Issue 4, 2018. August-September

   

GEORGIA IN MID-2018: A POSITIVE ECONOMIC TREND CONTINUES

In 2017, the Georgian economy grew well. By mid-2018, economists have observed a continuation of this trend. GDP increased by 5 percent in 2017, and during the period of January-May 2018, growth even accelerated to 6.1 percent. This economic growth is broad-based - agriculture is the only exception to this growth, with a decline in 2017.

Dr. Ricardo Guicci, Niklas Dornbusch, German Economic Team Georgia

Inflation in Georgia now amounts to a moderate 2.5 percent. It can be expected that the National Bank of Georgia will largely meet its inflation target of 3 percent in 2018. Thus, the country enjoys price stability.

After a significant depreciation in autumn 2017, the lari has regained value, without sizeable interventions by the National Bank of Georgia. A flexible exchange rate is essential for stability, even though the National Bank of Georgia has been repeatedly criticized for this policy.

Georgia's external trade strongly expanded in 2017 and during the period of January-May 2018, boosted by the regional economic recovery. Last but not least, Georgia's fiscal situation is stable, with its budget deficit amounting to 2.9 percent of GDP in 2017.

Against this background, the smooth implementation of the IMF programme and the upcoming disbursement of the IMF's third tranche of credit do not come as a surprise.

High Economic Growth

Georgia's real GDP growth amounted to 5.0 percent in 2017. In 2018, this positive economic trend has continued. According to preliminary estimates, Georgia's economic growth amounted to 6.1 percent year-over-year (YoY) during the period of January-May 2018. For 2018, the IMF foresees a further expansion of economic growth of 4.5 percent. Local investment banks even expect 5.4 percent growth.

Real GDP Growth

In 2017, growth was broad-based, driven by private consumption, investment and net exports. On the supply side, the picture was different. Services (6 percent) and industry (4.5 percent) increased significantly in 2017, while agriculture declined by 2.7 percent. This sharp disparity is a clear sign of structural problems and shows a need for vast reforms in the agricultural sector.

Price Stability

In 2017, inflation amounted to 6.0 percent and has thus exceeded the National Bank of Georgia's inflation target of 4.0 percent. Importantly, the underlying reasons for this development have a fiscal rather than monetary nature. In the beginning of 2017, excise taxes for petroleum, cars, tobacco and gas significantly increased, and this in turn affected consumer prices.

Now, however, inflation declined significantly and amounted to only 2.5 percent (yoy) in May 2018. The increase of the policy rate by the National Bank of Georgia in 2017 has most likely contributed to this stabilization.

The National Bank of Georgia Policy Rate

Due to the effect of high excise taxes and the tight monetary policy, National Bank of Georgia's inflation target of 3.0 percent will most likely be met in 2018. In order to sustainably reduce dollarization in Georgia, the long-term stabilization of the inflation rate at a low level is essential. Currently, high dollarization poses a significant risk to the country's macroeconomic and financial stability.

Lari Appreciates after Seasonal Fluctuations

In autumn 2017, the lari significantly depreciated versus the U.S. dollar, with the exchange rate increasing from 2.4 to 2.7 GEL/USD.

This depreciation caused concern and many debates, including discussions about the exchange rate policy of the National Bank of Georgia.

Now, the exchange rate has "normalized" and equals 2.5 GEL/USD (as of June 2018).

Apparently, the depreciation was caused by seasonal factors (energy imports and fewer tourists in autumn/winter).

It was important that the National Bank refrained from any major interventions on the foreign exchange market in order to support the local currency. Instead, it allowed the exchange rate to fluctuate and informed the public that the exchange rate can go both ways: upwards and downwards.

This is also important in order to sustainably reduce dollarization.

External Trade

In 2017, Georgian exports profited from the regional economic recovery and increased by 29.1 percent. Georgian imports increased by 9.4 percent.

These dynamics continue in 2018, with significant export growth in the period of January-May, especially to Azerbaijan (+156 percent), Ukraine (+93 percent), Armenia (+36 percent) and Russia (+13 percent). Also, exports to the EU further increased by 14 percent. Increasing exports are a welcome development, especially considering the still-significant trade deficit of 11.7 percent of GDP in 2017.

Export promotion remains a key target of the government.

Reasonable Budget Deficit

Finally, the country's budgetary situation appears to be stable. Georgia's fiscal deficit amounted to 2.9 percent of GDP in 2017 and is supposed to decrease to 2.3 percent by 2022. This planned fiscal consolidation is remarkable, given that public investment is planned to increase significantly at the same time. That combination is planned be realized through significant reductions in consumptive expenditures, from 26 percent of GDP in 2016 to 20.6 percent of GDP in 2022. Such a shift in fiscal spending, however, is only possible due to the country's high economic growth.

This clearly indicates the interdependence between the economic and the fiscal situations.

Outlook

Georgia's positive economic situation has decisively contributed to the smooth implementation of a three-year IMF programme, which includes a $258 million loan to be disbursed in several tranches.

The upcoming third tranche amounts to $44 million. The strict implementation of practically all IMF conditions is a welcomed development. While public discussion in Georgia is often critical of developments and policy, the country does stand out positively in this regard in comparison with practically all of its neighbors.

This, too, is an aspect that should be factored into a comprehensive assessment of developments.

The German Economic Team Georgia has been supporting the Georgian government in designing its reforms since 2014.

For more analysis on economic development and reform see the German Economic Team website at https://www.get-georgia.de/.