The state should not hesitate to invest. The best way to make

strategic state investments

in the infrastructure and social

projects is to create state

investment corporations.

Economic Environment and Investment

Our government has successfully realized the investment process. Moreover, privatization has been given new impetus recently. Despite this, however, we have not overcome the current investment crisis – we cannot see enough money to develop the economy. Why? First of all, because we lack an effective mechanism to stimulate the influx of investment capital.

Based on the experience of foreign countries, the state investment crisis is one aspect of the larger investment crisis. In our case, perhaps the state has crossed the line beyond which investment deficits are generated in the market economy. This hinders the supply of services to the public, the growth of employment and work standards, affects the development of business effectiveness, and as a result, it has a negative influence on general social aspects of everyday life.

In order to overcome this crisis, we must mobilize the country’s existing savings and attract foreign capital. World experience makes it clear that the best way out for countries in our situation is to create state investment corporations (SIC). SICs must be created in fields where private capital is leery of investment due to small profit and slow earnings. The works of SICs will be topical until an optimal level of business-relations and investment culture is achieved and investment risk is significantly reduced.

Eventually, privatization can be an honorable finale for the “state service” of many SICs. Privatization of SICs can successfully solve difficult state problems. The state sets the necessary rules, creates the SIC, gives them special rights and basic capital, and when the SIC proves its worth – obviously possible only with qualified management – the state gives them into private ownership at an optimal market price. The final profits should be several times the budget expenses.

The state’s professional coordination of the investment process will stimulate private investments as well, enlivening Georgia’s securities market, which was practically atrophied.

Invisible Hand

and Visible Hand

If there is an “invisible hand of the market” that assures economic development, then the SIC is the “visible hand” of the state, and directs investment into priority structural programs. Together with other actions, this can cardinally improve the existing work environment for developing private business, e.g. if the state builds a powerful fuel energy plant to stabilize the electric energy supply and fixes the highways, then small and medium-scale businesses become active and solve the rest of the problems.

The Investment Agency of the Georgian ministry of economic development is the body that sets priorities in Georgia. Like similar agencies worldwide, this agency must determine priority directions, establish legal norms to stimulate investments, and simultaneously regulate investment processes in the country. Unlike such agencies, SICs tend to guarantee the steady function of mechanisms that attract and distribute investment funds.

How Should Social Savings Turn into Investments?

With high-risk investment and temporary macroeconomic instability, SICs appear as organizations created to attract strategic and large-scale investments with state guarantees.

With the SIC, the creation of an infrastructure model guarantees:

Vitally important investment projects;

Attraction of investment and loan capital;

Investment of funds acquired through partial transformation of internal state loans from the treasury elsewhere into priority investment programs, which should be an essential aspect of state debt management;

Independent attraction of loan capital - including Western market capital - in order to finance commercial infrastructure projects, such as investment projects for state companies.

US President Franklin Delano Roosevelt offered a clear example of this conceptual approach. Roosevelt, founder of the “New Deal,” was the first to establish SICs. He asserted that economic development depended on private initiative and capital, but there are exceptions to this rule. These exceptions dictate the creation of companies owned by society and managed by the government, or the creation of the state corporations. The SIC’s goal is to provide society with certain services, but with conditions that would be impossible for private companies.

SICs mostly ease the problems generated when the state asks society to invest, while the state itself is unable to invest effectively. According to the Golden Rule of state finance, current expenses should be financed with taxes, and capital expenses with loans. In our country, funds from internal state loans are not directed into state investment, which fundamentally opposes the classical theory of managing internal state loans. Activating the Golden Rule – as used in Germany, the Great Britain and the New Zealand – would start a real revolution in Georgian state finance, but to tell you truth, I am not sure if our officials are up for this challenge.

Unlike state agencies and ministries, an SIC, as a corporation and legal entity, is separated from its owner – the state. Thus, in this case the owner is not automatically responsible for its debts, but acts as the guarantor for completely paying its debts in a timely manner. The SIC is a state agent of economy. This is why such organizations are called corporate agents of the government in the US.

The SIC must have a high level of durability, at least at the first stage. Its startup capital should be quite solid. In their initial years, SICs are often exempt from paying dividends or any other taxes. They may also receive state subsidies and cover state guarantees with its debt. SICs gain other necessary funds at the capital market. If an SIC’s debt is not covered by state guarantee, then it is not listed as state debt, the same way that it does not belong to the state sector. Factually, the state appears as the promoter of large social projects: it gives the SIC a jumpstart, then offers investors to finance the corporation or assume its debt. This way the savings transform into investments while bypassing the state apparatus. The new ability to address SIC debts does not depend directly on the fiscal condition of the state.

Also, the transparency of SIC work will be guaranteed by the state (parliament and the Chamber of Control), and by a regulator of investors and securities market (the commission of securities and exchanges). Only a high level of transparency allows us to avoid inappropriate spending of SIC funds.

We can look at Roosevelt once more. In 1933, he asked Congress, “To create a corporation equipped with governance, but as flexible and as full of initiative as private companies.” This talk was about the Tennessee Valley Authority, or TVA. The gorge of the Tennessee River was one of the most depressed regions of the US in the 1930s. To save millions of Americans from devastating poverty, Congress established the TVA based on Roosevelt’s initiative. This state investment corporation was called the most valuable part of the New Deal, and is entirely government-owned, even today.

The Mechanism for Financing Development

An SIC depends mainly on long-term obligatory financing. It can be said that without developed market debt, the US would never have developed an effective electric energy system and Japan would not have built its remarkable highways. China’s economic achievements are also the result of using the flexible mechanism of the SIC to attract investment and direct them appropriately.

An SIC could also be used in our country with equal effectiveness to realize socially oriented investment programs. For instance, the Tbilisi Mayor’s Office could create an SIC for rebuilding Tbilisi according to its general plan. In any other scenario, assuming a small circle of investors was involved, investment risk would be much greater, and the volume and quality of investment would suffer.

Other fields where SICs could be used include: Georgia’s eternal problem of electric energy, farming, and renovation of the resort infrastructure, which would allow us to privatize them at much greater profit than in their current debt-laden status.

The role of the SIC in developing regional infrastructure is something different. The plan for SIC participation in regional investment is quite simple. The SIC creates a structural investment project, then prepares a system of guarantees and determines the parameters of capital loans. The next stage is attracting and investing capital by assuming debt happens. After finishing the investment property, the SIC offers private business the property for long-term lease with option to purchase. The SIC directs revenue gained this way partly towards its obligatory debt, and partly to its expenses.

The Best Way for the

Non-Investing Country

Due to privileges granted by the government, SICs have an advantage even in capital markets: a relatively high rating compared to private companies. This rating is given to their debt by independent rating agencies. In Western markets, SICs are able to attract long-term capital with low interest rates. Obviously, this positively affects the prices of the large-scale projects.

State guarantees are no less important for SICs. It is practically impossible to attract investors to countries which rating agencies call “non-investing.” Unfortunately, Georgia is still in this category. Without such guarantees, in these “non-investing” countries investors often request 20% higher dividends on stocks and 10-12% higher interest on debt – if not more. The average cost of capital adds up to 14-16% annually for an infrastructure project that is financed 70% by debt. This is approximately twice what it costs in countries with stable economies and well-developed regulatory regimes. What can we do? As long as our country remains this way, investors demand high percentages in exchange for the risk.

However it is also possible to place the debts of the SIC in the domestic market. Here one thing gives us hope. What are the debts of the SIC? Mostly this is debt that the government owes to itself. This is why: the state collects taxes and directs part of this to the social security system, and as a rule its revenues are more than its expenses. The existing surplus profit is directed towards the debts of the SIC. They belong to such options which the state always allows the pension funds and insurance companies to buy without restricting quantities.

And finally, the level of reforms that are to be realized in the country is directly linked with the level of state thinking of the reformers. If, after a successful start, the new government deepened and developed quality economic reform, then nothing would be able to stop the economic rise of Georgia.