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Q1 2015 - Mitigation Of Regional Tensions Key To Stability

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  • Q1 2015 - Mitigation Of Regional Tensions Key To Stability

    Q1 2015 - MITIGATION OF REGIONAL TENSIONS KEY TO STABILITY

    Business Monitor International; Fitch Group Co.

    Caucasus Business Forecast Report
    October 30, 2014 Thursday

    BMI View: Armenia will continue to have difficult relations with
    neighbours Turkey and Azerbaijan through the medium term, as a result
    of sensitive historical grievances and strong domestic pressure groups
    on both sides. Nagorno-Karabakh will remain a particular potential
    flashpoint given the high profile of the region and ongoing talks,
    which are set to test commitment to peace in both Yerevan and Baku.

    The heavy troop presence on both sides of the border will remain a
    key risk. That said, the willingness of regional heavyweights Russia
    and Turkey to support the ongoing peace process means that a 'hot war'
    is not inevitable.

    Armenia is a small, landlocked country, mainly surrounded by
    hostile or unstable neighbours, which will weigh heavily on the
    country's risk profile through the medium term. That said, we hold
    a relatively sanguine outlook on Armenia's future, with a gradual
    mitigation of regional tensions, strong Russian support and the
    potential for reasonable economic growth set to support increased
    political stability.

    Challenges And Threats To Stability

    Nagorno-Karabakh: Armenia's relations with Azerbaijan will remain by
    far the single biggest threat to political stability until a resolution
    on Nagorno-Karabakh is found. Exchanges of small arms fire between
    the countries' armed forces stationed along the border are common;
    and an outbreak of war, although far from inevitable, cannot be ruled
    out. The situation is exacerbated by the provocative rhetoric often
    employed by both sides in relation to the issue.

    All Eyes On Nagorno-Karabakh Europe - Map Of Caucasus Region

    Relations With Turkey: Armenia has had no official diplomatic relations
    with Turkey since 1993, when its war with Azerbaijan prompted Ankara to
    close the border in solidarity with Baku. Although progress has been
    made, including the signing of two protocols on the re-establishment
    and development of diplomatic relations in October 2009 (yet to
    be ratified), the issue of relations with Turkey remains a hugely
    sensitive topic in domestic Armenian politics. This is a result of
    the early 20th century mass killings of ethnic Armenians by Ottoman
    forces, which Armenia refers to as genocide.

    Growing Domestic Opposition: Widespread perceptions of fraud during
    the February 2008 presidential elections led to mass protests and a
    violent crackdown by the authorities. While tensions have subsided,
    the subsequent period has seen the growth of a stronger and more active
    opposition movement both within parliament and among civil society
    and other groups. The presidential election in February 2013 has
    generally been regarded as peaceful and received considerable praise
    from international observers. However, although this has the potential
    for a positive outcome in the long run, the still closed nature of
    Armenian politics means that opposition groups have little outlet for
    their frustration at present, which poses risks to political stability.

    Wealth Disparity: Aside from perceptions of fraud in the political
    system, much of the opposition is driven by frustration at the large
    wealth disparity in society, which is considered by many to be among
    the most pronounced in the region. According to the International
    Crisis Group, more than 50% of Armenians live below the poverty line,
    which creates the potential for growing resentment among disadvantaged
    groups to spill over into outright protest. Poverty is most widespread
    and most extreme in rural areas, where as many as one-quarter of
    households are supported by family members working abroad, mainly in
    Russia. The over-dependence on remittance inflows was highlighted
    particularly starkly in 2009 as a result of the downturn in the
    Russian economy, which forced many migrant workers to return home,
    increasing the burden on public services.

    Corruption: The perception of public sector graft has been a major
    factor driving resentment against the regime in the past two years.

    Armenia's Soviet legacy means administrative practices are inefficient,
    highly bureaucratic and open to large-scale abuse. The public sector
    functions particularly badly at a local level in rural areas, driving
    widespread distrust among the population.

    Russian Focus: The decision by the Armenian government to join the
    Russia-Belarus-Kazakhstan customs union may improve security prospects
    in the medium term, with Russian troops set to remain on Armenian
    soil for the foreseeable future. However without a strong European
    Union policy anchor we may see the drive for further democratisation
    and economic development slow in the coming years.

    Political Risk Ratings

    Our long-term political risk rating for Armenia is 59.6 out of 100,
    placing it 17th out of 31 countries in emerging Europe. That said,
    it ranks higher than neighbours Russia (57.0), Azerbaijan (49.0)
    and Georgia (46.8).

    Armenia is strongest on our 'characteristics of society' component,
    where it scores 77.5 out of 100, reflecting its highly homogeneous
    society and relative lack of religious or ethnic tensions. It also
    scores well (60.0 out of 100) for 'policy continuity', given its broad
    historical policy stability. Weaker is the 'scope of state' component,
    where it scores 55.0 out of 100. This reflects low government spending
    on infrastructure and development (due in part to poor tax collection)
    and the extent to which policy is influenced by neighbouring states,
    particularly Turkey and Azerbaijan.

    Scenarios For Political Change

    Until 2008, the Armenian population had appeared willing to accept
    regular flawed elections and a lack of democratic accountability, with
    disengagement and apathy dominant. However, following the February
    2008 presidential elections, something of an awakening took place as
    thousands of supporters of Levon Ter-Petrossian, the main opposition
    candidate, took to the streets to protest against the result. This
    culminated in violent clashes with the police, resulting in hundreds
    of arrests and more than 100 prosecutions of opposition supporters.

    Although there has been no repeat of protests on this scale, the
    Armenian population has nevertheless shown itself to be increasingly
    engaged in politics in the past four years, demonstrated by a
    pronounced increase in the number and profile of protest groups. This
    has been met by restrictions on political groups and further efforts
    to censor the media, although the 2013 presidential elections were
    praised by international observers.

    As a result of this and ongoing regional tensions, Armenia faces
    a daunting set of external and domestic political challenges over
    the next decade. A strengthening and united opposition at home, and
    continuing tensions with powerful and aggressive neighbours (Turkey and
    Azerbaijan respectively), will provide a stern test of the country's
    institutions and the leader's abilities. Despite the clear risks of
    further instability, however, we have a relatively sanguine outlook
    on political stability and believe that significant potential exists
    for democratic advances at home and a mitigation of tensions abroad.

    Best Case Scenario - Big Strides Forward: The best case scenario
    for Armenia over the next 10 years, and one that we feel is eminently
    possible, is for a significant mitigation of domestic and international
    political risk factors. At home, this has been backed up by the
    successful presidential election in February 2013 that was free of
    major irregularities and allowed a smooth transition of power.

    Under this scenario, the domestic opposition would continue to
    channel its views through parliament and a broader development of
    the legal and regulatory framework would take place. This would mean
    increased meritocracy and efficiency, boosting public trust in state
    institutions and therefore mitigating the risks of further outbreaks
    of public protest.

    Internationally, this would require a major breakthrough on
    Nagorno-Karabakh, which will be extremely difficult given the lack of
    common ground on many aspects of the dispute between Yerevan and Baku.

    A land corridor between Armenia and Nagorno-Karabakh and the terms of
    a referendum for the enclave's inhabitants will remain the biggest
    sticking points. Any significant progress on Nagorno-Karabakh would
    increase the potential for the ratification of two protocols on the
    re-establishment and development of diplomatic relations with Turkey,
    which have stalled since October 2009.

    Lachin A Solution Europe - Map Of Nagorno-Karabakh & Surrounding Area

    Should these scenarios play out, we would expect a vast improvement
    in Armenia's risk profile, increasing investor confidence in
    the country and boosting foreign direct investment inflows. More
    importantly, a mitigation of regional tensions would allow vast
    new trade opportunities, particularly with Turkey, paving the way
    for a significantly higher growth trajectory. The upshot of all of
    this would be rising per capita incomes across the board, boosting
    living standards.

    Intermediate Scenario - 'Same Old': Our intermediate scenario,
    and one that we also feel has a strong chance of playing out, is a
    continuation of the status quo. Certainly, with progress on relations
    with Azerbaijan and Turkey threatening to aggravate domestic and
    regional tensions, we expect governments on all sides to remain
    extremely cautious. Domestically, the government may also decide to
    resist calls for political and legal reform.

    Should this scenario play out, we would expect it to limit Armenia's
    growth potential through the medium term. Ongoing tensions with
    Azerbaijan over Nagorno-Karabakh, as well as continued deadlock
    with Turkey, would keep investor risk aversion elevated and severely
    limit Armenia's export growth potential. This, in combination with
    frustration over the lack of reform at home, would likely increase
    domestic political tensions, with further public protests possible.

    Worst Case Scenario - Armed Conflict: We refuse to rule out the
    possibility of further armed conflict between Armenia and Azerbaijan.

    Large troop presences on both sides of the border, heightened
    sensitivity and provocative statements from the two parties have
    served to keep tensions high, which have often resulted in exchanges
    of small arms fire in the past. We highlight the potential for this to
    escalate into a bigger conflict, particularly given Azerbaijani threats
    to use all means to win back Nagorno-Karabakh if diplomatic efforts
    fail. However, this remains an outside bet for two main reasons. First,
    the Armenian army remains fairly well equipped and trained, thanks to
    Russian support, which is likely to dissuade Azerbaijan from launching
    an attack. Second, regional powers Russia and Turkey have gradually
    stepped up their involvement in the conflict in the past two years
    and we expect the leverage that Moscow and Turkey have over Armenia
    and Azerbaijan respectively to prevent an outbreak of full-scale war.




    From: A. Papazian
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