GEO

2019 Draft State Budget of Georgia: Analysis and Recommendations

07 November, 2018

 

Key Findings and Recommendations

According to 2019 draft state budget, slower economic growth (4.5%) is expected for the next year.

The rule for local self-government budgetary funding will be changed. Instead of equalizing transfer and share of income tax revenues, municipalities will receive 19% of VAT from the state budget. Ultimately, the income of local self-government will increase. In addition, their funding will not go through the state budget anymore and it will solely depend on economic growth of the country.

The Law on Economic Freedom will be significantly changed. The most unacceptable change of the draft state budget will be a removal of budget expenses to GDP ratio It means that law will not limit the growth of “Government Size” anymore, therefore, government’s involvement might increase and this happens in a reality when a new Prime Minister presented his small government program.celling which is 30% now.

Definition of Instead of public debt, the amount government debt will be restricted, which seems logical.budget deficit will become more comprehensive, which, on the one hand, is good, but, on the other hand, it could simplify overcoming of budget deficit ceiling (3% of GDP).

Due to fiscal decentralization reform, the state budget will increase only by GEL 270 million. Pension expenses and capital expenditure will also significantly increase. Number of people employed in budgetary organizations will decrease by 1 513. However, 60 million more will be spent for remuneration of the mentioned employees.

Expenses on healthcare and education will also increase. However, in both cases program budgeting has certain problems and they are not focused on increase of effectiveness of expenses.

The information about In addition, the budget of GPB will increase by GEL 6 million.number of employees of Georgian Public Broadcaster (GPB) and their salaries are absent in the budget.

The budget deficit is set to 2.7% of GDP. In order to cover the budget deficit, the Government of Georgia (GoG) will borrow GEL 1 226 million, out of which GEL 500 million will be a domestic debt.

 

Setting of budgetary programs remain problematic. Education programs and subprograms are worth mentioning in this regard. Low quality of education is a big problem of Georgia, but the school education program does not aim at improving the situation and there is not a single indicator for measuring the quality.

Expected outcomes and indicators of the budget are still given in the appendixes of the main text, which means that they are not a part of the text of the draft law on state budget. It demonstrates the GoG’s improper approaches towards program budgeting.

Recommendations

  • The GoG should refrain from removing specific restrictive norms on budgetary expenditure from the Law on Economic Freedom. If not, this will worsen fiscal reliability of the country.
  • It should be clarified in which cases the budget deficit can exceed 3% of GDP and this should be allowed only as an exception. 
  • Due to slower GDP growth rate and unpredictability of national currency exchange rate, it would be better to plan smaller budget deficit and fewer new debts.
  • Supervision over program budgeting should be improved in order to increase efficiency of budget spending. The special attention should be paid to specific indicators for measuring the outcomes.
  • Expected outcomes and indicators of the budget, which are given in the appendixes, should become a part of the main text of the law on state budget.

 

Macroeconomic Environment 

On October 1, the GoG submitted 2019 draft budget to the parliament of Georgia. According to the draft, the GoG expects 5% growth of GDP in 2018. It should be noted that in January-August 2018, an average GDP growth was 4.8%. In August, the rate dropped to 2%. Based on this data, the expectation of GoG for this year might be overoptimistic.

As for 2019, the GoG expects 4.5% GDP growth thus Georgia’s nominal GDP for the next year should amount to GEL 45 billion. Expected USD/GEL exchange rate is 2.63, GDP per capita – USD 4 600, inflation – 3%. The exports are expected to grow by 12.9% and imports – by 6.6%. Government debt is expected to be 42.2% of GDP – 32.4% would foreign Government debt and 9.8% domestic one.

Important fiscal amendments of the draft budget

2019 draft budget is special since it envisages important fiscal reforms: abolishment of equalizing transfer and amendments to the Law on Economic Freedom.

From 2019, one part of money received from income tax will not go to local self-governments (municipalities) anymore. Moreover, local budgets will not be able to receive money from state budget in a form of equalizing transfer. Instead of that, municipalities will receive 19% of VAT, GEL 946.6 million for 2019. Based on the old rule, municipalities would get GEL 900.6 million for 2019. Therefore, new rule increased funding of local self-governments by GEL 46 million. In addition, their funding will not go through the state budget anymore and it will solely depend on economic growth of the country. This can increase fiscal independence of municipalities.

GEL 946.6 million received from VAT will be distributed among municipalities according to specific formula. The formula considers such factors as: registered population and area of municipality, number of children younger than 6 years and children from 6 to 18 years, number of special status holders living in high mountainous areas.

As a result, in 2019 half (GEL 473 million) of VAT revenues allocated for municipalities will go to Tbilisi, 5% of the funding will go to Batumi (GEL 48 million), 3.5% - to Kutaisi (GEL 33 million), etc. To compare, in 2018 Tbilisi gets GEL 436 million from equalizing transfer and income tax, therefore, its funding will increase by GEL 37 million in 2019. In addition, GEL 130 million will be allocated from the state budget for purchasing new buses in Tbilisi.

As for the amendments to the law on Economic Freedom, article 2 of the law – which limits economic parameters – is almost rewritten.

Today this law sets three important ceilings/thresholds: 1. Sum of consolidated budget expenses (central and local together) and acquisition of non-financial assets should not exceed 30% of GDP; 2. Consolidated budget deficit should not exceed 3% of GDP and 3. Public debt should not exceed 60% of GDP.

According to the amendments, the first threshold will be totally removed. It means that law will not limit the growth of “Government Size” anymore; therefore, government’s involvement might increase. First, it is bad because there is a negative correlation between the government size and economic growth. Moreover, in existing reality when one political group dominates all branches of power and public institutions, removal of restriction of expenses should be assesses negatively.

Consolidated budget deficit ceiling (3% of GDP) will be substituted by the total budget ceiling, which, together with the consolidated budget, also includes financial resources of those state-owned institutions (LEPLs, N(N)LEs) that have their own revenues. This should be positively assessed. However, the draft law increases number of exceptions for growth of budget deficit. Recession might be one of such exceptions, but the term “recession” is not clearly explained in the draft law. In general, recession means shrinking of economy and revenues and growth of employment. However, the draft law might consider slowing down of economic growth rate as a recession too.

Another exception when the budget deficit can exceed the 3% threshold is a reform of education system, which is planned to be implemented until 2025.

As for the third threshold, instead of public debt, the government debt will be limited by 60% of GDP. The Government debt does not include the debt of the National Bank of Georgia. This amendment also seems logical since the state budget is not spent for serving the debt of the National Bank, which was GEL 16.7 billion as of August 31.

Moreover, the size of contingency funds of the Government and the President will also be differently regulated. According to the amendments, the ceiling for the sum of both Government’s and President’s contingency funds will be 1% of total budget expenses. Today this figure is 2%. If we consider spending practice of these funds, such an amendment seems to be positive.

Basic indicators of the State Budget

In 2019, the state budget expenditures will be GEL 12.7 billion, which is GEL 270 million (2.2%) more than the previous year’s figure. Such a slow growth rate is caused by the above-mentioned fiscal decentralization reform. Approximately GEL 700 million will not be taken from State budget as an equalizing transfer, but instead revenues from VAT will decrease.

The budget revenues, which includes tax revenues, grants and other revenues, will be GEL 33 million less in 2019 than in 2018. More specifically, GEL 148 million less grants will be raised from international organizations and foreign countries.

Due to abolishment of equalizing transfer, the state budget expenses will decrease by GEL 442 million. Number of people employed in budgetary organizations will decrease by 1 513. However, 60 million more will be spent for remuneration of the mentioned employees.

The most significant reduction of number of employees (239) is planned in the Ministry of Internally Displace Persons from the Occupied Territories, Labor, Health and Social Affairs. Nevertheless, remuneration expenses for employees is still increasing by GEL 1.4 million, which means salary raise for remained staff. Number of employees will decrease by 211 in the Ministry of Education, Science, Culture and Sports (remuneration expenses remain same); by 173 – in the Ministry of Economy and Sustainable Development; by 96 – the Ministry of Defense; by 72 in the Ministry of Environment and Agriculture; by 66 – in the Ministry of Foreign Affairs; by 49 – in the Ministry of Regional Development and Infrastructure; by 46 – in the Ministry of Justice, etc. In all ministries, where number of employees decreases, remuneration expenses remain the same or increases.  

Acquisition of non-financial assets i.e. infrastructure expenses will increase by GEL 454 million and reach GEL 2 082 million. GEL 60 million is expected to be raised from privatization.

The budget deficit will be GEL 1 226 million, which is 2.7% of GDP. In addition, next year the GoG should cover GEL 935 million of debt taken during previous years.

The GoG plans to borrow total of GEL 2 160 million to finance all planned budget receipts. It will borrow GEL 500 million from domestic market and GEL 1 660 million from foreign stakeholders.

Public institutions and budgetary programs, which will have significantly higher funding

In 2019, funding of the Ministry of Internally Displace Persons from the Occupied Territories, Labor, Health and Social Affairs will increase most significantly (by GEL 240 million). Additional GEL 225 million will be spent for the pension raise by GEL 20 from January 2019. Additional GEL 50 million will be spent on universal healthcare program, which will be funded by total of GEL 754 million. Although this program by definition is not universal anymore due to certain changes made in previous years in order to contain spending growth rate, this year the spending once again will be more by GEL 20 million than planned.

Funding of the Ministry of Regional Development and Infrastructure will increase by GEL 140 million. This money will be mainly spent on building of highways, renovation of sewage infrastructure and waste management program.

Funding of the Ministry of Economy and Sustainable Development will increase by GEL 95 million, which will be mainly spent on development of electricity network.

Funding of the GPB will increase by GEL 6 million (11.4%). The GPB’s funding is linked to the country’s GDP and should not be less than 0.14% of it. However, if in previous years the state budget contained information about number of people employed in the GPB and their remuneration, this time this type of information is absent in the draft 2019 budget. Only total funding of GPB – GEL 58.5 million – is given in the document.   

Program budgeting remains problematic. Many programs, including big ones, are not properly developed. The most important shortcomings are related to program and subprogram goals, intermediary and final outcomes and assessment indicators. Some programs and subprograms are not directed to improve the situation and does not satisfy basic requirements of program budgeting.

For instance, in September this year TI Georgia published a policy document on school education. Based previous years’ state budgets, the main recommendation was for the Ministry of Education, Science, Culture and Sport. We called on the Ministry to set specific goals, intermediary and final outcomes and indicators in the school education program. These outcomes should be linked to the quality of education and be measurable in order to assess the progress from year to year. The Ministry did not consider our recommendation and developed the same type of program for 2019.

 

economics