Issue 5, 2016. October-November



Economist Aleqsandre Bluashvili maps out Georgia's external debt, including the higher risk short term liabilities (19 percent of the total external debt) and the role of dollarization.

External debt of Georgia: a big picture

Georgia's external debt is currently $14.6 billion, $430 million less compared to the end of 2015.

As of the first quarter in 2016, the larger borrowers were the government (31 percent of the total external debt of $4.5 billion), followed by private companies ($3.1 billion, or 21.5 percent of total debt) and commercial banks ($3 bn or 20.5 percent of total debt).

External debt (even if high) is not necessarily a bad thing: access to foreign funds allows firms and the government to expand production or invest in infrastructure, which increases the productive capacity of the economy as a whole.

A simple cost-benefit analysis can be used to determine if additional borrowing can be justified: if projects financed by external borrowing will yield rewards worth more than the interest to be repaid in the future, the debt is viewed as sustainable over the longer term.

That means foreign borrowing goes into the productive sectors that will be able to generate enough exports of goods/services or substitute imports to reduce the current account deficit of Georgia and allow repayment of external debt in the future.

For countries like Georgia, several additional risk factors should also be taken into account. As Georgia cannot borrow in its own currency (with some exceptions), there is an exchange rate risk that comes with the external funds. During periods of lari depreciation, there may be questions regarding the solvency of private companies or government.

That makes intercompany lending in the form of FDI the least problematic part of Georgia's external debt portfolio. With this kind of borrowing, the country pays dividends instead of some predefined repayments, which removes the risk of defaulting on foreign debt. This type of borrowing makes up around 16 percent of Georgia's total external debt.

Short term liabilities = higher risk

The term structure for external debt is another important factor in the sustainability of foreign debt.

For instance, short-term liabilities are a high-risk form of external debt. A large share of short-term liabilities - debt with a contractual maturity of less than one year - in total external debt indicates that domestic borrowers rely heavily on "hot money" inflows to finance the investments/operations.

This type of foreign financing usually dries up fastest in times of economic crises, and during such crises it becomes harder for domestic borrowers to roll over short-term liabilities, which may eventually lead to series of defaults.

In 2015, short term liabilities were around 19 percent of Georgia's total external debt or around $2 billion in absolute terms. A closer look at debt numbers show that short term public external debt is only two percent of the total, while private companies (26 percent) and commercial banks (47 percent) have a relatively large share of short- term external liabilities in total external borrowings. It should be mentioned that a high share of short-term external debt of commercial banks is driven by non-resident deposits, which are classified as short-term regardless the actual maturity dates of the deposits.

Role of lari depreciation in public debt

As of the first quarter of 2016, the public debt to GDP ratio of Georgia stood at 40.9 percent, 2 percentage points higher than the previous year. Despite being still well below the 60 percent threshold defined in the "Economic Liberty Act of Georgia", lari depreciation against the dollar in 2015 resulted in a sharp jump of foreign public debt levels (from 26.6 percent in 2014 to 32.4 percent in 2015). The depreciation of the lari also increased interest rate expenditures for the state budget, from 3.2 percent of current expenditures in 2014 to 4 percent in 2015 and 4.7 percent in H1 2016.

"Despite the increase of the public debt to GDP ratio compared to 2014, this indicator is projected to decline over 2016 to 2019, according to Basic Data and Directions (BDD), which will positively influence the sustainability of the public debt," said Ioseb Skhirtladze, the head of external debt management division at the Ministry of Finance, in an e-mail interview with "As of August 2016, the external public debt to GDP ratio went down to 29.8 percent," he added.

Around 65 percent of the foreign public debt of Georgia is on concessional terms from multilateral organizations, which keeps the weighted average interest rate of external debt portfolio of the government below 2 percent, which means servicing this debt is less problematic for the Georgian state budget. "We expect access to concessional funding to continue over the medium term; over the longer run, interest rates on foreign borrowing will be subject to the macroeconomic indicators of the country," Skhirtladze said.

Concessional loan agreements with the World Bank, the Asian Development Bank, the Japan International Cooperation Agency, and others enable Georgia to invests in infrastructure and number of regional development projects. Without the support of these organizations, the government would have not been able to finance large scale construction projects (construction of the East-West Highway, for example), which are crucial to increase the long-term economic growth in the country.

The Georgian government receives two types of external funding: targeted funding, which is linked to particular projects and the disbursement of foreign funds depend on how successfully government implements those projects; and budget support funds, which are conditional only on general macroeconomic indicators and the government is free to decide where these funds are directed. The share of budget support funds in total external borrowing jumped up sharply in 2014, while share of external financing targeted for various infrastructure projects declined. This trend might create the risk that foreign borrowing is used to finance current spending, like paying wages of public servants, which usually does not have long term benefits for the country and raises questions regarding the sustainability of the external debt.

"Budget revenues exceeded current spending by more than 1bn lari in 2015, consequently budget support loans were also directed for different investment and infrastructural projects," explained Eka Guntsadze, the head of budget planning division at MOF in an e-mail interview with "Budget support loans are used just as efficiently as targeted funding, which implies that a higher share of borrowing for budget support should not create any doubts on the sustainability of the external debt of the country."

Aleqsandre Bluashvili currently works as a macroeconomist at TBC bank, Georgia, covering macro environment that bank has to operate in. Previously Aleqsandre worked in the National Bank of Georgia, monetary policy division. He holds master's degree in economics from the International School of Economics (ISET) at Tbilisi State University.

Dollarization and External Debt

In the context of analyzing external debt levels and the sustainability of foreign debt of the country, it is important to look at the general health of the economy. Advanced economies usually have higher debt/GDP ratios compared to developing countries, and there are fewer questions regarding the sustainability of the foreign debt of economies like the USA or Japan as opposed to the foreign debt of emerging economies.

Emerging economies are usually seen as higher risk, due to the structural weaknesses that exist in these countries' economies. A high share of dollar loans and deposits in the total loan and deposit portfolio of commercial banks in Georgia is one of the factors that adds to the riskiness of the country. This, in turn, influences the interest rates that Georgian companies pay for their external debt. All things being equal, low dollarization would imply an economy that is more resilient to exchange-rate shocks and, consequently, fewer concerns regarding the sustainability of foreign debt in periods of domestic or external economic distress.

65 percent of loans issued by commercial banks were in dollars, as of August 1 of this year. Only 41 percent were short-term loans, which are mostly intended for consumer purchases, while the rest of the loan portfolio is 70 percent dollarized.

Looking at historical trends, the dollarization of the domestic financial sector has been steadily decreasing, from above 80 percent before 2005 to around 65 percent in 2016. This trend is mostly driven by broad macroeconomic stability and lower inflation, which has helped restore the public's trust in the lari, and allows banks to extend lending in the national currency.

In addition to broader policies aimed at promoting the country's overall economic stability, the National Bank of Georgia also incentivizes lari saving and lending through a variety of measures. Their most recent step was to increase the reserve requirements for dollar funding in commercial banks from 15 percent to 20 percent.

The pension reform planned for next year is also a step forward in this regard, as it will create long-term resources in the national currency that will allow banks to offer long-term lari loans at lower interest rates.

Overall, the experience of different countries shows that the de-dollarization of the financial sector is a long-term process and can only be achieved by maintaining low inflation, a prudent fiscal position and transparent institutions over an extended period of time.