Georgia - Economy
Georgia suffered severe political and economic turbulence during the years following the re-establishment of its independence in 1991. In the mid-1990s Georgia began to experience modest but increasing levels of GDP growth and foreign investment. Until 1998 Georgia's economy grew on average 7%. This growth was attributable to the introduction of a new, stable currency, reduced rates of inflation, and the re-establishment of both economic and political stability. Economic growth and reform slowed in 1998, due to the Russian financial crisis, drought, and political events, including a major outbreak of hostilities in Abkhazia and an assassination attempt against the President. However, the period also saw completion of the first major infrastructure project, the Baku-Supsa early oil pipeline.
Growth through 2002 was positive, and Georgia's economic performance is slowly improving, with GDP growth of 3% in 1999, 2% in 2000, 4.5% in 2001, 5.3% in 2002, and 8.3% in the first nine months of 2003. Despite these setbacks, Georgia led the former Soviet Union in developing the legal infrastructure necessary for an attractive investment climate. Georgia maintains no currency controls, allows foreign investment in all but a few sectors deemed strategically important, and has implemented an impressive privatization program, including land privatization. Georgia was the second country of the former Soviet Union to join the World Trade Organization, which will provide additional opportunities for development.
Economic activity in Georgia remains below potential. The low level of increase in trade and GDP are due to fundamental economic problems that have eroded investor confidence in Georgia. The poor fiscal situation, pervasive corruption, and arbitrary implementation of laws and regulations have inhibited economic growth in the country. Georgia's electricity sector is in critical condition. Shortages of electricity have resulted in public unrest each year. In 1998, Georgia began to privatize its energy distribution system and hoped to privatize its energy generation system by 2000, an objective that remains unrealized.
Privatization is the only means to generate the capital needed to rehabilitate the economic sector. Due to a lack of investment, Georgia's transportation and communication infrastructure remains in very poor condition. The Ministry of Transport and Communication's agenda to privatize the telecommunications industry has been hampered by the lack of bidder interest.
Corruption in Georgia, both official and otherwise, has been a significant and persistent obstacle not only to domestic and foreign investment, but also to economic development. Its pervasive nature and high visibility have stunted economic growth and seriously undermined the credibility of the government and its reforms. In July 2000 the government created an Anti-Corruption Commission that made its report in the fall of 2000. Based on this report, an Anticorruption Coordinating Council (ACCC) was created in summer 2001 to implement recommendations of the Anti-Corruption Commission. Its recommendations include several measures that, if implemented, would improve the investment climate. However, few, if any, of the recommendations have been acted upon. The ACCC has, however, become more active, and in fall 2003 they recommended that members of the traffic police be removed and prosecuted based on reports of corruption.
Problems with fiscal policy affected macroeconomic conditions in recent years. An International Monetary Fund (IMF) program initiated in 1996 was put on hold in 1999 due to Georgia's failure to meet certain budgetary targets. However, an improved macroeconomic picture and a more realistic budget in the second half of 2000 paved the way for IMF Board approval of a new program for Georgia in January 2001. Though Georgia's fiscal performance since has been uneven, dialogue continues with the IMF and World Bank. The IMF program was halted repeatedly in 2001-02, following Georgia's continued difficulty in both reaching targets and complying with a number of requirements. Georgia reached a debt rescheduling agreement with the Paris Club in 2001, which covered its principal debts due in 2001 and 2002, and also contained a goodwill clause extending the agreement to the amounts falling due in 2003 conditional on the existence of an IMF program. In the summer of 2003, however, Georgia's IMF program (a Poverty Reduction and Growth Facility, which was scheduled to expire in January 2004) fell off-track, due to significant fiscal slippages in the first half of 2003 stemming from optimistic budget assumptions on certain receipts that did not materialize, and a slackening of the tax collection effort. The authorities were unable to obtain parliamentary support for a revised 2003 budget intended to fully close the emerging fiscal gap. Discussions on a successor IMF arrangement are expected to begin in January 2004.
Foreign direct investment (FDI) has declined in recent years to $61.8 million in 2001, compared to $83.65 million in 1999. Key sectors of economic activity in Georgia include energy, agriculture, trade, tourism, and transport, as well as significant projects in the food processing and telecommunications industries. The United States is the largest foreign investor in Georgia, annually contributing between 20%-34% of overall FDI in recent years. The construction of the Baku-Tbilisi-Ceyhan oil pipeline, which began in April 2003, and the Shah Deniz gas pipeline, expected to begin in 2004, will offer opportunities for investors in the energy sector as well as related infrastructure. Additional privatization is planned in the energy sector, including power distribution outside of Tbilisi and hydropower facilities.
Georgian agricultural production is beginning to recover following the devastation caused by the civil war and sectoral restructuring necessary following the breakup of the Soviet Union. Livestock production is beginning to rebound, and domestic grain production is increasing. Both will require sustained political will and infrastructure improvements to ensure appropriate distribution and return to farmers. Tea, hazelnut, and citrus production have suffered greatly as a result of the conflict in Abkhazia, an especially fertile area. Supported by European Union assistance, Georgia has taken steps to control the quality of and appropriately market its natural spring water. Georgian viniculture, well developed during Soviet times, is internationally acclaimed and has absorbed some new technologies and financing since 1994.
To encourage and support the reform process, the United States and other donors shifted the focus of assistance from humanitarian to technical and institution-building programs. Provision of legal and technical advisers to various government ministries is paired with training opportunities for parliamentarians, law enforcement officials, and economic advisers, complemented by extensive educational exchanges programs. The United States and other donors have increasingly imposed conditions on assistance in order to encourage improved performance on key issues and in key sectors, including energy. The United States terminated two assistance programs in fall 2003 due to lack of progress and commitment for reform on the part of the Georgian government. Georgia continues to depend on humanitarian aid, which is increasingly targeted to most-needy groups.
One of the Saakashvili government's first and most impressive actions has been to improve government finances and arrest the deterioration of basic government services. The government of Georgia hadn't been paying its bills or keeping its commitments to government workers and pensioners. Public infrastructure had been deteriorating. According to a 2002 business climate survey, Georgian businesses lost an average of 110 business days a year because of infrastructure failures, largely in the energy sector. Much of the problem involved an unwillingness to crack down on tax evasion. Unfair application of the tax laws meant well-connected individuals and businesses avoided taxes, often by bribing tax inspectors. Tax collections were very low.
By taking action on tax evasion, the government has significantly improved tax collection. In fact, tax revenues have already increased by 4 percent of GDP. As a result, this year the government has kept its budget commitments for the first time since 1997. It has cut the stock of budget arrears in half and was on track to eliminate them completely by the end of 2005. Moreover, it has begun to rebuild the country's infrastructure and renewed investments in health and education.
A second part of the reform agenda is tax reform. According to a 2003 business survey, Georgia businesses cited high tax rates and the unpredictability of the tax system as the primary obstacle to doing business. To reduce these obstacles the government is now pushing forward an impressive tax reform package. The reform would eliminate over 2/3 of existing taxes and significantly lower remaining tax rates. It would include a 12 percent flat income tax. Through greater simplification and uniformity, these changes will lower administration burdens and reduce opportunities for corruption. This gives domestic businesses greater incentives to operate openly in the formal sector and make investments. It will also lower barriers to greater foreign direct investment.
A third area of reform was the reduction of the size and scope of government. This makes a great deal of sense because by almost any comparison, the government sector is too big and the private sector too small in Georgia. The private sector accounts for only 40 percent of total employment in Georgia compared to 75 percent in Armenia and 80 percent in Estonia.
To begin to rectify the situation, the government has already reduced government employment by an estimated 50,000. The Economy Minister plans to eliminate his own ministry by 2007. Such actions will also allow pay increases for remaining civil servants, reducing the incentive for corruption.
At the same time, Georgia still had too many state-owned enterprises tying up valuable human capital. The Economy Ministry plans to privatize 1,800 state enterprises employing 180,000 people by 2007. Such privatizations further support a market-based allocation of capital and job creation in the economy.
The fourth area was fighting corruption. Georgia ranked 133 out of 145 in Transparency International's Corruption Perceptions Index. That President Saakashvili was elected on a strong anti-corruption platform gave his government the opportunity to address this serious problem.
Fighting corruption is fundamental to the whole economic reform agenda. Public finances can't be improved without fighting corruption among tax inspectors. A simpler, low rate tax code uniformly applied provides fewer incentives to evade. Fewer bureaucrats mean fewer bribes. Private ownership of business means success is determined by the company's bottom line and not its political connections.
