Robert Christiansen: Georgia’s Economic Prospects for 2008

(The material was recorded at Ivane Javakhishvili Tbilisi State University, Faculty of Business and Economics, where Mr. Christiansen delivered a presentation in November)

International financial institutions, especially International Monetary Fund missions and program works’ assistance play an important role in developing Georgia, as an independent state. These are technical assistance in the following issues: introduction of a new national currency – GEL (Lari), creating budgetary and modern banking systems, arranging economic stabilization and legal basis. There even was a certain criticism regarding not considering Georgia’s peculiarities and having certain bureaucratic deviations. Although generally they have greatly contributed to creating and improving economic climate. After almost 14 years of work they leave Georgia and declare: you, yourself are great reformers and do not need our assistance. At any rate this is an official argument for closing their missions to Georgia. At the same time they point to a threat of serious inflation, budgetary deficit and necessity of decreasing state spending together with decreasing trade deficit. They consider that Georgia reached sudden change in the sphere of export before massive demonstrations. Scrap metal was substituted by industry production. This is already a positive tendency and increased investment was also a promising signal. Announcing early elections is good, as pre-election expectations will soon come to an end and investment expectations will begin, to be more exact, continue, in case inflation does not hamper it.
Below you will find assessment by Mr. Robert E. Christiansen, Head of IMF Representation in Georgia of Georgian economy:
Robert Christiansen:
Overview of Microeconomic parameter: Inflation rate will rise. The prior problem of Georgia from the microeconomic point of view is inflation. It has quite high rate that has been caused by the following several factors: high prices on fuel and food on the world market, GEL (Lari) emission, quick rise of budget expenditure part, increasing deficit and growing trade balance deficit.
While analyzing each factor, its worth noting that there is a great difference between producers’ index and customer prices index – It is 0,92. What was condition like in the producer index in June of the previous year, when there was a peak of inflation? It exactly coincides with consumer price index changes for July of the previous year. According to today’s data this indicator is 18.2%. There is an obvious connection between these two indicators. That is why I say that Inflation may rise. What causes the rise of inflation? Which are factors affecting it? Import growth, while National Bank conducts emission, price of imported goods, two major products that are imported to Georgia: Oil and food. The price for oil has been systematically increasing in the world since 2004 that supported inflation. Prices increased on food, especially on wheat. The price drastically increased on the above mentioned products in 2006. This is one of the factors that will enable us to analyze inflation in Georgia. Although there is one more important factor –emission of money. Broad money M-2 supply has increased in 60 % for the last year. In my opinion, this is the most important factor that causes inflation. What causes such quick increase of money supply? Which factors can make it clear?
Why does the National Bank purchase such a big amount of US Dollars?
According to an opinion, in case GEL (Lari) becomes more stable, it may cause a danger to export, although export is not under great danger from this point of view. Looking through major articles of export basket will assure us in it. Perhaps cheap USD supports the development of domestic production, as the majority of production works on imported materials; cheap dollar enables it to be more competitive. Georgian export growth is of an utmost importance for the country’s stable economic growth. There are two factors, while speaking on stabilizing money: stabilization of nominal exchange rate (See table #1). Since the beginning of 2006 the nominal exchange rate kept stabilizing GEL. This factor didn’t have serious negative effect, as at the same time inflation was controlled and it obtained quite acceptable level. The second factor is real exchange rate. National Bank implemented a very good monetary policy and controlled it. Inflation will rise in case of real exchange rate increase. This is one of the reasons for microeconomic stability.
Government Spending – Government has an opportunity to affect microeconomic situation, its method lies in fiscal policy. Budget growth tendency: incomes increase and it amounts almost 5 billions in 2008. Expenditures have grown quite rapidly, especially in the year of 2007. It has started since Rose Revolution, when the government started to work. The government had expenditures of about 2 billions for 2004. The expenditures increased in 56% in the year of 2005, 39,2% – in 2006, and 39% in 2007. Deficit has increased proportionally-there was a small deficit in 2004, the amount of deficit increased every year (See table #2). This is GEL injection in Georgian Economy. Every single Lari out of three Laris is spent by the government. I believe that this government is able to do many important things but when expenditures rise so rapidly and progressively, a question quite naturally rises: whether these spending are right or not? Although discussing deficit shown below (See table #2) is not the major part of our talks.
Why does the deficit exist? Because spending is quite good. The problem lies in income. Where do the government incomes come from? What are the forms of taxes and where do they come from?
Privatization. Government sells its assets, receiving financial incomes and spending them. This process can not be stable. There are two questions: what happens when there is nothing to sell? What will be a result of microeconomic stability? Inflation will rise, government likes spending money. You may observe any time how the government likes to make changes in budget, how many changes will there be in a budget during a month. Three changes this year already and the fourth one may take place. The first change in budget didn’t seem so bad. We thought that 50 million GEL would be proficit that would be quite good and acceptable form the microeconomic point of view. Unfortunately this budget didn’t last for a long time. Three changes were introduced in this year’s budget and instead of the proficit we got deficit. 41% of additional expenditures added to the budget are foreign expenditures that do not influence inflation. Although 16% is a internal expenditure expenditures that support inflation. There is deficit and local expenditures increase that means that inflation rises on a local market. From microeconomic stability point of view there is a problem in Georgia. Growing Foreign Investments is a different subject of discussion. For managing foreign investments a government should implement a policy. On the one hand there is a strict fiscal policy, besides there should be an optimal monetary policy, directed on stabilizing real exchange rate of GEL There was a stable tendency last year. Lari has rapidly become stable that is a quite positive event. National Bank purchased bigger amount of Lari in comparison with the previous year. If we take a different view of economy, we’ll see that it still was under danger, as the amount of Lari was increasing. It again results in inflation. We already see the reflection of inflation, this indicator equaled 11% for the last 12 months (See table #5), by the end of December it will necessarily increase, the same will happen for the next year. The government seeks for ways of decreasing expenditures that is quite difficult due to political situation. Therefore, in my opinion, for the next 3-4 months it will be very difficult to keep microeconomic stability. Crisis is not feasible, but certain difficulties will take place.
Several years’ forecasts: export growth is necessary for developing Georgian economy. Export had a stable decrease during the last several years. (See table #4) and import was rising. This is opposite of what we would like to see. But export increased for the second, as well as third quarter of 2007. The question rose: whether this situation is stable or not? In order to answer it we should draw our attention to export products. In case this is scrap, it is not a good indicator. Scrap export increased in 50% for the second quarter of 2007. Although there is the indicator of export products: metal, fertilizers, cement. Investors’ origin does not bear an importance. Production of good products is actually important. Although exporting this product, for example scrap does not create vacancies.
My conclusion regarding export and economic stability is quite optimistic. We already see several signs, export will be stable. As situation has been improved, additional problem occurred. Namely, as we have mentioned investment flow depends on investors’ belief regarding economic stability in Georgia. Microeconomic instability threatens inflation. There is an opinion that political instability also makes a negative effect. When investors face risk, they do not invest. According to my forecasts, at the beginning of the year investment volume would be 2,4 billion USD. We have seen that investment amount has decreased a bit by the beginning of a month. At this moment we do not even know what to expect. Elections were planned to be held by the end of 2008 and we considered that investments would decrease. Early elections are set now and we think that this will positively affect investment and it will amount to 2,5-3 billion for the year of 2008. Still, this is the vague thing that a country’s economy faces. Last week my colleagues visited Washington and we discussed forecasts. Economic growth may reach 12-13%, large amount of investments may flow to Georgia, although don’t be surprised to face just opposite: quick decrease of investment and 5% of economic growth. My message to you would be the following – Economy requires stability, I mean microeconomic stability that implies decreasing inflation. Inflation is destructive for economy. At the same time we need political stability in order to have increased investments. USD 2 billion is quite a big amount that gives us the basis to think that economic growth will be stable. Export growth shows that Georgian economy is able to develop well. I would like to be an optimist and to believe that the situation will be far better this time next year.