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 Quarterly Review

2004 No. 2

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 George Eradze, David Gvenetadze, Ivan Habanec, 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 Erekle Natadze, Veronica Schneider, Simon Stone, [email protected] or to deliver them as a Word 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, Tel/Fax: (995 32) 53 71 39 (direct) and also to relate this to the Partnership and Fax: (995 32) 53 71 38 Cooperation Agreement between Georgia and the E-mail: [email protected] European Union. However, they represent the view of the authors and editors only and do not represent any To subscribe to GET, please, send an e-mail or fax official view of the European Commission, the stating your contact details and language of the Georgian-European Policy and Legal Advice Centre or edition to the e-mail address/fax numbers above. the Government of Georgia.

GEORGIAN ECONOMIC TRENDS – 2004 No.1

GEORGIAN ECONOMIC TRENDS

Contents

Foreword 3 Part I. Economic Trends 1. Summary 7 2. National Accounts and Main Trends 11 3. Government Finance 18 4. Money and Finance 26 5. International Trade and Foreign Economic Relations 33 6. Privatisation 40 7. Labour Market, Incomes and the Social Safety Net 46 8. The EU-Georgian Relations 58 Calendar of Events 65 Part II. Appendix: Feature Articles I. Note on foreign Direct Investments 80 By Daniel Linotte, Senior Economic Adviser to the OSCE

II. Georgian Wine Industry: Present State and Prospects of Development 88 By Nodar Chkartishvili, Director of the Georgian Research Institute of Viticulture and Winemaking Zurab Geliashvili, Head of Economic Department of the Georgian Research Institute of Viticulture and Winemaking

III. Innovation Systems in Employment 109 By Rezo Sakvarelidze, Head of Labour and Employment Policy Department of the Ministry of Labour, Health and Social Security Part III. Statistical Appendix Statistical Appendix 114 Abbreviations 127

GEORGIAN ECONOMIC TRENDS – 2004 No.2 1

FOREWORD

Dear Reader

The last six months or so have undoubtedly seen major changes in Georgia, with political events of varying formality transforming the prospects for the country’s economy and society. Georgia enjoys renewed credibility in the world, as evidenced by the outcome of the donor conference held in Brussels on June 16/17 under the joint auspices of the EU and World Bank. This conference pledged to provide about US$ 1 billion/Euro 850 million to meet Georgia’s urgent needs in the period 2004 – 06, in recognition of the Government’s strategic vision, as well as specific actions which it has already undertaken.

These donor initiatives have been mounted against the background of the Government’s Economic Development and Poverty Reduction Programme (EDPRP) and the approval of a new programme by the IMF under the Poverty Reduction and Growth Facility. This in turn bodes well for the renegotiation of Georgia’s external debt through the Paris Club in July.

Finally, if this were not enough good news, Georgia has also recently been included in the EU’s European Neighbourhood Policy, along with other countries of the South Caucasus; this opens up significant new cooperation opportunities with the EU, which are described in more detail in our chapter on EU-Georgian Relations.

Good news is of course always welcome and we would not wish to downplay the progress which this reflects. However, it is important that all players, including the Georgian public, recognise the requirement of understanding the mutual responsibilities which also arise from such developments. Among these is the need to actually “make things happen” within the overall cooperation structure and availability of resources that will be created. This in turn suggests that, on all sides, there should be a clear and active awareness of the policies that will hopefully produce the desired outcomes.

The role of GEPLAC in this environment can be extremely useful, and the Management of the Centre are conscious of both the opportunities and the challenges now presented in the area of policy advice. As we also stated in our last Foreword, the nature of economic problems in Georgia remains the same, though the potential solutions and chances of successful outcomes have obviously changed considerably, as demonstrated by the events reported above. We might reasonably say that we have reached “the end of the beginning” and all interested parties can now give serious thought to the details of what should be done next.

Part of the response, from GEPLAC’s point of view, is to promote greater awareness of a “GEPLAC position”, as a framework for our thinking in a number of areas. While not being too rigid, it should

GEORGIAN ECONOMIC TRENDS – 2004 No.2 3 FOREWORD provide additional clarity for our stakeholders, as well as our audience in the broadest sense, not forgetting also our own Experts, who will be called upon to provide detailed commentary in many fields.

So, what should be the approach to developing and publicising this GEPLAC position in a more urgent way, building on the more gradual approach that we have employed up to now? It seems there are three issues to be clear about: • What are the general principles that GEPLAC should apply to its advice? • What are the policy areas in which GEPLAC should be active? • Who should be the recipients of this advice?

Taking each of the above in turn, we may say the following: • As always, we would begin with the 3 elements of GEPLAC’s mission – support for Georgia’s increased participation in the world economy, improvement of the business environment and public sector efficiency. All advice we give should examine how these aims are promoted by a particular policy. At the same time we should remember that, important as these aims are, they are in turn only a practical route to a more fundamental goal, the overall improvement of the general welfare and living standards of the Georgian people. To a major extent, the role of GEPLAC should be to explain the process whereby individual policy actions, operating through one or more of the 3 elements, can in fact deliver such benefits. • Given that GEPLAC has finite resources and is not expert in every area of public policy, it must determine which it will emphasise. The most effective approach here would seem to be to focus on the content of the Partnership and Cooperation Agreement, in particular the National Programme. In this way, an activity that was formerly quite technical in content should be transformed into one which is readily understandable as a contribution to actual policy with consequences for the lives of the population. • This then raises the question of who should be the recipients of GEPLAC’s advice and why the background to this may have evolved somewhat. There is now a renewed commitment of Government to a market economy and the welfare objectives mentioned above, which we may also call “economic democracy”. The climate is therefore right for the Centre to continue to act not only in concert with state bodies, but also seek to further develop its communication with the private sector (specific organisations, industries, professional bodies, NGOs and the public in general) through a variety of means. These means will include an improved and more “real time” website and workshops with specific groups on chosen topics. Relating back to the National Programme, we may also argue that, if technical recommendations can be presented in their widest terms, including welfare aspects, this supports efforts to apply and enforce the related legislation, based on the active understanding and consent of the people.

4 GEORGIAN ECONOMIC TRENDS – 2004 No.2 FOREWORD

We should perhaps make some additional brief observations about the general environment in which economic policy is now to be made and presented in Georgia: • Government clearly has a huge task not only to achieve certain concrete goals, but also to manage the expectations of the voters who provided its mandate. This is especially so when there is such a climate of optimism, reinforced by the kind of positive news we mention at the beginning of this Foreword. • On the one hand, Georgia has never experienced a market economy at all potential levels of activity; the disappearance of the Soviet Union and its command economy was followed by a collapse of most fields of the Georgian local economy (especially manufacturing), and this has yet to be restored. • On the other hand, and against this background, necessity has led the Georgian people to operate, at least on the level of small business (and whatever the imperfections), a de facto market economy for some years. Therefore, both the concept and the reality are by no means unfamiliar. • However, a great deal of what one might call “economic vocabulary”, in the sense of more automatic thinking and communication by economic players, remains to be clarified. For example, what we are currently experiencing, and what needs to continue, as a background to policymaking in Georgia goes by many names, including:

θ “Transition”. This is now understood by economists to mean fairly precisely the process of becoming a market economy, with recognisable stages (e.g. removal of price controls), quantifiable progress and the achievement of an end result.

θ “Transformation”. This relates more to the process of individual enterprises being prepared for privatisation; however, it is useful as a concept of completing quite specific tasks (e.g. accounting standards) and procedures (e.g. creation of certain legal structures) and can be applied to the wider economy.

θ “Reconstruction”. This refers mostly to the restoration of infrastructure after events (e.g. wars) or long-term neglect, and is obviously a vital requirement for any country that wishes to improve the welfare of its citizens. It should, however, not be seen as necessarily a general restoration of what went before, or worse, simply an attempt to repair an outdated system.

All of the above are useful ideas that policymakers and governments can and should employ when proposing and implementing policy and the ultimate aims of this. However, as a means of broad communication they perhaps have a more limited use. In particular, they suggest processes which are finite and capable of completion within a period that may be seen as unrealistic. We therefore suggest that, in addition to these concepts, policy be strongly expressed in terms of “modernisation”. This is a notion that is easily understood and emphasises above all movement in a positive direction.

Our external articles provide concrete examples of some of the points made earlier and also raise further interesting questions. The first, by Daniel Linotte, a former Economic Team Leader of GEPLAC, now Senior Economic Adviser at OSCE, is a survey of issues and comparative analysis

GEORGIAN ECONOMIC TRENDS – 2004 No.2 5 FOREWORD relating to foreign direct investment (FDI), which is fairly generally accepted as a key necessity for Georgia’s economic regeneration. FDI is obviously a direct element both in Georgia’s increased participation in the world economy and in providing both finance and know-how for local business. The sources of FDI for Georgia can be quite varied (e.g. both the EU and the former Soviet Union), each with specific experience and expertise to contribute. The second, by Nodar Chkhartishvili and Zurab Geliashvili, respectively Director and Head of Division of Economy of the Georgian Research Institute of Viticulture and Winemaking, focuses on a particular sector, the Georgian wine industry. We should not forget that growth, exports and employment will arise from the combined actions of many sectors and the authors refer to a number of ideas which GEPLAC has endeavoured in the past, and will continue in the future, to emphasise. These include the sectoral approach to policy, the importance of a “level playing field”, the relevance of intellectual property rights for Georgian as well as foreign companies, the potential role of Government, and a theme appearing throughout this article, that of the need to modernise. The third, by Rezo Sakvarelidze, Head of Labour and Employment Policy Department of the Ministry of Labour, Health and Social Security, looks at policy for directly stimulating employment. It examines in particular the role of donors and also that of Government as a regulator in a specific area of economic activity.

We trust that you will find this edition of GET interesting and a particular stimulus to the current policy debate. As always, we also welcome your feedback and comment.

6 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER ONE: SUMMARY

NATIONAL ACCOUNTS AND MAIN TRENDS According to the preliminary estimates of the State Department for Statistics, Georgia’s GDP in Q1 2004 was GEL 2,109.9 million (USD 1,024.7 million, i.e., USD 224.9 per capita). GDP growth rate rose in Q1 2004 to 9.6 per cent, compared with 4.8 per cent in Q1 2003. It is a very positive development in the Georgian economy that the high growth tendency is continuing. The highest growth rate traditionally (like previous quarters) was observed in the industry, construction, transport and telecommunication sectors. At the same time not every sector of the Georgian economy grew in Q1 2004, particularly negative growth was observed in the sectors of agriculture, financial intermediation and education.

The acceleration of economic growth resulted from expansion in industry, construction and services. But the main driver of such a high rate of growth was the continuation of construction of Baku-Tbilisi-Ceyhan pipeline. The launch of the project positively affected the construction and services sectors. It is also worth mentioning that the project employed a substantial number of the labor force, which increased the income of population and correspondingly boosted domestic demand. Domestic demand together with the increased export is still the main driving force of economic growth in Georgia.

FOREIGN DEBT As of 31 March 2004, Georgia’s outstanding foreign debt, including state guaranteed debt, amounted to USD 1,839.1 million (GEL 3,687.5 million), that is 46.6 per cent of GDP in 2003. Compared with the end of 2003, the outstanding debt decreased by USD 10.1 million. It is a very positive development that the foreign debt is decreasing. Due to high debt obligations and limited budgetary revenues, the rescheduling of payments for foreign debt in 2004 is the sole feasible option for Georgia.

BALANCE OF PAYMENTS Figures for the balance of payment for 2003 were not available at the time when the previous issue of GET was being written and become available only currently. Thus, in this issue of GET we will analyse the yearly trends of BOP. The overall balance of payments deteriorated in 2003 compared with 2002. The increased deficit in balance of payments is mainly related to the increased deficit of balance of current accounts.

GOVERNMENT FINANCE Although the law on state budget for 2004 was not adopted before the end of Q1, the Ministry of Finance expected that state budget revenues would reach GEL 260.8 million. Actual state budget revenues based on treasury data were GEL 297.4 million, 14 per cent higher than planned. This was the first case in recent years where actual budget performance exceeded government expectations. Growth of budget revenues over the year was also substantial (33 per cent). Growth and target compliance was dominated by growth of non tax revenues. Although tax revenues were higher compared to previous year, they were slightly short of target.

Actual State budget expenditures of GEL 321.8 million were 26 per cent higher compared to the previous year. The main spending was on general government social security and debt servicing. Substantial growth was observed in the share of salaries in total spending. This reflects reform efforts of the Government in respect of human resourse management in the state institutions.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 7 SUMMARY

MONEY AND FINANCE The Government’s measures toward improved tax discipline resulted in increased demand for the Lari. The market responded, appreciating the nominal exchange rate of the Lari, which became a serious challenge for the money market. Within the free float exchange rate the NBG had to avoid dramatic fluctuation of the Lari exchange rate and prices. In Q1 2004 the NBG successfully used various monetary instruments to maintain a certain level of liquidity and kept exchange rate and prices stable.

As the result of the greater demand on the market, the Lari’s nominal exchange rate appreciated notably. The maximum nominal appreciation (official USD/GEL 1.9000 and market USD/GEL 1.8800) was on 6th and 10th of March. Maintaining a free floating exchange rate, the NBG however intervened trying to avoid drastic fluctuations on the market. During Q1, 2004 the NBG purchased USD 27.6 million via TICEX (plus some small amounts in other currencies). It was clear that the issuing of liquidity could create the danger of non- absorption, with an inflationary effect in the future. Thus the NBG’s authorities provided a public explanation of the current developments to prevent any panic on the market. It resulted in the depreciation of the nominal exchange rate of the Lari (up to 2.0700 on April 13th) but new T-Bills issued renewed demand and the Lari appreciated in nominal terms to (2.0000 by the end of April).

Improved tax and customs discipline was the one of the main achievements of Georgian authorities in Q1 2004. Businesses had to put legalised taxes and duties into prices of goods. That created price growth in Q1. But the strengthening of the Lari in nominal terms offset price growth for imported goods. As a result of that the CPI grew insignificantly in Q1 2004.

INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS In Q1 2004, registered external trade turnover was equal to USD 427.2 million, of which exports were USD 98.6 million and imports USD 328.6 million. The figures suggest that the growing negative trade balance trend continued during Q1 2004. Exports in USD increased by about 34 per cent compared with the O1 2003, while imports increased by 45.6 per cent reflecting needs for imported goods for construction of BTC, mainly tubes and pipes. Such significant growth in exports is a result of legalization of export flow and continuing GDP growth during Q1. The export coverage of import ratio decreased in Q1 2004 to 30 per cent, while in the Q1 2003 the ratio was 32.6 per cent.

After EU enlargement, the extension of the EU-Georgia Partnership and Cooperation Agreement (PCA) to the new Member States will mean that goods cleared at the first point of entry into the EU will be in free circulation throughout its whole territory without any further transit or other duties related to the new Member States. Enlargement extended the EU's trade policy regime to the acceding countries. The previous system, featuring a single trade regime for the EU and a different regime for each of the candidates, will disappear. A single set of trade rules, a single tariff, and a single set of administrative procedures will apply not just across the existing 15 member states but across the enlarged Union of 25. This will greatly simplify the dealings that third country operators have within Europe.

PRIVATISATION The first quarter of 2004 in Georgia was remarkable in terms of political developments and structural changes in the government bodies. These events left little room for implementation of privatisation of state property. A Department of Privatisation created in the Ministry of Economics, Industry and Trade, following the abolition of the Ministry of State Property Management (MSPM) in 2003, and dealing with the privatisation issues, has been experiencing structural and staff changes. This process considerably slowed down privatisation of state enterprises. The political developments and plans of the new Government to present to the Parliament new draft laws and changes in legislation also put potential investors in a waiting position.

8 GEORGIAN ECONOMIC TRENDS – 2004 No.2 SUMMARY

While the privatisation process of small enterprises showed some progress in the first quarter of 2004, there was no news in privatising medium and large enterprises (MLE). 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.

However, it seems that developments will take a new pace since the new Government is planning to attract foreign investors and create a more favourable environment for business in the country. A prominent Georgian businessman (operating in Russia) Kakhi Bendukidze was appointed a new Minister of Economy. He accepted the offer during the business forum held for Russian businesses in Tbilisi. The Minister has expressed his determination to push forward the privatisation process of Georgian state enterprises. 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. The new President and his team are determined to combat corruption and consequently the privatisation process is likely to become more transparent.

EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET LABOUR MARKET The labour market situation 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, the overall picture is flawed by persistent underemployment, widespread hidden and disguised unemployment and salaries falling way below the minimum subsistence level. 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 increasingly larger numbers of households. Most of the working age population is either underemployed or non-employed. New stable jobs are rarely created. 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.

SOCIAL POLICY AND THE SOCIAL SAFETY NET The vast majority of the population, including informal sector employees, the self-employed and the unemployed, 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 importance. Beginning from from April-May 2004, the pension rate grew to GEL 18 countrywide, where in addition to GEL 14 of the main flat-rate pension allowance another GEL 4 were added to cover for previously accumulated pension arrears.

Social policy and reforms are among the top government priorities. The national Economic Development and Poverty Reduction Programme (EDPRP), that has been endorsed by the donor community and is to be revised, considers among its priorities the reduction of poverty through support to economic growth leading to the creation of new jobs, and reform of the pension system, aimed at introducing a sustainable multi-pillar pension system, based on insurance principles.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 9 SUMMARY

EU-GEORGIAN RELATIONS According to the State Department for Statistics, in the first quarter of 2004 Georgia’s trade with the Member States of the European Union amounted to USD 121.9 million, which is about 27 per cent more than in the same period of previous year. During this period Georgian exports to the EU market amounted to USD 14.9 million (102.9 per cent compared with the previous year). Imports from EU Member States’ amounted to USD 106.2 million (131.8 per cent compared with the previous year). For the period, 28.4 per cent of Georgia’s foreign trade was with EU Member States, 15.1per cent of exports and 32.3 per cent of imports.

The overriding goal of any state’s foreign policy is the creation of international conditions ensuring durable security for its citizens – political, economic, cultural and social. That striving has the utmost importance for Georgia – a country tried by history, for whose citizens, the tradition of struggle for independence is of supreme value. Georgia’s European aspirations took root in that soil and were enhanced by belonging to European culture and tradition. Closer integration to the European Union is, therefore, the most advantageous choice from the point of view of national security, stability of the democratic order, sustainable economic development and establishment of a modern civil society. It also signifies a conscious assumption of co-responsibility for European affairs, and thus – a more effective impact on global politics. As a result, Georgia will have a more tangible influence in the region, promotion of good-neighbourly relations, and will be able to participate in shaping the directions of world politics in line with the interests of the state. Georgia attaches great importance to the development of regional co-operation in the South Caucasus. The South Caucasus has a crucial role to play as a major transit corridor between Europe and Asia, including in the energy sector. The South Caucasus and particularly Georgia plays an active part in EU regional programmes, such as TRACECA and INOGATE.

10 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER TWO: NATIONAL ACCOUNTS AND MAIN TRENDS

GDP AND MAIN TRENDS According to the preliminary estimates of the State Department for Statistics, Georgia’s GDP in Q1 2004 was GEL 2,109.9 million (USD 1,024.7 million, i.e., USD 224.9 per capita). GDP growth rate rose in Q1 2004 to 9.6 per cent, compared with 4.8 per cent in Q1 2003. It is a very positive development in the Georgian economy that the high growth tendency is continuing. The highest growth rate traditionally (like previous quarters) was observed in the industry, construction, transport and telecommunication sectors. At the same time not every sector of the Georgian economy grew in Q1 2004, particularly negative growth was observed in the sectors of agriculture, financial intermediation and education.

The acceleration of economic growth resulted from expansion in industry, construction and services. But the main driver of such a high rate of growth was the continuation of construction of Baku-Tbilisi- Ceyhan pipeline. The launch of the project positively affected the construction and services sectors. It is also worth mentioning that the project employed a substantial number of the labor force, which increased the income of population and correspondingly boosted domestic demand. Domestic demand together with the increased export (See Chapter Five) is still the main driving force of economic growth in Georgia. Table 2.1 shows the structure of GDP and its growth rates.

Table 2.1: Structure and growth rate of GDP, Q1 2004 (GEL million) Q1 2004 Q1 2004 vs. Q1 2003 Share in GDP Q1 (2002=100) 2004 (per cent)

Agriculture, forestry and fishing 435,2 -1.9 20.6

Industry 269.0 20.5 12.8

Domestic processing of products 84.2 1.9 4.0 Construction 105.1 54.6 5.0 Trade 263.6 7.9 12.5 Hotel and restaurant 52.5 13.5 2.5 Transport 209.0 5.2 9.9 Telecommunication 87.4 36.7 4.1 Financial intermediation 27.5 -5.6 1.3 Operation with real estate, 122.0 9.3 5.8 commercial activities State management, Defence 109.0 3.7 5.2 Education 78.4 -2.5 3.7 Health care and social services 71.5 4.5 3.4 Other services 81.9 35.7 3.9 Amendments by financial -18.1 34.4 -0.9 intermediation services Net taxes 131.5 -1.1 6.2 GDP 2,109.9 9,5 100.0 Source: State Department for Statistics

GEORGIAN ECONOMIC TRENDS – 2004 No.2 11 NATIONAL ACCOUNTS AND MAIN TRENDS

Figure 2.1: Structure of GDP, Q1 2004

Amendments by financial intermediation Other services services Net taxes 4% 1% 6% Health care and Agriculture, forestry social services and fishing 3% 20% Education 4% State management, Defence 5% Operation with real Industry estate, commercial 13 % activities . 6% Domestic processing Financial of products intermediation 4% 1% Telecommunication 4% Construction 5% Transport Trade 10 % 12 % Hotel and restaurant 2%

Source: State Department for Statistics

Non-recorded operations and the informal economy still remain a major problem for economic reform and policy, although there was a slight improvement of situation in Q1 2004. The new political environment after the ‘Rose Revolution’ and determination to crack down on corruption is the crucial factor that induced this positive development. From figure 2.2 we can observe that in Q1 2004 the share of the non-recorded economy in the total output is slightly reduced.

Figure 2.2: Share of Non-recorded Economy in Total Output, 2000 - Q1 2004

120

100

80 67.2 67.1 66.4 68.2 70.8 60

40

20 32.8 32.9 33.6 31.8 29.2 0 2000 2001 2002 2003 Q1 2004

Non-recorded Recorded

Source: State Department for Statistics

12 GEORGIAN ECONOMIC TRENDS – 2004 No.2 NATIONAL ACCOUNTS AND MAIN TRENDS

SECTORS OF ECONOMY

Agriculture

According to the preliminary data of SDS seasonal agricultural work (sowing of spring cultures) was implemented successfully and 16.5 thousand hectares were sown in Q1 2004 compared with 16.2 thousand hectares in the corresponding period of the previous year.

The structural reforms 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, by 2003 about 25 per cent of the country’s total arable land was privatised and about 30 per cent was leased. The growth evidenced in the sector is an important fact due to its strategic importance as about 50 per cent of the total labour force is employed in the agriculture.

Despite some positive developments in the sector, there is still evidence of some acute problems. Labor productivity is much lower (about 4 times) than in other sectors of economy. Most households are too small and rely on manual work; agricultural techniques are commonly obsolete; the fertility of soil is declining; and the irrigation and drainage systems need restoration. Solving these problems is 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 domestic market from smuggling and counterfeit goods also should be on the top policy agenda of the Government.

Industry

Registered output of industrial enterprises in Q1 2004 increased by 26.2 per cent compared with the corresponding period in previous year. According to the SDS, output amounted to GEL 376.2 million and was distributed by main fields of activity as follows: processing industry 54.1 per cent; energy and water supply 38.1 per cent; and mining industry 7.8 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 the small and medium enterprises is hindered by unfavourable legislation and widespread corruption. In previous years, the practice of the “state capture” and unfair competition was still in place. As a result, the most economically viable are those enterprises that are lobbied for 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 15 per cent of general industrial output was produced, while in the most developed countries the share of such firms is 50-60 per cent.

Construction

The boom in demand for private apartments facilitated the development of the construction sector in Georgia. The growth rate of the sector in Q1 2004 was outstanding and reached 54.6 per cent The total output of the sector was GEL 160.0 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 76.6 per cent in Q1 2004. In Q1 2004 there were functioning 374 construction firms out of 611 existing in Georgia. Out of operational 374

GEORGIAN ECONOMIC TRENDS – 2004 No.2 13 NATIONAL ACCOUNTS AND MAIN TRENDS construction firms, 66 are state owned and the other 374 are private firms. Private sector accounted for 96.0 percent of the output.

Transport and Telecommunications

The output of the transport sector increased by 5.2 per cent in Q1 2004. It is important to mention that there is evidence of increased activity in all types of transport services (railways, motorways and airlines as well as sea ports and city transport). Increases in international transportation of cargo contributed to the growth of turnover of Georgian transport services. The volume of transported cargo increased by 8.8 per cent and the turnover of cargo increased by 7.6 per cent. In the transportation of cargo the lion’s share fell on the motorway transport at about 56.5 per cent, and in terms of turnover of cargo the highest share fell on the railway transport at about 90.5 per cent of total turnover. The turnover of passengers of Georgian air companies in Q1 2004 increased by 64.4 per cent compared with the corresponding period of the previous year.

In Q1 2004, Batumi and Poti sea ports processed 4.0 million tonnes of cargo, that was 22.2 per cent more than in Q1 2004.

The further development of 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.

There was an overall extension of telephone communication networks in Q1 2004. The number of ordinary phone customers was 542.0 thousand (decreased by 2.9 per cent). This decline was compensated by the increased number of mobile telecommunication subscribers that reached 590.0 thousand. It is about 38.0 per cent more compared with the corresponding period in 2003.

Tourism

According to data of SDS in Q1 2004 Georgia was visited by 71.4 thousand people, among them 39.1 thousand from the CIS member countries and 32.3 thousand from the other foreign countries. The number of tourists in Q1 2004 increased by 9.7 thousand compared with the corresponding period in 2003.

According to the common assessment of SDS and State Department of Tourism in Q1 2004 tourism sector incomes were GEL 151.1 million. This is about 7.2 per cent of overall GDP.

FOREIGN DEBT

As of 31 March 2004, Georgia’s outstanding foreign debt, including state guaranteed debt, amounted to USD 1,839.1 million (GEL 3,687.5 million), that is 46.6 per cent of GDP in 2003. Compared with the end of 2003, the outstanding debt decreased by USD 10.1 million.

It is a very positive development that the foreign debt is decreasing. This tendency was resulted by the repayment of the debt to the bilateral creditors, particularly to Turkey, Uzbekistan and Ukraine. In addition to the debt repayment, the changing of USD’s exchange rate against SDR, EUR, JPY, CHF and KWD, in which more than half of Georgia’s foreign debt is denominated, induced a decrease in total debt in USD terms in Q1 2004. In the previous quarter, Georgia paid USD 26.1 million for debt

14 GEORGIAN ECONOMIC TRENDS – 2004 No.2 NATIONAL ACCOUNTS AND MAIN TRENDS servicing, including USD 19.6 million in principal and the rest for interest, commitments and penalties. The debt to GDP ratio is a key statistic in any assessment of debt sustainability. It is important to mention that this figure in Q2 2004 decreased compared with the same ratio in the previous year from 46.8 per cent to 46.6 per cent.

Table 2.2: Foreign Debt, 2003 – Q1 2004 (USD Million) 2003 Q1 2004 Total Debt 1, 849. 2 1,839.1 Debt service 145,2 26,1 of which: Principal Repayments 105, 1 19,7

Interest Payments 40, 1 6,4 Ratios, % Debt to GDP Ratio 46.8 46.6 Source: Ministry of Finance

Due to high debt obligations and limited budgetary revenues, the rescheduling of payments for foreign debt in 2004 is the sole feasible option for Georgia. A concessional restructuring of Georgia’s foreign debt would enhance its sustainability prospects. However, Georgia’s position in the negotiations with the official creditor countries of “Paris Club” significantly depends on the position of the International Monetary Fund (IMF) and the fulfilment of obligations accepted by the Government. That is why it is a very positive development that the terminated co-operation between the Government of Georgia and the IMF was renewed. On 4 June 2004, the Executive Board of the IMF approved a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 98 million (about USD 144 million) to support the government’s economic program into June, 2007.

Although the support of the IMF is crucial in the process of debt rescheduling, still to embark on a sustainable path would also require that Georgia (a) abstains from borrowing on commercial terms and continues to shift its financing mix towards more concessional sources (including grants); (b) considerably increases tax revenue collections; and (c) implements the reforms required to achieve and maintain solid export and GDP growth.

Box 2.1 PARIS CLUB Description of the Paris Club

The Paris Club is an informal group of official creditors whose role is to find co-ordinated and sustainable solutions to the payment difficulties experienced by debtor nations. Paris Club creditors agree to rescheduling debts due to them. Rescheduling is a means of providing a country with debt relief through a postponement and, in the case of concessional rescheduling, a reduction in debt service obligations.

The first meeting with a debtor country was in 1956 when Argentina agreed to meet its public creditors in Paris. Since then, the Paris Club or ad hoc groups of Paris Club creditors have reached 376 agreements concerning 79 debtor countries. Since 1983, the total amount of debt covered in these agreements has been $418 billion.

In spite of such an activity, the Paris Club has remained strictly informal. It is the voluntary gathering of creditor countries willing to treat in a co-ordinated way the debt due to them by the developing countries. It can be described as a "non institution".

Although the Paris Club has no legal basis nor status, agreements are reached following a number of rules and principles agreed by creditor countries, which help a co-ordinated agreement to be reached efficiently.

Functioning

GEORGIAN ECONOMIC TRENDS – 2004 No.2 15 NATIONAL ACCOUNTS AND MAIN TRENDS

The creditor countries meet 10 to 11 times a year, for negotiation sessions or to discuss among themselves the situation of the external debt of debtor countries or methodological issues on the debt of developing countries.

These meetings are held in Paris. The Chairman is a senior official of the French Treasury. Deputies to the Chairman in the French Treasury serve as co-president and vice-president. The current Chairman is Mr. Jean Pierre JOUYET, Head of the Treasury. Mrs Stéphane PALLEZ, Deputy to the Head of the Treasury in charge of international and European affairs at the Treasury, is Co-President and Mr Ramon FERNANDEZ, her Deputy in charge of debt, development and emerging markets, is Vice-President.

A permanent Secretariat General is maintained by a division of around 15 people of the French Treasury, that work part time for the Paris Club. The Secretary General is currently Mr Emmanuel MOULIN. This informal organisation has made it possible for the Paris Club to work with limited staff and a flexible structure.

Source: International Monetary Fund (IMF), www.imf.org

BALANCE OF PAYMENTS

Figures for the balance of payment for 2003 were not available at the time when the previous issue of GET was being written and become available only currently. Thus, in this issue of GET we will analyse the yearly trends of BOP. The overall balance of payments deteriorated in 2003 compared with 2002. The increased deficit in balance of payments is mainly related to the increased deficit of balance of current accounts from USD 257.7 million to USD 391.8 million. It is an interesting fact that the balance of capital and financial accounts improved in the corresponding period from USD 245.6 million to USD 395.5 million.

Table 2.3: Balance of Payments 1995-2003 (USD million) 1995 1996 1997 1998 1999 2000 2001 2002 2003 Current account Balance -363 -295 -499 -417 -197.4 -269 -211.4 -257.7 -391.8 Goods -422 -313 -675 -760 -533.8 -512 -549.4 -452.1 -630.5 Export 289.5 372.3 377.2 300 329.5 459 496.1 578.7 819.6 Import -711 -686 -1052 -1060 -863.4 -970 -1045 -1031 -1450.1 Services 4.9 4.3 -148 -55.2 -3.9 -9.8 77.1 93.1 52.9 Export 110.5 98 167.9 289.9 216.7 206.2 313.9 353.5 441.8 Import -106 -93.6 -316 -345 -220.6 -216 -236.8 -260.3 -388.9 Incomes -60.6 -70.4 127.4 190.8 146.9 117.5 32.4 -55.2 27.5 Credit 4 5.5 186.6 243.3 211.4 178.5 97.8 93.2 179,3 Debit -64.6 -76 -59.2 -52.4 -64.4 -61.1 -65.4 -148 -151.8 Current transfers 113.9 84.1 196.3 208.3 193.4 134.9 228.5 156.3 158.29 Credit 113.9 84.1 205.3 220.1 228.7 163.6 246.5 181.3 199.8 Debit 0 0 -9 -11.8 -35.3 -28.3 -18 -25.1 -41.51 Capital and Financial 210.2 323.6 378.5 421.4 336.8 66.5 237.7 245.6 395.5 account Balance FDIs ------242.5 265.3 158.7 131.7 109.9 145.7 333.9 Portfolio investments 0 0 2.4 0 0 2.7 --- 0.005 -9 Other investments 210.2 276.9 154 120.2 154.7 -83.2 179.9 71.9 35.12 Reserves assets -40.6 -0.5 -14 42 30.4 20 -46.9 -38.5 6.7 Overall Balance -112.5 27.7 -120.5 -5 169.8 -202.4 26.3 -12.2 3.7 Net errors and omissions 112.5 -27.7 120.5 5 -169.8 202.4 -26.3 12.2 -3.7 Source: State Department for Statistics

The deterioration of the balance of current account is the direct result of the decreased net exports in 2003 compared with 2002, as well as decreased transfers to government and remittances of long-term

16 GEORGIAN ECONOMIC TRENDS – 2004 No.2 NATIONAL ACCOUNTS AND MAIN TRENDS workers from abroad. The improvement in the balance of financial accounts is a consequence of the increased direct and portfolio investments. It is worth mentioning that the direct foreign investments in Georgia in 2003 were two times higher than in 2002. The start of the construction of oil pipeline Baku- Tbilisi-Ceyhan and institutional reforms in the country, are likely to support this trend in 2004.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 17

CHAPTER THREE: GOVERNMENT FINANCE

Although the law on state budget for 2004 was not adopted before the end of Q1, the Ministry of Finance expected that state budget revenues would reach GEL 260.8 million. Actual state budget revenues based on treasury data were GEL 297.4 million, 14 per cent higher than planned. This was the first case in recent years where actual budget performance exceeded government expectations. Growth of budget revenues over the year was also substantial (33 per cent). Growth and target compliance was dominated by growth of non tax revenues. Although tax revenues were higher compared to previous year, they were slightly short of target.

Actual State budget expenditures of GEL 321.8 million were 26 per cent higher compared to the previous year. The main spending was on general government social security and debt servicing. Substantial growth was observed in the share of salaries in total spending. This reflects reform efforts of the Government in respect of human resourse management in the state institutions.

STATE BUDGET REVENUES GEL 260.8 million was expected to be received by state budget in Q1 2004. Government expectations were fully realised and the State received GEL 297.4 million, GEL 36.6 million in excess of target. Sources of surplus are non tax revenues and foreign grants, while collection of tax revenues was slightly below the target. An outline of State budget revenues is presented in Table 3.1 below.

Table 3.1 State Budget Revenues Q1 2004 (GEL million) Q 1 Q 1 Actual Q1 Growth Per actual actual revenues target over the cent in revenue revenue as per cnt 2004 year total s 2004 s 2003 of target Total revenues and grants 260.8 297.4 223.6 114 133.0 100.0 Tax revenues 228.9 225.9 192.5 99 117.3 75.9 Non-tax revenues 31.9 60.4 23.3 189 258.8 20.3 Revenues of Special State Funds 82.6 79.7 56.9 97 140.0 26.8 Social security fund 69.8 67.5 48.0 97 140.5 22.7 Roads fund 12.8 12.3 8.9 96 137.5 4.1 Grants 11.2 7.8 143.1 3.8 Source: Ministry of Finance

Nominal growth of overall budget revenues over the year was 33 per cent. Comparison with the inflation rate between the periods indicates a real growth of public revenues. Of GEL 297.4 million in total sate budget revenues 75.6 per cent comes from tax revenues. The share of tax revenues is actually lower compared to previous periods as growth in other budget sources was faster compared to tax revenues. Non-tax revenues of GEL 60.4 million made up 20.3 per cent of the total figure while grants of GEL 11.2 million were 3.8 per cent of state revenues. Amounts actually received were respectively 258 per cent and 143 per cent of Q1 2003 figure. Revenues of Special State Funds (basically included in tax revenues above) formed 26.8 per cent of total state receipts. The target here was 97 per cent achieved, however received amounts were 40 per cent higher over the year. A detailed breakdown of central budget tax revenues is provided in Table 3.2.

18 GEORGIAN ECONOMIC TRENDS – 2004 No.2 GOVERNMENT FINANCE

Table 3.2: Central Budget Tax Revenues, Q1 2004 (GEL million) Q 1 Q 1 Actual Q1 Growth Per actual actual revenues target over the cent in revenue revenue as per cent 2004 year total s 2004 s 2003 of target Central budget tax revenues 148.7 146.3 135.7 98 107.8 100.0 Income tax 7.1 7.3 4.0 103 182.9 5.0 Profit tax 2.5 4.7 2.6 189 184.2 3.2 VAT 97.8 91.8 101.6 94 90.3 62.7 on domestic products 47.9 47.7 60.7 100 78.6 32.6 on imports 49.9 44.1 40.9 88 107.8 30.1 Excise 26.6 27.2 14.7 102 184.5 18.6 on domestic products 7.7 8.6 4.8 112 180.5 5.9 on imports 18.9 18.6 10.0 98 186.4 12.7 Customs duty 10.3 11.3 11.4 110 98.8 7.7 Other taxes 4.4 4.1 1.4 93 289.9 2.8 Source: Ministry of Finance; GET calculations

Tax revenues of central budget were only 7.8 per cent higher compared to the previous year as opposed to the 17 per cent improvement of tax revenues which includes revenues of special state funds. Central budget tax revenue performance was lower also in comparison with targeted amounts. Amounts actually collected were 98 per cent of government expectations. Direct taxes were collected in excess of target. GEL 4.7 million received under corporate income tax was higher than target by 89 per cent while GEL 7.3 million of income tax for physical persons exceeded target by 3 per cent of the planned amount. However, comparisons with historical data show that collection of direct taxes has improved by more than 80 per cent over the year. It seems that the sharp rise of profit tax receipts observed in 2002 and 2003 is to be continued in 2004. However share of direct taxes in central budget tax revenues remains very low at 8.2 per cent.

The situation with indirect taxes is ambiguous. VAT collections were only 90 per cent of the previous year’s level. However VAT revenues from imported goods increased by 7.8 per cent while domestic revenues decreased by 21 per cent. Being critical to overall budget performance (VAT receipts were 62 per cent of central budget tax revenues) VAT revenues of GEL 91.8 million were only 94 per cent of target. Domestic revenues were in line with planned amounts while VAT on imports was short of target by 12 per cent.

Excise duty collections were 102 per cent of target. GEL 27.2 million in revenues under this heading was 84 per cent higher compared to the previous year. Compliance with target was 112 per cent in the case of taxation of domestic products while excise revenues on imports were 98 per cent of the planned amount. In contrast to projections, there was a drastic rise (over 80 per cent) of excise revenues compared to previous year. However it should be mentioned that in Q1 2003 (reference figure) there was a dramatic decline in excise revenues with no evidence of reduced consumption of excise goods (petroleum products, tobacco, alcohol). Thus improvement in 2004 is explained by administrative measures. Collection of customs duty was considerably better compared to other taxes on imports in terms of projected figures. The GEL 11.3 million collected were 110 per cent of target. However, there was a reduction of 2 per cent over the year.

GEORGIAN ECONOMIC TRENDS – 2004 No2 19 GOVERNMENT FINANCE

The overall picture of tax collection can be summarised as follows. A sharp rise in direct taxes and excise duty is offset by a decline of customs duty receipts. Apparently efforts of the new administration were more effective in some areas than in others. Excise duty is being collected from a relatively small number of companies that makes administration easier. The source of the rise for indirect taxes is not clear from available data. As for VAT, it seems that there is a strong resistance from the side of enterprises to report transactions subject to VAT to their full extent as this tax directly affects prices and hence competition. The task of the new administration of Georgia is to concentrate on institutions, building up a taxpayer culture and removing tax induced price distortions.

Before political changes in Achara, there were problems with transfers of collected amounts to central budget. In Q1 2004, about GEL 9.4 million central budget funds were collected in Achara and were not transferred to respective central accounts. In the whole of 2003, these amounts were about GEL 55 million. This problem was resolved after political changes in Achara region. Besides these changes, the system for accounting of public revenues has changed since April 5, 2004. Under new arrangements all public revenues are directed to and distributed from a single treasury account. National Bank is no longer responsible for accounting of budget funds. Regional treasury accounts and separate accounts for customs are eliminated.

The highest growth in budget receipts was observed in non tax revenues. The GEL 60.4 million received under this category was 150 per cent higher compared to 2003 data. Non-tax revenues mainly consist of National Bank profits, repayment of state credit, dividends of state owned enterprises, privatisation of land, revenues from economic activities, administrative fees and penalties.

Own revenues of special state funds were 40 per cent higher compared to Q1 2003 and made up 97 per cent of target. However collection of social taxes which contribute to social security fund has improved to a lesser extent compared to collection of personal income tax. Generally these taxes have a similar tax base. The discrepancy can be explained by the fact that data on actual revenues are presented excluding social contributions of organizations financed by state budget. Revenues of the Roads Fund of GEL 8.9 million, were 96 per cent of planned amount, while the growth indicator was 37 per cent.

High rate of employers’ social contributions (31 per cent) is regarded as a major obstacle in legalization (contractual registration and reporting to tax structures) of labour relations in Georgia. Combined with income tax and employees’ social contributions, about 40 per cent of employers’ cost of labour does not reach the employee. Thus, there is a strong incentive to avoid registration and reporting of hired employment. The situation is complicated by the fact that social contributions are not being accumulated for individual employees and regardless of the amount of their reported salaries, they will be entitled to low pensions. Consequently, employees have little motivation to have registered employment. The draft tax code proposed by Ministry of Finance for consideration reduces both income and social taxes. Income tax is supposed to be reduced to 12 per cent and social tax to 20 per cent. Other principal features of the current draft are: reduction of VAT rate to 18 per cent abolition of some low income taxes and new administrative part of the tax code. Administrative part more precisely defines possible tax violations and penalties. This measure together with reduction of tax rates is intended to improve tax compliance. This draft is supposed to be passed by the Parliament in Autumn 2004 and will enter into force from 2005.

Box 3.1

OECD Study Shows Tax Wedges Continue to Fall

20 GEORGIAN ECONOMIC TRENDS – 2004 No.2 GOVERNMENT FINANCE

Tax wedges on labour, or the difference between what employers pay out in wages and social security charges and what employees take home after tax and social security deductions, are falling in many OECD countries, helping to reduce a major obstacle to job creation and people's willingness to work.

The tax wedge for a typical married production worker with two children, measured as a percentage of the overall cost to the employer, has declined over the last seven years by about one and half percentage points across the OECD's 30 member states.

Ireland saw the biggest fall in the tax wedge from 1996 to 2003, with a reduction of 18.3 percentage points, followed by Hungary (9.9 percentage points), the United States (8.3 percentage points), Italy (8.2 percentage points) and the United Kingdom (7.0 percentage points). However, in a number of countries the tax wedge increased over the period, with Iceland seeing the biggest increase, at 9.5 percentage points, followed by the Slovak Republic (7.1 percentage points), and Turkey (3.8 percentage points).

Most OECD countries continue, for example, offer significant benefits to married couples with children compared to single earners (see Table Below). And a comparison between the tax rates imposed on various levels of income shows all OECD countries taking account of the individual’s ability to pay in fixing the levels of taxes on.

Based on 2003 figures, the tax wedge for a single worker with average earnings was highest in Belgium (54.5 percent), followed by Germany (52.0 percent), and lowest in Korea (14.1 percent), followed by Mexico (17.3 percent). For a one-earner married couple with two children at the same earnings level, the tax wedge ranged from 42.1 percent in Turkey and 41.3 percent in Poland to 7.4 percent in Ireland and 8.9 percent in Iceland. On average, the tax wedge for a single production worker on average earnings represented 36.5% of labour costs, compared with 26.9% for a one-earner married couple with two children.

Household Tax Wedge in 2003 (as a % of total labour costs equivalent to the average production worker)

Country Single person One earner family Absolute Difference relative without children with two children Difference to the burden of single person Australia 28.3 20.4 -7.9 -27.9 Austria 45 29.5 -15.5 -34.4 Belgium 54.5 39 -15.5 -28.4 Canada 32.4 23.3 -9.1 -28.1 Czech Republic 43.8 30.6 -13.2 -30.1 Denmark 42.7 30.1 -12.6 -29.5 Finland 44.5 37.8 -6.7 -15.1 France 48.3 40 -8.3 -17.2 Germany 52 33.5 -18.5 -35.6 Greece 34.3 34.3 0 0 Hungary 45.7 30.5 -15.2 -33.3 Iceland 29.3 8.9 -20.4 -69.6 Ireland 24.5 7.4 -17.1 -69.8 Italy 45.3 35.5 -9.8 -21.6 Japan 27 23.2 -3.8 -14.1 Korea 14.1 13.6 -0.5 -3.5 Luxembourg 31.7 9.6 -22.1 -69.7 Mexico 17.3 17.3 0 0 Netherlands 43 33.7 -9.3 -21.6 New Zealand 20.6 20.4 -0.2 -1 Norway 36.8 27.6 -9.2 -25 Poland 42.9 41.3 -1.6 -3.7 Portugal 32.6 23.7 -8.9 -27.3 Slovak Republic 41.4 32.3 -9.1 -22 Spain 37.6 30.9 -6.7 -17.8 Sweden 46.6 39.5 -7.1 -15.2 Switzerland 29.2 17.8 -11.4 -39 Turkey 42.1 42.1 0 0 United Kingdom 31.1 18.3 -12.8 -41.2 United States 29.4 15.5 -13.9 -47.3 Unweighted Average 36.5 26.9 -9.6 -26.3 The tax wedge reflects Income tax plus employee contributions less cash benefits plus employer social security contributions.

GEORGIAN ECONOMIC TRENDS – 2004 No2 21 GOVERNMENT FINANCE

Source: www.oecd.org OECD

In Georgia like Greece Mexico and Turkey there is no difference between wage taxation of a single person without children and a one earner family. Actual tax burden in Georgia for person with GEL 200 salary per month is 39 per cent.

STATE BUDGET DEFICIT In Q1 2004 the state budget deficit was financed by GEL 24.4 million. From this amount, GEL 1.6 million was obtained by privatization of state property. There was no need for National Bank credit during the period under concern. GEL 22.8 million was borrowed from other sources including treasury bills and credits from international financial organizations.

STATE BUDGET EXPENDITURES State budget expenditures in Q1 2004 amounted to GEL 321.8 million. The figure shows a 26 per cent increase over government spending of the corresponding period of 2003. A breakdown of State Budget expenditures by function is provided in table below:

Table ?? State budget expenditures by function Q1 2003 (GEL million) Per Per Growth cent in cent in over the 2004 total 2003 total year General Government 81.2 25.2 47.3 18.5 171.6 Defence 24.2 7.5 11.8 4.6 205.6 Law and order 30.7 9.5 17.1 6.7 179.0 Education 13.4 4.2 9.2 3.6 146.5 Health care 1.8 0.6 1.4 0.6 126.6 Social Security 76.6 23.8 62.4 24.4 122.8 Housing 1.0 0.3 0.6 0.2 155.6 Culture sports religion 5.8 1.8 5.2 2.1 110.7 Energy 0.1 0.0 17.2 6.7 0.7 Agriculture 3.5 1.1 2.0 0.8 174.3 Construction and mining 0.2 0.1 0.1 0.0 200.0 Transport and communications 10.2 3.2 9.4 3.7 109.0 Other economic activities 0.7 0.2 0.5 0.2 152.8 Other 72.4 22.5 71.0 27.8 101.9 Total 321.8 100.0 255.181 100.0 126.1 Source: Ministry of Finance; GET calculations

The largest item of government spending was on General government which accounted for 25.2 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 of GEL 52 million. Growth over the year was 70 per cent here; GEL 81.2 million in Q1 2003 against GEL 47.3 million in Q1 2002. The second largest expenditure item was social security. Growth here was 22.8 per cent. From this amount, GEL 55.4 million was spent on purchase of goods and services, while GEL 21 million were transfers of a social nature.

22 GEORGIAN ECONOMIC TRENDS – 2004 No.2 GOVERNMENT FINANCE

Government spending under the category “Other” makes up 22.5 per cent of state budget expenditures. GEL 72.4 million was spent under this heading; a 1.9 per cent growth over the year. The amount is mainly comprised of interest payments on state debt of GEL 38.1 million (11.8 per cent of budget expenses), subsidies and current transfers to lower level budgets of GEL 21.5 million and principal payments of foreign debt of GEL 12.6 million.

Other functional categories were each less than 10 per cent of total expenditures. The highest growth was in financing of defense, law and order, agriculture and construction, respectively 105, 79, 74 and 100 per cent. Growth figures for education, health care, housing and other economic activities was higher compared to average growth of budget expenses, while growth for all other categories was lower than average. Expenditure figures for forthcoming quarters will bring more definite picture of government priorities. Breakdown of state budget expenditures by economic category is provided in the Table below.

Table ?? State Budget Expenditures by economic category. Q1 2003 (GEL million) Expenditure Per cen Expenditure Per cen s 2004 t in total s 2003 t in total Total 321.8 100 255.2 100 Salaries 47.1 14.6 21.2 8.3 Social contributions 8.5 2.6 7.6 3.0 Business trips 1.6 0.5 1.1 0.4 Other goods and services 89.4 27.8 63.5 24.9 Interest payments 38.1 11.9 47.4 18.6 Subsidies and current transfers 61.1 19.0 65.1 25.5 Capital Expenditures 11.2 3.5 9.6 3.8 Program expenses 0.0 0.0 0.0 0.0 Net lending 64.8 20.1 39.6 15.5 Source: Ministry of Finance; GET calculations

Other goods and services were purchased for GEL 89.4 million compared to GEL 63.5 million spent in 2003. This made up 27 per cent of budget expenses. About two thirds of the amount was spent for social security needs. Growth of 40.8 per cent under this category was higher than the average growth of budget expenditures. 19 per cent of state budget expenditures were subsidies and current transfers. Total GEL 61.1 million spent under this category was 6 per cent lower compared to corresponding period of previous year. Transfers ware mainly of a social nature (transfers to local budgets and the social security fund). 20 per cent of state budget expenditures comes on Net Lending category. GEL 64.8 million was spent and this was 63 per cent higher compared to 2003. From this amount 52 million were for programmes financed by international financial institutions, while GEL 12.6 million was spent on repayment of state debt . Interest payments were GEL 38.1 million and made up 11.9 per cent of total state budget expenditures. The amount was 20 per cent lower compared to interest paid in Q1 2003. Salaries of state employees were GEL 47.1 million, 120 per cent higher compared to previous year, however the growth rate of social contributions paid by state as an employer was only 11.7 per cent. This reflects the fact that the state was not always paying social contributions corresponding to paid salaries. The share of salaries in state budget expenditures increased from 8.3 per cent to 14.6 per cent over the year. This reflects the efforts of new administration in the reorganization of state institutions.

GEORGIAN ECONOMIC TRENDS – 2004 No2 23 GOVERNMENT FINANCE

Law on state Budget 2004 was passed by the parliament on 11 may 2004. Revenue side of the budget law is increased by 53 per cent compared to actual performance of 2003, while budgeted expenditures are 57 per cent higher. The new budget is in line with broad parameters discussed with international financial institutions and is regarded as sound. Detailed figures on budgeted revenues and expenditures for 2004 are provided in Annex 3.3

24 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER FOUR: MONEY AND FINANCE

The Government’s measures toward improved tax discipline resulted in increased demand for the Lari. The market responded, appreciating the nominal exchange rate of the Lari, which became a serious challenge for the money market. Within the free float exchange rate the NBG had to avoid dramatic fluctuation of the Lari exchange rate and prices. In Q1 2004 the NBG successfully used various monetary instruments to maintain a certain level of liquidity and kept exchange rate and prices stable.

MONETARY INSTRUMENTS

In the first quarter of 2004 the NBG managed the money supply using various monetary instruments. During Q1 2004, T-Bills remained one of the main sources of budget deficit financing even with the absence of the 2004 Budget. As of the April 1st, 2004 there were GEL 38.5 million outstanding in T- Bills repayable by May 19th. The net budget financing was GEL 19.5 million in Q1 2004 – twice more than in Q1, 2003 (GEL 8.4 million).

During Q1 2004, 12 T-Bills auctions were held, with total demand for GEL 133.9 million. GEL 55 million were placed. 8-12 commercial banks participated in those auctions. As of April 1st, there were GEL 93.4 million T-Bills in circulation. The Figure 4.1 shows the structure of T-Bills holders.

Figure 4.1: Structure of T-Bills holders in Q1 2004.

NBG Individuals 4% 10%

Companies 29%

Banks 57%

Source: National Bank of Georgia

The weighted average annual interest rate in Q1 2004 was 26.11 per cent which was significantly less than in Q1 2003 (34.35%). The structure of the holders indicates that banks dominated in Q1 2004. As it was mentioned in previous GET issues, the higher the share of bank investors and the lower that of non-bank ones, the lower the interest rates bid. The secondary market activity increased in Q1, 2004. There were 94 deals with total amount of GEL 15.9 million, while in Q1 2003 the total turnover was GEL 8.8 million.

During Q1, 2004 three Repo auctions were held with total amount of GEL 4.6 million. The NBG did not purchase T-bills. The MoF repaid GEL 1.4 million of those issued in 2003. As of April 1st GEL 4.4 million were outstanding and repayable for April 21st.

In Q1 2003, the NBG did not provide commercial banks with loans as a lender of last resort. But the NBG purchased liquidity from banks withdrawing money from circulation. During Q1 2004, reacting to

24 GEORGIAN ECONOMIC TRENDS – 2004 No.2 MONEY AND FINANCE the increased demand for the Lari, the NBG had to fulfil one of its central bank’s functions as a lender of last resort. There was a necessity to provide the financial market with additional of money to avoid dramatic fluctuations of exchange rate and prices. Therefore the NBG sold on the credit auctions GEL 8.2 million that was 45.56 per cent of the total turnover. During Q1, 2004 there were 5 7-days auctions held and 14 28 –days credit auctions. In this way commercial banks are able to maintain their short-term liquidity. The average interest rates fluctuated from 16 per cent for 7-days credit to 20 per cent for 28 credits.

Commercial banks widely used overnight deposits placed with the NBG during Q1 2004. The NBG offset excess liquidity using this new instrument and providing commercial banks with an alternative to operations with foreign exchange. As of April 1st, 2004 GEL 5.3 million were withdrawn via overnight deposits placed with the NBG with 2 per cent annual interest rate.

MONEY SUPPLY

Figure 4.2: Money Supply, December 2001 – March 2004

1,200,000

Depos its in f oreign currenc ies M3 GEL deposits 1,000,000 Currency outside commercial banks

800,000 d n a

ous 600,000 h M

L t 2 E G M0 400,000

200,000

0 D Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan- Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan- Feb Mar ec- 02 03 04 01

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

Following the increased demand for the Lari, foreign exchange reserves of the NBG grew in Q1. 2004. The NBG purchased USD 22 million from commercial banks through TICEX. Besides it received a USD 6.9 million BIS1 grant. The foreign exchange reserves grew by USD 20.2 million and were equal to 1.92 months of imports. During Q1 2004, the Net International Reserves increased by USD 30 million and as of April 1st, 2004 were USD 120 million, that was by USD 34 million more than targeted.

In Q1 2004, Net Domestic Assets decreased by GEL 56.6 million mainly at the expense of falling in Net Claims on Government. NCG fell by GEL 42.7 million since the Government covered its current obligations and decreased its net claims.

As of April 1st 2004, the Net Claims on Banks were GEL 8.2 million, that was the outstanding debt for the NBG’s loans issued through the credit auctions.

1 Bank for International Settlement

GEORGIAN ECONOMIC TRENDS – 2004 No.2 25 MONEY AND FINANCE

The loan issued by the German bank KfW to the energy sector was the main component of the Net Claims of the Economy. So that the repayment of a portion of this loan resulted in the decreasing of the NCE by GEL 6.3 million.

One can assume that the improvement in Budget revenues , the trade balance, external financing and direct foreign investments resulted in growth of money on the commercial banks’ correspondent accounts with the NBG (by 29 per cent). It caused the M1 growth by 2.4 per cent in Q1 2004.

The NBG absorbed USD 22.7 million through TICEX putting more Lari into circulation. Besides, the NBG converted USD 6.9 million received by the MoF as an external financing. Money in circulation was sterilised via debts service provided by the MoF (GEL 30.2 million). As of April 1st, 2004 GEL 5.3 million was withdrawn via overnight deposits placed with the NBG. As the result of all of that the increase of money demand did not have an inflationary effect on the economy since money in circulation fell by 1.5 per cent.

Deposit liabilities of commercial banks grew by 10.8 per cent in Q1 2004. Deposits in the national currency grew by 34.5 per cent and in foreign currency by 7 per cent. The difference between M2 and M3 growth became less than during previous periods. They grew in Q1, 2004 by 3.6 and 5.4 per cent respectively. However, these changes did not have any effect on M2 and M3 money multipliers which shown the same picture as during previous periods.

Table 4.1: Monetary Ratios 2002 2003 2004 Dec Dec Jan Feb Mar Dollarisation Ratio % 84.9 86.1 85.5 81.8 83.2 Money Multiplier (M2) 0.91 0.91 0.92 0.94 0.92 Money Multiplier (M3) 1.70 1.83 1.94 1.89 1.88 Source: GEPLAC calculations based on data provided by the National Bank of Georgia

BANKING

The banking system in Georgia is still characterised by low capitalisation while loans remain the major source of income. But it should be noted that some banks have been successfully improving and enlarging their services and that has positively affected their business.

Crucial factors for the development of a sound banking system in Georgia are improvement of banking supervision and financial sustainability of commercial banks. In line with harmonisation of Georgian banking legislation with that of the EU and further development of the commercial banking system, the NBG increased the minimum paid-in capital up to GEL 12 million2. According to the NBG’s order of 13th January, 2004 all newly established banks including foreign banks branches shall have paid-in capital of GEL 12 million. For already established banks this requirement should be fulfilled by 31st December, 2008 according to a special schedule.

As of April 1st 2004, there were 23 commercial banks including two branches of foreign banks. The license of a large bank operating on Achara was suspended by the NBG. The bank represented 5.3 per cent of the total assets, 6.3 per cent of the total liabilities and 8.1 of the total deposits. It resulted in the decreasing of the total banking capital as of the end of March 2004.

A limited issuing of the Lari into circulation, as well as its weakness as a measure of savings and capital accumulation, caused the high level of commercial banks’ dollarisation of both assets (83 per

26 GEORGIAN ECONOMIC TRENDS – 2004 No.2 MONEY AND FINANCE cent) and liabilities (66 per cent). It indicates that the national currency still plays only a weak role in money creation. It is reflected in low (less than 1) M2 money multiplier ratio.

Loans comprise 54 per cent of the banks’ assets. Meanwhile credits issued in Q1 2004 decreased by 7 per cent, compared with the end of the previous year. This could be explained by a fall in business activity caused by reaction to the anti-corruption measures. Deposits represent the largest share of banks’ liabilities (75-80 per cents).

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 the end of March 2004, six commercial banks accumulated 81 per cent of the assets, 86 per cent of the liabilities and 85 per cent of deposits. As a result of the increasing of banks’ capital and assets the quality of banking services should improve. These banks have enlarged their branch networks and the types of banking services. They introduced client services based on new banking technologies and provide internal settlement in real time.

DOMESTIC INFLATION

Table 4.2: Monthly Consumer Price Index and Inflation, 2003- 2004 Q1 (December 2002 = 100) Price Index Inflation from previous month 2003 Jan 102.10 2.1 Feb 101.59 -0.5 Mar 101.59 0.0 Apr 102.10 0.5 May 102.30 0.2 June 102.40 0.1 July 101.48 -0.9 Aug 101.38 -0.1 Sep 101.89 0.5 Oct 101.89 0.0 Nov 106.78 4.8 Dec 106.99 0.2 2004 Jan 107.42 0.4 Feb 107.85 0.4 Mar 107.96 0.1 Source: State Department for Statistics and GEPLAC calculations.

Improved tax and customs discipline was the one of the main achievements of Georgian authorities in Q1 2004. Businesses had to put legalised taxes and duties into prices of goods. That created price growth in Q1. But the strengthening of the Lari in nominal terms offset price growth for imported goods. As a result of that the CPI grew insignificantly in Q1 2004. (More detailed data provided in the Statistical Appendix table A4.4).

2 The corresponding EU Directive foresees EURO 5 million.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 27 MONEY AND FINANCE

DOMESTIC FOREIGN EXCHANGE MARKET

The budget developments became a key factor influencing the domestic foreign exchange market in Q1 2004. During that period, measures against corruption and for the improvement of tax discipline were implemented. It resulted in improved tax revenues collection. On the other hand, the 2004 Budget was not approved; thus there was no plan for spending. The accumulated amount was placed on the Government deposits and was not put into circulation. Moreover, about USD 6 million was received as Baku-Tbilisi-Ceyhan pipeline investment and required conversion into the national currency. Moreover, there was a short-term reaction of some importers to the anticorruption measures which resulted in declining imports. Being limited and sensitive, the domestic foreign exchange market responded to that by growing demand for the national currency and decreasing demand for foreign currencies. Some market players expected the further appreciation of the Lari until the new Parliament elections (March 28th 2004) and started purchasing the major currencies3 for low prices for further deals after the elections. All of that could explain the nominal appreciation of the Lari in Q1 2004. Analysing all of that, one could say that the improvement of the budget discipline will be a new and crucial factor determining a supply and demand equilibrium of the Georgian currency in the nearest future. Expectations of the market players will probably play a weaker role.

Figure 4.3: USD/GEL and EUR/GEL Nominal Exchange Rate, Q1 2004

1.5000

1.7000 USD/GEL EUR/GEL 1.9000

2.1000

2.3000

2.5000

2.7000

2.9000

4 4 4 4 4 4 4 04 04 04 04 ,0 ,0 04 04 04 04 ,0 04 04 04 04 ,0 ,0 04 04 04 04 ,0 04 04 04 04 ,0 04 1, 1, 1, 1, 1 1 1, 1, 1, 2, 2 2, 2, 2, 2, 2 2 2, 3, 3, 3, 3 3, 3, 3, 3, 3 3, ,0 ,0 0 0 ,0 ,0 ,0 0 0 0 ,0 ,0 ,0 0 0 ,0 ,0 ,0 0 0 0 ,0 ,0 ,0 0 0 ,0 ,0 1 9 3, 5, 4 8, 0, 3, 7 1 3, 8, 7 2, 5, 0, 6 8 3, 5, 1 0 0 1 1 17 22 2 2 3 0 05 0 1 1 1 20 25 2 0 0 1 12 1 1 2 2 27 3

Source: National Bank of Georgia

As the result of the greater demand on the market, the Lari’s nominal exchange rate appreciated notably. The maximum nominal appreciation (official USD/GEL 1.9000 and market USD/GEL 1.8800) was on 6th and 10th of March. Maintaining a free floating exchange rate, the NBG however intervened trying to avoid drastic fluctuations on the market. During Q1, 2004 the NBG purchased USD 27.6 million via TICEX (plus some small amounts in other currencies). It was clear that the issuing of liquidity could create the danger of non-absorption, with an inflationary effect in the future. Thus the NBG’s authorities provided a public explanation of the current developments to prevent any panic on the market. It resulted in the depreciation of the nominal exchange rate of the Lari (up to 2.0700 on April 13th) but new T-Bills issued renewed demand and the Lari appreciated in nominal terms to (2.0000 by the end of April). It should be noted that a nominal appreciation of the Lari could make

3 Hereinafter the USD and the Euro

28 GEORGIAN ECONOMIC TRENDS – 2004 No.2 MONEY AND FINANCE

Georgian exports more expensive and less competitive. But more a serious consequence could be a falling of income and public consumption as a large part of Georgian population receives transfers from abroad.

The following box provides a summary of the European Central Bank’s assessment of developments in the Euro Zone as of the beginning of May 2004. This reports a decision to keep interest rates unchanged in May 2004, which continued in June. We should note, however, that central banks around the world, including Australia, the UK and the most recently the US Federal Reserve (June 30) are beginning to raise rates again to anticipate inflationary pressure.

Box: 4.1

Overview of Recent Economic Developments of the Euro Zone. On the basis of our regular economic and monetary analyses, the ECB continues to expect that price stability will be maintained over the medium term. Accordingly, the ECB did not change its assessment of the monetary policy stance and left the key ECB interest rates at their current low levels. The low interest rates across the entire maturity spectrum are also supporting the economic recovery in the euro area. As always, the ECB will continue to monitor carefully all developments that could affect our assessment of risks to price stability over the medium term.

Regarding the current situation and the very short-term outlook, the conjectural indicators available still provide mixed evidence. All in all, they suggest that the recovery of real economic activity in the euro area has continued into 2004, albeit at a modest pace. Most recent information has been more encouraging, with the latest Euro area survey data offering more positive signals with regard to the beginning of the second quarter.

While the latest positive signals need to be confirmed by future developments, they underpin the expectation of the gradual recovery in the euro area continuing and strengthening over time. The conditions for such a recovery are in place.

First, global economic growth continues to be robust and world trade has strengthened. The global economic upturn is broadly based, both geographically and across sectors, and thus provides a favourable external environment for the Euro area. In this context, the ECB expects the Euro area exports to grow significantly this year and next. Second, favourable financing conditions, improvements in corporate efficiency and earnings and the strength of global demand should help investment. Growth in real disposable income should support private consumption, especially since households appear not to face financial constraints that might impede stronger spending. Over time, consumer spending should also be supported by an improvement in labour market conditions.

These considerations underpin the confidence in a continuation of the economic recovery, an expectation which is mirrored by available forecasts and projections. It is also in line with financial market developments over the past few weeks. Obviously, any forward-looking assessment is subject to risks and uncertainties. On the external side, the adverse terms-of-trade effects of recent rises in oil and other commodity prices pose risks at shorter horizons, while the persistence of global imbalances implies some uncertainties over the medium term. On the domestic side, uncertainties surrounding fiscal policy and structural reforms in some euro area countries seem to have contributed to preventing a more vigorous improvement in consumer confidence. A continued commitment to and greater clarity about the content and timing of these crucial reforms, supported by a better understanding of their necessity and benefits for all citizens, would help to resolve this uncertainty and thereby mitigate the associated risks for the euro area economy.

Turning to price developments, annual HICP inflation rates will exhibit some short-term volatility over the coming months, as the ECB already indicated on the occasion of previous meetings of the Governing Council. According to the Eurostat’s flash estimate, annual HICP inflation was 2.0% in April, after 1.7% in March. While no detailed information is available as yet, the recent rise in annual inflation rates is likely to mainly reflect a strong base effect in the energy component resulting from the marked decline of oil prices a year ago. Moreover, recent oil price increases have exerted additional

GEORGIAN ECONOMIC TRENDS – 2004 No.2 29 MONEY AND FINANCE upward pressure. As these factors will also play a role in the next few months, inflation rates of 2% or somewhat above are possible over the short term. Despite these recent, less positive developments, over longer horizons the ECB expects inflation rates to remain in line with price stability. In particular, wage developments should remain moderate. The latest data on wage growth in the fourth quarter of 2003 lend support to this view.

The outlook for price developments is in line with available forecasts and projections. However, at the current juncture, the increase in commodity prices in general, and oil prices in particular, may pose an upside risk to price stability. It will therefore remain important to pay close attention to inflation expectations.

Moving on to the monetary analysis, annual M3 growth has moderated only slowly since the summer of 2003. While there is evidence of continued portfolio shifts out of M3 into longer-term assets, the pace of this adjustment remains modest. Both monetary and credit growth continue to be supported by the historically low level of interest rates in the Euro area and may also reflect the improvement in the economic environment over the last few quarters.

Given the continued strength of monetary growth, liquidity conditions remain ample in the euro area. The impact of this high level of liquidity on inflation over the medium term will depend on future developments in the economy and financial markets. Should excess liquidity persist, it could lead to inflationary pressures over the medium term.

To sum up, the economic analysis indicates that the main scenario for the outlook for price developments over the medium term is in line with price stability. Cross-checking with the monetary analysis does not alter this view at the current juncture.

With regard to fiscal policies, the Governing Council sees increased reasons for concern. On the basis of the latest Commission forecasts, the average euro area budgetary position is not expected to improve much this year or next. A growing number of countries are likely to report significant imbalances, while fiscal consolidation efforts might fall short of commitments. It is essential that all countries concerned undertake credible measures to address these concerns. Such measures should be part of a comprehensive reform strategy. This would underpin the ongoing economic upswing by boosting confidence in sound public finances and by improving the prospects for future economic growth. The Governing Council welcomes the decision by the Commission to request more consolidation efforts from a number of countries.

Turning to structural reforms, the Governing Council reaffirms its view that such reforms are essential if the euro area’s growth potential is to expand substantially. In particular, both the employment rate and the labour productivity growth need to increase significantly. It should be stressed that this requires a strengthened technological and scientific base and its application in the Euro area as a whole, fostered by major efforts to enhance the human capital of the economy. In this context, there is some concern that youth unemployment remains high in several countries. In order to achieve these goals, it is necessary to strengthen the implementation of structural reforms, both at the European and the national level.

Source: Introductory statement to the press conference. Jean-Claude Trichet, President of the ECB, Helsinki, 6 May 2004

30 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER FIVE: INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

In Q1 2004, registered external trade turnover was equal to USD 427.2 million, of which exports were USD 98.6 million and imports USD 328.6 million. The figures suggest that the growing negative trade balance trend continued during Q1 2004. Exports in USD increased by about 34 per cent compared with the O1 2003, while imports increased by 45.6 per cent reflecting needs for imported goods for construction of BTC, mainly tubes and pipes. Such significant growth in exports is a result of legalization of export flow and continuing GDP growth during Q1. The export coverage of import ratio decreased in Q1 2004 to 30 per cent, while in the Q1 2003 the ratio was 32.6 per cent.

After EU enlargement, the extension of the EU-Georgia Partnership and Cooperation Agreement (PCA) to the new Member States will mean that goods cleared at the first point of entry into the EU will be in free circulation throughout its whole territory without any further transit or other duties related to the new Member States. Enlargement extended the EU's trade policy regime to the acceding countries. The previous system, featuring a single trade regime for the EU and a different regime for each of the candidates, will disappear. A single set of trade rules, a single tariff, and a single set of administrative procedures will apply not just across the existing 15 member states but across the enlarged Union of 25. This will greatly simplify the dealings that third country operators have within Europe.

TRADE TURNOVER, TRADE BALANCE AND DIRECTION OF TRADE According to the SDS data, during Q1 2004 recorded external trade turnover was equal to USD 427.2 million, of which exports were USD 98.6 million and imports USD 328.6 million. The figures above suggest that the growing negative trade balance trend continued during Q1 2004. Exports in USD terms increased by about 34 per cent, while imports increased by 45.6 per cent, reflecting needs for imported goods for construction of BTC, mainly tubes and pipes. Such significant growth in export is a result of legalization of export flow and continuing GDP growth during Q1. The export coverage of import ratio decreased in Q1 2004 to 30 per cent, while in the Q1 2003 the ratio was 32.6 per cent.

Figure 5.1: Registered Exports, Imports and Trade Balance, 1995 –2003 (USD thousands) 600

400

200

0 199 199 199 199 199 200 200 200 200 -200 5 6 7 8 9 0 1 2 3

-400

-600

-800

-1000

-1200 Trade Balance export import

Source: Data from the State Department for Statistics

GEORGIAN ECONOMIC TRENDS – 2004 No.2 31 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

The share of the ten main trade partners in the total registered trade turnover was about 73 per cent. As indicated in Table 5.1, the main partners in Q1 of 2004 were Russia, Turkey, UK, Azerbaijan and USA. These countries together represented about 50 per cent of Georgia’s registered trade turnover.

Table 5.1: Registered International Trade Turnover and Direction of Trade, Q1 2004 (USD thousands) International Trade Turnover Export (FOB) Import (CIF) Trade Turnover

USD Per cent USD Per cent USD Per cent

Total 98,660 100 328,604 100 427,264 100 Main partner countries (total) 79,071 80.1 234,342 71.3 313,413 73.4

Russia 15,731 15.9 56,527 17.2 72,258 16.9 Turkey 23,016 23.3 30,799 9.4 53,815 12.6 UK 4,450 4.5 30,231 9.2 34,680 8.1 Azerbaijan 1,894 1.9 24,392 7.4 26,286 6.2 USA 7,920 8.0 16,812 5.1 24,731 5.8 Ukraine 2,610 2.6 21,700 6.6 24,311 5.7 German y 1,140 1.2 21,448 6.5 22,588 5.3 France 2,812 2.8 18,180 5.5 20,991 4.9 Armenia 9,947 10.1 8,265 2.5 18,211 4.3 Switzerland 9,551 9.7 5,990 1.8 15,541 3.6 Others 19,589 19.9 94,262 28.7 113,851 26.6 Source: State Department for Statistics

During Q1 2004, CIS and EU accounted for 70 per cent of Georgia’s registered imports. Turkey accounted for another 9 per cent. Imports from USA were relatively small.

Figure 5.2: Georgia’s Registered imports by regions, Q1 2004

Others 21% CIS CIS (including Russia) 38% EU Turkey Turkey 9% Others EU 32%

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 23 per cent of Georgian exports. The EU’s share was about 15 per cent.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 32 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

Figure 5.3: Georgia’s Registered exports by region, Q1 2004

Others 24% CIS CIS (including Russia) 38% EU

Turkey

Turkey Others 25% EU 15%

Source: State Department for Statistics

COMPOSITION OF REGISTERED EXPORTS

The overall composition of Georgia’s recorded exports shows that the share of 10 product groups represented about 67.6 per cent of all registered exports during Q1 2004. Export of ferrous waste and scrap (HTS chapter 7204) is on the leading position with a value of USD 18.6 million. In comparison with the same period of the previous year, this item increased by USD 6 million. The export of ferrous waste and scrap goes to Turkey. Export of ferroalloys (HTS chapter 7202) represented 10.3 per cent of all exports with a value of USD 10.1 million.

Beverages and spirits (HTS chapter 22) are the second most important export items. This chapter includes, wine from fresh grapes and waters, including natural or mineral. Exports of wine (HTS chapter 2204) was equal to 8.2 million USD. The export of military aircraft and its parts and export of gold (HTS chapter 7108) during Q1 2004 was almost zero, due to the greatly reduced production. Other main export items are: mineral waters, ferroalloys, copper ores and concentrates, mineral fuels, mineral and chemical fertilizers. Table 5.2 indicates main registered export items according to the Harmonized Commodity Description and Coding System (HTS).

Table 5.2: Composition of registered exports according to the Harmonized Commodity System By HTS 2-digit categories, Q1 2004

USD Per cent thousands Total exports 98 660 100 Ferrous waste and scrap: ingots of iron or steel-7204 18 382 18.6 Ferroalloys –7202 10 130 10.3 Wine of fresh grapes, including fortified wines -2204; 8 234 8.3 Copper ores and concentrates –2603 5 457 5.5 Petroleum oils and oils from bituminous minerals, crude –2709; 5 286 5.4 Wheat -1001 5 030 5.1 Waters, including natural or artificial mineral waters- 2201, 2202; 4 915 5.0 Mineral or chemical fertilizers, nitrogenous –3102. 4 794 4.9 Aluminum waste and scrap -7602 2 244 2.3 Ethyl alcohol -2208 2 173 2.2 Other 32 015 32.4

Source: State Department for Statistics

GEORGIAN ECONOMIC TRENDS – 2004 No.2 33 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

Box 5.1 Trade and Enlargement

Ten countries joined the EU on 1 May 2004: Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia. From their day of accession, the new member states apply the EU's Common Commercial Policy in its entirety, including the Common External Tariff, EU preferential trade agreements, WTO commitments and EU trade defense measures. They also adopt internal market rules and benefit from the four freedoms set out in the Treaty.

Why is this good for third countries' businesses? Are there any mechanisms to ensure that the interests of third countries' businesses are respected?

Third countries will fully benefit from enlargement

An even larger market than before With a population of almost 455 million and a GDP of around €9,231 billion, the enlarged EU will account for some 19% of world trade and be the source of 46% of world outward FDI and host to 24% of inward FDI. The current European Union is already the largest single market in the world. There are no internal borders between the Member States and the harmonisation of regulations and standards ensures a freer circulation of goods and services than is possible within some countries. Enlargement will extend these characteristics to the acceding countries. Third countries will benefit from an increased single market and a simplified and enhanced access to the new acceding countries' markets.

A single set of rules for business Enlargement will extend the EU's trade policy regime to the acceding countries. The current system, featuring a single trade regime for the EU and a different regime for each of the candidates, will disappear. A single set of trade rules, a single tariff, and a single set of administrative procedures will apply not just across the existing fifteen member states but across the enlarged Union of twenty-five. This will greatly simplify the dealings that third country operators have within Europe.

A very open economy with a high standard of rules For trade in goods the new member states will have to adopt the Community Common Customs Tariff (CCT) upon accession. The average weighted industrial tariffs of the acceding countries are in general higher than the 3.6% average for the EU; the same applies to agricultural tariffs. Thus, in most cases, third countries' business will benefit from lower tariffs in their trade with new member states.

In the case of services third countries' services providers will benefit from the implementation of the single market in acceding countries, where they will get the same treatment as in the rest of the EU.

For investors the very high standards of treatment currently afforded by investors in the EU will be applicable throughout the enlarged Union. The national treatment provisions for inward investors as set out in the Treaty of Rome will be extended to the new Member States. For instance, the right of establishment and free movement of capitals entrenched in the Treaty will be applicable to all companies of the new Member States.

As regards technical regulations and their impact on the openness of an economy, the "one standard for all" principle of the single market will be extended to the acceding countries with the obvious advantages to third country suppliers. The advantages in terms of trade facilitation will accrue for the exporters of the third countries with which the Community has concluded mutual recognition agreements (or MRAs) as regards their exports to the new Member States.

Beyond the simplification of procedures, enlargement will bring a range of immediate and tangible economic benefits to third countries. These will arise out of the acceding countries adopting the same open standard of treatment of third countries which the current EU applies.

There are some sectors where the European Union maintains some limited quantitative restrictions with third countries, notably in the cases of textiles and steel. Although the new member states will apply these restrictions as of their accession, the effect on third countries will be limited. Indeed, WTO rules foresee that all textiles and clothing quotas shall be phased out by 31 December 2004. As far as steel is concerned, the two EC

GEORGIAN ECONOMIC TRENDS – 2004 No.2 34 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS agreements which foresee quotas run until 31 December 2004 and would disappear if the countries concerned joined the WTO before then.

Third countries will receive enhanced levels of intellectual property rights (IPR) protection in the acceding countries due to their adoption of EU directives in this field upon accession. The Europe Agreements already contain an obligation for the acceding countries to join the relevant international conventions in this area and bring levels of IPR to a similar level to that afforded in the EU.

At present no candidate country is a member of the WTO's Government Procurement Agreement (GPA). Upon accession, all will have to apply the EC directives on public procurement, which go beyond commitments in the GPA. In terms of the direct impact on market access for third countries, the application of EU public procurement rules, especially directive 93/38 which opened up procurement in the water, energy, transport and telecom sectors, will bring major benefits. Likewise for subsidies: new member states' subsidies will be brought within EU rules, which are in line with OECD and WTO disciplines. Once again this will benefit third countries by imposing stricter standards than the rules currently applied by the candidate countries. With accession, the new member states will lose their transition economy status and with it the right to obtain exemptions from WTO subsidies disciplines through the use of Article 29 of the Subsidies Agreement.

The EU will fully discharge all its obligations under WTO rules. The integration of new Members into the EU will contribute to the expansion of world trade. Should other WTO Members having initial negotiating rights in bindings being modified or withdrawn estimate that they are negatively affected, they can seek compensation according to WTO rules. The EU has in the past and will in the future fully discharge its obligations under the relevant WTO rules. In the field of trade in goods the GATT allows WTO members to submit claims for compensation in cases where in a given tariff line enlargement leads to an increase in the applicable bound duty. If substantiated, WTO rules foresee bilateral negotiations to agree to appropriate compensation following enlargement. A comparable compensation mechanism exists in the GATS, i.e. for trade in services.

Source: European Commission, Brussels

COMPOSITION OF REGISTERED IMPORTS

During Q1 2004 Imports were dominated by mineral products. Despite the fact that a significant share of Georgian imports was not recorded, the figures demonstrate that Georgia’s dependence on foreign energy continues. The import of petroleum gases, oils, and electrical energy together represented about 16 per cent of total recorded imports. Table 5.3 shows the largest imported product groups that together constituted about 44 per cent of total imports in Q1 2004.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 35 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

Table 5.3: Composition of registered Imports according to the Harmonized Commodity System By HTS 2-digit categories, Q1 2004 USD Per cent thousands Total imports 328604 100 Petroleum oils and oils from bituminous minerals (other than crude) 28360 8.6 – 2710 Petroleum gases -2711 24586 7.5 Electrical energy – 2716 18285 5.6 Motor cars and other motor vehicles- 8703 17789 5.4 Medicines –3004 17277 5.3 Wheat -1001 10504 3.2 Tubes and pipes - 7305 7524 2.3 Electric generating sets and rotary converters -8502 6778 2.1 Machines and mechanical appliances 6602 2.0 Sugar -1701 6213 1.9 Other 184686 56.2 Source: State Department for Statistics

Some reflections on the impact of EU enlargement on trade relations between Georgia and Acceding countries

As is well known, 10 Central and East European countries became full members of the European Union in May 2004. At the same time, bilateral trade and economic agreements with these countries will be terminated and the EU treatment in trade will start to apply to these countries. These 10 new members will join the Georgian Partnership and Co-operation Agreement (PCA).

Naturally, this gives rise to the question: what effect the accession of these 10 countries will have with regard to Georgian exporters.

The recent trend shows that the share of trade with the 10 Newly Acceded Countries in the total volume of Georgian trade is rather small. During this last period, trade with these countries has been on downtrend. For instance, in 2000 the share of Georgian exports to all the ten countries in the total volume of Georgian exports accounted for 2.1 per cent, in 2001 it was 1.8 per cent, in 2002 – 1.2 per cent and, according to the data for 2003, it made up just 0.8 per cent. A similar trend could be observed with regard to imports. Georgia exports to these countries strong and soft drinks, pharmaceutical products, nuts, iron, canned products in small quantities. The share of these products in total exports is insignificant. For instance, in 2003 wine exports totaled USD 36 million while the Newly Acceded Countries accounted for 2 per cent of the wine exports.

The accession of these countries is likely to facilitate the access of Georgian exports into these countries rather than make it more difficult and to encourage a significant growth in exports in future. Arguments in favor of this perception are considered below:

Until now, Georgia has enjoyed the Generalized System of Preferences (GSP) with only 4 of these 10 countries (Czech Republic, Slovakia, Poland and Estonia). The system would differ from country to country and has had no effect on real exports, and what is more, with Estonia and Poland there was a reduction in the volume of exports. With the completion of the accession procedure, the 10 Newly Acceded Countries will extend the European GSP scheme to Georgia and hence, ensure a better

GEORGIAN ECONOMIC TRENDS – 2004 No.2 36 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS access to the European market for the Georgian exporters. Thus, Georgia will enjoy the GSP treatment with 6 more countries instead of four. At the same time, for Georgian entrepreneurs it is always more convenient to have and to apply a common GSP system rather than to use several systems. The Generalized System of Preferences, by using a classical instrument of trade policy such as tariffs, is traditionally an independent instrument of trade policy, promoting trade. This system offers lower customs tariffs to developing countries against those for the developed countries, providing the preferential treatment for the access of their exports to the EU markets. The GSP helps accelerate the process of industrialization of developing countries, diversification of exports and hence, growth of export gains.

With regard to Georgian trade with the EU under the GSP system, it should be noted that a certain upward trend could recently be observed. In 2000, a Georgian export into the EU was USD 70.4 million and the GSP treatment was granted with regard to goods in the value of USD 18.5 million. By 2003 Georgian exports had grown to USD 76 million and the value of exports under the GSP was USD 42 million. The GSP utilization rate grew from 25.4 per cent in 1997 to 50 per cent in 2003. The number of “A” certificates of origin required for the utilization of preferences within the GSP had correspondingly increased and reached 526 in 2003 against 363 in 2000.

The continuing low rate of GSP utilization is accounted for by a lack of awareness of the system among Georgian entrepreneurs. It is also noteworthy that the system is applicable only to the so- called “non-sensitive” category of products. The GSP should be extended so as to cover fully the category of “sensitive” goods as well, which implies all the products competing with those produced in the EU.

To this end, a Special Incentive Arrangement was introduced in 1998, under which countries carried out progressive environmental and social policies and were granted additional tariff preferences. In view of the social policy, this implies a number of issues to be taken account of when setting basing conditions. These include: prohibition of child and forced labour; safety and healthcare regulations; maximum amount of work hours; and the extent of freedom of labour organizations.

What Georgia needs is these additional preferences, which would obviously be beneficial for the growth of Georgian exports to the EU and the Newly Acceded Countries, as well. Since 2000, the Georgian Government has been engaged in negotiations with the European Commission on granting special incentive arrangements for the protection of labour rights providing for the current customs tariffs reduction within the GSP. This would give Georgia another 5 per cent on average, however no tangible result has yet been achieved, whereas some of the former soviet republics, such as Moldova for instance, have been applying this system since 2000. It should also be noted that Georgia fulfilled its obligation and joined the convention of the International Labor Organization (ILO). This was ratified by the Parliament in 2003.

We find it reasonable for Georgia to activate its diplomatic endeavor so as to be as soon as possible granted additional preferences within the GSP that would enhance the competitiveness of Georgian exporters and increase access to the EU market for the Georgian products. Should the referred special incentives be made available, even with the present trade volume, this would give Georgian businessmen no less than € 1 million p.a. of additional preference. According to expert evaluation, this would increase Georgian exports to the EU states by at least 20 per cent, facilitating FDI flow to Georgia and also growth. The exports of ammonia fertilizer, nuts, beverages, iron products, canned foods, silicomanganese and other products to the EU would be the most likely to grow.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 37 INTERNATIONAL TRADE AND FOREIGN ECONOMIC RELATIONS

As concerns trade in wine, it is one of the largest exports of Georgia. In 2003, recorded wine exports reached US 36 million dollars. Notably, the Georgian wine exports are increasingly growing. However, this sector is largely dependent on the Russian consumer market. The target countries for the Georgian wine exports in 2003 were Russia (75 per cent), the Ukraine (10 per cent) and the USA (4 per cent). The share of 10 Newly Acceded Countries was insignificant and would not exceed 2 per cent approximately.

However, after the accession of these countries into the EU, the Georgian wine exports are likely to grow and particularly to the Baltic countries and Poland. Georgian exporters had certain problems on the EU market but these have been eliminated. In January 2004, negotiations between representatives of the General Directorate for Agriculture of the EU Commission and the Georgian side concluded with the completion of the process of formal recognition of the Georgian wine by the EU. From now on Georgian wine producers can export wine to the EU market in unlimited quantities. To do so Georgian entrepreneurs will have to present Certificate VI1. This Certificate VI1 is a document issued in a third country containing a detailed specification of the wine in question intended for the entry to the EU market. Georgian exporters will also need to observe certain rules (for instance, labels) regarding trade in wine in the EU, which is not considered to be a big problem.

Exports of Georgian natural and mineral waters have a great potential both in the 10 Newly Acceded Countries and the rest of the Europe. Although there is much to be done, particularly, it will require formal recognition by the EU of the mineral and natural waters of the third country (here, of Georgia) as in case with the Georgian wine.

Proceeding from the above, it could be concluded that granting the EU treatment to the 10 Newly Acceded Countries and extending the PCA application with regard to them will create favorable conditions for the enlargement of economic relations of Georgia with these 10 States and the entire European Union, as well as for the intensification of the process of integration.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 38

CHAPTER SIX: PRIVATISATION

The first quarter of 2004 in Georgia was remarkable in terms of political developments and structural changes in the government bodies. On 4th January, Mikheil Saakashvili was elected President of Georgia. In February, a new cabinet of ministers was appointed by the Parliament. On March 28th new parliamentary elections took place. Also in March tensions started between the central government and autocratic leader of the Autonomous Republic of Achara. Later, these tensions resulted in the peaceful displacement of the leadership of the Autonomous Republic. All these events left little room for implementation of privatisation of state property. A Department of Privatisation created in the Ministry of Economics, Industry and Trade, following the abolition of the Ministry of State Property Management (MSPM) in 2003, and dealing with the privatisation issues, has been experiencing structural and staff changes. This process considerably slowed down privatisation of state enterprises. The political developments and plans of the new Government to present to the Parliament new draft laws and changes in legislation also put potential investors in a waiting position.

While the privatisation process of small enterprises showed some progress in the first quarter of 2004, there was no news in privatising medium and large enterprises (MLE). 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.

However, it seems that developments will take a new pace since the new Government is planning to attract foreign investors and create a more favourable environment for business in the country. A prominent Georgian businessman (operating in Russia) Kakhi Bendukidze was appointed a new Minister of Economy. He accepted the offer during the business forum held for Russian businesses in Tbilisi. The Minister has expressed his determination to push forward the privatisation process of Georgian state enterprises. 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. The new President and his team are determined to combat corruption and consequently the privatisation process is likely to become more transparent.

MEDIUM AND LARGE ENTERPRISE PRIVATISATION Privatisation of MLEs that are still in state ownership remains a problematic issue. In the first quarter of 2004 there were no actual privatisation cases of MLEs. This was mainly due to the political situation in the country. As of 2003, the number of the medium and large enterprises approved for establishing as JSCs has remained unchanged at 1,4261. The total number of medium and large enterprises actually established as joint stock companies reached 1,377. The highest numbers of both approved and actually incorporated state enterprises are in the Agriculture and Food sector.

The experience of the last 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 aggravate the situation. It is obvious that in terms of privatisation of the MLEs some serious steps and measures need to be taken.

At the initial stage it is necessary to clearly establish 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.

1 The updated information as of 2004 is not available yet due to the transformation process of the MSPM.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 39 PRIVATISATION

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 have been liquidated yet. In some of them rehabilitation programmes are 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. However, the rehabilitation in the above mentioned cases so far has been more oriented to prolongation of the functioning of the assets. The enterprises are not being rehabilitated in a way to become efficient and consequently to attract investors. 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.

SMALL ENTERPRISE PRIVATISATION The privatisation of small enterprises in Georgia started in 1993. Figure 6.1 shows the dynamics of the small enterprise privatisation by year. The largest numbers of enterprises were privatised in 1995, when the Georgian economy started to stabilise and in 1998, when the largest zero reserve price auctions were held. Since then it seems that privatisation is approaching its end because the amount of available entities is diminishing. 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.

Figure 6.1: Small Privatisation

3000 2500 2000 1500 1000 500 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Ministry of State Property Management

40 GEORGIAN ECONOMIC TRENDS – 2004 No.2 PRIVATISATION

Despite the political developments that took place in the first quarter of the 2004 privatisation of small enterprises still achieved some success. As shown in Table A.6.1 of the Statistical Appendix, as of March 2004, 14,117 small enterprises had been approved for privatisation and 17,680 small enterprises have been actually privatised2 since 1993. In 2004, 109 small enterprises were privatised. Due to reorganisation of the privatisation offices in the regions the information is not complete and the Department of Privatisation still expects the number of privatised small enterprises to grow. The difference between the total numbers of actually privatised and approved for privatisation small enterprises indicates that many of them split during the privatisation process. The increasing number of the small enterprises approved for privatisation suggests that many of them had been parts of MLEs and became independent units after restructuring of the latter.

Most small enterprises are in the trade and service sectors - 32 and 46 per cent respectively. The regional breakdown given in the Table A.6.1 of the statistical appendix, shows that the majority of small enterprises are privatised in Tbilisi. A certain number of enterprises were privatised in all regions of Georgia during 2003. In the Autonomous Republic of Achara the privatisation process has 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.

Water Supply and Sewage System On June 28th the Tbilisi municipal Government cancelled the results of the tender that awarded management of Tbilisi water utility to the French Compagnie Generale des Eaux. One major reason cited by the mayor for annulling the tender was that at the time it was held “an appropriate climate did not exist for conducting legal business and for attracting foreign investors”. Other reasons were: the lack of information about the tender and concerns of the population of Tbilisi; reconsideration of receiving a new credit from the World Bank, due to the increasing budget revenues; and time deficit for municipal authorities to study the matter in more detail.

A tender to transfer JSC Tbiltskalkanali (Tbilisi Water Utility) into management by leasing was announced year 2001. JSC Tbiltskalkanali is 100 per cent owned by the Tbilisi Mayor’s Office and was to be transferred into management for 10 years. To facilitate the rehabilitation of this sector the WB was to allocate a credit worth USD 25 million. The credit was for 35 years and had a grace period of 10 years with interest at 0.75 per cent per annum. The credit allowed the water tariff to remain unchanged in the beginning of the reform.

To participate in the tender a company had to have 5 years experience of providing service to 1.5 million customers, an annual turnover not less than USD 50 million and qualified personnel. Five companies passed the pre-qualification phase of the tender and participated in the bidding process. The unsealing of bids took place on 15th January 2003. Compagnie Generale des Eaux (France) was the only company, which had submitted a proposal. The tendering commission evaluated the technical and financial proposals of the company and finally in September declared the proposal successful.

According to the proposal Compagnie Generale des Eaux was to pay a fix amount of GEL 20,000 per month for leasing. Customer tariff should not been changed for the first three years of operation and in the fifth year it should have been equal to the operator’s tariff. The leaseholder was to carry out

2 The total number of small enterprises, including those not approved for privatisation, is not available. Small enterprises are those with a book value of less than USD 44,000 on April 1st 1993.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 41 PRIVATISATION rehabilitation of the parts of water supply system that are urgent and the implementation of which will have maximal immediate positive effect on its operation. The company was planning to introduce metering of the water resources, which is crucial for payment collection, in two years. The company also planned to carry out water quality control.

As for the structural and staff changes, the company was going to employ the entire personnel of Tbilisi Water Utility engaged in the operation and maintenance of the system. It is important to note that today the total number of personnel is 2,800. Even though the enterprise is overstaffed, according to the conditions of the contract, the leaseholder company had no right to lay off personnel during the first year of lease. The company could offer financial compensation to those employees who would agree to leave. However, starting from the second year of lease the company could lay off excessive workforce without compensation. The company was also to undertake training programmes for the staff.

Since the new municipal authorities abolished the tender, they have to deal with the problems existing in JSC Tbiltskalkanali for the time being. The means to rehabilitate the most malfunctioning parts of the water supply system and to ensure its more or less stable operation should be found. Otherwise the cancellation of the tender results will do nothing but retard the revitalisation of the enterprise and consequently aggravate water supply in the capital.

Energy There was no progress in privatising the assets of the energy sector in the first quarter of 2004. The Ministry of Energy is drafting a short-medium term action plan to drag the system out of crisis. The plan is to be implemented in 18 months. Successful implementation of the action plan will enable further development of the system. The plan will consist of specific measures to be taken to ensure stable operation of the system after which the future development strategy could be set.

The Ministry of Energy of Georgia has identified two main aspects of energy policy as priorities for the future development of the sector – Energy Security and Self Sustainability. The goal is to create a profitable industry, which in future will not depend on further funding from either central budget and/or IFI’s. Also the Government’s objective is to ensure the most efficient use of internal resources and diversification of possible supply points of energy into the country.

In order to rehabilitate and improve the functioning of the system and reduce the risk of systemic collapse to an acceptable level, a considerable amount of investment is needed; therefore the Government would like to complete preparations and negotiations with the IFIs/donors. In the draft action plan the Government reaffirms its commitments to the timely and successful completion of IFI/donor programmes underway to rehabilitate the electricity generation and delivery infrastructures, and pledges to do its part in supporting these organizations during the term necessary for internally generated revenues to become available from the Georgian distribution sector. In particular, the Government will ensure that budget organisations pay their electricity bills on time, in cash, and in full.

In order to address the issue of historic debt, which continues to drain the financial and management resources of the major state-owned companies, the Government of Georgia fully supports the establishment of a formal Debt Resolution Agency, as well as legislation that will prohibit financial attacks on critical energy entities, while such an Agency is being established.

Improvement of payment collection rates will enable the energy companies to generate more income to improve their quality of service and security of supply. Therefore, metering and payment discipline in the sector are top priorities of the Ministry. The action plan includes installation of gas and

42 GEORGIAN ECONOMIC TRENDS – 2004 No.2 PRIVATISATION electricity meters first at wholesale units and further for individual customers. 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 is completely different with distribution company UDC and in the gas sector. Accurate metering will provide a clear picture of electricity and gas consumption in general, and also serve as the most powerful enforcement mechanism of the Ministry of Energy to fight against corruption and to identify defaulters.

The draft action plan also includes modification of legislation and structural reforms. The Government will strengthen the legislation that confirms the criminal nature of electricity theft, and ensure that the legislation is enforceable and effective. In addition to modification of legislation, the Government plans to take measures to change the consumer mind-set and foster an understanding and appreciation of the fact that energy supplies cannot be maintained if payments are not made to cover the cost; and that theft of energy, either directly or through non-payment, is a crime.

In terms of structural reforms the action plan envisages a merger of Georgian Wholesale Electricity Market (GWEM) and Georgian State Electricity System (GSE) (to give GSE responsibilities of GWEM) and creation of common responsible body for reaching equilibrium of supply and demand of electricity sector. The structural reform also includes transferring substations (switchyards) to the transmission company GSE. At the same time, control over dispatch of the stations will be transferred to GSE. Further, to obtain operational efficiency, the low voltage network, substations, and transformers will be transferred from GSE to United Distribution Company (UDC) within UDC’s territory. Some structural reforms are expected in the gas sector as well. Namely, it would be most appropriate to separate high-pressure gas pipeline operator from the policy maker in gas supplies.

According to the action plan, the Government will request the Georgian National Energy Regulatory Commission (GNERC) to develop service standards and to publish monthly performance data. The data will provide the population, businesses and public administration with information about the regularity and quality of supplies and other parameters relating to the performance of the sector’s entities. The Government will ensure that the power distribution companies that provide service for less than 24 hours per day will publish in local newspapers their weekly forecasted supply schedule. The Government will launch a major public relations campaign to explain the current state of the power sector and give a realistic picture of how service will improve over time. It will also specifically prepare the population for the expected service levels for the coming winter.

The Government plans to introduce international accounting standards (IAS) for the power sector utilities (and other utilities and companies).

The prolongation of the management contract for the UDC of PA Consulting is under consideration. The company has to achieve significant progress to become attractive to the investors, otherwise it would be difficult to sell or transfer it into management. UDC was created on the basis of grouping of state regional electricity distribution companies and PA Consulting was awarded an interim management contract for 18 months. The Georgian National Energy Regulatory Commission is expected to revoke 26 distribution licenses of companies that operate inside the territory of UDC.

The Ministry of Energy is preparing the privatisation process of the electricity generator companies. The actual privatisation is scheduled for 2005; however preparatory work has started. This includes grouping of the assets into lots, which will make the assets more attractive for the investors. For example, 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

GEORGIAN ECONOMIC TRENDS – 2004 No.2 43 PRIVATISATION and to sell it. Currently TBILGAZI has technical and commercial losses of approximately 75 per cent of consumed gas.

It seems that the Government is fully committed to solving the severe problems in the sector, and the successful implementation of the action plan will lead to a sustainable, financially viable energy sector.

Privatisation of large companies in Georgia is still in the future. In many spheres services were provided predominantly by public sector. Taking into account the planned reforms, the Government may introduce the model of public-private competition. Box 6.1 gives some guidelines which can assist the Government in successful implementation of this model.

Box 6.1

Quick Guide to Competitive Neutrality and Managed Competitions

Increasingly, when governments decide to contract out services, in-house units are also given the opportunity to bid for providing the service. This model of public-private competition is often referred to as "managed competition." It has brought competition to many jurisdictions where public services had long been the exclusive domain of public monopolies, but increasingly, private providers are crying foul, arguing that the playing field is often tilted against them in public-private competitions.

For managed competition to be an effective tool to cut costs and increase efficiencies, an ample supply of private firms must be eager to bid against the public sector for the opportunity to deliver public services. This requires that the potential bidders be confident that the playing field will be level.

What Is Competitive Neutrality?

Competitive neutrality means designing a set of policies and legal arrangements ensuring that all individuals and organizations - public, for-profit, and non-profit - are treated in an equal manner in the bidding process. To the extent possible, all protections and special privileges that public units usually enjoy over private firms simply by virtue of public-sector ownership should be removed, as should barriers that hamper the public-sector unit's ability to increase productivity and therefore effectively compete with the private sector.

To create a level playing field in a managed competition, the government must do many things that are not necessary if the service is contracted out only to private entities, including: determine the fully loaded costs of in- house service; build a firewall between the government as purchaser and the government as service provider; and make transparent any differences between the public and private bids.

Governments often do a poor job of ensuring competitive neutrality. Anti-competitive practices include: failing to fully cost out in-house services; requiring excessive performance bonds from private firms; rejecting lower bids from private firms; and permitting in-house teams to adjust their bids or proposals after seeing the private bids.

Needed: A Uniform Template for Managed Competition

When designing a managed-competition programme, public officials should strive to ensure as much equality as possible for each component of the procurement process, ranging from determining current in-house costs to defining the consequences of performance failure. While it may not be possible to have absolute equality in each area, governments should strive to get as close as possible.

Currently, there are no real guidelines that lay out how governments should conduct fair public-private competitions. The result is that the rules of the game vary from city to city, county to county, and state to state (sometimes the rules even change during the course of individual procurements). The following guidelines can assist governments in achieving a level playing field in managed competitions.

44 GEORGIAN ECONOMIC TRENDS – 2004 No.2 PRIVATISATION

Costing the Public-Sector Bid • Bring in an objective third party to determine the department's true costs. • Extend competition as completely as possible into the department. • Allocate to the target department or service a portion of the overhead costs, based on its use of overhead support. • Include depreciation costs, interest expenses on borrowed funds, and the cost of hiring outside consultants in any calculation of total costs.

Sealed Bids • Subject in-house bidders to the same requirements concerning sealed bids as private bidders.

Subsidies • Any subsidy should be available to both the in-house unit and external providers. • Qualifications • Public units should not be automatically pre-qualified in the competition process. • Consider the varying qualifications, technical, and managerial expertise of both public and private bidders when awarding the contracts.

Risk Valuation and Allocation • Examine the issue of risk before embarking on a managed-competition project. • Value and include in the public bid any risk allocated to the private sector in a transaction.

Performance Guarantees • Establish provisions for loss sharing (as well as gain sharing) for the public units. • Apply sanctions if the public team fails to achieve the service levels agreed upon at the promised price. • Do not permit the in-house unit to bid in the next round if it exceeds its bid by some threshold amount. • When possible, avoid requiring a performance bond from private bidders.

Preparing the In-House Units for Competition • Give maximum flexibility to in-house units to re-engineer their operations. • Don't set an arbitrary time period for re-engineering in-house operations and commencing a competition, but as a general rule, the period should be as short as possible and no more than two years.

Bidding on External Contracts • Either prohibit or restrict in-house units from bidding for outside contracts in areas where a commercial market exists. • If you choose to allow external bidding, do not provide the in-house units with any funding for capital or additional personnel that would be used for beefing up their operations for fulfilling outside contracts.

Using Consultants • Use separate consultants to manage the competition process and assist the in-house team in preparing its bid.

Unnecessary Requirements • Avoid saddling the contractor with government wage and benefit mandates.

Public-Private Joint Ventures • Research the legality of public-private joint ventures. • Allow both partners to share in the risks and rewards, but make sure the taxpayers are protected from any loss. Creating the Right Institutions for Competitive Neutrality • Organizationally split the government as purchaser from the government as provider. • Give managers the flexibility to decide whether managed competition is appropriate on a case-by-case basis.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 45 PRIVATISATION

• Consider transforming winning public-sector bidders into corporatized or commercialized organizational forms.

If managed competition is to become a major tool for driving change and increasing efficiency in the public sector, then governments must do a better job of creating a level playing field between public and private bidders. By following the set of common sense guidelines laid out above, governments at all levels can maximize the benefits of competition and minimize charges of unfair favouritism or discrimination from private and public bidders alike.

Source: www.privatization.org The Reason Foundation, Reason Public Policy Institute

46 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER SEVEN: LABOUR MARKET, INCOMES AND THE SOCIALSAFETY NET

LABOUR MARKET The labour market situation 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, the overall picture is flawed by persistent underemployment, widespread hidden and disguised unemployment and salaries falling way below the minimum subsistence level. 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. Most of the working age population is either underemployed or non-employed. New stable jobs are rarely created. 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.

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 lot 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 Q4 2003 (the latest available sets of figures), compared to a year before, fell by 1.2 percentage points to 10.7 per cent, while the unemployment rate calculated by the “loose” methodology fell by 1.9 percentage points to 13.1 per cent. The gap between the two measurements of unemployment rate in 2004 compared to a year before, therefore, fell by 0.7 percentage points, that might suggest that more people were engaged in active job search. While the anecdotal evidence does not suggest any better job opportunities on the labour market, it is apparent that there was more hope of finding a job on the part of the unemployed, that was reflected in the figures discussed above.

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 – 2004 No.2 47 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET

Table 7.1: Economic Status, Q1 2000 – Q4 2003 (thousands) 2002 2003 Q I Q II Q III Q IV Q I Q II Q III Q IV Total population over 15 years old 3, 016 3, 033 3, 021 2, 971 3, 082 3, 060 3, 132 3, 134 Total economically active population (labour force) (1) 1, 912 1, 983 2, 003 1, 945 1, 941 2, 037 2, 120 2, 103 Total economically active population (labour force) (2) 1, 983 2, 036 2, 063 2, 015 2, 025 2, 095 2, 170 2, 160 Employed 1, 659 1, 742 1, 768 1, 713 1, 679 1, 805 1, 897 1, 877 Hired 625 598 597 607 594 604 640 637 Self-employed 1, 028 1, 141 1, 168 1, 102 1, 083 1, 200 1, 255 1, 240 Unemployed (1) 254 241 236 232 262 233 223 226 Unemployed (2) 324 294 296 303 345 290 273 283 Total population outside the labour force (1) 1,103 1,050 1,017 1,026 1,141 1,023 1,002 1,028 Total population outsde the labour force (2) 1,033 997 957 956 1,057 965 952 971 Unemployment rate (per cent) (1) 13.3 12.1 11.8 11.9 13.5 11.4 10.5 16.7 Unemployment rate (per cent) (2) 16.3 14.4 14.3 15.0 17.1 13.9 12.9 13.1

Labour force participation rate (1) 63.4 65.4 66.3 65.5 63.0 66.6 67.7 67.1 Labour force participation rate (2) 65.7 67.1 68.3 67.8 65.7 68.5 69.3 68.9 Self-employment share in total labour force 53.7 57.5 58.3 56.6 55.8 58.9 59.2 59.0 Self-employment share in total employment 62.0 65.5 66.1 64.3 64.5 66.5 66.2 66.1 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 Household Survey were those for Q4 2003. For a more detailed table and 1998-2003 figures see Statistical Appendix Table A7.1.

Changes in the gap between the “strict” and “loose” measurements of unemployment applied by the ILO point to “labour market flows” that is one of the key indicators of the labour market used by the ILO and shows “migration” into and out of the labour force. Showing the difference between the numbers of those actively looking for a job and those who are not, rather than just changes in the number of employed, unemployed and those outside the labour force, “labour market flows” can serve as an indicator of the capability of the labour market to absorb unemployed rather than “produce” them. Therefore, the bigger the gap between the two measurements, the more people are outside the labour force. The more people outside the labour force, and the fewer people economically active, the lower will be the ILO “strict” standard unemployment rate calculated from the smaller base of the labour force number. For the low indicators of the unemployment rate to be real signs of improving trends in the labour markets, the participation rate should be at least stable, or growing. At the same time, a persistently large gap occurs where there is usually long-term unemployment and unstable insecure jobs when many people, in the light of dim employment prospects, are not even actively looking for job any more and others do not start looking for a job immediately after losing one.

The unemployment rate was lower both in Q4 2003 and during 2004 than that of a year before and the labour force participation rate was slightly higher, which implies that more people joined the active job search, thus returning to the labour force. The figures also suggest that while economic situation urged some of those formerly outside the labour force to make attempts to return to active participation in the labour market, not many of them were successful. However, if the lower unemployment rate was not due to technical changes preconditioned by the new methodology of the integrated survey in 2003 only, one can assume that employment trends improved, even if only slightly.

The labour force participation rate grew by 1.6 percentage points in annual terms to 67.1 per cent in Q4 2003. This is a quite high indicator, though in line with the last years’ trend. The growing participation rate, may be a reflection, apart from demographic changes in the working age population, of various processes: when an extremely hard household income situation urges those outside the labour force to start job search, when better prospects of finding a job emerge on the labour market

48 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET that affect the decision of the former “discouraged” workers to actively engage in job search again, or when both factors are involved. Given the slightly improved unemployment figures for 2003 (see table above) on the one hand, and anecdotal evidence of persisting grave household budget situation on the other, one can assume that this is the case when the labour force participation rate grew due to the both factors mentioned above. And last, but not least, symbolic pensions and pension arrears making pensioners engage in whatever activity they can find also contribute to growing participation rate and a reduced, if only slightly, unemployment rate.

While both the unemployed and the “discouraged” workers outside the labour force are virtually “non- employed”, and stand a high risk of poverty, optimistic employment and participation rate figures can also conceal a frequent incidence of underemployment, low remuneration, an overwhelming agricultural subsistence self-employment and a large number of pension age workers, who have to work to compensate for their token pensions.

In line with the usual trend, in 2003, the urban unemployment rate was not comparable to the rural one: 22.1 and 26.1 respectively by the “strict” and “loose” standards. The rural unemployment rate, as always, was supernaturally low and distorted the national figures – at 4.1 per cent by the ILO “strict” methodology and 5.4 per cent, by the ILO “loose” methodology. The existing Law on Employment artificially 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 puts majority of rural dwellers under the category of employed. In addition, many of those living in the 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.

Having said that the rural unemployment rate is usually over 5 times lower than the urban one and almost 3 times lower than the national one, one has to say as well that over half of the rural unemployed fall under the category of “discouraged” workers, which means that most of those country dwellers who neither have a job, nor a plot of agricultural land in the family, are not even looking for job, as such job search would be definitely in vain. The vast majority of the rural population comprises elderly people, and younger people migrate to cities in search of some employment. While some of them manage to find at least some kind of job and sometimes even 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.

Registered unemployment at 48,600 accounted for over 20 per cent of the “strict” measured and 16 per cent of the “loose” measured unemployment as of the end of Q3 2003 (48,700 as of end of 2003). For the majority jobless the registration procedure is not worth going through in order to be eligible for the monthly GEL 14 (approximately USD 6) paid as benefit, while the chances of finding a job through registration remain minimal.

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, the unemployed are especially at risk both from an economic and social point of view, and prolonged periods of unemployment bring

GEORGIAN ECONOMIC TRENDS – 2004 No.2 49 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET 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 tackled with policy measures and programmes aimed at raising the employability of the long-term unemployed and reintegrating them into the labour market.

EMPLOYMENT Slow growth and lack of job creation in the formal sector find their reflection in a declining trend in the numbers of wage and salaried workers and a rise in self-employment and the numbers of unpaid family workers. Employment and the labour force both remain dominated by self-employment that accounted for 66.1 per cent of the former and 59 per cent of the latter in Q4 2003. Being on the upswing, self-employment has been dominated by agricultural self-employment, almost 82 per cent in 2003.

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 poor. While poverty in the countryside is more associated with a lack of cash income, urban poverty involves insufficient food supply and undernourishment.

In marked contrast to expanding self-employment, hired employment has been shrinking (see table above), that is primarily preconditioned by poor job creation in the private sector due to an unfavourable business climate, and the contraction of the state sector, that still accounted for over 66 per cent of dependent employment in 2004. As of end of the year, wage and salary earners accounted for 34 per cent of total employment. Although the proportion of dependent (or hired) employment in total employment has been on a downwards trend for several years already, it was still largely perceived as a conventional “permanent employment”. However, 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.

Since the state sector was still the main supplier of waged and salaried jobs, and civil servants occupied over half of such jobs, the downward trend of hired employment is likely to continue at least in the short term, as staff cuts in Q1 2004, associated with reorganisation of the State Chancellery into the Cabinet of Ministers and those at the ministries are likely to be followed by more loss of jobs by civil cervants, as part of the Government’s endevour to optimize the effectiveness of governmental bodies. 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.

Overwhelming self-employment indicates a worsening 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 57 per cent of

50 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET those employed are the working poor, of which 28 per cent are rural unpaid family workers, almost 18 per cent are employees at budgetary organisations and another 11 per cent are non-agricultural own-account self-employed.

Widespread part-time employment, mostly involuntary, indicates the manner in which people attempt to adjust to downward labour demand choosing to accept short-time work rather than not to work at all. The patterns of employment are changing towards part-time employment and temporary employment. Time-related underemployment3 relates to the number of employed persons “whose hours of work in the reference period are insufficient in relation to a more desirable employment situation in which the person is willing and available to engage”4. So called “external groups” including agency or firm temporaries, outsourcing, subcontracting and casual workers, i.e., short-term workers, represent quite a substantial share of hired employment, indicating labour underutilisation. Part-time workers are more vulnerable from the point of view of their employability, since their career prospects and their competitiveness on the market are restricted. Much of the part-time and temporary work is involuntary and tends to be poorer quality employment rather than full-time work in respect of pay, benefits, security and access to on-the-job training.

Figure 7.1: Employment characteristics of the population over 15 years old, Q3 2003

Employee in Outside of state sector labour force 13% 34% Employee in private sector 6%

Self-employed Unemployed 39% 8%

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.

In line with the general trend of recent years, as of end of Q4 2003, 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 34 per cent (see pie-chart above). Compared to a year before, in Q4 2003, the share of hired employees (employed in state sector and private sector taken together) shrank by 1 percentage point to 19 per cent. In contrast, the self-employed category showed a corresponding increase by the 2 percentage points. This could mean that loss of jobs in dependent employment had to be offset by engaging in self-employment. Jobs were lost not only in the state, but also in the private sector that reflects the instability of private businesses. It is likely that

3 A resolution concerning the measurement of underemployment and inadequate employment situations, adopted by the 16th International Conference of Labour Statisticians, Geneva, 1998 calls it “visible underemployment”. 4 “Key Indicators of the Labour Market 2001-2002”, ILO

GEORGIAN ECONOMIC TRENDS – 2004 No.2 51 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET 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 (78 per cent) were civil servants, and, as mentioned above, their number is to be further reduced. Salaries of the majority of them have been low and irregular, and effectively oblige them seek additional income to support the family. The share of the unemployed (ILO “strict” standard) and those outside the labour force remained unchanged over the year, and the overall pattern of the economic status of the working-age population has been basically stable in recent years.

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 is 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. Hidden and disguised unemployment are widespread and growing long-term unemployment leads to the downsizing of the labour force, and, hence to 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 is to be 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.

SALARIES AND WAGES The average monthly nominal salary of hired employees across the economy was GEL 108 in Q4 20035, according to the SDS Integrated Household Survey figures. The share of the average monthly salary in the minimum subsistence of a family of four was almost 46 per cent.

About 52 per cent of all waged and salaried workers – budgetary organisations6 employees – were earning on average GEL 77.9 per month in Q4 2003. Employees of public enterprises and organisations, accounting for almost 14.5 per cent of hired workers, were paid GEL 119.3 per month on average in Q4 2003. Monthly remuneration of another category of wage and salary earners (about 29 per cent), private sector employees, was GEL 138.9 on average. Another 3.7 per cent of hired workers, those working in foreign organisations or joint ventures, had a monthly salary of GEL 241.7 on average.

Salaries of public sector employees (66 per cent of hired workers) as well as remuneration of the majority of private sector employees remain predominantly way below the subsistence minimum. 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. Instances of non-payment of salaries are frequent, resulting in building up budgetary arrears, and the growth of salaries in real terms is eroded by inflation.

5 At the time when this issue of GET was being written, the latest available Integrated Household Survey figures were those for 2003. 6 A budgetary organisation is a public organisation fully financed by the state budget.

52 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET

MINIMUM SUBSISTENCE LEVEL According to the SDS, the official minimum subsistence, calculated basing on the old methodology, introduced in early 1990s, was GEL 119.4 for an average consumer in Q4 2003, GEL 136 for a working man, and GEL 236.7 for an average family of four. (It was respectively GEL 118.9, GEL 135.5 and GEL 235.8 in Q1 2004). A new methodology has long been ready at the SDS and until recently it used to publish it as an “alternative” minimum subsistence7. 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 are closer to the average salary levels in the economy, i.e., are much lower than the “official” level.

As the data from the SDS integrated survey suggests, in Q4 2003, the average remuneration of only 3.7 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 33 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 14.5 per cent (employees of public enterprises) added to the aforementioned 33 per cent, i.e., 47.5 per cent were paid almost about the minimum subsistence for an average consumer (that is a non-working consumer). The average monthly remuneration of 52 per cent of waged and salaries workers was way below even that level, and the flat rate pension rate paid nationwide accounted for almost 17 per cent of the level for an average consumer. Subsisting on GEL 236.7 (about USD 125) 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 SAFETY NET The vast majority of the population, including informal sector employees, the self-employed and the unemployed, 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 importance.

Social policy and reforms are among the top government priorities. Reform of the pension system, provided for by the national Economic Growth and Poverty Reduction Programme (EGPRP), has already started, and is aimed at introducing a sustainable multi-pillar pension system, based on insurance principles.

Currently, the three main existing forms of social assistance for the vulnerable (except certain healthcare programmes) are state social allowance, unemployment benefit and the flat rate pension. The State Social Allowance for vulnerable families is targeted at households comprised exclusively

7 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.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 53 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET of “poor non-working pensioners” or of orphans, disabled children and invalids, and families with at least 7 children. In fact, it represents a 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 is GEL 22 for a qualifying household consisting of one member, or for each orphan under guardianship, and GEL 35 for a pensioners’ family of two or more, and for a family with at least 7 children.

The amount of the standard monthly Unemployment Benefit payable for the first six months of registered unemployment is fixed at GEL 14 for the duration of the eligible period. 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 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 does not take account either of the years worked or the salary history, and, at a monthly GEL 14 (approximately USD 6.5) on the one hand, is a poor incentive for tax compliance, and on the other, falls far below any minimum subsistence level (about 12 per cent of the official minimum subsistence of an average consumer). Starting from April 2003, the pensioners in Tbilisi are receiving an additional GEL 3 from the municipal budget. Beginning from from April-May 2004, the pension rate grew to GEL 18 countrywide, where in addition to GEL 14 of the main flat-rate pension allowance another GEL 4 were added to cover for previously accumulated pension arrears.

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 fall short of the target, and the system has been accumulating arrears for several years already. In the conditions of a transition economy the public pension system, inherited from the Soviet past, has long proved to be unsustainable and insolvent

The prerequisites necessary for the smooth functioning of a PAYG (pay-as-you-go) system fully dependent on the level of tax collection under the diminishing tax base and widespread tax avoidance and evasion cannot be working smoothly. The dependency ratio9 at an unsustainably low 1:1.4 is a reflection of shrinking hired employment and growing informal economy, resulting in an extremely low number of contributors to the fund. Low wages and no link between current contributions and future benefits are a poor motivation for those in employment to pay social tax, and a relatively high payroll tax rate. Inadequate law enforcement and widespread corruption discourage tax compliance on the part of employers.

The existing PAYG pension system fails to carry out its basic function of providing basic minimum pensions to the elderly. Average taxable salaries/wages are low, resulting in the low replacement rate10 of the current PAYG universal pension system. The average pension flat rate of the majority of pensioners is around 13 per cent of the average hired employees’ monthly salary. 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.

8 The contributions from workers’ wages that form the United State Social Insurance Fund (USSIF) revenue are 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. 9 The number of pensioners as a percentage of the number of people employed, or contributor to beneficiary ratio. 10 The average pension in terms of the average wage.

54 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET

The economic, political and social consequences of the crisis that the current pension system has been experiencing cannot be neglected as they place the most vulnerable elderly at poverty risk that may further result in social disintegration, marginalisation and social exclusion.

SOCIAL INSURANCE AND PENSION SYSTEM REFORM Implementation of the social insurance and pension system reform, whose principal goal is to introduce a new financially sustainable modern pension system suited to changing demands of a transition economy has already started, with the support of the World Bank and other donors. The pension reform programme provides for the introduction of social insurance and the transition of the pension system to insurance principles. Certain measures have already been taken, while others are underway. The reform envisages elimination of double entries and non-existent recipients as a result of adjusting the lists of benefit recipients, as well as further verification of registered pensioners and, finally, introduction of personal identification cards. As a result of restructuring of the United State Social Security Fund and the State Medical Insurance Company, in December 2002, the United State Social Insurance Fund was formed.

A number of laws, providing the necessary legal framework for introducing the social insurance system and new pension system based on insurance principles, prepared by the USSSF and the Ministry of Labour, Healthcare, and Social Affairs, in consultation with the World Bank, were passed by the Parliament on 20th July 2003, the last day of its spring session, all by ad hoc procedure, i.e., in their second and third reading. They were: laws “On Mandatory Insurance Pensions”, “On Mandatory Social Insurance”, and “On Introducing Individual (Personalized) Registration and Individual Accounts in the System of Mandatory Social Insurance”. The following is a short review of the laws.

REVIEW OF LAWS Law on Mandatory Social Insurance The reformed social protection of the population, including pension system is to be based on insurance principles, which is essential for a socially oriented society in the conditions of transition to a market economy. The law “On Mandatory Social Insurance” provides for transition of the social safety net to insurance principles that would build a basis for real guarantees of social protection. According to the law, the social insurance is going to be universal and mandatory; the social insurance funds will be distributed based on a solidarity principle; the insurance benefits will be differentiated, based on the size of insurance contribution and length of insurance period; and payment of the insurance benefits will be guaranteed. The following cases are stipulated for by the law: old age; disability; the loss of the breadwinner; temporary disability; pregnancy and childbirth; taking care of a child of up to 18 months of age; unemployment insurance; assistance in case of death of the insured (survivor’s pension); health rehabilitation; and mandatory medical insurance.

The law provides for a distinct demarcation between the insurance and state obligations that is supposed to guarantee the viability of the insurance system. In accordance with the new system of social protection, the non-insurance benefits (e.g., family assistance and pensions for those pensioners who will not be subject to insurance pensions, i.e., social pensions) will be financed from the state budget. Currently the annual state budget transfer to the United State Social Insurance Fund (the USSIF) covers hardly half of the sum necessary to pay the non-pension benefits, and the fund has to fill the gap using social tax proceeds, that, in its turn has been contributing to growing pension arrears. The fund management considers that when the function of payroll tax collection is exercised

GEORGIAN ECONOMIC TRENDS – 2004 No.2 55 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET by the fund itself, the proceeds directed to the fund would grow as the fund would be able to work on increasing the tax base coverage and strengthening tax administration, and the possibility of re- directing social tax proceeds to cover other under collection of other taxes would be eliminated.

Law on Mandatory Insurance Pensions In accordance with the law “On Mandatory Insurance Pensions”, the following persons will be eligible to receive mandatory insurance pensions after the law comes into effect: Georgian citizens, who will have been insured in accordance with the law “On Mandatory Social Insurance” and will be meeting the conditions provided for in the law; their disabled family members; and permanent residents, foreign citizens or persons without citizenship. Pensions of those persons who will have been registered as pension recipients before the law “On Mandatory Insurance Pensions” comes into force will not be regulated by this law, with the exception of those, who would have been eligible for old-age pension before the law would have taken effect, but who would continue working past its enactment for at least 2 years. The law differentiates among the three types of mandatory insurance pension: old age pension, disability pension and pension for the loss of the breadwinner (survivor’s pension). The mandatory old age insurance pension will be granted to persons having reached pension age11 and having at least 15 years of work record and/or insurance history, and will be comprised of a basic part and of a defined-contribution part12.

According to the law, state working pension will be financed out of insurer’s (the USSIF) budget that will be formed out of the mandatory social contributions paid to the insurer’s budget by the insured and the insurants. The pension capital accumulated on an individual (personified) account will be calculated on the basis of the mandatory insurance contribution paid to the insurer’s budget. The defined-contribution part of the state working pension will be granted on the basis of the funds accumulated on the insured’s defined-contributions individual account. The state will undertake the obligation of subsidizing the liabilities of the insurer – the United State Social Insurance Fund.

The laws “On Mandatory Social Insurance” and “On Mandatory Insurance Pensions”, provide for the pension insurance tariff equal to 28 per cent, of which 27 per cent is to be paid by the employer (insurant) and 1 per cent by the employee (insured). For the self-employed (self-insurants) a 14 per cent tariff will apply. The tariff will be distributed as follows: 20 per cent (from the 28 per cent tariff) is meant to cover the basic part of the pension (that is to be financed in accordance with the PAYG (pay-as-you-go) principle) and 8 per cent (from both 28 per cent and 14 per cent tariffs) – the defined-contribution part (i.e., insurance part to be financed in accordance with the PAYE (pay-as-you- earn principle) of the mandatory insurance pension. The overall payroll tax will be comprised of 33 per cent, of which 31 per cent will be to be paid by the employer (27 per cent, social insurance contribution; 3 per cent, medical insurance contribution; and 1 per cent, unemployment benefit contribution), and 2 per cent by the employee (1 per cent, social insurance contribution, and 1 per cent, medical insurance contribution).

Persons eligible for mandatory insurance pension will not have the right to claim this pension during the period of their employment, during which the size of their insurance contribution will be reduced from 28 to 8 per cent to be paid by the employer (insurant) of the pensioner engaged in hired employment or by the self-employed pensioner (self-insurant).

11 Currently, the pension age is 60 years of age for women and 65 years of age for men. The law “On State Pensions” provides for raising the pension age for women to 65 year of age. On the one hand, this would facilitate growth in the number of contributors, and on the other hand women will have equal rights with men to continue working. 12 Defined-contribution schemes (DC) specify in advance the contribution, but not the benefit, which depends on the accumulated contributions (and the rates of return on investments).

56 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET

Law on Introducing Individual (Personalized) Registration and Individual Accounts in the System of Mandatory Social Insurance To be able to build successfully a new system of state social protection based on insurance principles a sophisticated and smoothly functioning registration system must be in place. A law “On Introducing Individual (Personalized) Registration and Individual Accounts in the System of Mandatory Social Insurance” provides a legal framework for introducing insurance principles based on defined- contribution individual accounts in the system of the social safety net. Overall individual registration is meant to contribute to broadening the insurance contribution base, and, therefore legalisation of the informal economy, by encouraging payment of contributions that, unlike the present payroll tax, are to be directly linked to future benefits.

Although all the three laws that are to regulate social insurance and mandatory insurance pensions have now been passed by the Parliament, it will take some time, before the the new pension system is in place and running. The programme of introducing a multi-pillar system is to be carried out step by step. Before the multi-pillar system is in place, it is essential to: guarantee a transparent environment in the pension system; draft further appropriate legislation and improve existing normative acts; ensure continuous payment of current pensions and gradual repayment of accumulated arrears; implement personification and introduce identification cards; and, finally, ensure step-by-step transfer towards insurance principles and a differentiated pension system.

A multi-pillar system is to provide a plurality of possibilities and availability of choice for those who can afford to make provisions for their future pensions, as well as increase personal responsibility and create savings funds for investment. However, putting the system in place and reaching its smooth functioning will require time, effort and investment. The success of the reform will largely depend on the overall economic situation in the country and the rate of economic growth, as well as the legislative process. Currently, only a tiny share of the population would be able to afford participation in private voluntary schemes, and there is a long way to go until those who can afford it have confidence in them. However, for those who choose to, it is already possible to provide for one’s private pension13. In the conditions of Georgia, where household incomes are currently extremely low, privately managed retirement savings systems could not substitute for universal social insurance schemes and can only serve as an option for those who can afford to save for higher retirement income. After the pension reform is implemented, the state pension system is supposed to provide a mandatory insurance pension for those eligible, topped up by voluntary private schemes. In the meantime, improving payroll tax collection and compliance, broadening the tax base, paying the pension arrears and ensuring regular payment of pensions to the current pensioners remain the most important short- term goals.

Box 7.1: TRANSITION AND EU ACCESSION COUNTRIES’ EXPERIENCE

What Reforms Have Eastern European Economies Introduced So Far?

Most transitional economies have introduced some pension reforms, though not in any systematic way that provided a long-term solution to their problems. Among them are the following:

Poland introduced a new benefit formula in 1991 that abolished differences in benefit levels by occupation, increased the number of working years used in calculating the earning base, lowered the maximum pension, and

13 The law “On Non-State Pension Insurance” was passed in 1998. Georgian Pension Investment Holding (GPIH) founded in May 2001, offers, in addition to the existing universal PAYG scheme, voluntary private pension insurance.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 57 EMPLOYMENT, INCOMES AND THE SOCIAL SAFETY NET indexed pensions to the average wage.

Romania raised contributions rates in 1992 for those employed in occupations with early retirement provisions and raised benefits in the funded scheme. Multiple pension schemes are gradually being unified.

Bulgaria raised contribution rates in 1991 for employees eligible for early retiremen. In 1992 it raised the minimum retirement age, reduced the number of workers eligible for early retirement, and added incentives for those above retirement age to keep working.

Hungary placed a ceiling on contributions in 1992, increased the minimum number of contribution years, slightly revised the benefit formula and pension indexation, and created an independent social insurance fund, which separates contributions by use.

Albania established and independent social insurance agency in 1992, with an independent budget and financing. The pension fund was separated in 1993. Major reform legislation was passed in 1993, covering a gradual increase in the minimum contributions, employee contributions, and a flat contribution for the self-employed. The benefit formula was restructured and is now based on years of contributions and endexed annually.

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

58 GEORGIAN ECONOMIC TRENDS – 2004 No.2

CHAPTER EIGHT: EU-GEORGIAN RELATIONS

GEORGIA’S TRADE WITH THE EU According to the State Department for Statistics, in the first quarter of 2004 Georgia’s trade with the Member States of the European Union amounted to USD 121.9 million, which is about 27 per cent more than in the same period of previous year. During this period Georgian exports to the EU market amounted to USD 14.9 million (102.9 per cent compared with the previous year). Imports from EU Member States’ amounted to USD 106.2 million (131.8 per cent compared with the previous year). For the period, 28.4 per cent of Georgia’s foreign trade was with EU Member States, 15.1per cent of exports and 32.3 per cent of imports.

Three European Union Member States – UK, Germany, France together with Turkey are among Georgia’s top ten trade partners as shown in Table 8.1.

Table 8.1. (Per cent) 2003 first quarter 2004 first quarter Export Import Turnover Export Import Turnover UK 11.0 14.2 13.4 4.5 9.2 8.1 Germany 4.0 6.6 6.0 1.2 6.5 5.3 France 0.4 6.6 5.1 2.8 5.5 4.9 Turkey 25.1 8.6 12.7 23.3 9.4 12.6 Total 40.5 36.0 37.2 31.8 30.6 30.9 Source: State Department for Statistics

Table 8.2: Georgia’s Trade with the EU Countries, 2003 first quarter- 2004 first quarter (USD thousands) 2003 first quarter 2004 first quarter Turnover Import Export Balance Turnover Import Export Balance Austria 2,080.8 1,996.9 83.9 - 1,913.0 8,842.2 8,831.3 10.9 -8,820.3 Belgium 1,589.0 1,080.6 508.4 - 572.2 3,338.7 2,687.8 650.9 -2,036.9 Denmark 1,176.0 986.4 189.6 - 796.8 3,439.7 3,301.7 138.0 -3,163.7 France 11,633.6 11,371.9 261.7 - 11,110.2 20,991.5 18,179.9 2,811.6 -15,368.3 Germany 12,829.3 11,068.9 1,760.4 - 9,308.4 22,588.1 21,447.8 1,140.3 -20,307.5 Greece 885.8 829.3 56.5 - 772.7 2,660.0 2,614.7 45.3 -2,569.4 Ireland 91.7 76.3 15.4 - 61.0 405.9 405.9 - -405.9 Italy 5,790.8 5,106.2 684.6 -4,421.6 12,933.4 10,494.9 2,438.5 -8,056.4 Luxembourg 48.6 48.6 - - 48.6 138.2 138.2 - -138.2 Netherlands 2,577.1 1,986.4 590.7 - 1,395.7 7,376.6 5,742.2 1,634.4 -4,107.8 Portugal 103.0 91.5 11.5 - 80.1 304.7 298.7 6.0 -292.7 Finland 814.8 814.8 - - 814.8 917.5 917.5 - -917.5 Spain 614.5 365.9 248.6 -117.3 2,532.9 930.5 1,602.4 -671.8 Sweden 106.7 106.7 - - 106.7 191.7 191.7 - -191.7 UK 36,692.4 30,754.4 5,938.0 -24,816.4 34,680.5 30,230.6 4,449.9 -25,780.7 Total 77,034.1 66,684.8 10,349.3 -56,335.5 121,341.6 106,413.4 14,928.2 -92,828.8 Source: State Department for Statistics

Table 8.3: Georgia’s Trade with the New EU Member Countries, 2003 first quarter – 2004 first quarter (USD thousands) 2003 first quarter 2004 first quarter Turnover Import Export Balance Turnover Import Export Balance Estonia - - - - 52.9 39.2 13.7 -25.6 Cyprus 197.4 172.3 25.1 -147.2 376.3 356.1 20.2 -335.9

GEORGIAN ECONOMIC TRENDS – 2004 No.2 59 EU-GEORGIAN RELATIONS

Latvia 1,664.2 1,658.9 5.3 -1,653.6 743.5 475.5 268.0 -207.5 Lithuania 144.3 133.2 11.1 -122.1 424.1 264.0 160.1 -103.9 Malta ------Poland 569.1 496.4 72.7 -423.7 1,163.0 1,133.0 30.0 -1,103.0 Slovakia 145 77.3 67.7 -9.6 412.2 355.4 56.8 -298.6 Slovenia 654.4 - 654.4 -654.4 798.4 798.4 - -798.4 Hungary 1,444.4 1,441.3 3.1 -1,438.3 1,802.8 1,802.8 - -1,802.8 Czech Republic 516.4 431.5 84.9 -346.6 818 817.6 0.4 -817.1 Total 5,353.2 4,410.9 924.3 -4,795.5 6,591.2 6042 549.2 5,492.8 Source: State Department for Statistics

Table 8.4: Georgia’s Trade with the EU Acceding Countries, 2003 first quarter – 2004 first quarter (USD thousands) 2003 first quarter 2004 first quarter Turnover Import Export Balance Turnover Import Export Balance Bulgaria 2,660.1 2,614.1 46 -2,568.1 4,623.8 4,567.3 56.5 -4,510.8 Turkey 31,205.5 17,092.3 14,113.2 -2,979.1 53,815.2 30,799.0 23,016.2 -7,782.8 Romania 578 578 - -578 2,366.6 2,271.1 95.5 -2,175.6 Total 34,443.6 20,284.4 14,159.2 -6,125.2 60,805.6 37,637.4 23,168.2 -14,469.2 Source: State Department for Statistics

THE POLITICAL ASPECTS OF GEORGIA’S INTEGRATION TO THE EU

The overriding goal of any state’s foreign policy is the creation of international conditions ensuring durable security for its citizens – political, economic, cultural and social. That striving has the utmost importance for Georgia – a country tried by history, for whose citizens, the tradition of struggle for independence is of supreme value. Georgia’s European aspirations took root in that soil and were enhanced by belonging to European culture and tradition. Closer integration to the European Union is, therefore, the most advantageous choice from the point of view of national security, stability of the democratic order, sustainable economic development and establishment of a modern civil society. It also signifies a conscious assumption of co-responsibility for European affairs, and thus – a more effective impact on global politics. As a result, Georgia will have a more tangible influence in the region, promotion of good-neighbourly relations, and will be able to participate in shaping the directions of world politics in line with the interests of the state. Georgia attaches great importance to the development of regional co-operation in the South Caucasus. The South Caucasus has a crucial role to play as a major transit corridor between Europe and Asia, including in the energy sector. The South Caucasus and particularly Georgia plays an active part in EU regional programmes, such as TRACECA and INOGATE.

Georgia deems that the concentration on the implementation of concrete investment projects would be more beneficial to the population of the South Caucasus countries in the very short period of time, however there are few examples of implementing such projects, namely construction of so called TRACECA Bridge on the Georgia-Azerbaijan border and opening of the Poti-Illyichevsk rail ferry. Such projects will also ensure the success of the above interstate programmes in the long run. Involvement of financial institutions, such as EBRD and the European Investment Bank is crucial, they could finance the practical implementations of the recommendations developed by the above two regional programmes.

The international community regards the region as a common geopolitical and economic space. Such an approach towards the South Caucasus is reflected, first of all, in the development of mutually fruitful co-operation with the European and Euro-Atlantic structures. However, Georgia would welcome

60 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EU-GEORGIAN RELATIONS a more country-specific, individual approach from the EU, which would give the possibility to establish close regional co-operation with acceding countries who share a sea border with Georgia.

It is also important to support the close co-operation between Black Sea Economic Cooperation and the EU in a regional approach. At the same time, Georgia attaches great importance to the development of the Barcelona process, as a example for the future and would like to see Black Sea regional co-operation as a part of the EU Mediterranean political arrangements. The regional co- operation of Mediterranean and Black Sea Countries will further facilitate the economic development of the region and ensure its political and economic stability. While participating in this initiative, Georgia could be involved in the implementation of different economic projects envisaged under the EU Mediterranean partnership. Active regional co-operation of Georgia with the Mediterranean region, as well as through bilateral relations with its members, will further promote its integration into the EU structures. Closer integration with the EU is a profound challenge, requiring enormous political responsibility. Georgia considers that the Wider Europe - New Neighbourhood Initiative is a good mechanism facilitating the ongoing integration processes in Europe, as well as a close political, economic and cultural relations between the European states, and therefore, attaches great importance to the inclusion of the South Caucasian countries, particularly Georgia, in this initiative. The actions Georgia takes today will determine the effectiveness of our involvement in European Union structures.

The Prime Ministers in their Joint Statement made at the Conference in Bratislava 19 March 2004 welcomed the decision of the European Union to consider the South Caucasus democracies in the context of the European Neighbourhood Policy and expressed their belief that the development of a constructive strategy for the greater Black Sea region would be the first great challenge of a Wider Europe. They also underlined their will to encourage the European Union, NATO and the United States to make this region a priority, to create ever closer relationships, and to open institutions and markets to Black Sea democracies as the momentum of their reforms takes hold (see table 8.4). The final decision to admit countries of the South Caucasus to ENP was taken at the European Council meeting in Luxembuourg on June 14th. The next step would be for Georgia to work with the EU on the elaboration of Action Plans within the ENP, and GEPLAC will provide the support for the Georgian side.

The political changes in Europe after 1989 opened the way to unification of the European continent that had been divided for fifty years by “the iron curtain,” and even more, opened the way to the countries of the eastern part of the Eastern Europe. Georgia has expressed its political will to be linked with integrated to the European Union. Georgia institutes stability of democratic institutions, rule of law, respecting of human rights and protection of minorities.

As for honouring the commitments undertaken by Georgia at the accession to the Council of Europe, the progress achieved with regard to such directions should be stressed – the Parliament of Georgia ratified the European Convention for Human Rights and its additional protocols, European Convention for Prevention of Torture and Inhuman or Degrading Treatment or Punishment, Council of Europe conventions on Extradition and on Mutual assistance in criminal matters and Geneva Convention related to the Status of Refugees and its 1967 Protocol.

Freedom of press and independent media is one of the most significant achievements of Georgian democracy. The country should fulfill all the economic criteria. It is still essential to continue the adjustment process and to conduct an active policy of restructuring, modernization and privatisation. By becoming a part of European sphere it will let the country consolidate its reforms and will give its

GEORGIAN ECONOMIC TRENDS – 2004 No.2 61 EU-GEORGIAN RELATIONS economy an impulse needed for successful integration in world markets. However, Georgia must also be ready to bear the costs connected with approximation to the EU and is the recipient of technical and financial support under PCA. Only such a foundation of integration with the Union will bring tangible benefits to the country and the EU.

The present enlargement of the European Union through accession of Central and Eastern European countries has a decidedly different historic and political dimension than previous enlargements. It will permit the reunification of an area, which in the past was divided, contrary to the wishes of nations and states. It will lead to the realization of the common goal that guided the proponents of a united Europe and the founding fathers of the European Communities - the goal ensuring security and prosperity on the entire European continent.

In order for that to happen, it was essential to build mutual confidence and to grant support to the candidate states on their difficult path to membership -and afterwards. In accordance of one of the fundamental principles of the Union - the principle of solidarity - “the strong” must support “the weak;” the tangible benefits of that approach will shortly be perceptible to all citizens of Europe. Georgia also shares other fundamental principles of European integration - such as principle of equality and subsidiarity. The success of the Union as an integrational grouping is determined by active involvement of citizens in social and economic life, and assurance of equal participation in the process of member and candidate states, regions and social groups.

In all its negotiations, Georgia is guided by the goal of ensuring for the country’s society the optimum benefits from integration to the Union. Georgia is striving for comprehensive integration. The country should fully share the objectives and means of the Common Foreign and Security Policy of the EU. All international undertakings should be compatible with the Union’s foreign policy. In the face of growing threats to peace, security and democracy, Georgia should support the development of the Common European Security and Defence Policy and all actions to combat international terrorism. For NATO membership the country has to be actively involved in efforts to consolidate security, stability and democracy in the region.

Georgia fully shares all the principles and goals of European integration elaborated in the European treaties. In light of the recent political developments in Georgia participation into the European and Euro-Atlantic structures based on shared values of democracy, market economy, rule of law and the supremacy of the universal principles of human rights remains as a key priority of the Georgian foreign policy. One of the most important tasks facing Georgia is finding a way to persuade the societies and political elite of the member states that Georgia is a politically stable state, belonging to European traditions and cultural heritage.

The democratic society of the country always demonstrates political maturity and confirms its will to be welcome to the European Family. However, if the society is to be fully aware of the challenges ahead, it should have full information on all aspects of Georgia’s integration to the EU including the political, legal, economic, social and cultural ones. Success of the whole process will depend on presentation to the citizens of an objective image, justification of the costs and presentation of the benefits.

62 GEORGIAN ECONOMIC TRENDS – 2004 No.2 EU-GEORGIAN RELATIONS

Box 8.1 “Towards a Wider Europe: The New Agenda”

We welcome the decision of the European Union to consider the South Caucasus democracies in the context of the European Neighbourhood Policy. We believe that the development of a constructive strategy for the greater Black Sea region is the first great challenge of a Wider Europe. We will encourage the European Union, NATO and the United States to make this region a priority, to create ever closer relationships, and to open institutions and markets to Black Sea democracies as the momentum of their reforms takes hold.

Source: Bratislava, Slovakia, March 19, 2004. Prime Ministerial Conference: Towards a Wider Europe: The New Agenda

Box 8.2: European Constitution

The idea of an EU constitution was agreed at a summit in December 2001 and details were finalised at a meeting of EU heads of government in Brussels on June 19. One of the aims of the constitution was an attempt to redesign and simplify the Union as it prepared for its enlargement from 15 to 25 members in May 2004. Four EU treaties would be merged into a single simplified text, setting out for the first time what the EU does and does not do. It would settle the division of power between the EU and its member states for 50 years. But the question still remains whether the constitution can make an enlarged Europe work. In the recent negotiations, there were clear differences of philosophy between countries that wanted a large scale detailed document and those who would have preferred a much shorter one dealing with broader principles, along the lines of the US constitution.

The text has to be ratified by all 25 member states. Most countries will ratify the treaty through parliamentary votes, but in up to 10 member states there will be referendums and some of them are uncertain. If ratification fails in any one state, the treaty would be blocked. Attempts might be made to get around one country doing this, including possibility of that country being asked to leave the EU, but such an outcome would cause major legal and political problems. In elections to the European Parliament held in mid-June, certain political parties campaigned against the constitution and some (e.g. the UK Independence Party) sent MPs to Strasbourg who wish to leave the EU.

It could be argued that the EU might persevere with its existing legal base, but it would be less flexible, less efficient and less transparent. Without the treaty, Europe would also find it harder to focus on the new projects that opinion polls suggest its citizens want it to pursue(e.g. developing security against the treats of terrorism and uncontrolled migration).

The constitutional treaty contains much compromise, and in places is complex and difficult to read, but as a democratic project of 25 sovereign states it is a substantial achievement, and proof an enlarged EU can evolve.

These are the main features of the proposed constitution:

• A single simplified European Union treaty • A European Council President serving up to five years(formerly rotating six-month EU presidency by country) • EU foreign minister, new European diplomatic service • National parliaments able to ensure EU law does not impede member states’ rights • National veto abolished in some areas, including immigration and asylum policy; kept in tax,

GEORGIAN ECONOMIC TRENDS – 2004 No.2 63 EU-GEORGIAN RELATIONS

defence and foreign policy, and over financing EU budget • New “double majority” voting system for Council of Ministers. Positive vote requires at least 65% of EU population • Countries using Euro to get greater powers to set own policies • More defence co-operation among member states, including procurement • Commission to be reduced in numbers from 2014, with members sent from only two-thirds of member states on rotation basis • New powers to European Parliament over legislation and annual EU budget • Small countries minimum number of Parliament seats raised from four to six (maximum limit for big states 96)

• Procedure for leaving EU

64 GEORGIAN ECONOMIC TRENDS – 2004 No.2

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 reforming” 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

GEORGIAN ECONOMIC TRENDS – 2004 No.2 65 CALENDAR OF EVENTS

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

66 GEORGIAN ECONOMIC TRENDS – 2004 No.2 CALENDAR OF EVENTS

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,

GEORGIAN ECONOMIC TRENDS – 2004 No.2 67 CALENDAR OF EVENTS

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.

68 GEORGIAN ECONOMIC TRENDS – 2004 No.2 CALENDAR OF EVENTS

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

GEORGIAN ECONOMIC TRENDS – 2004 No.2 69 CALENDAR OF EVENTS

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

70 GEORGIAN ECONOMIC TRENDS – 2004 No.2 CALENDAR OF EVENTS

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 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.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 71 CALENDAR OF EVENTS

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

72 GEORGIAN ECONOMIC TRENDS – 2004 No.2 CALENDAR OF EVENTS

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 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.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 73

APPENDIX I: NOTE ON FOREIGN DIRECT INVESTMENTS

By Daniel Linotte, Senior Economic Adviser to the OSCE

"The first pillar of a strategy for development is the creation of a good investment climate - one that encourages firms, both large and small, to increase productivity. The private sector is not only the engine of aggregate growth, it is also the main provider of economic activity and opportunity for poor people." - Nicholas Stern, Senior Vice President and Chief Economist, the World Bank.

In the context of a sound macroeconomic framework, a good investment climate: - Provides a sound legal and regulatory framework for enterprises that promotes competition. - Strengthens governance and overcomes bureaucratic inefficiencies. - Improves access to key financial and infrastructure services. Source: The World Bank (website).

"A growing and deepening divide has opened up between transition economies where economic development has taken off and those caught in a vicious circle of international backwardness and macro-economic instability. This 'Great Divide' is visible in almost every measure of economic performance." - Erik Berlof and Patrick Bolton (2002), 'The Great Divide and Beyond: Financial Architecture in Transition', Journal of Economic Perspective, Vol. 16 (Winter), pp. 77-100.

The purpose of this short note is to provide background material on FDIs, including selected statistical data on OSCE participating States, sources of documentation, legal documents, etc.

In the Georgian context, where FDIs are essential for growth, incomes and employment, it might be useful to learn more about the factors that explain and influence flows of FDIs. Relying on the experience of other countries and so-called "best practices", instruments, measures and policies can also be identified, taking into consideration the specific conditions of the host country.

I. Definitions and data

1. Basic definitions and concepts

Multinational corporation / enterprise (MNC)

A multinational enterprise is a firm that controls assets and has productive capacity in two or more countries. A firm becomes a MNC by investing abroad, in a foreign or host country, distinct from the home country. MNCs' decisions and activities influence the speed and the scope of globalisation and impact on home and host countries.

74 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS

Foreign direct investments (FDIs)

FDIs are investments in productive assets that imply control, and managerial and technical inputs, by a company incorporated in a foreign country, as opposed to (indirect) investments in small portions of shares, or portfolio investments, of local companies by foreign entities.

FDIs modalities

Investing in productive assets abroad can be done through various modalities: take-overs, creation of joint ventures, transfer of productive assets (equipment) from the home country to the recipient one, etc. Privatisation schemes also impact on FDIs modalities.

Table 1: reference concepts / FDIs modalities

ν Multinational enterprise or corporation ν Home and host country ν Foreign investment ¬ Inflow (inward) and outflow (outward) ¬ Portfolio (financial) investment ¬ Direct investment • Take over - of a private company - of a state company (through privatisation) • Joint venture • Transfer of productive capacity

2. FDIs in the global economy

Recent decline

According to the World Investment Report published by the UN in July 2003, global investment inflows have decreased considerably, from $1.4 trillions in 2000 to $650 billions in 2002, representing 10% of world gross fixed capital formation (versus circa 2.5% in 1988). As indicated by Table 2, such a sharp decline followed a decade of fast growing FDIs that accelerated during the second half of the 1990s. In 2002, foreign affiliates contributed to more than 10% of world GDP (or about twice more than in 1988 in percentage terms). These trends and changes are key-features of the on-going globalisation process and, for recent years, they partly reflect the slowdown of economic activities and the impact of 9/11 on world business.

Uneven decline

The decline was uneven across regions. In 2002, inflows declined in 105 of 195 economies. US and UK accounted for half of the decline in countries with reduced inflows. In Latin America and the Caribbean, there was a 33% fall. In Africa, the corresponding fall is 41%. In Asia, the FDIs decline was

GEORGIAN ECONOMIC TRENDS – 2004 No 2 75 NOTE ON FOREIGN DIRECT INVESTMENT limited because China had a record inflow of $51 billions. Central and Eastern Europe witnessed increased inflows amounting to $29 billions.

Table 2: Selected FDIs and international production indicators ------Value in USD billion Annual growth rates (%) 1982 1999 2002 1991-95 1996-2000 2002 ------FDIs flows and stocks Inflows 59 209 651 21.1 40.2 -21.0 Outflows 28 242 647 16.5 35.7 -9.0 Inward stock 802 1,954 7,123 9.3 17.2 7.8 Outward stock 595 1,763 6,866 10.6 16.8 8.7

Foreign affiliates Gross product 640 1,458 3,437 6.7 7.9 6.7 Total assets 2,091 5,899 26,543 13.9 19.2 8.3 Exports 722 1,197 2,613 7.6 9.6 4.2 Employment ('000) 19,375 24,262 53,094 2.9 14.2 5.7

World data GDP 10,805 21,262 32,227 5.6 1.3 3.4 GFCF 2,286 4,819 6,422 4.2 1.0 1.3 Exports of Goods & Services 2,053 4,300 7,838 5.4 3.4 4.2 ------Source: UNCTAD Notes: - GDP = gross domestic product, - GFCF = gross fixed capital formation. [The discrepancy between inward and outward FDIs partly reflects statistical inaccuracies.]

World FDI inflows , 1997 - 2002

1600000 1400000 1200000 1000000 800000 600000 400000

Millions of dollars 200000 0 1997 1998 1999 2000 2001 2002 Years

76 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS

MNCs and FDIs in the OSCE region

In 2002, the highest OSCE outward FDIs flows are recorded for the US (US$ 119 billions), France (62), UK (39), Canada (28), the Netherlands (26) and Germany (24). Developed market economies are also the largest recipients of FDIs (see Annex Table 2). Regarding FDIs in transition countries, the Czech Republic and Poland dominate, with a total combined figure of US$ 13.4 billions. Such inflows are certainly related to EU membership. Russia and Kazakhstan follow; these are two CIS countries with large natural and energy resources endowments. Considering the total value of outward stocks of FDIs at the end of 2002, the main OSCE home countries are the US, UK, France and Germany, followed by the Netherlands and Switzerland. In stock terms, MNCs based in these countries invested almost US$ 4.5 trillions abroad. Assuming a capital-output ratio of 2 (i.e. you need 2 dollars of capital stock to produce 1 dollar of output in a year), the corresponding annual output would be higher than US$ 2 trillions, namely about 10% of the combined EU-US GDP, more than the French or UK GDPs, etc. As indicated by the Country Focus of Annex E, per capita stock of FDIs are much higher in Central and Eastern Europe than in CIS countries. De facto, with limited inflows of FDIs the poorest countries in the OSCE region seem to be trapped in a vicious circle of slow development. Low incomes correspond to small markets and attract very limited FDIs. As a result, growth is slow and incomes remain low, far below those of dynamic economies.

Sectorial concerns

Countries benefiting from generous endowments of raw materials and energy resources are able to attract FDIs to extract and export these products. However, experts believe that more investments in sectors such as manufacturing and services are strongly needed. Excessive investments in energy and raw material sectors can eventually lead to the so-called "Dutch disease" and related problems (see Box 1).

Box 1: "Economic diseases and problems" linked to excessive reliance on raw materials and energy products; security implications and recommendations

"Dutch disease"

The "Dutch disease" corresponds to the de-industrialization that occurs when the discovery of a natural resource raises the value of a nation's currency, making manufactured goods less competitive, therefore increasing imports and decreasing exports. The term apparently originated in Holland after the discovery of North Sea gas that led to large trade surpluses and a significant appreciation of the Dutch national currency. Some scholars see Russia and Kazakhstan as cases of Dutch disease.

References: - For a definition, see: http://www.investorwords.com/1604/dutch_disease.html - Oksana Dynnikova and Kiril Sosunov, "The Dutch Disease: Calibration for Russia", New Economic School, Moscow; http://www.nes.ru/english/about/10th-Anniversary/presentations/Sosunov.pdf - Ariel Cohen, "CONFRONTING KAZAKHSTAN’S ‘DUTCH DISEASE", CENTRAL ASIA - CAUCASUS ANALYST, Central Asia-Caucasus Institute / John Hopkins University, Wednesday / March 26, 2003.

The Prebisch-Singer Thesis

GEORGIAN ECONOMIC TRENDS – 2004 No 2 77 NOTE ON FOREIGN DIRECT INVESTMENT

According to the Singer-Prebisch Thesis, the terms of trade (ToT = price of exports / price of imports) between primary products and manufactured goods tend to deteriorate over time, particularly in the long run. This suggests that countries that export primary products (such as most developing countries) would be able to import less and less for a given level of exports. For this reason, developing economies should not focus on producing mainly primary products but should instead promote the development of manufacturing industry and rely on regional integration for widening markets.

Reference: Wikipedia, the free encyclopedia.

Immiserizing growth

Trade liberalisation of a resource intensive good could lead to a drop in welfare for the resource abundant country, which could be related to the "immiserizing growth" result, as demonstrated by Prof. Baghwati. That is explained by the decline of the international price of the exploited resource caused by excessive exports.

Reference: J. Baghwati, International Trade: Selected Readings, MIT Press, 1987.

Terms-of-Trade Volatility

In the short term, the terms-of-trade may change in significant and sometimes unpredictable manners, particularly when exports are concentrated on a few products. According to the evidence, within a year, fluctuations can easily reach 15 percent. Moreover, according to The Haberger-Laursen-Metzler Effect an exogenous increase (decrease) in the ToT faced by a small open economy leads to an improvement (deterioration) in that country’s trade balance. Such an effect is partly explained by the impact of the ToT change on real income and savings. The evidence supports the existence of the HLME, especially for small developing countries.

Reference: D. Linotte, M. Ibrasheva and A. Pupols “National Security in the Global Economy: Addressing Terms- of-Trade and Financial Risks (with a reference to Central Asia)”, in Central Asia in the System of Global Relations, Kazakh Institute of Strategic Studies and the OSCE, Almaty, 2002.

Security implications and policy recommendations (the role of FDIs)

In recent studies on the economic causes of conflict, World Bank experts conclude that civil wars are often related to the lack of diversification of the economic base and the concentration of exports on a few products. It is therefore essential to attract FDIs to widen the range of products and diversify exports of goods and services.

For more details see http://econ.worldbank.org/programs/conflict/

In summary:

ν FDIs modalities are manifold.

ν FDIs can be influenced by privatisation strategies.

ν Over the last two decades, FDIs have contributed to the globalisation process.

ν Recent trends indicate the negative impact of 9/11 on FDIs flows.

ν Excessive FDIs in energy and primary product sectors may eventually harm the development of the manufacturing sector and make national economies more vulnerable.

II. Explaining FDIs

3. Theories

78 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS FDIs decisions are taken by MNCs. What may explain such decisions? Different theories have been proposed to explain the behaviour of companies when they invest abroad. The modern theory of FDIs seems to date back to the MIT Ph.D. thesis of S. Hymer that underlines the importance of knowing local markets.1 Since, many fundamental works have been published.

Dunning's eclectic theory

The work of John H. Dunning is generally seen as the most influential work on MNCs. He underlines that no single theory could explain FDIs. For that reason, he proposes a general and eclectic explanation of MNCs that is refereed to as the "Ownership-Location-Internalisation (OLI) Paradigm", combining previous works and proposing a new interpretation.

The ownership advantages are controlled by the firm: - patents and know how, - labour and managerial skills / capabilities, - control over markets, - economies of scale, etc.

The location advantages includes: - natural resources / raw material endowments, - the cost and skills of the labour force, - the quality of governance and public services, - the size and growth of the market, - the proximity of large markets, - membership in trade and / or regional economic integration schemes, - infrastructures that lower transportation and communication costs, - modern and efficient financial and banking sector, etc. The internalisation advantages relates to markets imperfections, i.e. companies attempt. to secure rents because of restricted competition.2

Porter's strategic theory

Michael Porter (from Harvard University) made another interesting contribution to the theory of MNCs / FDIs. Investing abroad allows to sell globally, to penetrate protected markets, to benefit from the segmentation of national markets and to better meet local requirements, etc.3

ν From an economic policy perspective, some location variables are essential for attracting FDIs, particularly factors that can be controlled by public authorities.

ν Public bodies can change the levels of key-variables such as, for instance, education, the quality of public governance or membership in a regional integration scheme and, therefore, influence MNCs' decisions and the inflows and outflows of FDIs.

1 The International Operations of National Firms: A Study of Direct Investment, 1960. 2 Dunning, John H., ‘Reappraising the Eclectic Paradigm in an Age of Alliance Capitalism,’ Journal of International Business Studies (Third Quarter 1995), 461-91. 3 Kurt Pedersen, "The Eclectic Paradigm: 25 Years Anniversary". http://www.news.asb.dk/ibec/The_Eclectic_Paradigm.pdf

GEORGIAN ECONOMIC TRENDS – 2004 No 2 79 NOTE ON FOREIGN DIRECT INVESTMENT

4. Evidence

Numerous empirical studies have been conducted to evaluate theories and elaborate measures and policies related to MNCs and FDIs. Most of these studies have a geographical or sectorial focus. We report some of them. Regular surveys are also conducted to identify factors that impede or facilitate FDIs (see Box 2).

US FDIs in the EU: "The importance of interest rates"

Francisca Beer and Suzanne Cory analysed the locational factors that may influence US FDIs in 1) manufacturing and 2) all business in the EU12 countries over the period 1977-1989. Findings do not validate the 1) key-role of infrastructures and 2) the importance of taxation. The largest countries attract more FDIs that others. Interest rates, namely the costs of credit, also matter.4

Developing countries: "Stability is essential"

In a recent paper, Kitty Chan and Edouard Gemayel (from the US Department of Agriculture and IMF) study the impact of macroeconomic instability on the pattern of FDIs in the Middle East and North Africa. Their work relies on the economic, financial and political risk index of the International Country Risk Guide that comprises 22 variables, including: Economic risk components: GDP per capita, real GDP growth, inflation rate, budget balance as a percentage of GDP, current account balance as a percentage of GDP. Financial risk components: foreign debt as a percentage of GDP, debt service as a percentage of exports (i.e. the so-called "debt service ratio", DSR), foreign exchange reserves as months of import cover, and exchange rate stability. Political risks components: government stability, socio-economic conditions, investment profile, internal conflict, external conflict, corruption, military in politics, religious tensions, law and order, ethnic tensions, democratic accountability, and bureaucratic quality. Their conclusions underline that stabilising the environment is important for attracting FDIs.

Transition countries (I): "Human rights and democracy matter" Mike Pournarakis and Nikos Varsakelis "verify the argument that institutional factors such as civil and political rights and corruption are critical in explaining the behaviour of FDI inflows in (ten) transitional economies during the 1990s". Using statistical and econometric analysis, they conclude: "weak civil political rights status in many countries … prevents them from becoming attractive for FDI". From a purely economic standpoint, such conclusions definitely support the initiatives and activities of various organisations, including the OSCE, to promote human rights, freedoms and transparent democracy.5

Transition countries (II): "Distance from investors and progress with reforms" A systematic analysis of FDIs in the former Soviet Union and 10 Central and East European countries is proposed by Line Tondel for the period 1994-1998. FDIs in the region are still highly concentrated: Poland received 25% of all FDIs during the reference period. Considering the determinants of FDIs, psychological / cultural factors and proximity to centres of economic activity do matter. That is the case for German investments, but also for Scandinavian ones in the Baltics and Turkish FDIs in

4 F. Beer and S. Cory, "The Locational Determinants of U.S. FDI in the EU", Journal of Financial and Strategic Decisions, Vol. 9, No. 2, Summer 1996, 43-53. 5 M. Pournarakis and N. Varsakelis, "FDI in CEE Countries: Do Institutions matter?" December 2002.

80 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS Turkish speaking countries. Regression analysis reveals that progress with reforms is important for attracting

FDIs in CEE whereas market size and (as illustrated by Kazakhstan and Azerbaijan) natural and energy resource endowments are quite essential attracting factors in the former Soviet Union".6

FDIs and the environment: "The Chinese case" Is China a "pollution heaven" that may attract FDIs from countries where environmental rules are more stringent? A recent paper (by Judith M. Dean, Mary E. Lovely and Hua Wang) tries to answer that question using 1996 data on 626 manufacturing joint ventures. "FDI (in China) originating from HK, Macao and Taiwan is attracted to provinces with a relative abundance of low-skilled labour, and relatively low pollution levies. In contrast, FDI from OECD and other non-Chinese countries is attracted by high levels of skilled labour," in regions where there is high pollution levies -- "the reverse of the pollutionheaven hypothesis".7

Box 2: A recent survey

According to a recent survey, major deterrents to FDIs were ranked in the following order: 1. Instability and extent of regulations 2. Ambiguity of the legal system 3. Uncertainty of the economic environment 4. Corruption 5. High tax burden 6. Unclear ownership conditions 7. Low incomes 8. Difficulties when negotiating with authorities 9. Volatility of the political environment 10. Lack of physical infrastructures.

ν Empirical studies indicate that generalisation should be avoided. What matters with some regions, countries or companies does not necessarily apply elsewhere, with other geographical entities or economic agents.

ν Considering developing and transition countries, stability, democracy and human rights might be essential factors stimulating FDIs inflows, which underlines the importance of a comprehensive approach to development, combining political, legal and economical spheres.

ν Surveys do also underline the importance of a sound economic and legal environment, good governance, and adequate and transparent tax systems for attracting FDIs.

6 Lino Tondel, "Foreign direct investment during transition -- Determinants and patterns in Central Europe and the former Soviet Union", WP 2001: 9, Chr. Michelsen Institute / Development Studies and Human Rights. 7 J. Dean, M. Lovely and H. Wang, "FDI and Pollution Heavens: Evaluating the Evidence from China", Oct. 2002.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 81 NOTE ON FOREIGN DIRECT INVESTMENT

I. The impact of FDIs

FDIs can have significant impacts on GDP growth, incomes levels and their distribution, employment and wages, the trade balance (exports and imports), current and capital accounts, transfer pricing, tax collection, transfers of technology, knowledge and managerial skills, the environment, etc.

Very briefly, we review selected FDIs impacts.

5. FDIs, spillovers and growth effects

General findings "There appear to be good evidence that FDI efficiency spillovers exist. For developed countries, the limited evidence available indicates fairly consistently that the productivity of domestically owned firms is positively related to the presence of foreign firms. For developing countries, the results are generally positive, although somewhat mixed, with a number of (studies) showing a higher number of foreign presence increasing productivity in host country sectors, but others pointing to the limited or no efficiency spillovers. Foreign manufacturing in Mexico act in general as export catalysts for domestic firms. While there is evidence that joint ventures in Morocco and Venezuela exhibit higher productivity levels than their domestic counterparts, there is no evidence of positive short run spillovers from foreign to domestic firms … although that does not rule out positive spillovers in the long run. Overall, "while substantial support exists for positive spillovers from FDI, there is no consensus on causality".8

FDIs and growth in transition countries Regarding transition countries, the basic conclusion of an UNECE study about the impact of FDI is that the record is a very mixed one. Thus, the wider benefits of FDI are contingent on the domestic economic and institutional environment -- there is nothing automatic about them.9

6. FDIs and enterprise restructuring

Privatisation in transition economies can be a complex and difficult process. According to S. Djankov and P. Murrell from The World Bank, "private ownership produces more restructuring in the non-CIS region. In contrast, evidence is mixed for the CIS". Moreover, "the different types of private owners have very different effects. The most effective privatisation (to foreigners) is 10 times as productive as the least effective privatisation (to diffuse individual ownership)." Such outcomes seem to favour FDIs. However, one should keep in mind that MNCs are necessarily interested in buying enterprises that offers the best perspectives, particularly when taking into full account international economic conditions and their existing and well-established distribution networks, whereas domestic investors might lack knowledge and experience when choosing companies. What about also the ratio between the less effective privatisation to foreigners and the most effective one to nationals?10

7. FDIs and the environment

8 Ewe-Ghee Lim, "Determinants of, and the Relation Betwee, FDI and Growth: A Summary of the Recent Literature", IMF, WP/01/175, November 2001. 9 See Chapter 5 - ECONOMIC GROWTH AND FOREIGN DIRECT INVESTMENT IN THE TRANSITION ECONOMIES, Economic Survey of Europe, No. 1, 2001, UNECE. That study can be provided on request. 10 S. Djankov and P. Murrell, "The Determinants of Enterprise Restructuring: An Assessment of the Evidence", The IBRD / The World Bank, 2002.

82 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS

As already mentioned, FDIs might be influenced by environmental legislation. Moreover, in some instances, they also impact on the environment. Bad cases are provided by the activities of some MNCs in the agro-food sector in Central America, where the extensive use of pesticides has had negative consequences on the health of banana plantations' workers and surrounding rural populations.

ν There are positive linkages between the impact of FDIs on growth and levels of development: the more developed a country, the higher the growth impact of foreign investments.

ν Considering transition countries per se, FDIs may facilitate the restructuring of enterprises and, as result, facilitate the recovery process.

ν In some cases, the environmental consequences of FDIs should be carefully assessed.

II. Policies / measures related to FDIs

Dirk Willem te Velde divides policy factors affecting inward investment in three categories: (1) "affecting potential FDIs" ("determinants"), (2) "affecting established foreign investors" ("upgrading"), (3) "Affecting the response of domestic firms" ("linkages"). For each category, a line is drawn between so-called "industrial policies", macro-economic policies and other policies and factors. As discussed in the above text, these elements correspond mainly to location factors in Dunning's eclectic paradigm.11

8. Policies affecting potential FDIs ("determinants")

Industrial policies take generally the form of investment agencies that have promoted FDIs and targeted MNCs by providing information, organising visits, supporting feasibility studies and all kinds of promotion actions. In the case of Ireland, in some years, promotion could cost more than US$ 50 per inhabitant, which is far above what is observed and affordable in most developing and transition countries. Other factors include taxation, transfer pricing opportunities, foreign trade regimes, etc. A key question is how and how much effort should be devoted to attract new firms. Macro (and sectorial) economic policies also matter to make a country attractive. Expenditures in the field of education and infrastructure can ultimately attract FDIs as well as stable currencies, low inflation rates and adequate budgetary policies with limited deficits. The role of free trade zone should not be neglected, taking into account WTO rules. Other policies include regional economic integration schemes that permit access to markets larger than national ones, etc.

9. Policies targeting established foreign investors ("upgrading")

Those who have already been attracted must not be neglected and should be the focus of specific measures and policies. For instance, performance requirement for benefiting from tax concessions can also be adjusted to maximise the use of local resources. Interactions between domestic research institutions and MNCs can be encouraged as well as the establishment of specific training

11 Dirk Willem te Velde, "Policies Toward FDI in Developing Countries: Emerging Best-Practices and Outstanding Issues", Overseas Development Institute, March 2001.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 83 NOTE ON FOREIGN DIRECT INVESTMENT programmes for the youth and domestic managers. Considering macro and sectorial policies, the specific needs of MNCs could be met more adequately by, for instance, adapting and upgrading middle and high educational programmes in schools and universities, building new infrastructures, enhancing telecommunication services. Other measures could include double-taxation agreements with the home countries of MNCs.

10. Enhancing the response of domestic firms ("linkages") Linkages between FDIs and domestic firms have to be enhanced. For that purpose, R&D activities in local firms could be encouraged to better respond to the inputs requirements of MNCs. The exchange of information between local firms and MNCs could be promoted, using for that purpose business associations and chambers of commerce. At a macro-level, labour mobility across firms and sectors could be encouraged, etc.

11. International commitments Other important factors / measures for promoting FDIs include improving domestic legal frameworks by joining international conventions (such as MIGA, see Box 3), and acceding to the WTO.

Association Agreements" and Partnership and Co-operation Agreements (PCAs) between the EU and transition countries can also become so-called "nominal anchors" for more business conducive environments.

Box 3: The World Bank / MIGA

The Multilateral Investment Guarantee Agency (MIGA) was created in 1988 as a member of the World Bank Group to promote foreign direct investment into emerging economies to improve people's lives and reduce poverty. MIGA fulfils this mandate and contributes to development by offering political risk insurance (guarantees) to investors and lenders, and by helping developing countries attract and retain private investment. MIGA membership, which currently stands at 163, is open to all World Bank members.

Projects supported by MIGA have widespread benefits: local jobs are created, tax revenue is generated, skills and technological know-how are transferred. Local communities often receive significant secondary benefits through improved infrastructure, including roads, electricity, hospitals, schools, and clean water. Foreign direct investment supported by MIGA also encourages similar local investments and spurs the growth of local businesses that supply related goods and services. As a result, developing countries have a greater chance to break the cycle of poverty.

MIGA's guarantee coverage requires investors to adhere to social and environmental standards that are considered to be the world's best. Without World Bank Group involvement, projects often go ahead without adequate safeguards.

For more details, see: http://www.miga.org/screens/about/about.htm

ν The range of policies related to FDIs is definitely quite broad.

ν They can be used to attract FDIs, upgrade their impact on the economy and strengthen linkages with domestic producers.

ν Commitments created by WTO rules, trade and co-operation agreements (as well as IMF conditionality) should be integrated into the decision process.

ν Joining MIGA should be priority.

84 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS

Annex A: Selected National Experiences

1. Ireland

FDIs and the Irish economy In 2003, there were 1,050 foreign companies employing around 130,000 people that have set up their activities in Ireland. The impact of FDIs on the Irish economy is generally seen as important. Within a few decades foreign based MNCs helped to transform a largely agricultural society into one of the fastest growing economies in Europe, with one of the highest GDP per capita.

In 1995, foreign affiliates in Irish manufacturing were responsible for 47.1% of the total number of employees, 76.9% of value added, 52.6% of wages and salaries, 68% of R&D expenditures (in 1993), 82.3% of exports and 77.8% of imports. Value-added per employee in foreign-owned firms was 63.3% higher than in domestic firms.

Attracting FDIs Several factors explain the Irish success: - Active industrial policy: The Irish Development Agency was established in 1949 as part of the Department of Industry and Commerce, and with power to issue grants to cover land and building costs. It became a separate agency in 1969, responsible for national industrial development. It expanded rapidly and its promotion operations became world-wide, including Japan, Australia and even South Africa. US pharmaceutical and electronic companies were identified as essential for Irish development and these sectors now form the basis of industrial clusters, representing about the two thirds of employment in foreign companies. Besides, financial services grew in importance. In some instances, initial capital expenditure was provided, giving more impetus to FDIs. Fiscal incentives have also been very important in attracting FDIs, particularly to support export-oriented activities. - Macroeconomic stability in terms of low inflation rates and exchange rate stability is another key- stimulus for foreign investors. - Other elements include an educational and skill upgrading policy, EU membership and the availability of funds for infrastructural development, the use of English as an official language and traditional strong ties with the US, mainly through the emigration of Irish. - Upgrading existing FDIs became a priority, with a focus on companies that exhibit high value- added outputs. Increasing linkages between foreign companies and domestic ones is also a priority; a National Linkage Programme was initiated for that purpose.

2. Estonia

Successful transition Estonia can be seen as a successful example of transition. Within a decade, the country has been able to set up a functioning market economy based on private ownership. A stable environment was created for business activity with equal treatment for local and foreign investors.

The privatisation process The Estonian Privatisation Agency (based on the Treuhand Model -- namely the extensive use of highly advertised international public tenders with preliminary negotiations) could find strategic investors for local companies with the aim of conducting enterprise restructuring, ensure investment and market access, and improve management. 1150 companies with a total value of EUR 293 millions

GEORGIAN ECONOMIC TRENDS – 2004 No 2 85 NOTE ON FOREIGN DIRECT INVESTMENT were privatised during 1993-2001. The EPA was closed in 2001. Supervision activities related to contract enforcement are now taken over by the Ministry of Finance. The private sector now contributes to 80% of GDP and 99% of registered companies are in private hands. The Economic Freedom Index indicates the remarkable progress Estonia made over the last decade.12

Table: Economic Freedom Index in 2003 Country Rank HK 1 Singapore 2 Luxembourg 3 New Zealand 3 Ireland 5 Denmark 6 Estonia 6 US 6 Australia 9 UK 9 Finland 11 Source: Heritage Foundation Note: the lower the number, the more freedom

The importance of FDIs for privatisation In the Estonian privatisation context, FDIs were seen as very important. Considering the lack of domestic resources in terms of savings and managerial capabilities, FDIs can help improving rapidly competitiveness by provide sufficient capital, help the adoption of modern technologies and increase labour skills. As a result, FDIs inflows reached 6% of GDP per year during the reference period, an exceptional performance indeed. FDIs permitted the consolidation and restructuring of the banking sector that was able to attract 1/4 of the total FDIs stocks. In 2002, as the restructuring and privatisation process virtually ended, FDIs declined to 2.5% of GDP. Presently, reinvestments are increasing, partly encouraged by the exemption from taxes of reinvested earnings. 80% of FDIs came from EU countries, especially from Finland, Sweden and Denmark.

Table: Cumulative FDI-inflow per capita during 1989-2002, USD Czech Republic 3413 Hungary 2253 Estonia 1864 Slovak Republic 1784 Slovenia 1722 Latvia 1336 Lithuania 1024 Poland 997 Source: EBRD

Future benefits of EU membership Estonia has now become a full member of the EU, which may have additional impacts on future growth and development prospects. In 2004-2006, EUR 81 millions EU assistance will be provided to

12 Tonu Mertsina, "From Central Planning to the Market Economy: The Withdrawal of the State form the Economy", EU Secretariat, State Chancellery of the Republic of Estonia, November 27, 2007.

86 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS promote competitiveness raising programmes in addition to 77 millions for enhancing human capital and 89 millions to agriculture. High tech and knowledge activities should be expected to enlarge the economic base of the country.

3. South Korea

The take-off of the South Korean economy South Korea economic development was conditioned by many factors, including the cold war climate, the resulting competition between rival economic systems and the imperative to accelerate economic development in a country that had been ravaged by war. Economic development in South Korea relied on the active and often dominant role of the State and oligopolistic structures that led to the creation of huge conglomerates. These large entities would themselves become MNCs by investing abroad.

South Korean FDIs In the 1960s and 1970s, South Koran companies FDIs opened up markets for exports and to secure access to essential resources. In the 1980s, FDI were directed toward the US and then toward South Asia. FDIs in Europe grew quickly in the 1990s, partly reflecting a strategy to diversify economic ties and also reduce dependence on traditional markets, and were supported by several important official declarations, agreements and exchange programmes.13

ν The Irish experience shows that prospects for rapid growth and catching up with more advanced economies can be a reality. However, that requires a rather complex combination of factors, determined and committed decision-makers, adequate resources and a clear vision about the future of the country; all that in a democratic context.

ν The Irish case could have inspired Estonians who succeeded in making their country an EU member within a decade or so. The Estonian experience also shows that FDIs can be a leading force for successful privatisation.

ν After recovering from a devastating war, South Korea went through an exemplary path of economic growth and development, and despite a recent financial shock, national companies are now dynamic MNCs investing in high income countries.

ν Overall, the quality of governance and conducive legal and tax systems are quite essential for attracting FDIs and making success stories.

13 For more details, see Judith Cherry, Korean Multinationals in Europe, Surrey: Curzon, 2001.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 87 NOTE ON FOREIGN DIRECT INVESTMENT

Annex B: Selective Company News

BP (UK) - The British company is present in Azerbaijan since 1992. The focus of its operations is on offshore oil and gas exploitation and production in the Caspian Sea and the development and operation of export pipelines. - BP is leading the Baku-Tbilisi-Ceyhan (BTC) pipeline project. BTC CO has been formed to construct and operate the pipeline that has a length of 1759 km and shall allow the export of Azeri oil to the world market. - BP is presently exploring possibilities for social investment in the areas of health and sanitation, assistance for education activities, improvements to social and economic infrastructures and services, programmes to enhance economic opportunities, and other forms of income generating activities.

Delhaize (Belgium) - Delhaize Group was founded in Belgium in 1867. It is a food retailer headquartered in Belgium, which operates in 10 countries and on three continents (North America, Europe and Southeast Asia). - Delvita is the operating company for Delhaize Group's interests in the Czech Republic since 1991 and Slovakia since 1998. At the end of November 2002, Delvita operated 109 stores (93 in the Czech Republic and 16 in Slovakia). As of December 31, 2002, Delvita had 5,348 associates. - In May 2000, Delhaize Group acquired ownership interest in Mega Image, the largest supermarket operator in Bucharest, the capital of Romania. At the end of 2002, Delhaize Group owned 70% of Mega Image, which operated 12 supermarkets and employed 898 people.

Bata A bit of history: - Founded in Zlin, in what is now the Czech Republic, in 1894 by Tomas Bata. - After WWI, companies were opened in Poland, Yugoslavia, Holland, Denmark, the United Kingdom and the USA. By the early 1930s, the Bata enterprise and Czechoslovakia were the world's leading footwear exporters. - In 1992, the Organization and family were invited to return to the Czech Republic, where Bata had remained a symbol of national pride and achievement. International presence: - Retailer, manufacturer and distributor of competitively priced commercial fashion footwear and accessories. - Employs over 50,000 people in retail, manufacturing and wholesaling operations. - Over 4,700 company owned retail stores. - Bata companies annually manufacture over 140,000,000 pairs of shoes in 46 production facilities and over 30 million square feet of leather in 9 tanneries. - Bata companies serve almost 1 million customers each day.

General Electric (US) / Tungsram (Hungary) - November 15, 1989. The US General Electric Co. announces that it is purchasing 50% of the world renown Hungarian Tungsram plant (which makes lighting equipment). Tungsram had been owned by GE prior to its nationalization in 1948.

88 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS - Even under the communist system, Tungsram was able to sell its lighting products in more than 100 countries. The company's main assets included its traditionally strong scientific and technology capability and a skilled and relatively low-cost labour force. -

- In 1995, some 90 percent of GEL European production was located in Hungary, as several newly acquired West European facilities were closed down and their machinery was transferred to Tungsram. - The Nagykanizsa factory has become the world's largest and most outstanding producer of light sources.

ABN AMRO (The Netherlands) ABN AMRO Bank NB Uzbekistan A.O. became fully operational in December 1996 making it the first international full-service bank to operate in Uzbekistan. It provides a full range of services such as advisory, financing and operational services to large companies and institutional clients. EBRD supported the start up of ABN AMRO operations in the country.

Gazprom (RF) - Gazprom has published a list of its affiliates for the first time in 2000. The list contains the names of the following companies: Gazsnabtranzit, Moldova (where Gazprom owns 50 per cent of the authorized capital), EvRoPol Gaz, Poland, with 48 per cent belonging to Gazprom and Stella Vitae, Lithuania (30 per cent). Gazprom also owns 25 per cent in Latvias Gaze, Latvia, 50 per cent in Slovrusgaz, Slovakia, 50 per cent in Overgas Inc., Bulgaria, 45 per cent in Turusgaz, Turkey and 25 per cent in GazumFinland, etc. - In July, Gazprom signed a 25-year agreement with Georgia. - According the RFE/RL (30 January 2004), Azerbaijan decided to increase gas imports from Russia.

ν Company news indicates that FDIs take place in all sectors.

ν Some "transition countries" had their own multinationals and benefited from FDIs before experiencing communism.

ν Both big countries and smaller ones are the home of MNCs.

Annex C: Useful Data Bases

UNCTAD / DITE - UNCTAD's Division on Investment, Technology and Enterprise Development (DITE) is the focal point, within the UN system, for matters related to foreign investment and technology, and it has a leading role in the area of enterprise internationalisation. - DITE aims at advancing its research and technical co-operation activities with a view towards disseminating state-of-the-art information on trends and best practices in international investment, enterprise development and technology transfer, identifying policy options, and strengthening human and institutional capacity-building.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 89 NOTE ON FOREIGN DIRECT INVESTMENT

- DITE compiles statistics on foreign direct investment (FDI) world-wide. The interactive database presents aggregate FDI statistics, regularly updated. The database includes inflows, outflows, inward stocks and outward stocks for 196 reporting economies.

Internet addresses/links: - UNCTAD: www.unctad.org - DITE: http://r0.unctad.org/en/subsites/dite/ - DATA: http://r0.unctad.org/en/subsites/dite/fdistats_files/fdistats.htm

ITC - The International Trade Centre (ITC) is the technical cooperation agency of the United Nations Conference on Trade and Development (UNCTAD) and the World Trade Organization (WTO) for operational, enterprise-oriented aspects of trade development. - ITC supports developing and transition economies, and particularly their business sector, in their efforts to realize their full potential for developing exports and improving import operations. - ITC’s technical assistance concentrates on the three issues for which it believes the need for national capacity-building is most critical: helping businesses understand WTO rules; strengthening enterprise competitiveness; and developing new trade promotion strategies. - The country approach offers an overview of ITC's technical cooperation activities at the country and regional levels. It provides links to national trade support institutions and country specific business information. In addition, it presents trade and market profiles based on trade statistics, which benchmark national trade performance and provide indicators on export supply and import demand.

Internet addresses/links: - ITC: http://www.intracen.org/ - Data base (case of Tajikistan): http://www.intracen.org/countries/toolpd01/tjk_1.pdf

Annex D: Annex Statistical Tables

Annex Table 1: OSCE countries -- Basic indicators, 2002 ------Region/ Total GDP Total GDP per capita Country Billions US$ Population PPP US$, '000 Millions ------North America USA 10,110 288 35,060 Canada 882 31 28,070

EU 15 and European Economic Space (former EFTA) Austria 230 8 28,240 Belgium 282 10 27,350 Denmark 158 5 29,450 Finland 132 5 25,440 France 1,556 59 26,180 Germany 2,163 82 26,220

90 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS Greece 194 11 18,240 Ireland 109 4 28,040 Italy 1,467 58 25,320 Netherlands 443 16 27,470 Norway 163 5 35,840 Portugal 174 10 17,350 Spain 842 41 20,460 Sweden 224 9 25,080 Switzerland 226 7 31.250 UK 1,529 59 25,870

Central and Eastern Europe Bulgaria 54 8 6,840 Czech Republic 148 10 14,500 Hungary 130 10 12,810 Poland 391 39 10,130 Romania 141 22 6,290

Baltic States Estonia 15 1 11,120 Latvia 21 2 8,940 Lithuania 34 3 9,880

South Eastern Europe Albania 13 3 4,040 Croatia 43 4 9,780 Macedonia 13 2 6,210 Slovenia 35 2 17,690 Serbia & Montenegro n.a. 11 n.a.

Turkey 426 70 6,120

Western CIS Belarus 53 10 5,330 Ukraine 226 49 4,650 Moldova 7 4 1,560

Russia 1,127 144 7,820 Southern Caucasus Armenia 9 3 3,060 Azerbaijan 24 8 2,920 Georgia 11 5 2,210

Central Asia Kazakhstan 81 15 5,480 Kyrgyz Republic 8 5 1,520 Tajikistan 6 6 900 Turkmenistan 25 6 4,570 Uzbekiistan 40 25 1,590

GEORGIAN ECONOMIC TRENDS – 2004 No 2 91 NOTE ON FOREIGN DIRECT INVESTMENT

------Source: The World Bank. Note: PPP = Purchasing Power Parity.

Annex Table 2: FDIs flows and stocks (US$ millions), 2002 ------Region/ FDIs flows FDIs stocks Country Inward Outward Inward Outward ------North America USA 30,030 119,741 1,351,093 1,501,415 Canada 20,595 28,793 221,468 273,729

European Union and European Economic Space (former EFTA) Austria 1,523 5,670 42,539 40,220 Belgium 18,252 13,228 n.a. n.a. Denmark 5,953 4,839 71,784 74,605 Finland 9,148 9,841 35,509 69,468 France 51,505 62,547 401,305 652,105 Germany 38,033 24,534 451,589 577,849 Greece 50 655 12,056 7,026 Ireland 19,033 2,706 157,298 36,453 Italy 14,545 17,123 126,481 194,498 Netherlands 29,182 26,270 314,569 355,652 Norway 872 5,537 33,452 38,308 Portugal 4,276 3,523 43,962 31,983 Spain 21,193 18,456 217,769 216,051 Sweden 11,081 10,869 110,482 145,382 Switzerland 9,503 11,787 118,139 297,570 UK 24,945 39,703 638,561 1,033,003

Central and Eastern Europe Bulgaria 479 28 3,889 125 Czech Republic 9,319 281 38,450 1,496 Hungary 854 264 24,416 4,641 Poland 4,119 173 45,150 1,280 Romania 1,106 16 8,786 155

Baltic States Estonia 307 122 4,226 670 Latvia 396 9 2,723 67 Lithuania 732 18 3,981 60

South Eastern Europe Albania 213 4 988 86 Croatia 981 95 6,029 1,064 Macedonia 77 n.a. 907 5 Slovenia 1,865 117 5,074 1,066

92 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS Serbia & Montenegro 475 -- 1,959 --

Turkey 1,037 -- 18,558 3,950

Western CIS Belarus 227 - 206 1,602 -- Ukraine 693 - 5 5,355 153 Moldova 111 -- 713 19

Russia 2,421 3,284 22,583 18,018

Southern Caucasus Armenia 100 11 680 55 Azerbaijan 1,067 326 5,354 957 Georgia 146 -- 679 --

Central Asia Kazakhstan 2,561 423 15,354 464 Kyrgyz Republic -12 6 415 45 Tajikistan 9 -- 162 -- Turkmenistan 100 -- 1,163 -- Uzbekiistan 65 -- 1,332 ------Source: UNCTAD.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 93 NOTE ON FOREIGN DIRECT INVESTMENT

Annex Table 3: FDIs flows and stocks, 2002 ------Region/ FDIs as % of GFCF FDIs Stocks as % of GDP Country Inward Outward Inward Outward ------North America USA 1,9 7.5 12.9 14.4 Canada 14.3 19.9 30.4 37.6

European Union (EU15) and European Economic Space (EES, former EFTA) Austria 13.4(01) 7.1(01) 20.6 19.5 Belgium Denmark 17.7 14.4 41.7 43.4 Finland 35.0 37.8 27.0 52.8 France 18.4 22.4 28.2 45.8 Germany 10.4 6.7 22.7 29.0 Greece 0.2 2.1 9.0 5.3 Ireland 70.9 10.1 129.1 29.9 Italy 6.2 7.3 10.6 16.4 Netherlands 33.2 29.9 74.9 84.7 Norway 2.7 17.1 17.4 20.0 Portugal 13.6 11.2 36.0 26.2 Spain 12.8 11.1 33.2 33.0 Sweden 27.0 26.5 46.0 60.5 Switzerland 19.2 24.3 44.2 111.3 UK 10.1 16.1 40.8 66.1

Central and Eastern Europe Bulgaria 17.0 1.0 24.0 0.8 Czech Republic 59.1 1.8 54.8 2.1 Hungary 20.1(01) 2.8(01) 38.2 7.3 Poland 11.4 0.5 23.9 0.7 Romania 14.1(01) -0.2(01) 20.5 0.4

Baltic States Estonia 16.8 6.7 65.9 10.5 Latvia 18.0 0.4 32.4 0.8 Lithuania 24.7 0.6 31.4 0.5

South Eastern Europe Albania 26(01) -- 21.0 1.8 Croatia 35(01) 3.5(01) 28.4 5.0 Macedonia 96.4(01) 0.2(01) 23.9 0.1 Slovenia 37.1 2.3 23.1 4.8 S&M 9.8(01) -- 20.4 --

Turkey 12.4(01) 1.9(01) 10.2 2.2

94 GEORGIAN ECONOMIC TRENDS – 2004 No.2

NOTE ON FOREIGN DIRECT INVESTMENTS

Western CIS Belarus 5.8 -5.3 11.2 -- Ukraine 10.7(01) 0.3(01) 12.9 0.4 Moldova 77.9(01) -- 45.0 1.2

Russia 3.9 5.3 6.5 5.2

Southern Caucasus Armenia 18.6(01) 2.9(01) 28.7 2.3 Azerbaijan 14.6(01) 10.2(01) 86.4 15.4 Georgia 19.9(01) -- 19.9 --

Central Asia Kazakhstan 55.6(01) 0.5(01) 62.9 1.9 Kyrgyz Republic 2.3(01) 2.8(01) 25.9 2.8 Tajikistan 5.3(01) -- 14.8 -- Turkmenistan 10.1(01) -- 19.1 -- Uzbekistan 45.7(01) -- 13.8 ------Source: UNCTAD Notes: - GFCF = gross fixed capital formation, - GDP = gross domestic product.

GEORGIAN ECONOMIC TRENDS – 2004 No 2 95

APPENDIX II Georgian Wine Industry: Present State and Prospects of Development

Nodar Chkhartishvili, Director of the Georgian Research Institute of Viticulture and Winemaking

Zurab Gelashvili, Head of Economic Department of the Georgian Research Institute of Viticulture and Winemaking

Wine production is the oldest and most significant industry in Georgia and occupies a special position in the economy of Georgia. This industry has always played an important role as a material, cultural and intellectual wealth and in view of formation of a national economy. Favourable natural conditions, especially soil and climate, as well as a long cherished tradition have to great extent contributed to the development of this industry on the whole and in particular to the cultivation of species for the production of high quality wines.

Georgia is recognized by famous native and foreign scientists to be one of the countries, which are considered progenitors in terms of vine cultivation and the Georgian gene pool is seen as a valuable component of the world gene pool regarding a variety of wild sorts of vine, including the ancestor of the contemporary cultivated species - Usurvasi - and over 500 of indigenous Georgian species, which is indeed a unique phenomenon world-wide.

For thousands of years Georgians have been engaged in cultivation of new species forming and developing their own specific tradition and technologies for the production of various top-quality wines.

Thanks to the above-referred rare favourable conditions, original dry red and white vintage wines and sparkling and naturally sweet wines are produced out of the best quality Georgian species. Such unique Georgian species as Rkatsiteli, Saperavi, Mtsvane, Khikhvi, Chinuri, Tavkveri, Tsitskha, Tsolikauri, Krakhuna, Otskhanuri, Sapere, Aleksandroeuli, Mudzuretuli, Odzaleshi, Chkhaveri, Kachichi and many others are well-known all over the world. They provide a valuable base for making high quality wines, the production of much of which dates back 1500 years. Indeed, Georgian wines owe their prestige on internal and external markets to the valuable wine base provided by these species.

Until recently, wine-growing and wine-making were considered highly profitable industries. 15-20 years ago (in 1985-1990) viticulture accounted for 18-20 per cent of the overall agricultural products, the share of wine production in the output of food industry was 15-16 percent. These industries made an essential contribution to the Budget as well.

In 1985, in Georgia, the total area under vineyards amounted to 128 thousand hectares. In 1981-1990 the average annual production of grapes was 710 thousand tonnes of which over 500 thousand tonnes were processed at state wineries producing 28-30 thousand dekalitres of wine.

There were 18 specialized sapling farms and greenhouses operating in the country that produced on average 18-20 million saplings per year - enough to satisfy local demands and also for exporting them to neighbouring countries.

96 GEORGIAN ECONOMIC TRENDS – 2004 No.2

However, it should also be noted that despite certain achievements, some negative trends and processes could also be observed within the reference period. As a result of compulsory fulfilment of unrealistic government assignments during the authoritarian regime only 2 or 3 species yielding high profits dominated with over 92 per cent of production. Areas under species providing various red and white wines base of high value were limited to 3-4 per cent. Unique micro-zones supplying wine base for the production of wines internationally known for their geographical location were under the threat of destruction.

Loss of interest in production of diversified high quality wines and the disruption of state and popular quality control systems resulted in undermining of the international reputation of Georgian wines. No efforts were made to gain access to and establish themselves on an international marketplace.

In the last decade of the past century, the adverse political and economic developments in the country led to the situation in the wine industry becoming even worse due to the economic reforms performed in haste and without proper understanding or account of science-based recommendations and because of blunders in privatization of land evoking unnecessary processes that had a negative effect on viticulture and wine industry.

High-yielding vineyards cultivated on large tracts of land were segmented, extirpated and destroyed. Over half of about 50 thousand hectares of privatized vineyards was uprooted. As a result, the total area of vineyards in Georgia was cut from 112.9 thousand hectares in 1990 (including 101.6 hectares of productive area) to 68.9 thousand hectares in 2000 (up to 61.5 hectares of productive area), that is 1.6 times. A large part of vineyards (25-30 per cent) is not properly worked by land owners because of the lack of resources. With the scarce machinery, a great deal of works on vineyards segmented into small plots is mostly performed manually, which is labour-consuming. It is no doubt that economic efficiency deteriorated as costs rose. During the referred period the vintage reduced in volume from 691 thousand tons to 90 thousand tons that is 7.7 times. Combined with this, the yield per hectare declined by half to less than 35-37 centners.

The life of vineyards was reduced from 40 to 12-15 years. The age and variety balance has been destroyed. Unique species in traditional zones of wine-growing and in micro-zones supplying wine base for the production of original wines were endangered and the wine base for the production of famous brands was reduced dramatically.

Sapling farms stand idle and organized production of saplings ceased along with cultivation of vineyards. Technical bases comprising 18 sapling farms and green-houses equipped with advanced technologies for production of plantings have been totally destroyed. Over 1,000 nurseries for unique phylloxera-resistant species and their clones are lost.

This unfavourable situation with viticulture (i.e. growing of vines) had a negative impact on the development of the wine industry. Sharp reduction in the volume of vintage and lack of resources affected production capacity of primary wine factories. According to the data by “Samtrest” - the State Viticulture Department of Georgia, in 1990, the volume of grapes processed by wineries was 433 thousand tonnes, while in 2003 just 19.5 tonnes, that is 22.2 times less. Production of wines and wine base during these years fell from 16,183 thousand to 2,412 thousand dekalitres (6.7 times), that of “champagne-type” and sparkling wines – from 1,451.4 thousand to 160.2 thousand dekalitres (9- times), while production of brandy reduced from 2,165 thousand dekalitres to 138.9 thousand

97 Innovation Systems in Employment dekalitres (15.6-times), that of alcoholic beverages – from 822 thousand to 116.8 thousand dekalitres (7-times).

Until 1991, the Georgian wine industry produced over 50 brands, including such celebrated wines as Tsinandali, Gurjaani, Manavi, Mukuzani, Napareuli, Bakhtrioni, Rkatsiteli, Tabaani, Tsolikauri, Kindzmarauli, Akhasheni, Khvanchkara, Odzaleshi, Chkhaveri, etc.

The share of dry vintage wines in the total output accounts for just 15 per cent, that of semisweet wines – 5.5 per cent, sparkling wines – 2.2 per cent, while the share of ordinary dry wines exceeds 52 per cent and that of ordinary fortified wines is 17 per cent.

The weakening of the competitiveness of Georgian wines on foreign markets due to the problems accumulated in wine industry during these years has led to a significant reduction in exports even to traditional marketplaces. According to the data by “Samtrest”, in 2002 Georgian wines exports were just 1,731 thousand dekalitres against 2,437 thousand dekalitres in 1988 (70 per cent). Today, major wine producers are private companies. They should be interested in producing quality wines and exporting as much as possible to foreign markets to sell at a high price and to gain high profits.

At present, wine products are mainly exported to the CIS markets and first of all to Russia 1,664 thousand dekalitres of white, rose, dry red, semi-dry and semi-sweet wines, which accounts for 85 per cent of total wine exports. Notably, the share of bottled wines in total wine exports is 92 per cent.

One of the reasons preventing Georgian exports from being successful is counterfeited wines bottled outside the country in Moldova, Bulgaria, the Ukraine, Russia, Baltic countries and placed for sale under such reputed Georgian brands as Khvanchkara, Kindzmarauli, Mukuzani, etc., which have nothing in common with Georgian origin.

These adulterated wines produced in these countries and containing not even a bit of Georgian wine base enter foreign markets and especially Russia in large quantities, where they are sold quite cheaply under Georgian brand names. Such competition against original Georgian wines does much harm to the wine industry of Georgia and its export potential. Falsification of Georgian wines has become an international phenomenon. Unfortunately, there was no legal base ensuring any drastic measures against such products available in Georgia.

Production of high quality wines is also much hampered by an inflow of counterfeit wines to local markets and lack of control on behalf of the Government, as well. Markets are flooded with adulterated products.

For full Integration into the world trade system Georgia must take its responsibility for fighting against counterfeit products. Hence, it is necessary to take appropriate measures to this end.

Integration ties, contractual partnership relations in the country between wineries and suppliers that imply granting by wine-makers of certain material incentives for timely provision of high quality wine base and charging fines on contract parties for non-compliance, have been destroyed. Today, contracts are rarely concluded. The point is that management of the wineries seeks to purchase grapes cheap during the vintage period and hence, without concluding contracts in advance. Naturally, under such circumstances the quality of wine base does not count much. As a result the value of wines is undermined.

98 GEORGIAN ECONOMIC TRENDS – 2004 No.2

Even from this brief analysis of the current situation in viticulture, it is clear that the poor condition of this industry is a reflection of recent political and economic developments and their subsequent unsatisfactory social and economic effects.

With the market economy, the approach to viticulture in Georgia has changed together with organizational and legal forms of management. Therefore, while maintaining and perfecting a rich heritage, it is necessary that further development of these industries be guided by international achievements and up-to-date requirements.

Today, there are many new integrated state-owned and private enterprises operating in the country under various organizational and legal forms of management (such as companies, firms, joint stock companies, limited liability companies, farms and etc.), which require more regulation by the government. This implies creation of a favourable environment and a level competitive playing field for the ongoing integration processes to proceed in a proper direction. Such approach to the problem is the only way to attain effective functioning of these industries and recovery of the economy as a whole.

Research and related estimations show that production of wines is much cheaper and much more effective at those enterprises, where a winery and raw material base are incorporated under one legal entity. These processes are effectively implemented stage-by-stage and produce positive results.

With the ongoing political and economic reforms in Georgia, it is necessary to define major trends and parameters of future development of the viticulture taking into account a scientific assessment of the current situation, most favourable natural conditions, rational use of agro-ecological resources, demographic factors, common national and regional traditions, manpower and other factors and their real potential against domestic and foreign markets demand.

Proceeding from the above, the elaboration of a state programme for rehabilitation and the long-term steady development of these industries (for 2005-2020) is a priority task that can only be undertaken with governmental support.

Along with the recovery and enhancement of national traditions, the development of these industries should be based on contemporary national and international achievements, position and role of these industries in national economy and budget formation, and the potential for access to international markets in the future. To this end, gaining a strong position on the world market by original Georgian wines should be regarded as a guideline.

Revival of the viticulture and wine industry should happen gradually through defining rehabilitation policy and strategic targets by regions at the initial stage.

Production of wines under appellation of origin and brand control and a substantial increase in the output of superior quality dry red, rose and white wines, semi-dry sweet, semi-sweet and sweet wines, sparkling wines and high quality brand will remain a priority target in rehabilitation of Georgian viticulture and future development of the industry. This implies reorganization and optimization of diversified and quality raw material bases for the production of wines based on complex research and rational use of agro-ecological resources.

Rehabilitation of viticulture requires restoration of sapling farms. It is necessary to create a solid base for certified saplings production in the country. Revival of this industry is impossible without

99 Innovation Systems in Employment restoration and development of sound sapling production bases, such as sapling farms, nurseries, green-houses.

Saplings production requires fundamental restructuring. Sapling farms, both state and privately-owned should be oriented at the production of pure and phyto-sanitarily sound, virus-free, selected, and certified saplings. To this end, establishment of a research and production centre for the production of biologically pure and sound saplings on in vitro basis under the guidance of research organizations, should be among the top priorities. In particular, base saplings farms should be located on the premises of research organizations as production of selected certified saplings requiring a relevant scientific and technical base and a highly qualified staff, is a prerogative of scientific institutions only. To this end, it would be reasonable if it were co-ordinated by the Institute of Horticulture and Viticulture of Georgia.

According to preliminary estimates every year 800-1,000 hectares of vineyard will be cultivated, which approximately requires 3-4 million saplings. That is why restoration and reinstatement of selected saplings farms is so urgent. At the first stage (4-5 years) such nurseries should occupy at least 200- 300 hectares and ultimately be expanded up to 400-500 hectares. Large saplings farms throughout the country could be distributed by regions as follows: 2 or 3 in Kakheti, 1 or 2 in Kartli and 1-2 in Imereti, Racha-Lechkhumi and other regions of west Georgia.

Now a principle novelty in viticulture is an economically justified ecological approach. It is necessary to focus on the biological potential of the species and optimal combination of environmental factors in a single “soil-plant-atmosphere” system. On one hand, it assumes rational consumption of natural resources and on the other – adaptation of the plant (vine) to the environment, the maximum use of its genetic nature, and identification of its reaction to climatic effects.

Priority directions in agro-techniques and technology of viticulture should include:

- Complex study of agro-ecological zones and in particular, of unique microzones to identify most favourable areas for wine-growing and attaining high cost efficiency; distribution and spreading of unique species and their clones in traditional and newly identified microzones. - Management of natural soil fertility on vineyard areas and environmental monitoring, which implies perfection and adoption of up-to-date biodynamic, zero-to-minimum tillage (herbal- cord system, mulching) systems preventing ecological damage; production of ecologically pure and safe products through minimization of an environmental impact of chemical agents and production of vine saplings in compliance with regulations. - Improvement of integrated methods of pest control, primarily through combined application of genetic (growing endurable and excessive-endurance species), biological and agro-technical measures. - Regulation of the growth and productivity by agro-technical and biological methods; - Optimization of intensive and highly intensive development of vineyards and technological schemes on maintenance basing on scientific recommendations by local and foreign experts.

Priority directions with regard to selection remain: - Growing high endurance, high quality and wide technological range, ecoplastic species; identification and cultivation of clones, cultivation of chlorosis-resistant saplings by means of contemporary selection such as bioengineering, biotechnological and biophysical methods.

100 GEORGIAN ECONOMIC TRENDS – 2004 No.2

- Protection of biodiversity of the Georgian vine - the largest gene pool in the world counting over 500 indigenous species - both in situ and ex situ; marking according to up-to-date international methodology.

In wine production a strategic target should be: - Extension of the range of export products, restoration of the lost positions by Georgian wines on CIS markets, while seeking access to new marketplaces in other countries. To this end, it is necessary to expand production of high quality unique red, rose, white and sparkling wines as well.

Priority directions in viticulture are:

- Investigation of healing properties of vine and finished products, especially of wines, under the aegis of Wine and Health - Development of new technologies of maturing wine, primarily out of those indigenous species that are included in the Georgian gene pool; restoration and enhancement of traditional technologies (Kakhetian, Imeretian and etc.) and working out of theoretical principles with the view of identifying most useful properties for human health - Improvement and expansion of the production of sparkling wines, brandy and other alcoholic drinks on the basis of research study of the source of raw materials - Creation of a scientifically justified system of combating falsification of wines using molecular marking (DNA).

Rehabilitation of viticulture and wine production and their further development should be underpinned by scientific groundwork. Hence, attainment of a high level and efficiency of researches requires restoration of scientific and technical bases of research institutions, equipment of laboratories and offices to modern standards and ensuring material incentives for scientists engaged in these industries.

However, with the market economy, parameters of development of an industry, quality and scale of production are defined and regulated by the market, but to avoid spontaneity in order to achieve steady growth in viticulture it is necessary to specify reference parameters, which is both in the interests of the state and the Organization of International Viticulture (OIV).

Insofar as the Georgian viticulture is mainly oriented at production of wines, the process of its revival should be closely tied to wine industry. In planning vine-growing, it is necessary to take into account the demand of processing industries for raw material. As regards the scale of development of these industries, it should be underpinned by real opportunities, market demand and an available economic potential for budget formation.

A conceptual programme for rehabilitation of viticulture should form a basis for elaboration and stepwise implementation of short and long-term state programmes. In a regional aspect, main trends and indispensable measures to be taken to this end in the near future should be developed in short- term programmes, as well as specific implementation schemes, sources of finance and sums required; whereas long-term programmes will envisage a complex of measures to be taken with regard to attaining steady growth, which in practice will essentially change the present condition of these industries raising them to the level of up-to-date requirements and world standards.

101 Innovation Systems in Employment

To meet the challenges that Georgian viticulture is facing today, the share of moderately and relatively low-productivity unique species such as Saperavi and its clones, Khikhvi, Mtsvane, Aleksandroeuli, Mudzuretuli, Usakheloeuri, Odzaleshi, Otskhanuri Sapere, Chkhaveri and others should be increased from the current 5-6 per cent up to 50 per cent (as defined also by the Law on Vine and Wines). At present, with an increased demand for red, rose and sparkling wines on the world market, growing white and rose vines will be preferential while observing the proportion of white vines, raising the share of wine base for the production of sparkling wines.

Wine base for naturally rose wines should be paid a special attention and increased through expanding vineyards of indigenous Georgian species such as Shavkapito, Tavkveri, Kabistoni Red, Dzelvashi, Asuretian Red, Chkhaveri, Kachichi and others. These species provide naturally rose, delicate and invigorating wines for which there is a particularly high demand on international markets. The share of this category of wines in the total output should increase at the initial stage at least up to 10-15 per cent.

Production of wines should progressively become subject to control of an appellation of origin. At the first stage (during the first decade) their share in the total volume of production may initially be set at 20-25 per cent and subsequently increased until ultimate 45-50 per cent.

A special position among Georgian wines belongs to sparkling wines, which is largely predominated by their profitability. Today, throughout the country a wine base for the production of this type of wines has reached the minimum. By preliminary estimations, it is possible to produce 18-20 thousand million bottles of sparkling wine (including naturally sparkling wines of Atenuri type), which requires 8-10 thousand hectares of vineyard.

As concerns Georgian brandy, the same approach should be applied with regard to rehabilitation of the raw material base for its production. Creation of a raw material base for brandy base in special micro zones and with recommended species would enable production of brandy, the same as wine, under appellation of origin such as Gremi, Eniseli, Vartsikhe, etc.

A tradition of processing brandy base also needs to be revived. By preliminary estimations, 2-3 million dekalitres of wine base would produce 200-300 thousand dekalitres of brandy base of which 25-30 per cent after maturing will be placed for sale on world markets under well-known Georgian brands.

Today, production of table grapes is also in a poor condition being limited to just local consumption purposes. Production of table grapes should be restored and expanded so as to supply large towns and resorts and for exports purposes as well.

It is necessary to raise the level of production and supply to consumers of table grapes and currant grapes. To this end, scientists recommend special zones and species that would provide consumers with fresh grapes from the end of July to the end of November in the form of a natural conveyor.

On the basis of the analysis of the current situation with viticulture, past practical experience and opportunities for development and given a special role of the industry in the economy of the country, the total area under vineyards in Georgia is likely to be expanded to 90,0 hectares by 2020 and be maintained within these limits. This benchmark would be optimal.

As regards preserving age proportion, 90-92 per cent of vineyards will comprise matured vines and 8- 10 per cent will be occupied by young 1 to 3 year old vines. Thus, the area under vineyards of steady

102 GEORGIAN ECONOMIC TRENDS – 2004 No.2

productivity will comprise approximately 81-83 thousand hectares. In order to preserve high quality of raw materials i.e. condition, an average productivity of unique vine species per hectare should be limited to 70-75 centners and that of the rest – to 75-80 centners per hectare on average.

The above referred target parameters with regard to vineyards area and yield, considering losses (10- 15 per cent) caused by natural phenomena like hail, frosts, drought, floods, etc provide for a yearly production of 550 thousand tones of condition grapes starting since 2020 of which for local household consumption - 125 thousand tonnes (23 per cent) and the remaining 425 thousand tonnes – for industrial processing. The output of red and rose brands of naturally sweet, semi-sweet, dry, semi-dry and other unique wines of this type will amount to 8 million dekalitres, that of original white brands of naturally sweet, semi-sweet, dry, semi-dry and other unique wines of this type will amount to 7 million dekalitres, of dry table wines – 3 million dekalitres, of brandy – 1.5 million dekalitres, liquor and other alcohol products – 1.5 million dekalitres.

Money received from the sale of grape will total GEL 105 million, proceeds from all types of wine – GEL 340 million; of which from the sale of red and rose brand wines – GEL 175 million, from white brand wines - GEL 100 million, from dry table wines – GEL 35 million, sparkling wines – GEL 30 million, from the sale of brandy - GEL 40 million and from liquor and other alcohol products – GEL 35 million. Proceeds from the sale of all types of products of viticulture will altogether make up GEL 520 million. The total amount to be paid to the state budget as income tax will exceed GEL 130 million.

Throughout Georgia areas under vineyards by regions and hence, production volume of grapes and wine will be distributed as follows: the share of Kakheti will be 66-68 per cent, Kartli – 15-16 per cent, West Georgia (including Racha-Lechkhumi and the rest of the Black Sea coastline) – 18-20 per cent.

Kakheti – is a leading region in these industries producing red and white top quality brand wines under appellation of origin. Here, they count 25 microzones for the production of wines under appellation of origin: Tsinandali, Gurdzaani, Nafareuli, Kindzmarauli, Mukuzani, Kardanakhi, Akhasheni, Manavi, Tibaani, etc. Khakheti is the main provider of export wines and this tradition will persist in future too.

Meanwhile in Kakheti they are intensively growing species such as Saperavi and its clones, producing high quality wine base to meet large demand for red wines on world markets. At the same time, it is necessary to restore and ensure that such unique species providing wine material for special quality original white and European type wines of high value such as Kakhuri Green, Khikhvi, Kisi occupy an appropriate position. As concerns Rkatsitela, a universal species, it will always retain its high value.

Kartli – is one of the leaders in production of sparkling wines and quality wine-making in general. It mainly produces wine base for the production of naturally sparkling wines (Ateni-Khidistavi microzone). Ksani and Aragvi gorge is well known for the production of light white European type of wines manufactured from local Gori Green, Chinuri and other wine base. Here they produce naturally rose wines for which there is also a great demand on the world market. Rose wines are produced from the products of such local species as Tavkveri, Shavkapito and others.

Imereti – is a large and important region of viticulture in West Georgia, which is characterised by a diversity of quality white and red vine species in microzones; middle and upper region of Imereti is famous for high value sparkling wines characterized by an excellent bouquet and other positive taste properties.

103 Innovation Systems in Employment

Recently, a certain political stability in Georgia has found an adequate reflection in positive processes started in the viticulture sub-complex. Reanimation and progress in agro-industry has first appeared in these industries. It is an implicit priority for rehabilitation and strengthening of the economy to become a reality, which is also reflected in the Law on Vine and Wine (1998).

Despite a hard financial and economic situation in the country and other difficulties as well, the process of revival of these industries has been activated; local and foreign investors have been found who are now intensively growing new vineyards.

The process of revival is also underway in viticulture. The demand for Georgian and especially red, rose and sparkling wines on foreign markets has increased and has given rise to positive impulses. This stimulated a preferential growing of species producing red and rose wines in various regions of Georgia: in Kakheti – Saperavi, Kaberne Sovinion, Malbek and etc., in Racha-Lechhumi – Aleksandroeuli, Mudzuretuli, Usakhelouri; In Megrelia – Odzaleshi; In Guria and Adzaria – Chkhaveri.

In Georgia, new vineyards are grown on large areas by use of modern technologies and based on both local and international scientific achievements. From anecdotal evidence, during the last 7-8 years vineyards have been cultivated on more than 6-7 thousand hectares.

The biggest part of these newly cultiated vineyards (more than 70 per cent) is accounted by Kakheti region – mostly represented by Saperavi and Kaberne species. Unfortunately, a requirement of the Law with regard to cultivation of white vine species, such as Kakhuri Mtsvane, Khikhvi and others, has been ignored.

The process of growing new vineyards has also started in Kartli region, but in a spontaneous manner though, which is related to high risks and is unlikely to produce any effective results.

The buoyancy in viticulture is less noticeable in such a traditional zone as the Imereti region. Here only single instances of vineyard cultivation occur, which can not be regarded satisfactory. This can mainly be accounted by the fact that the local potential of development of viticulture and the uniqueness of leading species growing there is underestimated. It is necessary to develop fully the opportunities of production of Imeretian type of wines characterised by a wide diversity and high quality and certainly responding to market demands.

In 2003, a positive trend in terms of export of grapes wine and wine products could be observed. According to data by “Samtrest”, Georgia wines were exported to 25 countries; the total amount made up 2,370 thousand dekalitres, that is 38 per cent more than in 2002. It is a certain incentive for wine producers to enlarge a potential of wine exports and increase the output.

New and reconstructed wineries have been equipped with the latest processing lines and are successfully operating. The following companies have gained an international recognition and become major exporters: “JVS”, “Telavi Wine Cellar”, “Teliani Valley”, “Racha Wine”, “Tbilgvino”, “Kindzmarauli”, “Shumi”.

Launching of international projects in viticulture is a good possibility for the production of sound saplings and survival of the indigenous Georgian species gene pool. In particular, in accordance with the programme and under the financial support of the International Gene Pool Institute (IPGRI) in Tbilisi selection base of the Institute of Horticulture and Viticulture, 300 Georgian vine species were cultivated last year.

104 GEORGIAN ECONOMIC TRENDS – 2004 No.2

A project of restructuring the Institute and re-equipment of its scientific bases providing for cultivation of pilot vineyards, equipment of laboratories and offices with state-of-the-art technology, creation of a computerised centre, provision of new agricultural machinery and etc. has also been initiated under support and with the World Bank funding.

A project on rehabilitation of the industry has been developed and launched under the aegis of FAO, but as it frequently happens, even such positive initiatives are sometimes accompanied by negative effects, which have found their reflection in insufficient expertise, underestimation and neglecting of scientific recommendations, translation of foreign technologies into local background without prior verification or taking regard of local features.

There are cases of violation of legal regulations such as improper selection of vineyard areas and vine species, importation and distribution of species from abroad hybrids – the so-called “immediate progenitors” prohibited by law, illegal importation of grapes non-typical for Georgia. We hope all this is just a temporary phenomenon and the problems will be regulated together with the overall situation in the country and viticulture will be revived and further developed on a scientific basis.

105

APPENDIX I: Innovation Systems in Employment

Rezo Sakvarelidze, Head of Labour and Employment Policy Department of the Ministry of Labour, Health and Social Security

1. Introduction

A top priority of the social and economic policy of the country is attainment of full employment of labour resources and formation of a flexible state social protection system.

It should be noted that although with just those budgetary resources which are available today the problems can not be fully solved, we still believe that at the initial stage they would suffice to create a new pattern - a system, in which the state will have to perform only a policy-making and a regulatory function, later capable of operating autonomously.

While regulating employment problems in order to create new jobs, the focus should be on the development of small business. This target is of special importance in terms of problem-solving in employment in a regional context and also for providing jobs for young people and the less competitive members of the labour force.

At the same time it should be borne in mind that due to insecurity and a heavy tax burden, small businesses are in fact mainly operating in the shadow economy largely oriented to short-term activities and commercial and intermediation transactions.

Unfortunately, it must be said that the problem of integrating small business into a common national economic system has not yet been addressed. The major reasons among those accounting for low development of small businesses that still have a great impact, are:

- Economic instability and general drawbacks and obstacles to economic growth; - Difficulties in the financial sector and an almost total lack of credits and sponsorship on the part of the government; - Information vacuum and complications in obtaining information independently (with regard to commodity markets, world prices, new technologies, know-how and etc.); - Obstacles in obtaining required premises and equipment by small businesses; - Lack of knowledge about management and marketing in the conditions of market economy; - Imperfect tax system; - Excessive number of supervisory authorities, overlapping of functions and lack of entrepreneurs protection mechanisms; - Problems with initial capital and absence of liquid guarantees in gaining access to the financial market.

106 GEORGIAN ECONOMIC TRENDS – 2004 No.2 Innovation Systems in Employment

1. Formation of institutions promoting employment

In conducting an active employment policy, private institutions will occupy a special position. Private Consulting Centres for the promotion of unemployed and small entrepreneurs carry out the following functions: - Training of unemployed for entrepreneurial activities; - Providing consultations for unemployed and small entrepreneurs; - Legal support to unemployed and small entrepreneurs; - Consulting services for unemployed and small entrepreneurs.

Such centres have already started functioning in Zugdidi, Ozurgeti, Samtredia, Kutaisi, Zestafoni, Chiatura, Gori, Tbilisi (3), Tsnori, Rustavi and Akhaltsikhe. Today, all these centres are incorporated into one association – Consulting Institutions Association. In addition, with support of international organizations, the number of Association members increased in 2002 and new Marneuli and Akhalkalaki centres were founded. In 2003, these were added to by Batumi, Poti and Telavi institutions.

2. Creation of new jobs by means of business incubator

“Creation of New Jobs through Business Incubation” is a project initiated in Georgia at the end of 2003. The main purpose of this project is proving support to groups of various categories such as unemployed, self-employed, beginner and active entrepreneurs in their business activities. The project aims at presenting a pattern of available possibilities for employment to overcome the problem of structural unemployment in Georgia. In order to attain this goal, it is necessary to create a successful and a viable business-incubator, a pattern on which to base the national policy. The project aims to demonstrate the achievements gained through steady and high-income employment in one pilot business-incubator operating in Tbilisi.

The aim and mission of the business-incubator will be: - To offer premises to tenants at a price lower than a market price - To provide office services both to tenants and outsiders - To provide both on-site and off-site consultations and training - To create on-site and off-site consultations network for customers after they leave.

There are three stakeholders involved in this project: UN Development Program (UNDP), Swiss International Development Agency (SIDA) and Georgian Government represented by the Ministry of Labour, Healthcare and Social Affairs. It is a two-year project.

The project intends to attain certain results already in the course of project implementation: as soon as the business-incubator has been established, during the first year, the project will provide support to the following categories: - 12 permanent members of the business-incubator (unemployed individual entrepreneurs, self- employed individual entrepreneurs, beginner entrepreneurs) - 70-80 associated members of the business-incubator (beginner entrepreneurs, active, individual or small entrepreneurs) - up to 600 unemployed, self-employed, individual and small entrepreneurs.

Types of services rendered by the business-incubator:

GEORGIAN ECONOMIC TRENDS – 2004 No.2 107 Innovation Systems in Employment

1. Office 2. Premises 3. Advice 4. Legal support 5. Consulting 6. Guarantee 7. Leasing 8. Accounting

Type of the business-incubator: Multi-typed; Members of the business-incubator: - Permanent members - Associated members Permanent members of the business-incubator: 1. Unemployed (hereinafter Individual Entrepreneurs), who under the State Employment Promotion Program have received a commercial bank loan. 2. Self-employed (hereinafter Individual Entrepreneurs), who intend to take a loan from a macro- credit institution. 3. A beginner entrepreneur (6-12 months) or a branch of an operating company.

Associated members of the business-incubator: 1. Individual entrepreneur (not less than 6 month). 2. Small entrepreneur (not less than 1 year). 3. Medium entrepreneur.

One third of the associated members of the business-incubator may be from regions.

4. A guarantee Fund

Function: standing as a guarantor.

General rule and terms of guarantee: a) In order to maintain existing jobs and create new ones the Fund stands a guarantor to Private Law entities, individual entrepreneurs and registered unemployed in obtaining a bank loan; b) Decision with regard to a guarantee may be taken only if financial arrangements of a business plan allow for such a loan, but the value of mortgage provided by the borrower fails to fully cover requirements of a lending bank.

5. State Employment Promotion Programme

A pilot employment programme intended for unemployed and small entrepreneurs was implemented for the first time in Georgia in 2002-2003. The programme provides for granting interest-free lax loans to unemployed after prior selection and training for entrepreneurial activities. In implementing the programme the following sequence is observed:

108 GEORGIAN ECONOMIC TRENDS – 2004 No.2 Innovation Systems in Employment

- Registered unemployed who have decided to engage in entrepreneurial activities are selected and then sent to specialized consulting centres by the State Employment Agency within the quota envisaged by the Programme. - For identification of skills, registered unemployed, prior to being admitted to training courses, have to undergo testing at a local State Employment Agency by means of a professional diagnostics method elaborated by a specialized institution. - Business plans worked out by registered unemployed or acting entrepreneurs with the help of Consulting Centres are sent to the banks servicing the Programme.

Advantages of the Programme:

- It is the first programme in Georgia providing for the issue of “start up” loans on preferential terms by commercial banks. - It is based on market mechanisms and does not cause a gross interference in the market behaviour. - As a result of commercial banks’ participation in the Programme the amount spent exceeds by three times that envisaged by the State Budget (only one third of the programme is financed through the State Budget). - Zero interference in decision-making on behalf of state officials. - Minimal losses.

During the 2002 Pilot Programme, positive decisions were made by banks with regard to a total of 100 projects of which 51 were developed by unemployed. The majority of projects (69 out of 100) are from regions.

General performance indicators: - efficiency of Consulting Centres – 55.6 per cent against 30 per cent of the target; - programme efficiency (of the unemployed) = 20.5 per cent against 10 per cent of the target; - losses after one year – just 3.8 per cent.

During the 2003 Pilot Programme, positive decisions were made by banks with regard to a total of 120 projects of which 82 were developed by unemployed. The majority of projects (92 out of 120) are from regions.

General performance indicators: - project efficiency (of the unemployed) = 17.5 per cent against 10 per cent of the target

A guaranteed amount provided for in the Programme is an amount used without fail for the purposes of ensuring guarantee for registered unemployed employment projects with regard to which a positive decision has been made by a commercial bank servicing the Programme. Registered unemployed, as well as their property, will be insured against accidents for the term of the loan by an insurance company. The unemployed themselves and three of their family members will be insured for the first in-patient medical aid.

“Programme entrepreneurs” means acting entrepreneurs granted by the decision of commercial banks interest-free lax loans in account of which they will have to create additional jobs envisaged by the Programme and these additional jobs should not be paid less than a subsistence minimum.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 109 Innovation Systems in Employment

During 2002, 49 such projects were funded (an additional 212 unemployed were employed permanently) and by the 2003 Programme 38 entrepreneur projects were approved by a commercial bank decision (and an additional 173 unemployed were employed permanently).

6. Subsidized Jobs Programme

The programme aims at creating additional jobs for the less competitive members of the labour force (disabled people, unemployed members of families with many children, refugees, long-term unemployed and etc.) through support to small and medium enterprises.

1. Purpose:

- To promote low-competitive labour force employment.

2. Task:

- To subsidize jobs of acting entrepreneurs.

Implementation:

Offering permanent jobs to low-competitive labour force may become an alternative for social protection or professional re-training as any professional training or re-training is associated with concerns about remaining “educated unemployed” afterwards.

Idea of the proposal

Today, there is a quite high incidence of active entrepreneurs, who are in urgent need of working capital required for maintaining or expanding their businesses.

Should low-competitive labour force give preference to permanent employment, an acting successful entrepreneur will be able, if interested, to receive a grant in the amount enough to subsidize permanent jobs for each such employee. A person will be employed on the basis of a labour contract for an indefinite time.

Implementation phases

1. Announcement of tender for the Programme servicing commercial bank (hereinafter the Bank) or concluding agreement with a bank through “negotiations with one entity”; 2. Provision of information; 3. Registration at the State Employment Agency of interested people for taking part in the Subsidized Jobs Programme; 4. Selection by criteria specified by the bank of successfully operating entrepreneurs for participation in the Subsidized Jobs Programme (hereinafter the Programme); 5. Concluding a trilateral agreement between theEntrepreneur, Unemployed and the Bank; 6. Signing of a labour contract between the Entrepreneur and Unemployed; 7. Monitoring of the activities of the Entrepreneur by the Bank.

110 GEORGIAN ECONOMIC TRENDS – 2004 No.2 Innovation Systems in Employment

Fixing a sum for subsidizing a job

During two years this sum is fixed at 70/90 per cent of an average consumer minimum (with the social tax), depending on category (invalid, refugee, etc.).

Commitments of an Entrepreneur

1. To employ at least 5 people; 2. To appoint a person concerned for a trial period for deciding whether he is suited for a proposed position or a job to be fulfilled; 3. To conclude a labour contract for an indefinite period of time with each unemployed; 4. At least for the first two years, to appoint the unemployed a minimum remuneration in the amount no less than an average consumer minimum; 5. Upon expiry of the trial period, not to dismiss the employed on the grounds of being unsuitable for the position occupied or a job to be fulfilled;

All relations between the employer and the employed will be regulated under the Labour Code and current legislation.

Reorganization of an enterprise, staff reductions during the first two years will not concern the Programme participants. In case of company liquidation during the first year, the Bank will have to return the amount of the grant to the Programme.

GEORGIAN ECONOMIC TRENDS – 2004 No.2 111

STATISTICAL APPENDIX

CONTENTS *

Table A3.1: State Budget Revenues Q1 2004

Table A3.2: State Budget Expenditures by Economic and Functional Breakdown, Q1 2004-07-10

Table A3.3 State Budget Revenues 2004

Table A3.4 State Budget Expenditures 2004

Table A4.1: Accounts of the National Bank of Georgia

Table A4.2: Summary Accounts of Commercial Banks

Table A4.3: Monetary Survey

Table A4.4: Urban Consumer Price Index and Inflation

Table A5.1.1: Registered Foreign Trade Balance, Q1 2004

Table A5.2.1: Georgia’s Registered Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, Q1 2004

Table A5.2.2: Georgia’s Registered Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, Q1 2004

Table A6.1: Small Privatisation by Region, as of 1st January, 2004

Table A7.1: Economic Status, Q1 1998 – Q4 2003

* Note: First digit in the number of an appendix table indicates the number of the chapter to which it belongs.

112 GEORGIAN ECONOMIC TRENDS – 2004 No.2 Table A3.1: State Budget Revenues Q1 2004 (GEL million) Q 1 Actual Q 1 actual Growth Q1 actual revenues Per cent in revenues over the target revenues as per cnt total 2003 year 2004 of target Total revenues and grans 260.8 297.4 223.6 114 133.0 100.0 Tax revenues 228.9 225.9 192.5 99 117.3 75.9 Central budget tax revenues 148.7 146.3 135.7 98 107.8 49.2 Income tax 7.1 7.3 4.0 103 182.9 2.5 Profit tax 2.5 4.7 2.6 189 184.2 1.6 VAT 97.8 91.8 101.6 94 90.3 30.9 on domestic products 47.9 47.7 60.7 100 78.6 16.0 on imports 49.9 44.1 40.9 88 107.8 14.8 Excise 26.6 27.2 14.7 102 184.5 9.1 on domestic products 7.7 8.6 4.8 112 180.5 2.9 on imports 18.9 18.6 10.0 98 186.4 6.2 Customs duty 10.3 11.3 11.4 110 98.8 3.8 Othr taxes 4.4 4.1 1.4 93 289.9 1.4 Non-tax revenues 31.9 60.4 23.3 189 258.8 20.3 Revenues of Special state funds 82.6 79.7 56.9 97 140.0 26.8 Social security fund 69.8 67.5 48.0 97 140.5 22.7 Roads fund 12.8 12.3 8.9 96 137.5 4.1 Grants 11.2 7.8 143.1 3.8 Source: Ministry of Finance

Table A 3.2: State Budget Expenditures by Economic and Functional Breakdown, Q1 2004 (GEL million) Other Subsidies and Business Social goods Interest Capital Total Salaries current Net lending trips Contributions and payments expenditures transfers services General Government 81.2 10.2 3.1 1.1 13.8 0.5 0.3 52.2 Defence 24.2 12.7 0.2 0.1 7.9 3.2 Law and Order 30.7 13.2 1.4 0.3 6.3 8.7 0.7 Education 13.4 8.1 2.6 0.0 1.9 0.8 Health care 1.8 0.5 0.1 0.8 0.4 Social Security 76.6 0.0 0.0 55.4 21.1 Housing 1.0 0.0 0.0 0.5 0.5 Culture sports and religion 5.8 0.5 0.2 0.9 4.3 Energy 0.1 0.1 0.0 0.0 0.0 0.0 Agriculture 3.5 1.1 0.5 1.8 Construction and mining 0.2 0.1 0.0 0.0 Transport and communications 10.2 0.0 0.0 0.0 10.2 Other economic activities 0.7 0.5 0.2 0.1 0.0 Other expenses 72.4 0.1 0.0 0.0 38.1 21.5 12.6 Total 321.8 47.1 8.5 1.6 89.4 38.1 61.1 11.2 64.8 Source: Ministry of Finance Annex A3.3 State Budget Revenues 2004 (GEL million) Budget Actual Growth 2004 2003 per cent Total revenues and grans 1424.447 932.402 152.8 Tax revenues 1112.5 806.552 137.9 Income tax 14.4 19.993 72.0 Profit tax 6.9 11.822 58.4 VAT 494.3 368.481 134.1 on domestic products 235.3 218.034 107.9 on imports 259 150.447 172.2 Excise 135.8 89.197 152.2 on domestic products 39.9 21.934 181.9 on imports 95.9 67.263 142.6 Customs duty 83.5 56.085 148.9 Othr taxes 18.6 10.234 181.7 Non-tax revenues 130.9 78.095 167.6 Revenues of Special state funds 368.9 251.474 146.7 Social security fund 322.2 204.254 157.7 Roads fund 46.7 47.22 98.9 Grants 160.745 47.755 336.6 Source: Ministry of Finance

Annex A3.4 State Budget Expenditures 2004

Budget Actual Growth 2004 2003 per cent General Government 191.7 221.2 86.7 Defence 81.1 55.4 146.3 Law and order 144.3 82.0 176.0 Education 72.9 37.8 192.8 Health care 127.9 7.1 1804.4 Social Security 340.4 288.4 118.1 Housing 0.0 3.1 0.0 Culture sports rligion 31.6 23.6 134.0 Energy 145.2 36.6 397.2 Agiculture 59.1 11.0 537.9 Construction and mining 1.4 0.4 303.8 Transport and communications 100.3 53.8 186.6 Other economic activities 39.4 2.1 1843.0 Other 418.4 296.1 141.3 Total 1753.5 1118.5 156.8 Source: Ministry of Finance Table A4.1: Accounts of the National Bank of Georgia (GEL thousand) Dec-03 Jan-04 Feb-04 Mar-04

NET INTERNATIONAL RESERVES -311,364 -314,764 -286,372 -240,660 GOLD 1,604 1,604 1,604 1,575 FOREIGN EXCHANGE 395,678 403,388 395,274 422,750 USE OF IMF RESOURSES -593,162 -603,449 -571,041 -556,030 OHTER FOREIGN LIABILITIES -115,483 -116,307 -112,208 -108,955

NET DOMESTIC ASSETS 891,225 872,449 862,896 834,669 NET CLAIMS ON GENERAL GOVERNMENT 782,912 770,352 776,091 740,220 NET CLAIMS ON REPUBLICAN GOVERNMENT 805,466 802,382 802,180 776,908 LOANS TO REPUBLICAN GOVERNMENT 816,532 821,484 821,484 815,639 DEPOSITS OF GENERAL GOVERNMENT -33,620 -51,132 -45,393 -75,419 NET CLAIMS ON LOCAL GOVT -2,135 -2,972 -676 -6,711 SPECIAL FUNDS -7,352 -12,342 -12,760 -21,213 OTHER EXTRABUDGETARY FUNDS (net) -9,223 -11,951 -5,308 -4,573 CLAIMS ON THE REST OF ECONOMY 112,005 112,740 108,823 105,672 NET CLAIMS ON BANKS 6,320 -1,051 0 8,200

RESERVE MONEY 579,862 557,686 576,525 594,008 CURRENCY IN CIRCULATION 473,242 443,545 446,411 466,212 BANKS' DEPOSITS 106,620 114,141 130,113 127,796 REQUIRED RESERVES 81,405 84,138 89,785 89,946 BALANCES ON CORRESPONDENT ACCOUNTS 25,214 30,003 40,328 32,550 Source: the National Bank of Georgia Table A4.2: Summary Accounts of Commercial Banks (GEL thousand)

Dec-03 Jan-04 Feb-04 Mar-04 NET FOREIGN ASSETS 42,456 80,082 84,491 85,595 GOLD 3 222 FOREIGN EXCHANGE 242,456 276,156 269,808 275,537 FOREIGN LIABILITIES -200,002 -196,076 -185,319 -189,944

NET DOMESTIC ASSETS 576,396 587,167 580,138 600,354 DOMESTIC CREDIT 747,413 748,757 725,463 751,088 NET CLAIMS ON GENERAL GOVERNMENT -16,527 -18,252 -21,359 32,977 NET CLAIMS ON REPUBLICAN GOVERNMENT 32,225 33,451 36,404 46,239 CLAIMS ON THE REST OF ECONOMY 763,940 767,009 746,822 718,111 OTHER ASSETS (net) -171,017 -161,591 -145,326 -150,735

DEPOSIT LIABILITIES 618,852 667,249 664,628 685,948 DOMESTIC CURRENCY DEPOSITS 85,863 96,643 120,817 115,454 FOREIGN CURRENCY DEPOSITS 532,989 570,606 543,812 570,494 Source: the National Bank of Georgia Table A4.3: Monetary Survey (GEL thousand) Dec-03 Jan-04 Feb-04 Mar-04 NET FOREIGN ASSETS -268,907 -234,681 -201,881 -155,065 GOLD 1,606 1,606 1,606 1,577 FOREIGN EXCHANGE 638,133 679,544 665,082 698,287 FOREIGN LIABILITIES -908,647 -915,831 -868,569 -854,929

NET DOMESTIC ASSETS 1,329,295 1,318,263 1,288,982 1,272,158 DOMESTIC CREDIT 1,642,329 1,631,850 1,610,377 1,596,981 NET CLAIMS ON GENERAL GOVERNMENT 766,385 752,100 754,732 773,197 NET CLAIMS REPUBLICAN GOVERNMENT 837,692 835,833 838,584 823,147 TREASURY OBLIGATIONS 44,750 46,433 49,586 58,915 NET CLAIMS ON LOCAL GOVERNMENT -46,053 -49,183 -49,586 -14,413 NET CLAIMS ON PENSION FUND -10,166 -15,469 -17,814 -23,454 OTHER EXTRABUDGETARY FUNDS -10,692 -13,315 -7,277 -5,903 CLAIMS ON THE REST OF ECONOMY 875,944 879,750 855,645 823,784 OTHER ITEMS (net) -313,034 -313,587 -321,396 -324,823

BROAD MONEY (M3) 1,060,388 1,083,581 1,087,101 1,117,092

BROAD MONEY, EXCL FOREX DEPOSITS (M2) 527,398 512,976 543,289 546,598 CURRENCY OUTSIDE BANKS (MO) 441,536 416,333 422,472 431,144 CURRENCY IN CIRCULATION (NBG) 473,242 443,545 446,411 466,212 CURRENCY IN COMM. BANKS -31,707 -27,212 -23,939 -35,069 DEPOSIT LIABILITIES (GEL) 85,863 96,643 120,817 115,454 FOREIGN CURRENCY DEPOSITS 532,989 570,606 543,812 570,494 Source: the National Bank of Georgia Table A4.4: 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 Source: GET calculations based on data provided by State Department for Statistics Table A5.1.1: Registered Foreign Trade Balance, Q1 2004 (USD thousands) Countries Q1 2004 Export Import Total foreign trade 98,660.5 328,603.9 CIS 37,840.8 123,258.2 Armenia 9,946.7 8,264.5 Azerbaijan 1,894.4 24,392.0 Belarus 155.0 266.1 Kazakhstan 1,091.9 2,520.1 Kyrgizstan 223.8 210.5 Moldova 12.7 251.3 Russia 15,731.1 56,526.5 Tajikistan 21.9 - Turkmenistan 5,813.1 5,694.9 Ukraine 2,610.5 21,700.3 Uzbekistan 339.7 3,432.0

EU 14,928.1 106,413.3 Austria 10.9 8,831.3 Belgium 650.9 2,687.8 Denmark 138.0 3,301.7 Finland - 917.5 France 2,811.6 18,179.9 Germany 1,140.3 21,447.8 Greece 45.3 2,614.7 Ireland - 405.9 Italy 2,438.5 10,494.9 Luxembourg - 138.2 Netherlands 1,634.4 5,742.2 Portugal 6.0 298.7 Spain 1,602.4 930.5 Sweden - 191.7 UK 4,449.9 30,230.6 others 45,891.6 98,932.4

Source: State Department for Statistics Table A5.2.1: Georgia's Registred Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, Q1 2004 (USD thousands) HTS Category Export Import 01 - Live Animals 1 38 02 - Meat and edible meat offal 820 3,350 03 - Fish and crustaceans, molluscs and other aquatic invertebrates 153 558 04 - Dairy produce; birds eggs; natural honey; edible products of animal origin, not elsewhere specified or included 12 2,530 05 -Products of animal origin, not elsewhere specified or included - 6 06 -Live trees and other plants; bulbs, roots and the like; cut flowers and ornamental foliage 1 171 07 -Edible vegetables and certain roots and tubers 192 370 08 -Edible fruit and nuts; peel of citrus fruit or melons 1,017 1,053 09 -Coffee, tea, maté and spices 1,025 792 10 -Cereals 5,057 11,167 11 -Products of the milling industry; malt; starches; inulin; wheat gluten 276 5,226 12 -Oil seeds and oleaginous fruits; miscellaneous grains, seeds and fruits; industrial or medicinal plants; straw and fodder 304 122 13 -Lac; gums, resins and other vegetable saps and extracts 17 3 14 -Vegetable plaiting materials; vegetable products not elsewhere specified or included 24 24

15 -Animal or vegetable fats and oils and their cleavage products prepared edible fats; animal or vegetable waxes 1 2,204 16 -Preparations of meat, of fish or of crustaceans, molluscs or other aquatic invertebrates 13 723 17 -Sugars and sugar confectionery 1,927 8,139 18 -Cocoa and cocoa preparations 263 3,466 19 -Preparations of cereals, flour, starch or milk; bakers' wares 64 1,565 20 -Preparations of vegetables, fruit, nuts or other parts of plants 576 798 21 -Miscellaneous edible preparations 134 1,183 22 -Beverages, spirits and vinegar 15,388 1,431 23 -Residues and waste from the food industries; prepared animal feed 56 647 24 -Tobacco and manufactured tobacco substitutes 504 5,273 25 -Salt; sulfur; earths and stone; plastering materials, lime and cement 114 1,858 26 -Ores, slag and ash 5,837 477 27 -Mineral fuels, mineral oils and products of their distillation; bituminous substances; mineral waxes 6,863 73,016 28 -Inorganic chemicals; organic or inorganic compounds of precious metals, of rare earth metals, of radioactive elements or of isotopes 1,031 1,047 29 -Organic chemicals 190 537 30 -Pharmaceutical products 630 18,372 31 -Fertilizers 4,794 124

32 -Tanning or dyeing extracts; tannins and their derivatives; dyes, pigments and other coloring matter; paints and varnishes; putty and other mastics; inks 104 832

33 -Essential oils and resinoids; perfumery, cosmetic or toilet preparations 682 3,779 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 27 1,840

35 -Albuminoidal substances; modified starches; glues; enzymes - 309

36 -Explosives; pyrotechnic products; matches; pyrophoric alloys; certain combustible preparations - 782 37 -Photographic or cinematographic goods 0 90 38 -Miscellaneous chemical products 76 3,492 39 -Plastics and articles thereof 151 5,168 40 -Rubber and articles thereof 41 2,386 41 -Raw hides and skins (other than furskins) and leather 300 72 42 -Articles of leather; saddlery and harness; travel goods, handbags and similar containers; articles of animal gut (other than silkworm gut) 35 208

Source: State Department for Statistics Table A5.2.2: Georgia's Registred Exports and Imports by Harmonized Tariff Schedule (HTS) Chapters, Q1 2004 (USD thousands) HTS Category Export Import 44 -Wood and articles of wood; wood charcoal 1,794 1,153 45 -Cork and articles of cork - 531 46 -Manufactures of straw, of esparto or of other plaiting materials; basketware and wickerwork - 1 47 -Pulp of wood or of other fibrous cellulosic material; waste and scrap of paper or paperboard - 18

48 -Paper and paperboard; articles of paper pulp, of paper or of paperboard 74 6,024 49 -Printed books, newspapers, pictures and other products of the printing industry; manuscripts, typescripts and plans 69 899 50 -Silk - 30 51 -Wool, fine or coarse animal hair; horsehair yarn and woven fabric 15 101 52 -Cotton - 70

53 -Other vegetable textile fibers; paper yarn and woven fabric of paper yarn - 0 54 -Man-made filaments 1 169 55 -Man-made staple fibers - 498

56 -Wadding, felt and nonwovens; special yarns, twine, cordage, ropes and cables and articles thereof 7 135 57 -Carpets and other textile floor coverings 0 129 58 -Special woven fabrics; tufted textile fabrics; lace, tapestries; trimmings; embroidery - 20 59 -Impregnated, coated, covered or laminated textile fabrics; textile articles of a kind suitable for industrial use - 139 60 -Knitted or crocheted fabrics - 150 61 -Articles of apparel and clothing accessories, knitted or crocheted 131 762 62 -Articles of apparel and clothing accessories, not knitted or crocheted 150 1,129 63 -Other made up textile articles; sets; worn clothing and worn textile articles; rags 49 1,019 64 -Footwear, gaiters and the like; parts of such articles 1 1,395 65 -Headgear and parts thereof 1 26 66 -Umbrellas, sun umbrellas, walking sticks, seatsticks, whips, riding-crops and parts thereof - 2 67 -Prepared feathers and down and articles made of feathers or of down; artificial flowers; articles of human hair - 7 68 -Articles of stone, plaster, cement, asbestos, mica or similar materials 54 944 69 -Ceramic products 131 2,124 70 -Glass and glassware 249 2,603 71 -Natural or cultured pearls, precious or semi-precious stones,precious metals, metals clad with precious metal and articles thereof; imitation jewelry; coin 1,158 933 72 -Iron and steel 28,689 8,887 73 -Articles of iron or steel 2,239 12,863 74 -Copper and articles thereof 1,426 424 75 -Nickel and articles thereof 2,459 1,066 76 -Aluminum and articles thereof - 557 78 -Lead and articles thereof 77 27 79 -Zinc and articles thereof 20 0 80 - Tin and articles thereof - 0 81 -Other base metals; cermets; articles thereof 8 9 82 -Tools, implements, cutlery, spoons and forks, of base metal; parts thereof of base metal 13 657

83 -Miscellaneous articles of base metal 27 919

84 -Nuclear reactors, boilers, machinery and mechanical appliances; parts thereof 5,308 45,961 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 870 28,054 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 2,687 248 87 -Vehicles other than railway or tramway rolling stock, and parts and accessories thereof 1,338 23,631 88 -Aircraft, spacecraft, and parts thereof 247 3,799 89 -Ships, boats and floating structures 58 140

90 -Optical, photographic, cinematographic, measuring, checking, precision, medical or surgical instruments and apparatus; parts and accessories thereof 537 6,217

91 -Clocks and watches and parts thereof 1 111 92 -instruments; parts and accessories of such articles 1 7 93 -Arms and ammunition; parts and accessories thereof 0 453 stuffed furnishings; lamps and lighting fittings, not elsewhere specified or 14 6,416

95 -Toys, games and sports requisites; parts and accessories thereof 29 650 96 -Miscellaneous manufactured articles 10 1,256 97- Works of art, collectors' pieces and antiques 20 12 Source: State Department for Statistics Table A6.1: Small Privatisation by Region, as of 1st January, 2004 (Number of enterprises)

Approved for Total privatised Privatised in Region privatisation or liquidated 2003

Abkhazia 8 - - Achara 397 171 - Tbilisi 4,689 5,454 170 Guria 321 490 18 Lanchkhuti 64 110 - Ozurgeti 200 279 18 Chokhatauri 57 101 - Racha-Lechkhumi and lower Svaneti 171 282 3 Ambrolauri 60 98 2 Lentekhi 32 47 - Oni 48 73 - Tsageri 31 64 1 Samegrelo and upper Svaneti 1,122 1,554 9 Abasha 88 98 - Zugdidi 216 288 3 Martvili 55 60 2 Mestia 12 24 - Senaki 250 429 1 Chkhorotsku 39 65 - Tsalenjikha 52 70 2 Khobi 146 141 1 Poti 264 379 - Imereti 2,785 3,416 235 Kutaisi 636 967 137 Tkibuli 224 206 6 Tskaltubo 276 317 13 Chiatura 273 360 10 Bagdati 73 118 5 Vani 68 106 - Zestafoni 425 455 29 Terjola 132 154 - Samtredia 448 474 14 Sachkhere 95 101 14 Kharagauli 71 75 - Khoni 64 83 7 Kakheti 1,106 1,438 103 Akhmeta 179 207 25 Gurjaani 141 176 6 Dedoplistskaro 92 170 38 Telavi 222 286 14 Lagodekhi 74 74 8 Sagarejo 132 130 1 Signagi 140 229 - Kvareli 126 166 11 Mtsketa-Tianeti 327 422 11 Akhalgori 18 19 1 Dusheti 89 140 8 Tianeti 58 69 1 Mtslheta 133 158 - Kazbegi 29 36 1 Samtskhe-Javakheti 613 978 47 Adigeni 82 115 - Aspindza 30 49 - Akhalkalaki 66 113 9 Akhaltsikhe 247 384 15 Borjomi 160 266 16 Ninotsminda 28 51 7 Kvemo Kartli 1,157 1,693 61 Rustavi 358 489 17 Bolnisi 65 159 21 Gardabani 276 292 3 Dmanisi 21 73 - Tetritskaro 115 243 2 Marneuli 287 398 16 Tsalka 35 39 2 Shida Kartli 897 1,089 44 Tskhinvali - 5 - Gori 318 385 9 Kaspi 203 215 12 Kareli 141 188 5 Khashuri 235 296 18 Java - - - MSPM 524 584 60

Total 14,117 17,571 761 Source: Ministry of State Property Management Note: Number of enterprises actually privatised can exceed those approved for privatisation since some are split up during corporatisation. Table A7.1: Economic Status, Q 1 1998 - Q4 2003 (Thousand) 1998 1999 2000 2001 2002 2003 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 Q IV Q I Q II Q III Q IV Q I Q II Q III 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 3, 277 3, 269 3, 139 3, 083 3, 016 3, 033 3, 021 2, 971 3, 082 3, 060 3, 132 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 2, 066 2, 197 2, 144 2, 048 1, 912 1, 983 2, 003 1, 945 1, 941 2, 037 2, 120 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 2, 195 2, 314 2, 246 2, 165 1, 983 2, 036 2, 063 2, 015 2, 025 2, 095 2, 170 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 1, 818 1, 944 1, 913 1, 838 1, 659 1, 742 1, 768 1, 713 1, 679 1, 805 1, 897 Hired 714 737 786 741 737 743 741 710 679 695 675 691 681 672 636 630 625 598 597 607 594 604 640 Self-employed 1,387 1,546 1,092 990 973 1, 023 1, 030 905 912 1, 087 1, 095 1, 080 1, 034 1, 189 1, 194 1, 127 1, 028 1, 141 1, 168 1, 102 1, 083 1, 200 1, 255 Unemployed (1) 231 179 260 249 292 268 266 284 246 212 174 217 248 253 231 210 254 241 236 232 262 233 223 Unemployed (2) 356 272 309 301 333 308 314 342 382 309 292 337 377 370 333 327 324 294 296 303 345 290 273 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 1,210 1,072 995 1,034 1,103 1,050 1,017 1,026 1,141 1,023 1,002 Total population outsde the labour force (2) 1,108 1,019 937 980 1,000 997 962 1,044 1,035 952 952 985 1,082 955 893 918 1,033 997 957 956 1,057 965 952 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 12.0 11.5 10.8 10.3 13.3 12.1 11.8 11.9 13.5 11.4 10.5 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 17.2 16.0 14.8 15.1 16.3 14.4 14.3 15.0 17.1 13.9 12.9

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 63.1 67.2 68.3 66.4 63.4 65.4 66.3 65.5 63.0 66.6 67.7 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 67.0 70.8 71.5 70.2 65.7 67.1 68.3 67.8 65.7 68.5 69.3 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 50.1 54.1 55.7 55. 0 53.7 57. 5 58.3 56.6 55.8 58.9 59.2 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 56.9 61.2 62.4 61.3 62.0 65.5 66.1 64.3 64.5 66.5 66.2 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

GEORGIAN ECONOMIC TRENDS – 2004 No.2 125 ABBREVIATIONS

IDP Internally Displaced Person 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

126 GEORGIAN ECONOMIC TRENDS – 2004 No.2 ABBREVIATIONS

TRL Turkish Lira UNCTAC United Nations Conference on Trade and Development 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 – 2004 No.2 127