OREANDA-NEWS. Fitch Ratings has affirmed Georgia's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'BB-' with Stable Outlooks. The issue ratings on Georgia's senior unsecured Foreign - and Local-Currency bonds have also been affirmed at 'BB-'. The Country Ceiling has been affirmed at 'BB' and the Short-Term Foreign and Local Currency IDRs at 'B'.

KEY RATING DRIVERS

The ratings balance Georgia's large current account deficit, high level of external debt, low external liquidity and subdued per capita income levels with economic resilience and favourable governance indicators.

A flexible exchange rate, strong growth in tourism and recovering remittances are contributing to the adjustment of the external sector to a shock stemming from the collapse in oil prices and its impact on trade with and remittance flows from CIS countries. Foreign exchange reserves are projected to end 2016 at equivalent to 3.3 months of current external payments, up from 2.9 months at end-2015, but below the 'BB' median of 4.4 months.

Georgia runs a persistently large current account deficit, forecast at 11.9% of GDP in 2016 compared with a peer median of 2.4% of GDP, although net FDI inflows (9.8% of GDP in 2016) are also well in excess of peers (a median of 1.6% of GDP). The current account is forecast to narrow throughout the forecast period, as remittances and tourism pick up, but will still be close to 10% of GDP by 2018. FDI inflows generally have a heavy import requirement.

Current account financing will push up net external debt, which is forecast at 66.9% of GDP at end-2016 compared with a peer median of 15.7%. The debt structure provides some mitigants, as 89% of government debt (which constitutes 28% of gross external debt) is on a concessional basis and around 40% of corporate debt (52% of gross external debt) is inter-company lending. Nonetheless, debt service and liquidity ratios are weaker than the 'BB' median.

The fiscal deficit is forecast to widen to 4.4% of GDP, the largest since 2010, primarily due to higher social payments. Significant corporate tax reform is scheduled for 2017, which should stimulate growth in the medium term, but will cause a revenue shortfall estimated by the government at 1.2% of GDP in 2017. Compensatory measures are planned, but have not been publically announced and their full implementation could prove challenging. Fitch therefore expects the deficit to widen to 4.9%, before narrowing to 4.1% in 2018 due to fuller implementation of consolidation measures and stronger growth. Deficit financing will push up general government debt, forecast at 44.4% of GDP at end-2016, although it will remain below the peer median. At a projected 76.6% at end-2016, the foreign currency share of government debt is above the peer median of 51.2%.

Relations went off-track with the IMF with no reviews of the Stand-By Arrangement approved since 2014. The authorities are re-engaging with the Fund and aim to have a new agreement in place in 2017.

The outcome of parliamentary elections scheduled for 8 October is uncertain. Political parties are fragmented and another coalition government appears inevitable. Political parties tend to agree on key elements of economic policy, particularly the commitment to an open and business-friendly economy, and most are pro-EU. Georgia continues to enjoy very strong governance indicators by regional and rated peer standards.

Growth has held up fairly well in the face of the external shock. On a five-year average basis at 4.1%, it is above the peer median of 3.6%. Fitch forecasts growth of 3.2% in 2016, driven by reviving confidence, higher government spending, tourism and the start of work on a gas pipeline project. We expect growth to strengthen as the external environment improves and infrastructure projects support construction, although the import dependence of these projects will dull their impact on headline growth. Corporate tax reform will bolster medium-term growth, but offsetting fiscal measures may dampen output in the near term.

Banks have continued to weather the fall in the currency and weaker economic conditions. Non-performing loans rose to 3.9% at end-July from 3.2% one year earlier. A moderate devaluation buffer is built into foreign currency loans and only small open currency positions have underpinned the resilience of the sector to the lower lari. Banks are well capitalised, with capital adequacy at 17.5% at end-June, so are well positioned to absorb a moderate deterioration in their loan portfolios.

Georgia scores well above the peer median in the World Bank's Doing Business rankings, with Portugal the only sub-investment grade sovereign ranking higher. Human Development indicators are also above the 'BB' median, and per capita income is in line.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Georgia a score equivalent to a rating of 'BB' on the Long-Term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- External finances: -1 notch, to reflect high net external debt.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that could, individually or collectively, trigger negative rating action are:

- A widening in the budget deficit leading to a rise in public debt/GDP.

- A decline in foreign exchange reserves, for example by a widening in the current account deficit not financed by FDI.

- Deterioration in either the domestic or regional political environment that affects economic policymaking or regional growth and stability.

The main factors that could, individually or collectively, lead to positive rating action are:

- A revival of strong and sustainable GDP growth accompanied by fiscal discipline.

- Smaller current account deficits that contribute to lower net external indebtedness.

KEY ASSUMPTIONS

Fitch expects the Russian economy to contract 0.5% this year, before growing by 1.3% in 2017 and 2.0% in 2018. Economic growth in other key regional trading partners is also expected to improve in 2017 and 2018.