The world crisis started in August 2007 and was augmented by hostility in 2008 in Georgia.
These events intensified negative impact of external factors of world crisis. Georgia has never been direct participant of financial market. Based on this, government representatives and some of our experts reckon that negative impact of world crisis will not reach us. One might hear quite often that we managed to close borders and blocked the road to Georgia for crisis. However, it is hard to imagine this in the country with 85% of imported consumption. In other words world market is feeding our country and therefore influence of world crisis on our country is inflexible and hard.
We are not integrated in the world market. Georgia has quite law level of economic development (despite rating mania) and thus it tardily reacts on crisis. The wave of crisis blew up in USA approaches Georgia approximately in 6 months. Two months are needed for crisis to reach continental Europe and 3 to run up to Commonwealth countries. Taking comfort in the hope that we can be just spectators of negative tendencies that are developing at American stock exchanges is groundless. The same events with delay, but inevitably will develop in Georgia.
Hence, in the nearest future our main challenge will be all-out default and its aggravation. The scheme of development up today was the following: construction material producing companies provided their products to building companies; the last ones built some area for developer companies that took a credit from banks. On its part, bank issued loans both for developer companies and for the population. Population on its part gave received credit to Developer Companies. Population is bank’s debtor, building companies are providers’ debtors, providers are developers’ debtors and thus the chain of default evolves. Recently amount of consumer and mortgage loans made up $2.5 billion, while overall amount is more than $4 billion.
Up today, the most part of the population was taking credits in order to meet liabilities and was paying current loans with pyramid principle. Besides this, due to construction price increase, 60% of the population made business out of this. They were selling old apartments and buying new one and thus gaining profit. At present, the constructing area prices dropped by 50%. If the price of some area was $2000 now it has depreciated to $1000. However, as there is no transparent market in Georgia, actual demand-supply is not determined, market in undeveloped, buyer and seller have no competitive environment and thus this price is not realistic either. As there is no actual buyer, the abovementioned 50% discount is groundless. If there will be a buyer, the price might be even lower. The mentioned circumstances almost led people to bankruptcy, as they were running business based on the theory of future value. Imagine the despair of a person who bought a square meter of area for 25 thousand dollars and suddenly crisis approached him. Someone paid quarter of a million for 10 square meters shop area. What profit might the shop bring in terms of crisis? Due to price dropping and demand-supply derangement borrowers were left without the source of crediting.
In 2008-2009 Population found another way of paying credits – they were selling personal valuables of their families and thus meeting liabilities. In April even thiese sources depleted and thus the number of insolvent people exceeded 200 thousand.
Experts were initially prognosticating that banking-consumption market would blow up. However, banks were quite presumptuous and thought that they would solve the problems by putting up for the sale the mortgaged property. However, the mortgaged property for the credits issued in 2004-2005 years that was evaluated by market -value of those times depreciated by 50%. Such devaluation means that half of banks’ assets is not toxic but quite problematic.
Quite soon the start of disastrous and extremely dangerous period for the society is anticipated. Borrowers are not aware of this yet. Debtor thinks that bank will sell the mortgaged property (banks are planning this in May) and this it will cover debts. However, due to amendments made in criminal law it might be impossible to do this. When a citizen was signing an agreement, he/she was not familiar with piratical legislation that was adopted in last three years. If the banks do not desire to hold negotiations with their partners in acceptable and illegal norms, then why does it happen that more and more cases are directed to Fiscal Agency instead of court. Quite many banks, having a claim on seriousness, are cooperating with Fiscal Agency and Prosecutor’s Office instead of courts. Credit relations are regulated by Civil Code, but on contrary with it, amendments made in criminal law are quite severe. Meeting one’s liabilities cannot last long in fear of arrest. This method will work maximum for two months, then it will be followed by full collapse. Former employees of law enforcement agencies are involved in the system of frightening. They are summoning borrowers allegedly on behalf of banks. Banks are refuting cooperation with any “former policemen”. However, such rules of working are truly presented in banks’ arsenal and they are having it out with clients by methods of frightening. There might arouse another problem when selling mortgaged property. Borrower might not manage to sell constructing apartment that is mortgaged in the bank as it might appear that bank has sequestrated an apartment due to Developer Company’s loan to the bank. It amazing that both developer companies and banks are concealing this circumstance. However, there are specific facts of this and one might say that it has developed into tendency.
One might conclude that the sources of solving credit default are exhausted. World crisis has nothing to do with this. Georgian banks are not familiar with systems of sub-prime and NINJA Loans (No Income, No Job, No Assets) as well as CDO and CDS products, or artificial or synthetic securities – our banks were more careful. However, Georgia with GDP less than $3 billion wouldn’t have endured the basis of new financial paradigm – as Soros has called it. Coming out from the peculiarities of Georgia even $6 billion basket of banks is heavy for the country. Georgia has no resources to endure this impact, while market is not in the condition of bearing demand-supply freezing.
Construction is actually stopped. The number of employees in this sector has decreased to 50 thousand people. Financial future is vogue; if construction companies will not be able to pay bank loans and debts of construction materials providers, their projects will be sold out. For visualization, we can provide an example of company NOLA. The company was created with Israeli assets and was constructing almost every major project in 2004-2006 years. It was paying huge sums to the budget. Nola played major role in the construction volume of 2007 that made up $1 billion 700 million. This was the all-time sum for Georgia. You wouldn’t find in any of Georgian serial publications that this company is bankrupted today. However, this is a bitter truth. At present, several banks are arguing concerning company’s assets. Nola is a bright example of current tendencies in Georgia. Neither government nor business want to look the truth in the face: the chain of indebtedness starts from construction companies, and goes through developers, banks to the population who might be left homeless tomorrow.
Georgian banks resemble giant creatures standing and slumbering. If we compare credit dynamics of first quarter of 2009 with the same period of 2007, it becomes obvious that the scales of slump are huge. Banks are asserting that they are still operative and that is another lie – banks themselves have destroyed own market, got involved in the world crisis that was named as financial crisis.
The first stage of world crisis, that started in January 2007 and blew up in August, has passed; the second stage finished with bankruptcy of Lehman Brothers and third stage was accompanied with nationalization of USA eighteen major banks. The process that took a start in USA is gradually approaching Georgia. There is one difference – people in USA are beating their brains out in order to find the way out of crisis on the contrary there is nothing done in Georgia.
Population is left without means. It is paying debts and taxes and cannot spend money for other things. In other words, not only banks, but market is slumbering either. Market has stopped; the market that is a unity of the expenses of the population. It is shrinking gradually.
All the abovementioned means that GDP of Georgia will not even grow by 2% forecasted by Monetary Fund and it can even appear to be negative. We should anticipate serious crisis at the end of 2009. How we should escape this enchanted chain of indebtedness? First of all it is necessary to define the depth of the problem. According to all existing theoretical calculations of economic science the cure is $500 million. This sum is necessary to ensure that most part of employed people in Georgia not to lose jobs; to avoid bankruptcy of major part of construction companies and to help them to retain current front; to ensure liquidity of the banks and their active operating at the market; to save population from poverty and make them to spend money. Home consumption, savings and investments are issues that should be considered as a unity. Home consumption is a driving engine of the country’s economy. 65% of USA GDP is made up of home consumption; this indicator in India is 35%. Russia and China have catastrophically law rates – 6-7%.
If we sort out world countries by the type of economy we will get following results: the category of countries that have no economy (Somali, Haiti etc); the category of countries with developing economy (Georgia); the countries with export oriented economy (China, Japan); the business oriented countries with open economies (Europe, USA).
Up today it’s been considered that it is very good when a country is an exporter. However, this opinion is under question right now: quite soon, supposedly in autumn of current year, fourth stage of crisis starts that will be named as Asian crisis. Whole business, financial field and industry of Asia was connected with export. Asian export was consumed by USA. Decrease of consumption in USA and Europe had negative impact on China, Korea and Japan economies. China is taking response measures: it gives cheap money to the population, finances industry and business and increases home consumption. However, it’s really hard to rapidly increase 6-7% rate even up to India level. Whether China becomes second pole in the world (first is USA) depends on home consumption. If home consumption rate cannot even reach 40% the country is not ready for this.
Home consumption is a significant and new phenomenon in economic science and today for export oriented countries that are recognized as the best model of economy will face serious obstacles. The problem that started with US financial crisis and afterwards spread in Europe will approach Asian region in autumn. We will get Asian export crisis.
Georgia should elaborate optimal variant for its economy. It should find the way to increase consumption and savings that are minimal in our country. The share of domestic market is very small in GDP and thus Georgia has no resources. Therefore, special program should be elaborated that enables us to have more mild forms of crisis than expected. Just like chicken and egg, there can be no savings without consumption and no consumption without savings. The main obstacle for both of them is crisis and both are connected with unemployment and slump of business dynamics. Therefore, Georgia needs to adopt such program that enables to escape from a stalemate of frozen consumption and savings and thus enables growth. In the nearest future we shouldn’t expect any realistic foreign investment, except of portfolio investment. Every investor, when calculating profitability of a project first of all examines home consumption of a country. It would be better if we have recognized that Georgia is not country of regional economy any more. We are not allowed to enter Russian market; we cannot enter Turkish market either and cannot strike roots in Armenia or Azerbaijan olso. Therefore regional market is not an object for calculations. Rate of home consumption is more attractive for them.
Georgia has to overcome huge problem of unemployment and bad business environment. Volume of domestic market in connected with an employment level, while employment is a source of business dynamics. Solution of unemployment problem should be started with registering of unemployed people. The qualification of employees should be increased. It would be reasonable if the funds attracted from Europe will be spent in this field.
Creative and pure environment should be established in business and a person should have a chance to fully reveal own commercial talents.
Coming out from current critical situation, it would be justified to exempt small and average businesses from taxes. Small and average businesses are not bringing such benefits for the state budget. There are two matters in public finances: effectiveness and fairness. Fairness principle is of first-priority at this stage, effectiveness might be determinative as the state is lack of finances. However, in a strategic, future plan fairness will be of special importance. Hence, if 80% of people employed in small and average business will be exempted from taxes temporarily for 5 years, more working places will be created, home consumption increases and Georgia becomes attractive for investments. This the way out of crisis for Georgia. Taxation burden is decreased by many countries. Georgia allegedly decreased tax rates, but yet tax burden remains 38% in our country. This is one of the high rates in the world. It doesn’t matter that our profit tax is 20% and Finland’s is 58%. What matters is that Finnish 58% is lighter that our 20%. Economy is not like Mathematics; in economics 5X5 is not always 25. Since nineties of previous century, Japan spent 14 trillion Yen in order to decrease taxes due to stagnation. From 2002, it managed to achieve definite success. Barak Obama’s rescue plan is directed to reduction of taxes. Naturally Pareto effectiveness shock might be followed by zigzags. One shouldn’t blame us in populism, but it’s a fact that none of the economists managed to fully explain this crisis. Economic paradigms have changed in XXI century and nobody is aware of those new ones.
Therefore middle-term economic program of the country should be elaborated by contextual consideration of above-mentioned huge tendencies. Founding of private property, competitive environment and business freedom will become warranty for the construction of successful economy in Georgia. Otherwise, if we do not take serious approach toward crisis and do not study its symptoms and how to cure it, full collapse is awaiting us in first and second quarters of 2010.