S&P Global Ratings raised its long-term foreign and local currency sovereign credit ratings on the Government of Georgia to 'BB' while affirming the short-term ratings at 'B'. The outlook is stable.
Outlook
The stable outlook reflects the balance of risks between the potential for some erosion of institutional checks-and-balances and external vulnerabilities on the one hand, and upside to Georgia's growth prospects on the other.
We could raise the ratings if Georgia's growth rates translate into higher income levels while its exports profile diversifies further, both in terms of product and geography.
Downward ratings pressure could build if Georgia's institutional arrangements weakened and led to less predictable policymaking, as well as hurting business confidence and growth prospects.
Rationale
Georgia has maintained comparatively high growth rates over the past few years, even in a challenging external environment. The 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.
This resilience partly reflects the economy's success in attracting funds from abroad to finance its investment needs and its external deficits. At 33% and 5.7% in 2018, Georgia's investment-to-GDP and net FDI-to-GDP ratios are among the highest of all the 'BB' category sovereigns we rate. While we expect the external environment to remain challenging, policymakers' efforts to widen Georgia's economic base, to diversify its export geography and foreign investment, and to develop its infrastructure are likely to keep the pace of economic growth above that of peers while, ultimately, further reducing external imbalances--albeit the process will be only gradual.
In our view, continued growth of the NBG's FX reserves should help mitigate any immediate balance-of-payments risks. The NBG's reserves have increased by $250 million on average every year since 2016. Part of this momentum stems from the IMF program, in place since 2017, and higher reserve requirements for commercial banks against FX liabilities. However, the increase is also a result of the NBG's FX purchases. Indeed, FX reserves net of FX liabilities have been increasing and we expect this to continue over the medium term.
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 43% of GDP until year-end 2022.
The ratings are constrained by GDP per capita of $4,300 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 liabilities.
Institutional and Economic Profile: Various policy initiatives underpin an improved economic resilience
Georgia's economy remains narrow and characterized by comparatively low per capita income levels.
Nevertheless, we expect the authorities' reform focus should support sustained growth of 4% on average annually over the medium term--higher than Georgia's key trading partners.
Although shortcomings persist, we expect Georgia's institutional framework will remain among the strongest in the region.
In the last couple of years, net exports have emerged as a key growth driver for the Georgian economy. In particular, exports to the EU grew by 30% since the signing of the Deep and Comprehensive Free Trade Area Agreement between Georgia and the EU in 2016. Tourism, copper ores, ferro-alloys, wine, and medicines have all shown material growth over this period, suggesting some geographical widening of the export basket. With exports comprising more than half of GDP in 2018, Georgia is now a more open economy compared to 2016 (when exports were about 44% of GDP) or a decade ago when exports were less than one-third of national income. We project that the share of exports to GDP will stabilize from now on, and domestic demand will be the main growth driver over the forecast horizon.
Russia's ban on flights to Georgia from July following a series of protests in Tbilisi appears to have contributed to a slowing of tourism revenues relative to 2018. However, the effect of the Russian sanctions has been relatively limited as they were restricted to direct flights and not extended to other areas--such as Georgian wine--nor were there restrictions on the Georgian workforce in Russia, an important, albeit diminishing, source of remittance inflows. Arrivals of Russian tourists by land and flights via other destinations into Georgia continue. We understand that there is potential for the Russian authorities to lift the embargo, as suggested by their recent comments.
Georgia's economy grew by nearly 5% in real terms in the first half of the year. Incorporating a slight slowdown in the second half--lower tourism revenues and muted consumption following the lari's depreciation--we project real GDP growth of 4.5% in 2019. We have revised up this estimate from our previous 4.0% for the full year. We expect growth to moderate over the forecast horizon for a number of reasons. These include muted growth in Russia and Turkey, the latter emerging from a recession; a slowdown in the EU, where over 20% of Georgia's goods exports go; and slower consumption growth stemming from a moderation in credit growth following the authorities' introduction of new macroprudential norms for consumer leverage. We still see potential Turkish lira and Russian ruble volatility as a downside risk. Both are important trade partners, accounting for a combined 20% of exports and 40% of inbound worker remittances.
That said we believe that Georgia's economy will continue to grow at a comparatively high 4% annually over 2019-2022. We expect it to grow faster than other countries in the region. Georgia's long-established floating exchange rate regime, with intermittent intervention from the NBG, remains particularly important. Against a weaker external environment, the exchange rate has previously adjusted promptly, helping 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 other countries in the region in recent years and aggravated other economic problems.
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 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.
Despite the strong growth outlook, we expect Georgia's per capita income will remain modest at below $5,000 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 do not expect significant changes to these institutional arrangements over our four-year forecast.
Nevertheless, we see some downside risks from the ruling Georgian Dream party's majority in parliament should it use this majority to solidify its incumbent position. The domestic political landscape in Georgia has also seen heightened volatility recently with several public protests in 2019 and 2018. We consider that political uncertainty will likely stay elevated in the run-up to the parliamentary elections in 2020, but we do not expect any detrimental shifts to economic policymaking and anticipate a continued broad focus on reforms and attracting foreign investment.
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 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 do not expect a material escalation and we anticipate the conflict will remain largely frozen over the medium term. The protests in Georgia in June and the subsequent flight ban by Russia marked a reversal in the otherwise improving bilateral relations between the two countries in other areas in recent years.
Flexibility and Performance Profile: We anticipate that the NBG will continue to accumulate FX reserves, partially mitigating external risks
We expect net general government debt to peak in 2021 at 43% of GDP.
External metrics will improve through 2022 as the NBG continues to build up reserves and the current account deficit narrows.
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.
We see Georgia's balance of payments position as 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 percentage includes nonresident deposits as well as trade credit extended to the domestic corporate sector. Although Georgia's external position remains vulnerable, NBG's strengthened FX reserves partially mitigate the risks, in our view.
Georgia's accumulated stock of inward FDI remains substantial, at over 160% of the country's generated current account receipts, exposing the sovereign to risks should foreign investors decide to leave, for example because of 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 abrupt lari depreciation (due to a simultaneous corresponding contraction in FDI-related imports), it will likely have implications for Georgia's growth and employment.
The sizable stock of foreign liabilities also has consequences for the current account deficit. We note that the income deficit has widened, averaging nearly 5% of GDP in 2016-2018, from an average of 2% over 2013-2015. Even then, in our opinion, Georgia is less vulnerable to shifts in investor sentiment given the small proportion of market-based portfolio financing it receives relative to FDI and concessional debt.
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 more than 11% between 2014 and 2017. Because a substantial portion of imports was FDI-related, we expect the current account deficit to narrow further to below 7.0% in 2019 and average 6.3% through 2022. The growth in services exports--reflecting tourism revenue and transit fees--should also continue to help stabilize the external deficit, mitigating the growth in interest and dividends paid on foreign liabilities. In 2018, the services balance was nearly 14% of GDP, up from 3% a decade ago.
Supporting the accumulation of FX reserves, the authorities introduced a rule-based purchasing (put) option in early 2019 that allows banks to sell foreign currency to the NBG when the exchange rate is on an appreciating trend.
The NBG also continues to purchase FX via auctions. To date, in 2019, net FX purchases by the NBG have totaled $228 million. NBG FX reserves peaked at $3.74 billion in June this year (2.5x the level in 2008) before declining slightly following FX sales in August and September--the first since 2016--to curb the lari's depreciation. The NBG targets FX reserves based on an "assessing reserve adequacy" metric agreed with the IMF. This measure has strengthened over the last year with the authorities estimating that it currently stands at just over 100%.
Low fiscal deficits and moderate government debt characterize Georgia's public finances. The general government deficit has averaged 2.4% since 2011, exceeding 3.0% in only one year. Gross government debt has remained about 45% of GDP since 2016. However, this ratio is very sensitive to exchange rate movements given the large share of foreign-currency-denominated debt (80%) in the overall stock. For instance, we project that general government debt to GDP will rise somewhat in 2019 as a result of the 10% (year-to-date) lari depreciation after Russia's July ban on direct flights to Georgia. Similarly in 2015 and 2016, the lari depreciation caused a nearly 10% jump in the government debt ratio.
We expect that the pace of net debt accumulation will recede over the forecast horizon and net general government debt to GDP will peak in 2021 at 43%. The government typically only borrows for capital projects and from official sources of financing, mainly from international financial institutions (IFIs), as opposed to commercial sources. In fact, excluding capex, the government has consistently run an operating surplus. The preponderance of IFI debt has contributed to a favorable debt structure, with an average maturity of nearly eight years and a weighted average interest rate of just over 3%. We currently consider that the contingent fiscal liabilities stemming from public enterprises and the domestic banking system are limited.
Through 2019, inflation has exceeded 4% (outside the NBG's 3% target) owing to a hike in tobacco excises; core inflation has however been relatively subdued. Moreover, the weaker lari has also affected inflation. Further to its FX sales, the NBG hiked its key policy rate to 7% in September; moreover, it has not ruled out raising the rate to stem currency losses.
In our view, the effectiveness of Georgia's monetary policy compares favorably in a regional context. Specifically:
Inflation has remained consistently low, averaging less than 4% over 2010-2018. We anticipate the central bank will broadly meet its inflation target of 3% from 2020 onward;
Given the floating exchange rate regime, Georgia has promptly adjusted to changing external conditions while also avoiding abrupt and damaging swings in the real effective exchange rate in either direction; and
The banking system remains on a relatively stable footing. We note that nonperforming loans (based on the NBG's calculation) peaked at 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 3% in March 2019.
High levels of dollarization continue to constrain the effectiveness of monetary policy despite declines in recent years, in our view. Deposit dollarization at 62% is still significant, though down from 70% in 2016. Positively, we note the authorities' efforts to reduce the economy's dollarization, including through differentiating liquidity requirements for domestic and foreign currency liabilities, implementing pension reforms, 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 retail lending, 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.
