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Fitch Affirms Georgia at BB-; Outlook Positive

Fitch Ratings has affirmed Georgia’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at ‘BB-‘. The Outlook is Positive.

A full list of rating actions is at the end of this rating action commentary.

Georgia’s ratings are supported by governance and business environment indicators that are above the current medians of ‘BB’ category peers, and a track record of macroeconomic resilience against regional shocks. Confidence in the authorities’ economic strategy is also anchored by an IMF Extended Fund Facility (EFF) programme. Georgia’s external finances remain significantly weaker than the majority of ‘BB’ category peers.

The Positive Outlook on Georgia’s rating reflects favourable growth prospects and a steady improvement in the public finances. However, escalating negative developments in Turkey and risk of further US sanctions against Russia represent downside risks to Georgia’s economic outlook. Russia and Turkey are Georgia’s second- and third-largest trading partners, accounting for 14.5% and 7.9% of total exports in 2017, respectively. Both countries are also important sources of remittances, foreign direct investment (FDI), and tourism revenues.

So far Georgia’s economy has been resilient against recent regional volatility. Estimates from national statistics (GeoStat) show the economy to have grown 6.0% in real terms year-on-year (yoy) in 1H18, above Fitch’s expectations. Growth was broad-based; led by domestic demand through a strong pick-up in investment activity and robust export growth. Fitch projects real GDP growth to average 4.8% in 2019-2020, compared with 3.5% across ‘BB’ category sovereigns. Risks are on the downside due to the less favourable external environment.

Large current account deficits (CAD) and low external liquidity leaves Georgia’s highly open economy vulnerable to external shocks. At 8.9% of GDP in 2017, Georgia’s CAD is substantially wider than the current ‘BB’ peer median of 2.4% of GDP. Wide CADs reflect the country’s low level of domestic savings, as well as narrow export base and high import dependency. Fitch projects Georgia’s CAD to widen to 10.2% of GDP by 2020, covered largely by net inflows of FDI close to 8% of GDP.

Vulnerabilities in external finances are also reflected by high net external debt to GDP (67% of GDP at end 2017), which is more than four times the current ‘BB’ median peer ratio. Gross external financing requirement as a share of international reserves is high (estimated at 127.3% in 2018). Level of gross international reserves increased to USD3 billion in 2017, equivalent to 3.2 months of current account payments. This is below the current ‘BB’ median of 4.2 months. .

Despite stronger domestic activity, inflationary pressures have remained contained, reflecting a larger fading out of high base effect, as well as appreciation of Georgia’s nominal effective exchange rate on imported inflation. In July, the National Bank of Georgia (NBG) cut its benchmark (refinancing) rate by 25bp to 7.00%, its first rate adjustment since December 2017, after three rate hikes in 2017 responding to the impact of lari depreciation. For 2018, Fitch forecasts average inflation of 3%, in line with the NBG’s target.

Georgia’s public finances continue to improve. The cyclical upturn has helped boost tax revenue growth, while expenditures remain contained on the back of government priorities to reduce current expenditure in order to meet capital spending needs. For 2018 and 2019, Fitch is forecasting Georgia’s general government fiscal deficit to average 2.6% of GDP, down from 2.9% of GDP in 2017, and in line with the projected median deficit of ‘BB’ peers.

The government’s fiscal strategy, anchored by quantitative targets agreed with the IMF, will help stabilise government debt in the medium term, in our view. Georgia’s general government debt ratio (44.6% of GDP end 2017) is above the current median debt ratio (39% of GDP) of ‘BB’ category peers, but we project it will decline towards 41.3% of GDP by 2020. The composition of Georgia’s government debt is largely external, with a high share of concessional and multilateral debt (approx.72% of total debt). However, the foreign currency share of total debt is high (79.8%), exposing it to exchange rate volatility. There are also fiscal risks in the form of contingent liabilities from state-owned enterprises and budget on-lending activities.

Developments in the banking sector remain stable, with the authorities making gradual progress towards meetings structural benchmarks set out under the IMF’s EEF to strengthen the sector’s financial stability framework, and regulations on capital and liquidity requirements. Georgia scores a 2* on Fitch’s Macro-Prudential Indicator, indicating moderate vulnerability from strong credit growth. In 1H18, annual credit growth averaged 21%, picking up slightly from an average of 19% in 1H17 year-on-year. The average capital adequacy ratio of the sector is high at 18.9% (2Q18), while the share of non-performing loans is low at 2.4% (2Q18).

Presidential elections are scheduled for 28 October this year. The ruling Georgian Dream-Democratic Georgia (GDDG) has yet to nominate a candidate. At present, Fitch does not expect the outcome of the presidential elections to materially change Georgia’s economic strategy. In addition, we continue to expect that Georgia will make good progress with the IMF’s EFF, having successfully completed a second review back in June.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns Georgia’s a score equivalent to a rating of ‘BB+’ on the Long-Term FC IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term IDR by applying its QO, relative to peers, as follows:

– Macroeconomics: -1 notch to reflect the potential downside risks arising from Turkey’s currency crisis and risks of a further escalation of US sanctions against Russia which may hurt Georgia’s economic growth prospects.

– External finances: -1 notch, to reflect that Georgia relative to its peer group has higher net external debt, structurally larger current account deficits, and a large negative net international investment position.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.