Public Information Notice No. 01/113

Public Information Notice: IMF Concludes 2001 Article IV Consultation with Georgia

October 31, 2001

On October 26, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Georgia.¹

Background

In recent years, Georgia has struggled to address its deep-rooted economic problems. GDP growth has been lackluster since the Russian crisis in 1998, reflecting energy supply problems, two droughts, and uneven progress in structural reform. Poverty has remained widespread and the state's financial position has been too weak to offer an effective social safety net. Corruption has undermined both private sector development and fiscal stability. The country has one of the lowest tax-to-GDP ratios in the region and has accumulated a large stock of budgetary expenditure arrears, including on wages and pensions. Georgia has also been unable to service its external debts in full.

Since last year, Georgia has made progress in addressing some of the macroeconomic imbalances. Inflation was below 5 percent in the twelve months to August 2001, reflecting a prudent monetary policy and reduced domestic borrowing by the government. The rapid accumulation of budgetary expenditure arrears has been halted since mid-2000. The general government deficit was reduced from almost 7 percent of GDP in 1999 to 4 percent in 2000, and to below 2 percent in the first half of 2001, reflecting a sharp reduction in expenditure commitments and a modest improvement in tax revenues.

The floating exchange rate has been relatively stable over the last two years, although it depreciated by 4 percent against the U.S. dollar in the first quarter of this year, in the wake of the financial crisis in Turkey. The current account improved significantly in 2000, reflecting strong growth in exports of goods and services, although this trend was partly reversed in the first half of 2001. On March 6, 2001, Georgia became the second CIS country after Russia to reach an agreement with the Paris Club. Bilateral external debts due in 2001 and 2002 are to be rescheduled over 20 years, with a three-year grace period and a graduated repayment schedule.

Structural reforms in the fiscal area and in the financial sector have been accelerated over the last 12 months. Faced with a fragile banking system, the central bank's supervisory capacity has been strengthened. Public expenditure management and fiscal transparency have been improved, but serious problems remain in revenue collections, especially in the customs area. Some initial steps have been taken to address corruption, including through the establishment of an anti-corruption council and two presidential decrees. Other structural reforms have been slow, including in the energy sector, which remains burdened by old debts and low collection ratios. The government has prepared a first draft of a poverty reduction strategy, focused on setting the institutional foundations for private sector development and economic growth.

Executive Board Assessment

Executive Directors welcomed the recent increase in GDP growth, prudent macroeconomic policies that have helped to keep inflation low and the exchange rate relatively stable, and progress in lowering the external debt burden. Directors considered, however, that poor governance, corruption, and the size of the shadow economy remain serious obstacles to fiscal sustainability and private sector development. They emphasized the need for a determined and sustained assault on these problems in order to improve the medium-term outlook for debt sustainability, growth, and poverty reduction.

Directors welcomed the substantial improvement in fiscal performance since the last Article IV consultation, reflected in the significant reduction in the budget deficit on a commitments basis and no net accumulation of budgetary arrears since mid-2000. They noted, however, that this improvement relied primarily on expenditure cuts, for which Directors saw little further scope. Moreover, there is an urgent need to strengthen the social safety net, education, and health care. Directors therefore stressed that, to achieve fiscal viability over the medium term while establishing adequate basic social services, an immediate and effective revenue mobilization effort is needed. This effort should focus on improving tax administration, broadening the tax base, and curtailing tax exemptions. Directors urged the authorities to intensify reforms in the revenue collection agencies, particularly in the customs department, and to strengthen efforts to combat corruption and smuggling. They welcomed the planned 2002 reform of the tax code to simplify the tax system and widen the tax base, and encouraged the authorities to implement it with determination and, as a minimum, without allowing reforms to lead to any decline in revenues.

Directors commended the authorities for maintaining a prudent monetary policy, focused on achieving low inflation. They considered that the floating exchange rate regime remains adequate, given the low level of international reserves and the economy's vulnerability to external shocks. Directors supported the National Bank of Georgia's policy of purchasing foreign exchange in excess of its program targets when market conditions permit, while maintaining a close watch on developments in the monetary aggregates and inflation.

Directors welcomed the measures being taken to strengthen banking supervision and ensure prompt resolution of non-viable banks in the future. They noted the conclusion of the financial system stability assessment (FSSA) that the banking system remains weak and subject to considerable credit and foreign exchange risk. Directors, therefore, emphasized the need for strong supervision and encouraged the authorities to continue to work closely with the Fund to develop a framework for resolving insolvent banks.

Directors observed that Georgia's medium-term outlook remains challenging in view of widespread poverty and high external debt. They urged a greater effort to address the main structural obstacles to growth—emphasizing, in particular, the need for more effective implementation of measures to combat corruption and powerful vested interests, so as to improve the business environment and attract investment. Directors also urged the authorities to make progress on energy sector reform, with the support of multilateral agencies and foreign investors, to address the problems of low collections, large debts, and supply shortages.

Directors noted the risks to Georgia's balance of payments position associated with the downturn in the world economy and the continued economic problems in Turkey. They stressed the need to trim the external current account deficit and diversify exports in order to reduce external vulnerability.

Directors acknowledged that Georgia will continue to need concessional financing from multilateral lenders and bilateral donors for some time to come in support of the reform program and poverty reduction. They therefore welcomed the Paris Club debt rescheduling agreement reached in March 2001 and urged the authorities to conclude bilateral agreements on comparable terms.

Directors noted that, though the provision of data required for surveillance and program monitoring is adequate, the quality and timeliness of some data need to be improved.