18.Nov .2019 19:10

TBC Research - The recovery in FX credit without excessive risk taking: key for the GEL and the growth

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The growth of exports, tourism and remittance inflows recovered to 6.1% in October, having slowed to 0.5% in the previous month in USD terms. Higher tourism (+5.2% YoY) and exports (+4.5%) were predominantly behind the recovery of growth, but remittances also remained strong with a 11.7% YoY increase.

The weaker growth of imports in October (- 2.1% YoY) also supported the external balance. Although imports increased moderately, by 4.0% YoY in September in USD terms, this was primarily on the back of higher one-off imports of petroleum and transportation, which likely waned in October.

Already in October, the number of tourists visiting Georgia rose by 7.8% YoY and estimated inflows increased by 5.2% in USD terms, the latter having fallen by an estimated 6.9% YoY in Q3. This recovery was supported by a further acceleration of the growth of visitors from the EU, the strong contribution of visitors from Armenia (+12.7% YoY), Turkey (+16.9 YoY) and Azerbaijan (+7.7% YoY), and the sharp expansion of tourists from Israel (+56.9% YoY) and other Middle East and Central Asian countries. It should be noted that tourism inflows from the EU surpassed those from Russia for the first time in September, a trend that likely continued in October as well. The increasing number of direct low-cost flights connecting Georgia to Europe will continue to support the growth of the industry and increase the share of more stable markets in the total numbers of visitors.

Following the improvements in the previous quarters, trade and the estimated balance of major components of the current account both indicate further improvement in Q3 as well as in October. In particular, the estimated balance of trade in goods, tourism and remittance inflows improved by around 60 million USD in Q3 and by additional 50 mln USD in Oct 2019 compared to the same period a year ago. Although Q3 FDI data are not yet released, based on projections, FDI is likely down in Q3 YoY, but not necessarily QoQ, being close to new lower levels of around 5-6% of GDP, without large-scale projects. Assuming around 50% YoY drop in Q3 FDI, the external sector can still be assessed as being broadly balanced, with strengthening dynamics observed in October. Overall, the current account deficit continues to be closely related to FDI-related imports, indicating that the worries about Georgia’s large current account deficit might have been somewhat exaggerated.

Different factors affect the dynamics of the trade balance. As the base effect dissipates, which is predominately related to lower oil prices and a oneoff decline of BP-related imports, the trade balance is going to worsen. Higher fiscal spending in 2019 supports stronger domestic demand, including imports; however, going forward, this effect will be much smaller. A weak retail sector, especially nonmortgage lending, has a negative impact on domestic demand, with a higher impact on imports (see TBC Economic Review, insight #6); however, non-mortgage credit is bottoming out. At the same time, lower GDP growth and investments also have a negative impact on imports of goods. In addition, a weaker GEL exchange rate improves the trade balance, reflecting both the balance sheet (income effect) as well as some expenditure switching (substitution) effects with a time lag, assuming that the trade in goods and services is elastic. However, given the narrow base of exports and import substitutes and the higher share of imported intermediate inputs, the substitution effect is likely to be more limited. Moreover, exports and imports, as well as domestic and imported consumer prices dynamics, call into question the existence of the substitution effect, even in the medium term. Further analysis is necessary in this regard, including on the effect on tourism. Overall, if the positive impact of a weaker GEL on the trade in goods and services only arises from the income effect, the impact should only be temporary, depending on leverage level perceptions and consumer and business sentiments.

Weaker inflows also appear to be temporary to large extent. In particular, the economic stabilization of Turkey needs consideration. Similarly, the negative impact on tourism from Iran and Russia is going to fade. Although the global slowdown will certainly have negative implications for Georgia, based on existing projections, this effect should be moderate. While global growth projections have been revised downwards in IMF’s October World Economic Outlook, falling by 0.3 and 0.2 pp to 3.0% and 3.4% for 2019 and 2020, respectively. However, the outlook has improved for a number of Georgia's economic partners and we thus expect a lower overall impact on Georgia. Furthermore, if and when large infrastructure projects, such as the Anaklia Deep Sea Port and HPPs, enter a more active phase, FDI inflows should strengthen back to higher levels.

In our baseline scenario, the growth of exports is projected to be around 10% and 8% in 2019 and 2020 respectively, in USD terms. Given the latest indications, the growth of tourism inflows will remain positive at around 1% in 2019 before recovering to 8% growth in 2020. As for remittance inflows, growth for 2019 as a whole is expected to be 9.4% and to stand at 9.0% next year. The first half of 2019 saw a sizeable drop in FDI (-35% YoY), and assuming FDI stabilizes at around 5-6% of GDP, the decline should amount to around 30% for FY 2019, before returning to more moderate growth in 2020 large scale projects being an upside.

Fiscal stimulus remained strong in Q3, being reflected in a robust expansion of both capital (+85.1% YoY) and current expenditures (+15.0% YoY). The budget deficit increased by 434 million GEL, or by an estimated 3.7% of Q3 2019 GDP, pointing to a significant boost of growth from the fiscal sector. The deficit was especially sizeable in September. Fiscal policy has strongly supported growth in 2019, especially when taking into account the advance payments at the end of December 2018.

When adjusted for those advance payments and assuming some, albeit a much smaller transfer of actual spending from 2019 to 2020, the 2018, 2019 and 2020 adjusted budget deficits stand at -1.1%, - 4.5%, -3.5% of GDP respectively*. According to the draft 2020 budget, capital spending will be largely unchanged from 2019 in nominal terms and will be somewhat below 2019 levels when measured relative to GDP. Despite flat CapEx in nominal terms, it will remain high at above 7% of GDP. Current expenditures are projected to increase by 8.1% YoY in 2020, standing at 23.2% of GDP. Despite being more socially oriented, the 2020 budget remains prudent from the macro perspective, as also confirmed by the recent successful extension of the program with the IMF.

In September, the growth of bank credit was 14.6%, unchanged from the previous month. Corporate credit picked up further, while MSME and retail growth moderated a bit. After the strong cyclical growth in 2018, we still expect business credit, and especially corporate, to be moderate at around the same risk appetite. The recovery of GDP growth in 2017 led to the recovery of inventory buildup with some time lag, and also to a subsequent recovery in investments (excluding the BP project and pubic infrastructure related investments). Thereafter, inventory and investment growth have normalized. However, business credit continues to grow at above-trend rates. While some one-offs, taxation-related demand*, some substitution of FDI-related inflows, and the reclassifications of retail credit into MSME and MSME credit into corporate credit are each somewhat contributing, overall it appears that leverage in the business sector is also increasing. Together with high growth rates, high dollarization in this segment also contributes to higher debt levels. In addition to the cyclical argument, slower GDP growth going forward and worsened business confidence in Q3 2019 should also play a role. At the same, the bank business credit and local corporate bonds to GDP trend (with 11% growth of business credit YoY at the moment) indicates that the cyclical recovery in business credit, and especially in corporate credit, may not be yet over. However, as always, this trend should be interpreted with caution. Overall, the leverage level appears to be acceptable, but there is probably little upside for sustainable high doubledigit growth rates going forward.