Post-War Economy of Georgia: New Challenges and Old Mistakes

Abstract

It has been over a year now that Georgia survived Russia’s military aggression. In this period of time economic crisis has gained momentum in the country. Having hit the national roots it has also been conditioned by global financial crisis. In this span of time Georgian government made new mistakes as well, primarily concerning antirecessionary measures that they have elaborated and implemented. The chapter discuss new challenges, as well as the existing situation regarding the improvement of old mistakes.

Full text

Tbilisi, 2010
Georgia,2009
Post-War Challenges & Perspectives

About The Independent
Experts’ Club (IEC)
Founded on October 15, 2008
The war of August 2008 in Georgia created a new reality for the country. Motivated by these new challenges and a
desire to better understand the situation – past, present and forthcoming – a group of independent experts engaged
in the elds of policy analysis, economic, social, legal, security and military research, conict resolution and other
important issues has come together to collectively address and advance these topics.
The Club’s activity is based upon professionalism, equality, transparency and pluralism. Civil servants and members
of political parties cannot be members of the IEC.
The Club seeks to develop a more active expert and civil involvement in the assessment and evaluation of the events
and processes currently ongoing in Georgia whilst making these processes more public and providing an opportunity
for co-participation in expert analysis within various interested and engaged civil society groups. The Club will attempt
to integrate and focus current local intellectual potential (inter-alia international potential) upon enabling a further
understanding of the current situation in Georgia and developing a dialogue with the Government of Georgia and
international organizations as concerns a wide range of current and potential challenges.
The rst study of IEC - “Crisis in Georgia, 2008- Preconditions, Reality and Perspectives” - was published in February
2009.
Members of the Independent Experts’ Club are:
Zurab Abashidze Foreign Relations Council, former Ambassador to EU, NATO, Russia, PhD;
Mamuka Areshidze Centre for Strategic Researches of the Caucasus;
Tamara Chikovani Media Expert, former Head of Tbilisi Bureau of Radio FERL;
Archil Gegeshidze Georgian Foundation for Strategic and International Studies, PhD;
Tedo Japaridze International Centre for Black Sea Studies (Athens), Former Ambassador to the USA,
Canada and Mexico. Former Foreign Minister of Georgia, PhD;
Merab Kakulia Georgian-European Policy and Legal Advice Centre, former Vice-President of the National
Bank of Georgia, PhD;
Iago Kachkachishvili Tbilisi State University, Department of Sociology, PhD;
Kakha Katsitadze Tbilisi State University, Department of Philosophy, PhD;
George Khutsishvili International Centre for Conicts and Negotiations, PhD;
Gia Khukhashvili The Centre of Public Projects, Executive Secretary of the Independent Experts’ Club, PhD;
Zakaria Kutsnashvili Association “Law for People”, former MP;
Vladimer Papava Georgian Foundation for Strategic and International Studies, former Minister of Economy,
former MP, PhD;
Zaza Piralishvili Caucasian Public Strategies Institute, PhD;
Ramaz Sakvarelidze Tbilisi Medical University, Department of Medical Psychology,
former MP, PhD;
Irakli Sesiashvili Security policy expert, Association ”Justice and Liberty“;
Zaza Shatirishvili Tbilisi Free University, The University of Chicago – Visiting Scholar, PhD;
Lasha Tugushi Media Expert, “Resonance” newspaper - Editor in Chief, PhD;
Soso Tsiskarishvili European Integration Forum, Association “World Laboratory”, former Chairman of the State
Committee for Foreign Economic Relations, President of the Independent Experts’ Club.

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Independent Experts’ Club
Contents
Soso Tsiskarishvili
Introduction. Georgian/Russian Political Pathology .....................................................................5
Zurab Abashidze
18 Months Since Russian-Georgian War .......................................................................................8
Tedo Japaridze
Anticipation of turning point or the frenzy of reinventing the wheel?
(European and Euro-Atlantic Future of Georgia) ............................................................................ 13
George Khutsishvili
Georgia’s Security Dilemma in the Light of Post- August Realities ................................................... 21
Irakli Sesiashvili
Challenges in Georgian Army ...................................................................................................27
Mamuka Areshidze
Russian-Georgian Border: Current Situation and Challenges ............................................................................... 36
Vladimer Papava
Post-war Economy of Georgia: New Challenges and Old Mistakes ..................................................... 42
Merab Kakulia
Macroeconomic Paradigm of Post-war Georgia ............................................................................ 48
Iago Kachkachishvili
Transformation of Public Opinion on the Glimpse of
Russian-Georgian War in 2008 and 2009 Spring Crisis ........................................................................ 54
Zakaria Kutsnashvili
Democracy in Georgia through the Prism of 2009 Challenges................................................................. 65
Tamar Chikovani
Lost in Clouds ....................................................................................................................... 73
Ramaz Sakvarelidze
April 2009: War Waged for the Sake of War .................................................................................. 77
Shalva Pichkhadze
Thoughts of the Farewell Year … ..............................................................................................83
Zaza Piralishvili
Liberalism sans Democracy ......................................................................................................87
Kakha Katsitadze
The Collapse of Myths ............................................................................................................. 89

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Edited by Soso Tsiskarishvili

42
Vladimer Papava
POST-WAR ECONOMY
OF GEORGIA: NEW
CHALLENGES AND OLD
MISTAKES
as a result of Russian military aggression, while
part of it will be used for the rehabilitation of the
country’s economy. It is noteworthy that USD
4.55 billion is devised for both, state and private
(especially banking) sectors.
Georgian government had to bear additional
costs because of social problems related to
internally displaced persons from conict regions.
In the rst place, we should mention that the
government is building temporary residential
houses for these people, which on the one hand
revives the economy – additional demand appears
on construction materials, workers are being
employed, but the costs incurred for construction
are eventually still inationary in the short-term,
since it is the government that is buying these
houses and not people. However, the government
has no other choice.
In the post-war Georgia, the ow of foreign
direct investments (FDI) diminished, which is
caused primarily by the fact that under global
nancial crisis, the investors are trying to invest
in safer countries than is Georgia under Russian
aggression. Remittances from Georgians living
abroad to their relatives have also reduced under
global crisis. And if we also take into account that
Georgia has an extremely negative foreign trade
balance, where import exceeds export four times,
it should not be surprising that the maintenance of
stability of GEL exchange rate came under threat.
After the August war, International Monetary
Fund (IMF) allocated USD 750 million credit for
maintaining macroeconomic stability in Georgia
under the Stand-By Arrangement, out of which 250
1. While discussing old mistakes the author has used the results of analytical research “Georgian Economy: Mistakes, Threats and
Resolutions” which has entered in the volume prepared by Independent Experts’ Club “2008 crisis in Georgia: Preconditions, Real-
ity, Perspective.”
It has been over a year now that Georgia survived
Russia’s military aggression. In this period of
time economic crisis has gained momentum in
the country. Having hit the national roots it has
also been conditioned by global nancial crisis.
In this span of time Georgian government made
new mistakes as well, primarily concerning
antirecessionary measures that they have
elaborated and implemented.
Below we will discuss new challenges, as well as
the existing situation regarding the improvement of
old mistakes1.
Financial “Compensation”
of Russian-Georgian War
After a ve-day Russian-Georgian war, Georgia
faced new economic challenges given the existing
global nancial crisis. In particular, liquidation of
economic damage inicted by war, avoidance
of bank crisis, prevention of further growth of
relatively high level of ination, maintenance of the
stability of the national currency -GEL exchange
rate.
At donors’ conference in Brussels held on 22
October, 2008, the decision was adopted according
to which Georgia could receive nancial aid in the
amount of USD 4.55 billion: 2 billion as a grant and
2.55 billion – the credit. Georgia started receiving
this aid in 2008 and this process will continue until
2010. The considerable part of this aid should be
used for the elimination of the damage inicted

43
Independent Experts’ Club
USD million was put to National Bank reserves
in the fall of 2008. On 6 August 2009, the IMF
allocated additional USD 420 million within the
limits of the same program. As was determined, the
program was to last until 14 June 2011. This sum,
together with the abovementioned USD 4.55 billion
provides the guarantee that Georgia will avert
currency crisis.
It is noteworthy that the acceptance of USD 4.55
billion in full amount depends on the one hand on
how efciently and purposefully the allocated funds
will be used and on the other – how successfully
Georgian government will carry out the following
rounds of negotiations with donor countries and
organizations in order to get the promised funds.
It should be noted that the Georgian government
is successfully coping with negotiations and
fortunately, there have not been any obstructions
on the way to receiving the aforementioned
nancial aid so far.
Economic Crisis and the
“Paradox OF War”
It was due to poor development of Georgian
nancial market that global crisis did not have that
dramatic impact to cause the crash of economy in
Georgia. But at the same time it can’t be said that
global crises has had no impact whatsoever on
the Georgian economy. For instance, the volume
of foreign direct investments reduced, money
transfers from Georgian citizens living abroad
decreased, relatively low-interest rate loans from
European nancial markets have become less
available for Georgian banks as they have become
expensive under global crisis.
It is no less important to underscore that the
ongoing economic crisis in Georgia has got purely
national roots. The most important among them are
the following:
Most part of FDI in the country was 1.
concentrated on the acquisition of the
property right, privatization being one of
the ways. But they were directed at the
development of the real sector of economy
to a lesser extent. As a result, the imbalance
created between nancial resources in the
country and the development of the real sector
of economy was quite obvious.
When the government abolished regulatory 2.
function in the construction business, many
companies in this sector of the economy
started to build their activities on “nancial
pyramid” principle, i.e. when the money for the
fulllment of old obligations is already spent
and the company takes up a new obligation in
order to compensate the loss, but sooner or
later the pyramid collapses as usual.
Most Georgian banks would invest 3.
considerable part of relatively cheap credit
resources obtained on the European nancial
markets in construction business and
household technologies. Doing so, on the
one hand they supported the maintenance
of the abovementioned “nancial pyramid”
mechanism and on the other, instead of
crediting national economy they were crediting
import. The latter favored strengthening of the
existing imbalance between nancial resources
that the country received and the development
of the real sector of the economy.
Economic crisis was directly reected in the growth
of Gross Domestic Product. Namely, in the rst
quarter of 2009 compared to the same period of
the previous year it reduced by 5.9%, in second
quarter by 10.1% and by the end of the year, as is
attested by the IMF, it is anticipated that GDP will
reduce by 4%. The fall of economy had a direct
impact on the reduction of tax revenues, for which
reason in July 2009 the state budget of 2009 was
amended and tax revenues were reduced by GEL
500million which made up 10.5% of the projected
tax revenues. However, the budget still increased
by GEL 312 million, which was mainly due to the
abovementioned foreign injections.
The spring of 2009 was a due date for the
repayment of foreign debt of 500 million GEL
for Georgian banks but they did not dispose of
these resources. Banking crises was averted in
the country by the help of foreign investments
mentioned above from which they received USD
636 million which not only was enough to repay
foreign debt but it also availed the banks to have
the necessary resource to remain sustainable.
The fact that Georgian economy remains
sustainable is in the rst place thanks to donors’
aid which Russian aggression made “more easily
available” for the country. The war and especially
the lost one is a negative occurence by itself,
but if not that, it is doubtful that Georgia would
ever be able to receive such signicant nancial
aid under global crisis so swiftly, which lays the
grounds for sustainability of the country’s economy.
Therefore, we are obviously dealing with the so
called “Paradox of War”, when such an extremely
negative event as war allowed the country to avert
economic collapse.

44
Anti-Crisis Measures
Under global nancial crisis, the governments of
different countries are normally trying to elaborate
anti-crisis program. Taking into account the fact
that after the Rose Revolution the Parliament was
not able to come up with any program on economic
development, it should not be surprising that
neither there is any program in the country under
the recession, which is unfortunate.
What the government managed to come up with,
though, is the so called “New Financial Package”
which mainly cocerns banking and construction
sectors.
The steps made with regard to banking sector
were mutually exclusive. Namely, on the one hand,
by alleviating the regulatory normatives of banks,
the National Bank of Georgia (NBG) favors the
emergence of additional credit resource in the
country, and on the other hand, because banks
have difculties in placing their credit resources
during the ongoing recession, the government
took the decision on the emission of GEL 260
million of treasury bonds. In other words, the
government reduces credit resource by GEL 260
million that could have been used for crediting
the real sector. The government is going to spend
nancial resources obtained in the above manner
on infrastructural projects.
Emission of treasury bonds will not serve as anti-
crisis measure – just the opposite, by reducing
credit resource it restrains the possibility of the
development of the real sector.
It is worth pointing out that three weeks before
declaring the decision on the emission of treasury
bonds, the Ministry of Finance stated that they had
GEL 50 million of free funds on treasury account
and in order to make the better use of it a tender
was announced between banks as a result of
which they lended the sum to the winner bank. It
is interesting that the winnert was one of the most
problem banks which can now buy treasury bonds
with the money, which means that the government
will pay the bank the difference in interest rate for
its own money. This operation seems obviously
doubtful and it necessarily requires adequate
response from law-enforcement bodies.
As for the support of the construction sector,
construction companies will be able to get bank
loans under the Tbilisi Municipality guarantee for
the renewal of the residential fund of old Tbilisi.
Taking into account that many construction
companies function by the principle of “nancial
pyramid”, the aforementioned government
measures should be preceded by the initiation
of bankruptcy procedures against these types
of companies. Otherwise the above support of
construction sector will in reality mean supporting
“nancial pyramids” as well, which in the long
run will adversely affect not only construction,
but the banking sector as well, to say nothing of
inappropriate use of the corresponding funds of the
city budget.
Unfortunately, the abovementioned “new nancial
package” does not envisage any measures for the
improvement of social conditions of the population
at all, which, as a rule, is a recommended action
under recession period in order to stimulate the
demand.
“Jehovah’s Witnesses
Syndrome” In Tax System
In the second half of 2009, the president of Georgia
offered the country the so called “Act on Economic
Freedom”, which later developed into a draft bill of
the Georgian Constitution on “Making Adjustments
to the Georgian Constitution” and the organic law
of Georgia on “Economic Freedom, Opportunity
and Dignity”.
Some proposals reected in the above mentioned
organic draft law are virtually like “crushing into
the open door”, since similar problems in Georgia
have been long resolved and today they are not
urgent at all. In the rst place it concerns GEL
conversion. From the very rst day (i.e. more than
14 years ago), of its introduction in the country
it has been a convertible currency. Moreover, in
1997 Georgia joined article 8 of the agreement
of IMF, according to which the country undertook
the obligation that GEL convertibility would not be
restrained, and having become the member of the
World Trade Organization (WTO) in 1999 likewise
obliges Georgia to not restrain GEL conversion.
And international agreements stand higher than the
country’s legislation.
The situation is similar regarding the state
regulation of prices. For more than 13 years now
the prices have been liberalized: prices on bread
were last liberalized in 1996. Since then, Georgia,
being a member of the WTO has undertaken the
commitment which does not allow any regulations
of prices.
Georgia has had the law on investments for more
than 13 years, under which the investor has
unrestricted rights on repatriation of the prot.
Being the member of the WTO also makes Georgia
liable for the above.

45
Independent Experts’ Club
The requirement that the state must not have its
share in commercial banks is hard to understand.
In particular, it is not understandable the share of
which state should not be in banks – of any state
or only of the Georgian one. Today Georgian state
does not have any share in conmmercial banks
anyway, but in Georgian banking reality there
are two commercial banks that are state banks
as well. For instance, “VTB” is a Russian state
bank, and “International Bank of Azerbaijan” is an
Azerbaijanian bank.
Saying no to the introduction of new regulatory
institutions (which is one of the requirements of
the draft law) signals the fact that Georgia says no
to European integration, as European market is a
regulated one.
It is not justiable to set budget parameters in
advance by non-budget legislation, as there occurs
the precedent which in the future may turn into an
expanded list of such parameters.
According to amendments to be made to the
Constitution of Georgia, it turns out that the issues
such as introduction of new taxes or the increase of
the current tax rates must be resolved by means of
the Referendum. Taking into account that nobody
would agree to the increase of taxes, holding the
Referendum does not make any sense, since the
result is pretty predictable.
Such procedure reminds us of principles of
Jehovah’s Witnesses, who will always go against
blood transfusion, even being aware of how vital
it is for their health, but the physicians are obliged
to offer them the procedure anyway, although
knowing that their suggestion will be ignored.
Thus, in the case of making the aforementioned
amendments to the Constitution, Georgian tax
system will face the threat of “Jehovah’s Witnesses
syndrome.”
Tax policy, being the part of economic policy,
should normally vary according to the situation. By
making the abovementioned amendments to the
Constitution, Georgian state will be deprived of one
of the efcient instruments of economic policy.
Old Mistakes
Property Rights. One obvious mistake made
by the government which came to power after
the “Rose Revolution” was the infringment upon
property rights. Unfortunately, over the past year,
not a single case of returning or compensating
for forcefully expropriated property to its lawful
owner has been reported. What is more, lately
there have been reported even more precedents of
infringement upon property rights.
Alienation of State Property. A large-
scale privatization process which began in 2004
has been going on with full deance of the law.
Unfortunately, even today, this process is not
transparent. Especially accute issue is that of the
alienation of the Georgian railway, the available
information about which simply does not exist.
The situation is similar concerning Enguri Power
Plant.
Limitation of Competition. At the end
of 2004, as if under the veil of reforms, anti-
monopoly legislation was abolished and so was
the State Anti-Monopoly Agency which favored the
development of monopolies on the market. Despite
the fact that the restoration of anti-monopoly
legislation is the requirement of European
Union and represents one of the preconditions
for granting Georgia a free trade regime, the
government refuses to restore it on principle.
State Statistics. The State Department of
Statistics was incorporated within the Ministry of
Economic Development in 2004, which obviously
presents a conict of interests. According to
the new law the Department of Statistics has to
develop into an independent institution, however,
the authorities of the banks and the Ministry of
Finance and Economic Development have to be
the members of its supreme body – the supervisory
council which means that the conict of intersts will
actually persist.
Stimulation of Ination by the
Government. Unfortunately, it became quite
typical for our post-revolutionary Government
to initiate populist economic programs which
practically facilitated the growth of ination.
The one that desreves attention is the so called
National Program aiming at increasing employment
rate. Businesses were imperatively told to hire
an unemployed individual for a three – month
term who would be paid GEL 150 per month
from the state budget in 2006 and GEL 200 per
month in 2007-2008. Fortunately, after the war
the government abandoned carrying out similar
populist initiatives.
Budget Manipulations. Starting from
2008, a new methodology for the formation of
the national budget was introduced which led
to the “disappearance” of the phenomenon of a
budget decit, as such. Unused budgetary sums
during the year, that is, the excess of budgetary
revenues over expenditures, is called a budget
surplus. In reality, national budget revenues

46
imply tax revenues and not one-time collections.
If these revenues exceed budget expenditure
then we have a budget surplus, but if revenues
fall below, then the budget is decit-ridden. That
is exactly why, in all those documents meant
for “foreign use,” the national budget is reported
to be decient, although for domestic use the
government is deliberately promoting the surplus
budget. Unfortunately, not only has this drawback
of the budget
legislation been improved by the government, but
nothing is going to be done about it at all.
Employer - Employee Relations.
According to the version of the labor code adopted
by the post-revolutionary government, an employer
is granted maximum rights whilst depriving an
employee of all rights. Despite the fact that one of
the pre-conditions set by the European Union for
granting Georgia a free trade regime is to adopt
European type of labor legislation, the government
resolutely refuses to change the existing Labor
Code.
In 2006, it was the presidential initiative to combine
20 percent social tax and the 12 percent income
tax into a single income tax set at 25 percent
(taking into account that social tax and income
taxes are computed from various tax basis makes
it is absolutely impossible to combine them). So
the new tax change was made effective from 2007.
From 2009 the income tax rate was reduced to
20% which is certainly a benet for employees but
we should bear in mind that this rate was only 12%
about three years ago.
Free Economic Zone – A Trap for
Economic Development. Under the ongoing
economic liberalization measures carried out in
the country, the establishment of a Free Economic
Zone seems less expedient as the list of possible
tax benets and their scale are diminishing
exactly due to such liberalization. Currently (in
pre-war and especially post-war periods) Georgia
is experiencing the lack of investments, i.e.
investment “hunger” and the creation of a free
economic zone under these conditions will cause
its deepening even more, which in the long run will
impede the development of the entire economy.
Unfortunately, the government’s decision is to
create a free economic zone not only in Poti, but
also in Kutaisi, which means that the economic
development of Poti and Kutaisi will take place at
the expense of the rest of Georgia.
Weakening of the NBG. In the spring of
2008, the government deprived the NBG of its
bank supervisory function and left it with only one
function – to regulate ination. In addition, the
responsibility of the President of the NBG was
linked to violation of the upper margin of the annual
ination rate, which in turn, made him dependent
upon the Government, since more powerful
instruments to inuence the annual ination rate
are rather at Government’s disposal than at the
NBG’s. In 2009 a new draft law on the NBG was
prepared and the removal of the responsibility
of the NBG President for the violation of the
upper margin set on annual ination rate can be
considered its positive side. According to the new
law, nancial supervisory function of the bank was
resumed, which is fully justiable. Despite the
fact that the government has never admitted the
mistakes that caused the institutional weakening
of the NBG, the steps to be taken in 2009 with the
aim to improve those mistakes, deserve approval.
Issuance of Eurobonds and Increasing
External Debt by an Additional USD 500
Million. In April 2008 the government increased
the foreign debt of Georgia by USD 500 million
by issuing Eurobonds. Unfortunately, until now,
there is no public information whether this sum has
been spent or not. If yes, then we are not aware
of what it was spent on and if it has not, then it
is interesting to know where the money is. It is
necessary to have this information since the debt is
due to be repaid in 2013.
“Green Friday”. On Friday, 7 November of
2008, the demand of commercial banks for the
USD exceeded USD 31 million given the zero
supply on the Interbank Currency Market (with
the trend continuing for more than one month).
The NBG could satisfy only USD 270 thousand
of the demand and then stopped the currency
market operations under the excuse of technical
reasons. The panic started the same day: ATMs
were emptied instantly and exchange shops raised
the USD rate signicantly, often refusing to sell
dollars. Thus, the NBG arranged a “Green Friday”
in the country. The panic on the currency market of
Georgia continued over the week-end as well.
Reserves of NBG and the guaranteed source of
their replenishment through donors’ aid provide
objective grounds that no sharp rise and falls
will occur in the process of establishing the GEL
exchange rate. From 2009, NBG stopped the
operations on interbank currency market and
substituted it by currency auction mechanism held
according to Bloomberg system. Unfortunately,
after that it became actually almost impossible
to obtain information about currency reserves
dynamics which bears a threat that the bitter
experience of “Green Friday” might occur again.
Economic Program. The 2008 Presidential
and Parliamentary pre-election slogan “United
Georgia without Poverty!” turned into the title of the

47
Independent Experts’ Club
program passed by the Parliament at the end of
January 2008. This document, however, may only
be called a program conditionally, as it is limited
to several pages of some slogans and appeals.
Unfortunately, the government remains indifferent,
being unable to create a serious document which
would serve as the government program in all
intents and purposes.
As for poverty reduction, the only serious step
taken by the government was the implementation
of GEL 5 insurance packages, which, unfortunately
has not had any tangible effect.
Conclusion
All the signs characteristic for economic recession
have nally come to the surface in the post-war
Georgia. That the economy remains sustainable
whilst the national budget stays undiminished,
is in the rst place due to donors’ nancial aid
earmarked to Georgia as to the victim of Russian
aggression as a result of the decision adopted at
the conference in Brussels on 22 October, 2008.
Unfortunately, Georgian government does not
have any antirecessionary program for the given
situation except for those several measures
elaborated by the government that clearly proved
to be unsatisfactory.
As for the mistakes of previous years, Georgian
Government has never admitted committing
them and neither has it taken any pains for their
improvement so far.