## _cr09267

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### Executive Summary — background and recent developments
- Third Review under the SBA postponed to allow discussion of deeper-than-expected economic contraction and revision of government spending plans for 2009.
- Authorities requested augmentation of access and extension of the arrangement to mid-2011 to align program discussions with the 2010 budget.
- Real GDP growth for 2009 revised down to -4 percent; first quarter real GDP of -5.9 percent year-on-year.
- Contraction led by falling exports and remittances and a contraction in bank lending of 10 percent since end-2008.
- Staff projects recovery beginning in H2 2009, aided in part by back-loaded public spending in 2009.
- CPI inflation: 2.3 percent in June 2009.
- GDP deflator increase for 2009 revised down from 5 to 0 percent.
- Unemployment reached 16.5 percent in late 2008.
- Poverty: 23.7 percent in 2007 (World Bank estimate); likely increased due to conflict and downturn.
- FDI fell by about 70 percent in the first half of 2009 relative to the same period of 2008; net outflow in non-FDI private capital despite large injections from IFIs to commercial banks.
- National Bank of Georgia (NBG) foreign exchange operations: sales in May-June of $34 million compared with $130 million in January-February; SBA purchase of $190 million in late March; gross official reserves stood at $1.5 billion (about 3 months of next year’s projected imports) as of mid-July.
- Fiscal outturns H1 2009: nominal expenditure (adjusted for one-offs) 11 percent lower year-on-year owing to defense cuts; tax revenues (adjusted for one-offs) declined by 17 percent.
- Monetary aggregates contracted through H1 2009; real deposit interest rates rose to 8½ percent.
- Financial soundness indicators H1 2009 (selected):
  - Capital adequacy ratio: moved from 17.5 to 17.6 (periods shown in table).
  - Nonperforming loans rose by 15 percentage points since June 2008; reported 18.8 percent in latest period shown.
  - Loans in foreign exchange increased to 77.3 percent in latest period shown.
  - Specific provisions reached 9.4 percent in latest period shown.
  - Return on equity fell to -8.4 percent in latest period shown.

### Policy response and program implementation
- Authorities relied mostly on fiscal stimulus because monetary policy effectiveness was impaired by high dollarization and balance-sheet constraints.
- Reduction of policy interest rates and liquidity injections had limited pass-through; banks curtailed credit.
- Authorities decided to accommodate tax revenue losses with a higher deficit in 2009 and plan significant fiscal adjustment beginning in 2010 to preserve investor confidence ahead of large repayment obligations in 2013.
- Program performance through end-July:
  - All quantitative and structural performance criteria met, except one structural benchmark.
  - End-March and end-June fiscal deficit targets met because of expenditure underexecution in Q1; a tax revenue shortfall in Q2 equivalent to 0.7 percent of annual GDP increased the deficit but cumulative end-June PC remained met.
  - End-March and end-June monetary targets met by a large margin; NIR target observed after lower-than-projected FX intervention; NDA remained well below program ceiling.
  - End-March structural benchmark on liquidity management framework implemented in April.
  - Greater flexibility in the lari-dollar exchange rate introduced via foreign exchange auctions; the daily fixing session was eliminated on May 22.
  - FSA stress testing techniques advanced; end-June structural benchmark on appointment of remaining FSA board members not observed due to authorities’ decision to merge the FSA and the NBG.
  - End-June performance criterion on a contingency plan for the financial system was met.
  - End-July structural benchmark on submission of a new budget code to cabinet was observed; the code expands budget coverage to public agencies.

### Augmentation of access and extension of the SBA-supported program
- Rationale:
  - Weaker economic and external financing prospects increased financing needs.
  - Original strategy relied on official financing to fill the gap created by sudden private capital outflows, expecting reinvigoration of inflows in 2009-10.
  - International crisis reassessment indicates a more severe and prolonged downturn than initially envisaged.
- Proposed augmentation and extension aims to:
  - Facilitate an orderly exit from high public and external deficits and dependence on official support.
  - Fill the financing gap and contribute to somewhat faster international reserve accumulation.
  - Preserve program objectives and avoid disruptive external and fiscal adjustments.
- Staff recommends approval of the authorities’ request for an augmentation of access under the SBA by SDR 270 million (around 180 percent of quota).
  - Of the SDR 270 million augmentation, SDR 200 million would be available in 2010.
  - The augmentation would result in total access of 497 percent of quota.
- Staff recommends extension of the arrangement to June 14, 2011.

### External financing, reserves, and balance of payments (selected figures, millions of U.S. dollars)
- Current account balance: -2,915 (2008), -1,879 (2009), -1,768 (2010 proj.), -2,096 (2011 proj.)
- Capital and Financial Account: 2,911 (2008), 1,704 (2009), 1,597 (2010 proj.), 2,192 (2011 proj.)
- FDI (net): 1,523 (2008), 1,032 (2009), 907 (2010 proj.), 1,240 (2011 proj.)
- Other private inflows (net): 562 (2008), 304 (2009), 118 (2010 proj.), 294 (2011 proj.)
- General government (mostly loans): 652 (2008), 235 (2009), 376 (2010 proj.), 511 (2011 proj.)
- Financing: 5 (2008), 117 (2009), 51 (2010 proj.), -97 (2011 proj.)
- Gross International Reserves (-increase): -131 (2008), 110 (2009), -230 (2010 proj.), -75 (2011 proj.)
- Use of Fund Resources: 222 (2008), 164 (2009), 381 (2010 proj.), -223 (2011 proj.)
- Proposed augmentation of Fund resources in 2010: 303 (memorized within table)
- Gross international reserves (end of period): 1,480 (2008), 1,470 (2009), 1,708 (2010 proj.), 1,545 (2011 proj.)
- Reserves in months of next year GNFS imports: 3.2 (2008), 2.7 (2009), 3.5 (2010 proj.), 2.6 (2011 proj.)
- Reserve accumulation in 2010 (components, in millions of U.S. dollars):
  - Reserve accumulation (+ increase): 234
  - Reserve accumulation programmed in Country Report No. 09/127: 75
  - Use of Fund resources treated as precautionary in Country Report No. 09/127: 72
  - Augmentation of access to Fund resources in 2010: 87

### Fiscal policy: stance, measures, and financing
- 2009 stance: maintain expenditure in 2009 unchanged relative to agreed program level while reconciling demand support with debt sustainability; strong fiscal adjustment beginning in 2010.
- Fiscal deficit projections:
  - Fiscal deficit projected to increase from 5.6 percent of GDP (Second Review) to 9.4 percent owing mainly to downward revision in GDP growth.
  - Increase in the deficit-to-GDP ratio by 3.8 percentage points is due to decline in tax revenues (3/4 of total effect) and lower denominator effect (1/4).
- 2009 supplementary budget: increases spending authorization by 1½ percent of GDP (mostly capital and social expenditures); anticipated underexecution will keep spending unchanged relative to second review projections.
- Reallocations: defense spending expected to decline by 3½ percentage points of GDP relative to 2008; social spending projected to increase by 1 percentage point.
- Social expenditures (General Government, percent of GDP):
  - Health programs: 1.2 (2008), 1.6 (2009), 1.4 (2010)
  - Pensions: 4.0 (2008), 4.7 (2009), 4.7 (2010)
  - Social assistance: 0.9 (2008), 1.0 (2009), 1.2 (2010)
  - IDP: 0.3 (2008), 0.4 (2009), 0.3 (2010)
  - Other: 0.9 (2008), 0.6 (2009), 0.7 (2010)
  - Total: 7.2 (2008), 8.2 (2009), 8.3 (2010)
- 2010 budget and medium-term:
  - Grants expected to fall by half; revenues projected to decline by 2.8 percentage points of GDP in 2010.
  - Fiscal deficit expected to improve by 2 percentage points of GDP in 2010.
  - Non-interest expenditures (adjusted for one-off effects) projected to decline by nearly 10 percent in real terms (and 4.3 percent in terms of GDP).
  - Measures include administrative cost reductions, cuts in subsidies to semi-public institutions, capping the wage bill in real terms, reduction in cofinancing of investment projects, cuts to investment budget connected to winding down large infrastructure projects.
- Financing of 2009-2010 deficits:
  - Mix of T-bill issuance, privatization receipts, and external budget support.
  - IMF balance of payments support in 2009 of $100 million will be channeled to the budget.
  - In 2010, all of the IMF financing is provisionally channeled to the budget pending confirmation of other IFI budget support.
- External financing of the public sector (gross inflows, in millions of U.S. dollars):
  - Total: 1368 (2008), 1208 (2009), 916 (2010)
  - IMF: 257 (2008), 408 (2009), 375 (2010)
  - World Bank: 126 (2008), 245 (2009), 169 (2010)
  - Other Multilateral Institutions: 135 (2008), 280 (2009), 152 (2010)
  - Bilateral partners: 350 (2008), 275 (2009), 219 (2010)
  - Eurobond-2013: 500 (2008), ...... (2009), ...... (2010)
  - Memorandum items:
    - Grants: 388 (2008), 334 (2009), 157 (2010)
    - Loans: 723 (2008), 466 (2009), 384 (2010)
    - Budget support financing: 426 (2008), 320 (2009), 86 (2010)
    - Project financing: 185 (2008), 480 (2009), 455 (2010)
- Domestic T-bill issuance: re-launched after discontinuation in 2005; amounts limited to 0.9 percent of GDP in 2009 and 0.6 percent in 2010 on a net basis, focusing on 6 month maturities.

### Medium-term fiscal strategy, debt dynamics, and contingencies
- Beyond 2010, adjustment relies on expenditure containment; revenue measures considered if needed, priority on broadening tax base while further reducing income tax rates once conditions permit.
- Authorities’ scenario for 2010–2013:
  - Current expenditures decline by 3 percent in real terms from 2010 to 2013.
  - Capital spending decline by 12 percent over the same period.
  - Fiscal deficit declines to 4 percent of GDP in 2012 and just under 3 percent in 2013.
  - Medium-term fiscal targets to be included in the 2010 budget document (October 1, 2009, structural benchmark).
  - Medium-term expenditure framework document planned to be finalized by mid-2010.
- Debt dynamics:
  - Staff assesses the risk of debt distress as moderate.
  - Public debt-to-GDP ratio projected to peak at 47 percent of GDP in 2011 and decline to 41 percent by the end of the projections.
  - External public debt service-to-exports ratio in 2013 projected to exceed 25 percent; external debt service obligations would amount to 46½ percent of exports, or about 100 percent of the projected end-2012 gross international reserves.
  - Contingent risks: deeper or prolonged downturn, government support to financial sector, or failure to restore market access by 2012 would raise debt sustainability concerns.

### Financial sector vulnerabilities, supervision, and safeguards
- Financial sector resilient so far due to capital and liquidity injections into two largest banks.
- Vulnerabilities:
  - Rising nonperforming loans (increase of 15 percentage points since June 2008).
  - Continued uncertainty about the deposit base and potential further exchange rate depreciation affecting loan portfolio.
  - Banks building precautionary liquidity buffers, constraining credit supply.
- Policy actions and reforms:
  - Liquidity management framework published by NBG; foreign exchange swaps introduced and capped at GEL 60 million (roughly 3.5 percent of reserve money).
  - NBG intends to close the uncollateralized special lending facility when remaining GEL 68 million become due in September.
  - NBG intends to reduce the stock of certificates of deposit in response to planned T-bill issuance.
  - FSA and NBG merger planned to create a single supervisor; draft merger law in parliament.
  - Stress testing capacity strengthened with MCM technical assistance; bank-by-bank contingency plans to be elaborated.
  - Financial stability plan completed in June; status report on bank-by-bank contingency measures expected by end-September (structural benchmark).
- Capacity to repay and external debt risks:
  - With requested augmentation of 180 percent of quota, at its peak Georgia’s outstanding credit to the Fund would amount to 33 percent of exports and 58 percent of gross reserves.
  - Peak repurchases to the Fund of about $425 million (9½ percent of exports) and $500 million Eurobond-2013 (equivalent to 11 percent of exports) in 2013.
  - Rolling over the Eurobond will require regained access to capital markets, critically dependent on achieving a sustainable fiscal position by 2012.

### Outlook, risks, and staff guidance
- Staff projects recovery beginning in H2 2009 but outlook uncertain given deep contraction, weak capital inflows, and elevated political tensions.
- Balance of risks on the downside: size of 2009 GDP contraction, timing and pace of recovery, resumption of private capital inflows, further declines in private capital inflows, exports, remittances, delays/shortfalls in official assistance, or prolonged political tensions.
- Potential FX pressures and banking sector exposure due to highly-dollarized balance sheets of unhedged borrowers.
- Staff policy guidance emphasized:
  - Maintain exchange rate flexibility.
  - Calibrate pace of fiscal spending carefully to balance countercyclical support against maintaining fiscal buffer for unexpected obligations and preserving medium-term debt sustainability.

### Program status, reviews, and Executive Board action
- All end-March and end-June performance criteria under the SBA were met.
- Authorities requested completion of the Third Review, rephasing of purchases through remainder of 2009, and to purchase the SDR 94.6 million that becomes available upon completion of the third review.
- Availability and purchase schedule (selected entries, in millions of SDR and percent of quota):
  - 15-Sep-08 Approve the 18-month arrangement: 161.7; 107.6
  - 15-Dec-08 Complete the first review ...: 63.1; 42.0
  - 23-Mar-09 Complete the second review ...: 63.1; 42.0
  - 6-Aug-09 Complete the third review ...: 94.6; 62.9
  - Total available (reflecting requested augmentation and extension): 747.1 (millions of SDR); 497.1 (percent of quota)
- IMF Executive Board (Press Release No. 09/277, August 06, 2009):
  - Completion of the third review allows immediate disbursement of SDR 94.6 million (about US$148.4 million).
  - Board approved an augmentation under the SBA in the amount of SDR 270 million (about US$423.5 million) and extension of the SBA to June 14, 2011.
  - Purpose: facilitate an orderly exit from high public and external deficits and associated dependence on official financial support.

### Data, statistics, and technical assistance
- Program exchange rate for program purposes: GEL 1.67 = $1.
- NIR of the NBG: $879.8 million as of December 31, 2008 (at the program exchange rate).
- Program and statistical notes:
  - STA Resident Statistics Advisor missions conducted; remaining weaknesses in external sector statistics and data sharing identified.
  - Data provision broadly adequate for surveillance and program monitoring but shortcomings remain in national accounts, balance of payments, foreign trade, and fiscal statistics.
  - NBG monetary data compiled using STA’s Standardized Report Forms (SRF); GFS compiled on a cash basis in accordance with GFSM 2001.

*Source: Executive Summary and excerpts from IMF staff report and Letter of Intent (content unit _cr09267, as presented in the source PDF).*

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

### Executive Summary

### Background
- The Third Review under the SBA was postponed to allow discussion of a deeper-than-expected economic contraction and revision of government spending plans for 2009.
- Authorities requested augmentation of access and an extension of the arrangement to mid-2011 to align program discussions with the 2010 budget.

### Recent economic developments
- Real GDP growth for 2009 revised down to -4 percent, following first quarter real GDP of -5.9 percent year-on-year.
- Contraction led by falling exports and remittances and a contraction in bank lending of 10 percent since end-2008.
- Recovery in staff projection begins in second half of 2009, aided in part by back-loaded public spending in 2009.
- CPI inflation: 2.3 percent in June 2009.
- GDP deflator increase for 2009 revised down from 5 to 0 percent.
- Unemployment reached 16.5 percent in late 2008.
- Poverty: 23.7 percent in 2007 (World Bank estimate); likely increased due to conflict and downturn.
- Exports and imports: sharp year-on-year declines through early 2009 (figures summarized in text).
- FDI fell by about 70 percent in the first half of 2009 relative to the same period of 2008; net outflow in non-FDI private capital despite large injections from IFIs to commercial banks.
- National Bank of Georgia foreign exchange operations: sales in May-June of $34 million compared with $130 million in January-February; SBA purchase of $190 million in late March; gross official reserves stood at $1.5 billion (about 3 months of next year’s projected imports) as of mid-July.
- Competitiveness: lari devaluation of November 2008 partly eroded by partner countries’ devaluations.
- Fiscal outturns H1 2009: nominal expenditure (adjusted for one-offs) 11 percent lower year-on-year owing to defense cuts; tax revenues (adjusted for one-offs) declined by 17 percent, reflecting among other measures a reduction of personal income tax rates from 25 to 20 percent and reductions of taxes on interest and dividend income paid to nonresidents.
- Monetary aggregates contracted through H1 2009; real deposit interest rates rose to 8½ percent.
- Banks curtailed credit, intermediation margins widened through February 2009 then eased; policy rate reductions by the central bank had limited pass-through due to limited eligible collateral.
- Financial soundness indicators H1 2009 (selected):
  - Capital adequacy ratio: moved from 17.5 to 17.6 (periods shown in table).
  - Nonperforming loans rose by 15 percentage points since June 2008 (national definition); reported 18.8 percent in latest period shown.
  - Loans in foreign exchange increased to 77.3 percent in latest period shown.
  - Specific provisions reached 9.4 percent in latest period shown.
  - Return on equity fell to -8.4 percent in latest period shown.

### Policy response and program implementation
- Authorities relied mostly on fiscal stimulus because monetary policy effectiveness was impaired by high dollarization and balance-sheet constraints.
- Reduction of policy interest rates and liquidity injections did not resume bank lending due to balance sheet weaknesses and higher credit risk.
- Authorities decided to accommodate tax revenue losses with a higher deficit in 2009 and plan significant fiscal adjustment beginning in 2010 to preserve investor confidence ahead of large repayment obligations in 2013.
- Program performance through end-July:
  - All quantitative and structural performance criteria met, except one structural benchmark.
  - End-March and end-June fiscal deficit targets met because of expenditure underexecution in Q1; a tax revenue shortfall in Q2 equivalent to 0.7 percent of annual GDP increased the deficit but cumulative end-June PC remained met.
  - End-March and end-June monetary targets met by a large margin; NIR target observed after lower-than-projected FX intervention; NDA remained well below program ceiling.
  - End-March structural benchmark on liquidity management framework implemented in April.
  - Greater flexibility in the lari-dollar exchange rate introduced via foreign exchange auctions; the daily fixing session was eliminated on May 22.
  - FSA stress testing techniques advanced; end-June structural benchmark on appointment of remaining FSA board members not observed due to authorities’ decision to merge the FSA and the NBG.
  - End-June performance criterion on a contingency plan for the financial system was met; plan defines roles of NBG, FSA, and government and outlines next steps for bank-by-bank contingency plans.
  - Authorities increased efforts to secure additional fiscal financing through negotiations for advanced budget support and identification of additional assets for privatization.
  - End-July structural benchmark on submission of a new budget code to cabinet was observed; the code expands budget coverage to public agencies.

### Augmentation of access and extension of the SBA-supported program
- Rationale:
  - Weaker economic and external financing prospects increased financing needs.
  - Original strategy relied on official financing to fill the gap created by sudden private capital outflows, expecting reinvigoration of inflows in 2009-10.
  - International crisis reassessment indicates a more severe and prolonged downturn than initially envisaged.
- Proposed augmentation and extension aims to:
  - Facilitate an orderly exit from high public and external deficits and dependence on official support.
  - Fill the financing gap and contribute to somewhat faster international reserve accumulation.
  - Preserve program objectives and avoid disruptive external and fiscal adjustments.

### Financial sector vulnerabilities and safeguards
- Financial sector resilient so far due to capital and liquidity injections into two largest banks, enabling meeting external payment obligations and improving solvency and liquidity.
- Vulnerabilities:
  - Rising nonperforming loans (increase of 15 percentage points since June 2008).
  - Continued uncertainty about the deposit base and potential further exchange rate depreciation affecting loan portfolio.
  - Banks building precautionary liquidity buffers, constraining credit supply.
- Authorities are strengthening supervision and developing contingency plans for potential financial sector stress.

### Outlook and risks
- Staff projects recovery beginning in H2 2009, but outlook is uncertain given deep contraction, weak capital inflows, and elevated political tensions.
- Significant fiscal adjustment planned for 2010 to restore investor confidence and prepare for large external repayment obligations in 2013.

*Source: Executive Summary (_cr09267).*

### 10.      While some aspects of the strategy supported by the IMF program remain valid,

### _cr09267 - 10.      While some aspects of the strategy supported by the IMF program remain valid,

### Strategy adjustments under the program
- Fiscal strategy: rebalanced from supporting demand to "a program of rapid fiscal adjustment starting in 2010, aimed at returning to viable fiscal and external positions by 2012."
- Exchange rate policy: "Exchange rate flexibility—enhanced by recent institutional reforms—remains an essential instrument of external adjustment" if fiscal retrenchment is insufficient.
- Monetary policy: "should regain some traction as monetary conditions normalize," and "the monetary stance will be geared at consolidating the disinflation gains."
- Financial sector policy: "Financial sector supervision and regulation will continue to be strengthened through capacity building actions and by following up on the preparedness action plan outlined in the financial stability plan."
- Structural conditionality: "limited to fiscal and financial measures."

### Macroeconomic outlook and risks
- Growth projections:
  - Real GDP growth projected at "2 percent in 2010" under a moderate recovery scenario.
  - Authorities expect medium-term growth to rise to "6-7 percent"; Fund staff scenario assumes growth trending at "5 percent over the medium term."
- Inflation: staff’s scenario assumes some pickup of inflation, "which at 5 percent would remain well below pre-crisis levels."
- Risks (balance of risks on the downside):
  - Size of the GDP contraction in 2009, timing and pace of recovery, and resumption of private capital inflows.
  - Further declines in private capital inflows, exports, remittances, delays/shortfalls in official assistance, or prolonged political tensions could cause a deeper contraction.
  - Potential reemergence of foreign exchange pressures if financing shortfalls occur.
  - Banking sector exposure due to "highly-dollarized balance sheets of unhedged borrowers" could lead to deteriorating asset quality, depositor confidence losses, downward pressure on international reserves, and more serious balance of payments and financial sector difficulties.

### External financing, reserves, and balance of payments
- External financing gap in 2010-11 driven by deterioration in external outlook and need for a larger reserve buffer.
- Policy adjustment reduces much of the gap, notably "a reduction of the fiscal deficit (excluding grants) of 2½ percentage points of GDP in 2010."
- Remaining financing gap: "about $300 million in 2010, and $100 million in 2011" to be financed by "the proposed augmentation of access under the SBA."
- Need for higher reserve buffer justified by "highly uncertain private financial flows and unclear prospects about regaining market access in the near future."
- Balance of payments summary (selected figures, in millions of U.S. dollars):
  - Current account balance: -2,915 (2008), -1,879 (2009), -1,768 (2010 proj.), -2,096 (2011 proj.)
  - Capital and Financial Account: 2,911 (2008), 1,704 (2009), 1,597 (2010 proj.), 2,192 (2011 proj.)
  - FDI (net): 1,523 (2008), 1,032 (2009), 907 (2010 proj.), 1,240 (2011 proj.)
  - Other private inflows (net): 562 (2008), 304 (2009), 118 (2010 proj.), 294 (2011 proj.)
  - General government (mostly loans): 652 (2008), 235 (2009), 376 (2010 proj.), 511 (2011 proj.)
  - Financing: 5 (2008), 117 (2009), 51 (2010 proj.), -97 (2011 proj.)
  - Gross International Reserves (-increase): -131 (2008), 110 (2009), -230 (2010 proj.), -75 (2011 proj.)
  - Use of Fund Resources: 222 (2008), 164 (2009), 381 (2010 proj.), -223 (2011 proj.)
  - Proposed augmentation of Fund resources in 2010: 303 (memorizable within table as shown)
- Gross international reserves (end of period): 1,480 (2008), 1,470 (2009), 1,708 (2010 proj.), 1,545 (2011 proj.)
- Reserves in months of next year GNFS imports: 3.2 (2008), 2.7 (2009), 3.5 (2010 proj.), 2.6 (2011 proj.)
- Reserve accumulation in 2010 (components, in millions of U.S. dollars):
  - Reserve accumulation (+ increase): 234
  - Reserve accumulation programmed in Country Report No. 09/127: 75
  - Use of Fund resources treated as precautionary in Country Report No. 09/127: 72
  - Augmentation of access to Fund resources in 2010: 87

### Fiscal policy: stance, measures, and financing
- 2009 stance: maintain expenditure in 2009 unchanged relative to agreed program level while reconciling demand support with debt sustainability; move to "strong fiscal adjustment beginning in 2010."
- Fiscal deficit projections:
  - Fiscal deficit projected to increase from "5.6 percent of GDP (Second Review) to 9.4 percent" owing mainly to downward revision in GDP growth.
  - Increase in the deficit-to-GDP ratio by "3.8 percentage points" is due to decline in tax revenues (3/4 of total effect) and lower denominator effect (1/4).
- 2009 supplementary budget: increases spending authorization by "1½ percent of GDP" (mostly capital and social expenditures); anticipated underexecution will keep spending unchanged relative to second review projections.
- Reallocations: defense spending expected to decline by "3½ percentage points of GDP relative to 2008"; social spending projected to increase by "1 percentage point."
- Social expenditures (General Government, in percent of GDP):
  - Health programs: 1.2 (2008), 1.6 (2009), 1.4 (2010)
  - Pensions: 4.0 (2008), 4.7 (2009), 4.7 (2010)
  - Social assistance: 0.9 (2008), 1.0 (2009), 1.2 (2010)
  - IDP (assistance to 1990s IDPs): 0.3 (2008), 0.4 (2009), 0.3 (2010)
  - Other: 0.9 (2008), 0.6 (2009), 0.7 (2010)
  - Total: 7.2 (2008), 8.2 (2009), 8.3 (2010)
- 2010 budget and medium-term:
  - Grants expected to fall by half; revenues projected to decline by "2.8 percentage points of GDP in 2010."
  - Fiscal deficit expected to improve by "2 percentage points of GDP" in 2010.
  - Non-interest expenditures (adjusted for one-off effects) projected to decline by "nearly 10 percent in real terms (and 4.3 percent in terms of GDP)".
  - Measures include: administrative cost reductions, cuts in subsidies to semi-public institutions, capping the wage bill in real terms, reduction in cofinancing of investment projects, cuts to investment budget connected to winding down large infrastructure projects.
- Financing of 2009-2010 deficits:
  - Mix of T-bill issuance, privatization receipts, and external budget support.
  - IMF balance of payments support in 2009 of "$100 million" will be channeled to the budget (including 2009 financing treated as precautionary in the second review).
  - In 2010, "all of the IMF financing is provisionally channeled to the budget pending confirmation" of other IFI budget support.
- External financing of the public sector (gross inflows, in millions of U.S. dollars):
  - Total: 1368 (2008), 1208 (2009), 916 (2010)
  - IMF: 257 (2008), 408 (2009), 375 (2010)
  - World Bank: 126 (2008), 245 (2009), 169 (2010)
  - Other Multilateral Institutions: 135 (2008), 280 (2009), 152 (2010)
  - Bilateral partners: 350 (2008), 275 (2009), 219 (2010)
  - Eurobond-2013: 500 (2008), ...... (2009), ...... (2010)
  - Memorandum items:
    - Grants: 388 (2008), 334 (2009), 157 (2010)
    - Loans: 723 (2008), 466 (2009), 384 (2010)
    - Budget support financing: 426 (2008), 320 (2009), 86 (2010)
    - Project financing: 185 (2008), 480 (2009), 455 (2010)
- Domestic T-bill issuance: re-launched after discontinuation in 2005; amounts limited to "0.9 percent of GDP in 2009 and 0.6 percent in 2010 on a net basis," focusing on 6 month maturities.

### Medium-term fiscal strategy and contingencies
- Beyond 2010, adjustment relies on expenditure containment; revenues measures would be considered if needed, but priority is "broadening the tax base while further reducing income tax rates once conditions permit."
- Authorities’ scenario for 2010–2013:
  - Current expenditures decline by "3 percent in real terms from 2010 to 2013."
  - Capital spending decline by "12 percent" over the same period.
  - Fiscal deficit declines to "4 percent of GDP in 2012 and just under 3 percent in 2013."
  - Medium-term fiscal targets to be included in the 2010 budget document ("October 1, 2009, structural benchmark").
  - Medium-term expenditure framework document planned to be finalized by "mid-2010."

### Debt dynamics and debt sustainability
- Public debt increase significant due to 2008 conflict and crisis response, but "authorities’ adjustment strategy helps allay debt sustainability concerns."
- Debt service pressures: "debt service obligations are very high in 2013-14," reflecting a "$500 million Eurobond maturing in 2013" and peak Fund repurchase obligations in 2013.
- Debt sustainability summary (Box 1):
  - Staff assesses "the risk of debt distress as moderate."
  - Public debt-to-GDP ratio projected to peak at "47 percent of GDP in 2011" and decline to "41 percent by the end of the projections."
  - External public debt service-to-exports ratio in 2013 projected to "exceed 25 percent"; external debt service obligations would amount to "46½ percent of exports, or about 100 percent of the projected end-2012 gross international reserves."
  - Alternative scenarios/stress tests show sensitivity to adverse developments (new loans at less favorable terms; one-time nominal depreciation; nondebt creating flows lower than baseline). "None of the public external debt ratios breach relevant thresholds prescribed by the LIC DSA framework, except in 2013."
  - Sensitivity analysis "shows the unsustainability of the current primary balance, and underscores the importance of setting policies on a path of rapid deficit reduction."

- Fiscal adjustment decomposition (selected entries, in percent of GDP):
  - Total reduction in fiscal balance (2009-10): 2.1
  - Total reduction in fiscal balance (2010-13): 4.4
  - Policy adjustment and automatic stabilizers: 3.9 (Change 2009-10) and 5.8 (Change 2010-13)
  - Increase in revenues (tax revenues): 0.1 (Change 2009-10), -0.4 (Change 2010-13)
  - Decrease in expenditures (total): 4.3 (Change 2009-10), 6.1 (Change 2010-13)
  - Capital spending contribution to adjustment: 1.9 (Change 2009-10), 1.6 (Change 2010-13)
  - Exogenous factors contribution: -1.8 (Change 2009-10), -1.4 (Change 2010-13)

- Contingent risks to debt sustainability:
  - Deeper or prolonged downturn, government support to financial sector, or failure to restore market access by 2012 would raise debt sustainability concerns.

_italic: IMF staff report content as presented in the source PDF._

### 21.      The ministry of finance is making progress in designing fiscal reforms to

### _cr09267 - 21.      The ministry of finance is making progress in designing fiscal reforms to

### Fiscal reforms and public financial management
- New budget code submitted to cabinet (¶8h).
- Reform agenda includes:
  - strengthening the medium-term budget process;
  - submitting to parliament the Law on Internal Audit (end-September 2009 structural benchmark), which will expand the ministry of finance’s audit capacity and responsibilities;
  - adopting the International Public Sector Accounting Standards (IPSAS) to increase transparency and accountability;
  - creating an integrated information system for budget preparation and execution;
  - improving the risk-based audit functions in the revenue service;
  - implementing the electronic declaration and payment of all taxes.

### Monetary policy and liquidity management
- Short-term strategy: ease credit conditions through selective instruments such as foreign exchange swaps; allow liquidity injections from external budgetary support to increase reserve money to meet banks’ demand for higher precautionary balances.
- Constraints on easing credit:
  - NBG signaled monetary easing via repeated cuts in its refinancing (policy) rate amid declining inflation.
  - Monetary transmission ineffective due to market segmentation, banks’ risk aversion, and preference for higher precautionary liquid holdings.
  - Increase in real interest rates may have dampened credit demand; main constraint is banks’ reluctance to take new credit risk and need to reduce loan-to-deposit ratios.
- Foreign exchange swaps:
  - Intended to encourage domestic currency lending by allowing banks with foreign exchange liquidity to finance lari loans to unhedged borrowers.
  - NBG has issued only a limited amount of swaps and intends to cap total amount outstanding at GEL 60 million (roughly 3.5 percent of reserve money) to limit contingent dollar liabilities and risks of abuse and speculation.
- Liquidity management framework (structural benchmark) published by NBG:
  - In current environment of ample liquidity and large reserve buffers, traditional monetary instruments have limited traction.
  - NBG intends to close the uncollateralized special lending facility when remaining GEL 68 million become due in September.
  - In response to planned T-bill issuance, NBG intends to reduce the stock of certificates of deposit to allow banks to channel excess liquidity into T-bills and avoid further contraction in private credit.
  - Once conditions normalize, authorities intend to restore reserve requirements to a more binding level, increasing the role of NBG’s refinancing window, with T-bills available as collateral.

### Exchange rate policy
- Flexible exchange rate remains key to external adjustment; planned fiscal retrenchment should ease exchange rate pressures.
- Improvements:
  - Introduction of auctions increased day-to-day exchange rate volatility and gave market greater role.
  - Authorities intend to reduce frequency of auctions to once a week and widen the bidding spread from 1 to 2 percent.
  - Staff suggested longer-horizon disclosure of NBG auction intentions; authorities expressed concern that greater disclosure could be counterproductive given market size and need for flexibility.
- Operational details:
  - Current corridor: ± 0.5 percent around auction rate; proposed widening to ± 1.0 percent.
- Outlook:
  - Auctions have operated in an environment of diminished exchange rate pressures; authorities expect FX market to remain relatively stable through the rest of the year.
  - Auction system expected to allow smoother adjustment than the step devaluation of November 2008.

### Safeguarding the financial sector
- Overall assessment:
  - Banks have adequate liquidity and capital buffers, but systemic risks have risen; continued vigilance and strengthened contingency planning required.
- Stress testing:
  - Capacity being strengthened; preliminary stress tests (with MCM technical assistance) show system relatively resilient to moderate exchange rate shocks.
  - Large depreciation, combined with a significant interest rate shock and deterioration in loan quality, would cause system capital adequacy ratio to drop well below prudential requirement.
  - Authorities refining bank-by-bank stress testing.
- Supervision and institutional reforms:
  - FSA and NBG will be merged to create a single supervisor; draft merger law in parliament consolidates financial sector supervision under NBG and fills legal gaps for crisis response.
  - With ADB-financed assistance, authorities preparing for risk-based and consolidated supervision, and convergence to International Financial Reporting Standards with well-defined supervisory filters.
  - With MCM assistance, further development of stress-testing framework.
- Contingency planning:
  - Financial stability plan completed in June (¶8f); institutional framework for managing potential financial sector stress established.
  - Next step: FSA to elaborate bank-by-bank contingency measures based on stress test results and assurances of support from foreign shareholders. Status report expected by end-September (structural benchmark).
  - Memorandums of understanding signed with home country supervisors to clarify foreign parent banks’ roles; authorities unconvinced about deposit insurance scheme due to doubtful benefits to large depositors and moral hazard concerns.

### Capacity to repay and external debt risks
- With requested augmentation of 180 percent of quota, at its peak Georgia’s outstanding credit to the Fund would amount to:
  - 33 percent of exports;
  - 58 percent of gross reserves.
- Peak risks in 2013:
  - Peak repurchases to the Fund of about $425 million (9½ percent of exports);
  - $500 million Eurobond-2013 (equivalent to 11 percent of exports).
- In 2013, total external debt service and public external debt service expected to exceed 45 percent and 25 percent of exports, respectively.
- Rolling over the Eurobond will require regained access to capital markets, critically dependent on achieving a sustainable fiscal position by 2012.

### Staff appraisal: performance, strategy, and risks
- Macroeconomic context:
  - Balance of challenges shifted from FX pressures to worsening economy and external accounts; output contraction may be bottoming out with slow recovery in 2010.
  - With imports contracting, FX market pressures have subsided but could reemerge depending on current account trends, private capital inflows, donor financing, and confidence in the currency.
- Policy performance:
  - Government contained fiscal deficit within program ceiling despite significant tax revenue shortfalls.
  - Monetary targets met with ample margins.
  - Successful introduction of foreign exchange auctions supports transition to market-driven exchange rate.
- Fiscal strategy 2009–11:
  - Revised strategy aims for orderly transition from expansionary fiscal stance in 2009 to steady adjustment consistent with medium-term fiscal and external sustainability.
  - Decision to accommodate 2009 revenue losses in a higher deficit while targeting substantial expenditure contraction in 2010 viewed as appropriate balance.
  - Front-loading of adjustment: well over one third of targeted adjustment through 2013 planned to take place in 2010.
  - Decline in capital spending over medium term consistent with winding down of donor-financed projects.
  - Authorities’ decision to engage the Fund early in budgetary process to align program and 2010 budget is welcome.
- Financial sector and supervision:
  - FSA strengthened analytical capacity; financial stability plan prepared in June is a welcome step.
  - IMF technical assistance helped develop in-house stress testing tools; scope exists to advance bank-by-bank action plans and quantify contingency costs.
  - Proposed NBG–FSA merger could facilitate coordination between monetary and prudential policies.
- Role of augmentation and external support:
  - Augmentation of access would preserve program objectives and avoid disruptive adjustment in external and fiscal accounts.
  - Much of financing gap in 2010–11 to be closed by planned fiscal adjustment; timely disbursements of donor support and Fund resources in 2010–11 would help cover residual gap and build international reserves.
- Risks:
  - Risks stem from economic and financial environment and policy implementation.
  - Sustaining fiscal adjustment through 2012 may be tested by electoral cycles and adverse political, security, and economic developments.
  - Difficulties restoring market access would complicate debt service profile, given coincidence of peak Fund repurchases and $500 million Eurobond maturing in 2013.
- Policy guidance emphasized by staff:
  - Maintain exchange rate flexibility.
  - Calibrate pace of fiscal spending carefully to balance countercyclical support against maintaining fiscal buffer for unexpected obligations and preserving medium-term debt sustainability.

*Italic: Source: IMF staff report content from the provided PDF excerpt.*

### 40.      Staff supports the authorities’ request for completing the third review on the

### Staff supports the authorities’ request for completing the third review on the basis of Georgia’s performance under the SBA

### Recommendation on review completion, augmentation, and extension
- Staff supports the authorities’ request for completing the third review on the basis of Georgia’s performance under the SBA, and modification of program conditionality, as specified in the Letter of Intent (¶19, and Tables 1 and 2).
- Staff recommends approval of the authorities’ request for an augmentation of access under the SBA by SDR 270 million (around 180 percent of quota).
  - Of the SDR 270 million augmentation, SDR 200 million would be available in 2010.
- Staff recommends extension of the arrangement to June 14, 2011.
- The augmentation would result in total access of 497 percent of quota.

### Real sector developments and key indicators
- Continued decline in VAT turnover and FDI inflows pointing to deterioration (charts summarized in narrative).
- Stabilization observed in:
  - Rate of decline for exports and remittances.
  - Lari-denominated broad money M2 and total broad money M3.
  - Possibly credit to the private sector (indications only).
- Selected numerical series reported in figures and tables (preserved as in source):
  - Real GDP growth (Table 1): 2007: 12.3; 2008: 2.1; 2009: -4.0; 2010 proj.: 2.0; 2011 proj.: 4.0; 2012 proj.: 5.0; 2013 proj.: 5.0; 2014 proj.: 5.0.
  - GDP per capita (US$) 2007: 2,324; 2008: 2,924; 2009: 2,497; 2010 proj.: 2,457; 2011 proj.: 2,570; 2012 proj.: 2,780; 2013 proj.: 3,007; 2014 proj.: 3,236.
  - Consumer price index, period average: 2007: 9.2; 2008: 10.0; 2009: 1.8; 2010 proj.: 3.2; 2011 proj.: 4.0; 2012 proj.: 5.0; 2013 proj.: 5.0; 2014 proj.: 5.0.
  - Foreign direct investment (percent of GDP): 2007: 17.1; 2008: 12.2; 2009: 8.3; 2010 proj.: 9.7; 2011 proj.: 10.8; 2012 proj.: 11.2; 2013 proj.: 11.2; 2014 proj.: 11.2.
  - Current account balance (in millions of US$): 2007: -2,009; 2008: -2,915; 2009: -1,768; 2010 proj.: -1,782; 2011 proj.: -1,813; 2012 proj.: -1,837; 2013 proj.: -1,838; 2014 proj.: -1,795.
  - Current account balance (in percent of GDP): 2007: -19.6; 2008: -22.7; 2009: -16.1; 2010 proj.: -16.6; 2011 proj.: -16.0; 2012 proj.: -14.9; 2013 proj.: -13.8; 2014 proj.: -12.5.
  - Gross international reserves (in millions of US$): 2007: 1,361; 2008: 1,480; 2009: 1,708; 2010 proj.: 1,942; 2011 proj.: 2,115; 2012 proj.: 2,124; 2013 proj.: 1,950; 2014 proj.: 1,913.
  - Gross international reserves (in months of next year's imports): 2007: 2.2; 2008: 3.2; 2009: 3.5; 2010 proj.: 3.7; 2011 proj.: 3.8; 2012 proj.: 3.6; 2013 proj.: 3.1; 2014 proj.: 2.9.

### Exchange rate and reserves developments
- Regional foreign exchange markets stabilized after several large devaluations in previous months.
- Since mid-March, National Bank of Georgia (NBG) switched to lower foreign exchange purchases; cumulative and daily interventions shown in figures.
- Lower devaluation pressures associated with stabilization of:
  - Bank deposit dollarization (charts indicate stabilization).
  - International reserves, with IMF support.
- Exchange rate volatility increased in 2-week moving volatility measures (charts indicated).

### Fiscal sector developments and outlook
- Since the 2008 conflict, tax revenues have trended down; decrease in expenditures has been less pronounced.
- In 2008, external borrowing outstripped privatization proceeds as the main source of financing.
- Fiscal deficit expected to peak in 2009; after 2009, public finances expected to be on a more sustainable path through expenditure reduction.
- Owing to accumulation of deficits, public debt increases at a fast pace (charts and tables).
- Key fiscal numbers (Table 2 and other tables, preserved):
  - Revenues (in millions of lari): 2008: 5,854; 2009: 5,961; 2010 proj.: 5,426; 2011 proj.: 5,115; 2012 proj.: 5,601; 2013 proj.: 5,890; 2014 proj.: 6,487; 2015 proj.: 7,148.
  - Grants (in millions of lari): 2008: 617; 2009: 695; 2010 proj.: 554; 2011 proj.: 277; 2012 proj.: 278; 2013 proj.: 159; 2014 proj.: 143; 2015 proj.: 126.
  - Overall balance (in millions of lari): 2007: -1,208; 2008: -1,141; 2009: -1,726; 2010 proj.: -1,393; 2011 proj.: -1,006; 2012 proj.: -917; 2013 proj.: -732; 2014 proj.: -812.
  - Overall balance (in percent of GDP): 2007: -6.3; 2008: -5.6; 2009: -9.4; 2010 proj.: -7.3; 2011 proj.: -4.8; 2012 proj.: -4.0; 2013 proj.: -2.9; 2014 proj.: -2.9.
  - Fiscal deficit excluding grants (in millions of lari): 2007: 1,790; 2008: 1,836; 2009: 2,281; 2010 proj.: 1,670; 2011 proj.: 1,283; 2012 proj.: 1,075; 2013 proj.: 875; 2014 proj.: 938.
  - Nominal GDP (in millions of lari): 2007: 19,070; 2008: 20,231; 2009: 18,303; 2010 proj.: 19,042; 2011 proj.: 20,794; 2012 proj.: 22,926; 2013 proj.: 25,276; 2014 proj.: 27,866.

### Monetary and banking sector developments
- Deposits stabilized since mid-May; credit remains constrained.
- Deteriorating non-performing loan (NPL) ratios and large loan-to-deposit ratios constrain credit.
- Banks hold excess liquidity in the form of unremunerated excess reserves and certificates of deposit with NBG.
- Selected monetary aggregates (Table 6 and related tables preserved):
  - Broad money (M3) (in millions of lari): Dec-08: 4,258; Mar-09: 3,675; Jun-09: 3,594; Sep-09: 3,767; Dec-09 proj.: 4,173; Dec-10 proj.: 4,799.
  - Broad money (M3) 12-month growth (memorandum): 2008: 50.6; Dec-08: 28.9; Mar-09: 25.7; Dec-09 proj.: -2.0; Dec-10 proj.: 15.0.
  - Broad money excluding forex deposits (M2) 12-month growth (memorandum): 2008: 65.4; Dec-08: 46.8; Mar-09: 17.1; Dec-09 proj.: 12.3; Dec-10 proj.: 7.8.
  - Credit to the economy 12-month growth (memorandum): 2008: 62.4; Dec-08: 53.9; Mar-09: 28.3; Dec-09 proj.: -2.0; Dec-10 proj.: 5.9.
  - Foreign exchange deposits in percent of total deposits: Dec-07: 60.9; Dec-08: 75.7; Mar-09: 75.2; Dec-09 proj.: 75.0; Dec-10 proj.: 76.3.

### External financing, reserves, and Fund credit
- External financing and sources detailed in balance of payments and external financing tables (Table 10, Table 4).
- Table 9: Schedule of prospective reviews and purchases (reflects authorities' request to augment access by SDR 270 million and extend the arrangement through June 2011).
  - Availability and purchase schedule entries include:
    - 15-Sep-08 Approve the 18-month arrangement: 161.7 (in millions of SDR), 107.6 (in percent of quota).
    - 15-Dec-08 Complete the first review ...: 63.1, 42.0.
    - 23-Mar-09 Complete the second review ...: 63.1, 42.0.
    - 6-Aug-09 Complete the third review ...: 94.6, 62.9.
    - 15-Nov-09 Complete the fourth review ...: 47.3, 31.5.
    - 15-Feb-10 Complete the fifth review ...: 97.3, 64.7.
    - 15-May-10 Complete the sixth review ...: 50.0, 33.3.
    - 15-Aug-10 Complete the seventh review ...: 50.0, 33.3.
    - 15-Nov-10 Complete the eighth review ...: 50.0, 33.3.
    - 15-Feb-11 Complete the ninth review ...: 35.0, 23.3.
    - 15-May-11 Complete the tenth review ...: 35.0, 23.3.
  - Total available (reflecting requested augmentation and extension): 747.1 (in millions of SDR); 497.1 (in percent of quota).

### Debt dynamics and stress-test outcomes
- Staff projections and simulations present external debt and public debt indicators under baseline and stress scenarios (Figures 5a/5b; Tables 13 and 14 series).
- Selected debt vulnerability indicators and projections (preserved numeric results and labels):
  - External debt (nominal, percent of GDP): 2007: 34.6; 2008: 35.3; 2009: 41.5; 2010 proj.: 54.8; 2011 proj.: 63.8; 2012 proj.: 65.1; 2013 proj.: 61.2; 2014 proj.: 56.4; 2019 average: 41.9; 2029 average: 28.9.
  - PV of external debt (percent of GDP, Table 13a projections): 2009: 36.0; 2010: 47.0; 2011: 54.9; 2012: 56.3; 2013: 53.7; 2014: 50.3; 2019: 46.4; 2029: 37.0; baseline averages reported.
  - PV of PPG external debt (percent of GDP): 2010: 15.3; 2011: 24.2; 2012: 31.1; 2013: 32.3; 2014: 31.0; 2019: 28.7; 2029: 25.4.
  - Debt service-to-exports ratio (percent): 2009: 16.6; 2010: 32.9; 2011: 24.5; 2012: 25.8; 2013: 29.1; 2014: 46.6; 2019: 29.5; 2029: 21.1.
  - Public sector debt (percent of GDP, Table 14a): 2007: 34.2; 2008: 27.6; 2009: 22.1; 2010 proj.: 25.0; 2011 proj.: 36.9; 2012 proj.: 45.1; 2013 proj.: 47.3; 2014 proj.: 45.2; 2019 proj. average: 42.4; 2029 proj. average: 41.0.
  - PV of public sector debt (percent of GDP): 2010: 19.4; 2011: 29.1; 2012: 36.2; 2013: 38.6; 2014: 37.8; 2019: 36.3; 2029: 35.0.
  - Gross financing need (percent of GDP): 2010 proj.: 10.9; 2011 proj.: 11.0; 2012 proj.: 8.4; 2013 proj.: 8.6; 2014 proj.: 12.1; 2019 proj.: 7.9; 2029 proj.: 6.0.
- Sensitivity analyses and stress tests (Table 13b, Table 14b) show various alternative scenarios and bound tests (e.g., one-time 30 percent depreciation, lower growth, less favorable financing) with resulting indicator levels preserved in tabulated form in the source.

*Source: IMF staff report content as provided in the source document.*

### 1.      In September 2008, the International Monetary Fund (IMF) approved a Stand-By

### _cr09267 - Letter of Intent: Georgia (September 2009)

### Request and program status
- Request to augment access under the current Stand-By Arrangement (SBA) by SDR 270 million and to extend the arrangement to June 14, 2011.
- Continued commitment to policies in previous letters of intent dated September 9, 2008; November 28, 2008; and March 10, 2009.

### Recent economic developments (facts and indicators)
- Growth and output:
  - Growth in 2008: 2.1 percent.
  - Real GDP contraction in Q1 2009: 5.9 percent.
- Inflation and money:
  - End-period inflation 2008: 5.5 percent.
  - Twelve-month inflation as of end-June 2009: 2.3 percent.
  - Year-on-year growth of reserve money and broad money aggregates: negative since November 2008.
- Fiscal performance:
  - Tax collection in H1 2009 declined by 16.5 percent in nominal terms (excluding one-off effects).
  - Expenditure contained at GEL 2,921million, or 11percent lower than H1 2008 (excluding one-off effects).
  - Fiscal deficit reached 4.1 percent of projected annual GDP in H1 2009 (in line with program projections).
- External sector and financing:
  - NBG net sales of foreign currency: USD142 million in Q1 2009; USD 0.4 million in Q2 2009.
  - Exports of goods and services (Q1 2009): declined by 23 percent.
  - Imports of goods and services (Q1 2009): declined by 29 percent.
  - Worker remittances (Q1 2009): dropped by 26 percent (majority from Russia).
  - Current account deficit (Q1 2009): 17.6 percent of GDP.
  - FDI inflows: declined by more than 75 percent compared with Q1 2008.
  - Other capital inflows (mainly donor assistance): increased by 28 percent.
- Financial sector:
  - Non-performing loans: 3.5 percent of total loans in mid-2008 to 18.8 percent at end-June 2009.
  - Average capital adequacy: 17.6 percent (highest level in 12 months).
- Institutional and operational developments:
  - Liquidity management framework developed and published (structural benchmark for end-March 2009).
  - Foreign exchange swaps introduced on June 3, 2009.
  - From March 10, 2009 introduced foreign exchange auction mechanism; from May 25, 2009 NBG stopped participating in TICEX sessions and intervenes only via auctions.
  - Investment Management Agreement with the World Bank signed in July (Sovereign Investment Partnership Program).
  - NBG launched modernization project for the Georgian payments system (contract signed in July).
  - Financial stability plan prepared (structural performance criterion for end-June 2009).
  - New budget code submitted to the cabinet (structural benchmark for end-July).

### Macroeconomic projections and scenarios
- 2009 scenarios:
  - Government envisions a scenario with a contraction for the year as a whole of 1.5 percent, but program targets assume a contraction in real GDP of 4 percent in 2009.
  - Current account deficit for 2009 expected to moderate to around 16 percent of GDP from nearly 23 percent in 2008.
  - Exports and imports for 2009 projected to decline by 20 percent and 27 percent, respectively.
  - Worker remittances for 2009 expected to drop by around 18 percent.
  - Projected FDI inflows for 2009: around US$ 900 million (40 percent lower than in 2008).
  - Expected accumulation of gross reserves in the amount of over US$230 million, assuming all available purchases under the SBA are made.
- 2010 outlook:
  - Real GDP projected increase: 2 percent.
  - Inflation projected: around 3 percent.
  - Nominal GDP projected: GEL 19,042 million in 2010.
  - Anticipated strong recovery in FDI beginning in 2010.
  - Anticipated recovery in exports as an important growth source.
- Medium-term fiscal/financing assessments:
  - Financing gap anticipated for 2010-11: around $400 million (requesting additional Fund support).
  - Fiscal deficit for full-year 2009 projected at 9.4 percent of GDP (due to revenue shortfall and donor-financed spending sustaining demand).
  - Recent 2009 budget amendment envisions additional expenditures of about GEL 300 million, offset in part by underexecution of other spending of about GEL130 million.
  - Target deficit reduction to 7.3 percent of GDP in 2010 (SBA definition), largely through expenditure reductions.
  - Commitment to reduce the deficit to 2-3 percent of GDP by 2013 (to be presented to parliament by October 1).
  - Limited issuance of treasury bills in 2009: around GEL 160 million.
  - Government expects to mobilize additional external budget support in 2010 and reduce Government use of IMF resources for deficit financing as commitments are finalized.

### Policy measures and reforms (actions, benchmarks, and instruments)
- Monetary and exchange rate policy:
  - Continue strongly expansionary monetary policy in 2009.
  - Use a combination of swaps, sales of certificates of deposit and treasury bills to manage liquidity while limiting inflationary pressures.
  - Projected end-period inflation: 3.5 percent.
  - Maintain fully flexible exchange rate policy; further enhance interbank market role by reducing regular weekly auctions from two to one and increasing allowed bid range at auctions from 0.5 percent plus or minus the official exchange rate to one percent.
- Financial sector measures:
  - Foreign exchange swaps intended to attract foreign capital, increase lending in domestic currency, mitigate foreign currency exposure and reduce dollarization; kept at relatively low level initially.
  - Continue to refine the financial stability plan; provide status report on developing bank-by-bank measures based on stress test results and assurances of support from foreign shareholders (structural benchmark end-September 2009).
  - Consider merger of NBG and FSA administrative/technical functions; draft law submitted to parliament.
- Public finance reforms and governance:
  - Implement public finance reform action plan for 2009 with actions including liquidity management guidelines, PFMS technical specification, new medium-term framework format, improved local budget formats, risk assessment tax audit system functionality, tax and customs code streamlining and sub-legislation, electronic information exchange between banks and the Revenues Service, improved capital budget forms, customs audit and risk-based customs control, full functionality of the electronic treasury system, and inclusion of all taxes into the e-filing system.
  - Approved internal audit strategy and established internal audit harmonization unit in the Ministry of Finance; Law on internal audit to be submitted to Parliament by end-September, 2009 (proposed structural benchmark).
- Fiscal policy stance:
  - 2010 fiscal consolidation largely via expenditure reductions, with domestically financed capital spending targeted; social expenditures not to be affected by proposed cuts.
  - Budget to be submitted to parliament by October 1, reflecting intentions and medium-term expenditure framework; proposed structural benchmark under the program to present targets and maintain close dialogue with the Fund.
- Market and debt management:
  - Plan to develop the T-bill market to provide the NBG a monetary policy tool and risk-free assets for banks; NBG to support secondary market development by introducing an electronic trading platform shortly after primary auctions.

### Risks and contingency readiness
- Identified risks:
  - Continued global economic crisis and domestic political tensions could worsen growth outcomes.
  - Adverse terms of trade developments may limit current account improvement despite fiscal adjustment.
- Contingency measures:
  - Economic team meets regularly and stands ready to introduce corrective measures, including broader fiscal and monetary adjustments, to ensure deficit reduction targets remain robust to lower GDP growth outcomes.
  - Preparedness to consider broader fiscal measures if risks materialize.

*Source: Letter of Intent and program documents submitted by the authorities (IMF Stand-By Arrangement correspondence).*

### 32.      All end-March and end-June performance criteria under the Stand-By Arrangement

### 32.      All end-March and end-June performance criteria under the Stand-By Arrangement

### Program status, requests, and intentions
- All end-March and end-June performance criteria under the Stand-By Arrangement were met.
- The authorities request:
  - Completion of the Third Review.
  - A rephasing of purchases through the remainder of 2009, with amounts previously scheduled to be available following third and fourth reviews becoming available after the completion of this review in August.
  - To purchase the SDR94.6 million that will be available upon completion of the third review.
- Policy stance and contingency:
  - The authorities will maintain close policy dialogue with the Fund and are ready to take additional measures as appropriate to ensure program objectives are met.
  - If pressures on Georgia stemming from the global economic crisis are greater than anticipated, the government would adjust its fiscal and exchange rate policies to maintain external stability.
- Executive Board and SDR allocation:
  - The authorities welcome the Executive Board’s decision to back the US$250 billion general SDR allocation.
  - They intend to use their share of the allocation to bolster international reserves.
- Publication authorization:
  - The authorities authorize the IMF to publish this Letter of Intent and its attachments as well as the accompanying staff report.

### Rephasing, review schedule, and targets
- Request to modify end-September performance criteria (PCs) according to Table 1, which also establishes end-December PCs and indicative targets for 2010.
- Review schedule:
  - Fourth review will be based on end-September performance criteria and is scheduled for completion by end-December 2009.
  - Fifth review will be based on end-December performance criteria and is scheduled for completion by end-March 2010.
- The revised Technical Memorandum of Understanding (TMU) clarifies:
  - Treatment of purchases under the SBA that are directed for budget support.
  - Treatment of SDR allocations in the calculations of net international reserves (NIR) of the NBG as defined by the program.
- Structural benchmarks under the program are described in Table 2.

### Key numerical program items and table excerpts
- Exchange rate for program purposes: GEL 1.67 = $1.
- Net international reserves (NIR) of the NBG:
  - The stock of NIR amounted to $879.8 million as of December 31, 2008 (at the program exchange rate).
- Selected table entries (as presented in the source table excerpt; values given in sequence as in the table):
  - Ceiling on cash deficit of the consolidated government: 480 208 924 660 973 1,255 1,638 1,393
  - Ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector: 850 0 850 0 850 850 850 600
  - Ceiling on net domestic assets (NDA) of the NBG 1/: 310 237 -66 446 328 189 240 344 413 829
  - Floor on net international reserves (NIR) of the NBG 1/: 633 677 777 585 656 775 769 813 740 609
  - Ceiling on accumulation of external arrears 2/: 0 0 0 0 0 0 0 0
  - (Table columns correspond to program rows for Mar-09, Jun-09, Sep-09, Dec-09, and proposed targets; figures shown as in the source table.)
- Structural benchmark numeric targets and dates:
  - Submission to parliament of a state budget for 2009 with an overall fiscal deficit of no more than 3¾ percent of projected GDP (subject to an adjustor of at most 3 percent of GDP as set out in the TMU). — End-Dec-08.
  - Submission to parliament of a state budget for 2010 that: (i) is consistent with the program targets and assumptions, and an overall deficit of no more than 7.3 percent of GDP (program definition); (ii) contains a medium-term fiscal framework consistent with the program’s medium-term deficit reduction targets; and (iii) describes the medium-term policies underlying the fiscal deficit objectives through 2013. — October 1, 2009.

### Definitions and reporting arrangements (selected)
- Consolidated government:
  - Defined as the central government, local governments, extrabudgetary funds, public services providing general government system LEPLs, and the Sovereign Wealth Funds (Future Generations and Stable Development Funds). New extrabudgetary funds will be consolidated within the consolidated government.
- Public sector:
  - Consists of the consolidated government and the National Bank of Georgia (NBG).
- Ceiling on the cash deficit of the consolidated government:
  - Measured from the financing side at current exchange rates; defined as equal to total financing.
  - Total financing = (i) net domestic financing from banks and nonbanks, (ii) net external financing, and (iii) privatization receipts.
  - Net domestic financing components include:
    - (i) Loans provided by commercial banks to the consolidated government minus accounts held by the consolidated government at commercial banks; other securities issued by the consolidated government (for example, promissory notes) are included.
    - (ii) Loans provided by the NBG to the consolidated government minus accounts of the consolidated government held at the NBG in lari and foreign currency. Accounts outside MOF control are excluded (VAT refund account; earmarked grants account; account for state agencies deposits; account for local government revenues for the day to be transferred to their account; national disaster fund account; and investment grant and credit account). As of December 31, 2008, cash balances in these excluded accounts were lari 768 million.
    - (iii) Treasury bills that have been securitized and sold by the NBG, including bills purchased by nonbanks.
  - Net external financing includes loans disbursed for balance-of-payments support and project financing, net change in external arrears, change in accounts abroad (including Sovereign Wealth Fund accounts), minus amortization. Amortization includes all external debt principal payments by the consolidated government; amortization via third parties is accounted for at the time and amount of budget payment to the third party.
  - Privatization receipts include transfers of monies received by central and local governments from sales of assets, sales of shares, leases, and sale of licenses with duration of 10 years and longer, including receipts transferred to Sovereign Wealth Funds.
- Floor on the Net International Reserves (NIR) of the NBG:
  - NIR in U.S. dollars = foreign assets of the NBG minus foreign liabilities of the NBG.
  - Foreign assets include gold, gross foreign exchange reserves, Georgia’s SDR holdings, and the reserve position in the IMF.
  - Foreign liabilities include Georgia’s outstanding liabilities to the IMF, Georgia’s SDR allocation, and any other liabilities of the NBG, excluding foreign exchange balances in the government’s account with the NBG.
  - The NIR definition excludes foreign assets stemming from foreign currency deposits of financial institutions at the NBG and foreign assets arising from currency swaps with financial institutions.
- Adjustors to the NIR floor:
  - (a) Upward/downward by 50 percent for any excess/shortfall in the balance-of-payments support loans and balance-of-payments support grants relative to the projected amounts presented in Table 2.
  - (b) Upward/downward by 50 percent for any excess/shortfall in disbursements of project loans and project grants to the Treasury Single Account at the NBG relative to projected amounts presented in Table 2.
  - (c) Upward 100 percent for any shortfall in the amount of conversion for government imports relative to projected amounts presented in Table 2.
- Ceiling on net domestic assets (NDA) of the NBG:
  - Defined as reserve money minus NIR (as defined) and adjusted according to the NIR adjustors.
- Ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector:
  - Nonconcessional external loans are those from lenders other than the IMF with a grant element of less than 35 percent of the value of the loan.
  - Grant element calculated using currency-specific discount rates reported by the OECD (CIRRs). For maturities < 15 years, grant element uses six-month averages of commercial interest rates; for maturities > 15 years, uses 10-year averages.
  - Applies to debt as defined in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt and also to commitments contracted or guaranteed for which value has not been received.
  - Previously contracted nonconcessional external debt that has been rescheduled is excluded from the definition of “new debt” for this performance criterion.
- Continuous performance criterion on nonaccumulation of external arrears:
  - The consolidated government and the NBG will not accumulate any new external payment arrears on debt service obligations to official creditors during the arrangement.
  - Official external payment arrears are unpaid debt service beyond 30 days after the due date. This performance criterion is continuous.

*Attachment II. Georgia: Revised Technical Memorandum of Understanding — July 30, 2009*

### 15.      Supporting material: Details of official arrears accumulated on interest and

### 10. A key part of the Bank Group assistance has been to the private sector where IFC has

### _cr09267 - 10. A key part of the Bank Group assistance has been to the private sector where IFC has

### IFC assistance to the private sector (up to June 2009)
- IFC’s committed portfolio in Georgia as of June 2009 stood at about $298 million, of which $240 million is disbursed.
- The portfolio includes 9 clients, primarily in the banking sector and several real sector clients.
- Financial sector focus:
  - Provided investment and technical assistance to three leading banks—TBC Bank, the Bank of Georgia, and Bank Republic.
  - Helped establish ProCredit Bank of Georgia, the country’s first bank specializing in lending to micro and small enterprises.
  - Provided a credit line to TBC Leasing to support rapid growth of their portfolio of SME clients.
- Real sector focus and priorities:
  - Continues to look for opportunities to support growth of the private sector, particularly export-oriented companies or those supporting overall private sector development.
  - Sectors of interest include agrobusiness, infrastructure, manufacturing, and the development of natural resources.
- Technical assistance:
  - Strengthened client banks and introduced new financial products (including leasing and housing finance).
  - Worked to improve the business climate and corporate governance practices.
- Institutional engagement:
  - The World Bank-IFC Doing Business report has ranked Georgia as a top reformer.
  - The government is actively engaged with IFC to make further progress on reforms to improve the business environment.
- Contact note: Questions may be referred to Mr. A. Cholst (202-458-0324).

### IFC response to the global financial crisis
- IFC mobilized investment assistance to provide stability to the Georgian banking system in the wake of the global financial crisis.
- Joint actions with other institutions to support banks (see related EBRD/IFC coordinated packages described below).

### EBRD relations and portfolio summary (As of June 30, 2009)
- As of June 30, 2009 the EBRD had signed 120 investments in Georgia with cumulative commitments totaling $975.4 million.
- Current Portfolio Stock equals to $696.3 million.
- The EBRD’s first operation was signed in December 1994 (power rehabilitation project).
- 2007 activity:
  - Signed 23 transactions totaling $162.00 million.
  - Syndicated loan to ProCreditBank Georgia ($8 million).
  - Increased equity participation in Republic Bank; MCFF sub-operations in agriculture and health (total $9.35 million).
  - MCFF projects with TBC: agriculture ($26 million), general industry ($1 million), natural resources ($3 million).
  - Mortgage lines: TBC Bank ($12 million) and Republic Bank ($4m).
  - Loans for on-lending: Republic Bank ($10 million), Cartu Bank ($7 million), Basis Bank ($6 million).
  - Energy Efficiency facility: TBC Bank ($10 million) and Cartu Bank ($5 million).
- 2008 activity:
  - Annual business volume reached $276.2 million through 28 transactions.
  - Examples: $7.5 million loan to TBC Bank for SMEs; additional mortgage loan ($20 million) to Republic Bank; equity investment in Basis Bank; equity increase and subordinated debt ($5 million) to Republic Bank.
  - Municipal/environmental projects: Batumi Public transport ($3.2 million), Kobuleti ($1.9 million), Borjomi ($1.9 million) water supply projects.
  - $14 million loan to Geo Steel to finance construction and operation of 175 k ton capacity steel mini-mill.
  - In December 2008 EBRD, along with the IFC, provided Bank of Georgia with $200 million loan facilities comprising convertible subordinated, non-convertible subordinated and senior loans.
- 2009 first half:
  - As at 30 June 2009 the Bank had signed eight projects in private sector arriving at the business volume of USD 84.4 million.
  - In response to the global financial crisis, EBRD, IFC and FMO provided TBC Bank with a funding package of $161 million in loans and equity investment; EBRD contribution worth up to $70 million including acquisition of an equity stake for $36.8 million and provision of an $18.5 million subordinated and a $14.7 million senior loans.
- Portfolio composition:
  - The ratio of private sector projects in the portfolio stands at 94 percent.
  - The Bank plans to focus primarily on private sector financing, giving preference to non-sovereign operations; where sovereign guarantees are required, donor co-funding on a grant basis will be sought.
- ETC initiative:
  - Georgia is part of the ‘Early Transition Countries’ (ETC) initiative launched in April 2004.
  - Since launch of the ETC initiative, the Bank’s annual business volume in Georgia has been increased five times.
- EBRD portfolio table highlights (Outstanding Amounts in US$; as of June 30, 2009):
  - Bank Republic - MSE Loan (27-Apr 2006) 1.7
  - Bank Republic - MSME (12-Dec 2008) 10.0
  - Bank Republic Equity (15-Sep 2006) 8.3
  - Bank Republic Equity (Capital Increase) (23-Apr 2008) 1.4
  - Bank Republic Mortgage Loan (20-Dec 2006) 7.8
  - Bank Republic Mortgage Loan II (22-Aug 2008) 14.0
  - Bank Republic Subordinated Debt (07-Jul 2008) 5.0
  - Bank of Georgia - convertible subordinated debt (30-Dec 2008) 26.0
  - Bank of Georgia - subordinated debt (30-Dec 2008) 24.0
  - Bank of Georgia Senior Loan (30-Dec 2008) 50.0
  - Basis Bank Equity Investment - Georgian Financial Sector F/W (19-May 2008) 4.1
  - Batumi Public Transport Project (02-Sep 2008) 3.5
  - Borjomi Water Project (01-Dec 2008) 2.1
  - Geo Steel (20-Oct 2008) 14.0
  - Regional TFP: Bank of Georgia (Guarantee & Pre-export) (29-Jul 1999) 19.0
  - Regional TFP: TBC Bank (guarantee & pre-export) (17-Aug 1999) 21.9
  - Tbilisi International Airport (17-May 2006) 23.6
  - TBC Bank: investment in ordinary shares (7-Apr 2009) 38.7
  - TBC Bank: Subordinated Loan (14-Apr 2009) 18.5
  - TBC Bank - Senior Loan (14-Apr 2009) 14.7
  - TOTAL (selected block) 578.1
  - TOTAL REGIONAL 118.2
  - GRAND TOTAL 696.3

### Statistical issues (Annex IV)
- Overall assessment:
  - Data provision has some shortcomings, but is broadly adequate for surveillance and program monitoring.
  - The Fund has provided technical assistance (TA) in the compilation of macroeconomic statistics.
  - Despite improvements in national accounts, price, monetary, and government finance statistics, quality reflects insufficient resources and deficiencies in statistical methodologies and coverage.
  - Problems are particularly acute in the compilation of national accounts, balance of payments, foreign trade, and fiscal statistics.
- Data dissemination and standards:
  - The data module of the Report on the Observance of Standards and Codes (ROSC) prepared in July 2002 was published on May 27, 2003.
  - A General Data Dissemination System (GDDS) mission in November helped finalize metadata and on December 15, 2006 Georgia began participation in the GDDS.
  - Since then the country is working to meet the requirements of the Special Data Dissemination Standards.
- Real sector statistics:
  - National accounts follow the System of National Accounts 1993; annual and quarterly GDP estimates compiled by production and expenditure approaches.
  - Preliminary national accounts estimates available after 85 days, final estimates after 13 months.
  - 2002 ROSC mission found weaknesses: poor coverage of units in value added for agriculture, retail trade, construction, catering, and services; limited administrative sources for nonobserved economy; inadequate data for imports and exports of services.
  - Follow-up missions in 2004 and 2005 found progress but scope for improving constant price estimates and developing supply and use tables.
  - STA missions in May/June 2006 and August/September 2007 reported important progress on agricultural price indices; inadequate funding causing delays.
  - Authorities plan compilation of supply and use tables in current and constant prices and launching a PPI for agriculture.
- Monetary and financial statistics:
  - March 2002 STA mission found many recommendations of December 2000 mission implemented.
  - July 2002 ROSC recommended improvements in coverage of nonbank depository corporations, provision of metadata documentation, and increased transparency regarding governmental access to monetary statistics prior to public release.
  - NBG has begun compiling monetary data using STA’s Standardized Report Forms (SRF) and has been providing data regularly; these data published in the IFS Supplement since September 2006.
  - Beginning from December 2001, data published in IFS have been revised in accordance with the SRF.
  - A TA mission was scheduled for March 2009 to assist NBG in developing a data reporting and compilation framework for other financial corporations.
- Government finance statistics:
  - Annual and monthly GFS compiled on a cash basis in accordance with GFSM 2001 are reported to STA for publication in the GFS Yearbook and International Financial Statistics.
  - Country is well advanced on reforms to central and local government budget and accounting systems to fully adopt GFSM 2001 methodology and IPSASs, including staged introduction of accrual recording and expansion of balance sheet items.
  - Reforms documented in Accounting Reform Strategy, 2007–17.
  - Authorities’ commitment set out in Decree 101 issued by the Minister of Finance on February 10, 2006; implementation of some steps will require amendments to the law of Georgia on the budget system (Budget System Law).
- External sector statistics:
  - A September 2006 TA mission assisted transfer of balance of payments compilation responsibility from DS to NBG; advised on structure of NBG’s new balance of payments division and developed framework for source data collection.
  - Transfer led to improvements in data quality.

*IMF staff report content unit _cr09267 (excerpt).*

### 9.      The STA Resident Statistics Advisor (RSA) stationed in Baku undertook six

### 9. The STA Resident Statistics Advisor (RSA) missions and IMF review of Georgia

### STA RSA missions and external sector statistics
- The STA Resident Statistics Advisor (RSA) stationed in Baku undertook six peripatetic TA missions to Georgia during April 2007–October 2008.
- Focus of the RSA: further improving Georgia’s data collection and compilation programs for external sector statistics.
- Major remaining weaknesses in external sector statistics:
  - (i) data sharing between the public institutions involved in producing external sector statistics is not yet implemented;
  - (ii) the data collection system for private sector liabilities should be improved.

### Table of Common Indicators Required for Surveillance (as of June 9, 2009) — selected metadata and data-quality assessments
- Exchange Rates
  - Date of latest observation: 06/09/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities
  - Date of latest observation: 06/08/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: M
- Reserve/Base Money
  - Date of latest observation: 06/09/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: M
  - Data Quality—Methodological soundness: O, LO, LO, O
  - Data Quality—Accuracy and reliability: O,O,O,O,LO
- Broad Money
  - Date of latest observation: 06/08/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: M
- Central Bank Balance Sheet
  - Date of latest observation: 06/08/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: M
- Consolidated Balance Sheet of the Banking System
  - Date of latest observation: 04/09
  - Date received: 05/25/09
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of publication: M
- Interest Rates
  - Date of latest observation: 06/09/09
  - Date received: 06/09/09
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of publication: D
- Consumer Price Index
  - Date of latest observation: 05/09
  - Date received: 06/08/09
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of publication: M
  - Data Quality—Methodological soundness: O,LO,O,O
  - Data Quality—Accuracy and reliability: LO,LO,O,O,O
- Revenue, Expenditure, Balance and Composition of Financing — General Government
  - Date of latest observation: 05/09
  - Date received: 06/08/09
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of publication: M
  - Data Quality—Methodological soundness: LNO,LO,LNO,O
  - Data Quality—Accuracy and reliability: LO,O,LO,O,O
- Revenue, Expenditure, Balance and Composition of Financing — Central Government
  - Date of latest observation: 05/09
  - Date received: 06/08/09
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of publication: M
- Stocks of Central Government and Central Government-Guaranteed Debt
  - Date of latest observation: 12/08
  - Date received: 02/27/09
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of publication: Q
- External Current Account Balance
  - Date of latest observation: 12/08
  - Date received: 02/17/09
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of publication: Q
  - Data Quality—Methodological soundness: O,LO,LO,LO
  - Data Quality—Accuracy and reliability: LNO, LNO, LNO, LNO, LNO
- Exports and Imports of Goods and Services
  - Date of latest observation: 12/08
  - Date received: 02/17/09
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of publication: Q
- GDP/GNP
  - Date of latest observation: Q4/08
  - Date received: 03/26/09
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of publication: Q
  - Data Quality—Methodological soundness: O,LO,O,LO
  - Data Quality—Accuracy and reliability: LNO, LNO, LNO, LO, LO
- Gross External Debt
  - Date of latest observation: 12/08
  - Date received: 02/27/09
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of publication: Q
- International Investment Position
  - Date of latest observation: Q4/07
  - Date received: 10/21/08
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Frequency of publication: A

### IMF Press Release — Executive Board completes third review under the Stand-By Arrangement (Press Release No. 09/277, August 06, 2009)
- Arrangement details:
  - 18-month Stand-By Arrangement (SBA) totaling SDR 477.1 million (about US$748.3 million).
  - Completion of the third review allows immediate disbursement of an amount equivalent to SDR 94.6 million (about US$148.4 million).
  - Board approved an augmentation under the SBA in the amount of SDR 270 million (about US$423.5 million), equivalent to 180 percent of quota, and extension of the SBA to June 14, 2011.
  - The SBA was approved on September 15, 2008.
- Purpose of augmentation and extension:
  - To facilitate an orderly exit from high public and external deficits, and the associated dependence on official financial support, in view of weaker economic and external financing prospects.

### Executive Board summary — key observations and policy guidance (remarks by Mr. Murilo Portugal, Deputy Managing Director and Acting Chair)
- Economic outlook and risks:
  - “The economic and financial impact of the crisis on Georgia will stretch into 2010, despite some signs that the economy may have reached its trough.  Risks remain elevated due to uncertainties about the international economic environment and the strength of the recovery of private capital inflows and bank credit.”
- Fiscal strategy (2009–2010):
  - “The authorities’ economic strategy aims to support the incipient recovery by maintaining an expansionary fiscal stance in 2009, specifically by allowing revenue shortfalls to be fully accommodated in a widening of the fiscal deficit.”
  - “Starting in 2010, the authorities intend to move to a path of strong fiscal adjustment.”
  - “The emphasis placed by the authorities on expenditure reduction as the primary instrument of adjustment—while safeguarding social spending—is appropriate, but revenue measures should not be excluded if necessary.”
  - Recommendation: Structural fiscal reforms to enhance monitoring, planning, execution, and auditing of public expenditure.
- Exchange rate and monetary policy:
  - “The authorities have made a successful transition from the daily fixing session to foreign exchange auctions, which should set the stage for more exchange rate flexibility in response to market conditions, thereby protecting international reserves.”
  - Monetary policy constrained by high dollarization and constraints in banks’ balance sheets; as traditional monetary policy tools regain traction, authorities intend to adjust the monetary policy stance to preserve disinflation gains.
- Banking sector and financial stability:
  - Banking sector has weathered pressures but faces worsening loan portfolio quality and profitability; warrants continued close monitoring and preparedness.
  - Authorities prepared a Financial Stability Plan outlining policy options for public intervention in the event of additional stress.
  - With IMF technical assistance, stress testing capacity has been strengthened.
  - Recommendation: supervisory authority (to be merged with the National Bank) should develop bank-by-bank risk assessments drawing from stress test results and discussions with foreign shareholders and parent companies of local banks.

### Statement by Age Bakker, Executive Director for Georgia (August 6, 2009) — performance and policy assessment
- Program performance and structural measures:
  - Authorities met all performance criteria for the third review by a wide margin.
  - Progress in structural area: a new liquidity framework established and published (albeit with a small delay); a financial contingency plan developed; a new budget code submitted to cabinet by end-July to enhance budget monitoring and planning.
  - The only structural benchmark not met: appointment of remaining members of the Financial Supervisory Agency (FSA), due to merger plans of the central bank and FSA to create one supervisor.
- Macroeconomic developments and contributors to contraction:
  - Major channels of crisis impact: decline in exports, remittances and foreign direct investment.
  - Exchange rate market tensions abated since March due to auction-based mechanism; greater exchange rate flexibility helped lower central bank interventions and protected international reserves.
  - GDP growth slowed to 2.1 percent in 2008; economy shrunk by 2.5 percent in the last quarter of 2008, and contracted by almost 6 percent in the first quarter of 2009.
  - By end-June, inflation reached 2.3 percent.
  - Tax revenues dropped by almost 17 percent over first 6 months of 2009; fiscal deficit over first 6 months of 2009 was lower than program targets due to under execution and defense spending cuts.
- Outlook and projections:
  - Current account: expected to decline this year by more than 6.5 percent; current account deficit remains sizable at 16 percent of GDP.
  - Private capital inflows projected to slow further; enhanced and frontloaded donor inflows will partially compensate.
  - External financing gap expected in 2010 and 2011; most of projected financing gap will be closed by policy adjustment; remainder covered by proposed augmentation of the SBA.
  - Real GDP growth projections for 2009 revised by the authorities to -4 percent.
  - Authorities expect modest recovery beginning in second half of 2009; growth projected at 2 percent in 2010.
  - CPI inflation projected to remain low over the next year, in the range of 3-3.5 percent.
- Policy measures and financing:
  - Monetary/exchange rate: introduction of foreign currency swaps to stimulate banks to lend in domestic currency; swaps use limited due to risks of speculation; monetary policy tools considered adequate; reserve requirement increase may become desirable in due time.
  - Fiscal: expansionary fiscal stance in 2009; 2009 fiscal deficit expected to rise from 5.6 percent to 9.4 percent of GDP owing to a sharp decline in GDP and tax revenues.
  - Authorities committed to an ambitious and front-loaded fiscal adjustment strategy in 2010; 2010 fiscal balance expected to improve by 2 percentage points. With revenues projected to decline by 2.8 percentage points of GDP, this entails a 4.3 percentage point of GDP decline in non-interest rate expenditures, excluding one-off measures.
  - Spending cuts: reducing domestically-financed capital projects, administrative costs, subsidies to semi-public institutions and capping public salaries.
  - Financing of deficits (2009 and 2010): combination of external budget support, privatization receipts and issuance of treasury bills.
    - For 2009, the Fund is expected to cover about 9 percent of the financing.
    - For 2010, the Fund’s share is projected to be higher; authorities expect additional budget support from the World Bank and ADB.
  - Commitment to gradually reduce the deficit in the range of 2-3 percent of GDP by 2013; additional steps to be taken if measures insufficient.
  - Proposal: make the 2010 budget, which includes multi-year targets and related adjustment policies, a structural benchmark under the program.
- Financial sector measures:
  - Conservative prudential and regulatory policies contributed to banking sector resilience.
  - Nonperforming loans rising, but liquidity and capital buffers are strong, aided by injections from multilateral organizations into the country’s largest banks.
  - Authorities obtaining assurances from foreign parent banks for continued liquidity and capital support; in some cases formal comfort letters obtained.
  - FSA refining the financial stability plan; a status report to IMF staff by September on required actions in case of problems at individual banks.

### Request to the IMF Executive Board
- In light of good performance under the SBA, commitment to conditionality and further policy adjustments, the authorities requested:
  - Board approval of the completion of the third review,
  - augmentation of the arrangement by SDR 270 million,
  - extension of the arrangement to mid-2011.
- Authorities indicated their intention to draw the amount that becomes available at the completion of this review.

*Content based only on the supplied IMF document excerpt.*

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