Georgia lies in a strategic geographical position between Europe and Asia at the western end of the "Silk route". Given its strategic position, and the strong government commitment to economic reform, the country enjoys strong political and financial support from the international community.

The IMF, World Bank and the EBRD are active in the country, and although private foreign direct investment has been slow to take off, the next phase of economic reform, including privatisation of the energy and telecommunications sectors, should provide considerable investment opportunities. Georgia’s role as a regional trading hub has yet to be fully exploited.

Despite one of the lowest per capita income levels of the region, the economy has performed strongly in recent years, recording double-digit growth in both 1996 and 1997. The Russian crisis caused economic problems, from which the economy has not yet fully recovered, but the projected rebound in global economic activity, and more importantly Russia’s recovery, should support future economic activity.

Internal civil conflicts remain unresolved and remain a constraint to economic development. Although a solution to the problems remains elusive, the conflicts are less disruptive than in the years immediately following independence, and significantly have not undermined Georgia’s relations with the West.

The Government has activity sought to create a stable macro-economic environment attractive to foreign investors. The privatisation process has been accelerated, but more needs to be done on restructuring. Financial sector reform has transformed the banking sector. Again a number of weaknesses have still to be overcome, but the sector has been strengthened. The re-election of Eduard Shevardnadze’s reform orientated Citizens of Georgia party in October 1999’s Parliamentary election provides confirmation of Georgia’s commitment to economic reform.

GML has focused on structured trade finance transactions in Georgia, frequently involving energy flows, and exploiting the cross-roads position of the country, between exporters and importers of a variety of goods. We are convinced that secure structures can be created, and the returns far outweigh the mitigated risk profiles we have been able to produce.

• Summary
• Background
• Political Background
• Good International Relations With The West, But Difficult Still With Russia
• Parliamentary election result - a thumbs-up for economic reform
• Parliamentary elections - A precursor to next year’s presidential poll?
• Structural reforms attract continuing support
• Fiscal position
• Monetary & exchange rate policy
• Ongoing reform helping banking sector …..
• …. But A Number of Problems Still Need Overcoming
• Privatisation & restructuring
• Foreign investment climate
• Economic performance
• Inflation
• External accounts
• Outlook
• Key Economic Statistics
  

Summary
After political unrest and economic decline in the early-1990s, Georgia’s fortunes improved significantly between 1995 and 1997 when the economy moved out of a period of hyper-inflation and economic contraction into one of stabilisation and positive economic growth. However, the Russian crisis of 1998 caused economic hardship for the country, from which it is now starting to recover.

Real GDP growth is projected to remain weak this year, but should start to pick up in 2000 as external factors turn more favourable. Inflation may be slightly up on 1998, but continuing prudent monetary policy should ensure that such pressures are contained. The fiscal deficit, however, is expected to remain under pressure and is unlikely to meet the IMF-endorsed programme target.

One of the main features of the past year has been the government’s commitment to economic reform, which has enabled it to secure continuing IMF funding. One of Georgia’s main strengths has been its ability to maintain the political and financial support of the international community, despite difficult internal ethnic problems.

Public anger at the government’s inability to resolve the country’s multiple ethnic conflicts raised concerns about the prospects for the ruling Union of Citizens of Georgia (UCG) party ahead of the October Parliamentary election. In the event, however, the UCG won an overwhelming majority, thanks chiefly to President Shevardnadze. The President has played a pivotal role in Georgia’s economic transformation since 1995 - under him the country has embraced the concepts of a free market economy and secured strong support from the IMF and other multilateral agencies, including the World Bank and EBRD – and he is expected to stand, and win, a third term in office in April 2000.

Dependence on foreign loan financing and aid does not offer a permanent solution to Georgia’s financial problems, however, and it is important that the government maintain the reform momentum. Further structural reform aimed at boosting the ratio of tax:GDP (currently one of the lowest in the world) remains the key.

Georgia’s track record in attracting foreign investment has not been as impressive as some other CIS states. However, the government has made a concerted effort to create a more favourable investment climate over the past couple of years and the country’s prospects are starting to improve. Although the Russian crisis of mid-1998 meant that there has been no significant new investment over the past year, companies already with a presence in Georgia have been increasing their investment in the country. An accelerated privatisation process, along with improving regional prospects, should help to raise interest. However, the conversion of expressions of interest into real investment will depend on a continuation of the structural reform process and economic recovery.

Background
Located on the Eastern edge of the Black Sea, Georgia lies in a strategic position. Bordered by Russia to the North, Turkey to the South West, and Armenia and Azerbaijan to the South and South East, Georgia is considered the main gateway for land transportation of goods through the Caucasus.

Covering an area of 69,700 km² (similar in size to Ireland), the population of Georgia was estimated at 5.4 million in mid-1998, two thirds of which were ethnic Georgians and almost a quarter of whom live in the capital, Tbilisi. Just under a quarter of the population were under 14 years old. Total GNP was $4.6bn in 1997, making per capita GNP, at $850, one of the lowest in the region.

Although the country is divided by the Suram mountain range, which runs from North to South between the Lesser and Greater Caucasus mountains, Georgia is committed to constructing a functional trans-Georgia transportation infrastructure, linking its Caucasus and Central Asian neighbours. The country’s main seaport, Poti, has a capacity of 5-6mn tonnes per year and is used for most of the container traffic entering the country by sea. The port is being modernised to handle heavier tonnage - a US$65mn contract to build a new cargo quay at the port, awarded to Japan’s Mitsubishi Corporation in mid-year, is expected to be completed by the end of 2002.

Georgia has limited domestic energy resources and relies heavily on imports to meet its energy requirements (even then it is estimated that a significant proportion of demand is not met). A network of mountain rivers allow the generation of significant hydroelectric power, and the two main generating plants are Gardabani Thermal Power Plant near the capital Tbilisi, and a second station near Jvari. Georgia relies heavily on imported electricity from Russia, fuel oil from Azerbaijan and Turkey, and natural gas from Turkmenistan.

Georgia’s economy has traditionally revolved around Black Sea tourism and agriculture. During the Soviet period the country’s climate, beaches, ski slopes and health spas made it an attractive tourist destination for visitors from the USSR. The collapse of the USSR was severely felt by the industry but, in recent years, tourism, along with services, have experienced something of a revival.

Aside from the service sector, which accounts for over 50% of GDP, agriculture contributes around 30% of GDP. Major produce includes citrus and deciduous fruits, vegetables and vine crops, tea, cereals, sunflowers and a variety of field crops and dairy products. The industrial sector, which during the Soviet era flourished thanks to generous state-sponsored industrialisation, but deteriorated in the post-independence years, contributes only 16% to GDP. Within the industrial sector, wine production, food preparation, chemicals and textiles are the primary industries.

Average GDP growth (1994-98, %)

Political background
For centuries a battleground between Turks and Persians, Georgia, which was Christian, turned to Russia for protection in 1783, only to be annexed in the early 1800s. Briefly independent, it came under Soviet rule in 1921 and became a Union Republic in 1936. It was the first Republic formally to secede from the USSR, in 1991, but the years immediately following independence were beset by problems. The economy collapsed, separatist conflicts in Abkhazia and South Ossetia erupted and rampant corruption undermined the authority of the state.

The political environment in Georgia has improved significantly since former Soviet Foreign Minister, Eduard Shevardnadze, first became President in 1992, a year after Georgia gained independence. In contrast to his first term in office, during which the law and order situation remained troubled, Shevardnadze’s current term in office has been more peaceful. The success of his Union of Citizens of Georgia (UCG) party in the Parliamentary election of 1995 – it won 90 of the 150 seats filled by proportional representation and 17 of the 85 seats filled on a single-mandate basis – effectively provided Shevardnadze with the political muscle needed to push through urgently-needed economic reform and to restore some semblance of democratic government.

Despite the improvement in the law and order situation, internal conflicts, specifically the ongoing dispute with the separatist region of Abkhazia, remain a threat to the country’s stability. Repeated attempts to resolve the dispute have failed. A 1994 cease-fire ended the fighting in Abkhazia, but not the hostility. Although Georgian and Abkhaz leaders signed a joint declaration in 1997 agreeing not to use force to end the conflict, hopes of a diplomatic solution remain remote. Relations between the two sides have been strained by the decision of the Abkhazia leadership to conduct a referendum on independence in September 1999. The result of the plebiscite – overwhelming support for the current constitution which proclaims Abkhazia an independent sovereign state – has been condemned by Georgia, as has the Presidential vote, held simultaneously, which saw Vladislav Ardzinba re-appointed unopposed.

Ethnic conflicts in Adjaria and the breakaway region of South Ossetia also remain unresolved. Although the Autonomous Region of Adjaria is the least troubled of Georgia’s self-governing regions, relations between its leader, Aslan Ibragimovich Abashidze, and Georgian President Shevardnadze have deteriorated. The political status of South Ossetia remains uncertain, but some progress was made in 1998 when Shevardnadze and South Ossetian leader Ludvig Chibirov signed a joint statement proposing a peaceful settlement to their dispute.

Good International Relations With The West, But Difficult Still With Russia
The conflict in Abkhazia also remains a source of friction between Georgia and Russia. Following the imposition of Russian sanctions against Abkhazia in 1994, relations between Russia and Georgia improved markedly. However, Moscow’s easing of border controls with Abkhazia and softening of economic sanctions against the separatist state – an attempt to force Georgia to close its border with Chechnya - have been a source of recent friction. In contrast to its recent strained relations with Russia, Georgia enjoys good relations with the West.

Georgia became a full member of the World Trade Organisation in September 1999. In addition, it is a member of a number of other international organisations, including the Black Sea Economic Co-operation Council (BSECC), the United Nations Industrial Development Organisation (UNIDO) and the World Tourism Organisation.

Parliamentary election result – a thumbs-up for economic reform
Despite fears that public anger at the Government’s failure to resolve the multiple ethnic conflicts and assert control over the whole of Georgia would undermine UCG prospects in the 31 October Parliamentary election, the UCG nevertheless secured an overwhelming majority. The main casualty of the poll was the opposition Revival of Georgia alliance – a variety of anti-Shevardnadze forces headed by Aslan Abashidze (leader of the autonomous region of Arjaria). Despite pre-election opinion polls putting Revival on a par with the UCG, Abashidze’s alliance secured only 26% of the vote.

The success of the UCG is in stark contrast to its performance in local elections earlier this year, when it managed to poll only one-fifth of the vote. The reason for the apparent turnaround in voter sentiment appears to lie with President Shevardnadze. His pre-election warnings about the risks of an opposition victory appears to have struck a chord with voters.

With over 80% of the vote counted, the UCG was in a commanding position and was expected to take at least 125 seats in the 235-member assembly - Revival should take about 65 seats.

Parliamentary elections – A precursor to next year’s presidential poll?
The result of the Parliamentary election suggests Shevardnadze should enjoy a comfortable victory in the forthcoming Presidential poll in April 2000. Although he has not formally announced his intention to contest the poll, the success of the UCG in the Parliamentary poll suggests he will stand for a third term.

Despite overseeing at times painful structural economic reforms, Shevardnadze appears to command strong personal support. He is credited with extracting Georgia from its international isolation following independence and has played a pivotal role in maintaining good relations with the West and multilateral and bilateral agencies, on whose funding Georgia is critically dependent. At 71 his age and health could be an issue, but so far there is no credible alternative candidate. Revival has named Aslan Abashidze as its candidate, but there are rumours that he will be replaced by communist leader Jumber Patiashvili. Another Presidential hopeful is Irina Sansuli, a former Deputy Prime Minister. However, none of the current potential contenders enjoy the same international standing as Shevardnadze.

Structural reforms attract continuing support
Under President Shevardnadze, the concepts of a free market economy have been embraced and young reformers promoted to senior government posts. Since 1994, the Government has implemented a bold stabilisation and structural reform programme aimed at addressing the country’s large domestic and external imbalances. Prudent financial policies have been introduced; trade, prices and the exchange rate system have been liberalised; indirect and direct government subsidies have been phased out; economic policy management has been strengthened and major structural reforms have been implemented.

The authorities’ commitment to economic reform has won strong support from the major multilateral agencies, including the IMF and the World Bank. The IMF played a key role in helping Georgia overcome the budgetary crisis triggered by last year’s crisis in Russia and, although its current programme is due to end this year, it is expected to remain active in Georgia for the foreseeable future. Under the current IMF programme, attention has been focused on developing the private sector and improving the Georgian tax system. Support of small and medium-size enterprises has become a priority, as have measures to curb the influence of the parallel economy.

Future IMF support is likely to be conditional on further improvements in tax collection and positive progress with the privatisation programme. Persistent low tax collection and protracted delays in paying wages and pensions have been the main weaknesses of economic reform during the current IMF programme. The Fund is to resume talks with the government now that the 31 October Parliamentary elections are over.

Fiscal position
Prior to the Russian crisis, the Government’s financial position had improved significantly. Between 1994 and 1997, total revenue increased at an average annual rate of almost 40% in real terms and total expenditure was kept under tight control. By 1997, total revenue (excluding grants) was around 75% of current expenditure compared with less than 20% in 1994, with most of the increase attributable to improvements in tax administration and the elimination of many broad tax exemptions. At the same time, total government expenditure was cut from 23.5% of GDP to less than 12% in 1996 and 14% in 1997, with the bulk of the cuts being achieved through the elimination of bread and gas subsidies.

The impact of these revenue raising and cost cutting measures was to cut the budget deficit from 16.5% of GDP in 1994 to 4.1% of GDP in 1997. Despite this progress, a number of issues remained outstanding, most notably the level of wage and pension arrears. It also became apparent that, by the end of the period, the improvements in the budget deficit owed more to tight controls on expenditure than to improvements in the tax collection system - the latter is acknowledged to be the weakest point of the Government’s macro-economic reform programme. A new tax code, approved in late 1997, has broadened the tax base, mainly by abolishing exemptions on VAT and excise duties, but the lack of transparency in the country’s tax codes remains a fundamental problem - the ratio of taxes to GDP was a mere 9% in 1998, one of the lowest in the world.

Despite the problems of 1997, the 1998 budget, which was approved by Parliament in December 1997, called for a further reduction in the budget deficit, to 2.2% of GDP. The revenue:GDP ratio was expected to rise from 10% to 11.5% on the basis of further changes to tax policy and the tax administration system. However, the emergence of the Russian crisis in mid-1998 triggered macro-economic and financial problems for Georgia.

Tax revenue fell 22% below the target set in the Government’s IMF programme, as a result of which the overall budget deficit rose to 3.4% of GDP (on a commitment basis). At the same time, government expenditure arrears (mainly on wages, pensions and social transfers), which were expected to have been eliminated by the end of the year, rose to account for 2% of GDP.

In view of the slippages of 1998, the 1999 fiscal action programme called for the more forceful implementation of the government’s policy commitments under the IMF’s Enhanced Structural Adjustment Facility (ESAF). Total revenue and grants are budgeted to increase from 10.9% to 11.5% of GDP, and the overall fiscal deficit is targeted to fall to 3.0% of GDP. However, the performance during the first half of the year was disappointing and, in June, the authorities announced a series of additional revenue raising measures aimed at bringing the programme back on track.

Budget deficit (% of GDP)

Monetary & exchange rate policy
Under the auspices of various IMF programmes, the Government’s monetary and exchange rate policies have focused on maintaining a low level of inflation and on achieving exchange rate stability. In particular, tight monetary policies helped to contain inflationary pressures following the Russian crisis in mid-1998 and the subsequent depreciation of the Lari in the fourth quarter of the year. Although some slippage is unavoidable in 1999, the previously demonstrated success of these policies should ensure that they will be maintained.

The Georgian Lari remained stable during the first nine months of 1998. However, the currency weakened following the devaluation of the Russian rouble, depreciating by 7% between September and November, and heavy central bank intervention was required to help stabilise it over the final months of the year. This year, the currency has been supported by the recovery in public confidence.

Ongoing reform helping banking sector …..
Although a number of weaknesses still have to be overcome, the Georgian banking sector has been transformed in recent years. With the support of international financial institutions such as the IFC and the EBRD, and various bilateral agencies, the National Bank of Georgia (NBG) has implemented a series of financial sector reforms.

This process really started in earnest in mid-1995 when the NBG assumed a supervisory role over the sector. It introduced more stringent accounting and reporting requirements at the same time as raising minimum capital requirements (to 5 million Lari for new banks, a level which existing banks are expected to reach by the end of the year 2000). The NBG has also announced a tightening of prudential regulations and has implemented a bank certification programme. In order to be certified, banks are now required to present audited accounts and to demonstrate sound business plans and corporate governance - non-certified banks are not permitted to increase assets or raise deposits from the general public. As a result of these measures, the number of banks fell from 229 in 1995 to 45 at the start of 1999. A further six banks lost their licences by mid-year, due to "financial difficulties", reducing to 39 the number of certified banks. In addition to measures to strengthen supervision, steps have been taken to improve communications within the sector. USAID has financed the installation of SWIFT for commercial banks and they are now connected to the NBG’s main SWIFT terminal.

Two former state-owned, but now privatised, banks - the United Georgian Bank (UGB) and the Bank of Georgia - dominate the sector, accounting for approximately 50% of total commercial bank assets. They both have a client base mainly made up of former state-owned enterprises, but have adopted different operating strategies - UGB concentrating on the middle and upper market segments and Bank of Georgia on retail operations. Other leading banks include TBC Bank, a leader in product development which has established close relations with the IFC and Deutsche Investition und Entwicklungsgesellschaft (DEG), Absolute Bank, which has an American president and an array of international and joint venture customers, the International Black Sea Commercial Bank, which is part-owned by the EBRD and Bank of Greece, and the Turkish bank Emlak Bankasi.

Although limited, foreign investment in the sector is increasing. Absolute Bank was established in 1994 by a group of US investors and a consortium of Georgian enterprises and individuals, while the International Black Sea Commercial Bank was set up in 1996 by the Commercial Bank of Greece and the EBRD. The most recent addition to the sector, in 1998, has been the subsidiary of Turkey’s Emlak Bankasi which, although currently primarily focused on short-term interbank finance, is expected to turn its attention to the provision of trade finance, specifically for Turkish joint venture companies. A subsidiary of the Azeri Caucasian Bank is the only other foreign bank operating in the country.

The country’s non-bank financial markets are being developed at the same time as the restructuring of the banking sector. Since its inception in 1997 the market for Treasury Bills has developed substantially and the entry of several Georgian and foreign banks into the market has increased liquidity and intensified competition. A new securities law has been presented to Parliament - it provides for the establishment of an official stock exchange and an independent Securities and Exchange Commission.

…. But A Number of Problems Still Need Overcoming
Despite the substantial progress that has been made since 1995 in reforming the banking sector, it remains fragile. The Russian crisis and subsequent devaluation of the Lari in late-1998 created liquidity problems for a group of the country’s commercial banks and the NBG was forced to provide extraordinary liquidity support to them. At that time, other banks reverted to foreign borrowing and inter-bank borrowing to maintain liquidity. Inevitably there will be an increase in the incidence of non-performing loans in the aftermath of last year’s economic and financial difficulties and these will test the sector - further consolidation therefore looks unavoidable.

Privatisation & restructuring
The rate of privatisation of state-owned enterprises has accelerated in recent years, but there has been only limited progress in the restructuring of individual enterprises or of complete economic sectors. One critical element of this, the Bankruptcy Law, was enacted in 1997 but has yet to be implemented. In addition, the law creating a special service to fight corruption, drafted by a new anti-corruption commission set up in 1998, has yet to be enforced. As in many other parts of the world, concerns about the effect of restructuring on employment have been the main cause of the slow rate of progress, although this has been aggravated in Georgia by the continued state-ownership of the major industrial enterprises and, in many instances, the absence of financial viability as a result of tariffs which do not reflect or cover costs, and poor revenue collection rates. The World Bank and TACIS are, however, currently supporting the restructuring of eight privatised enterprises. Although not making up a significant proportion of the privatised enterprises in Georgia, it is considered that the lessons learnt from these eight enterprises can be replicated throughout the economy.

About half of the 1,115 medium-sized and large enterprises earmarked for privatisation had been sold by mid-1997 when a new privatisation law was introduced to speed up the process. In the same year, a decree suspending the privatisation of "strategic" enterprises was abolished. Some 50, mainly heavy industrial, enterprises had previously been categorised as "strategic" and the abolition of the decree has enabled their privatisation to start. Given their importance to the domestic economy and the investment and restructuring needed to make them attractive, this has taken place on a case-by-case basis. As with the privatisation of other enterprises in Georgia, all forms of privatisation have been employed to secure their sale, including zero price auctions (some of which took place in early-1998), tenders, specialised auctions and the offer of ten-year management contracts with a management buy-out option at the end of the period.

One of the more recent privatisation successes was the sale of a 75% stake in Telasi, the largest electricity distribution company in Tbilisi, to AES of the US. Negotiations over the sale of other electricity distribution companies are currently taking place, while the Government is also reported to be seeking buyers for the country’s power generators. Other sectors have also been targeted for privatisation, among them the telecommunications, oil, ports and water sectors - the Tbilisi and Kutaisi water supply and sewerage systems are reported to be next on the privatisation agenda.

Foreign investment climate
One of the Government’s core economic objectives has been the creation of a stable macro-economic environment which is attractive to foreign investors. The Government actively encourages Foreign Direct Investment (FDI) through a combination of its privatisation programme, new projects, joint ventures and green-field opportunities. At the same time, it has acted to improve the legal and contractual environment - in general, laws do not now discriminate between foreign and local investors. In most sectors there are no restrictions on foreign ownership (although there are some limits in the infrastructure sectors and foreign investment is prohibited in the defence and security sectors). The main exception to this rule is agricultural land ownership: foreigners are not permitted to own agricultural land and there is a 49 year limit to leases. Industrial land can, however, be purchased or leased for 99 years.

Reflecting its strategic geographical location on the Eastern edge of the Black Sea, Georgia offers considerable investment opportunities. Transport, transit and distribution, and tourism form the traditional backbone of the economy and are considered key investment opportunities. After years of minimal investment, Georgian infrastructure is in urgent need of rehabilitation and modernisation. The roads, ports and railways are the main priorities and although international financial institutions such as the World Bank and the EBRD are providing support, there is considerable scope for foreign private sector participation. Other sectors of potential investor interest include agriculture - tea and grape production have been identified as promising sectors - light industry, building materials, wood-working and the food industry.

In the power sector, several production-sharing agreements and joint-ventures have been signed in the Kura Basin East of Tbilisi and in the Black Sea region. JKX and Ramco Energy of the UK, National Petroleum of Switzerland and the American Frontera Resources Corporation have signed agreements to fund around 75% of a $150mn government domestic oil development programme.

As yet, none of the oil "majors" have signed agreements with Georgia but, with international oil prices back over $20 per barrel and world energy demand expected to pick up as global economic activity gathers momentum, investor interest is expected to increase.

According to official data, FDI in Georgia reached US$224mn in 1998, almost 30% higher than in the previous year. The fall-out from the Russian crisis meant that there were few new foreign investors in Georgia in 1998, but those companies already with a presence in the country increased the size of their investments. Leading investors have come from the US, the UK, Russia and Azerbaijan. Most of their interest has been in the oil and gas, banking, telecommunications, food processing and light industrial sectors - around one-third of FDI in 1998 was accounted for by the rehabilitation of the Baku-Supsa pipeline (through which the first deliveries of oil took place earlier this year). A further proportion was accounted for by foreign interest in the Government’s privatisation programme - it should be noted that many of these investors have committed themselves to significant investment in the country in the future.

Economic performance
The Russian crisis had a direct impact on the Georgian economy. Not only did it make implementation of economic reform quite arduous and magnify already large underlying internal and external imbalances, it depressed economic growth. Adding to these problems, the agricultural sector was hit by a drought. After growing at over 10% in both 1996 and 1997, real GDP growth slowed to 2.9% in 1998, well below the IMF programme target of 10%. The loss of such a key export market (Russia accounted for around one-third of Georgian exports prior to the crisis) had an immediate impact on GDP growth - it is estimated that real GDP contracted by around 2% in the second half of 1998. Even Georgia’s parallel economy, which is estimated to be equivalent to 50% of GDP, was hurt by the Russian crisis.

Although the situation has stabilised this year, it is doubtful whether growth will reach the 8% level targeted in the IMF programme (real growth is also targeted for 8% in the year 2000). The export sector remains depressed by events in Russia and the rest of the region, and domestic demand is being held back by the government’s commitment to fiscal prudence - capital spending has been severely scaled back over recent years - and weak consumer demand. Poverty remains endemic: GDP per head was just $1,980 in 1997 (PPP basis), and real income levels have contracted by 14.9% between 1990 and 1997. Unemployment is high (official estimates put it at around 13% in the second quarter of 1999 but independent estimates suggest that it is closer to twice this level) and is rising (the number of job-seekers registered at job centres rose by almost 30% in the year to September 1999). Welfare benefits are minimal and sizeable government wages and pensions arrears are an additional negative factor.

Real GDP growth (%)

Source: IMF, EBRD.

Inflation
The depreciation of the Georgian Lari between September and November 1998 (when it lost 7% of its value) resulted in a sharp increase in the rate of inflation in December, with the monthly rate of inflation rising to 12.1% after having averaged just 0.1% during the rest of the year. Inflationary pressures eased slightly in early-1999, but the sharp inflow of foreign flows and their rapid utilisation during the period meant that inflationary pressures remained relatively strong - inflation was 5.5% over the first eight months of the year. Under the country’s IMF programme, the target rate of inflation has been set at 9%, but a more realistic rate for this year is probably 11-12%.

Inflation (%)

Source: IMF

External accounts
Official trade data are incomplete and fail to cover all foreign trade activity: it is estimated that nearly half of exports and one-third of imports are unrecorded. However, according to recorded foreign trade data, Georgia runs a perennial deficit on the current account. This is principally due to the country’s trade deficit which has widened every year since 1995, rising from $484mn in 1997 to $608mn in 1998 as the impact of the Russian crisis hit Georgia’s exports (Russia accounts for 14.5% of total Georgian trade). Reflecting this deterioration in the trade deficit, the current account deficit increased, from $338mn in 1997 to almost $490mn last year. According to IMF figures, foreign exchange reserves appear to have held up during 1998, but they still represent only just over two months’ import cover.

The country’s principal exports are ferrous alloys, scrap metal, wine, tea, precious metal ores and concentrates, and oil and oil products. The country’s principal trading partners are Russia, Turkey, the USA, Germany, Azerbaijan, Turkmenistan, Armenia, Ukraine, Italy and the United Kingdom.

Georgia’s external debt is increasing, but the debt burden has improved as a result of a programme of rescheduling arrears and obligations on more favourable and/or concessional terms. The country’s external debt (which has been built up since independence) stood at $1.5bn at the end of 1997, some 44% of which was in the form of concessional loans. Strong multilateral support has ensured that debt service commitments have been held down and in 1997 the debt service ratio stood at just 6.4% of exports of goods and services. Approximately 58% of state debt is bilateral, with Turkmenistan accounting for around one-quarter of the total.

External debt profile

Source: World Bank

Outlook
The past year has been very tough for Georgia and the country’s short term outlook depends critically on whether the corrective measures currently being implemented by the government, particularly in the fiscal area, succeed in restoring economic stability. The Government’s current fiscal position is unsustainable and stronger measures aimed at addressing key issues such as tax avoidance and corruption are required to ensure continued economic development. In the longer term, the country’s considerable infrastructure problems will need to be addressed if economic development is to be maintained. At the same time, the Government will need to implement further legislative and structural reform before FDI inflows can really take off. The unstable political environment, in particular the ongoing ethnic conflict in Abkhazia, remains a very real inhibitor of foreign investment. A solution to the conflict seems elusive.

Nevertheless, Georgia commands a strategic geographical location and the projected upturn in global economic activity and recovery in regional economies should provide considerable investment opportunities. Real GDP growth will fall well short of IMF programme targets both this year and next, but some recovery is expected towards the end of the year 2000 as global economic activity improves and Russia emerges from its crisis. This should result in an improvement in the country’s external accounts while the tight monetary policies of the central bank should ensure that domestic inflationary pressures are kept to a minimum. Firmer international oil prices could also trigger renewed investment into the region.

Key Economic Statistics