Program information document (pid) appraisal stage
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- Country Georgia Sector
- Operation ID P122202 Lending Instrument
- Date of Appraisal May 16, 2011 Date of Board Approval
| PROGRAM INFORMATION DOCUMENT (PID)
APPRAISAL STAGE Report No.: AB6753
Country and Sector Background Georgia experienced rapid growth in excess of 9 percent per year between 2004 and mid-2008 as a result of implementing far-reaching reforms with impressive results. However, the double shocks from the August 2008 conflict and the subsequent global economic crisis resulted in a sharp downturn in economic growth. The economy contracted by 3.8 percent in 2009, with FDI inflows collapsing from 16.4 percent of GDP in 2007 to 6.1 percent in 2009 and exports falling from 31 percent of GDP in 2007 to 29.8 percent in 2009. Economic recovery took hold in 2010, with growth rebounding to an estimated 6.4 percent. The recovery has been led by a strong rebound in several sectors, including manufacturing (20.3 percent), construction (7.6 percent), and services including transport (13.1 percent), wholesale and retail trade (14.1 percent), and hotels and restaurants (12.9 percent). The recovery has benefited from a pickup in exports, tourism, bank lending, and continued high levels of public investment. At the same time, FDI inflows have remained weak at 4.7 percent of GDP in 2010, suggesting that the underlying drivers of growth are evolving in the post-crisis period, with a greater role for domestic private investment and the tradables sector. The rebound in both merchandise and services exports has played a major role in the economic recovery, with exports of goods and services up to 34.8 percent of GDP in 2010 from 29.8 percent in 2009. Private investment rates have recovered only modestly in 2010, suggesting that the strong growth rebound has been facilitated in part by higher capacity utilization. The economy is projected to grow by about 5 percent per year during 2011-14, which will require higher private domestic investment and productivity in the tradable sectors. Operation Objectives The Third Development Policy Operation (DPO-3) is the third in a series of three programmatic development policy operations intended to support the Government of Georgia’s policy reform program to (i) mitigate the impact of the economic downturn in the short-term; and (ii) facilitate recovery and prepare Georgia for post-crisis growth in the medium-term. In addition to a satisfactory macroeconomic and fiscal framework, the main policy areas supported are: (i) improving the efficiency and effectiveness of public finances; (ii) improving the effectiveness of the social safety net; and (iii) improving external competitiveness. DPO-3 shifts emphasis toward measures directed at sustaining the economic recovery and preparing Georgia for post-crisis growth in the medium term. Although growth has rebounded strongly to an estimated 6.4 percent in 2010, challenges remain in sustaining the economic recovery and in creating the conditions for sustained post-crisis growth. The macroeconomic and fiscal framework includes significant fiscal adjustment to safeguard sustainability as economic recovery takes hold during 2010-13, following the countercyclical fiscal stimulus to mitigate the downturn during 2008-2009. Improved efficiency and effectiveness of public expenditures are directed at facilitating fiscal adjustment and creating the conditions to sustain recovery and post-crisis growth in the medium term. Improved effectiveness of the social safety net is directed at cushioning the impact of the downturn and ensuring that the benefits of post-crisis growth are broadly shared. Improved external competitiveness is directed at ensuring that a vibrant and competitive tradable private sector sustains economic recovery and serves as the engine of post-crisis growth in the medium term. Rationale for Bank Involvement The DPO series is anchored in a strong Government program to respond to the crisis in the short term and implement key structural reforms in the medium term. In response to the double shocks, the authorities adopted a number of immediate mitigating measures. These included the scaling up of critical social and infrastructure investment expenditures as part of a countercyclical fiscal response, providing liquidity and regulatory support to the banking sector, and working with the international community to secure donor assistance. The Government’s response to the crisis has received broad support from the international community. Following a “Joint Needs Assessment” (JNA) in October 2008 led by the World Bank and the United Nations (with the collaboration of ADB, EC, EBRD, EIB, and IFC), and an International Donor Conference in Brussels, Georgia received pledges of financial support from the international community of $4.5 billion over three years, including $850 million for the banking sector. Furthermore, the IMF Board in September 2008 approved a $750 million Stand-By Arrangement (SBA), which was subsequently augmented by about $400 million and extended to June 2011. The Ninth and final Review of the IMF program was successfully completed on June 8, 2011. Support from the international community has included general budget support from the World Bank, ADB, US Treasury, and the EC. The Dutch Government has provided co-financing of Euro 4.5 million for DPO-1 and DPO-2. The Government’s medium term structural reform program addresses key medium-term post crisis development challenges (see Section IV). The areas of the Government’s reform program include: (i) maintaining macroeconomic stability through fiscal adjustment and single-digit inflation; (ii) generating employment by restoring rapid economic growth, upgrading infrastructure, ensuring high quality education, and maintaining a market-friendly business environment; (iii) enhancing competitiveness by continuing to reduce the burden of the state, maintaining an open trade regime, and establishing a deep and comprehensive free trade agreement with the EU; (iv) continuing to improve public service delivery; and (v) strengthening the social safety net comprising the two pillars of social assistance and health insurance with a focus on enhancing access for the most vulnerable. Financing IDA Credit of SDR 25.0 million (US$40 million equivalent). IDA terms: 25 year maturity including a 5 year grace period.
Institutional and Implementation Arrangements The Ministry of Finance will act as the main coordinator for managing the overall implementation of the DPO program. The Ministry also actively participates in implementing the overall strategic goals of the Government’s annual Basic Data and Directions reform program based on the “United Georgia without Poverty” strategy document. The primary implementing line agencies for the DPO program are: the Ministry of Finance, the Ministry of Economy and Sustainable Development, and the Ministry of Labor, Health, and Social Affairs. The monitoring of the reform program will be carried out through regular reviews and in the context of the supervision of this operation. Progress in the implementation of policy measures will be further monitored through other Bank financed projects, including those that complement actions supported under the DPO program. The monitoring of public sector reforms as well as public expenditures in social sectors is of particular importance to the Government. 6. Benefits and Risks Important results have been achieved under the support of the DPO program. The economic downturn was contained in 2009, growth rebounded strongly in 2010 and 2011, and fiscal policy moved from stimulus in 2009 to quality adjustment during 2010 and 2011. Public expenditure efficiency has benefited from reforms backed by the DPO series to enact a new Budget Code, enhance the results orientation of the budget, and strengthen capital budgeting. A greater share of public expenditures is being covered by improved performance indicators; and transparency and accountability of public investment is being strengthened. On the social safety net, coverage was scaled up and benefits were improved while enhancing targeting effectiveness. The shares of the poor and extreme poor receiving publicly subsidized health care and targeted social assistance have increased markedly. On external competitiveness, improvements were achieved in reducing the time required for tax compliance and for trading across borders (with e filings up markedly and the share of customs declarations through the red corridor down significantly); furthermore, brisk progress was made in identifying trade-related reforms for improved access of Georgian products to international markets. Independence of the statistics agency with streamlined institutional structures has been established. Georgia faces a number of macroeconomic risks and vulnerabilities. First, given the uncertain global economic outlook, the external environment could suffer a renewed deterioration, which would negatively impact exports, remittances, FDI, and other private capital inflows. Second, renewed domestic and regional tensions or other factors could affect investor and consumer confidence, which would constrain further private investment and growth of credit to the private sector. These scenarios would have an adverse impact on the growth outlook and require further external adjustment, including further realignment of the real exchange rate, faster fiscal adjustment, and additional official financing. Such a scenario would also add to the public debt burden and increase the ratio of nonperforming loans of the banking sector. Third, increases in food and fuel prices could intensify or result in second-round effects onto the prices of other products, which would raise pressures to further tighten monetary policy and also increase the fiscal costs for assistance to the vulnerable. Fourth, the 2012-13 elections carry the risk of adding to fiscal pressures. These risks are mitigated by a number of factors. First, the authorities are committed to the fiscal adjustment program and a flexible exchange rate policy, which provide key anchors for external and debt sustainability. Second, Georgia’s debt burden indicators remain within relevant prudential thresholds, with successful refinancing of the Eurobond in April 2011 providing a strong vote of confidence from capital markets. Third, on price pressures, the NBG has already preemptively tightened policy, which should help stabilize inflation to about 8.5 percent by end-2011. Fourth, the authorities have front-loaded a good part of fiscal adjustment and are committed to financing additional necessary expenditures through savings in other areas or through improvements in revenue collection. On mitigating regional tensions, mediation efforts are ongoing with support from the international community and bilateral partners. Domestically, political conditions remain stable, with parliamentary and presidential elections scheduled for 2012 and 2013, respectively. Poverty and Social Impacts and Environment Aspects The DPO series has been designed to mitigate the impact of the economic downturn on the poor and to improve living standards in Georgia over the medium term. First, the overall macroeconomic and fiscal framework has included significant reallocation of expenditures, which has created fiscal space for increased social protection and health expenditures. Second, reforms to scale up and strengthen the social safety net while maintaining targeting efficiency have had the greatest effect in supporting incomes of the poor over the course of the economic downturn. Third, in the medium term, reforms to sustain economic recovery and post-crisis growth are expected to be the driving force behind improved living standards. Finally, it should be noted that the prior actions supported under the public finance and external competitiveness pillars are expected to be neutral with regard to the impact on income distribution. The policy actions supported by this DPO series are not likely to cause significant effects on the environment, forests, and other natural resources of Georgia. The one policy area that required careful screening was business environment reforms. The reforms to the business environment supported by the DPO program focus on further streamlining tax administration to reduce the burden on the economy and improving customs administration infrastructure and hence do not weaken the institutions and regulations with respect to environmental protection. In general, experts observe that while the regulatory framework on the environment in Georgia is broadly aligned with international standards for the level of economic development of Georgia, the implementation of this framework can be strengthened. Strategic priorities in environmental protection for a three year period are explicitly stated in the Basic Data and Directions (BDD) document of the Government of Georgia comprising strategic objectives and budgeted activities for all sectors. Contact point Faruk Khan Senior Economist Tel: (202) 458-4764 Email: fkhan5@worldbank.org
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