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


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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

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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