The true price of war in Georgia

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.

Georgia’s banking system, efficient to an extent unseen in the post-Soviet region, has been fuelling consumption and the construction boom. After the outbreak of the war, the value of transactions made in the real estate market declined by 60 percent. And while lower economic growth is unlikely to be avoided, such a cold shower could have a positive impact on restoring a balance in the Georgian economy. Before the conflict, consumption in Georgia had been too high relative to investment.

In order for such a positive scenario to materialise, however, it is necessary to resolve other economic problems, not to mention the issue of rebuilding the country. Damages in civil infrastructure are estimated at 1.5 to 2 billion dollars.

The conflict also has a negative impact on Georgia’s image. It has been downgraded by Fitch and Standard & Poor’s agencies. This led to a drop in ratings of local banks. Turnover on the Georgian stock exchange also weakened.

There is no sector, which depends more on reputation, than tourism. Fires in the Kharagauli National Park, source of the Borjomi water or the oil contamination from demolished fishing boats in Kolkhida Park have resulted in losses of at least half a billion dollars and immeasurable damage to the environment. It was here, that luxury hotels were being built and new skiing facilities planned. War will definitely hit this group of investors hard. Losses will be substantial – tourists have left right in the middle of the tourist season and they will certainly not return this year. The situation may return to norm already next year. Three quarters of the visitors come from neighbouring countries: Armenia, Azerbaijan or Turkey. For them, such a trip will still have its advantages – price and proximity. Meanwhile, people from the West usually come to Georgia in search of an adventure; there are still few mass tourists. They are still likely to continue coming, because outside of the direct conflict areas, there are no major threats to safety.

There is also no news of nervous decisions of foreign investors, of course other than those from the fuel and energy sector. Political risk is taken into account when investing in this region. Exporters probably suffered the biggest losses, both large companies, as well as smaller family businesses. Losses arising from export difficulties may be estimated at 200 million dollars. They could become higher, because the damages have not been fully assessed and the situation is not yet stable.

Western countries are pledging substantial aid to Georgia – as much as 3.5-4 billion dollars in grants and loans. These amounts are entirely sufficient, provided that they are sensibly spent. They need to be devoted to reconstruction of infrastructure, but also to reducing the disproportions in the growth potential of Tbilisi and the rest of the country. This is the prerequisite for genuine stability of this country, which is what the West should care about.

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.

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