For the rating action annex, click here.

Rating action

Scope Ratings GmbH has today affirmed Georgia’s long-term issuer and senior unsecured local- and foreign-currency ratings at BB and revised the Outlook to Negative from Stable. The short-term issuer rating has been affirmed at S-3 in both local and foreign currency with a Stable Outlook.

Summary and Outlook

The Outlook change to Negative on Georgia’s BB ratings reflects:

1. The negative impact of the coronavirus outbreak on Georgia’s economy and public finances, owing to high economic dependence on tourism and travel sectors, alongside the economy’s small and open structure, and labour market vulnerabilities, amid a high net debtor position and structural current account deficits; and
    
2. The tighter financing conditions and elevated exchange rate pressures that weigh on the country’s foreign currency reserves, amid high shares of public and private sector debt denominated in foreign currency.

The affirmation at BB reflects: i) the government’s commitment to structural reforms (including on infrastructure and investment) and to Georgia’s Association Agreement with the EU; and ii) fiscal discipline, anchored by oversight via an Extended Fund Facility (EFF) arrangement with the IMF.

The Negative Outlook reflects Scope’s view that the risks to the ratings are tilted to the downside over the next 12 to 18 months. The long-term ratings could be downgraded if, individually or collectively: i) debt refinancing risks substantially increase; ii) capital outflows increase sharply and lari depreciation accelerates, resulting in material, adverse effects on debt sustainability and reserve adequacy; iii) growth prospects deteriorate more than expected; and/or iv) heightened geopolitical risks or institutional challenges re-emerge, undermining growth and investment outlooks.

Conversely, the rating Outlook could be revised back to Stable if, individually or collectively: i) financial conditions stabilise or improve for the government and/or there is substantial additional financial support allocated from multinational institutions; ii) external sector risks are reduced, including an easing in current market volatility; iii) reserves build-up resumes; iv) structural reforms improve productivity and labour market outcomes during 2020 and beyond; and/or; v) improvements in the fiscal framework strengthen fiscal sustainability.

Rating rationale

The first driver for the Negative Outlook is Georgia’s economic vulnerability to the Covid-19 shock, resulting in materially higher public debt and deficit levels. Scope projects Georgia’s real GDP to contract around 3% in 2020, after growth of 5% in 2019. This baseline assumes an average capacity utilisation in the economy of slightly above 70% in Q2 2020, based on measures deployed to contain the coronavirus’ transmission. In addition, drag from Georgia’s exposures to economic contractions in key trading partners alongside an economic recovery in the second half of the year are assumed. However, Scope notes significant downside risks to baseline forecasts.

Such key risks stem from: i) the economy’s dependence on tourism and travel services – these sectors are currently being hit by simultaneous supply and demand shocks, which, given the sectors account for around 30% of Georgian GDP, including indirect impacts on other economic sectors, presents severe consequences for the economy; ii) the vulnerability of the Georgian labour market, with almost half of employed persons being self-employed (reflecting the large agricultural sector and contributing family workers), groups whose cash buffers tend to be insufficient to offset the impact of sudden consumption shocks; and iii) the weak external environment and expected contraction in regional economies and in the EU, which will negatively affect goods exports, foreign direct investment (FDI) and remittance inflows to Georgia, only partially offset by benefits to domestic demand from lower oil prices.

For 2021, Scope expects a recovery in Georgia’s real growth to around 7% of GDP driven by a rebound in external demand, higher investments and employment gains. However, the speed of recovery will highly depend on the duration and intensity of measures deployed to contain the coronavirus and remains subject to risks.

The government has announced substantive fiscal policy easing to support the economy, with the general government deficit expected to widen to 7% of GDP in 2020, up on 2.7% in 2019. The government’s fiscal support package of 4% of GDP includes tax deferrals and interest subsidies for the tourism sector, support on utility bill payments for households, an increase in VAT refunds, a credit guarantee scheme, and higher funding for healthcare. This will be in addition to concessional loans from international financial institutions, including from the World Bank, which approved EUR 45m (0.3% of GDP) in financial assistance, the European Bank for Reconstruction and Development, which provides a EUR 1bn emergency financing package for 38 emerging economies including Georgia, and additional financing from the IMF. There is uncertainty to what degree stimulus actions will ultimately weaken the 2020 budget, also given the upcoming parliamentary elections. In 2021, the budget deficit is expected to narrow to 4.4% of GDP, reflecting both expected recovery in growth and the government’s commitment to fiscal prudence.

Scope projects Georgian public debt to increase to 50% of GDP in 2020, up from 41.4% in 2019 (slightly higher than the government’s medium-term target of below 45% of GDP for debt net of government deposits (the latter of around 3.5% of GDP)). The public debt ratio is, however, foreseen declining to 48.5% of GDP in 2021. Georgia’s debt trajectory is exposed to significant exchange rate risk, with 80% of debt issued in foreign currency (external debt, mostly in US dollars and euros).

The second driver of the revision of Georgia’s rating Outlook to Negative relates to tighter financing conditions and elevated exchange rate volatility, with the Georgian lari having depreciated about 10% vis-à-vis the US dollar and the euro since March 2020. Owing to central bank interventions, foreign currency reserves fell to USD 3.2bn at the end of March, down from USD 3.3bn at the beginning of 2020 and USD 3.5bn mid-2019 and remains below an IMF adequacy threshold of 100% coverage (of short-term external debt). Scope expects FX and capital flow volatility to last over the duration of the Covid-19 lockdown and global health crisis, risking further reductions in reserves. A large currency devaluation would adversely impact the government balance sheet given the large share of foreign currency-denominated public debt.

Inflation was 6% year-on-year in March, above a targeted 3% rate (reflecting past lari depreciation), with the central bank appropriately having increased the policy rate to 9% in December 2019, from 6.5% as of September 2019. As a result, in March, the yield on the five-year domestic currency government bond had increased to 9.6%, from 7.2% in the same month in 2019. Georgia, however, relies on foreign financing (80% of government debt is external debt, of which nearly 75% comprises multilateral loans and another 10% a single Eurobond issued in 2011), due to low liquidity in domestic capital markets. The government’s debt refinancing risk will pick up in 2021 once the USD 500m (equal to 15.6% of foreign currency reserves) Eurobond comes due in April 2021 – which constitutes a risk should external financial conditions remain highly adverse for a protracted time. The yield spread on the 2021 Eurobond over US treasuries with the same maturity increased from around 120 basis points at the beginning of March 2020 to over 400 basis points by April. Refinancing risk is, however, mitigated significantly by Georgia’s track record of sound access to concessional loans from international financial institutions – including from the IMF.

Despite these negative developments, Georgia’s ratings remain supported by key credit strengths.

Georgia’s government has been successful in attracting FDI to the economy, with FDI having financed 75% of persistently wide current account deficits over the last decade. Furthermore, Georgia’s current account deficits have fallen from an average of 10% of GDP over 2014-18 to 5.1% in 2019, supported by lower oil prices as well as the government’s export diversification strategy. Investments in the real economy are furthermore supported by a prioritisation towards public capital spending over current spending, with the former steadily increasing from 4.8% of GDP in 2016 to 7% in 2019 amid low budget deficits. Georgia ranks, moreover, seventh on ease of doing business among 190 economies included in the World Bank’s 2020 rankings.

The government’s credible reform agenda is supported by the EU-Georgia Association Agreement. The EU’s financial assistance to Georgia for 2019 amounted to EUR 127m (0.8% of GDP), including an additional EUR 25m from the ‘umbrella’ programme, supporting economic and institutional development.

Georgia has in the past posted low general government deficits, averaging 1.4% of GDP over the last three years. This has been underpinned by authorities’ commitment to fiscal discipline alongside oversight from the EFF arrangement with the IMF (amounting to USD 285.3m, or 1.6% of 2019 GDP, extended until April 2021). Georgia successfully completed the EFF’s fifth review in December 2019.

The Georgian banking sector is well capitalised and profitable with system-wide tier 1 capital amounting to 14.6% of risk-weighted assets in Q4 2019, above a regulatory target of 8.5%, alongside a return on equity of 20.3%, among the highest in emerging Europe. The non-performing loan ratio was a low 1.9% of total loans (4.4% under the central bank methodology) for the same quarter. However, Scope expects asset quality and profitability to markedly weaken as a result of the coronavirus shock, though mitigated by the central bank’s temporary lowering of capital and liquidity requirements for banks to help absorb potential losses, alongside the strengthening of the financial policy framework, including reforms on emergency liquidity assistance and banking resolution frameworks. In addition, Scope views positively government progress towards developing domestic capital markets to enhance lari liquidity, including the completion of the funded pension pillar as well as the legislation and support for establishing investment fund and covered bond markets. The dollarisation of the banking sector remains elevated despite a moderate decline over the past three years, with 55% of loans and 62% of deposits denominated in foreign currency. Possible large future exchange rate depreciations constitute a key risk for both bank and private sector balance sheets.

According to recent polling, support for governing party Georgian Dream for the October 2020 parliamentary elections stands at 34%-39%, down from 48.8% after the last parliamentary elections in 2016. Scope expects the next government to remain committed to structural reforms as well as to political association and economic integration with the EU. Still, heightened political instability seen in the second half of 2019, with public protests leading to the resignation of the prime minister, is adding to downside ratings risks. In addition, we expect geopolitical risks with Russia to persist in relation to unresolved conflicts in South Ossetia and Abkhazia, evidenced by Russia’s temporary ban on direct flights with Georgia. Scope sees a limited likelihood of a re-opening of trade corridors with Russia – the largest destination for Georgian exports – before upcoming parliamentary elections.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative ‘BB’ (‘bb’) rating range for Georgia. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Georgia, the following relative credit strength is identified: i) growth potential. The following relative credit weaknesses are identified: i) current account vulnerability; ii) vulnerability to short-term external shocks; iii) financial imbalances and financial fragility; and iv) geopolitical risk.

The combined relative credit strength and weaknesses indicate a sovereign rating of BB for Georgia.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers sustainability issues during the ratings process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its sovereign methodology, under which Georgia displays stronger performance than regional peers on the World Bank’s Worldwide Governance Indicators. In general, Georgia has made significant progress in recent years in improving the quality and effectiveness of its public administration and enhancing transparency. However, the lack of an established system of checks and balances and a fully functioning independent judiciary remain challenges.

Social factors are reflected in Georgia’s high, though gradually decreasing, poverty rate (20.1% of the population is under the national poverty line as of 2018 compared to 22% in 2016) and previously decreasing unemployment rates (11.6% in 2019, down from 13.9% in 2017), the latter reflecting still high levels of structural unemployment and skills mismatches. In addition, the share of informal employment in the non-agricultural sector is high, at 36.2% in 2018. Georgia’s working-age population (those aged 15-64) has decreased by 0.7% per year over the last five years, reflecting emigration.

Finally, environmental factors are considered during the rating process, but did not play a direct role in this rating action.

Rating committee
The main points discussed by the rating committee were: i) Georgia’s growth outlook, exposure to the Covid-19 shock; ii) labour market; iii) fiscal outcomes and projections; iv) debt sustainability, gross financing needs; v) external sector developments, foreign currency reserves and exchange rate developments; vi) banking sector; vii) geo-politics; and viii) peers.

Methodology
The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’ dated 25 July 2019, is available on www.scoperatings.com.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity and/or its agents did not participate in the ratings process. The rating was not requested by the rated entity or its agents. The rating process was conducted:
With Rated Entity or Related Third Party Participation   [NO]
With Access to Internal Documents                                [NO]
With Access to Management                                          [NO]
The following material sources of information were used to prepare the credit rating: public domain. Key sources of information for the rating include: GEOSTAT, Central Bank of Georgia, Ministry of Finance of Georgia, the IMF, the World Bank, the BIS and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Levon Kameryan, Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first assigned by Scope in 30 June 2017. The ratings/outlooks were last updated on 08 June 2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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