In one of the previous posts we discussed the issue of sustainability of Georgian growth, where it was identified that the growth was fully sustainable assuming that there was no change in exogeneous factors that would affect investors’ decision to make investments in Georgia.

For the sake of clarity we should go through balance of payments figure for 2006. There was large (around 18%) deficit in current account composed of significant deficit in goods and small surplus in services and transfers. Surplus in capital account was composed of large surplus in foreign direct investment and a small surplus in portfolio investment. To summarize the basics: country’s imports were comfortably accommodated by large FDI inflows ensuring stability in foreign balances and good conditions for economic growth.

It is worth noting that current account deficit has been rising during recent years making Georgia more dependent on FDI inflows.

The recent Russian provocation caused a massive outcry in world media and can be undoubtedly considered as a ”bad news of the month”. The events had a negative effect on Russian economy. During first days of the conflict 7 billion US dollar of investments were withdrawn from Russia and the tendency continued afterwards as well. Falling of RTS index (Russian Stock Exchange Index) accelerated and reached unprecedented levels.

What concerns Georgia, during first few weeks foreign reserves of National Bank of Georgia (NBG) (1.5 billion Us dollars) declined by 200 million US dollars. This process reversed soon afterwards, but situation is still shaky.

Although Armenians have large and rich diaspora in the world, foreign direct investment (FDI) has been historically low in Armenia. Although FDI growth rates remain high, Armenia still lies behind the countries in the region. To illustrate, FDI inflows in Armenia in 2006 were 450 US dollars, while foreigners invested around 1 billion dollars in Georgia, 3.7 billion dollars in Azerbaijan and 20 billion dollars in Turkey. Relative to neighboring countries FDI in Armenia stay at extremely low levels.

For 2007 Armstat reports 670 million dollars, while the same figure for Georgia is above 1.5 billion dollars. It is difficult to figure out its causes, however possible explanation can blockage that Armenia has been experiencing already for a decade.

Sustaining Karabakh problem in the present state is extremely risky for Armenia. Azerbaijan’s military strength is steadily increasing and the proof to that is last military parade, where Azerbaijan had opportunity to demonstrate this. It seems that Azerbaijan considers war scenario as one of the most probable way of resolving the conflict.

It is noteworthy that Azerbaijan is oil exporting country with 10 million inhabitants (vs. Armenia – a bit less than 3 million) and over 10 billion USD foreign reserves that are ready to use during the possible war scenario . Taking this into consideration and the fact that Armenia has full access to the rest of the world only through neighboring Georgia that strongly depends on Azeri gas and has closed borders with Russia, the situation for Armenia does not look very promising.

In case the war breaks out, Armenia will face it with very limited human, material and financial resources. Although many Armenians I have talked to truly and unconditionally believe that Kirk Kirkorian and other members of Armenian diaspora will be able to provide enough resources to cover this difference, I strongly doubt that the diaspora will be able to provide enough funds in a short periods of time.

It should be mentioned Armenia, like Georgia and unlike Azerbaijan strongly depends on foreign direct investment inflows that is major source of import financing. Since FDI is extremely vulnerable to instability, it very well may happen so that investors will not find Armenia the best place for their investments that may prove to be extremely harmful for the balance of payments. Therefore prolonged war can be devastating for Armenian economy.