Fitch Ratings to hold Annual Conference in Georgia, on 1 October 2019 in Tbilisi. The event traditionally will bring together Georgian financial market leaders and experts to share their views, experiences and challenges in the Georgian market.Among conference speakers are:
Nikoloz Gagua, Deputy Minister of Finance of Georgia, Selim Cakir, Resident Representative in Georgia, IMF, George Paresishvili, Chief Executive Officer, Georgian Stock Exchange ,Giorgi Laliashvili, Head of Financial Markets, National Bank of Georgia , Levan Surguladze, Director, Georgian Pension Agency
Key Rating Drivers 2019
Strong Structural Features: Georgia’s ratings are supported by governance and business environment indicators that are above the current medians of ‘BB’ category peers and a 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 are significantly weaker than the majority of ‘BB’ category peers.
New External Shock: Georgia is facing a new external shock after a testing external environment in 2018. Russia suspended flights to and from Georgia from 8 July invoking security issues, after an address by a Russian MP in the Georgian parliament reignited long-standing bilateral tensions. Russia is the largest source of tourist arrivals in Georgia.
Improving Deficit: Fitch Ratings forecasts the current account deficit (CAD) will narrow to an average of 5.3% over 2019-2021, as a slowdown in consumer lending and rising domestic savings following the launching of the funded pension pillar ease pressure on imports. The flight ban will partly reverse the recent rapid improvement in tourism revenues, with international visitors’ growth slowing to 4.3% yoy in July, from 19.9% in June.
Ongoing External Weaknesses: External vulnerabilities remain a key rating weakness but are gradually easing. The gross external financing requirement accounts for 87.4% of international reserves and is set to rise in 2021 when the USD500 million Eurobond matures. The liquidity ratio is weaker than peers’ and gross external debt (GXD) is twice the current ‘BB’ median. We forecast GXD to decline below 100% of GDP by 2021 due to sustained FDI inflows and a narrowing CAD, however.
Macro Performance: Fitch forecasts economic growth to decelerate to 4.3% in 2019, from 4.7% in 2018, as credit growth slows and the Russian flight ban hinders the expansion of the tourism sector. Nonetheless, it will remain above the forecast current ‘BB’ median of 3.3%. Acceleration in infrastructure spending and slightly looser fiscal policy will support a pick-up in growth to an average 4.7% in 2020-2021.
Easing Fiscal Policy: An augmented fiscal deficit of 2.5% of GDP was recorded in 2018, in line with the IMF programme target, as revenue over-performance offset higher-than-planned budget lending and capex. We expect increased education expenditure, in line with the new legislation introducing a floor on education spending, and higher capital spending in response to the current external shock to widen the augmented fiscal deficit to 2.7% of GDP in 2019.
Economic Growth: Stronger GDP growth prospects leading to higher GDP per capita, consistent with preserving macro stability, could lead to positive rating action. However, deterioration in either the domestic or regional political environment that affects economic policymaking, economic growth and/or political stability could lead to a negative rating action.
Fiscal Finances: A record of reduction in gross general government debt/GDP would lead to positive rating action. Worsening of the budget deficit, leading to a sustained rise in public indebtedness, would lead to a negative rating action.
External Finances: A significant reduction in external vulnerability would lead to positive rating action. An increase in external vulnerability, for example from a sustained widening of the CAD not financed by FDI, could lead to a negative rating action.
Georgia’s governance and business environment indicators rank above the median of ‘BB’
rated peers, supporting investment growth prospects.
The government has shown a strong commitment to meet performance and structural benchmarks set under the IMF EFF arrangement, which should contribute to further improvement of Georgia’s gross savings and investment/GDP ratios.
Macroeconomic performance has been resilient. We project economic growth for 2019 at 4.3%, above the five-year average growth rate of 3.9%.
General government debt/GDP (at 43.3% at end-2018) sits above the median for ‘BB’ category peers (39.4%). In addition, Georgia’s share of foreign currency-denominated debt is above the current ‘BB’ median. Foreign-currency debt at a forecast 77.9% of total debt is high, exposing public finances to exchange rate shocks.
Georgia’s external finances are weaker than the majority of ‘BB’ category peers’. Net external debt/GDP at 63.9% for 2018 is significantly higher than the current ‘BB’ median ratio of 9.7%. CADs are also high, reflecting a combination of structural factors, including a low level of domestic savings, a narrow export base, a relatively large re-export sector, and high import dependence. However, persistently high CADs remain adequately financed by large net FDI inflows.
Political risk associated with unresolved conflicts involving Russia in Abkhazia and South Ossetia remains material and the evolution of relations with Russia can affect domestic politics and the economy.
External liquidity is weak for a country that has high dollarisation and is vulnerable to FX volatility. Gross external financing requirements as a share of international reserves are high (at 87.4% in 2018), while the level of gross international reserves in months of current account payments is low (3.1 months at end-2018).
Georgia’s credit profile does not support a notching up of the Long-Term Local-Currency IDR above the Long-Term Foreign-Currency IDR. In Fitch’s view, neither of the two key factors warranting a notching (strong public finance fundamentals relative to external finance fundamentals; and evidence of previous preferential treatment of local-currency over foreign- currency creditors) are present in Georgia.
Fitch has affirmed Georgia’s Country Ceiling at ‘BBB−’, two notches above the Long-Term Foreign-Currency IDR. The likelihood of the Georgian authorities imposing exchange controls that would prevent non-sovereign issuers from honoring their foreign debt obligations is
significantly mitigated by the country’s reliance on FDI and its commitment to liberalizing its economy, integrating w ith the global economy and creating a favorable business climate.
Key Credit Developments
Russia Flight Ban Will Hit Economic Growth
Georgian economic growth maintained a robust pace in 2018 at 4.7%, boosted by net exports, although the sharp economic slowdown in Turkey and Iran led to a fall in remittances and tourism earnings from these countries. A slightly contractionary fiscal policy with delayed capital spending has also weighed on domestic demand. The economy expanded by 4.9% yoy in 1H19, boosted by an acceleration in public capital expenditure and robust external demand supporting an improvement in the trade deficit.
Credit growth will moderate further follow ing the enforcement of tighter lending standards by the National Bank of Georgia (NBG). We expect economic growth to decelerate in the second half of the year as the Russian ban on commercial flights to and from Georgia weighs on the tourism sector, which accounts for 7.5% of GDP. Russia’s air travel ban, imposed for national security reasons, followed an address to the Georgian parliament by a Russian MP that inflamed long-standing bilateral tensions and led to large demonstrations in Tbilisi.
Russian tourists accounted for 20.9% of total arrivals in 2018 and the number of arrivals from Russia contracted by 6.4% yoy in July 2019, although this was partly compensated for by Russian arrivals through alternative routes. Tourism inflow s from Turkey are likely to recover after declining last year and could partly offset the shortfall. We expect the economy to expand by 4.3%, down from 4.6% in our previous forecast. The government’s fiscal response in the form of higher infrastructure spending and support to the tourism sector could partly prevent further growth deceleration.
Fiscal Response to External Shock; Marginal Expected Debt Decline Over-performance of fiscal receipts due to strong nominal GDP growth offset higher-than- planned budget lending and capital spending in 2018, leading to an augmented fiscal deficit of 2.5% of GDP, in line with the IMF Quantitative Performance Criteria. The VAT credit refund reached GEL521 million (1.3% of GDP) and the outstanding stock declined to 3.8% of GDP.
Fitch forecasts the augmented fiscal deficit to widen to 2.7% of GDP as the government ramps up education spending in line with the newly legislated 6% of GDP floor to be reached by 2022 (from 3.8% of GDP) and pushes up infrastructure spending in response to the current external shock. The government targets a GEL550 million VAT refund (1.2% of GDP) in 2019 and aims at reducing the outstanding stock by 50% by 2021.
Fitch expects the Government Debt Management Strategy 2019-2021 and IMF quantitative targets will provide a policy anchor to bring gross general government debt/GDP on a dow nw ard trajectory in the medium term, although lari depreciation will lead to a 2.3pp increase in 2019. The high share of FX-denominated debt at a forecast 77.9% of total debt exposes the country to exchange rate volatility but a planned increase in domestic issuance to deepen local capital markets could gradually decrease currency risk.
The government launched the issuance of benchmark domestic bonds in 2018. The fiscal strategy also entails increasing local-currency buffers to three months of local-currency gross financing needs and foreign-currency buffers to 12 months of foreign-currency gross financing needs by 2021.
Monetary Policy Easing Put on Hold
Inflation picked up to 4.6% in July 2019 following an increase in excise tax on tobacco.
The NBG expects the rise to be temporary and inflation to come down as weak domestic demand balances inflationary pressures from the exchange rate, but above the NBG 3% target.
The NBG kept its refinancing rates stable at 6.5% in July 2019, and highlighted that monetary policy tightening could be possible in the short term, were a weaker currency following the Russian flight ban to put upward pressure on domestic prices. An undervalued nominal effective exchange rate, as estimated by the NBG, suggests appreciation pressures could arise, which would support low er inflation, while below-trend economic growth and decelerating credit growth suggest monetary policy easing could resume in the medium term.
Easing External Imbalances
Georgia’s CAD narrowed to 6.2% of GDP in 1Q19 (7.7% at end-2018). Exports grew by 11.5% yoy in 1H19, supported by robust tourism inflow s, while imports contracted by 4.8% yoy. Fitch expects decelerating growth in consumer lending and reform of the pension system to ease pressure on imports, leading to a further narrowing of the deficit. However, potential tighter Russian sanctions, for example targeting Georgian wine, agriculture products or Russian remittances to Georgia, could hamper the improvement. The NBG expects current sanctions w ill lead to a loss in tourism revenues of USD300 million (9% of tourism earnings).
Net FDI decreased to 5.5% of GDP in 2018 follow ing completion of large energy projects. We expect FDI to recover moderately over 2019-2021, supported by an acceleration in infrastructure investments and free trade agreements with the EU, the European Free Trade Association, China, Turkey and Hong Kong. Development of the Anaklia Port, estimated at USD560 million for Phase 11, has been put on hold following ing issues on funding. The project would be critical in attracting further FDI and enhancing trade connectivity but progress remains uncertain.
External vulnerabilities remain large but are decreasing. High GXD gives rise to large gross external financing requirements, which we forecast at 90.5% of international reserves in 2021 as the USD500 million Eurobond comes to maturity. External debt service is high at a forecast of 18.7% of current account receipts in 2019.
GXD decreased by 5pp in 2018 and w e expect it to decline further as FDI fully finances a smaller CAD and government external debt is refinanced domestically. External buffers have increased, supported by the NBG’s reserves accumulation policy, FX put options and higher reserves requirements for banks. Reduced tourism earnings, the potential need for new FX intervention by the NBG2, and high external redemption in 2021 could hinder further accumulation.
Rising Tensions Ahead of Elections
The political risk associated with unresolved conflicts involving Russia in Abkhazia and South Ossetia remains material and the evolution of relations with Russia can affect domestic politics as well as the economy. The ruling Georgian Dream coalition’s foreign policy combines a pro-Western stance and a constructive approach to Russia. The recent address by a Russian MP to the Georgian Parliament in July led to large demonstrations in Tbilisi, however, and criticism from Georgian politicians, who accused Russia of interfering in Georgia’s internal affairs.
Georgia’s banking sector remains sound, profitable and well capitalized, with capital adequacy at 18.2% in 2Q19 (18.4% at end-2018), while asset quality is high.
Macro-prudential measures3 adopted by the NBG in May 2018 and January 2019, in line with IMF Structural Benchmarks, have helped curb credit growth, which decelerated to 15% in 1Q19, from 17.1% at end-2018; mortgage loans grew at a solid 26%. Measures capping new FX lending have also supported a decline in dollarisation, although FX mortgage lending has increased, and dollarisation remains high at 62.9% of total deposits and 56.2% of loans at end- 2Q19. New upcoming regulation, including the banking resolution framework and prudential requirements in line with Basel III, will further support a strengthening of the regulatory framework.