Georgia Outlook Revised To Positive On Economic Resilience; 'BB-/B' Ratings Affirmed


Overview

  • We forecast Georgia's economy will maintain comparatively high growth rates, even in times of a more difficult external environment.
  • We anticipate the country will remain compliant with the conditions of the funded International Monetary Fund (IMF) program, which should support foreign exchange reserves and investor confidence.
  • We are revising our outlook on Georgia to positive from stable and affirming our 'BB-/B' long- and short-term sovereign credit ratings.

Rating Action

On April 12, 2019, S&P Global Ratings revised its outlook on the Government of Georgia to positive from stable. At the same time, we affirmed our 'BB-/B' long- and short-term foreign and local currency ratings.

Outlook

The positive outlook primarily reflects our view that Georgia's economic and external performance has the potential to outperform our current forecast over the next 12 months. It also reflects the country's continued compliance with the conditions of the existing funded IMF arrangement.
Upside scenario
We could raise the ratings if Georgia's economic performance proved stronger than our present expectations. We could also raise the ratings if Georgia's external position strengthened, for example, as a result of stronger export performance and higher foreign exchange reserves at the National Bank of Georgia (NBG). At the same time, we expect public finances to remain controlled.
Downside scenario
We could revise the outlook to stable if weaker growth in Georgia's key trading partners, contrary to our expectations, appeared to be undermining the country's medium-term economic prospects and its external position. We could also revise the outlook to stable or lower the ratings if Georgia's institutional arrangements weakened and led to less predictable policymaking, as well as damaging business confidence and growth prospects.

Rationale

The outlook revision primarily reflects the potential for Georgia's economic and external performance to turn out stronger than our current forecast over the next 12 months. We note that the country has maintained a comparatively high growth rate over the past few years, even against a challenging external environment.
Georgia's economy expanded by nearly 4% on average over 2015-2018, weathering periods of anemic external demand as trading partners were hit by falling oil prices, regional currencies were devalued, and some fell into recession. While we expect the external environment to remain challenging, the country's efforts to widen its economic base, to diversify its export geography and foreign investment, and to develop its infrastructure could keep the pace of economic growth above that of peers.
The revision of the outlook also reflects our expectation that the country will continue to comply with the conditions of a funded IMF arrangement, successfully completing the remaining reviews. In our view, that should strengthen Georgia's foreign exchange reserves, maintain investor confidence, and anchor its fiscal policy.
The ratings on Georgia continue to be supported by the country's relatively strong institutional arrangements in a regional comparison, and our forecast that net general government debt will remain contained, at close to 40% of GDP until year-end 2022.
The ratings are primarily constrained by GDP per capita of $4,400 in 2019, which remains low in a global comparison, as well as by balance-of-payments vulnerabilities, including Georgia's import dependence and sizable external debt.
Institutional and Economic Profile: Continued growth averaging 4% over the medium term
  • Georgia's economy remains narrow and characterized by comparatively low per capita income levels.
  • Nevertheless, we expect prudent policymaking should support sustained growth of 4% on average annually over the medium term.
  • Although shortcomings persist, we expect Georgia's institutional framework will remain among the strongest in the region.
Throughout 2018, Georgia continued to display economic resilience. Net exports remained a key growth driver as they were in 2017, following a negative contribution over 2014-2016. This is partly due to the stabilization in external demand from Russia, Azerbaijan, and Turkey (in 2017), but also a significant 30% growth in exports to the EU (over 2016-2018). Tourism, copper ores, ferro-alloys, wine, and medicines have all shown material growth over this period, suggesting some strengthening of the export basket to a wider geography. For 2019, along with lower imports, we expect net exports to maintain a positive contributor to growth.
However, our growth assumptions are moderate over the forecast for a number of reasons. These include a recession in Turkey; slower growth in the EU, where over 20% of Georgia's goods exports go; and weaker consumption stemming from a reduction in credit growth. We believe that potential volatility of the Turkish lira and Russian ruble, seen in particular in mid-2018, remain downside risks. Both countries are important trade partners amounting to a combined 20% of exports and 40% of inbound worker remittances. Further, recently introduced prudential measures by the NBG are likely to curb credit growth, with new limits on personal leverage ratios.
Still, we believe that Georgia's economy will continue to grow at a comparatively high pace of 4% annually over the medium term. As in the past, we expect this rate to be higher than other countries' in the region. In our view, the floating exchange rate regime that Georgian authorities have maintained for many years remains particularly important. Against the weaker external environment, the exchange rate has in the past adjusted promptly, helping to avoid any abrupt one-off swings. Among other things, this has preserved the stability of the financial system and allowed Georgia to avoid the credit crunch that hit some of the other countries in the region in recent years, aggravating their other economic problems.
We also believe that the authorities' reform focus could yield additional growth benefits, particularly in the long run. Current initiatives include:
  • Development of the country's infrastructure and prioritizing of capital spending (capex) rather than current budget expenditure;
  • Improvements in the business environment, including through the introduction of a new -private partnership framework, deposit insurance, land reform, and pension reform;
  • Tax reforms aimed at easing compliance and addressing the issue of value-added tax refunds; and
  • Education reform.
Given the strong growth story, we expect per capita income in Georgia will rise, but still remain modest in a global comparison, averaging $4,700 through 2022. This largely reflects the low starting base, exemplified by the prevalence of exports of low-value-added goods. In the agricultural sector, which employs a substantial part of Georgia's population (the IMF estimates that close to 40% of employment is related to agriculture), productivity remains comparatively low, weighing on Georgia's average per capita GDP. This, in turn, continues to constrain the sovereign ratings.
In our view, Georgia's institutional settings remain favorable in the context of the region, with several established precedents regarding power transfer, and a degree of checks and balances between various government bodies. We also note the NBG's broad operational independence. We don't expect significant changes to these institutional arrangements over our four-year forecast period.
Nevertheless, we see downside risks from the ruling Georgian Dream party's constitutional majority in parliament. Specifically, we believe there could be attempts to centralize power, solidifying Georgian Dream's incumbent position. We also see some risks of heightened volatility given the approaching parliamentary elections in 2020.
We continue to see risks from regional geopolitical developments. The status of South Ossetia and Abkhazia will likely remain a source of dispute between Georgia and Russia. Russia has continued to build stronger ties with the two territories, as highlighted by the recent partial integration of the South Ossetian military into the Russian army, the establishment of a customs post in Abkhazia, and regular visits to the territories by senior Russian government officials. However, we don't expect a material escalation, and we anticipate the conflict will largely remain frozen over the medium term. Positively, bilateral relations between the two countries in other areas have been improving in recent years.
Flexibility and Performance Profile: The funded IMF program should mitigate balance-of-payments risks and anchor fiscal policy
  • We expect net general government debt to peak in 2021 at 43% of GDP.
  • Weak external stock positions constrain the sovereign ratings.
  • A floating exchange rate and the NBG's overall operational independence underpin a degree of monetary flexibility, but the high level of dollarization remains a constraint.
Georgia's public finances are stable; the fiscal deficit has averaged 2.5% since 2011; gross government debt has remained steady as a percentage of GDP since 2016 and we expect that the annual increase in net debt (our preferred fiscal metric) will start to reduce over the forecast. The government typically only borrows for capital projects and from official sources of financing, mainly from international financial institutions (IFIs), as opposed to commercial borrowing. In fact, excluding capex, the government has run a consistent operating surplus.
While the significant proportion of debt denominated in foreign currency (80%) caused a nearly 10% of GDP jump in debt ratio following lari depreciation in 2015 and 2016, at the end of 2018, the government's gross leverage remains moderate at 45% of GDP. In our view, the debt structure is also favorable as IFI debt predominates, with an average maturity of over seven years and a weighted average interest rate of just over 3%. We expect the debt burden to start declining from 2021. Given our base-case expectation of relatively modest lari depreciation over 2019-2020, we believe the annual rise in net general government debt will slightly exceed the headline annual deficit. We currently consider that the contingent fiscal liabilities stemming from public enterprises and the domestic banking system are limited.
In our view, Georgia's balance of payments position is still vulnerable. Georgia remains a small, open economy with a narrow export base and a significant net external liability position built on persistent past current account deficits. Ultimately, this leaves the economy susceptible to changing external sentiment. While one-third of external debt belongs to the public sector, is concessional, and has long-dated maturities, the economy overall needs to roll over almost 30% of GDP in foreign debt annually, potentially exposing it to adverse external conditions. This number includes non-resident deposits as well as trade credit extended to the domestic corporate sector.
Georgia's accumulated stock of inward foreign direct investment (FDI) remains substantial, at about 160% of the country's generated current account receipts, exposing the sovereign to risks should foreign investors decide to leave, for example, due to changes in the business environment or a deterioration in Georgia's economic outlook. While a hypothetical sizable reduction in FDI inflows may not necessarily lead to a disorderly adjustment involving an abrupt depreciation of the lari (due to a simultaneous corresponding contraction in FDI-related imports), it will likely have implications for Georgia's growth and employment.
Following the completion of a foreign-funded gas pipeline project, inward FDI has reduced and is expected to average just over 7% of GDP over the forecast, compared with over 11% of GDP between 2014 and 2017. Because a substantial portion of imports were FDI related, we expect the recent improvements in external imbalances seen over 2017 and 2018 to be maintained at just over 7% of GDP, supported also by export growth.
Supporting the accumulation of foreign exchange reserves, which we expect to move above target over 2019 and which is set on an assessing reserve adequacy metric agreed with the IMF, the authorities have introduced a rule-based purchasing (put) option that allows banks to sell foreign currency to the NBG when the exchange rate is on an appreciating trend. We expect this accumulation of reserves to help protect Georgia from future external stresses.
In our view, the effectiveness of Georgia's monetary policy compares favorably in a regional context. Specifically:
  • Historically, inflation has remained consistently low, averaging less than 4% over 2010-2017. We anticipate the central bank will broadly meet its inflation target of 3% over the next four years;
  • Given the floating exchange rate regime, Georgia has promptly adjusted to changing external conditions, at the same time avoiding abrupt and damaging swings in the real effective exchange rate in either direction; and
  • The banking system remains on relatively strong footing. We note that nonperforming loans (based on the NBG's calculation) have remained at about 7%-8% even though the lari weakened notably in 2015-2016, while economic growth decelerated. According to the IMF's calculations, nonperforming loans amounted to 2.7% at the end of 2018.
High levels of dollarization continue to constrain the effectiveness of monetary policy, in our view. For instance, despite a recent decline from almost 70% at year-end 2016, dollarization of resident deposits remains substantial, at about 62%. Positively, we note the authorities' efforts to reduce the economy's dollarization, including through differentiating liquidity requirements for domestic and foreign currency liabilities, implementing a pension reform, developing the domestic debt capital market, and introducing deposit insurance, alongside other measures.
We anticipate that, over the next four years, the stock of domestic credit will expand by 14% a year on average (including foreign exchange effects), below the 19% trend between 2013 and 2018. Although pockets of vulnerability remain, particularly in the retail lending segment, we view positively the regulator's attempts to diffuse risks. The introduced measures include loan-to-value and payment-to-income limits, additional capital requirements for systemic banks, and bolstered nonbank sector supervision.

We do not expect the ongoing investigation into specific shareholders of TBC Bank on allegations of wrongdoing to become a broader issue, either for the bank or for the system as a whole. However, we note that, at nearly 40% of net system loans and liabilities, the bank has systemic importance.
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