Journal number 1 ∘ Marina Muchiashvili ∘ Zamira Shonia ∘ Maia Giorgobiani ∘
FISCAL SUSTAINABILITY ANALYSIS (REPUBLIC OF GEORGIA)

Summary

Fiscal policy sustainability is an important factor of the economic growth of the country. The decrease of economic growth rates in Georgia and increased fiscal deficit and state debt (both, foreign and internal) of the country in 2012-2015 (moreover, Georgia ranks first in the region with its public debt as % of GDP increase from 2012-2014), have made it actual to assess the fiscal stability of the country both, in medium-term and long-term perspectives. The analysis evidenced that by 2015, the marginal indicators of fiscal sustainability (public debt/ GDP, state debt/budget revenue and public debt/export) of Georgia remained below the thresholds.  Despite this, the fiscal sustainability  of Georgia may be threatened in the long-term perspective due to the different shocks  (severe currency devaluation being an important factor among them), significant growth of the future social liabilities, growing scales of subsidies for different branches of economy and increasing gross external debt of Georgia   (which already reached 90% of GDP). Without urgent adjustments in the fiscal policy, disclosures and management of fiscal risks, in the long Run, the government of Georgia may find it necessary to drastically cut the budgetary expenses. The article emphasizes that the macroeconomic stability and stable economic growth of Georgia in the medium-term and long-term perspective needs gradual adjustments of the fiscal policy.

Keywords: Public finance, fiscal sustainability, public debt sustainability, fiscal policy.

INTRODUCTION

The main aim of economic policy of the country is the provision of sustainable economic development on the modern stage of up growth. Researchers implemented on the example of developed countries show that reach of rapid economic growth became possible in the period when they had very low tax rates, small sizes of government and attractive business environment with limited regulations. After gaining independence, systemic reforms were fulfilled to reach high economic growth in Georgia (as tax system, as well as business deregulation As a result, the country took the advanced positionon simplicity of doing business in the world. Achievement of high rates of economic growth during this period conditioned transition of Georgia from group of the low-income countries to the group of low-middle-income  countries. In spite of this fact, according to the World Bank data GDP per capita (PPP) - 8 137 USD dollars, Georgia is only on 151 place in the world that is 4 times less than the  European Union average. For comparison, the same indicators for Russian Federation is nearly 3 times more (25 635 USD dollars), for Turkey– 2,4 times more (19 250 USD dollars) and for Azerbaijan-nearly 2 times more(17 515 USD dollars). Nowadays, a stable development oriented fiscal policy is crucial for the sustainable economic development of a country. A decrease economic grow rate, an increase if fiscal deficits and a public debt in Georgia in 2012-2015 years have raised concerns about the sustainability of its fiscal policy. Therefore, the need for adjustment of fiscal policy over a medium term is key issue.

1.Overview of the methods assesing fical sustainability

Fiscal sustainability implies fiscal policy consistent with macroeconomic stability and growth.  In general, fiscal sustainability is characterized by low inflation, debt-sustainability, avoidance of “stop-go polices” (pro-cyclical policy), and middle-term growth. High inflation, high real interest rates, financial crises, low private sector investment, pro-cyclical policies such as high expenses when revenues are high, overvalued exchange rates can be symptoms of unsustainable fiscal policy.

Fiscal sustainability is the capability of the government to maintain its current expenses and tax policy in middle-term and long-term period, without creation of danger to payment capacity of the government, or without denying its separate types of obligations and separate types of expenses (including pensions and other social expenses, health care, education, science and others) considered by the budget.

A closely connected concept is sustainability of public debt. Public debt is Sustainable when government can continue serving it without requiring an unrealistically (from social and political point of view) large correction to its future revenues or expenses. “Public debt can be regarded as sustainable when the primary balance needed to at least stabilize debt under both baseline and realistic shock scenarios is economically feasible, such that the level of debt is consistent with an acceptably low rollover risk and with preserving potential growth at a satisfactory level (IMF 2013). Inpracticefiscalsustainabilityisassessed by checking whether debt is on a declining path while remaining below certain thresholds. Related concepts are: solvency-the current debt stock is fully covered by the present discounted value of all expected future primary balances, and liquidity-ability to meet maturing obligations.

Some Economists call fiscal policy unsustainable if a country’s debt is growing faster than its GDP (Congressional Budget Office, 2007). Others define fiscal sustainability somewhat differently (see, e.g. Organization for Economic Co-operation and Development, 2007; Schick, 2005). For example, some assert that fiscal sustainability requires that the present value of future budget surpluses exceed the present value of future budget deficits (Anderson and Sheppard, 2009). This definition is derived from the condition of budget constrain between the periods and gives the possibility of drawing up of several indicators for establishment of sustainability. In particular, the state may be evaluated as solvent, if it has the capability of covering the state responsibilities in an unlimited period at the expense of budget surplus of the future period.

The definition of sustainability does not require specifying a target debt-to-GDP ratio, and any target is potentially arbitrary, especially if it is not subject to adjustment in light of new circumstances. Large debts can be paid back, yet small debts may not be sustainable if future income is insufficient.

Whatever debt-to-GDP ratio is chosen as a target for stabilization it must be low enough to inspire confidence by the investors, who buy a nation’s debt. The target for stabilization chosen in this study, a debt-to-GDP ratio of 50 percent, is chosen both for its near-term feasibility and to minimize the risk of increasing debt in the future.

The debt cannot grow faster over any long period than does the economy. Arithmetically, the primary deficit—which is the difference between revenues and spending (other than for interest on the debt)—should be zero if the average interest rate on the debt equals the growth rate of the economy.  If the interest payment on the debt as a percentage of GDP exceeds the growth rate of the economy, then a primary budget surplus is necessary to stabilize the debt. If the interest payment is less than the rate of growth of the economy, then a primary budget deficit may be consistent with fiscal sustainability (von Furstenberg, 1991).

A good indicator of fiscal sustainability should give a clear and easy to interpret message about whether the current policies would lead to debt / GDP ratio rise.Notwithstanding, evengoodindicatorsdonotgivethepossibilityofestablishmenthowtoreducethebudgetdeficit. Generally, corrective measures necessary for achievement of fiscal sustainability may be implemented by way of tax increase or reducing of costs. During the budget adjustment it is worth to consider that, the rise of tax burden and, also, reduce of infrastructural expenses may cause a slowdown of economic growth for overcoming of fiscal deficit and for deficit reduction that ultimately will have a negative influence on middle-term and long-term sustainability.

2.Disclosure and management of fiscal risks

IMF paper “Fiscal risks,  sources, disclosure, and management “ analyzes the main sources of fiscal risks and provides practical suggestions in this area, including a possible Statement of Fiscal risks and a set of Guidelines for fiscal risk disclosure and management.

Empirical evidence presented in the paper highlights the macroeconomic significance of fiscal risks from various sources. Unexpected changes in macroeconomic variables often have major consequences for fiscal sustainability- most notably and immediately in case of exchange rate depreciation in countries with large foreign currency debt. Increases in interest rates, adverse terms-of-trade shocks, and declining economic growth also have substantial fiscal implications. In addition, a key role is played by calls on explicit or implicit contingent liabilities- in the banking system or other parts of public sector(such as state-owned enterprises), or trough the government’s interactions with private sector agents(e.g. PPPs).

Identification, disclosure, and management of fiscal risks are mutually supportive activities.

Fiscal risks arise from macroeconomic shocks and the realization of contingent liabilities. Sources of risk include various shock to macroeconomic variables: economic growth, commodity prices, interest rates, or exchange rates, as well as calls on several types of contingent liabilities (obligations triggered by an uncertain event: including both explicit liabilities, those defined by law or implicit liabilities, moral or expected obligations for the government, based on public expectations or pressures, e. g., bailouts of banks or public sector entities.

The macroeconomic significance of fiscal risks is highlighted by comparing expectations with outcomes for fiscal variables. A comparison of WEO forecasts with outcomes of fiscal variables such as the debt/GDP or deficit/GDP ratios shows that unexpected changes are often large and vary widely. Unexpected changes in fiscal variables are larger in emerging/developing countries. The largest unexpected increases in the debt/GDP ratio are often related to exchange rate depreciations and calls on contingent liabilities.

Unexpected changes in key macroeconomic variables imply substantial fiscal risks. Forward looking estimates of risks from macroeconomic variables-in the form of standardized bound tests used in IMF debt sustainability templates-show that a one-half s. d. permanent shock to real growth would increase the debt/GDP ratio five years later by7% of GDP on average in a sample of  19 advanced and emerging market countries. A one-half s. d. shock to the primary deficit would raise the debt/GDP rate by 5%. And a one-half s. d. shock to interest rates would lead to smaller increases on average, but it would have even more significant effects in countries that rely on floating interest rate debt. In developing countries, a decline in economic growth would have an especially notable effect on debt dynamics.

The impact of exchange rate depreciation is immediate, and can be especially strong when a large share of the debt is in foreign currency. Exchange rate depreciation accounted for a major share of the increase in the debt/GDP ratio in the context of several emerging market crises during the 1990s (de Bolle and others, 2006).

For low-income countries, volatile aid flows present special challenge.

However, some of the largest fiscal costs arisen from contingent liabilities. Examples include: Banking crises, natural disasters, state owned enterprises, PPPs.

Public disclosure of information on fiscal risks can help to manage risks, improve economic efficiency, and reduce borrowing costs.

Study shows, that countries moving from no disclosure of macro-fiscal risks, contingent liabilities or quasi-fiscal activities to providing some information on all these counts would improve their credit rating, on average, by a full notch.

 3.Assessment of the debt burden for Georgia

 For assessment of the debt burden it is important the study not only public debt, but also the whole debts’ volume of the country and dynamics of various types of debts. Public debt include debt of general government and debt of national bank. The whole foreign debt includes the foreign debt of the country (Public debt, debt of the state enterprises and the private sector -banking and other sectors). In 2003 year public debt was 5,8 billion GEL and  in 2015 year it achieved 10,3 billion Gel. In 2003year, the whole foreign debt of the country was 3,5 billion USD dollars and for 2015 year it achieved historical maximum- 14,4 billion dollars (34,2 billion GEL), that is nearly 100  percent of GDP.  O.W. public foreign debt comprises 5.9 billion USD dollars (14.0 billion GEL) that is 39.8 percentof GDP. 

The share of public debt in whole foreign debt of Georgia in 2015 year comprises 41% (instead of 63%- in 2004 year), the rest is the share of the private sector. We should note that on the one hand this change of the debt structure can be evaluated positively, as the rise of financing of the private sector socially is examined as the contributory factor of future economic growth of the country, although, on the other hand,this change also increases the indirect obligations (contingent liabilities)  of the state and, accordingly, it should be considered at the time of development of debt management strategy of the country.

The study of theinternationalpractice showsthatthedevelopingcountries, whichhave had foreigndebtsharein GDP inthelimitsof 20-40%, experienced moreoftenthedebtcrisis. So, the  already reached level of public debt (40% of GDP), shows, that for Georgia it is important to speed up fiscal policy reforms.

Analysis shows that an important problem in the budgetary processis the increase of accuracy of forecast of the state budget income and spending by the Ministry of Finance as there is a significant deviation between the predicted values and the actual performance (according to both revenue and cost provisions). It is necessary to develop alternative forecast by independent institutes (forexample, Parliament Budget Office). The study of the functional structure of budget spending shows that the budget spending requires optimization to achieve the budget balancing.  Particularly, the share of the costs of administration is unjustifiably high (25% of total costs goes to it). For maintenance of fiscal stability important challenges are, also socially oriented budget –in the form of general insurance and general health care; the excessive centralization takes place in the revenue mobilization during the budget process; the share of the state subsidies is high in the whole expenditures.  Also noteworthy is that in 2013-2015 years Georgia was one of the leaders in the region by the increasing rates of domestic and foreign debts. As a result of the joint impact of internal and external shocks in 2014-2015 there was an acute currency crisis in Georgia (significant GEL devaluation-more than 40%), which, in its turn, increased the burden of foreign debt because of the high share of the country's foreign debt and posed a threat to macroeconomic stability. The situation was complicated in 2015 by the reduction of the volume of direct foreign investments in the country, which is considered as one of the main contributory factors for economic growth (due to the country's low savings). It is worth to mention that as the result of the impact of adverse external shocks (including the economic crises in the country's which are major trade partners of Georgia), in 2015 the country's export volume and remittances from abroad decreased. Therefore, in the fiscal field without the implementation of fiscal reforms of fundamental nature macroeconomic stability of the country is under serious risks. Timely pension reform (considering the growing trend of aging population), refine of the budget planning software approach and optimization of its expenditure part, priority financing of areas (education, science and health care programs) supporting the acceleration of economic growth and reduction of administration funding volume in middle and long-term period is appeared as the necessary condition for achievement of fiscal stability. Timely implementation of the necessary adjustments will increase the level of the country's macroeconomic stability and mitigate the negative impact of the foreign shocks  on the country’s macroeconomic stability.

4.Sensitivity analysis of the fiscal sustainability

In spite of the fact that the threshold values of the fiscal sustainability, namely, the state debt / GDP, the state debt / budget revenue, the state debt /export are below thresholds (50%, 300%, 200%) according to the baseline scenario, so far, the economic indicators shock tests show that the fiscal sustainability will be disturbed at the time of permanent long-term, or strict short-term economic shocks. Forexample, in the case ifthe 2008-2009 economic crisis shock repeats, when there was a simultaneous reduction of the GDP, the budget deficit growth and the exchange rate depreciation of GEL. Calculations showed that for the maintenance of fiscal sustainability of Georgia inthemid-termandlong-termperioditisneededfor the next 5 years the economic growth rate to be more than 7% and the budget deficit to return to the norm from 2016.

In 2016, for the provision of the fiscal sustainability it should be taken into account such negative operating factors in 2013-2015 years, as thequarterly distribution the annual deficit of the state budget, which these years was characterizedby a pronounced inequality. In these years, the total burden of the budget deficit came to the last months of the that became one of the significant factor of the national currency devaluation and therefore, for Macroeconomic instability.

While studying thecountry's fiscal sustainability, attention should be paid as well as to the determination of non-considered obligations (forexample, the future social obligations, state corporations debts, etc.), the changes of the population age structure, pensioners share growth in the population (this figure will exceed 30% of the population in the latest future according to the forecast) that will significantly increase the pension costs for future years. Also, the possible risks should be considered that are connected with the high volume of the public sector's total debt at (including state enterprises and public entities debts, budget, taking into account the high share of its total costs (more than1.5 billionin 2016 state budget) that is equal to the expenses of the social and health care spheres according to the size.

CONCLUSION

The research studied the reasons for the 2013-2015 years slowdowns. Themainreasonforthatisradicalchangeof fiscalpolicy of the country. Some initiatives of the new government were directed against the free market economy principle, which hampered investment decisions. The significant increase of social benefits was the main source of the budget deficits, which is not part of the economic growth oriented policy. Also, decrease in public investment had a negative effect on the economic growth. To reach high level of fiscal sustainability country needs to increase public investment spending and optimization of social expenditures (increase expenditures for education, implementation private pension system).

The fiscal sustainability analysis showed that the main marginal parameters of the government’s base scenario are satisfactory. However, the indicators of alternative scenarios exceed the marginal values. For low risk fiscal sustainability, the country should have a minimum 7% economic growth and a maximum 3% of GDP budget deficit in a medium term.

In the public debt structure the external debt dominates, which causes fiscal sustainability to be vulnerable to an exchange rate shock.

The public debt statistics only cover the debts of the general government and National bank. The total external public debt is 5,9 billion USD(40% of GDP).

The total external debt of public and private sectors is 14,4 billion USD (100% of GDP). The share of public debt in whole foreign debt of Georgiain 2015 year comprises41% (insteadof 63%- in 2004 year), therestis the share of theprivatesector. Private sectors debt contributes the development of private sector and thus increase economic growth. Therefore, the government should try to decrease its share in the overall debt.

One of the main problem of fiscal sustainability of Georgia in 2013-2015 years was the distribution of the debt burden during the year.  The observed tendency was that, total deficit was allocated during the last months of the year, which causes monetary pressure on exchange rates and price levels.

Therefore, a rising from the challenges existing in the budgetary system of Georgia, for achievement of fiscal stability in medium-term and long-term periods it is vital development and establishment of tax and spending policy oriented on only economic growth that at the same time will allow a gradual improvement of poor social condition existing in the country by enhancement of effectiveness of internal and external resources’ usage.

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