COMMISSION STAFF WORKING DOCUMENT  Ex-ante evaluation statement on further macro-financial assistance to Georgia Accompanying document to the   Proposal for a Decision of the European Parliament and of the Council providing further macro-financial assistance to Georgia
Date: 2011-01-13
Institutions: European Commission
Subjects: EU aid, Georgia, economic stabilisation, financial aid, financial cooperation

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EUROPEAN COMMISSION 

Brussels, 13.1.2011 
SEC(2010) 1617 final 

COMMISSION STAFF WORKING DOCUMENT 

Ex-ante evaluation statement on further macro-financial assistance to Georgia 

Accompanying document to the 

Proposal for a Decision of the European Parliament and of the Council providing further  

macro-financial assistance to Georgia 

COM(2010) 804 final 

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Ex-ante evaluation statement 

Further macro-financial assistance to Georgia 

TABLE OF CONTENTS 

1. 

PROBLEM ANALYSIS AND NEEDS ASSESSMENT _________________________________3 

1.1. 
1.2. 
1.3. 
1.4. 

INTRODUCTION ______________________________________________________________3 
GEORGIA'S MACRO-ECONOMIC SITUATION _________________________________________4 
IMF STAND-BY ARRANGEMENT AND OTHER DONOR SUPPORT __________________________7 
GEORGIA'S EXTERNAL FINANCING NEEDS __________________________________________8 

2.  OBJECTIVES AND RELATED INDICATORS OF THE MACRO-FINANCIAL 
ASSISTANCE _______________________________________________________________________9 

2.1. 
2.2. 

OBJECTIVES_________________________________________________________________9 
INDICATORS _______________________________________________________________10 

3.  DELIVERY MECHANISMS AND RISK ASSESSMENT _____________________________10 

3.1. 
3.2. 

DELIVERY MECHANISMS ______________________________________________________10 
RISK ASSESSMENT ___________________________________________________________11 

4.  ADDED VALUE OF EU INVOLVEMENT _________________________________________12 

5.  GENVAL CRITERIA ON MACRO-FINANCIAL ASSISTANCE_______________________13 

5.1. 
5.2. 
5.3. 
5.4. 
5.5. 

EXCEPTIONAL CHARACTER AND LIMITED TIMEFRAME _______________________________13 
POLITICAL PRECONDITIONS ____________________________________________________13 
COMPLEMENTARITY _________________________________________________________14 
CONDITIONALITY ___________________________________________________________15 
FINANCIAL DISCIPLINE _______________________________________________________15 

6. 

PLANNING OF FUTURE MONITORING AND EVALUATION_______________________16 

6.1. 
6.2. 

MONITORING_______________________________________________________________16 
EVALUATION_______________________________________________________________16 

7.  ACHIEVING COST-EFFECTIVENESS ___________________________________________16 

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1. 

PROBLEM ANALYSIS AND NEEDS ASSESSMENT 

1.1. 

Introduction 

The  EU  completed  in  early  August  2010  the  disbursement  of  a  EUR  46  million  macro-
financial assistance (MFA) operation to Georgia approved by the Council in November 2009. 
The assistance, which was provided in the form of grants, was part of a pledge of two possible 
EU  funded  MFA  operations  of  the  same  amount  made  by  the  European  Commission  at  the 
International  Donors'  Conference  of  October  20081.  The  approval  of  the  second  MFA  was 
conditional  on  the  continued  existence  of  external  financing  needs  over  and  above  those 
covered by the IMF arrangement.  

In a letter from 10 May 2010, the Georgian Minister of Finance requested the activation of the 
second  part  of  the  EC  pledge,  amounting  to  EUR  46  million.  In  this  context,  a  European 
Commission team visited Georgia in early September to assess the country's macroeconomic 
situation and prospects in 2010-11, focusing on the balance of payments and budgetary needs.  

The Commission considers that the activation of the second part of the MFA pledged in 2008 
is  warranted.  Although  the  Georgian  economy  is  recovering  (following  the  double  shock 
caused by the military conflict with Russia of August 2008 and the global financial crisis), the 
balance  of  payments  and  budgetary  position  remain  weak  and  vulnerable.  In  particular,  the 
lingering effects of the conflict with Russia, including the blockade of most direct trade with 
this country and the failure of foreign direct investment (FDI) inflows to recover to their pre-
crisis  level,  combined  with  a  still  very  sizeable  current  account  deficit  and  substantial  debt 
repayment obligations  (with  a serious bunching expected for 2012-14), leave the balance of 
payments fragile.  

In this context, the Commission proposes a further MFA to Georgia, amounting to EUR 46 
million.  The  EU  MFA  would  be  aimed  at  contributing  to  covering  the  country's  external 
financing  needs  in  2009-11,  as  identified  in  cooperation  with  the  IMF  in  the  context  of  the 
IMF  Stand-By  Arrangement  (SBA)  of  USD  1.17  billion,  in  place  since  October  2008.  The 
proposed assistance would be provided half in grants and half in loans. 

The  new  MFA  would  contribute  to  help  Georgia  to  address  the  lingering  economic 
consequences of the conflict with Russia and the global crisis. The new MFA will support the 
economic  reform  agenda  of  the  government.  It  would  reduce  the  short-term  financial 
vulnerability still faced by the economy, while supporting reform measures (including those 
in the IMF and World Bank programmes) aimed at achieving a more sustainable balance of 
payments and budgetary situation over the medium-term. The assistance would also promote 
policy measures to strengthen public finance management (building on those of the previous 
operation and of the EU's sectoral budgetary support operation), as well as measures to foster 
economic  and  financial  integration  with  the  EU,  in  particular  by  exploiting  the  potential 

1   The total assistance pledged at this Donors’ Conference by the EC amounted to up to EUR 500 million and 
was  aimed  at  supporting  the  Georgian  economy  in  the  aftermath  of  the  August  2008  armed  conflict  with 
Russia and in the context of the global financial crisis. 

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offered  by  the  future  Association  Agreement,  which  aims  at  concluding  a  Deep  and 
Comprehensive Free Trade Agreement (DCFTA)2 between the two parties. 

The proposed new MFA would be exceptional and limited in time and is intended to run in 
parallel to the SBA. It would complement support from international and bilateral donors. 

1.2. 

Georgia's macro-economic situation  

In the aftermath of the double shock of the military conflict with Russia of August 2008 and 
the global crisis, the Georgian economy is showing signs of recovery. Following two years of 
low or negative growth, 2010 is expected to see a revival of economic activity. While 2009 
saw  a  contraction  of  real  GDP  by  3.9%,  the  first  half  of  2010  recorded  a  strong  growth  of 
6.6% (on an annual basis). Manufacturing and transportation recorded the strongest increases, 
of 21% and 15% respectively. While the latest official projections and those included in the 
latest  IMF  Staff  Report  (issued  in  June  2010)  expect  real  GDP  to  grow  by  4.5%  this  year, 
VAT  turnover  data  for  the  first  half  of  the  year  suggest  that  growth  may  be  significantly 
higher (probably in the order of 6 to 7 percent). Despite the recovery gaining ground already 
in late 2009, economic growth has not yet been translated into an improved situation on the 
labour market. The unemployment rate remained at a worryingly high level of 16.9% in 2009. 

On the back of the economic recovery, the government has decided to tighten its budgetary 
and monetary policies. While the budget deficit reached 9.2% of GDP in 2009, the plan is to 
reduce it to 6.3% of GDP in 2010 and to 4.8% of GDP in 2011. However, there are reasons to 
assume  that  in  2010  an  even  higher  degree  of  fiscal  consolidation  can  be  achieved:  the 
authorities have introduced an explicit expenditure cap, which implies that a higher level of 
budgetary  revenues  would  be  translated  into  a  stronger  reduction  of  the  budget  deficit.  Tax 
revenues  in  the  second  quarter  of  2010  have  been  higher  than  what  the  last  IMF  review 
forecasted. Based on this trend, they could be at least 5% higher in 2010 than projected in the 
IMF  programme,  and  under  the  above-mentioned  cap  would  be  fully  saved,  resulting  in  a 
lower than programmed deficit. For 2011, the authorities are planning to reduce real spending 
by 3% relative to 2010. By 2013, the government aims at reducing the budget deficit to 3% of 
GDP, implying a reduction of at least 6 percentage points of GDP relative to the 2009 peak. 
Monetary  policy  began  to  be  tightened  in  the  summer,  with  policy  interest  rate  being 
somewhat increased, to keep inflation under control. This process is expected to continue. On 
the back of economic recovery annual CPI inflation is expected to pick up from its low of 3% 
at end-2009 to over 8% by end-2010. A further reason for the strong increase in inflation is 
the  fact  that  almost  half  of  the  CPI  basket  in  Georgia  consists  of  food  items,  so  that  recent 
increases  of  cereals  prices,  especially  those  of  wheat,  previously  imported  from  Russia,  are 
expected  to  feed  into  the  higher  CPI.  For  the  years  2010-2012,  the  monetary  authorities 
foresee a target average inflation rate of 7%. 

While  the  economic  recovery  seems  to  be  taking  hold,  the  economic  situation  remains 
vulnerable  as  the  financing  of  the  large  current  account  deficit  remains  uncertain.  Although 
the  crisis,  by  weakening  domestic  demand,  contributed  to  a  halving  of  the  current  account 

2   While negotiations on the Association Agreement were launched in July 2010, negotiations on the Deep and 
Comprehensive Free Trade Agreement have been delayed due to insufficient progress in key trade-related 
reforms.  Significant  progress  by  Georgia  in  implementing  the  EC's  key  recommendations  in  the  areas  of 
technical barriers to trade, competition policy, food safety and intellectual property rights is a precondition 
for the launching of negotiations. 

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deficit in 2009 (from 22.7% in 2008 to 11.7% of GDP), the deficit remains very large. The 
current  account  deficit  is  projected  to  reach  12.0%  of  GDP  in  2010  and  the  situation  is  not 
expected to improve in 2011. The trade deficit, which is projected to reach 22.8% of GDP in 
2010,  is  the  main  driver  of  the  large  current  account  deficit.  The  sharp  contraction  in  the 
country's industrial and agricultural exports caused by the global crisis was reinforced by the 
trade embargo on some Georgian products imposed by Russia in 2006 and extended in 2008. 
Georgian exports to the EU countries have remained low and the possibilities offered by the 
GSP+  remain  under-exploited.  While  a  certain  trade  re-orientation  and  changes  in  export 
profile  have  recently  taken  place,  Georgia's  exports  continue  to  lack  diversification:  three 
quarters  of  exports  in  the  first  quarter  of  2009  were  mineral  products,  including  metals. 
Overall, Georgian export performance remains far below its potential.  

Table 1: Georgia – Selected macroeconomic indicators, 2008-2012 

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In 2008, when the Georgian current account deficit was practically the double of its current 
size,  Georgia  experienced  much  higher  net  inflows  of  FDI  (amounting  to  USD  1.5  bn)  that 
allowed financing about half of the large current account deficit. During the crisis of 2008-09, 
the  inflows  of  public  sector  financing,  including  the  financial  support  of  International 
Financial Institutions and bilateral donors, partially replaced the decreased FDI inflows. But, 
for 2010-11, the financing of the current account is still uncertain. FDI inflows, which were 
expected to recover, are now projected to decline even further in 2010. FDI inflows reached a 
meagre USD 75 million in the first quarter of 2010 and their moderate recovery of the second 
quarter (when they attained USD 200 million) will not allow them to reach even their 2009 
level  of  USD  750  million.  Only  slow  recovery  in  FDI  inflows  is  expected  in  2011.  This 
disappointing performance of FDI inflows puts at risk the financing of the current account and 
the  build  up  of  international  currency  reserves  and  shows  that  foreign  investor  confidence, 
which experienced a dramatic blow due to the military conflict with Russia in 2008, has still 
not returned. It also reflects the loss of steam of the privatisation process as many of the most 
attractive  state  companies  and  assets  have  already  been  sold.  At  the  same  time,  the  official 
donor  financing  agreed  at  the  2008  International  Donors'  Conference  has  largely  been 
disbursed  as  much  of  it  was  frontloaded.  This means that in 2010-2011  Georgia  will face a 
shortage of FDI inflows while public sector financing will partly dry up.  

By  December  2009,  international  reserves  had  recovered  from  a  trough  of  USD  1.5  billion 
reached during the crisis to USD 2.1 billion, or 4.1 months of the next year’s imports. Yet, in 
the course of the first half of 2010, the level of reserves decreased again. In the first half of 
2010, the monetary authorities intervened somewhat more actively in the exchange markets as 
depreciation  pressures  on  the  local  currency  were  considered  to  be  temporary.  However,  in 
June  2010  the  authorities  let  the  exchange  rate  to  depreciate  by  8%  against  the  USD.  Since 
then,  no  significant  depreciation  pressures  have  been  observed  and  the  authorities  could 
reduce  their  level  of  intervention.  By  the  end  of  September  2010,  the  level  of  gross 
international reserves held by the National Bank of Georgia was at USD 2.1 billion, which the 
IMF considers suboptimal in the medium term, particularly since it has partly been achieved 
by  borrowing  from  the  IMF.  Net  international  reserves  are  at  an  even  more  worrying  level, 
having  actually  declined  from  USD  850  million  in  September  2008  to  USD  740  million  in 
September  2010.  Moreover,  there  is  a  risk  that  the  higher  current  demand  for  the  local 
currency  experienced  since  July  proves  a  seasonal  phenomenon  as  stronger  capital  inflows 
related  to  the  tourism  receipts  and  remittances  inflows  might  dry  up  in  the  winter.  This,  in 
turn, could lead to renewed depreciation pressures on the exchange rate market. Thus, while 
currently the pressures on the exchange market seem to be absent, they might re-appear later 
during the year and in early 2011 when tourism receipts and remittances inflows subside due 
to their seasonality. 

Even  long  before  the  2008  crisis,  Georgia's  financial  system  has  been  characterised  by  a 
widespread dollarization. Despite a recent decrease in the level of dollarisation from its peak 
of  75%,  about  70%  of  bank  loans  are  still  held  in  foreign  currency.  This  contributes  to  the 
reluctance  of  the  monetary  authorities  to  let  the  exchange  rate  to  strongly  depreciate  as  the 
majority  of  loans  are  unhedged,  with  creditor  income  being  paid  in  local  currency.  To  re-
establish the effectiveness of the monetary policy tools of the NBG, monetary authorities have 
recently  taken  measures  to  promote  the  de-dollarisation  of  the  economy  and  have  reduced 
their level of intervention in the exchange rate market.  

A further vulnerability in the balance of payments relates to the high level of external public 
debt  and  a  significant  need  for  a  debt  roll-over  in  the  coming  years.  External  public  sector 
debt increased from only around 21% of GDP in 2008, to around 32% of GDP in 2009 and is 

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expected  to  reach  41%  of  GDP  in  2010.  While  the  majority  of  the  external  public  debt  has 
medium  and  long-term  maturities,  substantial  external  debt  repayment  obligations  will 
become due in 2012-15. Amortisations will rise markedly in 2013, when they are expected to 
amount  to  USD  750  million,  reflecting  the  repayment of the Eurobond of  USD 500 million 
issued in 2008 as well a substantial repurchases under the IMF’s Stand-By Arrangement. This 
is  expected  to  push  up  the  debt  service  on  medium-  and  long-term  public  debt  to  the 
equivalent of 40% of exports in 2013.  

1.3. 

IMF Stand-By Arrangement and other donor support 

In  September  2008,  the  IMF  approved  an  18-month  Stand-By  Arrangement  for  Georgia, 
worth  USD  750  million.  In  2009,  Georgia  drew  an  amount  equivalent  to  USD  410  million. 
During the third programme review, approved by the IMF Executive Board in August 2009, 
the  Stand-By  Arrangement  was  extended  until  14  June  2011  and  the  financing  package 
increased by about USD 424 million, bringing the total Stand-By Arrangement programme to 
USD 1.17 billion. In 2010, the IMF plans to disburse USD 446 million to Georgia, of which 
USD 298 million to the budget. The programme remains on-track: on 9 July 2010, the IMF 
Board  completed  the  sixth  review  of  the  IMF  Stand-By  Arrangement,  concluding  that 
performance under the programme has been broadly satisfactory. The Board granted a waiver 
for the non-observance of the end-June quantitative performance criterion on the floor on net 
international  reserves  of  the  central  bank  and  a  waiver  of  applicability  of  the  end-June 
performance  criterion  on  the  ceiling  on  cash  deficit  of  the  consolidated  government3.  The 
Board  welcomed  the  fast  pace  of  public  deficit  reduction  that  the  Georgian  authorities  are 
aiming  at  for  2010.  It  qualified  the  recent  tightening  of  monetary  policy  as  an  appropriate 
reaction  warranted  by  downwards  pressures  on  the  domestic  currency.  Despite  the  fact  that 
the  economic  recovery  is  gaining  strength,  the  Board  pointed  out  the  risks  associated  with 
weak FDI inflows. Overall, the Board concluded that Georgia is in a good position to meet the 
objectives of the programme, which are to secure macroeconomic stability and growth based 
on private sector financing and investment. The completion of the sixth review of the Stand-
By Arrangement allowed for an immediate purchase by Georgia of an equivalent of USD 74.8 
million.  

The  next  IMF  review,  which  combines  the  seventh  and  the  eight  reviews,  is  scheduled  for 
November 2010. Its successful conclusion will trigger a new IMF disbursement of about USD 
150 million at the end of 2010. In 2011, two further tranches, amounting to around USD 53 
million each, will be disbursed.  

The  World  Bank  has  also  been  actively  involved  in  the  rehabilitation  of  the  Georgian 
economy. The Country Partnership Strategy package endorsed in September 2009 envisages 
Bank Group financing of USD 740-900 million for the period of 2010-13. This includes the 
remaining IDA-15 financing, IBRD financing and IFC investments and lending. Development 
policy  lending  has  been  the  core  element  of  World  Bank  strategy  in  Georgia.  Following  a 
successful  track  record  of  reforms  under  8  Poverty  Reduction  Support  Operations,  a 
programmatic  series  of  three  Development  Policy  Operations  (DPOs)  is  currently  being 
implemented. The first DPO, amounting to USD 85 million, was launched in July 2009. The 
second DPO, of USD 50 million, was approved by the Board in July 2010. The DPO program 
series  aim  at  mitigating  the  economic  downturn  and  facilitating  recovery  and  preparing 
Georgia  for  post-crisis  growth.  They  promote  policy  and  institutional  reforms  in:  (i)  public 

3   Consolidated  government  is  defined  as  the  central  government,  local  governments,  extra-budgetary  funds 

and Legal Entities of Public Law that provide general government services.  

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finances, including improving efficiency and effectiveness of public expenditures, and public 
investment; (ii) social protection, including targeting and scaling up of the safety net system, 
pensions,  and  improving  health  coverage  for  the  poor,  and  (iii)  specific  measures  to  further  
improve the investment climate, including policy reforms related to the modernisation of tax 
and customs administration. The third DPO, in the order of USD 25 million, is expected to be 
approved in the summer of 2011. 

The overall support package for 2008-2010 pledged by the international donor community at 
the 2008 Donors' Conference amounted to USD 4.5 billion, including USD 1 billion from the 
USA, USD 200 million from Japan, USD 173 million from the EU Member States and USD 
2.4  billion  from  the  Multilateral  Financial  Institutions.  The  total  public  sector  commitment 
amounted to USD 2.6 bn and the disbursements related to this commitment have been largely 
frontloaded.  According  to  the  recent  progress  report  of  the  United  Nations  and  the  World 
Bank on Georgia's Joint Needs Assessment, for the period from October 2008 to March 2010, 
donor commitments related to the general budget support have been honoured to 91%4.  

1.4. 

Georgia's external financing needs 

Table  2  below  summarises  Georgia's  external  financing  needs  for  the  period  2009-11.  The 
current  account  deficit  is  projected  to  remain  very  large,  amounting  to  about  between  12% 
and  13%  of  GDP  in  both  2010  and  2011.  Projected  net  inflows  in  the  capital  and  financial 
account,  which  were  very  negatively  affected  by  the  crisis  and  its  aftermath,  would  only 
partly cover this difference. This reflects in part, as noted, developments in FDI, which after 
having declined in 2009-10, are expected to recover only gradually in 2011 due to lingering 
political uncertainties and the loss of steam of the privatisation process. Moreover, consistent 
with  the  IMF  programme,  a  targeted  rebuilding  of  official  foreign  exchange  reserves  is 
assumed.  

All this leaves considerable external financing needs, to be covered by exceptional financing 
from  the  IFIs  and  bilateral  donors.  Based  on  the  estimates  provided  by  the  IMF,  total 
financing  needs  for  the  three  years  (2009-11),  excluding  those  covered  by  private  and  non 
crisis-related  official  inflows,  amount  to  around  USD  2.4  billion.  Out  of  this  amount,  the 
Breton  Woods  institutions  are  expected  to  provide  around  USD  1.5  billion,  including  some 
USD 900 million for the period 2010-11. The proposed new MFA would amount to EUR 46 
million and, together with the last MFA operation, would cover around 14% of the residual 
financing needs for the period 2009-11 (around USD 850 million).  

4   The  overall  disbursement  ratio  to  the  public  sector  was  of  44%  of  commitments.  The  disbursement  ratio 
ranged from 91% for budget support, 89% for the activities related to the internally displaced persons and 
12% for infrastructure. For the banking sector, the disbursement ratio was 66%. 

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Table 2: Georgia – External Financing Requirements and Sources, 2009-2011 

1 Current account balance1

Trade balance
Services
Income (net)
Net transfers1

2 Capital and financial account

         Capital account (net)
         Financial account
               Foreign direct investment (net)
               Private sector borrowing (net) (excl FDI)
               Public sector 1,2

3 Errors and omissions

4 Gross reserves (- increase)

5 Overall financing needs (1+2+3+4)

6 Exceptional IFI financing

IMF purchases
World Bank (gross)

7 Residual financing gap (after IMF/WB)        

Financing of the gap
     ADB
     USA
     Other bilateral donors
     EU structural budget support (ENPI)

     EU MFA                                                         
          New proposed MFA for 2010-11
          MFA approved in November 2009

Memorandum item
Total MFA as % of the residual gap for 2009-113

Sources: IMF staff projections and Commission's estimates

2009

2010

2011

   in million USD

-1.594

-2.661
426
-287
928

1.172

99
1.073
884
232
-43

0

-95

-517

227

106
121

-290

160
65
9
25

23
23

-1.378

-2.399
332
-150
839

1.090

180
910
765
-68
213

54

-616

-851

614

340
274

-237

105
19
12
78

15

15

-1.478

-2.591
364
-244
993

673

233
440
659
-149
-70

2

-205

-1.007

685

450
235

-322

149
26
32
46

    in million EUR 

54
23
31

14

1 Excludes crisis-related official grants and loans
2 Includes monetary authorities and general government. Includes repayments to the IMF.
3 Assuming exchange rate of euro vis-à-vis the US dollar of 1.3

2. 

OBJECTIVES AND RELATED INDICATORS OF THE MACRO-FINANCIAL ASSISTANCE 

2.1. 

Objectives 

The objectives of the proposed MFA operation are to:  

•  Contribute to covering the external financing needs of Georgia and to alleviating 

budgetary financing needs. 

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•  Support the fiscal consolidation effort and external stabilisation in the context of 

an IMF programme. 

•  Support  structural  reform  efforts  aimed  at  raising  sustainable  growth  and 

increasing the transparency and efficiency of public finance management. 

•  Facilitate  and  encourage  efforts  by  the  authorities  of  Georgia  to  implement 
measures  identified  under  the  EU-Georgia  ENP  Action  Plan  and  the  Eastern 
Partnership  so  as  to  promote  closer  economic  and  financial  integration  with  the 
EU, also in line with the plan to conclude a DCFTA between the two parties. 

2.2. 

Indicators 

The  fulfilment  of  the  objectives  of  the  assistance  will  be  assessed  by  the 
Commission, including in the context of the  ex-post  evaluation  (see below),  on the 
basis of the following indicators:  

•  Progress with macroeconomic and financial stabilisation, notably by assessing the 

degree of adherence to the IMF-supported programme. 

•  Progress with the implementation of structural reforms, notably the specific policy 
actions  identified  as  conditions  for  disbursement  of  the  assistance,  which  are 
included  in  the  aforementioned  Memorandum  of  Understanding.  Particular 
emphasis  will  be  put  on  the  implementation  of  measures  aimed  at  raising 
economic growth potential and improving public finance management.  

•  Progress  in  developing  economic  and  financial  integration  and  regulatory 

harmonisation with the EU. 

•  Progress  in  implementing  of  the  priorities  identified  in  the  EU-Georgia  ENP 

Action Plan and the Eastern Partnership.  

3. 

DELIVERY MECHANISMS AND RISK ASSESSMENT 

3.1. 

Delivery mechanisms 

The proposed new MFA would amount to EUR 46 million, consistent with the pledge the EC 
made  at  the  October  2008  International  Donors'  Conference.  Regarding  the  form  of  the 
assistance, the Commission proposes to disburse half of the envisaged amount in grants and 
the other half in loans.  

The  full  use  of  grants  in  the  previous  operation  had  to  be  understood  as  an  exceptional 
decision justified by the very difficult circumstances Georgia found itself in late 2008. Given 
Georgia’s level of development (as measured by its per capital income5) and debt indicators, 
and the recent improvement in the country's economic situation, it would not be reasonable to 

5   Georgia's per capita GDP was at EUR 1,774 in 2009, somewhat below Armenia's level of EUR 1921, but substantially 
above  the  level  of  Moldova,  the  poorest  among  the  Eastern  Partnership  countries,  with  per  capita  GDP  amounting  to 
EUR 1,091. 

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expect  the  full  amount  of  the  assistance  to  be  provided  in  grants.  The  blend  of  grants  and 
loans would also be justified when considering that Georgia has been a blend country for the 
World  Bank  since  January  2009.  For  the  upcoming  World  Bank  operations,  the  country  is 
expected to receive one third of the World Bank assistance in the form of the IDA lending, 
while two thirds of the assistance are expected to be provided on IBRD terms. At the same 
time, there are reasons to provide part of the assistance as a grant. Georgia's public debt trends 
remain a matter of concern. Also, in the OECD Development Assistance Committee (DAC) 
List of official development aid recipients, Georgia is positioned in the lower middle income 
country group. Furthermore, Georgia is scheduled to repay the last part of its debt towards the 
EU's6 previous MFA operations, amounting to EUR 13.6 million, in July 2011. Providing part 
of the assistance in the form of grant would help ensure a timely debt repayment towards the 
EU. 

MFA  is  an  untied  and  undedicated  macroeconomic  support  instrument,  which  helps  the 
beneficiary  country  meet  its  external  financing  needs,  and  may  contribute  to  alleviating 
budgetary financing needs. The funds would be paid to the National Bank of Georgia. Subject 
to provisions to be agreed in the Memorandum of Understanding, including a confirmation of 
residual budgetary financing needs, the funds may be transferred to the Treasury of Georgia 
as the final beneficiary.  

3.2. 

Risk assessment 

There  are  fiduciary,  policy,  repayment  and  political  risks  related  to  the  proposed  MFA 
operation.  

There is a risk that the macro-financial assistance, which is not dedicated to specific expenses 
(contrary  to  project  financing,  for  example),  could  be  used  in  a  fraudulent  way.  In  general 
terms,  this  risk  is  related  to  factors  such  as  quality  of  financial  circuits  and  management 
systems in the central bank and the ministry of finance, administrative procedures, control and 
oversight  functions,  security  of  IT  systems  and  adequate  internal  and  external  audit 
capabilities.  

To mitigate the risks of fraudulent use several measures will be taken. First, the Memorandum 
of  Understanding,  the  Grant  and  Loan  Agreements  will  comprise  a  set  of  provisions  on 
inspection,  fraud  prevention,  audits,  and  recovery  of  funds  in  case  of  fraud  or  corruption. 
Also,  the  assistance  will  be  paid  to  a  dedicated  account  at  the  National  Bank  of  Georgia 
(NBG).  Moreover,  before  the  agreement  on  the  Memorandum  of  Understanding  is  reached, 
the  Commission  services  will  conduct,  with  the  support  of  external  consultants,  an 
Operational  Assessment,  in  order  to  assess  the  reliability  of  financial  circuits  and 
administrative  procedures  that  are  relevant  to  this  type  of  assistance  and  will  determine 
whether  the  framework  for  sound  financial  management  of  macro-financial  assistance  is 
sufficiently effective in Georgia. In the light of this assessment, specific mechanisms applying 
to the management of the funds by the beneficiaries may be introduced in agreement with the 
national authorities. The Commission may also use other assistance instruments at its disposal 
to  help  the  beneficiary  authorities  improve  their  public  finance  management  systems  if  this 
area  is  not  sufficiently  covered  by  other  donors.  Against  this  background,  special 
conditionalities  on  improving  public  finance  management  will  potentially  be  required. 
Finally, the assistance will be liable to verification, control and auditing procedures under the 

6    This is the last outstanding repayment related to the loan of EUR 110 million provided to Georgia in 1998. 

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responsibility of the Commission, including the European Antifraud Office (OLAF), and the 
European Court of Auditors. 

There is also a risk that the Government of Georgia will not comply with the IMF programme 
conditions, as the programme targets may turn out more difficult to reach than assumed and as 
political  conditions  in  the  country  may  change.  However,  the  authorities  have  so  far  shown 
strong commitment to work with International Financial Institutions to implement the reform 
agenda.  The  positive  experience  of  implementation  under  the  previous  MFA  operation  in 
Georgia bodes well in this respect. 

There  is  also  a  risk,  albeit  limited,  of  a  non-repayment  of  the  loan  component.  The 
macroeconomic  adjustment  and  reform  programme  supported  by  the  proposed  MFA 
operation and the IMF's Stand-By Arrangement should mitigate this risk, to the extent that it 
helps  restore  balance  of  payments  and  fiscal  sustainability.  Also,  the  provisioning  of  the 
Budget Guarantee Fund for external lending of the EU, in line with the rules  governing the 
Guarantee Fund mechanism, is aimed at addressing possible adverse implications related to a 
non-repayment of the loan.  

Consolidation of the democratic reforms and institutions is at the core of the EU’s relations 
with Georgia. There are some shortcomings in the independence of the judiciary and there is a 
need to strengthen a pluralistic media landscape. The ongoing process of constitutional reform 
is  encouraging  but  there  are  uncertainties  concerning  the  final  direction  that  it  will  take. 
National parliamentary elections are scheduled for 2012, while presidential elections are due 
in  2013.  Overall,  risks  of  political  instability  or  backtracking  of  democratic  reforms  remain 
manageable. Finally, a failure to find a peaceful resolution of the military conflict with Russia 
represents a significant political risk. 

Having made a thorough assessment of the risks, the Commission services consider that there 
are sufficiently strong grounds to proceed with the MFA to Georgia.  

The  Commission  services  will  maintain  close  contacts  with  the  authorities  during  the 
implementation  of  the  macro-financial  assistance  in  order  to  address  quickly  any  concerns 
that may arise.  

4. 

ADDED VALUE OF EU INVOLVEMENT 

Georgia is a strategically key partner country of the EU within the European neighbourhood. 
By helping the country overcome the economic shock caused by the conflict with Russia and 
the global crisis, the proposed MFA will contribute to promote macroeconomic and political 
stability  in  the  Eastern  Partnership  region  and  closer  economic  and  political  ties  between 
Georgia  and  the  EU.  By  complementing  the  resources  made  available  by  the  international 
financial  institutions  and  other  donors,  it  contributes  to  the  overall  effectiveness  of  the 
package of financial support agreed by the international donor community in the aftermath of 
the crisis.  

In addition to the financial impact of the MFA, the proposed programme will strengthen the 
government's  reform  commitment  and  its  aspiration  towards  closer  relations  with  the  EU. 
This result will be achieved, inter alia, through appropriate conditionality for the disbursement 
of  the  assistance.  By  emphasising  certain  reforms  that  are  of  particular  importance  for 

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promoting  regulatory  convergence  and  economic  integration  with  the  EU,  the  MFA 
contributes to the objectives of the EU-Georgia Action Plan.  

In  a  wider  context,  the  proposed  action  fits  well  into  the  EU’s  general  approach  towards 
Georgia, which is one of a stronger engagement, as reflected in the opening of negotiations on 
an Association Agreement, a key component of which will be the conclusion of the Deep and 
Comprehensive Free Trade Area.  

5. 

GENVAL CRITERIA ON MACRO-FINANCIAL ASSISTANCE 

In  October  2002,  the  Council  reconfirmed  a  set  of  principles  for  the  use  of  the  European 
Union's macro-financial assistance (Genval criteria)7. The five criteria are: (i) the exceptional 
character of the assistance, (ii) its complementarity to financing of the International Financial 
Institutions  (IFIs),  (iii)  the  existence  of  policy  conditionality  attached  to  the  assistance,  (iv) 
the existence of political pre-conditions and, finally (v) strong financial discipline that needs 
to accompany the MFA. 

5.1. 

Exceptional Character and Limited Timeframe  

The MFA under preparation will be exceptional and limited in time and will run in parallel to 
the IMF Stand-By Arrangement. Georgia’s financing gap in the balance of payments has its 
origin  in  the  loss  of  investor  confidence  as  a  result  of  the  armed  conflict  of  autumn  2008, 
combined  with  the  existence  of  a  large  current  account  deficit.  The  global  financial  and 
economic  crisis  brought  an  additional  layer  of  uncertainty  to  the  prospects  of  recovery  of 
Georgia’s  economy.  The  government’s  aim  has  been  to  attract  financing  from  the  IFIs  to 
boost public infrastructure investment in the short-term so as to maintain as much as possible 
economic  growth  until  private  capital  inflows  are  resumed.  However,  the  FDI  inflows  are 
expected  to  remain  subdued  in  late  2010  and  recover  only  slowly  in  2011.  Against  this 
background  and  given  the  expected  time  of  approval  of  the  programme,  the  assistance  is 
expected to be implemented during 2011. The disbursement of the first instalment could take 
place in the first quarter of 2011. The second instalment, conditional on a number of policy 
measures, could be disbursed in the third quarter of 2011. 

5.2. 

Political preconditions  

MFA is reserved to the third countries that are geographically close to the EU territory, that 
respect democracy and human rights and with which the EU has important political, economic 
and  commercial  ties.  Georgia  is  a  presidential  democracy  with  regular,  reasonably  fair  and 
free  elections.  Currently,  under  the  'second  wave  of  democratic  reforms',  the  State 
Constitutional Commission has prepared, as  part of an open and participatory process, a draft 
of the new Constitution with the aim of establishing a better system of checks and balances, a 
further separation of powers and a more independent court system. The new Constitution is 
expected to be adopted by the Parliament still this year. 

Georgia and the EU first established contractual relations in 1996 through a Partnership and 
Cooperation Agreement which entered into force in 1999. EU-Georgia relations have become 

7 Council conclusions of 8 October 2002 on MFA and the accompanying letter of the Council President to the 

Commission President. 

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closer  since  the  adoption  of  the  five-year  European  Neighbourhood  Policy  Action  Plan  in 
November 2006. Russia’s invasion of Georgia in August 2008 brought a sense of urgency for 
the need to enhance EU-Georgia relations. The EU, under the French Presidency, brokered a 
ceasefire and committed significant diplomatic efforts and financial resources to the delivery 
of immediate humanitarian aid and other assistance to the post-war recovery and continues to 
contribute importantly to the conflict resolution. An EU Monitoring Mission (EUMM) to the 
break-away regions of about 200 civilian observers has been deployed.  

The extraordinary European Council held in Brussels on 1 September 2008 decided inter alia 
to step up relations with Georgia. Negotiating directives for a future EU-Georgia Association 
Agreement that will replace the current Partnership and Cooperation Agreement were adopted 
by the Council on 10 May 2010. Negotiations started on 15 July 2010, while negotiations on a 
Deep and Comprehensive Free Trade Area, to be established in the Association Agreement's 
framework, will be launched once the necessary pre-conditions for it have been met. During 
the  Prague  Summit  on  7  May  2009,  close  EU-Georgia  relations  have  entered  a  new  phase 
with  the  launch  of  the  Eastern  Partnership  of  the  European  Union,  a  multilateral  project 
endorsed by the Heads of state or government of the 27 EU Member States and the six partner 
countries including Georgia. 

5.3. 

Complementarity 

The  proposed  MFA  would  supplement  the  assistance  being  provided  by  the  IMF  in  the 
context of the Stand-By Arrangement and by other donors, including the World Bank, helping 
to  cover  part  of  the  residual  balance  of  payments  financing  gap.  The  share  of  residual 
financing covered by the EU MFA would amount to 14% for the period 2009-11.  

Regarding the complementarity with other EU instruments, the EU package of assistance to 
Georgia  includes  programmed  funds  under  the  ENPI  envelope  and  crisis  instruments  (the 
Instrument for Stability, Humanitarian Aid and the Macro-Financial Assistance). The package 
also  includes  the  costs  for  the  EU  Civilian  Monitoring  Mission  in  Georgia.  Through  the 
programmed sectoral budget support, the ENPI envelope has so far supported reforms in the 
area of public finance management, criminal justice sector, vocational education and training 
and  regional  development.  For  the  period  of  2011-2013  a  new  ENPI  package  of  EUR  180 
million has been allocated.  

Project  finance  or  technical  assistance  would  not  be  suitable  to  address  the  macroeconomic 
objectives  of  the  MFA.  The  key  value  added  of  the  MFA  in  comparison  to  other  EU 
instruments would be to alleviate the external financial constraint and to help create a stable 
macroeconomic  framework,  including  by  promoting  a  sustainable  balance  of  payments  and 
budgetary situation, and an appropriate framework for structural reforms. By helping to put in 
place an appropriate overall framework for macroeconomic and structural policies, MFA can 
increase  the  effectiveness  of  the  actions  financed  in  Georgia  under  other,  more  narrowly 
focused  EU  financial  instruments.  This  positive  effect  is  reinforced  by  the  fact  that  MFA 
leverages its impact with the programmes of the IFIs, with which it is closely coordinated.  

The MFA is to be discontinued as soon as the country's external financial situation has been 
brought back into a sustainable path. Afterwards, regular EU assistance instruments are meant 
to take over, notably the direct budget support provided under the ENPI Regulation. 

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5.4. 

Conditionality 

As  usual  with  the  MFA  instrument,  the  disbursements  would  be  conditional  on  successful 
programme  reviews  under  the  IMF's  Stand-By  Arrangement  and  Georgia’s  subsequent 
decisions  to  draw  funds.  In  addition,  the  Commission  and  the  Georgian  authorities  would 
agree  on  specific  structural  reform  measures  in  a  Memorandum  of  Understanding.  In  the 
context of the previous MFA operations, the Commission services have worked closely with 
the  Georgian  authorities  on  public  finance  management  (PFM)  reforms  that  aim  at 
establishing  a  more  transparent,  coherent  and  accountable  PFM  system.  While  the  policy 
conditionality  of  the  last  MFA  operation  referred  exclusively  to  the  PFM  area,  in  the  new 
MFA  its  scope  would  probably  be  enlarged,  notably  to  measures  aimed  at  fostering  the 
economic  and  financial  integration  as  well  as  regulatory  harmonisation  with  the  EU  in 
selected areas, under the ENP Action Plan and taking into account the new context created by 
the plan to conclude an Association Agreement. Following the successful implementation of 
the  last  MFA  in  which  the  Georgian  authorities  demonstrated  the  political  will  and  the 
capacity to implement structural reforms, the Commission believes that also this second MFA 
operation  would  contribute  to  the  implementation  of  the  government's  agenda  of  structural 
reforms. 

5.5. 

Financial Discipline 

Regarding  the  grant  component  of  the  proposed  assistance,  aiming  at  the  adoption  of  the 
European Parliament and Council decision on MFA to Georgia in the last quarter of 2010, the 
commitment appropriations in the 2011 EU budget would be used to finance the MFA grant 
element. The planned appropriations on the MFA budget line (01 03 02)8 in 2011 are deemed 
sufficient  to  finance  a  grant  amount  of  EUR  23  million  to  Georgia,  subject  to  the  final 
decision of the budgetary authority. 

The  loan  component  of  the  proposed  assistance  would  be  financed  through  the  borrowing 
operation that the Commission will conduct on behalf of the EU. The budgetary costs of the 
assistance will correspond to the provisioning, at a rate of 9%, of the amounts disbursed in the 
Budget Guarantee  Fund  for external lending of the EU, from budget line 01 04 01 14 ("the 
provisioning of the Guarantee Fund"). Assuming that the loan disbursements will be made in 
2011 for the amount of EUR 23 million and according to the rules governing the Guarantee 
Fund mechanism, the provisioning will take place in the 2013 budget.  

To ascertain that the beneficiary has in place a sound financial management in line with the 
requirements  of  the  Financial  Regulation,  the  Commission  services  continue  regular 
monitoring and intend to conduct an Operational Assessment that would provide an updated 
report  on  the  reliability  of  financial  circuits  and  administrative  controls  at  the  Ministry  of 
Finance and the National Bank of Georgia since the last Operational Assessment (2005) and 
the joint WB-EU PEFA9 study (2008).  

8   Commitment appropriations amount to EUR 98.9 million in 2010 and to EUR 99.9 million in 2011. 
9   The  joint  Public  Expenditure  and  Financial  Accountability  (PEFA)  study  by  the  World  Bank  and  the 
European Commission gave detailed information on Georgia’s budget preparation and execution as well as 
on control and oversight functions. 

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6. 

PLANNING OF FUTURE MONITORING AND EVALUATION 

This assistance is of exceptional and macroeconomic nature and its monitoring and evaluation 
will be undertaken in line with the standard Commission procedures.  

6.1.  Monitoring 

Monitoring  will  involve  the  review  of  reports  and  data  provided  by  the  authorities  and  by 
review missions to Georgia by Commission staff. To monitor the fulfilment of the objectives 
of  the  programme  throughout  the  implementation  period  of  the  assistance,  the  Commission 
will use two types of indicators: 

•  Adherence 

to 

the  IMF-supported  programme, 

including  compliance  with 
macroeconomic performance criteria and structural reform benchmarks identified 
under  the  Stand-By  Arrangement,  as  reported  by  the  IMF  in  the  context  of  the 
regular review of the programme. 

•  Progress  in  the  implementation  of  structural  policy  indicators,  which  are  to  be 
agreed with the authorities of Georgia in a Memorandum of Understanding. In this 
process,  the  Commission  services  will  monitor  key  areas  of  the  public  finance 
management  system,  as  they  will  be  identified  in  the  update  of  the  Operational 
Assessment, so as to have the relevant information on any changes in the control 
environment. Ahead of the disbursement of the second instalment the authorities 
will  be  asked  to  submit  a  compliance  statement  in  relation  to  the  MoU  policy 
conditionalities.  In  addition,  under  the  MoU  monitoring  system,  the  authorities 
will  be  obliged  to  submit  quarterly  reports  of  certain  economic  and  reform 
indicators. 

Although  this  assistance  is  centrally  managed,  where  appropriate,  the  EU  Delegation  in 
Georgia will also be called to provide reporting. An annual report to the European Parliament 
and  to  the  Council  on  the  implementation  of  MFA  is  foreseen  in  the  proposed  text  for  a 
Decision of the European Parliament and of the Council. 

6.2. 

Evaluation 

Ex-post evaluations of macro-financial assistance operations are foreseen in the Multi-annual 
Evaluation Programme of the Commission's Directorate-General for Economic and Financial 
Affairs. An ex-post evaluation of the proposed macro-financial assistance to the Georgia will 
be launched within a period of two years after the completion of the operation. A provision 
for  the  ex-post  evaluation  is  included  in  the  proposed  Decision  for  the  assistance,  and  will 
also  be  included  in  the  Memorandum  of  Understanding.  Budget  appropriations  from  the 
macroeconomic assistance budget line will be used for this evaluation.  

7. 

ACHIEVING COST-EFFECTIVENESS 

The proposed assistance would entail a high degree of cost effectiveness for several reasons:  

•  First, since the assistance would be leveraged by that provided by the international 
financial  institutions,  with  which,  as  noted,  it  would  be  closely  coordinated,  its 
ultimate  impact  could  be  very  significant  compared  to  its  cost.  Moreover,  in 

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negotiating  specific  policy conditions,  the  Commission  will  be  able  draw  on  the 
expertise of those institutions, including the International Monetary Fund and the 
World  Bank,  and  to  influence  their  conditionality  as  well  in  ways  that  will  take 
into account the EU's views. 

•  Second,  part  of  the  assistance  would  be  provided  in  the  form  of  loans,  the 

budgetary impact of which is, in principle, more limited.  

•  Third, by providing a coordinated macroeconomic support to Georgia on behalf of 
the EU countries, the MFA would be more cost efficient than the provision of a 
similar total amount of financial support by EU Member States individually.  

•  In  addition,  the  Commission  will  aim  at  achieving  synergies  with  other  EU 
policies  and instruments (in  particular  ENPI as indicated above) used to support 
the  implementation  by  the  beneficiary  of  the  relevant  measures  (notably  in  the 
area  of  public  finance  management).  Where  appropriate,  links  to  related  actions 
under the European Neighbourhood Policy or Eastern Partnership and to findings 
of the ENP Progress Reports on Georgia would be established.  

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