The Caucasus: Progress In A Troubled Region

Broadly positive developments last year suggest reform and economic development could take deeper root in 2019.

Could this be the year that market-centered economic reform takes root in Armenia? Last year the tiny Caucasian nation was chosen by The Economist as Country of the Year, a title awarded in 2017 to France.

Armenia was a natural choice this year. The success of former opposition leader Nikol Pashinian’s My Step Alliance in first forcing the corrupt Republican Party government into a power-sharing arrangement and then trouncing it in December’s early elections was dramatic. Pashinian’s bloc took over 70% of the vote and pushed the Republicans out of Parliament.

Now, for the encore: Close observers are wondering how far and how fast Pashinian will move, given the scale of what needs to be done—particularly in curbing the oligarchic vested interests that grip the economy. The stakes are high for this landlocked nation of just over 2.9 million people, almost one-third of whom live below the poverty line.

The stakes are also high for the region, where signs of recovery are taking hold. Armenia occupies a strategically sensitive position bordering Georgia; Turkey; Iran; and Azerbaijan, with which it has closed borders due to the unresolved dispute over the territory of Nagorno-Karabakh; and is dependent for energy on Russia.

“This year could really be a turning point for Armenia, but also for Georgia, whose already pro-reform government could be encouraged by developments in Yerevan,” says Maximilien Lambertson, Caucasus analyst for the Economist Intelligence Unit.

Lambertson reasons that December’s vote placed huge pressure on Pashinian to produce results. That means pushing economic reform and anti-corruption legislation through parliament; tackling poverty; and taking steps to resolve the issue of Nagorno-Karabakh, without which normal relations with Armenia’s powerful neighbor Turkey, not to mention energy-rich Azerbaijan, cannot resume.

“Pashinian will have to move carefully, mindful of what Armenia’s economy needs, but also of local realities,” Lambertson says.

Those close to the ground see reasons for optimism. Dimitar Bogov, regional lead economist for the European Bank for Reconstruction and Development (EBRD) in the Caucasus, expects the government to use its mandate to boost competition by tackling informal monopolies—Armenia currently has a single importer of sugar, for example—and improving transparency and governance in such areas as public administration, regulation, tax and customs.

“These are all areas in need of comprehensive reform that we and other international financial institutions will do whatever we can to support,” says Bogov, adding that success will reinforce sustainable economic growth.

Other priorities include diversification, moving Armenia away from its dependence on mining, which currently accounts for half of exports. Agriculture, IT and tourism are all areas seen to have big growth potential. Energy is another key area where change is needed, including boosting energy efficiency and sustainability and reducing money wasted on subsidies by making sure only those who really need help get it.

Projected GDP Growth (%)




Source: EBRD

Pashinian made a start with reform last April, focusing on improving the business environment, which led to Armenia jumping up the World Bank’s Doing Business table. Over 2019 and 2020, he should have strong growth and positive views of his economic management from lenders. Inflation is around 2% to 3%, and a conservative fiscal policy pushed the budget deficit to 2.7% of GDP last year against 4.8% in 2017, while the bank sector remains stable and well managed.

“The biggest risk to Armenia—but also to the other South Caucasus economies, which are also small, open economies—is a downturn in the global economy,” says Bogov.

Georgia: Rising Confidence

That would include Georgia. That country’s resilience last year was remarkable, given the major downturn in Turkey, one of its main trading partners, and the fact that the government followed a contractionary fiscal policy aimed at bringing the budget closer to balance.

“You might have expected to see a drop-off in growth and confidence. Instead, the reverse happened; while foreign direct investment, which reached around 10% of GDP in 2017, fell off only slightly to around 7% to 8%,” says Otar Nadaraia, chief economist at TBC Bank, Georgia’s second largest.

Many key sectors, however—notably tourism; real estate; construction; and the wine industry, which increased production 57% to 2 million hectoliters last year—continue to show impressive growth. Trade continues to benefit from Tbilisi’s free trade agreements with the EU, Turkey and China and its regional peers Armenia, Azerbaijan and the Commonwealth of Independent States. The government is also looking to sign one with the US.

Ongoing reforms—simplified business registrations, streamlined tax filing and payment and enhanced contract enforcement among them—moved Georgia further up the World Bank’s Ease of Doing Business rankings in 2018. Continuing infrastructure investments include the $2.5 billion construction of the Anaklia Deep-Sea Port, which is expected to give Georgia a central place in the region’s transport network and attract further investments, including some from China’s Belt and Road Initiative. The facility is slated for completion by the end of 2020.

“Reform needs are more sophisticated” in Georgia, says Bogov, “but some areas still need attention, including the justice system, especially for the settling of commercial disputes. Infrastructure connectivity is also an issue, particularly if Georgia is to continue expanding its tourism industry. Going forward, I would expect to see increasing numbers of projects financed through public-private partnerships.”


Business Friendliness Score

Ranking Increase


Source: World Bank, 2019 Ease of Doing Business rank, out of 190 countries

Other reforms Tbilisi might consider to please foreign investors include loosening restrictive laws on land ownership that have held back investment in agriculture. Employing nearly half the workforce and contributing roughly 8% of GDP, the sector has the potential to be one of the country’s most dynamic.

Fitch Ratings, which last August affirmed Georgia’s BB- assessment with a positive outlook, notes that reforms have been given a firm anchor by the three-year extended fund facility that Tbilisi signed with the International Monetary Fund in April 2017; disbursements have proceeded on schedule, and the IMF gave Georgia a solid report last December. Capital reserves built up at the central bank give Georgia some protection against its greatest potential challenge, a deterioration in global trade.

“Over 2019, we expect to see growth remain robust with a good investment outlook, supported by solid private- and public-sector capital spending. Credit growth is strong, and the bank sector has been doing some good intermediation,” says Marina Stefani, associate director at Fitch Ratings.

Azerbaijan: A Wake-Up Call On Oil

Azerbaijan enjoyed a moderate recovery in 2018 from the oil-price shock four years earlier. This year is expected to see the 878-kilometer Trans-Adriatic Pipeline completed and connected to the 1,841-kilometer Trans-Anatolian Pipeline. This will enable Baku to export gas from its vast Shah Deniz field, delivering a further economic boost when operations commence in 2020.

The non-oil economy has also posted some good news. Azerbaijan’s dramatic rise in the World Bank’s Ease of Doing Business table—an astonishing 32 places—highlights the government’s efforts to improve the once-murky business environment. New regulations simplify a range of business activities: obtaining permits, connecting to power grids, getting loans, paying taxes, and registering property. The government has also enacted reforms to protect minority investors, and put forth a plan for public debt levels—a ceiling of 30% of GDP in the medium term, tempered to 20% by 2025.

“The past few years have been a wake-up call about Baku’s dependence on hydrocarbons,” says Bogov. “The government needs to continue diversification, but also its reforms. … Initial efforts in the fight against corruption must continue.”

While there’s reason to regard the outlook as at least modestly favorable for all three of the region’s countries this year, they remain vulnerable to external events. In January, Russia increased energy prices for Armenia, rattling the cash-strapped economy. Relations between Armenia and Georgia will deepen, close observers say, potentially boosting trade and investment. Some hold hope that relations will also improve between Armenia and Azerbaijan. However, this would presume reaching agreement on thorny issues, including Nagorno-Karabakh.

But for all Caucasian neighbors, a continuation of last year’s broadly positive developments seems at least probable.