Plan B: Georgian Companies Switching to Alternative Strategy after Russia Suspends Free Trade Agreement

Plan B: Georgian Companies Switching to Alternative Strategy after Russia Suspends Free Trade Agreement

Plan B: Georgian Companies Switching to Alternative Strategy after Russia Suspends Free Trade Agreement

The FINANCIAL -- Georgia is preparing for the worst-case scenario as a result of a suspension of the free trade agreement with Russia. Wine and water producers are now facing loss of 9% of their export. Importers also need to find a replacement for Russia which makes up 5% of total import.

Russia has suspended the Free Trade Agreement with Georgia which was established in 1994. The decision was linked to the recent signing of the AA and DCFTA by Georgia. Zurab Abashidze, former speaker of President Shevardnadze, recently appointed as Special Representative of Georgia to Russia for his reportedly good relations in Russian political circles, told The FINANCIAL that the news of the trade limitation did not came as a surprise. Meanwhile the issue was never discussed with him, not even during his meeting with Grigory Karasin, Deputy Foreign Minister of Russia, he said.

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The volume of export to Russia during the first 6 months of 2014 was USD 134 million. This is around 0.8% of our GDP.

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It is still unclear how the tax fee will change the rates for Georgian exporters. Meanwhile, the new Georgian Government is sufficiently scared by the recent war with Russia and current events in Ukraine, that it is reluctant to announce countermeasures.

“The Georgian Government will make a decision after receiving the official information regarding the suspension of the FTA from Russia,” David Ghonghadze, spokesperson at the Ministry of Economy, told The FINANCIAL.

The improvement of relations with Russia was one of the main pledges of the new government headed by billionaire Bidzina Ivanishvili. But such expectations were not fully realized, as Russia continued its occupation of Georgian territory and only partly lifted economic sanctions. In July 2014 the new government tightened its relations with the EU and ratified the Association Agreement.

Since then the rhetoric of the Government has changed significantly. Russia’s decision to suspend free trade with Georgia has strengthened its pro-West strategy.

“The taxation fee on Russian products will bring an additional GEL 15-20 million to the budget,” Nodar Khaduri, Minister of Finance of Georgia, stated on the second day after the announced suspension of free trade with Russia.

For many Georgian exporters Russia makes up 30% of their export. Entrepreneurs with whom The FINANCIAL spoke last week, say that Russia’s move will not affect their business as much as it did in 2006.

“Even if the Russian market becomes closed to us again, the share of its allocated products will not be left unsold,” Giorgi Margvelashvili, President at JSC Tbilvino, told The FINANCIAL.

“First of all we need to get familiar with the rules of the new conditions. Accordingly, it is difficult to say by what percent the cost of our products will increase,” said Zurab Margvelashvili, Tbilvino, Director General at Tbilvino.

"The recent steps by Georgia towards the EU and NATO made it clear that Russia would respond this way,” said Margvelashvili.

Businessmen think that after the suspension of the free trade agreement, Russia will restrict import.

“But today’s reality differs from the situation in 2006,” Margvelashvili said.

The Russian Federation is a member of the WTO today. So, he is optimistic that the embargo will not be repeated. “However, nothing can be excluded,” he added.

“Russia is an important market, we hugely respect it. However, becoming dependent on it would be wrong. Currently, over 30% of our exported products are made up the Russian market,” said Margvelashvili.

Georgia and Russia signed an historic trade deal in 2011 after 18 years of negotiations, which allowed Russia to join the World Trade Organization (WTO). Georgia has repeatedly blocked Russia’s WTO entry since the two countries fought a short war in 2008.

“The Russian embargo in 2006 was a good lesson for Georgian companies. While before 2006 Tbilvino was exported to 13 countries, currently this number is 30,” Margvelashvili said.

The suspension of the FTA by Russia was expected by Healthy Water (Tskali Margebeli), the leading Georgian water producer. The Russian market occupies just 3% of the export portfolio of the company.

“This decision will hamper the export growth trend in Russia. However, we are still waiting for the customs fees interest rate. The situation will become clearer after that,” said Gia Gogoladze, General Director of Healthy Water (Tskali Margebeli).

Healthy Water cannot tell by what exact percent their export to Russia will decrease as the final customs fee is as yet unknown.

“We remain loyal to our strategy of diversification of the export market. As the share of the Russian market is small there will be no need to search for alternative just for replacing this exact market,” said Gogoladze.

In his words, the company is currently discussing various steps for development on the Russian market, and the possibility of a total block is not excluded.

Gogoladze underlined the main features that attract Georgian exporters to Russia. “The Russian market is an important one, first of all because of the high level of awareness and popularity of Georgian brands there. Therefore getting established on this market is easier. The size of the Georgian Diaspora is also an important factor,” he said.

“Georgian companies learned a lot during this period. At present, experienced companies no longer consider this market to be their major target. It is probably seen more as a market of additional opportunities. Companies there act with special care and risk management,” Gogoladze told The FINANCIAL.

“Suspension of the FTA may turn out to be good if the products imported from Russia are also to be taxed. The cost of Russian products will consequently increase. That means that they would then find it difficult to compete with local production,” said Vano Goglidze, Director General at Kula.

Kula started exporting its products to the Russian market from November 2013. The Russian market makes up 15-20% of our export basket.

“In general, the demand of our products on the Russian market far exceeds the supply. However, we are not increasing the market share in order to avoid a dependence on it,” said Goglidze.

"The Russian market is not stable. It is difficult to make any predictions. Accordingly, we cannot exclude the possible closure of the Russian market tomorrow. Today they have decided to interrupt the free trade agreement. Tomorrow they might decide to allow the return of our products. It is a very complicated market, as far as it is linked to political decisions,” he added.

“It is easy to enter the Russian market and companies that are focused on immediate profit and do not consider long term perspectives aspire to it. I think they should have learned from previous mistakes though,” Goglidze explained.

IDS Borjomi, which was sold to Russian Alfa-Group in 2012, declined to comment. Borjomi received permission to return to the Russian market in 2013. The majority of shares of Borjomi are owned by Alfa Group which reported total assets of USD 64,753,000 in 2011. The minority shares are owned by the family of the late Georgian business tycoon Badri Patarkatsishvili, who died in England in 2008.

“Export to Russia during the first 6 months of 2014 was USD 134 million. It was around 0.8% of our GDP. Even if Russia imposes an embargo for the remaining five months of the year Georgia will only have 0.5% less economic growth. However, currently an embargo is not being discussed, so far only tariff barriers will be implemented. The impact will accordingly be less. As there is no embargo on imported tariff barriers, the impact will be less. At the same time, Russia is a WTO member and will not be able to set higher discriminative rates, any more than it has with other countries,” said Besik Namchavadze, Senior Researcher at PMCG.

Like Namchavadze, Nutsa Tokhadze, Economic Analyst at Society and Banks, does not think that the suspended FTA by Russia will have fatal results for the Georgian economy. “Today, the establishment of trade restrictions, or even an embargo (which legally is not expected) by Russia will not have the same negative effect on the Georgian economy as it had in 2006. Trade restrictions by Russia are no longer a surprise as they were previously,” said Tokhadze.

“Since 2008, the unstable political situation with Russia encourages entrepreneurs to find alternative ways to sell their products (the same applies to imported products as well). As a result, the suspension of the free trade agreement by Russia, or even an embargo, will have a negative impact on our economy, but not on such a large scale as it was in 2006, when the Georgian market was heavily dependent on it,” said Tokhadze.

“The FTA suspension will hit wine and mineral water exports. Many Georgian products sold in Russia are high-end or luxury products, bought by the Russian middle and upper classes. Therefore, moderate price increases won’t be fatal for Georgian exports of these goods,” said Professor Florian Biermann from the International School of Economics at Tbilisi State University (ISET).

“Georgia may enter the European market, but neither Georgian wine nor Georgian mineral water, nor anything else that Georgia produces, are well-known products in Europe. Yet in the countries of the former Soviet Union, foremost in Russia, Georgian products enjoy an excellent reputation. Therefore, even if there are no huge losses in the short run, it is highly regrettable that the Georgian position in the Russian market gets weaker,” said Biermann, ISET.

According to Namchavadze, Georgian businesses are better aware of the business environment and demands of post Soviet countries. That is why they remain dependent on mostly post Soviet states. “They have better contacts; better knowledge of Russian than English is also an important factor. Regulations are lower in post Soviet countries. For example there are regulations on food safety. Meanwhile avoiding these regulations is easier due to the high level of corruption. Customers in these states are better aware of Georgian products than in the rest of the world,” he explained.

Namchavadze, PMCG, predicts that the import from Russia will be decreased. However, the reduction will not be caused by the interrupted Free Trade Agreement. He said that the existing economic crisis, caused by sanctions in Russia, will contribute to it.

“If the measure of import of Russian products to Georgia will not get reduced in accordance to the downgraded export, the negative trade balance will increase. This will have a negative impact on our economy. At the same time, we will have to look for alternative markets not only for export but also for import. In the event of finding an alternative market for which imported goods with the same quality and lower price will be possible, the reduction of import will be logical. Otherwise the negative trade import of Georgia will deteriorate or be left at the same level. The situation is the same in terms of export markets. The crucial factor is finding an alternative market for import and export that will improve our trade balance.  Thus, the effects of the suspension of trade with Russia will depend on finding rational export and import partners,” Tokhadze told The FINANCIAL.