By Venla Sipila

In its first review of Georgia's progress in its current International Monetary Fund (IMF)-supported programme, the international lender gives a positive assessment of the country's performance so far, stressing, however, that challenges persist and the need to further strengthen policies may arise in the current difficult and volatile external environment.

The Executive Board of the International Monetary Fund (IMF) has completed its first review of Georgia's performance under its current Stand-By Arrangement (SBA) with the country. The 18-month assistance arrangement worth 477.1 million Special Drawing Rights (SDR, some $726US million) was approved in September, shortly after the August military conflict with Russia. The aim of the programme is to support Georgian macroeconomic policies and rebuild gross external reserves, and to buttress investor confidence dented during the war.

Global Insight Perspective

Significance

The Georgian authorities have been able to achieve positive steps in stabilising the financial markets, supporting foreign currency reserves, and attracting external financial assistance for the country's recovery after the August military conflict with Russia: this is the assessment of the International Monetary Fund (IMF) in its first review of the Georgian performance under its current stand-by agreement with the country.

Implications

The positive conclusions of the international lender in relation of Georgian policy and performance in the current challenging conditions suggest that the IMF's initial trust in the country's ability and resources to manage the situation responsibly and decisively was warranted. This trust was implied in the exceptionally swift approval of the stand-by credit shortly after the war.

Outlook

However, even if implementation of the new programme and recovery measures has progressed well, Georgia still has to deal with considerable challenges and risks in financial and economic spheres. In addition to the increased risks caused by the August conflict, the external environment poses greater challenges now with the international financial unrest persisting and the global economic outlook turning ever gloomier.

The international lender expressed its satisfaction with the Georgian authorities' management of the current challenges in the framework of the programme supported by the stand-by loan. The credit was approved shortly after the August conflict, with Georgia being able to withdraw $250US million immediately, with disbursements of the rest planned for the next 18 months (seeGeorgia: 17 September 2008:). After the first review of Georgia's performance under the new programme, the IMF stated that the arrangement has produced positive initial results in supporting the authorities' strong actions to stabilise the financial markets. Moreover, Georgia's IMF-supported recovery programme has secured it significant additional financial assistance from other international donors. Indeed, additional support totalling $4US.5 billion was consequently approved by multinational organisations and bilateral donors, to support reconstruction of infrastructure and overall recovery of economic activity (see Georgia: 23 October 2008: ). In a sign of trust by the donors on Georgia's continued willingness to reform its economy and maintain responsible policies, the total amount pledged by creditors clearly exceeded the estimate of the country's financial reconstruction needs, which a joint assessment by international financial institutions had earlier put at around $3US.2 billion. In an indication of availability of international support, the Georgian authorities had stated that they do not need to withdraw the amount of additional Fund credit that would be available upon the completion of this review.

However, the road ahead is littered with significant challenges in financial and economic spheres. Indeed, the Fund also stated that, going forward, the Georgian development programme will focus on addressing the new challenges posed by the current international financial crisis and overall global economic downturn. Retaining confidence in the lari and the financial system in general remains important, while this calls for dealing with increased risks now that the tightness of international liquidity implies scarce availability of external market financing.

The statement by the IMF at the conclusion of the performance review reflects the three main goals specified when the arrangement was approved:

• Financial Stability: The IMF programme determined the immediate monetary tasks as securing sufficient banking-sector liquidity, exchange-rate stability and adequate level of foreign-currency reserves. The Fund now states that the monetary authorities remain committed to implementing a flexible exchange rate regime, as advocated by the IMF as a longer-term strategy. This reduces the need to intervene in the foreign currency markets, even if moderate intervention to stabilise the exchange rate can be defended.
• Fiscal Challenges: Further, the Fund adds that fiscal policy supports economic activity while addressing social issues and reconstruction needs during the recovery period. The Georgian budget enjoys considerable support for external grants and concessional credits. Reflecting the initial call by the IMF to repriotitise fiscal spending in the near term in order to allocate adequate funds to immediate reconstruction needs, the authorities now aim to support capital spending while minimiszing unproductive expenditures.
• Strengthening of Financial System: Concessional financial assistance from international donors is trusted to secure that Georgian banks will be able to service their debt obligations even in the current global environment of tight liquidity. However, financial challenges also include the longer-term task of strengthening the financial system by improving bank regulation and supervision, and tacking the challenge of mitigating liquidity risks and preventing a deterioration in banking asset quality calls for co-operation between monetary authorities and banks.

Outlook and Implications

When approving the current assistance programme in September, the IMF stressed that supporting confidence in the currency is an important near-term task, implying that currency interventions in the short term may be advisable. However, while avoiding excessive exchange-rate volatility in the short term is advisable so that confidence can be restored, a return to a flexible exchange-rate regime was recommended in the longer term. The lari exchange rate seems to have withstood the current challenges and increased financial risks relatively well. The National Bank of Georgia (NBG) had to let the lari depreciate by over 10% in one day against the U.S. dollar in November (see Georgia: 12 November 2008:). Nevertheless, since then, the exchange rate has held relatively stable, supporting the conclusion that the authorities have been fairly successful in restoring confidence and maintaining financial stability. As recommended by the IMF, in the longer term, interest rates should assume a greater role in inflation control, as this would reduce the need to support inflation goals by exchange-rate management.

The performance review reflects the IMF's earlier statements of its trust to Georgia's ability to recover from the shock of war, even if considerable challenges and risks still remain, partly intensified by the international financial crisis (seeGeorgia: 6 November 2008: ). The IMF and the Georgian authorities will continue their close dialogue over policies to attract investments and sustain growth. It has earlier been reported that a Fund mission is to return to Georgia at the end of January 2009 to conduct the second review of the current SBA programme.

As the initial shock of the war has now been followed by an increasingly difficult environment in international financial markets, challenges onGeorgia's recovery path certainly remain. The economy remains very dependent on external financing, not least due to the need to cover to its wide current-account deficit. The availability of non-debt-creating means for doing this may fall in the next years as the global economic downturn may reduce the supply of FDI. This implies greater need to borrow. Then again, as long as Georgia remains on its well-started reform path and strives to implement appropriate and co-ordinated macroeconomic policies, its access to concessional credits should remain unproblematic.