Chapter 5. Recommendations for policy makers

The chapter summarises the main conclusions and findings that have emerged from the analysis. It also offers recommendations targeted at policy makers in the government of Georgia. Among other concerns, these touch upon improvements in the macroeconomic situation and investment climate, political and institutional environment, and access to and cost of finance. These include barriers related to issues such as the policy and regulatory environment; the cost of, and access to, finance; energy pricing; and fossil-fuel subsidies.

    

Local financial institutions in Georgia have sought to strengthen sustainable energy markets by developing lending products to promote energy efficiency. Banks have also provided debt finance to developers of small hydro projects. This has helped the Georgian economy move towards a more sustainable and competitive development pathway. It also reflects the government’s push towards a more resource-efficient, low-carbon economy.

International financial institutions (IFIs) have provided significant volumes of sustainable energy credit-line facilities to at least eight commercial Georgian banks and financial institutions. These credit lines have been used to provide on-lending to industry, commercial companies and households, primarily for investment in energy efficiency.

The market for energy-efficiency investments is likely to be significantly larger than that represented by these facilities. Much of the investment is in energy efficiency served by mainstream corporate and small and medium-sized enterprise (SME) lending products. However, there are no explicit requirements in their loans to recognise energy savings and associated impacts of greenhouse gas (GHG) mitigation.

Promoting energy efficiency among SMEs has a range of benefits at the national level. For example, it can address competitiveness challenges by reducing the high costs of fossil-fuel inputs. It can also improve energy security by reducing dependence on imports of fossil fuel. However, Georgian policy makers have not typically viewed the area of sustainable energy lending, particularly to SME borrowers, as an area for direct government engagement or support.

Green lending is usually regarded as a fully commercial transaction between private institutions. Such investments are generally undertaken primarily for their productivity and cost benefits. Environmental or other co-benefits are usually an afterthought, if they are considered at all. Both government and IFIs assume that market dynamics for energy-efficiency finance would be self-supporting once the model had been demonstrated and borrowers could show net savings. Yet the market for green finance in Georgia has not developed as quickly as expected.

This report outlines several barriers that continue to hold back the development of a dynamic market. These include a policy and regulatory environment that remains “work-in-progress”, issues of cost of and access to finance, perverse incentives associated with energy pricing and fossil-fuel subsidies, and wider investment climate issues in Georgia. Policy makers can play a key enabling role to overcome many of these barriers, which are described in more detail below.

5.1. Strengthen environmental policy and regulation

A range of policy reforms is already promoting sustainable energy, climate and environmental performance, and wider green growth. However, significant work remains to finalise the laws and regulations that can underpin demand for green finance, particularly in relation to SMEs. Further details are set out below:

• Strengthen environmental legislation: Legislation associated with the Third Energy Package and other European Union (EU) directives, together with laws associated with the Energy Community, need to be finalised and fully adopted. However, while primary legislation is important, it is not enough. The government must support technical implementation by developing effective sub-regulations and supporting programmes. Ambitious energy-efficiency standards for energy-consuming appliances, transport and buildings need to be enforced and ratcheted upwards over time. Other areas of technical support include raising awareness of energy efficiency among end-user groups, promoting energy management systems (e.g. ISO 50 000 series standards, International Performance Measurement and Verification Protocol) and audits as part of energy services provision. The government might also consider developing a clean energy industrial strategy to promote indigenous technology and services provision.

• Ensure alignment of SME, climate and relevant sector policies: As noted earlier, Georgia has a growing and increasingly complex framework (policies, strategies and implementing programmes) for both green growth and SME development. The government needs to ensure consistency and integration between its policies and targets for renewable energy, energy-efficiency and GHG emission reductions. It also needs to ensure these objectives are aligned with, and reflected in, wider development objectives and sector programmes, particularly where these support SMEs.

• Strengthen environmental regulation and enforcement: Weak environmental regulation and enforcement (e.g. around emissions, waste, pollution, buildings, transport) can reduce the incentive for SMEs to focus on environmental performance and reduce demand for finance. Georgian enterprises, from small- to large-scale, consider stricter environmental policies and better enforcement to be the most important lever to influence investment decisions. Such decisions could revolve, for example, around resource-efficiency and cleaner-production measures (OECD, 2018[1]).

• Develop tax and other incentive frameworks: The Ministry of Economy and Sustainable Development (MESD) should discuss further tax incentives for environmental investments with the Ministry of Finance. These include accelerated amortisation and reduced taxes for renewable energy and energy-efficiency equipment, and possibly a corporate-tax credit for environmental investments.

• Promote green procurement through SMEs. Government spending on goods and services accounts for 18.4% of Georgian gross domestic product (World Bank, 2017[2]). In fact, Georgia’s State Procurement Agency has already considered integrating environmental and energy performance criteria into the Law on Public Procurement. The government should also review the ability of SMEs to engage with the procurement system. This process should ensure that SMEs can better enter the competitive market for the provision of sustainable goods and services (OECD, 2016[3]), (Singh, 2016[4]).

• Rationalise energy pricing: Relatively low energy prices in Georgia are positive for economic development. However, they have limited the incentive for SME investment in resource and energy efficiency and small-scale decentralised renewables. The government amended the Tax Code in 2017 to increase tax rates on fossil fuels. Natural gas, however, is still subsidised for electricity and heat generation, albeit at a lower level than some other countries in the region. The government should continue to pursue reforms to energy pricing. This includes integrating social protection for the poorest and most vulnerable energy consumers into energy tariff structures. Additional social protection measures based on income should be introduced through the welfare system. This would help avoid confusing and perverse price signals in relation to energy use.

5.2. Define role of SMEs in the green transition

In designing energy and sustainable development strategy, policy makers often focus on the role of larger companies and banks in financing and implementation. Policy makers should consider more explicitly the role of SMEs in delivering national targets. These targets should include those related to both energy efficiency and wider resource efficiency:

• Better consideration of SMEs in the development of green financing frameworks: It is not clear to what extent smaller SMEs have been considered during development of the National Energy Efficiency Action Plan (NEEAP) and the Low Emission Development Strategy (LEDS). Their concerns and challenges should be considered more closely during future policy development. This could include, for example, revisions of the NEEAP and LEDS, and development of the Green Economy Strategy or of the Intended Nationally Determined Contribution (INDC). This will allow a level of co-ordination and coherence in policy development.

• Understanding the role of SMEs in delivering national policies and targets: Georgia is committed to delivering its climate and sustainable development goals through a range of public and private strategies. At a sub-national level, these include the Municipal Project Support Facility, European Bank for Reconstruction and Development’s Green City Framework and the Asian Development Bank’s Tbilisi Sustainable Urban Transport Programme. For these types of programmes, SMEs and their participation should be an explicit consideration.

• Better estimates of SME financing requirements as part of the green transition: More robust estimates are required that downscale the national estimates of climate finance set out in the NEEAP, LEDS and INDC. These would show what percentage of finance is likely to be required by public vs. private actors, and by SMEs. This would be particularly important for priority thematic areas such as energy efficiency, buildings upgrade and small-scale renewable energy.

5.3. Improve wider access to finance for SMEs

Green investment cannot occur while Georgian SMEs experience wider challenges in accessing finance. To benefit from new export opportunities offered by the Deep and Comprehensive Free Trade Area arrangement, Georgian SMEs will need to invest in and modernise their businesses to improve competitiveness. The recommendations for the SME development strategy include five priority actions: (i) amend the legal framework on public grants; (ii) improve supply-side financial skills to leverage the regional presence of banks; (iii) promote demand-side financial education programmes targeting SME entrepreneurs; (iv) consider establishing a credit guarantee scheme as a risk-sharing mechanism; and (v) improve alternative non-bank and equity financing for SMEs.

• Amend the legal framework on public grants: Georgia needs to amend the laws regulating the provision of public grants. Amending the Law on Grants (PoG, 1996) is a prerequisite for the design of effective SME support policies implemented by Georgian Enterprise Development Agency (EDA/Enterprise Georgia), Georgia’s Innovation and Technology Agency (GITA) and other institutions that aim at providing financial assistance to companies struggling to access bank lending in Georgia.

• Improve SME banking capacity: Georgia should improve the capacity of its banking sector to serve SMEs better. The government could partner with key stakeholders such as the National Bank of Georgia and the Association of Banks of Georgia to develop country-wide capacity-building programmes for SME banking. This could be done through certification programmes by including topics such as products and delivery channels for SMEs. In addition, risk management courses could help identify the fundamental causes of SME risks and the tools required to manage them. Credit scores, for example, could assess borrowers’ creditworthiness. Further, forums for the managers of banks’ SME departments could be organised to share international best practice in the field.

• Promote demand-side financial education programmes targeting SME entrepreneurs. Georgia could put in place financial education initiatives to improve entrepreneurs’ financial skills. This would help reduce the asymmetry of information between SMEs and potential lenders, and thus the risk perceived by the latter. SMEs need greater knowledge of the financial products available in the market, as well as how to produce credible business plans and sound financial statements for loan applications. Enterprise Georgia has taken some positive steps already. These include creating a library of financial training materials, an SME toolkit and “mini-Master of Business Administration” courses for beneficiaries of “Produce in Georgia”. Further support could be organised through regional Chambers of Commerce and possibly with the participation of the National Bank of Georgia and the Association of Banks.

• Expand credit guarantee schemes: The Georgian government recently introduced a new credit guarantee scheme (CGS) to promote SMEs’ financial inclusion and address difficult collateral requirements. The budget for this scheme is rather modest but this is a first phase only and the scheme can be further adjusted and expanded. A CGS works as a risk-sharing mechanism between lenders (banks), borrowers (SMEs) and a guarantor (the state or a private entity). A CGS effectively creates market-based incentives for banks to lend more to SMEs. By reducing the perceived risk, banks are expected to request lower collateral and interest rates from borrowing SMEs. As a result, more credit is extended to borrowers than otherwise would be the case in the absence of a CGS.

• Improve alternative non-bank and equity financing for SMEs. The venture capital environment in Georgia could be further strengthened to foster improved access to capital for small and dynamic growing businesses. A fund could be established to act as a catalyst for private capital and to match early investment in SMEs with high-growth potential. The government could devise schemes to promote venture capital and early stage investment in Georgian SMEs. Such schemes would ensure economic additionality in the early stages of the funds. Public sector involvement could phase out as private markets mature. The government could also promote alternative forms of asset-based financing. These could include leasing and factoring (i.e. the sale of accounts receivable to a third party). In addition, it could promote awareness of investment opportunities, and support establishment of a network of business angels to provide expertise and capital through dedicated events.

5.4. Improve the availability and terms of green finance for SMEs

SMEs continue to face significant barriers when seeking access to green finance. Issues include the level of interest rates, the tenor and collateral requirements. Several options could improve the availability of green finance, and the terms on which SMEs can access it.

• Exploring new green financing instruments: Georgia should explore the role of dedicated concessional green instruments/funds to help widen access and improve the terms of environmental finance for SMEs. Building on ideas in both LEDS and NEEAP, such funds could provide direct green investment in projects (e.g. as partial grant co-finance for underserved market segments). Alternatively, they could offer green credit enhancement, such as blended finance with lower rates and longer tenor. They might also offer risk mitigation instruments for green lending portfolios, such as first loss and partial credit guarantees. This could be provided to existing commercial banks, as well as microfinance institutions by third parties, to widen access.

• Expanding green finance distribution channels for smaller SMEs: Smaller SMEs struggle to access IFI-supported green finance credit. The government could consider promoting green finance through other channels (e.g. microfinance organisations). Such channels have good distribution networks, but the cost of finance is high and tenors are short. Preferential leasing terms for green/energy efficient equipment and energy service company models might also help overcome collateral and capital barriers faced by smaller SMEs.

• Promoting concessionality: While IFIs are committed to not distorting commercial lending markets for energy-efficiency and renewable-energy lending, the cost of finance remains an issue. IFIs should consider encouraging differential pricing for green lending facilities, encouraging pass through of interest rate benefits to end borrowers. Where possible, IFIs should encourage development of local currency- lending facilities for green investment to reduce currency exposure for SME investment in energy efficiency and renewable energy.

• Using existing institutional structures to channel funding to SMEs: The role of state funds or entities could be expanded to incorporate a green mandate. Such structures would need to facilitate access to smaller-scale SMEs. This could occur either through their own programmes or platforms, or through a partnership with local financial institutions to reduce transaction costs. Potential structures might include the JSC Partnership Fund, the JSC Georgian Energy Development Fund or Enterprise Georgia. The first two of these, however, might lack the scale and scope to support redirecting financial flows towards climate and green growth agendas. This is especially the case in underserved sectors or companies such as SMEs. The government should base its decision on a review of relevant structures. To that end, it should assess whether any given national funding entities could aggregate large numbers of smaller projects to reduce risk, lower transaction costs and potentially gain access to international capital.

• Exploring the role of Enterprise Georgia: Enterprise Georgia provides perhaps the most useful vehicle to support the scale up of green investment in Georgia. It has an established network and platform to engage with smaller-scale companies across the country. The MESD and Enterprise Georgia could work with local financing institutions to incorporate cleaner production and resource-efficiency considerations into conditions of financial support for SMEs. Banks could also be encouraged to use environmental criteria in their credit decisions. The MESD and Enterprise Georgia should consider providing grants to SMEs. These would cover part of consultancy/audit costs to identify and implement resource efficiency, an environmental management system or other environmentally oriented measures. Such grants should be offered through a competitive application process and cover no more than half of total costs.

5.5. Scale the overall availability of green finance in the Georgian economy

As part of delivering Georgia’s sustainable development strategy, a significant step-change in both public and private sector green investment will be required to support SMEs. The government of Georgia should therefore examine how it might work with partners and domestic financial institutions to achieve a step-change in the wider availability of environmental finance.

• Exploring green banking regulation: The government of Georgia should continue to review and develop green banking regulations to improve sustainable lending and asset management among local financial institutions. This can be done in several ways. Better frameworks could identify and classify “green” and “brown” assets using, for example, the work carried out under the European Union Taxonomy on Sustainable Activities. Better reporting and disclosure could help disclose high carbon assets and or climate risk. Over the long term, the government could also consider preferential treatment of green assets through, for example, differentiated capital reserve requirements. The recent NBG “Roadmap for Sustainable Finance” (NBG, 2019[5]) represents a step in this direction. The Roadmap and the Action Plan until 2022 envisage several measures. These include introduction of a sustainable finance taxonomy, and integrating environmental, social and governance considerations into the relevant corporate governance codes for commercial banks and the capital market. These measures will need to be translated into practical guidance and support tools. They can be expected to green the financial market and improve its transparency and market discipline.

• Considering the issuance of green bonds: Georgia could support the development of a green bond market, with potential benefits for SME development. Government (with IFI support) could issue green bonds and encourage long-term domestic and international investors (e.g. pension funds) to invest. This could raise funds for green projects and potentially with dedicated windows for the SME sector. The government of Georgia and the National Bank of Georgia would have to develop green bond standards or adopt those used in other countries.

• Pooling international and domestic capital: At a macro level, the government should consider working to pool national and international climate and environmental funds. These would create financing and technical implementation platforms that can be transformational in their size and scope. This is particularly important when addressing sectors such as SME finance. In these sectors, economies of scale are difficult to achieve, significant structural barriers exist and borrower creditworthiness is a concern. Sources of initial capitalisation are likely to include donor funds, the Green Climate Fund and other forms of development finance for investment in energy-efficiency projects. These may be one approach to capitalisation.

• Exploring a possible role for a national development bank or fund: The government may wish to consider creating a new bank or national fund to support the distribution of finance. National development banks are often used to achieve developmental policy aims through concessional funds. Such institutions should be careful not to distort markets for commercial players (e.g. by picking winners or crowding out commercial banks). They also need to ensure appropriate levels of concessions and subsidies so that beneficiaries are not overcompensated. Such a fund would also need to build capacity to undertake project appraisal, monitor projects and evaluation results. In addition, it should help support market development with better data and insight into the benefits of green investment.

5.6. Raise awareness among SMEs of green transition opportunities

• Raising awareness of green opportunities among SMEs: SMEs often have a poorer understanding of available opportunities compared to larger, better-resourced companies. Better understanding among potential borrowers about energy-efficiency technologies and their cost-benefit profiles could improve demand for green investment. Countries are also setting up learning networks and platforms to improve information flows, raise awareness of benefits from green investment and good national and international practices, and enhance analytical capabilities.

• Supporting development of tools and methods to assist SME environmental performance: The government could create programmes to support the development of (and access to) environmental performance and management tools targeted at SMEs. These might initially be focused around energy management. They could include simple calculators to help understand the payback potential for improved efficiency, as well as to advise on how to access further support and finance.

• Strengthen “green branding”: Strong environmental and social performance is increasingly a key element for branding and market positioning. In some SME- relevant sectors (e.g. hotels, transport), sustainability is becoming a key differentiator, with energy and wider resource efficiency as a core component. The government could seek to identify SME sectors where environmental performance is a brand driver. It could then work with these sectors to promote uptake of more environmental technologies, including supporting national and international certification schemes.

References

[5] NBG (2019), “Roadmap for Sustainable Finance in Georgia”, National Bank of Georgia, webpage (accessed 23 October 2019), https://www.nbg.gov.ge/uploads/finstability/roadmap/sustainable_finance_roadmap_eng.pdf.

[1] OECD (2018), Mobilising Finance for Climate Action in Georgia, Green Finance and Investment, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264289727-en.

[3] OECD (2016), Promoting Better Environmental Performance of SMEs: Georgia, OECD Publishing, Paris, http://www.oecd.org/env/outreach/Georgia%20pilot%20project%20report%20final%20EN.pdf.

[4] Singh, J. (2016), Energy Efficiency Financing Option Papers for Georgia, World Bank, Washington, DC, http://documents.worldbank.org/curated/en/825761475845097689/Energy-efficiency-financing-option-papers-for-Georgia.

[2] World Bank (2017), Georgia – Private Sector Competitiveness Development Policy Operation, World Bank, Washington, DC, http://documents.worldbank.org/curated/en/478801501725663367/pdf/Georgia-Private-Sector-Competitiveness-PD-07112017.pdf.