The true price of war in Georgia

Damages in civil infrastructure estimated at 1.5 to 2 billion dollars. Western countries pledging aid to Georgia – 3.5-4 billion USD - writes Wojtek Szpociński, Institute of Eastern Studies/Economic Forum, School of Commerce and Law

The war in Georgia has not demolished the country’s economy, although losses are substantial. But Europe’s energy security depends on whether an upheaval may be averted.

The conflict in Georgia has resulted in a serious undermining of the supply route for energy resources from the Caspian basin. This is evident from the recent actions of neighbouring countries, which have suddenly undertaken intensive negotiations with Gazprom.

Governments of Turkmenistan and Uzbekistan recently signed agreements with Gazprom on intermediation in sale of natural gas to external markets. On the other side of the Caspian Sea, the very same Gazprom is holding negotiations with Azerbaijan. The threat of a lack of supplies is real enough for Azeri Socar to stop the expansion of a gas storage facility outside of Tbilisi, which had been planned for a year.

With regards to oil, the Kazakh company KazMunajGaz is giving up on its plans to build a new refinery in its oil terminal in Batumi. This is no surprise, however. After all, it was Kazakh oil, burning on the train, which had been blown up near Gori. Images of this fire made the news all over the world. Bombs also fell mere metres away from the BTC oil pipeline. The Russians missed, but the threat was a clear one.

In these circumstances, the trans-Caspian project may only be saved by giving the Georgia conflict a genuine international dimension, together with bringing effective peacekeeping forces, into so-called buffer zones.This is not all, however. The fate of the Georgian economy is no less important to the trans-Caspian project. An economically stable Georgia will by default be an independent and pro-West state.

Although the headlines of newspapers are very worrying, so far one can hardly talk of a breakdown of the Georgian economy.

Optimistic forecasts made already after the war point to GDP growth of 5 percent at the end of the year. This means a reduction by more than half, as before the outbreak of the conflict, growth was expected to reach 10 percent. Tax revenues have not began to disappear – they are 3 percent lower than in the respective half of the previous year. However, a turn for the worse is possible: with the borders becoming more difficult to control, trafficking would increase and excise revenues diminish.

The decline in customs revenues is precisely what hit the Georgian economy the hardest. In the first week of war, they were 20 percent lower than forecast. This is not surprising, given the collapse in exports and transit of goods through the country. The comforting news is that the situation is gradually coming back to normal.

Paradoxically, privatization proceeds are not declining, even though all privatization auctions concerning plants located in areas controlled by the Russian army resulted in failure. Luckily, the large privatizations planned for this year were completed already before the outbreak of the conflict. This includes the port of Poti, still occupied by the Russians.The intervention in defence of lari, the Georgian currency, was successful, although it cost the Georgian central bank 300 million dollars. This is a very high amount relative to the country’s small reserves, reaching barely 1.5 billion dollars. By comparison, Russia has spent 16 billion dollars to defend the rouble, which in spite of the incomparable magnitude of the market and reserves, is a significant amount. In the most critical moment of the conflict, the Georgian central bank salvaged itself by lowering interest rates, increasing the money supply, but at the same time increasing the risk of rising inflation. The fight over the exchange rate of the lari was a key issue. To an average Georgian, the stability of the domestic currency is a testament to the effectiveness of the state. Over the past 2-3 years the value of both deposits, as well as loans in lari has been rising at a fast pace.During the first days of the crisis, around 10 percent of deposits were withdrawn from the two largest commercial banks – Bank of Georgia and TBC. In spite of this, the banking sector, in large part foreign-owned, managed to maintain liquidity and the banking system did not break down. After a week or two the money returned to the banks. However, it was not possible to avoid completely any consequences of the war: banks are currently very cautious about granting new loans. This is probably due to the losses of insurance companies linked to them, which have not been assessed as yet.