IMPACT OF RUSSIAN SANCTIONS ON GEORGIAN ECONOMY

C O N F I D E N T I A L SECTION 01 OF 02 TBILISI 002114

SIPDIS

SIPDIS

DEPT PASS TO DEPT OF AGRICULTURE - PRIORITY
DEPT OF COMMERCE FOR 4231 DANICA STARKS
MOSCOW PASS TO USDA

E.O. 12958: DECL: 08/15/2027
TAGS: EAGR ECON ETRD PREL GG
SUBJECT: IMPACT OF RUSSIAN SANCTIONS ON GEORGIAN ECONOMY

REF: A. 06 TBILISI 419


B. 06 TBILISI 624

C. 06 TBILISI 709

D. 06 TBILISI 871

E. 06 TBILISI 1069

F. 06 MOSCOW 5104

G. 06 TBILISI 1647

H. 06 TBILISI 1730

I. 06 TBILISI 1786

J. 06 TBILISI 2601

K. 06 TBILISI 2626

L. 06 TBILISI 2846

TBILISI 00002114 001.2 OF 002


M. 06 TBILISI 3069


1. (U) Summary. A recent report by the International School
of Economics at Tbilisi State University provides a rigorous
analysis and confirms the widely held view that Russian
economic sanctions on Georgia have not had the intended
overall negative effect on the Georgian economy. Although
growth would have been higher had they not been imposed, the
sanctions came at a time when Georgia -- buoyed up by
increased foreign direct investment and economic aid from
donors -- was able to cushion the negative impact. The
blockade prompted maturation and diversification of the
Georgian export sector, and in fact, Georgian exports have
only increased since the beginning of 2006. At the
microeocnomic level, however, the ban caused losses of USD
600 million to key Georgian industries, affecting most
notably the wine sector and other agricultural industries
whose main export destination was Russia. Nevertheless, even
these industries were not as devastated as had been
predicted. If the GoG continues to seek new markets and then
is able to renew its ties with the Russian market, the cloud
on the Georgian economy caused by the sanctions will be seen
to have a silver lining. End Summary.

Timeline of the ban
--------------


2. (U) A series of economic sanctions by Russia started in
late 2005 and are still in place to this day:

- (C) December 2005: Russia restricts imports of agricultural
products from Georgia, citing problems with falsified export
certificates. GoG officials learn about the ban from the
press. Preliminary analysis indicates a negative effect on
exports (ref A).

- (U) January 2006: Gazprom doubles the price of gas to
Georgia to $110 per thousand cubic meters.

- (U) March 2006: Ban on imports from any country shipping
through Georgia; Russia cites falsified documents as a reason
(ref B). Two weeks later, Russia bans Georgian wine. The
Georgians cry foul claiming the wine meets U.S. and EU
standards (ref C).

- (C) March 2006: The ban is extended to cognac and
champagne. Minister of Foreign Affairs says privately the
ban would not be serious until the end of the harvest that
fall and hints the GoG will take the issue to the WTO
committee on market access and trade facilitation. In
Moscow, Russia's Chief Sanitary Inspector Gennadiy
Onishchenko refuses to meet with then Agricultural Minister
Svimonishvili. The GoG postpones tax collections for wine
producers for three months, and officials across the board
engage in a push to find new markets for wine (ref D).

- (C) May 2006: The ban is extended to mineral water, despite
Borjomi's strong working relationship with Onishchenko. The
ban follows then Minister of Defense Okruashvili's derogatory
statement about the purchasing preferences of Russian
consumers: that even fecal matter could be sold in Russia
(refs E and F).

- (C) July 2006: Russia closes the only official border
checkpoint with Georgia at Upper Lars (ref G),driving trade
into illegal smuggling routes in the separatist regions of
South Ossetia and Abkhazia (ref H). The Ministry of
Agriculture reports that Georgia had lost between USD 35-70
million because of the ban on wine and mineral waters (ref
I). The GoG continues helping the private sector develop a
long-term solution--looking to European markets for fresh
produce, improving standards, fighting falsified appellations
of origin, fighting smuggling of Georgian goods, and

TBILISI 00002114 002.2 OF 002


encouraging more food processing plants (ref H).

- (SBU) September, October 2006: Russian spy row prompts
Russia to recall its Ambassador and most of the diplomatic
corps (ref J) and to begin deportation of Georgians accused
of immigration violations. People die in the process of
deportation.

- (SBU) October 2006: Russia suspends all rail, air, road,
sea, and postal links to Georgia (ref K) prompting a request
for another donation of wheat from USDA (ref L).

- (U) Janaury 2007: Gazprom again doubles the price of gas
imports to Georgia to $235 per thousand cubic meters.

By the numbers
--------------


3. (SBU) The Russian blockade, though it continues, has not
had the intended or expected disastrous effect at the
macroeconomic level. The IMF initially predicted the longer
the economic blockade was in place, the worse the damage to
the economy, and that GDP growth in 2006 would be only 7
percent (ref M). However, the economy actually grew 9.4
percent in 2006 and is estimated to have grown by 11.4
percent in Q1 2007. Foreign direct investment (FDI) in 2006
was USD 1.1 billion and is predicted to be as much as USD 2.1
billion in 2007. Inflation accelerated in summer 2006 but
dropped below 10 percent by the end of the year and is
currently in the 7-8 percent range. Unemployment edged up
slightly, reaching 15.3 percent in early 2007, when
unemployment usually reaches a seasonal peak.


4. (SBU) This is not to say the blockade had no effect,
however. Extrapolating from trends over 1999-2005, exports
to Russia were reduced by about USD 175 million from those
predicted for 2006, largely because of the ban on
agricultural goods. According to time series analysis by the
Tbilisi State University economists, the Georgian economy
lost a total of USD 635 million (current dollars) from the
predicted value of GDP, about 7.8 percent, between January
2006 and March 2007. The agriculture sector took the greatet
hit, dropping 25 percent (USD 425 million) from predicted
output. The manufacturing sector dropped by only 2.6 percent
(USD 24 million) of its predicted output and construction
dropped 15 percent (USD 127 million) below the predicted
output. The remaining USD 24 million can be attributed to
various other sectors. The effect on migration patterns was
limited as Russia already had a strict visa regime in place
prior to the escalation in sanctions. Remittances from
Russia, averaging about USD 30-35 million per month, did not
decrease significantly, but there was a sharp drop --
averaging about USD 7.3 million per month -- in the outflow
of remittances to Russia after October 2006. Expansionary
measures taken by the NBG aimed at redirecting resources only
partially offset the impact of the Russian sanctions.
Georgia's economy was already on an increasing trajectory
prior to the blockade. Ironically, the Russian blockade
appears to have done more good than harm to the Georgian
economy, by forcing producers to look for alternative
markets, including the U.S.

Comment
--------------


5. (SBU) The analysis -- using official government data -- by
economists at Tbilisi State University appears to be
statistically sound, although its projections of potential
GDP and exports is limited by the short, 6 year time series.
We will continue to work with the GoG on further
business-friendly changes, including improvements to its
judicial system. We will look for ways to help Georgia
diversify its trade and industrial production and increase
its global competitiveness. End Comment.
PERRY