The Caucasus’ Chronic Crackup
Caucasus bonds continued to suffer with their own lingering conflicts highlighted by Russia-Ukraine, as Armenia, Azerbaijan and Georgia had index losses through end-July. The Moscow-Kiev confrontation summoned memories of the 2008 Georgian invasion over disputed South Ossetia, as a meeting between Armenia’s and Azerbaijan’s leaders reduced tension and yields 50 basis points following renewed fighting over Nagorno-Karabakh after a Russian-brokered ceasefire two decades ago. Baku has close ties with Turkey and as a major oil exporter just signed a $45 billion contract with a BP-headed consortium, and Yerevan joined Russia’s Eurasian Customs Union in late 2013 and relies on Gazprom imports but intends continued EU economic cooperation. Armenia inked a 3-year $125 million IMF program in March and its debut $700 million 7-year Eurobond last September at a 6.25 percent yield went mainly for repayment of a 2009 crisis loan from Moscow. GDP growth is forecast at 4 percent and inflation at the 5 percent target. The fiscal deficit should be 2 percent of GDP in 2015 after pension and wage adjustments while 2 percent current account gap improvement with mining FDI should bolster reserves now over 4 months imports. Occasional currency intervention has been required in view of the high financial system dollarization level, which also raises the cost of domestic Treasury borrowing. Foreign investor access to these securities will be enabled through Euroclear linkage, and capital market and private pension revisions should further promote integration and offer new business lines to banks preparing to meet Basel III regulatory standards, according to the Fund arrangement. Eurasia Union entry will hike average trade tariffs but also bring immediate energy and infrastructure project investment, including $300 million for a nuclear facility. Azerbaijan in contrast has ample foreign reserves and a current account surplus in addition to the $50 billion sovereign wealth fund, and direct Russian exposure is negligible at less than 5 percent of exports and with the main state owned bank IBA having a small cross-border subsidiary. The central bank recently lowered interest rates but private sector credit remains under 15 percent of GDP and lags neighboring transition economies, although mortgage lending has picked up and drawn supervisory scrutiny. World Bank business climate rankings are low particularly on governance and anti-corruption, and a new customs code was just enacted to meet eventual qualification for WTO admission. The state oil company preceded the sovereign in issuing external bonds which were “well received” despite bouts of geopolitical and general emerging market volatility, the Fund’s latest Article IV report comments.
Georgia signed another IMF standby for $150 million in July after reaching an EU association agreement, and a June financial sector assessment called for greater de-dollarization and small business credit and insurance-capital markets development. Unregulated intermediaries pose a domestic challenge and CIS tensions will hurt trade, FDI and remittances. Current gross external debt/GDP is over 80 percent including intra-company lines and must fall to 60 percent for medium-term sustainability, multilateral officials warned. Budget and current account deficit reduction will demand increased exchange rate flexibility and tax collection, and political stability could be complicated by the historic tendency to punish adversaries with the former US-educated president facing trial for alleged abuses, regional specialists comment.
