Georgia was one of the first Republics of the Former Soviet Union to declare independence. It has a population of 5.4 million and an area of 69,700 square kilometers (slightly larger than South Carolina). The country is bounded by the Black Sea to the west; the High Caucasus Mountain Range and Russia to the north; Turkey and Armenia to the south; and Azerbaijan to the east. Due to its strategic location, particularly its ports on the Black Sea, Georgia remains a gateway for land transportation across the Caucasus. It remains a pivotal country with regard to the development and expansion of oil and gas transportation routes originating from Kazakhstan, Azerbaijan and Turkmenistan. Georgia’s rich land produces a variety of high-value agricultural products, and its pleasant climate, varied topography and rich history and culture make it well suited to the revival of tourism in the country. After several years of civil strife and political unrest in the early 1990s, Georgia has made significant progress toward achieving political and economic stability in the last few years. The crisis in Russia, however, has hit hard in Georgia as well. Under an agreement with the IMF and World Bank, Georgia had established one of the region’s more stable currencies; significantly reduced its budget deficit; and generated real GDP growth rates of more than 10% in 1996 and 1997.

While growth slipped to 2.9 percent in 1998, Georgia sold off about half its foreign exchange reserves to protect the value of the lari. Even so, the value of the lari fell from 1.34 to 2.2 against the U.S. Dollar in 1998. The IMF suspended its program disbursements in the fall of 1998, largely due to below-target Government revenues and foreign exchange interventions. The Government of Georgia stopped the interventions in December, and has allowed the lari to float since then. The next IMF mission to Georgia is due in May. It will review Georgia’s performance in increasing revenues and consider resuming its program lending to Georgia. Privatization has taken on an even greater urgency in the Government’s macroeconomic reform program. More than 10,000 small enterprises and 1,100 medium/large firms have been privatized. The entire power sector has been targeted for privatization by President Shevardnaze. In the last months of 1998, the proceeds from privatization went to support current expenditures.

Over the next few years, there should be significant foreign direct investment as Merrill Lynch handles the privatization of the power sector through international tenders (see project profile). AIOC has completed the first oil pipeline from Baku to Supsa, a Georgian port on the Black Sea. The first loaded oil tanker put to sea from Supsa in early April. The terminal was commissioned on April 17. The urgency to build new pipelines has been greatly diminished owing to the uncertainty surrounding the direction of oil prices.

ECONOMIC OUTLOOK

The stabilization program implemented by the Government beginning in 1994/1995 resulted in some positive economic trends. A key element of the stabilization program was a dramatic fiscal adjustment, which reduced the budget deficit from 26% of GDP in 1993 to 4% in 1997. However, due to the loss of the Russian market, tax revenues missed their target and the budget deficit most likely increased in 1998. The Government significantly reduced inflation from 64% in the first three quarters of 1994 to about 7% in 1997 and 4% in 1998. Successful stabilization also laid the groundwork for introduction of a new national currency, the lari, in September 1995. The population converted U.S. $50 million of foreign currency within a month, leading to a four-fold increase of domestic currency in circulation and growth in the international reserves of the central bank.

Since Russia is Georgia’s main export market, the Russian crisis increased the country’s current account deficit from $347 million in 1997 to $500 million in 1998. The value of the lari actually rose against the Russian ruble, further weakening the competitiveness of Georgia’s products there. The current account deficit is now approaching 9% of GDP.

Following several years of severe contraction, Georgia’s economic growth resumed in 1995 when real GDP rose by 2.4%, followed by a robust growth rate of 10.5% in 1996 and 11% in 1997. Again, due in part to the Russian crisis and the worst drought in 50 years, growth slowed to 2.9% in 1998. Growth continues to be led by agriculture and the service sector, particularly transport and retail trade. In addition, the sharp reduction of the labor force in state enterprises (over 35% cut since 1991) shows that the Government remains committed to developing a privately dominated market economy.

Despite these successes, the economic situation remains fragile. One of the main sources of fragility is the weak state of public finance. There is still the need, identified by the IMF and included in the Government 1998 reform program, to vigorously pursue measures to increase tax revenues, and to continue downsizing the public sector to further improve efficiency of public spending. Moreover, many key reforms are still at an early stage. Privatization of medium and large enterprises has begun, but some firms have yet to make the critical adjustment to market signals. The development of agriculture remains constrained by the lack of well defined property rights and incomplete land reform. In addition, with all banks small by Western standards, and several of them insolvent, the banking sector fails to intermediate savings into investment efficiently. The Russian crisis has not helped the Government’s fiscal position, though it has strengthened its commitment to privatization.

Increased privatization likely will result in more foreign direct investment. Investment is expected to rise to 14% of GDP in 1998. Public investment will be directed primarily at rehabilitating and rebuilding the physical infrastructure – e.g., railways, power, roads, port facilities -- needed to support private sector development. Exports will continue to suffer due to slack demand from Russian markets. Combined with the large increase in imports associated with rebuilding the country’s infrastructure, the current account deficit likely will increase again in 1999. Economic growth is expected to continue in 1999, building on the recovery of the agriculture and service sectors observed during 1996-97. The recovery in agriculture will in part depend on whether there is sufficient rainfall.

BUSINESS AND INVESTMENT CLIMATE

The business and investment climate in Georgia has improved over the past several years, but lack of transparency in the tax and customs systems means significant barriers to new business development remain. Still, Georgia seems to have chosen to embrace open markets and the rule of law as a path to economic growth. With the passage of a Law on Promotion and Guarantees of Investment Activity (November, 1996) and the Law on Enterpreneurship, foreign investors now face more automatic and improved registration procedures. Under these laws, there is no discrimination between foreign and local investors in those sectors where foreigners are allowed to invest. Georgian legislation does not require foreign investors to re-invest profits locally. Also, the Law on Promotion and Guarantees of Investment Activity does not impose any extra duties for profit or capital repatriation from Georgia.

The laws allow unlimited foreign ownership in some sectors, but sharply limit foreign investment in some infrastructure. Property, including land, can be gained through acquisitions, mergers, takeovers, and Greenfield investments. Individual foreigners may not own land, but a foreign-controlled firm may purchase land. While the laws on this topic are evolving, the Government must retain a controlling block of shares in roads, and railways. The Government has agreed in principle to privatize Poti port (see project profiles), and allows foreign investors to own 75% of power facilities (see project profiles). The Law on Promotion and Guarantees of Investment Activity prohibits foreign investment in the defense and security sectors.

Although the business environment is improving, it remains burdened by Government influence and bureaucracy. Personal contacts play a very significant role in the successful establishment of a business. Moreover, key people shift in and out of Government, which can drastically alter a business’s operating environment. Georgian and foreign businesspeople routinely cite official corruption as a serious impediment to the conduct of business. The Government is currently undertaking a 6- month intensive program to implement measures against corruption, but substantial law enforcement and civil service reform will be necessary to wage an effective anticorruption effort. The prosecutor's office and the ministries of internal affairs and state security have anticorruption responsibilities, although these institutions have come under criticism for the ineffectiveness of their efforts, and alternatives are under active consideration. While official corruption severely frustrates foreign investors and significantly complicates future investment, the business climate in Georgia is perhaps more promising than elsewhere in the former Soviet Union. Although the legal framework for private business is in place, the enforceability of contracts is weak because there does not exist a strong, independent court system. Nonetheless, significant judicial reforms are underway. Judges who passed the recent qualification exam are slated to be seated on the bench in May 1999, when other significant reforms will also enter into effect.

In order to accelerate the pace of reform, the international community is working in close harmony with the Government of Georgia on a series of initiatives designed to enhance its ability to combat corruption and protect its borders. The U.S. in particular is providing assistance to the Georgian border guard service and other law enforcement agencies, and is promoting reforms in the judiciary and in administrative laws.

Another constraint posed to foreign investment is the dilapidated infrastructure. Foreign investors have to supply back-up electricity generation capacity to ensure that their businesses can function without interruption. This adds large costs to doing business. Speeding the privatization of the power sector should help alleviate this problem.

POLITICAL CLIMATE

After significant unrest and decline in the early 1990s, Georgia has made tremendous progress toward achieving political and economic stability, particularly over the past three years. It now stands as one of the best examples in the Former Soviet Union of a country’s conversion to a democratic and free market system. President Shevardnadze's reelection in November 1995, together with his Citizens Union party's gaining power in Parliament, reaffirmed the reformist, democratic character of Georgian politics. Separatist conflicts flared up in the early 1990s in Abkhazia and South Ossetia. While the latter has been largely dormant for over three years, the Abkhazia issue remains unresolved, with Russian “peacekeepers” and a UN Observer Mission deployed there. These conflicts have disrupted transport links to Georgia’s traditional markets in Russia, and policing activities continue to place a drain on the budget. The small Black Sea province of Adjara remains semi-autonomous. Throughout the rest of the country, the violence and organized crime of the early 1990s has been sharply reduced, with law and order established.

The Government party will be challenged in the Parliamentary elections next November from opposition parties, who criticize the Government for wage and pension arrears, failure to control corruption, and lack of public services.

SOURCES OF FINANCING

The banking system is in an early stage of development. As a result of strict commercial-bank oversight by the Georgia National Bank (GNB, the central bank of Georgia), the number of banks has declined from 247 in 1995 to around 70, and is still falling. There are now three large commercial banks with assets totaling U.S. $133.7 million (54 percent of total commercial bank assets). All three banks are privatized, former state-owned commercial banks.

Foreign investors have a right to hold foreign currency accounts with authorized banks. Any amount of lari generated by foreign investors can be sold for hard currency through interbank auction at a legal market-clearing rate, or converted in banks that have a hard currency operation license. Foreign exchange is also available on the local market. Georgian law does not limit the free flow of financial resources. But in practice, the flow is restrained because of poor and unreliable interbank communication (regular banking transactions within Georgia can take several days). Most banks issue 3-6 month credits, which are used for commercial operations. The interest rate is 5-8 percent per month. Some of the larger banks currently pay around 12 percent annually on U.S. dollar deposits, while the effective rate charged borrowers can reach 48 percent annually on U.S. dollar loans. The laws allowing banks to take possession of collateral remain weak and difficult to enforce. The European Partnership Fund, IBRD, and EBRD, plan to issue special purpose six-month credits at 11 percent interest and one-year credits at 14 percent.

SECTOR OVERVIEWS POWER

With support of the international donor community, the Government of Georgia is restructuring the nation’s power sector. In the electricity subsector, the Government has unbundled transmission, generation and distribution into separate enterprises and organizations. Nineteen smaller hydro power plants totaling 90 MW were privatized before a mass privatization process began in 1995, and four hydro power plants totaling about 180 MW have been leased to private operators. Most of Georgia’s remaining hydro and thermal generation units have been transformed into joint stock companies with 100 percent of the shares owned and operated by Sakenergo-Generation. The distribution enterprises have also been transformed into joint stock companies, with 100 percent of the shares controlled by the relevant local municipalities.

The Government has selected Merrill Lynch to conduct the international tendering for the assets. Merrill Lynch sold a 75 percent interest in Telasi, the Tbilisi Distribution Company, to AES Corporation, a U.S. company. Merrill Lynch is now preparing to bundle Georgia’s hydro and thermal generation facilities and sell the bundles. Bidders will be able to buy up to 75 percent interest from the Government in the bundled facilities, or bid on 25 – 30 year management contracts.

The two best opportunities for future U.S. business in the power sector will be in hydroelectric power and the privatization of electricity distribution and generation. In both these areas, there is a strong need for modernization and refurbishment. Nearly 60 percent of Georgia’s installed capacity is hydroelectric. Hydroelectric power is the main source of electricity during the summer. In the winter, thermal power stations account for half of the total power generated, while hydro and power imported from Armenia accounts for the rest. Thermal power stations are used only when needed because Georgia must purchase the natural gas to run them. The electricity generation sector is hindered by old plant and equipment; shortage of spare parts and fuel; and lack of maintenance funding.

Hydroelectric Power: There are more than 50 hydropower stations in Georgia, of which the 5 largest represent 70% of total capacity. The biggest hydropower plant, Enguri, is equipped with five units, with a total installed capacity of 1,270 MW. Due to mechanical problems, only four units are operable. The EBRD is financing repairs to Enguri and assistance with privatization.

Privatization of Electricity Distribution and Generation: According to some estimates by USAID, the rehabilitation costs for the power generation sector exceed $250 million and more than $200 million is needed for the rehabilitation of the distribution sector. The World Bank has financed much of the power sector rehabilitation. With the privatization program in high gear, there are opportunities first for investors, and then for equipment suppliers to help the new owners upgrade the facilities. (See project profile #GR2.)

TRANSPORTATION

Since independence, Georgia has sought to establish itself as the crucial link in a land corridor between Europe and Asia. It recognizes and hopes to provide the transit facilities for oil and gas pipelines from Central Asia and for container transit traffic for trade between Europe, Central and Eastern Asia and the Persian Gulf. Through the development of its rail lines and ports, Georgia expects to benefit from increased investment and the development of ancillary domestic activities.

Georgia will need to address a number of pressing needs: eroding asset base; lack of technical innovation and upgrading; and general lack of resources for rehabilitation and maintenance.

Poti is on the Black Sea and now represents Georgia’s primary port. The Black Sea port of Batumi lies within the semi-autonomous province of Adjara, while the port of Sukhumi is located in the separatist region of Abkhazia. The oil pipeline terminus at Supsa currently has no facilities to handle non-oil cargoes. While there is much potential at Poti, only Sea-Land Corporation has had success in developing new or refurbished facilities The Georgian Pipeline Company (owned by the AIOC) manages the oil pipeline, but it ends in Supsa, and the infrastructure there to get the oil out to the tankers relies on a Single Point Mooring (see Caspian Region project profiles).

The current road and rail links from the Caspian through Georgia to the Black sea are in need of upgrading, and such projects are receiving a high priority by the Government of Georgia. (see Caspian Region project profiles). While the Government has yet to secure donor financing to upgrade the road link to the Black Sea at Poti, the project is likely to cost about $62 million, and represents $8 million in U.S.

opportunities for equipment exports and construction supervision. The road link from Tbilisi to Armenia for the Azerbaijan-Georgia-Armenia-Turkey highway is likely to cost $37 million and represents $5 million in U.S. opportunities for equipment exports and construction supervision. Once there is peace in the region between Armenia and Azerbaijan, the blockades of Armenia by Turkey and Azerbaijan will be removed, and upgrading this road will be a spur to regional economic development.

The EBRD is loaning the Government of Georgia $20 million to improve the rail link between the Azeri-Georgian border and Georgian ports. The loan will go in large part to help bring about institutional changes at Sakartvelo Rkingza, the Georgian Railway Company. The project will help commercialize the Transcaucasus route and put the company on a more independent, commercial footing. More investments will be needed to bring the tracks up to modern standards. UTILITIES

The World Bank is partially financing a $300 million project to rehabilitate the Tbilisi Water and Sewer System. The project is investing in urgently needed improvements, securing a private sector operator under contract to the water authority, and establishing and managing a fund to use on prioritized repairs and maintenance. The project represents at least $10 - $20 million in procurement opportunities for U.S. firms and the possibility of a management contract for an interested U.S. water utility or water engineering company.

TOURISM

Georgia represents some good opportunities for tourism development in the near future. In the Soviet era, Georgia was a major destination for tourists from the Soviet Union and Eastern Europe. A TDA feasibility study recently completed by Radisson Hotels shows that there is an excess demand for business tourists in Tbilisi. A price analysis of rooms available shows an inordinately high range of $120 for basic rooms that guarantee hot showers and regular power supply to more than $300 for a five star accommodation. To serve the immediate needs of business tourists, investors could establish a Greenfield operation, or retrofit an existing property in Tbilisi to serve as a guest house.

OIL AND GAS

Georgia is well situated to be an oil transit center. In March 1996, Georgia signed a 30-year agreement with Azerbaijan to pump a portion of AIOC’s “early oil” along the western route to the Georgian Black Sea Port of Supsa. The Georgian Pipeline Company (GPC, a totally owned subsidiary of AIOC) has recently completed a crude oil pipeline from Sangachal, Azerbaijan (near Baku), across Georgia to Supsa. The GPC will need to procure maintenance equipment estimated at $1 million to $2 million per year to keep the pipeline operational. This may represent an export opportunity for U.S. firms.

Projects that have been mentioned as candidates for future pipeline routes and projects include:

Baku-Ceyhan Main Export Pipeline Route: Would take crude oil to a transshipment point on the Mediterranean Sea, avoiding the Bosphorous. Poti to Odessa, Ukraine: Ukraine has set up a pilot project to ship oil via rail across Georgia to Poti and then via oil tanker across the Black Sea to the Ukrainian port of Odessa, where an oil terminal is under construction. This project could result in up to 20,000 bbl/day in traffic.

Kazakhstan to Batumi: The volume of this oil traffic is currently running at about 25,000 barrels per day. The oil is shipped to Azerbaijan via barge, transferred by rail to Khashuri in western Georgia before entering a pipeline for the final stage to Batumi. Under a potential new agreement, 232 kilometers of pipeline would have to be rebuilt, which could then carry 2 million tons per year.

Georgia’s plans to become a transit center will depend on its ability to maintain friendly relations with its neighbors and on internal politics. Azerbaijan has complained that oil products exported from Baku are being illegally diverted to Armenia, which is under and economic blockade by Azerbaijan and Turkey. Besides developing its role as a transit center, Georgia is also looking at ways to increase its domestic production of oil. Georgia is modernizing its refinery at Batumi. It also, with support from USTDA, is looking at the construction of an oil refinery at Supsa, south of the port of Poti. This is a termination point for the early oil pipeline from Baku to Supsa.

The project at Supsa consists of the design and construction of a modularized two million tons per year oil refinery to produce a mix of products to be exported through the Black Sea and also used within Georgia or shipped to Armenia. USTDA funded a Definitional Mission in 1996 and has funded a follow-on Feasibility Study in 1997.

The TDA Feasibility Study is now in progress, including an Environmental Assessment to examine air, groundwater, surface water, wetlands habitat, and coastal and marine issues.

TDA Caspian Region Briefing Book