OPEN BORDER COULD INCREASE TRADE AND COOPERATION,

C O N F I D E N T I A L SECTION 01 OF 04 YEREVAN 000719 SIPDIS E.O. 12958: DECL: 09/20/2019 TAGS: EAID ECON ENRG ETRD PROG PREL AJ AM TU SUBJECT: OPEN BORDER COULD INCREASE TRADE AND COOPERATION, ENHANCE TRANSPARENCY Classified By: Ambassador Marie L. Yovanovitch. Reasons 1.4 (b/d) SUMMARY -------------- ¶1. (C) The closure of Armenia's border with neighboring Turkey has isolated this landlocked country and imposed a high price in terms of lost economic opportunities. Armenia is not part of any regional transportation or energy network. Its isolation has helped foster import monopolies, stifled development of a politically independent business culture, discouraged foreign investment and prompted out-migration of many talented workers. Nearly all of Armenia's imports--including food and refined petroleum--come through Georgia, a fact that results in premium-rate tariffs on Armenia-bound freight, contributes to a higher cost of living, and as the August 2008 Russia-Georgia conflict demonstrated, leaves Armenian supply lines vulnerable to disruption by events in Georgia. ¶2. (C) Opening Armenia's border with Turkey offers many potential economic benefits and enjoys the support of most, but not all, Armenians. Some caution that economic competition from Turkey would devastate small businesses. Less clear is the impact on the small number of well-connected businesspersons ("oligarchs") who monopolize many sectors of the economy and could see their control threatened. None have to date actively opposed the President's initiative, and some have openly supported it. Ultimately, Armenia may have no other way to achieve healthy economic growth than through opening its borders. END SUMMARY. HIGH COST OF LIVING, AND DOING BUSINESS -------------- ¶3. (SBU) For a developing country, Armenia is surprisingly expensive. Surveys have shown that retail prices for many consumer goods in Yerevan are higher than in many western European countries. In part, this reflects the choke-hold the Georgian transit industry/regime has on Armenian import markets. With closed borders with Turkey and Azerbaijan and minimal trade through the mountain roads from Iran, up to 80 percent of Armenia's imports flow through Georgia -- an advantageous position the Georgians fully exploit. ¶4. (C) Given the high tariffs for Armenia-bound freight transiting Georgia, Armenia has, according to some estimates, the highest freight transportation costs in the world. A 2007 study of the impact of opening the Turkish border 
estimated that transport comprises 20-25 percent of the costs of imported goods in Armenia. The Deputy Director of the Khimpro chemical plant in Vanadzor told Econoff that when importing inputs from Donetsk, Ukraine, transport costs for the segment from Donetsk to the Georgian port of Poti (a distance of 2,000 km by rail and ship) are the same as for transporting them from Poti to Vanadzor (500 km) by road or rail. With an open border, he could instead purchase inputs from Turkey and avoid shipping freight through Georgia. ¶5. (C) Closed borders also contribute to a high cost of living through the monopoly pricing they enable. With Turkish competitors out of the equation and imports through Georgia coming in at inflated prices, local businessmen can charge a premium for the goods they produce. For example, cement production in Armenia is controlled by two oligarchs, Gagik Tsarukian and Mika Bagdassarov. Khachatur Kokobelian, a leading pro-opposition businessman involved in the construction business, indicated he would prefer to import cement from Turkey, which would be considerably cheaper than what is available in Armenia. Kokobelian noted that for a project he is doing in Poland, he is able to import cement from Pakistan for less than it costs in Armenia. MISSED OPPORTUNITIES IN ENERGY TRANSIT -------------- ¶6. (C) Armenia has paid a high price for its closed borders with both Turkey and Azerbaijan in being unable to serve as a transit corridor for energy pipelines. If not for the frozen Nagorno-Karabakh conflict, the Baku-Tbilisi-Ceyhan pipeline could have been routed through Armenia, reducing the distance and construction cost, and providing Armenia both an alternative source of gas as well as much-needed transit fees. With other energy pipelines proposed for the southern Caucasus--most notably Nabucco--restoration of relations with Turkey, and ultimately with Azerbaijan, could allow Azerbaijan to connect to Nabucco and possibly other pipelines through Armenia. IMF SEES NOWHERE ELSE TO GROW -------------- YEREVAN 00000719 002 OF 004 ¶7. (C) IMF Senior Economist Carlo Sdralevich suggested to Econoff that, without open borders, Armenia is up against a developmental wall. While Armenia enjoyed double-digit GDP growth from 2002 to 2007, before leveling off to 6.8 percent growth in 2008 and an expected 15 percent decline in 2009, that growth was based in large measure on a construction bubble and remittances from Russia. Neither of those improved the country's productivity or competitiveness. With few engines of sustainable growth in Armenia, and neither Iran nor Georgia emerging as significant trading partners despite their shared borders, Turkey offers Armenia its best hope for significant economic growth, Sdralevich told us. ECONOMIC SECURITY -------------- ¶8. (C) Armenia learned in August 2008 just how much its economic security relies on stability in Georgia. During the Russia-Georgia crisis, Russia bombed the port of Poti and damaged roads and rail lines that carry the bulk of imports to Armenia, disrupting imports of food and fuel for several weeks. While the crisis was too brief to lead to a serious increase in prices, fuel stations began to ration gasoline and diesel, and some closed entirely. Fortunately for Armenia, this occurred in the summer, and there was no disruption to the natural gas pipeline running through Georgia. Despite minimal observable impact on the Armenian population, the GOAM and IMF estimated that Armenia suffered economic damages of over USD 600 million as a result of the events in Georgia. (Comment: While we consider that estimate to be too high, the conflict clearly had an impact and gave greater urgency to GOAM efforts to engage with Turkey. End Comment). -------------- BENEFITS OF AN OPEN BORDER -------------- ¶9. (C) Studies undertaken in recent years have attempted to estimate the potential economic impact both of opening the border with Turkey as well as of reaching a peace settlement over Nagorno Karabakh. While estimates vary, they range from about one to three percent additional GDP growth over the next 10-15 years. Gains would be expected in such areas as reduced transportation costs and increased exports, foreign direct investment (FDI),and temporary employment opportunities for Armenians in Turkey. A 2006 study by the Armenian International Policy Research Group, estimated that a peace settlement that reduced external conflict risk by 25 percent could lead to a 50 percent increase in annual FDI and an increase of GDP of three to ten percent. INCREASED TRANSPORTATION AND TRADE ROUTES -------------- ¶10. (C) Prior to the 1993 border closing there were at least six Turkey-Armenia border crossings in addition to the Gyumri-Kars railway (reftel). Reopening and upgrading these routes over time could stimulate the movement of both imports and exports by reducing travel distances and increasing competition among transport companies. Georgia might also, in this new competitive environment, reduce its tariffs on movement of freight through its territory so as to not completely cede the market. Armenian Deputy Finance Minister Vardan Aramian estimated that an open border would reduce costs of transporting products into Armenia by at least 20 percent. (Comment: With transport costs currently accounting for about 25 percent of the cost of imports, a 20 percent reduction in transportation costs could reduce import prices by five percent. While this discount would be welcome, breaking monopoly power over imports would likely achieve much greater savings. End Comment). New transit links would also hold the potential to benefit Azerbaijan (pending resolution of its conflict with Armenia) which also suffers from an over-dependence on transit routes through Georgia. ¶11. (C) While a reopened border would benefit consumers by lowering the cost of imports, it is less clear how Armenia's exports would be affected. Although an open border would also decrease transportation costs for exports, there are relatively few products where Armenia is currently competitive. Besides information technology -- which does not rely on an open border--and metals subject to world market prices (primarily copper and molybdenum),Armenia lacks a significant export sector. However, would-be entrepreneurial exporters who have been hindered under a closed-border regime could emerge if given access to new markets. Arsen Kazaryan, Chairman of the Union of Businesses and Manufacturers of Armenia, noted that an open border would improve access to traditional trade partners Syria and Lebanon, perhaps giving rise to new businesses ready to exploit the new opening. YEREVAN 00000719 003 OF 004 ARMENIA'S WINNERS AND LOSERS -------------- ¶12. (C) While most economists predict significant long-term economic benefits for Armenia from an open border, there will certainly be some losers, at least in the short term. Two sectors thought to be especially vulnerable to Turkish imports are agriculture and textiles, both of which largely continue to employ outmoded, Soviet-era technologies and practices. Although by U.S. standards Armenian produce tends to be very inexpensive, quality is also inconsistent, and farmers generally cannot compete with Turkish producers, as they find when they attempt to sell produce in Georgia; ultimately they might need to shift to new technologies or close operations. Armenian textiles are also likely to suffer from an influx of cheaper Turkish goods. Many also predict SMEs in general will be harmed by the new competition, as inexpensive Turkish goods flood across the border. (Comment: Turkish textiles and some produce are already imported into Armenia. However, an open border could be expected to reduce travel distances and transportation costs, thereby increasing the volume -- and reducing the cost -- of these and other imports relative to domestic products. End Comment.) ¶13. (C) The prospect of such adjustment elicits some anxiety here. But as Samvel Nikoyan, Deputy Parliament Speaker, told us, many of these concerns could be overstated. He noted that even with open borders, any country can still regulate its own trade through laws and ease the transition to more open markets. In addition, he asserted that in free economic relations, Armenians will always do well, pointing to the prosperity of Armenian Diaspora in the U.S., Russia and other countries as proof of the entrepreneurial spirit that should serve Armenians well with expanded economic opportunity. ¶14. (C) The impact on Armenian from stronger Turkish competition might also be mitigated through investment in Armenia by Turkish firms hoping to sell into Russia. The Chairman of the Turkish-Armenia Business Development Council suggested recently to the Ambassador that Turkish companies could establish operations in Armenia in order to take advantage of a Russia-Armenia Customs agreement that allows goods with just 5)10 percent Armenian content to be sold duty-free in Russia. OPEN BORDER COULD THREATEN MONOPOLISTS -------------- ¶15. (C) While epanded trade might give rise to new enterprises, conventional wisdom holds that many of the old enterprises will resist change. Armenian oligarchs -- well-connected businessmen who control imports of food, fuel and consumer products and comprise a major base of support for the President -- oppose a reopened border, the thinking goes, because of the potential threat to their monopoly positions. An increased number of border crossings could make it more difficult for businessmen to co-opt the Customs service (more palms to grease) to block competing imports. Opposition businessman Khachatur Kokobelian posited that Armenians' inherent entrepreneurial capabilities, unleashed in this new, more open environment, would result in enough competing product getting through so as to undermine monopoly power. ¶16. (C) Oligarchs may be concerned not only about losing their monopoly positions but about being able to compete at all. While some Armenian businesspersons may well prosper in a free economy, Richard Girakosian, director of the Armenian Center for National and International Studies (ACNIS), asserted that Armenia's oligarchs are not particularly sophisticated. Open borders would bring competition and sunshine to their commodity-based cartels, and would force them to compete in the "big leagues." Theoretically, the oligarchs could continue to use their political connections and corrupt practices to maintain their monopoly/oligopoly positions. But Girakosian suggested they may not be bright or flexible enough to succeed in that new, more competitive, complicated environment. ¶17. (C) Another potential area of unwelcome competition could come from Turkish buyers for products where Armenian businessmen now enjoy a monopsony (single-buyer) position. According to Kokobelian, a significant amount of Armenia's annual grape production is currently purchased by two leading oligarchs -- Prosperous Armenia leader Gagik Tsarukian (owner of the Noy Brandy factory) and parliament speaker (and potential 2013 Presidential candidate) Hovik Abrahamian. Because of their dominant market position and the inability of grape producers to export to Turkey, they are able to buy grapes for about half what Turkish buyers would be willing to YEREVAN 00000719 004 OF 004 pay for them if there were an open border. BUT THEY ARE NOT VISIBLY OPPOSING IT -------------- ¶18. (C) Despite their possible concerns about the impact of an open border, Armenia's oligarchs have not offered any visible opposition to the President's initiative. Indeed, the Prosperous Armenia party, headed by Tsarukian, has come out publicly in support of the President's reconciliation efforts with Turkey. Kokobelian posited that while many express concern in private about the impact of an open border on their business interests, they dare not openly oppose the process for fear of possible retaliation. COMMENT -------------- ¶19. (C) While there are sure to be both winners and losers from an open border, on the whole we believe that the net effect will be overwhelmingly positive for Armenia. There is the potential for a significant increase in cross-border trade, due to reduced transportation costs, an erosion of monopoly positions, and gains from comparative advantage. While competition from Turkey could overwhelm some SMEs, it is also possible that over time a freer business culture could help Armenian businesses lacking high-level connections compete in the regional market. An economy that typically relies on clan-based relationships and rent seeking would need to become more open, transparent, and based on arms-length transactions in order to succeed in a new regional market. END COMMENT. YOVANOVITCH