Economic development tendencies of Georgia in 2008 and prognoses of main directions in 2009

I. Dogonadze

During the recent years investment flows were considerably growing in Georgia (up to 2008 III quarter).

Naturally this had a major influence both on currency market and economical growth. In 2007, the volume of direct foreign investments made up $1750.25 million that exceeds previous year rate by 49.5 % ($1170.08 million). 25 percent of the overall investments in 2007 were accounted for industry and agriculture, 20 percent – transportation and communications, 18 percent – energy sector, 8 percent – construction field, 8% – banking sector. Owing to global financial crisis and August war events, foreign capital flows has considerably decreased. Of course this had a negative impact on the country’s economy. According to research conducted National Bank of Georgia, $848 million investment is expected in 2009 in Georgia. Decrease in foreign investment will have a negative affect on the various macroeconomic performances. In order to clear up the consequences it is necessary to define how the investments are influencing the mentioned performances. During this period, foreign investment flows were supplying foreign currency on the currency market. This created threat of National currency devaluation. In order to avoid this, National Bank was intervening in currency market by purchasing US dollars. The amount of US dollars bought by National Bank amounted: 195.092 million Gels – 2004, 91.272 million Gel – 2005, 451.378 million Gel – 2006, 918.176 million Gel – 2007, 821.748 million Gel – 2008. In order to avoid inflation, caused by the increased volume of supplied Lari National Bank was withdrawing the mentioned funds from circulation, via deposit certificates. As a result, the volume of deposit certificate emission of National Bank was growing majorly. Specifically, 380 million Gel – 2006, 4202 million Gel – 2006, 3761 million Gel 2008. From August 2008, because of abruptly increasing demand on US dollars, National Bank considerably decreased amount of purchased US dollars. From this period, it started to increase dollar supply on the market. From August until December, the volume of supplied US dollars amounted 809.723 million Gel. Due to abovementioned operations, National Bank’s official international reserves increased significantly. According to 2008 December state, the volume of mentioned reserves was more that $1460 million. This indicator exceeds the similar indicator for previous year by 7 percents. Whereas the mentioned, decrease in the volume of foreign investments invokes strengthening of US dollar. In order to avoid this, National Bank of Georgia will be induced to spent considerable volume of currency reserves. From this point view, necessicity of increasing currency reserves, via foreign financial aid, is very important.
Increased volume of investments, due to raised monetary aggregates, had a significant influence both on inflation processes and on dollarization indicator growth. Increasing investment flows have more affect on those monetary aggregates, which are rising at that time. In order to find out this, we will compare monetary aggregate absolute indicators during 2008.
Via the above table, we compare monetary aggregates’ growth indicators in the same period (in absolute value). Comparing M1 with M2 and M3 with M2 is especially important, as more growth of M2 indicator than of M1 means increase in the volume of available resources for the banks. That on its part means opportunity of creating bank assets or the bank money multiplier. On the basis of increased demand, this process invokes inflationary pressure (grows the money volume in the economy, that invokes price increase in a short-term periods). However, during the recent period, (from September), the price increase pace has slow down, that on its part was connected with monetary factors and current recession processes.

We can clearly see from the table that in March, April, June and July months of 2008, M2 increase was more than that of M1. This means that during the mentioned period the volume of time deposits in banks has increased according to odds in their increments. This is the defining factor in the creation of banking assets. In September, after the August war events, M2 reduced by 13.994 million Gel, while M3 increased by 120.229 million Gel.
When comparing M3 and M2 indicator increments, note that M3 in comparison with M2 has increased more. Due to given increment odds, the volume of banking deposits in foreign currency has increased. As US dollar is holding major position in foreign currencies, dollarization indicator is growing conformably. By 2009, due to population’s high confidence in US dollar, dollarization indicator increase is anticipated.
In April, July and September of 2008, M3 growth was significantly exceeding M2 growth. From this point of view, August data is especially important. In the mentioned period, M3 decreased by 432.345 million Gel, while M2 – 235.352 million Gel. This was caused by the fact that, due to hostilities, most part of the population transferred their national currency deposits (despite high interest rates on them) in terms of dollars. Some part of the population withdrew the own deposits from the banks. Owing to this, according to October results, the volume of overall deposits in comparison with the volume existing before August, including foreign currency deposits too, decreased by 215.376 million Gel. Actually, the volume of deposits has reduced even more. As, deposits in US dollars, due to dollar strengthening, increased by 15 % on the basis of reevaluation. It must be mentioned that during 2009, there is no objective reason of deposit growth, as the unemployment increase causes the reduced total income, which on its part, is a serious obstacle for the formation of savings. Based on the above mentioned, it can be concluded that cessation of foreign investment flows in 2009, will be the occasion of monetary aggregates reduced growth. This on its part calls forth decrease of National Bank reserves and domestic demand. Therefore, National Bank’s ability to preserve currency exchange rate stability will be weakened. Although, it should be mentioned that main portion of domestic demand was satisfied by imported products (80% of consumed products are imported). Therefore, reduced demand invokes reduced volume of imported goods. In this case, only those involved in import business will incur losses. During the last three years, (2005-2007) deficit in balance of payments’ current account increased by 2.8 points and exceeded $2 billion. Such dynamic was defined by abrupt increase of import. In 2008, import volume was $6 058104 thousand, while export volume was $1 497664 thousand. Origin of such increased import volume was a consuming boom, partially encouraged by consumer credit growth. At the end of 2005, indebtedness on consumer credits lent out by commercial banks made up 301.507 million Gel, in 2006 this sum was 509.031 million Gel and 1,036.269 million Gel in 2007, while at the end of 2008 this amount decreased by 6% and made up 971,882 million Gel.
According to common data of I, II and III quarters of 2998, balance of payments’ current account deficit amounts – 2 351 841.1 (thousand US dollars). This sum exceeds the previous year’s rate by 1 139 615.1 thousand US dollars. Current account deficit aggravation tendency is turning up. Consequently, in 2009, against the background of money transfer decrease, foreign investment flows diminution will considerably increase deficit of balance of payments. Economical crisis is already raging in the whole world that decreases employment in the countries and consequently the amount of transferred money from these countries by Georgians, who work there. In 2005, the volume of transferred money from foreign countries to Georgia amounted $403.134 million, in 2006 – $553.250 million, in 2007 – $ 866.156 million, while in 2008 this sum made up $1,002.122 million. Naturally, decrease in the mentioned sums incurs serious losses for the population of our country. It is essential to mention that export volume decrease is anticipated, that mainly is caused by the existing problems in the world’s raw material markets. On this account, country’s export will face serious problems this year, as according to 2008 January-September state, 20.8% of Georgian export account for ferroalloy, 9.5% – scrap-iron, 8.5% – copper ore and concentrated products. Major exporting countries of Georgia are Turkey (19.5%), Azerbaijan (13.4%), Ukraine (7.6%), Germany (2.2%), and Russia (1.9%). All the mentioned countries have serious economical problems, which decrease their demand on raw materials. Of course, all these factors have negative influence on our countries export and consequently, on exchange rate of national currency.
Together with the growth of foreign investments, it is essential to increase the volume of credits lent out to Georgian commercial banks that has significant affect on country’s economical growth. Georgian commercial banks are more depended on foreign financial funds than on bank deposits, as foreign financial sources are cheaper and long-term. At the end of 2008, total debts of Georgian banking system amounted 2,834.815 million Gel. In terms of national economy crediting of the commercial banks, increase of these financial resources is a significant encouraging factor of economical growth. As a result of decrease in the mentioned funds and non-banking deposits (due to hostilities in August), the volume of commercial bank crediting reduced by 22% in 2008 and amounted 1,433.170 million Gel. In the second half of 2008, the loans decreased by 62% in comparison with the first half of the same year.
Commercial bank credit volume on construction business is especially important. Crediting of construction companies was encouraging the economical growth. In the first half of 2008, 146.201 million Gel credit was lent out on construction sector, while in the second half of the same year this sum amounted only 75.670 million Gel. That is 48% less than the rate in the first half of the year. During 2008, the overall sum of crediting in construction filed amounted 221.871 million Gel. In comparison with 2007 rate, this sum has increased by 6%. Considerably decreased financing in 2009, creates serious difficulties for the construction companies. Due to increased credit risks, the mortgage crediting has decreased abruptly. The mortgage credits in 2997 amounted 7,529.102 million Gel, this rate is increased by 127% in comparison with the previous year. While, during 2008, the mortgage crediting volume was 14,329.745 million Gel, the rate has increased by 91% in comparison with 2007. The growth pace of mortgage credit volume in 2008 significantly drops behind with the growth pace in 2007.
The industrial sector crediting in 2008, amounted 210,445 million Gel that is by 41% less than the previous year indicator (359,401 million Gel). In the first half of 2008, debts in industrial filed made up 141,827 million Gel, while in the second half of the same year this indicator decreased by 52% and made up 68,618 million Gel. Agriculture crediting amounted only 26,509 million Gel in 2008, this a 6% growth in comparison with the previous year. The mentioned growth pace is considerably slower that the pace of 2007. Notice that the amount of crediting in the first half of 2008 was 21,865 million Gel, while in the second half of the year – 4,665 million Gel, that is 79% decrease.
The crediting was mostly made in the trade filed. In 2008, amount of crediting in the trade field was 792,590 million Gel; this sum is by 11% less than the amount of the previous year. IN the first half of 2008, overall money lend out on trading was 597,476 million Gel, while in the second half of 2008 – it was 195,114 million Gel, 67% less than the first half indicator. In 2008, the volume of crediting in the trading sector exceeded the overall volume of industry, construction and agriculture crediting by 333,745 million Gel. Consequently, naturally when the volume of circulation field crediting exceeds the real sector crediting volume, this is disadvantageous for the country’s economy, as imported products are prevailing in the trading sector and thus financing the trading field means import growth supporting. This is reflected in our country’s balance of payments accordingly. Of course, decreased financing of trading field, incurs losses for those people, who are involved in this business.
On the assumption of the above mentioned, foreign financial flow decrease in 2009 reduces the creation of value added in construction, trading, industry and, agriculture fields. IT is necessary to mention that Georgian commercial banks are facing serious problems with bad loans, due to the existing situation. Correspondingly, the volume of bad loan reserves has increased significantly. In 2008 July, bad loans accounted for 4% of total debts. However, at the end of the year, this mentioned indicator increased by 9%. The process was complicated by the appreciation of US dollar exchange rate. The 73 percent of Georgian commercial banks’ credit portfolio is in foreign currency that in its absolute value amounts 4,213.939 million Gel. After dollar appreciation, commercial banking assets were increased on the basis of reevaluation process. However, debtors have to pay more money to discharge the credit. In 2009, this will worsen their solvency even more.
From 2003, together with foreign investment growth, tax yield volume is increasing too. This is encouraged by both economical factors and decrease in shadow sector due to tax liberalization. In addition, tax administration improvement, increased prices on imported goods and currency exchange rate alert had a positive effect on the tax yield volume too.
In the given period, on the basis of tax administration improvement, tax yields were increasing significantly. The tax rates were reduced considerably. Specifically: social tax rate in 2995, was 31%, in 2006-2007 it amounted 20%, while from 1 January of 2008 the tax was canceled. VAT rate in 2005 was 20%, while from 2006 it is 18%. Income tax rate in 2005-2007 was 20%, while after 2008 the rate is 15%. Income tax rate has some features, in 2005, it was 20%, and in 2006-2007, the rate was reduced to 12%. From 1 January of 2008, the rate increased up to 25%, owing to the annulment of social tax. While, from 1 January of 2009 the mentioned rate is 20%. Naturally, social tax annulment is a great relief for employers and companies. However, increased income tax considerably reduces net income of physical bodies. The reduction of the net income against the background of economical crisis and rising unemployment level may have a negative impact on overall situation.
VAT is playing a significant role in income taxes. The factors influencing increased income from VAT are import volume growth, currency exchange rate and inflation processes. 78.9% of Georgia’s foreign trade turnover accounts for import. Therefore, income gained from VAT considerably depends on price alterations on import. This means that the more the prices on import increase the more funds are received in country’s budget and on the contrary. Currency exchange rate devaluation causes increasing prices on import. In terms of unchanged demand, together with the customs income growth, more revenue was in the budget from VAT. In both cases, tax income growth was made at the expense of price growth. Consequently, in order to avoid tax income decrease, considering the anticipated low prices, it is necessary to increase VAT rate. Changes in income and revenue taxes are very important. From 1 January of 2008, income tax rate increased from 12% to 25%. Of course, this will have a negative affect on physical bodies’ net incomes. Any changes in tax rates should be assessed by studying accompanying processes. The reduced net income of physical bodies means deterioration of their living conditions and thus creation of social problems. The social problems, in a long-term period, are always connected with additional budget expenses. Together with the price growth, reduce in net income is an obstacle in creating the savings in the country. This is especially important for domestic investments in the country.
Revenue tax rate was reduced to 15% from 1 January of 2008. Of course, small revenue tax rate has a positive influence on the country’s economy. As companies will be able to refinance the saved funds in their business and this is a source of additional income. If the tax is increased, the mentioned funds will be lost. Therefore, in order to give stimulus to the various branches of economy, it would be good to establish differential tax rate on different branches of the economy.
Because of the mentioned conclusions, it might be said that in 2009, due to anticipated decrease in production volume and domestic demand, industrial sector income will be reduced. This on its part reduces tax yields from revenue tax. Owing to the expected unemployment growth, accordingly the volume of tax yields from income tax will be reduced. Tax yields from VAT will be reduced, as a result of world price slump caused by recession processes. Another factor influencing the reduction of the mentioned tax volume will be the reduced domestic demand. However, Gel exchange rate devaluation can neutralize the mentioned process.
Coming out from all the abovementioned factors, we can develop the main tendencies of Georgia’s economic development in 2009:
· Reduced foreign investment flows and money transfers will aggravate Balance deficit. Currency reserves of the National Bank of Georgia will be considerably decreased in order to stabilize currency exchange rate.
· The Gel exchange rate devaluation chances will growth considerably. It is especially important that country’s macro economical processes to coincide with the foreign financial aid.
· Because of reduced foreign investments the monetary market volume will be decreased, that on its part reduces import and local production volume, considering the decreased domestic demand.
· Because of reduced foreign financial sources, Georgian commercial banks might not manage to credit the national economy with sufficient funds. As a result, this will delay the economical growth.
· Due to reduced economical growth, revenue and income tax volume will be decreased significantly. The reduced demand, reduced prices tax yields volume decrease can be expected.
· In order to avoid all the mentioned problems, it is necessary to increase the role of foreign financial aid and state economy.