Caucasus Business Projection Industry Update Quarter 3 2012

Core Views
Azerbaijan's President Ilham Aliyev will win re-election in the country's
October presidential election. The country is in essence a one-party
state dominated by Aliyev's New Azerbaijan Party, and there is little
organised domestic opposition able to challenge him in elections.
Recent revelations surrounding the presidential family's finances
may exacerbate recent protests, although we do not see this as a
significant challenge to the Aliyev regime.
Recent trade rapprochement between Georgia and Russia will
herald notable economic benefits for the South Caucasian state.
Since 2006, exports of Georgian mineral water and wine to Russia
have been banned on 'health and safety' grounds, but on April 11
the ban on mineral water was lifted. Although we do not expect a
full resumption of diplomatic relations in the medium term, Russia
offers a vast export market for Georgia and if fully capitalised upon
will provide a marked boost to the Georgian current account.
Despite real GDP growth of 7.2% in 2012, Armenian development
will remain hindered by its high poverty and unemployment rates. In
addition, any deterioration in the eurozone sovereign debt crisis risks
the withdrawal of multilateral funding, and a pronounced slowdown in
Russian growth on the back of plummeting oil prices would severely
impact Armenia's GDP growth potential.
Major Forecast Changes
We have revised down our forecast for Georgia's end-2013 refinancing
rate, from 5.75% to 3.75%, as a result of the country's sustained
period of deflation. The National Bank of Georgia has an inflation
target of 6.0% for 2013, and with consumer price inflation recorded
at -2.1% in March – the fifth consecutive month of negative inflation
– we see further rate cuts in the pipeline.
Key Risks To Outlook
The primary risk to our views for both the Armenian and Azeri
economies remains the elevated level of tension between the two
states over the disputed Nagorno-Karabakh region. With the Azeri
presidential election approaching in October, we expect an increase
in inflammatory nationalist rhetoric from Aliyev, with the potential for
the current stalemate to deteriorate rapidly into all-out conflict. If this
were to occur, it would lead to substantial downward revisions for
both economies across all macroeconomic indicators.
The upcoming presidential election in Georgia, scheduled for October,
presents a key risk to our outlook. If the United National Movement
(UNM) – the party of incumbent President Mikheil Saakashvili – wins,
diplomatic relations with Russia will remain strained, as the UNM
in the past has pressed for closer European integration and has
taken a hard line against the Russian presence in South Ossetia.
This would result in downward revisions to our current account and
GDP forecasts, as trade between the two states would very likely
be affected.