Political tensions in the South Caucasus will remain high over the coming years as increased Russian intervention in Georgia's breakaway territories fuels concerns that Russia will attempt to annex Abkhazia and South Ossetia. Meanwhile, Azerbaijani-Armenian relations will remain strained over the conflict surrounding Nagorno-Karabakh.
Armenia's economy will continue to struggle during 2016-2017 primarily due to its trade and remittance flow links with ailing Russia. Beyond this we continue to see little means of diversifying its growth model away from one driven by private consumption underpinned by volatile remittance flows.
Georgian real GDP growth will slow over the next two years relative to the 5.9% average growth achieved between 2011 and 2015 due to exposure to Russia's economic crisis, which has been triggered by Western sanctions and magnified by a dramatic fall in global oil prices. We forecast the Russian economy to contract 1.0% in real terms 2016, following a 3.7% contraction in 2015.
Azerbaijan will continue to tread a fine line between siding with either Russia or the EU. Azerbaijan's economic interests can be better served by increasing trade and energy routes with the EU, while maintaining good relations with Moscow will likely assist in keeping the autocratic regime of President Ilham Aliyev in power.
Given the close links between the Armenian economy and Russia the selloff in the Russian rouble, the collapse in global oil prices and the ongoing Western sanctions on Russia will all serve to constrain Russian real GDP growth. This in turn will see Armenian growth remain subdued as demand for exports remains stagnant. However, an alleviation of the sanctions, a sustained rise in oil prices and a strengthening of the rouble could all see Russian growth restored, which in turn would provide a notable boost to the Armenian economy, as exports rise and remittance flows from Russia increase.
Azerbaijan's reliance on government support for a rebalancing towards the non-oil sector could prove problematic. Levels of perceived corruption are extremely high, which could prove a deterrent to investment. This is highlighted by Azerbaijan's below-average score of 46.5 out of 100 in our Operational Risk Index, which is below average among EM and global peers.
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