Epistemology of Economic Crisis and Investment Surrounding in Georgia

Lamara Qoqiauri Doctor of Economics, Professor

Towadays, when the society makes significant attempts to reform economy, the importance of demand on investments has not reduced, though low effectiveness of our production doesn’t give opportunity for realizing these demands.

Low level of profitableness gives rise to the poor situation in the process of capital-formation. showing between state investments and budgetary deficit has been negative in our country during last years. A huge foreign debt is extremely serious factor for reducing inner resources for accumulation. No matter what the result of agreements without its restructuring is, the sum of annual expenses on service almost equals to the half of whole investments in the basic capital. Leaning upon these data, the experts come to the conclusion that under the conditions of the existed tendencies of development, perspectives of economical development of the country are doubtful. Changing of situation may give rise to the increasing of investment activity at the market of private investments, for which there is a necessity of radical improvement of the investment surrounding. For distinguishing negative sides of the investment surrounding, it is necessary to provide their pre-analysis and look through the history. Only by distinguishing problems in investment activities in our country may be constructive foundation for searching them. This defines directions for forming advantageous investment surrounding.
Unprofitable investment surrounding in relation with the peculiarities of further productiveness of our country, was characterized by:
– pauperization of reserve potential of the investment process, provoked by low profitableness of the enterprises, little quantity of the people’s savings and their incomplete reforming into investments;
– growth of demand on the reserve resource of investments in relation with transition to the expensive resource-saving technologies, that gave essential growth to the size of the advanced capital;
– deformations of economical growth, which interrupted capital inflow, made barrier to their entering to the production. Such is high monopolization in the production, activity of criminal forces, still high inflation, which reduces profitableness of long-termed investments;
– incomplete development of market industry, which is not able to fulfill ability of transition of a customer to the market;
– prolonged economical degradation stage, which is the most unprofitable period for investments, decreased profitableness of the enterprises, commercial credit became unavailable for filling even turnover resources, that has been resulted in the crisis of nonpayment.
Unprofitable investment climate was being spoiled by incompleteness of forming market subjects, displayed in the following:
– privatization was not be able to be formed in the so-called effective owners, which are initiators of the investment process;
– they founded not marketing mentality of the director corps, which hopes for covering dents of the enterprises by the state, which is oriented towards short-termed factors of development.
Let’s discuss the specifics of further production in the country, which influences unfavorably upon the investment surrounding, also we must define social-economical reasons of subjective passivity of the market towards the investment activities.
Why was the process of further production creating incomplete conditions for the investment activities? For answering these questions we must recall the situation that the investment process may become real if their volume is sufficient for realizing investments under the conditions of existed savings of the population. This means, that the process of further production gives possibilities for making more profit, then current requests are. Later these savings are accumulated by commercial banks, get to the security market and finally transform into the investments.
Beginning of economical reformation is related with the process of liberalization of prices, which devaluated cash assets of the population in a very short period of time. Self-repayment of national currency has fallen down so fast, that cash savings of the population factually disappeared. This has been provoked by the situation, that the people who saved money in the saving banks, lost there chance of turning their money into a firm currency or commodity valuables, for saving their assets from inflation. The reason for it was extraordinarily regime of money policy of the government, which announced, that the deposits of the population were to be frozen.
Thus, the most part of the people started accumulation process from the zero point since 1992-1993. Those financial resources, which would activate investment forces, were not owned neither by the state, which was bankrupted financially because of more then 30% of deficit in relation with the gross product, nor by the masses of workers.
According to the data of state department of statistics of Georgia, savings of the population by the end of 90s concluded 15%, though, to the experts’ mind, this size must be 3 times less.1
Herewith, most of the countries have high national norm of savings during the period of fast economical growth. Privately, population was saving 29% and sometimes more of incomes. Lack of savings was strengthened in 1998 by financial crisis, as it gave rise to the reduction of the accumulated savings because of losing capital of banking system.
We may name loss of confidence in banking of population and investment institutions to be more injured. This gave rise to the loss of desire of placing savings into the investments. Misfortune of the country economy was not only the lack of savings, but also extreme ineffectiveness of their usage. Today only 14% of the volume of savings may be discussed to be the investment potential. This is the part, which leads to the growth of deposits and purchasing securities. Remaining 86% of savings are kept at home in the most unprofitable form in cash, in foreign or national currencies.
Thus, the economy of our country is far from the equality of savings and investments – the most ideal proportion for economical growth described in economical theories.
Lack of savings reduces credit possibilities of commercial banks, as distribution at the monetary markets may not be thorough. That’s why our country has extremely small volume of crediting. Its size is less then 10% of gross product, while this proportion is 100% in the developed countries.
Following condition must be foreseen, that not only the process of saving has been interrupting factor for financial potential needed for investments. Reductions in the use of depreciation resources of protection-keeping of investments placed earlier have become extremely strict. This is related with the fact, that stopping of centralized financing of capital placement automatically reduced depreciation funds of the enterprises accumulated earlier, as the most part of them (about 70%) has been wasted on the centralized needs. Thus, resources for keeping threadbare facilities may not be sufficient. Increasing inflation spoiled them. Values of the investment commodity have being grown expensive and this, of course, gave tire to the reduction of depreciation fund, as later resource and possibilities for investments.
Georgia appeared in the situation of financial hanger that, of course, is interrupting for possibilities of investment process. Herewith, demand on the resource potential are still growing up. The reason for it is transition to the newer, industrial model of development, which is directed towards intensive type of further production, technical progress of resource-saving, and usage of new technologies. For transition to the new industrial model it is important to use expensive resource-saving technologies, which means high level of saving in the society. This definitely gives rise to the oppositions with realizing investment process.
Influence of the global financial crisis towards financial markets. Compulsorily high expenses on oil products in the customer structure influenced negatively upon savings of wide levels of people and relatively the volume of investments. So, demand has been reduced in dual-factored effect (second factor, which has partially formed by the influence of the first one, is related with reduction of corporations and devaluation of their securities). In 2007 concrete uncoordinated attempts of using levers of cash-credit regulations by the central banks of separate countries for the purpose of reducing oil prices, gave rise to the significant fluctuations of the exchange rate foreseeing taxation balances. Problems were mostly displayed in the distinction between percentage rates on the background of many dimensioned different priorities and difficulties. Rising of oil prices seemed to be reflected on the self-repayment of the US dollar, though growth of import in the numbers of countries gave rise to the growth of request on US dollar and their devaluation toward Japanese Yen, Euro and Pound Sterling, when agreements are steel being concluded in the US currency. By the beginning of devaluation of oil financial crisis has already spread beyond the USA borders, also presidential elections of the USA gave expectation of turning the country towards better side. Today, the countries of the world reduce basic exchange rate and distinction between them is also being reduced (See draft 1.2.)
Draft 1.2. Spread between LIBOR OIS rates.
Security market has been hit by devaluation of SPV assets for securing credits founded by the credit derivatives and firms entering banking holdings of banking corporations. SPC assets consist of bonds of commercial debts (CDO), privately, in this common case, from the bonds of hypothec credit debt (CMO), which is Securities provided by the totality of one of the kinds of securities firmed by the assets (ABS) – Securities guaranteed by hypothec (MBS). This pyramid, in which securities of each following level was guaranteed partially by the lower securities, while one of the guarantors of MBS was advantage real estate. Falling of prices on real estate devaluated securities of every level.
What happens on Wall Street? Together with the banks, which have serious problems with counting loss from supreme credits and at the same time granting bonuses to the top-managers, experts of financial domain also blame so-called “quantum” in Wall Street and head financial centers of the world. Does the current process conform to the point of view “the fish starts rotting from the head”? It is hard to say. On one hand, we can not blame financial institutions for aggressive crediting for keeping share of a market, if it is dictated with positive expectation, but by keeping legislative-regulating norms. Exactly these regulations were to prevent banks and other financial subjects to treat resources of debtors and others so irresponsibly, as those millionaires, who make bets in Monte Carlo casinos. Existed frames of regulation don’t conform with new methods of risk managing (according to the regulation norms, equation coefficient of weighed assets with a capital, norms of liquidity of reserve demand, limits of open currency positions and formal security of others), development of credit derivatives and widening balance free operations. Herewith, scheme of bonus compensation of the employees, which is common for the western financial institutions (of course, we don’t mean commercial houses) increases the interest in growing the volume of agreements, i.e. by obliging themselves with useless conditions, investments in high-risk assets with optimal estimation of the existing or prediction data, for example, with widened valuation of credit abilities of the potential borrower. This is the conflict of interests, when operation promises increasing bonus to the agent, while it is dangerous for the principle.
Let’s return to the “quantum” and their mathematic methods, which seem to lean upon concrete science, though we must remember sophistic oppositions of the highest mathematics, which are related with, for example, equally of two functions forcing to the endlessness r one and the same number. It sounds paradox, but genuine is in the simplicity and saying with the words of Ilia Chavchavadze, there are no big and little miracles. Sophistic models, which use many-leveled multivariate analyzing methods, very often lose focus and their usage in management assets and obligations, make new source of risk at the initial point. Notwithstanding the fact, that the most part of these models are far from elemental base and, relatively, results of analyzes are difficult to be perceived and sometimes inessential. It must be mentioned, that programs of financial management are available by the internet and their providers try to adverse those by annotating many- dimensioned schemes and incomplete promo-versions. Many of them are of dilettanti handmade. One part of the managers, having incomplete qualification, trusts in using these computer systems. Besides the problem of making incorrect decision, we must not forget the problem of envy dispositions to this problem. There are attempts of making mistakes due to worng information. This fact has took place with “Sociate Generale”, when first management hide loss hoping, that it would be able to cover these problems by another accounting, and later 5 billions were disappeared, that has been noted to the stock exchange later and employees were blamed in it. We may not say how much trustful is the analyzing leaning upon financial market data by using casual models.
Cause-effect aspects of the crisis. We may not still say, what was that main virus, which gave birth to the syndrome of immune-deficit and spoiled whole economical body and vital financial system, – it is possible only separate aspects of this, and only by diagnosing partially displayed symptoms. According to which reasons and results of the problem are connected to each other and discussed accordingly with the wider point, other aspects are represented relatively in a narrower corner. It is difficult for the human mind to realize a complex space in more then three dimensions that is adopted in theoretic formulation and implemented in computer systems and models of estimation and management. Insufficient degree of trust of the financial managers towards incomplete product of cybernetics and also virtual illusions of post-industrial economics of scientific-technological revolution, gave essential changing to the perceive of the reality, relation with the risk, illusions about future and turned into the most provoking factors for managing unnatural directions and scale-proportions.
It is difficult to define, whether crisis has covered whole economy first, or the securities of billions of dollars stopped their functioning. Direction of the vector of these relations is represented according to the problems of which are being discussed, i.e. directions of this vector is being changed in dynamics of developing crisis. Problems of credit rating and liquidity of banking-crediting organizations were less before displaying crisis not because of the fact that there were no increased credit risks, but they were transferred to the balance-free accounts. The reason is evident – for not using coefficients of increased risks in calculations of weighed assets according to the risks of the used regulation requests. Using securing and credit derivatives for attracting liquid cash sources is extremely effective, while regulating reaction is late and quite soft.
How change of prices influenced real estate. From one side, avoiding reductions related with regulation arbitrage and predictions leaning upon 10-15 years of economical growth tendencies forced credit managers to the brave credit expansion. At the initial stage this increased the prices of apartments and economical growth. On the background of the grown assets corporations tried to increase cash flows by increasing emission of shares, bonds and debt securities. There are too many persons having little experience, who often buy securities by the internet not according to their profitableness, but by their exchange rate. Bankrupting of NRON paled the attractiveness of debt securities of the corporations so, that “financial bubble” was blown in direction to the credit organizations. Founding of “Credit bubble” is related with the founding of price bubble on the living spaces; increasing prices by making mortgage loans more available might be continued until situation is changed at the market of real estate, though reduction of immigration to the USA and Great Britain, reduced demand on these large markets. Banks were interested in the growth of prices on real estate. This may be explained by the following condition: Mortgage loans were guaranteed by the apartments to be purchased and their market price defined existence of possible loss on credits in the case of default. Interest of the creditor in rising price on the real estate comes to the opposition with that of the borrower and at the same time rising of prices increases the share of expenses in the cash flow. Cash flows of the borrower are important components of their solvency. On the background of uninterrupted growth of prices on real estate and large number of the borrowers’ motivation of reducing expenses on analyzing credit abilities of the borrowers by the bank gave rise to the accents on guaranteeing hypothec credit and these priorities made credit abilities of the borrower of secondary meaning. Though this request is not abolished by the banks, but making calculations on returning debt by the debtor means, that data of default showing is quite high. Under the conditions of 2-3% growth of real sector of the economy it became more and more difficult to cover credit for the part of the borrowers. Apartments under the banks property return to the real estate market again.
Increased distribution and defaults reduced hypothec credits. This in its turn means decreasing of guaranteed on them. Tendency of falling prices and worsening qualities of assets, that gave rise to the strengthening of liquidity problems, forced the banks to decrease granting new credits. Granting of real estates took mostly place by using hypothec credits and this gave rise to the recession of the building sector.
Conclusions about credit crisis. Let’s state reasons of credit crisis in details:
1. It was not evident for the credit expert whether the claimant (and later debtor) was able to generate cash flows sufficient for covering the hypothec;
2. The hypothec covered almost full price of the apartment to be purchased, i.e. co participation of the borrower was minimal;
3. Exchange rate might be changed in various kinds of debts and increased sharply, that was not realized by everyone;
4. The borrower often used hypothec to receive cash for other purposes;
5. Many credit officers and commercial houses forced potential borrowers and supported to create false profile (mask) of their solvency, for the reason of making bonus, additional prices or commissions.
How new crisis influenced Georgian economy. According to the widely developed international economical relations, financial crisis, that began in the USA covered whole world in the chain principle, and especially those countries, which have had foreign economical relations with the USA (i.e. Georgia either). According to the fact, that Georgian economy is the consisting part of the world economics, global financial crisis, naturally influenced negatively upon Georgia and led the country to many provocations. Initial results of the crisis are evident by the beginning of 2009 and its complication is also inevitable. Global financial crisis gave rise to the problems in economical growth in every country. This is seen in reduced demand on the luxury, cars and other productions, that gave birth to the reduction of Gross Product in leading countries of the world.
Basic defining factor of economical growth in Georgia during last years was permanent inflow of private capital from the foreign countries.2 Thus reduction of direct foreign investments and bank credits will be important factor of reducing Georgian economical growth in 2009. Georgian government predicted Gross Product in 21535.9 millions before economical crisis. Today governmental prediction is 21308.7 million Georgian Laris (they consider reduction in about 227.0 million GEL that is about 1.05%). Growth of gross product was considered to be 4,0%,while after displaying results of the crisis it is 2.5%. In 2008 growth of GDP was not 8%, but 2,0%,3 though real situation may be more pessimistic and 2% growth may be possible only by directing financing from the donor countries towards activities providing high economical activity.
Significant reduction of investments in Georgia has begun after August events. During the current period we have the tendencies of reducing investments provoked by the global financial crisis. This is also related with the finishing of large list of privatization objects in Georgia, while small privatization objects do not make important climate. According to the governmental prediction, Georgia received 2.17 billions of investments in 2008, and is going to attract about 1.7 billions this year.4
According to the package of economical stimulation planned by the government, potential share of using gross domestic product and components of state purchasing is being significantly grown, while a component of investments is going to be reduced, that finally leads us to the insufficient distribution. Problems in production will increase negative balance between export-import and relatively, data of net export will be increased.
(Footnotes)
1
Materials of State Department of Statistics of
Georgia
2
“Georgian Economical Tendencies”, GEPLAC quarter review, October 2008, Pg. 7
3

– “Strategy of Protecting from the Global Economical Crisis”, Georgian Government, December, 2008.
4
See previous source.