Economic risk in Georgia

The economy is expanding and developing rapidly. GDP growth is estimated to double digits this year, and growth seems robust. GDP levels pr capita are still less than two thirds of their Soviet peak, and potential for further growth is huge, if a minimum of stability can be obtained.

The favourable developments over the last few years have also presented the government with some economic policy dilemmas. Strong growth has boosted imports, both of capital goods and consumer goods. Such import growth is normal at this stage of development, but may present a problem over time unless exports follow suit. Furthermore, the trade balance has been compensated by increasing inflows of foreign direct investment, particularly related to the construction of the BTC pipeline and to privatization of state assets. FDI has contributed to an upward pressure on the lari.

Low exports and a high degree of dependence on FDI combine to create a risk for foreign investors, as a reversal could leave Georgia vulnerable to devaluation. However, export growth has been strong, even given the trade fall-out with Russia, although it has not matched import growth. FDI seems relatively stable and is growing increasingly diversified, as non-pipeline, non-privatization inflows have increased most rapidly.

The problem for macroeconomic policy is that a high interest rate will lead to further nominal appreciation, whereas a lower interest rate will fuel inflation and real appreciation. The remedy proposed by international economic experts, and seemingly accepted by Georgian authorities, is to pursue a fixed exchange rate policy, supported by fiscal austerity.

There are some uncertainties as to how strictly authorities will follow this cure. Pressures on government expenditure are high, for several reasons. First, although real wages have increased rapidly over the last years, poverty remains widespread. In face, the share of poor by the official definition has increased from some 27 percent to above 30. One reason is that the poor spend disproportionately of their income on goods whose prices have risen more than average. Another reason is that unemployment has gone up, partly as result of (much needed) restructuring of the public sector. Second, military spending has been increasing, and increasing faster than budgeted. There are several drivers behind this development. First, there is a real need to modernize the armed forces, not least in the context of the country's NATO aspirations. Second, the conflict with Russia and the break-away regions lead both to a real perception in the Government that the military must be strengthened and to a pressure from opposition groups and the public to show strength.

However, the themes of fighting poverty while preserving sound macroeconomic management are at the top of the agenda in Georgia's consultations with the IMF, and the Government seems to accept the need for fiscal restraint in the years to come.

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