By Eric Livny, Mack Ott, Karine Torosyan, ISET

With the support of the DFID

Impact of Russian Sanctions on the Georgian

Economy

Sanctions timetableDate Description

Dec 19, 2005 Restrictions on imports of agricultural products from Georgia

Jan 2006 Sharp increase in the price of gas imported from Russia

Mar 15, 2006 Ban on Georgian wine, wine products, brandy and champagne

May 5, 2006 Ban on imports of Georgian mineral water

July 8, 2006 Georgian-Russian border checkpoint at Verkhniy Lars closed

Sep 27, 2006 Arrest of Russian officers by Georgian authorities

Sep 28, 2006Russia recalled its ambassador in Georgia, and began a partial evacuation of Russian diplomatic staff from Georgia

Oct 3, 2006Russia suspended air, rail, road, sea and postal links to Georgia, and stopped issuing entry visas to Georgian citizens

Jan 2007 Another sharp increase in the price of gas imported from Russia

Purpose of studyTo quantitatively assess the economic impact of

the sanctions regime on Georgia: Analysis of macroeconomic aggregates: GDP –

overall growth and structure, inflation, unemployment and capital.

Sector-specific analysis for industries affected directly (e.g. agriculture, transportation) and indirectly (e.g. trade and services, construction)

Analysis of international trade dataAnalysis of data on migration and remittances

which have direct implications for the Georgian labor market as well as household spending and investment patterns

LimitationsAs always in social science research, lack of a reliable

counterfactual. In our case, other factors are far from equal: extremely rapid growth in the neighboring countries (Azerbaijan and Armenia in particular) and surge in international assistance

Capturing only the short-term effect, whereas a full adjustment to new trade barriers and higher energy prices will take more time

Short time series reducing the reliability of quantitative estimates (primarily within the confidence bounds)

Official data capturing only the “tip of the iceberg” whereas much of the “redirection” effort takes place far from the official eye.

The macro indicators and average industry estimates not capturing the differentiated impact on Tbilisi and the rural parts of Georgia, except for data on agricultural output.

“View from Mars”The sanction regime appears to have little impact at

the level of macro aggregates, at least not an easily discernible one.

GDP growth is running ahead of the NBG estimates for2006 and has been reported to be well above the forecasts in the first quarter of 2007—a preliminary estimate of GDP growth in 2007/I is 13%.

Inflation rate, as measured by the CPI, accelerates in 2006 II-III, but drops back to under 10% in 2006 IV

Unemployment edged up slightly in 2006/III, but remained at or below the 2005 rate, being consistent with real GDP growth

Detailed view (major findings) - IThe total losses for the Georgian economy at the

level of up to $600 million current (2006) dollars. Despite this powerful blow on the Georgian economy, GDP growth performance in 2006 was very strong: between 8.5 and 9%

The biggest drop was in the agricultural sector. A few other sectors (trade services, repair services, transportation and storage) increased production above the long-term trend line, partially compensating for the slowdown in agriculture

Countercyclical fiscal and monetary measures as well as policies aimed at redirection of effort and resources have partially offset the impact of Russian sanctions

Detailed view (major findings) - II Drop in exports to Russia is 175 million. There

may have also been some damage to exports to other important trade partners.

The direct impact of Russian embargo and transport blockage on the labor migration from Georgia to Russia is quite limited: the flow Georgian citizens to Russia has already been restricted by the visa regime that had been put in place before the recent escalation in sanctions

There is no sizeable decrease in the flow of remittances from Russia, while there is a sharp drop is the outflow of remittances to Russia

Analysis of Aggregate GDPData: aggregate quarterly GDP, constant USD (1996)Time period: I.1996-IV.2006 for the total of 40

quartersSource: Department of Statistics under Ministry of

Economic Development of GeorgiaMethod:

Fit a quadratic time trend with seasonal adjustment through pre-sanction GDP data (36 quarters before 2006)

Extrapolate the trend to post-sanction time periods (4 quarters in 2006)

Compare predicted with actual GDP in each quarter of 2006

Predicted and Actual Quarterly GDP (1996-2006)

Values are in million constant (1996) USD

400

600

800

1000

1200

0 10 20 30 40number of quarters passed from 1996 4th quarter

level of output for sector in a quarter of year pred./fitted value of gdp

Aggregate GDP: ResultsThe overall GDP loss for 2006 is about 635

million current USD, or about 7.8% of the predicted GDP.

In all 4 quarters of 2006 the actual GDP was within the 95% confidence interval, but it was consistently closer to the lower bound of the interval.

Results suggest that there has been a level shift effect post embargo, but the growth rate of real GDP has not been reduced.

Agriculture, Forestry, Fishing Agriculture is the largest sector of production

in Georgia with 19% GDP share in 2006.Trade in agricultural products with Russia has

been rather high before sanctions. Agricultural output in 2006 was below its

predicted level by about 425 million current USD, which comprises: More than 5% of GDP in 2006 Almost 25% of the predicted output in agriculture 65% of estimated underproduction in Georgia in

2006

Predicted and Actual Quarterly Agricultural Output (1996-2006)

Values are in million constant (1996) USD

100

150

200

250

300

0 10 20 30 40number of quarters passed from 1996 4th quarter

output for sector in a quarter pred./fitted value of agriculture

ManufacturingAnother very important sector in Georgian

economy is manufacturing with 11% GDP share.We find evidence of some underproduction in

manufacturing sector in the first quarter of 2006, but production level catches up with the predicted level for the rest of the year.

Overall, the estimated decrease in manufacturing is about 24 million current USD, which comprises Only 0.3% of actual GDP in 2006 About 2.6% of predicted manufacturing output in 2006

No Effect in Manufacturing?Manufacturing is one of the most important and

quickly developing sectors in Georgia, and the lack of impact from the embargo is encouraging.

To understand this we conducted a series of interviews with producers of mineral water, wine, locomotives. It appears that:Even though sales to Russia were drastically reduced,

production level was kept high, increasing firm inventories

Some output was redirected to other markets Companies started development and production of

new products

ConstructionThe relative share of construction in total

production rose from 2.5% in 1996 to 9% in 2006.

During all four quarters in 2006 there was under-production in this sector compared to predicted output.

Overall loss in production in this sector is estimated to be about 127 million current USD, which is 1.6% of actual GDP in 2006 15% below predicted output in construction in 2006.

The Winning SectorsTrade and Repair ServicesThe relative share of trade services and repair

services is15%. Of the GDP. This sector exhibited 18 million current USD

excess in the level of actual production over predicted for 2006.

Transport and StorageCurrent share of this sector in total GDP is 9%. Post sanction production in this sector was 44

million USD above the predicted trend.

Impact on External Economic Relations: Georgian ExportsThe most direct effect of the Russian embargo

was on Georgia’s exports. We look at the aggregate monthly export data for Georgia for 01.2000-03.200772 pre-sanction 15 post-sanction months.

Georgian exports since January 2006 is 295 millions USD below its predicted level.

Losses in exports to Russia are estimated to be around 175 millions of USD.

Exports to some other key partners has dropped, too.

Analysis of Aggregate Exports

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Georgian exports, thousand of current USD Fitted values

Georgian Exports to Russia0

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ruseTi Fitted values

Georgian Exports to Armenia, Azerbaijan, and the UkraineThe estimated “over-exports” to Armenia is

about 19 million USD: Only in May of 2006, when the ban on Georgian

exports of wine to Russia was imposed, the excess exports to Armenia is almost 5 millions of USD

Contrary to our expectations, we estimate a net loss of in exports to Azerbaijan (45 mln USD) and to the Ukraine (25 mln USD) since January of 2006. However, it may well be the case that official data do not reflect many export-import transactions that took place to traverse the embargo.

Georgian Exports to Germany, Turkey, and the USAWe also observe the following changes in

exports: Exports going to Germany is below its predicted

level by 22 millions of current USD. Exports to Turkey is 42 millions less than

predicted. Exports to the USA show an increase of 24 million

above the estimated time trend. However, these results must be interpreted

with caution: the precision of our estimates in the case of these countries is not very high.

Labor MigrationWe use data from the CRRC Annual Household

Surveys conducted for regionally representative sample of households in Georgia, Armenia, and Azerbaijan.

Russia is the most popular migration destination, hosting 80% of all migrants from Armenia 90% of all migrants from Azerbaijan only 38% of all migrants from Georgia

The shares of migrants who are in Russia to work is: 85% of all Armenian migrants who are in Russia 90% of all Azeri migrants who are in Russia only 44% of all Georgian migrants who are in Russia

Labor MigrationBecause of visa regime with Russia since 2000,

Georgia migration has been diversifying away from Russia.

With current sanction by Russia we expect further diversification away from Russia and towards other countries. With time, as richer network of migrants is built in “new” destination countries, these countries will become increasingly attractive for Georgians.

In addition, since the work motive is much weaker for Georgian migrants it makes Georgia relatively immune to Russian sanctions.

RemittancesWe use data on monthly money transfers

available from the National Bank of Georgia to study the trend in remittances.

Starting in 2003-2004, the flow of remittances from Russia started to grow at a very high rate, reaching 20-30 millions USD per month in 2005. Also, the volatility of transfers has increased compared to pre-2003.

There is no drop in remittance inflows from Russia.

After October 2006 money transfers from Georgia to Russia dropped by 7.3 million USD per month.

Remittance Inflows from Russia, Thousands of Current USD

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remittances inflow Fitted values

Remittance Outflows to Russia, Thousands of Current USD

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out Fitted values

Interpretation - lack of a noticeable aggregate impact? Positive changes in the external environment (rapid economic

growth in Armenia and Azerbaijan, surge in international assistance) allowing for a “soft landing”.

Georgia being on a take off path following fundamental changes in the policy environment and investment climate.

The imposition of economic sanctions being preceded by political stand-off and the introduction of visa regime, diverting Georgian trade and migration flows away from Russia.

Ability of large companies (Borjomi, Samtrest, Electro Wagon Repair Works) to find new markets (for inputs and outputs), redirect trade flows and maintain employment levels. Government measures to temporarily soften budget constraints and encourage production (e.g. increasing inventories of wine).

Interpretation - lack of a noticeable aggregate impact? Prudent policy by the National Bank of Georgia that

allowed preventing an outburst of inflation following measures to soften credits for producers directly affected by the sanctions

Countercyclical fiscal measures by the Government of Georgia

Inadvertent positive impact: repatriation of capital and labor (potential migrants not leaving and finding employment in Georgia; capital outflows to Russia declining).

Producers’ ability to sustain “temporary” increases in production costs and carry larger inventories.

Policy recommendationsGreater caution in the use of expansionary measures by NBG

and the Georgian government should Russian sanction be extended to avoid overheating and inflationary pressures.

Diversifying trade and industrial production away from Russia-bound exports will require continued investment in road and railway infrastructure to reduce the costs of transportation to Armenia, Azerbaijan and Turkey.

Inducing greater competition and quality control in industries with products that can be re-oriented to traditional and new markets (EU and North America). Great role for producer cooperatives such as Samtrest in the wine industry

Introducing active labor market policy specifically targeting potential migrants and rural population.

Thanks you for your attention!We welcome questions, comments and

critique. Please contact us by emails:karine@iset.geeric@iset.ge

The full version of the paper is available upon request. The current (draft) version is available on the ISET website:www.iset.ge