Explanatory Memorandum to COM(2017)559 - Further macro-financial assistance to Georgia - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2017)559 - Further macro-financial assistance to Georgia. |
|---|---|
| source | COM(2017)559  |
| date | 29-09-2017 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
Georgia continues to face a weak external environment, which, through reduced exports and remittances, has contributed to relatively subdued GDP growth of 2.7% in 2016 (compared to 2.9% in 2015 and 4.6% in 2014). GDP growth is projected to increase gradually to 3.5% in 2017, supported by consumption and investment. Regional and global growth is also expected to pick up in 2017, but will remain subject to downside risks of geopolitical instability, protectionism and volatility in the financial markets.
Georgia’s fiscal deficit remains significant (4.1% of GDP in both 2016 and, as expected by the International Monetary Fund (IMF), in 2017). The public debt-to-GDP ratio has increased from 35.6% in 2014 to 44.6% in 2016, mainly due to the fact that around 80% of public debt is denominated in foreign currency, and the national currency (the Georgian lari, GEL) depreciated sharply during that period. Moreover, Georgia’s balance of payments position remains vulnerable due to a very large current account deficit (12.4% of GDP in 2016) and high external debt (111.8% of GDP in 2016). Georgia’s foreign exchange reserves have been broadly stable in absolute terms since 2011, totalling USD 2.8 billion at end-2016, but reserve needs have been increasing according to the composite IMF metric. Therefore, reserves are currently below the level estimated by the IMF to be adequate. Georgia also continues to adapt to the requirements of the Deep and Comprehensive Free Trade Area (DCFTA) with the EU, which, along with opportunities, also entail adjustment costs.
In this context, on 12 April 2017 Georgia and the IMF agreed a three-year (2017-2020) extended arrangement under the Extended Fund Facility (EFF). The EFF represents 100% of Georgia’s quota in the Fund (SDR 210.4 million, or about USD 285 million). The aim of the EFF programme is to support an economic reform programme which will help Georgia reduce economic vulnerabilities, and promote higher and more inclusive economic growth.
The government of Georgia also requested Macro-Financial Assistance (MFA) from the EU on 16 June 2017. In light of this request and the economic situation in the country, the Commission is submitting to the European Parliament and the Council a proposal for MFA to Georgia, based on Article 212 (2) of the TFEU. The proposal is for an amount of up to EUR 45 million, of which EUR 35 million are in the form of loans and EUR 10 million in the form of grants.
The proposed new MFA operation is the third one after Georgia’s military conflict with Russia in August 2008. In October 2008, the EU pledged two MFA operations of EUR 46 million each at the International Donors’ Conference in Brussels. The first of those operations (EUR 46 million, fully in the form of grants) was implemented in 2009-2010 and the second (again EUR 46 million, half in grants and half loans) in 2015-2017. The last tranche of the 2015-2017 MFA operation was disbursed in May 2017.
The proposed new MFA will help Georgia cover part of the external financing needs for the period of 2017-2020, which are estimated at USD 752 million (EUR 671 million). 1 The operation will reduce the economy’s short-term balance of payments and fiscal vulnerabilities. It will be designed and implemented in coordination with the adjustment and reform programmes Georgia has agreed with the IMF and the World Bank, as well as with the reforms agreed in the context of the EU’s budget support operations and the DCFTA.
As further elaborated in the Commission Staff Working Document accompanying this proposal, the Commission considers, based also on the assessment of the political situation made by the European External Action Service (EEAS), that the political and economic pre-conditions for the proposed MFA operation are satisfied.
• General context
The macroeconomic outlook for Georgia remains vulnerable. The ongoing fiscal consolidation could weaken domestic demand and lower economic growth in Georgia. In addition, the Georgian economy faces broader risks due to an uncertain regional and global economic outlook, external imbalances (notably, a large and still increasing current account deficit and significant external debt) as well international reserves that are below the adequate level.
The economic slowdown in the region and the fact that the currencies of major trading partners have depreciated sharply since late 2014 have weighed on Georgia’s exports and remittances. This contributed to a deceleration of economic growth to 2.7% in 2016, from 2.9% in 2015 and 4.6% in 2014. Georgia’s GDP growth in 2016 was mainly driven by investment, while private consumption remained subdued, reflecting the reduction in disposable income induced by the increase in the domestic-currency value of households’ repayment obligations on US dollar-denominated loans in a context of sharp depreciation of the lari. GDP growth is projected to increase gradually, to 3.5% in 2017, supported by consumption and investment, and to 5.0% in 2020 (the end of the recently-agreed arrangement with the IMF).
The exchange rate (USD/GEL period-average) moved from 1.77 in 2014 to 2.27 in 2016, meaning around 22% depreciation of the Georgian lari. The effects of this volatility are amplified by the still high dollarisation of the Georgian economy, where 70% of deposits and 65% of loans were denominated in US dollars in 2016.
Although the unemployment rate in Georgia (11.8% at end-2016) has been on a downward trend since 2009 (16.9%), it remains an important challenge. While employment opportunities have been created in new growth sectors, especially in tourism and other services, high unemployment persists due to challenges associated with skills mismatch and large regional disparities. Georgia also lacks an unemployment benefit scheme.
In terms of the external sector, Georgia’s current account deficit further deteriorated in 2016 to 12.4% of GDP (from 12.0% of GDP in 2015 and 10.6% in 2014) and, as noted, remains a major source of vulnerability. The current account deficit widened in 2014-2016, despite the slowdown in economic growth, as the weakness of exports more than compensated for the weak domestic demand for imports, resulting in a larger trade in goods deficit. The current account deficit is expected to worsen further to 12.9% in 2017, before decreasing modestly to 11% in 2020, according to IMF programme projections. The very large current account deficit is mainly driven by the trade in goods deficit which is only partly offset by the trade in services surplus and income and transfers from abroad, including remittances.
Although the current account deficit has mainly been financed by inflows of foreign direct investment, the latter is expected to decrease slightly from 11% of GDP in 2016 to 10.3% of GDP in 2017 and remain at a similar level until 2020. Moreover, debt-creating financial inflows have also contributed to the financing of the current account deficit. Hence, Georgia’s external debt, which hovered around 80% of GDP in 2008-2014, has increased significantly in the following years, to 111.8% of GDP at end-2016. The external debt is projected to increase further, to 120.2% in 2020. As most foreign debt is denominated in US dollar, the lari depreciation has played an important role in this increase.
The National Bank of Georgia (NBG) has generally refrained from large interventions in the foreign exchange market and allowed the lari to depreciate. This has allowed gross international reserves to remain stable overall, totalling USD 2.7 billion at end-February 2017 (about 3 months of next year’s imports). The recently-agreed IMF programme targets a 54% increase in reserves, from USD 2.8 billion at end-2016 to USD 4.2 billion in 2020 (about 4 months of import cover).
The period-average inflation (consumer price index, CPI) decelerated to 2.1% in 2016, compared to 4.0% in 2015. CPI is projected to increase to 5.7% in 2017, in line with the increase of excise duties which entered into force in January 2017, but should decrease to 3.0% in 2018 and remain at a similar level in 2019 and 2020.
Following a long period of fiscal consolidation since 2009, the fiscal deficit of the general government started to widen in 2015 (3.8% of GDP), partly as a result of an increase in social spending aimed at addressing the country’s high levels of poverty and inequality, but also reflecting the negative impact of the economic slowdown on tax revenues. The budgetary position further deteriorated in 2016, with the government deficit estimated by the IMF at 4.1% of GDP, as a result of both weaker-than-expected revenues and spending increases ahead of the October parliamentary elections (mainly in defence, public transport, infrastructure and healthcare). The fiscal deficit (which was projected to increase further, to around 6% of GDP this year, before the new IMF programme was agreed) is now forecast to remain at the same level (4.1%) in 2017 and to decrease gradually afterwards, reaching 3.1% in 2020. Public debt also increased to an estimated 44.6% of GDP in 2016 (from 35.6% in 2014) and is expected to rise further, peaking at around 47% in 2019, before decreasing gradually afterwards.
The fiscal strategy of the Georgian authorities is based on further consolidation. Notably, the Georgian authorities plan to reduce current spending (a reduction in the wage bill and administrative expenses, efficiency gains in healthcare spending, and new spending controls on local governments), whilst increasing capital spending, mainly in infrastructure, and introducing a second (funded) pillar of the pension system. On the revenue side, the Georgian authorities have increased taxes (notably, excise duties on tobacco products, vehicles and fuel) to compensate for revenue losses due to the corporate income tax reform that entered into force in January 2017 and are ready to take additional measures if needed.
The fiscal consolidation is complemented by the structural reform agenda which focuses on improving business environment, education and public administration as well as investing in infrastructure. Additional measures include fiscal reforms (notably, improving the management of risks stemming from public-private partnerships and state-owned enterprises), strengthening of the financial sector (for instance, introducing a deposit guarantee scheme and improving regulatory, supervisory and resolution frameworks for banks), as well as the ongoing adaptation to the requirements of the DCFTA.
The IMF’s projections of March 2017 point towards significant external financing needs for the period of 2017-2020, with the total external financing gap estimated at USD 752 million (USD 256 million in 2017, USD 222 million in 2018, USD 183 million in 2019 and USD 91 million in 2020). This financing gap can broadly be attributed to three factors: a relatively large current account deficit, the need to increase foreign exchange reserves, and significant expected debt amortisation requirements.
The proposed MFA operation of EUR 45 million (around USD 50 million), in addition to EUR 23 million (around USD 26 million) disbursed under the previous MFA operation in May 2017, would cover 10% of the total estimated financing gap and 33% of the residual financing gap (after deducting net IMF financing and the expected disbursement of World Bank policy-based loans).
Other key contributions to covering the residual financing gap include budget support grants from the French development agency, AFD (of USD 62 million in 2017), and the Asian Development Bank (expected to amount to USD 100 million in 2018-2019).
• Existing provisions in the area of the proposal
Decision No 778/2013/EU providing previous macro-financial assistance to Georgia in the amount of EUR 46 million (half in grants and half in loans) was adopted by the European Parliament and the Council on 12 August 2013. 2 The assistance was fully implemented in 2015-2017, with the last disbursement in in May 2017.
• Consistency with the other policies and objectives of the Union policies
The EU and Georgia have developed close political and economic relations over the years, leading to the conclusion of the Association Agreement, including the DCFTA, which was signed in 2014 and entered into force in July 2016. This Association Agreement, which has replaced the previous Partnership and Cooperation Agreement, will allow for political association and economic integration of Georgia with the EU. The EU Single Support Framework (SSF) identifies the priority sectors of cooperation with Georgia, funded by the European Neighbourhood Instrument (ENI). The SSF for 2017-2020 is currently being finalised.
Georgia’s economic ties with the EU are already well developed. In 2016, the EU was the main trading partner of Georgia, with a 32.6% share of trade, well ahead of other main trading partners (Turkey and Russia, with, respectively, 17.2% and 8.1% shares of trade). The EU is also Georgia’s main investment partner and donor.
Countries that are covered by the ENP are eligible for MFA. The EU MFA will complement the grants mobilised under the ENI and other EU programmes and in particular the conditionality envisaged under the budget support packages being implemented by the EU. By supporting the adoption, by the Georgian authorities, of an appropriate framework for macroeconomic policy and structural reforms, the EU’s MFA will enhance the added value and effectiveness of the EU’s overall financial interventions, including through other financial instruments.
Georgia has consolidated its democracy and the rule of law, as well as further reinforced respect for human rights. The latest parliamentary elections in October 2016 were competitive and well-administered. Regarding the judiciary, Georgia’s reforms have promoted judicial independence, professionalism and accountability.
In view of the above, the political preconditions for granting MFA to Georgia, including the aspect of political and economic closeness to the EU, may be considered to be satisfied. A detailed assessment of the satisfaction of the political criteria for MFA, produced by the EEAS, is annexed to the Commission Staff Working Document accompanying the proposal.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Summary of the proposed action
The MFA operation under consideration would amount to a maximum of EUR 45 million. The Commission proposes to provide the amount of the assistance in the form of medium-term loans of up to EUR 35 million and grants of up to EUR 10 million. Given the proposed size of the operation, the Commission is considering releasing the assistance in two instalments. 3 The first tranche would indicatively be composed of a loan element of EUR 15 million and a grant element of EUR 5 million, and the second tranche of a loan element of 20 million and a grant element of EUR 5 million.
The assistance will be managed by the Commission. Specific provisions on the prevention of fraud and other irregularities, consistent with the Financial Regulation, are applicable.
Disbursements under the proposed MFA operation would be conditional on successful reviews under the IMF programme and on the effective drawing by Georgia on IMF funds. In addition, the Commission – on behalf of the EU – and the Georgian authorities would agree on a specific set of structural reform measures, to be defined in a Memorandum of Understanding. These reform measures would support the authorities’ reform agenda and complement the programmes agreed with the IMF, the World Bank and other donors, as well as the policy programmes associated with the EU’s budget support operations. They would be consistent with the main economic reform priorities agreed between the EU and Georgia in the context of the Association Agreement, including the DCFTA and the Association Agenda.
The decision to disburse around 22% of the proposed assistance in grants (EUR 10 million out of a total of EUR 45 million) and the rest in loans is justified by Georgia’s level of economic and social development (as measured by the country’s per-capita income, with Georgia being classified by the World Bank as a lower middle-income country, and the incidence of poverty), as well as by its relatively high indebtedness. Whilst Georgia is no longer eligible for concessional financing from either the IMF or the World Bank, its graduation from this concessional financing is relatively recent. Nevertheless, this graduation argues in favour of prioritising the loan element.
• Legal basis
The legal basis for this proposal is Article 212 (2) TFEU.
• Subsidiarity (for non-exclusive competence)
The subsidiarity principle is respected as the objectives of restoring short-term macroeconomic stability in Georgia cannot be sufficiently achieved by the Member States alone and can be better achieved by the European Union. The main reasons are the budgetary constraints faced at the national level and the need for strong donor coordination in order to maximise the scale and effectiveness of the assistance.
• Proportionality
The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of short-term macroeconomic stability and does not go beyond what is necessary for that purpose.
As identified by the Commission based on the estimates of the IMF in the context of the Extended Fund Facility programme, the amount of the proposed new MFA, in addition to the last disbursement under the previous MFA operation in May 2017, corresponds to 10% of the total estimated financing gap for the period 2017-2020 and 33% of the residual financing gap (i.e. excluding the IMF’s net contributions and expected disbursements of World Bank policy-based loans). This is consistent with standard practices on burden-sharing for MFA operations, taking into account the assistance pledged to Georgia by other bilateral and multilateral donors.
• Choice of the instrument
Project finance or technical assistance would not be suitable or sufficient to address these macroeconomic objectives. The key value added of the MFA in comparison to other EU instruments would be to alleviate the external financial constraint and to help create a stable macroeconomic framework, including by promoting a sustainable balance of payments and budgetary situation, and an appropriate framework for structural reforms. By helping to put in place an appropriate overall policy framework, MFA can increase the effectiveness of the actions financed in Georgia under other, more narrowly-focused EU financial instruments.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Consultation of interested parties
MFA is provided as an integral part of the international support for the economic stabilisation of Georgia. In the preparation of this proposal for MFA, the Commission services have consulted with the IMF and the World Bank, which have already put in place sizeable financing programs and are preparing new ones. The Commission has also been in regular contact with the Georgian authorities.
• Collection and use of expertise
In line with the requirements of the Financial Regulation, the European Commission services have carried out an Operational Assessment of the financial and administrative circuits of Georgia in order to ascertain that the procedures in place for the management of programme assistance, including MFA, provide adequate guarantees. The preliminary findings from a mission conducted by a consultancy company for the purposes of this Operational Assessment were received in September 2017. They indicate that the current status of the administrative and financial circuits of Georgia is adequate for managing a new MFA operation although some weaknesses remain. The draft final report on this Operational Assessment is expected to be received in November 2017. Developments in that area will continue to be closely monitored also through the regular progress reports on public finance management (PFM) reforms produced by the EU Delegation in Tbilisi.
• Impact Assessment
The EU’s macro-financial assistance is an exceptional emergency instrument aimed at addressing severe balance-of-payment difficulties in third countries. Therefore, this MFA proposal is exempted from the requirement to carry out an Impact Assessment in accordance with the Commission’s Better Regulation Guidelines (SWD(2015) 111 final).
More generally, the Commission’s MFA proposals build on lessons learned from ex-post evaluations carried out on past operations in the EU’s neighbourhood. The new MFA and the economic adjustment and reform programme attached to it will help alleviate Georgia’s short-term financing needs while supporting policy measures aimed at strengthening medium-term balance of payments and fiscal sustainability and raising sustainable growth, thus complementing the programme agreed with the IMF. These policy conditions should address some of the weaknesses shown over the years by the Georgian economy and economic governance system. Possible areas of conditionality could, in principle, include reforms aimed at reinforcing social safety nets, PFM, strengthening the investment climate and supporting the implementation of the DCFTA.
4. BUDGETARY IMPLICATIONS
The planned assistance will be provided in the form of loans and grants. The loan part will be financed through a borrowing operation that the Commission will conduct on behalf of the EU. The budgetary impact of the loan assistance will correspond to the provisioning of the EU’s Guarantee Fund for external actions, at a rate of 9% of the amounts disbursed, from budget line 01 03 06 (“Provisioning of the Guarantee Fund”). Assuming that the two loan disbursements (of EUR 15 million for the first tranche and EUR 20 million for the second tranche) will be made in 2018, the provisioning will take place in the 2020 budget, in accordance with the rules governing the Guarantee Fund mechanism, for an amount of EUR 3.15 million.
The grant element of the assistance (EUR 10 million in total, i.e. EUR 5 million for each of the two tranches) will be financed from commitment appropriations of the 2018 budget, under the budget line 01 03 02 (Macro-financial assistance), with payments also taking place in 2018. 4
Based on current projections on the utilisation of the budget lines 01 03 02 and 01 03 06, the Commission assesses that the budgetary impact of the proposed MFA operation for Georgia can be accommodated.
5. OTHER ELEMENTS
• Review/revision/sunset clause
The proposal includes a sunset clause. The proposed MFA would be made available for two and a half years, starting from the first day after the entry into force of the Memorandum of Understanding.