Issue 6, 2013. December-January

   

THE GEORGIAN ECONOMY: STAGNATION OR NOT?

The Georgian economy is slowing, due to a troubling mixture of low investment, high political uncertainty, and a general contraction in transitional economies throughout the region. The Economic Policy Research Center (EPRC) looks at how these factors are affecting Georgia and what they could mean for future growth.

Economic growth in Georgia slowed down starting from the end of 2012 due to decreased FDI and election-related uncertainty.

In fact, three out of four economic indicators have decreased: there has been a decrease in aggregate demand, investments, and government spending. The only indicator that has improved is net exports; however, this improvement has not been drastic enough to outweigh the fall in all other categories.

External trade tendencies have shown a positive trend in terms of an 11% increase in exports in the first eight months of 2013, compared to the same period last year. However, even this level of growth is not very remarkable: Georgian exports grew by 30% from 2010 to 2011, and another 8% from 2011 to 2012.

As EPRC predicted, the projected 6% Gross Domestic Product (GDP) rate of growth will not reached in 2013, and even the adjusted estimate of 3-4% real annual growth is questionable.

At the same time, 2013 budget performance also presents a challenge, since the government is struggling to collect the previously projected revenues (as of the first nine months of the year up to 700 million GEL), which is likely to result in a spending cut. Currently, the EBRD forecasts 3% economic growth in 2013; the IMF prognosis is even lower, at 2.5%.

International Economic Slowdown

The last time that the country's economy has experienced a slowdown or negative growth was following the global crisis and the war of 2008.

Now, however, countries in transition are experiencing a slowdown, particularly Russia and Turkey - a trend that might have also caused a worsened economic outlook for Georgia. Average economic growth of countries in transition is projected to be 2.2% in 2013, with a modest recovery expected in 2014.

In the region, growth in Armenia is also predicted to decelerate this year, due to slower growth in agricultural sector and budgetary underspending - which has also been a major cause for the slowdown in Georgia.

The Start of a Deflationary Cycle?

In fact, for most of the past year, the Georgian economy has been facing deflation. From a layperson's perspective deflation is a good thing, since it leads to lower prices and increases real income, and thus the purchasing power of the citizens.

While both inflation and deflation interfere with the smooth running of the economy, economists, however, believe that moderate deflation is more damaging than moderate inflation.

Deflation can be harmful since falling prices actually inflate the real burden of debt and reduce incentives to produce. This has negative implications on the effectiveness of monetary policy. Moreover, deflation is fundamentally related to the risk of major systemic shocks in the financial markets.

Deflation and a Decrease in Demand

The main cause of deflation in Georgia is a decrease in demand. For Georgia, the drop in demand was followed by political uncertainty in the country stemming from the 2012 parliamentary elections and continuing until the presidential elections in October 2013.

In addition, low government spending, coupled with a decrease in investments, can also intensify deflation. That was the case over the past year, when the government drastically decreased spending on infrastructure works. The increase in government spending in social services is not enough to offset the difference: according to Geostat, the largest impact on price levels was due to the introduction of universal healthcare as well as government subsidies for child delivery services. Persistent deflation can lead to a number of negative outcomes, such as falling profits for enterprises, resulting in higher unemployment and a cut in income for the population at large.

The issue of unemployment - or, more precisely, low levels of formal employment - is an ongoing issue in Georgian reality. Out of Georgia's total workforce, only 32% of its citizens are formally employed - more than half of the labor force is self-employed - while the unemployment indicator is as high as 15% and projected to grow to above 17% in 2014, according to the latest data by thr IMF. Even though unemployment figures for 2013 are not yet available, there was a decrease in the number of employed in the business sector by roughly 6% as of the second quarter of 2013, compared to the previous year. If we look at business-sector employees according to activity types, the largest decrease is observed in construction: the number of those employed in the sector has decreased by 34%.

Almost all fields saw a decrease in their numbers of employees except for agriculture, due to the active governmental programs directed at this field and a much smaller formal employment base than in other sectors of the economy.

Conclusion

Given the global downturn and inauspicious growth prospects, the task of the government should be to pursue prudent fiscal and monetary policies.

The EPRC believes that the government should work on the preparation of a long-term economic strategy to present clear development directions and create a predictable environment for businesses and investors. This will be especially important as the government seeks to increase foreign direct investment. At the same time, the EPRC believes that the state taking on additional social liabilities - a trend visible in the 2014 budget - is not the way to proceed. Additional social liabilities will be justified only after the economic situation is improved and more or less sustainable growth is achieved. Scaling down infrastructural projects before the private sector takes over is unjustified, as we have seen by the economic and budgetary indicators that Georgia faces today. This is especially relevant given the fact that Georgia still needs large basic infrastructure projects, which are rarely financed by the private sector only. In this regard, the creation and implementation of public-private partnership schemes might be desirable.

Consistent policy initiatives will promote a sense of stability and certainty, thus increasing business activities and overcoming demand-driven shocks. An important point is pursuing activities for easing market entry for newly established businesses and fostering a truly competitive environment.