The FINANCIAL -- Despite the fact that the International Monetary Fund considers the Georgian Government and Economy to be resilient against the recent financial crisis, there are plenty of tasks that lie ahead. The high level of dollarization, fiscal deficit, increased foreign debt, weak external environment - these are issues which the Government of Georgia will have to face in the coming year.
5% Real GDP Growth and -6% of GDP General Overall Fiscal Balance - these are predictions made by IMF about Georgia for 2017. The results of the so-called Article IV assessment for Georgia have not been published by IMF because of a request made by the Government. The financial team of the Georgian Government does not agree with the possible deficit of 6%, which could be caused by a change in taxation of corporate income, and they were worried about the negative impact on investors’ expectations. Despite the fact that they do not agree with the IMF’s estimation, no measures to improve the deficit have been announced yet either.
“We expect real GDP growth to pick up, to 5% in 2017. The deterioration in the fiscal deficit that we project in 2017 reflects the move to taxation of dividends instead of corporate profits,” Francois Painchaud, Resident Representative of IMF, told The FINANCIAL.
“The budget revenue will be reduced by about 1.5% of the GDP. This is the only concrete measure that we know and so in our projections this is the only measure we have accounted for. If the Government announces other measures, and they are considering a lot of measures to limit the deterioration of the fiscal deficit, then we will reduce our deficit projection, but also growth and fiscal vulnerabilities,” said Painchaud.
Q. The past two years have been quite difficult for the Georgian economy, mostly due to the external impact. What is your estimation for now - is the worst over?
A. Georgia is experiencing a large and persistent external shock. Lower oil prices resulted in low growth in Russia and other trading partners. The currencies of Georgia’s trading partners have fluctuated and depreciated in a number of cases; the US Dollar has appreciated, which translated into higher debt service payments for people who have borrowed money.
Despite the shock, growth has been relatively resilient, we expect growth to be roughly 3% in 2016. Public debt has increased not only because of larger fiscal deficit, but because of depreciation of the Georgian Lari against the US Dollar. We have seen external vulnerability increase, current account deficit is still very large, so Georgia is borrowing a lot abroad and external debt has increased.
Despite the shocks, the financial sector remaining healthy, but we think that some of the buffers have eroded. We see that Georgia’s external environment remains weak. We expect growth in Georgia’s trading partners to be positive, so trading partners will grow, but not as fast as they used to before the crisis.
Q. Georgian officials were not prepared for the upcoming crisis that started developing from 2014. Do you think that they have gained any basic “skills” and if the situation in the region continues to deteriorate then will we handle it better?
A. Georgia has done relatively well despite the big shock, and instead of falling into recession, Georgia has continued to grow, despite the large depreciation of exchange rate, inflation remains low, real wages have increased, the banking sector is resilient and so I think that overall the policy response and resilience of the economy has been adequate.
Q. Post-Soviet states have faced lots of economic crises since independence. What are the main distinguishing features of this recent crisis?
A. I think that there are a few issues. Right now there is the perception that the oil-price shock will be persistent. The market does not expect oil prices to return to 100 dollars a barrel. So there is that persistence in the shock that we did not see in the previous crisis. Now we are in an environment where growth is already low, inflation is low and there are all kinds of factors that have played their role. Low productivity in advance economies and demographic changes, the transition to more balanced growth in China, these are also factors affecting how the world economy is performing.
Q. There are many speculations regarding the reasons for the recent devaluation of the Georgian Lari. Please can you provide us with your explanation?
A. Well, we think that the exchange rate over the last two years has reflected mostly economic developments. Fluctuations of the Lari has been mostly market-determined. Our recommendation to the National Bank of Georgia has been to limit interventions only to periods where there was excessive volatility or perhaps the need to rebuild the reserves. Otherwise, they should focus on inflation. Georgia is an inflation-targeter and the central bank should focus on inflation. It means that exchange rate should be market-determined.
Q. One of the reasons cited for the recent devaluation has been the purchase of Bank Republic by TBC Bank. What other impacts will this deal have on the Georgian banking sector?
A. The purchase of Bank Republic by TBC Bank looks like a normal market transaction, and sure, it is happening in the context of a banking system that is already fairly concentrated. The top two banks’ accounts are about 60% of assets and liabilities roughly. And the purchase of Bank Republic by TBC Bank is going to change a bit of the concentration of this system but not markedly. What we would advise the National Bank of Georgia is to continue to support the competition within the system, and also develop the capital market that will compete with the banking system. So the cost of capital would be lower.
Q. The country is in need of foreign direct investments. Can you tell which fields you believe will be effective to invest in?
A. Our measure of net FDI is USD 1.2 billion per year in 2014 and 2015 coming into Georgia. The total stock of FDI is about 100% of the GDP, or USD 14 billion. FDI has been going mainly to energy, transportation, tourism, manufacturing and the financial sector. Where it is going to be next, I do not know; investors are better placed to make decisions. What I can tell in a macroeconomic sense, is that it will be preferable if FDI were going to the trade sector, to increase export and reduce import, so that current account deficit and external debt declined.
Q. IMF has always welcomed a floating exchange rate in Georgia. Meanwhile, it remains one of the main challenges for the Georgian business community. What would you suggest to them for how they can cope with a floating exchange rate?
A. We think that Georgia has managed very well with a floating exchange rate. For example, the depreciation against the US Dollar supported export and remittances in Lari terms and supported incomes and this is a good thing. So, without that depreciation, income in Lari would have declined.
But it made debt service denominated in Dollars for people and businesses more difficult as well. So this leads us to the problem of the banking system - Dollarization. Maybe it is even more of a problem than the fluctuation in exchange rate. Our policy advice is to keep a floating exchange rate and then take measures to dedollarize the economy. Vulnerabilities would be reduced if businesses and individuals could borrow in Lari at a reasonable cost.
Q. Georgia is in need of reforms in the financial field. What specific reforms would you recommend?
A. The banking system was resilient against the crisis, suggesting good regulation and supervision from the National Bank of Georgia; good risk management practices by the banks, and loan restructuring. We welcome the commitment of authorities to keep banking supervision within NBG. We advise the Government to pursue a dedollarization policy to limit financial vulnerabilities.
Dollarization has a number of negative aspects, when there is currency depreciation, typically growth slows, the financial stability of a banking system is jeopardized and dollarization limits the effectiveness of its monetary policy. We would suggest a number of policy measures to support de-dollarization, the first one would be to: Keep macro stability and low inflation rate; Reduce fiscal and external vulnerabilities; Develop capital markets, so assets are available in Lari, that would include the pension reform; And the last measure would be to increase pricing in Lari for the two biggest items people purchase - cars and houses. If the price is in Dollars it makes people save money in Dollars. As a result banks would lend money in Lari as well.
Q. According to the IMFC’s last meeting report, unemployment still remains the main topic for consideration in the Euro Zone. In Georgia we face the same problem as well. Where do you see the solution? What can be done by the Government as well as private sector to decrease the level of unemployment?
A. The measures taken should boost growth. We would recommend that the Government encourage the private sector. Part of that is preserving macro stability and for us it means undertaking fiscal consolidation. Fiscal deficit and debt are increasing and Georgia needs to rebuild buffers in order to be able to respond to shocks in the future. Fiscal consolidation should safeguard growth-friendly investment and spending on the most vulnerable.
Secondly, an important element is what we hear from business and what is reflected in different indicators, which is that Georgia could be better at education. Skills, vocational training and education are areas which the Government needs to improve, especially in the rural regions.
There are other structural reforms the Government could also consider: the pension reform, deposit insurance, development of capital markets as a way to increasing savings, and change the bankruptcy law and finalize cadasters.
Q. In 2014 Georgia signed a Deep and Comprehensive Free Trade Agreement. How would you evaluate the progress of the country towards the DCFTA?
A. If you look at the shares of export going to Europe from Georgia, they increased in 2015 compared to 2014. And the share of import from Europe coming into Georgia increased from 2014 to 2015 as well. So this would suggest a bit more integration. But at the same time evaluation of the impact of the DCFTA is difficult because it is happening in a period when a lot of other things are happening. Banning car export to Azerbaijan; reopening the border with Russia; large commodity price fluctuation; large exchange rate fluctuation; weaker growth than was expected in Europe - all of these things make it difficult to quantify the impacts so far.
At the same time, you know, some of the economic adjustments need more time. The Georgian economy will need to take more time to adjust. What we advocate for Georgia is to continue the economic integration. We think that it will affect Georgia positively. So continue trade integration with Europe, China and other trading partners.
Perhaps there should be more communication between government and business in order to encourage them to use this opportunity better. There can be other constraints that need to be lifted too, for example labour market skills, better education especially in rural areas.
Q. IMF Conditionality is the way the organization helps countries on the road to development. Can you name the project which, in your opinion, made the biggest change for Georgia?
A. Let me clarify that the IMF engages with the Government of Georgia in many different ways. There are technical assistance (TA) made by us, to improve different technical issues, for example, one of the latest TA was undertaken at the Georgian Revenue Service. We provide TA in a lot of areas such as improving statistics, liquidity management, fiscal risk reporting. We also provide trainings to government officials, we send roughly 100 government officials abroad every year to improve their technical skills. We do our annual assessment of economic and financial developments and assessment of policies, which we call Article IV. The engagement of IMF with the Government of Georgia is much bigger than one programme. Looking forward, the main challenges for Georgia will be to maintain macro stability, economic integration and inclusive growth.