The FINANCIAL – Scope Ratings GmbH (Scope) has today affirmed Georgia’s long-term issuer and senior unsecured debt ratings at BB in both local and foreign currency and revised the Outlooks to Stable from Negative. The short- term issuer ratings have been affirmed at S-3 in local and foreign currency, with Outlooks maintained at Stable.
The revision of the Outlooks on Georgia’s long-term ratings to Stable reflects the following two core drivers:
1. an improved economic outlook due to a substantially stronger-than-expected recovery near term and Scope’s expectation that the government will remain committed to macro-financial stabilisation, expected to be advanced beyond 2021, supporting the growth outlook; and
2. gradual reduction in government debt-to-GDP levels medium run due to higher GDP and slowly declining fiscal deficits, supported by a re-anchoring of authorities’ pre-pandemic commitment to national fiscal rules.
This Outlook change reflects updated assessments of Georgia under the ‘domestic economic risk’ and ‘public finance risk’ categories of Scope’s sovereign ratings methodology.
The affirmation of Georgia’s ratings considers the country’s outstanding credit strengths, including solid medium-run growth potential despite a degree of scarring effects associated with the Covid-19 crisis, on the back of resumption of foreign direct investment (FDI) inflows to the economy and strong access to donor financing on concessional terms.
In Scope’s view, the current prolonged political instability should not impair Georgia’s credible macroeconomic policy framework.
Agency said the Stable Outlook represents Scope’s view that risks to ratings over the next 12 to 18 months are balanced. The ratings could be downgraded or the Outlooks revised to Negative if, individually or collectively: i) the medium-run public debt trajectory were to weaken, due, for example, to a looser commitment to fiscal discipline and/or weaker-than-expected growth prospects; ii) a deterioration in institutional quality and/or heightened geopolitical risks undermine growth and investment prospects; and/or iii) external vulnerabilities were to escalate, resulting in material adverse effects for debt sustainability and reserve adequacy.
“Conversely, the ratings/Outlooks could be upgraded if, individually or collectively: i) the implementation of reforms improves structural features of the economy, such as institutional strength or growth prospects, and/or curtails macro-financial risk; ii) fiscal sustainability improves, e.g., due to further enhancements of the fiscal framework and/or higher revenue growth; and/or iii) external sector risks are reduced, including a sustained reduction of current account deficits and/or build-up of reserves”.
According to Scope agency the first driver for the revision of Georgia’s credit rating Outlook to Stable is an improved economic outlook. The Georgian economy has already recovered to near pre-pandemic levels of output, after growing 12.7% year-on-year over the first six months of this year (29.8% YoY in Q2-2021)1. As a result, Scope raised its forecast for real GDP for 2021 by 3.5pps to 8%, from 4.5% assumed under the last review in March 2021.
“This substantially stronger-than-expected recovery has been anchored by pent-up household demand, solid growth in remittances and export recovery. Scope further expects Georgia to grow solidly in 2022 by 5.5%, close to but nonetheless above a medium-run growth potential of 5%, driven by recovery in investment, employment gains and growth of tourism receipts. Scope notes, however, that current political instability, upcoming October local elections, a recent surge in Covid-19 cases and the gradual pace of vaccination roll- out are downside risks to the economic outlook”.
“Georgia’s solid medium-run growth prospects support the BB long-term ratings. This is underpinned by a sustained capacity to attract FDI, which over 2015-2019 financed almost the whole of the current account deficit, averaging 7.9% of GDP annually. FDI more than halved in 2020 compared to in previous years2 due to transfers of ownership from non-residents to residents, a weaker external environment and prolonged political instability”.
“Despite outstanding risks, Scope expects resumption of FDI inflows medium term, supported by the underlying strengths of Georgia’s economic structure, including a favourable investment environment. Investments to the real economy and physical infrastructure advancements are furthermore helped by prioritisation of public capital spending over current spending, with the former budgeted to remain sizeable medium term (around 7% of GDP annually in 2022-2025, versus 8% of GDP in 2021). The government’s credible reform agenda is supported by the EU-Georgia Association Agreement, which, among other international agreements, incorporates annual bilateral financial assistance3 in amount of EUR 120- 130m (0.9% of 2020 GDP). Scope expects the government to remain committed to existing economic and political cooperation with the European Union, enhancing a credit-positive prudence of policy making medium term”, agency reported.
“More recently, the Georgian government signalled its intention to reject the second tranche (EUR 75m) of the EUR 150m in macro-financial assistance from the EU aimed at limiting the economic fallout of the Covid-19 pandemic. In any case, disbursement of the funds would have depended on Georgia’s implementation of judicial reforms”, According to Scope agency.
“The second driver of the Outlook revision is an improved debt trajectory compared to the expectation as of the Agency’s last review. Scope expects the government debt-to-GDP ratio to decline to 55% by 2022 (vs 59% under the previous review), from a cyclical peak of 60% last year, returning under a ceiling under national fiscal rules (of 60%). This reduction of debt ratio results from projected gradual moderation of budget deficits towards a threshold of 3% of GDP by 2023, consistent with fiscal rules. This is further abetted by ongoing engagement with the IMF, even after successful conclusion of a four-year Extended Fund Facility, as well as the gradual activation of government deposits (which totalled around 9% of GDP as of end-2020). In Scope’s view, the government’s track record of commitment to fiscal rules serves as an important anchor for medium-term debt sustainability. The resulting favourable effect on the government debt trajectory is furthermore anchored by good recovery prospects, which improve the tax revenue outlook, alongside by gradual unwinding of Covid-19 expenditure measures”.
“Almost three-quarters of government debt is in the form of concessional multilateral and bilateral loans, reflecting a track record of sound engagement with the IMF and other international donors. This creates a cushion against balance of payment crises and against Georgia’s high foreign-currency exposure of government debt (around 80% of which is denominated in hard currency)4. Refinancing risks are further eased by ability to issue on international capital markets on comparatively favourable terms, exemplified notably in the five-year USD 500m Eurobond with a coupon of 2.75% issued in April 2021”.
“Despite the affirmation of the ratings, significant challenges remain, which affect Georgia’s BB ratings longer term”, agency said.
“Firstly, Georgia’s small, open economy is vulnerable to external shocks and is reliant upon external financing. This is reflected in persistent wide current account deficits (current account balance of 12.5% of GDP in 2020, after -5.5% of GDP in 2019), which have led to an elevated net external liability position (net international investment position of -154.3% of GDP as of Q1 2021). This is a reflection of the high investment needs of a developing economy with low domestic savings, narrow export base as well as elevated reliance on tourism receipts, the latter which have been severely impaired during the pandemic crisis.”
Scope expects a gradual narrowing of current account deficits over the medium run towards pre- pandemic levels, supported by recovery over time in the tourism sector, the prospects for which, nevertheless, remain highly subject to pandemic-related risks.
Secondly, elevated dollarisation of the economy constitutes a risk for financial stability. Around 53% of loans and 60% of deposits of the banking sector are denominated in foreign currency. This is despite moderate decline over the past four years due to measures taken by authorities, including improved access to long- term resources in Georgian lari and the preferential treatment of local currency exposures under prudential regulations.
Periods of elevated exchange rate volatility pose, nevertheless, a key risk for public-sector, bank and private-sector balance sheets. The lari has stabilised recently at around 3.1 to the dollar but is still trading around 10% weaker than levels pre-pandemic.
Risks from elevated foreign-currency exposures are mitigated by authorities’ credible macroeconomic management, Georgia’s strong access to donor financing, which supports foreign-currency reserve stocks, and a well-capitalised banking sector. The National Bank of Georgia appropriately raised its policy rate three times thus far in 2021, by a cumulative two percentage points to 10%6, in the face of increasing inflationary pressure (of 11.9% year-on-year in July, from 9.9% in June).
Georgia’s international reserves stood at USD 3.87bn, adequately covering external debt maturing within one year. Nevertheless, reserves are down from USD 4.10bn at the beginning of the year, reflecting sales of FX of the central bank of around USD 273m in 2021 in support of the domestic currency.
Contingent liabilities affecting the sovereign’s balance sheet, rooted in the banking system, are limited. Georgian banks remain well capitalised and liquid with system-wide tier 1 capital of 13.5% of risk-weighted assets as of Q1 2021. This is underpinned by supervisory measures taken by the central bank, including provision of USD 200m of swap liquidity to the domestic banking system. Some further weakening in banks’ asset quality is possible, given withdrawal of crisis supervisory measures, including of temporary loan payment moratoria.
Lastly, prolonged political instability is adding to downside risks affecting growth and fiscal outlooks. Ruling party Georgian Dream and the largest opposition group, the United National Movement, both decided to withdraw from an EU-brokered agreement in April aimed at resolving the political crisis that followed the 2020 parliamentary elections, centred on electoral and judicial reforms. The United National Movement nonetheless signed the agreement this month. Even with these recent events, Scope expects the government to remain committed to furthering a credible macroeconomic policy framework despite the possibility of continued political instability after the October 2021 elections. Finally, Scope expects geopolitical risks with Russia to persist in relation to unresolved conflicts in South Ossetia and Abkhazia.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘bb’ for Georgia. No adjustment has been made to this indicative rating under the reserve currency adjustment under Scope’s methodology. As such, the ‘bb’ indicative rating can be adjusted under the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against the indicative peer group of countries.
For Georgia, the following QS relative credit strength has been identified: i) growth potential of the economy. The following QS relative credit weaknesses versus the peer group have been identified: i) current account resilience; and ii) resilience to short-term external shocks.
The QS generates no adjustment and indicates BB long-term ratings for Georgia. A rating committee has discussed and confirmed these results.
Factoring of Environment, Social and Governance (ESG)
“Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) as well as in the qualitative overlay (QS). Under governance-related factors in the CVS, Georgia displays stronger performance than regional peers on six World Bank Worldwide Governance Indicators. Georgia has made significant progress over recent years in improving the quality and effectiveness of its public administration and enhancing government transparency. However, the lack of an established system of checks and balances and of a fully functioning independent judiciary remain challenges”.
“Social factors considered under Scope’s methodology include high poverty (21.3% of the population was under the national poverty line in 2020) and elevated unemployment rates (22.1% in Q2 2021), although these were gradually decreasing pre-pandemic. The unemployment rate reflects still-high levels of structural unemployment and skills mismatches. Georgia’s working-age population (those aged 15-64) has been declining by 0.6% annually over the last five years, reflecting net emigration.
Substantial environmental risks resume such as in relation to air pollution in major cities. This is mitigated by coordinated policy measures aimed at reducing carbon emissions and setting up legislation and enforcement on waste management”, according to Scope agency.