Fitch Upgrades Georgia to 'BB-'; Outlook Stable

Fitch Ratings-London-15 December 2011: Fitch Ratings has upgraded Georgia's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'BB-' from 'B+'. The Outlooks on the ratings are Stable. The agency has also upgraded the Country Ceiling to 'BB' and affirmed the Short-term foreign currency IDR at 'B'. The rating on senior unsecured debt has been upgraded to 'BB-' from 'B+'.

"The upgrade reflects Georgia's strong growth performance, the government's progress in reining in the fiscal deficit, a reduction in inflation and a rise in foreign exchange reserves," says Charles Seville, Director in Fitch's Sovereign team.

Georgia has reduced its budget deficit to an estimated 3.7% of GDP in 2011, from 6.6% of GDP in 2010. The recently-passed 2012 budget targets a deficit of 3.6% of GDP and the high share of capital spending and the government's current surplus gives it further flexibility if needed.

General government debt is set to decline in 2012-13 from the peak of 37% of GDP reached in 2010. While 79% of debt is in foreign currency, higher than most sovereigns, Georgia can still borrow from multilateral and bilateral sources, drawing on a pipeline of funds pledged in 2008. Concessional terms bring down debt servicing costs relative to peers. Georgia has smoothed its maturity profile following a successful Eurobond issue in April 2011, whose proceeds were used to buy back the majority of a Eurobond maturing in 2013.

Real GDP is set to grow by an average of 5.5% in 2012-13, faster than the 'BB' median, as Georgia reaps the benefits of past structural reforms. Georgia is investing in infrastructure that will enable it to take full advantage of its role as a transit country for the region. Growth areas include hydroelectric power and tourism. Exports are diversified by product and by market, affording some resilience to slower global growth.

Inflation has fallen sharply to within the National Bank of Georgia's (NBG) target range, following a food price-driven spike in H111, and the currency has appreciated. The NBG has allowed a two-way free float, intervening to accumulate reserves (which stand at USD2.8bn, or four months of current account payments.) High dollarisation limits the effectiveness of monetary policy, but it is improving.

A current account deficit (CAD) estimated at 11% of GDP in 2011 is a weakness, and Fitch does not expect significant narrowing. Equity foreign direct investment will finance around half of the CAD in 2012-2013. The rest is financed by a mixture of public and private sector borrowing. As a result, net external debt is amongst the highest among 'BB'-rated sovereigns at 47% of GDP.

Despite its solid macroeconomic performance and the turnaround in its public finances in 2009-2011, Georgia remains a relatively low-income, highly dollarised country with a wide CAD, institutional weaknesses and political risk. A favourable business and investment climate is an offsetting asset.

Political risk weighs on the ratings. Georgia is located in a geopolitically unstable part of the world and the regions of Abkhazia and South Ossetia are a potential flashpoint between Russia and Georgia. A resumption of hostilities is a low risk, but would have negative rating implications.

Georgia's institutions will be tested as it holds the third round of elections since the Rose Revolution in 2003, with the current president Mikheil Saakashvili due to step down after two terms in office. An increase in domestic political risk could be a driver of negative rating action, not least because it might interrupt capital flows - which include donor funds and multilateral lending.

In the absence of an adjustment in the CAD, an interruption to capital flows could complicate the financing picture, leading to a loss of reserves, currency depreciation, and potential negative rating action.

Sustained, broad-based growth and an improvement in macroeconomic stability, or a reduction in external vulnerabilities, could lead to a ratings upgrade.