armenia and georgia economic relations and georgia econ relations_eng.pdfthis study consists of five...

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UNREALISED OPPORTUNITIES 1

ARMENIA AND GEORGIA ECONOMIC RELATIONS2

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This Study has been e laborated by UNDP Armenia to suppor t the Cross-Border Cooperat ion Pro ject between Shi rak and Samtskhe-Javakhet iRegions implemented jo in t ly wi th the f inanc ia l suppor t o f UNDP and the

Norwegian Government .

The Study has been implemented under the superv is ion and coord inat ion ofMr. Armen Yeghiazaryan and Mr. Tigran Jrbashyan, and wi th act ive

par t ic ipat ion of Mr. Ashot Iskandaryan, Mr. Sarg is Gr igoryan, Mr. Ar tashesShaboyan, Mr. Gr igor Sargsyan, Mr. Pavel Hovhannisyan, and Mr. Tigran

Gr igoryan. We would l ike to thank our Georg ian co l league Mr. Merab Kakul iafor h is cont r ibut ion in the development o f the Study.

The Study covers the per iod up to Ju ly 2007 .


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List of Abbreviations ...............................................................................................................5Introduction .............................................................................................................................6Executive Summary................................................................................................................7Background ...........................................................................................................................11Part 1 Analysis of Existing Legal Base .................................................................................161. Trade Regulations.............................................................................................................16Free Trade Agreement between Georgia and Armenia / CIS’s Free Trade Zone ................16World Trade Organisation.....................................................................................................21Generelized System of Preferencies ....................................................................................212. Investment Promotion and Protection ..............................................................................22Investment laws and institutional framework ........................................................................22Investment treaties ...............................................................................................................25Part 2 Trade and Investment Flows between Armenia and Georgia....................................28Trade in services...................................................................................................................33Foreign direct investments....................................................................................................37Part 3 Quantitative Analysis and Econometric Estimations..................................................40Model setup ..........................................................................................................................40Data mining...........................................................................................................................43Estimation and Results .........................................................................................................45Part 4 Analysis of the current status of economic relations between Armenian and Georgian bordering regions ..................................................................................................49Socio-Demographic trends ...................................................................................................49Population and area of bordering regions ............................................................................49Poverty..................................................................................................................................51Labour market.......................................................................................................................52Economic development status of the regions.......................................................................56Industry .................................................................................................................................56Agriculture.............................................................................................................................58Construction..........................................................................................................................60Transport and communication ..............................................................................................61Trade turnover ......................................................................................................................62Business Demography..........................................................................................................62Part 5 Assessment of possible impact from the conclusion of Free Trade Agreements with the EU ...........................................................................................................................65Current regime and existing trade patterns ..........................................................................65Application of the Algerian Free Trade Agreement model....................................................66Accession of Bulgaria and Romania ....................................................................................69FTA impact on EU-Armenia trade flows ...............................................................................69Growth of Georgian exports of transport services................................................................71Alternative option: GSP plus.................................................................................................71Rules of origin and cumulation .............................................................................................71Conclusions and Recommendations ....................................................................................73Annex 1.................................................................................................................................78Annex 2.................................................................................................................................80Annex 3.................................................................................................................................81Annex 4.................................................................................................................................82


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ACP - African, Caribbean, and PacificAEPLAC – Armenian-European Policy and Legal Advice CentreAMD – Armenian Dram BITs - bilateral investment treaties bln. – billion BOP – Balance of Payments CIS – Commonwealth of Independent States CPI – Consumer Price Index EBRD – European Bank for Reconstruction and Development EC – The European Commission ENP – European Neighbourhood Programme EU – The European UnionFDI – Foreign Direct Investments FTA – Free Trade Agreement GATS - General Agreement on Trade in Services GATT - General Agreement on Tariffs and Trade GDP – Gross Domestic ProductGEL – Georgian Lari GNFEA - Goods Nomenclature of Foreign Economic ActivityGNIA – Georgian National Investment AgencyGSP - Generalized System of Preferences GUUAM - Georgia, Ukraine, Uzbekistan, Azerbaijan and Moldova free trade agreementICSID - International Centre for the Settlement of Investment Disputes IFS - International Financial Statistics Km. – Kilometre MFN – Most Favoured Nations MITs - Multilateral Investment Treaties NGO – Non-Governmental Organisation NSS RA – National Statistical Service of the Republic of ArmeniaOECD – Organisation Economic Cooperation and Development PRSP – Poverty Reduction Strategy Paper RF – Russian Federation SACU - Southern African Customs Union Sq. Km. – Squire Kilometre TACIS – Technical Assistance to Commonwealth Independent States TC - transportation costs TDCA – Trade Development and Cooperation Agreement TRACECA - Transport Corridor Europe-Caucasus-AsiaUNCTAD - United Nations Conference on Trade and Development UNCITRAL - The United Nations Commission on International Trade LawUSA – United States of AmericaUS – United StatesUSSR – Union of Soviet Socialist Republics USD – United States Dollar VAT – Value Added TaxWITS - World Integrated Trade Solution WTO – World Trade Organisation


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Due to historical, geographical and national factors, the economies of Armenia and Georgiahave numerous similarities. The relations between these two countries became even deeper whenthey formed part of the USSR. After the collapse of the Soviet Union, in the beginning of 1990s,some of these economic relations were weakened due to the economic crises in Armenia andGeorgia. In the 1990s, the economic blockade of Armenia made Georgia the most important eco-nomic partner of Armenia. Since Georgia became the only transit corridor for Armenian exporters,the economic relations between Georgia and Armenia were intensified.

During the second half of 1990s, a number of agreements were concluded between Armeniaand Georgia in state and intergovernmental levels (e.g. free trade agreement, agreements in thefields of taxation, customs, and other economic activities).

The economic growth in both countries will obviously create new opportunities for economiccooperation. In this context, regional cooperation becomes more and more important for growingeconomies.

The overall objective of this Study is to foster the economic cooperation between Georgia andArmenia through improvement of the relations between these two countries in fields of trade, invest-ment, and transportation. Moreover, the specific objective of the Study is to contribute to theimprovement of the socio-economic conditions of the population in Shirak (Armenia) and Samtskhe-Javakheti (Georgia) regions by activating and fostering cross-border cooperation.

The Study also has the mandate of contributing to the initiation of a regional dialogue betweenArmenian and Georgian authorities and the civil society aimed at the intensification of regional rela-tions. It can be foreseen that the conclusions and recommendations set forth in this Study will con-tribute to this process and will promote also discussions between international organizations activein the region, intense dialogue between the Armenian and Georgian authorities and decision mak-ers on possible strengthening of economic relations and on regional development issues, as wellas foster business relations between these two countries.


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Development of trade relations with other countries and especially with neighbouring countriesis one of the key elements of economic development of a country, as well as for overall regionaldevelopment.

To support this process in Armenia and Georgia, this Study highlights the importance for devel-opment of a strategic partnership between these two countries, reviews and analyses current tradeand investment relations, as well as provides possible scenarios for further development of such apartnership.

This Study consists of five thematic parts and a part dedicated to conclusions and recommen-dations.

Part I - Analysis of Existing Legal Base - highlights specific issues related to the legal bases ofArmenia-Georgia trade and investment relations. This part provides a comparative analysis of theArmenian and Georgian legislation regulating bilateral and multilateral trade relations, traderegimes, and investment issues. It highlights also the existing legislative gaps and describes legalissues hindering the development of trade and investments flows between two countries.

The Free Trade Agreement concluded between Armenia and Georgia entered into force in1995. It aims to promote the establishment of stronger trade and commercial ties between partici-pating countries and to promote free trade in goods by eliminating tariffs, customs duties and quan-titative restrictions. It is consistent with the WTO rules i.e. with the definition set forth in ArticleXXIV:8 (b) of the General Agreement on Tariffs and Trade of 1994 (GATT). The Agreement elimi-nates all customs duties on goods originating in the territory of the countries that meet the require-ments for “originating goods”.

This part elaborates on a bilateral investment agreement, which was signed between Armeniaand Georgia on 4 June 1996 and entered into force on 18 January 1999. This agreement establish-es the terms and conditions for private investments by nationals and companies of one country inthe other country. The Agreement envisages international minimum standards of treatment guaran-teed to foreign investors such as fair and equitable treatment, full protection and security, MSN(Most Favoured Nation) treatment, national treatment, etc.

This part examines also the investment acts of Georgia and Armenia, which are quite liberalcompared with the relevant legislations of some other CIS countries. They provide for guaranteesto foreign investors in regard to their rights in a transparent and single document.

Part II - Trade and Investment Flows between Armenia and Georgia - analyses trade flowsbetween Armenia and Georgia, including trade in goods and services, trade concentration, tradestructure and volumes, as well as other related issues, such as transportation costs, tourism, etc.Moreover, this part provides also an analysis of investment flows between Armenia and Georgia,main areas of FDI, its structure and volumes. As regards trade in goods, Armenia plays an activerole in terms of merchandise trade. The main Armenian exports to Georgia include cement and cof-fee. The Armenian imports from Georgia mainly consist of sugar, fertilizers, citrus fruits, andprocessed wood. The concentration index shows that the trade between these two countries isbeing diversified year by year. As to the trade in services, it can be stated that given the favourablegeographical location of Georgia, it has significant revenues from its export of services. In particu-lar, Georgia highly benefits from its export to Armenia of transport and tourism services, and hasrather high revenues from transit of gas. On the other hand, the high volume of service imports fromGeorgia to Armenia is due to the fact that Armenia is a landlocked country.

The two countries are weakly interlinked with each other in terms of foreign direct investment,although there is an upward trend in the flows from Armenia to Georgia. This means that Armeniaagain plays the role of an active partner. The high growth of investment flows to Georgia during the


recent years can be explained by the construction of the Baku-Tibilisi-Ceyhan pipeline. The growthof FDI inflows to the Georgian economy shows that the investment climate has improved during thepreceding years.

Part III - Quantitative Analysis and Economic Estimations - provides an econometric analysis ofexisting trade flows between Armenian and Georgia, as well as envisages different scenarios withdifferent terms and conditions of trade relations. One of the main hypotheses is that although thegrowth of imports of goods from Georgia lags behind the growth of exports from Armenia toGeorgia, the difference is covered by growth of imports of services from Georgia. Should the livingstandards in Georgia be improved, the volume of imports from Armenia will decrease, since theArmenian imports to Georgia will be substituted by similar products – with higher quality - importedfrom the EU and other countries.

It is estimated that a one-percent increase in unit prices of exportable goods will have a ratherinsignificant impact on the exports: it will decrease only by approximately 0.09%. In other words,price elasticity of Armenian exports to Georgia is very inelastic due to the high level of concentra-tion of Armenian exports to Georgia (Armenia mainly exports to Georgia five types of goods, ofwhich cement is the major one).

It is projected also that a one-percent change in the consumer prices (inflation) in Georgia willbring to a 1.42% increase in exports of goods from Armenia. This is explained by the differences inthe monetary policies pursued in Armenia and Georgia.

Moreover, estimation results show that ceteris paribus one-percent increase in Georgian house-hold expenditures in US$ terms will result in a decrease in imported goods from Armenia by 1.1%.A negative effect of consumption on demand for imports is explained by the fact that the richer thepeople, the more they are inclined to substitute their consumption with more expensive goods.Besides, both Azerbaijan and Turkey have become serious competitors to the Armenian exports. Inaddition, during the past 4-5 years, the Armenian economy has been growing at a fast pace, whichhas led to the redirection of the demand for the same exportable goods towards domestic consump-tion. For instance, the boom of construction in Armenia has created an extra demand for cement;however cement producing factories have reached their full capacity utilisation and are, therefore,not able to supply the entire domestic market. To this end, it has become necessary to cut down thevolume of cement export to Georgia.

Part IV - Analysis of the Current Status of Economic Relations between Armenian and GeorgianBordering Regions - describes the socio-economic situation of Armenian and Georgian borderingregions, including issues related with the population, consumption, labour force, main economicactivities (agriculture, industry, trade, etc.). Moreover, this part provides information on comparativeadvantages of the development of economic relations between bordering regions of Armenia andGeorgia.

This part of the Study highlights that comparatively higher wages in Kvemo Kartli region can beattributed to the existence of a number of industrial giants in the main city (Rustavi) like Azot chem-ical combine and the metallurgical plant. In addition, there are also two mining companies engagedin the extraction of copper and gold, as well as a thermal power plant (Mtkvari Energetika). KvemoKartli accounts for more than ¼th of overall industrial output in Georgia.

The analysis shows that the poverty level in Armenia is higher in urban areas than in rural ones,while in Georgia it is vice versa. Taking into account the structure of the population by urban andrural settlements, it is obvious that bordering regions of Armenia and Georgia have higher povertylevel in comparison with their countries average indicators.

While the comparison of average wages by regions shows the advantage of Kvemo Kartliregion, the poverty level indicator is the worst in this region if compared with the other observedregions. This speaks about significant disparities within Kvemo Kartli, especially if we compare theincome levels of urban and rural populations.


The comparison of per capita industrial output shows the advantage of Kvemo Kartli regionwhere in 2005 the indicator of per capita industrial output was twice higher than in Lori and abouteight times higher than in Shirak and Tavush regions. This is due to the existence of industrial giantsin Rustavi only.

The observation of agricultural data in the bordering regions and the definition of some compar-ative advantages of separate regions show that the cooperation between Georgian and Armenianbordering regions can be as follows: cereals and animal husbandry products from the Georgian sideand potato and vegetables (as well as fruits from Tavush) from the Armenian side.

As a main finding of this part, it can be stated that developing services sector (tourism, trade,transportation and other) from the Georgian side can be one of the main fields of cooperation withthe Armenian regions. The labour from mainly the urban areas of Shirak and Lori can be quite use-ful in infrastructural construction activities. In addition to this, the Armenian regions, especiallyShirak, have a potential of developing their manufacturing activities given the large share of urbanpopulation.

The comparison of the data on industrial output, construction and services volume as well asthe data on wages shows that Samtskhe-Javakheti is the less developed region among the fiveobserved regions. This could be the decisive reason for/ the factor underlying the growth of con-struction in the last years and the large development projects which shall take place in this region(for example the funds from the Millennium Challenge Corporation as well as EU Tacis projectsfunds).

Part IV - Assessment of Possible Impact from the Conclusion of Free Trade Agreements withthe EU - provides basic information on the EU FTAs, and describes the possible impacts of con-cluding an FTA with the EU on Armenia-Georgia trade relations, trade flows and structure.

Calculations made within the framework of this Part show that of the conclusion of an EU-Armenia FTA will lead to a 0.55% reduction of EU-27’s trade-weighted average tariff rate, whileArmenia’s trade-weighted average tariff rate will drop by 3.11%. Moreover, this will contribute to1.55% and 4.24% increase of Armenian exports and imports to, and from the EU-27, respectively.

In case Armenia obtains the ‘GSP plus’ regime, the Armenian exports to the EU will increase by1.6%, and the Georgian exports of transport services to Armenia will increase by 0.06%.

The last part of the Study provides conclusions and recommendation drown on the basis of theanalyses and findings of the above mentioned five parts. The Study includes short- and long termrecommendations, which, by their nature, are possible solutions for intensification of trade relationbetween Armenia and Georgia, as well as the trade relations of Armenia and Georgia with othercountries. The core message of these recommendations is the creation of a single economic areabetween Armenia and Georgia, which may potentially foster trade relations between the two coun-tries, as well as with third countries, and boost the economic development of the whole region. Themain conclusions can be formulated as follows:

- Economic relations between Armenia and Georgia are concentrated in the fields of trade ingoods and services, investments and transit. The Study shows that within the framework ofthese relations, the two countries have rather different roles in terms of the nature thereof:Armenia is the more active economic partner considering that trade in goods is one of the mainareas of Armenia’s interaction with Georgia, while Georgia can be considered as a passive part-ner since Georgia is mainly providing transit services to Armenia.

- However, diversification of economic relations between Armenia and Georgia is observed.Although a decline of concentration in trade in goods is noted, both exports remain relativelyconcentrated (Armenia - trade in goods; Georgia - trade in goods, services, including transit).The diversification is more intensive in Armenia than in Georgia, which is shown by the analy-ses of elasticity and monetary policy of both countries.


- Rather passive economic development in the bordering regions of Armenia and Georgia isexplained by the low development level of bordering regions. The intensification of economicrelations, therefore, is rather low since there is no developed region able to promote cross-bor-der economic development and intensification of trade and investment relations in the border-ing parts of the two countries.

- The provisions of the bilateral investment agreement (including the double taxation treaty) arenot utilized effectively and there is a need to ratify the other outstanding bilateral investmenttreaties and negotiate new ones.

- It is projected that the conclusion of separate FTAs with the EU (i.e. EU-Armenia and EU-Georgia FTAs) will intensify the economic relations between Armenia and the EU as well asGeorgia and the EU, but it will have a very low impact on the development of Armenia-Georgiaeconomic relations. Conclusion of an FTA between the EU and Armenia-Georgia will promotejoint production of Armenian and Georgian exports to the EU.

Summarizing the above mentioned conclusions, it can be stated that the creation of a singleeconomic area between the two countries will: 1) reduce the possibility of applying trade restrictionson Armenia and Georgia by other more developed countries, 2) create wider possibilities for devel-opment of trade relations with the EU-27, 3) reduce trade related transaction costs (certification,accreditation, conformity assessment, etc.), 4)l promote internal investments in the area, 5) attractforeign investments, and 6) significantly contribute to the overall development of Georgia andArmenia.

The core recommendations of the Study are mainly related with the conclusion of a new freetrade agreement between Armenia and Georgia, which will provide for the necessary steps andappropriate actions to be implemented in view of creating a common market without frontiers; in allthese stages of economic integration between the countries different aspects of economic policyshould be harmonised with the EU requirements and approaches.

Moreover, it is recommended for Armenia to sign a Free Trade Agreement with the EU, whichwill stipulate provisions that allow using the trade preferences provided by the EU with unlimited useby Armenia of inputs originating in Georgia (cumulation of origin principle). This provision should bealso included in Georgia-EU FTA. Following the completion of the Caucasian Common Market,these two agreements should be replaced with a single FTA.


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Armenia and Georgia are two of the countries in the South Caucasus region which gained theirindependence in the early 1990s after the collapse of the USSR. During the years of independence,due to geo-political situations and related economic issues in the region, the two countries havepast different development trends.

Georgia is situated to the north of Armenia and borders Russia, Azerbaijan and Turkey.Georgia also has access to other countries through the sea. Armenia is a landlocked country, bor-dering Iran, Turkey, and Azerbaijan. Due to the Nagorno-Karabakh conflict and some other issues,the Armenian border with Azerbaijan and Turkey is blocked.

During these years, while Armenia had disputes with Azerbaijan on Nagorno-Karabakh conflict,Georgia has had several problems inside the country. The conflict with Abkhazia and Ossetia aswell as a number of political issues led to the outbreak of a civil war in the country, which had a neg-ative influence on the development of the country. The economic situation in Georgia became bet-ter after the Rose Revolution of 2003. The new government of Georgia promised to reorient the pol-icy toward privatization, free markets, reduced regulation, and control of corruption. The govern-ment reduced the number of taxes from 21 to 7 and introduced a flat income tax of 12%. It signifi-cantly reduced the number of licenses a business requires and introduced a one-window systemthat allows an entrepreneur to open a business in a relatively short period of time. Strict deadlinesfor agency action on permits were introduced, and consent is assumed if the agency fails to actwithin the time limit. The government intends to completely eliminate import duties by 2008, whichshould reduce costs and stimulate business.

Main socio-economic trends in Armenia and GeorgiaThe countries have passed different ways of development during the transition period. Both

countries had economic recession processes in early 1990s. The GDP of Armenia in 1993 was onlyabout 44% of the same indicator for 1989. From 1994, the GDP of Armenia followed an upwardtrend. In Georgia, the GDP in 1994 fell to 25% of the same indicator for 1989 and started to increasefrom 1995. The development rates of the economies of Armenia and Georgia were also different.Due to comparatively high growth rates in Armenia, especially starting from 2001 (when a double-digit growth was recorded), the marker of GDP in 2006 surpassed the level of 1989 by 29%, whileGeorgia’s GDP marker in 2006 comprised only 53% of its value in 19891.

GDP structureThe absolute value of Georgia’s GDP for 2006 is estimated to about 7.8 billion USD. The same

indicator for Armenia is less by about 18% and comprises 6.4 billion USD. However, if we comparethe per capita indicators of the GDP we see that Armenia has an advantage (1,983 USD in Armeniaand 1,774 USD in Georgia) by 11.8%.

The structure of GDP by production in Armenia and Georgia is presented in Chart 1. The maindifference which can be viewed in the Chart is that the GDP of Armenia is mostly based on theindustries that produce goods (industry, construction), while the basic branches of Georgian GDPare services.


1 EBRD Transition Report Update 2007

Chart 1. The structure of GDP (production side) in Armenia and Georgia, Y2006

Source: NSS RA, Statistics Georgia

The structure of GDP by expenditure side is presented in Table 1. The final consumption expen-ditures in Georgia as compared to the corresponding GDP are higher by about 11.2 percentagepoints, whereas the gross capital formation (or investment) has a larger share in Armenia’s GDP,which can be one of the reasons of higher growth rates of GDP recorded in recent years and pro-jected for the near future. Net export of goods and services in both countries is negative, but thedifference between exports and imports in Georgia is much larger.

Table 1. The structure of GDP by expenditure side, Armenia and Georgia, Y2006, % to GDP

Source: NSS Armenia and Statistics Georgia

PovertyOne of the most important challenges in both countries is the poverty level of population. Both

countries introduced Poverty Reduction Strategy Papers, indicating the ways of reducing poverty inthe countries. In 2005, the overall poverty incidence in Armenia was estimated to 29.8%, while theindicator of poverty incidence (by their poverty line) for Georgia was 39.4%. The indicators of pover-ty gap and severity of poverty also show that the situation in Georgia is a bit worse (Table 2).


Table 2. Poverty indicators for Armenia and Georgia, 2005

Source: Social Snapshot, NSS Armenia and PRSP update for Georgia

It should be noted here that the poverty lines are different in different countries and the figuresshould not be directly compared. As show harmonized data of poverty for 20032, poverty indicatorswere very close to each other: 50% of population in Armenia and 52% in Georgia were below thelevel of 2.15 dollars by PPP per day.

Another important area is the growing regional disparities in both countries. While some regionsare growing at high rates, other regions have numerous problems related with increasing povertyand unemployment issues. In Armenia, disparities are observed between Yerevan and all otherregions. In Georgia, some of the regions benefit from the advantage of having a number of activelarge industrial giants, while the regions that are mostly comprised of rural population have prob-lems with unemployment and poverty.

The peculiarities of economic development of these two countries are mostly conditioned by thegeopolitical situation in the region as well as their location. For Armenia, Georgia has become theonly transit corridor for almost all economic relations that need transportation, due to the conflictbetween Armenia and Azerbaijan, a closed border between Armenia and Turkey, and also takinginto account that Georgia has a sea port. Therefore, Georgia is located in the centre where two axescross. One is the way from Turkey to Azerbaijan, and the second is Armenia-Russia. As it can benoticed from the structure of GDP, transportation and communication services as well as other relat-ed services have a significant role for the GDP of Georgia. At the same time, Armenia has only twoways for transportation from and to the country. Taking into account the existence of sea ports inGeorgia and the fact that Georgia is the only corridor to reach Russia, which is one of the main tradepartners of Armenia, Georgia has a very important role for Armenia. Another neighbour which hasan open border with Armenia is Iran which has a very protected internal market for imported goods.

It should be noted that there are two main ‘transit corridors’ in the region (including at least oneof the observing countries3): 1) Iran-Armenia-Georgia-Russia; 2) Turkey-Georgia-Azerbaijan. Twocorridors are functioning, but it is obvious that the first corridor is more passive than the second one.Being in the centre of these corridors, Georgia is more passive in regard to the development oftrade relations with Armenia and, in its turn, Armenia does not consider Georgia as a potential can-didate for development of more intensive trade partnership.

Economic policiesThe economic policies pursued by Armenia and Georgia differ form each other in the spheres

of public finance and monetary policy. The share of government expenditure is rapidly growing inGeorgia, while the same picture is not observed in Armenia.4 The process of privatization is ongo-ing in Georgia, whereas in Armenia it is almost completed.


2 Growth, Poverty and Inequality:Eastern Europe and the Former Soviet Union, WB 20053 In fact there is also Iran-Azerbaijan-Russia corridor, and currently Azerbaijan and Iran are heavily investing in it.4 The growth of public expenditure in Georgia is mostly a result of more effective administration and the reduction of non-observed economy in a country, which took place in recent years. It reflects lower level of tax avoidance in Georgia dueto recent anti-corruption measures that is discussed below. Armenia’s tax rates are not lower than Georgia, so this cannot be put in regular discourse about the size of Government. This means that there is difference in the level of corrup-tion and “government capture”, not in public finance

The state budget deficit was estimated at 1.5% of GDP in 2006 on a cash basis in Armenia. Thecountry is increasing the expenditures on social and infrastructure programmes in order to meet thepoverty reduction targets. Despite significant nominal increases in tax revenues over the past twoyears, the high incidence of tax evasion and exemptions are reflected in the persistently low ratioof tax revenue to GDP. For example, the construction sector, the largest in the economy, remainsmostly exempt from taxation. In 2006, the Central Bank of Armenia shifted its main policy objectivefrom monetary targeting to inflation targeting. Annual average inflation for 2005 was only 0.6%, butreached to 5.2% in 2006.

As for Georgia, improved tax collection and progress in tackling corruption, as well as growingprivatisation revenues, helped to raise budget revenues during 2006 and allowed the governmentto increase their fiscal spending. Consolidated budget revenues increased by 34% during 2006 andtax receipts rose by more than 43%. High oil prices, extra government spending and strong capitalinflows have meanwhile increased inflationary pressures. By the end of 2006, inflation reached8.9%. To help lower inflation, the Central Bank allowed the national currency (lari) to appreciate innominal terms against the US dollar during 2006, reflecting foreign currency inflows. It also startedto issue certificates of deposits to reduce the money supply from September 2006. While the infla-tion figures are not much different in the countries, there is the difference in tolerance level of realappreciation of national currencies for the countries. The fact that Armenia faced much biggerinflows relative to the size of the economy in comparison of Georgia is also taking place.

External TradeThe share of external trade (goods and services) balance in the corresponding GDP for 2006

was -23.7% for Georgia and -14.4% for Armenia, which means that both countries have negativebalance in external trade. If we compare only the data on external trade in goods, it can be notedthat Armenia is exporting more goods (in value terms) than Georgia. Instead, the Georgian figuresof trade in services had an advantage compared to the Armenian ones.

In 2006, the share of export of goods in GDP for Armenia was 15.7%, while the correspondingfigure for Georgia was 12.7%. Exports in dollar terms in Armenia increased by 3.1% in 2006 andcontinue to be dominated by precious stones and base metals (copper, molybdenum). Imports,however, have increased by almost 22% over the same period, largely fuelled by increasing ener-gy and consumer goods prices. The share of imports of goods in GDP for Armenia was 34.4%.

In 2006 the trade deficit in Georgia widened dramatically by about 80% in dollar terms comparedwith 2005. While exports grew by about 20%, imports (mainly of investment goods related to pipelineconstruction5) grew by about 43% during this period, and comprise 50.0% as compared to GDP.Export growth was also negatively affected by a Russian trade embargo on Georgian wine and min-eral water, which took effect in March 2006. Wine was Georgia’s second most important export in2005, accounting for 9.2% of total exports. This decreased to 4.2% at the end of November 2006.

BOP and FDIThe trade deficit in Armenia continues to be offset by substantial flows of remittances. Strong

foreign currency inflows, particularly in the second half of 2006, have led to substantial nominal andreal appreciation of the dram against the US dollar and other major currencies. The capital accountrecorded a modest increase in foreign direct investment in 2005, enough to cover the 4.2% currentaccount deficit.

Compared to Georgia, FDI data have been much lower in Armenia, especially in 2006 (Table3). The growth of Georgian FDI inflows in 2006 is mainly related to the pipeline construction. As itcan be seen from Table 3, since 2003 FDI in Georgia has kept growing, following the positivechanges that took place in the economy. While in 2002 FDI per capita for Georgia and Armenia wasalmost similar, in 2006 FDI per capita for Georgia is more than 4 times higher than the correspon-ding indicator for Armenia.


5 Transition Report Update 2007, EBRD 2007

Table 3. FDI inflows in Armenia and Georgia, 2002-2006

External debtThe external debt indicator of Georgia has improved significantly, supported by debt relief

agreements with all bilateral creditors. The ratio of public external debt to GDP fell to 21.3% in 2006from 27.1% in 2005 (it was 51.5% in 2002). The share of public external debt for Armenia in 2006was 18.9% as compared to GDP (43.2% in 2002). Gross external debt stood at just over 2 billionUSD at the end of 2006, a modest increase year-on-year, most of which is concessional public debt.

Exchange rates and national currenciesThe yearly average value of exchange rate in 2006 for 1USD was 416.04 AMD. The apprecia-

tion of the Armenian dram against the US dollar, which started in 2004, has continued. In 2006, theArmenian dram appreciated by 9.1%, in 2005 – by 14.2%, and in 2004 by 7.8%. In 2006, the aver-age cost of one US dollar was 1.7766 Georgian lari. Starting from 2003, appreciation of theGeorgian lari against the US dollar has also been observed (in 2006, GEL appreciated by 2.0%, in2005 – 5.4%, in 2005 – 10.7%, and in 2004 by 2.2%).

Table 4. CPI for Armenia and Georgia, 2003-2006

The attitude of national currencies is related also with the price level in the country. Table 4shows that the CPI in 2005-2006 was lower for Armenia, while the rate of appreciation of the nation-al currency was higher than in Georgia.


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Free Trade Agreement between Georgia and Armenia / CIS’s Free Trade Zone

Armenia and Georgia have signed a number of bilateral, regional and international agreementsto eliminate trade barriers, facilitate the cross-border movement of goods and services, andincrease investment opportunities for their businesses. These trade agreements help to level theinternational playing field and encourage the governments to adopt open and transparent rulemak-ing procedures as well as non-discriminatory laws and regulations. They also support the strength-ening of business climates through elimination or reduction of tariffs, improvement of intellectualproperty regulations, opening of government procurement opportunities, easing the investmentrules, and much more.

For instance, in 1995 these two countries signed a free trade agreement to promote trade andcommercial ties between participating countries, and opened up opportunities for their exportersand investors to expand their business into key markets. They can speed up trade liberalisation bydelivering gains faster than through multilateral or regional processes. The agreement that is com-prehensive in scope and coverage can complement and provide momentum to these countries’wider multilateral trade objectives by making their best efforts to enforce effectively the agreement’sprovisions.

Therefore, the contracting parties to the Free Trade Agreement (the Agreement) are Georgiaand Armenia. The Agreement applies in respect of the territory to which the customs laws ofGeorgia and Armenia are respectively applicable. It was signed 14 August 1995, in Stepanavan,Armenia, and entered into force on 11 November 1998. The Agreement establishes a free tradearea in conformity with the definition set out in Article XXIV:8 (b) of the General Agreement on Tariffsand Trade of 1994 (GATT). The free trade area established by this Agreement provides the frame-work for trade relations between Georgia and Armenia. In addition, the Agreement covers commod-ity and service.

Moreover, bearing in mind a clear understanding of all benefits of external trade liberalisation,in the early 90’s Armenia, Georgia and other 10 former Soviet Union republics established theCommonwealth of Independent States (CIS), the main feature of which became an agreementestablishing a free trade area. The parties to the Agreement on the Creation of a Free Trade Area(the CIS Agreement) are the CIS countries. The territory of the Agreement covers customs territo-ries of the contracting parties. It was done on 15 April 1994, in Moscow, Russia. It is aimed at imple-menting provisions of the Agreement on the Creation of Economic Union, dated 24 September1993, Moscow, Russia, and to form the conditions for a free transference of goods and services. Itis to be emphasised that the contracting parties reserve the right to a self-dependent and independ-ent determination of a regime of foreign economic relations with states which are not signatories tothis agreement.6

Duties and chargesGeorgia and Armenia agreed not to impose customs duties, taxes and charges, which have an

equivalent effect on import and/or export of commodity originated from the customs area of one ofthe countries and designed for delivery to the customs area of another party. It is to be mentionedthat they also do not impose internal taxes and charges directly or indirectly on goods, covered bythe Agreement, that exceed the rate of relevant taxes or charges imposed on analogous goods ofthe domestic production or those produced in third countries. It is not allowed to introduce specialrestrictions or demands towards export or import of goods, covered by the Agreement, that in sim-


6 It is to be noted that at the end of 2002 Georgia ratified also the GUUAM (Georgia, Ukraine, Uzbekistan, Azerbaijan,and Moldova) free trade agreement. For official documents, visit to www.guuam.org.

ilar cases are not applied to analogous goods of the domestic production or those produced in thirdcountries. In addition these countries are not allowed to use different rules towards warehousing,unloading, storage, shipment of goods, originated from another country, as well as towards repay-ments and remittances, with the exception of rules that in similar cases are used towards domesticgoods or those originated from third countries.

The countries do not apply customs duties, taxes and levies which have equivalent effect andquantitative restrictions to importation and/or exportation of goods originating in customs territory ofone of the contracting parties and intended for customs territory of other contracting parties. If nec-essary, exceptions to this trade regime shall be further formulated. Armenia and Georgia do notdirectly or indirectly impose taxes and fiscal levies on goods originating in customs territory of othercontracting parties, in the amount exceeding their level for national goods.7

To simplify the customs clearance of goods imported to Georgia, on 25 July 2006 theParliament adopted a new Law on Customs Tariffs. New rates indicated in the law are effective fromSeptember 2006, while most of the general collection rules entered into effect together with the newCustoms Code, in January 2007. Three general rates of tariffs are introduced: zero, 5% and 12%.Alcohol beverages are taxed in accordance with the brand and the type of the products, in most ofthe instances the rates are fixed, while in the other instances 5% and 12% rates apply. The goodscommonly used in constructions and other industry are taxed with the zero tariffs, while the agricul-ture goods fall under 5% and 12% rates. New customs rates are aimed at lowering the prices forcustomers and improving the investment climate in Georgia.

In Armenia, there are only two tariff rates applied on imports of goods - 0 and 10 per cent.Armenia’s custom tariffs are expressed in ad valorem terms and levied c.i.f. values. More than 60%of the items in the tariff schedule are subject to 0 per cent duty rate, giving Armenia a weighted aver-age tariff of 4%. The general approach in applying customs tariff is that raw materials, capital goodsand intermediate products are subject to 0 per cent duty rate, and fuel products are subject to 10%duty rate. A value added tax is imposed on all imports and services. The basic rate of VAT is at 20%.Individuals importing goods into Armenia pay the VAT if the quantity or cost of goods exceeds thelegal limits of 300 USD or weight of 50 kilograms. The collection of VAT for imported goods is con-ducted by the customs officials. In Armenia the excise tax is imposed on products consisting oftobacco and tobacco products, alcoholic beverages (including wines) and crude oil and oil products.

For vehicles arriving in the Republic of Armenia that are registered in the bordering regionsaccording to the respective Government Decrees (passenger cars with 7 seats registered inAkhalkalak, Akhaltskha, Ninotsminday, Bolinis, Aspindza, Marneul and Tsalkay regions in Georgiaand trucks carrying 1.5 tons of load transported to Armenia as well as the road tax payers who abidein the above-mentioned regions in Georgia are fully exempt from paying road tax, and road tax pay-ers who abide in the above-mentioned regions of Georgia for trucks with 1.5-3 tons of carryingcapacity arriving in the territory of Armenia pay 50% of road tax only.8

Transit issuesAccording to national laws, the countries are required to ensure free transit, through their terri-

tory, of commodities that originated from the customs area of another party or of third countries anddesignated for the customs area of another party or of the third country.

The CIS Agreement declares that the observance of the principle of free transit is the mostimportant condition for achieving the objectives of the Agreement and an essential element of theprocess of attaching them to the system of international division of labour and cooperation. Thustransit transportation is not subject to groundless delays or restrictions. It is to be noted that condi-tions for transit including tariffs on transportation by any kind of transport and rendering servicesshould not be worse than the conditions provided by the contracting parties for their own consignorsand consignees and for their goods, as well as for carriers and vehicles for this contracting party, or


7 Article 8(2) of the CIS Agreement that the Contracting Parties will present full information on all current taxes and otherfiscal levies.8 The Customs Committee Decision of 22 February 1998; No. 7-MVB:

provided to consignors, consignees, their goods, carriers and vehicles of any other foreign state,unless otherwise provided by bilateral agreements.

The Governmental Decree of Georgia No. 27 of 8 February 2006 has fully entered into force. Itapplies to all forms of transportation (except for passenger cars), whether loaded or empty, thatcross the Georgian border and are subject to customs control. These transportation means have tocomply with the weight and size requirements as provided by the Georgian legislation. The totalweight of the vehicle shall not exceed 44 tons, whereas the weight load for single axle shall notexceed 10 tons; additionally the weight of the cargo that it carries has to comply with the manufac-turer’s requirements. This rule will seriously affect the vehicles carrying goods from abroad intoGeorgia, as most of them do not satisfy these requirements and will be sanctioned accordingly.

Georgia agreed in negotiations with Azerbaijan, which is not a WTO member, to provide afavourable transit tariff of 50% on the railway freight transportation based on the Agreement on Co-ordination of Railway Transportation.9 As regards Armenia, Georgia provides only 24% discount forfuel and petroleum oil products and 17% for the rest of cargoes. These transit tariff discounts arestated in Article 5 (2) of the Tariff Policy of Georgian Railway, adopted by the decision No. 1 of theMinistry of Transport and Communication on 3 January 2002. In this context, Georgia violates theMFN and national treatment principles of the WTO trading system by (a) discriminatory railway tar-iff discounts, (b) internal taxes and charges imposed on foreign vehicles, (c) compulsory motorinsurance,10 which are also applied to transit, as well as the rules of freedom of transit provided inGATT.

Trade ProvisionsImport RestrictionsArmenia and Georgia may apply only the general restrictions on import of goods. The import of

weapon, military equipment and technique and also import of toxic and radioactive industrial wasteswith the purpose of their utilization, safe disposal, interment and any other purposes is prohibited.

Quantitative restrictionsGeorgia and Armenia restrain from implementing discriminative measures in reciprocal trade,

as well as from application of quantitative restrictions towards import of goods or their equivalentmeasures within the framework of the Agreement. They may unilaterally ascertain quantitative orother special restrictions within reason and with a strictly defined period. These restrictions must beof exclusive character and may be applied only in cases envisaged by agreements in the frame-work of GATT. In addition, it is required that any party which applies quantitative restrictions inaccordance with the Agreement, must provide the other party with full information about the basicreasons for establishment, forms and possible terms of application of mentioned restrictions; hencethe consultations are appointed.

Armenia and Georgia do not apply quantitative restrictions (quotas or tariff rate quotas) onimports, and do not maintain a system of minimum import prices. In general, there are no importlicensing requirements neither in Georgia, nor in Armenia, and companies are able to import freely.The only exceptions are: pharmaceutical products and medicines, phytoprotection chemicals whichare regulated in the interest of public health and safety, and weapons and nuclear materials relat-ing to security.

Export restrictionsThe export of military weapons and ammunition, works of art of museum value and antiquary

is prohibited.


9 The Agreement on Co-ordination of Railway Transportation was signed in Serakhs on 13 May 1996 betweenUzbekistan, Georgia, Azerbaijan and Turkmenistan. The Republic of Armenia ratified the Agreement on 01 December1998.10 Foreign vehicles are required to purchase special Georgian motor insurance, even if they already have international-ly valid insurance certificate (the Law on Mandatory Insurance of Civil Liability for Owners of Motor Vehicles). This typi-cally amounts to about 25 USD per trip).

Quantitative restrictionsArmenia and Georgia do not introduce special restrictions or demands towards export of goods

covered by the Agreement, that in similar cases are not used towards analogous goods of the localproduction or those produced in third countries.

There are no export restrictions and export taxes in Armenia and Georgia, and there is no sys-tem of minimum export prices. As on the import side most exports are free of any prohibitions orquotas. In both countries export restrictions are imposed for health, security, and environmental rea-sons. The items affected are weapons, nuclear materials, pharmaceuticals, rare animals and plants,rare objects or artefacts considered part of the national patrimony. Exports of textiles and clothingto the European Union are subject to licensing under bilateral agreements with the European Union.

SafeguardsBeing members of the WTO, Georgia and Armenia may take a “safeguard” action (i.e., restrict

imports of a product temporarily) to protect a specific domestic industry from an increase in importsof any product which is causing, or which is threatening to cause, serious injury to the industry.Armenia and Georgia do not apply safeguard mechanisms which differ from those applied on MFNbases. Quantitative restrictions may be ascertained unilaterally and with strictly defined periods.These restrictions must be of exclusive character and may be applied only in cases envisaged bythe WTO agreements. The state, which applies quantitative restrictions, must provide the otherparty with full information on the reason for establishment, forms and possible dates of the applica-tion of the said restrictions.

Commodity nomenclatureDuring implementation of tariff and non-tariff regulation of bilateral economic relations for

exchange of statistics and implementation of customs procedures, Armenia and Georgia apply com-mon nine-digital commodity nomenclature of foreign economic activity based on the harmonizedsystem of description and coding of goods and on the combined tariff and statistic nomenclature ofthe European Union.

When implementing measures of tariff and non-tariff regulation, maintaining statistical account-ing and exchanging statistical information, as well as for customs control and clearance purposes,the parties apply the Goods Nomenclatures of Foreign Economic Activity based on the HarmonizedCommodity Description and Coding System. For their own needs, the parties shall, if necessary,carry out further development of national goods nomenclatures.11

Anti-Dumping and Countervailing MeasuresArmenia and Georgia consider that unfair business practice is incompatible with the Agreement’s

objectives and their legal framework, and they do not to allow for the following methods:• agreements between companies and their associations that aim to prevent or restrict competi-

tion or violate its conditions at the territories of the parties;• activities through which one or several companies, using their dominant condition, restrict com-

petition on the whole or on the substantial part of the parties’ territories.

Re-exportArmenia and Georgia do not permit a non-sanctioned re-export of goods, in regard to the export

of which another party producing these goods applies governmental regulation measures. It isagreed that both Armenia and Georgia determine the lists of goods according to which a non-sanc-tioned re-export is prohibited. The countries have also exchanged the lists of goods to which gov-ernmental regulation measures are applied. It is to be noted that re-export of such goods to thirdcountries may be implemented only through a letter of consent and in terms defined by the autho-rised bodies of the country of origin.


11 Article 7(2) provides that the Russian Federation shall carry out the maintenance of a standard copy of the HarmonizedCommodity Description and Coding System through the existing representative offices in relevant international organiza-tions, until other contracting parties declare their independent maintenance of the standard copy.

Armenia and Georgia should not permit a non-sanctioned re-exportation of goods for export ofwhich other contracting parties, on the territory of which these goods originate, apply measures oftariff and/or non-tariff regulation. Issues associated with re-exportation of goods must be regulatedin compliance with the Agreement on Re-exportation of Goods and Procedure of Granting a Permitfor Re-exportation (Annex II of the CIS Agreement).

Technical Barriers to Trade Currently the governments of Armenia and Georgia are taking measures necessary to ensure

that regulations, standards, testing and certification procedures meet the requirements of theAgreement on Technical Barriers to Trade (TBT Agreement).12 Member countries of the World TradeOrganization – e.g. Armenia and Georgia - are required to report to the WTO all proposed techni-cal regulations that set out specific characteristics of products that could affect trade with othermember countries.

In Armenia, the National Institute of Standards is the national body responsible for standards.The National Institute of Standards maintains the national fund of standards of the Republic ofArmenia which contains International (ISO), Interstate (GOST), Regional (EN), Armenian (AST) andother state standards. The National Institute for Metrology is called to implement all metrologicalactivities, maintain measuring standards (etalons), as well as perform certification (type approval)of measuring instruments both in the customs and inside Armenia, calibration, verification perform-ing bodies, testing laboratories accreditation activities, and state metrological control. There is alsoan accreditation agency which operates within the Ministry of Trade and Economic Development(the Ministry), as a separate department. It is empowered to perform accreditation activities: toorganise expert groups, assess technical competence of applicants by documentation presented,perform on spot checks, present results of assessment to the Accreditation Board for their final deci-sion. The Accreditation Board consists of fifteen members, representing both state governance bod-ies and stakeholders from NGOs (consumer protection, producers, trade organisations or associa-tions), scientific organisations, and it is headed by the Minister of Trade and EconomicDevelopment. The Board is authorised to grant or decline accreditation, widen or narrow the scopeof accreditation, cancel accreditation (if non-compliance or infringement is detected). The Board isalso responsible for granting authorisation for certification or testing in particular conformity assess-ment fields, accredited bodies or laboratories for which are not available. This authorisation is validfor one year.

The State Quality Inspection of Armenia operates within the structure of the Ministry as a sep-arate division and is headed by the Minister. It is entitled to perform control over the compliance ofproducts, processes/works, and services with mandatory requirements set by normative docu-ments, as well as observance of mandatory conformity assessment rules. It aims to preventinfringements of mandatory requirements by economic entities. It also inspects conformity assess-ment bodies for the compliance with normative documents and performs state metrological control.The Inspection administers a central (Yerevan) and ten territorial offices in regions.

As regards Georgia, the technical regulation system was reformed to give way to a voluntarystandards system and to reduce state regulation in this sphere. The new laws introduced technicalregulations harmonised with international and European standards that significantly simplify exportand import procedures for businesses. Sakstandarti (Georgian National Agency of Standards,Technical Regulations and Metrology) comprises different divisions: National Organ ofStandardization, Office of Accreditation, Institute of Metrology and Standardization, and Office ofControl and Supervision.

Institutional Cooperation Armenia and Georgia must regularly exchange information as regards the laws and other leg-

islative acts relating to the economic activity in trade and transport spheres, investments, taxation,


12 i.e. the transition into to a system of ‘voluntary’ standards and certification whereby the importer can choose to con-form his products to e.g. Georgian standards or the standards of any EU or CIS. If foreign standards are chosen, theymust be registered by the importer in a national responsible agency.

banking and insurance activity and other financial services including customs issues and statistics.It is required that they immediately inform each other about legislative amendments that may affectthe implementation of the Agreement.

They should notify each other of the operating tariffs and all their exceptions. These countriesshould take measures for a maximum simplification and unification of customs formalities, in partic-ular, by introducing single forms of customs and goods accompanying documentation, being guid-ed by current international agreements and arrangements.

To implement the agreed policy on export control towards third countries, Armenia and Georgiamust hold regular consultations and take mutually agreed measures for establishing an effectiveexport control system.

In order to implement the objectives of the Agreement and to elaborate recommendations forimprovement of trade and economic cooperation between the two countries, the parties haveagreed to establish a joint Georgian-Armenian Commission.

In addition, it should be mentioned that both Armenia and Georgia pay a special attention to theTRACECA (Transport Corridor Europe-Caucasus-Asia) project. The latter has resulted in a closercooperation and dialogue among member countries and their governments, aimed at facilitatingtrade, simplifying border-crossing procedures, and reducing transit fees.

Finally, there is an Armenian-Georgian Association for Business Cooperation which is an inter-governmental body that aims to strengthen cooperation and develop the bilateral relations betweentwo countries. The Association is actively involved, for instance, in trade facilitation matters includ-ing procedures and controls governing the movement of goods across national borders which iscurrently in the process of improvement so as to reduce associated cost burdens and maximise effi-ciency while safeguarding legitimate regulatory objectives.

World Trade OrganisationOn 6 October 1999, Georgia’s WTO accession negotiations were successfully concluded after

the WTO General Council adopted Georgia’s Working Party report and the so-called Protocol ofAccession that was signed by the State Minister of Georgia. On 20 April 2000, the Parliament ofGeorgia ratified the agreement on Georgia’s accession to the WTO, and on 14 June 2000 Georgiabecame the 137th full member of the WTO. The WTO Working Party adopted the final report ofArmenia’s accession in November 2002, and the General Council adopted the report in December,2002. The membership of Armenia to the WTO took place on 5 February 2003.

A key rule of the multilateral trade system is that reductions in trade barriers should be applied,on a most-favoured nation basis, to all WTO members. This means that none of the WTO members(e.g. Armenia and Georgia) should be discriminated against by another member’s trade regime.However, regional trade agreements - e.g. the Free Trade Agreement between Armenia andGeorgia - are an important exception to this rule. Under this Agreement, reductions in trade barri-ers apply only to the parties to the agreement. This exception is allowed under Article XXIV of theGeneral Agreement on Tariffs and Trade for trade in goods, in Article V of the General Agreementon Trade in Services (GATS) for Trade in Services, and in the Enabling Clause (i.e. the 1979Decision on Differential and More Favourable Treatment, Reciprocity and Fuller Participation ofDeveloping Countries).

Generalized System of Preferences In addition to enjoying MFN tariffs with other WTO members, Georgia also benefits from a

Generalized System of Preferences (GSP) when trading with the USA, Canada, Switzerland, andJapan. Accordingly, lower tariffs are applied on goods exported from Georgia to these countries. InJuly 2005, Georgia became one of the only two beneficiaries (besides Moldova) of the new EU GSPPlus scheme in the entire CIS and one of the 15 beneficiaries in the world. This is an important fac-tor in terms of facilitating export from Georgia. Under the old scheme, Georgia was allowed toimport only 3300 products to the EU market without any customs duties, and 6900 products under


certain preferences. After being granted the GSP Plus beneficiary status, Georgia is allowed toimport 7200 products to the EU market under the duty free regime. From 1 January 2006, Georgiaenjoys the ‘GSP Plus’ beneficiary status with Turkey as well.

As to Armenia, it is a beneficiary of GSP schemes provided by the EU, the USA, Canada,Switzerland, Japan, Poland, and Estonia.13 The GSP provides import duty reductions on a list ofproducts that meet the requirements stipulated by the country administering the GSP, whichincludes the rules of origin. To meet the rules of origin requirements under the GSP, the ArmenianChamber of Commerce and Industry, in accordance with the laws of Armenia, is empowered toissue a certificate of origin Form A, accepted in the countries administering the GSP. Currently theArmenian Government is applying for the ‘GSP Plus’ scheme: for especially vulnerable countrieswith special development needs. It will cover around 7,200 products that are allowed to enter theEU under the duty free regime. Here Armenia must meet a number of criteria including ratificationand effective application of 27 key international conventions on sustainable development and goodgovernance.

2. Investment Promotion and Protection

Investment laws and institutional framework

The primary statute dealing with foreign investment in Armenia is the Foreign Investment Act of1994 (the Armenian Act). In Georgia, the cornerstone of the modern legal framework for foreigninvestment is the Investment Activity and Guarantees Act of 1996 (the Georgian Act), the StatePromotion of Investments Act of 2006, and the Georgian National Investment Agency Act of 2002.In addition, there are various laws (including the secondary legislation) on privatisation, land acqui-sition, concessions and permits and licensing that are relevant for investors.

Both the Georgian Act and the Armenian Act determine in general terms the rights of foreigninvestors, guarantee these rights and establish the forms and methods of state regulation in thearea of investment activities. These Acts have established national treatment (foreign investors can-not be treated worse than domestic companies), the right to repatriate profits, 10-year guaranteesagainst adverse legislative changes (5-year in Armenia), and recourse to international dispute set-tlements.14 Investors rights are further specified in both Armenia’s and Georgia’s bilateral investmenttreaties (BITs).15 In addition, both investment laws do not identify any sector of the economy asbeing closed for foreign investment. They provide, in general terms, that it is prohibited to invest inan object whose creation and use does not meet the requirements of security, health or environ-ment and other requirements specified by the legislation.16

Substantive LawIn Georgia, an investment is any kind of property or intellectual value or right to be contributed

and used in the entrepreneurial activity carried out in Georgia for earning of possible income. Such‘assets’ include:a. monetary assets, a share, stocks and other securities;b. movable and immovable property - land, buildings, structures, equipment and other material

valuables;c. lease rights to land and the use of natural resources (including concession), patents, licenses,


13 For detailed discussion on EC GSP scheme, seeAEPLAC report on Increasing the Efficiency of the EC GSP Utilisationin Armenia, 2004.14 For more discussion on this topic, see “Investment Disputes”, infra.15 For more discussion on this topic, see “Bilateral Investment Treaty”, infra.16 This may includes production of nuclear, bacteriological or other weapons of mass destruction; production and dissem-ination of illicit drugs as well as other activities prohibited by international treaties and domestic legislations (e.g. Article 9of the Georgian Act).

know-how, experience and other intellectual valuables;d. other property or intellectual valuables or rights not prohibited by the laws of Georgia.

In Armenia a foreign investment means any type of property, including financial resources andintellectual values, which are being directly invested by a foreign investor in commercial and otheractivities conducted in Armenia to gain profit (revenue) or to achieve any other beneficial outcome.

Pursuant to the Armenian legal framework, foreign investors receive national treatment (i.e.they are treated no less favourably than domestic investors). There is one exception to this prefer-ential rule concerning the ownership of land. However, foreign companies established in Armeniaas legal persons have the same status as domestic entities and may own land. In addition, foreign-ers may obtain a permission to use land under long-term lease contracts.

The Armenian Act contains a so-called ‘stabilisation clause’. Accordingly, in the event of amend-ments to the foreign investment laws of Armenia, the legislation that was effective at the moment ofimplementation of the investment shall apply, upon the request of a foreign investor, during a five-year period from the moment of investing. Article 15 of the Georgian Act determines a ten-year peri-od: in such a case an investor shall conduct his activities in accordance with the legislation whichwas in force before the new legislative act has been effected.17

The guarantees against nationalisation and expropriation are provided. In Armenia foreigninvestment shall not be subject to nationalisation. Expropriation may only be allowed as an extrememean in case of an emergency declared in accordance with laws of Armenia, and only upon thedecision of a court and with full compensation. Investors must also be compensated for any dam-age or loss of profit resulting from illegal actions by state officials. Compensation shall be paid atcurrent market prices or prices determined by independent auditors either in the currency invested,or in any other currency mutually agreed upon by the parties. In Georgia the investments may onlybe subject to ‘requisition’: a) in cases specified by laws; b) by a court’s judgment, or c) in the caseof urgent necessity established by the legislation. The compensation should correspond to the actu-al value of the seized investment directly at the time when such requisition took place. In addition,the compensation must be paid without any delay and it shall also comprise damages suffered bythe investor from the moment of requisition till the payment of the sum of compensation.

In Armenia foreign investors are entitled to compensation, through a court’s judgment, for thematerial and moral damages - including lost profits - caused as a result of illegal actions by stateofficials. It is to be noted that compensation must be paid promptly at current market prices or pricesdetermined by independent auditors. This compensation is paid either in the currency invested, orin any other currency mutually agreed upon by the parties. For the period from the moment of orig-ination of the right to compensation through the moment of its execution, an interest in the dueamount of compensation shall be calculated at current rates for deposit accounts established on theloan market of Armenia.

In Armenia foreign investor’s profit (revenues) should, after paying the taxes and other feesrequired by the legislation, remain under the investor’s disposal. Moreover, foreign investors andforeign employees are entitled to freely transfer their property, profits and other means abroad.Foreign exchange is widely available, and the local currency - the Armenian dram - is freely con-vertible. The same is the regulatory framework in Georgia.

In Armenia the import of goods for paying in the statutory capital of enterprises with foreigninvestments is exempted from custom duties. If such goods are sold within a period of three yearsafter availing oneself of this privilege, the customs duty, including the collection of calculated penal-ties for a delay in payment, is due in accordance with the rules and procedures set by the customslegislation. It is to be noted that there are no corresponding provisions in the Georgian Act.

In Armenia enterprises with foreign investments are entitled to export their products, works andservices and import products, works and services for their own needs without any license, with theexception of the cases defined by the Armenian legislation and by international treaties. Althoughworded differently, the Georgian Act has a similar provision.


17 The same article provides that Articles 7 (“Investment Inviolability”), 8 (“Compensation for Investment Requisition”) and16 (“Procedure for Dispute Resolution”) shall not be subject to the legislative amendment.

Privileges established by the Armenian Act apply to those enterprises with foreign investmentwhere such investment is no less than 30 per cent at the moment of incorporation. There are nocorresponding provisions in the Georgian Act.

In Armenia, any foreign investor shall be entitled to exploit renewable and non-renewable nat-ural resources on the basis of concession contracts concluded by the foreign investor and theGovernment, as provided by the Concession Act of 2002. Concession contracts may contain excep-tions from the legislation in force in the Republic of Armenia. In such cases, they shall be subject toapproval by the Parliament.

Institutional and Policy ArrangementsThe Business Support Council of Armenia was established and its members were appointed by

the Presidential Decree No. 768 on “Establishing a Business Support Council” adopted on 31December 2000. The Charter of the Business Support Council became effective by the PrimeMinister’s Decree No. 131 of 22 February 2001. The main objective of the Council activities is toensure a favourable environment for investments and business in Armenia. The Prime Minister isthe Chairman of the Council; the Vice Chairman is the Chief Adviser on Economic Issues to thePresident. The Minister of Trade and Economy Development, the Minister of Finance and Economy,and the Mayor of the city of Yerevan are also included in the Council. Forty-four businessmen rep-resenting the business community are members to the Council, on rotation order, and eight repre-sentatives out of 44 are elected by rotation order once half year, the staff of which is formed inaccordance with the Prime Minister’s decree. Since the establishment of the Council, six rotationshave taken place. In addition in 2005, the Government adopted the Investment Policy Conceptwhich expressed general approaches and strategy of investment policy and presented a combina-tion of issues, principles and goals. The main goal of the investment policy of Armenia is:

“Ensuring sustainable economic growth, increasing prosperity of the population and protectionof environment via increasing of economic activity, formulation of favourable investment climate,and growth of investment volume.”

The Georgian National Investment Agency was established in 2002 when the GeorgianParliament adopted the National Investment Agency Act of 2002. As the only Georgian governmen-tal agency responsible for investment promotion, GNIA is designed to act as a “one-stop-shop” forcomprehensive information about investment opportunities in Georgia. The mission of GNIA is topromote and facilitate foreign direct investment in Georgia. The said Act outlines the role of theAgency and some programmes for the support to foreign and domestic enterprises. It needs to benoted that the programmes have long expired and functions assigned to GNIA in the law do not fullycorrespond with its current status and capacities. For example, the mandatory registration of invest-ments above 100.000 USD with GNIA and annual follow-up reporting of investment plans havenever been implemented. In 2002-2003, the ‘Fund of the President’ was used to stimulate invest-ments, mainly by domestic companies, through provision of subsidies and support to bank guaran-tees. The State Promotion of Investments Act seeks to refine the procedures of investment promo-tion. The Agency is to represent investors vis-à-vis administrative authorities during the licensingprocess. For this, the Agency charges fees that are to be determined by the Ministry of EconomicDevelopment. No fees apply for the category ‘investments of special importance’, investments over8 million GEL or over 2 million GEL, in case the investment is undertaken in highlands of Georgia.The Law further outlines the procedures of issuance of preliminary licenses and/or permits, clearlystating GNIA authority and the obligations of municipalities and state authorities to inform investorsabout the procedure in a timely manner.


Investment treaties

Bilateral Investment TreatyOver the last 50 years, the international community has taken decisive actions to promote the

flow of capital into developing countries by creating rights of fair treatment and effective remediesfor investors. The first key development was the substantial growth in the number of BilateralInvestment Treaties entered into by developed and developing countries. These treaties are agree-ments between two countries for the reciprocal encouragement, promotion and protection of invest-ments in each other’s territories by companies based in either country.

There are now about 2000 BITs in force worldwide.18 Over 140 states are party to at least onesuch treaty, two-thirds of which were concluded in the 1990s. These treaties provide rights of fairtreatment which investors can enforce directly against the Host State. They also commonly containthe Host State’s advance consent to the International Centre for the Settlement of InvestmentDisputes (ICSID) arbitration (as a division of the World Bank) in the event of investment disputesarising. The Host State is prepared to offer such rights to investors as a way of attracting invest-ments.

In addition, a number of Multilateral Investment Treaties (MITs) have been created which pro-vide rights that are largely similar to those found in BITs. The 1992 North American Free TradeAgreement (between Mexico, Canada and the USA) and the 1994 Energy Charter Treaty (in forcebetween EC states as well as 49 others) are the best examples.The Agreement on Promotion and Mutual Protection of Investments was signed by the governmentsof Armenia and Georgia on 4 June 1996 and entered into force on 18 January 1999.19 As of today,this Treaty constitutes the most important legal instrument for the mutual protection of foreigninvestments in both states. It has been concluded between two States in order to provide protectionto nationals of each state. ‘Nationals’ include both natural persons and companies i.e. investors cov-ered by protection of investment treaties can thus be divided into natural persons and legal entities.

The term ‘investor’ refers with regard to either Contracting Party to natural persons who,according to the law of the given Contracting Party, are considered to be its nationals. The Treatyextends the benefit of its protection to legal entities such as companies. It also requires that the enti-ty be incorporated or constituted under the laws of the contracting parties.

The term ‘investment’ means every kind of asset and in particular, though not exclusively,includes: a. movable and immovable property and any other related property rights such as mortgages;b. shares in, and stock, bonds and debentures of, and any other form of participation in, a com-

pany or business enterprise;c. claims to money, and claims to performance under contract having a financial value;d. intellectual property rights, technical processes, know-how and any other benefit or advantage

attached to a business; e. rights, conferred by law or under contract, to undertake any commercial activity, including the

search for, or the cultivation, extraction or exploitation of natural resources.If jurisdictional hurdles are overcome, the question arises whether the host state has breached

its substantive obligations. The Treaty determines the rights and protection available to investors ina particular host state. It provides broader protections for the investor than those available undercustomary international law such as:


18 See e.g. www.unctadxi.org. The BITs search engine has been designed by the United Nations Conference on Tradeand Development (UNCTAD), to provide a user-friendly way to retrieve either all available BITs signed by one country ora specific BIT between two countries. This table is illustrative only and should not be relied upon as a substitute for spe-cific legal advice. It is important to check the status and applicability of a treaty in each case, and to note that manytreaties are applicable to investments which came into existence before the treaty itself entered into force.19 The Parliament of Armenia ratified the Treaty on 18 February 1997 (N-161-1). Both Russian and Armenian versions ofthe Treaty are available on the official web site of the Ministry of Foreign Affairs of Armenia.

Full protection and security for the investmentInvestments are accorded ‘full protection and security’ by the host state. The practical effect of

this provision is that the host state will be liable to compensate the investor, should state authorities(such as the police) cause damage by, for example, taking unreasonable action or omitting to takereasonable protective action.20 The obligation of the host state to provide full protection and securi-ty to investors is independent and not relative to the level of protection provided by the state to itsown nationals or to nationals of other states. Therefore, the fact that the state did not protect theproperty of its own nationals is no defence to a claim by an investor of breach of this obligation.21

National and ‘most favoured nation’ treatmentAnother common protection provided by the Treaty is that the investment must be treated no

less favourably than that of nationals and companies of the host state (national treatment) or of anyother state (most favoured nation treatment, usually abbreviated to “MFN” treatment). Thus, thisprotection attempts to ensure “relative” standards of treatment, that is, standards which define thetreatment required for covered investment relative to the treatment given to other investments.22

Compensation for losses due to war or riot discriminatory measures impairing the investmentIf an investor suffers losses owing to war or other armed conflict, revolution, a state of national

emergency, revolt, insurrection, and riot or by military requisition, the investor’s compensationshould be no less favourable than the host state accords to its own nationals or companies of anythird state.

In addition, an obligation upon the host state not to impair the management or operation of theinvestment by arbitrary and discriminatory measures is imposed.

Protection against expropriation or nationalisation The obligation to compensate for expropriation is among the most crucial protections provided

by Treaty. This includes the physical or legal taking of property as well as measures which, whilethey may not deprive an investor of the legal right to his property, substantially diminish its value oranother benefit he derives from it (a good example being revocation of a licence required to oper-ate a business). Expropriation will generally be prohibited unless it is: • for a public purpose; • non-discriminatory; and • subject to prompt, adequate and effective compensation.23

The compensation should be equivalent to the fair market value of the expropriated investmentimmediately before the expropriatory action was taken or became known, whichever is earlier; bepaid without delay; be fully realizable; and be freely transferable at the prevailing market rate ofexchange on the date of expropriation.

Rights to repatriate investment and returnsThe Treaty contains a provision guaranteeing the right of investors to transfer the investment

and the returns on the investment into freely convertible currency after taxes and other mandatorypayments.


20 Asian Agricultural Products Ltd (AAPL) v Republic of Sri Lanka, ICSID Case No.ARB/87/3, Final Award, June 27, 1990,(191) 6 ICSID Review—Foreign Investment Law Journal 526; American Manufacturing Trading Inc v Republic of Zaire,ICSID Case No.ARB/93/1, Award, February 21, 1997, 5 ICSID Reports 10.21 American Manufacturing Trading Inc v Republic of Zaire, ICSID Case No.ARB/93/1, Award, February 21, 1997, 5ICSID Reports 10 and 30.22 See OECD, Most-Favoured-Nation Treatment in International Investment Law; September 2004. Emilio AgustínMaffezini v Kingdom of Spain, ICSID Case No.ARB/97/7, Award on Jurisdiction, January 25, 2000, (2001) 16 ICSIDReview—Foreign Investment Law Journal 212.23 See e.g. Metalclad Corporation v. United Mexican States (Award of 30 August 2000, ICSID Case no. ARB (AF)/97/1).

Dispute SettlementsDisputes concerning the investment between the investor and host state will be referred to inde-

pendent binding arbitration (often ICSID or UNCITRAL arbitration). The right to go to arbitration mayonly arise after attempts have been made to reach an amicable resolution (within 6 months).

Summarising the above mentioned analysis of the legislation base, it can be stated that:• The Armenia-Georgia Free Trade Agreement, which entered into force in 1995, aims to promote

stronger trade and commercial ties between participating countries and to accelerate the freetrade in goods by eliminating tariffs, duty and quantitative restrictions. It is consistent with theWTO rules i.e. with the definition set out in Article XXIV:8 (b) of the General Agreement onTariffs and Trade of 1994 (GATT). The provisions in the free trade agreements are wide-rang-ing; they have included many of the following topics: trade in goods, customs procedures, rulesof origin, transit, etc.

• The Agreement eliminates all customs duties on goods originating in the territory of the coun-tries that meet the requirements for ‘originating goods’. Neither country shall adopt or maintainany non-tariff measures on the importation of any good of the other country or on the exporta-tion of any good destined for the territory of the other country except in accordance with its WTOrights and obligations or in accordance with other provisions of the Agreement. The Agreementrequires ensuring free transit through the countries’ territory.

• Thus the Agreement must be mutually reinforced by the participating parties so as to providegreater opportunities in the goods and services sectors to a wide range of Armenian andGeorgian exporters, and to further strengthen trade and investment links between the countries.

• This part of the study also discusses relevant provisions of the Creation of a Free Trade Areawhich have became operational in 1994 and aim to form conditions for a free movement ofgoods and services. It provides cooperation in solving specific tasks targeting gradual elimina-tion of customs duties, taxes and levies which have equivalent effect and quantitative restric-tions in mutual trade; abolition of other barriers to a free transfer of goods and services; cre-ation and development of an effective system of mutual settlements and payments on trade andother transactions.

• A bilateral investment treaty between Armenia and Georgia - signed on 4 June 1996 andentered into force on 18 January 1999 - is an agreement establishing the terms and conditionsfor private investment by nationals and companies of one country in the country of the other.The Treaty provides international minimum standards of treatment guaranteed to foreigninvestors such as fair and equitable treatment, full protection and security, most-favoured-nationtreatment, national treatment. In addition, the Treaty stipulates that investments shall not beexpropriated or nationalized either directly or indirectly through measures tantamount to expro-priation or nationalization (“expropriation”) except for a public purpose in a non-discriminatorymanner upon payment of prompt, adequate and effective compensation.

• Finally, the investment acts of Georgia and Armenia are also examined and have proved to bequite liberal laws compared with the legislations of several other CIS countries. They assureexisting guarantees to foreign investors of their rights in a single transparent and stable docu-ment.


PPAARRTT 22.. TTRRAADDEE AANNDD IINNVVEESSTTMMEENNTT FFLLOOWWSS BBEETTWWEEEENN AARRMMEENNIIAA AANNDD GGEEOORRGGIIAA

Changes in the volumes of trade flows within the regional neighbourhood are the first indicatorsof the active or passive character of the country’s relationship with the countries in the region. Fromthis point of view, it is important to know which goods prevail in the trade flows of Armenia with itsneighbours, and in the production of which goods the neighbouring states have comparative advan-tages. Besides, the character of changes in the volumes of trade turnover during the last four or fiveyears is of a special interest. Finally, it is important to know whether the trade flows have a concen-trated or diversified character.

This report provides a comprehensive overview of the Armenia-Georgia merchandise tradingrelationship for the period covering 1998-2006, with a specific emphasis on Armenian exports toGeorgia. This part of the report examines also the nature of Armenia-Georgia merchandise trade,identifies the sectors in which Armenia has a comparative advantage and prospects for increasingArmenia’s exports to Georgia.

Growth of Armenian Exports to, and Imports from GeorgiaThe indicators of Armenia show that there has been a significant improvement in the external

trade over the past nine years (average annual growth in exports over the period amounted 21.91%as compared to 12.6% average growth in imports), which leads to a substantial trade deficit declinefrom 30% to GDP in 1998 to 18.6% in 2006.

Table 5 Armenia, Trade with the World and Georgia (USD, million)

* Since 2003, the statistics on external trade is presented by country of origin.

The volume of Armenia’s trade increased by 15.2% in 2006 as compared to 2005 andreached 3,198.36 billion USD, of which exports increased by 3.1% to 1,003.96 billion USD andimports by 21.8% to 2,194.4 billion USD.


Table 6 Armenia, main trade partners, 1998-2006

During 1998-2006, the trade between Georgia and Armenia has increased steadily, andGeorgia has became the fifth largest trade partner of Armenia (export, excluding Switzerland-export to this country mainly consists of polished diamonds and that is only processing of import-ed diamonds for re-export).

Chart 2 Exports to Main Trade Partners

The Armenian export structure, including exports to Georgia - although there is a clear diversi-fication tendency within the product group involved - remains highly concentrated, with diamondprocessing, jewellery and copper and molybdenum ore and concentrates, still accounting for morethan half of the total export to the World and with ores and mineral products (mainly cement)accounting for more than 40 percent of total exports to Georgia. The commodity composition ofArmenia’s export to Georgia has remained fairly constant over the observed period, with the topseven group of products accounting for more than 80 percent of the Armenian exports, however thenumber of products (at the 8-digit GNFEA level) has significantly increased from 85 in 1998 to 299in 2006.


Table 7 Commodity Share in Export to Georgia and World

Cement remains one of the main products exported to Georgia from Armenia. About 15.6 mil-lion USD of cement exports24 were indicated in 2006, showing an increase of 42.6% compared to2005, and more than 50 times increase compared to 2002. It is also important to mention that thereare two types of cement production in Armenia - production of moist and dry cement - both of whichare competitive on the Georgian market. Nevertheless, as the share of costs of gas in the total costsof moist cement production account for about 70-75%, the review of gas prices by Russia since2009 may highly impact the volume of moist cement exports to Georgia, although the dry cementmay still remain competitive. The next product group, by share of total Armenian exports to Georgia,is vegetable products. As it can be seen from Table 8, the share of these products in the totalArmenian exports to Georgia in 2006 accounted for 14.8 %. The most part of this product groupincludes coffee,25 exports of which in 2006 constituted about 7.9 million USD, compared to 5.6 mil-lion USD in 2005 (41.9% growth) and to 0.4 million USD in 2002 (more than 19 times growth). Thus,exports of coffee to Georgia have shown a steady high growth rate during the preceding five years.Another important item of Armenian exports to Georgia is ‘prepared or preserved meat’ falling underthe section for foodstuffs (see also Table 8). The volume of these products26 constituted 1.1 millionUSD in 2006, whilst in 2005 it accounted for only about 0.1 million USD. Thus, the growth rate ofexports increased by almost eleven times since 2005, though the exports of these products duringthe preceding years were rather insignificant. It is also worth noting that in 2006 large volumes ofexports of plastic bottles were observed. The exports of this product type accounted for 1.1 millionUSD for the mentioned period, whilst there were almost no exports of this product during the previ-ous years.


24 Products falling within CN codes 2523 10 00, 2523 29 00 and 2523 90 90.25 Products falling within CN codes 0901 11 00, 0901 21 00 and 0901 22 00.

Table 8 Commodity Share in Import from Georgia and World

The main product groups imported from Georgia to Armenia are prepared foodstuffs, chemicalproducts, wood and vegetable products, the share of which in total imports from Georgia accountsfor 40.0%, 30.3%, and14.8% respectively (see Table 8). The main product falling under Section“Prepared foodstuffs” and exported to Armenia is sugar,27 the exports volume of which in 2006 con-stituted more than 11.8 million USD, showing a growth of 2.5 times against the 2005 marker. Duringthe preceding years, the exports of this product to Armenia was quite insignificant. Another impor-tant item of Georgian export to Armenia are the chemical products, and in particular fertilizers.28 Theexports of the Georgian fertilizers, as in the case of sugar, experienced a high boost in 2006, reach-ing the figure of 9.5 million USD, whilst in 2005 the volume of exports of this product accounted for5.2 million USD. Thus, a growth of 1.8 times was observed. However, unlike sugar, large volumesof this product were exported to Armenia also during the preceding years: there has been a steadyincrease year-on-year. The third category by its share in the total Georgian exports to Armenia iswood, and especially that falling under subchapter 4407 of the Harmonised System.29 The Georgianexports of this product constituted 5 million USD in 2006, with an increase of 1.8 times comparedto 2005, and 2 times compared to 2002.

The export concentration index shows the degree of diversity of export assortment and theequality of the distribution of exported goods’ weights in the general export structure. If one or agroup of exported goods obviously overweighs the others, then the index value is equal to 1, andin the case of weight equality, the index value is zero30.


26 Products falling within CN code 1602 50 80.27 Products falling within CN code 1701 99 10.28 Products falling within CN codes 3102 21 00 and 3102 30 90.29 Wood sawn or chipped lengthwise, sliced or peeled, whether or not planed, sanded or end-jointed, of a thicknessexceeding 6 mm.30 Obviously, on the level of an exports’ eighth -digit coding used in our calculations, calculated concentration index pro-vide a complete idea about the exports concentration.

Table 9 Concentration indices of the trade between Armenia and Georgia

1NSS and own estimations. Estimated at the 4-digit level GN FEA (The trade concentration index is calculated inaccordance with Gini-Hirrschman coefficient)

As it can be seen from the table, the concentration indices for exports to Georgia are decreas-ing year by year, which means that products exported to Georgia from Armenia are constantly beingdiversified. Despite the fact that compared with 1998, in 2006 a quantitative growth of goods export-ed from Armenia to Georgia was observed (from 85 to 299), due to the weights of processed indus-trial goods (cement, plastic products) and some processed foods the increase of diversity of exportsdoes not seriously ‘soften’ the concentrated character of exports. In case of imports from Georgia,the concentration index is still relatively high,31 but volatile. In 2003 there has been a significantdecrease in the number of products imported from Georgia, which can be explained by the shift tostatistics based on the origin principle.

It is also important to analyse the exported products that Armenia and Georgia have a high levelof specialization. Armenia has presented seven main types of products (at the 4 digit level) where thelevel of specialization was very high. These groups of goods included cement, eggs, coffee, preparedmeat, electrical energy - here the export specialization index had absolute advantages (see Table 10).

Table 10: Armenia’s export specialization index* (2003-2006)


31 The world concentration index compared with 1998 has changed insignificantly and has the value of 0.2.

Georgia has high level of specialization in nuts, citrus fruits, sugar, cyanides and fertilizerswhere the high level of specialization is obvious (see Table 11).

Table 11: Georgia’s export specialization index (2003-2006)

The concentration character of Armenian exports is explained by high transportation costsand unsatisfactory level or absence of local materials. As a result, Armenia has to be specializedin spheres where the value added to imported materials is relatively high with low transportationcosts.

TTrraaddee iinn SSeerrvviicceess

Another important component of Armenia-Georgia economic relations is trade in servicesbetween these two countries. Being a landlocked country, Armenia has to use the more favourablegeographical location of Georgia to access to the markets of its main trading partners, such as theEU and the CIS, which is a large source of exports of Georgian transport services to Armenia.Another source of benefits for Georgia from trade in services is the transit of gas from the RussianFederation to Armenia, the importance of which cannot be underestimated. Besides, according tovarious statements of Georgian state officials, the number of Armenian tourists in Georgia has sig-nificantly increased, which is also an important element of service exports.


*The export specialization (ES) index is a slightly modified RCA index, in which the denominator is usually measured byspecific markets or partners. It provides product information on revealed specialization in the export sector of a country andis calculated as the ratio of the share of a product in a country’s total exports to the share of this product in imports to spe-cific markets or partners rather than its share in world exports:ES = (xij/Xit) / (mkj/Mkt)Where xij and Xit are export values of country i in product j, respectively, and where mkj and Mkt are the import values ofproduct j in market k and total imports in market k. The ES is similar to the RCA in that the value of the index less than unityindicates a comparative disadvantage and a value above unity represents specialization in this market.To make the indicator symmetrical - to present it in [-1;+1] surrounding, the received ES is transformed in the following way:symmetrical ESi = (ESi-1)/(ESi+1): The indicator shows in which exported good the country has a comparative advantage:The values tending to -1 show the absence of relative advantage in the given good, and the values tending to 1 show thepresence of such an advantage**Absolute advantages, ***No exports

Thus, to have a whole picture of economic relations between Armenia and Georgia, it is alsoimportant to analyse the structure of Georgian benefits from exports of services to Armenia. Theassessment of the mentioned benefits resulted from exports of Georgian transport services, tourismand transit of gas is provided below.

TransportBoth Armenia and Georgia are considered open economies in regard of external trade, but at

the same time, the transportation costs are extremely high. As it is shown in Table 12, the trans-portation costs in Armenia are more than twice higher than the world average, which is explainedby the fact that Armenia is a landlocked country. The high ratio of transportation services to exter-nal trade turnover in Georgia is mainly due to the fact that Georgia is a transit country for Armeniaand Azerbaijan, and transportation services currently are the largest item of Georgian exports.Thus, the high turnover of transport services indicates the high level of transportation costs forArmenia, whilst on the other hand it is a source of revenues for Georgia.

Table 12 Comparative analysis of transportation costs as of 2005, in % to GDP32

Although showing a downward trend, the transportation costs of Armenian and Georgianexports and imports may be considered as one of the highest worldwide, with the possible excep-tion of African landlocked countries.

Since the relevant statistical data on bilateral trade in transport services is not available, thetotal exports of Georgian transport service to Armenia is calculated on the basis of the data obtainedfrom an Armenian freight company, “Apaven”. The company provided the following figures in regardto the transportation costs of Armenian exporters and importers spent on the Georgian side (seeTable 13):


32 Source: WTO trade statistics

Table 13 Transportation of 1X20’ Maersk sea/land container Poti-Yerevan-Poti by rail and by truck (USD)

To calculate the average transportation cost per ton, the share of cargo transportation by roadand rail is required. For 2003, the total exported and imported goods by rail constituted 243,800 and990,300 tons respectively (1,234,100 tons in total), whilst the same figures for road cargo trans-portation amounted to 103,700 and 434,100 tons respectively (537,800 tons in total).33 These fig-ures show that about 74% of the Armenian trade is carried out by rail. Thus, the average cost perton is equal to 32.13 USD.34

Taking this figure as transportation cost per ton for all Armenian products traded through the ter-ritory of Georgia, the total transportation cost is calculated. In 2006 Armenia’s total trade by weightcarried out through the territory of Georgia amounted to about 3.1 million tons. Multiplying this fig-ure by the average cost per ton, we can have an estimate of Georgian transport services exportsto Armenia, which constitutes about 100.23 million USD.

In respect to the Armenian transport services exports to Georgia, it is important to mention thatArmenian transport companies are not competitive in comparison with those of Georgia, thereforethe volume of transport services exported to Georgia cannot be significant.

There is also an important fact which is worth to be mentioned: Armenia should negotiate for a50% railway tariff discount with Georgia, as the one provided to Azerbaijan. Georgian railway tariffsdiscount provided to Armenia is 21% in average, of which 24% - for oil commodities, 17% - for otherproducts, i.e. transit costs by the Georgian railways per 1 ton is 12.17 USD in average. If Georgiaprovides a higher tariff discount as it is the case with Azerbaijan, transport of a container from Potito Sadakhlo would cost 177.2 USD (7.7 USD per ton).

Transit of gasAs it is known, Armenia’s import of natural gas comes from the Russian Federation through the

territory of Georgia, which requires a transit fee of 10% of the natural gas transported by the Russia-Armenia gas pipeline. The price of the gas for Armenia is set at the level of 110 USD for thousandcubic meters, whilst at the same time the price for Georgia constitutes 230 USD for thousand cubicmeters. According to the Armenian gas importing company “Armrusgasprom”, the following data onthe volumes of imported gas was obtained (see Table 14):


33 Source: National Statistical Office of the Republic of Armenia, Transport and Communications of the Republic ofArmenia, 1999-200334 Average cost per ton = ((522 X 0.74) + (1357 X 0.26))/23 = 32.13 $. Calculation is done at a rate 23-24ton per 20 ft.Container (cargo plus container), which is typical weight for container in Armenia and Georgia

Table 14 Volumes of natural gas imported into Armenia from RF (million cubic meters)

* 10% of total gas imported to Armenia from Russia

Converting these figures to US dollars at a price of 230 USD for thousand cubic meters, we willhave the benefits of Georgia from the transit of gas (See Table 15).

Table 15 Volume of Georgian fees from the transit of gas from Russia to Armenia (USD, million)

Thus, in 2006 the Georgian benefits from the transit of gas through its territory accounted forabout 41 million USD35.

Tourism servicesAnother important component describing the trade in commercial services between Armenia

and Georgia is that of tourism services provided by these two countries to each other. A recentlyconducted study36 based on the survey organized by the Statistics Department under the Ministryof Economic Development of Georgia states that the volume of tourism services exported fromGeorgia to Armenia for the period of July-October 2006 constituted about 10.27 million USD. On theother side, Georgian imports of tourism services from Armenia for the same period amounted toabout 4.62 million USD. Thus, during the period of July-October 2006 Georgian net export oftourism services to Armenia was about 5.65 million USD.

Thus, the total benefits of Georgia from exports of transport and tourism services, as well asfrom transit of gas, are as follows:• Exports of transport services to Armenia – 100.23 million USD;• Transit of gas – 40.89 million USD;• Net exports of tourism services – 5.65 million USD;• In total – 146.77 million USD. 37

Summarizing the analyses of the trade in services between the observed two countries, itshould be mentioned that Georgia highly benefits from its favourable geographical location as wellas from the fact that Armenia is a landlocked country. High transportation costs for Armenianexporters and importers are significant source of revenues for the Georgian economy. Besides, highprices of domestic tourism services and low prices of passenger transportation to Georgia is anincentive for Armenia to use Georgian tourism services.


35 ‘’Georgia is entitled to 10 per cent of the gas transiting the country as an in-kind fee, but this is reduced by the tech-nical losses incurred in transportation, which amount to about 6 per cent of the quantity transported’’. ‘’In the Pipeline:Georgia’s Oil and Gas Transit Revenues’’. Andreas Billmeier, Jonathan Dunn, and Bert van Selm, IMF, 200436 Vakhtang Pkhakadze, Revaz Tsakadze, Department of Statistics under the Ministry of Economic Development ofGeorgia, with financial support of TACIS programme, “Report of the Survey on Shuttle Trade and International TouristServices”, Tbilisi, 200637 Calculation of the volumes of some other services such as telecommunications, is not possible due to lack of rele-vant data, caused by not provision of data by Armentel.

FFoorreeiiggnn DDiirreecctt IInnvveessttmmeennttss

Besides trade in goods and services, it is important to analyse also the investment flows. It is anoteworthy fact that the Georgian direct investment stock in Armenia is too small and amounts toonly 21,200 USD, whilst the total Armenian FDI stock for the period of 1988-2006 constitutes about1.7 billion USD.38 It is for this reason that the emphasis is made on the flows of Armenian directinvestments into the Georgian economy.

The share of Armenian FDI stock for 2000-2006 in the Georgian economy is also rather insignifi-cant (see Table 16 and Chart 3). However, in comparison with the Georgian direct investments into theArmenian economy, the figure is much larger and an upward trend may be observed (see Table 17).

Table 16 FDI stocks in Georgia by main investing countries, 2000-2006 (1000 USD)39

Chart 3 Share of FDI stocks in Georgia by main investing countries, 2000-2006 (%)


38 Source: National Statistical Service of the Republic of Armenia, “Socio-economic situation of the Republic of Armeniafor the period of January-February 2007”39 Source: Department of Statistics under the Ministry of Economic Development of Georgia

Table 17 Growth of FDI flows compared to previous year (%)

The volatility of FDI inflows growth rates across all the countries is obvious: this is natural forsmall countries since a small project undertaken by a foreign investor may lead to a significantincrease of growth rate as compared to the previous year. Besides, it is important to note that mostof the investment since 2003 can be attributed to the exceptional influence of the construction ofthe BTC pipeline and, more recently, the construction of the gas pipeline. The international consor-tia involved estimated that their contribution to these inflows accounted for 75% in 2005, and in2007 it will account for about 50%.40 At the same time, there is a clear upward trend in the FDI vol-ume invested in the manufacturing sector, which constituted about 110 million USD in 2005.

Another interesting fact is that a high growth of FDI inflows to the Georgian economy was indi-cated in 2003, which can be also explained by the political changes that took place in Georgia. Thenumber of countries investing in Georgia also increased significantly (see Table 18). Armenian andAzerbaijani FDI outflows to Georgia commenced in 2003.

Table 18 Number of countries investing into Georgian economy by years

Thus, it can be concluded that the two countries are weakly interlinked with each other interms of FDI, although Armenia is becoming more active in this sense, whereas Georgia is play-ing the role of a passive partner. The revolution in Georgia set favourable conditions for FDIinflows, including for those coming from Armenia.

Summarizing the analyses provided above, it is worth to highlight the following points:•• Trade in goods: Armenia plays an active role in regard to merchandise trade. The main

Armenian exports to Georgia include cement and coffee. The Armenian imports from Georgiamainly consist of sugar, fertilizers, citrus fruits and processed wood. The concentration indexshows that trade between these two countries is being diversified year by year.


40 GEPLAC, “Foreign Direct Investment to Georgia: Can Active Investment Promotion Policies Make a Difference?”,January 2007

•• Trade in services: Due to its favourable geographical location, Georgia has significant rev-enues from its export of services. In particular, Georgia highly benefits from export of transportand tourism services to Armenia, and has revenues from transit of gas. On the other hand, thelarge volume of service imports from Georgia to Armenia is due to the fact that the latter is alandlocked country.

•• FDI: The two countries are weakly interlinked with each other in terms of foreign direct invest-ment, although flows from Armenia to Georgia are increasing. This means that Armenia againplays a role of an active partner. The high growth rate of investment inflows to Georgia duringthe recent years can be explained by the construction of the BTC pipeline. The growth of FDIinflows into the Georgian economy shows that the investment climate has improved during thepreceding years.


PPAARRTT 33.. QQUUAANNTTIITTAATTIIVVEE AANNAALLYYSSIISS AANNDD EECCOONNOOMMEETTRRIICC

EESSTTIIMMAATTIIOONNSS

Model Setup

One of the major indicators that characterize economic relations between two countries is thetrade. As mentioned above, both Armenia and Georgia have undergone major structural changesin their economic systems since the collapse of the Soviet Union. Despite severe inflation andunemployment that was prevailing in both countries for the most of the 1990s, both countries man-aged to overcome the existing difficulties and have now become trading partners. The graph belowshows the evolution of trade between Armenia and Georgia. As it can be seen from the graph, theincrease in total trade volume, which is calculated as a sum of imports and exports, is mainly dueto a significant increase in exports from Armenia to Georgia, meanwhile the imports from Georgiahave been increasing in a more moderate pace.

Graph 1

However, it is to be mentioned that since 2003 imports of goods started to be declared basedon their origin rather than by country of imports, i.e. if a gadget was made in Germany but import-ed from Georgia, then it used to be declared as imports from Germany. Despite this structuralchange in trade declaration, the pattern described above still can be seen on the graph coveringthe past four years.

Graph 1 is based on figures that include only tradable goods and do not include services whichconstitute the second major component of trade. In this study, these two components of trade –goods and services – were broken down into two parts and analyzed separately. One of the mainhypotheses is that although the growth of imports of goods from Georgia has lagged behind thegrowth of exports from Armenia to Georgia, the difference has been made up by growth of importsof services from Georgia. Particularly, there are two major sources of exports of services fromGeorgia to Armenia. These are charges for transportation and tourism. Transportation charges intheir turn are divided into tariffs for communication, such as charges incurring from using the landfor putting up the fiber-optic lines connecting Armenia with the main computer centers, tariffs from


transporting gas from Russia to Armenia, and tariffs for transiting trucks from European countriesand Russia to Armenia. In this part of the research, the emphasis is put on an empirical analysis oftrade in goods, meanwhile the analysis of services is presented in Part 2 and Part 3 of the Study.

In order to be able to factor out variables that can potentially have an impact on trade relations,it was decided to suggest and estimate exports and imports demand functions for Armenia.

For any type of good tradable between the two countries – Armenia (A) and Georgia (G) – it ispossible to use the following functional forms:

where EX and IM are exports and imports of good i from and to Armenia in USD in real terms; Pi isthe price for good i - the unit price including transportation costs; P is the price index; and C is con-sumption in USD terms. Superscript A and G denote the country. ? is the nominal exchange rateversus USD. The exports and imports are given in real terms.

To obtain a better understanding of how exports and imports demand functions have been esti-mated, please refer to Box 1.

Thus, if we take the log of the equations (1)-(2) we will get the following relationships:

These theoretical equations assume that there should be equal (in absolute terms) impact ofunit price of goods and price inflation in trading partner country on exports or imports. However,there may be many reasons as to why this should not be considered a dogmatic statement, andtherefore coefficients in front of these variables in the equations may differ from each other even inabsolute terms. The simplest explanation is that for each type of good there should be its own fixedeffect of the unit price of good i on exports or imports. Therefore, the entire sample of all goods maynot necessarily produce equal coefficients (in absolute terms) on the first two right hand-side vari-ables in equations (3)-(4).

Due attention should be paid also to the coefficient in front of the consumption variable. Thetheoretical equation suggests that there should be one-to-one relationship between consumptionand exports, however the elasticity coefficient may vary from unity because of (a) fixed effects ofeach type of goods, and (b) year that the analysis covers.

Therefore, we will not constrain any of the coefficients when estimating the equations. Thus, headjusted relationships take the following forms:


Where, in addition to all notations, t denotes the time, and uit and eit are the idiosyncratic errorsthat can be added to the right hand-side of the equation in order to keep the coefficient constantacross the type of goods and time. This proposed framework can be used for estimating equations(5)-(6) for pooled dataset.


Nevertheless, there are several issues that should be considered, and some of them should bementioned in the model setup. First, the relationships described above do not take into account thedemand from the rest of the world, and consider only the mutual demand on goods solely betweenGeorgia and Armenia. However, if the variables can be controlled so that errors are not correlatedwith any of the right hand-side variables, then it will be possible to get a pure effect of each of thethree factors that are included in the relationship. To this end, it will be necessary to use special esti-mation techniques such as two-stage least squares estimation method. Second, the equationsshould be estimated in first-difference forms in order get rid of the effect of possible trend in the dataacross the time. This is something that is more known as unit root. If the data is not stationary, con-sistent estimations for coefficients cannot be achieved.

It is anticipated to get the following signs for each of the coefficients for the estimated equa-tions. The unit price of goods should have a negative sign on exports or imports, meaning that high-er unit price in Armenia should have a negative impact on exports of goods from Armenia toGeorgia; meanwhile higher prices of import goods from Georgia will have a negative effect on thevolume of imports to Armenia. At the same time, higher consumer prices in Georgia will create ademand for goods produced in Armenia, whereas higher consumer prices in Armenia will have apositive impact on the demand for goods imported from Georgia. The impact of consumption ratein the trading partner on the exports of goods can be ambiguous. The theory suggests that ceterisparibus higher consumption in trading partner country should proportionally increase the demandfor exports. This is true provided that there are only two trading partners. However, in case there isa third trading player in form of the ‘rest of the world’, then there can be a negative effect on thatvery variable. The factor behind it is that with increasing consumption, say in Georgia, Georgianswill import less Armenian goods, substituting them by imports from other trading partners, such asEU countries. The same is true for Armenia as well. The higher is the net wealth of Armenian con-sumers, i.e. higher consumption in Armenia, the more goods will the Armenian consumers substi-tute by importing from other trading partners.

Data Mining

As mentioned above, the change in trade declaration based on the origin rather than on coun-try of imports took place in the beginning of 2003. Therefore, to ensure the consistency of our data,this analysis includes data covering the period of 2003-2006. However, not all types of goods havebeen traded during the course of each of these four years. Therefore, in order to come up with abalanced panel of data, all goods that have not been traded during at least one of the years of theobserved period were excluded. The raw dataset was obtained from the National Statistical Service.The depth of the data included types of goods aggregated up to the 8th digit. Since this kind of datawas too detailed and did not allow for enough observations when filtered to obtain a balanced panelof data, the data was aggregated up the 4th digit. After filtering the data, 45 types of goods wereleft at the 4th digit of aggregation for exports data, and 25 types of goods for imports data. The listof the types of goods for both exports and imports is given in Table A1 and Table A2 of Annex 1.Table A3 provides the goods that were in the list of both exports and imports during 2003-2006.


Table 19. Entire and filtered Armenian exports and imports to and from Georgia

Table 19 provides the share of filtered data in the total value of exports and imports. The pur-pose of this calculation is to ensure that filtering out types of goods that did not encounter in at leastone of the observed years did not cut off the bulk of the total exports or imports during the givenyear. Moreover, it can be concluded that on average 63% of exports during 2003-2006 was madeof the same 45 types of goods aggregated to the 4th digit; meanwhile around 67% of imports werecreated by 25 types of goods.

Table A3 of Annex 1 shows that there were only 3 types of goods that were traded in both direc-tions. This suggests that during the preceding four years the two countries have been complement-ing each other rather than competing with each other.

The conclusions drawn on the basis of the tables lead to the hypothesis that trade between twocountries lies in different layers of demand. Georgia has a larger demand on tradable goods fromArmenia rather than the letter has on imports from Georgia. At the same time, the lower demand byArmenians for imports from Georgia is substituted by imports of services from Georgia. For moredetailed information on services, please refer to Part 2 of the Study.

For each observation, i.e. type of good, it has been possible to obtain the total weight or thenumber of units for each type of good, as well as its total value in US dollars. From here, the unitprice for each type of good was obtained and its change over the previous period as a change inthe unit price of good, or in other words deflator, was considered. By construction unit price of goodsalso include transportation costs (TC) associated with transit of goods for exports or imports. Inorder to be able to segregate TC from the entire value of goods, a survey was conducted with alocal freight company, “Apaven”. In fact, although the entire turnover of the trade has increased overthe years, it did not put any specific downward pressure on the transportation cost which stayedconstant over time.

Consumer prices, consumption and nominal exchange rate series were obtained from theInternational Financial Statistics (IFS) compiled by the International Monetary Fund. Series that rep-resent consumer prices are 91164...ZF... for Armenia, and 91564...ZF... for Georgia. Both are givenas an index which equals 100 for Y2000. Consumption series are represented by household con-sumption expenditures, including NPISHS, and given in 91196F..ZF... for Armenia and 91596F..ZF...for Georgia, as classified by IFS. Figures given in local currency were converted to US dollars,using the nominal exchange rate taken as average for each year, rather than the end-of-period41.The series corresponding in IFS are 911..AF.ZF... for Armenia and 915..AF.ZF... for Georgia.


41 More information on data dissemination and methods of data compilation can be found at http://www.imf.org.

Estimation and Results

Equations (5)-(6) were estimated using regression methods for panel of data for 2003-2006.Since the variables associated with the rest of the world were omitted, the right hand-side variablesmight be correlated with errors which can bring some endogeneity in the system. The control for thisestimation was done using two-stage least squares method, where as instruments were taken allexogenous variables as well as lagged series for unit prices. The equations were also controlled forfixed effects for cross-section data. Breusch and Pagan Lagrangian multiplier test was performed tomake sure that there is in fact a statistical difference in using fixed rather than random effects in thesystem. The results of the test are given in Annex 1 in Table A4. Nothing was controlled for timedimension since, as was mentioned in the model setup, the main variation brought into the systemis mainly due to various types of goods. Also because of the latter, cross-section coefficients covari-ance matrix was estimated using White’s cross-section estimates to take into account the het-eroskedasticity in the data. Equations were estimated in log-differences, which approximately equalto percentage change. This however forces to drop off one year of observations - Y2003 - which con-sisted of 45 data observations for exports, and 25 for imports. However, it was still possible to ensureconsistency in the estimation since even after dropping an entire year of observations, there were 3x 45 = 135 observations for exports, and 3 x 25 = 75 observations for imports. Outputs of estimationfor both exports and imports demand functions are given in tables below.

Table 20. Estimation results for exports demand function

Table 21. Estimation results for imports demand function


The tables above show that the estimated coefficients in the demand functions are of the ini-tially anticipated sign, as suggested by the theory. Coefficients are also statistically significant. Thecoefficient on consumption has a negative sign. As already mentioned, this can be explained by thefact that the export function is higher than the consumption rate in Georgia, more Georgians sub-stitute Armenian goods with those from the rest of the world. Particularly, with higher living stan-dards, Georgians would rather import goods from EU countries as goods of supposedly higherquality. Unfortunately, it was not possible to construct a model taking into account the demand ofimports and exports using not only two countries, but incorporating the rest of the world as well,since it was beyond the scope of this research. For this purpose, it was necessary to build a com-putable general equilibrium (CGE) model and calibrate it42.

Results of the regression analysis for exports demand function are as follows. One percentincrease in unit prices of exportable goods has a very minor impact on the exports: it will decreaseonly by approximately 0.09%. In other words, the price elasticity of Armenian exports to Georgia isvery inelastic. The explanation behind this is that the export to Georgia is very concentrated43. Thehuge bulk of exports consist of only 5 types of goods, of which cement is the largest. The Araratcement factory, which is the only cement factory in the region that uses dry technology, producescomparably cheap cement. Even with transportation costs from Armenia to Georgia, the import ofcement is still cheaper than its production in Georgia via the wet technology. Booming constructionin the region has increased the demand for cement, which Armenian producers were more thanready to provide with inflating prices from year to year.

However, it can be assumed that price elasticity of exports will grow as Georgia starts diversi-fying its imports, finding other sources of substitutes. Particularly, investment projects in the area ofdiversification of energy resources are observed. Besides importing electricity from Armenia,Georgia has set up lines of electricity imports also from Azerbaijan and Turkey.

With regard to consumer prices, a one percent change in consumer prices - an indicator moreknown as inflation - in Georgia brings to 1.42% increase in exports of goods from Armenia. This isexplained by the differences of the monetary policies pursued in Armenia and Georgia. Starting fromearly 2004, the US dollar exchange rate depreciation pressures placed all central banks in front ofa dilemma of either artificially depreciating their national currencies by sterilizing capital inflows andthus creating monetary inflation, or concentrating on inflation control, letting the local currencyappreciate and thus ‘hurt’ the exports. Georgia, being a country with comparable low exports ofgoods as a share in GDP, could not afford itself to have appreciation of real effective exchange rate.Exports of services in Georgia, half of which contributes to ‘passive’ type of exports of services suchas transit, is almost equal to the exports of goods. The table below shows the structure of Armenianand Georgian exports by year, from 2003 to 2006:

Table 22 Structure of Armenian and Georgian exports by year, from 2003 to 2006 (million USD)

* Source: National Statistical Service of the Republic of Armenia** Source: World Trade Organisation official web page


42 See for example AEPLAC 200443 For more details see Part 2

As it can be seen from the table, Armenian exports of goods as share in the GDP is higher thanin Georgia. This partially explains why the Central Bank of Armenia was not conducting anexchange rate monetary policy but rather aiming at price stabilization and productivity. Table 23shows the inflation and exchange rate dynamic of both countries. Inflation rate in Georgia duringthe recent years has stayed well above Armenia’s inflation, which made the Armenian goods cheap-er as compared to the Georgian ones. This explains the positive sign of the impact of Georgian con-sumer price change on exports from Armenia to Georgia.

Table 23. Exchange rate and inflation dynamics in Armenia and Georgia

* Negative sign means appreciation of the local currency versus USD.

It would be more than naive to bring inflation figures of trading countries without looking at thebilateral nominal exchange rate. The graph below shows the dynamics of exchange rate AMD/USD,GEL/USD and AMD/GEL. To make the visual concept easier, all three graphs were normalized withthe end of December 2002, set at 100. As seen from the graph, the Armenian dram has appreciat-ed against the Georgian lari by 20% during the last four years. At the same time, the inflation differ-ence between two countries amounted to almost 13%. In other words, during 2003-2006 in realterms the Armenian dram has appreciated against the Georgian lari, which made imports fromGeorgia more attractive and exports from Armenia less attractive.

Graph 2

The next variable is consumption. Estimation results show that ceteris paribus one percentincrease in Georgian household expenditures in USD terms will result in a decrease in importedgoods from Armenia by 1.1%. As explained above in the theoretical model setup, a negative effectof consumption on demand for imports is explained by the fact that the richer the people, the morethey are inclined to substitute their consumption with more expensive goods. Besides, both


Azerbaijan and Turkey have become real competitors to the Armenian exports. Particularly, sever-al agricultural products have been substituted by imports from neighbouring countries rather fromArmenia, either because of quality or cheapness. This, of course, can be one of the explanations.Another explanation is that during the preceding 3-4 years Georgia has undergone major geopolit-ical changes, which in one way or another have had an influence on the trade relationship betweenthe two countries. However, the most important explanation is that during past 4-5 years theArmenian economy has been growing at a fast pace, which made the demand of the sameexportable goods to be redirected towards domestic consumption. If we consider, say, the cementproduction, the boom of construction in Armenia has created an extra demand for cement, where-as the cement producing factories, because of reaching their full capacity utilization, were not ableto supply the entire domestic market without cutting down the volume of cement export to Georgia.

The estimates of the imports demand function are given in Table 21. The sign of the estimatesof the coefficients basically corresponds to the initial assumptions. However, the estimation resultsdid not appear very robust as we considered some series in cross-section and time dimensions.The estimation also did not produce any meaning magnitude of coefficients.

As an explanation to this it can be stated that, firstly, the non-robustness of estimation can bedescribed by the fact that the imports of goods from Georgia is very concentrated. As calculated andpresented in Part 2, the imports concentration index during the recent years has stayed on compar-atively high levels. This created an effect of dominant observations during the estimation, whichresulted in a non-stable estimation output. Besides, a number of goods in the imports decreased dur-ing the time, which also had a similar effect. Secondly, as described above, a large part of Georgianexports consists of services, and there are a few types of goods that Georgia exports consistently.This has also created problems in the estimation of the imports demand function from Georgia. Formore information on imports structure from Georgia to Armenia, please refer to Part 2.

Summarising the above mentioned results of the analysis, the findings can be formulated as follows:

• Increased living standards in Georgia will lead to decreased imports from Armenia, as a resultof substituting the Armenian imports to Georgia by similar products - with supposedly higherquality - imported from the EU and other countries.

• One percent increase in unit prices of exportable goods has a very minor impact on the exports:it will decrease only by approximately 0.09%. In other words, the price elasticity of Armenianexports to Georgia is very inelastic because of the high level of concentration of Armenianexports to Georgia (the main part of Armenian exports to Georgia consists of only 5 types ofgoods, of which cement is the largest). Nevertheless, it can be assumed that the price elastic-ity of exports will grow as Georgia starts diversifying its imports, finding other sources of substi-tutes.

• A one percent change in consumer prices (inflation) in Georgia brings to 1.42% increase inexports of goods from Armenia. This is explained by the differences in the monetary policiespursued in Armenia and Georgia.

• Moreover, estimation results show that ceteris paribus one percent increase in Georgian house-hold expenditures in USD terms will result in a decrease in imported goods from Armenia by1.1%. A negative effect of consumption on demand for imports is explained by the fact that thericher the people, the more they are inclined to substitute their consumption with more expen-sive goods. Besides, both Azerbaijan and Turkey have become real competitors to Armenianexports. In particular, several agricultural products have been substituted by imports from neigh-bouring countries rather than from Armenia, either because of quality or cheapness. Moreover,during the past 4-5 years the Armenian economy has been growing at a fast pace, which madethe demand of the same exportable goods to be redirected towards domestic consumption. Ifwe consider, say, the cement production, the boom of construction in Armenia has created anextra demand for cement, whereas the cement producing factories, because of reaching theirfull capacity utilization, were not able to supply the entire domestic market without cutting downthe volume of cement export to Georgia.


PPAARRTT 44.. AANNAALLYYSSIISS OOFF TTHHEE CCUURRRREENNTT SSTTAATTUUSS OOFF EECCOONNOOMMIICC RREELLAATTIIOONNSS BBEETTWWEEEENN AARRMMEENNIIAANN AANNDD

GGEEOORRGGIIAANN BBOORRDDEERRIINNGG RREEGGIIOONNSS

The activation of economic cooperation between Armenia and Georgia is very important notonly in a state level, but even more important for the development of regions in both countries.There are large regional disparities in both countries in terms of income of population, businessdevelopments and other socio-economic issues. The economic cooperation between the regionsnear the Armenian-Georgian border will provide extensive opportunities for the development ofthese regions.

The border between Armenia and Georgia lies between two regions from Georgia (Samtskhe-Javakheti, Kvemo Kartli) and three regions from Armenia (Shirak, Lori, Tavush). The length of theborder is about 164 km.

There are three frontier points which connect Armenia with Georgia: Bavra (Akherpo) point(Shirak to Samtskhe-Javakheti), Gogavan (Guguti) point (Lori to Kvemo Kartli) and Bagratashen(Sadakhlo) point (Tavush to Kvemo Kartli). The last one is the main border point which serves as atransit way between countries. The Gogavan point is used quite rarely and mostly for regionalissues.

To study the opportunities of economic cooperation between these bordering regions, it is nec-essary to obtain an understanding of the trends of socio-economic development of these fiveregions.

Socio-Demographic Trends

PPooppuullaattiioonn aanndd AArreeaa ooff BBoorrddeerriinngg RReeggiioonnss

It would be expedient to start the comparison of the bordering regions of Armenia and Georgiawith the main physical indicators: area and population. Each of the two Georgian bordering regionsis twice larger in terms of their area than each of the Armenian regions. The area of Kvemo Kartliregion in Georgia is 6,528 km2, and the area of Samtskhe-Javakheti – 6,412 km2, while the largestbordering region from Armenia (Lori) has an area of only 3,789 km2. However, since there are threeregions from Armenia that have a border with Georgia (two bordering regions), the difference inoverall bordering area is a bit less. The overall area of the Armenian regions that have border withGeorgia comprises 9,174 km2 (which is 30.8% of Armenia’s overall territory), while the correspon-ding area in Georgia is 12,941 km2 (or about 18.6% of Georgia’s overall territory44). The area of bor-dering regions from the Georgian side is larger by 41.1%.

The population indicators of the observed regions have lower disparities than the indicators ofarea. Moreover, the overall figures for bordering regions from Armenia and Georgia are close toeach other. The overall population from the Armenian side is 698.2 thousand (as of 01.01.200745),while the corresponding figure for Georgia is 716.1 thousand (as of 01.01.2006)46. The share of thepopulation living in the regions bordering with Georgia in the whole population of Armenia is about21.7%, whereas the same figure for Georgian regions is about 16.3%47.


44 Or 22.6% of the territory of Georgia, without Abkhazia and South-Ossetia regions which are currently out of the con-trol of the central government.45 Or 699.2 thousand as of 01.01.2006.46 Here and further in the text some data on Georgia refer to previous years because of unavailability of data.47 The population of Georgia is estimated without the Abkhazia and South-Ossetia regions which are currently out ofthe control of the central government.

The highest density of the population was registered in Shirak region (105 people per 1 km2)and the lowest in Samtskhe-Javakheti – only about 33 people per 1 km2 (Table 24).

Table 24. Main indicators of the bordering regions.

Source: NSS Republic of Armenian, Statistics Georgia

Taking a look at the changes in the number of people living in the observed regions during thelast five years, it becomes obvious that the number of people in Georgian regions is growing, whilethe population in the Armenian regions is decreasing (Chart 4). Moreover, the average annualgrowth rate of the number of people in these two regions of Georgia is higher than the average fig-ure for the country (mainly due to higher rates in Kvemo Kartli region). At the same time, the changein the population of the Armenian bordering regions is lower than the average figure for the coun-try, which speaks about the different trends of regional development in two countries.

Chart 4. Average annual population changes, 2002-2006, %

Source: Statistical Yearbooks of Armenia and Georgia

For the description of population it is important to understand the structure of each region bythe type of settlement (Chart 5). Two bordering regions from Georgia have population mainly fromrural settlements, which is decisive for the development of the region mainly by the agricultural pro-duction direction. At the same time, two out of three Armenian bordering regions have a large shareof urban population, which means that these regions should have a large share of industry in theeconomic structure of the regions.


Chart 5. The structure of population in the regions by the type of settlement (urban, rural)

Sources: NSS Armenia and Statistics Georgia

Another factor - which we think can have an influence on the further cooperation between theregions of Armenia and Georgia - is the structure of population in the regions of Georgia by ethnicity.While Armenia has a homogenous structure of population by ethnicity (about 98% of the population ofArmenia are Armenians), the structure of population in Georgia is very different by regions. If the shareof Georgians in the whole country is about 84%, the share of Georgians in these two bordering regionsis about 43-45%. The majority of the population of Samtshe-Javakheti region are Armenians (about55%), while in Kvemo Kartli region about 45% of the population are Azerbaijani and 6% are Armenians.

PPoovveerrttyyTaking into account the household survey results conducted in two countries, a comparison of

the figures of poverty in two countries has been made. As it can be seen from Table 25, the indica-tors of poverty incidence in 2004 were almost the same in a country level; however if it decreasedin Armenia in 2005, in Georgia the indicator of poverty incidence increased in 2005. Thus, in 2005the poverty level in Armenia was by about 10 percentage points lower than in Georgia. Anotherinteresting difference for the poverty indicators of the counties is the levels of poverty in urban andrural areas. In Armenia the poverty indicator in urban areas is higher than in rural ones, while inGeorgia it is vice versa: the poverty level is higher in rural areas than in urban ones.

Table 25. Poverty indicators in Armenia and Georgia, 2004 and 200548

Source: Social Snapshot, NSS Armenia and PRSP update for Georgia


48 As it was mentioned earlier the poverty lines are different in different countries and the figures should not be directlycompared.

When referring to the regional composition of poverty indicators, it should be stated that pover-ty incidence level is the highest in Shirak region of Armenia (Table 26). The indicator for 2005 inShirak was 42.5%, which was by 12.7 percentage points higher than the country average level ofpoverty incidence. The other two bordering regions of Armenia – Lori and Tavush - have compara-bly lower indicators of poverty incidence, constituting 28.8% and 25.8% respectively.

Table 26. Poverty indicators by regions of Armenia, 2004 and 2005

Source: Social Snapshot, NSS Armenia

Similar information regarding the Georgian bordering regions was not available. However, dif-ferent documents49 mention that the poverty level in Samtshke-Javakheti is 66% and the officiallydeclared minimum living standards – 51.1 %, while in Kvemo Kartli region it is much higher -78%.These figures have been calculated by the old methodology according to which Georgia’s averagepoverty was about 51% (while according to the new methodology it is 35.7%), therefore they arenot comparable with the relevant Armenian figures. Nevertheless, if these indicators are comparedwithin Georgia, it can be stated that in both bordering regions the poverty level is much higher thanin a country as average.

It is also interesting that if the comparison of average wages50 and poverty level in Armenianregions is more or less close to each other, in the Georgian region this trend is not observed.Samtskhe-Javakheti region has lower level of average wages but its poverty level is also lower thanin Kvemo Kartli region. Thus, the high level of poverty with the comparably high level of averagewages in Kvemo Kartli speaks about large disparities within the region among populations’ incomelevels. This can be explained with the existence of some industrial giants in the main city – Rustavi,while the rest of the region is not developed more than Samtskhe Javakheti region and, moreover,than the Armenian bordering regions.

Labour Market

Comparison of labour market indicators between the bordering regions from Armenia andGeorgia shows that the Georgian regions have some advantages. These advantages are viewed intwo different types of comparison. First, if we compare the figures of bordering regions with eachother and, second, if we compare bordering regions with the average indicators of their countries.

The registered unemployment rates for Georgian regions are much lower than for Armenianones. If in Samtshkhe-Javakheti region the unemployment rate was 9.2% in 2005, then for Shirakand Lori regions it was about 18%. The main reason for such an essential difference is obviouslythe structure of population by the type of settlement. Employment of urban population is more sen-sitive to economic processes in the country than the employment of rural population. Most of the


49 Georgia PRSP update, 200550 Labour market trends by regions are discussed below.

economically active rural population are employed at their own lands. The unemployment rate ofTavush region, which is more or less comparable with Georgian regions by its share of rural popu-lation, speaks about the influence of this factor.

The factor of rural population works also in case of comparing the employment rates of theregions with the average figures of their country. In observed Georgian regions the rates of unem-ployment are lower than the country average, while the same figures for the Armenian borderingregions (except Tavush) are much higher than the country average indicator.

Table 27. Main indicators of Labour market by bordering regions, 2005


To understand the figures of Table 27 (also the size of influence by urban-rural population fac-tor), it is worth to look at the structure of employment by types of economic activity.

In all five regions the biggest share of employment refers to agricultural activities. But if its sharein Shirak and Lori regions is a bit more than the half of all employment in the region, then Samtskhe-Javakheti region almost 80% are employed in agriculture. The employment structures of Tavushand Kvemo Kartli regions are mostly similar. The only substantial differences between these regionsare in the trade and social sectors. Kvemo Kartli region has the biggest share of employed in thetrade sector in comparison to all observed regions. This can be attributed to the favourable locationof the region. It has borders not only with Armenia but also with Azerbaijan. Taking into account therelations between Azerbaijan and Armenia, this region has become the trade centre between thethree countries.

Other differences between the shares of employment by types of activity in observed regionsare conditioned by the peculiarities of their countries. Thus, it can be noticed from Table 28 that theshare of employment in social (education, health, etc.) as well as construction sectors is higher inthe Armenian regions. The share of employment in social sectors in Armenia (whole country) beatsthe Georgian indicator by 2.4 percentage points.


Table 28. The structure of employment by types of activity in bordering regions, 2005


In a country level, the largest differences are viewed in the shares of employment in industryand agriculture sectors (Chart 6).

Chart 6. Shares of employment by main types of economic activities in Armenia and Georgia, 2005


The comparison of the level of monthly average wages in the two countries shows that the fig-ures and trends for Armenia and Georgia are very close to each other. If in 2002 the average month-ly wage of hired employees in Georgia was equal to 45.7 USD and in Armenia – 44.1 USD, then in2005 these indicators are even closer – 112.7 USD for Georgia and 113.7 USD for Armenia.However, a closer look at the level of wages by types of economic activities reveals some differ-ences between the countries’ indicators (Chart 7).


Chart 7. The level of wages in Armenia and Georgia by types of economic activity (NACE)*to corresponding country average wage level (average wages for the countries=100) (2004)

* A - Agriculture, hunting and forestry, B -Fishing, C - Mining and quarrying, D - Manufacturing, E - Electricity, gasand water supply, F - Construction, G -Wholesale and retail trade; repair of motor vehicles, motorcycles and personal andhousehold goods, H - Hotels and restaurants, I - Transport and communication, J - Financial intermediation, K - Realestate, renting and business activities, L - Public administration, M - Education, N - Health and social work, O - Other com-munity, social and personal service activities.


The largest advantage of Georgian wages are observed: (a) in the banking sector (financialintermediation) wages, where wages in Georgia are higher by 25% than the wages in the same sec-tor in Armenia and by 4.7 times higher than average wage level in Georgia, (b) construction, (c)transport and communication, (d) other services. The wages in Armenia are higher in: (a) miningand quarrying (by about 90% higher than in Georgia), (b) hotels and restaurants (by about 2.5 timeshigher than in Georgia), (c) public administration, (d) agriculture, (e) energy sector.

The disparity level between wages of different types of activities is higher in Georgia (index ofstandard deviation of wages by activities in Georgia is 108, in Armenia - 80).

The disparity of average wages in Georgian bordering regions is also higher than in Armenia.The level of monthly wages in Kvemo Kartli (74.5 USD) is by 38% higher than in neighbouringSamtshe-Javakheti region, where average monthly wages comprised about 54 USD in 2004. Thefigures of Armenian regions for 2004 lie between the figures of Georgian regions. Average month-ly wage in Shirak was 62.4 USD (2005 - 90.1), in Lori – 66.9 USD (2005 - 93.6) and in Tavush –59.0 USD (2005 - 83.8).

The average levels of wages in all five bordering regions are lower than the average levels oftheir corresponding countries (Chart 8).


Chart 8. The comparison of average monthly wage levels of bordering regions with theircountry average (countries average=100) 2004


Economic Development Status of the Regions

IInndduussttrryy

Industrial production plays one of the main roles in the economy of both countries. The shareof industrial production51 value added in GDP for 2006 in Armenia was 17.4%, while in Georgia -12.4%. At the same time the absolute values (in terms of current USD) of volumes of industrial out-put were very close to each other. In 2001, the volume of industrial output in Armenia comprised557.3 million USD and in Georgia – 557.2 million USD, whereas in 2006 it amounted to 1,546.7 mil-lion USD in Armenia, and 1,540.1 million USD in Georgia.

If the industrial output figures are very close to each other in a country level, in a regional levelthere are differences, particularly if we take into account the bordering regions. The overall share ofthree bordering regions from Armenia in the country’s total industrial output was 9.9%, which is thehighest indicator in comparison with the corresponding figures of the preceding six years. Thegrowth is due to the growth in industrial production in Lori region.

Industrial output levels are very different in the two bordering regions from the Georgian side.If in 2006 the share of Samtskhe-Javakheti in the total industrial output of Georgia was only 2.5%,the same indicator of Kvemo Kartli region was about 26.4%. Kvemo Kartli region has the secondlargest share in the industrial production of Georgia among all regions, after Tbilisi. The dynamicsof the shares of the bordering regions in the industrial production of their countries is presented inChart 9. As it can be seen from the chart, during 2001-2006 two out of five observed regions haveregistered growth in the shares of industrial output (Lori and Kvemo Kartli).


51 C, D, E – sectors in the classification of economic activities (NACE)

Chart 9. Dynamics of shares of industrial output in the total industrial output of their countries by observed regions, 2001-2006


Taking into account that the volumes of industrial output in Armenia and Georgia were veryclose to each other, Chart 9 describes also the comparison of the output levels between the regions.Thus, the industrial output of Kvemo Kartli was about 3.7 times higher than the same indicator forLori and more than 10 times higher than the indicators of the remaining regions.

This picture will change in case of comparing the per capita output levels (Chart 10). In 2006,the per capita industrial output volume for Kvemo Kartli region was 800 USD - about twice higherthan the indicator of Lori region (393 USD).

Chart 10. Per capita industrial output by regions, USD


The development of the industry in Kvemo Kartli region can be attributed to the fact that sever-al large industrial enterprises operate in the region. Rustavi is the main city of the region, where theAzot chemical combine and the metallurgical plant are located. The thermal power plant MtkvariEnergetika and the mining companies Kvartsiti and Madneuli engaged in the extraction of copper


and gold are among other large enterprises operating in the region. Samtske-Javakheti has lowerlevel of industrial production development. A large part of the enterprises functioning in the regioninclude mineral water bottling factories (Borjomi), bakeries, cheese and sausage producing plantsand timber processing enterprises.

The Table in Annex 2 provides detailed figures of Armenian regions as to their industrial pro-duction per capita. As it can be seen from the Table, the Lori region has an advantage over the aver-age level of Armenia in the production of basic metals. The other two regions have comparablylower indicators in all types of activities. The lack of data on industrial subsectors in the borderingregions from Georgia makes it impossible to draw a comparison and define the sub-sectors forcooperation between bordering regions of Armenia and Georgia.

Agriculture

In 2006, the shares of agricultural output in GDP were 18.2% for Armenia and 11.3% forGeorgia. In 2005, the volume of agricultural output in US dollars for Armenia was 1,077 million USD,and for Georgia - 1,427 million USD. The same figures presented by per capita interpretation arevery close to each other – 335 USD in Armenia and 327 USD in Georgia. The composition of agri-cultural output by two main branches of agriculture is different in these countries. Plant growing out-put accounted for 58.4% of the total agricultural output in Armenia, while in Georgia it was 52.7%.Taking a closer look at the figures of plant growing and animal husbandry outputs by per capitainterpretation, it can be seen that the indicator of plant growing output per capita is higher inArmenia, while the same indicator for animal husbandry is higher in Georgia (Table 29). Plant grow-ing output per sown area is also higher in Armenia (in 2005, Armenia’s figure was 1,905 USD perhectare against Georgia’s 1,392 USD per hectare).

Table 29. Agricultural output per capita in Armenia and Georgia, 2001-2005, USD

Source: Calculations are based on the figures of NSS Armenia and Statistics Georgia

Although the agricultural output data in a country level are more or less close to each other, theregional comparison provides a different pattern (Table 30). The per capita harvest of potato andvegetables in Kvemo Kartli region of Georgia is the highest between the indicators of all fiveobserved regions; moreover it was 2.5-3 times higher than the Georgia’s average level. The high-est indicator of the per capita harvest of cereals belongs to Samtskhe-Javakheti region. Fruit andgrapes are the advantage of Armenia’s Tavush region. Although Shirak and Lori regions did nothave an advantage over the other regions by their per capita production indicators, however Shirakregion’s productivity per hectare of sown area of potato and vegetable is the highest.


Table 30. Plant growing indicators by regions, 2005


The comparative indicators of animal husbandry by regions are as follows (Table 31):Samtskhe-Javakheti region has the highest figures of livestock number per capita in comparisonwith the other four regions, by three out of four observed categories – cattle, cows, sheep, andgoats. The highest number of pigs per capita is registered in Tavush region of Armenia. In a com-parison of production of animal husbandry, Kvemo Kartli has the highest indicators in egg and woolproduction. Samtshke-Javakheti is the leader in per capita milk production.

Table 31. Animal husbandry indicators by regions, 2005-2006


The observation of agricultural data in the bordering regions and the definition of some compar-ative advantages of separate regions show that the cooperation between Georgian and Armenianbordering regions can be as follows: cereals and animal husbandry products from the Georgian sideand potato and vegetables (as well as fruits from Tavush) from the Armenian side.


Construction

Construction has become the leading industry in the Armenia for the last few years. It has beenthe driving industry in GDP growth for Armenia during the last five years. Its share in total GDP for2006 comprised 26.7%, while in 2001 it was only 9.7%. However, the construction activities are notequally distributed between the regions of the country. About 82% of construction activities in thecountry fall to the share of Yerevan.

The share of construction in Georgian GDP has also been growing during the recent years, butit is much less than in Armenia. In 2005 the share of construction in GDP was 8.7%, while in 2001it was 3.9%. It is interesting that the distribution and trends of construction activities in Georgia aresimilar to the Armenian trends. In 2006, about 72% of construction was concentrated in Tbilisi.

Taking into account the above mentioned trends, it is worth to discuss the construction produc-tion in the bordering regions. The shares of construction in all five bordering regions in the total con-struction of their countries are very low. In 2006, Lori region’s share was 3.1%, Shirak’s share was1.3%, and Tavush’s share in the total construction was only 1%. At the same time, the share ofSamtskhe-Javakheti in Georgia’s construction was 2% and the share of Kvemo Kartli – 3.4%. Thetrend of the shares in construction shows that during last five years the shares of Armenian regionsin the country’s total construction have dropped, while the shares of Georgian bordering regions inthe total construction of Georgia are slowly growing. Chart 11 shows the volume of construction inthe observed regions. The largest volume in 2006 was registered in Lori – 46.5 million USD, whileSamtshke-Javakheti is still the last with volume of construction of 11.7 million USD.

Chart 11. Volumes of construction in the bordering regions of Armenia and Georgia, 2001-2006, million USD


Table 32 shows the per capita indicators of construction by the observed regions. It is obviousthat the figures in Armenia are much higher than the same figures in Georgia which is due to thehigher share of construction in Armenia’s GDP in comparison to the Georgian one. The growth inconstruction of Samtskhe-Javakheti is also worth to mention: it implies that the region (which isprobably the less developed between the five observed countries)52 is attracting more investments,which is a matter of several programmes and investments aimed at reduction of poverty in theregion (it is assumed that it is related also to the growth of construction in Armenia (as the majori-


52 The industrial production, construction and services volume data comparison as well as the comparison of data onwages show that Samtskhe-Javakheti is the less developed region between the five observed regions.

ty of the population of Samtskhe-Javakheti are Armenians, it could have served as an opportunityfor this region to gain from the development of Armenia)).

Table 32. Average per capita volumes of construction for YY2001-2006, USD


Transport and Communication

The comparison of transport and communication sectors turnovers between countries showsthe advantage of Georgia upon Armenia. The sector’s turnover per capita in 2005 was about twicehigher in Georgia than in Armenia. This can be explained by the location of the country and thegeopolitical situation in the South-Caucasus region (also the advantage of having a sea). Georgiais the main transportation route for Armenian exporters and importers. It has also a large role inAzerbaijan and Turkey relations.

However, the figures of the bordering regions show that the per capita indicators of transportand communication sector outputs of Georgian bordering regions are not higher than those ofArmenia. Moreover, the Samtskhe-Javakheti region has a very low figure in comparison to the otherfour regions. The other Georgian region – Kvemo Kartli - has good communication links - the mainmotor road and railway line connect Tbilisi with Armenia and Azerbaijan.

Table 33. Transport and Communication sectors’ turnover per capita by regions, USD



Trade turnoverThe comparison of trade turnover per capita indicators in a country level shows the higher

growth rate of Georgia, although the Y2005 figures are close to each other (Armenian figure is evenslightly higher). In a regional level, Kvemo Kartli region has the highest indicator of per capita tradeturnover, which can be explained by the location of this region. Being located between Armenia,Azerbaijan, and Georgia brings a significant advantage for trade, also taking into account theabsence of direct trade relations between Armenia and Azerbaijan. Again – similar to the case oftransport and communication - Samtskhe-Javakheti region has the lowest indicator in comparisonto the other four regions.

Table 34. Trade Turnover per capita by regions, USD


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The level of business activity can be measured also by the number of registered business enti-ties in the country or in a region. Thus, the comparative figures of registered entities per capita inGeorgia and Armenia show the more favourable position of Georgia in 2006. It can be noticed fromTable 35 that the advantageous position of Georgia can be attributed to higher growth rate of reg-istering business entities during the preceding five years. In Georgia there was an 86% growth ofthe number of entities per capita during last five years, while the same figure for Armenia was only12%. If the number of entities per 1,000 people in 2002 was higher in Armenia by 46%, then alreadyin 2006 the figure of Georgia topped that of Armenia by 14%.

The growth of the number of entities per capita is also higher in Georgian bordering regions incomparison to the Armenian ones. Due to this trend, the number of registered entities for KvemoKartli reached the level of 31 entities per 1,000 population, which is about the same level as inArmenia’s Tavush and Lori regions. The number of entities per 1,000 people is lower in Shirak andeven less in Samtshkhe-Javakheti – only about 19 entities per 1,000 people.


Table 35. Number of registered entities per 1000 people


Summarising the above analysis, it can be stated that:

- The border between Armenia and Georgia lies between two regions from Georgia (Samtskhe-Javakheti, Kvemo Kartli) and three regions from Armenia (Shirak, Lori, Tavush). The length ofthe border is about 164 km.

- The overall area of the Armenian regions that have border with Georgia comprises 9,174 km2

(which is 30.8% of Armenia’s overall territory), while the corresponding area from Georgia is12,941 km2 (or about 18.6% of Georgia’s overall territory53), which is larger by 41.1%.

- The overall figures for population living in the bordering regions of Armenia and Georgia areclose to each other. The overall population from the Armenian side is 698.2 thousand (as of01.01.2007), while the corresponding figure for Georgia is 716.1 thousand (as of 01.01.2006).During the recent five years the population in the bordering regions from Georgia has beengrowing, while the number of population in the Armenian side has been declining.

- Unfortunately the poverty estimates for Georgian regions are not available (the figures areavailable only for Georgia as a whole or by rural and urban population), which makes it very dif-ficult to compare the poverty estimates between the separate regions.

- The structure of population by urban and rural settlements shows that the Georgian regions aremostly comprised of rural population (75-80%), while in two out of three bordering regions ofArmenia the urban population has a larger share than rural one (about 60%). This can be adecisive factor in the future economic cooperation between the regions: industrial products fromthe Armenian side instead of agricultural products from the Georgian side.

- Mostly as a result of having more rural than urban population, the labour market figures in theGeorgian regions have better trends than in Armenian ones. The participation rate is higher andthe unemployment rate is lower.

- The average monthly wages in Armenian regions are close to each other, while the wages inKvemo Kartli region are by 40% higher than in the neighbouring Samtskhe-Javakheti region.The figures of wages for the Armenian regions lie between these indicators.


53 Or 22.6% of the territory of Georgia, without Abkhazia and South-Ossetia regions which are currently out of the con-trol of the central government.

- Comparatively higher wages in Kvemo Kartli region can be explained by the existence of anumber of industrial giants in the main city (Rustavi) such as the Azot chemical combine andthe metallurgical plant. In addition, there are two mining companies engaged in the extractionof copper and gold, and a thermal power plant - Mtkvari Energetika. Kvemo Kartli accounts formore than ¼th of the overall industrial production in Georgia.

- The poverty level in Armenia is higher in urban areas in comparison with the rural ones, whilein Georgia it is vice versa. Taking into account the structure of population by urban and ruralsettlements, it is obvious that bordering regions from Armenia and Georgia have higher pover-ty level in comparison with their countries average indicators.

- While the comparison of average wages by regions shows the advantage of Kvemo Kartliregion, the poverty level indicator is the worst in this region as compared to the other observedregions. This speaks about large disparities within Kvemo Kartli, especially in the income lev-els of urban and rural populations.

- The comparison of industrial production per capita shows the advantage of Kvemo Kartli regionwhere in 2005 the value of industrial production per capita was twice higher than in Lori andwas about eight times higher than in Shirak and Tavush regions. This is due to the existence ofacting industrial giants in Rustavi.

- The observation of agricultural data in the bordering regions and the definition of some compar-ative advantages of separate regions show that the cooperation between Georgian andArmenian bordering regions can be as follows: cereals and animal husbandry products from theGeorgian side and potato and vegetables (as well as fruits from Tavush) from the Armenianside.

- The volumes of construction are comparably higher in the Armenian bordering regions (espe-cially in Lori region). During the preceding two years, the volume of construction in Samtskhe-Javaketi region of Georgia is growing faster than in the neighbouring Kvemo Kartli region.

- Although the per capita indicators in services are more or less comparable in Armenian andGeorgian bordering regions, the Georgians regions (especially Kvemo Kartli) have a compara-ble advantage in developing this field due to their geographic location and circumstances.Developing services (tourism, trade, transportation, etc.) from the Georgian side can be one ofthe main fields of cooperation with the Armenian regions. The labour from mostly urban areasfrom Shirak and Lori can be useful during infrastructural constructions in this field. In additionto this, the Armenian regions, especially Shirak, have a potential of developing manufacturingactivities due to their large share of urban population.

- The comparison of data on industrial production, construction and services volume as well asthe data on wages show that Samtskhe-Javakheti is the less developed region among the fiveobserved regions. This could be the factor underlying the growth of construction in the lastyears and the large development projects which shall take place in this region (for example thefunds from the Millennium Challenge Corporation as well as EU Tacis projects funds).


PPAARRTT 55.. AASSSSEESSSSMMEENNTT OOFF PPOOSSSSIIBBLLEE IIMMPPAACCTT FFRROOMM TTHHEE CCOONNCCLLUUSSIIOONN OOFF FFRREEEE TTRRAADDEE AAGGRREEEEMMEENNTTSS WWIITTHH TTHHEE EEUU

Evaluating the impact of the European Neighbourhood Policy Action Plans’ implementation onthe Armenian-Georgian relations, some assumptions have been made. First, the strongest impacton deepening of economic relations between two countries in the short run will have the Free TradeAgreement concluded between Armenia and the EU, as envisaged by the ENP Action Plan. Sincethe major part of the Armenian trade is carried out through the territory of Georgia, this will stimu-late the growth of export of Georgian transport services to Armenia. It is also assumed that the EU-Georgia Free Trade Agreement will not have a strong impact on Armenia-Georgia relations.

Although the conclusion of Free Trade Agreements is only one of the activities envisaged bythe Action Plans of Armenia and Georgia, their effect is most easily computable. In this sense, it isworth noting that the other elements of the ENP Action Plans, targeted at the alignment of the stan-dards with the EU ones and thus improvement of the public administration of these countries, willin the long run highly contribute to the improvement of Armenia-Georgia relations.

To this end, the following methodology has been applied:EU and Armenian customs revenues under the current regime are calculated according to the

HS 8-digit code;The reduction of the customs revenues are provided based on the Algerian FTA model;Since it also leads to a reduction of prices, the growth of Armenian exports to and imports from

the EU are also calculated, based on import demand elasticity of the EU and Armenia, respective-ly. The import demand elasticity is provided by the World Integrated Trade Solution (WITS), soft-ware developed by the World Bank Group;

The product groups which are transported through the territory of Georgia are identified, andthe costs of the transport services are calculated;

The growth of exports of Georgian transport services resulted from the conclusion of an EU-Armenia FTA are calculated.

Current Regime and Existing Trade Patterns54

The EU is Armenia’s main trading partner. In 2005, the share of Armenian exports and importsconstituted 46.5% (365.3 million EUR) and 28.1% (408.4 million EUR) of the total Armenian exportand import respectively, whilst in 2004 it amounted to 35.3% (205.7 million EUR) for exports and25.4% (276.8 million EUR) for imports. In regard to the structure of trade between Armenia and theEU, it is worth noting that Armenian exports mainly consist of base metals (61.1% of total exports),precious stones and metals (26.8% of total exports), and textiles (5.9% of total exports), account-ing in total for about 94% of all Armenian exports. Imports to Armenia from the EU are more diver-sified. The main importing products are precious stones and metals (27.8%), machinery, electricalequipment, etc. (25.5%), vehicles (11.1%), chemicals (8.2%), foodstuffs, beverages, spirits, andtobacco products (5.9%), base metals (4.7%), and textiles (3.5%), which together constitute morethan 86% of the total Armenian imports. (See also Chart 12).


54 All calculations are made at the 8-digit level for the period of 2005.

Chart 12 Share of product groups in EU-Armenia trade (2005)

At present, the Armenian export to the EU benefits from the scheme of Generalised System ofPreferences, within the framework of which the EU grants tariff reductions in respect to somegoods. To benefit from this scheme, Armenian exporters must meet all the requirements prescribedby the EU and in particular those relating to the rules of origin, otherwise general (conventional)duties are applied to Armenian exports. Thus, not all the products are charged with the preferentialduties, but for convenience it is assumed that Armenian exports fully benefit from the GSP scheme.Under the current regime (taking into account the reductions provided under GSP) the total dutylevied on Armenian exports in 2005 by EU customs authorities accounted for 2.2 million EUR, whichconstituted about 0.6% of the total Armenian export to the EU. Duties collected from EU exportersby Armenian customs authorities in 2005 amounted to 11.1 mln. EUR. This constitutes about 2.7%of total Armenian imports.

Application of the Algerian Free Trade Agreement Model

Why the Algerian FTA was taken as a model for the future EU-Armenia FTA? A comparison ofvarious EU FTAs55 shows that the difference between the Agreements in respect to customs dutyreduction or elimination is not essential. All the tariffs in regard of products falling under HS chap-ters 25-97 (industrial products) are eliminated. Such a broad coverage is due to the WTO require-ment in regard of any free trade agreement signed between WTO members. The Article XXIV ofGeneral Agreement on Tariffs and Trade (GATT) states that:

“A free-trade area shall be understood to mean a group of two or more customs territories inwhich the duties and other restrictive regulations of commerce are eliminated on substantially allthe trade between the constituent territories in products originating in such territories”.

A slight difference between EU FTAs exists regarding the reduction or elimination of customsduties imposed on agricultural and processed agricultural products, but this will not have a signifi-cant effect on the final results of this analyses.

The second reason for considering the Algerian experience is the fact that both Armenia andAlgeria are engaged in the European Neighbourhood Policy, which makes it possible for Armeniato expect a regime similar to that of Algeria.


55 Agreements with Mediterranean countries, EU – South Africa Agreement on Trade, Development and Cooperation(TDCA), EU – Mexico Global Agreement and Association Agreement with Chile.

Total customs duties levied on Armenian exports by the customs authorities of the EU MemberStates will amount to about 159,000 EUR, having a further decrease by 92.6% in comparison to theamount levied under the fully applied GSP regime. But, on the other hand, the concessions provid-ed in the FTA framework must be reciprocal and thus the Armenian duties in respect of some prod-ucts must also be reduced or abolished. In case of signing a Free Trade Agreement like the Algerianone, the total amount of duties levied by Armenian customs authorities will constitute about 2.6 mil-lion EUR, whilst under the current regime this figure equals to 11.1 million EUR. Thus, the reduc-tion of the total customs duties will constitute 76.9%.

The following exports from Armenia to the EU will mostly benefit from the EU – Armenia FTA(see also Table 36):

Products falling within Section 11 of Harmonised System: Textiles and textile articles – 65.2%of total duties reduced (this mainly refers to HS heading 621256);

Products falling within Section 15 of Harmonised System: Base metals and articles of basemetal – 25.2% of total duties reduced (this mainly refers to HS heading 810257);

Products falling within Section 17 of Harmonised System: Vehicles, aircraft, vessels and asso-ciated transport equipment – 5.79% of total duties reduced (this mainly refers to HS heading870358).


EU-Algeria Association Agreement

Following the conclusion of negotiations in December 2001, Algeria and the EU signed anAssociation Agreement in April 2002 in Valencia. The agreement entered into force inSeptember 2005. It replaced the 1976 Co-operation Agreement. The Association Agreement provides for tariff-free trade in industrial goods with the EU. Thismeans that all duties and other equivalent charges imposed on the products falling within chap-ters 25-97 of the Harmonised System are abolished. In contrast to industrial goods, the liberal-isation of trade in agricultural products (HS chapters 1-24) is slack, and is mainly providedthrough tariff rate quotas, which is explained by high domestic protection and as a result low will-ingness on the EU side to open this sector for other countries' access.

Besides liberalisation of trade in goods, EU-Algeria FTA includes also other elements, which arelisted below:• Political dialogue and regular economic dialogue; • Clauses on freedom of establishment, liberalisation of services, free movement of capital

and the application of Community rules on competition; • Clauses in the area of justice and home affairs; • Strengthening economic co-operation; • Setting up social and cultural co-operation; • Financial co-operation; • Setting up an Association Council and Association Committee with decision-taking powers.

56 Brassieres, girdles, corsets, braces, suspenders, garters and similar articles and parts thereof, whether or not knittedor crocheted.57 Molybdenum and articles thereof, including waste and scrap.58 Motor cars and other motor vehicles principally designed for the transport of persons, including station wagons andracing cars.

Table 36 Product groups most benefiting from the EU-Armenia FTA (Exports from Armenia to the EU)

The reduction of total duties regarding imports into Armenia mainly occurs in respect of theproduct groups listed below (see also Table 37):• Section 17 of Harmonised System: Vehicles, aircraft, vessels and associated transport equip-

ment – 41.9% of total duties reduced (this mainly refers to HS heading 8703);• Section 16 of Harmonised System: Machinery and mechanical appliances; electrical equip-

ment; parts thereof; sound recorders and reproducers, television image and sound recordersand reproducers, and parts and accessories of such articles – 18.7% of total duties reduced(this mainly refers to HS Chapter 8559) ;

• Section 11 of Harmonised System: Textiles and textile articles – 13.4% of total duties reduced(this mainly refers to HS heading 6212).

Table 37 Product groups most benefiting from the EU-Armenia FTA (Imports into Armenia from the EU)


59 Electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and soundrecorders and reproducers, and parts and accessories of such articles

Accession of Bulgaria and RomaniaTaking into account the accession of Bulgaria and Romania to the EU on 1 January 2007, it is

necessary to analyse also the impact of their accession on the EU-Armenia trade flows. TheAlgerian model was designed for the analysis of FTA impact on trade with the EU-27.

Trade with these countries in 2005 amounted to 0.9 million EUR for exports and 82 million EURfor imports. The large volume of imports from these countries is due to the fact that the main importsto Armenia are those of automotive fuel (about 92.7% of total automotive fuel imported), which con-stitute 83.0% of total imports from Bulgaria and Romania. The other largest product groups areSection 460 and Section 1661 which account for 3.2 million EUR (3.9%) and 3.0 million EUR (3.7%)respectively. Exports from Armenia to these countries mainly consist of products of the Sections 4(0.41 million EUR or 45.2%), 1162 (0.21 million EUR or 22.7%) and 1563 (0.15 million EUR or 16.5%).

Under the current regime, these two countries collect about 12,000 EUR from Armenianexporters, having an average tariff rate of 1.34% on Armenian exports. On the other hand, Armeniancustoms authorities levied about 0.6 million EUR on imports from Bulgaria and Romania, the mainsource of which are prepared foodstuffs, beverages, and tobacco products (about 0.3 million EUR).The average tariff rate fixed in regard of imports from these two countries accounts for 0.68%. Thesimulations show that the reduction of customs duties in respect of products imported from Bulgariaand Romania will constitute about 0.26 million EUR, whilst Armenian exporters will gain about12,000 EUR, which means that all Armenian exports to these countries will be totally free of anycustoms duties and applicable charges.

Thus, under the current regime the total duties levied from imports from the EU-27 by Armenianauthorities account for about 11.5 million EUR, whilst the customs authorities of the EU-27 levyabout 2.2 million EUR. The reduction of duties levied from imports into Armenia from the EUaccounts for about 8.8 million EUR (reduction of the average tariff rate from 2.38% to 0.59%), andthe duties levied on Armenian exports will be reduced by 2.0 million EUR.

FTA Impact on EU-Armenia Trade FlowsThe next step is the evaluation of the customs duty elimination impact on EU-Armenia trade

flows. It is assumed that the prices of Armenian products exported to the EU will decrease by thevalue of the customs duty imposed on the products before conclusion of an FTA. The same is truefor the imports into Armenia from the EU. Taking into account also the import demand elasticity ofa certain product,64 the growth of trade volumes can be calculated.

The evaluation shows that in total the elimination of customs duties on the EU side will con-tribute approximately to a 1.5% growth of Armenian exports to the EU. The table below shows theproduct groups of Armenian exports which will be mostly affected by the EU-Armenia FTA (seeTable 38 and Annex 3).


60 Section 4: Prepared foodstuffs; beverages, spirits and vinegar; tobacco and manufactured tobacco substitutes.61 Section 16: Natural or cultured pearls, precious or semi-precious stones, precious metals, metals clad with preciousmetal, and articles thereof; imitation jewellry; coin.62 Section 11: Textiles and textile articles.63 Section 15: Base metals and articles of base metal.64 The data on import demand elasticity was obtained from the World Integrated Trade Solution (WITS) – a softwaredeveloped by the World Bank, in close collaboration with the United Nations Conference on Trade and Development(UNCTAD). It provides access to the major trade and tariffs data compilations, such as the COMTRADE database main-tained by the United Nations Statistics Division (UNSD), the TRAINS database maintained by the UNCTAD, the IDB andCTS databases maintained by the WTO.

Table 38 Armenian exports to the EU most benefiting from the EU-Armenia FTA

Similarly, the reduction or elimination of customs duties on the Armenian side will stimulateabout 4.9% growth of imports from the EU. The product groups which will mostly gain from a FreeTrade Agreement are as follows (see Table 39 and Annex 3):

Table 39 Armenian imports from the EU most benefiting from the EU-Armenia FTA


The simulation also shows that the exports from Armenia to Bulgaria and Romania will have anincrease of 4.51% (about 41,000 EUR), whilst the growth of imports to Armenia from these coun-tries will constitute 0.84% (about 685,000 EUR) (see Annex 4).

Growth of Georgian Exports of Transport ServicesTo understand what effect the analyzed FTA may have on the growth of Georgian transport

services, the Georgian component of transportation costs must be calculated. It is worth noting thatall the Armenian trade with the EU, with the exception of precious stones and metals, is carried outthrough the territory of Georgia. Besides, the mentioned products will not be affected by the FTAand thus are not included in this analysis. It is also assumed that only 20 feet containers are usedduring transportation through the territory of Georgia.

Taking the average cost per ton calculated in the second part of the current report (32.13 USDor 25.83 EUR65) for all products traded with the EU, the total transportation cost is calculated, whichis equal to 2,246,800 EUR in case of exports from Armenia, and 2,474,564 EUR in case of importsto Armenia, the sum of which is the same as Georgian transport service export to Armenia(4,721,364 EUR in total), which originates from the EU-Armenia trade (see also Annex 3). TheGeorgian transport service export to Armenia originating from Armenia’s trade with Bulgaria andRomania accounts for 5,347,385 EUR (see also Annex 4). This figure is mainly due to the fact thatmost of the fuel imported to Armenia comes from these two countries. Thus, Georgian transportservice exports originated from the EU-27 - Armenia trade amounts to 9,968,749 EUR. Analysesshow that a Free Trade Agreement signed between Armenia and the EU will contribute to a 1.9%of Georgian service export growth originated from the EU-27 -Armenia trade. Besides, the overallgrowth (originated not only from Armenia’s trade with the EU Member States, but also fromArmenia’s trade with other countries carried out through the territory of Georgia) of Georgian trans-port service export to Armenia will amount to 0.24%. Such a small growth is due to the small shareof the EU in Armenia’s total external trade by weight (for the EU-27 it is 12.37% of total productstraded through the territory of Georgia, whilst the share of the CIS countries is more than 76%).

Alternative Option: ‘GSP Plus’As mentioned above, Armenia currently benefits from the Generalised System of Preferences,

which means that lower tariff rates are imposed on Armenian exports to the EU. The GSP Regulation66

allows a further reduction of the EU tariff rates in regard of imports from developing countries, in caseif a number of conventions are ratified by the latter. This regime officially called special incentivearrangement for sustainable development and good governance is known as ‘GSP plus’.

Analyses show that obtaining a ‘GSP plus’ regime by Armenia will not have a significant impacton intensification of Armenia-Georgia relations. This is due to the fact that the GSP scheme is anon-reciprocal preferential arrangement and this regime will not affect the Armenian imports fromthe EU. Although the Armenian exports to the EU will have an increase of about 1.6%, the growthof Georgian transport service export to Armenia will constitute only about 0.06%.

Rules of Origin and Cumulation67

As trade policy often requires the differentiated treatment of foreign goods entering a givendomestic market, RoOs are used as a means of establishing the ‘economic nationality’ of goods andtheir eligibility under trade preference programmes. RoOs therefore provide guidelines for establish-ing the origin of goods, i.e. not just the source from where they have been shipped, but also theplace where they are deemed to have been produced. This ensures that concessionary access to


65 1€ = 1.2441 $; source: European Central Bank66 Council Regulation (EC) No. 980/2005 of 27 June 2005 applying a scheme of generalised tariff preferences, OJ L169, 30.6.2005, p. 1–4367 Naumann, E. 2006. Comparing EU free trade agreements - Rules of origin. (ECDPM InBrief 6I). Maastricht : EuropeanCentre for Development Policy Management

a given market benefits the intended recipient countries or regions rather than third-party countries.Cumulation is an important concept in RoOs and can determine the level at which countries are

able to use the trade preferences available to them within a free trade agreement or a unilateralpreference programme. Cumulation refers to the extent to which production may be aggregatedwith other countries without losing originating status for the purposes of the applicable RoOs. Ineffect, cumulation is a derogation from one of the core concepts of origin, i.e. that of a product hav-ing to be ‘wholly obtained’ in the exporting country.

Different forms of cumulation are provided for under the EU’s free trade agreements:• Bilateral cumulation with the EU is the simplest form of cumulation, and provides for the use of

EU-made inputs in the production of EU-destined goods made in the beneficiary country. Suchcumulation therefore deems EU-inputs to originate in the exporting country for the purpose ofqualifying under a free trade agreement;

• Diagonal cumulation is also provided for in the EU’s free trade agreements, and allows a limit-ed use of intermediary inputs from third countries that are not party to a particular FTA to becounted as being of domestic origin. However, such diagonal cumulation is usually only possi-ble following the conclusion of FTAs or administrative cooperation agreements between thecumulating countries. Diagonal cumulation certainly has the potential to significantly widen freetrade areas by incorporating countries with established trade links.

• Full cumulation refers to provisions that allow the unlimited use by the home country of inputsoriginating in certain other countries.The Euro-Mediterranean Agreements provide only for limited cumulation, generally allowing

only bilateral cumulation with the EU and vice versa (cumulation with third countries is possible ifthe non-originating inputs have undergone sufficient working and processing). The EU’s bilateralagreements with Tunisia, Morocco and Algeria provide for additional cumulation between thesecountries. The TDCA allows bilateral cumulation between South Africa and the EU, diagonal cumu-lation with other ACP (African, Caribbean, and Pacific) countries, as well as full cumulation withcountries that are members of the Southern African Customs Union (SACU). The agreements withMexico and Chile allow EU-Mexico and EU-Chile cumulation of origin.

Generally, only 10% of imported input is allowed to consider a product ‘originating’ in a countryparty to an EU FTA (under tolerance rules). In a small number of cases this threshold is set at alevel of 15%. This greatly limits the possibility of exportation of goods under the FTA tariff rates inthe production of which both Armenian and Georgian input is used. For that purpose, it is importantto envisage cumulation of origin during negotiations on the EU-Armenia and EU-Georgia FreeTrade Agreements.

Summarizing the impact of the EU-Armenia possible Free Trade Agreement on Armenia-Georgia economic relations, the following points are worth mentioning:

1. The EU27’s trade-weighted average tariff rate will be reduced by 0.55%, while the Armeniantrade-weighted average tariff rate will have a decrease by 3.11%;

2. This will contribute to 1.55% and 4.24% increase of Armenian exports and imports to and fromthe EU-27 respectively;

3. The growth of exports of Georgian transport services to Armenia will constitute 0.24%;4. Obtaining the ‘GSP plus’ regime by Armenia will contribute to 1.6% growth of Armenian exports

to the EU, and to 0.06% growth of Georgian exports of transport services to Armenia.5. To extend the benefits of the EU-Armenia FTA, it is important to include provisions on ‘cumula-

tion of origin’ between Armenia and Georgia, which will promote joint production of Armenianand Georgian exports to the EU,

6. As the possible FTAs concluded with the European Union by Armenia and Georgia do not leadto a significant increase in economic relations between the latter two, the emphasis should bemade on other components envisaged by the ENP Action Plans. Implementation of the ActionPlans in compliance with the EU legislation will allow Armenia and Georgia to have harmonisedrules in various fields of economic activity, which will highly contribute to the improvement andintensification of economic relations between these two countries.


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The findings of this Study led to the following main conclusions:

1. Armenian and Georgian economies are rather liberal, however there are some differences inthe field regulating customs issues, investment, and trade. As a result, the differences existingin the legal bases of these two countries have their negative impact on the development of traderelations, especially on the level of business representatives and private investors, which is oneof the core components for overall trade and investment relations development. In addition, itwill create daily losses through delays at borders, excessive documentation requirements, andlong deadlines for customs clearance.

2. The provisions of the bilateral investment treaty (including the double taxation treaty) are notutilized effectively and there is a need to ratify the other outstanding bilateral investment treatiesand negotiate new ones.

3. There is no balance between investment protection and governmental regulatory activity byproviding international standards of treatment guaranteed to foreign investors: fair and equi-table treatment, full protection and security, most-favoured-nation treatment, national treatment.

4. The Governmental Decree of Georgia No 27 of 8 February 2006 has fully entered into force. Itapplies to all forms of transportation (except for passenger cars), whether loaded or empty, thatcross the Georgian border and are subject to customs control, and requires them to comply withthe weight and size requirements as provided for by the Georgian legislation.

5. Georgia provides a favourable transit tariff of 50% on the railway freight transportation basedon the Agreement on Co-ordination of Railway Transportation. As regards Armenia, Georgiaprovides only 24% discount for fuel and petroleum oil products and 17% for the rest of cargoes.In this context, Georgia violates the MFN and national treatment principles of WTO trading sys-tem by (a) discriminatory railway tariff discounts, (b) internal taxes and charges imposed on for-eign vehicles, (c) compulsory motor insurance, which are also applied to transit, as well as therules of freedom of transit provided in GATT.

6. Georgia and Armenia must ensure that regulations, standards, testing and certification proce-dures do not create unnecessary obstacles. The countries are now adopting the EU’s newapproach to harmonisation of technical regulations and standards, the implementation of whichis vital to prevent technical barriers to trade. The countries must make all efforts to acceleratethe process of approximation to the EU new approach and to remove burdensome administra-tive procedures.

7. Economic relations between Armenia and Georgia are concentrated in the fields of trade ingoods and services, investments, and transit. The Study shows that within framework of theserelations the two countries have different roles in terms of the nature of the role: Armenia is themore active economic partner considering that trade in goods is one of the main areas ofArmenia’s interaction with Georgia, while Georgia can be considered as a passive partner, tak-ing into that Georgia is mainly providing transit services to Armenia.

8. The Armenian export structure, including exports to Georgia - although there is clear diversifi-cation tendency within the product groups involved - remains highly concentrated, with dia-mond processing, jewellery and copper and molybdenum ore and concentrates still accountingfor more than half of the total export to the World and with ores and mineral products (mainlycement) accounting for more than 40 percent of total exports to Georgia. The commodity com-position of Armenia’s export to Georgia has remained fairly constant over the observed period,with the top seven group of products accounting for more than 80 percent of the Armenianexports, however the number of products (at the 8-digit GNFEA level) has significantlyincreased from 85 in 1998 to 299 in 2006. Nevertheless, taking into account that gas constitutes the most part of cement production, theincrease in prices of imported gas from 2009 can have a negative effect on the volumes ofArmenian cement exported to Georgia. It is also worth noting that increase of welfare in Georgia


may bring to substitution of fruits imported from Armenia by imports with higher quality fromother countries.

9. The main product groups imported from Georgia to Armenia are prepared foodstuffs, chemicalproducts, wood, and vegetable products, the share of which in total imports from Georgiaamounted to 40.0%, 30.3%, and14.8% respectively in 2006.

10. The concentration indices for exports to Georgia are decreasing year by year, which means thatproducts exported to Georgia from Armenia are constantly being diversified. Despite the factthat compared with 1998, in 2006 a quantitative growth of goods exported from Armenia toGeorgia was observed (from 85 to 299), due to the weights of processed industrial goods(cement, plastic products) and some processed foods the increase of diversity of exports doesnot seriously ‘soften’ the concentrated character of exports. In case of imports from Georgia,the concentration index is still relatively high, but volatile.

11. It is also important to analyse the exported products that Armenia and Georgia have a high levelof specialization. Armenia has presented seven main types of products (at the 4 digit level)where the level of specialization was very high. These groups of goods included cement, eggs,coffee, prepared meat, electrical energy, where the export specialization index had absoluteadvantages. Georgia has high level of specialization in nuts, citrus fruits, sugar, cyanides, andfertilizers, where a high level of specialization is observed.

12. Both Armenia and Georgia are considered open economies in regard of external trade, but atthe same time, the transportation costs are extremely high. The transportation costs in Armeniaare more than twice higher than the world average, which is explained by the fact that Armeniais a landlocked country. The high ratio of transportation services to external trade turnover inGeorgia is mainly due to the fact that Georgia is a transit country for Armenia and Azerbaijan,and transportation services currently are the largest item of Georgian exports. Thus, the highturnover of transport services indicates the high level of transportation costs for Armenia, whilston the other hand it is a source of revenues for Georgia.

13. The analysis of trade in services between the observed two countries shows that Georgia high-ly benefits from its favourable geographical location, as well as from the fact that Armenia is alandlocked country. High transportation costs for Armenian exporters and importers are signifi-cant source of revenues for the Georgian economy. Besides, high prices of domestic tourismservices and low prices of passenger transportation to Georgia is an incentive for Armenia touse Georgian tourism services.

14. The two countries are weakly linked with each other in terms of foreign direct investment,although the flows from Armenia to Georgia are increasing. This means that Armenia againplays the role of an active partner. The high growth of investment inflows into Georgia duringrecent years can be explained by the construction of the BTC pipeline. The growth of FDIinflows into the Georgian economy shows that the investment climate has improved during therecent years.

15. Increased living standards in Georgia will lead to a decrease in the imports from Armenia, sinceGeorgia will substitute the Armenian imports by similar products - with higher quality - importedfrom the EU and other countries.

16. One percent increase in unit prices of exportable goods has a very minor impact on the exports:it will decrease only by approximately 0.09%. In other words, the price elasticity of Armenianexports to Georgia is very inelastic, because of the high level of concentration of Armenianexports to Georgia. Nevertheless, it can be assumed that the price elasticity of exports willgrow as Georgia starts diversifying its imports, finding other sources of substitutes.

17. A one percent change in consumer prices (inflation) in Georgia brings to 1.42% increase inexports of goods from Armenia. This is completely explained by the differences in the monetarypolicies pursued in Armenia and Georgia.

18. The estimation results show that ceteris paribus one percent increase in Georgian householdexpenditures in USD terms will result in a decrease in imported goods from Armenia by 1.1%.

19. Rather passive economic development in the bordering regions of Armenia and Georgia isexplained by the low development level of bordering regions. The intensification of economic


relations is, therefore, rather low since there is no developed region able to promote cross-bor-der economic development and intensification of trade and investment relations in the border-ing regions of the two countries.

20. The industrial production, construction and services volume data comparison as well as thecomparison of data on wages show that Samtskhe-Javakheti is less developed region between5 observed regions. This could be the decisive reason for the growth of construction in the lastyears and the large development projects which shall take place in this region (for example thefunds from Millennium Challenge Corporation as well as EU TACIS projects funds). Dataanalysing show that the less developed region from the Armenian side is Shirak. Taking intoaccount that Shirak and Samtskhe-Javakheti are neighbouring regions, the investments inthese two regions will be very effective to initiate active cooperation and future development.

21. The observation of agricultural data in the bordering regions and definition of some compara-tive advantages of the separate regions show that the cooperation between Georgian andArmenian bordering regions can be the following: cereals and animal husbandry products fromthe Georgian side (mostly from Samtskhe-Javakheti) and potato and vegetables (mainly fromShirak) from Armenian side (as well as fruits from Tavush).

22. The volumes of construction are comparably higher in the Armenian bordering regions (espe-cially in Lori region). During the preceding two years, the volume of construction in Samtskhe-Javaketi region of Georgia is growing faster than in the neighbouring Kvemo Kartli region

23. It is projected that the conclusion of separate FTAs with EU-Armenia and EU-Georgia will inten-sify the economic relations between Armenia and the EU as well as Georgia and the EU, butwill have a very low impact on the development of Armenia-Georgia economic relations.Conclusion of an EU and Armenia-Georgia FTA will promote joint production of Armenian andGeorgian exports to the EU. Moreover, it is important to include provisions on ‘cumulation of ori-gin’ between Armenia and Georgia.

Summarizing the above mentioned conclusions, it can be stated that the creation of a singleeconomic area between the two countries will reduce the possibility of application of trade restric-tions on Armenia and Georgia by other more developed countries, will create wider possibilities fordevelopment of trade relations with the EU-27, will reduce trade related transaction costs (certifica-tion, accreditation, conformity assessment, etc.), will promote internal investments in the area, willattract foreign investments, and will significantly contribute to the overall development of Georgiaand Armenia.

In order to enhance the economic relations in the fields of trade and investment and to strength-en their cooperation in view of liberalizing trade and investment between the countries, as well astaking into consideration that both countries have a liberal external trade policy and are taking stepstowards EU integration, it is necessary to undertake several measures which can be divided main-ly into two separate groups:1) short-term actions, and 2) long-term actions.

In a SHORT-TERM period it is recommended to develop the existing rules which can have animmediate influence on the economic cooperation between the countries.

1. The Free Trade Agreement between Armenia-Georgia, which entered into force in 1995,must be mutually reinforced by the participating parties so as to provide greater opportuni-ties in the goods and services sectors to a wide range of Armenian and Georgianexporters, and to further strengthen trade and investment links between the countries.Actions such as reduction of railway tariffs (up to 50%) between the countries, mutual elim-ination of road taxes shall be undertaken.

2. Countries should take measures for a maximum simplification and unification of customsformalities, in particular, by introducing single forms of customs and goods accompanyingdocumentation, being guided by current international agreements and arrangements. Theyshould notify each other of the operating tariffs and all their exceptions.

3. To implement the agreed policy on export control towards third countries, Armenia andGeorgia must hold regular consultations and take mutually agreed measures for establish-ment of an effective export control system.


4. The observation of agricultural data in the bordering regions and definition of some com-parative advantages of the separate regions show that the cooperation between Georgianand Armenian bordering regions can be as follows: cereals and animal husbandry prod-ucts from the Georgian side, and potato and vegetables (as well as fruits from Tavush) fromthe Armenian side.

5. Developing services (tourism, trade, transportation, etc.) from the Georgian side can beone of the main fields of cooperation with the Armenian regions. The labour from mostlyurban areas of Shirak and Lori can be useful during infrastructural constructions in thisfield. In addition to this, the Armenian regions, especially Shirak, have a potential of devel-oping manufacturing activities due to their large share of urban population.

6. Since the possible FTAs concluded with the European Union by Armenia and Georgia willnot lead to a significant increase in the economic relations between the latter two, theemphasis should be made on other components envisaged by the ENP Action Plans.Implementation of the Action Plans in compliance with the EU legislation will allow Armeniaand Georgia to have harmonised rules in various fields of economic activity, which willhighly contribute to the improvement and intensification of economic relations betweenthese two countries.

7. It is recommended for Armenia to sign a Free Trade Agreement with the EU, including pro-visions that allow using the trade preferences provided by the EU with unlimited use byArmenia of inputs originating in Georgia (cumulation of origin principle). This provisionshould be also included in the Georgia-EU FTA.

These steps are very important not only for the development of economic relations between thecountries but also because they may serve as a base for a more effective and closer cooperationbetween the countries in the future.

Taking into account the status of the existing economic relations as well as the opportunities fora more effective future economic cooperation and development, it is recommended from the strate-gic point of view (to reach the most effective cooperation between the countries in a LONG-TERMperiod).

1. To sign a new free trade agreement between Armenia and Georgia which defines the follow-ing steps and appropriate actions to be implemented for the creation of a common market withoutfrontiers.STEP 1. Free trade of goods

• To eliminate all customs duties and other charges on goods traded between the countries,including all indirect taxes; to replace current principle of VAT collection at the internal fron-tier with the VAT collection in the country of destination principle.

• In order to enhance market access between, and economic activity in the countries, to signan agreement on mutual recognition of the results of conformity assessment procedures.

• In order to ensure free movement of goods, to establish a Joint Committee on customsissues (in accordance with the EU practice), to establish a consultative procedure in orderto ensure legislative harmonisation foreseen in the fields directly related to customs suchas introduction of common rules of origin and customs valuation rules and procedures ofabolition of custom duties and other charges, and other customs procedures and rules.

STEP 2. Customs Union • With purposes of increasing economic efficiency and establishing closer economic rela-

tions between the countries, to adopt a program of establishment of a Customs Unionbetween the countries aimed at the introduction of a free trade area with common customtariffs by setting up common external trade policy with the possibility of further introductionof common competition policy. In order to eliminate non tariff barriers to trade, the harmo-nization of the standards, technical regulations and conformity assessment procedures ishighly recommended.

STEP 3. Common Market (Caucasian Common Market)• To attain gains in economic efficiency with higher mobility of labour and capital, including


free movement of goods and services that will result in a more efficient allocation ofresources (including by regional aspects), it is recommended to take steps in creation of acommon market that will remove all barriers to the mobility of all kind of resources andeliminate non-tariff barriers to trade.

The economic integration between Armenia and Georgia along with EU integration relatedadvantages will result to the following important advantages:

(a) An established larger common market will attract new foreign investments to the economy,intensify cooperation among economic operators, which will result in an improvement ofcompetitiveness of our economies in external markets.

(b) Due to integrated energy, telecommunication, transport infrastructure systems, the econo-my of scale will increase the effectiveness of the economies.

(c) The advantage of being a crossroad area. Armenia will have an easier access to theGeorgian seaports. Georgia will have an access to Iran and Russia. At the same time, itwill eliminate the reason of imposed restrictions and barriers to trade between the coun-tries in the region (Russia-Georgia, Turkey-Armenia).

2. Different aspects of economic policy in all these stages of economic integration between thecountries should be harmonised with the EU requirements and approaches.

3. All agreements signed during the economic integration stages between the countries should beopen for other neighbouring countries to join.

4. After the completion of the Caucasian Common Market, the EU-Armenia and EU-Georgia FTAsshould be replaced with a single FTA between the EU, on one side, and Armenia and Georgia,on the other side.


AAnnnneexx 11

Table A1. Types of goods exported during each of the years 2003-2006

id Code Name1 406 Cheese and curd2 407 Birds’ eggs, in shell, fresh3 901 Coffee; coffee husks and skins; coffee substitutes4 1704 Sugar confectionery, not containing cocoa5 1806 Chocolate and other food preparations containing cocoa6 1905 Bread, pastry, cakes and the like7 2203 Beer made from malt8 2501 Salt and pure sodium chloride, sea water9 2508 Other clays, andalusite, kyanite and sillimanite,mullite; chamotte or dinas

earths10 2523 Portland cement and other cements11 2815 Sodium hydroxide; potassium hydroxide; peroxides of sodium or potassium12 3004 Medicaments put up in measured doses 13 3208 Paints and varnishes dispersed or dissolved in a non-aqueous medium14 3209 Paints and varnishes dispersed or dissolved in an aqueous medium15 3214 Non-refractory surfacing preparations for walls, floors, ceilings or the like16 3402 Washing and cleaning preparations17 3405 Polishes and creams, for footwear, furniture, floors, coachwork, glass or

metal18 3808 anti-sprouting products and plant-growth regulators, disinfectants and

similar 19 3809 Finishing agents, used in the textile, paper, leather or like industries20 3824 Prepared binders for foundry moulds or cores; chemical products and

preparations21 3905 Polymers of vinyl acetate or of other vinyl esters, in primary forms22 3923 Articles for the conveyance or packing of goods; stoppers and lids of

plastics23 4901 Printed books, brochures, leaflets and similar printed matter24 6305 Sacks and bags, of a kind used for the packing of goods25 7010 Carboys, bottles, flasks and other closures, of glass.26 7607 Aluminium foil of a thickness not exceeding 0,2 mm27 8413 Pumps for liquids, liquid elevators28 8422 Dish washing machines; and similar machinery29 8427 Fork-lift trucks; other works trucks fitted with lifting or handling equipment30 8428 Other lifting, handling, loading or unloading machinery31 8429 Self-propelled bulldozers, graders, levellers, scrapers, tamping machines32 8474 Machinery for sorting or kneading earth, or other mineral substances, in

solid form33 8535 Electrical apparatus for switching electrical circuits for a woltage

exceeding 1000 34 8539 Electric filament or discharge lamps, arc-lamps35 8544 Insulated wire, cable and other insulated electric conductors36 8701 Tractors37 8702 Motor vehicles for the transport of ten or more persons38 8703 Motor cars39 8704 Motor vehicles for the transport of goods40 8708 Parts and accessories of the motor vehicles41 8716 Trailers; other vehicles, not mechanically propelled; parts thereof42 9018 Instruments and appliances used in medicine43 9401 Seats, whether or not convertible into beds, and parts thereof44 9403 Other furniture and parts thereof45 9603 Brushes, hand-operated mechanical floor sweepers, brooms


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id Code Name1 604 Foliage, branches and other parts of plants, for ornamental purposes2 802 Other nuts, fresh or dried3 805 Citrus fruit, fresh or dried4 808 Apples, pears and quinces, fresh5 1003 Barley6 1005 Maize7 1206 Sunflower seeds8 2208 Undenatured ethyl alcohol, spirits, liqueurs and other spirituous beverages9 2302 Bran, sharps and other residues, derived from the working of cereals10 2814 Ammonia, anhydrous or in aqueous solution11 2837 Cyanides, cyanide oxides and complex cyanides12 3004 Medicaments put up in measured doses 13 3102 Mineral or chemical fertilizers, nitrogenous14 3917 Tubes, pipes and hoses, and fittings therefor, of plastics15 3923 Articles for the conveyance or packing of goods; stoppers and lids of

plastics16 4403 Wood in the rough, whether or not stripped of bark or sapwood17 4407 Wood sawn or chipped lengthwise, sliced or peeled, sanded or

finger-jointed18 4818 Toilet paper, handkerchiefs, cleansing tissues and similar paper19 6203 Men’s or boys’ suits, ensembles, trousers, and shorts20 6406 Parts of footwear, gaiters, leggings and similar articles, and parts thereof21 7326 Other articles of iron or steel22 8309 Stoppers, caps and lids and other packing accessories, of base metal23 8607 Parts of railway or tramway locomotives or rolling-stock24 8609 Containers25 9403 Other furniture and parts thereof

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id Code Name1 3004 Medicaments put up in measured doses 2 3923 Articles for the conveyance or packing of goods; stoppers and lids of

plastics3 9403 Other furniture and parts thereof

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Model estimated:

Estimated results

AAnnnneexx 22

Source: Calculations based on figures from NSS Armenia


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