research reports

Highlights

• Real GDP in the US grew at a 3.1% annualized rate (3rd estimate) in 1Q19, unchanged from the 2nd estimate. Unemployment rate was 3.7% in June 2019, up from 3.6% in previous month.
• Chinese economic growth slowed to 6.2% y/y in 2Q19, after growing 6.4% y/y in 1Q19.
• In May 2019, economic growth was 7.3% y/y in Armenia, 4.7% y/y in Georgia, 2.2% y/y in Kazakhstan and -0.3% y/y in Russia, based on preliminary data. In 5M19, real GDP growth was 2.2% y/y in Azerbaijan and 1.0% y/y in Belarus.
• Annual inflation in the US was 1.6% in June 2019, down from 1.8% in previous month. Based on the Eurostat flash estimate, annual inflation in EU19 was 1.3% in June 2019, up from 1.2% in May 2019.
• In June 2019, annual inflation was above the target level in Georgia (4.3%), Russia (4.7%), Belarus (5.7%), Ukraine (9.0%) and Turkey (15.7%); inflation was within the target range in Kazakhstan (5.4%), and below the target in Armenia (2.5%). Annual inflation was 2.9% in Azerbaijan in June 2019.
• Fitch downgraded the sovereign credit rating of Turkey to BB- from BB keeping negative outlook on 12 July 2019.
• On 12 and 26 June 2019, TBC Bank issued US$ 300mn 5-year and US$ 125mn perpetual bonds, respectively. Both issues are listed on Euronext Dublin and Georgian Stock Exchange markets with 5.750% coupon rate for 5-year bond and 10.775% for perpetual.

Please see the full report for detailed coverage of the fixed income markets of Georgia, Armenia, Azerbaijan, Belarus, Kazakhstan, and Ukraine.

Enhanced customs procedures and trade infrastructure have transformed Georgia into a regional hub for the car trade since 2005. Successful reforms have enabled the economy to become a car-exporting country without its own car production industry. In the beginning, car re-exports were directed to its immediate neighbors Azerbaijan and Armenia, with destination markets diversified later. After continued growth during 2005-13 (with the exception of 2009), car exports fell sharply in 2014-16 due to the introduction of Euro-4 regulations in Azerbaijan coupled with the regional economic slowdown. However, car re-exports have recovered since 2017 as regional economies stabilized. Azerbaijan and Armenia are the largest export markets, with 71% of the total car re-exports in 2018. We expect car exports to traditional and new markets to grow, taking into account their improved economic outlook and low levels of car ownership.

Auto business turnover posted impressive growth of 14.8% CAGR over 2010-18, reaching GEL 2.6bn in 2018, up 17.6% y/y. The sector’s net profit margin averaged 5.1% in 2015-17 – in line with the total trade sector’s average of 5.2%. Car imports generated more than GEL 123mn in excise tax revenues in 2018 while car re-exports – Georgia’s second-largest export category – stood at US$ 408.3mn.

Government policy targets environmental and safety issues, addresses auto park renewal by making car ownership costly. With environmental and safety issues in mind, the Georgian government increased excise taxes on cars and fuel in 2017 and rolled out a mandatory vehicle inspection program in 2018. The government has also introduced a property tax on cars, pilot paid zonal parking, and car-sharing schemes, among other initiatives. Tax measures have incentivized hybrid car ownership, which has risen to over 48,600 cars in 2018 from 1,198 cars in 2015. This is only expected to continue. Despite growth in recent years, fully electric car ownership overall is low, with only 1,231 cars registered as of 2018. The development of charging infrastructure, the launch of an electric vehicle production plant, free parking facilities for electric vehicles and other government initiatives are set to support greater electric car presence in Georgia in the coming years.

Changes in excise tax structure expected to renew country’s outdated auto park. Georgia has one of the oldest passenger car stocks in the region at an average age of 20.3 in 2017 – higher than Poland (17.3), Romania (16.2), Lithuania (15.5), Russia (13.1) and Ukraine (19.6). Importantly, higher excise taxes on old cars and fuel from 2017 already yielded positive results in auto park renewal. Over 2017-18, 36.2% of the cars that received state registration were under seven years old, up from 9.4% of total clearance over 2012-16.

Georgia lags behind developed countries by number of private passenger cars per capita, showing room for further growth. On a per 1,000 capita basis, private passenger car penetration in Georgia is only 256 – far below the ratios found in Latvia (322), Estonia (419) and Russia (307) but still above Azerbaijan (112) and Turkey (147). We believe that actual car penetration number in Georgia is lower as official statistics incorporates idle vehicles and ongoing vehicle inspection program expected to reveal real numbers by the end of 2019.

The main catalysts shaping the future demand on cars will be the growing number of women drivers, the gradual renewal of auto park and rising household incomes. Despite the rising number of Georgian female drivers, out of the 1.23mn people in the country who hold a valid driver’s license, only 23% are women, showing room for further expansion. On top of this, mandatory technical inspection is expected to force drivers to move to relatively newer cars as 81.4% of vehicles registered in Georgia are already 12+ years old. Mandatory inspection also raises demand for auto parts and repair services. All of these, together with strong demand for car re-exports, are expected to drive auto sector revenue in the coming years.

• International visitors (tourists and same-day combined) surged 19.9% y/y to 0.7mn persons in June-19 after 14.2% y/y growth in May-19. This growth was mostly driven by 18.0% y/y increase in tourist arrivals, while same-day arrivals also posted strong growth of 23.6% y/y. Turkey contributed most to total growth, as arrivals surged in June-19 (+45.8% y/y), after continued decline from Sep-18 to May-19. Turkish visitors were main reason of same-day arrival growth in June-19. Arrivals from Russia remained largest source market, growing 30.8% y/y – mostly reflected in tourist growth figures.
   
• Visitors from the EU were up 29.3% y/y to nearly 52k visitors, with Germany (+67.7% y/y) and Poland (+17.4% y/y) driving growth. Visitors were also pronounced from Ukraine, Saudi Arabia and Kazakhstan, while arrivals from Iran more than halved (down since Jun-18 with the exception of Nov-18).
   
• Tourism generated US$ 379mn revenues in June-19 by our estimates, up 16.5% y/y bringing 1H19 revenues at US$ 1.5bn, up 11.4% y/y.
   
• We revise our tourism 2019 growth projection taking into account temporary travel restrictions on flights from Russia to Georgia starting on 8 July 2019. We expect tourism revenues to be flat y/y in 2H19 at US$ 1.9bn as we estimate tourism revenue loss of US$ 200mn in 2019 from reduced Russian arrivals. Therefore, we revise tourism revenues forecast for the full 2019 year at US$ 3.4bn from our initial projection of US$ 3.6bn.

Please see the full note here, which brings together tourist arrival data for reporting month, most recent statistical information available in the sector and 2019 forecast.

Georgia’s key positives lie in its economic and trade diversification, the success of implemented reforms, its macroeconomic resilience, low public debt level and strong banking sector. These factors insure economic resilience in the face of upcoming Russian sanctions on Georgia’s tourism and possibly on wine industry. Dealing with Russian sanctions is not a new challenge for Georgia. The 2006 Russian embargo forced Georgia to redirect its focus from Russian market, which expanded export destinations and improved quality of Georgian products. This also deepened economic ties with the rest of the world, with EU-Georgia free trade agreement signed in 2014, followed by free trade deals with China and other countries. We believe that upcoming Russian sanctions will further intensify Georgia’s economic diversification, use potential of new large markets – EU and China, and enhance its institutions.

Georgia’s exposure (as defined by combination of four channels: exports, tourism, remittances and FDI) to Russia accounted for 9.3% of GDP in 2018. Notably, since 2013 Georgian exports to Russian market increased significantly as trade was restored. Georgia also gained popularity among Russian visitors. Dependence on remittances from Russia has been reduced in recent years as EU became another alternative of Georgian migrants, while FDI from Russia is generally low.

In short,  recent Russian sanctions expected to weigh on Georgian economy, but unlike 2006 Russian embargo, the country is better placed to deal with negative shocks.  Summing up:
 

• We forecast sanctions to reduce Russian arrivals by 47% y/y in 2H19, while we forecast visitors from other countries to increase by 15% y/y in the same period, fully compensating reduced Russian visitors as well as sector revenues.
• We expect tourism revenues to be flat y/y in 2H19 at US$ 1.9bn in contrast of our initial growth projection of 12.3% y/y at US$ 2.1bn in 2H. Overall, we estimate tourism revenue loss of US$ 200mn in 2019 from reduced Russian arrivals. Therefore, we revise tourism revenues forecast for the full 2019 year at US$ 3.4bn (+6.9% y/y) from our initial projection of US$ 3.6bn.  
• Georgian wine export to Russia stood at US$ 114.5mn (3.4% of total exports) in 2018 and exports reached US$ 51.2mn in 5M19. We estimate revenue loss from possible Russian embargo on Georgian wine at US$ 58mn in 2H19. Notably, wine makers expected to adjust to market conditions quickly and redirect their product to  other destination markets, as Georgian wine is popular worldwide, unlike 2006.
• We expect real GDP growth at 4.3% in 2H19 as Russian sanctions expected to subtract 0.7ppts (US$ 260mn revenue loss or 1.6% of GDP) from Georgia’s real GDP growth. We expect 2019 full year growth at 4.5%, as economy expanded at an estimated 4.8% in 1H19.
• We  expect average GEL/US$ to remain close  2.7-2.75 in 2H19 and GEL to strengthen at 2.6 in 2020 as we do not expect additional pressure on GEL from Russian sanctions, but short term volatility due to uncertainty. Importantly, GEL remained undervalued by 7% vs US$ in 1H19 despite significant improvement in external balance. GEL weakness was mostly related to NBG’s FX purchases (US$ 216mn in 1H19) as well as other factors (FX reserve requirement, negative expectations from TRY depreciation, etc.). Our exchange rate projection considers different factors, including adequate international reserves and no FX purchases needed from NBG currently to comply with IMF program target, as well as external inflows from recent corporate Eurobond placements and trade balance in check.