world bank document · ldp - letter of development policy lti - large taxpayer inspectorate miga -...

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-73 16-GE

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ONA

PROPOSED THIRD STRUCTURAL ADJUSTMENT CREDIT

IN THE AMOUNT OF SDR 44.3 MILLION (US$ 60 MILLION EQUIVALENT)

TO

GEORGIA

June 4, 1999

This document has a restricted distribution and may be used by recipients only.in tperformance of their official duties. Its contents may not otherwise be disclosed with(World Bank authorization.

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CURRENCY EQUIVALENTS

(as of end-May 1999)

Currency Unit = LariUS$1 = 1.985 Laris

WEIGHTS AND MEASURES

Metric System

ABBREVIATIONS AND ACRONYMS

ADP - Agricultural Development ProjectCAS - Country Assistance Strategy

CERMA - Center for Restructuring and Management AssistanceCG - Consultative GroupCIS - Commonwealth of Independent States

EBRD - European Bank for Reconstruction and DevelopmentESAC - Energy Sector Adjustment CreditESAF - Enhanced Structural Adjustment FacilityESW - Economic and Sector Work

EU - European UnionFSU - Former Soviet UnionGDP - Gross Domestic Product

IBRD - International Bank for Reconstruction and DevelopmentIDA - International Development AssociationIFC - International Finance CorporationIMF - International Monetary FundLDP - Letter of Development PolicyLTI - Large Taxpayer Inspectorate

MIGA - Multilateral Investment Guarantee AgencyMSPM - Ministry of State Property Management

NBG - National Bank of GeorgiaNGO - Non Government OrganizationPOC - Permanent Oversight CommissionRTI - Regional Tax InspectoratesSAC - Structural Adjustment CreditSCD - State Customs Department

SD - Statistics DepartmentSDLM - State Department of Land ManagementSMIC - State Medical Insurance CompanySTDG - State Tax Department of Georgia

STF - Special Task ForceTBC - Tbilisi Credit BankTIG - Tbilisi Inspectorate of Georgia

VAT - Value Added Tax

GEORGIA'S FISCAL YEAR

January I - December 31

Vice President: Johannes Linm, ECAVPDirector: Judy O'Connor, ECCO3

_ Sector Leader Atman Aksoy, ECSPERe ible Staff: Leila Zlaoui, Task Manager, ECSPE

FOR OFFICIAL USE ONLY

GEORGIATHIRD STRUCTURAL ADJUSTMENT CREDIT

Credit and Project Summary

Borrower: Government of Georgia

Implementing Agency: Ministry of Finance

Amount: SDR 44.3 million (US$60 million equivalent)

Terms: Standard IDA, with 35 years maturity

Commitment Fee: A variable rate of 0.0-0.5% of the undisbursed credit balance, set annually by theExecutive Directors of IDA

Project ID Number: GE-PE-52153

Objectives: To support the implementation of the Government's reform program to reducemacroeconomic imbalances, and to provide an adequate incentive structure for theprivate sector development. The program includes measures to (i) strengthen the fiscalperformance while lessening the adverse impact of stabilization on the poor by ensuringbudgetary provisions for basic health care, education and social protection; (ii) improvelegislation and regulatory framework favorable to private sector growth; and (iii)complete the process of ownership change and market liberalization.

Benefits: The proposed credit would provide the Government of Georgia with financial supportto maintain the momentum of reforms and deepen the reform process in key areasessential to the sustainability of growth. The balance of payment and budgetary supportwould finance imports critical to economic activity and the rehabilitation of the capitalbase. The credit would ease the fiscal adjustment and enhance budgetary resources toallow provision of basic social protection.

Poverty: The credit is poverty-focused, and in line with the main conclusions of the recentlycompleted Poverty Assessment for Georgia would aim at reducing poverty bysupporting policies designed to (a) accelerate broad-based income growth, (b) improvethe quality of basic social services, and (c) sharpen the targeting of social assistance.

Risks: Three potential risks threaten the implementation of the program supported by thiscredit: (i) further deterioration of the political and security environment could distractGovernment attention from implementation of key reforms and worsen an already tightfiscal situation; (ii); special interest groups benefiting from the status-quo couldsucceed in delaying implementation of key fiscal or private sector developmentreforms; (iii) more generally, there is a significant risk of policy reversal if anti-marketforces start prevailing due to increased regional and political instability

This document has a restricted distribution and may be used by recipients only in the performance of their officialduties. Its contents may not otherwise be disclosed without World Bank authorization.

Table of Contents

I. Recent Developments and Economic Prospects .. 1.............................. A. Recent Developments ............................................................ 1B. Medium-Term Prospects and Financing Requirements .......................................... 4

II. Georgia's Adjustment Program ........................................................... 6A. Public Finance ........... , 7B. Private Sector Development ........................................................... 9

III. The Proposed Credit ........................................................... 13A. Rationale for the Credit ........................................................... 13B. The Proposed Credit and the Country Assistance Strategy ................................... 13C. Poverty Impact ............................................................ 19D. Credit Amount, Disbursement Procedures and Implementation Arrangements ............ 19E. Benefits and Risks ........................................................... 19

IV. Bank Operations ............................................................ 20

V. Collaboration with Other Donors ........................................................... 21

VI. Recommendation of the President ........................................................... 22

Annexes

Annex 1 Main Economic IndicatorsAnnex 2 Letter of Development PolicyAnnex 3 Policy MatrixAnnex 4 Schedule AAnnex 5 Schedule DAnnex 6 Country At A Glance

REPORT AND RECOMMENDATIONOF THE PRESIDENT OF THE IDA TO THE EXECUTIVE DIRECTORS

ON A PROPOSED THIRD ADJUSTMENT CREDITTO GEORGIA

1. I submit for your approval the following report and recommendation on a proposed creditto Georgia for SDR 44.3 million, the equivalent of US$ 60 million. The credit would be onstandard IDA terms with a maturity of 35 years including a grace period of 10 years. Thegovernment's program aims at restoring macroeconomic balance, and strengthening theenvironment for private sector-led growth.

2. The credit is a key element of IDA's country assistance strategy (CAS). Georgia'sadjustment effort is also supported by the International Monetary Fund (IMF) through a three-yearEnhanced Structural Adjustment Facility (ESAF) approved in February 1996 and whose thirdannual arrangement with access of SDR 55.5 million was approved on July 27,1998.

3. Georgia became a member of IBRD in August 1992, MIGA in December 1992, andbecame eligible for IDA terms in August 1993. It joined IFC in June 1995.

I. RECENT DEVELOPMENTS AND ECONOMIC PROSPECTS

A. Recent Developments

4. Georgia is a country of 5.4 million people in an area of 69,700 km2 bounded by Armenia,Azerbaijan, Russia, Turkey and the Black Sea. It is strategically located as a trade and transitcorridor in the Caucasus, between Europe and Asia. Georgia declared independence from theformer Soviet Union (FSU) in 1991. Its economy was highly integrated within the FSU whichaccounted for 86 percent of its external trade and most of its energy imports. Economic activityrevolved around Black Sea tourism; cultivation of citrus, fruits, tea and grapes; mining ofmanganese and copper; and a small industrial sector producing wine, metals, machinery, chemicaland textiles. It benefited from a highly educated labor force, a long tradition of entrepreneurship,substantial natural resources, a prosperous agricultural sector, and a significant undergroundeconomy.

5. The break-up of the ties with other FSU countries and widespread civil conflicts inAbkhazia and South Ossetia led to the collapse of the Georgian economy. Between 1990 and 1995,output fell by more than 70 percent as a result of disruptions in production, deteriorating terms oftrade driven mainly by sharp increases in energy costs, and shrinking domestic demand and exportmarkets. Capacity utilization in the industrial sector dropped to about 20 percent of its soviet timeslevel, heavy disruptions in agriculture took place and tourism was shut down. Significant externaldebt and payment arrears were accumulated, while lax fiscal and monetary policies led to largebudget deficits and hyperinflation.

6. Georgia entered the transition process with large macro economic imbalances and a heavylegacy of long term issues bound to be at the center of its development agenda for the decade tocome. The legacy from the soviet area and the subsequent economic collapse was marked by: (i) alarge, energy intensive, and highly inefficient enterprise sector; (ii) an energy sector drasticallyaffected by civil war damage, disrepair, financial collapse and improper operation; (ii) its road andport infrastructure- the backbone of its economy as a trade and transit corridor- heavilyhandicapped by lack of maintenance and investment and poor management. With hindsight,

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however, the most challenging legacy may have been the inadequate institutions lacking thecapacity needed for the transition to a well functioning market economy and the building of astrong developmental state and active civil society.

7. Cease fires agreements with South Ossetia in 1992 and Abkhazia in 1994 translated into anabatement of internal conflicts and allowed the Government to embark on a comprehensive reformprogram to rebuild the economy, with significant World Bank and IMF support. The Governmentprogram relied on strict monetary control, reform of the tax system and sharp reduction insubsidies, liberalization of prices, reform of the foreign exchange and trade regimes, reform of thebanking sector, and the maintenance of a minimal social safety net (see Box I below).

Box 1: Main economic reforms since 1994

The reform program launched in 1994 has brought about substantialmacroeconomic stabilization and moved the system towards a marketeconomy:* Exchange rate: for all commercial transactions, the exchange rates of

the Lari are negotiated freely between the banks, foreign exchangebureaus and their customers.

* Price and trade liberalization: Most prices were liberalized except forgas, electricity, some transportation and communication services andpharmaceutical products; abolition of export taxes, quantitativerestrictions on imports and most licensing requirements.

* Tax reform: rationalization of the tax system through the introductionof a VAT at 20 percent, a two rates custom duty at 5 and 12 percent, theunification of multiple corporate profit tax rates at 20 percent and areduction in payroll taxes from 35 to 33 percent.

* Public spending: Elimination of over 20,000 budgetary positionsbringing an overall employment reduction in the public sector of about40 percent; improved targeting of social benefits; reforms in theprovision of health and education services.

* State enterprises; enactment of a privatization law, corporatization andprivatization of over 13000 enterprises.

* Banking system: ; upgrading of prudential regulations and regulatoryframework and implementation of a comprehensive consolidation andrestructuring program which reduced the number of commercial banksfrom 225 in 1995 to 44 by end-98.

* Legal and regulatory frameworkfor private sector development:enactment of Tax and Custom codes; Law on customs tariffs; Law oncommercial banks; Law on entrepreneurs; Civil Code; Law onmonopoly activity and competition; Law on Bankruptcy; Law onagricultural land ownership; registration and leasing.

8. The program of structural reforms launched in 1994 and the accompanying fiscal andmonetary policies implemented by the Government were successful in restoring growth anddrastically improving internal and external imbalances. Following four years of deep recession, realGDP growth resumed in 1995 and exceeded 10 percent in 1996 and 1997. Inflation which at itspeak reached 6500 percent was brought to single digit level by 1997. The fiscal deficit was reducedfrom 20 percent of GDP in 1994 to 4.6 percent in 1997 and the current account deficit from 35

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percent of GDP in 1994 to about 11 percent in 1997. The exchange rate which was used as anominal anchor against inflation remained broadly stable against the dollar until mid 1998.

9. The situation deteriorated in 1998 as a result of internal security problems, a weak fiscalstance and the external shock from the Russian crisis. The fiscal outlook changed with theemergence very early in the year of serious difficulties due to a variety of factors including delaysin introducing a number of policy measures to broaden the tax base, further aggravated by weak taxcollection (see para.25). Exacerbated by unaccounted for refugees expenditure and the devastatingimpact of the Russian crisis on the Georgian economy during the second half of the year, the weakfiscal stance of the first six months of 1998 culminated into a fiscal crisis. Unable to meet itsrevenue and expenditure targets, the Government undertook successive rounds of across the boardexpenditure cuts and, despite the cuts, accumulated large payment arrears in particular to the healthsector. Tax revenues remained consistently below targets, covering only 64 percent of currentexpenditures.

10. The eruption of the Russian crisis in August 1998 led to a strong appreciation of theGeorgian Lari (GEL) against the Ruble, boosting the competitiveness of Russian products,lowering the value in domestic currency of workers remittances and depriving Georgian exportersfrom their primary market - Russia accounted for 30 percent of Georgia's exports before the crisis.The volume of transit goods to Russia through Georgia is reported to have declined substantiallyand the payment system deteriorated sharply. Real GDP growth decelerated sharply from 11percent in 1997 to less than 3 percent in 1998 and exports which grew by a record high 26 percentin 1997 declined by nearly 3 percent in 1998. The external shock coupled with the adversedevelopments on the fiscal front made it clear that the prevailing exchange rate was not sustainableand led to an acceleration of currency switching from the GEL to the dollar intensifying thepressures on the foreign exchange market.

11. The response of the National Bank of Georgia to the external shock was to tighten monetarypolicy through a variety of measures to eliminate excess demand pressure in the foreign exchangemarket while pursuing a policy of intervention in support of a smooth and moderate depreciation ofthe GEL. The weak fiscal stance, however, and the continuing wave of effects from the externalshock undermined the credibility of Government policies. The NBG efforts to support the currencyled to large losses in foreign reserves which dwindled from the equivalent of two months ofimports before the Russian crisis to about two weeks by end-November.

12. By the end of the year, however the Government took major steps to correct the internal andexternal imbalances built-up in 1998. A set of revenue-enhancing measures were adopted inNovember (see para. 26). In early December, the NBG announced its decision to stop interventionand let the GEL float to reach a new equilibrium. Since then, the GEL has been fluctuating in therange of 1.8 to 2.6 GEL to the dollar, the midpoint of which represents a 65 percent nominaldepreciation vis a vis the dollar compared to its level before the Russian crisis.

13. Not surprisingly, overall economic performance in 1998 was weak. While real GDP growthwas strong during he first half of the year (8 percent compared to the same period in 1997), itdecelerated sharply during the second half. It is estimated now at 2.9 percent (less than half theoriginal target) for the whole year. The fiscal deficit (excluding grants) reached 4.9 percent of GDPagainst a target of 2.7 percent and the current account deficit rose to 12 percent of GDP from 10.9percent in 1997. Inflation which reached a record low 1 percent over the first 9 months roseconsiderably following the depreciation of the GEL, reaching 11 percent in December. Because theinflationary shock occurred by the end of the year, average inflation declined to 3.6 percent for1998 from 7 percent in 1997.

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14. In view of the weak macroeconomic performance in 1998, the mid-term review discussionsof the IMF third annual ESAF arrangement could not be completed and agreement was reached inJanuary on the implementation of a shadow program through end-April 1999. The main prioractions under the shadow program included expenditure arrears reduction, introduction of excisestamps on cigarettes consolidating the VAT and excise tax, expanding the coverage of the largetaxpayer unit, eliminating current tax discrimination against imported alcoholic beverages,adopting a 1999 budget consistent with the program's overall macroeconomic objectives,submitting to parliament a draft on licensing, and implementing Capital Assets ManagementEarnings and Liquidity (CAMEL) 4 and 5 related measures and minimum capital requirement forcommercial banks.

15. Economic developments during the first quarter of 1999 are encouraging. Monetary andcredit trends were broadly in line with the program targets. In its attempt to minimize the increasein inflation following the marked depreciation of the GEL towards the end of 1998 and early 1999,the NBG respected the credit ceilings with a reasonably large margin. In addition the NBGcontinued its policy of non-intervention in the foreign exchange markets. The target to expandcoverage of large taxpayers was met. The NBG continues to take appropriate steps to strengthenthe banking system.

16. The fiscal performance, however, although improving, remains weak. Following the sharpdepreciation of the Ruble, the difficulties in tax collection have been complicated by a redirectionof trade, increased smuggling and a larger share of imports from Russia through regions that areunstable politically and difficult to control administratively. Because of difficulties in collectingtaxes on imports (customs duties, excises and VAT), particularly on fuel imports, the target oncumulative tax revenue through April 1999 was missed by 15.5 percent. Although the cumulativetarget through end April is not reached the gap between actual collection and target is, however,narrowing rapidly. For the month of April alone, the target was missed by 5.7 percent. In view ofthe revenue shortfalls and with interest payments in excess of 20 percent of actual revenues, theGovernment has continued to accumulate expenditure payment arrears. Because of the continuedweakness in fiscal policy, the track record period for the mid-term review of the ESAF wasextended by two months, through June 1999, to ensure that the improvements in revenue collectionare sustainable.

B. Medium-Term Prospects and Financing Requirements

17. In the current context, the sustainability of the growth process hinges upon adequatemacroeconomic policies in response to the shocks stemming from the Russian crisis, furtherstabilization gains, further strides in the implementation of structural and institutional reforms, andthe mobilization of external resources on concessional terms to mitigate the crisis impact. In viewof the external shock to the economy, growth prospects for Georgia have diminished in the shortterm. Under the combined influence of a sustained implementation of the Government'sadjustment program and adequate level of external aid, the Georgian economy could, however,maintain real positive growth in the range of 2 to 3.0 percent over the next two years, beforeresuming a higher growth path.

18. Exports which grew by over 20 percent on average (in volume terms) in 1996-97 anddeclined in 1998 are expected to rebound slightly by about 3 percent in 1999. Although therealignment of the GEL end- 1998 is helping export industries to regain competitiveness, it will takeexporters some time to diversify away from the depressed Russian market, find new outlays fortheir products and build marketing channels. As for imports the sharp volume increase registered in1997 (41 percent) and 1998 (17 percent) was largely driven by investments for the construction andrefurbishment of the "early oil" pipeline connecting Azerbajan to the Black Sea. With the

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completion of the project in early 1999 and the consequent slowdown in pipeline-related imports,and as a result of the change in relative prices induced by the GEL depreciation, the volume ofimports is expected to decline by about 10 percent in 1999. The current account deficit excludingtransfers will decline to 10.4 percent of GDP from 12 percent in 1998.

19. Over the medium term, growth which so far was dominated by agriculture and trade, isexpected to become gradually more broadly based, with a higher contribution from other sectorswhich will benefit from the impact of the implementation of the Government program of structuralreforms. Hence, privatization is expected to enhance the efficiency of key infrastructure (transport,energy, telecommunications) with a trickle down effect on overall economic efficiency. In addition,the various ongoing initiatives aiming at reducing administrative interference (public sector and de-licensing reforms), establishing a sound legal and regulatory framework and strengthening thejudiciary are expected to positively impact the investment climate. As a result, the activity of smalland medium enterprises in the manufacturing and service sectors is expected to pick up, increasingthe contribution of these sectors to overall growth.

20. Real annual growth is expected to reach 4.5 percent per year on average starting from2002, supported by an increase of the investment ratio from 8 percent of GDP in 1998 to 16 percentby 2005. Most of the increase would result from rising private investment from 7 percent to 13percent of GDP, for a large part in infrastructure (pipeline, energy, telecommunications and ports).Public investment is expected to triple from 1 percent in 1998 to 3 percent in 2005, largelyfinanced by foreign assistance. The current account deficit (excluding transfers) will improve from12 percent of GDP in 1998 to about 4 percent in 2005. After a record low of 3.6 percent in 1998,average inflation is expected to reach 22 percent in 1999, reflecting the pass thru of the GELdepreciation and energy prices adjustment. Inflation is expected to stabilize at around 4 percent byend 2001.

21. Externalfinancing requirements. In view of the difficult external environment and aheavy debt burden, Georgia will continue to need substantial external concessional assistance andcapital inflows to finance its transition to a market economy and its poverty alleviation efforts.Georgia's stock of external debt to GDP increased sharply from 30 percent in 1996 to 44 percent in1999. The external debt service ratio increased from 12 percent in 1997 to 19 percent in 1999 andis expected to exceed 21 percent during the 2000-2002 period. Georgia's capacity to service itsexternal debt is substantially hampered by its fiscal difficulties and a heavy overall debt burden -with external and internal debt payments in excess of 30 percent of Government revenues in 1999.Domestic savings are not expected to turn positive until the year 2001. New rounds of bilateralreschedulings are therefore expected to bring down the external debt service to more sustainablelevels. Although at less than half its 1998 level following the completion of works related to theearly oil pipeline, direct foreign investment will remain an important source of financing in 1999(US$96 million) and afterwards. The bulk of the external financing, however will be providedthrough multilateral and bilateral concessional assistance. In 1999 the remaining gap is expected tobe closed through an increase in access under the ESAF by 10 percent of quota, a new successorESAF arrangement, and a possible restructuring of principal debt payments falling due toTurkmenistan.

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Georgia: Balance of Payments and External Financing, 1998-2001

1998 19991 2000 2001

Current Account (excl all transfers) -616.8 -453.2 -462.2 -459.3Exports 473.3 504.2 550.6 613.4Imports 1163.7 1040.0 1086.2 1168.6Services (Non-factor) -41.6 -28.3 -38.9 -22.4Net Factor Income 115.2 111.0 112.3 118.3

o/w interest due 44.7 49.7 51.2 55.0Capital Account d 315.2 227.5 194.9 143.8

Disbursements I 137.0 169.8 203.0 179.6O/w World Bank Group 73.4 106.2 77.4 81.0

Amortization 82.1 108.2 136.9 167.3Foreign Direct Investment 221.0 96.1 108.8 122.2Net other financing 39.4 69.8 20.1 9.3

Overall Balance -301.6 -225.7 -267.2 -315.5Financing Items 301.6 150.8 142.3 157.2

Private Transfers 137.3 124.4 129.0 134.0Official Grants 73.4 97.7 61.41 56.0Change in Net Reserves ( - increase) 90.9 -71.3 -48.1 -32.8

Change in Gross Reserves 54.9 -94.6 -20.6 -15.9IMF (net) 36.0 23.3 -27.5 -16.9

Financing Gap 0.0 74.9 124.9 158.3

II. GEORGIA'S ADJUSTMENT PROGRAM

22. The previous generation of reforms (as outlined in Box 1 p.2 ) addressed the short termstabilization issues, the economic policy requirements and the legal and regulatory basis for a wellfunctioning market economy. This program made a significant stride on the structural policyagenda mainly by pushing the transfer of productive assets from the state to the private sector, andinitiated the long term process of institutional transformation. While the response of the economyto the reform package was impressive, the recent economic developments underscore the fragilityof Georgia's recovery and pinpoint to the major development challenges the country now faces. Inorder to achieve macroeconomic stability, maintain high economic growth and improve livingconditions, Georgia needs to intensify the process of building strong fiscal institutions, it needs tostreamline the interface between the administration and the private sector and establish a wellfunctioning network of physical infrastructure.

23. The Government's adjustment program aims at addressing this agenda. The program'sfocus is on: (i) strengthening public finance including adequate provision of health and educationservices and better targeting of social assistance programs and (ii) fostering an environmentconducive to sustained private sector investment and growth by focusing on the businessenvironment, state divestiture from the enterprise sector and enhancing the efficiency of keyinfrastructure. The proposed SACIII and Energy Sector Adjustment Credit (ESAC) support theGovernment program.

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A. Public Finance

24. Fiscal consolidation was a key element of Georgia's macroeconomic stabilization. At thestart of the stabilization process, with revenues at about 4 percent of GDP, the fiscal adjustmentwas achieved thanks to a drastic reduction of public expenditure (from 23.5 percent in 1994 to 12.3percent in 1995). Follow-up reforms have endowed Georgia with a tax regime characterized by alimited number of taxes, relatively low rates and low spread. The streamlining of the tax systemand the removal of most tax exemptions succeeded in bringing the tax revenue to GDP ratio closeto 9 percent by 1997.

25. The revenue gains allowed overall expenditure to rebound to over 14 percent of GDP, withmajor improvements in social sector spending, albeit from a very low basis. Over the last twoyears, however, the rate of revenue improvement, although still positive, has decreasedsubstantially. Revenues increased by 145 percent in 1996, 40 percent in 1997 and 13 percent in1998. This pattern reflects the major revenue and output recovery from a very low base in 1996 anda subsequent slow down mainly due to widespread evasion, weak and corrupt tax and customadministration and granting of tax advantages to powerful groups (such as producers or importersof wheat, flour, fuel cigarettes and alcohol). Faced with revenue shortfalls and increasing securityand refugee expenditure, the Government has started accumulating debt, salary and social sectorarrears, on a regular basis. The stock of arrears at end-December 1998 amounted to 140 millionGEL (2 percent of GDP). Three-quarter of the arrears have an immediate welfare impact. Wageand pension arrears represented 62 percent of the total and health arrears, 8 percent.

26. The Government recognizes that rapidly restoring public finances to a sound footing is keyto macroeconomic stability. On the revenue side, the Government objective is to boost internalrevenue mobilization under a fair and equitable tax regime with minimal economic distortions. Anumber of measures were introduced end- 1998 to improve revenue mobilization. They include,inter alia, the removal of VAT exemptions on imported wheat and domestically-produced flour, therestoration of the customs duty on natural gas and electricity to the standard 12 percent rate; anincrease in the excise rate to 60 percent for all petroleum products except mazout (previously onlygasoline was subject to the 60 percent rate); an increase in the VAT on bread to the standard 20percent rate; the elimination of VAT exemption for agriculture and the introduction of excisestamps on cigarettes and alcohol.

27. The Government is also aware of the need to strengthen the operational capacity of therevenue administration in order to fight evasion and corruption and broaden the tax base in asustainable manner. Over the last two years, the Govermment had embarked on a program ofmodernization of the State Customs Department (SCD) which collects custom duties, VAT andexcise on imports. The program focuses on institutional strengthening (review of staffing needs;internal reorganization; adoption of new procedures and controls), and improvement in physicalinfrastructure (computerization and improved communications; rehabilitation of facilities). Most ofthe benefits of the ongoing modernization program will take two to three years to fully be realized.In the short term it has allowed only for modest revenue increases.

28. In the short term, collection of customs revenues is still highly constrained by weak controlof customs territory; porous borders allowing for easy smuggling; massive tax evasion on excisablegoods; under invoicing of imports; weak enforcement capacity; splitting of consignment underpersonal exemption regime; and poor control of transit traffic. In view of these weaknesses, theGovernment has decided to complement the existing institutional strengthening program by hiringan internationally experienced contractor to carry out selected customs functions. For sustainabilitypurposes, an effective program of partnership and skills transfer between the contractor and theCustoms Department will be developed.

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29. Concerning the tax administration, the government past efforts concentrated on establishingor reorganizing tax institutions. Hence the Tax Inspectorate of Georgia and its regional branches,which collect most central and local government domestic taxes, were reorganized in 1995, and aLarge Taxpayer Inspectorate was established in 1996. To increase the efficiency of tax collections,the responsibility for the collection of payroll taxes was transferred from the Pension Fund to theTIG in 1998. The Tax Code of Georgia was constructed and is implemented. The TIG is nowbeing further reorganized along functional lines to separate out policy, management and controlfunctions, allowing for clear responsibility and performance delineation.

30. Although crucial for the establishment of sound fiscal institutions, this restructuring wasnot sufficient to sustain the high pace of revenue improvement registered in 1996-97. TheGovernment has now adopted an action plan to deal with the major weaknesses still plaguing thetax administration. The thrust of the action plan lays in measures to strengthen controls, enhancecoordination and information flows across revenue agencies; upgrade personnel skills, improve theinterface between the tax administration and the taxpayers, enhance management andaccountability and establish a system of sanctions and rewards to strengthen discipline whileimproving incentives. A special tax force of hand-picked tax inspectors has been established tooversee with support from donors the implementation of the action plan. The Government actionplan and implementation timetable are detailed in the Government Letter of Development Policy(LDP) and its attached matrix. In response to this package of tax policy and institutional measures,the tax revenue ratio is expected to rise from 8.9 percent of GDP in 1998 to 9.6 percent in 1999.

31. On the expenditure side, The Government's objective is to ensure that an expendituremanagement system that is efficient, transparent, and responsive to the stated expenditure prioritiesis in place. In the past, priority expenditures, such as those on health, education and povertybenefits have suffered from revenue shortfall, liquidity constraints and cash managementweaknesses. A reorganization of the Ministry of Finance along functional lines is underway tostrengthen the ministry's control over the management of revenue and expenditure. TheGovernment expenditure reform also includes measures to improve coordination between spendingministries, ensure strict control by the Ministry of Finance over total budgetary expenditures andintroduce management planning systems to improve the efficiency and effectiveness of alldepartments within the Ministry of Finance.

32. A new computerized system of revenue allocation has been introduced to give priority to thecore expenditure functions. All health, education and poverty benefits are core priorityexpenditures within the mandatory budgetary classification. As such, they are an integral part ofthe primary allocation of revenues collected every month. In the 1999 budget, the Government hasallocated to the education sector 13 percent of its overall consolidated budget, i.e., including centraland local budget outlays, the extrabudgetary funds and the State Medical Insurance Company(SMIC). Government allocation to the health sector amounts to 7.3 percent of the consolidatedbudget.

33. In its continued effort to sharpen the targeting of social assistance programs and in linewith the results of the poverty assessment, the Government is increasing the poverty benefit to themost vulnerable group of the population, the poor single pensioners. The Government will maintainthe current number of beneficiaries but increase the benefit to a level sufficient to bring theirmonthly expenditure to the level of the minimum poverty line. In the 1999 budget 14.3 millionGEL have been allocated for the poverty benefit. This will allow to reach some 55000 applicantscurrently registered as poor single pensioners. The level of assistance will be 18 GEL per poorsingle pensioner and 29 GEL for two poor single pensioners living together. Overall transfers to thelocal governments will specify the amount allocated to health, education and poverty benefit.

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34. The restructured Treasury Department will complement the budgeting process by providinglinks - through its regional network, which will monitor actual expenditure against its intendedpurpose. Treasury departments will work with spending ministries and others to createaccountability trails so that the disbursement of revenues can be tracked to the point of expenditure.To that purpose, the Treasury will require spending ministries and others relevant entities toprovide monthly/quarterly reports which will describe how much revenues was received and how itwas spent. The Government expenditure management action plan and implementation time tableare outlined in the Government Letter of Development Policy (LDP) and its attached matrix.

B. Private Sector Development

35. The Government's objective is to foster an environment conducive to private sectorinvestment and a diversification of the sources of growth. The key elements of the Governmentprogram are to (i) improve the investment climate and the environment in which businessesoperate; (ii) promote a dynamic land and real estate market; and (iii) pursue the enterpriseprivatization program especially in infrastructure.

B.1. Business environment

36. So far, the Government efforts to strengthen the private sector, have focused on theestablishment of a legal framework to foster enterprise governance and facilitate orderly entry andexit. The extensive legislative and regulatory framework established over the last four years coversareas as diverse as constitutional law, judiciary, business organization, bankruptcy, antimonopoly,property rights, natural resources and environment, and foreign investment.

37. Feedback from the business community in the context of an assessment to the constraints toprivate sector-led growth carried out in May 1998 reveals, however, disturbing trends. While themacroeconomic stabilization, the liberalization of markets and trade and the establishment of afairly comprehensive legal and regulatory framework have been instrumental in boosting privatesector activity and attracting foreign investment, a number of factors are now contributing todiscourage new entry, and greatly raise the uncertainty, risk and cost of doing business. Arbitraryinterpretations of laws and regulations, multiple licensing requirements and overlapping institutionsclaiming juridiction over various aspects of business activity, frequent and unjustified visits oflicensing or tax inspection teams, and complex business registration practices constitute a majorobstacle to the development of private activities.

38. Clearly, significant improvements to the business environment and to the interface betweenthe administration and the private sector are needed to reduce administrative hurdles andopportunities for rent-seeking by bureaucrats and creating a fair level playing field amongenterprises. In addition to measures to inject professionalism in the tax administration (see para.27), such improvement will require further simplification of business registration procedures, acomplete streamlining of licensing and transparent and fair public procurement.

39. Business registration procedures are in practice unnecessarily more complex thanprescribed by the law. Two steps that are not required by the law have been recently eliminated.These are the requirement to obtain a stamp/seal from the local police; the regulation of theNational Bank of Georgia prohibiting commercial banks to open new accounts for new businesseswithout a seal. In addition draft amendments to the Administrative Procedures Code have beensubmitted to the Parliament to eliminate the active role of the Statistics Department (SD). A reformof the licensing regime is underway. Key measures include (i) restricting licensing to a limitednumber of specified areas (e.g. where there is a direct, immediate and significant danger to the

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population), (ii) specifying a legal framework spelling out objective licensing criteria, (iii)simplifying the licensing process, (iv) assigning responsibility and establishing an institutionalmechanism to implement the recently enacted licensing law. In order to assess reform effectivenessand monitor progress, the government will undertake quarterly surveys measuring the licensingburden.

40. A modern and transparent state procurement system is critical to support the on goingeconomic reforms and the emerging private sector. It will enable development of the private sectorby providing suppliers a level playing field, besides reducing rent-seeking opportunities. Acomprehensive legal and institutional framework to regulate and manage state procurement isbeing established. The key steps involve (i) drafting and enacting a procurement legislation andpromulgating detailed regulations to enforce its provisions; (ii) adoption of a set of uniform countryspecific procurement documents and manuals; (iii) establishment of a procurement regulatory andoversight agency; and (iv) development of training material and delivery of workshops to introducethe new system.

41. The experience so far with private sector development in Georgia reveals a difficultinterface between the administration and the private sector as well as an important disconnectbetween laws and regulations and their actual implementation. There is a need for more systematicfeedback mechanisms to identify areas of administrative abuses, patterns of misconduct or moresimply gaps or weaknesses in existing regulations. Now that a substantial effort has been made inestablishing a legal and regulatory framework for business activity, the government main objectiveis to be able to monitor the investment climate, assess the quality of the business environment andrespond swiftly to major bottlenecks to the growth of the private sector. In order to establish moredirect lines of communication with the private sector, the Government has decided to enlarge theInvestment Council, chaired by the President and composed of high-ranking officials and membersof the Parliament, to include representatives of the private sector and CERMA an NGO whichsupports the development of the private sector. The enlarged Investment Council will meetquarterly to discuss business environment-related issues. The Government will prepare and discusswith IDA bi-annual reports on the issues facing the private sector and proposed measures toaddress them.

B.2. Land and real estate markets

42. The Government has designed a package of measures to promote land and real estatemarkets. These measures will also positively affect the development of the financial sector andfacilitate the process of enterprise restructuring. Until recently, the land surrounding privatizedenterprises was state property. In November 1998, the Government adopted a law on "Declarationof Private Ownership of Non-Agricultural Land in Use of Physical and Private Legal Person"which declares the land allocated to privatized enterprises, private legal persons and privatecitizens to be private based on existing sketches and documentation. Privatized land is beingregistered rapidly without additional surveying, after payment of a one-time fee. Under the newlaw, future privatization will include land as an integral part of the enterprise assets being sold. Sofar about 2500 companies have registered their land.

43. In order to stimulate the development of both real estate and financial markets, theGovernment will amend the law "On Administration and Disposition of State-Owned Non-agricultural land" to integrate features central for development of real estate markets. The revisedlaw will promote privatization over leasing and provide for the organization of future privatizationthrough a competitive process. In addition, the law will enhance transparency by carefully definingthe privatization mechanism and specifying the roles of the relevant public bodies including local

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self government, the State Department of Land Management (SDLM), the Ministry ofUrbanization and Construction, the Ministry of State Property Management.

B.3. Privatization

44. An assessment of the privatization process in Georgia was carried out in May 1998.Although Georgia has privatized about 10,000 small-scale and 1000 medium- and large-scaleenterprises, over three-quarters of the enterprise sector equity (as measured by its book value)remains in government's hands. The infrastructure sector had remained almost in its entirety in theGovernment portfolio and the privatization legislation excluded most of infrastructure from theprocess. Land was also excluded from the assets being privatized, considerably limiting the abilityof the enterprise sector to mobilize resources for restructuring. While progress was made indiversifying the privatization methods used, the process as a whole was characterized by a lack ofgenuine competition and low transparency, with a detrimental effect on privatization revenues, thebusiness environment and the performance of the enterprise sector. Inadequate treatment ofhidden liabilities was a major source of non-conclusion or ex-post undoing of transactions. Lowinterministerial cooperation, limited in house capacity and lack of professionalism have also takentheir toll on the speed and outcome of the privatization process.

45. Based on this assessment of past privatization experience, the Government has introduced anumber of modifications to the privatization legal and institutional framework. The newly enactedlaw " On Declaration of Private Ownership of Non-agricultural Land in Use of Physical andPrivate Legal Person." includes land as an integral part of the assets being privatized and the Lawon State Property Privatization has been amended to permit the privatization oftelecommunications; postal services; radio and television broadcasting; railways; water andsanitation systems; airports; gas distribution pipelines; ports; and roads. In addition, to providesufficient flexibility for structuring transactions, the ministry's regulations have been amended toeliminate maximum lease terms and minimum annual payments.

46. A Permanent Oversight Commission (POC) including the ministers of State PropertyManagement, Finance, and Economy; Presidential Advisor for Economic Reforms; and Chairmanof the Parliamentary Committee on Economic Reforms and Economic Policy has been created toenhance transparency and strengthen interministerial coordination and cooperation between theMinistry of State Property Management and line ministries. Because past tenders suffered frominsufficient time and support, the Government has modified tender procedures to give prospectiveinvestors up to 4 months to complete due diligence and develop investment proposals.

47. In addition, the Government has taken steps to limit the liability of new enterprise owners toamounts known at the time of the transaction and to discourage fraud while protecting rightfulcreditors. Lastly, the Govermnent has substantially increased its public information and marketingefforts. These now include regular advertisements in leading national newspapers, weekly pressconferences and in-depth interviews; television coverage; and information distribution on theinternet, to foreign embassies, and through Georgia's overseas embassies.

48. Private participation in infrastructure is a major element of the Government privatesector development program. In view of the difficulties the Government faces in imposingpayment discipline on both residential and industrial consumers, private management of keyinfrastructure and utilities is crucial to the imposition of hard budget constraints, reversing theprocess of capital erosion, bringing in new investment, ensuring adequate maintenance andimproving service quality. The main sectors involved are energy (power, gas and oil), water,telecommunications and transport.

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49. With support from the World Bank under the Energy Sector Adjustment Credit (FY99), theGovernment is implementing a program of reforms in the power oil and gas sectors aiming toenhance financial management, combat corruption, increase the availability of energy on asustainable basis, catalyze private investment, realize Georgia's pipeline transit potential, andupgrade environmental management. The program focuses on sector restructuring and privatizationand the establishment of adequate regulatory framework. A major step forward was achieved withthe recent privatization of the main power distribution company, Telasi. The World Bank is alsosupporting under a water sector project the corporatization of Tbilisi Water Utility (TWU), and thepreparation on the basis of the ongoing institutional study, of a strategy defining the regulatoryframework, the optimal form of participation of the private sector and a timetable forimplementation.

50. In the telecommunication sector, where substantial private investment has taken place, theGovernment objectives are to increase transparency in all telecommunication activities, strengthenanti-monopoly mechanisms, privatize the remaining assets and rejuvenate and expand local serviceand service to rural and under-served regions using market-based mechanisms. The Government ishiring internationally experienced advisors to assist with the definition of sector policy, regulatoryframework, and the privatization of the remaining state-owned assets.

51. The Government intends to sell its remaining 51 percent shares in GeorgiaTelecommunications (GT) and 75 percent of its shares in Georgia Electro Communications (GEC)by international competitive tender. In order to increase the attractiveness of these assets andenhance competition the Government has given GT and GEC the licenses for both domestic andinternational operations. It intends to obtain the services of an investment bank (by end-August1999) to assist in the privatization of GT and GEC and has already obtained the services of aregulatory advisor.

52. Regarding Poti Port, the Government objectives are to introduce modern seaporttechnologies, ensure sound operation, improve management skills, stimulate the transport marketand improve the quality of port services. The strategy involves the separation of commercialactivities and regulatory functions. In order to attract foreign investment and create a competitiveenvironment, the Government intends to establish joint-stock companies to be in charge ofoperation, development and financing of the main components of port activities. These companieswill lease corresponding pieces of infrastructure and their assets will be under majority privateownership. A new Port Authority will be created, acting as Landlord-port in charge of regulation,management of public properties and long-term planning. The Government will hire internationaladvisors to prepare and market the information memorandum, prepare and review biddingdocuments and assist in bids evaluation and negotiations with the potential investors.

53. As for medium and large non-infrastructure enterprises, the Government has made anassessment of the enterprises remaining in its portfolio in view of their privatization. TheGovernment's divestiture program covers 364 enterprises, divided into three "tiers." Tier I consistsof 29 State-majority enterprises that the Government wishes to privatize by tender. Tier II consistsof 31 State-majority enterprises that the Government expects to privatize through public auction.Tier III consists of mostly minority shareholdings in 304 enterprises, of which 236 were privatizedrecently.

54. A resolution unit has been established within the Ministry of State Property Management.The role of the unit, which will benefit from donor-funded technical advice, is to assess theviability of the major companies, and decide upon the most appropriate form of divestiture: (i)viable and suitable for tendering as is; (ii) partly viable but with substantial excess assets requiring

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a split of assets and liabilities between a viable part to be tendered and a non viable portion to beassigned for sale and settlement; or (iii) entirely non viable to be assigned for sale and settlement.

55. The Government has adopted a Statement of Intent on a Hospital Restructuring Programaiming at improving the efficiency and quality of health infrastructure and services. TheGovernment strategy envisages a significant reduction of publicly-owned facilities. Thecornerstone of the strategy is the sale at market prices of the real estate attached to excess capacityin the sector, and use of the resources thereby generated to upgrade and equip the remainingfacilities, train the personnel and cover restructuring costs such as severance payments to excesspersonnel. The action plan will be implemented in phases beginning in 1999.

III. THE PROPOSED CREDIT

A. Rationale for the Credit

56. Georgia's urgent need for adjustment financing is the result of a weak public financeperformance and the adverse impact of the crisis in Russia on Georgia's economy. TheGovernment has adopted a solid program aiming at strengthening the economy's capacity toovercome the current crisis and has started implementing key measures to regain control of thefiscal situation. Maintaining the reform momentum will depend among, other things, on externalfinancing support.

57. The proposed SAC would support the implementation of the Government's programdescribed above. Box 2 (page 14) presents the matrix of specific policy measures that theGovernment would have to implement prior to the release of the SACIII funds. The detailed reformprogram and the timetable is described in the attached Letter of Development Policy andimplementation matrix. (Annex 2 and Annex 3)

B. The Proposed Credit and the Country Assistance Strategy

58. The proposed credit supports the following priorities of the Bank's strategy in Georgia asspelled out in the September 1997 CAS (17000-GE): (i) consolidate the stabilization process bysupporting revenue performance, expenditure management and the provision of a limited range ofpublic services; (ii) strengthen and diversify the sources of growth by removing remaining barriersto private sector development, completing privatization, rehabilitating basic infrastructure andputting in place a sound regulatory framework; (iii) prevent a deterioration of the stock of humancapital and strengthen the safety net.

59. The policy reforms supported by SAC III are also necessary to the success of Bankinvestment operations. Strengthening the fiscal situation and protecting social sector expenditure iscritical to the success of the Health Project (FY96). Completing the process of land ownershipchange is needed for the success of the Agricultural Development (FY97), Municipal Developmentand Decentralization (FY98) projects. Creating an adequate framework for private participation ininfrastructure would help achieve the objectives of the Power Rehabilitation (FY97), Oil InstitutionBuilding (FY98) and Transport LIL (FY99) projects.

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Georgia: Third Structural Adjustment CreditMatrix of Specific Tranche Release Conditions

Policy Objectives Board Presentation Conditions Effectiveness Condition Second Tranche Conditions Third Tranche Conditions

MacroeconomicFramework

* A Program Monitoring * A macro-economic * Satisfactory * SatisfactoryCommittee composed of key framework consistent with macroeconomic macroeconomicofficials for each of the the Program objectives is performance (in particular performance (inprogram components has in place. This entails fiscal revenue and tax particular fiscalbeen established continued satisfactory arrears reduction targets) revenue and tax arrears

performance during the reduction targets)remaining of the trackrecord period with respectto monetary, credit andfiscal policy. Thefollowing key indicatorswill be closely monitoredin assessing that themacroeconomicframework is satisfactoryto IDA:

* Net domestic credit of thecentral bank and bankingsector's credit to theGovemment;

* Central bank policy withregards to exchange rateand foreign exchangeconditions;

* Revenue collection withparticular emphasis oncollection of excise taxes;

* Adequate match betweenrevenues and expenditure

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Policy Objectives Board Presentation Conditions Effectiveness Condition Second Tranche Conditions Third Tranche ConditionsProgress in achievingagreement on a programwith the IMF

Public Finance

Strengthen the Revenue * Adoption of reorganizationadministration decree for the STDG

* Job descriptions and newperformance monitoringsystems setting objectivesand performance targets,have been established formanagement and technicalstaff

Strengthen expenditure * Adoption of preparatory * Adequate execution of the * Adequate execution ofmanagement decrees for the 1999 budget the 2000 budget

reorganization of the * Adequate allocations to * Payment of allMinistry of Finance health, education and outstanding arrears to

* The Government has poverty benefit in the 2000 health education andincluded in the 1999 budget budget poverty benefit14.3 million GEL for the * Adoption of an overallpoverty benefit reorganization decree for

* The share of health the Ministry of Financeexpenditure amounts to 7.3percent of the consolidated1999 budget and the share ofeducation expenditureamount to 13 percent

* The monitoring mechanismfor the core socialexpenditures has beenestablished and is operating

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Policy Objectives Board Presentation Conditions Effectiveness Condition Second Tranche Conditions Third Tranche Conditions* Satisfactory execution of

health, education andpoverty benefit expenditures

Private SectorDevelopment

Improve the quality of * Enactment of a licensing law * Issuance of licensing * Satisfactorythe business satisfactory to IDA implementing regulations implementation of theenvironment * Enactment of a procurement satisfactory to IDA licensing reform

law * Undertake quarterly * Satisfactorysurveys to monitor implementation of thelicensing burden and new procurementimpact of licensing reform; regimeprepare action plan * Enactment of Lawsaddressing key issues and on Fees, Certificationsubmit the results to IDA and Accreditation and

* Adoption of implementing issue respectiveregulations on procurement implementationlaw satisfactory to IDA regulations

* Adoption of an institutional satisfactory to IDAstrengthening plan forcarrying out stateprocurement

* Satisfactoryimplementation of the newprocurement regime byselected central ministries

* Streamline business * Enact amendments to the * Submit to IDA bi-registration procedures by Administrative Procedures annual reportseliminating the requirement Code on eliminating summarizing the resultsto obtain a stamp/seal from requirement to visit SDS of the review of the

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Policy Objectives Board Presentation Conditions Effectiveness Condition Second Tranche Conditions Third Tranche Conditionsthe local police and other * Submit to IDA a report Enlarged Investmentadministrative entities; the summarizing the results of Council, and thedecree of NBG prohibiting the review of the Enlarged implementation of thecommercial banks to open Investment Council, main action plan to addressnew accounts for new issues discussed and action the issues identifiedbusinesses without a seal; plan to address themand the requirement to visitthe Statistic Department(draft amendments ofAdministrative ProceduresCode submitted to theParliament). Limit thenumber of signatures for theissuance on a tax ID numbertO one. Widely publcizethese changes in the media

Promote land and real * Land registration performed * Enactment of an amendedestatc markets for more than 3000 Law on Administration and

enterprises Disposition of State-owneda Submission to the Non-agricultural Land and

Parliament of amendments issuance of implementingto the Law on regulations satisfactory toAdministration and IDADisposition of State-ownedNon-agricultural Land,satisfactory to IDA

Private participation in * Amendments to the * Hiring of financial and e Recruitment ofinfrastructure privatization law legal advisor to assist in the financial/legal advisors

(satisfactory to IDA) privatization of for the implementation* Adoption of the key sets of telecommunication of the development

principles for enterprises; submission to strategy for Poti PortTelecommunication and IDA's non-objection a including structuringPoti-Port privatization satisfactory privatization concessionssatisfactory to IDA strategy and timetable and a arrangements for port

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Policy Objectives Board Presentation Conditions Effectiveness Condition Second Tranche Conditions Third Tranche Conditionsregulatory framework for operationsthe telecommunication * Offer for sale thesector telecommunication

* Submission to IDA's non- companies, Georgiaobjection a satisfactory Telecommunicationsdevelopment strategy and and Georgia Electroregulatory framework for CommunicationsPoti Port

Privatization of non- * Completion of zero-price * Submission of a report * Submission of ainfrastructure bidding for 244 companies demonstrating satisfactory progress reportenterprises * Establishment of a implementation of the non satisfactory to IDA's

Resolution Unit within the infrastructure privatization demonstratingMinistry of State Property program implementation of theManagement non-infrastructure

privatization program.(e.g., auctions resultsfor all enterprises inTier III have beenpublicized and Tier Iand II enterprises havebeen either privatizedor assigned to theResolution Unit)

Hospital restructuring * Agreement on the hospital * Initiation of the * Implementation of therestructuring program restructuring program in first phase of the

line with the steps agreed restructuring programupon with IDA and preparation of an

action plan satisfactoryto IDA for theimplementation of thesecond phase

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C. Poverty Impact

60. The focus of the proposed credit is in line with the main conclusions of the recentlycompleted Poverty Assessment for Georgia: (i) sustained economic growth and stablemacroeconomic performance have been central to poverty alleviation in the recent past and willremain crucial components of any poverty alleviation strategy; (ii) the Government's capacity totax and redistribute income will play a significant role in determining poverty outcomes in thefuture; (iii) a small but well targeted safety net can play an important role in reducing poverty. Theproposed credit will contribute to poverty reduction by supporting policies designed to acceleratebroad-based income growth, improve the quality of basic services and sharpen the targeting ofsocial assistance. Adequate allocations and spending on core social services will contribute toimproved basic health and education services. Reforms to boost the development of the privatesector will enhance growth prospects and increase job opportunities.

D. Credit Amount, Disbursement Procedures and Implementation Arrangements

61. The credit will be disbursed in three tranches in an amount equivalent to US$20 millioneach. The program was designed to emphasize actions taken prior to credit approval todemonstrate the Government's commitment to the program and set the stage for implementation ofkey follow-up steps.

62. The credit will follow the Bank's new simplified disbursement procedures for structuraladjustment operations. Thus disbursements will not be linked to specific purchases and they willbe no procurement requirements. Proceeds of the credit will be deposited by IDA in a CentralBank account at the request of the Borrower. If, after deposit in this Account, the Proceeds of thecredit are used for ineligible purposes (i.e., to finance items imported from non-members countries,or goods and services on the Bank's standard negative list), IDA will require the Borrower toeither: (a) return that amount to the account for use for eligible purposes; or (b) refund the amountdirectly to IDA. The credit administration will be the responsibility of the Ministry of Finance.Although an audit of the deposit account will not be required, the Bank reserves the right to requireaudits at anytime.

63. Implementation of the policy program will be monitored by an Inter-ministerial Committeechaired by the Advisor to the President on Economic Reforms. The committee will haveresponsibility for monitoring and evaluating progress under the various components of the programwith input from participating ministries and institutions. IDA will monitor implementation of theprogram through regular supervision missions, the committee's quarterly reports and continuousmonitoring by the resident mission.

E. Benefits and Risks

64. Risks. In view of the weak fiscal performance and the fragile political situation, theproposed credit presents several risks. With parliamentary elections scheduled for end 1999 andpresidential elections for 2000, electoral considerations could distract Government's attention fromits reform agenda. In addition, implementation of the program could suffer from increasingpolitical tensions and violence, worsening an already tight fiscal situation, leading to furtheraccumulation of wage and pensions arrears, and in return feeding even further discontentment.Also, interest groups favoring tax loopholes or a loose tax administration could succeed in derailingthe implementation of the fiscal program, as those favoring a biased business environment couldtry to derail the implementation of private sector development measures. More generally, there is a

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significant risk of policy reversal if anti-market forces start prevailing due to increased regionaleconomic and political instability.

65. Benefits. In our view, the proposed credit is essential to maintain the momentum ofreforms, deepen the reform process in areas that are key to the sustainability of growth and mitigatethe impact of the regional economic crisis on Georgia. The balance of payment and budgetarysupport would finance imports critical to economic activity and the rehabilitation of the capitalbase. The proposed credit would ease the fiscal adjustment and help protect basic socialexpenditure as public finance are gradually strengthened. Improvements to the businessenvironment would not only strengthen the capacity of the Georgian economy to respond to thecurrent crisis but also improve its image abroad at a time when investors are looking for saferemerging market niches. The economic team is fully committed to the reform program and awareof the social, economic and political stakes associated with a stable macroeconomic framework, anenvironment conducive to sustained growth and the need to improve the fiscal performance inorder to deliver an adequate level of basic social services to the Georgian people.

IV. BANK OPERATIONS

66. The Bank's assistance program in Georgia has combined policy-based lending withinvestment operations, technical assistance and Economic and Sector Work (ESW). Policy lendinghas supported macroeconomic stabilization, price and trade liberalization, and the initial phase ofstructural reforms, notably privatization, financial sector reform, and restructuring of theGovernment sector and social safety net. Support was provided under the Rehabilitation Credit(US$75 million approved in March 1995), the first Structural Adjustment Credit (SAC, US$60million approved in April 1996), and SACII (US$60 million approved in September 1997).Parallel technical assistance support was provided under the Institutional Building Credit (US$ 10million approved in July 1994), and two Structural Adjustment Technical Assistance credits(SATACs, US$5.0 and $4.8 million approved alongside the SACI and SACII operations).

67. Investment lending which began in 1994 has spanned a large number of sectors includingmunicipal infrastructure, transport, health, power, oil institution building, agriculture development,social investment, cultural heritage, environment and enterprise rehabilitation. All operations havebeen IDA credits and total commitments amounted to US$394.7 million, as of May 31, 1999.

68. Overall portfolio performance has been good and implementation progress ratingssatisfactory thanks to strong Government ownership and broad consultations with projectbeneficiaries and Government officials at the design stage. Due to fiscal difficulties, however,shortfall in counterpart funding have started affecting virtually all projects. We are working withthe Government on a plan to manage this situation, since if uncorrected these shortfalls willseverely delay project implementation, and in worst case lead to project suspension.

69. In addition to lending, the Bank has also assisted the Government's policy formulationprocess through ESW, including: a Country Economic Memorandum (CEM) and aMacroeconomic Update, a Transport Sector Review, an Agriculture and Food Sector Review, aPublic Expenditure Review, an informal Energy Sector Review followed by a Power PrivatizationStudy, an Education Sector Note, a Municipal Policy Note, and a Judicial Assessment. Aninformal note on the Constraints to (private sector led) Growth, a Privatization Assessment and anOverview of the Telecommunication Sector fed into the design of the proposed credit. DuringFY99, a Civil Service Assessment was completed and the following ESW initiated: a note onInstitutional Reform, a Financial Sector Review, an Education Sector Strategy, an AgricultureSector Update, a Pension Note, and a Health Financing Note.

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70. Institutional Development Fund (IDF) grants have been, or are being implemented insupport of Cultural Heritage, Decentralization of Municipal Management, preparation of a NationalEnvironmental Action Plan (NEAP), for strengthening of the Georgia Investment Center, forrestructuring of research and development organizations, and to assist in the development of publicprocurement procedures. Global Environment Facility (GEF) grants have also been given forbiodiversity protection, preparation of the NEAP, and for integrated coastal zone management.

71. Georgia joined IFC in June 1995. Over the last two years, IFC has worked closely withGeorgian partners and external sponsors to identify potential private sector projects. Totalapproved IFC investment to date is approximately US$45 million for five projects. The first IFCdirect investment in the Georgia Glass and Mineral Water Company was approved by the Board inMay 1997, and was followed by an investment in TBC Bank in February 1998. In July, 1998 IFCapproved an investment in the Ksani Glass Factory, and in August an investment in the Azerbaijan-Georgia Early Oil pipeline was approved, as was an investment in the Georgia Micro-enterpriseBank.

72. IFC's current active pipeline of possible investment projects include the Ninotsminda OilField, Tbilcombank, as well as possible projects in the tourism, health care, and agribusinesssectors. Investments related to transportation and power are also likely after privatization in thesesectors has progressed. In addition, IFC has offered to assist in the development of capital marketsby supporting the introduction of leasing, seeking to encourage the entry of Western banks, andmobilizing investors for a potential regional venture capital fund. In early 1998 IFC located a full-time officer in Tbilisi, which is expected to assist with the identification of investmentopportunities in Georgia.

V. COLLABORATION WITH OTHER DONORS

73. Cooperation with the IMF has been very active since early 1994. A three year ESAF wasapproved In February 1996 and Policy Framework Paper have been prepared jointly by the Bankand the IMF in this context. The third year annual ESAF arrangement was approved by the IMFBoard in July 1998.

74. To mobilize and coordinate external assistance, the Bank has organized ConsultativeGroup (CG) meetings for Georgia. A first full CG meeting was convened in November, 1994 tomobilize balance of payments financing to complement the IDA-financed Rehabilitation Credit andthe STF from the IMF. CG meetings were held in May, 1996 and November 1997 to mobilizequick-disbursing funds and investment financing.

75. The Government's capacity for donor coordination is growing, and the opening of theBank's Resident Mission in August 1996 helped in strengthening the Bank's role in in-country aidcoordination. Relations with bilateral and multilateral donors are good. The United States,Germany, Japan, Switzerland and EBRD are supporting jointly power sector reforms and acoordinated investment program. The Bank, EBRD, the EU and the Government of Germany haveworked closely on the banking sector

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VI. RECOMMENDATION OF THE PRESIDENT

76. 1 am satisfied that the proposed credit would comply with the Articles of Agreement ofIDA and I recommend that the Executive Directors approve it.

James D. WolfensohnPresident

by Sven Sandstrom

Attachments

June 4, 1999Washington, DC

Annex IPage I of 4

Georgia: Main Economic Indicators

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Real Growth Rate

GDP 2.4% 10.5% 11.0% 2.90/% 2.0% 3.5% 4.0%/6 4.5% 4.5% 4.5% 4.5%

Inflation (average) 162.7% 39.4% 7.1% 3.6% 22.0% 8.0%/e 6.0%/o 4.0% 4.0% 4.0% 4.0%inflation (end of period) 57.4% 13.7% 7.3% 10.6% 13.0% 7.00/ 4 4.0% 4.0% 4.0% 4.0% 4.0%

Exports (Merchandise) -12.9% 18.7% 25.9% -2.6% 3.1% 7.1% 9.2% 9.8% 10.1% 10.5% 10.9%Imports (Merchandise) -12.2% 9.7% 40.5% 16.8% -10.1% 2.8% 5.8% 4.9%/e 4.9% 5.0% 4.7%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

As % GDP

Exports 16.8% 11.2% 12.6% 13.8% 16.8% 15.4% 16.1% 16.8% 17.6% 18.5% 19.4%Imports 27.9% 18.9% 26.1% 28.0% 29.7/o 26.6% 26.6% 26.3% 26.0% 25.7% 25.6%Resource Balance -11.1% -7.8% -13.5% -14.3% -12.90/o -11.2% -10.5% -9.4% -8.3% -7.2% -6.2%

Current Account (Ineld Transfers) -7.5% -6.0% -7.2% -7.9% -5.3% -5.3% -4.9% -4.2% -3.3% -2.4% -1.6%Current Account (Excid Transfers) -14.0% -9.1% -10.9% -12.0% -10.4% -9.0% -8.4% -7.3% -6.1% -5.0% -4.0%

Domestic Savings -7.1% -1.8% -6.3% -6.4% -6.3% -2.4% 0.7% 2.9%/o 4.8% 7.9% 9.7%Investment 4.0% 6.0% 7.2% 7.8% 6.6% 8.8% 11.3% 12.3% 13.1% 15.2% 15.9%

o/w: Public 1.1% 1.2% 1.1% 0.9% 1.2% 1.4% 1.5% 1.8% 2.2% 2.8% 3.0%Consumption 107.1% 101.8% 106.3% 106.4% 106.3% 102.4% 99.3% 97.1% 95.2% 92.1% 90.3%

Government Revenue 7.1% 9.4% 9.8% 10.9% 11.2% 12.2% 13.7% 14.7% 15.5% 16.7% 17.9%o/w: Tax Revenue 4.7% 7.3% 8.6% 8.9% 9.6% 11.0% 12.0% 13.0% 13.8% 15.1% 16.3%

Government Expenditure 12.3% 13.90/o 14.5% 15.2% 13.0% 14.3% 15.7% 16.7% 17.3% 18.2% 19.1%Fiscal Deficit (Ineld Grants) -5.2% -4.5% -4.6% -4.3% -1.8% -2.1% -2.0% -2.0% -1.8% -1.5% -1.2%Fiscal Deficit (Excld Grants) -7.2% -5.7% -4.8% -4.9% -2.8% -2.6% -2.4% -2.3% -2.0% -1.6% -1.3%

Annex IPage 2 of 4

Georgia: Balance of Payments (millions of US dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Merclandise Exports (FOB) 362.8 417.0 493.5 473.3 504.2 550.6 613.4 687.0 770.4 866.3 978.1Nonfactor Services 121.8 93.9 167.9 232.1 230.7 240.3 268.0 301.9 340.2 379.1 421.1Exports ofGNFS 484.6 510.9 661.4 705.4 734.8 790.9 881.4 989.0 1110.6 1245.4 1399.2

Merchandise Imiports (FO3) 700.1 767.9 1052.4 1163.7 1040.0 1086.2 1168.6 1240.7 1315.2 1395.9 1490.3NonfactorServices 104.8 99.1 315.9 273.7 259.0 279.2 290.4 303.6 320.1 338.3 357.6Imports ofGNFS 804.9 866.9 1368.3 1437.4 1299.0 1365.4 1459.0 1544.2 1635.3 1734.3 1847.9

o/w: Energy 184.9 183.6 191.4 185.5 173.4 173,9 179.5 186.4 193.5 199.5 206.9

Resource Balance -320.3 -356.0 -706.9 -732.0 564.1 -574.5 -577.6 -555.3 -524.8 -488.9 -448.7

NetFactorIncome -84.8 -60.7 134.4 115.2 111.0 112.3 118.3 126.5 140.0 152.2 161.8Factor Payments 85.9 65.6 52.1 78.1 88.0 93.5 101.5 108.6 116.5 121.9 125.3

o/w: Interest 81.5 63.8 43.2 44.7 49.7 51.2 55.0 57.9 62.3 63.6 62.8o/w: Profit Remittances 4.3 1.8 8.9 33.4 38.3 42.3 46.4 50.7 54.2 58.2 62.5

Factor Receipts 1.0 4.9 186.6 193.3 199.0 205.9 219.7 235.2 256.5 274.1 287.1Private Transfers 0.0 0.0 103.2 137.3 124.4 129.0 134.0 140.0 148.0 153.0 160.0Official Tranisfers (Grants) 189.2 140.5 93.2 73.4 97.7 61.4 56.0 39.0 26.0 19.0 10.0

CurrentAccountBalancc(lncldTraiisfers) -215.9 -276.2 -376.1 -406.1 -231.1 -271.8 -269.3 -249.7 -210.8 -164.7 -116.9Current Account Balance (Excld T'ransfers) -405.1 -416.7 -572.5 -616.8 -453.2 -462.2 -459.3 -428.7 -384.8 -336.7 -286.9

Foreign Investment 6.3 54.4 236.3 221.0 96.1 108.8 122.2 140.3 160.8 170.0 180.0

Net Long-'lerm Loans -168.4 36.2 67.7 54.9 136.5 191.0 170.6 157.1 119.3 81.4 22.7Disbursements 100.0 120.5 122.9 137.0 244.7 327.9 337.9 340.9 218.5 180.1 138.5

o/w: GAP 0.0 0.0 0.0 0.0 74.9 124.9 158.3 172.1 58.6 26.5 -9.9Amortization 1/ 268.4 84.3 55.2 82.1 108.2 136.9 167.3 183.8 99.2 98.8 115.8

Change in Arrears 119.4 -346.7 -20.6 -69.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0Rescheduling 224.9 390.3 61.7 4.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other Capital Flows (inel errors & Omisions) 74.0 63.0 -30.2 104.2 69.8 20.1 9.3 7.4 3.8 2.3 0.0

Change in Reserves (- = increase) -115.2 -1.5 -15.1 54.9 -94.6 -20.6 -15.9 -22.6 -28.8 -36.8 -40.1IMF Credit 75.0 80.5 76.3 36.0 23.3 -27.5 -16.9 -32.5 -44.3 -52.2 -45.7

Memo:GDP (mil IJS $) 2886.3 4579.4 5241.4 5128.9 4369.6 5140.8 5489.7 5880.7 6299.6 6748.3 7229.0Average Exchange Rate (Lari/$) 1.28 1.25 1.30 1.41 2.00 1.90 1.96 1.99 2.02 2.05 2.08Real Exchange Rate 2/ 100.0 66.6 61.3 62.0 75.2 67.8 67.8 67.8 67.8 67.8 67.8Reserves in months of Imports 2.7 2.5 2.0 1.2 2.5 2.6 2.7 2.8 2.9 3.1 3.3

1/ Amortization due before rescheduling until 1998, and excl. IMF2/ Decrease = Appreciation

Annex IPage 3 of 4

Georgia: Financing Requirements (millions of US dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Current Account Balance (excl transfers) -405.1 -416.7 -572.5 -616.8 -453.2 -462.2 -459.3 -428.7 -384.8 -336.7 -286.9Amortization 268.4 84.3 55.2 82.11 108.2 136.9 167.3 183.8 99.2 98.8 115.8Change in Reserves (- increase) -115.2 -1.5 -15.1 54.9 -94.6 -20.6 -15.9 -22.6 -28.8 -36.8 -40.1

Financing needs 788.8 502.5 642.8 644.0 656.0 619.7 642.5 635.1 512.8 472.2 442.8

Total Disbursments:World Bank 85.1 76.7 64.2 73.4 106.2 77.4 81.0 72.1 50.5 47.3 43.0

o/w Adjustment 75.4 62.7 42.9 24.7 67.7 20.0 20.0 20.0 0.0 0.0 0.0IMF (net) 75.0 80.5 76.3 36.0 23.3 -27.5 -16.9 -32.5 -44.3 -52.2 -45.7EBRD 3.9 8.1 19.7 17.6 32.9 49.3 17.6 0.0 0.0 0.0 0.0IFAD 0.0 0.0 1.0 2.0 2.0 1.0 0.0 0.0 0.0 0.0 0.0Bilateral 11.1 25.6 35.5 34.4 23.9 75.3 81.0 96.7 109.4 106.4 105.4

Germany 10.7 25.6 15.5 19.4 11.7 0.0 0.0 0.0 0.0 0.0 0.0Japan 0.0 0.0 0.0 0.0 12.2 9.0 9.0 9.2 9.4 0.0 0.0US 0.0 0.0 20.0 15.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Russia 0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other Bilaterals (plus assumed) 0.0 0.0 0.0 0.0 0.0 66.3 72.0 87.5 100.0 106.4 105.4

Commercial 0.0 10.1 2.5 9.6 4.8 0.0 0.0 0.0 0.0 0.0 0.0

FDI 6.3 54.4 236.3 221.0 96.1 108.8 122.2 140.3 160.8 170.0 180.0Private Transfers 0.0 0.0 103.2 137.3 124.4 129.0 134.0 140.0 148.0 153.0 160.0

Grants 189.2 140.5 93.2 73.4 97.7 61.4 56.0 39.0 26.0 19.0 10.0US 106.6 65.0 35.6 43.8 43.8 0.0 0.0 0.0 0.0 0.0 0.0EU 64.1 52.9 7.8 18.2 32.7 26.4 24.1 0.0 0.0 0.0 0.0France 3.0 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Netherlands 2.5 8.6 4.0 8.5 8.0 0.0 0.0 0.0 0.0 0.0 0.0Japan 8.0 6.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other in-kind 5.0 5.0 45.7 1.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Additional grants needed 0.0 0.0 0.0 2.1 13.2 35.0 32.0 29.0 26.0 19.0 10.0

Identified Financing 370.5 395.9 631.9 604.6 511.3 474.7 474.9 455.6 450.4 443.5 452.7

Difference 418.3 106.6 10.9 39.4 144.7 145.0 167.6 179.5 62.4 28.8 -9.9of which:

Change in arrears 119.4 -346.7 -20.6 -69.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0rescheduling 224.9 390.3 61.7 4.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other capital (incl errors&Omissions) 74.0 63.0 -30.2 104.2 69.8 20.1 9.3 7.4 3.8 2.3 0.0GAP (net) 0.0 0.0 0.0 0.0 74.9 124.9 158.3 172.1 58.6 26.5 -9.9

Annex IGeorgia: Debt Indicators Page 4 of 4

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Total DOD (US$M) 1221.8 1369.0 1542.4 1682.3 1909.4 2083.9 2238.3 2354.8 2430.2 2459.4 2451.5Debt Service due after rescheduling (US$M) 1/ 170.5 77.5 98.5 127.7 179.3 215.7 239.2 274.2 205.8 214.6 209.3

Total Debt/GDP 42.3% 29.9% 29.4% 32.8% 43.7% 40.5% 40.8%S 40.0% 38.6% 36.4% 33.9%Debt Service afterrescheduling/GDP 1/ 5.9% 1.7% 1.9% 2.5% 4.1% 4.2% 4.4% 4.7% 3.3% 3.2% 2.9%/Debt Service after rescheduling/ Total Exports 1/ 35.1% 15.0% 11.6% 14.2% 19.2% 21.6% 21.7% 22.4% 15.1% 14.1% 12.4%DOD/Export 251.6% 265.4% 181.90/o 187.2% 204.5% 209.1% 203.3% 192.4% 177.8% 161.9%/e 145.4%

IBIRD Debt (US$M) 0,0 0.0 0.0 0.0 0.0 0.0 0.0 4.0 13.5 29.0 43.8IBRD Debt Service Due (USSM) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.6 1.5 2.5IBRD Debt/GDP 0.0%/0 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 0.2% 0.4% 0.6%IBRD Debt/Total DOD 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% 0.6% 1.2% 1.8%IBRD Debt Service! GDCP 0.0% 0.00/0 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0. 0.0M/a 0.0% 0.00/aIBRD Debt Service / Total Exports 0.0% 0.0% 0.0% 0.0% 0.00/a 0.0% 0.0% 0.0% 0.0% 0.1% 0.2%IBRD Debt Service/Total Debt Service 0.0% 0.0% 0.0% O 0.0% 0.0% 0.0% 0.0% 0.1% 0.3% 0.7% 1.2%

IDA Debt (US$M) 86.0 162.7 226.9 300.3 406.5 483.9 564.9 633.0 673.9 705.1 730.7IDA Debt Service Due (US$M) 0.2 0.6 1.0 1.3 1.8 2.2 2.6 3.0 3.3 4.0 6.2IDA Debt/GDP 3.0% 3.6% 4.3% 5.9% 9.3% 9.4% 10.3% 10.8% 10.7% 10.4% 10.1%IDA Debt/Total DOD 7.0% 11.9% 14.7% 17.9% 21.3% 23.2% 25.2% 26.9% 27.7% 28.7% 29.8%IDA Debt Service/GDP 0.0% 0.0% 0.0% 0.0% 0,0% 0.0% 0.0% 0.1% 0.1% 0.1% 0.1%IDA Debt Service/Total Exports 0.0% 0.1% 0.1% 0.1% 0.2% 0.2% 0.2% 0.2% 0.2% 03% 0.4%IDADebtService/TotalDebtService 0.1% 0.8% 1.0% 1.0O% 1.0% 1.0%/0 1.1% 1.1% 1.6% 1.9% 3.0%

Preferred Creditors Debt (US$M) 206.0 364.2 516.4 651.2 801.5 908.1 983.8 1006.3 997.5 976.3 955.9Preferred Creditors Debt Service Due(US$M) 2.8 6.1 7.5 11.1 33.3 44.1 38.1 56.3 73.0 81.7 75.7Preferred Creditors Debt/GD!P 7.1% 8.0% 9.9% 12.7% 18.3% 17.7% 17.9% 17.1% 15.8% 14.5% 13.2%Preferred Creditors Debt/Total DOD 16.9% 26.6% 33.5% 38,7% 42.0% 43.6% 44.0% 42.7% 41.0% 39.7% 39.00/%Preferred Creditors Debt Service/ GDP 0.1% 0.1% 0.1% 0.2% 0.8% 0.9% 0.7% 1.0% 1.2% 1.2% 1.0%Preferred Creditors Debt Service / Total Exports 0.6% 1.2% 0.9% 1.2% 3.6% 4.4% 3.5% 4.6% 5.3% 5.4% 4.5%Preferred Creditors Debt Service/Total Debt Service 1.6% 7.8% 7.6% 8.7% 18.6% 20.5% 15.9%/a 20.5% 35.5% 38.1% 36.1%

i/ Debt scrvice figures correspond to debt service due after all the rescheduling arrangements are taken into account, and all other arrearsand non-EU debt service due in 95, 96 and 97 are rescheduled at 10 year maturity, 5 year grace and 4 percent interest. It includes also dues to Turkmenistan which is still under negotiation.

Preferred Creditors include World Bank, IMF, and EBRD.All the debt is public.

Annex 2

Government of Georgia

Third Structural Adjustment Credit

Lefter of Development Policy

May 1999

1. Georgia has achieved significant progress under the stabilization and adjustmentprograms launched in 1994. The fiscal and monetary policies implemented have succeeded inbringing down inflation, reducing internal and external imbalances and stabilizing the exchangerate. Under the government program, a number of key reforms have been implemented includingthe liberalization of price and trade regimes, reform of the banking sector, a large program ofprivatization, and the establishment of a legal and regulatory framework for private sectordevelopment. Thanks to the combination of sound fiscal and monetary policies and importantstrides in the implementation of the structural reform agenda, real economic growth has resumedin 1995 and exceeded 10 percent in 1997.

2. The economic and financial situation deteriorated significantly in 1998 due to acombination of internal factors and external shocks. The fiscal outlook changed with theemergence very early in the year of serious difficulties as a result of unaccounted for refugeesexpenditure delays in introducing a number of policy measures to broaden the tax base and weaktax collection. With the devastating impact of the Russian crisis on the Georgian economy duringthe second half of the year, the weak fiscal stance of the first six months of 1998 culminated intoa fiscal crisis. Unable to meet its revenue and expenditure targets, the Government undertooksuccessive rounds of across the board expenditure cuts and, despite the cuts, accumulated largepayment arrears in particular to the health sector. Tax revenues remained consistently belowtargets, covering only 64 percent of current expenditures.

3. The onset of the Russian crisis in August 1998 led to a strong appreciation of theGeorgian Lari (GEL) against the Ruble, boosting the competitivity of Russian products, loweringthe value in domestic currency of workers remittances and depriving Georgian exporters fromtheir primary market. The volume of worker remittances and transit goods to Russia fromGeorgia declined substantially and the payment system deteriorated sharply. The loss ofcompetitiveness and the weak fiscal stance translated into intense pressures on the foreignexchange market

4. Despite the National Bank of Georgia efforts to tighten monetary policy to eliminateexcess demand pressure in the foreign exchange market, foreign reserves dwindled from theequivalent of two months of imports before the Russian crisis to about two weeks by end-November. By the end of the year, the Government decided to take major steps to correct theinternal and external imbalances built-up in 1998. A number of revenue-enhancing measureswere adopted in November, and in early December, the NBG announced its decision to stopintervention and let the GEL float to reach a new equilibrium.

5. Real GDP growth reached 2.9 percent (less than half the original target), the fiscal deficitreached 4.3 percent of GDP against a target of 2 percent and the current account deficit rose to 12percent of GDP from 10.9 percent in 1997. Inflation, which reached a record low 1 percent overthe first 9 months, rose considerably following the depreciation of the GEL, reaching 10.6 percent

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in December. Because the inflationary shock occurred by the end of the year, average inflationdeclined to about 3.6 percent for 1998 from 7.1 percent in 1997.

6. Against this background, the objectives of the Government reform program are to correctthe growing macroeconomic imbalances, strengthen the economy's capacity to address the shocksstemming from the Russian crisis and maintain it on a sustainable high growth path, and ensurethe provision of basic social services to vulnerable groups. The Government's program will focuson four key areas: (a) strengthen the fiscal position by enhancing revenues and improvingexpenditure management while allowing for adequate allocations to key social services; (b) createan environment favorable to private sector development; (c) reform land ownership to stimulateagricultural output and boost the development of real estate and financial markets; and (d)promote private participation in infrastructure and complete state divestiture from the enterprisesector.

A. Reducing Macroeconomic Imbalances and Strengthening the Fiscal Position

7. In order to improve Georgia's fiscal and external position, the Government objective is toreduce the overall fiscal deficit (on a commitment basis) to 1.8 percent of GDP in 1999.Monetary and exchange rate policies will aim at lowering inflation and stabilizing the exchangerate. In response to the Government tight monetary policy to contain the inflationary pressureswhich followed the GEL depreciation, inflation which hiked early 1999 is expected to abate bythe end of the year. Hence average inflation is expected to reach 22 percent for the whole yearand 13 percent by end-1999. On the external front the Government objective is to reduce thecurrent account deficit from 12 percent in 1998 to 10.4 percent in 1999 and rebuild the level ofreserves to the equivalent of two months of imports.

A.1. Strengthening the Fiscal Position.

Improving Revenue Mobilization

8. In 1998, revenues covered only 64 percent of expenditure. This was due to delays inintroducing a number of policy measures aimed at broadening the tax base and bringing into thetax net large segments of the economy. Lax tax enforcement and poor collection have also largelycontributed to difficulties in mobilizing revenues. In order to correct internal imbalances, theGovermment has adopted a two-pronged approach involving policy measures to reduceexoneration and special tax advantages, and strengthening the revenue administration to enhancecollection and combat fraud and corruption. The Government has removed all tax exemptions onwheat and flour, introduced VAT taxation on agriculture, removed other VAT exemptions,introduced a land surcharge tax, restored the 12 percent customs duty on natural gas andelectricity, placed a 60 percent excise duty on all petroleum products, and issued excise stamps oncigarettes and alcoholic products.

9. The Government is aware that efficient, and accountable tax institutions are key to thesuccess of revenue mobilization effort and to a sound business environment. In order for the taxpolicy to reach its revenue mobilization objectives while minimizing economic distortions andensuring a fair, equitable, neutral and non discriminatory treatment of taxpayers, the Governmentis also implementing sweeping institutional changes in the tax and customs administration.

10. Concerning customs, the Government had embarked over the last two years on a programof modernization of the State Customs Department (SCD) which collects custom duties, VAT andexcise on imports. The program includes institutional strengthening (review of staffing needs;internal reorganization; adoption of new procedures and controls), and improvement in physical

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infrastructure (computerization and improved communications; rehabilitation of facilities).However most of the benefits of the ongoing modernization program will take two to three yearsto fully be realized. Currently, collection of customs revenues is still highly constrained by weakcontrol of customs territory; porous borders allowing for easy smuggling; massive tax evasion onexcisable goods; under-invoicing of imports; weak enforcement capacity; splitting ofconsignment under personal exemption regime; and poor control of transit traffic.

11. In view of the tight fiscal position and the need to raise additional revenues, theGovernment intends to complement the existing institutional program by hiring a foreigncontractor to carry out significant customs functions. Contracting out customs functions is atransitory solution. The Government's long term objective is to build a modern and efficientcustoms department. For that purpose, an effective program of partnership and skills transferbetween the contractor and the customs Department will be developed.

12. Concerning the tax administration, initial Government efforts concentrated onestablishing or reorganizing tax institutions. Hence the State Tax Department of Georgia (STDG)and its regional branches, which collect most central and local government domestic taxes, werereorganized along functional lines in 1995, and a Large Taxpayer Unit was established in 1996.To increase the efficiency of tax collections, the responsibility for the collection of payroll taxeswas transferred from the Pension Fund to the STDG in 1998. The Tax Code of Georgia wasenacted and is implemented. The STDG is being reorganized along functional lines to separateout policy, management and control functions, allowing for clear responsibility and performancedelineation.

13. In addition, with substantial donor assistance, methodologies for dealing with third partyinformation and producing programs for the collection of tax arrears, the investigation of non-filing and stop-filing of tax returns, and the collection of tax debts have been prepared. Trainingof tax inspectors in the basic skills of collection has been performed. A program of training oftrainers is also being implemented to allow in-house training to begin. A training program onauditing procedures, standards and measures is underway and a Manager Manual has beenproduced. Numerous meetings have been held with general community groups, the businesscommunity and high schools to educate the public on their rights and responsibilities. A review ofthe pay and grading structure of the STDG is underway, which will identify and use private sectorcomparators as a basis for its development. Two pilot offices have been computerized and theremaining will follow as soon as the necessary hardware is received.

14. Based on a thorough review of the performance problems of the tax administration, theGovernment will further streamline its organization set-up. A number of key measures will beintroduced in the coming months to ensure that local government involvement optimizes taxrevenues, increase efficiency by consolidating tax offices and pooling resources, strengthenpersonnel management and incentive systems. These measures will allow for a turnaround in taxcollection in 1999. The Large Taxpayer Unit (LTU) is being strengthened to achieve the objectiveof mobilizing 50 percent of STDG revenues through the LTU by July 1, 1999. The Governmentwill also ensure effective implementation of the order abolishing the dual subordination orreporting arrangements for district/local tax offices so that these offices report vertically only toSTDG management and not any longer to or through the district or local authorities. As a firststeps towards the consolidation of regional tax inspectorates in Tbilisi, the 10 Tbilisi RegionalTax Inspectorates (RTI) will report to and be brought under the full direction of headquarters. Asa next step, the RTIs will be consolidated into larger units.

15. The Government has established a special tax force (STF) of hand-picked tax inspectors,to be placed under the direct control of the STDG chairman to oversee the implementation of the

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tax administration strengthening measures. The STF will concentrate on large taxpayers, andlocal and regional offices who account for 80 percent of tax revenues. It will focus its activity onthe implementation of measures to expand the tax base, and the programs for the collection of taxdebts and arrears and the investigation of non-filing and stop-filing of tax returns.

16. The Government is aware that all of these initiatives to build a strong and professionaltax department need to be complemented by strong measures to introduce discipline,professionalism and accountability. The Government has required all revenue administrationemployees to submit their declarations of income and assets. As a result, declarations of seniorofficials are being filed with the Bureau on Information on Assets and Finance on Senior PublicOfficials. Declarations of all other STDG employees have already been filed with the Bureau ofPublic Service. A new STDG management structure has been introduced. Job descriptions, andobjectives associated with each work activity including agreed performance measures have beenprepared for both the management and the staff. A Performance Appraisal System to judge theefficiency and effectiveness of all individuals within STDG will be established by September1999 and will be used initially at three-month intervals to assess progress. An in-confidencetelephone hotline has been set up in the central STDG so that the public can report harassmentand/or intimidation. The STDG has also instituted disciplinary proceedings against more than 150tax inspectors.

17. Formal appeal and investigation systems to investigate complaints against tax inspectorswill be established by December 1999. The system will be responsive, transparent and willinclude built-in safeguards against abuse of process. Available technical assistance will beutilized to undertake a series of high-level efficiency scrutiny of the whole STDG and monitorprogress in efficiency and effectiveness. With support from the donor community, theGovernment wants to define the STDG's medium term strategic objectives and technicalassistance needs. A full assessment will be undertaken in the coming months. Finally theGovernment will regularly identify and undertake actions against the worst tax offenders and willprovide IDA with periodic reports on progress with dealing with delinquent taxpayers.

A.2. Strengthening Expenditure Management.

Strengthening Expenditure Management

18. The reorganization of the Ministry of Finance along functional lines is underway tostrengthen the ministry's control over the management of revenue and expenditure. The BudgetDepartment will work with spending ministries and others so that budget proposals are properlycosted and expenditure outcomes are agreed. It will also work closely with counterparts in theTreasury to ensure that revenues are allocated in accordance with agreed budget plans and thatoutcomes are achieved.

19. A new computerized system of revenue allocation has been introduced to ensure thatpriority core expenditure functions are satisfied before all else. The new system will eliminate thesubjectivity of the present system and increase the sensitivity of the allocation process.

20. The restructured Treasury Department will complement the budgeting process byproviding links - through its regional network, which will monitor actual expenditure against itsintended purpose. Treasury departments will work with spending ministries and others to createaccountability trails so that the disbursement of revenues can be tracked to the point ofexpenditure. To that purpose, the Treasury will require spending ministries and others to providemonthly/quarterly reports which will describe how much revenues was received and how it wasspent. These new procedures will require improvements to the computer capacity within the

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Ministry and the creation of data exchange interfaces within, the ministry, between the treasuryand its regions and with tax and customs.

21. The Government's objective is to ensure that an expenditure management system that isefficient, transparent, and responsive to the stated expenditure priorities is in place. Because ofthe absence of such a system in the past, priority expenditure, such as those on health, educationand poverty benefits have suffered from revenue shortfall, liquidity constraints and cashmanagement weaknesses.

22. All health, education and poverty benefits are core priority expenditures within themandatory budgetary classification. As such, they are an integral part of the primary allocation ofrevenues collected every month. In the 1999 budget, the Government has allocated to theeducation sector 13 percent of its overall consolidated budget including central and local budgetoutlays, the extrabudgetary funds and the State Medical Insurance Company (SMIC), andexcluding amortization and repayment of the stock of arrears. All arrears to health and educationwill be repaid in 1999. The Government is aware that the allocation to education should concernonly Government expenditures and should not include additional financial resources such aspayments made by parents, school fees and other, administered under special funds. Hence, the1999 allocation excludes these special funds contribution to both the central and local budgets.

23. Government allocation to the health sector amounts to 7.3 percent of the consolidatedbudget. This allocation consists in Government expenditure and does not include disbursementsunder the World Bank-funded health project. Since the basic package of services to thepopulation is funded by the SMIC through payroll contributions, the Government will ensure thatany shortfall in the collection of payroll tax would be fully compensated by resources from thecentral budget. In order to ensure budget execution at all levels of Government, transfers from thecentral to the local budgets will specify the share of resources to be spent on health. In the 2000budget the same ratios will be applied for Health and education. The allocation to the povertybenefit will ensure that it remains , at a minimum constant in real terms.

24. In order for the health agencies to be able to plan basic core expenditures, theGovernment will ensure a smooth cash flow over the year. Hence, no less than 75 percent of themonthly share of the approved 1999 budget will be transferred to the responsible agencies by theend of each month. Within health expenditure, some programs are crucial to the welfare of thegeneral population. The core health expenditures and responsible agencies include: the programof the SMIC, the Ministry of Health's Medical Preventive Measures Program and the Ministry ofHealth's Other Program. Similarly, the Government considers that expenditures on generaleducation are a core priority within the education budget and will specify the share of overalltransfers to the local Governments to be devoted to general education.

25. The Government intends to reestablish an adequate level of poverty benefit in 1999.Confronted with large revenue shortfalls in 1998, the Government has further tightened thebenefits in an effort to reach the poor more effectively in the context of a highly constrainedbudget. Based on the analysis of the Household Survey conducted by the State Department ofStatistics in collaboration with the World Bank, eligible categories were reduced to one of themost vulnerable groups of the population, poor single pensioners. The Government will maintainthe current number of eligible pensioners but increase the benefit to a level sufficient to bringtheir monthly expenditure up to the level of the minimum poverty line. The Government hasallocated 14.3 million Lari for the poverty benefit. This allocation will allow the Government toreach some 55000 applicants currently registered as poor single pensioners. The level ofassistance will be 18 Lari per poor single pensioner and 29 Lari for two poor single pensioners

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living together. Overall transfers to the local governments will specify the amount allocated to thepoverty benefit.

26. In order to ensure adequate execution of these core social expenditures, the Governmenthas established a special monitoring mechanism for health, education and the poverty benefit. Nolater than the 2 0f* of each month, the Ministry of Finance will provide each of the concernedentities (local governments, line ministries and SMIC) with a report detailing the amount ofmoney transferred and the expenditure for which they are budgeted. Similarly, no later than the2 0th of the month, each of the entities will provide information to the Ministry of Finance and therespective line ministries with a report detailing resources received for the previous months andexpenditures performed. For the purpose of supervision of the credit, copies of these reports willbe provided to the World Bank Resident Mission.

B. Creating an Environment Favorable to Private Sector Development

27. Based on feedback from the business community, the Government intends to introducemeasures to enhance the business environment. The Government is aware of the importance of asound business environment to foster a dynamic domestic private sector and attract foreigninvestors. The quality of the business environment is a function of the regulatory framework inplace as well as its actual implementation. While the Government has ensured over the last yearsthat a sound legal and regulatory framework for private activities is in place, it is concerned byprivate sector complaints about weakness in implementation, and administrative abuses.

28. Arbitrary interpretations of laws and regulations, multiple licensing requirements andoverlapping institutions claiming jurisdiction over various aspects of business activity, frequentand unjustified visits of tax inspection teams, complex business registration practices, contributeto discourage new entry, and greatly raise the uncertainty, risk and cost of doing business. TheGovernment's program of reform of the tax and customs administration and the licensing regimeare designed to address the issues of interface between the administration and the private sectorby establishing feedback and appeal mechanisms to fight corruption and abuses.

29. The Government intends to reform its licensing system, which is currently perceived bythe business community as being a major constraint to enterprise efficiency and development.The goal of the reform is to create a licensing regime that is effective, consistent, transparent andunderstandable. This initiative will significantly reduce the heavy burden on firms of excessiveand unnecessary regulations. Regulatory statutes will be simplified, and their implementation-along with deregulation- publicly monitored. In April 1999, the Government submitted to theParliament a new draft law on licensing. This law reforming and simplifying the licensing regimewas enacted end-May 1999.

30. The new law provides that licensing can be undertaken only in exceptional casesinvolving safety of persons and the security of the state since it limits the constitutional right oftrade and commerce. The law provides for adequate arrangement for external monitoring. Toenhance its effectiveness, the law has fewer, more transparent and non-discretionaryimplementing regulations.

31. The law defines the circumstances when licensing can be applied; lists the categories ofactivities that are subject to licensing; and criteria for adding to or eliminating activities from thelist. Licensing in a field is regulated only on the basis of the specific legal provisions and not byany other law or instructions; and any license issued for a particular activity is the onlyinstrument that controls that activity. The law also provides for time-bound procedures forsuspension, termination and annulment of licenses. The law promotes transparency by providing

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for a public register where licenses will be registered. The law specifies that provisions forconcrete licensing conditions and procedures should be in writing, limit discretion, and bepublicly accessible. It defines a procedure for monitoring of license holders as well as forexternal monitoring of licensors.

32. The methodology and processes, needed to ensure sound implementation, will be definedby end-July 1999. The Government will draft and promulgate implementing regulations andperform a baseline regulatory assessment to determine the existing conditions, procedures, costand burden of licensing, against which improverments can be monitored and measured. To thatpurpose, a systematic methodology for reviewing the necessity and effectiveness of existing andproposed regulations will be developed. The review will provide an effective filteringmechanism to ensure that unnecessary procedures are not considered. The filtering mechanismwill provide a framework and criteria against which proposed licenses have to be assessed, sothat proposals, which do not fulfil the criteria, are filtered out at the initial stage. The stepsneeded to analyze and amend/eliminate relevant regulations will be specified and feedbackstudies will be conducted to ensure the regulatory burden falls in practice as envisaged in thelaw.

33. Following the strengthening of the legal and institutional framework for licensing, theGovernment will embark on a program to modemize the framework for certification andaccreditation since these areas are closely connected with licensing and their modernizationcrucial to the quality of the business environment.

34. In the past, there was a lack of clearly assigned institutional responsibility to develop astate procurement system. Other elements required for a state procurement system (e.g. enablingregulations, country specific procurement documents and manuals etc.) were also lacking. Theabsence of a comprehensive procurement system has created a vacuum and Governmentagencies have adopted ad hoc practices, which vary from sector to sector and even from agencyto agency. The current practices lack sufficient transparency and accountability -a seriousimpediment in introducing discipline in public expenditure.

35. The Government considers that a modern and transparent state procurement system iscritical to support the on going economic reforms and the emerging private sector. It will enabledevelopment of the private sector by providing intending suppliers a level playing field, besidesreducing rent-seeking opportunities. As a first step, a new Law on State Procurement has beenenacted in December 1998. The next steps of the procurement reform are to develop andintroduce a comprehensive set of implementing regulations and country-specific biddingdocuments and manuals to regulate and manage state procurement in the country. By end-June1999, a procurement regulatory and oversight agency will be fully staffed. The development oftraining material and delivery of workshops to introduce the new system will follow.

36. The Government's efforts are directed to complete the first phase of the publicprocurement reforms. The institutional arrangements already implemented include theestablishment of an independent Department of State Procurement within the Ministry ofEconomy, with a Director appointed by the President on the recommendation of the Ministry ofEconomy: the Director can be removed only by the President. The Department is the regulatoryand oversight agency for state procurement. Regulations defining the functional scope of theDepartment have also been issued.

37. The Government will complete the following critical elements of the state procurementreforms. The process of competitive recruitment of other staff for the Department to be fullyoperational will be completed by end-June 1999. Comprehensive procurement regulations will be

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promulgated by June 1999. A set of country-specific procurement documents and manuals will beadopted by September 1999. An institutional strengthening plan to implement the system ,on thebasis of agreed key measures, will also be adopted and relevant training and workshops will beoffered. The Government will specify and apply benchmarks to agencies with large procurementbudgets, to monitor the implementation of the new procedures to be prescribed by the Law andimplementing regulations by December 1999.

38. In order to facilitate entry for new businesses, the Government has simplified registrationprocedures, which are in practice unnecessarily more complex than what is prescribed by the law.Hence, three steps have been eliminated: the requirement to obtain a stamp/seal from the localpolice and other administrative entities; the regulation of the National Bank of Georgiaprohibiting commercial banks to open new accounts for new businesses without a seal; and theactive role of the Statistics Department (SD). As envisioned in the law, the SD should receive allthe information from the Courts when a business is registered into the Enterprise Register butshould not require the business owners to visit the department and provide it with the information.In addition the current practice of the tax administration which entails eight signatures for theissuance of a tax ID code has been streamlined to reduce the number to one as envisaged in thelaw. These changes have been introduced and will be widely publicized. These measures areexpected to benefit micro-enterprises, which are particularly vulnerable to administrative abuses,and to reduce the incentive to remain in the informal sector.

39. The Government wants to establish a partnership with the business community and createa feedback mechanism to monitor the quality of the business environment and act rapidly tocorrect abuses. To that effect the already existing investment council, chaired by the Presidentand composed of high-ranking Government officials and parliamentary Committees Chairmen,will be enlarged to include representatives of the business community and CERMA (Center forRestructuring and Management Assistance)-an NGO involved in supporting the development ofthe private sector. The enlarged Investment Council will meet quarterly to discuss issues relatedto the quality of the business climate. CERMA would act as the Council secretariat for thesemeetings, prepare background material and quarterly reports.

C. Reform Land Ownership to Boost Agricultural Production and the Development ofReal Estate and Financial Markets

40. The Government has embarked on a program of land privatization as a first step inpromoting active land and real estate markets. In the agricultural sector, the Government expectsactive land markets to increase the productivity of land by permitting consolidation or subdivisionof holdings over the next years to a more efficient size. Similarly, the development of real estatemarkets in cities is especially important to permit the turnover of large expanses of unusedenterprise land for more productive purposes, such as for use by private sector commercialentities, without requiring substantial capital investment in new infrastructure.

41. The government is aware that land itself has value and using land for collateral is oneimportant way for owners to gain access to additional capital resources. This is especiallyimportant in urban areas because most of Georgia's real assets are locked up in real estate, ofwhich land is an integral part. The ability to borrow against both agricultural and urban land willprovide an important source of financing for additional new investments by the private sector. Itwill also broaden the currently narrow range of financial services provided by the banking sector.Hence the Government intends to establish an adequate legal and regulatory framework to allowfor the use of land and building as collateral and encourage maintenance of the existing stock ofreal estate. To that effect, the Government has assessed the adequacy of civil code dispositionsregarding the mortgage and condominium legal framework. There is a consensus that the current

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framework is broadly adequate. The Government will monitor developments and address anylegal or practical bottlenecks that may appear to hamper land mortgaging. Regardingcondominiums, however, substantial assistance will be needed to build owners organizationmanagement structures in order to enhance the effectiveness of the civil code dispositions.

42. Land reform and farm restructuring began with Government resolution 48 of January 1992.By January 1996, 20 percent of all agricultural land had been privatized, which included 43percent of all arable land and 60 percent of all land under perennials. Most of this land is in plotsof up to 1.25 ha and is used for subsistence. Land distribution to individuals ceased in 1996 withthe passing of the Land Lease Law under which land not distributed to individuals can becommercially leased from the state for up to 49 years, even though most lease terms to date endafter 10 years. Under the land reform program, farmers received preliminary ownership rights tothe land, however for full ownership rights, the land needs to be registered.

43. The Government recognizes this problem and has initiated a nation-wide program toestablish registration offices, develop consistent registration procedures, and begin registration ofparcels on demand. In order to register land parcels they need to be surveyed and the appropriatedocuments presented to the registry local office. The World Bank Agricultural DevelopmentProject (ADP) is assisting the Government to develop a pilot project to systematically survey andregister all parcels in two districts outside of Tblisi, Mtskheta and Gardabani. Fortunately, theGeorgian title registration law permits the use of "general boundaries" principle, which allows formore rapid execution of parcel surveys. The Government is aware that without registration ofparcels, individuals cannot freely transfer land. For this reason the Government will issue theregulations and operating procedures for the title registration system satisfactory to IDA, andbegin implementing these new registration procedures in mid-1999.

44. The Government wants to begin registering land in the two pilot districts, where some ofthe systematic surveys of land parcels have already been completed. It will begin registering landwhen construction of the registration offices in these two districts has been completed in July1999. The World Bank has also proposed that the State Department of Land Management(SDLM) prepare a program for upgrading other registration offices outside of the two pilot areas,for possible ADP funding. This would allow sporadic registration in areas outside of the pilotareas, and training for registry personnel. The Government has also approached other donors forfunding to expand the titling program to other areas. Lessons learned for the pilot regions will beimplemented in other registration offices as the program is rolled out.

45. Concerning non-agricultural land, the legal framework consists of two laws recentlyenacted to govern the transfer of ownership rights from the public to the private sector. The law"On Declaration of Private Ownership of Non-agricultural Land in Use of Physical and PrivateLegal Person." permits privatized enterprises, private legal persons and private citizens toprivatize land allocated to them. The law declares the land allocated to privatized enterprises,private legal persons and private citizens to be private based on existing sketches anddocumentation. Privatized land will be registered rapidly without additional surveying afterpayment of a one-time fee equal to one times the annual land tax (or two times the annual landtax after January 1, 1999). Implementation of this law requires the State Department of LandManagement (SDLM) regional and municipal registrars to rapidly register the privatized land.The Government will ensure the capacity of the registrars to provide timely registration inaccordance with this legislation. So far 3184 enterprises have registered their land.

46. The second law 'On Administration and Disposition of State -owned Non-agriculturalLand' regulates how state-owned non-agricultural land will be administered and disposed of bothby privatization and by lease. The Government recognizes that this law presents a number of

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shortcomings. The law promotes leasing instead of privatization of state land with theshortcoming that the value of leased land decreases with time instead of increasing and leasedland has less value as collateral than land owned outright. Also the law provides broad powers tothe State Department of Land Management (SDLM), which may create a conflict of interest. Thespecific responsibilities assigned to the SDLM under the law include the organization,negotiation, conclusion of transactions, and enforcement of lease contracts. These responsibilitiesare in addition to the SDLM' s already existing broad responsibilities to register and provideinformation about land, deternine land use and to verify that land is being used as has beenagreed.

47. In June 1999, the Government will amend the law "On Administration and Disposition ofState-Owned Non-agricultural land" and issue implementing regulations to integrate featurescentral for development of real estate markets. The amended law and its implementingregulations will promote privatization over leasing, greatly expand the property rights of holdersof Government leases and provide for the organization of future privatization through competitiveprocesses as well as regulating direct disposition. In addition, the amended law will enhancetransparency by further defining the privatization mechanism and delimiting the roles of therelevant public bodies including local self government, the SDLM, the Ministry of Urbanizationand Construction, the Ministry of State Property Management. In this regard, the role of theSDLM in land privatization will be greatly reduced.

D. Promote Private Participation in Infrastructure and Divest from the EnterpriseSector

D.1. Private Participation in Infrastructure.

48. The Government is intensifying its privatization effort in the infrastructure sector with theobjective to stimulate export activities, improve the overall efficiency of the economy, enhanceconnectivity to the rest of the world and improve the welfare of the population. The Governmentprogram includes ports, airports, energy, water and telecommunication infrastructure. Acomprehensive program of divestiture from the power, oil and gas sectors is being developed andwill be implemented with support from IDA under the Energy Sector Adjustment Credit.Development of strategies for the Privatization of Telecommunication, Poti Port and the TbilisiWater Utility are underway with the view of completing privatization in those sectors in 1999-2000.

49. In the telecommunication sector, where substantial private investment has taken place, theGovernment objectives are to increase transparency in all telecommunication activities,strengthen anti-monopoly mechanisms, privatize the remaining assets and rejuvenate and expandlocal service and service to rural and under-served regions using market-based mechanisms. TheGovernment is hiring internationally experienced advisors to assist with the definition of sectorpolicy, regulatory framework, and the privatization of the remaining state-owned assets.

50. The Government intends to sell its remaining 51 percent shares in GeorgiaTelecommunications (GT) and 75 percent of its shares in Georgia Electro Communications(GEC) by international competitive tender. In order to increase the attractiveness of these assetsand enhance competition the Government has given GT and GEC the licenses for both domesticand international operations. The Government is committed to developing a competitivetelecommunications sector and will eschew the granting of exclusive rights. The Governmentintends to obtain the services of an investment bank (by end-August 1999) to assist in theprivatization of GT and GEC and has already obtained the services of a regulatory advisor. TheGovernment will submit to IDA for non objection a satisfactory privatization strategy and

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timetable and a regulatory framework by end-October 1999. The Government will offer for salethe telecommunication companies Georgia Telecommunications and Georgia ElectroCommunications by end February 2000.

51. Regarding Poti Port, the Government objectives are to develop a competitive portcapacity in order to foster Georgian trade, play a significant role in the Regional maritime transittraffic and develop the transport sector, and to reduce its financial involvement in portdevelopment. These objectives require that modern seaport technologies and organization beintroduced, existing facilities be revamped and developed, management skills be improved, andthat the private sector be associated with operation and financing of port terminals. The strategyinvolves separating commercial activities and regulatory functions and to grant concessions toprivate operators through a competitive and transparent process. More than 50 per cent of portoutput by volume is expected to be under the control of private concessionaires by the end of theyear 2000. The Government intends to establish joint-stock companies in charge of operation,development and financing of the main components of port activities. These companies willlease corresponding pieces of infrastructure and their assets will be under majority privateownership.

52. A new, financially sustainable, Port Authority will be created, acting as Landlord-port incharge of regulation, management of public properties (common use infrastructure) and long-term planning. The regulatory powers of the Poti Port Authority and the contents of theconcessions agreement will be structured to ensure that private operators do not engage inmonopolistic practices. By end September 1999, the Government will submit to IDA for nonobjection a satisfactory development strategy and regulatory framework for Poti Port. By endFebruary 2000, the Government will hire international advisors to prepare and market theinformation memorandum, prepare and review bidding documents and assist in bids evaluationand negotiations with the potential investors; in addition they will advise the Government inrelated matters, mainly human resources and labor issues.. All privatization in the infrastructuresector will be undertaken in the context of strategies specifying the Government objectives forthe concerned sub-sectors, and adequate regulatory arrangements and privatization modalities.

53. To support the Government's strategies for infrastructure development, facilitateenterprise restructuring by new owners and enhance privatization proceeds, importantmodifications have been made to the privatization legal and institutional framework. The law "OnDeclaration of Private ownership of Non-agricultural Land in Use of Physical and Private LegalPerson." includes land as an integral part of the assets being privatized. The Law on StateProperty Privatization has been amended to permit the privatization of telecommunications;postal services; radio and television broadcasting; railways; water and sanitation systems;airports; gas distribution pipelines; ports; and roads (for which parallel state-roads exist). Inaddition, to provide sufficient flexibility for structuring transactions, the privatization and otherrelevant legislation will be amended by end July 1999 to eliminate maximum lease terms andminimum annual payments.

54. To provide sufficient support for the Government's privatization of both infrastructureand other medium/large enterprises, the President has created a Permanent Oversight Commission(POC). Regular POC members include the ministers of State Property Management, Finance,and Economy; Presidential Aide for Economic Reforms; and Chairman of the ParliamentaryCommittee of Economic Reforms and Economic Policy. Depending upon the issue, heads of lineministries also participate. The POC plays a key role in securing cooperation and support fromall official bodies for the Government's privatization program and provides sufficient guidanceand oversight so that the Ministry of State Property Management (MSPM) can implement theGovernment's privatization program in an efficient manner.

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55. The Government is committed to completing the rapid transfer of remainingshareholdings and productive assets to private-sector owners and managers rapidly andtransparently. By including land as part of enterprise privatization, limiting the liabilities of newowners to those known at the time of the privatization transaction, and intensifying its marketingefforts, the Government will also seek to maximize privatization proceeds. Because past tenderssuffered from insufficient time and support, the Government has modified tender procedures togive prospective investors up to 4 months to complete due diligence and develop investmentproposals.

56. In addition, the Government has taken steps to limit the liability of new enterprise ownersto amounts known at the time of the transaction and to discourage fraud while protecting rightfulcreditors. Lastly, the Government has substantially increased its public information andmarketing efforts. These now include regular advertisements in leading national newspapers.Weekly press conferences and in-depth interviews; television coverage; and informationdistribution on the internet, to foreign embassies, and through Georgia's overseas embassies arealso used for marketing purposes.

D.2. Privatization of Medium/Large (Non-Infrastructure) Enterprises.

57. The Government's privatization program covers 364 enterprises, divided into three"tiers." Based on a preliminary classification, Tier I consists of 29 State-majority enterprises thatthe Government wishes to privatize by tender or auctions. Tier II consists of 31 State-majorityenterprises that the Government expects to privatize through public auction. Tier III consists ofmostly minority shareholdings in 304 enterprises for which the Government is already holdingpublic auctions.

58. By end- 1998, the Government completed special auctions for minority shareholdings in244 Tier III companies. The results of these auctions were announced and information on the newshareholders forwarded to share registrars. State shareholdings in another 60 Tier III companieswill be auctioned by end-June 1999.

59. The Government will focus its marketing efforts on the 29 "Tier I" companies that willbe offered for tender. If offers are not received by December 1999, company shares will beoffered through public auction to other investors. The Government plans to privatize the 31 "TierII" companies through special auctions, similar to those now underway and due to be completedby year-end 1999.

60. The Tier I companies include those of potential interest to foreign investors and whichwould benefit most from capital inflows, technology transfer, managerial expertise, and greateraccess to export markets. Companies categorized as Tier I include the motor vehicles, tractors,paint, electric machines, and wool plants in Kutaisi, Georgian Air, Azot fertilizer, and a chemicalfibers plant.

61. The Government is aware that even companies categorized as Tier I are deeplydistressed. Although they may have retained their production base and a trained workforce, theseenterprise have suffered from a complete disruption of former markets, supply sources, and highdebt. Whereas, for instance, the Kolkhida motor car plant in Kutaisi fornerly employed 12,000workers, only 350 are currently employed in a small portion of this large plant producing cottonmachinery for Central Asia.

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62. Hence, before issuing any tenders, the MSPM will assess the viability of Tier Icompanies. A preliminary assessment was undertaken and classified two Tier I enterprises forcarve-out, two for liquidations and the rest to either be tendered or auctioned. By July 15, 1999,the MSPM will present a formal assessment to the World Bank for non-objection which willplace each Tier I company into one of three categories: (1) viable and suitable for tendering(orauction) "as is;" (2) partly viable, but with substantial excess assets requiring divestment; or (3)non-viable.

63. For viable/suitable Tier I companies, The Government will issue tenders (or auctions),directly to pre-identified prospective investors and/or through publicly advertised requests forproposals by end-July 1999. For financially distressed companies, which typically characterizesTier I companies, The Government may issue tenders for 1 Lari symbolic payment - backed upby investment, employment, or other guarantees. A tender package issued by the Governmentmay make suggestions about necessary investment and other items of interest, but these are notbinding on bidders. In developing information memoranda and information summaries for Tier Icompanies, The Government will make efficient and maximum use of data already collected bythe MSPM and information memorandum previously developed by The MSPM case-by-caseprivatization program.

64. For partly viable companies with substantial excess assets, a Resolution Unit will becreated in the Ministry. Among its other activities, this unit will identify ("carve out") land,structures, and other assets and liabilities that will be used by the viable portion of the enterprise;retain remaining assets and liabilities for sale and settlement by the MSPM; and prepare an initialbalance sheet for the viable part of the enterprise. Preparation of the viable portion of anenterprise for tender will be strictly limited to this "carve out" of associated assets and liabilities.Neither the MSPM nor any Government entity will undertake any operational restructuring oradditional investment. Companies undergoing "carve out" will be offered for tender byDecember 1, 1999

65. Criteria for formally classifying an enterprise for a carve-out has been prepared. In orderfor an enterprise to enter into a carve-out operation, it must: (i) be a very large enterprise whichwould be unlikely to find investor interest if sold "as is"; (ii) there must be discrete business unitswhich appear to be viable if sold as is (such as would be for enterprises with different productlines, vertically integrated enterprises or simply large single-product enterprises whosetechnology allows for sale as discrete business units); (iii) the MSPM has a carve-out strategy thatcan be implemented rapidly and does in no case involve operational restructuring or in-depthfinancial restructuring, i.e. no new infusion of capitaL For any Tier I companies deemed to benon-viable, all assets and liabilities will immediately be assigned to the Resolution Unit for saleand settlement.

66. Depending upon the date a tender is issued and whether or not foreign investment is arealistic prospect, up to 4 months will be allowed for prospective investors to complete their duediligence and to prepare and submit a tender. Thus, all tenders should be received by December7, 1999. For companies for which tenders have been received, by end-January 2000, theGovernment tender commission will decide whether to accept a tender offer or assign shares forauction. For tendered Tier I companies for which no tender offers are received, state-ownedshares will then be offered for public auction or liquidated.

67. In the interest of moving the process along and returning assets to productive use asrapidly as possible, any tender negotiations will be cqmpleted no later than end-January 2000. Ifboth parties have not agreed on the transaction by then, the Government will assign state-ownedshares for public auction. So as not to have any opportunity to acquire a company more cheaply

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through public auction, the potential investor from an unsuccessful tender negotiation would beprecluded from participating in the follow-on public auction for shares in that company. By end-February 2000, the Government would have divested from at least 20 Tier I companies throughtender, public auction, or asset sale/liquidation.

68. Prospects are negligible for the 31 Tier II companies. Hence, the Government will moveimmediately to privatize its shareholdings through public auction. Three of them were recentlysold by auction and the rest will be sold in specialized or zero price auctions by the end of 1999.Bidding in these specialized auctions has already begun for a number of these enterprises. At least15 enterprises will be privatized by August 1, 1999. Given the demonstrated difficulty in valuingstate-shareholdings - which, to date, have sold for an average of 5% of their book value - theGovernment would prefer to move directly to "zero price" auction, i.e., auctions in which there isno minimum price. To alleviate public concerns - however misplaced - that State assets arebeing sold for too little, auctions for shares in Tier II companies may begin with a minimum priceof 100% or 50% of nominal value. By end-December 1999, the 31 Tier II companies will havebeen wholly privatized.

69. The Government has also entered into 5-year management contracts, scheduled to rununtil 2002 or 2003, for several major enterprises. These include Rustavi Metallurgical,Kaspicement, Madneuli copper/gold mine, Phero, and Borjomi.

70. The Government has adopted a Statement of Intent on Hospital Restructuring Program(HRP) aiming at improving the efficiency and quality of health infrastructure and services. TheGovernment strategy envisages a significant reduction of publicly-owned facilities. Thecornerstone of the strategy is the sale at market prices of the real estate attached to excesscapacity in the sector, and use of the resources thereby generated to upgrade and equip theremaining facilities, train the personnel and cover restructuring costs such as severance paymentsto excess personnel. The action plan will be implemented in phases beginning in 1999.

Annex 3

Georgia: Third Structural Adjustment CreditPolicy Matrix

Objectives Current Status Issues SAC III Measures Timetable

A. Reduce MacroeconomicImbalancesImprove Revenue Mobilization Hliring of a private company to take Customs revenue collection highly Launch the tender process, select best Hiring process will be

over significant custom functions constrained by weak control of custom bidder and conclude negotiation completed in June 1999underway territory, porous borders, weak

enforcement capacity and poor controlof transit traffic

Administrative reorganization, of tax Tax revenue collection highly Establish a steering committee headed March 1999administration, donor-funded training constrained by ineffective management by the chairman STDG withand computerization programs structure, lack of strategic focus on representation from technical assistanceunderway large taxpayers, inaccurate registration, providers to coordinate and monitor

weak enforcement capacity, poor job technical assistancedefinitions, and lack of efficiencytransparency and accountability Introduce a new management structure June 1999

Restructure STDG along functionallines to separate assessment, collectionand audit

All tax administration employees to May 1999submit their declarations of income andassets.

Strengthen the Large Taxpayers March 1999Inspectorate (LTI) to function as a fullserve tax office for the largest taxpayers

Expand the coverage of the LTI to cover July 199950 percent of STDG revenues

Audit list of outstanding debts, and April -June1 999prioritize by size and likelihood of quickrecovery

Implement the program of work to Continuousexpand the tax base and reduce taxarrears

Identify and undertake actions against Continuousworst tax offenders and provide IDAwith periodic reports on progress with

1

Annex 3Georgia: Third Structural Adjustment Credit

Policy MatrixObjectives | Current Status Issues SAC III Measures Timetable

dealing with delinquent taxpayers

Strengthen expenditure Reorganization of Ministry of Finance Inadequate organizational and Institutional strengthening of the May 1999Management along functional lines underway. management structure in the Ministry Ministry of Finance. Issue agreed

Computer data-base accounting for all of Finance (MOF). Lack of regulations/instructions regarding (i)revenue receipts and disbursement of management accountability or aims and objectives for the MOF; (ii)expenditures set up in Treasury. performance management within the formation of a Policy/Strategy GroupSingle Treasury bank account Ministry. Poor coordination between within the Ministry; (iii) nomination ofestablished in NBG to receive all departments. Inequitable revenue a senior person from the MOF to bemonies paid to the State. New allocation between spending units. responsible for institutional reform andprocesses for agreeing monthly Difficulties in reconciling revenue for liaising with the CSB, (iv) jointspending totals between Treasury and collection and assessment. Revenue work between the MOF and the CSB onspending ministries and their sub-units payments put to short term use by reform issues; and (v) more effectiveestablished. All invoices for goods banks before being made available to use of technical adviceand services cleared through Treasury Treasury. Ad hoc development of newso that they can be reconciled against technology for financial management Complete reorganization of MOF. June 1999appropriate expenditure plans. New within the ministry and associated Establish the new structure defining thesystem of allocating revenue to bodies (tax and customs) responsibilities of eachexpenditure plans based on a departmentldivisioncomputerized matrix is beingintroduced. Matrix operates on two Establish job definitions for each post. June 1999parameters: Economic and functional Implement new managementcategories performance monitoring system setting

objectives and performance targets

Treasury and MOF staff to work May 1999together to establish lines ofaccountability within spendingministries/entities by identifyingaccounting officers and calling forreports with the objective ofestablishing an effective expendituremonitoring mechanism first for healtheducation and poverty benefit and thenfor overall budget

Establish three coordinating groups May 1999(data management, expendituremanagement, borrowing and debt)

2

Annex 3

Georgia: Third Structural Adjustment CreditPolicy Matrix

Objectives Current Status Issues SAC III Measures Timetable

Establishment and strengthening of the June 1999Personal Office of the Minister ofFinance. Issue orders on the basis ofagreed recommendations on (i) thefunctions and structure of the Office; (ii)broad functional division ofresponsibilities of structural units andstaff of the Office; (iii) staffing levelsfor the Office; (iv) implementingregulations; and (v) transparentprocedures for recruitment of the staff

Complete staff recruitment and training June 1999for Personal Office of the Minister

Prepare a global strategy and action plan September 1999with defined benchmarks on use of newtechnology for financial management toensure proper interface betweencomputer systems

Complete implementation of the action December 2000plan

Ensure the provision of basic Economic categories include primary Inadequate budgetary execution Use the computerized matrix to Continuoussocial services core allocations, Non-core allocations accumulation of arrears to health and implement the new system of allocating

and capital allocations. Functional education spending units. Inadequate revenues to expenditure planscategories (representing spending budgetary allocation and execution forministries and their sub-units) grouped the poverty benefit Include health, education and poverty March 1999in three priority zones. Matrix benefit within the primary coreprovides protocol operation to ensure allocation category. Allocate 7.3allocation to priority expenditure. percent of the overall consolidated 1999

budget to the health sector and 13percent to the education sector.Allocate 14.3 million lari to the povertybenefit

Apply the same ratios to health and December 1999education for the allocations in the 2000Budget and ensure that the allocation tothe Poverty Benefit remains at leastconstant in real terms.

3


Policy MatrixObjectives Current Status Issues SAC III Measures Timetable

Implement the special monitoring Continuousmechanism for social expenditures

Remain current in budgetary execution 1999-2000of the health, education and povertybenefit expenditures

B. Creating an EnvironmentFavorable to Private SectorDevelopment

Enhance the business Law on licensing enacted in May There are more than 300 licenses. The Submit Law on Fees to parliament September 1999environment 1999, to be followed by laws on fees, regulatory burden of the existing satisfactory to IDA

certification and accreditation regime is a hindrance to private sectorIntroduce a simplified and development, promotes rent-seeking, Promulgate a set of procedures June 1999transparent licensing regime and reduces collection of budgetary satisfactory to IDA to implement the

revenues Law on Licensing

Develop interim regulations for June 1999formerly licensed activities that are tobe made subject to non-licensing formsof state regulation

Submission by ministries of draft July 1999licensing regulations to the Ministry ofJustice

Drafting of procedures for maintenance July 1999of the Licensing Registry

Conduct baseline survey to measure September 1999existing burden of licensing

Promulgate agreed requirements for August 1999form and contents of annual reports onlicensing to be furnished (a) by theimplementing ministries to the Ministryof Justice and (b) by the Ministry ofJustice to Parliament and President

4



Adoption of annual reporting August 1999requirements through appropriatePresidential Decree

Complete training of Ministry of Justice September 1999and other Ministry personnel in newLaw and regulations

Follow-up survey to measure impact of December 1999 and everylicensing reform three months thereafter

Develop principles on which to base June 1999laws on Certification and Accreditationto follow up Law on Licensing

Enactment of Laws on Fees March 2oooCertification and Accreditation

Introduce a transparent regime to New law on State Procurement Ad-hoc and non transparent Enactment of new law on State December 1998regulate state procurement, adopted in December 1998 procurement practices Procurement satisfactory to the IDAcontrol procurementexpenditures, and enable private Issue implementing regulations June 1999companies to compete for satisfactory to IDAGovemment orders on a levelplaying field Issue a Presidential Decree appointing April 1999

the Director of the new Department ofState Procurement and approveregulations of the Department

Complete competitive recruitment of End-June 1999Department's other staff

Complete staff training for Department September 1999of State Procurement

Develop and promulgate country- September 1999specific bidding documents

5



Identify and train staff of implementing September-December 1999ministries and regional/local procuringagencies

Identify three largest procuring agencies September 1999at central and local levels, and for each,ensure that at least one procurement isdone according to the new proceduresby December 1999

Establish and apply other benchmarks to December 1999ministries with large procurementbudgets, to monitor the implementationof the new procurement regime

Reduce cost of entry, especially Law on Entrepreneurs stipulates Current registration system is not Eliminate the requirement to obtain a June 1999for small business registration steps and procedures conform to dispositions under the law stamp/seal from the local police

Eliminate the regulation of the NBG June 1999prohibiting commercial banks to opennew account for new business without aseal

Eliminate the active role of the June 1999Department of Statistics in theregistration process

C. Reform Land Ownership

Stimulate agricultural production Two Laws govern the transfer of The law "On Administration and Start registration of privatized November 1998and the development of real ownership rights over land were Disposition of State-owned Non- agricultural and enterprise land (done)estate and financial markets enacted in 1998: agricultural Land" presents several

Law "On Declaration of Private shortcomings and may give rise to Amend the law "On Administration and June 1999Ownership of Non-agricultural Land conflict of interests Disposition of State-owned Non-in Use of Physical and Private legal agricultural Land" to promotePerson."; and law "On Administration privatization over leasing, provide forand Disposition of State-owned Non- the organization of future privatizationagricultural land through a competitive process, and

enhance transparency by carefullydefining the privatization mechanism

.______. _____ ._____._____._ _______and_________delim iting___ _____________________the________ andodelimitingsthe roles fofntheh relevant relevants_of_the_relevan

6



public bodies. Adopt implementingregulations satisfactory to IDA

Issue regulations and operating June 1999procedures for agricultural land titlingregistration system

D. Divestiture FromProductive Activities

Promoting Private Participation Government strategies for Inconsistency between Privatization Amend Privatization Law to permit December 1998in Infrastructure infrastructure privatization (e.g., Law and Decree on Strategic Plan for privatization of:

energy, telecommunications, Poti port, Privatization * Telecommunicationsrailways) are under development * Postal services

* Radio and television broadcasting* Railways* Water and sanitation systems* Airports* Gas distribution pipelines* Ports* Roads (with parallel state roads)

1 0-year maximum term for leases and Amend relevant laws or regulations to End-July 1999required minimum annual payments of eliminate maximum lease terms and10% of remaining book value could minimum paymentsimpede concession agreements forinfrastructure projects

Facilitating Overall PrivatizationProgram

To provide adequate Efforts underway to improve Need for better coordination between Create a Permanent Oversight September 1998coordination and encouragement coordination and public line ministries and MINSPM Committee - including MINSPM,for potential investors information/marketing MOF, President's office on regular basis

and line ministers as needed - to securecooperation and support from all official

bodies

7



Potential investors may need more time Amend tender procedures for major March 1999to conduct due diligence and prepare enterprises likely to be of interest toinvestment proposals foreign investors, allowing up to 4

months for potential investors to submitproposals

Need for more extensive dissemination Expand public information/marketing December 1998of information on privatization efforts to include regular advertisements (Continuous)opportunities in national newspapers, press

conferences, television, internet, andforeign and overseas embassies

Prepare privatization strategies with (ongoing)adequate treatment of regulatory andprivatization policies for allinfrastructure sub-sectors, beforeinitiating the transaction process

Hire financial and legal advisors to end August 1999assist in the privatization oftelecommunication enterprises

Submit to IDA non-objection a end October 1999satisfactory privatization strategy andtimetable and a regulatory frameworkfor the telecommunication sector

Submit to IDA non objection a end September 1999satisfactory development strategy andregulatory framework for Poti PortRecruit financial/legal advisors for the end February 2000implementation of the developmentstrategy for Poti Port includingstructuring concessions arrangementsfor port operations

Completing Privatization ofMedium/Large (Non-Infrastructure) Enterprises

To complete the transfer of Private sector is better able to derive Complete "zero price" bidding for 244 March 1999viable enterprises and productive and increase value from share companies

8



assets to private-sector owners ownership. Consistent over-estimationand managers as rapidly, of share values (e.g., 20x) results in Announce and provide results to share March 1999transparently, and profitably as repeated auctions/lenders. Auction registrarspossible prices have averaged 5% of book value

Complete "zero price" bidding for an June 30, 1999additional 60 companies (32 are alreadycompleted)

Announce and provide results to share June 30, 1999registrars

Privatization proceeds have beendiminished by the following:

* Non-inclusion of land withenterprise sales

* Hidden liabilities NINSPM and MOF will (a) limit an Ongoingenterprise's maximum liabilities tothose known at the time of theprivatization transaction, (b) assumeresponsibility for hidden or excessliabilities, and (c) act to control creationof additional liabilities and assetstripping at enterprises.

Inadequate capacity within MINSPM MINSPM will create a Resolution Unit May 5, 1999to assess enterprise viability and within MINSPM to sell assets and settleliquidate non-viable enterprises through liabilities for companies that are notasset sales viable or for which there is no investor

interest.

Need for structured and purposeful MINSPM commitment to a time-boundprogress on the privatization of Tier I schedule for privatizing Tier Icompanies companies:

* Assess and categorize each as (a) July 15, 1999viable and suitable for tendering asis, (b) partly viable, but with

9


Policy MatrixObjectives | Current Status t Issues SAC III Measures Timetable

substantial excess assets; or (c)non-viable

* For viable/suitable companies, July 30, 1999issue tenders to pre-identifiedpotential investors and/or advertiserequests for proposals. The tenderpackage may provide only non-binding guidelines (e.g., forinvestment and employmentguarantees)

* For partly viable/excess assets August 30, 1999companies, "carve out" excessassets and associated liabilities andassign these to the Resolution Unit.Enterprise preparation will belimited to this "carve out." TheGovernment will not engage inoperational restructuring oradditional investment

* For non-viable companies, all May 30, 1999assets/liabilities will be assigned tothe Resolution Unit

* Following "carve out" of December 1, 1999assets/liabilities, remaining viableenterprises will be tendered

* All offers will have been received.Companies for which no offers are December 7, 1999received will be assigned forauction

* Conclude tender negotiations orassign company shares for auction. January 30, 2000Potential investor from anunsuccessful tender negotiationwould be precluded fromsubsequent auction

* At least 20 companies will have February 28, 2000been privatized by tender, auction,or asset sale/liquidation

10



Need for timely progress toward MINSPM commitment to a time-boundprivatization for Tier II companies program for privatizing Tier II

companies:* Special auctions announced May 15, 1999* Bidding begins June 15, 1999* Completion of "zero price" August 1, 1999

auctions for 15 companies* For successful companies, auction August 15, 1999

results publicized and forwarded toshare registrars

* Remaining companies have been December 31, 1999privatized by auction or assetsale/liquidation

The Ministry will submit a quarterly Continuousimplementation report detailing theprogress made on the program throughthat date.

Improve the efficiency and Hospital master Plan under Overcapacity and lack of efficiency in Submit a Statement of Intent June 1999quality of health infrastructure preparation the health sector satisfactory to IDA describing theand services by optimizing the Hospital Restructuring Program foruse of existing resources Tbilisi

Satisfactory implementation of the ContinuousHospital Restructuring Program

11

Annex 4Schedule A

REPUBLIC OF GEORGIA

THIRD STRUCTURAL ADJUSTMENT CREDIT

Timetable of Key Processing Events

1. Time taken to prepare: 7 months

2. Prepared by: Govermnent of Georgia with theAssistance of IBRD/IDA staff

3. Pre-appraisal mission: November 1998

4. Negotiations: May 26, 1999

5. Planned Board presentation June 29, 1999

6. Planned date of effectiveness: August 31, 1999

7. Expected program completion: September 30, 2000

Annex 5

MOP Schedule D

Status of Bank Group Operations in GeorgiaOperations Portfolio

As of 31-May-99

Difference Betweenexpected

Original Amount in USS Millions and actualFiscal disbursements a/

Project ID Year Borrower PurposeIBRD IDA Cancellations Undisbursed Orig Frm Rev'd

Number of Closed Projects: 5

Active ProjectsGE-PE-50911 1999 REPUBLIC OF GEORGIA INTEG. COASTAL MGT 0.00 4.40 0.00 4.34 .12 0.00GE-PE-56514 1999 GEORGIA TRNSPT MIN RESTRUCT. 0.00 2.30 0.00 2.44 1.54 0.00GE-PE-8416 1999 GOVERNMENT OF GEORGIA ENTERPRISE REHABIL. 0.00 15.00 0.00 14.90 0.00 0.00GE-PE-39929 1998 GOVERNMENT OF GEORGIA SOCIAL INVEST. FUND 0.00 20.00 0.00 17.30 5.39 0.00GE-PE-50910 1998 GEORGIA MUNICIPAL DEV. 0.00 20.90 0.00 18.61 7.74 0.00GE-PE-51034 1998 GOVERNMENT OF GEORGIA SATAC II 0.00 5.00 0.00 1.50 1.38 0.00GE-PE-55573 1998 GOVERNMENT OF GEORGIA CULTURAL HERITAGE 0.00 4.49 0.00 4.23 1.22 0.00GE-PE-35784 1997 GOVERNMENT OF GEORGIA POWER REHAB. 0.00 52.30 0.00 2.70 -3.17 0.00GE-PE-44830 1997 GOVERNMENT OF GEORGIA OIL INSTITUTION BLDG 0.00 1.40 0.00 .56 .23 0.00GE-PE-8415 1997 GOVT. OF GEORGIA AGRICULTURE DEVELOP. 0.00 15.00 0.00 6.73 -3.52 0.00GE-PE-39892 1996 GOVERNMENT OF GEORGIA TRANSPORT 0.00 12.00 0.00 .09 .88 0.00GE-PE-8414 1996 GOVERNMENT OF GEORGIA HEALTH 0.00 14.00 0.00 9.46 8.19 0.00GE-PE-8417 1995 MINISTRY OF FINANCE MUNICIPAL INFRA. REH 0.00 18.00 0.00 1.02 2.65 0.00

Total 0.00 184.79 0.00 83.88 22.65 0.00

Active Projects Closed Projects TotalTotal Disbursed (IBRD and IDA): 97.44 213.56 311.00

of which has been repaid: 0.00 0.00 0.00Total now held by IBRD and IDA: 184.79 209.90 394.69Amount sold : 0.00 0.00 0.00

Of which repaid : 0.00 0.00 0.00Total Undisbursed : 83.88 .01 83.89

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.

Note:Disbursement data is updated at the end of the first week of the month and is currently as of 30-Apr-99.

Generated by the Operations Information System (OIS) Page I

Georgia at a glance Annex 6

Europe & Lower-POVERTY and SOCIAL Central middle-

Georgia Asia income Development diamond*1997Population, mid-year (millions) 5.4 476 2,285 Life expectancyGNP per capita (Atlas method, US$) 840 2,320 1,230GNP (Atlas method, US$ billions) 4.5 1,106 2,818

Average annual growth, 1991-97

Population (V.) -0.2 0.2 1.2 GNP GrossLaborforce (%/6) 01 5 13primary

Most recent estimate (latest year available, 1991-97) capita enrollment

Poverty (% of population below national poverty line) 30Urban population (% of total population) 58 67 42Life expectancy at birth (years) 73 69 69Infant mortality (per 1, 000 live births) 18 25 36Child malnutrition (% of children under 5) Access to safe waterAccess to safe water (% of population) .. .. 84Illiteracy (% of population age 15+) 1 .. 19Gross primary enrollment (% of school-age population) 86 92 111 Georgia

Male 116 Lower-middle-income groupFemale 113

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1976 1986 1996 1997Economic ratios'

GDP (US$ billions) .. .. 4.6 5.2Gross domestic investment/GDP .. 29.9 6.0 6.7 TradeExports of goods and services/GDP .. .. 11.2 11.9Gross domestic savings/GDP 29.8 -1.8 -4.2Gross national savings/GDP 2.3 1.9

Current account balance/GDP . -9.1 -10.2 Domestic InvestmentInterest payments/GDP . 1.4 0.8 SavingsTotal debt/GDP 30.1 29.6Total debt service/exports 15.3 13.9Present value of debt/GDP . 23.9 19.1Present value of debt/exports 213.4 208.9

Indebtedness1976-86 1987-97 1996 1997 1998-02

(average annual growth)GDP . . 105 10.9 7.6 -GeorgiaGNP per capita .. .. 12.7 12.8 8.1 Lower-middle-income groupExports of goods and services .. .. 17.8 18.4 12.2

STRUCTURE of the ECONOMY1976 1986 1996 1997 Growth rates of output and investment I%)

(% of GDP) , sAgriculture .. 26.8 33.4 3136Industry .. 37.0 25.1 23.4 75-_

Manufacturing .. 27.8 18.8 17.5 0 _0Services 36.2 41.5 45.0 -75 s 97

Private consumption .. 57.4 92.7 95.2 -150 -General government consumption . 12.8 9.1 9.0 0GDl iGDP

Imports of goods and services 18.9 22.7

1976-86 1987-97 1996 1997 Growth rates of exports and imports 1%)(average annual growth)Agriculture .. .. 3.0 3.5 45 -Industry - . 2.0 2.0 30.

Manufacturing .. 2.0 2.0 15SServices .. 16.8 17.2

Private consumption .. 2.2 15.4 15 92 93 94

General government consumption .. 40.0 10.9Gross domestic investment .. 57.0 90 9 -30 -Imports of goods and services .. 9.7 39.2 - Exports CI2Imports

Gross national product 4.4 -16.5 12.7 11.2 2

'The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

Georgia

PRICES and GOVERNMENT FINANCE1976 1986 1996 1997 Inflation (%)

Domestic prices(% change) 20,000 -

Consumer prices . . 394 7.1 15,000 7Implicit GDP deflator 0.5 6.1 40.2 7.1 10,000

Government finance 5,000(% of GoP, inc/udes current grants] a r _

Current revenue .. .. 8.1 9.9 92 93 94 95 9S 97

Current budget balance . .. -4.6 -3.5 - GDP deflator CPI

Overall surplus/deficit .. .. -5.8 -4.6 1

TRADE1976 1986 1996 1997 Export and import levels (USS millions)

(USmillions)Total exports (fob) .. 463 559 1,DDD T

Black metal .. .. 80 101Tea .. .. .19 24 750.

Manufactures .. .. 231 236Total imports (cif) .. .. 768 947 soo t

Food . .. 213 154 2Fuel and energy 184 196Capital goods .. .. 129 330 0

91 92 93 94 95 96 97Export price index (1995=100)Import price index (1995=100) .. .. 2. Exports w ImportsTerms of trade (1995=100) .. _.._.._..

BALANCE of PAYMENTS

(US$Smillions) 1976 1986 1996 1997 Current account balance to GDP ratio (%)

Exports of goods and services .11 623 oImports of goods and services 8. .. 67 1,192 91 92 93 tr

Resource balance . -356 -569 -> i

Net income .. .. -62 34Net current transfers .. .. 141 188 -20.

Current account balance .. .. -418 -535 30

Financing items (net) .. . 339 474Changes in net reserves .. .. 79 61 40 -

M.emo:Reserves including gold (US$ millions) .. .. 159 175Conversion rate (DEC, local/US$) .. .. 1,263.0

EXTERNAL DEBT and RESOURCE FLOWS1976 1986 1996 1997

(US$ millions) Composition of total debt, 1996 (US$ millions)

Total debt outstanding and disbursed .. .. 1,378 1,550IBRD 0 0 F 10IDA .. .. 157 212 B 157

Total debt service .. . 49 53IBRD 0 0 19

IDA I 1

Composition of net resource flowsOfficial grants .. .. 141 84 D: 13Official creditors .. .. 186 192Private creditors .. .. 0Foreign direct investment 54 189 E.995Portfolio equity . .. 0 0

World Bank programCommitments .. 91 155 A - IBRD E - BilateralDisbursements 76 64 B - IDA D - Other multilateral F - PrivatePrincipal repayments 0 0 C -IMF G - Short-termNet flows 76 64 1

Interest payments 1 1Net transfers .. .. 76 63

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