## 1geoea2022001

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---

### Mission and participants
- Mission: undertaken at the request of the Ministry of Finance of Georgia; remote mission during December 1 to December 16, 2021.
- IMF FAD mission team: Mr. Jason Harris (team leader), Mr. Tjeerd Tim, Mr. John Zohrab (FAD regional advisor), Mrs. Viera Karolova, and Mr. Jyoti Rahman.
- Ministry of Finance interlocutors: Mr. M. Gelashvili (Deputy Minister), Ms. E. Guntsadze (Deputy Minister), Mr. S. Gunia (Head of the Fiscal Risks Management Department FRMD), Mr. V. Chalapeikrishvili (Department of Macroeconomic Analysis and Fiscal Policy Projection), Mr. Skhirtladze (Public Debt and External Financing Department), and Ms. L. Pataraia (Treasury).
- Other institutional participants: Ms. M. Giorgobiani (Deputy Minister of Regional Development and Infrastructure), Ms. S. Tsurtsumia (Roads Department), Mr. N. Gagua (Deputy Governor, Bank of Georgia), Mr. V. Tsintsadze (Ministry of Economy and Sustainable Development), Ms. N. Tkhilava and Ms. M. Tskkhvarazde (Ministry of Environmental Protection and Agriculture), Mr. A. Aalanishvili (National Environmental Agency).
- External contributors and observers: World Bank representatives Ms. M. Dolidze, Ms. H. Thu Hang, Mr. E. Najdov, Mr. N. Narvind; Ms. N. Tevzadse (Caucasus Environmental NGO Network); EU Delegation to Georgia representatives; Mr Paul Matthews (UK Office of Budget Responsibility); Mr Mehdi Raissi (MCD resident representative for Armenia).
- Acknowledged support: Mr Shota Gunia, Mr. Selim Cakir (IMF Resident Representative), Mr John Kim, Ms. N. Jakhia and Ms. S. Shahnazar (interpretation).

### Purpose and activities
- Objectives:
  - update the public sector balance sheet (PSBS) for Georgia,
  - quantify climate change fiscal risks,
  - provide tools and analytical approaches to support inclusion of quantitative climate risk estimates in the 2022 Fiscal Risk Statement (FRS).
- Activities:
  - series of working sessions with MoF, MoESD and MoEPA staff introducing fiscal and climate change modelling approaches;
  - presentations on the UK approach and on “Long-Term Macroeconomic Effects of Climate Change: A Cross-country Analysis”.

### Executive summary — key findings
- PSBS position:
  - Net worth of public sector: 56 percent of GDP.
  - Net financial worth: minus 46 percent of GDP.
  - The pandemic caused roughly a 25 percent of GDP expansion of both sides of the balance sheet.
  - Pandemic-related deterioration in net financial worth: 10 percent of GDP.
  - Fiscal deficit in 2020: 9 percent of GDP.
- Balance sheet composition and methodological improvements:
  - Major portion of balance sheet composed of non-financial assets (infrastructure, land, minerals) with valuations less reliable; hence net financial worth considered the more reliable indicator.
  - Methodological improvements include sectorization of non-market SOEs into the general government, improved central government financial reporting, inclusion of the pension fund into the public sector, and planned revaluation of non-financial assets of budget organizations and LEPLs.
- SOEs and exposures:
  - SOEs underperformed in 2020 with increased losses and continued erosion of equity capital; aggregate operating balance around zero but currency losses and reliance on on-lending persist.
  - High foreign exchange exposure noted; Georgia among the highest exposures in measured countries.
- Climate change physical impacts and projections:
  - Average temperatures for Georgia have already risen half a degree.
  - IPCC projections for Georgia by 2100: between 1.4°C and 4.9°C under the Paris Agreement-scenario and the Business-As-Usual (BAU) scenario respectively.
  - Expected climate consequences: increased weather volatility, changes in precipitation patterns (increased flooding), more hot days (leading to droughts), glacial retreat (impacting hydropower generation).
- Fiscal impacts of climate change (quantitative estimates from adapted IMF methodologies):
  - Climate change could reduce GDP per capita by 13 percent by the end of the century, relative to baseline.
  - Climate change could increase public debt levels by 18 percent of GDP, relative to baseline.
  - With increased frequency and intensity of natural disasters considered, public debt could plausibly reach 111 percent of GDP by 2069 in the absence of policy changes.
  - In a more extreme scenario (higher temperatures and greater volatility), intertemporal net financial worth could be reduced by 35 percent of GDP.
  - Despite these impacts, these are described as large but manageable in the long run because baseline strong growth implies GDP is over four times as large in 2100 as today.
- Analytical tools used and next steps:
  - Methodology provided to MoF: link from rising temperatures to GDP growth based on recent IMF research; adaptation of long-term fiscal projection model to estimate climate pressures; use of IMF natural disaster fiscal stress test tool for floods and droughts.
  - Further refinements needed: tailoring assumptions and climate shocks to Georgian circumstances; better integration with MESD and MEPA; incorporation of climate adaptation effects; detailed review of contracts and project exposures (e.g., PPAs, SOEs) subject to force majeure and climate-related risks; creation of a risk register of public infrastructure against future climate scenarios; ensure new infrastructure designed for resilience.

### Recommendations — Public Sector Balance Sheet
- 1.1 Institutionalize the updating of the PSBS by including it as an annex to the annual FRS, starting in 2022.
  - Responsible: FRMD, 2022
- 1.2 Implement the SOE reform strategy in order to reduce fiscal risks and improve the returns on equity investments.
  - Responsible: MoF, ongoing
- 1.3 Ensure comprehensive coverage of non-financial assets in the central government consolidated financial statements.
  - Responsible: Treasury, 2022-23
- 1.4 Consider the options for revaluing non-financial assets, whether in the consolidated financial statements for central government or for the PSBS separately.
  - Responsible: Treasury, 2022-23
- 1.5 Include the Pension Fund’s assets and liabilities to contributors in future disclosures of the PSBS.
  - Responsible: FRMD, 2022

### Recommendations — Fiscal Risks from Climate Change
- 4.1 Use the long-term fiscal projection tool to refine the estimates of baseline and climate scenarios, further refining and tailoring the assumptions and climate shocks to Georgia.
  - Responsible: FRMD/MFU, 2022
- 4.2 Work with MESD and MEPA to better tailor the natural disaster shock to Georgian experiences; and match projected disaster scenarios.
  - Responsible: FRMD/MFU, 2022
- 4.3 Examine vulnerabilities of the government budget to climate change risks; including risks related to SOEs, current and future PPA contracts and other major long-term contracts and contingent liabilities.
  - Responsible: FRMD, 2022
- 4.4 Examine fiscal risks related to climate change transition risks.
  - Responsible: FRMD, 2022
- 4.5 Undertake a C-PIMA, which includes an assessment of if public infrastructure assets registers include climate change-relevant aspects such as an assessment of exposure to climate change risks.
  - Responsible: MoF, 2022

### A. The 2020 Public Sector Balance Sheet — headline figures
- Estimated consolidated public sector net worth: 56.1 percent of GDP in 2020.
- Total public sector assets: 160.1 percent of GDP.
- Total public sector liabilities: 104 percent of GDP.
- Main components (percent of GDP):
  - Non-Financial Assets: 102.3 percent of GDP.
  - Financial Assets: 57.8 percent of GDP, composed of:
    - Cash and deposits: 19.6 percent of GDP (including deposits of the General Government of 8.7 percent of GDP of which 2.9 percent of GDP held by the National Bank of Georgia (NBG); the NBG’s deposits of 8 percent of GDP, and deposits of the Pension Fund of 2.5 percent of GDP).
    - Debt securities held by the NBG for foreign exchange management: 19.6 percent of GDP.
    - Loans provided by the NBG to commercial banks under monetary policy instruments: 6.5 percent of GDP.
    - Other accounts receivable of the General Government: 6 percent of GDP.
- Liabilities breakdown (percent of GDP):
  - General government debt securities and loans: 62.5 percent of GDP.
  - Currency and deposits owed by the NBG: 26.1 percent of GDP.
  - Estimated pension liabilities of the pay-as-you-go scheme: 3.6 percent of GDP.
  - Pension liabilities of the cumulative pension scheme: 2.5 percent of GDP.
  - Other accounts payables of the General Government: 3.7 percent of GDP.
- Consolidation note: 27.5 percent of GDP of cross-holdings across public sector entities are consolidated/eliminated in the consolidated public sector column.

### B. Impact of the Pandemic (key quantified impacts)
- Assets and liabilities expanded by around 25 percent of GDP in 2020.
- Key drivers (percent of GDP where specified):
  - Automatic stabilizers: 2 percent of GDP decline in revenues relative to previously projected revenues.
  - Policy actions to counter the pandemic: expenditure actions 3.1 percent of GDP; revenue-side measures 0.7 percent of GDP.
  - General government fiscal deficit in 2020: 9 percent of GDP (financed through increased borrowing).
  - Continued infrastructure investment: fixed assets increased by 6 percent of GDP (elevated general government investment) plus 0.9 percent of GDP investment by public corporations.
  - Foreign exchange valuation changes from currency depreciation: Lari depreciated 14 percent against the US dollar and 25 percent against the Euro, resulting in a 9.9 percent of GDP increase in foreign debt and a 4.9 percent of GDP increase in central bank foreign exchange asset holdings.
- Changes in net worth and net financial worth:
  - Net financial worth declined by around 14 percent of GDP.
  - Net worth fell by only 1.4 percent of GDP.
  - Operating balance (revenue less current expense) was 1.4 percent of GDP in 2020.
- Favorable valuation/methodological changes improved net worth cumulatively by over 5 percent of GDP, including:
  - Subsoil/minerals valuation increase: 2.3 percent of GDP.
  - IPSAS-based central government financial statements impacts (depreciation, write-offs, volume changes): 3 percent of GDP.
  - Unexplained changes likely related to public corporations: 2.7 percent of GDP.

### C. Comparative position, vulnerabilities, and risks
- International position: Net worth of 56 percent of GDP places Georgia in the middle of countries in the IMF staff comparisons.
- Structural features:
  - No public banks.
  - Cumulative Pension Fund still small (2.5 percent of GDP).
  - General government liquidity exposure appears relatively comfortable.
- Areas of concern:
  - High exchange rate exposure: 2020 increase in public debt due to exchange rate depreciation was equivalent to 9.9 percent of GDP (breakdown: general government debt 7 percent of GDP; NBG debt 1.6 percent of GDP; SOEs excluding Marabda-Kartsakhi Railway 1.2 percent of GDP).
  - Resilience to another pandemic: General government debt rose from 40.4 percent of GDP to 60 percent of GDP due largely to the current pandemic; the 2021 Fiscal Risks Statement suggests debt could increase a further 20 percent in another pandemic in a medium lockdown scenario.
  - Deterioration in SOEs’ financial position: aggregate SOE loss in 2020 was equivalent to 0.9 percent of GDP.
  - Potential impairment of non-financial assets: notable impairments occurred in 2017 and 2018 for large SOEs; further impairments likely; climate change may cause substantial impairment.

### D. Evolution of the Balance Sheet (2012–2020)
- Balance sheet expansion: assets increased from 125.2 percent of GDP in 2012 to 160.1 percent of GDP in 2020.
- Asset composition changes (2012–2020):
  - Financial assets increased by 22.7 percent of GDP, with increases in currency and deposits and debt securities held by the NBG of 4.7 and 6.9 percent of GDP respectively, and central government other accounts receivable increase of 4.3 percent of GDP.
- Liabilities growth: public sector liabilities increased by 42.9 percent of GDP over nine years to reach 104 percent of GDP in 2020, mainly driven by government debt (+23.9 percent of GDP) and NBG deposits and debt securities (+9.8 and +5.6 percent of GDP respectively).
- Net worth trajectory:
  - Net worth declined from 64.1 percent of GDP in 2012 to 56.1 percent of GDP in 2020.
  - Net financial worth decreased by 8 percent of GDP.
- Drivers of net worth evolution (2012–2020):
  - Cumulative fiscal deficits for government: GEL 7.4 billion (financed through borrowing).
  - Public corporations cumulative deficits: GEL 2.8 billion; equity injections GEL 1.3 billion.
  - Capital expenditure financed from deficits: government cumulative investment GEL 16.8 billion; public corporations GEL 2.9 billion.
  - Revaluation of mineral resources: market price increases around GEL 5.2 billion over nine years.
  - Currency depreciation: Lari depreciated by 97 percent from 1.66 GEL per dollar in 2012 to 3.28 in 2020.

### E. Non-Financial Public Corporations (SOEs) — performance and on-lending
- SOE performance:
  - SOE operating balances on a GFSM 2014 basis were close to zero in recent years.
  - Foreign exchange losses increased SOE debt and decreased SOE equity.
  - No equity injections since 2018 except transfers of fixed assets into charter capital; equity injections increased equity capital by 0.2 percent of GDP in 2019.
- Outstanding on-lending portfolio (selected entries, GEL million):
  - United Water Supply Company: Outstanding on-lent value 603; Operating balance -11; Total revenue 72; Ratio of outstanding loan to revenue 8.4.
  - Georgian State Electrosystem (GSE): Outstanding on-lent value 508; Operating balance 183; Total revenue 380; Ratio 1.3.
  - Engurhesi: Outstanding on-lent value 264; Operating balance -29; Total revenue 27; Ratio 9.7.
  - Energotrans: Outstanding on-lent value 223; Operating balance 8; Total revenue 33; Ratio 6.9.
- On-lending portfolio characteristics and issues:
  - Value as at end-2020: 5.4 percent of GDP (slightly lower than 5.7 percent of GDP in 2018).
  - Currency composition: 98.7 percent denominated in foreign currency (up from 97 percent in 2018).
  - Risks: on-loans large relative to SOE borrowings, priced at government borrowing cost (implicit subsidy), and increase SOE foreign exchange exposure.

### Pension Fund and sectorization of SOEs
- Pension Fund:
  - Established January 2019.
  - Accumulated assets equivalent to 2.5 percent of GDP as at end-2020.
  - Assets projected to rise to over 60 percent of GDP by 2050, with liabilities of equal value.
  - GFSM 2014 treatment: the pension fund’s assets and corresponding liabilities to contributors are included in the PSBS.
- Sectorization of SOEs:
  - Ministry of Finance sectorization (2019): examined 241 SOEs and identified 196 non-market entities.
  - Follow-up identified additional 116 non-market enterprises controlled by local governments.
  - Out of 357 SOEs, 312 appeared to be non-market producers to be classified in the general government sector.
  - Fiscal impact estimates:
    - Estimated impact on 2019 general government: deficit -0.6 percent of GDP; consolidated debt +1.1 percent of GDP.
    - 2020 estimates: revenue of non-market SOEs 2 percent of GDP (subsidies 0.5 percent of GDP); expenditure 3.6 percent of GDP; resulting deficit -1.5 percent of GDP; value of non-financial assets 4.2 percent of GDP; financial assets 4.6 percent of GDP; total assets 8.8 percent of GDP; debt liabilities 3.1 percent of GDP (2.3 percent consolidated).

### Climate change — observed and projected physical impacts
- Observed temperature:
  - Georgia’s average temperature is already 0.47°C above the long-term average.
- Projected temperature change:
  - By the 2090s, Georgia’s average temperature projected to increase by between 1.4°C and 4.9°C compared to the 1986−2005 baseline under RCP2.6 and RCP8.5 respectively.
- Projected changes in frost and summer days (selected projections):
  - Frost days (<0°C) projected % changes for RCP scenarios (examples): RCP2.6 -8% (2030), -13% (2100); RCP8.5 -10% (2030), -44% (2100).
  - Summer days (>25°C) projected % changes for RCP scenarios (examples): RCP2.6 27% (2030), 39% (2100); RCP8.5 29% (2030), 129% (2100).
- Main adverse impacts anticipated: droughts, flooding, and landslides.
- Key vulnerabilities:
  - Hydropower dependency: 78 percent of domestically generated electricity in 2015 came from hydropower; reduced river flow during summer could reduce power generation during peak demand, increasing energy imports and negatively affecting GDP and the balance of payments.
- Documented disaster events (selected):
  - 2015 Tbilisi flood: USD 24.3 million physical damage; USD 4.37 million financial losses; USD 118 million for recovery.
  - EM-DAT aggregates (1991–2020): Flood total affected 166,222; Flood total damage (USD, million) 82,753. Drought 2000 total affected 696,000; total damage (USD, million) 300,594. Storm 2001-2013 total affected 8,668; total damage (USD, million) 102,580.
- International indices:
  - ND-GAIN Index: Georgia ranks 38th least vulnerable out of 181 countries; vulnerability score 68th least vulnerable and readiness score 33rd most ready.
  - INFORM Risk Index: Georgia ranks 91st out of 191 countries (medium risk).

### NDC commitments, climate governance, and fiscal practice
- NDC targets:
  - Unconditional objective: reduce GHG emissions by 35 percent below 1990 levels by 2030 excluding LUCF, which is 29.29 Mt CO2eq.
  - Intended reduction: 50−57 percent below 1990 levels excluding LUCF, which is 19.35−22.50 Mt CO2eq.
- Institutional responsibilities:
  - MEPA and MESD jointly coordinate climate change policy.
  - Climate Change Council (CCC) established as advisory body, chaired by the Minister of Environmental Protection and Agriculture.
- Adaptation planning:
  - Commitment to develop a National Adaptation Plan (NAP); current status: no comprehensive national climate adaptation plan published; only an agriculture sector adaptation plan exists.
- Fiscal risk practice:
  - Government advanced fiscal risk analysis over past 6 years; December 2021 FRS included a qualitative assessment of climate fiscal risks.
  - Government committed to producing a quantified assessment in FRS 2022.

### Nature and transmission of climate-related fiscal risks
- Economic channels:
  - Supply-side: impacts on productivity, land, capital, labor (e.g., landslides, infrastructure degradation).
  - Demand-side: consumption, investment, and trade impacts; possible persistent effects via reallocation to adaptation.
- Public finance transmission:
  - Direct impacts: increased public spending for repair/replacement, social transfers, emergency spending; materialization of explicit contingent liabilities.
  - Indirect impacts: reduced tax revenue, increased health care spending, implicit contingent liabilities (support to distressed institutions), pressure on sovereign capacity.

### Approaches to quantifying climate fiscal risks and scenarios
- Methods:
  - Identify transmission channels, apply economic modeling, use sensitivity analysis and alternative scenarios.
  - Quantify fiscal impact of natural disasters using historical and projected vulnerabilities.
  - Analyze discrete fiscal risks (e.g., hydropower capacity loss, contingent liabilities).
- Recommended climate scenarios:
  - Paris Agreement scenario (RCP2.6): example for Georgia — 1.6-degree Celsius rise in 2069 above the 50-year average to 2020.
  - Business-as-Usual (BAU) scenario (RCP8.5): example for Georgia — 3.65 Celsius degree rise in 2069 above the 50-year average to 2020.
  - BAU with climate volatility (volatile scenario): higher volatility and increased extreme weather frequency in addition to BAU warming.
- Stylized fiscal outcomes (relative to baseline):
  - Under BAU (RCP8.5): public debt likely to rise by around 8 percent of GDP relative to baseline.
  - Under volatile scenario: public debt increases 18 percent of GDP relative to baseline.
  - Under Paris (RCP2.6): debt largely matches the baseline scenario.
  - Additional disaster layering: a series of floods and droughts layered over the volatile scenario adds an additional 15 percent of GDP to public debt by 2069.
- Contextual figure:
  - In 2022, the primary balance is expected to be -2.3 per cent of GDP.

### Analytical tools, baseline assumptions, and limitations
- Tools used:
  - Long-Term Module: captures gradual environmental transformation fiscal pressures.
  - Disaster Module (Natural Disaster Shock Module for the Fiscal Stress Test): simulates supply side disaster shocks (flood, drought, earthquake, storms).
- Baseline assumptions and projections:
  - Baseline real GDP growth: around 3−3¾ percent a year into the late 2060s.
  - Employment projected to decline from 2027 in line with UN medium variant population projections.
  - Labor productivity (GDP per persons employed) assumed to grow by 4 percent a year from 2027.
  - Inflation assumed at 3 percent.
  - Revenues grow in line with nominal GDP from 2027; expenditures other than health and pensions grow in line with demographics.
  - Pension and health spending projected to increase by 2.4 percent of GDP (demographic-driven).
  - Projected baseline outcomes for 2069: Primary balance: -3.0 percent of GDP; Debt-to-GDP ratio: 78.1 percent of GDP.
- Results nature:
  - Stylized results based on cross-country empirical evidence; significant scope for refinement and improvement.
  - Further quantitative analysis planned for FRS 2022.

### Long-term macro-fiscal impacts (quantified projections)
- Productivity and GDP impacts:
  - Under RCP8.5 with greater climate volatility, labor productivity could slow by 0.09 to 0.18 of a percentage point a year.
  - This slowdown could reduce GDP by over 8 percent relative to the baseline in 2069.
  - By 2100:
    - GDP per capita projected to be reduced by 7 percent under RCP8.5.
    - GDP per capita projected to be reduced by over 13 percent under the high volatility scenario.
- Fiscal effects:
  - Primary deficits increase by ½ and 1¼ percent of GDP relative to baseline under BAU and volatile scenarios, respectively.
  - Debt-to-GDP ratios are 8 and 18 percent of GDP larger by 2069 under BAU and volatile scenarios, respectively.
  - The volatile scenario reduces the fiscal envelope by around 35 percent of GDP over the period.
- Intertemporal Net Financial Worth (INFW):
  - Baseline INFW: -240 percent of 2020 GDP under current policy settings.
  - Volatile scenario: INFW over 35 percent of 2020 GDP lower than baseline.
  - Under baseline INFW is estimated at -240 percent of 2020 GDP; lower revenues under the two high temperature scenarios would see INFW decline to 253 and 275 percent of 2020 GDP (as presented in source).
  - Note: assuming spending completely rigid likely overstates impacts; alternatives include focusing on discounted future revenue flows or introducing spending flexibility.

### Natural disasters — Disaster Module scenarios and fiscal stress testing
- Disaster Module features:
  - Simulates sectoral impacts, feeds into tax/expenditure/deficit/financing/debt changes, and generates macro and public finance outcomes.
  - Partial equilibrium framework with exogenous external and monetary sectors.
  - Allows four natural disaster modes and adjusts for severity and preparedness.
- Simulated Georgia scenarios:
  - Severe floods in 2028 and 2048.
  - Severe droughts in 2038 and 2058.
  - Stylized fiscal effects layered on the volatile scenario and scaled by degree of temperature rise over time.
- Cross-country evidence:
  - Droughts have a larger fiscal impact than floods in the ND FST due to weaker recoveries after droughts.
- Fiscal projections under climate scenarios with natural disasters (selected statistics):
  - The primary deficit peaks during the 2058 drought at 5 percent of GDP.
  - Public debt exceeds 110 percent of GDP in the scenario with more frequent and intense natural disasters.
  - Table scenario summary (per cent of GDP format presented in source): Baseline-3.1-2.50.6; BAU-3.5-2.70.8; Volatile-4.2-2.91.3; Volatile with disasters-4.9-3.41.5 (PB, PB*, Task format as in source).
- Suggested data and modelling refinements:
  - Update input data (October 2021 WEO used) and incorporate UN population projections (March 2022).
  - Calibrate Disaster Module to Georgia’s historical data and coordinate with MESD, MEPA, EPA.
  - Disaggregate productivity and capital effects; introduce physical capital stock accumulation identity; broaden labor input to include hours worked.
  - Incorporate external and monetary shocks and analyze labor supply, migration, and expenditure effects.
  - Carry out C-PIMA and integrate climate risk ratings into infrastructure registers.

### Discrete risks, contractual vulnerabilities, transition risks, and adaptation
- Discrete risks to analyze in FRS 2022:
  - Climate-change risks to public infrastructure; supplement infrastructure register with climate risk rating.
  - PPA contracts, other long-term contracts, and contingent liabilities for climate-change vulnerabilities (force majeure shifting risks to government).
  - Work with the National Bank of Georgia to integrate climate-related risks into financial supervisory expectations (scenario analysis and stress tests).
  - Analyze transition risks from mitigation policies, technology, and market sentiment on government, SOEs, and financial institutions.
- Adaptation measures and C-PIMA:
  - Model can accommodate an adaptation parameter to simulate effects of adaptive investment over 30 years.
  - C-PIMA assesses five PIM practices (C1–C5) from a climate perspective and provides a diagnostic and roadmap for reform priorities.
  - Recommendation: undertake a C-PIMA and extend model to analyze climate change adaptation measures (MoF, 2022–2023).

*Source: IMF mission report — PREFACE and EXECUTIVE SUMMARY and chapter content (1geoea2022001).*

### PREFACE ___________________________________________________________________________________________________ 6

### 1geoea2022001 - PREFACE

### Mission and participants
- Mission undertaken at the request of the Ministry of Finance of Georgia; remote mission during December 1 to December 16, 2021.
- IMF FAD mission team: Mr. Jason Harris (team leader), Mr. Tjeerd Tim, Mr. John Zohrab (FAD regional advisor), Mrs. Viera Karolova, and Mr. Jyoti Rahman.
- Ministry of Finance interlocutors: Mr. M. Gelashvili (Deputy Minister), Ms. E. Guntsadze (Deputy Minister), Mr. S. Gunia (Head of the Fiscal Risks Management Department FRMD), Mr. V. Chalapeikrishvili (Department of Macroeconomic Analysis and Fiscal Policy Projection), Mr. Skhirtladze (Public Debt and External Financing Department), and Ms. L. Pataraia (Treasury).
- Other institutional participants: Ms. M. Giorgobiani (Deputy Minister of Regional Development and Infrastructure), Ms. S. Tsurtsumia (Roads Department), Mr. N. Gagua (Deputy Governor, Bank of Georgia), Mr. V. Tsintsadze (Ministry of Economy and Sustainable Development), Ms. N. Tkhilava and Ms. M. Tskkhvarazde (Ministry of Environmental Protection and Agriculture), Mr. A. Aalanishvili (National Environmental Agency).
- External contributors and observers: World Bank representatives Ms. M. Dolidze, Ms. H. Thu Hang, Mr. E. Najdov, Mr. N. Narvind; Ms. N. Tevzadse (Caucasus Environmental NGO Network); EU Delegation to Georgia representatives; Mr Paul Matthews (UK Office of Budget Responsibility); Mr Mehdi Raissi (MCD resident representative for Armenia).
- Acknowledged support: Mr Shota Gunia, Mr. Selim Cakir (IMF Resident Representative), Mr John Kim, Ms. N. Jakhia and Ms. S. Shahnazar (interpretation).

### Purpose and activities
- Objectives: update the public sector balance sheet (PSBS) for Georgia, quantify climate change fiscal risks, and provide tools and analytical approaches to support inclusion of quantitative climate risk estimates in the 2022 Fiscal Risk Statement (FRS).
- Activities: series of working sessions with MoF, MoESD and MoEPA staff introducing fiscal and climate change modelling approaches; presentations on the UK approach and on “Long-Term Macroeconomic Effects of Climate Change: A Cross-country Analysis”.

---

### Executive summary — key findings
- PSBS position:
  - Net worth of public sector: 56 percent of GDP.
  - Net financial worth: minus 46 percent of GDP.
  - The pandemic caused roughly a 25 percent of GDP expansion of both sides of the balance sheet.
  - Pandemic-related deterioration in net financial worth: 10 percent of GDP.
  - Fiscal deficit in 2020: 9 percent of GDP.
- Balance sheet composition and methodological improvements:
  - Major portion of balance sheet composed of non-financial assets (infrastructure, land, minerals) with valuations less reliable; hence net financial worth considered the more reliable indicator.
  - Methodological improvements include sectorization of non-market SOEs into the general government, improved central government financial reporting, inclusion of the pension fund into the public sector, and planned revaluation of non-financial assets of budget organizations and LEPLs.
- SOEs and exposures:
  - SOEs underperformed in 2020 with increased losses and continued erosion of equity capital; aggregate operating balance around zero but currency losses and reliance on on-lending persist.
  - High foreign exchange exposure noted; Georgia among the highest exposures in measured countries.
- Climate change physical impacts and projections:
  - Average temperatures for Georgia have already risen half a degree.
  - IPCC projections for Georgia by 2100: between 1.4°C and 4.9°C under the Paris Agreement-scenario and the Business-As-Usual (BAU) scenario respectively.
  - Expected climate consequences: increased weather volatility, changes in precipitation patterns (increased flooding), more hot days (leading to droughts), glacial retreat (impacting hydropower generation).
- Fiscal impacts of climate change (quantitative estimates from adapted IMF methodologies):
  - Climate change could reduce GDP per capita by 13 percent by the end of the century, relative to baseline.
  - Climate change could increase public debt levels by 18 percent of GDP, relative to baseline.
  - With increased frequency and intensity of natural disasters considered, public debt could plausibly reach 111 percent of GDP by 2069 in the absence of policy changes.
  - In a more extreme scenario (higher temperatures and greater volatility), intertemporal net financial worth could be reduced by 35 percent of GDP.
  - Despite these impacts, these are described as large but manageable in the long run because baseline strong growth implies GDP is over four times as large in 2100 as today.
- Analytical tools used and next steps:
  - Methodology provided to MoF: link from rising temperatures to GDP growth based on recent IMF research; adaptation of long-term fiscal projection model to estimate climate pressures; use of IMF natural disaster fiscal stress test tool for floods and droughts.
  - Further refinements needed: tailoring assumptions and climate shocks to Georgian circumstances; better integration with MESD and MEPA; incorporation of climate adaptation effects; detailed review of contracts and project exposures (e.g., PPAs, SOEs) subject to force majeure and climate-related risks; creation of a risk register of public infrastructure against future climate scenarios; ensure new infrastructure designed for resilience.

---

### Recommendations — Public Sector Balance Sheet
- 1.1 Institutionalize the updating of the PSBS by including it as an annex to the annual FRS, starting in 2022.
  - Responsible: FRMD, 2022
- 1.2 Implement the SOE reform strategy in order to reduce fiscal risks and improve the returns on equity investments.
  - Responsible: MoF, ongoing
- 1.3 Ensure comprehensive coverage of non-financial assets in the central government consolidated financial statements.
  - Responsible: Treasury, 2022-23
- 1.4 Consider the options for revaluing non-financial assets, whether in the consolidated financial statements for central government or for the PSBS separately.
  - Responsible: Treasury, 2022-23
- 1.5 Include the Pension Fund’s assets and liabilities to contributors in future disclosures of the PSBS.
  - Responsible: FRMD, 2022

### Recommendations — Fiscal Risks from Climate Change
- 4.1 Use the long-term fiscal projection tool to refine the estimates of baseline and climate scenarios, further refining and tailoring the assumptions and climate shocks to Georgia.
  - Responsible: FRMD/MFU, 2022
- 4.2 Work with MESD and MEPA to better tailor the natural disaster shock to Georgian experiences; and match projected disaster scenarios.
  - Responsible: FRMD/MFU, 2022
- 4.3 Examine vulnerabilities of the government budget to climate change risks; including risks related to SOEs, current and future PPA contracts and other major long-term contracts and contingent liabilities.
  - Responsible: FRMD, 2022
- 4.4 Examine fiscal risks related to climate change transition risks.
  - Responsible: FRMD, 2022
- 4.5 Undertake a C-PIMA, which includes an assessment of if public infrastructure assets registers include climate change-relevant aspects such as an assessment of exposure to climate change risks.
  - Responsible: MoF, 2022

---

### Public Sector Balance Sheet — conceptual note
- PSBSs consolidate the entirety of what the public sector owns and owes to provide a comprehensive picture of public wealth, complementing fiscal aggregates such as government debt and deficits.
- Purpose: highlight opportunities to increase revenues, reduce risks, and improve fiscal policy making through integration of accumulated assets and liabilities under government control.

*Source: IMF mission report — PREFACE and EXECUTIVE SUMMARY (1geoea2022001).*

### 2.      This report updates, refines and extends Georgia’s PSBS, covering the period 2012

### 1geoea2022001 - 2.      This report updates, refines and extends Georgia’s PSBS, covering the period 2012 

### A. The 2020 Public Sector Balance Sheet
- Estimated consolidated public sector net worth: 56.1 percent of GDP in 2020.
- Total public sector assets: 160.1 percent of GDP.
- Total public sector liabilities: 104 percent of GDP.
- Main components (percent of GDP):
  - Non-Financial Assets: 102.3 percent of GDP (includes infrastructure, buildings, public holdings of land and mineral resources, fixed assets and equipment of SOEs such as railways, powerplants and the water network).
  - Financial Assets: 57.8 percent of GDP, composed of:
    - Cash and deposits: 19.6 percent of GDP (including deposits of the General Government of 8.7 percent of GDP of which 2.9 percent of GDP held by the National Bank of Georgia (NBG); the NBG’s deposits of 8 percent of GDP, and deposits of the Pension Fund of 2.5 percent of GDP).
    - Debt securities held by the NBG for foreign exchange management: 19.6 percent of GDP.
    - Loans provided by the NBG to commercial banks under monetary policy instruments: 6.5 percent of GDP.
    - Other accounts receivable of the General Government: 6 percent of GDP.
- Liabilities breakdown (percent of GDP):
  - General government debt securities and loans: 62.5 percent of GDP.
  - Currency and deposits owed by the NBG: 26.1 percent of GDP.
  - Estimated pension liabilities of the pay-as-you-go scheme: 3.6 percent of GDP.
  - Pension liabilities of the cumulative pension scheme: 2.5 percent of GDP.
  - Other accounts payables of the General Government: 3.7 percent of GDP (mainly payables to employees, accrued interest, and trade credits to suppliers).
- Consolidation note: 27.5 percent of GDP of cross-holdings across public sector entities are consolidated/eliminated in the consolidated public sector column.

### B. Impact of the Pandemic
- Assets and liabilities expanded by around 25 percent of GDP in 2020.
- Key drivers (percent of GDP where specified):
  - Automatic stabilizers: 2 percent of GDP decline in revenues relative to previously projected revenues.
  - Policy actions to counter the pandemic: expenditure actions 3.1 percent of GDP; revenue-side measures 0.7 percent of GDP.
  - General government fiscal deficit in 2020: 9 percent of GDP (financed through increased borrowing).
  - Precautionary liquidity increases: borrowing exceeded deficit financing needs to build cash deposits by central government and public corporations.
  - Continued infrastructure investment: fixed assets increased by 6 percent of GDP (elevated general government investment) plus 0.9 percent of GDP investment by public corporations.
  - Foreign exchange valuation changes from currency depreciation: Lari depreciated 14 percent against the US dollar and 25 percent against the Euro, resulting in a 9.9 percent of GDP increase in foreign debt and a 4.9 percent of GDP increase in central bank foreign exchange asset holdings.
- Changes in net worth and net financial worth:
  - Net financial worth declined by around 14 percent of GDP.
  - Net worth fell by only 1.4 percent of GDP.
  - Operating balance (revenue less current expense) was 1.4 percent of GDP in 2020.
- Favorable valuation/methodological changes improved net worth cumulatively by over 5 percent of GDP, including:
  - Subsoil/minerals valuation increase: 2.3 percent of GDP.
  - IPSAS-based central government financial statements impacts (depreciation, write-offs, volume changes): 3 percent of GDP.
  - Unexplained changes likely related to public corporations: 2.7 percent of GDP.

### C. State of Georgia’s Public Sector Balance Sheet (comparative and risk observations)
- International position: Net worth of 56 percent of GDP places Georgia in the middle of countries in the IMF staff comparisons.
- Structural features:
  - No public banks.
  - Cumulative Pension Fund still small (2.5 percent of GDP).
  - General government liquidity exposure appears relatively comfortable.
- Areas of concern:
  - High exchange rate exposure: 2020 increase in public debt due to exchange rate depreciation was equivalent to 9.9 percent of GDP (breakdown: general government debt 7 percent of GDP; NBG debt 1.6 percent of GDP; SOEs excluding Marabda-Kartsakhi Railway 1.2 percent of GDP).
  - Resilience to another pandemic: General government debt rose from 40.4 percent of GDP to 60 percent of GDP due largely to the current pandemic; the 2021 Fiscal Risks Statement suggests debt could increase a further 20 percent in another pandemic in a medium lockdown scenario.
  - Deterioration in SOEs’ financial position: aggregate SOE loss in 2020 was equivalent to 0.9 percent of GDP (per the Fiscal Risks Statement, based on the income statement). Major SOEs remain under-capitalized and may require restructuring via debt write-offs or equity injections.
  - Potential impairment of non-financial assets: notable impairments occurred in 2017 and 2018 for large SOEs; further impairments likely given past investment returns and SOEs’ poor financial performance; climate change may cause substantial impairment; valuations of non-financial assets in the PSBS could be optimistic, though future upward revaluations could offset impairments.

### D. Evolution of the Balance Sheet (2012–2020)
- Balance sheet expansion: assets increased from 125.2 percent of GDP in 2012 to 160.1 percent of GDP in 2020.
- Asset composition changes (2012–2020):
  - Financial assets increased by 22.7 percent of GDP, particularly currency and deposits and debt securities held by the NBG (increases of 4.7 and 6.9 percent of GDP respectively), and central government other accounts receivable (increase of 4.3 percent of GDP).
  - A slight decrease in assets in 2019 due to IPSAS methodological changes and GDP growth denominator effects.
- Liabilities growth: public sector liabilities increased by 42.9 percent of GDP over nine years to reach 104 percent of GDP in 2020, mainly driven by government debt (+23.9 percent of GDP) and NBG deposits and debt securities (+9.8 and +5.6 percent of GDP respectively).
- Net worth trajectory:
  - Net worth declined from 64.1 percent of GDP in 2012 to 56.1 percent of GDP in 2020.
  - Net financial worth decreased by 8 percent of GDP, mainly from the large increase in general government debt and an increase in SOE debt.
- Drivers of net worth evolution (2012–2020):
  - Cumulative fiscal deficits for government: GEL 7.4 billion (financed through borrowing).
  - Public corporations cumulative deficits: GEL 2.8 billion, financed through borrowing or equity injections (GEL 1.3 billion).
  - Capital expenditure financed from deficits: government cumulative investment GEL 16.8 billion; public corporations GEL 2.9 billion.
  - Revaluation of non-financial assets: market price increases of mineral resources by around GEL 5.2 billion over nine years.
  - Asset depreciation and impairments: noticeable impairments in 2017 and 2018 (GSE, Georgia Railway, Energotrans).
  - Currency depreciation: Lari depreciated by 97 percent from 1.66 GEL per dollar in 2012 to 3.28 in 2020, increasing public sector debt (around 80 percent of government debt in foreign currency) and decreasing net worth; NBG holding gains offset about half of revaluation losses.

### E. Non-Financial Public Corporations (SOEs)
- SOE performance and equity:
  - SOE operating balances on a GFSM 2014 basis were close to zero in recent years.
  - Foreign exchange losses increased SOE debt and decreased SOE equity.
  - No equity injections occurred since 2018 except transfers of fixed assets into charter capital in some SOEs; equity injections increased equity capital by 0.2 percent of GDP in 2019.
  - Unexplained residuals may reflect unrecorded transfers of non-financial assets from central and local governments to SOEs.
- Outstanding on-lending portfolio (table summary - key entries):
  - United Water Supply Company: Outstanding on-lent value 603 (GEL m); Operating balance -11; Total revenue 72; Ratio of outstanding loan to revenue 8.4.
  - Georgian State Electrosystem (GSE): Outstanding on-lent value 508 (GEL m); Operating balance 183; Total revenue 380; Ratio 1.3.
  - Engurhesi: Outstanding on-lent value 264 (GEL m); Operating balance -29; Total revenue 27; Ratio 9.7.
  - Energotrans: Outstanding on-lent value 223 (GEL m); Operating balance 8; Total revenue 33; Ratio 6.9.
- On-lending portfolio characteristics and issues:
  - Value as at end-2020: 5.4 percent of GDP (slightly lower than 5.7 percent of GDP in 2018).
  - Currency composition: 98.7 percent denominated in foreign currency (up from 97 percent in 2018).
  - Risks raised:
    - Large on-loans relative to SOE borrowings (notably GSE, Energotrans, Engurhesi, United Water Supply Company) weaken financial discipline and incentives for efficient investment and restructuring.
    - On-loans priced at government borrowing cost with no margin create an implicit subsidy and weaken incentives for SOE financial performance.
    - On-loans increase SOE foreign exchange exposure; several major SOEs also have foreign currency borrowings from private sources and significant foreign currency revenue/expenses.

*Source: Government Finance Statistics, Financial Statements (central government, National Bank of Georgia, Pension Fund), MoF’s data on SOEs, and IMF Staff Estimates.*

### 14.      The pension fund will accumulate substantial assets which, according  to GFSM

### 14.      The pension fund will accumulate substantial assets which, according  to GFSM

### Pension Fund and Public Sector Balance Sheet (PSBS)
- The pension fund was established in January 2019.
- It has already accumulated assets equivalent to 2.5 percent of GDP as at end-2020.
- Assets are projected to rise to over 60 percent of GDP by 2050, with liabilities of equal value.
- GFSM 2014 treatment: the pension fund’s assets and the corresponding liabilities to contributors are included in the PSBS.
- The pension scheme is a defined contribution scheme that is largely mandatory for employed persons in Georgia. The state provides an income-related supplement to the employer and employee contributions. The viability of the scheme will depend, in particular, on the extent to which the returns on the investment of the contributions will generate sufficient retirement income.
- Legislative and institutional safeguards: the legislation and the LEPL pension agency provide protections for contributors (against political influence on investment decisions) and for the Government (against being asked to bail out contributors). Nevertheless, GFSM 2014 treatment notes risks exist because the pension fund is substantially controlled by the Government.
- Recommendation captured elsewhere in the chapter: 1.5 Include the Pension Fund’s assets and liabilities to contributors in future disclosures of the PSBS.

### Sectorization of State-Owned Enterprises (SOEs)
- Ministry of Finance sectorization performed in 2019 examined 241 SOEs and identified 196 entities operating on a non-market basis.
- Follow-up work identified an additional 116 non-market enterprises controlled by local governments for which data were not available during the mission.
- Out of 357 SOEs in Georgia, 312 enterprises appeared to be non-market producers to be classified in the general government sector.
- Georgia became the first country in Central Asia and Eastern Europe to carry out such a comprehensive sectorization of SOEs.

Findings on fiscal impact (2019 and 2020)
- IMF technical assistance used to estimate impact of reclassified SOEs on general government.
- Estimated impact on 2019 general government: deficit -0.6 percent of GDP; consolidated debt +1.1 percent of GDP.
- 2020 estimates (based on aggregated balance sheet and income statement for 2020; limited data may cause imprecision):
  - Revenue of non-market SOEs: 2 percent of GDP (of which government’s subsidies 0.5 percent of GDP).
  - Expenditure of non-market SOEs: 3.6 percent of GDP.
  - Resulting deficit (net borrowing) for 2020: -1.5 percent of GDP.
  - Value of stocks of non-financial assets: 4.2 percent of GDP.
  - Financial assets: 4.6 percent of GDP.
  - Total assets: 8.8 percent of GDP.
  - Debt liabilities: 3.1 percent of GDP (2.3 percent of GDP on a consolidated basis).
- Sectorization conclusion: inclusion of non-market SOEs in the general government sector does not change public sector indicators but corrects the classification between general government (non-market) and public corporations (profit-oriented).

Box 1: Significance of Sectorization (summary points)
- Supports accurate estimates of the size of the general government sector for fiscal policy and limits under Georgia’s fiscal rules.
- Underpins reform of public corporations (stage one of SOE reform focuses on commercial SOEs operating at arm’s length).
- Provides sound basis for future reform of non-market SOEs.

### Financial Reporting and Non-Financial Asset Valuation
- Significant improvements introduced in financial reporting for the Central Government increased the reported size of the balance sheet by 2.7 percent of GDP.
- New IPSAS-based consolidated financial statements for 2019 and 2020 incorporated improved coverage of flows and stocks.
- Examples of effects on central government balance sheet:
  - Concessions and financial leasing increased assets and liabilities by 0.8 percent of GDP.
  - Deposits of the autonomous republics, local governments, and LEPLs in the Treasury Single Account (TSA) increased assets and liabilities of the central government by 1.9 percent of GDP (consolidated at the general government level).
- Coverage gaps remain for assets in budget organizations and LEPL financial statements (examples: administered non-financial assets and loans held by the Ministry of Interior and the Ministry of Infrastructure; assets to be sold by the State Property Agency).
- Treasury plans to require budget organizations and LEPLs to include missing assets in separate financial statements starting in 2022 and to clarify its accounting instruction.
- Many non-financial assets acquired before the Treasury was established in 1995 are not recognized at all; those acquired after 1995 are recognized at historic cost.
- Revaluation issues:
  - Revaluations by independent experts are required by Georgian legislation but may be prohibitively expensive.
  - Pending a cost-effective centralized approach, the chapter suggests using indexes derived from sample data to estimate revaluations for PSBS updates only.
  - Box 2 explains IPSAS options: cost model (chosen by the Treasury for all budget organizations and LEPLs) and revaluation model (requires regular revaluations).

### Recommendations (numbered as in source)
- 1.1 Institutionalize the updating of the PSBS by including it as an annex to the annual FRS, starting in 2022.
- 1.2 Implement the SOE reform strategy in order inter alia to reduce fiscal risks and improve the returns on equity investments.
- 1.3 Ensure comprehensive coverage of non-financial assets in the central government consolidated financial statements.
- 1.4 Consider the options for revaluing non-financial assets, whether in the consolidated financial statements for central government or for the PSBS separately.
- 1.5 Include the Pension Fund’s assets and liabilities to contributors in future disclosures of the PSBS.

### Climate Change Risks in Georgia (summary of subsequent section)
- Observed and projected temperature changes:
  - Georgia’s average temperature is already 0.47°C above the long-term average.
  - By the 2090s, Georgia’s average temperature is projected to increase by between 1.4°C and 4.9°C compared to the 1986−2005 baseline under RCP2.6 (strong mitigation) and RCP8.5 (business-as-usual), respectively.
- Projected changes in frost and summer days (selected projections from Figures):
  - Frost days (<0°C) projected % changes for RCP scenarios (examples): RCP2.6 -8% (2030), -13% (2100); RCP8.5 -10% (2030), -44% (2100).
  - Summer days (>25°C) projected % changes for RCP scenarios (examples): RCP2.6 27% (2030), 39% (2100); RCP8.5 29% (2030), 129% (2100).
- Main adverse impacts anticipated: droughts, flooding, and landslides.
- Key vulnerabilities and economic impacts:
  - Hydropower dependency: 78 percent of domestically generated electricity in 2015 came from hydropower; reduced river flow during summer could reduce power generation during peak demand, increasing energy imports and negatively affecting GDP and the balance of payments.
  - Landslide risk may compound impacts on energy infrastructure.
- Documented disaster losses and events:
  - 2015 Tbilisi flood: USD 24.3 million physical damage; USD 4.37 million financial losses; USD 118 million for recovery.
  - EM-DAT aggregate table (1991–2020): Flood total affected 166,222; Flood total damage (USD, million) 82,753. Drought 2000 total affected 696,000; total damage (USD, million) 300,594. Storm 2001-2013 total affected 8,668; total damage (USD, million) 102,580.
- Geographic heterogeneity:
  - Western and central Georgia: higher exposure of buildings to flood hazards (building density and riverine flood risk management).
  - Mountainous areas: higher exposure to landslides (geographical proximity to glaciers).
  - Climate-change scenarios indicate all regions will face compounded risks (drought, changing river flows, higher precipitation variability).
- International risk assessments:
  - ND-GAIN Index: Georgia ranks 38th least vulnerable country out of 181 countries; Georgia’s vulnerability score is 68th least vulnerable and readiness score is 33rd most ready.
  - INFORM Risk Index: Georgia ranks 91st out of 191 countries (medium risk country).

*Source: IMF staff (content from the specified IMF chapter).*

### 26.      Georgia has pledged to reduce  its GHG-emissions and develop an   economy that is

### 26.      Georgia has pledged to reduce  its GHG-emissions and develop an   economy that is 

### NDC commitments and targets
- Georgia’s National Determined Contribution (NDC) aims to:
  - contribute to limiting global warming to well below 2 degrees Celsius, compared to 1990;
  - increase the adaptative capacity of its economic sectors to the negative effects of climate change;
  - implement required adaptive measures by mobilizing domestic and international resources for sectors particularly vulnerable to climate change.
- Georgia’s GHG-emission commitments:
  - Unconditional objective: reduce GHG emissions by 35 percent below 1990 levels by 2030 excluding LUCF, which is 29.29 Mt CO2eq.
  - Intended reduction: 50−57 percent below 1990 levels excluding LUCF, which is 19.35−22.50 Mt CO2eq.
- Context:
  - Georgia had a relatively small footprint at signing the Paris Agreement: 0.03 percent of global emissions.
  - Main challenge: prevent further carbonization of the economy beyond committed targets.

### Climate governance and adaptation planning
- Institutional responsibilities:
  - Ministry of Environmental Protection and Agriculture (MEPA) and Ministry of Economy and Sustainable Development (MESD) are jointly responsible for coordinating climate change policy.
  - The government established the Climate Change Council (CCC) by decree as an advisory body for implementing and tracking NDC commitments; the CCC is chaired by the Minister of Environmental Protection and Agriculture and includes representatives from various public sector stakeholders.
- Adaptation planning:
  - Georgia committed to develop a National Adaptation Plan (NAP).
  - Current status: no comprehensive national climate adaptation plan published; only a climate change adaptation plan for the agriculture sector exists.
  - The updated NDC commits the government to producing a NAP.
- Framing:
  - Climate change adaptation is defined as minimizing losses and maximizing benefits from climate change (IPCC, 2021).
  - Article 7 of the Paris Agreement frames adaptation as enhancing adaptive capacity, strengthening resilience, and reducing vulnerability to contribute to sustainable development.
  - Fiscal trade-offs: upfront adaptation costs can be significant but medium- to long-run benefits can exceed costs; adaptation investment can reduce post-disaster upward pressures on public debt (IMF, 2019; IMF, 2022).

### Fiscal risk practice and progress
- Progress:
  - Government of Georgia has progressed fiscal risk analysis (FRS) over the past 6 years, improving analysis of SOE and power purchase agreement risks and expanding to public sector balance sheet (PSBS) risks.
  - December 2021 FRS included a qualitative assessment of major climate change fiscal risks.
  - Government committed to producing a quantified assessment in the FRS 2022.
- Next steps:
  - Use the report’s analytical tools and initial results to better identify, analyze, and quantify climate-related fiscal risks across FRMD, MoF units, MESD, and MEPA.

### Nature and transmission of climate-related fiscal risks
- Economic channels (supply and demand):
  - Supply-side vulnerabilities affect productivity, land, capital, and labor (examples: landslides, infrastructure degradation, land degradation, faster depreciation of machinery, reduced human performance).
  - Demand-side effects include consumption, investment, and trade impacts; may be temporary or persistent via resource reallocation to adaptation investment.
- Public finance transmission channels:
  - Direct impacts: increased public spending to repair/replace infrastructure; social transfers; natural disaster emergency spending; materialization of explicit contingent liabilities (e.g., state-backed insurance schemes); public investments/subsidies to mitigate/adapt.
  - Indirect impacts: reduction in tax revenue due to lower economic activity; increased health care spending; materialization of implicit contingent liabilities (e.g., support to distressed financial institutions); pressure on sovereign capacity to meet debt obligations due to budget reallocations.
- Fiscal sustainability:
  - Climate change effects may reduce the government’s ability to sustain spending and tax policies without threatening solvency or default.

### Approaches to quantifying climate change fiscal risks
- Common methods described:
  - Analyze economic effects and subsequent fiscal impact by identifying transmission channels, applying economic modeling, and using sensitivity analysis or alternative scenarios.
  - Analyze fiscal impact of climate-related natural disasters using historical and projected vulnerabilities to quantify economic and budgetary costs; disaster preparedness and lower public debt reduce probability of significant growth drops (Bayoumi, Quayyum, Das, 2021).
  - Analyze discrete fiscal risks to government budget vulnerabilities (e.g., reduced hydropower capacity due to drought; contingent liabilities related to SOEs or the financial sector).
- Balance sheet effects:
  - Quantitatively analyze impacts on government assets and liabilities, including increased maintenance, higher depreciation rates, and potential destruction of public assets.

### Climate scenarios, stylized fiscal outcomes, and key quantitative findings
- Three recommended climate scenarios:
  - Paris Agreement scenario (RCP2.6): international commitments met; IPCC models suggest limiting warming to well below 2 degrees Celsius. For Georgia: 1.6-degree Celsius rise in 2069 above the 50-year average to 2020.
  - Business-as-Usual (BAU) scenario (RCP8.5): Paris commitments not implemented; IPCC models suggest ~4 degrees global increase above pre-industrial. For Georgia: 3.65 Celsius degree rise in 2069 above the 50-year average to 2020.
  - BAU with climate volatility (volatile scenario): models higher volatility and increased frequency of extreme weather in addition to BAU warming.
- Stylized fiscal outcomes (relative to baseline):
  - Under BAU (RCP8.5): public debt likely to rise by around 8 percent of GDP relative to baseline due to dampened productivity, lower GDP growth, and reduced tax revenue.
  - Under volatile scenario: public debt increases 18 percent of GDP relative to baseline.
  - Under Paris (RCP2.6): debt largely matches the baseline scenario; RCP2.6 unusually results in a slight improvement in GDP levels for Georgia relative to historical trends.
- Additional disaster layering:
  - A series of floods and droughts layered over the volatile scenario adds an additional 15 percent of GDP to public debt by 2069.
- Contextual figures:
  - In 2022, the primary balance is expected to be -2.3 per cent of GDP.

### Analytical tools used and limitations
- Two excel-based modules employed:
  - Long-Term Module: captures slower-building fiscal pressures driven by gradual environmental transformation.
  - Disaster Module: simulates fiscal impacts of specific natural disasters.
- Nature of results:
  - Results are stylized and based on cross-country empirical evidence.
  - Significant scope exists for refinement and improvement; further quantitative analysis is planned (FRS 2022).

*Source: IMF staff.*

### 42.      These scenarios represent a starting point for climate change fiscal risk analysis, but

### Long-term Economic and Fiscal Effects of Climate Change

### Overview
- These scenarios represent a starting point for climate change fiscal risk analysis; further analysis could use the IMF’s Climate Macroeconomic Assessment Program (CMAP).
- Climate adaptation costs were estimated at around 3 percent of GDP per year for the next decade (2020 Fiscal Monitor).

### Baseline assumptions and projections
- Baseline real GDP growth: around 3−3¾ percent a year into the late 2060s.
- Baseline demographic effect: ageing population leads to higher health and pensions expenditure.
- Projected baseline outcomes for 2069:
  - Primary balance: -3.0 percent of GDP.
  - Debt-to-GDP ratio: 78.1 percent of GDP.
- Modeling inputs:
  - Baseline uses IMF World Economic Outlook, October 2021 forecasts to 2026; after 2026 growth projected using demographics, labor participation and labor productivity growth.
  - Employment projected to decline from 2027 in line with UN medium variant population projections; unemployment and participation rates assumed unchanged after 2026.
  - Labor productivity (GDP per persons employed) assumed to grow by 4 percent a year from 2027.
    - Historical comparison: 3.9 percent during 2010−19; World Bank estimate 4.5 percent for 2010−19.
    - Authorities’ macro models imply labor productivity growth rates in the 4.3−4.5 percent range.
  - Inflation assumed at 3 percent.
  - Revenues grow in line with nominal GDP from 2027; expenditures other than health and pensions grow in line with demographics.
  - Pension and health spending projected to increase by 2.4 percent of GDP (demographic-driven).

### Climate scenarios and macro-fiscal impacts
- Scenarios explored (based on Kahn et al (2021)):
  - Paris scenario (RCP2.6): strong global mitigation — broadly in line with baseline.
  - BAU scenario (RCP8.5).
  - Volatile scenario (RCP8.5 with increased climate volatility).
- Key projected impacts on productivity and GDP:
  - Under RCP8.5 with greater climate volatility, labor productivity could slow by 0.09 to 0.18 of a percentage point a year.
  - This slowdown could reduce GDP by over 8 percent relative to the baseline in 2069.
  - By 2100:
    - GDP per capita projected to be reduced by 7 percent under RCP8.5.
    - GDP per capita projected to be reduced by over 13 percent under the high volatility scenario.
- Fiscal effects:
  - Under BAU and volatile scenarios revenues decline in line with nominal GDP (revenue-to-GDP ratios held constant); expenditures assumed rigid and held unchanged in GEL terms from baseline.
  - Primary deficits increase by ½ and 1¼ percent of GDP relative to baseline under BAU and volatile scenarios, respectively.
  - Debt-to-GDP ratios are 8 and 18 percent of GDP larger by 2069 under BAU and volatile scenarios, respectively.
  - The volatile scenario reduces the fiscal envelope by around 35 percent of GDP over the period.

### Major channels of climate impact on labor productivity
- Higher depreciation of public and private capital stock:
  - Higher average temperatures and changing precipitation degrade roads, rail tracks, machinery and equipment; more volatile extremes increase damage and destruction of assets, shortening asset lifecycles and raising depreciation rates.
- Reduced hours worked:
  - Extreme weather days and higher temperatures can reduce days worked and increase absenteeism due to worsening health outcomes.
- Reduced technological effectiveness of existing industries:
  - Sectors like agriculture, tourism, and power production may see productivity and output declines, requiring increased capital investment and new technologies.

### Suggested model enhancements to better capture channels
- Introduce a physical capital stock accumulation identity to model changing depreciation rates and required capital expenditure; allows decomposition of labor productivity into capital deepening and TFP.
- Broaden labor input function to include hours worked (rather than employees only).
- Introduce production sectoral components within macro models to focus on sectors most directly impacted by climate change.

### Inflation, external balances, and adaptation
- Decline in labor productivity directly impacts nominal GDP with inflation assumed unchanged; climate change could cause inflation spikes through natural disasters and supply chain disruptions.
- Model allows for a parameter for climate adaptation (not used in this mission) to simulate effects of increased investment in adaptation (e.g., flood protection, resilient crops, alternative tourism).

### Intertemporal Net Financial Worth (INFW) and fiscal envelope
- Baseline INFW: -240 percent of 2020 GDP under current policy settings.
- Climate scenarios effects on INFW:
  - Intertemporal net worth would be over 35 percent of 2020 GDP lower in the volatile scenario than the baseline.
  - Under baseline INFW is estimated at -240 percent of 2020 GDP; lower revenues under the two high temperature scenarios would see INFW decline to 253 and 275 percent of 2020 GDP.
- Notes on spending rigidity:
  - Assuming spending is completely rigid likely overstates climate impacts on INFW.
  - Two alternative assessment approaches:
    - Focus on change in discounted future revenue flows (the fiscal envelope), invariant to future spending choices.
    - Introduce spending flexibility into expenditure projections to allow different degrees of spending adjustment over time.

### Natural disasters and fiscal stress testing
- Climate change likely increases frequency and severity of natural disasters; severe disasters can:
  - Disrupt economic activities and tax bases.
  - Hamper revenue administration operations.
  - Force governments to increase spending for support, relief and rehabilitation.
  - Cause long-term impacts via capital stock reductions.
- An Excel-based fiscal stress test framework is introduced to analyze quantitative effects of natural disasters and to inform policy advisors on potential fiscal consequences and mitigation options (e.g., increasing river discharge capacity, strengthening or removing public infrastructure in floodplains).

*Source: IMF staff estimates and analysis as presented in the chapter.*

### 65.      Fiscal effects of flood and drought —the two disasters that are relevant for Georgia

### Fiscal effects of flood and drought —the two disasters that are relevant for Georgia

### Disaster Module and modelling approach
- The Natural Disaster Shock Module for the Fiscal Stress Test (the Disaster Module) simulates the impact of a supply side disaster shock — pandemic, as well as flood, drought, earthquake, and severe storms — on economic activities.
- The Module:
  - simulates impacts on individual sectors of the economy;
  - feeds these impacts into tax, expenditure, and deficit/financing/debt changes; and
  - generates macroeconomic and public finance outcomes.
- Key features and assumptions:
  - A simple production function underpins the Module; the analysis is partial equilibrium in nature, with external and monetary sectors assumed exogenous.
  - The Module can record discretionary fiscal policy responses and materialization of contingency liabilities.
  - The Module allows four natural disaster modes and adjusts for: severity of the disaster; and preparedness of the country.
  - The Module is designed to be adapted to country circumstances and requires national macroeconomic and fiscal data; global impacts are applied as a starting point.
  - Authorities are encouraged to amend scale and nature of impacts to reflect national circumstances.

### Simulated scenarios: timing, scaling, and disaster types
- Disasters modelled for Georgia:
  - Severe floods are assumed in in 2028 and 2048.
  - Severe droughts are assumed in 2038 and 2058.
- Rationale:
  - Floods and drought are the climate related natural disasters that Georgia is at most risk of; consultations indicated flooding has become more frequent and severe over the past couple of decades.
  - Georgia experienced severe flooding in 2015, and a major drought in 2000.
- Scaling:
  - Stylized fiscal effects are layered on the fiscal projections under the volatile scenario.
  - To simulate rising temperatures increasing disaster intensity, impacts are scaled by the degree of temperature rise, so that the impact rises with time.

### Comparative fiscal effects of floods vs droughts
- Cross-country evidence and simulated results:
  - Droughts have a larger fiscal impact than floods in the ND FST.
  - Even when a more severe flood is simulated compared with the drought, the drought still leaves a worse fiscal legacy because severe floods are often followed by strong recoveries (and in some cases production can exceed pre-flood baseline), while severe droughts tend to dampen output for an extended period and are typically followed by a tepid recovery.

### Fiscal projections and key statistics under climate scenarios with natural disasters
- Peak impacts and debt implications:
  - The primary deficit peaks during the 2058 drought at 5 percent of GDP.
  - Public debt exceeds 110 percent of GDP in the scenario with more frequent and intense natural disasters.
  - Debt levels of this magnitude would likely result in challenges in meeting gross financing needs and could result in interest payment to revenue ratios that prove challenging.
- Use for fiscal rule and sustainability analysis:
  - Projections can be used to calculate a debt-stabilizing primary balance required to stabilize the debt-GDP ratio in 2069.
  - Table 4.2 (as presented) shows scenario values in the format provided in the source (all figures are per cent of GDP):
    - Baseline-3.1-2.50.6
    - BAU-3.5-2.70.8
    - Volatile-4.2-2.91.3
    - Volatile with disasters-4.9-3.41.5
  - Note: PB refers to primary balance. PB* refers to the debt-stabilizing primary balance, and is derived as (r-g)/(1+g)*Dt-1 where r is the real interest rate, g is the real GDP growth, and Dt-1 is the initial debt stock. Task refers to the fiscal consolidation required to stabilize debt.

### Suggested refinements and extensions (modelling and data improvements)
- Data updates and timing:
  - Update input data used for analysis (the analysis presented uses the October 2021 WEO data).
  - Run Long-Term and Disaster Modules with Georgia’s historical data and the medium-term fiscal framework.
  - Incorporate UN updated population projections to be released in March 2022 into the Long-Term Module.
  - Data updates should be carried out in the first quarter of 2022.
- Integrate historical disaster effects:
  - Analyze economic and fiscal effects of historical occurrences of natural disasters and integrate into baseline and volatile scenarios (current baseline does not include historical natural disasters).
  - Consider layering expected impacts of other fiscal risks (as done by the UK OBR) for inclusion in FRS 2022.
- Calibrate Disaster Module and integrate with Long-Term Module:
  - Calibrate to match Georgia’s expectations and co-ordinate with MESD, MEPA, EPA, and other agencies to develop home-grown scenarios.
  - Assuming input data updated in first half of 2022, task could be performed in third quarter of 2022 to allow publication in FRS 2022.
- Disaggregate productivity and capital effects:
  - Disaggregate labor productivity into capital-labor ratio and total factor productivity using historical national accounts and literature parameters.
  - Examine climate change effects on capital stock (e.g., faster depreciation under BAU and volatile scenarios).
  - If input data updated in first half of the year, this task could start in third quarter of 2022 for a qualitative discussion in FRS 2022.
- Incorporate external and monetary shocks:
  - Analyze how differential effects on labor productivity relative to neighbors could affect capital accounts and exchange rate.
  - Consider supply chain disruptions leading to inflation and exchange rate depreciation; with majority foreign currency public debt, this poses significant fiscal risk.
  - Include a qualitative discussion in FRS 2022; explore quantification approaches including MoF’s macroeconomic model in late 2022.
- Analyze labor supply and expenditure effects:
  - Consider migration effects if neighboring countries are more adversely affected, and examine specific expenditures (health, infrastructure) against climate change backdrop — qualitative in FRS 2022 with detailed quantification later.

### Discrete risks, fiscal vulnerabilities, and institutional measures
- Discrete risks to analyze in FRS 2022:
  - Identify and analyze climate-change risks to public infrastructure; assess exposure and vulnerability of public infrastructure.
  - Supplement future infrastructure register with a climate risk rating to identify public assets at risk within the PSBS and inform adaptation investments.
  - Consider requesting a Climate-Public Investment Management Assessment (C-PIMA) from the IMF in 2023.
- Contractual and contingent liability vulnerabilities:
  - Examine PPA contracts, other long-term contracts, and contingent liabilities for climate-change vulnerabilities (e.g., force majeure events shifting project risks to government).
  - Work with the National Bank of Georgia to integrate climate-related risks into financial supervisory expectations on management and disclosure (including scenario analysis and stress tests).
- Transition risks:
  - Analyze transition risks from climate mitigation policies, technology, and market sentiment; assess impacts on government, SOEs, and financial institutions.
  - Carry out assessment together with expert agencies and publish first results in FRS 2022.

### Adaptation measures and C-PIMA
- Extend analysis to adaptation measures:
  - Analyze effects and costs of climate adaptation measures (e.g., increasing resilience against landslides) to add adaptation scenarios and analyze cost-effectiveness to support design of adaptation pathways.
  - The modelling framework can accommodate an adaptation parameter (as in Khan et al (2021)) that assumes countries adapt to higher temperatures over 30 years; reducing this parameter (increasing adaptive investment) reduces macroeconomic impact.
- C-PIMA overview and benefits:
  - The IMF is developing the Climate PIMA Module (C-PIMA) to focus on climate aspects of PIM; a Board Paper was to be issued in late 2021 describing C-PIMA and plans.
  - C-PIMA assesses five key PIM practices from climate perspective: C1. Climate-aware planning; C2. Coordination between entities; C3. Project appraisal and selection; C4. Budgeting and portfolio management; C5. Risk management.
  - Benefits: diagnostic of institutional readiness; support development of framework for climate-related infrastructure planning and investment; roadmap of reform priorities; peer exchange.
  - Findings and recommendations from a C-PIMA are summarized in an IMF staff report covering five institutions and fifteen dimensions, with a roadmap of reform priorities.

*Recommendations (as listed in the source)*
- 4.1 Use the long-term fiscal projection tool to refine the estimates of baseline and climate scenarios, further refining and tailoring the assumptions and climate shocks to Georgia, so that quantified climate change fiscal risk analysis can be published in FRS 2022 (MoF, 2022).
- 4.2 Work with the MESD and MEPA to better tailor the natural disaster shock to Georgian experiences; and match projected environmental scenarios, so that quantified climate change fiscal risk analysis can be published in FRS 2022. (MoF, 2022)
- 4.3 Include likely non-climate change related natural disasters, and other evident fiscal risks, in the baseline. (MoF, 2022)
- 4.4 Examine discrete climate change-related fiscal risks, including vulnerabilities of the government budget to climate change risks, such as those relating to PPA contracts, other major long-term contracts, and contingent liabilities. (MoF, 2022)
- 4.5 Examine fiscal risks related to climate change transition risks. (MoF, 2022)
- 4.6 Extend the model to include the analyzes of climate change adaptation measures on climate change fiscal risks. (MoF, 2023)
- 4.7 Undertake a C-PIMA, which includes also assesses if public infrastructure assets registers include climate change-relevant aspect such the exposure of infrastructure to climate change risks. (MoF, 2022)

*Source: IMF staff estimates, extracted from the content unit titled "Fiscal effects of flood and drought —the two disasters that are relevant for Georgia."*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1geoea2022001.pdf_