Fostering Business Development and Digitalisation in Georgia

Introduction

Economic context

The Georgian economy had been experiencing steady growth since 2015, up to the outbreak of the COVID-19 pandemic in 2020. GDP growth rose from below 3% in 2015 and 2016 to 4.8% y-o-y in 2017, and stabilized around 5% in the following years (Table 0.1). Exports of goods and services have reached 54.8% of GDP in 2019, compared to 40.8% in 2015. In particular, exports towards the EU have risen since the application of the EU-Georgia Deep and Comprehensive Free Trade Area (DCFTA) in 2014, reaching 24.2% of total exports in 2019 (German Economic Team, 2019[2]). Although this increase was accompanied by a diversification of exported goods, with a growth of processed goods, the main export basis has remained low value added, limiting the export potential (Economic Intelligence Unit, 2019[3]). The current account deficit has been reducing, while FDI stock increased to up to 100% in 2018.

The Government of Georgia (GoG) has conducted a set of reforms in recent years, which included a long-awaited reform of the framework for insolvency (further detailed in Part 1), a modernisation of the labour code, and continued efforts to foster infrastructure development and integration in global value chains. Moreover, within the framework of an extended fund facility signed with the IMF in 2017, the government has adopted a second-pillar pension reform. These policy efforts have led to significant improvements in the business environment, as reflected by Georgia’s position in international assessments: Georgia ranks 12^th out of 180 countries in the Heritage Foundation’s 2021 Index of Economic Freedom, scoring higher than the European and World averages. Since 2016, the country has gained eleven positions, thanks to improvements in judicial effectiveness, labour freedom and fiscal policy (Heritage Foundation, 2021[4]). Georgia ranks 5^th out of 162 countries in the Fraser Institute’s Economic Freedom of the World 2021 and 74^th out of 141 countries in the World Economic Forum’s Global Competitiveness Index 2019 thanks to its business enabling environment, ICT adoption, labour market and future workforce skills.

However, several challenges remain. Georgia still suffers from high level of unemployment, stagnating at about 20% over the period 2015-2020 (down to 18.5% in 2020), and of poverty, which still affects nearly 20% of the Georgian population. Moreover, the country still entails a large rural population (about 41% in 2020) and informal economy. The skills mismatch is also a persistent issue, although the Government has tried to tackle it by introducing a comprehensive educational reform in 2019, which has been partially stalled by the pandemic (IMF, 2021[5]). The productivity levels remain relatively low, albeit increasing, and regional interconnectivity is still limited.

Moreover, the country has been severely hit by the COVID-19 pandemic: despite its initial success in limiting new infections during the first wave, Georgia recorded a surge in daily new cases during the following waves, becoming one of the most affected countries in the world on a per capita basis, both in terms of deaths and cases. Vaccination is slowly advancing, with international community aid providing additional doses of vaccines, but is still at low rates (23% of the population had been fully vaccinated by mid-September 2021). During the successive waves, the government has enacted a range of containment measures to limit the spread of the virus, which have taken a toll on the economy (OECD, 2020[6]). The Georgian GDP decreased by 6.2% in 2020. This is partially explained by the shock to the service sector, notably tourism, which holds a prominent place in the Georgian economy – services exports dropped by 63.5% in 2020. Unemployment and poverty significantly rose from the previous year despite the mitigating effect of government measures. These substantial anti-crisis measures however worsened the state of public finances, as the deficit reached 9.3% of the GDP and the public debt 60% of GDP. In addition to this, inflation reached a peak of 7%, in April 2020, while the lari was depreciated by 14% against the United States Dollar (USD) in the same year. The crisis is further exacerbated by the large informal sector, the high share of vulnerable workers, high unemployment and low saving rates (OECD, 2020[6]).

Nonetheless, Georgia has been experiencing recovery throughout 2021. The GDP contraction persisted in the first quarter of 2021, which registered -4.5%, but the trend was reversed in the second quarter of the year. GDP growth is now expected to reach 7.7% in 2021, mainly due to a reprise in key sectors such as tourism, manufacturing, construction and services, as well as to an increase in remittances and exports, which have been faster than anticipated (German Economic Team, 2021[7]). Public deficit is expected to narrow to 6.5% of GDP, and public debt should decrease compared to the 2020 level (German Economic Team, 2021[7]). These improvements are expected to continue in the following years, as projections envisage the achievement of the 3% target for the fiscal deficit before 2025, as well as a continuous decline of public debt in the years to come (World Bank, 2021[8]). However, inflation has risen to 12.8% y-o-y in August 2021, due to an increase in utility and commodity prices as well as elevated input costs due to the currency depreciation (IMF, 2021[9]), but it is expected to diminish from the beginning of 2022 onwards (IMF, 2021[9]). The lari has indeed been stabilised throughout 2021, and it has slightly appreciated, 0.8%, in real effective terms (IMF, 2021[5]). The positive trend should continue, as current World Bank forecasts expect a GDP growth of around 6% in 2022 as well as in 2023 (World Bank, 2021[10]). The recovery however is highly dependent on the country capability to vaccinate its population, and hence to avoid new waves of infections, and on its capacity to maintain a stable political environment that will foster the necessary reforms.

Table 0.1. Key macroeconomic indicators for Georgia, 2015-2020

Indicator	Unit of Measurement	2015	2016	2017	2018	2019	2020	20212	20222
GDP Growth**	Percentage y-o-y	3	2.9	4.8	4.8	5	-6.2	7.7	5.8
Inflation**	Percentage average	4.0	2.1	6.0	2.6	4.8	5.2	13.1	3.2
Government balance1**	Percentage of GDP	-1.3	-1.6	-0.5	-0.9	-1.8	-9.3	-6.5	-3.6
Current account balance*	Percentage of GDP	-11.8	-12.5	-8.0	-6.8	-5.5	-12.4	-10.0	-7.6
Exports of goods and service*	Percentage of GDP	40.9	40.8	46.5	50.6	54.8	37.4	-	-
Imports of goods and services*	Percentage of GDP	57.9	56.0	57.5	61.2	63.8	55.9	-	-
FDI net inflows*	Percentage of GDP	11.6	11.0	11.8	7.2	7.7	-	-	-
General government gross debt**	Percentage of GDP	36.6	40.2	38.6	37.5	40.4	60.6	54.2	53.6
Domestic credit to private sector*	Percentage of GDP	51.0	58.7	58.1	62.6	67.7	-	-	-
Unemployment**	Percentage of total labour force	21.9	21.7	21.6	19.2	17.6	18.5	22.1	-
Nominal GDP**	USD billion	14.9	15.1	16.2	17.6	15.7	15.7	18.2	20.5

Note: ¹ General government net lending/borrowing ² Latest forecasts available

Source: * (World Bank, 2021[11]) and (World Bank, 2021[10]) ** (IMF, 2021[12]), (IMF, 2021[13]), and (IMF, 2021[14]).

SME sector

SMEs play a predominant role in the economy of Georgia, representing 99.7% of enterprises in 2019. Their economic contribution has been growing over the past years: in 2019, SMEs amounted for 65% of total employment and 59.3% of value added, up from 58.1% in 2015 (Figure 0.1). They are concentrated in Tbilisi, with the capital city representing 51% of SME employment and 63% of value added (Figure 0.2).

Figure 0.1. Value added by firm size, 2015-2019

Source: Geostat.

Figure 0.2. Regional breakdown of firms

Note: Employment corresponds to the average annual number of persons employed. Data unavailable for Abkhazia.

Source: OECD analysis based on Geostat.

However, SMEs remain mostly concentrated in low-value-added sectors such as trade (including repair of vehicles), manufacturing and construction – these gathered 39% of Georgian SMEs in 2017.

The development of the SME sector in Georgia has been fostered by significant policy efforts provided by the Government. From an already strong position, Georgia has made further progress since 2016: its performance is reflected in the SME Policy Index (SMEPI) (OECD et al., 2020[1]), where the country appears as the best regional performer. It notably adopted a more strategic approach to small and medium-sized entrepreneurship development through targeted initiatives, including through the SME Development Strategy 2016-2020 and respective action plans, which have helped to improve the operational environment for SMEs drastically.

Box 0.1. SME Policy Index: Eastern Partner Countries 2020

The Small Business Act for Europe and the SME Policy Index

The SME Policy Index is a benchmarking tool for assessing and monitoring progress in the design and implementation of SME policies against EU and international best practice. Structured around the ten principles of the EU’s Small Business Act for Europe (SBA), it was developed by the OECD, the EU, the European Bank for Reconstruction and Development, and the European Training Foundation to assess the business environment for SMEs and provide relevant recommendations to address remaining challenges.

The Index is structured around five thematic pillars, further broken down in 12 dimensions based on the ten SBA principles. A cross-cutting level playing field pillar was added to the third edition of the Index (published in 2020, following assessments in 2012 and 2016).

2020 findings for Georgia

Georgia has made significant progress since 2016, confirming itself as the top performer in the EaP region. Its efforts to implement previous OECD recommendations particularly stand out regarding entrepreneurial learning and women’s entrepreneurship (+57% increase on average), and SME skills (+38%). The country’s performance remains weak with regards to bankruptcy and second chance policies, as well as SME greening.

Figure 0.3. SME Policy Index scores for Georgia

Source: (OECD et al., 2020[1]).

The previous SME strategy 2016-2020 entailed three overall targets – output growth, persons employed, and productivity growth. As illustrated below (Figure 0.4), the targets have been achieved very early in the implementation period of the Strategy, which provides evidence of the positive developments in the SME sector, but also that more ambitious targets could have been considered.

Figure 0.4. SME Development Strategy 2016-2020 overall targets

Source: Geostat.

The OECD has proposed some KPIs to monitor the impact of the new SME Strategy 2021-2025 (Table 0.2). While the first draft of the new Strategy planned to use the percentage of SMEs in total output as an overall target for the document, the OECD suggested to rather use SME output growth, and to use it as impact indicator for Priority 1 instead, for the share of SMEs in total output is influenced by the growth of large firms. As recommended by the OECD, the final version of the document foresees SMEs’ value added and productivity growth, which were initially included as impact indicator for Priority 1 and 3, respectively, as overall targets.

Table 0.2. Overall targets suggested by the OECD for the new Strategy

Indicator	Initial draft	OECD suggestion	Final draft
Share of SMEs in total output	70% by 2025	SMEs output growth: +30% by 2025 Use SMEs output growth instead of share, as the latter is affected by the growth of large firms Indicator more suitable to monitor Priority 1, for better institutional environment helps firms to operate, which is reflected in increased activity (i.e. output)	Included as impact indicator for Priority 1 +20 by 2025
Number of SME employees	+15% by 2025	Number of persons employed: +15% by 2025 Use persons employed instead of employees The 15% target seems realistic	Number of employees +10% by 2025 (target decreased because of the sharp, COVID-induced decline in 2020)
SMEs’ value added	+20% by 2025 Foreseen as impact indicator for Priority 1 in the initial draft	+30% by 2025 It could be considered as overall impact indicator instead of output growth 20% increase might not be ambitious enough given the 60% growth over 2015-2019 – but remains acceptable given uncertainties related to the COVID-19 impact	Included as an overall target indicator +20% by 2025 (in nominal terms)
SMEs’ productivity	+20% by 2025 Foreseen as impact indicator for Priority 3 in the initial draft	+25% by 2025 It could be considered as overall impact indicator, as SME productivity can be improved by all strategic priorities	Included as an overall target indicator +20% by 2025

With regard to the institutional framework, the main stakeholders in charge of SME policy implementation in Georgia are the Ministry of Economy and Sustainable Development (MoESD), and the two SME support agencies, Enterprise Georgia and Georgia's Innovation and Technology Agency (GITA), both created in 2014. Enterprise Georgia is responsible for the implementation of SME support programmes. It aims at improving private sector competitiveness by working on three main directions, i.e. business development, export promotion, and attraction of foreign direct investments. Its flagship programme, Produce in Georgia, includes financing tools such as co-financing of interest rate on commercial loans and matching grants. GITA complements this approach by focusing on support to start-ups, innovation and R&D, especially in the ICT field, through financing and non-financial instruments further detailed in this report. Other Ministries listed in Figure 0.5 are also closely involved, as well as the Business Ombudsman of Georgia and several legal entities under public law (LEPL), e.g. the national statistical agency Geostat, the National Competition Agency, GEOSTM, the Rural Development Agency, the National Tourism Administration, the Agency of Protected Areas, and the Service for Accounting, Reporting and Auditing Supervision (SARAS). The private sector is increasingly participating in policymaking and implementation via a number of business associations.

Figure 0.5. Institutional framework for SME policies in Georgia

Note: MoH refers to the Ministry of Internally Displaced Persons from the Occupied Territories, Labour, Health, and Social Affairs of Georgia. ComCom refers to the Communication Commission (former GNCC – Georgian National Communications Commission).

Source: OECD authors based on fact-finding questionnaires, working group meetings and desk research.

COVID-19 impact on SMEs

As outlined above, the COVID-19 crisis has taken a toll on the economy. Georgian SMEs have been particularly affected by the crisis for several reasons. SMEs appear over-represented in sectors that were most affected by containment measures, such as services, tourism, and retail trade. In general, they are less capitalised than larger firms, which increases the risk of liquidity shortages, and they have fewer clients and suppliers, making them more vulnerable to supply chain disruption and loss of revenues. Finally, the fact that they are less digitalised than large firms (see Part 2) results in them being less able to transition to remote work. The strong economic impact of the crisis on SMEs has been highlighted by the World Bank Enterprise surveys carried out in June 2020 and October/November 2020 (Figure 0.6).

Figure 0.6. Impact of the COVID-19 crisis on Georgian SMEs

Note: Panel (a) refers to the percentage of firms confirmed permanently closed since the COVID-19 pandemic was declared. Value for large firms in Panel (a) is zero.

Source: (World Bank, 2020[15]).

However, the Government responded with one of the most generous anti-crisis support package of the EaP countries, including a range of tools dedicated to SMEs. It encompassed measures to support labour, such as income tax exemptions, unemployment benefits and one-off assistance of GEL 300 to the self-employed, as well as property tax deferrals, additional VAT refunds, utility subsidies, and credit repayment deferrals. Financial instruments were also implemented, such as the expansion of the credit guarantee scheme expected to benefit up to 1 000 SMEs, improved co-financing conditions (e.g. with an extension of the loan/leasing co-funding period), and interest subsidies for existing loans for some of the hardly hit sectors (more detail on page 35). The Government also adopted sector-specific plans for tourism, agriculture and construction. As of October/November 2020, almost half of Georgian SMEs had received government assistance – however, this share appears to be below that of large firms (75%) (World Bank, 2020[15]).