Georgian Economy: Mistakes, Threats and Resolutions

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Almost all spheres of the Georgian economy appear to be in a difficult situation associated with high risks which are the consequences of a plethora of mistakes committed during the last years. Moreover, the current situation is significantly and gravely aggravated by Russia’s military aggression. The existing threats are seen to seriously hamper a rapid economic rehabilitation of the country in the period following the occupation.

The following is a description of the substance of mistakes which have been made in various sectors and the ways for preventing them in the future.

Property Rights
Substance of mistake

The biggest mistake made by the Government which came to power after the Rose Revolution is the infringement of property rights. Under pressure from law enforcement bodies, property owners were forced to surrender their property upon a “voluntary basis” for the benefit of the state. This process was conducted under the veil of deprivatisation which was supposedly implemented to correct the privatisation blunders committed before 2004. In reality, the infringement of the property right aimed at distributing this property amongst the so-called elite businessmen standing close to the Government. The situation worsened after more than one building was demolished without any legal grounds for doing so and within which each case was a vivid example of infringement of the property right.

Threats

Infringement of the property right arouses a perception of instability which is a factor hampering economic growth.

Resolution

An enhancement of the legislative framework to protect property rights does not suffice. The political will of the authorities is required in order to prevent it from happening again. At the same time, all those whose property is illegally or forcedly expropriated or destroyed should be paid an adequate compensation.

Sale of Public Property
Substance of Mistake

The large-scale privatisation process, which began in 2004 and went on in full defiance of the law — and bearing in mind the way in which Russian, Kazakh and Arab capital found their way into the country — is not at all surprising. Frequently, contracts concluded between the Government and a new owner exhibited a price which was several times lower than what was announced in the call for privatisation.

Quite often, companies with dubious founders and suspicious capital were established just prior to the holding of a tender for the very purpose of participating in the privatisation of one or another unit and then emerge as the winners.

There are also cases when another state becomes an owner of Georgian state property such as Tbilgaz having been transferred into the ownership of a Kazakh state company. This can hardly be considered as privatisation even though the Government of Georgia did present the transaction as such.

The biggest surprise overall was the nationalisation of the privatised United Bank of Georgia by the Russian Federation when the state Russian bank VneshtorgBank acquired its control stock following the encouragement of the Government of Georgia.

The Government has publicly rejected the concept of strategic units to be able to sell them freely.

Threats

The lack of transparency in the process of the privatisation of state property provides for the possibilities of corruption and the transfer of units of strategic importance to Russian companies (including state-owned companies) as an enemy of Georgia whilst enabling further possibilities for economic sabotage in Georgia.

Resolution

The process of the privatisation of state property should be made as transparent as possible so that information about the individual company founders is available for all citizens. Further, the law should prohibit the introduction of offshore companies into the Georgian economy. As concerns the units, which are presently under the control of Russian capital and companies of suspicious origin (Energo-Pro and Multi-Plex, amongst others), it is necessary to toughen their public supervision on the part of competent state authorities (the Agency for Financial Supervision, the National Energy and Water Supply Regulatory Commission and the National Communications Commission) and to have mechanisms for the enhancement of the rights and obligations of these authorities in this direction reflected in the relevant laws.

Limitation of Competition
Substance of Mistake

Following the Rose Revolution, the process of the disruption of public institutions began to facilitate a weakening of the Georgian statehood. At the end of 2004, for example, the anti-monopoly legislation and the State Anti-Monopoly Agency were abolished under the suggested reform framework which gave a strong impulse to the emergence of monopolies on the market.

Indeed, it was ridiculous to hear that the President of Georgia transferred the function of the anti-monopoly regulation of the market for salt, sugar and other goods — as reported during a television broadcast of a governmental session in October 2007 — to the Ministry of Interior even more so given that these commodities have nothing to do with the activities of the police or the State Security Office. Similar incidents — and equally ridiculous — have also taken place in the past such as the President commissioning the Minister of Defence to seek foreign markets for Georgian wine in 2006.

Threats

The limitation of market competition by monopolies does not only impede economic growth but ultimately causes damage to consumers who are forced to purchase required goods or services at monopolistically high prices. Furthermore, apart from the disadvantages created for consumers, the absence of an anti-monopoly regulation presents a serious barrier to Georgia’s being granted a free trade regime with the EU.

Resolution

It is necessary to ensure the adoption and enforcement of such a law on the anti-monopoly regulation which is in compliance with relevant EU recommendations.

State Statistics
Substance of mistake

Before 2005, the State Department for Statistics (SDS) was subordinated directly to the President of Georgia and incorporated within the Ministry of Economic Development in 2005 which obviously presents a conflict of interests. As a result, statistics in Georgia today bears the same political function as it did during the former Soviet Union; that is, in spite of the actual facts, they must reflect an unconditional yearly improvement of the country’s economic situation.

In August 2006, the SDS leaked information that the annual inflation rate was fixed at 14.5 percent as of July. Because of this, the National Bank of Georgia (NBG) and the Government of Georgia received severe but deserved criticism from the IMF Permanent Representative in Tbilisi. As a result, the Chairman of the Department was dismissed and the Government appointed another person who was ordered to make the published inflation rates gradually reduced. According to the Government, the annual inflation rate was set at 8.8 percent as of December 2006 and, therefore, it formally met the IMF’s requirement to curb inflation under a two-digit figure. The fact, however, emerged that neither the Georgian people nor experts in the field knew this to be true.

Unfortunately, the Government still continues to manipulate the state statistics with the “successful participation” therein on the part of international financial institutions.

Threats

Biased statistical data fail to provide a more or less realistic picture and, therefore, details about the actual situation of the Georgian economy remain hidden from everyone. Falsifying the existing economic data renders the carrying out of appropriate economic policy revision impossible and continuing to following this dishonest path is likely to drive the country and its population into very desperate straits.

Resolution

It is necessary to adopt a new State Law on Statistics which will render the respective public authorities truly independent from the Government. To this end, it is necessary to remove these institutions from the Government with a view to subordinating them to the President or, at the worst, to the Parliament.

The Government is Stimulating Inflation
Substance of mistake

Unfortunately, it became quite typical for our post-revolutionary Government to initiate populist economic programmes which only facilitated the growth of inflation rather than curbed it. One of the measures involved pursuing the noble objectives of increasing employment in Georgia under which businessmen were asked to hire an unemployed individual for a three-month term who would be paid GEL 150 per month from the state budget in 2006 and GEL 200 per month in 2007-2008. Indeed, as a result of spending tens of millions of lari from state coffers, few people were actually employed and, for many, it simply became a deal with businessmen who agreed to sign any document stating that a person was in his employ whilst happily receiving his “salary” for doing nothing at all. What is more, there were reports of some businessmen refusing to sign any employment documents unless the individual returned half of the money to him. In the end, these tens of millions of lari from the national budget were used for the payment of “unemployment allowances” rather than promoting employment itself. This sum entered the market for the purchase of consumer goods but only stimulated inflation given that no corresponding volume of goods or services was produced. It should also be noted that a similar programme, entitled “Clear City,” was implemented for students alongside this so-called “employment programme.” In addition, vouchers were issued for the purchase of various goods during the winter of 2007-2008 which further contributed to the continued upturn in inflation.

Threats

Such populist programmes only succeed in stimulating inflation and generally fail to attain their targets. Apart from making life more expensive for the common people, a high inflation rate undermines macroeconomic stability which is expected to eventually produce a negative effect upon the entire economy.

Resolution

The Government should express its political will and abandon its unprofessional practice and populism.

Budget Manipulations
Substance of Mistake

Starting from 2008, a new methodology for the formation of the national budget was introduced which led to the “disappearance” of the phenomenon of a budget deficit, as such. Unused budgetary sums are recorded as surplus over budget expenditure; that is, a budget surplus. In reality, the national budget revenues, by their nature, are renewable and it is for this reason that tax revenues are considered as budget revenues and not one-time incomes. We have a budget surplus, therefore, only in cases when these revenues exceed budget expenditure and we have a budget deficit, then, should they fall below. All one-time revenues, such as proceeds from privatisation, grants or credits, etc., merely represent a source for the coverage of a budget deficit.

Threats

This methodology creates the impression of a national budget surplus which, in fact, is far from reality. The budget reflects revenues from privatisation, a new foreign debt and one-time collections, etc., which is clear evidence of a budget deficit. The absence of true information about the national budget’s deficiency creates the illusion that the Government pursues an anti-inflation policy which, unfortunately, is not true.

Resolution

It is necessary to shift to a universally accepted methodology for the formation of the national budget which will consider only tax revenues, and not one-time payments to the budget, as budget revenues.

Employer-Employee Relations
Substance of Mistake

One of the “achievements” of the post-revolutionary Government is the adoption of a version of the Labour Code which grants maximum rights to an employer whilst depriving all rights of an employee. The Government justifies the establishment of such labour relations by its effort to make Georgia attractive for foreign investors.

In 2006, a presidential initiative envisaged combining the then 20 percent social tax and the 12 percent income tax into a single income tax set at 25 percent. This was accomplished with the new tax change made effective from 2007. Under a decision taken in 2008, however, the income tax rate will be decreased to 20 percent beginning in 2009 which, naturally, is certainly beneficial for employees. We should, however, bear in mind that this tax rate was only 12 percent a few short years ago.

The fact that a social tax and income tax are computed from various tax bases makes it impossible, in principle, to combine them.

Threats

The new Tax Code has further aggravated the social status of the employed and, in addition, the absence of any rights on the part of the majority of employees is a serious barrier to the EU granting a free trade regime to Georgia.

As concerns taxes, the 20 percent social tax was abolished for employers whilst increasing income tax from 12 percent to 25 percent for employees which substantially and detrimentally affects their status.

Resolution

In order to regulate labour relations, it is necessary to ensure the adoption and enforcement of a law which will be in compliance with relevant EU recommendations whilst ensuring a more or less guaranteed security for employees.

It would be reasonable to restore the social tax rate at the 12 percent level whilst reducing the income tax rate to 12 percent in order to equally distribute the employment tax burden between employers and employees with a view to reducing both these tax rates to 10 percent in the future.

Free Economic Zone – A Trap for Economic Development
Substance of Mistake

The idea of a Free Economic Zone (that is, an economic space wherein, unlike the rest of the territory of the country, various types of tax benefits are applicable) is largely associated with the name of Aslan Abashidze, the former leader of the Autonomous Republic of Ajara.

Under conditions of the ongoing economic liberalisation in the country, the establishment of a Free Economic Zone seems less expedient as the list of possible tax benefits and their scale are diminishing due to such a liberalisation. This argument is essential but, unfortunately, neither Abashidze nor the post-revolutionary Government wanted to take it into account.

Threats

The situation is getting even more acute because of the fact that the Georgian economy — during both the pre-war and post-war periods — is currently experiencing a lack of investments and, therefore, the creation of a Free Economic Zone under these conditions (as the Government decided to do in Poti) would only result in a worse investment “hunger” on the whole whilst ultimately hampering the economic growth of the country. In a situation of investment “hunger,” both foreign and native potential investors would only put their money in the Free Economic Zone (in this case, in Poti and its adjacent territories) whilst precluding investing capital elsewhere (such as Kutaisi, Zugdidi, Rustavi or Telavi, for example) which, therefore, would develop Poti but at the expense of the rest of Georgia.

Resolution

The current Law on the Special Industrial Zone in Georgia should be abolished. A contract on the establishment and development of a Free Trade Zone in Poti, as concluded with a selected foreign investor, should be terminated through the taking into account of international practice and upon the grounds that the territory was occupied and damaged by Russian troops during the confrontation in observance of international legal norms.

Weakening of the National Bank of Georgia
Substance of Mistake

The Government of Georgia intended to undermine the value of the National Bank of Georgia (NBG) as an independent institution as early as spring 2006 and even prepared changes and amendments to the Law on the NBG to this end. Under these changes and amendments, the National Bank would lose its bank supervisory function. As a result of this confrontation between the Government and the NBG, however, this intention remained unrealised and the National Bank was saved. In spring 2008, the Government took advantage of the resignation of the President of the NBG, at which time his duties were passed to the Vice-President, and finally managed to remove the NBG’s bank supervisory function despite the resistance of the financial-budgetary Committee of the Parliament and leave it with only one function; that is, to regulate inflation. In addition, the responsibility of the President of the NBG now became dependent upon the upper margin of the yearly inflation rate which in turn made him dependent upon the Government to the extent that it uses various powerful instruments to influence the yearly inflation rate.

Although the IMF stated a request in its memorandum that the Government of Georgia preserve the independence of the NBG, it was neglected given the fact that the IMF was no longer implementing programmes in Georgia by the spring of 2008.

Threats

The macroeconomic stability of Georgia is largely dependent upon the activities of the NBG and so limiting its area of regulation to the inflation rate creates a situation for other macroeconomic indicators — such as the exchange rate, balance of payments and foreign currency reserves, amongst others — to remain practically neglected; that is, the NBG will consider them only to the extent to which one or another macroeconomic indicator may have an effect upon the annual inflation rate. As concerns the transfer of the bank supervisory function from the NBG to its subordinate Financial Supervision Agency, the implementation of this function is now fixed at an institutionally lower level which thereby increases the possibility for the Government to exert pressure upon this Agency. Undermining the institutional value of the NBG makes it more dependent upon the Government, more politicised and ultimately creates a banking system which is less secured whilst substantially weakening the guarantees of macroeconomic stability.

Resolution

It is necessary to adopt a new Law on the NBG in order to increase its independence and to diversify its objectives (which should not be limited to only regulating the annual inflation rate) which will create firm guarantees for attaining and maintaining macroeconomic stability. As concerns the bank supervisory function, it is absolutely necessary to return this function to the NBG.

Issuance of Eurobonds and Increasing External Debt by an Additional USD 500 Million
Substance of Mistake

In spite of the fact that the national budget revenues were almost continuously on the uptrend after the Rose Revolution — and with the country’s leadership having no reason to increase the state debt — the Government of Georgia nonetheless enabled a growth in its foreign debt by another US 500 million dollars through the issuance of Eurobonds in April 2008. At the same time, the Government has practically admitted that they themselves do not know what the Eurobonds were for. At first, it was stated that this money was required to finance the construction of energy units but then confessed in the end that half of the sum would go to the Future Generations and Stable Development Funds with a decision regarding the use of the remaining money to be taken at a later date. These particular two Funds, however, should be filled by the budget surplus (real and not virtual). Moreover, the Government did not even bother to explain the reason for the loan which the tax payers will have to cover after a period of five years and including an annual 7.5 percent interest rate.
Following the Russian aggression, these USD 500 million may be used to recover economic losses and for other internal needs of the country.

Threats

Georgia is required to cover its foreign debt by 2013. Under its Constitution, Parliamentary elections will be held in 2012 and Presidential elections in 2013 which makes it very unlikely that a half billion dollars (and even more including the interest accrued) will be found in the national budget to cover this foreign liability. Under such conditions, the Government will have to again employ the same mechanisms and take a new external loan in the amount required to repay the old one. Given the elections cycle in Georgia, there is high possibility of building up a “debts pyramid;” that is, a mechanism designed to cover the old liabilities through an almost uninterrupted increasing of new foreign indebtedness which contributes to the unjustified increase in the external liabilities of the country in the long run.

Resolution

It is necessary to make changes to the Law of Georgia on the National Debt (it may also become necessary to prepare a qualitatively new draft law) which will strictly regulate issues related to increasing the national debt whilst also significantly increasing the responsibility of the Government in this sphere to prevent building up a “debts pyramid” in the country.

“Green Friday”
Substance of Mistake

On Friday, 7 November, the demand of commercial banks for the USD exceeded USD 31 million in the conditions of zero supply on the Interbank Currency Market (ICM) with the trend continuing as recently as last month and for more than one month. The NBG could satisfy only USD 270 thousand of the demand and then stopped the currency market operations upon the basis of technical reasons. This resulted in panic which saw ATMs being emptied at once and exchange shops raising the USD rate significantly and often refusing to sell dollars. As a result, the NBG organised a “Green Friday” for the country. The panic on the currency market of Georgia continued from Friday through the week-end with the NBG selling USD 47 million and fixing a new lari rate on Monday (10 November) when operations on the ICM recommenced under which the lari had depreciated by 15 percent against the morning of the “Green Friday.” Only after this, the management of the National Bank announced that it had planned the developments of 7 November in advance.

After the war in August, the IMF allocated a USD 750 million credit for maintaining macroeconomic stability in Georgia under the Stand-by Arrangement framework of which USD 250 million was transferred to the NBG reserves in the autumn of 2008. Instead of a progressive, creeping depreciation of the Georgian lari, the NBG tried to ensure an almost unnoticeable depreciation of it through the spending of these reserves. Up to USD 300 million were spent from the NBG reserves within one month which resulted in the lari falling against the USD by only 2.5 percent. Consequently, USD 250 million received from the IMF was spent with a very low result with the Government unable to think of anything better to do than organise the “Green Friday.”

Threats

After the “Green Friday,” the population avoided using the lari and commercial banks hesitated in issuing credits in lari which ultimately resulted in a higher dollarisation of the economy. Given that 80 percent of the consumer market is accounted for by imports, this gave impulse to a sudden fall in prices.

Resolution

The devaluation of the lari in Georgia was inevitable after the war but it was necessary in order to ensure that the process of devaluation proceeds at a gradual pace in order to maintain macroeconomic stability and prevent panic on the currency market as it was on the “Green Friday.” Assistance to Georgia in the amount of USD 4.5 million in 2008-2010 creates objective grounds for the exclusion of a possible sudden fall of the lari although it is not excluded that this may happen again if the organisers of this “Green Friday” do not put forward at least a political responsibility. The process of devaluation should proceed step-by-step in order to restore confidence in the national currency.

Economic Programme
Substance of mistake

The Presidential and Parliamentary elections of 2008 proceeded under the slogan “United Georgia without Poverty!” This slogan was embodied by the Government in its suggested programme under the same title which was passed by the Parliament at the end of January 2008. This document, however, may only conditionally be called a programme to the extent that it is limited to several pages and covered with catchy words and phrases.

It should be noted that a comprehensive National Programme on Economic Growth and Poverty Reduction was prepared and approved as early as in 2003 by the Georgian President together with the active participation and funding of the IMF, the World Bank and other international organisations and which at that time earned the high praise of these organisations. The unfortunate fact, however, is that the Government — brought to power on a wave of revolution and in its neglect of everything achieved before to the revolution — was so incapable in its activities that there was no attempt to launch the programme but, rather, consigned it to oblivion.

This notwithstanding, both the IMF and the World Bank successfully keep deceiving themselves and publicly declare their contribution to the programme to overcome poverty in Georgia; that is, to something that the Government of Georgia itself has not even recognised. Moreover, the IMF even affirmed in September 2007 that the programme on poverty reduction in Georgia had been successfully accomplished. Afterwards, the Government of Georgia had no desire to launch anything new with the IMF and the Fund would have to wait a long time before it could start another programme in Georgia if it were not for the Russian aggression.

Threats

The economic policy pursued recently by the Government of Georgia has had no programme whatsoever to underpin it. Even the 50-month or 18-month programmes which were proposed in 2008 are not accessible and give rise to rather justified doubts about whether or not these documents even exist at all whilst the availability of a real economic programme creates the grounds to suggest a higher risk of making blunders.

Resolution

The Government of Georgia needs to develop a new five-year programme on Economic Growth and Poverty Reduction and to actively engage and involve both national and international experts from the IMF, the World Bank and other international institutions in the process.

Vladimer Papava,

\”Crisis in Georgia, 2008. Preconditions, Reality, Perspectives\”,

Independent Experts’ Club

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