Document of The World Bank...related governance challenges will be difficult given Georgia’s current political cycle. There is significant political fragmentation, and electoral

Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 26931-GE

MEMORANDUM OF THE PRESIDENT

OF

THE INTERNATIONAL DEVELOPMENT ASSOCIATION

AND

THE INTERNATIONAL FINANCE CORPORATION

TO

THE EXECUTIVE DIRECTORS

ON A

COUNTRY ASSISTANCE STRATEGY

FOR

GEORGIA

NOVEMBER 6,2003

South Caucasus Country Unit Europe and Central Asia Region

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

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

APL BBP CAS CFAA CIS CPIA DFID DSA EBRD EDPW EU F A 0 FDI FIAS FSAP FSU FY GDP GEF GEL GNP GoG GTZ Ha HIPC IDA IDF IDP IFC IFAD

CURRENCY EQUIVALENTS (Exchange Rate Effective October 7, 2003)

Lari = US$0.473 US$l.O = 2.113 Lari

Currency Unit = Lari

GOVERNMENT FISCAL YEAR January 1 to December 3 1

WEIGHTS AND MEASURES Metric System

ABBREVIATIONS AND ACRONYM

Adaptable Program Loan Basic Benefits Package Country Assistance Strategy Country Financial Accountability Assessment Commonwealth o f Independent States Country Policy and Institutional Assessment Department for Intemational Development, U.K. Debt Sustainability Analysis European Bank for Reconstruction & Development Economic Dev’t & Poverty Reduction Program European Union Food and Agriculture Organization Foreign Direct Investment Foreign Investment Advisory Service Financial Sector Assessment Program Fonner Soviet Union Fiscal Year Gross Domestic Product Global Environment Facility Georgian Lari Gross National Product Government of Georgia Geman Technical Cooperation Hectare Heavily Indebted Poor Country Intemational Development Association Institutional Development Fund Intemally Displaced Persons

IMF JBIC KfW LIL MIGA MoF NBG NGO NPV OECD PER PIU PPP PRGF PRSP PSD SAC SATAC SDS SEC SIDA SIF SME SRS TACIS UNDP UNHCR USAID

Intemational Monetary Fund Japan Bank for Intemational Cooperation Geman Development Bank Learning and Innovation Loan Multilateral Investment Guarantee Authority Ministry of Finance National Bank of Georgia Non-Govemmental Organization Net Present Value Organization For Economic Coop’n & Development Public Expenditure Review Project Implementation Units Purchasing Power Parity Poverty Reduction and Growth Facility Poverty Reduction Strategy Paper Private Sector Development Structural Adjustment Credit Structural Adjustment Technical Assistance Credit State Department of Statistics Security and Exchange Commission Swedish Intemational Development Agency Social Investment Fund Small and Medium Enterprises Structural Reform Support Project Technical Assistance to the CIS (ELI) United Nations Development Program United Nations High Commissioner for Rehgees United States Agency for Intemational Development

Intemational Finance Corporation VAT Value Added Tax Intemational Fund for Agricultural Development WTO World Trade Organization

The World Bank Group Team IDA IFC

Vice President: Shigeo Katsu Country Director: Donna M. Dowsett-Coirolo Team Leaders: Peter NicholasKhristian Petersen

Vice President: Assaad Jabre Country Director: Edward Nassim Team Leaders: Anna AkhalkatsiLisa Kaestner

FOR 0FFICL-C USE ONLY GEORGIA

COUNTRY ASSISTANCE STRATEGY

Table o f Contents EXECUTIVE SUMMARY ............................................................................................................................... i I . INTRODUCTION ................................................................................................................................. 1 II . THE COUNTRY CONTEXT ................................................................................................................. 1

Economic and Political Background ..................................................................................................................... 1 MacroeconDmic Performance and Growth Prospects ......................................................................................... 2 Poverty Trends and the MDGs .............................................................................................................................. 8 Govemance ............................................................................................................................................................ 12 THE WORLD BANK GROUP’S TRACK RECORD IN GEORGIA ...................................................... 15 IDA’S Country Portfolio and Non-Lending Program ....................................................................................... 15 Lessons learned ..................................................................................................................................................... 18 GEORGIA’S ECONOMIC DEVELOPMENT AND POVERTY REDUCTION PROGRAM ...................... 19 THE WORLD BANK GROUP’S COUNTRY ASSISTANCE STRATEGY .............................................. 20 FY04-06 CAS Objectives and Focus .................................................................................................................. 20 (i) Faster and More Broad-Based Private Sector Growth ................................................................................. 20 (ii) Promoting Human Development, Social Protection. and Protecting the Environment .......................... 24 (iii) Improving Govemance and Eficiency o f Public Expenditures ............................................................... 25 Assistance Scenarios and Triggers ...................................................................................................................... 27 IMPLEMENTING THE CAS .............................................................................................................. 29 Strategic Considerations ....................................................................................................................................... 29 Outcomes and Monitoring ................................................................................................................................... 31 CAS Consultations ................................................................................................................................................ 33 Development Partners .......................................................................................................................................... 34

.

Iv . V .

V I .

ATTACHMENT I: IMF-IDA RELATIONS ................................................................................................. 38 ATTACHMENT 11: DEVELOPMENT PARTNERS IN GEORGIA ................................................................. 42 ATTACHMENT 111: CORE LABOR STANDARDS IN GEORGIA ................................................................ 43 & W E X I : COWTRYATA GLANCE ........................................................................................................ 44 A”EX.2: PORTFOLIO INDCATORS ........................................................................................................ 46 h N E X 3 : WORLD BANK GROUP PROGRAMSLMMARY ....................................................................... 47 &WEX 4: SMMARY OFNON-LENDINGSER WCES ............................................................................... 48 ANNEX5 SOCIAL INDICA TORS ............................................................................................................... 49 &WEX 6: ~ Y E C O N O M I C I m I C A T o R s .............................................................................................. 50 &WEX 7: mYEXPOSUREINDICA TORS ................................................................................................. 53 &WEX8: OPERA TIONSPOR~FOLIO ....................................................................................................... 54 A ~ E x ~ : CAS PROCRAMMATRIX ........................................................................................................ 56 AMVEX 10: CAS SUMMARY OF DE VEL OPMENT PMORITIES ................................................................ 65

This document has a restricted distribution and may be used b y recipients only in the performance o f their official duties . I t s contents m a y not be otherwise disclosed [without W o r l d B a n k authorization .

FIGURES Georgia: Index o f Sectoral Growth .................................................... 3 Georgia: Perceptions o f the Business Climate 2002 ................................ 13

Figure 1: Figure 2:

Table 1: Table 2: Table 3: Table 4: Table 5: Table 6: Table 7 : Table 8: Table 9:

Box 1:

TABLES Georgia: Selected Macroeconomics Indicators ......................................... 2 Impact of BTC and SCP ................................................................... 3 External Debt Indicators ........................................................................... 5 Change in Poverty between 1997 and 2002 ............................................. 8 Millennium Development Goals ........................................................ 11 Proposed Lending Program ............................................................. 28 Non-Lending Services Underway and Planned ....................................... 29 Lending Triggers ........................................................................................ 30 Core CAS Monitoring Benchmarks ........................................................... 32

BOXES Baku-Tbilisi-Ceyhan Pipeline .......................................................... 22

EXECUTIVE SUMMARY

1. Economic, Poverty and Governance Trends. Georgia is a small transition economy with a population o f about f ive mi l l ion people and a per capita GDP o f US$700. In Soviet times, Georgia exported agricultural and energy-intensive industrial products, and enjoyed a fairly high standard o f living compared with neighboring republics. After independence in 1991, however, the economy collapsed under the impact o f c iv i l war and the loss o f both preferential access to FSU markets and large budget transfers from Moscow. In the last five years, the Russia crisis, droughts and an earthquake have further buffeted Georgia. In amongst these shocks there have been br ief periods o f strong GDP growth, leading to a cumulative economic expansion o f 45 percent since 1995, as the private sector has taken some advantage o f economic liberalization. Nonetheless, GDP i s s t i l l only about one-third o f its 1990 level, despite the strong export potential residing in Georgia’s competitive labor force, good natural resource base and geographic position as a major transit route. Unemployment remains high and much economic activity resides in a large and growing informal sector. In the circumstances, poverty, vulnerability and inequality have al l increased over the period. While some indicators o f the business environment have improved in recent years, governance is today acknowledged by the authorities, donors and stakeholders to pose important constraints o n Georgia’s prospects o f attracting adequate private sector investment to support sustainable growth and implementation o f i t s recently completed PRSP. .. 11. Over the past decade, Georgia has made quite good progress on policy reform, including trade liberalization, legal and regulatory reform, privatization and competition, banking sector restructuring, and judicial and health sector reforms. However, these successes have often been diluted by weak implementation, in turn due partly to weak fiscal management and public sector capacity. Budget management in particular needs to be strengthened to improve the link between overall resource allocation and sector objectives, programs and policies. Progress in implementing Georgia’s PRSP will also require improvements in the very l o w revenue collection rate that currently compromises the Government’s ability to implement priority programs, as we l l as management o f the country’s fairly large external debt situation. Tackling these and related governance challenges will be difficult given Georgia’s current political cycle. There i s significant political fragmentation, and electoral politics are likely to dominate the agenda, as President Shevardnadze’s second and final term ends in April 2005.

iii. FY04-06 CAS Program. Georgia has recently completed i ts PRSP, known as the Economic Development and Poverty Reduction Program (EDPRP). The EDPRP focuses on f ive strategic pillars: governance, fiscal management, the business environment, human capital, and reducing the vulnerability o f the poor. I t also includes specific measures to improve major productive sectors o f the economy, the natural environment, post-conflict zones, and science and technology. The EDPRP serves as the organizing framework for the FY04-06 CAS, which will focus on (i) attaining faster and more broad-based growth, (ii) developing and strengthening human capital and strengthening public sector management, and (iii) improving governance and institutional capacity .

iv. M u c h o f the work in these areas will take place through IDA’S and IFC’s large and, despite the difficult environment, s t i l l fairly sound ongoing portfolios in Georgia, complemented

by Base Case lending o f up to $78 million, and by AAA and non-lending activities, including IFC’s advisory and linkages programs, designed to help build the foundation for institutional and policy renewal. This level o f lending i s significantly lower than in FYO1-03 ($168 million) and FY98-00 ($295 million). Given the aforementioned political cycle, i t may be dif f icult for Georgia to achieve a High Case scenario until the latter part o f this CAS period. Such a scenario would require significant improvements in governance, and would include an acceleration o f planned support for improving public sector management and a first PRSC, or a programmatic adjustment credit, for total IDA lending o f up to $100 million. The Base Case would be conditioned mainly on monitorable progress in governance, satisfactory macroeconomic performance, progress in initiating implementation o f the EDPRP, and continued good portfolio implementation. A L o w Case o f $45 m i l l i on i s envisaged if governance reform, macroeconomic management or the IDA portfolio deteriorates.

v. Risks. The strategy outlined above faces five kinds o f risks. First, if the governance

dialogue, lending and nonlending activities are focusing on this as a top priority. A second risk i s that o f a renewed weakening o f fiscal performance, with a consequent inability to maintain basic social services and manage external debt obligations. The IMF i s providing intensive advice to Georgia on fiscal policy, and IDA and other partners have offered, or are providing, assistance o n budget management and reform o f tax and customs administration. Progress in this area i s required to allow Georgia to return to the Paris Club for discussions o n further debt rescheduling. Third, Georgia remains vulnerable to both internal and external conflicts. Enhanced regional cooperation will be important to increase central government revenues, and for Georgia to maximize i t s potential as a transit economy and strengthen foreign investment, tourism and trade. Fourth, Georgia is, and will remain, vulnerable to external shocks. CAS interventions promoting energy development, irrigation and rural development, and diversifica- t ion o f Georgia’s trade patterns should help lessen the country’s vulnerability to these shocks over the medium-term. Finally, the period up to the April 2005 Presidential elections i s l ikely to be one o f considerable political uncertainty, with the direction o f pol icy before and after the elections being difficult to predict. IDA will engage in a broad dialogue with al l stakeholders during this period, and will support the EDPRP consultation process in an effort to build consensus o n the country’s main development challenges and opportunities. A CAS Progress Report wil l be presented to the Board after the Presidential elections if there has been sufficient change that circumstances warrant a review o f the assistance strategy.

climate does not improve, it will be dif f icult to carry out the EDPRP effectively. IDA’S policy -

vi. Issues for Discussion. The fol lowing issues are suggested for Board discussion:

0 I s the assistance strategy sufficiently selective and appropriate given the dif f icult governance climate?

0 I s it warranted to restrict PRSC or programmatic adjustment lending to the High Case?

MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION

AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON THE

COUNTRY ASSISTANCE STRATEGY FOR GEORGIA

I. INTRODUCTION

1. This joint IDA and IFC Country Assistance Strategy covers the three-year period from FY04 to FY06. It identifies key issues in Georgia’s economic and social development, reviews performance under the previous CAS, and discusses a selective program o f lending and non- lending operations under different scenarios o f risk and performance. The FY98-00 Georgia CAS (Report 17000-GE) was discussed by the Executive Directors in October 1997. A subsequent CAS was drafted in FYOl but was delayed as Georgia began work on i t s Poverty Reduction Strategy Paper (PRSP); a revised version was prepared in FY02 but was also delayed over concerns that broad changes in composition o f the Cabinet might signal shi f ts in policy directions, which ultimately did not materialize. The current CAS takes into account Georgia’s now completed PRSP, known as the Economic Development and Poverty Reduction Program (EDPRP). It has benefited from continuing close dialogue with government authorities, other national stakeholders and international development partners, both on the priorities for Bank Group assistance and on the EDPRP.

11. THE COUNTRY CONTEXT Economic and Political Background 2. Georgia i s a small transition economy with a population o f about five mill ion people and a per capita GDP o f US$700. In Soviet times, Georgia exported agricultural and energy- intensive industrial products to the former Soviet Union, and was a popular tourist destination for the region. After independence in 1991, the economy collapsed under the impact o f c iv i l war and the loss o f both preferential access to FSU markets and large budget transfers from Moscow. Output f e l l by 70 percent and exports by 90 percent, the worst decline suffered by any transition economy.

3. Immediately after independence in April 1991, a c iv i l war broke out in Georgia, followed by regional conflicts. By late-1 993, cease-fire agreements were reached with Abkhazia (brokered by the United Nations and Russia) and South Ossetia. The conflicts le f t a significant toll, with about 300,000 people displaced, much physical capital destroyed, important trade routes disrupted, and the new State’s authority undermined to this day in large segments o f the territory. To varying degrees the Government s t i l l lacks control both in Abkhazia and South Ossetia, and in Adjara (an autonomous region in western Georgia). In addition, the spill-over f iom the conflict in Chechnya has weakened Georgia’s control o f the Pankisi Gorge and surrounding territory, where rampant smuggling, extortion and kidnapping have taken place.

4. By mid-1990 ’~~ Georgia had begun to recover from the collapse o f its economy after independence and the c iv i l war. Reform efforts acquired momentum and growth began to accelerate. Since then, however, progress has been affected by the Russian crisis, droughts, an

earthquake and internal political fragmentation. Nonetheless, amongst these shocks there have been brief periods o f strong growth, leading to a cumulative expansion o f the economy by 45 percent since 1995, as the private sector has taken some advantage o f economic liberalization. Competition in telecommunications, for example, has led to very favorable call charges. Public sector initiatives have also shown results where they have been adequately financed, and performance o f the IDA portfolio has been generally good despite a dif f icult operating environment. However, agriculture and industry, traditionally Georgia’s major sources o f exports and employment, have made only modest recovery f rom their post independence collapse. And while several indicators o f the business environment have improved in recent years, govemance is generally considered to be a major constraint on Georgia’s prospects for attracting foreign investment, achieving higher sustainable growth rates, and successfully implementing i t s E D P W .

Gross For. Reserves (Import Cover) 1.0 1.3 1.0 1.4 1.8 1.1 1.3 1.4 1.5 Note: Latest IMF estimates and projections suggest higher growth; an update will provided to the Executive Directors during their discussion o f the CAS Source: World Bank, IMF and Georgia State Department o f Statistics.

, e Estimated; Projected.

5. Political fragmentation threatens to undermine Georgia’s already fragile economic situa- t ion and reform efforts. Inability to provide the expected level o f economic and social services has weakened support for the Government both in Parliament (where the number o f political parties i s growing) and from society. Significant political uncertainty remains l ikely for the next 18 months. Parliamentary elections took place on November 2, 2003, and President Shevardnadze’s second -- and, by constitutional mandate, final -- t e r m ends in April 2005.

Macroeconomic Performance and Gro w t . Prospects 6. Growth Trends to Date. In 1994, fol lowing the post-independence economic collapse and hyperinflation, the Government launched stabilization and structural reforms aimed at restoring economic growth. The economic response to these reforms o f the mid-1990s was dramatic at first, with real GDP growth rebounding to an average o f 10.6 percent a year in 1996- 97. Adverse exogenous shocks (the Russia crisis and severe droughts in 1998-2000) caused growth to slow during 1998-2000, although it has rebounded to an average o f 5 percent during 2001-02. The annual rate o f inflation was brought down to single digits by 1997, and has since remained at around 5 percent, except for a br ief upswing in late 1998 and early 1999 when the Russian financial crisis triggered a substantial depreciation o f the Georgian Lari. The exchange rate regime i s fully liberalized, and the real exchange rate since has been roughly stable.

Table 1: Georgia: Selected Macroeconomic Indicators

Annual Real GDP Growth (“h) GDP Level (1 990=100) Average Annual Inflation, CPI (%) Money Supply Growth (“A) FDI (million USD) Budget Deficit, as YO GDP Tax Revenues, as % GDP Exports (GNFS) as % GDP Current Account, as Yo GDP

1998 1999 2.9 3.0

33.8 34.8 3.6 19.1

221.0 61.7

12.8 13.8 16.2 38.4

-1.2 20.7

-6.1 -6.7

-10.2 -7.8

2000 1.9

35.4 4.0

39.0 152.6

14.2 40.3 -5.7

-4.0

2001 4.7

37.1 4.7

18.5 79.9 -2.0 14.3 39.8 -5.6

2002e 2003p 2004p 2005* 5.3

39.1 5.6

17.9 129.9

-2.0 14.4 39.6 -6.0

4.8 41.7 4.4

14.2 31.5

15.8 46.0

-11.1

-1.4

4.5 43.6

5.0 15.3 33.8

0.2 16.6 45.0

-10.8

4.0 45.3

5.0 15.1 34.0 0.5

17.4 45.0

-10.4

2006p 4.0

47.1 5.0

15.4 36.0 0.0

18.2 45 .O -9.5

- 3 -

7. Agriculture, industry, trade and transport dominate the structure o f the Georgian economy. Agriculture i s the largest sector, accounting for just under 20 percent o f GDP and 50 percent o f employment, although its share in GDP has decreased steadily (from over 30 percent o f GDP in 1996). Industry contributes about 14 percent o f GDP and 6 percent o f employment, with its share changing litt le. The share o f transport and telecommunications has nearly tripled from 4.6 percent in 1996 to 12.1 percent

Figure 1. Georgia: Index of Sectoral Growth 6 Agriculture, F : e r \

I ~ Fishmg I

I2j0 I - I- Industry 11 X X

lmn I A Construction

-x-- Trade, Restaurant & Hotel services

1 m TransDon& I

Communications

-e-- Fmancial intermediation I

1996 1997 ' 1998 1999 2000 2001 2002 ' ~ +GDP Source: Georgia State Department ofStatistics I I

by 2002. Transport has been the fastest growing sector, growing at over 20 percent annually because o f the rapid expansion o f o i l transit f rom the Caspian Sea. Other fast growing sectors include construction and financial services. Trade has grown slightly faster than overall GDP.

8. As a transit country Georgia will earn revenues on B T C transit fees, which vary f rom US$0.12 per barrel for the first f ive years o f B T C operation, US$0.14 per barrel f rom year 6 to 16, and thereafter to a I

The Baku-Tbilisi-Ceyhan Pipeline (BTC).

Table 2: Impact of BTC and S C P maximum o f US$0.25 per barrel. When B T C nears i t s full capacity o f 1 mi l l ion barrels per day in 2009, the revenues to Georgia from B T C could be in the order o f US$36 mi l l ion per year. Georgia

2006 2007 2008 2009 Oil transit (million ton) 14.2 27.8 37.1 40.9 BTC transit Revenue (US$m) 12.4 24.3 32.5 35.8 Gas transit (bcm) 2.0 3.0 5.0 6.6 Value o f 5% o f gas (US$m) 5.5 8.3 13.8 18.2 Total Revenue/GDP (%) 0.4 0.7 0.9 1.1

- - and Azerbaijan have indicated-a willingness to participate in efforts to ensure transparent reporting o f earnings, and the Wor ld Bank Group will fo l low up and provide support for this during implementation and operation o f the B T C pipeline. At the same t ime the South Caucasus Pipeline (SCP) would transport about 6.6 bcm in 2009, o f which Georgia would be entitled to 5 percent. Assuming that this gas gets monetized, the revenue effect o f B T C and SCP together would be about 1 percent o f GDP.

9. Inflation and Fiscal Outlook. Assuming improved fiscal and monetary policies (a coherent economic program with particular emphasis on improved revenue collection), the fiscal deficit (on a commitment basis) i s projected o n average to remain below 0.5 percent o f GDP, and the cash deficit to average 1.0 percent o f GDP, assuming that the stock o f domestic arrears are fully cleared by 2009. The tax-to-GDP ratio for the general government is assumed to increase by 1.4 percentage points o f GDP in 2003, and by 0.8 percentage point each year thereafter, with central government revenue increasing f rom 8.5 percent o f GDP in 2000 to a st i l l very l o w 11.4

- 4 -

percent o f GDP by 2005. The average rate o f inflation i s projected to stay around 5 percent per year. Gross reserves are projected at 1.1 months o f imports in 2003, and to increase gradually to 1.8 months o f imports by 2007.

10. External Balances and Sustainability. Gross international reserves amount to a l i t t l e over one month’s imports, and the economy thus remains vulnerable to external shocks. Debt service obligations absorb more than one-third o f central government revenue. In addition, real interest rates, though declining, are still about 20 percent, reflecting high-risk premiums for lending activities. Off icial grants and loans through 2005 are projected to average US$59 and US$139 million, respectively.

1 1. The bulk of Georgia’s external debt was accumulated after independence during the early 1990s. By 1994, fol lowing the c iv i l war and economic collapse, nominal public debt had climbed to US$1 billion, or 81 percent o f GDP, much o f it stemming from energy sector borrowing. In the context o f macroeconomic adjustment and more limited borrowing, the pace o f indebtedness slowed during the second hal f o f the 1990s, although the debt continued to grow in absolute terms. By 1999, the debt stock had risen to US$1.7 billion, but the ratio to GDP had declined to 60 percent, fol lowing strong output growth in the second ha l f o f the decade. With l i t t le net borrowing, debt accumulation has further slowed in recent years, to a stock o f US$1.8 bi l l ion at end-2002.

12. FSU countries (especially Russia and Turkmenistan) accounted for 65 percent o f total claims in 1994, but their share had come down to 38 percent by 1998 and 31 percent by 2002. Claims by Paris Club creditors, excluding Russia, have been relatively l o w (around 10 percent) and have increased only slightly since 1994. In turn, the share o f IMF and World Bank claims has r isen steadily since 1994, reaching 37 percent in 1998 and 45 percent in 2002.

13. During 1995-98, Georgia’s bilateral debt was rescheduled through 1 1 independent country-specific deals. However, Georgia soon began to accumulate arrears on some o f the rescheduled debt. In 200 1, the Paris Club granted a flow rescheduling o f principal obligations o n “enhanced Houston terms.” These reschedulings have implied little rel ief in NPV terms. The N P V o f debt and scheduled debt service relative to exports are 148 percent and 23 percent respectively. Indicators in relation to central government revenue are much less favorable. At end-2002, the ratio o f NPV o f debt to government revenue was 500 percent, while scheduled debt service payments amounted to 51 percent o f revenue. This reflects partly Georgia’s extremely l o w central government revenue collections, presently less than 10 percent o f GDP.

14. The CAS baseline scenario i s predicated o n continued implementation o f economic reforms. Annual average real GDP growth is projected to be in the 3.5-5.0 percent range during 2003-15, although growth rates may be higher in the init ial years because o f the impact o f construction o f the B T C pipeline. In their scenario planning the IMF and the Bank have used a conservative assumption o f 4 percent until 2008, and 3.5 percent thereafter. The current account deficit -- excluding pipeline construction-related imports -- would decline progressively, with exports and imports assumed to grow at an annual average o f about 7 percent over 2003-08, and at about 5 percent thereafter. The real exchange rate is assumed to remain constant at i ts end- May 2003 level. The ratio o f central government revenue to GDP is assumed to grow, o n

- 5 -

average, 0.6 percentage points per annum. Financing gaps are assumed to be f i l led through a combination o f grants and concessional loans.

15. The baseline scenario envisages a steady improvement in debt indicators (see Table 3). The ratio o f NPV o f debt to exports i s projected to fa l l to 123 percent by 2005 and then to stabilize at 80 percent by 2015. The debt service ratio would be reduced to 15 percent by 2005, 10 percent by 2008, and under 7 percent in the outer years. Debt indicators relative to government revenue also show a steady improvement, but would remain high throughout most o f the projection period. The N P V o f debt to revenue ratio would fa l l below 250 percent by 2008, and under 200 percent by 2010. The associated debt service ratio would be 24 percent in 2008, declining to 12 percent by 2015. These projections reflect a relatively slow improvement in central government revenue, from a very l o w base, to 16 percent by 201 5.

16. Stress tests show that the medium-term debt dynamics can be highly sensitive to some alternative assumptions. Under more sluggish export growth or an exogenous increase in debt (e.g., through the assumption o f significant non-guaranteed liabilities by the government), the ratio o f the NPV o f debt to exports would increase by up to 40 percentage points, climbing to almost 173 percent under the latter scenario in 2004. The ratio o f debt service to exports would go up by 10-15 percentage points relative to the baseline, reaching 24-30 percent in 2005. Changes o f this magnitude could put the balance o f payments under severe stress, especially given Georgia’s weak international reserve position.

17. Indicators relative to government revenue would also deteriorate sharply under certain scenarios. For example, under a hypothetical 30 percent real depreciation in 2004, the NPV ratio would jump to 467 percent and would remain above 300 percent through 2008; the associated debt service ratio would increase to 60 percent and then decline to under 40 percent by 2007.

Table 3. Georgia: External Debt Indicators (in percent)

~

Projections 2003 2004 2005 2006 2007 2008 2010 2012 2015

Baseline

N P V o f debt to exports ratio 145 133 123 114 106 100 89 85 82 Debt service to exports ratio 15.6 15.7 15.3 13.2 11.6 9.9 10.1 6.6 6.4 NPV o f debt to revenue ratio 404 354 323 283 253 231 190 168 146 Debt service to revenue ratio 46.2 44.7 42.8 35.3 29.6 24.4 22.6 13.8 12.0

After Naples Terms

NPV o f debt to exports ratio 98 95 94 91 89 87 83 83 82 Debt service to exports ratio 15.6 8.0 8.1 7.4 6.6 6.1 6.5 5.3 5.4 N P V o f debt to revenue ratio 275 253 246 226 212 201 187 176 169 Debt service to revenue ratio 46.5 22.8 22.5 19.8 16.9 15.0 14.7 11.1 10.0

Source: Country authorities and IMF staff estimates, projections and simulations. Note: Includes only public and publicly-guaranteed debt

- 6 -

18. A restructuring on Naples terms would have a significant impact on the various debt indicators. Under this scenario, the ratios o f NPV o f debt to exports and revenue would decline to 98 percent and 275 percent (in the base year), respectively (Table 3). The corresponding debt service ratios would decrease by an average o f 6 and 20 percentage points over the period 2004- 06 compared to the baseline. The ratio o f debt service to exports would reach single digits by 2004, while the debt servicehevenue ratio would fall to under 25 percent by the same year, below 20 percent by 2006, and to 10 percent by 2015. The path and level o f the debt service ratios suggest that Georgia’s external debt would become manageable with a stock operation on Naples terms.

19. Relations with the IMF. Improved fiscal management since mid-2000 paved the way for approval o f a new three-year program under the Fund’s Poverty Reduction and Growth Facility (PRGF). Disbursements under the previous Fund program had been suspended as fiscal performance deteriorated in the run-up to the 2000 presidential elections. The first and second reviews under the current PRGF took place in October 2001 and July 2002, respectively. At 2 percent o f GDP, the fiscal deficit was slightly higher than programmed because o f shortfalls in external financing, and revenue collection improved only slightly f rom 14.3 percent o f GDP to 14.4 percent over the period. An IMF mission that visited Georgia in July 2003 to discuss completion o f the postponed third review found that new fiscal pressures had emerged, with tax revenue falling short o f budget targets, and an accumulation o f substantial new budget arrears. The IMF thus saw the need inter alia to introduce tax reform measures, adjust electricity tariffs and revise the 2003 budget to close the fiscal gap. The authorities achieved the first two but were unable to secure parliamentary approval o f a revised budget. Although it was not possible to complete the third review, the IMF has been providing technical advice to Georgia o n the 2004 budget, and will begin discussions in January 2004, when the current PRGF expires, on a possible new program to support Georgia’s EDPRP.

20. Economic Opportunities and Obstacles. Given the small size o f Georgia’s domestic market, higher growth rates will need to come increasingly f rom export expansion, especially in those sectors where the country has a comparative advantage and the potential to create significant new j o b opportunities, such as agriculture and agro-processing. Fortunately, Georgia has a well-educated and relatively low-cost labor force, which could al low it to be competitive in producing high value goods and services. In addition, while much o f the country’s physical capital base has depreciated, there are st i l l large pockets o f equipment and facilities that can be used in export production. Georgia also has significant transportation infrastructure facilities, and i s located close to important regional and European markets. Being the most direct link between the Black Sea, the Caspian Sea and Central Asian countries, Georgia has the potential to become a regional transit hub, particularly for rapidly growing oil-producing countries such as Azerbaijan and Kazakhstan. In the next few years, construction activity and transit fees f rom energy pipelines wil l also bolster the economy.

21. Much o f Georgia’s pol icy framework favors competitive exports. The trade regime i s liberal (despite some recent increases in tariff rates and coverage), and Georgia faces n o significant trade barriers in world markets, having been a member o f WTO since June 2000. Realizing this export potential will require concerted action to address the governance issues outline above, which raise the risks and cost o f doing business in Georgia and undermine exporters’ competitiveness. In the absence o f much FDI and interaction with foreign buyers,

- 7 -

most Georgian firms have limited access to adequate technology and marketing sk i l ls that are essential to being competitive in world markets. This often results in l o w labor productivity despite the good education levels. Productivity differentials between Georgia and its rivals are larger than their wage differentials, indicating that Georgia's low-wage advantage i s being eroded by i t s productivity disadvantage. This i s part o f the reason why sectors that are highly competitive internationally such as garments and wood processing have not flourished in Georgia.

22. Earlier studies by FIAS and IDA', and a the recent FY03 Diagnostic Trade Integration Study, suggest an agenda o f challenges in order for Georgia to be able to realize i t s export potential. They include: (i) lack o f access for exporters to inputs at wor ld prices, particularly those procured in the domestic market, because the VAT refund mechanism i s unreliable; (ii) a tax code that i s subject to frequent changes as well as unpredictable and corrupt administrative practices; (iii) high transportation costs due to unofficial payments to border agencies and the road police; (iv) widespread smuggling, reflecting corruption and weak customs administration; (v) high cost and collateral requirements o f finance when it i s available; (vi) lack o f enforcement o f intellectual property rights; (vii) national standards that are not recognized outside the CIS region; (viii) inadequate and unreliable power supply; and (ix) obstacles to rural market integration, including poor rural transport and market infrastructure, weak rural/farmer organizations, and petty corruption along market routes. This environment encourages the proliferation o f informal and small-scale activities, creates a strong bias against formal domestic tradable activities, and does not allow the already small domestic market to become a platform for export growth.

23. As indicated above, infrastructure constraints limit Georgia's growth prospects. Since independence, Georgia has experienced frequent power cuts and l imi ted supply o f gas and electricity during the winter. The increase in energy import prices led to a six-fold decrease in gas imports and rendered thermal power generation uneconomical, causing overall electricity generation to fa l l by more than half. The country now relies largely o n hydro-electric stations for i t s power supply, but the largest one by far - Enguri - lies in the territory partially controlled by the breakaway region o f Abkhazia, and more than a third o f Enguri's electricity production i s consumed by Abkhazia without any payment. Collection rates o n electricity that finds i t s way to domestic consumers have been low, especially outside Tbilisi. Collection rates on gas consump- t ion have been l o w throughout the country. A s a consequence, energy infrastructure has been poorly maintained and the sector has accumulated significant external debts in the order o f 20 percent o f GDP by end-2002, and the quasi-fiscal deficit i s estimated at almost 6 percent o f GDP .

24. This situation persists despite sound legal and pol icy reforms to demonopolize and privatize the electricity sector. Generation, transmission and distribution have been separated, and are now largely under private ownership or management contracts. Reforms in the gas sector have followed a similar path - although at a slower pace - with large private Russian interests in transmission and distribution. The BEEPS shows that f i r m s in Georgia o n average lose more than 60 business days per year due to power outages. Governance issues at a l l levels - corporate, as wel l as regional and central government - have been the main problem.

See FIAS, Administrative Barriers to Investment (June 2001) and the Cost o f Doing Business Survey (2001).

- 8 -

25. Telecommunications, on the other hand, i s generally at a more advanced stage than other South Caucasus countries, with relatively cheap access. Similarly, the main roads are being renovated and the established road fund i s proving helpful. Emphasis in future needs to shift to improving secondary roads and access to telecommunication in rural areas, in order to take advantage o f Georgia’s potential for export o f agricultural products.

Poverty Trends and the MDGs 26. Georgians have experienced a severe decline in welfare since independence. Annual income per capita is about 56 percent below the pre-independence level, unemployment rates are high (16 percent in 2001), and many Georgians are underemployed. In the circumstances, poverty, vulnerability and inequality have al l increased over the period. Georgia clearly needs to achieve and sustain higher economic growth rates to improve living conditions. Given the small size o f the domestic market, this can be achieved only through a stronger expansion in export activities, especially o f those in which Georgia has a comparative advantage and the potential to generate new j o b opportunities, such as agro-processing. Equally important i s reliable delivery o f quality services, such as education, health, roads, electricity, heating, and clean water, and a wel l targeted social safety net.

Table 4. Change in poverty between 1997 and 2002

Poverty definitions (lines) Official minimum

Urban Rural

US$4.30 per capitdday at PPP” Recommended poverty line (baseline)

Urban Rural

US$2.15 per capitdday at PPP ‘ I

- 1997 46.6 46.7 46.4 13.6 13.6 13.8 13.4 9.7

Poverty Headcount (% o f population) 1998 1999 2000 2001 2002‘ 50.5 53.0 52.5 52.0 51.3b’ 53.3 60.4 56.6 54.3 53.7 47.1 44.6 48.0 49.6 48.8 19.8 23.2 23 .O 22.8 21.7 19.8 23.2 23.0 22.8 21.7 22.2 27.4 24.6 24.1 22.6 16.8 18.4 21.4 21.3 20.7 11.8 14.5 15.4 14.8 13.5

US$1.075 per capitdday at PPP ‘ I 1.7 3 .O 3.2 3.3 3.4 2.7 Source: SDS SGHH primary data and World Bank, see Georgia Poverty Update, Report No. 22350-GE. Note: The official poverty line uses a normative basket and CPI price data to cost it and i s around 100 GEL (about US$50 at current exchange rate) per equivalent adult per month. The recommended poverty line was developed jointly by the World Bank and SDS in 1998; it uses actual consumption patterns of the population and survey prices (its non-food component i s fixed in real terms to 1996 and deflated using the CPI for non-food items); it i s about 55 GEL (US$25) per month per equivalent adult. The equivalence scale used in the official and recommended methodology i s the scale developed by SDS and used in Georgia to determine the social assistance payments. International poverty lines expressed in dollar terms (US$ in PPP) are per capita and use the latest (1996) revision o f the World Bank, updated with the Georgia CPI. All figures are averages o f quarterly data. a/ Preliminary estimate; corrections for changes in the Survey not made. b/ Bank estimates using official methodology. c/ Using 0.33 as PPP conversion factor.

27. Strengthened economic performance did result in a reduction o f poverty in the mid-1 990s. However, Georgia’s growth rate slowed considerably between 1998 and 2000, and consequently inequality and poverty, as measured by any o f several methodologies, increased (see Table 4). Growth was affected by a number o f shocks, including the 1998 Russian crisis, severe droughts in 1998 and 2000, and the increase in the price o f energy imports in 2000. These problems were compounded by internal and extemal pol i t ical instability. Growth has been recovering since 2001 (Table l), leading to a slight reduction in overall poverty.

Poverty Profile.

- 9 -

28. IDA, in close collaboration with the State Department o f Statistics, prepared a Poverty Update for Georgia covering the 1998-2000 period. The study found that the increase in poverty affected various socio-economic groups differently, with growing differentiation among the poor, and signs that the poorest became even poorer. Poverty depth and severity both increased. Driven by the volatile economic environment and absence o f an adequate safety net, vulnerability to poverty for the average household rose significantly, with female-headed households being the most vulnerable. Although the extent o f absolute poverty at any point in time remained around 20-24 percent, 40 percent o f the population experienced poverty at least once during the year 1999-2000, and 60 percent o f the population faced a real r isk o f experiencing poverty in the medium term.

Differential Impact o f Rising Poverty.

29. The trend in overall poverty reflects somewhat different developments in urban and rural poverty. In 1997, rural and urban poverty incidence were almost the same. In 1999, the urban poverty headcount doubled in comparison to 1997, whilst the rural headcount increased by only 37.3 percent. Then in 2000, responding to the non-agricultural sector recovery after the Russian crisis, urban poverty dropped by 10.2 percent, stabilized in 2001 and declined further by 6.2 percent in 2002. Because o f the drought, however, rural poverty increased in 2000, remained unchanged in 2001 and only in 2002 decreased by 2.9 percent. A s a result, the difference between the urban and rural headcount has narrowed -- while in 1999, the urban poverty headcount was almost 50 percent over that in the rural population, in 2002 it was only 9 percent higher.

30. Determinants o f Poverty. The Georgia Poverty Update identified that the strongest determinants o f poverty risk in Georgia were economic: employment status, sector o f employment, ownership o f productive assets and education. It found an elevated poverty risk among urban households, households with an unemployed head and female headed households, as wel l as children aged 7- 15, the disabled, those with l o w levels o f education, single pensioners and orphans. The working poor are becoming the majority, often employed in the informal sector with insecure, temporary and l o w productivity jobs.

3 1. Non-Income Indicators of Poverty. Non-income indicators o f poverty in Georgia, inherited from Soviet times, s t i l l compare favorably with those o f countries with similar per capita income. The UNDP 2003 Human Development Report ranks Georgia 88'h among 175 nations. However, Georgia faces a major challenge in sustaining these relatively favorable indicators. Studies conducted by various international organizations (UNICEF, U S A I D , EC, etc.) indicate that maternal mortality, immunization rates, access to health, safe water and sanitation, and the quality o f social services have worsened in comparison with the pre-transition situation.

32. the Mil lennium Development Goals (MDGs) are indicated in Table 5.

Millennium Development Goals. The estimates o f Georgia's prospects for achieving

33. Capacity to Monitor Poverty. Starting in mid-1996, with technical assistance f rom IDA, DFID and other donors, household surveys have been conducted in Georgia o n a quarterly basis, The surveys provide detailed information f rom 3,350 households o n property, economic status, incomes, expenditures, consumption, household composition and demographics. In 2000,

- I d I E

v ri

3 .z c

c 3

W S B W 5'::s %

-12-

additional data were collected regarding access to education, health and actual food consumption. These surveys provide a wealth o f information necessary for monitoring poverty and the implementation o f Georgia’s EDPFW. Significant capacity to analyze the survey data has been developed at the State Department o f Statistics (SDS), although current budget constraints pose risks for adequately maintaining this work. The capacity to collect reliable administrative data on the non-income dimensions o f poverty could be strengthened.

34. Internally Displaced People. There are over 250,000 IDPs in Georgia. Their vulnerability to poverty i s magnified by their lack o f access to land. Thus IDPs living in collective centers are 3% times less likely to have access to land than the local population, and those living in private accommodations half as likely. In addition, IDPs’ rate o f unemployment i s very high - 40 percent among IDPs living in collective centers. Government benefits do seem, however, to be reaching the IDPs, with 80 percent to 90 percent receiving a government benefit.

35. Gender Issues. Gender inequality does not appear to be a major problem in Georgia, although data deficiencies do not permit deep enough analysis to reach definitive conclusion. According to official statistics, women make up 48 percent o f the labor force. Education outcomes are comparable by gender, with women having only slightly lower secondary completion rates than men, but higher enrollment in tertiary education. The legal framework for women’s rights i s sound, and they enjoy equal access to property and protection o f property rights. Given tight fiscal constraints, free universal access to daycare and kindergarten i s no longer provided, affecting women’s labor market participation. Women represent only 7 percent o f Parliamentarians (although this includes the Chairwoman o f Parliament), and hold only two o f the 16 cabinet positions, but a large number o f women serve as deputy ministers and department heads, and women have a large role in public l i fe. Georgia’s economic diff iculties and the continued impact o f civi l conflicts have put greater demands on women, with an increasing number responsible for supporting their famil ies (thus women are the main source o f income among IDPs). Men have suffered too, both psychologically from feeling they have failed in their role as providers, and physically, with increased incidence o f alcoholism and heart disease. Increasing economic growth, settling o f conflicts, and improving the situation o f IDPs will go far in improving the lives o f both women and men.

36. Core Labor Standards. Georgia i s among the countries that have ratified all the I L O conventions pertaining to the core labor standards: (i) elimination o f all forms o f forced or compulsory labor; (ii) effective abolition o f child labor, with priority to the worst forms; (iii) equal opportunity and non-discrimination in employment; and (iv) freedom o f association and the right to collective bargaining. The provisions o f the conventions have been incorporated into various elements o f Georgian legislation. Further detail i s provided in Attachment 111. However, no assessment has yet been initiated regarding their implementation, and Georgia i s behind in providing reports due to the I L O

Governance

37. A key constraint to Georgia’s development i s i t s difficult governance environment, including both weaknesses in public sector coordination and implementation capacity, and some aspects o f corruption. As discussed below, bribery appears to be getting worse at a time when neighboring countries are seeing improvements. The Government has become fragmented, with

- 1 3 -

the excellent work o f many pockets o f professionalism diluted by lack o f complementary support from other agencies. There are fears that the sustainability o f donor-financed projects may be compromised by lack o f follow-through once the projects close. Among the contributing factors underlying this situation are: (i) the fact that, as a relatively young state, Georgia has had to set up entirely new legal, government, and accountability structures and systems; (ii) geo-political fragmentation and lack o f strong leadership f rom Tbilisi; (iii) a weak and poorly paid and equipped c i v i l service operating without basic public sector management systems; (iv) a tradition o f close-knit clan and family based loyalties; and (v) a broad acceptance o f avoiding obligations to central government authority. Governance problems and corruption undermine Georgia’s competitiveness and hamper the creation o f jobs crucial for combating poverty. Furthermore, these problems mean that the efficiency and effectiveness o f public expenditures and services are sub optimal, which hurts the poor disproportionably.

38. Despite these problems, the Government has had some important successes in structural reform. Privatization o f telecommunications and energy started earlier than in most FSU countries, and there have been various legal reforms to improve the business climate. Unpopular but necessary tax reform and electricity tar i f f increases have been passed at various stages, including in recent months, and health sector restructuring i s underway, although in Tbil isi it has faced significant opposition. The benefits o f these and other structural reforms are, however, often hindered by poor implementation - thus the privatization o f electricity distribution did not, for example, y ie ld the expected returns, partly because weak law and order have hindered payment collection.

39. The Business Environment. The EBRD/World Bank Business Environment and Enterprise Performance Survey (BEEPS) shows that Georgia’s business ’ environment has improved in several

’

- __________ __ Figure 2. Georgia: Perceptions of the

Business Climate 2002 (0 i s best and 4 worst)

I

I areas over the last few years, with most 1 I

Financing of the BEEPS indicators - business 1 4 - finance, infrastructure, business tax burden, regulations, and judiciary - now being close to the CIS average (see Figure 2). But in the crucial areas o f crime and bribery Georgia’s indicators have worsened with the percentage o f firms reporting that they frequently paid bribes actually having increased slightly,

i \

Judiciary- lRepulations I - - * - .CIS & -&orma I

at the same t ime that the incidence has decreased in neighboring countries.

, Source:TheWorldBankandEBRD I A

40. Financial Sector. Georgia’s financial system is dominated by its banking sector, which is small by regional and international standards. The central bank, the National Bank o f Georgia (NBG), has a large degree o f independence, and over t ime has introduced tighter prudential requirements, stricter loan classification and provisioning rules, as we l l as better accounting standards. There are n o barriers to entry for banks, and foreign banks are present. However, the weak economy undermines investment in this sector despite structural reforms pursued since 1995. Bank capital i s 26 percent o f total assets, which i s relatively high, and reflects excess

- 14 -

liquidity in the banking system. This excessive liquidity mainly results from: (i) undeveloped credit skills and credit policy in banks (such as lending overly relying on collateral rather than based on cash-flow); (ii) lack o f credit information; (iii) excess T-bill yields due to a weak primary T-bill market. The risk-aversion o f the lending institutions has led to relatively l o w levels o f financial intermediation, and impedes enterprises access to finance. N e w legislation has recently been adopted to address money laundering, but it requires some strengthening. The National Bank o f Georgia will be primari ly responsible for implementation and i s attempting to build capacity to implement the law and regulations to ensure that Georgia’s anti-money laundering framework meets international standards.

41. ance i s hindering broad-based economic growth and poverty reduction in several ways.

Consequences of Poor Governance. Georgia’s climate o f corruption and poor govern-

Corruption is limiting the benefits o f an otherwise improved business environment. Enterprises o f every size report being harassed from al l sides, and there is a perception that there is an effective ceiling on enterprise growth for those without special influence. Weak and corruption-ridden enforcement authorities have contributed to a climate where crime and security issues are perceived to be more pervasive than in neighboring Caucasus countries. The end result has been serious difficulty in attracting much needed private investment.

N o t surprisingly, the shadow sector o f the economy is growing, and now constitutes maybe a third o f GDP. This large shadow economy, combined with pervasive corruption in tax and customs administration, has kept public revenues under 15 percent o f GDP, we l l below potential. Lack o f revenue and poor governance have severely hampered progress in education, health and social protection, slowed the maintenance and rehabilitation o f vital infrastructure, and contributed to unreliable and l o w quality utility services.

0

0

0 The national budget covers only a one-year cycle, and its strategic foundation i s weak. Overall resource allocation i s not wel l l inked to sector objectives, programs or policies. The EDPRP team made an attempt to cost and phase development priorities, and thereby develop the medium-term expenditure implications, but in practice the three planning tools - the EDPRP, the medium-term Indicative Plan, and the annual budget - are not yet adequately integrated into an effective cycle o f pol icy formulation, budget preparation and decision-making.

42. Fiscal Decentralization and Local Governance. In addition to the central government, there are three levels o f decentralized government: regions, rayons, and local self-governing units. Resource transfers to these decentralized bodies levels are unpredictable, incentives for increased regional tax collection effort are inadequate, and the distribution o f resources across local government units i s highly inequitable. A number o f expenditure responsibilities have been delegated to the local level, but without ensuring proper funding f rom the center. At the same time, the center attempts to regulate expenditures by enforcing national norms. Such rigidities create perverse incentives and perpetuate inefficiencies in the allocation o f public resources. The consequences o f the system are duplication or under-provision o f basic public services (e.g., water and electricity), under-funding o f key expenditures such as teachers’ salaries, and

- 15 -

accumulation o f arrears. regions and rayons, with poorer local government units spending much less than well-off ones.

Furthermore, there are large disparities in per capita spending by

111. THE WORLD BANK GROUP’S TRACK RECORD IN GEORGIA

IDA ’s Country Portfolio and Non-Lending Program

43. IDA lending to Georgia since its inception in FY95 has totaled $730.2 million for 33 credits (for 31 projects), o f which 16 have been completed. The current portfolio consists o f 17 credits (including one supplemental) totaling $297.2 mi l l ion (of which $190.8 million was undisbursed as o f October 6, 2003). In addition, three GEF projects have been approved for Georgia, amounting to $12.5 mil l ion. Since Georgia joined the IFC in 1995, I F C has approved $103.8 mi l l ion o f investments in 8 projects. IFC’s held portfolio in Georgia as o f October 2003 amounted to $27 mi l l ion (4 projects).

44. In preparation for this CAS, IDA’s Country Team commissioned an Independent Portfo- l i o Review (IPR) in Novembermecember 2002, which was then fol lowed by a Joint Portfolio Review (JPR) with the authorities in January 2003. The objective o f the IPR was to have an independent assessment o f the health o f the portfolio, i t s appropriateness in light o f earlier CAS objectives and evolving country conditions, and to provide guidance to the country team o n ways to improve the effectiveness o f IDA assistance to Georgia. The IPR found that most projects were relevant and generally we l l managed and supervised, although a weak governance and economic pol icy environment appeared to be limiting the potential impact and sustainability. Projects tended to be successful in delivering their planned inputs and outputs, but sustaining results were less certain due to lack o f funding for maintenance and operation, and the fragility o f implementation arrangements -- projects had to rely o n Project Implementation Units (PIUs) to create islands o f efficiency and integrity, with the future o f these PIUs uncertain once the project ends. In some cases sustainability apparently has been achieved through the use o f autonomous agencies (the Social and Municipal Development Funds), through the more private- sector oriented projects, and through the use o f community organizations. The IPR also concluded that many operations would benefit f rom a better definition o f expected outcomes and interim outputs. The follow-on JPR initiated a dialogue with a l l counterpart entities, and work i s underway, led by the Country Off ice in Tbilisi, to develop such indicators for operations where they were lacking at the init ial stage. Drawing on the IPR, QAG and OED reports, ICRs and its own supervision work, the Georgia Country Team has identified some main conclusions regarding what IDA’s assistance efforts have accomplished in Georgia to date and the lessons learned to improve future effectiveness.

45. Evaluation o f the Last CAS. The objectives o f the last C A S were to: (i) strengthen public finance; (ii) deepen and diversify sources o f growth; (iii) introduce pol icy and institutional reforms to protect Georgia’s environment and natural resources; and (iv) reduce poverty - the overarching objective. The Country Team concluded that these objectives were appropriate and represented the depth and breadth o f the country’s development challenges, but overestimated the capacity o f the Government to sustain the reform momentum o f the mid-1990s. The risks were correctly identified and remain relevant: failure to reach expected outcomes due either to unsatisfactory implementation o f policies and/or deterioration in the external environment; r isk

- 1 6 -

o f policy reversal from vested interests; and renewed c iv i l conflicts. governance factors were, however, underestimated.

The risks related to

46. Support f o r Structural Reform. Considerable progress has been made in supporting structural reform, including trade liberalization, legal and regulatory reform, privatization and liberalization, banking sector restructuring, and judicial and health sector reforms. However, weakened fiscal management, less than sufficient public sector capacity, and poor govemance have diluted these successes. These constraints have affected the implementation o f second- generation reforms requiring sustained commitment across Government, and an increased capacity to evaluate, design, monitor and enforce implementation. Subsequent to the IPR, in early FY04 OED completed a review o f IDA adjustment and related technical assistance operations in Georgia, and downgraded several ratings init ial ly assigned at the time o f project closing, for many o f the same reasons identified in the IPR.

47. Reducing Poverty. IDA interventions in the human development sectors have aimed at improving the efficiency and effectiveness o f public services, while at the same time explicitly emphasizing strategies and interventions that target poor and vulnerable population groups, including by improving their access to social services. Economic and sector work in human development, as wel l as pol icy advice and dialogue based o n E S W findings, have assisted the Government in defining strategic options in health, education and social protection, and guided the Bank’s project work in these areas. ESW has consisted o f a note o n Options for Pension Reform, a Poverty Update, and studies o f health, education and social protection in the Public Expenditure Review. The f i r s t Health Project closed o n December 3 1, 2002. The I C R for the project evaluates the achievement o f the project objective as mixed; unsatisfactory regarding the impact on the health o f the population, and satisfactory concerning the project’s substantial contribution towards reorienting the sector and strengthening institutions at the central level.

48. Social Sectors. Projects currently under implementation include an Education System Strengthening and Realignment Project (APL), a Primary Health Care Development Project, and a Structural Reform Support Project (SRSP), which include components for pensions and hospital restructuring, and a Social Investment Fund (SIF) Project. The education project aims at improving learning outcomes in primary and secondary education, the health care projects at improving financing and access to primary care services. The pension component o f the SRSP helped develop a management information system, including individual accounts, for the Georgian pension system; the ongoing health component i s rehabilitating the hospital sector. The SIF provided urgently needed assistance to poor and vulnerable communities. Whi le it is premature to assess the outcomes o f the ongoing projects in health and education, the SIF has already funded some four hundred micro-projects which rehabilitate small-scale social and economic infrastructure, thus improving access to better-quality essential services. A US$5 mi l l ion supplement to the SIF was approved in February 2003 to rehabilitate schools in Tbil isi damaged by the 2002 earthquake. A second SIF project that focuses o n community mobilization and small-scale infrastructure development was approved by IDA’S Board o f Directors in M a y 2003, and unanimously approved by the Georgian parliament in August 2003.

49. Infrastructure. The Roads Project has led to a substantial improvement in the main road network, thus reducing road transport costs and improving access to the major traffic corridors; institutional strengthening i s underway, and there has been a marked improvement in

- 17 -

the performance o f local contractors. The Energy Transit Institution Building project has helped the Government improve i t s capacity to negotiate and implement o i l and gas transit agreements maximize economic benefits, and minimize social and environmental costs. The Electricity Market Support is now underway after a year’s delays in hiring a management contractor for transmission and dispatch. The South Caucasus Trade and Transport Facilitation Study was completed in 2002, and was followed by a Policy Note which will form a basis for the proposed FY05 Trade and Transport Facilitation Project. In the power sector a study -- Revisiting Reform: Lessonsfiom Georgia -- reviewed the recent changes in the supply o f electricity and gas f rom the perspective o f the households, utility operators, and Government representatives. Households continue to have high levels o f access to network services, but the numbers mask poor service and supply shortages, particularly outside Tbilisi. Despite rapid increases in the price o f electricity and non-network fuels, the share o f government spending o n energy has remained constant. The study recommends that subsidies be targeted using actual levels o f electricity consumption, and that they be sufficient to ensure that households can pay for a basic minimum level o f electricity consumption.

50. Public Finance and Procurement. There were some improvements in public finance, supported by the Structural Reform Support Project, including the strengthening o f the treasury system. Since late 2002, however, the reform momentum has been compromised because o f an overall deterioration in the economic and political environment. This has also put at r isk the sustainability o f earlier achievements. The recent FY03 Public Expenditure Review provides a diagnosis and recommendations for expenditure and management reforms. The Government has yet to fo l low up o n many o f these recommendations, although a number have been included in the EDPRP. AAA has also included the Country Procurement Assessment Report issued in June 2002, and the FY03 Country Financial Accountability Assessment, which was discussed with key Government counterparts in June 2003.

51. IDA has assisted Georgia in developing a National Environmental Action Plan, a National Black Sea Act ion Plan, and a National Oi l Spill Contingency Plan to deal with existing and future risks o f o i l pol lut ion in the Black Sea coast. However, institutional and financial constraints compounded by limited political will have resulted in slow implementation o f these plans. Assistance has been provided for the establishment o f operational protected areas: 46,000 ha for protecting and managing threatened forest and wetlands habitats along the Black Sea, and 184,000 ha for protecting and managing three areas in the Caucasus Mountains. Activities have been supported to enhance public awareness and interest on the protection o f critical wetlands along the Black Sea, with some visible results. Efforts to establish a sustainable and effective integrated coastal zone management system have produced only modest results to date.

Environment and Natural Resources.

52. IFC’s lending and investments in Georgia have been tailored to the country’s special circumstances: l imited foreign investments, the non-existence o f large local companies, l imited access to financing for a nascent SME sector, and the lack o f advice for private companies o n business-related issues such as corporate governance and leasing. I F C has supported:

IFC Support.

Local Companies, for example GG&MW, a mineral water production company, where IFC’s loans supported the company’s acquisition o f key strategic assets and strengthened

- 18 -

control over i t s key brand, Borjomi mineral water. IFC’s equity investment helped the company rehabilitate two mineral water bottling facilities, diversify i t s product mix and develop the distribution network. IFC sold i t s stake in the company in 2002.

0 Foreign Investments. IFC invested in equity and provided loans to Ksani Glass Factory, a producer o f high-quality glass bottles and packaging. The $2.5 mill ion equity investment and $6.3 million loan supported Ksani’s expansion and modernization. At project completion, the facility will be producing 40,000 tons o f high quality glass bottles annually with a high level o f product flexibility. In the power sector IFC provided a $30 mill ion loan to AES Corporation to support the newly privatized Tbilisi area power distribution company Telasi. The loan was pre-paid in August 2003, when the AES corporation sold the Tbilisi electricity distribution system to UES. In the o i l and gas sector, IFC supported BP and other sponsors by financing the construction o f the Baku- Supsa Early Oil Pipeline, which carries Caspian oi l to Georgia’s Black Sea coast. IFC’s investment in the Georgian portion o f the pipeline was made in 1998 and totaled $30 million.

0 SME Sector. To reach small and medium enterprises, IFC provided equity and long-term credit l ines to TBC Bank and helped establish Georgia Microfinance Bank - the Procredit Bank - the country’s first bank specializing in lending to micro and small enterprises. In June 2000, IFC purchased a 10 percent stake in TBC Bank. IFC’s support helped TBC to grow from a “pocket” bank into the largest and one o f the best performing commercial banking institutions in Georgia. In 1999, IFC helped establish the Procredit Bank -- the f i rs t bank dedicated to lending to micro and small enterprises in the country, and now the fastest growing banking institution in Georgia.

0 Development o f Mortgage Lending. In the financial sector, IFC has focused on supporting the development o f the housing finance market. The introduction o f mortgage financing has allowed individuals for the f irst time to leverage their residences to raise their standard o f living. In 2000, IFC extended a $3 mil l ion credit l ine to the Bank of Georgia, and together with reflows, this credit l ine financed over 500 projects totaling $4.5 million. In June 2003, IFC provided a second $5 mill ion credit l ine to the Bank o f Georgia for housing finance and for on-lending to small and medium enterprises. In August 2001, IFC provided a second $3 mill ion loan to TBC Bank to support the development o f i t s mortgage lending.

Lessons learned 53. Georgia’s rapid initial progress with first generation reforms during the last decade led to over-optimism as to the speed at which deeper reforms could be implemented. In particular, IDA underestimated the pervasive impact o f weak governance on policy making and implementation. Some key analytical work was delayed (e.g., the Public Expenditure Review), partly to accommodate increased supervision needs o f an expanding portfolio. In retrospect this was inadvisable, and economic and sector work has been given higher priority in the proposed FY04-06 strategy. Given the Government’s weak capacity, there will be a focus on supporting policy and institutional reform, and project supervision i s being funded at higher than standard coefficients to allow intensive oversight, including strong attention to fiduciary aspects.

- 1 9 -

Responsibility for supervision has been decentralized to the Georgia Country Office in Tbilisi, and the Country Office has been strengthened by appointment o f a procurement officer. Improved coordination with other donors, some with large technical assistance programs in key areas, will be a crucial component o f the strategy.

54. tangible development outcomes even in this poor implementation environment:

The IPR noted that five mechanisms seem to have had a good track record o f producing

The use o f autonomous institutions l ike the Social Investment Fund and the Municipal Development Fund that can be financially self-sustaining;

Community-based efforts that do not rely heavily o n central government institutions, such as the irrigation and drainage project that i s helping to build local social capital;

Private-sector led activities, that again do not rely heavily on resources f rom the central government;

Empowerment o f c iv i l society organizations which can press for real and effective reform in their respective spheres o f influence; and

Active stakeholder participation in the design o f projects.

55. There are several implications o f the above findings. First, IDA needs to pay much closer attention to the broader institutional environment in Georgia, outside the immediate PIUdagencies responsible for project implementation, given risks to sustainability o f even very good operations. Particularly close attention is needed to assessment o f governance factors which may influence the possibilities for success in achieving and sustaining development outcomes. Second, IDA investment lending should rely as heavily as possible o n the mechanisms identified above, where these are appropriate. Third, projects should include tangible measures o f outcomes and impacts (including improved institutional effectiveness). Where these may not exist for some ongoing projects they should be developed as soon as possible, and the dialogue during supervision missions and future JPRs should focus more heavily o n these topics, going beyond monitoringhesolving implementation issues. Fourth, Georgia would benefit f rom a stronger AAA and non-lending work program to complement portfolio supervision and new lending. The strategy outlined in Section V reflects these recommendations.

IV. GEORGIA’S ECONOMIC DEVELOPMENT AND POVERTY REDUCTION PROGRAM

56. The Government finalized i t s PRSP (known in Georgia as the Economic Development and Poverty Reduction and Program, EDPRP) in June 2003. The EDPRP builds on the interim strategy (I-PRSP) presented to the Boards o f the IMF and IDA in January 2001. I t was developed with strong participation by c iv i l society. The EDPRP and a Joint Staff Assessment (JSA) were presented to the Boards o f the IMF and IDA in October and November 2003, respectively (Report No. 26964-GE).

57. The EDPRP has two strategic objectives: (i) rapid and sustainable economic development, with a target o f real GDP growth o f 5-8 percent a year; and (ii) a reduction in

- 20 -

extreme poverty, with a target o f a decline from 14 percent now to 4-5 percent by 201 5 , and a reduction in overall poverty, f rom 52 percent now to 20-25 percent by 2015. T o meet these two objectives the EDPRP focuses on progress in governance, macroeconomic policies, particularly in the fiscal area, the business environment, human capital, reducing the vulnerability o f the poor, development o f priority sectors o f the economy -- energy, transport and communications, tourism and agriculture, and the natural environment. The EDPRP also stresses the importance o f addressing the needs o f post-conflict zones and o f science and information technology.

58. As the JSA notes, the EDPRP presents a credible poverty reduction strategy and its broad pol icy priorities are appropriate and consistent with the development challenges facing Georgia. The main areas where further progress will be needed during implementation and subsequent updates o f the EDPRF’ include: (i) improve the consistency o f the budget process with the program; (ii) ensure that the Ministry o f Finance and other key ministries are centrally involved in implementing and further developing the program; (iii) develop a prioritization o f the EDPRP’s spending recommendations; (iv) implement measures to improve governance and reduce corruption; and (v) develop more specific, quantified, outcome measures.

v. THE WORLD BANK GROW’S COUNTRY ASSISTANCE STRATEGY

59. The Country Assistance Strategy for FY04-06 selectively supports the implementation o f the EDPRP in areas in which the Bank Group has a comparative advantage, and is closely coordinated with activities o f other IFIs and donors. Within this framework, IDA will a im to provide a level o f new financial assistance responsive to the authorities’ demonstrated commitment to improve governance, and supported by AAA, non-lending and outreach activities that may help build the foundation for institutional and policy renewal.

FYO4-06 CAS Objectives and Focus 60. The CAS will support Georgia’s EDPRP by assisting the Government to: (i) attain faster and more broad-based private sector growth, through the removal o f policy, institutional and infrastructure obstacles to private sector development; (ii) develop and strengthen human capital and social protection, as well as environmental protection, both through short-term interventions and longer-term sustainable programs to protect the most vulnerable; (iii) improve governance and efficiency of public expenditures, including the strengthening o f public expenditure management through annual process-based public expenditure reviews. Improving governance is a cross-cutting objective, which will be reflected in al l new lending activities as we l l as enhanced supervision support for the ongoing portfolio.

(i) Faster and M o r e Broad-Based Private Sector Growth 61. Constraints to Business Development. T o support private sector development and attract needed foreign investment, the CAS strategy focuses o n removing key policy, institutional and governance constraints, as well as financial, energy and infrastructure bottlenecks. On the basis o f the FY03 Diagnostic Trade Integration Study, IDA will provide reform support and progress monitoring through the ongoing Enterprise Rehabilitation Project, an FY06 Private Sector Development Project, and periodic Business Environment Surveys. IDA will also provide

- 2 1 -

advisory support (in conjunction with USAID) for improving access to affordable finance through further financial sector reform, and wil l help reduce trade, transit and marketing costs through the FY0.5 Trade and Transport Facilitation Project, building o n the FY03 South Caucasus Trade and Transport Facilitation Study. IFC will complement these activities through selective investments in manufacturing, services, financial, natural resources and other sectors, and through its advisory programs. Particular focus will be placed o n SME development. Support for alleviating energy bottlenecks will be provided by IDA’S ongoing energy portfolio and dialogue.

62. According to the recently completed studies conducted by F IAS and IDA (para. 22 above), key pol icy constraints for private sector development also include corruption in the administration o f taxes and customs, as well as lack o f confidence in the rule o f law (Le., enforcement o f contracts, property rights). To date, FIAS has undertaken five projects in Georgia, including an analysis o f administrative barriers to investment in 2001. Their findings are being incorporated in the Bank’s dialogue with the Government, with key measures to be included in any future PRSC. F IAS i s currently assisting the Government to implement the recommendations o f the Study o f Administrative Barriers to Investment in Georgia through public private sector dialogue. Annual updates o f the Cost ofDoing Business Survey throughout the CAS period will provide key monitoring indicators o f progress in this area. I F C would also provide support directly to the private sector through the Georgia Business Development Project, a five-year technical assistance program implemented by the Private Enterprise Partnership with the support o f the Canadian International Development Agency (CIDA). The main components o f the project include development o f the leasing sector, improvement o f corporate governance practices. The corporate governance initiative i s helping Georgian businesses improve their practices to build investor confidence and increase their access to financing. This component o f the program also includes advice to the Government on improving corporate governance policies and regulations.

63. Support to SMEs. The Small and Medium Scale Enterprise (SME) sector i s a crucial area for potential private sector growth, and IDA has been supporting the sector through its ongoing Enterprise Rehabilitation Project. IDA plans, through the FY06 Private Sector Develop- ment Project, to provide expanded support for management training, creation o f export-oriented clusters o f SMEs, advice to business associations and government, and monitoring o f the business environment. Additionally, I F C will conduct a targeted study o f the S M E sector in Georgia to i den t ie key obstacles to its development, and then recommend specific improvements in the regulatory and administrative environment. In addition to the Georgia Business Development Project, and to enhance the development impact o f the B T C pipeline project further, I F C has dedicated staff in the region to develop the S M E linkages and community development programs. Proposals currently under discussion include the promotion o f energy efficiency, use o f alternative energy and biodiversity, development o f community-based forest management and reforestation initiatives, as we l l as expansion o f IFC’s microfinance activities.

64. Financial Sector Reform. Reforms o f the financial sector will be crucial to the success o f SMEs. IDA has accordingly been actively involved in encouraging financial sector reform through the jo int IMF-Wor ld Bank Financial Sector Advisory Program (FSAP), which has been supporting: (i) strengthened banking and non-banking supervision; (ii) introduction o f international accounting standards; (iii) consolidation o f banks through higher capital requirement

- 22 -

ratios; and (iv) anti money-laundering legislation. IDA i s also discussing possible support for improvements in payment systems, and helping (with U S AID) to establish a secured interest/credit bureau. IFC i s complementing IDA’S financial sector advisory work with support to the banking system. It i s providing funding through three leading Georgian banks, targeting SME lending through i t s credit lines, equity participation, or a combination o f the two. IFC i s also considering future mortgage financing projects and i s assessing additional ways to promote SME development, including through a leasing company.

65. Energy Sector. Energy i s another major bottleneck in Georgia, and the FYOl Electricity Market Support project i s -- in close collaboration with KfW, USAID and EBRD -- introducing internationally experienced private management for electricity transmission, dispatch, and the wholesale market in an attempt to facilitate regional electricity trade, and introduce greater competitive pressure on electricity costs, and improve reliability o f supply. The Private Sector Advi- sory Service, managed by the World Bank Group, has advised the Government o f Georgia on privatization o f electricity distribution and generation outside Tbilisi, hiring o f private f i r m s to manage transmission network, system dispatch, and the wholesale electricity market. As a result the management o f both the wholesale market and the transmission and dispatch networks has been transferred to private foreign operators. However, results to date have not met expectations, and this has been one o f the most difficult areas in IDA’S ongoing portfolio in Georgia. Whi le policy and legal reforms have been impressive, implementation has been hampered by governance issues at all levels. Greater public support for improving tar i f f collections i s critical, and IDA will work closely with the authorities, other donors, non-governmental organizations and key stakeholders to try to achieve better knowledge and understanding by the public at large. IFC investment program includes financing o f the BTC project (Box 1).

Box 1 Baku-Tbilisi-Ceyhan Pipeline

The Baku-Tbilisi-Ceyhan Pipeline i s a major new route for energy from the Caspian. IFC’s current investment program includes financing of the BTC project, building on i ts investment in the construction of the Baku-Supsa early oil pipeline. IFC’s role in the BTC project i s to: (i) assist in mitigating political r isks and catalyzing significant long-term financing (both directly and by mobilizing commercial bank funding through i t s B loans); (ii) provide a sustainable environmental and social framework; (iii) initiate a Regional Review; (iv) undertake multi-stakeholder forums; (v) require substantial transparency and disclosure; (vi) help other lenders follow standards consistent with the WBG’s Safeguard Policies and Guidelines; (vii) help promote SME/community development, complementing BP/BTC’s work on this; and (viii) help BP establish the Caspian Development Advisory Panel (CDAP) to provide an independent review of BP‘s Caspian activities. Developmental impacts include (a) avoidance of additional shipping through the Bosphorus; (b) approximately U S 2 9 billion in revenues for Azerbaijan, US$580 million for Georgia and US3.4 billion for Turkey over 20 years, based on full development of a l l phases of the ACG fields; (c) establishment o f environmental offsets and Community/Social Investment Programs; and (d) development of new local jobs during construction/operational phases. Both Georgia and Azerbaijan have indicated a willingness to participate in efforts to ensure transparent reporting o f earnings, and the WGB will follow up and provide support for this during implementation and operation of the BTC pipeline.

- 23 -

66. Agricultural Reform Agenda. Agriculture and agro-processing have good growth potential in Georgia, both for domestic and export markets. Maximizing this potential will require: (i) removing obstacles to market integration, by strengthening rural transport and market infrastructure, promoting rural/farmer organizations, and reining in petty corruption along market routes; (ii) raising the productivity o f rural farmers, by facilitating the propagation and sale o f improved seeds and other planting materials and strengthening advisory services through collaborative public and private sector initiatives; and (iii) supporting initiatives to enhance the competitiveness o f selected industriedsub-sectors with evident growth potential and scope for considerable employment-generation. This i s l ikely to include several fields o f agro-processing and tourism. IDA assistance would also continue to focus on the key areas o f land market development, eliminating constraints on land market transactions, advancing land privatization and completing land titling (working with other donors including KfW, EC, USAID, UNDP and SIDA), and support for the agro-processing enterprise sector. Given agriculture’s strong linkage to rural poverty, the FY04 Constraints and Opportunities in Rural Growth Study and the FY05 Rural Development Project will seek to increase exports and rural incomes, including through investments in agribusiness and export promotion, development o f better market knowledge and infrastructure, and improvement o f small-scale rural infrastructure (e.g., roads) and off-farm employment opportunities. I F C i s exploring the possibility o f developing: (i) a GEF funded project on biodiversity and conservation o f the Georgian grape varieties, as well as a possible investment in the bio-diverse, organic wine project; and (ii) other agribusiness projects as opportunities emerge.

67. Public Infrastructure and Services. Improving infrastructure i s also crucial to rural growth. The FYOO Roads and FY04 Secondary and Local Roads projects focus on improving transport infrastructure. Secondary and rural local roads are the most important rural infrastructure connecting agricultural areas to market. According to studies conducted elsewhere in the region, poor road quality can add 28 percent to 44 percent t o usage costs. Furthermore, poor road quality can exacerbate poverty as poor households are disproportionately concentrated in remote areas. IFC is also interested in supporting projects to develop the transport sector, taking advantage o f Georgia’s strategic position between Europe and Asia.

68. Provision o f other critical public infrastructure and services i s being supported through a number o f ongoing projects: the FY03 Municipal Development and Decentralization (MDF), FYOO Agriculture Research, Extension and Training, FYO 1 Irrigation and Drainage Community Development APL, the FYOl Electricity Market Support and the FY03 Social Investment Fund projects. Proposed new projects include the FY04 Secondary and Local Roads Project and the FY06 Rural Telecommunications LIL focused o n developing rural telecommunications in l ine with the Government’s efforts to improve access. A study o f Urban Housing will be completed in FY04. Housing development i s also being supported by IFC’s credit lines which help finance the development o f its mortgage lending. The credit lines are available through TBC Bank and Bank of Georgia for real-estate based financing, including acquiring, constructing or upgrading both commercial and residential property, and also for financing small and medium companies for working capital and investment purposes. These loans were accompanied by U S A I D technical assistance to strengthen the banks’ mortgage lending policies and to improve operations in the area o f appraising, processing, and supervising mortgage loans.

- 24 -

69. An FY98 Cultural Heritage Project that focused on fostering market-oriented systems o f cultural heritage management, on the one hand, and a grant on the other, have highlighted Georgia’s potential for community-based tourism development. Such activities have the potential to serve as an important source o f non-farm income in selected rural communities and small towns. The participatory approach taken by the project has also made some contribution to promoting social and national cohesion, even in multi-ethnic and conflict zones such as Javakheti and South Ossetia. A small FY0.5 Community-based Tourism Project will build on th i s work to identify regional tourism opportunities, (Trans-Caucasus Tourism) by helping the Government prepare a development strategy for community-based tourism that would promote broad-based local development, reduce administrative barriers to tourism, and support the application o f preservation laws. In addition, IFC wil l explore opportunities to support development o f the tourism industry in Georgia.

Community-based Tourism.

70. expressions o f interest in the telecommunications and water sectors.

MIGA. MIGA has not yet provided a guarantee in Georgia, although it has received

(20 Promoting Human Developmen f , Social Protection, and Protecting the Environment

71. IDA assistance for human development and social protection i s aimed at improving the use o f scarce public resources. With much health and education spending by default n o w in private hands, public resources need to be focused on improving access for the poor. This will require, most crucially, increased overall expenditure, as wel l as better prioritization o f sectoral expenditures, including o f social protection programs, and qualitative improvements. Annual process-based Public Expenditure Reviews will provide the underpinnings for needed systemic changes in revenue and expenditure management, including improving the transparency and equity o f transfers f rom the central to the local budgets (which have an important role in providing social services). In terms o f specific investment support, no new projects in health and education are envisioned, as implementation o f ongoing operations will extend beyond the FY04-06 CAS period.

72. Education. Over the CAS period, an important focus will be on implementation o f the FYOl Education APL (second phase scheduled for early FY07), which aims at improving the learning outcomes o f both boys and girls through curriculum reform, development o f an examination system, training o f teachers, provision o f learning materials, and development o f capacity to make better use o f Georgia’s physical, financial and human resources. School rationalization and consolidation will be undertaken to ensure the most effective use o f the l imited resources available. Whi le the investment needs o f school buildings are substantially higher than what is currently affordable for Georgia, the MDF and SIF projects will continue to provide financing at the community level for critical social infrastructure needs, and for urgent repairs to school facilities in many communities.

73. Health. Building o n the reforms underway, and the first interventions in the sector (FY96 Health Project and FY02 Supplemental Credit), the FY03 Primary Health Care Development Project i s continuing to work with the Government o n improving the health care financing system, exploring risk-pooling options, introducing a new system o f primary health care (including an emphasis o n reducing maternal mortality), and improving the scope o f services funded through public funds to increase focus o n the poor and priority public health

- 25 -

interventions. Given the increasing role o f private sector provision o f health services, an FY04 Health Note will provide a detailed assessment o f financing, production, management and organization o f health services in Georgia.

74. Social Protection. The second SIF project (co-financed with IDA, KfW and USAID) is focusing o n community development through rehabilitation o f small scale economic and social infrastructure in poor rural and peri-urban communities. To assist Georgia in further protecting the most vulnerable, a variety o f instruments would be used, including the FY04 Social Protec- tion Reform Project and an FYOd Poverty Assessment. The Social Protection Reform Project would support Government’s efforts to improve administration, develop institutions and build capacity for pol icy implementation in the areas o f social insurance, employment services and labor market policies, social assistance, social services and chi ld welfare. UNICEF and S I D A will support the chi ld welfare component o f the project, and the Bank will prepare a Child Welfare Note in FY04.

75. I n t e r n a l l y Displaced Persons. IDA has been collaborating with a range o f other donors in supporting the Georgia S e l f Reliance Fund (GSRF), which pilots innovative interventions to help create sustainable livelihoods for IDPs. The GSRF currently has a capital o f over $1 million, with contributions from IDA’S Self-Reliance Fund, UNHCR, UNDP, Switzerland, and USAID. Approximately $500,000 has been disbursed to date, and four pi lot programs managed by IDP communities, national and international NGOs, are currently under implementation.

76. The Envi ronment and Natural Resources. IDA has supported preparation o f Georgia’s National Environmental Action Plan, Biodiversity Strategy, and the Black Sea Act ion Plan. Ongoing projects (the FY99 Integrated Coastal Management Project and the GEF component o f the FYOO Agriculture Research, Extension and Training Project) support environmental protection and monitoring o n the coasts, and address point and non-point source pol lut ion run off into the Black Sea Basin. Efforts continue to further protect coastal water quality and marine life. The FYO 1 Energy Transit Institution Building project i s increasing Government capacity for environmental management o f o i l and gas transport.

77. Forestry. The FY03 Forestry Development Project (and related GEF-financed Protected Areas Project) a im to improve forest management and sustainable use and conservation o f Geor- gia’s biodiversity. While better forest management has the potential to bring sizeable fiscal benefits as well, reform o f the sector is l ikely to be high risk, given the entrenched political and economic interests, including large amounts o f smuggled forest products. In order to maintain newly established protected areas, efforts needs to be directed at increasing community involvement, boosting tourism, improving infrastructure, and implementing income generating activities in buffer zones o f protected areas, where local communities face pressing subsistence needs. In addition, IFC i s planning, subject to finding suitable partners support for development o f community based forest management and reforestation initiatives along the B T C pipeline route.

@io Improving Governance and Efficiency o f PubIic Expenditures

78. The uncertain political environment in the 18 months between the November 2003 Parliamentary elections and the 2005 Presidential elections will make achieving governance reform especially difficult. While the governance agenda i s broad, IDA will focus selectively o n

- 26 -

areas where progress seems possible in this setting: (i) public expenditure management, where there i s already a solid analytical base; (ii) judicial reform; and (iii) a more intensive dialogue on c iv i l service reform, where there is a well-articulated reform plan. The Base Case envisages this dialogue culminating in a Public Sector Reform Project in FY06, or in FY05 in the High Case if the reform momentum accelerates.

79. Public Sector Management. Preparation o f the Public Sector Reform project will, in conjunction with a PHRD grant, help develop c iv i l service reform programs, with a focus on functional analysis o f the central government and assessment o f appropriate levels o f remuneration and employment, including consideration o f the social impact o f redundancies. The project i tself will aim to strengthen public institutions, and society’s abi l i ty t o ho ld those institutions accountable. Specifically it will support measures to: (i) establish revenue predict- ability; (ii) reduce inequities across local government units; (iii) improve incentives to boost the tax effort at the local level; (iv) clarify expenditure responsibilities by distributing functions/competences between rayons and Local Self Governing Units; and (v) help strengthen regulatory capacity, improve the efficiency and effectiveness o f the public sector, and restructure strategic sectors (energy, transport, telecom). Technical assistance provided by ongoing operations will become demand-based as Local S e l f Governing Units try to meet performance criteria. This will be closely coordinated with the ongoing Municipal Development and Social Investment Funds, and with the proposed FY05 Rural Development Project.

80. IDA will assist in strengthening the Government’s expenditure management systems through annual process-based public expenditure reviews to be conducted in collaboration with the Government as a fol low-up to the FY03 PER. The reviews will focus on strengthening the strategic content o f the budget formulation process and raising the credibility o f the budget as a management tool through the proper implementation o f the new Budget Systems Law. The Public Expenditure Review work would be coupled with the FY06 Public Sector Management, and would underpin, in the High Case, an FY06 PRSC (in the High Case the Public Sector Management Project would also be advanced to FY05). The IMF and IDA will also continue to conduct Debt Sustainability Analyses, and IFC and IDA will work with the government to ensure transparent reporting o f revenues during implementation and operation o f the BTC pipeline. Assistance in the area o f intergovernmental finance (in coordination with U S AID and the Urban Institute decentralization program) would also be provided through the Public Sector Management Project.

Process-Based Public Expenditure Reviews.

81. Country Financial Accountability Assessment. A CFAA was carried out by IDA in FY03, covering the whole public expenditure management framework, and analyzing the fiduciary risks in the system o f internal controls. The assessment concluded that the fiduciary risk of the Government’s current public expenditure management framework is high given Georgia’s dif f icult governance situation, and requires strong internal and external controls. The review’s major recommendations were for the Government to focus, as a first priority, on:

0

0

0

0

implementing a sound legal foundation for effective financial controls;

establishing an internal audit function;

strengthening the external audit function;

building staff capacity in financial management and auditing.

- 27 -

IDA will work with other donors to provide follow-up advice and support on these issues, including through the proposed Public Sector Management Project.

82. Local Governments. Transparency and capacity building at the local level will, in addi- t ion to support through projects such as the Social Investment Fund and Municipal Development and Decentralization, be monitored through performance indicators by an independent organiza- t ion funded through a competitive small grants program. Constructive competition between local governments will be encouraged through a highly transparent and well-publicized budget monitoring system. Indicators will be very similar to the financial eligibility conditions used by the MDF in assessing the borrowing capacity.

83. Support for Judicial Reform. According to the BEEPS, crime, corruption and the judicial system are the worst culprits preventing private sector- and export-led growth. The ongoing Judicial Reform Project has been helping to improve the quality and training o f judges, as wel l as associated court infrastructure. The Public Sector Management Project would focus on key measures to support and evaluate the impact o f the judicial reform, focus o n issues related to access to justice, including the reform o f the Bar Association and support for the Anti- corruption commission if political leadership on this issue i s forthcoming. Strong cooperation with other donors and with civil society will be critical to the success o f the project. USAID, UNDP, and DFID, amongst others, are providing substantial assistance in strengthening civil society’s voice, including local community action and development programs, media training, support to the elections process, and support to building and strengthening NGOs.

84. PRSC. In the event that Governance reform moves forward more quickly than currently expected, IDA would advance the Public Sector Reform Project to FY05, and plan for a f i r s t Poverty Reduction Strategy Credit (PRSC) in FY06. The PRSC would support implementation o f selected Government priorities within the EDPRP, and the proceeds o f the credit would help to meet Georgia’s substantial financing gaps and high debt service payments. If Georgia i s not yet ready for a PRSC because o f insufficient progress o n expenditure tracking and fiduciary arrangements, a programmatic adjustment instrument would be used instead.

Assistance Scenarios and Triggers 85. The Base Case lending scenario during FY04-06 would be conditioned o n satisfactory macroeconomic performance, specific and monitorable progress in governance (including fiscal management), and continued good portfolio implementation (see Table 8). As discussed above, the Base Case would support projects in public sector management (including judicial reform); social protection; rural development and community-based tourism; priority infrastructure investments (including roads, trade and transport facilitation, and rural telecommunications); and facilitation o f the growth o f export-oriented small and medium-scale enterprises.

86. A High Case would provide additional resources (bringing total lending up to $100 mil- l i on in FY04-06) if the scope for strengthening governance improves significantly. The High Case would include a first PRSC, or a programmatic adjustment credit, in FY06, and the Public Sector Management Project would be brought forward to FY05 to help lay the foundation for the PRSC. Low Case lending i s envisaged if the governance environment, macroeconomic performance, or IDA portfolio implementation deteriorates markedly. The L o w Case would provide

- 28 -

FY04 FY05 FY06 Project US% Project US$ Project US$

Secondary & Local Roads 20 Rural Development 15 Private Sector Development 10 Social Protection 10 Public Sector Management 8 Rural Telecom LIL 5

Trade & Transport Facilitation 9 PRSC 20 Community-Based Tourism 3

30 35 35

around $45 mill ion in selective support for key social sector, roads and rural development projects that would have a development impact even in a more difficult implementation environment.

FY04-06 No. US$

9 100

Table 6: Proposed Lending Program (in US$ mil l ions)

FY04 FY04-06 US$

Social Protection 10 Secondary & Local Roads 15

25 4 45 -

FY04 1

Secondary & Local Roads Social Protection

Project Secondary & Local Roads I 20

I lo/ lsocial Protection

u Base Case Lending Scenario

FY05 FY06

Rural Development 15 Private Sector Development 10 Trade & Transport Facilitation 7 Public Sector Management 8

25 23

Project US$ Project US$

Community-Based Tourism 3 Rural Telecom LIL 5 -

I

FY04-06 No. US$

87. Non-Lending Support. IDA will strengthen i ts non-lending activities in the key areas outlined above, with a special focus on support for public expenditure reform through process- based reviews carried out jointly with the authorities and other stakeholders to improve public sector management and the link with the EDPRP. Support for a better business environment will be provided through financial sector advisory work and business environment and labor market studies, as well as through IFC’s technical assistance program. Options for improving the environment for rural development will be explored in a rural infrastructure study, and a water resource and risk management study. Donor coordination and alignment with the Government’s EDPRP priorities will be facilitated by periodic donor coordination meetings, and support for PRSP updates. Finally, IDA’S flagship non-lending activity will be the preparation o f a major Policy Options Report for discussion with the incoming government in early 2005.

88. The IDA program i s built on expectations o f continued improvements in macroeconomic and debt sustainability indicators. The projected improvements in debt sustainability are particularly sensitive to a number o f macro-economic parameters including government and

- 29 -

Table 7: Non-Lending Sewices Underway and Planned

Underway and FY04 Macro-Monitoring CPAR Follow-up CFAA Follow-up Health Note FSAP Follow-up Advisory Child Welfare IDF Housing Note Rural Growth Post Conflict Grant Public Expenditure Review Follow-up PRSP Support Rural Infrastructure Study Planned Macro-Monitoring Poverty Profile Water ResourceRisk Management Labor Market Public Expenditure Reviews Updates Business Environment Study Policy Options Report for Incoming Government Donor Coordination Financial Sector Advisory PRSP Updates

FY Ongoing Ongoing Ongoing FY04 Ongoing FY 04 FY 04 FY 04 FY04 Ongoing Ongoing FY 04

FY05,06 FY05 FY05 FY06 FY05,06 FY06 FY05 FY05,06 FY05,06 FY05,06

export revenues, and non-debt creating capital inflows. IDA will closely monitor these indicators. Should such review indicate worsening prospects for improved debt sustainability, a progress report would be prepared and submitted to the Board, setting forth a recalibration o f IDA'S program necessary to ensure progress towards debt sustainability.

VI. IMPLEMENTING THE CAS

Strategic Considerations

89. As elaborated in Section I11 above, IDA and IFC already have a broad ongoing program o f support for the EDPRP objectives. In developing the FY04-06 CAS, several strategic choices were made. First, particular attention will be paid to sustainable support for rural poverty alleviation. Although urban poverty i s s t i l l higher in Georgia in absolute terms than rural, Table 4 shows an encouraging trend o f poverty reduction in urban areas, which have been more responsive to overall economic growth. Rural poverty, however, i s proving to be more intransigent, and several o f the new operations for FY04-06 pay particular attention to stimulating economic activity in rural areas in sustainable ways, including the Secondary and Local Roads, Rural Development, and Community-Based Tourism projects. These initiatives will be complemented by the Private Sector Development Project, which will focus on fostering productive clusters o f

- 3 0 -

Table 8: Lending Triggers

T o Remain in Base Case

Macroeconomic Policies

0 Maintenance o f macroeconomic stability, as measured by single digit inflation and suitable build up o f foreign reserves.

0 Tax collections increased by at least 0.5 percent o f GDP annually, and tax collections (excise plus VAT) from petroleum products maintained above 1.5 Dercent o f GDP.

Governance

Increased Government accountability, as measured by progress in unification o f government accounts in a single treasury, and establishment o f commitment controls.

Satisfactory budget execution o f priority programs (especially health, education, and social protection), i.e. at least 85% percent o f budgetary allocations disbursed as planned in the budget. Continued improvement in cash payment collections at the wholesale electricity market.

Some improvement in business environment, especially for exporters, as measured by annual surveys

Poverty 0 Establishment o f effective, transparent and par-

ticipatory arrangements for EDPRP monitoring and evaluation.

0 Timely preparation o f annual EDPRP progress reports, and improved prioritazation and sequencing o f activities in EDPRP updates.

0 Government provision o f adequate financing for carrying out and analyzing household budget surveys to support EDPRP monitoring and poverty targeting.

Portfolio

0 Good portfolio performance maintained, specifically delays in both effectiveness and implementation minimized.

0 Maximum o f two problem projects in the portfolio.

To Move to High Case (all Base Case Triggers plus:)

Macroeconomic Policies

0 Substantial improvement in tax revenues from petroleum products and cigarettes.

0 Substantial progress in settlement o f pension and wage arrears.

Governance

Adoption o f programmatic budgeting in key sectors (e.g., health, roads) within a medium term planning framework

Design and adoption o f a transparent transfer mechanism for local budgets.

0 Substantial improvement in cash payments collection at the wholesale electricity market.

Notable improvement in the business environment, especially in crime and corruption indicators

Poverty

0 Clear evidence o f improved targeting o f public funds to the poor (especially in health and social assistance programs).

0 Accelerated implementation o f priority EDPRP programs.

- 31 -

horizontal and vertical value chains in areas such as agro-processing, and by the Trade and Transport Facilitation and Rural Telecommunication projects, which will address important logistical hindrances to rural economic development.

90. Second, in addressing the needs o f the most vulnerable, the already very active ongoing social sector programs will be complemented by a social protection project, addressing a central theme o f the Bank’s CAS consultations (see paragraph 94 below). Third, the CAS is addressing the governance problems that hinder sustainability, and which were another recurrent theme in the consultations. While the Public Sector Management Project embeds crucial central government reforms in terms o f budget preparation and execution, as wel l as judicial and to the extent possible c iv i l service reform, the project also aims at empowering local governments through fiscal decentralization. Indeed, almost al l projects in the ongoing and planned portfolio have strong elements directly addressing fundamental governance problems through greater transparency, accountability, and fostering o f community participation.

91. Finally, bearing in mind both the political uncertainties during the next 18 months o n the lessons learned from the previous CAS, the FY04-06 CAS program wil l rely relatively less on the central government and more o n financially self-sustaining autonomous institutions and community-based efforts. Likewise, the program will rely more on strengthening private sector capacity and c iv i l society advocacy. An example is the already established GEOPRO public- private sector working group o n trade and transport facilitation, which anchored by a business confederation-supported secretariat plays a leading role in regular dialogue and advocacy, consultation on legal and administrative issues, technical assistance, and monitoring o f development impact. The planned projects will build further on the success o f this model, and an important strategic analytical contribution during FY05-06 will be the Policy Options Report for the incoming government, which should also serve as a basis for the subsequent CAS.

Outcomes and Monitoring 92. The proposed core indicators that would be used to measure progress are shown in Table 9, and more specific performance indicators are shown in the Program Matr ix (Annex 9). The Program Matrix provides performance indicators for those elements o f the EDPRP that IDA i s supporting through the CAS (other areas are either being supported by development partners, or are o f relatively lower priori ty for Bank support given the areas o f CAS focus defined above). IDA will also assist in developing monitoring procedures, and ensuring the indicators and the results o f the performance assessments are publ icly available throughout the country. IDA’S own performance would also be evaluated based on results o f regular client surveys and consultations with the Government and with c iv i l society.

93. The quarterly Household Survey will be a key element o f the measurement o f these indicators. As donor finance for these surveys declines, the Government has committed to a corresponding increase in its o w n share o f the cost. The f i rs t test o f this commitment will come with the 2004 budget. Resources will also be needed to improve the quality and the t imely dissemination o f the macro-economic and socio-demographic data provided by the State Department for Statistics and the Ministry o f Finance.

- 32 -

Increase to 97 percent enrollment in basic education for the poorest quintile. Pensions and social assistance benefits paid on time with no arrears build-up. Increase o f 10% in the proportion o f infants that receive immunization on time; 25% increase in the number o f pregnant women completing 4 mandatory prenatal visits Five percent reduction in the number o f new tuberculosis cases. Significant reduction in uncontrolled logging.

Table 9: Core CAS Monitoring Benchmarks

Education APL, SIF

Social Protection Reform Project; Poverty Assessment. Primary Health Care Project; Health Note.

Primary Health Care Project; Health Note. Forestry Development Project.

Stratepic CAS Goal: Faster and more broad-basec;

Strategic CAS Goal: Improve governance and efficiency Macroeconomic stability with consistent budget planning and execution. Increased public confidence in independence and fairness o f judiciary confirmed through independent surveys. Public perception o f progress in improving governance and reducing corruption, particularly payment o f bribes. Progress in rationalizing civi l service and introduction o f transparent personnel policies and code o f ethics.

Continued reduction in cost o f doing business as measured through annual surveys and BEEPS.

in public expenditures PRSC; PER TA; CFAA; CPAR. Public Sector Reform Project

Public Sector Reform Project; MDF.

Public Sector Reform Project; CFAA; CPAR.

Access to irrigation water increased from 150,000 hato 200,000 ha by 2006, and number o f legally registered . -

water user associations from 100 to 300. Substantial completion o f rural land titling and establishment of rural land registries. Proportion o f households having no electricity for a month or more reduced to 15%. Economic and social infrastructure rehabilitated in 150 poor communities, and operated on a sustainable basis and used by beneficiaries for the intended purposes.

wivate sector gro wth PSD Project; TTF Project; Enterprise Rehab. Project; Rural Development Project; PRSC; FSAP follow-up; Constraints and Opportunities in Rural Growth; IFC support to SME and financial sector. Irrigation and Drainage Community APL .

Agriculture Development Project. Rural Development Project. Electricity Market Support Project; Advisory Services. Social Investment Fund; also Secondary and Local Roads Project; Rural Development Project, Rural Telecom LIL.

- 3 3 -

CAS ConsuJiaiions

94. IDA’S strategy has been under discussion with a wide range o f stakeholders in Georgia since the first draft o f the current CAS (in FYO1). Those discussions included c iv i l society focus groups in four regions o f Georgia, NGOs, the foreign and domestic private sector, trade unions, and major donors. Subsequently, IDA has participated actively in working groups and meetings on the EDPW with the authorities, other donors, the private sector and non-governmental organizations, and those consultations are also reflected in the new CAS. Finally, views o n CAS priorities were again discussed during meetings with donors, the private sector, N G O participants in the EDPW process and the authorities at the time o f the Joint Portfolio Review in late January 2003. The themes identified below have recurred throughout these various discussions and consultations.

0 Social Conditions. Poverty was seen as being very widespread, and worse in urban areas, but there was a recognition that absolute poverty in the countryside i s s t i l l a serious problem. Deteriorating standards o f health care were frequently mentioned as a major element o f the decline in social conditions in Georgia. Pension arrears were another concern, and many participants said it was essential that the l imi ted funds available for social protection be targeted to the most needy, and that this in turn required more accurate identification o f the most vulnerable. Many focus groups referred to the cultural deprivation they felt, with many people no longer being able to afford newspapers or books, and with the sense that many children are n o longer receiving a good education.

0 Governance. Most focus groups sharply criticized the corruption and inefficiency o f Government agencies, and their lack o f accountability. The view was that l i t t le i s done to prosecute corrupt officials, and much productive energy i s wasted dealing with petty harassment. Small businesses in particular spend enormous amounts o f t ime and money dealing with corrupt officials. At the same time large businesses with powerful friends were seen to break the law with some impunity, and Government officials who broke the l aw were usually at worst moved to different posts. In reaction to these failings many participants wanted to see a more active N G O sector providing an alternative source o f services and advice. There was also a request for more outreach and transparency o n the part o f IDA and other donors in acknowledging these issues and pressing for reform.

0 Enterprise Development. Participants stressed that many o f the sectors that flourished in Soviet times - heavy industries and textiles in particular - are n o longer competitive. But many saw potential in newer sectors such as agro-processing for export. The main constraints to faster development o f these emerging sectors were seen to be red tape, corruption and lack o f market knowledge and entrepreneurial experience. Other obstacles often mentioned were poor access to credit, high interest rates, and inadequate sk i l ls and training. Some participants saw greater potential for j o b creation in rural areas, more so than in towns with dying heavy industries.

- 34 -

Development Partners 95. Donor coordination has been good in Georgia, and has improved further with the establishment o f the “Framework Group” which coordinates al l donor EDPRP activities. All requests for support for the EDPRP have been channeled through the Framework Group, coordinated by UNDP, which has collectively reviewed each proposal before passing it on to individual donors for possible support. This arrangement has substantial advantages for both Government and donors, since it has streamlined communications, reduced overlap between donor programs, and has allowed a broader review o f Government proposals. (Areas o f emphasis o f donors are detailed below and in Attachment 11).

96. UNDP in Georgia focuses its program activities in three areas: (a) democratic governance; (b) poverty reduction; and (c) environmental protection, as outlined in the second Country Cooperation Framework for Georgia (2001 -2005). In the sphere o f Govemance, major ongoing initiatives include support to the Foreign Investment Advisory Council, strengthening the Anti-corruption Promotion Group, and assistance to the Constitutional Court and Public Defender’s Office. U N D P has been active in capacity building o f the Georgian International O i l Corporation and o f the National Security Pol icy Management. UNDP is also contributing to land market development through creation o f a computerized program o f registration. Technical and financial inputs have been provided to strengthen the capacity o f Georgian institutions responsible for national statistics, notably the State Department o f Statistics. Environmental challenges are being addressed through projects supporting recovery, conversation and sustainable use o f Georgia’s agro-biodiversity, removal o f barriers to small hydro power sector development, and capacity building o f the Ministry o f Environment.

97. UNICEF priorities in Georgia include: education, integrated childhood development, immunization, fighting HIV/AIDS, and protecting children from violence, exploitation, abuse and discrimination. I t has been assisting the Government in national training o f health workers and professionals and in providing universal access to basic health services for women and children. UNICEF has been helping the Government in promoting the implementation o f the Convention o n the Rights o f the Child. Support also includes ensuring inclusive education for children with disabilities, and providing psychosocial support to children in need o f special protection, as wel l as introducing alternative, non-institutional methods o f childcare. Chi ld de- institutionalization has been also supported by SIDA through provision o f technical assistance during social protection reform project preparation and implementation phases.

98. EBRD’s main objective in Georgia i s to expand private sector development activities. During 2002 and 2003 it has been engaged in an active political dialogue with the Government to support substantial reduction o f administrative barriers to investments, representation o n the board o f companies and banks, support o f the initiatives o f local business associations. EBRD aims at further strengthening o f the Georgian banking sector through ongoing support to the regulator, management training, and further consolidation. EBRD’s interventions include financing for business start-ups and existing micro, small and medium-sized enterprises, as well as selectively supporting critical investments in infrastructure with specific focus o n those projects that promote the commercialization o f infrastructure, particularly o f the energy sector.

- 35 -

99. USAID assistance in the economic growth area focuses on strengthening agriculture sector, assisting the NBG to improve i t s supervision, inspection, and enforcement capacity, and furthering land market reform. The Georgian Enterprise Growth Initiative (GEGI) i s a major new private sector development activity to be implemented in close coordination with the CAS programs. U S AID has been actively involved in the energy and environmental sectors providing TA to regulatory bodies, supporting privatization o f the energy sector and improvement o f the international investment climate, assisting in elaboration o f environmentally sound laws in the energy sector, as wel l as policies in the sector oriented towards energy efficiency, conservation and water management. Through democracy and governance oriented projects U S A I D supports increased awareness o f legal rights, judicial and bar reform initiatives, strengthening local governments, building professionalism o f independent mass media as wel l as capacity o f c iv i l society and NGOs. U S A I D initiatives in the social sectors include programs in the regions to support income generation and economic self-reliance activities among internally displaced persons, crisis assistance to the most vulnerable, health care partnership programs, and reproductive health programs which promote improved maternal and perinatal services, safe motherhood, family planning, health information systems, and STI/HIV awareness and prevention.

100. EU’s Partnership and Cooperation Agreement (PCA) provides for cooperation in a wide range o f areas including the Food Security Program, rehabilitation in conflict zones (Engury Power Plan in Abkhazia), macro-financial assistance (establishment o f an agricultural credit institutions, reforms in accountancy and audit, assistance to the insurance sector and securities market regulation), support to trade liberalization, customs, and development o f transport infrastructure networks, advice on economic legislation and country legislature harmonization with EU standards, investments in the primary health care reconstruction program, development of the Georgian National Health Program, and training o f medical and administrative personnel, as well as provision o f technical assistance for the development o f the model o f Regional Health financing. TACIS i s the main financial instrument supporting the implementation o f the PCA.

101. The Netherlands has provided support for a wide range o f activities, focusing o n good governance, economic reforms, human rights and peace building, as wel l as substantial budget assistance as support for the structural reforms under SAC 111. Dutch support in these focus areas will continue, including for election preparation, prevention o f trafficking in human beings, confidence building measures in Abkhazia, and support for NGOs involved in poverty alleviation and human rights.

102. GTZ, working o n behalf o f German Government, provides support in the health sector primarily focusing o n structural improvements and training for medical technicians, promoting the vocational training sector to improve commercial and agricultural training and upgrading, implementing projects to privatize agriculture and build up effective land- and debt-management systems, promotes export and investment, and has been assisting in judicial and legal training as well as practical application o f c iv i l l aw in Georgia. German assistance is also channeled through KfW, which is supporting credit lines to agriculture sector enterprises, with participation through an equity stake in Procredit Bank. KFW is conducting cadastral works over almost the whole country, and contributing to social infrastructure in the districts bordering Bor jomi- Kharagauli National Park, as wel l as supporting Government efforts to rehabilitate schools and health facilities damaged during the recent earthquake.

- 3 6 -

103. Bilateral assistance from Canada (CIDA) comes mostly through the regional projects supporting trade policy capacity, expanding the micro credit programs, promoting NGO capacity development program that supports the principles o f good governance, strengthening health reform through the appropriate application o f health information technology and information management strategies, and contributing drought victims relief operations. C I D A is also supporting the Georgia Business Development Project, a five-year technical assistance program implemented by the Private Enterprise Partnership.

104. DFID has recently approved a new Primary Health Care (PHC) Development project through which technical assistance will be provided to the Government in the areas o f human resource development for the PHC system, health care financing, health management information systems, capacity building for the health policy development. DFID has been supporting the SDS in the multi-sector household and labor market surveys. The ongoing program also has a component aiming at development o f good governance and c iv i l society in two regions o f Georgia as well as conflict reduction and confidence building component.

105. In the agriculture sector IFAD supports rural development program for mountainous and highland areas and credit-union development and rural credit activities for small farmers, while F A 0 provides financial support to hazelnut rehabilitation.

106. 0

There are five categories o f risks to the strategy outlined above.

Governance. As mentioned above, the next 18 months encompasses a rather uncertain political period in Georgia, with heavily contested parliamentary and Presidential elections. O n the other hand, improvement in governance i s crucial for Georgia's growth and poverty reduction strategy to succeed. These issues therefore have acquired a central place in IDA'S development dialogue with Georgia and are reflected in the CAS triggers. Many o f the CAS interventions also directly address the challenges o f improving public sector efficiency and accountability; strengthening public expenditure management; improving regulatory arrangements and other factors affecting the business environment; modernizing the judiciary; and building capacity o f communities, local governments and other stakeholders to participate in decision-making and press for accountability in the use o f public resources.

0 Fiscal and Debt Vulnerability. A renewed weakening o f fiscal performance i s also a serious risk. Without an improvement in revenue collection and development o f a program that wil l al low Georgia to return to the Paris Club, the country will face a heavy debt burden over the medium term, and an increased inability t o provide basic social services. This would lead to a further deterioration in human capital, undermining growth and poverty alleviation. The IMF is providing intensive advice to Georgia o n fiscal policy; IMF and IDA are cooperating on Debt Sustainability Analysis; and IDA and other partners have offered, or are providing, assistance o n budget management and reform o f tax and customs administration, including through the annual Public Expenditure Reviews.

- 37 -

0 Confl ict . Georgia remains vulnerable to both internal and external conflicts. Any renewal o f domestic conflict would seriously limit the Government’s ability to implement the EDPRP. Similarly, enhanced regional cooperation will be an important factor i f Georgia i s to maximize its potential as a transit economy, and to strengthen foreign investment, tourism and trade. The CAS aims at mitigating these risks by targeted programs to increase the living standards o f the poor in general, and programs to strengthen commercial interaction between rural and urban areas and across regions in particular. In addition, IDA has been conducting analytical work and supporting technical exchanges on common issues among the South Caucasus countries. Finally, IDA stands ready to provide assistance if geo-political solutions to the Abkhazia and South Ossetia conflicts are reached.

0 Vulnerab i l i ty to Exogenous Shocks. As demonstrated by the droughts in 1998 and 2000 (with severe impacts o n both agriculture and hydropower availability), and by the Russia financial crisis, Georgia is, and will remain, vulnerable to external shocks. CAS interventions promoting energy sector development, irrigation, rural development and diversification o f Georgia’s trade patterns should help lessen the country’s vulnerability to these shocks over the medium term.

0 Poli t ical Uncertainties. The period up to the Presidential elections in April 2005 i s likely to be one o f considerable political uncertainty, with the direction o f reform before and after the elections being dif f icult to predict. IDA will engage in a broad dialogue with al l stakeholders during this period, and will work closely with other donors and national stakeholders to support the EDPRP consultation process in a continuing effort to build consensus o n the country’s main development challenges and strategies to address them. Finally, a CAS Progress Report will be presented to the Board after the Presiden- tial elections if there has been sufficient change that circumstances warrant a review o f the assistance strategy.

James D. Wolfensohn President

Shengman Zhang Managing Director

Peter Woicke Executive Vice President

Washington D.C. December 4,2003

- 38 -

ATTACHMENT I: IMF-IDA RELATIONS

Partnership in Georgia ’s Development Strategy

1. The IMF has taken the lead in assisting Georgia in enhancing macroeconomic stability. In this regard, the Fund has encouraged the authorities to pursue a prudent fiscal policy, including by increasing tax revenues and reducing domestic expenditure arrears. The IMF Board approved a new three-year program under the Fund’s Poverty Reduction and Growth Facility (PRGF) in January 2001. The f i rs t and the second reviews under the PRGF were completed in October 200 1 and July 2002, respectively. Implementation o f the 2002 macroeconomic program was broadly o n track. Quantitative criteria and indicative targets were met, except for those o n domestic arrears, fuel and excise tax collection and reserve money. At 2 percent o f GDP, the fiscal deficit was slightly higher than programmed because o f shortfalls in extemal financing, and revenue collection improved only slightly f rom 14.3 percent o f GDP to 14.4 percent over the period. An IMF mission which visited Georgia in July 2003 to discuss completion o f the postponed third review found that the fiscal pressures that emerged in early 2003 had continued, with tax revenue falling short o f budget targets, and an accumulation o f substantial new budget arrears. The IMF thus saw the need inter alia to introduce some tax reform measures, adjust electricity tariffs and revise the 2003 budget to close the fiscal gap. The authorities achieved the f i rs t two, but were unable to secure parliamentary approval o f a revised budget. The current PRGF will expire in the next several months, and the IMF will soon be initiating discussions to assess prospects for a possible new three-year program to support Georgia’s EDPRP.

2. IDA has taken the lead in the pol icy dialogue o n structural issues, focusing on: (i) strengthening public expenditure management; (ii) deepening and diversifying sources of growth, (iii) protecting the environment; and (iv) reducing poverty. The table on page 40 summarizes the division o f responsibility between the two institutions. In a number o f areas - for example the social sectors, rural development, environment, and infrastructure - IDA takes the lead in the dialogue and there i s no cross conditionality with the IMF-supported program. IDA is also leading the dialogue on private sector reform, and IDA analysis serves as inputs into the Fund program. In other areas - energy, the financial sector, public expenditure management, and revenue and customs - both institutions work together. Finally, in areas l i ke monetary pol icy the IMF takes the lead with l i t t le IDA involvement.

Areas in which IDA leads and there is no direct IMF involvement

3. sectors, infrastructure and environment.

Areas in which IDA leads and there is no direct IMF involvement include the social

0 In the social sectors IDA conducts annual updates o f Georgia’s Poverty Assessment based o n household data collected o n a quarterly basis. IDA’S focus has been to improve the budget execution o f expenditures for health, education and poverty benefits and to raise the efficiency in the use o f scarce public resources. Through the Social Investment Fund credits, IDA is focusing in particular o n areas with high poverty levels to provide basic infrastructure to the poorest communities. A Self-reliance Fund Grant will help authorities address the complex issues related to internally displaced people. IDA is also supporting a

- 3 9 -

dialogue with the Govemment on social protection reform that will lead to an IDA- supported project.

In education the Education Adaptable Program Credit aims at improving the leaming outcomes o f primary and secondary students, through curriculum reform, development o f an examination system, training o f teachers, provision o f leaming materials, and development o f capacity to make better use o f Georgia’s physical, financial and human resources. While the investment needs o f school buildings are substantially higher than i s currently affordable for Georgia, the Social Investment Fund projects continue to assist in financing urgent repairs to school facilities in many communities.

In health, IDA Credits to support the Government in improving the health care financing system, exploring risk-pooling options, introducing a new system o f primary health care and improving the focus o f services funded through public funds o n the poor and o n priority public health interventions. In addition SAC 3 and the Structural Reform Support Credit have supported hospital restructuring.

In infrastructure support is being provided through the Municipal Development and Decentralization Credit and the Social Investment Fund Credit. These projects are providing financing at the community level for critical infrastructure needs, primari ly for school and health facilities heating and repair, small hydropower schemes to provide electricity, drinking water and sanitation rehabilitation, as wel l as transportation infrastructure rehabilitation.

In rura l development IDA credits have supported the development o f private sector farming and agro-processing improvements, agricultural credit, irrigation and drainage, and agriculture research and extension. IDA has also been supporting the creation o f local institutions such as rural credit unions and water users associations through i ts Credits.

Areas in which IDA leads and its analysis serves as input into the IMFprogram

4. IDA has been leading the dialogue o n structural reforms through SAC 3, approved by IDA’s Board o f Executive Directors in June 1999, and closed in October, 2002. Despite considerable delays, the core conditions o f SAC 3 were met, but poor governance reduced their impact. Institution building and technical assistance has been supported through the Structural Reform Support Credit, also approved by IDA’s Board o f Executive Directors o n June 29, 1999. IDA also leads in the areas of:

Private sector development. SAC 3 supported improvements in the environment for private sector development, focusing on: (i) simpler licensing regulations; (ii) more transparent government procurement; (iii) reduced cost o f entry for businesses; and (iv) privatization o f state-owned commercial assets. IDA has also been supporting private sector participation in other areas such as energy, telecommunications, urban services and agriculture. The IMF has worked with the authorities to initiate audits o f the 2002 accounts o f three major state owned enterprises.

- 40 -

0 Energy. The energy system i s in poor condition, with unreliable supply, massive non- payment and mounting debts. IDA has been working with other donors, including the IMF, to encourage more private management and ownership, and to implement a series o f short-term action plans to improve the overall functioning o f the sector. The IMF has also been focusing on improved payments for electricity.

TABLE A. IDA-FUND COLLABORATION ON GEORGIA

Area

Macroeconomic Framework/ Management

Budget

Public Sector Reform

SociaVPoverty r Development

Infrastructure

Rural develop-

Specialized Advice from Fund Monetary policy, exchange rate, fiscal, and trade policies, economic statistics

Budget framework, tax policy and administration, customs, debt management, extra budgetary funds,

Public asset management, Proposals on audit o f three problematic enterprises, civi l service reform.

Specialized Advice from I D A Economic growth, expenditure allocations, economic statistics

Budget formulation, Country Procurement Assessment, Country Financial Accountabil- ity Assessment

Civ i l service reform, anti-corruption agenda, decentralization.

Poverty analysis; reforms in education, health, social protection; support to community driven development

Costs o f Doing Busi- ness Surveys. Support for improved legislation and regulatory framework for private sector, and support for privatization and market liberalization. Private sector participation in infrastructure

Reforms in agriculture, irrigation, forestry and, environment.

Key Instruments

IMF: PRGF performance criteria and benchmarks on monetary and fiscal targets. IDA: Macromonitoring; Trade and Transport Facilitation Project;; Financial Sector Advisory Work; Policy Options Report; PRSC conditionality in High Case ZMF: PRGF performance criteria on overall fiscal balance and revenue collection. Bunk: Public Expenditure Review Updates; Support for PRSP Updates; Policy Options Report; PRSC conditionality in High Case IMF: PRGF IDA: Public Sector Management Report

IMF: PRGF IDA: Support through IDA Credits for Education, Health and Social Investment Funds, Social Protec- tion study, SAC and ESAC conditions on payment o f poverty bene- f i t s and on homital restructuring. IDA: Business Environment Study, Labor Market Study, Private Sector Development Project, Trade and Transport Facilitation Credits.

IDA: Support though ongoing and proposed IDA Credits for Municipal Development, Roads, Transport and Power. IDA: Support though Rural Infra- structure and Water Resource studies; ongoing rural Credits, and proposed Credits for Rural Devel- opment, Rural Telecommunica- tions, Community Based Tourism.

- 4 1 -

0 Public Sector Management. IDA i s supporting the development o f a c iv i l service reform program, while the Fund i s providing technical assistance in support o f tax and customs administration reform.

Areas of shared responsibility

5. IDA and the Fund have been working jo int ly in the fol lowing main areas:

0 Poverty Reduction Strategy. Both institutions have been working closely with the Government to provide support to the development o f the PRSP, through seminars and workshops, direct staff input, and a multi-donor Trust Fund to support the work o f the PRSP secretariat..

0 Budget Planning and Execution. The annual process-based Public Expenditure Reviews will provide the underpinnings for systemic changes in expenditure management, with the immediate aim being improved budget formulation in 2004. The IMF i s focusing o n Treasury reform within the Ministry o f Finance.

0 Financial Sector Reforms. The joint Financial Sector Assessment Program has supported: (i) strengthened banking and non-banking supervision; (ii) introduction o f international accounting standards; (iii) and consolidation o f banks through higher capital requirement ratios; and (iv) anti money-laundering legislation. The IMF has focused in particular o n banking supervision.

0 Debt Sustainability Analysis (DSA). Given Georgia’s heavy external debt burden, IDA and the Fund conduct jo int Debt Sustainability Analysis o n a regular basis.

Areas in which the IMF leads and its analysis serves as input into the IDA program

0 Fiscal Framework. The IMF’s focus o n prudent fiscal pol icy has served as an important framework for IDA’S work o n public expenditure management.

Areas in which the IMF leads and there is no direct IDA involvement

0 Monetary Framework. The IMF closely collaborates with the NBG in the design and implementation of a monetary program that aims at remonetization o f the economy, while keeping inflation l o w and the exchange rate o f the La r i stable

0 Economic Statistics. IMF technical assistance has been conducive to improvements in national accounts, price, monetary and government financial statistics.

- 42 -

SECTOR ~ E A D NATIONAL AGENCY PARTNERS Agriculture Ministry o f Agriculture and Food IFAD, FAO, DFID,

UNDP, KFW Culture Ministry o f Culture EU

Fund for Cultural Heritage Protection

ATTACHMENT 11: DEVELOPMENT PARTNERS IN GEORGIA

Commission on PREGP (Poverty reduction and Economic Growth Program)

Trade

Territories, Preserves and Hunting Grounds

Telecommunications and Post Economic Developmenl

USAID, Netherlands

Private Sector Ministry o f Economy, Industry and USAID, EBRD, BP

Protected Areas State Department o f Protected UNDP

Roads Ministry o f Transport, Kuwait Fund for

Social Infrastructure

tional Bank o f Georgia tional Securities Commission

Council o f Justice, Supreme Court, EU, USAID, SOROS, General Courts Department, Judicial ABA, U S DOJ, Training Center, Ministry o f Justice Netherlands ALPE (Association for Legal Public Education) Georgian Municipal Development Fund (MDF) Secretariat o f Governmental

unicipal Development and

IMF, UNDP, DFID,

State Department of Roads

(GSIF) Georgian Social Investment Fund KFW

Transport and Communications inistry o f Transport, elecommunications and Post E ational Commission o f

I I A I kelecommunications and Transnort I

- 43 -

ATTACHMENT 111: CORE LABOR STANDARDS IN GEORGIA

1. and provides for sanctions against violators.

2. Trafficking in Persons. The law does not prohibit trafficking in persons specifically, although traff icking could be prosecuted under laws prohibiting slavery, forced labor, illegal detention, and fraud. Georgia i s both a source and a transit country for trafficked persons. There have been unconfirmed reports that government customs and border officials were involved in the trafficking o f persons. The Government has prosecuted some traffickers using fraud statutes, but otherwise has no active programs to address the problem o f trafficking. A government program for combating violence against women included a proposal for measures to eliminate trafficking in women for the purpose o f sexual exploitation; however, it has not been implemented due to budgetary constraints. Georgia i tself i s generally not a destination place for trafficked persons.

3. According to the law, the minimum age for employment o f children i s 16 years; however, in exceptional cases, the minimum age can be 14 years. The Ministry o f Health, Social Service, and Labor enforces these laws and generally they are respected. The Government has not ratified the ILO Convention 182 on the worst forms o f chi ld labor.

Forced Labor. The Constitution prohibits forced or bonded labor, including by children,

Effective Abolition of Child Labor.

4. The Constitution provides for the equality o f men and women. Women's access to the labor market has improved but remained primarily confined, particularly for older women, to low-paying and low-skilled positions, often without regard to high professional and academic qualifications. Salaries for women continued to lag behind those o f men. Reportedly men were given preference in promotions. O f the 1 14,5 12 registered unemployed persons throughout the country, 46 percent were women. Women sometimes, but not often, f i l led leadership positions. According to UNDP, employers frequently withheld benefits connected to pregnancy and childbirth.

Elimination of Discrimination in Employment.

5. Freedom of Association and the Right to Collective Bargaining. The l a w prohibits discrimination by employers against union members, and employers may be prosecuted for antiunion discrimination and forced to reinstate employees and pay back wages; however, there are reports o f managements warning staff not to organize trade unions. Some workers, including teachers in the Imereti region, employees o f various mining, winemaking, pipeline, and port facilities, and the Tbi l isi municipal government reportedly complain o f being intimidated or threatened by employers for union organizing activity. Observers also claimed that employers failed to transfer compulsory union dues, deducted f rom wages, to union bank accounts. The Ministry o f Labor has investigated some complaints, but no action has been taken against any employers to date. There are no legal prohibitions against affiliation and participation in international organizations. The Constitution and the law allow workers to organize and bargain collectively, and some workers exercise this right; however, the practice o f collective bargaining is not widespread.

-44-

ANNEXI: COUNTRYATA GLANCE

Georgia at a dance 8120l03

POVERTY and SOCIAL Georgia

2002 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1996-02

Population (%) Labor force (%)

Most recent estimate (latest year available, 199642)

Poverty (% of population below national poverfy line) Urban population (% of total population) Life expectancy at birth (years) infant mortality (per 7,000 live births) Child malnutrition (% ofchildren under 5) Access to an improved water source (% ofpopulabon) Illiteracy (% ofpopulation age 75+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATlOS and LONG-TERM TRENDS

GDP (US$ billions) Gross domestic investmenVGDP Exports of goods and serviceslGDP Gross domestic savingslGDP Gross national savingslGDP

Current account balancelGDP Interest paymentslGDP Total debtlGDP Total debt servicelexports Present value of debVGDP Present value of debffexDOrts

(average annual growth) GDP GDP per capita Exports of goods and services

1982

26 4

34.5

1982-92 199242

-6.2 2.1 -6.7 2.6

.. 11.5

5 2 730 3 8

-05 0 5

11 57 73 24 3

79

95 95 96

1992

4 5 23 4 35 7 -7 2

0 0 1 8

2001

4 7 5 5

-1 2

Europe 8 Central

Asia

476 2 160 1 030

0 1 0 4

63 69 25

91 3

102 103 101

2001

3 2 18 5 23 0 2 7 6 7

0 9 54 0 6 2

33 3 65 4

2002

5 4 6 4 5 7

Low- income

2 495 430

1 072

1 9 2 3

30 59 81

76 37 95

103 87

2002

3 3 18 0 27 1

5 9 10 6

1 2 54 9 9 5

2002-06

Devebpment diamond'

Life expectancy

T

1 GNI Gross per primary capita nrollment

1

I

Access to improved water source

1 -Georgia

I ~ Low-mcome group

Economic ratios'

Trade

T

Indebtedness

-Georgia ~ Low-income group

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annual growth) Agriculture Industry

Services

Private consumption General govemment consumption Gross domestic investment Imports of goods and services

Manufacturing

1982 1992

23.0 52.9 38.2 23.9 30.5 17.7 38.8 23.2

53.3 97.8 12.2 9.4

.. 66.3

1982-92 199242

.. 3.3

.. 2.4 4.3

.. 11.4

.. 8.4

2001

22.1 21 9

56.0

87.6 9.7

38.8

2001

3.0 4.0

8.7 -13.9 10.3 2.9

2002

196 23 1

57 3

84 3 9 8

39 2

2002

3.0 4.0

-24.8 4.7

608.5 4.2

I I Growth of investment and GDP ("A) 7% -

I I I 1 Growlh of expolto and Imports (%)

I -----Exports "Imports I

Note: 2002 data are preliminary estimates. This table was produced from the Development Economics central database. *The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will

be incomolete.

-45-

Georgia

PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplusldeficit

TRADE

(US$ millions) Total exports (fob)

Black metal Tea Manufactures

Total imports (cifl Food Fuel and energy Capital goods

Export price index (1995-100) Import price index (1995=100) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, locaVUS$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment Pofloiio equity

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1982

3.5

1982

1982

1982

1992

887.4 1,314.2

12.6 -21.6 -35.6

1992

267

645

1992

3.30E-5

1992

7 9 0 0

0 0 0

5 0

22 0 0

0 0 0 0 0 0

2001

4.7 5.3

16.5 0.4

-1.4

2001

639 42 62

273 1,078

143 176 470

98 97

101

2001

1,153 1,490 -336

20 108

-1 9

149 2.1

2001

1,729 0

396

77 0 3

69 64 13

160 0

90 63

0 63

3 61

2002

5.6 4.4

16.9 0.6

-0.7

2002

695 46 70

288 1,146

153 185 489

101 99

102

2002

1,249 1,583 -334

33 122

-26

193 2.2

2002

1,825 0

478

129 0 3

57 -1 7

55 59

0 59

3 56

Ti----

I 97 98 99 00 01

-GDP deflator . l o I C P l

, Export and import levels (US$ mill.)

11 250 -

96 97 98 99 00 01 02

s Exports Imports

1 Current account balance to GDP (%)

1 Composition of 2002 debt (US$ mill.)

I D: 145

A - IBRD B - IDA D -Other multilateral F - Private C - IMF G -Short-term

E - Bilateral

~~

Note: This table was produced from the Development Economics central database. 8/20/03

- 4 6 -

ANNEX 2: PORTFOLIO INDICATORS

Selected Indicators* of Bank Portfolio Performance and Management As Of Date 10/30/2003

Indicator 2001 2002 2003 2004 Portfolio Assessment Number of Projects Under Implementation a

Average Implementation Period (years) Percent of Problem Projects by Number Percent of Problem Projects by Amount a,

Percent of Projects at Risk by Number a , d

Percent of Projects at Risk by Amount a,

Disbursement Ratio (%) e

Portfolio Management CPPR during the year (yeslno) Supervision Resources (total US$) Average Supervision (US$/project)

19 2.3 0.0 0.0 0.0 0.0

19.6

Yes 1255

66

18 3.4

16.7 27.5 22.2 31.9 18.5

Yes 1557

86

18 3.4 5.6 5.2 5.6 5.2

21.4

Yes 1591

76

17 3.7 5.9 5.3 5.9 5.3 6.7

Yes 1480

78

Memorandum Item Since FY 80 Last Five FYs Proj Eva1 by OED by Number 14 8 Proj Eva1 by OED by Amt (US$ millions) 415.0 190.2 % of OED Projects Rated U or HU by Number 7.1 12.5 % of OED Projects Rated U or HU by Amt 14.0 30.5

a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the

beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,

which includes all active projects as well as projects which exited during the fiscal year.

-47-

ANNEX 3: WORLD BANK GROUP PROGRAM SUMMARY

Proposed IBRDllDA Base-Case Lending Program

Fiscal year Project Strategic Rewards Implementation (H/M/L) Risks (H/M/L) US$M

2004 SECONDARY AND LOCAL ROADS 20.0 M M SOCIAL PROTECTION 10.0 H M Result 30.0

2005 RURAL DEVT 15.0 M M TRADE AND TRANSPORT FACILITATION 7.0 H M COMMUNITY-BASED TOURISM 3.0 M L Result 25.0

2006 PRIVATE SECTOR DEVELOPMENT 10.0 H H PUBLIC SECTOR MANAGEMENT 8.0 H H RURAL TELECOMS LIL 5.0 M L Result 23.0

Overall Result 78.0

CAS Annex B3 (IFC & MIGA) for Georgia Georgia - I F C and M I G A Program, FY 2001-2004

2001 2002 2003 2004

IFC approvals (USJm) 0.29 9.72 5.00 0.00

Sector (YO) Finance & Insurance 100 100 100 Total 100 100 100 0

Investment instrument(%) Loans 51 50 Equity Quasi-Equity Other Total

100 7

41 50 100 48 50 0

MIGA guarantees (US$m) 0.00 0.00 0.00 0.00

- 48 -

ANNEX 4: SUMMARY OF NON-LENDING SERVICES

Product Completion F Y Cost (US$OOO) Audience a Objective

Recent completions Child Welf Note Caspian Oil & Gas Follow-Up Busness Env Study Trade Diagnostic Study Trade Faciltation Dialogue High Educ Note Revisitng Reform CFAA

Private Sector TA Banking Sector Advisory TA

FSAP Follow-Up TA

Underway Macro-Monitoring CPAR Follow-up CFAA Follow-up FSAP Follow-up Advisory Public Expenditure Review PRSP Support Health Note Child Welfare IDF Housing Note Rural Growth Post Conflict Grant Rural Infrastructure Study

Planned Policy Options Report for Incoming Government Poverty Profile Water Resource/Risk Management Public Expenditure Reviews Update Donors Coordination Financial Sector Advisory PRSP Updates Macro-Monitoring Business Environment Study Labor Market

FY03 FY03 FY03 FY03 FY03 FY03 FY03 FY03 FY03 FY03 FY03

Ongoing Ongoing Ongoing Ongoing Ongoing Ongoing FY04 FY04 FY04 FY04 FY04 FY04

FY05 FY05 FY05 FY05,06 FY05,06 FY05,06 FY05,06 FY05,06 FY06 FY06

33 13 38 173 28 43 73 1 04 93 29 275

250 75 187 145 120 194 52 52 50 116 162 83

300 266 52

240 100 150 207 200 124 100

KG,PD KG,PD PD,PS

KG,PD,PS PD,PS

KG, P D, PS KG,PD

PS KG,PS KG,PS KG,PS

KG PS PS

KG,PS PS PS

KG,PD,PS KG,PD,PS

KG KG,PD,PS

KG,PD KG,PD,PS

KG,PD,PS KG, PD, PS KG , PD , PS

PS PD,PS KG, PS

PD KG, PD, PS

PD,PS KG,PD,PS

a. Government, donor, Bank, public dissemination. b. Knowledge generation, public debate, problem-solving.

-49-

ANNEX 5: SOCIAL INDICATORS

Georgia Social Indicators

POPULATION Total population, mid-year (millions)

Urban population (% of population) Total fertility rate (births per woman)

POVERTY (“A of population) National headcount index

Urban headcount index Rural headcount index

Growth rate (% annual average for period)

INCOME GNi per capita (US$) Consumer price index (1995=100) Food price index (1995=100)

INCOME/CONSUMPTION DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highest quintile (% of income or consumption) SOCIAL INDICATORS Publlc expenditure

Heaith (% of GDP) Education (Oh of GDP) Social security and welfare (YO of GDP)

Net prlmary school enrollment rate (“A of age group)

Male Female

Access to an improved water source (?A ofpopulation)

Urban Rural

Total

Total

Immunization rate (x under 12 months)

Measles DPT

Child malnutrition (% under 5 years) Life expectancy at blrth (yeas)

Total Male Female

Mortallty Infant (per 1,000 live births) Under 5 (per 1,000 live births)

Male (per 1,000 population) Female (per 1,000 population)

Births attended by skilled health staff ( O h )

Adult (15-59)

Maternal (modeled, per 100,000 live births)

Latest s ing le year

1970-75

4.9 0.8

49.5 2.5

33

240 113

1980-85

5.3 0.8

53.9 2.4

71 67 75

30 36

210 94

1995-2001

5.3 -0.4 56.5

1.1

11.1 12.1 9.9

590 201 174

38.9 6.0

45.2

0.7

4.0

95 95 95

79 90 61

73 86 3

73 69 77

24 29

250 133 22 96

Same regionl income g roup

Europe & Central

Asia

474.6 0.1

62.8 1.6

1,970

4.0 4.4 8.8

91 98 83

95 94

69 64 73

31 38

317 137

LOW- income

2,505.9 1.9

30.8 3.5

430

1.1 2.8

76 90 70

60 61

59 58 60

80 121

312 256

Note 0 or 0 0 means zero or less than haif the unlt shown Net enrollment rate break in senes between 1997 and 1998 due to change from ISCED76 to ISCED97, ratios exceeding 100 indicate discrepancies between the estimates of school-age population and reported enrollment data

2003 World Development indicators CD-ROM, World Bank

E 8 L

*

- 9 3 4 %

-53-

ANNEX 7: m Y EXPOSURE INDICA TORS

Georgia - Key Exposure Indicators

Actual Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Total debt outstanding and disbursed (TDO) (US$m)a

Net disbursements (USSm)"

Total debt service (TDS) (US$m)"

Debt and debt service indicators

TDO/XGS~ TDO/GDP TDS/XGS ConcessionallTDO

IDA exposure indicators (Yo) IDA DSipublic DS Preferred creditor DS/public DS (%)' IDA DS/XGS IBRD TDO (us$mld

Of which present value of guarantees (US$m)

Share of IBRD portfolio (Yo) IDA TDO (US$mld

IFC (USSm) Loans Equity and quasi-equity /c

1466

153

40

174.0 41.0 4.7 43.5

3.7 19.7

0.2 0.0

0 212

2.8

1648

153

92

181.9 45.5 10.2 46.0

2.1 14.3

0.2 0.0

0 274

3.0 2.8

1653 1638 1729 1837 1938 1921 1944 1962

59 33 114 15 65 -19 20 15

108 118 77 129 188 215 231 226

179.4 187.7 160.3 173.2 173.3 161.1 153.3 145.4 58.3 53.8 54.0 54.3 51.4 48.1 46.9 44.7 11.7 13.5 7.2 12.1 16.8 18.0 18.2 16.8 49.6 49.1 49.7 54.0

2.3 2.4 4.3 3.3 2.4 2.8 3.7 5.0 30.8 36.8 44.7 44.6 33.4 36.7 42.5 41.2

0.3 0.2 0.3 0.3 0.4 0.4 0.5 0.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

0 0 0 0 0 0 0 0 346 347 396 491 531 590 639 685

18.3 51.1 42.0 49.8 50.6 53.1 55.6 55.6 5.8 6.8 7.0 7.3 4.9 4.9 6.9 8.9

MIGA MIGA guarantees (US$m)

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short- term capital. Debt service are based on actual payments through 2002, and on due payments thereafter.

b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for Intemationd Settlements. d. Includes present value of guarantees. e. Includes equity and quasiequity types of both loan and equity instruments.

6 a

mcq -*In

m t - 2 t m m N

$1

fi Y c z1 PI x w

0 0 0 0

'r

I

0 \o

I

e

ru 0

a

W z E 5 2 2

x P w c c X W

I

c\1 W

I

w

a a a a

I

M \o

I

b D z E m 4 -1 m a

2 c? W c U Y EL x W

Y -1

e e e e

-0 9 2 s

I * 9

-65-

ANNEX 10: CAS SUMMARY OFDEVELOPMENTPRIORITIES

As Of Date 09/02/2003

Country Major issue Country Bank Reconciliation performance' priority' priority" of country and

Bank priorities Network area

Poverty Reduction 8 Economic Management

Poverty reduction Fair Rural poverty Economic policy Fair-Good Fiscal Public sector Poor Corruption Gender Good-Excellent Gender balance in

public service

Human Development Department Education Fair Quality Health, nutrition & population Fair Resource allocation Social protection Fair-Good Timely benefit

payment

Environmentally 8 Socially Sustainable Development

Rural development Fair-Good Markets Environment Fair Enforcement Social development Fair IDPs

Finance, Private Sector 8 Infrastructure Financial sector Fair-Good Insufficient financial

Private sector Good Corruption Energy & mining Fair Payment culture Infrastructure Fair O&M

intermediation

High High High High Moderate High Ongoing dialogue, CAS triggers Moderate Moderate

High High High High High High

High High High High High High

High High

High High High High Moderate High CAS focus on budget allocations

a. Use "excellent," "good," "fair," or "poor." b. Indicate principal country-specific problems (e.g., for poverty reduction. "rural poverty;" for education, "female secondary complet!on;" for environment, "urban air pollution") c. To indicate priority, use "low," "moderate," or "high." d. Give explanation, if pnorities do not agree; for example, another MDB may have the lead on the issue. or there may be ongoing dialogue.

MAP SECTION

Documents

Document of The World Bank...related governance challenges will be difficult given Georgia’s current political cycle. There is significant political fragmentation, and electoral