CBS Weekly Review: The impact of escalating Georgian-Russian tensions

In June, we were prompted to address the issue of deteriorating Georgian-Russian relations by the announcement on 30 May that Russia was sending several hundred "railway troops" to Abkhazia, the latest in what had been a series of provocative moves on both sides. At the time I argued that the situation in Abkhazia was less dangerous than it might appear, and that the risk of a shooting war there was extremely low.

That view remains unchanged. Yet it does not take a full-fledged war to hurt market sentiment. There are good grounds for supposing that the violent incidents from Abkhazia and now also South Ossetia have started to have a significant negative effect on investor sentiment about Georgia. It is true that there is only one way to measure this – through the share price of Georgia’s only foreign-listed company, Bank of Georgia. But in our view Bank of Georgia is indeed is a reasonable proxy for investor sentiment about the country more generally.

Part of the issue is certainly that the negative incidents in question have become more serious. Since 18 June there have been four small bombings in Abkhazia, at least one and perhaps three of which led to loss of life, as well as an overnight exchange of shelling and gunfire in South Ossetia between Georgian and Ossetian security forces, which resulted in two deaths.

Bank of Georgia vs comparables

It is difficult to identify suitable comparables for Bank of Georgia, and certainly impossible to attribute share price movements to specific incidents. However Bank of Georgia’s underperformance since the start of June relative to five other banks – two Kazakh, two Russian, and one Ukrainian – does require some explanation given the relative health of the Georgian economy and the absence of any particular negative news from Bank of Georgia.

Chart 1: Bank of Georgia recent share price vs. other FSU banks

Our assumption is that Bank of Georgia’s recent underperformance is indeed being caused by negative vibrations from Abkhazia and South Ossetia. This would be rational, strictly speaking, only if the recent bombings were causing investors to believe that the chances of a return to full-fledged conflict in one or both breakaway republics were increasing. (Small explosions in Abkhazia do not have any impact on Bank of Georgia’s business; a war with Russian-backed secessionists most certainly would.)

This leads to a mixed conclusion. On the one hand, we continue to believe that war in Abkhazia or South Ossetia is exceedingly unlikely, and despite the noise, less likely than it was a year or two ago. War would serve the interests of none of the relevant parties, not least the United States and Europe, who would have considerable influence over Georgian actions in a time of crisis. At the same time, one implication of this view is that the only plausible path to war would be a combination of accidents and bad luck leading to a negative spiral of action and reaction. And the recent uptick in violence does make such a scenario marginally more likely – but still very remote, particularly given the uptick in international concern about the situation.

Summer won't unfreeze these conflicts

One result of the recent events has been to encourage external players to focus more time and effort on the situation, particularly with regard to Abkhazia. The German Foreign Ministry has drawn up a three-stage peace plan, and US Secretary of State Condoleezza Rice made clear during her recent visit to Tbilisi that the Bush Administration will push hard for a settlement during its waning months. Meanwhile both the Russian and Georgian sides have put forward proposals which – while very far apart on many key issues – at least seem to have been made in good faith. A comprehensive peace deal on Abkhazia is not in prospect, but it is the process that matters more than the end point. A return to the negotiation table with higher-level involvement from the West would help calm the situation on the ground and break the cycle of negative news flow.

Despite recent events, Abkhazia and South Ossetia are fundamentally similar to many other frozen conflicts around the world. Both regions were the site of bloody fighting that has not been forgotten, and there are high emotions and grievances on all sides. These conflicts will always generate aggressive rhetoric; they will become intertwined with geopolitical issues such as Georgia’s potential NATO accession; and from time to time they will generate active flare-ups of the sort that we have seen recently.

But with the West engaged, and playing the important role of reining in the more martial instincts of the Georgian government, and with Russia increasingly focused on the potential risks and opportunities represented by Abkhazia in connection with the 2014 Olympics in Sochi, the chances of these conflicts becoming unfrozen are tiny. Their impact on Georgian risk and valuations of Georgian assets, including Bank of Georgia, will rarely be as large as it is at present.

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Best regards,
Laurent Ruseckas
Director, Eurasia Research
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