - Minimum reserve requirement adjustment (effective July 1, 2021): will vary between 25 percent (for banks with deposit dollarization above 70 percent) and 10 percent (for those with deposit dollarization below 40 percent); between thresholds the requirement reduced by one percentage point for every two percentage point reduction in deposit dollarization. Previously the reserve requirement was 25 percent regardless of dollarization. ### Outlook and Risks - Growth outlook: - Near-term prospects improved; strong V-shaped recovery expected if vaccinations accelerate and tourism rebounds. - Output gap expected to close by 2023, faster than previously forecast; medium-term growth still implies output will not reach pre-pandemic trend. - Inflation forecast: - End-2021 inflation projected at 13.1 percent. - Inflation expected to decline below the NBG’s target by end-2022 as temporary effects fade. - Current account and reserves: - Current account deficit projected to narrow from 10 percent of GDP in 2021 to 5.5 percent by 2026. - Financing: expected to be primarily by FDI. - Foreign exchange reserves: projected to remain near or above 100 percent of the ARA metric throughout the forecast horizon and reach 109 percent by 2026. - Baseline projections include impact of an SDR allocation of US$ 286 million approved in August 2021; authorities indicated they do not intend to use the additional SDRs in the near term and will include them as reserves. - Risks (Annex II): - Downside risks: COVID-19 variants or vaccination delays; renewed political uncertainty; further lari depreciation; depreciation risks for public debt given high share denominated in foreign currency; large current account deficits making Georgia vulnerable to shortfalls in financial inflows. - Upside risk: better control of COVID-19 could produce a stronger recovery due to sizeable fiscal support, pent-up demand, and faster tourism growth. ### Policy Discussions and Recommendations — Macro and Fiscal - Overall staff recommendations: - Continued focus on policies to address pandemic challenges and reduce risks. - Clarify adjustment plans to comply with the fiscal rule and build resilience. - Maintain an appropriately tight monetary stance to address inflation risks. - Address fiscal risks as crisis support is unwound. - Implement structural measures to strengthen growth and inclusiveness. - Rebuilding fiscal buffers and complying with the fiscal rule: - Unwind crisis support measures and reduce deficit and debt as the economy recovers. - Staff advised saving at least half of expected revenue increases to enable faster progress on fiscal consolidation required to comply with the fiscal rule by 2023 and provide a buffer against risks while maintaining a mildly contractionary stance. - Baseline assumes gradual consolidation starting in 2021: deficit narrowing to 6.5 percent of GDP (from 9.2 percent in 2020), reaching 3.6 percent in 2022 and 2.6 percent in 2023, in compliance with the fiscal rule. - Approximately 2.4 percent of GDP in temporary COVID-19 fiscal support should end in 2022; more remaining adjustment focused on 2023. - Staff advised faster deficit reduction in the 2022 budget to smooth the need for new fiscal measures over subsequent years and safeguard compliance with the fiscal rule. - Fiscal space, spending pressures, and revenue measures: - Ambitious capital spending plans and current spending pressures (education, pension, health), and fiscal risks from SOEs, PPPs and PPAs could increase adjustment needs. - Social assistance: doubling social assistance to vulnerable families with children to GEL 100 per child per month will cost GEL 75 million in 2021 (for six months) and GEL 150 million per year afterwards. - Staff supported postponing the education spending floor of 6 percent of GDP and argued for a more gradual increase. - Staff welcomed plans to review tax expenditures by end-2021 including VAT and income tax expenditures. - Recommendations to create additional fiscal space: - Strengthen tax administration (including by enhancing tax compliance). - Streamline tax incentives and expenditures. - Address distortions in the current system. - Consider a comprehensive tax policy review over the medium term, including with IMF TA, and accompany any tax policy changes with targeted social support given the already regressive current flat-tax system. ### Fiscal Risks from SOEs, PPAs, and Contingent Liabilities - SOE and PPA risks: - Comprehensive sectorization exercise of 2020 revealed 183 enterprises to be incorporated into the general government sector starting in 2021. - 2020 FRS estimates hypothetical impact on 2019 fiscal statistics would increase debt by 0.8 percent of GDP. - IMF TA estimates a higher impact: 2019 debt would increase by 1.1 percent of GDP based on GFSM 2014. - Pilot compilations for 65 non-market SOEs estimate debt liabilities totaling 3.1 percent of GDP in 2019. - 2020 FRS estimated PPP liabilities at GEL 390 million (0.8 percent of GDP), including GEL 267 million (Nenskra Hydro) and GEL 122 million (Tbilisi Airport). - Under the baseline, fiscal costs associated with PPAs are estimated to peak at 0.17 percent of GDP in 2025 and amount to US$ 883 million over 2020-2043. - Downside PPA scenarios (market prices lower by 10-30 percent) could make PPA costs 3.5-4.8 times larger, peaking at 0.4-0.6 percent of GDP in 2025. - Staff recommendations: - Continue SOE reform, publish and expand SOE reform strategy and pilot cases. - Strengthen PIM and integrate off-budget investments (PPPs, PPAs and PCs) into the budget process. - Undertake external independent reviews before major infrastructure projects over a defined threshold. - Expand annual Fiscal Risk Statements to disclose risks from individual PPA projects and cover environmental, social, and governance (ESG) risks. - Specify clear criteria in advance for any deviations from the feed-in premium scheme. - Staff argued for dismantling the Partnership Fund given its non-commercial objectives; authorities plan to limit its operations and incorporate it in the general government. ### Monetary Policy, External Position, and Reserves - Monetary policy stance: - Moderately tight monetary policy essential to keep inflation expectations anchored. - Staff supported recent policy rate increases that constrained credit growth and kept the stance moderately tight; core inflation contained relative to headline prices. - Risks to inflation are tilted to the upside; NBG should continue to increase rates if inflation expectations and/or core inflation do not decrease in line with expectations. - External position and reserves: - Georgia’s external position in 2020 broadly in line with fundamentals; external vulnerabilities increased relative to 2019. - GIR reached 108 percent of the ARA metric at end-2020; staff project GIR coverage in 2021 of 99 percent of the ARA metric. - Gross international reserves (in millions of USD): 2019: 3,506; 2020: 3,911; 2021: 3,911; projected 2026: 4,683. - With considerable financial dollarization, NBG should continue prudent FX intervention to avoid disorderly market conditions. ### Financial Sector Resilience and Policy Priorities - FSAP stress-test findings: - Banks are adequately capitalized: credit losses from the pandemic under a conservative baseline over the next three years can be absorbed. - Under a stress scenario of an extended pandemic and adverse external financial environment, capital shortfalls are not deemed substantial and are manageable systemically. - Banks are sufficiently liquid, including in a stressed scenario of high deposit withdrawals. - Recent dynamics and prudential recommendations: - Precautionary provisioning in April 2020 sharply reduced profitability; buffers were subsequently released but banks remained above minimum capital and liquidity requirements. - Staff urged authorities to use available policy tools to preserve capital (e.g., asking banks to minimize dividends and bonuses until recovery is more certain). - Staff called for prompt dealing with problem loans: NPLs at 6.7 percent of loans and restructured loans at 19 percent (figures as of July 2021). - Emphasized ex ante preparedness: effective insolvency framework implementation, creation of a market for bad loans, prompt write-downs, full provisioning without relying on real estate collateral. - Finalize bank recovery and resolution procedures, establish early intervention arrangements including preparations for a bridge bank, and ensure backup funding for the deposit insurance scheme. - Authorities’ stance: - Authorities agreed banks should prepare for possible pandemic deterioration but did not see the need to restrict bank payouts as long as banks meet pre-COVID capital requirements. - Authorities highlighted substantial ex ante loan loss provisions under the assumption that NPLs would peak at up to 10 percent; NPLs have declined from a peak of 8.5 percent in March 2021 and have been adequately provisioned. - Authorities argued further restrictions on dividends and bonuses could reduce attractiveness of Georgian banks to investors. ### Reducing Dollarization and Fintech / CBDC Considerations - Dollarization measures implemented or planned: - Differentiated reserve requirements for FX deposits (effective July 1, 2021). - More stringent LTV and PTI requirements for unhedged borrowers in FX. - Introduction of a currency-induced credit risk (CICR) pillar 2 capital buffer. - Outright ban on FX loans below 200,000 GEL for households, corporates and SMEs. - LCR requirement for banks in FX; higher reserve requirements on bank FX liabilities and associated penalty rates of remuneration. - Fintech and CBDC: - NBG advancing a CBDC project and aims to choose a technology provider by the end of this year; implementation and timeline depend on trial outcomes. - Potential benefits: reduce transaction costs, increase payment speed and efficiency for SMEs in rural areas, encourage fintech development. - Risks: bank liquidity from deposit outflows, privacy concerns, cybersecurity issues; cryptocurrency is unregulated and not subject to AML/CFT rules. - Staff stressed adopting legal and regulatory framework for licensing and AML/CFT supervision of VASPs; NBG has developed a draft AML/CFT regulation for VASPs and plans public consultations. ### Structural Reforms and Inclusive Recovery - Staff called for a renewed structural reform agenda to attract FDI, diversify exports, increase productivity, and address high unemployment and inequality. - Education and labor market: - Education reform coupled with active labor market policies (ALMPs), particularly targeted vocational training, would help address skills mismatches, high unemployment, and encourage formal labor market entry. - Infrastructure and public investment: - Continued investment in infrastructure needed to realize transit hub ambitions, unlock tourism potential, and facilitate exports. - Authorities committed to expanding road and transportation infrastructure and have made substantial progress on the East-West highway. - Strengthening the PIM process should help maximize the impact of capital spending. - Feasibility study for a cable under the Black Sea to strengthen regional electricity and internet connectivity. - Governance: - Structural fiscal measures—strengthening PIM, regular Fiscal Risk Statements, sectorization for SOEs, SOE reforms, and commitments to limit the Partnership Fund—are important for enhancing governance and controlling fiscal risks. ### Labor Market, Poverty, and Social Policy - Labor market and employment: - Number of employed shrunk by 62,000 between 2019Q4 and 2021Q2; about 90,000 people joined the ranks of the unemployed; 27,000 joined the labor force. - Youth NEET in 2019: 26 percent. - Informality: GEOSTAT reports 31 percent of employed in 2020 were informally employed; ILO statistics show informality declined from 51 percent in 2019 to 38 percent in 2020. - ILO composite measure of labor underutilization (LU4): 20.5 percent. - Poverty and social protection: - Poverty rose to 21.3 percent in 2020. - Recommendation: enhance ALMPs, evaluate and scale cost-effective ALMPs, expand childcare and public kindergartens to boost female labor force participation, and improve targeting of social assistance. - Staff noted limited room to cut current spending; suggested improving efficiency of social safety nets and targeting. ### Public Debt, DSA Findings, and Fiscal Rule Compliance - Public debt assessment: - Summary conclusion: public debt assessed as sustainable with fiscal consolidation and higher growth expected to put the public debt-to-GDP ratio on a downward path after 2020 rise. - Gross public debt (percent of GDP, As of June 03, 2021): - 2019: 33.9 - 2020: 40.4 - 2021: 60.0 - 2022: 54.1 - 2023: 53.5 - 2024: 52.0 - 2025: 50.7 - 2026: 49.2 - projection (final column): 48.2 - Public gross financing needs (percent of GDP): - 2019: 4.2 - 2020: 6.5 - 2021: 14.3 - 2022: 13.9 - 2023: 7.6 - 2024: 6.3 - 2025: 6.3 - 2026: 6.9 - projection (final column): 8.2 - Real GDP growth (selected): 2019: 4.8; 2020: 5.0; 2021: -6.2; 2022: 7.7; 2023: 5.8; 2024–2026: 5.2 each year. - Compliance with fiscal rule (Liberty Act): - Fiscal rule ceiling: 60 percent gross general government debt to be attained by 2023. - Georgia’s public debt projected at 52 percent of GDP in 2023 (approximately 54 percent including SOEs and PPPs), in compliance with the fiscal rule. - Government deposits projected at 2.7 percent of GDP provide additional cushion. - Recommendation: commence fiscal consolidation in 2021 to avoid abrupt consolidation in 2022-23; target a debt anchor of 50-53 percent of GDP to limit breach probability to 5-10 percent over a 6-year horizon. - Stress tests and vulnerabilities: - Public debt remains sustainable in standardized stress tests; combined macro-fiscal shock could breach the fiscal rule but is judged unlikely. - Vulnerability driver: high share of FX-denominated public debt (currently 80 percent of public debt FX-denominated). - Offsetting factors: successful $500-million Eurobond refinancing at 2.75 percent for 5 years; over 97 percent of outstanding debt in long-term maturity; reserves adequate; public debt service profile relatively smooth (averaging 5.9 percent of GDP over 2022-26); much external debt owed to IFIs on concessional terms. ### Key Projections and Selected Figures (from Tables) - Real GDP (percent change): 2019: 5.0; 2020: -6.2; 2021: 3.5; 2022: 7.7; 2023: 5.8; 2024: 5.5; 2025: 5.2; 2026: 5.2. - Output Gap: 2019: -0.6; 2020: -3.9; 2021: -2.8; 2022: -1.0; 2023: -0.4; 2024–2026: 0.0. - CPI, End-of-period: 2019: 7.0; 2020: 2.4; 2021: 4.5; 2022: 13.1; 2023: 3.2; 2024–2026: 3.0. - Current account (percent of GDP, Table): 2019: -5.5; 2020: -12.3; 2021: -12.5; 2022: -10.9; 2023: -10.0; 2024: -7.6; 2025: -6.2; 2026: -5.7. - Gross international reserves (billions USD): 2019: 3.5; 2020: 3.9; 2021: 3.9; 2022: 3.6; 2023: 3.8; 2024: 4.0; 2025: 4.3; 2026: 4.7. - Deposit dollarization (percent of total): 2019: 64.0; 2020: 67.5; 2021: 61.4; 2022: 67.0; 2023: 66.7; 2024: 66.2; 2025: 65.6; 2026: 65.0. - Credit to the private sector (percent change): 2019: 20.7; 2020: 22.4; 2021: 2.4; 2022: 6.4; 2023: 10.5; 2024: 11.8; 2025: 8.7; 2026: 8.4. ### Risk Assessment (Annex II) — Selected Scenarios and Policy Responses - Unexpected shifts in the COVID-19 pandemic: - Likelihood: Medium; Expected impact: High. - If materialized: Capital outflows, lari depreciation, accelerating inflation. - Policy response: Maintain exchange rate flexibility; utilize reserves to prevent disorderly depreciation; tighten monetary policy to anchor inflation expectations. - Prolonged pandemic: - Likelihood: Medium; Expected impact: High. - Policy response: Extend targeted support via spending reprioritization; use monetary policy space to support demand if inflation expectations anchored. - Faster containment: - Likelihood: Medium; Expected impact: High. - Policy response: Maintain prudent macro policies; proceed with fiscal consolidation. - Widespread social discontent and political instability: - Likelihood: High; Expected impact: High. - Policy response: Strengthen policy response and communication; maintain reform ownership; utilize reserves to prevent disorderly depreciation. - Structural risks (e.g., financial and fiscal risks from dollarization, SOEs and PPAs) identified as Medium likelihood with High expected impact; recommended policy responses include tight monetary policy, stronger resolution framework, improved SOE governance, and enhanced fiscal risk management. _Staff report excerpt: Georgia — Staff Report for the 2021 Article IV Consultation (selected chapter and annexes)._ ### 1. Real Sector Developments ____________________________________________________________________ 21 ### 1. Real Sector Developments ### Context - Pre-COVID growth: Real GDP growth averaged 4.9 percent between 2017 and 2019 (compared to 3.5 percent between 2014 and 2016), driven largely by domestic demand. - Current account: Improved from 12.5 percent of GDP in 2016 to 5.5 percent of GDP in 2019, reflecting an increase in tourism revenues. - Policy framework: Fiscal rule, inflation-targeting regime, and robust financial sector regulation and supervision supported macroeconomic and financial stability. - COVID-19 impact (2020): - Real GDP declined by 6.2 percent in 2020. - Government support: 3.8 percent of GDP in 2020. - Fiscal deficit: 9.2 percent of GDP in 2020. - Public debt: 60 percent of GDP in 2020. - Unemployment: increased from 16.6 percent in 2019Q4 to 22.1 percent in 2021Q2 (note: new ILO methodology adopted in 2020 accounts on average for an 8-percentage point increase in the unemployment rate in 2010–19). - Labor force participation: increased from 50.5 to 51.4 percent. - Average household incomes: declined by 4.5 percent in 2020. - Poverty: share below the national poverty line rose from 19.5 percent in 2019 to 21.3 percent in 2020. - Vaccinations and cases (2021): - Around 11 percent of the target population fully vaccinated and 25 percent received at least one dose (pace picked up from early May and accelerated with additional vaccines). - New cases reached all-time highs; goal to inoculate more than half of the population by end of the year. - Political uncertainty: - Opposition boycott of Parliament ended April 2021 after more than six months; related agreement provision could trigger early parliamentary elections in 2022 if the ruling party receives less than 43 percent of votes in local elections in October 2021. ### Recent Economic Developments - Recovery momentum and inflation: - 2021Q2: GDP growth 29.8 percent y-o-y; 2021H1 growth 12.7 percent. - 2021 projection: Growth projected to reach 7.7 percent, implying output will exceed its 2019 level in 2021. - Inflation: 11.9 percent y-o-y in July 2021 (17.4 percent m-o-m annualized); core inflation 6.4 percent y-o-y in July. - Inflation drivers: exchange rate depreciation, utility price increases, higher global commodity and food prices; diversion of some types of food for exports. - External and trade developments: - Net money transfers: increased by 35.8 percent (y-o-y) in January through July 2021. - Exports (Jan–Jul): grew 27.8 percent (dollar terms, y-o-y), driven by copper ores and motor cars. - Imports (Jan–Jul): grew 19.3 percent (driven by industrial supplies and capital goods); trade deficit increased by 13.3 percent. - Tourism: signs of faster-than-expected recovery, driven by foreign and domestic tourists. - Exchange rate and reserves: - Lari movements: depreciated by 20.5 percent against the US dollar between February 2020 and April 2021; then appreciated 9.0 percent in May–July 2021. - NBG interventions: sold US$ 248.1 million in January–April 2021; sold US$ 30 million in August; paused interventions otherwise. - Gross international reserves (end-July 2021): US$ 3.9 billion. - Eurobond refinancing (April 2021): USD 500 million at 2.75 percent for 5 years (previous 10-year bond was 6.875 percent). - NEER/REER since February 2020: lari depreciated by 2.5 percent in nominal effective terms and appreciated by 0.8 percent in real effective terms (through July 2021). - Fiscal developments and revenues: - Initial 2021 budget: expected deficit around 7½ percent of GDP, with around 2.2 percent of GDP in COVID-19 tax relief and spending measures. - VAT revenues (April–July): increased on average by 60 percent year-on-year and by around 14 percent relative to 2019. - VAT refunds (Jan–Jul average): GEL 150 million. - January–July 2021 deficit: declined by 0.6 percentage points of GDP compared to 2020; would have fallen by 1.2 percentage points y-o-y in the absence of COVID-19 fiscal measures. - Supplementary budget: GEL 1.2 billion in additional spending; two-thirds of the 2.9 percent of GDP pandemic support package envisaged for the year has been disbursed as of July 2021. - Supplementary budget additional spending breakdown (amounts in GEL): GEL 445 million COVID-19 healthcare costs, GEL 177 million support to agriculture, GEL 75 million social benefits to vulnerable families with children, GEL 255 million capital spending, GEL 260 million other items. - Monetary policy and credit: - NBG policy rate: raised by a cumulative 200 basis points since March 2021; policy rate at 10.0 percent as of August 4, 2021 (highest since 2008). - Credit growth (constant exchange rates): slowed to 7.7 percent y-o-y in March 2021 before picking up in Q2 despite tightening. - Banking sector soundness: - H1 2021: profits rebounded strongly; capital adequacy ratio recovered to 19.2 percent. - NPLs: provisioning at 80 percent; NPL level declined to 6.7 percent by July 2021 (NBG’s more stringent definition); under traditional IMF definition NPLs remained below 3 percent. - Minimum reserve requirement adjustment (effective July 1, 2021): will vary between 25 percent (for banks with deposit dollarization above 70 percent) and 10 percent (for those with deposit dollarization below 40 percent); between thresholds the requirement reduced by one percentage point for every two percentage point reduction in deposit dollarization. Previously the reserve requirement was 25 percent regardless of dollarization. ### Outlook and Risks - Growth outlook: - Near-term prospects improved; strong V-shaped recovery expected if vaccinations accelerate and tourism rebounds. - Output gap expected to close by 2023, faster than previously forecast; medium-term growth still implies output will not reach pre-pandemic trend. - Inflation forecast: - End-2021 inflation projected at 13.1 percent. - Inflation expected to decline below the NBG’s target by end-2022 as temporary effects fade. - Current account and reserves: - Current account deficit projected to narrow from 10 percent of GDP in 2021 to 5.5 percent by 2026. - Financing: expected to be primarily by FDI. - Foreign exchange reserves: projected to remain near or above 100 percent of the ARA metric throughout the forecast horizon and reach 109 percent by 2026. - Baseline projections include impact of an SDR allocation of US$ 286 million approved in August 2021; authorities indicated they do not intend to use the additional SDRs in the near term and will include them as reserves. - Risks (Annex II): - Downside risks: COVID-19 variants or vaccination delays could require new lockdowns and reduce external demand; renewed political uncertainty could increase lari volatility, undermine investment and confidence, and hinder structural reforms; further lari depreciation could increase inflation pressures and threaten financial stability given high dollarization; depreciation could pose vulnerabilities for public debt given high share denominated in foreign currency; large current account deficits make Georgia vulnerable to shortfalls in financial inflows. - Upside risk: better control of COVID-19 could produce a stronger recovery due to sizeable fiscal support, pent-up demand, and faster tourism growth. ### Policy Discussions and Recommendations - Overall staff recommendations: - Continued focus on policies to address pandemic challenges and reduce risks. - Clarify adjustment plans to comply with the fiscal rule and build resilience. - Maintain an appropriately tight monetary stance to address inflation risks. - Address fiscal risks as crisis support is unwound. - Implement structural measures to strengthen growth and inclusiveness. - A. Rebuilding Fiscal Buffers and Controlling Risks — Achieving Compliance with the Fiscal Rule - Fiscal strategy: - As economy recovers, unwind crisis support measures and reduce deficit and debt. - Fiscal stance in 2021 relative to 2020 remains mildly contractionary and appropriate. - Staff advised saving at least half of expected revenue increases to enable faster progress on fiscal consolidation required to comply with the fiscal rule by 2023 and provide a buffer against risks while maintaining a mildly contractionary stance. - If additional outlays are needed (e.g., pandemic intensifies), these should be offset through spending reprioritization to avoid abrupt consolidation in 2022–23. - If revenue overperformance continues, extra revenues should be used to reduce the deficit. - Supplementary budget assessment: - Staff welcomed prioritization of COVID-19 health response, social transfers to vulnerable families with children, and some development needs (capital spending), but noted some permanent measures will add to medium-term spending pressures. - Encouraged assessment of social safety nets’ performance and scope to improve targeting and automatic stabilization properties. - Medium-term consolidation: - Authorities committed to complying with the fiscal rule; medium-term plans backload adjustment measures. - Baseline assumes gradual consolidation starting in 2021: deficit narrowing to 6.5 percent of GDP (from 9.2 percent in 2020), reaching 3.6 percent in 2022 and 2.6 percent in 2023, in compliance with the fiscal rule. - Approximately 2.4 percent of GDP in temporary COVID-19 fiscal support should end in 2022; more remaining adjustment focused on 2023 (Text Table 3). - Staff advised faster deficit reduction in the 2022 budget to smooth the need for new fiscal measures over subsequent years and safeguard compliance with the fiscal rule. *GEORGIA — INTERNATIONAL MONETARY FUND.* ### 17. Additional fiscal policy space will be needed to meet the authorities’ medium-term ### 17. Additional fiscal policy space will be needed to meet the authorities’ medium-term ### Fiscal space, spending pressures, and revenue measures - Ambitious capital spending plans to address development needs, current spending pressures (education, pension, health), and fiscal risks from SOEs, PPPs and PPAs could increase adjustment needs and add to medium-term fiscal policy challenges. - In a downside scenario, staff estimates an additional 0.5 percent of GDP in targeted cash transfers to vulnerable households could be offset by spending reprioritization (including capital spending). - Social assistance: the social assistance to vulnerable families with children was doubled to GEL 100 per child per month and the threshold increased to 120,000. This measure will cost the budget GEL 75 million in 2021 (for six months) and GEL 150 million per year afterwards. - Staff supported postponing the introduction of an education spending floor of 6 percent of GDP (which would increase education spending by about 50 percent) and argued for a more gradual increase to reflect capacity constraints and evolving education needs. - Staff welcomed plans to comprehensively review tax expenditures by end-2021 including VAT and income tax expenditures. - Recommendations to create additional fiscal space: - Strengthen tax administration (including by enhancing tax compliance). - Streamline tax incentives and expenditures. - Address distortions in the current system. - Consider a more comprehensive tax policy review over the medium term, including with IMF TA, and accompany any tax policy changes with targeted social support given the already regressive current flat-tax system. ### Authorities’ views on fiscal consolidation and priorities - Authorities broadly agreed with the need for gradual fiscal consolidation and creating additional fiscal space. - They did not see scope to save more of the currently expected revenue increases in the supplementary budget, noting that close to 40 percent of additional spending was due to higher-than-envisioned COVID healthcare costs. - Authorities agreed with staff’s recommendation to save revenue increases beyond those projected in the supplementary budget in an upside scenario and to reprioritize spending in a downside scenario. - Authorities see more scope to contain current spending to make space for higher capital expenditures and consider raising revenues through improved tax administration. ### Controlling fiscal risks from SOEs, PPPs, PPAs, and public corporations - Progress and planned reforms: - Substantial progress in disclosing SOE fiscal risks; sectorization exercise carried out to include all non-market SOEs in general government fiscal reporting starting in 2021. - Plans to reform governance of public corporations (PCs) in line with OECD principles and to publish the SOE governance reform strategy, pilot it, and adopt a framework PC law. - Staff recommendations: - Continue SOE reform to manage and mitigate fiscal risks. - Publish and expand SOE reform strategy and pilot cases. - Strengthen public investment management (PIM) framework and better integrate off-budget investments (PPPs, PPAs and PCs) into the budget process. - Undertake external independent reviews before major infrastructure projects over a defined threshold. - Expand annual Fiscal Risk Statements (FRS) to disclose risks from individual PPA projects and cover environmental, social (e.g., demographics), and governance (ESG) risks. - Specify clear criteria in advance for any deviations from the feed-in premium scheme. - Staff argued for dismantling the Partnership Fund given its non-commercial objectives; authorities plan to limit its operations and incorporate it in the general government. ### Achieving the inflation target and external position - Monetary policy stance: - A moderately tight monetary policy stance is essential to keep inflation expectations anchored. - Staff supported recent policy rate increases that constrained credit growth and kept the stance moderately tight; core inflation has been contained relative to headline prices. - Drivers of the recent inflation increase appear temporary; the NBG’s stance and recent exchange rate appreciation should help ensure these are transitory. - Risks to inflation are tilted to the upside; the NBG should continue to increase rates if inflation expectations and/or core inflation do not decrease in line with expectations. - External position and reserves: - Georgia’s external position in 2020 was broadly in line with fundamentals and desirable policies, but external vulnerabilities increased relative to 2019. - Gross international reserves are expected to decline from 108 to 99 percent of the ARA metric in 2021 as exceptional donor support moderates before rising to 109 percent at the end of the forecast horizon. - With considerable financial dollarization, the NBG should continue prudent use of foreign exchange intervention as needed to avoid disorderly market conditions. - Authorities agreed with the assessment and remain ready to increase rates as needed; officials noted limits to effectiveness in a dollarized system and supported judicious FX sales to prevent disorderly conditions. ### Ensuring a resilient financial sector - FSAP stress test findings: - Banks are adequately capitalized: all credit losses from the pandemic under a conservative baseline over the next three years can be absorbed. - Under a stress scenario of an extended pandemic and adverse external financial environment, capital shortfalls are not deemed substantial and are manageable systemically. - Banks are sufficiently liquid, including in a stressed scenario of high deposit withdrawals. - Recent dynamics and prudential recommendations: - Precautionary provisioning in April 2020 sharply reduced bank profitability; buffers were subsequently released but banks remained above minimum capital and liquidity requirements. - In 2021, income from strong loan portfolio growth, reversal of provisions, and lari appreciation contributed to higher profitability and capital ratios; some factors could reverse in a downside scenario. - Staff urged authorities to use available policy tools to preserve capital, for example by asking banks to minimize dividends and bonuses until recovery is more certain. - Authorities’ stance: - Authorities agreed banks should prepare for possible pandemic deterioration but did not see the need to restrict bank payouts as long as banks meet pre-COVID capital requirements. - Authorities highlighted that banks made substantial ex ante loan loss provisions under the assumption that NPLs would peak at up to 10 percent; NPLs have declined from a peak of 8.5 percent in March 2021 and have been adequately provisioned. - Authorities argued that further restrictions on dividends and bonuses could reduce attractiveness of Georgian banks to investors. - Dealing with problem loans and financial safety nets: - Staff called for prompt dealing with problem loans: NPLs at 6.7 percent of loans and restructured loans at 19 percent (figures as of July 2021). - Emphasized ex ante preparedness: effective insolvency framework implementation, creation of a market for bad loans, prompt write-downs, full provisioning without relying on real estate collateral. - Finalize bank recovery and resolution procedures, establish early intervention arrangements including preparations for a bridge bank, and ensure backup funding for the deposit insurance scheme. - Authorities plan to develop a prompt corrective action framework, agree an operational framework for a bridge bank with the MOF to be implemented within 2-3 years, and seek to develop legislation on minimum required eligible liabilities (MREL) with IMF help. ### Reducing dollarization and fintech/digital currency considerations - Dollarization: - Recent modification to differentiated reserve requirements for FX deposits could be a useful step. - Authorities have implemented measures: more stringent LTV and PTI requirements for unhedged borrowers in FX; introduction of a currency-induced credit risk (CICR) pillar 2 capital buffer; an outright ban on FX loans below 200,000 GEL for households, corporates and SMEs; an LCR requirement for banks in FX; higher reserve requirements on bank FX liabilities and associated penalty rates of remuneration. - Loan and deposit dollarization have declined slowly but steadily; further measures to reduce loan dollarization should be informed by impact assessment and progress in reducing deposit dollarization. - Fintech and CBDC: - NBG is moving ahead with its central bank digital currency (CBDC) project and aims to choose a technology provider by the end of this year; implementation and timeline depend on trial outcomes. - Potential benefits of CBDC: reduce transaction costs, increase payment speed and efficiency for SMEs in rural areas, encourage fintech development. - Risks: bank liquidity from deposit outflows, privacy concerns, cybersecurity issues; cryptocurrency is unregulated and not subject to AML/CFT rules. - Staff stressed the importance of adopting legal and regulatory framework for licensing and AML/CFT supervision of virtual asset service providers (VASPs). - NBG has developed a draft AML/CFT regulation for VASPs and plans public consultations; after legislative amendment, NBG will work on implementation of AML/CFT preventive measures including the “travel rule”. ### Structural reforms and inclusive recovery - Staff called for a renewed structural reform agenda to attract FDI, diversify exports, increase productivity, and address high unemployment and inequality. - Education and labor market: - Education reform coupled with active labor market policies (ALMPs), particularly targeted vocational training, would help address skills mismatches, high unemployment, and encourage formal labor market entry. - Infrastructure and public investment: - Continued investment in infrastructure is needed to realize transit hub ambitions, unlock tourism potential, and facilitate exports. - Authorities committed to expanding road and transportation infrastructure and have made substantial progress on the East-West highway. - Strengthening the PIM process should help maximize the impact of capital spending. - Authorities are conducting a feasibility study for a cable under the Black Sea to strengthen regional electricity and internet connectivity. - Governance: - Structural fiscal measures—strengthening PIM, regular Fiscal Risk Statements, sectorization for SOEs, SOE reforms, and commitments to limit the Partnership Fund—are important for enhancing governance and controlling fiscal risks. *Source: IMF staff report excerpt.* ### 37. Legal and judiciary reforms are important for resource reallocation in the aftermath of ### 37. Legal and judiciary reforms are important for resource reallocation in the aftermath of ### Legal and judiciary reforms — implementation and importance - The law on Rehabilitation and Collective Satisfaction of Creditors recently came into effect and "significantly modernized and strengthened the insolvency framework." - To support implementation of the new framework: - Authorities introduced regulations for insolvency professionals. - Training and certification of insolvency practitioners started in April 2021 with the first graduates expected to be certified by October 1st. - A transparent and efficient judiciary system is identified as essential for good governance and the business environment. - Authorities have taken steps to modify and make more transparent processes for judicial appointments, drawing on Venice Commission recommendations; the Venice Commission and some development partners signaled scope for further improvements. ### Authorities’ structural reform planning and priorities - Authorities broadly agreed with staff key priorities for structural reform. - A 10-year Development Plan touching on a wide range of structural reform priorities is being prepared and "is expected to be released soon." - Education reform work has been delayed by focus on the COVID-19 pandemic; authorities are engaging with development partners in this area. - In cooperation with international donors, authorities are engaging in a comprehensive review of social and labor policies, which should consider the need for and modalities of additional ALMPs. - Other priorities noted by the authorities: - Continued progress in liberalizing the energy market and unbundling of energy generation from transmission. - Capital market development. - Ongoing work on free trade agreements with South Korea, Israel and other countries to increase private sector development opportunities. ### Staff appraisal — macroeconomic impact of COVID-19 and policy response - The COVID-19 crisis caused the largest output contraction since the 1990s, reflecting domestic mobility restrictions and a slowdown in tourism. - Poverty and unemployment rose, undoing much of the progress of recent years. - Authorities responded by: - Strengthening healthcare. - Providing substantial assistance to vulnerable households and businesses. - Receiving sizeable donor support. ### Recovery dynamics and risks - The economy is described as "bouncing back in a V-shaped recovery." - Recent momentum supported by: - Robust growth in remittances and exports. - Early signs of a faster than expected rebound in tourism. - Pent-up demand. - COVID-19 case numbers are rising sharply and the pandemic remains a key risk. - The recovery will be secure only "if a strong pace of vaccinations is sustained." ### Fiscal policy guidance - As recovery proceeds, fiscal policy should shift toward: - Unwinding crisis support measures. - Bringing down the deficit and debt. - The pandemic led to sharp rises in the fiscal deficit and debt due to fiscal support costs and revenue declines. - Fiscal policy should remain anchored by Georgia’s fiscal rule, a source of policy credibility. - With new revenues from the improved outlook for 2021 largely financing additional healthcare costs as well as capital and other spending, it is critical that any further revenue increases are saved to speed progress on fiscal consolidation to comply with the fiscal rule by 2023 and provide a buffer against risks. - Some of the new adjustment needed to comply with the fiscal rule (beyond the unwinding of COVID-19 measures) should be included in the 2022 budget to avoid backloading new measures to 2023. ### Fiscal risks and structural fiscal actions - Rising spending pressures and fiscal risks require: - Efforts to expand fiscal space. - Further strengthening the fiscal framework. - Continuation of comprehensive SOE reforms. - Drivers of increased fiscal adjustment needs: - Ambitious capital spending plans. - Rising current spending pressures including for education, pension, and health outlays. - Fiscal risks stemming from SOEs and PPAs. - Policy measures recommended: - Strengthen the public investment management framework to boost efficiency and maximize growth benefits. - Undertake a comprehensive review of tax expenditures and further strengthen tax administration to generate additional revenue. - Continue efforts to manage and mitigate risks, including comprehensive reform of SOE governance. ### Monetary policy and external sector - Monetary policy should guard against temporarily high inflation becoming entrenched. - Recent increases in the monetary policy rate were appropriate to keep temporary commodity price increases and supply constraints transient and to anchor inflation expectations. - With the recovery faster than expected and risks to inflation tilted to the upside, the NBG should hike rates further if inflation expectations or core inflation suggest high inflation risks becoming entrenched. - The inflation targeting framework and floating exchange rate regime have helped Georgia adjust to the COVID-19 shock and remain appropriate. - Georgia’s external position in 2020 was broadly in line with levels implied by fundamentals and desirable policies. - External vulnerabilities have increased relative to 2019 due to the massive hit to tourism, a recovery only over a few years, and the build-up of external debt. - Considering risks, including financial dollarization, the NBG should continue prudent use of foreign exchange interventions to prevent disorderly market conditions. - The recent introduction of differentiated reserve requirements on foreign exchange liabilities of banks could be useful to reduce deposit dollarization. ### Financial sector resilience and priorities - The NBG’s prudent pre-crisis supervisory approach and decisive actions afterwards contributed to financial sector resilience; the banking system remains adequately capitalized and liquid. - Stress tests from the recent FSAP mission found: - Banks have sufficient capital to absorb credit losses stemming from the pandemic under a conservative baseline scenario over the next three years. - Under a stress scenario of an extended pandemic and an adverse external financial environment, capital shortfalls are not deemed substantial and are assessed to be manageable from a systemic perspective. - Banks are sufficiently liquid, including in a stressed scenario of high deposit withdrawals. - Near-term priorities: - Preserve sufficient retained earnings; the NBG should ask banks to preserve retained earnings until significant downside risks recede. - Deal with problem loans by identifying effective ways to resolve non-performing loans, including utilizing the new insolvency framework or NPL sales to avoid a legacy of bad loans. - Medium-term financial sector agenda from FSAP recommendations includes: - Implementing Basel regulations on banks’ large exposures as planned. - Formalizing and enhancing supervisory processes. - Developing a prompt corrective action framework for banks. - Taking steps to be able to swiftly implement a bridge bank if needed. - Exploring CBDC development for opportunities to increase financial efficiency and inclusion, conditional on addressing risks and developing a sound regulatory framework. ### Structural reform priorities for growth and inclusion - Reinvigorating the structural reform agenda is vital to enhancing economic growth and making it more inclusive. - Key actions and expected effects: - Implementation of the recently adopted insolvency framework and training of insolvency professionals will help facilitate resource reallocation in the wake of the crisis. - Renewed efforts to improve education and vocational training would help address skills mismatches in the labor market. - The authorities’ planned review of the social protection system could complement these actions with strengthened active labor market policies aimed at tackling entrenched unemployment. - Continued structural fiscal and judiciary reforms are important to further strengthen governance and the business environment. ### Staff recommendation on Fund engagement - Staff recommend initiation of a Post Financing Assessment (PFA). - Georgia’s credit outstanding is 230 percent of quota, which triggers the expectation of PFA. - Authorities have indicated interest in a new Fund-supported program, but the timing of a potential program is unclear. *Source: IMF staff report excerpt.* ### 50. It is recommended that the next Article IV consultation be held on the standard 12- ### 50. It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### Real sector developments - COVID-19 crisis effects: - Increased absolute poverty, reduced employment and labor force participation. - Loss in employment driven by construction, hospitality and trade industries. - Growth and inflation: - Real GDP: 2019: 5.0; 2020: -6.2; 2021: 3.5; 2022: 7.7; 2023: 5.8; 2024: 5.5; 2025: 5.2; 2026: 5.2. - Output Gap: 2019: -0.6; 2020: -3.9; 2021: -2.8; 2022: -1.0; 2023: -0.4; 2024: 0.0; 2025: 0.0; 2026: 0.0. - Headline CPI, Period average: 2019: 4.9; 2020: 5.2; 2021: 3.8; 2022: 9.3; 2023: 5.4; 2024: 3.0; 2025: 3.0; 2026: 3.0. - CPI, End-of-period: 2019: 7.0; 2020: 2.4; 2021: 4.5; 2022: 13.1; 2023: 3.2; 2024: 3.0; 2025: 3.0; 2026: 3.0. - Drivers of inflation and rebound: - Acceleration partly reflecting removal of utility subsidies, rising food and commodity prices, and lari depreciation against the dollar and in effective terms. - Flash estimates suggest a dramatic rebound in GDP growth after the COVID-19 shock. ### External sector developments - Current account and trade: - Current account balance (in billions of US$): 2019: -1.0; 2020: -2.0; 2021: -1.8; 2022: -1.8; 2023: -1.5; 2024: -1.3; 2025: -1.4; 2026: -1.5. - Current account (percent of GDP): 2019: -5.5; 2020: -12.3; 2021: -12.5; 2022: -10.9; 2023: -10.0; 2024: -7.6; 2025: -6.2; 2026: -5.7. - Trade balance (percent of GDP): 2019: -21.3; 2020: -19.8; 2021: -19.8; 2022: -18.9; 2023: -19.1; 2024: -18.1; 2025: -17.6; 2026: -17.1. - Transfers, tourism, reserves: - Net money transfers increase has been sustained; remittances (net) in Table 2: 2019: 915; 2020: 1,167; 2021: 1,201; 2022: 1,383; 2023: 1,314; 2024: 1,366; 2025: 1,421; 2026: 1,477 (in millions of US$). - Hotel reservations and flights rebounded before weakening; major sources of tourism remain well below pre-COVID-19 levels. - Gross international reserves (in billions of US$): 2019: 3.5; 2020: 3.9; 2021: 3.9; 2022: 3.6; 2023: 3.8; 2024: 4.0; 2025: 4.3; 2026: 4.7; supported by external borrowing (including IMF and donor financing). - Gross international reserves (in million of USD), Table 2 memorandum: 2019: 3,506; 2020: 3,911; 2021: 3,911; 2022: 3,650; 2023: 3,801; 2024: 4,034; 2025: 4,343; 2026: 4,683. - External financing and reserves adequacy: - Gross external debt (percent of GDP): 2019: 106.6; 2020: 124.8; 2021: 129.5; 2022: 133.9; 2023: 116.8; 2024: 111.8; 2025: 108.4; 2026: 104.1. - Gross external debt, excl. intercompany loans: 2019: 87.7; 2020: 104.1; 2021: 109.0; 2022: 110.3; 2023: 95.9; 2024: 91.7; 2025: 83.7; 2026: 79.7 (percent of GDP). - Gross international reserves in percent of IMF Composite measure (floating): 2019: 98.3; 2020: 111.0; 2021: 107.6; 2022: 97.8; 2023: 98.5; 2024: 98.5; 2025: 100.3; 2026: 103.8. ### Fiscal sector developments - Debt and composition: - General government debt (percent of GDP): 2019: 40.4; 2020: 60.0; 2021: 60.0; 2022: 60.8; 2023: 54.2; 2024: 53.6; 2025: 52.1; 2026: 50.7. - Foreign-currency denominated share of government debt (percent of GDP): 2019: 32.0; 2020: 47.5; 2021: 47.5; 2022: 49.6; 2023: 43.9; 2024: 42.1; 2025: 39.3; 2026: 36.8. - Most external debt is to bilateral and multilateral official creditors. - Revenue and spending: - Revenue and grants (percent of GDP): 2019: 27.1; 2020: 25.1; 2021: 25.2; 2022: 25.7; 2023: 26.1; 2024: 26.1; 2025: 26.0; 2026: 25.9. - Tax revenue (percent of GDP): 2019: 23.7; 2020: 22.2; 2021: 22.6; 2022: 22.9; 2023: 23.6; 2024: 23.7; 2025: 23.8; 2026: 23.8. - Revenue performance in 2021 strong, driven by profit tax as well as VAT and excises (due to higher import prices). - Total expenditure (percent of GDP): 2019: 28.9; 2020: 34.4; 2021: 32.6; 2022: 32.2; 2023: 29.7; 2024: 28.7; 2025: 28.4; 2026: 28.3. - Capital spending reached a record high in 2020 in GEL and as a share of GDP despite COVID-19. Capital spending (percent of GDP): 2019: 8.0; 2020: 8.6; 2021: 7.9; 2022: 8.0; 2023: 7.4; 2024: 6.4; 2025: 6.1; 2026: 5.7. - For current spending, COVID-19 increased real spending on subsidies and social benefits; social benefits (percent of GDP): 2019: 8.5; 2020: 11.3; 2021: 10.4; 2022: 10.3; 2023: 9.1; 2024: 9.2; 2025: 9.3; 2026: 9.3. - Balances and borrowing: - Net lending / borrowing (GFSM 2001) (percent of GDP): 2019: -1.8; 2020: -9.2; 2021: -7.4; 2022: -6.5; 2023: -3.6; 2024: -2.6; 2025: -2.4; 2026: -2.3. - Augmented Net lending / borrowing (EFF definition) (percent of GDP): 2019: -2.1; 2020: -9.3; 2021: -7.6; 2022: -6.6; 2023: -3.9; 2024: -2.9; 2025: -2.7; 2026: -2.6. ### Financial sector developments - Credit and dollarization: - Credit to the private sector (percent change): 2019: 20.7; 2020: 22.4; 2021: 2.4; 2022: 6.4; 2023: 10.5; 2024: 11.8; 2025: 8.7; 2026: 8.4. - Deposit dollarization (percent of total): 2019: 64.0; 2020: 67.5; 2021: 61.4; 2022: 67.0; 2023: 66.7; 2024: 66.2; 2025: 65.6; 2026: 65.0. - Credit dollarization (percent of total): 2019: 55.4; 2020: 55.7; 2021: 55.7; 2022: 55.0; 2023: 55.0; 2024: 54.9; 2025: 53.9; 2026: 52.9. - Loan dollarization resumed its decline after the COVID-19 shock; deposit dollarization was more persistent. - Asset quality and profitability: - Nonperforming loans to total gross loans (IMF definition): Dec 2019: 2.7; Mar 2020: 1.9; Jun 2020: 2.2; Sep 2020: 2.4; Dec 2020: 2.3; Mar 2021: 2.3; Jul 2021: 2.4. - NPLs and watch loans stabilized at levels close to those observed during the previous crisis. - Bank profitability recovered to pre-crisis levels owing to higher net interest income and lower provisions. - Financial soundness indicators (selected): - Capital to risk-weighted assets (Basel III): 2018: 18.4; 2019: 19.5; 2020: 17.0; 2021 (Dec): 18.0; 2021 (Mar): 17.6; 2021 (Jul): 19.2. - Return on assets (ROA): Dec 2018: 3.0; Dec 2019: 2.5; Dec 2020: -7.1; Dec 2021: -2.4; Mar 2021: -0.9; Jul 2021: 4.0. - Return on equity (ROE): Dec 2018: 23.3; Dec 2019: 20.3; Dec 2020: -64.4; Dec 2021: -21.7; Mar 2021: -8.1; Jul 2021: 37.3. ### External vulnerability and financing outlook - External vulnerability indicators (projections): - Current account balance (percent of GDP): 2019: -5.5; 2020: -12.5; 2021: -10.0; 2022: -7.6; 2023: -6.2; 2024: -5.7; 2025: -5.6; 2026: -5.5. - External public debt (percent of GDP): 2019: 34.5; 2020: 49.3; 2021: 42.8; 2022: 39.8; 2023: 37.2; 2024: 34.5; 2025: 31.9; 2026: 28.8. - External debt (percent of GDP, excluding intercompany loans): 2019: 87.7; 2020: 109.0; 2021: 95.9; 2022: 91.7; 2023: 87.6; 2024: 83.7; 2025: 79.7; 2026: 73.0. - Gross external financing requirement (in millions of USD): 2019: 2,134; 2020: 2,998; 2021: 3,298; 2022: 2,089; 2023: 2,070; 2024: 2,265; 2025: 2,471; 2026: 2,751. - Total financing sources (in millions of USD): 2019: 2,230; 2020: 2,028; 2021: 2,388; 2022: 2,323; 2023: 2,379; 2024: 2,605; 2025: 2,829; 2026: 2,884. - IMF financing (in millions of USD, Table 7 financing needs): IMF: 2019: 35; 2020: 315; 2021: 107; 2022–2026: 0 (prospective years show 0 in the table). - Reserve cover and months of imports: - Gross international reserves (in months of next year GNFS imports, Table 2 memorandum): 2019: 4.7; 2020: 4.8; 2021: 4.4; 2022: 4.3; 2023: 4.0; 2024: 3.7; 2025: 3.6; 2026: 3.7. ### Policy note - Recommendation: - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. *Source: IMF staff report (GEORGIA, selected figures and tables).* ### Annex I. Implementation of the 2018 Article IV ### Annex I. Implementation of the 2018 Article IV Recommendations ### The 2018 Article IV consultation: context and overall recommendations - The 2018 Article IV with Georgia took place in a favorable growth environment and focused on reforms to increase resilience and promote growth. - Recommendations focused on: (i) preserve fiscal sustainability while addressing bottlenecks to growth; (ii) strengthen monetary and financial policy frameworks; (iii) improve external stability; and (iv) implement structural reforms to promote private sector-led activity through economic diversification and job creation. - The 2018 Article IV occurred during the Second Review of the EFF program originally scheduled to expire in April 2020. In 2020 the program was extended by one year and augmented to help Georgia deal with the fallout of the COVID-19 pandemic. The last review of the augmented EFF was successfully concluded in April 2021 with program objectives largely achieved. ### Fiscal Policy — recommendations and implementation - Recommendations: - Strengthen the fiscal rule and make it less pro-cyclical. - Increase fiscal transparency by increasing coverage and clarifying escape clauses. - Limit fiscal risks from SOEs and PPAs by strengthening supervisory powers over SOEs. - Implementation and outcomes: - The authorities reduced the procyclicality of the fiscal rule by abolishing expenditure ceilings (set as a share of GDP) and specifying escape clauses, which were utilized in 2020 due to the COVID-19 pandemic. - Efforts to increase coverage are ongoing with the help of IMF TA. - Control over fiscal risks has been strengthened through notable improvements in the annual Fiscal Risk statements. - The authorities are seeking to comprehensively revamp SOE governance. ### Financial Sector — recommendations and implementation - Recommendations: - Implement targeted and market-based prudential measures encouraging prudent pricing of FX risk. - Bring the crisis management framework in line with best international practice. - Implementation and outcomes: - The authorities introduced payment-to-income and loan-to-value ratio caps with tighter limits on FX denominated loans in 2019. - These measures proved helpful in 2020 when the currency depreciated owing to the COVID-19 pandemic. - Emergency liquidity assistance and resolution frameworks were developed and a full set of implementing regulations adopted by end-2020 in line with EFF program conditionality. ### Structural reforms — recommendations and progress - Recommendations: - Reform education and strengthen labor market policies. - Develop capital markets. - Reform the judiciary. - Implementation and outcomes: - Comprehensive education reform began in 2019: improved teacher qualification requirements and retirement packages for teachers unwilling to meet new requirements. - Work on other elements of education reform (e.g., strengthening vocational education) is ongoing but has been set back by COVID-19. - Creation of the Pension Agency should help mobilize savings in domestic currency; the Agency is in its initial phase and so far has invested only in bank deposits, with more diversified investments expected soon. - Efforts to enhance mediation as an alternative to the judicial system have been undertaken. - Overall assessment: Progress in implementing structural recommendations has been slow. ### Annex II. Risk Assessment Matrix — key risks, likelihoods, expected impacts, and policy responses - Conjunctural shocks and scenarios (shorter horizon, 12–18 months) - Unexpected shifts in the COVID-19 pandemic - Likelihood: Medium - Expected impact: High - If materialized: Capital outflows amid high current account deficit and significant external financing requirements would threaten external stability, likely resulting in lari depreciation and accelerating inflation. - Policy response: Maintain commitment to exchange rate flexibility, but utilize foreign exchange reserves to prevent a disorderly depreciation; tighten monetary policy to keep inflation expectations anchored. - Prolonged pandemic - Likelihood: Medium - Expected impact: High - If materialized: Insufficient policy support would likely increase poverty among vulnerable populations in informal employment; lack of tourism recovery would reduce medium-term growth. - Policy response: Extend targeted measures to support individuals and businesses by reprioritizing spending; utilize available monetary policy space to support demand to the extent inflation expectations remain anchored. - Faster containment - Likelihood: Medium - Expected impact: High - If materialized: Higher growth in trading partners would enable a faster recovery in Georgia. - Policy response: Maintain prudent macroeconomic policies to build up buffers; proceed with fiscal consolidation. - Widespread social discontent and political instability - Likelihood: High - Expected impact: High - If materialized: Political polarization and social tensions could result in a disorderly lari depreciation, undermine policymaking and external financing flows. - Policy response: Strengthen the policy response and improve communication about economic policy; maintain commitment and ownership of reforms; utilize foreign exchange reserves to prevent a disorderly depreciation. - Structural risks (longer horizon) - Accelerating de-globalization - Likelihood: Medium - Expected impact: Medium - If materialized: Would put merits of Georgia’s efforts to become a logistics hub in doubt and require finding new sources of growth less reliant on the external environment. - Policy response: Allow the exchange rate to adjust; utilize monetary policy space to prevent prolonged negative output gap; extend targeted measures to support individuals and businesses by reprioritizing spending. - Georgia-specific structural risks - Financial risks - Likelihood: Medium - Expected impact: High - If materialized: Depreciation in a highly dollarized economy could hurt growth and threaten financial stability as households and firms struggle to repay loans; higher inflation and depreciation expectations could trigger a vicious cycle. - Policy response: Maintain tight monetary policy to keep inflation expectations anchored; strengthen the resolution framework; adjust macroprudential measures to avoid undue tightening of financial conditions. - Fiscal risks - Likelihood: Medium - Expected impact: High - If materialized: The need to cover contingent liabilities could result in lower capital spending or lower current spending. - Policy response: Continue improving SOE governance and fiscal risk management practices; utilize fiscal buffers accumulated due to capital markets development strategy. - Political risks - Likelihood: High - Expected impact: Medium - If materialized: Policy uncertainty could undermine confidence and hurt growth. - Policy response: Maintain macroeconomic policy discipline; strengthen social safety nets to protect the most vulnerable and ensure sufficiently inclusive growth. ### Annex III. Public Debt Sustainability Assessment — findings and projections - Summary conclusion: - Georgia’s public debt is assessed as sustainable, with fiscal consolidation and higher growth expected to put the public debt-to-GDP ratio on a downward path after a sharp rise in 2020 due to the COVID-19 pandemic. - Expanding coverage of fiscal reporting to include non-market SOEs into the general government, starting in 2021, will add to the projected stock of debt subject to the fiscal rule limit. - Taking this into account, the debt-to-GDP ratio is projected to have peaked at the limit in 2020, and to gradually fall to 52 percent of GDP by 2023, in compliance with Georgia’s fiscal rule. - Main risks to sustainability stem from the high share of foreign exchange denominated debt. - Public debt developments and drivers - Public debt-to-GDP increased sharply in 2020 after an extended period of stability. - Gross public debt stood at 40 percent of GDP at end-2019, having remained stable on average over 2016-19. - Debt increased by 20 percentage points of GDP in 2020, reaching the upper limit of the fiscal rule. - Factors behind the 2020 increase included: - widening of the fiscal deficit due to drop in GDP and revenues, rise in spending including the government’s fiscal relief package in response to COVID-19 (3.8 percent of GDP), accelerated VAT refunds, and elevated capital spending; - economic contraction; - accumulation of government deposits (which increased by 3.6 percent of GDP) to guard against downside risks; - exchange rate depreciation; and - other residual debt-increasing factors. - Medium-term outlook and metrics - Under a realistic baseline medium-term fiscal path, public debt-to-GDP ratio (excluding SOE debt) is expected to decline over the projection horizon starting in 2021. - In 2026, public debt is projected at 48 percent of GDP in gross terms and 45 percent of GDP measured net of government deposits, broadly in line with previous program commitments. - Gross financing needs are expected to average 7.1 percent of GDP over 2022-26. - Compliance with the fiscal rule (Liberty Act) - Georgia’s fiscal rule imposes a 60 percent ceiling on gross general government debt to be attained by 2023 (within three years of the escape clause being triggered due to the pandemic). - Georgia’s public debt is currently projected at 52 percent of GDP in 2023 (approximately 54 percent including SOEs and PPPs), in compliance with the fiscal rule. - Government deposits, projected at 2.7 percent of GDP, provide some additional cushion for adherence to the rule. - Fiscal risks from incorporating non-market SOEs into general government reporting, PPP liabilities, and contingent liabilities in the form of PPAs and SOEs could add to projected debt starting in 2021 and reduce space within the fiscal rule’s limits. - The rule provides very little room for relaxing fiscal policy and underscores the urgency of commencing fiscal consolidation in 2021 to avoid a more abrupt consolidation path in 2022-23. - Stress-test results and vulnerabilities - Public debt remains sustainable in all standardized stress tests and below high-risk thresholds, considering shocks to real GDP growth, the primary balance, the real interest rate, and the real exchange rate. - Debt would not stabilize under the constant primary balance scenario (at 2020 levels), but that scenario is considered unrealistic given the pandemic shock and authorities’ past fiscal discipline. - Under a combined macro-fiscal shock (low growth, inflation, deteriorated primary balance, high interest rates), debt levels stabilize at a level that breaches the benchmark threshold; such a scenario also would breach Georgia’s fiscal rule and is judged unlikely. - Remaining risks and mitigating factors - After a comfortable Eurobond rollover in April 2021, short-term risks associated with high gross financing needs remain low. - Vulnerabilities stem mostly from a high share of FX-denominated debt: currently, 80 percent of public debt is FX-denominated. - Offsetting factors: - successful refinancing of a $500-million sovereign Eurobond maturing on April 12, 2021 at a 2.75 percent coupon rate for 5-year maturity; - government has been successful in securing debt of long-term maturity (representing over 97 percent of outstanding debt); - reserves are adequate; - the public debt service profile is relatively smooth (averaging 5.9 percent of GDP over 2022-26); - much of the external debt service is owed to international finance institutions at concessional terms, mitigating risks to debt sustainability. *Prepared by IMF staff as presented in Annex I, Annex II, and Annex III of the source document.* ### 6. The public debt analysis does not incorporate contingent liabilities to the general ### 1geoea2021002 - 6. The public debt analysis does not incorporate contingent liabilities to the general ### Fiscal risks and state-owned enterprises (SOEs) - Key fiscal risks stem from power purchasing agreements (PPAs) and SOEs. - Under the EFF arrangement, authorities strengthened assessment, monitoring, and transparency of those risks, including disclosing them in the annual Fiscal Risk Statement (FRS). - A comprehensive sectorization exercise of SOEs in 2020 revealed 183 enterprises to be incorporated into the general government sector starting in 2021. - The 2020 FRS estimates the hypothetical impact of this exercise on 2019 fiscal statistics would increase debt by 0.8 percent of GDP. - IMF TA provided in June 2021 estimates a higher impact whereby 2019 debt would increase by 1.1 percent of GDP based on GFSM 2014 (considering 84 percent of SOEs in terms of annual turnover). - With IMF TA support, pilot balance sheet compilations for 65 non-market SOEs (representing 84 percent of all non-market SOEs in terms of annual turnover) estimated debt liabilities totaling 3.1 percent of GDP in 2019. - The impact of incorporating these SOEs in public finance statistics is yet to be estimated for 2021-26. - The authorities are committed to comprehensive governance reform of SOEs to help reduce fiscal risks. - The 2020 Fiscal Risk Statement estimated PPP liabilities at GEL 390 million (0.8 percent of GDP), including the Nenskra Hydro Power Plant (GEL 267 million) and Tbilisi Shota Rustaveli International Airport (GEL 122 million). ### Public Debt Sustainability Analysis (DSA) — baseline projections and key indicators - Nominal gross public debt (in percent of GDP, As of June 03, 2021): - 2019: 33.9 - 2020: 40.4 - 2021: 60.0 - 2022: 54.1 - 2023: 53.5 - 2024: 52.0 - 2025: 50.7 - 2026: 49.2 - projection (final column): 48.2 - Public gross financing needs (in percent of GDP): - 2019: 4.2 - 2020: 6.5 - 2021: 14.3 - 2022: 13.9 - 2023: 7.6 - 2024: 6.3 - 2025: 6.3 - 2026: 6.9 - projection (final column): 8.2 - Real GDP growth (in percent): - 2019: 4.8 - 2020: 5.0 - 2021: -6.2 - 2022: 7.7 - 2023: 5.8 - 2024: 5.5 - 2025: 5.2 - 2026: 5.2 - projection (final column): 5.2 - Inflation (GDP deflator, in percent): - 2019: 5.1 - 2020: 4.9 - 2021: 6.9 - 2022: 8.3 - 2023: 6.1 - 2024–2026: 3.0 each year - Effective interest rate (in percent): - 2019: 3.4 - 2020: 3.5 - 2021: 3.9 - 2022: 3.0 - 2023: 2.7 - 2024: 2.8 - 2025: 3.1 - 2026: 3.3 - projection (final column): 3.6 - Change in gross public sector debt (annual, in percent of GDP): - 2019: 0.6 - 2020: 1.6 - 2021: 19.6 - 2022: -5.9 - 2023: -0.6 - 2024: -1.5 - 2025: -1.4 - 2026: -1.4 - cumulative: -1.1 (and cumulative projection -11.9) - Identified debt-creating flows (annual, in percent of GDP): - Primary deficit: - 2019: 0.1 - 2020: 0.6 - 2021: 7.7 - 2022: 5.0 - 2023: 2.3 - 2024: 1.2 - 2025: 1.0 - 2026: 0.7 - cumulative (projection): 10.9 - Primary (noninterest) revenue and grants (percent of GDP): - 2019: 27.1 - 2020: 27.1 - 2021: 25.1 - 2022: 25.7 - 2023: 26.1 - 2024: 26.1 - 2025: 26.0 - 2026: 25.9 - cumulative (projection): 155.7 - Primary (noninterest) expenditure (percent of GDP): - 2019: 27.1 - 2020: 27.7 - 2021: 32.8 - 2022: 30.7 - 2023: 28.4 - 2024: 27.3 - 2025: 27.0 - 2026: 26.6 - cumulative (projection): 166.6 - Automatic debt dynamics (annual, percent of GDP and cumulative): - 2019: -0.7 - 2020: -0.3 - 2021: 6.1 - 2022: -7.0 - 2023: -4.6 - 2024: -2.9 - 2025: -2.6 - 2026: -2.4 - cumulative (projection): -2.2 and -21.6 (cumulative) - Other identified debt-creating flows and residuals (selected): - Other identified debt-creating flows: - 2019: 0.6 - 2020: 0.5 - 2021: 3.2 - 2022: -2.6 - 2023: -0.6 - 2024: 0.1 - 2025: 0.2 - 2026: 0.2 - cumulative (projection): 0.1 and -2.6 - GG: Privatization and Drawdown of deposits (negative): - 2019: -0.6 - 2020: 0.3 - 2021: 3.1 - 2022: -2.8 - cumulative (projection): -4.1 - GG: Net acquisition of financial assets: Budget lending: - 2019: 1.2 - 2020: 0.2 - cumulative (projection): 1.4 - Residual, including asset changes: - 2019: 0.6 - 2020: 0.7 - 2021: 2.6 - cumulative (projection): 1.5 ### Stress tests, alternative scenarios, and vulnerabilities - Scenarios considered in Figure 3: - Baseline assumptions (selected): - Real GDP growth: 2021: 7.7; 2022: 5.8; 2023: 5.5; 2024–2026: 5.2 each year. - Inflation: 2021: 8.3; 2022: 6.1; 2023–2026: 3.0 each year. - Primary balance: 2021: -5.0; 2022: -2.3; 2023: -1.2; 2024: -1.0; 2025: -0.7; 2026: -0.7. - Effective interest rate: 2021: 3.0; 2022: 2.7; 2023: 2.8; 2024: 3.1; 2025: 3.3; 2026: 3.6. - Historical scenario (selected): - Real GDP growth: 2021: 7.7; 2022–2026: 3.6 each year. - Primary balance: 2021: -5.0; 2022–2026: -0.6 each year. - Constant Primary Balance scenario: - Primary Balance held at -5.0 from 2022–2026. - Stress tests (Figure 4) include: - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Macro-Fiscal Shock, and Additional Stress Tests. - Under shock scenarios, gross nominal public debt and public gross financing needs can rise substantially relative to baseline (charts show debt in percent of GDP and percent of revenue and financing needs in percent of GDP under shocks). - Debt profile vulnerabilities and heat map indicators (selected references): - Gross financing needs benchmark of 15 percent is used to flag vulnerability. - Market perception indicators use EMBIG and bond spread shocks of 200 and 600 basis points. - External financing requirement scenarios of 5 and 15 percent of GDP are considered. ### Medium-term fiscal path, policy implications, and recommendations - Pre-pandemic fiscal position and pandemic response: - During 2015-2019, small fiscal deficits averaged 1.3 percent of GDP; deposit buffer averaged 2.7 percent of GDP; gross debt remained below 40 percent of GDP. - COVID-19 fiscal support: 3.8 and 2.9 percent of GDP in 2020 and 2021 in measures supporting health, vulnerable households, and viable businesses. - By end-year (2020), the budget deficit reached 9.2 percent of GDP and public debt widened by 20 percentage points of GDP. - Deposit buffers reached a historic high of 6.5 percent of GDP. - Fiscal rule and adjustment needs: - Georgia’s Liberty Act prescribes ceilings on the general government deficit and gross debt of 3 and 60 percent of GDP. - An escape clause triggered in 2020 allows temporary deviation for up to three years, making the rule binding again in 2023. - Under the baseline, compliance with the fiscal rule is expected: deficit projected at 2.6 percent of GDP and stock of debt (including PPPs and non-market SOEs) projected at 52 percent of GDP. - Recommendation: somewhat faster fiscal consolidation in 2022 (when COVID-19 relief measures are expected to roll off) could deliver a smaller deficit and smoother adjustment across 2022 and 2023. - Stochastic simulations suggest targeting a debt anchor of 50-53 percent of GDP would be appropriate so that debt exceeds the fiscal rule limit only with a 5-10 percent probability over a 6-year forecast horizon. - Composition of medium-term consolidation: - Baseline consolidation predicated on unwinding COVID-19 crisis support, containing medium-term current spending pressures, and lowering capital spending. - Current spending pressures include recent pension indexation reform. - Tax revenues (after VAT refunds) are projected to recover close to 2019 levels as a share of GDP; higher VAT refunds under a new system are expected to be compensated by growth in other gross tax revenues. - Withdrawal of COVID-19 support measures in 2022 expected to bring current spending below pre-pandemic levels as a share of GDP after accounting for rise in basic pension benefits. - Education spending projected to remain close to 4 percent of GDP; the education spending floor of 6 percent of GDP originally targeted for 2022 is expected to be delayed. - Capital spending is assumed to gradually decline to 5.6 percent of GDP in the medium run (in line with 2013-2018 average) — below the government target of 8 percent of GDP under the Government Program for 2021-24. - Reaching authorities’ ambitions for education reform, infrastructure investment, and other priorities while ensuring buffers would require additional fiscal space. - Risks from SOEs and PPAs: - Materialization of adverse macroeconomic shocks and fiscal risks could require capital injections and conversion of accumulated SOE losses into government debt. - Poor SOE financial performance during 2013-19 produced net losses, negative return on assets and equity, and rising debt-to-equity leverage. - The negative impact of the pandemic on SOE financial results in 2020 remains to be fully assessed; the impact on fiscal parameters in future years is unknown. - Recapitalization needs noted as of 2018 were assessed against a 40 percent equity benchmark (text references recapitalization needs but does not provide a completed numeric total in the excerpt). - Policy priorities: - Maintain transparency and monitoring via the Fiscal Risk Statement and continue IMF TA-supported balance sheet work. - Pursue comprehensive governance reform of SOEs to reduce fiscal risks. - Implement measured fiscal consolidation to comply with the Liberty Act and rebuild buffers, targeting a debt anchor of 50-53 percent of GDP to allow room for countercyclical policy. - Balance capital spending ambitions with the need to preserve fiscal space and buffers; consider phased approaches to education spending increases to avoid large one-year budgetary shocks (example: gradual salary hikes were estimated to cost GEL 100 million per year for teachers’ remuneration reforms). *Source: IMF staff.* ### 1.1 percent and 0.6 percent respectively) on government debt and deficit. ### 1geoea2021002 - 1.1 percent and 0.6 percent respectively) on government debt and deficit. ### Fiscal risks from State-Owned Enterprises (SOEs) and Power Purchase Agreements (PPAs) - Support to SOEs totaled GEL 67 million in 2020 in the form of on-budget subsidies. - SOEs are estimated to have lost revenues totaling about GEL 130 million (0.3 percent of GDP) due to the pandemic in 2020, while operating expenses remained constant. - Most revenue losses were by SOEs in the transport and aviation industry: Tbilisi Transport Company (GEL 40 million), Georgian Railway (GEL 30 million), and United Airports of Georgia (GEL 47 million). - SOE loan liabilities are estimated at a 78 percent debt-to-asset ratio and are amplified by a high share of FX-denominated debt and on-lending practices. - A fiscal buffer is partially provided by the authorities’ commitment not to take over any SOE debt or provide equity injections until SOE reform is finalized. - Contingent liabilities from SOEs, stemming largely from PPA contracts such as ESCO’s guaranteed purchase agreements, could materialize if market prices available for imports into the region significantly fall below the guaranteed purchase price. - Under the baseline, fiscal costs associated with PPAs are estimated to peak at 0.17 percent of GDP in 2025 and amount to US$ 883 million over 2020-2043. - Under downside scenarios where market prices are lower by 10-30 percent, PPA costs could be 3.5-4.8 times larger, peaking at 0.4-0.6 percent of GDP in 2025. - Authorities’ mitigating measures include: establishing a new feed-in premium mechanism for new PPAs, a new PPP framework, and constraining activities of the Partnership Fund. ### Fiscal policy, reform priorities, and fiscal space - Priority reform areas: strengthen public financial management to optimize expenditures; improve efficiency of public investment management (PIM) including by standardizing project appraisal and selection; wide-scale SOE reform. - Enhance social safety nets to improve targeting and reduce fiscal costs associated with broader ad hoc approaches. - Medium-term capital spending target of 8 percent (authorities’ target) includes infrastructure projects: strategic highways, water, education, urban transport, logistics, communications, energy, and technology. - Public investment efficiency gap estimated at 15-20 percent in 2018 needs narrowing to meet investment goals. - There is limited room to cut current spending: primary current spending remains above pre-pandemic levels under baseline projections while capital spending is reduced. - Other current primary spending is compressed below pre-pandemic levels by 0.8 percent of GDP in the medium run. - Interest bill expected to fall in 2022 but then rise again as the share of domestic debt financing increases and the debt stock, while falling, remains higher than pre-pandemic levels. - To comply with the fiscal rule, the fiscal deficit needs to be reduced by around 4 percent of GDP in the next two years; providing a buffer and funding priority spending would require an even larger adjustment. ### Revenue mobilization and tax policy - Georgia’s tax system: simple flat tax, low tax burden, described as highly rigid, regressive, and subject to loopholes. - Georgia’s Economic Liberty Act allows temporary changes in tax rates for a maximum of three years but prevents new state taxes or increases in top tax rates (except excises) without a referendum. - Georgia’s 20 percent flat personal income tax (PIT) rate is identified as a disproportionately high burden for low-income earners. - Scope to increase tax revenue under the current system through improved tax compliance and revisiting tax expenditures (e.g., VAT exemptions and tax incentives) to broaden the tax base. - Small businesses with turnover below GEL 500,000 enjoy a 1 percent turnover tax compared to the 20 percent PIT rate. - Property tax rates are at less than 1 percent, rely on self-declared property values, and are linked to household income rather than wealth. - A broader medium-term revenue strategy could be considered based on a comprehensive tax policy review to raise additional revenue while avoiding undermining competitiveness and attending to distributional implications. ### Public investment and infrastructure agenda - Authorities’ infrastructure agenda includes: strategic highways, water supply, education, urban transport, expanding broadband networks, diversifying energy supply (from mainly hydro to include wind and solar), constructing power transmission lines, and tourism development including ski resorts. - Ongoing development projects mentioned: the Poti port and Anaklia deep-sea port infrastructure, modern logistic centers in Tbilisi and Kutaisi, a cargo terminal in Kutaisi international airport, the Baku-Tbilisi-Kars Railway, and construction and rehabilitation of roads such as the East-West highway connecting Tbilisi to Batumi. - Digital infrastructure expansion aims to grow the digital economy and increase competitiveness. ### External sector assessment — current account, reserves, and external sustainability - Georgia’s external position in 2020 was assessed as broadly in line with fundamentals and desirable policies, despite COVID-19 shocks. - The 2020 current account (CA) deficit is estimated at 12.5 percent of GDP, 7.0 percentage points higher than in 2019. - Tourism revenue fell by 83 percent (y-o-y) in 2020. - CA deficit projected to narrow to 10 percent of GDP in 2021 and gradually decline to 5.5 percent of GDP by 2026, with tourism revenue recovering by 111 percent in 2021 y-o-y (largely due to a low base in 2020) and expected to return to 2019 levels only in 2023. - Lari depreciation in 2020: 5.6 percent nominal and 7.4 percent real effective terms. - IMF EBA-lite CA approach: 2020 actual CA -12.5; COVID-19 adjustor +4.7; adjusted CA -7.9; CA Norm -6.9; CA Gap -1.0. - REER model results: CA Gap 1.9; REER undervaluation 5.1 percent. - Georgia’s NIIP stood at negative 156.8 percent of GDP in 2020; NIIP widened by 20.1 percent of GDP relative to end-2019. - FDI and loans account respectively for about 51.6 percent and 32.2 percent of total liabilities. - Higher loan disbursements increased by 17.4 percent of GDP; higher net FDI inflows increased by 4.5 percent of GDP. - An important contributor to external debt stock build-up in 2020 was an increase in the government’s concessional loans from IFIs (by around $1.0 billion); the private sector’s external debt remained virtually unchanged in nominal terms. - Financial account: estimated surplus at 6.1 percent of GDP in 2020, slightly higher than 2019 and higher than projected in the Seventh Review by 3.5 percentage points. - Net FDI inflows and net portfolio inflows were much lower than 2019 (by 2.2 and 3.5 percent of GDP y-o-y, respectively). - Net loan inflows were much higher (by 2.3 percent of GDP y-o-y), reflecting large inflows of donor financing. - Financial account surplus projected to gradually decrease to about 6 percent of GDP over the medium term (after a temporary increase in 2022). - Over the medium term, the bulk of Georgian external debt is expected to remain held by IFIs and related parties—mostly on concessional terms—and dominated by medium and long-term debt. *Prepared by IMF staff; figures, projections, and assessments as presented in the source chapter.* ### 8. Gross international reserves (GIR) reached 108 percent of the ARA metric at the end ### 8. Gross international reserves (GIR) reached 108 percent of the ARA metric at the end of 2020, and the end-2020 NIR target for the eighth EFF review was met with a comfortable margin ### GIR and NIR outcomes (2020) - Net international reserves (NIR) stood at $1,335 million (program exchange rate) by end-2020. - Gross international reserves (GIR) stood at $3,911 million (market exchange rate) by end-2020. - Both NIR and GIR were higher than projected at the time of the Seventh Review. - The higher-than-projected reserves were mainly driven by the lower-than-expected need for FX interventions by the NBG. - GIR reached 108 percent of the ARA metric at the end of 2020. - The end-2020 NIR target for the eighth EFF review was met with a comfortable margin. - Program and project loans/grants were moderately lower than projected. ### Outlook and 2021 projections - GIR in 2021 are expected to decrease relative to 2020. - Factors contributing to a 2021 decrease in GIR: - Protracted recovery in tourism in 2021. - Further FX intervention: the NBG has sold around US$ 273 million so far in 2021. - Continued donor financing and the SDR allocation are expected to support reserves but not fully offset the decline. - Staff project GIR coverage in 2021 of 99 percent of the ARA metric. ### Assessment of external position and vulnerabilities - Georgia’s external position in 2020 was assessed to be broadly in line with fundamentals and desired policy settings. - The assessment incorporated an additional cyclical adjustment accounting for the temporary impact of the pandemic on tourism and oil trade balance. - External vulnerabilities increased due to: - The protracted recovery in tourism. - A gradually narrowing current account (CA) deficit. - The large negative net international investment position (NIIP). - A build-up in external debt. - Pressures on reserves. - Policy implication: strong and prudent macroeconomic policies are needed to maintain and strengthen external sustainability over the medium term. ### Annex VI — Strengthening the Labor Market in Georgia: Stylized facts (selected) - Unemployment in Georgia has been persistently high and job creation slow. - 2014-15 accounted for 110,600 additional employed persons out of a total of 128,300 additional employed persons between 2010 and 2019. - Number of employed individuals declined by 12,600 between 2015 and 2019. - The COVID-19 pandemic led to a decline of 81,300 employed individuals between 2019 and 2021Q2. - GDP growth averaged 4.7 percent between 2011 and 2019. - Main drivers of growth 2011–2019: financial, insurance and real estate activities (FIREA) (0.9 percentage points total), construction (0.4 percentage points), and manufacturing (0.4 percentage points). - Between 2017 and 2019, growth averaged 4.9 percent, with contributions: FIREA 0.7 percentage points, wholesale and retail trade 0.7 percentage points, accommodation and food service activities 0.6 percentage points. - These industries accounted for almost half of GDP growth but only 20.5 percent of employment on average. - Trade contributed on average 0.8 p.p., and accommodation and food services 0.4 p.p., to the average annual growth in employment of 0.4 p.p. between 2017 and 2019. - Labor force participation rates have been declining; COVID-19 caused male participation to stabilize while female participation declined further. - Between 2019Q4 and 2021Q2: - Number of employed shrunk by 62,000 people. - About 90,000 people joined the ranks of the unemployed. - 27,000 joined the labor force. - Job losses roughly split between women and men: 33,000 and 30,000 people, respectively, between 2019Q4 and 2021Q2. - Women dropped out of the labor force (12,000 people) rather than become unemployed (21,000), while men entered the labor force (39,000) and continued to actively look for work (68,000). - With the decrease in the labor force in 2020, the unemployment rate rose by less than one percent to 18.5 percent as the pandemic hit. - In 2021Q2, compared to 2019, the unemployment rate increased by about 5 percentage points, reaching 22.1 percent. - Youth unemployment: in 2019 the share of people below 34 among the unemployed was 44.4 percent, decreasing to 43.9 percent in 2020. - In 2019, 26 percent of Georgian youth were NEET. - In 2020 around 63 percent of the unemployed were men; 66 percent of the unemployed lived in urban locations. - ILO composite measure of labor underutilization (LU4) for Georgia is 20.5 percent. - Informality: according to GEOSTAT 31 percent of the employed in 2020 were informally employed. According to ILO statistics, informality declined from 51 percent in 2019 to 38 percent in 2020. - Nearly 20 percent of the employed are in agriculture, which contributes only around 2 percent of GDP and only 0.1 percentage point to growth between 2017 and 2019. - Employment composition changed very little between 2017 and 2020. ### Annex VI — Policy considerations (selected) - Labor market flexibility: - Lack of labor market flexibility is unlikely to be a central issue for Georgia; hiring and redundancy are considered easy, and the labor tax wedge is low. - In 2019 the Pillar II pension system introduced an employer contribution of 2 percent of salary for pensions. - The Labor Code was amended in 2020 (EU accession roadmap) to offer more protection to the employed; changes include standards for working hours, leave hours and break time, remuneration for overtime, mediation rules, requirement for written contracts, and authorization for labor inspectors to inspect labor relations. - Education and skills: - Education reforms are a key element of addressing youth unemployment and school-to-work transition issues. - Government reforms include strengthening teacher qualification requirements and increasing teacher salaries while reducing headcount. - Efforts to strengthen vocational education are underway, supported by donors; example: a KfW-financed Center of Excellence for construction and logistics. - Reform implementation slowed due to COVID-19 but remains a government priority. - Active labor market policies (ALMPs): - ALMPs could help older unemployed cohorts (around 40 percent of the unemployed are between ages 35 and 54). - ALMP measures include improving search and matching (employment services), subsidizing jobs, and paying for training. - Evidence summary: Card et. al. (2015) — job search assistance relatively more successful for disadvantaged participants; training and private sector employment subsidies have larger effects for the long-term unemployed; public sector employment subsidies have small or negative effects. - Georgia delivers ALMPs via multiple agencies, notably the State Employment Promotion Agency, the Agricultural and Rural Development Agency, and the National Tourism Administration. - Recommendation: evaluate existing ALMP efforts for cost-effectiveness and scale up the most promising measures. - Sectoral constraints and policies: - Limited scope to boost employment in FIREA activities (high productivity, not labor intensive). - Growth in services (notably tourism-related) could be promising but depends on domestic and external demand. - Infrastructure development is important to facilitate tourism growth and provide services remotely (call centers, IT outsourcing). - Suggested measures: develop infrastructure, set up export promotion mechanisms, attract FDI. - Female labor force participation: - Measures to increase female participation include expanding availability and access to childcare (e.g., adding public kindergartens and simplifying access). - Remittances may reduce labor supply incentives; fiscal policy could address this by lowering income tax rates on low wages (e.g., earned income tax credit-like measures) as part of a medium-term reform package, given fiscal adjustment needs. - General objective: boost productivity (including in agriculture) to create higher paying jobs and make work more attractive than remittances or subsistence agriculture. *Source: IMF staff summary of Chapter/Annex content in 1geoea2021002.* ### 17. Dealing with the entrenched unemployment problem should help reverse the increase ### 17. Dealing with the entrenched unemployment problem should help reverse the increase ### Poverty, unemployment, and emigration - Poverty increased to 21.3 percent in 2020, undoing all poverty reduction since 2017. - Job destruction during the COVID-19 pandemic is a central driver of the 2020 rise in poverty. - Older people are somewhat shielded from the increase in poverty through state pensions; prime-age population lacks a developed safety net (except Targeted Social Assistance payments for the most vulnerable), making employment access crucial. - Policy implication: addressing entrenched unemployment is expected to help reverse the increases in poverty and emigration and reduce inequality. ### Fiscal policy and public debt projections - 2021 revised growth projection: upward from 4.3% to 7.7% for 2021. - 2021 deficit projection: 6.9% of GDP (down from 7.6% in the previous projection). - Government net debt for 2021: 50.3% of GDP. - Budget targets: - Return to a 3.0% of GDP deficit in 2023. - Government net debt target of 48.2% of GDP in 2023. - Longer-term objective: reduce public debt back to under 40% of GDP by 2030. - Fiscal strategy elements: - Fiscal consolidation over the next three years consistent with fiscal rules. - Growth-oriented tax policy, friendly tax administration, tax dispute reform, and capital market reform. - Planned reduction in the share of direct taxes in total tax burden and incentives for FDI to accelerate and diversify exports. - Administrative reform: full automatization of tax payment and return filing. ### Monetary policy, inflation, and exchange rate policy - NBG forecast for inflation in 2021: approximately 9%. - Core inflation (excluding food, energy, and tabaco) as of August: 6.8%; headline inflation as of August: 12.8%. - Recent monetary stance: contractionary policy to anchor inflation expectations despite transitory nature of recent inflation. - Drivers of inflationary pressure: - Rise in global oil and food prices. - Government utility bill subsidy program introduced in 2020 (initially reduced headline inflation end-2020). - Imported inflation influenced by prior Lari depreciation. - Significant improvements in aggregate demand since Q2 2021. - Exchange rate and FX interventions: - Georgia maintains floating de jure and de facto exchange arrangements. - NBG intervenes via foreign exchange auctions to accumulate reserves or smooth excessive volatility; interventions aim to limit frequency and volume to support price and financial stability objectives. - Recent appreciation of the exchange rate expected to help lower inflation. ### Financial sector resilience and risks - Financial sector judged resilient under adverse scenarios; buffers helped absorb the 2020–21 crisis. - June 2021 loan portfolio growth relative to March 2021: 12.6% (excluding exchange rate effects), driven by construction, agriculture, and energy sectors. - 2021 Q2 loan growth composition: - Annual growth rate of foreign currency-denominated loans: 1.3%. - Growth rate of loans in the domestic currency: 27.6%. - High dollarization remains a challenge and long-term priority to reduce. - Policy measure to encourage de-dollarization (effective July 6): minimum reserve requirements for foreign currency funds determined individually by each commercial bank according to deposit dollarization; reserve requirements reduced for banks with less than 70% deposit dollarization. - Supervisory enhancements: - Plan to formalize and enhance supervisory processes per NBG’s “Supervisory Strategy 2020-2022”. - Plans to communicate material supervisory findings regularly to banks’ supervisory boards. - macroprudential and monetary policy are key tools to achieve price and financial stability. ### Social protection and labor market policy - Insufficient safety nets for prime-age population; Targeted Social Assistance exists for the most vulnerable. - Government prioritizes educational reforms: - Focus on early and pre-school education; improvements in teachers’ professional training. - Vocational education reforms to align with European certification framework over next 5 years. - Higher education: develop academic programs based on international accreditation and improve inclusiveness for individuals with special needs. - Infrastructure and inclusion policies intended to support job creation and regional development: - Fiscal medium-term plan includes construction of a full net of highways within 10 years, and electricity and water projects to ensure nationwide supply. - Collaboration with World Bank on technological innovation, environmentally friendly industries and jobs. - National Broadband Development Strategy 2020–25 aims to connect up to 500,000 people in over 1,000 villages to high-speed internet. ### State-owned enterprises, governance, and structural reforms - Government plans to use SOE potential more efficiently by reforming public corporations in line with OECD principles. - Georgia completed a sectorization exercise of SOEs to improve transparency and accountability. - Plans to include all non-market SOEs in general government fiscal reporting for 2021 and to reform governance of public corporations in line with OECD principles. - Continued cooperation with international partners to finance green, digital, and inclusive development projects. ### IMF program engagement, technical assistance, and data/statistical issues - 36-month EFF approved April 12, 2017; arrangement extended by one year in 2020 and augmented by SDR 274 million (130 percent of quota) bringing total access to SDR 484 million (230 percent of quota). Last review completed April 9, 2021. - Authorities requested a new IMF-supported program with anticipated commencement in early 2022. - Technical assistance provided in fiscal, monetary/financial, legal, statistics, and training areas (specific TA topics listed in staff report). - Data adequacy: - General: data provision has some shortcomings but is broadly adequate for surveillance; scope to improve price, national accounts, and external sector statistics. - National accounts: since late 2019 follow SNA 2008 concepts; GEOSTAT publishing volume estimates of GDP by expenditure approach since 2015 (annual frequency covering 2010–20). - Price statistics: CPI scope limited to urban areas; owner-occupied housing not covered in CPI; residential property price index disseminated since mid-May 2020. - Government finance statistics: MOF advancing adoption of GFSM 2014 and IPSASs; work under way to expand coverage to non-market SOEs. - Monetary and financial statistics: NBG compiles data in line with MFSMCG and reports OFC data regularly since early 2017. - External sector statistics: improvements in FDI statistics and reconciliation between GEOSTAT and NBG; financial account and trade coverage enhancements supported by TA. - Data standards: Georgia subscribed to the SDDS on May 17, 2010; Data ROSC published March 2012. _Staff report excerpt: Georgia — Staff Report for the 2021 Article IV Consultation — Informational Annex (as of August 30, 2021)._ --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021002.pdf_