Miracle in the Caucasus
It seems almost impossible. Three years ago Georgia was deep in crisis, with runaway inflation and a war raging with Abkazia. Most foreign investors wouldn’t touch the country with a bargepole. But today, somehow, Georgia has GDP growth and inflation figures which would be envied by many industrial countries. And, with its first treasury bill auction, the government has just taken the first step toward creating western-style capital markets.
“Nobody believed that this small country could have made progress so fast,” reflects Hunter Monroe, the local IMF representative. Just a few years ago, “the government had nearly become irrelevant to the economy. There were questions over whether the government could take on these problems”.
These achievements and, perhaps more important, the fact that Georgia is in the heart of the world’s next most promising oil belt, is beginning to attract a new degree of international attention.
Six US congressmen recently gathered for dinner at a small hotel on a cobbled Tbilisi backstreet to discuss Georgia’s future with a clutch of western businessmen. The congressmen had just flown into this country of 5.5 million people to consider $100 million in aid allocated by the US Senate foreign appropriations sub-committee. Congress will decide this month if it will approve this amount, more than double earlier US aid packages to Georgia.
“This gives you an idea of how important Georgia has become. This package indicates an awakening,” says Enders Wimbush, a long-time Caucasus analyst who oversees Eurasia-Pacific programmes at Science Applications International Corporation (SAIC) in Virginia. Others acknowledge, however, that they have not yet seen the light. “Developing?” one of the visiting congressmen said doubtfully during a rooftop dinner at Betsy’s Place, where foreign diplomats, journalists and business people mingle. “The country hasn’t changed since I was here in 1969.”
Those who believe Georgia has performed an economic miracle in the past two years might forgive such remarks, for much of the region is only just waking from a long and troubled sleep. Many of Tbilisi’s buildings, decorated with intricate ironwork balconies and carved wooden doors, look long neglected. The large building that housed opposition forces during the 1991 civil war remains a burnt-out ruin on the tree-lined Rustaveli Avenue. Cars zigzag around countless potholes that have appeared since Russian funding disappeared with Georgia’s bid for independence in 1991. The city is still plagued by power cuts, a feudal postal system and an antiquated telephone network.
And yet, against such odds, GDP is expected to grow by roughly 10% this year and at a similar rate next year. “We hope in 1998 that GDP will increase not less than 10%,” says economics minister Vladimer Papava. “And if you compare the year 2000 to 1995, we hope GDP will have increased by 80%. We think this is a real level which can be achieved and sustained.”
Considering Georgia’s GDP fell by 11.4% in 1994, this might seem a tall order. During those years, Georgia’s means of production, outdated and uncompetitive, collapsed. Factory parts were routinely dismantled and sold as scrap. But last year’s GDP growth rate, at 11%, was the highest in central and eastern Europe. That compares with 2.5% in 1995, the year of the country’s economic turning-point. While these growth rates naturally include a sizable recovery factor, officials insist there are real signs of growth in key areas such as agriculture and trade, with plenty of potential in industries such as energy, communications and transport. According to the Georgian Investment Centre, an information group recently established in Tbilisi to help foreign investors, agriculture represented 32% of GDP in 1996, trade 25%.
Many credit the country’s return from the dead to Eduard Shevardnadze, the Georgian former Soviet foreign minister who was installed as president in November 1995. Perhaps the ultimate political operator, Shevardnadze has managed to survive an assassination attempt, straddle a political minefield at home and convince the west that Georgia has a future worth investing in. A few years ago, one of his old friends on the international stage – former US secretary of state George Shultz – invested $50,000 of his own money in a Georgian project.
Just three years ago, in 1994, inflation was raging out of control at 15,000%. The government had just devalued the currency, and it took 5 million coupons to buy a single US dollar. People burnt money for fuel as bread prices trebled overnight. Crime was so pervasive that streets emptied at dusk. Kalashnikov-toting paramilitary men loyal to Jaba Ioseliani, a bandit now in jail, took over the lobby of the Metechi Palace, the luxury hotel where diplomats and international businessmen stay. Now, the city has reclaimed its streets, the country has its own stable currency, the lari, and the central bank has wrestled inflation down to a current rate of 2%, with full-year inflation projected around 10% to 11%.
Georgia’s comeback has captured a growing number of western enthusiasts. “Few observers in 1992 anticipated Georgia’s return from the dead, when current wisdom scoffed at the notion that the former Soviet republics could survive the demise of the USSR,” says SAIC’s Wimbush. After being spurned by the west following that demise, and after more than two centuries of foreign domination, Georgia can’t seem to move fast enough to claim its place in the global political and economic arena. The western world is at last waking up to Georgia’s existence.
In April, British Airways started running direct flights from London to Tbilisi. McDonald’s is planning to open two fast-food restaurants in the capital by the end of 1998 – always a sure sign that the west has arrived. Advertisements for Marlboro cigarettes and Coca-Cola are everywhere. Cellular phones are starting to appear. And fashion stores filled with goods imported from Europe and Asia continue to spread down Rustaveli Prospect, next door to new cafés and bars. Indeed, it is this nascent trade that many say is helping to fuel the country’s new-found growth.
“I walk along the street and see 10% of the country’s GDP there,” says Robert LaMont, a US lawyer who works in Tbilisi. The spending power of Georgians remains a frustrating mystery for the government, although it is generally accepted that the average monthly wage is $20 to $30. Certainly, many Georgians feel more prosperous these days. One division head in the finance ministry, dressed in jeans and an open-necked shirt, recalls that three years ago he was making only a dollar or two a month. “Now, I earn $40 a month,” he says proudly.
But some believe the real monthly take-home income of many Georgians averages closer to $300 when unreported income is taken into account. This would go some way to explain what’s behind Georgia’s estimated 40% shadow economy. Tax collection remains one of the government’s single biggest headaches.
This headache recently erupted into a migraine. On August 18, Shevardnadze announced that government revenues were Lari65 million ($50 million) below the target for 1997 because of unpaid taxes. That means finance minister Mikhail Chkusseli will probably have to cut a matching amount from budgeted expenditures. Although the tax-collection problem is not new, this is the first time the government has been forced formally to “sequester” the budget – cut authorized expenditures to make up the shortfall.
Shevardnadze made his announcement on the departing heels of five IMF economists who had just spent two weeks huddled with the government, poring over progress on the budget and other fiscal issues. This was part of a regular, semi-annual visit the fund pays in connection with a special programme involving a total of $240 million in loans over the three years to 1998.
Shevardnadze bluntly blamed the low budget revenues on “a poor system of management and corruption on the part of a number of tax and customs services”. This, he said, “has led to delays in pensions, wages and benefits”. The president’s words seem tinged with the exasperation felt keenly by other like-minded officials. These reformers have had the thankless task of rooting out corruption and getting the general public to understand they must pay taxes to keep the wheels of government turning. The government has also had to win back the trust of a populace all too aware of government corruption and the memory of mass personal savings lost overnight when inflation hit in 1994.
Chkusseli, appointed finance minister this spring at the age of 26, clearly feels the burden of this task. Like other ministers, who typically work 14- to 16-hour days, Chkusseli looks tired at the end of another day spent arguing points with the IMF. But as soon as tax is mentioned, he snaps to attention: “It’s really frustrating. It’s difficult to make changes in the mentality of the people in Georgia. First people must realize they should pay tax to the state. And on the other hand those spending their money should feel this responsibility.” When asked about his next task, he responds: “It’s political. It’s hard to see where the economy stops and politics start, especially when you’re dealing with financial and economic reform. The biggest [issue] is strengthening the budget system.”
Here it seems some help is on the way. The government held its first treasury bill auction on August 21, a live test run of Lari1 million. By the end of the year, the government plans to issue a total of Lari10 million, which Chkusseli says will be used to help plug the government’s deficit. But this first small experiment will have much broader implications for the country’s as yet undeveloped capital markets.
“The treasury bills should give the incentive to develop capital markets in the country,” says Nodari Javakhishvili, president of the Georgian National Bank, the central bank. “We are trying to develop financial markets on a small scale [initially]. In the coming year, the amount will grow. Interest from the banks is high, and foreign customers are also interested.” By March 1998, government officials expect to have a fledgling stock exchange running. At the same time, the government is establishing a treasury system that will centralize government expenditures – an essential step in the effort to wrestle control of this thorny area.
Javakhishvili has himself been laying the groundwork for a healthy financial sector in his ruthless restructuring of the banking system. Over the past two years, he has slashed the number of banks from 239 to 54 – with just 48 now certified to participate in credit auctions. By 2001, a requirement forcing banks to have a minimum Lari5 million capital base will have reduced the number of banks still further. “Everybody should not necessarily survive. Those which do would strengthen the concentration of bank capital. There are still some banks which have Lari300,000 in statutory capital,” he says.
There is a severe capital shortage, which is one of the principal reasons that interest rates for borrowers average an exorbitant 40% to 60%. Georgians are still reluctant to deposit money with banks, although deposits are slowly rising, to a current Lari100 million from just Lari20 million 18 months ago. Absolute Bank pays a hefty interest rate of 18% for six-month deposit accounts for a minimum balance of $1,000. “We pay that so people take notice,” says Leigh Durland, the bank’s American president. He is also trying to attract more customers by issuing Georgia’s first payment card and getting five other Georgian banks to participate. The card will work more like a debit card, being used against existing account balances, but will give Georgians their first experience of paying with plastic.
Javakhishvili reckons that when the final phase of bank restructuring is over there will be about 15 certified banks still functioning. A career banker known for his honesty and acumen, Javakhishvili has won praise for his policies from the World Bank and the IMF. But he has also acquired plenty of enemies among those who have felt the sting of his fiscal reform.
George Bazgadze, a co-founder of Georgian Consulting, which advises some 70% of Georgia’s foreign investors, thinks foreign banks will have a chance to pick off Georgian banks that fail to meet the new capital requirement. “Many of these banks will need to merge. And given the Georgian character, this will be hard. They will prefer bankruptcy rather than to be owned by another Georgian bank. So foreigners will come.”
Foreign financial institutions are already looking at Georgia’s banking sector. US investment bank Merrill Lynch has been studying Georgia’s banking legislation, while Midland Bank, Salomon Brothers and US fund manager Fidelity Investments have also been looking at prospects in the region.
Georgia has also been making rapid strides on the legislative front. Since last year parliament has passed a long list of laws covering such areas as tax codes, banking, privatization, landownership, foreign investment and monopolies. Western observers reckon Georgia’s parliament has drafted more laws in the past two years than any other. “We have to pass in one year laws that may take a decade elsewhere,” says the parliamentary speaker, 34-year old Zurab Zhvania. Regarded as one of Shevardnadze’s anointed successors and an adamant reformer, Zhvania says parliament is laying the groundwork for an independent system of courts. Although the supreme court operates independently, the country’s common courts are still influenced by the ministry of justice.
Zhvania says he plans to give priority in the next parliamentary session to integrating Georgia into the international community, something close to the government’s heart. Georgia signed a partnership and cooperation agreement with the EU in April 1996, making it a fully fledged trade and economic partner of the EU member states. But the ultimate prize, full EU membership, remains elusive. Zhvania makes no effort to hide his ambitions here: “Our major target is to integrate Georgia into the world economic system and Europe in particular. This is the highest priority. At the first parliament sitting in September, the first resolution is to start unilateral legislation for the harmonization of Georgia’s national legislation with EU legislation,” he says.
SAIC’s Wimbush believes Georgia will more than succeed in such goals: “Georgia will become the Switzerland of the whole region. They have Shevardnadze, the best leader in the former Soviet Union. And the country is brilliantly located in the centre of the Euro-Asian corridor, making it one of the hottest investment spots in the next 20 years.”
In most minds, this intense investor interest will be spurred by one magic word – oil. Many expect to see the legendary silk road, which once passed through Georgia from China and central Asia to Europe, turn into a veritable oil slick in a matter of years. The hottest spot in the oil industry is now the Caspian Sea region, where Europe, central Asia and the Middle East meet. Oil reserves there are estimated to be bigger than those of America and potentially as great as Kuwait’s.
Georgia – with its two, large Black Sea ports, Poti and Batumi – is expected to become one of the principal passageways for Caspian oil and gas to international markets. Azerbaijan, Georgia’s neighbour, is already one of the oil industry’s most coveted prizes in the region, indeed the world, along with Kazakhstan. By 2010, industry experts estimate that the Caspian could produce as much oil as the North Sea does today. By then, the world could be consuming 30% more oil than it does at present.
A $315 million western-route pipeline through Georgia is already two-thirds built and expected to be completed by late 1998, with the potential to carry 200,000 barrels a day. Batumi port already carries over 1 million barrels of oil a month from Kazakhstan to the west. It is this vast potential that has tempted the US Congress to dig unusually deep into its pockets. Some of the proposed $100 million aid package, if approved, will go towards redeveloping the Poti area.
“More and more congressmen and senators are beginning to think dumping all this money into Russia isn’t such a great idea,” Wimbush says. “A lot of us on the outside have argued that it’s important to stabilize countries on the periphery. Russia is such an unknowable. It’s a flywheel which could come off any time.”
Shevardnadze’s speech to the Overseas Private Investment Corporation, during his July visit to the US, demonstrated that he knew his audience well. Emphasizing the importance of the oil industry to the region, he spoke of related investment opportunities in Georgia. The development of the Eurasian Transport Corridor will, he said, make “investment in construction of railroads and highways, and reconstruction of the Black Sea ports, of great importance, especially considering the construction of the oil pipeline, which requires modern infrastructure”.
Georgian Consulting’s Bazgadze is anxious that the government also deploys more resources in other parts of the economy. “Pipelines and transit corridors are wonderful, but we need investments that build, produce and train in Georgia. We need investment in agriculture, recreation, tourism and high technology.” The food sectors – citrus fruits, vegetables, tea, grain, corn, tobacco and wine – have always been particularly important to Georgia.
The country is famous for its wines and mineral waters. A recent financing for the producers of Borjomi mineral water, a household name in Georgia and elsewhere, aims to put that name back on the export map once again.
In June, the EBRD extended a $10 million six-year secured loan to Georgian Glass & Mineral Water Company. The loan, the first the EBRD has made for a private-sector industrial project in Georgia, will help revive the Borjomi name in traditional markets such as Moscow, St Petersburg and Kiev. Georgia lost these markets during the break-up of the Soviet Union. Because the name had been so popular, other suppliers stepped in with their own versions of the product. Georgians are still smarting from being usurped in this way. “This is one of the best examples of western investment into Georgia, but generally this brand needs to be regulated,” says economics minister Papava. “People are bottling Borjomi in New York, where there’s a Soviet émigré population, and also in Russia. This is why the issue of a trademark is important.”
Tourism is another once-prominent industry ripe for revival. Georgia’s Black Sea coast was once the holiday retreat of choice for Kremlin leaders and thousands of other tourists. Abkazia was a favourite destination. But this region has slipped from Georgia’s hands since the Abkazians defeated the Georgian army more than two years ago, expelling or killing thousands of ethnic Georgians in the process. Since the 1994 ceasefire, an uneasy peace has reigned, with roughly 9% of the population now living as refugees. There is no clear resolution in sight, and certainly the question of tourism there is the last thing on any politician’s mind.
Meanwhile, there is the problem of the large amount of funding needed for what still exists. Zurab Soselia, deputy minister of trade and foreign economic affairs, acknowledges that tourism “is quite a big problem. It cannot be developed with small investments. The tourism infrastructure we have has not been updated for 10 years.” The prerequisites are already there, given the country’s renowned countryside and coasts, skiing, a Christian heritage dating back to the fourth century, and numerous climatic microzones. Twelve of the world’s 14 climatic zones are represented in Georgia and the country is also known for its medicinal waters.
Before 1989, Georgia attracted 4.5 million tourists a year, about two-thirds of whom came from the Soviet Union. “Now there’s just a fraction of this,” Soselia says, and this figure includes business visitors. Perhaps tellingly, postcards are almost impossible to find in Tbilisi.
These are just some of the reasons foreign investment has been difficult to coax from international investment funds. Galia Velimoukametova, a fund manager for Russia and the CIS at Baring Asset Management in London, is one of the many sceptics. “There’s nothing available to invest in. There’s the dispute with Abkazia, so it’s quite a risky country to invest in. And the economic situation is far from being great, though there is some opportunity. But infrastructure is still needed,” Velimoukametova says.
The limited opportunities, as she sees them, include the Borjomi mineral water project, which Barings has invested in. But for the moment, Velimoukametova is more preoccupied with Tbilisi’s chronic electricity problems and the fact that the city was without heat for much of last winter. “One Georgian friend lives in London, and last year as a gift he bought his mother a small power-generating device,” she recalls.
Yet precisely these difficulties cause Georgia’s need for foreign investment. Papava says that foreign investment up to 1996 “was not more than $160 million”. One important issue which has curtailed foreign and domestic investment in Georgia is landownership. The government owns virtually all urban land, making it almost impossible to determine the value of private companies occupying that land. Because domestic companies cannot use their buildings as collateral they are unable to secure long-term lending. This troubles foreign investors. “When foreign companies buy shares in companies, they need to know what they’re getting,” Papava says. “Everything else is already in place for investment, except this land issue. We have a new law about agriculture, but not about urban land.” Georgians pride themselves on what they consider one of the best legislative policies on foreign investment in the region. He hopes legislation on the urban land issue will be passed this autumn.
In the meantime, Georgia’s infrastructure is waiting for more money. Elizabeth Haskell, owner of Betsy’s Place and one of Tbilisi’s first foreign investors, puts it this way: “Right now is really a critical time. There are a lot of businesses coming in to explore. If their businesses are successful, then this place will grow and expand. I think there’s a time period where it will either succeed or fail, and you may not know until the end.”
Like countless others, Haskell says much will depend on what happens with the so-called red directors – hangers-on from the Soviet era who depend on bribes and government subsidies and solidly oppose reform. “The question is, will market forces make them go?”
Temuri Basilia, Shevardnadze’s chief economic adviser and regarded as the father of Georgia’s economic reforms, believes that privatization will bring this about. “The red directors are still very active. But the privatization process is under way and new owners are appearing. Those who can adapt to this system will remain. Those who cannot will go bankrupt,” he says.
Others fear, however, that the process will be far more complicated. One well-respected Georgian businessman with ties to the west recently wrote to the government, expressing concern about the corruption still alive from the top down in Georgia: “The corruption which has redeveloped in our government as a handmaiden of economic growth needs to be stamped out. Corruption threatens to undermine the rule of law and constitutional democracy we have sacrificed so much to gain over the past three years,” he wrote.
Western observers and Georgia’s new breed of entrepreneurs are hoping Shevardnadze will listen hard to these concerns. The IMF’s Monroe concurs that “corruption is something we’re very concerned about”. But he adds that the country’s recent history is no ordinary one. “Georgia is coming out of chaos,” he points out. And it is this process, the building of a bridge from chaos to prosperity, which the west will keenly watch.
