The FINANCIAL — Q&A with Archil Jacobashvili, Associated Professor, Georgian-American University (GAU)
Q. For the year 2009 the Government has reduced income tax to 20%. How could this fiscal measure help to revive the economy?
A. I can only appreciate the tax cuts, which are always the best answer against economic slowdowns. As already mentioned, the immediate cut of corporate tax to 10% has also been recommended. In the future hopefully we will reach a point where the tax decentralization (for example: the replacement of corporate taxation responsibility to regional governments) will bring more economic benefits, overshooting the political risks connected with it. Regional contrasts remain a serious problem of the Georgian economy, and only decentralized taxation seems to be an effective measure for the solution of this problem.
Q. From fiscal to monetary policy: do you think the Government and the National Bank have the upper hand against inflation?
A. Not fully. Budget discipline, as well as non-monopolistic price buildings are the important preconditions for price stability, but the inflation could also have monetary reasons: we have a two-currency economy and the prices of durable goods (real estate; cars; technical products) are mainly invoiced in USD. So the refinance rate of the National Bank as an instrument for the steering of the monetary base is relevant only for domestic money markets (GEL). But for net-importer countries domestic price levels are imported from the world market, and this thesis is also valid for Georgia.
The devaluation of the GEL, which is occurring because of the over-demand of the USD, is leading immediately to the increasing of price levels. Even the expectation of the GEL’s devaluation could force economic subjects to set higher prices in order to eliminate the currency risks from their daily activities.
The worldwide deflations due to the financial crisis could have disinflation impacts also for Georgia, but it has been recommended for monetary expansion to be more conservative than it has been, especially since the several rate cuts over the last few months. The reason: the almost higher level of USD substitution to the domestic currency.
Q. Putting the exchange rate to monetary instruments, the National Bank pledges the equilibrium-oriented FX-policy, allowing for weakness as well as hardness of the GEL, but between the managed ranges without any significant volatility. Is the exchange rate actually at its optimal level?
A. I’m a strong supporter of hard GEL. The job of the policy makers is not only the theoretical definition of equilibrium, but also the usage of relevant instruments for rent seeking against and/or from equilibriums.
At first, let me define the idea of the equilibrium level of the FX-rate, which in real terms is based on the ensuring of simultaneous equilibriums between the main macro-markets from real as well as monetary sectors. The outgoing point is the conflict of interests in the stabilization policy. Should it be oriented at domestic equilibrium (price stability), or foreign equilibrium (exchange rate stability)? Both paradigms are substitutive to each other: one or the other, but not both at the same time.
Now, in the case of the Georgian economy, hardness of the GEL is essential for the nation with its revenues in GEL, but outflows in USD. Georgia isn’t yet an export nation and this is a fact. The hardness of the GEL is also essential for the increase of investor confidence, and for price stability, especially when the country depends on the import of gas and oil.
Therefore, in my opinion, the policy makers should do reorientation from the ensuring of foreign equilibrium into domestic equilibrium, avoiding a real revaluation, but forcing the nominal revaluation of the GEL at the same time.
The actual regime of the managed floating is the second best solution in the FX-policy. A free exchange rate, which means a permanent change of it via markets, could be the best solution. Additionally, it requires the participation of capital markets at the definition of the exchange rate, which isn’t possible at this time.
The green-weekend decision from November 2008, which meant the correction of the exchange rate, was unavoidable, but the adjustment strip from 1.44 to 1.65 was larger than necessary. In my opinion, the level of 1.55 could be optimal. The following devaluation is the result of decreasing capital inflows, but the Georgian financial sector seems to be resistant against exogenous shocks and hopefully the situation will be resolved in the nearest future.
Q. In November 2008 you said that a fundamental reform of medical insurance was required. Now the “GEL 5 Insurance” is already on its way. How could you appraise the success of this reform?
A. Indeed, the state instigated it, but the policy holders should actually be fully responsible for the general insurance, themselves paying the monthly premium of GEL 5, without the state’s contribution. In this reform I also think that the involvement of the firms which are employing the members of the insurant society is also missing. If the firms have to pay less corporate tax (actual: 15%; recommended: 10%), they get more free funds in order to take part in the insurance of their employees (for example: policy holder GEL 5 + employer GEL 5). The success of the reform could be gauged at the coverage ratio of the healthcare expenditures.
Now the Georgian Government has budgeted only GEL 15 Million and set limits on the benefits (actual: GEL 1,000 for ambulatory services; GEL 2,000 for stationary treatment, and GEL 5,000 for urgent services), which seems to be miscalculated because, especially in the first years, more and more policy holders are able to seek the benefits of insurance programmes, making serious problems for the insurance companies therefore.
I think that during 2009 the Government should undertake additional measures in order to avoid a gap expectation at the end of the budget year 2009.
I remember the same situation during the unification of East Germany with West Germany. In 1991 the Federal Government budgeted 25 Billion Deutsche Marks for the medical insurance of 15 Million East Germans, but at the end of the year this amount had risen about 8 times.
However, the direction of the reform you asked me about is correct, but its success depends on its profundity, and in the case of such initiatives the state is recommended to take professional opinions from within and without of the country.
Written By Madona Gasanova