THE SOUTH CAUCASUS: A REGIONAL OVERVIEW AND CONFLICT ASSESSMENT
REGIONAL OVERVIEW

Economic Development

All three countries of the Caucasus suffered significantly from the collapse of the Soviet Union and the break-up of the central planning system. Regional conflicts and the absence of export markets worsened the situation. The majority of industrial entities stopped functioning and the general infrastructure has worn out. GDP has decreased roughly by 50% since 1991, poverty levels have reached 60-80%, and unemployment has skyrocketed. This has resulted in dramatic levels of emigration from the region to Russia, Turkey, the Persian Gulf, and the West. Nevertheless, since 1994 all three countries have shown signs of macroeconomic recovery and progress in the implementation of structural reforms. Loans from international organizations were spent to cover budget deficits and finance reforms. The Caucasian states have laid the ground for a market economy, and have implemented free foreign currency exchange and the unimpeded repatriation of profits abroad.

Armenia has arguably been hardest hit by the economic downturn. In the early 1990s, it struggled with the economic embargo imposed by Turkey and Azerbaijan and the absence of energy resources. Since 1994, Armenia’s GDP has been on the rise at the average rate of 5%, even at the time of the Russian Financial Crisis in 1998. Armenia declined to enter the CIS Customs Union and instead aimed at becoming a member of the WTO. It is estimated that nearly 1,5 million people (half of the country’s population) have left Armenia permanently or temporarily in search of jobs, mainly to Russia. 45% of the work force is employed in the state sector, of which 36% are engaged in agriculture. Armenia’s economy is dominated by such industries as machine building, metalworking, electronics, chemicals and non-ferrous metallurgy. Other industries include construction, food processing and knitwear. Much of the heavy industry is based on the extraction and processing of ores and chemicals. Armenia’s economy is heavily dependent on imports of raw materials. Real wages in Armenia have dropped more than in any other country of the former Soviet Union, except Tajikistan. PPP (purchasing power parity) GDP per capita is estimated at $2200. Armenians, reportedly, spend 80% of their income on food.

The recovery of the Azerbaijani economy, on the other hand, started in 1994 after several Production Sharing Agreements (PSA) with leading Western oil companies, for the exploration of the nation’s hydrocarbon resources, were signed. Industrial output increased, and the gradual privatization of state property continued. The 2001 UNDP Human Development Report placed Azerbaijan’s GDP per capita at $2850, calculated on purchasing power parity (PPP). Conventional figures are closer to $650. The heavy dependence on the oil and gas sector (84% of exports) remains a concern among local and international economists as it poses a significant risk of the ‘Dutch disease’ hitting the country. Foreign Direct Investments (FDI) is also disproportionately concentrated in the oil and gas sectors, and in the Baku area, while the rest of the country gets only a minimum of foreign investment. The national currency, the Manat, remains weak and unpopular among the public, which prefers to invest in US Dollars as a secure way to fight inflation.

Over the last decade, Georgia’s industry and agriculture stagnated, and many structural problems fundamental to the economy remain unsolved. The economic crisis also affected social welfare systems, such as health, education and pensions. Despite macroeconomic stability achieved in 1994, no significant progress has been made in the strengthening of the State finances. Today, Georgia is classified as a food-deficit, low-income country. GDP per capita at PPP is ca. $2400. The new Georgian currency, the Lari (GEL), introduced in October 1995, has nevertheless performed satisfactorily. Starting from 1998, budgetary problems emerged, which were aggravated by the financial crisis in Russia – Georgia’s then major trading partner – resulting in a significant worsening of the macroeconomic and financial situation in the country. In the year 2000, severe drought significantly damaged the agricultural sector, while floods in Summer 2002 did severe harm to many parts of the country, especially Northern districts.

Structural Reforms.

When elected President of Armenia in 1998, Robert Kocharian promised to implement an effective economic policy. His economic program included supporting the industry, creating more jobs, creating favorable conditions for foreign investments, and cracking down on tax evasion and the black market. The IMF and the World Bank continue to have a large influence over the Armenian government. They have been urging the conduct of structural reforms in the country, especially the privatization of Armenia’s electricity network. The IMF has approved $40 million loan for the improvements in the transportation sector, and it was announced that future loans would be contingent upon progress in the fight with corruption. 85% of Armenia’s medium and large size enterprises and almost all of the agricultural land have been privatized. The telecommunication sector of Armenia has been largely privatized, with the Greek company OTE acquiring 90% of ArmenTel, the Armenian state operator, in 1998. In order to liquidate its debt to Russia, the Armenian Government has agreed to transfer several large Armenian industrial enterprises to Russian ownership with Russia agreeing to write off $98 million of Armenia’s debt.

The reform process in Azerbaijan is progressing, with a major novelty being the creation of an oil fund. Nearly 95% of all rural land and property will be transferred to private hands by 2002, yet due to poor financing and lagging supply-side reforms, the agricultural sector continues to experience growth problems. Floods in Summer 2002 worsened the situation. In the industrial sector, the long-awaited second stage of privatization started in August 2000, and should finally open up access to the larger enterprises of Azerbaijan’s industry and speed up the privatization process in general. 300 enterprises will be put on auction. In some sectors, such as agriculture, the share of private production is now close to 100%, whereas in service and industrial sectors it is at ca. 50%. Currently nearly 31% of the total work force is concentrated in the agricultural sector. According to the Azerbaijan Confederation of Entrepreneurs, some 70% of the able-bodied population (nearly 2,600,000 people) work in the private sector of the economy. The number of commercial banks in Azerbaijan decreased in the past few years as the National Bank tried to tighten regulations of the banking system by increasing the requirements of the level of founding capital for commercial banks. Currently there are 4 large state-owned banks and nearly 50 commercial banks. High levels of corruption, harassment by governmental officials and tax police, and a weak legal system nevertheless create little incentives for local businessmen to operate in the country. As part of the structural reforms in the Government and in order to create transparency in oil revenues, President Aliyev in 1999 created a special ‘State Oil Fund’, where all revenues from the extraction and sale of oil and gas, as well as bonuses from contracts with the western oil companies, will be accumulated. The state oil fund is subordinated to the President and is expected to spend funds for the development of Azerbaijan’s infrastructure, an investment-friendly environment, and the welfare needs of IDPs and refugees.

After the implementation of an anti-crisis program in 1994, developed in close consultation with international financial organizations, Georgia achieved macroeconomic stability. Economic reforms have been more successful than political reforms. The government developed a legislative framework to promote and sustain a free and competitive market-oriented economy and to encourage foreign investment. Important legislative milestones were reached in 2000 with the passage of key legislation aimed at extending the scope of the privatization program, creating capital markets, promoting accounting reform, and registering ownership of enterprises and agricultural land. Georgia professes to have some of the most progressive business legislation in the former Soviet Union, although there is often a disparity between the passage of legislation and implementation of the laws. Georgia became a member of the WTO in June 2000. By the end of 1997 about 60 percent of cultivated agricultural land was in private ownership. Privatization of small and medium enterprises was conducted between 1993-1998, during which more than 12,800 objects of trade and service were privatized. After that, the privatization of larger companies was launched. A total of 1,200 large enterprises have been transformed into joint stock companies, of which 910 have been privatized. Privatization remains to be carried out in the energy sector. Work is currently underway to elaborate strategies for privatizing energy distribution and energy generation branches, as well as the communications sector and the seaport of Poti.

Transport and Communications: The ‘Silk Road’

The South Caucasus has a favorable geographic location at the crossroads of Asia, Europe and the Middle East, and the three states have been eager to develop East-West and North-South transport corridors through their territory. Communication links through Iran and Turkey have been developed from scratch, since borders were mainly closed in the Soviet era and little trading took place. The key issues currently are the building and development of energy pipelines from Azerbaijan’s Caspian coast to Georgia’s Black sea coast, as well as through to Turkey; and the creation of new and modern highway and rail links across the region. Together with the highway from the Georgian-Turkish border to Istanbul, that is currently under construction, these new initiatives will link the Caucasus to western markets by road more efficiently. In 1998, Azerbaijan organized a major international conference in Baku on the restoration of the Ancient Silk Road, with the participation of the leaders of several regional nations. The Azerbaijani government has been successful in pushing through East-West energy projects, such as the completion of the Baku-Supsa pipeline in 1999, the decision to build the Baku-Ceyhan oil pipeline and the Baku-Erzurum gas pipeline. Construction on these twin lines is expected to begin in Summer 2002 and expected to be completed by 2005. At the same time, the reconstruction of major highways and seaports has been underway with credits from the World Bank and the EU. The latter has established the TRACECA (Transport Corridor Europe-Caucasus-Asia) and the TACIS (Technical Assistance to CIS) programs for similar purposes. In 1999, Azerbaijan completed the construction of its new airport, whose international standards and increased capacity should further develop Baku’s role as the transportation hub of the Caspian region.

Armenia is a landlocked country. Its major transportation routes, particularly railroads, were through Azerbaijan, and have hence been closed due to the war in Mountainous Karabakh, and the economic embargo imposed by Turkey prevented the opening of links westward. Infrastructure in the north of the country was severely hit by a 1988 earthquake. 40% of Armenia’s roads are in need of repair and only the roads to Georgia and Iran are main arteries. The American-Armenian billionaire Kirk Kerkorian allocated $38 million for the repair of roads, a program that started in 2001 and should finish by the end of 2002. In 2001, an Argentinean-Armenian businessman, Eduardo Eurnekian pledged to invest $50 million in upgrading Armenia’s main airport, Yerevan’s Zvartnots. Armenia has been largely excluded from the regional "East-West" transport corridors and oil and gas pipelines because of its war with Azerbaijan. Even though an Armenian delegation was invited and took part in the Silk Road conference in Baku in 1998, little came out of it for the Armenian side. Azerbaijan demands the liberation of its occupied territories before getting engaged in any kind of economic, trade or transportation cooperation with Armenia. In addition to that, the economic embargo by Turkey has also severely hit Turkey’s economy and transportation. Georgia’s ports of Batumi and Poti remain Armenia’s major gates to the outside world.

Georgia, with its outlets to the Black Sea, has a pivotal location to provide the shortest and most secure route between the Caspian and Central Asian basins and the West, as alternative to the vulnerable routes through Russia and Iran. Since April 1999, oil is flowing westward through the territory of Georgia via the new Baku-Supsa pipeline. Georgia has several main airports and two major Black Sea ports. Georgia has rail ferry links with Ukraine, Romania, and Bulgaria. The privatization and rehabilitation of the port of Poti, with technical assistance from USAID, is seen as an integral part of the development of the ‘Eurasian Corridor’ across Georgia. The port of Sukhumi in Abkhazia is currently not under the control of the Georgian government. The transport system in Georgia is relatively stable due to various international projects. However, Georgia’s road and rail transport systems are, as yet, inadequate to support Georgia’s role as a major transit route for trade between Europe and Central Asia. The Soviet-built transport systems were not designed to fulfill such a role, and several years of minimal maintenance during the early 1990s took a heavy toll. Upgrading these systems is a major priority. An important proposed construction project is the Akhalkalaki-Kars rail link with Turkey. The transit of Azerbaijani oil is also important for the Georgian economy. TRACECA will imply the establishment of strong and sustainable transport and energy corridors and their effective maintenance by a modernized telecommunication network across the whole region. The TRACECA countries have also signed bilateral agreements on a preferential trade regime and on cargo treatment.