08TBILISI190, GEORGIA’S ECONOMY HOLDS ITS BREATH AS 2008 BEGINS

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Reference ID Created Released Classification Origin
08TBILISI190 2008-02-06 04:25 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Tbilisi

VZCZCXRO0349
RR RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSI #0190/01 0370425
ZNR UUUUU ZZH
R 060425Z FEB 08
FM AMEMBASSY TBILISI
TO RUEHC/SECSTATE WASHDC 8811
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 04 TBILISI 000190 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EUR/CARC AND EEB/IFD/OMA 
 
E.O. 12958: N/A 
TAGS: ECON EINV PGOV GG
SUBJECT: GEORGIA'S ECONOMY HOLDS ITS BREATH AS 2008 BEGINS 
 
REF: 07 TBILISI 652 
 
1. (SBU) Summary: Georgia's GDP grew an estimated 12 percent 
in 2007, while inflation was reported at 11 percent for the 
year.  Growth was based on increasing inflows of foreign 
investment and robust government spending.  Because political 
turmoil has caused foreign investors to hesitate, although 
perhaps not abandon, their investment plans, growth will slow 
in 2008.  Exports grew in 2007 despite Russian trade 
sanctions, and Turkey is becoming Georgia's leading trading 
partner.  Nevertheless, the current account deficit is large 
and growing, and continued interest from foreign investors 
will be needed to maintain an acceptable balance of payments. 
 The banking sector continued to grow strongly in 2007. 
Although there are no obvious signs of trouble, the health of 
the banking sector will bear watching.  Unemployment was 
slightly higher in 2007 than in 2006.  Wages also increased, 
however.  The government has ambitious plans to further 
liberalize the economy, which clocked in at number 18 on the 
World Bank's ease of doing business index in 2007, in order 
to cut unemployment and continue increasing incomes.  End 
Summary. 
 
2. (SBU) 2007 opened as a banner year for the Georgian 
economy, with real GDP growth accelerating from 11.4 percent 
in the first quarter to more than 13 percent in each of the 
second and third quarters of the year.  It is estimated that 
growth will end up at 12 percent for the year.  Growth was 
based on robust government spending and inflows of foreign 
investment, while growth in consumer demand was relatively 
flat.  2008 is shaping up to be a year of more modest growth, 
principally because the political uncertainty surrounding the 
rise and fall of Irakli Okruashvili, the November protests 
and the hotly disputed presidential elections in January has 
inevitably made some investors delay their investments or 
perhaps even reconsider them altogether.  The government is 
planning to slow the growth of spending and along with it the 
boost it has been providing to the economy.  Tourism is 
already noticeably slower in the ski resorts of Gudauri and 
Bakuriani, and continued bad publicity about Georgia would 
not help that important sector.  The Georgian government's 
2008 budget, passed in late December by the parliament, 
forecasts only 5.5 percent growth during 2008.  The Ministry 
of Finance expects to see a per capita income of USD 2800 by 
the end of 2008, compared to USD 1200 in 2004. 
 
3. (SBU) A slowdown in the flow of investment will come as a 
disappointment, since the government had been predicting a 
total inflow for 2007 of USD 2 billion, compared to the USD 
307 million the country received in 2003, the last year of 
former President Shevardnadze's rule.  Some expect the total 
to be about USD 1.4-1.5 billion, which nevertheless still 
exceeds 2006's USD 1.1 billion of investment.  Georgia helped 
its image in 2007 by improving its showing on the World 
Bank's "Doing Business" report from number 34 in the world to 
an impressive number 18.  The investment that the country has 
been receiving has been concentrated in the financial and 
real estate sectors and has not brought readily noticeable 
benefits in new employment, a situation that contributed to 
dissatisfaction with the Saakashvili administration expressed 
in the November protests and the January election.  On the 
other hand, manufacturing and mining have shown relatively 
strong growth, 15 percent in 2006 and perhaps a similar 
amount in 2007.  This is attributable to strong external 
demand for ferroalloys, cement, and domestic demand for food 
products, textiles and construction materials.  If these 
trends continue, the supply of new jobs may begin to more 
strongly benefit the average Georgian household and to shore 
up support for the government.  Unfortunately, such 
employment may never spread far enough to benefit older 
workers and those who lack skills -- not an insignificant 
part of the population. 
 
4. (SBU) The more rancorous political climate has brought a 
re-orientation of the government's budget priorities.  Fast 
growth of the economy, better tax administration and 
reduction of corruption continue to give the government more 
resources with which to work.  At a recent briefing to the 
diplomatic corps, Finance Minister Nika Gilauri told his 
audience that the government received GEL 5.9 billion (USD 
3.68 billion) in revenues in 2007, 1 percent more than the 
planned receipts for the year.  Government revenues were only 
GEL 1.2 billion in 2003.  The GOG is budgeting for GEL 5.15 
billion in revenues in 2008, of which only 6 percent will 
come from privatizations.  In a recent Wall Street Journal 
interview, PM Gurgenidze said that the government wants to 
sell 25 percent of its remaining industrial assets in 2008. 
One of the companies to be sold is Georgian Railways, which 
has attracted the attention of some American investors. 
Gilauri said that the government is planning to turn its 
 
TBILISI 00000190  002 OF 004 &#x000
A; 
 
attention from building and repairing infrastructure to 
ameliorating social problems.  The areas of expenditure in 
the 2008 budget that are receiving the largest increases are 
health and education, as well as pensions, and the entire 
share of social programs will increase from 28 percent in 
2007 to 33 percent in 2008.  Defense expenditure will be 
sharply down.  Total expenditure of GEL 5.7 billion, as 
planned, would result in an estimated budget deficit of about 
2-3 percent of GDP, compared to 2007's estimated 5 percent. 
 
5. (SBU) Inflationary pressures increased during 2007. 
Year-end inflation was 11 percent, and the government was 
unable to keep the figure in single digits as it had wished. 
Some economic experts, such as the Georgian Foundation for 
Strategic and International Studies' Lado Papava, claim that 
inflation is really much higher.  Poorer Georgians certainly 
have been hit hard by higher food prices, and their concerns 
are undoubtedly contributing to Saakashvili's unpopularity. 
If investment and growth slow down as expected, inflationary 
pressure may be somewhat less in 2008.  On the other hand, 
although the government has expressed a desire to rein in 
spending, the fact is that 2008 is an election year and the 
impulse to spend, especially on measures that put money in 
the consumer's pocket, will be difficult to resist.  If it is 
unwilling to slow expenditures, the government has only some 
very rudimentary tools to use on the monetary side to control 
inflation.  It has expressed a willingness to allow the lari 
to appreciate, bearing some of the brunt of the fight.  The 
National Bank of Georgia (NBG), the central bank, has 
conducted regular auctions of certificates of deposit since 
late 2006, but has not met its targets because it has been 
unwilling to offer interest rates that will clear the market. 
 The government has yet to make the government securities 
held by the NBG fully marketable and has been reluctant to 
issue new domestic debt that could be used for open market 
operations. 
 
6. (SBU) Reflecting government concern about inflation, if 
not a truly effective response to the problem, the government 
in late 2007 announced that it intends to introduce 
legislation that will require the president of the central 
bank to resign if inflation exceeds 12 percent per year, and 
to appear before the Parliament if it tops 7 percent.  For 
its part, the government is considering legislation to 
require budget surpluses.  A tighter fiscal policy conforms 
with IMF recommendations, even though the IMF's last program 
expired in mid-2007.  The central bank proposal is in line 
with continuing hostility to the NBG and its independence 
from some government figures, notably Prime Minister 
Gurgenidze and ex-Minister for Reform Kakha Bendukidze, who 
will remain in the government as an advisor to the Prime 
Minister and head of the Chancellery.  Bendukidze is 
promoting a currency board for Georgia to strip the NBG of 
its monetary policy setting function, but has not achieved 
much traction for the idea.  He has had more success with a 
proposal to fold the NBG's banking regulation function into a 
Financial Supervision Agency, that would have oversight of 
the stock exchange, insurance and money laundering as well. 
No NBG president has been nominated to replace Roman 
Gotsiridze since he resigned last year.  The acting director, 
David Amaglobeli has actually grown in respect since he took 
the helm of the bank after Gotsiridze.  The pressure on the 
central bank is likely to continue and even increase in the 
next few months. 
 
7. (SBU) Russian trade sanctions on Georgia continued through 
early 2008.  There are some signs that the Government of 
Russia is ready to discuss lifting the bans on wine and 
mineral water exports from Georgia, but only time will tell 
whether the statements are sincere, and whether Georgian 
officials are ready to respond in kind.  Despite the trade 
problems with Russia, Georgia's exports continued to grow 
through 2007.  In 2007, Georgia exported USD 1240.2 million 
in goods, 25 percent more than it did in 2006.  The CIS 
countries as a group were Georgia's biggest export market. 
Of them, Azerbaijan stands out as a destination for Georgian 
exports.  The EU, as a whole, absorbed 21.7 percent of 
Georgia's exports.  Among individual countries, Turkey was 
Georgia's single biggest export partner (USD 171.7 million) 
followed by the U.S. which received USD 149.5 million of 
Georgian exports, according to Georgian statistics.  Russia, 
formerly Georgia's single largest export partner, took only 
USD 53 million in exports, compared to USD 154 million in 
2005, before the embargoes were imposed. 
 
8. (SBU) Wine is the best known Georgian product, and the 
Russian embargo has taken a serious toll on exports.  Total 
wine exports from Georgia to the world declined from USD 81.3 
million in 2005, before the embargo, to USD 29.2 million in 
2007.  Ukraine is now by far Georgia's best market for wine, 
 
TBILISI 00000190  003 OF 004 
 
 
absorbing 50 percent of Georgia's total exports of the 
product.  Russia took 77 percent of Georgia's wine exports in 
2005 but virtually none in 2007.  Poland and Czech Republic 
doubled their modest imports of Georgian wine since 2006, but 
other markets in the EU, including the Baltics, remained flat 
or even declined, as did the United States.  Overall, leading 
Georgian exports in 2007 were iron and steel (including 
scrap), mineral ores, beverages (mineral water, wine and 
spirits), vehicles and fruits and nuts. 
 
9. (SBU) Despite sharply increased prices for 
Gazprom-supplied natural gas, Russia took a back seat to 
Turkey on imports into Georgia in 2007.  (Note: Turkey 
concluded a free trade agreement with Georgia late in the 
year that promises further increases in trade with that 
country.)  Other important sources of imports, which totaled 
5.2 billion in 2007, include Ukraine and Azerbaijan.  The 
latter country became a major energy supplier to Georgia for 
the first time in 2007.  The EU countries, notably Germany 
and Italy, together supplied 35.5 percent of Georgia's import 
needs.  The United States supplied 3.9 percent (USD 203.9 
million).  Overall, the figures indicate that Georgia has 
rapidly re-oriented its trade away from Russia, although 
relationships with other countries of the former Soviet Union 
remain strong. 
 
10. (SBU) Even though exports are stronger, Georgia is still 
faced with financing a significant 20.2 percent of GDP 
current account deficit, which has grown from 15.3 percent in 
2006.  Remittances from Russia, the U.S. and other countries 
(which totaled 7 percent of 2007 GDP), foreign assistance and 
stronger inflows of foreign investment have permitted Georgia 
to cover the gap and maintain a positive balance of payments. 
 As a result of these inflows and NBG intervention to dampen 
the appreciation
 of the lari, international reserves at the 
central bank were USD 1.3 billion at the end of 2007, 
compared to USD 930 million at the end of 2006.  This relates 
to approximately three months of import cover.  The economy's 
strong demand for imports is unlikely to abate, and points up 
one of the key vulnerabilities of the economy, that is, if 
investment slows and less state assets are available for 
privatization, it will become more difficult for the country 
to fund its appetite for imported goods -- many of which are 
consumer items that are not available from domestic 
producers.  The central bank's reserves peaked in October 
2007 and dropped late in the year and in January 2008, as the 
inward flow of foreign exchange stalled, perhaps temporarily. 
 The situation will not become critical if interest among 
foreign investors begins to pick up again fairly soon. 
 
11. (SBU) As a result of increasing inflows of investment and 
remittances, global weakness of the dollar and more 
willingness on the part of the NBG to use the exchange rate 
as an anti-inflation tool, the lari appreciated considerably 
against the dollar in 2007.  It finished the year at 1.59 
lari to the dollar, appreciating 7.7 percent over the year. 
It gained 3.6 percent against the euro. 
 
12. (SBU) In 2007, the growth of the financial sector 
continued.  Commercial banking assets increased by 70 
percent, and profits by 65 percent.  Despite worries about a 
global credit crunch, Georgian banks continue to attract 
capital, including a USD 65 million credit facility from 
Merrill Lynch to Bank of Georgia announced on January 10. 
According to the NBG, overdue loans in October 2007 were 1.5 
percent of the total, compared to 2.3 percent a year earlier. 
 However, given rapid growth and the history of financial 
problems experienced by other economies undergoing similar 
transitions, the health of the banking sector bears watching. 
 The Galt and Taggart Index, which measures the small stock 
market in Georgia, increased from 790 to 1041 over the year, 
although it peaked around 1500 in August before news of the 
Okruashvili affair broke. 
 
13.(SBU) Available unemployment and wage statistics are not 
especially current, but as of the second quarter of 2007, the 
unemployment rate was 14.9 percent (ILO strict methodology), 
2 percentage points higher than in the same period of 2006. 
This figure considerably understates the unemployment 
picture, and there has been little change in the poverty 
picture, with one in four Georgians living at or below the 
official poverty line.  At the same time, average private 
sector wages were on an upward vector, reaching GEL 385 (USD 
240) per month in the third quarter of 2007, according to the 
Department of Statistics. 
 
14. (SBU) Georgia's new Prime Minister, Lado Gurgenidze, was 
president of the largest commercial bank in Georgia, the Bank 
of Georgia.  As a financial expert, he is taking a great 
interest in Georgia's economic future.  In December, he 
 
TBILISI 00000190  004 OF 004 
 
 
announced a low-interest loan program for entrepreneurs that 
he said will begin in February or March of 2008.  In late 
January, after the presidential elections, Gurgenidze 
submitted a package of economic measures to the Parliament, 
mostly aimed at further liberalizing the financial system, 
the tax code, and customs regulations.  The package includes 
a proposal to reduce the new 25 percent income tax to 15 
percent over the next five years.  (Note: the social tax on 
wages was abolished when the income tax was raised to 25 
percent.)  Corporate taxes are 15 percent of income, and 
plans include eliminating taxes on dividends  and interest 
income in 2009.  The law would require the government to 
maintain a budget surplus of at least 0.1 percent of GDP. 
The surplus would be saved in funds for "future generations" 
(including costs of reconstruction of Abkhazia and South 
Ossetia after reunification) and for unexpected economic 
challenges.  A single regulator for the banking, insurance, 
securities and other financial services will be established. 
Stock exchange and other investor rules will be liberalized, 
and anti-money laundering laws will be amended to 
"streamline" rules for bank ownership while increasing 
transparency of ownership structures.  Gurgenidze's express 
objective is to make Georgia an international financial 
center in the mold of Cyprus, attracting billions of dollars 
of portfolio investment.  Gurgenidze and the government are 
also banking on the development of a free economic zone in 
Poti, where business will be free of almost all taxes, to 
boost employment and growth. 
 
15. (SBU) Comment: The government's political difficulties 
with the opposition have not dented its resolve to make 
Georgia the most liberal economy between Ireland and 
Singapore.  But whether Georgia can peacefully resolve its 
political difficulties -- not only with the opposition, but 
also with Russia and the breakaway territories of Abkhazia 
and South Ossetia -- will determine how soon Georgia can 
reach the peaks of economic success envisaged by the 
government and its new Prime Minister. 
TEFFT

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