## _cr06175

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---

### Developments Since the Rose Revolution
- Real GDP fell almost 75 percent after the breakup of the Soviet Union.
- 2000–2003 averages:
  - Real GDP growth averaged 5.8 percent.
  - CPI inflation averaged 4.8 percent.
  - Tax revenues averaged 13.2 percent of GDP.
  - Cash fiscal deficit was 1.8 percent.
  - Domestic arrears totaled 3.4 percent of GDP by end-2003.
- Post-January 2004 reform actions included:
  - Anti-corruption actions in tax and customs administration (firings, prosecutions, reparations payments), reorganization of the state tax department, and creation of a financial police.
  - Simplification and streamlining of the tax system to reduce regulatory burdens.
  - Public sector governance measures: civil service restructuring, strengthened management in state-owned enterprises, and reinvigorated privatization.
- Outcomes from restructuring:
  - Tax revenues rose by 3.7 percent of GDP in 2004 and by a further 1.6 percent in 2005.
  - Improved revenues enabled increased pensions, upgraded defense capacity, and arrears clearance while maintaining fiscal stability.
- Political and external context:
  - Reintegration of South Ossetia and Abkhazia remains a priority.
  - Relations with Russia are tense; Russia is Georgia’s largest trading partner and Georgia depends on Russia for gas and electricity.

### Recent Developments (2005)
- Growth and inflation:
  - Real GDP growth in 2005 is estimated at 7.7 percent.
  - Twelve-month CPI inflation hovered around 10 percent in the first half of 2005 and declined to 6.2 percent by end-2005.
- Poverty (latest available 2004 data):
  - 52 percent of the population living under the official subsistence level.
  - 17 percent in extreme poverty.
- Fiscal outturns and composition (2005):
  - General government deficit was 2.4 percent of GDP in 2005 (budgeted at 4.8 percent).
  - Tax revenues rose to 19.8 percent of GDP.
  - Total expenditure and net lending increased from 18.6 percent of GDP in 2004 to 24.9 percent in 2005.
  - Current expenditures increased by 4.5 percent of GDP, notably transfers and subsidies to Legal Entities of Public Law (LEPLs) to buy defense goods.
  - Social spending increased from 7.1 percent of GDP in 2004 to 8.1 percent in 2005 (cash basis).
  - Defense spending increased from an estimated 1.6 percent to 3.5 percent of GDP (figures exclude LEPL defense-related expenditures; all such expenditures ceased since January 2006).
  - Privatization receipts of 3.6 percent of GDP financed the deficit, modest net foreign repayments, and an increase in government deposits with the National Bank of Georgia (NBG).
- Monetary and external sector:
  - Introduction of a reserve money target strengthened the monetary framework.
  - NBG gross international reserves increased by US$91 million in 2005 despite substantially lower capital inflows than in 2004.
  - Lari appreciated about 2 percent nominally against the U.S. dollar and in real effective terms during 2005.
  - International reserves remained at about 2 months of non-pipeline imports.
  - Remonetization continued.
- Banking sector (2005):
  - Returns to assets and equity rose.
  - Credit to the private sector grew 83 percent.
  - Lari-denominated loans tripled; loan dollarization reduced by about 10 percentage points to 77 percent of total loans.
  - Deposit growth was 31 percent; deposit dollarization declined to 72 percent.
  - Non-performing loans fell from 6.2 percent at end-2004 to 3.8 percent at end-2005.
  - Consolidation: 3 banks merged or closed in 2005; number of banks later stood at 18 after a bank resolution in February 2006.
  - Banking supervision became more proactive; an insolvent bank was resolved through temporary administration and sale procedures in early 2006 with no significant depositor runs.
- Balance of payments and external financing:
  - A fiscal stance less expansionary by more than 2 percent of GDP compared with the budget helped prevent a projected widening of the current account deficit in 2005.
  - Lower-than-projected official disbursements and slower pipeline project implementation, and lower FDI in new pipelines, slowed import growth.
  - Preliminary data suggest export growth (net of a one-time adjustment for unregistered trade in 2004) also slowed.
- Debt treatment:
  - Georgia reached debt rescheduling agreements with most bilateral creditors on terms comparable to those offered by the Paris Club in July 2004.
  - Authorities requested the Paris Club extend the deadline for concluding remaining discussions to end-February 2006.

### Structural reforms advanced (selected)
- Fiscal:
  - Comprehensive tax reform effective in 2005: number of taxes reduced from 21 to 7; personal income tax unified at 12 percent (replacing 12–20 percent rates); VAT reduced from 20 to 18 percent; payroll tax reduced from 33 to 20 percent; exemptions and special regimes curtailed.
  - Revenue administration improvements continued.
  - Single Treasury Account (STA) became fully operational in early 2006 (LEPLs operate outside the STA).
  - Progress toward GFSM 2001 compliance by early 2007; first Medium-Term Expenditure Framework (MTEF) produced in 2005.
  - New customs code submitted to parliament in October 2005.
- Banking:
  - NBG developing a financial sector development strategy for the medium term.
  - Proposal to eliminate restrictions limiting nonbank shareholders to 25 percent of equity in Georgian banks.
  - Major banks created a credit information bureau.
- Energy:
  - Quasi-fiscal losses declined from 4.5 percent of GDP in 2004 to an estimated 4 percent in 2005 due mainly to increased collections from communal metering and reinforced payment discipline.
- Business environment:
  - Law passed in June 2005 reducing licensed businesses from 900 to 150 and introducing “one-window” approvals and the “silence is consent” principle.

### Competitiveness (box finding)
- Georgia’s real exchange rate (RER) appreciated over the past 24 months due to strong real GDP growth and foreign exchange inflows (FDI and repatriation of savings).
- RER appreciation has begun to affect external competitiveness: the share of Georgian exports in trading partners’ import markets started to decline in early 2005.
- Cost of doing business indicators remain poor compared to neighbors, although U.S. dollar wages are the lowest in the region.
- The RER is most likely still undervalued; two recent studies indicate marked productivity improvements in 2004–05.

### Performance Under the Program
- Overall assessment:
  - Performance under the program has been good.
  - All but one quantitative performance criteria were met.
  - Target on arrears clearance was missed: authorities cleared arrears of GEL 104 million (0.9 percent of GDP) in 2005 versus the programmed GEL 149 million (1.3 percent of GDP).
  - Structural performance criterion on submission of a new customs code was delayed to allow more time for discussions with the business community.
  - Authorities requested completion of the third review under the arrangement and waivers for the missed performance criteria.

### Program focus and policy settings for 2006
- Medium-term prospects and policy priorities:
  - Robust growth likely to continue.
  - Focus on removing obstacles to growth including:
    - A public investment program addressing infrastructure needs (roads and power supply).
    - A financial sector development strategy to increase the sector’s contribution to growth.
    - Measures to improve institutional quality and reduce rent-seeking opportunities affecting private sector investment.
- Fiscal policy (2006):
  - Fiscal deficit to be maintained broadly unchanged while increasing social expenditures.
  - Social measures include higher minimum pensions and a targeted poverty benefit program scheduled for implementation in mid-2006.
- Monetary policy (2006):
  - Monetary program targets reserve money growth of 25 percent for the year.
  - Authorities’ inflation objective is 5 percent by end-2006.
  - Target for further reserve accumulation to 2.3 months of import coverage.
  - Efforts to strengthen NBG’s ability to conduct monetary operations and improve coordination between the NBG and ministry of finance.
- Fiscal transparency and governance:
  - Authorities developing guidelines for monitoring and reporting activities of all central government LEPLs.
  - A Banking System Development Strategy for 2006–09 is under preparation.

### Risks and policy priorities
- Main risks to the medium-term outlook:
  - Election pressures with significant elections scheduled for each of the next three years.
  - Political tensions regarding the status of Abkhazia and South Ossetia.
  - Energy sector vulnerabilities.
- Governance:
  - Important to implement further measures to improve governance, building on progress made in recent years.

### Overall appraisal
- Georgia has made substantial progress in creating a sound policy framework.
- The authorities’ strong record of accomplishment bodes well for continued successful implementation of the program.

---

### Financial Sector: Box 4 — Developing the Financial Sector in Georgia
- Current state:
  - Financial sector development lags many other transition countries.
  - Monetization was low after independence; financial intermediation is shallow.
- Recent developments and credit boom:
  - Since end-2004, commercial banks’ lending to the private sector increased by more than 80 percent.
  - Some additional loans are consumption-related or mortgages, fuelling property prices in Tbilisi.
- Importance for growth and required reforms:
  - Stronger financial sector essential to sustain development and support SMEs.
  - Required reforms include:
    - greater consolidation and foreign entry,
    - enhanced creditors’ rights,
    - increasing minimum capital requirements,
    - implementing fit and proper ownership requirements,
    - strong and effective banking supervision,
    - adoption of forthcoming FSAP recommendations.
- Key statistics (selected; banking system credit to economy — Georgia):
  - 1996: 3.3
  - 1998: 4.7
  - 2000: 7.3
  - 2002: 8.3
  - 2004: 9.5
  - 2005 Est.: 15.0
- Monetization (M3 or M2 where available) — Georgia:
  - 1996: 6.7
  - 1998: 7.3
  - 2000: 10.3
  - 2002: 11.6
  - 2004: 15.2
  - 2005 Est.: 16.5
- Policy recommendations and priorities:
  - Ensure strong and effective banking supervision to preserve sector health amid rapid expansion.
  - Increase minimum capital requirements and allow foreign banks to enter and further consolidate the sector.
  - Implement fit and proper ownership requirements.
  - Adopt FSAP recommendations to strengthen the financial sector.
  - Deepen financial intermediation to support SMEs, investment, and job creation.
  - Complement financial-sector reforms with broader structural reforms to sustain competitiveness and medium-term growth.

### IMF staff recommendation and program decision (paragraph 53 summary)
- Staff supports the authorities’ request for waivers for the nonobservance of performance criteria.
- Staff recommends completion of the third review of the PRGF arrangement.
- Proposed next Article IV consultations be held in the 24-month cycle.

### Key macroeconomic outcomes and projections (selected exact figures)
- Nominal GDP (millions of lari): 9,970 (2004); 11,660 (2005); 11,600 (Prel. Est.); 13,080 (Proj. 2006).
- Nominal GDP (US$ million): 5,193 (2004); 6,303 (2005); 6,409 (Prel. Est.); 7,522 (Proj. 2006).
- Real GDP growth: 6.2 (2004); 6.4 (2005); 7.7 (Prel. Est.); 6.4 (Proj. 2006).
- Consumer price index, period average: 5.7 (2004); 9.4 (2005); 8.3 (Prel. Est.); 5.3 (Proj. 2006).
- Consumer price index, end-of-period: 7.5 (2004); 7.0 (2005); 6.2 (Prel. Est.); 4.7 (Proj. 2006).
- GDP/capita (US$): 1,203 (2004); 1,461 (2005); 1,485 (Prel. Est.); 1,743 (Proj. 2006).
- Poverty rate (in percent): 52.7 (2004).
- Investment (percent of GDP): 26.6 (2004); 28.9 (2005); 26.4 (Prel. Est.); 26.6 (Proj. 2006).
  - Public investment: 2.4 (2004); 5.5 (2005); 4.2 (Prel. Est.); 3.8 (Proj. 2006).
  - Private investment: 24.2 (2004); 23.4 (2005); 22.1 (Prel. Est.); 22.8 (Proj. 2006).
- Gross international reserves (US$ million): 383 (2004); 493 (2005); 474 (Prel. Est.); 620 (Proj. 2006).
  - Months of imports of goods and services (excl. pipeline imports): 2.0 (2004); 2.0 (2005); 2.1 (Prel. Est.); 2.3 (Proj. 2006).
- Average exchange rate (lari per dollar): 1.9 (2004); 1.8 (2005).

### Fiscal sector (selected exact figures)
- Total revenue and grants (percent of GDP): 21.7 (2004); 21.7 (2005); 23.4 (Prel. Est.); 22.9 (Proj. 2006).
  - Tax revenue: 18.2 (2004); 18.1 (2005); 19.8 (Prel. Est.); 19.3 (Proj. 2006).
- Total expenditure and net lending (percent of GDP): 18.6 (2004); 25.2 (2005); 24.9 (Prel. Est.); 25.0 (Proj. 2006).
  - Current expenditure: 16.2 (2004); 19.7 (2005); 20.7 (Prel. Est.); 21.3 (Proj. 2006).
- Primary balance (percent of GDP): 4.3 (2004); -2.4 (2005); -0.5 (Prel. Est.); -1.3 (Proj. 2006).
- Fiscal balance, commitment basis (percent of GDP): 3.1 (2004); -3.5 (2005); -1.5 (Prel. Est.); -2.2 (Proj. 2006).
- Fiscal balance, cash basis (percent of GDP): -0.2 (2004); -4.8 (2005); -2.4 (Prel. Est.); -2.6 (Proj. 2006).
- Public debt (percent of GDP): 46.4 (2004); 37.8 (2005); 36.2 (Prel. Est.); 30.5 (Proj. 2006).
  - External debt (P&PG) (percent of GDP): 35.8 (2004); 29.4 (2005); 27.1 (Prel. Est.); 22.9 (Proj. 2006).

### Near-term macro framework and 2006 projections (selected)
- Real GDP growth projected at 6.4 percent in 2006 (staff projection in mid-report); elsewhere 2006 staff projections: 6.5 to 7.5 percent.
- Programmed deficit of 2.6 percent of GDP on a cash basis for 2006, assuming all remaining domestic arrears are cleared.
- Staff projects the deficit to decline to 1.1 percent of GDP (from 1.5 percent in 2005) under certain assumptions.
- Monetary program targets:
  - Reserve accumulation of about US$146 million in 2006, increasing non-pipeline import coverage to 2.3 months.
  - Reserve money growth limited to 25 percent.
  - Targeted decrease of CPI inflation to 4.7 percent by end-December 2006 (MEFP Table 2).

### 2006 budget: features and fiscal composition (selected)
- 2006 budget highlights:
  - Budgeted deficits: 2.2 percent of GDP (commitment basis), clearance of arrears budgeted at 0.4 percent of GDP yielding a cash-basis deficit of 2.6 percent of GDP.
  - Increase in current expenditures of 0.6 percent of GDP; decrease in capital expenditure of 0.5 percent of GDP.
  - Social spending projected to increase to about 9 percent of GDP (reflecting minimum pension increases and the targeted poverty benefit program scheduled for mid-2006).
  - Budget includes GEL 35 million in temporary energy subsidies to cushion private gas consumers from the 70 percent increase in gas tariffs, prior to introduction of the new poverty benefit.
- Revenue and financing assumptions:
  - 2006 budget includes conservative 19.3 percent of GDP revenue projection (prepared before 2005 outturns known).
  - Actual 2005 tax revenues amounted to 19.8 percent of GDP.
  - Authorities expect 2006 tax revenues to be about 1 percent of GDP higher than budgeted and intend to use excess revenues first to finance clearance of any additional verified arrears.
  - Grants expected to increase in 2006, partially offsetting declining privatization receipts: 2006 MCA disbursements comprise the majority of projected 1.3 percent of GDP in grants.
  - Privatization receipts projected at 2.6 percent of GDP.

### Monetary and exchange rate policies (selected exact figures)
- Reserve money growth target: 25 percent for 2006.
- Current reserve requirements: 2 percent for lari deposits and 13 percent for foreign currency deposits.
- NBG gross international reserves target: about US$620 million (2.3 months of non-pipeline imports projected).
- NBG operations: ready to use indirect instruments and sterilize FX interventions; plan to securitize some non-tradable government debt held by the central bank to increase instruments.

### Structural performance criteria and benchmarks (2005–2006 selected status)
- Submission of a new Customs Code to parliament (End-September 2005): Completed with a delay (submitted in October).
- Prepare a Medium Term Expenditure Framework (MTEF) for 2006-09 (End-September 2005): Observed.
- Formulate action plan to reduce number of regulatory bodies and licenses (End-September 2005): Observed (law adopted June 24).
- Prepare a strategy for reducing the number of import tariff bands and the maximum tariff rate and discuss in parliament (End-September 2005): Not observed (draft law submitted end-February 2006).
- Complete the transition to a treasury single account (End-December 2005): Observed (STA operational Jan 1, 2006).
- Upgrade Fit and Proper criteria for bank owners and managers (End-December 2005): Observed (amendments submitted in October).
- Complete electronic re-registration of taxpayers (End-December 2005): Not observed (70 percent of Tbilisi completed; remainder expected by end-March 2006).
- Introduce a targeted poverty benefit (End-December 2005): Not observed (postponed to July 2006; proposed as end-June 2006 performance criterion).
- Publish strategy paper on pension reform (End-December 2005): Observed (parliament approved legislation representing first steps).

### Quantitative performance criteria and indicative targets (selected exact cumulative figures from end-December 2004 basis)
- Floor on general govt. tax revenue (cumulative): 448.9; 963.6; 985.6; 1565.2; 1621.8; 2106.6; 2299.6
- Ceiling on cash deficit of the general govt. 3/ (cumulative): -30.4; 197.4; 215.9; 58.1; 418.7; 408.8; 141.9; 556.5; 535.7; 278.7
- Ceiling on change in domestic expenditure arrears (cumulative): -31.9; -60.6; -68.5; -95.6; -76.4; -149.2; -103.7
- Ceiling on net credit of the banking system to the general govt. (NCG) (cumulative): -52.6; -1.5; -148.0; 16.1; -119.7; 67.0; -106.1
- Ceiling on reserve money (cumulative): -27.4; 33.7; 42.8; 134.7; 96.9; 217.5; 164.9
- Floor on total net international reserves (NIR) of the NBG (cumulative): -2.4; 15.3; 75.8; 69.3; 81.3; 101.8; 122.9
- Ceiling on contracting or guaranteeing of external debt (nonconcessional medium- and long-term and short-term): 0.0 across listed periods.
- Ceiling on accumulation of external arrears: 0.0 across listed periods.
- Indicative target — Ceiling on net domestic assets (NDA) of the NBG (cumulative): -23.0; 5.5; -97.5; 6.4; -53.5; 29.2; -62.4
- Baseline assumption on external project financing (cumulative): 25.7; 95.7; 114.2; 175.6; 165.8; 270.1; 249.3
- Quantitative targets for 2005 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.

### Debt sustainability, alternative scenarios and bound tests (selected exact figures and outcomes)
- Baseline public sector debt (percent of GDP):
  - 2003: 60.8
  - 2004: 46.4
  - 2005: 41.1
  - 2006 (estimate): 34.3
  - 2011 (projection): 15.5
- NPV of public sector debt-to-revenue ratio:
  - 2003: 85.8
  - 2004: 57.4
  - 2005: 149.2
  - 2011: 42.9
- Key macro assumptions (selected):
  - Real GDP growth (in percent): 2003: 11.1; 2004: 6.2; 2005: 7.7; 2006–11 average: 4.7; 2016–25 average: 3.5
  - Average nominal interest rate on forex debt (in percent): 2003: 2.3; 2004: 1.2; 2005: 1.1; 2016–25 average: 1.0
  - Inflation rate (GDP deflator, in percent): 2003: 3.5; 2004: 9.6; 2005: 8.0; 2016–25 average: 3.0
  - Grant element of new external borrowing (in percent): 2003: 37.4; 2004: 34.0; 2005: 30.1
- Sensitivity analysis — major findings:
  - Export growth shock is the most critical exception: a return of export value growth from about 10 percent in 2005 to about 2 percent (historical average of 2 1/2 percent minus one standard deviation of about 1/2 percent) could, even if limited to 2 years, push NPV of debt-to-exports to more than 150 percent despite favorable financing assumptions (30 percent grant element).
  - Official reserves are low (about 2 months of non-pipeline imports); reserve shocks could erode exchange rate stability.
  - Long-run growth around 3 percent materially worsens debt dynamics.
  - Less favorable financing (interest on new borrowing higher by 2 percentage points) materially worsens external debt indicators in simulations.

### IMF–World Bank–Donor coordination and program linkages
- The Fund leads macroeconomic stability and fiscal reforms; World Bank leads structural issues, public expenditure management, and social sectors; IFC provides private sector and financial sector investment and technical assistance.
- World Bank CPS for FY06–09 endorsed September 15, 2005; IDA PRSO and multiple projects support infrastructure, public sector financial management, rural development, and social sectors.
- EBRD active in Georgia: as of December 31, 2005, EBRD cumulative commitments US$401.3 million; portfolio outstanding US$259.8 million.
- Technical assistance:
  - Extensive IMF TA missions across FAD, MFD, STA, LEG during 2001–05.
  - FSAP update mission visited Tbilisi in February 2006.

---

*Source: Executive Summary and selected sections, IMF Country Report _cr06175.*

### Executive Summary ......................................................................................................

### Executive Summary

### Developments Since the Rose Revolution
- The breakup of the Soviet Union resulted in a fall in real GDP in Georgia of almost 75 percent.
- From 2000 to 2003:
  - Real GDP growth averaged 5.8 percent.
  - CPI inflation averaged 4.8 percent.
  - Tax revenues averaged 13.2 percent of GDP.
  - The cash fiscal deficit was 1.8 percent.
  - Domestic arrears totaled 3.4 percent of GDP by end-2003.
- The Rose Revolution brought a new government in January 2004 that implemented an ambitious reform agenda, including:
  - Anti-corruption actions in tax and customs administration (firings, prosecutions, reparations payments), reorganization of the state tax department, and creation of a financial police.
  - Simplification and streamlining of the tax system to reduce regulatory burdens.
  - Public sector governance measures: civil service restructuring, strengthened management in state-owned enterprises, and reinvigorated privatization.
- Outcomes from restructuring:
  - Tax revenues rose by 3.7 percent of GDP in 2004 and by a further 1.6 percent in 2005.
  - The improved revenue performance enabled increased pensions, upgraded defense capacity, and arrears clearance while maintaining fiscal stability.
- Political context:
  - Reintegration of South Ossetia and Abkhazia remains a priority.
  - Relations with Russia are tense; Russia is Georgia’s largest trading partner and Georgia depends on Russia for gas and electricity.

### Recent Developments (2005)
- Growth and inflation:
  - Real GDP growth in 2005 is estimated at 7.7 percent.
  - Twelve-month CPI inflation hovered around 10 percent in the first half of 2005 and declined to 6.2 percent by end-2005.
  - The decline in inflation was aided by a much smaller-than-planned fiscal deficit that slowed money growth.
- Poverty (latest available 2004 data):
  - 52 percent of the population living under the official subsistence level.
  - 17 percent in extreme poverty.
- Fiscal outturns and composition (2005):
  - General government deficit was 2.4 percent of GDP in 2005 (budgeted at 4.8 percent).
  - Tax revenues rose to 19.8 percent of GDP.
  - Total expenditure and net lending increased from 18.6 percent of GDP in 2004 to 24.9 percent in 2005.
  - Current expenditures increased by 4.5 percent of GDP, notably transfers and subsidies to Legal Entities of Public Law (LEPLs) to buy defense goods.
  - Social spending increased from 7.1 percent of GDP in 2004 to 8.1 percent in 2005 (cash basis).
  - Defense spending increased from an estimated 1.6 percent to 3.5 percent of GDP (figures exclude defense-related expenditures by LEPLs for which no data are available; all such expenditures ceased since January 2006).
  - Privatization receipts of 3.6 percent of GDP financed the deficit, modest net foreign repayments, and an increase in government deposits with the National Bank of Georgia (NBG).
- Monetary and external sector:
  - Introduction of a reserve money target strengthened the monetary framework.
  - NBG gross international reserves increased by US$91 million in 2005 despite substantially lower capital inflows than in 2004.
  - The lari appreciated about 2 percent nominally against the U.S. dollar and in real effective terms during 2005.
  - International reserves remained at about 2 months of non-pipeline imports.
  - Remonetization continued.
  - Cooperation between the NBG and the treasury in forecasting liquidity improved, though unexpected government spending still causes swings in reserve money.
- Banking sector developments:
  - Returns to assets and equity rose in 2005.
  - Credit to the private sector grew 83 percent (from a low base).
  - Lari-denominated loans tripled; loan dollarization reduced by about 10 percentage points to 77 percent of total loans.
  - Deposit growth was 31 percent; deposit dollarization declined to 72 percent.
  - Non-performing loans fell from 6.2 percent at end-2004 to 3.8 percent at end-2005.
  - Consolidation: 3 banks merged or closed in 2005; number of banks later stood at 18 after a bank resolution in February 2006.
  - Banking supervision became more proactive; authorities resolved an insolvent bank through temporary administration and sale procedures in early 2006 with no significant depositor runs.
- Balance of payments and external financing:
  - A fiscal stance that was less expansionary by more than 2 percent of GDP compared with the budget helped prevent a projected widening of the current account deficit in 2005.
  - Lower-than-projected official disbursements and slower pipeline project implementation, and lower foreign direct investment in new pipelines, slowed import growth.
  - Preliminary data suggest export growth (net of a one-time adjustment for unregistered trade in 2004) also slowed.
- Debt treatment:
  - Georgia reached debt rescheduling agreements with most bilateral creditors on terms comparable to those offered by the Paris Club in July 2004.
  - The authorities requested the Paris Club extend the deadline for concluding remaining discussions to end-February 2006.
- Structural reforms advanced in several areas:
  - Fiscal:
    - Comprehensive tax reform effective in 2005: number of taxes reduced from 21 to 7; personal income tax unified at 12 percent (replacing 12–20 percent rates); VAT reduced from 20 to 18 percent; payroll tax reduced from 33 to 20 percent; exemptions and special regimes curtailed.
    - Revenue administration improvements continued.
    - Treasury reforms continued; Single Treasury Account (STA) became fully operational in early 2006 (LEPLs operate outside the STA).
    - Progress toward GFSM 2001 compliance by early 2007; first Medium-Term Expenditure Framework (MTEF) produced in 2005 with further work needed.
    - A new customs code was submitted to parliament in October 2005.
  - Banking:
    - NBG started developing a financial sector development strategy for the medium term.
    - Proposal to eliminate restrictions limiting nonbank shareholders to 25 percent of equity in Georgian banks.
    - Major banks created a credit information bureau.
  - Energy:
    - Quasi-fiscal losses declined from 4.5 percent of GDP in 2004 to an estimated 4 percent in 2005 due mainly to increased collections from communal metering and reinforced payment discipline.
  - Business environment:
    - Law passed in June 2005 reducing licensed businesses from 900 to 150 and introducing “one-window” approvals and the “silence is consent” principle to reduce processing time.

- Box finding on competitiveness:
  - Georgia’s real exchange rate (RER) appreciated over the past 24 months due to strong real GDP growth and foreign exchange inflows (FDI and repatriation of savings).
  - RER appreciation has begun to affect external competitiveness: the share of Georgian exports in trading partners’ import markets started to decline in early 2005.
  - Cost of doing business indicators remain poor compared to neighbors, although U.S. dollar wages are the lowest in the region.
  - The RER is most likely still undervalued, and two recent studies indicate marked productivity improvements in 2004–05.

### Performance Under the Program
- Overall assessment:
  - Performance under the program has been good.
  - All but one quantitative performance criteria were met.
  - The target on arrears clearance was missed due to concerns about inflation; authorities are committed to clear the entire stock by end-2006.
  - The structural performance criterion on submission of a new customs code was delayed to allow more time for discussions with the business community.
  - The authorities requested completion of the third review under the arrangement and waivers for the missed performance criteria.

### Program Focus and Policy Settings for 2006
- Medium-term prospects:
  - Economic prospects over the medium term are favorable; robust growth is likely to continue.
  - Policy focus on removing obstacles to growth, including:
    - A public investment program addressing infrastructure needs (roads and power supply).
    - A financial sector development strategy to increase the sector’s contribution to growth.
    - Measures to improve institutional quality and reduce rent-seeking opportunities affecting private sector investment.
- Fiscal policy (2006):
  - Fiscal deficit is to be maintained broadly unchanged while increasing social expenditures.
  - Social measures include higher minimum pensions and a targeted poverty benefit program scheduled for implementation in mid-2006.
- Monetary policy (2006):
  - Monetary program targets reserve money growth of 25 percent for the year.
  - Authorities’ inflation objective is 5 percent by end-2006.
  - Target for further reserve accumulation to 2.3 months of import coverage.
  - Efforts underway to strengthen the NBG’s ability to conduct monetary operations and control inflation, and to improve coordination between the NBG and ministry of finance.
- Fiscal transparency and governance:
  - Authorities are developing guidelines for monitoring and reporting activities of all central government Legal Entities of Public Law (LEPLs).
  - A Banking System Development Strategy for 2006–09 is under preparation.

### Risks and Policy Priorities
- Main risks to the medium-term outlook:
  - Election pressures with significant elections scheduled for each of the next three years.
  - Political tensions regarding the status of Abkhazia and South Ossetia.
  - Energy sector vulnerabilities.
- Governance:
  - Important to implement further measures to improve governance, building on progress made in recent years.

### Overall Appraisal
- Georgia has made substantial progress in creating a sound policy framework.
- The authorities’ strong record of accomplishment bodes well for continued successful implementation of the program.

*Source: Executive Summary, IMF Country Report _cr06175.*

### 14.      The program is broadly on track, with only one missed quantitative

### 14.      The program is broadly on track, with only one missed quantitative performance criterion

### Overall program implementation and macro performance
- Program broadly on track with only one missed quantitative performance criterion (Table 8).
- Fiscal outturns stronger than programmed:
  - Tax revenues well above program levels offset expenditures slightly above program levels.
- Monetary outcomes:
  - After slightly exceeding the June indicative reserve money target, the NBG contained reserve money growth and observed the end-September quantitative performance criterion and end-December indicative targets on reserve money by wide margins.
  - NIR targets were met comfortably.
- Arrears clearance missed:
  - Authorities cleared arrears of GEL 104 million (0.9 percent of GDP) in 2005, versus the programmed GEL 149 million (1.3 percent of GDP).
  - The September performance criterion for clearance of domestic expenditure arrears and the indicative target for the year were missed.

### Structural performance and benchmarks
- End-September structural performance criteria:
  - One end-September structural performance criterion was met.
  - Submission of the Customs Code to parliament was implemented with a short delay (Table 9).
- Structural benchmarks:
  - Two of three end-September structural benchmarks were met.
  - Missed benchmark: submission of the trade liberalization strategy delayed to allow business community comment and consideration of more radical liberalization.
    - Resulting strategy: reduce top tariff rate from 30 to 12 percent in 2006, 5 percent in 2007, and eliminate import tariffs by 2008.
  - End-December performance criterion met for completing transition to the single treasury account.
  - Benchmarks met: propose upgraded “Fit and Proper” criteria for bank owners; prepare a pension strategy.
  - Missed two of five end-2005 benchmarks.
  - Introduction of targeted poverty benefits delayed; proposed as a performance criterion for end-June 2006.
  - Registering taxpayers benchmark is underway.

### Medium-term prospects, public investment, and fiscal planning
- Authorities assess medium-term prospects as strong (Table 10).
- Public investment program focus:
  - Improving roads and power supply considered key to maintaining growth.
- Fiscal planning and medium-term frameworks:
  - Authorities seek to improve the Basic Data and Directions (BDD) document (equivalent of an MTEF).
  - Four supplementary budgets in 2005 considered positive reflection of strong revenue and privatization performance.
  - Discussions on tying expenditure policy to a well prioritized medium-term strategy.

### Financial sector strategy and governance
- NBG and government preparing a financial sector development strategy for 2006–09 focusing on:
  - Streamlining cumbersome regulations and harmonizing with Basle principles.
  - Consolidating NBG's functions and independence.
  - Refining the payments system.
  - Introducing measures to develop capital markets, including for government securities.
  - Easing the entrance of foreign banks into Georgia.
- Governance and judicial reforms:
  - Further reforms, particularly in the judicial area, are needed despite progress on reducing corruption and improving governance.
  - Trade liberalization strategy eliminating all tariffs by 2008 viewed as key to integrate Georgia into the global economy.

### Main challenges and risks
- Key challenge: maintain macroeconomic stability amid significant inflows, election pressures, and regional tensions.
- Sources of inflows and support:
  - Privatization proceeds, remittances, official assistance, and grants from the Millennium Challenge Account (MCA) expected to finance rural infrastructure and energy rehabilitation.
- Policy implications:
  - Controlling inflation will rely on monetary policy.
  - Need to strengthen NBG’s ability to conduct monetary operations and improve coordination between NBG and ministry of finance.
  - Regional tensions and political uncertainties present risks to sustainable medium-term growth.

### Near-term macroeconomic framework and projections (2006)
- Real GDP growth projected at 6.4 percent in 2006 (assumes agricultural slowdown to sustainable level and high oil and gas prices).
- Fiscal stance and deficits:
  - Programmed deficit of 2.6 percent of GDP on a cash basis, assuming all remaining domestic arrears are cleared.
  - Budget projects fiscal deficit on a commitment basis to increase to 2.2 percent of GDP.
  - Staff projects the deficit to decline to 1.1 percent of GDP (from 1.5 percent in 2005).
- Monetary program targets:
  - Reserve accumulation of about US$146 million in 2006, increasing non-pipeline import coverage to 2.3 months.
  - Reserve money growth limited to 25 percent.
  - Targeted decrease of CPI inflation to 4.7 percent by end-December 2006 (MEFP Table 2).

### 2006 budget: features and fiscal composition
- Key features:
  - Fiscal framework in line with the PRSP and MTEF.
  - Financing from privatization proceeds and concessional resources.
  - Conservative tax revenue projections given 2004 tax administration improvements and 2005 tax reform.
  - Focus on quality and sustainability of increased expenditures on infrastructure, energy, and defense; replace untargeted social programs with targeted extreme poverty benefits.
- Budgeted deficits and arrears:
  - 2006 budget envisages roughly unchanged fiscal stance: deficit of 2.2 percent of GDP on a commitment basis.
  - Clearance of arrears budgeted at 0.4 percent of GDP, yielding a deficit of 2.6 percent of GDP on a cash basis.
- Expenditure composition:
  - Increase in current expenditures of 0.6 percent of GDP.
  - Decrease in capital expenditure of 0.5 percent of GDP.
  - Wage bill expected roughly unchanged as a share of GDP.
  - Defense spending to decline slightly.
  - Social spending projected to increase to about 9 percent of GDP (reflecting minimum pension increases and the targeted poverty benefit program scheduled for mid-2006).
  - Budget includes GEL 35 million in temporary energy subsidies to cushion private gas consumers from the 70 percent increase in gas tariffs, prior to introduction of the new poverty benefit.
- Revenue and financing assumptions:
  - 2006 budget includes conservative 19.3 percent of GDP revenue projection (prepared before 2005 outturns known).
  - Actual 2005 tax revenues amounted to 19.8 percent of GDP.
  - Authorities expect 2006 tax revenues to be about 1 percent of GDP higher than budgeted and intend to use excess revenues first to finance clearance of any additional verified arrears (plan to resolve all arrears claims outstanding as of end-2005 by end-2006; MEFP paragraph 16 and Table 1; planned structural performance criterion for end-December 2006).
  - Despite reductions in customs duties, import taxes expected unchanged as a percentage of GDP due to reduced smuggling.
  - Grants expected to increase in 2006, partially offsetting declining privatization receipts:
    - 2006 MCA disbursements comprise the majority of projected 1.3 percent of GDP in grants.
    - Privatization receipts projected at 2.6 percent of GDP.

### Monetary and exchange rate policies
- 2006 monetary program targets reserve money growth at 25 percent, consistent with single-digit inflation objective (Box 2, MEFP paragraph 32).
- No direct central bank borrowing foreseen; authorities intend to introduce legislation prohibiting any such borrowing in the future (end-March performance criterion).
- NBG operations and instruments:
  - NBG ready to use indirect monetary policy instruments more actively, including sterilizing foreign exchange interventions.
  - Ministry of finance and NBG nearing agreement on securitizing some non-tradable government debt held by the central bank (MEFP, paragraph 33) to increase stock of instruments.
  - In event of unexpected capital inflows, NBG will sell treasury bills and central bank CDs to contain monetary expansion from foreign exchange purchases.
  - Plans to streamline reserve requirements by equalizing requirements for domestic and foreign-currency deposits as dedollarization continues.
- Current reserve requirements: 2 percent for lari deposits and 13 percent for foreign currency deposits.
- Box 2: discussion of inflation targeting prerequisites and NBG preparedness (price stability objective, central bank independence, accountability, transmission mechanism, econometric modelling, public communication).

### External competitiveness
- CPI-based real exchange rate and low labor costs suggest the lari may be undervalued.
- Upward pressure on the exchange rate from international financial support and FDI could be accommodated.
- Surveys of cost of doing business suggest external competitiveness may be weaker than real exchange rate comparisons indicate.
- Authorities committed to a floating exchange rate regime and to refrain from intervention other than to smooth market fluctuations, but concerned about negative impact of lari appreciation on exports and household U.S. dollar exposures.

### Structural reforms, transparency, and LEPL reform
- Fiscal transparency improvements since 2004, but concerns about quasi-fiscal funds outside the budget with limited accountability:
  - Two funds (Armed Forces Fund and Law Enforcement Fund) formed in early 2004 are now closed and being liquidated (MEFP, paragraph 30).
  - Reform and Development Fund transformed into an NGO.
- LEPL (Legal Entities of Public Law) reform:
  - Authorities undertaking reforms of LEPLs as cornerstone of decentralization strategy.
  - Need for urgent monitoring and reporting framework to maintain fiscal transparency and accountability (MEFP, paragraph 29).
  - Agreed progress will be reviewed in context of fourth review of Georgia’s PRGF arrangement.
- LEPL scale and risks:
  - Between 1999 and 2003 an estimated 700 budgetary organizations converted to LEPLs.
  - In December 2005 about 2,700 individual schools converted to LEPLs, bringing estimated number to more than 3,400.
  - Main fiscal risks associated with LEPL reform include:
    - Weakening monitoring and reporting of general government fiscal accounts, with implications for budget transparency and control.
    - Delegation of authority creating problems controlling quality of spending, as LEPLs have less developed Public Expenditure Management systems.
    - Significant risk that LEPLs may incur debt and arrears.

### Public financial management and tax administration
- Authorities emphasize upgrading the Budget Systems Law (BSL) to organic status after passing certain technical amendments; intend to be GFS 2001 compliant by 2007.
- Ministry of finance tax administration priorities:
  - (i) self-assessment;
  - (ii) risk management;
  - (iii) taxpayer segmentation.
- An FAD regional tax administration advisor will assist authorities.
- Customs code judged a significant improvement; staff urged strengthening penalty provisions and authorities agreed to consider the recommendation.

### Financial sector supervision and safety nets
- NBG plans further financial sector reforms (Box 4) including strengthening supervision (MEFP paragraphs 34–39).
- Consideration being given to introduction of deposit insurance, contingent on appropriate preconditions.
- Authorities believe sector consolidation (merging or closing weak banks) is important prior to deposit insurance introduction.
- An FSAP update is underway; authorities plan to implement recommendations, to be reflected in an FSSA to be presented to the Board with the fourth review.

*IMF staff report discussion summary.*

### Box 4. Developing the Financial Sector in Georgia

### Box 4. Developing the Financial Sector in Georgia

### Current state of the financial sector
- Financial sector development in Georgia has lagged behind many other transition countries.
- Monetization was low after independence, trailing the levels in Central and Eastern European economies and the Baltics.
- Financial intermediation is shallow.
- Commercial banks have targeted activities to a small group of companies and consumers, resulting in lower private sector credit than in comparable countries.

### Recent developments and credit boom
- Since end-2004, commercial banks’ lending to the private sector has increased by more than 80 percent—albeit from very low levels.
- Some of the additional loans are consumption-related or mortgages, fuelling property prices in Tbilisi.
- Over the last year, increased confidence in the Georgian banking system, higher consumer spending, and emerging business opportunities have triggered a credit boom.

### Importance for growth and required reforms
- A stronger financial sector will be essential to sustain recent economic development.
- Greater financial intermediation, particularly benefiting small- and medium-sized enterprises, should spur investment and job creation.
- As firms’ financing needs go beyond retained earnings, and equity financing is not viable given shallow equity markets, the banking sector will play a crucial role.
- For the financial sector in Georgia to catch up with advanced transition economies, reforms need to gain momentum, including:
  - greater consolidation and foreign entry,
  - enhanced creditors’ rights,
  - increasing minimum capital requirements,
  - implementing fit and proper ownership requirements,
  - strong and effective banking supervision,
  - adoption of forthcoming FSAP recommendations.

### Key statistics (Table 1. Selected Transition Economies: Financial Sector Development, 1996–2005; In percent of GDP)
- Banking system credit to economy — Georgia:
  - 1996: 3.3
  - 1998: 4.7
  - 2000: 7.3
  - 2002: 8.3
  - 2004: 9.5
  - 2005 Est.: 15.0
- Banking system credit to economy — Selected CEE 1/:
  - 1996: 36.5
  - 1998: 35.4
  - 2000: 35.8
  - 2002: 31.3
  - 2004: 35.5
  - 2005 Est.: 39.0
- Banking system credit to economy — Baltics 2/:
  - 1996: 11.8
  - 1998: 16.1
  - 2000: 17.5
  - 2002: 22.4
  - 2004: 37.6
  - 2005 Est.: 54.1
- Monetization 3/ — Georgia:
  - 1996: 6.7
  - 1998: 7.3
  - 2000: 10.3
  - 2002: 11.6
  - 2004: 15.2
  - 2005 Est.: 16.5
- Monetization 3/ — Selected CEE 1/:
  - 1996: 49.7
  - 1998: 48.0
  - 2000: 51.1
  - 2002: 53.6
  - 2004: 53.3
  - 2005 Est.: 55.4
- Monetization 3/ — Baltics 2/:
  - 1996: 21.6
  - 1998: 23.6
  - 2000: 28.9
  - 2002: 33.6
  - 2004: 38.7
  - 2005 Est.: 47.6
- Sources: International Monetary Fund, IFS, WEO, and MCD centralized databases.
- Notes:
  - 1/ Includes Poland, Czech Republic, Hungary; simple average.
  - 2/ Includes Estonia, Latvia, Lithuania; simple average.
  - 3/ M3 where available, M2 otherwise.

### Policy recommendations and implementation priorities
- Ensure strong and effective banking supervision to preserve sector health amid rapid expansion.
- Increase minimum capital requirements and allow foreign banks to enter and further consolidate the sector.
- Implement fit and proper ownership requirements.
- Adopt FSAP recommendations to strengthen the financial sector.
- Deepen financial intermediation to support SMEs, investment, and job creation.
- Complement financial-sector reforms with broader structural reforms to sustain competitiveness and medium-term growth.

*Source: _cr06175 - Box 4. Developing the Financial Sector in Georgia*

### 53.      Given Georgia’s good overall performance under the program, and commitments

### _cr06175 - 53.      Given Georgia’s good overall performance under the program, and commitments

### Program decision and IMF staff recommendation
- Staff supports the authorities’ request for waivers for the nonobservance of performance criteria.
- Staff recommends completion of the third review of the PRGF arrangement.
- It is proposed that the next Article IV consultations be held in the 24-month cycle.

### Key macroeconomic outcomes and projections (selected)
- Nominal GDP (millions of lari): 9,970 (2004); 11,660 (2005); 11,600 (Prel. Est.); 13,080 (Proj. 2006).
- Nominal GDP (US$ million): 5,193 (2004); 6,303 (2005); 6,409 (Prel. Est.); 7,522 (Proj. 2006).
- Real GDP growth: 6.2 (2004); 6.4 (2005); 7.7 (Prel. Est.); 6.4 (Proj. 2006).
- Population (1/ excludes Abkhazia residents): 4.3 (2004); 4.3 (2005); 4.3 (Prel. Est.); 4.3 (Proj. 2006).
- Consumer price index, period average: 5.7 (2004); 9.4 (2005); 8.3 (Prel. Est.); 5.3 (Proj. 2006).
- Consumer price index, end-of-period: 7.5 (2004); 7.0 (2005); 6.2 (Prel. Est.); 4.7 (Proj. 2006).
- GDP/capita (US$): 1,203 (2004); 1,461 (2005); 1,485 (Prel. Est.); 1,743 (Proj. 2006).
- Poverty rate (in percent): 52.7 (2004).
- Unemployment rate: 12.6 (2004).
- Investment (percent of GDP): 26.6 (2004); 28.9 (2005); 26.4 (Prel. Est.); 26.6 (Proj. 2006).
  - Public investment: 2.4 (2004); 5.5 (2005); 4.2 (Prel. Est.); 3.8 (Proj. 2006).
  - Private investment: 24.2 (2004); 23.4 (2005); 22.1 (Prel. Est.); 22.8 (Proj. 2006).
- Gross domestic saving (percent of GDP): 18.3 (2004); 17.1 (2005); 19.0 (Prel. Est.); 19.4 (Proj. 2006).
- Saving-Investment balance: -8.3 (2004); -11.8 (2005); -7.4 (Prel. Est.); -7.1 (Proj. 2006).

### Fiscal sector (selected)
- Total revenue and grants (percent of GDP): 21.7 (2004); 21.7 (2005); 23.4 (Prel. Est.); 22.9 (Proj. 2006).
  - Tax revenue: 18.2 (2004); 18.1 (2005); 19.8 (Prel. Est.); 19.3 (Proj. 2006).
- Total expenditure and net lending (percent of GDP): 18.6 (2004); 25.2 (2005); 24.9 (Prel. Est.); 25.0 (Proj. 2006).
  - Current expenditure: 16.2 (2004); 19.7 (2005); 20.7 (Prel. Est.); 21.3 (Proj. 2006).
- Primary balance (percent of GDP): 4.3 (2004); -2.4 (2005); -0.5 (Prel. Est.); -1.3 (Proj. 2006).
- Fiscal balance, commitment basis (percent of GDP): 3.1 (2004); -3.5 (2005); -1.5 (Prel. Est.); -2.2 (Proj. 2006).
- Net change in expenditure arrears: -2.6 (2004); -1.3 (2005); -0.9 (Prel. Est.); -0.4 (Proj. 2006).
- Fiscal balance, cash basis (percent of GDP): -0.2 (2004); -4.8 (2005); -2.4 (Prel. Est.); -2.6 (Proj. 2006).
- Financing (percent of GDP): 0.2 (2004); 4.8 (2005); 2.4 (Prel. Est.); 2.6 (Proj. 2006).
  - Privatization: 0.9 (2004); 3.4 (2005); 3.6 (Prel. Est.); 2.6 (Proj. 2006).
  - External financing: 0.2 (2004); 0.8 (2005); -0.3 (Prel. Est.); -0.2 (Proj. 2006).
  - Domestic financing: -0.9 (2004); 0.6 (2005); -0.9 (Prel. Est.); 0.3 (Proj. 2006).
- Public debt (percent of GDP): 46.4 (2004); 37.8 (2005); 36.2 (Prel. Est.); 30.5 (Proj. 2006).
  - External debt (P&PG) (percent of GDP): 35.8 (2004); 29.4 (2005); 27.1 (Prel. Est.); 22.9 (Proj. 2006).

### External sector and reserves
- Exports of goods and services (percent of GDP): 55.0 (2004); 34.2 (2005); 34.1 (Prel. Est.); 31.2 (Proj. 2006).
  - Annual percentage change in exports: 48.7 (2004); 9.6 (2005); 11.0 (Prel. Est.); 7.5 (Proj. 2006).
- Imports of goods and services (percent of GDP): 51.4 (2004); 52.4 (2005); 47.3 (Prel. Est.); 44.3 (Proj. 2006).
  - Annual percentage change in imports: 46.9 (2004); 23.7 (2005); 13.7 (Prel. Est.); 9.7 (Proj. 2006).
- Net imports of oil: 233 (2004); 304 (2005); 326 (Prel. Est.); 389 (Proj. 2006).
- Current account balance (US$ million): -429 (2004); -742 (2005); -472 (Prel. Est.); -537 (Proj. 2006).
  - In percent of GDP: -8.3 (2004); -11.8 (2005); -7.4 (Prel. Est.); -7.1 (Proj. 2006).
- Gross international reserves (US$ million): 383 (2004); 493 (2005); 474 (Prel. Est.); 620 (Proj. 2006).
  - In months of imports of goods and services (excl. pipeline imports): 2.0 (2004); 2.0 (2005); 2.1 (Prel. Est.); 2.3 (Proj. 2006).
- Foreign direct investment (US$ million): 50 (2004); 37 (2005); 31 (Prel. Est.); 41 (Proj. 2006).
- Average exchange rate (lari per dollar): 1.9 (2004); 1.8 (2005).

### Government operations (selected quarterly and annual figures, in millions of lari)
- Total revenue and grants (2004 total): 2166; Total revenue (2004 total): 2042.
- Tax revenue (2004 total): 1811.
- Total expenditure and net lending (2004 total): 1853.
- Current expenditure (2004 total): 1618.
- Wages and salaries (2004 total): 312.
- Capital expenditure (2004 total): 208.
- Overall balance (commitments) (2004): 313.
- Net change in expenditure arrears (2004): -259.
- Overall balance (cash) (2004): -243.
- Privatization receipts (2004): 87 (quarteral entries reflect privatization proceeds across quarters).

### National Bank of Georgia (NBG) accounts and monetary aggregates (selected)
- Reserve money growth (annual percent): 13.9 (2003); 44.3 (2004); 44.3 (Dec. 2004); projected 25.0 (Dec. 2006).
- Reserve money (RM) levels (millions of lari): 580 (Dec. 2003); 837 (Dec. 2004); 1,252 (Dec. 2005); 1,252 (Dec. 2006 proj. listed as 1,252).
- Net foreign assets (US$ million, foreign exchange reserves): 192 (Dec. 2003); 373 (Dec. 2004); 367 (Dec. 2005); 620 (Dec. 2006).
- Broad money (M3) growth (percent, year-over-year): 22.8 (2003); 42.6 (2004); 42.6 (Dec. 2004); 29.0 (Dec. 2006 proj.).
- Broad money (M3) levels (millions of lari): 1,060 (Dec. 2003); 1,512 (Dec. 2004); 2,465 (Dec. 2006 proj.).
- Foreign exchange deposits in percent of total deposits: 86.1 (2003); 74.3 (2004); 69.0 (Dec. 2006 proj.).
- M2 multiplier: 0.91 (2003); 1.01 (Dec. 2004); 1.13 (Dec. 2005); 1.13/1.14–1.97 noted series across periods.

### Banking sector prudential indicators (end-of-period, selected)
- Capital adequacy ratio (percent): 20.3 (2003); 18.8 (2004); 18.3 (2005).
- Leverage ratio 1/: 33.5 (2003); 27.9 (2004); 29.3 (2005).
- Nonperforming loans (percent of total loans): 7.5 (2003); 6.2 (2004); 5.8 (2005).
- Specific provisions (percent): 4.5 (2003); 4.3 (2004); 4.1 (2005).
- Loans collateralized by real estate (percent): 31.9 (2003); 33.5 (2004); 34.7 (2005).
- Loans in foreign exchange (percent): 87.7 (2003); 86.7 (2004); 81.9 (2005).
- Liquidity ratio (percent): 43.3 (2003); 45.0 (2004); 39.1 (2005).

### Balance of payments and medium-term outlook (selected)
- Current account balance (US$ million): -293 (2003); -429 (2004); -742 (2005); -472 (Prel. Est. 2005); -537 (Proj. 2006).
- Trade balance (US$ million): -598 (2003); -719 (2004); -1,235 (2005); -907 (Prel. Est.); -1,048 (Proj. 2006).
- Exports (US$ million): 730 (2003); 1,272 (2004); 1,386 (2005); 1,403 (Prel. Est.); 1,522 (Proj. 2006).
- Imports (US$ million): -1,328 (2003); -1,991 (2004); -2,620 (2005); -2,310 (Prel. Est.); -2,570 (Proj. 2006).
- Gross international reserves (US$ million, memorandum): 191 (2003); 383 (2004); 493 (2005); 474 (Prel. Est.); 620 (Proj. 2006).
- Nominal GDP (US$ billion, memorandum): 5.1 (2003); 5.2 (2004); 6.3 (2005); 6.4 (Prel. Est.); 7.5 (Proj. 2006).

### Millennium Development Goals (selected indicators)
- Population (millions): 5.4 (1990); 5.1 (1995); 4.5 (2000); 4.4 (2003).
- Gross domestic product (US$ billion): 5.1 (1990); 2.1 (1995); 3.0 (2000); 4.0 (2003).
- GDP per capita (US$): 940 (1990); 410 (1995); 686 (2000); 917 (2003).
- Infant mortality rate (per 1,000 live births): 43 (1990); 41 (1995); 41 (2000); 41 (2003).
- Immunization, measles (percent of children under 12 months): 63 (1995); 73 (2000); 73 (2003).
- Access to an improved water source (percent of population): 76 (2003).
- Access to improved sanitation (percent of population): 83 (2003).
- Fixed line and mobile telephones (per 1,000 people): 98.9 (1990); 102.3 (1995); 140.2 (2000); 239.7 (2003).
- Public and publicly guaranteed external debt (percent of GDP): ...64.1 (1995); 51.3 (2000); 46.4 (2003).
- Investment (percent of GDP): 29.1 (1990); 23.9 (1995); 21.6 (2000); 24.4 (2003).
- Trade (percent of GDP) 2/: 85.6 (1990); 67.9 (1995); 81.2 (2000); 78.8 (2003).

*Sources: Georgian authorities; and Fund staff estimates.*

### 1.  Quantitative targets

### 1. Quantitative targets

### Quantitative performance criteria and indicative targets (cumulative changes from end-December 2004)
- Floor on general govt. tax revenue:
  - 448.9; 963.6; 985.6; 1565.2; 1621.8; 2106.6; 2299.6
- Ceiling on cash deficit of the general govt. 3/:
  - -30.4; 197.4; 215.9; 58.1; 418.7; 408.8; 141.9; 556.5; 535.7; 278.7
- Ceiling on change in domestic expenditure arrears of the general govt.:
  - -31.9; -60.6; -68.5; -95.6; -76.4; -149.2; -103.7
- Ceiling on net credit of the banking system to the general govt. (NCG):
  - -52.6; -1.5; -148.0; 16.1; -119.7; 67.0; -106.1
- Ceiling on reserve money:
  - -27.4; 33.7; 42.8; 134.7; 96.9; 217.5; 164.9
- Floor on total net international reserves (NIR) of the NBG:
  - -2.4; 15.3; 75.8; 69.3; 81.3; 101.8; 122.9
- Ceiling on contracting or guaranteeing of external debt:
  - A. Nonconcessional medium- and long-term external debt: 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
  - B. Short-term external debt (less than one year): 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0
- Ceiling on accumulation of external arrears:
  - 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0

### Indicative target
- Ceiling on net domestic assets (NDA) of the NBG:
  - -23.0; 5.5; -97.5; 6.4; -53.5; 29.2; -62.4

### Baseline assumption on external project financing 3/
- 25.7; 95.7; 114.2; 175.6; 165.8; 270.1; 249.3

Notes from table text:
- Quantitative targets for 2005 are based on accounting exchange rates of GEL 1.85/US$, US$1.46/SDR, and US$1.21/EUR.
- (In millions of lari), (In millions of U.S. dollars), (In millions of lari)
- Section 1 of this table shows quantitative targets for 2005 based on cumulative changes from end-December 2004.
- The ceiling for the cash deficit of the government is adjusted, as indicated in footnote 3, for deviations from projected external financing, reported in Section 3 of the table.
- The continuous performance criterion for external arrears is defined in paragraph 21 of the July 2005 TMU.
- 3/ The program target on the cash deficit is adjusted in 2005 for deviations from projected disbursements of external project finance (Section 3) as specified in the July 2005 TMU, subject to a cap on the cumulative upward adjustment of GEL 100 million for 2005.

### Source line for table figures
- Sources: Georgian authorities; and Fund staff estimates.

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### Structural performance criteria and benchmarks, 2005
- Measure 1: Submit a new Customs Code to parliament, harmonized with basic EU norms and standards and incorporating FAD recommendations (End-September 2005 (*))
  - Status: Completed with a delay
  - Comments: The customs code was submitted to parliament in October.
- Measure 2: Prepare a Medium Term Expenditure Framework (MTEF) for 2006-09 as part of the Basic Data and Directions document (End-September 2005 (*))
  - Status: Observed
  - Comments: The 2006 budget includes the medium-term expenditure framework for 2006–09.
- Measure 3: Formulate an action plan to reduce significantly the number of regulatory bodies and licenses required by private firms (End-September 2005)
  - Status: Observed
  - Comments: The law reducing significantly the number of regulatory bodies and licenses was adopted by parliament and signed by the president on June 24.
- Measure 4: Publish 2004 oil and gas transit revenue according to international transparency standards (End-September 2005)
  - Status: Observed
  - Comments: Gas transit revenues were posted on the GGIC website as of July 23 and oil transit revenues were published in the newspaper Sakartvelos Respublika on September 15, 2005.
- Measure 5: Prepare a strategy for reducing the number of import tariff bands and the maximum tariff rate and discuss in parliament (End-September 2005)
  - Status: Not observed
  - Comments: The draft law devising the new tariff regime was submitted to parliament at end-February 2006.
- Measure 6: Upgrade the Fit and Proper criteria for bank owners and managers to international standards, by submitting revisions to commercial banking law and related decrees (End-December 2005)
  - Status: Observed
  - Comments: The necessary amendments to the commercial banking law were submitted to parliament in October. Changes to supporting regulations will be completed once parliament approves the amendments.
- Measure 7: Complete the transition to a treasury single account for central government expenditures and revenues (End-December 2005 (*))
  - Status: Observed
  - Comments: On January 1, 2006 the treasury moved to the Single Treasury Account for general government revenues and central government expenditures.
- Measure 8: Complete electronic re-registration of existing taxpayers and registration of new taxpayers (End-December 2005)
  - Status: Not observed
  - Comments: The re-registration has been completed for regions and in 70 percent of Tbilisi. The authorities expect to complete the remainder by end-March 2006.
- Measure 9: Introduce a targeted poverty benefit to replace numerous in-kind benefits (End-December 2005)
  - Status: Not observed
  - Comments: The authorities have postponed implementation of the benefit scheme until July 2006.
- Measure 10: Publish a strategy paper on pension reform to put the social security system on a sounder fiscal footing (End-December 2005)
  - Status: Observed
  - Comments: Parliament approved legislation that represents the first steps toward pension reform.

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### Macroeconomic framework, 2004–09 (selected indicators)
- Real GDP (percent change):
  - 6.2; 8.5; 7.7; 6.4; 5.0; 5.0; 5.0 (2004–09 sequence)
- Consumer price index (average):
  - 5.7; 9.4; 8.3; 5.3; 4.0; 4.0; 4.0
- Broad money (M3, lari):
  - 42.6; 31.8; 26.4; 29.0; 15.8; 15.5; 16.6
- Exports (US$):
  - 74.1; 9.6; 10.3; 8.5; 8.1; 7.5; 6.9
- Imports (US$) 1/:
  - 49.9; 30.0; 16.0; 11.3; 4.2; 5.3; 6.1

General government (percent of GDP):
- Total revenues and grants:
  - 21.7; 21.7; 23.4; 22.9; 25.0; 24.8; 25.1
- Tax revenues:
  - 18.2; 18.1; 19.8; 19.3; 21.0; 21.5; 22.0
- Nontax revenues 2/:
  - 2.3; 2.5; 2.7; 2.2; 1.8; 1.6; 1.6
- Grants:
  - 1.2; 1.2; 0.9; 1.3; 2.2; 1.7; 1.5
- Expenditures and net lending:
  - 18.6; 25.2; 24.9; 25.0; 25.3; 25.6; 26.0
- Current expenditure:
  - 16.2; 19.7; 20.7; 21.3; 21.3; 21.7; 22.1
- Noninterest:
  - 15.9; 18.6; 19.7; 20.3; 20.5; 21.0; 21.5
- Interest:
  - 1.2; 1.0; 1.0; 0.9; 0.8; 0.8; 0.7
- Capital expenditure and net lending:
  - 2.4; 5.5; 4.2; 3.8; 4.0; 3.9; 3.9
- Primary balance:
  - 4.3; -2.4; -0.5; -1.3; 0.5; 0.0; -0.2
- Overall balance (commitment basis):
  - 3.1; -3.5; -1.5; -2.2; -0.3; -0.8; -0.9
- Net change in expenditure arrears:
  - -2.6; -1.3; -0.9; -0.4; 0.0; 0.0; 0.0
- Overall balance (cash basis):
  - -0.2; -4.8; -2.4; -2.6; -0.3; -0.8; -0.9

Financing (percent of GDP):
- Financing:
  - 0.2; 4.8; 2.4; 2.6; 0.3; 0.8; 0.9
- Privatization:
  - 0.9; 3.4; 3.6; 2.6; 0.7; 0.3; 0.1
- Domestic financing:
  - -0.9; 0.6; -0.9; 0.3; 0.4; 0.0; 0.1
- External financing (net):
  - 0.2; 0.8; -0.3; -0.2; -0.5; 0.5; 0.7
- Disbursements (incl. in-kind):
  - 1.2; 2.3; 1.1; 1.4; 1.4; 1.3; 1.1
- Amortization:
  - -1.5; -1.5; -1.4; -1.6; -1.9; -0.8; -0.5

Saving and investment:
- Investment:
  - 26.6; 28.9; 26.4; 26.6; 26.2; 26.4; 26.4
- General government:
  - 2.4; 5.5; 4.2; 3.8; 4.0; 3.9; 3.9
- Nongovernment sector 1/:
  - 24.2; 23.4; 22.1; 22.8; 22.3; 22.5; 22.5
- Of which: FDI:
  - 9.7; 11.6; 6.5; 5.2; 2.8; 2.3; 1.9
- Gross domestic saving:
  - 18.3; 17.1; 19.0; 19.4; 20.9; 21.6; 21.8
- General government saving:
  - 5.5; 2.0; 2.7; 1.6; 3.6; 3.1; 3.0
- Nongovernment sector 1:
  - 12.8; 15.1; 16.3; 17.9; 17.2; 18.5; 18.8
- Current account deficit 1/:
  - 8.3; 11.8; 7.4; 7.1; 5.4; 4.8; 4.6

Gross official reserves of the NBG 3/:
- 383; 493; 474; 620; 700; 768; 847
  - (In months of imports of non-pipeline goods and services): 2.0; 2.0; 2.1; 2.3; 2.4; 2.5; 2.6
  - (In months of imports of goods and services): 1.7; 1.8; 1.9; 2.2; 2.4; 2.5; 2.6

External debt, public and guaranteed:
- External debt stock:
  - 1,858; 1,852; 1,735; 1,720; 1,687; 1,654; 1,657
- External debt service, total:
  - 169; 180; 167; 196; 225; 138; 101

Memorandum items:
- Nominal GDP (in millions of lari):
  - 9,970; 11,660; 11,600; 13,080; 14,307; 15,624; 17,061
- Nominal GDP (in millions of US$):
  - 5,193; 6,303; 6,409; 7,522; 8,352; 9,258; 10,066
- External debt stock (public and guaranteed; percent of GDP):
  - 35.8; 29.4; 27.1; 22.9; 20.2; 17.9; 16.5
- Domestic public debt (percent of GDP):
  - 10.6; 8.4; 9.1; 7.6; 6.8; 6.2; 5.5
- M3-velocity (M3 annual average):
  - 7.8; ...; 6.8; 6.0; 5.4; 5.1; 4.8
- Social sector expenditures (percent of GDP):
  - 6.3; 7.9; 7.6; 8.6; 10.2; 10.7; 11.2
- Social sector spending, cash basis (percent of GDP):
  - 7.1; ...; 8.1; 9.0; 10.2; 10.7; 11.2

Notes:
- 1/ Large oil and gas pipeline projects are projected to increase imports, investment, and the current account deficit substantially in 2003–06.
- 2/ Sustained increase in nontax revenues from 2006 onward reflects transit fees from the BTC oil pipeline and the South Caucasus gas pipeline.
- 3/ International reserves are reported at current exchange rates and may differ from reserves at program rates as reported in the monetary accounts.
- (In millions of U.S. dollars; unless otherwise indicated)
- Sources: Georgian authorities; and Fund staff estimates.

---

### Indicators of financial obligations to the Fund, 2001–10 (selected)
- Total Fund credit outstanding (SDR million):
  - 2001: 228.6
  - 2002: 228.0
  - 2003: 194.3
  - 2004: 171.3
  - 2005: 164.9
  - 2006: 159.5
  - 2007: 161.6
  - 2008: 139.5
  - 2009: 121.5
  - 2010: 107.4
- In percent of quota:
  - 152.1; 151.7; 129.3; 114.0; 109.7; 106.1; 107.5; 92.8; 80.8; 71.4
- In percent of GDP:
  - 9.1; 8.7; 6.8; 4.9; 3.8; 3.1; 2.8; 2.2; 1.8; 1.5
- In percent of exports of goods and nonfactor services:
  - 23.5; 22.2; 14.7; 8.7; 7.6; 6.8; 6.4; 5.1; 4.2; 3.5
- Disbursements (PRGF):
  - 27.0; 22.5; 0.0; 14.0; 28.0; 28.0; 28.0; 0.0; 0.0; 0.0
- Total obligations from existing and prospective drawings:
  - 14.8; 24.9; 35.3; 38.1; 35.3; 34.4; 27.0; 23.2; 19.0; 15.1
- Principal (repayments/repurchases):
  - 12.0; 23.1; 33.8; 37.0; 34.4; 3; 3.4; 25.9; 22.1; 18.0; 14.1
- Charges and interest:
  - 2.8; 1.8; 1.6; 1.1; 0.9; 1.0; 1.1; 1.1; 1.0; 1.0
- Total obligations to the Fund (in percent of quota):
  - 9.8; 16.6; 23.5; 25.4; 23.5; 22.9; 18.0; 15.4; 12.7; 10.1
- Net credit from the Fund:
  - 15.0; -0.6; -33.8; -23.0; -6.4; -5.4; 2.1; -22.1; -18.0; -14.1
- Net resources from the Fund:
  - 12.2; -2.4; -35.3; -24.1; -7.3; -6.4; 1.0; -23.2; -19.0; -15.1

Sources: Fund Finance Department; and staff estimates and projections.

---

### Proposed schedule of reviews and disbursements under the PRGF Arrangement
- Board Approval: June 4, 2004 — SDR 14 million
- First Review: Test date June 30, 2004; Board date December 20, 2004 — SDR 14 million
- Second Review: Test date December 31, 2004; Board date July 20, 2005 — SDR 14 million
- Third Review: Test date September 30, 2005; Board date March 31, 2005 — SDR 14 million
- Fourth Review: Test date March 31, 2006; Board date July 2006 — SDR 14 million
- Fifth Review: Test date September 30, 2006; Board date December 2006 — SDR 14 million
- Sixth Review: Test date March 31, 2007; Board date June 2007 — SDR 14 million

---

### Georgia: Fund relations (as of January 31, 2006) and related items
- Membership Status: Georgia joined the Fund on May 5, 1992 and has Article VIII Status.
- Quota (General Resources Account): 150.30 (SDR Million) — Percent of Quota: 100.00
  - Fund holdings of currency: 150.30 100.00
  - Reserve position in Fund: 0.01 0.01
- SDR Department holdings: 6.71 (SDR Million) — N/A
- Outstanding Purchases and Loans: PRGF Arrangements: 162.54 (SDR Million) — 108.14 percent of quota
- Latest Financial Arrangements:
  - PRGF approved 6/4/04 to 6/3/07 — Amount Approved (SDR million) 98.00 — Amount Drawn (SDR Million) 42.00
  - PRGF 1/12/01 to 1/11/04 — 108.00 approved — 49.50 drawn
  - PRGF 2/28/96 to 8/13/99 — 172.05 approved — 172.05 drawn

Projected payments to Fund (SDR million; based on existing use of resources and present holdings of SDRs):
- Forthcoming principal, charges/interest, total (2006–2010):
  - Principal: 33.44; 25.94; 22.11; 17.96; 14.10
  - Charges/interest: 0.72; 0.57; 0.45; 0.35; 0.28
  - Total: 34.15; 26.50; 22.56; 18.31; 14.38

Safeguards assessment:
- Assessment completed December 10, 2004, concluded safeguards in place at the NBG appear generally adequate; identified vulnerabilities in internal audit and internal controls and recommended measures.

Exchange arrangements:
- Since April 29, 1993, TICEX conducts periodic auctions daily to determine exchange rate vis-à-vis the U.S. dollar.
- Georgia’s exchange rate regime is classified as “managed floating.”
- Georgia maintains no exchange restrictions on payments and transfers for current international transactions except for security-related restrictions notified to the Fund pursuant to Executive Board Decision No. 144-(52/51).

Article IV Consultation:
- The 2003 Article IV consultation was concluded on October 17, 2003.

FSAP participation:
- Two FSAP missions visited Tbilisi during May 1–15, and July 24–August 7, 2001.
- An FSAP update mission visited Tbilisi during February 15–28, 2006.

Resident representation and advisors:
- Resident Representative: The fifth resident representative, Mr. Christiansen, took up his post on August 1, 2004.
- National Bank of Georgia resident advisors: multiple advisors and peripatetic technical assistance visits listed (names and dates as provided in source).
- Ministry of Finance resident advisors: multiple FAD advisors and missions described (names and dates as provided in source).

Technical assistance missions, 2001–05 (selected by department and subject):
- Fiscal Affairs Department (FAD): Public Expenditure Management; Assessment of Treasury system; Review of draft Budget System Law; Tax Policy review; Revenue Administration; various missions dated Jun. 12–19, 2001; Mar. 14–Apr. 02, 2002; Jan. 16–30, 2003; Sep. 29–Oct. 11, 2003; Oct. 27–Nov. 13, 2003; June 8–21, 2004; Nov. 8–23, 2004; November 2005.
- Monetary and Financial Systems Department (MFD): Banking, payment systems, bank supervision, reserve management; advisory missions dated Feb. 26–Mar. 8, 2001; Oct. 23–Nov. 6, 2001; Mar. 11–19, 2002; Sep. 24–Oct 9, 2002; June 16–20, 2003; April 20–30, 2004; Oct. 24–Nov. 5, 2004; April 18–29, 2005.
- Statistics Department (STA): National accounts, balance of payments, money and banking, data ROSC, government finance statistics, price statistics; missions dated Mar. 26–Apr. 6, 2001; Feb. 13–27, 2002; Mar. 2–15, 2002; July 15–31, 2002; May 20–June 3, 2003; Nov. 5–18, 2003; Apr. 26–May 7, 2004; Apr. 18–29, 2005; May 23–June 3, 2005; June 15–28, 2005.
- Legal Department (LEG): Tax Code follow-up assistance Jan. 28–Feb. 9, 2001; Jul. 13–24, 2001.

---

### IMF–World Bank relations (Partnership in Georgia’s Development Strategy)
- The government’s PRSP; Economic Development and Poverty Reduction Program (EDPRP) was presented to the Boards of IDA and the IMF in October and November 2003.
- A Joint Staff Advisory Note together with the Progress Report on the EDPRP was sent to the Boards of IDA and IMF in June 2005.
- The IMF completed the second review under the PRGF arrangement in July 2005.
- On September 15, 2005, IDA endorsed a new Country Partnership Strategy (CPS) for FY06–09, and approved the first in a program of three Poverty Reduction Support Operations (PRSOs).

*Source: _cr06175 - 1.  Quantitative targets*

### 2.      The Fund has taken the lead in assisting Georgia in improving macroeconomic

### 2.      The Fund has taken the lead in assisting Georgia in improving macroeconomic

### Division of labor: IMF, World Bank, IFC
- The Fund has taken the lead in assisting Georgia in improving macroeconomic stability and pursuing fiscal reforms.
- The World Bank has taken the lead in the policy dialogue on structural issues, focusing on: (i) strengthening public expenditure management; (ii) improving performance of the public sector; (iii) reducing corruption; (iv) deepening and diversifying sources of growth; (v) protecting the environment; and (vi) reducing poverty.
- Georgia is one of the largest IDA borrowers in the CIS, with borrowing of US$816 million for 40 operations.
- IFC became a shareholder and member in 1995 and, as of January 1, 2006, has invested around $137 million to finance projects in the financial, power, oil and gas, and manufacturing sectors.

### PRSO program and social/sectoral support
- The PRSO has supported further elaboration and implementation of key elements of the government’s poverty reduction strategy as described in the EDPRP and Progress Report.
- The PRSO program is built on four pillars:
  - (i) strengthening public sector accountability, efficiency, and transparency;
  - (ii) improving electricity and gas sector services;
  - (iii) improving the environment for private sector development;
  - (iv) improving social protection, education and health care services.
- Other World Bank support has included project support and Analytic and Advisory Activities across education, health care, social protection, energy, roads, water and sanitation, agriculture, agricultural research and extension, irrigation and drainage, forestry, environment, biodiversity, enterprise development, municipal development, judicial reform, and cultural heritage.
- A Public Expenditure Review (PER) was prepared in 2002; a Trade Study in 2003. The PER is being followed by a series of annual programmatic PERs, the first of which is under preparation.
- A Country Procurement Assessment Report (CPAR) was prepared in 2002 and a Country Financial Accountability Assessment (CFAA) in 2003. Updates of these are scheduled for FY06.
- A series of annual programmatic Poverty Assessments are being implemented.

### IFC activities and financial sector support
- IFC investments and support:
  - Around $137 million invested as of January 1, 2006.
  - Support to financial sector: housing finance market development, credit lines and technical assistance to the Bank of Georgia and TBC Bank.
  - Helped establish ProCredit Bank of Georgia, specializing in lending to micro and small enterprises.
  - Provided a credit line to TBC Leasing to support SME portfolio growth (project builds on two years of technical assistance to grow the leasing sector).
  - Investments and support in oil transit (equity and credit to local and international companies, including investments by British Petroleum and other sponsors in the Baku-Supsa Early Oil Pipeline and the Baku-Tbilisi-Ceyhan Pipeline).
  - Other IFC investments: electricity distribution (AES-Telasi), mineral water (GGMW), and glass bottle production (Ksani Glass Factory).
  - Donor-supported technical assistance for client bank strengthening, introduction of leasing and housing finance, public-private partnerships in energy, business climate, and corporate governance practices.
- The Foreign Investment Advisory Service (FIAS) carried out an Assessment of Administrative Procedures for Doing Business in 2003 and finalized an advisory project in July 2004 to assist the Government in removing administrative obstacles to investment.
- The Private Enterprise Partnership (PEP) finalized an extensive study of barriers to SMEs in early 2005. PEP and FIAS are holding joint consultations with the Government to identify concrete improvement steps.

### Areas of lead and input: Bank leads, Fund leads, shared responsibilities
- Areas in which the World Bank leads and there is no related conditionality in the IMF-supported program:
  - Social sectors, rural development, environment, infrastructure, judicial reform.
- Bank-led social sector activities:
  - IDA updates Poverty Assessment based on quarterly household data and focuses on execution of budgetary expenditures for health, education and poverty benefits.
  - Social Investment Fund credits target high-poverty areas for basic infrastructure to the poorest communities.
  - PRSO strengthens dialogue on social protection reform (safety nets, pensions, poverty benefits, labor market institutions and policies).
- Education:
  - Adaptable Program Credit addresses curriculum reform, national assessment and examination system, teacher training, learning materials, capacity to use resources, and introduces a per capita based formula for financing basic education.
- Health:
  - IDA credits support health care financing improvements, exploration of risk-pooling, new primary health care systems, and targeting public services to the poor and priority public health interventions.
  - SAC III and the SRS Credit have supported hospital restructuring.
  - IDA policy work in health sector reform in the context of the Medium-Term Expenditure Framework (MTEF) and the PRSO program.
- Infrastructure:
  - Support via Secondary and Local Roads Project, Municipal Development and Decentralization Project II, and Social Investment Fund Project for community-level infrastructure (school and health facility heating/repair, small hydropower, drinking water and sanitation, transport rehabilitation).
  - IFC supported privatization of Tbilisi electricity distribution through AES-Telasi investment and advised on UEDC management contract.
  - Infrastructure Pre-Investment Facility project to facilitate strategic infrastructure investments via feasibility and effectiveness technical assistance, focusing on energy and transport.
- Rural development:
  - IDA credits supporting private sector farming and agro-processing, agricultural credit, irrigation and drainage, agricultural research, and creation of local institutions (rural credit unions, water users associations).
  - Recently approved Rural Development Project to develop productivity and profitability of private agriculture to increase incomes and employment and reduce rural poverty.
- Judicial reform:
  - Judicial Reform Project funds new court administration and case management procedures, rehabilitation/construction of courthouses, computerized network system, judicial training assistance, and public information/outreach.

- Areas in which the World Bank leads and its analysis serves as input into the IMF program:
  - Structural reforms via the PRSO program and the Structural Reform Support Project.
  - Private Sector Development:
    - PRSO focuses on improving investment climate and reducing constraints.
    - IDA supports private sector participation in energy, urban services, and agriculture.
    - IMF worked with authorities to initiate audits of accounts of three major state-owned enterprises.
  - Energy:
    - Energy system in poor condition with unreliable supply and unsustainable debts, but under PRSO authorities improved payment collections and service levels substantially in the power sector.
    - Government, IDA, other donors and the Fund worked to introduce private management and ownership and implement short-term action plans and longer-term steps.
    - IDA provided additional funding to the power sector in 2004.
    - Fund focus: reducing quasi-fiscal losses via improved bill collections; tariff reform at cost-recovery levels to be facilitated by Bank-assisted tariff policy methodology review.
    - Georgian authorities prepared the Energy Sector Strategic Action Plan for 2005–08, implemented and updated periodically under PRSO.
    - Bank to finance feasibility study for a major new hydropower plant that could add about 20 percent to the country’s hydropower capacity.
  - Public Sector Management:
    - First PRSO supports administrative and civil service reform, improvements in public expenditure management and strengthening financial accountability.
    - Public Sector Financial Management Reform Support Project to provide technical assistance and capacity building.
    - Fund providing technical assistance in support of tax and customs administration reform.
  - Municipal Finance:
    - Municipal Development and Decentralization Project II assisting review of intergovernmental fiscal relations and suggesting an equalization transfer system.

- Areas of shared responsibility (Bank and Fund jointly):
  - Poverty Reduction Strategy:
    - Both institutions supported development of the PRSP/EDPRP via seminars, workshops, direct staff input, and donor coordination.
    - A JSAN on progress with EDPRP implementation was issued in June 2005.
  - Budget Planning and Execution:
    - Annual programmatic Public Expenditure Reviews and the PRSO provide underpinning for systemic expenditure management changes, MTEF development, and financial accountability improvements.
    - Public Sector Financial Management Reform Support Project will finance technical assistance and investment to support budget planning and management within the MoF and line ministries and introduction of an integrated public financial management system.
    - Fund focusing on treasury reform within the ministry of finance.
  - Financial Sector Reforms:
    - Joint Financial Sector Assessment Program supported:
      - (i) strengthened banking and non-banking supervision;
      - (ii) introduction of international accounting standards;
      - (iii) consolidation of banks through higher capital requirement ratios;
      - (iv) anti money-laundering legislation;
      - (v) strengthening regulatory environment and removing impediments for viable nonbank financial institutions; and
      - (vi) strengthening the payment system.
    - IFC strengthened banking sector via investment and technical assistance and supported development of financial leasing market through technical assistance.
    - Fund focused on banking supervision, anti-money laundering legislation, and improvements in monetary control instruments with extensive technical assistance from its Monetary and Financial Systems Department.

- Areas in which the IMF leads and its analysis serves as input into the World Bank program:
  - Fiscal Framework and reforms in tax policy and tax and customs administration:
    - Fund’s focus on prudent fiscal policy served as an important framework for IDA’s work on public expenditure management.
    - Fiscal Affairs Department now taking the lead in tax policy and tax and customs administration reform.
  - Economic Statistics:
    - IMF technical assistance led to improvements in national accounts, price, monetary and government financial statistics.
    - Bank grant on Statistical Capacity Building will build on Fund TA recommendations to strengthen national accounts statistics quality.

- Areas in which the IMF leads and there is no direct World Bank involvement:
  - Monetary Framework:
    - IMF collaborates closely with the NBG in design and implementation of a monetary program to rebuild international reserves while keeping inflation low and remonetizing the economy.

### World Bank Group strategy and recent operations
- On September 15, 2005, the World Bank Executive Board endorsed the new Country Partnership Strategy (CPS) for FY06-09 to assist Georgia with deeper institutional reform and infrastructure improvements.
- CPS goals:
  - (i) Generating growth and job creation by removing barriers to private sector development and improving infrastructure, finance and markets;
  - (ii) Enhancing human development and social protection through improved education, health, social protection, and community services;
  - (iii) Strengthening public sector management and budgetary processes to enable Georgia to better plan and meet its development goals.
- Along with the CPS, the first PRSO of a series of three single tranche annual Poverty Reduction Support Operations was approved:
  - US$13.5 million is a regular IDA credit and US$6.5 million is an IDA grant.
- Other recent operations and amounts:
  - US$5 million Infrastructure Pre-Investment Facility Project;
  - US$3 million Public Sector Financial Management Reform Support Project;
  - US$24 million Reform Support Credit;
  - US$20 million Secondary and Local Roads Project;
  - US$3.6 million Electricity Market Support Project;
  - US$10 million Rural Development Project;
  - US$5 million Irrigation and Drainage Community Development Project Additional Funding for flood control.
- The Bank continues discussion with the government on a more comprehensive medium-term reform strategy to be supported by future PRSOs and technical assistance.

### Table 1 highlights (Bank-Fund collaboration on Georgia) — specialized advice and key instruments (select points)
- Economic Framework/Management:
  - Fund specialized advice: Monetary policy, exchange rate, fiscal, and trade policies, economic statistics.
  - Bank specialized advice: Economic growth, economic statistics.
  - Key instruments: IMF PRGF performance criteria and benchmarks on monetary and fiscal targets; IDA PRSO program; macromonitoring; Trade and Transport Facilitation Project; Financial Sector Advisory Work; Policy Options Report.
- Budget:
  - Fund specialized advice: Budget framework, tax policy and administration, customs, debt management, extra-budgetary funds.
  - Bank specialized advice: Budget management, Public Expenditure Review, Country Procurement Assessment, Country Financial Accountability Assessment.
  - Key instruments: IMF PRGF performance criteria on overall fiscal balance and revenue collection; Bank PRSO program and Programmatic Public Expenditure Review.
- Public Sector Reform:
  - Fund specialized advice: Public asset management, audit of 3 problematic state-owned enterprises.
  - Bank specialized advice: Civil service reform, anti-corruption agenda, decentralization.
  - Key instruments: IMF PRGF; IDA PRSO and Public Sector and Financial Management Reform Project.
- Social/Poverty:
  - Fund specialized advice: Prioritization of expenditure cuts to protect social spending.
  - Bank specialized advice: Poverty analysis; reforms in education, health, social protection; support to community driven development.
  - Key instruments: IMF PRGF; IDA PRSO and IDA Credits for Education, Health and Social Investment Funds, Programmatic Poverty Assessment, SRS support for hospital restructuring, Pensions and Social Assistance, and policy work in health sector reform under the MTEF.
- Private Sector Development:
  - Fund role: Costs of Doing Business Surveys; support for improved legislation and regulatory framework.
  - Bank role: PRSO program; Business Environment Study; Integrated Trade Development Strategy; Labor Market Study.
  - IFC: investments and technical assistance.
- Infrastructure:
  - Fund role: Private sector participation in infrastructure.
  - Bank role: Ongoing and proposed IDA Credits for Municipal Development and Decentralization Project II (MDDP II), Secondary and Local Roads, Infrastructure Pre-Investment Facility.
  - IFC: investments and advisory services.
- Rural development:
  - Bank role: Support through Rural Infrastructure and Water Resource studies; ongoing rural Credits; proposed Credits for Rural Development, Rural Telecommunications, Community Based Tourism.

### EBRD snapshot
- As of December 31, 2005, the European Bank for Reconstruction and Development (EBRD) had signed 49 investments in Georgia with cumulative commitments totaling US$401.3 million.
- Current Portfolio Stock equals to US$259.8 million.
- Current portfolio includes thirty three private sector projects (of which five projects are regional).
- The ratio of private sector projects in the portfolio stands at 80 percent.

*IMF/World Bank staff report content as provided in the source document.*

### 2.      During 2004, all operations signed in Georgia were in the private sector and

### _cr06175 - 2.      During 2004, all operations signed in Georgia were in the private sector and

### EBRD operations and signings (2004)
- Total operations signed in Georgia: US$95.2 million.
- Sectoral breakdown and notable operations:
  - Energy sector signings: US$78.6 million.
  - SME line of credit to a local bank: US$2.7 million.
  - Equity increase in a local partner bank: (amount not separately stated in source text).
  - Expansion of Trade facilitation program: US$10.9 million.
  - Equity investments in local producers:
    - Refreshment drinks producer: US$1.1 million (equity).
    - Private local wine producer: US$1.2 million (equity).

### EBRD operations and signings (2005)
- Total transactions signed: 18 transactions for US$105.9 million.
- All but one transaction were in the private sector and all were without sovereign guarantees.
- Breakdown of transactions and amounts:
  - Three DIF equity investments (all in agribusiness): US$5.3 million.
  - Two MCFF risk sharing facilities with local banks: US$10.0 million.
  - First-ever municipal transport project with no sovereign guarantee: US$3.4 million.
  - One regional energy project: US$29.4 million.
  - Wine bottling project: US$7.3 million.
  - SME credit line: US$10.0 million.
  - Two MCFF sub-loans: US$5.0 million.
  - Two bank capital increases: US$1.5 million.
  - First-ever syndicated loan to a local bank: US$20.0 million in total, of which US$7.0 million on EBRD’s account.
  - First loan to a local leasing company: US$3.0 million.
  - Trade Finance Programs (TFPs) with three partner banks: US$24.1 million.

### EBRD strategic focus and ETC initiative
- EBRD objectives in Georgia:
  - Help Georgia exploit its privileged location to become a regional transportation and natural resources hub.
- Early Transition Countries (ETC) initiative (launched April 2004):
  - Purpose: increase investments in the Bank’s seven poorest countries and build on international efforts to address poverty.
  - Focus: private sector business development and selected public sector interventions.
  - Approach: streamlined financing, focus on smaller projects, mobilize more investment, encourage ongoing economic reform.
  - Risk stance: Bank will accept higher risk in ETC projects while respecting principles of sound banking.

### EBRD portfolio for Georgia (as of December 31, 2005) — selected outstanding amounts (US$, million)
- Note: Evaluated at an exchange rate of US$1.183 per Euro; total listed: 259.8.
- Selected public sector projects:
  - Power Rehabilitation Project (19-Dec-94): 6.1
  - Georgia State Electro system (22-Dec-98): 27.0
  - Georgia: Trans-Caucasian Rail Link Project (22-Dec-98): 11.1
  - SOCAR - South Caucasus Gas Pipeline (regional) (4-Nov-04): 9.0
- Selected private sector projects:
  - Bank of Georgia Equity and Convertible Loan (16-Jul-98): 2.4
  - Bank of Georgia – SME Loan (27-Jul-03): 3.5
  - Bank of Georgia Capital Increase (16-Nov-05): 1.0
  - MCFF Bank of Georgia Full Recourse Portion (14-Jun-05): 5.0
  - MCFF TBC Bank Full Recourse Portion (13-Jun-05): 5.0
  - MCFF TBC Bank Lomisi Ltd Sub Loan (03-Aug-05): 3.5
  - MCFF - TBC Bank Nola Ltd Sub-Loan (NRP) (2-Dec-05): 1.5
  - TBC Bank - SME Credit Line (19-Dec-03): 6.0
  - TBC Bank SME Credit Line III (26-Sept-05): 10.0
  - TBC Bank Syndicated Loan (20-Dec-05): 7.0
  - TBC Leasing, Senior Debt (20-Dec-05): 3.0
  - Intellectbank (Sub Project of Georgia SME) (11-Nov-97): 0.5
  - TbilComBank (Sub Project of Georgia SME) (12-Dec-96): 0.6
  - TbilcreditBank (Sub Project of Georgia SME) (12-Dec-96): 0.0
  - United Georgian Bank (20-Nov-97): 3.2
  - ProCredit Bank, Georgia (Formerly MBG) (30-Mar-00): 2.6
  - ProCredit Bank, Georgia - Senior Loan (11-Oct-01): 6.0
  - TFP: Bank of Georgia (Guarantee & Pre-export) (2-Mar-01): 17.2
  - TFP: TBC Bank (Guarantee & Pre-export) (17-Aug-99): 4.5
  - TFP: United Georgian Bank (31-Mar-01): 1.9
  - JSC Channel Energy Poti Port (19-Mar-02): 10.2
  - Tbilisi Public Transport (29-Jul-05): 3.7
  - Georgian Wines (29-Sep-99): 0.6
  - Georgian Wines & Spirits Ltd (10-March-05): 7.3
  - DIF Iberia Refreshments (25-Sep-03): 2.2
  - DIF Teliani Valley (20-May-2004): 1.1
  - DIF Delidor (17-June-05): 1.5
  - DIF-Lomisi Ltd (20-Dec-05): 3.0
  - Baku-Tbilisi-Ceyhan (BTC) Pipeline (regional) (03-Feb-04): 62.5
  - Lukoil Overseas : South Caucasus Gas Pipeline (regional) (28-Jul-05): 29.4
  - Regional Fund Investments: 0.7
- Total portfolio outstanding amount: 259.8
- Footnote: US$ amounts calculated at an exchange rate of US$1.183 U.S. dollars per Euro, as of December 31, 2005.

### Statistical issues and IMF technical assistance
- Overall assessment:
  - Fund provided substantial technical assistance in compilation of macroeconomic statistics.
  - Despite improvements, quality of macroeconomic statistics remains poor due to deficiencies in methodologies, coverage, and insufficient resources.
  - Acute problems: national accounts, balance of payments, foreign trade, and fiscal statistics.
  - Core statistical indicators are provided on a timely basis and generally adequate for surveillance and program monitoring.
- GDDS participation:
  - Data ROSC prepared July 2002; published on Fund’s external website on May 27, 2003.
  - In August 2005 authorities notified Fund of commitment to participate in GDDS and appointed a national GDDS coordinator.
  - Next steps: prepare GDDS metadata and plans for statistical improvement.
- Real sector / national accounts:
  - National accounts follow System of National Accounts 1993; GDP estimates by production and expenditure compiled annually and quarterly.
  - Preliminary national accounts estimates available after four months; final estimates after 13 months.
  - 2002 ROSC found inadequate data sources; business register coverage not comprehensive due to lack of economic census.
  - Coverage of units by value added: relatively good for industry, satisfactory for transport and communications, poor for agriculture, retail trade, construction, catering, and services.
  - Weaknesses: compilation of constant price estimates; assessment and validation of source data.
  - Technical assistance missions: April/May 2004 proposed improvements for expenditure-side estimation; April 2005 follow-up identified problem in volume measure of taxes on products leading to revision of GDP data for 2004.
- Money and banking:
  - March 2002 STA mission: many recommendations from December 2000 implemented piecemeal; remaining methodological problems.
  - Recommendations to NBG included: disaggregating resident data beyond “general government” and “the rest of the economy”; incorporating Fund-related accounts transparently in central bank survey; distinguishing restricted deposits of insolvent banks from deposit liabilities in broad money.
  - July 2002 data ROSC: most elements for monetary statistics fully or largely observed; recommended improving coverage of nonbank depository corporations and metadata documentation; increase transparency on governmental access to monetary statistics prior to public release.
  - NBG submitted pilot monetary data in SRF format to STA; STA validated monetary aggregates and is converting its monetary database into SRF format for IFS supplement.
- Government finance statistics (GFS):
  - GFS on a cash basis reported to STA for GFS Yearbook.
  - Classification broadly follows 1986 GFS Manual but differs significantly from international standard in concepts and definitions.
  - Central treasury uses a single-entry cash basis; hampers reconciliation of bank statements and reporting on accounts payable.
  - Limited budget classifications for expenditure; frequent changes in expenditure code structure cause discrepancies.
  - Bridge tables linking national codes and GFSM 2001 codes established by 2003 GFS mission and used in 2004 reporting.
  - Authorities plan to compile and disseminate GFS on a GFSM 2001 basis starting in 2007.
- Balance of payments (BOP):
  - June 2005 BOP mission found partial implementation of 2002 ROSC and 2002/2003 BOP mission recommendations.
  - SDS actions: expanded data sources for several BOP items; implemented new software for customs declarations database; produced BOP in standard Fund format with separate identification of exceptional financing.
  - Customs Department improvements: ASYCUDA client-server installed in all customs offices; instructions for completing customs declarations elaborated and implemented; improved verification of customs declarations.
  - SDS staffing worsened during latest SDG reorganization (permanent staff reduced); communication equipment upgraded.
  - June 2005 BOP mission focus: NBG assuming responsibility for BOP compilation; review estimation methods especially for workers’ remittances and compensation of employees; identify data sources and produce partial international investment position statement.

### Table of Common Indicators and data quality (as of February 28, 2006) — selected items and observations
- Exchange Rates: Latest observation 1/31/06; Date received 2/3/06; Frequency: D/W/M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest observation 1/31/06; Date received 2/3/06; Frequency: D/W/M.
- Reserve/Base Money: Latest observation 1/06; Date received 2/3/06; Frequency: M/M/M; Data Quality – Methodological soundness: O, LO, LO, O; Accuracy and reliability: O,O,O,O,LO.
- Broad Money: Latest observation 1/06; Date received 2/20/06; Frequency: M/M/M.
- Central Bank Balance Sheet: Latest observation 1/06; Date received 2/3/06; Frequency: M/M/M.
- Consolidated Balance Sheet of the Banking System: Latest observation 1/06; Date received 2/20/06; Frequency: M/M/M.
- Interest Rates: Latest observation 1/31/06; Date received 2/3/06; Frequency: W/W/M.
- Consumer Price Index: Latest observation 1/06; Date received 2/7/06; Frequency: M/M/M; Methodological soundness: O,LO,O,O; Accuracy and reliability: LO,LO,O,O,O.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Latest observation 1/06; Date received 2/21/06; Frequency: M/M/M; Methodological soundness: LNO,LO,LNO,O; Accuracy and reliability: LO,O,LO,O,O.
- External Current Account Balance: Latest observation Q3/05; Date received 12/30/05; Frequency: Q/Q/Q; Methodological soundness: O,LO,LO,LO; Accuracy and reliability: LNO,LNO,LNO,LNO,LNO.
- GDP/GNP: Latest observation Q3/05; Date received 10/25/05; Frequency: Q/Q/Q; Methodological soundness: O,LO,O,LO; Accuracy and reliability: LNO,LNO,LNO,LO,LO.
- Gross External Debt: Latest observation 1/06; Date received 2/14/06; Frequency: M/M/M.

### Debt sustainability assessment
- Overall judgment:
  - Georgia is at moderate risk of debt distress.
  - Baseline scenario judged sustainable.
  - Domestic debt negligible; external debt indicators well below relevant debt-burden thresholds.
  - Contributing factors to moderate risk: uncertain regional political outlook and weak record in meeting debt service obligations under previous administration.
- Baseline scenario projections:
  - Public debt falls from 41.1 percent of GDP at end-2005 to 21.9 percent at end-2009 and continues to decline thereafter.
  - In NPV terms, public debt expected to fall by about half before the end of the decade.
  - Assumptions underlying baseline:
    - Real GDP growth of just over 5 percent in the medium term and 3½ percent over the long term.
    - Budget deficit including net lending of 1 percent of GDP over the medium term.
    - Clearance by end-2007 of expenditure arrears of 1.1 percent of GDP at end-2005.
    - Clearance by end-2008 of energy-related debt to Turkmenistan of more than one percent of GDP at end-2005.
    - Fiscal deficit funded through external financing and privatization receipts through 2009.
    - Share of concessional debt declining from over 37 percent of new external borrowing in 2003 to an average of about 24 percent over the medium term.
    - Share of domestic debt decreasing steadily over the medium and long term.
- External debt outlook:
  - External debt projected to decline steadily from 2006.
  - External debt estimated around 27 percent of GDP at end-2005, equivalent to less than 100 percent of exports in NPV terms.
  - Projected gross external debt accumulation over medium term: about $100 million a year.
  - Total external debt declining as share of GDP to about half of the end-2003 stock by end-2006.
  - With limited private external borrowing, projected capital flows from FDI and transfers (both private and official, including about $300 million from the MCA) expected to finance a shrinking trade deficit stabilizing at about 8 percent of GDP in the long run, provided export values grow at around 6 percent.

*Source: Excerpt from IMF staff report content unit _cr06175 (as provided).*

### 4.      Alternative scenarios and bound tests are constructed to examine the sensitivity

### _cr06175 - 4.      Alternative scenarios and bound tests are constructed to examine the sensitivity

### Overview
- The chapter constructs alternative scenarios and bound tests to examine the sensitivity of the baseline projection of public and publicly guaranteed debt to a range of potential shocks (referenced as Tables 2a and 2b).
- Most stress factors would not jeopardize Georgia’s debt sustainability; key exceptions are identified below.

### Major exceptions and vulnerabilities (text summary)
- Export growth shock:
  - A return of export value growth from about 10 percent in 2005 to about 2 percent (the historical average of 2 1/2 percent minus one standard deviation of about 1/2 percent) is a critical exception.
  - Even if limited to 2 years, the NPV of debt-to-exports ratio would reach unsustainable levels of more than 150 percent, even if the financing gap were financed at better than commercial terms (30 percent grant element).
- Official reserves:
  - Official reserves are low (at about 2 months of non-pipeline imports); such a shock could erode exchange rate stability.
- Long-run growth threshold:
  - At long run growth of about 3 percent, debt dynamics begin changing and NPV of debt to GDP and debt to revenue rise substantially.

### Key quantitative baseline indicators (selected exact figures from tables)
- Public sector debt (percent of GDP):
  - 2003: 60.8
  - 2004: 46.4
  - 2005: 41.1
  - 2006 (estimate in table context): 34.3
  - 2011 (projection): 15.5
- Of which foreign-currency denominated (percent of GDP):
  - 2003: 46.9
  - 2004: 33.9
  - 2005: 27.1
  - 2011: 11.5
- Change in public sector debt (percent of GDP):
  - 2003: -2.2
  - 2004: -14.4
  - 2005: -5.3
- NPV of public sector debt (percent of GDP):
  - 2003: 13.9
  - 2004: 12.5
  - 2005: 34.9
  - 2011: 10.7
- NPV of public sector debt-to-revenue ratio (in percent):
  - 2003: 85.8
  - 2004: 57.4
  - 2005: 149.2
  - 2011: 42.9
- Debt service-to-revenue ratio (in percent):
  - 2003: 24.2
  - 2004: 24.4
  - 2005: 14.2
  - 2011: 3.6
- Gross financing need (percent of GDP):
  - 2003: 3.8
  - 2004: 5.1
  - 2005: 5.2
  - 2011: 3.2

### Key macroeconomic and fiscal baseline assumptions (selected exact figures)
- Real GDP growth (in percent):
  - 2003: 11.1
  - 2004: 6.2
  - 2005: 7.7
  - 2006–11 average (table): 4.7
  - 2016–25 average (table): 3.5
- Average nominal interest rate on forex debt (in percent):
  - 2003: 2.3
  - 2004: 1.2
  - 2005: 1.1
  - 2016–25 average (table): 1.0
- Inflation rate (GDP deflator, in percent):
  - 2003: 3.5
  - 2004: 9.6
  - 2005: 8.0
  - 2016–25 average (table): 3.0
- Grant element of new external borrowing (in percent):
  - 2003: 37.4
  - 2004: 34.0
  - 2005: 30.1
  - 2006 baseline row shows 33.8 then projections with many positive values (table includes 3.7 and later 31.0, 20.3, 22.5, 23.1, etc.)

### Sensitivity analysis — scenarios and bound tests (summary of structure and key outcomes)
- Table 2a (Public debt sensitivity, 2006–25) and Table 2b (Public and PPG external debt sensitivity, 2006–25) present:
  - Alternative scenarios (A-series):
    - A1. Real GDP growth and primary balance at historical averages.
    - A2. Primary balance unchanged from 2005.
    - A3. Permanently lower GDP growth (specified technical assumption in footnote).
  - Bound tests (B-series):
    - B1. Real GDP growth at historical average minus one standard deviation in 2007–08.
    - B2. Primary balance at historical average minus one standard deviation in 2007–08.
    - B3. Combination of B1–B2 using one-half standard deviation shocks.
    - B4. One-time 30 percent real depreciation in 2007.
    - B5. 10 percent of GDP increase in other debt-creating flows in 2007.
  - In Table 2b additional tests and notes:
    - A2 (less favorable financing): assumes interest rate on new borrowing is by 2 percentage points higher than baseline, while grace and maturity periods remain the same.
    - B2 (export value shock): exports assumed to remain permanently at the lower level, while current account as a share of GDP returns to baseline (implying import adjustment).
    - B6. One-time 30 percent nominal depreciation relative to baseline in 2007.
- Key outcome of bound tests:
  - Export value growth shock (B2 in Table 2b) produces the most severe deterioration in NPV of debt-to-exports ratio: figures rise to very high values, with a noted outcome that NPV debt-to-exports could exceed 150 percent under a return of export growth to about 2 percent (text discussion).
  - Many other shocks (growth, primary balance, depreciation, net non-debt creating flows) produce varying increases in debt indicators but typically do not reach the unsustainable threshold highlighted for the export shock.

### Policy implications and recommendations (inferred from analysis content)
- Vigilance on export performance:
  - Protecting export value growth or building buffers is critical because a sharp and persistent export shock can push NPV debt-to-exports above unsustainable levels (>150 percent).
- Reserve accumulation and external buffers:
  - Given reserves are low (about 2 months of non-pipeline imports), policy should prioritize rebuilding reserves to reduce vulnerability to external shocks and preserve exchange rate stability.
- Growth-enhancing policies:
  - Preventing a decline in long-run growth toward about 3 percent is important, as debt dynamics materially worsen at that threshold.
- Financing terms:
  - Maintaining favorable grant elements/soft financing reduces vulnerability; less favorable financing (interest rates higher by 2 percentage points) materially worsens external debt indicators in simulations.

*Source: Georgian authorities; and Fund staff estimates, projections, simulations, and staff projections as presented in the supplied content.*

### Introduction

### Introduction

### Overview
- The government’s economic program for 2006, supported by a PRGF arrangement, aims to achieve poverty reduction through sustained, rapid, and equitable economic growth in an environment of low inflation.
- This Memorandum of Economic and Financial Policies reviews progress to date in implementation and describes economic policies and strategy through 2006.

### Current Economic Developments and Performance
- Real GDP growth:
  - First nine months of 2005: 7.7 percent.
  - Preliminary estimate for 2005: about 8 percent.
- Inflation:
  - 2005: 6.2 percent.
  - Despite significant increases in prices for tobacco and alcohol (mainly due to increased excise taxes) and petroleum products, inflationary pressures were avoided.
- Fiscal outcomes 2005:
  - Overall fiscal deficit (cash basis) for 2005: 2.4 percent of GDP.
  - Cumulative fiscal deficit on a commitments basis for 2005: GEL 177 million (projection at second review: GEL 407 million).
  - Cash deficit for 2005: GEL 279 million.
- Monetary and external sector:
  - Reserve money increase in 2005: 19.7 percent (below program target).
  - Lari appreciation in 2005: 2.5 percent against the U.S. dollar (nominal); 3.1 percent in real effective terms.
  - Gross international reserves of NBG increased by 24 percent to $474 million in 2005, equivalent to about 2.1 months of non-pipeline imports.
- Revenue and administration improvements:
  - Customs Department revenues for 2005 increased by 66 percent compared with 2004.
  - Tax revenues in 2005: GEL 2,300 million, a 27 percent increase compared with 2004.
  - Estimated ratio of tax revenues to GDP for 2005: at least 19.8 percent.
  - Customs Department staff reduced by 9.5 percent; one-window principle introduced; technical equipment improved with donor assistance.
- Arrears and verification:
  - Stock of claimed arrears as of end-December 2005: GEL 182 million.
  - Cleared verified arrears in 2005: GEL 104 million.
  - Stock at end-2005: GEL 182.1 million in claimed arrears and GEL 59 million in verified arrears.
  - Government plans to complete evaluation of all arrears claimed as of end-2005 and clear all those that are verified during 2006 without increasing the overall fiscal deficit.

### Structural and Institutional Reforms
- Medium-term expenditure framework (MTEF):
  - Basic Data and Directions (BDD) prepared and submitted to parliament in May 2005.
  - Strategic priorities and spending projections for 2006-2009 submitted to parliament as part of the proposed 2006 budget.
  - Government adopted a decree establishing a clear link between line ministries’ strategies and strategic priorities reflected in the BDD.
- Customs and trade reform:
  - New Customs Code developed and submitted to parliament on October 17, 2005; submission delay caused a missed structural performance criterion for end-September.
  - Proposed tariff regime (if approved): move from 16 bands to 3; reduce maximum tariff from 30 percent to 12 percent for 2006; eliminate the 12 percent band beginning in 2007; eliminate all tariffs in 2008.
  - New Customs Code expected to take effect on April 1, 2006.
- Business environment and regulatory reform:
  - Law on “Licenses and Permissions” approved in June (year implied 2005) reducing list of activities requiring licenses and permits by about 85 percent.
  - Introduction of “one-window for approval” and “silence is consent” principles; simplified standardization and certification requirements.
- Civil service and public administration:
  - Civil service reform strategy under preparation with medium-term action plans developed for each ministry.
  - Number of ministries reduced from 18 to 13; numerous state departments consolidated and subordinated to ministries.
- Anti–money laundering progress:
  - Ratified 1990 Council of Europe Strasbourg Convention; adopted Law “On Facilitating the Prevention of Illicit Income Legalization” (in force since January 2004); established Financial Monitoring Service (FMS) at the NBG.
  - FMS became a member of the Egmont Group in June 2004; has regulations on monitoring entities and forwards suspicions to Special Service of Criminal Prosecution of Illegal Income Legalization at the General Prosecutor’s Office.
  - FMS-submitted amendments to Criminal Code and Criminal Procedure Code were approved by parliament in December 2005.

### Economic Policies and Projections for 2006
- Growth and inflation targets:
  - Real GDP growth projected for 2006: 6.5 to 7.5 percent.
  - End-period inflation for 2006 projected: 5-6 percent.
- External sector and reserves:
  - Target for gross international reserves of the NBG: 2.3 months of non-pipeline imports.
  - Current account deficit projected to stabilize at 7.4 percent of the GDP.
- Macroeconomic policy stance:
  - Program requires disciplined fiscal and monetary policies and coordination between the two.
- MTEF and strategic planning:
  - MTEF (BDD and budget appendices) to be updated during 2006 with emphasis on expenditure priorities for 2007-10.
  - Medium-term strategic action plan for 2006-09 being prepared, incorporating EDPRP, Individual Policy Action Plan, and EU Neighborhood Policy Paper.
  - PRSP progress report preparation to be completed by end-September 2006.

### Fiscal Policy and Budget Priorities for 2006
- Budget projections and deficits:
  - Proposed 2006 budget projects tax revenues of 19.3 percent of GDP.
  - Overall fiscal deficit on a commitment basis projected for 2006: 2.2 percent of GDP.
  - Overall fiscal deficit on a cash basis projected for 2006: 2.6 percent of GDP.
- Revenue measures:
  - Anticipated improvement in tax collections from Customs Code reform and better administration.
  - Further reforms: upgrading information and data processing systems; introducing a harmonized system of commodity nomenclature; improving technical equipment at customs clearance points; simplifying tax declaration procedures; allowing electronic filing for selected taxpayers.
- NBG borrowing and legal changes:
  - Government did not borrow from the NBG in 2005 and no such borrowing is planned for 2006.
  - NBG will submit to parliament an amendment prohibiting government borrowing from the NBG under all circumstances (structural performance criterion for end-March 2006).
- Social spending and education:
  - Total allocations for social spending in the 2006 budget: 8.6 percent of GDP.
  - Comprehensive education reform begun in 2005 will continue; from 2006 the education system will be funded from the state budget.
- Pensions and poverty alleviation:
  - Minimum pension increased to GEL 28 per month as of January 1, 2005 (equivalent to about $15).
  - Planned minimum pension increase in 2006: increase by GEL 10 to GEL 38 per month, with increases of 5 lari on March 1, 2006 and a further 5 lari on September 1, 2006.
  - Poverty alleviation program to be introduced on June 1, 2006 (structural performance criterion for end-June 2006).
    - Guiding principle: social assistance targeted to households living below the extreme poverty line rather than exclusively to certain categories.
    - Cash benefits determined according to current living conditions and family size.
    - State will supplement income of households at least to the level of the extreme poverty line.
    - Main outcome indicator: at least 60 percent of those identified as extremely poor will be covered by the program.
- Gas price shock and mitigation:
  - Average cost of gas: $64 per thousand cubic meters (tcm) in 2004 and 2005; $110 per tcm in 2006.
  - Government plans to delay increasing household gas tariff until May 2006.
  - Budgetary cost to bridge difference between import price and household price: projected GEL 35 million.
  - Once poverty alleviation program is operational (June 1, 2006), government will assess using it to compensate low-income households for higher gas tariffs.
- Local budgets:
  - Draft law on Budget of Local Self-Management Units submitted to parliament in November 2005 to regulate preparation and approval of local budgets and methodology for transfers.

### Privatization and LEPL Financial Management
- Privatization:
  - Continue privatization in 2006; state to retain only properties essential for state functions.
  - Emphasis on transparent privatization of enterprises in energy distribution, power generation and communication sectors.
  - Proceeds estimated at GEL 338 million or 2.6 percent of GDP.
- Legal Entities of Public Law (LEPLs):
  - Process to establish a database of all central government LEPLs begun; database expected to be populated by end-March 2006 (structural performance criterion for end-March).
  - Refining a system for financial monitoring of LEPL activities through line ministries.
  - Operational guidelines for financial management and reporting to ensure adequate monitoring are advanced and will be completed by end-June 2006.

*Source: _cr06175 - Introduction*

### 30. In early 2004, several quasi-fiscal funds were established outside the government to

### _cr06175 - 30. In early 2004, several quasi-fiscal funds were established outside the government to 

### Quasi-fiscal funds, fiscal transparency, and treasury reform
- In early 2004, several quasi-fiscal funds were established outside the government to meet critical expenditure requirements in the aftermath of the Rose Revolution.
- The Army Development Fund and the Law Enforcement Fund ceased operations on January 1, 2006.
- Publicly announced that the two funds would be liquidated by end-March 2006.
- The Reform and Development Fund now operates as an NGO and does not have any fiscal functions.
- Any other funds which continue to operate and finance general government expenditures will:
  - report their financial activities on a current basis, and
  - be treated as part of the general government.
- Treasury reform:
  - Single treasury account system became fully functional by end-2005; expenditure and income accounts were merged into a single treasury account.
  - Mid-term plans: introduce a new classification of the budget and a new methodology of registration based on cash-based method indicated in GFS 2001.
  - Objective: continue consolidation of public finances into the treasury system.

### Monetary policy framework and objectives for 2006
- Program orientation:
  - A disciplined monetary program featuring a flexible exchange rate regime is central to macroeconomic strategy for 2006 and beyond.
  - Target for end-year inflation of 5-6 percent.
- Projected money and reserve aggregates for 2006:
  - Increase in money demand of 12 percent during 2006.
  - Increase in the money multiplier of 3 percent over the same period.
  - Reserve money growth limited to 25 percent.
  - Broad money growth limited to 29 percent.
- External reserves and interventions:
  - Plan to increase gross foreign reserves to about 2.3 month of non-pipeline imports or about $620 million.
  - NBG will intervene in foreign exchange markets only as necessary for smoothing sharp fluctuations, especially given large capital inflows expected in 2006.
- Legal/structural measures:
  - Amendments to existing legislation will be submitted to parliament to prohibit government borrowing from the NBG under all circumstances (structural benchmark for end-March 2006).

### Financial market development and monetary instruments
- Objectives:
  - Foster development of markets for safe assets of various maturities.
  - Strengthen NBG’s ability to conduct monetary policy by increasing its portfolio of marketable securities.
- Agreed measures by end-March 2006 (structural benchmark):
  - Government together with the NBG will agree on measures to achieve objectives.
  - Securitize all existing NBG claims on the government at the rate of GEL 40–50 million per year with maturities of 2–5 years.
  - NBG will begin issuing CDs with a maturity of up to one year.

### Banking supervision, transparency, and sector strengthening
- Legislative and regulatory changes:
  - Plan to change the Law on Activities of Commercial Banks regarding consolidated supervision and definitions of bank insiders, Fit and Proper Criteria for bank administrators and significant shareholders.
  - Submitted legislation to parliament to eliminate restrictions on the percent of total shares in a commercial bank that can be owned by an individual or legal entity (structural benchmark for end-March 2006). In effect, this will allow an individual or legal entity to own 100 percent of a commercial bank.
- Transparency and disclosure measures:
  - NBG publishing standardized forms about financial data of commercial banks in NBG’s bulletin and sending them electronically to each bank.
  - NBG planning regulation on transparency specifying details on information to be disclosed regularly.
  - Require banks to publish their quarterly statements and to post them on the NBG’s website (as agreed at the time of the second review).
- Institutional reforms at the NBG:
  - Consolidation of bank supervision department into a single structure, downsized and with new management; process to be extended to the rest of the NBG.
  - Prepare a Banking System Development Strategy for 2006-2009 by end-March 2006 (structural benchmark for end-March 2006).
  - Continue closing or merging commercial banks not fully complying with prudential requirements.
- Crisis management example:
  - After an on-site inspection of a larger commercial bank, NBG concluded the bank should be either liquidated or sold.
  - Interim management introduced; sale arranged to the most competitive bid from a sound local commercial bank.
  - Buyer requested a short-term credit line from the NBG as contingency; if activated, additional liquidity may complicate monetary policy; NBG will use monetary policy tools (including short-term CDs) to mop up excessive liquidity.
- Safeguards and controls:
  - NBG will fully implement recommendations of the 2004 Safeguards Assessment Report of the IMF’s Finance Department, including formally documenting all internal control processes, key operating policies and procedures.
  - An FSAP update mission visited Tbilisi to study issues including the recent surge in private sector credit pertaining to financial stability.

### Structural reforms and business environment
- Broad commitment:
  - Government recognizes importance of aggressive structural reform program to foster growth and international competitiveness, with emphasis on business environment and property rights protection.
- Licensing and permits:
  - Parliament approved in June 2005 a new law on Licensing and Permits.
  - Law reduced the number of licenses and permits from more than 950 to 150.
  - Implementing the new regulatory framework requires amending dozens of individual laws.
- Regulatory and institutional changes:
  - Preparing a new system of government supervision of food and medicine in parallel with restructuring the Ministry of Agriculture.
  - Preparing legislation aimed at establishing a system of self-regulation for professional activities/fields; initial draft on accounting and auditing fields is already developed.

### Energy sector rehabilitation
- Quasi-fiscal deficit and causes:
  - In 2004 quasi-fiscal deficit of the sector amounted to 4 ½ percent of GDP (caused mainly by low collection rates, non-payment of electricity consumed in Abkhazia, and energy theft), financed partially by transfers from the government, but mostly through debt and the run-down of the stock of capital.
- 2006 budget and targets:
  - 2006 budget appropriated more than GEL 247 million, about 1.9 percent of GDP, to investment in the energy sector.
  - Projected quasi-fiscal deficit for 2005 was about 4 percent of GDP and will be reduced further in 2006.
- Objective: rehabilitate energy sector facilities so that electricity can be supplied 24 hours per day to all paying customers.

### Program monitoring, performance criteria, and targets
- Reviews and timing:
  - Completion of the fourth review under the PRGF arrangement scheduled for mid-June 2006 requires observance of structural performance criteria for end-March 2006 shown in Table 1 and quantitative performance criteria in Table 2.
  - End-June structural criterion and end-September quantitative performance criteria will apply to the fifth review scheduled for mid-December 2006.
- Review focus:
  - Progress in resolving arrears.
  - Progress toward developing a system of financial monitoring for LEPLs.
  - Ongoing and planned steps to add momentum to structural reforms, especially in energy, public sector operations, the business climate, and trade liberalization.
- Selected structural performance criteria and benchmarks (timing as indicated):
  - Upgrade Fit and Proper criteria for bank owners and managers to international standards by submitting revisions to commercial banking law and related decrees — End-December 2005.
  - Complete transition to a treasury single account for central government expenditures and revenues — End-December 2005.
  - Complete electronic re-registration of existing taxpayers and registration of new taxpayers — End-December 2005.
  - Introduce a targeted poverty benefit to replace numerous in-kind benefits — End-December 2005.
  - Publish a strategy paper on pension reform — End-December 2005.
  - Submit to parliament amendments to prohibit government borrowing from the NBG under any circumstances — End-March 2006.
  - Submit legislation to parliament to eliminate restrictions on percent of total shares in a commercial bank that can be owned by an individual or legal entity — End-March 2006.
  - Establish and populate a database of all central government LEPLs — End-March 2006.
  - Prepare a Banking System Development Strategy for 2006-2009 — End-March 2006.
  - Prepare a detailed strategy for securitizing government debt to the NBG — End-March 2006.
  - Introduce a poverty alleviation program targeted on households living in extreme poverty — End-June 2006.
- Quantitative targets (excerpt from Table 2; stocks and targets shown in document):
  - Ceiling on net credit of the banking system to the general govt. (NCG): 633.1 (End-Dec. 2005 actuals), Targets: 0.0 (Mar.), -17.7 (June), -50.7 (Sep.), 37.0 (Dec.).
  - Ceiling on reserve money: 1001.5 (End-Dec. 2005 actuals), Targets: 42.9 (Mar.), 70.8 (June), 157.4 (Sep.), 250.4 (Dec.).
  - Floor on total net international reserves (NIR) of the NBG: 186.5 (End-Dec. 2005 actuals), Targets: 1.8 (Mar.), 40.2 (June), 118.7 (Sep.), 151.6 (Dec.).
  - Ceiling on nonconcessional medium- and long-term external debt contracting or guaranteeing: 0.0 (End-Dec. 2005 actuals), Targets: 20.0 (Mar.), 20.0 (June), 20.0 (Sep.), 20.0 (Dec.).
  - Ceiling on short-term external debt (less than one year): 0.0 across actuals and targets.
  - Ceiling on accumulation of external arrears: 0.0 across actuals and targets.
  - Indicative target — Ceiling on net domestic assets (NDA) of the NBG: 656.3 (End-Dec. 2005 actuals), Targets: 39.5 (Mar.), -3.5 (June), -62.2 (Sep.), -30.1 (Dec.).
  - Quantitative targets for 2006 are based on accounting exchange rates of GEL 1.85/US$, US $1.46/SDR, and US$1.21/EUR.
  - Note: Table shows stock variables based on cumulative changes from end-December 2005 projections; continuous performance criterion for external arrears defined in paragraph 21 of the July 2005 TMU.

### IMF Staff Representative statement (March 31, 2006) and Public Information Notice highlights
- Updated macro estimates and performance:
  - Estimated real GDP growth for 2005 revised upward to 9.3 percent.
  - Inflation in the twelve months that ended in February fell further to 5.1 percent of GDP.
- Program trajectory and institutional agreements:
  - Authorities appear on track to meet indicative quantitative targets and performance criteria for end-March.
  - Fiscal and monetary performance through end-February was well in line with program targets.
  - Memorandum of Understanding between the Ministry of Finance and National Bank of Georgia signed; includes a securitization schedule for non-marketable government debt held by the NBG.
  - Legislation to eliminate commercial bank ownership restrictions was passed by parliament; amendments to prohibit government borrowing from the NBG were submitted to parliament.
- Trade liberalization:
  - Authorities plan to pass trade reform in three stages after objections to the three-year plan reported in the staff report.
  - First stage: highest tariff rate of 30 percent would be reduced to 12 percent, and number of import tariff bands reduced from sixteen to three (0, 5 and 12 percent).
- LEPL monitoring:
  - Authorities making good progress toward establishing and populating the LEPL database and appear on track to meet the related end-March structural performance criterion.
- Public Information Notice (PIN) No. 06/42 — IMF Executive Board concluded the Article IV consultation with Georgia on March 31, 2006.
  - Background and assessment elements reiterated:
    - Robust growth rates of about 7 percent on average in 2004–05.
    - Average CPI inflation of about 7 percent over 2004–05.
    - Tax collections rose from 14.5 percent of GDP in 2003 to an estimated 19.8 percent of GDP in 2005.
    - Gross international reserves slowly increased to 2.1 months of nonpipeline imports at end-2005.
    - Fiscal decentralization underway; progress on poverty reduction appears limited given scarce data.
  - Executive Directors:
    - Commended authorities for impressive progress including macro stability, fiscal turnaround, and anti-corruption actions.
    - Supported the 2006 economic program aiming at bolstering growth and keeping inflation at single-digit rates while carrying forward structural reforms.
    - Endorsed plans to increase public spending in priority areas based on assurances fiscal sustainability will be maintained.

*Italic: Source — Statement by IMF Staff Representative and Public Information Notice excerpts from the document.*

### introduction of a medium-term expenditure framework, which should help to improve fiscal

### _cr06175 - introduction of a medium-term expenditure framework, which should help to improve fiscal

### Fiscal policy, public finance, and MTEF
- Introduction of a medium-term expenditure framework (MTEF) to improve fiscal planning and expenditure control; structural performance criterion on preparing an MTEF was met.
- Authorities met the objective to cease operations of several quasi-fiscal funds on January 1 and to liquidate them by end-March; one remaining fund to be converted into an NGO and privately financed.
- Fiscal outcomes and projections:
  - General government deficit (cash basis) in 2005: 2.4 percent of GDP.
  - Tax revenues in 2005: 19.7 percent of GDP (a 26.4 percent increase compared with 2004).
  - Total revenue and grants (percent of GDP): 2002: 15.8; 2003: 16.2; 2004: 21.7; 2005: 23.4.
  - Tax revenue (percent of GDP): 2002: 14.4; 2003: 14.5; 2004: 18.2; 2005: 19.8.
  - Total expenditure and net lending (percent of GDP): 2002: 17.8; 2003: 18.7; 2004: 18.6; 2005: 24.9.
  - Fiscal balance, commitment basis (percent of GDP): 2002: -2.0; 2003: -2.5; 2004: 3.1; 2005: -1.5.
  - Fiscal balance, cash basis (percent of GDP): 2002: -1.9; 2003: -1.3; 2004: -0.2; 2005: -2.4.
- Directors cautioned that decentralization of fiscal responsibilities could weaken fiscal transparency; stressed need to monitor Legal Entities of Public Law (LEPLs) transparently and ensure full accountability.
- Directors urged the government to resist additional spending pressures ahead of local elections in the fall.
- Recommendation: strengthen tax administration further despite gains from the 2005 tax reform.

### Social safety nets and poverty reduction
- Directors encouraged strengthening social safety nets and introduction of the targeted poverty benefit as planned.
- Authorities’ social spending and measures:
  - Total allocations for social spending budgeted at 8.6 percent of GDP for 2006.
  - Increased minimum pensions.
  - Targeted poverty benefit program scheduled for introduction in June (2006); as of report, 300 thousand statements submitted from people eligible for social assistance.
  - Explore using poverty program to compensate low-income households for higher gas tariffs.
- Policy emphasis: shield the poor from adverse economic conditions and improve environment for private investment through infrastructure and energy reliability investment.

### Monetary policy, liquidity management, and central bank
- Directors viewed the current stance of monetary policy as appropriate and welcomed NBG efforts to contain inflation.
- Observations and recommendations:
  - Stronger fiscal position creates challenges requiring enhanced coordination between fiscal and monetary authorities.
  - Extremely small treasury bill market makes effective liquidity management more challenging.
  - Welcome memorandum of understanding between the NBG and the ministry of finance on securitizing some outstanding nontradable debt held by the NBG to provide monetary policy instruments.
  - Encouraged authorities to strengthen autonomy of the central bank.
  - Endorsement of a floating exchange rate regime with foreign exchange interventions limited to smoothing temporary and extreme fluctuations; authorities committed to monitor appreciation pressures.
- Monetary outcomes and projections:
  - Consumer price index, end-of-period (percent change): 2002: 5.4; 2003: 7.0; 2004: 7.5; 2005: 6.2.
  - Reserve money (end-of-period percent change): 2002: 18.4; 2003: 13.9; 2004: 44.3; 2005: 19.7.
  - Broad money (including foreign exch. deposits) (end-of-period percent change): 2002: 17.9; 2003: 22.8; 2004: 42.6; 2005: 26.4.
  - Exchange rate, lari/U.S. dollar, period average: 2002: 2.20; 2003: 2.15; 2004: 1.92; 2005: 1.81.
  - For 2006: projected real GDP growth 6.5 to 7.5 percent; end-period inflation estimated to stabilize around 5-6 percent.
  - For 2006: gross foreign reserves projected to increase to about 2.3 month of non-pipeline imports (staff projection).
- NBG actions and financial market development:
  - Memorandum of understanding to securitize some outstanding nontradable debt held by the NBG to expand marketable instruments.
  - NBG strategy to attract international interest, consolidate banking sector, foster competition, and strengthen independence.
  - Agreement on reform package to streamline NBG balance sheet and increase NBG’s portfolio of marketable securities, including government debt held by the NBG.

### Financial sector performance and supervision
- Directors commended continued efforts to strengthen the financial system; cautioned that strong credit growth requires robust banking supervision to avoid credit boom pitfalls.
- Banking sector outcomes and reforms:
  - Credit to the private sector grew by 83 percent in 2005 (from a very low level).
  - Georgia’s level of monetization remains below 20 percent of GDP.
  - Expansion of credit accompanied by longer maturities, lower lending rates, and de-dollarization.
  - Draft legislation on deposit insurance is ready.
  - Increased minimum capital requirement implementation has been brought forward and is now expected to be implemented in July next year.
  - Work continuing to increase transparency, consolidation, and ease entrance of foreign banks.
  - An FSAP update mission visited Georgia recently; Directors looked forward to discussing FSAP update in the next review.

### External sector, trade liberalization, and debt
- External sector statistics and outlook:
  - Trade balance (percent of GDP): 2002: -12.9; 2003: -15.0; 2004: -13.8; 2005: -14.1.
  - Current account balance (excl. pipeline imports) (percent of GDP): 2002: -5.5; 2003: -2.8; 2004: -3.5; 2005: -4.1.
  - External debt (percent of GDP): 2002: 51.7; 2003: 46.3; 2004: 35.8; 2005: 27.1.
  - Gross international reserves in months of imports: 2002: 1.1; 2003: 1.5; 2004: 2.0; 2005: 2.1.
- Directors noted improved economic outlook and strong capital inflows could put appreciation pressures on the exchange rate; recommended close monitoring.
- Directors welcomed planned liberalization of the trade regime:
  - Proposed move from 16 tariff bands to 3 and reduction of maximum tariff from 30 percent to 12 percent for 2006.
  - Further consultations to ultimately eliminate tariffs altogether will continue.
  - EU/Georgia Action Plan to encourage further economic integration.
- Debt sustainability and Paris Club:
  - Directors broadly agreed with debt sustainability analysis; appreciation of national currency in 2004 and government repayment efforts eased the debt burden.
  - Directors welcomed bilateral agreements after July 2004 Paris Club rescheduling and urged finalization of outstanding agreements with Paris Club and other bilateral creditors on comparable terms.

### Structural reforms, governance, and privatization
- Directors welcomed substantial progress in fighting corruption, improving governance and transparency, and enhancing the business climate.
- Structural reform agenda:
  - Focus on removing bottlenecks in infrastructure and energy.
  - Recommend strengthening legal institutions to entrench good governance and enforce creditor and property rights.
  - Emphasized importance of moving ahead with the privatization agenda; privatizations to be transparent with emphasis on energy distribution, power generation, and communication sectors.
- Business climate and regulatory reforms:
  - Doing Business improvements cited: cut number of activities requiring licenses from 950 to 150; eased cost of separating redundant workers; cut time and cost to register property.
  - Remaining needs: further simplify tax collection and enhance investor protection.
- Energy sector:
  - Authorities committed to rehabilitate energy sector facilities to supply electricity 24 hours per day to all paying customers.
  - 2006 budget appropriated more than 1.9 percent of GDP for investment in the energy sector.
- Customs Code and trade policy:
  - End-September structural performance criterion on submission of the Customs Code delayed; submitted to parliament in October and passage expected soon.
  - Customs department reorganization increased subsequently collected revenues by 66 percent compared with 2004.

### Data, statistics, and program monitoring
- Directors noted data provision is adequate for surveillance and program monitoring but encouraged further strengthening of the statistical database with Fund technical assistance, particularly for national accounts, balance of payments, and fiscal statistics.
- Program and PRGF details:
  - PRGF arrangement approved on June 4, 2004 for SDR 98 million (about US$141.2 million).
  - Completion of the third review enables drawing SDR 14 million (about US$20.2 million), bringing total disbursements to SDR 56 million (about US$80.7 million).
  - Board approved waivers for nonobservance of end-September 2005 quantitative performance criterion on clearance of domestic expenditures arrears and end-September 2005 structural performance criterion on submission of a new customs code.
  - Authorities committed to complete evaluation of all arrears claimed as of end-2005 and clear all verified arrears by the end of 2006.

*IMF Executive Board discussion and staff report excerpts as presented in the provided content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06175.pdf_