21.Apr .2021 22:00

Reforms, Policies, Forecasts – Exclusive Follow-Up with IMF

Reforms, Policies, Forecasts – Exclusive Follow-Up with IMF
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The last review of the 4-year Technical Assistance Program for Georgia is completed, which means that the IMF Program will close with the contribution of 484 million SDRs or about 687 million USD into Georgia’s reforms. Selim Cakir, the representative of the IMF in Georgia sat down with The Checkpoints for an exclusive interview to sum up the achievements of the program and identify priority areas for Georgia’s reforms going forward.

 
The last review of the technical assistance program for Georgia is completed – what does that mean in IMF-Georgia relations?
 
This was a three year arrangement. Then we extended it later on to a fourth year and that’s the maximum a program can have. So, we reached the maximum length. The good thing is it has been concluded successfully. You know we see it at the Fund that a successful conclusion of a Program on time is rather an exception than a rule. Now that it has expired, the authorities already requested their interest in a follow-up program. So we will at some point start negotiations. We also have in-between which we haven’t done yet annual check-up what we call Article 4 consultations and in the meantime maybe before a Program we’ll try to do that kind of check the pulse of the economy, identify reform areas and then engage in Program negotiations.
 
Do you think the pandemic will have impact on the pool of priorities for the reforms in the upcoming program?
 
Definitely. I mean the pandemic of course impacted also what we tried to achieve at the start of our earlier program. If you look at our former program among the aims was fiscal consolidation, building more buffers, in the meantime increase the resilience of the country which we achieved – current account deficit declined, fiscal deficit declined but due to COVID inevitably we had this rise in the fiscal deficit and another rise in the current account deficit. So, going forward the Program will have to take into consideration the developments of the COVID. We will also look into the external needs of the country as well and that will depend a lot on how the pandemic evolves, what the levels of the revenues are. Of course, it will also have an impact on our reform agenda. Now, we see – as you may have noticed in between the lines of our press statement and in our earlier statements – SOE reform going forward as crucial – that will definitely be among cornerstones of the Program. And also, there is a need now to reduce the fiscal deficit and the debt going forward. The fiscal rule requires Georgia’s deficit to come below 3% of GDP by 2023 which means an important amount of fiscal consolidation to take place next year, and of course a lot again will depend on where the pandemic is, where the economy is and if there is need for further fiscal support. But I can easily see agreeing on fiscal deficit and taking necessary measures as part of new program as well.
 
Since you mentioned SOEs – I mean we have seen your recommendations and the Ministry of Finance has taken some steps towards this issue – for example, it has calculated the quasi-fiscal costs of state owned enterprises, but year after year we still see deteriorated financial results of these companies – for example, the Railway had a loss of 164 million Lari last year. So, would you say that this part of IMF’s recommendation has been fulfilled and in which part had it been fulfilled then?
 
First priority we had with the authorities on that part was the kind of improving the transparency of fiscal risks. And these include also the fiscal risks coming from the SOE. The fiscal risks statement that accompanies the budget document has become a very comprehensive one. Now, of course, identifying those risks are not enough. The next step is to take steps to contain it. Now, for that – together with the authorities we identified a comprehensive strategy for SOE reform with the technical assistance mission. But this strategy has to become the government’s strategy: Identifying it is not enough, it has to become the government’s strategy and be implemented. Definitely we see the need to develop a comprehensive new governance framework, covering establishing commercial objectives; performance management; and principles for competitive neutrality among other things. Other donors are also involved in that – for example, you mentioned Georgian Railway – ADB as far as I know is looking into how to make the Georgian Railways be more efficient. These SOEs definitely need to be better managed to become more efficient and also if you recall there are some Eurobonds of these SOEs are coming due, and for the confidence of those investors reforms also need to be made. 
 
These Eurobonds that you mentioned are over 1.7 billion Lari – do you think these loans of SOEs might have an impact on state budget and fiscal strength of the country?
 
As far as I know the intention is to roll-over the Eurobond of Georgian Railways. We think it can be done. We know that the authorities are talking also to international investors and some of the IFIs to facilitate that. I don’t see a problem in that. But for those issuances to be successful and also to bring the balance sheets back into the order a reform agenda has to be set and implemented. So I see them hand in hand. You know, it’s not an issue of roll-over itself, it’s an issue of reforming those institutions. We think time has come for that, and that would definitely be among the pillars of a new program if IMF and the government agrees of course on a new one.
 
What can help Lari stability in Georgia in current situation?

First of all, we have to acknowledge that Georgia faced multiple shocks in a row. The first was travel restrictions imposed on Georgia in 2019. Later on, of course, the pandemic in 2020, and recently there are some spill-overs from Turkish Lira volatility to Georgian Lari. Of course, an improvement in any of these shocks would help Georgia, right? But the most important element in the policy response. So, in that sense, maintaining macro-economic policy discipline; adhering to the fiscal deficit, the fiscal rule and inflation targets, combined with sustained donor funding during the pandemic, we think will help contain depreciation pressures. Some adjustment in the exchange rate is expected – when the economy faces a major negative external shock like a COVID-19. And while we believe floating exchange rate regime continues to work well as a shock absorber, we are also aware and understand that excessive Lari volatility could become disruptive to financial stability as Georgia remains a dollarized economy. The Central Bank has a difficult task – it has to find balance between the supporting the economic activity, containing inflation and provide foreign exchange through interventions but at the same time they also have to keep an eye on the level of reserves in order to maintain confidence. So, a combination of all these factors will help stabilize further.
 
A number of interesting points you have raised and I will have follow-up questions on those, but firstly, what are some of the projections on Turkey – do you think that spill-over effect that you just mentioned will be maintained for certain time on Georgia?

A lot depends on the authorities’ policy response. So far the Central Bank of Turkey has signaled that it intends to keep rates where they are – that they will not engage in a rate-cut cycle. But of course the markets have their own suspicions – proof of the pudding is in the eating, as they say – so the most important will be the Central Bank’s rate actions and the authorities’ policy response. We are also like a market participants we are in a wait and see mode. We don’t have a program engagement with Turkey, so as such we don’t in a way recommend policy actions. We are more in an observing side of events. Short answer is we have to wait and see.
 
Also, since we are talking about the immediate neighbor of Georgia – there is one more interesting neighbor and it is Armenia, and let me say why I think that it is an interesting case for Georgia. We keep hearing from the IMF that the floating exchange rate is serving Georgia well. I would like you once again to explain what IMF means under this statement because, for example, if we take Georgia and the last 5 years, we will see that Lari has lost around 45% of its value against USD, while in Armenia the depreciation is 10% while this country practices some kind of semi-pegged regime. In figures, it feels that Armenia is doing the right thing. Why does the IMF believe that Georgia is doing the right thing?
 
Well, I’m not in charge of Armenia. So, I won’t comment whether Armenia does right or wrong. But I can comment on what Georgia does. If we think of a kind of an extreme and say that all these shocks that we discussed that Georgia had a fixed exchange rate regime in place when faced with those shocks. You know, I would argue that the National Bank of Georgia could have depleted its reserves, defend the exchange rate and the country would be facing a much more devastating adjustment afterwards, or the budget would not have been able to provide all the support it did to the businesses and vulnerable segments of the society and also the recession could have been much deeper. I mean I understand and we also appreciate the concerns about the rate of the depreciation of the currency – it mitigates the impact of the shock in the economic activity. And the National Bank of Georgia is trying to find the delicate balance between avoiding the excessive volatility through its foreign exchange interventions and preserving the country’s external reserves at the adequate level. Unfortunately, the future remains uncertain – there is a new global wave of pandemic, new variants are there, vaccination efforts are weak – also we hope that things will improve. But in case it doesn’t, country needs those reserves. And again, defending the certain level of exchange rate would have been probably a worse use of the country’s limited resources. So, I understand the pain, and I appreciate the concerns, but the alternative could have been much worse for Georgia. 
 
You mentioned the high level of dollarization, do you think it is wise to keep larization policies during the pandemic when we see that this is not the usual situation neither for Georgia nor for the whole world and considering the depreciation tendency that Lari has?
 
The exchange rate volatility I think is very much related to the external shocks the country’s facing and has to do less with larization efforts of the Central Bank, in my view. Now, the Central Bank and the authorities have been in a way paused in their efforts. In the long run, it would increase the efficiency of the monetary policy – it is in the best interest of Georgia but I think the authorities also see now the priority is to deal with the pandemic and with its effects. The larization is not today’s priority and I think the authorities see it that way as well.

Thank you for that answer. And also, Lari depreciation has a spill-over effect on inflation, and we see that the monetary policy is getting stricter to fight that effect. My first question – do you think strict monetary policy is a right approach and second – what is more important for Georgia, Lari stability and less inflation or fully floating exchange rate to better absorb external shocks?
 
We think the National Bank remains properly focused on achieving its inflation target, which is a corner stone of Georgia’s macro-economic policy framework. Now the most recent policy rate increase of course responds to alleviated inflation expectations following a somewhat prolonged period of inflation exceeding its target. Now the monetary policy faces a difficult trade-off between the supporting the economy and ensuring inflation remains well controlled. Now, most of the drivers of current inflation are temporary in our view but we also of course note that survey-based inflation expectations remain alleviated. We believe continued adverse external developments – they happen – may necessitate further policy rate increases. These are difficult trade-offs unfortunately. But achieving inflation target and keeping the inflation expectations under control – it’s of course the priority of the National Bank and we support that.

If we look at this new outlook of 3.5% economic growth for Georgia, what kind of signal is it for business community, for investors, for policy makers?
 
Global economy has witnessed the worst recession since the Great Depression, last year. And this is as we always repeat is truly a crisis like no other. So going forward a lot will be dependent on the pace of the pandemic which is now shaped unfortunately by the uneven progress in vaccination process among countries. Now, in the absence of enough vaccination, again, unfortunately lockdowns become inevitable and these lockdowns have very negative economic implications in every country not only in Georgia. So, when it comes to Georgia, if the pandemic situation requires a new lockdown then the risks to our 3.5% growth forecast will be to the downside. In other words, our forecast doesn’t incorporate another lockdown assumption in itself. Now, over the medium term we still think Georgia’s growth rate will recover to slightly above 5%, supported by the infrastructure spending along with the gradual recovery in tourism and external demand. But the pandemic of course will leave some lasting damage. I mean if you look at the level of real output what we expect in 2024 now it is 11% lower compared to pre-pandemic projection we had for that year. But again this will all depend on how the pandemic evolves.
 
Unfortunately, right now what we see is that we see cases growing again, we already have 4-digit number for again of daily cases, which is not a very good sign, of course. What should be the approach of Georgia if these downside risks that we have talked about still materialize and if we get another lockdown? What way does Georgia have to support its economy – is it taking more debt, is it raising taxes or is there some other choice on the table right now?

If there is a new lockdown, that definitely will be a case for targeted cash transfers to households and also to support businesses. But we think then in such a scenario – such a hypothetical scenario – we think spending re-prioritization should be the first line of defense, instead of new taxes. The capital budget in Georgia has been around 8% now for a couple of years in a row. That is of course important, but at the same time, in such a scenario we see a room for cutting some of the capital spending and increasing targeted cash transfers to vulnerable households. 

Yes, raising taxes would be a tough challenge, considering that 700 thousand citizens are under the poverty line and that the employment is raising mainly in the formal sector- of course, that would be a big burden…
 
Yes, we agree with your analysis and that’s why we think some spending prioritization is important. Now, it’s also important to maintain the credibility of the fiscal rule and the budget has been supporting for three years but if another shock happens, I think that then this time instead of raising taxes or increasing debt – the way to go is to reprioritize other spending. 

And also on this note, what about some better rules for administering taxes – we hear a lot of cases of VAT frauds, which have become quite frequent and we are waiting for exact statistics form the government to see the numbers, so, do you think there is room for improvement of those holes?
 
In the program, you know we have provided extensive technical assistance to the government particularly on improving the tax administration and the administration has evolved a lot. Automatic VAT refunds was one of the targets of the Program, and that is being now implemented. It is important to have automated refund system because then you are providing funds to the private sector in the difficult time, when they are cash-strapped. I specifically don’t know how the fraud situation is but we think we are overall happy with the Georgia revenue administration, the way they have handled their own reform of the administration and the how the government is now able to put in place automated VAT refund program. These are not easy achievements. We really appreciate authorities’ efforts and the current Minister of Finance also was in charge of the revenue administration reform and we think he did a good job then.
 
You also mentioned the vaccination and the pace of vaccination is of critical importance right now. We see that more people are being vaccinated in Georgia right now but the pace is very slow according to the authorities. Would IMF want to see more active information campaign on vaccination for Georgia?
 
This is not an area of the expertise of the institution. 
 
I’m just asking this because nowadays it is so intertwined with the economic growth, with opening businesses, with less stricter lockdowns, and that’s why my question comes to you as well as to all the other respondents who analyze the economic situation of this country…
 
No question about it. Without success in vaccination we can’t have the sustained economy. Georgia is a service intense country in the sense tourism and services industry has a big role in the GDP and the economic activity, and without the vaccine under control, domestic demand or having tourism recover – this will be very difficult to achieve. Of course, it is very important, and of course, as IMF we would like vaccine roll-out to be faster and more vaccines to be available to the country. But this is not an area that we provide advice to the authorities whereas UN, WHO, WB – they have the expertise in this area – it’s not that Georgia is alone and they provide advice, they try to also help with the negotiations for securing enough vaccine, having the correct vaccine roll-out strategy. Is the pace very strong? No, of course we observe that. But again this is not an area of expertise for us.

Anyway, thank you for bringing this context as well to our discussion. What about the financial sector and how the IMF looks at this sector – what do you see as downside risks there and how would you assess the way the financial sector is showing its resilience to the pandemic on the background that Fitch Ratings recently upgraded the ratings of three banks including two systemic banks in Georgia?
 
We think Georgian financial sector is resilient. There are many factors for that. Of course, one of them is the good management of these companies – they should take their line here. But the other line is Central Bank of Georgia is a good supervisor, and those banks were supervised very well before the pandemic as well that help the financial system to face this shock with the better capitalization ratios relative to other countries. Now, that enabled also banks to keep credit flowing to the economy during COVID-times – credit growth has been resilient and the bank recapitalization remains adequate notwithstanding an increase in non-performing assets and restructured loans.
 
We observe that the regulatory capital ratios declined by about 2 percentage points to 71.6%- still a high level and of course we note that the sector has finished the year with a small profit which is quite an achievement in a difficult year. Now, the buffers built in March 2020 – if you remember the Central Bank asked the banks to a preemptive provisioning of a half a billion Lari – we think this is still be sufficient to cover the deterioration in asset quality due to pandemic. We have to observe what happens there on the NPLs, on the restructured loans. Of course, the biggest risk is slower than expected growth, further significant Lari depreciation, resulting in a rising NPLs. Now, we think that the pandemic related policies should not be withdrawn too soon by National Bank of Georgia.

We understand that the banks will be given two year period to rebuild their capital buffers and the timeline to start this process will depend on the profitability and be agreed through consultations with the industry. I want to reconnect with your earlier questions as well, I want to say that you know times are very difficult, it’s not easy for Georgia; but the way I see it if Georgia manages to come out of this pandemic with still a healthy financial system, with adequate FX reserves, despite the depreciated exchange rate and of course the slowed economic activity – it is still not a bad outcome, right? But of course it is still early to talk about this before the end of the pandemic. We still have to see all its impact on the economy and the financial sector. But we will say – so far, so good.