IMF REPRESENTATIVE WARNS OF INFLATION, GOVERNMENT

C O N F I D E N T I A L SECTION 01 OF 02 TBILISI 002401 SIPDIS SIPDIS STATE FOR EUR/CARC AND EB/IFD/OMA COMMERCE FOR ITA/MAC DANICA STARKS TREASURY FOR OIA:WLINDQUIST E.O. 12958: DECL: 09/25/2017 TAGS: EFIN ECON PGOV GG SUBJECT: IMF REPRESENTATIVE WARNS OF INFLATION, GOVERNMENT INFIGHTING OVER CONTROL OF ECONOMIC POLICY TBILISI 00002401 001.2 OF 002 Classified By: Ambassador John F. Tefft, reason 1.4(b) and (d). ¶1. (C) Summary: In a September 19 meeting with the Ambassador, the IMF's resident representative in Georgia, Robert Christiansen, told the Ambassador that he is concerned about a possible resurgence of inflation, which hit more than 14 percent in mid-2006 but has subsided to around 7-8 percent since then. Discipline in government spending is the only way to control inflation, in his opinion. He sees an ongoing competition for control of economic policy within the government. The future of the central bank, the National Bank of Georgia (NBG),needs to be decided, specifically whether it will retain its bank supervision role and even its monetary policy role. His conversations with commercial bankers do not reveal concern about the recently experienced global contraction of credit. End Summary. ¶2. (C) Christiansen told the Ambassador that the economy is heating up, with real GDP growth of 12 percent year on year in the first half of 2007. He worries that the threat of inflation is increasing. The cause, he said, is not foreign investment, which is surging, but the government's "fiscal mismanagement." Although inflation is now running at 7.7 percent, Christiansen said, all indicators including the producer price index and the growth of broad money (currently about 50% for the year) predict an upward spike in inflation in the near future. He thinks the rate will be about 10 percent by the end of the year. He says the consensus among government officials is that so long as inflation is less than 10 percent, they will have no political problems as a result. (Inflation is especially painful for the poor in Georgia. While overall inflation has been relatively moderate, as Christiansen notes, there have been significant increases in the costs of foodstuffs such as potato (79 percent),corn flour, chicken meat and eggs, according to the Department of Statistics.) ¶3. (C) The threat Christiansen perceives is manageable if the government takes the necessary steps, he said. This mainly means reining in government spending and increasing interest rates to slow down growth. But Christiansen is not optimistic that spending will easily be contained as Georgia moves into an election year. The best that could be done, he said somewhat ironically, is to give the government a budget for election-related spending and hope they stick to it. He believes there is competition going on for management of the economy between Presidential insiders led by Prosecutor General Zurab Adeishvili and Internal Affairs Minister Merabishvili on the one hand and Prime Minister (and former Finance Minister) Zurab Noghaideli on the other. He sees Adeishvili gaining more control over the Ministry of Finance with the appointment of Nika Gilauri and the forced resignation of the Director of Taxation, Mindia Gadaevi. (Note: we have been impressed with Gadaevi's energy and sincere devotion to improving the revenue service. Christiansen brought the first news of his resignation to us. We have heard separately that Gadaevi will soon be appointed the new head of Millennium Challenge Georgia.) He thinks Noghaideli ally Aleksi Aleksishvili will not become president of the NBG even though he has been nominated to the post. ¶4. (C) In the meantime, Christiansen said, decisions must be made about the direction of the central bank, now that its poorly regarded former head, Roman Gotsiridze, is out. Adeishvili is concerned about corruption in the supervision of banks and apparently wants to strengthen it, possibly by establishing a entirely separate agency to handle the task. The NBG can then either retain an active role in monetary policy, or a currency board could be initiated, leaving the NBG with a very small role to play in the economy. ¶5. (C) Establishing a currency board, where money emission is strictly limited by the foreign currency reserves on hand at the central bank, is a pet project of the State Minister for Economic Reforms, Kakha Bendukidze. Christiansen says that the banking sector must be "exceedingly strong" and it must have good supervision if a currency board is to work. The latter is now lacking, in his view. Under a currency board, he adds, all shocks to the economy will have to be absorbed by impacts on the gross domestic product. The government will have to be careful and disciplined in its spending. He is not sure the government fully understands the implications and is really ready to take responsibility for the possible impact of a currency board on growth. That said, Christiansen admits a currency board has worked well for Estonia, which is in many ways a model and mentor for TBILISI 00002401 002.2 OF 002 Georgian officials. Bendukidze would like to see Georgia become an international financial center. His advisors have told him that Georgia can only succeed in competing with other tax havens and offshore banking centers if it has a good and compliant money laundering law, and Bendukidze seems to be giving up his hitherto unsuccessful efforts to weaken the money laundering regime. The Financial Monitoring Service has drafted stronger anti-money laundering laws based on recent MONEYVAL recommendations and is about to present them to the government. ¶6. (C) Christiansen told us that he has discussed the recent tightening of credit conditions in the global economy with local commercial bankers. He said the bankers have told him there has so far been no noticeable adverse effects on their ability to raise capital. TEFFT