Caucasus Business Forecast Report Q4 2009

Economic Recovery Expected

In 2010 BMI's Q409 Caucasus Business Forecast Report discusses the shape of the economic recovery in the three Caucasus countries in 2010. We expect trend growth to be lower in Armenia, Azerbaijan and Georgia over our five-year forecast period, compared with the previous five years. Unlike the vast majority of countries in the emerging Europe region, we project Azerbaijan to experience a 'V-shaped' recovery with real GDP growth forecast at 9.0% in 2010, following a 3.8% expansion in 2009. However, the medium-term outlook for the other two states is considerably weaker. We believe that the main risk to the Caucasus region over the medium term is political. Indeed we are particularly concerned by the elevated social unrest in Georgia, which combined with the uptick in tensions with Russia over the separatist regions of South Ossetia and Abkhazia, weighs on the country's short-term political risk rating. That said, we see the continued thaw in relations between Armenia and Turkey (who have had no diplomatic links since the early 1990s) as having positive implications not just for Armenia and Turkey, but also for the wider Caucasus region. We expect tensions between pro-government forces and the opposition in Armenia to remain elevated.

Indeed, the recently held mayoral election in the capital Yerevan on June 1 indicates the distrust and ill-feeling which still exists between Armenian political groups. Following the release of the election results, which revealed the re-election of incumbent mayor Gagik Beglaryan with 40% of the vote, the opposition claimed that its losses were due to electoral fraud. The opposition Armenian National Congress has since refused to take up its seats in the 65-member city council in protest over the alleged fraud. While there have been no significant protests by the electorate in favour of the opposition, we caution that as the country heads deeper into recession, the unemployment rate rises, and real incomes fall, the potential for an increase in social protests is definitely elevated. This is reflected in our short-term political risk rating, which has recently been lowered to 55.2 out of 100.

Georgia's current account deficit widened to US$2.91bn in 2008 from US$2.01bn in 2007. The 2008 shortfall represented a whopping 22.3% of GDP, up from 19.8% the previous year. Going forward in 2009 and 2010, we expect the balance of payments dynamics that began to emerge in Q408 and Q109 to manifest themselves further. While export demand will certainly fall, financing pressures should cause imports to fall even further, and this will rein-in the current account deficit to 10.7% of GDP in 2009 and 5.1% in 2010. We forecast the shortfall to stabilise around 3.0% of GDP in 2013.

Production from the second phase of the Azeri Shah Deniz development in the Caspian Sea has been pushed back until 2016, according to Norwegian major StatoilHydro's president in Azerbaijan Kristian Hausken. While the second phase is apparently ready to be developed, the delay is due to disputes over the transit terms for transporting gas from the field to Europe, Hausken added. The second phase of the Shah Deniz project was originally planned to come onstream in 2011/2012, but this date was pushed back until 2014 in March 2009 by UK major BP. However, Hausken stated that the 2011-2012 date is overly optimistic, and the field will likely come onstream around 2016. Currently, Shah Deniz produces around 5.5bn cubic metres (bcm) of gas per annum. The gas is exported to Turkey via Georgia. Peak production of phase two is expected to reach 20bcm. With start-up of the second phase now having been delayed, it is unclear when peak production will be reached.