When Ukrainian President Victor Yanukovich decided not to sign the association agreement with the European Union and instead opted for a Russian package of long-term economic support, many Ukrainians perceived this not to be a purely economic decision.  Rather, they feared this to be a renunciation of Western cultural and political values, and – to put it mildly – were not happy about this development.

The Russian political system, characterized by a prepotent president, constrained civil rights, and a government controlling important parts of the economy through its secret service, is not exactly the dream of young Ukrainians. Russia can offer economic carrots, but these do not count much against the soft power of Europe that comes in the form of political freedom, good governance, and economic development to the benefit of not just a small group of oligarchs.

Hence, it was all but surprising when many young Ukrainians took their anger about Yanukovich to the streets. After protests that lasted for nearly three months, President Yanukovich fled the country, a temporary government took over, and chaos broke out on the Crimean peninsula.

The dispute about the Crimea has the potential to impede the relations between Russia and the West for a long time to come, in particular if Russia enforces an annexation of the territory. Moreover, the tensions could quickly turn into a military conflict. The aircraft carrier USS George H.W. Bush was moved into an operational distance to the Crimea, accompanied by 20 smaller U.S. warships, and 12 additional fighter planes will be stationed in Poland. Yet even if there will be no direct confrontation between official Russian and U.S. forces, Ukraine could become the battleground of a proxy war, a kind of conflict that was common in the Cold War era. In this respect, one can already read the writing on the wall: the new Ukrainian government begs the U.S. for supplying arms and ammunition, and while the Obama administration is still reluctant to give in to such requests, the call is supported by hawkish U.S. congressmen who might finally prevail.Ukraine is a country that is geographically close to Georgia and, like Georgia, has vital economic stakes in the Black Sea area. Georgia will not be unaffected by whatever happens in Kiev and Simferopol. What are the likely short-run and long-run economic consequences of the turmoil in Ukraine and what challenges and opportunities may arise?

A KAIROS FOR GEORGIA

The National Competitiveness Report for Georgia, written in 2013 by the ISET Policy Institute on behalf of USAID, extensively discusses what the outstanding assets of Georgia’s economy are. The report points out that one of the advantages Georgia has is its geographical location, providing for possibilities to transform Georgia into a logistics hub.

There are three main routes to transport goods from Europe to the Central Asian countries (e.g. from Hamburg to Taraz in Kazakhstan). One route goes via the Baltic ports of Klaipeda or Riga, and then through Ukraine and Russia, and another route goes overland through Poland and Ukraine. A third one, the so called Caucasian Transit Corridor (CTC), has the Georgian port city of Poti and Turkey as its Western connection points, then goes through Georgia, Azerbaijan, and the Caspian Sea, and further east splits up into a Kazakhstan and a Turkmenistan branch.

According to the Almaty based company Comprehensive Logistics Solutions, the fastest and cheapest route is the one through the Baltic ports. The transport from Hamburg to Taraz takes around 33 days and costs 6,220 USD per standard container. The overland transport via Ukraine takes around 34 days and costs 7,474 USD. Finally, transport through the CTC currently takes the longest time, namely around 40 days, and costs 6,896 USD.

Unlike many other economic activities, competition for transportation is more or less a zero-sum game played by nations. If transport through Ukraine and Russia will be restrained due to closed borders and political instability, the total transport volume will not change substantially. Rather, instead of going through the northern routes, the goods will flow through the CTC. A similar development could be observed when the embargo against Iran was tightened and shipping goods through Iranian ports became increasingly difficult for Armenia and Azerbaijan. As a result, Azerbaijan, traditionally importing through Iran and exporting through Poti, now facilitates both its imports and exports through Poti.

The tensions between Russia and Ukraine are an unparalleled opportunity for the countries that participate in the CTC to gain ground in the competition with northern transit routes. The CTC can become much faster and cheaper if (a) a deepwater port and modern port facilities with warehouses will be built in Poti, (b) the road and train infrastructure will be improved, and (c) it will be easier to bring cargo over the Caspian Sea. Regarding the latter point, it would be important to assist Azerbaijan in improving the port management at Baku (in particular reducing corruption) and in reforming the monopolistic Azerbaijani State Caspian Sea Shipping Company.

Azerbaijan invests 775 mln USD into the Georgian part of the Baku-Tbilisi-Kars railway, proving their serious interest to upgrade CTC. Given this impressive commitment of Azerbaijan, Georgia should not stand back. Once critical investments have taken place, CTC's advantage could be sustained beyond the current crisis. It is a competitive route that simply needs upgrading, which can happen now as a fallout of the conflict between Ukraine and Russia.

JUST SUNSHINE AND ROSES?

Unfortunately, the crisis in Ukraine is not just an opportunity for Georgia, but also a challenge. Trade and capital flows between Georgia, Ukraine, and Russia will almost instantaneously be affected negatively, hitting Georgia in a situation of economic recovery.

ISET-PI, in its February 2014 report on the leading GDP indicators for Georgia, estimates the GDP in 2013 to be 2.6%, while GeoStat, the statistical office of Georgia, believes it to be 3.1%.

After the unsatisfactory performance of the Georgian economy in 2013, most economists believe that Georgia will get back to its remarkable growth trajectory in 2014. The IMF, in its Economic Outlook, predicts a real GDP Growth of 6% in 2014, and the government of Georgia expects this number to be 5%. Yet with an escalating crisis in Ukraine, it is questionable whether these rosy forecasts are still realistic.

The least problem are the imports Georgia receives from Ukraine and Russia, even though in 2013, the two countries were the 3^rd and the 4^th largest importers to Georgia, respectively. According to GeoStat, the imports from Ukraine and Russia are mainly comprised of consumption goods. About 30% were foodstuff, and the ten main import goods in this time (in order of monetary volume) were cigarettes, sunflower oil, chocolate, bread, cakes, meat other than poultry, poultry, and sugar.

So let us face it: if the supply of these goods would be reduced through a breakdown of production and logistics, roadblocks, damaged infrastructure etc., the consequences for Georgia would not be utterly severe. From Ukraine and Russia, Georgia receives few goods that are (1) needed for investment projects and (2) cannot be produced domestically (an example of sophisticated investment goods that need to be imported would be ski lifts for tourism projects). Moreover, as Ukraine and Russia supply primarily standard goods that are produced almost everywhere, it is unlikely that a cutback in their imports would lead to sharp price rises in Georgia. Very quickly, increased imports from other countries would close any supply gaps. In addition, many imported consumption goods, like Ukrainian orange juice, are but luxury for ordinary Georgians.

The probable effects on exports are more alarming. In 2013, Russia and Ukraine absorbed 14% of total Georgian exports, and 68% of all wine exported from Georgia was sold in Russia and Ukraine (44 and 24 percentage points, respectively). In both countries, Georgian wines are sold at the higher end of the price range and are typically consumed by people with middle and high income. It is likely that sales, in particular those in Ukraine, will suffer from crisis. This may happen through decreased demand for luxury foods and through a possible depreciation of the Ukrainian hryvna and vis-à-vis the Georgian lari.

Another sector that may face adverse consequences is the car re-export business. While the potential of this business for healthy economic progress is unclear, it accounts for roughly 25% of Georgian exports. Of these 25%, about 7 percentage points go to Russia and Ukraine. Many cars are imported to Georgia on the land route from Europe through Ukraine and Russia (often driven by private, small-scale importers), and if it will become more difficult to cross the border between Russia and Ukraine, this business, providing income to many low-skilled Georgians, may be at risk.

It should also be noted that Ukrainians and Russians make up an ever-increasing share of the tourists coming to Georgia, and also through this channel, an economic downturn in Ukraine and Russia will have unpleasant consequences for Georgia.

Finally, Georgia may suffer from ebbing capital flows. According to the National Bank of Georgia, in 2013 a total of 801 mln USD was flowing in from Russia, and Ukraine contributed 45 mln USD. The recipients of these payments are often pensioners and elderly people, depending on remittances of their children and other family members. The crisis may aggravate a trend that already exists: in January 2014, money inflows decreased by 4% from Russia and by 5% from Ukraine (compared to January 2013).

The crisis in Ukraine yields short-run risks and long-run opportunities for the Georgian economy. While there is little that can be done about the risks, the opportunities call for courageous steps to improve the Caucasus Transit Corridor. If the countries that hold stakes in the CTC are now further reducing the cost of transportation and make the route faster and more customer-friendly, the CTC may establish itself as the main trading route connecting Europe and Central Asia.