Monica Ellena in Tbilisi -

The idea is attractive: Chinese trade and investment to help shore up Georgia’s economy and bolster its position in a strategic, albeit vulnerable, part of the world.

“China is very important for us,” says Dimitry Kumsishvili, the 41-year-old newly-appointed minister of economy, speaking ahead of the Silk Road Forum in Tbilisi on October 15-16. “Chinese investments in Georgia are very successful and [Beijing] is ready to start negotiations for a free trade agreement.”

The numbers bear him out. In economic terms, China became Georgia’s fourth largest trading partner in 2014, accounting for 7.2% of trade turnover, up 200% in a decade. Imports still outpace exports, but these are on the rise and accounted for 5.4% of the total in the first eight months of the year (up from 2.7% in the same period of 2014). In addition to rising exports, Beijing was also the country’s third largest provider of foreign direct investment (FDI) in 2014, stumping up €170mn.

The Ministry of Economy’s doors are then wide open to China and investors have walked in. Quite literally. Urumqi-based Hualing Group, Georgia’s single largest investor, bought the building housing the Ministry of Economy, which featured on the privatisation list, and has plans to transform it into a high-end hotel. Little wonder that the country is looking east.

Traversed by key pipelines carrying Caspian oil from Azerbaijan to Europe, Georgia is actively pushing its competitive geographical advantage at the crossroads between Europe and Asia to widen its foreign trade portfolio. “In 2014 we signed the [Deep and Comprehensive Free Trade Area] with the European Union, thus unlocking the access to a 500mn-strong market, and we are finalising a similar trade deal with EFTA. We also have a free trade accord with the CIS countries and Turkey,” he says.

A deal with China means Georgia would have free trade agreements with “two-thirds of the world population [and] shows that Georgia’s strength [lies] in its location for trade and logistics,” says Kumsishvili, adding that Hualing is also developing the 1,000-acre, €35mn free industrial zone in Kutaisi, Georgia’s second city.

It’s the economy, stupid

It has been an uphill year for Georgia. As Western sanctions and low oil prices began to take their toll on Russia’s economy, Georgia has started to suffer. In 2014 growth reached 4.7%, but in February the government adjusted its 2015 growth forecast down to 2% from the earlier 5%. The economy expanded by 2.8% in January-August, down from 6.1% in the same period last year and remittances declined by 24%. Exports dropped by 24% to €1.27bn y/y, with the CIS countries and the EU as the main destination for Georgian goods, at 38% and 28% respectively. The current account deficit remains stubbornly high, hovering around 10% of GDP in 2014, and reaching 14% in the first quarter of 2015. 

Despite the headwinds, softly-spoken Kumsishvili – an economist who served as the right hand man of former economy minister Giorgi Kvirikashvili before a brief stint as deputy mayor of Tbilisi – is confident the growth trend will continue upwards. “Despite a 35% devaluation [of the Georgian lari], we had a 2.8% real GDP growth in the first eight months and the private sector created about 60,800 jobs, up by 12%, not counting government and self-employment. These figures are real,” he reinforces, adding that, “going deeper we had two-digit growth in sectors like construction and mining. Industrial production grew by 60.7%. It is a good trend.”

But consolidating those trends requires diversification. Copper ores, ferroalloys and motor cars (re-sales) account for about a third of the total country’s exports, while agricultural products such as nuts and wine amounted to 6.3% and 3.8% of the total respectively. Other items include medical products and fertilisers. Manufacturing is lagging behind. “If you look at other countries, there is no successful economy without a strong industrial policy – Georgia doesn’t have an industrial policy at all,” he stresses. “If you stay on your traditional sectors and you don’t diversify there is a high risk; what we try right now is to find and test new directions. Our main target is to strengthen the economy, not to substitute imports. We also need to create more jobs.”

Government-sponsored initiatives aim to stimulate non-traditional sectors, cultivate entrepreneurship and expand the country’s export potential. To date, the programme Produce in Georgia has supported the establishment of 114 manufacturing and food-processing companies, by helping to give them finance and technical assistance to enter export markets, while the newly established Innovation and Technology Agency looks at best practises in peer countries such as Belarus and Armenia to develop the IT sector. “About $500mn of Belarus’ current account comes from export-oriented IT programming. We have zero, we don’t sell our software, we just don’t have IT in our economy,” he said. “We are working with universities to create a critical mass of engineers and programmers to boost a knowledge-based economy.”

Kumsishvili also stresses the need to attract investment into Georgia’s traditional sectors, notably hospitality and energy. In the first nine months 4.5mn foreign tourists flocked into Georgia, up by 6.7% y/y, and research commissioned by the Ministry of Economy shows there is a lack of rooms in Tbilisi and the regions. “The energy sector is also very attractive, we have over 26,000 rivers and use about 25% of our hydropower potential,” he says. “The electricity consumption in Turkey and Georgia is increasing by 5-10% a year and it shows that the demand and the supply is here. When we talk about Georgia as a hub, becoming an energy hub is also key.”

Trust the lari

Backing new enterprises is one thing, guaranteeing their sales is another, as domestic demand remains weak.

The devaluation of the lari shrank Georgians’ purchasing power and triggered a political blame game involving the government, the central bank, the opposition, and the former prime minister Bidzina Ivanishvili, who is widely believed to be still pulling the political strings from the sidelines. Since November 2014, the national currency has lost up to 35% of its value against the dollar, hitting the lowest rate since 2004. “The devaluation is our [government’s] biggest challenge, as it affects individuals with loans in foreign currency,” admits Kumsishvili, adding that he is confident that the lari will stabilise in the medium term.

Banks have come to the rescue by prolonging loans and extending their maturity, but 67% dollarisation of bank loans and savings is problematic. “It remains a concern in the event of a shock,” Demetrios Efstathiou, head of trading strategies at London-based ICBC Standard Bank, wrote in a recent note to investors. “The level of FX reserves ($2.5bn as of September 1) is not enough for the central bank to act as a lender of last resort.” However, “the banking sector is well supervised and capitalised”, he added. 

International financial institutions such as the European Bank for Reconstruction and Development (EBRD) realised the need of local financing and have successfully issued bonds in lari. Planned reform of the pension sector could also help counteract dollarisation and develop Georgia’s embryonic capital markets. “Very few people keep their deposits in lari, most savings are in dollars, we need to increase the trust, the “long-lari” [long-term investment in lari] is necessary,” Kumsishvili explains, adding that the government wants “to introduce [the pension reform] early next year”.

To refill the government’s coffers that the sharp devaluation left short of cash, in February the government stepped up the privatisation process, selling state assets that by year-end will total GEL110mn (€40.5mn). The list includes a series of residential and commercial buildings, including the National Bank of Georgia’s historical home, while the sale of Georgia Post and 24.5% of Telasi, the electricity distributor in Tbilisi, were announced for a later stage.

The sale of a 230MW combined-cycle thermal power plant in Gardabani, on the outskirts of the capital, to Chinese group Pegasus EastWest for a total of $290mn (€254mn) was announced in June but has yet to be finalised. “It is a big deal we are negotiating, I think by next month we should finalise it,” states Kumsishvili, though keeping “confidential” the final price tag.

A security dividend too?

Potentially, the key Chinese investment lies on the Black Sea coast, in Anaklia, where plans to build a large deep-water harbour are underway. Beijing strongly supports PowerChina, one of the two consortia bidders still in the race, the other being a US-led group.

Georgia would use Anaklia as a key card for its target to become a transit hub, as it is also adding a railroad which could diversify land routes for Chinese goods to Europe, most of which currently run through Russia. Eight years after its brief war with Russia over South Ossetia, and with Russian troops still present both there and in Abkhazia, a significant Chinese investment in Georgia could give Moscow pause for thought. “Anaklia is a very important project for us and it will have competitive advantages. A strategic location, capacity to receive Panamax-type vessels, one-stop shop solutions, simple and fast procedures, and all-year round safe navigation,” explains Kumsishvili. It will also result in a significant increase of the cargo turnover – initially 40mn tonnes but with the capacity to expand to 100mn.

For China, the port, coupled with the railway, would mean easier and faster access to Europe. In February, “the pilot cargo train from China arrived in Georgia in nine days and from Georgia to Europe is three days, so 12 days [altogether]. It is one of the shortest ways to the EU. Georgian Railways is working with the Chinese railways and we hope to put in place a follow-up [soon],” Kumsishvili says.