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FM AMEMBASSY TBILISI
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S E C R E T SECTION 01 OF 04 TBILISI 000205 
 
SIPDIS 
 
E.O. 12958: DECL: 02/15/2020 
TAGS: ECON EINV PGOV PREL GG
SUBJECT: GEORGIA: SCENESETTER FOR EWG AND VISIT OF EEB A/S 
FERNANDEZ 
 
Classified By: Ambassador John R. Bass for reasons 1.5 (b) and (d). 
 
¶1.  (C) SUMMARY:  Once infamous for its rampant corruption 
and organized crime, Georgia is now a model of reform among 
post-Soviet economies.  The economy and Georgia's 
pro-business orientation are top priorities for President 
Saakashvili and he is quick to highlight his government's 
successes.  Managing a weakened economy that is starting to 
rebound from the August 2008 conflict with Russia and the 
world economic crisis remains the biggest domestic challenge 
for the Government.  However, as the Government focuses on 
finding new sources of financing and investment, it risks 
backsliding on the very reforms that define its success. 
Because the Saakashvili government in office only until 2013, 
there is a feeling that time is short and reform must happen 
now; if it is delayed, the opportunity might pass.  As the 
prime initiator of economic reform, the Government is pushing 
ahead at all costs, and even public comment on laws sometimes 
remains a luxury policymakers believe they can not afford. 
Your visit and the Economic Working Group provide 
opportunities to encourage the government to stay the path of 
reform, but to also bring others into the process.  Despite 
recent missteps, Georgia values its international reputation 
and listens carefully to its international partners and the 
business community.  The Economic Working Group is a great 
venue to deliver a straightforward message: without 
implementation of promised reforms, increased transparency 
and greater predictability, and further development of rule 
of law, Georgia will struggle to attract legitimate, serious 
western investors.  END SUMMARY. 
 
CHALLENGES ) WAR, FINANCIAL CRISIS 
 
¶2. (C) After several years of double digit GDP growth and 
deepening economic reforms following the 2003 Rose 
Revolution, 2008 and 2009 were difficult, both politically 
and economically, for Georgia.  In addition to the loss of 
20% of Georgia's territory, the Georgian economy was hit hard 
during the August 2008 war with Russia.  Russian troops 
controlled the country's major port and cross-country 
highway, stopping commerce into the region.  More than 30,000 
new internally displaced persons (IDPs) added to the stress 
on the Georgian budget, as the government struggled to 
quickly house these people before winter.  Although most 
foreign investors stayed in place, inflows of new foreign 
direct investment slowed to a trickle as plans for new 
investments were put on hold or shelved.  A few months later, 
the global financial crisis caused an even greater shock to 
the economy, with unemployment increasing sharply and 
investment and government revenues dropping precipitously. 
While pledges of assistance helped mitigate the worst of the 
financial crisis, led by the U.S. with our pledge of $1 
billion in post-conflict aid, the economy shrunk four percent 
in 2009.  The Georgian Government was further challenged by 
domestic protests from April to July 2009 that negatively 
affected tax collection and discouraged investors.  GDP is 
projected to grow by two percent in 2010, assuming continued 
global economic growth and the return of international 
investments. 
 
A CALMER GEORGIA, BUT INSECURITY RULES 
 
¶3. (S) While today Georgia is calmer and more stable, these 
improvements are far from durable and a palpable sense of 
insecurity permeates society and politics.  Miscalculations 
and provocations - domestically, in the territories or north 
Qand provocations - domestically, in the territories or north 
across the mountains - could easily spark renewed crisis. 
With a stabilized economy and no viable rival, President 
Saakashvili is stronger politically but paradoxically more 
insecure, burdened by the fear history will judge him to have 
lost irrevocably the occupied territories and concerned that 
our measured approach to defense cooperation and engagement 
with Moscow presage a deeper reorientation of U.S. interests. 
 These concerns are reinforced by a steady drumbeat of 
Russian accusations about the legitimacy and behavior of his 
government and comparative silence from the West about 
Moscow's consolidation of its position in the territories. 
In this hothouse environment, your visit is an important, 
visible manifestation of our commitment to support Georgia's 
reform and Euro-Atlantic aspirations - and an opportunity to 
remind the government that realization of those aspirations 
ultimately depends on a renewed commitment to deeper 
democratic and economic reforms.  Saakashvili continues to 
cast about for the "one big thing" that will secure Georgia's 
place in the west.  Our challenge is to convince President 
Saakashvili that the "one big thing" is a renewed commitment 
to Georgia's democratic and economic development, even while 
we work to prevent a slide back into conflict and instability. 
 
GEORGIA ) A MODEL FOR ECONOMIC REFORM 
 
TBILISI 00000205  002 OF 004 
 
 
 
¶4. (C) Although often overshadowed by political crisis and 
conflict over the separatist territories, reform and 
modernization of the Georgian economy has been one of the 
most tangible successes of the Rose Revolution.  When it came 
to power in early 2004, the Saakashvili government inherited 
a barely functioning economy rampant with corruption and 
controlled by organized crime.  The government quickly took 
steps, including a complete overhaul of the police and an 
aggressive no-tolerance policy for organized crime, to 
legitimize the economy.  This led to increased jobs, 
increased tax collection and increased government revenue, 
fueled by large inflows of foreign direct investment and an 
aggressive privatization program. 
 
¶5.  (SBU) The Saakashvili government inherited a broken 
energy sector, where even in the capital electricity and gas 
were often unavailable.  The government worked hard to 
diversify energy supplies and decrease its dependence on 
Russia.  Georgia now has long-term energy agreements with 
Azerbaijan to provide natural gas.  Thanks to a renewed 
government focus on developing Georgia's plethora of 
hydropower resources, the country is now a net exporter of 
electricity, selling kilowatts to Russia, Turkey and the 
larger Caucasus region.  Planned infrastructure projects 
funded by the United States as well as other international 
donors and financial institutions will further strengthen 
Georgia's energy infrastructure, allowing for greater energy 
security and increased exports to energy starved markets in 
Eastern Turkey. 
 
RUSSIAN EMBARGO HAMPERS THEN STRENGTHENS ECONOMY 
 
¶6.  (C) An additional roadblock was thrown into Georgia's 
path towards economic development in 2006, when Russia ) its 
largest trading partner ) put into place a complete embargo 
on all Georgian goods.  Georgian companies struggled to find 
new markets for Georgian goods, including its famous wine. 
Although Russia still prohibits the import of Georgian 
products, the Georgian economy has more than rebounded.  It 
has diversified with new markets throughout the former Soviet 
Union and Europe, and has increased the overall quality of 
its goods to better compete.  Georgia is a member of the WTO 
and is currently discussing a free trade agreement with the 
European Union.  Georgia benefits from the U.S. General 
System of Preferences program and is keen to discuss the 
possibility of free trade with the United States.  We are in 
the process of discussing a new Bilateral Investment Treaty 
with Georgia to help promote further U.S. investments. 
 
CHALLENGES REMAIN ) TRANSPARENCY, PREDICTABILITY 
 
¶7.  (C) In spite of the global financial crisis, Georgia's 
economy is stronger and more resilient than it was five years 
ago.  Many business people you will meet during your visit 
will highlight the importance of Georgia's reforms and the 
improvements to the business climate during the past five 
years.  They will point out that Georgia is now 11th on the 
World Bank's "Ease of Doing Business Report," and was 
recognized internationally in 2009 for its sustained 
performance in reforming the laws and regulations that 
determine the business enabling environment.  In fact, the 
GoG deserves great credit for simplifying the process of 
opening a business, and has streamlined taxes and engaged the 
business community in a constructive dialogue.  It has fought 
against low-level corruption and won.  The government has 
successfully harvested the low-hanging fruit of reform and 
Qsuccessfully harvested the low-hanging fruit of reform and 
reaped the benefits. 
 
IMPLEMENTATION AND PERCEPTION 
 
¶8.  (C) Now, Georgia must tackle the harder issues - 
including transparency, predictability, and rule of law.  As 
Georgia's share of the economic pie has shrunk, there have 
been more accusations of higher-level corruption and an 
increase in government control of and intervention into the 
market.  Businesses perceive the government to be weighted in 
favor of companies that are willing to bend the rules, and do 
not believe the Georgian legal system can protect them. 
While Georgia has quickly adopted legislation to improve the 
judicial system, it has been slower to implement these 
protections.  Increased aggressiveness and lack of 
transparency in tax collections during the past six months 
worry the business community, as Georgia seems to be backing 
away from the reforms that brought it success.  Your visit 
provides an ideal opportunity to stress to all that Georgia 
must hold strong on its path of economic reform if it is to 
succeed in transforming this formerly failed state.  If 
Georgia wants the foreign investment it so desperately seeks, 
it must complete its reform of the legal system; it must also 
 
TBILISI 00000205  003 OF 004 
 
 
present and protect a transparent, level-playing field where 
businesses can compete.  In business, perceptions are as 
important as reality.  If serious western investors hear that 
they can not get a fair shake in Georgia, they will look to 
other more predictable markets.  The competition for 
investment dollars is fiercer than ever, and Georgia has to 
show both the political will and the willingness to tackle 
the hard issues if it wants to win. 
 
CONFLICT AND INSECURITY 
 
¶9.  (C) It is hard to overestimate the extent to which an 
intense climate of insecurity permeates Georgian society and 
political culture.  Russian forces, located as close as 25 
miles to Tbilisi, are building permanent bases and Georgians 
confront a steady drip of Russian statements alleging 
Georgian aggression or announcing the latest step in 
incorporating Abkhazia into Russia's economy.  Moscow's 
statements suggesting that Georgia is planning provocations 
in the North Caucasus have raised fears among Georgian 
officials that Russia is looking for another pretext for 
armed conflict.  Tbilisi, in turn, is overly focused on 
weapons acquisition as an antidote to its jitters. It fears 
our approach to defense cooperation (heavily focused on 
developing the structures and processes to assess threats, 
develop appropriate responses and make informed decisions 
about use of force before moving to acquisition) is a 
trade-off to secure Russian cooperation on other issues, such 
as Iran. 
 
¶10.  (C) The immediate security environment has stabilized, 
with fewer incidents along the administrative boundaries with 
the separatist territories of Abkhazia and South Ossetia. 
Shootings and explosions still occur, but much less 
frequently; detentions are the major source of tension, 
especially around South Ossetia.  Overall the Abkhaz de facto 
authorities have proven more interested in engaging with 
international partners.  The South Ossetians are steadfastly 
uncooperative, even when proposals would benefit their own 
residents. 
 
DOMESTIC POLITICAL CHALLENGES 
 
¶11.  (SBU) The Saakashvili-led United National Movement (UNM) 
continues to hold a constitutional majority in Parliament, 
and its current poll numbers reflect broad popular support. 
The government's restrained handling of the months-long 
opposition protests in 2009 reinforced Saakashvili's and his 
party's popularity throughout the country and reduced support 
for opposition leaders.  The government has made tangible 
democratic progress, including the passage of a new electoral 
code in December, 2009, which will set rules for upcoming May 
2010 municipal elections. The divergent positions and motives 
of the opposition precluded the kind of grand bargain which 
could have turned the electoral code into an engine for new 
democratic reforms.  In the current zero-sum environment, the 
government did not stretch itself, either.  The revised code 
has been sent to the Council of Europe's Venice Commission to 
assess its adherence to international standards.  Substantial 
government influence, if not outright control, over broadcast 
and other media pose significant challenges to the 
opposition.  In addition, the government has formed a 
constitutional commission to review ideas for constitutional 
change to lessen the power of the president. 
 
MEDIA ENVIRONMENT 
 
¶13. (SBU) Georgian media at present reflect the polarized 
political environment in the country, largely divided into 
pro-government and pro-opposition operations.  Nationwide 
Qpro-government and pro-opposition operations.  Nationwide 
television channels remain the main source of information for 
most people.  Television content is limited, resulting in a 
majority of the population that is poorly informed about a 
variety of issues and everyday concerns.  There are no hard 
walls separating the editorial and management sides of media 
organizations.  The media market is small, creating financial 
challenges.  Journalists are low-paid and practice 
self-censorship. 
 
RELATIONS WITH RUSSIA 
 
¶13. (SBU) While official relations between Russia and Georgia 
remain contentious, the two governments reached a preliminary 
agreement in December to reopen a border crossing for transit 
traffic to Armenia and limited access for Georgians, and the 
government has indicated that it is willing to sign a 
protocol as early as March.  Georgian Airways ran a few 
charter flights to Moscow and St. Petersburg in January -- 
the first direct commercial flights since a brief period in 
2008 -- and is negotiating for permission for more regular 
 
TBILISI 00000205  004 OF 004 
 
 
flights.  The Russian embargo remains in place against 
Georgian products, though Russian goods are readily available 
in Georgia. 
 
A TOUGH NEIGHBORHOOD 
 
¶14. (C) Georgia is concerned by a significant increase in 
military supplies from Russia to Armenia planned for 2010 
primarily via overflights between Russia and Armenia. 
Although Georgia has continued to allow the flights to 
maintain a good relationship with Armenia, it does not 
believe Armenia has the capacity to use these shipments 
itself and fears that such armaments as large-caliber 
ammunition for aircraft could be intended for Russian forces 
in Armenia, instead of the Armenian military.  Not only could 
such shipments disrupt the balance in the Nagorno-Karabakh 
conflict, but they could potentially be used to squeeze 
Georgia from the south as well. 
 
¶15. (S) Georgia is also trying to manage its relationship 
with Iran.  Georgia agrees with many of our concerns about 
Iran's policies, and has been willing to raise those concerns 
directly with the Iranians.  Georgia still faces lingering 
anger from Tehran for extraditing an Iranian arms smuggler to 
the United States several years ago.  At the same time, it 
cannot afford to alienate a powerful regional neighbor and a 
potential major commercial partner -- especially as it seeks 
to prevent any further recognitions of the breakaway regions. 
 Although the government has assured us that a proposed hydro 
project does not involve Iranian banks, we continue to 
monitor the deal. 
BASS