fiscal risks of georgia:tax revenues and public debt
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Fiscal Risks of Georgia:Tax Revenues and Public Debt
August 20, 2012
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ContentsIntroduction ......................................................................................................................................... 3Data and Methodology ........................................................................................................................ 6Overview the Fiscal Situation of Georgia in 2004-2012 ................................................................... 9Dynamics of Future Tax Revenues .................................................................................................. 13Fiscal Sustainability Analysis ........................................................................................................... 18Research Results ................................................................................................................................ 22Findings and Recommendations ...................................................................................................... 24References........................................................................................................................................... 26Schedule .............................................................................................................................................. 27
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IntroductionFiscal stability is a necessary condition for sustainable economic development of any
country. Recent global financial crisis has made the issue more actual and hence created the
need to study the fiscal sustainability. Even some developed countries were under the default
risk. In order to prevent the similar scenario, it is necessary to assess the countrys long-term
fiscal sustainability, and determine whether the countrys economy is ready to respond to
any possible negative challenges.
PMC Research Centre has highlighted two fiscal sustainability risks: 1. Reduction of the tax
revenue dynamics to GDP; and 2. Growth in the public debt to GDP. Study the dynamics of
tax revenue is important itself as 84 percent of the budget revenue comes from taxes.
According to the Economic Freedom Act, from 2013 the budget deficit shall not exceed 3
percent of GDP, the budget expenditures 30 percent of GDP, while the public debt 60
percent of GDP. In addition, under the same Act, the government will not be able to increase
national taxes without referendum. Taking all this into consideration, the Research Centre
studied how real it is to meet these conditions, whether the tax revenues will be reduced to
the extent that the state will not be able to fulfil its obligations or the public debt will
increase rapidly.
The years of 2011-2012 were positive for the economy of Georgia. This is the period of
exiting from the crisis and improving the main macroeconomic indicators. For example, the
public debt to GDP was 45 percent in 2010, while it will be reduced to 33 percent by the end
of 2012. The budget deficit to GDP was 6.7 percent in 2009, while the forecast for 2012 is 1.5
percent.
A group of researchers has studied how sustainable is the positive tendency and if the
economy of Georgia can respond to undesirable challenges, for example, the repeated
financial crisis.
In the first part of the research we discuss the fiscal situation of Georgia during 2003-2011.
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The dynamics of the future tax revenues is studied in the second part of the research. Based
on the study of all types of taxes, we have concluded that the value added tax (VAT), from
which almost half of the tax revenue comes, does not follow the economic growth in direct
proportion. According to the model used by the Ministry of Finance, the excise tax on
imported goods is forecasted by the economic growth rate, we have associated this tax with
the import growth rate.
Given these findings, we have developed a model for tax revenues, and concluded that tax
revenues to GDP are expected to decrease in the long run. Percentage change is not
significant but cumulative difference for the year 2025 is estimated to be 3 billion GEL.
In the third part of the research we study the fiscal sustainability to the public debt. The
results show that the debt crisis does not threaten Georgia in the medium term and the long
term. Moreover, the countrys fiscal sector is prepared to withstand 3-year shocks of
economic growth, foreign exchange rate and budget deficit as well. Stress tests have shown
that the macro-economic indicators, which are considered to be the marginal fiscal
sustainability parameters, do not exceed the maximum limit. However, the shock resistance
ability should not be understood as the measurement of the level of economic development.We do not come to a conclusion that the current level of Georgias economic development is
desirable and does not require further reforms and success.
We have studied the stress scenario for tax revenues, when the tax revenue growth rate is
significantly lower than the nominal GDP growth rate. This scenario describes the case
when countrys economy grows at the expense of the sectors exempted from VAT
(education, healthcare, financial intermediation, agriculture, lotteries and gambling, urban
and interregional transport). Also, the decrease in share of excise goods was assumed, while
the dependence of direct taxes on the economic growth will not change. According to the
above scenario, tax revenues to GDP will significantly reduce: in 2012 it makes 24.6 percent,
while it will reduce to 20.5 percent by 2020.
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Final part of the research is devoted to the analysis of the stress scenario results, on the basis
of which we have made final conclusions and recommendations regarding the fiscal
sustainability of Georgia.
The aim of the study is not to make an accurate forecast of future economic growth rates,
exchange rates, inflation rates and other key macroeconomic indicators but it is to discuss
the countrys fiscal sustainability and solvency at the time of various economic growth rates,
inflation rates and exchange rates.
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Data and MethodologyThe data used in the research are mainly obtained from the Ministry of Finance of Georgia,
National Statistics Office of Georgia and National Bank of Georgia. According to the
methodology and targets of the study we have used both the annual and quarterly data. For
the regression analysis we have adjusted the quarterly data on the seasonal basis. Part of the
data has been obtained from 1996 that resulted in the statistically significant findings.
The studies are based on the econometric and mathematical research methods: regression
analysis (the least-squares method), extrapolation, trend identification and financial
programming. The regression analysis, trend identification and extrapolation were used for
determining the causal relationship between economic variables. The financial programming
elements were used to build the tax revenues and fiscal sustainability study models.
The tax revenues and fiscal sustainability study models have common assumptions. First of
all we have introduced exogenous variables: the real GDP growth rate, inflation rate and
foreign exchange rate.
For the period through 2016 we have matched the GDP growth rate with the estimatedfigures of the Ministry of Finance. As the estimated growth of the economy for 2012-2016 is
6-7 percent subject to the economic growth convergence theory we have assumed that
economic growth rate in the following years (2017-2025) will have the decreasing trend (see
the Schedules, Table 3). According to the convergence theory, the economic growth rate
tends to the convergence point that is equal to the long-term technological progress rate.
Also, the economic growth rate is the marginal value. To attain the growth rate of a previous
year, it requires more investments than one year ago. Consequently, the countries fail to
achieve the high rate of annual economic growth within a long-term period.
The inflation rate is the target of the monetary policy in Georgia. Before 2015 it is at the rate
of 6 percent and in the next years (2016-2025) it will gradually decrease to 2 percent (see the
Schedule, Table 3).
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In the fiscal sustainability model the exchange rate of a Georgian Lari to US dollar is fixed at
the current rate (1.65). Further, we assume its rapid devaluation within the exchange rate
test. The objective was not to forecast future exchange rate of GEL precisely. We identified
what will be the fiscal sustainability in case of rapid devaluation of GEL. GEL Exchange rate
devaluation test is significant because 82 percent of the public debt is the foreign debt and
devaluation will increase the value of foreign debt in GEL considerably. In addition, the debt
service is accounted in US dollars and in case of devaluation of the national currency the
debt service amount will go up.
In the tax revenue model the taxes are calculated by types. The revenues depend on the
economic growth rate, change in inflation rate and foreign exchange rate, import growth
rate and improvement of tax administration. We assumed the improvement of
administration by 1 percent annually before 2015.
According to the basic model (in compliance with Ministry of Finance of Georgia
methodology) the main principles of the tax revenue forecast are as follows:
The income tax increases pro rata the nominal GDP growth rate (by coefficient 1);
The profit tax increases pro rata the nominal GDP growth rate of the previous year(by coefficient 1);
The value added tax pro rata the nominal GDP growth rate (by coefficient 1 as will
be changed further as a result of the study);
The excise tax pro rata the real GDP growth rate (by coefficient 0.5);
The custom duty pro rata the import growth rate (by coefficient 1);
Other taxes increase pro rata the real economic growth (by coefficient 0.5).
For the analysis of fiscal sustainability we have used the methodology of the International
Monetary Fund. According to this methodology, a country is fiscally sustainable if the
government can service the debt without extraordinary financing. The criteria of the
International Monetary Fund for the fiscal sustainability risks are determined as follows:
Low risk: All indicators of the debt burden are lower than the marginal values;Medium risk: The basic scenario indicators are satisfactory but the indicators of the
alternative scenario exceed the marginal values;
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High risk: The debt burden indicators by the basic scenario exceed the marginalvalues;
Debt stress: The country fails to service the debt.
The values of the sustainability indicators are determined by the level of economy
development of a country. The IMF identifies Georgia as a lower-middle-income country to
which confirms the strong policy (Table 1).
Table 1. Marginalindicators of fiscalsustainabilityPublic debt (%) Debt service (%)
Export GDP Revenues Export Revenues
Weak policy 100 30 200 15 25
Medium policy 150 40 250 20 30
Strong policy 200 50 300 25 35Source: International Monetary Fund
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Overview the Fiscal Situation of Georgia in 2004-2012
Since 2004 the reforms have been implemented in Georgia very rapidly. Among them, the
most significant ones were the economic reforms. Enhancements of the public institutionswere accompanied with the fiscal reforms aimed at improving business environment, which
had a clear impact on the economic development during the years 2004-2007.
The gross domestic product is a good indicator of the countrys development course and its
fiscal sustainability. The growth of GDP in Georgia could be divided into three stages: 1)
from 2005 to 2007, which could be called as years of economic prosperity when the GDP was
characterized by the high growth rate; 2) The year 2008 and 2009, which could be named as
years of economic downturn, when the economic growth was 2.3 percent and then
decreased by 3.8 percent, mainly due to the global financial crisis and Russia-Georgia war of
August 2008; 3) The years of 2010-2011 were the phase of economic recovery, as in 2010 the
GDP growth rate was 6.3 percent and in 2011 7.0 percent.
The indicators of public debt and budget deficit were changing according to the tendencies
of the gross domestic product. The public debt and budget deficit are significant variables for
assessing the fiscal sustainability. When country has a high deficit, its public debt grows
gradually. If the country fails to pay the debt it will face a default.
Source: Ministry of Finance of Georgia and National Statistics Agency of Georgia
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As it is shown in the figure the dynamics of the public debt may be also divided into 3 parts:
1. 2004-2007, when the public debt decreased from 63.2 percent to 25.5 percent of GDP,
resulted from the rapid growth of GDP and reinforcement of the GEL exchange rate,
when up to 85% of the public debt of Georgia was nominated in US dollars. In the
same years, according to the IMF Government Finance Statistics 2001, Georgia ran
the surplus budget (see the Schedule, Figure 1);
2. 2008-2010, when the public debt raised as a result of the significant increase in the
budget deficit;
3. 2011-2012 when the public debt to the GDP began to drop and in 2012 decreased to
33.4 percent of the GDP.
Since 2004, Georgia chooses the policy of economic liberalization which had a great
influence on the fiscal sector. The type of taxes decreased from 21 to 7 together with
decreasing the tax rates (see Table 2 below).
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Table 2. Types of tax and dynamics of tax rates2004 2005 2006 2007 2008 2009 2010 2011 2012
Taxes 21 6 6 6 5 5 5 5 5
VAT 20% 20% 18% 18% 18% 18% 18% 18% 18%
Income tax 12-
20%
12% 12% 12% Social +
income
25 %
Social +
income
25 %
20% 20% 20%
Social tax 33% 20% 20% 20% _ _ _ _ _
Profit tax 20% 20% 20% 20% 15% 15% 15% 15% 15%
Custom duty Difference 0-30 % Differentiated 0%, 5%, 12%.
The tax liberalization fuelled the high economic growth rates during the several years and
decreased the level of corruption and shadow economy. As a result, compared to 2003 the tax
revenues in 2008 increased by 5.5 times (see the Schedule, Table 1).
Throughout the growth of budget revenues, the budget expenditures were increasing as well
(see the Schedule, Table 2). In 2004, the share of wages increased as a result of increasing
salaries in public sector and it had a decreasing trend in the following years. During 2005-
2008, procuring equipment and developing material base for public institutions has caused a
rapid growth of expenses under the item Goods and Services. Increase in public debt has
increased a debt service as well, by 2008 it decreased to 1.7 percent of expenditures and
increased up to 4 percent in 2011. Among the recent tendencies, the growth of social
expenses, both in nominal and relative indicators, was significant. About a quarter of the
budget expenditures had been spent on the social expenses.
Being affected by the Russia-Georgia war and the global financial crisis of 2008, the fiscal
policy of Georgia has changed radically. In 2009, subject to the GDP decrease, the budget
revenues decreased as well, while no reduction was achieved in the expenditures. To the
contrary, in order to overcome the economic crisis, government employed the fiscal
encouragement and allocated 2- billion GEL for that. As a result the budget deficit increased
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up to 6.7 percent of GDP. Georgias reliance on the public debt and donor aid was
significantly increased.
Since 2011 Georgia has begun to overcome the economic crisis and turned again to the
economic growth. In 2011 the budget deficit to GDP decreased to 1.3%; the economy growth
rate exceeded the public debt growth rate. As a result, the public debt to GDP started to
decrease.
Despite the positive fiscal tendencies of the recent years, our goal is to assess the readiness of
the Georgian economy against the economic shocks. As it was mentioned above, we will
discuss the test of significant decrease in tax revenues and increase in public debt, which can
be caused by decrease in economic growth rate, increase in budget deficit, and devaluation of
GEL exchange rate.
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Dynamics of Future Tax RevenuesFor making a medium- and long-term forecast of tax revenues, we have studied the
dependence of revenues on the GDP growth rate and inflation during the years 1996-2011.
In the first scenario, we made a long-term forecast of the tax revenues based on the medium-
term forecasting model of the Ministry of Finance (Table 3). According to the government
policy the income tax rate will decrease to 18 percent from 2013 and to 15 percent from
2014. Based on this model the revenues from income tax and excise tax significantly decrease
as a percent of the GDP whereby and in 2025 the total tax revenues will decrease up to 22.4
percent of the GDP.
Table 3. Tax revenues to GDP, the medium -term forecast
Total tax revenues2012 2013 2014 2015 2016 2020 2025
24.6% 23.9% 22.9% 22.8% 22.8% 22.5% 22.4%Income tax 6.4% 5.9% 5.1% 5.1% 5.1% 5.2% 5.2%
Profit tax 3.3% 3.3% 3.4% 3.4% 3.5% 3.6% 3.7%
VAT 11.2% 11.2% 11.3% 11.3% 11.4% 11.5% 11.5%
Excise tax 2.4% 2.2% 2.0% 1.8% 1.7% 1.3% 1.0%
Custom duty 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.5%
Property tax 0.8% 0.7% 0.7% 0.6% 0.6% 0.4% 0.3%
Other taxes 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%
Tax revenues in the nominal (million
GEL)6,625 7,232 7,833 8,824 9,806 14,184 19,720
In the second scenario, we have modified the tax revenue model based on the thorough
study of the tax revenues.
The relationship between taxes (value added, income, profit and property taxes) and
economic growth and inflation rate have been established using the regression analysis (see
the Schedule, Charts 2-5, Table 4-5).
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Chart 2: Dynamics of the Value Added T ax
Source: Ministry of Finance of Georgia
During 2005-2007, high growth rate of VAT was caused by high economic growth and
improved tax administration. In 2008-2009, due to the economic crisis, revenue from VAT
decreased, but its ratio to the GDP was maintained. As shown in the Chart 2, revenues from
VAT were increasing together with GDP growth rate.
Revenue from VAT is around 46 percent of the total tax revenues and therefore it is very
important to study and accurately forecast this type of tax. Based on the regression analysis,
we have concluded that the revenue from value added tax is positively related to the real
GDP growth rate, with a coefficient of 0.84 but not 1.0, as it is in the medium-term model of
the Ministry of Finance (see the Schedule, Table 4), meaning that the growth of the real GDP
by 1 percent will increase the revenue from VAT by 0.84 percent.
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Chart 3: Dynamics of Excise Tax
Source: The Ministry of Finance
The revenue from excise tax to GDP is stable over time; the high growth rate of the excise
tax revenue was observed in 2010 mainly caused by the increase in the excise tax rates and
imposing excise tax on mobile operators.
70 percent of the excise tax is coming from taxing imported goods. In our tax forecasting
model we connected the income of excise on the imported goods to the import growth rate.
The import growth rate is in correlation with the economic growth rate. Based on the
research, we can conclude that the growth of the excise tax from the imported goods is
related to the amount of total import with a coefficient of 0.7, while the income from excise
tax on domestic production is related to the growth of GDP with a coefficient of 0.5 (see the
Schedule, Chart 3-4). Hence, the growth of total import by 1 percent will increase the excise
tax revenue from the imported goods by 0.7 percent and the growth of GDP by 1 percent
will increase the excise tax income from domestic goods by 0.5percent.
Based on the research results, we have justified the positive relationship between the direct
taxes and the economic growth with the coefficient of 1.0. The income tax revenue increases
by the same rate as the GDP of the same year while the profit tax increases by the same rate
as the GDP of the past year.
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Chart 4: Income tax dynamics
Source: Ministry of Finance of Georgia
Chart 5: Profit tax dynamics
Source: Ministry of Finance of Georgia
As a result of studying each type of taxes, we developed a modified model of tax revenues
(Table 4), according to which, tax revenues to GDP in the long-term period decreases more
than according to the basic model. The percentage change is not significant, but for 2025 the
difference sums up to 3 billion GEL.
The modified model of tax revenues is given below:
TR(t) = IT(t-1)*(1+gt)*(1+it)*(1+at) + PT(t-1)*(1+g(t-1))*(1+i(t-1))*(1+at)+
+VAT(t-1)*(1+0,84gt)*(1+it)*(1+at) + ATD(t-1)*(1+gt/2) + ATI(t-1)*(1+0,7mt)
+ CT(t-1)*(1+mt)*(1+et) + RT(t-1)*(1+gt/2)*(1+at) + AT(t-1)*(1+0,02)
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Where:
TRtax revenues
ITincome tax revenue
PTprofit tax revenue
VATvalue added tax revenue
ATD
excise tax revenue from domestic goodsADIexcise tax revenues from imported goods
CTcustom tax revenue
RTproperty tax revenue
ATrevenue from other taxes
treporting period
t-1previous year
geconomic growth rate
iinflation rate
aadministration improvement
m
import growth rate
epercent change of the exchange rate
Table 4: Tax revenues to GDP, m odified model
Total tax revenues2012 2013 2014 2015 2016 2020 2025
24.6% 23.9% 22.9% 22.7% 22.6% 22.1% 21.7%Income 6.4% 5.9% 5.1% 5.1% 5.1% 5.2% 5.2%
Profit 3.3% 3.3% 3.4% 3.4% 3.5% 3.6% 3.7%
Tax 11.2% 11.1% 11.1% 11.0% 10.9% 10.6% 10.3%
Excise 2.4% 2.3% 2.2% 2.1% 2.0% 1.8% 1.6%
Custom 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4%
Property 0.8% 0.7% 0.7% 0.6% 0.6% 0.4% 0.3%
Other taxes 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%
Tax revenues in nominal (million
GEL)
6625 7226 7815 8787 9744 13942 19075
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Fiscal Sustainability AnalysisFor the analysis of fiscal sustainability we studied the ability of Georgian fiscal sector to
service the liabilities and in the long run, not to increase the public debt up to the marginal
indicators of debt burden discussed in the methodology section.
As of 2012, the amount of public debt of Georgia does not constitute any threat to the fiscal
sustainability (33 percent of the GDP).
Currently, 78 percent of the public debt is the external debt (see the Schedule, Table 6, Chart
6) and in the recent years, the annual weighed rate of the debt service varies from 2 to 3
percent.
To study the fiscal sustainability, in addition to the above mentioned exogenous variables, we
introduced the following assumptions:
According to the basic scenario, from 2013 to 2025, the budget deficit (overall balance
according to the IMF GFS 2001) is 3 percent of GDP. This is the maximum value of
the deficit allowed by the law;
The current proportion of external debt/internal debt in financing deficits will be
maintained in future years 78%/22%;
From 2016, the debt service interest rate will grow by 0.25 percentage point annually;
For the calculation of budget revenues we use the modified model of tax revenues.
First of all we have studied the fiscal sustainability according to the basic model:
Table 5Parameters 2012 2013 2014 2015 2016 2020 2025 MarginDebt/GDP 32.4% 29.4% 27.3% 26.4% 25.8% 24.6% 26.4% 50Debt/export 77.0% 65.4% 58.1% 55.6% 53.7% 49.2% 50.2% 200Debt/revenues 113.0% 111.4% 108.3% 105.8% 104.2% 102.0% 110.7% 300Debt service/export 4.7% 6.1% 5.5% 3.8% 3.7% 4.3% 5.1% 25Debt service/revenues 6.8% 10.4% 10.2% 7.2% 7.2% 8.9% 11.2% 35Budget revenues/GDP 28.6% 26.4% 25.2% 25.0% 24.7% 24.1% 23.8%
udget expenditures/GDP 29.6% 29.4% 28.2% 28.0% 27.7% 27.1% 26.8%
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At the next stage of the study, we considered the possible economic shocks that will have
biggest impact on fiscal sustainability. Those are:
GDP shock;
Budget deficit shock;
GEL exchange rate shock;
Combined shock;
Tax revenues shock.
We consider the shock on 3-year period, during 2013-2015. We assume two types of shocks,
individual and combined. In the combined version drop in the GDP growth rate, increase in
budget deficit and GEL devaluation will take place simultaneously. The probability of having
all the shocks at the same time is quite high, as was already observed in 2009, when decrease
in GDP caused increase in budget deficit and devaluated GEL. At the last stage, we will study
the tax revenues shock.
GDP growth rate shockIn 2013, the economy drops by 2%, in 2014 the economic growth rate is 1%, in 2015 3%
and in 2016 6%. The budget deficit remains at 3% of GDP and exchange rate stays the
same:
Table 6Parameters 2012 2013 2014 2015 2016 2020 2025 MarginDebt/GDP 32.4% 31.6% 30.5% 30.1% 29.0% 26.4% 27.4% 50Debt/export 77.0% 70.2% 65.0% 63.4% 60.4% 52.9% 52.3% 200Debt/revenues 113.0% 116.8% 117.7% 117.2% 114.9% 109.0% 116.4% 300Debt service/export 4.7% 6.6% 6.2% 4.5% 4.2% 4.6% 5.3% 25Debt service/revenues 6.8% 11.0% 11.3% 8.2% 8.0% 9.5% 11.8% 35Budget revenues/GDP 28.6% 27.1% 26.0% 25.7% 25.2% 24.2% 23.6%
udget expenditures/GDP 29.6% 30.1% 29.0% 28.7% 28.2% 27.2% 26.6%
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Budget deficit shockIn 2013, budget deficit increases to 7% of GDP, in 2014 5.5%, in 2015 4.5% and in 2016
3%. The economic growth rate and exchange rate remain the same:
Table 7Parameters 2012 2013 2014 2015 2016 2020 2025 MarginDebt/GDP 32.4% 33.4% 33.3% 33.3% 31.5% 28.0% 28.4% 50Debt/export 77.0% 74.3% 70.9% 70.0% 65.7% 56.0% 54.2% 200Debt/revenues 113.0% 126.6% 132.5% 133.7% 128.2% 118.1% 123.2% 300Debt service/export 4.7% 6.1% 5.5% 3.8% 4.5% 4.9% 5.5% 25Debt service/revenues 6.8% 10.4% 10.2% 7.2% 8.9% 10.3% 12.4% 35Budget revenues/GDP 28.6% 26.4% 25.2% 24.9% 24.6% 23.7% 23.1%
udget expenditures/GDP 29.6% 33.4% 30.7% 29.4% 27.6% 26.7% 26.1%
Foreign exchange rate shockIn 2013, the exchange rate of GEL to US dollar will drop by 50% (1 USD will be equal to 2.48
GEL) and will be kept stably until 2025. The economic growth rate and budget deficit remain
the same:
Table 8Parameters 2012 2013 2014 2015 2016 2020 2025 MarginDebt/GDP 32.4% 40.5% 37.1% 35.2% 33.5% 29.0% 28.9% 50Debt/export 77.0% 90.0% 78.9% 74.0% 69.7% 58.0% 55.1% 200Debt/revenues 113.0% 152.2% 146.2% 140.3% 135.0% 121.2% 124.1% 300Debt service/export 4.7% 9.2% 8.2% 5.6% 4.8% 5.1% 5.6% 25Debt service/revenues 6.8% 15.5% 15.2% 10.7% 9.3% 10.6% 12.5% 35Budget revenues/GDP 28.6% 26.6% 25.4% 25.1% 24.8% 23.9% 23.3%
udget expenditures/GDP 29.6% 29.6% 28.4% 28.1% 27.8% 26.9% 26.3%
Combined shockAll of these three shocks take place simultaneously during 2013-2015: economic growth
drops, budget deficit increases and GEL devaluates and from 2016 all three indicators
changes back to the basic model state:
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Table 9Parameters 2012 2013 2014 2015 2016 2020 2025 MarginDebt/GDP 32.4% 47.6% 47.9% 47.7% 44.2% 35.3% 32.6% 50Debt/export 77.0% 105.7% 102.0% 100.4% 92.1% 70.5% 62.2% 200Debt/revenues 113.0% 174.5% 183.3% 184.4% 173.8% 144.3% 137.3% 300Debt service/export 4.7% 9.9% 9.3% 6.7% 6.4% 6.1% 6.3% 25Debt service/revenues 6.8% 16.4% 16.8% 12.3% 12.0% 12.6% 13.9% 35Budget revenues/GDP 28.6% 27.3% 26.1% 25.9% 25.4% 24.4% 23.8%
udget expenditures/GDP 29.6% 34.3% 31.6% 30.4% 28.4% 27.4% 26.8%
Tax revenue shockIn the economic growth decreases the share of sectors subject to the value added tax and the
share of goods subject to excise tax (petroleum products, tobacco, telephone communications
etc.).As a result, tax revenues do not grow by the forecasted proportion. The correlation
coefficient of value added tax and economic growth is 0.5 instead of 0.84 and correlation
coefficient of excise tax revenue from local product and economic growth is 0.25 instead of
0.5. The ratio of direct taxes to GDP stays the same:
Table 10: Tax revenues to GDP
Total tax revenues2012 2013 2014 2015 2016 2020 2025
24.6% 23.6% 22.4% 22.0% 21.7% 20.5% 19.4%Income tax 6.4% 5.9% 5.1% 5.1% 5.1% 5.2% 5.2%
Profit tax 3.3% 3.3% 3.4% 3.4% 3.5% 3.6% 3.7%
VAT 11.2% 10.9% 10.6% 10.3% 10.0% 9.1% 8.1%
Excise tax 2.4% 2.3% 2.2% 2.1% 2.0% 1.7% 1.6%
Custom duty 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4%
Property tax 0.8% 0.7% 0.7% 0.6% 0.6% 0.4% 0.3%
Other taxes 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%
Tax revenues in nominal (million
GEL) 6625 7152 7646 8503 9342 12913 17110
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Research Results
The research showed that, according to the basic scenario the economy of Georgia is fiscally
sustainable, all parameters of the public debt burden are below the margin, and sustainability
is not under threat in the medium and long-term periods. Tax revenue to GDP decreases to
24 percent by the year 2025.
The three year shock of GDP growth does not cause the loss of fiscal sustainability. The debt
service and long-term sustainability indicators do not deteriorate dramatically.
The fiscal sector of Georgia does not lose sustainability from the three-year budget deficit
shock. However, the relative indicators of the public debt increase more significantly than in
case of the GDP growth shock.
A 50 percent devaluation of GEL exchange rate rapidly increases the public debt service and
debt stock parameters. In 2013, the public debt to GDP reaches 40.5 percent, but it is still
under the marginal indicators - fiscal sustainability is maintained.
The worst shock for the economy will be the combined shock, one when the stress scenarios
of economic growth, budget deficit and exchange rate develop at the same time. The
simultaneous development of all of these shocks is more likely than the occurrence of only
one of them. The economic downturn or slowing down of growth rate, results in the growth
of the budget deficit and devaluation of exchange rate as similar thing already happened in
Georgia during 2009-2010. When there is an economic downturn, reducing the budget
expenditures becomes politically difficult and pushes the budget deficit to increase. The
decrease in economy also negatively effects the stability of the national currency.
The combined shock test has shown that during 2013-2015, the relative ratio of the debt to
GDP (47.9%) is close to the marginal rate of debt burden (50%) and consequently, a more
severe combined shock will be danger for the fiscal sustainability. We can conclude that the
combined shock parameters we assumed (GDP growth rate, budget deficit, GEL exchange
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rate) are cautions and their further deterioration will cause the loss of sustainability.
However, in this case, the debt service indicators will be again lower than the marginal
parameters. The debt service to export will increase up to 10 percent and the debt service to
budget revenues up to 17 percent, while their marginal rates are 25 and 35 percents
accordingly.
As a result of considerations of the stress scenarios we can conclude that according to the
methodology of the International Monetary Fund, the fiscal sustainability of Georgia is
under the low risk, all debt burden indicators are lower than the margins and do not reach
critical levels during the three-year shock period.
In the tax revenue shock test the ratio of tax revenues to GDP significantly decreases (to 20%
by 2020, to 19% by 2025).If this scenario develops from 2013 to 2025, the tax revenues will
be by 15 billion (cumulatively) GEL less than of the basic model and by 12 billion GEL less
than of the modified tax model.
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Findings and Recommendations
Based on the research we can conclude that the public debt of Georgia is not a heavy burden
for the national economy and the relative ratios of the public debt should be further reduced
by using the relevant fiscal policy and debt management. Rapid decrease of the tax revenues
to the gross domestic product is not anticipated, if the national economy continues its
growth with the same tendency and the discriminative taxation will not be extended, when
certain sectors are taxed heavily (e.g. the Economic Freedom Act does not limit extension of
the excise tax and the growth of excise tax rate, as well as the growth of the land and
property taxes) and some sectors are tax exempted.
The tendency in decrease of government interventions in the economy (reflected in the size
of the state budget as a percent of GDP) will continue in the medium and long-term periods
and the budget volume as a share of GDP will decrease by 3 percent (to 26.1% of the GDP)
by the year 2025.
The decrease of tax revenues to GDP contributes to the economy development, but it isnecessary that government should meet its liabilities in conditions of significant reduction in
state expenditures to GDP. The research has shown that the debt service indicator is not at
that level that could be a threat for countrys solvency. The other issue is the social liabilities
(wages, pensions, social allowances etc.) which will decrease in relative terms but in nominal
value will preserve growth tendency. This is a challenge for the government, how it will
intervene in the economy and distribution of revenues. The most undesirable scenario for
the economy is the maintenance of high share of social expenditures at the expense of budget
deficit. If such practice continues permanently, the fiscal sustainability of the country will be
under the threat.
Another finding of the study is that in case of the proper fiscal management, the
maintenance of the fiscal sustainability of Georgia is realistic, both in the medium and long-
term periods. For this purpose it is necessary to make a good forecast of future revenues and
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expenses; to draw a well-balanced budget will increase the Georgian economy resistance
against possible fiscal risks and will promote the high indicators of the economic growth. If
the government tries to maintain the current ratio of the budget expenses to GDP (29.6%) in
the long-term, it will have to identify ways to increase non-tax revenues, because even in
case of the most positive scenario, this indicator decreases to 26.8%.
Our recommen dations:1. To take into consideration the research concludes about the tax revenues forecast model,
especially findings related to value added tax and excise tax tendencies.
2. Not to use the 3 percent budget deficit limit without emergency and to move to the
balanced budget. This will strengthen the fiscal sustainability of the country and
reinforce it against the possible economic shocks. Also, the balanced budget contributes
to the high economic growth; when state borrows money it often results in the rise of the
internal interest rates and hinders implementation of investments.
Though the marginal indicators of the public debt of Georgia do not approach the marginal
levels of debt burden parameters and the budgetary system is fiscally sustainable, we should
not forget the total external debt of the country, which currently exceeds 11 billion US
dollars (see the Schedule, Table 7). The goal of our research was to study and analyse
external public debt and not the total external debt. However, we are highlighted this topic
here as the total external debt has significant impact on the country credit ratings, which in
turn determines the interest rate ofcountrys future liabilities, including the accessibility and
interest rates of the sources of financing the state budget deficit. In addition, if countrys
private sector has problems in servicing foreign liabilities, government will have to take
certain measures to maintain countrys economic sustainability.
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References1. Georgia: Request for a Stand-By Arrangement and an Arrangement Under the Standby
Credit Facility International Monetary Fund, IMF Country Report No. 12/98, April
2012
2. The Joint World BankIMF Debt Sustainability Framework for Low-Income Countries
IMF, April 2012
3. Aghion, P., and S. Durlauf, 2005, Handbook of Economic Growth, Vols. 1A and 1B
(Amsterdam: North-Holland)
4. Becker, S., Deuber G., Stankiewicz, S. (2010). Public Debt in 2020: A sustainability
analysis for DM and EM Economies., International Topics, Current Issues. Deutsche
Bank Research.
5. Glenday, Graham, Estimation of VAT Revenues based on Import and Domestic VAT
Returns and Collection Data, Duke Center for International Development, Duke
University, 2003
6. Disclosing Fiscal Risks in the Post-Crisis World - Greetje Everaert, Manal Fouad, Edouard
Martin, and Ricardo Velloso, IMF, 2009
7. Fiscal Risks: Sources, Disclosure, and Management - Aliona Cebotari, Jeffrey Davis,
Lusine Lusinyan, Amine Mati, Paolo Mauro, Murray Petrie, and Ricardo Velloso, IMF,
2010
8. Managing Fiscal Risks, Teresa Ter-Minassian Annual Meeting of the Spanish Economic
Association, Zaragoza, December 12, 2008
9. A Practical Guide to Public Debt Dynamics, Fiscal Sustainability and Cyclical Adjustment
of Budgetary Aggregates, Julio Escolano, Fiscal Affairs Department, IMF, 2010
10.Economic Cooperation and Development Organization. 2010. Restoration of Fiscal
Sustainability: A Lesson for Public Sector. The Research Institute of Politics 6, 4: 1-20
(in Georgian)
11.Financial Sustainability Report, National Bank of Georgia, 2011(in Georgian)
12.Tax Code of Georgia
13.2012 State Budget of Georgia
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ScheduleChart 1. Budge t deficit structure
Source: Ministry of Finance of Georgia
Table 1: Consolidated budget (mln GEL)2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Revenues 1175 1937 2821 3910 5139 6552 5476 6086 7200 7450
Indirect taxes 608 910 1397 1801 2454 2639 2531 2834 3499 3788
Revenue % 51.7% 47.0% 49.5% 46.1% 47.8% 40.3% 46.2% 46.6% 48.6% 50.8%
Direct taxes 420 621 585 846 1215 2113 1858 2033 2591 2833
Revenue % 36% 32% 21% 22% 24% 32% 34% 33% 36% 38%
Grants 48 125 105 168 102 617 389 472 307 239
Revenue % 4.1% 6.5% 3.7% 4.3% 2.0% 9.4% 7.1% 7.8% 4.3% 3.2%
Other revenues 69 210 294 378 479 484 487 526 563 450
Revenue % 5.9% 10.8% 10.4% 9.7% 9.3% 7.4% 8.9% 8.6% 7.8% 6.0%
Privatization 30 73 439 719 888 698 212 220 240 140
Revenue % 2.6% 3.8% 15.6% 18.4% 17.3% 10.7% 3.9% 3.6% 3.3% 1.9%
Source: Ministry of Finance of Georgia
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Table 2: Consolidated budget (mln GEL)2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Expenditures 1446 1977 2993 3947 5719 6920 6685 7023 7505 7964
Payroll 289 415 550 565 676 1008 1048 1120 1165 1218Expenditure % 20.0% 21.0% 18.4% 14.3% 11.8% 14.6% 15.7% 15.9% 15.5% 15.3%
Goods and services 312 328 564 767 1581 1614 1105 1139 1179 1188
Expenditure % 21.6% 16.6% 18.8% 19.4% 27.6% 23.3% 16.5% 16.2% 15.7% 14.9%
Interest 169 141 120 104 97 121 171 206 290 341
Expenditure % 11.7% 7.1% 4.0% 2.6% 1.7% 1.7% 2.6% 2.9% 3.9% 4.3%
Subsidies 105 217 441 343 413 524 435 393 426 447
Expenditure % 7.3% 11.0% 14.7% 8.7% 7.2% 7.6% 6.5% 5.6% 5.7% 5.6%
Social affairs 383 434 558 762 851 1379 1506 1624 1660 1821
Expenditure % 26.5% 22.0% 18.6% 19.3% 14.9% 19.9% 22.5% 23.1% 22.1% 22.9%
Other expenditures 0 16 100 527 636 750 944 1001 833 954
Expenditure % 0.0% 0.8% 3.3% 13.4% 11.1% 10.8% 14.1% 14.3% 11.1% 12.0%
Capital expenditures 189 426 660 879 1465 1524 1476 1540 1952 1995
Expenditure % 13.1% 21.5% 22.1% 22.3% 25.6% 22.0% 22.1% 21.9% 26.0% 25.1%
Source: Ministry of Finance of Georgia
Table 3: Key figures2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Debt % GDP 29.4 27.3 26.4 25.8 25.2 24.8 24.6 24.6 24.8 25.0 25.5 25.9 26.4Foreign debt (mln GEL) 7373 7700 8330 9100 9916 10811 11788 12852 13995 15216 16503 17862 19286
Internal debt (mln GEL) 1954 2074 2217 2385 2578 2798 3046 3321 3624 3954 4310 4694 5104
Total public debt (mln GEL) 8910 9335 10202 11101 12029 13078 14234 15498 16861 18321 19865 21499 23218
Inflation 6.0% 6.0% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 2.0% 2.0%
Economic growth 6.5% 7.0% 7.0% 6.0% 6.0% 6.0% 5.5% 5.5% 5.0% 5.0% 4.5% 4.5% 4.0%
Nominal GDP (mln GEL) 30256 34189 38634 43077 47815 52836 57855 63062 68107 73215 77974 83042 88025GEL to USD rate of exchange 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65 1.65
Revenues % GDP 26.4% 25.2% 25.0% 24.7% 24.5% 24.3% 24.2% 24.1% 24.0% 23.9% 23.9% 23.9% 23.8%
Expenditures % GDP 29.4% 28.2% 28.0% 27.7% 27.5% 27.3% 27.2% 27.1% 27.0% 26.9% 26.9% 26.9% 26.8%
Revenues (mln GEL) 8002 8623 9644 10656 11719 12864 14001 15194 16353 17529 18648 19809 20970
Expenditures (mln GEL) 8910 9648 10803 11949 13154 14449 15737 17086 18397 19725 20987 22300 23611
Current expenses 7932 8553 9574 10606 11669 12814 13951 15144 16303 17479 18598 19759 20920
Capital expenses 978 1096 1229 1342 1484 1635 1786 1942 2093 2246 2389 2541 2691
Budget expenses 908 1026 1159 1292 1434 1585 1736 1892 2043 2196 2339 2491 2641
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Table 4. Value added taxRYI real GDP + import, INF - inflation, ADM administration
improvement variable
Dependent Variable: LOG(VAT)
Method: Least SquaresSample (adjusted): 1996Q2 2011Q4
Included observations: 63 after adjustments
Variable Coefficient Std. Error t-Statistic Prob.
C -4.704441 1.527700 -3.079428 0.0031
LOG(RYI(-1)) 0.845993 0.231202 3.659116 0.0005
INF(-1) 1.835530 0.221837 8.274227 0.0000
ADM 0.336177 0.096577 3.480912 0.0009
R-squared 0.971970 Mean dependent var 5.152089
Adjusted R-squared 0.970545 S.D. dependent var 1.037276
S.E. of regression 0.178022 Akaike info criterion -0.552432
Sum squared resid 1.869819 Schwarz criterion -0.416360
Log likelihood 21.40160 F-statistic 681.9684
Durbin-Watson stat 1.187378 Prob(F-statistic) 0.000000
Chart 2. Value added tax regressive analysis result
-.8
-.4
.0
.4
3
4
5
6
7
1996 1998 2000 2002 2004 2006 2008 2010
Residual Actual Fitted
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Chart 3. Excise tax on importLOG(AQ) = 2.636460681 + 0.7015591837*LOG(IMP)
AQ excise tax revenue; IMP import amount
-.4
-.2
.0
.2
.4
10.4
10.8
11.2
11.6
12.0
2005 2006 2007 2008 2009 2010 2011
Residual Actual Fitted
Chart 4. Excise tax on domestic productsLOG(DAQ) = 3.936758528 + 0.5663236657*LOG(DOM)
DAQ excise tax revenue, DOM excise goods produced in Georgia
-.6
-.4
-.2
.0
.2
.4
9.2
9.6
10.0
10.4
10.8
2006 2007 2008 2009 2010
Residual Actual Fitted
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Table 5. Income taxNY- nominal GDP, ADM administration improvement variable
Dependent Variable: LOG(PITSA)
Method: Least Squares
Sample: 1996Q1 2011Q4
Included observations: 64
Variable Coefficient Std. Error t-Statistic Prob.
C -4.774058 0.429644 -11.11165 0.0000
LOG(NYSA) 1.206037 0.058965 20.45352 0.0000
ADM 0.324934 0.068079 4.772905 0.0000
R-squared 0.978719 Mean dependent var 4.779460
Adjusted R-squared 0.978022 S.D. dependent var 0.859115
S.E. of regression 0.127365 Akaike info criterion -1.237783
Sum squared resid 0.989528 Schwarz criterion -1.136586
Log likelihood 42.60906 F-statistic 1402.726
Durbin-Watson stat 0.730652 Prob(F-statistic) 0.000000
Chart 5. Income tax regressive analysis result
-.4
-.2
.0
.2
.4
3
4
5
6
7
1996 1998 2000 2002 2004 2006 2008 2010
Residual Actual Fitted
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Chart 6. Public debt structure Chart 6. Public debt structure
Chart 7. Public de bt statistics of different countries
Source: International Monetary Fund
Creditor Thou $ Thou GELTotal 5,392,068 8,939,070Foreign debt 4,215,704 6,998,070
Multilateral creditors 2,457,193 4,078,941
Bilateral creditors634,811 1,053,786
Securities (Eurobonds) 564,750 937,485
Foreign debt of the National Bank 558,950 927,858
Internal debt 1,176,364 1,941,000
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Table 7. Total foreign debt structure, as at March 31, 2012, in million US dollarsGovernmental sector 3 805
National Bank 783
Banks 2 086
Other sectors 2 107
Intercompany loans 2 616
Total 11 397Source: National Bank of Georgia
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