VZCZCXRO7497
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHSI #0652/01 0871028
ZNR UUUUU ZZH
R 281028Z MAR 07
FM AMEMBASSY TBILISI
TO RUEHC/SECSTATE WASHDC 5843
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 TBILISI 000652 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/CARC AND EB/IFD/OMA 
COMMERCE FOR 4231 DANICA STARKS 
TREASURY FOR OIA 
 
E.O. 12958: N/A 
TAGS: ECON PGOV GG
SUBJECT: THE GEORGIAN ECONOMY LOOKS FORWARD TO A YEAR OF 
GROWTH IN 2007 
 
 
¶1. (U) This telegram is sensitive but unclassified.  Not for 
Internet distribution. 
 
¶2. (SBU) Summary:  Georgia's economy overcame Russian 
sanctions and grew 9.3 percent in 2006.  Growth is expected 
to continue at a 7-8 percent rate in 2007.  Prospects for 
increased foreign direct investment are good.  Exports and 
tourism receipts grew in 2006 and similar results in 2007, 
along with investment, would help to keep the economy on 
track despite a large trade deficit.  The main threat to 
macroeconomic stability is inflation, which reached 11 
percent annualized in February 2007.  However, the GOG has 
promised the IMF to maintain fiscal discipline, reduce the 
growth of the money supply and take a more relaxed approach 
to the trend of appreciation of the lari.  End Summary. 
 
GROWTH DESPITE RUSSIAN SANCTIONS 
-------------------------------- 
 
¶3. (SBU) Georgia has entered 2007 with a realistic chance for 
growth, macroeconomic stability, a stepped up pace of 
investment and concomitant job creation -- if it can 
implement the right mix of policies.  Although a thaw in 
Russian-Georgian relations is not clearly in the offing, the 
Russian government reportedly is beginning to recognize what 
the IMF and others in Georgia have been saying for the past 
few months: Russian sanctions didn't cripple the Georgian 
economy as much as the Kremlin hoped, and in fact, they 
opened Georgia's eyes to new markets for its traditional 
products.  Moreover, if it is true that bad news is better 
than no news at all, worldwide publicity generated by the 
Russian sanctions on Georgia may have helped to bring the 
country's three year old westward orientation and accelerated 
reform program to the attention of foreign investors. 
 
¶4. (SBU) Investors seem poised to act.  For the past few 
years, Georgia's FDI statistics have been buoyed by 
investment in the Baku-Tbilisi-Ceyhan and Shah Deniz 
pipelines, and by privatization of many large state-owned 
enterprises.  With the pipelines' completion in early 2006, 
and the list of major unprivatized state companies rapidly 
growing shorter, the flow of investment seemed to be about to 
dry up.  However, in 2006, despite these changes, Georgia 
received an estimated USD861 million in FDI, 63 percent more 
than in 2005.  The government has been citing an even higher 
figure, USD1.2 billion, in spite of the fact that the USD400 
million sale of UEDC and some hydroelectric plants have been 
delayed into 2007.  In the course of their review of 
Georgia's IMF program, IMF officials interviewed the most 
important investors identified by the GOG as having plans to 
invest in 2007.  The IMF found their plans to be firm.  It is 
conceivable that Georgia may receive up to another USD1.7 
billion in investment in 2007. 
 
¶5. (SBU) Once official figures are out, the 2006 real growth 
rate of the Georgian economy may be as high as 9.3 percent, 
in spite of Russia's embargo on Georgian exports and 
transport.  In fact, Georgian exports increased by 14.7 
percent percent in 2006. Its most important export was still 
iron and copper scrap metal.  Along with strong growth comes 
strong demand for imports, especially as the lari 
strengthened by 4.5 percent against the dollar over 2006, 
even with a certain amount of National Bank of Georgia 
intervention to control appreciation.  Imports of energy were 
more expensive and pushed up import figures, with the cost of 
natural gas doubling in 2006 and doubling again at the outset 
of 2007.  As a result, oil and gas imports increased by 118 
percent and the trade deficit by 65 percent in 2006 over 
¶2005.  Tourism receipts, especially from Armenians visiting 
the Georgian coast, helped to offset the increase in imports. 
 The National Bank of Georgia's foreign currency reserves 
nearly doubled from the end of 2005 to the end of 2006.  In 
March 2007 the NBG announced reserves had exceeded USD1 
billion for the first time, sufficient to cover more than 3 
months of imports.  Turkey replaced Russia as Georgia's 
largest export market, with Azerbaijan not far behind.  That 
imports from Russia grew is not surprising in light of 
increased natural gas prices, but imports from Turkey jumped 
85 percent in one year, reflecting a significant redirection 
of trade in goods to Georgia's neighbor to the Southwest. 
 
¶6. (SBU) The GDP growth figures are encouraging, even if to a 
certain extent they are based on continuing legalization of 
the informal economy that was prominent under the former 
regime.  Construction is booming and is far and away the 
 
TBILISI 00000652  002 OF 003 
 
 
largest component of GDP growth.  Significant growth is also 
occurring in financial intermediation, trade and mining. 
Labor productivity is increasing and helping to push economic 
growth upward.  Agricultural production, which constituted 
11.7 percent of Georgia's GDP, contracted in 2006 due to 
drought that caused poor harvests. 
 
¶7. (SBU) The financial sector saw significant growth over the 
year 2006.  The French bank Societe Generale purchased a 
controlling share of Bank Republic, and NBG officials have 
told us that another major European bank is about to enter 
the market.  The issuance of shares on the London Stock 
Exchange by the Bank of Georgia is another sign of growth. 
The assets of commercial banks increased by 58 percent from 
January 2006 to January 2007.  Because of the increased tempo 
of lending, the quality of the banks' debt portfolios bears 
watching.  However, the overall state of the financial sector 
is generally judged to be good.  The percentage of commercial 
banks' classified debts was 6.4 percent in the third quarter 
of 2006.  Although deposits and lending are strongly 
dollarized (91 percent of individuals' bank accounts are in 
foreign currency, mainly dollars) the growth rate of loans in 
Georgian lari was greater than that of foreign currency 
loans.  Interest rates on loans in the national currency are 
about 20 percent and 16-18 percent on foreign currency loans. 
 
 
THE INFLATION CHALLENGE 
----------------------- 
 
¶8. (SBU) With food constituting a major portion of the basket 
of goods measured for changes in the Consumer Price Index, 
the poor harvest in 2006 had some effect on inflation, along 
with increases in energy prices.  In August 2006, the 
12-month change in the CPI peaked at 14.52 percent, up from 
5-6 percent six months earlier.  By the end of 2006, 
inflation had subsided somewhat, resulting in a year-end 
inflation figure of 8.9 percent.  However, with inflows of 
foreign investment, and new increases in the cost of food, 
inflation again ticked up in the beginning of 2007, to 10.4 
percent year on year in January and 11 percent in February. 
A revision of the the consumer basket on which the CPI is 
calculated also affected the inflation statistic 
significantly.  The Georgian Department of Statistics says 
that monthly inflation would have been 1.9 percent rather 
than 2.7 percent in January under the old formula.  February 
2007 month-to-month inflation was 0.72 percent. 
 
¶9. (SBU) The degree to which government policies are 
contributing to inflation is a bone of contention between the 
government and the IMF.  Clearly, NBG interventions to 
purchase foreign currency, aimed at keeping the value of the 
lari from appreciating too strongly, add to the money supply 
and influence the rise in consumer prices.  The national 
bank's decision to reinstate reserve requirements for 
commercial banks and to issue its own deposit certificates 
helped to calm inflation in 2006.  Stronger action by the 
NBG, including increasing reserve requirements and utilizing 
more effective sales of government securities, along with a 
more flexible attitude toward the value of the lari, will be 
necessary to quell inflationary pressures in 2007.  The IMF 
says the government will have to do its part by maintaining 
strict fiscal discipline. 
 
¶10. (SBU) The government's fiscal stance is a continuous 
compromise between Georgia's pressing need for infrastructure 
and social spending and the goal of macroeconomic stability. 
Government spending added significantly to growth in 2006. 
While revenues increased 33 percent, expenditures increased 
39 percent.  The government's deficit in 2006 was 2.9 percent 
of GDP.  With the IMF still having a strong influence under 
its current Poverty Reduction and Growth Facility, the 
government somewhat reined in its spending toward the end of 
the year, which helped to reduce inflationary pressures.  The 
goal for 2007 is a slightly lower deficit, at 2.5 percent of 
GDP.  The government's total debt at the end of 2006 was 
about 29 percent of 2006 GDP, of which 62 percent is held by 
foreign creditors.  Debt service is 2.2 percent of 
consolidated expenditures. 
 
THE CONTINUING PROBLEM OF UNEMPLOYMENT 
-------------------------------------- 
 
¶11. (SBU) Unemployment remains high in Georgia, around 13.7 
percent.  The total number of employed people has been 
 
TBILISI 00000652  003 OF 003 
 
 
steadily declining since 2000, while the percentage of that 
group in self-employment has increased.  In the third quarter 
of 2006, two thirds of the work-force reported themselves as 
self-employed.  However, wages and salaries are important to 
the average family in Georgia, which may have several 
household members employed.  Wages and salaries constituted 
35 percent of total monthly household income.  The second 
largest share was use of debt, savings and sale of property. 
Remittances from outside Georgia added about 10 percent to 
household incomes, and there is so far no indication that 
they are shrinking despite Russian threats and pressure 
against Georgians living in that country.  48 percent of 
household expenditures went for food, beverages and tobacco. 
 
THE BOTTOM LINE 
--------------- 
 
¶12. (SBU) The Government of Georgia has stated that 
macroeconomic stability is a crucial ingredient in its 
economic growth strategy.  In part, the economy's ability to 
weather the shocks imposed by Russia on Georgia's economy 
underline the success of the government's reform path. 
Embassy Tbilisi is seeing an increasing number of investors 
exploring the possibilities offered by Georgia's agricultural 
and tourism sectors in response to the improved climate for 
business, although manufacturers are lagging behind. 
Inflation remains the principal threat to macroeconomic 
stability.  The government's target for inflation in 2007 is 
6 percent or less.  This will require a cautious approach to 
spending.  The government has promised the IMF to save any 
greater-than-expected privatization revenues and above-budget 
income to finance the budget deficit.  Ongoing improvements 
in the tax administration process may help to realize that 
goal.  On the other hand, President Saakashvili proposed 
reducing taxes in his recent State of the Union speech, which 
may complicate keeping the government's promise if Parliament 
acts quickly on his suggestion.  On the monetary policy side, 
the NBG seeks to limit the growth of the money supply by 
increasing international reserves.  It says it will deal with 
the increased inflows of foreign investment by allowing the 
lari to appreciate, with only limited, sterilized 
interventions.  It also intends to strengthen its open market 
operations through direct sales and repurchases of government 
securities.  It will push development of the secondary market 
in government securities.  If the government and the NBG can 
stick to their stated intentions, the IMF believes they can 
meet their goal for controlling inflation. 
 
 
TEFFT