KEY RATING DRIVERS
The upgrade of Georgia’s IDRs reflects the following key rating drivers:
The Georgian economy proved resilient to negative developments in 2018. Economic growth remained robust, the currency was relatively stable and the National Bank of Georgia (NBG) built reserves despite a severe economic shock in Turkey and heightened sanctions risk in Russia. Georgia’s resilience reflects a diversification of sources of current account inflows, the floating exchange rate and prudent fiscal and monetary policy settings, underpinned by steadfast adherence to its IMF programme. All requirements under the Extended Fund Facility with the IMF were achieved as of end-June 2018 and end-December 2018.
External imbalances are gradually easing. Georgia’s current account deficit is structurally high, but Fitch estimates that it narrowed to 7.5% of GDP in 2018, despite the testing external environment. In 2017, Russia and Turkey were Georgia’s second- and third-largest trading partners, respectively, in addition to being leading sources of tourists, remittance and FDI, although financial sector links are small. Rising tourism revenues and remittances, notably from the EU, and exports resulted in an estimated 13.9% increase in current external receipts. The first quarterly current account surplus on record was recorded in 3Q, the peak tourism season.
We forecast a further narrowing of the current account deficit as the recently launched funded pension pillar will likely encourage savings and the implementation of macro-prudential measures will lead to a deceleration in consumer lending, reducing pressure on imports. The deficit is expected to remain over 7% of GDP to 2020, which is large compared with the current ‘BB’ median of 2%.
The 3Q current account surplus insulated the lari from the sharp fall in the Turkish lira and caused an appreciation of the real effective exchange rate. REER appreciation, combined with weak fiscal stimulus and contained wage pressures slowed annual average inflation to 2.6% in 2018 from 6% in 2017. The NBG cut its refinancing rate by 25bp in January 2019 to 6.75%, owing to subdued inflationary pressure. Additional monetary policy easing is likely, given the expectation of decelerating credit growth and low imported inflation from neighbouring countries. We forecast inflation to remain in line with the NBG target of 3.0% (and below the current peer median of 3.5%) in 2019-2020.
Growth remained robust at an estimated 4.8% in 2018 and the five-year average of 5.0%, which compares favourably with the current median for peers of 3.1%. Private investment and external demand supported growth in 2018, which should be bolstered in 2019 by a pick-up in capital spending, which dipped last year. Growth potential is estimated between 4.5%-5.0% by the NBG and at 5.2% by the IMF, driven by productivity gains and capital formation.
The 2018 fiscal outturn, an estimated augmented deficit of 2.5% of GDP, including budget on-lending, outperformed the authorities’ 2.8% initial target and current ‘BB’ median, due to strong revenue performance and delayed implementation of infrastructure projects, meaning public capex was subdued. We expect the augmented fiscal deficit to widen slightly in 2019 to 2.6% of GDP as the government ramps up capital spending. Contained current expenditure and dynamic tax receipts will help maintain a neutral fiscal stance. The newly adopted fiscal rule replaces the previous expenditure ceiling and sets a 3% of GDP upper limit for the fiscal deficit and a 60% of GDP debt ceiling.
Fiscal policy is consistent with a gradual decline in gross general government debt (GGGD)/GDP, which we forecast at 42.5% of GDP in 2019, lower than the current ‘BB’ median of 48.1%. With 81% of total GGGD external, it is vulnerable to exchange rate fluctuation. We expect the share of external debt to decrease, as the government increases local issuance to deepen domestic capital market. Debt composition is favourable with 72% being to multilateral creditors. Interest payments account for an estimated 4.4% of government revenues in 2018, almost half the current ‘BB’ median, while government maturities coming due within one year are in line with peers at 4.9% of GDP.
Fitch forecasts that sustained FDI, along with portfolio flows and private sector borrowing will fully finance the current account deficit. Net foreign direct investment slowed in 2018 to 7.4% of GDP, from 9.5% in 2017, due to the completion of a large infrastructure project. We expect it to recover in 2019-2020 to an average 8% of GDP, boosted by new Free Trade Agreements, large projects in the transportation sector and development of the Anaklia port. We expect the central bank will continue its policy of reserve accumulation through interventions in the FX market and the launching of FX put options in 2019, while remaining committed to a floating exchange rate. Fitch forecasts reserves to rise to USD3.5billion at end-2019 from USD3.3billion at end-2018 (3.2 months of CXP cover; peer median 4.2).
Georgia’s ‘BB’ IDRs also reflect the following key rating drivers:
External finances remain a key rating weakness with net external debt at 61.9% of GDP at end-2018, 4.5x the current ‘BB’ median. Large external indebtedness gives rise to large gross external financing needs, at a forecast 86.4% of international reserves in 2019. Georgia is highly vulnerable to an external shock that would put downward pressure on the currency and lead to a sharp rise in external debt service. Low external liquidity, at 107.5% versus 150.3% for the current ‘BB’ median, provides little buffer to the economy in case of a surge in external financing needs.
Governance and business environment indicators are well above the current medians of ‘BB’ category peers, with Georgia ranking 6th out of 190 in the 2019 World Bank Ease of Doing Business Indicator. Political risk associated with unresolved conflict with Russia in Abkhazia and South Ossetia remains material.
The banking sector remains sound and profitable, with robust capitalisation, adequate liquidity and good asset quality. However, dollarisation remains high at 64.4% of deposits at end-November 2018 and Fitch’s MPI score of 2* reflects some vulnerabilities from sustained high credit growth. High growth in consumer lending and mortgage loans has led to a fast rise in household indebtedness, but new macro-prudential measures, including limits on loan-to-value and payment-to-income ratios, an increased floor on new FX-lending, a new leverage ratio and capital requirements will likely ease credit growth.
Fitch has revised Georgia’s Country Ceiling to ‘BBB-‘, two notches above the Long-Term Foreign-Currency IDR, from ‘BB’, one notch above, to reflect our view that the country’s high private sector external debt, reliance on FDI, commitment to liberalising its economy, integrating with the global economy and creating a favourable business climate, and successful navigation of recent external stresses substantially reduce the likelihood of the authorities imposing capital and/or exchange controls.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Georgia a score equivalent to a rating of ‘BB+’ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
– External finances: -1 notch, to reflect that relative to its peer group, Georgia has higher net external debt, structurally larger current account deficits, and a large negative net international investment position.
The removal of the -1 notch under “Macroeconomic policy and performance” since the previous review reflects Georgia’s track record of resilience to negative developments in its main trading partners. Policy framework is sound and strengthening, as reflected by the NBG meeting its inflation target, prudent fiscal strategy and compliance with IMF’s quantitative performance criteria and structural benchmarks.
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.
The main risk factors that, individually or collectively, could trigger positive rating action:
-A significant reduction in external vulnerability, stemming from decreasing external indebtedness and rising external buffers.
-Further fiscal consolidation leading to a decline in GGGD/GDP.
– Stronger GDP growth prospects leading to higher GDP per capita level, consistent with preserving macro stability.
The main factors that could, individually or collectively, lead to negative rating action are:
– An increase in external vulnerability, for example a sustained widening of the CAD not financed by FDI.
-Worsening of the budget deficit, leading to a sustained rise in public indebtedness.
-Deterioration in either the domestic or regional political environment that affects economic policymaking or regional growth and stability.
The global economy performs in line with Fitch’s Global Economic Outlook.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR upgraded to ‘BB’ from ‘BB-‘; Outlook Stable
Long-Term Local-Currency IDR upgraded to ‘BB’ from ‘BB-‘; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at ‘B’
Short-Term Local-Currency IDR affirmed at ‘B’
Country Ceiling upgraded to ‘BBB-‘ from ‘BB’
Issue ratings on long-term senior unsecured foreign-currency bonds upgraded to ‘BB’ from ‘BB-‘
Issue ratings on long-term senior unsecured local-currency bonds upgraded to ‘BB’ from ‘BB-‘
Issue ratings on short-term senior unsecured local-currency bonds affirmed at ‘B’