Peace in Karabakh will give a high economic dividend, new study shows
30 January 2019

A new study that analyses the economic effect of a full resolution of the Nagorno-Karabakh conflict in multiple dimensions, including public finances, trade, the energy and water sectors, and financial markets was presented to an audience of diplomats, EU officials and journalists during a policy dialogue held at the European Policy Centre in Brussels. The study, entitled "The economic effect of a resolution of the Nagorno-Karabakh conflict on Armenia and Azerbaijan", was prepared by the consultancy firm, Berlin Economics, and financed by the European Union.

During the event, which was co-organised by the EPC and LINKS, the Director of Berlin Economics, Dr Ricardo Giucci, presented the main findings of the report, which was followed by a panel discussion.

You can read and download the Berlin Economics report from their website here

The proceedings kicked off with opening remarks by the EU Special Representative for the South Caucasus, Toivo Klaar who said that the European Union had important core interests in the South Caucasus, which it considered a strategic gateway to Asia and the Middle East. Its multiple layer agenda with the region included security, rule of law, democratic state building, regional co-operation, economic prosperity, energy, environment and sustainable development, and of course the peaceful resolution of conflicts. EUSR Klaar welcomed the report of Berlin Economics and said that despite the fact that it was difficult to delve into the future, it was sometimes useful to do so. He said that the report of Berlin Economics enabled a debate on what a peaceful settlement of the Nagorno Karabakh conflict can lead to, and what were the economic benefits that one could expect from such a peace process.

Presenting the findings of the report, the Director of Berlin Economics Dr Riccardo Giucci, said that his team had looked at the issue from a purely economic perspective, working on the assumption that the conflict had been resolved completely. In that scenario they tested the impact on four economic sectors: fiscal savings, trade, water and energy and investment. The report found that the main economic benefits of peace for Armenia and Azerbaijan would lie in the public finances; the energy and water sectors; and financial markets and investments.

In public finances, both Armenia and Azerbaijan would strongly benefit from large savings on conflict-related fiscal expenditures. Military expenditures could be reduced by 2% of annual GDP in both countries to a level comparable with other countries at peace. In addition, Armenia could save annual expenditures of 0.9% of GDP for supporting the local economy in Nagorno-Karabakh and 0.1% of GDP in interest payments, thus saving 3% of GDP every year. Azerbaijan could eventually save expenditures for supporting displaced people amounting to 0.4% of annual GDP, thus reducing total expenditure by 2.4% of GDP yearly. Such large fiscal savings would enable both countries to sharply reduce budget deficits and at the same time substantially increase spending in socially useful areas such as education or health by eliminating present budgetary pressures.  

Very substantial "benefits of peace" could in the long run also be gained in the domain of the energy and water sectors. An integrated electricity market is a demanding political, technical and economic project, but would allow significantly cheaper generation of power. This would mainly benefit Armenia, deferring the need for investment into expensive new power plants as the country could import electricity during the dry season. The ability to purchase gas from Azerbaijan, which would require rehabilitation or reconstruction of pipelines, would also benefit Armenia, which would have a better bargaining position with competition on the supplier side, while Azerbaijan would gain a new customer and transit route. The joint management of shared water resources, however, would strongly benefit Azerbaijan, where water is scarce. A more efficient joint usage of water resources would lead to more and better quality water arriving in Azerbaijan from the Kura-Aras basin, its main freshwater source. Hence, very substantial gains exist, but as the benefits for both countries lie in different fields (energy for Armenia, water for Azerbaijan), these gains are not easy wins. In order to materialise the gains, trading benefits in the energy sector for benefits in the water sector ("energy for water deal") could be a net gain for all involved parties. 

Capital flows to Armenia and Azerbaijan are constrained at present to a large extent due to elevated country risk as a consequence of the ongoing conflict. The effect of country risk on ratings, risk premiums on bonds, loans and equity, investment and, finally, economic growth is likely to be very strong. Both countries' ratings would probably improve by one notch (Armenia from B+/B1 to Baa3/BB-, Azerbaijan from BB+/Ba2 to BBB-/Ba1). This would lead to noticeable effects e.g. on sovereign Eurobond interest payments where fiscal savings for Armenia would amount to USD 10 m annually, USD 12.5 m for Azerbaijan. Most important, however is the long run effect on investment and economic growth. Increases in the inward FDI stocks due to reduced country risk could significantly and permanently elevate the level of GDP for both countries, by 3.4% to 6.0% of GDP in Armenia and 6.0%-10.6% in Azerbaijan.

In the dimension of trade, benefits of peace exist, but would overall be smaller than might be expected at first. As Armenia and Azerbaijan are both relatively small economies and complementarities in the export and import baskets are not large, bilateral goods trade would be limited at around 1% of total trade for Armenia and less than 1% of Azerbaijan's total trade in the long run. Also, transport routes with other trade partners could not be shortened when borders are opened. Considerable benefits in trade would however materialise for Armenia due to an increase of trade with Turkey. Armenia would annually export USD 123 m to its western neighbour in the medium term, while in the long term the share of Turkey in Armenia's trade would reach a sizeable 13%.

Dr Giucci said that the research shows that a resolution of the Nagorno-Karabakh conflict would yield large economic benefits of peace and would hence be in the economic interest of both countries and their people. Both countries will benefit massively from increased investments. Armenia would in addition very strongly benefit from substantial fiscal savings, also due to reduced needs for expensive investments in power plants. For Azerbaijan, additional budgetary resources can be used to invest in people's skills. The agricultural sector could grow thanks to better access to fresh water, supporting a gradual import substitution in the agro-food sector. In combination, this would contribute to reducing the country's dependency on the oil and gas sector. 

Considering the cumulative, multi-year impact of conflict resolution over a medium to long term perspective, it appears likely that 10 years after conflict resolution, both countries could be on a higher development path: on the one hand, huge annual fiscal savings will have permitted large public investment into the health and education of the populations as well as infrastructure, thus increasing productivity and wages. On the other hand, the reduction in country risk will have unlocked large volumes of investment, with a large impact on the permanent level of GDP. These effects will not only happen at the same time, but will reinforce each other to result in significantly improved standards of living in both countries. The economic benefits of peace hence form a strong argument in favour of finding a permanent solution to the Nagorno-Karabakh conflict Dr Gucci said.

After the presentation, the moderator of the event, Amanda Paul, introduced the three panellists: Azerbaijani independent analyst, Ilgar Gurbanov, Armenian academic Anahit Shirinyan, and LINKS Director, Dennis Sammut who commented on the report.


photo: EUSR Toivo Klaar making opening remarks at a Policy Dialogue on the economic benefits of peace held at the EPC in Bruissels on 29 January 2019 (picture courtesy of EPC)