Kovzanadze: Global Vision, Extraordinary Approaches & Fundamental Changes Needed
BLOG By Irakli Kovzanadze, Chairman of the Budget and Finance Committee
Georgia’s results for the year 2017 were mostly positive, let’s take a look at the numbers:
Real GDP growth exceeded the forecast of 4% and reached 4.8% y/y growth.
Current account deficit reduced from 12% of GDP to 7%.
Tourism increased by 28%
Export increased by 29%
Budget deficit reduced to 3%
The State budget revenue target was met by 101% percent (the actual revenues exceeded the target by 131 million), among them, the tax revenue target was met by 100.1% or the target was exceeded by GEL 11.3 million:
• The expenditure target was met by 100%. All this is good achievement, but the governing team has higher ambition.
The main challenge of the Georgian economy in 2017 was inflation that reached 6.7%, instead of the targeted 4%, and the exchange rate that fluctuated significantly through the year. The high level of unemployment is one of our key challenges, as well as the low level of the household income and high dollarization of the economy. If not this high level of dollarization, the Georgian people would not feel the exchange rate fluctuations so painfully.
2017 was an important year from the perspective of the economic reforms.
• The deferred profits tax, or the “Estonian model” of the profits tax- was initiated by the Georgian authorities to help businesses invest. It’s initial positive results are already apparent: the reinvestment increased by 500 million (as part of the FDI), according to the three quarter data available for 2017. (The annual figures will be available shortly). It will take about two years to see the whole positive result of this reform.
• Deposit insurance system – let me note that I was advocating introduction of the deposit insurance system as early as in 20005-2006. The draft law was not then supported. By 2017, Georgia was the only country in Eastern Europe and the whole Post Soviet space that lacked deposit insurance system. The system was enacted in 2018 in Georgia, however, if we implemented the deposit insurance earlier, presently we would have insured the deposits of much higher amount than GEL 5000, which is a present threshold. The deposit insurance system provides security to the depositors and on the other hand, increases trust towards the banks, protects from fluctuations and increases stability of the banking and the whole financial sector, leading to the positive economic outcomes. I have noted continuously that adequate monetary policy, strict banking supervision and effective deposit insurance system are the three main pillars of the stability of the country’s financial sector.
• Insurance market – there were significant strides made to strengthen the state insurance supervision and imposing compulsory insurance requirement in certain cases (for example, for the vehicles registered in foreign countries, for the owners of places of public gatherings. Such efforts are important for the development of the insurance industry, minimization of risks and creation of long-term investment capital. The insurance sector is at the initial stage of development in Georgia.
• Stricter supervision for banks and non-bank credit institutions- it’s been years that the society has complained about the fact that the commercial banks own and manage the assets that are outside the banking profile through Banking Holding Groups and various companies managed as ‘pyramids’. By the end 2017, the National Bank of Georgia was given a right through a legislative amendment to implement regulation and supervision of three additional directions, other than banks, including: so called banking holdings (including assessment of effectiveness of the managerial decisions), financial groups and non-bank credit institutions. The NBG was granted all the tools as well as the responsibility to ensure order in this sector and the process is already underway.
• Capital market- the key measures of the capital market reform will be implemented in 2018. In 2017, the parliament of Georgia supported the initiative of the government of Georgia and the revenues from the shares and the bond and securities (including the treasury bills, state or corporate bonds) were excluding from the income tax base. This amendment ensured the similar tax treatment of the bonds and the banking sector deposits that is a step forward towards development of the securities market in Georgia.
But these positive statistics have not yet found their way to the life of the Georgian population.
Economic growth is important as much as its results reflected on the life on every member of the society. Our aim is an inclusive growth. This needs time. There are reasons impeding direct transmission of the economic growth of the country to the revenues of our citizens.
On one hand, we need more economic growth, but high dollarization is a significant negative factor. In spite of the fact that the dollarization decreased during the last few years thanks to the measures taken by the NBG, it still remains high (in 2017 Deposit dollarization reduced to from 71 to 66%, while loan dollarization reduced from 65 to 57 percent) .
Half of loans of physical persons in Georgia are denominated in a foreign currency, while their income is in local currency. Thus, during the 70 percent devaluation of the past years, the debt service costs of these families increased by 70 percent.
For example, if a person’s income was GEL 1,700 per month, while he had a loan in foreign currency (USD) and to service his debt he needed USD 500 a month. He would have needed GEL 850 before the devaluation. HE would have needed GEL 1,300 to service the same debt after the devaluation, while his income in GEL terms did not change.
Defaulting on debt would mean a loss of the pledged apartment, other real estate or some other asset. He was ought to reduce his consumption, spending on food, clothes, other needs, utilities, pastime, etc. this was a big burden for him. On the other hand, this reduces the aggregate demand and negatively affects the economic growth.
The priorities of the government and the team for 2018 can be grouped in the following directions:
• In 2018 the government will spend GEL 4 billion for spatial planning, infrastructural development, and business facilitation. This will improve infrastructure in towns and the regions, by reducing the gap between the center and the rest of the country, as well as tens of thousands of new jobs and faster economic growth.
• Pension reform – Georgia intends to move to the accumulating pension system starting from the third quarter of 2018, where the employee, the employer and the state will all contribute to the pension scheme. This is not a simple reform. The government expects that the cost of this reform will reduce the budget revenues by GEL 40 million. While the budget expenditures will increase by GEL 150 million. Even though it is costly, it is very important and vital step for sharing social responsibility and protecting pensioners in the long term. At the same time the reform will create the investment resource and a new source for activation of capital markets in the country.
• Capital market reform- here also, several new activities are planned. The legislative changed are in line with the best international experience and the free market principles. Capital market reform will encompass the pension reform and the insurance reform, that were mentioned earlier. Ultimately, we will get a dynamic market for bonds and capital, which will be able to compete with the banking sector by its scale and the rules of the game. To put is simpler, today, banking sector is the main channel if we need to borrow or to deposit, after the reform of the capital market, the market will be diversified, and there will be a healthy alternative in the form of the securities.
• Automatic reimbursement of the VAT is also an important issue. This means that companies will now be able to use about GEL 500-600 million a year, that was practically frozen and kept out of circulation. Automatic reimbursement of the VAT will expand business activity.
As for the second part of your question, the main economic challenges of the year 2018 will still be the unemployment, lari’s fluctuations and economic sustainability of our major trading partners.
Overall, focusing on the current economic challenges is not sufficient for us, we need extraordinary approaches, deep reorganization of the economy, institutional changes to build foundation for fast and sustainable growth of the next millennium where Georgia will be notably marked in the world economy.
I think that the problems that impede fast, sustained and inclusive growth of our economy is more global, fundamental and institutional than the problems that we face day to day. Let me mention several:
• Sectoral distribution of our economy: Georgia’s economic sectoral structure is not competitive and fails to respond to the modern challenges. 3/4th of our consumer market is import dependent, respectively, trade is a very important sector of our economy (16% of GDP), industry (17% of GDP) and service sector are still underrepresented. This is not the way forward. We will continue to lag behind the European countries. Nowadays our government tries to facilitate exports, they create export facilitation programs, take measures, but would not it be reasonable to support import facilitation, would not it be cheaper? At the same time, the macroeconomic effect would have been the same and I think, the results would have been seen faster.
• Agriculture and land reform are very important issues. Agriculture employs 45% of the country’s labor force and produces only 9% of the GDP. Moreover, even with the unprecedented state support of this sector during the last few years, the share of agriculture in GDP is declining. The reduction of the share of agriculture in GDP is not a problem by itself, as the share of agriculture in the GDP of the developed countries is smaller: 0.8% of GDO in Germany, 1.2% in USA, 1.8%in France, 28% in Turkey, 30% in Bulgaria. The most important feature is the output, i.e. the volume of the produce created in the sector of agriculture. We have no modern knowledge or technologies in Agriculture; productivity in the sector is very low. The land parcels of the physical persons are on average 1.2 hectares, while, large part of the land are still owned by the state and are excluded from the production process. We can’t be competitive with such setting. Land needs to get an owner, (excluding the exceptions, of course) farms shall merge and increase. In any other situation, agriculture in Georgia will never become sustainable, growing and successful business.
• Economic disparity among the regions- what is the situation here? We have Tbilisi, the major city, with 35% of the country’s population and 75% of the country’s business sector. (New York is 9% of the USA economy; London is 22% of the UK economy, Tokyo is 32% of the Japanese economy, Erevan is 41 % of the Armenian economy). The fact that the unemployment level in Tbilisi is 21% while its only 5% in rural areas is a paradox, because we all know that the jobs are in Tbilisi, that’s why everyone tries to come and live in Tbilisi.
• Urbanization – again Tbilisi, then Batumi, where economic activity is intensifying. There is some limited activity growth in Kutaisi. Big concentration is an economic and social impediment. It is also complex and long-term issue. Georgia will still see the population moving out of villages and increasing the population of the large towns. Without this, Georgia will never become competitive neither globally, nor regionally. This is the world trend. (in the USA, rural population is 18% of total population; 25% in EU, 26% in Switzerland, 26% in Turkey, 37% in our neighbor Armenia, and 45% in Georgia. The country needs to develop a long term policy and spell that into tactics. We shall study the situation and assess the economic, social, transport, communication and demographic trends of the potentially growing cities such as Kutaisi, Zugdidi, Anaklia, Telavi, Gurjaani, Gori, Akhalkalaki, where the conditions allow to host businesses and labor force. The state may consider constructing municipal houses, apartments, provision of dwelling to the needed families, granting some allowances. Such as providing land to business for a symbolic price of GEL 1 or others,
• Considering the modern tendencies and realities we must actively think to convert Georgia to an IT hub providing electronic technology services, financial technology services, including block chain technologies. These ideas have the supporters and the opponents. At the same time Georgia has comparative strengths and weaknesses. But overall, these are the technologies of the future, still un-pawed land, where Georgia needs to find its niche soon.
• The Georgian authorities strive to establish Georgia as a transport hub. Some results are already apparent. The projects such as Karsi-Akhalkalaki railways, Anaklia port, Tbilisi, Kutaisi Airports will make Georgia more attractive for transport and transit. There is one more possibility, yet undeveloped, which, I trust deserves attention. This is a water freight via Black sea with our partners such as Romania, Bulgaria, Ukraine. The international trade and transport specialists would agree that adding such a connection would enhance Georgia’s role as a transit hub in the region. Such initiatives deserve the governmental support.
• One more important issue, worth mentioning is the size of the Georgian market. Even though Georgia is a star in Doing Business rating, (political stability, low corruption and low criminal, simplicity of starting a business, low taxes, etc..), Georgia is still limited by its market size (3.5 million people, o/w 1.2 million are the labor force) to have abundant aggregate demand. Georgia signed the free trade agreements with the EU, China and work with India to sign the trade agreement. This will expand possibilities for our country to trade with goods and services. It will also help export and import capital. The free trade agreements are not about free relocation of the labor force. I trust we shall start negotiations with some of our friends and neighbors to discuss possibilities of creating an united market.
These is my professional viewpoint. I trust we need global vision, drastic, fundamental, deep-rooted changes, or else we will be in a vicious circle with limited choice of the growth rates of 4% or 6% or the pension amounts of GEL 180 or GEL 220 a month; or the exchange rates of 2.6 or 2.4 and so on. We need to surpass these details and attain new, higher levels.