The FINANCIAL -- Georgia’s economic growth: beating expectations in 2017
Among the pleasant surprises early this year, were the figures for Georgia’s economic growth in 2017. According to GeoStat estimates, Georgia’s real GDP grew by 4.8% year over year (YoY) in 2017. This result moderately surpassed the ADB, EBRD, IMF and World Bank’s last growth projections of 4.2%, 3.9% 4.0%, and 3.5% growth, respectively. The National Bank of Georgia’s (NBG) 4.5% growth projection also slightly underestimated Georgia’s economic growth in 2017. The real winner in this race was ISET-PI’s annual GDP growth forecast. In November 2017, we predicted 4.7% YoY growth, and since then our updated forecasts indicated 4.8% real GDP growth.
Yet, compared to neighboring countries (in particular Armenia and Turkey), Georgia’s performance was quite modest. According to the latest World Bank estimates, Turkey enjoyed 6.7% annual growth – driven by improved external demand from the EU, fiscal expansion and the low GDP base of the previous year. However, due to political instability, massive depreciation of the lira and double-digit inflation, the growth rate of the Turkish economy is expected to slow to 3.5% YoY in 2018. Signs of economic recovery were observed in Russia as well. The country’s 1.5% growth in 2017 was driven by a variety of factors: increased oil prices on the world market, an improved trade balance, huge infrastructure projects, a stabilized exchange rate and low inflation. These positive developments in Russia were transmitted to Armenia through remittances and trade channels. Economic growth in Armenia was the highest in the region (an impressive 7.7% in 2017, up from 0.2% in the previous year). The country benefitted in particular from higher metal prices, which drove up industrial output and exports. In Azerbaijan, real GDP growth was flat at 0.1%, but was recovering from the 3.8% contraction of 2016. A tightened monetary and fiscal policy in the country failed to curb pressure on prices, and inflation reached 13.4% YoY. However, on a positive note for Azerbaijan, the non-oil sector grew by 2.7% YoY. Another important economy is China, as Chinese ambitions to expand its economic influence can have a powerful impact on the entire region. In 2017, China became the third largest trade partner of Georgia. Therefore, China’s 6.9% growth rate for the year comes as good news for our country.
How much do we depend on our neighbors?
How much does the economy of Georgia depend on other countries? The table below gives an idea about linkages with partner countries with respect to trade, foreign direct investment, remittances and number of international arrivals in 2017. Darker colors correspond to stronger linkages and, consequently, stronger spillover effects from other countries. For example, we can see that the EU and Russia each absorbed high shares of Georgian exports, at 24% and 14% respectively. These countries are also the main sources for Georgian remittances (31% and 33% respectively). Thus, positive economic developments in the EU and Russia have strong positive effects on the Georgian economy.
The data also show that the spillover effects from large and fast-growing economies like China are still limited. However, China’s increasing importance as a trade partner (a FTA between Georgia and China came into force on 1 January 2018) and a source of foreign investments will amplify its positive (and negative) influence on the Georgian economy in the future.
Overall, the economies of Georgia and the whole region are continuing to recover from the sluggish growth of previous years. For Georgia, the recovery is due to improvements in both the external and domestic environment. Accelerated economic growth in trade partner countries and rising metal prices caused a spike in exports, increased money transfers and boosted tourism. On the domestic front, improvements in consumer and business confidence, the growth of government expenditure and private lending, and the corporate income tax reform, all stimulated domestic investment and consumption. Downside pressure on Georgia’s growth came from the hike in excise taxes on fuel and increasing oil prices on international markets. These factors led to higher inflationary expectations and induced monetary tightening, which further hurt growth.
Both producer and consumer prices in Georgia showed high growth in 2017. CPI annual inflation was 6%, while producer prices increased by 10.2%. The year-on-year hike in prices was mainly caused by the following factors:
a. Supply side pressure due to a hike in excise taxes on fuel, tobacco products, and car imports.
b. Sharp fuel price increases (23.7% YoY) on the international market. For Georgia, this meant an increase in transportation prices and, indirectly, an increase of domestic production costs.
c. Nominal depreciation of the Georgian lari in annual terms with respect to partner countries, which contributed to the rise of import prices.
The product categories that exhibited the highest price growth in annual terms were alcoholic beverages & tobacco, as well as transport. Prices for these product categories increased by 17.1% and 15.1% YoY respectively in 2017. Food prices were indirectly affected by higher fuel prices. Moreover, the rise of meat and dairy prices was driven by the increase in exports of live bovine animals and sheep (especially to Iraq and Iran), reducing the supply of meat and dairy on the local market. These upward pressures on the CPI and PPI led to higher inflationary expectations and provided justification for a tighter monetary policy stance by the National Bank of Georgia.
Credit, household debt and financial sector stability
The indebtedness of the population continued to grow in 2017. Household debt as a share of GDP has been growing in recent years, reaching 31.9% in Q3 2017 (4 percentage points (pp) higher than in the same period of 2016). The household debt to disposable income ratio constituted 49.4% in Q3 2017 (7.7 pp higher than in the same quarter of 2016).
Yet, despite the increase in household debt indicators, the share of non-performing loans (NPL) to total loans declined. This could in part be explained by the strict lending standards of commercial banks, as well as by the fact that de-dollarization policies may have eased currency mismatch problems among Georgian households and led to fewer defaults.
The profitability of the Georgian banking sector increased significantly in 2017. The profit of the banking sector reached 869 million GEL (a 13% YoY increase). Total loans (stocks) granted by commercial banks to businesses and households increased by 15.5% YoY. This increase was driven mainly by retail credits, which surged by 20.3% YoY. Business loans rose by 10.2% YoY in 2017.
Dollarization rates of non-bank deposits and loans decreased in 2017: the dollarization of deposits fell by 5.8 pp, while loans were less dollarized by 7.5 pp. The fact that dollarization declined during the year despite fluctuations with the lari’s nominal exchange rate, indicates that the macro-prudential mechanisms implemented by the NBG earlier in 2017 had the desired effect.
At the same time, the de-dollarization policy affected lending rates: the artificially-induced surge in demand for retail loans in national currency among physical persons led to an increase in retail borrowing rates for individuals and households, while for legal entities loans in national and foreign currencies became cheaper.
Trade conditions were good for Georgia in 2017. After two consecutive years of export contraction, Georgia showed positive dynamics in external merchandise trade. Trade turnover increased by 13.8% YoY. Exports rose by 29.1% and imports by 9.4% YoY. The overall trade deficit widened by 1.4% YoY.
The boost in exports was primarily driven by improved external demand conditions and a surge in metal prices. Ferro-alloys and copper ores prices spiked by 81.3% and 34.4% YoY respectively. Car re-exports (+41% YoY), wine (+50.6% YoY), medicaments (+30.9% YoY), and spirituous beverages (+37.8% YoY) were the other main drivers of the export hike in the reported period. The bad news is that the structure of Georgian exports is still characterized by low diversification – the top ten export commodities accounted for 63.3% of total exports.
The structure of imports was more diversified – the top ten import commodities accounted for 34.8% of total imports. Import of copper ores (36.1% YoY), which are used for re-export, was the main driver of the imports increase. It seems that excise tax had a significant impact on imports of fuel. Despite a 12.3% YoY increase in import values, the fact that oil prices on international markets went up by an average 23.3% YoY (IMF crude oil prices) suggests that the quantity of imported petroleum decreased by roughly 8.9% (authors’ calculations). It turns out that the price elasticity of demand on fuel is higher in Georgia than is assumed by general economy theory.
The geographic composition of trade also changed in 2017. Exports to CIS countries increased by 59.9% YoY and constituted 43.3% of total exports. This increase was mainly driven by export growth to Russia (+91.3% YoY) and Azerbaijan (78.1% YoY). Exports to EU countries increased by 13.2% and those to other countries rose by 12% YoY in 2017. The increased importance of the Russian market for Georgian exporters contains political risks for producers in light of previous embargos. While Georgia still needs time to finish the process of harmonization to take full advantage of the Association Agreement and DCFTA with the European Union, the recently-signed FTA with China, which came into force in January 2018, is expected to boost exports to China quite rapidly.
According to GeoStat, the volume of total remittances to Georgia amounted to 1,379 million USD in 2017, a 19.8% YoY increase. The recovery of remittances is a clear sign that the economies of Georgia’s partner countries continue to improve. All top source countries of money inflows to Georgia showed a notable increase: Russia (+15.4% YoY), Italy (+17.9% YoY), the United States (+11.2% YoY) and Greece (+13.4% YoY).
Money inflows from Israel showed unprecedented annual growth of 96.1%. This stemmed from the wave of Georgian emigration that started in 2014 when the countries ratified a visa-free regime. Following this, many Georgians stayed in Israel illegally or sought asylum there after finding it to be an outstanding country in which to work and send money back to their homeland. Israel overtook Turkey (+25.6% YoY) to become the fifth biggest source of money inflows from Georgia in 2017.
Despite the positive dynamics in 2017, money inflows were still 4.3% behind 2014 levels. However, the exchange rate depreciation and moderate levels of inflation have boosted the purchasing power of remittances. Remittances in CPI adjusted lari terms, which measures the purchasing power of money inflows to Georgia, showed a 19.5% and 20.6% YoY increase compared to 2016 and 2014 respectively. Thus, remittances were an additional external factor that stimulated economic growth in 2017. Moreover, remittances are a source of foreign currency inflows into the country and are important for lari exchange rate stability.
In 2017, there were 7,554,936 international arrivals to Georgia, which was a 18.8% YoY increase. Of these, 77.8% arrived by land, 20.7% by air, 1% by rail and 0.5% by sea.
As usual, the highest share of total visitors to Georgia were from neighboring countries – Armenia, Azerbaijan, Russia and Turkey. Taken together, visitors from neighboring countries constituted 80.1% of the total visitor flow. However, dramatic growth was seen in visitors from Iran (+118.3% YoY) and Saudi Arabia (+164.6% YoY) in 2017. The high growth in those numbers emphasize the huge potential of Asia in terms of tourism development for Georgia.
The year 2017 was very successful for Georgia in terms of international tourism. The number of tourists (visitors who stayed in Georgia for 24 hours or more) constituted 3,478,932 people, a 27.9% YoY increase. These tourists brought 2.2 billion USD to Georgia in the first three quarters of 2017, which was 29% more than in the same period of the previous year. Tourism was one of the main drivers of economic growth in 2017 and one of the main sources of foreign currency inflow. It is expected that the total export of tourism services in 2017 will be higher than the total export of goods, which constituted 2.7 billion USD.
Overall, 2017 was quite a good year for Georgia: it was marked by faster growth, a recovery of exports, effective reform efforts (e.g. the larization and CIT reforms) and a significant boost in the tourism sector. On the negative side, Georgia’s existing external weaknesses were still apparent in the 2017 data: low diversification of the export sector, reliance on primary commodities and re-exports – all significantly increase the future vulnerability of the economy. The increase in household indebtedness is also a cause for concern, despite the fact that banking sector stability appears intact. Tackling these issues with relevant policies should be at the top of the agenda for policy makers in the coming year.