South Caucasus economic and political trends forecast for 2015

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April 6, 2015
“Foreign Policy” report for Lenta.ru
Translated by Kristina Rus

Economic roots of instability

What awaits the South Caucasus this year

The drop in oil prices and economic difficulties in the coming year will affect the entire South Caucasus, except Abkhazia and South Ossetia: a steady cash flow from Moscow makes these countries immune to the changes in the world affairs. The region has experienced the first blow of the crisis back in December 2014; January and February news show that the entire year will remain under the sign of recession. Economic problems may provoke political instability. 

Read more on that in the new chapter of the forecast of “International threats – 2015,” prepared for Lenta.ru by “Foreign policy” agency.

Azerbaijan

The Central Bank of Azerbaijan announced about the unpegging of the national currency from the dollar. Inflation benchmarks shifted upwards. This is a major shift in financial policy of the country, which for many years kept the inflation and the exchange rate at bay. Manat, provided by petrodollars, was not only the most reliable currency in the South Caucasus, but also the most expensive: a colossal for a scale of a small country foreign trade surplus pushed up the manat exchange rate.

This year, the picture may change. Azerbajan is not threatened by a financial or budgetary crisis – gold and currency reserves now amount to more than $12 billion, and although in recent months they were quickly consumed ($3 billion spent in the fall), recent decisions of the Central Bank will allow to save them. The state oil fund is estimated at $37 billion. The state budget is based on oil price of $90 dollars per barrel, well above current prices. The planned budget deficit of $2.2 billion for the year will be higher, but currency reserves will cover the deficit for several years.

A drop in oil prices will affect the overall economy of Azerbaijan. Depreciation of the manat will make imports more expensive, which in 2013-2014 was 23-24% of Azerbaijan’s GDP. This may cause social tensions. During the years of the oil boom the country was unable to replace imports, which play a big role in many consumer markets. In recent years the country has been able to ensure the growth in agriculture and manufacturing industries, but the main stream of petrodollars was allocated to construction industry, which grew with a rapid speed (up to 36% per year). The crisis, on the one hand, will encourage import substitution, especially in agriculture and food industry, and on the other hand will hit the fastest growing sector of the Azerbaijan economy [construction – KR].

Political consequences are possible. The same groups in the Azerbaijani elite are the beneficiaries of construction and foreign trade. Their weakening can be expected, leading to shifts in exceptionally stable establishment. The intrigue of the year is whether Azerbaijan will be able to turn the decline in oil prices to its advantage and to overcome extreme (several times higher then Russia) dependence on hydrocarbon exports. State reforms could influence the situation, aimed at attracting investment, both domestic and foreign – into industries, not associated with oil and gas production. In turn, these reforms will certainly cause the resistance of powerful elite groups whose formal and informal powers to intervene in the activities of economic agents can be affected.

Баку
Baku (East News)

The economic difficulties faced this year by Baku will reduce the likelihood of a renewed war in Karabakh. A balance of power was established in the conflict zone in the two postwar decades, virtually precluding large-scale military action, especially because the economic damage to Azerbaijan from such a conflict risks to destroy its oil miracle. The position of the Minsk group mediators, including Russia, is the same – especially in terms of preventing the resumption of hostilities. However, the risk of armed incidents in the conflict zone remains: because of the increasing economic difficulties, both sides will need a valve for letting off steam. Perhaps the tensions in the conflict zone will encourage intermediaries to develop new initiatives if not for resolution, then for cooling the situation.

Armenia

Armenia at the end of 2014 survived the devaluation of dram against the dollar by 14 percent. The dram exchange rate against the ruble has strengthened. Due to the economic crisis in Russia has the volume of money transfers to Armenia from abroad has dropped. Armenia, like other countries of the region, is dependent on imports of many products, and devaluation of the dram with the decline in foreign currency inflows will lead to lower real incomes and consumption.

Yerevan joined the Eurasian Economic Union, and this to a large extent will determine the tendencies of development of the Republic. Membership in the Eurasian Economic Union (EEU) will soften the impact of the economic crisis in the country. On the one hand, Armenia will receive favorable conditions for the export of goods to Russia, Kazakhstan and Belarus, as well as Russian gas at a low price. Due to integration its revenues from customs duties will grow. On the other hand, Russia, in fact, assumes a part of the political responsibility for the condition of the Armenian economy, as her problems could be construed as failures of a politically significant integration project. This provides some insurance in case of a sharp deterioration in the economic situation in the country.

Владимир Путин и Серж Саргсян
Vladimir Putin and Serzh Sargsyan (Dmitry Azarov/Kommersant) 

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President Serzh Sargsyan managed to overcome the political crisis, defeating one of the most influential leaders of the opposition – Gagik Tsarukyan, who previously announced his intention to change the power in the country. A long period of domestic political confrontation ended with the victory of the President – probably not without the help from Moscow. Attempts to destabilize the political situation are likely to continue, but are unlikely to be successful. The vast majority of the political elite of Armenia, regardless of their view of the President, support the country’s integration into the Eurasian Economic Union and maintaining a close union with Russia. Among the non-governmental organizations and media, supported by the US and EU, there are opponents of this course, but there are no strong political leaders, able to consolidate this opposition.

Georgia

Armenia has no common border with other countries of the Eurasian Economic Union, and this makes for a particularly important relationship with Georgia: goods from Armenia to Russia go through its territory. It is possible that the countries will find the mechanisms of cooperation that will enable them to enjoy the benefits of both free trade zones: Armenia with the countries of the EEU, and Georgia with the EU. Armenia’s integration into the Eurasian Economic Union creates an additional incentive for dialogue about the establishment of transport communication through Abkhazia (at least by car) in addition to the existing route through Upper Lars. Apparently, this year we will see increased activity in this direction.

To date, Georgia has suffered from the economic crisis more than Armenia. The devaluation of the lari to US dollar amounted to 22.4 percent, remittances in January decreased by 23.3%. Exports decreased: in the first place – because of a strong downturn in Ukraine, second – due to the decline in exports to Russia, associated with the devaluation of the ruble. In 2014, the Georgian economy showed a good growth of 4.7 percent, but this year, a similar result will be difficult to achieve.

In light of the economic difficulties the internal political struggle associated with the attempts of the opposition “United National Movement” to return to power may increase. The appointment of former Georgian President Mikhail Saakashvili and his associates to a number of political posts in Kiev should be considered as an attempt of such return. At least they got a high political platform for their own propaganda. Saakashvili already announced that he intends to win the parliamentary elections in Georgia in 2016. It is unlikely that the UNM would venture to stage a coup before the election. But we cannot exclude that the elections in Georgia will be held ahead of schedule: the growing economic difficulties can push the ruling “Georgian Dream” to not wait until the UNM will take advantage of these difficulties in their propaganda. The intrigue of early elections is that “Dream” and the UNM, now represented in the parliament, are likely to lose a significant share of mandates. At the same time other forces may win seats in the parliament, which  will destroy the long-standing monopoly of “Western-Atlanticists” on the political Olympus of Georgia.

Internal political dynamics in Georgia are largely dependent on U.S. policy towards that country. It cannot be excluded that the American elite groups interested in aggravation of confrontation with Moscow, will seek to turn Georgia into another hotbed of confrontation. However, the U.S. is not prepared to provide Georgia with effective support – in essence, offering Tbilisi to provoke Moscow at their own risk. In such circumstances, sober-minded politicians in Tbilisi prefer to avoid conflict in the relationship with Moscow.

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