"The Positive Outlook reflects Georgia's strong economic recovery, a reduction in both the budget and current account deficits, an improvement in the financial sector's health and some easing of political risk," says Art Woo, Director in Fitch's Sovereign Group.
The Georgian economy is recovering strongly, benefiting from the global economic recovery, large-scale international donor financing and an apparent improvement in trade performance. Fitch estimates real GDP growth of 6.5% in 2010, after a contraction of 3.9% in 2009. The agency projects relatively strong GDP growth will continue, with 5.0% and 6.0% forecast for 2011 and 2012, respectively.
The stronger macroeconomic backdrop should help to support continued fiscal consolidation. The programmed budget deficit target was achieved in 2010, coming in at 6.6% of GDP, down from a 9.2% shortfall in 2009. The government plans to reduce the deficit further to 3.9% in 2011 and 3.1% in 2012, driven by reductions in expenditure as a percentage of GDP. Fitch views this as achievable, but sees some downside risks to the implementation, given the government's short track record of fiscal consolidation (the deficit widened every year between 2005 and 2009). The proposed Economic Freedom Act may also constrain the government's fiscal flexibility by making it harder to raise taxes. Reducing the budget deficit and stabilising the government debt-to-GDP ratio, which was 38% of GDP at end-2010, would be important for any potential rating upgrade.
Georgia's current account deficit (CAD) has also narrowed. Fitch estimates that the CAD came in at 10.5% of GDP in 2010, down from 11.3% in 2009 and an average of 19.2% during 2006-08. This reflects stronger tourism receipts, workers' remittances, and revenues generated from the transport of energy. Nevertheless, the CAD remains sizeable and Georgia needs to attract substantial foreign direct investment and other private sector capital inflows to finance it. In addition, large CADs have driven a marked rise in Georgia's net external debt, which the agency estimates to have reached 53% of GDP in 2010, well above the ten-year 'B' range median of 9%.
Georgia's banking sector is also stronger due to an improvement in asset quality, healthy growth in deposits, and rising profitability. This has led to bank lending resuming, which should support the economic recovery. Capitalisation was relatively high at 17.4% at end-2010, providing a buffer against shocks. This is important given Georgia's history of macroeconomic and financial volatility and the high dollarisation rate of over 70%, which makes the banking sector and economy vulnerable to exchange rate risk.
Political risk in Georgia appears to have eased somewhat over the past 18 months or so, although Fitch still views it as relatively high. Relations with Russia remain difficult, but the agency does not expect a resumption of military conflict in the foreseeable future. Domestic political tensions also appear to have eased, as the governing United National Movement party has a dominant position and most opposition parties are participating in the electoral process following the failure of street demonstrations to oust President Mikheil Saakashvili in spring 2009.
Georgia's ratings are underpinned by its level of human development, which is well above the 'B' range median, a favourable business climate (underscored by Georgia's 12th spot in the World Bank's Ease of Doing Business rankings) low corruption and generally sound governance, strong GDP growth prospects, a track record of relatively low inflation and strong support from the international community.
Potential drivers of a rating upgrade would be progress in sustainably reducing the budget deficit and stabilising the government debt-to-GDP ratio. Similarly, a longer track record of robust and sustained economic growth, especially if accompanied by an improvement in Georgia's current account deficit and private sector capital inflows, would be positive for the ratings. Conversely, negative rating action could be taken if Georgia failed to implement fiscal consolidation to reduce the budget deficit and stabilise the public debt ratio, another severe bout of political instability occurred, or there was a failure to attract adequate capital inflows or a weakening in the trade and growth performance.
