ISET Economist Blog

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One Notch More Attractive to Investors with Deep Pockets
Just recently, a rare occurrence made the headlines in Georgia: Moody’s Investors Service upgraded the government of Georgia’s local and foreign currency issuer ratings first time in seven years, to Ba2 from Ba3, with commentary that the outlook remains stable. This news was met with great excitement, but was soon overshadowed by the unfortunate news of Georgia’s downgrade on the Global Competitiveness Indicators, without fully appreciating or understanding the significance of the Moody's upgrade. SO WHAT IS IT ALL ABOUT? Moody's Investors Service provides international financial research on bonds issued by commercial and government entities. Moody's, along with Standard & Poor's and the Fitch Group, is considered one of the Big Three credit rating agencies, occupying more than 90% of the market. Credit ratings express an agency’s opinion about the ability and readiness of a bond issuers, such as governments and financial and non-financial institutions, to meet their financial obligations fully and in due time. The creditworthiness of borrowers is assessed using an extensive set of indicators, and is expressed using a standardized ratings scale. There are slight differences between the rating scales of the three agencies, but they mostly fall under two broad categories: investment and speculative grades. The investment grades by Moody’s range from Aaa, highest quality, to the lowest risk credit; Baa3 is medium quality moderate risk credit (see the table below). There are eight other notches between Aaa and Baa3. The speculative grade ratings, where Georgia currently falls, despite the upgrade, starts with Ba1. Ba1, Ba2 (current ranking), and Ba3 fall under the category of credit judged to have speculative elements and a significant credit risk. There are seven other notches before the lowest category of grade C, for issuers with a very high probability of default. The outlook provides information to lenders on the potential evolution of a rating, and thus increases the precision of the rating. A positive outlook means that a rating may be raised. A negative outlook means that a rating may be lowered, and stable means that a rating is not likely to change. Developing (or evolving) means that a rating may be raised or lowered. Rationale for grade upgrade to Ba2 and stable outlook. According to the Moody’s Investors Service report, the upgrade in the rating was driven by Georgia’s recent economic growth and demonstrated resilience, effective macroeconomic policy management, and strong banking supervision that allowed banks to support an economy facing significant economic, financial and exchange rate shocks. Moody’s report underlines such significant ongoing processes such as diversification of trade, accessing new markets and building new investment relationships and the Association Agreement and Deep and Comprehensive Free Trade Agreement (DCFTA) with the European Union. In addition, recent and prospective trade agreements, such as those with a number of Commonwealth of Independent States members, Turkey, and the prospect of a free trade agreement with China, were relevant. The report emphasized that these agreements will help to maintain FDI levels at close to 10% of GDP, and will likely increase exports and economic growth in the medium term. With this recent upgrade, Georgia becomes one of the best performing countries in the region; however, sovereign credit ratings, except the one for Kazakhstan, still fall within the speculative credit grade category, reflecting ongoing economic and political vulnerabilities in the region. WHY DOES IT MATTER? Credit rating agencies are extremely important for developing countries like Georgia for a number of reasons. Sovereign credit ratings play an important part in determining countries' access to international capital markets, and the terms of that access, e.g. how much they can borrow and at what interest rate. Country sovereign ratings, which are widely available and comparable across countries, allow for savings on costs of information collecting and analysis. This is especially true for developing countries, and generally in countries with low levels of financial transparency.  The sovereign ratings play an important role even if the governments do not issue bonds, as the sovereign rating often provides a ceiling for the private sector, and the absence of a credit rating usually deters its access to international capital markets. Institutional investors in both the developed and developing world rely heavily on rating agencies in making investment decisions, or in the case of donors, in providing official development aid. A downgrade to speculative grade, or so-called to junk grade, forces some institutional investors, such as pension or insurance funds, to sell bonds or other financial instrument by the downgraded issuer, usually because of regulatory requirements. A recent study by the World Bank on the ratings of 20 developing countries between 1998 and 2015, found that a downgrade to junk raised the interest rates on a country’s short-term bonds by an average of 1.38 percentage points, which is considered to be a significant increase in cost of borrowing. Empirical evidence also establishes a connection between sovereign credit ratings and FDI. Cai et al. (2016) studied the effect of sovereign credit ratings on FDI flows between 31 donor (OECD) and 72 recipient (non-OECD) countries during the period 1985 – 2012. Sovereign ratings were found to be significant drivers of bilateral FDI flow. The study also looked into the regional effect; more specifically, it showed that FDI tends to flow to countries located in high quality credit neighborhoods. Investors prefer to invest in high average credit rating region, compared to low average rating regions. Second, sovereign ratings serve as an incentive for developing country governments to implement more prudent and sound monetary and fiscal policies, since performance on these policies constitutes a cornerstone of the rating methodologies. Analysis by Hanusch and Vaaler (2013) provides an interesting example as to how credit rating agencies contribute to fiscal discipline. The literature of political budget cycles predicts increases in government spending and fiscal deficit close to elections, allowing governments to appear competent in fiscal and economic affairs by providing additional public goods and services. The opposite is signaled through a public announcement of a credit downgrade, which is accessible to financial markets as well to constituents. According to the authors, this serves as a disciplining device for fiscal policy to not surrender to short-term political pressures, and rather to promote policies supporting long- term development objectives.  They show that governments going into an election year immediately after a rating downgrade are 27% more likely to lose at the polls. Governments going into an election year with a negative rating outlook run smaller budget deficits compared to those with positive or stable outlooks. IMMEDIATE CONSEQUENCES Driven by Moody's upgrade of Georgia's government bond ratings, which indicates the government's improved capacity to provide needed support to commercial banks, Moody's has upgraded JSC Bank of Georgia's (BoG) and JSC TBC Bank's local-currency deposit ratings to Ba2 from Ba3, and their foreign-currency deposit ratings to Ba3 from B1. BoG's senior unsecured foreign-currency debt rating was also upgraded to Ba2 from Ba3. The ratings continue to carry a stable outlook. In other words, most immediately, two major financial institutions will be able to access international capital markets at a lower cost, albeit slightly, which could lead to positive developments for these institutions and subsequently for the whole Georgian economy. Given the very strong similarity in credit rating methodologies of the three major agencies, it is very likely that the two other agencies, Standard & Poor's and Fitch Group, will also upgrade Georgia’s ranking, which will reinforce Georgia’s image as a one notch more secure place for lending and investment. However, one has to keep in mind that the market is more sensitive to negative news, compared to positive, and therefore this upgrade comes with increased responsibility for fiscal discipline and sound monetary policy. See our article usage guidelines 
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Wanna Get Rich? Make Batumi Your “Second Home”!
ISET-PI’s Researcher Irakli Kochlamazashvili was invited to Maestro TV on March 22, 2016, where he talked about reasons behind decrease in Georgian nut export. He explains that not many countries produce nuts. The major player in the region in this field is Turkey, which produces around 70 percent of nuts. Because most production belongs to Turkey, it is up to them to decide prices. Therefore, it is hard for Georgia to compete. Another issue is that Georgia does not use shells, which are useful for different purposes including making furniture. From Georgian side there were expectations that the prices would have stayed the same as in 2014. According to Irakli, this was a result of an incorrect analysis. Nut export has a huge potential for Georgia, as it is already bigger than wine. Government needs to be more concerned about this sector. In this case it has an ability to assist the industry through consultation centers that belong to the Ministry of Agriculture. Irakli claims that informing farmers is a good way to help increase nut production and export. Watch the video from Business Contact on Maestro TV to learn more.
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How Businessmen Grow Wings
ISET Hosting a Workshop with Georgian and Lithuanian Energy Regulators Regulations in the energy sector are there in order to ensure improvements in efficiency and service quality. They are essential because many actors in the energy sector of any country are state companies and/or natural monopolies for which efficiency and quality of service are somewhat foreign concepts.An EU-funded twinning project "Strengthening capacities of the regulatory cost audit and market monitoring" brings together the regulatory authorities of Georgia and Lithuania in order for them to learn from each other’s experience (and mistakes). As part of this project, on March 15, 2016, ISET hosted a workshop involving energy regulators from both countries. The Lithuanian National Commission for Energy Control and Prices (NCC) was represented by Vygantas Vaitkus. The Georgian National Energy and Water Supply Regulatory Commission (GNERC) was represented by three ISET alumni (class 2011): Giorgi Kelbakiani, Nikoloz Sumbadze and Irakli Galdava, chief specialists with GNERC’s electricity and gas departments.
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What Does It Take to Become a “Vakeli“?
Open Society Georgia Foundation commissioned ISET-PI to prepare a policy paper regarding the progress made on the implementation of Deep and Comprehensive Free Trade Area (DCFTA) in Georgia and to conduct a training for the members of the European Integration Committee and the Economic Affairs Committee of the Georgian Parliament regarding DCFTA in frames of the project “Raising support and enhancing understanding of the Europeanization process in Georgia: information and communication campaign on EU-Georgia Association Agreement, including DCFTA”.
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Law Can’t Buy Me Love… To The National Currency
In February 2016, the average cost of cooking one standard Imeretian khachapuri declined to 3.44 GEL, which is 4.3% lower month-on-month (that is compared to January 2016), and 4.7% higher year-on-year (compared to February 2015). The monthly (negative) change in the Index follows the traditional seasonal trend in fresh milk production, which gradually resumes in January and February. The annual increase, however, reflects an uptick in price inflation. Practically all khachapuri ingredients (with the exception of flour, which dropped 1.6% y/y) went up in price compared to last year: cheese (up 4.9%), eggs (2.7%), milk (10%), butter (15%) and yeast (9.3%). These increases are very much in line with the official estimate of annual inflation by GeoStat, currently standing at 5.6%.
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Is Georgia Heading towards an Oversupply of Hotels?
On September 22-26, 2014 researchers from the Leibniz Institute of Agricultural Development in Transition Economies (IAMO) in Germany visited ISET in the framework of their research tour to Georgia. Several panel discussions and workshops were conducted with the goal to discuss current challenges of agriculture and rural development in transition countries. Both academic and policy discussions brought together several stakeholders of Georgian agriculture, such as Georgian Farmers’ Association (GFA), EU Delegation to Georgia, GIZ, USAID, Agricultural Policy Research Center (APRC) at ISET-PI, etc. Among others, topics such as policies for sustainable agriculture, development of modern agricultural value chains, agricultural trade policies of transition countries, the role of education and extension in agricultural development, and structural transformation pathways of farms in transition countries were discussed by the participants.