Issue 1, 2018. February-March



Now that the New Year festivities feel like a distant memory, it is a good time to reflect on what the economic data can tell us about the trends in 2017, and what that could mean for the future.

George Welton

By any reasonable account, a review of 2017 suggests a very positive picture, with a combination of the recovery in consumer confidence, improvements in commodity prices and extractive production, as well as veritable booms in tourism, construction, transportation, communication and finance leading to strong economic growth. If we project this picture forward and combine it with public and private infrastructure spending, this would seem to suggest strong growth and a stronger lari for the next few years.

A 4.8 percent growth rate for 2017 is a dramatic improvement on the 2.8 percent in 2016 and the IMF predicts this growth will continue. To understand which sectors are driving that growth, it is important to look at the size of the sector as well as its year-on-year growth. We can start with a quick review of Georgian GDP (see pie chart Structure of GDP, Sum of Q1-3, 2017).

The first two economic categories ('trade' - 17 percent and 'other' - 16 percent) deserve some explanation. The position of 'trade' is mostly a reflection of the fact that Georgia is a very consumption-oriented society so imports and retail hold a disproportionate significance. Manufacturing is heavily concentrated in extractive industries, processing products like steel and food and wine production. Most of the rest of the categories are self-explanatory.

If we consider the dynamic of these sectors, comparing the first three quarters of 2016 with the same period in 2017, we can get a sense of the drivers of growth.

As we can see, and unsurprising to anyone wondering around Tbilisi, the biggest growth was recorded in construction and tourism. 'Tourism' is not a category listed in national accounts so 'hotels and restaurants' is a somewhat limited proxy. Following this we have high growth in finance, communication, rental services and mining.

What is perhaps more interesting is that trade as a whole recovered so strongly. Trade is made up of retail and import/export and is by far the largest economic sector of the economy, so the growth in this sector accounts for almost ¼ of the growth in the general economy and reflects both a strong recovery in consumer confidence (as people are buying more again) and significant recovery in international trade.

The picture in terms of trade further supports the idea that both domestic consumption and exports have been major drivers of overall growth. Exports as a whole grew by 29 percent in 2017 and imports grew by 9 percent.

If you take into account both the size of growth and the importance of the sector, this shows that growth in ferroalloys and copper account for almost ½ of the export growth for the year. The growth in motor car exports brings it up to about 1/3 of volume that existed at its peak in 2013. Wine has, obviously, experienced huge growth and, particularly when merged with 'alcohol,' would be Georgia's 3rd biggest export and responsible for around 1/8 of the overall export growth. On the negative side, the drop in hazelnuts has been pretty calamitous and mostly reflects the impact of the stink bug on the Georgian harvest.

Another way of looking at it is that exports have done well due to improvements in mining and commodity prices as well as the recovery in the CIS region, which has occurred at the same time. Oil prices were far higher in 2017 than they had been at the beginning of the crisis in 2015, although most of the improvement occurred in 2016. That means it has taken a year for the CIS region to significantly start to recover. The CIS region as a whole grew by 2 percent in 2017. This is not great, but compares favorably to the rate in 2016 - and -2.2 percent growth in 2015. It might also suggest that the recent rise in oil prices won't be felt in the region until the end of the year.

The geographic distribution of exports also demonstrates how growth in the region is driving the current success, with exports to Europe increasing by 10 percent, compared to the 60 percent increase in exports to CIS countries, in particular exports to Russia, which increased by 91 percent. This means that the CIS is now responsible for 43 percent of Georgia's export market; Russia makes up 14 percent, compared to Europe as a whole, which holds a 24 percent share.

What do all of these shifts mean for 2018? The IMF is continuing to predict similar growth this year, which continues to put us way ahead of the regional average. This is good news but any recovery in consumption will put a disproportionate negative pressure on the lari: growth in exports is unlikely to keep pace with the growth in imports, since Georgia imports 3x what it exports.

The counterweights to the balance of trade are tourism, remittances, international borrowing and FDI. In predicting currency levels in the medium term, the key question is which of the four will rise quicker? They all have the potential to grow. Overall remittances are rebounding since the huge drop in 2015. Russian remittances are only at 57 percent of their previous high and Greece is only at 69 percent, suggesting considerable opportunity for recovery. There is no evidence that tourism growth has plateaued yet and FDI numbers remain fairly strong.

However, undoubtedly the biggest economic story of 2018 will be infrastructure spending. The government plans to spend $4.5 billion over the next few years on infrastructure, mostly bridges, roads and tunnels. Also, there are still a large number of big hydro projects that seem to be moving forward as well as projects like Anaklia.

Hopefully, the long-term impact of this infrastructure spending will be to significantly increase the capacity of the country for transport and logistics, increasing productivity across the board as well as directly stimulating tourism, the transport sector, export-oriented local manufacturing and much more.

The more immediate impact, however, is that such a large cash injection will have a significant stimulus effect on the economy and on the currency. Depending on when all this spending occurs, and again assuming nothing else changes, we might expect a boost to both the GDP and the value of the lari. The exact nature and timing of that is not clear yet. While some contracts have already been signed and work has started, the 'ramping up' of the actual infrastructure spending volume may not occur until the end of the year, or even 2019. If this happens alongside a strong regional recovery, then we could expect a few very strong years ahead.