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Business Opportunities and Challenges in Georgia and Caucasus

Event:
19th CEEMAN Annual Conference
Georgia - Tbilisi | 2011
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Thank you very much for organizing this conference and inviting me to participate. I am glad that I have this opportunity to discuss the challenges and opportunities that this country is facing. I will try to give you a brief overview of the Georgian economy as it has a strong impact on society at large but I would also like to look at some other reports concerning what can facilitate business growth in this country. 

You must have heard about the Rose Revolution in 2003. Subsequently, in 2004, we initiated some drastic reforms, especially in the economy. We achieved very high growth, mainly because we had one of the highest foreign direct investment rates in the world. As a result, GDP growth reached double-digit figures. This lasted until the financial crisis or, more precisely, until the war with Russia, because - as far as Georgia is concerned, the crisis came right after that war. The post-war situation was compounded by the world financial crisis. We lived through very difficult times in 2009 and 2010 when the economy contracted about 4 percent. Bad as the situation was, it was one of the best performances in our neighborhood. Oil-rich economies, like Russia’s, contracted far more than ours. 

In 2010, the economy bounced back and we had a growth rate of 6 percent, which is very robust. We hope that this year we will repeat that success. As for the following years, we expect some slight increases. 

In our case, the most beneficial effect was produced by the international financial institutes. We received significant funds to repair the damage that we suffered during the war. This helped us overcome some of the problems that were caused by the international crisis. 

Our debt indicators are favorable. Anything below 50 percent of GDP is quite safe and we are considerably below that threshold. The debt repayment schedule is sound and is not overburdening the country. This is important because despite the war and the financial crisis, the government has managed to reign in the debt. 

The debt portfolio is 21 percent domestic and 79 percent external. The foreign debt comes mostly from the multilateral institutions, which means that the interest rate is very low. The average rate on the foreign debt is only 2 percent, whereas for Greece that rate may be 7 percent. 

The budget deficit is also a hot topic in many countries nowadays. We tried to introduce a government stimulus in the real economy. Before the crisis, the construction sector was one of the main drivers of the economy and we did not want it to be completely ruined. As of 2010, the budget deficit started falling and this trend is expected to continue. Three years after the start of the crisis, this is one of the best achievements across comparable countries. 

The financial sector is very resilient. The banks have only very moderate contingent liability of the sovereign. The ratio of assets to nominal GDP is 50.8 percent as of end-December 2010. The banking sector has been entirely privately owned since 1995 and there are no restrictions on foreign ownership of banks. The sector is well-capitalized with average Basel I capital adequacy ratio of 24 percent. 

The percentage of non-performing loans of total loans is only 7 percent, which compares very favorably to the situation across the region. During the war and the crisis we had a wide gap between loans and deposits but it was subsequently narrowed. By now, the banks have completely recovered. Meanwhile, the amount of bank deposits has grown to pre-crisis levels. 

After the war with Russia, we experienced a boycott of Georgian goods in that country. Gradually, they imposed a full-scale blockade on our economy. A market of 140 million consumers was closed to us. 

In 2000, after 10 years of independence, we became a member of the World Trade Organization. In 2005, we changed and simplified our tax code and almost did away with the so-called customs tax. We do not have any trade restrictions in terms of trade barriers, unlike many other countries in our region. We enjoy a preferential trade regime with Europe and, as a result, exports to Europe are growing. This means that the European countries are replacing the Russian market. 

Our exports and imports are diversified, both in terms of products and geographic location. Combined with the lack of customs duties and the preferential trade regimes, that helped a lot during the crisis. 

Georgia has become a reliable energy transport hub. This is important because energy security is a key issue in any business and many businesses are run by energy. That is why we have a strategic focus on this sector. In 2005, when we were almost completely dependent on Russia for our natural gas supplies, the two Russian gas pipelines exploded one after the other. This happened in the middle of winter, when there was no other source of heat. Back then, Georgia had no connections with any gas-exporting countries other than Russia. That taught us a very good lesson. We learned that we cannot rely on a single exporter, no matter who it is. We started negotiations with all surrounding countries, and mainly with Azerbaijan. By now we have four pipelines across our territory which means that we are getting some free oil and gas for that service. 

One of these is a pipeline that starts at the Sangachal Terminal in Azerbaijan. It runs across Georgia and Turkey and ends at the Mediterranean town of Ceyhan. Another one goes from Sangachal to the Georgian town of Supsa, on the Black Sea coast. A third line - the Nabucco pipeline - is still under construction. It is supposed to cross Georgia and Turkey and carry natural gas through the Black Sea to Central Europe. 

Since Georgia is not a natural gas producer, it was the only country in the region that was not affected by the natural gas crisis in 2009. It is also the only exporter of renewable energy in the region. The energy sector has improved tremendously after suffering to the point that there were towns that had no electrical power at all. Some children grew up in that situation and believed it was normal. One of the factors behind this was the huge corruption in the energy sector. Then, of course, we tried to rehabilitate the older power generation and introduce some regulation concerning energy distribution. It took us only three years to stabilize the market. In 2007, Georgia became a net exporter of electrical power in our region. Interestingly, Georgia kept exporting electricity to Russia even during the war. The reason for that is that southern Russia does not have a good grid connecting that region to the rest of the country. Therefore, the Krasnodar region receives electricity mainly from Georgia. 

After becoming an energy exporter, we decided to expand our market. We entered negotiations with Turkey. We have already reached an agreement under which the construction of a high voltage line will be provided by Georgia. Once it is in place, the grid will allow us to export electricity to Iraq and Syria, and - most importantly - to European Union markets. Our government is already conducting negotiations with two Balkan countries on the export of electrical power to them. As a result of this, the energy sector is attracting foreign direct investment and many countries are active on our hydro power market. Georgia has significant untapped hydro resources; only an estimated 18 percent of the country’s hydro potential is currently being utilized. Naturally, some Turkish companies are involved as they want to export energy to Turkey. This is interesting because Turkey also has rivers. The reason that they are coming here is our deregulation, especially in the energy sector, as well as the low taxation regime. 

Georgia’s energy imports are quite diversified. Until 2005 all natural gas supplies came from Russia. We had no energy security at all. Now, that country accounts for only 6 percent whereas more than 50 percent is provided by Azerbaijan and another 13 percent is from Armenia. For some countries it is unimaginable to survive without Russian natural gas, but we have shown that it is possible. 

The geographic distribution of petroleum and oil imports is also diversified. Azerbaijan provides 45 percent, followed by Romania, Bulgaria, Turkmenistan, Greece, Italy, and Russia. 

You probably know that our main agricultural products are wine, mineral water, nuts, citruses and suchlike. Before the Russian embargo, Russia was our main export destination, taking 80-90 percent of all our wine and water exports. After the embargo this changed; now it is Ukraine that takes about half the wine and water that Georgia exports. In addition to that, we export to plenty other European countries. Never in our history have we had so many European partners. Efforts are also being made to penetrate the Indian and East Asians markets. In a sense, the Russian embargo was a blessing in disguise because it provided an incentive to our businessmen to explore new opportunities and seek new markets. Moreover, the revenues from Georgian wine at these new markets are considerably higher than from the Russian market. 

The tourism sector also benefited from our reforms. The first thing that we are trying to sell to tourists, regardless of their status, is our rule of law. Crime rates are very low and there is a very insignificant likelihood that somebody will get victimized. According to a Gallup study, Georgia has a lower crime rate than any European country other than Iceland but Tbilisi has a lower crime rate than Reykjavik which makes our capital safer than any European capital. This is one of the things that attract tourists. The other one is infrastructure. 

We believe in a small government that makes sensible investments and does not overtax the businesses so that they can reinvest their profits. We invested a lot in core infrastructure, such as roads, water, sanitation, and electricity. That is one of the reasons that business boomed in Georgia, particularly the tourism business. The year 2009 saw a 35 percent increase in tourist arrivals in Georgia. In 2010, that figure was 45 percent. This was followed by another increase of 43 percent in the first quarter of 2011. At this point, tourism is one of our main economic drivers, after power generation and agriculture. We also have some small-scale manufacturing. 

The Radisson hotel where this conference is taking place was opened in 2010. Another Radisson opened in Batumi this summer. Many other new hotels are under construction and some are almost finished. For example, Anaklia used to be just a stretch of land along the Black Sea cost without a single house. Now we have three big hotels there. 

Let me tell you a little more about what the government is doing to create a favorable business environment and make it possible to invest in Georgia. Before 2004, taxation was messy. I would not even call it taxation. There was something like a tax code developed in 1988 by the UNDP. It was translated at Moscow University into different languages of the then Soviet Union. Then, it was brought to Tbilisi and became the tax code of Georgia. This was fine because it served the interests of the then government, which was totally corrupt. The scale of corruption was tremendous; it was unlike any other country. Corruption was everywhere: in the customs offices, in the police, in the army, in the civil registry, in the tax system. 

We started the war on corruption by reshuffling all institutions. A good example is the Ministry of Internal Affairs. We dismissed 35,000 policemen in one day. For a whole month, we did not have a single traffic policeman. Amazingly, there were fewer accidents during that month than in the previous months when the 35,000 policemen were on their jobs. This is a harsh way to combat corruption but it works. Remove the corrupt people and corruption will disappear. Of course, you also have to deal with the whole institution or else the corruption will come back. We changed the hiring system and started hiring more motivated young people who had finished high school. We also improved the training system and provided continuous training. 

A lot of people nowadays approach me and ask me to explain the complex issues surrounding the war on corruption. There are no complex issues. It only takes political will. In the case of Georgia, it was a decision made by 4.5 million people because they were fed up with the pervasive corruption and gave the government a clear mandate. 

Another reform that we implemented was the increase of the salaries of the employees in the government sector. Of course, to do that you need to downsize that sector first. Then, you will have sufficient funds to motivate those who have remained. You also have to implement internal audits. As a result, you will have no corruption. 

We used to have very high taxes. The personal income tax was 25 percent. We also paid 33 percent for social security. There was VAT and a special tax for transportation. Altogether, we paid 16 different taxes. We abolished most of them. Now we have VAT, personal income tax, corporate income tax, and a property tax. That is all. We have also cut the tax rates. 

At the beginning of 2004, our budget was 400 million laris and the government was collecting only 16 percent of the GDP through taxes. Now our budget is 7 billion laris and we collect 26 percent of the GDP. The so-called “corruption tax” disappeared and life became much easier for the ordinary citizens. You need not wonder why I advertise our tax system so much. Companies like it and come here to do business. 

We have made strong efforts to avoid double taxation with many countries. This helps when either of the two countries has a significantly lower tax rate. 

Compared to most other countries in the world, our tax rate is lower. Only some of the emirates and Hong Kong have lower taxes. 

Lowering the tax rate is just one way to improve tax collection. It is also necessary to simplify the process. We have introduced electronic filing, which enables companies to submit their declaration by the Internet, without visiting the offices of the tax inspectors. This saves money, time, and energy. By now, all tax declarations are submitted electronically. 

We believe in the rule of law, property rights, and a minimal state fiscal footprint. What we mean by the latter is few low and flat taxes. We also believe in a minimal social security burden on businesses. At the moment, this burden is zero because businesses do not pay any social tax. Our debt-to-GDP ratio must never exceed 60 percent. 

We also want to have single-digit inflation. We promote free trade and try to create a flexible labor market with minimal state interference in employeremployee relations. It has been internationally recognized that our labor code is the most liberal in the world. We are aiming for limited government. This means that the government should not spend more than 30 percent of the country’s GDP. Also, it should not interfere in business sectors such as banking. There is not a single state-owned bank in Georgia nowadays. We are committed to deep deregulation, dramatically minimized and simplified licensing, and aggressive privatization. State assistance to the poor should be means-tested and focused. 

These government principles are enshrined in our Economic Freedom Act. We have cemented them in legal terms by passing a law according to which it takes a 75 percent parliamentary majority to change them. 

People always ask why we speak of aggressive privatization rather than smart and clever privatization. In our view, it is not aggressive it can be smart and clever. If you keep public assets in your hands for too long, at some point you will start liking it. You end up thinking that somebody is performing very well. This may be true but in that case you do not realize that you are not allowing others to perform well. 

As for the means-tested benefits system, I have to tell you that we provide all kinds of benefits to the poor. For instance, health care is completely free for them and we provide them with special vouchers for education. We do not have any public schools in the sense that they do not receive a cent from the budget. We give the citizens school vouchers and they are free to choose between public and private schools. 

According to a 2011 World Bank report, Georgia is the world’s top reformer over the past five years. Also, we rank very favorably in terms of ease of doing business and economic freedom. We are ahead of most core European and east European countries in that respect. These rankings are trustworthy because they are compiled by the World Bank and the Heritage Foundation. 

It is also interesting to look at the rankings of Transparency International, which measures corruption. In terms of bribe payment in the past 12 months, Georgia has a much more favorable score than most European countries: only 3 percent admit that they have paid bribes versus 5 in Spain, 7 in France, 9 in Austria and 15 in Poland. Also, Georgia is a world leader in terms of perception of the degree by which corruption has fallen. 

Another indicator of the economic opportunities that are available in Georgia are the Investing Across Borders Indices of the World Bank, indicating the degree of foreign direct investment regulation. A score of 100 means no restriction at all. We have been assigned that score in mining, oil and gas, agriculture and forestry, light manufacturing, telecommunications, electricity generation, banking, insurance, transport, media, construction, tourism, retail, health care, and waste management. On all of these indicators, Georgia is a world leader. 

According to the World Bank, Georgia is one of the most open countries to foreign equity ownership as measured by the Investing Across Sectors indicators. All of the 33 sectors covered by the indicators are fully open to foreign investment. There are neither sectors with monopolistic or oligopolistic market structures nor any perceived difficulties in obtaining any required operating. 

If you ask me what challenges the Georgian economy is facing, I would naturally start with the Russian problem. But that is not all. We still do not have a widespread managerial culture in our enterprises. Another problem is access to capital, both bank and non-bank capital. First of all, we need to boost domestic savings and then transform them into investment. Unfortunately, the domestic investment rate is very low. So far we have relied on foreign direct investment; that was our major source of growth. That explains why we reached 12 percent growth in 2007. The total amount of investment in that year was USD 2 billion. Last year, it was USD 600 million, whereas this year the figure is likely to be one billion. 

You may wonder whether other countries will follow us. For example, will the Arab nations embark on the same reform process? I have to tell you that the first months are extremely painful. There will be job losses, salary cuts and other measures that the public does not like at all. However, there is no alternative. There is no other way to make the public system healthier. A comparison with our neighbors may be misleading because they have completely different economies. For example Azerbajan’s is an oil and natural gas economy. Economies of that type are very different from any other. As for Armenia, I have the impression that they are following in our footsteps. This is simply common sense. I do not think that we did anything that is not common sense. 

Fortunately, there is consensus in our society that we have to stay the course. There is no single major political force that is opposed to this course. There is some debate as to what kind of relationship we should have with Russia. But there is very little disagreement concerning the economy. If there is any debate it is about small details, such as whether another USD 10 million should be spent on a particular project or not. Nobody says anything like “We need to increase VAT by 5 percent” or “Let us introduce another 10 regulators”. I hope that for the next 10 years, the political spectrum will not change dramatically and the consensus will be maintained.
Event:
19th CEEMAN Annual Conference: Management Education in a Changing World: Are We Ready for the Challenge?
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Filmed:
September 2011
Published from:
October 2011
Citation:
Kakha Baindurashvili, Business Opportunities and Challenges in Georgia and Caucasus,
Accessed: October 21 2018,
Available at: http://video.ceeman.org/lectures/636/2011_ceemanac_tbilisi_baindurashvili_bocgc
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