Issue 5, 2013. October-November



On September 18, GeoStat announced that the overall growth rate of Georgia's GDP for the second quarter was 1.5 percent. This sounds awful. However, a more detailed consideration of the breakdown of that number, and other information coming out of the government statistical office, tells a far more optimistic story. Outside of the government sector, the economy is actually doing better and FDI also looks better than the headline figure might suggest. This is quite surprising given the state of uncertainty in politics and may suggest a positive outlook for 2014.

George Welton

The simplest way to understand the basis of this growth is to look at nominal (non-inflation adjusted) growth. This is a reasonable approach as inflation has been very low over the last year (less than 1 percent) and because "real" growth figures, for a range of reasons, can miss dynamic changes in the structure of economic activity.

When thinking about growth it is important to look at relative growth in a sector and the absolute importance of a sector at the same time. Below is a table that, based on GeoStat figures, shows the relative importance of major sectors as well as the nominal growth in that sector between Q2 2012 and Q2 2013.

Relatively slow "trade" and "manufacturing" growth are definitely a big part of the overall picture, but the most significant decline in the economy, in nominal terms, was in public administration. As this sector had an 8 percent decline and the sector is worth 10 percent of the economy, this drop alone is worth 0.8 percent of lost growth. Similarly, construction dropped by 15 percent, and this sector is worth 5 percent of the overall economy, so this is worth 0.75 percent of growth. Put another way, if we exclude these sectors then growth would be 3.5 percent rather than 2 percent and this does not even take into account the multiplier effects that stronger performance in these sectors would have.

Understanding why these sectors have declined is, therefore, critical. Both figures confirm the common suspicion that the biggest drag on economic growth is slow government spending on infrastructure. In the area of public administration, while the nominal growth is -8 percent, the "real growth" for the sector, provided by GeoStat, is +2.4 percent. This discrepancy exists because the nominal figure given by GeoStat includes the depreciation of current government assets, while the "real" figures do not. This large depreciation would usually be offset by new government expenditure on infrastructure. That fact that this does not happen here is reflective of the slow-down in government spending on infrastructure.

This slow-down is also the main reason for the decline in construction.GeoStat further breaksdown construction into three subcategories.

What this first shows is that the majority of the construction sector is doing well. This is consistent with the experience of most people who look around Tbilisi and see fairly considerable building work taking place at the moment. However, the construction of roads and infrastructure is down by more than 50 percent, so that even though its overall contribution to the economy is not dramatic, the impact is considerable.

In addition, a slow-down in some parts of construction can also help to explain some of the slow movement in other sectors. Steel and cement, are large parts of the manufacturing sector and they are heavily dependent on construction. Similarly, large volumes of "trade" are imports related to government and infrastructure construction. And as a significant employer, a slow-down in construction has a range of other multiplier-effects.

The suggestion that the economy's malaise might be largely due to slow government spending is also supported by a report released by the IMF this summer. In that report, the IMF urges "the authorities to reverse the shortfalls in government spending" and even suggests that the Georgian Government relax its public sector deficit targets in response to the more difficult growth circumstances.

FDI also seems to offer a more positive outlook than the headline figure, though the picture is complicated. FDI has grown 7 percent year-on-year since Q2 2012. But this number actually hides some interesting details.

The first thing that immediately stands out from this chart is that many of the large FDI sectors actually grew by quite a lot more than 7 percent. Most notably, FDI in energy grew by 12 percent, manufacturing grew by 75 percent and construction grew by 800 percent.

Of course, one should not get too excited by these figures. Growth of 800% should not be taken to suggest that the sector is exploding. FDI is often very erratic, and one big deal or one successful company can significantly confuse the general picture. But overall, the trend looks strong.

The declines that balance this out are clearly more connected to nervousness about investment than a more profound slow-down in any of these sectors. For example, slow agricultural investments are occurring in spite of clear GDP growth in the sector. This could, for example, reflect uncertainty over the impact of the various proposed agricultural "funds" or could suggest that cheap local credit has made FDI less attractive. Slow growth in finance-related FDI is also happening in spite of the banks posting dramatic increases in profits.

Finally, the strange negative FDI in hotels and restaurants, which by itself, pulls down growth by 5%, is almost certainly a reflection of uncertainty coupled with great success. FDI reflects incoming foreign investments and the profit made by foreign companies in Georgia which is not repatriated (as it is assumed it is locally invested). Therefore FDI is negative if Georgians are investing abroad or if foreign owned companies are repatriating profits.

The large negative FDI in hotels is at least partially the result of the fact that the hotels are currently full, and unusually profitable.

This may sound odd, but for the large negative FDI to be possible, the companies need to be producing a lot of profit, as without this profit, they would have nothing to send home. Therefore one can see these figures as both good and bad. It is a shame that the hotels do not want to invest their profits right now in Georgia but it is great news for the economy that they are doing so well.

None of this changes the fact that the economy has slowed considerably since the October election. However, it should offer three notes of cautious optimism for any businessperson or potential investor.

First, in spite of a dramatic change in the political environment, the challenges of political cohabitation and an inexperienced team in government, the economy is not doing too badly.

Second, the economy will do considerably better when the government starts spending more money on infrastructure. The fact that this expansion in spending is being encouraged by international financial institutions is also an indicator that government finances are not in particularly bad shape.

Finally, there is still dynamic activity going on even during these difficult times. The construction sector, outside of government contracts, seems to be growing again. Agriculture seems to be generally responding to the various efforts to stimulate it, though FDI is weak. Hotels and restaurants remain profitable. The energy sector, long promoted, is finally seeing strong investment. At the same time most of the rest of the economy is holding steady, in anticipation of a more predictable environment.

I wait with optimism for 2014.