Georgia - Georgia Rehabilitation Credit

Report No. PIC1781 Project Name Georgia-Rehabilitation Credit Region Europe and Central Asia Sector Economy-wide Project ID GEPA8410 Principal Responsible Entity Deputy Prime Minister for Economic Reforms Date PID Prepared March 21, 1995 Appraisal Date February 1, 1995 Projected Board Date March 30, 1995 Country Background I. Since independence, Georgia has experienced a severe economic decline arising from the disruption in payments and trade within the FSU, large terms of trade shocks, economic recession in the region, and aggravated by two years of civil conflicts and increasingly loose financial policies. Production has been declining in all sectors of the economy. Overall, output is reported to have decreased by at least 75 percent since 1989, and although the development of the informal sector - a long-standing feature of the Georgian economy - may have moderated the decline, the economic contraction appears to be one of the sharpest among FSU countries. II. The economic decline has been accompanied by an acceleration of the inflationary process (with a monthly inflation rate reaching 60t on average during the first months of 1994), and substantial currency substitution. The fiscal performance also weakened considerably after 1992 due largely to shortfalls in revenues. In 1993, tax collection collapsed to about 3t of GDP and public expenditures for wages, social programs and investment were drastically reduced. III. With the continuous deterioration of the economic situation aver the last five years, the living standards of the majority of the population have declined sharply. Real wages have declined by about 90 percent over the course of the last two years. Families now spend on average about 80 percent of their reported income on food and must rely to a large extent on informal activities, sales of personal effects and assets, or remittance from abroad to cover their basic expenditures. In addition, rationing of electricity, lack of heating during the winter, and cuts in public transportation are imposing considerable hardship on the population. The Government's capacity to guarantee an adequate safety net has also declined sharply. IV. In spite of these many difficulties, some progress was achieved in implementing structural reforms. Most prices were liberalized in 1992; the import regime was open and privatization (mostly of housing and land) was more advanced than in many other FSU countries. The Country's Adjustment Program  V. Toward the end of 1993, the intensity of civil conflicts abated and the Government achieved greater political control. These positive developments opened the way for the design of an economic program that would correct the deep macro-economic imbalances and attempt to rebuild the economy. The Government - geared by a group of reformers - expressed its commitment to restore macroeconomic stability and foster the resumption of growth. To that end, a comprehensive program of macroeconomic stability and structural reforms has been designed with the assistance of the IMF and the World Bank. To demonstrate its commitment to reversing economic trends and to accelerating the transition to a market economy, the Government has over the last few months, taken a series of decisive and courageous measures. These include a sharp reduction in subsidies for bread and transportation, the adjustment of energy prices to cost recovery levels, the tightening of monetary and credit policies, and several decrees to speed up privatization. On December 15, 1994, the Board of Directors of the IMF approved a first purchase of SDR 27.75 million (approximately US$39 million) under the Systemic Transformation Facility (STF). VI. The Government's program focuses on four interconnected and mutually reinforcing elements. First, macroeconomic stabilization is to be achieved through a drastic fiscal adjustment and tight monetary policies. Second, reforms of the public sector will be undertaken to reduce and redefine the role of the Government in the economy. The aim is to ensure the sustainability of the stabilization program, the strengthening of the institutions of public management, and a growing reliance on private sector activity through an acceleration of the privatization process. It is also to reallocate scarce public resources toward basic social services. Third, the development and a more efficient functioning of markets will be fostered by finalizing the liberalization of domestic prices as well as of the foreign exchange and trade regimes; by promoting competition and creating a favorable environment for private sector development; and by strengthening the financial sector. Finally, a minimum social safety net, compatible with the limited available resources, will be maintained by ensuring a minimum level of cash transfers to the poorest groups of the population. The Proposed Credit Objectives VII. The main objective of the credit is to support the Government's economic reform program aimed at restoring macroeconomic stability and at promoting the resumption of growth and improvement in living standards. The other objectives are to: (i) provide budgetary support to maintain the level of basic public expenditures, in particular for wages and the social safety net; (ii) provide foreign exchange for the purchase of critical imports; (iii) improve the functioning of the foreign exchange market; and (iv) provide a framework for financial assistance from other donor agencies. Description VIII. The reform program to be supported by the credit comprises three sets of policies: (a) those aimed at reducing and redefining the - 2-  role of the public sector in the economy; (b) those that foster the development and increased efficiency of markets; and (c) those that maintain a minimum social safety net through improved targeting of benefits. Among the key reforms are price and trade liberalization; phasing out of the state order system; restructuring of the Government sector; privatization and private sector development; and improved targeting of social benefits. Financing IX. The amount of the credit would be SDR 51.0 million (US$75 million equivalent) provided under standard IDA terms (35 years of maturity, including ten years grace period). The proceeds of the proposed credit would be disbursed in one tranche upon effectiveness. US$15 million (20 percent of the credit) could provide retroactive financing for eligible imports procured in the four months preceding the date of loan signing. Implementation Arrangements X. The Deputy Prime Minister for Economic Reforms will oversee, coordinate, and monitor implementation of the policy reform program. Proceeds of the credit will be disbursed monthly upon evidence acceptable to the Bank that imports of eligible goods have taken place. The Credit funds will be disbursed into a Ministry of Finance (MOF) foreign exchange account with the NBG specially set up for this purpose. The NBG will withdraw the foreign exchange as and when needed to meet market demand and will reimburse the MOF at that time with the equivalent local currency at the market exchange rate. Poverty Category XI. The credit is poverty focused. The proposed credit would support: (i) public sector reforms that reallocate public expenditures to ensure access to basic health and education services by the poor; and (ii) increases in cash transfers to the poorest groups (pensioners, children, unemployed, refugees and low-paid government employees) by redirecting resources saved through the elimination of generalized subsidies and improved targeting. Other reforms aim at further targeting of benefits and restructuring of the pension system to generate additional resources for protecting the poorest. Environmental Aspects XII. As an adjustment operation, this project has been assigned to Category U (unrated) for the purposes of Operational Directive 4.01, which does not require an environmental assessment. Project Benefits XIII. Implementation of the proposed reforms will help to restore macroeconomic stability and to reverse the decline in economic activity, thus promoting employment in the private sector and improved living standards. This objective will also be served through the availability of foreign exchange for obtaining critical imports. - 3 -  Project Risks XIV. The proposed project faces four risks. The first risk relates to possible slippage in implementation of reforms resulting from lack of continuous political support or from social tensions due to difficult living conditions following the sharp price realignment. The lack of adequate and timely external assistance of the magnitude required could also lead to growing social tensions, by forcing a much stronger domestic adjustment that would be socially hard to sustain. This risk will be mitigated by the Bank's financial support and by its efforts to mobilize external donor support and humanitarian aid. The second risk is that Georgia may be unable to reach agreements with its main creditors, Russia and Turkmenistan, leading to further disruption in energy supplies. This risk is being addressed by policies aimed at achieving full cost recovery in the energy sector, and by bilateral negotiations underway to regularize previous arrears. The risk of weak implementation capacity will be addressed through continuous technical support, in particular through the Institutional Building Credit. Finally, there is the risk that civil conflicts could resurface. However, it is expected that negotiations underway will lead to a lasting resolution of conflicts. Task Manager: Michelle Riboud, EC4C2 (202) 473-8743 (tel) (202) 477-3378 (fax) Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 4 -