Issue 3 2016. June-July



The Georgian economy has fared very well despite last year's economic turbulence, which included a game-changing shift in oil prices and deep corrections in emerging market exchange rates compounded by a strengthening dollar.

These challenges have pushed Georgia to diversify away from its largest regional trade partner and increasingly look toward the EU for cooperation. Georgia is expected to deliver relatively stronger growth in the region and start capitalizing on its steadfast focus on EU integration, according to the latest assessments published by the European Bank of Reconstruction and Development (EBRD), the Fitch Ratings and S&P Global Ratings agencies.

Keti Khukhunashvili

"Resilient" Economy

In his assessment of ongoing economic challenges, Agris Preimanis, the Lead Economist for Central Asia at the EBRD, explains that "through various channels, including the reduction of exports and remittances, and reduction of income associated with oil revenues, we saw that the entire region was affected and Georgia was not alone in seeing lower economic growth. However, Georgia stood out as a more resilient country compared to the rest of region."

Georgia has one of the highest real GDP growth rates among CEE countries and its immediate neighbors, achieving 2.8% real GDP growth in 2015 versus a contraction in Russia and below 2% growth for most other CEE countries. Moreover, the EBRD recently raised growth forecasts for Georgia for 2016 and 2017 - to 3.4% and 3.9%, respectively - crediting better tourist inflows and improved business confidence and investor confidence as reasons for a more positive outlook. "External conditions remain difficult, as Russia is still in recession, and other trading partners are not doing as well. However, Georgia is expected to turn the corner and there is improvement in business sentiment. We see increased trust in the national currency and in the NBG's actions. Against this background, growth in Georgia is projected to deliver relative improvement," noted Preimanis in his interview with

The Georgian currency was also relatively more resilient to the stronger dollar and other factors affecting regional currencies. Even though the lari dropped more than 20% against the greenback in 2015, it continued to weaken at a slower pace of approximately 8% since the beginning of 2016 (as at 16 May 2016).

The EBRD credits this leveling off in the pace of depreciation to increased trust in the local currency and the Central Bank's policies.

These factors are also expected to help decrease dollarization on both the loans and deposits sides. Additionally, the improving trade deficit, which has contracted by approximately 14% in the first four months of the year, led to less pressure on the GEL exchange rate versus the U.S. dollar, euro and other trade partner currencies. Supporting this recovery, inflation was reigned in after exceeding the NBG target rate in 2015 to a more acceptable level of 3.2% in April 2016 (y/y).

This careful optimism is shared by rating agencies, as well in the most recent affirmations in rating levels and outlook assessment issued by Fitch Ratings and S&P Global Ratings in the press releases accompanying their respective May 2016 ratings actions.

Both agencies see supportive fiscal and external conditions for Georgia to deliver on its stronger growth prospects. In particular, the S&P has highlighted the prudent level of general government debt (at 40% of GDP) and several positive developments expected in the country, including progress toward the EU-Georgia Association Agreement. According to the EBRD, the effects of the EU's promising Deep and Comprehensive Free Trade Area (DCFTA) regime may even skew the preferred foreign currency for Georgia in favor of the euro: It may soon be more relevant to use the euro as the benchmark currency given Georgia's increasing diversification toward the EU - currently comprising 24% of the country's exports in the first four months of 2016.

Lingering Challenges

This is not to dismiss the lingering challenges in the Georgian economy. The S&P has highlighted its discomfort with the level of current account (CA) deficit - at 10.6% in 2014, 11.6% in 2015 and a projected 10.3% of GDP in 2016 (data according to the IMF) - which remains high despite recent improvements in the trade balance. This is compared to less than negative 5% of GDP for oil-importing regional peers and positive balances for the oil exporters Russia and Azerbaijan in 2015. However, this may even be a blessing in disguise, since the major cause and the source of the persistently high level of CA deficit is, in fact, the high level of FDI, which in turn results in a high level of imports that are essential for projects financed by FDI. Without the FDI-driven imports, the CA deficit could be at a level similar to that of oil-exporting countries.

On the other hand, S&P signals concern with the country's external debt levels, which are compounding the effects of the lingering CA deficit and which contributed to the 2015 CA deficit, the highest since 2012. This deficit is not supported by the country's current dependence on imports and the composition of exports largely based on low-value-added goods that may not allow for further significant improvements in the trade balance.

Furthermore, the level of dollarization is also persistently high, which adds to the real effects of the approximately 20% depreciation versus the U.S. dollar that materialized by the end of 2015. As the ERBD notes in its May 2016 Economic Prospects report, Georgia has not seen a significant increase in non-performing loans (NPLs) levels and any further jump is not expected, despite a certain lag in such increases. Nevertheless, the depreciation was very testing for local businesses.

As explained by the EBRD's Lead Economist, "the NPL numbers mask the impact on the real economy - many companies that borrowed in dollars and have incomes in the local currency are experiencing a more difficult time as a result. Even though the shock is not big enough to cause a significant problem in the economy, these companies need to tighten their belts, and we will see the continued effect of this throughout 2016."

Positive Outlook

The positive news, however, is that Georgia is managing to develop its FDI potential by focusing on becoming a regional transport and communications hub, a tourism destination and a green-energy provider for neighboring economies. Opportunities in all three sectors are promising and substantial, including greater trading ties with China and the engagement in the Silk Road Belt project, the Anaklia Deep Sea Port development, and the DCFTA.

The country is already making impressive progress. As S&P notes in its May 2016 credit action report, Georgia has financed 75% of its CA deficit through net FDI, primarily concentrated on the energy sector in 2015. A hefty portion of last year's FDI was also concentrated in the energy sector, particularly the South Caucasus gas pipeline connecting Azerbaijan and Turkey and passing through Georgia. Tourism is also emerging as a sector for significant cash-generating potential, delivering a 15% increase year on year in the number of visitors in the first four months of 2016. The international consensus places high hopes on the sector already in 2016. As Agris Preimanis of the EBRD notes, "Looking at the broader picture for tourism in the region, and particularly among the FSU countries, Georgia stands to benefit the most, not least because of constraints in tourist flows to other countries."

The broader consensus is for Georgia to use the DCFTA and its progressing integration with the EU as a catalyst for continued improvement in local economic competitiveness and policy reform. Georgia has the opportunity to build solid macroeconomic positions for long-term growth by developing high-value-added, niche exports, and creating a robust communications/transportation network, as well as by enhancing its tourist potential and green energy generation capabilities. The more active progression of the Silk Road Belt initiative also presents an important gateway for Georgia to reprise and capitalize on its role as the transportation and communications hub in the region.

"Georgia should look at the DCFTA and the Association Agreement as being an anchor for continued improvement in competitiveness and reform. This will help in terms of trade with other countries and will improve domestic competitiveness compared to foreign companies. That, combined with expected progress in an economic environment where we see other trading partners of Georgia improving as well, Georgia has a solid basis for growth in the medium term," noted the EBRD's Preimanis.