Georgian Economic Trends Quarterly Review

2005 No. 1

The European Union, GEPLAC and Georgian Economic Trends

The relations of the European Union (EU) with the countries of Eastern Europe and Central Asia were underpinned in 1991 through a programme of technical assistance called Tacis. Since then these relations have deepened through political dialogue into a partnership resulting in greater cooperation towards common goals. In the case of Georgia, such cooperation is the subject of a Partnership and Cooperation Agreement with the EU which entered into force in July 1999.

The Georgian – European Policy and Legal Advice Centre (GEPLAC) was first established in 1998 as a project under the Tacis programme. The current phase of the project is being implemented by Deutsche Gesellschaft fur Technische Zusammenarbeit (GTZ) GmbH. In addition to Georgian Economic Trends (GET) and the Georgian Law Review, GEPLAC is involved in the provision of economic policy and legal advice to the government of Georgia on both a programmed and ad hoc basis.

While GET is produced with the financial assistance of the EU, the content is the sole responsibility of the authors and can in no way be taken to reflect the views of the EU.

GEORGIAN ECONOMIC TRENDS

Georgian Economic Trends (GET), a quarterly GET also publishes feature articles by outside publication, aims to provide all those interested in the contributors: academicians, government officials, progress of economic reform in Georgia with a review members of parliament, independent scholars and of developments and transition. GET was established researchers, etc. on economic issues of in 1995 and is published in Georgian and English. This contemporary relevance in Georgia. Before being and previous editions of GET are available on the accepted for publication, all articles will be reviewed internet at: by members of GET Editorial Board that may also seek permission to edit such articles. www.geplac.org Articles will be published only if they are deemed to The following people worked on this edition (in be consistent with GET editorial policy. alphabetical order): Contributors are requested to submit their papers David Jinjolia, George Eradze, David Gvenetadze, either in English or in Georgian by e-mail as an Mark Hudson, Natalia Kakabadze, attached Word file (Font: Arial, size 10 for English Shota Keldishvili, Dimitri Kemoklidze, and AcadNusx, size 10 for Georgian) to Gocha Kereselidze, Sophie Khmaladze, Veronica Schneider, editor-in-chief at David Lelashvili, Erekle Natadze, [email protected] or to deliver them as a Word Veronica Schneider, Simon Stone, Irakli Tsereteli file on a diskette to the address below.

GET draws on information from a wide range of The ideas, opinions, findings, interpretations and government and non-government sources including in conclusions contained in the feature articles are particular the State Department for Statistics, the those of the author(s) only and do not necessarily National Bank of Georgia, the United State Social coincide with those of GET Editorial Board, neither Insurance Fund, the Ministry of Finance, the Ministry of do they represent any official view of the European Foreign Affairs, the Ministry of Economy, Industry and Commission, the Georgian-European Policy and Trade, Department of Privatisation, the Ministry of Legal Advice Centre or the Government of Georgia. Labour, Healthcare and Social Affairs as well as other Government ministries and departments. Wherever Readers may quote any information used provided it possible every care is taken to ensure that data is properly acknowledged. sources are fully acknowledged since without the full co-operation and support of information providers, For further information or comments please contact: including regular consultation, it would not be possible to produce this review. Veronica Schneider Editor-in-Chief The purpose of GET is to offer an independent Georgian Economic Trends analytical account of economic trends drawing on Georgian-European Policy and Legal Advice Centre information made publicly available. As part of this (GEPLAC) work, commentary and advice are offered on policy 42, Kazbegi Ave, Tbilisi 380077 and on the collection and dissemination of economic Tel: (995 32) 53 71 40 / 53 71 42 / 53 71 43 and other information. These are always intended to 53 71 45 / 53 71 46 support the process of economic reform in Georgia, Fax: (995 32) 53 71 38 and also to relate this to the Partnership and E-mail: [email protected] Cooperation Agreement between Georgia and the European Union. However, they represent the view of To subscribe to GET, please, send an e-mail or fax the authors and editors only and do not represent any stating your contact details and language of the official view of the European Commission, the edition to the e-mail address/fax numbers above. Georgian-European Policy and Legal Advice Centre or the Government of Georgia.

GEORGIAN ECONOMIC TRENDS – 2005 No.1

GEORGIAN ECONOMIC TRENDS

Contents

Foreword 3 Part I. Economic Trends 1. Summary 10 2. National Accounts and Main Trends 15 3. Sectors of Economy 20 4. Government Finance 28 5. Money and Finance 35 6. International Trade and Foreign Economic Relations 44 7. Privatisation 52 8. Labour Market, Incomes and the Social Safety Net 55 9. The EU-Georgian Relations 66 Calendar of Events 70

Part II. Appendix: Feature Articles I. Regional Economic Integration: Selected Issues 93 By Dr.Daniel Linotte, Senior Economic Adviser, OSCE Secretariat II. The BTC Pipeline in Georgia and the Region: an Update 114 By Wref Digings, Head of BP Georgia

Part III. Statistical Appendix Statistical Appendix 118 Abbreviations 131

GEORGIAN ECONOMIC TRENDS – 2005 No.1 1

FOREWORD

Dear Reader

Welcome to the first edition of GET in 2005. This year sees the 10th anniversary of our activities, and we propose some small celebrations that will shortly be announced on the GEPLAC website. We also publish an extra-long Foreword, which we hope you will find interesting and topical.

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Georgia is one of a number of countries currently addressing the challenges of political independence from the Soviet Union. In some, such as the Baltic republics, this independence has been accomplished quite smoothly, and after much hard work in preparation, they are now members of the European Union. In others, such as the Ukraine, there have recently been quite major events and there are further complex issues ahead.

The consolidation of political independence appears to have wide support and is generally welcomed by the populations of the countries of the former Soviet Union. However, the economic consequences of political independence are perhaps less welcomed, at least so far. This does not mean that these countries are attempting to become “economically independent”, since the modern world economy contains a huge number of cross-border inter-dependent relationships. Indeed, complete economic independence, or “self sufficiency”, except in a very small number of strategic areas (e.g. energy, basic foodstuffs) is rarely sought after by governments and policy makers.

Rather, the recently independent states are attempting to confront a situation in which they were very abruptly disconnected from a much larger economic entity. In the case of Georgia, the consequences of this are obvious in terms of the loss of markets and investment for industry, causing high unemployment and poverty. These are, of course, matters that the Government, donors and GEPLAC itself are constantly concerned with and we have written about them before from many perspectives. This edition of GET examines them in yet another context, namely that of regional economic cooperation among politically independent countries. As always, we look at the issue from the point of view of Georgia’s relations with

GEORGIAN ECONOMIC TRENDS – 2005 No.1 3 FOREWORD the EU, and it is also particularly appropriate that we do so now, as the Government is currently involved in the following important actions: • Publication of a Progress Report on the Economic Development and Poverty Reduction Programme (EDPRP), • Determining priorities for sectoral policy under the European Neighbourhood Policy (ENP), under which the EU identifies the following over-riding opportunities and challenges; Proximity, Prosperity and Poverty. The European Commission’s Country Report on Georgia, in relation to ENP, appears on the GEPLAC website under the “Georgia and EU” heading. • Possibly by Q2 2005, receive the first funding under the Millennium Challenge initiative, which includes an emphasis on large scale infrastructural improvements.

As suggested above, the development of markets and attraction of investment are a key to economic regeneration, in Georgia and other transition economies. This has to be achieved in an increasingly competitive world. Therefore, an important task for policy makers is to adopt strategies that also clearly address the issue of competitiveness. There are certain countries in the world that, in general terms (for example, because of major geographic disadvantages, or highly unstable security environments), may be seen as hardly able to compete, or even engage with, the global economy, at all. Georgia obviously does not fall into this category, though if we nevertheless start by analysing the related issues of geography and security, this can lead us to some interesting conclusions regarding economic development strategy.

Academic discussions about the competitiveness of countries often draw in such concepts as “absolute and comparative advantage”, with which many of our readers will be familiar. In layman’s terms, it’s partly about where they have certain built-in advantages over others. We may also say that, if a given country can identify activities in which there is no direct competition, so much the better. As a market for goods, and therefore the related investment, Georgia is a small country located on the eastern borders of Europe, and therefore not particularly attractive. However, it is at the transit crossroads of East and West, with major and very different geopolitical regions in four different directions. The geography of Georgia is a factor that will not change and is unique to it; however, the exploitation of this as a benefit will ultimately determine whether the policy aims of economic regeneration are achieved.

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This is more or less the same as saying that Georgia’s economic future probably does lie very much in being a “transit country”, something which is of course often stated, though the definition could perhaps use some careful examination. Obviously, it means promoting transport activities through the territory of Georgia, but in certain circumstances it could also mean exporting in its own right, if investors can be convinced of the merits of locating in the country to serve a regional market, rather than somewhere else. Whatever the agreed definition, however, a successful outcome in this activity is in turn dependent on effective policy in two areas: the establishment of more active cooperative links with neighbouring countries and an improvement of infrastructure.

In regard to cooperation, we may identify as a priority much closer operational relations between the countries of the South Caucasus, Russia and Turkey; this would include customs, inspection and other measures that aim at facilitating physical trade (wherever it originates from), including the actual reopening of certain long-abandoned transport routes. At some borders, such progress requires significant changes in political and diplomatic relationships. This is recognised, though we would argue for “best efforts” approaches in the short term, with more durable solutions thereafter.

At this point, we may ask what can be the nature of further efforts towards this improvement of technical operations between counties and what may be the relevance of PCA. Probably, there are three fields and these may of course overlap:

• For dealings with other countries that are actively seeking to implement PCA, such as the immediate neighbours in the South Caucasus, there is an apparent benefit in harmonisation in areas of direct contact, with trade and transit an obvious priority. Moreover, their respective legislative programmes could be coordinated to bring this about. It should also not be forgotten that the three countries of this sub-region all point naturally and therefore potentially can open routes, in different directions. In addition, they all have different natural/geographic advantages, as well as economic traditions and connections, and if pooled, however informally, these can yield benefits.

• With Russia and Turkey (and arguably also Iran as a more indirect counterpart), PCA should be seen in its widest application as a means to promote modernisation and transition to a market economy. This does not require any detailed assessment of compliance under PCA, but rather draws attention to the

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sectors in which any net progress will inevitably assist Georgia. In particular it can enable it to converge with these much larger, but still developing, economies, which are already trading partners.

• In relations with more economically advanced countries, including of course the EU, it can provide a legislative and regulatory regime in which inward investors and traders can be comfortable. For example, if there is adequate and enforced employment and environmental law, as well as protection of intellectual property rights and standards, a potential counterpart can operate without risk to its reputation or assets. In the absence of this, it must effectively negotiate its individual regulatory regime bilaterally with Government, something which is feasible only for the largest players. In other words, modernisation is not simply a luxury for countries that are candidates for imminent EU membership, but for any that wish to operate in the modern global economy.

We believe strongly that the analysis of such issues, which are the components of overall macroeconomic performance benefits greatly from a “sectoral” approach. We have therefore added a new Chapter to GET, which analyses a number of sectors, including those directly relating to transit.

Having thus argued in favour of Georgia’s role as a transit country, we should consider the following questions: • What does Georgia actually have to do to be a successful transit country? The answer to this question can be long or short, depending on the detail demanded by the enquiry. Fundamentally, and as a matter of political economy, however, Georgia needs to operate an open-border policy in all respects, with appropriate regulatory/procedural and governance structures, as well as promoting measures to minimise the cost of transit operations, in comparison with alternative routes. The activities of the EU’s TRACECA initiative, involving countries of the South Caucasus, Black Sea and Caspian regions, make an important contribution to this aim. At the same time, Georgia must maintain secure borders, not only to protect the physical well-being of its citizens, but also to ensure that the efforts of honest businesses are not undermined by smuggling and counterfeiting. In the reality of Georgia’s location, it is recognised that these are clearly difficult issues; however, one determinant of successful outcomes is obviously a close coordination of security and customs operations.

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• What infrastructure is required in a transit country? Again, the answer could be extremely long, though a few key recommendations could be made. Looking at the problem from one perspective, policy makers should evaluate all pre-existing rail and road routes that are obviously not usable (or usable only to a very limited extent) at present. The work required to reactivate these is a combination of the physical (civil engineering) and political (diplomatic) initiatives. The most obvious cases are routes in a North-South direction which were bequeathed from the Soviet Union. From an alternative perspective, one may consider a much more extensive strategy and create new transport infrastructure, based on new demands and opportunities. In the case of Georgia, this clearly means the East-West routes which permit transport not only of oil and gas from the Caspian basin, but potentially also of a variety of other goods along surface routes, as economic activity increases.

The location of markets is of relevance to this question as well. In the case of oil and gas, the transport media exist to cover very large distances, and their use is justified by the scale of the business. However, where trade flows and individual shipments are more modest, careful analysis needs to be carried out. For example, the potential of markets in southern Russia and Ukraine, especially for existing and likely future Georgian products, is reasonably high. That of eastern Turkey is less so and expensive infrastructure investment in that direction is perhaps not so easily justified. In regard to the potential trade with the EU, where obvious preferences apply, but which have yet to be exploited, there are quite specific logistical questions to be resolved as that market is quite far away from Georgia.

Nevertheless, the definition of infrastructure should perhaps not be limited to physical projects, especially transport, though the importance we place on this is clear. We would argue for a broader definition of “economic infrastructure”, with investments of varying size, including maintenance of a strong security environment, improved and more reliable energy supplies, telecommunications systems, access to information, IT services and training. Language skills (not only English, but regional languages as well) are also important, though on the other hand, apparently modest developments in the application of Georgian, such as in the likely future availability of consumer software, can have significant unforeseen benefits for business. Overall, this is the practical enabling environment that Georgia needs, not only in terms of legislation

GEORGIAN ECONOMIC TRENDS – 2005 No.1 7 FOREWORD

and regulations, but also an effective application and enforcement, that would provide the opportunity to entrepreneurs to access the physical infrastructure which may be about to improve significantly.

• What are the likely benefits from being a transit country? Simplifying hugely the academic position, it is generally argued that increased trade creates benefits (in part due to countries “doing what they do best”), though there are obviously many caveats to consider. This analysis is presented in both theoretical and practical terms by our first external contributor, Dr Daniel Linotte, formerly a GEPLAC Team Leader, OSCE Senior Economic Advisor and now head of the trade policy team at YUPLAC in Belgrade. Dr Linotte’s article focuses on the processes whereby gains from trade and, in particular, the establishment of regional economic groupings of varying formality, are achieved. It also considers the political economy of managing complex trade and investment relations.

Looking at the issue slightly more narrowly, it is important to consider benefits not only in absolute terms, but also in relation to the costs of creating the related infrastructure. This raises a further question: how can we even be sure that investment in infrastructure will facilitate trade, or in fact stimulate it where none exists at present? To what extent can anticipated gains justify a given expenditure? After all, there are many examples around the world of ambitious and “prestigious” infrastructure projects (roads, railways, ports and bridges) that have yielded little or no economic benefit. In the case of Georgia, however, it seems that the quality of infrastructure (whether simply physical or taking the broader definition) is sufficiently low that, if investment is sensibly targeted, there is likely to be a real benefit and the investment will facilitate trade that is currently impeded. The key challenge is to seize the opportunity, but in any event some first moves have to be made.

In more obvious financial terms, the benefits of increased trade and the active development of a transit role may be divided into the more direct and the indirect or “multiplier/spin-off” effects. In addition to a great deal of information on progress on the construction of the BTC pipeline, the second of our external contributions, by Mr Wref Digings, Head of BP Georgia, provides a clear summary of the direct financial benefits of this particular project to Georgia, both currently and in the future. The indirect benefits of this, and other major infrastructural investments that might come about, are potentially quite varied. It seems certainly appropriate that all such

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investments should contribute to the welfare of inhabitants of the regions in which they are located, not least because they are often far from Tbilisi and concern some of Georgia’s poorest citizens. Such actions give a much-needed regional dimension to the general effort to regenerate Georgia’s economy.

Ultimately, however, the benefits that Georgia can gain from closer regional cooperation and the creation of regional infrastructure must depend strongly on the response of individuals and local firms. The spin-off benefits of increased transit activity include not only an opportunity for increased sales of Georgian produce, but also the provision of private sector services within Georgia (e.g. fuel, maintenance, catering and retail sales), all of which contribute to local incomes.

An important opportunity now exists to promote Georgia’s role as a transit country, which, as we have seen, can have a number of features. As a strategy capable of presentation to the public, it has obvious appeal, not least because of its nature as a clear focus of cooperation between Government, the private sector and institutions of civil society and the donor community.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 9

CHAPTER ONE: SUMMARY

NATIONAL ACCOUNTS AND MAIN TRENDS In 2004 Georgia’s GDP amounted to GEL 9,800 milllion, that is about USD 5,148.8 million. Real GDP growth rate was 8.4 percent. Among the major sectors of economy, negative growth was recorded in agriculture and domestic processing of products. Industry, Construction, trade, telecommunication and financial intermediation have shown a high growth rate. Anti-corrption measures by the government and improved administration reduced the scales of illegal economy, which resulted in the reduction of share of unrecorded output in total output to 28.2 percent from 33.4 percent in 2003.

NATIONAL DEBT To the beginning of 2005, Georgia’s national debt was GEL 4,964.3, that is 50.7 percent of GDP. Georgia’s internal debt amounted to GEL 1,574.1 million, that is GEL 6.1 million more than at the end of 2003. As of December 31, 2004, Georgia’s outstanding foreign debt amounted to USD 1,857.7 million (GEL 3,390.2 million). Compared with the end of 2003, the outstanding debt of the country has increased by USD 8.4 million, while in GEL terms it has significantly reduced (by GEL 447 million), that is due to strengthening of GEL against the US dollar, Euro and SDR. In 2004, credits of USD 121.2 million, including the state guaranteed credits, were disbursed, but Georgia paid USD 212.9 million for debt servicing, including USD 183.5 million for principal debt and USD 29.4 million for interest, commitments and penalties.

In July 2004, Georgia achieved a new agreement with the official creditor countries of the Paris Club, to restructure USD 153.4 million in maturities due from 1 June 2004 to December 31 2006. The parties have agreed the new schedule to service these debts from 2011 to 2025. In the same manner, one half of the arrears (USD 32.08 million) accrued from the beginning of 2003 as of end of May 2004 will also be rescheduled. The rest is to be repaid over three years.

BALANCE OF PAYMENTS The current account balance in Q1-Q3 2004 remained negative, but has improved slightly compared with Q1-Q3 2003. The current account deficit was 7.3 percent of GDP. The trade turnover of goods and trade deficit have increased, respectively by USD 552.1 million and USD 178.7 million compared with the corresponding period of previous year. Georgia still exports more services than it imports. Transportation, travelling, communications, personal and financial services (other than insurance) generates net inflow of revenues.

A positive trend of 2004 was significant growth of foreign direct investments, that is largely associated with the construction of Baku-Tbilisi-Ceyhan oil pipeline and Baku-Tbilisi-Erzerum gas pipeline. In 2004, intergovernmental grants totalled USD 42.8 million in Q1-Q3, while in the corresponding period of previous year it was only USD 3.8 million. At the Brussels donors meeting in June 2004, Georgia secured USD 1.1 billion in aid pledges for 2004-2006, two-thirds of which is in the form of grants. As for the reserve assets of the country, in Q1-Q3 2004 they increased by USD 173.3 million.

GOVERNMENT FINANCE According to the 2004 State Budget, total revenues at the end of 2004 were expected to reach GEL 1,742.3 million. Actual State Budget revenues were GEL 1,773 million, GEL 31 million higher than planned. Higher than expected tax revenues explains the main portion of the surplus. External grants and non-tax revenues also were received in excess of expected amounts. Overall tax collection has improved drastically by 64 per cent over the year. Almost all taxes were collected at levels substantially higher than those of 2003. Actual State Budget expenditures of GEL 1924 million were 59 per cent higher compared to

10 GEORGIAN ECONOMIC TRENDS – 2005 No.1 SUMMARY the previous year. The main spending was on social security, debt servicing and general government. State Budget deficit financing was GEL 150 million.

SECTORS OF ECONOMY INDUSTRY The industrial output is constantly growing in the recent years and the growth rate, especially since 2002, is very good. Registered output of industrial enterprises in 2004 increased by 8.61 per cent compared with the previous year. According to the SDS, output amounted to GEL 1,714.2 million and was distributed by main fields of activity as follows: processing industry 63.8 per cent; energy and water supply 28.4 per cent; and mining industry 7.8 per cent.

Despite these improvements there remains a number of persistent problems in the sector. Serious impediments to investment are the large arrears of the companies towards the budget, poor management, outdated material-technical base and underdeveloped infrastructure.

CONSTRUCTION The boom in demand for private apartments facilitated the development of the construction sector in Georgia. The growth rate of the sector in 2004 reached 7.5 per cent. The total output of the sector was GEL 693.7 million.

AGRICULTURE Agricultural sector in 2004 was characterised by the negative growth rate about - 6.7 per cent. Unfavourable weather conditions adversely affected the agrarian sector in the beginning of 2004. Compared with 2003, there was decrease in the production of almost all the main agricultural products produced in the arable sector. Particularly, there was decrease in the production of grain, wheat, maize, sunflower, potatoes, vegetables, fruit, tea, citrus and grapes. Average yields of these crops also decreased. Unlike the arable sector, livestock-related agriculture (production of meat, milk and eggs) slightly expanded.

TOURISM The tourism business has a very good potential in Georgia, though the unsettled political conflict in the region of Abkhazia (one of the best regions for tourism development in Georgia), lack of safety of the tourists and undeveloped tourism infrastructure hinders the realisation of the sector’s full potential. According to data of SDS, in 2004 Georgia was visited by 368.3 thousand visitors.

ENERGY The production of crude oil and oil products in 2004 was 97.6 and 37.5 thousand tonnes. Natural gas production has amounted to 10.9 million cubic meters and 6.8 billion kwh of electricity was generated. Most of the country’s demand for oil and natural gas was satisfied from imports. In 2004, 526.9 thousand tonnes of oil and oil products and 1,231million cubic meters of natural gas was imported. While 100 per cent of natural gas was imported from Russia, supply of imported oil and oil products was diversified: 74 per cent came from Azerbaijan, 11 per cent from Turkmenistan, 6 per cent from Bulgaria and 5 per cent from Romania. Electricity imports increased to 1.12 billion kwh (1.07 billion kwh in 2003). As the most of county’s oil and gas demand was satisfied from imports in 2004 and power generation was also partly dependent on imports, Georgia’s energy self sufficiency was very low.

1 The figures expressing the sums of sectoral outputs and rates of the growth of sectoral output differ from those in GDP Table. These differences are conditioned by the fact that the GDP table includes only sums value added produced in the sectors.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 11 SUMMARY

TRANSPORT 2004 was a difficult year for the smooth development of the transport sector in Georgia. The political tension in Adjara Region as well as misunderstanding among the Georgian and Azerbaijan authorities about the cargo transit through Georgia by railway transport negatively affected the development of the sector. In 2004, the volume of transported cargo increased by 0.1 per cent and the turnover of cargo decreased by 11.2 per cent compared with the previous year.

The further development of the TRACECA project is likely to increase the output of the Georgian transport system. The possibility of transportation of humanitarian shipments to Afghanistan and Iraq through the territory of Georgia also creates an additional opportunity of raising transit volumes in the near future.

TELECOMUNICATIONS The output of telecommunications sector increased from GEL 373 million in 2003 to GEL 500 million in 2004. State enterprises share in the total telecommunications sector’s output in 2004 was 12 per cent.

MONEY AND FINANCE 2004 was a year of great importance for the Georgian economy. According to the estimations of the State Department for Statistics the annual real GDP growth reached 8.4 per cent. The Government achieved the improving of tax discipline and increasing of budget revenues in 2004. Reducing the share of the shadow economy resulted in the moving of money into the banking sector and increasing of deposits. During 2004, the Lari denominated deposits increased by 168 per cent.

A noteworthy development of 2004 was a revaluation of the national currency against the US dollar – the major currency of savings and capitalisation in Georgia. This factor offset the inflation pressure and also affected the banking business as well.

One of the main developments of 2004 was the announcement about acquisition of TbilUniversalBank by Bank of Georgia. One can assume that the market will push the banks to continue that trend during the next years.

2004 annual inflation was 7.5 per cent.

INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS During 2004, recorded external trade turnover was equal to USD 2,495 million, of which exports were USD 648 million and imports USD 1,715 million. Exports increased by 40 per cent, while imports increased by 62 per cent. Total trade averaged around 47 percent of GDP during in 2004. The significant increase in trade figures is the result of legalization of international trade.

According to SDS data, the CIS countries remain Georgia's main trading partners (namely Russia, Azerbaijan, Turkmenistan, Ukraine and Armenia), but their share appears to have decreased considerably over time. Trade with non-CIS countries has been expanding.

According to balance of payments data, 46.6 per cent of registered exports of services in 2004 were revenues from transportation. Travel amounted to about 34 per cent of all services.

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PRIVATISATION The Government has launched a new phase of reforms in Georgia and privatisation is a crucial component of this process. It will play a distinctive role in the economic development of the country. More than 15,000 enterprises have been privatised since the beginning of the privatisation process in Georgia in 1992. The number of the remaining state owned enterprises is quite substantial - there are approximately 1,800 small, medium and strategically important enterprises with state participation, with over 180,000 persons employed. Major trends of the current privatisation policy are a quick transfer of the remaining enterprises into private ownership and a radical deregulation of the economy to mobilise private investments.

It is obvious that in terms of privatisation of the MLEs some serious steps and measures need to be taken. In such sectors as energy, telecommunications, manufacturing and transport many assets have become a heavy burden for the economy and urgently need restructuring, rehabilitation, or liquidation.

In 2004, there were some privatisation cases of state owned MLEs as well as municipal enterprises. The most interesting cases due to the scales of the privatised entities were the privatisation of the joint stock company Tbilaviamsheni, Georgian 60-years-old Tbilisi based aerospace manufacturing plant; privatisation of Elmavalmshenebeli, Georgian Telecome, hotels Iveria and In-tourist, and recently put into the tender Chiaturmanganumi, Vartsikhe Hydro Power Station and Georgian Ocean Shipping Company but still the privatisation process of these objects is not completed.

In 2004, privatisation of small enterprises still is continuing. Due to reorganisation of the privatisation offices in the regions, the information is not complete. The process of the data supply is aggravated also by the fact that the most of the small enterprises are under municipal ownership and it takes extra effort to collect and to combine these data in the centralised data processing system.

EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET LABOUR MARKET Although economic situation in Georgia is undergoing a certain revival and there is anecdotal evidence of businesses emerging that should bring about at least some new jobs, the labour market situation still remains largely unfavourable and unstable. Whilst unemployment rate figures are generally in line with those for transition economies and, if taken alone, may even suggest optimistic conclusions for labour market trends, the overall picture is flawed by persistent underemployment, widespread hidden and disguised unemployment and majority of salaries falling way below the minimum subsistence level. Most of the working age population is either underemployed or non-employed. New stable jobs are rarely created and very few of them are relatively stable. The labour market is dominated by agricultural subsistence self- employment. A large portion of the employed are engaged in unofficial and unregistered low-paying largely self-employment activities. Just around 20 per cent of the working age population have waged or salaried jobs and the vast majority of those employed are hardly earning a living. All the above-mentioned long-term labour market problems adversely effect the poverty situation that is continuously reflected in painful declines in living standards experienced by large numbers of households.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 13 SUMMARY safety net is symbolic. Fundamental steps are to be taken on the way to restructuring the state social protection system to create an economically viable, affordable and equitable social safety net that would be fit to alleviate poverty effectively, especially for the most vulnerable. In conditions of inadequate pension assistance, alleviating poverty in old age is of vital importance. Social policy and reforms are among the top government priorities and while certain steps have already been made, more are to follow.

The EDPRP, revised by the new Government, emphasizes that to reduce social inequality arising from poverty effective implementation of reforms is needed. EDPRP acknowledges that one of the main causes of poverty is unemployment, and stresses that, while to alleviate and overcome poverty rapid and sustained economic growth is to be attained, it is not going to be achieved overnight. Therefore, in the short-term the assets of the poor can only be increased through public transfers2.

According to the current pay-as-you-go public pension system, a flat-rate old age pension payable to the majority of pensioners countrywide grew from GEL 14 to GEL 18 in May 2004, in accordance with a presidential decree, of which GEL 14 is the main flat-rate pension allowance and another GEL 4 is paid to cover previously accumulated pension arrears. The pension rate was raised to GEL 28 beginning from January 2005. The accumulation of pension arrears has been stopped and the repayment of outstanding arrears started, that is considered by the EDPRP Progress Report as the first step on the way of implementing the pension reform.

EU-GEORGIA RELATIONS According to the State Department for Statistics, in 2004, Georgia’s trade relations with the Member States (25) of the European Union amounted to USD 727.7 million, which is about 42 per cent more than in the same period of previous year. During this period, Georgian exports to the EU market were USD 111.6 million (36.7 per cent more compared with previous year). EU Member States’ exports to Georgia amounted to USD 616.2 million (43.1 per cent more compared with previous year). For the period, 29.2 per cent of Georgia’s total foreign trade was with EU Member States, 17.2 per cent of exports and 33.4 per cent of imports.

2 Economic Development and Poverty Reduction Programme, Progress Report, January 2005

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CHAPTER TWO: NATIONAL ACCOUNTS AND MAIN TRENDS

GDP AND MAIN TRENDS According to the SDS preliminary estimates, in 2004 Georgia’s GDP amounted to GEL 9,800 million, that is about USD 5,148.8 million. Real GDP growth rate was 8.4 percent. The highest growth rate was recorded in Q4 (21.2 percent), while in Q1 the growth was negative (-5.3 percent). Among the major components of domestic demand, private consumption grew significantly. Due to remarkable growth in state budget revenues and expenditures, consumption of the general government has also increased significantly. As for the share of gross capital formation in GDP, it has increased to 26 percent compared with 24.1 percent in 2003. This is a quite hopeful trend since the capital stock is largely obsolete in Georgia. The remuneration of the labour force in Georgia is still low (see Chapter Eight) and its share in GDP is only 22 per cent.

Among the major sectors of the economy, negative growth was recorded in agriculture and domestic processing of products. The majority of goods produced in these sectors are intended for self- consumption. At the same time, agriculture still maintains the leading position in Georgia’s GDP and employment. Industry, construction, trade, telecommunication and financial intermediation have shown a high growth rate in 2004. This was partially related to the inclusion in the national accounts of previously unrecorded output. Anti-corruption measures by the government and improved administration reduced the scale of the illegal economy, which resulted in the reduction of share of unrecorded output in total output to 28.8 percent from 33.4 percent in 2003.

Table 2.1: Structure and growth rate of GDP, 2004 2004 vs. 2003 Share in GDP (2003=100) 2004 (percent)

Agriculture, forestry and fishing 93.3 16.2 Industry 112.2 13.2 Domestic processing of products 98 3.8 Construction 107.5 6.4 Trade 109.5 13.4 Hotel and restaurant 103.7 2.7 Transport 105.8 9.8 Telecommunication 125.5 4.2 Financial intermediation 108.7 1.3 Operation with real estate, renting and business activities 106.3 5.2 Public administration and defence 104.8 5.4 Education 100.9 3.5 Health care and social services 101 3.4 Other service activities 111.7 3.4 Private households with employed persons 100.6 0.1 Amendments by financial intermediation services 91 -0.8 Net taxes --- 8.5 GDP 108.4 100 Source: State Department for Statistics

GEORGIAN ECONOMIC TRENDS – 2005 No.1 15 NATIONAL ACCOUNTS AND MAIN TRENDS

FOREIGN DEBT As of 31 December 2004, Georgia’s outstanding foreign debt, including state guaranteed debt amounted to USD 1,857.7 million (GEL 3,390.2 million). Compared with the end of 2003, the outstanding debt of the country has increased by USD 8.4 million, while in GEL terms it has significantly reduced (by GEL 447 million) that is due to strengthening of GEL against the US dollar, Euro and SDR. The ratio of foreign debt to the country’s GDP has reduced from 44.8 percent in 2003 to 34.6 percent in 2004. By 31 January 2005, Georgia’s foreign debt had increased to USD 1,858.4 million, but reduced in GEL terms to 3,382.5 million. The World Bank, EU, IMF, Austria, Turkmenistan and Russia are the largest creditors of Georgia. Among them the multilateral creditors are playing the leading roles.

Table 2.2: Foreign Debt by 31 December 2004 (USD Million) million USD million GEL Multilateral creditors 1068 1950 World Bank 678 1237 EU 116 213 IMF 265 484 IFAD 917 Bilateral creditors 693 1265 Austria 100 183 Turkmenistan 157 287 Russia 153 280 Turkey 53 97 USA 40 72 Others 190 347 State guaranteed credits 96 175 Total 1858 3390 Source: Ministry of Finance

In 2004, credits of USD 121.2 million, including the state guaranteed credits, were disbursed, including USD 63.5 million from the World Bank, USD 20.4 million from IMF, USD 20.5 million from Germany, USD 2.4 million from IFAD, USD 7.2 million from Japan, USD 1.4 million from Kuwait, USD 6.2 million from EBRD. In 2004, Georgia paid USD 212.9 million for debt servicing, including USD 183.5 million for principal debt and USD 29.4 million for interest, commitments and penalties. Georgia reduced its debt to Turkmenistan by USD 96.5 million compared with the end of 2003. In January 2005, credits of USD 24.4 million was disbursed and USD 7.6 million was paid for debt servicing.

In 2001, Georgia agreed with the Paris Club on the re-scheduling payments for Georgia’s foreign debt due in 2001-2002. In July 2004, Georgia achieved a new agreement with the official creditor countries of the Paris Club, to restructure USD 153.4 million in maturities due from 1 June 2004 to December 31 2006 on extended Houston terms. The parties have agreed the new schedule to service these debts from 2011 to 2025. In the same manner, one half of the arrears (USD 32.08 million) accrued from the beginning of 2003 as of end of May 2004 will also be rescheduled. The rest is to be repaid over three years from 2004 to 2006.

INTERNAL DEBT As of January 1, 2005 Georgia’s internal debt amounted to GEL 1,574.1 million, that is GEL 6.1 million more than at the end of 2003. In 2004, GEL 95.4 million was paid for servicing the internal debt that was mainly allocated for servicing the Treasury bills and loans borrowed from the NBG

16 GEORGIAN ECONOMIC TRENDS – 2005 No.1 NATIONAL ACCOUNTS AND MAIN TRENDS

(GEL 92.4million in total). The rest was allocated from the budget of Tbilisi. To the end of 2004, Georgia’s national debt in total was GEL 4,964.3 million, that is 50.7 percent of GDP.

BALANCE OF PAYMENTS According to the preliminary estimates of the SDS, the current account balance in Q1-Q3 2004 remained negative, but has improved slightly compared with Q1-Q3 2003. The current account deficit was 7.3 percent of GDP, that is lower than in Q1-Q3 2003 (9.3 percent). The trade turnover of goods and trade deficit have increased, respectively by USD 552.1 million and USD 178.7 million. Export of goods increased by 41 percent and import by 38.3 percent compared with the corresponding period of previous year. A significant trend observed in 2004 was the growth of recorded external trade turnover, that is due to the legalization of import and export flows. High economic growth has also supported expansion of trade.

Table 2.3: Balance of Payments Q1-Q3 2003 and 2004 (USD million) Q1-Q3 2003 Q1-Q3 2004 Current account -267.6 -263.5 Goods -446.5 -625.2 Credit 560.4 747.1 Debit -1006.9 -1,372 Services 42.2 38.9 Credit 331 390.9 Debit -288.8 -352 Incomes 26.6 56.5 Credit 138.9 173 Debit -112.4 -116.5 Current Transfers 110.1 266.4 Credit 141.6 302.2 Debit -31.5 -35.9 Capital and Financial Account 262.5 249.7 FDIs 221.5 365.9 Portfolio Investments -9 0 Other Investments -0.7 4.6 Reserve Assets 2.4 -173.3 Net Errors and Omissions 5.1 13.8 Source: State Department for Statistics Note: 2004 data are preliminary estimates

Georgia still exports more services than it imports. Transportation, travelling, communications, personal and financial services (other than insurance) generates net inflow of revenues. Georgia has significant potential to increase the export of services. Transportation and tourism could be considered as the most promising sectors. Transportation of Caspian oil and gas through Georgia by pipelines and expansion of railway links with the neighbouring countries should positively affect the transit revenues of Georgia.

Another significant source of financing trade deficit are the transfers of Georgian migrants working abroad and foreign grants. In Q1-Q3 2004 repatriation of remuneration of short-term workers abroad increased to USD 150.9 million compared with USD 120.2 million in Q1-Q3 2003, while workers remittances (transfers of long-term workers) reduced to USD 40.6 million from USD 43.3 million,

GEORGIAN ECONOMIC TRENDS – 2005 No.1 17 NATIONAL ACCOUNTS AND MAIN TRENDS respectively. Georgia is continuing to receive strong donor support from international donors. In 2004, intergovernmental grants totalled USD 42.8 million in Q1-Q3, while in the corresponding period of previous year it was only USD 3.8 million. At the Brussels donors meeting in June 2004, Georgia secured USD 1.1 billion in aid pledges for 2004-2006, two-thirds of which is in the form of grants.

A permanent current account deficit makes Georgia a net debtor country. However, a positive trend of 2004 was significant growth of foreign direct investments, that is largely associated with the construction of Baku-Tbilisi-Ceyhan oil pipeline and Baku-Tbilisi-Erzerum gas pipeline. In Q1-Q3 2004 FDI was USD 365.9 million (including USD 31.6 million of reinvested earnings) compared with USD 221.5 million (including USD 38 million of reinvested earnings) in the corresponding period of previous year. Another source of financing of current account deficit was foreign loans. Net borrowings of Georgian central government and commercial banks increased. Only general government in Q1-Q3 2004 borrowed USD 78.4 million, while USD 198.4 million debt was rescheduled and USD 149.9 million was repaid. In Q1-Q3 2003 USD 49.6 million was borrowed by the general government, but USD 38.6 million was repaid (in that time no debt was rescheduled). In addition, commercial banks borrowed USD 68.6 million in the first nine months of 2004, while in the corresponding period of previous year it was about USD 22.4 million.

As for the reserve assets of the country, in Q1-Q3 2004 they increased by USD 173.3 million. Acting against the strengthening of the GEL the NBG conducted significant foreign exchange intervention, bought US dollars and augmented international reserves.

Box 2.1: ECONOMIC POLICY AND REFORM

Progress in EDPRP implementation

The government of Georgia, with support of International Organizations and civil society, has prepared the Economic Development and Poverty Reduction Program of Georgia (EDPRP), the main goals of which are: the reduction of poverty through support to economic growth leading to the creation of new jobs; a higher living standard; and ensuring the participation of all citizens in the country's development process.

In December 2000, the Intermediary Document of (EDPRP) was introduced to the IMF, World Bank, UNDP and other International Organizations and donor countries, which have expressed their willingness to assist Georgia in realizing this Programme. The EDPRP was approved in June 2003, and the government of Georgia subscribed to its implementation. IMF Board of Directors adopted its three-year Programme of "Poverty Reduction and Growth Facility" in the framework of which approximately USD 141 million of concessional loan will be received.

The government of Georgia fully acknowledged that elimination of such a problem, as poverty, is impossible without sustainable economic growth, which should be achieved through fostering economic and structural reforms and ensuring just distribution of state resources. The goal cannot be achieved without promoting the creation of new jobs, the main prerequisites of the latter being an improvement in the country's investment climate and small and medium business development. Implementation of these objectives would support the establishment of the middle class, which would be an important step forward towards reducing poverty. Complex measures should be undertaken on a step-by-step basis in order not only to improve the social sector, but also to stimulate the country's overall economic growth.

The structure of 2004 state budget expenditures was developed in a way to accommodate social protection measures to the maximum, including priorities outlined in the EDPRP. In some cases (e.g. social protection and pensions), the 2004 state budget earmarked more funds to finance measures envisaged by the EDPRP. However, as described below some measures failed to receive funding in volumes determined by the EDPRP, since the bulk of funds in the 2004 state budget were directed to repay arrears of previous years and strengthen the defence capacities of the country.

18 GEORGIAN ECONOMIC TRENDS – 2005 No.1 NATIONAL ACCOUNTS AND MAIN TRENDS

State budget 2004 financed the sectors outlined by the EDPRP in the following way: Social protection and pensions – according to the EDPRP, the state budget 2004 had to allocate GEL 289 million in total for social protection and pensions. The budget law foresaw GEL 365.5 million or 26.4 percent over the EDPRP projection. It financed important measures such as pensions, benefits and allowances in the amount of GEL 280.8 million, of which GEL 224.3 million were directed to pensions. Substantial funds were allocated to repay pension arrears of previous years totalling GEL 76.7 million.

Healthcare – the total volume of funding state healthcare insurance programs was GEL 93.4 million, which is GEL 3 million over EDPRP projections. The budget law envisaged GEL 14.7 million and GEL 56.8 million for out and inpatient care respectively. GEL 8.6 million have been allotted to providing special patients with medicines, and GEL 7 million to facilitate the institutional and functional reform of the social sphere.

Energy – the state budget 2004 also concentrated on the energy sector, which has been acknowledged as a priority by the EDPRP. The state budget envisaged GEL 63.9 million for the energy sector, which is GEL 1.8 million over EDPRP projections.

Education – according to the EDPRP the state budget had to foresee GEL 61.1 million for funding education while the budget envisaged only GEL 42.2 million. In 2002-2004 the salaries in this sector increased on average by 60- 65 percent. In 2004, salary arrears of education sector employees in the amount of GEL 17 million were fully repaid.

Agriculture and food – for measures outlined by the EDPRP, the state budget envisaged GEL 24.8 million, when the programme projected GEL 29.5 million (GEL 4.7 million more).

Tourism – to facilitate the development of this sector, the state assigned GEL 0.7 million for funding targeted programs (which is GEL 0.2 million less than the EDPRP projection).

Environmental protection, forestry resources and land management – the budget 2004 envisaged assigning GEL 6.6 million to finance measures outlined by the EDPRP, whereas the assignment in 2004 was GEL 6. 9 million.

Transport and communication – the state budget envisaged GEL 46.4 million according to measures outlined by the EDPRP (which is GEL 10.3 million less than projected by the programme). The funds are fully directed to maintain roads. The budget 2004 envisaged the financing of such measures that are not included in the EDPRP at all, namely GEL 5.6 million to pay arrears on compensations for road construction works performed in previous years, and measures to cope with the consequences of natural calamities GEL 9 million.

Other measures – for funding other measures foreseen by the EDPRP the state budget 2004 had to assign GEL 13.4 million, whereas in reality only GEL 4.4 million have been envisaged, directed to co-financing investment projects.

Source: Economic Development and Poverty Reduction Program, Progress Report, Tbilisi, January 2005. Poverty Reduction and Economic Growth Program of Georgia, Final Document, Tbilisi, October 2001.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 19

CHAPTER THREE: SECTORS OF ECONOMY

SECTORS OF ECONOMY

Industry Industry in Georgia, as one of the main branches of the national economy, plays an important role in developing the country’s economy. The difficult process of transformation to a market economy and the coincidence of the political and economic cataclysms in 90-s had a negative influence on the general economy as well as on the particular industry sector. Industrial decline reached a critical point in 1993 and 1994. Due to the structural reforms in the economy and institutional reforms in the state, such as start of a process of privatization, stabilization of the monetary and fiscal systems, price and trade liberalization, strengthening of the state institutions and rule of law, industry began to recover from 1996.

The analysis of last years shows that important elements of market economy were established, a great number of industrial enterprises were privatized or transferred to joint-stock companies, new macroeconomic and judicial environment were created. Of the recent reforms undertaken after the ‘Rose Revolution’ the most crucial were: the reduction of the administrative corruption; the new wave of the privatization; and the adoption of the new Tax Code that is considered more liberal by experts. The transparency of the current policy-making process, the participation of the stakeholders in creating a new liberal business environment (e.g. a series of consultations between the government and industrial entrepreneurs in the process of drafting the new tax code), and the establishment of new rules that put lobbying by interest groups into the frames of legality, together created the necessary preconditions for fair competition and minimized non-economic factors of risk and unpredictability.

Despite these improvements there remains a number of persistent problems in the sector. The restructuring of industrial enterprises is being carried out weakly. The deficiencies in the bankruptcy mechanisms and bad debt situation hinder the identification of viable enterprises. Most industrial enterprises are privatised, but many of them stand idle. Because of depreciation the stock of capital in industry is reducing. The average annual rate of modernising the basic capital in Georgia is very low (only 3 per cent). Serious impediments to investment are the large arrears of the companies towards the budget, poor management, outdated material-technical base and underdeveloped infrastructure. Unstable electricity supply often causes the interruption of the enterprises’ activity and the high cost of energy in Georgia, compared with the neighbouring countries, undermines the competitiveness of Georgian enterprises. Access to finance is one of the biggest obstacles to the development of industry; however interest rates on commercial bank loans are gradually reducing. Unfavourable business environment leads to widespread use of the shadow economy. The share of unregistered output in the total production remains still high at an estimated 30 per cent.

The general situation in the industrial sector still depends heavily on the activity of a small number of enterprises. 50 enterprises account for a little over three quarters of industrial output. The development of small and medium enterprises is hindered by unfavourable legislation and widespread corruption. In previous years, the practice of “state capture” and unfair competition was still in place. As a result, the most economically viable are those enterprises that lobby by illicit means. In such a business environment, small and medium enterprises have little chance for survival and further development. It is worth mentioning that in the small and medium industrial enterprises only 19 per

20 GEORGIAN ECONOMIC TRENDS – 2005 No.1 SECTORS OF ECONOMY cent of general industrial output was produced, while in the most developed countries the share of such firms is 50-60 per cent. Registered output of industrial enterprises in 2004 increased by 8.61 per cent compared with the previous year. According to the SDS, output amounted to GEL 1,714.2 million and was distributed by main fields of activity as follows: processing industry 63.8 per cent; energy and water supply 28.4 per cent; and mining industry 7.8 per cent.

Figure 3.1: Distribution of the industrial output by sectors, 2004

7.8 28.4

63.8

Processing industry Energy and water supply Mining industry

Source: State Department for Statistics

The industrial output is constantly growing in the recent years and the growth rate, especially since 2002, is very good.

Figure 3.2: Growth rates of the industrial output according to the structure of GDP, 1999 - 2004

14 12 10 8

6 11.4 12.2 4 8.8 5.3 2 3.7 0 -2 1999 2000 2001 2002 2003 2004 -4 -4.4 -6

Source: State Department for Statistics

Construction The boom in demand for private apartments facilitated the development of the construction sector in Georgia. The growth rate of the sector in 2004 reached 7.5 per cent. The total output of the sector was GEL 693.7 million. It is worth mentioning that a considerable part of the output arose from the construction of Baku-Tbilisi-Ceyhan oil and Shah-Deniz gas pipelines. The share of these projects in the overall construction output was 56 per cent in 2004. Private sector activity accounted for 85.4 per cent of total output

1 The figures expressing the sums of sectoral outputs and rates of the growth of sectoral output differ from those in GDP’s Table. These differences are conditioned by the fact that GDP’s table includes only sums value added produced in the sectors.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 21 SECTORS OF ECONOMY

The number of people employed in the sector was 17 thousand in 2004 that is about 1.9 thousand more than in 2003. Of the total employees in the sector, 44.5 per cent was employed in the large enterprises, 31.6 per cent - in the medium, and 23.9 per cent – in the small ones.

Agriculture Agricultural sector in 2004 was characterised by the negative growth rate about - 6.7 per cent. Unfavourable weather conditions adversely affected the agrarian sector in the beginning of 2004.

Compared with 2003, there was decrease in the production of almost all the main agricultural products produced in the arable sector. Particularly, there was decrease in the production of grain, wheat, maize, sunflower, potatoes, vegetables, fruit, tea, citrus and grapes. Average yields of these crops also decreased.

Unlike the arable sector, livestock-related agriculture (production of meat, milk and eggs) slightly expanded.

22 GEORGIAN ECONOMIC TRENDS – 2005 No.1 SECTORS OF ECONOMY

Table 3.1: Output of the Agricultural Products, 1996 – 2004 (thousand tonnes)

1996 1997 1998 1999 2000 2001 2002 2003 2004 Grain&bean, total 652 902 598 773 407 713.6 680 738.7 675.7 Wheat 114 311 145 226.1 89.4 306.5 200 225.0 186 Maize 491 546 420 490 295.9 288.6 400 450 410 Haricot bean 21.7 15 9.2 9.3 2.6 10 10 9.6 12.6 Sunflower 4 31.4 22.8 40.5 2.6 41.8 20 24 22 Potatoes 285 353 350 433.3 302 422.2 415 424 390 Vegetables 386 513 380 417 354.2 396 405 430 400 Fruits 361 299 279 296 250 200 150 260 160 Grapes 311 309 238 220 210 150 80 200 180 Tea 86.2 33.2 47.2 60 24 23 24 25.5 20 Citrus 117.8 57.1 85.1 56 40 60 33 50 38 Source: State Department for Statistics

Figure 3.3: Growth rates of the agricultural output according to the structure of GDP, 1997 - 2004

5 10.3 6.9 8.2 3.9 -1.4 0 1997 1998 1999 2000 2001 2002 2003 2004 -5 -6.5 -6.7 -12

-10

-15

Source: State Department for Statistics

The structural reforms being implemented in the sector can be considered as a very positive development that in the future should be reflected in the sector’s output. As a result of land reform, currently about 25 per cent of the country’s total arable land has been privatised and about 30 per cent has been leased. A new draft law on the additional privatisation of the arable land has been prepared that will soon be reviewed by Parliament. Adoption of the law would give a new impetus to the development of agribusiness in Georgia. The development of the sector is important due to its strategic importance: about 55 per cent of the total labour force is employed in agriculture.

Despite some positive developments in the sector, there is still evidence of some acute problems. Labour productivity is much lower (about 4 times) than in other sectors of economy. Most households are too small and rely on manual work; banking credits are not accessible for the sector; insurance services are not widely used in the sector; agricultural techniques are commonly obsolete; the fertility of soil is declining; and the irrigation and drainage systems need restoration. Solutions to these problems are related to the creation of favourable conditions for investment in agriculture. Partially, the solution of these problems can be found in the development of the land market that correspondingly can attract lenders in the sector. Together with the above-mentioned problems, protecting the

GEORGIAN ECONOMIC TRENDS – 2005 No.1 23 SECTORS OF ECONOMY domestic market from smuggling and counterfeit goods also should be on the top policy agenda of the Government.

A modernized infrastructure is essential in order to create favourable business conditions and attract both domestic and foreign investments to the sector. At the current formative stage of modern agro business in Georgia, the Government is putting significant effort into this area. Among other programmes and projects, the Ministry of Agriculture, in cooperation with the World Bank, is implementing a programme of rehabilitation of systems. It is expected that, in the short term, the participation of private owners/farmers in investments in the rehabilitation of the system will increase. One of the key aspects of the development of agricultural infrastructure is the introduction of technically modernized, highly efficient and energy-efficient agricultural machinery. For the development of private investments in this direction, the Government supports the wide application of leasing in the acquisition of the means of production.

Tourism The tourism business has a very good potential in Georgia, though the unsettled political conflict in the region of Abkhazia (one of the best regions for tourism development in Georgia), lack of safety of the tourists and undeveloped tourism infrastructure hinders the realisation of the sector’s full potential.

According to data of SDS, in 2004 Georgia was visited by 368.3 thousand visitors: 218.5 thousand from the CIS countries and 149.8 thousand from other countries. The number of tourists in 2004 increased by 17.5 per cent compared with 2003.

According to data of SDS the visitors are divided according the following aims: travelling and recreation – 28.1 per cent, visiting friends and relatives – 31.7 per cent, business and professional aims – 37.6 per cent, the other aims – 2.6 per cent.

Energy The production of crude oil and oil products in 2004 was 97.6 and 37.5 thousand tonnes. Natural gas production has amounted to 10.9 million cubic meters and 6.8 billion kwh of electricity was generated. Most of the country’s demand for oil and natural gas was satisfied from imports. In 2004, 526.9 thousand tonnes of oil and oil products and 1,231million cubic meters of natural gas was imported. While 100 per cent of natural gas was imported from Russia, supply of imported oil and oil products was diversified: 74 per cent came from Azerbaijan, 11 per cent from Turkmenistan, 6 per cent from Bulgaria and 5 per cent from Romania. Electricity imports increased to 1.12 billion kwh (1.07 billion kwh in 2003). As the most of county’s oil and gas demand was satisfied from imports in 2004 and power generation was also partly dependent on imports, Georgia’s energy self sufficiency was very low.

In the electricity and gas sector management, the main problem was liquidity. Therefore, metering and payment discipline in these sectors remain top priorities of the Ministry of Energy. Tbilisi electricity distribution company TELASI, due to major investments in the metering sector in recent years, has increased its collection rate up to 60-70 per cent. However, the situation was completely different in the regions and in the gas sector, where liquidity was very low.

Low collection rates had deterred allocation of funds for maintenance of fixed assets at Hydro Power Plants (HPP). The electricity transmission lines also needed rehabilitation (losses in high voltage grid was average 6.29 per cent in 2004). No funds have been disbursed for rehabilitation works in energy sector from state budget for several years. From 2004, as a sign of government commitment, state

24 GEORGIAN ECONOMIC TRENDS – 2005 No.1 SECTORS OF ECONOMY budget has envisaged funds for rehabilitation works in energy sector. In 2004, state budget disbursement by the Ministry of Energy envisaged about 18 million GEL in this regard.

Table 3.2: State Budget Disbursement for Rehabilitation Works by the Ministry of Energy, 2004 Activity Annual Plan Actual Disbursement (million GEL) (million GEL) % Rehabilitation works at HPP-s and 8.997 8.780 97.6 improvement of metering system in the electricity sector Rehabilitation works for the electricity 3.500 3.470 99.1 transmission lines Rehabilitation of the gas distribution 5.819 5.814 99.9 network and improvement of metering systems in the gas sector Source: Ministry of Energy

The Government has granted a two-year extension on a contract with US Company PA Consulting signed in May 2003 to manage United Power Distribution Company of Georgia (UDC). UDC was created on the basis of grouping of state regional electricity distribution companies and PA Consulting was awarded an interim contract for 18 months.

Transit energy The transit revenue from the Baku-Supsa oil pipeline in the year of 2004 was USD 9.3 million, 47.1 million barrels of oil was transited at transit fee of 0.19-0.20 US cents per barrel (initial fee 0.19 was changed to 0.20 from the first of June).

Baku-Tbilisi-Ceyhan (BTC) pipeline is expected to be completed in 2005. It will be the main export route for oil from Azerbaijan’s Azeri-Chirag-Guneshli (AGG) oil field. USD 4billion of investment in the AGG oil field development will increase AGG’s production from today’s level of 0.1 million barrel per day (bpd) to 1 million bpd by 2010. However AGG’s production would remain around 1 million bpd for a few years and then decline to less than half of that amount. BTC’s operator, British Petroleum, will therefore probably need to look beyond Azerbaijan oil to make optimal use of the pipeline. Kazakh oil would be the obvious candidate with the projected production of 3 million bpd by 2015. The second projected gas pipeline (the South Caucasus Pipeline (SCP)) that crosses Georgia will bring Azerbaijan’s gas to Turkey. Georgia will receive 5 per cent of the gas transported through SCP. Georgia will have profits from the right to purchase additional gas transited through this pipeline.

Since the transit fee for Baku-Supsa (USD 0.19 per barrel) exceeds the fee for BTC (USD 0.12), Georgia’s revenues from oil transit would be reduced if oil now transited via Baku-Supsa was redirected trough BTC. Georgia can expect to receive around 1 per cent of GDP in revenues from the two projected pipelines. While tax revenue in the country remains low (the tax-to-GDP ratio in 2004 was 18 per cent) energy transit revenues would make a significant contribution to the country’s budget. Though these transit revenues can not be compared to oil and gas producing countries revenues, energy transit has some advantages (see the box 3.1).

Box 3.1: POLICIES

Nonrenewable energy resource revenues: implications for fiscal policy

GEORGIAN ECONOMIC TRENDS – 2005 No.1 25 SECTORS OF ECONOMY

Implications for fiscal policy volatility and uncertainty of the revenue stream: while oil price volatility can have a major effect on overall government revenue in oil producing countries, price volatility is not an issue for countries that transit oil—Georgia’s transit fees are fixed and do not depend on oil price developments. As a consequence, instruments that oil producing countries put in place to address price volatility, such as hedging or revenue stabilization funds, are less likely to be useful tools for macroeconomic policy management in oil transiting countries.

Exhaustibility of the revenue stream: the Georgian example shows that in specific cases, this may be a more significant problem in oil producing countries than in oil transiting countries. The decline in ACG production that is projected to take place in the second decade of the century will lead to sharply lower oil revenues for Azerbaijan’s government - but Georgia’s transit fees from BTC need not decline if the pipeline can be used to transport Kazakh oil. As in the case of volatility, this implies that instruments of macroeconomic policy that are designed to address the exhaustibility of nonrenewable resources (such as oil revenue savings funds) are less likely to play a useful role in oil transiting countries.

Real exchange rate volatility and Dutch disease: these phenomena will likely be a less serious issue for oil transiting countries than for oil producing countries because of the much smaller magnitude of the flows involved. In the case of Georgia, projected 2008 oil transit revenues are just 2 percent of exports of goods and services for that year and hence a significant effect on the exchange rate is unlikely. By contrast, in Azerbaijan, oil exports are responsible for around 90 percent of total exports. With oil exports that large relative to the rest of the economy, there is a significant risk that exchange rate appreciation driven by oil exports puts other sectors of the economy at a competitive disadvantage (‘Dutch Disease’). The corollary is that instruments to mitigate exchange rate appreciation, such as natural resource funds that keep their assets abroad in foreign-currency-denominated securities, would not be justified in the case of Georgia.

Source: IMF 2004, In the Pipeline: Georgia’s Oil and Gas Transit Revenues

Transport Georgia’s transport sector is quite developed in the sense that the 4 principal modes (road, rail, air and sea) all play a part. Ministry of Economic Development is carrying out the elaboration of state policy in this sector and coordinates its implementation, while the bodies of the transport administration, Motor Vehicle Transport Administration, Civil Aviation Administration and Maritime Transport Administration, have regulatory responsibilities. In reflection of its geographic location, Georgia is seeking to promote its role of a transit country. Participation in Transport Corridor Europe- Caucasia-Asia (TRACECA) programme serves to achieve this goal. It will provide Georgia with access to European and World Market via alternative transport routes. TRACECA should also support the regional integration between the member states.

2004 was a difficult year for the smooth development of the transport sector in Georgia. The political tension in Adjara Region as well as misunderstanding among the Georgian and Azerbaijan authorities about the cargo transit through Georgia by railway transport negatively affected the development of the sector. In 2004, the volume of transported cargo increased by 0.1 per cent and the turnover of cargo decreased by 11.2 per cent compared with the previous year. In cargo transportation, the lion’s share was carried by motorway (62.5 per cent), and in terms of turnover, railway cargo transport accounted for about 88.2 per cent of total turnover. The number of passengers carried by Georgian air companies in 2004 increased by 22.6 per cent compared with the previous year.

In 2004, Batumi and Poti sea ports processed 13.4 million tonnes of cargo that was 7.6 per cent less than in 2003.

26 GEORGIAN ECONOMIC TRENDS – 2005 No.1 SECTORS OF ECONOMY

Figure 3.4: Growth rate of the output of the Transport Sector according to the structure of GDP, 1997 - 2004

30 51.7 20 42

10 13.9 9.7 5.4 4.4 5.8 0 1.6 1997 1998 1999 2000 2001 2002 2003 2004

Source: State Department for Statistics

Turnover statistics indicate that Georgia has become a transit country, especially for oil products transported from Kazakhstan, Azerbaijan and Turkmenistan to the Western countries. While this East- West traffic will certainly continue to grow, the North-South surface traffic, which operated during the time of the Soviet Union, has significantly reduced. The closure of rail and road links connecting Georgia with the North Caucasus/Kuban region of Russia through Abkhazia (which formerly carried 8 – 12 million tons of freight per year, including also that of Armenia) became a serious impediment to expansion of trade and the Georgian economy generally. A resolution of this problem would provide the opportunity to promote transport and trade on a major scale, encompassing also Turkey and Iran, and serve as a significant spur to regional economic development. Georgian Railways is also looking into new investment priorities, which includes the construction of railway connecting Georgia with Turkey, which would enable the railways to handle a greater volume of European traffic.

In order to further develop the transport sector and resolve existing problems in the sector Policymakers in Georgia should address the following issues:

• Physical infrastructure: current conditions limit certain operations and generally increase the cost of transportation within Georgia; • Safety: the number of road accidents in Georgia is rather higher than that of the EU member countries; • Administration: the differentiation of state management and regulation functions was not carried out yet at Georgian Railways.

The development of transport will greatly contribute to the economic efficiency in Georgia and to the improvement of the investment climate in the country.

Telecommunications

GEORGIAN ECONOMIC TRENDS – 2005 No.1 27 SECTORS OF ECONOMY

The output of telecommunications sector increased from GEL 373 million in 2003 to GEL 500 million in 2004. State enterprises share in the total telecommunications sector’s output in 2004 was 12 per cent. The number of ordinary phone customers was 596 thousand (as of October 1). A substantial increase was observed in the number of mobile telecommunications subscribers. There are now 800 thousand subscribers (as of January 1), which is 42.7 per cent more compared with the corresponding figure in 2003.

28 GEORGIAN ECONOMIC TRENDS – 2005 No.1

CHAPTER FOUR: GOVERNMENT FINANCE

According to the 2004 State Budget, total revenues at the end of 2004 were expected to reach GEL 1,742.3 million. Actual State Budget revenues were GEL 1,773 million, GEL 31 million higher than planned. Higher than expected tax revenues explains the main portion of the surplus. External grants and non-tax revenues also were received in excess of expected amounts. Overall tax collection has improved drastically by 64 per cent over the year. Almost all taxes were collected at levels substantially higher than those of 2003. Actual State Budget expenditures of GEL 1924 million were 59 per cent higher compared to the previous year. The main spending was on social security, debt servicing and general government. State Budget deficit financing was GEL 150 million.

CONSOLIDATED BUDGET REVENUES Revenues of the consolidated budget for the year 2004 were expected to reach GEL 2,216.2 million. Actual revenues collected were GEL 2,282.3 million that is 3 per higher compared to target. The revenue target was revised upwards during the year. This was the first case in recent years when revenue targets were met. We would like to remind the reader that consolidated budget incorporates the central government budget, special state funds and local government budgets. Because of its universal nature, figures of Consolidated Budget are most suitable for making judgements about the global trends and comparisons with GDP. Total revenues of the consolidated budget were 73 per cent higher compared to the corresponding figure of the previous year and made up 23.3 per cent of GDP (against 15.6 per cent in 2003). Tax revenues collected formed 79.4 per cent of consolidated budget revenues. Growing at 53 per cent over the year, tax revenues made up18.5 per cent of GDP, ( 14 per cent in 2003). Changes in comparative figures over the year show obvious improvement of revenue collection by the new administration.

STATE BUDGET REVENUES Initial revenue projections for the State Budget 2004 envisaged collections of GEL 1,424.4 million, by the end of the year. However during the year it proved that budget revenues would be higher than expected. The Government revised the budget revenue target twice and a new target was set at GEL 1,742.3 million, 22.3 per cent higher than the initial target. According to MOF preliminary estimates, State Budget receipts were actually GEL 1,772.9 million, that is 102 per cent of the revised target. Nominal growth of overall budget revenues over the year was 90 per cent. This indicates a real improvement in the management of public finance in Georgia and shows the results of efforts of the new administration

A comparison of 2004 State Revenues with planned and previous year figures is provided in Table 4.1.

28 GEORGIAN ECONOMIC TRENDS – 2005 No.1 GOVERNMENT FINANCE

Table 4.1: State Budget Revenues, 2004 (GEL million) Actual Growt revenues Per Actual Differenc h over Target as per cent in revenues e the cent of total year target

31 102 100 Total revenues and grants 1742.3 1772.97 190 Tax revenues 1293 1322.08 29 102 164 75 Non-tax revenues 246.59 259.94 13 105 333 15 Capital Revenues 81.4 67.01 -14 82 4 Revenues of Special state funds 413.3 437.03 24 106 174 25 121.26 3102 7 Grants 9123.94 256 Source: Ministry of Finance, GEPLAC calculations

The tax revenue target of the State Budget was set at GEL 1,293 million, 8 per cent higher than the initial target. Actual tax revenue receipts of GEL 1,322 million indicate a 102 per cent collection performance. However, it is more important that actual tax collection was improved over the year by 64 per cent. Revenues of the Special State Funds which are actually included in tax revenues above were GEL 437 million that is 106 per cent of revised target. Revenue mobilisation has sharply improved here. Collected amounts were 74 per cent higher compared to 2003 revenues.

Non-tax revenues were 14.7 per cent of total State Budget revenues (8.4 per cent in 2003). These mainly consist of: NBG profits transferred to the central budget; dividends of state owned enterprises; various fees; and penalties. The mobilisation of GEL 259.9 million under this category indicates highest growth in budget items over the year (233 per cent).

External grants received were GEL 123.9 million. Received amounts were 2.5 times higher compared to the previous year. Generally, owing to a loss of confidence by international community in the previous administration, grants and concessional lending were scarce over 2002 and 2003.

A detailed breakdown of central budget tax revenues is provided in Table 4.2.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 29 GOVERNMENT FINANCE

Table 4.2: Central Budget Tax Revenues, 2004 (GEL million)

Actual Growt revenues Per Actual Differenc h over Target as per cent in revenues e the cent of total year target

Central budget tax revenues 890.78 901.483 11 101 162 100 Income tax 16.38 16.39 010082 2 Profit tax 11.31 11.31 010096 1 VAT 589.6 598.68 9102162 66 on domestic products 257.1 258.99 2101119 29 on imports 332.5 339.69 7102226 38 Excise 164.53 161.91 -3 98 182 18 on domestic products 62.8 62.00 -1 99 283 7 on imports 101.73 99.91 -2 98 149 11 Customs duty 86 88.05 2102157 10 Other taxes 22.96 25.15 2110246 3 Source: Ministry of Finance, GEPLAC calculations

Tax revenues of central budget exceeded the target by 1 per cent, however comparison with previous year shows an impressive (62 per cent) improvement. As seen from the table, direct taxes were collected exactly as set by target. The reason for this is that income and profit tax receipts starting from Q3 2004 are directed to local budgets. Consequently they are no longer included in target and revenue figures of central budget. Annual targets were set according to actual collection in first half of the year. There was a sharp rise of revenues from direct taxes in consolidated budget. Continuous rise in profit tax receipts is observed from 2002 while for personal income tax this is the first significant improvement over the period. This is connected with global trend of legalisation of business activities as well as personal incomes.

The situation with indirect taxes has also improved considerably. Collection of VAT has improved significantly compared to the previous year by 62 per cent, while collection of excise duty improved by 82 per cent. Improvement in VAT collection is dominated by a 126 per cent improvement of VAT collection on imported goods while collection for domestic products has improved only by 19 per cent. Total amount collected under VAT heading was GEL 598 million and made up 102 per cent of government expectations. GEL 162 million was collected under excise duty heading and target was met at 98 per cent. For both imported and domestically produced excise goods collection has improved considerably by 49 and 183 per cent respectively. Collection of customs duty exceeded target by 2 per cent and has improved over the year by 57 per cent. Other taxes were collected at 110 per cent of target. However comparison with the 2003 figure show that collection has improved by 146 per cent.

The overall picture of tax collection is similar to that of the end of the previous quarter. All taxes were collected at levels substantially higher than those of 2003. This is in line with a general trend towards legalization of businesses and personal incomes. Improvement of collection of taxes on imports, VAT and excise is a result of administrative reform and reduced corruption in tax and customs structures. Domestic VAT has improved only by 19 per cent. It can be suggested that administration of a large

30 GEORGIAN ECONOMIC TRENDS – 2005 No.1 GOVERNMENT FINANCE number of domestic firms is a more complex task compared to administration of a relatively small number of import businesses and producers of excise goods. promotion.

Parliament voted in December 2004 on the new tax code proposed by the government. The new tax code abolished some low income generating taxes reducing the number of taxes from 21 to 8. VAT rate was reduced from 20 percent to 18 percent and the payroll tax rate from 33 percent to 20 percent. Flat 12 percent rate was set for personal income tax replacing marginal rates between 12 percent and 20 percent. The revenue loss from reduced tax rates is supposed to be offset by raising excise tax rates, broadening tax base (by reducing tax exemptions) and improved administration resulting in higher tax compliance. Another principal feature of new tax code is its administrative part which defines more precisely possible tax violations and penalties, and provides more flexible dispute resolution schemes including arbitration. Administration of tax collection has improved considerably even under the old tax code. This is a result of reform process in tax and customs departments. Improved institutional capacities will help the Government in proper application of the new tax code. Overview of reform in tax department is provided in Box 4.1

Box 4.1: Reform in tax department of the Ministry of Finance Stage I Reduction of staff Staff is reduced by 18 units January time term employment contracts are abolished Stage II liquidation of operating department Staff is reduced by 150 units April Merger of Roads fund Staff is increased by 162 units

Introduction of inspection of excise Staff is increased by 150 units payers

Stage III 864 staff members were examined Promoted 123 employees May-July Lowered in rank 99 employees

Stage IV Structural Reorganisation Number of inspections reduced August- from 72 to 12 September Staff is reduced by 421 units

Positions of land tax collectors were Staff is reduced by 988 units abolished

Throughout Training general training provided to 120 2004 staff members management training provided to 3 members

Source Ministry of Finance

GEORGIAN ECONOMIC TRENDS – 2005 No.1 31 GOVERNMENT FINANCE

STATE BUDGET DEFICIT The State Budget deficit was expected to be GEL 184 million. Actual financing of the State Budget deficit was considerably lower at GEL 150 million. Of this amount, GEL 21.5 million was borrowed from the National Bank and GEL 129.1 million was attracted from other sources, mainly investment credits of international financial organisations and by means of T-bills. However at the end of the year volume of issued T-bills was lower than at the beginning. Consequently actual financing of budget deficit by means of T-bills was negative. For detailed information on T-bill market developments see the Money and Finance chapter.

STATE BUDGET EXPENDITURES State Budget expenditures in 2004 amounted to GEL 1,924 million. The figure shows a 59.4 per cent increase over government spending of the corresponding period of 2003. A breakdown of State Budget expenditures by function is provided in the table below:

Table 4.4: State Budget Expenditures by Function, 2004 (GEL million) Growth Expenditures Per cent Expenditures Per cent over the 2004 in total 2003 in total year General Government 301.1 15.7 272.9 22.6 110.3 Defence 158.8 8.3 60.4 5.0 262.9 Law and order 239.6 12.5 107.6 8.9 222.6 Education 65.3 3.4 41.0 3.4 159.3 Health care 54.8 2.8 10.3 0.9 530.7 Social Security 450.8 23.4 287.8 23.8 156.6 Housing 2.8 0.1 3.1 0.3 89.0 Culture sports religion 39.2 2.0 25.0 2.1 156.8 Energy 78.4 4.1 36.8 3.0 213.2 Agriculture 29.2 1.5 14.7 1.2 198.1 Construction and mining 1.5 0.1 0.7 0.1 203.7 Transport and communications 68.0 3.5 47.9 4.0 142.0 Other economic activities 4.3 0.2 2.5 0.2 170.6 Other 430.0 22.4 296.2 24.5 145.1 Total 1923.6 100.0 1207.1 100.0 159.4 Source: Ministry of Finance; GET calculations

The largest expenditure item was social security. Growth here was 56 per cent. However goods and services purchased of GEL 363 million were 474 per cent higher compared to the previous year, while subsidies and current transfers were made only for 38 per cent of 2003 figure and amounted to GEL 85 million. This apparently reflects changes in accounting policies.

The second largest item of government spending is under the category Other, which makes up 22.4 per cent of State Budget expenditures. GEL 430 million was spent under this heading; a 45 per cent growth over the year. The amount is mainly comprised of interest payments on state debt of GEL 141 million (7,3 per state of budget expenses), subsidies and current transfers to lower level budgets of GEL 129 million and principal payments of foreign debt of GEL 150 million.

32 GEORGIAN ECONOMIC TRENDS – 2005 No.1 GOVERNMENT FINANCE

Spending on general government made up 15.7 per cent of total State Budget expenditures. This heading incorporates current expenses of government agencies (mainly salaries and goods purchased), as well as expenses of programmes financed by international financial organizations. Growth over the year was 10 per cent here (lower than average); GEL 301 million in 2004 against GEL 272 million in 2003.

Expenditures on law and order increased this year to 12.5 per cent of total budget expenses from 8.9 per cent in 2003. This is connected with reform processes in law enforcement structures and also with purchase of new equipment for the police. GEL 240 million spent for law and order was 223 per cent of corresponding 2003 spending.

Other functional categories were each less than 10 per cent of total expenditures. The higher than average growth was in financing of defence, education, health care, culture, energy, agriculture, construction and other economic activities.

Breakdown of State Budget expenditures by economic category is provided in the table below.

Table 4.5: State Budget Expenditures by Economic Category, 2004 (GEL million) Per Per Growth Expenditure Expenditure cent in cent in over the s 2004 s 2003 total total year Total 1923.6 100.0 1207.1 100.0 159 Salaries 200.3 10.4 138.5 11.5 145 Social contributions 32.3 1.7 6.9 0.6 466 Business trips 9.7 0.5 29.9 2.5 32 Other goods and services 604.2 31.4 218.2 18.1 277 Interest payments 140.9 7.3 168.7 14.0 84 Subsidies and current transfers 538.3 28.0 394.7 32.7 136 Capital Expenditures 166.7 8.7 9.1 0.7 1842 Net lending 231.106 12.0 241.133 20.0 96 Source: Ministry of Finance; GET calculations

Other goods and services were purchased for GEL 604 million compared to GEL 218 million spent in 2003. Two thirds of the amount was spent for social security needs. Growth of 177 per cent under this category was considerably higher, compared to overall growth of budget expenditures. 28 per cent of State Budget expenditures were subsidies and current transfers. A total of GEL 538 million spent under this category was 36 per cent higher compared to the corresponding period of the previous year. Transfers ware mainly of a social nature (transfers to local budgets and social security fund), however substantial amounts were spent under this heading for general government, education, law and order, and agriculture needs. GEL 77 million was a subsidy to the energy sector. 12 per cent of State Budget expenditures comes in the Net Lending category. The GEL 231 million spent was 4 per cent lower compared to 2003. From this amount, GEL 81 million were programmes financed by international financial institutions, while GEL 150 million was spent on repayment of state debt. Interest payments were GEL 141 million and made up 7.3 per cent of total State Budget expenditures against 14 per cent a year ago. The amount was 16 per cent lower compared to interest

GEORGIAN ECONOMIC TRENDS – 2005 No.1 33 GOVERNMENT FINANCE paid in 2003. Appreciation of Georgian currency contributed to lower interest payments. Salaries of state employees were paid at GEL 200 million, 45 per cent higher compared to the previous year. The growth rate of social contributions paid by the state as an employer was 366 per cent.

STATE BUDGET 2005

State budget 2005 has been adopted by the parliament. On the revenue side the target is set at GEL 1,946 million while spending is expected to be GEL 2,261 million. Government expects to get 9.7 per cent higher revenues compared to actual budget of 2004. Expenditure growth is higher (17 per cent). State budget deficit is expected to be GEL 314 million. Main sources of financing are long term investment credits by international financial organizations.

34 GEORGIAN ECONOMIC TRENDS – 2005 No.1

CHAPTER FIVE: MONEY AND FINANCE

2004 was a year of great importance for the Georgian economy. According to the estimations of the State Department for Statistics, the annual real GDP growth reached 8.4 per cent. The Government also achieved the improving of tax discipline and increasing of budget revenues in 2004. Reducing the share of the shadow economy resulted in the moving of money into the banking sector and increasing of deposits. During 2004, Lari denominated deposits increased by 168 per cent.

A noteworthy development of 2004 was a revaluation of the national currency against the US Dollar – the major currency of savings and capitalisation in Georgia. This factor offset the inflation pressure and also positively impacted the banking sector.

One of the main developments in the sector was the announcement of the acquisition of TbilUniversalBank by Bank of Georgia. One can assume that the market will push the banks to continue that trend during future years.

MONEY SUPPLY The improvement of tax collection and transfer to the official economy of a part of the shadow economy caused the significant growth of deposits denominated in Lari. During 2004, these increased by 168 per cent while Dollar denominated deposits grew by 25 per cent. During previous years the rate of increase of deposits denominated in US Dollars was always higher both in absolute and percentage terms (See previous GET editions). Also, the significant amount of money received as the result of increased collection of tax and non-tax revenues was accumulating on the Government accounts (The annual growth of the Government deposits was 256 per cent). The initiall 2004 Budget did not foresee such large revenues and expenditures. That was why a target schedule (a plan) of spending of the increased revenues did not exist. The collected amounts were accumulated on the accounts but have not been spent before the Government revised again the targets of the Budget (See GET previous edition. Government Finance) .

In addition, Georgia received GEL 58.6 million Structure Adjustment Credit (GEL 13.8 million in March and GEL 44.8 million in August) from the World Bank. That amount required conversion into the local currency. The market reacted to that by increased demand and creation of a shortage of the Lari, resulting in its appreciation in the nominal terms.

Commercial banks supplied foreign currency on the Tbilisi Interbank Currency Exchange (TICEX) to buy Lari. Within those conditions, the National Bank of Georgia (NBG) had to purchase foreign currency, but there was a significant risk to put more amounts into circulation than the market was able to absorb. If this had been the case, the revolving inflation effect of oversupply of the Lari would have become inevitable. In July, the NBG responded to this challenge by decreasing of reserve requirements for Lari deposits from 13 to 2 per cent (while for foreign currency deposits it remained 13 per cent). The reason was to transfer money from reserve accounts into circulation.

At the same time since the beginning of 2004, the NBG had been using credit and lately deposit auctions as instruments to maintain money supply.

During 2004 the NBG delivered about GEL 373 million through TICEX, satisfying the high demand for legal tender, but it also withdrew about GEL 24 million.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 35 MONEY AND FINANCE

Figure 5.1: Money Supply, December 2001 – December 2004

1,600,000

Deposits in foreign currencies M3

1,400,000 GEL deposits

Currency outside commercial banks

1,200,000

1,000,000

800,000 M2

GEL thousand GEL M 600,000 0

400,000

200,000

0 D Feb Apr Jun Aug Oct D Feb A pr Jun A ug Oct D Feb Apr Jun Aug Oct Dec ec- ec- ec- 01 02 03

Source: GEPLAC calculations based on data provided by the National Bank of Georgia

During 2004, as the result of restrained monetary policy but dramatically increasing Lari deposits (both Government and in commercial banks) M0 increased by 39.5 per cent, M1 by 44.3 per cent, M2 by 60.4 per cent, M3 by 42.6 per cent.

Table 5.1: Monetary Ratios 20032004 2004 2004 Dec Mar Jun Jul Aug Sep Oct Nov Dec Dollarisation Ratio % 86.13 83.17 82.27 81.21 78.27 77.89 78.00 76.68 74.32 Money Multiplier (M2) 0.91 0.92 0.91 0.96 0.94 0.95 0.99 0.93 1.01 Money Multiplier (M3) 1.83 1.88 1.81 1.93 1.77 1.77 1.86 1.74 1.81 MO/ GEL Deposits 5.14 3.73 3.68 3.26 3.06 3.10 3.03 2.77 2.68 Source: GEPLAC calculations based on data provided by the National Bank of Georgia

As the result of the rapid expansion of the Lari denominated deposits the dollarisation of the deposits and M3 money multiplier decreased. M2 money multiplier increased and became more than 1, which indicates that banks create new money from the Lari deposits. It was noteworthy that due to the weak position of the Lari as a mean of exchange and payment, new money was not created from the deposits placed with the commercial banks in previous years. However, due to the moving of money from outside of the banking system into banks, and increased competition between banks, it is likely that they will extend more credits in the national currency in the future, especially if the risk of the devaluation of the Lari stays low.

36 GEORGIAN ECONOMIC TRENDS – 2005 No.1 MONEY AND FINANCE

MONETARY INSTRUMENTS1

Interbank Credit and Deposit Auctions. The credit auctions play an important role as a source of credit resources for commercial banks and at the same time through this mechanism a surplus of money is absorbed when necessary. During 2004, the interbank credit auctions were widely used to regulate short term liquidity on the money market. Within the growing demand for the Lari the NBG put money into circulation through credits issued to commercial banks.

As the result of decreasing of reserve requirements in July, the level of liquidity in commercial banks increased. Banks were no longer obliged to freeze 13 per cent of attracted deposits, but just 2 per cent, on the NBG account. As the result of that, the demand for credit resources fell and there were no credit auctions in July and August. Starting from August 2004, there was a high supply of 7 and 28 days money from commercial banks. The NBG purchased GEL 173 million from GEL 174 million supplied by commercial banks and withdrew money from circulation.

To manage the liquidity the NBG launched a new instrument – deposit auctions. Initially there were only overnight deposits, but since September the NBG started to attracted deposits from commercial banks offering 10 per cent annual interest for longer maturities Besides the regulation of money supply, those auctions became a new investment possibility for the commercial banks, so that there was a demand for the longer maturities, instead of overnight deposits. These varied from 27 to 70 days with almost equal interest rate. In total, the NBG accepted GEL 58 million in time deposits. It seems likely that the banks will use this possibility to place the Lari deposits widely since they are a safe investment for them and their maturity profile is likely to become longer.

T-Bills. The primary T-Bills market was characterised by extending maturities and reduction of interest rates in 2004. It is well known that during the last several years the NBG and the Ministry of Finance pursued a deliberate policy toward the total replacement of direct crediting with a new approach of the issuance of Government Treasury Bills. The improvement of the economic situation and particularly fiscal position was taken by them as a signal to extend the maturity of T-Bills. The maximum maturity of T-Bills issued by the Ministry of Finance during in 2004 was 364 days, the minimum 140 days. The average weighted annual interest rate fell from 40 per cent in January to 14 in December. It is likely that the increasing of tax revenues and nominal appreciation of the Lari increased the credibility of the Government securities. It should also be noted that in July banks received more free liquidity because of cutting reserve requirements from 13 to 2 per cent, and the consequent excess of liquidity during that period was placed by banks into T-Bills. That was why the annual interest rate continued to fall. It is likely that within the tendency of falling of interest rates the involvement of commercial banks on the market could reduce and be substituted by non-bank investors. There were no T-Bills auctions in December while in November the Ministry of Finance repaid the outstanding debt of T-Bills by issuing new ones. There was no necessity of funding the Budget deficit by new issuing because of the high level of the Budget revenues.(See Government Finance Chapter). The volume of the issuing in 2005 will depend on how the new Tax Code will affect the level of the tax revenues. If tax collection is below target, the Ministry of Finance will have to resort to issuing new T-Bills.

1 The National Bank of Georgia implements monetary policy in accordance with the annual programme, which is the subject of approval by the Parliament. The main goal of the monetary policy is keeping the stable exchange rate of the national currency (Lari) and maintaining the price level within the annual inflation of 5-6 per cent.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 37 MONEY AND FINANCE

DOMESTIC INFLATION

Table 5.2: Monthly Consumer Price Index and Inflation, 2004 (December 2003 = 100) Price Index Inflation from previous month 2004 Jan 100.40 0.4 Feb 100.80 0.4 Mar 100.90 0.1 Apr 100.70 -0.2 May 100.74 0.04 June 99.13 -1.6 July 99.92 0.8 Aug 99.32 -0.6 Sep 100.81 1.5 Oct 102.43 1.6 Nov 103.76 1.3 Dec 107.39 3.5 Source: State Department for Statistics and GEPLAC calculations.

2004 annual inflation was 7.5 per cent. There were two main reasons for inflation exceeding the programmed target (5-6 per cent): the price rise of imports, particularly petrol and other fuel, and the slight depreciation of the nominal exchange rate of the Lari by the end of the year. The successful anticorruption measures resulted in the improvement of tax administration and collection. A part of the shadow economy was legalised, therefore imports became more expensive. There were increases of prices of excisable goods. According to the new Tax Code, the excises for petrol, fuel and tobacco have increased starting from January 1st 2005 that would affect prices as well. As the result of that, inflation expectations strengthened by the end of 2004. The appreciated nominal exchange rate of the Lari offset price increases in Q1-Q3 but the slight nominal depreciation of the Lari in Q4 2004, accelerated the inflation.

One could expect that the price increases for fuel and petrol will cause the increasing of prices in January 2005 for imported and domestic goods since these are a component of their costs. However, the strict control over money supply will restrain any dramatic price growth.

38 GEORGIAN ECONOMIC TRENDS – 2005 No.1 MONEY AND FINANCE

DOMESTIC FOREIGN EXCHANGE MARKET

Figure 5.2: USD/GEL Nominal Market Exchange Rate, 2004

2.1500

2.0500 Buy Sell

1.9500 USD/GEL

1.8500

1.7500

1.6500 1/6/2004 2/3/2004 3/2/2004 6/8/2004 7/6/2004 8/3/2004 1/20/2004 2/17/2004 3/16/2004 3/30/2004 4/13/2004 4/27/2004 5/11/2004 5/25/2004 6/22/2004 7/20/2004 8/17/2004 8/31/2004 9/14/2004 9/28/2004 11/9/2004 12/7/2004 10/12/2004 10/26/2004 11/23/2004 12/21/2004 Source: National Bank of Georgia

During 2004, there was a stable demand for the national currency. The NBG supplied it on the market while increasing its foreign currency reserves. As the result of that, the foreign currency reserves increased by 77 per cent during 2004. The Lari appreciated in nominal terms by 19.1 per cent during January 1st 2004 - September 7th 2004, which was reflected in depreciation of the US Dollar from USD/GEL 2.10 to USD/GEL 1.70 (official rate). On the later date, the market rate was USD/GEL 1.69. Within these circumstances, the NBG made a decision to start to supply market with the US Dollars, selling them on TICEX on September to hamper the further appreciation of the Lari. Against the background that the NBG has not supplied the foreign currency on the market since December 1998, the main aim of the US Dollar intervention was to show the market players that the NBG is ready to change its policy to keep the stability of the exchange rate of the Lari and avoid the inevitable possible fluctuation of it. The NBG issued USD 3.4 million in September and USD 9 million in December through TICEX. After that measure the nominal exchange rate of the Lari depreciated gradually and the official rate fluctuated within USD/GEL 1.7700 -1.8750 in Q4 2004. The annual appreciation of the Lari during 2004 was 12 per cent. No similar appreciation of the Lari is anticipated in 2005 because of the unforeseen budget revenues in 2005 are not likely. It means that the supply-demand process of the Lari will be more predictable. Moreover, the NBG probably will continue to widely use the monetary instruments to regulate money supply and nominal exchange rate.

BANKING The recent year’s experience shows a substantial progress in the banking sector of Georgia. The reform in banking system has been implementing by the National Bank of Georgia. As the result of the reforms the number of banks decreased from 228 by the end of 1994 to 21 by the end of December 2004, mostly at the expense of insolvent banks and those that could not meet the NBG’s special requirements. 13 of existing banks have foreign shareholders among which are EBRD, IFC and other international financial organisations. There are two branches of foreign banks - Azeri and Turkish.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 39 MONEY AND FINANCE

The process of bank enlargement continued. At the beginning of 2003, 80 per cent of banks’ assets and 85-90 per cent of banks’ deposits were accumulated by 8 commercial banks. As of December 31st 2004, six commercial banks accumulate 83 per cent of assets, 85 per cent of liabilities and 84 per cent of deposits. Each of them owns more than 5 per cent of assets of the whole banking system.

As of December 31st 2004 comparing with the year end 2003, the share of the total assets of the commercial banks to GDP increased from 15.7 per cent to 17.3 per cent, total loans from 9.2 per cent to 9.8 per cent, liabilities from 11.6 per cent to 13.5 per cent, deposits from 8.5 per cent to 9.9 per cent. The share of long term credits increased from 50 per cent in December 2003 to 61 per cent in December 2004.

The Government achieved the improving of the tax discipline and increasing of the budget revenues in 2004. Declining of part of the shadow economy resulted in the moving of money into the banking sector and increasing of the banks’ deposits.

A significant development of 2004 was a revaluation of the national currency against the US Dollar – the major currency of savings and capitalisation in Georgia. Georgian banks make loans mainly in US Dollars, because foreign credit lines and long-term Dollar deposits are the main components of their credit resources. However in 2004, with the strong national currency, loans made in US Dollars brought less interest in Lari terms.

One of the main developments of 2004 was the acquisition of TbilUnivesalBank by Bank of Georgia. One can assume that the market will push the banks to continue that trend during the next years.

The banks have been developing a segment of consumer credits. It is notable that the share of long- term consumer credits increased remarkably in 2004 while volumes of short term credits extended during the same period of time decreased. The average annual interest rates of those loans fell from 20.5 per cent in December 2002 to 19.3 in December 2004.

The volume of individuals’ deposits in the banks increased by 96 per cent in Lari and by 23 per cent in foreign currencies by December 2004, comparing with year-end 2003. It indicates not only the fact that the level of credibility of the commercial banks within the population has been increasing but the competition for clients among the banks as well. With the strong Lari in 2004 the banks attracted more deposits in the national currency. The companies’ current accounts grew faster (by 40 per cent during the same period) but it was a result of some transfer to the official economy from the shadow economy and strengthening the tax administration. Within the process of enlargement of commercial banks, the credibility of the largest banks will continue to increase that will raise the share of individuals’ deposits in the liabilities of these banks. Moreover, the individuals’ deposits will grow in those largest banks where consumer credits will be one of the priority of the lending policy.

The strengthening of the nominal exchange rate of the Lari led toward decreasing of interest income of commercial banks. Within these circumstances, banks will have to decrease their administrative costs and develop the other kinds of services. Some of Georgian banks already offer to their customers plastic card services and express money transfers. The competition for the clients will increase in the nearest future. Moreover, such services require innovation and application of new technologies that in turn is impossible without adequate capitalisation of the banks. Therefore, the above-mentioned factors will catalyse the process of takeover and merging in the nearest future. First of all, this process will apply to so called “pocket banks” that serve the relatively small group of shareholders and customers. The process of enlarging will lead some of banks toward

40 GEORGIAN ECONOMIC TRENDS – 2005 No.1 MONEY AND FINANCE universalisation that means that “pocket banks” will have to diversify their business or will be closed down. Along with the BANKING subchapter, in this issue we continue to analyse Georgian commercial banks. This has been motivated by high interest of a wide spectrum of readers in this sector. At the same time, it includes a component of observation of the Georgian business sector. The readers have an opportunity to receive not only data reflecting banks’ activity generally, but also that of particular cases. In this edition we provide the observation of JSC Bank of Georgia.

JSC Bank of Georgia:General Overview2 Bank of Georgia (BoG) was created on the base of State “BinSozBank” in 1993 and inherited one of the largest networks of branches both in Tbilisi and the regions. During the process of creation of a commercial banking system in Georgia, it remained one of the largest banks by assets and capital. A successful co-operation of BoG with certain foreign financial institutions played an important role in developing of the lending business and therefore maintaining its financial stability. Later on, those institutions became principal shareholders of the bank.

In 1998, BoG signed an agreement with EBRD for a USD 7 million credit line on financing of small and medium – sized enterprises (SMEs) and issuing micro loans. In 1999, there was a new agreement for USD 7 million signed on backing by EBRD of long-term letters of credit issued by BoG. In 2000, as the result of successful cooperation, EBRD expressed a willingness to become one of the principal shareholders of the bank. In 2003, EBRD allocated USD 4 million for financing SMEs.

In 1999, the bank entered an agreement with German Investment and Development Company (DEG)3 on allocation of EUR 1.5 million for SME development. In 2002, EUR 3 million were allocated for the same purpose. In addition, in 2000, BoG signed an agreement with DEG on a EUR 2 million credit line for development of a mortgage loans programme. In 2001 DEG purchased 12 per cent of shares of BoG.

International Finance Corporation (IFC) allocated USD 3 million for a mortgage loans programme in 2000 and USD 5 million for mortgage loans and SME development programmes in 2003.

Black Sea Trade and Development Bank4 allocated a credit line of USD 1.5 million for financing of trade deals in 2000. BoG signed an agreement with German AKA Export Finance Bank for EUR 5 million for financing exports from Germany in 2003 and with Czech Export Bank on USD 2 million for financing exports from Czech Republic in 2004.

In the end of 2004, Firebird Republics Fund5 became the third principal foreign shareholder of Bank of Georgia along with the EBRD and DEG.

Bank of Georgia has subsidiary companies constituting the Bank of Georgia Group. There are Georgian Card, Galt and Taggart Securities, Georgian Leasing Company, British-Caucasus Insurance Company6. The bank also has a share in a “National Credit Information Bureau LLC” - a credit bureau established in 2004 by a number of Georgian banks and foreign partners.

2 Source: JSC Bank of Georgia 3 Deutsche Investitions-und Entwicklungsgesellschaft 4 The Black Sea Trade and Development Bank (BSTDB) is an international financial institution established by Albania, Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania, Russia, Turkey, and Ukraine. With an authorized capital of SDR 1 billion (approx. 1,325 billion US Dollars), the Bank supports economic development and regional cooperation by providing trade and project financing, guarantees, and equity for development projects supporting both public and private enterprises in its member countries. 5 Firebird Republics Fund, created in April 1997, invests primarily in publicly traded equities of companies operating in selected former Soviet republics and early-stage Eastern European markets, including Bulgaria and Romania. 6 Georgian Card - initially it was French-Georgian processing centre GEORGIAN CARD. Galt and Taggart Securities founded in 2000 with TbilUniversalBank as one of the founders. Currently is a full-service

GEORGIAN ECONOMIC TRENDS – 2005 No.1 41 MONEY AND FINANCE

Acquisition Bank of Georgia announced the purchase of 100 per cent of the shares of TbilUniversalBank (TUB) in November 2004. This process will be completed by the end of April 2005. One could say that the Georgian market was grown-up for further enlargement of the banks: the paid-in capital requirements were administratively increased up to EU standards by the NBG, the competition for customers required further developing and sophistication of the banking business. There was also an outside factor: the banking sector in the Eastern Europe has been developed enough by foreign investors so that Georgian banks became a new investment opportunity (but small comparing with some other CIS countries).

TbilUniversalBank was a medium size profitable bank. Its share within commercial banks according to the loan portfolio was 2.3 per cent, deposits 3 per cent, assets – 2.4 per cent. The bank had shown GEL1.5 million net profit for first nine months of 2004. The bank specialised on small and medium businesses and consumer credits.

The specialisation of TUB and the network of branches of BoG created a precondition for successful development of consumer and mortgage loans. Moreover, TUB already constituted a financial infrastructure that included an investment-banking firm and a leasing company. That was an excellent condition for further universalisation of the bank. Both banks had the same software system that decreased the risk of the acquisition.

Indicators of business Bank of Georgia is one of the second bank by assets and total capital within the Georgian banking system. As of the end of October 2004, the share of loans issued by BoG in the total banking system was 20.7 per cent, the share of attracted deposits was 20.2 per cent. The largest share of loans is made to individuals (38 per cent), to trade and services – 32 per cent, to industry – 18 per cent and to other sectors -12 per cent. The bank has the leading position in the segment of individuals loans, since the average indicator for the whole banking system was 24 per cent (as of September 30, 2004).

The bank has 960 employees (including the branches and TUB). Eighty employees work in companies constituting the BoG Group. That is a very high indicator of job creation in the official sector in Georgia.

Bank of Georgia is the only joint-stock company which is fully listed on the Georgian Stock Exchange. The shares receive a price quotation and are tradable for the public through brokerage companies. In 2004, the bank had to write off loss provisions so the bank had GEL 7 million loss. . .However, the bank was acknowledged by potential investors as transparent and promising enough so that the price of shares did not decrease. Moreover, the price of shares increased from GEL 2 to GEL 5.6 during 2004. At the beginning of 2005 the price of shares exceeded GEL 6. There are very high indicators for Georgian company. The current target for BoG is to be transparent, profitable and large enough to attract new investors in 2007.

Innovation Development of retail banking is one of the main activities of Bank of Georgia. Nowadays, the bank has 17 ATMs (one of the largest networks in Georgia), 15 of which are located in Tbilisi. As of the end

investment-banking company. Georgian Leasing Company initially founded by TbilUniversalBank and American shareholders; British-Caucasus Insurance Company (BCI) one of the largest company on Georgian insurance market.

42 GEORGIAN ECONOMIC TRENDS – 2005 No.1 MONEY AND FINANCE of May 2005, the existing ATMs are planned to be replaced with new ones. By the end of 2005, their total number should be increased to 40. Within the frame of retail banking development, BoG issues mortgage loans, consumer loans and micro loans. The bank issues “express loans” up to USD 3,000 without collateral for clients who have sustainable income.

Development of retail banking also foresees the receiving of insurance services by retail customers. British-Caucasus Insurance Company will start to provide life insurance products in 2005 for customers.

One of the important segments of the retail service is internet banking and the services in real time via mobile phones. The budget of the bank in 2005 foresees the GEL 14 million investments into the network modernization and informational technologies.

The corporate banking foresees offering loans to large companies and SMEs, as well as investment banking, asset management, private banking and leasing and insurance services for companies.

Credit lines extended by foreign financial institutions, interbank loans and long-term deposits have been the main sources of the credit resources for Georgian commercial banks. Signing an agreement with the USAID, Bank of Georgia launched a new instrument of borrowing through issuing corporate bonds. The bank will issue the bonds amounting to USD 3 million. USD 1.5 million will be guaranteed by USAID according to the agreement. The proceeds will be invested in small and medium energy generating enterprises – a strategic sector of the economy.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 43

CHAPTER SIX: INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

During 2004, recorded external trade turnover was equal to USD 2,495 million, of which exports were USD 648 million and imports USD 1,715 million. Exports increased by 40 per cent, while imports increased by 62 per cent. Total trade averaged around 47 percent of GDP during in 2004. The significant increase in trade figures is the result of legalization of international trade.

According to balance of payments data, 46.6 per cent of registered exports of services in 2004 were revenues from transportation. Travel amounted to about 34 per cent of all services.

TRADE TURNOVER, TRADE BALANCE AND DIRECTION OF TRADE According to the SDS data, during 2004 recorded external trade turnover was equal to USD 2,495 million, of which exports were USD 648 million and imports USD 1,715 million. Exports increased by 40 per cent, while imports increased by 62 per cent. The total trade averaged around 47 percent of GDP during in 2004.

Table 6.1: Georgia: Trade Balance, 1994-2002 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Exports (million USD) 152 199 240 192 238 330 320 348 444 648 Imports (million USD) 395 687 942 880 602 651 684 731 1058 1847 Trade balance (million -243 -488 -702 -688 -364 -321 -364 -383 -614 -1199 USD) GDP(million USD) 1909 3072 3576 3620 2804 3043 3210 3302 3948 5300 Exports/GDP 8 6 7 5 8 11 10 10.5 11.2 12.2 Trade/GDP 29 29 33 30 30 32 31 32.6 38 47.1 Trade balance/GDP 12.8 15.9 19.6 19 13 10.5 11.3 11.6 15.5 22.6 Source: State Department of Statistics

Such significant growth in trade turnover is a result of anti-corruption measures implemented by the Georgian Government that caused legalization of import and export flows. It is worth mentioning that the Sarpi customs checkpoint is now under control of central Government, this gives possibilities to avoid illegal importation and fuller remittances from taxes and customs duties to the central budget.

At the same time in 2004 GDP grew by 8.4 per cent, which has facilitated trade as well. Despite the above mentioned changes the negative trade balance has grown and therefore the ratio of export coverage of imports decreased in the recording period in comparison with the previous year, from 42 to 35 per cent.

Georgia's economy is orientated towards the neighbouring countries. Georgia's most important trade partners are EU, CIS and Turkey. The share of the ten main trade partners in the total registered trade turnover was about 72.2 per cent. As indicated in Table 5.2, the main partners in 2004 were Russia, Turkey, UK, Azerbaijan and Germany. These countries together represented about 50 per cent of Georgia’s registered trade turnover. Trade with non-CIS has been expanding and is led by Turkey which has been an important source for imports of consumer goods. Exports to Turkey increased

GEORGIAN ECONOMIC TRENDS – 2005 No.1 44 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS from 13 percent of total in 1996 to 18.3 per cent in 2004. Exports have also been growing to more non-traditional markets such as the EU (UK, Germany and Italy), Switzerland, and the USA.

Table 6.2: Registered International Trade Turnover and Direction of Trade, 2004 (USD millions) International Trade Export (FOB) Import (CIF) Trade Turnover Turnover

USD Per cent USD Per cent USD Per cent

Total 648.8 100 1 847 100 2 495.8 100 Main partner countries (total) 513.9 79.2 1 313.2 71.1 1827.1 73.2 Russia 104.6 16.1 257.8 14.0 362.4 14.5 Turkey 118.7 18.3 202.3 11.0 321.0 12.9 UK 31.6 4.9 171.4 9,3 203.0 8.1 Azerbaijan 25.4 3.9 157.7 8.5 183.1 7.3 Germany 15.9 2.5 151.1 8,2 167.0 6.7 Ukraine 15.3 2.4 142.4 7.7 157.7 6.3 Turkmenistan 115.1 17.7 32.7 1.8 147.8 5,9 USA 21.3 3.3 111.0 6.0 132.2 5.3 Armenia 54.5 8.4 25.4 1.4 79.9 3.2 Italy 11.6 1,8 61.5 3.3 73.1 2.9 Others 134.9 20.8 533.8 28.9 668.7 26.8 Source: State Department for Statistics

In 2004, CIS and EU accounted 69 per cent of Georgia’s registered imports. Turkey accounted for another 11 per cent. Imports from USA were relatively small.

Figure 6.1: Georgia’s Registered imports by regions, 2004

Others 20% CIS 36%

Turkey 11%

EU 25 33%

CIS EU 25 Turkey Others

Source: State Department for Statistics

As for the export side, the main market for Georgian products is still the CIS. Turkey was a destination for 18 per cent of Georgian exports. The EU’s share was about 17 per cent.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 45 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

Figure 6.2: Georgia’s Registered exports by region, 2004

Others 14% Turkey 18% CIS 51% EU 25 17%

CIS EU 25 Turkey Others

Source: State Department for Statistics

COMPOSITION OF REGISTERED EXPORTS Table 6.3 indicates the main registered export items according to the Harmonized Commodity Description and Coding System (HS). The overall composition of Georgia’s recorded exports shows that the share of 12 product groups represented about 73.5 per cent of all registered exports of 2004.

Table 6.3: Composition of registered exports according to the Harmonized Commodity System By HTS 4-digit categories, 2004 USD Per cent thousands Total exports 648 756 100 Ferrous waste and scrap: ingots of iron or steel-7204 95 948 14.8 Aircraft, powered spacecraft and spacecraft launch vehicles - 83 686 12.9 8802 Wine of fresh grapes, including fortified wines -2204; 48 719 7.5 Ferroalloys –7202 42 510 6.6 Sugar- 1701 34 288 5.3 Waters, including natural or artificial mineral waters- 2201, 2202; 33 379 5.1 Copper ores and concentrates –2603 31 825 4.9 Mineral or chemical fertilizers, nitrogenous –3102. 28 756 4.4 Wheat -1001 22 817 3.5 Ethyl alcohol -2208 18 911 2.9 Gold, unwrought or in semimanufactured forms,-7108 18 830 2.9 Nuts fresh of dries -0802 17 691 2.7 Other 171 396 26.4

Source: State Department for Statistics

The composition of Georgian registered exports has changed in recent years. Export of ferrous waste and scrap (HTS chapter 7204) has been the leading export item in the last couple of years, the same was observed in 2004 with a value of USD 95.9 million. In comparison with the same period of the previous year, this item increased by USD 36 million. 86 per cent of export of ferrous waste and scrap goes to Turkey, the destination of another 5 per cent of these export was India. During the recording period, export of military aircraft (HTS chapter 8802) was USD 83.6 million. Export of ferroalloys (HTS chapter 7202) represented 6.6 per cent of all exports with a value of USD 42.5 million. USA (35 per cent), Russia (29 per cent) and Turkey (11 percent) are the main export markets for Georgian ferroalloys.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 46 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

Within the food and agricultural products category, wine, hazelnuts, mineral water and beverages are among major exports of Georgia. Wine exports have had a twelve-fold increase from USD 4 million in 1995 to USD 48.7 million in 2004. About 74 per cent of Georgia’s wine exports are to Russia, 9.5 per cent goes to Ukraine, although Georgia has begun to export small volumes to a number of other countries as well.

Other main export items are: sugar; waters, including natural or mineral waters, copper ores and concentrates; gold; and mineral and chemical fertilizers.

COMPOSITION OF REGISTERED IMPORTS Table 6.4 shows the largest imported product groups that together constituted about 43.6 per cent of total imports in 2004. Main commodity imports include: oil and gas products; wheat and flour; medical supplies; and sugar. The share of registered imports of oil products as well as wheat and flour has been declining.

Table 6.4: Composition of registered Imports according to the Harmonized Commodity System By HTS 4-digit categories, 2004 USD Per cent thousands Total imports 1 847 038 100 Petroleum oils and oils from bituminous minerals (other than crude) 186 450 10 – 2710 Motor cars and other motor vehicles- 8703 116 553 6.3 Petroleum gases -2711 80 080 4.3 Tubes and pipes - 7305 80 048 4.3 Medicines –3004 77 955 4.2 Wheat -1001 75 022 4.0 Sugar -1701 50 801 2.7 Flour -1101 48 756 2.6 Electrical energy – 2716 32 277 1.7 Turbojets, turbo propellers and other gas turbines, and parts 28 150 1.5 thereof -8411 Cigars, cigarettes, of tobacco or of tobacco substitutes -24 02 27 793 1.5 Other 1 043 153 56.4 Source: State Department for Statistics

GEORGIAN ECONOMIC TRENDS – 2005 No.1 47 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

EXPORT AND IMPORT OF SERVICES

Table 6.5: Registered Export and Import of Services, Q1-Q3 2004 (USD thousands) Q1-Q3 2004 Exports % Imports % Total services 390932.5 100 352014.5 100 Transportation 182205.2 46.6 144353.5 41.0 services - sea transport 42688.4 10.9 46532.2 13.2 -air transport 36539 9.3 46971.9 13.3 -railway transport 65175.8 16.7 18818.7 5.3 -auto transport 11880.9 03.0 32030.7 9.1 - pipe lines 25921.1 06.6 0 0 Travel 132595.8 33.9 110057.8 31.3 Communications 13433.7 3.4 11440.4 3.2 Insurance 7535.2 1.9 28950.6 8.2 Other 55162.6 14.1 57212.2 16.3 Source: State Department for Statistics, Balance of Payments

The intangibility of services makes them difficult to measure accurately. Unlike trade in goods, trade in services involves no packages with documentation showing an internationally recognized commodity code.

Considering the natural difficulties of measuring trade in services, the share of unrecorded trade is higher in services than in the case of trade in goods. However, measurement in trade in services has slightly improved, for instance in comparison with the same period of the previous year in Q1-Q3 2004 exports of services increased by 18.1 per cent and imports of services increased by 22 per cent, which is partially a result of improvement in measuring the trade in services.

According to balance of payments data1 (see Table 6.5), 46.6 per cent of registered exports of services in 2004 were revenues from transportation. Travel amounted to about 34 per cent of all services. Analysing figures of trade in services shows that during 2004 the export of services has increased by USD 60 million in comparison of the same period of the previous year.

Box 6.1: POLICIES

European Communities Trade Policy

In response to the Tsunami disaster, the European Commission has today proposed to accelerate the entry into force of the new EU preferential trade regime for developing countries. The new Generalized System of Preferences (GSP) will now come into effect on April 1. The focus of the new regime is on developing countries most in need such as the Maldives, Sri Lanka, Thailand and Indonesia. The EU GSP, already by far the most generous in the world, provides for further tariff concessions, in particular in the clothing and the fishery sectors. Its benefits will extend to all the countries affected by the recent Tsunami.

In parallel, the European Commission is working on simplifying and, where appropriate, relaxing the rules of origin to allow countries to take fuller advantage of the benefits of GSP.

1 By the time this issue of GET was ready for publication, only Q1-Q3 2004 balance of payments data were available.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 48 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

European Commissioner for Trade Peter Mandelson said: “By accelerating this boost to developing countries’ market access, the European Union has acted quickly to provide relief for countries affected by the recent tsunami. By lowering tariffs for poorer countries, we are extending benefits to all developing countries.”

Background

The EU GSP is the preferential trade regime the EU has been granting to developing countries for the last 30 years. It is worth more than €52 billion in trade flows, and is by far the most important preferential trading regime in the world, providing more market access for developing countries than the preferential access schemes of the US, Japan and Canada combined. Following the Tsunami of December 2004, the European Commission identified the rapid entry into force of the new EU GSP as a way to aid countries affected by the disaster. The Commission is proposing to bring forward its entry into force by three months, to 1 April 2005 . The acceleration has already been welcomed by EU Member States and the European Parliament.

Through tariff concessions the new regime will open about € 3 billion worth of new trade flows for countries affected by the tsunami. In the new GSP, all fishery products will benefit from tariff cuts. In the case of Sri Lanka, which will benefit from the special incentive scheme aimed at encouraging sustainable development and good governance (GSP Plus), this implies that about 90 per cent of exports, including clothing items, will enter the EU at zero duty. In the case of Thailand , the new concessions will apply to extremely sensitive products such as shrimps. Indonesia and India will benefit from new tariff cuts for their textile and shoes sectors respectively.

Tariffs for Thai shrimp will fall from 12 per cent (Most Favoured Nation rate) to 4.2 per cent. Tariffs for Indian textiles and clothing will be set at 9.5 per cent instead of 12 per cent under MFN. Tariffs for shoes from Indonesia and Thailand will drop from 17 per cent to 13.5 per cent. Source: EU Commission

EUROPEAN NEIGHBOURHOOD POLICY: COOPERATION IN THE FIELD OF TRADE ENP, sets objectives for partnership with neighbouring countries based on commitments to shared values and economic reforms, including liberalization of trade for gradual participation in the Internal Market and promotion of the free movement of persons, goods, services and capital.

The ENP foresees greater market opening in accordance with the principles of the WTO. The ENP provides ways and means to deepen trade liberalisation and regional integration. For the Eastern neighbours, like Georgia the priority remains fuller implementation of the trade-related provisions of the PCA, along with continued economic reform.

Georgia became a member of the WTO in June 2000. Participation in the WTO has encouraged integration with Europe. Georgian trade and exchange systems rank among the most liberal of the transition economies. Georgia has a liberal foreign exchange system with no restrictions on payments and transfers for current international transactions. The IMF’s trade restrictiveness index (TRI) for Georgia is currently on a scale of 1 to 10. Tariffs on the majority of import items were reduced, according to the so-called “sectoral initiatives” that Georgia had joined. Those initiatives cover chemical products, timber and paper products, rubber, still, agricultural and medical equipment, IT products, civil aircraft, furniture, fish and fishery products and vegetable.

In terms of market access arrangements, Georgia gets MFN treatment by way of its WTO membership. Additionally, the EU, USA, JAPAN, Canada, Switzerland, and Turkey granted GSP preferences to the Georgian products.

Georgia-EU’ Partnership and Co-operation Agreement (PCA), entered into force in 1999. Georgia enjoys under the PCA, MFN treatment with the EU before it became a WTO member. Since Accession to the WTO from June 2000 Georgia received permanent, unconditional, MFN status from all the WTO

GEORGIAN ECONOMIC TRENDS – 2005 No.1 49 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS members. After EU enlargement, EU-Georgia Partnership and Cooperation Agreement (PCA) has been extended to the new Member States.

Georgia benefits from the EU Generalized System of Preferences (GSP) and has requested inclusion in the list of beneficiaries for the GSP social incentive scheme. The global utilization rate (effective GSP imports compared to eligible imports) has increased from 52 per cent in 2000 to 67 per cent in 2003, which is above average.

Georgia has signed number of bilateral free trade agreements among the CIS members. Georgia has now six free trade agreements (FTAs), one each with Armenia, Azerbaijan, Kazakhstan, Russia, Turkmenistan, and Ukraine. Georgia is not a party to any FTA outside the CIS. Georgia is a member of GUUAM free trade agreement with Ukraine, Moldova and Azerbaijan.

Framework for cooperation in the field of trade The ambitions of the European Neighbourhood Policy must be matched by adequate financial and technical support. The following framework of concrete steps can be suggested as the instrument for future EU/Georgia cooperation in the field of Trade:

(1) Concrete steps to be taken to ensure that both the EU and Georgia derive the full benefits of the provisions on trade contained in the existing Partnership and Cooperation Agreement. Legislative and regulatory approximation has to be pursued on the basis of commonly agreed priorities, focusing on the most relevant elements of the acquis for stimulation of trade and economic integration, taking into account the economic structure of the Georgia.

(2) Regarding trade in goods, steps should be taken to be ready to request inclusion in the list of beneficiaries for new special GSP+ scheme2. It covers around 7,200 products which can enter the EU duty free. Georgia must meet a number of criteria including ratification and effective application of 27 key international conventions on sustainable development and good governance, in addition, Georgia needs to demonstrate that it is a small beneficiary under the GSP and that its economies are poorly diversified (and are therefore vulnerable). Additional preferences are immediately granted to developing countries that have ratified and effectively implemented the 16 core conventions on human and labour rights and 7 (out of 11) of the conventions related to good governance and the protection of the environment. At the same time beneficiary countries must commit themselves to ratifying and effectively implementing the international conventions which they have not yet ratified. In any case, the 27 conventions have to be ratified by the beneficiary countries by 31 December 2008.

In the field of trade in goods, some bilateral agreements could be signed, for instance in the area of wine industry, natural and mineral waters, etc. Conclusion of bilateral agreement on trade in wine could be one of them. This future agreement could cover oenological practices and processes and compositional requirements for wine; reciprocal protection of wine names and related provisions; certification requirements.

Steps should be taken to improve administrative co-operation, and ensure the gradual elimination of non-tariff barriers to trade and the development of appropriate infrastructures. The movement of industrial products can be facilitated through convergence with the Union’s laws and regulatory structures. This could be supplemented by the conclusion of Agreements on Conformity Assessment

2 In 20th October 2004, the European Commission has adopted a proposal setting out the details of the EU system of trade preferences (GSP) for the period 2006-2008.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 50 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS and Acceptance of Industrial Products (ACAAs) between the Community and Georgia, building on experience with the current initiative towards neighbouring Mediterranean countries.

(3) Further legislative approximation in the area of customs, along with capacity-building, including computerisation, will also contribute to trade facilitation.

(4) For agricultural products, convergence with EU standards for sanitary and phyto-sanitary controls will greatly enhance reciprocal trade between the partner countries and the EU. Exchanging information and close co-operation in international organisations responsible for the control of animal and plant diseases and improved sanitary conditions to protect consumers are priorities. Georgia needs to improve administrative capacity to ensure levels of food safety to enable them to access EU markets.

Regulatory convergence in key trade-related disciplines will bring economic benefits, both in terms of reforms in Georgia, and in terms of enhanced investment climate. In particular, increased levels of effective protection of intellectual and industrial property rights as well as effective enforcement of such rights, along with regulatory convergence and improved market access in the area of public procurement are likely to have significant effects on economic development and on investment levels. Actions could also be taken to increase harmonisation and the sustainability of the statistical systems. Such steps will also benefit domestic markets as well as facilitating trade.

GEORGIAN ECONOMIC TRENDS – 2005 No.1 51

CHAPTER SEVEN: PRIVATISATION

The Government has launched a new phase of reforms and privatisation is a crucial component of this process. It will play a distinctive role in the economic development of the country. More than 15,000 enterprises have been privatised since the beginning of the privatisation process in 1992. The number of the remaining state owned enterprises is quite substantial - there are approximately 1,800 small, medium and strategically important enterprises with state participation, with over 180,000 persons employed. Major trends of the current privatisation policy are a quick transfer of the remaining enterprises into private ownership and a radical deregulation of the economy to mobilise private investments. The Government is planning to attract foreign investors and create a more favourable environment for business in the country. The opening up of the Autonomous Republic of Achara, where very little privatisation has taken place in the past years, will have a positive effect on the overall process. In 2005, Georgia will become a more attractive country both for domestic and international investors due to the parameters of the new Tax Code. The Ministry of Economic Development has published a list of 372 enterprises where the state is offering its share for sale by auction. This process of privatisation should be completed in 18 months. To ensure impartiality and transparency of the privatisation process and world wide access to information, the Ministry of Economic Development distributes information about privatisation by its official publication and other newspapers and also by its web site (www.privatization.ge).

MEDIUM AND LARGE ENTERPRISE PRIVATISATION Privatisation of medium and large enterprises (MLE) that are still in state ownership remains a problematic issue. The experience of recent years showed that the ways used for privatising large Georgian enterprises are not bringing results. The enterprises are oversized. The assets are in poor condition. Indebtedness, overstaffing, and influence from different interest groups has also aggravated the situation. It is obvious that in terms of privatisation of the MLEs some serious steps and measures need to be taken. In such sectors as energy, telecommunications, manufacturing and transport many assets have become a heavy burden for the economy and urgently need restructuring, rehabilitation, or liquidation.

The Ministry of Economic Development has published a list of 372 enterprises where the state is offering its share for sale by auction. The opening up the Autonomous Republic of Achara for privatisation prompted the introduction of 26 enterprises from the tourism sector onto the privatisation list.

Tbilisi’s 330 room Iveria Hotel was sold to German investors for USD 2.3 million. The building had previously been temporary housing for over 1,000 refugees from the civil war. Each of these 270 families received USD 7,000 to find new accommodation. The London-based Salford Fund has also expressed interest in one of the capital’s hotel; the 30 year-old Hotel Adjara has become the object of their curiosity. Once again, the 239 room hotel houses a number of refugee families, and once again

52 GEORGIAN ECONOMIC TRENDS – 2005 No.1 PRIVATISATION each family will receive USD 7,000 as part of the purchase. Hotel “In-tourist” was sold for USD 3 million.

JSC Tbilaviamsheni was 100 per cent state owned. However, in 2003, the plant was transferred into operation by the company founded by the old management. It was likely that the majority shareholding will be purchased by this company. Some assets which are not directly related to the plant such as a parking lot, club, unfinished construction and two warehouse buildings are excluded from the charter capital of the enterprise and are to be sold separately. On 3 November 2004, the joint stock company Tbilaviamsheni aerospace manufacturing plant was sold to Tbilaviamsheni LLC, which paid USD 67 million for the enterprise.

Two Russian and one Georgian-Russian company expressed their desire to acquire the Joint Stock Company Elmavalmshenebeli. The state was selling 51 per cent of the enterprise. The remaining 49 per cent of the company stocks has been privatized by the former Ministry of Property Management. Diamant and Dema Computer Limitted and Radox are the companies competing for the controlling shares of Elmavalmshenebeli. The winner of the tender was Dema Computers Limited that paid about USD 4 million for the stocks.

Four companies were interested In the purchasing of the shares in Chiaturmanganumi and Vartsikhe Hydro Power Station. Particularly, Ukrainian company Inter-Pipe, Russian – Eurasia Holding, Georgian Ferro and British Moravia Georgia Corporation. The winner in the tender was Russian Rurasia Holding and Georgian Ferro these companies will pay USD 132 million for the stocks of Chiaturmanganumi and will establish a holding company.

In many enterprises the valuation and auditing process is not completed. Also it is necessary to establish clearly the responsible authorities for every single asset to be privatised. The identification of the responsible bodies for each of the enterprises will exclude future possible claims of different parties, which would hamper the smooth and proper privatisation process.

The Government has to be more decisive in restructuring the enterprises and implementing liquidation/bankruptcy procedures to make these enterprises attractive for foreign investors. Bankruptcy procedures lead to reorganisation/rehabilitation or liquidation of an insolvent enterprise. Liquidation of unviable, unattractive enterprises is a logical end of the painful privatisation process and it has benefits to the economy: some taxes and other third party payment arrears will be paid. Although in some MLEs liquidation/bankruptcy procedures have been started, none of the largest enterprises has been liquidated yet. In some of them rehabilitation programmes were under way. If rehabilitation is successfully implemented, the enterprises will be able to service their debts, improve overall performance and become efficient. Privatisation of efficient enterprises will be much easier and will result in larger revenues to the state. In some cases it is unrealistic to achieve efficiency; however, the decision to liquidate these assets needs a stronger political will.

A better understanding of the situation in each particular case of the large enterprise is needed to achieve their privatisation by a sound investor, which will be able and eager to operate them, make necessary investments, and generate profit. Liquidation of the large enterprises will save viable parts of them and stop further generation of debts. Both outcomes will benefit the overall economic situation in the country.

In the law on state budget 2004, privatization receipts of GEL 81.4 million are envisaged. The Ministry of Economic Development has already mobilized GEL 71.7 million as a revenue of the consolidated budget of Georgia (among them 67 million were revenues of the central budget).

GEORGIAN ECONOMIC TRENDS – 2005 No.1 53 PRIVATISATION

The Draft Law of Georgia on State Budget 2005 stipulates that privatization gains in central budget will be GEL 94.2 million. We should take into consideration the fact that in 2005 receipts from privatization will exceed targeted parameters of the budget by about GEL 200 million. The incremental revenues will be utilized to finance activities in the following sectors:

- Defence - GEL 80 million

- Education - GEL 17 million

- Energy sector – GEL 40 million

- Pension reform – GEL 24 million

- Foreign debt service - GEL 39 million

SMALL ENTERPRISE PRIVATISATION The privatisation of small enterprises in Georgia started in 1993. Privatisation of large enterprises is still underway (telecommunications, energy, manufacturing sectors) and presumably there will be new small enterprises created as a result of that restructuring. Thus the privatisation process of small enterprises may last longer. The acquisition of small enterprises by insiders is still widespread, which in many cases diminishes government revenues and retards efficient operation of the small enterprises. However, the existing resale market seems to be effective enough to ensure the acquisition of assets by more capable owners and increasing competition puts pressure on companies to increase efficiency.

Due to reorganisation of the privatisation offices in the regions, the information is not complete. The process of the data supply is aggravated also by the fact that the most of the small enterprises are under municipal ownership and it takes extra effort to collect and to combine these data in the centralised data processing system.

Most small enterprises are in the trade and service sectors - 32 and 46 per cent respectively. Enterprises were privatised in all regions of Georgia during 2004. In the Autonomous Republic of Achara the privatisation process had been stalled for years. Recent developments seem to have had a positive effect on the opening up of the region for privatisation. In terms of small enterprise privatisation, a substantial increase should be expected. Local entrepreneurs have already expressed interest in privatising small enterprises. Increased competition in Achara will become a driving force for the future development of the region.

ENERGY There was no major progress in privatising the assets of the energy sector in 2004. However, the Ministry of Energy is preparing the privatisation process of 5 electricity generator companies in Imereti region, 29 gas distribution companies and some other assets. All these assets are included in the privatisation list. The actual privatisation is scheduled for 2005; however preparatory work has started. This includes grouping of the assets into lots, which will make them more attractive for the investors. For example, the 5 electricity generator companies in western Georgia will be reorganised into one juridical entity. The Government is considering a possibility to take a pre-privatisation loan to create basic improvements in the Tbilisi gas distribution company TBILGAZI, to show a positive trend in collections and to sell it. Currently TBILGAZI has technical and commercial losses of approximately 75 per cent of consumed gas.

The privatisation of the energy assets is a part of a short-medium term action plan of the Ministry of Energy. The plan is to be implemented in 18 months and aims to drag the energy system out of crisis. Successful implementation of the action plan will enable further development of the system.

54 GEORGIAN ECONOMIC TRENDS – 2005 No.1

CHAPTER EIGHT: LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET

LABOUR MARKET Although the economic situation in Georgia is undergoing a certain revival and there is anecdotal evidence of businesses emerging that should bring about at least some new jobs, the labour market situation still remains largely unfavourable and unstable. Whilst unemployment rate figures are generally in line with those for transition economies and, if taken alone, may even suggest optimistic conclusions for labour market trends, the overall picture is flawed by persistent underemployment, widespread hidden and disguised unemployment and majority of salaries falling way below the minimum subsistence level.

Most of the working age population is either underemployed or non-employed. New stable jobs are rarely created and very few of them are relatively stable. The labour market is dominated by agricultural subsistence self-employment. A large portion of the employed are engaged in unofficial and unregistered low-paying largely self-employment activities. Just around 20 per cent of the working age population have waged or salaried jobs and the vast majority of those employed are hardly earning a living. All the above-mentioned long-term labour market problems adversely effect the poverty situation that is continuously reflected in painful declines in living standards experienced by large numbers of households.

UNEMPLOYMENT The analysis of economic status of the population below is based on the data of the SDS on-going Household Survey1. These internationally comparable sets of figures, being calculated according to the ILO principles and methodology (e.g., registration figures cannot be considered a good source of information in internationally adopted terms, i.e., according to the ILO definitions2), yield a great deal of interesting information on the labour market. The estimates derived from the survey figures are instrumental for tracking changes in the labour force, employment and unemployment, labour force participation rates, and the population outside the labour force.

There is no doubt that the household survey results are indispensable for following the overall trends in the labour market and household income. However, a lot remains beyond the figures and beyond the survey. In accordance with internationally applied methodology, the survey does not take into consideration the size of remuneration. In addition, it does not cover those engaged in the informal economy, nor does it reflect the full extent of underemployment and poverty.

According to the SDS integrated survey results, the national unemployment rate calculated by the ILO “strict” methodology as of the end of Q3 2004 (the latest available sets of figures at the time of working on this GET issue), compared to a year before, grew by 2.6 percentage points to 13.1 per cent, while the unemployment rate calculated by the “loose” methodology grew by just 2.3 percentage points to 15.2 per cent. The gap between the two measurements of unemployment rate, compared to a year before, therefore, fell, though very insignificantly, that suggests that more people were engaged in

1 The continuous Household Survey has been implemented by the SDS since Q3 1996 with the financial support of the World Bank and in co-operation with Statistics Canada. The SDS was implementing the Labour Force Survey (LFS) in 1998-1999 with the assistance from the ILO and the UNDP and figures for those years come from the LFS (see Statistical Appendix Table A7.1). 2 In accordance with the ILO definition, employment is based on any work done for an hour during the reference period (a week).

GEORGIAN ECONOMIC TRENDS – 2005 No. 1 55 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET active job search, i.e., were returning to the labour force – a trend that could be observed in recent years.

There apparently was more hope and new expectations of finding a job on the part of the unemployed associated with new reforms in Q4 2003 and Q1 2004, that was reflected in higher participation rate figures in annual terms. However, as neither integrated household survey figures nor the anecdotal evidence indicate any massive better job opportunities on the labour market, and only modest part of these expectations were realised, the participation rate started falling and the unemployment rate resumed growing in Q2 and Q3 2004, compared to a year ago. At the same time, jobs have been lost both in the public sector and in the informal sector. Both former civil servants who lost their jobs as a result of government restructuring and former self-employed vendors selling goods in the street around the main market in Tbilisi who had to formalize their activities in line with new requirements, were likely to become active job seekers at the end of 2003 and in the beginning of 2004. The staff cuts in public sector persisted throughout 2004.

While the participation rate resumed its growth in Q2 2004 after having fallen in Q1 2004 and the unemployment rate on the contrary, was reduced, these were only seasonal changes, and annual comparison suggests that fewer people were actively looking for a job, i.e., some unemployed were likely to abandon the labour force. In Q3, however, the participation rate remained unchanged in quarterly terms and fell by 1.9 percentage points to 65.8 per cent in annual terms and the unemployment rate grew drastically in both quarterly and annual terms. Although such a fall is quite essential, it is still in line with the last years’ trend and participation rate is still relatively high in Georgia that may be a reflection on the one hand of the extremely hard household income situation that urges those outside the labour force to start job search, and on the other of better prospects of finding a job emerging on the labour market that affect the decision of the former “discouraged” workers to actively engage in job search again. And last, but not least, while pensions are growing, the current pension rate (see further in this Chapter) is still too low to live on, and pensioner job seekers also contribute to high participation rate.

Table 8.1: Economic Status, Q1 2003 – Q3 2004 * (thousands) 2003 2004 Q I Q II Q III Q IV Q I Q II Q III Total population over 15 years old 3, 082 3, 060 3, 132 3, 134 3, 143 3, 122 3, 181 Total economically active population (labour force) (1) 1, 941 2, 037 2, 120 2, 103 2, 007 2, 054 2, 093 Total economically active population (labour force) (2) 2, 025 2, 095 2, 170 2, 160 2, 089 2, 106 2, 146 Employed 1, 679 1, 805 1, 897 1, 877 1, 746 1, 809 1, 819 Hired 594 604 640 637 620 608 578 Self-employed 1, 083 1, 200 1, 255 1, 240 1, 125 1, 201 1, 239 Unemployed (1) 262 233 223 226 260 245 274 Unemployed (2) 345 290 273 283 342 298 327 Total population outside the labour force (1) 1,141 1,023 1,002 1, 028 1, 130 1, 065 1, 086 Total population outsde the labour force (2) 1,057 965 952 971 1,047 1,013 1,032 Unemployment rate (per cent) (1) 13.5 11.4 10.5 10.7 13.0 11.9 13.1 Unemployment rate (per cent) (2) 17.113.912.913.116.414.115.2

Labour force participation rate (1) 63.0 66.6 67.7 67.1 63.9 65.8 65.8 Labour force participation rate (2) 65.7 68.5 69.3 68.9 66.5 67.5 67.5 Self-employment share in total labour force 55.8 58.9 59.2 59.0 56.1 58.5 59.2 Self-employment share in total employment 64.5 66.5 66.2 66.1 64.4 66.4 68.1 Source: Data from the SDS Household Survey Note: (1) ILO Standard (or “strict” methodology), i.e., excluding “discouraged” workers. (2) ILO “Loose” methodology, i.e., including “discouraged” workers. * At the time of writing this issue of GET, the latest available results of the on-going Integrated Household Survey were those for Q3 2004. For more detailed tables and 1998-2000 figures see Statistical Appendix Tables A7.1.1 and A7.1.2.

56 GEORGIAN ECONOMIC TRENDS – 2005 No.1 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET

The rural unemployment rate is usually a way below the urban one (almost 8 times lower in Q3 2004) and the national one (about 4 times lower). In line with the usual trend, in Q3 2004, the urban unemployment rate was not comparable to the rural one: 26.8 and 30.4 respectively by the “strict” and “loose” standards (28 per cent and 30.8 per cent respectively in Tbilisi). The rural unemployment rate, as always, was way below that in the cities and distorted the national figures – at 3.5 per cent by the ILO “strict” methodology and 4.2 per cent, by the ILO “loose” methodology.

The existing Law on Employment, finding its reflection in the survey questionnaires, contributes to misrepresentation of the unemployment situation in the villages and in the whole country as well. Considering each farmer owning 1 hectare or more of agricultural land, or his/her family member as self-employed artificially excludes majority of rural dwellers from the category of unemployed. In addition, many of those living in villages are engaged in unpaid family work and are counted as agricultural self-employed, a category accounting for the majority of total employment. Thus, both the rural and national unemployment rates are automatically reduced, the participation rate is raised, and the overall labour market situation appears distorted. In reality, while land is the basic source of income for most rural households and provides them with a subsistence minimum, many village dwellers, especially those whose lot of land is not very large and those who cannot afford to work their land, are hardly earning a subsistence.

The vast majority of the rural population comprises elderly people: younger people migrate to cities in search of some employment. While some of them are more successful and sometimes even manage to help their relatives in villages, others join the urban unemployed. The number of urban “discouraged” workers also surpasses that of the urban unemployed, and if some of the country dwellers can hardly earn subsistence, the “discouraged” unemployed in the cities are left without any income whatsoever.

Only a modest portion of the unemployed usually bother to register: registered unemployment at 53,400 accounted for 16.5 per cent of the “strict” measured and 14 per cent of the “loose” measured unemployment as of the end of Q3 2004 (47,900 as of end of Q4 2004). For the majority of the jobless, the registration procedure is not worth going through since the chances of finding a job through registration remain minimal and the monthly benefit, though recently raised from GEL 14 to GEL 20, still is a poor incentive for getting registered. At the same time, some of the registered unemployed are very likely to be engaged in unofficial activities. Therefore, this indicator seems highly unreliable.

Although, according to anecdotal evidence, there are expectations of better employment prospects associated with the new reforms, there is still a frequent incidence of underemployment, long-term unemployment, low remuneration, an overwhelming agricultural subsistence self-employment and a large number of pension age workers, who have to work to compensate for their albeit increased, but still token pensions.

In a situation where the unemployed are not covered by sound unemployment insurance schemes or any other form of support, providing at least a subsistence minimum, they are especially at risk both from an economic and social point of view. Prolonged periods of unemployment bring with them not only loss of income, but also diminishing employability of the job-seeker. Long-term unemployment persists, and being out of practice results in loss of qualification and access to information on available jobs. It contributes to growing poverty and leads to social isolation and social exclusion. Both the economic and social dimensions of this persistent and serious problem are enormous and have to be

GEORGIAN ECONOMIC TRENDS – 2005 No.1 57 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET tackled with policy measures and programmes aimed at raising the employability of the long-term unemployed and reintegrating them into the labour market.

EMPLOYMENT After having declined since 1998, the numbers of hired employment showed growth in annual terms in Q1 2004 and remained practically unchanged in Q2 2004 compared to a year ago. In Q3 2004, however, the number of hired employees fell in annual terms, reflecting massive staff cuts that took place over the year in the public sector on the one hand, and slow growth and poor job creation in the formal sector on the other. Certain measures are being taken and reforms are underway to improve the business environment (e.g., new Tax Code has been passed – see Chapter III), however, there is still a long way to go to encourage a more extensive job creation in the private sector that still remains quite limited due to an unfavourable business climate. In spite of all the above-mentioned, wage and salary earners accounted for almost 32 per cent of total employment in Q3 2004, of which 21 per cent were state sector employees. Irrespective of the contraction of the state sector it still accounted for over 65 per cent of dependent employment in Q3 2004 and still remained the main supplier of waged and salaried jobs.

Though largely the staff cuts associated with reorganisation of the Government may have been well reasoned in order to raise efficiency of civil servants, this process will have to be offset by job creation in other sectors. Therefore, if the downward trend of hired employment is to be reversed, more steps are to be made to make the business environment more favourable and stimulate job creation in the private sector.

Though dependent (or hired) employment hardly accounts for one third of the overall employment, it is still largely perceived as a conventional “permanent employment”, though anecdotal evidence suggests that many hired employees, especially those in the state sector, where salaries have been mostly low, were also engaged in self-employment, or some other alternative employment as a secondary activity, most of which was in the informal sector. Active employment policy, including training and re-training and other special policy measures will be likely to be needed to facilitate employment of those former civil servants, who will fail to be absorbed by the private sector, mostly due to their low competitiveness on the tough labour market.

Self-employment numbers, however, in contrast to the usual upward trend of the recent years, followed the same pattern, as hired employment in 2004 and after being on the rise in Q1, remained stable in Q2 and fell in Q3 in annual terms too. Self-employment (largely informal) persistently dominates both employment and the labour force, it accounted for 68.1 per cent of the former and 59.2 per cent of the latter in Q3 2004. In its turn, self-employment has been dominated by rural self- employment, 82 per cent in Q3 2004. These 82 per cent were broken down as follows: 40 per cent – rural unpaid family workers, another 35 per cent – agricultural self employed, about 6 per cent – non- agricultural self-employed, and just a tiny portion of entrepreneurs.

Self-employment in agriculture is largely a pre-defined status, since, as mentioned above, 1 hectare of agricultural land in the possession of a family renders its members self-employed by definition (Law on Employment). However, whereas land for many, especially rural, households is the basic source of livelihood, whether 1 hectare of land is enough to keep an average family of four employed enough to earn at least minimum subsistence remains a controversial issue. Many of such agricultural self- employed are likely to be poor. Nevertheless, assuming that urban unemployed and underemployed have no land to work on whatsoever, they are likely to be in much more extreme poverty than the rural

58 GEORGIAN ECONOMIC TRENDS – 2005 No.1 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET poor. While poverty in the countryside is more associated with a lack of cash income, urban poverty involves insufficient food supply and undernourishment.

Overwhelming self-employment indicates a labour market situation where more and more people are either non-employed or engaged in low-income, low-productivity and unstable activities, mostly in the informal sector. The SDS integrated survey results suggest that at least 56 per cent of those employed were the working poor as of end of Q3 2004, of which over 28 per cent are rural unpaid family workers (counted as self-employed), almost 16 per cent are employees at budgetary organisations and another 12 per cent are non-agricultural own-account self-employed.

Another characteristic of the Georgian labour market is widespread part-time employment and temporary employment, mostly involuntary. Such patterns of employment are common for all transition economies and indicate the manner in which people attempt to adjust to low labour demand choosing to accept short-time and part-time work in the absence of a stable job. The labour underutilisation finds its reflection in the so called “external groups” including, outsourcing, subcontracting and casual workers, representing quite a substantial share of hired employment. While such hired labour arrangements contribute to raising overall employment opportunities, such jobs usually do not provide any social safety and/or at all and limit the chances of a comprehensive professional growth: part-time workers are more vulnerable from the point of view of their employability, since their career prospects, competitiveness on the market, pay, benefits, security and access to on-the-job training are restricted.

Figure 8.1: Employment characteristics of the population over 15 years old, Q3 2004

Outside of Employee in labour force state sector 34% 12% Employee in private sector 6%

Self- Unemployed employed 9% 39%

Source: Data from the SDS Integrated Household Survey Note: Share of the population outside labour force is given according to the ILO ‘strict’ standard of measurement, i.e., including discouraged workers.

The overall pattern of the economic status of the working-age population has been basically stable in recent years. In line with the pattern, in Q3 2004, the two largest groups by economic status accounted for the majority of the population over 15 years: the self-employed, for 39 per cent and those outside of labour force, for another 34 per cent (see Figure 8.1 above). 43 per cent overall were non-employed (those outside the labour force and the unemployed). The share of those employed in the state sector was almost twice as large as that of those employed in the private sector, and the share of the self-employed was over two times larger than the share of wage and salary earners. Jobs tend to be unstable not only in the private sector in reflection of the instability of private

GEORGIAN ECONOMIC TRENDS – 2005 No.1 59 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET businesses, but also in the state sector. In Q3 2004, the share of the state sector employees shrank by 1 percentage point both in seasonal and annual terms. At the same time, the share of the unemployed grew by the same 1 percentage point compared to a year ago.

It is likely that many of the jobs in the private sector, with the exception of those at large private companies, are insecure, unstable and low paid; it is also very likely that many of them would be in the informal sector. At the same time, the overwhelming majority of the state sector employees (76 per cent in Q3 2004) were civil servants, and, as mentioned above, their number has been reduced as a result of staffing reforms carried out in 2004. While salaries of more senior government officials have been raised dramatically, the great majority of civil servants remain low paid, and this effectively obliges them seek additional income to support the family.

The majority of jobs, especially in cities, are created in the informal sector. The informal economy, dominated, as overall employment, by irregular self-employment, is represented largely by unrecognised, unrecorded and unregulated small-scale activities. Underemployment and hidden and disguised unemployment are widespread. The majority of the employed are engaged in low-paying and insecure segments of the labour market and working under poor conditions. Stable, long-term, full-time jobs are rare, both in the formal and informal sectors. Long-term unemployment curbs the growth of the labour force, and is reflected in the misleadingly low unemployment rate. The economic status figures fail to reflect all the drama of the situation, since the ILO methodology of counting the unemployed ignores the size of labour remuneration and its consistency with the size of the minimum subsistence.

The Economic Development and Poverty Reduction Programme (EDPRP), that has been endorsed by the donor community and revised by the new Government, considers among its priorities the reduction of poverty through support to economic growth leading to the creation of new jobs (see below).

SALARIES AND WAGES The average monthly nominal salary of hired employees across the economy was GEL 125.7 in Q3 20043, according to the SDS Integrated Household Survey figures. The share of the average monthly salary in the minimum subsistence of a family of four grew compared to a year ago by 5 percentage points and was 53 per cent at the end of Q3 2004. The share of remuneration in monetary household income was 36 per cent and in total household income – about 28 per cent.

About 50 per cent of all waged and salaried workers – budgetary organisations4 employees – were earning on average GEL 81.3 per month in Q3 2004. Employees of public enterprises and organisations, accounting for almost 16 per cent of hired workers, were paid GEL 141.1 per month on average in Q3 2004. Monthly remuneration of another category of wage and salary earners (about 31 per cent), private sector employees, was GEL 153.1 on average. 3 per cent of hired workers, those working in foreign organisations or joint ventures, had a monthly salary of GEL 334.3 on average, and hired employees under “other” category (about 0.4 per cent) were earning monthly salaries of GEL 125.7.

Salaries of public sector employees (65.6 per cent of hired workers) as well as remuneration of the majority of private sector employees remain predominantly way below the subsistence minimum.

3 At the time when this issue of GET was being written, the latest available Integrated Household Survey figures were those for Q3 2004. 4 A budgetary organisation is a public organisation fully financed by the state budget.

60 GEORGIAN ECONOMIC TRENDS – 2005 No.1 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET

Whilst hired employment remains the primary source of income for urban households, it is as unstable as any other source of household income in the country. Although the average monthly nominal salary of hired employees grew by almost 15 per cent in absolute terms compared to a year ago, its growth in real terms has been continuously affected by inflation (See chapter Five). The remuneration of hired employees grew mainly at the expense of staff cuts of civil servants. Starting from January 2005 the minimum salary of civil servants has been fixed at GEL 115.

MINIMUM SUBSISTENCE LEVEL According to the SDS, the official minimum subsistence, calculated basing on the old methodology, introduced in early 1990s, was GEL 118.8 for an average consumer, GEL 135.5 for a working man, and GEL 235.7 for an average family of four as of end of Q3 2004. (It was respectively GEL 132, GEL 150.5 and GEL 261.8 as of end of Q4 2004). A new methodology has long been ready at the SDS and until recently it used to publish it as an “alternative” minimum subsistence5. However, it can be argued which of the methodologies better takes into consideration the real basket that can secure a reasonable minimum subsistence. The minimum subsistence levels, calculated in accordance with the new “alternative” methodology were closer to the average salary levels in the economy, i.e., were much lower than the “official” level.

As the data from the SDS integrated survey suggests, in Q3 2004, the average remuneration of only 3 per cent of hired employees (those working at foreign organisations or joint ventures) surpassed the minimum subsistence for a family of four. Average salaries of almost 35 per cent of hired workers (private enterprises, foreign organisations employees and those under “other” category) were higher than the minimum subsistence for a working man, and another 16 per cent (employees of public enterprises) added to the aforementioned 35 per cent, i.e., 51 per cent were paid salaries greater than the minimum subsistence for an average consumer (that is a non-working consumer).

The average monthly remuneration of another 50 per cent of waged and salaries workers comprised of civil servants was way below even that level, and the flat rate pension rate paid nationwide accounted for about 15 per cent of the level for an average consumer. Subsisting on GEL 236 per month for a family of four does not seem to be an easy task. According to the above and anecdotal evidence, however, many households have to survive on much less than that, especially those with only one breadwinner. At the same time, even a family of four with only one member working and the rest being dependents would not be considered among the most vulnerable and subject to receipt of a state social allowance (see below), since to fall under this category, a household has to consist of non- employed pensioners and/or orphans only. Apparently, this challenge is to be tackled among others on the priority agenda, and especially through providing more opportunities for employment.

SOCIAL POLICY AND THE SOCIAL SECURITY REFORM Since a large share of the Georgian economy is accounted for by informal activities, the vast majority of the population, including informal sector employees, the self-employed and the non-employed, as well as their family members, have no social protection whatsoever, and the assistance for those covered by the social safety net is symbolic. Fundamental steps are to be taken on the way to restructuring the state social protection system to create an economically viable, affordable and equitable social safety net that would be fit to alleviate poverty effectively, especially for the most vulnerable. In conditions of inadequate pension assistance, alleviating poverty in old age is of vital

GEORGIAN ECONOMIC TRENDS – 2005 No.1 61 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET importance. Social policy and reforms are among the top government priorities and while certain steps have already been made, more are to follow.

Social Assistance System Reform The EDPRP, revised by the new Government, emphasizes that to reduce social inequality arising from poverty effective implementation of reforms is needed (see Box 2.1 in Chapter II). EDPRP acknowledges that one of the main causes of poverty is unemployment, and stresses that, while to alleviate and overcome poverty rapid and sustained economic growth is to be attained, it is not going to be achieved overnight. Therefore, in the short-term the assets of the poor can only be increased through public transfers6.

The key principle of the social assistance system reform that the Government has already started, as per the revised version of the EDPRP, is monetization of social assistance. In contrast to the category-based system of social assistance that has been applied up to now7, the reformed social assistance system, which is to be fully in place by the end of the year, employs individual needs assessment (or means testing) targeting methodology.

The basic difference between the two approaches is that while usually a category-based targeting system implies improving general level of living according to categories that are entitled for getting the assistance, the main goal of a needs assessment based system is reduction of extreme poverty.

The new social assistance system envisages payment of monthly cash benefits to destitute households living below the poverty line. To determine that a particular household can be eligible for getting the assistance those claiming for the benefit will have to be interviewed using a score-based questionnaire that is currently being drawn up at the SDS. The questionnaire will use weighted factors to evaluate the poverty risk of a household.

The indicators to be applied are going to be both statistical and non-statistical (e.g., non-statistical indicators imply judgements concerning potential beneficiary groups of population that are most likely to be at poverty risk – orphans, single pensioners, families with many children, etc.). According to the EDPRP, the identification strategy is to be finalised and the questionnaire should be ready by the end of Q1 2005, and the new social assistance system should be presented in Q4 2005. By preliminary estimates, the amount of the monetary benefit to be paid to each recipient household will vary in the range of GEL 60 and GEL 125 depending on the size of the qualifying household.

Apart from the state social allowance mentioned above, the other two existing forms of social assistance for the vulnerable were the unemployment benefit and the flat rate old age pension.

The amount of the standard monthly Unemployment Benefit payable for the first six months of registered unemployment was fixed at GEL 20 for the duration of the eligible period after being raised by GEL 6 by a presidential decree “On Additional Measures of Social Security of the Unemployed” of August 28 2004. To become an official benefit recipient, a person should be registered as unemployed, therefore should have a certain working record in the official sector. As a result, the

5 Since a governmental decision ”On Introducing Changes into Calculation Methodology and Re-calculation of the Minimum Subsistence Level” was passed in August 1999 and a draft presidential decree “On Defining and Applying Subsistence Minimum” was drawn up, no other formal steps have been taken. 6 Economic Development and Poverty Reduction Programme, Progress Report, January 2005 7 The State Social Allowance for vulnerable families was targeted at households comprised exclusively of “poor non-working pensioners” or of orphans, disabled children and invalids, and families with at least 7 children. In fact, it representseda topping- up of symbolic pensions of the poorest elderly and a modest child allowance for the most destitute families. The State Social Allowance payable to recipients was fixed between GEL 22 and GEL 35 depending on the size of the household.

62 GEORGIAN ECONOMIC TRENDS – 2005 No.1 LABOUR MARKET, INCOMES AND THE SOCIAL SAFETY NET number of the unemployed who bother to register is usually way below the actual one and the number of the benefit recipients is insignificant.

Pension System According to the current pay-as-you-go public pension system, a flat-rate old age pension payable to the majority of pensioners countrywide grew from GEL 14 to GEL 18 in May 2004, in accordance with a presidential decree, of which GEL 14 was the main flat-rate pension allowance and another GEL 4 was paid to cover previously accumulated pension arrears. (Since starting from April 2003, the pensioners in Tbilisi have been receiving an additional GEL 3 from the municipal budget, they were paid GEL 21). Those pensioners who were to receive more than one month’s pension were to be paid an additional monthly GEL 2, so that their pension arrears be covered stage by stage. The pension rate was raised to GEL 28 beginning from January 2005. The accumulation of pension arrears has been stopped and the repayment of outstanding arrears started, that is considered by the EDPRP Progress Report as the first step on the way of implementing the pension reform. The Progress Report, however, does not clearly state which concrete reforms are being envisaged in the pension system.

The current flat-rate old age pension does not take account either of the years worked or the salary history, and, though it has grown, is still a poor incentive for tax compliance on the one hand (in accordance with the new Tax Code in force since the beginning of 2005, the payroll tax to be paid by employers is 20 per cent of the salary, while employees are not levied any payroll tax), and on the other, falls far below minimum subsistence level (about 15 per cent of the official minimum subsistence of an average consumer in Q3 2004). .

The state pay-as-you-go pension system covering all the population of the pension age has long encountered a number of problems. Under the conditions of a narrow tax base, a big informal economy, and constant tax under-collection and non-compliance, the pensions financed by the payroll tax proceeds8 used to fall short of the target, and the system was accumulating arrears for several years. While low wages and no link between current contributions and future benefits had been a poor motivation for those in employment to pay social tax, inadequate law enforcement and a relatively high payroll tax rate had been discouraging tax compliance on the part of employers.

As the new Tax Code was passed by the Parliament and is in force since the beginning of 2005, there are hopes associated with the new reduced payroll tax rate mentioned above, that is believed to contribute to a better tax collection, and, accordingly, a better pension financing. The new Government also managed to achieve certain success in tax collection discipline, resulting in fewer instances of tax evasion, and, therefore, certain expansion of the tax base. At the same time, in 2004, the United State Social Insurance Fund carried out re-registration of the pensioners, and as a result of this exercise, the number of actual pension recipients was slightly reduced.

There are, however, other prerequisites also necessary for the smooth functioning of a PAYG (pay-as- you-go) system fully dependent on the level of tax collection. For instance, the current dependency ratio9 is unsustainably low at 1:1.4 that is a reflection of shrinking hired employment and a large informal economy, resulting in an extremely low number of contributors to the fund.

8 The contributions from workers’ wages that formed the United State Social Insurance Fund (USSIF) revenue were 26 per cent of gross wages for budgetary organisations and 27 per cent for others paid by the employer and 1 per cent paid by employees, according to the old Tax Code, while in accordance with the new Tax Code in force since the beginning of 2005, the payroll tax to be paid by employers is 20 per cent of the salary, while employees are not levied any payroll tax. 9 The number of pensioners as a percentage of the number of people employed, or contributor to beneficiary ratio.

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Though certain steps have already been taken by the new Government to raise the current pension rate, and more are in the pipeline, the existing PAYG pension system still fails to carry out its basic function of providing basic minimum pensions to the elderly.

However, while average taxable salaries/wages are low, resulting in the low replacement rate10 of the current PAYG universal pension system, the share of the average pension flat rate of the majority of pensioners in the average hired employees’ monthly salary has grown slightly since the beginning of the year: it was 14 per cent in Q3 2004 compared to around 12 per cent in Q1 2004. However, there is still a long way to go before the pension is able to provide a pensioner with the minimum requirements, and currently the majority of pensioners are either relying on extended family ties, or try to engage in any kind of employment providing them with a subsistence minimum.

Reforming the pension system is among the Government’s priorities as the economic, political and social consequences of the crisis that the current pension system has been experiencing place the most vulnerable elderly at poverty risk that may further result in social disintegration, marginalisation and social exclusion.

Box 8.1: PRACTICES

Is Early Retirement a Good Way to Reduce Unemployment and Facilitate Privatisation?

Some governments view early retirement as a painless remedy for unemployment, arguing that the vacancy left by the retiree can be filled by a younger worker who should otherwise be unable to find work. In Spain early retirement is allowed only if the retiring worker is replaced by a younger person just entering the labour force. Socialist economies in Eastern Europe and the former Soviet Union have long disguised the true rate of unemployment and underemployment by encouraging people to retire early, a practice that has intensified in recent years with enterprise reform and privatisation. Romania eased eligibility requirements for retirement in 1990 as part of its restructuring programme, increasing the number of pensioners by 40 per cent between 1989 and 1992. China has done the same. Some countries are considering “buying out” workers who oppose privatisation, and paying them pensions out of the public coffers, in order to reduce the liabilities of state enterprises and make them more attractive to potential investors.

Early retirement, though appealing in the short run, is a costly and shortsighted way to reduce unemployment and facilitate enterprise reform. It reduces the country’s labour force (especially its experienced labour force), shrinks potential output, reduces political pressures to cut unemployment, and results in regressive redistributions. Pension benefits are often much higher than unemployment benefits, and these costs continue for many years. The government is stuck with a large liability as a result of privatisation combined with early retirement. And provisions for early retirement may be difficult to change when the apparent short-term need is gone.

There is little evidence that early retirement reduces unemployment. Many of the vacancies created by early retirement are never filled, perhaps because of permanent reduction in labour demand in certain industries. Younger workers are imperfect substitutes for older, more experienced workers; they have different skills, which, in some cases, are complementary rather than substitutes. The productivity of some young workers may be less than the going wage. Some of the younger replacement workers possess special skills that would have make them employable in any event, while workers without these skills remain unemployed. When Bulgaria and Romania tried to increase the employment of younger workers in public enterprises by lowering the retirement age, enterprises did not take on new inexperienced workers but instead reduced employment. And to encourage workers to retire early, the government must increase current and future levels of pensions spending, leading to higher payroll taxes, which, in turn, may lead to higher unemployment.

10 The average pension in terms of the average wage.

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Rather than being painless, early retirement is a costly solution to the unemployment problem and an expensive way to restructure enterprises. Unemployment should be attacked in other ways, while pension plans should be aimed at the truly old.

Source: Averting the Old Age: Policies to Protect the Old and Promote Growth. A World Bank Policy Research Report

GEORGIAN ECONOMIC TRENDS – 2005 No.1 65

CHAPTER NINE: THE EU-GEORGIA RELATIONS

GEORGIA’S TRADE WITH THE EU According to the State Department for Statistics, in the period 2004, Georgia’s trade relations with the Member States (25) of the European Union amounted to USD 727.7 million, which is about 42 per cent more than in the same period of previous year. During this period, Georgian exports to the EU market were USD 111.6 million (36.7 per cent more compared with previous year). EU Member States’ exports to Georgia amounted to USD 616.2 million (43.1 per cent more compared with previous year). For the period, 29.2 per cent of Georgia’s total foreign trade was with EU Member States, 17.2 per cent of exports and 33.4 per cent of imports.

Three Member States – UK, Germany, Italy - plus Turkey, are among Georgia’s top ten trade partners, as shown in Table 9.1.

Table 9.1: Georgia’s Trade with the Largest Trade Partners EU Countries, 2004 (USD thousands) 2004 Export Import Turnover UK 31.6 171.4 203.0 Germany 15.9 151.1 167.0 Italy 11.6 61.5 73.1 Turkey 118.7 202.3 321.0 Total: 177.8 586.3 764.1 Source: State Department for Statistics

Table 9.2: Georgia’s Trade with the EU Countries, 2004 (USD thousand) 2004 Turnover Import Export Balance Austria 22582 22265.0 317.0 -21948.0 Belgium 20621.2 15546.5 5074.7 -10471.8 Denmark 9189.3 8434.7 754.6 -7680.1 France 72963.2 63230.4 9732.8 -53497.6 Germany 167037.0 151118.2 15918.8 -135199.4 Greece 21817.3 14485.2 7332.1 -7153.1 Ireland 2240.6 2184.9 55.7 -2129.2 Italy 73064.5 61470.8 11593.7 -49877.1 Luxembourg 591.1 471.0 120.1 -350.9 Netherlands 44457.5 34594.8 9862.7 -24732.1 Portuguese 2301.5 2158.5 143.0 -2015.5 Finland 6337.5 6337.5 -6337.5 Spain 15901.5 6405.6 9495.9 3090.3 Sweden 4913.6 4850.2 63.4 -4786.9 UK 203004.2 171425.4 31578.8 -139846.6 Estonia 1318.4 445.0 873.4 428.4 Cyprus 8487.1 8056.2 430.9 -7625.3 Latvia 3936.0 2906.1 1029.9 -1876.2 Lithuania 4424.2 3554.2 870.0 -2684.2 Malta 455.4 1.1 454.3 453.2 Poland 9957.6 8429.6 1528.0 -6901.6 Slovakia 3964.5 1336.4 2628.1 1291.7 Slovenia 3970.1 3970.1 -3970.1 Hungary 10237.1 10152.8 84.3 -10068.5 Check Republic 13977.2 12348.4 1628.8 -10719.6 Total 727749.6 616178.6 111571 -504607.6 Source: State Department for Statistics

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Table 9.3: Georgia’s Trade with the EU acceding and candidate Countries, 2004 (USD thousand) 2004 Turnover Import Export Balance Bulgaria 54427.2 38875.2 15552.0 -23323.2 Turkey 321034.3 202290.7 118743.6 -83547.1 Romania 15309 14020.1 1288.9 -12731.2 Total 390770.5 255186 135584.5 -119601.5 Source: State Department for Statistics

THE PROSPECTS OF THE DEVELOPMENTS IN EU-GEORGIAN RELATIONS During half a century, the European Union has made remarkable achievements. It has brought peace to its Member States and significant welfare improvements to the citizens. The European Union has unified those states which in the middle of the 20th century were involved in bloodshed and war as two opposing sides. Today their sovereign rights are within limits of supra-national institutions, and by means of cooperation, they also seek mutually beneficial ways and solutions to settle the discord that may arise between the CIS countries. From the date of foundation of this grouping, its goal has been to bring peace and welfare not only to the countries unified into it, but to the whole world as well. Therefore, it is not surprising, that the EU is one of the leading worldwide donors.

During its history, the European Union was expanded five times. From a certain point of view every expansion raised a number of challenges which took time to resolve. Such issues have been sharply exposed during the fifth expansion made in 2004, as the level of economic development of the central and eastern European Countries was much different from the other countries of the European Union.

Expansion has brought the border of European Union closer to the South Caucasus. With a second stage of expansion into eastern Europe, taking into account the joining of Bulgaria and Romania in the Union, Georgia will be connected to these countries through the Black Sea; and if Turkey were also to enter , Georgia would have a land border with EU.

Georgia started its relationship with European Union from the day of its independence. The Partnership and Cooperation Agreement (PCA) between Georgia and the EU represents a legal basis which entered into force in 1999. Another step made towards collaboration with the European Union is the New Neighbourhood Initiative of Europe into which the South Caucasus was included in 2004

To fulfill closer integration, Georgia, Azerbaijan and Armenia have already tried to create a similar general instrument. First appeals concerning integration of the countries of South Caucasus were made in 1996, by ex-presidents and other officials of South Caucasian countries.

Development of a closer economic and political relationship within the region has great importance, as it could bring profit and success to Georgia as an integral part of the South Caucasus. In this case, we would have a region with attractive economic potential for the West and European Union, not only considering the functions of “Transport Corridor”, but also the development of tourism; because the three countries of South Caucasus have great potential for close and efficient collaboration in that area.

International society considers the region as a unified geo-political and economic space. Such an approach to the South Caucasus is stipulated by mutually beneficial collaboration with European and Euro-Atlantic Institutions. It is noteworthy that, from the very beginning of the relationship with European Union, Georgia was not considered as a separate country. However, it is also true, that it would be advisable to make an individual approach for Georgia, at least concerning unification of the country. This will enable it to develop a closer regional relationship with its frontier neighbours.

In some ways, it is extremely difficult to establish South Caucasus as a unified region, as occurred in the Balkans and Eastern Europe. Accordingly, taking into account the above mentioned, it is not easy

GEORGIAN ECONOMIC TRENDS – 2005 No.1 67 THE EU-GEORGIAN RELATIONS to achieve higher regional integration. Georgia, Azerbaijan and Armenia have different political cultures, different kinds of societies and have no equal level of democracy. It should also be born in mind that one of the regional neighbours is Iran, which remains a sensitive country in a number of respects.

At the same time as regional initiatives are proceeding, Georgia should make its own practical steps to develop closer relations with the European Union, although it is worth mentioning that Georgia has no wide choice from this point of view. The European Union, as a rule, avoids receiving countries one by one (Greece is the only example) and therefore its other negotiations are also usually not conducted on such a basis either.

Another reason for the European Union to prefer a regional approach is that it makes the countries of the same region take examples of each other’s development and hasten the reforms, which are indispensable for satisfying Copenhagen Criteria. That is the reason why quite different countries, from the point of view of their economic statehood, like Czech Republic, Cyprus, Malta, Lithuania, and Estonia joined the European Union this year.

From the regional point of view, it is important for Georgia to support the closer collaboration between the Black Sea Economic Cooperation organisation (BSEC) and the European Union. Regional collaboration among the countries of the Mediterranean Sea and the Black Sea will promote the economic development of the region, as well as its political and economic stability. During participating in the mentioned initiative, Georgia is supposed to be involved in the fulfillment of various projects considered by European Union-Mediterranean partnership.

The active regional participation of Georgia with the Mediterranean region, as well as mutual relations with its member states will promote the country’s further integration with the structures of the European Union. Integration in the European Union is an important and challenging task, which requires the greatest responsibility.

All countries of the Black Sea (with the exception of Russia, who has no target to do so) can become potential candidates of European Union. Romania and Bulgaria should become European Union members by 2007, Turkey possibly after 2014. Until 2007 Georgia together with Moldova and Ukraine, which have corresponding interests at this time, should manage to redefine their region around the Black Sea.

The mentioned relations are possible to be developed in the limits of BSEC, or by creating a new instrument, which will aim to make an accent on “The Black Sea Region.” From 2007 Georgia will probably have a sea border with European Union, that will give it the possibility to form more active policy in relation to the European Union. In any case, Georgia will need to agree its relevant legislation of immigration and sea transport with the EU legislation.

The latest events in Ukraine are particularly important, since they will raise the relations between Georgia and Ukraine to a new phase. The possibility of cooperation means that similar reform initiatives can be contemplated, thus bringing both countries closer to the EU.

As with the Ukraine, Georgia should try to prepared and do its maximum to develop close relations with Turkey. During this time Georgia should continue active working in several directions. To maintain a simplified visa regime with Turkey and to deepen collaboration in various economic projects (BTC project among them) will be particularly necessary, because by the second decade of the century the mutual economic relations of these two countries should have an irreversible character.

This is not enough, though. Georgia should strive for its own economic development and political stability. Neither Turkey nor Moldova, Romania or Bulgaria will desire “to carry such country as a burden,” that cannot deal with elemental economical problems, has two unsettled conflicts, cannot manage to defend its borders, cannot deal decisively with corruption and which sees the majority of its population on the edge of poverty. Fortunately, the reforms started in the latest months, give us promise to eradicate these problems even partially in the near future. To all appearances, the start of solving problems by the new Government caused quite a hopeful disposition in European Union.

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Our neighbours and strategic partners should see that their close relations with Georgia will not provoke any problems for them, but on the contrary, will benefit them.

Georgia totally shares all those principles and goals of European integration established in European agreements. On the background of political events developed in Georgia, the entire integrity of the country in European and Euro-Atlantic structures depends on democratic values, market economics, rule of law, human rights protection and the supremacy of universal principals. Inclusion in the European Union represents a principal priority of Georgia’s foreign policy.

The most important task that stands before Georgia is to persuade societies and political elite of the participant countries of European Union of the fact that Georgia represents a stabilized country, which is a country of European traditions and culture. The democratic society of the country permanently denotes its political readiness and demonstrates its willingness to join the European family. At the same time, if society totally acknowledges its responsibilities, it should possess full information about all perspectives of Georgia’s integration – political, juridical, economical, social and cultural. The success of the whole process will depend on showing the real picture to its citizens, evaluating all costs and benefits.

Henceforth, our country will continue building its statehood in a new juridical space. New guarantees of security will underpin its statehood. At the same time, Georgia takes all obligations from pluralist democracy and is establishing an entirely new political reality in the whole South Caucasus.

Not only European history and the culture of Georgia should be highlighted, but also the European character of political culture. It will greatly advantage the improvement of the European Union viewpoint about Georgia and will finally demonstrate the fact that Georgia wants to get into closer relations with the European Union, not only for economic and political purposes, but mostly to prove that “We are also Europeans”.

Georgia should continue its way towards economic and democratic reforms, as there is no alternative way for our country’s security, prosperity and peace.

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CALENDAR OF EVENTS

JANUARY 2004

4 Elections Presidential Elections were held in Georgia. Mikheil Saakashvili has been elected President of Georgia.

6 USA-Georgia Relations The US Department of State released a statement on January 6th. It calls on Georgia to establish closer co-operation with the International Monetary Fund. “Georgia should agree with the IMF a concrete programme if the country wants the issue on rescheduling debts be discussed in the Paris Club”, is said in the statement. “We are ready to work with the new authorities of Georgia to assist the country in developing the free market and implementing democratic reforms. Unfortunately the former authorities of Georgia failed to fulfil the IMF criteria on relieving poverty and increasing economic growth”, says the statement.

7 Customs The customs tariff on grain import is abolished in Georgia from January 1, 2004.

11 Banking For the provision of stable and firm functioning of the banking system, National Bank fixed gradual growth of a minimum amount of the authorized capital for the commercial banks and subsidiaries of foreign commercial banks in the amount of GEL 12 million. Thus, by December 31, 2004 the minimum authorized capital should be no less than GEL 6.4 million; by December 31, 2005, no less than GEL 7.8 million; by December 31, 2006, no less than GEL 9.2 million; by December 31, 2007, no less than GEL 10.6 million; and by December 31, 2008, no less than GEL 12 million. Increases in authorized capital should be conducted in a monetary form and only in the national currency.

12 Investment Climate Mikheil Saakashvili, President of Georgia, expressed his intention to fight against corruption in Georgia, against oligarchs and to restore relations with international financial organisations. “We want to form a normal investment climate to assure the investors that Georgia today is a different country. They should know that the Georgian state will protect their investments and their rights and will not rob them”, said Mr. Saakashvili.

14 Parliament Draft law “On the Fund for Development and Reforms” was adopted by the Parliament at the January 14th emergency session unanimously in 3 readings. The document was submitted by Zurab Adeishvili, the Minister for Justice. In his words, after such a fund is founded, the officials can get adequate wages from the fund resources. Mr. Adeishvili says the international donor organisations have already expressed readiness to transfer resources to the Fund. The Fund will also finance preparation of legislative acts, and training of public officials.

13 EU–Georgia Relations The EU Allocates EUR 28 million to Georgia for implementing National Indicative Programme for 2004 -2006. In 1992-2003 the EU assistance to Georgia was EUR 385 million, from which EUR 84 million was allotted in the framework of TACIS national programme.

The programme signed in Tbilisi on January 13th determines the common objectives and methods for conducting assistance to Georgia in 2004-2006. The programme will be fulfilled

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within the framework of the TACIS programme of the European Union. The indicative programme will be directed at fulfilling the EU strategy which foresees enhancement of Georgia’s independence and its advance in the development of democracy and a market economy.

“The National Indicative Programme of 2004-2006” involves some priority sectors, such as support to institutional, legislative and administrative reform, for which it is foreseen to allot EUR 11.5 million. The budget in the amount of EUR 12.5 million is designed to promote the relief of social aftermaths of the transitional period, firstly in the healthcare sector. EUR 4 million will be allocated for the programme on rehabilitation of conflict zones.

14 Parliament Parliament unanimously approved Irakli Rekhviashvili in the post of the Minister for Economy, Industry and Trade.

14 Parliament The Parliament of Georgia ratified on January 14th a credit agreement between the German Bank for Reconstruction and Development (KfW) and the Government of Georgia on allocating EUR12 million for settling an energy crisis in Georgia.

18 Assistance The German Bank for Reconstruction and Development allocated EUR 8 million to develop the system of cadastre and land registration in Georgia.

27 Transport According to information of the Administration of Air Transport of Georgia, there are 21 airlines operating in Georgia, among them 7 Georgian ones.

28 Anti-Corruption Bureau The Anti-Corruption Policy Co-ordination Bureau in the office of the President of Georgia was closed.

29 Tourism Department for Resorts and Tourism of Georgia announced that 313 thousand tourists visited Georgia in 2003, i.e. 15,000 more than last year. In 2003 Georgia’s incomes from tourism were GEL 750 million, i.e. GEL 103 million more than in 2002.

29 Tourism In summer 2004 the Bazaleti tourist complex is to start functioning. Construction of this complex on the Lake Bazaleti was started four years ago by the Israeli-American-Georgian Company Nova Management Georgia. Over the years several hotels and a sport-recreation complex were built and the beach was covered by sea sand. The Bazaleti tourist complex has a capacity of 1,600. The cost of construction was USD 25 million.

30 Assistance During a meeting of President Mikheil Saakashvili with FRG Chancellor Gerhard Schroeder the sides discussed the issue of bilateral co-operation, the situation in Georgia and implementation of democratic change in the country along with Germany rendering assistance to Georgia. It was mentioned at the meeting that Germany will allot EUR 12 million to the new government of Georgia to be spent for covering the energy deficit and rehabilitation of the energy system.

February

4 EU-Georgia Relations Hughes Mingarelli, Director of the East Europe, Caucasus and Central Asia Directorate in international relations of the EU, said at a press-conference that the

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EU is ready to allot EUR 30 million to Georgia for assisting the country in the transitional period. In his words, this assistance will be distributed as follows: EUR 12 million will be allotted as a technical aid in implementing structural reforms, EUR 12 million to support the programme of food security, EUR 4 million to a rehabilitation programme in the zones of conflict and EUR 2 million for the initiative on protecting human rights and democracy.

6 Parliament Parliament of Georgia approved a package of constitutional amendments, according to which the President has the right to dissolve parliament, to form a government and to combine a part of Constitutional Court functions. Government will be transformed into a Cabinet of Ministers (was abolished in 1995), the work of which will be co-ordinated by a Prime Minister. President of Georgia combines the function of head of government. Parliament has the right to dismiss government by three fifths of MPs votes. Cabinet of Ministers, in which parliament may express no-confidence, has the right in three months’ time to work in the former staffing. President presents the ministers’ candidacies to parliament.

12 Government The Parliament of Georgia adopted a law “On the structure, powers and order of the government activities”. The document determines the structure of a new government and the rules of its functioning. According to the law, there will be a Cabinet of Ministers, a prime- minister’s post will be determined, the amount of the ministries will be reduced from 17 to 15. All the state departments will be within the ministries. The cabinet of ministries will be headed by a prime-minister who, within the amendments to the Constitution, in agreement with the President has the right to submit to the Parliament the candidacies for future ministers.

13 Ministry of Finance The Finance Ministry prepared and submitted to the Parliament a law with the aim of improving financial-economic condition of the enterprises and to establish a favourable investment environment in the country. According to this law, an enterprise is granted the right to reschedule the indebtedness only once and only in case its solvency is recognized. The term of rescheduling the tax indebtedness cannot exceed three years. The period of freezing the tax indebtedness cannot exceed 12 months and the term of delay is not more than 24 months (from the end of a freezing period). In the period of freezing the tax indebtedness interests and penalties are not charged on it. In the period of delay a monthly rate of 0.5 per cent is charged on the unpaid sum.

13 Georgian wine The Georgian wine “Tamada” (producer – GWS company) has been awarded the Grand-Prix in the nomination “The best dry wine of the CIS” at the contest “Prodexpo-2004” in Moscow, held on February 9-13th. Several wines of the company got seven gold medals and certificates of high quality. GWS produces wines of 28 designations. The volume of production is 4 million bottles per year, with a share of export production of more than 90 per cent. The company also produces brandy and chacha (grape vodka).

15 Government The Parliament received a programme of activities of the government and a list of ministerial candidates for approval. The government will have four state ministers on special affairs (the so-called “ministers without portfolio”). The state minister for conflict settlement will be Giorgi Khaindrava, for co-ordination of Georgia’s integration in Europe –Tamar Beruchashvili, for SMEs –Jambul Bakuradze and for national consent – Guram Absandze.

Zurab Zhvania, the current State Minister will be a prime-minister. Six of the candidates presented for ministerial posts headed these services as acting ministers. They were: Tedo Japaridze, the Foreign Minister; Gela Bezhuashvili, the Defence Minister; Giorgi Baramidze,

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the Interior Minister; Zurab Noghaideli, the Finance Minister; Irakli Rekhviashvili, the Minister for Economy; and Eter Astemirova, the Minister for Refugees and Accommodation. The State Security Ministry will be headed by Zurab Adeishvili, at acting Justice Minister at that time.

The new persons in the government are: Giorgi Papuashvili, the Minister for Justice, David Shervashidze – the Minister for Agriculture and Food, Giorgi Tsereteli – the Minister for Health, Tamar Sulukhia – the Minister for Infrastructure, Nikoloz Gilauri – the Minister for Fuel, Energy and Communication, Kakha Lomaia – the Minister for Education Giorgi Gabashvili – the Minister for Culture and Sport, and Tamar Lebanidze – the Minister for Environment Protection. In compliance with the acting legislation, the candidates for the posts of a prime-minister and three law-enforcement ministers – defence, internal affairs and state security were presented to the Parliament by the President. The prime-minister will present the candidacies to the other ministerial posts.

17 Parliament The Parliament had its extraordinary session and heard a five-year programme of the government activities and approved a composition of the Cabinet of Ministers.

19 Co-operation HE Fabrizio Romano, Extraordinary and Plenipotentiary Ambassador of Italy to Georgia and Tedo Japaridze, Foreign Minister of Georgia, signed in Tbilisi a ratification protocol of the convention “On avoiding double taxation of incomes and capital between the governments of Italian Republic and Georgia”.

20 Taxation President Mikheil Saakashvili put forward an initiative on releasing from criminal responsibility those businessmen, who up to April 1, 2004 will declare in their tax declarations their incomes concealed earlier from the state, and will express readiness to pay taxes from these sums.

March

1 Service Hotel “Courtyard Marriott”, located on central square of Tbilisi – Tavisupleba square – received its first guests.

4 Co-operation Cabinet of Ministers of Georgia presented its new five year programme on country development and implementation of reforms in state management (2004-2009) to the representatives of 37 donor organizations and countries during the meeting on 1st of March. A summing meeting with the donors, at which a decision will be made on delivering financial support to Georgia in implementing the present programme, will be held in Brussels in June, 2004

5 Energy The Russian foreign economic association Technopromexport won the international tender for conducting rehabilitation works at Inguri HPP. Technopromexport shouldered obligations to implement the USD17.3 million project, 80 per cent of this sum is financed by EBRD and 20 per cent - by the Georgian side. According to the contract, the Russian company will conduct in 2 years the construction works for strengthening and cementing an arch cascade of the dam and rehabilitation works in the HPP derivation tunnel.

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5 Co-operation A ceremony was held in Tbilisi signing an intergovernmental agreement between Sweden and Georgia on opening a co-ordination centre of the Swedish International Development Agency (SIDA). From the Georgian side Tamar Beruchashvili, the State Minister, from the Swedish side - SIDA deputy general director Jerker Thunberg, signed the document. Mr. Eric Johnson will head the regional co-ordination center.

SIDA’s programme of assistance in South Caucasian countries aims to promote implementation of institutional reforms in the transitional period to democracy and market economy. Major directions of the Agency’s assistance for the period up to 2005 will be the development of a democratic system of management, promotion of the reforms of the social and health care sector, combat against AIDS, assistance to vulnerable families, management of natural resources, and support to development of small and medium business.

9 Co-operation President Mikheil Saakashvili met with President of France Jacques Chirac in Paris. President of France expressed readiness to support Georgia in the process of integration and rapprochement of Georgia with the European Union. President of Georgia also met with the French Ministers of Foreign Affairs, Internal Affairs, Economy and other officials.

12 Co-operation President Mikheil Saakashvili visited Armenia and met with the President Kocharian. The Presidents confirmed their readiness for more active co-operation within the organization of Black Sea Economic Co-operation (BSEC) and stressed the importance of closer co-operation in such regional projects as TRACECA and INOGATE. The sides underlined the need for intensifying the activities of intergovernmental Georgian-Armenian Commission for Economic Co-operation.

14 Agriculture A Representative office of the UN organisation of Food and Agriculture opens in Tbilisi. Opening the FAO representation in Tbilisi will enable the government of Georgia to simplify relations with the head office of this organization and also to implement more projects in Georgia. At present the FAO implements several projects in Georgia, in particular, on subtropical cultures, cattle-breeding, formation of consulting centers for farmers, rehabilitation of seedling farms, also formation of new farms for growing fruit and nut seedlings in different regions of Georgia.

15 Customs A ceremony was held dedicated to the start of construction of a new customs- checkpoint “Red Bridge” on the Georgia-Azerbaijan border. The construction works are conducted within an American Programme “Georgia Border Security and Law Enforcement Assistance” (BSLE).

18-19 Conference International conference on issues of oil, gas, energy and infrastructure was held in Tbilisi on the initiative and auspices of Georgian International Oil Corporation (GIOC), British exhibition company ITE-Group, the Fuel and Energy Ministry of Georgia and Georgian National oil company Saknavtobi. The issues discussed at the Conference concerned development of projects on CEP (Chief Export Pipeline) Baku-Tbilisi-Ceyhan, South- Caucasian pipeline Baku-Tbilisi-Erzrum, European transport corridor and tendencies and potentials of oil and gas transportation through Georgia.

22 Customs Giorgi Godabrelidze is appointed head of Customs Department of the Ministry of Finance

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31 Government According to the decree of Zurab Zhvania, Prime Minister of Georgia, a working group has been formed, which should prepare a new Code of Tax to be submitted to the government in May. The new Code of Tax will be in effect from January, 2005.

April

7 Assistance EU Allocation EUR 30 million to Georgia as economic aid is announced after a meeting of President Mikheil Saakashvili of Georgia with High Commissioner of EU Javier Solana, held on April 7 in Brussels. The allocated sum is planned to be directed at: developing the infrastructure of the roads; construction of penitentiary system objects; the purchase of grains; and also implementation of some other projects.

8 Government Prime-Minister of Georgia Zurab Zhvania signed a governmental decree (№23) on forming United Centre for Serving the Investors, which should be formed within the Agency for Trade and Investment Promotion. Main tasks of the centre are: information, consulting and analytical services for existing and potential investors; promotion of investment activities by means of assisting applications for licenses and permits and registering procedures; marketing, legal and financial research; analysis of investment barriers and problems the investors are facing and their solution; exposing the investors’ potential and prospects in Georgia and support to development; identification of potentials for joint projects of local and foreign investors and their promotion; preparation of proposals to the Government for improving the investment environment.

10 Water supply Tbilisi Sakrebulo came to an agreement with the French company Generale des Eaux on leasing Tbilisi municipal company for water supply and sewerage Tbiltskalkanali. With this aim in view a joint venture will be formed on a parity principle. Company Generale des Eaux was the only participant of the tender on transferring into 10-year-long management of the biggest in Georgia network of Tbilisi water supply and sewerage – LLC Tbiltskalkanali.

11 Government Prime Minister of Georgia Zurab Zhvania signed an order on measures to provide unimpeded implementation of Baku-Tbilisi-Ceyhan (BTC) oil pipeline.

15 Transport Tudor Draganel, an economic representative of the Romanian Embassy in Georgia, announced that from May, 2004 a new Romanian passenger ferry will start operating on the route Constanca-Odessa-Novorosiisk-Batumi-Istanbul

19 Government The apparatus of the State Minister of Georgia on EU integration was formed under the Decree of 19th April 2004 by the Prime Minister of Georgia, Zurab Zhvania, in accordance with the Presidential Decree N61 of 14th February 2004.

19 Transport State company LLC Sakartvelos Rkinigza (Georgian Railway), supported by several international financial organizations, in particular, EBRD, KfW, WB started elaboration of a number of projects for developing infrastructure of the Georgian Railway. Among the projects, there is railway construction at the section Akhalkalaki (Georgia) – Kars (Turkey), rehabilitation of Tskhinvali section of the railway, railway station in Poti, modernization of Khashuri locomotive depot and Tbilisi carriage depot, putting in order a ferry pass Batumi- Constance, renovation of the railway carriages; also the project is being prepared for promotion of institutional reform of the Georgian railway system. Financing of the present projects is planned to be implemented through grants and credits. It will be long-term credits for 10-30

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years, expected rate of interest 1.5-6 per cent.

22 Social protection A Resolution of the Government is now in effect for gradual repayement of pension indebtedness, accumulated over the last year and on additional measures for social protection of the population. In compliance with the document to repay gradually the indebtedness on pensions from April, 2004 the amount of pensions for unemployed pensioners will grow by GEL 3, i.e. up to GEL17 and from May 2004 – by one lari more.

May

2 Assistance Zurab Zhvania, Prime Minister of Georgia and Ann Wenman, US Minister for Agriculture, signed an agreement on allocating to Georgia 50,000 tons of wheat as a humanitarian aid from the USA

3 Banking JSC Bank of Georgia is recognized the best CIS bank by the European Bank of Reconstruction and Development (EBRD) on the results of 2003 in financing of trade and conducting documentary operations

4 Transport Parliament ratified an agreement on air communication with Great Britain and Turkey. The MPs stressed the political significance of such a decision

4 Exhibitions International exhibition on Telecommunications “Georgia Telecom – 2004 was launched in Tbilisi for the first time. More than 20 companies participated in the exhibition: ATDI (France), Delta Comm (Georgia), Elektrokavshiri (Georgia), Geocell (Georgia), Geone (Georgia), Globaltel (Russia), Greennet (Georgia), Hesfibel (Turkey), Huawei Technologies (China), Iberiatel (Georgia), Sagem (France), Siemens Mobile (Germany), Telenet (Georgia), ZTE (China)

6 Tourism VI international tourist fair “Caucasus Tourism Fair 2004” was held in Tbilisi. Tourist companies from 9 countries, in particular, from Austria, Italy, the USA, Russia, Iran, Turkey, Armenia, Georgia participated in the event

7 Government Zurab Zhvania, the Prime Minister of Georgia, formed a special commission to study the economic potential of Adjara autonomous republic.

7 Assistance Georgia is among 16 world poorest countries (Armenia, Benin, Bolivia, Vanuatu, Ghana, Georgia, Honduras, Cape-Verde, Lesotho, Madagascar, Mali, Mozambique, Mongolia, Senegal, Sri-Lanka, Nicaragua) which USA assists in implementing economic and democratic reforms. The states, which will receive aid, should meet three basic requirements: efficient democratic governance, care for people’s well-being, free economy.

8 Transport KLM Royal Dutch Airlines starts regular flights to Tbilisi on June 16, 2004. “Boeing 737-900” will operate flights to and from Amsterdam three times a week.

11 Parliament The Parliament of Georgia, at plenary session adopted state budget of Georgia for 2004.

14 Cooperation President of Georgia Mikheil Saakashvili met President of Romania Ion Iliesku

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during his official visit in Romania. Prospects of future political and economic cooperation were discussed

14 Cooperation The American Chamber of Commerce in Georgia (AmCham) held elections for its Board of Directors, President of the Board, and other officer positions at the General Assembly. The new Board of Directors has announced its priorities: lobbying for members’ interests, promoting and liberalization of the Tax and Customs Codes, promoting a friendly investment climate in Georgia and organizing regular debates for the Chamber’s members. The AmCham, has been active in Georgia for six years and aims to promote the development of businesses between Georgia, the United States, and the international community in Georgia.

16 Assistance An EBRD initiative, involving 7 developing countries of the former USSR – Azerbaijan, Armenia, Georgia, Kyrgyzstan, Moldova, Tajikistan and Uzbekistan – foresees increase of their financing by EUR 30 million per year from the present EUR 10 million.

21 Government According to the Georgian Government’s decree of May 21 a moratorium will be introduced throughout Georgia for a period of one month on woodcutting. During this term there should be conducted serious measures for halting the total destruction of the forest areas.

21 Business The EBRD is investing USD 1.2 million for an equity stake in Teliani Valley, a wine processing, bottling and distribution company in Georgia, to help expand its production facilities, improve marketing initiatives and increase sales of its high-quality wines. The Bank's stake will enable the owners of Teliani Valley to restore a newly acquired building in the Telavi area, replacing the existing and dilapidated rented plant. Part of the finance will also allow the company to acquire oak barrels and other equipment to improve the quality of the wine. The funding is being provided under the EBRD's Direct Investment Facility programme, which makes direct equity investments in medium-sized private-sector businesses, with an emphasis on countries that are at an earlier stage of transition to market economies. The EBRD is a minority shareholder in the company and will assume a Board position.

22 Banking According to the information of National Bank of Georgia, there are 23 commercial banks operating in the country.

25 Co-operation Russia and Georgia start preparing economic agreement between two countries. This has become a main result of the two-day working visit to Moscow of the Georgia’s prime-minister Zurab Zhvania. Mikhail Fradkov, head of the Russian Federation Government, confirmed its readiness to bring relations with Georgia to a new level.

28 Co-operation Russia and Georgia sign the protocol on finishing bilateral talks on the Russian Federation joining the World Trade Organization. The document was signed on May 28 by German Greff, the Minister of Russian Federation for Economic Development and Trade and Irakli Rekhviashvili, the Minister for Economy. The protocol fixes the finishing of talks on commodities, services and agriculture. The document reflects systemic issues (correspondence of legislation and trade-economic policy of the Russian Federation to WTO norms). The sides agreed to do their best and make efforts for rapid settlement of yet-unsettled trade-economic problems. The ministers signed a protocol “on settlement of the problems

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between the sides” and Georgia-Russia agreement “on extending the economic co-operation of two countries”.

28- Business Conference Tbilisi hosted the first conference of the Russian business in Georgia. 29 The Russian delegation was headed by the Minister of Economic Development and Trade German Greff. The forum participants discussed the prospective projects for the Russian capital investments. A special interest was expressed by the Georgian side in the participation of the Russian businessmen in development of the energy and agroindustrial sector of Georgia. The Georgian side suggested to Russian entrepreneurs a packet of investment proposals, a total value of which makes up several billion dollars. One of them is connected with resuming a railway communication between Russia and Georgia on the route Sochi- Sokhumi-Tbilisi.

June

7 Assistance IMF Approved a new three–year programme of financial assistance to Georgia under the “Millennium Challenge” programme. The programme is unique not only due to the volume of allocated resources, but also due the fact, that the resources will be disposed by the government of the country, receiving the assistance. It is the first opportunity for Georgia to direct the sums, received within the Millennium Challenge, to the spheres, which require the urgent solution of problems. A major task of the Millennium Challenge is to facilitate quick and dynamic development of economy in the countries, which participate in this programme.

With the assistance of its new three-year program (USD144 million) the IMF intends to support Georgia’s National Programme for Economic Development and Poverty Reduction.

8 Privatisation The program of “Total Privatisation”, proposed by the Minister of Economic Development, Kakha Bendukidze, has been supported by the Prime-Minister, Zurab Zhvania. “A fundamental principle of the aggressive privatisation policy means that any state property should be sold, except the objects, which will remain state or community owned on the decision of the Georgian authorities”.

9 Parliament Minister of Economic Development of Georgia, Kakha Bendukidze, presented his program of country’s economic development to the parliamentary committees for Financial- Budgetary Issues, Sectoral Economy and Economic Policy.

11 Cooperation The I session of the intergovernmental Georgian-Azerbaijani commission on economic cooperation was held in Tbilisi preceding the visit to Georgia of President of Azerbaijan Ilham Aliev.

11 Assistance The agreements on allocating EUR 5.8 million were signed in Tbilisi by the Minister of Finance of Georgia, Zurab Noghaideli and Ingrid Mateus-Mayer, a member of board of directors of the German Bank for Reconstruction and Crediting (KfW|) Within the first agreement Georgia will receive EUR 3.3 million, which will be directed at elaborating the mechanism for covering multimillion debts in the energy sector, also on forming and operating the Agency for Serving the Debts in the Energy Sector. In particular, the German experts will assist the Georgian Government to prepare and launch the tender on determining the company

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to manage the Agency activities. The experts’ work and the tender winner company activities will be financed over two years by the grant mentioned above.

The other agreement foresees allocation of EUR 2.5 million grant to the Georgian government. The sum is designated for financing the work of a group of experts, who will determine major priorities for financing different KfW projects in Georgia.

14 Cooperation President of Georgia, Mikheil Saakashvili and President of Azerbaijan, Ilham Aliev, discussed the prospects of future cooperation between the two countries during the official visit of the President of Azerbaijan to Georgia.

An agreement on coordination of the railway transport was signed between the governments of Georgia and Azerbaijan. The Agreement on expanding cooperation in the energy sector was also signed. The Ministry of Finance of Georgia and the Ministry of Azerbaijan on Taxes signed an agreement on cooperation and mutual assistance. The protocol was signed on further development of cooperation in civil aviation between the aviation services of Georgia and Azerbaijan and an agreement on cooperation between TV and Radio Broadcasting Corporation of Georgia and State TV and Radio Broadcasting Company of Azerbaijan.

Ministry of Economy of Georgia and the Ministry of Economic Development of Azerbaijan are to elaborate draft agreement on long-term economic cooperation between two countries.

16 Assistance At Brussels Conference of donor-countries and international financial-credit institutions, organised by the EC and the WB, a decision was made on granting Georgia USD 1 bilion (EUR 850 million) as a free of charge assistance for supporting the new Government of the country in its endeavours towards economic reforms and democracy. Delegation of Georgian government members, headed by Prime Minister Zurab Zhvania, participated in the conference work.

The Government of Georgia plans to use the financial aid for the development of state management, economy, energy, infrastructure, implementation of the Economic Development and Poverty Reduction Programme, etc. The Eurocommission and the international financial- credit organisations will conduct monitoring of funds spending.

16 Transport KLM Royal Dutch Airlines started regular flights between Amsterdam and Tbilisi. The flights will be operated on Mondays, Wednesdays and Fridays by “Boeing 737-900”.

17 Financial Sector Tbilisi hosted exhibition “Financexpo” for the first time. The exhibition was organised by the Union of Next Generation Initiative in partnership with the National Bank of Georgia, the Association of Georgian Banks, the Ministry of Finance, the International Chamber of Commerce of Georgia. At a conference, held within the exhibition, participants presented their products and services. Such exhibitions are scheduled to be held annually. The aim of these exhibitions is to show the present condition of Georgia’s financial market and potential for its development.

18 Agroindustry International Agroindustrial exhibition was held in Tbilisi. More than 100 companies (including 70 – foreign ones) from 11 countries (Azerbaijan, Austria, Armenia, Germany, Georgia, India, Italy, Russia, the USA, Turkey, France) presented their products: alcoholic drinks and beverages, dairy products, the produce of canned industry, confectionery,

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equipment for processing industry, technologies for products packing, etc.

19 Assistance The Government of the Netherlands allotted USD 178 thousand for implementing the project “Support to the State Department for Statistics for Conducting Integrated Research of Families”. This project is co-financed by the Government of Georgia. An integrated research of families is a key instrument in monitoring a level of poverty in the country, manifesting the progress in implementation of the programme on poverty reduction and evaluation of its impact.

24 Parliament Parliament adopted a decision, according to which an interim parliamentary commission is being formed to study violations in the energy sector of Georgia. The commission will include 15 MPs.

24 Parliament Parliament of Georgia ratified agreement with Lithuania “On avoiding double taxation on incomes and capital”. The agreement was signed in September 2003 within the visit to Georgia of the President of Lithuania. The agreement concerns the residents of one or both signatory countries. The regime for avoiding double taxation will concern the tax on profit, capital returns, incomes from real property, international operations, credits, salaries for managers of the companies, professors, teachers, scientist, students’ stipends, pensions, etc.

24 Assistance The WB board of directors aproved allocation of three credits (total of USD 47.6 million to Georgia. From this sum USD 24 million – a credit to support the reforms, USD 3.6 million – a credit to support the energy sector and USD 20 million – a project of construction of roads of local designation. Main goals of these projects are: promotion of economic growth through support to the process of fight against corruption and efforts directed at improving the system of management; assistance in improving efficiency of the state sector, and also its joining to the process of implementing the Programme of Economic Growth and Poverty Reduction.

30 Privatisation Minister of Economy, Kakha Bendukidze presented at the governmental session main directions of the privatisation policy. The Minister informed that at present the state owned shares in 1800 joint stock and limited liabilities companies. A major form of privatising the industrial enterprises will be the so-called “international sale”, the enterprises will be sold at open auctions or in direct sale at maximum possible price.

In the process of privatisation the Government of Georgia will be assisted by the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC), in particular, it is foreseen to open for the Georgian commercial banks the direct credit lines with the help of which the Georgian citizens may take part in privatisation of small and medium-sized objects. The EBRD and IFC will assist the Government of Georgia in restructuring big enterprises and preparing them for privatisation.

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July

6 Parliament Parliament of Georgia hosted a presentation of the Georgian National Scheme of the International Association of Business and Parliament (IABP) and the first session of its organising committee. The organising committee involves more than 10 MPs and about 20 famous Georgian businessmen, representing both their companies and the business – associations. Nino Burjanadze, Speaker of the Parliament, mentioned, that “the aim of establishing the national scheme IABP is to provide all the political parties in the Parliament and the business-circles with the possibility of close cooperation to enable the laws adopted by the Parlaiment provide maximum favourable terms for business development”.

6 Cooperation President of Georgia, Mikheil Saakashvili and President of Islamic Republic of Iran, Mohammed Khatami, discussed the prospects of future cooperation between the two countries during the official visit of the President of Georgia in Iran. The Presidents discussed directions of developing the Iranian-Georgian cooperation in trade, economic, transport, cultural and other spheres. An agreement was reached on allocating two million dollars to Georgia by Iran.

7 Assistance Prime-Minister of Georgia, Zurab Zhvania chairman of the Georgian Committee of Millennium Challenge Corporation (MCC) delivered speech at the presentation saying “that the programme goal is to assist the developing countries in providing economic growth and poverty reduction, conducting economic and legislative reforms”. A precise volume of help to Georgia will be defined after the presented projects are approved. Within the programme the Georgian Government plans to declare as priorities the projects on developing the infrastructure, in particular, rehabilitation and construction of roads, bridges, sewege systems, etc. Other priority will be development of agriculture, for which a special investment fund will be formed to finance the projects in the regions of Georgia.

8 Agriculture Association of Wheat and Bread Product Producers, “Global-Agro” is formed. The major goal of the Association is to form a competitive environment and the protect the interests of both producers and consumers of the produce in this sphere, to assist the government in elaborating the measures and forming the mechanisms for the fight against the wheat and flour smuggling in the country, in establishing a legislative and normative base in the sector.

12 Aid Government of Switzerland allocated financial aid (CHF 800,000) to most vulnerable population of Georgia. Money will be spent on pensions for lonely pensioners and the families with two or more pensioners. One-time assistance of GEL 100 is foreseen for the vulnerable sections of the population

13 Assistance German Bank for Reconstruction and Development (KfW) allocates EUR 10 million for the rehabilitation of the Georgian energosystem, namely for full rehabilitation of the “Alaverdi” electricity transmission line, which connects the Georgian energosystem with the Armenian one and of some substations (Lisi, Marneuli, Gardabani and Didube).

15 Privatisation The list of 372 enterprises to be privatised was presented by the Minister of Economic Development, Kakha Bendukidze. It is only a part of the objects planned for sale in 2004-2006, the objects, the legal work on which has been completed and which are ready for

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public procedures. The next privatisation list will be released 3-4 months later.

17 Energy State Electrosystem of Georgia (control and transmission service) signed an agreement with the German consulting company Lahmeyer International on delivering the consulting services in the process of rehabilitation of the Georgian energosystem. The contract costs EUR 1.3 million. Lahmeyer won the tender launched within the project “For Promotion of Georgian Wholesale Electricity Market”. The project is financed by th eWorld Bank and the German Bank for Reconstruction and Development (KfW)

18 Transport Georgian airline company Airzena-Georgian Airlines received the certificate of the European organisation Joint Aviation Authorities (JAA) to conduct works for technical services to the planes “Boeing-737-500”, “Boeing-737-400” and “Boeing-737-300” type.

23 Assistance A regular IMF Mission started work in Tbilisi. The IMF Mission’s objective is to discuss with the Government the first review on the programme of financial assistance to Georgia, within a three-year aid programme through the Programme of Poverty Reduction and Growth Facility (PRGF), approved by the executive board of this international financial organisation on June 4, 2004.

25 Cooperation Georgia and Ukraine signed a Memorandum on Economic Cooperation. The memorandum was signed during the official visit to Kiev of the Georgian Prime-Minister Zurab Zhvania

30 Cooperation The representatives of the governments of Georgia and the Netherlands signed a memorandum on “The Program of Cooperation with the Arising Markets“ (PSOM). Within the programme the government of Holland will annually allocate EUR 500,000 for 2-3 joint projects of economic cooperation of private companies from both states. The sum allotted will make up 50 per cent of the project cost. The projects should have high standard on corporate social responsibility. The projects will be determined with the help of special tenders, conducted once a year by the agency of the government of Holland – EDV, which will implement the programme in Georgia through consultations with the Embassy of the Netherlands in Georgia. Ms.Tamar Beruchashvili, the State Minister for Eurointegration Issues, will coordinate the Programme from the Georgian side. The programme is foreseen for two years and might be prolonged in case both sides consider it mutually beneficial.

August

2 Government The IMF Mission, having finished its regular visit to Georgia, positively evaluated the work of the Georgian Government. The Mission expressed satisfaction with the Georgian Government activities in increasing tax revenues in the budget and, correspondingly, with the project of introducing changes into the state budget of Georgia for 2004.

9 Cooperation The government of Israel shouldered additional obligations and promised the businessmen of its country to give them state guarantees in case they fail to successfully put their investments in Georgia. The Israeli government will fully compensate supposed losses of Israeli businessmen in Georgia. Thanks to this decision a risk factor is zero for the Israeli businessmen ready to invest into the Georgian economy.

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11 Cooperation An extended governmental delegation from Turkey headed by Prime Minister of Turkey Recep Erdogan and 120 leading Turkish businessmen accompanying him visited Georgia. Head of the Turkish Government met with President of Georgia Mikheil Saakashvili and the Prime Minister Zurab Zhvania. They discussed the issues of extending Georgian- Turkish economic cooperation. Within the visit Tbilisi hosted a business-forum of Georgian and Turkish Businessmen.

12 Energy American consulting company PA Consulting Group and Bank of Georgia signed a guarantee agreement. Within the USAID programme “Georgia’s Energy Security Initiative” PA Consulting is implementing the project on economic development of agricultural communities, which foresees promotion of energy projects in the regions of Georgia. Within this project the selected communities are given an opportunity to get long-term (7 year term) and cheap credits (at 8-12 per cent). The project is financed by the USAID (USD 600,000) and the Bank of Georgia (USD 120,000).

15 Parliament The Parliament of Georgia approved introduction of changes into the law “On the State Budget of Georgia for 2004”. In compliance with these changes, an income side of the Georgia’s state budget for 2004 with grants makes up GEL 1,655,030 thousand. Expenditure side of the state budget makes up GEL 1,926,174 thousand. The revenues and grants of the central budget are determined in the amount of GEL 1,257,330 thousand, and expenditures – GEL 1,426,974.

26 Government Government of Georgia approved the new draft tax code and submitted it to the Parliament

29 Government Reorganisation of Antimonopoly Service and Tax Inspectorate resulted in formation of a new service: State Agency for Free Trade and Competition.

September

1 Cooperation / US Agency for International Development (USAID) and Georgian Enterprise Growth Initiative (GEGI) gave grants of total USD 271,965 to seven Georgian NGOs and business-associations (Association of Freight Forwarders of Georgia, Federation of Professional Accountants and Auditors of Georgia, Centre of Economic Policy and Research, NGO Constitution Article 42, NGO Partnership for Social Initiatives, Association of Georgian Insurers, Association of Georgian Exporters) to implement the projects for promoting the reforms in the private sector of Georgia and for improving the entrepreneurial environment.

2 Banking / Lado Gurgenidze has been appointed Director General of Sakartvelos Banki (Bank of Georgia)

2 Transport / LLC “Sakaeronavigatsia” signed a contract with the Italian company Alenia Marconi Systems, which will assemble in Tbilisi airport an instrumental flight system” DMG, corresponding to international standards.

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6 Cooperation Supreme bodies of financial control during a regular annual meeting of the heads of CIS countries’ financial controlling bodies held in Astana, took obligations on providing transparency of their activities and signed a memorandum

9 Tourism From September 9, 2004 changes came into force to the law of Georgia “on consular fees”, which foresees granting Georgian visas at a reduced tariff. According to the changes price of one-term visa for entering Georgia for a month makes up equivalent to USD 10 in Georgia National currency for three months – USD 30. Cost of two-term visa makes up 150 per cent from one-term visa cost over a relevant period. Cost of multiple visa for a term up to a year makes up USD100. One-term transit visa cost USD 5, two-term – USD 10. One of the reasons of visa regime simplification is promotion of tourism sector development in the country.

9 Government President of Georgia signed a decree on dismissing Giorgi Chanturia, GIOC president, from his post.

12 Agriculture/ Tbilisi hosted international exhibition “Interfood Georgia 2004”. The exhibition was organized by British exhibition company ITE Group Plc jointly with its exclusive partner in Georgia, the company “Iteca Kavlasia”. It was officially supported by Georgia’s Ministry of Agriculture, Farmers Association of Georgia, Union of Winemaking and Vinegrowing of Georgia. About 30 companies from 9 countries of the world took part . They exhibited food products, food additives, alcoholic and soft drinks, equipment and technologies for food and processing industry, etc.

19 Communication Megacom company of cellular communication stops functioning. National Commission for Communications canceled Megacom company (DAMPS-network operator) licence for serving telephone cellular communication due to the licence term termination and nonpayment of the company’s’ debt to the commission in time.

22 Government Government of Georgia introduces state monopoly on lottery business. The relevant changes into the laws “On holding lotteries, gambling and other winning games” and “On licenses and permits for entrepreneurial activities” were prepared by the Ministry of Culture and Sport. The government approved the presented draft laws.

29 Privatisation Batumi Hotel “Intourist” was sold at auction at USD 3.02 million. The “Intourist” will remain a hotel and will be reconstructed as a five-star hotel.

30 Assistance Government of the Netherlands allotted EUR 3 million grant for Georgia. The sum is designated for promoting the reforms of state management, conducting the anti-corruption measures, achieving fiscal stability and fight against poverty

October

1 Cooperation Tbilisi hosted constituent meeting of the Armenian-Georgian Association fo Business Cooperation, which involved the representatives of the Parliament, government business circles, and public figures. Co-chairman of the Association from the Georgian side is Beso Jugheli, MP, chairman of the faction “Majoritarian”. Honorary chairman from the Georgian

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side is Zurab Zhvania, Prime Minister of Georgia. In the beginning of November analogous constituent meeting will be organized in Yerevan, where co-chairman and honorary president o the association from the Armenian side will be named. It is supposed they will be Armenian MP Vladimir Badalian and chairman of Armenian Ministerial Council Andranik Markarian respectively. In compliance with the adopted structure, the association will involve 9 commission on each of the sides: commissions on business, communications, social issues, culture and science, sport and tourism, health care, etc, which will promote solution of the problems, existing in Georgia and Armenia in the relevant spheres.

8 Government At October 8 Governmental session a draft law “On legalization of undeclared tax liabilities, finances and property” was discussed. The businessmen of Georgia are given an opportunity to legalize undeclared tax liabilities, finances and property. When the law is in effect, the controlling and law enforcement bodies are prohibited from checking businessmen’s entrepreneurial activities, which they conducted till January 1, 2004. The draft law will be submitted to the Parliament for discussions till October 20. After the law is in effect, the businessmen will be given a 12-month term for presenting the financial and property declarations.

8 Assistance An agreement on allocation of USD 1 million credit line to the Georgian Leasing Company (GLC) by the American Overseas Private Investment Corporation (OPIC) was signed within American-Georgian business-council launched in Tbilisi. The credit is allocated for 10 years. GLC plans to use it for expanding leasing portfolio for small and middle companies mostly in the agrarian and services sector and to assist them in modernization and equipment renewal.

12 Banking Firebird Avrora Fund, an investment fund working in the CIS and East European countries, bought 512,248 shares of Sakartvelos Bank. A total sum of this deal, conducted at the Georgian Stock Exchange, made up more than GEL 3.07 million. Correspondingly, 1 share cost 6.0 lari, which is the highest rate over 4 years of biddings with the Bank shares at the exchange

14 Energy The German company Lahmeyer Internaitonal will start works for installing SCADA (Supervisory, Control and Data Acquisition) system by the end of October. The specialists consider the present project is of great importance for Georgia as with SCADA system introduction the energy system management will considerably improve.

19 Government Nikoloz Vashakidze is appointed president of Georgian International Oil Corporation (GIOC).

22 Cooperation President Mikheil Saakashvili had a tête-à-tête meeting with the President of Armenia Robert Kocharian, officially visiting Georgia on October 22-24. During the meeting they discussed a wide range of issues in regard to cooperation of two countries in the spheres of energy, transport, customs, legislation unification. A joint meeting of the governmental representatives of both countries was held, attended by the Presidents, at which they discussed the prospects of economic cooperation.

23 Pipeline BP company announced the commencement of South-Caucasian Gas Pipeline (SCP) for gas transportation from the “Shah-Deniz” sea deposit. The construction started from welding of pipes at the 213 km section of the gas pipeline in the center of Azerbaijan. The

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welding will be finished in 10 months. Over that period 39,000 pipes will be welded at the Azerbaijanian section, 22,000 – at the Georgian. The construction is scheduled to be finished by the 4th quarter of 2005.

24 Energy Government of Georgia prolonged for one year the term of contract, according to which the American company PA Consulting conducts management of united distributing Company (UDC). The Minister mentioned that “the talks have already started, during which the details of the agreement should be determined. The term of contract, according to which PA Consulting conducts UDC management, expires this November. USAID has already foreseen in its budget the resources required for financing PA Consulting (USAID finances salaries for the company staff and covers all the expenses for UDC management).

25 Agriculture Government of Georgia allocated GEL1, 005,626 by the special governmental decree for purchase of grapes from the population. This sum has been distributed among seven wineries of Kakheti region (LLC Tsinandali, Sakartvelos Gvinis Sagandzuri, LLC Chandari, LLC Khirsa, LLC Altasi, LLC Sameba, LLC Alazan-irgsi, LLC Kindzmarauli).

26 Technology Georgia started producing notebooks. The first notebooks assembled in Georgia by the Maxtop company (Intel company Georgian partner) on the basis of Intel technology, will be sold in the first decade of November. The Georgian notebooks will be mostly oriented at the local market.

27 Government According to the decision of President of Georgia, from January 1, 2005 the minimum pension would be redoubled in the country

28 Parliament / At the plenary parliamentary session the draft Tax Code was adopted in the first reading. In the new Tax Code, instead of the present 22 taxes in Georgia there will be only 8: VAT (its rate reduces from 20 to 18%), tax on income (acting progressive rate in the amount from 15% to 20% is changed with fixed 12%), tax on profit (will be 20% as it is at present) and social tax (the rate reduces from 30% to 20%). In addition, the new Tax Code foresees preserving excise on oil products, tobacco products, cars, alcoholic drinks, taxes on use of natural resources, property, gambling business.

28 Cooperation The second session of a Joint Intergovernmental Commission on Economic and Technical Cooperation between Georgia and Greece was held at the Ministry Foreign Affairs of Georgia. The Georgian delegation was headed by the State Minister for the European integration Tamar Beruchashvili, Greek delegation – by the deputy Minister of Foreign Affairs of Greece Evripidis Stilianidis. The existing condition of bilaterial trade-economic cooperation in the spheres of agriculture, transport, communications, tourism, energy, banking sphere was discussed at the session. The sides also have discussed prospects of the further development of the bilateral relations within the framework of the EU new initiative “European Neighborhood Policy”

29 Assistance Georgian Governmental delegation, headed by the State Minister for European Integration Tamar Beruchashvili, visited Germany. During the meeting in Bonn at the governmental level, the issues of delivering financial and technical assistance to Georgia were discussed. The sides agreed on the program of cooperation for 2004-2005 and on the packet of projects at a total sum of EUR 26 million.

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November

1 Transport After an 18-month break, on November 1 the British airline company British Mediterranean Airways (franchising partner of British Airways) resumed flights to Georgia. The flights from London airport Heathrow to Tbilisi will be conducted at 13.20 on Fridays and Sundays. The plane arrives to Tbilisi at 21.30 at local time. The flights from Tbilisi to London will be conducted on Mondays and Saturdays at 10.30. The plane will arrive to London at 13.15, local time. The flights between Tbilisi and London are conducted by aero buses A320 and A321.

3 Cooperation Sakartvelos Banki (Bank of Georgia) signed an agreement with the US Agency of International Development (USAID) on forming single credit system. According to the document, JSC Sakartvelos Banki will issue the first corporate (private) bonds at the financial market of Georgia worth of USD 3 million and USAID will provide 50 per cent guarantee for bonds (on USD 1,5 million). The resources, received from selling the bonds, will be used for financing energy projects for small and middle enterprises. The project implementation became possible thanks to USAID technical assistance and joint work of the companies PA Consulting Group, Winrock International, JSC Galt&Taggart Securities and JSC Sakartvelos Banki. The project is being implemented within USAID project “Initiative of Energosecurity of Georgia” – component of Development Credit Authority”. PA Consulting Group is engaged in the project administration.

3 Banking Tbiluniversalbanki merged with Sakartvelos Banki. The shareholders of these banks reached an agreement on Sakartvelos Banki (Bank of Georgia) to buy 80.011 per cent of Tbiluniversalbanki shares. Bank of Georgia also reached an agreement with the European Bank for Reconstruction and Development (EBRD) on buying 19.99 per cent of Tbiluniversalbanki shares. A relevant memorandum has already been signed and the decision will be approved by the stockholders’ meeting scheduled for December, 2004

3 Privatisation The government of Georgia approved the plan of the Ministry of Economic Development on privatization of JSC Tbilaviamsheni. The decision was adopted on privatization of JSC Tbilaviamsheni through a direct sale. The enterprise will be sold to LLC Tbilaviamsheni, which was founded by an initiative group of the enterprise present authorities. Aviaconstruciton factory will be sold at USD 67 million. Half of the sum will be transferred to the state budget of Georgia by the end of the current year. Principal terms of privatization are: to preserve the enterprise profile, to fulfill the state orders first. Over three years the factory authorities should provide 20 per cent increase of the staff, 10per cent growth of salaries.

5 Energy The representatives of the Chinese company Sichuan Electric Power Import and Export Corporation (investors of HadoriHPP construction in Georgia) signed an interim agreement on operating the station from November 15, 2004 with the Wholesale Energy Market, managed by the Spanish company Iberdrola. KhadoriHPP construction on the river Alazani is the first energoproject, implemented in Georgia by the Chinese side. The construction works started in spring 2001. A total cost of the investment project is about USD 25 million. A project capacity of the station is 24 mWt – two units with 12 mWt each. While working at full capacity KhadoriHPP will practically manage to fully satisfy the requirements of the Kakheti region in electricity

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11 Cooperation / London hosted conference “Investment into Georgia” The conference was organized by the Georgian government jointly with the European Bank of Reconstruction and Development (EBRD). Prime Minister of Georgia Zurab Zhvania, minister of economic development Kakha Bendukidze, minister of finance Zurab Noghaideli, National Bank president Irakli Managadze, other officials and number of Georgian businessman participated in the conference. The conference was also attended by more then 250 businessmen from Great Britain and the USA. Business conference in London was the greatest economic arrangement ever organized by the Georgian Government. The conference aimed at familiarizing the international political and business circles with the course of economic and political reforms in the country, business-situation, promotion to confidence and business contacts between Georgian and foreign businessmen, mobilization of investments in different sectors of Georgian economy

16 Communications / Magticom offered its subscribers in Georgia a new service – “Magtinet”, which enables to use unlimited Internet from any place, where the Wi-Fi technologies are installed: in airports, hotels, cafes, offices, houses, etc. As a pilot project Magticom has already offered its clients to use Magtinet in the Tbilisi café “Batonebi”. Over the first three months the service will be free of charge.

22 Business/ Sakartvelos Banki (Bank of Georgia) announced about buying British-Caucasian Insurance Company (BCI), one of the leading companies at the Georgian insurance market. The Bank has already bought 45 per cent (GEL 1,767,150) of BCI shares and also signed with the insurance company the obligatory, having a legal effect Memorandum on mutual understanding, according to which the Bank will buy the remaining shares of BCI (55%).

24 Cooperation / Deputy Minister of Foreign Affairs of Georgia, Kakha Sikharulidze and Deputy Minister of Foreign Affairs of Italy, Margarita Boniver, signed the agreement on creation of a Consulting Forum - Council of Economic, Industrial and Financial Cooperation. The purpose of this council – coordination of economic activities between two countries.

25 Parliament / Parliament of Georgia approved in the third reading the draft law on abolishing the law of Georgia “On the state control, analysis and standardization of precious metals and precious stones”, (in force from September, 1998). In compliance with the decision adopted, the activities in the sphere of precious metals and precious stones in Georgia becomes self- regulated. The state structure, the function of which was control over standard on the basis of the law mentioned above (the Finance Ministry department on precious metals and precious stones), is being abolished. From now on these activities: standardization, expertise, certification of precious articles, etc, will be conducted by the private laboratories, having a status of a legal entity of private law (associations, LLC, etc.).

26 Cooperation / The Embassy of Italy to Georgia launched a presentation of a joint Italian- Georgian project “Italy-Georgia Economic Partnership Programme” (IGEPP). The project aims at promoting the development of industrial and trade cooperation of Italy and Georgia (sectors: construction, agriculture and processing of agrarian produce). The project duration is 18 months and it costs EUR 500.000. The project is financed by the Italian side.

29 Cooperation / Tbilisi hosted business-forum “Potentials of Cooperation and Investments in Georgia for Italian Enterprises”, organized by Embassy of Italy and Trade-Industrial Chamber of Georgia.

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30 Business / A laboratory for wine quality control in compliance with the international standards was opened in Tbilisi. The lab is equipped with the modern equipment from Germany and may conduct fullvalue analysis of wine quality on the basis of 60 parameters.

December

3 Privatisation/ The Ministry of Economic Development of Georgia and the authorities of LLC Tbilaviamsheni signed a contract on direct sale of the state-owned 90 per cent of the enterprise shares. State-owned 62,735,237 shares were sold at USD 67 million.

5 Banking / The German Bank for Development KfW signed an agreement on partnership with the Georgian Bank “Respublica” within the project on forming a Credit Guarantee Fund. The Fund aims at promoting the availability of credit resources for SMEs.

6 Business / Taxpayers Union of Georgia was transformed into Businessmen Federation. Badri Patarkatsishvili was elected chairman of Businessmen Federation.

9 Parliament / The Parliament of Georgia approved a draft new Tax Code in the second reading

10 Assistance / Head of US Agency for International Development (USAID) Danny Robertson and the Minister for Health, Labour and Social Issues Lado Chipashvili signed a memorandum on mutual understanding, which foresees allocation of USD 3 million for the program on payment for electricity consumed by the population of Georgia in winter.

10 Transport / President of Georgian Airways (former AirZena) airline company Tamaz Gaiashvili signed an agreement with the American company ILEFC on leasing two planes “Boeing-737”. At present the company has 5 airliners, in particular, three planes “Boeing-737 – 500” leased from the German company Hapag-Lloyd. The new two planes will fly to Dubai and Milan.

12 Business / USA company Frontera Resources is going to invest USD 37 million into oil prospecting and extracting in Georgia in 2005. After starting its work in Georgia in 1997 the company has already invested USD 70 million into the sector.

15 Government / The Georgian Ministry of Economic Development arranged a meeting with the representatives of Georgia’s donor countries and organizations and presented a report on progress in implementing “The National Program for Economic Development and Poverty Reduction”. 19 Transport / Airline company Georgian National Airlines (former Air BISEC) and Russian airline company Siberia united their routes Tbilisi-Moscow-Tbilisi and will jointly develop the business.

20 Assistance / IMF approved allocation of second credit tranche to Georgia (SDR 14 million credit regular tranche (about USD 21.5 million)). within three – year – long program of assistance to Georgia on program of Poverty Reduction and Economic Growth

22 Parliament / The Parliament of Georgia approved a draft new tax code in the third reading. The new tax code will be in effect from January 1, 2005.

24 Parliament / At the special session the MPs voted for adopting a draft law “On amnesty,

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legalization of property and undeclared tax liabilities from 1992 through 2003” in the second and third readings. The draft law should be in effect from January 1, 2005

24 Cooperation / The Parliament of Georgia ratified “Agreement on Avoiding Double Taxation on Incomes, Capital and Taxes Between United Kingdom of Great Britain and Northern Ireland and Georgia.” The agreement was signed on July 13, 2004 in London by Salome Zurabishvili, the Minister of Foreign Affairs of Georgia and Head of Great Britain Foreign Office Jack Straw.

24 Banking / National Bank of Georgia gets the right to conduct bilateral currency interventions. Such a right was given to NB on the basis of document “National Bank’s monetary-credit policy major directions“adopted on December 24. NB has been given the right to conduct from next year the operations not only for buying, but also for selling the currency. Thus, NB will manage to efficiently promote stable rate of national currency.

January

8 Government / Presidential Economic Council was formed. The main function of the Council will be preparation of proposals and recommendations on economic development of the country. The President will chair the Council.

10 Cooperation / The Ministry of Economic Development of Azerbaijan elaborated the draft intergovernmental agreement with Georgia on “Cooperation in the Sphere of SMEs”

17 Cooperation / Salome Zurabishvili, Minister of Foreign Affairs of Georgia and HE Stefan Shpeck, Extraordinary and Plenipotentiary Ambassador of Swiss Confederation in Georgia, signed the “Agreement Between the Government of Swiss Confederation and Government of Georgia on Technical, Financial and Humanitarian Cooperation”.

18 Privatisation / The Tender Commission declared that the Russian company EurazHolding jointly with the Georgian-Austrian company DCM-Ferro (affiliate of metaltrader DCM DECOmetal International Trading GmbH) presented the best investment proposals and offered the highest price for purchase of a state packet of shares of JSC Chiaturmanganumi (Chiaturmanganese) with manganese mines and VartsikheHPP (hydro power plant) with cascades and won the tender.

18 Banking / Russian Vneshtorgbank bought control packet of shares of United Georgian Bank (USD 7 million)

21 Privatisation / The Russian company Dema Computers Ltd. won the tender on privatizing 51per cent of JSC Elmavalmshnebeli (Tbilisi Locomotives Constructing Factories).

23 Transport / Motorboat “Kometa” started regular moves between Batumi and Hopa (Turkish city)

25 Legislation / Law on “Amnesty and Legalization of Undeclared Taxes and Property” is in effect In Georgia from January, 25

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25 Privatisation / British-Austrian Consortium won the tender on privatization of Ocean Shipping Company of Georgia (OSCO)

27 Government / The Ministry of Economic Development of Georgia and JSC Tbilisi International Airport announced the international tender for selecting the best project proposal on constructing a new airport on the territory of the Tbilisi international airport and on renewing and reconstructing its infrastructure.

28 Customs / The agreement on mutual cooperation of the Georgian and Turkish customs services was signed in Sarpi by Giorgi Godabrelidze, chairman of Customs Department of the Georgian Finance Ministry and Riza Turagai, head of Turkish Customs.

30 Communications / The Georgian National Commission for Communication (GNCC) launched a commercial tender for getting a license of mobile telephone communication operator. An initial price for license is fixed at GEL 5,807,000 (approximately USD 3 million).

30 Tourism / During the visit to Iran of the Chairman of Tourism and Resorts Department of Georgia, Saba Kiknadze, the “Program on Cooperation in Tourism between Georgia and Iran” was signed

February

1 Assistance / EBRD allocated EUR 5.5 million to Tbilisi Municipality for municipal transport development.

2 Banking / Black Sea Bank for Trade and Development opened USD 5 million credit line to Georgian JSC ProCreditBank for financing micro, small and medium - size enterprises, which is a priority direction of the Bank activities. ProCreditBank has been functioning in Georgia since 1999. Over that period the credits were given to 12,000 entrepreneurs working in Georgia.

5 Transport / The airline company Georgian Airways started regular internal flights on Tbilisi- Batumi-Tbilisi route. The air ticket on Tbilisi-Batumi air flight makes up USD 25 equal in lari; the flight duration is about 45 minutes.

7 Assistance / President of the USA, George W. Bush submitted to the US Congress a draft budget of the United States for 2006, in which he asked the law-makers to allocate total USD 80.2 million to Georgia on three key programs, including economic help, training of serviceman and financing of defense supplies and services from the USA.

16 Privatisation / State share In Sakartvelos Telecomi (Telecom of Georgia) Is sold (51per cent at USD 5 million) to American company Telcell International Inc.

17 Parliament / Extraordinary parliamentary session the MPs approved the new Cabinet of Ministers of Georgia headed by Prime-Minister Zurab Noghaideli and the governmental program for 2005-2009.

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22 Parliament / The Parliament of Georgia ratified an agreement on avoiding double taxation of incomes and capital between Georgia and Latvia

23 Government / Georgian Cabinet of Ministers discussed and approved the draft law “On Privatization of Sate-owned Agricultural Lands”. This draft law will be submitted to the Parliament in the nearest future. This initiative of the government will promote the formation of the land market in Georgia and attraction of investments in agriculture.

25 Trade Unions / Trade Unions of Georgia transferred to the state 90 per cent of its property.

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APPENDIX I: REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES (WITH A REFERENCE TO THE OSCE REGION)

by Dr.Daniel Linotte, Senior Economic Adviser, OSCE Secretariat

Content

Introduction I. Generalities on REI 1. History and recent trends 2. Reference categories and concepts 3. REI and Economic Analysis 4. REI within the OSCE region

II. The European Union 5. Historical background 6. Main Institutions 7. Policies 8. EU trade 9. Deepening 10. Enlargement 11. EU Enlargement and Third Countries 12. EU external relations

III. Other REI Schemes 13. Free Trade Agreements (EFTA, NAFTA, CEFTA) 14. The Commonwealth of Independent States 15. Sub-regional REI schemes within the CIS

IV. REI, WTO membership and trade facilitation 16. REI and WTO 17. The importance of trade facilitation

Conclusion

List of figures, tables and boxes Figure 1: Regional Trade Agreements in the World, 1948-2002 Table 1: Categorising trade blocs Table 2: Levels of economic and commercial regional integration Table 3: Selected regional integration / trade liberalisation / trade facilitation agreements (or initiatives) within the OSCE region Table 4: Main EC/EU Treaties Table 5: EU policies and fields of action Table 6: Successive enlargements Box 1: Bela Balassa, 1928-1991 Box 2: Benelux Box 3: The European Economic Area

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Introduction

All OSCE countries are engaged in various regional integration schemes, with a focus on trade promotion and economic co-operation matters.

The most ambitious and advanced regional economic integration (REI) scheme is the EU that started with the creation of the European Steel and Coal Community by 6 states in 1951. The Founding Fathers of the European integration process aimed it at assuring post-war reconciliation and political stability through economic co-operation. They also shared fundamental common values in terms of democracy, political and economic freedoms and rights. Their initiative proved to be successful. The reduction and then the elimination of tariff and non-tariff trade barriers among member states contributed to the expansion of their economies and, as a result, their peoples could enjoy high standards of living. The European integration project evolved into what is now the European Union of 25 members. Bulgaria and Romania will join in 2007 and other countries are preparing themselves for the next waves of accession. By the end of the current decade most of Europe will belong to the same economic space and apply common visions and policies. Besides, the concept of “New Neighbourhood” is being elaborated to strengthen ties with non-member countries in the East and South.

Following the momentum created by the EU, other countries initiated similar experiences. EFTA is one of them. More recently NAFTA was created, allowing for a huge free trade area between the US, Canada and Mexico. Transition countries are also engaged in regional integration schemes such as the CIS and other sub-regional integration schemes within the CIS (e.g. the Russian-Belarus State Union, the Eurasian Economic Community, GUUAM, the Common Economic Space, etc.) to promote development, trade and economic co-operation.

In some REI instances, despite political declarations and formal commitments, progress can be slow, which underlines the importance of the WTO framework for trade liberalisation and the need for effective trade facilitation measures.

This short note presents some of the main ideas and analytical tools on regional economic integration. It reviews the main REI experience, namely the EU, with a focus on relations with third countries and the impact of enlargement. It considers other REI cases in the OSCE region (EFTA, NAFTA, CIS, GUUAM, the Common Economic Space, etc.). In a last section, the importance of WTO rules and trade facilitation is underlined.

Considering the vast amount of available material on regional integration matters, this document is based on selective information, aiming at identifying key-issues and stimulating further discussions. This document does not claim to be the final word on such complex and sometimes controversial issues.

I. Generalities on REI schemes

1. History and recent trends

Historical precedents REI Agreements are not new. "Customs unions have existed since the seventeenth century, but until the establishment of the GATT system in 1947, customs unions tended to cluster around one

94 GEORGIAN ECONOMIC TRENDS – 2005 No.1 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES hegemonic state.”1 Historically, one famous regional integration scheme is the German "Zollverein" promoted by Prussia 180 years ago.2 The Austro-Hungarian Empire was also a customs union that had to be renegotiated every 10 years, etc.

A growing trend According to Bhagwati and Panagariya, regional trade agreements came in two waves, the first one dates from 1958 to 1970 and was initiated by the Rome Treaty that established the European Community; the second wave began in the mid-1980s (and accelerated in the 1990s), principally with the Single European Act.3

Figure 1: Regional Trade Agreements in the World, 1948-2002

Source: WTO Secretariat.

By May 2003, over 265 agreements had been notified to the WTO (and its predecessor, GATT). Of these, 138 were notified after the WTO was created in January 1995. Over 190 are currently in force; another 60 are believed to be operational although not yet notified. According to WTO, the total number of regional trade agreements could reach 300 by the end of 2005.

2. Reference categories and concepts

Categorizing trade blocs

As indicated in Table 1, which proposes a particular classification of trade blocs, regional economic integration is a complex phenomenon that relates to different situations. Broadly speaking, it corresponds to growing trade and economic relations within a group of countries, faster than with the rest of world. Such a process might be the result of a formal agreement between partners.4

1 E. Mahant, “Regional Economic Integration—Bringing Values Back In,” in: Globalization and the Political Economy of Trade Policy, ed. by C. Parakevopoulos et al., The APF Press, Toronto, 2000, p. 42.

2 During the reign of Frederick William I in the eighteenth century, Prussia itself went through fundamental administrative reforms, building up what was then perceived as a modern and model state.

3 J. Bhagwati and A. Panagariya, “Preferential Trading Areas and Multilateralism,” in: The Economics of Preferential Trade Agreements, J. Bhagwati and A. Panagariya Editors, AEI Press, Washington, 1996, pp. 1-78.

4 For the distinction between formal and informal trade blocs, see: Trade Blocs? The Future of Regional Integration, edited by V. Cable and D. Henderson, Royal Institute of International Affairs, London, 1994.

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Box 1: Bela Balassa, 1928-1991

With Jacob Viner, the Hungarian born American economist Bela Balassa stimulated pioneering works on regional integration. In 1961, he published a famous book: The Theory of Economic Integration. According to Balassa, regional integration agreements generally aim at removing discrimination between foreign and domestic goods, services, and factors of production.

Proximity also makes countries natural partners. The sharing of a common border should normally be an incentive for exchanging goods and services, and traveling between countries, even in the absence of a formal agreement. Distance is often seen as an impediment for trade. Moreover, the existence of a formal agreement does not imply that it is effectively enforced.

Table 1: Categorising trade blocs ------Informal Large and/or growing trade Absence of agreement Formal Agreement between partners - Effective - Ineffective Natural Proximity, neighbors “Unnatural” Distant partners; natural obstacles ------Source: D. Linotte and L. Aune, "The GUUAM July 2002 Free Trade Agreement: A Preliminary Assessment", Central Asia and the Caucasus, Center for Social and Political Studies (Sweden), No. 1 (19), 2003.

Level / intensity of regional integration

Considering formal regionalism, a tentative list is provided in Table 2. The lowest level is a preferential trade agreement between at least two countries. In that case, mutual import tariffs are made lower than those against the “rest of the world.” The next stage is the complete elimination of tariffs between partner countries—that corresponds to a free trade area, in which member countries retain national tariff levels on imports from outside the area. In a customs union, member countries adopt common external tariffs, which requires negotiating and agreeing on their levels (and not contradicting WTO rules for REI contracting parties members of the organization). The highest stage of integration is the creation of a common political entity. It may require monetary, economic and commercial institutions, within a federal, confederation-type or centralized political system.

Table 2: Levels of economic and commercial regional integration ------Preferential trade agreement Lowering of tariff barriers between contracting parties Free Trade Area (FTA) Elimination of tariff barriers (and non-tariff-barriers) Customs Union (CU) FTA + Adoption of a common external tariff Common Market (CM) CU + free movement of labor and capital Monetary Union (MU) CM + adoption of a common currency Economic and Monetary MU + Centralized public finance Union (EMU)

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Political Union (PU) Single political entity with corresponding economic and commercial institutions ------Source: See Table 1.

3. REI and economic analysis

The economic analysis of REI is far from simple and straightforward. It requires complex analytical tools and computer models that often rely on specific assumptions that do not necessarily correspond to realities.5 Nevertheless, these instruments may provide some insight and quantification about the consequence of trade liberalization and the impact of other policy measures. Whenever possible, policy makers should try to base their decision on such evaluations. For that purpose, building up adequate expertise and institutions is also essential.

Trade creation and trade diversion Following the seminal work of J. Viner, that was stimulated by Benelux experience (see Box 2), the economic analysis of regional integration agreements first concentrated on their gains and losses from a static perspective (i.e. ignoring dynamic aspects), particularly for countries that are involved in such schemes.6

There is trade creation in a REI framework when low costs imports replace high-cost ones. Such a situation implies welfare gains for importers and/or consumers because they pay less. In the case of trade diversion, as a result of a regional trade agreement, a costly source of imports replaces a cheap one, which causes a loss in the importing country.

In the real world, trade creation and trade diversion effects are often combined. For some markets, there are gains, for other markets there are losses. Gains and losses are also unevenly distributed among countries, people, consumers and producers.

Overall, a country benefits from a REI agreement when trade creation effects are larger than trade diversion effects. A country may lose from such an agreement when trade diversion effects are quite large. In welfare terms, this implies that trade liberalization within a REI framework could eventually lead to welfare losses and might not be a so-called “first-best option”—whereas, as indicated by economic theory at least, full unilateral liberalization leads to net welfare gains, particularly for small countries.7

5 It should be noted that different schools of thought compete in the field of econometric modelling. Adopting a particular methodology may lead to very specific outcomes. In other words, one has to be cautious when referring to quantified outcomes. See David F. Hendry, "Econometrics: Alchemy or Science? - Essays in Econometric Methodology", Oxford University Press, 2000.

6 See: J. Viner, The Customs Union Issue, Carnegie Endowment for International Peace, New York, 1950.

7 From an economic perspective, a small country cannot alter its terms-of-trade. (ToT = price of exports / price of imports).

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Box 2: Benelux

Co-operation between Belgium, the Netherlands and Luxembourg started in 1944, during WWII. The main goal was the elimination of obstacles to the movement of people and trade in goods and services among the three countries, and includes political and administrative co-operation. Benelux also supports European integration. The creation of Benelux can be seen as the first concrete step that led to the broader project of European integration. To some extent, integration among Benelux countries is still ahead of the EU process.

Source: Benelux web-site.

Cost-benefit analysis (CBA) A CBA of regional trade agreements should consider all goods (and services) to be fully conclusive about their welfare implication—a complex task indeed. Relying on aggregated data, so-called "Computable General Equilibrium Models" (CGEMs) are used for simulation and studying the impacts of different trade policy regimes on social welfare. They rely on restrictive assumptions about the preferences and behaviours of economic agents. They help identify losers and winners.

Compensation schemes Compensatory transfer (or income redistribution) schemes could be envisaged to compensate the losers of REI. Several compensation criteria were suggested, reflecting different perspectives, giving importance either to losers or winners, or combining both. The names of Kaldor, Hicks and Scitovsky are often referred to when discussing social welfare, collective choices and compensation transfers. Compensation criteria are based on potential actions that could eventually be implemented, depending on many factors, including the goodwill of politicians/policy makers and the bargaining strength of potential losers and winners. The fact that in some countries the unemployed workers receive unemployment benefits indicates that compensation schemes for losers can be implemented when resources are made available.8

Competition and economies of scale effects Two key-dynamic effects of REI are competition and economies of scale. By eliminating their mutual tariff and non-tariff barriers, the members of a REI scheme completely merge their markets. As a result, competition may increase. Moreover, bigger markets may allow for economies of scale when long-term average costs of production decline as a result of enlarging production capacities, etc. Consumers should benefit from such changes.

Public finance aspects The elimination of tariff barriers has immediate negative impacts on tax collection, which may alter the financial base of the state and, subsequently, lead to downward adjustments of public expenditures or additional borrowings and debts. That is true of countries that have limited direct and indirect (turnover or value-added) taxes, which is particularly the case for transition countries characterized by a large shadow economy and limited institutional capacity for tax collection.9

8 See: M. Olson, The Logic of Collective Action: Public Goods and the Theory of Groups, Harvard University Press, Cambridge, Mass., 1971.

9 See: Y. Eilat and C. Zinnes, The Shadow Economy in Transition Countries: Friend or Foe?, mimeo., Harvard University, 18 December, 2000.

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Terms of trade implications The creation of a regional trade bloc can also impact on the terms of trade of the region vis-à-vis the rest of the world. As the trade bloc may represent a big entity on international markets, one may assume that it can, in some cases, modify world prices and improve its terms of trade. For small countries, by definition, the terms-of-trade argument does not apply.

“Building blocs” versus “stumbling blocs” Following the work of Bhagwati on REI, a distinction is made between “building blocs” and “stumbling blocs.”10 These concepts should help to answer the question: does a trade bloc enhance the welfare of all countries and not only of those belonging to the bloc? A building bloc increases the welfare of all countries, “in” and “out.” A stumbling bloc has positive effects only for countries that are “in” and is detrimental to others.

Levels of development The evidence seems to indicate that developing countries may benefit more from a “north-south” than from a “south-south” free trade agreement. Moreover, integration between low-income countries often leads to divergence between countries within the regional bloc, which does not seem to be the case for trade blocs between rich counties.11

Domino effect Another aspect of REI is the so-called “domino effect,” which implies that when a trade bloc exists there is a tendency for outsiders to try to join the club because of the benefits of membership and the costs of staying out, especially when confronted with a large trade bloc.12

4. REI within the OSCE region

Considering the OSCE region, as indicated by Table 3, there are various REI schemes; some of them are de jure and de facto more ambitious, effective and advanced than others. Several REI schemes among transition countries were initiated after the collapse of the former regime. Some of these schemes involve non-OSCE states. Some OSCE participating states belong to several REI arrangements, which may raise compatibility and credibility issues.

Table 3: Selected regional integration / trade liberalisation / trade facilitation agreements (or initiatives) within the OSCE region ------North America NAFTA Canada, Mexico, US (Western) Europe European Union (15 + 10) Austria, Belgium, Denmark, Finland, France,

10 See: J. Bhagwati, The World Trading System at Risk, Princeton University Press, Princeton, 1991.

11 A.J. Venables, “Winners and Losers from Regional Integration Agreements,” Discussion Paper 2528, Center for Economic Policy Research, London, August 2000.

12 See: R. Baldwin, “A Domino Effect of Regionalism,” NBER Working Paper No. 4465, Cambridge, Mass., 1993.

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Germany, Greece, Ireland, Italy, The Netherlands, Luxembourg, Portugal, Spain, Sweden, UK Czech Republic, Cyprus, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovenia, Slovakia EFTA Iceland, Liechtenstein, Norway, Switzerland European Economic Area EU + EFTA (without Switzerland) Baltic region, Central and Eastern Europe Baltic Co-operation: Estonia, Latvia and Lithuania Council of the Baltic Sea States Denmark, Estonia, Finland, Iceland, Germany, Latvia, Lithuania, Norway, Poland, Russia, Sweden CEFTA Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia, Slovenia South Eastern Europe / Balkans Stability Pact Albania, Bosnia-Herzegovina, Bulgaria, Croatia, FYROM, Moldova, Romania, Serbia & Montenegro Former Soviet Republics (with the exception of the Baltic States) Commonwealth of Independent States All former Soviet Republics without the three Baltic States Belarus - Russia Union GUUAM Georgia, Ukraine, Uzbekistan, Azerbaijan, Moldova EurAsian Economic Community Belarus, Kazakhstan, Kyrgyz Republic, Russia, Tajikistan Central Asian Co-operation Organisation Kazakhstan, Kyrgyz Republic, Tajikistan, Uzbekistan Common Economic Space Belarus, Kazakhstan, Russia, Ukraine Others Black Sea Economic Co-operation Albania, Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania, Russia, Turkey, Ukraine Economic Co-operation Organisation Afghanistan, Azerbaijan, Iran, Kazakhstan, Kyrgyz Republic, Pakistan, Tajikistan, Turkey, Turkmenistan and Uzbekistan Shanghai Co-operation Organisation China, Kazakhstan, Kyrgyz Republic, Russia, Tajikistan and Uzbekistan ------

II. The European Union

5. Historical background

European integration was above all motivated by the desire to avoid the repetition of war and promote co-operation among the nation-states of Europe, particularly between France and Germany. On May

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9, 1950 the French foreign minister Robert Schuman presented a proposal to integrate the coal and steel industries of Western Europe which led to the creation of the European Coal and Steel Community (ECSC) by six founding members: Belgium, West Germany, France, Italy, Luxembourg and the Netherlands.13 This first step was followed by another successful initiative: the Rome Treaty of 1957 that established the European Economic Community.

The European Economic Community’s purpose was the formation of a common market among the 6 members based on the so-called "four freedoms" of movement: of goods, services, capital and people. The European Atomic Energy Community was also created to pool non-military nuclear resources of the member states. Since, the European project evolved by enlarging and deepening. Other major treaties were concluded after 1957. These documents represent the constitutional basis of the European Union.

Table 4: Main EC/EU Treaties ------Date Acronym Name Feature(s) ------1951 ESCC The Paris Treaty on the Sectorial co-operation European Steel and Coal Community 1957 Rome Treaties EEC - European Economic Community The four freedoms Common policies EURATOM - European Atomic Energy Community Sectorial co-operation 1986 Single European Act Single market Eliminating internal barriers 1992 Maastricht Treaty EMU / Euro on the European Union 1997 Amsterdam Treaty Enhancing democracy 2001 Treaty of Nice New constitutional basis Enlargement Voting rules Seats in Parliament 2004 EU Constitution ------

6. Main institutions

The EU is run by a series of interrelated institutions, for which checks and balances matter. The most important ones are: • European Parliament, • Council of the EU, • Commission, • European Court of Justice • Court of Auditors.

13 Another famous declaration was the Winston Churchill speech at Zurich University on September 19, 1946, calling for a "United States of Europe", which contributed to the creation of the Council of Europe.

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The European Parliament It is an elected body by the citizens of the member states. Elections take place every five years. Only 20 per cent are women. It can influence policies but it can not introduce them. The Parliament’s main roles are as follows: - Examination and adoption of EU legislation, a power shared with the Council of Ministers, - Approve or reject the annual budget of the EU, - Assent international agreements (such as accession / enlargement ones), - It can also dismiss the European Commission, etc.

The Council of the EU / Council of Ministers It brings together representatives of the member states governments. It discusses and sets the rules for all the activities of the EU bodies. It adopts common policies that are developed by national civil servants and the Commission.

Before 1986, policies could still be vetoed. In 1986, a qualified majority voting was introduced, implying that the making of economic policy belongs to both EU and national levels. Unanimity is required for matters such as enlargement and fiscal harmonisation.

The European Commission It is a body assisted by about 24,000 civil servants. It proposes policies and draft legislation. It ensures that Treaties and related decisions are properly fully implemented, etc.

The governments of the EU choose the President of the EU. Other members are nominated by their respective governments. The Commission is appointed for 5 years and can be dismissed by the Parliament. The Commission is expected to act independently of the governments of the member states.

The European Court of Justice It interprets EU laws and its rulings are binding. It ensures that European legislation is understood the same way everywhere in the EU. It settles disputes on law interpretation. Individuals can bring proceedings against EU institution before the Court.

The European Court of Auditors Auditors ensure that EU funds are properly used, legally and for the intended purpose.

Other important institutions/bodies are the European Economic and Social Committee, the Committee of the Regions, the European Investment Bank, etc.

7. Policies

Regional integration implies the adoption and the implementation of common policies at national and EU levels. In the early days of the European co-operation and integration process, there was only a common commercial policy regarding coal and steel. Others were added over time. As indicated by Table 5, the range of EU common actions and policies is quite large and, considering past experience, it could still grow. Some policies have also changed their aims and broaden their scope. For instance, in the case of the agricultural policy, environmental protection is now taken into account. In fact, environmental matters are high priorities on the EU agenda.

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Table 5: EU policies and fields of action Agriculture External Relations Audiovisual External Trade Budget Fraud Competition Fisheries Consumers Food Safety Culture Foreign and Security Policy Customs Humanitarian aid Development Information society Economic and Monetary Affairs Internal market Education, Training, Youth Justice and Home Affairs Employment and Social Affairs Public health Energy Regional policy Enlargement Research and Innovation Enterprise Taxation Environment Transport Source: EU web-site.

8. EU trade

Policy issues Trade policy relates to the use of policy instruments and measures that aim at influencing the level, the direction and the composition of trade, i.e. exports and imports of goods and services. In the EU case, the creation of the "common market" (including the customs union) meant the early adoption of common tariffs on imports of goods and other instruments to protect the member states economies, particularly agriculture.

Considering tariffs, these were progressively reduced within the framework of GATT. Moreover, special preferential agreements were concluded under GSP (general system of preferences) schemes. Free trade agreements were also concluded. Over time, other matters were added to the negotiation package during the Uruguay Round and within the WTO. These new fields include agriculture, services, intellectual property rights and investment related measures. The European Commission and the Council are both responsible for trade policy. Lobbying is a feature of the informal and formal trade policy process.

Merchandise trade flows In 2002, two thirds (67.3 per cent) of West European (that combines EU and EFTA countries) merchandise trade was internal; for the EU itself the corresponding figure is about 60 per cent. Such high proportions are typical features of West European and EU trade relations, as they are reported by WTO statistics. These facts reflect the depth and the duration of regional economic integration in Western Europe. Geographical and cultural distances between Western European countries are also small and transportation infrastructures are well developed, which favour intense exchanges of goods and services.

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9. Deepening

The "Single Market" and the Euro illustrate the deepening of the integration process.

"Deepening versus enlargement?" It should be noted that the debate about "widening versus deepening" the European Union persisted for many years. In the 1990s, the idea that both strategies could be pursued simultaneously gained more support allowing for more flexibility. In that context, so-called "closer co-operation" expresses the idea that some EU member States may want to move ahead with the integration process without reaching consensus within the EU.

The "Single Market" The adoption of a customs union by European states meant inter alia the elimination of tariff barriers among member countries. However, that did not lead automatically to a genuine common internal market when non-tariff barriers and other impediments to the four freedoms remain in place. The Single Market was initiated to improve the situation.

To make the Single Market happen, EU institutions and member countries worked for seven years from 1985. They drafted and adopted hundreds of directives needed to sweep away technical, regulatory, legal, bureaucratic and protectionist barriers that stifled free trade and free movement within the Union. The Single Market was formally completed by the end of 1992 even if progress is till needed in some areas (e.g. pensions).

The Euro The establishment of the internal market brought a new stimulus to the idea of a single currency because maintaining national currencies implies conversion costs and exchange rate fluctuations that constrain trade and FDIs.

In June 1988, the Hanover European Council concluded that "in adopting the Single Act, the Member States of the Community confirmed the objective of progressive realisation of economic and monetary union." A committee was set up under the chairmanship of Commission President Jacques Delors with "the task of studying and proposing concrete steps leading towards this union."

The Delors Report set out a plan to introduce EMU over three stages, including an institutional framework to allow policy to be decided and executed at the Community level.

Following the establishment of the European Monetary Institute, the European Central Bank was created and Euro notes and coins were finally introduced in 12 EU countries on 1 January 2002.

10. Enlargement

The EU went through 5 successive enlargement. According to experts, the 2004 enlargement poses a formidable challenge, "since it is without precedent in terms of scope and diversity: the number of candidates, the area (increase of 34 per cent) and population (increase of 105 million), the wealth of

104 GEORGIAN ECONOMIC TRENDS – 2005 No.1 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES different histories and cultures."14 There are also concerns about financial implications and international migrations.

Table 6: Successive enlargements ------Year Countries ------1973 Denmark, Ireland and the United Kingdom 1981 Greece 1986 Portugal and Spain 1995 Austria, Finland and Sweden 2004 Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovak Republic, Slovenia 2007 Bulgaria and Romania (projected) ------

11. EU Enlargement and Third Countries

United States of America The EU and the United States are the world’s largest economies. They account together for about half the world economy. The EU and the US have also the world biggest bilateral trading and investment relationship. Transatlantic flows of trade and investment amount to around USD 1 billion a day, representing almost 40 per cent of world trade.

In 2002, exports of EU goods to the US amounted to EUR 240 billion (24.2 per cent of total EU exports), while imports from the US amounted to EUR 175 billion (17.7 per cent of total EU imports). Considering investments, the total amount of 2-way investment represents over EUR 1.1 trillion, with each partner employing about 4 million people in the other. The share of EU investment in the US amounted to more than 52 per cent of EU Foreign Direct investment over the period 1998-2001 (EUR 162.663 million a year on average). US investment in the EU amounted to more than 61 per cent of EU FDI inflows over 1998-2001 (EUR 72.041 million a year on average).15

US firms are major investors and traders with candidate countries. As a result, EU enlargement will simply strengthen EU-US ties. However, US firms might for a while suffer from stronger competition. Trade negotiations may also become harder across the Atlantic.

Russia According to EU experts, Russia should benefit from the last EU enlargement. The EC estimate that Russia benefits from tariff decrease in new member states by about 325 million Euro a year. It will consolidate economic and political stability in Russia's direct neighbourhood, which should have positive impact on trade.

The EU is Russia’s largest trade partner and the bilateral trade volume is expected to increase. EU enlargement will give Russia direct access to one large and harmonised market of some 450 million people. As a result, Russia will benefit from a single set of trade rules, a single tariff and a single set of

14 EU web-site. http://europa.eu.int/comm/enlargement/intro/index_en.htm

15 EC web-site: http://europa.eu.int/comm/trade/issues/bilateral/countries/usa/index_en.htm.

GEORGIAN ECONOMIC TRENDS – 2005 No 1 105 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES administrative procedures, which will apply across the enlarged Union. This means that a Russian product meeting the requirements of the EU market can be sold anywhere on the EU market of 25 countries. Simplification will benefit particularly SMEs for which the compliance costs with trade procedures are relatively high. Macroeconomic studies have concluded that Russia’s welfare will increase as a result of enlargement.16

Considering the Russian enclave of Kaliningrad, European Commission President Romano Prodi said after the 22 April 2004 meeting with President Putin that most of the problems concerning Kaliningrad and EU enlargement have been solved. Even if some details have to be fixed, President Putin underscored that an agreement was reached "on the extension of the movement of our goods to Kaliningrad and the common EU customs procedures."17 It is worth recalling that the European Commission has had an active assistance programme in the area for more than ten years to support regional economic development, enterprise restructuring, SME development and building up human resources.18

Ukraine From 1 May 2004, Ukraine has shared a common border with the EU. The short-term impact of the new situation could be negative because the effects of more stringent non-tariff barriers will prevail over lower tariffs. According to Ukrainian experts, in the worse possible scenario, short-term losses (combining antidumping measures, market losses and technical barriers) could reach USD 340 million per annum. In the medium term, more benefits will accrue especially if Ukraine joins the WTO.19 It is interesting to notice that lower average EU tariffs will allow for trade creation and trade diversion effects. Ukrainians experts calculated that trade creation will be the highest with the Visegrad countries (i.e. Poland, followed by Hungary, Slovakia and the Czech Republic) and the lowest for the three Baltic states where, in fact, trade diversion should predominate.

In the medium term, Ukraine should benefit from additional FDIs: the EU market will expand due to accelerated growth in acceding countries which will have a positive impact on Ukrainian exports; labour costs in acceding countries will increase, stimulating firms to invest outside the EU; when joining WTO, Ukraine will also be able to improve its market access to the EU market.

12. EU external relations

Overview The EU is a global player in trade, finance, money and development aid, and has bilateral and multilateral agreements covering almost all countries and regions on five continents. Democracy, human rights, good governance and sustainable development as well as conflict prevention and post- conflict reconstruction are also parts of the EU international agenda and are supported by various assistance programmes.

16 See http://www.eur.ru/en/cis_7.htm.

17 RFE, 23 April 2004.

18 See http://www.eur.ru/en/cis_8.htm.

19 "Impact of EU Enlargement in 2004 on Ukraine Foreign Trade", Survey Report prepared by the International Centre for Policy Studies, Kyiv, October 2003.

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Schematically, EU external affairs can divided between: 1) external relations per se, 2) foreign trade and 3) the special (development assistance and commercial) relations with "ACP (African, Caribbean and Pacific) countries" under the Cotonou Convention.

Relations with South Eastern Europe The EU’s main aim for South Eastern Europe is to create conditions for permanent peace. For that purpose, the EU has been and is sill at the forefront of efforts to achieve this aim. In 1999, the EU promoted the Stability Pact for South Eastern Europe to encourage the States of the region in their efforts to foster peace, democracy, the respect of human rights and economic prosperity. EU relations with SEE are anchored within the framework of the so-called Stabilisation and Association Process (SAP) that prepares the integration of the countries of the region into EU structures. The 2000 Feira European Council stated that all countries covered by SAP are potential candidates for EU membership.

The EU is the single largest assistance donor to the Western Balkans with aid programmes such as Phare, Obnova and CARDS. EU countries are also present in Kosovo with more than 30,000 troops (80 per cent of the total international force) and hundreds of civilian police.

Partnership and Co-operation Agreements with CIS countries Russia and former Soviet republics are building long-term relationships with the EU based on Partnership and Co-operation Agreements (PCAs), covering trade, investment, co-operation in science, energy, transport, the environment and other sectors, as well as a political dialogue and joint action to combat crime, drugs and money laundering. EU technical assistance to these countries is delivered by the Tacis programme, launched in 1991. The Tacis budget for the period 2001-2006 is €3.14 billion.

Mediterranean Partners The Conference of EU and Mediterranean Foreign Ministers in Barcelona (27-28 November 1995) marked the start into a new "partnership" phase of the relationship between the EU and its Mediterranean Partners. Thus, the Barcelona Declaration expresses the partners’ intention to: establish a common Euro-Mediterranean area of peace and stability based on the respect for human rights and democracy, create an area of shared prosperity through the progressive establishment of a free-trade area between the partners, develop human resources and promote understanding between cultures, etc.

"The European Neighbourhood Policy" The May 2004 enlargement implies that countries became new neighbours of the EU. For that reason, it is essential not only to prevent the emergence of new dividing lines but also to enhance international relations within the new context. The European Neighbourhood Policy (ENP) is based on the conviction that EU's enlargement on 1 May 2004 represents an opportunity to strengthen co-operation and interdependence with the countries that are now new neighbours of the EU.

The ENP is distinct from the issue of potential membership. It offers a privileged relationship with neighbours, which will build on mutual commitment to common values principally within the fields of the rule of law, good governance, the respect for human rights, including minority rights, the promotion of good neighbourly relations, and the principles of market economy and sustainable development. The level of ambition of the EU’s relationships with its neighbours will take into account the extent to

GEORGIAN ECONOMIC TRENDS – 2005 No 1 107 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES which these values are effectively shared. ENP seeks to make the full use of existing tools and introduces a new instrument, the European Neighbourhood Instrument to foster cross-border and transnational co-operation.

III. Other REI schemes

The EU experience stimulated other countries to create their own REI schemes. Some of them strictly concentrate on pure trade matters. Others are more ambitious and aim at the creation of common markets. Former command economies are expressing their will to improve economic ties that were severely affected by the transition process and, for that purpose, they foster new regional organisations.

13. Free Trade Agreements

REI schemes based on Free Trade Agreements have definitely less scope than the EU project. Nevertheless, they can be very effective instruments for promoting trade and export-led growth in member countries. They may also have side effects in terms of transparency and good governance, particularly in developing countries having FTAs with rich countries.

EFTA The legal basis of EFTA was first the so-called “Stockholm Convention” that entered into force on 3 May, 1960; it was updated on 21 June, 2001 and the new version, referred as the Vaduz Convention, entered into force on 1 June, 2002.

The EFTA Convention proposes a framework with a set of rules on trade relations amongst member countries, namely Iceland, Liechtenstein, Norway and Switzerland. The provisions arrange for free trade of industrial goods. Most of the provisions relate to the abolition and prohibition of import duties and quantitative restrictions, and equivalent measures for both exports and imports. EFTA has supporting institutions, including a Secretariat that is based in Geneva, Switzerland, and is staffed by experts from member countries.

Box 3: The European Economic Area

The Agreement on the European Economic Area (EEA Agreement) entered into force on 1 January 1994. It presently applies between Iceland, Liechtenstein and Norway on the one side and the 25 Member States of the European Union on the other, forming together the 28 EEA States. The European Economic Community is also contracting party to the Agreement.

The aim of the EEA Agreement is to guarantee the free movement of goods, persons, services and capital, as well as equal conditions of competition and non-discrimination against individuals in all 28 EEA States. By removing barriers to trade and by opening new opportunities for 450 million Europeans, the EEA Agreement stimulates economic growth and adds to the international competitiveness of the EEA States.

Source: EFTA web-site.

NAFTA

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On January 1, 1994, NAFTA entered into force. A key-objective is the elimination of tariffs on imports of goods between the three member countries: Canada, Mexico and the U.S. One key-aspect of NAFTA is the freeing of trade between high-income countries and a developing one.

The lowering and removal of tariffs takes into account countries’ peculiarities, i.e. their levels of development. Mexico has until 2008 to remove import duties; the U.S. and Canada had to remove duties by the late 1990s. NAFTA also promotes fair competition, investments and the enforcement of intellectual property rights. The Agreement has eight parts that cover 22 chapters.

CEFTA Former Czechoslovakia, Hungary and Poland signed the Central European Free Trade Agreement on 21 December, 1991. It became effective on 1 March, 1993. Slovenia joined in 1996 and was followed by Romania and Bulgaria in 1997 and 1999, respectively. Croatia also joined in 2004.

14. The Commonwealth of Independent States

The termination of the command economy system and related political and administrative structures led to serious economic crises in transition countries. New borders were also erected and, as a result, traditional (non-market based!) economic and trade linkages virtually collapsed. The CIS was created to address these problems.

A 12-country organisation The CIS was established by a treaty signed at Minsk, Belarus, on Dec. 8, 1991, by the Heads of State of Russia, Belarus, and Ukraine. The original signatories were joined by Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan and Uzbekistan. Presently, it has 12 members and its headquarters is in Minsk. The CIS is based on the principle of "sovereign equality" and serves the further development and strengthening of friendship, good neighbourhood, trust and mutual understanding and co-operation between states.

CIS institutions The work of the CIS is accomplished through several institutions: the Council of the Heads of States, other Councils, Defence Ministers, Border Troops Commander, the Interparliamentary Assembly, the Executive Committee, etc. At present, there are 60 organs and committees to support sectorial cooperation; they meet regularly to discuss technical and implementation matters.

Economic and trade dimension In September 1993, the CIS countries signed the Treaty on the Establishment of the Economic Union. Considering the promotion of trade, it first relied on a set of bilateral agreements signed in 1991-1993. In 1994, it was decided to move toward a multilateral framework establishing a free trade area with the adoption of an Agreement. The outcome of this Agreement was limited. As a result, a Protocol was adopted in 1999 to amend and supplement the free trade Agreement.

On 21 June 2000, the Council of the Heads of State also adopted a Plan for the realisation of actions to be achieved till 2005. It includes specific measures related to administrative and procedural matters, etc. Another Plan (of Measures for the Realisation of the Programme of Actions for the Development of the CIS) covers aspects of the free trade agreement such as the role of private business, specific kinds of products, economic projects and competition matters.

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Overall, the CIS is not perceived as a highly performing organisation and could eventually, in a near future, lose members more interested by the prosperous, democratic and enlarging EU, and eager to adopt strategic visions regarding their future foreign relations and belonging.

15. Sub-regional integration within the CIS

For various (historical, cultural, political, economic and geographical) reasons CIS countries engaged themselves into sub-regional economic and trade integration schemes, at least formally. Such moves cannot yet be properly assessed because time, resources and institutions are needed to achieve concrete goals. It worth recalling that it took almost half a century to remove all internal barriers within the EU and the Euro was introduced only recently. Even within the EU, a multi-tier system seems to be the rule.

Belarus - Russia Union Treaty (1996) As stated in the Union Treaty, "The Russian Federation and the Republic of Belarus … have agreed upon the following: Article 1: The Community of Russia and Belarus shall be transformed into a Union with the terms of reference stemming from its Charter. Each of the member countries of the Union shall retain its state sovereignty, independence, territorial integrity, etc."20

Considering economic matters, one key-step in the unification process is the adoption by both parties of a common currency. Originally, both sides agreed that the Russian rouble should become a common currency of the Union from January 1, 2005. That date is now seen as unrealistic as other economic matters should be resolved first.

Despite many political statements, effective progress toward economic and monetary integration is almost inexistent.

Georgia-Ukraine-Uzbekistan-Azerbaijan-Moldova (GUUAM, 1997) The leaders of four countries (Georgia, Ukraine, Azerbaijan and Moldova) decided to create GUAM in 1997. In April 1999, GUAM was joined by Uzbekistan (and became GUUAM), which subsequently suspended its participation in the organization in June 2002.

From the beginning, GUUAM was seen as a political, economic and strategic alliance to strengthen national independence and full sovereignty. Economic matters were stressed in a joint 1997 communiqué with a focus on the so-called “Trans-Caucasus transportation corridor” and the “full utilization of existing economic possibilities.” A Free Trade Agreement was concluded at the GUUAM Yalta Summit of July 2002 with the creation of a Free Trade Area involving four countries: Georgia, Ukraine, Azerbaijan and Moldova. The future participation of Uzbekistan remains unclear.21

The US provides assistance to GUUAM for trade facilitation matters. Considering radical political changes in 2003 and 2004, their strategic importance and geo-political location, much more economic, political and security (defense) support should be provided to GUUAM countries.

20 http://idc.cis.lead.org/idc/arboretum/belarus/bel-rus-union-doc.html

21 For more details, see D. Linotte and L. Aune, "The GUUAM July 2002 Free Trade Agreement: A Preliminary Assessment", Central Asia and the Caucasus, Center for Social and Political Studies (Sweden), No. 1 (19), 2003.

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EurAsian Economic Community (2000) On October 10, 2000, Belarus, Kazakhstan, the Kyrgyz Republic, the Russian Federation and Tajikistan created a new international organisation, the “EurAsian Economic Community (EAEC)”. One of the aims of EAEC is the achievement of the objectives defined in the Customs Union’s agreements of 1995, the Agreement on the Deepening of Integration in the Economic and Humanitarian fields of 1996 and the 1999 Agreement on Customs Union and the Unified Economic Space. Central Asian Co-operation Organisation (2002) An agreement was signed between Kazakhstan, the Kyrgyz Republic, Tajikistan and Uzbekistan, on February 28, 2002, to establish the “The Central Asian Co-operation Organization”. The agenda of CACO is quite large and includes regional economic integration, trade expansion and the removal of obstacles and barriers impeding commercial and economic relationship between member-states.

Common Economic Space (2003) On 18 September 2003, the Russian Federation, Ukraine, Kazakhstan and Belarus signed an agreement on the formation of the Common Economic Space (CES). The Treaty has been ratified by the Parliaments of the member countries.

The CES aim is the creation of a unified customs territory commonly regulated and allowing for the free movement of goods, service, capital and labour force. Such a space shall require competition rules and some degree of co-ordination in the field of macroeconomic policy, taxation and exchange rates. Trade and investments within the region shall be supported taking into account WTO rules. The adoption of a common currency was also mentioned.

The organisational structure shall reflect the integration needs. There will be a Council of the Heads of States and a Commission. The latter shall start its work with the formulation of a common tariff policy, which implies agreeing on and adopting a common tariff schedule.

Other regional co-operation schemes involving CIS countries CIS countries are also involved in regional co-operation organisations with third countries outside the OSCE region. Such schemes include the Shanghai Co-operation Organisation (SCO) and the Economic Co-operation Organisation (ECO). These organisations promote trade and economic linkages among members.

Part IV: WTO membership and trade facilitation

16. Regional Trade Agreements and the WTO

The creation of REI schemes should not contradict WTO rules on regional trade agreements for countries that are already members of the WTO or are willing to become members. Non compliance with WTO rules can delay accession.

Regional trade arrangements among WTO members have to be notified to the organization. In all, during the period from 1948-1994, 124 notifications were made. Some of these agreements are no longer in force, or they have been amended or superseded by redesigned agreements. Since 1995, over 100 new agreements were notified although not all of them are fully enforced. For WTO

GEORGIAN ECONOMIC TRENDS – 2005 No 1 111 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES members, regional trade agreements are permitted under specific conditions spelled in rules contained in GATT and GATS, as described below.

FTAs and GATT Paragraph 4 of GATT underlines “the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreement.” Moreover, “the purpose of a customs union or of a free trade agreement should be to facilitate trade between the constituent territories and not raise trade barriers of other contracting parties with such territories.”

Paragraph 5 states that the provision of this Agreement shall not prevent the formation of a free-trade area; provided that: (a) duties applied by the area shall not be higher or more restrictive; and (b) the formation of the free trade area shall be done within a reasonable length of time. 10 years is seen as a limit, unless exceptional cases for which a full explanation has to be provided. The parties of a free trade area have to notify WTO contracting parties about their mutual arrangement and provide them with adequate information. Compensations are also envisaged.

The 1994 Understanding of the Interpretation of article XXIV of GATT reaffirms “that the purpose of such [free trade] agreements should be to facilitate trade between the constituent territories and not to raise barriers to the trade of other [WTO] Members with such territories; and that in their formation or enlargement the parties to them should to the greatest possible extent avoid creating adverse effects on the trade of other members.”

FTAs and GATS GATS is the the General Agreement on Trade in Services, an international agreement reached under the “Uruguay Round” of GATT in 1994. Following the terms of GATS Article V, “this Agreement shall not prevent any of its Members from being a party to or entering into an agreement liberalizing trade in services between or among the parties to such an agreement, provided that such an agreement: (a) has substantial coverage [in terms of number of sectors, volume of trade affected and modes of supply] and (b) provides for the absence or elimination of substantially all discrimination … between or among the parties…”

17. The importance of trade facilitation

REI schemes cannot work well when national customs departments do not process formalities properly and quickly. Streamlining the crossing of borders has positive impacts on both trade and security.

The meaning of trade facilitation Trade Facilitation is often defined as "the simplification and harmonisation of international trade procedures" with trade procedures being the "activities, practice and formalities involved in collecting, presenting, communicating and processing data required for the movement of goods in international trade". This definition relates to a wide range of activities such as import and export procedures (e.g. customs or licensing procedures); transport formalities; and payments, insurance, and other financial requirements. Work in the area has been carried out by organisations such as the United Nations Conference on Trade and Development (UNCTAD) and the United Nations Economic Commission for Europe (UNECE) for several decades.

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UNECE and trade facilitation UNECE plays a major role as the organisation that has developed standards for trade facilitation for more than 40 years: the UN Layout Key for trade documents; guidelines for national trade facilitation bodies; codes for locations (LOCODE), trade data elements (UN/TDED) and other codes; the only global standard for electronic data interchange (UN/EDIFACT), as well as key–expertise on trade facilitation.

The Kyoto Convention The World Customs Organisation 1973 "Kyoto Convention" is an international instrument on the harmonisation of customs techniques covering all aspects of customs legislation. Since 1973, the growth in international cargo, developments in information technology and a highly competitive international business environment, have created conflicts with traditional customs methods and procedures. WCO has therefore revised and adopted a new Kyoto Convention in 1999 to ensure that it meets the current demands of international trade.

Conclusion

• The world economy is characterised by two tendencies: globalisation and regional integration. • The number of regional economic integration schemes has grown fast over the last ten years. • The scope of REI agreements is quite large, with different levels of depth and size. • The economic analysis of REI addresses many dimensions. Trade creation and trade diversion effects are widely used concepts when assessing the impact of REI / trade liberalisation schemes. They allow the assessment of welfare changes. • REI benefits and loses are not evenly distributed within (and between) countries, which may indicate a need for income compensation and redistribution policies. • Within the OSCE region, there are several REI experiences, notably among transition countries. • As the most advanced regional integration scheme, the EU has gained unique and far-reaching experience. EU integration is supported by various institutions and specialised bodies that implement a wide range of common policies and actions. • The EU is both deepening and enlarging. Deepening means widening the scope of existing policies and/or adopting new ones. • The EU went through 5 waves of enlargement. Considering its importance, the May 2004 enlargement is seen as the most challenging. EU enlargements have impacts on third countries such as trade diversion and creation effects and more competition. Following the historical 2004 EU enlargement, EU external relations envision new relationships with neighbouring countries, which can foster trade and economic relations. • Free trade agreements are more limited in scope than the EU. However, as indicated by NAFTA, they might have significant impacts on trade, growth and employment, particularly for developing countries (e.g. Mexico). • Following the termination of old structures, transition countries have promoted various regional integration scheme. The CIS aims inter alia at improving trade and economic links among members. It has been followed by sub-regional initiatives such as the Belarus Russia Union, GUUAM, the CES, etc. It is too early to evaluate their impact. Nevertheless, mutual compatibility should be carefully assessed as countries belong to several schemes. • Regional integration agreements must be compatible with WTO rules. They also require measures to facilitate trade. Even in the absence of effective integration, WTO membership and trade facilitation should be priorities, taking into account the development needs of the countries.

GEORGIAN ECONOMIC TRENDS – 2005 No 1 113 REGIONAL ECONOMIC INTEGRATION: SELECTED ISSUES

The views are those of the author only and do not necessarily represent an official position.

114 GEORGIAN ECONOMIC TRENDS – 2005 No.1

APPENDIX II: The BTC PIPELINE IN GEORGIA AND THE REGION: AN UPDATE

By Wref Digings, Head of BP Georgia

Introduction

The Baku Tbilisi Ceyhan (BTC) pipeline is a project that demands superlatives. It is the world’s longest oil pipeline and part of one of the largest ever energy sector investments. Before the end of 2005, it will link a major new energy resource to world markets: a great shared achievement for the project’s investors and the governments of Azerbaijan, Georgia and Turkey.

BP owns 30.1 per cent of BTC and is managing its construction on behalf of ten other companies. It is truly an international partnership, with shareholders representing the UK, Azerbaijan, USA, Norway, Turkey, Italy, France and Japan. The partners will fund around 30 per cent of the project cost, with the remainder coming from third party financing provided by the International Finance Corporation, the European Bank for Reconstruction and Development, seven international export credit agencies and a syndicate of 15 commercial banks.

Although BTC is probably our highest profile investment in the region, its USD 3 billion construction cost represents only a fraction of the USD 20 billion committed by BP and its partners to the development of Caspian oil and gas resources. In Azerbaijan, BP operates the Azeri, Chirag and Gunashli oil fields, which will feed into BTC, as well as the giant Shah Deniz gas field. We are currently also managing construction of BTC’s sister project, the South Caucasus gas pipeline (SCP), which will run parallel to BTC in Azerbaijan and Georgia. In addition, we already operate the Western Route Export Pipeline from Baku in Azerbaijan to Supsa on the Georgian Black Sea coast. In Georgia, where we have worked since 1996, Air BP has a significant aviation fuel business. In Turkey we are active with Black Sea exploration and have a substantial downstream business.

The scale and duration of these investments closely connects our future success to the future stability and prosperity of this region. BP talks frequently of the need to secure “mutual advantage” in countries where we operate. Our activities here provide a perfect example of this, and we hope that our projects, supported by some major social investment activities, will make a real and lasting contribution to the region’s long term development.

Regional Context Throughout history, Georgia has been a crossroads for international trade. The completion of BTC and SCP will further cement this role and the country’s position in the region. BTC is of particular significance in this respect as it represents the first direct transportation link between the oil-rich land- locked Caspian and world markets, via the Mediterranean and avoiding the congested Bosphorus Straits. The pipeline reinforces the economic and political links between Azerbaijan, Georgia and Turkey, and Western Europe; and provides a model for future government co-operation. Although the focus of this article is on BTC, the SCP pipeline fulfils a similar role and provides Georgia, Turkey and potentially other European markets with a new source of gas supply. Such supply diversification is a key strategic element in securing long-term energy security for these countries.

114 GEORGIAN ECONOMIC TRENDS – 2005 No.1 THE BTC PIPELINE IN GEORGIA AND THE REGION: AN UPDATE

Like Georgia, BP has some vital strategic relationships outside of the Caucasus region. For example, in Russia, our share in the giant TNK-BP business means we have a long-term interest in that country; we are now the largest oil and gas producer in the United States; and in Europe, we are the largest energy company, with USD 35 billion capital employed this year and 43,000 staff. We supply oil and gas to more than five million European customers every day.

Since September 11th 2001, there has been increasing focus on the security of global energy supplies and in particular the importance of the Caspian and Caucasian region. Europe’s indigenous energy supplies cannot meet the demands of its customers; it already imports more than half of its daily energy needs and authoritative forecasts indicate this could grow to 60-70 per cent by 2020. Despite the increasing development of alternative energy supplies, on that timescale, oil and gas will most certainly be the main source of Europe’s energy supplies in the short and medium term. Europe therefore needs to turn its face outwards and be engaged in all parts of the energy equation, for example by establishing peace, security and good governance in energy rich areas like the Caspian and Caucasian region. The opening of the BTC oil pipeline is therefore not only significant to the region but also to the wider international community. To put that statement in context, BTC will meet 25 per cent of world oil demand growth for 2005-6.

Project Progress

BTC’s legal and fiscal regime is leading-edge. It consists of a treaty-level Inter-Government Agreement between Azerbaijan, Georgia and Turkey; and three further Host Government Agreements (HGAs) between each of the countries and the BTC investors. This framework sets out the basis for investor incentives and protection; the technical and environmental standards we must follow; the basis of the taxes we must pay and every other aspect of our formal relationship with the countries though which BTC passes.

At present, BTC is close to 90 per cent complete and the first oil lifting is due in the second half of 2005. When finished it will consist of eight pump stations and 1,760 kilometres of pipe, 248 of which are in Georgia. The pipeline runs from the Sangachal receiving terminal south of Baku in Azerbaijan to a new marine facility at the Turkish port of Ceyhan. It will have the capacity to transport at least one million barrels of oil a day for its initial 40-year operational life.

Construction has taken place over widely different terrains, with elevation varying from sea level to 2,800 metres. The entire pipeline has been buried at least one metre underground, with only the pump stations and block valves remaining visible. The two pump stations in Georgia – at Gardabani and Tetritskaro – are almost complete, each the size of five football fields.

In addition, SCP construction is also progressing well, and we are already more than half way through construction. This year will see SCP completed and it will be ready to receive gas deliveries before winter 2006.

Benefits to Georgia

The total value of our investment during construction of BTC and SCP in Georgia will amount to around USD 1 billion, with more than USD 200 million spent locally. Today, BTC and SCP, account for more than 60per cent of output in the Georgian construction sector. This makes BP and its

GEORGIAN ECONOMIC TRENDS – 2005 No 1 115 THE BTC PIPELINE IN GEORGIA AND THE REGION: AN UPDATE partners the biggest source of foreign investment in the country. At its peak, more than 6,000 people were employed in construction, more than 75 per cent of these were Georgian nationals. In addition, more than 3,000 landowners have received over USD18 million in compensation.

Georgia will derive some important financial benefits from tax and other government revenues generated from the operation of the BTC pipeline. Transit income from BTC based on committed volumes will exceed USD 700 million and average annual income at peak throughput is around USD 50 million.

Although the number of direct employees will be reduced after construction, BP expects to remain in Georgia for many decades to come. Our ongoing operations expenditure in is estimated at USD 35 million a year, with significant local procurement and continuing employment of around 300.

Encouraging Sustainable Development

As well as the benefits of direct investment and income from the pipeline, Georgia is set to receive more than USD 80 million in additional social and economic investment commitments from BP and its partners over the next few years. We first began investing in Caspian communities in the 1990s, but BTC and SCP have led to a major expansion of this activity through a series of innovative new programmes.

In Georgia, these include: USD 5 million on a Community Investment Programme to promote sustainable social and economic and development for those living along the pipeline route; USD 3 million on an Improved Schools Programme; USD 3 million for an Environmental Investment Programme focusing on conservation and biodiversity; USD 3 million on cultural heritage; and more than USD 8 million in environmental protection, tourism promotion and enterprise development in the Borjomi region. We are also continuing to plan a longer-term Regional Development Initiative spanning the three countries and focusing on areas such as enterprise development, effective governance and energy. Many of these programmes depend on partnerships between the private sector, host governments, international donor organizations and development NGOs – another example of the need for mutual advantage.

In October 2004, the BTC partners committed a new grant programme for Georgia. The programme, totalling USD 40 million by 2010, will be used to help fund social and economic projects for the benefit of the people of Georgia. An initial USD 9 million payment has already been transferred and will be devoted to a student voucher scheme, raising payments to those below the extreme poverty line and on pension increases in Kvemo–Kartli and Samtskhe-Javakheti regions (as part of a wider government initiative). Also in October 2004, BP announced its own USD10 million social investment programme to be spent on mutually agreed projects covering areas such as primary healthcare, education and the promotion of links between Georgia and governments, businesses and civil society in the European Union.

Setting the Standards

Through vehicles such as Regional Development Initiative and the recent BP commitments, we have deliberately sought to broaden and deepen the scope of our social investment to include issues such as governance and policy reform, as well as the vital promotion of small and medium enterprise. We

116 GEORGIAN ECONOMIC TRENDS – 2005 No.1 THE BTC PIPELINE IN GEORGIA AND THE REGION: AN UPDATE hope that through promoting cooperation with EU institutions and compliance with EU standards we can play a small but important role in assisting Georgia to achieve its goal of closer long-term relations with Europe.

Where our projects are concerned, the highest standards have been implemented throughout. These include BP’s global health, safety and environmental policy. Safety is always top of BP’s priority list and our record in Georgia is good: the Western Route Export Pipeline has just recorded six million man-hours without a safety incident. We are never complacent and it is an essential requirement that all staff and contractors are trained to the same BP standards.

As part of our commitments to Georgia and our project lenders, BTC has developed a world-class response plan to deal with the very unlikely event of an oil spill. As well as a team of specialists, there will be three oil spill response bases in Georgia to ensure the utmost is done to protect the environment.

We have implemented a system of fair and non-discriminatory employment practices. In addition, the BTC Human Rights Undertaking, signed in September 2003 commits BTC to maintaining the highest international human rights standards. Consistent with this commitment is the human rights training that we are providing for the Special State Protection Service (SSPS), who will protect the pipeline during operations. Adherence to international human rights undertakings is a central element in BTC’s recent agreement with the Georgian government on the provision of certain non-lethal equipment, facilities and operations funding for SSPS.

We have also undertaken steps towards increasing transparency, in line with the Extractive Industries Transparency Initiative (EITI) announced at the World Summit on Sustainable Development in Johannesburg in September 2002 – by publishing project agreements and details of payments to host governments. In Georgia we hope that encouraging such practices will support the government’s own objectives of improving the business environment and attracting more foreign direct investment.

Conclusion

Through its groundbreaking approach to health, safety, environmental and social issues the BTC project has in many ways set the standards for future international energy projects. On these issues, and many others, BTC has been subject to unprecedented levels of external scrutiny. Through this process we have learned that there are still many ways to improve on the way we do business, and future projects will undoubtedly benefit from BTC’s experience.

Fundamentally, BTC’s success depends upon the existence of enduring mutual benefits between the project’s investors, host governments, communities and others affected by its construction. We strongly believe that these mutual benefits exist, and hope that BTC and our other investments will encourage and support the continuing development of this vitally important region.

GEORGIAN ECONOMIC TRENDS – 2005 No 1 117

BTC and Other Pipeline Export Routes from Azerbaijan

STATISTICAL APPENDIX

CONTENTS *

Table A4.1: Consolidated Budget Revenues, 2004

Table A4.2: State Budget Expenditures, 2004

Table A5.1: Accounts of the National Bank of Georgia

Table A5.2: Summary Accounts of Commercial Banks

Table A5.3: Monetary Survey

Table A5.4: Urban Consumer Price Index and Inflation

Table A6.1.1: Georgia’s Registered Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, 2004

Table A6.1.2: Georgia’s Registered Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, 2004

Table A8.1.1: Economic Status, Q1 1998 – Q4 2000

Table A8.1.2: Economic Status, Q1 2001– Q3 2004

* Note: First digit in the number of an appendix table indicates the number of the chapter to which it belongs.

118 GEORGIAN ECONOMIC TRENDS – 2005 No.1

Table A4.1: Consolidated budget revenues, 2004 (GEL million) Actual Growth Actual revenues Per cent Share in Target Difference over the revenues as per cent in total GDP % year % of target Total revenues and grants 2216.2 2282.3 66.0 103 173 100 23.3 Tax revenues 1746.3 1811.2 64.9 104 153 79 18.5 Central budget tax revenues 890.8 901.5 10.7 101 162 39 9.2 Income tax 244.4 268.7 24.3 110 176 12 2.7 Profit tax 154.0 161.6 7.6 105 160 7 1.6 VAT 619.9 628.2 8.3 101 154 28 6.4 on domestic products 261.7 262.6 0.9 100 119 12 2.7 on imports 358.2 365.5 7.3 102 197 16 3.7 Excise 166.4 163.8 -2.6 98 164 7 1.7 on domestic products 62.8 62.0 -0.8 99 283 3 0.6 on imports 103.6 101.8 -1.8 98 130 4 1.0 Customs duty 98.0 100.1 2.1 102 142 4 1.0 Other taxes 124.7 134.1 9.4 107 105 6 1.4 Non-tax revenues 262.6 274.4 11.8 104 318 12 2.8 86.1 72.7 -13.4 84 3 0.7 Revenues of Special state funds 349.9 371.2 21.3 106 163 16 3.8 Social security fund 284.8 296.4 11.6 104 164 13 3.0 Roads fund 65.2 74.9 9.7 115 159 3 0.8 Grants 121.3 123.9 2.7 102 256 5 1.3 Source: Ministry of finance, GEPLAC Calculations Table A4.2: State budget expeditures, 2004 (GEL million) Other Subsidies Social Capital Business goods Interest and Net Total Salaries contributi Expendit trips and payments current lending ons ures services transfers General Government 301.1 59.1 16.9 4.8 59.3 72.6 7.7 80.7 Defence 158.8 27.1 0.6 0.9 69.4 8.5 52.3 Law and order 239.6 58.3 5.9 1.8 68.6 71.3 33.7 Education 65.3 10.6 3.3 0.2 2.6 48.3 0.3 Health care 54.8 32.4 1.2 0.2 6.9 13.7 0.4 Social Security 450.8 0.4 0.1 0.0 362.6 85.9 1.7 Housing 2.8 0.1 0.0 0.5 1.1 1.0 Culture sports rligion 39.2 1.8 0.5 0.0 6.5 29.8 0.6 Energy 78.4 0.6 0.2 0.1 0.2 77.2 0.2 Agiculture 29.2 5.2 2.1 0.2 19.6 1.1 0.9 Construction and mining 1.5 0.5 0.2 0.0 0.9 0.0 Transport and 0.7 0.2 0.0 0.1 0.1 66.9 communications 68.0 Other economic activities 4.3 2.1 0.7 0.1 0.8 0.4 0.1 Other 430.0 1.4 0.4 0.9 5.5 140.9 128.6 1.7 150.4 Total 1923.6 200.3 32.3 9.7 604.2 140.9 538.3 166.7 231.1 Source: Ministry of finance, GEPLAC Calculations Table A5.1: Accounts of the National Bank of Georgia (GEL thousand) Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 July-04 Aug-04 Sep-04 Oct-04 Noe-04 Dec-04

NET INTERNATIONAL RESERVES -311,364 -314,764 -286,372 -240,660 -189,578 -168,086 -115,378 -84,496 32,642 74,693 53,521 95,150 107,700 GOLD 1,604 1,604 1,604 1,575 1,575 1,575 1,405 1,405 1,405 1,409 1,409 1,409 1,484 FOREIGN EXCHANGE 395,678 403,388 395,274 422,750 429,559 442,047 526,236 535,531 611,591 670,113 634,713 676,420 698,690 o/w SDR HOLDINGS, IMF RECORD 10,157 10,333 1,392 28,657 3,916 3,720 15,692 8,961 1,111 23,377 893 792 20,408 USE OF IMF RESOURCES (IMF RECORDS) -593,162 -603,449 -571,041 -556,030 -515,900 -506,695 -539,196 -520,198 -484,754 -495,809 -478,836 -477,577 -481,758 OTHER FOREIGN LIABILITIES -115,483 -116,307 -112,208 -108,955 -104,812 -105,013 -103,823 -101,234 -95,598 -101,021 -103,765 -105,102 -110,715

NET DOMESTIC ASSETS 891,225 872,449 862,896 834,669 763,922 783,308 771,047 734,604 685,439 672,697 668,271 691,202 728,836 NET CLAIMS ON GENERAL GOVERNMENT 782,912 770,352 776,091 740,220 693,301 712,243 702,859 682,626 634,603 670,936 689,278 681,870 721,722 CLAIMS ON GENERAL GOVERNMENT 816,532 821,484 821,484 815,639 811,349 811,349 811,349 811,349 811,349 816,652 819,298 819,650 841,414 LOANS TO GENERAL GOVERNMENT 701,125 707,497 707,497 701,125 701,125 701,125 701,125 667,702 667,702 621,952 621,952 621,952 625,132 DEPOSITS OF GENERAL GOVERNMENT -33,620 -51,132 -45,393 -75,419 -118,048 -99,106 -108,490 -128,723 -176,746 -145,716 -130,020 -137,780 -119,691 CLAIMS ON REST OF THE ECONOMY 112,005 112,740 108,823 105,672 101,650 101,818 100,694 98,328 93,344 98,618 101,323 102,615 107,885 NET CLAIMS ON BANKS 6,320 -1,051 0 8,200 0 3,900 0 0 0 -41,795 -65,219 -24,020 -41,000 OTHER ASSETS, NET -10,011 -9,593 -22,018 -19,424 -31,030 -34,654 -32,506 -46,350 -42,507 -55,062 -57,111 -69,264 -59,772

RESERVE MONEY (M1) 579,862 557,686 576,525 594,008 574,344 615,221 655,670 650,108 718,082 747,390 721,792 786,352 836,536 CURRENCY IN CIRCULATION 473,242 443,545 446,411 466,212 463,219 479,409 504,188 514,172 555,415 600,255 585,485 593,249 676,157 BANKS' DEPOSITS 106,620 114,141 130,113 127,796 111,124 135,813 151,482 135,936 162,667 147,135 136,307 193,103 160,379 REQUIRED RESERVES 81,405 84,138 89,785 89,946 93,473 98,961 74,223 73,767 71,983 75,342 88,746 89,203 92,334 BALANCES ON CORRESPONDENT ACCOUNTS 25,214 30,003 40,328 32,550 14,651 35,852 71,259 56,170 90,684 71,793 47,561 103,900 68,045

OVERNIGHT DEPOSITS FROM BANKS 0 0 0 5,300 3,000 1,000 6,000 6,000 0 0 0 0 0 Source: the National Bank of Georgia Table A5.2: Summary Accounts of Commercial Banks (GEL thousand)

Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Noe-04 Dec-04 NET FOREIGN ASSETS 42,456 80,082 84,491 85,595 50,965 67,816 66,743 91,115 76,765 19,311 45,522 35,019 54,595 GOLD 2.5 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 0.0 FOREIGN EXCHANGE 242,456 276,156 269,808 275,537 245,912 252,679 254,241 269,925 247,179 206,663 236,539 223,516 265,003 FOREIGN LIABILITIES -200,002 -196,076 -185,319 -189,944 -194,949 -184,865 -187,501 -178,812 -170,416 -187,353 -191,019 -188,499 -210,408

NET DOMESTIC ASSETS 576,396 587,167 580,138 600,354 615,810 659,741 649,842 687,766 688,222 764,206 760,802 794,420 841,345 DOMESTIC CREDIT 747,413 748,757 725,463 751,088 778,370 758,731 783,998 834,183 833,884 880,643 910,434.5 901,223.4 965,615.7 NET CLAIMS ON GENERAL GOVERNMENT -16,527 -18,252 -21,359 32,977 42,426 30,998 37,643 55,316 42,361 20,119 25,029 15,821 17,472

NET CLAIMS ON REPUBLICAN GOVERNMENT 32,225 33,451 36,404 46,239 55,915 54,697 62,919 77,443 75,481 58,944 56,236 52,192 40,296 LOANS TO FINANCE LOCAL GOVT DEFICIT 10,612 8,367 6,445 4,282 2,038 1,836 1,757 1,609 1,265 669 534 426 29 OTHER CLAIMS ON LOCAL GOVT (NET) -54,530 -54,578 -55,354 -11,983 -11,263 -20,012 -19,289 -17,849 -26,257 -30,764 -24,993.3 -29,708.0 -17,268.6 OTHER EXTRABUDGETARY FUNDS (NET) -1,470 -1,364 -1,969 -1,330 -1,042 -1,254 -1,323 -1,210 -1,683 -1,759 -1,646 -1,911 -1,625 SPECIAL FUNDS -2,814 -3,127 -5,053 -2,241 -1,645 -2,309 -4,553 -2,920 -3,774 -3,885 -2,206.1 -2,272.6 -1,646.3 CLAIMS ON REST OF THE ECONOMY 763,940 767,009 746,822 718,111 735,944 727,733 746,355 778,867 791,524 860,523 885,406 885,402 948,144 CLAIMS ON ENTERPRISES (GEL) 55,995 50,289 54,637 52,700 52,016 49,423 55,290 56,180 64,464 64,544 70,089 72,192 88,689 CLAIMS ON INDIVIDUALS (GEL) 37,829 36,671 39,962 37,651 39,109 33,802 32,851 35,617 36,547 38,302 40,254 40,094 46,917 FOREX LOANS (ENTERPRISES & INDIVS) 670,115 680,049 652,223 627,761 644,819 644,508 658,213 687,069 690,513 757,677 775,062.4 773,116.4 812,537.0 OTHER ASSETS NET -171,017 -161,591 -145,326 -150,735 -162,561 -98,989 -134,156 -146,417 -145,662 -116,437 -149,633 -106,803 -124,270

DEPOSIT LIABILITIES 618,852 667,249 664,628 685,948 666,774 727,558 716,584 778,881 764,987 783,517 806,323.6 829,438.9 895,940.2 DOMESTIC CURRENCY DEPOSITS 85,863 96,643 120,817 115,454 109,293 119,701 127,018 146,321 166,251 173,273 177,368 193,415 230,104 FOREIGN CURRENCY DEPOSITS 532,989 570,606 543,812 570,494 557,481 607,857 589,566 632,560 598,736 610,244 628,955.5 636,023.8 665,836.1 Source: the National Bank of Georgia Table A5.3: Monetary Survey (GEL thousand) Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Noe-04 Dec-04

NET FOREIGN ASSETS -268,907 -234,681 -201,881 -155,065 -138,614 -100,270 -48,635 6,619 109,408 94,004 99,043 130,169 162,295 GOLD 1,606 1,606 1,606 1,577 1,577 1,577 1,407 1,407 1,407 1,411 1,411 1,411 1,484 FOREIGN EXCHANGE 638,133 679,544 665,082 698,287 675,471 694,725 780,478 805,456 858,769 876,776 871,252 899,936 963,693 FOREIGN LIABILITIES -908,647 -915,831 -868,569 -854,929 -815,661 -796,572 -830,519 -800,244 -750,768 -784,182 -773,620 -771,178 -802,882

NET DOMESTIC ASSETS 1,329,295 1,318,263 1,288,982 1,272,158 1,239,195 1,273,438 1,232,969 1,249,972 1,164,023 1,227,176 1,244,705 1,235,821 1,349,637 DOMESTIC CREDIT 1,642,329 1,631,850 1,610,377 1,596,981 1,573,322 1,572,792 1,587,551 1,615,137 1,561,831 1,650,196 1,701,035 1,685,709 1,795,223 NET CLAIMS ON GENERAL GOVERNMENT 766,385 752,100 754,732 773,197 735,727 743,240 740,503 737,942 676,963 691,055 714,307 697,692 739,194 NET CLAIMS REPUBLICAN GOVERNMENT 837,692 835,833 838,584 823,147 786,084 817,582 806,803 813,049 769,495 803,681 809,023 810,094 829,816 TREASURY OBLIGATIONS 44,750 46,433 49,586 58,915 67,682 66,242 73,288 83,631 81,765 65,248 61,989 57,888 45,823 NET CLAIMS ON LOCAL GOVERNMENT -46,053 -49,183 -49,586 -14,413 -10,682 -29,248 -22,870 -20,265 -41,950 -45,801 -39,133 -54,927 -29,968 NET CLAIMS ON PENSION FUND -10,166 -15,469 -17,814 -23,454 -25,514 -29,890 -30,211 -32,793 -31,355 -47,418 -40,602 -34,929 -26,817 OTHER EXTRABUDGETARY FUNDS -10,692 -13,315 -7,277 -5,903 -12,113 -12,062 -8,770 -16,791 -12,233 -12,102 -7,919 -16,446 -28,381 CLAIMS ON THE REST OF THE ECONOMY 875,944 879,750 855,645 823,784 837,595 829,551 847,048 877,195 884,868 959,141 986,729 988,017 1,056,029 OTHER ITEMS, NET -313,034 -313,587 -321,396 -324,823 -334,127 -299,354 -354,582 -365,165 -397,808 -423,020 -456,330 -449,887 -445,586

BROAD MONEY (M3) 1,060,388 1,083,581 1,087,101 1,117,092 1,100,581 1,173,168 1,184,334 1,256,591 1,273,431 1,321,181 1,343,748 1,365,991 1,511,933

BROAD MONEY, EXCL FOREX DEPOSITS (M2) 527,398 512,976 543,289 546,598 543,100 565,311 594,768 624,031 674,695 710,937 714,792 729,967 846,097

CURRENCY OUTSIDE BANKS (M0) 441,536 416,333 422,472 431,144 433,807 445,610 467,749 477,710 508,444 537,663 537,424 536,552 615,993 CURRENCY IN CIRCULATION (NBG) 473,242 443,545 446,411 466,212 463,219 479,409 504,188 514,172 555,415 600,255 585,485 593,249 676,157 CURRENCY IN COMM. BANKS' VAULTS -31,707 -27,212 -23,939 -35,069 -29,413 -33,798 -36,438 -36,462 -46,971 -62,592 -48,061 -56,697 -60,165 DEPOSIT LIABILITIES (GEL) 85,863 96,643 120,817 115,454 109,293 119,701 127,018 146,321 166,251 173,273 177,368 193,415 230,104 FOREIGN CURRENCY DEPOSITS 532,989 570,606 543,812 570,494 557,481 607,857 589,566 632,560 598,736 610,244 628,955 636,024 665,836

Source: the National Bank of Georgia Table A5.4: Urban Consumer Price Index and Inflation

Period Inflation Rate (per Price index cent) (i) from previous period

Monthly 2000 Dec 100.00 2001 Jan 100.70 0.7 Feb 101.30 0.6 Mar 101.30 0.0 Apr 102.32 1.0 May 101.29 -1.0 June 100.89 -0.4 Jul 100.18 -0.7 Aug 100.48 0.3 Sep 99.88 -0.6 Oct 100.58 0.7 Nov 101.99 1.4 Dec 100.00 103.42 1.4 2002 Jan 102.00 105.48 2.0 Feb 103.22 106.75 1.2 Mar 103.64 107.18 0.4 Apr 105.50 109.11 1.8 May 105.50 109.11 0.0 June 103.08 106.60 -2.3 Jul 101.94 105.42 -1.1 Aug 101.84 105.32 -0.1 Sep 102.25 105.74 0.4 Oct 102.66 106.16 0.4 Nov 103.79 107.33 1.1 Dec 100.00 105.55 109.15 1.7 2003 Jan 102.10 107.77 111.45 2.1 Feb 101.59 107.23 110.89 -0.5 Mar 101.59 107.23 110.89 0.0 Apr 102.10 107.76 111.44 0.5 May 102.30 107.98 111.67 0.2 June 102.40 108.09 111.78 0.1 Jul 101.48 107.11 110.77 -0.9 Aug 101.38 107.01 110.66 -0.1 Sep 101.89 107.54 111.22 0.5 Oct 101.89 107.54 111.22 0.0 Nov 106.78 112.70 116.55 4.8 Dec 100.00 106.99 112.93 116.79 0.2 2004 Jan 100.40 107.42 113.38 117.25 0.4 Feb 100.80 107.85 113.84 117.72 0.4 Mar 100.90 107.96 113.95 117.84 0.1 Apr 100.70 107.74 113.72 117.61 -0.2 May 100.74 107.78 113.77 117.65 0.04 June 99.13 106.06 111.95 115.77 -1.6 Jul 99.92 106.91 112.84 116.70 0.8 Aug 99.32 106.27 112.16 116.00 -0.6 Sep 100.81 107.86 113.85 117.74 1.5 Oct 102.43 109.59 115.67 119.62 1.6 Nov 103.76 111.01 117.17 121.17 1.3 Dec 107.39 114.90 121.27 125.42 3.5 Source: GET calculations based on data provided by State Department for Statistics Table A6.1.1: Georgia's Registred Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, 2004 (USD thousands) HTS Category Export Import 01 - Live Animals 1 790 02 - Meat and edible meat offal 844 16,686 03 - Fish and crustaceans, molluscs and other aquatic invertebrates 214 4,326 04 - Dairy produce; birds eggs; natural honey; edible products of animal origin, not elsewhere specified or included 4,432 22,047 05 -Products of animal origin, not elsewhere specified or included - 79 06 -Live trees and other plants; bulbs, roots and the like; cut flowers and ornamental foliage 472 952 07 -Edible vegetables and certain roots and tubers 1,128 3,674 08 -Edible fruit and nuts; peel of citrus fruit or melons 21,284 5,273 09 -Coffee, tea, maté and spices 5,151 5,673 10 -Cereals 22,997 77,463 11 -Products of the milling industry; malt; starches; inulin; wheat gluten 594 55,343 12 -Oil seeds and oleaginous fruits; miscellaneous grains, seeds and fruits; industrial or medicinal plants; straw and fodder 1,028 1,039 13 -Lac; gums, resins and other vegetable saps and extracts 85 356 14 -Vegetable plaiting materials; vegetable products not elsewhere specified or included 42 95

15 -Animal or vegetable fats and oils and their cleavage products prepared edible fats; animal or vegetable waxes 709 23,595 16 -Preparations of meat, of fish or of crustaceans, molluscs or other aquatic invertebrates 102 6,942 17 -Sugars and sugar confectionery 35,607 59,005 18 -Cocoa and cocoa preparations 1,571 20,006 19 -Preparations of cereals, flour, starch or milk; bakers' wares 96 14,113 20 -Preparations of vegetables, fruit, nuts or other parts of plants 2,181 7,687 21 -Miscellaneous edible preparations 1,289 11,401 22 -Beverages, spirits and vinegar 101,377 11,402 23 -Residues and waste from the food industries; prepared animal feed 149 4,514 24 -Tobacco and manufactured tobacco substitutes 1,089 38,293 25 -Salt; sulfur; earths and stone; plastering materials, lime and cement 5,336 12,003 26 -Ores, slag and ash 39,922 1,275 27 -Mineral fuels, mineral oils and products of their distillation; bituminous substances; mineral waxes 22,801 318,631 28 -Inorganic chemicals; organic or inorganic compounds of precious metals, of rare earth metals, of radioactive elements or of isotopes 6,236 6,343 29 -Organic chemicals 1,752 3,358 30 -Pharmaceutical products 2,622 90,406 31 -Fertilizers 28,854 1,182

32 -Tanning or dyeing extracts; tannins and their derivatives; dyes, pigments and other coloring matter; paints and varnishes; putty and other mastics; inks 368 10,018

33 -Essential oils and resinoids; perfumery, cosmetic or toilet preparations 3,775 22,990 34 -Soap, organic surface-active agents, washing preparations, lubricating preparations, artificial waxes, prepared waxes, polishing or scouring preparations candles and similar articles, modeling pastes, "dental waxes" and dental preparations with a bas 271 13,633

35 -Albuminoidal substances; modified starches; glues; enzymes 0 1,712

36 -Explosives; pyrotechnic products; matches; pyrophoric alloys; certain combustible preparations 76 2,581 37 -Photographic or cinematographic goods 11 839 38 -Miscellaneous chemical products 246 12,379 39 -Plastics and articles thereof 830 31,681 40 -Rubber and articles thereof 1,263 21,446 41 -Raw hides and skins (other than furskins) and leather 1,562 635 42 -Articles of leather; saddlery and harness; travel goods, handbags and similar containers; articles of animal gut (other than silkworm gut) 141 2,262

Source: State Department for Statistics Table A6.1.2: Georgia's Registred Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, 2004 (USD thousands) HTS Category Export Import 44 -Wood and articles of wood; wood charcoal 12,052 7,615 45 -Cork and articles of cork 11 2,857 46 -Manufactures of straw, of esparto or of other plaiting materials; basketware and wickerwork 1 12 47 -Pulp of wood or of other fibrous cellulosic material; waste and scrap of paper or paperboard - 57

48 -Paper and paperboard; articles of paper pulp, of paper or of paperboard 897 33,618 49 -Printed books, newspapers, pictures and other products of the printing industry; manuscripts, typescripts and plans 210 8,543 50 -Silk - 130 51 -Wool, fine or coarse animal hair; horsehair yarn and woven fabric 15 525 52 -Cotton - 473

53 -Other vegetable textile fibers; paper yarn and woven fabric of paper yarn - 56 54 -Man-made filaments 7 1,783 55 -Man-made staple fibers - 2,989

56 -Wadding, felt and nonwovens; special yarns, twine, cordage, ropes and cables and articles thereof 15 960 57 -Carpets and other textile floor coverings 4 732 58 -Special woven fabrics; tufted textile fabrics; lace, tapestries; trimmings; embroidery - 181 59 -Impregnated, coated, covered or laminated textile fabrics; textile articles of a kind suitable for industrial use 1 800 60 -Knitted or crocheted fabrics 73 1,223 61 -Articles of apparel and clothing accessories, knitted or crocheted 869 5,924 62 -Articles of apparel and clothing accessories, not knitted or crocheted 979 20,002 63 -Other made up textile articles; sets; worn clothing and worn textile articles; rags 353 8,009 64 -Footwear, gaiters and the like; parts of such articles 122 8,789 65 -Headgear and parts thereof 5 449 66 -Umbrellas, sun umbrellas, walking sticks, seatsticks, whips, riding-crops and parts thereof - 149 67 -Prepared feathers and down and articles made of feathers or of down; artificial flowers; articles of human hair - 18 68 -Articles of stone, plaster, cement, asbestos, mica or similar materials 141 9,370 69 -Ceramic products 624 14,239 70 -Glass and glassware 1,646 13,670 71 -Natural or cultured pearls, precious or semi-precious stones,precious metals, metals clad with precious metal and articles thereof; imitation jewelry; coin 20,270 1,339 72 -Iron and steel 140,692 27,549 73 -Articles of iron or steel 6,486 115,894 74 -Copper and articles thereof 8,377 2,406 75 -Nickel and articles thereof 129 3 76 -Aluminum and articles thereof 11,131 4,772 78 -Lead and articles thereof 177 162 79 -Zinc and articles thereof 67 182 80 - Tin and articles thereof - 14 81 -Other base metals; cermets; articles thereof 146 118 82 -Tools, implements, cutlery, spoons and forks, of base metal; parts thereof of 129 4,124 83 -Miscellaneous articles of base metal 128 7,573

84 -Nuclear reactors, boilers, machinery and mechanical appliances; parts thereof 15,925 192,432 85 -Electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, and parts and accessories of such articles 6,361 125,862 86 -Railway or tramway locomotives, rolling-stock and parts thereof; railway or tramway track fixtures and fittings and parts thereof; mechanical (including electro- mechanical) traffic signalling equipment 6,146 2,730 87 -Vehicles other than railway or tramway rolling stock, and parts and accessories thereof 7,659 156,673 88 -Aircraft, spacecraft, and parts thereof 85,465 20,860 89 -Ships,p,pgp, boats and floating structures gp, g, g,p , 61 1,595 medical or surgical instruments and apparatus; parts and accessories thereof 1,897 35,087 91 -Clocks and watches and parts thereof 24 558

92 -instruments; parts and accessories of such articles 33 76 93 -Arms and; ammunition; g, parts and , accessories pp thereof , 263 23,057 stuffed furnishings; lamps and lighting fittings, not elsewhere specified or 279 27,799 95 -Toys, games and sports requisites; parts and accessories thereof 157 4,606

96 -Miscellaneous manufactured articles 177 3,334 97- Works of art, collectors' pieces and antiques 40 58 Source: State Department for Statistics Table A8.1.1: Economic Status, Q 1 1998 - Q4 2000 (Thousand) 1998 1999 2000 Q I Q II Q III Q IV Q I Q II Q III Q IV Q I Q II Q III Q IV Total population over 15 years old 3, 099 3, 136 3, 194 3, 008 3, 032 3, 049 3, 092 3, 018 3, 123 3, 151 3, 133 3, 199 Total economically active population (labour force) (1) 2,332 2,462 2,146 1,990 2, 018 2, 052 2, 058 1, 917 1, 951 2, 102 2, 064 2, 095 Total economically active population (labour force) (2) 2,457 2,555 2,195 2,042 2, 058 2, 093 2, 106 1, 975 2, 087 2, 199 2, 181 2, 215 Employed 2, 101 2,283 1,887 1,741 1, 725 1, 784 1, 792 1, 633 1, 705 1, 890 1, 890 1, 878 Hired 714 737 786 741 737 743 741 710 679 695 675 691 Self-employed 1,387 1,546 1,092 990 973 1, 023 1, 030 905 912 1, 087 1, 095 1, 080 Unemployed (1) 231 179 260 249 292 268 266 284 246 212 174 217 Unemployed (2) 356 272 309 301 333 308 314 342 382 309 292 337 Total population outside the labour force (1) 1,162 1,054 975 1,039 1,110 1,078 1,049 1,158 1,172 1,048 1,069 1,104 Total population outsde the labour force (2) 1,108 1,019 937 980 1,000 997 962 1,044 1,035 952 952 985 Unemployment rate (per cent) (1) 9.9 7.3 12.1 12.5 14.5 13.0 12.9 14.8 12.6 10.1 8.4 10.4 Unemployment rate (per cent) (2) 14.5 10.6 14.1 14.7 16.2 14.7 14.9 17.3 18.3 14.0 13.4 15.2

Labour force participation rate (1) 75.3 78.5 67.2 66.2 66.6 67.3 66.6 63.5 62.5 66.7 65.9 65.5 Labour force participation rate (2) 79.3 81.5 68.7 67.9 67.9 68.6 68.1 65.4 66.8 69.8 69.6 69.2 Self-employment share in total labour force 59.5 62.8 50.9 49.7 48.2 49.8 50.1 47.2 46.7 51.7 53.0 51.6 Self-employment share in total employment 66.0 67.7 57.9 56.9 56.4 57.3 57.5 55.4 53.5 57.5 57.9 57.5 Source: The State Department for Statistics, Labour Force Survey, Household Survey Note: (1) ILO Standard (or “strict” methodology) (2) ILO “Loose” Methodology Table A8.1.2: Economic Status, Q 1 2001 - Q3 2004 (Thousand) 2001 2002 2003 2004 Q I Q II Q III Q IV Q I Q II Q III Q IV Q I Q II Q III Q IV Q I Q II Q III Total population over 15 years old 3, 277 3, 269 3, 139 3, 083 3, 016 3, 033 3, 021 2, 971 3, 082 3, 060 3, 132 3, 134 3, 143 3, 122 3, 181 Total economically active population (labour force) (1) 2, 066 2, 197 2, 144 2, 048 1, 912 1, 983 2, 003 1, 945 1, 941 2, 037 2, 120 2, 103 2, 007 2, 054 2, 093 Total economically active population (labour force) (2) 2, 195 2, 314 2, 246 2, 165 1, 983 2, 036 2, 063 2, 015 2, 025 2, 095 2, 170 2, 160 2, 089 2, 106 2, 146 Employed 1, 818 1, 944 1, 913 1, 838 1, 659 1, 742 1, 768 1, 713 1, 679 1, 805 1, 897 1, 877 1, 746 1, 809 1, 819 Hired 681 672 636 630 625 598 597 607 594 604 640 637 620 608 578 Self-employed 1, 034 1, 189 1, 194 1, 127 1, 028 1, 141 1, 168 1, 102 1, 083 1, 200 1, 255 1, 240 1, 125 1, 201 1, 239 Unemployed (1) 248 253 231 210 254 241 236 232 262 233 223 226 260 245 274 Unemployed (2) 377 370 333 327 324 294 296 303 345 290 273 283 342 298 327 Total population outside the labour force (1) 1,210 1,072 995 1,034 1,103 1,050 1,017 1,026 1,141 1,023 1,002 1, 028 1, 130 1, 065 1, 086 Total population outsde the labour force (2) 1,082 955 893 918 1,033 997 957 956 1,057 965 952 971 1,047 1,013 1,032 Unemployment rate (per cent) (1) 12.0 11.5 10.8 10.3 13.3 12.1 11.8 11.9 13.5 11.4 10.5 10.7 13.0 11.9 13.1 Unemployment rate (per cent) (2) 17.2 16.0 14.8 15.1 16.3 14.4 14.3 15.0 17.1 13.9 12.9 13.1 16.4 14.1 15.2

Labour force participation rate (1) 63.1 67.2 68.3 66.4 63.4 65.4 66.3 65.5 63.0 66.6 67.7 67.1 63.9 65.8 65.8 Labour force participation rate (2) 67.0 70.8 71.5 70.2 65.7 67.1 68.3 67.8 65.7 68.5 69.3 68.9 66.5 67.5 67.5 Self-employment share in total labour force 50.1 54.1 55.7 55.0 53.7 57.5 58.3 56.6 55.8 58.9 59.2 59.0 56.1 58.5 59.2 Self-employment share in total employment 56.9 61.2 62.4 61.3 62.0 65.5 66.1 64.3 64.5 66.5 66.2 66.1 64.4 66.4 68.1 Source: The State Department for Statistics, Labour Force Survey, Household Survey Note: (1) ILO Standard (or “strict” methodology) (2) ILO “Loose” Methodology

ABBREVIATIONS

ACDI Agricultural Co-operative Development International BSEC Black Sea Economic Co-operation CAP Common Agricultural Policy CASE Centre for Social and Economic Research CEFTA Central European Free Trade Agreement CHF Swiss Frank CIS Commonwealth of Independent States CPI Consumer Price Index DB Defined Benefit DC Defined Contribution DMB Deposit Money Bank (Commercial Bank) EBRD European Bank for Reconstruction and Development ECB European Central Bank ECCC European Community Custom Code ECU European Currency Unit EFSA European Food Safety Authority EFTA European Free Trade Agreement EGPRP Economic Growth and Poverty Reduction Programme EMI European Monetary Institute EMS European Monetary System EMU Economic and Monetary Union ERM Exchange Rate Mechanism ESAF IMF Enhanced Structural Adjustment Facility EU European Union EUR Euro FAO Food and Agricultural Organisation FDI Foreign Direct Investment FSU Former Soviet Union FTA Free Trade Agreement FXB Foreign Exchange Bureau (x) GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GCT General Customs Tariff GDP Gross Domestic Product GEL Georgian Lari GEDI Georgian Economic Development Institute GEPA Georgian Export Promotion Agency GEPLAC Georgian-European Policy and Legal Advice Centre GET Georgian Economic Trends GNP Gross National Product GSP Generalised System of Preferences GUUAM Regional organisation founded in 1997 as a political, economic and strategic alliance (Georgia, Ukraine, Uzbekistan, Azerbaijan and Moldova) H Half year ha hectares HS Harmonised Commodity Description HTS Harmonised Tariff Schedule ICC International Chamber of Commerce IDP Internally Displaced Person

GEORGIAN ECONOMIC TRENDS – 2005 No.1 129 ABBREVIATIONS

IFAD International Fund for Agricultural Development ILO International Labour Organisation IMF International Monetary Fund INOGATE Interstate Oil and Gas Transport to Europe ISIC International Standard Industrial Classification JPY Japanese Yen JSC Joint Stock Company KWD Kuwait Dinar KWh Kilowatt hour LDC Least Developed Countries LFS Labour Force Survey LIBOR London Inter-bank Offered Rate MFA Multi-fiber Agreement MFN Most Favoured Nations status MoF Ministry of Finance MoHSS Ministry of Healthcare and Social Safety MRAs Mutual Recognition Agreements MSPM Ministry of State Property Management MWh Megawatt hour NBG National Bank of Georgia NDA Net Domestic Assets NDC Notional Defined Contribution NFA Net Foreign Assets NMP Net Material Product NTB Non-tariff Barriers NTR Normal Trade Relations OECD Organisation for Economic Co-operation and Development PAYE Pay-as-you-earn pension system PAYG Pay-as-you-go pension system PCA Partnership and Co-operation Agreement PPI Producer Price Index PREGP Poverty Reduction and Economic Growth Program PRGF Poverty Reduction and Growth Facility (IMF) PSI Pre-shipment inspection Q Quarter year RM Reserve Money RUR Russian Ruble SAC World Bank Structural Adjustment Credit SCD State Customs Department SDR Special Drawing Rights SDS State Department for Statistics SFr Swiss Frank SIS State Institute of Statistics of Turkey STI State Tax Inspectorate TBT Technical Barriers on Trade agreement TEN Trans-European Networks TICEX Tbilisi Interbank Currency Exchange TRACECA Transport Corridor Europe-Caucasus-Asia TRI Trade Restrictiveness Index TRIMs Trade-Related Investment Measures TRIPS Trade-Related Intellectual Property Rights TRL Turkish Lira UNCTAC United Nations Conference on Trade and Development

130 GEORGIAN ECONOMIC TRENDS – 2005 No.1 ABBREVIATIONS

UNCITRAL United Nations Comission on International Trade Law UNDP United Nations Development Program USAID United States Agency for International Development USD United States Dollar USITC United States International Trade Commission USSSF United State Social Safety Fund USTR United States Trade Representative VAT Value Added Tax WP Working Party WTO World Trade Organisation

GEORGIAN ECONOMIC TRENDS – 2005 No.1 131