by Venla Sipila
The new, reform-minded Georgian government that came to power after last year's "Rose Revolution" enjoys vast international support. Indeed, the decision by the International Monetary Fund (IMF) to resume lending in June 2004 paved the way for the Paris Club of international creditors to agree on restructuring Georgia's debts in July 2004, pulling the Georgian sovereign away from an effective default scenario.
For a long time, public finances remained one of the sectors where Georgia's transition economy had showed the weakest performance since gaining independence from the Soviet Union. However, with the election of the new, liberal-minded government, Georgia has recently shown rapid improvement in tax administration. The parliament ratified a new, very liberal tax code in December 2004, which it hopes will contribute to clamping down on corruption and improving tax collection. The new tax code certainly encourages development of a more transparent business culture and thus supports tax revenue collection. The IMF has also commended the new Georgian administration on fiscal progress made by increased tax collection. Nevertheless, the Georgian government cannot afford to halt efforts to further strengthen tax enforcement. Irrespective of the positive developments, the budget continues to depend heavily on foreign financing.
Now, the new Georgian government has presented a revised draft of the 2005 state budget. The new revenue and expenditure estimates indicate an increase of the deficit to some 400 million lari, whereas the original 2005 state budget draft projected a 315-million-lari deficit, already implying a 16% increase in spending. To some extent, the expansionary 2005 budget following the adoption of the new tax code signals the intent of President Saakashvili's administration to consolidate the gains of the revolution. Prime Minister Zurab Noghaideli recently briefed parliament on the revisions, with the body’s consideration of the draft scheduled to begin this week. The new version sees fiscal spending increasing by 452.1 million lari (some US$245.7 million), taking budget expenditures to a total of 2.7 billion lari. The government intends to cover the increase in spending with a combination of greater tax proceeds and privatization revenue. Notably, the fiscal draft projects privatization proceeds as quadrupling over the current year to stand at 374 million lari, while total budget incomes are forecasted to stand at some 2.3 billion lari.
The increased revenues will be spent for funding prioritized sectors. In the energy sector, an allocation of 283 million lari, an increase in the draft revision of 164 million lari, will be used partly for rehabilitation and improvement of existing power stations and partly for construction of new energy generation units. An additional 185.4 million lari will be allocated for strengthening Georgia's defense potential and internal law and order. The total amount allocated for this purpose in 2005 stands at 577 million lari, marking an increase of nearly 48% compared with the previous figures. Social expenditures are proposed to be boosted by 25 million lari, of which 5.5 million lari will be allocated to additional financing for benefits paid to socially vulnerable groups for their energy expenses and 15.3 million lari will be channeled towards financing hospital reconstruction programs. In total, social spending will stand at 642 million lari. Additional expenditures are proposed for education, road construction, and culture and recreational facilities.
As a counterpart to upward revisions in spending, the government now expects tax proceeds to run higher by 37 million lari, of which 23.4 million lari will come from earnings from privatization taxation and 11.5 million lari from social taxes. In addition, 36 million lari of extra nontax revenue is expected, of which 27.7 million lari will come from privatization, while the central government also expects to receive some 8.7 million lari in transfers from territorial budgets to the Ministry of Defence and the Ministry of Internal Affairs. Expectation of grants was increased by 2.9 million lari, conditional on an expected increase in financing for a road-rehabilitation project.
The suggested amendments put the cash budget deficit at around 5.7% of the estimated GDP, already higher than the IMF recommends. Indeed, the international lender urges a tighter stance and restricting the budget deficit to around 4.0–4.5% of GDP. A gradual increase in expenditures, accompanied by further efforts to strengthen tax receipts, would be more suitable from the point of view of controlling the inflation rate, as well as in order to protect external competitiveness.
The tragic death of Prime Minister Zurab Zhvania in February 2005 may still create more uncertainty in Georgian economic policies, including the fiscal sphere. New Prime Minister Noghaideli has pledged to concentrate on economic reform and development, with the immediate concern being the privatization process. But it is not yet clear to what extent he will be shaping policy, and to what extent only overseeing its implementation. The expansionary budget draft matches the populist nature of the government; while the administration may succeed in meeting its promises to the electorate in this budget, it will have to implement a number of key structural changes in the economy.
Georgia needs to strive to make further progress with fiscal consolidation, as well as to improve expenditure allocation and clear more arrears. Keeping the budget deficit in control is necessary for maintaining the newly improved working relationships with the IMF and the World Bank, as well as being the key to lowering inflation. In our baseline scenario, we assume a gradual fiscal consolidation over the next several years, with budgets prepared in accordance with IMF requirements.
