## 1. The Georgia 2020 Strategy

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### Background, program rationale, and objectives
- A two-year Fund-supported program expired in April 2014 and "managed to meet many of its objectives."
- Achievements under the previous program:
  - Current account and fiscal deficits fell.
  - Exchange rate flexibility increased.
  - Program helped catalyze official financial support.
  - Maintained macroeconomic discipline during the 2012–13 political transition.
  - Supported central bank independence.
- Implementation challenges:
  - Change of government midway made accommodating a reorientation toward higher social spending difficult within the existing fiscal framework.
  - Growth slowed and revenues fell short in 2013; the program expired without completing the last two reviews.
- Authorities’ request and program objectives:
  - Authorities requested a new three-year Stand-By Arrangement.
  - Near-term aims: boost confidence by providing a prudent and sustainable macroeconomic framework, catalyze official financial support and investment, and provide modest external financing.
  - Medium-term objective: reduce macroeconomic vulnerabilities and support sustainable and inclusive growth aligned with the Georgia 2020 socio-economic development strategy.

### Georgia 2020 Strategy — goals, pillars, and metrics
- Main goal:
  - "A sustainable growth that benefits a majority of the population."
- Core approach:
  - Private sector growth supported by a lean, efficient and transparent government; respect for property rights; openness to trade; and integration with international financial markets.
  - Reduce un- and under-employment with a focus on improving education quality; complement with a comprehensive health and social security system.
- Three pillars and sample measures:
  - Private sector competitiveness:
    - Set up Alternative Dispute Resolution Courts.
    - Revise bankruptcy legislation.
    - Strengthen intellectual property rights.
    - Reduce technical barriers to trade.
    - Develop infrastructure.
  - Human capital development:
    - Improve labor market matching.
    - Update infrastructure of schools; develop vocational training.
    - Streamline administration of targeted social assistance.
    - Introduce a uniform health procurement mechanism.
    - Strengthen primary health care.
  - Access to finance:
    - Develop capital markets.
    - Facilitate venture capital.
    - Improve access to agricultural investments.
- Targets and metrics:
  - Strategy identifies quantitative targets to be achieved by 2017 and 2020, such as the level of FDI, ranking on the Doing Business survey, Travel and Tourism ranking, PISA scores, Gini coefficient, health-care coverage, and Innovation Fund financing.
- Preconditions and commitments:
  - Preserve central bank independence.
  - Strengthen monetary policy transmission mechanisms.
  - Reduce the current account deficit.
  - Ensure a floating exchange rate.
  - Maintain fiscal sustainability.
  - Preserve financial stability.
  - Improve policy formulation and budget planning.
  - Maintain a qualified civil service.
  - Improve the tax system.
- Integration:
  - Reforms mandated by the EU-Georgia Association Agreement and DCFTA are integral to the policy agenda.

### Recent economic developments (selected facts)
- Growth and activity:
  - GDP growth fell to 3 percent in 2013 (from 6 percent in 2012).
  - Domestic activity accelerated strongly in late 2013; GDP growth reached 7 percent in the fourth quarter.
  - Latest indicators point to growth tapering off in the first quarter of 2014 as the fiscal stimulus wears off.
- Inflation and monetary policy:
  - Almost two years of price deflation ended in late 2013; inflation rose to 2½ percent by end-2013.
  - National Bank of Georgia (NBG) actions:
    - Cut its refinancing rate by a total of 150 basis points to 3.75 percent in 2013.
    - Raised its policy rate by 25 basis points to 4 percent in February (first increase since early 2011).
  - Monetary policy described as "accommodative"; nominal effective exchange rate strengthened thereafter.
- Fiscal developments:
  - Fiscal policy became procyclical in 2013, increasing macroeconomic volatility.
  - 2013 outcomes:
    - Revenues for the year were almost 2 percent of GDP less than in the approved budget.
    - The 2013 deficit increased to 2.6 percent of GDP (still below the 2.8 percent of GDP program target).
    - Wages and subsidies were 0.4 percent of GDP higher; capital spending and other items were under executed.
  - Specific operations and effects:
    - Government deposits at the central bank fell by almost GEL 240 million (0.9 percent of GDP) in December alone.
    - The central bank sold more than US$400 million in reserves (15 percent of total) to counter depreciation pressures.
    - NBG gross international reserves fell to US$2.6 billion by end-March, about US$480 million less than at end-September.
    - Repayments to the Fund amounted to US$166 million in 2013q4 and 2014q1.
- External sector and vulnerabilities:
  - Current account deficit fell from close to 12 percent of GDP in 2012 to less than 6 percent in 2013.
  - Staff estimates half of the 6 percent of GDP reduction was due to a cyclical drop in imports; remainder likely structural.
  - Net external liabilities are around 100 percent of GDP.
  - Exports to Russia "quadrupled" after the trade embargo was lifted; Russia became Georgia’s third largest export market.
  - Services balance improved, supported by tourism.
  - Remittances grew by ½ percent of GDP.
  - External funding composition: predominantly FDI and official financing; smaller share of portfolio investment.
- Financial sector and credit:
  - Credit growth recovered to reach 18 percent y/y (exchange rate adjusted) in March.
  - Household lending:
    - Household loans increased by 27 percent year-on-year in March (exchange rate adjusted).
    - Lari-denominated household loans grew by 40 percent; foreign-currency household loans grew by 5 percent.
    - Share of household loans increased from 46 percent to 50 percent.
  - Corporate lending weaker but showing increases in agriculture, industry, and hospitality.

### EU-Georgia Association Agreement and DCFTA — expected effects
- Status:
  - Association Agreement and DCFTA initialed on 29 November 2013; Association Agreement signed on June 27, 2014.
- Scope:
  - Gradual integration into the EU Internal Market; comprehensive reform agenda for approximation to EU norms.
  - Agreement contains eight Titles and 34 Annexes and enhanced cooperation across some 28 key sector policy areas.
- DCFTA specifics:
  - Complete elimination of tariff and non-tariff barriers on almost all goods and substantial liberalization of services trade (with minor exceptions).
  - Commitments on rules of origin; competition and subsidies; intellectual property; environmental, social and labor policies; food safety; technical regulation for industrial goods; public procurement; customs.
- Estimated economic gains (EU studies):
  - Exports to the EU increase by 12 percent in the long run (assumed 5–10 years after DCFTA implementation).
  - Imports from the EU increase by 7.5 percent.
  - GDP will be 4 percent higher (elsewhere in the text: increase GDP by 4.3 percent (€292 million in national income), provided all reforms are completed).
  - DCFTA expected to make Georgia more attractive for FDI.

### Outlook and key risks
- Growth projections:
  - Growth in 2014 projected to reach 5 percent, largely because of the strong base effect from the end of 2013.
  - Medium-term growth projected to average 5 percent, in line with staff’s estimate of potential growth.
  - Authorities believe potential growth is around 6 percent or higher; staff is more cautious and considers some 2013 slowdown may be permanent.
- Inflation outlook:
  - Increased economic activity and higher imported food prices expected to raise inflation towards 5 percent by the end of the year, aligning with the NBG’s 6 percent target over the medium term.
- Key risk drivers:
  - Reversal of cyclical import compression when public and private investment recover and fiscal deficit widens in 2014–15.
  - Dependence on continued capital inflows given high external liabilities.
  - Uncertain external environment in partner countries and potential spillovers.
  - Need to implement Georgia 2020 reforms and DCFTA-related reforms to achieve higher potential growth and stronger FDI inflows.

---

### Balance of payments, reserves, and external financing needs

### Reserve outlook and balance-of-payments need
- Recovery in domestic demand, driven largely by investment, is increasing imports.
- Exports and remittances are affected by tensions in Ukraine and a slowdown in key trading partners such as Russia and Turkey.
- Increased capital inflows will likely cover only part of the projected widening of the current account deficit.
- Foreign exchange intervention in early 2014 and about US$250 million in projected repayments to the Fund in 2014 imply that, without Fund financing and the donor support that this would catalyze, central bank reserves would:
  - fall below US$2.5 billion, or
  - fall to about 2.7 months of imports.
- Assessment: such reserve levels would be low, especially amid rising regional tensions that could affect market confidence.

### Program financing and planned support (2014)
- Temporary external financing gap of about US$260 million in 2014.
- Planned needs to keep reserves at US$2.7 billion imply financing need of around US$260 million.
- Planned disbursements and donor support to cover gap:
  - Planned disbursements from the Fund about US$120 million.
  - Expected donor budget support: US$90 million from the World Bank, and US$50 million from the ADB.
  - Program does not assume EU macro-financial assistance disbursements in 2014.
- Stand-By Arrangement (SBA) request:
  - SDR 100 million (about US$155 million, 67 percent of quota) financing for 2014–17.
  - SDR 80 million would be available in 2014.
  - First and second purchases under the program: SDR40 million (about US$62 million) each, to be disbursed to the Ministry of Finance.
- Arrangement design:
  - Duration: three years, monitored through six reviews (initially quarterly, then semi-annually).
  - Performance criteria: general government cash deficit, general government expenditure, cash deficit of the Partnership Fund, net international reserves of the NBG, and external arrears.
  - Indicative targets on net domestic assets of the NBG and an inflation consultation clause.
  - Structural benchmarks set through December 2015.
  - Front-loaded phasing of access reflecting 2014 financing needs and signaling nature of the program.

### Near- and medium-term external risks and contingency
- Main risks are to the downside.
- Possible adverse scenarios and channels:
  - Further escalation in the Russia-Ukraine crisis would worsen Georgia’s trade balance and inflows of remittances.
  - Armenia’s accession to the Eurasian Economic Union could reduce Georgia’s exports to Armenia (11 percent of total).
  - Lari could come under pressure if regional tensions or global financial market shocks lead to further depreciations among Georgia’s trading partners.
  - Medium-term risk: delays to growth-enhancing structural reforms, including DCFTA-related reforms.
- Proper response to further widening of external financing needs would include policy adjustment—exchange rate depreciation and fiscal tightening—and likely additional financing; access may need augmentation if higher tensions require higher reserves.

---

### Fiscal policy stance, path, and measures

### 2014–2017 fiscal path and specific measures
- 2013 deficit: 2.6 percent of GDP.
- 2014 budget:
  - Envisaged deficit widening to 3.8 percent of GDP from 2.6 percent of GDP in 2013.
  - Spending increases reflect full-year impact of pension increases (0.5 percent of GDP) and universal healthcare (0.7 percent of GDP).
  - Capital spending projected to increase by 0.6 percent of GDP, conditional on improved implementation.
- Authorities’ revised 2014 stance:
  - Agreed to limit the 2014 budget deficit to no more than 3.7 percent of GDP (LOI ¶13).
  - Measures include abolishing a preferential import VAT grace period (one-off revenue gain of around 0.2 percent of GDP) and containing capital spending.
  - Staff estimate: the 3.7 percent of GDP deficit will still generate a fiscal impulse of close to 1 percent of GDP, following an unintended fiscal contraction of roughly similar magnitude in 2013.
  - Staff advice: be ready to hold back spending if balance of payments outlook worsens; if first-half outturn is stronger than expected, undershoot the full-year target.
- 2015 target and measures:
  - Program targets a budget deficit of 3 percent of GDP in 2015, backed by pre-announced measures (LOI ¶14).
  - Revenue: preparing an increase in tobacco excises.
  - Expenditure: wages, subsidies and spending on goods and services kept constant in real terms; benefit levels kept constant in 2015; health expenditure projected constant in nominal terms between 2014 and 2015.
  - Staff cautions against regressive measures and noted risks of not increasing benefit levels in 2015.
  - Authorities to draw on FAD tax policy technical assistance for revenue measures that could also reduce inequalities.
- Medium term:
  - Aim to reduce the deficit to no more than 2½ percent of GDP by 2017.
  - This path would keep government debt comfortably below 40 percent of GDP and respect limits set by the Economic Liberty Act.
  - Strategy relies on widening the tax base, strengthening revenue administration, and containing current expenditure.
  - Authorities are considering eliminating the tax-free threshold for personal income tax; staff cautioned this would disproportionately affect low-income households.
  - Government prioritizes increasing public investment for transport and regional infrastructure, but the 30 percent of GDP expenditure limit under the Economic Liberty Act creates choices between higher investment and social spending.

### Fiscal administration, tax measures, and benchmarks
- Tax administration reforms supported by Fund technical assistance (LOI ¶26):
  - Integrate taxpayer registration by the GRS with business registration from the Ministry of Justice.
  - Abolish the Alternative Audit program and strengthen GRS audit capacity by hiring and training new staff.
  - Introduce single taxpayer accounts by June 2015 to improve monitoring and accuracy of tax payment data.
  - Increase efforts to refund the stock of excess tax credits.
- Fiscal risk management:
  - Authorities will attach a fiscal risk statement to the 2015 budget (December structural benchmark), initially with sensitivity analysis focused on revenues; later expansions to include public guarantees, state-owned enterprises and off-budget vehicles.
- Commitments (from LOI and program):
  - Ensure the general government deficit does not exceed an equivalent of 3.7 percent of GDP in 2014.
  - Maintain the budget deficit to no more than GEL 1,080 million, equivalent to 3.7 percent of GDP (performance criteria December 2014).
  - Include in the 2015 state budget a statement of fiscal risks — End-Dec 2014.
  - Approve the budget for 2015 with 3 percent of GDP deficit — End-Dec 2014.
  - Abolish the alternative tax audit program — End-April 2015.
  - Introduce a single taxpayer account system in the General Revenue Service — End-June 2015.

---

### Monetary policy framework, reserves, and de-dollarization

### Monetary policy objectives and conditionality
- NBG monetary policy objective: price stability.
  - Inflation targets: 6 percent for 2014, falling to 5 percent for 2015 and 2016.
- Program conditionality:
  - Introduce an inflation consultation clause: CPI inflation targets initially quarterly, from 2015 bi-annual with quarterly guidance targets.
  - Two consultation bands: inner band of ±2 percent (prompts consultations with staff) and outer band of ±3 percent (prompts consultation with the Executive Board).
  - Program retains an indicative target on net domestic assets (NDA) as a tripwire against excessive central bank balance sheet expansion.
- NBG actions and commitments:
  - Publish quarterly inflation reports (with press conferences) according to a fixed pre-announced schedule.
  - Use Fund technical assistance to improve inflation modeling and communication strategy.
  - Reaffirmed commitment to preserving NBG independence.

### Reserve targets and exchange rate stance
- Program target: increase gross international reserves from around US$2.5 billion at present to US$2.7 billion by end-2014.
  - US$2.7 billion would cover 3 months of 2015 imports and about 100 percent of short-term liabilities.
- Program aims to increase gross international reserves to around US$3.0 billion by end-2015 (3.1 months of 2016 imports).
- Authorities reiterated commitment to a floating exchange rate.
- NBG willingness to allow the exchange rate to depreciate:
  - Willing to allow depreciation by 7 percent against the dollar (2 percent in nominal effective terms) over December and January.
- Exchange rate assessment (Box 4 findings):
  - Average CGER-based estimates of lari’s overvaluation declined to 8 percent, compared to 15 percent at the 2013 Article IV.
  - Underlying current account deficit fell to 8.4 percent of GDP from 10.3 percent of GDP in 2013.
  - Macro-balance approach indicates real effective exchange rate would need to depreciate by about 7 percent to bring underlying current account to its norm (6.8 percent of GDP).
  - External sustainability approach points to overvaluation of about 17 percent (anchored on reducing net foreign liabilities to 60 percent of GDP).
  - Equilibrium real exchange rate approach suggests the lari is broadly in line with its equilibrium value following recent depreciation.
  - Lari depreciated by 5 percent against the US$ and 10 percent against the Euro since end-2012.

### De-dollarization measures and outcomes
- High dollarization creates depreciation-related balance sheet risks and limits NBG’s lender-of-last-resort capacity.
- Measures to promote lending in lari:
  - In 2013 the NBG relaxed collateral standards for refinancing lari loans.
  - Government placed GEL80 million in long-term deposits with commercial banks to promote long-term lending in lari, with plans to expand the scheme.
  - Regulatory rules include additional risk weighting for FX loans and higher reserve requirements on FX liabilities.
- Results:
  - Loan dollarization reduced to 60 percent in March from 67 percent a year ago.
  - Household loan dollarization fell from 43 percent to 36 percent (constant exchange rates).
  - Deposit dollarization fell from 61 percent to 57 percent (constant exchange rates).

---

### Financial sector soundness, supervision, and the Partnership Fund

### Banking sector indicators and supervision
- Banking sector metrics:
  - Capital adequacy ratio: 17 percent (13 percent for tier 1 capital).
  - Liquidity ratio: 42 percent.
  - NBG minimum requirements: 12 percent (capital), 30 percent (liquidity).
  - Bank profits rose by 16 percent in 2013 after substantial provisioning in 2012.
  - Share of consumer loans in total loans around 17 percent.
  - Foreign currency loans comprise about one-third of total household loans.
- Supervisory concerns and actions:
  - Rapid growth in floating-rate lari loans and consumer lending monitored closely.
  - New liquidity requirement for non-resident deposits if they exceed 10 percent of total deposits.
  - Result: year-on-year growth in nonresident deposit slowed to 13 percent in February; share stabilized at around 15 percent of total deposits (excluding deposits from non-resident banks).
  - NBG to introduce the liquidity coverage ratio as its core liquidity ratio; minimum required 100 percent.
  - Move towards Basel III compliance and risk-based supervision; Pillar 1 standardized approach initiated in 2013.
  - Firm-level stress tests indicate sufficient capital to absorb loan deterioration from various macro shocks.

### Institutional arrangements for AML/CFT
- Government moving the Financial Monitoring Service (FMS) from the NBG to report to the Prime Minister’s office.
  - Staff stressed importance of maintaining FMS independence and confidentiality/integrity of financial data.
  - Prime Minister gave personal commitment to protecting confidentiality and FMS independence.
  - Government agreed to seek comments from the EU Council of MONEYVAL and the Egmont Group and would amend the FMS law if needed (LOI ¶30).

### The Partnership Fund (PF) — mandate, risks, and safeguards
- PF legal form and governance:
  - PF is a Joint Stock Company (JSC) organized as a commercial financial institution.
  - Governance: investment board, risk management committee, supervisory board chaired by the Prime Minister; PF needs government approval for equity participation.
- Corporate mandate and operations:
  - Financing instruments: equity participations, senior loans, quasi-equity through subordinated convertible debt, performance bonds/guarantees.
  - Target sectors: energy, agriculture, manufacturing, and real estate.
  - PF not allowed to finance the service industry; will charge market rates.
- Project participation preconditions:
  - PF will only participate in projects where a corporate investor takes at least 51 percent of the project’s total equity.
  - PF financing (debt plus equity plus guarantees) will not exceed 100 percent of the equity of the private partner.
- Reporting and audit:
  - Semi-annual IFRS audits by an internationally recognized auditing company.
  - Regular ratings reports from rating agencies; audited financial statements and ratings reports publicly available.
- Fiscal risk considerations:
  - PF projects do not create contingent sovereign liabilities; liabilities limited to PF balance sheet.
  - PF may borrow on its own balance sheet without state guarantee.
- Staff cautions:
  - Staff expressed concerns about creating a new state financial institution given recent credit growth and recommended studying existing public funds and consolidation before establishing a new institution (LOI ¶31).
  - Staff recommended transferring state enterprises from the Partnership Fund back to government and financing PF operations with greater transparency.

---

### Debt sustainability, stress tests, and vulnerabilities

### Public debt and external debt outlook
- Public debt is projected to remain low at around 30 percent of GDP.
- External debt projected to decrease gradually to less than 60 percent of GDP (Annex 1).
- High share of foreign currency denominated debt: about 84 percent of total public debt in 2013.
- Exchange rate vulnerability example:
  - A 30 percent real depreciation would increase the stock of external debt to about 85 percent of GDP and the total stock of public debt by 8 percent of GDP.
- Debt projections (selected Table 1/Annex I values):
  - Public gross debt series (2012–2019 selected): 31.0, 30.0, 32.2, 33.9, 33.6, 33.1, 32.3, 31.7, 31.1
  - Public debt (percent of GDP): 2014 30.0; 2015 32.2; 2016 33.9; 2017 33.6; 2018 33.1; 2019 32.3

### Stress tests and scenario outcomes (selected)
- General finding: macro shocks do not substantially jeopardize public debt sustainability except under sizable growth shocks or multiple simultaneous shocks.
- Specific outcomes:
  - A 5 percent real exchange rate shock leaves the public debt profile unaffected.
  - A real interest rate shock only marginally affects the public debt profile.
  - A shock to the primary balance of about 3 percent of GDP increases debt on impact but the debt stock stabilizes at around 32 percent of GDP in 2019.
  - A one percent reduction in real GDP growth causes the debt-to-GDP ratio to increase to 40 percent of GDP in 2016 and then gradually decline to about 36 percent of GDP in 2019.
  - When all macro shocks considered simultaneously the debt-to-GDP ratio increases to 45 percent of GDP in 2016 and stabilizes thereafter.
  - Debt-related stress tests show vulnerability to large depreciation: 30% depreciation shock raises external debt-to-GDP to about 85 percent in the illustrated shock.

### External vulnerability metrics (selected series)
- Current account balance (percent of GDP): 2014 -11.7; 2015 -5.9; 2016 -8.4; 2017 -7.9; 2018 -6.9; 2019 -6.3
- Gross international reserves (in millions of USD): 2014 2,873; 2015 2,823; 2016 2,701; 2017 2,979; 2018 3,434; 2019 3,763
- Reserves in months of next year's imports: 2014 3.7; 2015 3.3; 2016 3.0; 2017 3.1; 2018 3.4; 2019 3.5
- Gross external financing need (in billions of US dollars): 2014 -1,854 (current account in Table 3 format); (Table 3 projections list gross external financing needs around $4.0–4.5 billion across 2014–2019 in Annex)

### Key debt-related policy recommendations
- Deliver greater exchange rate flexibility, fiscal consolidation, and structural reforms to strengthen competitiveness and lower net foreign liabilities to a sustainable level (about 60 percent of GDP).
- Maintain adequate reserves, using timely foreign currency purchases to build reserves in line with the program’s NIR path.
- Prepare a debt management strategy accounting for public and private external obligations and upcoming Eurobond maturities (two US$250 million Eurobonds maturing in 2017 assumed rolled over in staff baseline; US$1 billion in sovereign and state enterprise Eurobonds mature in 2021–22).
- Complete an updated safeguards assessment of the NBG by the first review under the SBA.

---

### Program monitoring, conditionality, and structural reform agenda

### Program monitoring framework and schedule
- Monitoring instruments:
  - Quantitative performance criteria (PC)
  - Indicative targets (IT)
  - Structural benchmarks (SB)
  - An inflation consultation clause (described in the TMU)
- Test dates and review timing:
  - Reviews based on end-September and end-December 2014 test dates and semi-annually thereafter (end-June and end-December).
  - First and second reviews expected after November 15, 2014 and February 15, 2015, respectively.
- Performance criteria (examples and targets as presented):
  - Ceiling on the General Government cash deficit (in mn lari) 810 / 1,080 (end-September / end-December)
  - In Percent of GDP 2.8 / 3.7 (end-September / end-December)
  - Ceiling on Expenditures of the General Government - 9,012 (end-December)
  - Floor on NIR of NBG (End-period stock, in mn USD) 1,510 / 1,520 (end-September / end-December)
  - Indicative target on NDA of NBG (End-period stock, in mn lari) 450 / 600 (end-September / end-December)
- Structural benchmarks (selected and dated):
  - With the support of the World Bank, conduct a thorough assessment of credit market imperfections — End-Sep 2014.
  - Include in the 2015 state budget a statement of fiscal risks — End-Dec 2014.
  - Approve the budget for 2015 with 3 percent of GDP deficit — End-Dec 2014.
  - Abolish the alternative tax audit program — End-April 2015.
  - Introduce a single taxpayer account system in the General Revenue Service — End-June 2015.
  - Consolidate LEPLs in the 2014 government financial statements — End-June 2015.
  - Publish GDP by expenditure in constant prices — End-Dec 2015.

### Technical Memorandum of Understanding (TMU) — definitions and reporting
- Program exchange rates (Table 1):
  - SDR Special Drawing Rights 0.65
  - GEL Georgian Lari 1.75
  - EUR Euro 0.73
- Key TMU definitions and reporting requirements (selected):
  - General government definition: central and local governments, excluding LEPLs; includes any new funds or extra-budgetary entities of a fiscal nature (GFSM 2001 definition).
  - Ceiling on the Cash Deficit of the General Government: cash deficit measured from financing side at current exchange rates; components and reporting timelines specified in TMU paragraphs 8–12.
  - Floor on NIR of the NBG: NIR in U.S. dollars = foreign assets of the NBG minus foreign liabilities of the NBG, including all of Georgia’s liabilities to the IMF; stock of NIR amounted to US$1,452 million as of March 31, 2014 (at program exchange rates).
  - NDA definition and ceiling; supporting material and adjustors described.
  - Continuous PC on accumulation of general government external arrears; reporting timelines specified.
  - Data frequency and timeliness: weekly NIR, monthly revenue/expenditure components, quarterly debt and cash balances, etc., with specific deadlines in TMU paragraphs 12, 14, 21, 24, 27.

### Structural reform priorities under the program
- Macro-critical reforms targeted in the SBA:
  - Tax administration modernization (increase GRS audit staffing from 230 to 350 during 2015; eliminate alternative audit by April 2015; introduce single taxpayer accounts by June 2015).
  - Public financial management reforms (Treasury Single Account coverage, fiscal risk statement, broaden fiscal accounts).
  - National statistics improvements (revise Law on Statistics by December 2014; publish GDP by expenditure in constant prices by End-Dec 2015).
- Other reform areas:
  - Improve business environment and competition, strengthen property rights, develop commercial dispute resolution mechanisms, streamline bankruptcy procedures.
  - Improve workers’ skills, vocational training, and labor market matching; establish System of Labour Mediation in 2014.
  - Implement DCFTA-related approximation of EU sanitary, phytosanitary and technical regulations by end-2015 planning and gap analysis.
  - Conduct an assessment of access to finance for enterprises (structural benchmark for September 2014).
- Social and human capital measures:
  - Improve access to education, update school infrastructure, develop VET aligned with labor market needs, strengthen public-private partnerships for VET.
  - Streamline administration of targeted social assistance and sustain basic package of current universal health coverage.

---

*Source: IMF staff report excerpts — content unit _cr14250.*

### 1. The Georgia 2020 Strategy  ______________________________________________________________________5

### 1. The Georgia 2020 Strategy

### Background and performance under the previous program
- A two-year Fund-supported program expired in April 2014 and "managed to meet many of its objectives."
- Achievements under the program:
  - Current account and fiscal deficits fell.
  - Exchange rate flexibility increased.
  - Program helped catalyze official financial support.
  - Maintained macroeconomic discipline during the 2012–13 political transition.
  - Supported central bank independence.
- Implementation challenges:
  - When the government changed midway through the program it was difficult to accommodate the new government’s reorientation toward higher social spending within the program’s existing fiscal framework.
  - Growth slowed and revenues fell short in 2013; the program expired without completing the last two reviews.
- Remaining vulnerabilities and needs:
  - High underlying current account deficit and external debt leave Georgia dependent on continued capital inflows.
  - Uncertain environment in partner countries has worsened the balance of payments outlook and created new risks.
  - Recent strong growth owed to large productivity gains from mid-2000s reforms; sustaining those gains requires further reforms to create a more competitive and diversified emerging market economy with strong trade links with the region and the EU.
  - Growth needs to become more inclusive as unemployment and poverty remain high.
- Authorities’ request and program objectives:
  - Authorities requested a new three-year Stand-By Arrangement.
  - Near-term aims: boost confidence by providing a prudent and sustainable macroeconomic framework, catalyze official financial support and investment, and provide modest external financing.
  - Medium-term objective: reduce macroeconomic vulnerabilities and support sustainable and inclusive growth aligned with the Georgia 2020 socio-economic development strategy.

### The Georgia 2020 Strategy (Box 1)
- Main goal:
  - "A sustainable growth that benefits a majority of the population."
- Core approach:
  - Private sector growth supported by a lean, efficient and transparent government; respect for property rights; openness to trade; and integration with international financial markets.
  - Reduce un- and under-employment with a focus on improving education quality; complement with a comprehensive health and social security system.
- Three pillars and sample measures:
  - Private sector competitiveness:
    - Set up Alternative Dispute Resolution Courts.
    - Revise bankruptcy legislation.
    - Strengthen intellectual property rights.
    - Reduce technical barriers to trade.
    - Develop infrastructure.
  - Human capital development:
    - Improve labor market matching.
    - Update infrastructure of schools; develop vocational training.
    - Streamline administration of targeted social assistance.
    - Introduce a uniform health procurement mechanism.
    - Strengthen primary health care.
  - Access to finance:
    - Develop capital markets.
    - Facilitate venture capital.
    - Improve access to agricultural investments.
- Targets and metrics:
  - Strategy identifies quantitative targets to be achieved by 2017 and 2020, such as the level of FDI, ranking on the Doing Business survey, Travel and Tourism ranking, PISA scores, Gini coefficient, health-care coverage, and Innovation Fund financing.
- Preconditions and commitments to achieve the strategy:
  - Preserve central bank independence.
  - Strengthen monetary policy transmission mechanisms.
  - Reduce the current account deficit.
  - Ensure a floating exchange rate.
  - Maintain fiscal sustainability.
  - Preserve financial stability.
  - Improve policy formulation and budget planning.
  - Maintain a qualified civil service.
  - Improve the tax system.
- Integration objectives:
  - Political and economic integration recognized as a cornerstone; reforms mandated by the EU-Georgia Association Agreement and DCFTA are integral to the policy agenda.

### Recent economic developments
- Growth and activity:
  - GDP growth fell to 3 percent in 2013 (from 6 percent in 2012).
  - Domestic activity accelerated strongly in late 2013; GDP growth reached 7 percent in the fourth quarter.
  - Latest indicators point to growth tapering off in the first quarter of 2014 as the fiscal stimulus wears off.
- Inflation and monetary policy:
  - Almost two years of price deflation ended in late 2013; inflation rose to 2½ percent by end-2013.
  - National Bank of Georgia (NBG) actions:
    - Cut its refinancing rate by a total of 150 basis points to 3.75 percent in 2013.
    - Raised its policy rate by 25 basis points to 4 percent in February (first increase since early 2011).
  - Monetary policy described as "accommodative"; nominal effective exchange rate strengthened thereafter.
- Fiscal developments:
  - Fiscal policy became procyclical in 2013, increasing macroeconomic volatility.
  - 2013 fiscal outcomes:
    - Revenues for the year were almost 2 percent of GDP less than in the approved budget.
    - The 2013 deficit increased to 2.6 percent of GDP (still below the 2.8 percent of GDP program target).
    - Composition of spending: wages and subsidies were 0.4 percent of GDP higher; capital spending and other items were under executed.
  - Specific fiscal operations and effects:
    - The sudden fiscal expansion in December 2013 was largely financed by drawing down government deposits at the central bank, which fell by almost GEL 240 million (0.9 percent of GDP) in December alone.
    - The central bank sold more than US$400 million in reserves (15 percent of total) to counter depreciation pressures.
    - NBG gross international reserves fell to US$2.6 billion by end-March, about US$480 million less than at end-September.
    - Repayments to the Fund amounted to US$166 million in 2013q4 and 2014q1.
- External sector and vulnerabilities:
  - Current account deficit:
    - Fell from close to 12 percent of GDP in 2012 to less than 6 percent in 2013.
    - Staff estimates half of the 6 percent of GDP reduction was due to a cyclical drop in imports; remainder likely to persist due to structural improvements.
  - Net external liabilities are around 100 percent of GDP.
  - Exports and remittances:
    - Exports to Russia "quadrupled" after the trade embargo was lifted; Russia became Georgia’s third largest export market.
    - Services balance improved, supported by tourism.
    - Remittances grew by ½ percent of GDP.
  - External funding composition: predominantly FDI and official financing; smaller share of portfolio investment.
- Financial sector and credit:
  - Credit growth recovered to reach 18 percent y/y (exchange rate adjusted) in March.
  - Household lending dynamics:
    - Household loans increased by 27 percent year-on-year in March (exchange rate adjusted).
    - Lari-denominated household loans grew by 40 percent; foreign-currency household loans grew by 5 percent.
    - Share of household loans increased from 46 percent to 50 percent.
  - Corporate lending weaker but showing increases in agriculture, industry, and hospitality.

### EU-Georgia Association Agreement (Box 2) — implications
- Agreement status:
  - Association Agreement and DCFTA initialed on 29 November 2013; Association Agreement signed on June 27, 2014.
- Scope and content:
  - Association Agreement aims at gradual integration into the EU Internal Market and includes comprehensive reform agenda for approximation to EU norms.
  - Agreement contains eight Titles and 34 Annexes laying down relevant EU legislation to be adopted by specific dates.
  - Enhanced cooperation across some 28 key sector policy areas (economic dialogue; public finances; taxation; transport; energy; environment; industrial policy; financial services; agriculture; education; and more).
- DCFTA specifics:
  - Complete elimination of tariff and non-tariff barriers on almost all goods and substantial liberalization of services trade (with minor exceptions).
  - Commitments on rules of origin; competition and subsidies; intellectual property; environmental, social and labor policies; food safety; technical regulation for industrial goods; public procurement; customs.
  - Georgia commits to reducing technical barriers to trade and aligning sanitary and phytosanitary legislation with the EU’s.
  - Enhanced cooperation in customs and customs-related matters; simplification of customs requirements while preventing customs fraud.
- Estimated economic gains (EU studies):
  - Exports to the EU increase by 12 percent in the long run (assumed 5–10 years after DCFTA implementation).
  - Imports from the EU increase by 7.5 percent.
  - GDP will be 4 percent higher (elsewhere in the text: increase GDP by 4.3 percent (€292 million in national income), provided all reforms are completed).
  - DCFTA expected to make Georgia more attractive for FDI by creating a more stable and predictable regulatory environment.

### Outlook and risks
- Growth projections:
  - Growth in 2014 projected to reach 5 percent, largely because of the strong base effect from the end of 2013.
  - Medium-term growth projected to average 5 percent, in line with staff’s estimate of potential growth.
  - Authorities believe potential growth is around 6 percent or higher; staff is more cautious and considers some 2013 slowdown may be permanent.
- Inflation outlook:
  - Increased economic activity and higher imported food prices expected to raise inflation towards 5 percent by the end of the year, aligning with the NBG’s 6 percent target over the medium term.
- Key risk drivers highlighted:
  - Reversal of cyclical import compression when public and private investment recover and fiscal deficit widens in 2014–15.
  - Dependence on continued capital inflows given high external liabilities.
  - Uncertain external environment in partner countries and potential spillovers.
  - Need to implement Georgia 2020 reforms and DCFTA-related reforms to achieve higher potential growth and stronger FDI inflows.

*International Monetary Fund — Selected chapter: "1. The Georgia 2020 Strategy" (from the IMF staff report).*

### 12. The deterioration in the current account deficit and the need to rebuild foreign

### 12. The deterioration in the current account deficit and the need to rebuild foreign reserves

### Balance of payments need and reserve outlook
- Recovery in domestic demand, driven largely by investment, is increasing imports.
- Exports and remittances are being affected by tensions in Ukraine and a slowdown in key trading partners such as Russia and Turkey.
- Increased capital inflows will likely cover only part of the projected widening of the current account deficit.
- Foreign exchange intervention in early 2014 and about US$250 million in projected repayments to the Fund in 2014 imply that, without Fund financing and the donor support that this would catalyze, central bank reserves would:
  - fall below US$2.5 billion, or
  - fall to about 2.7 months of imports.
- Assessment: such reserve levels would be low, especially amid rising regional tensions that could affect market confidence.

### Near- and medium-term risks
- Main risks are to the downside.
- Possible adverse scenarios and channels:
  - Further escalation in the Russia-Ukraine crisis would worsen Georgia’s trade balance and inflows of remittances.
  - Financial spillovers from regional tensions are likely to be small given limited links, but contagion could affect FDI.
  - Armenia’s accession to the Eurasian Economic Union could reduce Georgia’s exports to Armenia (11 percent of total), though impact could be less if Armenia negotiates tariff exclusions.
  - The lari could come under pressure if regional tensions or global financial market shocks lead to further depreciations among Georgia’s trading partners.
  - Medium-term risk: delays to growth-enhancing structural reforms, including DCFTA-related reforms.
- Political outlook: domestic political environment and opportunities for economic reform should improve after June’s local elections, with no national elections until the fall of 2016.

### Program objectives and policy stance (2014 and medium term)
- 2014 program objective: support domestic economy while safeguarding external stability.
- Fiscal and monetary policies for 2014 should boost growth, but authorities agreed to tighten policy relative to the approved budget if balance of payments pressures intensify and to allow the lari to depreciate if needed.
- Medium-term program goals:
  1. Reduce the fiscal deficit to ensure fiscal sustainability and create space for countercyclical policies.
  2. Aim to lower the current account deficit and build foreign reserves, including by providing Fund financial assistance.
  3. Strengthen the monetary policy framework through greater exchange rate flexibility and improved inflation targeting.
  4. Contain fiscal risks from quasi-fiscal activities.
  5. Support reforms in revenue administration.
  6. Bolster financial sector stability.
- Complementary measures: authorities’ structural reforms to strengthen the business environment, improve education and training, encourage private investment, create jobs and reduce poverty; EU-Georgia Association Agreement reforms to improve trade competitiveness and reduce the trade deficit.

### Fiscal policy: 2014–2017 path and measures
- 2014 budget:
  - Envisaged deficit widening to 3.8 percent of GDP from 2.6 percent of GDP in 2013.
  - Spending increases reflect full-year impact of pension increases (0.5 percent of GDP) and universal healthcare (0.7 percent of GDP).
  - Capital spending projected to increase by 0.6 percent of GDP, conditional on improved implementation.
- Authorities’ revised 2014 stance:
  - Agreed to limit the 2014 budget deficit to no more than 3.7 percent of GDP (LOI ¶13).
  - Measures to achieve this include abolishing a preferential import VAT grace period (one-off revenue gain of around 0.2 percent of GDP) and containing capital spending.
  - Staff estimate: the 3.7 percent of GDP deficit will still generate a fiscal impulse of close to 1 percent of GDP, following an unintended fiscal contraction of roughly similar magnitude in 2013.
  - Staff advice: be ready to hold back spending if balance of payments outlook worsens; if first-half outturn is stronger than expected, undershoot the full-year target.
- 2015 target and measures:
  - Program targets a budget deficit of 3 percent of GDP in 2015, backed by pre-announced measures (LOI ¶14).
  - Revenue: preparing an increase in tobacco excises.
  - Expenditure: wages, subsidies and spending on goods and services kept constant in real terms; benefit levels kept constant in 2015; health expenditure projected constant in nominal terms between 2014 and 2015.
  - Staff cautions against regressive measures and noted risks of not increasing benefit levels in 2015.
  - Authorities to draw on FAD tax policy technical assistance for revenue measures that could also reduce inequalities.
- Fiscal strategy for the medium term:
  - Aim to reduce the deficit to no more than 2½ percent of GDP by 2017.
  - This path would keep government debt comfortably below 40 percent of GDP and respect limits set by the Economic Liberty Act.
  - Strategy relies on widening the tax base, strengthening revenue administration, and containing current expenditure.
  - Authorities are considering eliminating the tax-free threshold for personal income tax; staff cautioned this would disproportionately affect low-income households.
  - The government prioritizes increasing public investment for transport and regional infrastructure, but the 30 percent of GDP expenditure limit under the Economic Liberty Act creates choices between higher investment and social spending.
- Fiscal risk management:
  - Authorities will attach a fiscal risk statement to the 2015 budget (December structural benchmark), initially with sensitivity analysis focused on revenues; later expansions to include public guarantees, state-owned enterprises and off-budget vehicles.

### Fiscal administration and tax measures
- Tax administration reforms supported by Fund technical assistance (LOI ¶26):
  - Integrate taxpayer registration by the GRS with business registration from the Ministry of Justice.
  - Abolish the Alternative Audit program and strengthen GRS audit capacity by hiring and training new staff.
  - Introduce single taxpayer accounts by June 2015 to improve monitoring and accuracy of tax payment data.
  - Increase efforts to refund the stock of excess tax credits.

### Monetary and exchange rate policies
- NBG monetary policy objective: price stability.
  - Inflation targets: 6 percent for 2014, falling to 5 percent for 2015 and 2016.
  - Recent experience: price deflation over the last two years due to lower food prices and strength of the lari, prompting significant monetary easing.
  - NBG projects inflation should come close to the 2014 target by year-end and sees current monetary stance as broadly appropriate, while staff note risks from further nominal effective strengthening of the lari.
  - Staff recommendation: greater exchange rate flexibility may be needed; continued de-dollarization efforts could help.
- Program conditionality on monetary framework:
  - Introduce an inflation consultation clause (LOI Table 1): CPI inflation targets initially quarterly, from 2015 bi-annual with quarterly guidance targets.
  - Two consultation bands: an inner band of ±2 percent (prompts consultations with staff) and a wider ±3 percent band (prompts consultation with the Executive Board).
  - Program retains an indicative target on net domestic assets (NDA) as a tripwire against excessive central bank balance sheet expansion.
  - NBG concerns: NDA volatility largely due to movements in government deposits over which NBG has little control; LOI includes commitments to keep government spending close to quarterly projections to avoid sterilization difficulties and reserve losses as seen in 2013.

### Boxed evidence on links with Russia and Ukraine (highlights)
- Current transfers, including remittances, account for about 9 percent of GDP; about half of these are from Russia.
- Transfers from Russia and Ukraine declined 6½ percent yoy in the first four months of the year; higher remittances from elsewhere have offset this so far.
- Share of Russia in Georgia’s exports rose to 7 percent in 2013 (10 percent in the first quarter of 2014) from 2 percent in 2012 after lifting of the Russian trade embargo in May 2013.
- Ukraine accounts for 7 percent of Georgia’s exports; together exports to Russia and Ukraine are equivalent to 3½ percent of Georgia’s GDP.
- Tourism: sector makes up 6½ percent of GDP and employs 10 percent of the workforce; Russian tourists account for about 14 percent of total tourist arrivals and Ukrainian tourists 2½ percent.
- Direct financial links are limited: two banks (one a subsidiary of a Russian bank and another of a Ukrainian bank) account for 8 percent of total banking sector assets; little FDI from Russia or Ukraine in official statistics.

*Source: IMF staff report excerpt.*

### 26. The program will support further enhancement of the monetary policy framework. The

### _cr14250 - 26. The program will support further enhancement of the monetary policy framework. The

### Monetary policy framework and communication
- The NBG plans to use technical assistance from the Fund to improve its inflation modeling and to refine its communication strategy (LOI ¶19).
- The NBG will publish its quarterly inflation reports (with press conferences) according to a fixed pre-announced schedule.
- To strengthen monetary policy transmission, the NBG will continue policies aimed at encouraging further de-dollarization.
- The authorities reaffirmed their strong commitment to preserving NBG independence as key to maintaining monetary and financial stability.

### International reserves and external viability
- Program target: increase gross international reserves from around US$2.5 billion at present to US$2.7 billion by end-2014.
  - US$2.7 billion would cover 3 months of 2015 imports and about 100 percent of short-term liabilities.
- Program aims to increase gross international reserves to around US$3.0 billion by end-2015 (3.1 months of 2016 imports).
- Recent reserve decline reflected foreign exchange sales earlier in the year plus scheduled repayments to the Fund; with Fund repayments falling sharply in 2015 and fiscal tightening expected to lower the current account deficit, reserves are to be rebuilt.
- The NBG will time foreign exchange purchases in the third and fourth quarters, rather than pre-announcing auctions, to avoid potential panic.

### Exchange rate stance and valuation
- Authorities reiterated commitment to a floating exchange rate.
- The NBG’s willingness to allow the exchange rate to depreciate by 7 percent against the dollar (2 percent in nominal effective terms) over December and January signals acceptance of greater exchange rate flexibility.
- Box 4 (exchange rate assessment) findings:
  - Average CGER-based estimates of lari’s overvaluation declined to 8 percent, compared to 15 percent at the 2013 Article IV.
  - Underlying current account deficit fell to 8.4 percent of GDP from 10.3 percent of GDP in 2013.
  - Macro-balance approach indicates real effective exchange rate would need to depreciate by about 7 percent to bring underlying current account to its norm (6.8 percent of GDP).
  - External sustainability approach points to overvaluation of about 17 percent (anchored on reducing net foreign liabilities to 60 percent of GDP).
  - Equilibrium real exchange rate approach suggests the lari is broadly in line with its equilibrium value following recent depreciation.
  - Lari depreciated by 5 percent against the US$ and 10 percent against the Euro since end-2012, but nominal and real effective exchange rates changed little due to currency weakness in Turkey, Russia, and Ukraine.

### De-dollarization efforts and related measures
- High dollarization creates depreciation-related balance sheet risks and limits NBG’s lender-of-last-resort capacity.
- Measures to promote lending in lari:
  - In 2013 the NBG relaxed collateral standards for refinancing lari loans, encouraging lari floating interest rate loans.
  - Government placed GEL80 million in long-term deposits with commercial banks (in exchange for sale of long-term bonds) to promote long-term lending in lari, with plans to expand the scheme.
  - Regulatory rules include additional risk weighting for FX loans and higher reserve requirements on FX liabilities.
- Results of de-dollarization measures:
  - Loan dollarization reduced to 60 percent in March from 67 percent a year ago.
  - Household loan dollarization fell from 43 percent to 36 percent (all measured in constant exchange rates).
  - Deposit dollarization fell from 61 percent to 57 percent (constant exchange rates).

### Financial sector soundness and supervision
- Banking sector indicators:
  - Capital adequacy ratio: 17 percent (13 percent for tier 1 capital).
  - Liquidity ratio: 42 percent.
  - NBG minimum requirements: 12 percent (capital), 30 percent (liquidity).
  - Bank profits rose by 16 percent in 2013 after substantial provisioning in 2012.
  - Share of consumer loans in total loans remains relatively low at around 17 percent.
  - Foreign currency loans comprise about one-third of total household loans.
- Supervisory concerns and actions:
  - Staff concerned about rapid growth in floating-rate lari loans (introduced March-2013) and consumer lending; supervisors are monitoring closely.
  - To stem rapid growth of non-resident deposits (which grew by 50 percent in 2012), in June the NBG introduced a new liquidity requirement: banks must hold more than the standard liquidity level (30 percent) if non-resident deposits exceed 10 percent of total deposits.
    - Result: year-on-year growth in nonresident deposit slowed to 13 percent in February; share stabilized at around 15 percent of total deposits (excluding deposits from non-resident banks).
  - The NBG will introduce the liquidity coverage ratio as its core liquidity ratio for supervision; banks will be required to keep this ratio at a minimum of 100 percent.
    - The liquidity coverage ratio will account for different characteristics of assets and liabilities; runoff rates on deposits will vary by type, owner, concentration, maturity, and currency.
  - Move towards Basel III compliance and risk-based supervision:
    - In 2013 banks started to comply with the standardized approach of Pillar 1 of Basel III.
    - Banks, with NBG assistance, are developing Internal Capital Adequacy Assessment Processes incorporating quantitative risks (interest rate, liquidity, concentration, reputation) and key Pillar 2 qualitative risks.
    - Firm-level stress tests by major banks show sufficient capital to absorb loan deterioration from various macro shocks; results will inform Pillar 2 capital requirements.

### Institutional arrangements for AML/CFT
- Government moving the Financial Monitoring Service (FMS) from the NBG to report directly to the Prime Minister’s office.
  - Staff stressed the importance of maintaining FMS independence and confidentiality/integrity of financial data.
  - Prime Minister gave personal commitment to protecting confidentiality and FMS independence.
  - Government agreed to seek comments from the EU Council of MONEYVAL and the Egmont Group and would amend the FMS law if needed (LOI ¶30).

### Structural reforms and access to finance
- Authorities consider establishing a financial institution (possibly a development bank) to facilitate private investment and improve access to finance.
  - Staff expressed concerns: unclear evidence of an access to finance problem given recent credit growth; uncertainty that a state institution would be the best solution; recommended consultation with Fund and development partners (LOI ¶31).
  - Staff urged study of existing public funds and consolidation before establishing a new state financial institution.
  - Staff recommended transferring state enterprises from the Partnership Fund back to government and financing Partnership Fund operations with greater transparency.

### Program financing, modalities, and safeguards
- Temporary external financing gap of about US$260 million in 2014:
  - Current account deficit projected to widen with recovering imports and weaker external demand.
  - Georgia has about US$250 million in scheduled repayments to the Fund in 2014.
  - Planned needs to keep reserves at US$2.7 billion imply financing need of around US$260 million.
  - Planned disbursements and donor support to cover gap:
    - Planned disbursements from the Fund about US$120 million.
    - Expected donor budget support: US$90 million from the World Bank, and US$50 million from the ADB.
    - Program does not assume EU macro-financial assistance disbursements in 2014.
- Stand-By Arrangement (SBA) request:
  - SDR 100 million (about US$155 million, 67 percent of quota) financing for 2014–17.
  - SDR 80 million would be available in 2014.
  - First and second purchases under the program: SDR40 million (about US$62 million) each, to be disbursed to the Ministry of Finance.
- Arrangement design:
  - Duration: three years, monitored through six reviews (initially quarterly, then semi-annually).
  - First two reviews based on end-September and end-December test dates; thereafter end-June and end-December dates.
  - Performance criteria: general government cash deficit, general government expenditure, cash deficit of the Partnership Fund, net international reserves of the NBG, and external arrears.
  - Indicative targets on net domestic assets of the NBG and an inflation consultation clause.
  - Structural benchmarks set through December 2015.
  - Front-loaded phasing of access reflecting 2014 financing needs and signaling nature of the program.
- Safeguards and repayment capacity:
  - Safeguards assessment in progress and to be completed before the first review; last assessment was completed in 2011.
  - Memorandum of understanding between Ministry of Finance and NBG on responsibilities for servicing obligations to the Fund signed in 2009 remains in effect; authorities will update as needed (LOI ¶32).
  - Georgia’s capacity to repay the Fund judged adequate:
    - Public debt at 32 percent of GDP, largely owed to multilaterals at favorable terms and long maturities.
    - Main risk: relatively high external debt of about 80 percent of GDP.
    - Staff baseline assumes two US$250 million Eurobonds (issued by state-owned Georgian Oil and Gas Corporation and Bank of Georgia) would be rolled over when they mature in 2017.
    - Important to prepare a debt management strategy that accounts for public and private external obligations and the US$1 billion in sovereign and state enterprise Eurobonds that will mature in 2021–22.
    - Declining exposure of the Fund to Georgia (disbursements under proposed arrangement well below scheduled repurchases on previous credit) is an additional safeguard.

### Program risks and contingency considerations
- Implementation risks:
  - Difficulties implementing fiscal consolidation in 2015 and delays in structural reforms.
  - Absence of planned disbursements from 2015 onwards could reduce incentives for unpopular but beneficial policies.
- External risks:
  - Further deterioration of the external environment could widen financing needs.
  - Proper response to further widening of external financing needs would include policy adjustment—exchange rate depreciation and fiscal tightening—and likely additional financing; access may need augmentation if higher tensions require higher reserves.
- Balance sheet risks:
  - Staff will monitor balance sheet risks to ensure the economy can withstand possible exchange rate depreciation.
- Authorities’ readiness:
  - Authorities are ready to make additional policy adjustments should the external environment deteriorate, providing assurances on capacity to repay the Fund.

*Document: _cr14250 - 26. The program will support further enhancement of the monetary policy framework. The (IMF content unit).*

### 40. Public debt is projected to remain low at around 30 percent of GDP while external

### _cr14250 - 40. Public debt is projected to remain low at around 30 percent of GDP while external

### Debt outlook and currency exposure
- Public debt is projected to remain low at around 30 percent of GDP.
- External debt, although high, is projected to decrease gradually to less than 60 percent of GDP (Annex 1).
- High share of foreign currency denominated debt: about 84 percent of total public debt in 2013.
- Exchange rate vulnerability example:
  - A 30 percent real depreciation would increase the stock of external debt to about 85 percent of GDP and the total stock of public debt by 8 percent of GDP.
- Authorities broadly agreed with the DSA results but noted that a 30 percent depreciation was a very unlikely scenario.

### Stress-test and scenario analysis
- General finding: macroeconomic shocks do not substantially jeopardize public debt sustainability except under sizable growth shocks or multiple simultaneous shocks.
- Specific stress-test outcomes:
  - A 5 percent real exchange rate shock leaves the public debt profile unaffected.
  - A real interest rate shock only marginally affects the public debt profile.
  - A shock to the primary balance of about 3 percent of GDP increases debt on impact but the debt stock stabilizes at around 32 percent of GDP in 2019.
  - A one percent reduction in real GDP growth causes the debt-to-GDP ratio to increase to 40 percent of GDP in 2016 and then gradually decline to about 36 percent of GDP in 2019.
  - When all the macro shocks are considered simultaneously the debt-to-GDP ratio increases to 45 percent of GDP in 2016 and stabilizes thereafter.

### Macroeconomic vulnerabilities and near-term risks
- Key vulnerabilities:
  - High current account deficit.
  - High foreign indebtedness.
  - High dollarization, which weakens monetary policy effectiveness and exposes banks to greater risks.
- Near-term risks have risen due to:
  - Crisis in Ukraine and slower growth in Russia and Turkey, affecting exports, trade linkages, and remittances.
  - Potential higher risk premia deterring foreign direct investment.
- Resulting transmission channels include trade linkages with Russia and Ukraine, remittances from Russia, and potential hits to business confidence and investment.

### Fiscal stance, targets, and recommendations
- 2014 fiscal stance:
  - A deficit of 3.7 percent of GDP in 2014 is judged acceptable if consistent with macroeconomic stability and fiscal sustainability, given a commitment to deficit reduction in 2015.
  - Authorities are taking corrective measures to reduce the 2014 budget deficit but should be prepared to do more if risks materialize (for example, by underexecuting spending and allowing the lari to depreciate).
- 2015 fiscal measures and targets:
  - Authorities pre-announced measures for 2015 that will lower the budget deficit to 3 percent of GDP.
  - Planned measures include increasing excises on tobacco and moderating growth of civil service wages and other categories of current spending by keeping them constant in real terms.
  - Social spending increased by almost 50 percent from 2012 to 2014; importance of ensuring 2015 measures do not disproportionately affect the poor and vulnerable is emphasized.
- Additional fiscal policy options to support equity and revenue:
  - Increasing property taxes (or expanding this tax base).
  - Removing tax expenditures benefiting high-wealth individuals.
  - Reforming the personal income tax.
- Policy implementation advice:
  - The government’s pledge to target a much smoother and more predictable fiscal deficit path through the year is welcome and should avoid volatility even if the deficit falls below its target.

### Monetary policy, reserves, and exchange-rate framework
- Monetary policy stance:
  - With inflation well below target, monetary policy has been stimulatory via lower policy rates and measures encouraging new credit in domestic currency.
  - Monetary conditionality introduces an inflation consultation clause; NBG efforts to improve inflation modeling and communications are welcomed.
- Reserve and exchange-rate guidance:
  - To lower net foreign liabilities to a sustainable level (about 60 percent of GDP) in the medium term, the current account deficit should be brought down to about 5 percent of GDP, with 60 percent of this adjustment having taken place by the program’s conclusion.
  - Authorities need to deliver greater exchange rate flexibility, fiscal consolidation, and structural reforms to strengthen competitiveness.
  - Given volatility and dollarization risks, the NBG should maintain an adequate level of reserves, using timely foreign currency purchases to build reserves in line with the program’s NIR path.
  - When conditions normalize, the NBG should consider moving to pre-announced foreign exchange purchase auctions to rebuild reserves consistent with a floating exchange rate regime.
  - Interventions to defend the lari should respect the program’s NIR targets and aim only at preventing disruptive exchange rate moves.
- Institutional note:
  - Respecting the independence of the NBG while enhancing cooperation between the government and the NBG is essential.

### Financial sector, prudential framework, and de-dollarization
- Prudential modernization:
  - NBG should continue to modernize its prudential and supervisory framework, move toward Basel III compliance, and incorporate Basel II risks in capital adequacy measures.
- De-dollarization measures and effects:
  - Policies to encourage de-dollarization—through NBG refinancing, the government’s scheme to place long-term lari deposits at banks, and regulatory rules—seem to be working and should allow greater exchange rate flexibility and more effective monetary policy.
- Institutional and governance issues:
  - The FSAP visit in June will provide further assessment of financial sector strength and possible improvements.
  - Following the decision to move the Financial Monitoring Service from the NBG, the government should strengthen the Service’s operational independence and ensure confidentiality.
- State financial institution caution:
  - Authorities should carefully assess merits of establishing another state financial institution to facilitate private investment and access to finance.
  - Recommendation to first analyze the extent of access-to-finance problems and underlying market failures.
  - Creating a new institution may create substantial fiscal and market-distorting risks unless clear safeguards, objectives, mandate, governance, and oversight rules are in place.
  - Any decision to establish such an institution will require revision of the draft law previously submitted to parliament; cooperation with the Fund and other development partners (World Bank and KfW) is welcome.

### Structural reforms and trade integration
- Structural reform priorities:
  - Enhance competition.
  - Strengthen property rights protection.
  - Develop commercial dispute resolution mechanisms.
  - Streamline bankruptcy procedures.
  - Improve workers’ skills.
  - Further improve public administration.
- Trade integration:
  - Signing the Association Agreement and the DCFTA with the EU will grant Georgian goods free access to the EU market and should make Georgia more attractive to foreign investors, conditional on approximation of EU regulations making the regulatory environment more predictable.

*Source: IMF staff report excerpts in content unit _cr14250 - 40. Public debt is projected to remain low at around 30 percent of GDP while external*

### 53. The proposed program will facilitate Georgia’s external adjustment, reduce key

### 53. The proposed program will facilitate Georgia’s external adjustment, reduce key macroeconomic vulnerabilities, and support growth.

### Program objectives and staff recommendation
- Facilitate Georgia’s external adjustment, reduce key macroeconomic vulnerabilities, and support growth.
- Fiscal consolidation planned from 2015 to keep public debt low and create space for countercyclical policy.
- Monetary policy to aim at price stability through improved inflation targeting and exchange rate flexibility.
- Contain risks from quasi-fiscal activities and support improvements in tax administration.
- Complement authorities’ reforms to strengthen the business environment, improve education and training, create jobs and reduce poverty and inequality.
- Staff supports the authorities’ request for a 36-month SBA, and the establishment of performance criteria for end-September and end-December 2014, based on the program set out in their Letter of Intent.

### Recent macroeconomic developments (findings)
- Real GDP growth moderated in recent years; 2004–07 average and 2009–13 average shown in Figure 1 (charted data).
- Real contributions to growth, 2013: net exports led growth but lower investment constrained growth (charted data).
- Real quarterly GDP: 2012Q1 = 100 index; economy accelerated in second half of 2013 (charted data).
- Consumer price inflation: food and headline inflation fell sharply but headline inflation is on the rise (charted data).

### Fiscal developments (findings and key figures)
- The budget deficit has fallen (Figure 2).
- Public debt is relatively low (Figure 2).
- After increasing social spending in 2013, the new government plans to increase investment (Figure 2).
- Expenditure led adjustment, with expenditure reduction noted (Figure 2).
- Table 1 projections (selected rows, preserve values exactly):
  - Real GDP: 2014 6.2; 2015 3.2; 2016 5.0; 2017 5.0; 2018 5.0; 2019 5.0
  - Nominal GDP (in billion of laris): 2014 26.2; 2015 26.8; 2016 29.2; 2017 32.2; 2018 35.5; 2019 39.1
  - Nominal GDP (in billion of U.S. dollars): 2014 15.8; 2015 16.1; 2016 16.1; 2017 17.5; 2018 18.9; 2019 20.4
  - GDP per capita (in thousand of U.S. dollars): 2014 3.5; 2015 3.6; 2016 3.6; 2017 3.9; 2018 4.2; 2019 4.6
  - Overall balance (percent of GDP): 2014 -3.0; 2015 -2.6; 2016 -3.7; 2017 -3.0; 2018 -2.7; 2019 -2.5
  - Public debt (percent of GDP): 2014 30.0; 2015 32.2; 2016 33.9; 2017 33.6; 2018 33.1; 2019 32.3
  - Deposit dollarization (percent): 2014 66.0; 2015 62.1; 2016 63.6; 2017 61.2; 2018 60.0; 2019 58.8
  - Gross international reserves (in billions of US$): 2014 2.9; 2015 2.8; 2016 2.7; 2017 3.0; 2018 3.4; 2019 3.8
  - Current account balance (in percent of GDP): 2014 -11.7; 2015 -5.9; 2016 -8.4; 2017 -7.9; 2018 -6.9; 2019 -6.3

### External sector (findings and key statistics)
- Change in Gross International Reserves: periodic losses noted in 2012–13 (Figure 3).
- Exchange rates: the lari depreciated against the dollar and euro; nominal effective exchange rate remained stable (Figure 3).
- Fiscal loosening at end-2013 led to changes in fiscal balance and government deposits (Figure 3).
- Current account developments (Figure 4): current account deficit fell through much of 2013 and was financed primarily by FDI.
- Net foreign liabilities remain high (Figure 4).
- Table 3 projections (selected rows, preserve values exactly):
  - Current account balance (in billions of US$): 2014 -1,854; 2015 -951; 2016 -1,347; 2017 -1,380; 2018 -1,306; 2019 -1,276
  - Trade balance (in billions of US$): 2014 -4,216; 2015 -3,492; 2016 -4,041; 2017 -4,309; 2018 -4,512; 2019 -4,783
  - Exports (in billions of US$): 2014 3,502; 2015 4,246; 2016 4,456; 2017 4,683; 2018 5,050; 2019 5,483
  - Imports (in billions of US$): 2014 -7,718; 2015 -7,738; 2016 -8,497; 2017 -8,992; 2018 -9,562; 2019 -10,266
  - Gross international reserves (end of period, in billions of US$): 2014 2.9; 2015 2.8; 2016 2.7; 2017 3.0; 2018 3.4; 2019 3.8
  - Current account balance (percent of GDP): 2014 -11.7; 2015 -5.9; 2016 -8.4; 2017 -7.9; 2018 -6.9; 2019 -6.3

### Monetary and financial sector (findings and indicators)
- Interest rates on loans to firms fell in lari and in foreign currency, lowering borrowing costs (Figure 5).
- Deposit and credit dollarization remains high but is falling (Figure 5).
- Credit to the private sector restored growth; private credit (YoY percent change) rose in 2013–14 (Figure 5).
- NBG lowered policy rates; policy and interbank rates trended down (Figure 5).
- Banking sector profitability and regulatory metrics (Figure 6):
  - Returns on Assets and Equity indicate reported profitability (Figure 6).
  - Liquidity and capital ratios meet regulatory requirements (Figure 6).
  - Non-performing loans have fallen (Figure 6).
  - Non-resident deposits have stabilized but remain high (Figure 6).
- Table 4 monetary projections (selected rows, preserve values exactly):
  - Broad money (M3) period changes: 2012 Act 7.9; 2013 Act 8.3; 2014 Jun Act 9.8; 2014 Dec Proj 10.8; 2014 Dec Proj (year) 11.9 (percentage change, year on year series also provided).
  - Resident foreign exchange deposits: 2014 Jun Act 4.5 (percent change series).
  - Private credit (percent change, YoY): 2014 Jun Act 10.6; 2014 Dec Proj 12.6

### External vulnerability indicators (Table 6; selected items)
- Current account balance (percent of GDP): 2014 -11.7; 2015 -5.9; 2016 -8.4; 2017 -7.9; 2018 -6.9; 2019 -5.0
- External public debt (percent of GDP): 2014 27.5; 2015 26.1; 2016 27.6; 2017 27.5; 2018 27.4; 2019 26.8
- External debt (percent of GDP, excluding intercompany loans): 2014 63.7; 2015 62.3; 2016 64.0; 2017 63.5; 2018 63.5; 2019 61.7
- Gross international reserves (in millions of USD): 2014 2,873; 2015 2,823; 2016 2,701; 2017 2,979; 2018 3,434; 2019 3,763
- Reserves in months of next year's imports of goods and services: 2014 3.7; 2015 3.3; 2016 3.0; 2017 3.1; 2018 3.4; 2019 3.5

### Program financing and reviews (findings and schedule)
- The tables assume Fund disbursements and reflect a program scenario (Table 3 note).
- Table 7 and Table 8 present Fund credit, prospective purchases under the SBA, and external financing requirements and sources; they reflect a program scenario with IMF disbursements.
- Schedule of prospective reviews and available purchases (Table 9):
  - 30-Jul-14: Approve the 36-month SBA; Amount of Purchase SDR 40; Percent of quota 26.7
  - 15-Nov-14: Complete first review based on end-September 2014 performance criteria; Amount of Purchase SDR 40; Percent of quota 26.7
  - 15-Feb-15: Complete second review based on end-Dec 2014 performance criteria; Amount of Purchase SDR 40; Percent of quota 26.7
  - Subsequent reviews and purchases scheduled through 15-Feb-17 with repeated Amount of Purchase SDR 42.7 entries; Total available SDR 100; Percent of quota 67

*Source: IMF staff report and Georgian authorities as presented in the provided content.*

### Annex I. Debt Sustainability Analysis

### Annex I. Debt Sustainability Analysis

### Debt and Market Indicators (selected series)
- Nominal gross public debt (2012–2019): 31.0, 30.0, 32.2, 33.9, 33.6, 33.1, 32.3, 31.7, 31.1
- Public gross financing needs (2012–2019, in percent of GDP): 4.9, 2.4, 3.8, 6.4, 5.8, 5.5, 5.2, 5.4, 6.2, 5.?
- Real GDP growth (in percent, 2012–2019): 6.7, 6.2, 3.2, 5.0, 5.0, 5.0, 5.0, 5.0, 5.0
- Inflation (GDP deflator, in percent, 2012–2019): 7.1, 1.2, -0.7, 3.5, 5.0, 5.0, 5.0, 5.0, 5.0
- Nominal GDP growth (in percent, 2012–2019): 14.3, 7.5, 2.5, 8.8, 10.3, 10.3, 10.2, 10.2, 10.2
- Effective interest rate (in percent, 2012–2019): 5.3, 3.5, 3.0, 2.8, 3.0, 3.0, 2.9, 2.9, 3.0
- Sovereign spreads: EMBIG (bp) = 403 (year unspecified in table); 5Y CDS (bp) = 566
- Ratings (Foreign / Local): Moody's Ba3 / Ba3; S&P's BB- / BB-; Fitch BB- / BB-

### Contribution to Changes in Public Debt (selected rows)
- Change in gross public sector debt (2012–2019, cumulative to 2019): 2.0, 0.2, 2.2, 1.7, -0.3, -0.6, -0.7, -0.6, -0.6, -1.1
- Identified debt-creating flows (2012–2019, cumulative to 2019): -3.1, -1.1, 0.6, 0.6, -0.8, -1.1, -1.3, -1.2, -1.1, -5.0
- Primary deficit (2012–2019): 2.1, 0.9, 0.9, 2.3, 1.5, 1.2, 1.0, 1.0, 1.0, 8.1 (cumulative)
- Primary (noninterest) revenue and grants (2012–2019, cumulative to 2019): 26.2, 28.8, 27.5, 27.1, 27.1, 27.1, 27.0, 27.0, 26.8, 162.1
- Primary (noninterest) expenditure (2012–2019, cumulative to 2019): 28.3, 29.7, 28.5, 29.4, 28.6, 28.4, 28.1, 28.0, 27.8, 170.3
- Automatic debt dynamics (2012–2019, cumulative to 2019): -3.2, -1.3, 1.4, -1.7, -2.2, -2.2, -2.2, -2.1, -2.1, -12.6
  - Interest rate/growth differential (2012–2019, cumulative to 2019): -2.6, -1.1, 0.1, -1.7, -2.2, -2.2, -2.2, -2.1, -2.1, -12.6
  - Of which: real interest rate (2012–2019, cumulative to 2019): -0.9, 0.6, 1.1, -0.3, -0.7, -0.7, -0.7, -0.7, -0.6, -3.7
  - Of which: real GDP growth (2012–2019, cumulative to 2019): -1.6, -1.7, -0.9, -1.5, -1.5, -1.5, -1.5, -1.5, -1.4, -8.9
- Exchange rate depreciation contribution (2012–2014): -0.7, -0.2, 1.2
- Other identified debt-creating flows (2012–2019, cumulative to 2019): -2.0, -0.7, -1.7, 0.0, -0.1, -0.1, -0.2, -0.1, -0.1, -0.5
  - GG: Privatization and Drawdown of deposits (negative): -2.0, -0.7, -1.7, 0.0, -0.1, -0.1, -0.2, -0.1, -0.1, -0.5
- Contingent liabilities (2012–2019): 0.0 across series
- Residual, including asset changes (2012–2019, cumulative to 2019): 5.1, 1.3, 1.6, 1.2, 0.5, 0.6, 0.6, 0.6, 0.5, 3.9

### Baseline and Alternative Scenarios — Key Assumptions (selected)
- Baseline scenario (2014–2019):
  - Real GDP growth: 5.0, 5.0, 5.0, 5.0, 5.0, 5.0 (2014–2019)
  - Inflation: 3.5, 5.0, 5.0, 5.0, 5.0, 5.0 (2014–2019)
  - Primary Balance (percent of GDP): -2.3, -1.5, -1.2, -1.0, -1.0, -1.0 (2014–2019)
  - Effective interest rate: 2.8, 3.0, 3.0, 2.9, 2.9, 3.0 (2014–2019)
- Historical scenario (2014–2019):
  - Real GDP growth: 5.0, 5.9, 5.9, 5.9, 5.9, 5.9
  - Inflation: 3.5, 5.0, 5.0, 5.0, 5.0, 5.0
  - Primary Balance: -2.3, -2.2, -2.2, -2.2, -2.2, -2.2
  - Effective interest rate: 2.8, 3.0, 2.9, 2.7, 2.7, 2.8
- Constant Primary Balance scenario (2014–2019):
  - Primary Balance: -2.3 each year (2014–2019)
  - Effective interest rate: 2.8, 3.0, 3.0, 2.9, 3.0, 3.1

### External Debt and External DSA (selected series and metrics)
- Baseline: External debt (2009–2019, percent of GDP, selected years): 58.8 (2009), 63.2 (2010), 59.1 (2011), 63.7 (2012), 62.3 (2013), 64.0 (2014), 63.5 (2015), 63.5 (2016), 61.8 (2017), 59.4 (2018), 56.5 (2019)
- Change in external debt (2009–2019): 14.3, 4.3, -4.0, 4.6, -1.5, 1.8, -0.5, -0.1, -1.7, -2.4, -2.9
- Identified external debt-creating flows (4+8+9, 2009–2019): 12.6, 0.0, -5.7, 2.7, -0.8, -0.5, -0.8, -1.9, -2.0, -2.6, -3.1
- Current account deficit, excluding interest payments (2009–2019, percent of GDP): 7.6, 7.5, 10.2, 8.7, 2.9, 5.1, 4.8, 3.8, 3.3, 3.1, 2.5
- Deficit in balance of goods and services (2009–2019, percent of GDP): 19.1, 17.8, 19.0, 19.7, 12.9, 16.0, 15.2, 14.1, 13.3, 12.6, 12.1
- Exports (2009–2019, percent of GDP): 29.8, 34.9, 36.5, 38.2, 44.7, 47.3, 46.3, 46.1, 46.2, 46.0, 45.7
- Imports (2009–2019, percent of GDP): 48.9, 52.7, 55.5, 57.8, 57.7, 63.2, 61.5, 60.2, 59.4, 58.6, 57.8
- Net non-debt creating capital inflows (negative, 2009–2019): -6.3, -5.8, -6.2, -3.7, -5.6, -5.7, -5.8, -5.8, -5.4, -5.4, -5.4
- Automatic debt dynamics (2009–2019): 11.3, -1.7, -9.7, -2.2, 1.9, 0.1, 0.1, 0.1, 0.0, -0.3, -0.2
  - Contribution from nominal interest rate (2009–2019): 2.9, 2.7, 2.6, 3.0, 3.0, 3.2, 3.1, 3.1, 3.0, 2.6, 2.5
  - Contribution from real GDP growth (2009–2019): 2.0, -3.4, -3.7, -3.3, -2.0, -3.1, -3.0, -3.0, -2.9, -2.8, -2.7
- Residual, including change in gross foreign assets (2009–2019): 1.6, 4.3, 1.7, 1.8, -0.6, 2.2, 0.3, 1.8, 0.4, 0.2, 0.2
- External debt-to-exports ratio (in percent, 2009–2019): 197.5, 181.1, 162.2, 167.0, 139.2, 135.5, 137.2, 137.8, 133.9, 129.3, 123.6
- Gross external financing need (in billions of US dollars, 2009–2019): 2.6, 2.5, 3.5, 4.3, 3.8, 4.2, 4.0, 4.1, 4.3, 4.3, 4.5
- Gross external financing need (in percent of GDP, selected years): 24.2, 21.6, 24.0, 26.9, 23.5, 26.2, 23.1, 21.8, 21.1, 19.6, 18.8

### Key macroeconomic assumptions (historical averages and projections, selected)
- Real GDP growth (selected series 2003–2019 and projections): historical variability noted; baseline projections of 5.0 percent annually (2014–2019).
- GDP deflator in US dollars (change in percent, selected series): -12.5, 1.7, 15.7, 3.4, -1.4, 9.3, 11.2, -4.8, 3.1, 3.0, 3.0, 3.0, 3.0
- Nominal external interest rate (in percent, selected series): 5.4, 5.0, 5.1, 5.6, 4.8, 4.8, 1.3, 5.2, 5.2, 5.2, 5.0, 4.5, 4.5
- Growth of exports (US dollar terms, in percent, selected series): -13.0, 26.6, 29.6, 14.9, 19.3, 19.5, 13.0, 5.6, 6.1, 7.6, 8.3, 7.6, 7.5
- Growth of imports (US dollar terms, in percent, selected series): -29.8, 16.5, 30.5, 14.4, 1.5, 19.4, 20.4, 9.6, 5.4, 5.8, 6.7, 6.6, 6.6
- Current account balance, excluding interest payments (percent of GDP, selected series): -7.6, -7.5, -10.2, -8.7, -2.9, -10.5, 5.4, -5.1, -4.8, -3.8, -3.3, -3.1, -2.5
- Net non-debt creating capital inflows (selected series): 6.3, 5.8, 6.2, 3.7, 5.6, 8.8, 4.3, 5.7, 5.8, 5.8, 5.4, 5.4, 5.4

### Debt-Related Stress Tests (selected outcomes)
- External debt (percent of GDP) under shocks (labels and sample values from charts):
  - Interest rate shock: baseline 57; shock shown as 58
  - Historical scenario: shown value 54; baseline 57
  - CA (current account) shock: baseline 57; scenario value 69
  - Combined shock (permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance): baseline 57; combined shock value 67
  - 30% depreciation shock: baseline 57; shock value 85
  - Growth shock examples: baseline: 4.9, scenario: 5.6, historical: 4.8; baseline: 5.0, scenario: 2.7, historical: 5.9; baseline growth shock values referenced: -3.5, -6.2, -10.5 (growth shock in percent per year)
- Gross financing need under baseline (right scale) is shown as an important metric in stress illustrations.

### Key Findings (as presented)
- Identified debt-creating flows and automatic debt dynamics point to modest reductions in public debt ratios under the baseline projections (change in gross public sector debt trending slightly negative from mid-projection years).
- Primary balance improvements are projected (primary deficit narrowing from 2.3 percent of GDP in 2014 to around 1.0 percent of GDP by 2017–2019 under the baseline).
- External debt peaks around 2014–2016 in baseline projections and declines thereafter toward 56.5 percent of GDP by 2019.
- Gross external financing needs remain significant in dollar terms (around $4.0–4.5 billion across 2014–2019) and in percent of GDP (around 18.8–26.2 percent across selected years).
- Stress tests indicate vulnerability to large depreciation (30 percent depreciation raising external debt-to-GDP notably, e.g., to 85 percent in the illustrated shock) and combined shocks.

### Policy Recommendations and Government Policy Commitments (from Letter of Intent)
- Fiscal policy and public finance:
  - Keep the fiscal deficit to 3.7 percent of GDP in 2014.
  - Initiate medium-term fiscal consolidation with a substantial part of deficit reduction in 2015, primarily by containing current spending, supported by specific revenue measures.
  - Control and monitor fiscal risks, including limiting public guarantees and other contingent liabilities, and improve disclosure of fiscal risks in the budget.
  - Continue to modernize revenue administration, including phasing out the system of alternative audit, and introducing taxpayers’ accounts.
  - Widen coverage of the Treasury Single Account to include all budget entities and large LEPLs.
  - Build up fiscal and foreign reserve buffers in response to increasing external uncertainties.
- Exchange rate, monetary policy and financial sector:
  - Remain committed to a floating exchange rate and pursue policies that reduce dollarization.
  - Strengthen the inflation targeting regime, including improving inflation modeling and enhancing the NBG’s communication strategy.
- Statistical and structural reforms:
  - Improve national accounts statistics by introducing quarterly real national accounts from the demand side, and make business reporting to GEOSTAT compulsory.
  - Introduce structural reforms to promote growth and competitiveness and implement Georgia 2020 Socio-Economic Strategy.
- IMF program request and financial support:
  - Request IMF support under a Stand-By Arrangement (SBA) for a period of 36 months in the amount of SDR 100 million (67 percent of quota).
  - Request IMF support for balance of payments need in the amount of SDR 80 million in 2014 to maintain reserves above 3 months of imports:
    - SDR 40 million to be made available upon program approval.
    - SDR 40 million upon completion of the first review.
  - Commit to monitoring and consulting with the IMF and to authorizing publication of the Letter of Intent and attachments.

*Source: IMF staff; Annex I. Debt Sustainability Analysis, As of March 21, 2014.*

### 12.      For the medium-term, we remain committed to reducing the general government

### 12.      For the medium-term, we remain committed to reducing the general government

### Fiscal policy: medium-term objective
- Reduce the general government fiscal deficit to a prudent level of no more than 2.5 percent of GDP.
- Keep public debt comfortably below 40 percent of GDP to build room for countercyclical policies and increase savings to reduce the trade deficit.
- Preserve fiscal sustainability while improving welfare.

### Fiscal policy: 2014 commitments and measures
- Ensure the general government deficit does not exceed an equivalent of 3.7 percent of GDP in 2014.
- Maintain the budget deficit to no more than GEL 1,080 million, which is equivalent to 3.7 percent of GDP (performance criteria December 2014).
- Measures to achieve the 2014 ceiling:
  - Introduce VAT payments on imports at the border instead of granting a one month grace period (GEL 60 million, 0.2 percent of GDP).
  - Lower capital spending (GEL 25 million, 0.1 percent of GDP).
- Total general government expenditure will not exceed Lari 9,012 million (performance criteria December 2014), consistent with the initial 2014 budget.
- Aim to keep actual quarterly spending close to the schedule agreed with the IMF to avoid a large part of the annual deficit occurring in the final quarter.

### Fiscal policy: 2015 commitments and measures
- Reduce the 2015 general government deficit to no more than 3.0 percent of GDP.
- Measures to achieve the 2015 target:
  - Increase the excise on cigarettes to generate GEL 65 million (0.2 percent of GDP) in 2015; draft law to be submitted to parliament in October, effective January 2015.
  - Keep social benefits constant in nominal or real terms depending on category; contain social expenditure at GEL 2,840 million, improving the balance in 2015 by 0.7 percent of GDP compared to 2014.
  - Keep spending on goods and services to no more than 1,130 million, consistent with keeping it constant in real terms between 2014 and 2015; this will improve the balance by 0.2 percent of GDP.
  - Keep spending on wages and salaries constant in real terms between 2014 and 2015 at no more than 1,570 million; this will improve the balance by 0.2 percent of GDP.
  - Grant only moderate increases in subsidies and other expenditure categories, which together will improve the balance by close to 0.3 percent of GDP.
  - Plan an increase of capital expenditure in 2015 of around GEL 400 (0.7 percent of GDP compared to 2014).
  - Allow for a slight increase in interest expenditure of around GEL 60 million (0.2 percent of GDP) and of net lending of around GEL 30 million (0.1 percent of GDP).
- Agreement with the Fund on a budget that includes these measures and targets a 3.0 percent deficit for 2015 will be a structural benchmark for end-December 2014.
- Request follow-up technical assistance from the Fiscal Affairs Department (FAD) on tax policy; explore measures identified by FAD (e.g. mining, thin capitalization, taxation of immovable property and personal income tax) in consultation with the IMF to raise revenue while improving efficiency and equity.

### Public debt composition and guarantees
- Seek a more balanced composition between external and domestic debt to keep government debt sustainable.
- Do not plan to issue any public guarantees.
- Aim to gradually lower the share of foreign currency denominated debt as the share of market-based debt increases.
- If guarantees are reconsidered, consult with the IMF and WB and include such guarantees in the fiscal risk statement attached to the annual budget.

### Access to finance and Partnership Fund
- Consider establishing a financial vehicle to facilitate private investment and improve access to finance, acknowledging potential risks and committing to:
  - Ensure no market distortion, no competition with commercial banks, no undue fiscal risks, adherence to transparency and governance practices, and sound economic objectives.
  - Conduct an assessment of access to finance (structural benchmark, September 2014).
  - Consult with the IMF and development partners on mandate, policy instruments, structure, and operational and financial setting before introducing legislation.
- Partnership Fund (PF) commitments:
  - Continue to operate using minority co-financing to catalyze commercially viable projects with developmental objectives.
  - PF financing (debt plus equity plus guarantees) will not be allowed to exceed 100 percent of the equity of the private partner in the project.
  - PF will pursue only commercial objectives.
  - Partnership Fund will not run a cash deficit (performance criterion, December 2014).

### Monetary and financial sector policies
- Commit to price stability and exchange rate flexibility; reaffirm strong institutional and financial independence of the NBG consistent with the NBG’s organic law and the Constitution of Georgia.
- Refine the inflation targeting framework and strengthen communication strategy.
  - From 2015, reduce the inflation target from 6 to 5 percent.
  - Monetary policy in 2014 will take into account the transition to the new inflation target.
  - Expect inflation to reach 5 percent by the year’s end (2014), close to the target.
  - Request IMF technical assistance to improve inflation modeling and communication strategy.
  - Commit to regular publication each quarter of the inflation report, with associated press conferences, on a fixed pre-announced schedule.
  - Include an inflation consultation clause in the SBA, with central (bi-annual) targets consistent with inflation targets of 5 percent and dual consultation bands:
    - Inner consultation band of +/- 2 percent: NBG will consult with IMF staff.
    - Outer consultation band of +/- 3 percent: consultation with the IMF Board will be triggered.
  - During transition, continue to monitor NDA (indicative target).
- Net international reserves and FX purchases:
  - Objective to maintain reserves comfortably above 3 months of imports.
  - Under the Fund-supported program, project reserves to remain at around US$2.7 billion at the end of 2014.
  - Achieve this despite making US$257 million in repayments this year from earlier programs to the IMF.
  - Expect to increase reserves to US$3.0 billion in 2015—equivalent to 3.1 months of 2016 imports.
  - NBG plans to purchase foreign currency during 2014, provided purchases do not add to depreciation pressures.
- Reduce dollarization and encourage use of the Lari:
  - Loan and deposit dollarization around 60 percent; policies aim to increase Lari usage.
  - Existing policies include additional risk weighting for FX loans to unhedged borrowers, higher reserve requirements for FX liabilities, and higher negative liquidity carry for FX liabilities.
  - Promote long-term Lari lending by placing long-term government deposits with commercial banks.
- Strengthen the banking system:
  - Capital adequacy ratio (NBG definition) for banks at 18 percent (26 percent under Basel I definition).
  - NPL ratio according to NBG methodology decreased to 7 percent (3 percent according to the standard 90-day overdue definition).
  - Additional liquidity requirement for large non-resident deposits introduced last year; their share stabilized at 15 percent of total deposits.
- Appreciate IMF-World Bank FSAP mission (May 2014); discussing incorporation of recommendations into the SBA and likely include some in future program conditionality.

### Structural reforms and Georgia 2020 priorities
- Plan wide-ranging structural reforms over the coming seven years to promote private sector competitiveness, strengthen human capital, and improve access to finance; many reforms described in Georgia 2020 socio-economic development strategy.
- Seek support from development partners including World Bank, Asian Development Bank, and European Commission; continue IMF cooperation on tax administration, public financial management and national accounts statistics.

### Social and human capital measures
- Reduce poverty and inequality via:
  - Improve access to education, update school infrastructure, develop vocational education and training (VET) aligned with labor market needs and strengthen public-private partnerships for VET.
  - Continue targeted assistance of municipalities for upgrading infrastructure, including local roads, water supply, and irrigation.
  - Streamline administration of targeted social assistance and sustain the basic package of the current universal health coverage.

### Tax administration modernization
- Strengthen tax administration to improve taxpayer services and secure full compliance; enhance cooperation with IMF’s FAD.
- Main steps:
  - Strengthen tax audit capacity, increase attention to core filing and payment obligations, significantly increase GRS audit staffing from 230 today to 350 during 2015, pay attention to staff training, and eliminate alternative audit by April 2015 (structural benchmark).
  - Introduce single tax payers’ accounts in the first half of 2015 (structural benchmark June 2015) to better manage distribution of tax payments and shift monitoring basis from payments data to tax return information.
  - Reduce stock of excess tax credits and avoid build-up of overdue refunds; perform auditing of firms with overpaid taxes based on streamlined risk-based methodology and introduce pre-release, risk-based auditing of refund requests.

### Public financial management, fiscal rules, and transparency
- Continue public financial management reforms and develop framework for assessing and disclosing fiscal risks under various macroeconomic scenarios.
  - Include a fiscal risk statement in the 2015 budget, supported by FAD (structural benchmark December 2014).
  - Broaden coverage of fiscal accounts by consolidating LEPLs in the 2014 government financial statements (structural benchmark, June 2015).
- Fiscal rules: deficit limited to 3 percent of GDP, gross public debt to 60 percent of GDP, and expenditure to 30 percent of GDP; intend to make rules more transparent and increase accountability and consult IMF on best practices.
- Improve fiscal transparency and cash management:
  - Starting in 2015, all central and local budget units will be executed by the Treasury and all their cash inflows and outflows will be integrated into the Treasury Single Account.

### Statistics and GEOSTAT
- Strengthen statistics and increase resources to GEOSTAT.
  - Revise the Law on Statistics by December 2014 to make it mandatory for businesses to report to GEOSTAT and ensure application of sanctions for nonreporting, in line with IMF and United Nations recommendations.
  - Provide resources so GEOSTAT can publish quarterly labor force statistics (including rural-urban and regional unemployment rates).
  - With STA technical assistance, aim to publish GDP by expenditure in constant prices (structural benchmark, December 2015).

### AML/CFT and Financial Monitoring Service (FMS)
- Preserve strong operational independence of the FMS and protect confidentiality and integrity of banking data, including not sharing records with other government entities.
- Request consultation with MONEYVAL and the Egmont Group; if needed, submit an amended law to Parliament reflecting MONEYVAL and Egmont recommendations together with IMF comments.
- FMS will continue to honor bilateral obligations with financial monitoring units in other countries.
- Continue to strictly enforce AML/CFT regulations and widen AML/CFT oversight to new activities such as gambling and leasing.

### Market development, business environment, and trade-related reforms
- Unified approach to government support for underdeveloped sectors; work with World Bank to review performance of the largest funds and prepare an action plan for future operation, including possible consolidation, by September 2014.
- Streamline business environment with focus on SMEs:
  - Entrepreneurship Development Agency (EDA) established; start full-scale operations in the second half of 2014 to provide training, support export promotion and SMEs’ adaptation to DCFTA requirements.
  - Elaborate an SME development strategy by the end of 2015.
- EU-Georgia DCFTA implementation and quality infrastructure:
  - Strengthen legislative and institutional framework in food safety; amended the Code on Food/Feed Safety, Veterinary and Plant Protection and continue to strengthen the National Food Agency.
  - By the end of 2015, elaborate a list of EU sanitary and phytosanitary, animal welfare and other legislative measures to be approximated by Georgia under the EU-Georgia DCFTA.
  - Develop a national system of quality infrastructure and elaborate a market surveillance action plan by the end of 2015, following a gap analysis and needs assessment during 2015.
- Labor market matching improvements:
  - Streamline communication between employers and jobseekers through online web-portals with free registration of jobseekers; add the employer’s registration module to the web-portal by the end of 2014.
  - Form a System of Labour Mediation in 2014 to support effective resolution of labor disputes.

*Source: Excerpt from IMF country document (content unit _cr14250).*

### 32.      We recognize the importance of completing an updated safeguards assessment of the

### _cr14250 - 32.      We recognize the importance of completing an updated safeguards assessment of the

### Safeguards assessment and memorandum of understanding
- Authorities recognize the importance of completing an updated safeguards assessment of the NBG by the first review under the SBA arrangement.
- A memorandum of understanding between the Ministry of Finance and the NBG is approved to clarify responsibilities related to the financial obligations associated with IMF resources for budget support.

### Program monitoring framework and review schedule
- Monitoring instruments:
  - Quantitative performance criteria (PC)
  - Indicative targets (IT)
  - Structural benchmarks (SB)
  - An inflation consultation clause (described in the TMU)
- Test dates and review timing:
  - Reviews are to be conducted based on end-September and end-December 2014 test dates and semi-annually thereafter based on end-June and end-December test dates.
  - The first and second reviews will be expected to take place after November 15, 2014 and February 15, 2015, respectively.

### Inflation consultation targets and bands (as presented)
- Table entries (as in source):
  - Central point55
  - Inner band, upper limit/lower limit7/37/3
  - Outer band, upper limit/lower limit8/28/2
- Table 2 (Inflation Consultation Target and Bands):
  - September 30, 2014 / December 31, 2014
  - Inflation target 5.05.0
  - Inner band ±2.0±2.0
  - Outer band ±3.0±3.0

### Quantitative performance criteria and indicative targets (as presented)
- Table entries (end-September / end-December, as in source):
  - Performance Criteria
    - Ceiling on the General Government cash deficit (in mn lari) 8101,080
    - In Percent of GDP 2.83.7
    - Ceiling on Expenditures of the General Government- 9,012
    - Floor on NIR of NBG (End-period stock, in mn USD)1,5101,520
    - Ceiling on the accumulation of external arrears of the General Government (continuous criterion) (in mn USD) 00
    - Ceiling on the cash deficit of the Partnership Fund (in mn lari)00
  - Indicative Targets
    - Ceilin g on NDA of NBG (End-period stock, in mnl lari)450600

### Proposed structural benchmarks (Table 3, dates preserved)
- Financial Sector
  - With the support of the World Bank, conduct a thorough assessment of the presence, nature and remedies for credit market imperfections — End-Sep 2014
- Fiscal
  - Include in the 2015 state budget a statement of fiscal risks — End-Dec 2014
  - Approve the budget for 2015 with 3 percent of GDP deficit — End-Dec 2014
  - Abolish the alternative tax audit program — End-April 2015
  - Introduce a single taxpayer account system in the General Revenue Service — End-June 2015
  - Consolidate LEPLs in the 2014 government financial statements — End-June 2015
- Statistics
  - Publish GDP by expenditure in constant prices — End-Dec 2015

### Technical Memorandum of Understanding — key definitions and reporting requirements
- Program exchange rates (Table 1, Program Exchange Rates):
  - SDR Special Drawing Rights 0.65
  - GEL Georgian Lari 1.75
  - EUR Euro 0.73
- General government definition and reporting:
  - General government = central government and local governments, excluding Legal Entities of Public Law (LEPLs); includes any new funds or extra-budgetary entities of a fiscal nature (GFSM 2001 definition).
  - Supporting material: monthly revenues within two weeks; monthly expenditures and arrears of the central government within four weeks; stock of general government debt broken down by currency and original maturity within one month from the end of each quarter; daily cash balances in all accounts of the general government as of end of previous business day.
- Quantitative PCs and ITs listed in TMU (paragraph 5):
  - PC ceiling on cash deficit of the general government
  - PC ceiling on expenditures of the general government
  - PC floor on NIR of the NBG
  - Continuous PC (zero ceiling) on accumulation of external arrears
  - PC ceiling on the cash deficit of the Partnership Fund
  - Indicative target ceiling on NDA of the NBG

### Inflation consultation mechanism
- Inflation defined as 12-month percentage change of CPI as measured and published by Geostat.
- If observed year-on-year CPI inflation falls outside outer bands on any program test date, authorities will consult with the IMF’s Executive Board before further purchases under the SBA.
- If observed year-on-year CPI inflation falls outside inner bands, the NBG will discuss with IMF staff.

### Definitions and reporting for key fiscal and monetary aggregates
- Ceiling on the Cash Deficit of the General Government
  - Definition (paragraph 8): Cash deficit measured from financing side at current exchange rates = i) net domestic financing from banks and nonbanks; ii) net external financing; iii) privatization receipts.
  - Net domestic bank and nonbank financing (paragraph 9) includes:
    - a. Net lending provided by commercial banks to the general government, including securities, plus use of government deposits in commercial banks; monitoring based on NBG monetary survey and Treasury data; change in local governments’ cash balances monitored via ‘budget of territorial unit’ account data.
    - b. Net lending provided by the NBG to the general government, including securities, plus use of government deposits at the NBG; monitoring based on central bank survey and treasury data; changes monitored via TSA and Revenue Reserve Account data and ‘Accounts of Territorial Units’; from 2015 local government accounts monitored using NBG monetary survey.
    - c. Securities issued by the general government and purchased by nonbanks are included in domestic financing.
  - Net external financing (paragraph 10): total loans disbursed to general government for budget support (including IMF financing whose domestic counterpart finances the budget), project financing (capital expenditure and net lending), net change in external arrears, change in accounts of the general government abroad, minus amortization and net deposit accumulation in the state budget’s foreign currency account. Amortization includes all external debt-related principal payments by the general government.
  - Privatization receipts (paragraph 11): proceeds to central and local governments from sale of shares, sale of nonfinancial assets, leases and sale of licenses with duration of 10 years or longer.
  - Supporting material (paragraph 12): data on domestic financing within four weeks after end of each month; external project financing monthly within two weeks of end of each month; data at actual exchange rates; privatization receipts monthly within two weeks; securitized debt sold by NBG monthly within two weeks.

- Ceiling on the Expenditures of the General Government
  - Definition (paragraph 13): Expenditures comprise all current and capital expenditures and net lending according to GFSM 1986: current expenditures include compensation of employees, purchase of goods and services, subsidies, grants, social expenditures, other expenditures, other accounts payables, and domestic and external interest payments; capital expenditure includes projects financed by foreign loans and grants and domestically financed capital expenditure; net lending = lending minus repayments to the general government.
  - Supporting material (paragraph 14): Expenditure data derived from general government accounts covered under the ceiling; Ministry of Finance responsible for reporting; data reported within four weeks after the end of the quarter.

- Ceiling on the Cash Deficit of the Partnership Fund
  - Definition (paragraph 15): cash deficit = expenditures minus revenues.
  - Revenues (paragraph 16): dividends from assets and investments, interest earnings from loans provided, fees for services and guarantees, any other income from assets.
  - Expenditures (paragraph 17): all current and capital expenditures; current expenditures include compensation of employees, purchase of goods and services, transfers, other accounts payables, domestic and external interest payments; capital expenditures comprise net acquisition of nonfinancial assets as defined under GFSM 2001; purchase of financial assets by the Partnership Fund not considered part of expenditures.
  - Supporting material (paragraph 18): Ministry of Finance to provide quarterly revenue, expenditure and financial operations within four weeks of end of each quarter.

- Floor on the Net International Reserves (NIR) of the NBG
  - Definition (paragraph 19): NIR in U.S. dollars = foreign assets of the NBG minus foreign liabilities of the NBG, including all of Georgia’s liabilities to the IMF. Foreign assets include gold, gross foreign exchange reserves, Georgia’s SDR holdings, and the reserve position in the IMF. Pledged or encumbered assets excluded. Foreign liabilities include Georgia’s outstanding liabilities to the IMF (face value), Georgia’s SDR allocation, and other liabilities of the NBG (including foreign currency deposits of financial institutions at the NBG and currency swaps and foreign exchange forward contracts with financial institutions), excluding foreign exchange balances in the government’s account with the NBG. Valuation at program exchange rates. The stock of NIR amounted to US$1,452 million as of March 31, 2014 (at program exchange rates).
  - Adjustors (paragraph 20):
    - Upward/downward by 50 percent for any excess/shortfall in balance of payments support loans and balance of payment support grants relative to projected amounts in Table 3.
    - Upward/downward by 50 percent for any excess/shortfall in disbursements of project loans and project grants to the treasury single account at the NBG relative to projected amounts in Table 3.
  - Projected Balance of Payment Support Financing (Table 3, in millions of U.S. dollars, cumulative from the beginning of the calendar year):
    - Balance of payments support loans and grants / Project loans and grants
    - September 30, 2014 106.6119.5
    - December 31, 2014 164.3180.5
  - Supporting material (paragraph 21): Data on NIR (actual and program exchange rates) and related foreign financing items provided weekly within three working days following the end of the week.

- Ceiling on Net Domestic Assets (NDA) of the NBG
  - Definition (paragraph 22): NDA = reserve money − NIR. Ceiling on NDA = projected reserve money − target NIR. The stock of NDA amounted to GEL -21 million on March 31, 2014.
  - Adjustors (paragraph 23):
    - Upward/downward by 50 percent for any shortfall/excess in balance of payments support loans and grants relative to projected amounts in Table 3.
    - Upward/downward by 50 percent for any shortfall/excess in disbursement of project loans and project grants to the TSA at the NBG relative to projected amounts in Table 3.
  - Supporting material (paragraph 24): NBG will provide its balance sheet including reserve money and NDA on a daily basis using actual and program exchange rates.

- Continuous performance criterion on accumulation of general government external arrears
  - External debt definition (paragraph 25): As set forth in point No. 9 of Executive Board Decision No. 6230-(97/140), as revised on August 31, 2009 (Decision No. 14416-(09/91)); external debt = debt contracted by the general government with nonresidents other than the IMF.
  - External arrears definition (paragraph 26): unpaid external debt service by the general government to official and private creditors beyond 30 days after due date.
  - Supporting material (paragraph 27): Details of external arrears on interest and principal reported to the IMF within one week from the date of the missed payment; data at actual exchange rates.

*Attachment I. Technical Memorandum of Understanding (TMU) — as provided in the source*

### Appendix to the TMU: The Partnership Fund

### Appendix to the TMU: The Partnership Fund

### Organization and operational structure — Legal Structure
- The Partnership Fund (PF) is incorporated as a Joint Stock Company (JSC).
- Under civil law, JSCs are profit maximizing entities, organized with value creation as their main objective.

### Organization and operational structure — Corporate Governance
- The PF is organized as a commercial financial institution. Its governance structure includes:
  - An investment board, currently composed of internal members (CEO, CIO, portfolio officers) and can add external members (like experts and private sector representatives), which approves business cases and initiates projects;
  - A risk management committee, composed of internal members (CFO, Chief Legal Officer, and Chief Accountant), which advises on project risks to be reflected in project implementation agreements;
  - A supervisory board (i.e. board of directors), which approves projects (based on the feasibility studies, risk assessments, and business cases presented by the investment board and risk committee) and approves budget for project development needs. The supervisory board includes members of the government and is chaired by the Prime Minister; and
  - In cases of equity participation in projects, the PF needs government approval.

### Corporate mandate and portfolio management — Corporate Mandate
- The corporate mandate of the PF is approved by the supervisory board and the government.
- Financing instruments the PF will provide:
  - Equity participations;
  - Senior loan;
  - Quasi-equity through subordinated convertible debt;
  - Performance bonds/guarantees.
- Target sectors for investments: energy, agriculture, manufacturing, and real estate.
- Under its corporate mandate, the PF is not allowed to provide financing to the service industry.
- The PF will charge market rates for services provided.

### Corporate mandate and portfolio management — Portfolio Management Strategy
- The PF’s portfolio management strategy sets portfolio limits, performance management objectives, and project evaluation guidelines.
- Principles:
  - The PF will participate only in commercially viable projects; and
  - The PF’s performance will be monitored on the basis of the following evaluation criteria: IRR, APV, sharp ratio, and risk adjusted return.

### Project Development Methodology
- Participation preconditions:
  - The PF will only participate in projects in which a corporate investor, with sufficient experience in industry, expresses its willingness to take an equity participation that represents at least 51 percent of the project’s total equity.
  - PF financing (debt plus equity plus guarantees) will not be allowed to exceed 100 percent of the equity of the private partner in the project.
- The PF will pursue only commercial objectives.

### Reporting and Auditing
- The PF will engage an internationally recognized auditing company to conduct semi-annual IFRS audits of its financial statements.
- The PF will hire on a permanent basis the services of rating agencies, which will prepare regular ratings reports—there will be no minimum rating requirement for the PF.
- The PF’s audited financial statements, as well as the ratings reports will be available on permanent basis to a broad audience.

### Fiscal risks associated with the PF
- Fiscal risks will be limited because:
  - The PF projects don’t create any kind of contingent liability for the sovereign balance sheet, as the government has no legal obligation to bail out the PF, should it become illiquid or insolvent;
  - All liabilities of the PF are limited to its own balance sheet;
  - The PF has its own revenue sources, namely: the dividends from its investments, the interest earnings from the loans it provides, the fees it charges on the guarantees it provides, and the proceeds of asset sales;
  - The PF may decide to borrow from credible financial institution with recourse to its balance sheet facility and without state guarantee.

*Appendix to the TMU: The Partnership Fund (text as provided).*

### 2. The program’s macroeconomic framework.

### 2. The program’s macroeconomic framework.

### Macroeconomic objectives and baseline assumptions
- Authorities estimate potential growth rate is above 6 percent, but conservatively assume a growth rate of 5 percent for this and the next year.
- Public debt ratio might reach almost 34 percent of GDP this year and should steadily decline over the medium-term towards 31 percent after 5 years.
- Budget deficit estimated at 3.7 percent of GDP this year, declining to 2.5 percent of GDP over the course of the 3-year program period.
- Current account deficit projected to reach 8.4 percent of GDP for this year, gradually declining to 5 percent of GDP over the next five years.
- Inward foreign direct investment conservatively estimated at 6 percent of GDP.
- External debt scheduled to drop by 10 percent of GDP over the next 5 years, to reach about 56 percent of GDP, excluding inter-company loans.
- Gross international reserves: US$ 2.7 billion this year rising to US$ 4.8 billion over the next 5 years; import coverage from 3 months now to 4 months.
- Central bank target: stable, moderately low inflation rate of 5 percent over the next 3 years horizon.

### 3. Fiscal policy — objectives and measures
- Overarching objective: keep public debt comfortably below 40 percent of GDP; under the program baseline public debt to GDP ratio projected to decline to about 31 percent by 2019.
- Current-year adjustments:
  - Government reduced this year’s budget deficit from 3.9 percent to 3.7 percent of GDP.
  - Government specified fiscal measures to reduce the 2015 fiscal deficit to no more than 3 percent of GDP.
- Fiscal expansion drivers:
  - Increased spending on targeted social assistance from 1 percent to 1.8 percent of GDP in the current fiscal year.
- 2015 consolidation details:
  - Program outlines measures to secure a 0.7 percent of GDP fiscal consolidation in 2015, primarily based on containing current spending, supported by specific revenue measures.
  - After overall growth of social expenditures of well over 20 percent in 2014, in 2015 social benefits will be kept constant in nominal or real terms, depending on the category of the benefit.
  - Spending on goods and services, wages and salaries will be kept constant in real terms.
  - Increased excises on cigarettes expected to generate revenues equal to 0.2 percent of GDP.
- Policy implementation and safeguards:
  - Reaching agreement on the government’s draft 2015 budget that includes all necessary measures to secure a deficit of no more than 3 percent of GDP in 2015 will be an important topic of the first review scheduled for October/December 2014.
  - Government will handle assumption of contingent liability with great care; currently no plans to issue guarantees. If guarantees are considered, government will consult with the IMF and the World Bank and include them in the fiscal risk statement attached to the annual budget.
  - Any possible public financial vehicle to facilitate private investment will be structured to minimize fiscal risks and be consulted with the IMF and other development partners before introducing legislation.

### 4. Monetary and Financial Sector Policies
- Institutional stance:
  - National Bank of Georgia (NBG) independence enshrined in the constitution and organic law; government reaffirms strong institutional and financial independence of the NBG.
  - Importance of consistency between government and NBG policies is recognized.
- Inflation and exchange rate policy:
  - NBG expects inflation to reach 5 percent by year’s end, which is the new, reduced inflation target for 2015, under an enhanced inflation targeting regime and a flexible exchange rate regime.
  - Central bank will improve inflation modeling and refine communication strategy, including quarterly publication of an inflation report and press conference on a fixed schedule.
  - Consistent with Fund policy, the NBG will consult with IMF staff if actual inflation deviates more than 2 percent from the target; if deviation exceeds 3 percent, the Board will be involved in the consultation.
- Reserves policy:
  - NBG plans to purchase foreign currency in the remainder of this year to boost gross reserves to US$ 2.7 billion by the end of 2014, assuming no depreciation pressures by the time of purchases.
- Dollarization and banking measures:
  - Loan and deposit dollarization around 60 percent.
  - Program of placing long-term government deposits with commercial banks to promote long-term Lari-lending.
  - Additional risk-weighting on FX loans and higher reserve requirements on FX liabilities to help reduce dollarization.
- Financial sector assessment:
  - A World Bank-Fund mission is updating the FSAP for Georgia; finalization is expected by October. Authorities and staff will assess which FSAP recommendations could be included in program conditionality.

### 5. Structural reform
- Comprehensive structural reforms following association agreement with the EU and Country Partnership Strategy with the World Bank.
- Macro-critical structural reforms under the Stand-By Arrangement in:
  - Tax administration,
  - Public financial management,
  - National statistics.
- Authorities have requested Fund technical assistance in these domains and are committed to use Fund TA effectively.
- Other reform areas:
  - Streamlining the business environment with focus on SMEs,
  - Improving labor market matching services through labor market mediation,
  - Easing access to finance for businesses, particularly SMEs.
- Specific actions:
  - Conduct an assessment of access to finance for enterprises (structural benchmark for September 2014).
  - Take measures to remove market imperfections and promote domestic capital markets.
  - Establishing a public financial vehicle to facilitate private investment will be carefully considered in consultation with the IMF and other development partners to ensure sound operation and avoid undue fiscal risks.

### 6. The balance-of-payments outlook and access
- External financing context:
  - Relatively large current account deficit and maturing external debt obligations result in external financing requirements exceeding US$ 2 billion annually.
- IMF access and catalytic role:
  - With continued sound policies and financing from other IFIs and macrofinancial assistance from the EU, access under the Stand-By Arrangement can be catalytic and limited to SDR 100 million for the entire 3-year period.
  - In light of uncertainties from Russia and Ukraine, observed drop in exports and remittances, low external reserves, and US$ 257 million repayments to the Fund in 2014:
    - Disbursing SDR 40 million on the occasion of program approval and again after the first review would provide useful support for the balance-of-payments in 2014.
    - These drawings, together with program implementation, will help bolster creditor and investor confidence.

*Source: 2. The program’s macroeconomic framework.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14250.pdf_