fiscal risks of georgia:tax revenues and public debt

7/28/2019 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


Chart 5: Profit tax dynamics


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


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:




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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:



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:



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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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


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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27

ScheduleChart 1. Budge t deficit structure


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%



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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%


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


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



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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



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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

fiscal risks of georgia:tax revenues and public debt

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