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English Languages – Geor- Gian Economic Trends and Georgian Law Review Georgian-European Policy and Legal Advice Centre (GEPLAC) GEPLAC was established in 1997. It is an EU-funded project to facilitate the closer re- lations between Georgia and the European Union. In providing its recommendations to the Georgian Government, GEPLAC follows the provisions of the EU-Georgia Partnership and Cooperation Agreement. The fifth phase of the project is being implemented by Altair Assesores, the British Council, the European Social and Legal Economic Projects (ESTEP) and the Georgian Foundation for Strategic and International Studies (GFSIS). GEPLAC issues two quarterly publications in Georgian and English languages – Geor- gian Economic Trends and Georgian Law Review. Although these publications are issued within the framework of the EU Technical Assistance programme, they represent the views of the authors and do not represent any official opinion of the European Union. GEORGIAN ECONOMIC TRENDS Quarterly review March 2006 No 4 This project is funded by the European Union GEORGIAN ECONOMIC TRENDS Georgian Economic Trends (GET) is a quarterly publication of the Georgian-European Policy and Legal Ad- vice Centre (GEPLAC), which aims at providing all interested readers with a review of developments in the Georgian economy and analysis of economic reform and policy pursued by the government. GET is issued in both Georgian and English languages and is available on the internet. GET is an independent publication. The materials represent the views of the authors and do not represent any official opinion of the European Commission, the Georgian-European Policy and Legal Advice Centre, or the Georgian Government. For further information please contact: Georgian-European Policy and Legal Advice Centre, 3a, Chitadze Street, Tbilisi,0108, Georgia Tel: (095 22) 243555 Fax: (095 22) 921371 E-mail: [email protected] www.geplac.org Editorial Board: Christophe Cordonnier, Kakha Gogolashvili, Merab Kakulia, Vladimer Papava, Alexei Sekarev, Ivan Samson. Separate chapters were prepared by the following experts: Lela Bakhtadze GDP and Real Sector, Public Finance Nata Kakabadze Money and Banking, External Sector, EU-Georgia Economic Relations Veronika Schneider Labour Market and Households Budgets CONTENTS Introductory Note ________________________________________________________________ 7 Part I. OvervieW OF THE GEORGIAN ECONOMY Main Economic Events ____________________________________________________________ 9 Summary Macroeconomic Indicators ________________________________________________ 15 1. Gross Domestic Product and Real Sector ___________________________________________ 17 2. Public Finance _______________________________________________________________ 23 3. Money and Banking ___________________________________________________________ 27 4. Labour Market and Households Budgets ___________________________________________ 33 5. External Sector _______________________________________________________________ 38 6. EU-Georgia Economic Relations _________________________________________________ 43 Part II. ECONOMIC TRENDS AND POLICY ANALYSIS 1. Georgia’s economic growth: how to avert possible risks in future _______________________ 48 Cristophe Cordonnier, Professor, GEPLAC economic expert 2. Trends in levying excise goods and mobilizing revenues in Georgia ______________________ 57 David Narmania, PhD of Economics, Chairman of Board of Georgia’s Young Economist’s Associations Part III. ECONOMIC REFORM AGENDA The search for a development path: challenges for Georgia _______________________________ 62 Ivan Samson, Professor, Director of Espace Europe Institute at UPMF University, Grenoble; GEPLAC economic expert, with support of Anastasiya Zagainova, economic researcher at PEPSE laboratory, UPMF, Grenoble INTRODUCTORY NOTE Macroeconomic framework in 2005 and GET contribution to policy discussions It is widely recognized that Georgia’s economic performance has been improving in the recent years. Data pre- sented in the current issue of Georgian Economic trends confirm this conclusion. In 2005, real GDP grew by 9.3 percent (5.9 percent in 2004), driven by the sectors of construction (23.3 percent increase over 2004) and services, most notably telecommunications (29.5 percent) and financial services (52.5 percent). Industry and agriculture were on the growth path as well, with a year-on-year output increase of 11.4 and 12 percent, respectively. In manufacturing sector, significant output increases were registered in food processing, production of fer- roalloys, construction materials, alcoholic beverages as well as timber processing. Energy sector (electric power generation, natural gas and water generation and distribution) saw an increase in output of 5 percent over 2004. Domestic demand was strong in 2005, as indicated by the increase in monetary aggregates and credits to the economy, thus underpinning the real GDP growth. An important positive development in 2005 was further fiscal consolidation. The tax/GDP ratio for the central government increased from 13.5 percent in 2004 to 15.8 percent in 2005, which is mainly attributed to improve- ments in tax administration. This has strengthened the financial position of the authorities. Total expenditure increased from 16.6 percent of GDP in 2004 to 22.6 percent in 2005, in particular on social protection, education, health care programs and defence. Substantial funds were spent on transfers to local budgets. Authorities man- aged to reduce the stock of domestic expenditure arrears significantly, by an estimated 0.9 percent of GDP, while the full elimination of these arrears is envisioned in 2006. The year-average consumer price inflation increased in 2005 to 8.2 percent, from 5.7 percent in 2004. For 2006, the IMF projects an average consumer price inflation of 5.3 percent, which, given there is no external or internal shocks, seems quite realistic in the current macroeconomic environment. The Lari was broadly stable against foreign currencies in the last two years. However, an appreciation trend has been persisting in both nominal and – even stronger – in real terms. The nominal year-average exchange rate in 2005 was 1.81 Lari per U.S. Dollar (1.92 Lari in 2004). In real terms Lari has been appreciating since early 2004, reflecting a strong demand for the domestic currency under a buoyant real GDP growth, and foreign exchange inflows from investment and workers remittances. The National Bank data show that the index of real effective exchange rate (REER), measured against December 1995, grew from 106.8 in January to 110.3 in December 2005. The related competitiveness losses have been compensated so far by internationally very low domestic wage levels, but a narrow export base is a source of concern in the medium- and long-term perspective. According to the World Development Indicators of the World Bank, poverty in Georgia remains high. In 2005, 52 percent on households were living under the official subsistence level and 17 percent in extreme poverty. The external sector performance presented a mixed picture in 2005. Compared with the previous year, both export revenue and import expenditure (goods and services, in fob terms) increased by 32.9 percent, as shown in the balance of payments data. Since the current account balance was negative at USD 349 in 2004, equal growth rates of exports and imports caused a widening of the current account deficit to USD 689 million in 2005. At the same time, Georgia’s foreign debt has been decreasing steadily since 2000 and reached a level of 22 percent of GDP in 2005. *** The current issue of Georgian Economic Trends, prepared by GEPLAC team of experts, sheds more light on the economic situation in the country. The data series have been composed so as to give a consistent six-year retrospective of main indicators. The numbers for the more recent period, usually starting from 2003, are given in a quarterly breakdown. We believe that such approach to data presentation offers a comprehensive view on Georgia’s economic development over the recent years. It should be noted that some data series have been revised to reflect the new updated numbers released by the Georgian Department of Statistics. The Department has introduced, with the support from international institu- tions, serious improvements to the database, related mainly to the coverage and integrity of data. These improve- ments of the statistics should be taken into account in the interpretation of the economic trends. For example, it is widely believed that parts of the growth of GDP and exports should be attributed to a better coverage, in particular to the incorporation of shadow sector activities into the official statistics. A new element in this issue is the comparison of Georgia’s economy with that of the enlarged EU, along such key indicators as real GDP growth, GDP per capita in PPP terms, lending rates and others. While the income disparity remains high, Georgian economy has been growing much faster that that of the EU25. A source of con- cern is, however, the quality of growth in Georgia: despite high annual rates, it has not resulted in a notable job creation and higher living standards yet. This situation clearly calls for adequate medium- and long-term policy responses. The Georgian Government is aware of that and has recently taken a number of adequate measures in the fiscal and regulatory areas. Other policy options, which the authorities might consider, are discussed in the analytical papers in this issue of GET. These refer to the excise taxation as one of the
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