## 1geoea2024002

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---

### Headline and core inflation developments
- Headline inflation fell to 0.3 percent (y/y) in February 2024, down from a peak of 13.9 percent in January 2022.
- Core inflation was at 2.6% in February 2024.
- At their peak in 2022, food, transport, housing, and fuel costs contributed 11.3 percentage points to headline inflation; these components are now dragging headline inflation down by 0.7 percentage points.
- Georgian import weighted commodity import price index rose from 2020 to mid-2022 and declined since July 2022.
- Transport fuel costs (roughly 8 percent of the CPI basket) fell every month between July 2022 and May 2023 and remain 10% below their July 2022 peak.
- Imported goods (about 25 percent of the Georgian CPI basket) saw annual price inflation peak at 21 percent at the end of 2021 and fall to close to 0 percent in February 2024 after a period of deflation.

### Drivers of inflation in Georgia
- Large external shocks—commodity price swings, sharp exchange rate movements, and war-related migration and FX inflows—drove recent inflation volatility.
- The lari nominal effective exchange rate (NEER) appreciated roughly 70 percent since February 2021; over half of this appreciation occurred since the start of the Russian invasion of Ukraine.
- War-related migration: over 100,000 migrants moved from Russia and Belarus to Georgia in 2022.
- Money transfers into Georgia increased by 85 percent in 2022 compared to 2021; financial inflows remain significantly above pre-war levels.
- Staff estimate that, at its peak, NEER appreciation reduced inflation by 6 percentage points.
- Domestic demand pressures:
  - Real GDP growth: 11 percent in 2022 and 7.5 percent in 2023.
  - Unemployment: 16.4 percent in 2023 (lowest since 2010, noting methodological break prior to 2010).
  - Labor shortages: 48 percent of firms surveyed by the Business Association of Georgia (BAG) in Q4 2023 indicated labor shortages were a hindering factor.
  - Wage growth: 17.3 percent in 2022 and 16.8 percent in 2023.
  - Unit wage costs (UWCs) grew 14 percent in Q4 2023.
  - Domestic inflation was 2.4 percent (y/y) in February 2024; services inflation was 5.3 percent.
- Phillips curve / pass-through:
  - Estimated slope of the Phillips curve in Georgia is around -0.1 (model in Chan, Koop and Potter (2016)): every percentage point unemployment is below NAIRU increases inflation by 0.1 percentage points.
  - Staff estimate of NAIRU in Georgia is around 17 percent.
- Labor share of output:
  - Labor share was roughly 41 percent in 2019; it fell over the pandemic and is only now starting to exceed pre-pandemic levels.

### Monetary policy stance and effectiveness
- Estimated impact of monetary tightening:
  - A 100 basis points tightening by the NBG decreases inflation by 0.8 percentage point at its peak.
  - Roughly half of this effect operates via the exchange rate channel; the peak impact is felt in around 8 quarters.
- Historical stance and effects:
  - NBG policy rate increased from 8 percent to 11 percent between January 2021 and April 2022.
  - Staff estimate that, conservatively, this tightening lowered the peak of inflation by 1.6 percentage points from 15.5 percent to 13.9 percent in early 2022.
  - In May 2023 the NBG began normalizing with a 50 basis points cut and has since cut to 8.25 percent across recent meetings; the NBG delivered a 75bps cut in March (cited as larger than usual).
- Dollarization and transmission:
  - About 45 percent of loans in Georgia are in foreign currency.
  - Despite high dollarization, empirical evidence shows monetary policy has been effective; weaknesses in some financial channels may be offset by a stronger exchange rate channel given FX exposures.
- Natural rate (R*) estimates and interpretation:
  - Two models produce R* estimates of 7.5 percent and 8.25 percent respectively.
  - These estimates are subject to high uncertainty but suggest monetary policy is quickly approaching neutral and indicate broadly where policy may stabilize.

### Challenges for monetary policy and outlook
- Main policy trade-offs:
  - The NBG must balance below-trend inflation against a positive output gap.
  - Significant uncertainty exists about the persistence of the positive supply shock (NEER appreciation, commodity price declines, migration-driven inflows).
- Risks of premature easing:
  - Aggressive interest rate cuts while the output gap is positive risk raising inflation in the near term and causing later overshooting, necessitating subsequent tightening.
  - Monetary policy operates with significant lags, highlighting limits on near-term control of inflation and the importance of a medium-term perspective.
- Output gap situation:
  - Three models (HP filter, augmented HP per Chan and Grant (2017), and SVAR (IMF 2023)) all indicate a currently positive output gap, suggesting output is above trend-consistent levels.

### Short-term inflation projection
- Staff short-term projection:
  - Inflation is projected to return to close to 3 percent by mid-2024 even without significant cuts in interest rates.
- Drivers of the projected move toward 3 percent:
  - One-off factors (falling commodity prices and exchange rate appreciation) are finishing their pass-through into inflation.
  - Base effects are strong: annualized month-on-month inflation averaged 2.4 percent over the last 6 months.
  - Indicators significant for future inflation, such as core and PPI inflation, have already started increasing.

### Credibility of the NBG and inflation expectations
- It is highly unlikely that the current period of below target inflation in Georgia will pull inflation expectations significantly below the 3 percent target.
- Over the period that the NBG has had a 3 percent inflation target, inflation in Georgia has averaged 6.5 percent, indicating minimal risk that inflation expectations become stuck below target.
- The NBG’s survey of firm one year ahead inflation expectations is currently at 4.8 percent and has never been below 4 percent since 2014.
- Trend inflation estimate referenced is around 4 percent (model: unobserved components stochastic volatility model per Chan, Koop and Potter (2013)); Figure 13 reports 16% and 84% tiles around this estimate.
- Given trend inflation and survey evidence, current uncertainty increases the argument for a more gradual normalization of the policy rate.

### Migration, FX inflows, and macro risks
- Migrant and capital flows triggered by Russia’s war in Ukraine have raised both supply and demand in Georgia:
  - Demand effects include higher demand for housing, food, and services.
  - Supply effects include provision of labor and exchange rate appreciation due to migration-related FX inflows, giving cheaper access to imported inputs.
- This has contributed to a booming economy:
  - 11 percent growth in 2022,
  - 7.5 percent growth in 2023,
  - an appreciation of the lari of almost 40 percent in nominal effective terms since the start of the war.
- High uncertainty about durability of these effects because FX inflows may normalize and migrants may return or depart; if these occur, growth would likely slow substantially and inflation could rise.

### Structural change and medium-term growth
- Growth and composition:
  - Growth in Georgia averaged 5.6 percent per year from 2003-2023.
  - Trend growth slowed to around 4.5-5 percent prior to the pandemic.
  - Investment accounted for an estimated 65 percent of growth over 2003-2023; total factor productivity accounted for the remaining 35 percent.
  - Subperiods:
    - 2003-2013: growth averaged 6.2 percent.
    - 2012-2023: growth averaged 4.9 percent, predominantly driven by investment (70 percent).
- Russia–Ukraine war effects and migration:
  - Over 100,000 migrants from Belarus and Russia moved to Georgia in 2022.
  - ICT share of GDP expanded from 3.9 percent in 2021 to 6.7 percent in 2023.
  - Money transfers into Georgia increased by 85 percent in 2022 relative to 2021 and remain elevated.
  - Staff estimate that the roughly 70 percent appreciation of the lari since February 2021 has led to an increase of growth by around 2.5 percentage points (via an SVAR).
  - Illustrative calculation: a 4 percentage point increase in migrant share of the working age population could lead to an increase in long run GDP per capita of 8 percent (based on Jaumotte and others (2016) elasticities).
- Productivity and structural change:
  - Output per worker averaged 4.2 percent growth (y/y) from 2010-2023 (old methodology yields 4.8 percent).
  - Structural change accounted for about one-third of output per worker growth; output per worker is roughly 7.5 times higher between agriculture and higher productivity sectors.
  - Employment share shifts 2003–2022:
    - Agriculture share fell from 50 percent to 37 percent.
    - Services share rose from 43 percent to 54 percent.
  - Within services, employment in higher-productivity sectors expanded; employment in public sector/administrative services fell from 83 percent of services workers in 2010 to 45 percent in 2022.

### Agricultural productivity, land, and rural labor
- Close to two-thirds of Georgia’s agricultural workers, roughly 400,000 individuals, are subsistence farmers who sell less than half of their produce on the market.
- Yields per hectare are substantially below global averages and have not shown marked improvement in over a decade.
- Farm structure and land registration:
  - Almost 80 percent of agricultural holdings in Georgia are less than 1 hectare in size and 99 percent are less than 5 hectares.
  - Land registration in 2022 was around 40 percent nationally and fell to 20 percent in rural areas.
  - Over 2.8 million plots have been registered under National Agency of the Public Registry (NAPR) efforts, with the aim for all land to be registered by the end of 2024.
  - Sixty-four percent of registered agricultural land is under state ownership with unclear responsibility for land management and allocation between national and local authorities.
  - Privatization of land in state ownership has practically ceased since 2010.
  - A constitutional amendment bans the selling of agricultural land to foreign citizens; in 2022 just 0.3 percent of FDI in Georgia was in agriculture.
- Labor force and education gaps:
  - Labor force participation in rural areas is roughly 5 percentage points lower than in urban areas using Georgia’s updated methodology.
  - Educational attainment differences: 58 percent of individuals in urban areas have either tertiary or vocational education, compared to 35 percent in rural areas.
  - PISA 2023: 67 percent of Georgia’s 15-year-old students are categorized as ‘low performing’ at reading, compared to the OECD average of 26 percent.

### Labor market, unemployment, and equilibrium estimates
- Unemployment in Georgia in 2023 was 16.4 percent, down from 17.3 percent in 2022.
- Using more internationally comparable methods (for 2022), unemployment is likely above 10 percent.
- In 2022 close to a fifth of unemployed workers reported having been out of work for over four years.
- Youth unemployment: 29 percent of those aged 30 and under in the labor market are unemployed; around two-thirds of unemployed youth have no previous work experience.
- For those 30 and under with vocational or tertiary education, youth unemployment falls from 35 percent (for those with secondary education or less) to 21 percent.
- Equilibrium unemployment estimates:
  - Phillips curve-based estimates (Chan, Koop, and Potter (2016) amended) of equilibrium unemployment in Georgia are around 18 percent.
  - Labor market flows-based steady-state unemployment projection (Smith (2011) approach) implies a steady state unemployment rate of 15 percent given current momentum.
  - Both approaches are highly uncertain; on balance, there appears little to no spare capacity in the labor market for further growth without policy intervention.

### Investment, savings, and fiscal/structural policy recommendations
- Investment and savings:
  - Investment has averaged 26 percent of GDP since 2010.
  - Investment fell to 19 percent of GDP in 2021 and remained low in 2022.
  - On recovery, investment reached 25.8% of GDP in 2023, with private domestic investment estimated to have accounted for 11 percentage points of this.
  - Current account deficit has averaged 9.4 percent of GDP (period not fully specified in provided text).
  - Prior to the pandemic investment had closed to around 6 percent, a level staff currently estimate to be sustainable over the medium term, due to gross national savings rising to an average of 21 percent from 2017-2019.
  - The pandemic led to a large decline in savings that have since only partially recovered; household survey data suggests the savings rate of households didn’t fall over this period, implying the fall and recovery is largely a function of firm balance sheets recovering.
- Political risks to investment:
  - Investment is sensitive to uncertainty and political instability; World Bank Enterprise Survey finds political instability ranked as the largest obstacle.
  - Near-term uncertainties include elections in 2024 and pressures from maintaining economic ties with both the EU and Russia.
  - Policy unpredictability can harm investment; example: short-notice reversal on opening the electricity market in 2023.
- Policy recommendations — agriculture and land:
  - Complete land registration.
  - Promote land consolidation.
  - Resolve issues around state management of land.
  - Allow foreign ownership of land.
  - Staff estimate that substantial policy reforms in this area could sustainably raise trend growth by 0.5 percentage points per year over the medium term.
- Policy recommendations — competitive markets, finance, and infrastructure:
  - Promote competition in finance; NBG has made this part of its 2023-2025 supervisory strategy.
  - Facilitate access to expensive infrastructure and data to support new market entrants.
  - Limit further concentration of the banking system to avoid restricting competition and access to finance, particularly for young dynamic firms.
  - Infrastructure investment, particularly in transport and logistics, will have high returns and support productivity and competition.
- Education and long-term growth:
  - Higher quality education would reduce youth unemployment, increase rural participation, and allow expansion of high-productivity industries such as finance, professional services, and IT.
  - Time frame for educational reforms to affect the labor force is significant; such policies are unlikely to raise growth within the short to medium term.

*Prepared by IMF staff (April 29, 2024).*

### 1. Headline and Core Inflation __________________________________________________________________ 3

### 1. Headline and Core Inflation

### Headline and core inflation developments
- Headline inflation fell to 0.3 percent (y/y) in February 2024, down from a peak of 13.9 percent in January 2022.
- Core inflation was at 2.6% in February 2024.
- At their peak in 2022, food, transport, housing, and fuel costs contributed 11.3 percentage points to headline inflation; these components are now dragging headline inflation down by 0.7 percentage points.

### Commodity and import price dynamics
- Georgian import weighted commodity import price index rose from 2020 to mid-2022 and declined since July 2022.
- Transport fuel costs (roughly 8 percent of the CPI basket) fell every month between July 2022 and May 2023 and remain 10% below their July 2022 peak.
- Imported goods (about 25 percent of the Georgian CPI basket) saw annual price inflation peak at 21 percent at the end of 2021 and fall to close to 0 percent in February 2024 after a period of deflation.

---

### Drivers of Inflation in Georgia

- Large external shocks—commodity price swings, sharp exchange rate movements, and war-related migration and FX inflows—drove recent inflation volatility.
- The lari nominal effective exchange rate (NEER) appreciated roughly 70 percent since February 2021; over half of this appreciation occurred since the start of the Russian invasion of Ukraine.
- War-related migration: over 100,000 migrants moved from Russia and Belarus to Georgia in 2022.
- Money transfers into Georgia increased by 85 percent in 2022 compared to 2021; financial inflows remain significantly above pre-war levels.
- Staff estimate that, at its peak, NEER appreciation reduced inflation by 6 percentage points.
- Domestic demand pressures:
  - Real GDP growth: 11 percent in 2022 and 7.5 percent in 2023.
  - Unemployment: 16.4 percent in 2023 (lowest since 2010, noting methodological break prior to 2010).
  - Labor shortages: 48 percent of firms surveyed by the Business Association of Georgia (BAG) in Q4 2023 indicated labor shortages were a hindering factor.
  - Wage growth: 17.3 percent in 2022 and 16.8 percent in 2023.
  - Unit wage costs (UWCs) grew 14 percent in Q4 2023.
  - Domestic inflation was 2.4 percent (y/y) in February 2024; services inflation was 5.3 percent.
- Phillips curve / pass-through:
  - Estimated slope of the Phillips curve in Georgia is around -0.1 (model in Chan, Koop and Potter (2016)): every percentage point unemployment is below NAIRU increases inflation by 0.1 percentage points.
  - Staff estimate of NAIRU in Georgia is around 17 percent.
- Labor share of output:
  - Labor share was roughly 41 percent in 2019; it fell over the pandemic and is only now starting to exceed pre-pandemic levels.

---

### Monetary Policy Stance and Effectiveness

- Estimated impact of monetary tightening:
  - A 100 basis points tightening by the NBG decreases inflation by 0.8 percentage point at its peak.
  - Roughly half of this effect operates via the exchange rate channel; the peak impact is felt in around 8 quarters.
- Historical stance and effects:
  - NBG policy rate increased from 8 percent to 11 percent between January 2021 and April 2022.
  - Staff estimate that, conservatively, this tightening lowered the peak of inflation by 1.6 percentage points from 15.5 percent to 13.9 percent in early 2022.
  - In May 2023 the NBG began normalizing with a 50 basis points cut and has since cut to 8.25 percent across recent meetings; the NBG delivered a 75bps cut in March (cited as larger than usual).
- Dollarization and transmission:
  - About 45 percent of loans in Georgia are in foreign currency.
  - Despite high dollarization, empirical evidence shows monetary policy has been effective; weaknesses in some financial channels may be offset by a stronger exchange rate channel given FX exposures.
- Natural rate (R*) estimates and interpretation:
  - Two models produce R* estimates of 7.5 percent and 8.25 percent respectively.
  - These estimates are subject to high uncertainty but suggest monetary policy is quickly approaching neutral and indicate broadly where policy may stabilize.

---

### Challenges for Monetary Policy and Outlook

- Main policy trade-offs:
  - The NBG must balance below-trend inflation against a positive output gap.
  - Significant uncertainty exists about the persistence of the positive supply shock (NEER appreciation, commodity price declines, migration-driven inflows).
- Risks of premature easing:
  - Aggressive interest rate cuts while the output gap is positive risk raising inflation in the near term and causing later overshooting, necessitating subsequent tightening.
  - Monetary policy operates with significant lags, highlighting limits on near-term control of inflation and the importance of a medium-term perspective.
- Output gap situation:
  - Three models (HP filter, augmented HP per Chan and Grant (2017), and SVAR (IMF 2023)) all indicate a currently positive output gap, suggesting output is above trend-consistent levels.

---

### Short-term Inflation Projection

- Staff short-term projection:
  - Inflation is projected to return to close to 3 percent by mid-2024 even without significant cuts in interest rates.
- Drivers of the projected move toward 3 percent:
  - One-off factors (falling commodity prices and exchange rate appreciation) are finishing their pass-through into inflation.
  - Base effects are strong: annualized month-on-month inflation averaged 2.4 percent over the last 6 months.
  - Indicators significant for future inflation, such as core and PPI inflation, have already started increasing.

*Prepared by IMF staff (April 29, 2024).*

### 18. There is no sign that low inflation is damaging the credibility of the NBG. It is highly

### 1geoea2024002 - 18. There is no sign that low inflation is damaging the credibility of the NBG. It is highly

### Credibility of the National Bank of Georgia (NBG) and inflation expectations
- It is highly unlikely that the current period of below target inflation in Georgia will pull inflation expectations significantly below the 3 percent target.
- Over the period that the NBG has had a 3 percent inflation target, inflation in Georgia has averaged 6.5 percent, indicating minimal risk that inflation expectations become stuck below target.
- The NBG’s survey of firm one year ahead inflation expectations is currently at 4.8 percent and has never been below 4 percent since 2014.
- Outside direct surveys, trend inflation estimates support the view that expectations are unlikely to fall below 3 percent; the current estimate for trend inflation is around 4 percent.

### Trend inflation estimation and model basis
- Trend inflation estimate referenced is based on the univariate model of inflation described in Chan, Koop and Potter (2013).
- The model is an unobserved components stochastic volatility model with time variation in both the trend and persistence of inflation and has been shown to have good forecasting performance.
- Figure evidence (Figure 13) shows an estimated trend inflation around 4 percent (with 16% and 84% tiles reported in the figure).

### Recent macro developments and risks to the supply–demand balance
- Migrant and capital flows triggered by Russia’s war in Ukraine have raised both supply and demand in Georgia through multiple channels:
  - Demand effects include higher demand for housing, food, and services.
  - Supply effects include provision of labor (many migrants are remote workers in sectors such as tech) and exchange rate appreciation due to migration-related FX inflows, giving cheaper access to imported inputs.
- This has contributed to a booming economy with:
  - 11 percent growth in 2022,
  - 7.5 percent growth in 2023,
  - an appreciation of the lari of almost 40 percent in nominal effective terms since the start of the war.
- High uncertainty about durability of these effects because:
  - FX inflows may normalize, potentially causing depreciation;
  - Migrants may return to home countries or move elsewhere; if these occur, growth would likely slow substantially and inflation could rise.

### Monetary policy response under uncertainty
- One response is more cautious monetary policy (Brainard (1967) approach) — responding less vigorously to shocks to allow learning and course correction.
- Academic research notes uncertainty does not automatically require cautious responses; the appropriate response depends on economy structure and type of uncertainty (Hansen and Sargent (2015), Tetlow (2018)).
- In Georgia’s case, there is an asymmetry: inflation expectations and trend inflation are likely above target, increasing the cost of reducing the policy rate too fast and then having to reverse course.
- Therefore, current uncertainty increases the argument for a more gradual normalization of the policy rate than would be justified otherwise.

### Conclusion and policy recommendations
- The current uncertainty over Georgia’s future economic path supports normalizing the policy rate at a gradual pace.
- Current below-target inflation is primarily due to the fall in commodity prices and exchange rate appreciation.
- Inflows from the Russian invasion of Ukraine have caused a boom, pushing up wages and domestic inflation and resulting in a positive output gap.
- Given high uncertainty about the balance of demand and supply factors, there is a good case for:
  - looking through the current period of low inflation,
  - focusing on closing the output gap to bring inflation sustainably back to the 3 percent target in the medium term.

### Additional medium-term growth and structural findings (selected)
- Growth and composition:
  - Growth in Georgia averaged 5.6 percent per year from 2003-2023.
  - Trend growth slowed to around 4.5-5 percent prior to the pandemic.
  - Investment accounted for an estimated 65 percent of growth over 2003-2023; total factor productivity accounted for the remaining 35 percent.
  - Distinct subperiods:
    - 2003-2013: growth averaged 6.2 percent, broadly balanced between TFP and capital growth.
    - 2012-2023: growth averaged 4.9 percent, predominantly driven by investment (70 percent).
- Russia–Ukraine war effects and migration:
  - Over 100,000 migrants from Belarus and Russia moved to Georgia in 2022.
  - ICT share of GDP expanded from 3.9 percent in 2021 to 6.7 percent in 2023.
  - Money transfers into Georgia increased by 85 percent in 2022 relative to 2021 and remain elevated.
  - Staff estimate that the roughly 70 percent appreciation of the lari since February 2021 has led to an increase of growth by around 2.5 percentage points (via an SVAR).
  - If recent migrants settle permanently, evidence suggests possible increases in per capita GDP growth via higher labor productivity; illustrative calculation: a 4 percentage point increase in migrant share of the working age population could lead to an increase in long run GDP per capita of 8 percent (based on Jaumotte and others (2016) elasticities).
- Productivity and structural change:
  - Output per worker averaged 4.2 percent growth (y/y) from 2010-2023 (old methodology yields 4.8 percent).
  - Structural change accounted for about one-third of output per worker growth; output per worker is roughly 7.5 times higher between agriculture and higher productivity sectors.
  - Employment share shifts 2003–2022:
    - Agriculture share fell from 50 percent to 37 percent.
    - Services share rose from 43 percent to 54 percent.
  - Within services, the share employed in higher-productivity sectors (construction, retail, professional services) expanded substantially; employment in public sector/administrative services fell from 83 percent of services workers in 2010 to 45 percent in 2022.

*Source: IMF staff calculations and analysis as presented in the provided content.*

### 7. Structural change will remain a core driver of Georgia’s growth given Georgia’s high

### 7. Structural change will remain a core driver of Georgia’s growth given Georgia’s high levels of agricultural employment. However, as productivity across industry and subsectors of services converge, growth will need to be driven increasingly by raising efficiency and innovation as opposed to pure reallocation.

### Agricultural productivity and structural transformation
- Share of workers in agriculture fell from 50 percent in 2003 to 37 percent in 2022.
- Close to two-thirds of Georgia’s agricultural workers, roughly 400,000 individuals, are subsistence farmers who sell less than half of their produce on the market.
- Yields per hectare are substantially below global averages and have not shown marked improvement in over a decade (World Bank 2022b).
- To maintain structural change, agricultural productivity in Georgia must continue to rise.

### Farm structure, land registration, and land markets
- Almost 80 percent of agricultural holdings in Georgia are less than 1 hectare in size and 99 percent are less than 5 hectares.
- Land registration in 2022 was around 40 percent nationally and fell to 20 percent in rural areas.
- Low registration reflected fears of losing social allowances, losing land to lenders, and higher taxation (World Bank, 2022b).
- Over 2.8 million plots have been registered under National Agency of the Public Registry (NAPR) efforts, with the aim for all land to be registered by the end of 2024.
- Sixty-four percent of registered agricultural land is under state ownership with unclear responsibility for land management and allocation between national and local authorities (World Bank, 2022b).
- Privatization of land in state ownership has practically ceased since 2010.
- A constitutional amendment bans the selling of agricultural land to foreign citizens; in 2022 just 0.3 percent of FDI in Georgia was in agriculture.

### Services reallocation and within-sector convergence
- Much of past productivity growth was due to reallocation within services toward high productivity subsectors.
- Output per worker across services subsectors has converged dramatically between 2010 and 2022, reducing scope for further gains from reallocation.
- Professional services remain an outlier in productivity but face high educational barriers to entry, limiting their ability to expand employment share dramatically.

### Firm growth, competition, and access to finance
- World Bank firm-level evidence indicates majority of employment growth is in large firms that are relatively less productive, while smaller high-productivity firms are failing to grow (World Bank, 2022a).
- Georgia’s banking sector concentration: largest two banks account for 79 percent of total deposits and 76 percent of total loans.
- High concentration could partly explain high implicit spreads experienced in Georgia.
- In the World Bank’s Enterprise Survey (2023), access to finance was listed as the third largest obstacle to firms, with 16.5 percent pointing to it as their largest obstacle.
- In the World Economic Forum’s Global Competitiveness Index (GCI), Georgia’s financial system ranks 91st out of 140 countries in terms of development.
- Aggregate access to credit: relatively high domestic credit to GDP and fewer firms reporting being credit constrained than the average for Europe and Central Asia, but a substantially higher share of loans require collateral and the amount of collateral is also higher.

### Infrastructure, trade costs, and non-tariff barriers
- Georgia ranked 83rd in transport infrastructure in the last GCI, reflecting poor quality infrastructure.
- High transport and logistics costs act as a bottleneck to growth and raise input costs, lowering productivity and insulating firms from competition.
- High non-tariff barriers persist despite free trade agreements such as the Deep and Comprehensive Free Trade Agreement with the EU; benefits of trade agreements are limited by these non-trade barriers.

### Population, migration, and labor supply
- Georgia’s population is estimated to fall by 2.6 percent by 2030 (United Nations, 2022), relative to 2014-2019.
- The population decline represents a drag on the working age population of around 0.3 percentage point per year.
- In the UN’s no migration scenario, the population falls by just 0.3 percent over the same period.
- Median age expected to rise from 36.5 in 2022 to 38.6 in 2030; only a quarter of this rise is because of net migration.
- Aging and net migration are projected to be a drag on participation and aggregate labor supply by around 0.1-0.2 percentage point per year.

### Labor force participation, rural-urban differences, and education
- Labor force participation in rural areas is roughly 5 percentage points lower than in urban areas using Georgia’s updated methodology.
- The change in methodology led to a drop in recorded aggregate participation of around 11 percentage points and a drop of 24 percentage points in rural areas.
- Educational attainment differences: 58 percent of individuals in urban areas have either tertiary or vocational education, compared to 35 percent in rural areas.
- The large group of individuals not engaged in highly productive work (including subsistence farmers) is central to policy: raising their productivity in farming or helping them join the wider labor force is key to maintaining growth.

### Unemployment: levels, composition, and drivers
- Unemployment in Georgia in 2023 was 16.4 percent, down from 17.3 percent in 2022.
- Using more internationally comparable methods (for 2022), unemployment is likely above 10 percent and higher than many comparator countries.
- In 2022 close to a fifth of unemployed workers reported having been out of work for over four years; these long-term unemployed tend to be older, less educated, and more likely to live in rural areas.
- Youth unemployment: 29 percent of those aged 30 and under in the labor market are unemployed, representing about a third of unemployment in Georgia.
- Around two-thirds of unemployed youth have no previous work experience.
- PISA 2023: 67 percent of Georgia’s 15-year-old students are categorized as ‘low performing’ at reading, compared to the OECD average of 26 percent.
- For those 30 and under with vocational or tertiary education, youth unemployment falls from 35 percent (for those with secondary education or less) to 21 percent.
- Unemployment for those with tertiary or vocational education in 2022 was still 13 percent.

### Equilibrium unemployment estimates and labor market dynamics
- Philips curve-based estimates (model of Chan, Koop, and Potter (2016) amended to focus on wage inflation) of equilibrium unemployment in Georgia are around 18 percent.
- Labor market flows-based steady-state unemployment projection (Smith (2011) approach) implies a steady state unemployment rate of 15 percent given current momentum in the Georgian labor market.
- Both approaches have shortcomings and are highly uncertain:
  - Phillips-curve approach may be slow to detect structural changes in the NAIRU.
  - Flows-based approach does not account for wage and inflation implications of the steady state it implies.
- Given strength of current wage growth, tight monetary policy may be required to slow down labor market dynamics implied by the 15 percent steady state.
- On balance, there appears little to no spare capacity in the labor market for further growth without policy intervention.

### Investment, savings, and capital
- Investment has averaged 26 percent of GDP since 2010.
- Investment fell to 19 percent of GDP in 2021 and remained low in 2022.
- On recovery, investment reached 25.8% of GDP in 2023, with private domestic investment estimated to have accounted for 11 percentage points of this.
- Current account deficit has averaged 9.4 percent of GDP since (period not fully specified in provided text), reflecting investment in excess of national savings.

*Source: IMF staff summary of chapter content.*

### 2010. Prior to the pandemic this had closed to around 6 percent, a level staff currently estimate to

### Assessment of Growth and Policy Recommendations

### Investment and Savings
- Prior to the pandemic investment had closed to around 6 percent, a level staff currently estimate to be sustainable over the medium term (IMF first SBA review, 2022), due to gross national savings rising to an average of 21 percent from 2017-2019.
- The pandemic led to a large decline in savings that have since only partially recovered; savings must fully recover to sustainably maintain investment.
- Household survey data suggests the savings rate of households didn’t fall over this period, implying the fall and subsequent recovery is in large part a function of firm balance sheets recovering.
- This pattern is consistent with the low labor share in Georgia and the high share of income that goes to corporates.

### Political Risks to Investment
- While Georgia’s high level of investment looks sustainable, there are risks from political factors:
  - Investment can be sensitive to uncertainty and political instability (Julio and Yook 2012).
  - In the WBES, political instability was ranked as the largest obstacle to the business environment.
  - Near-term uncertainties include elections in 2024 and pressures from maintaining economic ties with both the EU and Russia.
  - Policy unpredictability can harm investment; example given is the short-notice reversal on opening the electricity market in 2023.

### Growth Outlook and Drivers
- Pre-pandemic trend growth in Georgia was likely around 5 percent; demographic headwinds, in part fueled by outward migration, are likely to lower this to around 4.5 percent over the next ten years.
- This projected growth will be driven by continued structural change and high levels of investment.
- Estimates exclude the potentially positive effect on potential growth from recent inward migration given uncertainty around migrants' duration of stay and scale of impact.
- Unresolved policy issues, particularly around land registration and markets, could slow structural transformation and growth if unaddressed.
- Maintaining dynamic competitive markets is required to preserve productivity growth in manufacturing and services.

### Policy Recommendations — Agriculture and Land
- The greatest opportunities to raise growth above the projected level focus on raising agricultural productivity:
  - Complete land registration.
  - Promote land consolidation.
  - Resolve issues around state management of land.
  - Allow foreign ownership of land.
- Staff estimate that substantial policy reforms in this area could sustainably raise trend growth by 0.5 percentage points per year over the medium term.

### Policy Recommendations — Competitive Markets, Finance, and Infrastructure
- A focus on competitive markets is necessary to maintain growth outside agriculture:
  - The National Bank of Georgia (NBG) has made promotion of competition in finance part of its 2023-2025 supervisory strategy.
  - Actions such as facilitating access to expensive infrastructure and data to support new market entrants will be helpful.
  - Limit further concentration of the banking system to avoid restricting competition and access to finance, particularly for young dynamic firms.
  - Infrastructure investment, particularly in transport and logistics, will have high returns and support productivity and competition.
- These policies are broadly seen as a continuation of current government policy and are necessary to maintain the expected 4.5-5 percent trend growth; raising government investment as a share of GDP would be required to go beyond these figures.

### Education and Long-Term Growth
- Improved educational outcomes are vital for raising long-run growth, especially in a services-oriented economy:
  - Higher quality education would reduce youth unemployment, increase rural participation, and allow expansion of high-productivity industries such as finance, professional services, and IT.
  - Policies should address low teacher quality and the significant rural-urban gap in educational outcomes.
- The time frame for educational reforms to be implemented, improve outcomes, and meaningfully affect the labor force is significant; such policies are unlikely to raise growth within the short to medium term.

*Source: GEOSTAT, IMF staff calculations.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1geoea2024002.pdf_