Georgian roulette

The relationship has become especially active following the inauguration of the Kazakhstani president at the beginning of this year, when the heads of both countries signaled a political green light. As per the results of 2003, trade between the nations was hardly US$10 mln, while at present the figure has reached US$60 mln. While investment into the Georgian economy [by Kazakhstani investors] totaled US$300 mln over the first five months of the current year. At the current rate of investment, it can be predicted that total amount of Kazakhstani investment will total US$1 bln by year’s end.

Sergei Smirnov

BankTuranAlem (BTA) was one of the first Kazakhstani companies to enter the economy of Georgia. Following the purchase of 49% in Silk Road Bank, a Georgian financial institution, in March of 2005, BTA declared itself “a guide for Georgian investment into Kazakhstan and, vice versa, Kazakhstani investment into Georgia.” The BTA financial and industrial group plans on building, at a cost of US$350 mln, an oil refinery on the territory of Georgia, which will have a processing capacity of 5 mln tons per year. A noteworthy point is that this sum is being raised not only by BTA, but with the help of a number of Western banks. The financial and industrial group has also purchased the largest telecommunications company in the country, Electrosvaz Georgia, at a cost of US$90 mln. Moreover, BTA plans on purchasing more than 20 health resort facilities in the Georgian autonomous region of Adjari. The Kazakhstani party plans on investment of US$200 mln into these resorts over the next few years.
The major operator in the agricultural market of Kazakhstan, the State Food Corporation (SFC – controlling around 40% of Kazakhstan’s agricultural exports), has also demonstrated an interest in Georgia. SFC plans on setting up a transit route to the Black Sea, which could become an alternative for overloaded Russian and Ukrainian ports. It is preparing to construct a special terminal at the Georgian port of Pot’i for the loading of agricultural goods.
Cooperation in the energy sector has also become active. Kazakhstan intends to invest in the construction of hydroelectric facilities, and wishes to take part in building a network of such stations on the territory of Georgia, which will range in output from 300 to 1000 megawatts. State-owned KazTransGas (KTG) has purchased bankrupt JSC Tbilgasi of Georgia (now called KazTransGas – Tbilisi LLP). Having paid US$12.5 mln, the Kazakhstani plans not only on the investment of an additional US$82 mln into the gas-delivery system of the Georgian capital city, but also to be in the black within two years.
However, to say that Kazakhstan will gain from all of this would be too bold at this early stage. The reasons for this are understandable. If the gains for the Georgian parties are obvious, those for the Kazakhstani ones are not considering the high-risk of investment into that country, which can offset any expected returns.

The Georgian Economy as per Statistics
When assessing the condition of Georgia’s economy, one comes to the uncomfortable conclusion: neither the country’s entrance into the WTO nor the Rose Revolution has improved the situation radically. The major economic activity of Georgia is concentrated in the service sector, accounting for 56.9% of the GDP. Other major spheres contributing to the economy include agriculture (primarily growing grapes, citrus fruits and tea) – 20.5% of GDP, as well as mining (production of manganese and copper) and food processing (alcoholic and non-alcoholic beverages) – 22.6%. As regards exports, the following items prevail in order of importance: citrus fruits, tea, wine, scrap metal, re-exported fuel, and mineral water. In 2005, Georgia exported about 60 mln bottles of wine, 70% of which went to Russia – the major trading partner of Georgia within the CIS. Trade between these two countries in 2005 totaled US$505.8 mln (in 2004, this number was US$336.7 mln). At the same time, the Georgian share of Russia’s total trade was merely 0.1%, while the Russian portion of Georgia’s trade was 16%.
Primary imports into Georgia include: machinery and equipment, vehicles, agricultural products, flour, and pharmaceuticals. Major exporters to Georgia include Turkey (18.3%), Turkmenistan (17.8%), Russia (16.2%), and Armenia (8.4%). The largest importers of Georgian products include: Russia (14%), Turkey (11%), Great Britain (9.3%), Azerbaijan (8.5%), Germany (8.2%), Ukraine (7.7%), and the USA (6%). The country survives on the export of raw materials and agricultural products, while importing finished goods from other nations. Domestic consumption is not rising, indicative of serious problems within the economy.
Existing salary levels do not permit expectations for increases in domestic consumption over the next few years. As per information from the Georgian State Department of Statistics, in December 2004 the official average salary was 140 lari (around US$78) per month. Average monthly salaries in key sectors of the economy are: agricultural industry – 53 lari (US$30), the hotel and restaurant sector – 65 lari (US$36), the educational sphere – 75 lari (US$42), and the healthcare industry – 83 lari (US$46). The average pension payment is 28 lari (US$15) per month. As well, as per data from January 2005, one kilo of meat costs US$3-3.5, a kilo of cheese is US$3-4.2, and petrol is priced at US$0.8-1 per liter.
Permanent problems include a negative trade balance and a deficit in energy resources. Georgia’s own power-generation capacity covers only 40% of energy consumption, with the remaining 60% being supplied by other CIS countries – mainly Russia. The nation imports most of its energy resources, including natural gas and oil products. The most difficult situation relates to natural gas, which accounts for 24% of the country’s energy consumption. During the summer season, the volume of natural gas use reaches 4.7 mln cubic meters per day, while in winter the number is 7 mln cubic meters per day.
No doubt, Georgia has achieved some success with Western help. Therefore, economic growth in 2005 was 9.3% (in 2004 – 9.5%, in 2003 – 8.6%, in 2001 – 5.3%, in 2000 – 1.9%, and in 1999 – 3.5%). In the period following the Rose Revolution the economy grew by almost four times, from US$500 mln to US$1.8 bln. However, calling this a success would be a stretch, as the growth in state revenue is mainly defined by single occurrences – the privatization of large national enterprises, the return of financial resources from the friends and relatives of former president Eduard Shevardnadze (for example, Giya Djokhtarberidze, the son-in-law of the ousted president, paid US$15 mln in order to secure his release from prison) and from the relatives of the Adjari leader, Aslan Abashidze, as well as injections of foreign capital.
One should note that after Mikhail Saakashvili ascended to power, he prioritized the privatization program. Initially, plans were made to sell 1,800 state-owned facilities (ranging from plants to incomplete construction projects, as well as hotels in the resort areas of the country) over the period of a year and a half. However, privatization has been occurring at a slower speed than the [new] Georgian government had supposed, and by the end of 2005, more than 650 facilities on the list had yet to undergo privatization.
According to official information, in 2005 privatization brought more than US$250 mln into the national budget. In that year, the following state-owned facilities had been sold: Georgian Steamship Line (US$93 mln), Telecom Georgia (US$5 mln), Rustavski Metallurgical Plant (US$27 mln), and the copper concentrate production facility of JSC Madneuli (US$35.1 mln). In total, more than 1500 companies have been privatized in the republic. In 2006, major parts of the hydroelectric sector and oil storage facilities in Batumi are slated for privatization. According to estimates by Georgian experts, privatization will last until the end of 2008, following which the majority of the nation’s economy will be in the hands of the private sector (mostly foreign investors), and the state budget will lose the revenue stream from the privatization process.

… The Real Situation
Georgia has become quite addicted to assistance from abroad. In this vein, Russia supplies Georgia with energy resources at prices two times below global ones. The U.S. has already provided more than US$1 bln. Specifically, during 2005 Georgia received US$138 mln from the American government (about 14% of Georgia’s state budget). Besides, over the past few years, approximately a million people have emigrated from the country, with most of them settling in Russia. As per estimates of Georgian specialists, the total amount of all forex inflow, including both official and unofficial [cross-border trade and remittances], from Russia into Georgia has reached US$2 bln per year – about 20% of Georgia’s GDP. Therefore, the country receives a significant influx of foreign capital. However, Georgia does not properly manage this incoming capital, and the current economic situation is the result. For comparative purposes, as per Marshal’s plan, Germany was supposed to have only received US$1.3 bln following World War II. Certainly, the dollar was more expensive at that time, but Georgia is merely the size of Bavaria (though, the local elite seem to have bottomless pockets).
The government has also failed to eliminate its budget deficit. In 2004, the budget shortfall was US$133 mln, while state revenue that year was US$671.7 mln. This year that situation repeats itself: according to the accepted legislation “On the state budget of Georgia for 2006”, revenues are expected to be US$1.7 bln, while expenditures are to reach US$1.8 bln. The deficit will be covered primarily by capital allocated within the framework of an American aid package. With regards to the volume of per capita American aid, only Israel receives more than Georgia.
One of the major factors in running a budget deficit concerns contraband oil products. Experts say that the full legalization of these supplies would increase tax revenues by 30%, with the state budget receiving an additional US$165 mln per year. 75% of tobacco sales are outside of the tax collection net (this could supply an additional US$53 mln). According to independent research, the total volume of the country’s shadow economy is equal to 69% of the official GDP volume.
The living standards of the population of Georgia are very low: 54% live below the poverty line. Many large industrial enterprises are no longer operating, or do so at only minimal capacity. As per official data, in the middle of 2005 Georgia had 370,000 unemployed workers, or 18% of the working-age population. Independent research shows that in comparison with 2003, the level of unemployment in 2005 had increased by 20%, and included up to 47% of the working-age population (the official statistics fail to include unemployed village residents and those from the cities who also own a dacha, or country home). Increases in salaries are offset by mass cutbacks in staffing.
The social and economic problems of Georgia are exasperated by a high level of corruption. According to Transparency International, a monitoring organization, in 2005 Georgia was one of the most corrupt nations in the world, ranking 132nd out of the 158 nations that are included on the index. IMF experts believe that at present 3% of corporate revenues are spent on bribing officials, which, as per data from the EBRD, is twice as high as in Russia. The government headed by President Saakashvili, which came to power in 2003 following the Rose Revolution, announced a campaign against corruption. Such a step is quite understandable. Corruption, together with the unsolved issues concerning Abkhazia and South Osetia, is one of the most serious hindrances to foreign direct investment (FDI). However, the outcome of this stringent “fight” has been the arrest of several former high-ranking officials. Frankfurter Rundschau, an influential German newspaper, has observed that in this widely promoted campaign against corruption only a curtain of smoke has been put up, behind which there occurs the reallocation of assets in favor of the new ruling elite.
Military buildup also contributes to the negative situation of the country. Georgia is a world leader in regards to growth in military spending. This year, the country is slated to spend on defense an amount unprecedented in the history of post-Soviet Georgia: US$324 mln. This amount comprises 21.4% of budgetary spending and 6% of the nation’s GDP. For comparative purposes, the government allocated 0.6% of GDP for healthcare and 0.7% for education. This is the highest percentage among all CIS countries. The unaffordable increase in military spending, which outpaces real economic growth and creating another hole in the nation’s modest state budget, causes one to think that the government is trying to solve many of its problems through military means. Indeed, such an opinion has been stated. Particularly, Irakli Okruashvili, the Defense Minister, who is also a famous vintner, has announced, “We will celebrate January 1, 2007 in Tsxinvali.” And, if not for direct pressure by Georgia’s Western partners, the authorities would have already initiated such actions, which has already at one time ended for them in sad circumstances. Improvement of the population’s social and economic situation still seems to be beyond the priorities and interests of the new Georgian government.

Investment Landscape
In 2004, the total volume of FDI in Georgia was estimated to be US$500 mln, which was mostly connected to the investment of British Petroleum (BP) into the construction of the Baku-Tblisi-Jeyhan oil pipeline, as well as the South-Caucasian Gas pipeline over the territory of Georgia. Completion of the pipelines’ construction resulted in a notable decrease in FDI in 2005, which totaled around US$448 mln.
Another reason for the decreasing FDI pertains to failures during the privatization process for large enterprises in Georgia. There were cases reported when foreign businesses refused to transfer of funds for purchase of already agreed upon privatization transactions. In January 2005, Russia’s Evrasholding and the Austro-Georgian JV of DMC-Ferro jointly purchased two facilities – the Chiaturski Magnesium Plant and the Vartsikhski Hydroelectric Station – for US$132 mln (approximately a quarter of Georgia’s budget). However, in June 2005 the winners of the tender refused to provide payment for the two assets after already disbursing US$20 mln.
As per information from the Russian side, after conducting a more detailed analysis, a conclusion was formed that exploitation and development of these assets would not justify the necessary financial investment into them. Vladimir Papava, the former Economics Minister, who is currently a member of Georgia’s parliament, agrees with this opinion, “I do not know whether anybody deceived the Russians or not, but I will tell you one thing: while working as [Economics] Minister, I understood that these two facilities were unprofitable, and no serious investor would ever buy them.”
KLM, a Dutch airline, has also decided to cease operations in Georgia. According to Gogi Mzhavanadze, head of the Department of Civil Aviation under the Georgian Ministry of Economic Development, “The reason why KLM has decided to close its representative office in the country was the low level of profit. KLM conducted an analysis of operations in Georgia during 2005, deciding that revenues do not correspond with the expected levels set forth two years previously.” The airline had its last Amsterdam-Tbilisi-Amsterdam on March 3, 2006.

Are you holding an ace, or the queen of spades?
Kazakhstani companies are attracted by cheap privatization. However, considering the unstable situation in the country (both political and legislative), this type of business is similar to playing in a casino – a turn of the roulette wheel and one gains or loses everything.
When considering the purchase of JSC Tbilgasi, Danial Akhmetov, the Kazakhstani Prime Minister, stated, “We understand that sale of our raw materials should be diversified, which is why we think working with Georgia is the correct choice. However, we have set a condition that we shall sell our natural gas at the rate of US$110 per a thousand cubic meters, and the Georgian party accepts the price. Kazakhstan is not offering any subsidy to Georgia’s consumers. They will either pay this price, or we will take appropriate measures of an economic character, which will permit a resolution to be found in solving the problem.”
Whatever price may be set for Georgia, it is worth noting that Kazakhstani natural gas will cost the same as Gazprom’s, taking into account the cost of transport via Russia. Since Gazprom has taken on the cause of setting prices for former Soviet republics at that prevalent internationally, the benchmark of US$110 [per a thousand cubic meters] is far from reaching the upper limit. How is the Kazakhstani party intending to make Georgian consumers pay these new prices for gas if they were unable to pay the lower prices of before? As per information from BBC, Tbilgasi annually lost up to 60% of its natural gas through theft: the population managed to decrease the numbers reported by individual meters by several times. In response to gas shutoffs for nonpayment, the residents of major districts set up protests.
Besides, there also exists the experience of Georgia’s largest foreign investor, AES Corporation, an American company, which spent US$275 mln for the purchase and development the Tbilisi city electrical works. However, in 2003 AES was forced to sell these assets at a loss and exit the Georgian market. AES was operating at a loss, as the company could not force consumers of electricity, including state enterprises, pay their bills. No basis exists in assuming that the Americans were softhearted with regards to dealing with clients in arrears. The financial director of the Georgian subsidiary was murdered after they increased tariffs for electricity.
How KazTransGas plans on rehabilitating the gas distribution network in the city of Tbilisi within two years is unclear, as the system, according to one Georgian expert, is in a “catastrophic condition.” Sarik Sultangaliev, general director of KTG, has said that the company needs to invest 10 years of hard work and KZT 600 mln (editor’s note: US$1 : KZT 117) in annual investment for the ongoing capital repair of the gas delivery system in order to put [Kazakhstan’s own] Almatygas into immaculate condition. That the Almaty gas network is in much better condition than the Tbilisi one is a noteworthy fact, as wells as the fact that the purchasing power of Almaty consumers is incomparably higher.
One should take into account that prices for basic products in Georgia shot up following the recent ban in Russia of Georgian wine, mineral water and other goods. More and more people in Georgia are complaining about the government, and as per the opinion of the opposition in the nearest future there may be civil unrest, which could reach its culmination by October. Zviad Dzidziguri, a former member of Mr. Saakashvili’s team, who is presently part of the conservative party, believes that should the authorities continue acting in their present manner, the opposition will have to repeat the scenario of the last year of Shevardnadze’s term in office. This means the redistribution of power (or at least an attempt to do so), as well as a new period of instability. In such conditions, one can not dream of profits.