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Georgian-European Policy and Legal Advice Centre (GEPLAC)

GEPLAC was established in 1997. It is an EU-funded project to facilitate the closer relations between Georgia and the European Union. In providing its recom-mendations to the Georgian Government, GEPLAC follows the provisions of the EU-Georgia Partnership and Cooperation Agreement.

The fi fth phase of the project is being implemented by Altair Assesores, the Brit-ish Council, the European Social and Legal Economic Projects (ESTEP) and the Georgian Foundation for Strategic and International Studies (GFSIS).

GEPLAC issues two quarterly publications in Georgian and English languages – Georgian Economic Trends and Georgian Law Review. Although these publica-tions are issued within the framework of the EU Technical Assistance programme, they represent the views of the authors and do not represent any offi cial opinion of the European Union.

GEORGIAN ECONOMIC TRENDSQuarterly reviewOctober2006

This project is funded bythe European Union

GEORGIAN ECONOMIC TRENDS

Georgian Economic Trends (GET) is a quarterly publication of the Georgian-European Policy and Legal Advice Centre (GEPLAC), which aims at providing all interested readers with a review of devel-opments in the Georgian economy and analysis of economic reform and policy pursued by the govern-ment. GET is issued in both Georgian and English languages and is available on the internet.

GET is an independent publication. The materials represent the views of the authors and do not repre-sent any offi cial opinion of the European Commission, the Georgian-European Policy and Legal Advice Centre, or the Georgian Government.

For further information please contact:Georgian-European Policy and Legal Advice Centre,3a, Chitadze Street, Tbilisi,0108, GeorgiaTel: (095 32) 921371Fax: (095 32) 931716E-mail: [email protected]

Editorial Board:

Christophe CordonnierKakha GogolashviliMerab KakuliaVladimer PapavaAlexei SekarevIvan Samson

Proof-reader John Wright

Separate chapters were prepared by the following experts:

Lela Bakhtadze Gross Domestic Product and Real Sector, Public FinanceGocha Tutberidze Money and Banking, External Sector, EU-Georgia Economic RelationsVeronika Schneider Labour Market and Households Budgets

CONTENTS

Overcoming infl ationary pressures: effective sterilisationversus Lari appreciation. GEPLAC Comment __________________________________________ 7

Main Economic Events ____________________________________________________________ 8

Summary Macroeconomic Indicators ________________________________________________ 13

PART I. OVERVIEW OF THE GEORGIAN ECONOMY

1. Gross Domestic Product and Real Sector ___________________________________________ 15

2. Public Finance ________________________________________________________________ 21

3. Money and Banking ___________________________________________________________ 25

4. Labour Market and Household Budgets ____________________________________________ 31

5. External Sector _______________________________________________________________ 36

6. EU-Georgia Economic Relations _________________________________________________ 41

PART II. ECONOMIC TRENDS AND POLICY ANALYSIS

1. Diversifying and Promoting Exports in Georgia _____________________________________ 46Volkhart Vincentz, PhD in economics, Osteuropa-Institut, Munich; GEPLAC Economic Expert,with collaboration of Dimitri Kemoklidze

2. “Dutch Disease” in Georgian economy: current reality and potential threats _______________ 57Nana Aslamazishvili, PhD in economics,Head of Monetary Statistics and Balance of Payments Division, National Bank of Georgia

PART III. ECONOMIC REFORM AGENDA

Achieving Coherence between the Georgian Medium-Term Reform Programand the EU-Georgia Action Plan (ENP AP) ___________________________________________ 63Ivan Samson, Professor, Director of Espace Europe Institute at UPMF University, Grenoble; GEPLAC economic expert

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GEPLAC COMMENT

Overcoming infl ationary pressures: effective sterilisation versus Lari appreciation

According to the recent Doing Business Report 2007 of the World Bank, Georgia has made more progress in making itself “business-friendly” than any other country in the past year. As a result, it has leapt from 112th position to 37th in the World Bank’s table measuring the ease of doing business - ahead of even such countries as Italy and Spain.

The international recognition of this remarkable success comes shortly after the IMF in mid-August rendered a word of warning to the government that “the current level of infl ation… poses a serious risk to macroeconomic stability”. Indeed, as argued in the previous issue of Georgian Economic Trends, growing infl ationary pressure originates from a combined effect of loosened expenditure stance, sharp increase of credits to the economy and continuing capital infl ows. The negative impact of these devel-opments will be aggravated, at least in the short run, by losses in export revenue, owing to the Russian blockade on wine and waters, as well as possible price rises for the imported energy, fi rst of all on Gas.

Georgian authorities recognize that, as recommended by the IMF, expenditure restraint, a smaller defi cit and slower growth of money supply would help to reduce demand pressures till end-2006. At the same time, because Georgia is becoming more attractive to foreign investors, the supply of foreign currency in the recent years has been increasing, mainly due to large infl ows of capital and remittances. Lari has suffi ciently appreciated both in nominal and real effective terms since 2004.

The National Bank has reacted so far to this process by buying out foreign currency and increasing its reserves, but managed only to slow down the appreciation trend. At present, the NBG has quite limited possibilities to sterilise excessive stock of money, in an environment of underdeveloped fi nancial mar-ket. Certifi cates of deposit recently issued by NBG may become an effi cient instrument if they are made lucrative. Substantial sterilisation efforts of NBG will be followed by an increase of interest rates, albeit moderate owing to the low monetisation of the economy. Needless to say that antiinfl asionary exertion of NBG will remain unproductive, unless supported by a tightened expenditure stance.

If the National Bank refrains from expanding currency reserves and thus money emission, Lari would continue its nominal and real appreciation. This kind of development will have controversial conse-quences. On the one hand, domestic prices on imported commodities, including energy, would become lower and help to keep infl ation broadly under control. On the other hand, further real appreciation of Lari would limit export capabilities including diversifi cation of export markets, strengthen the import orientation of the Georgian economy and erode the value of remittances, which represent an important source of households’ income. In the medium- and longer-term perspective, it would lead to sharp dete-rioration of the current account balance, which is becoming visible already, and hence induce a reverse trend, i.e. cause a large-scale depreciation of the national currency. Infl ationary pressure in such case would turn much more severe then now.

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MAIN ECONOMIC EVENTS2006July 5Georgian President Mikheil Saakashvili met with his U.S. counterpart George W. Bush in Wash-

ington. Developments in consolidating Georgia’s democratic transition, cooperation in energy security and Georgia’s Euro-Atlantic aspirations and common commitment to working together to advance free-dom and security around the world were on the agenda of the talks, according to the White House. At a news conference after the talks the U.S. President hailed Georgia’s drive to achieve economic growth through reforms and welcomed the Georgian authorities’ efforts to eradicate corruption. He said Geor-gia is a friend of the United States and both countries sharre same values.

July 5Talks over purchasing additional amount of Shah-Deniz gas at a reduced price have not yet been

completed, Georgian PM Zurab Nogaideli said after a meeting with the Azerbaijani leadership in Baku. The Georgian Prime Minister met with his Azerbaijani counterpart Artur Rasizade, President Ilham Aliyev and other offi cials. Issues related with the Baku-Akhalkalaki-Kars railway project to link Az-erbaijan with Turkey via Georgia were also discussed during the talks. The Azerbaijani Prime Minister noted that Baku will spare no efforts to implement the railway project, Azeri state news agency AzerTag reported.

July 8The Russian side closed the Zemo Larsi checkpoint on the Russian-Georgian border, citing the

necessity of carrying out repair works. According to the Georgian Border Police it is not known how long the repair works will continue. The Zemo Larsi is the only legally operating border checkpoint with Russia. Two others are located in the breakaway regions of South Ossetia and Abkhazia. Vasil Maglaperidze, the Governor of Mtskheta-Mtianeti region, said that “repair jobs cannot be a real reason for closing down the major highway.”

July 12Vimpel-Communications (VimpelCom) said it has bought 51 percent of Georgian cellular op-

erator Mobitel for USD 12.6 million. Mobitel, which was founded in 2003, but has never conducted any operations, owned GSM-1800 cellular licenses. “Upon closing of the transaction, VimpelCom plans to hold a tender for purchase of equipment and start construction and development of the network,” the company said in a statement. VimpelCom is a leading mobile phone service provider in Russia and Ka-zakhstan with newly acquired operations in Ukraine, Tajikistan and Uzbekistan. The company operates under the “Beeline” brand in Russia and Kazakhstan. “We are pleased to announce our entry into Geor-gia... This market undoubtedly has big development potential. With VimpelCom’s entry into Georgia, the total population of our license area is about 237 million. In line with VimpelCom’s CIS expansion strategy, this is the fi fth CIS country outside of Russia in which VimpelCom will have operations,” Al-exander Izosimov, Chief Executive Offi cer of VimpelCom, said. Currently there are two mobile phone operators in Georgian: Geocell - with 55 percent market share and MagtiCom - with 45 percent market share, according to independent sources, the company said. The penetration rate of cellular services in Georgia is about 30 percent, according to the VimpelCom.

July 13President Saakashvili hailed the launch of the Baku-Tbilisi-Ceyhan oil pipeline as of “historic

importance” at an offi cial inaugural ceremony of the BTC. Azerbaijani, Georgian and Turkish leaders, as well as senior offi cials from the region and the United States gathered in Ceyhan to participate in the ceremony.“For us, the Baku-Tbilisi-Ceyhan oil pipeline is much more than simply an economic or even political energy project. This is a historical precondition for laying a fi rm foundation for freedom, independence and future success of our countries,” Mikheil Saakashvili said. The Georgian President stressed that the construction of the BTC pipeline has contributed much to economic development before 2003. “However, following the rose revolution [in 2003], other factors have also contributed to the economic growth, including improvement of investment environment, effective governance and reduction of corruption,” Saakashvili said, adding that Georgia becomes more and more attractive for investments. In his speech Saakashvili called Turkey “a major partner”, which, as he put it, will become “number one investor” soon. Speaking at a news conference in Istanbul on July 12 U.S. Deputy Under-

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secretary for Energy Clay Sell said that BTC was “an effort of great strategic and economic importance to the countries involved.”The interest of consuming nations ... is to have a multitude of transit routes,” the Associated Press quoted Undersecretary Clay Sell.

July 13The United States is very pleased with the opening of the Baku-Tbilisi-Ceyhan oil pipeline,

Sean McCormack, Spokesman of the U.S. Department of State said at a press briefi ng in Washington. “I think it’s a good thing for the people of Turkey, a good thing for the people in the region and it’s a good thing for the people of the world in terms of having multiple sources of energy supply and energy delivery in a cost-effective way,” the U.S. offi cial said. Azerbaijani, Georgian and Turkish leaders, as well as senior offi cials from the region and the United States participated in the offi cial inaugural cer-emony of the Baku-Tbilisi-Ceyhan pipeline in Turkey.

July 14The Georgian government has decided to re-open bilateral market-access negotiations with

Moscow within the framework of Russia’s WTO accession talks, the Georgian Foreign Ministry said.The Georgian side said that Russia has violated the May 2004 protocol on conclusion of bilateral market-access negotiations through banning imports of Georgian wines and spirits, as well as mineral waters. Tbilisi has also complained that operation of two illegal border crossing points - one in breaka-way South Ossetia (Roki Tunnel) and another on in breakaway Abkhazia (Gantiadi) is also a violation of the protocol signed by the two countries in May, 2004. The Ministry of Economic Development will be in charge of negotiations with Russia.

July 25The Georgian Parliament approved amendments to the 2006 state budget envisaging an increase

of expenditures by GEL 323 million (USD 182.3 million). A large portion of this sum - GEL 212.5 mil-lion (up to USD 120 million) - will be allocated to the Defense Ministry.“Defense funding is increasing not because Georgia is on the path of militarization, but because we are actually building the defense system anew,” Parliament’s Vice-Speaker Mikheil Machavariani said. Initially, draft amendments en-visaged an increase of expenditures by GEL 77 million. However, Finance Minister Lexo Alexishvili, who presented the draft amendments to the Parliament, said that the increase by GEL 323 million was made possible as the result of a growth of revenues. He said that by the end of 2006 GDP growth will reach two-digit fi gures. The Finance Ministry reported a surplus in the collection of tax and non-tax revenues by GEL 190 million and GEL 133.8 million respectively. Increased revenues will also be distributed to the following structures and activities: Tbilisi city municipality budget will be funded by GEL 44.5 million; GEL 9.5 million will be allocated for regional (infrastructure development) projects; GEL 25.1 million will go to the Healthcare Ministry; GEL 9.9 million (including GEL 1.6 million for Border Police) to the Interior Ministry; the Central Election Commission will receive GEL 7.8 million for local self-governance elections scheduled for this autumn; Economic Development Ministry’s road department - GEL 3 million; Parliament - GEL 580 thousand.

July 26Georgia saw the largest reduction in corruption among all transition countries from 2002-2005,

says a World Bank (WB) report. “Anticorruption in Transition 3 - Who is Succeeding … And Why?” is a detailed report of studies examining the patterns and trends in corruption in Eastern Europe and Central Asia. “Among countries showing the most dramatic improvements are Georgia and the Slovak Republic, where committed leaders are implementing strong programs of economic and institutional reform and fi rm-level bribery has fallen substantially,” the World Bank report reads. “The most striking improvements from 2002 to 2005 were in Georgia where the percentage of fi rms reporting that bribery of tax offi cials was frequent fell from 44 percent to 11 percent in these three years.”The report says that “major improvements” are also observed in customs-related bribery in Georgia.The fi rms in the survey report less frequent bribery in the courts then three years ago in a few countries, including in Georgia, Romania and the Slovak Republic, according to the WB report.

August 4President Saakashvili announced that the country’s major economic goal will be a twofold re-

duction of unemployment by 2009 through the creation of a more business-friendly climate. Saa-kashvili said that the fi rst thing the country needs in order to give the economy new impetus is “a

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modern and effi cient” tax administration and the “decriminalization of fi nancial relations” between the state and entrepreneurs. “We should carry out reform of the tax service, envisaging the unifi cation of the tax [department] and customs [service], where the tax police will be only one of the units and where [the tax police] will be the last resort and last point of relationship with business, and it should only be used in extremely rare cases. All the rest should be solved based on civil relations between the state and business. “It will not be just a mechanical unifi cation… This will include the creation of a uni-fi ed digital data base, and no professional will be sacked,” he added.

President Saakashvili admitted that Georgia needs a “much better judiciary system” and the re-in-troduction of tax arbitraition, which was abolished in April, 2005 - less than fi ve months after it was introduced. But Saakashvili added that new tax arbitration system will be “much better” and that the state and businesses will be in equal positions. He said the new arbitration system should be introduced by the beginning of 2007. He said that the state is ready to start a microcredit program from January 2007 for those willing to launch private businesses, especially in the agricultural sector.

President Saakashvili said that although there is unemployment, the country lacks qualifi ed cadre in various sectors, especially in the fi elds of construction and services. “The Education Ministry is now working on the creation of new re-training centers. Seven centers of this kind will be opened in Sep-tember, including in Kobuleti [Adjara] to train tourism service staff; in Tbilisi we are going to open [a training center] for the construction business. But we will need much more, we might need thirty, forty, or even fi fty [re-training centers] of this kind, and it will take time,” Saakashvili said.

The Georgian leader announced that starting from September the government will fi nance a three-month internship program in private businesses for at least 50 000 citizens. “I want to tell our busi-nessmen that you will not lose anything as a result of this program; you will have an unpaid employee for three months without any obligation to recruit them after three months. But through participation in this program you [businessmen] will take a huge patriotic step,” Saakashvili added. He said that the government will fund internships for an additional 100 000 citizens for next year “and if there is more interest we will allocate even more funds for this program.” “In addition, we are ready to consider a further reduction of taxes after these 150 000 citizens undergo this program. And also here I want to remind our businessmen that starting from this September, we will have zero percent custom dues for almost 90 percent of products. And I also want to remind you that we have one of the lowest tax rate levels among the Eastern European states,” Saakashvili added.

August 18International Momentary Fund (IMF) has warned the Georgian authorities to tighten fi scal

and monetary policies to reduce current 14,5 percent infl ation to 10 percent by the end of 2006. An IMF mission, which visited Georgia on August 11-18 to assess recent economic developments, said in-fl ation accelerated in Georgia to 14.5 percent by the end of July which is well above the planned targets and “poses a serious risk to macroeconomic stability.” The 2006 budget set infl ation rate at 5-6 percent. Twelve-month infl ation was about 6 percent as of end-April 2006, according to IMF.

The National Bank of Georgian (NBG) reported 10 percent infl ation in May, which was alarming news, as in December NBG President Roman Gotsiridze told parliamentarians while discussing 2006 draft budget that a major goal in 2006 was not to let the infl ation rate reach two digit fi gures. Offi cials cite mainly external factors, including rising energy prices as a reason behind the increasing infl ation rate in Georgia. In a statement issued on August 18 upon conclusion of its visit the IMF mission said that “sharp increase” in infl ation refl ects demand pressures in the economy resulting mainly from excess money supply. IMF mission has recommended that combination of expenditure restraint, a smaller defi -cit and slower growth of reserve and broad money would help reduce demand pressures.“Against this background, the mission noted that such risks constitute another rationale for implementing a cautious fi scal stance that allows greater accumulation of international reserves.”

August 23At a government’s session Finance Minister Lexo Alexishvili presented for consideration the

forecast budgetary targets for 2007, setting revenues at GEL 3.4 billion (roughly USD 1.9 billion) and expenditures at GEL 3.8 billion (roughly USD 2.2 billion). According to the Finance Ministry these forecast targets are preliminary fi gures that might change according to macroeconomic developments in the remaining months of 2006.

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August 30Georgia Prime Minister Zurab Nogaideli said that the government has ambitions to halve unem-

ployment next year. “80-85 thousand new jobs will be created in Georgia next year, which will, actual-ly, halve unemployment in the country,” MP Nogaideli told a government session. He said that the new presidential program, envisaging government-sponsored three-month internships in private businesses for at least 50 000 citizens, will largely contribute to the decrease in unemployment.

August 31President Mikheil Saakashvili told leading Georgian businessmen that he is asking each of them to

buy at least 10 tons of grapes from wine-growers in order to lessen the impact of Russia’s decision to ban Georgian wine imports. President Saakashvili met with businessmen in the town of Sagarejo in the eastern region of Kakheti, which is home to over 60 percent of Georgia’s vineyards. The outdoor meeting, which was televised live, took place in a vineyard.

September 2New customs tariffs came into force starting from September 1, according to which the number

of tariffs are reduced from the previous 16 to 3. In addition, customs tariff rates are reduced to zero percent, 5 percent and 12 percent on remaining three tariffs. Customs tariff rates before September 1 ranged from minimal 6 percent to 30 percent.The government says the liberalized customs tariffs mean lower prices for the consumers and boosting investments. “Custom dues on most of the products will equal to zero, except on most agricultural products and those products which are produced locally, as we do not want to create additional competition for locally produced products. This is very important decision of our Parliament and our government and I think that it will boost development of business in Georgia,” President Saakashvili said, while meeting with a group of businessmen on August 31. Ac-cording to the new rules, up to 90 percent of all imported goods are exempted from customs duties. This 90 percent includes non-agricultural products and raw materials, except construction material, which will be taxed with 12 percent rate.

September 6Georgia is ranked 37th in the world in terms of the ease-of-doing-business index, according

to the World Bank’s report Doing Business 2007: Georgia was placed 100th in last year’s report, and the drastic improvement in 2006 makes Georgia the top reformer of the year. According to the report, Georgia made more progress than any other country in the world through the introduction of fl exible labour rules and other reforms. The report provides a global ranking of 175 economies on key business regulations and reforms. The report notes that social security contributions paid by businesses in Georgia decreased from 31 percent of wages to 20 percent, making it easier for employers to hire new workers, while the collection of corporate taxes increased by 300 percent. Romania and Mexico came in second and third, respectively, in terms of reforms aimed at easing business. From the CIS countries only Armenia, which is ranked 34th in the report, is ahead of Georgia in the ease-of-doing-business index.

September 15The French bank Societe Generale announced the acquisition of a 60 percent stake of the Geor-

gian Bank Republic. The terms of the deal where not disclosed. AFX news agency reported that the European Bank for Reconstruction and Development (EBRD) also acquired a 10 percent stake in Bank Republic. Bank Republic, with 74 000 clients, had GEL 7.1 million net profi t in 2005 and GEL 5.8 mil-lion net profi t in the fi rst half of 2006.

September 25The European Bank for Reconstruction and Development (EBRD) has established a regional

centre in Tbilisi, which will cover the Bank’s activities in the Caucasus, Moldova and Belarus. The EBRD said that the regional centre in Tbilisi shows the strengthening of the Bank’s activities in the region. EBRD Business Group Director Olivier Descamps visited Georgia to mark the opening of the centre.

27 SeptemberThe Board of Directors of the European Bank for Reconstruction and Development intend to dis-

cuss and approve a new strategy of the Bank’s activity in Georgia. The head of the business group

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in Southern and Eastern Europe, Caucasus and Central Asia, Olivier Descamps, stated that energy is a top priority. This implies primarily projects related to energy effi ciency, security and transit of energy resources. It is planned to fi nance the gas distribution sector and gas pipeline rehabilitation projects. Development of regional infrastructure in Georgia will become a second priority. The main recipi-ents of investment will be municipal enterprises engaged in waste recycling and water supply. The third priority will be support of local enterprises engaged in agribusiness, tourism and service spheres. In addition to fi nancial assistance, it is planned to encourage Georgian banks to invest in manufacturing. The focus will be made on the issuance of credits. And fi nally, the EBRD’s main priority still remains cooperation with the Georgian banking sector. In this respect, the EBRD intends to help banks expand and consolidate, to provide long-term fi nancial resources, to develop other types of fi nancial service, namely, leasing. Olivier Descamps noted that the new strategy in Georgia is an ambitious one, but there are all the conditions for its successful implementation. Next year, the EBRD intends to launch 250 million Euro worth 30 new projects.

28 SeptemberMembers of The Black Sea Economic Cooperation Organization signed an agreement on the devel-

opment of a circular highway around the Black Sea. The memorandum envisages the construction of about 7 thousand kilometre long motor road connecting Turkey, Georgia, Russia, Ukraine, Moldova, Romania and Bulgaria. A memorandum on the development of sea routes in the Black Sea basin was signed as well to allow all types of transport on sea and ease cooperation between member states’ port administrations. According to Russia’s transport minister, Igor Levitin, the issue of the circular motor road will be fi nally approved in November. So far, transport agencies of interested member states have prepared their proposals concerning the road construction. Levitin stated that the EBRD and BSEC bank have expressed their readiness to fi nance the construction. BSEC member states are Azerbaijan, Arme-nia, Albania, Bulgaria, Greece, Georgia, Moldova, Russia, Romania, Turkey and Ukraine.

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SUMMARY MACROECONOMIC INDICATORS

2000 2001 2002 2003 2004 2005 2006**GDP and real sectorNominal GDP mln GEL 6043.1 6674.0 7456.0 8564.1 9824.1 11591.8 6063.7Real GDP mln GEL, 1996 4618.2 4840.1 5105.0 5669.6 6001.8 6562.8 3256.1Nominal GDP per capita GEL 1298.6 1445.0 1625.9 1880.0 2166.2 2563.7 1357.5

USD 657.5 697.0 741.4 876.9 1139.1 1415.6 751.2Real GDP per capita GEL, 1996 992.4 1047.9 1113.2 1244.5 1323.3 1452.2 377.1GDP by sectorsIndustry % of nominal GDP 17.3 16.6 17.6 17.7 16.1 15.6 14.0Agriculture % of nominal GDP 20.6 21.0 19.2 19.3 16.4 14.8 12.8Construction % of nominal GDP 3.7 3.9 5.1 6.4 8.1 8.8 6.5Real GDP growth % over prev. year 1.8 4.8 5.5 11.1 5.9 9.3 7.8Real growth by sectorsIndustry % over prev. year 3.2 -2.5 8.4 7.7 4.0 11.4 7.5Agriculture % over prev. year -12.0 8.2 -1.4 10.3 -7.9 12.0 -11.6Construction % over prev. year 4.0 10.3 43.1 46.6 36.1 22.3 21.2Price indexesGDP defl ator 1996=100 130.5 137.5 145.8 150.6 163.2 175.9 193.0Consumer prices (year average) 2000=100 100 104.7 110.5 115.8 122.4 132.5 141.9Producer prices (year average) 2000=100 100 103.6 110.8 113.9 119.2 128.0 138.9InvestmentsGFCF1 % of nominal GDP 25.4 27.2 24.5 26.7 27.5 26.3 21.5Net FDI2 infl ow mln USD 131.7 109.9 163.3 336.3 489.5 539.3 428.0Labour marketPopulation mln 4.63 4.60 4.57 4.54 4.52 4.52 4.40Labour force mln 2.05 2.11 2.10 2.05 2.04 2.02 1.94Unemployment rate % 10.3 11.1 12.6 11.5 12.6 13.8 13.8WageAverage nominal wage GEL 72.5 82.6 99.1 101.5 116.4 149.3 -

%, over prev. year 7.1 13.9 20.0 2.4 14.7 28.3 -Living standardLevel of poverty % population 51.8 51.1 52.1 54.5 35.7 39.4 38.5Depth of poverty 20.2 19.3 19.8 21.1 12.2 13.5 13.4Severity of poverty 10.7 9.9 10.3 11.2 6.1 6.6 6.7National accountsHousehold consumption % of nominal GDP 89.4 78.6 77.0 71.6 72.8 66.8 67.3Government consumption % of nominal GDP 8.5 9.6 9.8 9.2 14.9 12.6 15.7Gross capital formation % of nominal GDP 26.6 28.3 25.5 27.7 28.3 26.9 21.9Net exports % of nominal GDP -16.7 -14.4 -13.2 -14.6 -16.6 -17.8 -24.1Government fi nanceRevenue mln GEL 639.4 740.3 816.1 956.0 1773.0 2607.5 1554.3Expenditure mln GEL 833.9 906.4 1040.7 1118.5 1923.6 2616.5 1576.2Defi cit(-) or Surplus (+) mln GEL -194.5 -166.1 -224.6 -162.5 -150.6 -9.0 -21.9Financing of defi citDomestic % of defi cit 77.4 13.5 40.0 31.9 11.0 398.0 286.3Foreign % of defi cit 22.6 86.5 60.0 68.1 89.0 -298.0 -186.3Total Debt mln GEL 4192.5 4449.5 4843.3 4608.0 4306.6 4076.1 4056.0Domestic % of debt 35.7 33.5 31.4 34.0 36.6 37.7 37.3Foreign % of debt 64.3 66.5 68.6 66.0 63.4 62.3 62.7Monetary indicatorsM2 (year end) mln GEL 382.1 403.8 462.3 527.4 846.1 1069.9 1251.8Velocity of money (M2) 19.53 17.89 17.78 16.23 11.78 10.83 9.69Deposit rate*** % per annum 12.2 11.1 11.4 10.6 9.5 8.7 7.4Lending rate**** % per annum 25.3 24.0 23.1 21.6 20.2 17.9 17.2Treasury bill rate % per annum 17.14 29.93 43.42 44.26 19.66 12.57 -

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2000 2001 2002 2003 2004 2005 2006**Balance of paymentsCurrent account mln USD -161.2 -211.4 -197.6 -369.5 -346.9 -692.9 -527.8Capital account mln USD -4.8 -5.2 17.6 19.9 40.8 58.7 40.8Financial account mln USD 92.1 218.7 222.2 356.3 483.3 731.5 452.3Net errors and omissions mln USD 53.9 44.8 -3.7 -24.3 1.3 14.3 34.7Overall balance mln USD 20.0 -46.9 -38.5 17.6 -178.5 -111.6 0.0External economic positionGross international reserves mln USD 109.7 159.9 198.4 191.6 383.7 474.1 529.1

Import. coverage (month) 1.4 1.8 2.3 1.6 2.3 2.1 1.7

Exchange rate (year average) USD/GEL 1.9759 2.0723 2.1945 2.1459 1.9168 1.8126 1.8091Real effective exchange rate %, 1995=100 110.2 108.2 102.7 94.9 107.0 110.3 111.1Terms of trade (year end) 1995=100 99.5 97.8 96.0 77.0 72.0 75.0 -NPV3 of external debt % of nominal GDP 38.9 36.8* 36.6* 39.6* 28.3* 22.7 -Foreign debt service % of total exports 9.1 6.3 5.0 4.6 6.5 5.0 -

Source: Georgian Government. Basic Data and Directions 2007-2010; Department for Statistics, Ministry of Economic Development; Ministry of Finance; National Bank of Georgia (NBG) and IMF

Note: * revised data ** January-June *** the numbers of deposit rate refl ect weighted average rates on time deposits denominated in domestic and foreign currency **** the numbers of credit rate refl ect weighted average rates on short term (up to one year) and long term (over the one year) credits denominated

in domestic and foreign currency Acronyms used: 1.GFCF -Gross Fixed Capital Formation 2.FDI - Foreign Direct Investments 3.NPV- Net Present Value

Georgian economy compared with EU25Georgia EU-25

2000 2001 2002 2003 2004 2005 2006* 2005Real GDP growth, % over prev. year 1.8 4.8 5.5 11.1 5.9 9.3 7.5 1.7GNI per capita (PPP, Euro) - - - 2 308.0 2 331.0 - - 20 098.02

in % of EU-231 (PPP) - - - 11.7 11.6 - - -GDP per capita (nominal USD) 657.5 697.0 741.4 876.9 1139.1 1415.6 1599.0 29 247.0Infl ation (year average) 4.0 4.7 5.6 4.8 5.7 8.2 5.0 2.2end of year 4.6 3.4 5.4 7.0 7.5 6.2 6.0 -Lending rate (year average)3 25.3 24.0 23.1 21.6 20.2 17.9 . 4.0Fiscal balance, % to GDP -3.2 -2.5 -1.9 -3.2 -2.3 -0.1 -3.1 -2.3Public debt, % to GDP 69.4 66.7 65.0 53.8 43.8 35.2 35.3 63.4of which:domestic 24.8 22.3 20.4 18.3 16.0 13.3 11.6 -foreign 44.6 44.4 44.6 35.5 27.8 21.9 23.7 -Current account, % to GDP -5.3 -6.9 -5.8 -9.3 -6.8 -10.8 -10.6 -0.9Net FDI infl ow, mln USD 131.7 109.9 163.3 336.3 489.5 539.3 - -140 462.0Memorandum items:Nominal GDPmln GEL 6043.1 6674.0 7456.0 8564.1 9824.1 11 591.8 13 080.0 -mln USD 3058.4 3220.6 3397.6 3990.9 5125.3 6395.2 7186.8 13 494 524.0mln Euro 3310.7 3594.0 3591.2 3523.7 4119.0 5139.2 - 10 844 200.0Exchange rates (nominal, year average)USD/GEL 1.9759 2.0723 2.1945 2.1459 1.9168 1.8126 1.8200 -Euro/USD 0.9238 0.8961 0.9461 1.1326 1.2443 1.2444 - -

Source: Georgian Government. Basic Data and Directions 2007-2010; Department for Statistics, Ministry of Economic development; NBG; World Bank; IMF; European Central Bank and Eurostat

Note: * forecast 1. EU23 (excludes Cyprus and Malta) 2. 2004 3. the numbers for Georgia refl ect weighted average rates on short term (up to one year) and long term (over the one year) credits denominated in

domestic and foreign currency; the number for the EU refers to the euro zone (EU12) only and refl ects the rate on new loans in Euro with duration of up to one year

15

1. GROSS DOMESTIC PRODUCTTable 1: Nominal and Real Gross Domestic Product

Nominal

GDP(mln GEL)

Share oflabour cost

(%)

Share of operating surplus

(%)

Share of net taxes(%)

GDP defl ator (1996=100)

Real GDP (in 1996 prices,

mln GEL)

Change in real GDP

compared to last year’s

corresponding period (%)

Real GDP per capita (in 1996 prices, GEL)

2000 6043.1 27.6 64.9 7.5 130.5 4618.2 1.8 992.42001 6674.0 25.2 66.9 7.9 137.5 4840.1 4.8 1047.92002 7456.0 22.3 69.6 8.2 145.8 5105.0 5.5 1113.22003 8564.1 20.3 72.1 7.6 150.6 5669.6 11.1 1244.52004 9824.3 20.7 69.5 9.9 163.2 6001.8 5.9 1323.3Q 1 2021.5 24.9 67.2 7.9 154.8 1302.5 6.3 286.9Q 2 2431.0 20.5 70.1 9.4 163.4 1487.0 7.3 327.8Q 3 2575.2 19.7 69.5 10.7 166.0 1551.3 5.2 342.1Q 4 2796.6 18.7 70.5 10.8 168.4 1661.0 4.9 366.52005 11591.8 19.8 68.3 11.9 175.9 6562.8 9.3 1451.5Q 1 2414.1 21.6 67.1 11.3 175.0 1375.3 5.6 303.9Q 2 2820.2 21.6 66.5 12.0 171.0 1644.0 10.6 363.5Q 3 3057.4 19.4 68.0 12.6 175.7 1734.7 11.8 383.7Q 4 3300.1 17.3 70.9 11.8 181.9 1808.8 8.9 400.32006Q 1* 2744.8 20.4 66.8 12.8 183.4 1491.2 8.4 328.4Q 2* 3318.9 17.7 68.3 14.1 185.8 1764.9 7.4 401.1

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculationsNote: * Preliminary assessment

According to preliminary assessments, GDP in Q2, 2006 showed quite a high annual growth rate, which can be mainly explained by an increased household consumption and government spending. Despite the ban on imports from Georgia imposed by the Russian Federation, economic activity was still signifi cantly infl uenced by growing external demand. At the same time, the GDP growth rate some-what slowed down compared to the same period last year and the previous quarter. This slowdown was caused by a drop in agricultural production due to bad weather conditions.

In the reviewed period, labour productivity (added value per employee) made GEL 800 in 1996 basic prices. It continued to be the domestic resource to meet total demand. This indicator was high again in the spheres of fi nancial intermediation (GEL 6260), hotels and restaurants (GEL 3930), construc-tion (GEL 2980), transport and communications (GEL 2380) and industry (GEL 2070). Despite some increase, it remained low in health care (GEL 470), agriculture (GEL 330) and education (GEL 190) sectors.

Source: Department for Statistics, Ministry of Economic Development

PART I. OVERVIEW OF THE GEORGIAN ECONOMY

16

Q2, 2006 saw some changes in GDP structure by production: trade had the highest share with an almost 5 percentage point annual growth. A certain decrease was observed in the construction share. Agriculture and transport shares also fell.

Table 2: Contribution of selected sectors of the economy to GDP real change 2006, Q2*

Change to last year corresponding period (%)

Contribution to GDP real change (percentage points)

Agriculture -14.4 -2.1Mining 23.9 0.2Manufacturing 20.1 1.7Energy 9.6 0.3Household production 0.1 0.0Construction 19.1 1.7Trade 9.8 1.1Hotels and restaurants 10.6 0.3Transport 12.9 1.1Communications 16.1 0.7Financial intermediation 20.3 0.4Real estate 6.0 0.2Rent 0.9 0.0Public administration 0.2 0.0Education 9.8 0.3Health care 14.0 0.5Other social services 19.2 0.6Hired employment in household 1.1 0.0FISIM 2.5 0.0GDP at Basic Prices 7.9 7.0Taxes 3.9 0.4Subsidies -6.6 0.0GDP at Market Prices 7.4 7.4


Growth rates of added value were much higher than GDP growth rate in a number of sectors in the ac-counting period. In particular, the real annual growth in fi nancial intermediation comprised 20.3 percent, in construction – 19.1 percent and in communications - 16.1 percent. Financial intermediation largerly affected GDP annual growth as credits to economy sharply increased, which, on its part, was caused by a strengthened deposit base in commercial banks and new credit lines opened by foreign banks.

Table 3: Indicators of industry

Value added inindustry at current

basic prices(mln GEL)

Index ofindustry

(1996=100)

Real value addedin industry at basic

prices(% changes over thesame period of the

previous year)

Share of value added in industry at current Basic prices (%)

Mining Manufacturing Energy production and distribution Other

2000 1044.2 107.9 3.2 3.9 49.5 25.2 21.42001 1111.0 105.2 -2.5 3.4 46.4 23.1 27.12002 1315.8 114.0 8.4 3.8 47.5 23.7 25.02003 1515.3 122.8 7.7 5.0 49.2 21.4 24.42004 1581.8 127.8 4.0 4.9 50.8 19.2 25.1Q1 328.3 103.2 14.1 4.9 46.5 27.0 21.6Q2 371.3 119.7 6.0 5.0 56.1 18.7 20.1Q3 407.2 129.1 -3.1 5.1 51.8 14.1 29.0Q4 475.0 159.1 2.8 4.5 48.8 18.7 28.02005 1809.1 142.4 11.4 4.7 54.8 18.0 22.5Q1 376.2 111.4 8.0 5.0 51.5 24.2 19.3Q2 416.6 130.3 8.9 4.8 58.3 18.4 18.5Q3 475.1 145.8 12.9 4.7 55.7 14.2 25.3Q4 541.2 181.9 14.3 4.5 53.6 16.7 25.22006Q1* 392.1 112.0 0.5 5.9 57.7 22.1 14.3Q2* 458.5 148.3 13.8 7.4 58.9 18.3 15.4


17

Q2, 2006 saw a sharp increase in added value created in industry, exceeding the previous year’s cor-responding indicator by 5 percentage points, which was the result of the growth in mining and manufac-turing industries respectively by 23.9 and 20.1 percents.

The high growth rate of the mining industry can be explained by an increase in extraction of minerals, needed for producing construction materials, chemical industry and fertilizers, as well as raw oil and manganese ore.


The contribution of manufacturing to the country’s economic dynamics was impressive. The account-ing period saw an increase in grain processing, production of non-alcoholic drinks and tobacco products, cement, alabaster, oil products, mineral fertilizers, fl ying apparatus and ready-made metal products.

It is noteworthy that the increase in industrial goods was largely conditioned by external demand, which caused the increase in industrial exports. At the same time, a decrease was observed in the pro-duction of alcoholic beverages, fruit and vegetable juice because of the embargo imposed by Russia and a drop in the supply of agricultural products of intermediate consumption. On the other hand, food industry oriented on domestic consumption increased.

Although electricity generation in Q2, 2006 was 9.6 percent higher than in the same period last year, Georgia still largely depended on imported energy resources.

Table 4: Indicators of agriculture

Value added inagriculture at

currentbasic prices(mln GEL)

Index ofagriculture(1996=100)

Real value added in agriculture

at basic price(% changes over thesame period of the

previous year)

Share of value added in agricultureat current basic prices (%)

Plant growing Animalhusbandry Other

2000 1245.0 91.3 -12.0 43.2 45.6 11.22001 1399.0 98.8 8.2 46.7 44.2 9.12002 1434.6 97.3 -1.4 46.7 47.3 6.02003 1653.0 107.4 10.3 46.9 41.0 12.12004 1610.7 99.0 -7.9 44.4 46.6 9.0Q1 344.1 84.7 -21.8 29.2 52.6 18.2Q2 471.5 114.7 0.1 48.4 42.1 9.5Q3 420.7 100.0 1.8 50.8 46.0 3.2Q4 374.4 96.4 -11.2 45.9 47.5 6.62005 1717.7 110.8 12.0 46.9 45.3 7.8Q1 465.2 101.0 19.2 31.0 56.5 12.5Q2 461.6 117.8 2.7 50.2 40.5 9.3Q3 382.1 117.2 17.2 62.5 33.8 3.7Q4 408.9 107.4 11.4 46.8 48.8 4.42006Q 1* 361.6 92.6 -8.3 31.5 57.3 11.2Q 2* 411.7 100.8 -14.4 44.0 39.1 16.9


18

The downward trend in agricultural production continued in the reviewed period, which was ex-pressed in a sharp decline of added value in this sector. The decrease in agricultural produce was, as mentioned above, mainly caused by unfavourable weather conditions.

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculations

A signifi cant decrease was observed in vegetable products, meat, milk and egg production. A better situation was observed in forestry and fi shery where timber logging and fi sh production increased sig-nifi cantly.

Table 5: Indicators of transport and communications

Value added intransport and

communicationsat current basic prices

(mln GEL)

Index oftransport &

communications(1996=100)

Real value added in transport &

communications at basic prices

(% changes over the sameperiod of the previous year)

Share of value added in transportand communications at current basic

prices (%)

Transport Communication

2000 858.8 239.9 13.1 82.4 17.62001 911.1 243.3 1.4 79.6 20.42002 1057.4 264.6 8.7 79.3 20.72003 1187.5 286.9 8.4 74.2 25.82004 1313.2 303.6 5.8 71.0 29.0Q1 281.4 260.7 5.8 69.6 30.4Q2 312.2 286.1 -1.5 70.0 30.0Q3 365.6 339.1 11.4 71.5 28.5Q4 353.9 328.6 7.3 72.3 27.72005 1462.5 333.6 9.9 67.7 32.3Q1 296.9 272.1 4.4 66.0 34.0Q2 359.6 335.5 17.3 68.8 31.2Q3 400.5 363.5 7.2 67.7 32.3Q4 405.6 363.3 10.5 68.1 31.92006Q 1* 370.8 358.7 31.8 71.2 28.8Q 2* 327.9 382.5 14.0 65.7 34.3

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculations* Preliminary assessment

Annual and quarterly growth in transportation services in Q2, 2006 made 12.9 percent and 3.7 per-cent respectively. This can be explained by increased passenger and cargo volumes shipped by land and sea as well as increased pipeline transportation volumes. However, air cargo transportation and cargo handling volumes decreased, expressed in the reduction of both annual and quarterly transport GDP shares.

Communications showed high annual and quarterly growth rates (16.1 percent and 8.4 percent re-spectively) in the reviewed period. This was achieved thanks to the enhancement of cellular telephone networks and intensive development of intercommunications.

19

Table 6: Indicators of construction

Value added in construction at

current basic prices(mln GEL)

Index ofconstruction(1996=100)

Real value added in construction atbasic prices

(% changes over the same period ofthe previous year)

2000 224.7 167.3 4.02001 259.6 184.6 10.32002 379.5 264.2 43.12003 547.4 387.3 46.62004 793.2 526.3 35.9Q1 151.6 419.0 126.0Q2 170.1 437.5 20.8Q3 223.5 592.0 40.0Q4 248.0 656.8 13.52005 1015.3 643.7 22.3Q1 105.1 278.6 -33.5Q2 228.5 628.6 43.7Q3 346.1 878.4 48.4Q4 335.7 789.0 20.12006Q1* 165.0 350.7 25.9Q2* 228.9 748.5 19.1


The construction sector continued with its dynamic growth in Q2, 2006, though some slowdown in the growth rate was observed due to the completion of the Baku-Tbilisi-Ceyhan oil pipeline. This time, the construction industry was largely infl uenced by international projects on the construction of South Caucasus gas pipeline and main highways. State funded infrastructure development projects and private housing also played an important role.

Table 7: Indicators of trade, hotels and restaurants

Valueadded intrade atcurrentbasicprices

(mln GEL)

Index oftrade

(1996=100)

Real valueadded in tradeat basic prices(% changes

over the sameperiod of the

previous year)

Value added

in hotels &restaurantsat current

basic prices(mln GEL)

Index ofhotels &

restaurants(1996=100)

Real valueadded in hotels& restaurantsat basic prices(% changes

over the sameperiod of the

previous year)

Share of value addedin hotels & restaurantsat current basic prices

(%)

Hotels Restaurants

2000 762.3 119.4 10.8 141.1 165.1 8.2 19.7 80.32001 871.0 129.9 8.8 192.1 220.9 33.7 46.2 53.82002 956.2 135.0 3.9 218.6 237.5 7.6 35.2 64.82003 1137.6 151.3 12.1 244.9 271.2 14.2 30.9 69.12004 1247.2 163.6 8.2 266.2 279.8 3.2 24.5 75.5Q1 247.6 131.4 1.9 67.3 286.4 25.9 31.4 68.6Q2 309.3 164.3 10.1 61.1 254.7 23.0 18.7 81.3Q3 317.1 171.3 9.2 64.6 269.2 -25.0 23.1 76.9Q4 373.2 187.6 10.3 73.2 308.9 6.1 24.2 75.82005 1315.7 169.2 3.4 328.2 325.7 16.4 29.5 70.5Q1 292.6 148.3 12.9 69.8 303.9 6.1 29.9 70.1Q2 327.5 180.7 10.0 85.8 369.2 45.0 31.7 68.3Q3 336.0 167.3 -2.3 83.5 303.2 12.6 23.6 70.4Q4 359.5 180.6 -3.7 89.0 326.6 5.7 27.1 72.92006Q 1* 359.3 168.2 13.8 70.1 329.8 8.5 34.8 65.2Q 2* 547.3 198.4 9.8 67.8 408.2 10.6 38.9 61.1

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculations* Preliminary assessment

The most impressive growth rate in trade in the reviewed period was determined by a sharp growth in demand for domestically produced and imported goods. At the same time, wholesale trade grew at a higher rate than retail trade. It is noteworthy that the clampdown on informal trade resulted in a decrease of this sphere’s unobserved segment share by 8.1 percentage points compared to the same period last year.

20

As prices on hotel and restaurant services grew, their real annual and quarterly increase comprised 10.6 percent and 23.8 percent, respectively. Compared to restaurants, hotels grew at a higher rate. De-spite the 5.6 percentage point drop compared to the same period last year, the share of observable seg-ment still remained high (39.6 percent) in total output of the sector.


In Q2, 2006 Georgia’s economy still depended upon consumption (77 percent of GDP) and import (imports comprised 60.7 percent of GDP while exports - 33.8 percent).

Although investments made by large international energy projects and the public sector grew, the accounting period saw a 4 percent annual decrease in capital formation, however, the quarterly in-crease comprised 32.2 percent. However, statistical errors provides the ground to assume that the annual growth rate of investments was actually higher.

Household and state consumption showed a high annual growth rate in Q2, 2006. Export of goods and services increased impressively in annual and quarterly terms. Moreover, it is noteworthy that statistical errors between GDP volumes calculated by applying production and expenditure methods far exceeded last year’s corresponding indicator, making it diffi cult to assess accurately changes.

Enhancement of the tax base in the accounting period resulted in annual and quarterly growth (re-spectively, by 1.3 percentage point and 0.7 percentage point) of the tax share in GDP revenue structure. A signifi cant increase was observed in operational profi ts thanks to an impressive increase in revenues in the sphere of business.


Because of an increase in primary income from abroad and current transfers in Q2, 2006, Gross National Income, Net National Income and Net Disposable Income showed high annual and quarterly growth rates (respectively, 20.5, 21.2 and 24.2 percents). Moreover, the latter exceeded the costs on fi nal consumption by 28.3 percent, thus refl ecting the increase in net savings in the country.

21

2. PUBLIC FINANCETable 8: Total Consolidated Budget Revenues

Total revenues (mln GEL)

Total tax revenue (mln GEL)

GDP %

Tota

lre

venu

es

Tota

l tax

re

venu

e

VA

T

Pro

fi t ta

x

Exc

ise

duty

Inco

me

tax

Cus

tom

s du

ty

Soc

ial

tax

2000 905.2 854.3 15.0 14.1 4.6 1.3 1.5 1.8 0.9 2.12001 1033.9 954.7 15.5 14.3 5.2 1.0 1.3 2.0 0.8 2.12002 1135.3 1054.7 15.2 14.1 5.4 1.1 1.2 1.9 0.8 1.72003 1272.7 1186.6 14.9 13.9 4.8 1.2 1.2 1.8 0.8 2.12004 2102.0 1827.6 21.4 18.6 6.4 1.6 1.6 2.7 1.0 3.0Q1 391.2 328.6 19.4 16.3 5.1 1.7 1.4 2.6 0.7 2.9Q2 511.5 445.2 21.0 18.3 6.1 2.0 1.6 2.6 1.0 2.8Q3 562.8 501.0 25.0 19.5 7.0 1.5 1.7 2.6 1.1 3.0Q4 636.5 552.8 22.8 19.8 7.0 1.4 1.8 3.0 1.2 3.32005 3152.7 2411.5 27.2 20.8 8.5 1.8 2.4 2.5 1.1 3.7Q1 618.2 471.1 25.6 19.5 8.1 1.8 2.2 2.8 1.0 3.1Q2 608.0 566.0 29.5 20.1 8.2 2.1 2.7 2.4 1.0 3.1Q3 745.9 655.2 25.7 25.7 8.4 2.1 2.7 2.4 1.2 3.9Q4 918.6 719.2 21.8 21.8 9.2 1.4 2.3 2.6 1.1 4.52006Q1* 827.7 609.7 22.2 22.2 9.3 2.5 2.2 2.8 1.2 3.5Q2* 997.4 780.7 30.1 23.5 9.6 2.9 2.6 2.6 1.6 3.5

Source: Treasury Service, Ministry of Finance; Department for Statistics, Ministry of Economic Development and GEPLAC calculationsNote: * preliminary assessment

Consolidated budget revenues in Q2, 2006 exceeded the target by 25.2 percent although received grants were 64.3 percent less than planned. The result was achieved mainly thanks to much higher tax and, especially, capital revenues than anticipated. Moreover, annual as well as quarterly increase in rev-enues and grants were observed. The annual growth can be explained by increases in tax and non-tax revenues, while the quarterly growth – by an impressive increase in tax and capital revenues.

Fiscal effi ciency kept growing in the accounting period, expressed in a larger share of gross revenues in GDP than last year’s corresponding period.

Annual and quarterly growth of tax revenues was again high in Q2, 2006, which was determined by a signifi cant enhancement of the tax base along with further improvements in fi scal administration. Besides, the tax revenue structure somewhat changed: the share of profi t tax remarkably increased, whereas the excise share decreased compared to the previous year. This was the result of moving of the collection of the profi t tax from local to the state budget from January 1, 2006, and consequent improved administration of the mentioned tax. The share of Customs tax also grew signifi cantly compared to both last year’s corresponding period and the previous quarter. This improvement was mainly caused by the increase in import of excise goods, clothes and footwear, building and other material.

Source: Treasury Service, Ministry of Finance; Department for Statistics, Ministry of Economic Development and GEPLAC calculations

22

VAT continued to be the main source of tax revenues in the second quarter of 2006. Its annual (37.8 percent) as well as quarterly (25 percent) increase was linked to the increase in the import of wheat, computer equipment and devices. At the same time, VAT from locally produced goods and provided services decreased in the annual and quarterly terms, mainly due to a drop in the production of alcoholic beverages and petroleum.

Social tax ensured large amounts to the consolidated budget in the reviewed period. Annual and quar-terly growth of this tax revenues comprised 30 and 18.7 percent, respectively. Moreover, the amounts paid by private sector employers signifi cantly exceeded those paid by state organizations.

Q2, 2006 saw a sharp annual and quarterly increase (63.6 and 36.9 percents respectively) in Profi t tax revenues. This led to the increase in signifi cance of this tax in forming consolidated budget revenues.

Income tax revenues were also marked by a high annual growth (30.7 percent) in the accounting period but the quarterly growth was relatively modest (15 percent). It is noteworthy that following the increase in public sector wages, the consolidated budget received 2.2 times more revenues from state sector than in the same period last year and in previous quarter.

As the production and consumption of fi ltered cigarettes and tobacco products continued to grow and the import of vehicle petroleum and diesel increased in the second quarter of 2006, excise revenues kept rising both in annual and quarterly terms (15.5 and 45.8 percents respectively).

The most impressive annual and quarterly growth (respectively, 86.2 and 62.1 percents) was ob-served in customs revenues in Q2, 2006, which can be explained by the increase in import of excise goods, animal and vegetable food products, chemical production and building material.


As the tax administration and registration further improved, amounts to the budget in the form of fi nes and penalties signifi cantly increased, resulting in 2.2 times more non-tax revenues in Q2, 2006 than in the corresponding period last year. However, due to a decrease in license, permit and gambling business fees these revenues almost halved compared to the previous quarter.

Despite the large-scale privatization process in the accounting period (USD 245.2 million worth state assets were privatized), capital revenues to the consolidated budget were less by 43.9 percent than in the same period last year. However, due to the low basic indicator, it signifi cantly exceeded (3.2 times) the previous quarter indicator.

Given the increasing dynamics in consolidated budget revenues from own sources, the second quar-ter of 2006 saw a signifi cant annual decrease (35 percent) in grants, though the quarterly increase was high (33.7 percent).

23

Table 9: Consolidated Budget Expenditures

Total expenditure (mln GEL)

GDP %

Tota

l exp

endi

ture

Gen

eral

sta

te s

ervi

ce

Def

ence

, pu

blic

ord

er a

nd s

ecur

ity

Fore

ign

debt

ser

vice

Edu

catio

n

Hea

lth c

are

Soc

ial s

afet

y an

d so

cial

se

curit

y

2000 1126.5 18.6 2.2 1.7 - 2.2 0.6 3.42001 1237.9 18.5 3.1 2.0 - 2.1 0.8 2.92002 1409.5 18.9 3.5 2.0 0.9 2.2 0.9 3.02003 1522.1 17.8 3.1 1.9 0.9 2.1 0.4 4.02004 2412.2 24.6 3.6 4.4 0.5 2.9 1.0 4.7Q1 417.5 20.4 4.4 2.9 0.6 2.1 0.4 4.2Q2 516.9 21.3 3.0 3.1 0.6 3.2 0.5 5.1Q3 576.1 22.4 3.4 4.0 0.4 2.5 0.9 4.5Q4 901.7 32.2 3.7 6.8 0.4 3.1 1.9 5.02005 3280.8 28.3 3.1 5.9 0.3 2.5 1.8 5.4Q1 621.2 25.7 3.2 5.5 0.5 2.2 1.4 6.4Q2 773.4 27.4 2.5 5.4 0.3 2.1 1.7 6.0Q3 827.8 27.1 2.8 5.7 0.2 2.4 1.8 4.8Q4 1058.4 32.1 4.8 6.8 0.4 3.1 2.0 4.62006Q1 766.7 27.9 3.3 6.4 0.3 2.5 1.3 5.2Q2 1074.5 32.4 3.8 8.1 0.2 2.9 1.8 4.7

Source: Treasury Service, Ministry of Finance; Department for Statistic, Ministry of Economic Development and GEPLAC calculations

The reviewed period saw a high growth in total consolidated budget expenditure in annual as well as quarterly terms (respectively, 38.9 and 40.1 percents). At the same time, its structure signifi cantly changed, which was expressed in a decreased share of fi nancing in the social sector and energy sector and in an increased share of spending on defense and housing and utilities sectors. Compared to the previous quarter, the state budget capital expenditure increased by 2.2 times as well.

One of priorities of consolidated budget expenditure in Q2, 2006 was the fi nancing of measures related to civil defense and military needs, which comprised 81.9 percent in annual terms. Amounts al-located for this purpose were mainly spent on equipment and civic training. It is also noteworthy that capital expenditure in this fi eld increased by 6.3 times compared to the previous quarter.

Compared to the corresponding period last year, the consolidated budget allocations for social safety and social security somewhat decreased in the accounting period due to rather high base indicators, though quarterly growth comprised 8.3 percent. Most of these funds were used to fi nance projects on outpatient medical care, social safety of poor families, internally displaced people and refugees.

Quite a high annual and quarterly growth rate was observed in general state service expenditure (39.5 and 75.1 percents, respectively), which was mainly spent on fi nancing the activity of executive and leg-islative powers as well as on co-fi nancing the implementation of international organizations’ projects. It is noteworthy, that only 9 percent of capital expenditure was spent in this fi eld.

The reviewed period saw a sharp increase in fi nancing housing and utilities infrastructure both in annual (2.6 times) and quarterly (72.9 percent) terms. These allocations were mainly spent on the con-struction and upgrade of utilities infrastructure.

Q2, 2006 saw a substantial increase in budget expenditure in the education sector, which exceeded last year’s corresponding indicator by 38.2 percent and the previous quarter indicator by 57.2 percent. Most of this funding went to the vocational education system and international education programmes.

Despite quite an impressive increase in fi nancing public order and security in the accounting period, its share in total expenditure decreased both in annual and quarterly terms. This happened mainly due to downsizing the fi nancing of investment projects for law-enforcement institutions and state security.

24


By the end of the second quarter in 2006, the state debt comprised GEL 4056 million, meaning that its volume decreased by GEL 64.6 million compared to the previous quarter and by GEL 470.3 million compared to the corresponding period last year. The state debt service comprised GEL 26 million in the reviewed period. The largest part of it (70.4 percent) was used for domestic debt service. Thus, a stable upward trend of servicing domestic debt rather than a foreign one continued.

Table 10: Budget Balance

Balancedefi cit (-) surplus (+)

Balance(expenditure %)

Balance(GDP %)

2000 - 207.0 18.4 3.42001 - 155.9 12.6 2.32002 - 251.6 17.9 3.42003 - 201.3 13.2 2.42004 - 288.4 12.0 2.9Q1 - 25.0 6.0 1.2Q2 - 5.1 1.0 0.2Q3 + 3.4 0.6 0.1Q4 - 261.7 29.0 9.42005 -24.0 0.7 0.2Q1 + 7.5 1.2 0.3Q2 +78.8 10.2 2.8Q3 - 29.7 3.6 0.1Q4 -80.6 7.6 2.42006Q1 +70.6 9.2 2.6Q2 -64.1 6.0 1.9

Source: Treasury Service of the Ministry of Finance of Georgia, Department for Statistics of the Ministry of Economic Development of Georgia and GEPLAC calculations

Given that the expenditure was 6.3 percent more than revenues, the budget defi cit comprised GEL 64.1 million in the accounting period. Local sources fi nanced 45.4 percent of the defi cit while foreign sources – the remaining 56.6 percent.

25

3. MONEY AND BANKINGTable 11: NBG accounts (thousand GEL, end of period)

NBGinternational

reserves

NBG claims on General Government

Reservemoney (M1)

Currency in circulation

Banks’ deposits

Real cash Balances Index

(December 1995=100)*Required

reserves

Balances on correspondent

accounts

2000 217 058 760 750 391 737 329 157 38 943 23 636 2 1002001 332 861 749 415 429 857 365 669 53 300 10 888 2 2562002 414 573 766 681 508 969 417 178 72 228 19 525 2 2422003 397 636 795 572 579 912 472 242 81 405 25 214 2 5902004 700 174 841 414 836 536 676 158 92 334 68 045 3 442Q1 424 325 815 639 594 008 466 212 89 946 32 550 2 527Q2 527 641 811 349 655 670 504 188 74 223 71 259 2 781Q3 671 522 816 652 747 390 600 225 75 342 71 793 3 252Q4 700 174 841 414 836 536 676 158 92 334 68 045 3 4422005 851 599 832 849 1 001 451 811 400 129 833 60 218 3 890Q1 699 838 841 691 809 154 658 218 97 725 53 211 3 253Q2 794 216 841 972 879 314 694 576 109 141 75 597 3 513Q3 802 746 836 230 933 404 746 508 122 067 64 829 3 757Q4 851 599 832 849 1 001 451 811 400 129 833 60 218 3 8912006Q1 877 952 832 849 978 908 775 443 139 334 64 132 3 664Q2 954 043 832 849 1 044 679 803 260 158 689 82 729 3 642

Source: NBG and GEPLAC calculationsNote: * The real cash balance is derived from dividing the indicator for currency in circulation by CPI for the corresponding period (December 1995=100)

In Q2, 2006 the dynamics of the National Bank’s (NBG) international reserves was mainly infl uenced by foreign currency purchases at Tbilisi Interbank Currency Exchange (TICEX). In the accounting pe-riod, the NBG purchased USD 97.2 million at TICEX and sold USD 22.9 million. Thus, the NBG net purchases made up USD 74.2 million. At the same time, the volume of foreign debt service payments did not change, which also contributed to a further increase in international reserves. Compared to the corresponding period last year, the reserves grew by almost 23 percent, while compared to the previous quarter - by 12 percent.

Although actual state budget revenues signifi cantly exceeded the target, the government’s debt to the NBG remained unchanged.

Compared to the same period in 2005, reserve money (M1) showed a 24.7 percent increase in Q2, 2006. The dynamics of this indicator were strongly infl uenced by the decrease in government deposits in the NBG, especially in June when their amount dropped by GEL 49 million, comprising GEL 248 million. In addition, infl ationary pressure strengthened in May (with annual infl ation exceeding 10 percent) and the NBG actively started the sterilization of excess liquidity through credit and deposit auctions. By means of this instrument, the NBG managed to remove GEL 45.6 million from circulation in June. However, in order to avoid an undesirable appreciation of the Lari exchange rate, the NBG purchased USD 24 million at TICEX in June only, which actually resulted in an increase of money in circulation by GEL 44.6 million.

Thus, the NBG interventions at TICEX, changes in government deposits and the regulation of money supply through monetary policy instruments signifi cantly affected the amount of money in circulation. In the second quarter this indicator was higher by 13.8 percent than the fi rst quarter indicator and higher by 22 percent than the corresponding indicator last year.

26

Source: NBG and GEPLAC calculations

The growth rate of reserve money was also somewhat affected by the dynamics of commercial banks’ required reserves and balances on their correspondent accounts in the NBG. The volume of required re-serves in the accounting period increased by 45.3 percent compared to the previous year’s corresponding indicator and by 13.8 percent compared to the previous quarter indicator. In the same period, balances on commercial banks’ corresponding accounts grew by 28.9 percent and 9.4 percent respectively.

As currency in circulation increased, the index of real cash balances decreased, because of a rise in the consumer price index in the reviewed period.

Table 12: Commercial banks’ accounts (thousand GEL, end of period)

Commercial banks’ credits to economy

Share of credits to non-budgetary sector

(%)

Net foreign assets

Deposits

Share of households in deposits (%)in national

currencyin foreign currency

2000 430315 100.0 -12610 67094 235868 -2001 489783 99.51 3708 54989 328606 42.52002 629486 98.93 25040 71478 401301 53.52003 785923 98.42 42456 85863 532989 60.32004 964917 99.97 54595 230104 665836 50.5Q1 726407 99.33 85595 115454 570494 57.0Q2 739842 99.74 66743 127018 589566 58.3Q3 875977 99.92 19311 173273 610244 54.8Q4 964917 99.97 54595 230104 665836 50.52005 1730466 100.00 -231480 333611 841285 54.7Q1 1070710 99.98 20984 203870 684471 57.2Q2 1229399 99.98 -18482 253233 738697 58.2Q3 1431937 99.98 -22138 296225 825201 54.0Q4 1730466 100.00 -231480 333611 841285 54.72006Q1 1948496 99.99 -269532 378414 915702 55.0Q2 2263516 99.35 -308977 522700 1032399 48.2


Along with the enforcement of banks’ mediation activity, an upward trend in households and legal persons’ deposits continued into Q2, 2006. Compared to the corresponding period last year, total depos-its were up by 56.8 percent while the quarterly increase was 20 percent. It is noteworthy that deposits in the national currency kept increasing faster both in annual and quarterly terms. An annual increase in Lari denominated deposits comprised 106 percent (foreign currency deposits -40 percent ) and a quar-terly increase comprised 44 percent (foreign currency deposits -12.7 percent). This, naturally, translated into a decrease of the deposit dollarization indicator, which by the end of the reviewed period comprised 66 percent.

The deposit structure also experienced signifi cant changes in Q2, 2006. In particular, the share of household deposits, compared to the previous year’s same period, dropped by 10 percent and compared to the previous quarter - by 6.8 percent. Such a change in deposit structure can be explained by the

27

further legalization of the economy and, consequently, increased demand on Lari on the part of legal persons.

An increasing trend of crediting by commercial banks was observed again in the accounting pe-riod. Annual increases of total loans to private enterprises made up 45.6 percent, while the quarterly increase was 16.1 percent. The share of agriculture in the structure of credit to the economy was very small, which can probably be explained by unfavourable weather conditions and trade and transport restrictions imposed by Russia. The share of industry signifi cantly decreased, while there was a slight increase in the share of construction. The trade and service sector traditionally dominated the structure of credit.


Compared to the same period last year, commercial banks’ foreign liabilities more than doubled in the accounting period, while compared to the previous quarter it increased by 14.5 percent, which is con-nected to the opening of new credit lines for Georgian commercial banks on the part of foreign banks and international fi nancial institutions. The same period saw a relatively modest increase in commercial banks’ foreign assets, which comprised 99.2 percent in annual terms and 14.4 percent in quarterly terms. Net foreign assets of commercial banks, naturally, sharply increased both in annual (almost 17 times) and quarterly (16.7 percent) terms.

Table 13: Money aggregates (thousand GEL, end of period)

Money outside banks(M0)

Reserve money(M1)

Broad money(M2)

Broad money(M3)

Money multiplier Money velocity

M2 M3 M2 M32000 315007 391737 382101 617969 0.98 1.58 19.53 11.672001 348850 429857 403839 732445 0.94 1.70 17.89 10.232002 390787 508931 462265 863566 0.91 1.70 17.78 9.542003 441536 579912 527398 1060388 0.91 1.83 16.23 8.072004 615993 836536 846097 1511933 1.01 1.81 11.78 6.59Q1 431144 594008 546598 1117092 0.92 1.88 18.24 8.92Q2 467749 655670 594768 1184334 0.91 1.81 16.76 8.42Q3 537663 747390 710937 1321181 0.95 1.77 14.02 7.55Q4 615993 836536 846097 1511933 1.01 1.81 11.78 6.592005 736284 1001451 1069895 1911181 1.07 1.91 10.83 6.07Q1 608555 809154 812425 1496897 1.00 1.85 14.27 7.74Q2 636495 879314 889728 1628425 1.01 1.85 13.03 7.12Q3 686116 933404 982341 1807542 1.05 1.94 11.80 6.41Q4 736284 1001451 1069895 1911181 1.07 1.91 10.83 6.072006Q1 709102 978908 1087516 2003218 1.11 2.05 12.03 6.53Q2 729106 1044679 1251806 2284205 1.20 2.19 9.69 5.31

Source: NBG

Q2, 2006 saw a signifi cant increase in money outside banks as well as deposits in national currency, which caused an increase in broad money aggregates (M2). An annual growth of this indicator com-prised 17 percent and a quarterly growth - 15.1 percent. Along with the growth of monetary aggregates, the money multiplier increased as well.

28

Table 14: Change in prices

Consumer Price IndexDecember 1995=100

(end of period)

Change in ConsumerPrice Index

(%, as compared with the end of previous period)

Change in Core Infl ation (%, as compared with the end of previous

period)*

Producer Price indexDecember 2000=100

(end of period)

2000 156.7 4.6 0.9 100.02001 162.1 3.4 1.3 108.92002 170.9 5.4 0.5 111.32003 182.7 7.0 2.3 118.72004 196.5 7.5 2.2 120.1Q1 184.5 1.0 0.2 119.5Q2 181.3 -1.7 -0.3 118.3Q3 184.6 1.8 0.9 119.4Q4 196.5 6.4 1.4 120.12005 208.6 6.2 3.0 130.1Q1 202.4 3.0 0.6 129.8Q2 197.7 -2.3 0.0 128.3Q3 198.7 0.5 1.1 127.4Q4 208.6 5.0 1.2 129.22006Q1 211.6 1.5 0.6 133.9Q2 220.3 4.1 0.9 145.3

Source: Department for Statistics, Ministry of Economic Development and NBGNote: * The core infl ation indicator no longer includes exogenous factors and mainly refl ects the impact of monetary policy on the price developments. A

stable core infl ation refl ects the fact that the pursued monetary policy did not induce sharp change in consumer prices

The quarterly increase in the consumer price index in Q2, 2006 was 4.1 percent while the annual increase was 11.4 percent. Infl ationary processes were strongly infl uenced by such exogenous factors as the rise in world prices on oil products and sugar, increases in electricity and natural gas tariffs, de-crease in vegetable imports and increase in poultry prices due to bird fl u. At the same time, there was a stable growth of base infl ation, meaning that along with exogenous factors, infl ationary processes were strongly infl uenced by endogenous, i.e. monetary factors as well. The infl ationary process was aggra-vated by the government’s expenditure policy, which stimulated demand in the economy.

Consumer prices were marked with signifi cant fl uctuation by months. In April, the monthly infl ation rate was 1.8 percent, mainly determined by a hike in prices on oil products, tobacco and poultry. An-nual infl ation was moderate though, not exceeding 6 percent. May saw a strengthening of infl ationary processes with the infl ation rate going up by 2.4 percent. This time the price dynamics was strongly affected by a rise in vegetable prices, caused by unfavorable weather conditions, on the one hand, and by a decrease in vegetable imports, on the other. The effect of increased oil and egg prices was still signifi cant. In May the annual infl ation reached 10 percent. Although June saw a 0.2 percent drop in the general level of consumer prices thanks to a decrease in excise duty on cigarettes, the annual infl ation was set at 11.4 percent.


The rise in the producers’ price index persisted in Q2, 2006, which, naturally, pushed consumer prices up. The increase in producer price index was again determined by increased tariffs for electricity and gas production and distribution, water collection, treatment and distribution.

29

Table 15: Interest rates

Money Market Rate

(GEL)*

Money Market Rate

(in foreign currency)**

Commercial banks’ interest rates(annual weighted average)

on loans on deposits

GEL Foreign currency GEL Foreign currency

short-term long-term short-term long-term short-term long-term short-term long-term

2000 - - 22 17 30 20 11 2 11 132001 - - 24 17 27 21 8 3 11 122002 24 16 25 16 25 20 11 12 11 122003 12 13 25 19 23 19 10 12 10 112004 8 8 27 20 22 17 8 12 9 11Q1 17 11 27 20 23 18 10 13 9 11Q2 16 8 29 19 23 18 8 13 9 11Q3 6 7 27 20 22 17 7 12 9 11Q4 6 7 25 21 22 17 7 12 8 112005 8 7 22 21 20 16 9 12 8 10Q1 9 5 23 21 22 16 8 11 8 10Q2 7 7 22 22 21 16 9 11 8 10Q3 8 8 21 21 20 16 8 12 7 10Q4 10 8 21 20 20 15 9 13 8 112006Q1 7 11 21 20 19 15 10 13 8 11Q2 7,8 9 20 20 19 16 7 13 6 10

Source: NBG and GEPLAC calculationsNote: * The money market interest rate in national currency includes an annual weighted average interest rate on up to 1-year maturity loans issued

through Interbank Credit Auctions and bank to bank market ** The money market interest rates in foreign currency include an annual weighted average interest rate on up to 1-year maturity loans issued

directly at the bank to bank market

Despite a sharp increase in deposits in commercial banks, deposit rates did not show any increase in the accounting period. Some decrease was observed on short-term deposits in both national and foreign currencies. As regards loan rate dynamics, it was rather stable. Interest rates on short-term loans in do-mestic currency slightly decrease whereas those on long-term loans in foreign currency increased a bit. All these, overall, resulted in the increase in net interest margin compared to the previous quarter.


The formation of money market interest rates in the national currency was still largely infl uenced by interbank credit auctions with the NBG representing the main buyer. Through credit auctions, the NBG purchased GEL 60.1 million in the second quarter. This was conditioned by the necessity to neutralize infl ationary pressure. Consequently, an average interest rate on loans of up to one year maturity slightly increased. A totally different situation was observed on the money market in foreign currency - the vol-ume of transactions decreased signifi cantly, an average interest rate on foreign currency denominated loans up to one year of maturity decreased as well, which reveals a drop in demand for foreign currency resources on a bank-to-bank market.

30

Table 16: Exchange Rates and net NBG Net Interventions

Nominal Exchange Rate (average for the period) USD/GEL Banknote Rate

(average for the period)

Real Effective Exchange Rate

December 1995=100 (end of period)

Net NBG interventions

(thousand USD)USD/GEL Euro/GEL2000 1.9759 - - 110.2 -714162001 2.0723 1.8473 2.0816 108.2 -354482002 2.1945 2.0714 2.3822 102.7 -404592003 2.1459 2.4243 2.1502 94.9 -426852004 1.9168 2.3814 1.9160 107.0 -182662Q1 2.0589 2.5753 2.0587 97.3 -21982Q2 1.9506 2.3513 1.9475 100.7 -60226Q3 1.8484 2.2582 1.8455 108.5 -80379Q4 1.8094 2.3409 1.8124 107.0 -200752005 1.8126 2.2601 1.8154 110.3 -42919Q1 1.8272 2.3995 1.8302 103.6 -10600Q2 1.8250 2.3032 1.8276 104.1 -10885Q3 1.8046 2.2039 1.8068 104.6 -24652Q4 1.7936 2.1338 1.7960 110.2 -179822006Q1 1.8148 2.1810 1.8131 105.5 11323Q2 1.8033 2.2637 1.8008 111.1 -74282


In the accounting period the domestic currency market conjuncture was mainly determined by such factors as FDI, remittances, foreign credit lines, further legalization of the economy and a drop in government deposits. Their interaction resulted in maintaining the tendency of an excessive supply of foreign currency.


To avoid undesirable Lari appreciation, the NBG actively carried out interventions at the TICEX. In May it had to purchase an especially large amount of foreign currency (USD 42.4 million). Neverthless, in June, the nominal Lari exchange rate increased by 2 percent on average compared to the same period in 2005 and by 2.4 percent compared to the last month of the previous quarter.

Source: NBG

A real effective Lari exchange rate showed an upward trend in the accounting period, which, along with the appreciation of the nominal rate, was caused by a relatively high infl ation rate in trade partner countries. The quarterly increase of this indicator was 5.5 percent, while the annual indicator was 6.7 percent.

31

4. LABOUR MARKET AND HOUSEHOLD BUDGETSTable 17: Population and Employment (thousand persons)

Total population

over 15 years old

Economically active population * Employed

Total employment

rate (%)Total Labour forceparticipation

rate (%) *Total Hired Self-

employed

Share of working age employees

(%)

Share of employees

aboveworking age

(%)

2000 3148.1 2051.6 65.2 1839.3 684.3 1043.9 79.2 20.8 58.42001 3191.1 2113.3 66.2 1877.7 654.6 1135.9 80.2 22.0 58.82002 3239.5 2104.2 65.0 1839.2 650.9 1184.9 80.0 20.1 56.82003 3104.9 2050.8 66.1 1814.9 618.5 1195.2 79.8 18.9 58.52004 3151.1 2041.0 64.8 1783.3 600.9 1180.8 77.9 19.2 56.6Q1 3142.6 2006.7 63.9 1746.4 619.8 1125.4 83.4 20.6 55.6Q2 3121.7 2053.9 65.8 1809.0 608.1 1200.6 87.1 20.7 57.9Q3 3180.9 2093.1 65.8 1819.2 577.5 1239.3 86.2 22.1 57.2Q4 3159.3 2010.2 63.6 1758.6 598.1 1158.1 84.2 20.5 55.72005 3162.3 2023.9 64.0 1744.6 600.5 1143.3 82.0 18.8 55.2Q1 3177.9 1999.4 62.9 1705.1 595.1 1108.7 80.3 19.7 53.7Q2 3148.7 2035.5 64.6 1763.2 604.5 1158.0 82.9 17.1 56.0Q3 3131.5 2011.8 64.2 1744.9 587.4 1156.7 81.2 18.8 55.7Q4 3191.1 2048.8 64.2 1765.1 614.8 1149.9 83.9 19.4 55.32006Q1 3169.8 1925.1 60.7 1643.1 586.2 1055.5 82.9 17.1 51.8Q2 3138.7 1952.3 62.2 1699.9 566.9 1130.4 83.8 16.2 54.2

Source: Department for Statistics, Ministry of Economic DevelopmentNote: * ILO “strict” methodology

The labour market showed important positive changes in Q2 2006. Although unemployment and underemployment are widespread among the population of working age, the unemployment rate was lower. The labour force participation rate is quite high, and many of the working age population are en-gaged in seeking employment. The hired employment decreased, partially to refl ect the smaller numbers of public sector employees, as the restructuring measures were taken to make civil servants work more effi ciently and their salaries higher. About 19 percent of the population of working age were engaged in salaried employment. Although salaries in absolute terms have been rising for several years already, especially those of civil servants, many salaries are still rather modest. Self-employment still dominates the overall employment, and the self-employment in agriculture still dominates the overall self-employ-ment. Many of the non-agricultural self-employment activities are unoffi cial and low-paying

In Q2 2006, the labour force participation rate grew compared to the previous quarter by 1.6 per-centage points and decreased compared to a year ago by as much as 2.4 percentage points. As the time series show, the labour force participation rate has been showing a downward trend in annual terms for several years. Although the quarterly growth might well have been affected by seasonal changes, there are grounds to expect that it is likely to grow further. Taking into consideration, the above labour force participation rate developments and fl uctuations, the participation rate in Georgia is rather high that is characteristic of a transition economy. Such high participation rates are likely to be a refl ection of hard household income situation and also of growing hopes and expectations of possible successful job searches. As more people join the ranks of active job seekers, the tougher the competition on the labour market, and, therefore, the higher the motivation for training or re-training.

Q2 2006 saw a decrease in both the share and size of hired employment. In the period under consid-eration, hired employment accounted for 33.3 percent of total employment. During 2005, though, the size of hired employment was fl uctuating from quarter to quarter, to refl ect seasonal factors. In 2006, however, the fi gures refl ect the government re-structuring and optimization exercises on the one hand, and the process, whereby, as anecdotal evidence shows, while new jobs are being created in the private sector, other jobs are being lost. The newly created jobs, by defi nition, may offset some of the public sector staff cuts.

32

The share of total employment in the labour force grew in Q2 2006 compared to a year ago. As the fi gures suggest, this annual growth in the total employment fi gures is likely to be largely accounted for by the share of the self-employment in total employment that grew as well during the same period. The share of total employment in the total economically active population grew by 0.4 percentage points, as the labour force participation rate shrank by 2.4 percentage points in annual terms. At the same time, while the share of the self-employment in total employment grew by 0.8 percentage points, the share of hired employment in total decreased by 0.9 percent, suggesting that some of the job losses could be compensated by self-employment activities. Though the share of the self-employment in total employ-ment grew, the size of self-employment in terms of absolute fi gures has been on a downward trend since 2003.

Table 18: Unemployment (thousand persons)

Total population

over 15 years old

Unemployment * Unemployment rate (%) * Non-active population of 15-70 years old *

Total Unemployment Rate (%) *

Among people of working

age **

Among people older then workingage **

Total Employed in household

2000 3148.1 212.2 10.3 12.2 2.6 898.8 265.02001 3191.1 235.6 11.1 13.4 1.8 872.4 250.52002 3239.5 265.0 12.6 14.9 2.2 910.0 280.22003 3104.9 235.9 11.5 13.4 2.3 847.1 257.32004 3151.1 257.6 12.6 14.9 1.8 895.4 257.1Q1 3142.6 260.2 13.0 15.3 1.8 923.2 268.5Q2 3121.7 244.9 11.9 14.0 1.7 861.5 242.2Q3 3180.9 273.8 13.1 15.5 2.2 868.9 254.2Q4 3159.3 251.6 12.5 14.8 1.6 927.9 263.32005 3162.3 279.3 13.8 16.3 0.9 913.6 248.5Q1 3177.9 294.3 14.7 17.3 2.3 941.5 258.8Q2 3148.7 272.3 13.4 15.9 1.3 902.5 241.0Q3 3131.5 266.9 13.3 15.7 0.8 911.7 244.9Q4 3191.1 283.7 13.8 16.1 2.7 898.6 249.42006Q1 3169.8 282.0 14.6 16.5 0.5 1244.6 279.1Q2 3138.7 252.4 12.9 14.3 1.1 1186.4 242.1

Source: Department for Statistics, Ministry of Economic DevelopmentNote: * ILO “strict” methodology ** Working age is given as 15-60 for women and 15-65 for men.

In Q2 2006, the labour force participation rate fell, and so did the unemployment rate. While the former decreased by 2.4 percentage points, the decrease in the latter amounted to 0.5 percentage points in annual terms. The seasonal decrease in the unemployment rate was quite impressive - by 1.7 percent-age points that happened on the background of the quarterly growth in the labour force participation rate. The rural unemployment rate is usually approximately 6 times lower than the urban one, according to the general pattern, and the highest unemployment rate is usually in Tbilisi.

33

Table 19: Wages (GEL)

Average monthly wages and salaries

Average nominal monthly wages and salaries share in minimum subsistence

Nominal monthly wages and salaries

Nominal of a working man(%)

of a family of four(%)

Pubic sector including Budgetary

organisations

Private sector

2000 72.5 62.9 35.9 54.0 106.12001 82.6 70.0 39.9 63.0 120.62002 99.1 79.0 45.0 77.6 139.42003 101.5 77.7 44.3 79.3 145.82004 116.4 84.9 48.4 93.7 160.0Q1 109.5 80.6 45.9 86.6 159.8Q2 112.8 84.1 47.9 88.9 155.9Q3 121.8 91.1 51.9 98.9 165.7Q4 121.6 84.0 48.3 101.3 158.42005 149.3 98.0 56.1 130.9 184.0Q1 128.0 84.2 47.9 108.3 162.9Q2 146.1 96.5 55.0 124.0 182.4Q3 156.4 102.4 58.9 142.9 184.8Q4 166.7 109.1 62.7 148.3 206.12006Q1* 171.2 182.6** 103.1** 155.6 211.9Q2* 188.9 187.1** 105.6** 161.8 233.8

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculationsNote: * Preliminary assessment ** Date are calculated according to a different methodology

The average monthly nominal salary of hired employees across the economy showed a 29.3 percent growth in annual terms and a 10.3 percent in quarterly terms.

It is important that the salaries of those in hired employment be compared to the minimum subsist-ence levels. It should be noted, that in the previous GET issues, such comparisons were based on the minimum subsistence levels that used to be calculated by the Department for Statistics (DS) based on the methodology that had been applied for years. Currently the DS uses a different methodology to cal-culate those levels. It should also be mentioned, that the DS has re-calculated data series for past periods using the other methodology as well. It should be noted that while previously comparisons were made to show the share of the salary in the minimum subsistence, currently the comparisons show the shares of the minimum subsistence in the salary (as the minimum subsistence calculated by the methodology currently applied is lower than the average monthly salary levels).

The share of minimum subsistence of a family of four in the average monthly salary was 99.5 percent, the share of the level for a working man in the average monthly salary was 56.2 percent and the share of the level for an average consumer was 49.8 percent at the end of Q2 2006. The minimum subsistence for an average family (family of four) share in the salary of private sector employees was 80.4 percent. The comparisons focus on the minimum subsistence for a family of four as salaries are often the only source of household income, and very many households have just only one salary earner.

During the period under consideration, the salaries of 27.1 percent of all hired workers - public sector employees -were GEL 161.8 per month on average. 64.3 percent of those in total hired employment - private sector employees were paid GEL 233.8 per month on average. Foreign organisations employees monthly salary - another 8.7 percent of the total hired labour - was GEL 560.6 on average.

The average monthly salaries and wages across the economy grew in both annual and quarterly terms. Though the salaries of many of the higher ranking government offi cials were raised substantially, in order to attract more professionals to such posts, the rise of salaries of lower ranking bureaucrats and public sector employees was more modest. (The minimum remuneration of civil servants has been fi xed at GEL 115 starting from January 2005, however, the offi cial minimum salary in the country, still remains GEL 35). For urban households, wages and salaries remain the primary, if not the only source of income.

34

Table 20: Monthly Household Monetary Income (GEL)

Wages and salaries

Self-employment

Income from sale of agricultural

produce

Income from asset

holdings

Pension, stipends,

family allowances,

benefi ts

Remittances

Debt or use of savings,

sale of property

Total monetary income

Wages (% of total income)

2000 43.9 21.6 20.9 1.3 8.5 11.9 26.9 135.0 32.52001 52.7 24.3 21.4 1.6 12.3 18.1 18.6 149.0 35.42002 57.5 28.9 28.9 1.0 12.2 23.6 44.4 196.5 29.32003 60.4 32.2 30.8 1.6 8.3 38.6 41.7 213.7 28.32004 67.4 36.6 34.3 2.3 15.6 34.1 42.7 232.9 28.9Q1 62.0 33.5 36.5 2.3 8.0 31.3 40.6 214.1 29.0Q2 65.6 34.9 30.5 2.3 15.6 31.4 46.0 226.2 29.0Q3 72.4 37.0 30.6 2.0 19.6 35.0 42.5 239.2 30.3Q4 69.5 41.0 39.5 2.7 19.4 38.6 41.8 252.5 27.52005 87.5 39.5 32.1 3.3 25.6 36.6 43.1 267.6 29.7Q1 73.9 41.1 31.1 3.6 22.2 34.7 40.5 247.0 29.9Q2 87.3 41.5 24.5 3.1 26.8 32.7 36.9 252.7 34.6Q3 90.6 39.7 28.6 3.1 25.5 37.5 40.2 265.2 28.1Q4 98.0 35.7 44.2 3.4 27.8 41.4 54.9 305.4 26.02006Q1 95.9 35.6 34.7 1.9 27.7 38.4 36.4 270.1 25.2Q2 103.8 37.8 26.3 0.9 32.8 45.5 54.8 301.6 27.8


In Q2 2006, the average monthly household income nationally was GEL 373. The non-monetary income plays a very important role in the household budgets of many Georgian families. This time it accounted for 19.1 per cent of the total monthly household income. It is rural households incomes, for which the impact of this items is particularly strong. For urban households, however, usually its share in the total household income is about 3 times as small as that for rural households. In Tbilisi, the share of the non-monetary income in total household incomes, as a rule, is close to marginal.


Salaries and wages accounted for the largest share in the total monetary household income in Q2 2006 - 34.4 percent, a decrease in both annual and quarterly terms. Debt, use of savings and sale of property was the second largest item in the total monetary income - 18.2 percent - was. The share of this house-hold income item in total monetary income increased in annual terms, as well as in quarterly terms. This time assistance from relatives and friends and their remittances from outside Georgia accounted for the third biggest share in total - 15.1 per cent (as opposed, for instance, to income from sale of agricultural produce at the end of 2005 that was the third largest item in the total monetary incomes at that time). The share of remittances in Q2 2006 was larger than both a year ago and in the previous quarter.

The importance of self-employment activities’ contribution to the total monetary household income was refl ected in its fourth place on the list - it accounted for 12.5 percent, its share in total having de-creased both in annual and in quarterly terms. The share of pensions, stipends and allowances in the total monetary household income grew compared to both a year ago and a quarter ago and comprised 10.9 percent. Another source of monetary income - income from monetary income gained from sale

35

of agricultural produce, was pushed down on the list by the items above, though it still accounted for a substantial portion of the total - 8.7 percent. The share of this item shrank both in annual terms and compared to the previous quarter. Since this particular household income item is especially dependent on the season in quarterly terms and on the harvest and CPI in annual terms, the trend traced seems quite logical.

Table 21: Monthly Household Monetary Expenditure (GEL)

Tota

l Mon

etar

y E

xpen

ditu

res

*

Con

sum

er

expe

nditu

re

(pur

chas

e of

goo

ds

and

serv

ices

)

Food

, bev

erag

es,

toba

cco

Clo

thin

g an

d fo

otw

ear

Hou

seho

ld g

oods

Hea

lth c

are

Ele

ctric

ity a

nd

heat

ing

Tran

spor

t

Edu

catio

n, c

ultu

re

and

recr

eatio

n

Oth

er c

onsu

mer

ex

pend

iture

Sav

ings

and

pu

rcha

se o

f pr

oper

ty

2000 217.0 197.0 100.9 12.7 27.1 10.2 15.8 13.6 7.0 9.7 20.02001 222.6 201.8 106.7 12.2 25.6 11.5 17.1 12.4 7.3 9.2 20.62002 240.0 216.7 113.0 12.4 7.6 15.7 20.0 25.7 13.3 9.1 23.22003 245.9 219.8 116.8 13.3 7.6 13.8 20.0 22.2 6.2 19.9 26.12004 268.2 245.7 131.6 14.5 9.1 15.3 21.8 23.5 6.6 23.1 22.7Q1 261.6 233.0 124.4 14.0 10.1 14.5 22.0 20.9 6.8 20.3 28.6Q2 256.3 232.8 128.0 12.5 8.8 15.1 18.0 22.4 7.7 20.4 23.4Q3 257.1 238.1 131.4 12.4 8.0 16.0 18.1 24.3 4.6 23.2 19.1Q4 298.6 278.9 142.8 19.2 9.7 15.8 29.2 26.4 7.3 28.6 19.62005 287.0 265.5 133.9 14.9 9.8 19.5 26.1 27.0 7.9 26.5 21.5Q1 279.5 261.1 131.7 15.0 10.2 18.4 27.1 26.5 8.6 23.5 18.5Q2 273.7 257.4 132.0 12.9 8.7 20.3 22.9 27.3 9.0 24.2 16.4Q3 272.2 250.0 128.6 13.3 9.2 18.8 22.7 25.5 5.8 26.1 22.2Q4 322.3 293.3 143.3 18.2 10.9 20.3 31.7 28.6 8.1 32.2 29.02006Q1 281.0 262.2 131.6 14.7 10.4 19.4 30.2 22.2 9.1 24.6 18.8Q2 316.2 276.2 139.5 12.2 9.5 26.2 23.8 29.4 10.0 25.6 40.0

Source: Department for Statistics, Ministry of Economic Development* Note: Total expenditures in this table do not include agricultural expenditures and transfers

In Q2 2006, the share of the monetary expenditure in the average monthly household expenditure was 82.4 percent. The money spent for the purchase of consumer goods and services, i.e., consumer expern-ditures accounted for 87.3 percent of total monetary expenditures, thus showing quite a substantial fall in both annual and quarterly terms. As the time series suggest, the general pattern usually refl ects the expenditures on food, beverages and tobacco dominating the overall consumer household expenditure - 44.1 percent of the total household monetary expenditure. Its share in the total monetary expenditure showed an annual, as well as quarterly decrease.


The second largest item in the total monetary household expenditure was that on savings and pur-chase of property - as opposed to the second place held by electricity and gas expnediture in winter at the end of 2005. At 12.7 percent, it doubled both in annual and quarterly terms. Transport accounted for the third largest share - 9.3 percent, showing a quarterly growth and an annual decrease. Expenditures on healthcare and purchase of medicines accounted for 8.3 percent on the total monetary household ex-penditure. The share of healthcare expenditure in total appeared substantially bigger as a result of both annual and quarterly comparisons. Georgian households spending on electricity and gas accounted for 7.5 percent of total - an annual decrease and a huge quarterly seasonal fall. The share of expenditure on education, culture and recreation in total monetary expenditure remained virtually unchanged.

36

5. EXTERNAL SECTORTable 22: Main components of external economic relations (million USD)

Trade balance of goods and services

Current account balance

Current account balance (GDP %)

Net foreign direct

investments

Portfolio investments

Change in gross

international reserves

International reserves by import months

Total foreign debt (GDP

%)

2000 -533.7 -161.2 -5.3 131.7 2.7 -23.3 1.4 50.92001 -479.6 -221.4 -6.9 109.9 2.0 50.2 1.8 50.02002 -447.5 -197.6 -5.8 163.3 0.0 38.5 2.3 51.52003 -582.0 -369.5 -9.2 336.3 0.0 -6.7 1.6 45.92004 -858.6 -346.9 -6.7 489.5 -13.1 192.0 2.3 34.2Q1 -181.7 -100.5 -10.2 117.5 0.0 20.0 1.3 38.6Q2 -159.3 -58.5 -4.7 117.1 0.0 63.2 1.6 36.2Q3 -238.8 -98.3 -7.1 131.3 0.0 90.1 2.2 33.9Q4 -278.7 -89.6 -5.8 123.6 -13.1 18.7 2.3 34.22005 -1140.8* -690.0 -10.8 539.3 15.5 91.4 2.1 27.1*Q1 -195.9 -117.8 -8.9 86.7 5.6 -2.1 1.7 28.8Q2 -216.1 -134.0 -8.7 198.1 2.9 56.6 2.0 27.4Q3 -322.5* -182.5* -10.8* 75.6 7.0 9.6 2.0 27.2Q4 -406.4* -255.7* -13.9* 178.9 0.0 27.3 2.1 27.12006Q1 -315.9* -189.9 -12.6* 133.8 0.0 5.6* 2.0 27.0*Q2 -481.4 -337.9 -18.4 294.2 0.1 57.6 1.7 27.2

Source: Department for Statistics, Ministry of Economic DevelopmentNote: * verifi ed data

Current account defi cit hit a record high in Q2, 2006 compared to the corresponding period of last year, exceeding 150 percent. The main reason for this was the fast growth of imports, which was caused by number of factors such as Lari real exchange rate dynamics, affected by its nominal appreciation and a simultaneous infl ationary pressure, rise in and frequent fl uctuation of world oil prices, emergence of additional consumer as well as investment demand, which was boosted by a sharp increase in bank credit volumes and government’s spending policy. Another component of trade balance - exports also fell under a strong negative pressure largely caused by a ban on wine, mineral waters and other products in Russia since March. At the same time, the dynamics of Lari real exchange rate undermined competi-tiveness of export goods produced by Georgia’s manufacturing industry. Thus, according to BOP, the export growth rate largely lagged behind the import growth rate and comprised 16.6 percent. Moreover, non-trade current transactions, despite their clearly expressed positive tendencies, failed to neutralize a negative effect, caused by the increase in imports. As a result, the CAD dropped by 9.7 percentage points of GDP in the second quarter as compared with the same period last year and comprised 18.4 percent.

The balance of services in the accounting period increased by USD 24.3 million, that is by 150 per-cent, which was caused by a sharp - 42.4 percent - increase in revenues from business and personal tourism over the reporting period. Revenues from pipeline transportation increased as well – by 80 percent. The increase in demand on government services, including consulate and embassy services, brought Georgia an additional net USD 10 million instead of 3.4 million in last year’s same period. At the same time, the balance of transport services deteriorated by USD 13 million, as costs for transpor-tation of Georgian passengers and cargos by foreign companies grew faster than the service provided by Georgian operators to foreigners. As imports increased sharply, so did fi nancial expenditure paid by Georgia on cargo insurance.

Although the service balance improved, the trade defi cit in goods and non-factor services deepened more than twice in Q2, 2006 and made up 26.2 percent of GDP.

37


The income account improved more than twice in the reviewed period as compared to the same pe-riod last year. One of the reasons for such growth was a sharp, four-time decrease in direct investment dividends and profi ts repaid to foreigners. The external liabilities service spending decreased by 25 per-cent as well, partially because of a nominal appreciation of the Lari. Income of Georgian citizens from foreign sources, however, increased by USD 6 million, i.e. 10.4 percent, in annual terms.

Remittances from workers living abroad over a long period of time increased by 30.4 percent in Q2, 2006 compared to the corresponding period of last year. Moreover, non-budgetary public grants increased twice. As a result, the transfer account improved by 61.2 percent and made up USD 107.0 million.

As mentioned above, in the reviewed period the Georgian economy was functioning in the setting of increased domestic demand, caused by large fi nancial infl ows to the country. One of the sources for increased aggregate domestic spending was FDI, which almost tripled in Q2, 2006 compared to Q2, 2005 and reached USD 294.3 million. Almost half of this amount accounted for costs made by British Petroleum for the Shah Deniz gas pipeline. Actual proceeds from privatization to the government sector made up USD 73 million. As regards the structure of direct investments, 83 percent of capital was in-vested in the sphere of services, mainly transport, 16 percent went to industry and less than 1 percent to agriculture. Apart from direct investments, the banking sector received USD 60 million in other invest-ments. The mentioned transactions resulted in the increase of country’s international reserves by USD 50.1 million in the accounting period.

Table 23: Imports structure by commodity groups

Total imports Oil products Motor cars Natural gas Medication Wheat and meslin Sugar Electricity Other

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

2000 709.4 100 71.8 10.1 15.5 2.2 50.3 7.1 45.8 6.5 29.2 4.1 25.4 3.6 14.5 2.0 457.0 64.42001 753.2 100 87.7 11.6 13.1 1.7 48.8 6.5 53.6 7.1 14.4 1.9 24.1 3.2 15.6 2.1 495.8 65.82002 795.6 100 88.9 11.2 21.9 2.8 52.4 6.6 62.0 7.8 20.1 2.5 34.7 4.4 17.7 2.2 498.0 62.62003 1141.2 100 104.8 9.2 46.5 4.1 66.0 5.8 62.9 5.5 28.0 2.4 53.0 4.6 26.4 2.3 753.6 66.02004 1847.9 100 186.3 10.1 116.3 6.3 80.1 4.3 78.0 4.2 75.0 4.1 50.8 2.8 32.3 1.7 1229.1 66.5Q1 328.7 100 28.3 8.6 18.1 5.5 26.0 7.9 17.3 5.3 10.5 3.2 6.2 1.9 17.1 5.2 205.1 62.4Q2 438.5 100 41.1 9.4 21.1 4.8 14.4 3.3 17.9 4.1 20.2 4.6 16.5 3.8 4.7 1.1 302.5 69.0Q3 490.0 100 56.9 11.6 30.4 6.2 12.2 2.5 15.3 3.1 27.9 5.7 13.3 2.7 0.3 0.1 333.7 68.1Q4 590.7 100 60.0 10.2 46.7 7.9 27.5 4.7 27.4 4.6 16.4 2.8 14.7 2.5 10.2 1.7 387.8 65.72005 2490.9 100 336.3 13.5 178.5 7.2 90.8 3.6 92.5 3.7 45.1 1.8 78.2 3.1 40.1 1.6 1629.2 65.4Q1 454.5 100 56.8 12.5 28.6 6.3 28.4 6.2 23.3 5.1 8.2 1.8 16.7 3.7 17.5 3.8 275.0 60.5Q2 527.3 100 74.0 14.0 36.5 6.9 19.2 3.6 28.0 5.3 9.9 1.9 13.1 2.5 3.4 0.6 343.3 65.1Q3 687.6 100 104.1 15.1 48.1 7.0 14.4 2.1 18.4 2.7 12.3 1.8 19.6 2.9 1.6 0.2 469.2 68.2Q4 821.4 100 101.4 12.3 65.3 7.9 28.9 3.5 22.8 2.8 14.8 1.8 28.7 3.5 17.7 2.2 541.8 66.02006Q1 682.4 100 80.8 11.8 65.5 9.6 56.8 8.3 25.4 3.7 16.9 2.5 11.0 1.6 10.9 1.6 415.1 60.8Q2 898.2 100 122.5 13.6 72.8 8.1 44.7 5.0 31.1 3.5 20.7 2.3 16.4 1.8 8.4 0.9 581.7 64.8


38

According to data on foreign trade statistics, imports increased sharply – by 70 percent – in the re-viewed period as compared to last year’s corresponding period. The growth of imports was caused by both external and internal factors. World oil price dynamics is worth mentioning among external fac-tors, while among internal factors the emergence of additional demand, caused by credit expansion and government’s spending policy, is to be mentioned.

The above mentioned is proved by the fact that all import product categories increased more or less evenly. As a result the share composition of the commodity structure, in fact, did not change: oil prod-ucts were on the fi rst place again. Although its share, compared to the same period last year, decreased by 0.4 percentage point, the import value of oil and oil products went up by 65.5 percent in nominal terms. 75 percent of this accounted for oil imported from Turkmenistan and Azerbaijan, while the rest originated in Europe.

In Q2, 2006, as compared to the second quarter last year, the import of motor cars doubled. Its share increased by 1.2 percentage point. It is precisely this commodity category that represented the main object for consumer credit applications. Motor cars were mainly imported from Germany (46 percent), the USA (16 percent) and Japan (10 percent).

Due to a doubling of the supplier’s price on natural gas in the accounting period, the import value in-dicator, naturally, went up. However, a non-price factor, that is increase in domestic demand, resulted in a higher consumption of gas. As a result, the value of natural gas imports grew by 133 percent in annual terms and its share in total imports increased from 3.6 percent to 5 percent. Russia remained Georgia’s main gas supplier.

Import of pharmaceuticals in the second quarter did not increase much in nominal terms. Therefore, given the doubling of total imports, its share decreased in comparison to the previous year’s same pe-riod. This product downgraded from the third commodity category to the fourth.

In the accounting period, compared to Q2, 2005, wheat imports from Russia, Kazakhstan and Ukraine doubled. Given that it exceeded the overall rate of import growth, its annual share in total imports in-creased by 0.4 percentage point.

The value indicator of imported sugar on the Georgian market grew by 25 percent compared to the same period last year, however, its share in total imports decreased. Among large importers was Brazil again, with a 68 percent share, Azerbaijan, coming second this time, and Turkey - the third.

Although the second quarter is seasonally less energy-intensive, the value of energy imports, due to price-related impact, signifi cantly increased, but the growth of overall economic activity in the country increased electricity consumption as well. At the same time, the supply from Armenia sharply dropped and the Georgian economy almost entirely relied on the power supplied by Russia.


The country composition of imports increased as evenly as by commodity in the reviewed period. The share of the top fi ve countries in imports remained unchanged (56.9 percent) compared to the last year indicator. As for the top ten countries, it ranged within a 73 percent limit. Out of USD 60 million increases in Russian imports, USD 40 million accounted for energy carriers and wheat. Turkey was the second by total volume as well as quantitative indicator of growth – the import from this country grew by USD 52 million. It is noteworthy that Turkish imports to Georgia were quite diversifi ed. Ten main commodity categories imported from this country comprised only 28 percent of imports. German im-ports doubled, with 30 percent accounting for motor cars and the rest mainly for electrical equipment and spare parts.

39

In Q2, 2006 compared to last year’s same period, 11 countries left and 13 new countries entered the list of importers to Georgia.


Despite Russia’s embargo on Georgian production, the trade data shows a 23 percent increase in ex-ports in the reviewed period as compared with the previous year’s corresponding period. Accordingly, Russia, in the export structure by countries, downgraded from the fi rst to the tenth place.

The commodity structure, naturally, experienced changes as well. Revenues from export of natural grape wine fell by 70 percent compared to last year’s same period. The share of this product in total ex-ports comprised a mere 2.2 percent (instead of 9.2 percent a year before) and moved down to the 14th po-sition. Georgian wine has so far succeeded in fi nding new markets mainly in Ukraine and Kazakhstan.

Table 24: Exports structure by commodity groups

Total exportsOtherfl ying

apparatus Copper ore Black metal

scrap Ferroalloy Motor cars Unprocessed gold

Nitrogen fertilizers Other

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

mln

US

D

%

2000 322.8 100 7.1 2.2 9.8 3.0 39.0 12.1 13.6 4.2 0.3 0.1 0.0 0.0 16.2 5.0 236.7 73.32001 317.6 100 35.7 11.2 9.6 3.0 33.1 10.4 17.6 5.5 0.5 0.2 12.5 3.9 4.9 1.5 203.8 64.22002 345.9 100 41.1 11.9 13.2 3.8 36.5 10.5 15.5 4.5 0.6 0.2 28.6 8.3 12.0 3.5 198.5 57.42003 461.4 100 28.1 6.1 23.4 5.1 60.1 13.0 26.1 5.7 1.1 0.2 20.3 4.4 18.4 4.0 283.8 61.52004 647.0 100 84.0 13.0 31.8 4.9 95.9 14.8 42.5 6.6 3.8 0.6 18.8 2.9 28.8 4.4 341.2 52.7Q1 95.5 100 0.0 0.0 5.5 5.7 18.4 19.2 10.1 10.6 0.5 0.6 0.0 0.0 4.8 5.0 56.2 58.9Q2 199.8 100 46.2 23.1 11.4 5.7 22.6 11.3 11.7 5.9 0.5 0.3 10.5 5.2 5.3 2.6 91.7 45.9Q3 157.9 100 20.6 13.0 10.2 6.4 21.5 13.6 6.9 4.3 1.2 0.8 4.7 3.0 5.8 3.7 87.0 55.1Q4 193.8 100 17.3 8.9 4.9 2.5 33.4 17.3 13.8 7.1 1.6 0.8 3.6 1.9 12.9 6.7 106.3 54.92005 866.2 100 69.4 8.0 36.4 4.2 84.2 9.7 80.2 9.3 17.9 2.1 34.7 4.0 35.8 4.1 507.6 58.6Q1 170.3 100 8.4 5.0 14.0 8.2 28.0 16.5 21.4 12.6 1.5 0.9 6.3 3.7 4.9 2.9 85.7 50.4Q2 202.7 100 28.2 13.9 8.0 3.9 24.5 12.1 16.5 8.1 2.6 1.3 9.6 4.8 7.9 3.9 105.4 52.0Q3 225.1 100 2.4 1.1 9.3 4.1 19.2 8.5 20.3 9.0 5.4 2.4 9.6 4.3 9.1 4.1 149.8 66.5Q4 268.1 100 30.3 11.3 5.2 1.9 12.5 4.7 22.0 8.2 8.5 3.2 9.3 3.5 13.9 5.2 166.6 62.12006 Q1 221.0 100 15.5 7.0 10.2 4.6 13.5 6.1 19.6 8.9 4.5 2.0 11.1 5.0 10.0 4.5 136.6 61.8Q2 249.0 100 35.9 14.4 23.0 9.2 20.3 8.2 20.1 8.1 9.5 3.8 11.8 4.8 9.0 3.6 119.3 47.9


The export of aircraft increased signifi cantly. This product represented the largest export commod-ity in the second quarter. Turkmenistan continued to be the consumer of 98 percent of this commodity under a debt restructuring agreement between the governments of the two countries.

Copper ore was among the top seven export commodities, coming second in the accounting period, which refl ects a signifi cantly enlivened activity in the sphere of its extraction. The export of this product almost tripled compared to the corresponding indicator of the previous year.

Q2, 2006 saw an expansion of the ferroalloy market. The largest consumer of this commodity was the USA, instead of Russia, in the accounting period. However, Russia still remained to be a large market for this commodity.

Black metal scrap continued to be the main export category, though its value, compared to the previ-ous year’s same period, decreased by 17 percent, which can be viewed as a positive trend.

40

In the accounting period, motor cars were among the top seven export commodities, with the value indicator, which had been growing at a quite high rate since Q2, 2005, showing an almost four-fold in-crease. This can be attributed to the increase in imports of the mentioned commodity category, which, after going through customs clearance, receives the status of export when leaving the country.

Nitrogen fertilizers were also among main export commodities because of a sharp decrease in the export of walnuts, wine and mineral waters.

Table 25: Georgia’s foreign trade with CIS (million USD)

Imports Exports Total balance

Total CIS Other countries Total CIS Other

countries Total CIS Other countries

2000 709.2 229.3 479.9 322.6 128.3 194.3 -386.6 -101.0 -285.62001 753.0 253.9 499.2 317.6 144.3 173.3 -435.4 -109.6 -325.82002 795.5 292.3 503.2 345.9 168.7 177.2 -449.6 -123.6 -326.02003 1141.2 370.1 771.1 461.4 224.8 236.6 -679.8 -145.3 -534.52004 1847.9 657.2 1190.6 646.9 327.7 319.3 -1200.9 -329.5 -871.4Q1 328.7 123.0 205.7 95.5 35.5 60.0 -233.2 -87.5 -145.7Q2 438.5 142.3 296.2 199.8 119.8 80.0 -238.7 -22.4 -216.3Q3 490.0 168.7 321.3 157.9 81.5 76.4 -332.1 -87.2 -244.9Q4 590.7 223.3 367.4 193.8 90.9 102.9 -396.9 -132.4 -264.52005 2490.9 997.7 1493.2 866.7 408.4 458.4 -1624.2 -589.3 -1034.9Q1 454.5 181.0 273.5 170.3 62.4 107.9 -284.2 -118.5 -165.6Q2 527.3 210.3 317.0 202.7 110.1 92.6 -324.6 -100.3 -224.3Q3 687.7 287.1 400.5 225.3 97.9 127.4 -462.3 -189.2 -273.1Q4 821.5 319.3 502.2 268.4 138.0 130.4 -553.1 -181.3 -371.82006Q1 682.4 265.9 416.5 221.0 113.1 107.9 -461.3 -152.8 -308.6Q2 898.2 357.5 540.7 249.0 119.2 129.8 -649.3 -238.3 -410.9


Georgia’s total trade turnover in Q2, 2006 grew by 57 percent in annual terms of which the turnover with CIS countries grew by 49 percent and with other countries – by 64 percent. Despite the sharp de-terioration of relations with Russia, the Georgian economy still sold most of its production on the CIS market.

The share of exports to this group of countries in total exports dropped only by 3 percentage points in the accounting period and comprised 47.9 percent. At the same time, the CIS share in imports increased by 0.9 percentage point, reaching 39.8 percent.

By the end of Q2, 2006 the state debt increased by USD 27.3 million. Meanwhile the Lari fl uctuation still signifi cantly affected the amount of debt denominated in the national currency, which decreased by GEL 44.9 million. Liabilities to bilateral creditors went down by USD 22.7 million by the end of the quarter whereas they went up by USD 48.4 million under multilateral agreements. A sharp increase in the latter was accounted by the IMF’s tranche of the amount of USD 20.4 million. New disbursements on World Bank’s investment credits made up USD 15.5 million by various projects. As regards foreign debt payments, they totaled USD 53.7 million, which is more by USD 1.8 million than the payments in Q2, 2005. USD 48.2 million of this was paid by government as principal and USD 5.5 million as inter-est.

41

6. EU-GEORGIA ECONOMIC RELATIONSTable 26: Main indicators of economic relations between EU and Georgia*

Trade FDI by EU countries

Turnover(thousand

USD)

Exports(thousand

USD)

Sharein totalexports

(%)

Imports(thousand

USD)

Sharein totalimports

(%)

Balance(thousand

USD)

Volume(thousand

USD)

Share inTotal FDI (%)

2000 264 559 76 389 24 188 170 22 -111 781 39 780 302001 302 451 61 605 19 240 846 34 -179 241 69 812 642002 295 474 63 220 18 232 254 29 -169 034 58 446 352003 512 750 81 590 18 431 160 38 -349 570 95 823 282004 728 911 111 363 17 617 548 33 -506 185 195 622 39Q1 127 845 15 414 16 112 431 34 -97 017 - -Q2 199 630 31 543 16 168 087 38 -136 544 - -Q3 184 268 28 717 18 155 551 32 -126 834 - -Q4 217 168 35 689 18 181 479 31 -145 790 - -2005 829 410 165 271 19 664 139 27 -498 868 243 710 54Q1 155 123 32 483 19 122 640 27 -90 157 38 673 43Q2 168 749 23 957 12 144 792 29 -120 835 44 246 42Q3 233 099 52 247 23 180 852 26 -128 605 49 841 66Q4 272 439 56 584 21 215 855 26 -159 271 110 949 622006 Q1 209 292 34 265 16 175 027 26 -140 762 29 352 22Q2 266 438 38 462 15 227 976 25 -189 514 104 179 35

Source: Department for Statistics, Ministry of Economic DevelopmentNote: * To avoid possible discrepancy, the data for all the periods include indicators of 25 EU member states

Georgia’s trade relations with the EU in Q2, 2006 comprised 23.2 percent of the total turnover and involved 21 countries. It is noteworthy that exports grew by 60.4 percent compared to the same period last year, while imports increased by 50 percent. However, the increase of imports in nominal terms was much more large-scale than that of exports.

In the reviewed period, one fi fth of Georgian products exported to Europe comprised of walnuts, which is characterized with strong seasonality, whereas other main export commodities depended, along with external demand, on domestic level of production and existing capacity. Such commodity catego-ries as ores and copper concentrates, mineral nitrogen fertilizers, ferroalloy, non-ferrous scrap metal, isotopes, etc. belonged to this commodity type.


Walnut exports to the EU was below the previous quarter indicator by 40 percent, but exceeded by almost three times last year’s corresponding period indicator. Main consumers of this product on the EU market were Germany, Italy, Czech Republic, accounting for 75.1 percent of total walnut exports.

42

The reviewed period saw an increase in demand for ores and copper concentrates on the EU market, resulting in the export of a notable amount of this commodity (worth USD 6 million) from Georgia. It is noteworthy that no ores and copper concentrates were exported to the EU in the corresponding period last year and only a small amount of this commodity was exported in the previous quarter. As a result, the mentioned commodity became the second large export commodity.

Georgian mineral waters remained popular in Europe in Q2, 2006. Although its export value did not change much compared to the previous year’s corresponding indicator and comprised USD 6 million, its share in total European exports decreased signifi cantly and downgraded from the fi rst place last year to the third with a 15 percent share.

According to annual indicators, the reviewed period saw a shift in ferroalloy and mineral fertilizers towards the CIS and the USA and a sharp drop in these commodities to Europe. Therefore, shares of these two products in Europe-bound exports fell, respectively, from 14 to 5 percent and from 10 to 4 percent, but increased to other countries by 28 percent.

Q2, 2006 witnessed a sharp increase in exports of precious metal articles to the EU, making this commodity into the list of largest export commodities. USD 2.3 million precious metal articles were exported in this quarter compared to USD 0.1 million in the same period of the last year.

Table 27: Exports from Georgia to EU countries (thousand USD)

2005 2006 Q 1 Q 2 Q 3 Q 4 Q 1 Q2

Total exports to EU 32 483 23 956 52 247 56 584 34 265 38 462Of which:Austria - 244 180 621 1344 6Belgium 705 1 248 1 815 1 307 929 2 240Cyprus 22 81 31 108 40 432Check Republic 891 185 2 099 3 457 1 204 1 239Denmark 43 - 1 175 556 6Estonia 1 040 275 601 865 1 026 239Finland - - - - 1 1France 2 417 291 5 887 2 950 429 2 899Germany 4 351 3 810 6 638 13 664 6 868 10 890Greece 2 477 1 921 3 711 2 302 326 193Hungary - - 24 7 - -Ireland - 5 414 523 6 9Italy 4 814 3 980 8 409 16 351 7 274 6 288Latvia 201 229 248 1 067 347 418Lithuania 119 343 254 256 253 854Luxembourg - - - 29 - -Malta 1 6 4 1 2 -Netherlands 4 549 2 533 2 566 1 737 722 1 520Poland 390 135 166 45 210 133Portugal 188 2 22 - 155 181Slovakia 216 166 892 1 625 484 121Slovenia - - 3 16 - -Spain 3 786 1 742 6 621 2 089 2 662 4 934Sweden - 8 5 134 - 8UK 6 272 6 749 11 656 7 253 9 429 5 852


The largest consumer of Georgian exports in the reviewed period was Germany, which received ores and copper concentrates, walnut, clothes, lab equipment and other commodities. Moreover, compared to the previous quarter, exports to Germany increased by 58 percent and almost tripled compared to the same period in 2005.

In Q2, 2006, compared to the previous quarter, exports to Italy signifi cantly decreased, however it went up by 1.6 times compared to last year’s corresponding period. The main commodity determining the trade dynamics with this country over the past years was walnuts. It is precisely this product that accounted for 63.5 percent of Georgian exports to Italy in the reviewed period. More than a half of total walnut exports went to this country as well.

43

Georgia’s exports to the United Kingdom decreased in the accounting period in both annual and quar-terly, especially in the latter, terms. The export structure to this country became more concentrated with 90 percent of its value comprising of mineral waters and precious metal articles.

Spain was fourth by exports in the accounting period. Compared to Q2, 2005, Georgia exported al-most three times more to this country. A considerable increase was observed also in quarterly dynamics. Therefore 92 percent of exports accounted for copper ore, mineral fertilizers, scrap metal and other ores. Spain’s share in the commodity exported to the EU was up by 5.6 percentage points and comprised 12.8 percent.

Georgia’s fi fth largest partner in the fi eld of exports among EU countries was France with a 7.5 per-cent share in total EU exports in the reviewed period. The increase in exports to this country was deter-mined by demand on ferroalloy in the accounting period. It is also noteworthy that exports to France was marked with sharp, quarterly fl uctuation; exports carried out in the previous quarter and in previous year’s same period comprised, respectively, mere USD 0.3 million and USD 0.4 million.

Export of mineral waters to Belgium increased 1.5 times compared to Q2, 2005. In addition, walnuts and some grape wine were also exported. As a result, the share of Belgium in Georgia’s exports to the EU went up to 5.8 percent. A quarterly dynamics also showed a sharp increase.

The accounting period saw a quick annual decrease in exports to the Netherlands. A commodity structure experienced sharp changes as well. The share of this country in the EU exports decreased from 10.6 percent last year to 4.0 percent. Nevertheless, exports to the Netherlands doubled compared to the previous quarter.

Q2, 2006 saw a sharp decline in export to Greece both in quarterly and annual terms. The share in Georgia’s exports to the EU, Greece moved down form the fi fth position last year to the twelfth posi-tion.


The import structure from the EU was quite homogeneous in the accounting period. The largest im-port category was still represented by motor cars, which increased more than twice compared to last year’s corresponding period. This was mainly determined by increased consumer demand. However, a 25 percent rise in price of motor cars also contributed to the increase of this import category. Thus, the share of motor cars in imports from the EU went up.

Compared to the same period last year, the increase in import of pharmaceuticals was not signifi cant, however, due to much higher increase in imports from the EU, the share of this commodity in total im-ports decreased by 5 percentage points. Still, this commodity category maintained its second place in the import structure.

The doubling of computer equipment imports in the second quarter, as compared to last year’s same period, can also be explained by an increase in consumer demand, which caused a signifi cant growth of the share of this commodity in EU imports.

The consumption of European oil products in Georgia tripled in Q2, 2006 compared to the same period last year and comprised 3.5 percent instead of 1.1 percent. The share of this product in the EU import structure also increased, showing the fourth position.

Machinery imported from EU countries for construction works in Q2, 2006 increased as many as 10 times in annual terms, which can be explained by a sharp boost in road and infrastructure construction. The imports of such products were also accelerated by the boom in housing in the country.

44

Seeing TV and radio equipment among leading import commodity groups in the reviewed period was connected with investments in electronic media sector. There was USD 4.4 million worth of equipment imported for this purposes.

Thus, the structure of imports from the EU was quite diversifi ed and, therefore, the top ten of main category imports comprised only 43 percent. At the same time, the share of investment commodity - machinery and spare parts – was quite high, thus representing a positive tendency.

Table 28: Imports to Georgia from EU countries (thousand USD)

2005 2006

Q 1 Q 2 Q 3 Q 4 Q 1 Q2Total imports from EU 122 640 144 792 180 852 215 855 175 027 227 976Of which: Austria 3 474 4 530 5 796 5 212 4 690 8 075Belgium 4 651 6 101 6 216 8 612 8 362 9 257Cyprus 572 196 669 297 203 833Check Republic 1 680 4 766 6 839 7 268 6 177 5 327Denmark 1 192 2 770 1 417 1 685 1 221 4 396Estonia 116 102 843 83 161 171Finland 2 971 4 397 2 496 3 387 4 932 5 060France 11 911 14 528 29 806 35 089 15 967 17 854Germany 34 202 46 737 56 511 69 310 68 063 92 230Greece 4 856 2 582 5 346 5 809 3 820 6 551Hungary 1 480 4 423 4 752 3 685 4 595 3 283Ireland 493 916 977 1 944 1 066 1 469Italy 11 390 12 767 20 178 20 088 15 106 23 452Latvia 1 268 1 282 2 459 1 186 1 288 1 464Lithuania 1 182 882 1 337 1 613 901 1 927Luxembourg 89 392 184 275 131 53Malta - - - - - 0Netherlands 10 725 10 230 11 396 20 735 13 905 18 151Poland 3 193 3 609 3 288 3 567 3 480 4 242Portugal 643 1 075 677 748 731 581Slovakia 888 391 455 1 216 978 855Slovenia 616 1 179 643 1 616 1 009 1 463Spain 1 173 2 190 2 356 2 732 2 877 4 157Sweden 4 662 990 3 275 696 601 1 764UK 19 214 17 757 12 938 19 002 14 763 15 361


One fourth of Georgian imports in Q2, 2006 came from the European 25 countries. Germany was the largest yet again with a 40 percent share in EU imports. A little more than one third of that accounted for motor cars. A large part of machinery imports intended for construction works came from Germany as well. It is noteworthy that the commodity structure of German imports was quite diversifi ed.

The second largest importer among EU states was Italy, although the value of commodities from this country was less by 4 times than that of German imports. Imports from Italy displayed an upward trend and almost twice exceeded last year’s corresponding indicator. According to trade statistics, 83.7 per-cent of merry-go-rounds and other amusement rides were imported from this country.

Imports from the Netherlands were up by 77.4 percent compared to Q2, 2005 and by 30.5 percent compared to the previous quarter, thus comprising 8 percent of imports from the EU. The largest import category from this country was computer equipment, making up 47 percent of such equipment imported from the EU. The Netherlands also exported motor cars and cosmetics to Georgia.

France moved down to the fourth position by import volumes. Due to the relatively low growth rate, its share in the EU imports to Georgia signifi cantly decreased in both quarterly and annual terms. The structure of imports from this country was quite diversifi ed, though pharmaceuticals were in the lead. Increased volumes of alcoholic beverages and blends used in French drinks were imported from France in Q2, 2006. The import of French cars comprised almost 10 percent of total imported European cars.

45

The imports form the United Kingdom grew at a lower than moderate rate compared to the previous quarter. Compared to the same period last year it fell by 13 percent. Accordingly, the share of this coun-try in total EU imports sharply dropped. The structure of import commodities also changed.

Table 29: Direct investments by EU countries in Georgia (thousand USD)

Countries 2003 2004 2005 2005 2006 Q1 Q2 Q3 Q4 Q1 Q2

Total 340070 499107 89366 105944 75618 178857 449785 133833 294233EU 95823 195622 38673 44246 49841 110949 243710 29352 104179Austria 18108 23157 4563 3046 618 6505 14732 3662 1952Check republic 250 277 57 38 620 565 1280 1097 12170Denmark 0 0 0 0 319 0 319 133 42UK 37670 87875 11779 20989 24593 75591 132952 8823 53060Germany 4145 5141 945 631 1234 2222 5032 1552 669Ireland 37 41 9 6 317 262 592 343 78Italy 15896 32480 3858 6469 6770 5742 22838 1933 16926Cyprus 676 21333 14538 9705 9028 14265 47537 8499 16840Luxembourg 250 277 57 38 214 244 553 116 73Netherlands 0 0 0 0 275 217 492 732 65Poland 0 0 0 0 164 130 294 246 39Greece 1967 2178 449 299 490 979 2217 522 294France 16709 22863 2418 3025 5040 3901 14383 1301 1906Sweden 81 0 0 0 160 0 160 152 21Hungary 34 0 0 0 0 327 327 242 43EU share (%) 28 39 43 42 66 62 54 22 35


Foreign Direct Investments from EU countries in the accounting period more than doubled compared to the previous year’s corresponding period. Great Britain was the leader yet again because of British Petroleum investments in the South Caucasus Gas Pipeline construction. This country accounted for 50.9 percent of EU investments and for 18 percent of total direct investments to Georgia. The participa-tion of Italy in the BP project made this country the second largest EU investor. Cyprus, with its USD 16.8 million investment in the Kulevi oil terminal, was again signifi cant. Czech investment increased as a result of participation of the residents of this country in the privatization of energy facilities. The mentioned four countries provided 95 percent of EU direct investment to Georgia.

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PART II. ECONOMIC TRENDS AND POLICY ANALYSIS

1. DIVERSIFYING AND PROMOTING EXPORTS IN GEORGIAVolkhart Vincentz, PhD in economics, Osteuropa-Institut, Munich; GEPLAC Economic Expert,with collaboration of Dimitri Kemoklidze

IntroductionThe political changes in late 2003 were also refl ected in the economic tenets of the new Georgian

government. Paternalistic approaches that characterized the economy in former days have now widely disappeared. The economy should develop by decentralized competitive forces with a minor role for the state. These changes in economic ideology brought Georgia closer to European values and the convic-tions of a market economy. The EU reacted to the new situation by granting preferences and developing closer relations to Georgia.

In a small country a market oriented approach should be accompanied by outward orientation; i.e. close integration into the world economy. Former trade ties remain important but new markets and ex-port products are needed. Such a diversifi cation of trade in terms of trading partners as well as products requires strategies adjusted to different export destinations.

The EU, to which Georgia will shortly be a direct neighbour, seems a natural trade partner with a huge, but demanding market. Using the preferences in EU-trade, Georgia as a small, low income coun-try can concentrate on its advantage of low labour costs. Trade policy should facilitate the intended changes in the geographical orientation of trade. But it is the actual functioning of the economy, rather than economic concepts that determine which measures of trade policy are applicable in the current situation and which are not.

This article starts by taking stock of trade performance. It will analyze the trends and regional distri-bution of Georgian exports. The second part looks at Georgia’s trade potential and international trends in trade that can be utilized. Some consideration is given to the specifi c case of wine export. Finally, trade policy and various means of export promotion are addressed. Tariffs, technical barriers to trade, information aspect of trade promotion as well as more active means of export promotion are examined with respect to their contribution to the diversifi cation of exports.

Facts on tradeBefore the data of Georgian exports are scrutinized to discover trends and patterns, the issue of reli-

ability of the data has to be addressed. Unfortunately Georgian trade data seem to be plagued by severe problems. According to the balance of payments (BoP) total goods exports in 2005 were 1472 m USD but according to the Department of Statistics of the Ministry of Economic Development it was 867 m USD. Actually, the BoP fi gures are adjusted for coverage by adding almost half of the total export as unregistered trade. These additions show a barely declining trend. In 2005 and in the fi rst quarter of 2006 only 57 percent of total trade was registered.

Large discrepancies also crop up if Georgian trade statistics are compared to mirror statistics. Table 1 shows the data of Georgian exports to EU-25 in the Georgian and the EU statistics. Such discrepancies extend to almost all countries and a wide range of products [1]. On average Georgian statistics give sig-nifi cantly lower fi gures than the mirror statistics. One of the known reasons for the unreliability of trade data is insuffi cient border control, which is unable to curtail signifi cantly illegal trade. It is assumed that in earlier years a large amount of goods was smuggled into the CIS, but that contraband trade is now on the retreat. However, the data shows fi rstly, that the discrepancies between Georgian data and the mirror statistics remained high in recent years. Secondly, at least in 2003 no discrepancy appeared in the Rus-sian trade data while the reported Georgian trade with Armenia as well as Azerbaijan was even higher than in the fi gures of the respective countries. From the CIS countries only the national statistics of Ka-zakhstan and Belarus showed higher imports than the respective Georgian fi gures. If smuggling into the CIS occurred on a signifi cant scale, then customs on both sides of the border failed to detect it.

Table 1: Export of Georgia to EU 25 (million USD)

2000 2001 2002 2003 2004 2005GE data 76.4 61.6 63.2 81.6 111.4 165.2EU data 215.6 212.4 202.5 265.5 362.0 328.4

Source: Department for Statistics, Ministry of Economic Development; EU Comext Database

47

No geographical pattern could be discerned in the discrepancies between Georgian and the mirror statistics. In 2003 the highest discrepancy, measured in percentages, occurred in the export with Greece, Hungary, and Korea. Whatever the explanations for these huge differences in the reported trade data are, it renders the following analysis of export trends, based on the statistics, less conclusive. The men-tioned results should urge an improvement to control trade fl ows and the data collection at customs. Without a sound data base no trade policy can be substantiated by facts. Given these strong caveats, we proceed with the analysis of the data as they are.

Table 2 states the data for aggregate trade according to the balance of payments. After a drop of ex-ports at the end of the nineties, merchandise export started to grow strongly in 2002. Export for goods as well as services tripled in 2000 - 2005. However the increase of imports was even higher. The trade defi cit exceeded 1 bn USD in 2005, while the balance of service trade showed only a small surplus. An important part of export in services was pipeline transport. Its revenue grew in the last year to 38.6 m USD and will continue to grow in future when the full capacity of the completed pipeline (BTC) can be used and new pipelines (Southern Caucasian Pipeline, SCP) will go into operation. It is estimated that revenues from the BTC and the SCP pipeline can increase to 95 m USD in 2012 [2]. Just recently the EU gave a green light for another gigantic project, the Nabucco pipeline, which, if it is actually built, will link the Caspian Sea to Vienna.

The current account defi cit is lower than the trade defi cit because of a signifi cant infl ow of remit-tances (94 m USD) and of transfers (360 m USD). However, the current account defi cit of 690 m USD in 2005 is more than 10 percent of GDP, which is unsustainable in the medium term. In recent years signifi cant fl ows of fi nancial aid helped to fi nance the trade defi cit. Although recently international re-serves increased and the GEL (Georgian Lari) appreciated, the problem of fi nancing the external defi cit will remain since fi nancing by remittances and aid money is no sustainable solution.

Table 2: Georgian foreign trade and current account (million USD)

2000 2001 2002 2003 2004 2005Export, goods 522 496 602 831 1093 1472Import, goods 1023 1046 1085 1467 2009 2686Trade balance -501 -549 -483 -636 -916 -1214Export, services 214 314 392 443 539 696Import, services 216 237 357 389 482 624Balance services -2 77 35 54 56 72Net income + transfer 372 260 250 212 511 453Current account -130 -211 -198 -369 -349 -689in % of GDP -4,3 -6,6 -5,8 -9,2 -6,7 -10,7

Source: NBG

In this article macro-policy of the external sector is only touched on. An increase of the real exchange rate in the last two years worsened export possibilities. However, very low wages as well as some pro-ductivity gains should be suffi cient to avoid a deterioration in competitiveness [3]. Although the main problems of the export industries are not related to macro policy but rather refl ect structural weaknesses, the outward orientation of the country should be supported by avoiding overvaluation.

The changes in the geographical distribution of exports in recent years gives no clear picture, partly because the fl ows are rather volatile but mainly because of the mentioned limitations of the trade data. If illegal trade is bigger with some partners, say the CIS, than with others, say the EU, the comparison of country shares as given in table 3 does not provide conclusive evidence. According to the data of registered trade, the CIS is still the leading customer for Georgian goods followed by Turkey and the EU. It seems that the reorientation from the former Soviet market is much less pronounced in Georgia than it was e.g. in the new EU-member states. Although the Russian share in Georgian exports declined from 30 percent in 1998 to 18 percent in 2005, it is still high compared to international standards. Cor-recting for distance between trading partners as well as for their relative size, Georgian exports to Rus-sia and Turkey are well above “normal” [4]. On the other hand the gravity model fi nds untapped export potential with USA, Germany, Belgium, Romania, Korea etc. Although the inertia of the past still infl u-ences the regional trade pattern, Georgia succeeded in expanding its sales markets in the last decade. At present exports are less geographically concentrated than a decade ago. Turkey advanced most among Georgians main export destinations and now ranks second after Russia. The share of exports to Turkey fl uctuated much in the past, not least because Turkey became the main customer for Georgian scrap metal exports, whose demand is volatile.

48

Table 3: Geographical distribution of Georgian exports (percent)

2000 2005Commonwealth of Independent States countries (CIS) 39.8 47.1European Union countries (EU) 23.7 19.1Other regions 36.5 33.8from totalBlack Sea Economic Cooperation Organization countries (BSEC) 60.0 57.7

Source: Customs Department, Ministry of Finance

Georgian export concentrates on a rather small number of items. Ten products (at the 4-digit level) make up 64 percent of all Georgian export. In case of EU trade only three product groups encompass 56 percent of Georgian exports. (Table 4) Some of the main export goods have few prospects. An example is the export of scrap metal which advanced to the top of the Georgian export list. Scrap export is likely to be qualifi ed as a distress export, when inventories or machinery are liquidated for short-term objec-tives of the (new) owner. As business returns to normal wealth maximizing behaviour and corporate governance sets in scrap export will fall as it did in other countries after the transition crisis.

Table 4: Georgian top export products (million USD)

to World to EU- 25

Products 2005 20065 months Products 2005 2006

5 monthsTotal export: 866.2 388.2 Total export: 165.2 55.0 Including: Including: Ferrous waste and scrap; 84.2 27.1 Other nuts, fresh or dried 55.0 18.3 Wine of fresh grapes 81.3 25.2 Waters, including mineral waters 19.1 8.2 Ferro-alloys 80.2 35.5 Mineral or chemical fertilizers 18.8 2.1 Other nuts, fresh or dried 70.3 23.9 Parts for use with machinery 10.7 2.0 Other aircraft 69.4 40.9 Isotopes and compounds of it 3.2 1.4 Copper ores and concentrates 36.4 23.6 Other articles of precious metal 2.8 0.2 Mineral or chemical fertilizers 35.8 17.3 Wine of fresh grapes 2.4 1.0 Gold 34.7 18.6 Ferrous waste and scrap 2.4 1.2 Waters, including mineral waters 32.5 17.8 Gold 2.1 1.0 Spirits, liqueur 29.2 11.7 Petroleum oils 1.8 0.6 Others 312.2 146.8 Women’s or girls’ suits 1.8 0.8

Fruit and vegetable juices 1.4 0.9 Others 43.7 17.3


An atypical export is “other aircraft”, which includes repair services and manufacturing of aircrafts in the enterprise „TbilAviaMsheni”. In the last years the fi rm repaired military aircrafts of Turkmenistan as an in-kind payment for old Georgian energy debts. The future exports of this privatized fi rm cannot be forecast, but it remains uncertain once, around 2008, the debt to Turkmenistan is paid off.

The main export is agricultural products as wine to Russia and hazelnuts to the EU. In addition to ag-ricultural production, there is some processing of raw materials (manganese) and fertilizer production. The narrow basket of exports goods makes Georgia vulnerable to any changes of foreign demand, as the recent Russian ban on Georgian agricultural exports proved.

Source: Kandogan Yener. Does Product Differentiation Explain the Increase in Export of Transition Countries, University of Michigan, Flint School of Management, Working paper No. 2003 - 05, July 2003

49

If one looks at the diversifi cation of export products in transition countries a typical pattern can be observed. (Graph above) Shortly after the start of the transformation the number of exported goods increased, but decreased again in the 5th or 6th year after reform started. This hump in variety before a sustainable growth of variety sets in is attributed to distress exports when fi rms in liquidity crisis and without real owner sold their stocks. As has been said this also applies to Georgia with regard to scrap metal and some other goods. Thus, the change of Georgian export variety, as shown in graph below, is diffi cult to interpret. The number of exported goods increased in the last three years slightly, although the sales of the new export goods were small. There are some indications that distress exports are on the decline, so that the increase in variety can already have a sound and sustainable base. As expected the number of varieties exported to the demanding EU-market is only one third of the number of products that were exported world wide.

Source: Department for Statistics, Ministry of Economics Development and GEPLAC calculationsNote: * Number of exported products out of 943 products at the 4-digit level

In table 5 the growth of exports between 2000 and 2005 is decomposed according to variety. The bulk of the observed export increase was “existing goods” that were exported in 2000 as well as in 2005, while the “new goods” (only exported in 2005) and the “ceased export goods” (only exported in 2000) had about equal value. Thus, export growth was not based on the enlargement of the range of export goods, but on the increase of traditionally sold goods*.

Table 5: Decomposition of export growth

World EUExport abs. mln USD growth % abs. mln USD growth %2000 322 76 existing 524 +162 95 +124ceased -25 -8 -22 -29new 45 +14 16 +212005 865 168 165 116

Source: Department for Statistics, Ministry of Economic Development and GEPLAC calculations

Trade potentialsBefore the question of the Georgian trade potential is addressed in more detail, a short glance at tariffs

is warranted. Since January 2006 Georgia enjoys the preferences of the GSP+ in its trade with the EU. This means that from 2006 to 2008 Georgia can export duty free almost all goods except for arms and ammunition and some agricultural goods to the EU. GSP+ covers 7200 goods to which another 2100 goods from the MFN with zero duty rate has to be added. These are 9300 duty free products out of about 10000 tariff lines of the EU Common Customs Code. If products, as e.g. wine (some type of wine are included in the GSP+ scheme), attract both an ad valorem duty and an ad quantum duty the nil rate will apply to the ad valorem duty only while the full amount of the ad quantum duty will still be payable. The application of GSP+ is conditional on fi rstly the ratifi cation and application of 27 key international conventions and, secondly, on the existence of a poorly diversifi ed economy, which means that the fi ve largest sections of its GSP-covered imports to EU must represent more than 75 percent of total GSP-covered imports.**

* This conclusion applies only to the measures on the 4-digit level. More highly disaggregated data may display a different picture

** There are 21 sections in the Customs Code. Thus the diversifi cation is measured on quite aggregated level, which makes it unlikely that Georgia will miss this application criterion in the coming years

50

Georgia has also a multilateral free trade agreement with the CIS and in addition a number of bilateral free trade agreements with single CIS countries. Thus, to a large extent Georgian exports can enter the neighbouring countries duty free. From the export side Georgia can be considered as a part of a unilat-eral free trade zone. However, since the EU trade regime is rather new, trade data as yet do not refl ect the advantages of the most recent tariff reduction.

Export fl ows are governed by comparative advantage. The climate and soil in the country favours agricultural production, the availability of some raw materials as copper and manganese contribute to exports. In economic terms however the most important source for trade should be the abundant labour with its low wages. The product groups in which Georgia is competitive are shown in table 6. A value of the index of revealed comparative advantage (RCA) above unity indicates a comparative advantage and below unity a disadvantage of the country. In addition to minerals, Georgia is strong in agricultural products and its processing. This export structure is not in contrast to the expected labour-intensive exports, but it does not confi rm the expectations fully because of the lack of labour-intensive manufac-tured products in the top-list of exports.

Table 6: Revealed Comparative Advantage (RCA), 2003

Processed food 6.85 Wood products 0.80Minerals 2.80 Chemicals 0.55Fresh food 1.95 Non-electronic machinery 0.21Basic manufactures 1.01 Clothing 0.19Transport equipment 0.87 Misc. manufacturing 0.09

Source: International Trade Centre UNCTAD/WTO

The missing dominance of labour-intensive manufactures can be partly explained by the geographic location of the country. Georgia is surrounded by other low wage countries. The advantage of low labour costs should fi gure most prominent in the trade with the high wage countries of the EU, but it is hardly effective in the trade with the neighbouring low-income countries. Moreover these countries compete with Georgia also on third-party markets for labour-intensive products. Although within the region Georgia has the least wages, other cost elements as transportation and transactions cost might compensate the small wage advantage. Thus, specializing in labour intensive exports will work for the trade with the high income countries of the EU, but is of less relevance for trade in the proximity.

Although even big countries as Russia or Turkey are small in economic terms as measured by GDP, they are still large in comparison to Georgia. Thus, the size of the neighbouring export markets should be suffi cient in comparison to the Georgian export potential.

Before we consider in more detail the Georgian export potential vis-à-vis EU, the question will be addressed whether Georgia can become a hub for the exports of the region. This function of bridging was often recommended to smaller countries. The Baltic States are partly a successful example for such a distribution centre. Concerning pipeline transport Georgia is already exploiting its role as transit coun-try. Georgia might also try to become a port for sending goods from the surrounding region and Central Asia to Western Europe. Of course the preferential access to the EU applies only to goods produced mainly in Georgia. Moreover, Georgia is not the sole country with tariff preferences from EU. Turkey has also mainly duty-free access to the EU and therefore competes with Georgia on similar grounds. Fi-nally, except for the Black Sea ports the accessibility of Georgia for bulky goods from its neighbours is complicated by mountains. Surprisingly, Georgia has even a disadvantage in transport cost compared to its neighbours [5]. In sum, the location of Georgia at the Black Sea, which holds for Russia and Turkey too, could be only turned into a competitive advantage, if Georgia succeeds to develop an infrastructure and organizational and institutional knowledge on EU trade, which is of use e. g. for Central Asian ex-ports to Europe.

One of the major trends in world trade in the last decades is processing trade. Low income countries can participate in this trade by inward processing of imported materials. In a narrow sense processing trade refers to transactions where a foreign party has raw materials and components processed on a con-signment basis in the exporting country. In most cases the inputs are imported free of duties and VAT. In a broader aspect the processed items can also be made from domestic goods or imported intermedi-ates from a third country. The important aspect is that the customer, who fi nally imports the processed good, is in close connections with the supplier, i.e. exporter, because the products are done according to the specifi cation and quality requirements of the customer. In most cases these are not fi nal goods but specifi c parts or components used as intermediates for a fi nal use good.

51

The demand for processing exports was early spotted and used in special export processing zones by many countries including China. The advances in IT together with the worldwide decline of tariffs made it possible to dissect single stages from the vertical production process to let them produce out-side the fi rm. The possibility of outsourcing a part of the total production process to third parties led to a de-localization of the labour intensive production to low wage countries. More and more goods were outsourced in the last decades. Already in the 1950s the textile industry used processing trade by ex-porting textile fabrics to low wage countries in North Africa and Yugoslavia and re-exporting the sewed clothes. The sewing industry is a most mobile production which quickly moves according to changes in wages. While in the early 1990s much of this processing trade went to the new EU-member states it moved further eastwards as labour costs in the Central European countries started to increase. While sewing works mostly as an enlarged workbench, which needs only little capital, other types of process-ing trade deal with technologically more advanced products. Examples are the production of wiring har-nesses, assembling of parts or machining of parts and components. Outsourcing becomes increasingly the norm in manufacturing for original equipment manufacturers (OEMs). Outsourcing takes also place in services as bookkeeping, call-centers or programming. An outsourcing activity, that is closer to the Georgian food processing industry, demonstrates the rather long detours processing trade can take. The crabs caught on the German coast of the Northern Sea are transported by trucks to Morocco where their carapaces are removed by manual labour before the crab meat is re-exported to Germany.

Georgia should be able to exploit this trend of outsourcing processing activities. Actually, it happens already on a limited scale. Very likely suits and parts for machinery, which are on the list of Geor-gian top exports to EU in table 4, belong to the category of labour-intensive processing trade. Overall processing trade in Georgia, as shown in table 7, is very volatile, and still underdeveloped. Only about 3 percent of total exports belong to such trade. The balance of this trade, i.e. the value added result-ing from this processing trade, is almost negligible. Again the data might provide the wrong picture. If customs control is lax, business can try to use the tax and tariff advantages by declaring normal trade actions as processing trade. Information is not suffi cient to judge whether such misuse of preferences applies to Georgia.

Table 7: Georgian trade in goods for processing (million USD)

2002 2003 2004 2005

Balance 1.63 0.81 3.24 0.55Export 20.02 39.85 23.61 50.20Import -18.39 -39.04 -20.37 -49.65

Source: NBG

In many cases the outsourcing party undertakes FDI to enable the processing activity. If so, consider-able technology diffusion goes along with the trade because it is the deep customer-supplier relations that characterize these types of deals. This gives the chance for learning and upgrading of the production in the processing country.

Mostly export processing trade is accompanied by preferences, as tax and tariff exemption. They are applied to processing of inputs from the foreign party that specifi ed the assignment, or also to activities where raw materials are imported by the processing fi rm itself. In any case abuse of the granted prefer-ences demands an effi cient control of this trade.

FDI provides a widely untapped potential for Georgian exports. The same factors that foster general exports, as the duty free access to EU, also help to attract export-oriented FDI. Only in recent years FDI climbed to about 500 m USD, from which a large part is investment in pipelines. The stock of FDI per capita in Georgia is below 400 USD compared with more than 2000 USD in the new EU members and 800 USD per capita in South-Eastern Europe. But nevertheless this low FDI fl ow, which was 6 - 8 percent of GDP in recent years, is an important source of fi nancing the current account defi cit. Capital infl ow will increase as the privatization of the energy sector continues.

As several earlier studies showed, low FDI are to the most part a result of bad business climate and political turbulences.

Almost all transition countries followed a FDI- and export-led growth strategy. The latest example is Slovakia. It adopted around 1999 a rather strong laissez-faire policy to create a friendly business climate. However, at the same time it adopted an active policy to attract FDI by tax exemptions, cheap land, and several direct (roads) and indirect (fi nancial) subsidies.

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The international success stories of catching up were almost always achieved by FDI-oriented, ex-port-led growth. However, these outward oriented strategies included considerable effort by the govern-ment to attract foreign capital and enter foreign markets. The close contact to international markets is believed to be one of the main driving forces that help to push the local industry towards improvement and creation of new products. The forces for diversifi cation in the geographical as well as the product space eventually are unleashed by international competition. Only the participation in this competition gives fi rms the chance to learn and to absorb organizational and technological knowledge.

The case of wine exportsBefore prospects and possibilities of the Georgian trade policy in general are addressed, it is useful

to look at the special case of wine export, because it provides examples of the different aspects of trade policy. In 2005 wine exports were the second biggest export product of Georgia. Its export increased since 1995 from 4 mln USD to 82 mln USD in 2005. The bulk of the wine, 86 percent goes to Russia, another 10 percent to Ukraine. Exports to EU were only 2.5 mln USD in 2005.

Therefore, the Russian ban on Georgian wine in March 2006, followed by a similar import stop of mineral water in May, can have serious effects on the Georgian wine industry. The Russian trade re-strictions, which were also applied to Moldova, were superfi cially justifi ed by the discovery of danger-ous substances in the beverages. However, tests in other countries could not verify these accusations. Clearly the import ban to both countries is politically motivated. They should deter the former allies from defecting from the Russian sphere of infl uence. In response Georgia started an emergency plan to reorient its exports. But short-term successes on the EU market cannot be expected. The incident shows the importance of export diversifi cation and demonstrates the diffi culties to reorient trade fl ows.

In 2004 the quantitative restrictions of the import of Georgian wine to EU were canceled. In the con-text of GSP+ the ad valorem tariff on some type of wine was abolished at the beginning of 2006 while the ad quantum tariff has still to be paid. But tariffs and quotas are only a part of hindrances against export. Important are the technical barriers to entry as conformity to standards and regulations in the importing country.

In January 2004, negotiations between the representatives of the DG Agriculture of the EU Commis-sion and Georgian stakeholders concluded with the completion of the process of formal recognition of Georgian wines by the EU. As a result Georgian wine producers can export wine to the EU market in un-restricted quantities. To perform exports Georgian producers are obliged to present the VI1 certifi cate, which is a certifi cate of origin as well as of conformity in terms of chemical and sensory quality. These data has to be provided by an accredited laboratory. Georgia has by now two such wine laboratories which however as yet are not formally approved by the EU.

But for a successful appearance on the EU-market the mandatory requirements are not suffi cient. The wine has to be labeled and branded, to distinguish it from the competitors and to increase its visibility for the consumers. To do so, the recognition of geographical incidence, protection against falsifi cation and exact information about the content are necessary. This requires e.g., registry of the areas under cultivation, the control of over 160 wineries and the traceability of the product over the whole gestation period.

The mentioned issues of a broader recognition of Georgian labels and standards are at this time nego-tiated with the EU. The conclusion of a bilateral agreement on trade in wine with the EU would facilitate trading and marketing of Georgian wine in the EU. The prospective agreement should cover:� Oenological practices and processes and requirements with regard to composition of wines;� Reciprocal recognition of country of origin and trade marks and related provisions;� Certifi cation requirements.In addition to the trade related formal regulations which had to be adhered to, it is of course necessary

to supply at competitive prices a product that suits the taste of EU-consumers. For a long time, Georgia concentrated on the Russian Market which - in contrast to Europe - prefers sweet wines. Thus, the reori-entation of exports goes hand in hand with changing product characteristics. In addition, long-standing relations between producer and customer may have lulled the entrepreneurial spirit. The new challenge, imposed on the wine industry by the Russian ban, might in medium term even be useful if it triggers new initiatives to diversify wine exports with respect to regions as well as products, e.g. dry wines for EU. In the short run, however, the Russian import ban will hurt the Georgian wine industry and lead to bankruptcies among the wineries.

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Tariffs and TBTsLast year Georgian trade policy began to streamline the regulations for trade and to remove avoidable

obstacles. The recent amendments to the Law on Customs Tariffs and Duties, foresee a broad decrease of import tariffs in particular for goods not produced in Georgia. Imports are often part of the export products either as an intermediate product or as the service of machinery and capital. In a small country with a limited variety of locally produced products inexpensive imports are important to keep the price of export goods low.

Another important cost factor for exporters is compliance with regulations and standards. This in-cludes the search cost for obtaining the necessary information about trade regulations. The compliance of Georgian products with the requirements of foreign market is compulsory. The adherence to standards and regulations in the recipient country represent technical barriers to trade (TBT)***. Technical product specifi cations, as requirements on safety, consumer health and environmental protection, differ among countries and certifi cates of conformity (tests, certifi cates, inspections, applications and authorizations) may not be recognized by the trade partner. All these measures usually serve legitimate goals of public policy - e.g. protecting human health and safety, or the environment. Although there are also attempts to misuse TBTs for protecting the domestic industry from competition.

In order to minimize the negative effect of TBTs, the WTO requires each member to establish an enquiry point which is able to answer enquiries from other members and interested parties as well as to provide relevant documents regarding technical regulations, standards adopted, and conformity assess-ment procedures. The enquiry point in Georgia should expand its activity by not only submitting the relevant information to the WTO Secretariat but also to seek the information of other states and use it to inform Georgian business. As said, not all standards and rules of a country are mandatory for exporters. Nevertheless it may pay to adopt foreign requirements voluntarily in order to improve te market access, to use them for branding its own products, and to get protection from recognized labels.

To reduce the cost of TBTs, the best solution is to adopt international standards as local standards. In Georgia producers can choose whether they want to apply Georgian or international standards. Geor-gian National Agency for Standards, Technical Regulation and Metrology (STM) is responsible for standardization and certifi cation in Georgia. Since June 2005 both functions of setting standards and of controlling its compliance are split and are assigned to different bodies. This will increase the transpar-ency of the procedure.

If the equivalence of the standards and regulations is recognized by both trading partners, a single conformity test is suffi cient to market the products both, at home and in the EU. If requirements between the EU and Georgia differ two conformity tests are still required. But if a mutual recognition of conform-ity tests is agreed, both conformity tests may be performed by Georgian bodies. This however assumes that accredited laboratories and institution for testing are available. The case of wine laboratories is an important fi rst step in this respect. Georgia might even try to become a stronghold of conformity testing for EU-standards in the region. This service, e.g. in the area of food and feed safety, might be marketed to other countries of the region and Central Asia which are still lacking such technical possibilities.

The conditions of mutual recognition can be the content of bilateral agreements [6]. Such agreements will cover mainly products which are important for exports. As Georgian exports are concentrated on agricultural products and its processing these sectors should be covered by bilateral agreements on TBT. Most TBTs in agriculture are sanitary and phytosanitary measures (SPS) designed to protect humans, animals, and plants from contaminants, diseases, and pests.

As yet we considered hindrances created by the trading partner, but there are also barriers for export-ers on the Georgian side. According to World Bank’s „Doing business“ Georgia was ranked in 2006 at place 95 (out of 175 countries) in the category „Trading across borders“ [7]. This is a big improvement compared to 2005, in which the hindrances to trading were much higher. Altogether the business climate in Georgia improved in 2006 dramatically. However concerning foreign trade and exports, Georgia still belongs to the worst third of all countries in the category “protecting investors”. No improvement was recorded here in the last year. Although “trading across borders” climbed by 54 ranks last year, the paperwork and procedures for exporting were in 2006 still more cumbersome than in the OECD, whose data are stated in brackets. In Georgia an exporter needed 8 (4.8) documents that took about 13 (10.5) days. With 1370 USD per container the cost of export were higher in Georgia than in the OECD

*** The term “technical barriers to trade” is here applied to all of these measures, even where they may be consistent with WTO rules (i.e., legitimate efforts by a country to protect its consumers and agricultural resources).

54

(811 USD). But compared to the region ”Europe and Central Asia” the Georgian cost is almost average. Judged by the disadvantage in transport costs, it seems that recently these costs declined signifi cantly. Further improvements of the trade conditions might realize e.g. through the envisaged new customs code. But as shown in the international comparison the export conditions in Georgia are still less than perfect; there remains room for progress. In addition, measures aimed at one aspect of trade or customs may have unintended side-effects in other aspects. By introducing stricter rules in customs, assigning clearer responsibilities, and allowing less discretion, better control over the customs activities were es-tablished. However, some observers suggested that these measures to fi ght corruption also led to more bureaucracy and slowed down customs clearance. In any case as important as the institutional design and laws may be, in most cases it turns out that the institutional quality, i.e. the manner in which the institutional design is implemented and enforced, is more important than the institutional design itself [8]. Thus, much effort should be concentrated on the execution and enforcement of rules and regula-tions. This is especially necessary in a country with a weak control over its foreign trade fl ows, which the large discrepancies in Georgian trade data suggest.

The cost to overcome the TBT might differ substantially for different destinations of exports. A Swiss estimate [9] of the cost to overcome the TBT to EU is in the range of 0.5 - 1 percent of the total export value. The cost of TBT depends very much on the accessibility of information for the exporters as well as the availability of reference laboratories. If information is diffi cult to come by, costs are obviously higher.

Normally, tariffs and TBTs are the biggest factors that restrain trade. As said, tariffs for exports to CIS and EU are almost absent. This raises the question, why non-registered trade is still as high as in-dicated in the fi rst paragraphs. One explanation is that TBTs, which Georgian exporters face, are much more costly than the Swiss estimate suggests. If so, reducing red tape around TBTs is an effi cient way to promote registered exports. However, if it is not these cost consideration that determines the scale of smuggling, then either the exports of illegal goods, as arms or drugs, or various advantages of staying in the shadow, as tax avoidance, come to mind as an explanation for the non-declaration of trade. In any case, there are good reasons to study in detail the scope and kind of illegal trade.

Information and active promotionKnowledge about tariffs and TBTs are essential for importers as well as exporters. As the practice of

export promotion centers all over the world demonstrates, exports can be best helped by spreading the information about opportunities and regulations concerning the export activities. The range of instru-ments to facilitate exports can be the participation in fairs, organization of meetings with foreign or domestic businessmen or the training of trade experts and managers.

The addressee of the export promotion can be the foreign importer who learns about the domestic economy and its potential. Such services and information are offered by various states and organiza-tions. In Georgia a Business Information Centre in Tbilisi and a website of the Georgian National In-vestment Agency (GNIA) (http:// www.investingeorgia.org/en) provide some information on foreign trade. Mostly efforts are made to inform potential importers of Georgian goods. In promoting exports, the possibilities and regulations to engage in processing trade, using the low labour costs in the country, should be stressed. Processing trade is linked to foreign direct investment (FDI). Export oriented FDI with a labor-intensive production should be targeted. Investment promotion is in this case identical to export promotion. An improved investment climate and a stable legal environment should make it pos-sible to attract more such investments. The question of a special export processing zone to attract FDI should be addressed if the demand for it is clearly stated by potential investors. As always if preferences are granted, their misuse can easily wipe out the intended benefi ts. Again the issue of enforcing and handling rules and regulations is more essential than the institutional form.

Export promotion should not only focus on potential foreign importers but should with the same intensity address potential Georgian suppliers. Information about applicable tariffs, GSP+ regulations and the mandatory certifi cates should be readily available to the domestic producer in Georgian. A user-friendly guide for exporters in the mother tongue should explain the procedures of exporting (tariffs, TBT, certifi cates etc.) to different countries. Such information can be added to the existing website or a new one can be created for this purpose.

The box lists examples of websites that facilitate access to foreign markets; however those sites are only available in English.

55

International Websites for Export promotion http://www.intracen.org/menus/countries.htmWebsite of the International Trade centre provides services for trade development as well as trade

analysis. It contains very useful data about the trade performance of all countries.http://madb.europa.euMarket access database with information on tariffs, TBTs, SPSs and other (accessible only from

EU countries)http://exporthelp.europa.euThe export helpdesk of the EU provides data on tariffs, regulations and TBT and was designed to

facilitate market access to the EU.

The importance of addressing potential exporters may seem less relevant because exports are done by large trading companies or middlemen who are know about the existing regulations. Despite these mediators, there is a need to address directly potential exporters. As the export statistics reveal there are a large number of exporters with rather small exports below thousand USD. For them an easy access to export information is critical. International practice shows that export promotion is mostly geared to SME which, compared to large fi rms, have a disadvantage in the fi eld of information. The information barrier can easily prevent exports just because the potential exporter does not know about existing tariff preferences and the possibilities of support. Export promotion can fulfi l the function of guiding small entrepreneurs through the process.

Export promotion has not to be done by the state alone. The state might be rather the facilitator or organizer who bundles and focuses existing information and activities. Export promotion can to large part be done by industry and entrepreneurs with the guidance of the state. The task is to create com-munication channels through which trade relevant information reaches the widest possible range of entrepreneurs and farmers. As far as associations of industry and agriculture exist, they should be used as communication channel to address its members. If these private organizations are still rudimentary they may expand in line with the state efforts of export promotion. The government’s endeavours of export promotion should also assure the participation of NGOs and private specialists as well as other state bodies as the Georgian WTO enquiry centre or STM.

Of course export promotion does not end with the propagation of information; more active means of export promotion are widely used [10]. We addressed already the question of export promotion zones. Another instrument is an export credit agency (ECA) which can be found in most countries. However, judging the usefulness of an ECA depends on the kind of exports envisaged. Often ECA provide insur-ance against risks which can not be taken by the exporter. In most cases these are political risks as ex-propriation, convertibility/transfer, war/civil unrest. However, if we consider the export to the EU such risks are rather irrelevant; although they may exist in other export destinations.

Another purpose of an ECA is to create conditions that private fi rms engage in fi nancing export activi-ties rather than to substitute private fi nancing. In the case of Georgia as a poor country there is a case for credit insurance or working capital guarantee if the domestic banking system is not able to do so. This would be legitimate if the creditworthy export project can be only fulfi lled with state insurance of bank credits or guarantees. Bank credit might not be available because the exporter is unable to provide adequate collateral or does not have a suffi cient credit history. Of course, distinguishing this case from the subsidizing is diffi cult. The WTO Agreement on Subsidy and Countervailing Measures prohibits export subsidy where government provides contribution of which the benefi t is greater than that avail-able from private market.

Given the mentioned defi ciencies in customs control and the declining but still high corruption, one may doubt whether Georgia at present is able to prevent the misuse of otherwise sensible institutions as ECAs or export promotion zones. It seems that active export promotion at this point of time runs a high risk, that fi nancial means may be diverted and become prey of rent-seeking behavior.

Experiences of the last decades show that successful catching-up was almost always linked to an ex-port-led growth with high foreign direct investment. This was true in Ireland, in all new member states of the EU as well as in the tiger states of South-East Asia. In all cases the national governments were

56

active to attract foreign investments and to stimulate the export of domestic producers. In many cases signifi cant material incentives were given as wage subsidies, tax breaks, low priced land, or superior infrastructure. Researchers do not agree on the importance of these incentives for attracting FDI, but it seems clear that a good investment climate, stable macroeconomics and a reliable and accountable policy are necessary ingredients for success. The focus on exports and FDI is ultimately based on the experience that domestic producers will grow best if they face competition on international markets. Working on these markets provides the knowledge about organizational and technological improve-ments that helps to improve their own productivity. Export-led poverty reduction is a viable concept which is helped by the widely duty-free access to the export markets of the EU.

References:1. Reliability of trade statistics of Georgia in UNCTAD/WTO, International Trade Centre; http://

www.intracen.org2. Billmeier Andreas, Dunn Jonathan, Van Selm Bert. In the Pipeline: Georgia’s Oil and Gas Transit

Revenues, IMF Working Paper WP/04/209, November 2004.3. Papaphilippou Apostolos. Monetary Developments in Georgia: Recent Trends and Policy Impli-

cations, Georgian Economic Trends, Quarterly Review, June 2006.4. UNCTAD/WTO, International Trade Centre.5. IMF. Georgia: Selected Issues, Country Report No. 06/170, May 2006, p. 54.6. The Bilateral Agreements on Technical Barriers or Agriculture between Switzerland and the EU.

http://www.europa.admin.ch7. www.doingbusiness.org8. Islam Roumeen, Reshe Ariell. Trade and harmonization: if your institutions are good, does it mat-

ter if they are different?, World Bank Policy research working Paper no. 3907, May 2006.9. http://www.europa.admin.ch10. Workshop on Export Promotion & Diversifi cation: Industrial Policy & Export Institutions for the

21st Century”, World Bank, May 9 - 10, 2006, http://web.worldbank.org

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2. “DUTCH DISEASE” IN GEORGIAN ECONOMY: CURRENT REALITY AND POTENTIAL THREATSNana Aslamazishvili, PhD in economics,Head of Monetary Statistics and Balance of Payments Division, National Bank of Georgia

The “Dutch Disease” Phenomenon Too much wealth managed unwisely – this is a more or less the accepted defi nition for the “Dutch

Disease”. The discovery of natural gas deposits in the North Sea by the Netherlands in the 1960’s caused an unprecedented surge in the country’s export revenues, the appreciation of the Gulden, the national currency at that time, and decline in competitiveness of traditional exports. Since then the phenomenon known as the “Dutch Disease” has become a headache for many countries.

An attempt to explain such a paradoxical effect of the increase in wealth was undertaken by M. Corden and P. Nearvy in 1982, who outlined the classical model of “Dutch Disease”. The essence of the model is that a boom in the natural resources sector disturbs the balance between this sector, the traditional tradable sector and non-tradable sector (retail trade, restaurants, hotels, construction). At the beginning, the export of natural resources boosts the country’s foreign currency revenues. When these infl ows are used to increase imports, they neither affect money supply directly nor spur growth in demand. However, unrestricted increases in imports are unjustifi able. Therefore, increasing revenues from natural resource exports are converted into the national currency on domestic foreign exchange markets. If a national currency exchange rate is fi xed in a country, the conversion of foreign currency into a local one requires that money supply be increased, which causes a hike in domestic prices. If a national currency exchange rate is not fi xed, the disturbance of the demand-supply balance on a domes-tic currency market will entail the appreciation of the local currency. In both cases, the real exchange rate of the currency increases, meaning that much less goods and services can be purchased by a foreign currency unit in a country than before. Such a situation reduces the profi tability of traditional exports. Export goods, having become more expensive due to the rise in domestic prices, turn out to be less competitive in international markets, which results in a sharp decline in the production of traditional exports sector. However, this is not the only result. The so-called “Resource Movement Effect” takes shape, when capital and the workforce start shifting to the non-tradable sector. A normal course of this process, however, inevitably requires that the infrastructure of this sector be rehabilitated and upgraded, investments be made in retraining of workforce, etc. If fi nancial diffi culties or/and infl exible governance infrastructure prevent all these from happening, it will be diffi cult for a country to avoid unemployment and associated social cataclysms. Thus, the process of “Dutch Disease” is a very painful development for any economy.

It is well known that the “Dutch Disease” is not always associated with the discovery of natural re-sources. The experience of many countries has proven that an increase in foreign direct investments and international fi nancial assistance can also produce a similar effect.

Georgian signs of the “Dutch Disease” Since mid 2002, Georgia has experienced a boom in foreign investments that were related to the con-

struction of the Baku-Tbilisi-Ceyhan oil pipeline (BTC). At the beginning, most of these investments accounted for the import of pipes and other material as well as equipment needed for the construction and therefore, did not spur much of an increase in demand on the country’s domestic market. As a re-sult, the exchange rate was stable and infl ation kept under control. The symptoms of a likely “disease” went unnoticed by society at large. However, since mid 2002, the foreign trade balance trajectory took a downward trend, which was explained by huge volumes of pipeline-related imports and was not viewed in a negative light. From 2003, the construction of the oil pipeline started in full swing and caused a sharp surge in expenses in Lari (compensation for the use of land, cargo handling service in Poti and Batumi seaports, purchase of material from Georgian companies as well as food products from the lo-cal population, rent for housing of foreign specialists, wages of local construction workers, etc.). The intensity of covering the above-mentioned costs, which can be clearly seen from the table below, has naturally affected the domestic currency market conjuncture – the demand on Lari increased.

The volume of USD sold at Tbilisi Interbank Currency Exchange (TICEX) hit a record high in 2004, reaching USD 277 million and exceeding the 2003 level by 2.7 times. The total volume of USD sold at TICEX over 2002-2004 (the Baku-Tbilisi-Ceyhan pipeline construction years) comprised USD 482.1 million, thus exceeding a similar indicator for the previous three years (1999-2001) by 1.5 times. The

58

NBG bought 58 percent of this amount and used it not only to increase its international reserves but also to maintain equilibrium on the domestic currency market.

Table 1: Costs of Georgian section of the Baku-Tbilisi-Ceyhan oil pipeline construction (thousand USD)

2002 2003 2004Total 60464.0 182809.2 218223.7Cost of Georgian section of BTC pipeline construction inside Georgia 60338.0 179971.8 215855.8Cost of Georgian section of BTC pipeline construction outside Georgia 126.0 743.0 1479.9Construction costs of schools, health care and other facilities 0 2094.4 888.0

Source: Papava Vladimer. The Baku-Tbilisi-Ceyhan Pipeline: implications for Georgia, pp. 85-102, www.silkroadstudies.org

Along with the boom* in pipeline-related foreign investments, political changes, which took place in the country, further deteriorated inequality between demand and supply on the domestic foreign ex-change market and weakened the effi ciency of monetary policy instruments. Under new political reali-ties - fi ght against smuggling, corruption and illegal revenues as well as improvements in tax adminis-tration - tax and non-tax state budget revenues sharply increased; so did expenditures as well, boosting demand in consumption. On the other hand, measures taken against contraband imports created certain barriers impeding the outfl ow of foreign currency, which also contributed to the saturation of the cur-rency market.

A large-scale privatization programme has become another source of foreign currency infl ows. On the one hand, this source helps increase international reserves, thus providing certain guarantees for the protection of the country from external shocks, but on the other hand, the monetization of such revenues through budget channels, among them in the form of sharp increase in costs on the so-called public works, has signifi cantly affected the infl ationary processes.

Source: NBG

A clear-cut upward trend is observed in remittances by Georgian nationals living and working abroad. While in 2000-2002 such remittances, in the form of swift money transfers alone, comprised 2.5 percent of GDP, in 2003-2006 this indicator almost tripled. To better illustrate the scale of such transfers, we compared the volume of transfers with FDI and export revenues. In 2002-2004, when FDI to Georgia reached its record high, the volume of foreign currency infl ows in the form of swift money transfers alone made up 60 percent of FDI. However, given that remittances are not carried out only through swift money transfers (that can be tracked through bank channels) and given an increasing practice of money transfers via internet, post, plastic cards, cheques, etc., it would not be diffi cult to assume the amount of such infl ows and its infl uence on the level of consumption, investments, savings and dollarization in the country, which, unfortunately, is diffi cult to study quantitatively. A signifi cant scale of this phenomenon can be easily guessed from its ratio to export revenues - in 2005 it already exceeded one-fourth of the latter.

Table 2: Dynamics of remittances from abroad *

2000 2001 2002 2003 2004 2005Volume (mln USD) 63.3 69.6 83.9 196.6 249.1 403.1% to GDP 2.1 2.2 2.5 5.0 4.8 6.2 % to FDI 41.6 87.1 68.5 58.7 49.6 117.2 % to Export Revenue 10.8 14.7 15.2 26.9 19.6 25.4

Source: NBGNote: * swift money transfer

* Apart from oil pipeline construction, foreign investment infl ows were signifi cant in such sectors of Economy as energy, communications, hotel business and construction. These capital infl ows added to the demand for Lari on the domestic market.

59

The combination of these developments has upset the macroeconomic equilibrium, making eco-nomic processes larger in scale and more diffi cult to predict.

Source: NBG

The accompaying charts illustrate that along with the increase in FDI, large amounts in the form of remittances have started to arrive since 2003. At the same time, a sharp increase was observed in budget revenues, including non-tax revenues, which, given the high dollarization level, led to an increase in conversion of earlier saved dollar holdings into Lari. As a result, a boost of supply factors was appar-ent on the domestic currency market, which strongly attracted excess foreign currency to its interbank, client and banknote segments. A gradual appreciation of Lari nominal exchange rate started. While in 2003 the national currency appreciated by 2.3 percent, in 2004 the indicator reached 11.9 percent. In the following year, 2005, the process of Lari nominal appreciation slowed down.

Source: NBG

However, as the respective charts show, it was impossible to prevent the increase in Lari Real Ef-fective Exchange Rate, which is a clear symptom of the “Dutch Disease”. The growth of domestic de-mand, triggered by a sharp increase in budget expenditure, created an imbalance between tradable and non-tradable sectors, which translated into a signifi cant increase in annual infl ation and foreign trade defi cit.

Source: Department for Statistics, Ministry of Economic Development of Georgia

60

Source: Department for Statistics, Ministry of Economic Development of Georgia

Thus, the Georgian model of the “Dutch Disease”, dubbed by Professor Vladimer Papava as “the Georgian disease” [5, p.96], has a number of characteristic features. To start with, it is not related to the export of natural resources but is rather caused by a surge in FDI and money transfers, on the one hand, and, on the other, by an increase in budget revenues resulting from improved state control in the country. Second, the traditional export sector is less vulnerable to the appreciation of real effective exchange rate because exports are still focused on raw materials, mainly comprising scrap metal, hazelnut and walnut, non-ferrous metals and concentrates (almost one-fourth of exports), while almost the same volume of exports are re-export goods, such as wheat, fl our, sugar, medicines and motor cars.

As regards the growth of imports, this is determined, on the one hand, by the fact that it became cheaper as the real effective exchange rate appreciated, and on the other, by the need for imported goods to carry out foreign investment-related construction works. Because of these characteristic features, the balance between traditional tradable and non-tradable sectors in Georgia is disturbed.

It could be said that unlike the classical model of “Dutch Disease”, macroeconomic disproportions caused by FDI and international aid may, in general, be temporary, since these infl ows themselves are temporary. However, without considering their effect and without pursuing a fl exible policy, the country may face a severe economic situation, which would be very painful to overcome. In this regard, Profes-sor Vladimer Papava quite rightly reckons that the main reason of infl ationary pressure is not only the increase in money supply due to purchase of excess foreign currency by the NBG, but also the increase in money supply due to softer expenditure policy [2]. He believes that it is unacceptable to allow the Lari to further appreciate, because it will inevitably aggravate the “Dutch Disease”.

How to avoid aggravation of “Dutch Disease”? We believe that in order to neutralize the negative effects of foreign capital infl ows, caused by these

factors, it is necessary to timely take some measures. The application of monetary instruments alone will defi nitely not bring about desirable results. First, we should admit that we face the “Dutch Disease”, albeit not in its classical form, and should not rule out the danger of its possible aggravation. Conse-quently, it is crucial to have a consistent strategy to avoid it, the strategy which has been tested and ap-plied in many countries. This strategy implies the harmonization and coordination of monetary, fi scal, exchange rate, banking and trade policies.

The experience of several countries proved that the most “popular policy response” [3] to capital infl ows is sterilization in various forms: decrease of money supply and open market operations, increase of minimal reserve requirement level or interest rates. The issuance of deposit certifi cates by NBG - a new and effective monetary regulation mechanism - is worth singling out.

The issue of securities by the NBG was prompted by the need to prevent current infl ationary proc-esses. A deposit certifi cate is a security denominated in the national currency, in a non-material form and is equipped with all functions characteristic for securities. Given its liquidity, this instrument offers more opportunities to market participants to invest their means without risk. Although at present the issue of deposit certifi cates is primarily aimed at sterilizing money, their role in the development of cur-rency markets in the country is more important, since it gives commercial banks an opportunity to put this instrument on secondary markets and trade in it.

However, without proper control on budget expenditures, it will be diffi cult to achieve desirable results. There are many examples of the optimization of budget expenditure in countries being in such a condition. Given the situation in money circulation, it would probably be expedient to use budget rev-

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enues to decrease foreign liabilities, to spend on embassies in foreign countries or on other objectives, i.e. for such activities which do not entail the increase in money supply.

Promoting technological imports through tariff liberalization is an effective means to slacken de-mand on the Lari and weaken the pressure of foreign currency on the domestic market. Zero tax rates on the import of inputs was introduced. This is indeed a progressive step, though we should bear in mind that it will be a one-way street without promoting exports.

The main issue in policy regarding capital infl ows is to decide the extent to which they should be al-lowed to enter and the extent to which their entry should be restricted. It is unacceptable to view them only in a positive light and to disregard the consequences of their possible impact on the fi nancial sector. Experts expect that an investment boom in the country starting from the last quarter of the current year. This assumption is strengthened by a draft amendment to the Law on State Support of Investments, be-ing under active consideration in the government, which envisages the introduction of more benefi ts to foreign investors. However, in such a case, there is, fi rstly, the need to have adequate mechanisms and infrastructure, to avoid the so-called Embarras de Richesses**, and, secondly, investments oriented on employment, environmental safety and import of modern technologies should be encouraged, which would contribute to the increase and diversifi cation of export potential. It is precisely such an approach that will make it possible to achieve desirable results from the liberalization of foreign trade.

Although certain measures to overcome the “Dutch Disease” are apparently neglected, we would like to focus on the signifi cance of some of them. One of such measures is the insurance of deposits. As mentioned above, the infl ow of foreign investments in the country brings forth the need for additional money emission. The introduction of a deposit insurance system and the encouragement of the accumu-lation of money in banking channels through it, will create a real source of money supply available for domestic investments. Thus, the optimization of foreign capital infl ows and better utilization of existing resources in the country for investment purposes will defi nitely bring about positive qualitative changes in the country’s economic development. It is precisely this approach that Hernando de Sotto, the author of a popular book, “The Mystery of Capital”, means by saying that developing countries possess no less capital than developed ones, though, in contrast to the latter, the former keep them in the form of “dead capital” [4].

It is no secret that the frequent disregard of the interests of depositors in the recent past in Georgia signifi cantly undermined confi dence in the banking system and it will defi nitely take time to restore it. The result of this mistrust is that our banking system, in terms of mobilizing monetary means, is one of the countries lagging far behind many, including post Soviet countries (see the table 3). Thus, a high concentration of deposits in the banking system will enhance the possibility to fi nance the economy through own resources and decrease the dependence of the national economy on foreign investments, which, in its turn, will mitigate the risk of further aggravation of the “Dutch Disease”.

Table 3: Deposits in banking and non-banking fi nancial institutions to GDP in Georgia and other countries, percent

Country Deposits to GDP Country Deposits to GDPGeorgia 7.8 Moldova 26.7Kyrgyzstan 8.8 Latvia 30.8Armenia 9.8 Chile 33.3Azerbaijan 12.3 Poland 34.2Romania 13.3 Estonia 35.7Belarus 15.3 Bulgaria 38.9Kazakhstan 19.6 Hungary 41.0Peru 21.6 USA 43.3Russia 22.3 Italy 54.6Argentina 23.1 Czech Republic 61.0Mexico 23.9 Panama 70.1Ukraine 24.0 Germany 100.9Brazil 24.0 Netherlands 107.5Turkey 24.1 Japan 121.6Lithuania 26.6 Switzerland 136.1

Source: International Financial Statistics, April, 2006

** Embarrassed rich (French)

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Measures, like the reformation of a pension system and creation of private pension funds, promotion of savings in national currency, establishment of a securities market are no less popular and benefi cial for the monetary (and not only) policy. Such an infrastructure will minimize the risks of FDI and in-crease the motivation of local investors to invest their own capital in the national economy.

References:1. Corden Max W., and Nearvy Peter J. Booming Sector and De-Industrialization in a Small Open

Economy, The Economic Journal, Vol. 92 (December, 1982), pp.825-848.2. Papava Vladimer. On devaluation of competence of IMF, The 24 Hours newspaper, September 18,

2006.3. Calvo Guillermo A., Leiderman Leonardo, Reinhart Carmen M. Infl ows of Capital to Developing

Countries in the 1990s, Journal of Economic Perspectives, Volume 10, Number 2, Spring 1996, pp 123-139.

4. De Sotto Hernando, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, New York, Basic Books, 2000. 276p

5. Papava Vladimer. The Baku-Tbilisi-Ceyhan Pipeline: Implications for Georgia. In: The Baku-Tbilisi-Ceyhan Pipeline: Oil Window to the West. Ed. by S. Frederick Starr and Svante E. Cornell, Uppsala University, pp.85-102. http://www.silkroadstudies.org/BTC.htm

6. IMF. International Financial Statistics, April 2006.7. Nkusu Mwanza. Aid and “Dutch Disease” in Low-Income Countries: Informed Diagnoses for

Prudent Prognoses. IMF Working Paper WP/04/49, March 2004.8. Ebrahoim-zadeh Christine. Back to Basics, Finance & Development, Volume 40, Number 1,

March 2003.9. Hogarth Glenn, Stern Gabriel. Movement of Capital: causes, consequences and response in the

fi eld of policy, Bank of England, Central Bank’s Operations Guide, N14, 1998.10. Christiansen Robert E. On infl ation in Georgia, The Rezonansi newspaper, September 1, 2006.

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PART III. ECONOMIC REFORM AGENDA

ACHIEVING COHERENCE BETWEEN THE GEORGIAN MEDIUM-TERM RE-FORM PROGRAM AND THE EU-GEORGIA ACTION PLAN (ENP AP)Ivan Samson, Professor, Director of Espace Europe Institute at UPMF University, Grenoble; GEPLAC economic expert

IntroductionThe main objective of this paper is to discuss the most optimal ways of integration of the EU-Georgia

ENP Action Plan (ENP AP) into Georgian national policy framework and to ease its implementation through a forthcoming Action Plan Implementation Programme (APIP) of the Georgian Government. It is also to contribute to the already well-engaged process of unifying the strategic documents of govern-ment agencies.

The reason for this paper is that some voices expressed the idea that the ENP AP could lack consist-ency with the medium-term reform program of the Georgian government as expressed in the Basic Dates and Directions for 2007-2010 (BDD). Such assumptions are likely to hinder the implementation process of the ENP AP. The paper will contradict these voices by showing that if there are differences between the two documents, there is in no way opposition between them, neither in substance nor even in approach. It will also provide recommendations for preventing or at least minimising possible future misunderstandings and for fi nding clear decision criteria.

A close similarity in the substance of the two documentsIf one compares the two documents, the similarity is striking. The levers and the ways of implement-

ing the development of the country are well-identifi ed.- Peaceful management of security issues “Restoration of territorial integrity with peaceful means

and achievement of civil unifi cation” (BDD); “Promote sustained efforts towards the peaceful resolu-tion of the confl ict in Tskhinvali region/South Ossetia, Georgia, and in Abkhazia, Georgia” (ENP AP): this a critical precondition of any economic development based on foreign investment, which is the best development path to recommend.

- Rule of law “Effective justice - high degree of confi dence based on the sense of equality;” and “Ca-pable law enforcement system - effi ciency in actions and public control” (BDD); “Strengthening the stability and effectiveness of institutions guaranteeing democracy and the rule of law; Reform of the judicial system”(ENP AP).

- Regional integration: “Creation of preconditions for implementing Georgia’s strategic interests in the neighbourhood area, the Black Sea and South Caucasus region” (BDD); “Enhance and develop new areas of cooperation in the Black Sea region including Southern Caucasus” (ENP AP).

- Integration with the EU: “Increased degree of economic and cultural integration with EU - reduction of barriers for movement of people, capital, goods and services” (BDD); “The European Neighbour-hood Policy opens the perspective of moving beyond cooperation to a signifi cant degree of integration, including through a stake in the EU’s Internal Market and gradual extension of four freedoms to Geor-gia” (ENP AP).

- Reform of public administration: “Reformation of public administration and public service; im-provement of decision-making system; rationalization of managerial expenditures; introduction of a contest system for staff selection; creation of environment for due motivation of the hired personnel” (BDD); “Civil service reform: Continue to develop and implement reform of public administration with a view to its modernisation, accountability and transparency; strengthening of the already functioning training centres” (ENP AP).

- Anti-corruption: “Implementation of Anti-corruption Action Plan Increasing effi ciency of special anti-corruption supervision system for high-rank offi cials“ (BDD); “Ensure the implementation of the recently approved National Anti-Corruption Strategy by 2009 “(ENP AP).

- Privatisation: “Minor governance” - out of alternatives for ownership forms, giving priority to pri-vate ownership” (BDD); “Pursue transparent privatisation process both as regards divestiture and use of privatisation proceeds” (ENP AP).

64

- Business climate: “Improvement of licensing and permissions regulation and introduction of princi-ples of ‘one window’ and ‘silence presumption’; (…) Minimization of state regulation of entrepreneur-ship” (BDD); “Develop and implement a comprehensive programme to improve the business climate, in particular to improve the conditions to starting a business, hiring and fi ring workers, registering prop-erty, getting credit, protecting investors, enforcing contracts, and closing a business” (ENP AP).

- Food safety: “Creation and stage-by-stage implementation of the uniform system of food security; increase of the country’s epizootic reliability” (BDD); “Increase food safety for consumers and facilitate trade through reforms and modernisation of the sanitary and phyto-sanitary services” (ENP AP).

- Infrastructures: “Elimination of the reasons for energy defi cit; restructuring and rehabilitation of energy sector (…) Rehabilitation and construction of regional and inter-district roads” (BDD); “Coop-eration in specifi c sectors: including transport, energy, environment, telecommunications, research and innovation” (ENP AP).

- Poverty: “Reduced extreme poverty and more work places in private sector - visible economic growth and directed social assistance” (BDD); “Take signifi cant steps to reduce levels of poverty” (ENP AP).

- Environment: “Conditions for sustainable environmental development - coordination of private interests and sustainable nature consumption; (…) Creation of competitive system of utilizing natural (including forestry) resources and facilitation of formation of secondary market” (BDD); “Promotion of sustainable development; Identify steps to establish and implement the national strategy on sustainable development; (…) Take steps to improve integration of environmental considerations into other policy sectors” (ENP AP).

The strong coherence which derives from the confrontation of the two documents is very substan-tial:

- They identify the same priorities for reform and development;- On all these key questions the two documents express close views.Some apparent differencesThere are also some apparent differences between the BDD and the ENP AP documents. Let’s review

the most obvious.Guiding principles: The BDD report expresses in a preamble its ”guiding principles” (“minor gov-

ernance”, “good governance”, “targeted assistance”, “targeted spending” and “good practice”) whereas there is nothing similar in the ENP AP, that relies more on facts, as the previous and existing relations between EU and Georgia.

Sequencing: In the sequence of priorities, the BDD has a very strong accent on governance issues (“Formation of fl exible, accountable and capable governance”; “Increased competence in state govern-ance”; “Developed self-government - decentralized authority and responsibility”) whereas the ENP AP focuses more on institutional dimension “Strengthen rule of law … through rebuilding state institutions” and “Strengthen democratic institutions and respect for human rights and fundamental freedoms”.

NATO: The BDD has as a key priority the “achievement of consistency with NATO membership requirements” while the ENP AP does not focus on that institution.

Economic activity: According to BDD views, the key word is “freedom” of individuals (“High degree of economic freedom - economic impartiality and minimum interference”), whereas the ENP document has a more complex approach focusing on the relevant legal framework of business activity (Priority area 2).

Institutional development: In the BDD document, the basic direction of the institutional side of the reform is the deregulation of economic activity, while in the ENP AP the basic direction is the conver-gence with EU rules and standards.

The question raised by the above observations is the correct and fl awless interpretation of these dif-ferences, which appear upon basic similarities.

The different nature of the documentsA fi rst explanation is the very different nature of the documents. The BDD is a unilateral paper ex-

pressing the views of the government, whereas the ENP AP is a bilateral document negotiated with the

65

EU and thus containing views from both sides. The asymmetry of Georgia-EU negotiations, refl ecting just the difference in the size of their economies, should also be borne in mind.

There is another basic difference between two documents according to scope. The BDD is a docu-ment aiming at consolidating mid-term priorities of Georgian ministries. For example the current priori-ties of the Ministry of Economic Development (MOED) are only two: trade and transport.

BDD defi nes fi ve government priorities:- Restoration of territorial integrity with peaceful means and achievement of civil unifi cation;- Sustainable economic growth and facilitation of growth;- Formation of fl exible, accountable and capable governance;- Rehabilitation and development of infrastructure;- Achievement of consistency with NATO membership requirements. The BDD identifi es also specifi c outcomes of the reform:- Increased competence in state governance - high effi ciency of management and spending;- High degree of economic freedom - economic impartiality and minimum interference;- Effective justice - high degree of confi dence based on the sense of equality;- Developed self-government - decentralized authority and responsibility;- Adequate defence - developed military infrastructure and real prospect of NATO membership;- Capable law enforcement system - effi ciency in actions and public control;- Consumer-oriented sustainable energy sector - uninterrupted power supply, fi nancial sustainability

and encouraging investment climate;- Reduced regional disparity - rehabilitated basic infrastructure (inter-regional roads and local water

supply);- Conditions for sustainable environmental development - coordination of private interests and sus-

tainable nature consumption;- Reduced extreme poverty and more work places in private sector - visible economic growth and

directed social assistance;- Opportunities of quality and competitive education - affordable and quality system based on liberal

values;- Open and tolerant environment - cultural pluralism and civil and cultural integration;- Increased degree of economic and cultural integration with EU - reduction of barriers for movement

of people, capital, goods and services;The ENP document, while identifying 8 priority areas, has a more long term orientation. 1. Strengthen rule of law especially through reform of the judicial system, including the penitentiary

system, and through rebuilding state institutions. Strengthen democratic institutions and respect for hu-man rights and fundamental freedoms in compliance with international commitments of Georgia (PCA, Council of Europe, OSCE, UN).

2. Improve the business and investment climate, including a transparent privatisation process, and continue the fi ght against corruption

3. Encourage economic development and enhance poverty reduction efforts and social cohesion, promote sustainable development including the protection of the environment; further convergence of economic legislation and administrative practices.

4. Enhance cooperation in the fi eld of justice, freedom and security, including in the fi eld of border management

5. Strengthen regional cooperation 6. Promote peaceful resolution of internal confl icts7. Cooperation on Foreign and Security Policy8. Transport and Energy

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All these areas, except item 7, are represented in BDD. It should be noticed that all the BDD priorities are refl ected in the ENP documents. The integration with the EU, especially within its single market, is a clear objective of the BDD. Moreover, one can fi nd in the BDD such issues which are usually presented as typical from EU requests, as the orientation towards the consumer or the protection of environment.

Title 4 of the ENP AP, “General objectives and actions”, represents two thirds of the document and lists “further actions”, which “complement, in many cases, the specifi c priorities”.

This difference in scope explains why this part of the document contains important issues that might be not yet on the annual agenda or just in the fi rst steps of convergence. This is true for such wordings as “Increase compliance with relevant industrial standards, SPS and veterinary norms” (4.5.1), as “Jointly identify priority industrial sectors for possible legislative approximation” (4.5.1), as “In the medium-term, draw up a fi rst list of measures for gradual convergence towards EU general food safety principles and requirements” (4.5.1) or as ”Initiate a dialogue on the principles of the EU Code of Conduct for Business Taxation” (4.5.5).

An important aspect is that these measures are broadly compliant with the BDD objective of “achiev-ing consistence with NATO membership requirements”. Progress along policy tasks listed in ENP AP, both under “priority areas” and “further actions”, will be indispensable for the success in the Intensifi ed Dialogue, recently granted to Georgia. The economic dimension of the possible future NATO member-ship is thus consistent with a successful implementation of the ENP AP.

Trade opening and FDI are the conditions of the economic take-off of GeorgiaRecent experience shows that more openness to international trade and investment positively corre-

lates with faster economic growth and reduced income inequality. India, China, Vietnam, Uganda and Mexico are all among “globalising” countries that have grown faster as a result of more integration. Open economies also tend to have less price distortions and thus tend to stimulate more investment and subsequently also faster economic growth. One can add that for small countries, these processes are more important than for large ones, and that a well managed trade opening is the key factor of economic development. Authors and facts underline the importance of trade openness for economic growth, but stress at the same time also the key role played by proper and country-specifi c domestic institutions and policies, for which trade opening cannot be a substitute.

Foreign direct investments (FDI) may provide extra fi nance, stimulate the transfer of technology and know-how and, last but not least, provide an easier access to export markets. They may also have posi-tive spill over effects on the domestic economy through linkages with local suppliers and contribute to productivity improvements. The largely successful restructuring of CEEC candidate countries’ manu-facturing industry can be to a great degree attributed to the activity of foreign investors. There is clear evidence that FDI penetration of industry is associated with productivity improvements and effi ciency gains at the branch level. For the export fi rm, it is a way to overcome some diffi culties such as trade bar-riers, import quotas. For the host country it is an opportunity to learn by doing and to increase the share of the added value which is locally produced.

The correlation of FDI with growth is often established but the direction of its action is not clear: quite often one observes bi-direction causation, with virtuous circles effects. Country’s attractiveness to for-eign investments (‘investment climate’) has to be maintained and export-oriented investment promoted in order to alleviate negative balance of payments effects. As shown in the recent extensive review of theoretical and empirical literature related to FDI, the domestic institutional environment matters a lot.

It should be noted that FDI does not play an automatically positive role. FDI can have a low techno-logical spill over if the foreign-owned sector is isolated from the rest of the economy, as for example the construction of BTC pipeline. FDI may be connected to product cycles and transport mainly mature technologies that can hardly stimulate exports. This trend is stronger when the IPR (Industrial Property Rights) are not well protected in the recipient country. Currently, FDI in Georgia are not mainly industry oriented, they go also to infrastructure (e.g. telecommunications) or services (such as retail trade, insur-ance and banking). For example, more than half of accumulated FDI stock in Central and East European countries is located outside manufacturing industry.

Only FDI may help accelerate Georgia’s economic development, especially in transport infrastructure (roads, railways, seaports and airports), tourism (hostelry) agro-food industry and other manufacturing. The successful development of NIC (new industrialised countries) in the 80’s and 90’s of South East-ern Asia (Hong-Kong, South Korea, Singapore and Taiwan) was based on export substitution. This is an export oriented development strategy based on strong FDI infl ows enabling increasing value-added

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production, from light manufacturing industry towards engineering services, devoted to export markets. The basic conditions were strong state policies (sometimes authoritarian) ensuring stable and attractive investment climate, the solution of the agriculture problem, the building of positive externalities (edu-cation, social policy and transport and communication infrastructure). In most of developing countries where these conditions were not met, economic development stagnated (Latin America) or regressed (Africa) in the 90’s.

More recently, large countries like China, India or Brazil combine import substitution and export substitution strategies. They are open to strong FDI fl ows oriented towards emerging large domestic markets. They export manufactured goods according to their comparative advantages (cheap labour, raw material intensive goods, and some higher skills). They are able to negotiate and organise strong infl ows of knowledge and know-how connected to FDI and to benefi t from outsourcing strategies of multinational companies.

Smaller countries like Georgia have not the dimension to become attractive markets for investors nor the strength to negotiate know how transfers. They have two options:

- To integrate with each other in order to reach these two targets as MERCOSUR in Latin America, - To integrate with strong economic powers as USA in the ALENA or with the EU in the ENP. The

latter form of economic integration based on neighbourhood enables increased access to markets, better FDI and knowledge fl ows, better export of services and productive subcontracting thanks to proximity.

When possible and under certain circumstances, the two processes can be combined: the regional sub-integration within Asia, South America or Africa increases the attractiveness of these regions becoming larger markets for investors. This option should seriously be taken into consideration for Georgia, the integration with the EU being associated with the integration within Black Sea countries, including South Caucasus.

One should noted that FDI have integrating effects which are stronger than simple trade. They tend to make uniform not only the modes of production between two nations. With productive behaviours are associated the mastering of technologies, labour and quality, education and skills, labour and social conditions, and quite often fi nancial tools. FDI has been seen as the “main force in international eco-nomic integration”.

Both BDD and ENP AP approaches are based on the assumption that economic opening and FDI at-tractiveness are the key factors of the economic development of Georgia and of the improvement of the living standards of its population. On the one side it is possible to say that BDD puts a strong accent on economic opening and liberalisation, whereas ENP AP has a focus on improving the institutional frame-work of investment and of economic activity, which is the ground of FDI fl ows. Moreover, economic opening thanks to FDI seems to be the favourite way of Europe, which realises two thirds of productive capital exports from developed countries. It should be noted that the two approaches, trade opening and FDI opening, are complementary. The important and increasing trade defi cit of Georgia shows that the benefi ts of trade opening don’t come automatically, if the business and investment climate do not create the conditions and incentives for entrepreneur’s responses to new opportunities. Especially in post-com-munist countries, experience showed that quite often FDI infl ows are a precondition for obtaining the full benefi ts of economic opening. On the other side one should underline that there is no opposition between the two documents in that respect. The authors of BDD welcome in the ENP AP trade and visa related issues, but also all the issues which condition the effi cient framework of the business activity and the attractiveness of the country, such as confl ict resolution, border management, rule of the law, energy delivery and safety.

The different issues the documents addressCurrently, Georgia is not seeking EU accession, but rather integration with Europe. Of course it is not

forbidden to campaign for the EU accession of Georgia, and nothing in the EU regulation makes this outcome impossible in principle. Some people think it is just a question of time. But what to do mean-while? The main obstacle, the main distance between Georgia and the EU is not the legal and regulatory system of Georgia, it is the level of development of its economy and of the rule of the law. The example of Romania is quite clear in that respect. In the sphere of the economy the target of the reform is thus not to implement the legal approximation in itself, but to use it as a tool for economic development.

The basic aim of the reform process in Georgia is thus to reach a sustainable growth for achieving economic development. This target is valid for both initiatives, BDD and ENP AP.

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However one should have in mind that the two papers have to address different problems. BDD is focused on the current need of the government to continue the reform of the country. Georgia is still suf-fering from its Soviet past and has to get rid of it. That is why a large concern is still the ineffi cient and corrupted state bureaucracy, whereas the administration should be at contrary the instrument of State reformism. A concern of the authors of the BDD document is that some regulatory orientations of the reform process may express a focus on legal approximation in itself instead of a focus on business ini-tiative and economic development. But the major concern is that even when the regulatory orientation of the reform is focused in the right direction, the concrete conditions of correct implementation and effi ciency of the measures are not met.

Two problems are pending here. The fi rst one is the reality of the economic and institutional condi-tions of the country. For example, as far as SPS (sanitary and phytosanitary) measures are concerned, aiming at food safety, it is reported that only this reform would cost 3 bln Euro in Latvia. Even if such amount of money would become available to Georgia, allowing the country to purchase laboratories and to train experts, how to make these measures implemented upstream in the poor rural areas? It is exactly the question a rich country like Kazakhstan is currently facing in its WTO negotiation, given the high degree of poverty and of market remoteness of its rural population.

The second problem raised is even more important, because some measures may even have a nega-tive impact on the reform. It is the real situation of the central and local administration, of the judiciary system and of the whole system in charge of the implementation of the rule of the law which is the problem. There is a risk that a new regulation, due to administrative controls and sanctions which are connected, might increase fi rstly the opportunities for corruption and bribery. The key criterion is here the overall situation of state administration and of mentality in the country regarding corruption, and the concrete state of any particular administration and its civil servants and the levels of their salaries, their competencies and their professional ethics.

On the other side, the aim of ENP is to foster Georgia’s economic development by giving access to the EU internal market and enabling the country to benefi t from the four fundamental freedoms, the free movement of goods, services, capitals and persons. Why is EU integration important for Georgia? Major economies like the USA or the EU expand their institutional environment to neighbouring areas, both for providing reference in institutional development and for building an economic space familiar to their companies and investors. The building of institutional areas is an important form of economic in-tegration, and will highly foster trade and FDI fl ows within this area. It makes sense to orient part of the legal development of Georgia towards EU practice. So far the institutional environment of Georgia was still close to that of Russia, but political factors prevent Georgia to benefi t from this situation. Moreo-ver, thanks to Common Economic Spaces between Russia and the EU, this Russian environment started already getting closer to that of the EU. Turkey has already a customs union with the EU. Bulgaria and Romania are at the end of accession process, and Ukraine, Moldova, Azerbaijan and Armenia are also involved in the ENP process. It is thus urgent for Georgia to orient its institutional environment towards the EU so as to foster economic integration in this direction, i.e. to benefi t from trade opening and FDI fl ows. Because of its low development level, mere trade integration of Georgia with the EU may play against Georgia. Current trade defi cits refl ect this situation. Only more complete integration measures, with movements of capital and institutional convergence, are likely to bring Georgia benefi ts of its economic opening towards the EU. This is exactly what the EU is able to provide to Georgia within the European Neighbourhood Policy. This will also help Georgia to better integrate with countries coming closer to the EU, as Russia and Turkey, actually all the countries of the Black Sea region.

For these reasons, in the ENP AP document, the emphasis is put on the measures making the economic spaces homogenous. One should understand that highly developed market economies are not economies without rules. It is the opposite. The EU market is the most organised, the most sophisticated market in the world. The defi nition of these rules and their enforcement is the function of a modern state. A mod-ern state leaves as much room as possible to the market, to fi rms for the defi nition of products, of com-pany strategies, and focuses its activities on matters where the markets fail, such as granting a suffi cient degree of competition on domestic markets, ensuring stable labour conditions of the production activi-ties, protecting the health of consumers as far as products are concerned, thinking about environment issues and saving non-reproducible resources or developing fundamental research. These functions of a modern and liberal state are implemented thanks to the existence of special bodies and a number of regulations and standards the companies have to comply with. This makes the market access for third parties more diffi cult. For entering the European single market, Georgian goods have thus to comply with the EU regulations and standards. That is why the ENP focuses on regulatory and standard issues.

69

The MOED insisted for example for including in the priorities of BDD the measures which could help the fi rms of Georgia reaching EU standards for specifi c goods. The ENP AP is exactly oriented towards helping Georgia to adapt its standards and regulation for a better access to the EU single market.

The main difference between BDD and ENP AP documents is thus not a difference in substance, but the fact they have different problems to solve.

About ideologyOne may argue that there is at least one difference between BDD and ENP AP, i.e. their ideological

background. However, this argument appears to be not exact and we would like to stress here again the different situation of Georgia and the EU, Georgia being just leaving the communist system of political totalitarism and administrated economy while European countries have sometimes several centuries of democratic experience and of the development of a market economy.

First, it would be a mistake to oppose liberal Georgia and interventionist EU. We discuss here the orientation of economic reform as well as the choices of economic policy. There are in the Georgian government persons with more liberal and even libertarian thinking, exactly as there are in the Euro-pean member states and in the European Commission. And there are also in both sides persons with less confi dence in the virtues of the spontaneity of markets because they consider that real open or hidden economic forces or groups use them in favour of their particular and personal interests. The opposite situation that of a more liberal orientation in the EU, might even be closer to reality. Quite often one criticized the ultra-liberalism of Brussels in its approach of state aid dismantling and deregulation, or in the over-emphasis put on competition. Let’s take two recent examples. The discussion of the Bolken-stein initiative showed that the Commission orientations were extremely liberal, and the European Par-liament had to intervene to make this regulation closer to the orientations of the populations of member states. More important, the issue of the European Lisbon agenda and the discussions about the recently increasing technological gap between the EU and the USA is showing that the opposition of Brussels to industry policy oriented towards IT technology development was disastrous when the USA supports this orientation with huge amounts of public money. On the other side, it is easy to observe in Georgia behaviours which are not liberal at all. For example, while welcoming the reforms of tax code, customs code or labour code, business is also complaining against state intervention in Georgia in the form of arbitrary tax inspection and court decisions. Another example is the suspension of the judiciary institu-tion of arbitrage, which might have given for the fi rst time the right to business against the state.

Second, one should not over-estimate the implications of what seems liberal or non liberal by doc-trine. The analysis of economic policies all around the world shows that they are never the mere im-plementation of ideological options. Basically, the decisions of economic policies are a combination of three factors: the different advice and recommendations given by domestic experts as well as by international organisations; the combination of the pressures exerted by different groups of interests and concerned about the implications of the decisions for their own situation; and the identifi cation by the policy maker of the key priorities he/she has to manage thanks to this decision in economic policy. The analysis of such combination is so widely developed that it carries a name among the experts: it is the “political economy” of the reform or of the economic policy. After the measure has been taken, the policy makers dress it with ideology to try to “sell” it to their own electorates, which is sometimes quite diffi cult just because by defi nition economic policy is always a compromise policy. Experience shows that concrete economic policy measures are usually quite far from where they started. The best example is that of USA which is, behind the liberal wording, the most Keynesian state among OECD countries due to its huge and standing defi cits (trade and budget) and support to the economy thanks to defence budgets and other measures.

The third reason to be cautious about ideological characterisation of economic orientations is con-nected to the specifi c situation of post-Soviet transition countries and economies. Experience of post-Soviet reforms showed also that the liberal ideology was often chosen not because of deep trust in its virtues, but because it was the only one providing an answer to the question: how to dismantle and reform a post-Soviet state? Actually the post-Soviet reformers are more liberal in words than in action because there is no other “ready-to-wear” theoretical tool for reforming ‘hypertrophical’ states. One should recognise that so far the EU had not developed very convincing experiments and solutions in that respect. May be the most interesting experiences took place in countries like Australia or New Zealand. But it is probably a mistake to use the Western deregulatory policies for addressing transition reforms, because the problems to solve are quite different and one critical issue of state reform in transition is the existence of strong rent-seeking behaviours.

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The needs of transition economies are to reform the state so as to get rid of bureaucratic and corrupt state interventionism, and at the same time to have a strong state able to ensure the rule of the law, the stability of the economic and regulatory environment for business, the consistency and coherence of the reform policy so as to develop a clear pedagogy of virtuous behaviours. This orientation is well included in the BDD document. However there is always the danger that the efforts for strengthening the rule of the law fuel old bureaucratic behaviours, or that the efforts for decrease state bureaucracy and controls leaves room again to rent-seekers and oligarchs. This paradox is diffi cult to manage. In that respect, the use of the institutional framework of European countries, which provide quite large spectrum of work-able options, could help managing this paradox. In other words, the use of the EU as an institutional an-chor can help diminishing the maximum level of State action required for the continuation of the reform in Georgia. That is also the contribution the ENP can provide to the implementation of the BDD.

Recommendations- As we wrote in GET 2005/4, the basic criterion of any reform measure is its impact on the economic

development of Georgia, on investment and FDI, on business and job creation. The EU is not good or bad by itself for Georgia, as well as the legal approximation of Georgia with EU. When the latter is wished it should be checked whether it is not at the expenses of the above criterion.

- The ENP AP, and further APIP, leaves room for different sequencing of reforms, because of its long term perspective. It would be recommended to start with the measures which are the closest to BDD.

- Moreover there are in ENP AP measures which are well appreciated by the initiators of BDD, as confl ict resolution, border management, the rule of the law or trade policies. Such measures should be-come important in the ENP and APIP and come soon at agenda.

- In turn, for the above reasons, we propose to make reference to BDD in any APIP measure is wel-come because it refl ects their deep common substance.

- For all concrete sector-specifi c issues, such as Labour code, Competition, Food security, Company law or Standards, we recommend to avert any ideological lock-in of the discussion that may lead to artifi cial opposition of the two documents. The way we recommend is to proceed to a concrete impact assessment of measures discussed, in order to assess whether these are adapted to the very situation of Georgia, match the available implementation and enforcement capacities, whether they bring effi cient regulation of economic activity and improved rule of law, or just increased bureaucracy and corruption opportunities.

- In the ENP implementation process, an increased conditionality could become welcome because it is likely to bring concrete outcome. It may help the process of making closer ENP AP and APIP to BDD.

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