Home / Economy / Cheap Money and Economic Development: Necessity of Development Bank

Cheap Money and Economic Development: Necessity of Development Bank

What is the price of money in Georgia and what is the price of money in general? The price of money is an interest rate that commercial banks make us pay for taking a loan (there exists other definitions too).

In a production process, success (profitability) of the company is determined mainly by two things: first – the costs and the second – demand for the produced products; the first component includes price of money as well. The more money a company pays for a bank loan’s interest rate (cost of money), the higher its expenses are. As a result, the company profits shrink.

According to the National Bank data, over the past 10 years, average annual interest rate on loans is 15%. With rough calculations, it signifies that on each borrowed 100 GEL, companies or physical entities should return 15 GEL more. Profitability of a company implies profits raised from 1 GEL (USD) invested, after paid expenditures. It is less probable that the profitability of a company in Georgia would be somewhat close or equal to paid interest rates. This indicates that the cost of money is significantly high for Georgian companies, and various reports, including Global Competitiveness Index, prove this by arguing that access to financial resources is one of the key obstacles for Georgian businesses.

Cheap and the so-called “long-term” finance is of crucial importance for economic development of the country. Commercial banks are normally conservative in their considerations and take fewer risks when issuing loans. Furthermore, they also strive for short-term profits and do not offer money to domestic entrepreneurs for long-term development of the country. To put it bluntly, commercial banks give priority to their own segment in the economic life of a country.

With the goal of overcoming existing development-related challenges and contribute in the formation of healthy societies, along with other instruments, countries generally establish development banks. Mariana Mazzucato and Caetanno Penna differentiate several objectives that development banks serve. These include: counter-cyclical measures, large-scale infrastructural projects, supply of mission-oriented finances and introduction of new technologies. The counter-cyclical activities of a development bank are directed to eradicating problems generated by the cycles of capitalism (the so-called business cycles) through the supply of cheap money to companies. As to the infrastructural projects, development banks, indeed, finance important highways, seaports and other major energy projects.

The government of Georgia applies several instruments for resolving the problems related with the financial resource availability. Among them – the program operated by the Ministry of Economy – “Produce in Georgia” and the Partnership Fund of Georgia. The latter institute may be considered as an initial form of the Development Bank that incorporates certain functions of such institutions. Partnership Fund has been actively funding priority programs in the country, especially in energy and tourism sectors, however, the development of production and promotion of innovation has a minimal role in the Fund’s portfolio.

Discussion about reforming the Partnership Fund actualized in 2014. The government of Georgia asked the Development Bank of Germany (KfW Entwinklungsbank) for assistance and advice in the process of reforming the Fund. It has to be noted that the management of the Partnership Fund has actively discussed these reformation process, after which Partnership Fund was supposed to make emphases on those high-risk economic sectors, where private financial institutions would have less interest. However, Partnership Fund has not carried out the reform yet and discussions over foundation of the Development Bank have stopped.

If we look to the performance of the Partnership Fund, it shows that this institution is chiefly oriented on commercially profitable projects and it pays less attention to criteria such as employment potential, innovations, positive externality and technological spillovers. Therefore, it turns out that the Partnership Fund participates in the sectors with higher chances for attracting financial capital. The Fund is most active in energy and real estate sectors and ratio of these directions in total value of projects accounts to 90%, while the ratio of industrial development projects in total value of projects of Partnership Fund accounts to 6.9%.

Key Outlines of New Development Bank

 Georgian economy is in crucial need of Development Bank and cheap money that will help to eradicate market challenges and ensure structural transformation of economy. First of all, one should start with realizing that human resources are exceptionally unused, which indicates that there is an army of unemployed citizens in the country. Unemployment on the other hand strengthens migration processes. Such reality necessitates making strategic investments in the sectors that create high-paid and stable job places.

It turns out, that Georgian state will have to carry out large-scale re-industrialization and Development Bank is to become its “financial arm.” Obviously, it will be better to establish Development Bank on the existing basis and Partnership Fund is the best option, which has experience of management of major investment projects. This is mentioned in the KfW report that focuses on the perspectives of the Development Bank in Georgia.

For economic development it is of crucial importance that Development Bank be oriented on small and medium business promotion projects, including on funding startups that have chances of taking credit from commercial banks. Key accent should be on processing industry that creates stable and high-paid jobs. Development Bank should make scope on such projects as promotion of technology transfer and their adaptation to domestic economy.

Tato Khundadze