Issue 1, 2015. February-March



ISET looks at the numbers behind the FDI statistics.

Nino Mosiashvili and Nikoloz Pkhakadze

Foreign direct investment (FDI) is critical to every developing county, and Georgia is no exception in this regard. Georgia wants to grow out of poverty and catch up with the economically more developed regions of the world. For this to happen, foreign resources are needed, particularly if the domestic savings rate is as low as in Georgia.

Yet FDI is not only about the capital made available to the economy but also, and even more importantly, about trust foreigners have into the Georgian economy. It is one thing to make cheerful statements about Georgia's rosy economic future and something completely different to risk one's own money. Investors will not invest if they do not see real opportunities for attractive profits and reasonable chances for a solid return.

Given the crucial role of FDI, it is prominently featured in many political debates, but the concept is not always well understood. The chart shows Georgian FDI from 2009 to the third quarter of 2014. As one can see, FDI reaches a low in the second quarter of 2014 and then soars at the very end of the chart. Does this mean that investor sentiments have declined in early summer, but then improved drastically toward the end of last year?

This is indeed how it was understood by many journalists and politicians, who issued alarming statements when FDI went down in the second quarter. And when it went up in the third quarter, the government interpreted this as foreign appraisal of its economic policy. However, the reasons behind the high intra-year volatility of FDI are much more complicated.

Don't Panic! And Don't Praise!

After TBC Bank was listed on the London Stock Exchange, the European Bank for Reconstruction and Development (EBRD) sold a good deal of the TBC shares it held. These shares are now with investors who own less than 10 percent of TBC shares each. By definition, only financial investments that make up at least 10 percent of the stock of a company count as FDI, and so the EBRD is no longer a foreign direct investor with TBC. As a consequence, while the proportion of foreign ownership of TBC was not changed,the transaction had a negative impact on FDI.

Around the same time, TBC bought 80% of the shares of Constanta Bank from the foreign OikoCredit, as foreign owners were replaced by Georgian ones, this also negatively affected FDI. But these events do not negatively reduce capital availability - and they do not indicate a loss of trust in the Georgian economy on the part of foreign investors. Yet the increase in FDI in the third quarter does not justify triumphant comments, either.

The reason for the dramatic upturn was the construction of residential buildings necessary for the European Youth Olympic Festival ("Tbilisi 2015"), carried out by Chinese investors. This sports event was acquired for Tbilisi under the previous government, so there is no justification for the new government to consider this FDIas foreign support for their economic policies.

Moreover, the constructionstarted three years ago,and the third quarter of 2014 just happened to be the period when a big portion of cash flows from the direct investors was received. If this amount had been spread throughout the duration of the whole project, which would be the right thing to do if one is interested in FDI as a measure of economic activity of foreigners in Georgia, one would see slightly higher FDI numbers in all previous quarters and no peak in the third quarter of 2014.

And Don't Take FDI At Face Value!

According to the definition of the International Monetary Fund, direct investment is "a category of cross-border investment associated with a resident in one economy having control or a significant degree of influence on the management of an enterprise that is resident in another economy." In practice, a "significant degree" translates into the guideline that an investor must hold more than 10 percent of the voting power in a company for the investment to count as FDI, causing a discontinuity when a foreign investor increases their investment beyond 10 percent. This was behind the anomaly we saw in the third quarter of 2014. There are a couple of other catches with FDI - one can easily construct hypothetical examples of increases and decreases of FDI that are not associated with positive or negative economic developments, respectively. Some FDI may even be harmful for an economy .

All of these considerations are based on the assumption that FDI data is reliable, but obtaining reliable FDI data is not easy. FDI data - disaggregated by country and sector - is compiled and reported by Geostat quarterly, and it is based on three sources: data from the National Bank of Georgia about FDI in the financial sector (including commercial banks, microfinance and insurance companies), data from the Ministry of Economy on privatizations (some of which involve foreigners), and, most importantly, questionnaires sent to companies. While the first two sources are very reliable, there are considerable uncertainties regarding the data obtained from questionnaires. This has implications, as through the years 2007 to the third quarter of 2014, 79 percent of the identified FDI came from the questionnaires (the financial sector and privatizations accounted for 11 percent and 9 percent, respectively).

Questionnaires about FDI are sent periodically to about two thousand companies. The list of companies is updated each quarter to include newly founded companies. However, a problem is that companies are not legally obliged to fill out the surveys (though GeoStat says that the majority of companies involved in the survey provide the information requested). Based on a recommendation of international organizations, Geostat plans to make responding obligatory for companies in the near future.

To conclude, politicians and journalists should not take FDI numbers at face value. In a small country like Georgia, even the decisions of single businesses can lead to considerable changes in the FDI, as in the second and third quarters of 2014.

Only if it is known how particular FDI movements come about, can they be interpreted economically in terms of capital availability and investor confidence. If such background information in FDI developments is lacking, as it is often the case, it would be better to not refer to FDI numbers if one wants to say something about Georgia's economic fortunes.