Georgia - DCFTA Study 2015

NOVEMBER 15, 2015

Impact Study of the DCFTA implementation on SMEs sector In GEORGIA

“This publication has been produced with the assistance of the European Union. The contents of this publication are the sole responsibility of “International Business Development and Investment Promotion Center “ (Georgia) and can in no way be taken to reflect the views of the European Union.”

Contents Introduction ............................................................................................................... 3

1. Methodology ....................................................................................................... 4

2. DCFTA implementation and the SME sector in Georgia ................................... 4

3. Results of SMEs survey in the context of their expectations towards DCFTA .. 7

4. Conclusions and recomendations ...................................................................... 12

5. Bibliography ..................................................................................................... 13

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Introduction Georgia's main economic activities include cultivation of agricultural products such as grapes, citrus fruits, and hazelnuts; mining of manganese, copper, and gold; and producing alcoholic and nonalcoholic beverages, metals, machinery, and chemicals in small-scale industries. The country imports nearly all its needed supplies of natural gas and oil products. It has sizeable hydropower capacity that now provides most of its energy needs.

Georgia has overcome the chronic energy shortages and gas supply interruptions of the past by renovating hydropower plants and by increasingly relying on natural gas imports from Azerbaijan instead of from Russia.

Over the past years government developed and introduced wide ranging system changes in all sectors, including economic reforms. Economic reforms, implemented by the government, were addressed to create attractive business environment with the aim of inviting foreign investments, facilitate private sector development, stimulate entrepreneurial activities in various fields of economy and improve/expand employment opportunities.

Attraction of foreign direct investment (FDI) is the one of the main priorities for Georgia. Liberal investment environment and equal approach to local and foreign investors makes country as an attractive destination for FDI. Stable economic development, liberal and free market oriented economic policy, 6 taxes only and reduced tax rates, reduced number of licenses and permissions, dramatically simplified administrative procedures, preferential trade regimes with foreign countries, advantageous geographic location, well developed and integrated transport infrastructure, educated, skilled and competitive workforce presents a solid ground for successful business in Georgia.

From 2006 to 2014, foreign direct investments (FDI) in Georgia amounted to 10 484.9 million USD totally. In 2014, foreign direct investments amounted to 1 272.5 million USD, that is 35.1% higher compared to the same period of the previous year.

About 55% of the total labor force is employed in agriculture, though much of this is subsistence farming (invest in Georgia). Georgian agricultural production is beginning to recover following the devastation caused by the civil unrest and the necessary restructuring following the breakup of the Soviet Union. Livestock production is beginning to rebound, although it continues to be confronted by minor and sporadic disease outbreaks. Domestic grain production is increasing, and government invests in improvement of infrastructure improvements to ensure appropriate distribution and revenues to farmers. Viticulture and winemaking are the most important fields of Georgia’s agriculture. Russia was traditionally the biggest export market for Georgian wine. This, however, changed in 2006, when Russia banned imports of wine and mineral water from Georgia.

Since then Georgian wine producers have struggled to maintain output and break into new markets.

The signing of the Association Agreement with the European Union in June 2014 and the coming into effect of the Deep and Comprehensive Free Trade Area (DCFTA) in September are landmark achievements for Georgia.

The Deep and Comprehensive Free Trade Area (DCFTA) is a part of the Association Agreement (AA) and aims at Georgia’s gradual integration into the EU’s internal market. EU-Georgia DCFTA is supposed to realize three out of four freedoms the EU internal market is based, namely goods, services and capital will move freely between Georgia and the European Union.

The Association Agreement is aimed at deepening political and economic relations between the EU and Georgia. It is based on common values and describes the gradual improvements needed in areas such as trade, the environment, agriculture, tourism, energy, transport, and education to bring Georgia in line with EU standards. Overall, the process is focused on democracy and the rule of law, human rights good governance, and economic development.

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The Deep and Comprehensive Free Trade Area (DCFTA) is the instrument used to enhance Georgia's trade and economic growth through bringing its legislation closer to that of the EU. It also removes the existing barriers on the trade of goods and services with the EU. This creates better opportunities for Georgian businesses – big and small – to trade with the EU, and for the European businesses to invest in Georgia.

This paper proposes research analyses on DCFTA opportunities for the SMEs reflecting expectations of SMEs, as well as current situation of compliance with DCFTA requirements and existing problems in this regards including recommendations for policy improvement.

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Methodology

The survey has been conducted based on the action research approach. It considered the close collaboration with a group of SMEs representatives (about 50 SMEs from Georgia with a strong prevalence of businesses from the agriculture sector and rural areas from different regions of the country) to explore their vision on the DCFTA implementation process in Georgia and identify their expectations and problems they face with in this regard.

In course of research the following methods was used: the surveys/questionnaires, interviews and focused group. in order to achieve the aim and objectives of the Project qualitative and quantitative data collection tools were applied in terms of sectoral and overall analysis.

Qualitative methods provided social, cultural, political and historical context of the research questions by means of interview with stakeholders (experts, government and SMEs representatives in three countries), literature reviews, and casual chain analysis. The survey included both open-ended and closed-ended questions including series of closed questions, with boxes to tick, and then finish with a section of open questions for more detailed response.

The main sources of basic data for this study were based on the data of the National Statistics Office of Georgia, the data of the Ministry of Sustainable Economic Development of Georgia and of the Georgian Investment agency (InvestinGeorgia.org) as well as secondary sources of information from the articles and studies elaborated by local and foreign experts were used.

2. DCFTA implementation and the SME sector in Georgia

The DCFTA between Georgia and the EU was signed in June 2014 as part of the AA. Georgian Parliament ratified the agreement in July 2014 and the European Parliament in December 2014. The majority of EU Member States (26) finalized ratification procedure of the agreement in their national legislative bodies. As soon as all EU member states ratify the AA, the agreement will enter into force. However, since 1st of September 2014, Georgia is benefiting from the provisional application of the DCFTA as a part of the AA. In the long-term perspective, the DCFTA is expected to have economic benefits for Georgia, as it will result in the gradual integration of the Georgian economy into the EU internal market. In the short to medium-term, the DCFTA seems to be associated with substantial regulatory costs connected to EU approximation process. In the short-to medium-term, its economic impact is supposed to be rather limited, but it will definitely have great political significance, especially because it is an important breakthrough in Georgia’s EU integration course.

Benefits which DCFTA can have for the ordinary Georgians are higher quality locally-grown food and other goods; better business opportunities for all, including small and medium sized companies; more European investment into Georgian manufacturing; increased average salaries; better access to improved health services; 4

and energy savings due to more efficient use of energy resources and the development of renewable energy sources. Independent studies suggest that Georgia’s export to the EU could rise by 12% and Georgia’s GDP could increase by 4.3%, or €292 million in the long term. There are challenges ahead for Georgia to complete the agreed reforms and correctly implement the DCFTA. It will take time for improvements to be noticed. But with commitment and patience these benefits will become reality.

The DCFTA may give an impetus for EU–Georgian economic ties by prompting companies to search for prospective niches in both markets. For European exporters, opportunities may emerge in such areas as machines agricultural, equipment for processing and food storage, chemical products or pharmaceuticals.

Moreover, transport vessels, electrical and home appliances and furniture may successfully compete in the Georgian market.

The main focus in the context of DFTA implementation is given to the readiness of the Georgian economy and its private sector (SMEs) for the implementation of the new Georgian trade-related regulations approximated with the EU aqcuis. With regard to the DCFTA, the agricultural sector and the associated obligations, is one of the most sensitive areas when it comes to analyzing the preparedness of Georgia’s private sector. Georgia’s agricultural sector employs a large number of people – 55% of the total employed population. More specifically, a large percentage of socially vulnerable population is employed in this sector.

Since starting application of the DCFTA, Georgia pays particular attention to promotion of of private sector development and its competitiveness with special emphasis on SMEs as this segment of business sector is still very vulnerable, having comparatively small share in the country’s GDP (around 20%). In addition, SMEs have great potential for development and hence contribute to economic development and inclusive growth.

Supporting SMEs is rather important in the scope of effective implementation of the Georgia-EU Deep and Comprehensive Free Trade Area (DCFTA), as together with new opportunities the DCFTA opens to Georgia, there are also challenges for business sector such as compliance with the EU regulations.

Georgia has already taken important steps aiming of supporting SMEs. In February 2014, the Entrepreneurship Development and Innovation and Technology Agencies were set up through the Ministry of Economy and Sustainable Development of Georgia. The main aim of the Entrepreneurship Development Agency is to support and raise competitiveness of businesses that is achieved by means of financial and non-financial instruments including financial contribution to start-ups and development of existing businesses, entrepreneur’s education, development of business skills, consulting entrepreneurs on different directions, export support etc. The Agency provides assistance to entrepreneurs in popularizing their products on local and European market. One of the main directions of the Agency is to support business sector to adapt in adhering to the DCFTA requirements. In addition, the agency aims at supporting modern innovations and technological developments, as well as R&Ds, and innovative start-up businesses. Lack of innovations and modern technologies in the business sector, especially in development of SMEs is one of the major unfavorable factors, which negatively affects competitiveness of enterprises.

In June 2014, the new governmental program - “Produce in Georgia” was introduced. The main purpose of the program is to support establishment of new competitive businesses, as well as promote existing entrepreneurs in processing agricultural products and innovative directions. “Produce in Georgia” has three components: 1. financial support-providing co-financing of credit interest rates and collateral, requested by financial institutions; 2. providing the infrastructure, which for potential investors foresees, providing state owned real estate for symbolic price, and 3. providing technical assistance, such as consulting entrepreneurs in their fields of interests, helping them in a process of harmonization with the European norms, searching/ introducing new modern technologies and etc.

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As of March 2015, within the program “Produce in Georgia” 64 projects were supported, the expected total investment in value will exceed 110 million US dollars. Besides, “Produce in Georgia” introduces micro and small enterprises development direction, which aims to encourage business activities in regions paying special emphasis to vulnerable regions, diversifying products and services produced, while increasing competitiveness of these regions. Within the Program, financial and consulting support will be provided to individual entrepreneurs as well as groups; financial contribution considers co-financing for start-ups for the beneficiaries.

The Program on industrial productions and micro and small enterprises is implemented by the Entrepreneurship Development Agency, while agricultural projects are carried out by the Agricultural Projects’ Management Agency under the Ministry of Agriculture of Georgia.

Within a scope of technical assistance of the Program, consultations are provided in respect to introducing new technologies, drafting sales and marketing plans, which will significantly affect growth and development of companies and is important to implement the DCFTA requirements. To provide consulting services to companies on European standards, the Entrepreneurship Development Agency and the European Bank for Reconstruction and Development (EBRD) signed a Memorandum of Cooperation.

Since 2015, Entrepreneurship Development Agency (EDA) has been actively involved in providing effective technical support to companies, including enhancing capacities of the EU market oriented companies. The EDA in partnership with the Caucasus University is carring out certified training for export managers, having special emphasis on opportunities provided by the DCFTA, raising awareness about the EU requirements and regulations. Support and expertise of our European partners provided to Georgia in the process of step by step development and effective implementation of the DCFTA requirements is of utmost importance. The EU support projects on quality infrastructure development have to be noted as well as development of this sector based on EU’s best practices will provide possibility to limit technical barriers to trade, significantly minimize business expenditures and facilitate increase of competitiveness of Georgian products. A number of important projects are being currently implemented in food safety as well. It has to be noted that in the beginning of 2015, an important step forward was taken towards private sector development in Georgia by signing the EU support program (budget of 45 million EUROs), which aims strengthening institutions and supporting SMEs in the DCFTA implementation framework. Also, in close cooperation with the OECD and with support of the GIZ Georgia is in the process of elaborating SMEs development Strategy and Action Plan. The Strategy and Action Plan will identify priority directions and actions to be implemented by the government of Georgia (GoG) in the future. All these steps undertaken by the Georgian government to support SMEs sector are supposed to improve competitiveness of the Georgian SMEs in accessing European and international markets.

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3. Results of SMEs survey in the context of their expectations towards DCFTA Geographical coverage of the Survey: The survey has been conducted in 5 main regions of Georgia covering the Adjara and Guria regions from the western part of the country and the Kakheti and Kvemo kartli regions as well as Tbilisi, the capital of Georgia from the eastern part of the country. The total number of SMEs engaged in the survey is 58 including majority 62% from Adjara (36 SMEs) region as a main tourist destination of the country and the rest from other parts of the country.

Chart N1

Distribution according to the type (scale) of companies’ interviewed: Almost half of SMEs interviewed (25 companies - 43%) was represented from the small businesses (10-49 employees), while 15 (26%) of them were from micro businesses (less than 10 employees) and 18 (31%) from medium business companies (50-250 employees).

Chart N2

Sectorial distribution of SMEs according to their field of activity: 7 Â

The main focus of survey was made on the SMEs acting in the agricultural field that comprised 50% (29 companies) as well as companies from food industry that amounted 15% (9 companies), wholesale (15%) and the services related to Hotel, restraint and tour businesses (15%).

Chart N3

Distribution of SMEs according to export-import activities: 36 % (21 companies) of the companies interviewed carry our export-import activity, while 17% (10 companies) of them are engaged in export-import activities equally, 19% (11 companies) are focus their activities mostly on import operations and almost 28% do not carry export-import operations.

Chart N4

Expectations of SMEs regarding the DCFTA possible benefits per industry: 8 Â

The 4th question (What domestic industries will benefit from the DCFTA) of the questioner aimed at identifying SMEs expectations regarding the possible benefits from the DCFTA per field indicated in the questioner. In this part we gave interviewers possibility to mark several fields and thus customize their option according to priority. As a result of analyses of this part of the survey, majority of SMEs regarded that DCFTA may mostly contribute to Agricultural (45 interviewers) and food industry (29 interviewers) while the next places was up to services related to Hotel, restraint, tour businesses (30 interviewers), wholesale (22 interviewers) and etc.

Expectations of SMEs regarding the negative impact of the DCFTA on the listed industries: This part of the survey (On what domestic industries will the DCFTA has a negative impact) has shown the positive expectations from the SMEs towards the future DCFTA application as far as the great majority of the companies interviewed (48 companies) answered that DCFTA will not have a negative impact on any of the domestic industries listed. Only 5 companies indicated the agriculture and 4 companies Food industry as a relatively vulnerable fields in terms of DCFTA implementation.

Expectation of SMEs about the possible improvement of business climate after the DCFTA come into force: Great majority, the 91% (55 companies) of respondents regards that DCFTA will contribute to the improvement of business climate in the country while only 8,6% (5 companies) regard that it will remain unchanged and no one argued that DCFTA could somehow worsen the business environment.

Expectation of SMEs about the possible impact of the DCFTA on the quality of domestic products: Great majority, 94,8% (55 companies) expressed their opinion that quality of domestic products will be improved after the DCFTA application and only 5,2% (3 companies) regarded that it will remain unchanged.

None of the respondents think that DCFTA could somehow worsen the quality of national products.

Does the Government provide enough information on challenges and possibilities of DCFTA? This part of the survey reveals the weaknesses related to awareness on DCFTA related issues among the SMEs as far as the majority of respondents (60%) argued that the government does not provide enough information to the small businesses regarding the DCFTA possibilities, while only about 28% think that information provided is relatively enough and for the 12% this question was difficult to answer. Therefore this aspect of the survey confirms that low awareness on DCFTA related issues is one of the main challenges that the national government need to address. The next question in the questioner related to “needs and supporting measures to be taken by the government to promote trade relations with the EU and make the best use of DFTA for the SMEs” was requested to answer in a narrative manner and it was one of the most important ones in terms of revealing the needs from the side of small businesses. Therefore we considered necessary to make analyses of this question at the end after reflecting remaining questions (with boxes to tick).

Are you familiar with the Content of DCFTA? To what extent are you familiar with the requirements of the European Eunion?

The quarter (25%) of the SMEs interviewed considered it difficult to answer this part of the questioner, while only about 20 – 25% pointed that they are familiar with the Content of DCFTA and the requirements of the European Union. The majority, up to 50% consider that they are not familiar with the issue concerned.

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Actually, to sum up those who has difficulties to answer and those who think that they are not familiar with the issue, we can all over again argue that the awareness of DCFTA is a main chalange.

Do you consider your product competitive enough for the EU Market? Are you ready for make an additional investments in your company to improve the competitiveness of its products?

About half (50%) of the SMEs consider their product competitive for the EU market while the rest of them thinks that it not competitive and some (10 companies) considered it difficult to answer. At the same time, 75% of the companies expressed their readiness to make additional investments for the improvement of the competitiveness of their products and only 5% are not ready for investment while for 19% it was difficult to answer.

What impact will DCFTA have on your business? What is missing in your business to benefit from the opportunities the DCFTA provides?

The great majority (91%) of SMEs interviewed regard that DCFTA will have an positive impact on their business, while only 9% thinks that it might have no impact and none of them consider that it could have a negative impact. As for the needs of the businesses to benefit from the opportunities the DCFTA provides, the majority pointed out the need for access to credits and investments, the second priority issue was up to opportunities for hiring skilled employees and respectively the following aspects was also paid attention: partners in the EU, opportunities to expend production, free production capacities, Knowledge about the EU market and EU legislation and etc.

Chart N5

What kind of supporting measures are necessary to be taken by the national government to promote trade relations with the EU and make the best use of the DCFTA for the SMEs? This part of the questioner seemed to be a bit challenging for many of the respondents but nevertheless they demonstrated active participation and provided valuable contribution to the survey. As a result the following aspects had been revealed based of the summarizing the responses of the respondents related to necessary measures to be taken by the national Government: • Awareness rising activities about the DCFTA, its benefits and opportunities as well as interpretation of the respective EU trade legislation is necessary through seminars, conferences and different kind of events promoting people-to people contacts and sharing experience and EU best practices. TV and other 10 Â

mass media tools should be actively involved in the spread of information as well as organization of partnership forums to contribute to networking between the Georgian and EU partners (consumers companies).

• Access to capitals – accessibility to preferential credits and loans are necessary to invest in increasing the scale of national production and quality of national products as well as consultation services for SMEs are instrumental including from EU financed projects line TAM/BAS, DCFTA Facility, EastInvest and etc.

• Capacity building of the staff of the national SMEs and access to new technologies as well as new innovative approaches are needed to access the EU market such as application of web-based instruments like web-based portals for the advertisement of national products and attraction of customers. Apart from that national SMEs should have a possibility to participate in international exhibitions and fairs to promote their products.

• Government should provide support in setting up certified laboratories for food safety standards and help in registration of national products in EU market as well as effective Implementation of Antimonopoly legislation by the government is needed.

• Government should give more preferences to the export oriented SMEs and in this context national legislation should be re considered (Tax code) in order to decrease the taxes for such companies.

• Government should adopt a SME support and export promotion strategy in the short and long term as well as action plans (strategies) is necessary for the development of each export oriented sectors, notably in agriculture.

What opportunities do you see for your business under the DCFTA? The following aspects had been revealed based of summarizing the respondent’s major observations: • Possibility for attraction of European investments and access to 500 million EU single market and possibility to distribute production in a high price what will contribute to increase of employment.

• Opportunity to rump up the national production and diversify the export of national products as well as improvement of the quality of products and access to EU investments as well as to EU grants.

• Access to new technologies and increasing the export potential, facilitation of communication with European consumers (companies) what will have a positive impact on the overall economic and social environment of the country.

What risks for your business does, in your opinion, DCFTA bring?

Many of the respondents (about 40%) pointed out that there are no risks, but the rest of them indicated the following: Transition (adaptation) costs needed at the initial phase for the modernization of the national production, fierce competition that Georgian products could face on EU market, lack of qualified staff and modern technologies, low awareness, quality of products (The majority of comments have already been pointed out in the other fields).

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What EU support programmes for SME are you aware of?

ENPARD, TAM/BAS, INST-INVEST

What EU support programmes for SMEs do you benefit from?

ENPARD, TAM/BAS, INST-INVEST

4. Conclusions and recommendations: • DCFTA awareness is relatively low in Georgia. Local SMEs are less informed about benefits of the DCFTA and the trade requirements of the EU. Therefore low awareness is considered to be the major obstacle for the practical application of the DCFTA by the SMEs. Therefore Government has to facilitate interaction with the SMEs providing necessary information through organization of different awareness rising events (Seminars, info days, conferences) in order to deliver necessary information regarding the EU trade regulations, food safety standards and the preferences the DCFTA proposes. In this respect, support of EU expertise and the assistance of other donor organizations would be very instrumental.

• Major challenges to note is possible increased imports from the EU and additional pressure on the domestic producers, especially in the short run. This paired with increased costs due to stringent compliance requirements with the EU standards. So, Supporting SMEs is extremely important in the scope of effective implementation of the DCFTA, as together with new opportunities the DCFTA opens to Georgia, there are also challenges for business sector such as compliance with the EU regulations.

• DCFTA shall be beneficial for Georgia in the context of increased benefit for the citizens who will have access to better quality products on the national market and in the long-term the possibility of having higher incomes due to new business opportunities and increased economic growth brought by the trade with the EU. Agriculture and food industry has a huge potential in terms of export of national products to the EU market but at the same time SMEs active in the field are week and need proper support from the Government in terms of modernization their production and increasing their products quality in line with European standards. Number of Governmental programmes introduced during the recent years by the government has proved to be instrumental proposing preferential agro loans and Co-financing possibilities (“Preferential agro loan programme”; “produce in Georgia”) but nevertheless more efforts are needed to facilitate disbursement of loans for farmers from the commercial banks.

• In the long-term perspective, the DCFTA is expected to have economic benefits for Georgia, as it will result in the gradual integration of the Georgian economy into the EU internal market. In the short to mediumterm, the DCFTA seems to be associated with substantial regulatory costs connected to EU approximation process. In the short-to medium-term, its economic impact is supposed to be rather limited, but it will definitely have great political significance, especially because it is an important breakthrough in Georgia’s EU integration course.

• Benefits which DCFTA can have for the ordinary Georgians are higher quality locally-grown food and other goods; better business opportunities for all, including small and medium sized companies; more European 12

investment into Georgian manufacturing; increased average salaries; better access to improved health services; and energy savings due to more efficient use of energy resources and the development of renewable energy sources.

• Trade balance in agricultural and related products, as well as in trade turnover as a whole, between the EU and Georgia has been largely negative. The EU has been by far rather protective of its domestic agricultural and food industry and has been imposing tariff and nontariff barriers in trade. The DCFTA shall see many tariffs disappear, however the nature of reductions shall differ among the product categories. For example in agriculture one product – garlic- shall see the tariff-rate quota, while a number of others shall maintain the market entry prices.

• It is necessary to draw up a medium- and long-term strategies for the entire agricultural sector and to assess its export potential, determine those sectors in which Georgia might have a comparative advantage.

Assessing the country’s competitive advantage in agricultural goods and targeting the most promising fields in the short-run, while later on the gains created could be further expended to other fields as well through the spillover effect. Special attention should be paid in correctly utilizing the technical and financial assistance provided by the EU, so they bring tangible results.

• Access to information for the producers is a key in the process together with the training and education.

A fruitful initiative to overcome information asymmetry shall be creation of a handbook for producers on the trade information how to export to the EU that shall be very specific, including information on both tariff and non-tariff barriers. Currently existing web portal under the Ministry of Economy and Sustainable Development of Georgia has initially been created to serve that mission; however it is quite complicated and does not provide relevant and practical information for SMEs, therefore it has to be improved and simplified.

5. Bibliography

1. EU-Georgia Association Agreement - http://eeas.europa.eu/georgia/pdf/eu-ge_aa-dcfta_en.pdf 2. National Statistics office of Georgia - http://www.geostat.ge/ 3. Invest in Georgia - http://www.investingeorgia.org/en/ 4. Ministry of Sustainable Economic Development of Georgia - http://www.economy.ge 5. Produce in Georgia - http://qartuli.ge/ 6. Office of the State Minister of Georgia on European and euro-atlantic integration - http://www.eunato.gov.ge/en

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