Fitch Affirms Georgia at ‘BB-‘; Outlook Stable

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The FINANCIAL — Fitch Ratings has affirmed Georgia’s Long-Term Foreign Currency Issuer Default Rating at ‘BB-‘ with a Stable Outlook.

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

KEY RATING DRIVERS

Georgia’s ratings balance favourable governance and business environment indicators compared with rated peers and resilience to recent macroeconomic shocks with weak external finances, including large current account deficits, high net external debt and low external liquidity.

In April the Georgian government and the IMF agreed a three-year arrangement under the extended fund facility (EFF) for an amount of around USD285.3 million to support the Georgian authorities’ reform agenda. The overall objectives of the programme are to ensure fiscal consolidation over the medium-term; implementing structural reforms aimed at improving domestic savings, investment and competitiveness; and unlocking bilateral and multilateral support to finance infrastructure investment and build foreign exchange reserves.

In Fitch’s view, the new IMF programme will provide an anchor to macroeconomic policy, potentially increasing confidence in the authorities’ reform effort. At the same time, the difficulties faced by the previous IMF programme (linked to a stand-by agreement) are a reminder of the potential challenges posed by multi-year programmes.

“Georgia’s recent macroeconomic performance has been resilient to the shocks affecting the region. Over five years, GDP growth has averaged 4% (BB median of 3.6%). GDP growth accelerated in 1H17 to 4.9% year-on-year, due to both an improvement in economic conditions among Georgia’s main trading partners (eurozone countries, Turkey and Russia) and domestic demand. We expect real GDP growth to average around 4.5% this year, and similar growth over the next two years.

Inflation has risen this year due to increased excise duties and higher international prices for food. Inflation rose to 7.1% in June from 1.8% in December 2016, before falling back. We expect inflation to average 5.6% this year, before falling towards the policy target, averaging 3.5% in 2018 and 3% in 2019.

External finances remain a key rating weakness. The current account deficit (CAD) was 13.5% of GDP in 2016, up from 12% in 2015, driven by a worsening of the primary income deficit. We expect this to unwind to some extent, so that the CAD falls to 11.3% this year. Over the next two years, we expect improvements in remittances to further shrink the CAD, to 10.2% by 2019. Foreign direct investment (FDI) flows remain a crucial source of funding for the CAD. In 2016, inward equity FDI (according to IMF data) was around USD1.4 billion (around 9.6% of GDP),” Fitch Ratings reported.

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Net external debt was estimated at 66% of GDP at end-2016, more than four times the ‘BB’ median. Despite a favourable composition of the debt stock, with a share of both concessional debt and inter-company loans, estimated external debt service is substantially higher than peers. Georgia’s external liquidity position is also weak, with FX reserves at around three months of import cover, and a liquidity ratio below 100% (vs. BB median of over 150%).

“The budgetary process for 2018 is in its early stages. We do not currently expect significant deviations from the tax and spending changes introduced in 2017 and the medium-term fiscal framework underpinned by the IMF programme. We expect the deficit to narrow this year to 3.9% of GDP, from 4.1% in 2016 (against the original budgeted 3%). Current expenditure restraint, in the context of higher public investment, is expected to result in a fall in the spending-to-GDP ratio, and thus a smaller deficit of 3.5% in 2018 and 3.4% in 2019,” Fitch Ratings said.

General government debt was 44.6% at end-2016, somewhat below the ‘BB’ median of 51%. Our public finance projections envisage the public debt ratio remaining at around 45% through 2019. Georgia has a very high share of foreign currency-denominated debt (around four-fifths) and its public finances are therefore vulnerable to exchange rate shocks. However, most of the foreign-currency debt is on concessional terms, implying moderate debt maturities and low interest rates (the weighted average interest on external debt is 2%).

The overall soundness of the banking sector mitigates the risks stemming from widespread dollarisation (at around two-thirds of bank deposits). The aggregate capital ratio was 16.5% at end-2Q17, and levels of non-performing loans are low (3.5% of gross loans). The Georgian authorities have introduced a strategy with specific policies to encourage the expansion of loans and deposits in lari. Despite a decrease in recent months, around two-thirds of bank deposits are in foreign currency. Moreover, Georgia scores 2 on Fitch’s Macro-Prudential Indicator, indicating moderate vulnerability from strong credit growth.

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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 IDR scale.

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

– External finances: -1 notch, to reflect high net external debt (66% of GDP at end-2016, compared with the BB median of 16%), structurally large 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 Long-Term Foreign Currency 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.

RATING SENSITIVITIES

The main factors that could, individually or collectively, trigger positive rating action are:

-Strong and sustainable GDP growth consistent with macroeconomic stability;
-A reduction in external vulnerability; and
-Shrinkage in budget deficits and public sector indebtedness.

The main factors that could, individually or collectively, trigger negative rating action are:

-An increase in external vulnerability, for example a widening of the current account deficit not financed by FDI;
-Worsening of the budget deficit, leading to further rise in public indebtedness; and
-Deterioration in either the domestic or regional political environment that affects economic policymaking or regional growth and stability.

KEY ASSUMPTIONS

Fitch does not expect a deterioration of bilateral relations with Russia and assumes that potential spikes in tensions related to the latent conflicts in Abkhazia and South Ossetia do not affect the Georgian economy’s performance and stability.

The full list of rating actions is as follows:

Long-Term Foreign- and Local-Currency IDRs affirmed at ‘BB-‘; Outlook Stable
Short-Term Foreign- and Local-Currency IDRs affirmed at ‘B’
Country Ceiling affirmed at ‘BB’
Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at ‘BB-‘
Issue ratings on long-term senior-unsecured local-currency bonds affirmed at ‘BB-‘
Issue ratings on short-term senior-unsecured local-currency bonds affirmed at ‘B’

 

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