## Executive Summary ## Source details **Canonical URL:** [Executive Summary](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1187.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1187.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1187.pdf.json) --- ### The Policy Response to the Twin Crises and Recent Developments - Fiscal response and stabilization - The total fiscal stimulus injected into the economy in 2008 and in 2009 was equivalent to nearly 10 percent of GDP. - The fiscal deficit declined from 9.2 percent of GDP in 2009 to 6.6 percent of GDP in 2010 and is projected at 3.9 percent of GDP in 2011. - Public debt rose from 22 percent of GDP in 2007 to 39 percent of GDP in 2010. - Macroeconomic outcomes and inflation - Real GDP growth exceeded 6 percent in 2010 and is projected at 5½ percent in 2011. - Inflation rose to 12 percent on the back of rising commodity prices; core inflation remains subdued. - End-2011 inflation in the medium-term scenario is revised up to 8 percent, declines to 6.5 percent in 2012, and then gradually to 5 percent. - Financial sector and external financing - The confidence shock led to a 29 percent loss of deposits (exchange rate adjusted). - The crisis-related real exchange rate depreciation was 18 percent (peak to trough). - FDI was 5 percent of GDP in 2010; the recovery of FDI has been slower than anticipated. - To fill the gap opened by the fall in net private capital inflows, Georgia relied about equally on official inflows and current account adjustment. - Social mitigation measures - Authorities issued transferable electricity vouchers and considered increases in social spending to alleviate the social impact of higher food and energy prices. ### Strengthening the Exit Strategy and Foundations for Sustained Growth - Key policy challenges - Create conditions for solid economic growth even without a strong rebound of FDI, while preserving a viable external position. - Strengthen public balance sheets. - Maintain price stability. - Prevent emergence of new private sector imbalances and systemic risks as credit and external borrowing resume. - Medium-term scenario (principal numerical assumptions and policy settings) - Real GDP: 5½ percent in 2011; stabilizes at 4¾ percent thereafter. - Balance of payments: - FDI increases from 5 to 6 percent of GDP over the medium term. - Gross international reserves increase to $2.9 million by end-2016. - Current account deficit declines from 12.5 percent of GDP in 2011 to 5.5 percent of GDP in 2016. - Fiscal policy: - Deficit converges to 1.3 percent of GDP by 2016 (compared with 2 percent under the previous scenario). - Adjustment path: a 9 percent decline in real primary spending over 2011–12, followed by real growth of primary spending of around 3 percent on average per year through 2016. - Capital budget in real terms declines by 17 percent in 2011–12 as post-crisis spending winds down. - Money and credit: - Broad money growth projected to exceed nominal GDP growth by about 7 percentage points a year over the medium term. - Private credit growth averages 18 percent per year. - Credit-to-GDP ratio rises from 31 percent in 2010 to 43 percent in 2016. - Banks assumed to finance part of loan portfolios through external borrowing while reducing the loan-to-deposit ratio. - External and fiscal sustainability - Staff considers policies should aim to reduce the current account deficit to 5–6 percent of GDP over the medium term. - Debt sustainability analysis indicates slightly more fiscal adjustment than under the previous scenario is needed. - Real exchange rate adjustment would be facilitated by fiscal consolidation. - In event of continued international market instability, balance-of-payments gaps could reemerge in 2012–14 due to debt rollover needs. ### Sectoral and Structural Measures to Support Growth - Authorities’ growth strategy and priorities - A more proactive approach emphasizing structural reforms in agriculture and targeted public investment (including energy and logistics). - Authorities preparing a three-year plan for agriculture focusing on logistics, irrigation, training and technologies, and land consolidation. - Potential targeted public investment or public-private partnerships in selected sectors; staff cautioned on large direct and contingent fiscal costs from PPPs or public enterprise investments. - Competitiveness - Crisis-related real depreciation has moved the lari closer to equilibrium; standard assessments suggest the real effective exchange rate remains moderately overvalued by 7–9 percent. - Medium-term policy aim: moderate real exchange rate depreciation combined with productivity gains and trading-partner recovery to narrow the current account deficit. ### Policy Guidance and Conditional Actions - Monetary policy - Recent monetary tightening should help stabilize inflation expectations. - Further monetary tightening should be conditional on evidence that inflation is not abating as projected or that credit is growing too fast. - Fiscal policy and expenditure priorities - Reallocate expenditure toward productivity-enhancing spending within fiscal constraints to meet deficit reduction goals. - Staff stressed that the new growth strategy must be consistent with fiscal policy’s objective of bringing the deficit to a sustainable position (1½ percent of GDP by 2016 referenced as a policy goal in discussions). - Financial sector and prudential considerations - Monitor and prevent reemergence of private sector imbalances as credit and external borrowing resume. - Maintain exchange rate flexibility as a central instrument of adjustment. ### Vulnerabilities and Risks - Crisis legacies and ongoing vulnerabilities - Private sector balance sheets weakened: higher loan dollarization and indebtedness; a deteriorated bank loan portfolio and increased NPLs (partly reflecting pre-crisis vulnerabilities). - External environment likely to remain volatile; the expected rebound of FDI is uncertain. - Continued reliance on official financing helped limit output contraction but leaves exposure to external rollover risks in 2012–14. - Contingent scenarios - A moderate recovery in private capital inflows together with policy adjustment is required to reach external and fiscal sustainability under the medium-term scenario. ### External adjustment and external debt vulnerabilities (authorities’ views and staff analysis) - Authorities’ view - Required external adjustment over the medium term could be fully achieved through productivity gains; reaffirmed commitment to exchange rate flexibility. - External debt repayment profile peaks at just over $1 billion in 2013 (equivalent to 8 percent of GDP). - Baseline financing assumed a mix of external borrowing and issuance of domestic government paper for government obligations to the Fund; central bank obligations met through accumulation of international reserves. - Staff recommendations - Gradually raise issuance of domestic government paper to insure against adverse market developments and to avoid excessive reliance on a single large Eurobond. - Consider alternative refinancing strategies based on market developments. ### Box 2 — Georgia: Alternative Financing Scenario (differences compared with the baseline scenario, 2011–2016) - Eurobond issuance: 2011: 0 2012: 0 2013: -300 2014: 0000 2015: 0 2016: 0 - T-bill issuance: 2011: 75 2012: 75 2013: 75 2014: 75 2015: 00 2016: 0 - Sterilized intervention: 2011: 50 2012: 100 2013: 150 2014: 0000 2015: 0 2016: 0 - Current Account balance (in percent of GDP): 2011: 0.4 2012: 0.7 2013: 1.1 2014: 0.0 2015: 0.0 2016: 0.0 - Exchange rate (in percent, - = depreciation): 2011: -1.4 2012: -2.7 2013: -3.8 2014: 0.0 2015: 0.0 2016: 0.0 - Credit growth (exchange rate-adjusted, in percent): 2011: -1.5 2012: -2.5 2013: -3.0 2014: 0.7 2015: 0.6 2016: 0.9 - Gross international reserves: 2011: 50 2012: 150 2013: 0000 2014: 0 2015: 0 2016: 0 ### Gross international reserves and market intervention - Authorities consider present level of gross international reserves ($2.3 billion) to be appropriate given perceived risks. - Staff analysis: GIR presently meets nearly all standard and composite reserve adequacy thresholds; maintaining these ratios roughly unchanged over the medium term would require a gradual increase of GIR to $2.9 billion by 2016. - Meeting this objective while repaying the Fund will limit room for central bank sales of foreign exchange over the medium term. - Staff noted intervention in response to temporary pressures should be systematically financed by purchases of foreign exchange in the market during quiet times. ### Private capital inflows and balance of payments risks - Projected rebound of private capital inflows has been revised down relative to the previous scenario but remains a risk factor. - Large improvement projected for 2011 rests on: - inflows from banks to meet the increase in reserve requirements; and - the repatriation of the proceeds of the Eurobond issued by Georgian Railway in 2010. - Reserve requirement increases: on foreign exchange liabilities of banks were increased from 5 to 10 percent on January 20, 2011, and to 15 percent on February 17, 2011; net inflows generated in 2011 by this measure are estimated at around $264 million. - Nonresident deposits grew by roughly 1½ percent of GDP from mid-2008 to end-2010 due to attractive yields offered. ### Restoring a sound fiscal position and social mitigation - Authorities intend to reduce the deficit to under 4 percent of GDP in 2011, below the 4.3 percent target under the Stand-By Agreement, by sticking to the budgeted expenditure envelope. - This would correspond to an improvement in the structural fiscal balance of 2.3 percent of GDP relative to 2010—implying nearly half of the adjustment targeted from 2010 to 2016 would take place in 2011. - Adjustment strategy based on expenditure containment, notably by scaling back the capital budget where countercyclical spending was concentrated. - Staff recommended directing the largest portion of any increase in the social budget to targeted programs rather than untargeted pensions. ### Box 3 — Social Programs in Georgia (highlights) - TSA introduced in 2006 based on proxy means tests (PMT); benefit amounts to GEL 30 per month for the household head, plus GEL 24 for each additional household member; approximately 400,000 beneficiaries. - Minimum pensions: universal GEL 80 monthly benefit for men above 65 and women above 60. - MIP targeted to the poor introduced in 2008; target group comprises about 900,000 beneficiaries. - Georgia: Social Expenditures (General Government), 2008–11 (in percent of GDP): - Health programs: 2008: 1.2 2009: 1.5 2010: 1.6 2011: 1.4 - Pensions: 2008: 4.0 2009: 4.5 2010: 4.3 2011: 3.9 - Social assistance: 2008: 1/ 1.1 2009: 1.3 2010: 1.2 2011: 1.1 - Other: 2008: 0.9 2009: 0.7 2010: 0.7 2011: 0.6 - Total: 2008: 2/7.2 2009: 7.9 2010: 7.8 2011: 7.0 ### Tax referendum requirement and suggested escape clause (Box 4) - Constitutional amendment: tax increases subject to a referendum requirement starting in 2013; an escape clause to be specified through separate legislation. - Staff recommended the escape clause cover a sufficiently wide range of contingencies: link to a deficit and debt threshold and based on prospective debt dynamics. - Suggested triggers could include: a 3-percent-of-GDP ceiling on the general government deficit; a 2-percent-of-GDP ceiling on the primary gap; and a 40-percent ceiling on the debt-to-GDP ratio. ### Price stability and monetary policy - Consumer price inflation reached 12 percent in January 2011; projected to decline to around 8 percent by year-end in absence of additional shocks. - NBG tightened monetary stance since June 2010: - Policy rate raised by a cumulative 300 basis points, with the last 50 basis points increase on February 16. - Reserve requirements on dollar liabilities increased from 5 to 15 percent (effective February 17). - Increases in liquidity requirements (October 1, 2010) and regulatory capital requirements (January 1, 2011). - Planned transition to an inflation-targeting framework should anchor expectations around the inflation target rather than the exchange rate. - Constraints to effective inflation targeting: structural, informational, and statistical limitations; staff encouraged building inflation forecasting and modeling capacity with Fund technical assistance. ### Financial sector stability, funding, and nonresident deposits - Banking sector reduced exposure to foreign borrowing significantly. - Authorities plan to introduce a 100-percent marginal liquidity requirement on nonresident deposits in excess of 10 percent of the deposit base. - Empirical evidence on volatility of nonresident deposits described as "inconclusive": - Nonresident deposits declined more rapidly than domestic deposits in the immediate aftermath of the 2008 conflict. - Nonresident deposits proved more resilient during April–May 2009 unrest. - NPLs declined from 8.6 percent of the loan portfolio in mid-2009 to 5.4 percent currently (as reported in parts of the report), though alternate series show higher NPLs under other definitions and timepoints. ### Debt rollover risks, reserves, and policy implications - External debt repayment obligations peak at just over $1 billion in 2013 (equivalent to 8 percent of GDP). - Staff: Solvency risks manageable but balance-of-payments gaps could reemerge in 2012–14 on account of debt rollover risks. - Authorities consider current GIR ($2.3 billion) appropriate; staff: GIR should rise to $2.9 billion by 2016 to maintain reserve adequacy ratios. - Recommendation: gradually raise issuance of domestic government paper and lengthen maturities; complement fiscal consolidation with enhanced exchange rate flexibility and reserve accumulation. ### Staff appraisal — macroeconomic stance and policy recommendations - Overall: policy response succeeded in stabilizing the economy and restoring confidence; main challenge is transition from recovery to durable growth in an unsettled external environment. - Key recommendations: - Structural reforms in agriculture and selective public investment aligned with fiscal consolidation. - Narrow the current account deficit to 5–6 percent of GDP over the medium term through fiscal adjustment and real exchange rate adjustment. - Allow recent preemptive monetary tightening to play out; further tightening contingent on inflation and credit developments. - Continue building capacity for inflation forecasting and monetary policy transmission analysis. - Maintain exchange rate flexibility; if FX sales are used to support the lari, offset with purchases in quieter times to rebuild net international reserves. - Fiscal anchor: an adjustment need of approximately 5 percent of GDP relative to 2010 to bring the deficit to a sustainable position. ### Key macroeconomic indicators (selected projections and historical figures) - Nominal GDP (million lari): 19,075 (2008 Act.), 17,986 (2009 Act.), 20,566 (2010 Act.), 23,332 (2011 Proj.), 26,028 (2012 Proj.), 28,833 (2013 Proj.), 31,788 (2014 Proj.), 35,046 (2015 Proj.), 38,638 (2016 Proj.). - Real GDP growth (annual percent): 2.3 (2008), -3.8 (2009), 6.3 (2010), 5.5 (2011), 4.7 (2012), 4.8 (2013), 4.7 (2014), 4.8 (2015), 4.8 (2016). - Consumer price index, period average: 10.0 (2008), 1.7 (2009), 7.1 (2010), 10.2 (2011), 7.3 (2012), 6.3 (2013), 5.8 (2014), 5.5 (2015), 5.4 (2016). - Current account (percent of GDP): -22.6 (2008), -11.2 (2009), -9.9 (2010), -12.5 (2011), -11.5 (2012), -10.5 (2013), -8.0 (2014), -6.3 (2015), -5.5 (2016). - Gross international reserves (US$ millions): 1,480 (2008), 2,111 (2009), 2,263 (2010), 2,780 (2011), 2,590 (2012), 2,488 (2013), 2,462 (2014), 2,730 (2015), 2,902 (2016). - Total government debt (percent of GDP): 25.0 (2008), 37.3 (2009), 39.5 (2010), 41.1 (2011), 40.5 (2012), 40.8 (2013), 39.0 (2014), 37.9 (2015), 36.9 (2016). - Deposit dollarization and FX exposure: - Deposit dollarization (percent): 60.9 (2008), 60.0 (2009), 61.7 (2010), 75.7 (2011 Mar.), 75.2 (2011 Jun.), 73.2 (2011 Sep.), 72.6 (2011 Dec.). - Loans in foreign exchange (percent of total loans): 65.9 (2008), 64.9 (2009), 67.5 (2010), 72.8 (2011). - Nonperforming loans (national definition, percent of total loans): 3.0 (2008), 3.4 (2009), 9.9 (2010), 12.8 (2011 Mar.), 15.2 (2011 Jun.), 18.8 (2011 Sep.), easing to 12.5 (2011 Dec.) and 12.7 (2012 Mar.) under alternate series. - Financial flows (US$ millions): Financial account: 2,784 (2008), 1,428 (2009), 824 (2010), 1,773 (2011), 1,517 (2012), 1,662 (2013), 1,402 (2014), 1,357 (2015), 1,029 (2016). - Direct investment (net): 1,494 (2008), 659 (2009), 575 (2010), 706 (2011), 809 (2012), 837 (2013), 869 (2014), 908 (2015), 960 (2016). _Executive Summary, IMF country staff report (see canonical source PDF)._ ### Executive Summary ...................................................................................................... ### Executive Summary ### The Policy Response to the Twin Crises and Recent Developments - Fiscal response and stabilization - The total fiscal stimulus injected into the economy in 2008 and in 2009 was equivalent to nearly 10 percent of GDP. - The fiscal deficit declined from 9.2 percent of GDP in 2009 to 6.6 percent of GDP in 2010 and is projected at 3.9 percent of GDP in 2011. - Public debt rose from 22 percent of GDP in 2007 to 39 percent of GDP in 2010. - Macroeconomic outcomes and inflation - Real GDP growth exceeded 6 percent in 2010 and is projected at 5½ percent in 2011. - Inflation rose to 12 percent on the back of rising commodity prices; core inflation remains subdued. - End-2011 inflation in the medium-term scenario is revised up to 8 percent, declines to 6.5 percent in 2012, and then gradually to 5 percent. - Financial sector and external financing - The confidence shock led to a 29 percent loss of deposits (exchange rate adjusted). - The crisis-related real exchange rate depreciation was 18 percent (peak to trough). - FDI was 5 percent of GDP in 2010; the recovery of FDI has been slower than anticipated. - The private sector external position improved since mid-2010, allowing reduced central bank intervention and a strengthened net international reserve position. - To fill the gap opened by the fall in net private capital inflows, Georgia relied about equally on official inflows and current account adjustment. - Social mitigation measures - To alleviate the social impact of higher food and energy prices, authorities issued transferable electricity vouchers and considered increases in social spending. ### Strengthening the Exit Strategy and Foundations for Sustained Growth - Key policy challenges going forward - Create conditions for solid economic growth even without a strong rebound of FDI, while preserving a viable external position. - Strengthen public balance sheets. - Maintain price stability. - Prevent emergence of new private sector imbalances and systemic risks as credit and external borrowing resume. - Medium-term scenario (principal numerical assumptions and policy settings) - Real GDP: 5½ percent in 2011; stabilizes at 4¾ percent thereafter. - Balance of payments: - FDI increases from 5 to 6 percent of GDP over the medium term. - Gross international reserves increase to $2.9 million by end-2016. - Current account deficit declines from 12.5 percent of GDP in 2011 to 5.5 percent of GDP in 2016. - The cyclical recovery of trading partners and exchange rate adjustment contribute about equally to the narrowing of the current account deficit. - Fiscal policy: - Deficit converges to 1.3 percent of GDP by 2016 (compared with 2 percent under the previous scenario). - Adjustment path: a 9 percent decline in real primary spending over 2011–12, followed by real growth of primary spending of around 3 percent on average per year through 2016. - Capital budget in real terms declines by 17 percent in 2011–12 as post-crisis spending winds down. - Money and credit: - Broad money growth projected to exceed nominal GDP growth by about 7 percentage points a year over the medium term. - Private credit growth averages 18 percent per year. - Credit-to-GDP ratio rises from 31 percent in 2010 to 43 percent in 2016. - Banks assumed to finance part of loan portfolios through external borrowing while reducing the loan-to-deposit ratio. - External and fiscal sustainability - Staff considers policies should aim to reduce the current account deficit to 5–6 percent of GDP over the medium term. - Debt sustainability analysis indicates slightly more fiscal adjustment than under the previous scenario is needed. - Real exchange rate adjustment would be facilitated by fiscal consolidation. - In event of continued international market instability, balance-of-payments gaps could reemerge in 2012–14 due to debt rollover needs. ### Sectoral and Structural Measures to Support Growth - Authorities’ growth strategy and priorities - More proactive approach emphasizing structural reforms in agriculture and targeted public investment to improve productivity and attract private investment (including energy and logistics). - Authorities preparing a three-year plan for agriculture focusing on logistics, irrigation, training and technologies, and land consolidation. - Potential targeted public investment or public-private partnerships in selected sectors, with staff cautioning on large direct and contingent fiscal costs from PPPs or public enterprise investments. - Competitiveness - Crisis-related real depreciation has moved the lari closer to equilibrium; standard assessments suggest the real effective exchange rate remains moderately overvalued by 7–9 percent. - Medium-term policy aim: moderate real exchange rate depreciation combined with productivity gains and trading-partner recovery to narrow the current account deficit. ### Policy Guidance and Conditional Actions - Monetary policy - Recent monetary tightening should help stabilize inflation expectations. - Staff and authorities agree that further monetary tightening should be conditional on evidence that inflation is not abating as projected or that credit is growing too fast. - Fiscal policy and expenditure priorities - Reallocate expenditure toward productivity-enhancing spending within fiscal constraints to meet deficit reduction goals. - Staff stressed that new growth strategy must be consistent with fiscal policy’s objective of bringing the deficit to a sustainable position (1½ percent of GDP by 2016 referenced as a policy goal in discussions). - Financial sector and prudential considerations - Monitor and prevent reemergence of private sector imbalances as credit and external borrowing resume. - Maintain exchange rate flexibility as a central instrument of adjustment. ### Vulnerabilities and Risks - Crisis legacies and ongoing vulnerabilities - Private sector balance sheets weakened: higher loan dollarization and indebtedness; a deteriorated bank loan portfolio and increased NPLs (partly reflecting pre-crisis vulnerabilities). - External environment likely to remain volatile; the expected rebound of FDI is uncertain. - Continued reliance on official financing helped limit output contraction but leaves exposure to external rollover risks in 2012–14. - Contingent scenarios - Staff analysis shows that a moderate recovery in private capital inflows together with policy adjustment is required to reach external and fiscal sustainability under the medium-term scenario. _Executive Summary, IMF country staff report (see canonical source PDF)._ ### 12. The authorities broadly agreed with staff’s assessment, but considered that the ### 12. The authorities broadly agreed with staff’s assessment, but considered that the ### External adjustment and external debt vulnerabilities - Authorities viewed the required external adjustment over the medium term could be fully achieved through productivity gains, consistent with their revised growth strategy; they emphasized high uncertainty surrounding equilibrium real exchange rate assessments and reaffirmed commitment to exchange rate flexibility. - The external debt repayment profile is an important vulnerability: government and central bank face large external debt service obligations in 2012–14, peaking at just over $1 billion in 2013 (equivalent to 8 percent of GDP). - Under the baseline scenario: - Government obligations to the Fund are assumed to be paid through a mix of external borrowing and issuance of domestic government paper. - Central bank obligations are met through accumulation of international reserves. - Staff presented an alternative refinancing strategy involving greater issuance of domestic government paper, which would involve faster external adjustment; recommended gradually raising issuance of domestic government paper to insure against adverse market developments. - Authorities were considering alternative financing options based on developments in international financial markets through the rest of the year, noting that accumulating deposits in anticipation of future debt service would create political pressures to increase spending. ### Box 2 — Georgia: Alternative Financing Scenario - Baseline: government’s main external debt repayment obligations financed primarily through issuance of an $800-million Eurobond in 2013; this issuance would allow the government to repay the maturing $500-million Eurobond and about three quarters of its obligations to the Fund over 2013–15. - Alternative scenario: assume Eurobond issue of only $500 million and additional issuance of domestic government paper of $300 million to refinance the government’s component of the debt to the Fund. - Additional domestic issuance is assumed to start in 2011 and span over 4 years to avoid unduly crowding out credit to the private sector. - Because domestic paper issuance would be in lari, additional external adjustment would be needed to generate the needed foreign exchange; to avoid a decline in international reserves, the central bank would have to increase sterilized purchases of foreign exchange in the market, leading to further (temporary) depreciation of the lari and improvement of the current account; the current account adjustment would replace the foregone external borrowing. - Table (Differences compared with the baseline scenario, 2011–2016, as presented): - Eurobond issuance: 2011: 0 2012: 0 2013: -300 2014: 0000 2015: 0 2016: 0 - T-bill issuance: 2011: 75 2012: 75 2013: 75 2014: 75 2015: 00 2016: 0 - Sterilized intervention: 2011: 50 2012: 100 2013: 150 2014: 0000 2015: 0 2016: 0 - Current Account balance (in percent of GDP): 2011: 0.4 2012: 0.7 2013: 1.1 2014: 0.0 2015: 0.0 2016: 0.0 - Exchange rate (in percent, - = depreciation): 2011: -1.4 2012: -2.7 2013: -3.8 2014: 0.0 2015: 0.0 2016: 0.0 - Credit growth (exchange rate-adjusted, in percent): 2011: -1.5 2012: -2.5 2013: -3.0 2014: 0.7 2015: 0.6 2016: 0.9 - Gross international reserves: 2011: 50 2012: 150 2013: 0000 2014: 0 2015: 0 2016: 0 - Sources for the Box: Staff projections. ### Gross international reserves and market intervention - Authorities consider the present level of gross international reserves ($2.3 billion) to be appropriate given perceived risks. - Staff analysis shows GIR presently meets nearly all standard and composite reserve adequacy thresholds; maintaining these ratios roughly unchanged over the medium term would require a gradual increase of GIR to $2.9 billion by 2016. - Meeting this objective while repaying the Fund will limit the room for central bank sales of foreign exchange over the medium term. - Authorities noted intervention in response to temporary pressures will continue to be needed in Georgia’s thin foreign exchange market to avoid abrupt exchange rate movements; staff noted such intervention should be systematically financed by purchases of foreign exchange in the market during quiet times to avoid a ratcheting down of GIR relative to its target. ### Private capital inflows and balance of payments risks - Projected rebound of private capital inflows has been revised down relative to the previous scenario but remains a risk factor for the balance of payments. - The large improvement projected for 2011 rests essentially on: - inflows from banks to meet the increase in reserve requirements; and - the repatriation of the proceeds of the Eurobond issued by Georgian Railway in 2010. - Reserve requirement increases: on foreign exchange liabilities of banks were increased from 5 to 10 percent on January 20, 2011, and to 15 percent on February 17, 2011; net inflows generated in 2011 by this measure are estimated at around $264 million. - Beyond 2011, increase in private capital inflows reflects moderate increases in both FDI and other private inflows. - Nonresident deposits grew by roughly 1½ percent of GDP from mid-2008 to end-2010 due to attractive yields offered. - Staff and authorities agreed risks of overheating from these inflows appear negligible at present; staff noted these inflows may prove useful given uncertainty about more traditional external financing such as FDI. - Authorities highlighted financial stability concerns related to these inflows (discussed in Section II.D). ### Restoring a sound fiscal position - Authorities reiterated commitment to durable fiscal adjustment over the medium term as contained in their 2010 medium-term fiscal framework. - Authorities intend to reduce the deficit to under 4 percent of GDP in 2011, below the 4.3 percent target under the Stand-By Agreement (SBA), by sticking to the budgeted expenditure envelope. - This would correspond to an improvement in the structural fiscal balance of 2.3 percent of GDP relative to 2010—implying nearly half of the adjustment targeted from 2010 to 2016 would take place in 2011. - Adjustment strategy based on expenditure containment, notably by scaling back the capital budget where countercyclical spending was concentrated; much capital spending reflects phasing out of external project support. - Authorities consider reducing government spending over the medium term to be more growth enhancing than raising taxes. - Staff welcomed deficit reduction objectives but noted challenges: - Elections in 2012 and 2013 will generate new pressures. - Expenditure compression will require tough decisions, especially rationalizing public capital spending around fewer projects and strengthening social safety nets. - Authorities expect economic recovery to lessen demand for social assistance but acknowledged pressures for broad increases, particularly in pensions due to steep rise in food and fuel prices. - Some limited measures taken, e.g., electricity vouchers (not well targeted); staff agreed a real increase in social spending will need consideration in the 2012 budget. - Staff noted targeted social assistance (TSA) is much more efficient than untargeted pensions and recommended directing the largest portion of any increase in the social budget to targeted rather than untargeted programs. ### Box 3 — Social Programs in Georgia - Social safety net relies on three pillars: a targeted social assistance program (TSA), pensions, and health programs. - TSA introduced in 2006, based on proxy means tests (PMT) with over 100 indicators; benefit amounts to GEL 30 per month for the household head, plus GEL 24 for each additional household member; approximately 400,000 beneficiaries. - Minimum pensions: universal GEL 80 monthly benefit for men above 65 and women above 60; in comparison, monthly pension was GEL 14 in 2003. - Pensions account for about three-fourths of the social protection budget and above half of social spending of the public sector; about half of the population lives in a household receiving pension income. - Medical insurance program (MIP) targeted to the poor introduced in 2008; target group identified using same PMT as TSA but comprises about 900,000 beneficiaries; MIP entails transfer from public budget to private insurers as purchasers of health care for the poor; in 2009 MIP accounted for nearly half the total health budget. - Georgia: Social Expenditures (General Government), 2008–11 (in percent of GDP, as presented): - Health programs: 2008: 1.2 2009: 1.5 2010: 1.6 2011: 1.4 - Pensions: 2008: 4.0 2009: 4.5 2010: 4.3 2011: 3.9 - Social assistance: 2008: 1/ 1.1 2009: 1.3 2010: 1.2 2011: 1.1 - Other: 2008: 0.9 2009: 0.7 2010: 0.7 2011: 0.6 - Total: 2008: 2/7.2 2009: 7.9 2010: 7.8 2011: 7.0 - Footnotes cited in the source: 1/ Includes assistance to internally displaced persons (IDPs). 2/ The 2009 increase reflects both the 5.7 percent decline in nominal GDP and the nominal increase in spending stemming from two minimum pension hikes, the introduction of health insurance for the most vulnerable, and the increase in the number of social assistance beneficiaries after the 2008 conflict. The subsequent decline mainly reflects that pensions were frozen in 2010 and 2011. ### Tax referendum requirement and suggested escape clause (Box 4) - By recent constitutional amendment, tax increases will be subject to a referendum requirement starting in 2013; authorities’ rationale is to preserve Georgia’s favorable investment climate and avoid ratcheting up the tax burden. - Authorities confirmed an escape clause would be specified through separate legislation. - Staff recommended the escape clause cover a sufficiently wide range of contingencies: link to a deficit and debt threshold and based on prospective debt dynamics to capture adverse shocks not immediately reflected in the fiscal deficit (as illustrated in the DSA). - Box 4 staff suggestions for an escape clause: - Trigger under exceptional circumstances, but before fiscal indicators signal severe fiscal stress; temporarily suspend referendum requirement to restore fiscal flexibility. - Should be forward-looking and restore full tax autonomy when fiscal indicators are projected to exceed certain thresholds under unchanged policies. - Authorities preferred objective criteria rather than political consensus for triggering the clause. - Based on international experience, suggested thresholds could include: a 3-percent-of-GDP ceiling on the general government deficit (as initially envisaged by authorities); a 2-percent-of-GDP ceiling on the primary gap (difference between the primary deficit and its debt stabilizing level); and a 40-percent ceiling on the debt-to-GDP ratio; criteria would need well-defined definitions (e.g., GFS 2001 Manual). ### Price stability and monetary policy - Consumer price inflation rose unexpectedly since mid-2010, reaching 12 percent in January 2011; nearly all of this inflation originates from hikes in international prices of food and energy. - In absence of additional external shocks or second-round effects, inflation projected to decline by year-end to around 8 percent. - Uncertainty has increased due to spike in oil prices stemming from Middle East turmoil. - Main monetary policy challenge: avoid emergence of second-round effects that would entrench inflation and undermine confidence in the lari. - The NBG tightened monetary stance sizably since June 2010 in response to exchange rate pressures and rising inflation: - Policy rate raised by a cumulative 300 basis points, with the last 50 basis points increase on February 16. - Central bank CD rates have moved in parallel. - Reserve requirements on dollar liabilities increased in two steps from 5 to 15 percent (effective February 17) to balance tightening across currencies. - Increases in liquidity requirements (October 1, 2010) and regulatory capital requirements (January 1, 2011) add to tightening. - Authorities noted higher reserve requirements on dollars may encourage larger firms to finance themselves abroad, but in effect few companies have access to international financial markets at this stage. - NBG indicated readiness to tighten monetary conditions further; staff suggested further increases be linked to deviations of inflation from current projections or credit growth markedly in excess of projected level. - Planned transition to an inflation-targeting framework should anchor expectations around the inflation target rather than the exchange rate, allowing greater exchange rate flexibility. - Constraints to effective inflation targeting include structural (imperfect interest rate transmission), informational (inadequate understanding of inflation process and transmission mechanisms), and statistical (insufficient price and economic activity indicators). - Staff encouraged building inflation forecasting and modeling capacity with technical assistance from the Fund. ### Financial sector stability and private sector imbalances - Since stabilization in 2010, supervisory authority began restoring liquidity and capital requirements toward pre-crisis levels and progressing toward risk-based supervision. - Authorities noted relatively low credit-to-GDP ratio suggests scope for continued financial deepening, while stressing importance of monitoring risks based on debt-service-to-income ratios (which remain high) and loan-penetration ratios (which remain low). - Banking sector improvements: - NPLs declined from 8.6 percent of the loan portfolio in mid-2009 to 5.4 percent currently. - Adequate provisioning reported. - Currency-induced credit risk (loan dollarization) remains a vulnerability; although credit dollarization increased at end-2010, the risk of a large depreciation appears lower, reflecting modest estimated misalignment relative to the equilibrium exchange rate. *IMF staff report excerpt (Georgia), pages 11–17.* ### 23. On the funding side, the Georgian banking sector has succeeded in reducing ### _cr1187 - 23. On the funding side, the Georgian banking sector has succeeded in reducing ### Funding and nonresident deposits - The Georgian banking sector "has succeeded in reducing considerably its exposure to foreign borrowing," which had been "a major systemic vulnerability during the financing crisis." - The central bank view: - Nonresident deposits can provide diversification benefits. - Nonresident deposits "also create new financial stability risks, owing to the potentially volatile nature of these inflows." - Authorities’ planned measure: - Introduce a "100-percent marginal liquidity requirement on nonresident deposits in excess of 10 percent of the deposit base." - Empirical evidence and mission assessment: - Evidence of higher volatility of nonresident deposits is described as "inconclusive": - Nonresident deposits "declined more rapidly than domestic deposits in the immediate aftermath of the 2008 conflict." - Nonresident deposits "proved to be a more resilient source of funding during the subsequent domestic political unrest in April-May 2009." - The mission "welcomed the authorities’ alertness to new risks and the decision to monitor these deposits closely." - The mission "encouraged the authorities to review the need for such a measure on a regular basis as more information on the nature and volatility of the nonresidents’ deposits become available." - Policy trade-off noted: - "Financial stability risks should be weighed against other risks, including that of curtailing a useful source of balance of payments financing." ### Nonperforming loans (NPLs) and provisions (figure summary) - Figure caption: "Georgia: Nonperforming Loans and Provisions Ratios, 2006-11 (In percent)." - Series and definitions included in the figure: - "NPLs/ Total loans (NBG definition) 1/" - "Specific provisions/ NPLs (RHS) 1/" - "NPLs/ Total loans (IMF definition) 2/" - Footnotes: - "1/ NPLs are defined as loans in substandard, doubtful, and loss loan categories." - "2/ NPLs are defined as loans with overdue payments (principle and/or interest) over 90 days." - Sources: "Georgian authorities; and Fund staff estimates." ### Relations with the Fund - An Ex Post Assessment Update (EPA) reviewed Georgia’s economic performance during "2004–10" under two Fund-supported programs: - "2004–07 Poverty Reduction and Growth Facility (PRGF)" - "2008–11 SBA" - EPA conclusions: - Cooperation with the Fund "was fruitful, and the objectives of the two programs were broadly met." - PRGF results: - Helped remove key impediments to effective economic policy and promote private sector activity, producing "an impressive acceleration of growth." - Critique: "the program could have been more forceful in addressing risks associated with overheating and increasing financial vulnerabilities." - SBA results: - "Effective in restoring confidence and macroeconomic stability in the aftermath of the crises." - Remaining concern: "it remains to be seen whether the program objectives toward the exit strategy will be fully met, in view of Georgia’s still large current account deficit." - Policy alignment and preferences: - "Macroeconomic policies were generally aligned with previous Fund recommendations." - On fiscal strategy: staff recommended considering additional tax revenue measures, but "the authorities preferred to implement an expenditure-based strategy," which "proved successful in meeting their objectives." - On exchange rate: staff recommended flexibility; authorities "considered that intervention was occasionally needed to avoid excessive volatility." - Future engagement: - "The authorities confirmed their interest in a successor arrangement to reinforce confidence and provide a safety net against possible shocks during the challenging debt rollover period ahead." - "Its modalities will be discussed at the time of the final review of the current SBA." ### Staff appraisal — macroeconomic stance and policy recommendations - Overall assessment: - "The policy response to the crisis has succeeded in stabilizing the economy and restoring confidence." - Key challenge: "transition from recovery to durable growth," requiring further adjustment in an unsettled external environment. - Growth and structural policy: - Authorities have a "more proactive growth strategy" in response to weak FDI. - Recommendation: "Structural reforms in agriculture could unlock the sector’s growth potential." - Public investment: "Selective use of public investment to attract private sector involvement is potentially fruitful," but must be "designed carefully and integrated in the broader fiscal strategy to avoid risks of undermining fiscal adjustment." - Current account and external adjustment: - Despite external adjustment since 2008, "the current account deficit remains, by most measures, unsustainably high." - Medium-term objective: support narrowing of the current account deficit "to 5–6 percent of GDP." - Policy instruments: - Fiscal adjustment should contribute to narrowing the deficit. - "Real exchange rate adjustment would also be needed over the medium term, consistent with closing the remaining (moderate) exchange rate misalignment." - Debt rollover and market access risks: - "Balance-of-payments gaps could reemerge in 2012–14 on account of debt rollover risks." - Georgia is favorably placed to access international markets, but an alternative refinancing strategy could involve: - "Greater issuance of domestic government paper, accompanied by faster external adjustment." - Recommendation: "The authorities are encouraged to raise issuance of domestic government paper and lengthen maturities gradually to cover this possibility." - Exchange rate regime guidance: - "Exchange rate flexibility should remain a fundamental pillar of growth and adjustment." - The "foreign exchange auction system introduced in March 2009 has already enhanced flexibility." - Policy guidance: tolerate "greater exchange rate volatility" and, if sales of foreign exchange are used to support the lari, offset with purchases in quieter times to rebuild net international reserves and exit Fund support. - Fiscal policy guidance: - Fiscal anchor: bring the deficit to a sustainable position over the medium term, implying "an adjustment need of approximately 5 percent of GDP relative to 2010." - Progress: "Through a sizable deficit reduction in 2010, the authorities have started to make good progress toward this objective." - Importance of 2011 budget discipline: "Keeping spending in 2011 within the budget envelope is key to safeguarding the structural improvement of the deficit." - Medium-term trade-offs: - Expenditure-based adjustment will require difficult prioritization. - Need to "carve out sufficient fiscal space to enhance social safety nets and to avoid an unsustainable compression of other current spending." - Importance of "rationalizing the capital budget, and of preserving adequate flexibility on the revenue side." - "Revenue measures should also be considered if expenditure pressures cannot be contained and the escape clause to the referendum requirement on tax increases should be sufficiently broad." - Monetary policy and inflation: - Immediate challenge: "prevent the entrenchment of the commodity-price shock into permanent inflation." - Observations: - "Core inflation remains subdued, the large increase in headline CPI raises the risk of second-round effects." - "The preemptive tightening to date should help stabilize inflation expectations." - Guidance: - Allow recent policy rate and reserve requirement increases "to play out." - "Further monetary policy tightening should be contingent on evidence that inflation is not abating as projected or credit is growing too fast." - Authorities' readiness "to tighten further if needed is welcome." - Transition to inflation targeting: - Medium-term task: "manage the transition to inflation targeting." - Reforms implemented: introduced market-based policy instruments and developed financial markets, improving monetary policy traction. - Recommendation: continue building "inflation forecasting and modeling capacity and improving underlying statistics." - Financial sector and prudential stance: - Given "the relatively low level of financial intermediation," authorities must balance financial development and prudential safeguards. - NPL-related concerns have "abated." - With rising credit growth, supervisory authority "has moved decisively and appropriately to contain the emergence of new risks by tightening prudential regulations." - Commendations: increases in risk monitoring and assessment capacity; move to risk-based supervision. - Authorities acted preemptively on risks from growth in nonresident deposits. - Recommendation: "review on a regular basis whether the recently introduced liquidity requirement to limit such inflows remains necessary, given the limited evidence about the added risks and these inflows’ potential usefulness for balance of payments financing." *Source: IMF staff report content provided in the supplied excerpt.* ### 37. It is expected that the next Article IV consultation be held in accordance with ### _cr1187 - 37. It is expected that the next Article IV consultation be held in accordance with Decision No. 14747-(10/96), 9/28/2010, as amended. ### Macroeconomic performance and projections (National accounts) - Nominal GDP (in million lari): 19,075 (2008 Act.), 17,986 (2009 Act.), 20,566 (2010 Act.), 23,332 (2011 Proj.), 26,028 (2012 Proj.), 28,833 (2013 Proj.), 31,788 (2014 Proj.), 35,046 (2015 Proj.), 38,638 (2016 Proj.). - Real GDP growth (annual percent): 2.3 (2008), -3.8 (2009), 6.3 (2010), 5.5 (2011), 4.7 (2012), 4.8 (2013), 4.7 (2014), 4.8 (2015), 4.8 (2016). - Population (in million, excludes Abkhazia residents): 4.4 (constant across series). - GDP deflator, period average: 9.7 (2008), -2.0 (2009), 7.6 (2010), 7.5 (2011), 6.5 (2012), 5.8 (2013), 5.3 (2014), 5.3 (2015), 5.3 (2016). - Consumer price index, period average: 10.0 (2008), 1.7 (2009), 7.1 (2010), 10.2 (2011), 7.3 (2012), 6.3 (2013), 5.8 (2014), 5.5 (2015), 5.4 (2016). - GDP per capita (in US$): 2,937 (2008), 2,455 (2009), 2,629 (2010), 2,920 (2011), 3,066 (2012), 3,171 (2013), 3,292 (2014), 3,434 (2015), 3,628 (2016). ### Investment, saving, and external balances - Investment (percent of GDP, net basis): 21.5 (2008), 15.3 (2009), 15.0 (2010), 17.2 (2011), 18.9 (2012), 20.3 (2013), 21.2 (2014), 21.3 (2015), 21.4 (2016). - Public investment: 4.3 (2008), 6.9 (2009), 7.2 (2010), 6.0 (2011), 5.8 (2012), 5.9 (2013), 5.8 (2014), 5.6 (2015), 5.4 (2016). - Private investment: 17.2 (2008), 8.5 (2009), 7.8 (2010), 11.2 (2011), 13.1 (2012), 14.4 (2013), 15.4 (2014), 15.7 (2015), 16.0 (2016). - Gross national saving (percent of GDP): -1.1 (2008), 4.1 (2009), 5.1 (2010), 4.7 (2011), 7.4 (2012), 9.8 (2013), 13.2 (2014), 15.0 (2015), 15.9 (2016). - Saving-investment balance (percent of GDP): -22.6 (2008), -11.2 (2009), -9.9 (2010), -12.5 (2011), -11.5 (2012), -10.5 (2013), -8.0 (2014), -6.3 (2015), -5.5 (2016). - Current account balance (in millions of US$): -2,912 (2008), -1,210 (2009), -1,147 (2010), -1,597 (2011), -1,554 (2012), -1,464 (2013), -1,164 (2014), -956 (2015), -872 (2016). - Current account (percent of GDP): -22.6 (2008), -11.2 (2009), -9.9 (2010), -12.5 (2011), -11.5 (2012), -10.5 (2013), -8.0 (2014), -6.3 (2015), -5.5 (2016). - Exports of goods and services (percent of GDP): 28.7 (2008), 29.8 (2009), 35.2 (2010), 36.9 (2011), 38.1 (2012), 39.2 (2013), 40.3 (2014), 41.6 (2015), 42.8 (2016). - Imports of goods and services (percent of GDP): 58.3 (2008), 48.9 (2009), 52.9 (2010), 55.6 (2011), 55.4 (2012), 55.1 (2013), 54.2 (2014), 54.1 (2015), 54.7 (2016). ### Fiscal outcomes and projections (Annual General Government) - Total government debt (percent of GDP): 25.0 (2008), 37.3 (2009), 39.5 (2010), 41.1 (2011), 40.5 (2012), 40.8 (2013), 39.0 (2014), 37.9 (2015), 36.9 (2016). - Foreign-currency denominated share (percent of GDP): 20.9 (2008), 31.7 (2009), 33.9 (2010), 35.9 (2011), 35.4 (2012), 35.8 (2013), 34.1 (2014), 33.1 (2015), 32.3 (2016). - Revenues (millions of lari and percent of GDP): - Revenues: 5,264 (2011 Act.), 5,809 (2012 7/8 Rev.), 5,866 (2013 Act.), 6,315 (2014 7/8 Rev.), 6,381 (2015 Proj.), with percent of GDP: 29.3 (2011), 28.4 (2012), 28.5 (2013), 27.4 (2014), 27.3 (2015), and subsequent projections down to 26.1 (2016). - Taxes: 4,389 (2011 Act.), 4,860 (2012 7/8 Rev.), 4,867 (2013 Act.), 5,571 (2014 7/8 Rev.), 5,589 (2015 Proj.); tax share ~24.4–24.0 percent of GDP across years. - Grants: 389 (2011 Act.), 510 (2012 7/8 Rev.), 473 (2013 Act.), 304 (2014 7/8 Rev.), 351 (2015 Proj.); grants percent of GDP decline to 0.4 (2016 Proj.). - Current expenditures (millions of lari and percent of GDP): 5,407 (2011 Act.) representing 30.1 percent of GDP; falling to 8,516 (2016 Proj.) representing 22.0 percent of GDP. - Operating balance (millions of lari and percent of GDP): -143 (2011 Act.; -0.8 percent), improving to 1,567 (2016 Proj.; 4.1 percent). - Capital spending and net lending (millions of lari and percent of GDP): 1,506 (2011 Act.; 8.4 percent), projected 2,086 (2016 Proj.; 5.4 percent). - Overall balance (millions of lari and percent of GDP): -1,648 (2011 Act.; -9.2 percent), improving to -520 (2016 Proj.; -1.3 percent). - Total financing (millions of lari and percent of GDP): 1,648 (2011 Act.; 9.2 percent), projected 520 (2016 Proj.; 1.3 percent). - External financing (millions of lari): 694 (2011 Act.; 3.9 percent of GDP), projected 519 (2016 Proj.; 1.3 percent). - Privatization receipts: 358 (2011 Act.; 2.0 percent), projected 0 (2016 Proj.; 0.0 percent). ### Monetary and financial sector indicators - Reserve money (12-month growth percent): -4.5 (2009), 21.8 (2010), 4.5 (2011), 7.1 (2012), 7.0 (2013), 7.0 (2014), 7.0 (2015), 7.5 (2016). - Broad money (including fx deposits) 12-month growth: 7.0 (2009), 8.1 (2010), 28.5 (2011), 16.0 (2012), 19.0 (2013), 19.0 (2014), 18.5 (2015), 18.5 (2016). - Bank credit to the private sector (annual percent change): 28.2 (2008), -13.5 (2009), 20.5 (2010), 13.2 (2011), 19.1 (2012), 22.8 (2013), 15.1 (2014), 14.9 (2015), 19.9 (2016). - Deposit dollarization (percent): 60.9 (2008), 60.0 (2009), 61.7 (2010), 75.7 (2011 Mar.), 75.2 (2011 Jun.), 73.2 (2011 Sep.), 72.6 (2011 Dec.), and subsequent readings around 70.1–74.5 in later months. - Nonperforming loans (national definition, percent of total loans): 3.0 (2008), 3.4 (2009), 9.9 (2010), 12.8 (2011 Mar.), 15.2 (2011 Jun.), 18.8 (2011 Sep.), easing to 12.5 (2011 Dec.) and 12.7 (2012 Mar.) under IMF definition other series also provided. - Loans in foreign exchange (percent of total loans): 65.9 (2008), 64.9 (2009), 67.5 (2010), 72.8 (2011), series remaining around mid-70s thereafter. - Capital adequacy ratio (national definition): 17.5 (2008), 15.7 (2009), 17.0 (2010), 13.9 (2011 Mar.), with subsequent fluctuations up to 20.2 (2011 Sep.) and readings ~16.3 later. ### External sector and vulnerabilities - Gross international reserves (in millions of US$): 1,480 (2008), 2,111 (2009), 2,263 (2010), 2,780 (2011), 2,590 (2012), 2,488 (2013), 2,462 (2014), 2,730 (2015), 2,902 (2016). - Reserves in months of next year's imports of goods and services: 3.4 (2008), 4.2 (2009), 3.8 (2010), 4.5 (2011), 4.0 (2012), 3.8 (2013), 3.6 (2014), 3.7 (2015), 3.7 (2016). - External debt (nominal, in millions of US$): 5,664 (2008), 6,254 (2009), 7,148 (2010), 7,948 (2011), 8,221 (2012), 8,420 (2013), 8,137 (2014), 8,078 (2015), 7,712 (2016). - External debt (percent of GDP): 44.0 (2008), 58.1 (2009), 61.9 (2010), 62.0 (2011), 61.0 (2012), 60.4 (2013), 56.2 (2014), 53.4 (2015), 48.2 (2016). - External public sector debt (nominal, US$): 2,691 (2008), 3,382 (2009), 3,937 (2010), 4,506 (2011), 4,606 (2012), 4,840 (2013), 4,802 (2014), 4,880 (2015), 5,080 (2016). - External public debt (percent of GDP): 20.9 (2008), 31.4 (2009), 34.1 (2010), 35.1 (2011), 34.2 (2012), 34.7 (2013), 33.1 (2014), 32.3 (2015), 31.8 (2016). ### Debt sustainability analysis (highlights) - External debt-to-exports ratio (in percent): 115.1 (2006), 123.7 (2007), 153.6 (2008), 195.0 (2009), 176.1 (2010), 167.9 (2011), 160.1 (2012), 154.1 (2013), 139.3 (2014), 128.3 (2015), 112.5 (2016). - Gross external financing need (in billions of US$): 1.5 (2006), 2.7 (2007), 3.9 (2008), 2.7 (2009), 2.4 (2010), 3.0 (2011), 3.4 (2012), 3.8 (2013), 2.8 (2014), 2.5 (2015), 2.3 (2016). - Baseline: External debt (percent of GDP): 37.8 (2006), 38.5 (2007), 44.0 (2008), 58.1 (2009), 61.9 (2010), 63.7 (2011), 63.6 (2012), 62.6 (2013), 58.0 (2014), 55.1 (2015), 49.2 (2016). - Public sector debt (percent of GDP): 27.3 (2006), 21.5 (2007), 27.6 (2008), 37.3 (2009), 39.5 (2010), 41.1 (2011), 40.5 (2012), 40.8 (2013), 39.0 (2014), 37.9 (2015), 36.9 (2016). - Debt-stabilizing primary balance (percent of GDP) for public sector debt: -0.9. ### Financial flows and balance of payments (summary) - Trade balance (in millions of US$): -3,833 (2008), -2,399 (2009), -2,566 (2010), -3,048 (2011), -3,084 (2012), -3,063 (2013), -2,961 (2014), -2,972 (2015), -3,100 (2016). - Net imports of oil (in US$): 762 (2008), 555 (2009), 642 (2010), 780 (2011), 820 (2012), 849 (2013), 874 (2014), 898 (2015), 940 (2016). - Financial account (in millions of US$): 2,784 (2008), 1,428 (2009), 824 (2010), 1,773 (2011), 1,517 (2012), 1,662 (2013), 1,402 (2014), 1,357 (2015), 1,029 (2016). - Direct investment (net): 1,494 (2008), 659 (2009), 575 (2010), 706 (2011), 809 (2012), 837 (2013), 869 (2014), 908 (2015), 960 (2016). - Net capital inflows to private sector (in percent of GDP): 16.4 (2008), 7.4 (2009), 4.3 (2010), 11.2 (2011), 9.1 (2012), 7.8 (2013), 7.9 (2014), 7.4 (2015), 5.1 (2016). ### Key challenges, risks, and policy directions (extracted) - Risks identified: fiscal consolidation needs; greater exchange rate flexibility; enhanced effectiveness of monetary policy. - Policy suggestions and conditional engagements: - Fiscal consolidation to improve the overall balance (overall balance improving from -9.2 percent of GDP in 2011 to -1.3 percent in 2016 in projections). - Continued external financing and privatization receipts supported fiscal adjustment; privatization receipts decline in projections to 0 by 2016. - Monetary policy and reserve management to support exchange rate flexibility while maintaining reserve adequacy (reserves projected around 2,590–2,902 million US$ and reserves in months of imports around 3.6–4.5 across projections). - Financial sector vigilance: address elevated nonperforming loans (peaked around 18.8 percent in 2011 Sep. under national definition) and high share of FX loans (~mid-70s percent), and support de-dollarisation efforts noted elsewhere in the Annexes. - Programmatic context: - The report documents relations with the Fund including Stand-By Arrangement (SBA) with purchases and an ongoing expected Article IV consultation in accordance with Decision No. 14747-(10/96), 9/28/2010, as amended. - IMF and other multilateral engagement (World Bank, EBRD) support infrastructure, financial sector stabilization, and technical assistance (TA) on fiscal, monetary, and payment systems noted in mission tables and annexes. *Source: INTERNATIONAL MONETARY FUND — GEORGIA: Staff Report for the 2011 Article IV Consultation — Informational Annex (Prepared by the Middle East and Central Asia Department, March 7, 2011).* ### 1. Exchange Rate Flexibility ........................................................................................... ### 1. Exchange Rate Flexibility ### I. Introduction - This Ex Post Assessment (EPA) Update reviews Georgia’s performance under two Fund-supported programs between 2004 and 2010: - 2004–07 Poverty Reduction and Growth Facility (PRGF): total access of SDR 206 million or 147.5 percent of quota. - 2008 Stand-By Arrangement (SBA): total access of SDR 747 million or 497 percent of quota (expires in June 2011). - The 2003 EPA (Country Report No. 04/26) concluded that progress during 1996–2003 fell short of expectations due to pervasiveness of corruption, political fragmentation, and low institutional capacity. - Since 2004, Georgia experienced radical political and economic changes after the Rose Revolution of November 2003, with ambitious reforms during 2004–07, severe shocks in 2008–09 (conflict with Russia and the global crisis), and recovery beginning in late-2009 and accelerating in 2010. ### II. Macroeconomic Developments: From Fast Growth to Recession - Growth dynamics (2004–07): - Real GDP grew at an average rate of 9 percent, reaching a peak of 12.3 percent in 2007. - Growth driven mainly by large foreign capital inflows, in particular FDI, and privatization. - Homegrown structural reforms facilitated transition to a market-based economy and fostered capital inflows. - Emerging macroeconomic challenges prior to the double shock: - Inflation: picked up in early 2005, remaining just below 10 percent throughout the period. - Fiscal: revenue-to-GDP ratio increased by more than 10 percentage points in four years; expenditure arrears eliminated, but difficulties containing expenditures favored a procyclical fiscal stance. Procyclicality continued in 2008, with the fiscal deficit partly financed by issuance of a Eurobond to be repaid in 2013. - External imbalances: widening current account deficit; central bank accumulated foreign exchange reserves rapidly to contain lari real appreciation pressures. Despite stable nominal effective exchange rate, the real rate appreciated by about 30 percent over the period due to relatively high inflation. - Monetary/exchange rate policy: large accumulation of international reserves only partially sterilized, contributing to expansion of monetary and credit aggregates; reserve requirements and policy rate increases did not contain aggregate expansion. - Financial sector vulnerabilities: banks tapped external wholesale funding; exposure to currency-induced credit risk and real estate prices increased; financial dollarization declined on lari appreciation and tax collection in lari but remained high; capitalization, liquidity, and provisioning were generally strong though two major banks were temporarily undercapitalized in 2006 and several banks experienced liquidity shortages in the first half of 2008. - Capital inflows and reserves: - Large external private capital inflows financed the widening current account deficit during 2004–07. - Gross international reserves increased fivefold from 2004 to 2007 (series plotted in millions of USD). - Real effective exchange rate (REER) appreciated significantly during 2004–07 (Index, 2000 = 100). - Monetary aggregates (private credit, broad money) grew rapidly during 2004–07 (12-month growth rates, in percent). ### III. The 2008–09 Dual Shock and Its Effects - Sequence and impact: - August 2008 conflict with Russia followed by the global crisis led to large decline in international reserves and a substantial balance of payments financing gap, including banks’ high repayment obligations in early-2009. - The financing gap was closed by Fund support and substantial loans and grants from official creditors and donors. - Donors pledged $4.5 billion of financial assistance over 2008–11. - Output and inflation: - Decline in output in 2009 was 3.8 percent. - Average inflation fell below 2 percent in 2009 reflecting lower world commodity prices and depressed domestic demand. - Current account and fiscal: - Current account deficit ballooned to 22.7 percent of GDP in 2008, then improved in 2009. - Fiscal deficit increased significantly in 2008 and further in 2009—to 9.2 percent of GDP—owing to tax revenue shortfalls. - Expenditure composition shifted from defense toward conflict-related reconstruction and social spending. - Monetary and exchange rate responses: - Immediately after the conflict, the National Bank of Georgia (NBG) pegged the lari to the U.S. dollar to stabilize it. - As pressures mounted and reserve losses increased, the NBG allowed the exchange rate to depreciate substantially and moved gradually to a more flexible exchange rate regime (see Box 1). - Large policy rate cuts from mid-2008 to end-2009 had limited impact on deposit and lending rates; credit continued to contract. - Limits on loan-to-deposit ratios, elevated credit and funding risks, and worsening bank balance sheets constrained the effectiveness of monetary stimulus. - Banking sector resilience: - Banking sector weathered crises relatively well, aided by regulatory easing and large liquidity injections. - Systemic risks abated and lending resumed since early-2010. - Banks’ balance sheets cushioned by ample capital and provisioning, but elevated NPLs and large exposure to currency-induced credit risk remain important vulnerabilities. - Deposit and credit dollarization ratios, which shot up during the conflict, have been declining recently but continue to be high. - Authorities are reinforcing prudential regulations by tightening prudential norms toward precrisis levels. ### IV. Recovery and Policy Stance in 2010 - Growth and inflation: - Recovery began in last quarter of 2009 and accelerated in first half of 2010. - Output growth in 2010 estimated at 6.3 percent, in line with growth in the region. - Inflation surged to around 10 percent in 2010, owing to rising food prices. - External and fiscal positions: - Current account deficit narrowed but remained high at about 10 percent of GDP. - Fiscal consolidation started in mid-2010, consisting mostly of expenditure compression, though overall spending was higher than originally budgeted as revenue windfalls were allocated to higher spending in mid-year. - Monetary policy and exchange rate developments: - Monetary policy tightening started in June 2010 in response to initial lari depreciation and recent inflationary pressures. - In the second half of 2010, facing lari appreciation pressures, the NBG purchased dollars to reverse the crisis-induced decline in international reserves. - After a period of limited intervention from mid-2009 to early-2010, the authorities intervened heavily in mid-2010 as depreciation pressures reemerged amid municipal election uncertainty and expansionary policies. ### V. Box 1 — Exchange Rate Flexibility: Findings on Regime and Practice - 2005–07: foreign exchange reserves increased rapidly to contain real exchange rate pressures from large capital inflows; tensions arose between NBG objectives of maintaining external purchasing power of the lari and ensuring price stability. - March 2008: NBG declared price stability as main monetary objective. - Immediately after August 2008 conflict: NBG pegged the lari to the U.S. dollar to stabilize it; as pressures mounted and reserve losses increased, the peg was abandoned and the exchange rate depreciated. - In October 2008, NBG lost about 20 percent of reserves over a three-week period attempting to contain depreciation pressures. - The exchange rate depreciated by 16 percent in the first ten days of November 2008 after abandoning the peg. - From March 2009: - A multiple-price foreign exchange auction system was adopted and direct intervention in the interbank market was phased out by end-May 2009. - Auctions improved foreign exchange market functioning and enhanced exchange rate flexibility; NBG’s share in total foreign exchange market turnover declined. - Auction frequency reduced gradually from three a week to two and later to infrequent (ad-hoc) interventions. - Mid-2010: as pressures reemerged, heavy intervention resumed, resulting in significant reserve losses. The Exchange Market Pressure Index and FX market turnover series show stronger NBG interventions coinciding with renewed depreciation pressures. ### VI. Key Quantitative Findings and Indicators (as reported) - PRGF total access: SDR 206 million or 147.5 percent of quota. - SBA total access: SDR 747 million or 497 percent of quota. - Real GDP growth: - Average 2004–07: 9 percent. - Peak 2007: 12.3 percent. - 2009 decline: 3.8 percent. - 2010 estimated growth: 6.3 percent. - Inflation: - Just below 10 percent during 2005–07. - Average inflation fell below 2 percent in 2009. - Inflation surged to around 10 percent in 2010. - Current account: - 2008 peak: 22.7 percent of GDP. - 2010 level: about 10 percent of GDP. - Fiscal balance: - 2009 fiscal deficit: 9.2 percent of GDP. - Reserve and exchange rate movements: - REER appreciated by about 30 percent over 2004–07. - In October 2008, NBG lost about 20 percent of reserves over a three-week period. - Exchange rate depreciated by 16 percent in the first ten days of November 2008. - Gross international reserves increased fivefold from 2004 to 2007. - Donor pledges: $4.5 billion over 2008–11. *Source: Ex Post Assessment Update of Georgia’s performance under the 2004–07 PRGF and the 2008 SBA, 2004–2010 (EPA Update text).* ### 12. However, market confidence has ### _cr1187 - 12. However, market confidence has ### Market confidence, FDI, and capital flows - Market confidence has not been fully restored, and FDI inflows are yet to rebound. - The recovery of FDI inflows has been slower than initially anticipated. - Banking sector outflows have reflected mostly debt prepayments. - Inflows to nonfinancial corporates have been strong, mostly due to the July Eurobond issued by the Georgian Railways. - The program assumed a strong recovery of FDI inflows, which has not materialized as projected. - Shortfalls in capital inflows were to be met by faster exchange rate adjustment; the exchange rate has depreciated during the program period. - Reserves were used to counter exchange rate pressures in early 2009 and again in mid–2010. - Additional exchange rate adjustment could have been desirable against the risk of permanently lower FDI. ### Structural reform progress (transition to a market-based economy) - During 2004–07, structural reforms modernized the economy, producing a more efficient public sector and an environment more conducive to entrepreneurship. - Since 2008, reform priorities shifted toward enhancing the effectiveness and flexibility of macroeconomic policies to restore macroeconomic stability and investor confidence and to strengthen the financial sector. - Reforms implemented since 2004 included: - Forceful measures to fight corruption. - Civil service reform with drastic reductions in public employment. - Restoration of financial and technical viability of the electricity sector. - Simplification of regulations to facilitate business activity. - An ambitious privatization program launched in 2004. - Revenue collection increased beyond expectations. The 2003 EPA indicated potential for revenue-to-GDP to increase by 4 percentage points over five years; the tax-to-GDP ratio increase was almost twice higher than expected due to reorganization of revenue administration and streamlining of tax policy. ### Anti-corruption outcomes - 2003 Transparency International Corruption Perception Index: Georgia scored 124 out of 133. - 2010 Transparency International survey: Georgia ranked 68 out of 178 countries in its Corruption Perception Index. - 2010 Global Corruption Barometer: 77 percent of Tbilisi’s residents feel the Georgian government has been effective in fighting corruption (highest percentage among the 86 countries surveyed). - 2008 World Bank Enterprise Survey: Georgian firms face less corruption than firms in the region; the Incidence of Graft Index is below the European and Central Asian region’s average. ### Monetary and financial sector reforms and gaps - Progress in monetary and financial areas during 2004–07 was uneven. - Advances included improved banking supervision through new regulations and staff training. - Several important 2001 FSAP recommendations remained unimplemented at the end of the PRGF (notably inadequate assessment and supervision of credit concentration and connected lending; limited supervisory powers related to governance). - Reforms to enhance monetary policy focused on strengthening the independence of the NBG and increasing effectiveness and transparency of monetary policy. - Since 2008, significant progress was achieved in public expenditure management, banking supervision, and exchange rate and liquidity management. ### Tax policy, fiscal flexibility, and social protection - Some tax policy initiatives were ill-timed; proposed tax cuts on income and dividends were implemented during the crisis, aggravating the 2009 tax shortfall. - Late-2009 proposal (Economic Freedom Act) to require referendum for any increase in rates or base of existing taxes and to prohibit progressive taxes would have rigidified the budget; scope was ultimately limited and an escape clause was introduced, with triggers to be specified through separate legislation in 2011. - During the SBA, the government increased social benefits to support the poor. - World Bank estimates (noted in the source): poverty headcount may have increased from 23.7 percent in 2007 to 27.1 in 2009. - Minimum pension: raised to $35 per month in 2007, from $7 in 2003. - Poverty remained entrenched in rural areas, which benefitted only marginally from rapid economic growth. ### PRGF (2004–07) — objectives, design, performance, and lessons - PRGF objectives: tackle corruption and governance issues, boost tax collections, streamline government operations, reform the civil service, and create a business-friendly environment. - Conditionality was frontloaded and concentrated in the fiscal area (tax and customs collections, arrears clearance, social and infrastructure spending). - Quantitative performance criteria (PCs) were almost always met, often by wide margins; structural PCs and benchmarks were implemented though often with delay. - Program outcomes: helped boost economic growth, fight corruption, strengthen revenue performance, and improve governance and the business environment. - Areas for stronger program focus in later years: - Address overheating and increasing banking sector vulnerabilities earlier. - Adopt a more prudent fiscal stance and more effective expenditure control. - Strengthen monetary policy effectiveness. - Redirect conditionality toward strengthening banking prudential regulation. - Lack of reliable monitoring indicators limited assessment of poverty reduction progress. ### SBA (2008–11) — objectives, design, performance, and lessons - SBA aim: provide significant resources to replenish international reserves and help restore investor confidence after the August 2008 conflict-induced crisis. - Facility choice: SBA preferred over PRGF because of larger access needs and expectation of short-term BOP needs; PRGF/PRS requirements would have delayed support. - Program initially focused on stabilizing the macroeconomic situation and supporting domestic demand, with quarterly reviews; conditionality emphasized countercyclical fiscal response, protecting reserves, and strengthening the banking sector. - Since mid-2009 program focus shifted toward consolidation and preparing an exit strategy; in the third review the program was extended through mid-2011 and augmented by about 180 percent of quota to support faster reserve accumulation. - Performance in 2008–10 was broadly satisfactory, but slippages occurred in fiscal and exchange rate areas: - The peg adopted immediately after the conflict was defended longer than intended, becoming unsustainable at a large reserve cost. - Quantitative PCs were met in most reviews; the NIR target for end-June 2010 was missed because of foreign exchange market pressures due to municipal elections. - PCs on fiscal deficit were frequently modified to allow automatic stabilizers and countercyclical spending. - April 2010 budget supplement allocated most additional revenues from higher growth to new spending, against previous Fund advice. - A new PC on government spending was introduced at the sixth review to contain supplementary spending revisions. - Monetary policy effectiveness remained weak, though traction gained since April 2010 in moving toward inflation targeting. - Net international reserves (excluding Fund support) had yet to reach precrisis levels, a main objective of the SBA. - Collaboration with official creditors and donors (World Bank, EBRD) was close. - The large budget financing by the Fund may have reduced incentives for faster adjustment; fiscal consolidation in 2010 could have been more ambitious. ### Challenges, risks ahead, and implications for future Fund engagement - Main challenge: prepare for high debt obligations coming due in 2012–13. - Main risk: failure of FDI to rebound. - Policy strategy recommended: fiscal consolidation and increased exchange rate flexibility, combined with enhanced effectiveness of monetary policy. - A successor arrangement with the Fund can help anchor confidence and guide design and implementation of the required policy strategy. *Source: _cr1187 - 12. However, market confidence has* ### 31. The country is well positioned to refinance its large debt repayments due in ### The country is well positioned to refinance its large debt repayments due in 2012–13, but rollover risks cannot be ruled out. ### Debt rollover risks and financing outlook - Solvency risks on the sovereign debt appear manageable, as reflected in the DSA. - Debt repayment obligations in 2012–13 are described as high. - Georgia’s ongoing recovery and rating upgrades should facilitate rollover. - Potential adverse spillovers noted: - Instability in the Euro zone and Middle East. - Sluggish rebound in investor confidence, evidenced by the slow return of capital inflows. - Market evidence: the state-owned Georgian Railways issued a Eurobond in July 2010 with a yield considerably higher than similarly-rated sovereign Eurobonds. ### Main macroeconomic risk and policy implications - Principal risk: protracted low capital inflows. - If capital inflows do not rebound: - Policy adjustment would need to be stronger than currently planned. - Required measures would include larger fiscal consolidation to preserve debt sustainability and exchange rate adjustment to its equilibrium level. - Need to refocus growth strategy to promote domestically-originated growth and export diversification, including expansion in: - Tourism (where progress has been made). - Transportation (where progress has been made). - Agriculture (where little action has been taken). - If capital flows rebound massively: - Develop strategies to manage inflows while avoiding overheating. - Recommended tools: enhanced exchange rate flexibility, improved monetary policy efficiency, and regulatory measures to discourage short-term capital inflows ("hot money"). ### Fiscal consolidation: findings and recommendations - Pursuing fiscal consolidation is crucial given elevated risks. - A successful adjustment could be based on reduced spending, consistent with authorities’ strategy. - Constraints: reduced room for further expenditure cuts, inflation pressures, and electoral pressures. - Recommendation: enhance credibility of adjustment through introduction of new tax measures; preserve ability to rapidly adopt revenue measures for lasting consolidation. - Increase budget flexibility to create fiscal space for pro-growth and poverty-reduction spending. ### Exchange rate flexibility and international reserves - Fiscal consolidation should be complemented by: - Enhancing exchange rate flexibility by limiting foreign exchange intervention to smoothing extreme volatility. - Building up international reserves. - Rationale: - International reserve buffer is on an upward trajectory but remains below its precrisis level and inadequate given high dollarization ratios. - A higher reserve buffer would enhance financial stability by strengthening NBG’s role as a lender of last resort in foreign exchange. ### Monetary policy reform and inflation targeting preparations - Preparing for a move to inflation targeting can help monetary policy gain traction. - Prerequisites to continue implementing: - Improve price statistics. - Investigate and develop the transmission mechanism from the policy rate to inflation. - Improve modeling capacity for inflation forecasting. - Introduce a strong accountability framework. - During transition: - NBG should complement policy rate changes with other instruments (e.g., changes in reserve requirements) when needed. - Gradual sustainable de-dollarization through sound policies and local currency and capital market development will enhance monetary policy effectiveness. ### Financial sector resilience and supervisory priorities - Need to further enhance banking sector resilience by: - Tightening regulation back towards precrisis levels. - Expanding the central bank’s supervisory capacity. - Conducting regular stress tests. - Reconsider merits of a deposit insurance scheme covering only lari-denominated term deposits. - Risks requiring monitoring: - Elevated NPLs. - Large exposure to currency-induced credit risk. - Recommendation: Update the 2001 FSAP in due course to assess financial sector health and remaining vulnerabilities. ### IMF engagement options and program design considerations - A successor arrangement with the Fund can guide macroeconomic policy to regain market confidence consistent with authorities’ exit strategy. - Key program objectives: - Support macroeconomic stability to anchor investor confidence and strengthen access to international financial markets. - Design and implement a sound macroeconomic framework built on more conservative FDI inflow assumptions. - Strengthen monetary policy capacity. - Address fiscal consolidation buttressed by an explicit expenditure cap to strengthen expenditure control. - Promote exchange rate flexibility and a higher international reserve buffer. - Choice of Fund facility depends on actual or potential balance of payments need; a blended arrangement is suggested because Georgia is eligible for concessional support. - Preferred near-term option: a precautionary (in absence of an actual balance of payments gap) SBA/SCF blended arrangement, offering access options of an SBA with more favorable terms than a stand-alone SBA; in this case, a PRS document would not be required and program monitoring could occur semiannually. - If risks materialize and greater policy adjustment is needed, consider a blended ECF/EFF with longer duration and more advantageous financing terms; a PRS document would not be a delaying factor since it need only be circulated to the IMF Board by the time of the second review. ### Selected macroeconomic indicators (highlights from Table 1, 2004–10) - Nominal GDP (in million lari): 9,824 (2004) 11,621 (2005) 13,790 (2006) 16,994 (2007) 19,075 (2008) 17,986 (2009) 20,566 (2010; Prel./Proj. indicated). - Real GDP growth: 5.9 (2004) 9.6 (2005) 9.4 (2006) 12.3 (2007) 2.3 (2008) -3.8 (2009) 6.3 (2010). - GDP deflator, period average: 8.4 (2004) 7.9 (2005) 8.5 (2006) 9.7 (2007) 9.7 (2008) -2.0 (2009) 7.6 (2010). - Consumer price index, period average: 5.7 (2004) 8.3 (2005) 9.2 (2006) 9.2 (2007) 10.0 (2008) 1.7 (2009) 7.1 (2010). - Consumer price index, end-of-period: 7.5 (2004) 6.2 (2005) 8.8 (2006) 11.0 (2007) 5.5 (2008) 3.0 (2009) 11.2 (2010). - GDP per capita (in US$): 1,188 (2004) 1,484 (2005) 1,765 (2006) 2,326 (2007) 2,937 (2008) 2,455 (2009) 2,629 (2010). - Investment (percent of GDP): 27.5 (2004) 28.1 (2005) 25.6 (2006) 25.7 (2007) 21.5 (2008) 15.3 (2009) 15.0 (2010). - Gross international reserves (in millions of US$): 352 (2004) 474 (2005) 881 (2006) 1,361 (2007) 1,480 (2008) 2,111 (2009) 2,263 (2010). - In months of next year's imports of goods and services: 1.3 (2004) 1.3 (2005) 1.8 (2006) 2.2 (2007) 3.4 (2008) 4.2 (2009) 3.8 (2010). - Current account balance (in millions of US$): -354 (2004) -710 (2005) -1,175 (2006) -2,010 (2007) -2,912 (2008) -1,210 (2009) -1,147 (2010). - Current account balance (in percent of GDP): -6.9 (2004) -11.1 (2005) -15.1 (2006) -19.7 (2007) -22.6 (2008) -11.2 (2009) -9.9 (2010). ### Status of key 2003 recommendations (selected) - Tax-to-GDP ratio has increased by about 10 percentage points; expenditure arrears have been cleared. - Progress in public expenditure management, but lingering difficulties to contain spending. - Active promotion of tourism, but no defined strategy for agriculture. - Shift toward concessional financing, but also increased exposure to external private capital flows. - Effectively fought corruption and improved governance and the business climate. - Civil service reform in 2004. - Audits expanded to cover all SOEs with turnover higher than $5 million in 2004. - Cost-recovery mechanism for price setting and reforms to curtail fraud in the energy sector mostly completed by 2006. - Tariff reform in 2006 reduced the number of rates from 16 to 3 and the top rates from 30 to 12 percent. - Extensive Fund technical assistance provided in fiscal, statistics, and money laundering areas. ### Structural reforms 2004–10 (selected measures and outcomes) - Governance and public sector: - Routine auditing of SOEs widened in 2004 to all SOEs with turnover higher than $5 million. - Supervisory boards and performance-based contracts appointed for SOEs. - Public tenders announced on the State Procurement Agency website. - Ambitious privatization program; 2,700 schools transformed into legal entities of public law in 2005. - Civil service and anticorruption: - Public employment reduced by 23 percent. - Police modernization; misconduct of state officials severely punished. - Tax and customs reform: - 2005 tax reform reduced number of taxes from 21 to 7. - Personal income tax replaced by a single flat rate of 12 percent and later merged with payroll tax (payroll tax rate decreased in 2009). - VAT rate reduced from 20 to 18 percent. - Customs code simplification (2007); tariff revision in 2006 reduced rates from 16 to 3 and top rates from 30 to 12 percent. - PFM and treasury reforms: - New budget code adopted in 2009 introducing program budgeting and better integrating the Basic Data and Directions (BDD) into the budget cycle. - T-bill market re-activated in 2009 and term structure extended to two years in early 2010. - Integrated PFM information system design finalized in 2009; full implementation expected in 2013–14. - Treasury accounting reforms to comply with IPSAS norms by 2020 and transition to accrual GFS 2001. - Tax administration improvements: - E-filing systems, dispute resolution office (2008), e-declaration service (2009). - New tax code merging customs and tax codes (2010). - Revenue service transformed into an independent entity (2010); customs clearance zones set up (2010). - Monetary and exchange rate reforms: - Strengthened LOLR facility; increased exchange rate flexibility via auction-based foreign exchange market. - Improved liquidity framework, re-activated standing facilities, introduced guaranteed access to refinancing loans, reformed payment system, improved reserves management. - Note: creation of the Financial Supervision Agency in 2008 and its subsequent merger into the NBG likely diverted attention from banking issues and stretched capacity. *Source: IMF staff report (excerpt)._cr1187* ### 6. Financial sector reforms. A series of measures were adopted to strengthen financial ### _cr1187 - 6. Financial sector reforms. A series of measures were adopted to strengthen financial ### Financial sector reforms (section 6) - Measures adopted to strengthen financial sector supervision: - (i) enhanced monitoring of banks, notably by re-organizing the banking supervision department, and conducting regular stress tests; - (ii) adoption of a contingent plan for dealing with crises scenarios and bank resolution; - (iii) expansion of central bank’s powers over banks under temporary administration granted through the amendment of the NBG’s organic law. ### Annex I — The Authorities’ Reaction (summary of comments) - General stance: - Authorities broadly shared the report’s conclusions and recommendations and considered the report to adequately reflect developments in Georgia during the period under review. - Views on macroeconomic developments 2004–07: - Saw widening of the current account deficit and increasing money and credit expansion as effects of permanent upward shifts in potential output and financial deepening rather than overheating. - Believed monetary policy played a crucial role in keeping inflation under control and did not agree that monetary policy was not very effective during the PRGF period. - Banking sector vulnerabilities and supervision: - Attributed increased vulnerabilities in the precrisis period mainly to the lack of a macro-prudential and forward-looking regulatory framework rather than concentration and connected lending. - Noted supervision had been concentrated on micro-prudential risks; central bank resisted pressures to ease micro-prudential requirements, which “remained conservative compared to peer countries.” - Reported recent tightening of regulation back toward precrisis levels and a gradual move toward risk-based supervision, including systemic risk considerations, macro-prudential oversight, and more forward-looking supervisory assessment. - Fiscal policy and Eurobond: - Indicated fiscal balances were targeted pre-conflict and crisis, public debt was on a downward trend in GDP terms over 2004–07. - Clarified the 2008 Eurobond was not issued to finance the fiscal budget but to establish Georgia’s benchmark in international capital markets; proceeds were safeguarded in two sovereign reserve funds. - Viewed tax policy initiatives during the fiscal stimulus as appropriate despite their permanent nature, judging countercyclical benefits to outweigh medium-term consolidation challenges. - Noted maintaining an expenditure cap would be challenging given rising food and fuel prices. - Exchange rate policy: - Emphasized commitment to exchange rate flexibility; pegged the currency briefly after August 2008 shock to maintain public confidence, abandoned the peg about two weeks later, but faced renewed limits after the end-September shock and then allowed depreciation in early November 2008. - Argued greater exchange rate flexibility before introducing the auction system in early 2009 was infeasible due to preparation time. - Considered mid-2010 exchange rate pressures transitory and interventions to contain volatility justified given high private sector dollar indebtedness; reported interventions by end-2010 were less than envisaged under the SBA-supported program and net international reserves were higher than end-year target. - Cited a post-period exchange rate assessment indicating the real effective exchange rate is overvalued by less than 10 percent versus previous findings of larger overvaluation, implying no additional adjustment was necessary during the SBA. - Legal and fiscal flexibility: - Noted the Economic Freedom Act’s referendum requirements for new taxes and rate increases can be suspended through an escape clause to be defined in a separate organic law to preserve tax policy flexibility. - Debt and growth composition: - Did not see refinancing of the 2013 Eurobond as a challenge; cited encouraging secondary market performance and confidence in favorable refinancing conditions. - Emphasized FDI is not the only growth source; tourism and energy also important contributors. ### Public Information Notice (PIN) — Executive Board conclusions (March 28, 2011) - Short-term assessment: - Economic recovery proceeding at a solid pace, with real GDP growth of above 6 percent in 2010. - Inflation rose to 13.7 percent in February (headline), while core inflation remained low. - Current account deficit narrowed to 10 percent of GDP in 2010. - Central bank reduced intervention and strengthened net international reserve position as exchange rate pressures abated. - Fiscal deficit narrowed to 6.6 percent of GDP in 2010 from 9.2 percent in 2009, driven by containment of current spending. - Central bank tightened monetary stance steadily since June 2010 in response to exchange rate pressures and rising inflation concerns. - Financial stability indicators improved: decline of non-performing loans and adequate bank capitalization and provisioning; prudential requirements restored toward pre-crisis levels. - Executive Directors’ guidance: - Short-term priority: limit impact of commodity-price shock on the most vulnerable and contain inflationary risks; welcomed increased social spending and readiness to tighten monetary policy further if needed. - Medium-term priorities: transition from recovery to durable growth via structural reforms in agriculture and targeted public investment; further reduce fiscal deficit to a sustainable level; rationalize the capital budget and preserve revenue flexibility. - Encouraged exchange rate flexibility to remain a central instrument of adjustment and increased issuance of domestic government paper to contain external debt rollover risks. - Supported progress toward inflation targeting by enhancing inflation forecasting, modeling capacity, and underlying statistics. - Welcomed strengthening of financial sector supervision and recommended continued vigilance. ### Georgia — Selected macroeconomic indicators (highlights, 2008–11) - Nominal GDP (in million lari): 19,075; 17,986; 20,566; 23,332 - Real GDP growth: 2.3; -3.8; 6.3; 5.5 - Consumer price index, period average: 10.0; 1.7; 7.1; 10.2 - Consumer price index, end-of-period: 5.5; 3.0; 11.2; 8.0 - GDP per capita (in US$): 2,937; 2,455; 2,629; 2,920 - Investment (percent of GDP): 21.5; 15.3; 15.0; 17.2 - Public: 4.3; 6.9; 7.2; 6.0 - Private: 17.2; 8.5; 7.8; 11.2 - Current account balance (in millions of US$): -2,912; -1,210; -1,147; -1,597 - Current account (in percent of GDP): -22.6; -11.2; -9.9; -12.5 - Gross international reserves (in millions of US$): 1,480; 2,111; 2,263; 2,780 - Foreign direct investment (percent of GDP): 12.2; 6.1; 5.0; 5.5 - Average exchange rate (lari per US$): 1.48; 1.67; 1.78; ... ### Statement by Georgia’s Executive Director (Mr. Bakker) — key points (March 23, 2011) - Economic developments: - After a contraction of 3.9 percent in 2009, growth in 2010 was estimated between 6.3–6.5 percent. - Budget deficit declined to 6.6 percent of GDP in 2010 (from 9.2 percent in 2009); government aims to bring the budget deficit below the 4.0 percent level in 2011. - Annual inflation reached 13.7 percent in February 2010 (headline), driven primarily by rising food prices. - Financial sector metrics (February 2011 figures reported): - Capital adequacy ratio: 16.8 percent - Liquidity ratio: 40.1 percent - NPL ratio: 5.3 percent - Policy priorities and challenges: - Improving monetary transmission en route to inflation targeting; committed to flexible exchange rate and reducing dollarization of the banking sector. - Immediate challenge: avoid second-round inflation effects while easing social conditions within fiscal framework; government distributed power and food vouchers. - Emphasis on increasing tax productivity and balancing expenditure containment with revenue-enhancing measures. - Growth drivers and external financing: - FDI in 2010 was US$ 553 million (about 5 percent of GDP). - Main future growth pillars identified: agriculture, tourism, and energy; authorities intend active state role to reform sectors and attract private investment. - Authorities expect refinancing of the 2013 Eurobond not to be challenging given encouraging secondary market performance and improved credit ratings. *Source: Excerpts from the IMF documents provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1187.pdf_