Twin deficit is a situation when a country’s economy is running two deficits at the same time. These are fiscal deficit and a deficit on the current account of the balance of payments. According to the twin deficit hypothesis, persistent fiscal shocks which cause a deterioration of the government’s budget also worsen a country’s current account balance. Since, excess government spending is accompanied by excess private consumption as well, thus reducing national saving and making it necessary to borrow from abroad, thus fiscal deficit is accompanied by current account deficit.

It is believed that fiscal consolidation is a necessary measure for correcting the account deficit. Constant or long-term government deficit decreases national savings that causes fall in the current account balance. By National Accounting – a fall in national saving due to a government deficit translates – other things equal – into a fall in the current account balance. This effect can be partially offset by private domestic saving which Georgia lacks. At the same time, loosening of fiscal policy raises interest rates (a fall in public saving) may also crowd out investment. With flexible exchange rates according to Mundell-Fleming model, fiscal deficit appreciates the currency; hence domestic goods are relatively higher in price that crowds out net export. 

In 2012 the government of Georgia was further consolidating the budget and managed to reduce the fiscal deficit to comprise 2.9% of GDP, as a comparison the figure was 9.2% in 2009, reflecting the expansionary fiscal policy stimulated through deficit growth. Since financial consolidation that is reduction in budget deficit is crucial for macroeconomic stability, further reductions are planned for bringing the budget deficit to tolerable levels. The government plans to further decrease fiscal deficit to equal 2.8% of GDP in 2013. In the conditions of the new government, fundamental changes are planned to be made to the expenditures as per different categories. Elevated current account deficit of Georgia is partially due to appreciation of GEL exchange rate that caused a surge in imports, and further deteriorated the country’s trade balance to -5465 million USD a record high since 2007 that comprises 24.9% of the country’s GDP.

A key challenge in the process of fiscal consolidation in Georgia is to manage social expenditure pressure and at the same time provide adequate pensions for the aging population and social assistance to the poor.  Pensions represent the largest category of social spending, accounting for more than half of the total social protection expenditures. As per the World Bank recommendation, in the conditions of rapid rise in the old-age population who rely on the basic public pension benefit, the pension program will continue to be a heavy burden on the budget.  The budget will face social expenditure pressures in the medium-term, therefore without private saving for retirement maintaining even the existing pension rates will lead to higher fiscal costs over time. Although as per the pre-election promises, the government plans to increase pensions in the nearest future. In order to address these challenges the policymakers should come up with some type of retirement savings schemes, or identify financial instruments for long-term retirement savings.

According to the working paper of European Central Bank, the relationship between fiscal policy and the current account changes depends on the government debt to GDP ratio, since this variable affects private sector expectations. The research concluded that in low debt and medium debt countries where state debt level is up to 44% of GDP (this is where Georgia stands at the moment) the relationship is positive, i.e. an increase in fiscal deficit leads to higher current account deficit. In this case for combating the current account deficit the government of Georgia has to consolidate fiscal policy by reducing the burden on the state budget.  Government should be cautious regarding excessive spending, cut non-priority spending especially avoid increases in wages and pensions. Together with spending constraints, fiscal consolidation also requires authorities’ commitment to enhancing the transparency, quality and efficiency of public spending.

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