Kovzanadze: Global Vision, Extraordinary Approaches & Fundamental Changes Needed

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Georgia’s results for the year 2017 were mostly positive. 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% and the budget deficit reduced to 3%. The State budget revenue target was met by 101% (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%. This is a great achievement, but the governing team has a higher ambition.

The main challenge to the Georgian economy in 2017 was inflation, which 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 household income and high dollarization of the economy. If not for this high dollarization, the Georgian people would not feel the exchange rate fluctuations so painfully.

2017 was an important year from the perspective of economic reform.

The deferred profits tax, or the “Estonian model” of profits tax- was initiated by the Georgian authorities to help businesses invest. It’s initial positive results are already clear: reinvestment increased by 500 million (as part of the FDI), according to Q3 data available for 2017 (the annual figures will be available shortly). It will take around two years to see the complete positive result of this reform.

The deposit insurance system that I advocated for the introduction of in as early as 2005-2006, the draft law of which was not then supported, was at last implemented. By 2017, Georgia was the only country in Eastern Europe and the whole Post Soviet space that lacked a deposit insurance system. The system was enacted in 2018 in Georgia; however, if we had implemented the deposit insurance earlier, presently, we would have insured deposits of a much higher amount than GEL 5000, which is the present threshold. The deposit insurance system provides security to depositors, increases trust towards the banks, protects from fluctuations, and increases the stability of the banking and financial sector, leading to positive economic outcomes. I have noted continuously that an 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.

There were significant strides made to strengthen the state insurance supervision and impose compulsory insurance requirements in certain cases (for example, for vehicles registered in foreign countries, for the owners of places of public gatherings, etc.). 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.

There is now stricter supervision for banks and non-bank credit institutions. For years, society has been complaining about commercial banks owning and managing assets that are outside the banking profile through Bank Holding Groups and various companies managed as ‘pyramids’. By the end 2017, the National Bank of Georgia (NBG) 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 given the tools and the responsibility to ensure order in this sector and the process is already underway.

Key measures of capital market reform will be implemented in 2018. In 2017, the Parliament of Georgia supported the initiative of the government that revenues from shares, bonds and securities (including treasury bills, state or corporate bonds) be excluded from income tax. This amendment ensured the similar tax treatment of bonds and the banking sector deposits; a step forward towards development of the securities market in Georgia.

But these positive statistics have not yet found their way into the lives of the Georgian population.

Economic growth is important as its results impact on the life on every member of society. Our aim is inclusive growth, which 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. Despite dollarization decreasing over 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%).

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%devaluation of the past years, the debt service costs of these families increased by 70%.

For example, if a person’s income was GEL 1,700 per month and he had a loan in foreign currency (USD), to service his debt he needed USD 500 a month. He would have needed GEL 850 before the devaluation and GEL 1,300 to service the same debt after the devaluation, while his income in GEL terms remained unchanged.

Defaulting on debt would mean a loss of the pledged apartment, other real estate or some other asset. He was forced to reduce his consumption, spending on food, clothes, other needs, utilities, entertainment, etc.: a heavy burden for him. On the other hand, this reduces the aggregate demand and negatively affects 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 on 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 creating tens of thousands of new jobs and faster economic growth.

• Pension reform – Georgia intends to move to the accumulating pension system starting from Q3, 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 the cost of this reform will reduce the budget revenues by GEL 40 million and budget expenditures will increase by GEL 150 million. Even though it is costly, it is a 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- the legislative changes here are in line with the best international experience and free market principles. Capital market reform will encompass the pension reform and the insurance reform mentioned earlier. Ultimately, we will get a dynamic market for bonds and capital which will be able to compete with the banking sector in scale and rules of the game. To put is simply, today, the banking sector is the main channel if we need to borrow or deposit. After the reform of the capital market, the market will be diversified, and there will be a healthy alternative in the form of securities.

• Automatic reimbursement of VAT. This means that companies will now be able to use about GEL 500-600 million a year, that was previously frozen and kept out of circulation. Automatic reimbursement of VAT will expand business activity.

The main economic challenges of the year 2018 will still be unemployment, Lari fluctuations and the 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 and institutional changes to build a foundation for fast and sustainable growth of the next millennium where Georgia will be notably marked in the world economy.

The problems impeding the fast, sustained and inclusive growth of our economy are more global, fundamental and institutional than the problems that we face day today.

Sectoral distribution of our economy

Georgia’s economic sectoral structure is not competitive and fails to respond to modern challenges. 3/4 of our consumer market is import-dependent; respectively, trade is a very important sector of our economy (16% of GDP), while industry (17% of GDP) and the service sector are still underrepresented. This is not the way forward. We will continue to lag behind the European countries. Nowadays, our government is trying to facilitate exports by creating export facilitation programs, but would not it be better and cheaper to support import facilitation? At the same time, the macroeconomic effect would be the same and I think the results would have been seen faster.

Agriculture and land reform

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 over 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 developed countries is smaller: 0.8% of GDO in Germany, 1.2% in USA, 1.8% in France, 28% in Turkey, and 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 physical persons are on average 1.2 hectares, while a large part of the land is still owned by the State and is excluded from the production process. We can’t be competitive with such a setting. Land needs to have an owner (excluding the exceptions, of course); farms should merge and increase. In any other situation, agriculture in Georgia will never become a sustainable, growing and successful business.

Economic disparity among the regions

We have Tbilisi, a 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 it is only 5% in rural areas is a paradox, because we all know that the jobs are in Tbilisi; that’s why everyone tries to go and live there.

Urbanization

Tbilisi, then Batumi, is where economic activity is intensifying. There is some limited activity growth in Kutaisi. This large concentration is an economic and social impediment. It is also a 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 globally, nor regionally. This is a world trend- in the USA, the rural population is 18% of the total population; 25% in the 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 us to host businesses and labor force. The state may consider constructing municipal houses, apartments, provision of dwelling to families in need, granting some allowances such as providing land to businesses for a symbolic price of GEL 1.

IT

Considering the modern tendencies and realities, we must actively work to convert Georgia into an IT hub providing electronic technology services and financial technology services, including blockchain technologies. These ideas have both supporters and opponents. At the same time, Georgia has comparative strengths and weaknesses. Overall, these are the technologies of the future, still un-pawed land, where Georgia needs to find its niche quickly.

Transport

The Georgian authorities strive to establish Georgia as a transport hub. Some results are already apparent, with projects such as Karsi-Akhalkalaki railways, Anaklia Port, Tbilisi, Kutaisi Airports making Georgia more attractive for transport and transit. There is one more possibility, yet undeveloped, which I think deserves attention: water freight via the Black Sea with partners such as Romania, Bulgaria and Ukraine. 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 government’s support.

Georgian Market Growth

Even though Georgia is a star in the Doing Business rating (political stability, low corruption, 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 an abundant aggregate demand. Georgia signed the free trade agreements with the EU and China and is working with India to sign a 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 a united market.

The above is my professional viewpoint. I believe we need a global vision and drastic, fundamental, deep-rooted changes, or else we will be caught in a vicious circle with limited choice of growth rates between 4% or 6%, pensions of GEL 180 or GEL 220 a month; and exchange rates of 2.6 or 2.4. We need to surpass these details and attain new, higher levels.

By Irakli Kovzanadze, Chairman of the Budget and Finance Committee