Ministry of Economy and Sustainable

Development of Georgia

Regulatory Impact Assessment (RIA)

Investment Funds

Econometric Analysis

Department of Economic Policy

Luka Lazviashvili

2021
Table of Contents
Indroduction .................................................................................................................................................. 3
Linear Regression Models ............................................................................................................................ 4
1. GDP – with start of the period variables ............................................................................................... 4
2. GDP – with average variables............................................................................................................... 5
3. Saving rate ............................................................................................................................................ 6
4. Taxes ..................................................................................................................................................... 7
5. Capital market indicators ...................................................................................................................... 9
Panel Auto-Regressive Distributed Lag Models (Panel ARDL) ................................................................ 10
1. Scatter plot .......................................................................................................................................... 10
2. Correlations ......................................................................................................................................... 12
3. ARDL models - GDP .......................................................................................................................... 13
4. Causalities ........................................................................................................................................... 15
5. ARDL models – Capital market indicators ......................................................................................... 16
Structural Vector Auto-Regressive Models (S-VAR)................................................................................. 18
1. Impulse-Response and Variance Decomposition Analysis - GDP ..................................................... 19
2. Impulse-Response and Variance Decomposition Analysis - Taxes .................................................... 21
Projection on the Past.................................................................................................................................. 22
1. Capitalization ...................................................................................................................................... 23
2. Turnover.............................................................................................................................................. 24
Future Benefits Account ............................................................................................................................. 25
Scenario 1................................................................................................................................................ 25
Scenario 2................................................................................................................................................ 26
Scenario 3................................................................................................................................................ 26
Conclusion .................................................................................................................................................. 28
 Introduction

The paper provides a detailed analysis related to implementing international standard

regulations about investment funds and its potential impact on capital market development and
economic growth in Georgia. The analysis covers 30 countries, including 24 developing and 6
developed nations, spanning the years 1999 to 2012. The countries were selected based on the
2018 Inclusive Development Index report, where Georgia ranks 32nd among the included
countries. The data was sourced from the World Bank's database.

Three types of methods were employed for the analysis:

1. Linear Regression Models (OLS) for cross-sectional analysis

2. Panel Auto-Regressive Distributed Lag Models (Panel ARDL)
3. Structural Vector Auto-Regressive Models (S-VAR)

The models satisfy the demands for confidence and stability. The results are utilized for:

1. Projecting capital market development in Georgia over past years. What numbers would we
obtain if the indicators of the capital market followed the same dynamics as those of other countries
in relation to their GDP growth rates.

2. Assessing future benefits and their impact on GDP growth.

3
 Linear Regression Models

The method used is based on Levine & Zervos (1998), where the authors attempted to
identify the influence of the banking sector, changes in the size and liquidity of the capital market
on economic growth. As an economic growth variable was taken the averages of the entire period,
while the capital market indicators were taken for the start of the period.

Similarly, the analysis includes regression models using economic growth, capital market
indicators, the banking sector, and control variables. However, I constructed models by including
capital market indicators both for the initial period and the entire period. Additionally, the my
study explores also reverse impacts, demonstrating how the growth of economic factors affects the
indicators of the size and liquidity of the capital market.

1. GDP – with start of the period variables

In the specified model, it is noted that significant positive determinants for the GDP per
capita are banking sector and the initial values of enrollees in schools. In cases where the loans
granted by the banking sector to the private sector ratio to GDP increases by 1%, GDP per capita
growth on average is 0.04% higher. Also, not surprisingly, the correlation between the level of
education and economic growth is positive. Moreover, GDP per capita at the start of the period is

4
99% statistically significant while, in accordance with convergence theory, coefficient is low and
negative. Where the initial level of GDP per capita is higher, the growth rate is relatively low, and
where it is low, the growth rate is high. The coefficient for the initial value of the capitalization is
not statistically significant.

The same results are observed in two other models, where the turnover and value traded
are used instead of the initial level of capitalization. The coefficients of the mentioned indicators
are statistically insignificant. It can be concluded that in the models of initial indicators,
meaningful impacts were confirmed only from the banking sector, education, and the initial values
of GDP.

2. GDP – with average variables

In models with a such specification, the significance among the capitalization indicators is
evident only in case of turnover. When the indicator of liquidity shows an increase, not at the initial
level, but on average by 1% annually, it is observed that, on average, GDP per capita growth is
1.05% higher.

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3. Saving rate

Moreover, we can see how much the capital market indicators changes impact saving rate
and taxes.

The models above show the negative impact of both, turnover and talue Traded indicators
on saving rate.

6
 The explanation for this is as follows: since these indicators of capital market positively
affect GDP per capita growth rate, and savings does not increase at the same proportionality, the
saving rate (savings/GDP) growth rate decreases. Also, the positive impact of GDP growth and
negative impact of education level are noteworthy.

From the correlation table, it appears that the annual change in saving rate has positive and
strongest correlation with turnover.

4. Taxes

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 As indicated by the models, Taxes over GDP ratio has positive correlation with
Capitalization and Turnover. Coefficients are low but significant. Apart from this, Taxes are
lower where GDP per capita growth rate and initial value are higher. On the other hand, Taxes
are higher where the initial level of education and inflation are higher.

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5. Capital market indicators

The models where the indicators of capital market are dependent variables, it’s shown that
GDP per capita average growth rate coefficient has 90% significance level only for capitalization
equation. The relationship is negative and intuitively: where the GDP growth rate is higher, the
quantity of bonds listed is not growing with the same proportion as GDP causing capitalization
(value of all bonds listed/GDP) to decrease.

Moreover, the banking sector loans have positive correlation on all of the 3 indicators of
capital market. Where the initial volume of bank loans was higher, capital market was growing
with higher rate.

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 Panel Auto-Regressive Distributed Lag Models (Panel ARDL)

This section discusses the use of panel data models, specifically Panel AutoRegressive
Distributed Lag (PARDL) models, in the context of economic analysis. These models, similar to
the models above, are based on OLS method, but by means of lagged variables capture more
complexity. It helps to enhance the model's explanatory power and provide more precise
coefficients. Using of panel data drastically increases data sample but it’s important to control the
specific influences of a country on the dependent variables. Since we are interested only in
dynamic, not cross sectional, relationships, these specific influences are unnecessary. The use of
fixed effects in these models helps to control the specific country characteristics, ensuring that the
observed relationships are not driven solely by the chosen countries. In the end, the models will
be used for economic and cost-benefit analysis.

Additionally, the control variables with initial levels are omitted in favor of dynamic
indicators that capture important portion of GDP variance in the models. Those variables are: real
interest rate, cpi inflation and real effective exchange rate.

Before modeling, there is a brief statistical introduction to the subject.

1. Scatter plot

In the scatter plots below GDP per capita growth relationships with capital market and
banking indicators are shown. Considering the data type is panel, I took overall averages for all
the countries to visualize on scatter plot. The averages are from 1999 to 2012.

Scatter plot shows an obvious positive correlation between GDP per capita growth and
capital market indicators. The banking sector indicator has positive correlation with GDP too but
the link is relatively weak.

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 Means by DATEID

8 6
STOCK_CAPITALIZATION

6
4
4

TURNOVER
2 2

0 0
-2
-2
-4

-6 -4
-6 -4 -2 0 2 4 6 8 -6 -4 -2 0 2 4 6 8

GDP_PER_CAPITA GDP_PER_CAPITA

6 4

4
3
VALUE_TRADED

2
BANK_CREDIT

0 2

-2 1
-4
0
-6

-8 -1
-6 -4 -2 0 2 4 6 8 -6 -4 -2 0 2 4 6 8

GDP_PER_CAPITA GDP_PER_CAPITA

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2. Correlations

In case of annual averages, GDP per capita growth rate has strongest and positive
correlation with turnover (36.5%). It indicates strong correlation in a long run. In dynamic terms,
taken each year dynamics, it has the strongest correlation with capitalization (30%) meaning strong
link in a short run.

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3. ARDL models - GDP

13
 All of the 3 models have a strong explanatory power with the most coefficients being
statistically significant. Specifically from the capital market indicators, the significance is shown
by capitalization and turnover. The value traded variable is insignificant as it was in simpler
regression models.

Turnover shows high significance and its 1% increase causes GDP per capita growth rate
increase by 0.09%. The coefficient is lower than it was in simpler regressions with average
variables, but considering the standard deviation there was only 0.7 while in this case is 5.1, it
appears that the 1 standard deviation increase in liquidity of the capital market is associated with
a 0.5% growth in GDP per capita growth rate for both models, showing a consistent pattern across
both models.

The significance is shown by the variable of capitalization too. Its t and t-1 period increases
by 1% causes the GDP per capita growth rate to increase by 0.144% and 0.085% respectively.

Here it should be stated that, for the accounting of economic benefits, to get the dynamic
of GDP per capita growth I will use this specific model with capitalization variable.

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4. Causalities

It is important to identify the causal relationships too. From the specificity of panel data, a
fixed effects test has been used to obtain consistent results.

The test shows that between the indicators of capital market and GDP there is only one and
strong causal link that is from capitalization to GDP per capita. The capitalization 1 and 2 period
lags granger cause GDP per capita growth rate changes. It means that for contemporaneous value
of GDP per capita growth t-1 and t-2 values of capitalization are statistically significant.

In addition, in the link between the banking sector and GDP per capita growth, the latter is
the cause of the former. Here too, the contemporaneous changes in the banking loans over GDP
are granger caused by 1 and 2 period lags of GDP per capita growth rate changes.

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5. ARDL models – Capital market indicators

16
 In the 2 models above, it’s defined, besides GDP, which variables affect capitalization and
turnover of capital market. In the model for value traded, the coefficient of GDP per capita growth
rate is still insignificant, so it isn’t shown here. Thus, I will use the results of these 2 models to: on
the one hand, estimate how the variables of capitalization and turnover should’ve been
dynamically developed in link with GDP per capita growth rate changes during 2000-2012 if the
international standard legal framework or other important conditions were implemented, and how
the dynamics will continue over the next 10 years starting from 2021 given any hindering factors
are eliminated; on the other hand, I will use the forecasted dynamics of capitalization and turnover
to derive the future value traded dynamics (since the models constructed primary for value traded
didn’t meet statistical significance needs) and use it to get the future volumes of value traded in
the section of economic benefits.

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 Structural Vector Auto-Regressive Models (S-VAR)

This type of model allows us to graphically represent the impact of a positive shock over a
selected time interval on a predetermined variable. It addresses the issue of endogeneity and
simultaneity. Beyond impulse-response analysis, it is used for forecasting and decomposition of
variations. The structure emphasizes the importance of structuring the matrix of correlations for
the given period, in case of Cholesky decomposition method it means implementing one-sided
restrictions. During such times, the alignment of the indicators in the model has significant
importance.

Given the absence of automatic effect fixation in VAR, data processing is done manually
for this model, ensuring the insignificance of specific country factors. This happens by subtracting
the overall averages from each data point.

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1. Impulse-Response and Variance Decomposition Analysis - GDP

19
 On the left, you observe impulse-response graphs, while on the right, there is the variance
decomposition. From capital market indicators, the positive shock of capitalization is the most
impactful and statistically significant. Affected by it, the GDP per capita growth rate increases by
2.2%. In the decomposition of the variance, capitalization contributes to nearly 22% of the GDP
variance, again showcasing a relatively high explanatory power.

In case of turnover, positive shocks associated with it exhibit less impact on GDP per
capita, but the statistical significance is still evident. It takes a modest 3.27% portion in the variance
decomposition.

The positive shock in value traded show a comparatively lower and less pronounced impact
on GDP per capita. In the variance decomposition, its contribution is minimal, representing only
0.74%.

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2. Impulse-Response and Variance Decomposition Analysis - Taxes

გადასახადების შემთხვევაში,

First and foremost, the positive shock associated with turnover leads to a temporary 0.16%
increase in taxes. However, the shock's effect diminishes afterward, with no lasting impact. In the
variance decomposition, the liquidity indicator only accounts for a modest 1.64%.

These findings are utilized to forecast the dynamics of taxation in the future economic
benefits sector.

In case of value traded, as in the previous occasions, its statistical significance was still
denied.

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 Projection on the Past

The results obtained above can be utilized for analyzing past years, to evaluate how closely
aligned Georgia's capital market dynamics were with a natural path of dynamics, where it would
follow the dynamics of capital markets in other countries without any undesirable factors.

For this purpose, the previously shown ARDL models are employed, where the dependent
variables are the capitalization and turnover of the capital market. The coefficients obtained are
used to estimate how much Georgia's capital market indicators should’ve developed in the link
with GDP per capita dynamics. Since we have factual data of the capital market indicators for the
years 2000-2012, this analysis is also conducted for the same period.

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1. Capitalization

Growth Difference
10

-2

-4
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Model Actual

On the graph, you can observe the actual and modelled dynamics of capitalization for the
years 2003-2012. The model of capitalization incorporate factors such as taxes, GDP, inflation,
the banking sector, and the lags of capitalization itself. The dynamics obtained are calculated by
multiplying factual numbers with coefficients. If the factual numbers of capitalization growth rate
followed the dynamics of the model (the blue line), the average annual growth would be 4.35. In
reality, however, the average annual growth of capitalization was 0.34. This makes it clear that
some obstructive factors really exist and without them the capital market in Georgia would develop
with about same dynamics as other countries. Finally, in 2012 capitalization should’ve been about
50% rather than factual 5.54%.

Levels
60

50

40

30

20

10

0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Model Actual

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2. Turnover

Growth Rates
15

10

-5

-10

-15
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Model with taxes Without taxes Actual

The dynamics should have been significantly different in the case of turnover too. On the
graph, you can see the actual dynamics alongside two versions of the model, one considering taxes
as a variable and the other without it. Both models show similar dynamics. Based on the dynamics
extracted from the models, the projected indicator for the year 2012 would have been
approximately 18%, as opposed to the factual 0.25% that was recorded.

Levels
25

20

15

10

0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Model with taxes Without taxes Actual

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 Future Benefits Account

In this section, 3 scenarios of future development of capital market are shown. The benefits
are calculated as a volume of value traded in US dollars along with the fiscal benefits derived from
income taxes. There are three scenarios, each encompassing a 15% and 27.5% version of tax
regimes.

To forecast the dynamics of capital market indicators, aside from obtained coefficients,
forecasts of explanatory variables like GDP growth, taxes, inflation, and loans are needed. These
forecasts relies on the combination of average growth rates during 2013-2019 and coefficients
obtained from the models.

Scenario 1. In this scenario, the initial changes in capitalization and turnover are
considered standard positive shocks, with standard deviations of 2% for capitalization and 6.23%
for turnover, based on the capital market data of Georgia from the period 2000-2012.

Scenario1
1200 40
35
1000
30
800
25
600 20
15
400
10
200
5
0 0
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

Fiscal Revenue Mln $ Fiscal Revenue Mln $

Value Traded Mln $ Value Traded Mln $

In the case of a 15% tax rate, the accumulated value traded will be 958 million dollars,
which is more than the estimated 734 million dollars in the case of a 27.5% tax rate. However, the
fiscal revenue is higher in the case of the higher tax rate. The volume of the value traded, finally,
will be 2.41% of GDP in the first case and 1.93% in the second.

25
 Scenario 2. In this scenario, the initial changes in capitalization and turnover are based
on the average growth rates, estimated in the section of the projection on the past. In the case of
capitalization, it's 4.34%, while for turnover, it's 0.55%.

Scenario 2
2000 80
70
1500 60
50
1000 40
30
500 20
10
0 0
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

Fiscal Revenue Mln $ Fiscal Revenue Mln $

Value Traded Mln $ Value Traded Mln $

In this scenario, the value traded after 10 years will be 1.7 billion dollars in the case of the
lower tax rate, while it will be 1.4 billion dollars in the case of the higher tax rate. The fiscal
revenue is higher during the higher tax rate, as it was in scenario 1, but the difference from the
alternative is much smaller. The volume of the value traded will be 3.87% of GDP in the first case,
while 3.25% in the second.

Scenario 3. In this scenario, the standard positive shocks are considered as the initial
changes in capitalization and turnover, with their standard deviations derived from the capital
market data of Georgia for the period 2000-2012. In the case of capitalization, it's 2%, while for
turnover, it's 6.23%.

Scenario 3
2000 80

1500 60

1000 40

500 20

0 0
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

Fiscal Revenue Mln $ Fiscal Revenue Mln $

Value Traded Mln $ Value Traded Mln $

26
 The value traded after 10 years will amount to 1.88 billion dollars in the case of a lower
tax rate, whereas it will be 1.52 billion dollars in the case of a higher tax rate. Fiscal revenue is
higher with the higher tax rate, as observed in other scenarios, but here the difference between
fiscal revenues is much smaller compared to the disparity in the value traded alternatives. The
volume of the value traded will represent 4.57% of GDP in the first case, while it will be 3.85% in
the second.

To summarize, the following is a column chart illustrating the cumulative estimates of the
value traded over the next 10 years for all three scenarios.

Value Traded, Mln dollars

2000
1,878.27
1800 1,726.42
1600 1,519.15
1,391.15
1400

1200
958.11
1000
734.05
800

600

400

200

0
2031

27
 Conclusion

The analysis presented in the paper indicates a significant positive relationship between the
dynamics of capital market indicators and overall economic performance, specifically Gross
Domestic Product (GDP). Based on the simple regression models, it is demonstrated that the
average (not initial) value of turnover over the entire period is a significant determinant of GDP
per capita growth. The Autoregressive Distributed Lag (ARDL) models reveal the significance of
capitalization and turnover variables as determinants of GDP per capita. Causality tests indicate
that only past values of capitalization growth rates are statistically significant and Granger cause
changes in GDP per capita. Finally, the S-VAR models confirm that the strongest determinant
among capital market indicators for GDP per capita growth rate is capitalization, contributing the
most to the variance decomposition.

The analysis of future benefit scenarios is based on theoretically and statistically sound
models and coefficients. However, it relies on certain forced assumptions that could be perceived
as flaws. The unavailability of data on capital market indicators for Georgia in the World Bank's
financial document after 2012 necessitated chaining forecasted dynamics to 2012 factual data
instead of the most current data. Having quarterly data for financial indicators would be beneficial
for a more accurate forecast through direct S-VAR modeling, allowing for endogenously estimated
forecasts. Currently, the forecasts are generated by combining model coefficients and Excel file
calculations. In the existing conditions, the results are logically valid, while the assumptions
provide some flexibility.

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