Issue 5, 2012. October-November

   

GATEWAY TO THE CAUCASUS: GEORGIA AS INVESTMENT HUB?

The Georgian government has focused on reforming the business climate in order to attract foreign direct investment. After eight years of reforms, Investor.ge looks at Georgia's potential to be a hub for international companies looking to invest in the region.

Monica Ellena

In his heyday, former U.S. Vice President Dick Cheney claimed that America had to become "the best place in the world to do business."

Georgia has been quick to follow suit. The country has a stellar record in establishing the conditions for investors to set up shop. Accolades include the World Bank's number-one reformer, to number one in enterprise surveys in spending the least time dealing with regulations, to 12th in ease of doing business in 2011.

But is that enough?

For EsbenEmborg, the Tbilisi-based partner of the Washington firm, SEAFManagement LLC, it is a no-brainer.Logistically, politically, and operationally Georgia is a natural hub for the region."You've got it all: a port, transportation network, stable politics, low levels of corruption, investor-friendly environment and good relationships with both Armenia and Azerbaijan. Taken one by one, these countries' economies are too small, but if you combine them, you have quite an interesting and sizeable market."

Moving here: What are the advantages?

Initiatives are mushrooming, from private projects to government measures. Projects such as the recently-built Tbilisi Logistic Center can boost the movement of goods with its state-of-the-art, 90,000 square meter container terminal with rail and road access, a container depot and TIR Parking. Actions like the double-taxation avoidance treaties are an incentive for companies to locate here.Georgia currently has double-tax avoidance agreements with 31 countries.

Oriflame Cosmetics SA, a Swedish cosmetics and beauty products company, entered the South Caucasus via oil-rich Azerbaijan in 1998, opening in Georgia in 2000. The company took a step ahead this year by registering Oriflame Caucasus as a special trading company (STC), which it located in Tbilisi. An STC is a special corporate category in Georgia that uses special taxing rules designed to facilitate reexport of its products. "This new entity takes advantage of the government's efforts to encourage companies to use Georgia as a regional center," saidLevan Bokuchava, Oriflame Georgia's country director."At the moment Oriflame has management offices in both Yerevan and Baku," he said."But operationally, it's Tbilisi that feeds the Caucasus."

Georgia's favorable tax system is yet another incentive for multinationals to operate here. Last year, Japan Tobacco Inc., the world's third-largest tobacco company by sales, moved its top and middle management for the Caucasus from Kiev to Tbilisi. "The market has grown significantly over the last decade.It simply made sense to manage it on the spot rather than remotely," said Dmitriy Lovenetskiy , the company's chief financial officer for the Caucasus region. "Currently the legal entity is limited to operate in Georgia, but our plan is to expand into the neighboring republics in 2013. The Caucasus economies are growing fast, so you need a center to feed them. Georgia is the default center."

JTI considered using an STC tax regime in Georgia, however they decided that there is still some ambiguity in the legislation and a lack of practical experience with it that make it a risky option for the company. However, they did make use of Georgia's Advanced Tax Ruling (ATR) system."The ATR allowed us to get clarity on the taxation for our operations and mitigate risk of possible future tensions with tax authorities," Lovenetskiy said. "It helps both parties to have a clear frame of understanding, at least in the medium term."

Nonetheless, because Ukraine has a stronger manufacturing industry and infrastructure than Georgia, JTI decided to keep their operation there. As retail, services, hospitality, and even agriculture are expanding in Georgia, the manufacturing sector is struggling to keep the pace here, they said.

Government investment attraction or deterrence for private investment?

The Georgian government launched the Partnership Fund in June 2011, adding to its various efforts to give the sector a push. However, of the four portfolios comprising the fund, the manufacturing portfolio so far remains the only one without funded projects. The other three — real estate, agriculture and energy — are up and running.

"The challenges are the sizeable investments needed and the small market Georgia represents," said Kakha Hizanishvili, the fund's chief investment officer. "That's why pushing the regional hub idea can also boost the sector. We need investors to look at Georgia as the entry point to the Caucasus as a whole, providing them with the conditions to build plants and factories. Textiles and pharmaceuticals have real potential.These sectors have access to a friendly tax regime, cheap energy, a cheap but educated labor force and transport links."

The state transferred stakes in key infrastructure companies to the fund to provide its initial, paid-in capital, including, 24% of Georgian Railway LLC, 100% of Georgian Oil and Gas Corporation LLC, 100% of Georgian State Electro System LLC, and 49% of Electricity System Commercial Operator LLC. Currently the fund has a total capitalization of roughly $2 billion.

Nevertheless, some fear this could be a deterrent for private investors. "The risk is that foreign investors will feel put off at entering a market where the government is already present with an equity fund that size," says Emborg, of SEAF, whose company operates two funds with assets totaling $72 million, invested in 15 companies focusing mainly on retail.

Economies of scale

"Size is one of the three main differences between us and private funds, the other differences being the sectors and the types of companies we decide to invest in,"Hizanishvili said. "As a governmental body, we are able to invest in areas and on a scale that foreign investors could not get into. None of our projects are smaller than $30 million, apart from agriculture, where the bottom limit is $5 million." The fund invests mainly in so-called greenfields, or start-up companies.By contrast, private equity funds tend to focus more on brownfields, or already existing firms.The bottom line is that Georgia's Partnership Fund facilitates the creation of new companies and encourages other funds to buy minority ownership shares as selling stakes, says Hizanishvili. "The government has done everything it can to bolster foreign investments in Georgia," stresses Nicole Jordania, an investment advisor at the Tbilisi-based consultancy firm, The Noè Group. "The results are clear, with potential investors from countries that range from the United States to India," she said. "The challenge now is to make Georgia an investment center for the whole South Caucasus region."