Caspian Business Journal

Georgia: Are We Seeing The Demise Of The Caucasian Tiger?

Despite ongoing political unrest and a debilitating economic embargo by Russia in the four years that followed the Rose Revolution, Georgia somehow remained a regional economic dynamo. John Mackedon asks whether the recent double impact of the global financial crisis and a crushing defeat in a brief war with Russia may finally have seized this once resilient economic engine?Few economic landscapes have been more turbulent, or more resilient, than that of Georgia’s over the last five years. The economic turnaround experienced by the small, Caucasian country following the Rose Revolution in 2003 resulted in unprecedented flows of foreign direct investment (FDI) into Georgia, surges in gross national income (GNI), and annual economic growth of over 10% for more than four years. During this same time period, however, Georgia also underwent a series of economic and political trials – including an economic embargo by Russia and a surprise early presidential election – which threatened to undermine the economic viability of the fledgling nation.

Throughout this, Georgia’s economy somehow continued to grow at an impressive rate and seemed almost impervious to the economic turmoil it had so long suffered since gaining independence in 1991. This resilience, however, has now been put to the ultimate test, following the combined negative economic effects brought on by last year’s brief war with Russia and the continuing global economic crisis. As Georgia prepares for what could possibly be its first year of negative economic growth, analysts are left wondering whether the country will be able to pull off another economic miracle or whether its luck has finally run out.

A brief history

The years between independence and the Rose Revolution in Georgia were defined by economic hardship, endemic corruption and political upheaval. The break-up of the Soviet Union in the early 1990s had a devastating effect on all of the former Soviet republics which, overnight, were forced to take control of their own economic affairs and begin the transition to a free-market economy. Georgia was particularly vulnerable. Although it was one of the first republics to fight for independence, breaking away from the Soviet Union in April 1991, it was also one of the earliest to sink into economic and political chaos. Civil wars in both Abkhazia and South Ossetia coincided with a military coup which left Georgia without a president just eight months after gaining independence.

The years to follow were defined by de-facto rule among rival clans. In an effort to restore international legitimacy to the failing state, former Soviet Foreign Minister Eduard Shevardnadze was eventually tapped to assume the role of president in 1995. But it even took this political heavyweight the remainder of the decade to finally consolidate power and restore some semblance of order. Widespread corruption, rampant inflation and dysfunctional state institutions ensured that little economic progress would be made during Georgia’s first decade of independence.

After twelve years of independence Georgia ranked 148 for gross domestic product (GDP) per capita ($3,200), one of the lowest among former Soviet republics, ahead of just the Kyrgyz Republic, Uzbekistan, Moldova and Tajikistan[1] and gross national income (GNI) per capita was a scant $830[2]. This reality ensured that only the boldest of investors risked investing in Georgia and FDI stayed at under $500 million. Georgia seemed set to remain one of the most volatile economic markets in the region, largely dependent on foreign aid for survival.

Fair is the Rose

This bleak outlook changed, however, when November 2003’s Rose Revolution resulted in the ousting of Eduard Shevardnadze’s regime and brought to power the reform-minded Mikheil Saakashvili. Upon election as president in January 2004, Saakashvili immediately placed economic reform at the top of his administration’s agenda and began addressing the problems of corruption and institutional failures. The results of these ambitious policies were palpable almost immediately. Corrupt government officials at all levels were rooted out and replaced by more reform-minded candidates and measures were introduced to begin paying backlogged government salaries and pension arrears. This flurry of anti-corruption initiatives and institutional reform was rewarded with a flood of foreign aid and increased interest from foreign investors, as investors from the all over the world – including the United Kingdom, the United States of America, Kazakhstan and Turkey – poured hundreds of millions of dollars into Georgia’s state coffers.

The Saakashvili administration continued to pursue a fiercely liberal economic agenda, chipping away at a stifling bureaucracy that hindered the flow of capital and investment and instigating an ambitious privatization effort. The continued dissolution of trade and investment barriers immediately resulted in a doubling of foreign direct investment (FDI) in Georgia, from $453 million in 2005 to $1.17 billion one year later, and helped ensure that this investment would remain over $1.5 billion in the years to come.[3]

This impressive influx of FDI, coupled with the ambitious privatization initiative, encouraged the authorities to continue to liberalize Georgia’s investment environment while making similar efforts in the social sectors of the country. In the years following the Rose Revolution and leading up to the global financial crisis (and a brief war with Russia), Georgia’s economy grew at an annual rate of 10.5% while social indicators, such as corruption and media freedom, continued to improve. In response to the widespread reforms being implemented by the Saakashvili regime, Georgia gained an impressive 66 spots on Transparency International’s corruption index between the years of 2004 and 2008, jumping from number 133 to number 67 on that list. Furthermore, these impressive economic and social improvements resulted in a surge in PPP GDP (from $12.18 billion in 2004 to $21.6 billion in 2008)[4] and a nearly doubling of GNI (from $830 in 2003 to $1,506 in 2006).[5]

Foreign Direct Investment in Georgia 1990-2008 (Millions of dollars)

Source: United Nations Conference of Trade and Development. World Investment Report, 2009 Georgia Country Fact Sheet

The withering of the rose

Few countries have ever experienced such startling economic and social reform in so short a time period and it appeared as if nothing could slow the economic growth of Georgia’s newly awakened economy. Although not readily apparent from its tale of economic prosperity, not all has been rosy for Georgia over the last five years.

While investments in the country have continuously increased, GNI has improved and improvements have been made in certain social sectors, a series of political and economic setbacks have shaken investor confidence and led political and economic analysts to question the Saakashvili regime’s commitment to continue to adhere to such a bold economic and social agenda. Cracks in the system first appeared in the spring of 2006, following two years of unfettered economic growth in Georgia, spurring unprecedented foreign investment. FDI in Georgia was growing by leaps and bounds in the years following the Rose Revolution and investors from everywhere were swarming to take advantage of the refreshingly unrestrictive investment environment. Investors from everywhere, it seemed, except Russia.

While regional neighbors such as Kazakhstan and Turkey where quick to embrace the new economic opportunities which accompanied Saakashvili’s ascension to power, Russia grew more and more weary of the course its small southern neighbor had embarked on. This distrust became manifest in March 2006, when Russia implemented an embargo on Georgian wine – a product which accounted for nearly 10% of Georgia’s exports in 2005, 65% of which went to Russia.[6] This economic disaster was further exacerbated in the coming months when Russia declared a full-blown embargo on all Georgian agriculture products and mineral water and canceled all air, land, sea and communication routes with Georgia.

This mounting pressure from abroad was augmented by increasing domestic political unrest in Georgia and eventually began to stymie the impressive economic successes Georgia had achieved during the previous few years. Surprisingly, however, this impact was minimal and did not result in any serious contraction in FDI, GNI, GDP in 2006 or 07. In fact, PPP GDP shrunk only slightly, to $19.65 billion[7] during this time period and overall economic growth actually reached an all-time high of 12.5% in 2007.[8] Although Saakashvili was coming under attack in the political arena, as many of his staunchest political allies morphed into his strongest critics and political rivals – including former Defense Minister Irakli Okruashvili, former Minister of Foreign Affairs Salome Zurabashvili and Speaker of the Parliament Nino Burdjanadze – the overall state of the national economy remained relatively stable and continued to attract serious investment.

Even more amazingly, the political turmoil which followed the government’s decision to use force during a political protest rally and destroy a leading opposition television news station in November 2007 was turbulent enough to force Saakashvili into an early presidential election (which, amid some controversy, he won) but it seemingly did little to stem the investment coming into Georgia. As early as March 2008, Georgia was already boasting an impressive $450 million in foreign direct investment and was anticipating more than $1 billion more during the remainder of the year,[9] showcasing the same kind of economic resilience which had accompanied similarly turbulent times during previous years.

Surviving the Storm?

This time, however, global events would show that Georgia, like nearly every other country in the world, was ill equipped to deal with the impending financial crisis. Unfortunately, unlike nearly every other country in the world, Georgia would suffer an additional economic blow – a five day war with Russia in August 2008. In the midst of a global financial meltdown, Georgia now also faced the task of recovering from the inevitable destruction that conflict brings. So, after nearly half a decade of unprecedented economic growth and recovery, the dual impact of a global financial crisis and an international war dealt the first blow potent enough to slow the growth of Georgia’s post-revolution economy; but for how long?

Remarkably, not even the combined effects of a devastating war, ongoing political turmoil and the largest global economic crisis in decades were destructive enough to force Georgia’s economy immediately into negative growth. Buoyed by more than $4 billion in international aid money and continued support from such agencies as the International Monetary Fund and the World Bank, Georgia’s economy was somehow predicted to grow by 2% in 2008.[10] While this humble figure is certainly a far cry from the double digits experienced by the small nation over the previous years, it was enough to convince investors of the overall resilience of Georgia’s economy. Although a loss of bank deposits resulting from the war with Russia, falling exports and declining remittances then lead to a negative growth rate of 5.9% during the first quarter of 2009[11] and may have created real doubt about the potential for a speedy economic recovery, improvements in Georgia’s overall investment landscape continue to help assuage these doubts.

Following the war, the Saakashvili administration began diverting defense funds towards more social public expenditures to help deal with the ongoing economic crisis and foreign aid has been leveraged to mitigate the most devastating effects of these crises. Furthermore, efforts to reduce external public debt in previous years mean that the country is better placed to withstand the impending economic shocks, highlighting the soundness of many of the economic reforms which have been carried out since the Rose Revolution.

As a result of such measures, Georgia has become the first country to gain more than 100 spots on the International Finance Corporation’s (IFC) Doing Business Report over a period of just five years, moving from 112 in 2005 to 11 in 2010,[12] thus continuing to show extraordinary economic tenacity in the face of the most difficult circumstances. The continued maintenance of an extremely open business environment and removal of unnecessary economic hurdles, improvement in the domestic political landscape and a little luck may ultimately pave the road to Georgia’s economic salvation one more time.

Footnotes:

[1] CIA World Fact Book 2003

[2] The World Bank, World Development Report 2005: A Better Investment Climate for Everyone.

[3] United Nations Conference of Trade and Development. World Investment Report, 2009. Georgia Country Fact Sheet. Found at: http://www.unctad.org/sections/dite_dir/docs/wir09_fs_ge_en.pdf

[4] CIA World Fact Book

[5] Ibid

[6] Georgian Department of Statistics as quoted by Eurasianet.org and Civil.ge

[7] CIA World Factbook

[8] The World Bank. Georgia Country Profile

[9] Civil.ge

[10] Civil.ge

[11] International Monetary Fund Program Note: Georgia, August 2009

[12] The World Bank. Georgia Country Brief 2009