INVESTMENT ENVIROMENT AND FOREIGN DIRECT INVESTMENT IN GEORGIA

Nato Bebiashvili, Assistant Professor, Georgian Technical University

According to UNCTAD, the following trend has been characteristic of developing countries since 1995 – most countries continued to liberalize their investment environment in order to get involved in the global economy.

The conduct of a policy aimed at creating favorable conditions for foreign direct investment (FDI) is a significant component of this trend.
Foreign direct investment has generally a tendency for growth both in individual countries and globally, which is clearly presented in the table below:
The growth of a volume of direct investments on the world capital market over the past few decades has become possible thanks to the efforts of the Triad of the largest world investors (the European Union, Japan and the United States). The share of these countries in total world inward and outward FDI flows has fluctuated at around 92% and 80% respectively.
Developing countries are eager to attract foreign direct investment, from which they expect to get such potential benefits as: creation of new jobs, accumulation of capital, attraction and introduction of new technologies, and the development of competition.
Foreign direct investment (FDI) is the most important source of capital for Georgia and other post-Soviet states. Such investment not only supports new plants and equipment, but usually entails bringing in modern management methods as well. The Georgian Government is eager to welcome foreign investors. From 2002 to 2006, FDI averaged 9% of GDP, with much of it dedicated to the construction of the Baku-Tbilisi-Ceyhan oil pipeline and the South Caucasus gas pipeline. In 2006, which saw diminishing pipeline investment as a function of total FDI, more than half of FDI went to the banking, manufacturing, and tourism sectors.
In our opinion, foreign direct investment is of a vital importance for Georgia in terms of economic development, growth of revenues and employment. Therefore, more information concerning factors that influence foreign direct investment flows is needed. Based on existing foreign experience, it is possible to identify the tools, activities and policy directions; although a due regard for a recipient country’s peculiar features would be also advisable and necessary.
We believe that for attracting foreign investments no less attention is to be paid to such an important issue as the creation in Georgia of the economically and politically sustainable investment environment, for which purpose economy crisis, corruption, “red tape” and other impeding factors should be eliminated.
As mentioned, the investment environment is an aggregate of factors characteristic of a given country and determining opportunities and stimuli to enable companies to expand scope of their activity, implement investments, create new jobs and take active part in global competition. The risk of investment decision-making is on entrepreneurs; however, the state renders a significant impact on the investment environment, when protecting the rights to ownership, exercising legislative control and business taxation, creating conditions for functioning of a financial market, and a market infrastructure. The role of the state is also essential in handling such general problems as corruption, criminality, and political instability. The investment climate improvement should be a priority task for any state. Policy and political activities play a significant part in the shaping of the investment environment. The investment environment encompasses all which an investor takes into consideration, when evaluating how advantageous are conditions in the given country for investing. These include also such factors as the ideology and policy, economy and culture existing in the country. The less favorable is the investment climate, the higher will be the investment risk for the investor and the investment attraction costs for the recipient country.
The World Bank’s studies show that the main factors that negatively affect the investment environment include: political uncertainty (28%), macroeconomic instability (23%), taxes (19%), legal regulation (10%), and corruption (10%).
The investment climate improvement will necessitate the establishment of a respective legal base and regulatory framework in compliance with international standards that would provide foreign investors with definite safeguards and incentives.
In it advisable that a network of investment funds, trust and leasing companies as well as joint ventures with foreign partners be set up.
The attraction and efficient use of foreign investments are among the most important factors for developing the domestic economy.
On the other hand, Georgia is already attractive to foreign investors thanks to its favorable geographical location ( Georgia is located at the crossroad between Europe and Asia. It is the shortest route from Central Asia to Europe, and could be a North-South Bridge between Turkey and the Russian Federation. Georgia has two deep-water ports on its Black Sea coast), cheap and skilled workforce, customers that are less demanding to products quality, in contrast to the European market. It should, however, be mentioned that there is a whole number of reasons that make Georgia less attractive to foreign investors. These are: political instability, great foreign debt, still unspecified future prospects of economic growth. In addition, Georgian market is not vast, natural resources are scarce and therefore investment here should be oriented to exports.
In order to attract investments, it is advisable that the following measures be carried out:
– The introduction of a preferential taxation system;
– The authorization of accelerated depreciation;
– The conduct of a selective policy toward the attraction of foreign capital, which implies the grouping of branches according to the foreign capital attraction expediency;
– The regulating of existing legal base.
The dramatic change of government swept in by the 2003 peaceful “Rose Revolution” marked the start of serious political and economic reform in Georgia. Before 2003, Georgia’s economic development suffered from a reputation for instability, violence, corruption, and unreliable supplies of energy. The picture has significantly changed for the better. Since 2004, the Georgian government has undertaken institutional reforms including the restructuring and downsizing of government ministries, privatizing large state-owned entities, increasing the pay of public servants and more vigorously prosecuting corruption, reducing the number and rates of taxes and improving tax and fiscal administration, streamlining licensing requirements, deregulating, simplifying customs and border formalities, and undertaking many other efforts to make it easier to do business in Georgia.
Georgia is extremely open to foreign investment and is eager to welcome new investors. The country has begun to develop a regulatory framework intended to foster competition. Legislation governing foreign investment establishes favorable conditions, but not preferential treatment, for foreign investors. The Law on Promotion and Guarantees of Investment Activity protects foreign investors from subsequent legislation that alters the condition of their investments for a period of ten years.
Legislation governing foreign investment includes the Constitution, the Civil Code, the Tax Code, and the Customs Code. Other legislation includes the Law on Entrepreneurs, the Law on Promotion and Guarantees of Investment Activity, the Bankruptcy Law, the Law on Courts and General Jurisdiction, the Law on Limitation of Monopolistic Activity, the Law on Customs, Tariffs, and Duties, the Accounting Law, and the Securities Market Law.
In 2005, registration of businesses was simplified. Paperwork and fees were reduced and processing time shortened to about 8–10 days from the submission of documents. All companies are required to register with the Ministry of Finance, providing founder’s and firm principals’ names, dates and places of birth, occupations and places of residence; incorporation documents; area of activity; and charter capital. This information is made public and any person may request and review such information. Business registration and tax registration are separate procedures handled by the same department within the Ministry of Finance.
The Government of Georgia has privatized most of the largest formerly state-owned enterprises in the country (see Figure 1 below):
Figure 1

Georgian law guarantees the right of an investor to convert and repatriate income after payment of all required taxes. The investor is also entitled to convert and repatriate any compensation received for expropriated property. The Georgian Constitution protects ownership rights, including ownership, acquisition, disposal or inheritance of property. Foreign citizens living in Georgia possess rights and obligations equal to those of the citizens of Georgia. The Constitution allows restriction or revocation of property rights only in cases of extreme public necessity, and then only as allowed by law.
The Georgian law on investment allows expropriation of foreign investments only with appropriate compensation. Recently proposed amendments to the expropriation law would allow payment of compensation with property of equal value as well as money. Compensation includes all expenses associated with the valuation and delivery of expropriated property. Compensation must be paid without delay and must include both the value of the expropriated property as well as the loss suffered by the foreign investor as a result of expropriation. The foreign investor has a right to review of an expropriation in a Georgian court.
The Georgian government has made a commitment to greater transparency and simplicity of regulation. As recognized by the World Bank and International Financial Corporation’s 2007 Doing Business Georgia improved in six of the 10 areas studied, making it the top reformer overall. The tax on corporate profits is 20%; the tax on personal income is a flat 12%. The Value Added Tax is 18%. The number of taxes has been reduced from twenty-two to seven; rates were lowered in three instances, and only raised in the case of excise taxes on cigarettes, alcohol, and fuel.
It would be interesting to analyze the foreign direct investment inflows to Georgia during the last decade. To do this, we, based on the Statistical Department’s data, have compiled the following table:
The reforms and initiatives carried out by the Georgian Government after 2003 for the purpose of improvement of the investment environment have yielded positive results, this being also evidenced by international studies and estimates.
In 2005, foreign direct investments in Georgia totaled USD 450 million (against USD 499 million in 2004). A definite decline in comparison with the previous year’s was caused by completion of the Baku-Tbilisi-Ceyhan oil pipeline construction, although the amount of the other investments (other than those related to the pipeline) increased by USD 44 million as compared with 2004 – from USD 139 million to USD 183 million. In 2006, the foreign direct investments in Georgia made USD 1,190 million, exceeding the previous year’s index by USD 740.2 million. In January-June 2007, foreign direct investments in Georgia amounted to USD 656.8 million (an increase by USD 203.9 million against the similar period’s indicator).
The amount of European Union FDIs in Georgia reached USD 407.1 million in 2006, exceeding the previous year’s indicator by USD 164.4 million. At the same time, notwithstanding the rated growth, the EU’s share in total investments dramatically fell in both quarter and yearly terms. The cause was the entry of the South Caucasian (Shah-Deniz) gas pipeline in the completion phase. In 2007, the amount of direct investments made in Georgia from the EU countries was USD 321.1 million, exceeding the similar indicator of the previous year by USD 171.1 million.
According to the International Monetary Fund, as a result of the business climate improvement together with the stable macroeconomic situation in Georgia as a whole, the country is becoming more attractive to foreign investors. The growth inertia resulting from reforms assists the economy in compensating for the damage incurred from the loss of the main export market (Russia).
It is a recommendation of the International Monetary Fund that the Georgian government maintained the rate of GDP growth within 7-8% and that of inflation at 6%. Regrettably, this recommendation fails to be complied with. To fulfill it, the conduct of a strict monetary and fiscal policy will be necessary.
It should be mentioned that notwithstanding Russia’s ban and sanctions, foreign investors are still and even more interested in investment activities in Georgia (see Figure 2 below):

Source: International Monetary Fund
In 2006, like in the previous years, leader in direct investments made in Georgia was the United Kingdom – USD 182 million. Part of these represented the funds invested as a result of privatization, another part being the investments made by British Petroleum. It is to be mentioned that in 2006, when the volume of investment flows related to the construction of the oil pipeline was gradually reducing, investments in the spheres of power engineering, construction and tourism, being especially furthered by the active privatization processes, showed a rising tendency. The service sphere attracted USD 717 million of investments throughout the year which comprised 43 percent of the total investments; USD 231 million was invested in industry; the banking sector attracted USD 72 million. In addition, portfolio investments significantly increased in 2006, in particular up to USD 120 million, whereas until then this indicator had been rather low. The source of the mentioned investments was mainly the selling of the Bank of Georgia’s shares at the London Stock Exchange.
The October 2006 deterioration of relations between Georgia and Russia has had an adverse impact on Georgia’s international ratings. Owing to the geopolitical risk growth, the economic expansion rates have slowed down and affected foreign investors’ mood. Such risks have been partially balanced with still high economic prospects having resulted from reforms carried out in the economic sphere. It should, however, be noted that according to the 2006 statistics, per capita GDP constituted USD 1,700, which is a rather low indicator.
According to surveys conducted by the World Bank (WB) and the European Bank for Reconstruction and Development (EBRD) in 2002 and 2005, the Georgia’s business environment has significantly improved. Especially noteworthy is the betterment of its macroeconomic situation. For example, in 2002 84% of the surveyed firms named the administration of taxes as the main problem, whereas in 2005 this indicator was lowered down to 23%. Also decreased were tax rates. An important achievement has become the reduction of corruption. In 2002 the corruption was named as the most important problem by 66% of the surveyed, whereas in 2005 the percentage was reduced to 39%.
The World Bank has recognized Georgia as the world’s fastest reforming economy in its 2007 “Doing Business” report, ranking it as the world’s 37th easiest place to do business, in league with countries such as France, Slovakia and Spain.
The World Bank’s “Anti-Corruption in Transition 3” report places Georgia among the countries showing the most dramatic improvement in the struggle against corruption, due to implementation of a strong program of economic and institutional reform, with firm-level bribery falling substantially.
Georgia also significantly improved in Transparency International’s annual Corruption Perceptions Index, moving up from 130th place in 2005 to 99th place in 2006, out of 163 countries.
Based on the economy’s overall performance and the Georgian government’s strong commitment to structural changes, Georgia received its first sovereign credit rating in late 2005 from Standard and Poor’s — a B+ long term, and B short term rating.
A significant progress achieved by Georgia by the Heritage Foundation’s Index of Economic Freedom should be mentioned. Georgia jumped from the 100th place in 2005 to 68th place in 2006, and was ranked the 35th out of 116 countries in 2007, with its score improving from “mostly unfree” to “mostly free”. Areas of improvement were concentrated in monetary policy, the financial sector, and foreign investment, while property rights, regulation, and the informal market scores remained poor. According to Heritage Foundation’s Index of Economic Freedom for 2007, the mostly free 10 countries include: 1. Hong Kong, 2. Singapore, 3. The USA, 5. New Zealand, 6. The United Kingdom, 7. Ireland, 8. Luxembourg, 9. Switzerland, and 10. Canada. Georgia is ranked the 35th worldwide, and the 20th in Europe.
According to the World Bank, among the ten successful reformer countries announced in 2007 Georgia is ranked the 5th.
Although in the autumn 2007, signs if a political crisis became evident in Georgia, which has to a certain extent, affected the country’s stability and the investment climate as a result. It is a well-known fact that the flow of investments is greatly dependent on a stable situation in the country. To ensure this, Georgian authorities are taking important steps (pre-term presidential elections were called and held, a new renewed government was staffed). All this serves as a guarantee that the country regains stability and thus chances to progress.
On the Risk Map published in 2007 by an international independent, specialist risk consultancy Control Risks Group, Georgia has been placed among the countries at medium political and high security risk. This was conditioned by many reasons. In spite of the progress achieved in different spheres, capital investment in Georgia is still a risk-associated business. Foreign investors fear frequent changes in the local tax legislation and the dependence of the judicial system on government authorities. Investors lack confidence in stability, and apprehensions of possible economic shock and turmoil interfere with desire to invest.
In addition, the investment climate available in Georgia is characteristic of the following negative aspects:
· Political tension and frequent cases of business lobbying by the executive and legislative authorities, by using arbitrary forms, which undermines the foundation of healthy competition in general as well as among investors.
· Violation of the country’s territorial integrity, non-spread of Georgia’s jurisdiction to Abkhazia and South Ossetia, which cannot but create the foci of tension in the neighboring regions.
· Complicated social status of the population (almost half of the population is at and below the subsistence level), which leads to social tension and shocks.
It should, however, be noted that in spite of the enumerated difficulties, the country does have a certain positive potential in order to interest foreign investors, namely:
· Rich and relatively cheap resort and tourist resources
· The richest reserves of well-known mineral and medicinal water
· Relatively cheap and qualified labor
· Specialists of high intelligence level
· Possibility of participation in the privatization process by foreign investors
· Possibility of gaining fast profit.
We think it necessary to name the following reasons for investing in Georgia:
1. Georgia is a successful reformer country;
2. Strategic geographic location;
3. Stable macroeconomic environment;
4. Competitive trade regimes;
5. Liberal tax environment;
6. Simplified licensing and permitting procedures;
7. Large-scale privatization policy;
8. Definite progress in combating corruption;
9. Dynamic banking sector;
10. Liberal labor laws ;
11. Georgia is a country of the ancient cultural traditions.
The main source of sustained future growth that reduces poverty and increases employment will have to be private investment, both domestic and foreign. The most useful investment will have an emphasis on exports to new and more diverse markets. The government’s challenge is to implement existing legislation, continue the fight against corruption, defuse tensions in the separatist regions and undertake new reforms, especially to improve the judicial system, in order to increase investor confidence.
To our view, it is necessary that solid investment legislation be drafted, that the supremacy of law be observed in the sphere. At present the following relevant laws are in force in Georgia: the 1995 Law of the Republic of Georgia on Foreign Investments; the 1996 Law on the Promotion and Guarantees of Investment Activities; the 2002 Law on the Georgian National Investment Agency; and the 2006 Law on the State Support of Investments. We think that the said laws shall be revised and harmonized with the relevant international laws and conventions.
The inflow of any investment depends on the investor’s trust. In order to make the country more investment-friendly, it is necessary that a respective state program reflecting the country’s economy development main directions is elaborated and the ways of improving the investment environment be set out.
The priority directions of attracting foreign investments include: the development of the scientific-technical sphere; the export potential’s increase; the banking sector operation betterment.
When attracting foreign investments, the regional factor should be taken into consideration, for each regions of Georgia have their characteristic peculiarities.
We think that for improving the investment climate in Georgia decisive steps should be taken: in the first turn, the struggle against corruption must be intensified, because in spite of the marked progress made in this sphere international experts opine that Georgia is still a country with high levels of corruption and red tape; another important issue is the perfection of the tax code. Despite numerous amendments and the elimination of many taxes, the code still remains to be hardly understandable and ambiguous, especially in the part of administration of taxes. Also unacceptable to investors is the frequency of changes made in the tax code and in legal acts in general. Licensing and permit-taking procedures need to be simplified, although the year 2006 should be noted for improvement tendencies in the area. One more urgent problem is accessibility to preferential credits. The country shall not be completely oriented to foreign direct investment inflows – the promotion of local investors is also necessary. Lately the Georgian government has attained a serious progress in the sphere of regulation and anticorruption policy. However, the regulatory measures only will not suffice to ensure the sustainable economic growth unless they are accompanied with the strengthening of market institutions. In particular, the right of ownership should be more protected; the court system needs reforming in order to keep pace with the business environment liberalization, which requires the taking of immediate measures on the part of the authorities.
In our opinion, economic development of the country requires the creation of such investment environment that could be attractive to both foreign and domestic business people, so that they would invest in Georgia rather than in other countries.