South Caucasus feeling Russia's pain

By bne IntelliNews December 19, 2014

Monica Ellena in Tbilisi -


The economies of the South Caucasus face challenges given the fallout from the geopolitical tensions and the difficulties that the Russian economy is facing. The heat is stronger on Georgia and Armenia, whose economies registered weaker trade and a decline in remittances from workers abroad, given their strong economic ties to Russia. At the end of 2014, their currencies – the Georgian lari and the Armenian dram – felt the shockwaves sent by the ruble quake.

According to Fitch Ratings, the high dollarization in both republics is a distinct weakness – the financial sector is well capitalised and liquid, but further weakening in the exchange rate could weigh on financial stability. The falling oil price is Azerbaijan’s primary enemy, and further declines could slow growth and potentially cause financial and economic distress in the country.

Tensions between Armenia and Azerbaijan escalated in November when Azerbaijani forces downed what Baku said was an Armenian military helicopter east of the disputed Nagorno-Karabakh enclave. The action, which Armenia vowed to avenge, killed three crew members and it was the first aircraft shot down in the conflict zone in the past 20 years.

However, growth across the South Caucasus is set to continue. For 2015, the International Monetary Fund (IMF) forecast Armenia’s economy to expand by 2.6%, Azerbaijan by 4% and Georgia by 5%.


In 2013, President Serzh Sargasyan announced Armenia would join the Russia-led Eurasian Economic Union (EEU) instead of signing the Association Agreement with the EU like neighbouring Georgia has done. Following the unexpected decision, Russia has been consolidating its economic and political influence on the land-locked republic of 3mn. The economic rationale for the EEU accession is weak, but Armenia cannot afford to harm its relations with Russia. However, the tie-up could turn sour over Russia’s deepening economic troubles.

Remittances from abroad have long been a major source of income for many Armenian families and the government itself, as the hard currency enables the country to finance its trade and current account deficits. Russia is the core source of such transfers, accounting for 86% of total remittances, which were in turn equivalent to roughly 18% of Armenia’s GDP. It then comes as no surprise that as money transfers from Russia have dwindled, the country’s growth suffered. According to data from the Central Bank of Armenia (CBA), non-commercial money transfers amounted to about $145.7mn in September, a 7% year-on-year decline and 9.8% decrease compared with August. The monthly decline is the fourth in a row: Russian money transfers to Armenia fell by 4.6% on year in June, by 6.6% in July and 7.7% in August.

The Russian ruble’s collapse has had a spill-over effect on the dram, which on December 5 hit its lowest level against the US dollar since 2006. In Yerevan, the central bank sought to downplay the dram’s fall against the greenback and attributed it to “recent developments in the regional and international financial markets," adding that the “exchange rate is in the “stabilisation zone” and that “reserves are absolutely sufficient for preventing all kinds of artificial exchange rate fluctuations and ensuring financial stability.”

In August, the CBA revised its economic growth forecast for 2014 downwards to 3.6% from its previous forecast of 4.1%. Likewise, international financial institutions also have lowered Armenia’s 2014 GDP growth forecast, with the IMF setting it at 2.6%, down from 4.3%. Consumer prices rose by 2.8% on year, largely driven by food prices in November, and inflation is forecast to close at 4% by year-end.

With two closed borders, with Turkey and Azerbaijan, Armenia’s geopolitical position is fragile and Russia has been a vital guarantor of regional security. President Sargsyan, a former defence minister, stated in early December that the military budget would top AMD200bn ($432mn) in 2014, up from AMD19.1bn in 1995 and AMD64.4bn in 2005.


President Ilham Aliyev has been courted by the West to turn Azerbaijan into an alternative energy supplier to Russia, but the president could face challenges both on the economic and social side from the falling oil price. The lower energy price will slow growth, highlighting the corruption and limited development outside of the glittering capital Baku, which might fuel social unrest.

Growth slowed in 2014. A contraction of agricultural output and falling oil extraction combined to leave GDP growth at 2.5% on year between January and September. The weak agricultural activity undermined the non-oil GDP growth, which retreated to 6% in January-September from 10.4% in the year-earlier period.

Azerbaijan has been trying to diversify its economy, but results so far have been unspectacular. In an interview with the Russian broadcaster Russia-24 on December 2, Aliyev, in his third presidential term, stressed that developing the non-oil sector is a priority for the future and put the target at 10% of the GDP by the end of 2015.

The IMF forecasts 4.0% economic growth in Azerbaijan for 2014 and 3.5% in 2015, down from 5.8% in 2013, driven by a decline in oil output and a slowdown in non-oil growth of 7% in 2014 and 6% in 2015. However, the IMF considers that short-term risks arising from low oil prices are mitigated in Azerbaijan by reserve buffers.

The energy-rich republic has calculated the 2015 budget based on an oil price of $90 per barrel, down from $100 this year, and predicted a significant fall in the sector's contribution to GDP. The government is confident that the economy can withstand a drop to $60 a barrel. International reserves remain strong and the government is ready to revise the budget if the oil price changes significantly.

State-owned energy company SOCAR is focused on developing the second stage of the Shah Deniz offshore gas condensate field, the expansion of the South Caucasus gas pipeline, and the construction of the Trans-Anatolian (TANAP) and Trans-Adriatic (TAP) gas pipelines, which will take the country’s gas into the heart of Europe via Turkey.

An estimated 3tn cubic metres of Azerbaijani gas will reach Europe via TAP, a part of the 3,500km-long Southern Gas Corridor. The expansion of the South Caucasus pipeline will connect the Azerbaijani Sangachal terminal with eastern Turkey through Georgia. It will link up with the SOCAR-led TANAP to be connected with a third pipeline TAP on the Turkish-Greek border. TANAP and TAP are scheduled to be finalized in 2018 and 2020 respectively.

Geopolitical tensions with neighbouring Armenia are not to be overlooked. In October, the government announced the defense budget will increase by 3.1% in 2015 to AZN2.95bn ($3.75bn), accounting for 17.9% of the total government budget, up from 14.7% in 2014. The increase further raises the stakes in the country’s arms race with Armenia after tensions rose again in November.


Georgia experienced steady growth in 2014, growing by 5.6% between January and October, according to the National Statistics Office, Geostat. The IMF expects growth to reach again 5% in 2015, although Renaissance Capital sees softer growth at 4.3%. The IMF stated its forecast is subject to risks, mainly on the downside, due to the escalation of regional tensions or further disappointment over the strength of the Eurozone recovery that could weaken foreign investment and trade. “But there is upside potential too. The recent decline in oil prices, if sustained, should lead to higher growth and a lower current account deficit.”

Georgia marked both the beginning and the end of the year with a sharp weakening of its currency against the dollar. The currency remained broadly stable throughout 2013 and 2014, while other currencies significantly lost their value against the dollar, but the lari winter blues sent ripples of worry. While some analysts linked the lari’s depreciation to Russia’s strains, the National Bank of Georgia and local analysts consider that the decline was triggered by market overreaction, as investors adjusted to the weaker external environment. The NBG’s primary monetary policy objective remains inflation targeting and it will intervene to sustain the lari only in case the depreciation starts affecting prices. On December 17, the NBG stated it expects no significant inflationary pressures and said that annual inflation may only reach the revised target of 5% in the second half of 2015. In the 2015 state budget approved on December 12, the government forecast annual inflation to reach 4% by the end of next year.

Analysts agree that the republic’s economic fundamentals remain sound – there’s a stable macroeconomic environment, prudent monetary and fiscal policies, a business-friendly environment, and a healthy banking sector. Fitch Ratings warns that a prolonged period of exchange rate volatility could weigh on the investment and business climate

Investment from local and international investors seems to reflect the stability. Foreign direct investment doubled in the third quarter from the year before, amounting to $508mn, up from $255mn, marking the biggest inflow in a single quarter in the last six years, according to preliminary data released by the national statistics service on December 9.

Remittances remain the biggest exposure for Georgia to Russia, which still accounts for 51% of the total flow. In the first 10 months of 2014, private money transfers from Russia amounted to $616mn, down from $653mn in the year-earlier period. However, increasing remittances from other countries, namely Greece and Italy, offset somewhat the decline from Russia and conflict-hit Ukraine. In 2013 Georgia received $1.47bn in private money transfers, about 9% of total GDP.

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