Tbilisi  - Grand colonial facades front gutted buildings and roads have been ripped open while new hotels, residences and commercial complexes are springing out of the ground.

The air is filled with industrious optimism, brought on by the anticipation of a boom in tourism for the port city of Batumi in Georgia that offers prime beach access to the Black Sea.

The city expects to attract 2 million tourists annually by 2012. In the year prior to Georgia's war with Russia over the breakaway provinces of South Ossetia and Abkhazia, tourist numbers peaked at 350,000.

Five days of fighting in August 2008 drastically cut visitor numbers as Russian bombs fell near the city during the peak of the tourist season.

The war caused roughly 1 billion dollars of infrastructure damage in Georgia. Investor confidence plummeted and banks were hit as 5 per cent of deposits were withdrawn, while foreign investors left the country.

Georgia's allies later rallied round to jump-start what was expected to be a quick economic recovery, several months before the full impact of the global economic crisis became apparent.

International donors pledged 4.55 billion dollars in aid, while the International Monetary Fund (IMF) provided a 750-million-dollar credit line to prop up the Georgian central bank.

"Things started stabilizing towards the end of the year - but then the international environment really turned against Georgia," said Edward Gardner, the IMF's Senior Resident Representative in Georgia.

The slump in the international economy meant that private capital flows into Georgia never resumed and led to a collapse of its export market.

Enterprises started drawing on their free balances as their deposits dwindled, causing banks to cut back on credit and amplify the external crisis, Gardner said.

At least Batumi appears to be weathering the global economic crisis well.

"We are not feeling it, because there is so much construction all around Batumi," said Levan Varshalomidze, the president of the self- declared Autonomous Republic of Adjara, of which Batumi is the capital.

But elsewhere in Georgia, considered a post-Soviet success story until last summer, the signs are far from rosy.

"All in all the economy has contracted about 6 per cent from last year, with a corresponding increase in unemployment," Gardner concluded.

One year on from the war, the country's tumultous internal political situation is preventing a return to business as usual.

Economic Development Minister Lasa Zhvania believes domestic events in the last 12 months have had a greater impact than the war itself.

"Political instability has damaged (foreign investment) much more than the war," Zhvania said.

In 2009, the IMF estimates that Georgia will receive roughly 1 billion dollars in private capital, compared to 2.3 billion dollars in 2007.

In April and May, foreign investment again stalled as anti- government demonstrators called for the resignation of President Mikheil Saakashvili, Gardner says.

Nevertheless, as the world economy is showing the first signs of recovery, Georgia should begin to see improvements, the IMF economist added.

Now, he said, was the time for Georgia to start reconsidering its economic growth model, which was previously based on a huge growth in bank credit, financed by banks borrowing abroad.

"In the new world it's not obvious that banks will be able to borrow abroad like they did before," Gardner warned.

The economist said privatization had run its course in Georgia, while infrastructure development was also levelling off.

"To continue growth, Georgia will need to start investing in the export sector," Gardner said, adding that the country was still lacking in international competitiveness.

There are encouraging signs however, such as a large Egyptian investment in a free industrial zone being developed near Georgia's second largest city, Kutaisi.

In recent months, Egyptian home appliances producer company, Fresh Electric, pledged to invest 1.2 billion dollars to convert an old car production site into factories making textiles, ceramics and home appliances, according to Zhvania.

The minister said a Russian boycott of Georgian goods did the country a favour, as it forced Georgia to look for new markets and improve its quality control to meet international standards.

"We have started to have much better quality management, of wine for example," Zhvania said, adding that this opened them up to new markets in Europe, the United States and China.

Back in Batumi, there are also benefits to be drawn from the political tensions with Russia over Georgia's breakaway regions.

Previously, Georgians flocked to Black Sea resorts in what is now the separatist province of Abkhazia. With access to the region blocked, newly developed Batumi is looking like an increasingly appealing option. (dpa)