## _cr09331 - Executive Summary

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### Key findings: current state and near-term outlook
- Real GDP is projected to contract by 4 percent in 2009, and to grow by 2 percent in 2010.
- The economy "appears to have turned the corner" with stabilized financial conditions, but the outlook is clouded by weak export market growth, slow recovery of private capital inflows, and tight credit conditions.
- All end-September quantitative performance criteria and all structural benchmarks have been met.
- Improved confidence and stronger liquidity conditions should lead to an easing of credit conditions, but the recovery remains tentative.

### External and exchange rate developments
- Gross international official reserves reached $2,030 billion in October, including about $230 million from the SDR allocations.
- The foreign exchange market has been stable with only minimal central bank intervention; interbank transactions now account for the bulk of fx market turnover.
- The exchange rate has been relatively stable vis-à-vis the U.S. dollar; the real effective exchange rate has depreciated markedly since March 2009 due to low domestic inflation and a weakening U.S. dollar.
- A roughly $400 million external financing gap remains in 2010, mostly because of the slow recovery of private capital inflows; Fund financing is expected to fill this temporary gap to avoid disruptive exchange rate overshooting and adverse balance-sheet effects (given high liability dollarization).

### Financial sector and banking system
- The banking sector has weathered the crisis relatively well; systemic risks have abated.
- Banks’ capitalization, liquidity, and provisioning ratios are comfortable and have improved since the beginning of the year.
- Banks’ excess reserves at the National Bank of Georgia (NBG) have grown to 19 percent of lari broad money at end-October.
- Credit to the private sector contracted by 13 percent in the first 10 months of 2009.
- The average U.S. dollar lending rate stands at around 21 percent—15 percent for prime customers.
- Loan dollarization has continued to increase; deposit dollarization and loan dollarization remain high.
- Stress tests indicate capital buffers would be sufficient to withstand all but the most extreme shocks; even in those extreme cases the risk to government finances would be limited.
- Authorities continue to upgrade the regulatory and supervision framework and have developed a contingency plan for severe financial sector stress.

### Banking sector indicators (selected snapshots)
- Capital adequacy ratio (national definition): 20.2 percent in September 2009.
- Capital adequacy ratio (Basel I definition): 27.4 percent (period-end shown).
- Liquidity ratio: 40.6 percent in September 2009.
- Nonperforming loans (national definition): around 18.2 percent of total loans in September 2009; under IMF definition NPLs reported at 8.3 percent (period shown).
- Specific provisions: 10.2 percent of total loans (period shown).
- Loans collateralized by real estate: about 49.1 percent of total loans (period shown).
- Loans in foreign exchange: 77.6 percent of total loans (period shown).
- Return on equity: negative in recent periods (e.g., -7.3 percent in latest period shown).
- Loan-to-deposit ratio: declined from 165.3 (peak earlier) to 143.0 in September 2009.
- Credit-to-GDP ratio: around 29.6 percent (latest reported).

### Stress tests, contingency planning, and prudential measures
- Macro Credit Risk Model used for stress testing (technical assistance from Fund’s MCM).
- Scenario outcomes:
  - A 10 percent lari depreciation combined with a 15 percent decline in real GDP would cause manageable recapitalization needs in some banks, not requiring public intervention.
  - A 30 percent lari depreciation combined with a 15 percent decline in output would generate recapitalization needs for most systemic banks, estimated at 3¼ percent of GDP, with a possible need for public financial support.
- 80 percent of the increase in NPLs is estimated to originate from the exchange rate effect alone.
- Authorities intend to develop an improved macroprudential Macro Credit Risk Model and require systemic banks to carry out extended stress tests.
- Contingency plan prepared: bank-by-bank measures, policy options for containment of liquidity and solvency crises, potential role of shareholders, and options on the use of public funds.
- Recent interventions: liquidity injection through government deposits; lending of last resort to one systemic bank and subsequent facilitation of its acquisition by a foreign investor.
- Supervisory reforms: move to risk-based and consolidated supervision starting in 2010; supervisor authorized to adjust regulatory requirements bank-by-bank; considerations to introduce dynamic provisioning, fx-denominated provisions for fx loans, and fx-denominated capital for fx-assets.
- Recommendations: maintain relatively high capital charges on foreign exchange lending; consider deposit insurance (possibly limited to lari deposits) when conditions normalize; restore tighter liquidity requirements that prevailed before September 2008 if deposit insurance is absent.

### Fiscal developments and 2010 fiscal stance
- End-September fiscal deficit was below the program ceiling; the annual deficit (9.6 percent of GDP) is projected to be within the annual target.
- Authorities will transition fiscal policy from an expansionary stance in 2009 to strong consolidation in 2010, with a reduction in the deficit of 2¼ percent of GDP in 2010.
- Fiscal deficit projected to decrease from 9.6 percent of GDP in 2009 to 7.3 percent in 2010.
- Underlying improvement in the structural balance is estimated at 2.2 percent of GDP in 2010.
- 2010 budget includes additional revenues from adjustments to the indirect tax base and higher capital expenditures; spending adjustments include expenditure containment and reclassification effects noted for goods and services and defense arrears penalties.
- Shortfalls in expected privatization revenues (revised down by 0.6 percent of GDP) and some external financing shortfalls are being made up by higher issuance of T-bills—authorities intend to increase T-bill issuance to GEL 260 million, or 1.4 percent of GDP, by end-2009.
- Fiscal adjustment measures and quantitative changes (in percent of GDP) 2009–10 and 2010–13 (selected):
  - (1) Policy adjustment and automatic stabilizers — Change 2009-10: 2.4; Change 2010-13: 7.4.
  - Decrease in expenditures — Change 2009-10: 2.5; Change 2010-13: 7.2.
  - Capital spending reduction — Change 2009-10: 0.5; Change 2010-13: 2.7.
  - (2) Exogeneous factors — Change 2009-10: -0.1; Change 2010-13: -2.5.
  - (1)+(2) = Total reduction in fiscal balance — Change 2009-10: 2.3; Change 2010-13: 4.9.

### Financing of the 2010 fiscal deficit and external financing (gross inflows, in millions of U.S. dollars)
- Financing mix includes T-bill issuance, external borrowing, and privatization; domestic currency counterpart of IMF foreign exchange purchases in 2010 may be drawn down subject to SBA conditions and donor confirmations.
- Georgia: External Financing of the Public Sector, 2008–10 (Gross inflows in millions of U.S. dollars):
  - Total: 2008: 1,368; 2009: 1,052; 2010: 987.
  - IMF: 2008: 257; 2009: 338; 2010: 385.
  - WB: 2008: 126; 2009: 252; 2010: 175.
  - Other Multilateral Institutions: 2008: 135; 2009: 246; 2010: 201.
  - Bilateral partners: 2008: 350; 2009: 216; 2010: 226.
  - Eurobond-2013: 500 (2008 entry shown).
- Memorandum items:
  - Grants: 2008: 388; 2009: 298; 2010: 271.
  - Loans 1/ 2/: 2008: 723; 2009: 416; 2010: 331.
  - Budget support financing 2/: 2008: 426; 2009: 278; 2010: 152.
  - Project financing: 2008: 185; 2009: 435; 2010: 450.

### Macroeconomic assumptions and risks for 2010 and medium term
- 2010 real GDP projection of 2 percent assumes:
  - a negative fiscal impulse in 2010 of -2 percent of GDP will be offset by a 4 percent increase in private demand in real terms,
  - supported by a small increase in FDI inflows and resumption of bank lending.
- Import demand in Georgia’s trading partners assumed to grow 3 percent in volume terms in 2010, following a decline of 16 percent in 2009.
- Short-term external outlook has deteriorated slightly relative to the last review; FDI projected to recover only slowly in 2010.
- Projected deterioration in the terms of trade (by some 4½ percent) due to higher oil prices is expected to dominate an underlying improvement in volume terms and a recovery of remittances; current account deficit projected to widen by about 1 percent of GDP relative to 2009.
- Medium-term adjustment requires resumption of private capital inflows to around $1.7 billion annually in 2011–12, up from around $1.1 billion in 2009–10.

### Monetary and credit conditions
- Despite easing liquidity conditions, deposit and lending rates have remained high.
- Central bank’s refinancing rate (in local currency) remains disconnected from overall market conditions because of dollarization and inadequate collateral.
- Monetary projections for 2010:
  - Broad money projected increase: 13 percent.
  - Credit to the private sector projected increase: 9 percent.
  - Central bank gross international reserves projected to reach $2.1 billion.
  - Net international reserves (NIR) projected to decline to $609 million to cover the projected net financing need of the private sector in 2010.
- Policy actions: increase issuance of CDs to mop up excess local currency liquidity; T-bill issuance will mop up only part of excess local currency liquidity—additional CD issuance by the central bank is needed.

### Selected macro and fiscal projections (tables and charts excerpted)
- Nominal GDP (in million lari): 2007: 16,994; 2008: 19,070; 2009: 18,028; 2010 proj.: 19,042; 2011 proj.: 20,794; 2012 proj.: 22,925; 2013 proj.: 25,275; 2014 proj.: 27,866.
- Real GDP growth (annual change): 2007: 12.3; 2008: 2.1; 2009: -4.0; 2010 proj.: 2.0; 2011 proj.: 4.0; 2012–2014 proj.: 5.0 each year.
- Consumer price index, period average: 2007: 9.2; 2008: 10.0; 2009: 1.8; 2010–2014 proj.: 4.8, 5.0, 5.0, 5.0, 5.0.
- Overall balance (percent of GDP): 2007: -4.7; 2008: -6.3; 2009: -9.6; 2010 proj.: -7.3; 2011 proj.: -5.5; 2012 proj.: -3.9; 2013 proj.: -2.4; 2014 proj.: -1.7.
- Current account balance (millions US$): 2007: -2,009; 2008: -2,915; 2009: -1,626; 2010 proj.: -1,765; 2011 proj.: -1,850; 2012 proj.: -1,911; 2013 proj.: -1,980; 2014 proj.: -2,062.
- Current account balance (percent of GDP): 2007: -19.7; 2008: -22.7; 2009: -15.1; 2010 proj.: -16.0; 2011 proj.: -15.4; 2012 proj.: -14.7; 2013 proj.: -14.1; 2014 proj.: -13.5.
- Gross international reserves (millions US$): 2007: 1,361; 2008: 1,480; 2009: 2,005; 2010 proj.: 2,086; 2011 proj.: 2,259; 2012 proj.: 2,268; 2013 proj.: 2,094; 2014 proj.: 2,057.

### Debt dynamics, sustainability, and Fund financing
- External debt (nominal, in millions US$): Dec-07: 3,652; Dec-08: 5,401; Jun-09: 6,016; Dec-09 proj.: 5,926.
- Public external debt (percent of GDP): Dec-07: 17.5; Dec-08: 20.9; Jun-09: 31.5; Dec-09 proj.: 37.6.
- Public sector debt (percent of GDP) baseline path (Table 14a): 2009: 37.1; 2010: 43.3; 2011: 45.4; 2012: 43.6; 2013: 40.2; 2014: 37.8.
- PV of public sector debt (percent of GDP): 2009: 29.8; 2010: 35.2; 2011: 37.7; 2012: 37.1; 2013: 35.0; 2014: 32.6.
- Gross financing need (percent of GDP): 2009: 7.1; 2010: 10.8; 2011: 8.3; 2012: 6.8; 2013: 6.6; 2014: 9.8.
- Existing Fund credit (end of period stock, in millions of SDR): 2007: 159.2; 2008: 298.8; 2009: 501.6; 2010: 487.5; 2011: 449.4; 2012: 301.3; 2013: 158.0; 2014: 29.4; 2015: 14.0; 2016: 4.2; 2017: 0.0.
- SBA availability and purchase schedule highlights:
  - Approve 18-month arrangement: 15-Sep-08 — 161.7 (SDR million; 107.6 percent of quota).
  - Complete the fourth review: 15-Nov-09 — 47.3 (SDR million; 31.5 percent of quota).
  - Total available: 747.1 (SDR million); Total purchases available: 497.1 (SDR million).

### Program strategy, policy priorities, and staff recommendations
- Program objectives for 2010:
  - Set fiscal policy on a path of steady adjustment.
  - Support private sector activity through continued structural reforms.
  - Consolidate improvements in the banking sector to restore credit growth and strengthen confidence.
  - Ensure preparedness for unexpected new shocks, a more prolonged slump, or inadequate recovery of private financial inflows.
- Fund financing intended to fill the temporary 2010 external financing gap to avoid destabilizing exchange rate adjustments given high liability dollarization.
- Staff supports completion of the fourth review and modification of program conditionality as specified in the Letter of Intent.
- Policy priorities emphasized by staff:
  - Reserve cushion and limited FX intervention to stabilize expectations.
  - Fiscal consolidation through expenditure reduction after 2009, with social spending preserved in GDP terms.
  - Continued monitoring and strengthening of banking sector resilience, liquidity management, and contingency planning.
  - Advance public finance management reforms (budget code, medium-term expenditure framework, programmatic budgeting) and fiscal rules effective 2012.

### Structural reforms, institutional changes, and technical assistance
- Legal and institutional changes:
  - New Organic Law of Georgia “On the National Bank of Georgia” approved Sept 24, 2009; effective Dec 1, 2009; FSA merged with NBG; NBG given authority to supervise entire financial sector and responsibility for maintaining price stability over the medium term.
  - NBG implementing reserve management modernization with Straight Through Processing and IFRS-compliant systems; project to be fully operational by end of 2010.
- Public finance management reforms:
  - Ministry of Finance implementing Public Finance Management Reform Policy Vision 2009-2013 and 2009 Action Plan.
  - Draft budget code submitted to cabinet (structural benchmark for end-July 2010); programmatic budgeting methodology targeted end-September 2010.
- Statistical and legal reforms:
  - Reorganize State Department of Statistics by end of H1 2010; subscribe to IMF SDDS in H1 2010.
- Technical assistance:
  - Resident representative: Edward Gardner took up post March 15, 2009.
  - Numerous Fund TA missions across FAD, MCM, STA, LEG between 2004–2009; stress testing assistance Apr. 21–30, 2009.

*Source: _cr09331 - Executive Summary (IMF staff report content and annexes as provided in the source content)._

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

### _cr09331 - Executive Summary

### Key findings: current state and near-term outlook
- Real GDP is projected to contract by 4 percent in 2009, and to grow by 2 percent in 2010.  
- The economy "appears to have turned the corner" with stabilized financial conditions, but the outlook is clouded by weak export market growth, slow recovery of private capital inflows, and tight credit conditions.  
- All end-September quantitative performance criteria and all structural benchmarks have been met.  
- Improved confidence and stronger liquidity conditions should lead to an easing of credit conditions, but the recovery remains tentative.

### External and exchange rate developments
- Gross international official reserves reached $2,030 billion in October, including about $230 million from the SDR allocations.  
- The foreign exchange market has been stable with only minimal central bank intervention; interbank transactions now account for the bulk of fx market turnover.  
- The exchange rate has been relatively stable vis-à-vis the U.S. dollar; the real effective exchange rate has depreciated markedly since March 2009 due to low domestic inflation and a weakening U.S. dollar.  
- A roughly $400 million external financing gap remains in 2010, mostly because of the slow recovery of private capital inflows; Fund financing is expected to fill this temporary gap to avoid disruptive exchange rate overshooting and adverse balance-sheet effects (given high liability dollarization).

### Financial sector and banking system
- The banking sector has weathered the crisis relatively well; systemic risks have abated.  
- Banks’ capitalization, liquidity, and provisioning ratios are comfortable and have improved since the beginning of the year.  
- Banks’ excess reserves at the National Bank of Georgia (NBG) have grown to 19 percent of lari broad money at end-October.  
- Credit to the private sector contracted by 13 percent in the first 10 months of 2009.  
- The average U.S. dollar lending rate stands at around 21 percent—15 percent for prime customers.  
- Loan dollarization has continued to increase; deposit dollarization and loan dollarization remain high.  
- Stress tests indicate capital buffers would be sufficient to withstand all but the most extreme shocks; even in those extreme cases the risk to government finances would be limited.  
- The authorities continue to upgrade the regulatory and supervision framework and have developed a contingency plan for severe financial sector stress.

### Fiscal developments and 2010 fiscal stance
- The end-September fiscal deficit was below the program ceiling; the annual deficit (9.6 percent of GDP) is projected to be within the annual target.  
- The authorities will transition fiscal policy from an expansionary stance in 2009 to strong consolidation in 2010, with a reduction in the deficit of 2¼ percent of GDP in 2010.  
- The fiscal deficit is projected to decrease from 9.6 percent of GDP in 2009 to 7.3 percent in 2010.  
- Underlying improvement in the structural balance is estimated at 2.2 percent of GDP in 2010 (see Box 1).  
- The 2010 budget includes additional revenues from adjustments to the indirect tax base and higher capital expenditures; spending adjustments include expenditure containment and reclassification effects noted for goods and services and defense arrears penalties.  
- Shortfalls in expected privatization revenues (revised down by 0.6 percent of GDP) and some external financing shortfalls are being made up by higher issuance of T-bills—authorities intend to increase T-bill issuance to GEL 260 million, or 1.4 percent of GDP, by end-2009.

### Macroeconomic assumptions and risks for 2010
- The 2010 real GDP projection of 2 percent assumes a moderate recovery: a negative fiscal impulse in 2010 of -2 percent of GDP will be offset by a 4 percent increase in private demand in real terms, supported by a small increase in FDI inflows and resumption of bank lending.  
- Import demand in Georgia’s trading partners is assumed to remain subdued (3 percent growth in volume terms in 2010, following a decline of 16 percent in 2009). Net exports are expected to contribute positively to growth.  
- The short-term external outlook has deteriorated slightly relative to the last review; FDI is projected to recover only slowly in 2010.  
- A projected deterioration in the terms of trade (by some 4½ percent) due to higher oil prices is expected to dominate an underlying improvement in volume terms and a recovery of remittances; the current account deficit is projected to widen by about 1 percent of GDP relative to 2009.  
- Medium-term adjustment requires a resumption of private capital inflows to around $1.7 billion annually in 2011–12, up from around $1.1 billion in 2009–10.

### Monetary and credit conditions
- Despite easing liquidity conditions, deposit and lending rates have remained high.  
- The central bank’s refinancing rate (in local currency) remains disconnected from overall market conditions because of dollarization and inadequate collateral.  
- Broad money (M3), domestic currency money (M2), reserve money, and credit to the private sector showed large year-on-year movements in 2008–09 (detailed indicators in the tables); credit-to-GDP ratio around 29.6 percent (latest reported).  
- Loan-to-deposit ratio declined from 165.3 (peak earlier) to 143.0 in September 2009.

### Banking sector indicators (selected snapshots)
- Capital adequacy ratio (national definition) moved to 20.2 percent in September 2009.  
- Capital adequacy ratio (Basel I definition) reported at 27.4 percent (period-end shown).  
- Liquidity ratio increased to 40.6 percent in September 2009.  
- Nonperforming loans (national definition) around 18.2 percent of total loans in September 2009; under IMF definition NPLs reported at 8.3 percent (period shown).  
- Specific provisions rose to 10.2 percent of total loans (period shown).  
- Loans collateralized by real estate about 49.1 percent of total loans (period shown).  
- Loans in foreign exchange 77.6 percent of total loans (period shown).  
- Return on equity negative in recent periods (e.g., -7.3 percent in latest period shown).

### Program strategy and policy priorities
- The revised strategy approved at the third review under the SBA remains valid; objectives for 2010 program:  
  - set fiscal policy on a path of steady adjustment;  
  - support private sector activity through continued structural reforms;  
  - consolidate improvements in the banking sector to restore credit growth and strengthen confidence; and  
  - ensure preparedness for unexpected new shocks, a more prolonged slump, or inadequate recovery of private financial inflows.  
- Fund financing is intended to fill the temporary 2010 external financing gap to avoid destabilizing exchange rate adjustments given high liability dollarization.

*Source: _cr09331 - Executive Summary*

### Box 1. Georgia: Fiscal Impulse and Discretionary Fiscal Stance in 2007–10

### Box 1. Georgia: Fiscal Impulse and Discretionary Fiscal Stance in 2007–10

### Definitions and methodology
- Fiscal impulse (FI)
  - Measures the change in net income injected by the government in the domestic economy.
  - Constructed by subtracting from the government balance all government outlays and revenues that do not accrue to or subtract from private income (e.g., government imports, external interest payments, grants received from abroad).
  - FI = change in the adjusted balance, normalized by the previous year’s GDP (after correcting for inflation).
  - Note: A positive figure indicates a positive impulse.

- Discretionary fiscal stance (DF)
  - Measures the change in the structural fiscal balance.
  - Structural balance = standard fiscal balance minus (i) cyclical component of revenues and (ii) exogenous factors (budget grants, total interest payments, post-war spending).
  - DF = change in the structural balance (as a ratio to GDP).
  - Note: A positive figure means that the structural balance improves.

- Methodological notes
  - In the absence of unemployment compensation or other contingent transfer schemes, there is no cyclical component to be removed from expenditures.
  - Project grants and the related capital spending are not subtracted from the balance because they offset each other.
  - Post-war spending is measured as the sum of transfers to the internally displaced persons plus the cost of their new housing; these costs are expected to decline over time.

### Key findings on FI and DF, 2007–2010
- Expected relationship
  - In principle, a negative DF (deterioration in the structural balance) should be associated with a positive FI (positive demand impact).

- Observed deviations
  - 2007: Relationship fails — large increase in government imports (mainly for defense) worsened the fiscal stance without stimulating domestic demand.
  - 2008: DF remained negative, contributing to a positive FI; FI further boosted by a shift toward domestic spending and post-war foreign-financed expenditures.
  - 2009: FI remained positive despite a neutral fiscal stance (zero DF) because of a pronounced shift toward domestic spending and low tax revenues for cyclical reasons.

- Interpretation
  - Some discretionary measures do not contribute to aggregate demand (e.g., government imports).
  - Some factors that impact the economy are not discretionary (e.g., automatic stabilizers).

### Fiscal adjustment measures and quantitative changes (in percent of GDP)
- Measures — Change 2009-10 — Change 2010-13 — Comments

- (1) Policy adjustment and automatic stabilizers — 2.4 — 7.4
  - Increase in revenues — -0.2 — 0.2
  - Tax revenues 1/ — 0.3 — 0.2
    - Comment: Indirect tax increase (2010), improvement in revenue administration offset by possible tax cuts (2012-13).
  - Other revenues — -0.4 — 0.0
    - Comment: NBG profit transfer to the budget discontinued after 2009.
  - Decrease in expenditures — 2.5 — 7.2
    - Current spending 2/ — 1.4 — 4.8
      - Compensation for employees — 0.0 — 0.8
        - Comment: Reduction in defense personnel costs offset by reclassification of legal entities of public law (LEPL) expenditures (2010), constant real wage bill (2011-13).
      - Use of goods and services — 0.1 — 1.2
        - Comment: Administrative expenditure cuts of 14 percent cumulatively in real terms in 2010-2013 (except in ministries of education, health and agriculture).
      - Subsidies — 0.6 — 0.6
        - Comment: Reclassification of LEPL expenditures from subsidies to other categories (2010), and cuts of 14 percent cumulatively in real terms (2011-13).
      - Social expenses — -0.1 — 0.9
        - Comment: Increase in pensions and social assistance, health reform (2010), efficiency gains and decrease in number of beneficiaries of subsistence minimum (2011-13).
      - Other expenses — 0.8 — 1.3
        - Comment: Decrease in reserve funds and cofinancing of investment projects (2010-2013), no more construction of houses for IDPs (from 2011 on).
    - Capital spending — 0.5 — 2.7
      - Comment: Phase-out of road rehabilitation, and reconstruction/renovation of public buildings (2010-13).
    - Net lending — 0.6 — -0.3
      - Comment: Termination of subsidized lending program (2010).

- (2) Exogeneous factors — -0.1 — -2.5
  - Increase in revenues — -0.8 — -2.1
    - Tax arrears clearance — -0.6 — -0.2
      - Comment: Belated VAT payment (2009) and penalty (2010) received from the ministry of defense.
    - External grants — -0.2 — -1.9
      - Comment: Reduction in donor support (2010-13).
  - Decrease in expenditures — 0.6 — -0.4
    - Tax arrears clearance — 0.6 — 0.2
      - Comment: Belated VAT payment (2009) and penalty (2010) paid by the ministry of defense.
    - Interest payments — 0.0 — -0.6
      - Comment: Public debt increase (2010-13).

- (1)+(2) = Total reduction in fiscal balance — 2.3 — 4.9

- Notes
  - Source: Ministry of Finance; and Fund staff estimates.
  - Figures may not add up due to rounding.
  - 1/ Excluding tax arrears clearance.
  - 2/ Excluding interest payments and tax arrears clearance.

### Financing of the 2010 fiscal deficit and external financing (gross inflows in millions of U.S. dollars)
- Financing mix: T-bill issuance, external borrowing, and privatization; domestic currency counterpart of IMF foreign exchange purchases in 2010 may be drawn down subject to SBA conditions and donor confirmations.
- Georgia: External Financing of the Public Sector, 2008-10 (Gross inflows in millions of U.S. dollars)
  - 2008 2009 2010
  - Total13681052987
  - IMF                                                            257338385
  - WB126252175
  - Other Multilateral Institutions135246201
  - Bilateral partners350216226
  - Eurobond-2013500......
- Memorandum items:
  - Grants388298271
  - Loans 1/ 2/723416331
  - Budget support financing 2/426278152
  - Project financing185435450
- Notes
  - Source: Georgian authorities; and Fund staff estimates.
  - 1/ Includes Eurobond in 2008.
  - 2/ Excludes SBA purchases.

### Medium-term strategy and fiscal rules
- Policy objectives
  - Reduce deficit to under 3 percent of GDP by 2013 (end-September structural benchmark).
  - Emphasis on expenditure containment: winding down externally financed large scale projects initiated after the 2008 conflict; impact of economic recovery on social assistance costs; potential cuts in military, administrative, and non-essential capital outlays.
  - Revenue priority: improve revenue administration and reduce the flat income tax rate from 20 to 15 percent once conditions permit—and not before 2012.

- Institutional reforms
  - Medium-term expenditure framework to be detailed in the MTEF.
  - New budget code to be implemented in 2010 to improve medium-term budget planning; proposed structural benchmark for end-July 2010.
  - Move to programmatic budgeting by 2012; request for Fund technical assistance (proposed structural benchmark for end-September 2010).
  - New budget code measures include: (i) consolidate and simplify budget legislation; (ii) unify central and local budgets; (iii) accelerate the budget approval and execution process.
  - Additional reform agenda items: implement Law on Internal Audit; adopt International Public Sector Accounting Standards (IPSAS); create integrated information system for budget preparation and execution; simplify tax and customs procedure; improve risk-based audit functions; expand tax dispute resolution system; draft procedural manuals for tax inspectors.

- Fiscal rules in the Economic Freedom Act (AEFOD)
  - Caps: budgetary expenditures at 30 percent of GDP, fiscal deficit at 3 percent, public debt at 60 percent; enforced from January 1, 2012.
  - If ceilings breached, government must elaborate a plan approved by parliament to revert to thresholds within three or four years (depending on reasons).

### Monetary and exchange rate policy linkages to fiscal stance
- Monetary program and projections for 2010
  - Broad money projected increase: 13 percent.
  - Credit to the private sector projected increase: 9 percent.
  - Central bank gross international reserves projected to reach $2.1 billion.
  - Net international reserves (NIR) projected to decline to $609 million to cover the projected net financing need of the private sector in 2010.
  - NFA of the banking sector projected to remain roughly unchanged.

- Exchange rate policy
  - Move to foreign exchange auctions to give market forces greater role; authorities still envisage foreign exchange intervention in 2010 to fill private sector external financing gap and avoid disruptive volatility.
  - Auction adjustments: widened bidding spread from 1 to 2 percent.
  - Authorities’ contingency: faster expenditure contraction as first defense; ultimately allow for faster depreciation if persistent pressures build up.
  - Staff estimates of real exchange rate overvaluation range: 6 percent (ERER approach) to 21 percent (macro-balance approach).

### Selected contextual observations
- Relationship between DF and FI can fail when large components of discretionary spending do not affect domestic demand (e.g., government imports), or when cyclical/revenue factors dominate.
- Post-war and donor-financed spending dynamics materially affect measured fiscal stance and impulse.
- Debt dynamics: spike in debt service obligations in 2013 creates rollover/repayment risks; medium-term solvency ratios stabilize at relatively low levels and vulnerability to standard shocks is low.

*Source: IMF staff estimates and Georgian authorities as presented in the source content.*

### 25.      Stress tests conducted by the authorities indicate that substantial

### Stress tests conducted by the authorities indicate that substantial

### Stress test results and implications
- Stress tests are based on a Macro Credit Risk Model developed with technical assistance from the Fund’s Monetary and Capital Market Department.7
- A 10 percent lari depreciation (vis-à-vis the U.S. dollar) combined with a 15 percent decline in real GDP would cause manageable recapitalization needs in some banks, that would not require public intervention.
- A 30 percent lari depreciation combined with a 15 percent decline in output would generate recapitalization needs for most systemic banks, estimated at 3¼ percent of GDP, with a possible need for public financial support.
- 80 percent of the increase in NPLs is estimated to originate from the exchange rate effect alone.
- The authorities plan to improve macro-prudential analysis by developing a macroeconomic credit risk model that better captures real-financial dynamic linkages.
- Systemic banks are required to carry out stress tests based on an extended Macro Credit Risk Model, intended to capture bank-specific effects.

### Contingency planning and recent interventions
- The authorities have prepared a contingency plan to safeguard the financial sector in the event systemic risks materialize; the plan (structural benchmark for end-September) discusses bank-by-bank contingency measures based on stress test results and the potential role of shareholders.
- The contingency plan outlines policy options for the containment of liquidity and solvency crises, separately for systemic and non-systemic banks, including options on the use of public funds.
- The authorities injected liquidity through government deposits and provided lending of last resort to one systemic bank, and later facilitated its acquisition by a foreign investor.
- The mission recommended extending the contingency plan to include exit strategies.

### Supervision, regulatory changes, and prudential measures
- The authorities plan to move gradually to risk-based and consolidated supervision starting in 2010.
- Under the new law on commercial banks, the supervisor is authorized to adjust regulatory requirements based on bank-by-bank risk assessments.
- The authorities are considering introducing requirements for dynamic provisioning, fx-denominated provisions for fx loans, and fx-denominated capital for fx-assets to reduce balance sheet vulnerability to exchange rate fluctuations.

### Banking sector condition and risks
- Banks’ balance sheets are on the mend, although NPLs could rise further.
- Thanks to tight provisioning requirements, the current level of provisions appears sufficient to cover loan losses.
- Recent stabilization of NPLs could be temporary given the lags with which loan quality reacts to economic conditions.
- Relatively high capital charges on foreign exchange lending have proven their usefulness and should not be eased.
- A deposit insurance scheme, possibly limited to lari deposits, should be considered when conditions normalize as a safeguard against future deposit instability.
- In the absence of deposit insurance, prudential considerations call for the restoration of the (tighter) liquidity requirements that prevailed before September 2008.

### Policy stance, program issues, and outlook
- The authorities have been reluctant to introduce regulatory and non-traditional monetary policy instruments to stimulate credit; measures considered include loan guarantees, direct government deposits into the commercial banks, and deposit insurance schemes, but they have been rejected to avoid distortions and moral hazard.
- One exception: introduction of a small credit guarantee scheme targeting residential real estate development (roughly $30 million).
- Performance criteria for end-December 2009 are unchanged except for the NDA ceiling; the proposed NDA ceiling has been raised to reflect higher reserve money growth.
- New PCs are proposed through June 2010, with indicative targets covering the rest of 2010.
- Economic developments and the outlook for 2010 are broadly in line with the expectations of the third review; growth is expected to be positive in 2010, but the economic recovery remains fragile.
- Fiscal deficit reduction objective for 2010 is ambitious but backed by a realistic budget and a strong policy commitment; expenditure pressures will increase ahead of the May municipal elections.
- Balance of payments financing remains critical to sustain the economic recovery as fiscal policy is tightened; Fund financing will help reduce the risks of an overshooting of the exchange rate in 2010.
- The priority for monetary policy in the short run is to reduce the excess balances of banks; T-bill issuance will mop up only part of the excess local currency liquidity, so additional CD issuance by the central bank is needed.
- The banking sector has weathered the crisis relatively well; banks have retained a solid capital base, reconstituted strong liquidity buffers, and set aside adequate provisions.
- Risks remain in the pace at which lending interest rates will decline, credit will expand, and FDI inflows will resume.

*Source: _cr09331 - 25.      Stress tests conducted by the authorities indicate that substantial*

### 41.      On the basis of Georgia’s performance under the SBA, staff supports the

### _cr09331 - 41.      On the basis of Georgia’s performance under the SBA, staff supports the

### Program decision
- On the basis of Georgia’s performance under the SBA, staff supports the authorities’ request for completing the fourth review, and modifying program conditionality, as specified in the Letter of Intent (¶28, and Tables 1 and 2).

### Real sector developments
- VAT turnover (year-on-year, in percent): charted from Jan-08 to Sep-09 with ranges shown from -30 to 50 (no single summary value provided).
- Remittances (in millions US$) and remittance growth (in percent): series plotted Jan-08 to Jul-09 with scales -30 to 120 (LHS) and -300 to 120 (RHS) (no single summary values provided).
- Trade flows remain weak: Imports and Exports (year-on-year, in percent) series Jan-08 to Jul-09 with ranges -60 to 80.
- Inflation: "Inflation has increased recently, but remains low." Consumer price index period average values appear elsewhere (see Tables).

### Exchange rate and reserves
- "The USD exchange rate has been remarkably stable" with lari/US$ levels indicated spanning 1.35 to 1.75 in charts.
- Foreign exchange intervention (in millions US$): daily and cumulative interventions plotted Jan-08 to Sep-09; interventions shown as (+ = net purchases, - = net sales).
- Cumulative intervention and daily intervention series plotted with ranges -600 to 600 and -80 to 80 respectively.
- Reserve cushion: SBAGIR (excluding SBA) series plotted Mar-08 to Sep-09 with scale 0 to 2,000 (presumably millions US$).
- Exchange-rate indexed chart (December 2007 = 100) shows AR M - Dram, GEO - Lari, UKR - Hryvna, RUS - Ruble, AZE - Manat across Dec-07 to Jun-09 with index range 60–180.

### Fiscal sector developments and outlook
- Financing sources 2003–2014 (in percent of GDP): External financing (net), Grants, Privatization shown in chart.
- Fiscal deficit expected to peak in 2009 (Overall balance and Operating balance, in percent of GDP, plotted 2003–2014).
- After 2009, public finances projected to be on a more sustainable path through expenditure reduction (Total revenues and Expenditures, in percent of GDP, 2003–2014).
- Public debt projected to increase through 2011 owing to accumulation of deficits (Total public debt, Domestic public debt, External public debt, in percent of GDP, 2004–2014).
- Table 1 / Table 2 / Table 3 / Table 4 / Table 10 provide detailed fiscal numbers and projections (selected figures below from Tables 1–3 and memoranda):
  - Nominal GDP (in million lari): 2007: 16,994; 2008: 19,070; 2009: 18,028; 2010 proj.: 19,042; 2011 proj.: 20,794; 2012 proj.: 22,925; 2013 proj.: 25,275; 2014 proj.: 27,866.
  - Real GDP growth (annual change): 2007: 12.3; 2008: 2.1; 2009: -4.0; 2010 proj.: 2.0; 2011 proj.: 4.0; 2012–2014 proj.: 5.0 each year.
  - Consumer price index, period average: 2007: 9.2; 2008: 10.0; 2009: 1.8; 2010–2014 proj.: 4.8, 5.0, 5.0, 5.0, 5.0 (table shows period-average then end-of-period separately).
  - Overall balance (in percent of GDP): 2007: -4.7; 2008: -6.3; 2009: -9.6; 2010 proj.: -7.3; 2011 proj.: -5.5; 2012 proj.: -3.9; 2013 proj.: -2.4; 2014 proj.: -1.7.
  - Total revenues (percent of GDP): 2007: 29.3; 2008: 30.7; 2009: 29.4; 2010 proj.: 28.5; 2011 proj.: 26.7; 2012 proj.: 26.6; 2013 proj.: 26.5.
  - Total public debt (in percent of GDP) projected path shown through 2014 (see fiscal charts and Table 14a for detailed debt projections).

### Monetary sector developments
- Lari and FX-denominated deposits: year-to-date percent series Jan-09 to Nov-09 show GEL deposits and FX deposits (ct August 2008 lari) with ranges -30 to 15 (year-to-date percent).
- Broad monetary aggregates M2 and M3 have been growing since June (year-to-date percent series Jan-09 to Nov-09).
- Private credit continues to contract: GEL loans and FX loans (ct. Aug 2008 lari) year-to-date percent series Jan-09 to Nov-09 show contraction with ranges -35 to 0.
- Policy rate reductions reflected in T-bill and CD rates though not fully passed through to deposit and lending rates; chart shows CD rate, Policy rate, Refinancing rate, T-bill yield across 12/30/07 to 8/30/09 with scale 0–20 (in percent).

- Table 5 and Table 6 monetary accounts (selected figures):
  - Broad money (M3) levels (in millions of lari): Mar-09: 4,027; Jun-09: 4,188; Sep-09: 3,966; Dec-09 proj.: 4,258; 2010 proj. and beyond shown in tables.
  - M3 12-month growth memorandum: 2008: 28.9; Mar-09: 6.9; Dec-09 proj.: 7.0; 2010 proj.: -8.7; subsequent projections given (see Table 6).
  - Foreign exchange deposits as percent of total deposits: Dec-07: 60.9; Dec-08: 60.0; Jun-09: 61.7; Dec-09 proj.: 75.7; later quarterly values show 71.0–75.2 range.

### Banking sector developments
- Nonperforming loans (NPLs) stabilized per national and IMF definitions; charts show NPL ratios and specific provisions series Dec-06 to Sep-09.
- Share of loans collateralized by real estate trends upward while collateral prices remain depressed (Loans collateralized by real estate and Tbilisi Apartment Price Index (2003=100) series Dec-06 to Sep-09).
- Liquidity indicators improved: Liquid assets/Short-term liabilities, Current assets/Total assets, Current assets/Current liabilities series Dec-06 to Sep-09. Minimum liquidity ratio requirement reduced from 30 to 20 percent in September 2008.
- Banks’ reliance on external wholesale financing, although high, has dropped: Loan-to-deposit ratio and Foreign liabilities/Foreign assets series Dec-06 to Sep-09.
- Capitalization: CAR (Standard definition) series Dec-06 to Sep-09 show Georgian banks highly capitalized (chart with values up to 36.0 percent).
- Profitability: large losses incurred in 2008 and early-2009; Return on assets series compared across countries for 2007–2009 (latest available).

### External sector and vulnerabilities
- Current account balances (in millions US$ and percent of GDP):
  - Current account balance (in millions of US$): 2007: -2,009; 2008: -2,915; 2009: -1,626; 2010 proj.: -1,765; 2011 proj.: -1,850; 2012 proj.: -1,911; 2013 proj.: -1,980; 2014 proj.: -2,062.
  - Current account balance (percent of GDP): 2007: -19.7; 2008: -22.7; 2009: -15.1; 2010 proj.: -16.0; 2011 proj.: -15.4; 2012 proj.: -14.7; 2013 proj.: -14.1; 2014 proj.: -13.5.
- Trade balance (in percent of GDP) and GNFS exports/imports growth: GNFS exports annual percentage change 2007: 24.7; 2008: 15.9; 2009: -18.7; 2010 proj.: 7.9; 2011 proj.: 12.8; subsequent projections given. GNFS imports annual percentage change 2007: 34.1; 2008: 26.7; 2009: -27.6; 2010 proj.: 7.6.
- Gross international reserves (in millions of US$): 2007: 1,361; 2008: 1,480; 2009: 2,005; 2010 proj.: 2,086; 2011 proj.: 2,259; 2012 proj.: 2,268; 2013 proj.: 2,094; 2014 proj.: 2,057.
  - In months of next year's imports of goods and services: 2007: 2.2; 2008: 3.3; 2009: 4.1; 2010 proj.: 4.0; 2011 proj.: 4.0; 2012 proj.: 3.8; 2013 proj.: 3.3; 2014 proj.: 3.0.
- External debt and public external debt (selected):
  - External debt (nominal, in millions US$): Dec-07: 3,652; Dec-08: 5,401; Jun-09: 6,016; Dec-09 proj.: 5,926 (Table 11 summary).
  - Public external debt (in percent of GDP): Dec-07: 17.5; Dec-08: 20.9; Jun-09: 31.5; Dec-09 proj.: 37.6 (Table 11 / Table 7).
- Debt sustainability and stress tests (Figures 6a/6b, Tables 13a–14b):
  - Baseline and alternative scenario projections for PV of debt-to-GDP, PV of debt-to-exports, PV of debt-to-revenue, debt service-to-exports, debt service-to-revenue presented for 2009–2029.
  - Table 13a baseline: External debt (nominal, percent of GDP) 2009: 55.1; 2010: 61.0; 2011: 60.3; 2012: 56.8; 2013: 52.5; 2014: 48.8. PV of external debt (percent of GDP) 2009: 36.4; 2010: 47.8; 2011: 53.0; 2012: 52.7; 2013: 50.3; 2014: 47.3; 2019: 43.5; 2029: 28.7.
  - Debt service-to-exports ratio (in percent) shown rising across projections with notable peaks under stress scenarios (see Tables 13b and 14b for sensitivity results).
  - Public sector debt (percent of GDP) baseline path (Table 14a): 2009: 37.1; 2010: 43.3; 2011: 45.4; 2012: 43.6; 2013: 40.2; 2014: 37.8; 2019 average: 31.2; 2029 average: 24.1.
  - PV of public sector debt (percent of GDP): 2009: 29.8; 2010: 35.2; 2011: 37.7; 2012: 37.1; 2013: 35.0; 2014: 32.6; 2019: 26.6; 2029: 21.6.
  - Gross financing need (percent of GDP) 2009: 7.1; 2010: 10.8; 2011: 8.3; 2012: 6.8; 2013: 6.6; 2014: 9.8; 2019: 5.1; 2029: 3.0.

### Fund financing and program modalities
- Existing Fund credit (end of period stock, in millions of SDR): 2007: 159.2; 2008: 298.8; 2009: 501.6; 2010: 487.5; 2011: 449.4; 2012: 301.3; 2013: 158.0; 2014: 29.4; 2015: 14.0; 2016: 4.2; 2017: 0.0.
- Prospective purchases under the SBA and schedule of reviews and purchases (Table 9):
  - Availability and purchase schedule includes amounts and dates: e.g., 15-Sep-08 Approve the 18-month arrangement: 161.7 (in millions of SDR; 107.6 percent of quota); 15-Dec-08 Complete the first review … 63.1 (42.0 percent of quota); 23-Mar-09 Complete the second review … 63.1 (42.0 percent of quota); 6-Aug-09 Complete the third review … 94.6 (62.9 percent of quota); 15-Nov-09 Complete the fourth review … 47.3 (31.5 percent of quota); subsequent prospective review purchases listed through 15-May-11 and totals (Total available 747.1; Total purchases available 497.1).

### Key projections and macro assumptions used in debt sustainability analyses
- Real GDP growth assumptions: historical and projection values include 2007: 9.4; 2008: 12.4; 2009: 2.1; and projections (examples) 2010: 6.5; 2011: 3.8; 2012: -4.0; then 2013–2014: 2.0, 4.0, 5.0 depending on table context. (See Tables 13a, 14a for scenario-specific assumptions.)
- Growth of exports and imports of goods and services (US$ terms): exports 2007: 16.6; 2008: 24.7; 2009: 15.9; 2010–2014 projections vary (e.g., 2010 proj.: 7.9; 2011 proj.: 12.8); imports 2007: 33.0; 2008: 34.1; 2009: 26.7; 2010 proj.: 7.6.
- Effective interest rate, GDP deflator changes, grant-equivalent financing and grant elements of new borrowing specified in debt-sustainability tables (see Tables 13a–14b for exact scenario values).

### Policy implications and priorities (as reflected in staff analysis)
- Support for completing the fourth review and modifying program conditionality indicates:
  - Continued engagement under the SBA.
  - Use of program resources and conditionality adjustments to address fiscal deficit peak in 2009 and transition to expenditure reduction thereafter.
- Emphasis on reserve cushion and limited FX intervention to stabilize expectations.
- Fiscal consolidation through expenditure reduction envisaged after 2009 to place public finances on a more sustainable path.
- Monitoring of banking sector soundness: liquidity improvements, NPL trends, collateral and real estate price developments, and bank capitalization amid past losses.

*Source: IMF staff report content as provided in the supplied PDF excerpts.*

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

### _cr09331 - 1.      In September 2008, the International Monetary Fund (IMF) approved a Stand-By

### Recent Economic Developments
- IMF actions and program:
  - On August 6, 2009 the IMF’s Executive Board completed the third review of the SBA and approved an increase in the credit available under the SBA of SDR 270 million, and an extension of the program until June 14, 2011.
- Growth and sectoral performance:
  - Growth in H1 2009 amounted to minus 8.5 percent.
  - Most sectors contracted, with trade, manufacturing, and construction specifically noted.
  - Plummeted private capital inflows, shrinking external trade and commercial bank lending contributed to contraction.
- Inflation and monetary aggregates:
  - End-period inflation was 5.5 percent for 2008.
  - Twelve-month inflation was 2.3 percent as of end-June 2009 and picked up to 3.2 percent as of end-October 2009.
  - Expect inflation to reach 3.5 percent by the end of 2009.
  - Year-on-year growth of reserve money and lari broad money negative since November 2008 but turned positive in Q3 2009.
- Fiscal performance:
  - Tax collection in the first three quarters of 2009 declined by 9.6 percent in nominal terms compared with the same period of last year.
  - Expenditures in the same period were contained at GEL 4,637 million (general government, including capital expenditures), or 6.1 percent lower than the same period of last year (excluding one-off effects).
  - Fiscal deficit reached 6.7 percent of projected annual GDP in the first three quarters.
- Legal and institutional changes:
  - On September 24, 2009, Parliament approved the new Organic Law of Georgia “On the National Bank of Georgia”, effective December 1, 2009.
  - Financial Supervision Agency (FSA) merged with the NBG; NBG given authority to supervise the entire financial sector and responsibility for maintaining price stability over the medium term; allows introduction of a soft inflation targeting regime.
- Exchange rate management:
  - Since May 25, 2009, NBG foreign exchange interventions are conducted only through foreign exchange auctions.
  - From March to end-October, NBG’s net sales of foreign currency were less than USD 15 million on average per month.
  - Starting from October, NBG expanded deviation band for auction bids from 0.5 percent to 1 percent of the official exchange rate.
- External sector and reserve dynamics:
  - Q2 2009 exports and imports of goods and services declined by 26.6 percent and 35.9 percent, respectively.
  - Worker remittances dropped by 22 percent.
  - FDI inflows declined by 81 percent compared with the same period in 2008.
  - Current account deficit dropped to 13.6 percent of GDP for H1 2009, an improvement of 15.1 percentage points from H1 2008 (28.7% in H1, 2008).
- Banking sector developments:
  - Commercial banks’ net profit in September 2009 positive for the first time since July 2008.
  - Share of non-performing loans slowly decreasing since July 2009.
  - Over the last six months, deposit volumes have shown steady growth.
  - Average capital adequacy at end-September increased by almost 3 percentage points since May, currently at 20.2 percent.
  - Credit to the private sector contracted sharply since the beginning of the year but stabilized recently.
- Foreign exchange swaps:
  - Since June 3, 2009, total volume of foreign exchange swaps reached GEL 60 million.
  - Pricing suggests market did not anticipate exchange rate depreciation.
  - Commercial banks used swaps to convert existing FX denominated loans into lari loans; demand limited given high lari liquidity.
  - NBG not intending to increase volume of swaps beyond existing level.
- Reserves management modernization:
  - NBG implementing new portfolio management system covering front-middle-back office and accounting functionality based on Straight Through Processing (STP) principles; IFRS compliant.
  - Project scheduled to be launched in November, following contract signing, and expected fully operational by end of 2010.
- Financial sector contingency planning and supervision:
  - Based on FSA stress tests, a Contingency Plan (CP) prepared to coordinate policy actions to mitigate systemic risks and reduce social cost of financial distress.
  - Members of Contingency Working Group agreed on coordination and policy modalities, including division of responsibilities among MOF and NBG-FSA.
  - FSA continues regular stress tests system-wide and bank-by-bank.
  - Legislation upgraded to enable risk-based supervision; in process of introducing risk-based supervision.
  - New NBG Organic law fills legal gaps in regulator’s intervention powers.
- Public finance management reforms:
  - Ministry of Finance on track implementing Public Finance Management Reform Policy Vision 2009-2013 and 2009 Action Plan.
  - Draft budget code submitted to cabinet (structural benchmark for end-July 2010) and being discussed in Parliament; adoption expected for November 2009.
  - By end-September 2010 intend to seek cabinet approval of methodology to introduce programmatic budgeting (structural benchmark).
- Statistical and legal reforms:
  - Reorganize State Department of Statistics (SDS) by end of H1 2010; new Law on State Statistics to strengthen independence.
  - Intend to become a subscriber of IMF’s Special Data Dissemination Standard (SDDS) in H1 of 2010.
  - Liberty Act introduced in 2009 to enact structural fiscal limitations effective 2012: consolidated budget at 30% of GDP, consolidated budget deficit at 3% of GDP and public debt at 60% of GDP.

### Macroeconomic Policies for 2009 and 2010
- Growth and inflation projections:
  - The 8.5 percent contraction of real GDP in H1 2009 expected to decrease in the second half.
  - Moderate projections point to approximately 4 percent real GDP contraction in 2009, precluding any further external shocks.
  - In 2010, anticipate economic recovery with real GDP growth projected at 2%.
  - Target inflation rate of 6% per annum in 2010.
- External sector projections and reserve needs:
  - Current account deficit for 2009 expected to moderate to around 15 percent of GDP from nearly 21.6 percent in 2008.
  - Exports and imports of goods and services projected to decline by 19 percent and 28 percent, respectively, in 2009.
  - Worker remittances expected to drop by around 10 percent for the year.
  - Project FDI inflows of around US$700 million for 2009, 54 percent lower than in 2008.
  - Expect accumulation of gross reserves in 2009 of about US$525 million, excluding purchase of SDR 47.3 million available upon completion of the fourth review.
  - Sought Fund support in covering a financing gap of around $400 million in 2010 to increase reserve buffer.
- Fiscal policy stance and targets:
  - Fiscal stance for remainder of 2009 will continue to sustain demand, with significant contribution from donor-financed spending.
  - Shortfall in revenue linked to economic deterioration will widen fiscal deficit to 9.6 percent of GDP for 2009.
  - Starting in 2010 committed to ambitious deficit reduction: target to reduce deficit to 7.3 percent of GDP in 2010 (SBA definition).
  - Draft 2010 budget submitted to Parliament on November 1, 2009 envisages sustainment of social expenditures as share of GDP while tapping donor funding for bulk of infrastructure spending.
  - Committed to steady reductions in the deficit to 2-3 percent of GDP by 2013.
- Domestic debt and treasury instruments:
  - In Q3 2009, domestic debt instruments (treasury bills) introduced.
  - Plan to increase issuance of T-bills in 2009 to around GEL 270 million.
  - Treasury Bills issued in 2009 will be entirely rolled over in 2010 and, depending on market conditions, approximately GEL 100 million of T-Bills will be issued in addition.
  - In 2010 Ministry of Finance plans to introduce 2-year Treasury Notes as well.
  - Due to banking sector capacity limits to absorb additional T-Bills, government will rely on external balance of payments support to finance portion of 2010 budgetary needs.
  - Government’s use of IMF resources for deficit financing will be reduced as additional budgetary support commitments are finalized.
- Public finance reform and technical measures:
  - Continued implementation of public finance reform action plan for 2009, including liquidity management guidelines, PFMS specifications, new format for Basic Data and Directions (BDD), improved local budgets, risk assessment tax audit functionality, tax and customs code streamlining, bank-Revenues Service electronic exchange, capital budget improvements, customs audit and risk-based customs control, full functionality of electronic treasury, and inclusion of all taxes into e-filing.
  - These reforms expected to enhance efficiency and resilience.
- Monetary policy and exchange rate policy:
  - Monetary policy transmission weakened due to crises and remains ineffective under excess liquidity.
  - NBG will increase issuance of CDs with due attention not to increase interest rates to a contractionary stance.
  - As market conditions allow, NBG will take further measures to restore monetary policy transmission channel.
  - Continue to project end-period inflation of 3.5 percent in 2009 and 6 percent in 2010.
  - Remain fully committed to a flexible exchange rate policy; continue foreign exchange auctions; NBG will intervene to smooth extreme volatility, counter speculative pressures and if large depreciation threatens financial stability.
- Structural reforms and competitiveness:
  - Emphasis on further privatization and reductions of the state’s role to enhance competitiveness and reduce external current account deficit over the medium term.

### Program Monitoring and Targets
- Performance under SBA:
  - All end-September performance criteria under the Stand-By Arrangement were met.
  - Request completion of the Fourth Review.
  - Intend to treat as precautionary the purchase of SDR 47.3 million available upon completion of the fourth review.
- Contingency and policy readiness:
  - Maintain close policy dialogue with the Fund and ready to take additional measures as appropriate.
  - If global crisis pressures exceed expectations, government would adjust fiscal and exchange rate policies to maintain external stability.
- Quantitative and structural adjustments:
  - Request modification of the end-December PC on NDA according to attached Table 1, which establishes end-March 2010 and end-June 2010 PCs, and indicative targets for September and December 2010.
  - Fifth review to be based on end-December 2009 PCs and scheduled for completion by end-March 2010.
  - Sixth review based on end-March 2010 PCs scheduled for completion by end-June 2010.
  - Seventh review based on end-June 2010 PCs scheduled for completion by end-September 2010.
  - Revised Technical Memorandum of Understanding clarifies measurement of government cash deficit, treatment of SBA purchases directed for budget support and of SDR allocations in NBG net international reserves calculations.
  - Structural benchmarks under the program described in Table 2.
- Representative quantitative figures from Table 1 (selected):
  - Ceiling on cash deficit of the consolidated government (Sep-09 Third review Actual): 1,124 (in millions of laris).
  - Ceiling on cash deficit (Dec-09 Third review Adjusted PC): 1,255 (in millions of laris).
  - Ceiling on contracting or guaranteeing of new nonconcessional external debt by public sector (Third review Actual Sep-09): 0 (in millions of U.S. dollars); Third review Adjusted PC Dec-09: 850 (in millions of U.S. dollars).
  - Ceiling on net domestic assets (NDA) of the NBG (Third review Actual Sep-09): 258 (in millions of laris); Third review Adjusted PC Dec-09: 344 (in millions of laris).
  - Floor on net international reserves (NIR) of the NBG (Third review Actual Sep-09): 858 (in millions of laris); Third review Adjusted PC Dec-09: 813 (in millions of laris).
- Structural benchmarks status (selected from Table 2):
  - FSA and NBG to sign and implement a memorandum of understanding to strengthen cooperation. End-Oct-08. Structural Benchmark. Observed.
  - NBG to introduce revised LOLR facility. End-Dec-08. Structural Performance Criterion. Observed.
  - Submission to parliament of a state budget for 2009 with an overall fiscal deficit of no more than 3¾ percent of projected GDP. End-Dec-08. Structural Benchmark. Observed.
  - NBG to develop and publish a liquidity management framework, including introduction of a refinancing mechanism. End-Mar-09. Structural Benchmark. Not observed. Implemented with delay.
  - NBG, FSA and government to develop a financial stability plan defining roles under stress. End-Jun-09. Structural Performance Criterion. Observed.
  - Submission of a new budget code to the cabinet. End-Jul-09. Structural Benchmark. Observed.
  - Status report on implementation of Financial Stability Plan action plan including bank-by-bank contingency measures. End-Sep-09. Structural Benchmark. Observed.
  - Submission to parliament of the Law on Internal Audit. End-Sep-09. Structural Benchmark. Observed.

*Letter of Intent and attachments; signatures: Nika Gilauri, Prime Minister of Georgia; Kakha Baindurashvili, Minister of Finance; Giorgi Kadagidze, President of the National Bank of Georgia.*

### 7.3 percent of GDP (program definition); (ii) contains

### _cr09331 - 7.3 percent of GDP (program definition); (ii) contains

### Medium-term fiscal framework and benchmarks
- Program requires a medium-term fiscal framework consistent with the program’s medium-term deficit reduction targets and describing medium-term policies underlying fiscal deficit objectives through 2013.
- Structural benchmarks (selected calendar items reported in source):
  - Cabinet approval of a new medium-term expenditure framework (Basic Data and Directions) that includes expenditure ceilings applicable to the 2011 budget. — July 31, 2010 — Structural Benchmark — Observed
  - Cabinet approval of the methodology to introduce a programmatic approach to budgeting, identifying the requirements in terms of budget preparation processes and information needs. — September 30, 2010 — Structural Benchmark

### Institutional coverage and reporting responsibilities
- Consolidated government defined as: central government, local governments, extrabudgetary funds, and LEPLs that provide general government services. Newly established extrabudgetary funds will be consolidated within the consolidated government.
- Public sector defined as: consolidated government and the National Bank of Georgia (NBG).
- Reporting responsibilities:
  - Treasury Department of the Ministry of Finance (MOF) to provide detailed monthly information on revenues, expenditures, and arrears of the consolidated government, and data on cash balances in MOF accounts.
  - NBG and Treasury to provide data on domestic bank and nonbank financing within four weeks after month end.
  - Debt Unit at MOF to provide external project financing and other external borrowing monthly within two weeks of month end (specifying projects by creditor).
  - Privatization receipts reported monthly by the Treasury Department within two weeks of month end.
  - NBG to report securitized debt sold by the NBG monthly within two weeks of month end.
  - NBG to provide weekly table on foreign exchange flows (inflows, outflows, and NIR) within three working days following the end of the week.

### Ceiling on the cash deficit of the consolidated government (definition and monitoring)
- Definition: Cash deficit measured from the financing side at current exchange rates, equal to total financing, where total financing = (i) net domestic financing from banks and nonbanks, (ii) net external financing, and (iii) privatization receipts.
- Net domestic financing components:
  - (i) Net lending (borrowing net of repayments) by commercial banks to the consolidated government plus use of consolidated government deposits at commercial banks; includes securities issued by consolidated government and purchased by commercial banks (e.g., T-Bills). Monitoring based on NBG’s monetary survey and Treasury data; change in local government cash balances monitored via “budget of territorial unit” account data from the Treasury Department.
  - (ii) Net lending (borrowing net of repayments) by the NBG to the consolidated government plus use of consolidated government deposits at the NBG; includes securities issued by consolidated government and purchased by the NBG (e.g., T-Bills). Monitoring based on Central Bank survey and Treasury data; change in central government cash balances monitored via “GEL TSA state budget” account data from the Treasury Department.
  - (iii) Securities issued by consolidated government and purchased by nonbanks (e.g., T-Bills or securitized claims sold by the NBG).
- Net external financing: loans disbursed for budget support (including IMF), project financing (capital expenditure and net lending), net change in external arrears, change in consolidated government accounts abroad, minus amortization. Amortization includes all external debt principal payments by the consolidated government.
- Privatization receipts: all transfers of monies received by central and local governments from sale of central or local government assets, including sale of shares, non-financial assets, leases and sale of licenses with duration of 10 years and longer.

### Floor on Net International Reserves (NIR) of the NBG
- Definition: NIR (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 reserve position in the IMF. Gross foreign exchange reserves are liquid, convertible currency claims of the NBG on nonresidents, including readily available cash holdings.
  - Exclusions: pledged/encumbered assets used as collateral or guarantees; foreign assets from foreign currency deposits of financial institutions at the NBG; foreign assets arising from currency swaps with financial institutions.
  - Foreign liabilities = 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.
  - For program monitoring, stocks of foreign assets and liabilities are valued at program exchange rates (GEL 1.67 = $1).
- Stock noted in document: The stock of NIR amounted to $879.8 million as of December 31, 2008 (at the program exchange rate).
- Adjustors to the NIR floor:
  - Upward/downward by 50 percent for any excess/shortfall in balance-of-payments support loans and balance-of-payments support grants relative to projected amounts presented in Table 2.
  - 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.
  - Upward 100 percent for any shortfall in the amount of conversion for government imports relative to projected amounts presented in Table 2.
- Supporting material and frequency: weekly NBG foreign exchange flows table (inflows, outflows, and NIR), including details of net foreign financing (balance of payments support loans, cash grants to the consolidated government, amortization excluding repayments to the IMF, interest payments on external debt by MOF and the NBG), conversions for government imports and transfers of receipts from the Sovereign Wealth Funds — provided within three working days following the end of the week.

### Ceiling on Net Domestic Assets (NDA) of the NBG
- Definition: Net domestic assets = reserve money minus NIR (as defined above), adjusted according to paragraph 8 (adjustors described under NIR).
- Supporting material: NBG to provide its balance sheet including net domestic assets monthly within two weeks of the end of each month; data provided using both actual and program exchange rates.

### Ceiling on contracting or guaranteeing new nonconcessional external debt by the public sector
- Definition: Nonconcessional external loans = loans from lenders other than the IMF with a grant element of less than 35 percent of the value of the loan.
- Calculation of grant element:
  - Use currency-specific discount rates reported by the OECD (CIRRs).
  - For maturities < 15 years, grant element based on six-month averages of commercial interest rates.
  - For maturities > 15 years, grant element based on 10-year averages.
- This performance criterion applies to debt as defined in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) August 24, 2000) 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 “new debt” for this performance criterion.
- Supporting material: MOF to provide details of all new commitments and government guarantees for external borrowing on a monthly basis within two weeks of the end of each month, using actual exchange rates.

### Continuous performance criterion on nonaccumulation of external arrears
- Definition: During the arrangement period, the consolidated government and the NBG will not accumulate any new external payment arrears on debt service obligations to official creditors.
- Official external payment arrears defined as unpaid debt service by the consolidated government and the NBG beyond 30 days after the due date.
- The performance criterion on nonaccumulation of external debt is continuous.

*Source: Attachment II. GEORGIA: REVISED TECHNICAL MEMORANDUM OF UNDERSTANDING, November 25, 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

### _cr09331 - 10. A key part of the Bank Group assistance has been to the private sector where IFC has

### IFC assistance to the private sector in Georgia
- IFC committed portfolio in Georgia as of June 2009: about $298 million, of which $240 million is disbursed.
- Portfolio composition: 9 clients, primarily in the banking sector and several real sector clients.
- Financial sector focus:
  - Investment and technical assistance to three leading banks: TBC Bank, the Bank of Georgia, and Bank Republic.
  - Helped establish ProCredit Bank of Georgia (first bank specializing in lending to micro and small enterprises).
  - Provided a credit line to TBC Leasing to support rapid growth of SME client portfolio.
- Real sector focus and sectors of interest:
  - Continued search for opportunities in export-oriented companies and firms that support private sector development.
  - Sectors of interest include agrobusiness, infrastructure, manufacturing, and development of natural resources.
- Technical assistance:
  - Strengthening client banks and introducing new financial products (including leasing and housing finance).
  - Efforts to improve the business climate and corporate governance practices.
- Reform engagement:
  - World Bank-IFC Doing Business report ranked Georgia as a top reformer; government actively engaged with IFC to make further reforms to improve the business environment.

### EBRD relations with Georgia (As of June 30, 2009)
- Cumulative commitments: $975.4 million (120 investments signed since first operation in December 1994).
- Current Portfolio Stock: $696.3 million.
- 2007 activity:
  - 23 transactions totaling $162.00 million.
  - Syndicated loan to ProCreditBank Georgia ($8 million).
  - Increased equity participation in Republic Bank, MCFF introduced and 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 to MSMEs: 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: $276.2 million across 28 transactions.
  - Examples: $7.5 million loan to TBC Bank (SME development); $20 million mortgage loan to Republic Bank; equity investment in Basis Bank; equity increase and subordinated debt ($5 million) to Republic Bank.
  - Municipal/environmental infrastructure: Batumi Public transport ($3.2 million), Kobuleti ($1.9 million), Borjomi water supply ($1.9 million).
  - Geo Steel loan: $14 million for 175 k ton capacity steel mini-mill (October 2008).
  - Joint EBRD-IFC support to Bank of Georgia: $200 million loan facilities (December 2008) to support Bank of Georgia post-war.
- First half 2009 and crisis response:
  - As at 30 June 2009: eight projects, business volume of USD 84.4 million.
  - Joint funding package with EBRD, IFC and FMO to TBC Bank: $161 million total; EBRD contribution up to $70 million including equity stake acquisition $36.8 million, subordinated loan $18.5 million, senior loan $14.7 million.
- Strategic orientation:
  - Ratio of private sector projects in portfolio: 94 percent.
  - Bank plans to focus primarily on private sector financing; may consider selected public sector projects; preference for non-sovereign operations; sovereign guarantees would seek donor co-funding on a grant basis.
- Early Transition Countries (ETC) initiative:
  - Georgia is part of ETC initiative (launched April 2004) to increase investments in seven poorest countries.
  - Focus on private sector business development and selected public sector interventions; streamlined financing for smaller projects, mobilizing more investment and encouraging economic reform.
  - Since ETC launch, Bank’s annual business volume in Georgia increased five times.

### EBRD portfolio snapshot (selected items, Outstanding Amounts in millions of US$; As of June 30, 2009)
- TOTAL (listed section) = 578.1
- TOTAL REGIONAL = 118.2
- GRAND TOTAL = 696.3
- Selected outstanding amounts:
  - Bank Republic - MSME (12-Dec 2008): 10.0
  - Bank Republic Equity (15-Sep 2006): 8.3
  - Bank Republic Mortgage Loan II (22-Aug 2008): 14.0
  - 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
  - Geo Steel (20-Oct 2008): 14.0
  - Georgian Property Equity Investment (29-Aug 2007): 15.2
  - ProCredit Georgia - Syndicated Loan (21-Jun 2007): 8.0
  - Regional TFP: Bank of Georgia (Guarantee & Pre-export) (29-Jul 1999): 19.0
  - 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
  - Enguri Hydro power Plant Rehabilitation project (22-Dec 1998): 23.2
  - Baku-Tbilisi-Ceyhan (BTC) Pipeline (03-Feb 2004): 49.2
  - Caucasus Online (22-Dec 2008): 30.6
  - Lukoil Overseas : South Caucasus Gas Pipeline (28-Jul 2005): 27.7

### IMF Stand-By Arrangement (SBA) fourth review and Georgia macro-financial assessment (Press Release No. 09/456, December 11, 2009)
- SBA original approval: SDR 477.1 million (about US$ 759.3 million) on September 15, 2008.
- Aug 6, 2009 augmentation and extension: access augmented to SDR 747.1 million (about US$1,189 million); SBA extended until June 14, 2011.
- Completion of fourth review allows immediate purchase: SDR 47.3 million (about US$ 75.3 million).
- Board modifications and new structural benchmarks:
  - Modified end-December 2009 performance criterion on ceiling for net domestic assets.
  - New structural benchmarks:
    - Government approval of a new medium-term expenditure framework by July 31, 2010.
    - Government approval of a methodology to introduce a programmatic approach to budgeting by September 30, 2010.
  - Objective: strengthen efficiency of adjustment strategy by improving linkages between medium-term expenditure framework and annual budgets, and building capacity for program budgeting.
- Executive summary of IMF assessment (Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair):
  - Economy shows tentative signs of recovery; external environment remains weak for export market growth and uncertain for recovery of private capital inflows.
  - Domestic credit conditions still very tight; interest rates have started coming down.
  - Authorities’ strategy stabilized financial conditions and market confidence, evidenced by steady reflow of deposits, stabilization of foreign exchange market, narrowing Eurobond spreads.
  - Large fiscal stimulus helped avert deeper contraction.
  - Authorities’ sizeable fiscal adjustment targeted for 2010 aimed at placing public finances on sustainable path; combined with structural reforms to enhance spending efficiency and business environment.
  - Foreign exchange market pressures abated since May 2009; intervention in support of the lari very limited.
  - External current account deficit narrowed markedly but remains structurally high; exchange rate remains important adjustment instrument.
  - Credit conditions: real interest rates remain tight due to prior liquidity squeeze; banks returned to comfortable liquidity and interest rates have begun to decline.
  - Banking sector: weathered crisis relatively well; systemic risks abated; banks retained solid capital base, reconstituted strong liquidity buffers, and set aside adequate provisions; indirect foreign currency exposure risks remain pervasive and authorities upgraded monitoring including stress testing.
- Key macroeconomic recent developments and projections (as presented by Executive Director Age Bakker):
  - Real GDP contraction: shrank by 8.5 percent in the first half of 2009.
  - Inflation: end-October CPI inflation 3.2 percent (annual), compared to 5.5 percent at end-2008.
  - Current account deficit: declined to 13.6 percent of GDP in the first half of 2009 (down from 28.7 percent in the first half of 2008).
  - Non-performing loans (NPLs): 18 percent of total loans in October (authorities’ definition).
  - For the year 2009: real GDP expected to contract by 4 percent, with risks tilted to the downside.
  - 2010 outlook: authorities expect GDP growth to return to positive numbers; inflation not projected to exceed the inflation target of 6 percent.
  - External current account: improvement projected to be slightly reversed in 2010, owing mostly to adverse terms of trade developments (higher energy prices).
- Monetary and exchange rate policy actions:
  - Central bank cut policy rate by 100 basis points to 5 percent (last week referenced in document).
  - Transmission to market rates hampered by high dollarization; deposit and loan rates have started to drop due to improved liquidity.
  - Authorities stepped up issuance of CDs to mop up excess local currency liquidity.
  - Commitment to flexible exchange rate policy; widened deviation band for auction bids and reduced frequency of FX auctions in absence of pressures; commitment to allow faster depreciation if persistent downward pressures arise.
- Fiscal policy and financing:
  - 2009 fiscal deficit expected to widen to 9.6 percent of GDP (due to fiscal stimulus and donor financing).
  - External public debt expected to climb to 30 percent of GDP (24 percent in NPV terms).
  - 2010 budget aims to reduce fiscal deficit by around 2¼ percentage points; most adjustment to come from expenditure cuts, mainly subsidies and capital projects; social spending will not be lowered in terms of GDP.
  - Fiscal target beyond 2010: authorities committed to reduce deficit to 2-3 percent of GDP by 2013.
  - Economic Freedom Act anchors commitment to fiscal sustainability; fiscal rules to become effective in 2012.
  - Financing mix: external budget support, privatization and treasury bills. Fund expected to cover 45 percent of required financing; authorities expect additional financing from World Bank and ADB; expected Fund budget support to be reduced once additional financing secured.
  - Public finance reform action plan under implementation to improve transparency, discipline, efficiency and accountability of public finances.
- Banking sector resilience and contingency planning:
  - Stress tests (developed with Fund assistance) show sector resilience even under extreme scenarios; recapitalization needs manageable.
  - Authorities prepared a contingency plan with bank-by-bank measures and division of responsibilities; have effectively restructured one systemically-relevant bank.
  - Further steps: introduce risk-based supervision and make balance sheets less susceptible to exchange rate shocks.
- Request to IMF Executive Board:
  - Authorities request Board approval of completion of the 4th review and new program conditionality.

*Source: IMF press release and annexes as contained in the provided content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09331.pdf_