Analysis of the 2020 draft Anti-Crisis Budget

22 June, 2020

In response to the dire economic situation in the country caused by the COVID-19 pandemic, the Government of Georgia (GoG) submitted draft amendments to the Law on the State Budget for 2020 to the Parliament on June 9, 2020. We present an analysis of this draft law and recommendations.

Key Findings

The GoG forecasts a 4% economic decline in 2020. The World Bank predicts a 4.8% decline. Given the severe epidemiological situation in our region, we think 4% economic decline is optimistic;
In 2020, the receipts of the state budget will increase by GEL 3.9 billion and reach GEL 18.4 billion. GEL 133.5 million, mobilized through the StopCoV fund, will become part of the budget, which is the right decision. Tax revenues will decrease by GEL 1.5 billion primarily due to the economic crisis and new tax breaks;
GEL 547 million will save in the current budget. The GoG could save more. Large sums of money were saved only from programs that were actually delayed by the pandemic, and the allocated funds could no longer be used. The expenses of the following ministries will be reduced the most: the Ministry of Regional Development and Infrastructure (by GEL 251 million), the Ministry of Education, Science, Culture and Sports (by GEL 128 million) and the Ministry of Defense (by GEL 75 million);
The state budget expenditures will increase by GEL 1.5 billion and reach GEL 15.9 billion. Social expenses will increase by GEL 1 billion. A total of GEL 5.3 billion will be spent in this direction;
The expenses of the following three ministries will increase by a total of GEL 1.7 billion GEL: the Ministry of Internally Displaced Persons from the Occupied Territories, the Ministry of Labor, Health and Social Affairs (by GEL 1,152 million), the Ministry of Economy and Sustainable Development (by GEL 458 million) and the Ministry of Environment and Agriculture (by GEL 128 million);
The Administrative Expenses will increase by GEL 115 million and reach GEL 3 billion. Remuneration expenses will decrease by GEL 22 million, but the procurement of goods and services will increase by GEL 137 million. The increase was due to funding for anti-pandemic measures;
In 2020, the budget deficit will be GEL 4.3 billion, which is 8.4% of the projected GDP. This figure in the current budget stands at 3.2%.
In 2020, the GoG will borrow more than GEL 8 billion, which is the record-high amount. By the end of 2020, the government debt will reach GEL 27.6 billion, which is 54.8% of the projected GDP. The GoG will not spend GEL 2.5 billion from the taken debts this year;
The GoG plans to invest GEL 600 million, taken from the additional domestic debt, in the deposit certificates of commercial banks. This means that the GoG subsidizes commercial banks. At the same time, the GoG fulfills the function of the National Bank - to provide liquidity to commercial banks.

Recommendations

The GoG needs to come up with alternative scenarios for economic growth and budgeting. We need to know how the budget will change if the country’s economy shrinks by more than 4%;
The GoG needs to save a lot more money from the current budget. First of all, it concerns administrative costs. The GoG needs to come up with a detailed plan for how much money will be spent on business trips, representation expenses, non-staff employees, purchase of furniture, fuel and other goods and services in 2020;
The need for some of the GoG’s anti-crisis programs raises questions. This primarily applies to mortgage funding program. When part of the unemployed cannot receive any money at all, or the government cannot properly help the socially vulnerable, it is not clear why we should finance the middle and high-income population to buy houses;
By refusing to subsidize commercial banks, the GoG can borrow GEL 600 million less. While government debt is approaching the ceiling defined by law and the country's fiscal system is becoming more vulnerable to future economic shocks, the GoG should not subsidy banks and fulfill the function of the National Bank- to provide liquidity to commercial banks;
It is necessary to reduce the real budget deficit and the burden of government debt to make the country more resilient in the face of expected or unexpected economic crisis.

1. Macroeconomic environment

According to the draft amendments, the GoG forecasts a 4% economic decline this year. Prior to the spread of the COVID-19, the forecast for economic growth for this year was 4.5%. In 2020, the nominal Gross Domestic Product (GDP) will remain at the level of GEL 50 billion as 4% economic decline will be outweighed by 4.8% increase in price level (deflator). The World Bank predicts a 4.8% decline in Georgia's economy in 2020. In January-April, Georgia’s economy shrank by 3.6%, mainly due to a 16.6% decline in April.

For the remaining period of 2020, the GEL exchange rate against USD is projected at 2.98. The GoG expects that per capita income will fall to USD 4,534 in 2020 ($ 4,764 in 2019). The projected annual inflation rate is 3.5%, exports will fall by 6% and imports will rise by 2%.

By 2021, the GoG expects a 4% economic growth and 9.5% growth of exports.

2. Receipts of the State budget²

Key Findings:

In 2020, the receipts of the state budget will increase by GEL 3.9 billion and reach GEL 18.4 billion;

Tax revenues will decrease by GEL 1.5 billion primarily due to the economic crisis and new tax breaks;

Budget grants will increase by GEL 316 million the main source of which is the EU;

Other budget revenues will increase by GEL 155 million mainly due to the reflection of GEL 133.5 million in the state budget that was mobilized through the StopCoV fund;

Privatization plan will decrease by GEL 40 million and will amount to GEL 90 million.

In 2020, the receipts of the state budget of Georgia will be GEL 18.4 billion, which is GEL 3.9 billion more than the current budget receipts and GEL 5.2 billion (28%) more than that of the 2019 budget.

As for the budget revenues, which include tax revenues, grants and other revenues, they will be GEL 1 billion less than in the current budget and GEL 462 million less than in 2019.

After tax revenues, the second most important source of budget revenues will be government debt. This year, the GoG will borrow more than GEL 8 billion. This is the largest debt ever taken by the GoG in a single-year period. For example, in 2019, the GoG borrowed GEL 3 billion.

Data source: The Ministry of Finance

Due to the economic crisis and new tax breaks, the tax revenues will decrease by GEL 1.5 billion, compared to the current budget for 2020:

The Value Added Tax (VAT) revenues will decrease by GEL 644 million;
The Income Tax revenues will decrease by GEL 425 million, of which GEL 230 million is due to the tax breaks;
The Profit Tax revenues will decline by GEL 130 million;
Revenues from the Excise, Import and other taxes will decrease by a total of GEL 285 million.

Compared to the current state budget for 2020, grants will increase by GEL 316 million in the new budget. The increase comes entirely from the additional EUR 330 million attracted from the EU. Investment grants increase by GEL 1 million, while budget contributions (classified as grants) from LEPLs will decrease by GEL 15 million.

Other budget revenues will increase by GEL 155 million and reach GEL 675 million. The increase is mainly due to the reflection of GEL 133.5 million in the state budget mobilized through the StopCoV fund³. It is the right decision to include StopCoV fund donations in the budget, because the same standards of transparency and accountability will apply for the spending of this money as we have for budget expenditures. Other revenues will also increase due to the GEL 54 million that will be obtained from the interest on deposits placed as a result of additional funding.

Privatization plan will decrease by GEL 40 million and will amount to GEL 90 million. The GoG's plan to return loans given to various sectors of the economy will decrease by GEL 50 million and reach GEL 80 million.

3. Expenditures of the State Budget⁴

Key Findings:

The state budget expenditures will increase by GEL 1.5 billion and reach GEL 15.9 billion, of which the largest part – GEL 1 billion - will be directed to social expenses. A total of GEL 5.3 billion will be spent in this direction;

The unemployment assistance of GEL 525 million will be one of the significant factors for the increase of social spending;

Healthcare expenses will increase by GEL 393 million. The costs of preventing the spread of the COVID-19 and healthcare will increase by GEL 285 million;

Funding of the Ministry of Economy will increase by GEL 485 million, of which GEL 330 million will be directed to the financing of the credit guarantee scheme;

Expenses of the Ministry of Environment and Agriculture will increase by GEL 485 million, of which GEL 69 million will be spent on vintage support activities;

The Administrative Expenses will increase by GEL 115 million. Separately remuneration expenses will decrease by GEL 22 million, but the procurement of goods and services will increase by GEL 137 million. Compared to 2019, the Administrative Expenses will increase by GEL 308 million. As for separately remuneration expenses, it will increase by GEL 100 million;

The present budget expenses will decrease by GEL 547 million, of which GEL 454 million will be saved by three ministries: the Ministry of Regional Development and Infrastructure, the Ministry of Education, Science, Culture and Sports, and the Ministry of Defense;

The number of employees in budgetary organizations will remain unchanged -112,214 people will be employed.

According to the draft law, in 2020, the state budget expenditures will be GEL 15.9 billion, which is GEL 1.5 billion more than the current budget expenditures, and GEL 2 billion (15%) more than in 2019.

As a result of the amendments, the Current Budget Expenses will increase by GEL 1.7 billion, of which the largest part – GEL 1 billion - will be directed to social expenses. In 2020, a total of GEL 5.3 billion will be spent in this direction.

Due to the COVID-19, the overall expenses of the budget will increase by GEL 2 billion. However, the present budget expenses will decrease by GEL 547 million (5%), therefore, an additional burden for the budget will be up to GEL 1.5 billion. From the GEL 547 million-reduction of overall expenses GEL 200 million will be from Current Expenses, and GEL 347 million – from Capital Expenses.

The following public institutions made savings from the current budget:

Ministry of Regional Development and Infrastructure - GEL 251 million
Ministry of Education, Science, Culture and Sports - GEL 128 million
Ministry of Defense - GEL 75 million
Ministry of Economy and Sustainable Development - GEL 26.6 million
Ministry of Environment and Agriculture - GEL 15 million
Ministry of Finance - GEL 12 million
Ministry of Internal Affairs - GEL 10 million
General courts - GEL 8 million
Parliament - GEL 4 million
Ministry of Foreign Affairs - GEL 3 million
Government administration - GEL 1 million
Administration of the President - GEL 750 thousand
Other institutions together - GEL 12.6 million

83% of the savings comes from three institutions: the Ministry of Regional Development and Infrastructure, the Ministry of Education, Science, Culture and Sports, and the Ministry of Defense.

The Ministry of Regional Development and Infrastructure will reduce expenses on construction and rehabilitation of road infrastructure by GEL 117 million, of which GEL 86 million should have been spent on the construction of high-speed highways. Costs of renovation-rehabilitation of water supply infrastructure will be reduced by GEL 50 million. Expenses on the rehabilitation of regional and municipal infrastructure will decrease by GEL 44 million.

The Ministry of Education, Science, Culture and Sports will save GEL 53 million from sports funding programs, GEL 21 million - from culture funding, GEL 20 million - from general education reform and students transportation, GEL 18 million- from infrastructure development, and GEL 9 million - from higher and vocational education.

The Ministry of Defense will save GEL 15 million from current expenses, and GEL 60 million - from capital expenses, such as infrastructure development and purchase of military products including the anti-missile defense systems from France.

The Administrative Expenses of the state budget, which include remuneration expenses and procurement of goods and services, will increase by GEL 115 million (4%) and reach GEL 3,065 million. Separately remuneration expenses will decrease by GEL 22 million (1.4%), but the procurement of goods and services will increase by GEL 137 million (10%). This increase is due to the purchase of goods and services required for anti-COVID-19 activities. Compared to 2019, the Administrative Expenses will increase by GEL 308 million (11%).

According to the explanatory note of the draft law, the pandemic will increase expenses on goods and services by GEL 195 million, out of which GEL 44 million will be spent on quarantine space services, and GEL 151 million will be added to other health care expenses (tests, personal protection equipment, etc.).

The GEL 137 million-increase of the funding on procurement of goods and services raises questions, as this is the type of expenditure where the GoG should make significant savings. In addition, transportation and office expenses, as well as business trip expenses, were automatically saved over a period of several months due to switching to a remote work regime. It should also be noted that in 2019, GEL 81 million was spent on business trips from the item of goods and services, GEL 22.6 million was spent on representation expenses, and GEL 199 million was spent on office expenses. From the same article, GEL 242 million was spent on non-staff member contracted employees. This expense creates a separate problem in terms of budget transparency and the risks of nepotism.

Compared to 2019, remuneration expenses will increase by GEL 100 million, while the number of employees in budgetary organizations will remain unchanged -112,214 people will be employed. Transparency International Georgia also wrote about the increase in remuneration expenses when it assessed the initial state budget of 2020.⁵

Additional costs incurred as a result of the pandemic

As a result of the amendments to the state budget, the cost of social security will increase the most - by GEL 793 million. The largest part - GEL 525 million - of these funds will be spent on unemployment assistance. GEL 170 million will be allocated for subsidizing utility costs, and an additional GEL 61 million - for the socially vulnerable population. Assistance to people with special needs will rise by GEL 24 million.

Healthcare expenses will increase by GEL 393 million. More specifically, the costs of preventing the spread of the COVID-19 and healthcare will increase by GEL 285 million, and funding for the improvement of the health infrastructure will rise by GEL 60 million. The Universal Healthcare program expenses will increase by GEL 45 million and the annual budget of this program will be GEL 802 million. However, in 2019, the actual cost of the Universal Healthcare program amounted to GEL 829 million, and GEL 802 million probably will not be enough. This year, as of June 10, the cost of the program has already reached GEL 460 million.

As a result of the amendments to the state budget, an additional GEL 20 million will be allocated for the purchase of IDP homes.

Funding of the Ministry of Healthcare will increase by a total of GEL 1,154 million.

Funding of the Ministry of Economy will increase by GEL 485 million, of which GEL 330 million will be directed to the financing of the credit guarantee scheme, GEL 70 million will be spent on subsidizing hotels’ loans interest, GEL 20 million will be allocated for the small grants program. The same amount will be spent for the construction sector support activities. GEL 45 million will be allocated for quarantine services and air travel subsidies.

Expenses of the Ministry of Environment and Agriculture will increase by GEL 485 million, of which GEL 69 million will be spent on vintage support activities, including subsidizing the price of grapes. GEL 40 million will be spent on the farmers assistance program (GEL 200 per farmer). GEL 20 million will be allocated for the creation of food stocks and subsidizing prices of food products.

Due to the fact that the revenues of the autonomous republics and municipalities will be reduced this year, the total amount of transfers from the state budget will increase by GEL 85 million.

Data source: The Ministry of Finance

3. Budget deficit and government debt

Key Findings:

In 2020, the budget deficit will be GEL 4.3 billion, which is 8.4% of the projected GDP;

In 2020, the GoG will borrow more than GEL 8 billion, but at the same time will cover the previously taken debt of GEL 1 billion. As a result, government debt will increase by GEL 7 billion, of which GEL 1.8 billion will be domestic debt and GEL 5.2 billion will be foreign debt;

By the end of 2020, the government debt will reach GEL 27.6 billion, which is 54.8% (maximum of 60% allowed by law) of the projected GDP. The GoG will not spend GEL 2.5 billion from the taken debts this year;

The GoG plans to invest GEL 600 million, taken from the additional domestic debt, in the deposit certificates of commercial banks. This means that the GoG subsidizes commercial banks. At the same time, the GoG fulfills the function of the National Bank - to provide liquidity to commercial banks;

Georgia's international partners have allocated GEL 4.5 billion to finance the deficit caused by the pandemic.

The GoG planned to increase the budget deficit and public debt for 2020 from the very beginning (at the end of 2019). In fact, that budget was partly motivated by 2020 parliamentary elections and Transparency International Georgia wrote about that in October last year.⁶ The GoG planned to take the record-high public debt of GEL 3 billion, in 2020, making the country’s fiscal system more vulnerable to the sudden economic crisis caused by such factors as a pandemic.

According to the proposed draft law, the operating balance⁷ of the 2020 state budget is planned at the level of GEL 2.3 billion, while in the current budget for 2020 this number is only GEL 380 million. A significant deterioration in the operating balance was due to a decrease in tax revenues and an increase in costs. Negative operating balance is not desirable for sustainable long-term economic growth and can only be used to mitigate short-term losses cause by COVID-19.

The deterioration of the operating balance will lead to the worsening of the total budget balance.⁸ In 2020, the negative total balance of the budget will be GEL 4.3 billion, while in the current budget it is planned to be GEL 1.2 billion. The total negative balance of the budget will be 8.4% of the GDP projected for 2020. In the current budget, the similar figure is 3.2% of GDP. As for the 2019 budget, it stood at 2.9% of GDP.

It should be noted that under the Organic Law of Georgia on Economic Freedom, the ceiling of 3% of GDP is set for the total negative balance of the consolidated budget⁹ (the deficit under the Budget Code), not for the state budget. In 2020, the deficit of the consolidated budget will be GEL 4.2 billion, which is 8.3% of the projected GDP.

Since the balance of the consolidated budget is higher than 3% of GDP, the GoG is obliged to submit to the parliament a plan on how to return to the parameters defined by the law. The duration of the return plan should not exceed 3 years. The plan is presented in the basic economic and financial indicators document, according to which, the deficit of the consolidated budget will be 4.8% of GDP in 2021, 4% - in 2022, and 3% - in 2023.

The state budget deficit calculated by the traditional method¹⁰ will be GEL 4.5 billion (9% of GDP) in 2020. In the current budget for 2020, the traditional deficit is GEL 1.9 billion (3.6% of GDP). In the 2019 budget, it was GEL 1.4 billion (2.8% of GDP).

Data source: The Ministry of Finance

*Projected indicators are given for 2020

By the end of 2020, the government debt will reach GEL 27.6 billion, which is 54.8% of the projected GDP. As of May 31 of this year, the debt of the GoG was GEL 23.7 billion, which is about 47.5% of GDP.

Data source: The Ministry of Finance

*Projected indicators are given for 2020

Up to 77% of the Georgian government debt is foreign debt. Therefore, if GEL depreciates the foreign debt expressed in GEL and its ratio to GDP will increase. For instance, due to the depreciation of GEL, in January-April 2020, the government's foreign debt increased by GEL 1.9 billion.

Out of the GEL 7 billion borrowed in 2020, the GoG will not spend GEL 2.5 billion this year. The mentioned amount will be transferred to the budget remainder.

The GoG plans to invest GEL 600 million, taken from the additional domestic debt, in the deposit certificates of commercial banks, the purpose of which is to create long-term liquidity of GEL for them. The interest rate on the domestic debt will be higher than the GoG will receive from deposits. This means that the GoG subsidizes commercial banks. At the same time, the GoG fulfills the function of the National Bank - to provide liquidity to commercial banks.

While government debt is rising to 54.8% of GDP and the country’s fiscal system is becoming more vulnerable to future economic shocks, the GoG should refrain from taking additional GEL 600 million in domestic debt to subsidize commercial banks. Moreover, due to the instability of the GEL exchange rate, the government debt to GDP ratio may exceed 60% (which is the maximum debt ration allowed by the Law on Economic Freedom) by the end of the year. The government debt to GDP ratio of 54.8% is calculated at the GEL/USD exchange rate of 2.98. There is a risk of exceeding the ceiling of 60% of GDP even if the economy shrinks by more than projected 4%.

The GoG will spend part of the taken foreign debt in 2021, another part may also be used this year if the second wave of the COVID-19 starts and the economy is somewhat locked again. At the same time, foreign debt will serve other purposes apart from financing the budget deficit. Due to the decline in tourism, exports and remittances, Georgia will lose up to USD 3 billion in revenues from foreign sources, which, in addition to the shrunk economy, would put a lot of pressure on the GEL exchange rate. The increase in foreign grants and debt, coming in foreign currency, will play a significant role in stabilizing the GEL exchange rate.

In order to finance the deficit caused by the COVID-19, the Asian Development Bank (ADB) provided Georgia with the largest funding of GEL 1,455 million. Moreover, the German Credit Institute for Reconstruction (KfW) allocated GEL 885 million to Georgia. Other international partners have also provided significant assistance (see Figure 5).

________________________________________

¹ Receipts are the sum of revenue, disposal of non-financial and financial assets, and newly taken loans. It includes all funds that go to the budget while the revenue includes only tax revenues, grants and other specific sources of income.

² Legal Entity of Public Law

³https://stopcov.ge/en/Fund

⁴Expenditures are the sum of expenses, increase of non-financial and financial assets and repayments of previously taken loans. It includes any funds that go out of the budget, while the expenses include only funds spent for specific purposes, such as administrative, social, education, etc.

⁵ Draft 2020 State Budget of Georgia: Analysis and Recommendations, Transparency International Georgia, 25 October, 2019: https://transparency.ge/en/blog/draft-2020-state-budget-georgia-analysis-and-recommendations

⁶ Draft 2020 State Budget of Georgia: Analysis and Recommendations, Transparency International Georgia, 25 October, 2019: https://transparency.ge/en/blog/draft-2020-state-budget-georgia-analysis-and-recommendations

⁷ Operating balance is the difference between budget revenues and expenses

⁸ Total budget balance is the difference between the operational balance and change in the non-financial assets. If the total budget balance is negative the budget is deficient, if it is positive the budget has a surplus.

⁹ The consolidated budget is the sum of state, autonomous republican and local self-government budgets.

¹⁰ Since the total budget balance does not fully cover all budget revenues and expenditures, in the traditional sense, the budget deficit means how much the budget has been reduced by using new debt and budget remainder.

Tags: economics

Attached files:

ig-01-e-01.jpg ig-02-e-01.jpg ig-03-e-01.jpg ig-04-e-01.jpg ig-05-e-01.jpg